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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-10890
HORACE MANN EDUCATORS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 37-0911756
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1 Horace Mann Plaza, Springfield, Illinois 62715-0001
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: 217-789-2500
Securities Registered Pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ------------------------
Common Stock, par value $0.001 per share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 1, 2001, was approximately $667 million.
As of March 1, 2001, 40,527,757 shares of Common Stock, par value $0.001
per share, were outstanding, net of 19,341,296 shares of treasury stock.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for the 2001 Annual Meeting of Shareholders, exclusive of
disclosures made pursuant to Regulation S-K, (S) 306 and (S) 402 (i), (k) and
(l), incorporated by reference into Part III of Form 10-K.
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HORACE MANN EDUCATORS CORPORATION
FORM 10-K
YEAR ENDED DECEMBER 31, 2000
INDEX
Item
Number Page
- ------ ----
PART I
1. Business
Forward-looking Information........................................ 1
Overview........................................................... 1
History............................................................ 3
Selected Historical Consolidated Financial Data.................... 4
General............................................................ 6
Corporate Strategy and Marketing................................... 6
Property and Casualty Segment...................................... 10
Annuity Segment.................................................... 20
Life Segment....................................................... 22
Investments........................................................ 24
Cash Flow.......................................................... 26
Competition........................................................ 27
Insurance Financial Ratings........................................ 28
Regulation......................................................... 30
Employees.......................................................... 32
2. Properties........................................................... 33
3. Legal Proceedings.................................................... 33
4. Submission of Matters to a Vote of Security Holders.................. 33
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters................................................ 33
6. Selected Financial Data.............................................. 34
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................. 34
7A. Quantitative and Qualitative Disclosures About Market Risk........... 34
8. Consolidated Financial Statements and Supplementary Data............. 34
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................................ 34
PART III
10. Directors and Executive Officers of the Registrant................... 34
11. Executive Compensation............................................... 35
12. Security Ownership of Certain Beneficial Owners and Management....... 35
13. Certain Relationships and Related Transactions....................... 35
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..... 35
SIGNATURES........................................................... 41
Index to Financial Information....................................... F-1
PART I
ITEM 1. Business
Forward-looking Information
It is important to note that the Company's actual results could differ
materially from those projected in forward-looking statements. Additional
information concerning factors that could cause actual results to differ
materially from those in the forward-looking statements is contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Overview
Horace Mann Educators Corporation (together with its subsidiaries, the
"Company", "Horace Mann" or "HMEC") is an insurance holding company incorporated
in Delaware. Through its subsidiaries, HMEC markets and underwrites personal
lines of property and casualty and life insurance and retirement annuities.
HMEC's principal insurance subsidiaries are Horace Mann Insurance Company
("HMIC"), Teachers Insurance Company ("TIC") and Horace Mann Life Insurance
Company ("HMLIC"), each of which is an Illinois corporation, Allegiance
Insurance Company ("Allegiance"), a California domiciled personal lines property
and casualty insurance company and Horace Mann Lloyds ("HM Lloyds"), domiciled
in Texas.
The Company markets its products primarily to educators and other employees
of public schools and their families. The Company's 1.1 million customers
typically have moderate annual incomes, with many belonging to two-income
households. Their financial planning tends to focus on security, savings and
primary insurance needs. Horace Mann is the largest national multiline insurance
company focused on the niche educator market.
The Company sells and services its products primarily through an exclusive
sales force of full-time agents employed by the Company and trained to sell
multiline products. The Company's agents sell only the Company's products and
supplemental products authorized by the Company. Many of the Company's agents
are former educators who utilize their contacts within, and knowledge of, the
target market. Compensation for sales agents includes an incentive element based
upon the profitability of the business they write.
The Company's insurance premiums written and contract deposits for the year
ended December 31, 2000 were $821.7 million and operating income (net income
before the after tax impact of realized investment gains and losses,
restructuring charges, litigation charges and the provision for prior years'
taxes) was $25.1 million. The Company's total assets were $4.4 billion at
December 31, 2000. The property and casualty segment accounted for 60% of the
Company's insurance premiums written and contract deposits for the year ended
December 31, 2000, while accounting for 35% of operating income for the period.
The annuity and life insurance segments together accounted for 40% of insurance
premiums written and contract deposits for the year ended December 31, 2000 (25%
and 15%, respectively), and provided 128% (77% and 51%, respectively) of
operating income for the period.
1
The primary products of the Company's property and casualty segment are
private passenger automobile and homeowners insurance. In each of the last 10
years, the Company's combined loss and expense ratio for its property and
casualty product lines outperformed the total property and casualty industry
combined loss and expense ratio, as reported by A.M. Best Company ("A.M. Best"),
an independent insurance rating agency. During this period, the Company's
combined loss and expense ratio was better than the total property and casualty
insurance industry combined loss and expense ratio by an average of
approximately 12 percentage points per year. During the same period of time, the
Company's combined loss and expense ratio was better than the personal lines
insurance industry segment combined loss and expense ratio by an average of
approximately 10 percentage points per year.
One of the reasons why the Company's property and casualty lines have
performed better than the industry is the Company's property and casualty
expense ratio, which has been consistently better than the industry ratio since
1983. During the last 10 years, the Company's property and casualty expense
ratio has been better than the property and casualty industry personal lines
average expense ratio as reported by A.M. Best by an average of 4.7 percentage
points per year. The Company's property and casualty expense ratio for the year
ended December 31, 2000 was 20.8%.
The Company is one of the 20 largest participants in the fixed and variable
403(b) tax-qualified annuity market according to a 2000 A.M. Best report.
Approximately 70% of the Company's new annuity contract deposits in 2000 were
for 403(b) tax-qualified annuities; approximately 80% of accumulated annuity
value on deposit is 403(b) tax-qualified. At December 31, 2000, the accumulated
value of all of the Company's annuity contracts (tax and non-tax qualified) was
$2.4 billion, representing 129,000 contracts in force. For the 2000 year, 89% of
the accumulated cash value of the Company's fixed annuity business remained on
deposit and 84% of the Company's variable annuity business remained on deposit.
All annuities issued since 1982 and approximately 78% of all outstanding fixed
annuity accumulated cash values are subject in most cases to substantial early
withdrawal penalties, typically ranging from 5% to 13% of the amount withdrawn.
Withdrawals of outstanding variable annuities are limited to amounts less than
or equal to the then current market value of such annuities, minus withdrawal
penalties as applicable. Generally, a penalty is imposed under the Internal
Revenue Code on amounts withdrawn from tax-qualified annuities prior to age 59
1/2. Total accumulated annuity funds on deposit at December 31, 2000 consisted
of 44% variable annuities and 56% fixed annuities.
The investment portfolio of the Company, including variable annuity assets
under management of $1.0 billion, had an aggregate market value of $3.9 billion
at December 31, 2000. Investments other than variable annuity assets consist
principally of investment grade, publicly traded fixed income securities. At
December 31, 2000, investments in non-investment grade securities represented
5.8% of total investments excluding variable annuity assets. There are no
significant investments in mortgage loans, real estate, foreign securities or
privately placed securities.
2
History
The Company's business was founded in Springfield, Illinois in 1945 by two
Illinois teachers to sell automobile insurance to other teachers within the
State of Illinois. The Company expanded its business to other states and
broadened its product line to include group and individual life insurance in
1949, 403(b) tax-qualified retirement annuities in 1961 and homeowners insurance
in 1965.
In 1968, INA Corporation ("INA") acquired a 25% interest in HMEC, and
completed its acquisition of HMEC in 1975. In 1982, INA and Connecticut General
Corporation merged to form CIGNA. In August 1989 an investor group directed by
Gibbons, Green, van Amerongen, L.P. (subsequently Gibbons, Goodwin, van
Amerongen) ("GGvA") and certain members of the Company's senior management
acquired HMEC from CIGNA. In November 1991, HMEC completed an initial public
offering of its common stock (the "IPO"). The common stock is traded on the New
York Stock Exchange under the symbol "HMN."
Following the 1991 initial public offering, GGvA owned approximately 44% of
the outstanding shares of the common stock. Pursuant to an agreement with GGvA,
in May 1995 HMEC purchased approximately one-half of the shares of its common
stock owned by GGvA and in July 1995 completed a secondary public offering of
most of the remaining shares of its common stock owned by GGvA.
3
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following statement of operations and balance sheet data have been
derived from the consolidated financial statements of the Company. The
consolidated financial statements of the Company for each of the periods in the
five year period ended December 31, 2000 have been audited by KPMG LLP. The
following selected historical consolidated financial data should be read in
conjunction with the consolidated financial statements of HMEC and its
subsidiaries and Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Year Ended December 31,
---------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
(Dollars in millions, except per share data)
Statement of Operations Data:
Insurance premiums written and contract deposits........ $ 821.7 $ 821.2 $ 827.8 $ 771.3 $ 704.8
Insurance premiums and contract charges earned.......... 598.7 595.1 577.8 542.7 502.7
Net investment income................................... 192.4 188.3 191.7 198.9 198.6
Net investment income, after tax........................ 129.4 126.7 128.3 132.6 132.4
Realized investment gains (losses)...................... (9.9) (8.0) 9.9 5.3 2.5
Total revenues.......................................... 781.2 775.4 779.4 746.9 703.8
Amortization of intangible assets(1).................... 8.8 0.2 6.9 10.7 11.2
Interest expense........................................ 10.2 9.7 9.5 9.4 10.5
Income from continuing operations before income taxes... 9.7 93.4 116.8 119.6 100.6
Income from continuing operations(2).................... 20.8 44.5 85.3 87.1 73.8
Discontinued operations(3).............................. - - - (3.5) (9.2)
Net income(2)........................................... 20.8 44.5 85.3 83.6 64.6
Operating income(4)..................................... 25.1 70.7 78.9 83.6 73.1
Ratio of earnings to fixed charges(5)................... 2.0x 10.6x 13.3x 13.7x 10.6x
Per Share Data(6):
Basic:
Operating income(4)................................... $ 0.62 $ 1.71 $ 1.82 $ 1.82 $ 1.56
Realized investment gains (losses), after tax......... (0.16) (0.13) 0.15 0.08 0.03
Restructuring charges, after tax...................... (0.04) - - - -
Litigation charges, after tax......................... (0.12) (0.02) - - -
Provision for prior years' taxes...................... 0.21 (0.48) - - -
Income from continuing operations..................... 0.51 1.08 1.97 1.90 1.57
Discontinued operations(3)............................ - - - (0.08) (0.19)
Net income............................................ 0.51 1.08 1.97 1.82 1.38
Diluted:
Operating income(4)................................... $ 0.61 $ 1.70 $ 1.80 $ 1.80 $ 1.54
Realized investment gains (losses), after tax......... (0.15) (0.13) 0.15 0.07 0.03
Restructuring charges, after tax...................... (0.04) - - - -
Litigation charges, after tax......................... (0.12) (0.02) - - -
Provision for prior years' taxes...................... 0.21 (0.48) - - -
Income from continuing operations..................... 0.51 1.07 1.95 1.87 1.55
Discontinued operations(3)............................ - - - (0.07) (0.19)
Net income............................................ 0.51 1.07 1.95 1.80 1.36
Shares of Common Stock-weighted average:
Basic................................................. 40.8 41.2 43.2 45.8 47.0
Diluted............................................... 41.0 41.7 43.8 46.5 47.6
Shares of Common Stock - ending outstanding............. 40.5 41.0 42.1 44.3 47.3
Cash dividends.......................................... $ 0.42 $ 0.3825 $ 0.3325 $ 0.2825 $ 0.22
Balance Sheet Data, at Year End:
Total investments....................................... $2,912.3 $2,630.2 $2,840.8 $2,769.0 $2,784.3
Total assets............................................ 4,420.6 4,253.8 4,395.5 4,131.9 3,861.0
Total policy liabilities................................ 2,362.3 2,341.3 2,308.0 2,278.6 2,310.0
Short-term debt......................................... 49.0 49.0 50.0 42.0 34.0
Long-term debt.......................................... 99.7 99.7 99.6 99.6 99.6
Total shareholders' equity.............................. 428.0 400.1 496.6 506.0 484.4
Book value per share(7)................................. $ 10.56 $ 9.75 $ 11.80 $ 11.43 $ 10.25
(continued on next page)
4
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA - (continued)
Year Ended December 31,
--------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
(Dollars in millions, except per share data)
Segment Information:
Insurance premiums written and contract deposits
Property and casualty.................................. $ 493.5 $ 495.1 $ 487.8 $ 458.0 $ 427.1
Annuity................................................ 206.4 205.7 223.3 199.2 166.9
Life................................................... 121.8 120.4 116.7 114.1 110.8
Total.............................................. 821.7 821.2 827.8 771.3 704.8
Operating income(4)
Property and casualty.................................. $ 8.9 $ 39.5 $ 53.2 $ 61.4 $ 54.0
Annuity................................................ 19.3 27.3 23.1 19.3 16.3
Life................................................... 12.9 14.6 12.4 12.9 12.1
Corporate and other, including interest expense........ (16.0) (10.7) (9.8) (10.0) (9.3)
Total.............................................. 25.1 70.7 78.9 83.6 73.1
Statutory Operating Data(8):
Property and casualty:
Loss and loss adjustment expense ratio................. 85.2% 76.3% 74.4% 71.7% 74.1%
Expense ratio.......................................... 20.8% 19.8% 19.3% 19.4% 19.4%
Combined loss and expense ratio(9)..................... 106.0% 96.1% 93.6% 91.1% 93.5%
Industry average combined loss
and expense ratio(9)(10)............................. 110.3% 107.8% 105.6% 101.6% 105.8%
Personal lines industry segment average combined
loss and expense ratio(9)(10)........................ 110.0% 104.5% 102.7% 99.8% 104.9%
Annuity accumulated value on deposit..................... $2,366.9 $2,487.3 $2,475.5 $2,314.2 $2,075.5
Life insurance in force.................................. $ 12,637 $ 12,300 $ 11,799 $ 11,188 $ 10,645
Adjusted capital and surplus of insurance subsidiaries
(includes investment reserves)(11)..................... $ 405.8 $ 405.7 $ 379.8 $ 372.3 $ 404.6
- -----------
(1) Amortization of intangible assets is comprised of amortization of goodwill
and amortization of acquired value of insurance in force and is the result
of purchase accounting adjustments related to the 1989 acquisition of the
Company and the 1994 acquisition of Allegiance.
(2) 1999 includes a non-recurring charge of $20.0 million, or $0.48 per share,
to record an additional federal income tax provision representing the
Company's maximum exposure for disputed prior years' taxes (for tax years
1994 through 1997). 2000 includes a non-recurring benefit of $8.7 million,
or $0.21 per share, from resolution of tax years 1994 through 1996.
(3) In December 1996, the Company announced its strategic decision to withdraw
from the group medical insurance business and during 1997 the Company
accelerated the withdrawal. Group medical results net of taxes are reported
separately as discontinued operations and 1997 and 1996 include additional
after tax charges of $3.5 million, or $0.07 per diluted share, and $3.9
million, or $0.08 per diluted share, respectively, for estimated losses
during the phase-out period.
(4) Income from continuing operations before the after tax impact of realized
investment gains and losses, restructuring charges, litigation charges,
provision for prior years' taxes, debt retirement costs and discontinued
operations.
(5) For the purpose of determining the ratio of earnings to fixed charges,
"earnings" consist of income from continuing operations before income taxes
and interest expense (including amortization of debt issuance cost), and
"fixed charges" consist of interest expense (including amortization of debt
issuance cost).
(6) Basic earnings per share is computed based on the weighted average number
of shares outstanding. Diluted earnings per share is computed based on the
weighted average number of shares and common stock equivalents outstanding.
The Company's common stock equivalents relate to outstanding common stock
options, Director Stock Plan units and Employee Stock Plan units and
warrants prior to their repurchase in 1999.
(7) Due to the adoption by the Company on January 1, 1994 of Financial
Accounting Standard No. 115 ("FAS 115"), total shareholders' equity
included a decrease, net of taxes, of $4.0 million and $40.0 million at
December 31, 2000 and 1999 and an increase, net of taxes, of $57.3 million,
$62.2 million and 29.7 million at December 31, 1998, 1997 and 1996,
respectively. Excluding the FAS 115 market value accounting for
investments, book value per share was $10.66, $10.73, $10.44, $10.03 and
$9.62 at December 31, 2000, 1999, 1998, 1997 and 1996, respectively.
(8) Statutory data has been derived from the financial statements of the
Company prepared in accordance with statutory accounting practices and
filed with insurance regulatory authorities.
(9) Property and casualty combined loss and expense ratio includes policyholder
dividends.
(10) Source: Best's Aggregates and Averages (1997 through 2000 Eds.). The
industry averages for the year ended December 31, 2000 are from Review
Preview, A Special Supplement to Best's Review and BestWeek,
Property/Casualty Edition, January 2001, published by A.M. Best.
(11) Investment reserves were the Asset Valuation Reserves.
5
General
The Company markets and underwrites personal lines of property and casualty
and life insurance and retirement annuities. The following table sets forth by
segment the amount of insurance premiums written and contract deposits for the
Company for the periods indicated.
Insurance Premiums Written and Contract Deposits
(Dollars in millions)
Year Ended December 31,
---------------------------------------------
2000 1999 1998
------------- ------------- -------------
Property and casualty.. $493.5 60.1% $495.1 60.3% $487.8 58.9%
Annuity................ 206.4 25.1 205.7 25.0 223.3 27.0
Life................... 121.8 14.8 120.4 14.7 116.7 14.1
------ ----- ------ ----- ------ -----
Total.............. $821.7 100.0% $821.2 100.0% $827.8 100.0%
====== ===== ====== ===== ====== =====
Corporate Strategy and Marketing
The Horace Mann Value Proposition
In April 2000, the Company's management announced steps to re-energize the
Company's core business and accelerate growth of the Company's revenues and
profits. These initiatives are intended to make the Company's products more
responsive to customer needs and preferences and expand the Company's product
lines within the personal financial services segment; grow and strengthen the
agent force and make the Company's agents more productive by improving the
products, tools and support the Company provides to them; increase cross-selling
and improve retention in the existing book of business; expand the Company's
penetration of targeted geographic areas and new segments of the educator
market; and broaden the Company's distribution options to complement and extend
the reach of the Company's agent force.
Further analysis of these strategic initiatives was completed in the third
quarter of 2000. During the fourth quarter of 2000, management began
implementing specific plans that address the initiatives above. The Company has
begun targeting high-priority geographic markets with dedicated staff teams. New
compensation and evaluation systems are being implemented to improve the
performance of the Company's agents and agency managers. New approaches to
customer service are being developed and tested that will free agents to spend
more time selling. Additional distribution options are being examined to
capitalize fully on the value of the Company's payroll deduction slots in
schools across the country. And, the Company will increase its use of technology
to improve the efficiency of its agency force and its administrative operations.
The Horace Mann Value Proposition states the core of the Company's strategy
to reignite its growth: Provide lifelong financial well-being for educators and
their families through personalized service, advice and a full range of tailored
insurance and financial products.
Target Market
The Company's target market through 2000 consisted of educators and other
employees of public schools and their families. The Company also sold its
products to other education-related customers, including private school
teachers, education support personnel, and their families, and customer
referrals. Horace Mann is the largest national multiline insurance company
focused on the niche educator market. In 2001 and beyond, the Company will
expand its service to the
6
educator market by also targeting Kindergarten - 12 teachers at private schools,
kindergarten - 12 principals and administrators at both public and private
schools, faculty and staff at junior and community colleges, and college
students majoring in education.
The U.S. Department of Education estimates that there are approximately 4
million elementary and secondary teachers in public and private schools in the
United States. It also estimates that the number of public and private school
teachers is growing approximately 1% annually. Recent federal programs which
reduce class size and add additional teachers may increase this growth rate. In
addition to increases in the number of teachers that result from growth in the
general population and in the number of school age children, turnover among the
teacher population increases the size of the Company's target market. Annual
turnover of 8% in the educator market, combined with the 1% growth rate cited
above, results in a 9% annual increase in the Company's niche market. New
teachers and educational support personnel are solicited by the Company's agents
and the Company attempts to retain customers who have retired or left the
teaching profession. The Company's 1.1 million customers typically have moderate
annual incomes, with many belonging to two-income households. Their financial
planning tends to focus on security, savings and primary insurance needs.
Exclusive Agency Force
A cornerstone of the Company's marketing strategy is its exclusive sales
force of full-time agents who are employees of the Company trained to sell
multiline products. As of December 31, 2000, the Company employed 978 full-time
agents, including 668 agents having more than two years of experience with the
Company. Many of the Company's agents were previously teachers or other members
of the education profession who both understand their customers' needs and
maintain relationships with current and former educators. The Company's agents
market and write the full range of the Company's products with all agents
licensed in both property and casualty and life products and approximately 70%
of experienced agents licensed by the National Association of Securities
Dealers, Inc. ("NASD") to sell variable annuities. They are under contract to
market and write only those products authorized by the Company. The agency force
is managed through 68 agency offices in 39 states.
The Company's service commitment to its policyholders begins with personal
contact at the point of sale between the Company's agents and potential
policyholders. In addition, the Company's agents often have direct access to
school premises, placing them in an advantageous position to write and service
individual insurance business for educators. In surveys, the Company's customers
have stated that important reasons for choosing and staying with Horace Mann are
the personal service and broad array of products the Company's agents deliver as
well as education association sponsorships. Management believes that Horace
Mann's name recognition and policyholders' loyalty lead to new customers and
cross selling of additional insurance products. At December 31, 2000, 33% of the
Company's 1.1 million customers had more than one Horace Mann product.
The Company's agents pre-underwrite policy applicants. The Company
structures its agent training and its agent compensation to provide incentives
for agents to adhere to the Company's underwriting standards and practices and
business growth plans. Agents' compensation increases by writing more profitable
business, not just additional business. Agents' compensation after an initial
two-year period is comprised entirely of commissions and incentive bonuses based
on profitability of insurance written, retention of customers and sales. In
2000, incentive bonuses represented 20% of compensation for agents having more
than two years of experience with
7
nearly 95% of the bonuses based on profitability. The profitability-related
portion of agent compensation is based on individual and agency loss ratios in
the case of property and casualty policies, where permitted by law, and
persistency in the case of life policies.
The Company is in the process of changing what is expected from its agents.
Prior to 2001, agent compensation focus and rewards centered around
profitability, service and tenure with the Company. The new direction will
continue to focus on profitability but will also place a greater emphasis on
individual agent productivity, new premium growth, educator business, cross-
selling and business retention. New compensation programs for both agents and
agency managers will be implemented in 2001 and will reflect the new direction.
Management believes that the revised compensation structure along with other
strategic initiatives will have a positive impact on agent productivity in the
future and will continue to help produce more profitable business.
Geographic Composition of Business
The Company's business is geographically diversified. Based on direct
insurance premiums earned and contract deposits for all product lines for the
year ended December 31, 2000, the top five states and their portion of total
premiums were North Carolina, 7.9%; Texas, 6.0%; Massachusetts, 5.3%; Illinois,
5.2%; and Minnesota, 5.0%.
HMEC's property and casualty subsidiaries write business in 48 states and
the District of Columbia. The following table sets forth the Company's top ten
property and casualty states based on total direct premiums in 2000:
Property and Casualty Segment Top Ten States
(Dollars in millions)
Property and Casualty
Segment
------------------------
Direct Percent
State Premiums(1) of Total
----- ----------- --------
Massachusetts................................. $ 35.6 7.2%
North Carolina................................ 35.2 7.1
California.................................... 33.8 6.8
Texas......................................... 32.3 6.5
Minnesota..................................... 31.4 6.4
Florida....................................... 28.2 5.7
Pennsylvania.................................. 22.8 4.6
Michigan...................................... 20.8 4.2
South Carolina................................ 19.8 4.0
Georgia....................................... 16.1 3.3
------ -----
Total of top ten states.................... 276.0 55.8
All other areas............................... 218.5 44.2
------ -----
Total direct premiums...................... $494.5 100.0%
====== =====
- ---------
(1) Defined as earned premiums before reinsurance and is determined under
statutory accounting practices.
8
HMEC's principal life insurance subsidiary writes business in 48 states and
the District of Columbia. The following table sets forth the Company's top ten
combined life and annuity states based on total direct premiums and contract
deposits in 2000:
Combined Life and Annuity Segments Top Ten States
(Dollars in millions)
Direct Premiums and Percent
State Contract Deposits(1) of Total
----- -------------------- --------
North Carolina.......................... $ 29.7 9.0%
Illinois................................ 29.2 8.8
Virginia................................ 20.8 6.3
Tennessee............................... 19.6 5.9
Texas................................... 16.8 5.1
Indiana................................. 14.4 4.4
Maine................................... 11.8 3.6
Louisiana............................... 10.5 3.2
South Carolina.......................... 10.5 3.2
Pennsylvania............................ 10.1 3.1
------ -----
Total of top ten states.............. 173.4 52.6
All other areas......................... 156.4 47.4
------ -----
Total direct premiums................ $329.8 100.0%
====== =====
- ------------
(1) Determined under statutory accounting practices.
National, State and Local Education Associations
The Company estimates that less than half of its policyholders are members
of the National Education Association ("NEA"), the nation's largest
confederation of state and local teachers' associations. NEA has approximately
2.5 million members.
The Company has had a long relationship with NEA and many of the state and
local education associations affiliated with NEA. The Company maintains a
special advisory board, primarily composed of leaders of state education
associations, that meets with Company management on a regular basis. These
meetings provide management with the opportunity to better assess the present
and future needs of its target market and to cultivate better relations with
education association leaders. In certain states, where approved by the
applicable state insurance departments, state or local association members are
entitled to a discount on premiums for certain property and casualty insurance
products sold by the Company and to additional product features and coverages.
From 1984 to September 1993 and beginning again in September 1996, on a
national level NEA purchased from the Company educator excess professional
liability insurance for all of its members. NEA has committed to purchase this
insurance from the Company through August 2002. Premium from this product
represents less than 1% of all insurance premiums written and contract deposits
of the Company. Between September 1993 and September 1996, the Company did not
write this policy.
It is the practice of NEA and affiliated state and local education
associations to "sponsor" various insurance products and services, including
those of the Company and its competitors. "Sponsorship" is generally determined
independently by each of these organizations. Being "sponsored" generally means
that NEA and such state and local associations evaluate a product, authorize the
use of their names in connection with the marketing of the product and, in some
instances, recommend that their membership consider buying the product. From
time to time during the past 30 years, NEA has sponsored various Company
products and currently sponsors the Company's homeowners policy, which was
co-sponsored by 39 NEA-affiliated state associations as of December 31, 2000.
Since 1988, the Company's homeowners policy was the
9
only product of the Company that was sponsored by NEA (exclusive of the educator
excess professional liability insurance policy purchased by NEA as described
above). NEA-affiliated education associations in 41 states sponsor products of
the Company other than homeowners. NEA-affiliated education associations in 46
states sponsor one or more of the Company's products. In many cases,
associations that sponsor one of the Company's products also sponsor competing
products. The Company does not pay NEA or any affiliated associations any
consideration in exchange for sponsorship of Company products. The Company does
pay for advertising that appears in NEA and state education association
publications.
Some of the advantages of education association sponsorship include
prestige and enhanced brand awareness, increased opportunity for the Company's
agents to market products on school premises, and improved agent recruiting,
especially among former teachers. The Company's customers decide whether to
purchase the Company's products for a number of reasons, including pricing and
service of the product and the customer's relationship with the selling agent.
Education association sponsorship may be one factor in such a decision.
In addition to its longstanding relationships with NEA and affiliated state
and local education associations, the Company has established its brand name
through its annual scholarship program for dependents of public school
employees; its annual educator surveys; sponsorship of the National Teacher Hall
of Fame; participation in the national conventions of the American Association
of School Administrators (AASA), the National Association of Elementary School
Principals (NAESP) and the National Association for Sport and Physical
Education; sponsorship of the educator and student resource website
www.reacheverychild.com and availability of educator information on the
Company's website www.horacemann.com as well as local agent contacts with school
districts. The Company tailors its products to the educator market, including
certain educator-specific features and hybrid products, which distinguishes the
Company's products from competitors.
Educator Credit Union Relationships
As of December 31, 2000, the Company had established relationships with
over 100 educator credit unions serving over 700,000 members in 37 states.
Beginning in 2001, and consistent with the restructuring actions the Company
took in the fourth quarter of 2000, the educator credit union distribution
system has been integrated into the Company's core marketing organization, with
Horace Mann agents providing service for all of the credit union relationships.
Prior to 2001, at some of those credit unions, a salaried representative of the
Company was available to meet with prospective customers, while other of those
credit unions referred their members to the Company and its agents for their
insurance needs. The Company's future strategy regarding educator credit union
relationships is under further review.
Property and Casualty Segment
The property and casualty segment represented 60% of the Company's total
insurance premiums and contract deposits and 35% of the Company's operating
income in 2000.
10
The primary property and casualty product offered by the Company is private
passenger automobile insurance, which in 2000 represented 45% of the Company's
total insurance premiums written and contract deposits and 75% of property and
casualty net written premiums. As of December 31, 2000, the Company had
approximately 588,000 voluntary automobile policies in force with annual
premiums of approximately $414 million. The Company's automobile business is
primarily preferred risk, defined as a household whose drivers have no accidents
and no more than one violation. The Company has instituted a program in a
limited number of states to provide non-preferred risk coverage to the educator
market, with a third-party vendor underwriting such insurance and the Company
receiving a commission on its sale. The Company has also begun implementation of
a tiered rating system to enhance its ability to differentiate automobile risk
by price. Adopting a tiered rating system allows the Company to better match
premiums to risk, so the best drivers pay the lowest rates. And, with more
flexibility in pricing, the Company can write insurance for educators who in the
past might not have met the Company's underwriting standards.
In 2000, homeowners insurance represented 14% of the Company's total
insurance premiums written and contract deposits and 24% of property and
casualty premiums. The Company writes primarily residential homes. As of
December 31, 2000, the Company had approximately 288,000 homeowners policies in
force with annual premiums of approximately $120 million. A tiered rating system
has also been implemented for homeowners business.
The educator excess professional liability insurance represented the
remaining 1% of the Company's 2000 property and casualty premiums. See
"Business - Corporate Strategy and Marketing - National, State and Local
Education Associations."
The results of companies in the insurance industry have historically been
subject to significant fluctuations due to competition, economic conditions,
interest rates and other factors. In particular, the property and casualty
insurance industry has historically experienced pricing and profitability
cycles. With respect to these cycles, the factors most affecting current and
prospective results of operations are intense price competition and aggressive
marketing by property and casualty insurers, which have historically resulted in
higher combined loss and expense ratios. Periods characterized by higher
combined loss and expense ratios have typically been followed by withdrawal of
capacity in the property and casualty industry and a firming of prices,
resulting in lower combined loss and expense ratios. Because of the nature of
the property and casualty cycle, it is difficult to predict future trends in the
industry's overall combined loss and expense ratio. Management of the Company
believes that these factors will continue to produce pricing and profitability
cycles for the industry in the future. Generally, the personal lines segment of
the property and casualty insurance market has been less subject to the pricing
and profitability cycles that have affected the commercial lines segment and the
overall industry. Because virtually all the Company's property and casualty
business is personal lines business, management believes the Company's
operations are less subject to pricing and profitability cycles than the
operations of many other insurers.
Results of property insurers are also subject to weather and other
conditions prevailing in an accident year. While one year may be relatively free
of major weather or other disasters, another year may have numerous such events
causing results for such a year to be materially worse than for other years.
11
Selected Historical Financial Information For Property and Casualty Segment
The following table sets forth certain financial information with respect to
the property and casualty segment for the periods indicated.
Property and Casualty Segment
Selected Historical Financial Information
(Dollars in millions)
Year Ended December 31,
------------------------
2000 1999 1998
------ ------ ------
Statement of Operations Data:
Insurance premiums written(1)...................... $493.5 $495.1 $487.8
Insurance premiums earned(1)....................... 490.0 491.1 476.4
Net investment income.............................. 35.7 37.0 38.9
Operating income before income taxes............... 3.8 54.6 66.5
Operating income................................... 8.9 39.5 53.2
Net investment income, after tax................... 27.6 28.3 29.0
Catastrophe costs, after tax....................... 10.5 12.7 18.5
Statutory Operating Statistics:
Loss and loss adjustment expense ratio............. 85.2% 76.3% 74.4%
Expense ratio...................................... 20.8% 19.8% 19.3%
Combined loss and expense ratio
(including policyholder dividends)............... 106.0% 96.1% 93.6%
Combined loss and expense ratio before
catastrophes (including policyholder dividends).. 102.7% 92.2% 87.7%
GAAP Operating Statistics:
Loss and loss adjustment expense ratio............. 85.2% 76.3% 74.4%
Expense ratio...................................... 20.9% 19.7% 19.3%
Combined loss and expense ratio
(including policyholder dividends)............... 106.1% 96.0% 93.7%
Combined loss and expense ratio before
catastrophes (including policyholder dividends).. 102.8% 92.1% 87.8%
Automobile and Homeowners (Voluntary):
Insurance premiums written......................... $473.2 $470.7 $459.0
Insurance premiums earned.......................... 469.4 465.0 449.9
Policies in force (in thousands)................... 876 872 859
- -----------
(1) After the Company's portion of the March 2000 industry settlement of
automobile insurance rate filings in North Carolina, which reduced the
Company's premiums by $2.3 million for the year ended December 31, 2000.
Property and Casualty Ratios
In each of the last 10 years, the Company's combined loss and expense ratio
for its property and casualty product lines outperformed the total property and
casualty industry combined loss and expense ratio, as reported by A.M. Best.
During this period, the Company's combined loss and expense ratio was better
than the total property and casualty insurance industry combined loss and
expense ratio by an average of approximately 12 percentage points per year.
During the same period of time, the Company's combined loss and expense ratio
was better than the personal lines insurance industry segment combined loss and
expense ratio by an average of approximately 10 percentage points per year.
12
The table below compares the Company's combined loss and expense ratios with
published industry averages.
