Back to GetFilings.com
================================================================================
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, 2001
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, 2002, was approximately $914 million.
As of March 1, 2002, 40,796,259 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 2002 Annual Meeting of Shareholders, exclusive of
disclosures made pursuant to Regulation S-K, Section 306 and Section 402 (i),
(k) and (l), incorporated by reference into Part III of Form 10-K.
================================================================================
================================================================================
HORACE MANN EDUCATORS CORPORATION
FORM 10-K
YEAR ENDED DECEMBER 31, 2001
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............................................................... 11
Annuity Segment............................................................................. 21
Life Segment................................................................................ 23
Investments................................................................................. 25
Cash Flow................................................................................... 27
Competition................................................................................. 28
Insurance Financial Ratings and IMSA Certification.......................................... 29
Regulation.................................................................................. 32
Employees................................................................................... 34
2. Properties..................................................................................... 34
3. Legal Proceedings.............................................................................. 35
4. Submission of Matters to a Vote of Security Holders............................................ 35
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters.......................... 35
6. Selected Financial Data........................................................................ 36
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations....................................................................... 36
7A. Quantitative and Qualitative Disclosures About Market Risk..................................... 36
8. Consolidated Financial Statements and Supplementary Data....................................... 36
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure......................................................... 36
PART III
10. Directors and Executive Officers of the Registrant............................................. 36
11. Executive Compensation......................................................................... 37
12. Security Ownership of Certain Beneficial Owners and Management................................. 37
13. Certain Relationships and Related Transactions................................................. 37
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................... 37
SIGNATURES..................................................................................... 43
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, Horace Mann
Property & Casualty Insurance Company ("HMPCIC") (formerly Allegiance Insurance
Company), 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, 2001 were $875.6 million, net income was $25.6 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 $35.6 million. The Company's total assets were $4.5
billion at December 31, 2001. The property and casualty segment accounted for
59% of the Company's insurance premiums written and contract deposits for the
year ended December 31, 2001, while accounting for 15% of operating income for
the period. The annuity and life insurance segments together accounted for 41%
of insurance premiums written and contract deposits for the year ended December
31, 2001 (27% and 14%, respectively), and provided 111% (58% and 53%,
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 9 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 4.5 percentage
points per year. The Company's property and casualty expense ratio for the year
ended December 31, 2001 was 21.6%.
The Company is one of the 20 largest participants in the fixed and variable
403(b) tax-qualified annuity market according to information from A.M. Best for
2000. Approximately 60% of the Company's new annuity contract deposits in 2001
were for 403(b) tax-qualified annuities; approximately 75% of accumulated
annuity value on deposit is 403(b) tax-qualified. At December 31, 2001, the
accumulated value of all of the Company's annuity contracts (tax and non-tax
qualified) was $2.4 billion, representing 139,000 contracts in force. For the
2001 year, 93% of the accumulated cash value of the Company's fixed annuity
business remained on deposit, and 92% of the Company's variable annuity business
remained on deposit. All annuities issued since 1982, and approximately 79% 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, 2001 consisted of 42% variable annuities and 58% fixed annuities.
The investment portfolio of the Company, including variable annuity assets
under management of $1.0 billion, had an aggregate fair value of $4.0 billion at
December 31, 2001. Investments other than variable annuity assets consist
principally of investment grade, publicly traded fixed income securities. At
December 31, 2001, investments in non-investment grade securities represented
5.3% 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, 2001 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,
---------------------------------------------------------
2001 2000 1999 1998 1997
--------- --------- --------- -------- -----------
(Dollars in millions, except per share data)
Statement of Operations Data:
Insurance premiums written and contract deposits.. $ 875.6 $ 821.7 $ 821.2 $ 827.8 $ 771.3
Insurance premiums and contract charges earned.... 615.2 598.7 595.1 577.8 542.7
Net investment income............................. 199.3 192.4 188.3 191.7 198.9
Net investment income, after tax.................. 133.8 129.4 126.7 128.3 132.6
Realized investment gains (losses)................ (10.0) (9.9) (8.0) 9.9 5.3
Total revenues.................................... 804.5 781.2 775.4 779.4 746.9
Amortization of intangible assets(1).............. 5.8 8.8 0.2 6.9 10.7
Interest expense.................................. 9.3 10.2 9.7 9.5 9.4
Income from continuing operations before income
taxes........................................... 28.3 9.7 93.4 116.8 119.6
Income from continuing operations(2).............. 25.6 20.8 44.5 85.3 87.1
Discontinued operations(3)........................ -- -- -- -- (3.5)
Net income(2)..................................... 25.6 20.8 44.5 85.3 83.6
Ratio of earnings to fixed charges(4)............. 4.0x 2.0x 10.6x 13.3x 13.7x
Per Share Data(5):
Basic:
Operating income(6)............................ $ 0.88 $ 0.62 $ 1.71 $ 1.82 $ 1.82
Realized investment gains (losses), after tax.. (0.16) (0.16) (0.13) 0.15 0.08
Restructuring charges, after tax............... (0.12) (0.04) -- -- --
Litigation charges, after tax.................. -- (0.12) (0.02) -- --
Provision for prior years' taxes............... 0.03 0.21 (0.48) -- --
Income from continuing operations.............. 0.63 0.51 1.08 1.97 1.90
Discontinued operations(3)..................... -- -- -- -- (0.08)
Net income..................................... 0.63 0.51 1.08 1.97 1.82
Diluted:
Operating income(6)............................ $ 0.87 $ 0.61 $ 1.70 $ 1.80 $ 1.80
Realized investment gains (losses), after tax.. (0.15) (0.15) (0.13) 0.15 0.07
Restructuring charges, after tax............... (0.12) (0.04) -- -- --
Litigation charges, after tax.................. -- (0.12) (0.02) -- --
Provision for prior years' taxes............... 0.03 0.21 (0.48) -- --
Income from continuing operations.............. 0.63 0.51 1.07 1.95 1.87
Discontinued operations(3)..................... -- -- -- -- (0.07)
Net income..................................... 0.63 0.51 1.07 1.95 1.80
Shares of Common Stock-weighted average:
Basic.......................................... 40.6 40.8 41.2 43.2 45.8
Diluted........................................ 40.9 41.0 41.7 43.8 46.5
Shares of Common Stock - ending outstanding....... 40.7 40.5 41.0 42.1 44.3
Cash dividends.................................... $ 0.42 $ 0.42 $ 0.3825 $ 0.3325 $ 0.2825
Book value per share(7)........................... $ 11.27 $ 10.56 $ 9.75 $ 11.80 $ 11.43
Balance Sheet Data, at Year End:
Total investments................................. $ 2,975.7 $ 2,912.3 $2,630.2 $2,840.8 $ 2,769.0
Total assets...................................... 4,489.0 4,420.6 4,253.8 4,395.5 4,131.9
Total policy liabilities.......................... 2,475.6 2,362.3 2,341.3 2,308.0 2,278.6
Short-term debt................................... 53.0 49.0 49.0 50.0 42.0
Long-term debt.................................... 99.8 99.7 99.7 99.6 99.6
Total shareholders' equity........................ 459.2 428.0 400.1 496.6 506.0
(continued on next page)
4
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA - (continued)
Year Ended December 31,
------------------------------------------------------------
2001 2000 1999 1998 1997
-------- ---------- --------- --------- ---------
(Dollars in millions, except per share data)
Segment Information:
Insurance premiums written and contract deposits
Property and casualty.......................... $ 519.3 $ 493.5 $ 495.1 $ 487.8 $ 458.0
Annuity........................................ 239.1 206.4 205.7 223.3 199.2
Life........................................... 117.2 121.8 120.4 116.7 114.1
Total....................................... 875.6 821.7 821.2 827.8 771.3
Operating income(6)
Property and casualty......................... $ 5.2 $ 8.9 $ 39.5 $ 53.2 $ 61.4
Annuity........................................ 20.6 19.3 27.3 23.1 19.3
Life........................................... 18.7 12.9 14.6 12.4 12.9
Corporate and other, including interest expense (8.9) (16.0) (10.7) (9.8) (10.0)
Total....................................... 35.6 25.1 70.7 78.9 83.6
Statutory Operating Data(8):
Property and casualty:
Loss and loss adjustment expense ratio........ 85.2% 85.2% 76.3% 74.4% 71.7%
Expense ratio................................. 21.6% 20.8% 19.8% 19.3% 19.4%
Combined loss and expense ratio(9)............ 106.8% 106.0% 96.1% 93.6% 91.1%
Industry average combined loss
and expense ratio(9)(10)................... 117.0% 110.1% 107.8% 105.6% 101.6%
Personal lines industry segment average combined
loss and expense ratio(9)(10).............. 112.5% 109.9% 104.5% 102.7% 99.8%
Annuity accumulated value on deposit............. $ 2,402.1 $ 2,366.9 $ 2,487.3 $ 2,475.5 $ 2,314.2
Life insurance in force.......................... $ 13,216 $ 12,637 $ 12,300 $ 11,799 $ 11,188
Adjusted capital and surplus of insurance subsidiaries
(includes investment reserves)(11)............ $ 415.5 $ 405.8 $ 405.7 $ 379.8 $ 372.3
- ------------------
(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 HMPCIC.
(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. 2001
includes a non-recurring benefit of $1.3 million, or $0.03 per share, from
resolution of tax year 1997.
(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 included an additional
after-tax charge of $3.5 million, or $0.07 per diluted share, for estimated
losses during the phase-out period.
(4) 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).
(5) 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.
(6) Income from continuing operations before the after-tax impact of realized
investment gains and losses, restructuring charges, litigation charges,
provision for prior years' taxes and discontinued operations.
(7) Due to the adoption by the Company on January 1, 1994 of Financial
Accounting Standard No. 115 ("FAS 115"), total shareholders' equity
included an increase, net of taxes, of $26.3 million, $57.3 million and
$62.2 million at December 31, 2001, 1998 and 1997 and a decrease, net of
taxes, of $4.0 million and $40.0 million at December 31, 2000 and 1999,
respectively. Excluding the FAS 115 fair value accounting for investments,
book value per share was $10.62, $10.66, $10.73, $10.44 and $10.03 at
December 31, 2001, 2000, 1999, 1998 and 1997, 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 (1998 through 2001 Eds.). The
industry averages for the year ended December 31, 2001 are from Review
Preview, A Special Supplement to Best's Review and BestWeek,
Property/Casualty Edition, January 2002, published by A.M. Best.
(11) Investment reserves were the Asset Valuation Reserves ("AVR"). AVR,
required under statutory accounting practices, is a reserve intended to
stabilize the surplus of life insurance companies against the effects of
fluctuations in the fair value of certain invested assets. Changes in AVR
are charged or credited directly to statutory surplus.
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,
------------------------------------------------
2001 2000 1999
-------------- -------------- --------------
Property and casualty... $519.3 59.3% $493.5 60.1% $495.1 60.3%
Annuity................. 239.1 27.3 206.4 25.1 205.7 25.0
Life.................... 117.2 13.4 121.8 14.8 120.4 14.7
------ ----- ------ ----- ------ -----
Total................ $875.6 100.0% $821.7 100.0% $821.2 100.0%
====== ===== ====== ===== ====== =====
Corporate Strategy and Marketing
The Horace Mann Value Proposition
The Horace Mann Value Proposition articulates the Company's overarching
strategy and business purpose: Provide lifelong financial well-being for
educators and their families through personalized service, advice, and a full
range of tailored insurance and financial products.
In 2000, the Company's management announced steps to focus on the Company's
core business and accelerate growth of the Company's revenues and profits. These
initiatives are intended to:
. Grow and strengthen the agency force and make the Company's agents
more productive by improving the products, tools and support the
Company provides to them;
. Expand the Company's penetration of targeted geographic areas and new
segments of the educator market;
. Broaden the Company's distribution options to complement and extend
the reach of the Company's agency force;
. Increase cross-selling and improve retention in the existing book of
business; and
. 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.
During the fourth quarter of 2000, management began implementing specific
plans that address the initiatives above. New compensation and evaluation
systems were implemented during 2001 to improve the performance of the Company's
agents and agency managers. The Company has begun targeting high-priority
geographic markets with dedicated staff teams. New approaches to customer
service are being developed and tested that will free agents to spend more time
selling. Additional distribution options are being initiated 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.
Target Market
The Company's target market through 2001 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
6
customer referrals. Horace Mann is the largest national multiline insurance
company focused on the niche educator market. In 2002 and beyond, the Company
will expand its service to the 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 of America. It also estimates that the number of public and
private school teachers is growing approximately 1% annually. Recent federal and
state 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. 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, 2001, the Company employed 867 full-time
agents, including 553 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 65%
of the Company's agents licensed by the National Association of Securities
Dealers, Inc. ("NASD") to sell variable annuities. They are under contract to
market and write only the Company's products and supplemental products
authorized by the Company. The agency force is managed through 69 agency offices
in 38 states and writes business in 49 states and the District of Columbia.
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, 2001, 34% 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 additional
higher-quality business, not just additional quantities of business. Agents'
compensation after an initial two-year period is comprised entirely of
commissions and
7
incentive bonuses based on profitability of insurance written, retention of
customers and sales. In 2001, incentive bonuses represented 23% of compensation
for agents having more than two years of experience with nearly 90% 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 annuity contracts and life policies.
The Company has modified its agent compensation and reward structure, in
order to provide incentive for agent performance that is more closely aligned
with the Company's objectives. Prior to 2001, agent compensation and rewards
focused on profitability, customer service and tenure with the Company. The
revised structure continues to focus on profitability but also places a greater
emphasis on individual agent productivity, new premium growth, growth in
educator and cross-sold business and business retention. New compensation
programs for both agents and agency managers were implemented in 2001 and
reflect the revised structure. Also in 2001, the Company implemented enhanced
agent training programs, to help new agents achieve production targets more
rapidly and help experienced agents sharpen and strengthen their skills, and
began providing agents with additional tools and support programs, to help them
make a successful transition to their new role under the Company's Value
Proposition. Management believes that the revised compensation structure along
with other strategic initiatives are having a positive impact on agent
productivity -- average agent productivity in 2001 increased approximately 40%
compared to 2000 -- and that these impacts will continue in the future and will
continue to help produce more profitable business.
Broadening Distribution Options
Management has begun to broaden the Company's distribution options to
complement and extend the reach of the Company's agency force. This initiative
initially focuses on more fully utilizing approximately 6,000 payroll deduction
slots in school systems across the country which are assigned to Horace Mann. In
2001, the Company began building a network of independent agents who will
comprise a second distribution channel for the Company's 403(b) tax-qualified
annuity products. In addition to serving educators in areas where the Company
does not have agents, the independent agents will complement and extend the
annuity capabilities of the Company's agents in under-penetrated areas. All
agreements with independent agents and broker/dealers will include clearly
defined guidelines governing the relationship between independent agents and the
Company's agents.
As an example of the potential for this initiative, in January 2002, the
Company announced that it has been selected as one of four providers of fixed
and variable annuities to Chicago, Illinois, public school employees. Beginning
in April 2002, the Company will partner with an independent broker/dealer, which
has been providing retirement planning services to Chicago Public School
employees for more than two decades, to pursue this opportunity to bolster
business growth in the annuity segment. The Chicago Public Schools is the
third-largest school district in the United States of America.
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, 2001, the top six states and their portion of total
premiums were North Carolina, 7.8%; Texas, 5.8%; Massachusetts, 5.6%; Illinois,
5.1%; Florida, 4.9%; and Minnesota, 4.9%.
8
In October 2001, the Company reached conclusion on its strategic direction
for automobile business in the state of Massachusetts. Horace Mann has formed a
marketing alliance with The Commerce Group, Inc. ("Commerce") and through this
alliance, by January 1, 2002, Horace Mann began providing its Massachusetts
customers with Commerce automobile insurance policies, while continuing to write
other Horace Mann products, including property and life insurance and retirement
annuities. Horace Mann ceased writing automobile insurance policies in
Massachusetts on December 31, 2001. For the full year 2001, net premiums written
in Massachusetts for voluntary automobile business were $18.9 million and for
involuntary residual market business were $7.8 million. Total direct premiums
earned for Massachusetts automobile business were $32.2 million in 2001. In
2002, premiums written for this business will be reduced to zero, and premiums
earned will be reduced significantly, reflecting run-off of the policies in
force at December 31, 2001. Management anticipates that this transaction will
have a positive impact on operating income of approximately $0.10 per share in
2003 and beyond. The improvement in 2002 earnings will be somewhat less
reflecting the run-off of policies in force. The Company plans to utilize the
benefits of this transaction to invest in its marketing, customer service and
technology infrastructures.
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 2001:
Property and Casualty Segment Top Ten States
(Dollars in millions)
Property and Casualty
Segment
----------------------
Direct Percent
State Premiums(1) of Total
- ----- ----------- --------
Massachusetts ................................ $ 38.7 7.5%
North Carolina ............................... 37.7 7.3
California ................................... 35.0 6.8
Minnesota .................................... 32.1 6.2
Texas ........................................ 31.7 6.2
Florida ...................................... 30.7 6.0
Pennsylvania ................................. 22.7 4.4
South Carolina ............................... 22.0 4.3
Michigan ..................................... 20.5 4.0
Georgia ...................................... 16.9 3.3
------- -----
Total of top ten states ................... 288.0 56.0
All other areas .............................. 226.6 44.0
------- -----
Total direct premiums ..................... $ 514.6 100.0%
======= =====
- ------------------
(1) Defined as earned premiums before reinsurance and is determined under
statutory accounting practices.
9
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 2001:
Combined Life and Annuity Segments Top Ten States
(Dollars in millions)
Direct Premiums and Percent
State Contract Deposits(1) of Total
- ------- -------------------- --------
Illinois ..................................... $ 30.8 8.6%
North Carolina ............................... 30.3 8.4
Tennessee .................................... 22.8 6.3
Virginia ..................................... 22.7 6.3
Texas ........................................ 18.8 5.2
Indiana ...................................... 16.7 4.7
Pennsylvania ................................. 12.3 3.4
Florida ...................................... 12.0 3.3
South Carolina ............................... 11.7 3.3
Maine ........................................ 10.9 3.0
------- -----
Total of top ten states ................... 189.0 52.5
All other areas .............................. 171.2 47.5
------- -----
Total direct premiums ..................... $ 360.2 100.0%
======= =====
- ----------------
(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
2.6 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 2007. 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 since 1968, NEA has sponsored various Company products and
currently sponsors the Company's homeowners policy, which was co-sponsored by 39
NEA-affiliated state associations
10
as of December 31, 2001. Since 1988, the Company's homeowners policy was the
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 36 states sponsor products of
the Company other than homeowners. NEA-affiliated education associations in 43
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.