Property and Casualty Combined Loss and Expense Ratio(1)
Property and
The Personal Lines Casualty
Company(2) Industry Segment(3) Industry(3)
---------- ------------------- ---------------
Year Ended December 31,
2000................... 106.0% 110.0% 110.3%
1999................... 96.1 104.5 107.8
1998................... 93.6 102.7 105.6
1997................... 91.1 99.8 101.6
1996................... 93.5 104.9 105.8
1995................... 93.3 103.5 106.5
1994................... 93.7 104.5 108.5
1993................... 93.3 103.9 106.9
1992................... 97.1 112.5 115.8
1991................... 98.4 107.1 108.8
- ----------
(1) Combined loss and expense ratio includes policyholder dividends and is
determined according to statutory accounting practices.
(2) The Company did not have any California property and casualty business
during each of the years from 1991 through 1993.
(3) Source: Best's Aggregates and Averages (1992 through 2000 Eds.). 2000 is
an estimate from Review Preview, A Special Supplement to Best's Review and
BestWeek, Property/Casualty Edition, January 2001, published by A.M. Best.
Catastrophe costs before federal income tax benefits for the Company and the
property and casualty industry for the ten years ended December 31, 2000 were as
follows:
Catastrophe Costs
(Dollars in millions)
Property and
The Casualty
Company(1) Industry(2)
---------- ---------------
Year Ended December 31,
2000................... $16.2 $ 4,300.0
1999................... 19.6 8,320.0
1998................... 28.4 10,070.0
1997................... 6.2 2,600.0
1996................... 20.9 7,370.0
1995................... 13.9 8,320.0
1994................... 16.2 17,010.0
1993................... 8.3 5,620.0
1992................... 13.3 22,970.0
1991................... 9.9 4,730.0
- ----------
(1) Net of reinsurance and before federal income tax benefits. Includes
allocated loss adjustment expenses and reinsurance reinstatement premiums.
The Company's individually significant catastrophe losses net of
reinsurance were as follows:
2000 - $5.0 million, May tornadoes; $2.7 million December winter storms.
1999 - $5.4 million, Hurricane Floyd; $3.1 million, May tornadoes
primarily in Oklahoma.
1998 - $7.9 million, May Minnesota hailstorm; $2.9 million, May Upper
Midwest hailstorm; $2.0 million, June Midwest wind/hail;
$1.6 million, Hurricane Georges.
1997 - $1.4 million, July wind/hail/tornadoes; $1.1 million, Denver,
Colorado hailstorm.
1996 - $8.2 million, Hurricane Fran.
1995 - $2.9 million, Texas wind/hail/tornadoes; $2.2 million Hurricane
Opal.
1994 - $6.0 million, Northridge, California earthquake.
1993 - $2.2 million, East Coast blizzard.
1992 - $1.9 million, Hurricane Andrew.
1991 - $1.0 million, Hurricane Bob.
(2) Source: Insurance Services Office, Inc. news release dated January 23,
2001. These amounts are before reinsurance and federal income tax benefits
and exclude all loss adjustment expenses.
During the last 10 years, the Company's property and casualty expense ratio
has been better than the property and casualty industry personal lines average
expense ratio as reported by A.M. Best by an average of 4.7 percentage points
per year. The Company's property and casualty expense ratio for the year ended
December 31, 2000 was 20.8%.
13
The table below compares the Company's expense ratios with published industry
averages.
Property and Casualty Expense Ratio(1)
Property and
The Personal Lines Casualty
Company(2) Industry Segment(3) Industry(3)
---------- ------------------- ---------------
Year ended December 31,
2000................... 20.8% 25.3% 27.5%
1999................... 19.8 25.6 28.0
1998................... 19.3 25.0 27.7
1997................... 19.4 24.3 27.1
1996................... 19.4 23.4 26.4
1995................... 19.8 23.7 26.3
1994................... 19.8 23.5 26.0
1993................... 19.6 23.9 26.2
1992................... 19.6 24.4 26.6
1991................... 19.8 24.7 26.4
- ----------
(1) Determined according to statutory accounting practices.
(2) The Company did not have any California property and casualty business
during each of the years from 1991 through 1993.
(3) Source: Best's Aggregates and Averages (1992 through 2000 Eds.). The 2000
personal lines result is an estimate from A.M. Best. The 2000 total
industry result is an estimate from Review Preview, A Special Supplement to
Best's Review and BestWeek, Property/Casualty Edition, January 2001,
published by A.M. Best.
Property and Casualty Reserves
In eight of the last ten years the Company's property and casualty reserves
have developed cumulative redundancies. At December 31, 2000, 99.4% of the
Company's net reserves for claims and claims expenses were carried at the full
value of estimated liabilities and were not discounted for interest expected to
be earned on reserves. Due to the nature of the Company's personal lines
business, the Company has no exposure to claims for toxic waste cleanup, other
environmental remediation or asbestos-related illnesses.
The Company establishes property and casualty claim reserves to cover its
estimated ultimate liability for claims and claims adjustment expense with
respect to reported claims and claims incurred but not yet reported as of the
end of each accounting period. In accordance with applicable insurance laws and
regulations and generally accepted accounting principles ("GAAP"), no reserves
are established until a loss occurs, including a loss from a catastrophe.
Underwriting results of the property and casualty operations are significantly
influenced by estimates of property and casualty claims and claims expense
reserves. These reserves are an accumulation of the estimated amounts necessary
to settle all outstanding claims, including claims which are incurred but not
reported, as of the date of the financial statements.
The reserve estimates are based on known facts and on interpretations of
circumstances, including the Company's experience with similar cases and
historical trends involving claim payment patterns, claim payments, pending
levels of unpaid claims and product mix, as well as other factors including
court decisions, economic conditions and public attitudes. The effects of
inflation are implicitly considered in the reserving process. The establishment
of reserves, including reserves for catastrophes, is an inherently uncertain
process and the ultimate cost of losses may vary materially from the recorded
reserve amounts. The Company regularly updates its reserve estimates as new
facts become known and further events occur which may impact the resolution of
unsettled claims. Changes in prior year reserve estimates, which may be
material, are reflected in the results of operations in the period such changes
are determined to be appropriate.
14
In the fourth quarter of 2000, the Company conducted a comprehensive review
of all components of its property and casualty reserves. As a result of that
review, the Company increased total property and casualty reserves for prior
years by $24.7 million at December 31, 2000. This increase consisted of
approximately $6 million strengthening of prior years' direct reserves,
primarily automobile, based on the further analysis of adverse trends which
emerged during 2000. It also included an approximately $17 million reduction of
ceded reserves resulting from the adoption of a different actuarial method to
reflect more accurately prior years' loss experience. This reduction of the
ceded reserves was related to automobile facility business in four states,
primarily Massachusetts. Prior years' reserves for automobile and homeowners
business assumed from state reinsurance facilities were also strengthened by
$1.8 million at December 31, 2000. In total, these reserve actions result in a
level of reserve adequacy that is consistently conservative with the Company's
estimates in recent years but which, in hindsight, did not exist at year-end
1999.
For the full year, net strengthening of reserves to provide for the adverse
development of property and casualty claims occurring in prior years, excluding
involuntary business, was $20.9 million in 2000, compared to favorable
development of $7.6 million recognized in the year ended December 31, 1999.
Full year strengthening of total reserves for property and casualty claims
occurring in prior years was $22.7 million in 2000, compared to favorable
development of $4.6 million recognized in the year ended December 31, 1999.
Due to the inherent uncertainty in estimating reserves for claims and claims
expenses, there can be no assurance that ultimate liabilities will not exceed
amounts reserved, with a resulting adverse effect on the Company. Management
believes that the Company's overall reserve levels at December 31, 2000 are more
than adequate to meet its future obligations.
15
The following table is a summary reconciliation of the beginning and ending
property and casualty insurance claims and claims expense reserves, displayed
individually for each of the last three years. The table presents reserves on a
net (after reinsurance) basis. The total net property and casualty insurance
claims and claims expense amounts are reflected in the Consolidated Statements
of Operations listed on page F-1 of this report. The end of the year gross
reserve (before reinsurance) balances are reflected in the Consolidated Balance
Sheets also listed on page F-1 of this report.
Reconciliation of Property and Casualty Claims and Claims Expenses Reserves
(Dollars In millions)
Year Ended December 31,
-----------------------
2000 1999 1998
------ ------ ------
Gross reserves, beginning of year................................ $299.8 $298.9 $310.6
Less reinsurance recoverables.................................. 64.4 55.9 41.3
------ ------ ------
Net reserves, beginning of year.................................. 235.4 243.0 269.3
------ ------ ------
Incurred claims and claims expense:
Claims occurring in the current year........................... 394.7 379.5 379.6
Increase (decrease) in estimated reserves for claims
occurring in prior years(1):
Policies written by the Company............................ 20.9 (7.6) (23.3)
Business assumed from state reinsurance facilities......... 1.8 3.0 (1.6)
------ ------ ------
Total increase (decrease)................................ 22.7 (4.6) (24.9)
------ ------ ------
Total claims and claims expense incurred................... 417.4 374.9 354.7
------ ------ ------
Claims and claims expense payments for claims occurring during:
Current year................................................... 247.4 240.0 239.0
Prior years.................................................... 155.6 142.5 142.0
------ ------ ------
Total claims and claims expense payments................... 403.0 382.5 381.0
------ ------ ------
Net reserves, end of period...................................... 249.8 235.4 243.0
Plus reinsurance recoverables.................................. 49.1 64.4 55.9
------ ------ ------
Gross reserves, end of period(2)................................. $298.9 $299.8 $298.9
====== ====== ======
__________________________
(1) Shows the amounts by which the Company decreased or increased its reserves
in each of the periods indicated for claims occurring in previous periods
to reflect subsequent information on such claims and changes in their
projected final settlement costs. Favorable reserve development generally
occurs as a result of subsequent adjustment of reserves to reflect
additional information. Also refer to the fourth and third paragraphs
preceding this table for additional information regarding the increase in
reserves recorded in 2000.
(2) Unpaid claims and claims expense as reported in the consolidated balance
sheets also include life, annuity, and group accident and health reserves
of $10.0 million, $9.8 million and $8.5 million at December 31, 2000, 1999
and 1998, respectively, in addition to property and casualty reserves.
The provision for claims and claims expenses for insured events in prior
years increased by $22.7 million and decreased by $4.6 million and $24.9 million
for the years ended December 31, 2000, 1999 and 1998, respectively. The reserve
strengthening recorded in 2000 is described above. The favorable claim
development experienced in 1999 and 1998 resulted primarily from improving
trends in the frequency and severity of voluntary automobile claims. Future
reserve actions, if any, will depend on claim trends.
The year-end 2000 gross reserves of $298.9 million for property and
casualty insurance claims and claims expense, as determined under GAAP, were
$49.1 million more than the reserve balance of $249.8 million recorded on the
basis of statutory accounting practices for reports provided to state regulatory
authorities. The difference is the reinsurance recoverable from third parties
totaling $49.1 million that reduces reserves for statutory reporting and is
recorded as an asset for GAAP reporting.
16
Fluctuations from year to year in the level of catastrophe losses impact a
property and casualty insurance company's loss and loss adjustment expenses
incurred and paid. For comparison purposes, the following table provides amounts
for the Company excluding catastrophe losses:
Impact of Catastrophe Losses(1)
(Dollars in millions)
Year Ended December 31,
--------------------------
2000 1999 1998
------ ------ ------
Claims and claims expense incurred... $417.4 $374.9 $354.7
Amount attributable to catastrophes.. 16.1 19.4 28.0
------ ------ ------
Excluding catastrophes............. $401.3 $355.5 $326.7
====== ====== ======
Claims and claims expense payments... $403.0 $382.5 $381.0
Amount attributable to catastrophes.. 14.2 17.4 25.2
------ ------ ------
Excluding catastrophes............. $388.8 $365.1 $355.8
====== ====== ======
- -----------------
(1) Net of reinsurance and before federal income tax benefits. Includes
allocated loss adjustment expenses.
Analysis of Claims and Claims Expense Reserves
The claim reserve development table below illustrates the change over time
of the net reserves established for property and casualty insurance claims and
claims expense at the end of various calendar years. The first section shows the
reserves as originally reported at the end of the stated year. The second
section, reading down, shows the cumulative amounts paid as of the end of
successive years with respect to that reserve liability. The third section,
reading down, shows retroactive reestimates of the original recorded reserve as
of the end of each successive year which is the result of the Company's learning
additional facts that pertain to the unsettled claims. The last section compares
the latest reestimated reserve to the reserve originally established, and
indicates whether or not the original reserve was adequate or inadequate to
cover the estimated costs of unsettled claims. The table also presents the gross
reestimated liability as of the end of the latest reestimation period, with
separate disclosure of the related reestimated reinsurance recoverable. The
claim reserve development table is cumulative and, therefore, ending balances
should not be added since the amount at the end of each calendar year includes
activity for both the current and prior years.
17
In evaluating the information in the table below, it should be noted that
each amount includes the effects of all changes in amounts of prior periods. For
example, if a claim determined in 1999 to be $150 thousand was first reserved in
1990 at $100 thousand, the $50 thousand deficiency (actual claim minus original
estimate) would be included in the cumulative deficiency in each of the years
1990-1998 shown below. This table presents development data by calendar year
and does not relate the data to the year in which the accident actually
occurred. Conditions and trends that have affected the development of these
reserves in the past will not necessarily recur in the future. It may not be
appropriate to use this cumulative history in the projection of future
performance.
Property and Casualty
Claims and Claims Expense Reserve Development
(Dollars in millions)
December 31,
- ----------------------------------------------------------------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Gross reserves for property
and casualty claims and
claims expenses................ $319.4 $331.5 $358.2 $373.5 $389.1 $369.7 $340.4 $310.6 $298.9 $299.8 $298.9
Deduct: Reinsurance
recoverables................... 20.9 14.8 17.7 21.6 19.5 23.8 34.1 41.3 55.9 64.4 49.1
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Net reserves for property
and casualty claims and
claims expenses................ 298.5 316.7 340.5 351.9 369.6 345.9 306.3 269.3 243.0 235.4 249.8
Increase in reserves due
to purchase of Allegiance
Insurance Company:
Gross reserves for property
and casualty claims and
claims expenses............ - - - 30.6 - - - - - - -
Deduct: Reinsurance
recoverables............... - - - 0.6 - - - - - - -
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Net reserves for property
and casualty claims and
claims expenses............. - - - 30.0 - - - - - - -
Paid cumulative as of:
One year later................. 111.3 116.1 117.6 133.4 140.8 139.3 148.6 142.0 142.5 155.6
Two years later................ 167.4 170.0 169.6 190.5 194.5 195.3 202.1 191.4 203.2
Three years later.............. 197.1 197.2 197.8 218.4 224.2 223.0 225.1 223.0
Four years later............... 212.9 212.1 213.6 234.1 237.9 233.8 240.2
Five years later............... 220.7 220.5 222.6 241.0 243.1 241.4
Six years later................ 225.3 224.8 226.0 243.7 247.1
Seven years later.............. 228.2 227.1 227.5 246.1
Eight years later.............. 229.5 227.9 229.0
Nine years later............... 229.9 229.0
Ten years later................ 230.7
Reserves reestimated as of:
End of year.................... 298.5 316.7 340.5 381.9 369.6 345.9 306.3 269.3 243.0 235.4 249.8
One year later................. 279.9 297.3 306.1 327.6 314.0 283.4 261.2 244.4 238.4 258.1
Two years later................ 266.7 272.1 267.7 281.9 269.2 249.6 250.2 239.3 261.2
Three years later.............. 246.7 246.8 246.4 258.1 251.4 245.8 247.8 254.9
Four years later............... 236.5 235.2 233.3 249.3 248.9 243.8 257.1
Five years later............... 227.8 232.4 229.8 229.7 247.4 250.9
Six years later................ 230.8 230.1 230.0 246.6 252.9
Seven years later.............. 231.1 230.1 229.8 250.2
Eight years later.............. 231.7 230.0 231.9
Nine years later............... 231.8 231.2
Ten years later................ 232.4
Reserve redundancy (deficiency)
- initial net reserves in
excess of (less than)
reestimated reserves:
Amount(1)................... $ 66.1 $ 85.5 $108.6 $131.7 $116.7 $ 95.0 $ 49.2 $ 14.4 $(18.2) $(22.7)
Percent..................... 22.1% 27.0% 31.9% 34.5% 31.6% 27.5% 16.1% 5.3% -7.5% -9.6%
Gross reestimated
liability - latest............. $245.2 $257.8 $260.4 $278.7 $281.5 $273.9 $285.1 $284.5 $300.9 $302.3
Reestimated reinsurance
recoverables - latest.......... 12.8 26.6 28.5 28.5 28.6 23.0 28.0 29.6 39.7 44.2
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Net reestimated
liability - latest............. 232.4 231.2 231.9 250.2 252.9 250.9 257.1 254.9 261.2 258.1
Gross cumulative excess
(deficiency)(1)................ $ 74.2 $ 73.7 $ 97.8 $125.4 $107.6 $ 95.8 $ 55.3 $ 26.1 $ (2.0) $ (2.5)
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
- -----------------
(1) See "Business - Property and Casualty - Property and Casualty Reserves."
As the table above illustrates, the Company's net reserve for property and
casualty insurance claims and claims expense at the end of 1999 was strengthened
in 2000 by $22.7 million, while gross reserves were strengthened $2.5 million.
The strengthening of net reserves for property
18
and casualty claims and claims expenses in 2000 included a reduction of ceded
reserves of approximately $17 million. See "Business - Property and Casualty -
Property and Casualty Reserves."
Property and Casualty Reinsurance
All reinsurance is obtained through contracts which generally are renewed
each calendar year; however, the catastrophe, liability and property reinsurance
program effective January 1, 2000, as well as the treaty effective January 1,
2001, are three year contracts with rate guarantees. Although reinsurance does
not legally discharge the Company from primary liability for the full amount of
its policies, it does make the assuming reinsurer liable to the extent of the
reinsurance ceded. Historically, the Company's losses from uncollectible
reinsurance recoverables have been insignificant due to the Company's emphasis
on the credit worthiness of its reinsurers. Past due reinsurance recoverables as
of December 31, 2000 were also insignificant.
The Company is a national underwriter and therefore has exposure to
catastrophic losses in certain coastal states and other regions throughout the
United States. Catastrophes can be caused by various events including
hurricanes, windstorms, earthquakes, hail, severe winter weather and fires, and
the frequency and severity of catastrophes are inherently unpredictable. The
financial impact from catastrophic losses results from both the total amount of
insured exposure in the area affected by the catastrophe as well as the severity
of the event. The Company seeks to reduce its exposure to catastrophe losses
through the geographic diversification of its insurance coverage, deductibles,
maximum coverage limits, the purchase of catastrophe reinsurance, and the
purchase of a catastrophe-linked equity put option and reinsurance agreement.
The Company maintains an excess and catastrophe treaty reinsurance program.
The Company reinsures 95% of catastrophe losses above a retention of $8.5
million per occurrence up to $80 million per occurrence for 52% of the coverage
in 2001 and above a retention of $7.5 million per occurrence up to $80 million
per occurrence for the remaining 48% of the coverage in 2001. In 2000, the
retention for all of the coverage was $7.5 million per occurrence up to $80
million per occurrence in 2000. In addition, the Company's predominant insurance
subsidiary for property and casualty business written in Florida reinsures 90%
of hurricane losses in that state above a retention of $10.3 million up to $46.3
million with the Florida Hurricane Fund, based on the Fund's resources. These
programs are augmented by a $100 million equity put and reinsurance agreement.
This equity put provides an option to sell shares of the Company's convertible
preferred stock with a floating rate dividend at a pre-negotiated price in the
event losses from catastrophes exceed the catastrophe reinsurance program
coverage limit. Before tax benefits, the equity put provides a source of capital
for up to $154 million of catastrophe losses above the reinsurance coverage
limit. For liability coverages, in both 2000 and 2001, including the educator
excess professional liability policy, the Company reinsures each loss above a
retention of $500,000 up to $20 million. The Company also reinsures each
property loss, including catastrophe losses that in the aggregate are less than
the retention levels above, above a retention of $250,000 up to $2.5 million in
2000 and 2001.
19
The following table identifies the Company's most significant reinsurers
under the traditional catastrophe reinsurance program, their percentage
participation in the Company's aggregate reinsured catastrophe coverage and
their rating by Standard & Poor's Corporation ("S&P" or "Standard & Poor's") and
A.M. Best. No other single reinsurer's percentage participation in 2001 or 2000
exceeds 5%.
Property Catastrophe Reinsurance Participants In Excess of 5%
Participation
S&P A.M. Best -------------
Rating Rating Reinsurer Parent 2001 2000
- --------- --------- ------------------------------ ---------------------------- ---- ----
AA A+ AXA Reinsurance Company AXA Group 15% 15%
AA A++ Erie Insurance Exchange 14% 12%
A A Continental Casualty Company* Loews Corporation 7% 6%
A+ A Lloyd's of London Syndicates** 7% 6%
AAA A++ American Re-insurance Company Muenchener Rueckversicherungs-
Gesellschaft AG (Munich Re)
of Germany 6% 6%
AA A+ St. Paul Fire and Marine
Insurance Company The St. Paul Companies, Inc. 6% 10%
- -------------
* Includes 2 percentage points and 1 percentage point from CNA Reinsurance
Company Ltd. of London, England in 2001 and 2000, respectively.
** For 2001 and 2000, the participation by Lloyd's of London in the Company's
catastrophe reinsurance program is disbursed among 11 syndicates.
For 2001, property catastrophe reinsurers representing 99.6% of the
Company's aggregate reinsured catastrophe coverage were rated "A- (Excellent)"
or above by A.M. Best or "A" or above by S&P.
Annuity Segment
Educators in the Company's target market benefit from the provisions of
Section 403(b) of the Internal Revenue Code. This section of the Code allows
public school employees and employees of not-for-profit private schools to
reduce their pretax income by making periodic contributions to an individual
qualified retirement plan. The Company has offered tax-qualified annuities to
its marketplace, designed to allow contractholders to benefit from these tax
provisions, since 1961, the year Congress created this option for educators. The
Company is one of the 20 largest participants in the fixed and variable 403(b)
tax-qualified annuity market according to a 2000 A.M. Best report. Approximately
70% of the Company's new annuity contract deposits in 2000 were for 403(b) tax-
qualified annuities; approximately 80% of accumulated annuity value on deposit
is 403(b) tax-qualified. In 2000, annuities represented 25% of the Company's
total insurance premiums written and contract deposits and 77% of the Company's
operating income.
The Company sells fixed and variable tax-qualified annuities primarily
under its combination contract which allows the contractholder to allocate funds
to both fixed and variable alternatives. The features of the Company's
combination fixed/variable annuity contract contribute to business retention.
Contractholders can change at any time their allocation of deposits between a
guaranteed interest rate fixed account and 30 mutual fund investment options.
Prior to 2000, the Company had the fixed account and only seven mutual fund
investment options. In May 2000, the Company introduced two additional variable
mutual fund investment options. In September 2000, in time for the Company's
important back-to-school selling season, the Company more than tripled the
number of choices available to its customers by introducing 21 new investment
options in its tax-deferred annuity product line. At the same time, the Company
provided its agents with proprietary asset allocation software that assists
educator customers in selecting the best retirement investment options for their
individual needs and circumstances.
20
Under the fixed account option, both the principal and a rate of return are
guaranteed. The 30 mutual fund options include funds managed by some of the
best-known names in the mutual fund industry, such as Fidelity, Strong, J.P.
Morgan, Wilshire, T. Rowe Price, Putnam, Neuberger Berman, Alliance Capital,
Ranier, Davis and Warburg Pincus, offering the Company's customers several
investment options, regardless of their personal investment objectives and risk
tolerance. Total accumulated fixed and variable annuity cash value on deposit at
December 31, 2000 was $2.4 billion.
For the year ended December 31, 2000, 86% of the total accumulated cash
value of the Company's annuity business remained on deposit, compared to average
retention of 89% for stock life insurance companies for 1999, as reported by
A.M. Best. Total accumulated cash value retention for the last three months of
2000 improved to 88% following the Company's expansion of variable investment
options and introduction of its proprietary asset allocation software. All
annuities issued since 1982 and approximately 78% of all outstanding fixed
annuity accumulated cash values are subject in most cases to substantial early
withdrawal penalties, typically ranging from 5% to 13% of the amount withdrawn,
compared to an average of 39% of accumulated values subject to withdrawal
penalties for stock life insurance companies for 1999, as reported by A.M. Best.
For the Company, withdrawals of outstanding variable annuities are limited to
amounts less than or equal to the then current market value of such annuities,
minus withdrawal penalties as applicable. Generally, a penalty is imposed under
the Internal Revenue Code on amounts withdrawn from tax-qualified annuities
prior to age 59 1/2. Total accumulated annuity funds on deposit at December 31,
2000 consisted of 44% variable annuities and 56% fixed annuities. The growth of
the annuity segment over the last five years has come primarily from the
variable annuity product.
21
Selected Historical Financial Information For Annuity Segment
The following table sets forth certain information with respect to the
Company's annuity products for the periods indicated.
Annuity Segment
Selected Historical Financial Information
(Dollars in millions, unless otherwise indicated)
Year Ended December 31,
--------------------------------
2000 1999 1998
-------- -------- --------
Statement of Operations Data:
Contract deposits:
Variable.............................................. $ 121.1 $ 129.2 $ 138.6
Fixed................................................. 85.3 76.5 84.7
Total............................................... 206.4 205.7 223.3
Contract charges earned................................. 17.0 16.7 15.6
Net investment income................................... 105.4 105.3 107.7
Net interest margin (without realized gains)............ 39.3 38.1 35.7
Net margin (includes fees and contract charges earned).. 59.0 57.6 53.5
Operating income before income taxes.................... 29.2 41.8 35.4
Operating income........................................ 19.3 27.3 23.1
Operating Statistics:
Fixed annuity:
Accumulated value..................................... $1,331.8 $1,355.6 $1,352.7
Accumulated value persistency......................... 88.7% 92.3% 92.8%
Variable annuity:
Accumulated value..................................... $1,035.1 $1,131.7 $1,122.8
Accumulated value persistency......................... 84.1% 88.5% 93.5%
Number of contracts in force............................ 128,654 125,352 120,253
Average accumulated cash value (in dollars)............. $ 18,397 $ 19,843 $ 20,586
Average annual deposit by contractholders (in dollars).. $ 2,282 $ 2,327 $ 2,416
Annuity contracts terminated due to surrender,
death, maturity or other:
Number of contracts................................. 10,848 8,353 6,987
Amount.............................................. $ 322.0 $ 269.2 $ 224.8
Accumulated fixed annuity value grouped
by applicable surrender charge:
0%.................................................. $ 298.8 $ 315.9 $ 319.8
5% and greater but less than 10%.................... 852.3 841.4 825.3
10% and greater..................................... 86.2 108.4 120.6
Supplementary contracts with life contingencies
not subject to discretionary withdrawal........... 94.5 89.9 87.0
Total accumulated fixed annuity value........... $1,331.8 $1,355.6 $1,352.7
Life Segment
The Company entered the individual life insurance business in 1949 with
traditional term and whole life insurance products. In 1984, the Company
introduced "Experience Life," a flexible, adjustable premium life insurance
contract which allows the customer to combine elements of term life insurance,
interest-sensitive whole life insurance and an interest-bearing account. At
December 31, 2000 the Company had in force approximately 94,000 Experience Life
policies representing approximately $6.4 billion of life insurance in force with
annual insurance premiums and contract deposits of approximately $70.8 million.
The Company's traditional term, whole life and group life business in force
consists of approximately 180,000 policies, representing approximately $6.2
billion of life insurance in force with annual insurance premiums and contract
deposits of approximately $38.7 million as of December 31, 2000. In 1997, the
Company introduced a new series of five limited duration term life insurance
products. In 1998, the Company introduced a new series of whole life products
designed to serve the needs of customers who also want limited life insurance
coverage (as low as $5,000 death benefits) but who want the features of a whole
life policy. The Company does not charge any penalty for withdrawal of life
insurance cash values. In 2000, the Company instituted a program to offer long-
term care and variable universal life policies, with two third-party vendors
underwriting such
22
insurance and the Company receiving a commission on its sale. In 2000, the life
segment represented 15% of the Company's total insurance premiums written and
contract deposits, including approximately 1.5 percentage points attributable to
the Company's group life and group disability income business, and 51% of the
Company's operating income.
During 2000, the average face amount of ordinary life insurance policies
issued by the Company was $101,776 and the average face amount of all ordinary
life insurance policies it had in force at December 31, 2000 was $55,851.
The maximum individual life insurance risk retained by the Company is
$200,000 on any individual life and $100,000 is retained on each group life
policy. The excess of the amounts retained are reinsured with life reinsurers
that are all rated "A (Excellent)" or above by A.M. Best.
The life insurance and annuity industry, while it has not generally been
subject to the factors that produce cyclicality in the property and casualty
insurance industry, is nonetheless subject to competitive pressures and interest
rate fluctuations. As a result, the life insurance and annuity industry has
developed new products designed to shift investment and credit risk to policy or
contractholders while still providing death benefits. This trend has generally
caused profit margins to shrink on new products relative to older life insurance
and annuity products and has provided more competitive returns to the holders of
the new products than those available under other investment alternatives.
Management cannot predict whether these trends will continue in the future.
Selected Historical Financial Information For Life Segment
The following table sets forth certain information with respect to the
Company's life products for the periods indicated.
Life Segment
Selected Historical Financial Information
(Dollars in millions, unless otherwise indicated)
Year Ended December 31,
------------------------------
2000 1999 1998
-------- -------- --------
Statement of Operations Data:
Insurance premiums and contract deposits............. $ 121.8 $ 120.4 $ 116.7
Insurance premiums and contract charges earned....... 91.7 87.3 85.8
Net investment income................................ 51.2 47.0 45.4
Operating income before income taxes................. 19.9 22.3 19.0
Operating income..................................... 12.9 14.6 12.4
Operating Statistics:
Life insurance in force:
Ordinary life...................................... $ 10,967 $ 10,749 $ 10,573
Group life......................................... 1,680 1,551 1,226
Total............................................ 12,647 12,300 11,799
Number of policies in force:
Ordinary life...................................... 196,361 198,898 201,689
Group life......................................... 77,221 66,953 57,010
Total............................................ 273,582 265,851 258,699
Average face amount in force (in dollars):
Ordinary life...................................... $ 55,851 $ 54,520 $ 52,422
Group life......................................... 21,756 23,166 21,505
Total............................................ 46,227 46,267 45,609
Persistency rate (ordinary life insurance in force).. 91.0% 91.7% 92.8%
Lapse ratio (ordinary life insurance in force)....... 9.0% 8.3% 7.2%
Ordinary life insurance terminated due to death,
surrender, lapse or other:
Face amount of insurance surrendered or lapsed... $1,087.6 $ 998.9 $ 888.2
Number of policies............................. 13,877 13,092 9,396
Amount of death claims........................... $ 30.1 $ 26.4 $ 26.5
Number of death claims......................... 1,317 1,326 1,300
23
Investments
The Company's investments are selected to balance the objectives of
minimizing interest rate exposure, providing a high current yield and protecting
principal. These objectives are implemented through a portfolio that emphasizes
investment grade, publicly traded fixed income securities. When impairment of
the value of an investment is considered other than temporary, the decrease in
value is recorded as an adjustment to the valuation reserve and a new cost basis
is established. At December 31, 2000, investments in non-investment grade
securities represented 5.8% of total investments. At December 31, 2000, fixed
income securities represented 96.3% of investments excluding the securities
lending collateral. Of the fixed income investment portfolio, 94.4% was
investment grade and 99.8% was publicly traded. The average quality of the
total fixed income portfolio was A+ at December 31, 2000, and the average option
adjusted duration of total investments was 4.4 years. There are no significant
investments in mortgage loans, real estate, foreign securities or privately
placed securities.
The Company's investments are managed by outside managers and advisors which
follow investment guidelines established by the Company. The Company has
separate investment strategies and guidelines for its property and casualty
assets and for its life and annuity assets, which recognize different
characteristics of the associated insurance liabilities, as well as different
tax and regulatory environments. The Company manages interest rate exposure for
its portfolios through asset/liability management techniques which attempt to
coordinate the duration of the assets with the duration of the liabilities under
insurance policies. Duration of assets and liabilities will generally differ
only because of opportunities to significantly increase yields or because policy
values are not interest-sensitive, as in the property and casualty segment.
The investments of each insurance subsidiary must comply with the insurance
laws of such insurance subsidiary's domiciliary state. These laws prescribe the
type and amount of investments that may be made by insurance companies. In
general, these laws permit investments, within specified limits and subject to
certain qualifications, in federal, state and municipal obligations, corporate
bonds, mortgage-backed bonds, other asset-backed bonds, preferred stocks, common
stocks, real estate mortgages and real estate.
24
The following table sets forth the carrying and market values of the
Company's investment portfolio as of December 31, 2000:
Investment Portfolio
(Dollars in millions)
Percentage Carrying Value
of Total -------------------------------------------
Carrying Life and Property and Amortized
Value Total Annuity Casualty Cost
----------- -------- ------------ --------- --------
Publicly Traded Fixed Maturity Securities
and Cash Equivalents:
U.S. government and agency obligations(1):
Mortgage-backed securities................ 17.3% $ 504.6 $ 462.0 $ 42.6 $ 495.7
Other..................................... 4.3 126.0 110.8 15.2 124.6
Investment grade corporate and public
utility bonds............................. 37.0 1,076.5 978.0 98.5 1,085.9
Municipal bonds............................. 10.1 295.1 7.7 287.4 286.4
Other mortgage-backed securities............ 13.8 400.3 359.4 40.9 398.4
Non-investment grade corporate and public
utility bonds(2).......................... 5.8 168.7 114.5 54.2 189.3
Foreign government bonds.................... 1.1 30.6 27.8 2.8 29.3
Short-term investments(3)................... 0.7 20.3 12.7 7.6 20.3
Short-term investments, loaned
securities collateral(3).................. 7.0 204.9 192.3 12.6 204.9
----- -------- -------- ------ --------
Total publicly traded securities........ 97.1 2,827.0 2,265.2 561.8 2,834.8
----- -------- -------- ------ --------
Other Investments:
Private placements, investment grade(4)..... 0.2 5.8 5.7 0.1 5.4
Private placements,
non-investment grade (2)(4)............... - 0.1 0.1 - 0.1
Mortgage loans and real estate(5)........... 0.6 17.3 17.3 - 17.3
Policy loans and other...................... 2.1 62.1 61.3 0.8 62.1
----- -------- -------- ------ --------
Total other investments................. 2.9 85.3 84.4 0.9 84.9
----- -------- -------- ------ --------
Total investments(6).................... 100.0% $2,912.3 $2,349.6 $562.7 $2,919.7
===== ======== ======== ====== ========
__________________
(1) Includes $244.8 million market value of investments guaranteed by the full
faith and credit of the United States government and $385.8 million market
value of federally sponsored agency securities.