In addition to NEA-affiliated education associations, the Company has begun
to establish relationships with other education-related associations. As of
December 31, 2001, 25 associations representing school principals and/or
administrators in 16 states sponsored one or more of the Company's products.
Some of the advantages of sponsorship by education and education-related
associations 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. 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; financial support of the Horace Mann - NEA Foundation Award for
Teaching Excellence; participation in the national conventions of the American
Alliance for Health Physical Education Recreation & Dance (AAHPERD), the
American Association of School Administrators (AASA), the Association of
Educational Service Agencies (AESA), the Association of School Business
Officials (ASBO), the National Association of Elementary School Principals
(NAESP) and the National Association of Secondary School Principals (NASSP);
relationships with approximately 100 educator credit unions serving over 500,000
members in 31 states; 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.
Property and Casualty Segment
The property and casualty segment represented 59% of the Company's total
insurance premiums written and contract deposits and 15% of the Company's
operating income in 2001.
The primary property and casualty product offered by the Company is private
passenger automobile insurance, which in 2001 represented 44% of the Company's
total insurance premiums written and contract deposits and 74% of property and
casualty net written premiums. As of December 31, 2001, the Company had
approximately 596,000 voluntary automobile policies in force with annual
premiums of approximately $436 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
11
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 implemented a tiered rating system,
based on customers' credit ratings, 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 2001, homeowners insurance represented 14% of the Company's total
insurance premiums written and contract deposits and 25% of property and
casualty net written premiums. The Company writes primarily residential homes.
As of December 31, 2001, the Company had approximately 292,000 homeowners
policies in force with annual premiums of approximately $130 million. A tiered
rating system, based on customers' credit ratings, has also been implemented for
homeowners business.
The educator excess professional liability insurance represented the
remaining 1% of the Company's 2001 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 through rate reductions 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. In addition to
the typical cycles experienced historically, the September 11, 2001 terrorist
attacks on the United States of America are having a significant effect on the
property and casualty insurance industry, including the availability and pricing
of reinsurance programs. 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.
12
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,
------------------------------
2001 2000 1999
-------- -------- --------
Statement of Operations Data:
Insurance premiums written(1)........................ $ 519.3 $ 493.5 $ 495.1
Insurance premiums earned(1)......................... 508.3 490.0 491.1
Net investment income................................ 37.7 35.7 37.0
Operating income before income taxes................. 1.9 3.8 54.6
Operating income..................................... 5.2 8.9 39.5
Net investment income, after tax..................... 28.8 27.6 28.3
Catastrophe costs, after tax......................... 7.3 10.5 12.7
Statutory Operating Statistics:
Loss and loss adjustment expense ratio............... 85.2% 85.2% 76.3%
Expense ratio........................................ 21.6% 20.8% 19.8%
Combined loss and expense ratio
(including policyholder dividends)............... 106.8% 106.0% 96.1%
Combined loss and expense ratio before
catastrophes (including policyholder dividends).. 104.6% 102.7% 92.2%
GAAP Operating Statistics:
Loss and loss adjustment expense ratio............... 85.2% 85.2% 76.3%
Expense ratio........................................ 21.6% 20.9% 19.7%
Combined loss and expense ratio
(including policyholder dividends)............... 106.8% 106.1% 96.0%
Combined loss and expense ratio before
catastrophes (including policyholder dividends).. 104.6% 102.8% 92.1%
Automobile and Homeowners (Voluntary):
Insurance premiums written........................... $ 496.6 $ 473.2 $ 470.7
Insurance premiums earned............................ 485.5 469.4 465.0
Policies in force (in thousands)..................... 888 876 872
- ----------
(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 9 percentage points per year.
13
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,
2001.............................. 106.8% 112.5% 117.0%
2000.............................. 106.0 109.9 110.1
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
- ----------
(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 1992 and 1993.
(3) Source: Best's Aggregates and Averages (1993 through 2001 Eds.). 2001 is an
estimate from Review Preview, A Special Supplement to Best's Review and
BestWeek, Property/Casualty Edition, January 2002, 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, 2001
were as follows:
Catastrophe Costs
(Dollars in millions)
Property and
The Casualty
Company(1) Industry(2)
---------- ------------
Year Ended December 31,
2001.............................. $11.2 (3)
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
- ----------
(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:
2001 - $3.7 million, June Midwest wind/hail/tornadoes; $2.3 million
April tornadoes; $2.2 million Tropical Storm Allison.
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.
(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.
(3) Not available.
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 4.5 percentage points
per year. The Company's property and casualty expense ratio for the year ended
December 31, 2001 was 21.6%.
14
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,
2001.............................. 21.6% 24.9% 26.2%
2000.............................. 20.8 25.6 27.6
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
- ----------
(1) Determined according to statutory accounting practices.
(2) The Company did not have any California property and casualty business
during 1992 and 1993.
(3) Source: Best's Aggregates and Averages (1993 through 2001 Eds.). The 2001
personal lines result is an estimate from A.M. Best. The 2001 total
industry result is an estimate from Review Preview, A Special Supplement to
Best's Review and BestWeek, Property/Casualty Edition, January 2002,
published by A.M. Best.
Property and Casualty Reserves
In seven of the last ten years the Company's property and casualty reserves
have developed cumulative redundancies. At December 31, 2001, 99.3% 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 other than claims under
homeowners insurance policies for environmentally related items such as toxic
mold.
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 accounting principles generally accepted in the United States of
America ("GAAP"), no reserves are established until a loss occurs, including a
loss from a catastrophe. Underwriting results of the property and casualty
segment 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.
15
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 2001, the Company recorded a net
strengthening of property and casualty reserves of $16.5 million. During the
first half of 2001, the Company continued to refine its process and methods for
evaluating property and casualty reserves and selected a new independent
property and casualty actuarial consulting firm. During the second quarter of
2001, a comprehensive review of property and casualty loss reserving
methodologies and assumptions was completed in conjunction with the new
actuarial firm. Based on management's review of this further enhanced analysis
and the opinion of the new actuarial firm, prior years' net reserves -
predominantly related to 1999 and prior accident years - were increased by $11.0
million at June 30, 2001. This consisted primarily of an $8.0 million reduction
in reserves to be ceded by the Company to its reinsurers and reinsurance
facilities, including $1.5 million related to the Company's automobile residual
market business, primarily in Massachusetts; $2.0 million for its voluntary
automobile ceded excess liability coverage; and approximately $4.5 million
related to its educators excess professional liability product. At December 31,
2001, the Company increased reserves for property and casualty claims occurring
in prior years by an additional $4.7 million. Ceded and assumed reserves were
strengthened by $6.4 million, primarily as a result of an updated review of
subrogation recovery activity on business ceded to the state automobile
insurance facility in Massachusetts. That strengthening was partially offset by
$1.7 million of favorable development of reserves on the Company's direct
automobile business.
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,
2001 are adequate to meet its future obligations.
16
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,
------------------------
2001 2000 1999
------ ------ ------
Gross reserves, beginning of year ............................. $298.9 $299.8 $298.9
Less reinsurance recoverables .............................. 49.1 64.4 55.9
------ ------ ------
Net reserves, beginning of year ............................... 249.8 235.4 243.0
------ ------ ------
Incurred claims and claims expense:
Claims occurring in the current year ....................... 416.8 394.7 379.5
Increase (decrease) in estimated reserves for claims
occurring in prior years(1):
Policies written by the Company ..................... 14.5 20.9 (7.6)
Business assumed from state reinsurance facilities .. 2.0 1.8 3.0
------ ------ ------
Total increase (decrease) ........................ 16.5 22.7 (4.6)
------ ------ ------
Total claims and claims expense incurred(2) ......... 433.3 417.4 374.9
------ ------ ------
Claims and claims expense payments for claims occurring during:
Current year ............................................... 255.9 247.4 240.0
Prior years ................................................ 155.2 155.6 142.5
------ ------ ------
Total claims and claims expense payments ............ 411.1 403.0 382.5
------ ------ ------
Net reserves, end of period ................................... 272.0 249.8 235.4
Plus reinsurance recoverables .............................. 34.1 49.1 64.4
------ ------ ------
Gross reserves, end of period(3) .............................. $306.1 $298.9 $299.8
====== ====== ======
- ----------
(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 third paragraph preceding this
table for additional information regarding the increase in reserves
recorded in 2001 and 2000.
(2) Benefits, claims and settlement expenses as reported in the Consolidated
Statements of Operations, listed on page F-1 of this report, also include
life, annuity, group accident and health and corporate amounts of $42.3
million, $48.6 million and $41.3 million for the years ended December 31,
2001, 2000 and 1999, respectively, in addition to the property and casualty
amounts.
(3) Unpaid claims and claims expense as reported in the Consolidated Balance
Sheets, listed on page F-1 of this report, also include life, annuity, and
group accident and health reserves of $8.2 million, $10.0 million and $9.8
million at December 31, 2001, 2000 and 1999, respectively, in addition to
property and casualty reserves.
The provision for claims and claims expenses for insured events in prior
years increased by $16.5 million and $22.7 million and decreased by $4.6 million
for the years ended December 31, 2001, 2000 and 1999, respectively. The reserve
strengthening recorded in 2001 and 2000 are described above. The favorable claim
development experienced in 1999 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 2001 gross reserves of $306.1 million for property and
casualty insurance claims and claims expense, as determined under GAAP, were
$34.1 million more than the reserve balance of $272.0 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 $34.1 million that reduces reserves for statutory reporting and is
recorded as an asset for GAAP reporting.
17
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,
------------------------
2001 2000 1999
------ ------ ------
Claims and claims expense incurred ......... $433.3 $417.4 $374.9
Amount attributable to catastrophes ........ 11.2 16.1 19.4
------ ------ ------
Excluding catastrophes .................. $422.1 $401.3 $355.5
====== ====== ======
Claims and claims expense payments ......... $411.1 $403.0 $382.5
Amount attributable to catastrophes ........ 14.2 14.2 17.4
------ ------ ------
Excluding catastrophes .................. $396.9 $388.8 $365.1
====== ====== ======
- ----------
(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 fourth 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.
18
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 2000 to be $150 thousand was first reserved in
1991 at $100 thousand, the $50 thousand deficiency (actual claim minus original
estimate) would be included in the cumulative deficiency in each of the years
1991 - 1999 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,
---------------------------------------------------
1991 1992 1993 1994 1995 1996
------ ------ ------ ------ ------ ------
Gross reserves for property and casualty
claims and claims expenses............ $331.5 $358.2 $373.5 $389.1 $369.7 $340.4
Deduct: Reinsurance recoverables........ 14.8 17.7 21.6 19.5 23.8 34.1
------ ------ ------ ------ ------ ------
Net reserves for property and casualty
claims and claims expenses............ 316.7 340.5 351.9 369.6 345.9 306.3
Increase in reserves due
to purchase of HMPCIC:
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........................ 116.1 117.6 133.4 140.8 139.3 148.6
Two years later....................... 170.0 169.6 190.5 194.5 195.3 202.1
Three years later..................... 197.2 197.8 218.4 224.2 223.0 225.1
Four years later...................... 212.1 213.6 234.1 237.9 233.8 240.2
Five years later...................... 220.5 222.6 241.0 243.1 241.4 245.0
Six years later....................... 224.8 226.0 243.7 247.1 242.8
Seven years later..................... 227.1 227.5 246.1 247.5
Eight years later..................... 227.9 229.0 246.2
Nine years later...................... 229.0 228.9
Ten years later....................... 228.5
Reserves reestimated as of:
End of year........................... 316.7 340.5 381.9 369.6 345.9 306.3
One year later........................ 297.3 306.1 327.6 314.0 283.4 261.2
Two years later....................... 272.1 267.7 281.9 269.2 249.6 250.2
Three years later..................... 246.8 246.4 258.1 251.4 245.8 247.8
Four years later...................... 235.2 233.3 249.3 248.9 243.8 257.1
Five years later...................... 232.4 229.8 229.7 247.4 250.9 256.4
Six years later....................... 230.1 230.0 246.6 252.9 250.1
Seven years later..................... 230.1 229.8 250.2 252.6
Eight years later..................... 230.0 231.9 250.2
Nine years later...................... 231.2 232.0
Ten years later....................... 231.1
Reserve redundancy (deficiency) - initial
net reserves in excess of (less than)
reestimated reserves:
Amount(1)........................... $ 85.6 $108.5 $131.7 $117.0 $ 95.8 $ 49.9
Percent............................. 27.0% 31.9% 34.5% 31.7% 27.7% 16.3%
Gross reestimated liability - latest..... $258.8 $261.7 $280.8 $283.4 $275.5 $285.9
Reestimated reinsurance recoverables -
latest................................ 27.7 29.7 30.6 30.8 25.4 29.5
------ ------ ------ ------ ------ ------
Net reestimated liability - latest.. $231.1 $232.0 $250.2 $252.6 $250.1 $256.4
Gross cumulative excess (deficiency)(1) $ 72.7 $ 96.5 $123.3 $105.7 $ 94.2 $ 54.5
====== ====== ====== ====== ====== ======
December 31,
------------------------------------------
1997 1998 1999 2000 2001
------ ------ ------ ------ ------
Gross reserves for property and casualty
claims and claims expenses............ $310.6 $298.9 $299.8 $298.9 $306.1
Deduct: Reinsurance recoverables........ 41.3 55.9 64.4 49.1 34.1
------ ------ ------ ------ ------
Net reserves for property and casualty
claims and claims expenses............ 269.3 243.0 235.4 249.8 272.0
Increase in reserves due
to purchase of HMPCIC:
Gross reserves for property
and casualty claims and
claims expenses................... -- -- -- -- --
Deduct: Reinsurance
recoverables...................... -- -- -- -- --
------ ------ ------ ------ ------
Net reserves for property and
casualty claims and claims
expenses.......................... -- -- -- -- --
Paid cumulative as of:
One year later........................ 142.0 142.5 155.6 155.2
Two years later....................... 191.4 203.2 212.7
Three years later..................... 223.0 233.0
Four years later...................... 236.7
Five years later......................
Six years later.......................
Seven years later.....................
Eight years later.....................
Nine years later......................
Ten years later.......................
Reserves reestimated as of:
End of year........................... 269.3 243.0 235.4 249.8 272.0
One year later........................ 244.4 238.4 258.1 266.3
Two years later....................... 239.3 261.2 276.9
Three years later..................... 254.9 268.7
Four years later...................... 257.0
Five years later......................
Six years later.......................
Seven years later.....................
Eight years later.....................
Nine years later......................
Ten years later.......................
Reserve redundancy (deficiency) - initial
net reserves in excess of (less than)
reestimated reserves:
Amount(1)........................... $ 12.3 $(25.7) $(41.5) $(16.5)
Percent............................. 4.6% -10.6% -17.6% -6.6%
Gross reestimated liability - latest..... $286.8 $304.1 $309.9 $302.9
Reestimated reinsurance recoverables -
latest................................ 29.8 35.4 33.0 36.6
------ ------ ------ ------
Net reestimated liability - latest....... $257.0 $268.7 $276.9 $266.3
Gross cumulative excess (deficiency)(1).. $ 23.8 $ (5.2) $(10.1) $ (4.0)
====== ====== ====== ======
- ----------
(1) See "Business - Property and Casualty - Property and Casualty Reserves."
As the table above illustrates, the Company's net reserves for property and
casualty insurance claims and claims expense at the end of 2000 were
strengthened in 2001 by $16.5
19
million, while gross reserves were strengthened $4.0 million. The strengthening
of net reserves for property and casualty claims and claims expenses in 2001
included a reduction of ceded reserves of approximately $13 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 reinsurance program effective
January 1, 2001 and the educator excess professional liability contract
effective January 1, 2000, 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, 2001 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 of America. 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. 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 $11.0 million up to $47.4 million with the Florida Hurricane Fund,
based on the Fund's resources. Through December 31, 2001, these catastrophe
reinsurance programs were augmented by a $100 million equity put and reinsurance
agreement. This equity put provided 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 exceeded the catastrophe reinsurance
program coverage limit. Before tax benefits, the equity put provided a source of
capital for up to $154 million of catastrophe losses above the reinsurance
coverage limit. For liability coverages, in both 2001 and 2002, 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
2001 and 2002.
At the time of this Report on Form 10-K, management is in what it believes
to be the final stages of negotiating a replacement equity put and reinsurance
agreement with a subsidiary of Swiss Reinsurance Company. The Swiss Re Group is
rated "A++ (Superior)" by A.M. Best. The terms of the three year agreement are
expected to be similar to the prior equity put and reinsurance agreement. Before
tax benefits, the proposed equity put coverage of $75 million
20
would provide a source of capital for up to $115 million of catastrophe losses
above the reinsurance coverage limit. The Company would also have the option, in
place of the equity put, to require the Swiss Re Group member to issue a 10%
quota share reinsurance coverage of all of the Company's property and casualty
book of business. Fees related to this equity put option, which are charged
directly to additional paid-in capital, are estimated to increase to 145 basis
points in 2002 from 95 basis points in 2001 under the prior agreement. An
additional provision of this agreement would prevent Horace Mann's exercise of
the option in the event it's S&P financial strength rating was below "BBB" prior
to a triggering event. The Company's S&P financial strength rating was "A+" at
December 31, 2001.
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 2002 or 2001
exceeds 5%.
Property Catastrophe Reinsurance Participants In Excess of 5%
Participation
S&P A.M. Best -------------
Rating Rating Reinsurer Parent 2002 2001
- ------ --------- --------- ------ ---- ----
AA A+ AXA Reinsurance Company AXA Group 17% 15%
AA A++ Erie Insurance Exchange 14% 14%
AA- A Mapfre Reinsurance Corporation Sistema MAPFRE 7% ***
AA- A+ St. Paul Fire and Marine
Insurance Company The St. Paul Companies, Inc. 6% 6%
A A- Lloyd's of London Syndicates* 5% 7%
A- A Continental Casualty Company** Loews Corporation *** 7%
AAA A++ American Re-insurance Company Muenchener Rueckversicherungs-
Gesellschaft AG (Munich Re)
of Germany *** 6%
- ----------
* For 2002 and 2001, the participation by Lloyd's of London in the Company's
catastrophe reinsurance program is disbursed among 4 and 11 syndicates,
respectively.
** Includes 2 percentage points from CNA Reinsurance Company Ltd. of London,
England in 2001.
*** Less than 5%.
For 2002, property catastrophe reinsurers representing 100% 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 information from A.M. Best for 2000.