(2) A non-investment grade rating is assigned to a security when it is acquired,
primarily on the basis of the Standard & Poor's Corporation ("Standard &
Poor's" or "S&P") rating for such security, or if there is no S&P rating,
the Moody's Investors Service, Inc. ("Moody's") rating for such security, or
if there is no S&P or Moody's rating, the National Association of Insurance
Commissioners (the "NAIC") rating for such security.
(3) Short-term investments mature within one year of being acquired and are
carried at cost, which approximates market value. Short-term investments
include $225.1 million in a money market fund rated "AAA" (S&P or its
equivalent) and $0.1 million in certificates of deposit. The Company loans
fixed income securities to third parties, primarily major brokerage firms.
The Company separately maintains a minimum of 100% of the value of the
loaned securities as collateral for each loan.
(4) Market values for private placements are estimated by the Company with the
assistance of its investment advisors.
(5) Mortgage loans are carried at amortized cost or unpaid principal balance
less valuation reserves and real estate acquired in the settlement of debt
is carried at the lower of cost or market. Carrying value is net of a $1.8
million valuation reserve for anticipated losses.
(6) Approximately 8% of the Company's investment portfolio, having a carrying
value of $240.3 million as of December 31, 2000, consisted of securities
with some form of credit support, such as insurance. All of these
securities have the highest investment grade rating.
25
Fixed Maturity Securities
The following table sets forth the composition of the Company's fixed
maturity securities portfolio by rating as of December 31, 2000:
Rating of Fixed Maturity Securities(1)
(Dollars in millions)
Percent
of Total
Carrying Carrying Amortized
Value Value Cost
-------- -------- ---------
AAA................................ 42.9% $1,118.9 $1,099.7
AA................................. 8.2 212.3 205.2
A.................................. 20.5 534.4 535.2
BBB................................ 22.8 595.6 608.5
BB................................. 1.3 35.3 38.9
B.................................. 4.0 103.0 116.4
CCC or lower....................... 0.1 1.8 4.0
Not rated(2)....................... 0.2 6.4 7.2
----- -------- --------
Total........................... 100.0% $2,607.7 $2,615.1
===== ======== ========
- -----------
(1) Ratings are as assigned primarily by S&P when available, with remaining
ratings as assigned on an equivalent basis by Moody's. Ratings for publicly
traded securities are determined when the securities are acquired and are
updated monthly to reflect any changes in ratings.
(2) This category includes $0.5 million of publicly traded securities not
currently rated by S&P, Moody's or the NAIC and $5.9 million of private
placement securities not rated by either S&P or Moody's. The NAIC has rated
98.0% of these private placement securities as investment grade.
At December 31, 2000, 35.8% of the Company's fixed maturity securities
portfolio was scheduled to mature within the next 5 years. Mortgage-backed
securities, including mortgage-backed securities of United States governmental
agencies, represented 31.1% of the total investment portfolio at December 31,
2000. These securities typically have average lives shorter than their stated
maturities due to unscheduled prepayments on the underlying mortgages. Mortgages
are prepaid for a variety of reasons, including sales of existing homes,
interest rate changes over time that encourage homeowners to refinance their
mortgages and defaults by homeowners on mortgages that are then paid by
guarantors.
For financial reporting purposes, the Company has classified the entire
fixed maturity portfolio as "available for sale". Fixed maturities to be held
for indefinite periods of time and not intended to be held to maturity are
classified as available for sale and carried at market value. Fixed maturities
held for indefinite periods of time include securities that management intends
to use as part of its asset/liability management strategy and that may be sold
in response to changes in interest rates, resultant prepayment risk and other
factors related to interest rate and resultant prepayment risk.
Cash Flow
As a holding company, HMEC conducts its principal operations through its
subsidiaries. Payment by HMEC of principal and interest with respect to HMEC's
indebtedness, and payment by HMEC of dividends to its shareholders, are
dependent upon the ability of its insurance subsidiaries to pay cash dividends
or make other cash payments to HMEC, including tax payments pursuant to tax
sharing agreements. Restrictions on the subsidiaries' ability to pay dividends
or to make other cash payments to HMEC may materially affect HMEC's ability to
pay principal and interest on its indebtedness and dividends on its common
stock.
The ability of the insurance subsidiaries to pay cash dividends to HMEC is
subject to state insurance department regulations which generally permit
dividends to be paid for any 12 month
26
period in amounts equal to the greater of (i) net gain from operations in the
case of a life insurance company or net income in the case of all other
insurance companies for the preceding calendar year or (ii) 10% of surplus as of
the preceding December 31st. Any dividend in excess of these levels requires the
prior approval of the Director or Commissioner of the state insurance department
of the state in which the dividend paying insurance subsidiary is domiciled. The
aggregate amount of dividends that may be paid in 2001 from all of HMEC's
insurance subsidiaries without prior regulatory approval is approximately $42
million.
Notwithstanding the foregoing, if insurance regulators otherwise determine
that payment of a dividend or any other payment to an affiliate would be
detrimental to an insurance subsidiary's policyholders or creditors, because of
the financial condition of the insurance subsidiary or otherwise, the regulators
may block dividends or other payments to affiliates that would otherwise be
permitted without prior approval.
The insurance subsidiaries' sources of funds consist primarily of premiums
and contract fees, investment income and proceeds from sales and redemption of
investments. Such funds are applied primarily to payment of claims, insurance
operating expenses, income taxes and the purchase of investments, as well as
dividends and other payments to HMEC.
Competition
The Company operates in a highly competitive environment. There are
numerous insurance companies that compete with the Company, although management
believes that the Company is the largest national multiline insurance company to
target the nation's educators as its primary market. In some specific instances
and geographic locations competitors have specifically targeted the educator
marketplace with specialized products and programs. The Company competes in its
target market with a number of national providers of personal automobile and
homeowners insurance and life insurance.
For annuity business, the marketplace has begun to see a competitive impact
from new entrants such as mutual funds and banks into the tax-deferred annuity
products market. Among the major national providers of annuities to educators,
Variable Annuity Life Insurance Company, a subsidiary of American General
Corporation, has been among the Company's major tax-qualified annuity
competitors. Mutual fund families, independent agent companies and financial
planners are also competitors of the Company. Management believes that the
significant expansion in 2000 in the number of mutual fund choices available
through the Company's tax-deferred annuity product will have a positive impact
on both retention and growth of its annuity business.
The Company competes with a number of national providers of automobile and
homeowners insurance, such as State Farm, Allstate and Nationwide, and several
regional companies. The Company also competes for automobile business with
certain direct marketing companies, such as 21st Century, American International
Group (AIG) and GEICO.
The insurance industry consists of a large number of insurance companies,
some of which have substantially greater financial resources, more diversified
product lines, and lower cost marketing approaches, such as direct marketing,
mail, internet and telemarketing, compared to the Company. The Company believes
that the principal competitive factors in the sale of property and casualty
insurance products are price, service, name recognition and education
association sponsorships. The Company believes that the principal competitive
factors in the sale of life
27
insurance and annuity products are product features, perceived stability of the
insurer, service, name recognition, education association sponsorships and
price.
Insurance Financial Ratings
The Company believes that the ratings assigned to its principal insurance
subsidiaries by A.M. Best, Standard & Poor's Corporation ("Standard and Poor's"
or "S&P"), Fitch, Inc. ("Fitch") (formerly Duff & Phelps Credit Rating Co.) and
Moody's Investors Service, Inc. ("Moody's") contribute to the Company's
competitiveness.
A.M. Best
HMIC, TIC, Allegiance and HM Lloyds are rated "A+ (Superior)" and HMLIC is
rated "A (Excellent)" by A.M. Best.
A.M. Best's ratings for the industry range from "A++ (Superior)" to "F (In
Liquidation)", and some companies are not rated. Publications of A.M. Best
indicate that the "A++ and A+ (Superior)" ratings are assigned to those
companies that in A.M. Best's opinion have, on balance, superior financial
strengths, operating performance and market profile when compared to the
standards established by A.M. Best and have a very strong ability to meet their
ongoing obligations to policyholders. The "A and A- (Excellent)" ratings are
assigned to those companies that in A.M. Best's opinion have, on balance,
excellent financial strengths, operating performance and market profile when
compared to the standards established by A.M. Best and have a strong ability to
meet their ongoing obligations to policyholders. In evaluating a company's
financial strength, operating performance and market profile, A.M. Best reviews
the company's leverage/capitalization, capital structure/holding company, credit
quality and appropriateness of reinsurance program, adequacy of loss/policy
reserves, quality and diversification of assets, liquidity, profitability,
revenue composition, management experience and objectives, market risk,
competitive market position, spread of risk and event risk. The objective of
A.M. Best's rating system is to provide an overall opinion of an insurance
company's ability to meet its obligations to policyholders.
Standard & Poor's
Each of HMEC's principal insurance subsidiaries is rated "AA- (Very
Strong)" for financial strength by Standard & Poor's, with the exception of HM
Lloyds which is not yet rated by Standard & Poor's. As a result of factors
impacting the Company's earnings for the three months ended December 31, 2000,
Standard & Poor's placed the Company's financial strength ratings on
"CreditWatch with negative implications." Management anticipates that the
CreditWatch status will be resolved in the second quarter of 2001, based on
further dialog between management and Standard and Poor's.
S&P publications define financial strength ratings as follows. A Standard &
Poor's Insurer Financial Strength Rating is a current opinion of the financial
security characteristics of an insurance organization with respect to its
ability to pay under its insurance policies and contracts in accordance with
their terms. This opinion is not specific to any particular insurance policy or
contract, nor does it address the suitability of a particular insurance policy
or contract for a specific purpose or purchaser. Furthermore, the opinion does
not take into account deductibles, surrender or cancellation penalties, the
timeliness of payment, or the likelihood of the use of a defense such as fraud
to deny claims. Insurer Financial Strength Ratings do not refer to an insurer's
ability to
28
meet nonpolicy obligations (i.e., debt contracts). The ratings are based on
current information furnished by the insurance company or obtained by S&P from
other sources it considers reliable. S&P does not perform an audit in connection
with any rating and may, on occasion, rely on unaudited financial information.
The ratings may be changed, suspended, or withdrawn as a result of changes in,
or unavailability of, such information or based on other circumstances.
Financial strength ratings are divided into two broad classifications. An
insurer rated "BBB" or higher is regarded as having financial security
characteristics that outweigh any vulnerabilities, and is highly likely to have
the ability to meet financial commitments. An insurer rated "BB" or lower is
regarded as having vulnerable characteristics that may outweigh its strengths.
"BB" indicates the least degree of vulnerability within the range; "CC" the
highest. Financial strength ratings are assigned at the request of the insurers
and based on extensive quantitative and qualitative analysis including
consideration of ownership and support factors, if applicable. The rating
process includes meetings with insurers' management. Plus (+) and minus (-)
signs show relative standing within a category; they do not suggest likely
upgrades or downgrades. Insurers rated "AAA" offer extremely strong financial
security characteristics. Insurers rated "AA" offer very strong financial
security. CreditWatch highlights the potential direction of a short- or long-
term rating. It focuses on identifiable events and short-term trends that cause
ratings to be placed under special surveillance by Standard & Poor's analytical
staff. Ratings appear on CreditWatch when such an event or a deviation from an
expected trend occurs and additional information is necessary to evaluate the
current rating. A CreditWatch listing, however, does not mean a rating change is
inevitable.
Fitch
Each of HMEC's principal insurance subsidiaries is rated "AA" for financial
strength by Fitch. As a result of factors impacting the Company's earnings for
the three months ended December 31, 2000, Fitch placed the Company's financial
strength ratings on "Rating Watch Negative." Management anticipates that the
Rating Watch status will be resolved in the second quarter of 2001, based on
further dialog between management and Fitch.
A Fitch Insurer Financial Strength Rating ("IFS Rating") provides an
assessment of the financial strength of an insurance organization, and its
capacity to meet senior obligations to policyholders and contractholders on a
timely basis. The IFS Rating is assigned to the insurance organization itself,
and no liabilities or obligations of the insurer are specifically rated unless
otherwise stated. The IFS Rating is based on a comprehensive analysis of
relevant factors that in large part determine an insurance organization's
financial strength, including its regulatory solvency characteristics,
liquidity, operating performance, financial flexibility, balance sheet strength,
management quality, competitive positioning and long-term business viability.
The IFS Ratings use a scale of "AAA" through "D". Ratings of "BBB-" and higher
are considered to be "Secure", and those of "BB+" and lower are considered to be
"Vulnerable". The IFS Rating of "AA" is assigned to insurers that are viewed by
Fitch as possessing very strong capacity to meet policyholder and contract
obligations. Risk factors are viewed to be modest, and the impact of any adverse
business and economic factors is expected to be very small. Placing a company's
ratings on "Ratings Watch Negative" reflects the apparent decline in key factors
upon which the rating is based. Being placed on watch, however, does not mean a
rating change is inevitable.
29
Moody's
HMLIC, HMIC and TIC are rated "A2 (Good)" for financial strength by
Moody's. Following the Company's preannouncement of earnings for the three
months ended December 31, 2000, Moody's affirmed the Company's ratings.
A Moody's Insurance Financial Strength Rating is an opinion of the ability
of a company to punctually repay senior policyholder obligations and claims.
Specific obligations are considered unrated unless individually rated. Moody's
Insurance Financial Strength Ratings are based on industry analysis, regulatory
trends, and an evaluation of a company's business fundamentals. Industry
analysis examines the structure of competition within the company's operating
environment and its competitive position within that structure. Analysis of
regulatory trends attempts to develop an understanding of potential changes in a
particular country's regulatory system, accounting system and tax structure. The
analysis of a company's business fundamentals focuses primarily on franchise
value, management, organizational structure/ownership and financial analysis.
The financial analysis includes an assessment of capital adequacy, investment
risk, asset/liability management, profitability, liquidity, underwriting,
reserve adequacy and financial leverage. Moody's rating symbols for insurance
financial strength ratings are broken down into nine distinct symbols ranging
from "Aaa (Exceptional)" to "C (Lowest)". These symbols comprise two distinct
groups - those with the greatest financial strength "Aaa (Exceptional)" to "Baa
(Adequate)" and those with the least financial strength "Ba (Questionable)" to
"C (Lowest)". Numeric modifiers are used to refer to the ranking within the
group - "1" being the highest and "3" being the lowest. However, the financial
strength of companies within a generic rating symbol is broadly the same.
Insurance Companies rated "A" offer good financial security. However, elements
may be present which suggest a susceptibility to impairment sometime in the
future.
Regulation
General Regulation at State Level
As an insurance holding company, HMEC is subject to regulation by the
states in which its insurance subsidiaries are domiciled or transact business.
Most states have enacted legislation that requires each insurance company in a
holding company system to register with the insurance regulatory authority of
its state of domicile and furnish to it financial and other information
concerning the operations of companies within the holding company system that
may materially affect the operations, management or financial condition of the
insurers within the system. All transactions within a holding company system
affecting insurers must be fair and equitable and the insurer's policyholder
surplus following any transaction must be both reasonable in relation to its
outstanding liabilities and adequate for its needs. Notice to applicable
regulators is required prior to the consummation of certain transactions
affecting insurance subsidiaries of the holding company system.
In addition, the laws of the various states establish regulatory agencies
with broad administrative powers to grant and revoke licenses to transact
business, regulate trade practices, license agents, require statutory financial
statements, and prescribe the type and amount of investments permitted. See
"Business - Investments" for discussion of investment restrictions or
limitations imposed upon the Company under applicable insurance laws and
regulations.
30
The NAIC annually calculates financial ratios to assist state insurance
regulators in monitoring the financial condition of insurance companies. A
"usual range" of results for each ratio is used as a benchmark. Separate ratios
are established for property and casualty and life insurance companies.
Departure from the usual range in any of the ratios could lead to inquiries from
individual state regulators, and further investigation or other actions may
result. In 1999, no unusual ratios were reported by the principal insurance
subsidiaries of HMEC.
As part of their regulatory oversight process, state insurance departments
routinely conduct detailed financial examinations (generally not more frequently
than once every three years) of the books, records and accounts of insurance
companies domiciled in their states. Typically, such examinations are conducted
concurrently by two or three states under guidelines promulgated by the NAIC. In
1999, routine financial examinations of HMLIC, HMIC, TIC and Allegiance were
completed for the period ended December 31, 1997. A routine examination of
Allegiance for the three year period ended December 31, 2000 was initiated in
December 2000. A routine examination of HM Lloyd's for the two year period ended
December 31, 2000 was initiated in January 2001. HM Lloyd's was formed and
commenced business in 1999. Management believes that HMEC and its subsidiaries
are in compliance in all material respects with all applicable regulatory
requirements.
The NAIC has adopted risk-based capital guidelines to evaluate the adequacy
of statutory capital and surplus in relation to an insurance company's risks.
State insurance regulations prohibit insurance companies from making any public
statements or representations with regard to their risk-based capital levels.
Based on current guidelines, the risk-based capital statutory requirements will
have no negative regulatory impact on the Company's insurance subsidiaries.
Assessments Against Insurers
Under insurance insolvency or guaranty laws in most states in which the
Company operates, insurers doing business therein can be assessed for
policyholder losses related to insolvencies of other insurance companies. The
amount and timing of any future assessments on the Company under these laws
cannot be reasonably estimated and are beyond the control of the Company. Most
of these laws do provide, however, that an assessment may be excused or deferred
if it would threaten an insurer's financial strength, and most assessments paid
by the Company pursuant to these laws may be used as credits for a portion of
the Company's premium taxes. The Company paid $0.1 million, $0.1 million and
$0.3 million in connection with insurer insolvency proceedings for the years
ended December 31, 2000, 1999 and 1998, respectively, of which $0, $0 and $0.2
million for the same periods, respectively, is recoverable as premium tax
credits in future periods.
Mandatory Insurance Facilities
The Company is required to participate in various mandatory insurance
facilities in amounts related to the amount of the Company's direct writings in
the applicable state. In 2000, the Company reflected a net loss from
participation in such mandatory pools and underwriting associations of $4.8
million before federal income taxes.
31
California Earthquake Authority
The California Earthquake Authority ("CEA") was formed by the California
Legislature to encourage companies to write residential property insurance in
California and began operating in December 1996. All companies which write
residential property insurance in California are also required to offer
earthquake coverage. The CEA operates as an insurance company providing
residential property earthquake coverage under policies sold by companies which
have chosen to participate in the CEA. The participating companies fund the CEA
and share in earthquake losses covered by the CEA in proportion to their market
share.
The Company has not joined the CEA. The Company's exposure to losses from
earthquakes is managed through its underwriting standards, its earthquake policy
coverage limits and deductible levels, and the geographic distribution of its
business, as well as its reinsurance program. After reviewing the exposure to
earthquake losses from its own policies and from participation in the CEA,
management believes it is in the Company's best economic interest to offer
earthquake coverage directly to its homeowners policyholders. See "Property and
Casualty--Property and Casualty Reinsurance."
Regulation at Federal Level
Although the federal government generally does not directly regulate the
insurance business, federal initiatives often impact the insurance business.
Current and proposed federal measures which may significantly affect the
insurance business include employee benefits regulation, controls on the costs
of medical care, medical entitlement programs such as Medicare, changes to the
insurance industry anti-trust exemption, minimum solvency requirements and
allowing national banks to engage in the insurance, annuity and mutual fund
businesses. With the passage of the Financial Services Modernization Act of
1999, it is possible there will be increased pressure for federal regulation of
the insurance industry.
Federal income taxation of the build-up of cash value within a life
insurance policy or an annuity contract could have a material adverse impact on
the Company's ability to market and sell such products. Various legislation to
this effect has been proposed in the past, but has not been enacted. Although no
such legislative proposals are known to exist at this time, such proposals may
be made again in the future.
The variable annuities underwritten by HMLIC and the mutual funds used as
investment vehicles for those products are regulated by the Securities and
Exchange Commission (the "SEC"). Horace Mann Investors, Inc., the broker-dealer
subsidiary of HMEC, performs certain management functions for the Company's
proprietary mutual funds and also is regulated by the SEC and the National
Association of Securities Dealers.
Employees
At December 31, 2000, the Company had approximately 2,700 employees,
including 978 full-time agents. The Company has no collective bargaining
agreement with any employees.
32
ITEM 2. Properties
HMEC's home office property at 1 Horace Mann Plaza in Springfield, Illinois
consists of an office building totaling approximately 230,000 square feet which
is owned by the Company. HMEC also owns buildings with an aggregate of
approximately 209,000 square feet at other locations in Springfield. These
properties are adequate and suitable for the Company's current and anticipated
future needs.
ITEM 3. Legal Proceedings
The Company is not currently party to any material pending legal
proceedings other than ordinary routine litigation incidental to its business.
See also "Note 11 - Contingencies - Lawsuits and Legal Proceedings" contained in
the Index to Financial Information on page F-1 herein.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
HMEC's common stock began trading on the New York Stock Exchange ("NYSE")
in November 1991 under the symbol of HMN at a price of $9 per share. The
following table sets forth the high and low sales prices of the common stock on
the NYSE Composite Tape and the cash dividends paid per share of common stock
during the periods indicated.
Market Price
---------------------- Dividend
Fiscal Period High Low Paid
------------- -------- --------- --------
2000:
Fourth Quarter....................... $22 3/16 $14 1/16 $0.105
Third Quarter........................ 16 1/2 12 0.105
Second Quarter....................... 18 5/8 12 5/8 0.105
First Quarter........................ 21 12 5/8 0.105
1999:
Fourth Quarter....................... $31 $19 1/8 $0.105
Third Quarter........................ 33 24 13/16 0.0925
Second Quarter....................... 27 3/16 20 1/4 0.0925
First Quarter........................ 29 3/8 21 9/16 0.0925
As of March 1, 2001, the approximate number of holders of common stock was
6,000.
In February 2001, the Company's Board of Directors announced a regular
quarterly dividend of $0.105 per share. The payment of dividends in the future
is subject to the discretion of the Board of Directors and will depend upon
general business conditions, legal restrictions and other factors the Board of
Directors of HMEC may deem to be relevant.
In May 1999, the Company's Board of Directors authorized the repurchase of
shares of the Company's common stock up to $100 million. This was in addition to
the $100 million stock repurchase programs announced in January 1998 and
February 1997. Since early 1997, the Company repurchased 8,165,100 shares, 17%
of the Company's shares outstanding at December 31, 1996, at an aggregate cost
of $203.7 million. Under the share repurchase program, shares
33
of common stock may be purchased from time to time through open market and
private purchases, as available. The repurchase of shares is financed through
use of cash and, when necessary, the existing bank line of credit. However, the
Company has not utilized the bank line of credit for share repurchases since the
second quarter of 1999.
During 2000, options were exercised for the issuance of 557,000 shares,
1.4% of the Company's shares outstanding at December 31, 1999.
As an insurance holding company, HMEC depends on dividends and other
permitted payments from its insurance subsidiaries to pay cash dividends to
shareholders of HMEC. The payment of dividends and such other payments to HMEC
by its insurance subsidiaries is restricted by the laws of each subsidiary's
state of domicile, and insurance regulators have authority in certain
circumstances to block payments of dividends and other amounts by the insurance
subsidiaries that would otherwise be permitted without regulatory approval. See
"Business - Cash Flow" and "Business - Regulation."
ITEM 6. Selected Financial Data
The information required by Item 301 of Regulation S-K is contained in the
table in Item 1--"Business--Selected Historical Consolidated Financial Data."
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The information required by Item 303 of Regulation S-K is contained in the
Index to Financial Information on page F-1 herein.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
The information required by Item 305 of Regulation S-K is contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contained in the Index to Financial Information on page F-1 herein.
ITEM 8. Consolidated Financial Statements and Supplementary Data
The Company's consolidated financial statements, the report of its
independent accountants and the selected quarterly financial data required by
Item 302 of Regulation S-K are contained in the Index to Financial Information
on page F-1 herein.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
ITEM 10. Directors and Executive Officers of the Registrant
The information required by Items 401 and 405 of Regulation S-K is
incorporated by reference to the Company's Proxy Statement for the 2001 Annual
Meeting of Shareholders.
34
ITEM 11. Executive Compensation
The information required by Item 402 of Regulation S-K is incorporated by
reference to the Company's Proxy Statement for the 2001 Annual Meeting of
Shareholders.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 403 of Regulation S-K is incorporated by
reference to the Company's Proxy Statement for the 2001 Annual Meeting of
Shareholders.
ITEM 13. Certain Relationships and Related Transactions
The information required by Item 404 of Regulation S-K is incorporated by
reference to the Company's Proxy Statement for the 2001 Annual Meeting of
Shareholders.
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) The following consolidated financial statements of the Company
listed below are contained in the Index to Financial Information on Page F-1
herein:
Consolidated Balance Sheets as of December 31, 2000, 1999 and 1998.
Consolidated Statements of Operations for the Years Ended December 31,
2000, 1999 and 1998.
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 2000, 1999 and 1998.
Consolidated Statements of Cash Flows for the Years Ended December 31,
2000, 1999 and 1998.
(a)(2) The following consolidated financial statement schedules of the
Company listed below are contained in the Index to Financial Information on page
F-1 herein:
Schedule I - Summary of Investments - Other than Investments in Related
Parties.
Schedule II - Condensed Financial Information of Registrant.
Schedules III and VI Combined - Supplementary Insurance Information and
Supplemental Information Concerning Property and Casualty Insurance Operations.
Schedule IV - Reinsurance.
(a)(3) The following items are filed as Exhibits. Management contracts and
compensatory plans are indicated by an asterisk (*).
35
Exhibit
No. Description
- ------- -----------
(3) Articles of incorporation and bylaws:
3.1 Restated Certificate of Incorporation of HMEC, filed with the
Delaware Secretary of State on October 6, 1989, incorporated by
reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1996, filed with the Securities and
Exchange Commission (the "SEC") on November 14, 1996.
3.1(a) Certificate of Amendment to Restated Certificate of Incorporation of
HMEC, filed with the Delaware Secretary of State on October 18,
1991, incorporated by reference to Exhibit 3.2 to HMEC's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1996, filed
with the SEC on November 14, 1996.
3.1(b) Certificate of Amendment to Restated Certificate of Incorporation of
HMEC, filed with the Delaware Secretary of State on August 23, 1995,
incorporated by reference to Exhibit 3.3 to HMEC's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1996, filed with
the SEC on November 14, 1996.
3.1(c) Certificate of Amendment to Restated Certificate of Incorporation of
HMEC, filed with the Delaware Secretary of State on September 23,
1996, incorporated by reference to Exhibit 3.4 to HMEC's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1996, filed
with the SEC on November 14, 1996.
3.1(d) Certificate of Amendment to Restated Certificate of Incorporation of
HMEC, filed with the Delaware Secretary of State on June 5, 1998,
incorporated by reference to Exhibit 3.1 to HMEC's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1998, filed with the SEC
on August 13, 1998.
3.1(e) Certificate of Amendment to Restated Certificate of Incorporation of
HMEC, filed with the Delaware Secretary of State on June 22, 2000,
incorporated by reference to Exhibit 3.1(e) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2000, filed with
the SEC on August 11, 2000.
3.2 Form of Certificate for shares of Common Stock, $0.001 par value per
share, of HMEC, incorporated by reference to Exhibit 4.5 to HMEC's
Registration Statement on Form S-3 (Registration No. 33-53118) filed
with the SEC on October 9, 1992.
3.3 Bylaws of HMEC, incorporated by reference to Exhibit 4.6 to HMEC's
Registration Statement on Form S-3 (Registration No. 33-80059) filed
with the SEC on December 6, 1995.
36
Exhibit
No. Description
- ------- -----------
(4) Instruments defining the rights of security holders, including indentures:
4.1 Indenture dated as of January 17, 1996, between HMEC and U.S. Trust
Company of California, N.A. as trustee, with regard to HMEC's 6 5/8%
Senior Notes Due 2006, incorporated by reference to Exhibit 4.4 to
HMEC's Annual Report on Form 10-K for the year ended December 31,
1995, filed with the SEC on March 13, 1996.
4.1(a) Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.1).
4.2 Certificate of Designations for HMEC Series A Cumulative Preferred
Stock (included in Exhibit 10.15).
(10) Material contracts:
10.1 Credit Agreement dated as of December 31, 1996 (the "Bank Credit
Facility") among HMEC, certain banks named therein and Bank of
America National Trust and Savings Association, as administrative
agent (the "Agent"), incorporated by reference to Exhibit 10.1 to
HMEC's Annual Report on Form 10-K for the year ended December 31,
1996, filed with the SEC on March 26, 1997.
10.2* Stock Subscription Agreement among HMEC (as successor to HME
Holdings, Inc.), The Fulcrum III Limited Partnership, The Second
Fulcrum III Limited Partnership and each of the Management
Investors, incorporated by reference to Exhibit 10.17 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1989,
filed with the SEC on April 2, 1990.
10.3* Horace Mann Educators Corporation Deferred Equity Compensation Plan
for Directors, incorporated by reference to Exhibit 10.1 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1996, filed with the SEC on November 14, 1996.
10.4* Horace Mann Educators Corporation Deferred Compensation Plan for
Employees, incorporated by reference to Exhibit 10.4 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1997,
filed with the SEC on March 30, 1998.
10.5* Amended and Restated Horace Mann Educators Corporation 1991 Stock
Incentive Plan, incorporated by reference to Exhibit 10.5 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1999,
filed with the SEC on March 30, 2000.
10.5(a)* Amendment to Amended and Restated Horace Mann Educators Corporation
1991 Stock Incentive Plan, incorporated by reference to Exhibit
10.1(a) to HMEC's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000, filed with the SEC on August 11, 2000.
37
Exhibit
No. Description
- ---- -----------
10.5(b)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.5(a) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1999, filed with the SEC on March
30, 2000.
10.5(c)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.5(b) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1999, filed with the SEC on March
30, 2000.
10.6* Severance Agreements between HMEC and certain officers of HMEC,
incorporated by reference to Exhibit 10.9 to HMEC's Annual Report
on Form 10-K for the year ended December 31, 1993, filed with the
SEC on March 31, 1994.
10.6(a)* Revised Schedule to Severance Agreements between HMEC and certain
officers of HMEC.
10.7* Horace Mann Incentive Compensation Program, incorporated by
reference to Exhibit 10.7 to HMEC's Annual Report on Form 10-K for
the year ended December 31, 1996, filed with the SEC on March 26,
1997.
10.8* Horace Mann Supplemental Employee Retirement Plan, 1997
Restatement, incorporated by reference to Exhibit 10.1 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1997, filed with the SEC on November 14, 1997.
10.9* Horace Mann Executive Supplemental Employee Retirement Plan, 1997
Restatement, incorporated by reference to Exhibit 10.2 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997,
filed with the SEC on August 14, 1997.
10.10* Amended and Restated Employment Agreement entered by and between
HMEC and Paul J. Kardos as of October 6, 1998, incorporated by
reference to Exhibit 10.2 to HMEC's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1998, filed with the SEC on
November 13, 1998.
10.10(a)* Amendment Agreement to the Amended and Restated Employment
Agreement entered by and between HMEC and Paul J. Kardos as of
October 6, 1998 dated as of February 1, 2000, incorporated by
reference to Exhibit 10.11(a) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1999, filed with the SEC on March
30, 2000.
38
Exhibit
No. Description
- ---- -----------
10.11* Employment Agreement entered by and between HMEC and Louis G.
Lower II as of December 31, 1999, incorporated by reference to
Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1999, filed with the SEC on March 30, 2000.
10.12* Separation Agreement entered by and between HMEC and Larry K.
Becker as of June 20, 2000, incorporated by reference to Exhibit
10.4 to HMEC's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2000, filed with the SEC on August 11, 2000.
10.13* Letter of Employment entered by and between HMEC and Peter H.
Heckman effective April 10, 2000, incorporated by reference to
Exhibit 10.14 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1999, filed with the SEC on March 30, 2000.
10.14* Letter of Employment entered by and between HMEC and Thomas K.
Manion effective July 6, 2000, incorporated by reference to Exhibit
10.5 to HMEC's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2000, filed with the SEC on August 11, 2000.
10.15 Catastrophe Equity Securities Issuance Option Agreement
(Catastrophe Equity Securities Issuance Option and Reinsurance
Option Agreement) entered by and between HMEC and Centre
Reinsurance, dated February 15, 1997 and related letter from Centre
Reinsurance, incorporated by reference to Exhibit 10.12 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1996,
filed with the SEC on March 26, 1997.
10.15(a) Amendment effective February 15, 1997 to Catastrophe Equity
Securities Issuance Option Agreement (Catastrophe Equity Securities
Issuance Option and Reinsurance Option Agreement), incorporated by
reference to Exhibit 10.1(a) to HMEC's Quarterly Report on Form
10-Q for the quarter ended March 31, 1998, filed with the SEC on
May 15, 1998.
10.15(b) Amendment effective February 15, 1997 to Catastrophe Equity
Securities Issuance Option and Reinsurance Option Agreement,
incorporated by reference to Exhibit 10.12(b) to HMEC's Annual
Report on Form 10-K for the year ended December 31, 1998, filed
with the SEC on March 31, 1999.
10.15(c) Amendment effective June 1, 1999 to Catastrophe Equity Securities
Issuance Option and Reinsurance Option Agreement, incorporated by
reference to Exhibit 10.1(c) to HMEC's Quarterly Report on Form
10-Q for the quarter ended September 30, 1999, filed with the SEC
on November 12, 1999.
39
Exhibit
No. Description
- ---- -----------
(11) Statement regarding computation of per share earnings.
(12) Statement regarding computation of ratios.
(21) Subsidiaries of HMEC.
(23) Consent of KPMG LLP.
(b) No reports on Form 8-K were filed by HMEC during the fourth quarter of
2000.
(c) See list of exhibits in this Item 14.
(d) See list of financial statement schedules in this Item 14.
Copies of Exhibits may be obtained by writing to Investor Relations, Horace Mann
Educators Corporation, 1 Horace Mann Plaza, Springfield, Illinois 62715-0001.
Persons requesting copies will be charged a reasonable fee to cover reproduction
and mailing expenses.
40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Horace Mann Educators Corporation has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
HORACE MANN EDUCATORS CORPORATION
/s/ Louis G. Lower II
- --------------------------------------
Louis G. Lower II
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of Horace Mann
Educators Corporation and in the capacities and on the date(s) indicated.
Principal Executive Officer: Directors:
/s/ Louis G. Lower II /s/ Ralph S. Saul
- -------------------------------------- --------------------------------------
Louis G. Lower II Ralph S. Saul, Chairman of the
President, Board of Directors
Chief Executive Officer and a Director
/s/ William W. Abbott
--------------------------------------
William W. Abbott, Director
--------------------------------------
Principal Financial Officer: Mary H. Futrell, Director
/s/ Peter H. Heckman /s/ Dr. Emita B. Hill
- -------------------------------------- --------------------------------------
Peter H. Heckman Dr. Emita B. Hill, Director
Executive Vice President and
Chief Financial Officer
--------------------------------------
Donald E. Kiernan, Director
--------------------------------------
Joseph J. Melone, Director
Principal Accounting Officer:
--------------------------------------
Jeffrey L. Morby, Director
/s/ Thomas K. Manion
- --------------------------------------
Thomas K. Manion /s/ Shaun F. O'Malley
Senior Vice President and Controller --------------------------------------
Shaun F. O'Malley, Director
Dated: March 29, 2001
/s/ Charles A. Parker
--------------------------------------
Charles A. Parker, Director
/s/ William J. Schoen
--------------------------------------
William J. Schoen, Director
41
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42
HORACE MANN EDUCATORS CORPORATION
INDEX TO FINANCIAL INFORMATION
Page
----
Management's Discussion and Analysis of
Financial Condition and Results of Operations......................... F- 2
Report of Management Responsibility for Financial Statements............ F-27
Independent Auditors' Report............................................ F-28
Consolidated Balance Sheets............................................. F-29
Consolidated Statements of Operations................................... F-30
Consolidated Statements of Changes in Shareholders' Equity.............. F-31
Consolidated Statements of Cash Flows................................... F-32
Notes to Consolidated Financial Statements
Note 1 - Summary of Significant Accounting Policies.................. F-33
Note 2 - Restructuring Charges....................................... F-43
Note 3 - Investments................................................. F-44
Note 4 - Debt and Warrants........................................... F-47
Note 5 - Shareholders' Equity and Stock Options...................... F-49
Note 6 - Income Tax.................................................. F-52
Note 7 - Fair Value of Financial Instruments......................... F-53
Note 8 - Statutory Surplus and Subsidiary Dividend Restrictions...... F-55
Note 9 - Pension Plans and Other Postretirement Benefits............. F-57
Note 10 - Reinsurance................................................. F-61
Note 11 - Contingencies............................................... F-62
Note 12 - Supplementary Data on Cash Flows............................ F-63
Note 13 - Segment Information......................................... F-64
Note 14 - Unaudited Interim Information............................... F-66
Financial Statement Schedules:
Schedule I - Summary of Investments-Other than
Investments in Related Parties...................................... F-67
Schedule II - Condensed Financial Information of Registrant........... F-68
Schedule III and VI Combined - Supplementary Insurance
Information and Supplemental Information Concerning
Property and Casualty Insurance Operations.......................... F-72
Schedule IV - Reinsurance............................................. F-73
F-1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in millions, except per share data)
Forward-looking Information
Statements made in the following discussion that state the Company's or
management's intentions, hopes, beliefs, expectations or predictions of the
future are forward-looking statements. It is important to note that the
Company's actual results could differ materially from those projected in such
forward-looking statements due to, among other risks and uncertainties inherent
in the Company's business, the following important factors:
. Changes in the composition of the Company's assets and liabilities through
acquisitions or divestitures.
. Prevailing interest rate levels, including the impact of interest rates on
(i) unrealized gains and losses on the Company's investment portfolio and
the related after-tax effect on the Company's shareholders' equity and
total capital and (ii) the book yield of the Company's investment
portfolio.
. The impact of fluctuations in the capital markets on the Company's ability
to refinance outstanding indebtedness or repurchase shares of the Company's
outstanding common stock.
. The frequency and severity of catastrophes such as hurricanes, earthquakes
and storms, and the ability of the Company to maintain a favorable
catastrophe reinsurance program.
. Future property and casualty loss experience and its impact on estimated
claims and claim adjustment expenses for losses occurring in prior years.
. The Company's ability to develop and expand its agency force and its direct
product distribution systems, as well as the Company's ability to maintain
and secure product sponsorships by local, state and national education
associations.
. The competitive impact of new entrants such as mutual funds and banks into
the tax deferred annuity products markets, and the Company's ability to
profitably expand its property and casualty business in highly competitive
environments.
. Changes in insurance regulations, including (i) those affecting the ability
of the Company's insurance subsidiaries to distribute cash to the holding
company and (ii) those impacting the Company's ability to profitably write
property and casualty insurance policies in one or more states.
. Changes in federal income tax laws and changes resulting from federal tax
audits affecting corporate tax rates or taxable income, and regulations
changing the relative tax advantages of the Company's life and annuity
products to customers.
. The Company's ability to maintain favorable claims-paying ability ratings.
. Adverse changes in policyholder mortality and morbidity rates.
. The resolution of legal proceedings and related matters.
F-2
Year Ended December 31, 2000 Compared To Year Ended December 31, 1999
The Horace Mann Value Proposition
In April 2000, the Company's management announced steps to re-energize the
Company's core business and accelerate growth of the Company's revenues and
profits. These initiatives are intended to make the Company's products more
responsive to customer needs and preferences and expand the Company's product
lines within the personal financial services segment; grow and strengthen the
agent force and make the Company's agents more productive by improving the
products, tools and support the Company provides to them; increase cross-selling
and improve retention in the existing book of business; expand the Company's
penetration of targeted geographic areas and new segments of the educator
market; and broaden the Company's distribution options to complement and extend
the reach of the Company's agent force.
Further analysis of these strategic initiatives was completed in the third
quarter of 2000. During the fourth quarter of 2000, management began
implementing specific plans that address the initiatives above. The Company has
begun targeting high-priority geographic markets with dedicated staff teams. New
compensation and evaluation systems are being implemented to improve the
performance of the Company's agents and agency managers. New approaches to
customer service are being developed and tested that will free agents to spend
more time selling. Additional distribution options are being examined to
capitalize fully on the value of the Company's payroll deduction slots in
schools across the country. And, the Company will increase its use of technology
to improve the efficiency of its agency force and its administrative operations.
The Horace Mann Value Proposition states the core of the Company's strategy
to reignite its growth: Provide lifelong financial well-being for educators and
their families through personalized service, advice and a full range of tailored
insurance and financial products.
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
Year Ended Growth Over
December 31, Prior Year
-------------- ----------------
2000 1999 Percent Amount
------ ------ ------- ------
Automobile and property (voluntary).. $473.2 $470.7 0.5% $ 2.5
Annuity deposits..................... 206.4 205.7 0.3% 0.7
Life................................. 121.8 120.4 1.2% 1.4
------ ------ -----
Subtotal - core lines............ 801.4 796.8 0.6% 4.6
Involuntary and other
property & casualty................ 20.3 24.4 -16.8% (4.1)
------ ------ -----
Total............................ $821.7 $821.2 0.1% $ 0.5
====== ====== =====
F-3
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
Year Ended Growth Over
December 31, Prior Year
-------------- ----------------
2000 1999 Percent Amount
------ ------ ------- ------
Automobile and property (voluntary).. $469.4 $465.0 0.9% $ 4.4
Annuity.............................. 17.0 16.7 1.8% 0.3
Life................................. 91.7 87.3 5.0% 4.4
------ ------ -----
Subtotal - core lines............ 578.1 569.0 1.6% 9.1
Involuntary and other
property & casualty................ 20.6 26.1 -21.1% (5.5)
------ ------ -----
Total............................ $598.7 $595.1 0.6% $ 3.6
====== ====== =====
For the year, premiums written and contract deposits for the Company's core
lines increased slightly compared to 1999, reflecting growth in each of the
Company's segments. This comparison includes the North Carolina settlement
described below. However, premiums written and contract deposits for the fourth
quarter of 2000 increased 3.6% over a year earlier, including a 13.2% growth in
new annuity deposits.
At December 31, 2000, the Company's exclusive agent force totaled 978, an
11.5% decline from a year earlier. The number of experienced agents in the agent
force, 668, was down 5.6% at December 31, 2000, compared to a year earlier. The
Company had higher than normal terminations of new and experienced agents in
2000, but those agents were generally the Company's less productive agents. As a
result, overall agent productivity is increasing. The Company is in the process
of changing what is expected from its agents. Through 2000, agent compensation
focus and rewards centered around profitability, service and tenure with the
Company. The new direction will continue to focus on profitability but will also
place a greater emphasis on individual agent productivity, new premium growth,
educator business, cross-selling and business retention. In addition, the
Company's agency management team has been strengthened through the promotions of
several of its most experienced and capable agents. Hiring of new agents during
2000 kept pace with the prior year. In 2000, modifications were made to agent
recruiting and the new agents' finance programs. And in 2001, new compensation
plans for all agents and agency managers will be implemented. Management
believes these actions along with other strategic initiatives will have a
positive impact on agent productivity in the future.
In March 2000, following lengthy negotiations, the North Carolina Rate
Bureau and that state's Commissioner of Insurance agreed to settle the
outstanding 1994, 1996 and 1999 private passenger automobile insurance rate
filing cases resulting in an adverse impact of approximately $250 million for
the insurance industry. Horace Mann's portion of the adverse settlement,
recorded in the first and fourth quarters of 2000, was $3.0 million pretax,
comprised of $2.3 million premium refunds and $0.7 million interest charges.
North Carolina is the Company's second largest property and casualty state
representing approximately 7% of total premiums.
Total voluntary automobile and homeowners premium written growth was 0.5%
for 2000, including the effect of the North Carolina settlement. The average
premium per policy increased for both automobile and homeowners, as did the
number of homeowners policies in force. The number of automobile policies in
force was slightly lower than year-earlier levels. Automobile insurance premium
decreased slightly ($2.7 million, or 0.8%) compared to 1999, and homeowners
F-4
premium increased 4.7% ($5.2 million). The property and casualty increase in
premiums resulted from growth in average premium per policy of 1% for automobile
and 2% for homeowners, compared to a year earlier. Over the prior 12 months,
unit growth was 0.5%, bringing policies in force at December 31, 2000 to
876,000. Compared to December 31, 1999, total property and casualty policies in
force increased 4,000 with an 8,000 unit increase in homeowners partially offset
by a decrease in automobile units.
Based on policies in force, the property and casualty 12-month retention
rate for new and renewal policies was 88%, comparable to the 12 months ended
December 31, 1999.
For the first time since the fourth quarter of 1998, annuity contract
deposits exceeded the same quarters in the prior year in both the third and
fourth quarters. The growth of 13.2% compared to the fourth quarter of 1999
included 44.7% growth in new single premium and rollover deposits. In May 2000,
the Company introduced two additional variable mutual fund investment options.
In September 2000, in time for the important back-to-school selling season, the
Company more than tripled the number of choices available to its customers by
introducing 21 new investment options in its tax-deferred annuity product line.
At the same time, the Company provided its agents with proprietary asset
allocation software that assists educator customers in selecting the best
retirement investment options for their individual needs and circumstances.
Compared to full year 1999, new annuity deposits increased 0.3%, reflecting
a 7.1% increase in new single premium and rollover deposits and a 2.1% decrease
in scheduled deposits received. New deposits to variable annuities decreased
6.3% and new deposits to fixed annuities were 11.5% higher than 1999. Variable
annuity accumulated funds on deposit at December 31, 2000 were $1.0 billion,
$96.6 million less than a year earlier, an 8.5% decrease. Variable annuity
accumulated deposit retention decreased 4.4 percentage points over the 12 months
to 84.1%. However, this retention for the last three months of 2000 showed
improvement at 87.3% following the Company's expansion of variable investment
options and implementation of proprietary asset allocation software. Fixed
annuity cash value retention for the 12 months ended December 31, 2000 was
88.7%, 3.6 percentage points lower than the same period last year; also showing
some improvement in the last three months of 2000 at 89.3%. Over the last 12
months, the number of annuity contracts outstanding increased 3.2%, or 4,000
contracts.
At December 31, 2000, approximately 71% of accumulated variable annuity
funds on deposit were in the Company's Equity and Balanced mutual funds.
Investment returns for these two funds have been less than their comparable
Lipper average returns in recent periods contributing to the higher level of
surrenders in 2000 compared to 1999. In 2000, the Company took actions to
increase the variable annuity options available to customers, as described
above, and also took steps to improve the returns of its proprietary mutual
funds.
Life premium growth was 1.2% for the year ended December 31, 2000, compared
to 1999. The life insurance in force lapse ratio was 9.0% for the twelve months
ended December 31, 2000, compared to 8.3% for the same period last year. Both
premium growth and the lapse ratio reflect the shift in new business over the
prior 18 months from whole life to term life insurance.
F-5
Net Investment Income
Investment income of $192.4 million for 2000 increased 2.2%, or $4.1
million, (2.1% after tax) compared to the prior year primarily due to growth in
the size of the investment portfolio. Average investments (excluding the
securities lending collateral) increased 1.1%, compared to 1999. The average
pretax yield on the investment portfolio was 7.1% (4.8% after tax) for 2000,
compared to a pretax yield of 7.0% (4.7% after tax) for 1999.
Realized Investment Gains and Losses
Net realized investment losses were $9.9 million for the year ended
December 31, 2000, compared to net realized investment losses of $8.0 million
for 1999. For both periods, most of the net realized gains and losses occurred
in the fixed income portfolios.
Benefits, Claims and Settlement Expenses
Year Ended Growth Over
December 31, Prior Year
--------------- ----------------
2000 1999 Percent Amount
------ ------ ------- ------
Property and casualty......... $417.4 $374.9 11.3% $42.5
Annuity....................... 1.6 - 1.6
Life.......................... 47.0 41.3 13.8% 5.7
------ ------ -----
Total....................... $466.0 $416.2 12.0% $49.8
====== ====== =====
Property and casualty
statutory loss ratio:
Before catastrophe losses. 81.9% 72.4% 9.5%
After catastrophe losses.. 85.2% 76.3% 8.9%
In 2000, the Company's benefits, claims and settlement expenses were
affected adversely by strengthening of prior years' reserves for property and
casualty claims and a higher level of non-catastrophe property losses.
In the fourth quarter of 2000, the Company conducted a comprehensive review
of all components of its property and casualty reserves. As a result of that
review, the Company increased total property and casualty reserves for prior
years by $24.7 million at December 31, 2000. This increase consisted of
approximately $6 million strengthening of prior years' direct reserves,
primarily automobile, based on the further analysis of adverse trends which
emerged during 2000. It also included an approximately $17 million reduction of
ceded reserves resulting from the adoption of a different actuarial method to
reflect more accurately prior years' loss experience. This reduction of the
ceded reserves was related to automobile facility business in four states,
primarily Massachusetts. Prior years' reserves for automobile and homeowners
business assumed from state reinsurance facilities were also strengthened by
$1.8 million. In total, these reserve actions result in a level of reserve
adequacy that is consistently conservative with the Company's estimates in
recent years but which, in hindsight, did not exist at year-end 1999.
For the full year, net strengthening of reserves to provide for the adverse
development of property and casualty claims occurring in prior years, excluding
involuntary business, was $20.9 million in 2000, compared to favorable
development of $7.6 million in 1999. Full year
F-6
strengthening of total reserves for property and casualty claims occurring in
prior years was $22.7 million in 2000, compared to favorable development of $4.6
million in 1999.
In 2000, the higher level of non-catastrophe property losses included: non-
catastrophe weather-related property claims; greater-than-expected fire losses;
and losses on lower value homes. The fourth quarter of 2000 was affected by
severe winter weather experienced in many areas of the country. The non-
catastrophe property loss ratio by quarter and for the full year was as follows:
Growth Over
2000 1999 Prior Year
---- ---- -----------
Non-catastrophe property
loss ratio for the:
Quarter ended March 31...... 79.0% 81.9% -2.9%
Quarter ended June 30....... 91.4% 72.8% 18.6%
Quarter ended September 30.. 82.8% 78.1% 4.7%
Quarter ended December 31... 80.7% 53.3% 27.4%
Year ended December 31...... 83.4% 71.0% 12.4%
After determining that the increase in non-catastrophe property losses
experienced in the early months of 2000 was due to underlying loss trends,
rather than the normal cyclicality of the property business, management began
and has continued to implement pricing, underwriting and loss control
initiatives. Although the Company's actions have begun to have a positive
impact, management expects that the full impact of these changes will not be
realized until well into 2001. Management anticipates that these actions will
enable the Company to improve the profitability of its existing book of
homeowners business and attract new business that meets its profitability
standards.
For 2000, the increase in non-catastrophe property losses more than offset
the Company's decline in catastrophe losses compared to the prior year.
Catastrophe losses were $16.2 million in 2000 and $19.6 million in 1999, a
decrease of 17.3%.
The voluntary automobile loss ratio excluding catastrophe losses was 80.9%
for 2000, 8.4 percentage points higher than the prior year. This increase was
primarily due to the strengthening of prior years' reserves in 2000 versus
favorable reserve development in 1999, which represented 7.2 percentage points
of the increase in the loss ratio. Also, on a per-policy basis for the year,
average voluntary automobile premium increased 1% and average current accident
year loss costs increased 2% compared to 1999.
During the fourth quarter of 2000, the Company also completed a thorough
review of its life and annuity reserves. The increase in annuity benefits of
$1.6 million recorded in 2000 represented mortality experience on annuity
contracts on payout status of which $1.3 million resulted from the application
of a more accurate reserving model.
Life mortality experience was somewhat higher in 2000 than in 1999. The
largest single item which caused the increase in life segment benefits was due
to positive experience in 1999 on a small closed block of individual accident
and health policies.
F-7
Interest Credited to Policyholders
Year Ended Growth Over
December 31, Prior Year
------------ ----------------
2000 1999 Percent Amount
----- ----- ------- ------
Annuity...................... $66.1 $67.2 -1.6% $(1.1)
Life......................... 26.5 24.4 8.6% 2.1
----- ----- -----
Total...................... $92.6 $91.6 1.1% $ 1.0
===== ===== =====
Interest credited to fixed annuity contracts decreased as the average
accumulated deposits for the year ended December 31, 2000 decreased 1% compared
to 1999. The fixed annuity average annual interest rate credited was 5.0% for
both 2000 and 1999. Life insurance interest credited increased as a result of
continued growth in the interest-sensitive life insurance reserves.
Operating Expenses
For 2000, operating expenses increased $18.2 million, or 16.6%, compared to
1999. First, expenses in 2000 included non-recurring charges of $0.7 million for
interest on the North Carolina settlement and $3.6 million, or approximately
$0.06 per share after tax benefits, attributable to the chief executive officer
transition. Second, in the fourth quarter of 2000 the Company wrote off $1.0
million book value of personal computers not compatible with the Company's
software upgrade and $2.5 million of previously capitalized software costs.
Third, operating expenses for 2000 included increased costs to support business
growth initiatives.
The total corporate expense ratio on a statutory accounting basis was 24.2%
for the year ended December 31, 2000, 2.1 percentage points higher than in 1999.
The property and casualty expense ratio, the 14th lowest of the 100 largest
property and casualty insurance groups for 1999 (the most recent industry
ranking available), was 20.8% for the year ended December 31, 2000, compared to
19.8% in 1999. The increase in these expense ratios primarily reflects the
modest level of premium growth, which was lower than anticipated, while
statutory expenses for the Company increased 9.7% including the items described
above.
Amortization of Policy Acquisition Expenses and Intangible Assets
For 2000, the combined amortization of policy acquisition expenses and
intangible assets of $64.8 million increased by $11.6 million, or 21.8%,
compared to 1999.
Amortization of intangible assets increased to $8.8 million for the year
ended December 31, 2000, compared to $0.2 million for 1999, reflecting the
higher level of amortization of the value of annuity business acquired in the
1989 acquisition of the Company ("Annuity VIF"). The negative amortization of
Annuity VIF for the full year 1999 included a $6.2 million reduction due to
favorable experience identified in 1999. The $5.2 million Annuity VIF
amortization recorded for 2000 reflected the scheduled increase in amortization,
the effect of higher than expected annuity surrenders in 2000 and the lower than
expected market value appreciation on the in force annuity business. Assuming
annuity surrenders return to expected levels, Annuity VIF amortization for 2001
is expected to be $4.5 million. Annuity VIF amortization was ($4.2) million,
$2.0 million and $5.6 million for the twelve months ended December 31, 1999,
1998 and 1997, respectively. The negative Annuity VIF amortization in 1999 was
partially offset by a $3.4 million increase in the amortization of annuity
policy acquisition costs deferred after the 1989 acquisition of the
F-8
Company. The amortization of the value of property and casualty business
acquired in the 1989 acquisition of the Company was completed in the third
quarter of 1999; amortization was $0.7 million for 1999.
Policy acquisition expenses amortized for the year ended December 31, 1999
of $53.0 million were $3.0 million lower than the current period including a
$1.5 million reduction recorded in 1999 to reflect favorable life mortality
estimates which resulted in higher anticipated future gross profits.
Income Tax Expense
Excluding the benefit in 2000 and the expense in 1999 related to the
Company's previously announced dispute with the Internal Revenue Service ("IRS")
regarding tax years 1994 though 1997, the effective income tax rate was -24.7%
for the year ended December 31, 2000, compared to 30.9% for 1999.
Interest of $2.1 million on refunds from the IRS for federal tax years 1994
and 1995 reduced the 2000 effective income tax rate 22.1 percentage points. The
refunds resulted from issues separate from the Company's dispute with the IRS
regarding tax years 1994 through 1997. Income from investments in tax-advantaged
securities reduced the effective income tax rate 45.1 and 4.6 percentage points
for the years ended December 31, 2000 and 1999, respectively. While the amount
of income from investment in tax-advantaged securities in 2000 was comparable to
a year earlier, the reduced level of income before income taxes in 2000 resulted
in this having a more significant impact on the effective income tax rate.
As previously reported, the Company has been contesting proposed additional
federal income taxes relating to a settlement agreement with the IRS for prior
years' taxes. (See "Year Ended December 31, 1999 Compared with Year Ended
December 31, 1998 - Income Tax Expense.") In the third quarter of 1999, the
Company recorded an additional federal income tax provision of $20 million
representing the maximum exposure of the Company to the IRS with regard to the
issue for all of the past tax years in question (1994 through 1997). In the
third and fourth quarters of 2000, the 1994 through 1996 exposure was resolved
resulting in a reduction of $8.7 million from the $20.0 million tax liability
established in 1999. Both of these amounts were included in net income for the
respective years but were excluded from operating income.
Operating Income
For the year ended December 31, 2000, operating income (net income before
the after-tax impact of realized investment gains and losses, restructuring
charges, litigation charges and provision for prior years' taxes) decreased
64.5%, or $45.6 million, and operating income per share on a diluted basis of
$0.61 decreased 64.1%, or $1.09 per share.
F-9
Full year 2000 operating income was significantly affected by the following
factors that occurred in the fourth quarter.
. $16.1 million after tax strengthening of prior years' reserves for property
and casualty claims;
. $2.9 million after tax of additional weather-related automobile and
property losses in December, compared to typical experience for that month;
. $1.6 million after tax charge related to life and annuity reserves as well
as the deferred acquisition costs and value of insurance in force assets
related to those segments;
. An after tax charge of $0.7 million representing all remaining expenses
related to the Company's change of chief executive officer during 2000;
. An after tax write off of $2.3 million in book value of personal computers
and previously capitalized software development costs; and
. A benefit of $2.1 million for interest on refunds from the IRS.
Operating income for the full year 2000 was also affected adversely by five
items from the first nine months of the year. (1) In the second quarter of 2000,
there was a higher level of non-catastrophe property losses including: losses on
lower value homes; non-catastrophe weather-related property claims; and greater-
than-expected fire losses. (2) Property and casualty reserve releases in 2000
through September 30 were lower than those for the first nine months of 1999.
(3) In the third quarter of 2000, there was a deterioration in voluntary
automobile loss trends. (4) In the first nine months of 2000, holding company
expenses were higher than the prior year including expenses attributable to the
chief executive officer transition and costs to support business growth
initiatives. And, (5) the Company's portion of the adverse automobile insurance
rate settlement in North Carolina, as described above, of $1.6 million after
tax, or approximately $0.04 per share, was recorded in the first quarter of
2000. (The full year charge was $1.9 million after tax, or $0.05 per share.) In
addition, operating income comparisons to prior year were adversely impacted by
non-recurring items in the first quarter of 1999, primarily in the life segment,
totaling approximately $0.04 per share, and a significant decrease in the fourth
quarter of 1999 in the amortization of Annuity VIF to reflect experience and
trends, which increased annuity segment operating income by approximately $0.10
per share in 1999.
F-10
Operating income by segment was as follows:
Year Ended Growth Over
December 31, Prior Year
--------------- ---------------------
2000 1999 Percent Amount
------ ------ ------- -----------
Property & casualty
Before catastrophe losses........ $ 19.4 $ 52.2 -62.8% $(32.8)
Catastrophe losses, after tax.... (10.5) (12.7) 2.2
------ ----- ------
Total including catastrophe
losses..................... 8.9 39.5 -77.5% (30.6)
Annuity............................ 19.3 27.3 -29.3% (8.0)
Life............................... 12.9 14.6 -11.6% (1.7)
Corporate and other expense........ (9.4) (4.4) (5.0)
Interest expense, after tax........ (6.6) (6.3) (0.3)
------ ------ ------
Total........................ $ 25.1 $ 70.7 -64.5% $(45.6)
====== ====== ======
Total before catastrophe
losses..................... $ 35.6 $ 83.4 -57.3% $(47.8)
====== ====== ======
Property and casualty
statutory combined ratio:
Before catastrophe losses...... 102.7% 92.2% 10.5%
After catastrophe losses....... 106.0% 96.1% 9.9%
Property and casualty segment operating income was lower than in 1999
primarily due to strengthening of prior years' reserves versus reserve releases
in 1999, a higher level of non-catastrophe property losses, a deterioration in
voluntary automobile loss trends in the third quarter of 2000, and an adverse
industry settlement of outstanding automobile insurance rate filing cases for
1994, 1996 and 1999 in North Carolina. The Company's portion of this
settlement, including interest, was $1.9 million after tax. Property and
casualty segment earnings for 2000 also were affected negatively by lower than
expected business volume in the automobile line partially offset by a $2.2
million decrease in after tax catastrophe losses. During 2000, the Company's
average voluntary automobile insurance premium per policy increased 1% while
average loss costs increased 2%, compared to the prior year. The Company's
plans to implement credit-based automobile and homeowners rates remain on track,
which management expects will have a positive impact on both loss ratios and
business growth for these products in the Company's target market.
The property and casualty combined ratio before catastrophes of 102.7% was
10.5 percentage points higher than 1999, reflecting the factors cited above.
Full year net strengthening of reserves to provide for the adverse development
of property and casualty claims occurring in prior years, excluding involuntary
business, was $13.6 million after tax in 2000, compared to favorable development
of $4.9 million after tax in 1999. Net strengthening of total reserves for
property and casualty claims occurring in prior years was $14.8 million after
tax in 2000, compared to favorable development of $3.0 million after tax in
1999, representing 5.6 percentage points of the increase in the combined ratio
before catastrophes.
Annuity segment operating income was below the 1999 total. In 2000,
increases in both annuity interest rate spreads and contract fees for the year
were offset by increased amortization expenses, higher operating expenses and
higher net mortality losses on annuity contracts in payout status. The
increased amortization of the value of annuity business acquired in the 1989
F-11
acquisition of the Company included the effect of the 1999 net reduction
reflecting favorable experience in prior periods and higher than expected
annuity surrenders during 2000. In 2000, operating expenses in the annuity
segment include a higher level of new product development costs. For 2000, the
net interest margin increased 3.1% and fees and contract charges earned
increased 1.8%. Variable annuity accumulated deposits were $1.0 billion at
December 31, 2000, $96.6 million, or 8.5%, less than 12 months earlier. Fixed
annuity accumulated cash value of $1.3 billion was $23.8 million, or 1.8%, less
than December 31, 1999.
Life insurance earnings for the full year 1999 reflected lower expenses
resulting from a decrease in the amortization of deferred policy acquisition
costs to reflect favorable mortality estimates and positive experience on a
small closed block of accident and health business. Excluding those items, life
operating income in 2000 was comparable to a year earlier. Mortality costs for
2000 were somewhat higher than in the prior year.
The 2000 Corporate and Other Expense category in the preceding table
reflects higher holding company expenses, including outside consulting fees to
support business growth initiatives and charges related to the chief executive
officer transition.
Net Income
Net Income Per Share, Diluted
Year Ended Growth Over
December 31, Prior Year
------------------- ------------------
2000 1999 Percent Amount
------ ------ ------- -----------
Operating income.................... $ 0.61 $ 1.70 -64.1% $(1.09)
Realized investment gains (losses).. (0.15) (0.13) (0.02)
Restructuring charges............... (0.04) - (0.04)
Litigation charges.................. (0.12) (0.02) (0.10)
Provision for prior years' taxes.... 0.21 (0.48) 0.69
------ ------ ------
Net income........................ $ 0.51 $ 1.07 -52.3% $(0.56)
====== ====== ======
Net income, which includes realized investment gains and losses,
restructuring charges, litigation charges and the provision for prior years'
taxes, for the year ended December 31, 2000 decreased by $23.7 million, or
53.3%, and net income per diluted share decreased by 52.3% compared to 1999.
This change includes the $45.6 million decline in operating income partially
offset by the $8.7 million benefit in the current period related to prior years'
taxes compared to the $20.0 million provision recorded in 1999 (see the
description above). Net income also reflected $6.4 million of after tax
realized investment losses for the year, compared to $5.2 million of after tax
realized investment losses in 1999.
In addition, the Company had three items that were unusual in nature and did
not impact operating income. (1) The provision for prior years' taxes is
described above.
(2) In December 2000, the Company recorded restructuring charges of $2.2
million pretax ($1.5 million, or $0.04 per share, after tax) reflecting two
changes in the Company's operations. Specifically, the Company restructured the
operations of its group insurance business, thereby eliminating 39 jobs, and its
credit union marketing group, eliminating 20 additional positions. The changes
will improve business results and more closely align these functions with the
Company's
F-12
strategic direction. Employee termination costs, which represent severance,
vacation buy-out and related payroll taxes, represented $1.8 million pretax of
the total accrued. The eliminated positions encompass management, professional
and clerical responsibilities. Termination of lease agreements for office space
used by the credit union marketing group represented $0.3 million pretax of the
total accrued. The remaining $0.1 million pretax was primarily attributable to
the write-off of software related to these two areas. Restructuring charges have
been separately identified in the Statement of Operations for the year ended
December 31, 2000. None of the restructuring costs were paid as of December 31,
2000.
(3) The Company recorded litigation charges in both 2000 and 1999. In
December 2000, the Company recorded an after tax charge of $5.0 million,
representing the Company's best estimate of the actual and anticipated costs of
defending and ultimately resolving litigation brought against the Company in
regards to its disability insurance product. The lawsuit is on behalf of certain
policyholders who purchased the Company's disability insurance product and
allege that they were not adequately made aware of certain features. While the
actual costs for the Company to resolve this issue could be either less or more
than the liability established in 2000, management believes that, based on facts
and circumstances available at the time, the amount recorded will be adequate to
resolve the matter. Disability insurance represented less than 1% of the
Company's insurance premiums written and contract deposits for the year ended
December 31, 2000. During the second quarter of 2000, all remaining suits that
had been filed in Alabama related to life insurance policies were settled at a
cost of $0.1 million after tax and after receipt of insurance proceeds. In 1999,
a charge of $1.0 million after tax and after receipt of insurance proceeds was
recorded for the litigation in Alabama.
Return on shareholders' equity was 6% based on operating income and 5%
based on net income for the 12 months ended December 31, 2000.
Year Ended December 31, 1999 Compared With Year Ended December 31, 1998
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
Year Ended Growth Over
December 31, Prior Year
-------------- -----------------
1999 1998 Percent Amount
------ ------ -------- -------
Automobile and property
(voluntary).............. $470.7 $459.0 2.5% $ 11.7
Annuity deposits........... 205.7 223.3 -7.9% (17.6)
Life....................... 120.4 116.7 3.2% 3.7
------ ------ ------
Subtotal - core lines.. 796.8 799.0 -0.3% (2.2)
Involuntary and other
property & casualty...... 24.4 28.8 -15.3% (4.4)
------ ------ ------
Total.................. $821.2 $827.8 -0.8% $ (6.6)
====== ====== ======
F-13
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
Year Ended Growth Over
December 31, Prior Year
-------------- -----------------
1999 1998 Percent Amount
------ ------ -------- -------
Automobile and property
(voluntary).............. $465.0 $449.9 3.4% $15.1
Annuity.................... 16.7 15.6 7.1% 1.1
Life....................... 87.3 85.8 1.7% 1.5
------ ------ -----
Subtotal - core lines.. 569.0 551.3 3.2% 17.7
Involuntary and other
property & casualty...... 26.1 26.5 -1.5% (0.4)
------ ------ -----
Total.................. $595.1 $577.8 3.0% $17.3
====== ====== =====
The property and casualty and life segments both experienced modest premium
growth for 1999. Nonetheless, total insurance premiums written and contract
deposits showed no growth for the year because of a decline in new annuity
deposits. Annuity growth of 12.1% for 1998 benefitted from new tax legislation
which contributed to a high volume of single premium and rollover deposits to
tax-qualified products. In 1999, single premium annuity deposits declined
significantly, (20.7%), compared to 1998.