Approximately 60% of the Company's new annuity contract deposits in 2001 were
for 403(b) tax-qualified annuities; approximately 75% of accumulated annuity
value on deposit is 403(b) tax-qualified. In 2001, annuities represented 27% of
the Company's total insurance premiums written and contract deposits and 58% of
the Company's operating income.
21
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 32 mutual fund investment options.
Prior to 2000, the Company had the fixed account and only seven mutual fund
investment options. In both May 2001 and 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 in
2000, 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.
Under the fixed account option, both the principal and a rate of return are
guaranteed. The 32 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, Credit Suisse, and Ariel, 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, 2001 was $2.4 billion.
For the year ended December 31, 2001, 93% of the total accumulated cash
value of the Company's annuity business remained on deposit, compared to average
retention of 77% for stock life insurance companies for 2000, as reported by
A.M. Best. All annuities issued since 1982, and approximately 79% 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 43% of accumulated values subject to
withdrawal penalties for stock life insurance companies for 2000, 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, 2001 consisted of 58% fixed annuities and 42% variable annuities.
The growth of the annuity segment over the last five years has come primarily
from the variable annuity product.
22
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,
--------------------------------------
2001 2000 1999
---------- ---------- ----------
Statement of Operations Data:
Contract deposits:
Variable .................................................. $ 117.0 $ 121.1 $ 129.2
Fixed ..................................................... 122.1 85.3 76.5
Total .................................................. 239.1 206.4 205.7
Contract charges earned ....................................... 14.9 17.0 16.7
Net investment income ......................................... 107.7 105.4 105.3
Net interest margin (without realized gains) .................. 39.8 39.3 38.1
Net margin (includes fees and contract charges earned) ........ 57.0 59.0 57.6
Operating income before income taxes .......................... 30.7 29.2 41.8
Operating income .............................................. 20.6 19.3 27.3
Operating Statistics:
Fixed annuity:
Accumulated value ......................................... $ 1,393.7 $ 1,331.8 $ 1,355.6
Accumulated value persistency ............................. 93.4% 88.7% 92.3%
Variable annuity:
Accumulated value ......................................... $ 1,008.4 $ 1,035.1 $ 1,131.7
Accumulated value persistency ............................. 92.4% 84.1% 88.5%
Number of contracts in force .................................. 139,410 128,654 125,352
Average accumulated cash value (in dollars) ................... $ 17,230 $ 18,397 $ 19,843
Average annual deposit by contractholders (in dollars) ........ $ 2,183 $ 2,282 $ 2,327
Annuity contracts terminated due to surrender,
death, maturity or other:
Number of contracts .................................... 7,222 10,848 8,353
Amount ................................................. $ 186.4 $ 322.0 $ 269.2
Accumulated fixed annuity value grouped by applicable surrender
charge:
0% ..................................................... $ 299.1 $ 298.8 $ 315.9
5% and greater but less than 10% ....................... 901.7 852.3 841.4
10% and greater ........................................ 95.0 86.2 108.4
Supplementary contracts with life contingencies
not subject to discretionary withdrawal ............. 97.9 94.5 89.9
Total accumulated fixed annuity value ........... $ 1,393.7 $ 1,331.8 $ 1,355.6
Life Segment
The Company entered the individual life insurance business in 1949 with
traditional term and whole life insurance products. The Company's traditional
term, whole life and group life business in force consists of approximately
184,000 policies, representing approximately $7.0 billion of life insurance in
force with annual insurance premiums and contract deposits of approximately
$40.2 million as of December 31, 2001. 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 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, 2001 the Company had in force
approximately 90,000 Experience Life policies representing approximately $6.2
billion of life insurance in force with annual insurance premiums and contract
deposits of approximately $69.6 million. In 2000, the Company instituted a
program to offer long-term care and variable universal life policies, with two
third-party vendors underwriting such insurance and the Company receiving
23
a commission on its sale. In 2001, the life segment represented 14% of the
Company's total insurance premiums written and contract deposits, including
approximately 1.3 percentage points attributable to the Company's group life and
group disability income business, and 53% of the Company's operating income.
During 2001, the average face amount of ordinary life insurance policies
issued by the Company was $116,895 and the average face amount of all ordinary
life insurance policies it had in force at December 31, 2001 was $58,333.
The maximum individual life insurance risk retained by the Company is
$200,000 on any individual life and $125,000 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,
--------------------------------
2001 2000 1999
-------- -------- --------
Statement of Operations Data:
Insurance premiums and contract deposits ............... $ 117.2 $ 121.8 $ 120.4
Insurance premiums and contract charges earned ......... 92.0 91.7 87.3
Net investment income .................................. 55.2 51.2 47.0
Operating income before income taxes ................... 28.9 19.9 22.3
Operating income ....................................... 18.7 12.9 14.6
Operating Statistics:
Life insurance in force:
Ordinary life ...................................... $ 11,291 $ 10,967 $ 10,749
Group life ......................................... 1,925 1,680 1,551
Total ........................................... 13,216 12,647 12,300
Number of policies in force:
Ordinary life ...................................... 193,560 196,361 198,898
Group life ......................................... 80,507 77,221 66,953
Total ........................................... 274,067 273,582 265,851
Average face amount in force (in dollars):
Ordinary life ...................................... $ 58,333 $ 55,851 $ 54,520
Group life ......................................... 23,911 21,756 23,166
Total ........................................... 48,222 46,227 46,267
Persistency rate (ordinary life insurance in force) .... 90.9% 91.0% 91.7%
Lapse ratio (ordinary life insurance in force) ......... 9.1% 9.0% 8.3%
Ordinary life insurance terminated due to death,
surrender, lapse or other:
Face amount of insurance surrendered or lapsed... $ 944.0 $1,087.6 $ 998.9
Number of policies ........................... 11,865 13,877 13,092
Amount of death claims .......................... $ 30.1 $ 30.1 $ 26.4
Number of death claims ....................... 1,317 1,317 1,326
24
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, 2001, investments in non-investment grade
securities represented 5.3% of total investments. At December 31, 2001, fixed
income securities represented 96.3% of investments excluding the securities
lending collateral. Of the fixed income investment portfolio, 95.4% was
investment grade and 99.8% was publicly traded. The average quality of the total
fixed income portfolio was A+ at December 31, 2001, and the average option
adjusted duration of total investments was 5.0 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.
25
The following table sets forth the carrying and fair values of the
Company's investment portfolio as of December 31, 2001:
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 ............... 21.4% $ 635.7 $ 599.9 $ 35.8 $ 621.2
Other .................................... 2.4 71.3 55.6 15.7 68.4
Investment grade corporate and public
utility bonds ............................ 46.9 1,395.3 1,201.9 193.4 1,366.8
Municipal bonds ............................. 7.8 232.2 7.6 224.6 224.2
Other mortgage-backed securities ............ 8.4 251.0 198.7 52.3 246.0
Non-investment grade corporate and public
utility bonds(2) ......................... 5.3 159.4 117.0 42.4 177.7
Foreign government bonds .................... 0.7 19.5 19.5 -- 17.4
Short-term investments(3) ................... 1.0 30.1 26.0 4.1 30.1
Short-term investments, loaned
securities collateral(3) ................. 3.3 98.4 97.9 0.5 98.4
----- -------- -------- -------- --------
Total publicly traded securities ...... 97.2 2,892.9 2,324.1 568.8 2,850.2
----- -------- -------- -------- --------
Other Investments:
Private placements, investment grade(4) ..... 0.2 5.4 5.3 0.1 5.0
Private placements,
non-investment grade(2)(4) -- 0.1 0.1 -- 0.1
Mortgage loans and real estate(5) ........... 0.4 10.6 10.6 -- 10.6
Policy loans and other ...................... 2.2 66.7 65.6 1.1 66.7
----- -------- -------- -------- --------
Total other investments ............... 2.8 82.8 81.6 1.2 82.4
----- -------- -------- -------- --------
Total investments(6) .................. 100.0% $2,975.7 $2,405.7 $ 570.0 $2,932.6
===== ======== ======== ======== ========
- ----------
(1) Includes $183.0 million fair value of investments guaranteed by the full
faith and credit of the United States government and $524.0 million fair
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. The
rating agencies monitor securities, and their issuers, regularly and make
changes to the ratings as necessary. The Company incorporates rating
changes on a monthly basis.
(3) Short-term investments mature within one year of being acquired and are
carried at cost, which approximates fair value. Short-term investments
include $36.5 million in asset-backed securities rated "AAA" (S&P or its
equivalent), $35.9 million in money market funds rated "AAA", $30.0 million
in repurchase agreements rated "AAA", $26.0 million in floating rate notes
with 81% rated "AAA" and 19% rated "AA", 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) Fair 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
and real estate acquired in the settlement of debt is carried at the lower
of cost or fair value.
(6) Approximately 4% of the Company's investment portfolio, having a carrying
value of $124.7 million as of December 31, 2001, consisted of securities
with some form of credit support, such as insurance. All of these
securities have the highest investment grade rating.
26
Fixed Maturity Securities
The following table sets forth the composition of the Company's fixed
maturity securities portfolio by rating as of December 31, 2001:
Rating of Fixed Maturity Securities(1)
(Dollars in millions)
Percent
of Total
Carrying Carrying Amortized
Value Value Cost
-------- -------- ---------
AAA .................................... 36.7% $1,015.6 $ 987.6
AA ..................................... 6.3 175.9 168.0
A ...................................... 20.8 574.9 554.1
BBB .................................... 31.6 876.6 869.5
BB ..................................... 1.5 41.3 46.3
B ...................................... 2.1 57.3 62.0
CCC or lower ........................... 0.8 22.7 34.1
Not rated(2) ........................... 0.2 5.6 5.2
----- -------- --------
Total ............................... 100.0% $2,769.9 $2,726.8
===== ======== ========
- ----------
(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 $0.1 million of publicly traded securities not
currently rated by S&P, Moody's or the NAIC and $5.5 million of private
placement securities not rated by either S&P or Moody's. The NAIC has rated
92.1% of these private placement securities as investment grade.
At December 31, 2001, 27.0% 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 29.8% of the total investment portfolio at December 31,
2001. 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 fair value. The net adjustment
for unrealized gains and losses on securities available for sale 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. 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 related factors.
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.
27
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 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 2002 from all of HMEC's insurance subsidiaries
without prior regulatory approval is approximately $40 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, Farmers 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), GEICO and USAA.
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
28
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 insurance and annuity products are
product features, perceived stability of the insurer, service, name recognition,
education association sponsorships and price.
Insurance Financial Ratings and IMSA Certification
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") and Moody's Investors Service, Inc.
("Moody's"); the ranking assigned to its principal insurance subsidiaries by The
Ward's Financial Group ("Ward's"); and the certification of its principal life
insurance subsidiary by the Insurance Marketplace Standards Association ("IMSA")
contribute to the Company's competitiveness.
A.M. Best
HMIC, TIC, HMPCIC and HM Lloyds are rated "A+ (Superior)" and HMLIC is
rated "A (Excellent)" by A.M. Best. A.M. Best's annual review of each of the
subsidiaries' ratings is currently scheduled for April 2002.
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 balance sheet
strength, operating performance and business profile when compared to the
quantitative and qualitative 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 balance sheet strength, operating performance and
business profile when compared to the quantitative and qualitative standards
established by A.M. Best and have a strong ability to meet their ongoing
obligations to policyholders. In evaluating a company's balance sheet strength,
operating performance and business profile, A.M. Best reviews the company's
capitalization/leverage, capital structure/holding company, credit quality and
appropriateness of reinsurance program, adequacy of loss/policy reserves,
quality and diversification of assets, liquidity, profitability, market risk,
revenue composition, management experience and objectives, 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 "A+ (Strong)" for
financial strength by Standard & Poor's with a ratings outlook of "Stable", 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" in January 2001, and in
August 2001 downgraded the ratings one notch from "AA-" to "A+" and identified
the outlook for the ratings as "Stable".
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
29
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 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 the major
rating categories; 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 characteristics. Insurers rated
"A" offer strong financial security characteristics, but are, in S&P's opinion,
somewhat more likely to be affected by adverse business conditions than are
insurers with higher ratings. 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 S&P'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- (Very
Strong)" for financial strength by Fitch with a ratings outlook of "Stable". As
a result of factors impacting the Company's earnings for the three months ended
December 31, 2000, Fitch placed the Company's "AA" financial strength ratings on
"Rating Watch Negative" in February 2001, and in April 2001 downgraded the
Company's "AA" ratings one notch to "AA-". Fitch reaffirmed the "AA-" rating in
August 2001 and identified the outlook for the rating as "Stable".
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" and may be amended with a (+)
or (-) sign to show relative standing within the major rating category. 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
30
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.
Moody's
HMLIC, HMIC, TIC and HMPCIC 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 qualitative factors of both
the industry and the company and quantitative financial analysis. Industry
analysis examines trends effecting the industry, the overall economic
environment, concentration within the industry, demographics and competitive
issues, the impact of financial convergence and consolidation and the accounting
and regulatory environments. The analysis of a company's business fundamentals
focuses primarily on organizational structure, ownership, corporate governance,
strategic issues, quality of management, company franchise, distribution and
product characteristics. The financial analysis includes an assessment of
capital adequacy, financial leverage, profitability, asset/liability management
and liquidity, asset quality, investment risk and business fundamentals. 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.
Ward's
As of 2001, Horace Mann is one of only two insurance groups that have been
named to The Ward's Financial Group's Top 50 for both its property and casualty
and life subsidiaries in each of the last eight years. Identified annually, the
Top 50 represent benchmark groups of 50 life insurance companies and 50 property
and casualty insurance companies that, over the prior five years, have in Ward's
opinion excelled at balancing safety, consistency and performance. The
methodology utilized by Ward's to identify the Top 50 is purely quantitative and
is not intended to evaluate qualitative issues and/or other issues that may
impact, or be of interest to, policyholders and/or agents and risk managers.
Specific items evaluated by Ward's include average surplus and premiums, net
income, risk-based capital, compound annual growth in premiums, and the five
year average returns on average equity, average assets and total revenue.
31
IMSA
In July 2001, Horace Mann Life Insurance Company, the Company's principal
life insurance subsidiary, earned membership in the Insurance Marketplace
Standards Association ("IMSA"). IMSA is an independent, voluntary association
created by the life insurance industry to promote high standards of ethical
market conduct in advertising, sales and service for individual life, annuity
and long-term care products. To earn IMSA certification, HMLIC underwent self-
and independent third-party assessments to demonstrate that it has adopted
IMSA's principles of ethical behavior. HMLIC is an IMSA member for three years,
after which it must demonstrate continuous improvement and repeat the self- and
independent assessment process to retain its membership. As of December 31,
2001, fewer than 250 companies had earned IMSA membership.
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.
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 2000, 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 HMPCIC were
completed for the period ended December 31, 1997. A routine examination of
HMPCIC for the three year period ended December 31, 2000 was initiated in
December 2000; audit fieldwork has been completed with the issuance of the final
examination report still pending. A routine
32
examination of HM Lloyd's for the two year period ended December 31, 2000 was
completed in 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 many 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 $0.6 million, $0.1 million and
$0.1 million in connection with insurer insolvency proceedings for the years
ended December 31, 2001, 2000 and 1999, respectively, of which $0.1, $0 and $0
million for the same periods, respectively, is recoverable as premium tax
credits in future periods. The Company's payments in 2001 included $0.4 million
related to the insolvency of the Reliance Insurance Group. A total charge of
$1.3 million pretax, representing the Company's estimated portion of the
industry assessment for this insolvency, was reflected in the Company's
operating expenses for the year ended December 31, 2001.
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 2001, the Company reflected a net loss from
participation in such mandatory pools and underwriting associations of $2.5
million before federal income taxes. For additional information on the Company's
strategic direction for automobile business in the state of Massachusetts, see
also "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Year Ended December 31, 2001 Compared to
Year Ended December 31, 2000 -- Insurance Premiums and Contract Charges, and --
Net Income."
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.
33
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 Segment -- 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, 2001, the Company had approximately 2,500 employees,
including 867 full-time agents. The Company has no collective bargaining
agreement with any employees.
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. The Company also owns buildings with an
aggregate of approximately 38,000 square feet at other locations in Springfield.
In addition, the Company leases buildings in Springfield with an aggregate of
approximately 86,000 square feet. These properties are adequate and suitable for
the Company's current and anticipated future needs.
34
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
- ------------- ----------- ----------- ----------
2001:
Fourth Quarter ............. $ 22.40 $ 16.25 $ 0.105
Third Quarter .............. 22.05 15.72 0.105
Second Quarter ............. 21.75 14.80 0.105
First Quarter .............. 21.375 15.25 0.105
2000:
Fourth Quarter ............. $ 22.1875 $ 14.0625 $ 0.105
Third Quarter .............. 16.50 12.00 0.105
Second Quarter ............. 18.625 12.625 0.105
First Quarter .............. 21.00 12.625 0.105
As of March 1, 2002, the approximate number of holders of common stock was
5,000.
In February 2002, 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 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. As of December 31, 2001, $96.3 million remained authorized for future
share repurchases. However, in 2001 management stated its intention to utilize
excess capital to support the Company's strategic growth initiatives.
35
During 2001, options were exercised for the issuance of 207,575 shares,
0.5% of the Company's shares outstanding at December 31, 2000.
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 2002 Annual
Meeting of Shareholders.
36
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 2002 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 2002 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 2002 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, 2001, 2000 and 1999.
Consolidated Statements of Operations for the Years Ended December 31,
2001, 2000 and 1999.
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 2001, 2000 and 1999.
Consolidated Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999.
(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.
37
(a)(3) The following items are filed as Exhibits. Management contracts and
compensatory plans are indicated by an asterisk (*).
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.
38
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 10.17).
(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.
10.1(a) Waiver Relating to Credit Agreement, incorporated by
reference to Exhibit 10.1(b) to HMEC's Quarterly Report on
Form 10-Q for the quarter ended March 31, 2001, filed with
the SEC on May 14, 2001.
10.1(b) Waiver Relating to Credit Agreement, incorporated by
reference to Exhibit 10.1(b) to HMEC's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2001, filed
with the SEC on November 14, 2001.
10.1(c) Waiver Relating to Credit Agreement, incorporated by
reference to Exhibit 10.1(c) to HMEC's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2001, filed
with the SEC on November 14, 2001.
10.1(d) Amendment to Credit Agreement.
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.
39
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* Horace Mann Educators Corporation 2001 Stock Incentive Plan.
10.6(a)* Specimen Employee Stock Option Agreement under the Horace
Mann Educators Corporation 2001 Stock Incentive Plan.