The Company ended 1999 with 708 experienced exclusive full-time agents, a
growth of 2.3% compared to 12 months earlier. The total agency force of 1,105
agents decreased 2.0% compared to a year earlier as a result of fewer hires and
increased terminations over the 12-month period. Modifications were made to
agent recruiting and the new agents' finance programs that management believes
will have a positive impact on agent growth in future years.
Total voluntary automobile and homeowners premium written growth was 2.5%
for 1999, resulting from growth in the average premium per policy for both
automobile and homeowners and an increase in the number of homeowners policies
in force. Automobile insurance premium increased 1.0%, or $3.7 million, compared
to 1998, and homeowners premium increased 7.8%, or $8.0 million. Nearly one-half
of the property and casualty increase in premiums resulted from unit growth of
1.5%, bringing 1999 year-end policies in force to 872,000. Compared to December
31, 1998, total property and casualty policies in force increased 13,000, the
entire increase attributable to homeowners insurance. The Company's average
annual premium per policy for automobile and homeowners increased approximately
1% and 3%, respectively, compared to a year earlier. While automobile policies
in force ended the year equal to 1998, the 1% increase in average premium per
automobile policy kept pace with loss cost developments.
Based on policies in force, the property and casualty 12-month retention
rate for new and renewal policies was 88%, slightly less than for the 12 months
ended December 31, 1998. The change in property and casualty retention was
primarily caused by greater price competition for automobile insurance.
New annuity deposits decreased 7.9% compared to 1998, with a 5.4% decline
in the fourth quarter. The full year decline was primarily attributable to a
20.7% decrease in 1999 in single premium deposits, which in 1998 benefitted from
new tax legislation which contributed to a high volume of single premium and
rollover deposits to tax-qualified products. The change in new annuity deposits
also included an 0.8% increase in scheduled deposits received. New deposits
F-14
to variable annuities decreased 6.8% and new deposits to fixed annuities were
9.7% lower than in 1998. Variable annuity accumulated funds on deposit at
December 31, 1999 were $1.1 billion, $8.9 million more than a year earlier, an
0.8% increase. However, variable annuity deposit retention decreased 4
percentage points over the 12 months to 89.4%. Deposits in the three additional
mutual funds introduced by the Company in March 1997 increased to $145 million
at December 31, 1999 from $70 million 12 months earlier. Fixed annuity cash
value retention for the 12 months ended December 31, 1999 was 92.3%, 0.5
percentage points lower than 1998. Over the 12 months of 1999, the number of
annuity contracts outstanding increased 4.2%, or 5,000 contracts.
Life premium growth was 3.2% for the year ended December 31, 1999. This
growth included new business from term life products introduced early in 1997
and a new series of whole life products introduced late in the third quarter of
1998 and reflects an insurance in force lapse ratio of 8.3%. Customer acceptance
of these new products continued to grow, as they accounted for approximately
half of the Company's new life sales in 1999.
Net Investment Income
Investment income of $188.3 million for 1999 decreased 1.8%, or $3.4
million, (1.2% after tax) compared to 1998 due to a decline in the average yield
on the investment portfolio that resulted from a steady decline in interest
rates from early-1997 until early-1999 and because the yield available in the
bond market in 1998 and 1999 was lower than the imbedded yield of the portfolio
during most of this period. There was also minimal growth in the investment
portfolio. The average pretax yield on the investment portfolio was 7.0% (4.7%
after tax) for 1999 compared to a pretax yield of 7.2% (4.8% after tax) for
1998, a decrease of 18 basis points, or 2.5%. Average investments (excluding the
securities lending collateral) increased only slightly during 1999 reflecting
modest growth in business, customers' preference for variable as opposed to
fixed annuity contracts and the utilization of capital for the share repurchase
program. All of the investment income decrease in the annuity segment was offset
by a reduction in interest credited to fixed annuity deposits.
Realized Investment Gains and Losses
Net realized investment losses were $8.0 million for the year ended
December 31, 1999, compared to net realized investment gains of $9.9 million in
1998. Most of the net realized gains and losses occurred in the fixed income
portfolios. The net realized investment losses in 1999 were about two-thirds due
to credit decisions and rate of return considerations in the Company's fixed
income investment portfolio and about one-third due to the sale of U.S. Treasury
securities for duration management purposes in a rising interest rate
environment. Realized investment gains in 1998 included calls and tenders in the
Company's bond portfolio as well as credit and rate of return decisions.
F-15
Benefits, Claims and Settlement Expenses
Year Ended Growth Over
December 31, Prior Year
---------------- -----------------
1999 1998 Percent Amount
------- ------- -------- -------
Property and casualty.... $374.9 $354.4 5.8% $20.5
Life..................... 41.3 41.9 -1.4% (0.6)
------ ------ -----
Total.................. $416.2 $396.3 5.0% $19.9
====== ====== =====
Property and casualty
statutory loss ratio:
Before catastrophes.. 72.4% 68.5% 3.9%
After catastrophes... 76.3% 74.4% 1.9%
Property and casualty claims and settlement costs reflected a high level of
catastrophe losses in both years and an increase in fire and non-catastrophe
weather claims in 1999. Although catastrophe losses in 1999 were lower than in
1998, the second quarter of 1999 was the Company's second-worst ever, trailing
only the record set in the second quarter of 1998, as policyholders in 25 states
incurred damages from 13 separate events. Also, Hurricane Floyd in the third
quarter of 1999, with claims of $5.4 million for the Company, was the worst
storm for the Company and the industry in 1999. The fourth quarter 1999
homeowners loss ratio was 55.9%, 40.5 percentage points lower than in the first
nine months of 1999, reflecting the impact of weather on this line of business,
and 1.8 percentage points greater than the fourth quarter of 1998. Catastrophe
losses were $0.7 million in the fourth quarter of 1999 and $2.7 million in the
fourth quarter of 1998.
In 1999, the increase in the Company's average voluntary automobile
insurance premium per policy kept pace with loss cost developments. This
favorable result reflected a number of operational changes, principally savings
realized to date from new claims evaluation software that was fully installed by
June 1999.
Property and casualty results for 1999 included continuation of favorable
development of prior years reserves, although at a lower level than in 1998.
Favorable development of property and casualty claims occurring in prior years,
excluding involuntary business, was $7.6 million in 1999, compared to $23.3
million in 1998. Favorable development of total property and casualty claims
occurring in prior years was $4.6 million in 1999, compared to $24.9 million in
1998.
Life mortality was slightly lower in 1999 than in 1998. The decrease in
life segment benefits primarily resulted from positive experience on a small
closed block of individual accident and health policies.
F-16
Interest Credited to Policyholders
Year Ended Growth Over
December 31, Prior Year
---------------- -----------------
1999 1998 Percent Amount
----- ----- ------- ------
Annuity.......................... $67.2 $72.0 -6.7% $(4.8)
Life............................. 24.4 22.8 7.0% 1.6
----- ----- -----
Total.......................... $91.6 $94.8 -3.4% $(3.2)
===== ===== =====
Interest credited to fixed annuity contracts decreased in 1999 as the fixed
annuity average annual interest rate credited decreased 0.4 percentage points to
5.0% in 1999, compared to a rate of 5.4% in 1998. In addition, the average
accumulated deposits for the year ended December 31, 1999 increased only
slightly compared to the same period in 1998. Life insurance interest credited
increased in 1999 as a result of continued growth in the interest-sensitive life
insurance reserves.
Operating Expenses
For 1999, operating expenses were equal to 1998, including the deferral of
additional acquisition costs. The Company began deferring additional sales-
related costs in 1999 for all new life and annuity contracts, consistent with
common industry accounting practices. This change increased acquisition costs
deferred by $4.8 million for the year ended December 31, 1999. Excluding the
deferral of additional sales-related costs, operating expenses for 1999
increased $4.8 million, or 4.4%, compared to 1998. In 1999, the Company's
operating expenses included $2.3 million attributable to additional employee
health insurance costs, compared to 1998.
The total corporate expense ratio on a statutory accounting basis was 22.1%
for the year ended December 31, 1999, 0.9 percentage points higher than in 1998.
The property and casualty expense ratio was 19.8% for the year ended December
31, 1999, compared to 19.3% in 1998. The increase in these expense ratios
primarily reflects the modest level of premium growth and additional employee
health insurance expense.
Amortization of Policy Acquisition Expenses and Intangible Assets
For 1999, the combined amortization of policy acquisition expenses and
intangible assets of $53.3 million increased by $0.9 million, or 1.7%, compared
to $52.4 million for 1998. Amortization of intangible assets decreased by $6.7
million to $0.2 million for the year ended December 31, 1999, compared to $6.9
million for 1998. Experience and trends in the Company's annuity business
identified in 1999 produced a $6.2 million reduction in the amortization of the
value of annuity business acquired in the 1989 acquisition of the Company
partially offset by a $3.4 million increase in the amortization of annuity
acquisition costs deferred after the 1989 acquisition of the Company.
Also in 1999, the amortization of life deferred acquisition costs decreased
$1.5 million to reflect then-current mortality estimates, resulting in higher
anticipated future gross profits. The amortization of the value of property and
casualty business acquired in the 1989 acquisition of the Company was completed
in 1999.
F-17
Income Tax Expense
Excluding the $20.0 million additional provision for prior years' taxes, the
effective income tax rate was 30.9% for the year ended December 31, 1999,
compared to 27.0% for 1998. Income from investments in tax-advantaged
securities reduced the effective income tax rate 4.6 and 3.2 percentage points
for the years ended December 31, 1999 and 1998, respectively. In 1998, non-
recurring tax benefits reduced the effective rate 5.6 percentage points and
contributed $6.5 million, or $0.15 per share, to operating income for the year.
As previously reported, the Company has been contesting proposed additional
federal income taxes relating to a settlement agreement with the Internal
Revenue Service ("IRS") for prior years' taxes. Based on developments in that
process during 1999, it appeared that the Company could be forced to litigate
the issue with the IRS in order to reach a resolution of the issue acceptable to
the Company. Therefore, in the third quarter of 1999, the Company recorded an
additional federal income tax provision of $20 million representing the maximum
exposure of the Company to the IRS with regard to the issue for all of the past
tax years in question (1994 through 1997). While the ultimate resolution of the
issue, through settlement or litigation, may result in the Company paying less
than the maximum exposure, given the vagaries of litigation and of reaching an
acceptable agreement with the IRS, management believed it prudent to book the
maximum exposure in 1999. This reserve was a charge to net income in 1999 but
was excluded from the determination of reported operating income.
F-18
Operating Income
For the year ended December 31, 1999, operating income (net income before
the after-tax impact of realized investment gains and losses, litigation charges
and provision for prior years' taxes) decreased 10.4%, or $8.2 million, and
operating income per share on a diluted basis of $1.70 decreased 5.6%, or $0.10
per share. Results for 1999 were lower than the prior year due principally to
non-recurring tax benefits in 1998 of $6.5 million, or $0.15 per share.
Operating income by segment was as follows:
Year Ended Growth Over
December 31, Prior Year
------------------- ----------------------
1999 1998 Percent Amount
---- ---- ------- ------
Property & casualty
Before catastrophe losses and
non-recurring tax benefits.......... $ 52.2 $ 65.2 -19.9% $(13.0)
Catastrophe losses, after tax......... (12.7) (18.5) -31.4% 5.8
Non-recurring tax benefits............ - 6.5 -100.0% (6.5)
------ ------ ------
Total including catastrophe losses
and non-recurring tax benefits.... 39.5 53.2 -25.8% (13.7)
Annuity................................. 27.3 23.1 18.2% 4.2
Life.................................... 14.6 12.4 17.7% 2.2
Corporate and other expense............. (4.4) (3.6) (0.8)
Interest expense........................ (6.3) (6.2) (0.1)
------ ------ ------
Total............................... $ 70.7 $ 78.9 -10.4% $ (8.2)
====== ====== ======
Total before catastrophe losses
and non-recurring tax benefits.... $ 83.4 $ 90.9 -8.3% $ (7.5)
====== ====== ======
Property and casualty
statutory combined ratio:
Before catastrophe losses........... 92.2% 87.7% 4.5%
After catastrophe losses............ 96.1% 93.6% 2.5%
Property and casualty segment operating income was lower than in 1998 due
primarily to a non-recurring tax benefit in 1998 and a lower level of favorable
development of prior years' reserves than in 1998. Favorable development of
property and casualty claims occurring in prior years (excluding involuntary
business), was $4.9 million after tax in 1999, compared to $15.1 million after
tax in 1998. Favorable development of total property and casualty claims
occurring in prior years was $3.0 million after tax in 1999, compared to $16.2
million after tax in 1998. During 1999, the Company's increase in average
voluntary automobile insurance premium kept pace with loss cost developments.
The homeowners combined ratio of 105.8% was 5.0 percentage points better than in
1998, reflecting the decline in catastrophe losses. However, catastrophe losses
in both years were significant as the second quarter of 1999 represented the
Company's second-worst ever for catastrophe losses, trailing only the record set
in the second quarter of 1998, with an unusually large number of catastrophes
that were widespread across the country. Hurricane Floyd in the third quarter
of 1999 with claims of $3.5 million after tax for the Company was the worst
storm for the Company and the industry in 1999.
The 18.2% increase in annuity segment operating income for 1999 was driven
by lower expenses, an increase of 7.7% in the net interest margin and a 9.6%
increase in fees and contract charges earned. The reduction in expenses
resulted from the deferral of additional sales-related
F-19
costs and a net decrease in the amortization of the value of acquired insurance
in force and deferred acquisition costs to reflect recent experience and trends.
The net deferral of additional sales-related costs contributed $1.2 million to
operating income for the year ended December 31, 1999. Variable annuity
accumulated deposits were $1.1 billion at December 31, 1999, $8.9 million, or
0.8%, more than 12 months earlier. Fixed annuity accumulated cash value of $1.4
billion was comparable to December 31, 1998.
The increase in life insurance earnings for 1999 reflected slightly lower
mortality costs and lower expenses. The expense reductions were due to the $1.9
million after tax net deferral of additional sales-related costs and a decrease
in the amortization of deferred acquisition costs to reflect current mortality
estimates.
Net Income
Net Income Per Share, Diluted
Year Ended Growth Over
December 31, Prior Year
------------------ ------------------
1999 1998 Percent Amount
---- ---- ------- ------
Operating income.................... $ 1.70 $ 1.80 -5.6% $(0.10)
Realized investment gains (losses).. (0.13) 0.15 (0.28)
Litigation charges.................. (0.02) - (0.02)
Provision for prior years' taxes.... (0.48) - (0.48)
------ ------ ------
Net income.......................... $ 1.07 $ 1.95 -45.1% $(0.88)
====== ====== ======
Net income, which includes realized investment gains and losses, litigation
charges and the provision for prior years' taxes, for the year ended December
31, 1999 decreased by 47.8% and net income per diluted share decreased by 45.1%
compared to 1998. Two non-recurring charges were recorded in the third quarter
of 1999 that reduced 1999 net income: an additional federal income tax
provision of $20.0 million, or $0.48 per share, representing the Company's
maximum exposure for disputed prior years' taxes; and a net cost of $1.0 million
(after insurance proceeds), or $0.02 per share, to settle certain litigation in
Alabama related to life insurance policies. The settlement of litigation in
Alabama included the lawsuit in which a verdict of $12.35 million was rendered
against the Company on June 25, 1999 as well as 39 other suits brought by the
same law firm and 6 other cases represented by another law firm but of a similar
nature. Net income also reflected $5.2 million of after tax realized investment
losses for the year ended December 31, 1999, compared to $6.4 million of after
tax realized investment gains in 1998.
Return on shareholders' equity based on operating income for the last 12
months was 16%. Based on net income, return on equity was 10% for the last 12
months.
Liquidity and Financial Resources
Investments
The Company's investment strategy emphasizes investment grade, publicly
traded fixed income securities. At December 31, 2000, fixed income securities
represented 96.3% of investments excluding the securities lending collateral.
Of the fixed income investment portfolio, 94.4% was investment grade and 99.8%
was publicly traded. The average quality of the total fixed income portfolio
was A+ at December 31, 2000.
F-20
The duration of the investment portfolio is managed to provide cash flow to
satisfy policyholder liabilities as they become due. The average option
adjusted duration of total investments was 4.4 years at December 31, 2000 and
4.1 years at December 31, 1999. The Company has included in its annuity
products substantial surrender penalties to reduce the likelihood of unexpected
increases in policy or contract surrenders. All annuities issued since 1982 and
approximately 78% of all outstanding fixed annuity accumulated cash values are
subject in most cases to substantial early withdrawal penalties.
Cash Flow
The short-term liquidity requirements of the Company, within a 12-month
operating cycle, are for the timely payment of claims and benefits to
policyholders, operating expenses, interest payments and federal income taxes.
Cash flow in excess of these amounts has been used to fund business growth,
retire short-term debt, pay dividends to shareholders and repurchase shares of
the Company's common stock. Long-term liquidity requirements, beyond one year,
are principally for the payment of future insurance policy claims and benefits
and retirement of long-term notes.
Operating Activities
As a holding company, HMEC conducts its principal operations in the personal
lines segment of the property and casualty and life insurance industries through
its subsidiaries. HMEC's insurance subsidiaries generate cash flow from premium
and investment income, generally well in excess of their immediate needs for
policy obligations, operating expenses and other cash requirements. Cash
provided by operating activities primarily reflects net cash generated by the
insurance subsidiaries. Net cash provided by operating activities was
approximately $24 million less than in 1999 as a result of an increase in claims
paid, primarily automobile, and expenses.
Payment of principal and interest on debt, fees related to the catastrophe-
linked equity put option and reinsurance agreement, dividends to shareholders
and parent company operating expenses, as well as the share repurchase program,
are dependent upon the ability of the insurance subsidiaries to pay cash
dividends or make other cash payments to HMEC, including tax payments pursuant
to tax sharing agreements. The insurance subsidiaries are subject to various
regulatory restrictions which limit the amount of annual dividends or other
distributions, including loans or cash advances, available to HMEC without prior
approval of the insurance regulatory authorities. Dividends which may be paid
by the insurance subsidiaries to HMEC during 2001 without prior approval are
approximately $42 million. Although regulatory restrictions exist, dividend
availability from subsidiaries has been, and is expected to be, adequate for
HMEC's capital needs.
Investing Activities
HMEC's insurance subsidiaries maintain significant investments in fixed
maturity securities to meet future contractual obligations to policyholders. In
conjunction with its management of liquidity and other asset/liability
management objectives, the Company, from time to time, will sell fixed maturity
securities prior to maturity and reinvest the proceeds in other investments with
different interest rates, maturities or credit characteristics. Accordingly,
the Company has classified the entire fixed maturity securities portfolio as
available for sale.
F-21
Financing Activities
Financing activities include primarily repurchases of the Company's common
stock, payment of dividends, the receipt and withdrawal of funds by annuity
contractholders and borrowings and repayments under the Company's debt
facilities. Fees related to the catastrophe-linked equity put option and
reinsurance agreement, which augments its other reinsurance program, have been
charged directly to additional paid-in capital.
For the year ended December 31, 2000, receipts from annuity contracts
increased slightly. Annuity contract maturities and withdrawals increased $65.2
million, or 26.4%, compared to the same period last year due about equally to
higher withdrawals from both the variable and fixed annuity options. Variable
annuity deposit retention decreased 4.4 percentage points over the 12 months to
84.1%. However, this retention for the last three months of 2000 showed
improvement at 87.3% following the Company's expansion of variable investment
options and introduction of its proprietary asset allocation software. Net
transfers to variable annuity assets decreased $36.1 million compared to the
same period last year reflecting a greater allocation of funds by customers to
fixed annuities rather than variable annuities and the decrease in total annuity
contract receipts. Retention of fixed annuity accumulated cash value was 88.7%
for the 12 months ended December 31, 2000, 3.6 percentage points lower than the
same period last year; also showing some improvement in the last three months of
2000 at 89.3%.
During 2000, the Company repurchased 1,082,400 shares of its common stock,
or 3% of the outstanding shares on December 31, 1999, at an aggregate cost of
$15.1 million, or an average cost of $13.99 per share, under its stock
repurchase program. Repurchases in 2000 compare to 1,075,300 shares repurchased
in 1999 at an aggregate cost of $25.1 million. The repurchase of shares was
financed through use of cash and, when necessary, the Bank Credit Facility.
However, the Company has not utilized the Bank Credit Facility for share
repurchases since the second quarter of 1999. As of December 31, 2000, $96.3
million remained authorized for future share repurchases.
Capital Resources
The Company has determined the amount of capital which is needed to
adequately fund and support business growth, primarily based on risk-based
capital formulas including those developed by the National Association of
Insurance Commissioners. Historically, the Company's insurance subsidiaries
have generated capital in excess of such needed capital. These excess amounts
have been paid to HMEC through dividends. HMEC has then utilized these
dividends and its access to the capital markets to service and retire long-term
debt, increase and pay dividends to its shareholders, fund growth initiatives,
repurchase shares of its common stock and for other corporate purposes.
Management anticipates that the Company's sources of capital will continue to
generate capital in excess of the needs for business growth, debt interest
payments and shareholder dividends.
The total capital of the Company was $576.7 million at December 31, 2000,
including $99.7 million of long-term debt and $49.0 million of short-term debt.
Total debt represented 25.6% of capital (excluding unrealized investment losses)
at December 31, 2000, which was at the upper end of the Company's target
operating range of 20% to 25%.
Shareholders' equity was $428.0 million at December 31, 2000, including an
unrealized loss in the Company's investment portfolio of $4.0 million after
taxes and the related impact on deferred policy acquisition costs and the value
of acquired insurance in force associated with annuity and interest-sensitive
life policies. The market value of the Company's common stock and
F-22
the market value per share were $866.1 million and $21 3/8, respectively, at
December 31, 2000. Book value per share was $10.56 at December 31, 2000, $10.66
excluding investment market value adjustments. At December 31, 1999, book value
per share was $9.75, $10.73 excluding investment market value adjustments. The
increase over the 12 months included the effects of unrealized investment gains
and losses and share repurchases. Excluding these items, book value per share
was approximately equal to a year earlier.
In January 1996, the Company issued $100.0 million face amount of 6 5/8%
Senior Notes ("Senior Notes") at a discount of 0.5% which will mature on January
15, 2006. Interest on the Senior Notes is payable semi-annually. The Senior
Notes are redeemable in whole or in part, at any time at the Company's option.
The Senior Notes have an investment grade rating from Standard & Poor's
Corporation ("S&P") (A-), Fitch, Inc. ("Fitch") (formerly Duff & Phelps Credit
Rating Co.) (A), and Moody's Investors Service, Inc. ("Moody's") (Baa1) and are
traded on the New York Stock Exchange (HMN 6 5/8). As a result of factors
impacting the Company's earnings for the three months ended December 31, 2000,
S&P placed the Company's debt rating on "CreditWatch with negative implications"
and Fitch placed the Company's debt rating on "Rating Watch Negative". Moody's
issued a statement affirming their rating. Management anticipates that the
CreditWatch and Rating Watch status will be resolved in the second quarter of
2001, based on further dialog between management and the respective rating
agencies.
As of both December 31, 2000 and December 31, 1999, the Company had short-
term debt of $49.0 million outstanding under the Bank Credit Facility. The Bank
Credit Facility allows unsecured borrowings of up to $65.0 million at Interbank
Offering Rates plus 0.3% to 0.5% or Bank of America National Trust and Savings
Association reference rates. The rate on the borrowings under the Bank Credit
Facility was Interbank Offering Rate plus 0.3%, or 6.8%, as of December 31,
2000. The commitment for the Bank Credit Facility terminates on December 31,
2001. The Company anticipates entering into a replacement bank credit facility
prior to the end of 2001 and does not expect material difficulties in doing so.
The Company's ratio of earnings to fixed charges for the year ended
December 31, 2000 was 2.0x compared to 10.6x for 1999. The decline was primarily
attributable to the factors affecting income before income taxes that were
described above.
Total shareholder dividends were $17.2 million for the year ended December
31, 2000. In February 2001, the Board of Directors announced a regular quarterly
dividend of $0.105 per share.
The Company reinsures 95% of catastrophe losses above a retention of $8.5
million per occurrence up to $80 million per occurrence for 52% of the coverage
in 2001 and above a retention of $7.5 million per occurrence up to $80 million
per occurrence for the remaining 48% of the coverage in 2001. In 2000, the
retention for all of the coverage was $7.5 million per occurrence up to $80
million per occurrence. In addition, the Company's predominant insurance
subsidiary for property and casualty business written in Florida reinsures 90%
of hurricane losses in that state above a retention of $10.3 million up to $46.3
million with the Florida Hurricane Fund, based on the Fund's resources. These
catastrophe reinsurance programs are augmented by a $100 million equity put and
reinsurance agreement. This equity put provides an option to sell shares of the
Company's convertible preferred stock with a floating rate dividend at a pre-
negotiated price in the event losses from catastrophes exceed the catastrophe
reinsurance program coverage limit. Before tax benefits, the equity put provides
a source of capital for up to $154 million of catastrophe losses above the
reinsurance coverage limit.
F-23
Market Risk
Market risk is the risk that the Company will incur losses due to adverse
changes in market rates. The Company's primary market risk exposure is the risk
that the Company will incur economic losses due to adverse changes in interest
rates. This risk arises as the Company's profitability is affected by the
spreads between interest yields on investments and rates credited on insurance
liabilities.
The Company manages its market risk by coordinating the projected cash
outflows of assets with the projected cash outflows of liabilities. For all its
assets and liabilities, the Company seeks to maintain reasonable durations,
consistent with the maximization of income without sacrificing investment
quality and providing for liquidity and diversification. The risks associated
with mutual fund investments supporting variable annuity products are assumed by
those contractholders, and not by the Company.
Through active investment management, the Company invests available funds
with the objective of funding future obligations to policyholders, subject to
appropriate risk considerations, and maximizing shareholder value. This
objective is met through investments that 1) have similar characteristics to the
liabilities they support; 2) are diversified among industries, issuers and
geographic locations; and 3) are predominately investment-grade fixed maturity
securities. No derivatives are used to manage the exposure to interest rate risk
in the investment portfolios. At December 31, 2000, 20% of the fixed investment
portfolio represents investments supporting the property and casualty operations
and 80% support the life and annuity business. For a discussion regarding the
Company's investments see "Business-Investments."
The Company's life and annuity operating earnings are affected by the
spreads between interest yields on investments and rates credited or accruing on
life and fixed annuity insurance liabilities. Although substantially all
credited rates on fixed annuities may be changed annually (subject to minimum
guaranteed rates), competitive pricing and other factors, including the impact
on the level of surrender and withdrawals, may limit the Company's ability to
adjust or to maintain crediting rates at levels necessary to avoid narrowing of
spreads under certain market conditions.
Using financial modeling and other techniques, the Company regularly
evaluates the appropriateness of investments relative to the characteristics of
the liabilities that they support. Simulations of cash flows generated from
existing business under various interest rate scenarios measure the potential
gain or loss in fair value of interest-rate sensitive assets and liabilities.
Such estimates are used to closely match the duration of assets to the duration
of liabilities. The overall duration of liabilities of the Company's multiline
insurance operations combines the characteristics of its long duration interest-
sensitive life and annuity liabilities with its short duration non interest-
sensitive property and casualty liabilities. Overall, at December 31, 2000, the
duration of fixed maturity securities was approximately 4.4 years, and the
duration of insurance liabilities was approximately 4.5 years.
The life and annuity operations participate in the cash flow testing
procedures imposed by statutory insurance regulations, the purpose of which is
to insure that such liabilities are adequate to meet the Company's obligations
under a variety of interest rate scenarios. Based on these procedures, the
Company's assets and the investment income expected to be received on such
assets, are adequate to meet the insurance policy obligations and expenses of
the Company's insurance activities in all but the most extreme circumstances.
F-24
The Company periodically evaluates its sensitivity to interest rate risk.
Based on commonly used models, the Company projects the impact of interest rate
changes, assuming a wide range of factors, including duration and prepayment, on
the fair value of assets and liabilities. Fair value is estimated based on the
net present value of cash flows or duration estimates. At December 31, 2000,
assuming an immediate decrease of 100 basis points in interest rates, the net
fair value of the Company's assets and liabilities would increase by
approximately $9 million after tax, 3% of shareholders' equity. A 100 basis
point increase would decrease fair value of assets and liabilities by $13
million after tax, 4% of shareholders' equity. At December 31, 1999, assuming an
immediate decrease of 100 basis points in interest rates, the net fair value of
the Company's assets and liabilities would increase by approximately $21 million
after tax, 5% of shareholders' equity. A 100 basis point increase would decrease
fair value of assets and liabilities by $2 million after tax, 1% of
shareholders' equity. In both cases, these changes in interest rates assume a
parallel shift in the yield curve.
While the Company believes that these assumed market rate changes are
reasonably possible, actual results may differ, particularly as a result of any
management actions that would be taken to mitigate such hypothetical losses in
fair value of shareholders' equity. Based on the Company's overall exposure to
interest rate risk, the Company believes that these changes in interest rates
would not materially affect the consolidated near-term financial position,
results of operations or cash flows of the Company.
Recent Accounting Changes
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133" and SFAS No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities," which is
required to be adopted in 2001. These statements will not have a material impact
on the Company because it does not have significant holdings of derivatives or
hedges, as defined within the context of SFAS No. 133.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities" -- a
replacement of FASB SFAS No. 125. SFAS No. 140 revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral, but it carries over most of SFAS No. 125's provisions without
reconsideration. This statement is effective for transactions occurring after
March 31, 2001 but is not expected to have a material impact on the Company's
accounting for its lending of fixed income securities to third parties.
The National Association of Insurance Commissioners ("NAIC") has codified
statutory accounting practices, which are expected to constitute the only source
of prescribed statutory accounting practices and are effective January 1, 2001.
Codification will change prescribed statutory accounting practices and may
result in changes to the accounting practices that insurance enterprises use to
prepare their statutory financial statements. The states of domicile of the
Company's principal operating subsidiaries, Illinois, California and Texas, have
adopted the NAIC's codification. Although the evaluation of the impact of
adopting the NAIC codification on the Company's statutory financial statements
is not yet complete, at this time management anticipates that the impact will
not be material.
F-25
Effects of Inflation and Changes in Interest Rates
The Company's operating results are affected significantly in at least
three ways by changes in interest rates and inflation. First, inflation directly
affects property and casualty claims costs. Second, the investment income earned
on the Company's investment portfolio and the market value of the investment
portfolio are related to the yields available in the fixed-income markets. An
increase in interest rates will decrease the market value of the investment
portfolio, but will increase investment income as investments mature and
proceeds are reinvested at higher rates. Third, as interest rates increase,
competitors will typically increase crediting rates on annuity and interest-
sensitive life products, and may lower premium rates on property and casualty
lines to reflect the higher yields available in the market. The risk of interest
rate fluctuation is managed through asset/liability management techniques,
including cash flow analysis.
Effects of Recession
The Company markets its products primarily to educators and other employees
of public schools and their families located throughout the United States.
Although this market is affected by school budgetary constraints, as well as
general economic downturns that result in decreased purchases of new automobiles
and homes and reductions in individual savings, management believes that this
market historically has continued to purchase insurance even in periods of
recession. Historically, despite changing economic conditions, sales of
insurance products to the Company's market have remained stable or increased,
suggesting continuation of this historical trend.
F-26
REPORT OF MANAGEMENT RESPONSIBILITY FOR FINANCIAL STATEMENTS
Horace Mann Educators Corporation
The consolidated balance sheets of Horace Mann Educators Corporation and
subsidiaries as of December 31, 2000, 1999 and 1998, and the related
consolidated statements of operations, cash flows and shareholders' equity for
the years ended December 31, 2000, 1999 and 1998 have been prepared by
management, which is responsible for their integrity and reliability. The
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America and include some amounts that are based
upon management's best estimates and judgements. The financial information
contained elsewhere in this annual report on Form 10-K is consistent with that
contained in the financial statements.
Management is responsible for establishing and maintaining a system of
internal control designed to provide reasonable assurance as to the integrity
and reliability of financial reporting. The concept of reasonable assurance is
based on the recognition that there are inherent limitations in all systems of
internal control, and that the cost of such systems should not exceed the
benefits derived therefrom. A professional staff of internal auditors reviews on
an ongoing basis the related internal control system design, the accounting
policies and procedures supporting this system and compliance therewith.
Management believes this system of internal control effectively meets its
objective of reliable financial reporting.
In connection with their annual audits, independent certified public
accountants perform an examination, in accordance with generally accepted
auditing standards, which includes the consideration of the system of internal
control to the extent necessary to form an independent opinion on the fairness
of presentation of the financial statements prepared by management.
The Board of Directors, through its Audit Committee composed solely of
directors who are not employees of the Company, is responsible for overseeing
the integrity and reliability of the Company's accounting and financial
reporting practices and the effectiveness of its system of internal controls.
The independent certified public accountants and internal auditors meet
regularly with this committee, and have access to this committee with and
without management present, to discuss the results of their audit work.
F-27
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Horace Mann Educators Corporation:
We have audited the accompanying consolidated balance sheets of Horace Mann
Educators Corporation and subsidiaries (the Company) as of December 31, 2000,
1999 and 1998 and the related consolidated statements of operations, changes in
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 2000. In connection with our audits of the
consolidated financial statements, we also have audited the financial statement
schedules, as listed in the accompanying index. These consolidated financial
statements and financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedules based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Horace Mann
Educators Corporation and subsidiaries as of December 31, 2000, 1999 and 1998,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the related financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present fairly,
in all material respects, the information set forth therein.