10.6(b)* Specimen Director Stock Option Agreement under the Horace
Mann Educators Corporation 2001 Stock Incentive Plan.
10.7* Severance Agreements between HMEC and certain officers of
HMEC.
10.7(a)* Revised Schedule to Severance Agreements between HMEC and
certain officers of HMEC.
10.8* 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.
10.9* 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.
40
Exhibit
No. Description
- --- -----------
10.10* 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.
10.11* 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* 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.
10.13* Letter of Employment entered by and between HMEC and Daniel
M. Jensen effective September 4, 2001.
10.14* Letter of Employment entered by and between HMEC and
Douglas W. Reynolds effective November 12, 2001.
10.15* Letter of Employment entered by and between HMEC and Bret
A. Conklin effective January 14, 2002.
10.16* 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.
10.17 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.
10.17(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.
10.17(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.
41
Exhibit
No. Description
- --- -----------
10.17(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.
(b) No reports on Form 8-K were filed by HMEC during the fourth quarter of
2001.
(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.
42
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/ Joseph J. Melone
- ---------------------------------------------- ------------------------------------------------
Louis G. Lower II Joseph J. Melone, Chairman of the
President, Board of Directors
Chief Executive Officer and a Director
/s/ William W. Abbott
------------------------------------------------
William W. Abbott, Director
Principal Financial Officer: /s/ Mary H. Futrell
------------------------------------------------
Mary H. Futrell, Director
/s/ Peter H. Heckman
- ----------------------------------------------
Peter H. Heckman /s/ Donald E. Kiernan
Executive Vice President and ------------------------------------------------
Chief Financial Officer Donald E. Kiernan, Director
/s/ Jeffrey L. Morby
------------------------------------------------
Jeffrey L. Morby, Director
Principal Accounting Officer:
/s/ Shaun F. O'Malley
------------------------------------------------
/s/ Bret A. Conklin Shaun F. O'Malley, Director
- ----------------------------------------------
Bret A. Conklin
Senior Vice President and Controller /s/ Charles A. Parker
------------------------------------------------
Charles A. Parker, Director
/s/ William J. Schoen
------------------------------------------------
William J. Schoen, Director
Dated: March 28, 2002
43
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-37
Independent Auditors' Report.......................................... F-38
Consolidated Balance Sheets........................................... F-39
Consolidated Statements of Operations................................. F-40
Consolidated Statements of Changes in Shareholders' Equity............ F-41
Consolidated Statements of Cash Flows................................. F-42
Notes to Consolidated Financial Statements
Note 1 - Summary of Significant Accounting Policies............... F-43
Note 2 - Restructuring Charges.................................... F-55
Note 3 - Investments.............................................. F-57
Note 4 - Debt..................................................... F-60
Note 5 - Shareholders' Equity and Stock Options................... F-62
Note 6 - Income Taxes............................................. F-65
Note 7 - Fair Value of Financial Instruments...................... F-67
Note 8 - Statutory Surplus and Subsidiary Dividend Restrictions... F-69
Note 9 - Pension Plans and Other Postretirement Benefits.......... F-70
Note 10 - Reinsurance.............................................. F-75
Note 11 - Contingencies............................................ F-76
Note 12 - Supplementary Data on Cash Flows......................... F-77
Note 13 - Segment Information...................................... F-78
Note 14 - Unaudited Interim Information............................ F-80
Financial Statement Schedules:
Schedule I - Summary of Investments-Other than
Investments in Related Parties................................. F-82
Schedule II - Condensed Financial Information of Registrant........ F-83
Schedule III and VI Combined - Supplementary Insurance
Information and Supplemental Information Concerning
Property and Casualty Insurance Operations..................... F-87
Schedule IV - Reinsurance.......................................... F-88
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 impact of fluctuations in the financial markets on the Company's
variable annuity fee revenues, valuations of deferred policy
acquisition costs and value of acquired insurance in force, and the
level of guaranteed minimum death benefit reserves.
. 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
Critical Accounting Policies
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America ("GAAP") requires
the Company's management to make estimates and assumptions based on information
available at the time the financial statements are prepared. These estimates and
assumptions affect the reported amounts of the Company's assets, liabilities,
shareholders' equity and net income. Certain accounting estimates are
particularly sensitive because of their significance to the Company's financial
statements and because of the possibility that subsequent events and available
information may differ markedly from management's judgements at the time the
financial statements were prepared. For the Company, the areas most subject to
significant management judgements include: reserves for property and casualty
claims and claim settlement expenses, reserves for future policy benefits,
deferred policy acquisition costs, value of acquired insurance in force and
valuation of investments. Additional information regarding the accounting
policies for each of these areas is provided within the relevant topics in
"Results of Operations -- Year Ended December 31, 2001 Compared to Year Ended
December 31, 2000," as well as in the Company's Notes to Consolidated Financial
Statements.
The Horace Mann Value Proposition
The Horace Mann Value Proposition articulates the Company's overarching
strategy and business purpose: Provide lifelong financial well-being for
educators and their families through personalized service, advice, and a full
range of tailored insurance and financial products.
In 2000, the Company's management announced steps to focus on the Company's
core business and accelerate growth of the Company's revenues and profits. These
initiatives are intended to:
. Grow and strengthen the agency force and make the Company's agents
more productive by improving the products, tools and support the
Company provides to them;
. Expand the Company's penetration of targeted geographic areas and new
segments of the educator market;
. Broaden the Company's distribution options to complement and extend
the reach of the Company's agency force;
. Increase cross-selling and improve retention in the existing book of
business; and
. 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.
During the fourth quarter of 2000, management began implementing specific
plans that address the initiatives above. New compensation and evaluation
systems were implemented during 2001 to improve the performance of the Company's
agents and agency managers. The Company has begun targeting high-priority
geographic markets with dedicated staff teams. New approaches to customer
service are being developed and tested that will free agents to spend more time
selling. Additional distribution options are being initiated 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.
F-3
September 11, 2001
The September 11, 2001 terrorist attacks on the United States of America
did not result in any material claims against the Company from either life or
property and casualty insurance policies.
The Company has experienced some secondary short-term impacts. In the third
quarter of 2001, financial market changes had an adverse impact on variable
annuity fees, valuations of deferred policy acquisition costs and value of
acquired insurance in force, and the level of a guaranteed minimum death benefit
reserve established during the quarter. In the fourth quarter of 2001,
improvements in financial market performance offset a portion of the third
quarter impact. In addition, in the weeks following the attack, the Company
experienced a slowdown in new business volume for life insurance. However,
during the same period of time, new business for the Company's other segments
reflected an increase, compared to the same period in 2000.
The credit quality of the Company's investment portfolio has not been
materially impacted by the economic effects of the attack. The Company holds
approximately $18 million of fixed maturity securities from five issuers related
to the aviation and leisure industries. These securities had a net unrealized
loss of approximately $3 million at December 31, 2001. At September 30, 2001,
these securities were all investment grade. During the fourth quarter
approximately $13 million, or 70%, were downgraded to below investment grade
having ratings ranging from BB+ to BBB-, as assigned by Standard & Poor's
Corporation, at December 31, 2001.
The Company is not immune to future secondary effects of this event such as
those generated by additional fluctuations in variable annuity account values
and increases in reinsurance costs. Management believes these impacts will be
manageable. The cost of the Company's entire property and casualty reinsurance
program for 2002 increased approximately 35%, or $2.5 million, compared to 2001.
Results of Operations -- Year Ended December 31, 2001 Compared to Year Ended
December 31, 2000
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
Year Ended Growth Over
December 31, Prior Year
--------------- ----------------
2001 2000 Percent Amount
------ ------ ------ ------
Automobile and property (voluntary) ...... $496.6 $473.2 4.9% $ 23.4
Annuity deposits ......................... 239.1 206.4 15.8% 32.7
Life ..................................... 117.2 121.8 -3.8% (4.6)
------ ------ ------
Subtotal - core lines ............... 852.9 801.4 6.4% 51.5
Involuntary and other
property & casualty .................... 22.7 20.3 11.8% 2.4
------ ------ ------
Total ............................... $875.6 $821.7 6.6% $ 53.9
====== ====== ======
F-4
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
Year Ended Growth Over
December 31, Prior Year
--------------- ---------------
2001 2000 Percent Amount
------ ------ ------- ------
Automobile and property (voluntary) ...... $485.5 $469.4 3.4% $ 16.1
Annuity .................................. 14.9 17.0 -12.4% (2.1)
Life ..................................... 92.0 91.7 0.3% 0.3
------ ------ ------
Subtotal - core lines ............... 592.4 578.1 2.5% 14.3
Involuntary and other
property & casualty .................... 22.8 20.6 10.7% 2.2
------ ------ ------
Total ............................... $615.2 $598.7 2.8% $ 16.5
====== ====== ======
Premiums written and contract deposits for the Company's core lines
increased 6.4% compared to 2000, driven by double-digit growth in the annuity
segment as well as accelerating growth in the property and casualty segment.
This comparison includes the North Carolina settlement recorded in 2000
described below.
At December 31, 2001, the Company's exclusive agency force totaled 867, an
11.3% decline from a year earlier. The number of experienced agents in the agent
force, 553, was down 17.2% at December 31, 2001, compared to a year earlier. The
total agent count decreased due primarily to terminations of less-productive
agents. As a result, overall agent productivity continued to increase, and for
the full year average agent productivity was 37.6% higher than in 2000.
The Company has modified its agent compensation and reward structure, in
order to provide incentive for agent performance that is more closely aligned
with the Company's objectives. Prior to 2001, agent compensation and rewards
focused on profitability, customer service and tenure with the Company. The
revised structure continues to focus on profitability but also places a greater
emphasis on individual agent productivity, new premium growth, growth in
educator and cross-sold business, and business retention. In addition, the
Company's agency manager compensation structure has been similarly modified, and
the agency management team has been strengthened through the promotions of
several of its most experienced and capable agents. The number of new agents
hired during 2001 was comparable to the prior year, in spite of the Company's
implementation of more stringent agent selection criteria to improve agent
productivity and retention in the future. The new compensation plan for agency
managers became effective January 1, 2001. The new compensation plan for all
agents was implemented on August 1, 2001, and there were approximately 800
agents at the time of implementation. Also in 2001, the Company implemented
enhanced agent training programs, to help new agents achieve production targets
more rapidly and help experienced agents sharpen and strengthen their skills,
and began providing agents with additional tools and support programs, to help
them make a successful transition to their new role under the Company's Value
Proposition. Management believes these actions, along with other strategic
initiatives, will continue to 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
F-5
$250 million for the insurance industry. Horace Mann's portion of the adverse
settlement was $3.0 million pretax, comprised of $2.3 million in premium refunds
and $0.7 million in interest charges. North Carolina is the Company's second
largest property and casualty state representing approximately 7% of total
property and casualty premiums for the year ended December 31, 2001.
In December 2001, the North Carolina Commissioner of Insurance (the
"Commissioner") ordered a 13% reduction in private passenger automobile
insurance premium rates effective in April 2002. The Commissioner's Order was in
response to a request from the North Carolina Rate Bureau (the "Bureau"), which
represents the insurance industry, to increase private passenger automobile
insurance rates by 5%. The Bureau has voted to appeal the Commissioner's Order
in the state appellate court and raise rates while the case is being heard. The
difference between the rates ordered by the Commissioner and the Bureau would
have an adverse impact of approximately $350 million for the insurance industry.
The Company's earned premiums would be negatively impacted by approximately $2
million and $3 million in 2002 and 2003, respectively. In addition, the
difference in rates between the Commissioner and the Bureau must be held in an
escrow account pending the court's decision. If the court should rule in favor
of the Bureau, the insurers will be entitled to the funds previously escrowed.
If the court should rule in favor of the Commissioner, the escrowed funds plus
interest will be refunded to the policyholders.
Total voluntary automobile and homeowners premium written growth was 4.9%
for 2001, including the effect of the North Carolina settlement in the prior
year. The average premium per policy and the number of policies in force
increased for both automobile and homeowners insurance, compared to a year
earlier. Voluntary automobile insurance premium written increased 3.8% ($13.5
million) compared to 2000 and homeowners premium increased 8.5% ($9.9 million).
The property and casualty increase in premiums written resulted from growth in
average premium per policy of 3% for automobile and 8% for homeowners, compared
to a year earlier, as the impact of rate actions began to flow through policy
renewals and new business. Over the prior 12 months, unit growth was 1.4%, or
12,000, with an 8,000 unit increase in automobile and a 4,000 unit increase in
homeowners. At December 31, 2001, there were 596,000 voluntary automobile and
292,000 homeowners policies in force for a total of 888,000.
Based on policies in force, the property and casualty 12-month retention
rate for new and renewal policies was 88%, equal to the 12 months ended December
31, 2000 despite implemented rate increases over the period. The Company plans
additional rate increases in 2002 and beyond, with primary emphasis on the
homeowners line, which are expected to have an adverse impact on retention of
homeowners policies in force. The Company's plans to implement tiered rating
systems based on customers' credit ratings for automobile and homeowners
business remain on track, which management expects will have a positive impact
on both loss ratios and business growth in the educator market. Tiered rating,
together with price increases implemented and planned, are expected to return
the Company to rate adequacy, with average premium growth keeping pace with
average loss experience over time. For 2002, the Company is targeting combined
ratios of approximately 96% for voluntary automobile and 108% for homeowners, as
a result of the impact of rate actions coupled with other initiatives described
under "Results of Operations -- Year Ended December 31, 2001 Compared to Year
Ended December 31, 2000 -- Benefits, Claims and Settlement Expenses."
Growth in premiums written for involuntary and other property and casualty
was primarily attributable to an atypical recovery from a state mandatory
automobile insurance facility received in 2001. In February 2002, the Company
announced that it obtained a five-year extension of its
F-6
contract with the National Education Association to be the exclusive provider of
professional liability coverage to its members through August 2007. Premiums
from this product are included in the involuntary and other property and
casualty category.
In October 2001, the Company reached conclusion on its strategic direction
for automobile business in the state of Massachusetts. Horace Mann has formed a
marketing alliance with The Commerce Group, Inc. ("Commerce") and through this
alliance, by January 1, 2002, Horace Mann began providing its Massachusetts
customers with Commerce automobile insurance policies, while continuing to write
other Horace Mann products, including property and life insurance and retirement
annuities. Horace Mann ceased writing automobile insurance policies in
Massachusetts on December 31, 2001. For the full year 2001, premiums written in
Massachusetts for voluntary automobile business were $18.9 million and for
involuntary residual market business were $7.8 million. In 2002, premiums
written for this business will be reduced to zero, and premiums earned will be
reduced significantly, reflecting run-off of the policies in force at December
31, 2001. For the full year 2001, claims and settlement expenses in
Massachusetts for voluntary automobile business were $9.1 million and for
involuntary residual market business were $11.5 million. Claims and settlement
expenses in 2002 will reflect run-off of the business and a decline in exposure
to loss, as the policies written as the Company's risk expire. Management
anticipates that this transaction will have a positive impact on operating
income of approximately $0.10 per share in 2003 and beyond. The improvement in
2002 earnings will be somewhat less reflecting the run-off of policies in force.
The Company plans to utilize the benefits of this transaction to invest in its
marketing, customer service and technology infrastructures.
Growth in annuity contract deposits reached double-digit levels for the
year ended December 31, 2001. In September 2000, 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
helps agents assist educator customers in selecting the best retirement
investment programs for their individual needs and circumstances. The fourth
quarter of 2000 was the first full quarter with the expanded investment options.
New annuity contract deposits of $64.2 million for the three months ended
December 31, 2001, increased 7.0%, compared to contract deposits of $60.0
million for the same period in 2000.
Compared to the full year 2000, new annuity deposits increased 15.8%,
reflecting a 45.8% increase in new single premium and rollover deposits and a
3.8% increase in scheduled deposits received. New deposits to variable annuities
decreased 3.4%, or $4.1 million, and new deposits to fixed annuities were 43.1%
higher than in 2000. The Company offers a dollar cost averaging program for
amounts systematically transferred from the fixed annuity option to the variable
mutual fund investment options over a 12-month period. Variable annuity
accumulated funds on deposit at December 31, 2001 were $1.0 billion, $26.7
million less than a year earlier, a 2.6% decrease including the impact of a
decline in financial market values. Variable annuity accumulated deposit
retention improved 8.3 percentage points over the 12 months to 92.4%, reflecting
improvement 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, 2001 was 93.4%, 4.7
percentage points better than in 2000. Fixed annuity accumulated cash value was
$1.4 billion at December 31, 2001, $61.9 million, or 4.6%, more than a year
earlier. The number of annuity contracts outstanding increased 7.8%, or 10,000
contracts, compared to December 31, 2000.
F-7
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. For the twelve months ended December
31, 2001, the amount of variable annuity surrenders was 54% lower than for the
same period last year. The amount of fixed annuity surrenders decreased 41%
compared to 2000.
In January 2002, the Company announced that it has been selected as one of
four providers of fixed and variable annuities to Chicago, Illinois, public
school employees. Beginning in April 2002, the Company will partner with an
independent broker/dealer, which has been providing retirement planning services
to Chicago Public School employees for more than two decades, to pursue this
opportunity to bolster business growth in the annuity segment. The Chicago
Public Schools is the third-largest school district in the United States of
America.
For the twelve months ended December 31, 2001, annuity segment contract
charges earned decreased 12.4%, or $2.1 million, compared to the twelve months
of 2000. Improvements in retention of variable and fixed accumulated values, as
described above, resulted in a decline in surrender fees earned. Also, declines
in average market values reduced the Company's variable annuity fee revenues.
Life segment premiums and contract deposits for the twelve months of 2001
were 3.8% lower than a year earlier, primarily reflecting a decline in
disability income business. In 2001, the Company began ceding a larger portion
of its disability income business as part of the group restructuring announced
in the fourth quarter of 2000. Excluding the disability product from both years'
results, life segment premiums written and contract deposits would be comparable
to the twelve months ended December 31, 2000. The life insurance in force lapse
ratio was 9.1% for the twelve months ended December 31, 2001, compared to 9.0%
for the prior year.
Net Investment Income
Investment income of $199.3 million for 2001 increased 3.6%, or $6.9
million, (3.4% after tax) compared to the prior year due primarily to growth in
the size of the investment portfolio. Average investments (excluding the
securities lending collateral) increased 2.5% over the past 12 months. The
average pretax yield on the investment portfolio was 7.2% (4.8% after tax) for
2001, compared to a pretax yield of 7.1% (4.8% after tax) for the prior year.