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
February 8, 2001
F-28
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED BALANCE SHEETS
As of December 31, 2000, 1999 and 1998
(Dollars in thousands)
2000 1999 1998
-------- -------- --------
ASSETS
Investments
Fixed maturities, available for sale, at market
(amortized cost 2000, $2,615,156; 1999,
$2,575,403; 1998, $2,552,537).............................. $2,607,738 $2,507,280 $2,651,379
Short-term and other investments............................. 99,728 122,929 102,049
Short-term investments, loaned securities collateral......... 204,881 - 87,392
---------- ---------- ----------
Total investments......................................... 2,912,347 2,630,209 2,840,820
Cash........................................................... 21,141 22,848 12,044
Accrued investment income and premiums receivable.............. 101,405 92,755 102,661
Value of acquired insurance in force and goodwill.............. 92,260 102,068 101,055
Deferred policy acquisition costs.............................. 141,604 130,192 101,658
Other assets................................................... 116,756 144,061 114,503
Variable annuity assets........................................ 1,035,067 1,131,713 1,122,739
---------- ---------- ----------
Total assets.............................................. $4,420,580 $4,253,846 $4,395,480
========== ========== ==========
LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY
Policy liabilities
Fixed annuity contract liabilities........................... $1,217,756 $1,238,379 $1,239,234
Interest-sensitive life contract liabilities................. 481,140 443,309 402,490
Unpaid claims and claim expenses............................. 308,881 309,604 307,387
Future policy benefits....................................... 180,049 179,157 179,693
Unearned premiums............................................ 174,428 170,845 179,194
---------- ---------- ----------
Total policy liabilities.................................. 2,362,254 2,341,294 2,307,998
Other policyholder funds....................................... 122,233 126,530 124,820
Other liabilities.............................................. 324,312 110,698 197,292
Short-term debt................................................ 49,000 49,000 50,000
Long-term debt................................................. 99,721 99,677 99,637
Variable annuity liabilities................................... 1,035,067 1,126,505 1,118,890
---------- ---------- ----------
Total liabilities......................................... 3,992,587 3,853,704 3,898,637
---------- ---------- ----------
Warrants, subject to redemption................................ - - 220
---------- ---------- ----------
Preferred stock, $0.001 par value, authorized
1,000,000 shares; none issued................................ - - -
Common stock, $0.001 par value, authorized
75,000,000 shares; issued, 2000, 59,859,053;
1999, 59,292,053; 1998, 59,274,690........................... 60 59 59
Additional paid-in capital..................................... 338,243 333,892 336,686
Retained earnings.............................................. 452,624 449,023 420,274
Accumulated other comprehensive income
(loss), net of taxes:
Net unrealized gains (losses) on fixed
maturities and equity securities......................... (4,038) (40,016) 57,327
Minimum pension liability adjustment....................... (937) - -
Treasury stock, at cost, 2000, 19,341,296 shares; 1999,
18,258,896 shares; 1998, 17,183,596 shares................... (357,959) (342,816) (317,723)
---------- ---------- ----------
Total shareholders' equity................................. 427,993 400,142 496,623
---------- ---------- ----------
Total liabilities, redeemable securities
and shareholders' equity................................. $4,420,580 $4,253,846 $4,395,480
========== ========== ==========
See accompanying notes to consolidated financial statements.
F-29
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
Year Ended December 31,
--------------------------------
2000 1999 1998
------ ------ ------
Insurance premiums written and contract deposits.. $821,653 $821,209 $827,787
======== ======== ========
Revenues
Insurance premiums and contract charges earned... $598,714 $595,128 $577,812
Net investment income............................ 192,396 188,267 191,723
Realized investment gains (losses)............... (9,906) (7,969) 9,908
-------- -------- --------
Total revenues................................. 781,204 775,426 779,443
-------- -------- --------
Benefits, losses and expenses
Benefits, claims and settlement expenses......... 466,048 416,186 396,328
Interest credited................................ 92,561 91,629 94,776
Policy acquisition expenses amortized............ 55,972 53,041 45,477
Operating expenses............................... 127,910 109,694 109,673
Amortization of intangible assets................ 8,769 215 6,921
Interest expense................................. 10,204 9,722 9,487
Restructuring charges............................ 2,236 - -
Litigation charges............................... 7,783 1,585 -
-------- -------- --------
Total benefits, losses and expenses............ 771,483 682,072 662,662
-------- -------- --------
Income before income taxes........................ 9,721 93,354 116,781
Income tax expense (benefit)...................... (2,438) 28,849 31,469
Provision for prior years' taxes.................. (8,682) 20,000 -
-------- -------- --------
Net income........................................ $ 20,841 $ 44,505 $ 85,312
======== ======== ========
Earnings per share
Basic............................................ $ 0.51 $ 1.08 $ 1.97
======== ======== ========
Diluted.......................................... $ 0.51 $ 1.07 $ 1.95
======== ======== ========
Weighted average number of shares
and equivalent shares
Basic.......................................... 40,782,173 41,245,633 43,238,656
Diluted........................................ 40,966,774 41,708,439 43,838,434
See accompanying notes to consolidated financial statements.
F-30
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share data)
Year Ended December 31,
---------------------------------
2000 1999 1998
--------- --------- ---------
Common stock
Beginning balance.................................. $ 59 $ 59 $ 59
Options exercised, 2000, 557,000 shares; 1999,
17,363 shares; 1998, 113,682 shares; and
shares awarded, 2000, 10,000 shares............... 1 - -
--------- --------- ---------
Ending balance..................................... 60 59 59
--------- --------- ---------
Additional paid-in capital
Beginning balance.................................. 333,892 336,686 340,564
Options exercised and shares awarded............... 5,301 362 2,200
Catastrophe-linked equity put option premium....... (950) (950) (1,475)
Purchase of 8,450 warrants in 1999 and
13,650 warrants in 1998........................... - (2,206) (4,603)
--------- --------- ---------
Ending balance..................................... 338,243 333,892 336,686
--------- --------- ---------
Retained earnings
Beginning balance.................................. 449,023 420,274 349,274
Net income......................................... 20,841 44,505 85,312
Cash dividends, 2000, $0.42 per share; 1999,
$0.3825 per share; 1998, $0.3325 per share........ (17,240) (15,756) (14,312)
--------- --------- ---------
Ending balance..................................... 452,624 449,023 420,274
--------- --------- ---------
Accumulated other comprehensive income
(loss), net of taxes:
Beginning balance................................. (40,016) 57,327 62,167
Change in net unrealized gains (losses) on fixed
maturities and equity securities................. 35,978 (97,343) (4,840)
(Increase) decrease in minimum pension
liability adjustment............................. (937) - -
--------- --------- ---------
Ending balance.................................... (4,975) (40,016) 57,327
--------- --------- ---------
Treasury stock, at cost
Beginning balance, 2000, 18,258,896 shares; 1999,
17,183,596 shares; 1998, 14,896,796 shares........ (342,816) (317,723) (246,092)
Purchase of 1,082,400 shares in 2000, 1,075,300
shares in 1999; 2,286,800 shares in 1998
(See note 5)...................................... (15,143) (25,093) (71,631)
--------- --------- ---------
Ending balance 2000, 19,341,296 shares; 1999,
18,258,896 shares; 1998, 17,183,596 shares........ (357,959) (342,816) (317,723)
--------- --------- ---------
Shareholders' equity at end of period............... $ 427,993 $ 400,142 $ 496,623
========= ========= =========
Comprehensive income (loss)
Net income......................................... $ 20,841 $ 44,505 $ 85,312
Other comprehensive income (loss), net of tax:
Change in net unrealized gains (losses)
on fixed maturities and equity securities........ 35,978 (97,343) (4,840)
(Increase) decrease in minimum pension
liability adjustment............................. (937) - -
--------- --------- ---------
Other comprehensive income (loss).............. 35,041 (97,343) (4,840)
--------- --------- ---------
Total......................................... $ 55,882 $ (52,838) $ 80,472
========= ========= =========
See accompanying notes to consolidated financial statements.
F-31
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
---------------------------------
2000 1999 1998
--------- --------- ---------
Cash flows from operating activities
Premiums collected............................... $ 618,253 $ 623,762 $ 618,419
Policyholder benefits paid....................... (465,414) (453,353) (459,595)
Policy acquisition and
other operating expenses paid................... (187,248) (179,951) (176,054)
Federal income taxes paid........................ (16,101) (16,600) (36,441)
Investment income collected...................... 191,103 186,824 195,599
Interest expense paid............................ (10,028) (9,523) (9,309)
Other............................................ (6,317) (3,013) (3,853)
--------- --------- ---------
Net cash provided by operating activities...... 124,248 148,146 128,766
--------- --------- ---------
Cash flows from investing activities
Fixed maturities
Purchases....................................... (750,928) (698,847) (842,375)
Sales........................................... 464,305 388,644 487,945
Maturities...................................... 243,618 286,758 351,112
Net cash (used for) received from
short-term and other investments................ 26,814 (18,524) 26,296
--------- --------- ---------
Net cash (used in) provided by
investing activities......................... (16,191) (41,969) 22,978
--------- --------- ---------
Cash flows used in financing activities
Purchase of treasury stock....................... (15,143) (25,093) (71,631)
Dividends paid to shareholders................... (17,240) (15,756) (14,312)
Principal (payments) borrowings
on Bank Credit Facility......................... - (1,000) 8,000
Repurchase of common stock warrants.............. - (2,426) (4,959)
Exercise of stock options........................ 5,302 362 2,200
Catastrophe-linked equity put option premium..... (950) (950) (1,475)
Annuity contracts, variable and fixed
Deposits........................................ 206,393 205,684 223,324
Maturities and withdrawals...................... (312,365) (247,212) (184,800)
Net transfer from (to) variable annuity assets.. 28,437 (7,676) (96,905)
Net (decrease) increase in interest-sensitive
life account balances........................... (4,198) (1,306) 505
--------- --------- ---------
Net cash used in financing activities.......... (109,764) (95,373) (140,053)
--------- --------- ---------
Net increase (decrease) in cash................... (1,707) 10,804 11,691
Cash at beginning of period....................... 22,848 12,044 353
--------- --------- ---------
Cash at end of period............................. $ 21,141 $ 22,848 $ 12,044
========= ========= =========
See accompanying notes to consolidated financial statements.
F-32
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements are prepared on the basis
of generally accepted accounting principles ("GAAP"). The preparation of
financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The consolidated financial statements include the accounts of Horace Mann
Educators Corporation and its wholly-owned subsidiaries ("HMEC"; and together
with its subsidiaries, the "Company"). All significant intercompany balances
and transactions have been eliminated in consolidation.
The subsidiaries of HMEC sell and underwrite tax-qualified retirement
annuities and private passenger automobile, homeowners, and life insurance
products, primarily to educators and other employees of public schools and their
families. The Company's principal operating subsidiaries are Horace Mann Life
Insurance Company, Horace Mann Insurance Company, Teachers Insurance Company,
Allegiance Insurance Company and Horace Mann Lloyds.
Investments
The Company invests primarily in fixed maturity investments. These
securities are classified as available for sale and carried at market value.
The net adjustment for unrealized gains and losses on securities available for
sale, carried at market, is recorded as a separate component of shareholders'
equity, net of applicable deferred tax asset or liability and the related impact
on deferred policy acquisition costs and value of acquired insurance in force
associated with interest-sensitive life and annuity contracts.
Short-term and other investments are comprised of policy loans, carried at
unpaid principal balances; short-term fixed interest securities, carried at cost
which approximates market value; mortgage loans, carried at unpaid principal
less a valuation allowance for estimated uncollectible amounts; real estate
acquired in the settlement of debt, carried at the lower of cost or market; and
equity securities, carried at market.
Interest income is recognized as earned. Investment income reflects
amortization of premiums and accrual of discounts on an effective-yield basis.
Realized gains and losses arising from the sale of securities are determined
based upon specific identification of securities sold.
F-33
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Deferred Policy Acquisition Costs
Deferred policy acquisition costs net of accumulated amortization were
$141,604, $130,192 and $101,658 as of December 31, 2000, 1999 and 1998,
respectively.
Acquisition costs, consisting of commissions, premium taxes and other costs,
which vary with and are primarily related to the production of insurance
business, are capitalized and amortized as follows. Capitalized acquisition
costs for interest-sensitive life contracts are amortized over 20 years in
proportion to estimated gross profits. For other individual life contracts,
acquisition costs are amortized in proportion to anticipated premiums over the
terms of the insurance policies (10, 15 and 20 years). For investment (annuity)
contracts, acquisition costs are amortized over 20 years in proportion to
estimated gross profits. For property and casualty policies, acquisition costs
are amortized over the terms of the insurance policies (six and twelve months).
Deferred policy acquisition costs for interest-sensitive life and investment
contracts are adjusted for the impact on estimated future gross profits as if
net unrealized investment gains and losses had been realized at the balance
sheet date. The impact of this adjustment is included in net unrealized gains
and losses within shareholders' equity.
Deferred acquisition costs are reviewed for recoverability from future
income, including investment income, and costs which are deemed unrecoverable
are expensed in the period in which the determination is made. No such costs
have been deemed unrecoverable during the periods reported.
The Company periodically reviews the assumptions and estimates used in
capitalizing policy acquisition costs. The Company began deferring additional
sales-related costs in 1999 for all new life and annuity contracts, consistent
with common industry accounting practices. The impact of this change was an
increase to net income of $3,582 and $3,108 for 2000 and 1999, respectively.
When the Company was acquired in 1989, deferred acquisition costs were
reduced to zero in connection with establishing the value of acquired insurance
in force in the application of purchase accounting.
F-34
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation and
are included in other assets in the consolidated balance sheets. Depreciation
and amortization are calculated on the straight-line method based on the
estimated useful lives of the assets.
December 31,
-------------------------
2000 1999 1998
------- ------- -------
Property and equipment.......... $62,652 $60,907 $55,028
Less: accumulated depreciation.. 33,025 30,543 26,541
------- ------- -------
Total......................... $29,627 $30,364 $28,487
======= ======= =======
At the beginning of 1998, the Company adopted the accounting treatment
required by the American Institute of Certified Public Accountants' Statement of
Position 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." Adoption of this statement decreased the Company's
2000, 1999 and 1998 operating expenses by $202, $1,568 and $2,400, respectively,
before income taxes as costs incurred to develop internal-use software are
capitalized and depreciated over their expected useful lives.
Value of Acquired Insurance In Force and Goodwill
When the Company was acquired in 1989, intangible assets were recorded in
the application of purchase accounting to recognize the value of acquired
insurance in force and goodwill. In addition, goodwill was recorded in 1994
related to the purchase of Allegiance Insurance Company.
The value of acquired insurance in force by operating segment and goodwill,
net of amortization, were as follows:
December 31,
---------------------------
2000 1999 1998
------- -------- --------
Value of acquired insurance in force
Property and casualty............... $ - $ - $ 719
Life................................ 12,434 14,409 16,529
Annuity............................. 30,812 37,027 31,557
------- -------- --------
Subtotal.......................... 43,246 51,436 48,805
Goodwill.............................. 49,014 50,632 52,250
------- -------- --------
Total............................. $92,260 $102,068 $101,055
======= ======== ========
The value of acquired insurance in force is being amortized over the
following periods utilizing the indicated methods for life and annuity,
respectively, as follows: 20 years, in proportion to coverage provided; 20
years, in proportion to estimated gross profits. Goodwill is amortized over 40
years on a straight-line basis.
F-35
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
The value of acquired insurance in force for investment contracts (those
issued prior to August 29, 1989) is adjusted for the impact on estimated future
gross profits as if net unrealized investment gains and losses had been realized
at the balance sheet date. The impact of this adjustment is included in net
unrealized gains and losses within shareholders' equity.
Significant appreciation and the resultant growth in annuity assets and the
retention of the Company's annuity business in recent years have favorably
impacted projected future gross profits for the business. Therefore, previously
scheduled annual amortization of the December 31, 2000 balance was revised as
reflected in the table below. Such amounts are evaluated annually and
amortization schedules updated as indicated.
Scheduled amortization of the December 31, 2000 balances of value of
acquired insurance in force by segment and goodwill over the next five years is
as follows:
Year Ended December 31,
--------------------------------------
2001 2002 2003 2004 2005
------ ------ ------ ------ ------
Scheduled amortization of:
Value of acquired insurance in force
Life................................ $1,839 $1,726 $1,625 $1,537 $1,460
Annuity............................. 4,464 3,917 3,632 3,686 3,719
------ ------ ------ ------ ------
Subtotal.......................... 6,303 5,643 5,257 5,223 5,179
Goodwill.............................. 1,618 1,618 1,618 1,618 1,618
------ ------ ------ ------ ------
Total............................. $7,921 $7,261 $6,875 $6,841 $6,797
====== ====== ====== ====== ======
The accumulated amortization of intangibles as of December 31, 2000, 1999
and 1998 was $140,601, $131,832 and $131,617, respectively.
F-36
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Variable Annuity Assets and Liabilities
Variable annuity assets, carried at market value, and liabilities represent
tax-qualified variable annuity funds invested in various mutual funds, including
the Horace Mann mutual funds. In September 2000, the Company introduced 21 new
investment options in its tax-deferred annuity product line. Variable annuity
assets were invested in the offered mutual funds as follows:
December 31,
----------------------------------
2000 1999 1998
---------- ---------- ----------
Horace Mann Equity Fund
(formerly Horace Mann Growth Fund).......................... $ 428,821 $ 566,932 $ 605,803
Horace Mann Balanced Fund..................................... 315,015 404,712 427,368
Horace Mann Small Cap Equity Fund
(formerly Horace Mann Small Cap Growth Fund)................ 83,304 60,042 28,629
Horace Mann Socially Responsible Fund......................... 75,782 59,129 35,368
Horace Mann International Equity Fund......................... 42,512 26,040 10,290
Wilshire Large Company Growth Portfolio -
Institutional and Investment................................ 19,036 - -
Wilshire 5000 Index Portfolio - Institutional and Investment.. 16,829 - -
Horace Mann Income Fund....................................... 11,376 13,237 13,952
Fidelity VIP Growth Portfolio................................. 7,041 - -
Fidelity VIP Index 500 Portfolio.............................. 4,915 - -
Fidelity VIP Mid Cap Portfolio................................ 4,690 - -
Alliance Premier Growth Portfolio............................. 4,142 - -
Strong Mid Cap Growth Fund II................................. 3,397 - -
Putman VI Vista Fund.......................................... 2,869 - -
Horace Mann Short-Term Investment Fund........................ 2,274 1,621 1,329
JP Morgan U.S. Disciplined Equity Portfolio................... 1,845 - -
Warburg Pincus Small Company Growth Portfolio................. 1,640 - -
Davis Value Portfolio......................................... 1,489 - -
Rainier Small/Mid Cap Equity Portfolio........................ 1,444 - -
Fidelity VIP Overseas Portfolio............................... 1,410 - -
Strong Opportunity Fund II.................................... 1,299 - -
T. Rowe Price Small-Cap Stock Fund............................ 1,251 - -
Fidelity VIP Growth & Income Portfolio........................ 820 - -
Wilshire Large Company Value Portfolio........................ 500 - -
T. Rowe Price Small Cap Value Fund............................ 343 - -
Fidelity VIP Investment Grade Bond Portfolio.................. 312 - -
Fidelity VIP High Income Portfolio............................ 261 - -
Neuberger Berman Genesis Assets Account....................... 252 - -
Wilshire Small Company Growth Portfolio....................... 128 - -
Wilshire Small Company Value Portfolio........................ 70 - -
---------- ---------- ----------
Total variable annuity assets............................... $1,035,067 $1,131,713 $1,122,739
========== ========== ==========
The investment income, gains and losses of these accounts accrue directly
to the policyholders and are not included in the operations of the Company.
F-37
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Future Policy Benefits, Interest-sensitive Life Contract Liabilities and
Annuity Contract Liabilities
Liabilities for future benefits on life and annuity policies are
established in amounts adequate to meet the estimated future obligations on
policies in force. Liabilities for future policy benefits on certain life
insurance policies are computed using the net level premium method and are based
upon assumptions as to future investment yield, mortality and withdrawals. As a
result of the application of purchase accounting, future policy benefits for
direct individual life insurance policies issued through August 29, 1989 were
revalued using interest rates of 9% graded to 8% over 10 years. For policies
issued from August 30, 1989 through December 31, 1992, future policy benefits
are computed using an interest rate of 6.5%. An interest rate of 5.5% is used to
compute future policy benefits for policies issued after December 31, 1992.
Mortality and withdrawal assumptions for all policies have been based on various
actuarial tables which are consistent with the Company's own experience.
Liabilities for future benefits on annuity contracts and certain long-duration
life insurance contracts are carried at accumulated policyholder values without
reduction for potential surrender or withdrawal charges. The liability also
includes provisions for the unearned portion of certain policy charges.
Unpaid Claims and Claim Expenses
Liabilities for property and casualty unpaid claims and claim expenses
include provisions for payments to be made on reported claims, claims incurred
but not reported and associated settlement expenses. At December 31, 2000, 99.4%
of the Company's liabilities for property and casualty unpaid claims and claim
expenses were carried at the full value of estimated liabilities and were not
discounted for interest expected to be earned on reserves. Estimated amounts of
salvage and subrogation on unpaid property and casualty claims are deducted from
the liability for unpaid claims.
The process by which liabilities are established for insured events
requires reliance upon estimates based on experience and available data. As
information develops which varies from experience, provides additional data or,
in some cases, augments data which previously were not considered sufficient for
use in determining liabilities, adjustments may be required. The effects of
these adjustments are charged or credited to income for the period in which the
adjustments are made.
In the fourth quarter of 2000, the Company conducted a comprehensive review
of all components of its property and casualty reserves. As a result of that
review, the Company recorded a net strengthening of these reserves in 2000 of
$22,658, as shown in the following table. The strengthening primarily reflected
a $17,000 reduction of ceded reserves resulting from the adoption of a different
actuarial method to reflect more accurately prior years' loss experience.
F-38
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
This reduction of the ceded reserves was related to automobile facility business
in four states, primarily Massachusetts. The remaining net strengthening of
prior years' reserves was primarily in the automobile line of business and was
based on the further analysis of adverse trends which emerged in 2000. No other
unusual adjustments were made in the determination of the liabilities during the
periods covered by these financial statements. Due to the nature of the
Company's personal lines business, the Company has no exposure to claims for
toxic waste cleanup, other environmental remediation or asbestos-related
illnesses. Management believes that, based on data currently available, it has
reasonably estimated the Company's ultimate losses.
The following table sets forth an analysis of property and casualty unpaid
claims and claim expenses and provides a reconciliation of beginning and ending
reserves for the periods indicated.
Year Ended December 31,
-----------------------------
2000 1999 1998
-------- -------- --------
Gross reserves, beginning of year................ $299,803 $298,929 $310,632
Less reinsurance recoverables.................. 64,410 55,890 41,324
-------- -------- --------
Net reserves, beginning of year.................. 235,393 243,039 269,308
-------- -------- --------
Incurred claims and claims expense:
Claims occurring in the current year........... 394,711 379,455 379,603
Increase (decrease) in estimated reserves for
claims occurring in prior years(1):
Policies written by the Company............ 20,858 (7,583) (23,317)
Business assumed from state
reinsurance facilities................... 1,800 3,000 (1,600)
-------- -------- --------
Total increase (decrease).............. 22,658 (4,583) (24,917)
-------- -------- --------
Total claims and claims expense incurred... 417,369 374,872 354,686
-------- -------- --------
Claims and claims expense payments
for claims occurring during:
Current year................................. 247,286 240,045 238,986
Prior years.................................. 155,636 142,473 141,969
-------- -------- --------
Total claims and claims expense payments... 402,922 382,518 380,955
-------- -------- --------
Net reserves, end of period...................... 249,840 235,393 243,039
Plus reinsurance recoverables.................. 49,056 64,410 55,890
-------- -------- --------
Gross reserves, end of period(2)................. $298,896 $299,803 $298,929
======== ======== ========
- ------------
(1) Shows the amounts by which the Company decreased or increased its reserves
in each of the periods indicated for claims occurring in previous periods to
reflect subsequent information on such claims and changes in their projected
final settlement costs. Favorable reserve development generally occurs as a
result of subsequent adjustment of reserves to reflect additional
information. Also refer to the second paragraph preceding this table for
additional information regarding the increase in reserves recorded in 2000.
(2) Unpaid claims and claims expense as reported in the consolidated balance
sheets also include life, annuity, and group accident and health reserves of
$9,985, $9,801 and $8,458 at December 31, 2000, 1999 and 1998, respectively,
in addition to property and casualty reserves.
F-39
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Fluctuations from year to year in the level of catastrophe claims impact a
property and casualty insurance company's claims and claims adjustment expenses
incurred and paid. For comparison purposes, the following table provides
amounts for the Company excluding catastrophe losses.
Year Ended December 31,
----------------------------
2000 1999 1998
-------- -------- --------
Claims and claims expense incurred... $417,369 $374,872 $354,686
Amount attributable to catastrophes.. 16,122 19,371 28,019
-------- -------- --------
Excluding catastrophes............. $401,247 $355,501 $326,667
======== ======== ========
Claims and claims expense payments... $402,922 $382,518 $380,955
Amount attributable to catastrophes.. 14,200 17,400 25,200
-------- -------- --------
Excluding catastrophes............. $388,722 $365,118 $355,755
======== ======== ========
Insurance Premiums and Contract Charges Earned
Property and casualty insurance premiums are recognized as revenue ratably
over the related contract periods in proportion to the risks insured. The
unexpired portions of these property and casualty premiums are recorded as
unearned premiums, using the monthly pro rata method.
Premiums and contract charges for interest-sensitive life and annuity
contracts consist of charges for the cost of insurance, policy administration
and withdrawals. Premiums for long-term traditional life policies are
recognized as revenues when due over the premium-paying period. Annuity and
interest-sensitive life contract deposits represent funds deposited by
policyholders and are not included in the Company's premiums or contract charges
earned.
Stock Based Compensation
The Company grants stock options to executive officers, other employees and
directors. The exercise price of the option is equal to the fair market value of
the Company's common stock on the date of grant. The Company accounts for stock
option grants in accordance with Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," and accordingly, recognizes no
compensation expense for the stock option grants.
F-40
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Alternatively, Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," allows companies to recognize compensation cost for stock-based
compensation plans, determined based on the fair value at the grant dates. If
the Company had applied this alternative accounting method, net income and net
income per share would have been reduced to the pro forma amounts indicated
below:
Year Ended December 31,
--------------------------
2000 1999 1998
------- ------- -------
Net income As reported $20,841 $44,505 $85,312
Pro forma(1). $18,995 $42,907 $84,485
Basic net income per share As reported $ 0.51 $ 1.08 $ 1.97
Pro forma.... $ 0.47 $ 1.04 $ 1.95
Diluted net income per share As reported $ 0.51 $ 1.07 $ 1.95
Pro forma.... $ 0.46 $ 1.03 $ 1.93
- ----------
(1) The fair value of each option grant was estimated on the date of grant using
the Modified Roll-Geske option-pricing model with the following weighted
average assumptions for 2000, 1999 and 1998, respectively: risk-free
interest rates of 5.9%, 5.9% and 5.6%; dividend yield of 2.4%, 1.9% and
1.3%; expected lives of 10 years; and volatility of 53.2%, 50.3% and 26.2%.
Income Taxes
The Company uses the liability method for calculating deferred federal
income taxes. Income tax provisions are generally based on income reported for
financial statement purposes. The provisions for federal income taxes for the
years ended December 31, 2000, 1999 and 1998 include amounts currently payable
and deferred income taxes resulting from the cumulative differences in the
Company's assets and liabilities, determined on a tax return and financial
statement basis.
Deferred tax assets and liabilities include provisions for unrealized
investment gains and losses with the change for each period included in net
unrealized gains and losses in shareholders' equity.
Earnings Per Share
Basic earnings per share is computed based on the weighted average number of
shares outstanding. Diluted earnings per share is based on the weighted average
number of shares and common stock equivalents outstanding. The common stock
equivalents relate to outstanding common stock options, Director Stock Plan
units and Employee Stock Plan units and in 1998 also warrants.
F-41
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
The computations of net income per share on both basic and diluted bases,
including reconciliations of the numerators and denominators, were as follows:
Year Ended December 31,
-------------------------
2000 1999 1998
------- ------- -------
Basic - assumes no dilution:
Net income for the period........................... $20,841 $44,505 $85,312
------- ------- -------
Weighted average number of common
shares outstanding during the period.............. 40,782 41,246 43,239
------- ------- -------
Net income per share - basic........................ $ 0.51 $ 1.08 $ 1.97
======= ======= =======
Diluted - assumes full dilution:
Net income for the period........................... $20,841 $44,505 $85,312
------- ------- -------
Weighted average number of common shares
outstanding during the period..................... 40,782 41,246 43,239
Weighted average number of common equivalent
shares to reflect the dilutive effect of common
stock equivalent securities:
Stock options................................... 62 387 451
Common stock units related to Deferred
Equity Compensation Plan for Directors........ 114 69 49
Common stock units related to Deferred
Compensation Plan for Employees............... 9 6 1
Warrants........................................ - - 98
------- ------- -------
Total common and common equivalent shares adjusted
to calculate diluted earnings per share........... 40,967 41,708 43,838
------- ------- -------
Net income per share - diluted...................... $ 0.51 $ 1.07 $ 1.95
======= ======= =======
Options to purchase 2,301,275 shares of common stock at $16.13 to $33.87
per share were granted during 1997, 1998, 1999 and 2000 but were not included in
the computation of 2000 diluted earnings per share because the options' exercise
price was greater than the average market price of the common shares during
2000. The options, which expire in 2007, 2008, 2009 and 2010, were still
outstanding at December 31, 2000.
Comprehensive Income (Loss)
Comprehensive income (loss) represents the change in shareholders' equity
during a reporting period from transactions and other events and circumstances
from non-shareholder sources. For the Company, comprehensive income (loss) is
equal to net income plus the change in net unrealized gains and losses on fixed
maturities and equity securities and the change in the minimum pension liability
adjustment for the period as shown in the Statement of Changes in Shareholders'
Equity.
F-42
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
The components of comprehensive income (loss) were as follows:
Year Ended December 31,
--------------------------------------
2000 1999 1998
-------- --------- -------
Net income.............................................. $ 20,841 $ 44,505 $85,312
-------- --------- -------
Other comprehensive income (loss):
Change in net unrealized gains (losses) on
fixed maturities and equity securities
Unrealized holding gains (losses) on
fixed maturities and equity securities
arising during period........................... 43,177 (158,423) 3,855
Less: reclassification adjustment for gains
(losses) included in net income................. (12,174) (8,664) 11,301
-------- --------- -------
Total, before tax............................. 55,351 (149,759) (7,446)
Income tax expense (benefit).................. 19,373 (52,416) (2,606)
-------- --------- -------
Total, net of tax......................... 35,978 (97,343) (4,840)
-------- --------- -------
(Increase) decrease in minimum
pension liability adjustment
Before tax........................................ (1,441) - -
Income tax benefit................................ (504) - -
-------- --------- -------
Total, net of tax......................... (937) - -
-------- --------- -------
Total comprehensive income (loss)......... $ 55,882 $ (52,838) $80,472
======== ========= =======
Statements of Cash Flows
For purposes of the statements of cash flows, cash constitutes cash on
deposit at banks.
Reclassification
The Company has reclassified the presentation of certain prior period
information to conform with the 2000 presentation.
NOTE 2 - Restructuring Charges
In December 2000, the Company recorded restructuring charges of $2,236
pretax ($1,453, or $0.04 per share, after tax) reflecting two changes in the
Company's operations. Specifically, the Company restructured the operations of
its group insurance business, thereby eliminating 39 jobs, and its credit union
marketing group, eliminating 20 additional positions. The changes will improve
business results and more closely align these functions with the Company's
strategic direction. Employee termination costs, which represent severance,
vacation buy-out and related payroll taxes, represented $1,827 of the total
accrued. The eliminated positions encompass management, professional and
clerical responsibilities. Termination of lease agreements for office space
used by the credit union marketing group represented $285 of the total accrued.
The remaining $124 was primarily attributable to the write-off of software
related to these two areas. Restructuring charges have been separately
identified in the Statement of Operations for the year ended December 31, 2000.
None of the restructuring costs were paid as of December 31, 2000.
F-43
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 3 - Investments
Net Investment Income
The components of net investment income for the following periods were:
Year Ended December 31,
------------------------------
2000 1999 1998
-------- -------- --------
Fixed maturities.................................................... $185,745 $182,561 $185,271
Short-term and other investments.................................... 10,220 9,212 10,700
-------- -------- --------
Total investment income.......................................... 195,965 191,773 195,971
Less investment expenses............................................ 3,569 3,506 4,248
-------- -------- --------
Net investment income............................................ $192,396 $188,267 $191,723
======== ======== ========
Realized Investment Gains (Losses)
Realized investment gains (losses) for the following periods were:
Year Ended December 31,
------------------------------
2000 1999 1998
-------- -------- --------
Fixed maturities.................................................... $(12,906) $(9,777) $10,537
Short-term and other investments.................................... 3,000 1,808 (629)
-------- ------- -------
Realized investment gains (losses)............................... $ (9,906) $(7,969) $ 9,908
======== ======= =======
F-44
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 3 - Investments-(Continued)
Fixed Maturity Securities
The amortized cost, unrealized investment gains and losses, and market
values of investments in debt securities as of December 31, 2000, 1999 and 1998
were as follows:
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------- ---------- ---------- ----------
As of December 31, 2000
U.S. government and agency obligations
Mortgage-backed securities............ $ 495,696 $ 10,564 $ 1,655 $ 504,605
Other................................. 124,611 2,507 1,060 126,058
Municipal bonds......................... 286,384 10,329 1,658 295,055
Foreign government bonds................ 29,310 1,873 563 30,620
Corporate bonds......................... 1,280,269 24,682 54,329 1,250,622
Other mortgage-backed securities........ 398,886 4,764 2,872 400,778
---------- -------- ------- ----------
Totals.............................. $2,615,156 $ 54,719 $62,137 $2,607,738
========== ======== ======= ==========
As of December 31, 1999
U.S. government and agency obligations
Mortgage-backed securities............ $ 506,132 $ 3,587 $11,604 $ 498,115
Other................................. 136,400 330 5,304 131,426
Municipal bonds......................... 307,045 3,348 8,343 302,050
Foreign government bonds................ 21,875 439 327 21,987
Corporate bonds......................... 1,184,792 9,362 49,046 1,145,108
Other mortgage-backed securities........ 419,159 1,302 11,867 408,594
---------- -------- ------- ----------
Totals.............................. $2,575,403 $ 18,368 $86,491 $2,507,280
========== ======== ======= ==========
As of December 31, 1998
U.S. government and agency obligations
Mortgage-backed securities............ $ 489,752 $ 17,741 $ 24 $ 507,469
Other................................. 192,166 7,106 248 199,024
Municipal bonds......................... 301,751 17,430 40 319,141
Foreign government bonds................ 21,829 2,827 706 23,950
Corporate bonds......................... 1,180,452 59,118 12,047 1,227,523
Other mortgage-backed securities........ 366,587 9,042 1,357 374,272
---------- -------- ------- ----------
Totals.............................. $2,552,537 $113,264 $14,422 $2,651,379
========== ======== ======= ==========
The Company's investment portfolio includes no derivative financial
instruments (futures, forwards, swaps, option contracts or other financial
instruments with similar characteristics).
F-45
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 3 - Investments-(Continued)
Maturity/Sales Of Investments
The market value and amortized cost of fixed maturity securities at December
31, 2000, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
Percent of
Total Market Market Amortized
Value Value Cost
------------ ---------- ----------
Due in 1 year or less......................... 7.0% $ 183,197 $ 183,386
Due after 1 year through 5 years.............. 28.8 750,429 745,879
Due after 5 years through 10 years............ 28.5 741,620 746,527
Due after 10 years through 20 years........... 15.6 407,216 404,931
Due after 20 years............................ 20.1 525,276 534,433
----- ---------- ----------
Total........................................ 100.0% $2,607,738 $2,615,156
===== ========== ==========
Proceeds from sales/maturities of fixed maturities and gross gains and gross
losses realized for each year were:
Year Ended December 31,
------------------------------
2000 1999 1998
-------- -------- --------
Proceeds........................................... $707,923 $675,402 $839,057
Gross gains realized............................... 4,940 3,941 18,081
Gross losses realized.............................. (17,846) (13,718) (7,544)
Unrealized Gains (Losses) on Fixed Maturities
Net unrealized gains (losses) are computed as the difference between market
value and amortized cost for fixed maturities. A summary of the net increase
(decrease) in unrealized investment gains (losses) on fixed maturities, less
applicable income taxes, is as follows:
Year Ended December 31,
-------------------------------
2000 1999 1998
-------- --------- --------
Unrealized gains (losses) on fixed maturities
Beginning of period............................... $(68,123) $ 98,842 $103,256
End of period..................................... (7,418) (68,123) 98,842
-------- --------- --------
Increase (decrease) for the period.............. 60,705 (166,965) (4,414)
Income taxes (benefit).............................. 21,247 (58,438) (1,545)
-------- --------- --------
Increase (decrease) in net unrealized gains (losses)
on fixed maturities before the valuation impact
on deferred policy acquisition costs and value
of acquired insurance in force.................... $ 39,458 $(108,527) $ (2,869)
======== ========= ========
F-46
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 3 - Investments-(Continued)
Securities Lending
The Company loans fixed income securities to third parties, primarily major
brokerage firms. As of December 31, 2000 and 1998, fixed maturities with a fair
value of $204,881 and $87,392, respectively, were on loan. There were no
securities on loan at December 31, 1999. The Company separately maintains a
minimum of 100% of the value of the loaned securities as collateral for each
loan. Effective beginning in 1998, SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities," required the
securities lending collateral to be classified as investments with a
corresponding liability included in Other Liabilities in the Company's
consolidated balance sheet.
Investment in Entities Exceeding 10% of Shareholders' Equity
At December 31, 2000 and 1999, the Company's investment portfolio included
$53,706 and $42,087, respectively, of fixed maturity securities issued by Ford
Motor Company and its affiliates representing 12.5% and 10.5%, respectively, of
shareholders' equity at those dates and other than obligations of the United
States Government and government agencies and authorities, there were no other
investments which exceeded 10% of total shareholders' equity. At December 31,
1998, there were no investments which exceeded 10% of total shareholders' equity
in entities other than obligations of the United States Government and
government agencies and authorities.
Deposits
At December 31, 2000, securities with a carrying value of $14,057 were on
deposit with governmental agencies as required by law in various states in which
the insurance subsidiaries of HMEC conduct business.
NOTE 4 - Debt and Warrants
Indebtedness and scheduled maturities at December 31, 2000, 1999 and 1998
consisted of the following:
Effective December 31,
Interest Final ----------------------------
Rates Maturity 2000 1999 1998
-------- -------- ---- ---- ----
Short-term debt:
Bank Credit Facility.................... Variable 2001 $ 49,000 $ 49,000 $ 50,000
Long-term debt:
6 5/8% Senior Notes, Face amount
less unaccrued discount of $279, $323
and $363, respectively................. 6.7% 2006 99,721 99,677 99,637
-------- -------- --------
Total................................. $148,721 $148,677 $149,637
======== ======== ========
F-47
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 4 - Debt and Warrants-(Continued)
Issuance of 6 5/8% Senior Notes ("Senior Notes") and Redemption of Convertible
Notes
On January 17, 1996, the Company issued $100,000 face amount of Senior Notes
at an effective yield of 6.7%, which will mature on January 15, 2006. The net
proceeds from the sale of the Senior Notes were used to finance the redemption
of the Company's 4%/6 1/2% Convertible Notes. Interest on the Senior Notes is
payable semi-annually at a rate of 6 5/8%. The Senior Notes are redeemable in
whole or in part, at any time, at the Company's option, at a redemption price
equal to the greater of (i) 100% of their principal amount and (ii) the sum of
the present values of the remaining scheduled payments of principal and interest
thereon discounted, on a semi-annual basis, at the Treasury yield (as defined in
the indenture) plus 15 basis points, together with accrued interest to the date
of redemption.
Bank Credit Facility
The Bank Credit Facility provides for unsecured borrowings of up to $65,000.
Interest accrues at varying spreads relative to corporate or eurodollar base
rates and is payable monthly or quarterly depending on the applicable base rate
(Interbank Offering Rate plus 0.325% at December 31, 2000). The unused portion
of the Bank Credit Facility is subject to a variable commitment fee which was
0.125% on an annual basis at December 31, 2000. The Company's obligations under
the Bank Credit Facility are unsecured. The commitment for the Bank Credit
Facility terminates on December 31, 2001. The Company anticipates entering into
a replacement bank credit facility prior to the end of 2001 and does not expect
material difficulties in doing so.
Warrants
No warrants were outstanding at December 31, 2000 and 1999. During 1999,
the Company repurchased all remaining warrants, representing 107,537 shares of
the Company's common stock, for $2,427. During 1998, the Company repurchased
61.8% of its then outstanding warrants, representing 173,713 shares of the
Company's common stock, for $4,959. At December 31, 1998, warrants to purchase
107,537 shares of the Company's common stock at $2.70 per share were
outstanding.
Covenants
The Company is in compliance with all of the covenants contained in the
Senior Notes indenture and the Bank Credit Facility Agreement.
F-48
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 5 - Shareholders' Equity and Stock Options
Share Repurchase Program
During 2000, the Company repurchased 1,082,400 shares of its common stock,
or 3% of the outstanding shares on December 31, 1999, at an aggregate cost of
$15,143, or an average cost of $13.99 per share, under its stock repurchase
program. Since early 1997, 8,165,100 shares, or 17% of the shares outstanding
on December 31, 1996, have been repurchased at an aggregate cost of $203,657,
equal to an average cost of $24.94 per share. Including shares repurchased in
1995, the Company has repurchased 33% of the shares outstanding on December 31,
1994. Shares of common stock may be purchased from time to time through open
market and private purchases, as available. The repurchase of shares was
financed through use of cash and, when necessary, the Bank Credit Facility.
However, the Company has not utilized the Bank Credit Facility for share
repurchases since the second quarter of 1999. As of December 31, 2000, $96,343
remained authorized for future share repurchases.
Authorization of Preferred Stock
In 1996, the shareholders of HMEC approved authorization of 1,000,000 shares
of $0.001 par value preferred stock. The Board of Directors is authorized to
(i) direct the issuance of the preferred stock in one or more series, (ii) fix
the dividend rate, conversion or exchange rights, redemption price and
liquidation preference, of any series of the preferred stock, (iii) fix the
number of shares for any series and (iv) increase or decrease the number of
shares of any series. No shares of preferred stock were outstanding at December
31, 2000, 1999 and 1998.
The Company's catastrophe reinsurance program is augmented by a $100,000
equity and reinsurance agreement. The equity put provides an option to sell
shares of the Company's convertible preferred stock with a floating rate
dividend at a pre-negotiated price in the event losses from catastrophes exceed
the catastrophe reinsurance program coverage limit. Before tax benefits, the
equity put provides a source of capital for up to $154,000 of catastrophe losses
above the reinsurance coverage limit. Fees related to this equity put option
were charged directly to additional paid-in capital.
In connection with the equity put described in the preceding paragraph, the
Board of Directors has designated a series of preferred stock to be available
for use in the put. The Series so designated is Series A Cumulative Convertible
Preferred Stock (the "Series A Stock") and 100,000 shares have been assigned to
this series. None are currently issued or outstanding. The Series A Stock is
dividend paying, at a floating rate which varies with movements in the London
Interbank Offered Rate and with changes in the risk rating of the Series A Stock
as determined by Standard & Poor's Corporation. The Series A Stock does not
require any sinking fund or similar mechanism regarding payment of such
dividends. Beginning on the fourth anniversary of the issuance of Series A
Stock, the holders thereof have the right to demand conversion of the Series A
Stock into common stock of the Company at a conversion rate based on then
prevailing
F-49
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 5 - Shareholders' Equity and Stock Options-(Continued)
market prices for the common stock; however, upon receipt of a conversion
demand, the Company has the right to redeem the Series A Stock prior to such
conversion. The Series A Stock has liquidation rights which place the Series A
Stock ahead of the common stock in priority. The Series A Stock has no voting
rights other than the requirement that the Series A Stock approve any changes in
the Series A Stock, the creation of any other class of stock on a par with or
superior to the Series A Stock and certain extraordinary transactions such as
certain mergers involving the Company.
Director Stock Plan
In 1996, the shareholders of HMEC approved the Deferred Equity Compensation
Plan ("Director Stock Plan") for directors of the Company and reserved 600,000
shares for issuance pursuant to the Director Stock Plan. Shares of the
Company's common stock issued under the Director Stock Plan may be either
authorized and unissued shares or shares that have been reacquired by the
Company. As of December 31, 2000, 1999 and 1998, 113,944 units, 68,822 units
and 48,689 units, respectively, were outstanding under this plan representing an
equal number of common shares to be issued in the future.
Employee Stock Plan
In 1997, the Board of Directors of HMEC approved the Deferred Compensation
Plan for Employees ("Employee Stock Plan"). Shares of the Company's common
stock issued under the Employee Stock Plan may be either authorized and unissued
shares or shares that have been reacquired by the Company. As of December 31,
2000, 1999 and 1998, 8,507, 5,613 and 2,489 units, respectively, were
outstanding under this plan representing an equal number of common shares to be
issued in the future.
Stock Options
In 1991, the shareholders approved the 1991 Stock Incentive Plan (the "1991
Plan") and reserved 4,000,000 shares of common stock for issuance under the 1991
Plan. In 2000, the shareholders approved an increase of 2,000,000 in the number
of shares of common stock reserved for issuance under the 1991 Plan. Under the
1991 Plan, options to purchase shares of HMEC common stock may be granted to
executive officers, other employees and directors. The options are exercisable
in installments generally beginning in the first year from the date of grant and
expiring 10 years from the date of grant.
F-50
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 5 - Shareholders' Equity and Stock Options-(Continued)
Changes in outstanding options and shares available for grant were as
follows:
Options
Weighted Average Range of ---------------------------------------
Option Price Option Prices Vested and Available
per Share per Share Outstanding Exercisable for Grant
---------------- ------------- -------------- ----------- ---------
At December 31, 1997..... $12.73 $ 9.00-$27.46 1,298,582 1,120,282 1,433,600
--------- --------- ---------
Granted................ $33.70 $29.21-$34.53 233,950 65,462 (233,950)
Vested................. $11.12-$27.46 - 65,350 -
Exercised.............. $12.79 $ 9.00-$33.87 (113,682) (113,682) -
Canceled............... $15.15 $ 15.15 (30,000) (30,000) 30,000
--------- --------- ---------
At December 31, 1998..... $16.21 $ 9.00-$34.53 1,388,850 1,107,412 1,229,650
--------- --------- ---------
Granted................ $21.42 $19.53-$25.63 484,600 68,689 (484,600)
Vested................. $22.42-$34.53 - 115,142 -
Exercised.............. $18.50 $15.15-$23.31 (17,363) (17,363) -
Canceled............... $29.07 $22.42-$33.87 (4,012) (4,012) 4,012
--------- --------- ---------
At December 31, 1999..... $17.52 $ 9.00-$34.53 1,852,075 1,269,868 749,062
--------- --------- ---------
Increase in options
available for grant.. - - 2,000,000
Granted................ $17.24 $13.84-$18.08 1,469,300 42,350 (1,469,300)
Vested................. $22.42-$33.87 - 176,234 -
Exercised.............. $ 9.06 $ 9.00-$15.15 (557,000) (557,000) -
Canceled............... $28.59 $22.42-$34.53 (27,650) (27,650) 27,650
--------- --------- ---------
At December 31, 2000..... $18.98 $ 9.00-$33.87 2,736,725 903,802 1,307,412
========= ========= =========
As of December 31, 2000, the weighted average life of vested and exercisable
options was 5.0 years and the weighted average price of such options was $20.19
per option. The weighted average prices of vested and exercisable options as of
December 31, 1999 and 1998 were $14.70 and $12.84, respectively.
F-51
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 6 - Income Taxes
The federal income tax liabilities and recoverables included in other
liabilities and other assets, respectively, in the consolidated balance sheets
as of December 31, 2000, 1999 and 1998 were as follows:
December 31,
------------------------------
2000 1999 1998
-------- -------- -------
Current liability (asset)................ $(10,012) $ 19,006 $(2,971)
Deferred liability (asset)............... (203) (20,435) 21,549
Deferred tax assets and liabilities are recognized for all future tax
consequences attributable to "temporary differences" between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. The "temporary differences" that give rise to the deferred
tax balances at December 31, 2000, 1999 and 1998 were as follows:
December 31,
----------------------------
2000 1999 1998
------- -------- -------
Deferred tax assets
Unrealized losses on securities........................... $ 2,949 $ 21,547 $ -
Discounting of unpaid claims and
claims expense tax reserves............................. 6,906 7,166 8,277
Life insurance future policy benefit reserve revaluation.. 13,808 17,195 21,346
Unearned premium reserve reduction........................ 11,634 11,395 12,037
Postretirement benefits other than pension................ 10,367 9,775 9,102
Other, net................................................ 8,750 6,200 3,181
------- -------- -------
Total gross deferred tax assets....................... 54,414 73,278 53,943
------- -------- -------
Deferred tax liabilities
Unrealized gains on securities............................ - - 30,867
Intangible assets......................................... 15,070 17,573 18,197
Deferred policy acquisition costs......................... 39,141 35,270 26,428
------- -------- -------
Total gross deferred tax liabilities.................. 54,211 52,843 75,492
------- -------- -------
Net deferred tax liability (asset).................. $ (203) $(20,435) $21,549
======= ======== =======
Based on the Company's historical earnings, future expectations of adjusted
taxable income, as well as reversing gross deferred tax liabilities, the Company
believes it is more likely than not that gross deferred tax assets will be fully
realized and that a valuation allowance with respect to the realization of the
total gross deferred tax assets is not necessary.
The components of federal income tax expense (benefit) were as follows:
Year Ended December 31,
----------------------------
2000 1999 1998
-------- ------- --------
Current..................................... $ (5,104) $35,237 $ 42,844
Deferred.................................... (6,016) 13,612 (11,375)
-------- ------- --------
Total tax expense (benefit)............. $(11,120) $48,849 $ 31,469
======== ======= ========
F-52
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 6 - Income Taxes-(Continued)
Income tax expense for the following periods differed from the expected tax
computed by applying the federal corporate tax rate of 35% to income before
income taxes as follows:
Year Ended December 31,
----------------------------
2000 1999 1998
-------- ------- -------
Expected federal tax on income............................. $ 3,402 $32,674 $40,874
Add (deduct) tax effects of:
Tax-exempt interest...................................... (4,240) (4,293) (3,706)
1994 and 1995 IRS audit - interest, net of tax........... (2,146) - -
Goodwill................................................. 566 566 566
Acquisition related benefits and other, net.............. (20) (98) (6,265)
-------- ------- -------
Income tax expense provided on income
before provision for prior years' taxes.................. (2,438) 28,849 31,469
Provision for prior years' taxes........................... (8,682) 20,000 -
-------- ------- -------
Income tax expense (benefit) provided on income............ $(11,120) $48,849 $31,469
======== ======= =======
As previously reported, the Company has been contesting proposed additional
federal income taxes relating to a settlement agreement with the Internal
Revenue Service ("IRS") for prior years' taxes. In the third quarter of 1999,
the Company recorded an additional federal income tax provision of $20,000
representing the maximum exposure of the Company to the IRS with regard to the
issue for all of the past tax years in question (1994 through 1997). In 2000,
the Company reached a final resolution with the IRS for the tax years 1994, 1995
and 1996 in an amount that was $8,682 less than was previously accrued. That
amount has been included in net income for the year ended December 31, 2000.
NOTE 7 - Fair Value of Financial Instruments
Generally accepted accounting principles require that the Company disclose
estimated fair values for certain financial instruments. Fair values of the
Company's insurance contracts other than annuity contracts are not required to
be disclosed. However, the fair values of liabilities under all insurance
contracts are taken into consideration in the Company's overall management of
interest rate risk through the matching of investment maturities with amounts
due under insurance contracts. The following methods and assumptions were used
to estimate the fair value of financial instruments.
Investments - For fixed maturities and short-term and other investments,
fair value equals quoted market price, if available. If a quoted market price is
not available, fair value is estimated using quoted market prices for similar
securities, adjusted for differences between the quoted securities and the
securities being valued. The fair value of policy loans is based on estimates
using discounted cash flow analysis and current interest rates being offered for
new loans. The fair value of mortgage loans is estimated by discounting the
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and the same remaining maturities. The
carrying value of real estate is an estimate of fair value based on discounted
cash flows from operations.
F-53
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 7 - Fair Value of Financial Instruments-(Continued)
Annuity Contract Liabilities and Policyholder Account Balances on Interest-
sensitive Life Contracts - The fair values of annuity contract liabilities and
policyholder account balances on interest-sensitive life contracts are equal to
the discounted estimated future cash flows (using the Company's current interest
rates earned on its investments) including an adjustment for risk that the
timing or amount of cash flows will vary from management's estimate.
Other Policyholder Funds - Other policyholder funds are supplementary
contract reserves and dividend accumulations which represent deposits that do
not have defined maturities. The carrying value of these funds is used as a
reasonable estimate of fair value.
Long-term Debt - The fair value of long-term debt is estimated based on
quoted market prices of publicly traded issues.
The carrying amounts and fair values of financial instruments at December
31, 2000, 1999 and 1998 consisted of the following:
December 31,
----------------------------------------------------------------------
2000 1999 1998
---------------------- --------------------- ----------------------
Carrying Fair Carrying Fair Carrying Fair
Amount Value Amount Value Amount Value
---------- ---------- ---------- ---------- ---------- ----------
Financial Assets
Investments
Fixed maturities................... $2,607,738 $2,607,738 $2,507,280 $2,507,280 $2,651,379 $2,651,379
Short-term and other investments... 99,728 102,520 122,929 125,316 102,049 105,859
Short-term investments,
loaned securities collateral..... 204,881 204,881 - - 87,392 87,392
---------- ---------- ---------- ---------- ---------- ----------
Total investments.............. 2,912,347 2,915,139 2,630,209 2,632,596 2,840,820 2,844,630
Cash................................. 21,141 21,141 22,848 22,848 12,044 12,044
Financial Liabilities
Policyholder account balances on
interest-sensitive life contracts.. 94,775 92,684 94,141 92,048 91,719 89,576
Annuity contract liabilities......... 1,217,756 1,017,044 1,238,379 1,052,732 1,239,234 1,142,859
Other policyholder funds............. 122,233 122,233 126,530 126,530 124,820 124,820
Short-term debt...................... 49,000 49,000 49,000 49,000 50,000 50,000
Long-term debt....................... 99,721 92,674 99,677 89,613 99,637 101,525
Fair value estimates shown above are dependent upon subjective assumptions
and involve significant uncertainties resulting in variability in estimates with
changes in assumptions. Fair value assumptions are based upon subjective
estimates of market conditions and perceived risks of financial instruments at a
certain point in time. The disclosed fair values do not reflect any premium or
discount that could result from offering for sale at one time an entire holding
of a particular financial instrument. In addition, potential taxes and other
expenses that would be incurred in an actual sale or settlement are not
reflected in amounts disclosed.
F-54
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 8 - Statutory Surplus and Subsidiary Dividend Restrictions
The insurance departments of various states in which the insurance
subsidiaries of HMEC are domiciled recognize as net income and surplus those
amounts determined in conformity with statutory accounting practices prescribed
or permitted by the insurance departments, which differ in certain respects from
generally accepted accounting principles.
Reconciliations of statutory capital and surplus and net income, as
determined using statutory accounting practices, to the amounts included in the
accompanying financial statements are as follows:
December 31,
---------------------------------
2000 1999 1998
--------- --------- ---------
Statutory capital and surplus of insurance subsidiaries...... $ 389,249 $ 387,081 $ 363,130
Increase (decrease) due to:
Deferred policy acquisition costs........................... 141,604 130,192 101,658
Difference in policyholder reserves......................... (2,448) (7,514) (2,498)
Goodwill.................................................... 49,014 50,632 52,250
Value of acquired insurance in force........................ 43,246 51,436 48,805
Liability for postretirement benefits, other than pensions.. (28,488) (27,257) (26,021)
Investment market value
adjustments on fixed maturities............................ (7,418) (68,123) 98,842
Difference in investment reserves........................... 21,403 27,726 33,733
Federal income tax liability................................ (6,866) (158) (15,611)
Non-admitted assets and other, net.......................... 11,064 6,552 5,054
Shareholders' equity of parent company and
non-insurance subsidiaries................................. (33,646) (1,748) (13,082)
Parent company short-term and long-term debt................ (148,721) (148,677) (149,637)
--------- --------- ---------
Shareholders' equity as reported herein.................... $ 427,993 $ 400,142 $ 496,623
========= ========= =========
Year Ended December 31,
---------------------------------
2000 1999 1998
--------- --------- ---------
Statutory net income of insurance subsidiaries............... $ 23,881 $ 75,722 $ 67,865
Net loss of non-insurance companies.......................... (17,853) (3,710) (380)
Interest expense............................................. (10,204) (9,722) (9,487)
Tax benefit of interest expense and other
parent company current tax adjustments...................... 15,539 (6,928) 2,893
--------- --------- ---------
Combined net income.......................................... 11,363 55,362 60,891
Increase (decrease) due to:
Deferred policy acquisition costs........................... 12,781 14,612 18,408
Policyholder benefits....................................... 7,891 7,681 1,852
Federal income tax expense (benefit)........................ (6,324) (3,090) 5,256
Provision for prior years' taxes............................ 8,682 (20,000) -
Amortization of intangible assets........................... (8,769) (215) (6,921)
Investment reserves......................................... (2,067) (7,931) 6,061
Loss on group medical business, net of tax benefits......... - (376) 1,738
Other adjustments, net...................................... (2,716) (1,538) (1,973)
--------- --------- ---------
Net income as reported herein.............................. $ 20,841 $ 44,505 $ 85,312
========= ========= =========
F-55
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 8 - Statutory Surplus and Subsidiary Dividend Restrictions-(Continued)
The Company has principal insurance subsidiaries domiciled in Illinois,
California and Texas. The statutory financial statements of these subsidiaries
are prepared in accordance with accounting practices prescribed or permitted by
the Illinois Department of Insurance, the California Department of Insurance and
the Texas Department of Insurance as applicable. Prescribed statutory accounting
practices include a variety of publications of the National Association of
Insurance Commissioners ("NAIC"), as well as state laws, regulations and general
administrative rules. Permitted statutory accounting practices encompass all
accounting practices not so prescribed.
The insurance subsidiaries are subject to various regulatory restrictions
which limit the amount of annual dividends or other distributions, including
loans or cash advances, available to HMEC without prior approval of the
insurance regulatory authorities. The aggregate amount of dividends that may be
paid by the insurance subsidiaries to HMEC during 2001 without prior approval is
approximately $42,000.
The NAIC has adopted risk-based capital guidelines that establish minimum
levels of statutory capital and surplus based on risk assumed in investments,
reserving policies, and volume and types of insurance business written. State
insurance regulations prohibit insurance companies from making any public
statements or representations with regard to their risk-based capital levels.
Based on current guidelines, the risk-based capital statutory requirements will
have no negative regulatory impact on the Company's insurance subsidiaries.
The NAIC has codified statutory accounting practices, which are expected to
constitute the only source of prescribed statutory accounting practices and are
effective January 1, 2001. Codification will change prescribed statutory
accounting practices and may result in changes to the accounting practices that
insurance enterprises use to prepare their statutory financial statements. The
states of domicile of the Company's principal operating subsidiaries, Illinois,
California and Texas, have adopted the NAIC's codification. Although the
evaluation of the impact of adopting the NAIC codification on the Company's
statutory financial statements is not yet complete, as of the date of these
financial statements management anticipates that the impact will not be
material.
F-56
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 9 - Pension Plans and Other Postretirement Benefits
All employees of the Company are covered by a defined contribution plan and
are eligible to participate in the Supplemental Retirement Savings (401(k))
Plan. Certain employees also participate in a supplemental defined contribution
plan. Employees hired on or before December 31, 1998 are also covered under a
defined benefit plan, with certain employees covered under a supplemental
defined benefit plan.
Benefits under the defined benefit and supplemental retirement plans are
based on employees' years of service and compensation for the highest 36
consecutive months of earnings under the plan. Under the defined contribution
plan, contributions are made to employees' accounts based on a percentage of
compensation that is determined by the employees' years of service. Retirement
benefits to employees are paid first from their accumulated accounts under the
defined contribution plan with the balance funded by the defined benefit and
supplemental retirement plans.
The Company's policy with respect to funding the defined benefit plan is to
contribute amounts which are actuarially determined to provide the plan with
sufficient assets to meet future benefit payments consistent with the funding
requirements of federal laws and regulations. For the defined benefit plan,
investments have been set aside in a trust fund. The supplemental retirement
plans are non-qualified, unfunded plans.
Employees of the Company are also eligible to participate in the
Supplemental Retirement and Savings Plan, a 401(k) plan, and may generally
contribute up to 10% of eligible compensation on a before tax basis. The Company
contributes an amount equal to 50% of the first 6% of eligible compensation
contributed each month by participating employees.
Total pension and supplemental savings expense was $11,783, $9,593 and
$9,471 for the years ended December 31, 2000, 1999 and 1998, respectively.
Defined Contribution Plan
Pension benefits under the defined contribution plan were fully funded and
investments were set aside in a trust fund. Contributions to employees' accounts
under the defined contribution plan, which were expensed in the Company's
statements of operations, and total plan assets were as follows:
Year Ended December 31,
-------------------------
2000 1999 1998
------- ------- -------
Contributions to employees accounts.. $ 5,626 $ 5,814 $ 5,919
Total assets at the end of the year.. 92,609 85,519 77,820
F-57
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
Defined Benefit Plan and Supplemental Retirement Plans
The following table summarizes both the funding status of the defined
benefit and supplemental retirement pension plans at the end of each year and
identifies the assumptions used to determine the projected benefit obligation
and the components of net pension cost for the defined benefit plan and
supplemental retirement plans for the following periods:
Supplemental
Defined Benefit Plan Retirement Plans
----------------------------- ------------------------------
December 31, December 31,
----------------------------- ------------------------------
2000 1999 1998 2000 1999 1998
------- ------- ------- -------- ------- -------
Change in benefit obligation:
Benefit obligation at beginning of year......... $47,282 $49,446 $43,354 $ 8,775 $ 6,190 $ 5,606
Service cost.................................... 1,625 1,816 1,563 719 353 341
Interest cost................................... 3,525 3,351 3,081 855 616 382
Actuarial (gain) loss........................... 4,689 (3,291) 5,058 2,884 1,913 (65)
Benefits paid................................... (6,291) (4,040) (3,610) (1,042) (297) (74)
------- ------- ------- -------- ------- -------
Benefit obligation at end of year............... $50,830 $47,282 $49,446 $ 12,191 $ 8,775 $ 6,190
======= ======= ======= ======== ======= =======
Change in plan assets:
Fair value of plan assets at beginning of year.. $52,966 $50,576 $46,097 $ - $ - $ -
Actual return on plan assets.................... (3,274) 6,430 8,089 - - -
Employer contributions.......................... - - - 1,042 297 74
Benefits paid................................... (6,291) (4,040) (3,610) (1,042) (297) (74)
------- ------- ------- -------- ------- -------
Fair value of plan assets at end of year........ $43,401 $52,966 $50,576 $ - $ - $ -
======= ======= ======= ======== ======= =======
Funded status..................................... $(7,429) $ 5,684 $ 1,130 $(12,191) $(8,775) $(6,190)
Unrecognized net actuarial (gain) loss............ 8,304 (3,941) 1,426 1,431 493 (1,255)
Unrecognized prior service (asset) cost........... (3,204) (3,815) (4,424) 1,954 2,268 2,582
------- ------- ------- -------- ------- -------
Accrued benefit cost included
in the consolidated balance sheets.............. (2,329) (2,072) (1,868) (8,806) (6,014) (4,863)
Additional liability to recognize unfunded
accumulated benefit obligation.................. - - - (3,358) (2,228) (1,107)
------- ------- ------- -------- ------- -------
Accrued benefit cost.............................. $(2,329) $(2,072) $(1,868) $(12,164) $(8,242) $(5,970)
======= ======= ======= ======== ======= =======
Amounts recognized in the statement of
financial position consist of:
Accrued benefit cost.......................... $(2,329) $(2,072) $(1,868) $ (8,806) $(6,014) $(4,863)
Minimum liability............................. - - - (3,358) (2,228) (1,107)
Intangible asset.............................. - - - 1,917 2,228 1,107
Accumulated other comprehensive income........ - - - 1,441 - -
------- ------- ------- -------- ------- -------
Net amount recognized....................... $(2,329) $(2,072) $(1,868) $ (8,806) $(6,014) $(4,863)
======= ======= ======= ======== ======= =======
F-58
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
Supplemental
Defined Benefit Plan Retirement Plans
----------------------------- ------------------------
Year Ended December 31, Year Ended December 31,
----------------------------- ------------------------
2000 1999 1998 2000 1999 1998
------- ------- ------- ------ ------ ----
Components of net periodic benefit cost:
Service cost............................ $ 1,625 $ 1,816 $ 1,563 $ 719 $ 353 $ 341
Interest cost........................... 3,525 3,351 3,081 855 616 382
Expected return on plan assets.......... (4,283) (4,353) (3,969) - - -
Amortization of prior service cost...... (610) (610) (611) 314 313 313
Recognized net actuarial loss (gain).... - - - 1,946 166 (228)
------- ------- ------- ------ ------ -----
Net periodic benefit cost................. $ 257 $ 204 $ 64 $3,834 $1,448 $ 808
======= ======= ======= ====== ====== =====
Weighted-average assumptions
as of December 31:
Discount rate......................... 7.25% 8.00% 6.75% 7.25% 8.00% 6.75%
Expected return on plan assets........ 8.75% 8.75% 8.75% * * *
Rate of salary increase............... 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%
- ------------
* Not applicable.
Postretirement Benefits Other than Pensions
In addition to providing pension benefits, the Company also provides certain
health care and life insurance benefits to retired employees and eligible
dependents. Through December 31, 2000, employees with ten years of service are
eligible to receive these benefits upon retirement. Effective January 1, 2001,
the requirement will increase to age 55 and 20 years of service for employees to
be eligible to receive these benefits upon retirement. Employees hired on
January 1, 2001 or after will not be eligible for postretirement medical
benefits. Employees who were at least age 55 and had 10 years of service in the
year 2000 were not affected by this change. Postretirement benefits other than
pensions of active and retired employees are accrued as expense over the
employees' service years.