Realized Investment Gains and Losses
Net realized investment losses were $10.0 million for the year ended
December 31, 2001, compared to net realized investment losses of $9.9 million
for 2000. In the fourth quarter of 2001, the Company sold all of its holdings in
securities issued by Enron Corporation and its affiliates, which resulted in a
realized investment loss of $7.8 million. The remaining $2.2 million of net
realized losses in 2001 primarily resulted from the sale, for credit reasons, of
nine fixed income securities and the impairment of fixed income securities
issued by three telecommunications companies, which were only partially offset
by the first quarter full repayment of an impaired commercial mortgage loan and
the release of a related reserve for uncollectible mortgages. For 2000, nearly
all of the net realized gains and losses occurred in the fixed income portfolios
with $8.8 million of the realized losses due to credit-related sales and
impairments and the remainder resulting from normal portfolio management
activity.
F-8
The Company reviews the fair value of the investment portfolio on a monthly
basis to determine if there are any securities that have fallen below 80% of
book value. This review, in conjunction with the Company's investment managers'
monthly credit reports and current market data, is the basis for determining if
a security has suffered an other-than-temporary decline in value. A write-down
is recorded when such decline in value is deemed to be other-than-temporary,
with the realized investment loss reflected in the Statement of Operations for
the period.
Benefits, Claims and Settlement Expenses
Year Ended Growth Over
December 31, Prior Year
---------------- ------------------
2001 2000 Percent Amount
------ ------ ------- -------
Property and casualty ..................... $433.3 $417.4 3.8% $ 15.9
Annuity ................................... (0.8) 1.6 (2.4)
Life ...................................... 41.1 47.0 -12.6% (5.9)
Corporate & other ......................... 2.0 -- 2.0
------ ------ ------
Total ................................... $475.6 $466.0 2.1% $ 9.6
====== ====== ======
Property and casualty
statutory loss ratio:
Before catastrophe losses ............ 83.0% 81.9% 1.1%
After catastrophe losses ............. 85.2% 85.2% --
In 2001, the Company's benefits, claims and settlement expenses were
affected adversely by strengthening of prior years' reserves for property and
casualty claims and by a higher level of non-catastrophe weather-related losses
than the prior year. In 2000, the Company's results were also adversely affected
by strengthening of prior years' property and casualty reserves.
Underwriting results of the property and casualty segment are significantly
influenced by estimates of the Company's ultimate liability for insured events.
Reserves for property and casualty claims include provisions for payments to be
made on reported claims, claims incurred but not yet reported and associated
settlement expenses. The process by which these reserves are established
requires reliance upon estimates 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. 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.
Net strengthening of reserves for property and casualty claims occurring in
prior years, excluding involuntary business, was $14.5 million for the full
year, compared to $20.9 million in 2000. Total reserves for property and
casualty claims occurring in prior years, including involuntary business, were
strengthened $16.5 million in 2001, compared to $22.7 million a year earlier.
F-9
During the first half of 2001, the Company continued to refine its process
and methods for evaluating property and casualty reserves and selected a new
independent property and casualty actuarial consulting firm. During the second
quarter of 2001, a comprehensive review of property and casualty loss reserving
methodologies and assumptions was completed in conjunction with the new
actuarial firm. Based on management's review of this further enhanced analysis
and the opinion of the new actuarial firm, prior years' net reserves -
predominantly related to 1999 and prior accident years - were increased by $11
million at June 30, 2001. This consisted primarily of an $8 million reduction in
reserves to be ceded by the Company to its reinsurers and reinsurance
facilities, including $1.5 million related to the Company's automobile residual
market business, primarily in Massachusetts; $2.0 million for its voluntary
automobile ceded excess liability coverage; and approximately $4.5 million
related to its educators excess professional liability product.
At December 31, 2001, the Company increased reserves for property and
casualty claims occurring in prior years by an additional $5 million. Ceded and
assumed reserves were strengthened by $6.4 million, primarily as a result of an
updated review of subrogation recovery activity on business ceded to the state
automobile insurance facility in Massachusetts. That strengthening was partially
offset by $1.7 million of favorable development of reserves on the Company's
direct automobile business. The Company's property and casualty net reserves
were $272 million and $250 million at December 31, 2001 and 2000, respectively.
In October 2001, the Company reached conclusion on its strategic direction
for automobile business in the state of Massachusetts. For further discussion,
see "Results of Operations -- Year Ended December 31, 2001 Compared to Year
Ended December 31, 2000 -- Insurance Premiums and Contract Deposits, and -- Net
Income."
In 2001, the higher level of non-catastrophe property losses included
claims attributable to severe weather experienced in many areas of the country,
including non-catastrophe claims related to Tropical Storm Allison and wind and
hail storms throughout the Midwest during the second quarter (with additional
development related to these events recorded in the third quarter) as well as
winter storms in the first quarter. In the fourth quarter of 2001, the Company
experienced higher levels of both fire and non-catastrophe weather-related
losses. Non-catastrophe weather-related losses in the fourth quarters of 2001
and 2000 were notably greater than historical experience. The non-catastrophe
property loss ratio by quarter and for the full years 2001, 2000 and 1999 was as
follows:
2001 2000 1999
---- ---- ----
Non-catastrophe property
loss ratio for the:
Quarter ended March 31 .................. 85.1% 79.0% 81.9%
Quarter ended June 30 ................... 99.4% 91.4% 72.8%
Quarter ended September 30 .............. 99.7% 82.8% 78.1%
Quarter ended December 31 ............... 82.8% 80.7% 53.3%
Year ended December 31 .................. 91.5% 83.4% 71.0%
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
F-10
loss control initiatives. Although the Company's actions have begun to have a
positive impact, with minimal effect on policy retention through 2001,
management expects that the full impact of these changes will not be realized
until 2002 and beyond. In light of experience and competitive actions in 2001,
future rate increases are anticipated to be more aggressive than the Company's
original plans. The Company has also initiated further tightening of
underwriting guidelines, expanded reunderwriting of existing policies, coverage
and policy form restrictions in all states where permitted, and limited coverage
of new homeowners business to educators in certain areas. In addition, due to
the claims experience in the fourth quarter of 2001, the Company has initiated a
significant reinspection program of its property book of business. The Company
also is strengthening its homeowners policies' contract language to further
protect the Company against water damage and mold claims. The Company has also
begun the process of redesigning its claim handling procedures in order to
better control loss costs. 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 2001, incurred catastrophe losses for all lines were $11.2 million
including a net benefit of $1.1 million due to favorable development of reserves
for 2000 catastrophe losses. Incurred catastrophe losses were $16.2 million in
2000.
The voluntary automobile loss ratio excluding catastrophe losses was 77.6%
for full year 2001, compared to 80.9% in 2000. Strengthening of prior years'
reserves increased the voluntary automobile loss ratio by 2.0 and 5.4 percentage
points in 2001 and 2000, respectively. The voluntary automobile loss ratio,
excluding both catastrophe losses and prior years' reserve strengthening, was
75.6% in 2001, consistent with the prior year's results. The increase in average
voluntary automobile premium per policy in 2001 nearly kept pace with the
increase in average current accident year loss costs, due to a favorable result
in the fourth quarter of 2001 wherein the growth in premiums exceeded the growth
in loss costs.
The annuity benefits of $(0.8) million recorded in 2001 were comprised of
three components. They were: 1) a release of reserves for certain supplementary
contracts recorded in the third quarter of 2001, 2) a guaranteed minimum death
benefit reserve on variable annuity contracts established in the third quarter
of 2001, and 3) current period mortality experience on annuity contracts in
payout status. Annuity benefits were $1.6 million in 2000, including $1.3
million attributable to mortality experience on annuity contracts on payout
status resulting from the application of a more refined reserving model.
The primary component of the decrease in benefits for the life segment was
a $2.6 million reduction in reserves recorded in 2001 related to policy
coverages that are no longer in force. In addition, life segment benefits in
2001 reflected ceding of a larger portion of the Company's disability income
business as part of the group restructuring announced in the fourth quarter of
2000. Life mortality experience in 2001 was slightly better than a year earlier.
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
on assumptions as to future investment yield, mortality and withdrawals.
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. In the event actual
experience
F-11
varies from the estimated liabilities, adjustments are charged or credited to
income for the period in which the adjustments are made.
Early in 2001, management discovered some deficiencies in the tax
compliance testing procedures associated with certain of the Company's life
insurance policies that could jeopardize the tax status of some of those life
policies. Deficiencies in the Company's computer-based monitoring of premiums,
combined with the complexity of certain of the Company's life insurance
products, resulted in the acceptance of too much premium for certain policies
under the applicable tax test the Company was using. As a result of this
discovery, the Company retained outside experts to assist with the investigation
and remedy of this issue. The deficiencies in the testing procedures have been
identified and corrected. The Company is still in the process of quantifying the
financial impact of these errors, as well as finalizing the strategy for
remedying the problems caused by them. Such a problem is not uncommon in the
life insurance industry and will be cured using standard Internal Revenue
Service ("IRS") procedures that have been established specifically to address
this type of situation. The $2.0 million of policyholder benefits recorded in
the Corporate and Other segment in 2001, as well as $1.0 million of operating
expense, represent the Company's current best estimate of the costs to the
Company to resolve these problems. Management anticipates that the strategy for
dealing with this issue, as well as the cost amount, will be finalized in the
second quarter of 2002.
As a result of the tax status issue described above, the complexity of the
Company's product underlying the policies in question, and the complexity of
administering that product and other life products offered by the Company,
management is re-examining the life product portfolio and related administrative
efficiencies.
Interest Credited to Policyholders
Year Ended Growth Over
December 31, Prior Year
------------- -----------------
2001 2000 Percent Amount
----- ----- ------- ------
Annuity ................................... $67.9 $66.1 2.7% $ 1.8
Life ...................................... 28.6 26.5 7.9% 2.1
----- ----- -----
Total ................................... $96.5 $92.6 4.2% $ 3.9
===== ===== =====
The fixed annuity average annual interest rate credited increased to 5.1%
for the year ended December 31, 2001, compared to 5.0% for the prior year. In
addition, the average accumulated fixed deposits increased 1.4% for the year
ended December 31, 2001, compared to 2000. Life insurance interest credited
increased as a result of continued growth in the interest-sensitive life
insurance reserves.
Operating Expenses
Although operating expenses for the current year included increased costs
to support business growth initiatives, for 2001, operating expenses decreased
$4.2 million, or 3.3%, compared to a year earlier, primarily as a result of two
items. First, expenses in 2000 included non-recurring charges of $0.7 million
for interest on the North Carolina settlement and $3.6 million 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. Operating
F-12
expenses in 2001 included $1.3 million representing the Company's estimated
portion of the industry assessment related to the insolvency of the Reliance
Insurance Group.
The total corporate expense ratio on a statutory accounting basis was 23.3%
for the year ended December 31, 2001, 0.9 percentage points less than 2000. The
property and casualty expense ratio, the 16th lowest of the 100 largest property
and casualty insurance groups for 2000 (the most recent industry ranking
available), was 21.6% for the year ended December 31, 2001, compared to 20.8%
for the prior year.
Effective April 1, 2002, current participants in the Company's defined
benefit and supplemental defined benefit retirement plans will stop accruing any
new benefits under these plans, but will continue to retain the benefits they
have accrued to date. The settlement costs for the defined benefit plans are
based upon assumptions of future events. Defined benefit plan settlement costs
are anticipated to increase by approximately $3 million in 2002 due to an
increase in the number of expected retirements. To the extent that actual
experience differs from those assumptions, adjustments may be required with the
effects of these adjustments charged or credited to income for the period in
which the adjustments are made.
Amortization of Policy Acquisition Expenses and Intangible Assets
For 2001, the combined amortization of policy acquisition expenses and
intangible assets was $63.8 million, compared to the $64.8 million recorded in
2000.
Amortization of intangible assets decreased to $5.8 million for the year
ended December 31, 2001, compared to $8.8 million for the same period in 2000.
The decline reflected the lower level of amortization of the value of annuity
business acquired in the 1989 acquisition of the Company ("Annuity VIF")
comprised of the scheduled decrease in amortization reported in the Company's
Form 10-K for the year ended December 31, 2000 and the favorable impact of
improved persistency on the valuation of Annuity VIF.
Amortization of intangible assets includes goodwill amortization of $1.6
million in both 2001 and 2000. As further described in "Recent Accounting
Changes," Statement of Financial Accounting Standards ("SFAS") No. 142,
"Goodwill and Other Intangible Assets," eliminates the amortization of goodwill
for fiscal years beginning after December 15, 2001.
Policy acquisition expenses amortized for the year ended December 31, 2001
of $58.0 million were $2.0 million more than the prior year primarily from the
property and casualty segment. Over the past 12 months, this segment has
experienced accelerated growth in business and the acquisition cost amortization
period matches the terms of the insurance policies (six and twelve months).
Policy acquisition costs, consisting of commissions, premium taxes and
other costs, which vary with and are primarily related to the production of
business are capitalized and amortized on a basis consistent with the type of
insurance coverage. For investment (annuity) contracts, acquisition costs, and
also the Annuity VIF, are amortized over 20 years in proportion to estimated
future gross profits. Capitalized acquisition costs for interest-sensitive life
contracts are also amortized over 20 years in proportion to estimated future
gross profits. The most significant assumptions that are involved in the
estimation of future gross profits include future market performance and
business surrender/lapse rates. In the event actual experience differs
significantly from assumptions or assumptions are significantly revised, the
Company may be
F-13
required to record a material charge or credit to amortization expense for the
period in which the adjustment is made.
Income Tax Expense
Excluding the benefits in both 2001 and 2000 related to the Company's
dispute with the Internal Revenue Service ("IRS") regarding tax years 1994
through 1997, the effective income tax rate on income including realized
investment gains and losses was 14.1% for the year ended December 31, 2001,
compared to -24.7% for 2000.
In 2001, the Company's tax provision was reduced by $3.0 million reflecting
the release of excess tax provision previously recorded and representing a 10.7
percentage point reduction in the effective income tax rate. 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 13.4 and 45.1 percentage points for the years ended
December 31, 2001 and 2000, respectively. While the amount of income from
investments in tax-advantaged securities in the current year was comparable to
2000, 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 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 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
for an amount that was $8.7 million less than was previously accrued and that
amount was included in net income for the year ended December 31, 2000. In the
third quarter of 2001, the Company's liability for the 1997 tax year was
resolved, resulting in a release of $1.3 million that had previously been
accrued for that tax year. That amount was included in net income for the year
ended December 31, 2001. The benefits of these dispute resolutions were excluded
from the determination of reported operating income.
Operating Income
For the year ended December 31, 2001, operating income (net income before
the after-tax impact of realized investment gains and losses, restructuring
charges and adjustment to the provision for prior years' taxes) was adversely
affected primarily by strengthening of prior years' property and casualty claim
reserves and by a higher level of losses from severe weather than the prior
year. Based on the Company's full year 2001 earnings and generally positive
underlying trends, at the time of this Report on Form 10-K management
anticipates that 2002 full year operating income will be within a range of $1.15
to $1.25 per share. As described throughout this discussion of Results of
Operations, certain of the Company's significant accounting measurements require
the use of estimates and assumptions. As additional information becomes
available, adjustments may be required. Those adjustments are charged or
credited to income for the period in which the adjustments are made.
F-14
In addition to strengthening of prior years' property and casualty claim
reserves and adverse homeowners loss experience, the Company's 2001 operating
income reflected the following items:
. An after-tax charge of $2.7 million, representing the Company's
current best estimate of the costs required to remedy problems with
the life insurance tax status of certain of its life policies;
. An after-tax charge of $0.9 million reflecting the Company's portion
of industry assessments related to the insolvency of the Reliance
Insurance Group;
. A $3.0 million reduction of the Company's tax provision reflecting the
release of excess tax provision previously recorded;
. A $1.7 million after-tax reduction in life insurance reserves related
to policy coverages that are no longer in force; and
. A $0.8 million after-tax reduction in reserves for supplementary
contracts.
Operating income by segment was as follows:
Year Ended Growth Over
December 31, Prior Year
--------------- ----------------
2001 2000 Percent Amount
------ ------ ------- ------
Property & casualty
Before catastrophe losses ................... $ 12.5 $ 19.4 -35.6% $(6.9)
Catastrophe losses, after tax ............... (7.3) (10.5) 3.2
------ ------ -----
Total including catastrophe losses ..... 5.2 8.9 -41.6% (3.7)
Annuity ....................................... 20.6 19.3 6.7% 1.3
Life .......................................... 18.7 12.9 45.0% 5.8
Corporate and other expense ................... (3.0) (9.4) 6.4
Interest expense, after tax ................... (5.9) (6.6) 0.7
------ ------ -----
Total .................................. $ 35.6 $ 25.1 41.8% $10.5
====== ====== =====
Total before catastrophe losses ........ $ 42.9 $ 35.6 20.5% $ 7.3
====== ====== =====
Property and casualty statutory combined ratio:
Before catastrophe losses ................ 104.6% 102.7% 1.9%
After catastrophe losses ................. 106.8% 106.0% 0.8%
Property and casualty segment operating income was lower than in 2000 due
primarily to adverse experience on homeowners business. During 2001, the
Company's increase in average voluntary automobile insurance premium per policy
nearly kept pace with the increase in average loss costs for the current
accident year. The Company's plans to implement tiered rating systems based on
customers' credit ratings for automobile and homeowners business 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
Company is continuing to approach the pricing and underwriting of its homeowners
products aggressively, to accelerate margin recovery. And, due to homeowners
loss experience in the fourth quarter of 2001, the Company has identified
additional initiatives. Actions include further tightening of underwriting
guidelines, expanded reunderwriting of existing policies, coverage and policy
form restrictions in all states where permitted, limited coverage of new
homeowners business to educators in certain areas, reinspection of the
homeowners book of business and redesign of the Company's claim handling
procedures. An adverse industry settlement of outstanding automobile insurance
rate filing cases
F-15
for 1994, 1996 and 1999 in North Carolina, including interest, reduced the
Company's property and casualty segment operating income by $1.9 million after
tax in 2000.
The property and casualty combined ratio before catastrophes of 104.6% was
1.9 percentage points higher than 2000, reflecting the factors cited above.
Catastrophe losses in 2001 were $7.3 million after tax, including a net benefit
of $0.7 million after tax due to favorable development of reserves for 2000
catastrophe losses. Incurred catastrophe losses were $10.5 million after tax in
2000. Increases in reserves for property and casualty claims occurring in prior
years, excluding involuntary business, were $9.4 million after tax in 2001,
compared to $13.6 million after tax in 2000. In 2001, reserves were increased
$10.7 million after tax, including involuntary business, for property and
casualty claims occurring in prior years, compared to an increase of $14.8
million after tax in 2000 representing a decrease of approximately 1.4
percentage points in the combined ratio including catastrophes.