F-59
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
The following table presents the funded status of postretirement benefits
other than pensions of active and retired employees (including employees on
disability more than 2 years) as of December 31, 2000, 1999 and 1998 reconciled
with amounts recognized in the Company's statement of financial position:
December 31,
------------------------------------
2000 1999 1998
-------- -------- --------
Change in accumulated postretirement benefit obligation:
Accumulated postretirement benefit
obligation at beginning of year......................... $ 29,660 $ 34,257 $ 29,584
Changes during fiscal year
Service cost............................................ 564 628 552
Interest cost........................................... 2,366 2,158 2,043
Benefits paid........................................... (1,749) (1,768) (1,231)
Actuarial (gain) loss................................... (75) (5,615) 3,309
-------- -------- --------
Accumulated postretirement benefit
obligation at end of year............................... $ 30,766 $ 29,660 $ 34,257
======== ======== ========
Unfunded status........................................... $(30,766) $(29,660) $(34,257)
Unrecognized net loss from past
experience different from that assumed................... 2,278 2,403 8,236
-------- -------- --------
Accrued postretirement benefit cost..................... $(28,488) $(27,257) $(26,021)
======== ======== ========
Year Ended December 31,
------------------------------------
2000 1999 1998
-------- -------- --------
Components of net periodic benefit cost:
Service cost............................................. $ 564 $ 628 $ 552
Interest cost............................................ 2,366 2,158 2,043
Amortization of prior (gains) losses..................... 50 218 83
-------- -------- --------
Net periodic benefit cost............................... $ 2,980 $ 3,004 $ 2,678
======== ======== ========
Sensitivity Analysis
A one percentage point change in the assumed health care cost trend rate for
each year would change the accumulated postretirement benefit obligation as
follows:
December 31,
-----------------------------------
2000 1999 1998
----- ----- -------
Accumulated postretirement benefit obligation
Effect of a one percentage point increase.............. $ 606 $ 864 $ 1,379
Effect of a one percentage point decrease.............. (546) (743) (1,351)
Service and interest cost components of the net
periodic postretirement benefit expense
Effect of a one percentage point increase............ $ 81 $ 75 $ 203
Effect of a one percentage point decrease............ (66) (60) (177)
F-60
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
The assumed net weighted annual average medical rates of increase in the per
capita cost of covered benefits for participants in the plan who retired prior
to January 1, 1994 were 5.8%, 6.1% and 6.3% as of December 31, 2000, 1999 and
1998, respectively. The net medical trend rates are 6.5% in 2001 grading down
to 5.0% in 2004 and thereafter. For those participants retiring after December
31, 1993, benefits are provided at a level amount of $10.00 per month per year
of employment. The weighted average discount rate used in determining the
accumulated postretirement benefit obligation was 7.25%, 8.00% and 6.75% at
December 31, 2000, 1999 and 1998, respectively.
NOTE 10 - Reinsurance
In the normal course of business, the insurance subsidiaries assume and cede
reinsurance with other insurers. Reinsurance is ceded primarily to limit losses
from large exposures and to permit recovery of a portion of direct losses;
however, such a transfer does not relieve the originating insurance company of
contingent liability.
The Company is a national underwriter and therefore has exposure to
catastrophic losses in certain coastal states and other regions throughout the
United States. Catastrophes can be caused by various events including
hurricanes, windstorms, earthquakes, hail, severe winter weather, and fires, and
the frequency and severity of catastrophes are inherently unpredictable. The
financial impact from catastrophic losses results from both the total amount of
insured exposure in the area affected by the catastrophe as well as the severity
of the event. The Company seeks to reduce its exposure to catastrophe losses
through the geographic diversification of its insurance coverage, deductibles,
maximum coverage limits, the purchase of catastrophe reinsurance, and the
purchase of a catastrophe-linked equity put option and reinsurance agreement
(also see Note 5).
The total amounts of reinsurance recoverable on unpaid claims classified as
assets and reported in other assets in the balance sheets were as follows:
December 31,
-------------------------
2000 1999 1998
------- ------- -------
Reinsurance Recoverables on Unpaid Claims
Life and health.......................... $ 4,619 $ 4,485 $ 3,890
Property and casualty
State insurance facilities............. 32,026 45,222 35,988
Other insurance companies.............. 17,030 19,188 19,902
------- ------- -------
Total................................ $53,675 $68,895 $59,780
======= ======= =======
F-61
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 10 - Reinsurance-(Continued)
The Company recognizes the cost of reinsurance premiums over the contract
periods for such premiums in proportion to the insurance protection provided.
Amounts recoverable from reinsurers for unpaid claims and claim settlement
expenses, including estimated amounts for unsettled claims, claims incurred but
not reported and policy benefits are estimated in a manner consistent with the
insurance liability associated with the policy. The effect of reinsurance on
premiums written, premiums earned, and benefits, claims and settlement expenses
were as follows:
Ceded to Assumed
Gross Other from State
Amount Companies Facilities Net
-------- --------- ---------- --------
Year ended December 31, 2000
Premiums written............ $829,437 $24,078 $16,294 $821,653
Premiums earned............. 605,252 23,105 16,567 598,714
Benefits, claims and
settlement expenses....... 461,396 13,736 18,388 466,048
Year ended December 31, 1999
Premiums written............ 825,328 23,891 19,772 821,209
Premiums earned............. 599,949 25,308 20,487 595,128
Benefits, claims and
settlement expenses....... 435,605 39,183 19,764 416,186
Year ended December 31, 1998
Premiums written............ 832,231 27,174 22,730 827,787
Premiums earned............. 583,637 26,024 20,199 577,812
Benefits, claims and
settlement expenses....... 420,788 41,284 16,824 396,328
There were no losses from uncollectible reinsurance recoverables in the
three years ended December 31, 2000. Past due reinsurance recoverables as of
December 31, 2000 were not material.
NOTE 11 - Contingencies
Lawsuits and Legal Proceedings
In December 2000, the Company recorded an after tax charge of $5,000,
representing the Company's best estimate of the actual and anticipated costs of
defending and ultimately resolving litigation brought against the Company in
regards to its disability insurance product. The lawsuit is on behalf of
certain policyholders who purchased the Company's disability insurance product
and allege that they were not adequately made aware of certain features. While
the actual costs for the Company to resolve this issue could be either less or
more than the liability established in 2000, management believes that, based on
facts and circumstances available at the time, the amount recorded will be
adequate to resolve the matter. Disability insurance represented less than 1%
of the Company's insurance premiums written and contract deposits for the year
ended December 31, 2000.
F-62
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 11 - Contingencies-(Continued)
There are various other lawsuits and legal proceedings against the Company.
Management and legal counsel are of the opinion that the ultimate disposition of
such other litigation will have no material adverse effect on the Company's
financial position or results of operations.
Assessments for Insolvencies of Unaffiliated Insurance Companies
The Company is also contingently liable for possible assessments under
regulatory requirements pertaining to potential insolvencies of unaffiliated
insurance companies. Liabilities, which are established based upon regulatory
guidance, have been insignificant.
NOTE 12 - Supplementary Data on Cash Flows
A reconciliation of net income to net cash provided by operating activities
as presented in the consolidated statements of cash flows is as follows:
Year Ended December 31,
---------------------------------------
2000 1999 1998
-------- -------- --------
Cash flows from operating activities
Net income.......................................... $ 20,841 $ 44,505 $ 85,312
Adjustments to reconcile net income to net
cash provided by operating activities:
Realized investment (gains) losses.............. 9,906 7,969 (9,908)
Depreciation and amortization................... 6,761 (1,013) 5,342
Increase in insurance liabilities............... 113,616 76,401 74,900
(Increase) decrease in premium receivables...... (7,357) 11,357 (2,296)
Increase in deferred policy acquisition costs... (12,780) (14,615) (18,408)
(Increase) decrease in reinsurance recoverable.. 3,364 (3,078) (1,997)
Increase (decrease) in federal
income tax liabilities........................ (27,655) 32,409 (6,731)
Decrease in accrued loss
on discontinued operations.................... - - (2,689)
Increase in liabilities for restructuring
and litigation charges........................ 9,919 - -
Other........................................... 7,633 (5,789) 5,241
-------- -------- --------
Total adjustments............................. 103,407 103,641 43,454
-------- -------- --------
Net cash provided by operating activities... $124,248 $148,146 $128,766
======== ======== ========
F-63
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 13 - Segment Information
The Company's operations include the following operating segments which
have been determined on the basis of insurance products sold: property and
casualty, annuity and life insurance. The property and casualty insurance
segment includes primarily personal lines automobile and homeowners products.
The annuity segment includes primarily fixed and variable tax-qualified annuity
products. The life insurance segment includes primarily interest-sensitive life
and traditional life products.
The accounting policies of the segments are the same as those described in
Note 1 - Summary of Significant Accounting Policies. The Company accounts for
intersegment transactions, primarily the allocation of agent and overhead costs
from the Corporate and Other segment to the property and casualty, annuity and
life segments, on a cost basis. Operating income is equal to net income (loss)
before the after tax impact of realized investment gains and losses,
restructuring charges, litigation charges and provision for prior years' taxes.
F-64
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 13 - Segment Information-(Continued)
Summarized financial information for these segments is as follows:
Year Ended December 31,
------------------------------------
2000 1999 1998
------ ------ ------
Insurance premiums and contract charges earned
Property and casualty.............................. $ 489,952 $ 491,060 $ 476,458
Annuity............................................ 17,017 16,706 15,556
Life............................................... 92,998 87,618 85,798
Intersegment eliminations.......................... (1,253) (256) -
---------- ---------- ----------
Total......................................... $ 598,714 $ 595,128 $ 577,812
========== ========== ==========
Net investment income
Property and casualty.............................. $ 35,695 $ 37,012 $ 38,900
Annuity............................................ 105,340 105,224 107,698
Life............................................... 51,264 47,005 45,453
Corporate and other................................ 1,295 319 761
Intersegment eliminations.......................... (1,198) (1,293) (1,089)
---------- ---------- ----------
Total......................................... $ 192,396 $ 188,267 $ 191,723
========== ========== ==========
Net income
Operating income
Property and casualty............................ $ 8,969 $ 39,537 $ 53,282
Annuity.......................................... 19,274 27,320 23,048
Life............................................. 12,880 14,570 12,345
Corporate and other, including interest expense.. (16,013) (10,712) (9,803)
---------- ---------- ----------
Total operating income........................ 25,110 70,715 78,872
Realized investment gains (losses), after tax...... (6,439) (5,180) 6,440
Restructuring charges, after tax................... (1,453) - -
Litigation charges, after tax...................... (5,059) (1,030) -
Provision for prior years' taxes................... 8,682 (20,000) -
---------- ---------- ----------
Total......................................... $ 20,841 $ 44,505 $ 85,312
========== ========== ==========
Amortization of intangible assets
Value of acquired insurance in force
Property and casualty............................ $ - $ 719 $ 1,032
Annuity.......................................... 5,176 (4,242) 1,996
Life............................................. 1,975 2,120 2,275
---------- ---------- ----------
Subtotal...................................... 7,151 (1,403) 5,303
Goodwill........................................... 1,618 1,618 1,618
---------- ---------- ----------
Total......................................... $ 8,769 $ 215 $ 6,921
========== ========== ==========
December 31,
------------------------------------
2000 1999 1998
---------- ---------- ----------
Assets
Property and casualty............................. $ 733,922 $ 681,432 $ 737,260
Annuity........................................... 2,639,872 2,611,766 2,730,092
Life.............................................. 969,181 840,594 863,864
Corporate and other............................... 115,584 153,493 95,579
Intersegment eliminations......................... (37,979) (33,439) (31,315)
---------- ---------- ----------
Total........................................ $4,420,580 $4,253,846 $4,395,480
========== ========== ==========
F-65
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
NOTE 14 - Unaudited Interim Information
Summary quarterly financial data is presented below.
Three Months Ended
-------------------------------------------------------
December 31, September 30, June 30, March 31,
------------- -------------- -------- ----------
2000
- ----
Insurance premiums written and contract deposits... $212,673 $210,002 $204,466 $194,512
Total revenues..................................... 192,941 197,566 198,395 192,302
Restructuring charges, after tax................... (1,453) - - -
Litigation charges, after tax...................... (4,994) - (65) -
Provision for prior years' taxes................... 5,882 2,800 - -
Net income (loss).................................. (13,774) 12,207 9,682 12,726
Per share information
Basic
Realized investment gains (losses), after tax.. $ (0.10) $ (0.02) $ 0.01 $ (0.04)
Restructuring charges, after tax............... (0.04) - - -
Litigation charges, after tax.................. (0.12) - - -
Provision for prior years' taxes............... 0.15 0.07 - -
Net income (loss).............................. (0.34) 0.30 0.24 0.31
Diluted
Realized investment gains (losses), after tax.. $ (0.10) $ (0.02) $ - $ (0.04)
Restructuring charges, after tax............... (0.04) - - -
Litigation charges, after tax.................. (0.12) - - -
Provision for prior years' taxes............... 0.14 0.07 - -
Net income (loss).............................. (0.34) 0.30 0.23 0.31
1999
- ----
Insurance premiums written and contract deposits... $207,195 $208,305 $207,644 $198,065
Total revenues..................................... 199,780 195,433 190,182 190,031
Litigation charges, after tax...................... (22) (1,008) - -
Provision for prior years' taxes................... - (20,000) - -
Net income (loss).................................. 22,490 (5,458) 10,422 17,051
Per share information
Basic
Realized investment gains (losses), after tax.. $ 0.02 $ (0.01) $ (0.09) $ (0.05)
Litigation charges, after tax.................. - (0.02) - -
Provision for prior years' taxes............... - (0.48) - -
Net income (loss).............................. 0.55 (0.13) 0.25 0.41
Diluted
Realized investment gains (losses), after tax.. $ 0.01 $ - $ (0.09) $ (0.05)
Litigation charges, after tax.................. - (0.02) - -
Provision for prior years' taxes............... - (0.48) - -
Net income (loss).............................. 0.54 (0.12) 0.25 0.40
1998
- ----
Insurance premiums written and contract deposits... $211,082 $209,686 $210,065 $196,954
Total revenues..................................... 192,292 196,564 194,489 196,098
Net income......................................... 22,271 24,934 15,648 22,459
Per share information
Basic
Realized investment gains (losses), after tax.. $ (0.05) $ 0.06 $ 0.04 $ 0.10
Net income..................................... 0.52 0.58 0.36 0.51
Diluted
Realized investment gains (losses), after tax.. $ (0.05) $ 0.06 $ 0.05 $ 0.09
Net income..................................... 0.52 0.57 0.36 0.50
F-66
SCHEDULE I
HORACE MANN EDUCATORS CORPORATION
SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 2000
(Dollars in thousands)
Amount
shown in
Market Balance
Type of Investments Cost(1) Value Sheet
------------------- ---------- ---------- ----------
Fixed maturities:
U.S. Government and U.S. Government agencies
and authorities.................................. $ 620,307 $ 630,663 $ 630,663
States, municipalities and political subdivisions.. 286,384 295,055 295,055
Foreign government bonds........................... 29,310 30,620 30,620
Public utilities................................... 117,809 115,825 115,825
Other corporate bonds.............................. 1,561,346 1,535,575 1,535,575
---------- ---------- ----------
Total fixed maturity securities................ 2,615,156 $2,607,738 2,607,738
---------- ========== ----------
Mortgage loans and real estate....................... 17,282 xxx 17,282
Short-term investments............................... 20,337 xxx 20,337
Short-term investments, loaned securities............ 204,881 xxx 204,881
Policy loans and other............................... 62,122 xxx 62,109
---------- ----------
Total investments.............................. $2,919,778 xxx $2,912,347
========== ==========
- ---------------
(1) Bonds at original cost reduced by repayments and adjusted for amortization
of premiums or accrual of discounts and impairment in value of specifically
identified investments.
See accompanying Independent Auditors' Report.
F-67
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
BALANCE SHEETS
As of December 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
2000 1999 1998
--------- --------- ---------
ASSETS
Investments and cash.......................................... $ 8,565 $ 21,734 $ 5,580
Investment in subsidiaries.................................... 521,563 478,748 589,964
Other assets.................................................. 49,668 51,417 53,989
--------- --------- ---------
Total assets.............................................. $ 579,796 $ 551,899 $ 649,533
========= ========= =========
LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY
Short-term debt............................................... $ 49,000 $ 49,000 $ 50,000
Long-term debt................................................ 99,721 99,677 99,637
Other liabilities............................................. 3,082 3,080 3,053
--------- --------- ---------
Total liabilities......................................... 151,803 151,757 152,690
--------- --------- ---------
Warrants, subject to redemption............................... - - 220
--------- --------- ---------
Preferred stock, $0.001 par value, authorized
1,000,000 shares; none issued............................... - - -
Common stock, $0.001 par value, authorized 75,000,000
shares; issued, 2000, 59,859,053; 1999, 59,292,053;
1998, 59,274,690............................................ 60 59 59
Additional paid-in capital.................................... 338,243 333,892 336,686
Retained earnings............................................. 452,624 449,023 420,274
Accumulated other comprehensive income (loss), net of taxes:
Net unrealized gains (losses) on fixed maturities
and equity securities..................................... (4,038) (40,016) 57,327
Minimum pension liability adjustment........................ (937) - -
Treasury stock, at cost, 2000, 19,341,296 shares; 1999,
18,258,896 shares; 1998, 17,183,596 shares.................. (357,959) (342,816) (317,723)
--------- --------- ---------
Total shareholders' equity................................ 427,993 400,142 496,623
--------- --------- ---------
Total liabilities, redeemable securities
and shareholders' equity................................ $ 579,796 $ 551,899 $ 649,533
========= ========= =========
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-68
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF OPERATIONS
(Dollars in thousands)
Year Ended December 31,
-----------------------------
2000 1999 1998
-------- -------- -------
Revenues
Net investment income........................ $ 1,292 $ 318 $ 759
Realized investment gains.................... 242 481 1,123
-------- -------- -------
Total revenues............................ 1,534 799 1,882
-------- -------- -------
Expenses
Interest..................................... 10,204 9,722 9,487
Amortization of goodwill..................... 1,618 1,618 1,618
Other........................................ 1,101 1,479 713
-------- -------- -------
Total expenses............................ 12,923 12,819 11,818
-------- -------- -------
Income (loss) before income taxes
and equity in net earnings of subsidiaries... (11,389) (12,020) (9,936)
Income tax expense (benefit)................... (3,058) (3,686) (2,766)
-------- -------- -------
Income (loss) before equity
in net earnings of subsidiaries.............. (8,331) (8,334) (7,170)
Equity in net earnings of subsidiaries......... 29,172 52,839 92,482
-------- -------- -------
Net income..................................... $ 20,841 $ 44,505 $85,312
======== ======== =======
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-69
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
-------------------------------
2000 1999 1998
--------- -------- --------
Cash flows from operating activities
Interest expense paid.................................... $(10,028) $ (9,523) $ (9,309)
Federal income taxes recovered........................... 7,483 6,901 5,672
Cash dividends received from subsidiaries................ 36,500 63,500 62,100
Other, net............................................... 693 421 9,588
-------- -------- --------
Net cash provided by operating activities............ 34,648 61,299 68,051
-------- -------- --------
Cash flows from investing activities
Net (increase) decrease in investments................... 7,214 (12,306) 18,039
Capital contribution to subsidiary....................... (20,000) - -
-------- -------- --------
Net cash provided by (used in) investing activities.. (12,786) (12,306) 18,039
-------- -------- --------
Cash flows used in financing activities
Purchase of treasury stock............................... (15,143) (25,093) (71,631)
Dividends paid to shareholders........................... (17,240) (15,756) (14,312)
Principal (payments) borrowings on Bank Credit Facility.. - (1,000) 8,000
Repurchase of common stock warrants...................... - (2,426) (4,959)
Exercise of stock options................................ 5,302 362 2,200
Catastrophe-linked equity put option premium............. (950) (950) (1,475)
-------- -------- --------
Net cash used in financing activities................ (28,031) (44,863) (82,177)
-------- -------- --------
Net increase (decrease) in cash............................ (6,169) 4,130 3,913
Cash at beginning of period................................ 8,043 3,913 0
-------- -------- --------
Cash at end of period...................................... $ 1,874 $ 8,043 $ 3,913
======== ======== ========
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-70
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
NOTE TO CONDENSED FINANCIAL STATEMENTS
December 31, 2000, 1999 and 1998
The accompanying condensed financial statements should be read in
conjunction with the Consolidated Financial Statements and the accompanying
notes thereto.
See accompanying Independent Auditors' Report.
F-71
SCHEDULE III & VI (COMBINED)
HORACE MANN EDUCATORS CORPORATION
SUPPLEMENTARY INSURANCE INFORMATION
(Dollars in thousands)
Discount, Other Benefits,
Deferred Future policy if any, policy Premium claims
policy benefits, deducted in claims and revenue/ Net and
acquisition claims and previous Unearned benefits premium investment settlement
Segment costs claims expenses column premiums payable earned income expenses
- ------- ----------- --------------- ----------- -------- ---------- -------- ---------- ----------
Year Ended December 31, 2000
Property and casualty........ $ 16,936 $ 298,896 $ 0 $166,202 $ - $489,952 $ 35,695 $417,369
Annuity...................... 46,434 1,220,334 xxx - 111,511 17,017 105,340 67,758
Life......................... 78,234 668,596 xxx 8,226 10,722 92,998 51,264 73,482
Other, including
consolidating eliminations.. N/A N/A xxx N/A N/A (1,253) 97 N/A
-------- ---------- -------- -------- -------- -------- --------
Total...................... $141,604 $2,187,826 xxx $174,428 $122,233 $598,714 $192,396 $558,609
======== ========== ======== ======== ======== ======== ========
Year Ended December 31, 1999
Property and casualty........ $ 16,705 $ 299,803 $ 0 $162,793 $ - $491,060 $ 37,012 $374,872
Annuity...................... 41,558 1,240,757 xxx - 114,611 16,706 105,224 67,078
Life......................... 71,929 629,889 xxx 8,052 11,919 87,618 47,005 65,865
Other, including
consolidating eliminations.. N/A N/A xxx N/A N/A (256) (974) N/A
-------- ---------- -------- -------- -------- -------- --------
Total...................... $130,192 $2,170,449 xxx $170,845 $126,530 $595,128 $188,267 $507,815
======== ========== ======== ======== ======== ======== ========
Year Ended December 31, 1998
Property and casualty........ $ 16,048 $ 298,929 $ 0 $172,474 $ - $476,458 $ 38,900 $354,381
Annuity...................... 25,818 1,240,987 xxx - 111,754 15,556 107,698 71,996
Life......................... 59,792 588,888 xxx 6,720 13,066 85,798 45,453 64,727
Other, including
consolidating eliminations.. N/A N/A xxx N/A N/A N/A (328) N/A
-------- ---------- -------- -------- -------- -------- --------
Total...................... $101,658 $2,128,804 xxx $179,194 $124,820 $577,812 $191,723 $491,104
======== ========== ======== ======== ======== ======== ========
Claims and claims
adjustment expense Amortization Paid
incurred related to of deferred claims
------------------- policy Other and claims
Current Prior acquisition operating adjustment Premiums
year years costs expenses expense written
-------- -------- ------------ --------- ---------- --------
Year Ended December 31, 2000
Property and casualty........ $394,711 $ 22,658 $45,983 $ 58,416 $402,922 $493,364
Annuity...................... xxx xxx 4,694 20,741 xxx xxx
Life......................... xxx xxx 6,725 44,168 xxx xxx
Other, including
consolidating eliminations.. xxx xxx (1,430) 33,577 xxx xxx
------- --------
Total...................... xxx xxx $55,972 $156,902 xxx xxx
======= ========
Year Ended December 31, 1999
Property and casualty........ $379,455 $ (4,583) $44,227 $ 54,453 $382,518 $495,075
Annuity...................... xxx xxx 5,820 7,208 xxx xxx
Life......................... xxx xxx 3,286 43,178 xxx xxx
Other, including
consolidating eliminations.. xxx xxx (292) 16,377 xxx xxx
------- --------
Total...................... xxx xxx $53,041 $121,216 xxx xxx
======= ========
Year Ended December 31, 1998
Property and casualty........ $379,603 $(24,917) $42,779 $ 51,699 $380,955 $487,727
Annuity...................... xxx xxx (700) 16,558 xxx xxx
Life......................... xxx xxx 3,398 44,167 xxx xxx
Other, including
consolidating eliminations.. xxx xxx N/A 13,657 xxx xxx
------- --------
Total...................... xxx xxx $45,477 $126,081 xxx xxx
======= ========
N/A Not applicable.
See accompanying Independent Auditors' Report.
F-72
SCHEDULE IV
HORACE MANN EDUCATORS CORPORATION
REINSURANCE
(Dollars in thousands)
Column A Column B Column C Column D Column E Column F
Ceded to Assumed Percentage
Gross Other from State of Amount
Amount Companies Facilities Net Assumed to Net
----------- --------- ----------- ----------- --------------
Year ended December 31, 2000
Life insurance in force......... $12,646,371 $ 746,447 - $11,899,924 -
Premiums
Property and casualty......... $ 494,539 $ 21,154 $ 16,567 $ 489,952 3.4%
Annuity....................... 17,017 - - 17,017 -
Life.......................... 94,949 1,951 - 92,998 -
Other, including
consolidating eliminations.. (1,253) - - (1,253) -
----------- --------- --------- -----------
Total premiums.......... $ 605,252 $ 23,105 $ 16,567 $ 598,714 2.8%
=========== ========= ========= ===========
Year ended December 31, 1999
Life insurance in force......... $12,300,704 $ 783,527 - $11,517,177 -
Premiums
Property and casualty......... $ 493,804 $ 23,231 $ 20,487 $ 491,060 4.2%
Annuity....................... 16,706 - - 16,706 -
Life.......................... 89,695 2,077 - 87,618 -
Other, including
consolidating eliminations.. (256) - - (256) -
----------- --------- --------- -----------
Total premiums.......... $ 599,949 $ 25,308 $ 20,487 $ 595,128 3.4%
=========== ========= ========= ===========
Year ended December 31, 1998
Life insurance in force......... $11,798,613 $ 643,910 - $11,154,703 -
Premiums
Property and casualty......... $ 480,447 $ 24,188 $ 20,199 $ 476,458 4.2%
Annuity....................... 15,556 - - 15,556 -
Life.......................... 87,634 1,836 - 85,798 -
----------- --------- --------- -----------
Total premiums.......... $ 583,637 $ 26,024 $ 20,199 $ 577,812 3.5%
=========== ========= ========= ===========
- --------------------
NOTE: Premiums above include insurance premiums earned and contract charges
earned.
See accompanying Independent Auditors' Report
F-73
HORACE MANN(R)
- ----------------------------------------
Insuring America's Educational Community
The Horace Mann Companies
1 Horace Mann Plaza
Springfield, Illinois 62715-0001
217-789-2500
www.horacemann.com
www.reacheverychild.com
HA-C00336 (Mar.01)
===============================================================================
HORACE MANN EDUCATORS CORPORATION
EXHIBITS
To
FORM 10-K
For the Year Ended December 31, 2000
VOLUME 1 OF 1
===============================================================================
The following items are filed as Exhibits to Horace Mann Educators
Corporation's Annual Report on Form 10-K for the year ended December 31, 2000.
Management contracts and compensatory plans are indicated by an asterisk(*).
EXHIBIT INDEX
Exhibit
No. Description
- ------- -----------
(3) Articles of incorporation and bylaws:
3.1 Restated Certificate of Incorporation of HMEC, filed with the
Delaware Secretary of State on October 6, 1989, incorporated by
reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1996, filed with the
Securities and Exchange Commission (the "SEC") on November 14,
1996.
3.1(a) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on October
18, 1991, incorporated by reference to Exhibit 3.2 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1996, filed with the SEC on November 14, 1996.
3.1(b) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on August 23,
1995, incorporated by reference to Exhibit 3.3 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1996, filed with the SEC on November 14, 1996.
3.1(c) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on September
23, 1996, incorporated by reference to Exhibit 3.4 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1996, filed with the SEC on November 14, 1996.
3.1(d) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on June 5,
1998, incorporated by reference to Exhibit 3.1 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1998, filed with the SEC on August 13, 1998.
3.1(e) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on June 22,
2000, incorporated by reference to Exhibit 3.1(e) to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2000, filed with the SEC on August 11, 2000.
1
Exhibit
No. Description
- ------- -----------
3.2 Form of Certificate for shares of Common Stock, $0.001 par value
per share, of HMEC, incorporated by reference to Exhibit 4.5 to
HMEC's Registration Statement on Form S-3 (Registration No.
33-53118) filed with the SEC on October 9, 1992.
3.3 Bylaws of HMEC, incorporated by reference to Exhibit 4.6 to
HMEC's Registration Statement on Form S-3 (Registration No.
33-80059) filed with the SEC on December 6, 1995.
(4) Instruments defining the rights of security holders, including indentures:
4.1 Indenture dated as of January 17, 1996, between HMEC and U.S.
Trust Company of California, N.A. as trustee, with regard to
HMEC's 6 5/8% Senior Notes Due 2006, incorporated by reference to
Exhibit 4.4 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1995, filed with the SEC on March 13, 1996.
4.1(a) Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.1).
4.2 Certificate of Designations for HMEC Series A Cumulative
Preferred Stock (included in Exhibit 10.15).
(10) Material contracts:
10.1 Credit Agreement dated as of December 31, 1996 (the "Bank Credit
Facility") among HMEC, certain banks named therein and Bank of
America National Trust and Savings Association, as administrative
agent (the "Agent"), incorporated by reference to Exhibit 10.1 to
HMEC's Annual Report on Form 10-K for the year ended December 31,
1996, filed with the SEC on March 26, 1997.
10.2* Stock Subscription Agreement among HMEC (as successor to HME
Holdings, Inc.), The Fulcrum III Limited Partnership, The Second
Fulcrum III Limited Partnership and each of the Management
Investors, incorporated by reference to Exhibit 10.17 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1989,
filed with the SEC on April 2, 1990.
10.3* Horace Mann Educators Corporation Deferred Equity Compensation
Plan for Directors, incorporated by reference to Exhibit 10.1 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996, filed with the SEC on November 14, 1996.
2
Exhibit
No. Description
- ------- -----------
10.4* Horace Mann Educators Corporation Deferred Compensation Plan for
Employees, incorporated by reference to Exhibit 10.4 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1997,
filed with the SEC on March 30, 1998.
10.5* Amended and Restated Horace Mann Educators Corporation 1991 Stock
Incentive Plan, incorporated by reference to Exhibit 10.5 to
HMEC's Annual Report on Form 10-K for the year ended December 31,
1999, filed with the SEC on March 30, 2000.
10.5(a)* Amendment to Amended and Restated Horace Mann Educators
Corporation 1991 Stock Incentive Plan, incorporated by reference
to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2000, filed with the SEC on August 11,
2000.
10.5(b)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.5(a) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1999, filed with the SEC on
March 30, 2000.
10.5(c)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.5(b) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1999, filed with the SEC on
March 30, 2000.
10.6* Severance Agreements between HMEC and certain officers of HMEC,
incorporated by reference to Exhibit 10.9 to HMEC's Annual Report
on Form 10-K for the year ended December 31, 1993, filed with the
SEC on March 31, 1994.
10.6(a)* Revised Schedule to Severance Agreements between HMEC and certain
officers of HMEC.
10.7* Horace Mann Incentive Compensation Program, incorporated by
reference to Exhibit 10.7 to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1996, filed with the SEC on
March 26, 1997.
10.8* Horace Mann Supplemental Employee Retirement Plan, 1997
Restatement, incorporated by reference to Exhibit 10.1 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1997, filed with the SEC on November 14, 1997.
3
Exhibit
No. Description
- ------- -----------
10.9* Horace Mann Executive Supplemental Employee Retirement Plan, 1997
Restatement, incorporated by reference to Exhibit 10.2 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1997, filed with the SEC on August 14, 1997.
10.10* Amended and Restated Employment Agreement entered by and between
HMEC and Paul J. Kardos as of October 6, 1998, incorporated by
reference to Exhibit 10.2 to HMEC's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1998, filed with the SEC on
November 13, 1998.
10.10(a)* Amendment Agreement to the Amended and Restated Employment
Agreement entered by and between HMEC and Paul J. Kardos as of
October 6, 1998 dated as of February 1, 2000, incorporated by
reference to Exhibit 10.11(a) to HMEC's Annual Report on Form
10-K for the year ended December 31, 1999, filed with the SEC on
March 30, 2000.
10.11* Employment Agreement entered by and between HMEC and Louis G.
Lower II as of December 31, 1999, incorporated by reference to
Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1999, filed with the SEC on March 30, 2000.
10.12* Separation Agreement entered by and between HMEC and Larry K.
Becker as of June 20, 2000, incorporated by reference to Exhibit
10.4 to HMEC's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000, filed with the SEC on August 11, 2000.
10.13* Letter of Employment entered by and between HMEC and Peter H.
Heckman effective April 10, 2000, incorporated by reference to
Exhibit 10.14 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1999, filed with the SEC on March 30, 2000.
10.14* Letter of Employment entered by and between HMEC and Thomas K.
Manion effective July 6, 2000, incorporated by reference to
Exhibit 10.5 to HMEC's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2000, filed with the SEC on August 11,
2000.
10.15 Catastrophe Equity Securities Issuance Option Agreement
(Catastrophe Equity Securities Issuance Option and Reinsurance
Option Agreement) entered by and between HMEC and Centre
Reinsurance, dated February 15, 1997 and related letter from
Centre Reinsurance, incorporated by reference to Exhibit 10.12 to
HMEC's Annual Report on Form 10-K for the year ended December 31,
1996, filed with the SEC on March 26, 1997.
4
Exhibit
No. Description
- ------- -----------
10.15(a) Amendment effective February 15, 1997 to Catastrophe Equity
Securities Issuance Option Agreement (Catastrophe Equity
Securities Issuance Option and Reinsurance Option Agreement),
incorporated by reference to Exhibit 10.1(a) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1998, filed
with the SEC on May 15, 1998.
10.15(b) Amendment effective February 15, 1997 to Catastrophe Equity
Securities Issuance Option and Reinsurance Option Agreement,
incorporated by reference to Exhibit 10.12(b) to HMEC's Annual
Report on Form 10-K for the year ended December 31, 1998, filed
with the SEC on March 31, 1999.
10.15(c) Amendment effective June 1, 1999 to Catastrophe Equity Securities
Issuance Option and Reinsurance Option Agreement, incorporated by
reference to Exhibit 10.1(c) to HMEC's Quarterly Report on Form
10-Q for the quarter ended September 30, 1999, filed with the SEC
on November 12, 1999.
(11) Statement regarding computation of per share earnings.
(12) Statement regarding computation of ratios.
(21) Subsidiaries of HMEC.
(23) Consent of KPMG LLP.
5