Annuity segment operating income in 2001 reflected reduced fee income
related to decreases in both variable annuity market values and surrender
charges for fixed and variable annuities. In addition, operating expenses
increased in 2001, reflecting the growth in annuity business volume. For 2001,
the net interest margin was slightly more than the prior year while fees and
contract charges earned decreased 12.4%. These factors were offset by (i) the
favorable impact of financial market performance on valuations of deferred
policy acquisition costs and valuation of business acquired and (ii) the release
of reserves for certain annuity contracts on payout status. In 2000, annuity
segment operating income was reduced by $1.0 million due to mortality experience
on annuity contracts on payout status primarily as a result of application of a
more accurate reserving model. Variable annuity accumulated deposits were $1.0
billion at December 31, 2001, $26.7 million, or 2.6%, less than 12 months
earlier. Fixed annuity accumulated cash value of $1.4 billion was $61.9 million,
or 4.6%, greater than December 31, 2000.
Life insurance earnings increased compared to 2000 due primarily to better
than expected mortality and group disability results, as well as the $1.7
million reserve reduction recorded in 2001.
In 2001, the Corporate and Other Expense category in the preceding table
reflected (i) an after-tax charge of $2.7 million related to problems with the
life insurance tax status of certain of the Company's life policies and also
(ii) a $3.0 million reduction of the Company's tax provision reflecting the
release of excess tax provision previously recorded. In 2000, the Corporate and
Other Expense category reflected higher holding company expenses, including
charges related to the chief executive officer transition.
F-16
Net Income
Net Income Per Share, Diluted
Year Ended Growth Over
December 31, Prior Year
------------- ----------------
2001 2000 Percent Amount
----- ---- ------- ------
Operating income ........................... $0.87 $0.61 42.6% $0.26
Realized investment losses ................. (0.15) (0.15) -- --
Restructuring charges ...................... (0.12) (0.04) (0.08)
Litigation charges ......................... -- (0.12) 0.12
Adjustment to the provision
for prior years' taxes ................... 0.03 0.21 (0.18)
----- ----- -----
Net income ............................ $0.63 $0.51 23.5% $0.12
===== ===== =====
Net income, which includes realized investment gains and losses,
restructuring charges, litigation charges and adjustments to the provision for
prior years' taxes, for the year ended December 31, 2001 increased by $4.8
million, or 23.1%, and net income per diluted share increased by 23.5% compared
to 2000. This change included the $10.5 million increase in operating income.
After-tax realized investment losses were comparable for the two periods. As
discussed above in "Income Tax Expense", net income reflected resolution of
federal income tax exposures which increased net income by $1.3 million and $8.7
million for the years ended December 31, 2001 and 2000, respectively. In
addition, net income in 2000 reflected an after-tax charge of $5.0 million due
to litigation regarding the Company's disability insurance product.
The Company recorded restructuring charges in both 2001 and 2000. As
described in "Insurance Premiums and Contract Charges," in 2001 the Company
reached conclusion on its strategic direction for automobile business in the
state of Massachusetts. On December 31, 2001, Horace Mann ceased writing
automobile business in that state. On October 18, 2001 the Company paid $6.4
million to the Commonwealth Automobile Reinsurers ("C.A.R.") as full payment of
its proportionate liability to C.A.R. for policy years 2002 and beyond. That
payment and other related expenses of approximately $1 million resulted in an
after-tax charge of $4.7 million, or $0.12 per share, reflected as a
non-operating income restructuring charge. All of the restructuring charges
incurred in 2001 related to Massachusetts automobile business were paid by
December 31, 2001. In 2000, the Company recorded an after-tax charge of $1.5
million, or $0.04 per share, as a result of the restructuring of the Company's
group insurance business and its credit union marketing group. Restructuring
charges have been separately identified in the Statements of Operations for the
years ended December 31, 2001 and 2000.
Return on shareholders' equity was 8% based on operating income and 6%
based on net income for the 12 months ended December 31, 2001.
Status of Litigation Regarding Disability Insurance
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 a class action 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.
In
F-17
July 2001, the Company submitted a settlement agreement to the court which was
mutually agreed upon by all parties to this lawsuit. The settlement, which
provides additional benefits for current policyholders and compensation to those
who demonstrate they did not understand what they purchased, was approved by the
court on October 31, 2001. The settlement was finalized on November 30, 2001 and
is being administered. While the actual costs incurred by the Company to resolve
this litigation could be either less or more than the liability established in
2000, management believes that, based on facts and circumstances available at
this time and on the settlement agreement approved by the court in October 2001,
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 years ended December 31, 2001 and 2000.
Results of Operations -- Year Ended December 31, 2000 Compared To Year Ended
December 31, 1999
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
====== ====== =====
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
====== ====== =====
F-18
In 2000, 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 agency force totaled 978, an
11.5% decline from a year earlier. The number of experienced agents in the
agency 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 began to increase. The Company
began 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 was the Company's second largest property and casualty state
representing approximately 7% of total premiums for the year ended December 31,
2000.
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
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 of 2000. 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
F-19
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 a year earlier; also
showing some improvement in the last three months of 2000 at 89.3%. Over the 12
months of 2000, 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 were 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 a year earlier.
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.
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.
F-20
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.
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 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.
F-21
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 continued to implement pricing, underwriting and loss control initiatives.
Although the Company's actions began to have a positive impact in 2000,
management expected that the full impact of these changes would not be realized
until well into 2001. Management anticipated that these actions would 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 refined 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-22
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 was 20.8% for the year ended December
31, 2000, compared to 19.8% in 1999. The increase in these expense ratios
primarily reflected 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. 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 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.
F-23
Policy acquisition expenses amortized for the year ended December 31, 1999
of $53.0 million were $3.0 million lower than in 2000 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 investments 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. 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, compared to the prior year.
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.
F-24
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 1999 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.
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 were on track at December 31, 2000,
which management
F-25
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 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 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)
====== ====== ======
F-26
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 included the $45.6 million decline in operating income partially
offset by the $8.7 million benefit in 2000 related to prior years' taxes
compared to the $20.0 million provision recorded in 1999 (see the description
above). Net income in 2000 also reflected $6.4 million of after-tax realized
investment losses, 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 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.
F-27
Liquidity and Financial Resources
Special Purpose Entities
At December 31, 2001, 2000 and 1999, the Company did not have any
relationships with unconsolidated entities or financial partnerships, such as
entities often referred to as structured finance or special purpose entities,
which would have been established for the purpose of facilitating off-balance
sheet arrangements or other contractually narrow or limited purposes. As such,
the Company is not exposed to any financing, liquidity, market or credit risk
that could arise if the Company had engaged in such relationships.
Related Party Transactions
The Company does not have any contracts or other transactions with related
parties that are required to be reported under the applicable securities laws
and regulations.
Ariel Capital Management, Inc., HMEC's largest shareholder with 19% of the
common shares outstanding, is the investment adviser for two of the mutual funds
offered to the Company's annuity customers.
Investments
The Company's investment strategy emphasizes investment grade, publicly
traded fixed income securities. At December 31, 2001, fixed income securities
represented 96.3% of investments excluding the securities lending collateral. Of
the fixed income investment portfolio, 95.4% was investment grade and 99.8% was
publicly traded. The average quality of the total fixed income portfolio was A+
at December 31, 2001.
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 5.0 years at December 31, 2001 and 4.4 years
at December 31, 2000. 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 79% 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.
F-28
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 $25 million more than in 2000, primarily reflecting
a recovery of federal income tax amounts in the current year compared to
payments made in 2000.
The Company has entered into various operating lease agreements, primarily
for computer equipment, computer software and real estate (agency and claims
offices across the country and portions of the home office complex). These
leases have varying commitment periods with most in the 1 to 3 year range.
Operating cash flow reflects payments on these leases of approximately $8
million for each of the years ended December 31, 2001, 2000 and 1999. It is
anticipated that the Company's payments under operating leases in 2002 will be
comparable to prior years. The Company does not have any other arrangements that
expose it to material liability that are not recorded in the financial
statements.
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 2002 without
prior approval are approximately $40 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.
Financing Activities
Financing activities include primarily payment of dividends, the receipt
and withdrawal of funds by annuity contractholders, repurchases of the Company's
common stock, 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.
F-29
For the year ended December 31, 2001, receipts from annuity contracts
increased 15.8%. Annuity contract maturities and withdrawals decreased $134.0
million, or 42.9%, compared to 2000 including decreases of 53.6% and 40.8% in
surrenders of variable and fixed annuities, respectively. Reflecting continued
improvement in recent quarterly trends, cash value retention for variable and
fixed annuities was 92.4% and 93.4%, respectively, for the 12 month period ended
December 31, 2001. Net transfers to variable annuity assets increased $82.0
million compared to 2000 reflecting the Company's expansion of its variable
investment options.
The Company did not repurchase shares of its common stock under its stock
repurchase program during 2001, consistent with management's stated intention to
utilize excess capital to support the Company's strategic growth initiatives. In
2000, 1,082,400 shares were repurchased at an aggregate cost of $15.1 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, 2001, $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 ("NAIC"). 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 NAIC has codified statutory accounting practices, which constitute the
only source of prescribed statutory accounting practices and were effective
January 1, 2001. Codification changed prescribed statutory accounting practices
and resulted 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. As a result of adopting the NAIC
codification, the Company's statutory surplus of its insurance subsidiaries
increased approximately $19 million primarily due to the allowance of deferred
tax recoverables under codification.
The total capital of the Company was $612.0 million at December 31, 2001,
including $99.8 million of long-term debt and $53.0 million of short-term debt.
Total debt represented 26.1% of capital (excluding unrealized investment gains
and losses) at December 31, 2001, which was slightly higher than the Company's
target operating range of 20% to 25%.
Shareholders' equity was $459.2 million at December 31, 2001, including an
unrealized gain in the Company's investment portfolio of $26.3 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 the market
value per share were $864.4 million and $21.22, respectively, at December 31,
2001. Book value per share was $11.27 at December 31, 2001, $10.62 excluding
investment fair value adjustments. At December 31, 2000, book value per share
was $10.56, $10.66 excluding
F-30
investment fair value adjustments. The increase over the 12 months included the
effects of unrealized investment gains and losses. Excluding these items, book
value per share was slightly lower than 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") (BBB+), Fitch, Inc. ("Fitch") (A-), and Moody's Investors
Service, Inc. ("Moody's") (Baa2) 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 "A-" debt rating
on "CreditWatch with negative implications" and Fitch placed the Company's "A"
debt rating on "Rating Watch Negative" in January 2001 and February 2001,
respectively. In April 2001, Fitch reaffirmed their "A" rating and identified
the outlook for the rating as "Stable". However, as a result of factors
impacting the Company's earnings for the three months ended June 30, 2001, Fitch
downgraded the rating to "A-" in August 2001 and identified the outlook for the
rating as "Stable". In August 2001, S&P downgraded their rating to "BBB+" and
identified the outlook for the rating as "Stable". Moody's issued a statement in
February 2001 affirming their "Baa1" rating and identified the outlook for the
rating as "Stable". However, in February 2002 Moody's downgraded the debt rating
to "Baa2" and identified the outlook for the rating as "Stable".
As of December 31, 2001 and December 31, 2000, the Company had short-term
debt of $53.0 million and $49.0 million, respectively, 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 through December
31, 2001. The rate on the borrowings under the Bank Credit Facility was
Interbank Offering Rate plus 0.4%, or 2.4%, as of December 31, 2001. The
Company's earnings in the fourth quarter of 2000 could have caused a breach of a
financial covenant of the Company's Bank Credit Facility in 2001 but, in the
first quarter of 2001, the lender agreed to modify that covenant for the first,
second and third quarters of 2001. As a result of earnings for the second
quarter of 2001, and again based on third quarter 2001 earnings, the lender
agreed to further modify that covenant. The commitment for the Bank Credit
Facility terminated on December 31, 2001. However, in November 2001, management
completed negotiation of an amendment to the existing Bank Credit Facility
extending it through June 30, 2002. The amendment extending the term of the
commitment for the Bank Credit Facility also modified the rate on the borrowings
under it to be Interbank Offering Rate plus 0.75%, or 2.7%, as of January 1,
2002. Management is reviewing its capital market alternatives and believes that
the Company will be able to obtain replacement financing for the Bank Credit
Facility. The Company cannot predict on what terms and conditions such financing
would be available, and the availability of alternative financing, in the form
of long-term debt instruments or a replacement credit facility, is always
subject to prevailing market conditions at the time of securing such financing.
The Company's ratio of earnings to fixed charges for the year ended
December 31, 2001 was 4.0x compared to 2.0x for the prior year.
Total shareholder dividends were $17.1 million for the year ended December
31, 2001. In February 2002, the Board of Directors announced a regular quarterly
dividend of $0.105 per share.
F-31
The Company reinsures 95% of catastrophe losses above a retention of $8.5
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 $11.0 million up to $47.4 million with the Florida Hurricane Fund,
based on the Fund's resources. Through December 31, 2001, these catastrophe
reinsurance programs were augmented by a $100 million equity put and reinsurance
agreement. This equity put provided 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 exceeded the catastrophe reinsurance
program coverage limit. Before tax benefits, the equity put provided a source of
capital for up to $154 million of catastrophe losses above the reinsurance
coverage limit.
At the time of this Report on Form 10-K, management is in what it believes
to be the final stages of negotiating a replacement equity put and reinsurance
agreement with a subsidiary of Swiss Reinsurance Company. The Swiss Re Group is
rated "A++ (Superior)" by A.M. Best. The terms of the three year agreement are
expected to be similar to the prior equity put and reinsurance agreement. Before
tax benefits, the proposed equity put coverage of $75 million would provide a
source of capital for up to $115 million of catastrophe losses above the
reinsurance coverage limit. The Company would also have the option, in place of
the equity put, to require the Swiss Re Group member to issue a 10% quota share
reinsurance coverage of all of the Company's property and casualty book of
business. Fees related to this equity put option, which are charged directly to
additional paid-in capital, are estimated to increase to 145 basis points in
2002 from 95 basis points in 2001 under the prior agreement. An additional
provision of this agreement would prevent Horace Mann's exercise of the option
in the event it's S&P financial strength rating was below "BBB" prior to a
triggering event. The Company's S&P financial strength rating was "A+" at
December 31, 2001.
The cost of the Company's catastrophe reinsurance coverage program for 2002
increased approximately 50%, or $2.0 million, compared to 2001 as a result of
the effects on the reinsurance market of the September 11, 2001 terrorist
attacks. However the increase was manageable and 48% of the Company's
traditional coverage for catastrophe losses has rates which are fixed through
2003. The cost of the Company's entire property and casualty reinsurance program
for 2002 increased approximately 35%, or $2.5 million, compared to 2001.
Insurance Financial Ratings and IMSA Certification
As disclosed in the 2000 Form 10-K, certain ratings of the Company's
insurance subsidiaries were under review as a result of the Company's earnings
for the three months ended December 31, 2000. Management also initiated
discussions with each of the agencies rating its insurance subsidiaries as a
result of earnings reported for the quarter ended June 30, 2001. At the time of
this Report on Form 10-K, these reviews have been completed by all agencies.
A.M. Best Company, Inc. ("A.M. Best") has rated each of the Company's
property and casualty subsidiaries "A+ Superior" and has rated the Company's
principal life insurance subsidiary "A (Excellent)." A.M. Best's annual review
of Horace Mann's ratings is currently scheduled for April 2002.
Moody's Investors Service, Inc. ("Moody's") affirmed the Company's
financial strength ratings following the Company's January 2001 preannouncement
of earnings for the three months ended December 31, 2000, and in August 2001
issued an opinion update which again affirmed
F-32
those ratings. In July 2001, Moody's assigned a financial strength rating of "A2
(Good)" to Horace Mann Property and Casualty Insurance Company (formerly
Allegiance Insurance Company). HMLIC, HMIC and TIC are also rated "A2 (Good)"
for financial strength by Moody's.
Fitch, Inc. ("Fitch") placed the Company's financial strength ratings on
"Rating Watch Negative" in February 2001. Although the Company's insurance
subsidiaries remain in the "AA (very strong)" rating category, in April 2001,
Fitch downgraded Horace Mann's financial strength ratings one notch from "AA" to
"AA-". Fitch reaffirmed its "AA-" rating in August 2001 and identified the
outlook for the rating as "Stable".
Standard & Poor's Corporation ("S&P") placed the Company's financial
strength ratings on "CreditWatch with negative implications" in January 2001. In
August 2001, S&P downgraded the Company's financial strength ratings from "AA-"
to "A+" and identified the outlook for the ratings as "Stable".
As of 2001, Horace Mann is one of only two insurance groups that have been
named to The Ward's Financial Group's ("Wards") Top 50 for both its property and
casualty and life subsidiaries in each of the last eight years. Identified
annually, the Top 50 represent benchmark groups of 50 life insurance companies
and 50 property and casualty insurance companies that, over the prior five
years, have in Ward's opinion excelled at balancing safety, consistency and
performance.
In July 2001, Horace Mann Life Insurance Company, the Company's principal
life insurance subsidiary, earned membership in the Insurance Marketplace
Standards Association ("IMSA"). IMSA is an independent, voluntary association
created by the life insurance industry to promote high standards of ethical
market conduct in advertising, sales and service for individual life, annuity
and long-term care products. To earn IMSA certification, HMLIC underwent self-
and independent third-party assessments to demonstrate that it has adopted
IMSA's principles of ethical behavior. HMLIC is an IMSA member for three years,
after which it must demonstrate continuous improvement and repeat the self- and
independent assessment process to retain its membership. As of December 31,
2001, fewer than 250 companies had earned IMSA membership.
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
F-33
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,
2001, 20% of the fixed investment portfolio represented investments supporting
the property and casualty operations and 80% supported 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 surrenders 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, 2001, the duration of the investment portfolio was approximately 5.0 years,
and the duration of insurance liabilities was approximately 4.7 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.
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, 2001,
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 $10 million after tax, 3% of shareholders' equity. A 100 basis
point increase would decrease fair value of assets and liabilities by $16
million after tax, 5% of shareholders' equity. 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. 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
F-34
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 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations", effective for all business combinations initiated after June 30,
2001, and No. 142, "Goodwill and Other Intangible Assets", effective for fiscal
years beginning after December 15, 2001. SFAS No. 141 requires the purchase
method of accounting be used for all business combinations. Goodwill and certain
intangible assets will remain on the balance sheet and not be amortized. SFAS
No. 142 establishes a new method of testing goodwill for impairment. On an
annual basis, and when there is reason to suspect that their values may have
been diminished or impaired, these assets must be tested for impairment. The
amount of goodwill determined to be impaired will be expensed to current
operations. The Company has not determined the impact, if any, that the goodwill
impairment testing prescribed by these statements will have on its consolidated
financial position or results of operations. Amortization of goodwill was $1.6
million for the year ended December 31, 2001. As of December 31, 2001, the
Company's Consolidated Balance Sheet reflected goodwill of $47.4 million.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations", effective for fiscal years beginning after June 15,
2002. The accounting practices in this statement apply to legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development and (or) the normal operation of a
long-lived asset. This statement will not have a material impact on the Company
because it does not own a significant amount of property and equipment.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", effective for fiscal years
beginning after December 15, 2001. This statement establishes a single
accounting model, based on the framework established in SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of", for long-lived assets disposed of by sale, including disposal
of a segment of a business. This statement is not expected to have a material
impact on the Company.
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 fair value of the investment
portfolio are related to the yields available in the fixed-income markets. An
increase in interest rates will decrease the fair 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.
F-35
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 of
America. 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-36
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, 2001, 2000 and 1999, and the related
consolidated statements of operations, changes in shareholders' equity, and cash
flows for the years ended December 31, 2001, 2000 and 1999 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 auditing standards
generally accepted in the United States of America, 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-37
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, 2001,
2000 and 1999, 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, 2001. 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, 2001, 2000 and 1999,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 2001, 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 7, 2002
F-38
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED BALANCE SHEETS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands)
2001 2000 1999
----------- ----------- -----------
ASSETS
Investments
Fixed maturities, available for sale, at fair value
(amortized cost 2001, $2,726,831; 2000,
$2,615,156; 1999, $2,575,403) ........................ $ 2,769,867 $ 2,607,738 $ 2,507,280
Short-term and other investments ....................... 107,445 99,728 122,929
Short-term investments, loaned securities collateral ... 98,369 204,881 --
----------- ----------- -----------
Total investments ................................. 2,975,681 2,912,347 2,630,209
Cash ..................................................... 33,939 21,141 22,848
Accrued investment income and premiums receivable ........ 112,746 101,405 92,755
Value of acquired insurance in force and goodwill ........ 85,789 92,260 102,068
Deferred policy acquisition costs ........................ 157,776 141,604 130,192
Other assets ............................................. 114,665 116,756 144,061
Variable annuity assets .................................. 1,008,430 1,035,067 1,131,713
----------- ----------- -----------
Total assets ...................................... $ 4,489,026 $ 4,420,580 $ 4,253,846
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities
Fixed annuity contract liabilities .................... $ 1,278,137 $ 1,217,756 $ 1,238,379
Interest-sensitive life contract liabilities .......... 518,455 481,140 443,309
Unpaid claims and claim expenses ...................... 314,295 308,881 309,604
Future policy benefits ................................ 179,109 180,049 179,157
Unearned premiums ..................................... 185,569 174,428 170,845
----------- ----------- -----------
Total policy liabilities .......................... 2,475,565 2,362,254 2,341,294
Other policyholder funds ................................. 123,434 122,233 126,530
Other liabilities ........................................ 269,640 324,312 110,698
Short-term debt .......................................... 53,000 49,000 49,000
Long-term debt ........................................... 99,767 99,721 99,677
Variable annuity liabilities ............................. 1,008,430 1,035,067 1,126,505
----------- ----------- -----------
Total liabilities ................................. 4,029,836 3,992,587 3,853,704
----------- ----------- -----------
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, 2001, 60,076,921;
2000, 59,859,053; 1999, 59,292,053 .................... 60 60 59
Additional paid-in capital ............................... 341,052 338,243 333,892
Retained earnings ........................................ 461,139 452,624 449,023
Accumulated other comprehensive income
(loss), net of taxes:
Net unrealized gains (losses) on fixed
maturities and equity securities .................. 26,336 (4,038) (40,016)
Minimum pension liability adjustment ................ (11,438) (937) --
Treasury stock, at cost, 2001 and 2000, 19,341,296
shares; 1999, 18,258,896 shares ....................... (357,959) (357,959) (342,816)
----------- ----------- -----------
Total shareholders' equity ........................ 459,190 427,993 400,142
----------- ----------- -----------
Total liabilities and shareholders' equity ........ $ 4,489,026 $ 4,420,580 $ 4,253,846
=========== =========== ===========
See accompanying notes to consolidated financial statements.
F-39
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
Year Ended December 31,
--------------------------------------------
2001 2000 1999
------------ ------------ ------------
Insurance premiums written and contract deposits ... $ 875,566 $ 821,653 $ 821,209
============ ============ ============
Revenues
Insurance premiums and contract charges earned .. $ 615,242 $ 598,714 $ 595,128
Net investment income ........................... 199,267 192,396 188,267
Realized investment losses ...................... (10,019) (9,906) (7,969)
------------ ------------ ------------
Total revenues .............................. 804,490 781,204 775,426
------------ ------------ ------------
Benefits, losses and expenses
Benefits, claims and settlement expenses ........ 475,583 466,048 416,186
Interest credited ............................... 96,502 92,561 91,629
Policy acquisition expenses amortized ........... 58,048 55,972 53,041
Operating expenses .............................. 123,679 127,910 109,694
Amortization of intangible assets ............... 5,774 8,769 215
Interest expense ................................ 9,250 10,204 9,722
Restructuring charges ........................... 7,312 2,236 --
Litigation charges .............................. -- 7,783 1,585
------------ ------------ ------------
Total benefits, losses and expenses ......... 776,148 771,483 682,072
------------ ------------ ------------
Income before income taxes ......................... 28,342 9,721 93,354
Income tax expense (benefit) ....................... 4,024 (2,438) 28,849
Provision for prior years' taxes ................... (1,269) (8,682) 20,000
------------ ------------ ------------
Net income ......................................... $ 25,587 $ 20,841 $ 44,505
============ ============ ============
Earnings per share
Basic ........................................... $ 0.63 $ 0.51 $ 1.08
============ ============ ============
Diluted ......................................... $ 0.63 $ 0.51 $ 1.07
============ ============ ============
Weighted average number of shares
and equivalent shares
Basic ....................................... 40,616,843 40,782,173 41,245,633
Diluted ..................................... 40,877,120 40,966,774 41,708,439
See accompanying notes to consolidated financial statements.
F-40
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share data)
Year Ended December 31,
-----------------------------------
2001 2000 1999
--------- --------- ---------
Common stock
Beginning balance ....................................... $ 60 $ 59 $ 59
Options exercised, 2001, 207,575 shares; 2000,
557,000 shares; 1999, 17,363 shares; and
shares awarded; 2000, 10,000 shares ................... -- 1 --
Conversion of Director Stock Plan units, 2001,
10,293 shares ......................................... -- -- --
--------- --------- ---------
Ending balance .......................................... 60 60 59
--------- --------- ---------
Additional paid-in capital
Beginning balance ....................................... 338,243 333,892 336,686
Options exercised, conversion of Director
Stock Plan units and shares awarded ................... 3,759 5,301 362
Catastrophe-linked equity put option premium ............ (950) (950) (950)
Purchase of 8,450 warrants in 1999 ...................... -- -- (2,206)
--------- --------- ---------
Ending balance .......................................... 341,052 338,243 333,892
--------- --------- ---------
Retained earnings
Beginning balance ....................................... 452,624 449,023 420,274
Net income .............................................. 25,587 20,841 44,505
Cash dividends, 2001, $0.42 per share; 2000,
$0.42 per share; 1999, $0.3825 per share .............. (17,072) (17,240) (15,756)
--------- --------- ---------
Ending balance .......................................... 461,139 452,624 449,023
--------- --------- ---------
Accumulated other comprehensive income (loss), net of taxes:
Beginning balance ..................................... (4,975) (40,016) 57,327
Change in net unrealized gains (losses) on fixed
maturities and equity securities .................... 30,374 35,978 (97,343)
Increase in minimum pension
liability adjustment ................................ (10,501) (937) --
--------- --------- ---------
Ending balance ........................................ 14,898 (4,975) (40,016)
--------- --------- ---------
Treasury stock, at cost
Beginning balance, 2001, 19,341,296 shares, 2000,
18,258,896 shares; 1999, 17,183,596 shares ............ (357,959) (342,816) (317,723)
Purchase of 1,082,400 shares in 2000; 1,075,300
shares in 1999 (See note 5) ........................... -- (15,143) (25,093)
--------- --------- ---------
Ending balance 2001 and 2000, 19,341,296 shares;
1999, 18,258,896 shares ............................... (357,959) (357,959) (342,816)
--------- --------- ---------
Shareholders' equity at end of period ...................... $ 459,190 $ 427,993 $ 400,142
========= ========= =========
Comprehensive income (loss)
Net income .............................................. $ 25,587 $ 20,841 $ 44,505
Other comprehensive income (loss), net of tax:
Change in net unrealized gains (losses)
on fixed maturities and equity securities ........... 30,374 35,978 (97,343)
Increase in minimum pension
liability adjustment ................................ (10,501) (937) --
--------- --------- ---------
Other comprehensive income (loss) ................. 19,873 35,041 (97,343)
--------- --------- ---------
Total ........................................... $ 45,460 $ 55,882 $ (52,838)
========= ========= =========
See accompanying notes to consolidated financial statements.
F-41
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
-------------------------------------
2001 2000 1999
----------- --------- ---------
Cash flows from operating activities
Premiums collected ............................. $ 642,596 $ 618,253 $ 623,762
Policyholder benefits paid ..................... (487,619) (465,414) (453,353)
Policy acquisition and
other operating expenses paid ................ (193,713) (187,248) (179,951)
Federal income taxes recovered (paid) .......... 7,520 (16,101) (16,600)
Investment income collected .................... 195,086 191,103 186,824
Interest expense paid .......................... (9,091) (10,028) (9,523)
Other .......................................... (5,922) (6,317) (3,013)
----------- --------- ---------
Net cash provided by operating activities .. 148,857 124,248 148,146
----------- --------- ---------
Cash flows used in investing activities
Fixed maturities
Purchases .................................... (1,140,930) (750,928) (698,847)
Sales ........................................ 732,076 464,305 388,644
Maturities ................................... 283,153 243,618 286,758
Net cash (used for) provided by
short-term and other investments ............. (2,107) 26,814 (18,524)
----------- --------- ---------
Net cash used in investing activities ...... (127,808) (16,191) (41,969)
----------- --------- ---------
Cash flows used in financing activities
Purchase of treasury stock ..................... -- (15,143) (25,093)
Dividends paid to shareholders ................. (17,072) (17,240) (15,756)
Principal borrowings (payments)
on Bank Credit Facility ...................... 4,000 -- (1,000)
Repurchase of common stock warrants ............ -- -- (2,426)
Exercise of stock options ...................... 3,759 5,302 362
Catastrophe-linked equity put option premium ... (950) (950) (950)
Annuity contracts, variable and fixed
Deposits ..................................... 239,124 206,393 205,684
Maturities and withdrawals ................... (178,364) (312,365) (247,212)
Net transfer (to) from variable annuity assets (53,550) 28,437 (7,676)
Net decrease in interest-sensitive
life account balances ........................ (5,198) (4,198) (1,306)
----------- --------- ---------
Net cash used in financing activities ...... (8,251) (109,764) (95,373)
----------- --------- ---------
Net increase (decrease) in cash ................... 12,798 (1,707) 10,804
Cash at beginning of period ....................... 21,141 22,848 12,044
----------- --------- ---------
Cash at end of period ............................. $ 33,939 $ 21,141 $ 22,848
=========== ========= =========
See accompanying notes to consolidated financial statements.
F-42
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America ("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"). HMEC and its subsidiaries have common
management, share office facilities and are parties to several intercompany
service agreements for management, administrative, data processing, agent
commissions, agency services, utilization of personnel and investment advisory
services. Under these agreements, costs have been allocated among the companies
in conformity with customary insurance accounting practices consistently
applied. In addition, certain of the subsidiaries have entered into intercompany
reinsurance agreements. HMEC and its subsidiaries file a consolidated federal
income tax return, and there are related tax sharing agreements. 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,
Horace Mann Property & Casualty Insurance Company (formerly 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 fair value. The
net adjustment for unrealized gains and losses on securities available for sale,
carried at fair value, 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.
F-43
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
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 fair 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 fair value; and
equity securities, carried at fair value.
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. The Company
reviews the fair value of the investment portfolio on a monthly basis to
determine if there are any securities that have fallen below 80% of book value.
This review, in conjunction with the Company's investment managers' monthly
credit reports and current market data, is the basis for determining if a
security has suffered an other-than-temporary decline in value. A write-down is
recorded when such decline in value is deemed to be other-than-temporary, with
the realized investment loss reflected in the Statement of Operations for the
period.
Deferred Policy Acquisition Costs
Deferred policy acquisition costs net of accumulated amortization were
$157,776, $141,604 and $130,192 as of December 31, 2001, 2000 and 1999,
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).
The Company periodically reviews the assumptions and estimates used in
capitalizing policy acquisition costs, and also periodically reviews its
estimations of future gross profits. The most significant assumptions that are
involved in the estimation of future gross profits include future market
performance and business surrender/lapse rates. In the event actual experience
differs significantly from assumptions or assumptions are significantly revised,
the Company may be required to record a material charge or credit to
amortization expense for the period in which the adjustment is made.
F-44
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
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.
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.
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,
-----------------------------
2001 2000 1999
------- ------- -------
Property and equipment .................. $68,160 $62,652 $60,907
Less: accumulated depreciation .......... 38,625 33,025 30,543
------- ------- -------
Total ................................. $29,535 $29,627 $30,364
======= ======= =======
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 Horace Mann Property & Casualty Insurance Company
(formerly Allegiance Insurance Company).
The value of acquired insurance in force by operating segment and goodwill,
net of amortization, were as follows:
December 31,
--------------------------------
2001 2000 1999
------- ------- --------
Value of acquired insurance in force
Life .................................... $10,595 $12,434 $ 14,409
Annuity ................................. 27,798 30,812 37,027
------- ------- --------
Subtotal ............................. 38,393 43,246 51,436
Goodwill .................................. 47,396 49,014 50,632
------- ------- --------
Total ................................ $85,789 $92,260 $102,068
======= ======= ========
F-45
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
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 has been amortized
over 40 years on a straight-line basis through December 31, 2001.
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets", effective for fiscal years beginning after December
15, 2001. Goodwill and certain intangible assets will remain on the balance
sheet and not be amortized. SFAS No. 142 establishes a new method of testing
goodwill for impairment. On an annual basis, and when there is reason to suspect
that their values may have been diminished or impaired, these assets must be
tested for impairment. The amount of goodwill determined to be impaired will be
expensed to current operations. The Company has not determined the impact, if
any, that the goodwill impairment testing prescribed by these statements will
have on its consolidated financial position or results of operations. Goodwill
amortization was $1,618 for each of the years ended December 31, 2001, 2000 and
1999.
For the amortization of the value of acquired insurance in force, the
Company periodically reviews its estimates of future gross profits. The most
significant assumptions that are involved in the estimation of future gross
profits include future market performance and business surrender/lapse rates. In
the event actual experience differs significantly from assumptions or
assumptions are significantly revised, the Company may be required to record a
material charge or credit to amortization expense for the period in which the
adjustment is made.
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.
Scheduled amortization of the December 31, 2001 balances of value of
acquired insurance in force by segment over the next five years is as follows:
Year Ended December 31,
------------------------------------------
2002 2003 2004 2005 2006
------ ------ ------ ------ ------
Scheduled amortization of:
Value of acquired insurance in force
Life ............................ $1,726 $1,625 $1,537 $1,460 $1,394
Annuity ......................... 3,779 3,785 3,917 4,037 4,140
------ ------ ------ ------ ------
Total ......................... $5,505 $5,410 $5,454 $5,497 $5,534
====== ====== ====== ====== ======
F-46
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
The amount of interest accrued on the unamortized balance of value of
acquired insurance in force and the interest accrual rates were as follows:
Year Ended December 31,
---------------------------
2001 2000 1999
------ ------ -------
Interest accrued on the unamortized balance
of value of acquired insurance in force
Life ........................................ $ 906 $1,069 $1,248
Annuity ..................................... 1,639 1,754 2,052
------ ------ ------
Total ..................................... $2,545 $2,823 $3,300
====== ====== ======
Interest accrual rate
Life ........................................... 7.9% 8.0% 8.1%
Annuity ........................................ 5.7% 5.6% 5.6%
The accumulated amortization of intangibles as of December 31, 2001, 2000
and 1999 was $146,375, $140,601 and $131,832, respectively.
F-47
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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,
------------------------------------
2001 2000 1999
---------- ---------- ----------
Horace Mann Equity Fund
(formerly Horace Mann Growth Fund) .......................... $ 376,081 $ 428,821 $ 566,932
Horace Mann Balanced Fund ..................................... 292,126 315,015 404,712
Horace Mann Socially Responsible Fund ......................... 71,610 75,782 59,129
Horace Mann Small Cap Growth Fund ............................. 58,395 83,304 60,042
Horace Mann International Equity Fund ......................... 33,491 42,512 26,040
Wilshire Large Company Growth Portfolio -
Institutional and Investment ................................ 22,823 19,036 --
Wilshire 5000 Index Portfolio - Institutional and Investment... 19,806 16,829 --
Fidelity VIP Growth Portfolio ................................. 14,852 7,041 --
Horace Mann Income Fund ....................................... 13,996 11,376 13,237
Fidelity VIP Index 500 Portfolio .............................. 12,105 4,915 --
Fidelity VIP Mid Cap Portfolio ................................ 11,368 4,690 --
Alliance Premier Growth Portfolio ............................. 9,270 4,142 --
J.P. Morgan U.S. Disciplined Equity Portfolio ................. 5,738 1,845 --
Wilshire Large Company Value Portfolio ........................ 5,546 500 --
T. Rowe Price Small-Cap Stock Fund ............................ 5,303 1,251 --
Strong Opportunity Fund II .................................... 5,079 1,299 --
T. Rowe Price Small Cap Value Fund ............................ 4,932 343 --
Strong Mid Cap Growth Fund II ................................. 4,919 3,397 --
Putnam VT Vista Fund .......................................... 4,502 2,869 --
Neuberger Berman Genesis Assets Account ....................... 4,369 252 --
Ariel Appreciation Fund ....................................... 4,351 -- --
Fidelity VIP Investment Grade Bond Portfolio .................. 3,797 312 --
Rainier Small/Mid Cap Equity Portfolio ........................ 3,579 1,444 --
Davis Value Portfolio ......................................... 3,566 1,489 --
Fidelity VIP Overseas Portfolio ............................... 3,339 1,410 --
Fidelity VIP Growth & Income Portfolio ........................ 3,152 820 --
Credit Suisse Small Cap Growth Portfolio ...................... 2,926 1,640 --
Horace Mann Short-Term Investment Fund ........................ 2,797 2,274 1,621
Ariel Fund .................................................... 2,499 -- --
Wilshire Small Company Value Portfolio ........................ 1,279 70 --
Wilshire Small Company Growth Portfolio ....................... 428 128 --
Fidelity VIP High Income Portfolio ............................ 406 261 --
---------- ---------- ----------
Total variable annuity assets ............................... $1,008,430 $1,035,067 $1,131,713
========== ========== ==========
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-48
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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, 2001, 99.3%
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 reconciliation of beginning and ending reserves located
within this Note to Financial Statements. The strengthening primarily reflected
a $17,000 reduction of ceded reserves. This reduction of the ceded reserves was
related to automobile facility business in four states, primarily Massachusetts.
F-49
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
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. In 2001, the Company recorded a net strengthening
of property and casualty reserves of $16,574. During the first half of 2001, the
Company continued to refine its process and methods for evaluating property and
casualty reserves and selected a new independent property and casualty actuarial
consulting firm. During the second quarter of 2001, a comprehensive review of
property and casualty loss reserving methodologies and assumptions was completed
in conjunction with the new actuarial firm. Based on management's review of this
further enhanced analysis and the opinion of the new actuarial firm, prior
years' net reserves, predominantly related to 1999 and prior accident years,
were increased by $11,000 at June 30, 2001. This consisted primarily of an
$8,000 reduction in reserves to be ceded by the Company to its reinsurers and
reinsurance facilities, including $1,500 related to the Company's automobile
residual market business, primarily in Massachusetts; $2,000 for its voluntary
automobile ceded excess liability coverage; and approximately $4,500 related to
its educators excess professional liability product. At December 31, 2001, the
Company increased reserves for property and casualty claims occurring in prior
years by an additional $4,700. Ceded and assumed reserves were strengthened by
$6,400, primarily as a result of an updated review of subrogation recovery
activity on business ceded to the state automobile insurance facility in
Massachusetts. That strengthening was partially offset by $1,700 of favorable
development of reserves on the Company's direct automobile business. 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 other than claims under homeowners insurance policies for
environmentally-related items such as toxic mold. Management believes that,
based on data currently available, it has reasonably estimated the Company's
ultimate losses.
F-50
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
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,
-------------------------------
2001 2000 1999
-------- -------- ---------
Gross reserves, beginning of year ................... $298,896 $299,803 $ 298,929
Less reinsurance recoverables ..................... 49,056 64,410 55,890
-------- -------- ---------
Net reserves, beginning of year ..................... 249,840 235,393 243,039
-------- -------- ---------
Incurred claims and claims expense:
Claims occurring in the current year .............. 416,770 394,711 379,455
Increase (decrease) in estimated reserves for
claims occurring in prior years(1):
Policies written by the Company .............. 14,574 20,858 (7,583)
Business assumed from state
reinsurance facilities ..................... 2,000 1,800 3,000
-------- -------- ---------
Total increase (decrease) ................ 16,574 22,658 (4,583)
-------- -------- ---------
Total claims and claims expense incurred(2)... 433,344 417,369 374,872
-------- -------- ---------
Claims and claims expense payments
for claims occurring during:
Current year ................................... 255,939 247,286 240,045
Prior years .................................... 155,208 155,636 142,473
-------- -------- ---------
Total claims and claims expense payments ..... 411,147 402,922 382,518
-------- -------- ---------
Net reserves, end of period ......................... 272,037 249,840 235,393
Plus reinsurance recoverables ..................... 34,104 49,056 64,410
-------- -------- ---------
Gross reserves, end of period(3) .................... $306,141 $298,896 $ 299,803
======== ======== =========
- ----------
(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 increases in reserves
recorded in 2001 and 2000.
(2) Benefits, claims and settlement expenses as reported in the Consolidated
Statements of Operations also include life, annuity, group accident and
health and corporate amounts of $42,239, $48,679 and $41,314 for the years
ended December 31, 2001, 2000 and 1999, respectively, in addition to the
property and casualty amounts.
(3) Unpaid claims and claims expense as reported in the Consolidated Balance
Sheets also include life, annuity, and group accident and health reserves
of $8,154, $9,985 and $9,801 at December 31, 2001, 2000 and 1999,
respectively, in addition to property and casualty reserves.
F-51
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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,
------------------------------
2001 2000 1999
-------- -------- --------
Claims and claims expense incurred ...... $433,344 $417,369 $374,872
Amount attributable to catastrophes ..... 11,215 16,122 19,371
-------- -------- --------
Excluding catastrophes ................ $422,129 $401,247 $355,501
======== ======== ========
Claims and claims expense payments ...... $411,147 $402,922 $382,518
Amount attributable to catastrophes ..... 14,200 14,200 17,400
-------- -------- --------
Excluding catastrophes ................ $396,947 $388,722 $365,118
======== ======== ========
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-52
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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,
---------------------------------
2001 2000 1999
--------- --------- ---------
Net income As reported................ $ 25,587 $ 20,841 $ 44,505
Pro forma(1)............... $ 21,169 $ 18,995 $ 42,907
Basic net income per share As reported................ $ 0.63 $ 0.51 $ 1.08
Pro forma.................. $ 0.52 $ 0.47 $ 1.04
Diluted net income per share As reported................ $ 0.63 $ 0.51 $ 1.07
Pro forma.................. $ 0.52 $ 0.46 $ 1.03
- ----------
(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 2001, 2000 and 1999, respectively:
risk-free interest rates of 5.1%, 5.9% and 5.9%; dividend yield of 2.3%,
2.4% and 1.9%; expected lives of 10 years; and volatility of 46.0%, 53.2%
and 50.3%.
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, 2001, 2000 and 1999 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 versus financial
statement basis.
Deferred tax assets and liabilities include provisions for unrealized
investment gains and losses with the change for each period included in the net
unrealized gains and losses component of accumulated other comprehensive income
(loss) 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.
F-53
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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,
---------------------------
2001 2000 1999
------- ------- -------
Basic - assumes no dilution:
Net income for the period ........................ $25,587 $20,841 $44,505
------- ------- -------
Weighted average number of common
shares outstanding during the period ........... 40,617 40,782 41,246
------- ------- -------
Net income per share - basic .................... $ 0.63 $ 0.51 $ 1.08
======= ======= =======
Diluted - assumes full dilution:
Net income for the period ........................ $25,587 $20,841 $44,505
------- ------- -------
Weighted average number of common shares
outstanding during the period .................. 40,617 40,782 41,246
Weighted average number of common equivalent
shares to reflect the dilutive effect of common
stock equivalent securities:
Stock options ............................... 125 62 387
Common stock units related to Deferred
Equity Compensation Plan for Directors . 121 114 69
Common stock units related to Deferred
Compensation Plan for Employees ........ 14 9 6
------- ------- -------
Total common and common equivalent shares adjusted
to calculate diluted earnings per share ....... 40,877 40,967 41,708
------- ------- -------
Net income per share - diluted ................... $ 0.63 $ 0.51 $ 1.07
======= ======= =======
Options to purchase 1,101,025 shares of common stock at $19.34 to $33.87
per share were granted during 1997, 1998, 1999 and 2001 but were not included in
the computation of 2001 diluted earnings per share because the options' exercise
price was greater than the average market price of the common shares during
2001. The options, which expire in 2007, 2008, 2009 and 2011, were still
outstanding at December 31, 2001.
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-54
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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,
-------------------------------
2001 2000 1999
-------- -------- ---------
Net income ................................................. $ 25,587 $ 20,841 $ 44,505
-------- -------- ---------
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 ....... 32,337 43,177 (158,423)
Less: reclassification adjustment for
losses included in net income ..................... (14,392) (12,174) (8,664)
-------- -------- ---------
Total, before tax ............................... 46,729 55,351 (149,759)
Income tax expense (benefit) .................... 16,355 19,373 (52,416)
-------- -------- ---------
Total, net of tax ............................. 30,374 35,978 (97,343)
-------- -------- ---------
Increase in minimum
pension liability adjustment
Before tax .......................................... (16,156) (1,441) --
Income tax benefit .................................. (5,655) (504) --
-------- -------- ---------
Total, net of tax ............................. (10,501) (937) --
-------- -------- ---------
Total comprehensive income (loss) ............. $ 45,460 $ 55,882 $ (52,838)
======== ======== =========
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 2001 presentation.
NOTE 2 - Restructuring Charges
Restructuring charges were incurred and separately identified in the
Statements of Operations for the years ended December 31, 2001 and 2000.
Massachusetts Automobile Business
In October 2001, the Company recorded restructuring charges of $7,290
pretax ($4,738, or $0.12 per share, after tax) reflecting a change in the
Company's presence in the Massachusetts automobile market. On October 18, 2001,
Horace Mann announced that it had formed a marketing alliance with The Commerce
Group, Inc. ("Commerce") for the sale of automobile insurance in the state of
Massachusetts. Through this alliance, and by January 1, 2002, Horace Mann began
providing its Massachusetts customers with Commerce automobile insurance
policies, while continuing to write other Horace Mann products, including
property and life insurance and retirement annuities.
F-55
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 2 - Restructuring Charges-(Continued)
Horace Mann ceased writing automobile insurance policies in Massachusetts
by December 31, 2001, and on October 18, 2001 paid $6,438 to the Commonwealth
Automobile Reinsurers ("C.A.R.") as full payment of its proportionate liability
to C.A.R. for policy years 2002 and beyond. The Company also paid legal and
other related consulting costs totaling $506 pretax. The remaining $346 was
attributable primarily to the write-off of software used only to process
Massachusetts automobile business. The Company anticipates that this
restructuring will result in elimination of approximately 30 positions,
primarily in a claims-handling office located in Massachusetts, although
specific termination plans were not determined by December 31, 2001. The
Company's Consolidated Balance Sheet at December 31, 2001 did not reflect any
accrued amounts due to the restructure of its Massachusetts automobile business.
The Company expects that this transaction will have a positive impact on
operating income of approximately $0.10 per share in 2003 and beyond. The
improvement in 2002 earnings will be somewhat less reflecting the run-off of
current policies in force. The Company plans to utilize the benefits of this
transaction to invest in its marketing, customer service and technology
infrastructures. On a full year basis, the Company's Massachusetts automobile
business has represented premiums written and earned of approximately $27,000 in
2001. In 2002, premiums written for this business will be reduced to zero, and
premiums earned will be reduced significantly reflecting run-off of the policies
in force at December 31, 2001. For the full year 2001, claims and settlement
expenses in Massachusetts for voluntary automobile business were $9,137 and for
involuntary residual market business were $11,455. Claims and settlement
expenses in 2002 will reflect run-off of the business and a decline in exposure
to loss, as the policies written as the Company's risk expire.
Printing Services Operations
In November 2001, the Company recorded restructuring charges of $450 pretax
($293, less than $0.01 per share, after tax) reflecting the decision to close
its on-site printing services operations based on a cost benefit analysis.
Employee termination costs, for termination of 13 individuals, which represented
severance, vacation buy-out and related payroll taxes represented $409 of the
total charge. The eliminated positions encompass management, technical and
clerical responsibilities. The remaining $41 was attributable primarily to the
write-off of equipment related to this function.
Group Insurance and Credit Union Marketing Operations
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
F-56
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 2 - Restructuring Charges-(Continued)
improve business results and more closely align these functions with the
Company's strategic direction. Employee termination costs, for termination of an
estimated 50 individuals, represented severance, vacation buy-out and related
payroll taxes. The eliminated positions encompass management, professional and
clerical responsibilities. As of December 31, 2001, 39 individuals have been
terminated with two additional terminations scheduled in 2002. Termination of
lease agreements represented office space used by the credit union marketing
group. The remaining charge was attributable primarily to the write-off of
software related to these two areas.
The following table provides information about the components of the charge
taken in December 2000, the balance of accrued amounts at December 31, 2000 and
2001, and payment activity during the year ended December 31, 2001. The
adjustment to employee termination costs during the year ended December 31, 2001
reflected placement of nine individuals from terminated positions into other
open positions within the Company.
Original Reserve at Reserve at
Pretax December 31, December 31,
Charge 2000 Payments Adjustments 2001
-------- ------------ -------- ----------- ------------
Charges to earnings:
Employee termination costs ........ $ 1,827 $ 1,827 $ (970) $ (221) $ 636
Termination of lease
agreements ...................... 285 285 (50) (235) --
Write-off of capitalized
software ........................ 106 -- -- -- --
Other ............................. 18 18 (49) 31 --
------- ------- ------- ------- -------
Total ........................ $ 2,236 $ 2,130 $(1,069) $ (425) $ 636
======= ======= ======= ======= =======
NOTE 3 - Investments
Net Investment Income
The components of net investment income for the following periods were:
Year Ended December 31,
------------------------------
2001 2000 1999
-------- -------- --------
Fixed maturities .............................. $192,547 $185,745 $182,561
Short-term and other investments .............. 10,346 10,220 9,212
-------- -------- --------
Total investment income ..................... 202,893 195,965 191,773
Less investment expenses ...................... 3,626 3,569 3,506
-------- -------- --------
Net investment income ....................... $199,267 $192,396 $188,267
======== ======== ========
F-57
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 3 - Investments-(Continued)
Realized Investment Gains (Losses)
Realized investment gains (losses) for the following periods were:
Year Ended December 31,
--------------------------------
2001 2000 1999
-------- -------- --------
Fixed maturities ........................... $(14,371) $(12,906) $ (9,777)
Short-term and other investments ........... 4,352 3,000 1,808
-------- -------- --------
Realized investment gains (losses) ....... $(10,019) $ (9,906) $ (7,969)
======== ======== ========
Fixed Maturity Securities
The amortized cost, unrealized investment gains and losses, and fair values
of investments in debt securities as of December 31, 2001, 2000 and 1999 were as
follows:
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
As of December 31, 2001
U.S. government and agency obligations
Mortgage-backed securities ........ $ 621,249 $ 15,353 $ 860 $ 635,742
Other ............................. 68,334 3,054 83 71,305
Municipal bonds ...................... 224,172 9,335 1,362 232,145
Foreign government bonds ............. 17,411 2,088 47 19,452
Corporate bonds ...................... 1,549,631 50,284 39,643 1,560,272
Other mortgage-backed securities ..... 246,034 6,748 1,831 250,951
---------- ---------- ---------- ----------
Totals .......................... $2,726,831 $ 86,862 $ 43,826 $2,769,867
========== ========== ========== ==========
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
========== ========== ========== ==========
The Company's investment portfolio includes no derivative financial
instruments (futures, forwards, swaps, option contracts or other financial
instruments with similar characteristics).
F-58
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 3 - Investments-(Continued)
Maturity/Sales Of Investments
The fair value and amortized cost of fixed maturity securities at December
31, 2001, 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 Fair Fair Amortized
Value Value Cost
---------- ---------- ----------
Due in 1 year or less .................... 4.0% $ 110,117 $ 108,597
Due after 1 year through 5 years ......... 23.0 638,089 625,401
Due after 5 years through 10 years ....... 29.9 826,615 814,228
Due after 10 years through 20 years ...... 14.8 410,305 405,401
Due after 20 years ....................... 28.3 784,741 773,204
----- ---------- ----------
Total .................................. 100.0% $2,769,867 $2,726,831
===== ========== ==========
Proceeds from sales/maturities of fixed maturities and gross gains and
gross losses realized for each year were:
Year Ended December 31,
-----------------------------------------
2001 2000 1999
----------- ----------- -----------
Proceeds ..................... $ 1,015,229 $ 707,923 $ 675,402
Gross gains realized ......... 16,945 4,940 3,941
Gross losses realized ........ (31,316) (17,846) (13,718)
Unrealized Gains (Losses) on Fixed Maturities
Net unrealized gains (losses) are computed as the difference between fair
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,
-----------------------------------
2001 2000 1999
--------- --------- ---------
Unrealized gains (losses) on fixed maturities
Beginning of period .............................. $ (7,418) $ (68,123) $ 98,842
End of period .................................... 43,036 (7,418) (68,123)
--------- --------- ---------
Increase (decrease) for the period ............ 50,454 60,705 (166,965)
Income taxes (benefit) ............................. 17,659 21,247 (58,438)
--------- --------- ---------
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 ................... $ 32,795 $ 39,458 $(108,527)
========= ========= =========
F-59
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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, 2001 and 2000, fixed maturities with a fair
value of $98,369 and $204,881, 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. SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities," as amended by SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,"
requires 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, 2001, 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. 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.
Deposits
At December 31, 2001, securities with a carrying value of $15,055 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
Indebtedness and scheduled maturities at December 31, 2001, 2000 and 1999
consisted of the following:
Effective December 31,
Interest Final ------------------------------
Rates Maturity 2001 2000 1999
--------- -------- -------- -------- --------
Short-term debt:
Bank Credit Facility ................... Variable 2002 $ 53,000 $ 49,000 $ 49,000
Long-term debt:
6 5/8% Senior Notes, Face amount
less unaccrued discount of $233, $279
and $323, respectively .............. 6.7% 2006 99,767 99,721 99,677
-------- -------- --------
Total .......................... $152,767 $148,721 $148,677
======== ======== ========
F-60
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 4 - Debt-(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. The Company's earnings in the fourth quarter of 2000 could have caused
a breach of a financial covenant of the Company's Bank Credit Facility in 2001
but, in the first quarter of 2001, the lender agreed to modify that covenant for
the first, second and third quarters of 2001. As a result of earnings for the
second quarter of 2001, and again based on third quarter 2001 earnings, the
lender agreed to further modify that covenant. An amendment to the Bank Credit
Agreement was made prior to December 31, 2001, which extended the maturity from
December 31, 2001 to June 30, 2002. 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 0.4% at
December 31, 2001, increasing to Interbank Offering Rate plus 0.75% effective
January 1, 2002). The unused portion of the Bank Credit Facility is subject to a
variable commitment fee which was 0.15% on an annual basis at December 31, 2001.
The Company's obligations under the Bank Credit Facility are unsecured. The
commitment for the Bank Credit Facility terminates on June 30, 2002. Management
is reviewing its capital market alternatives and believes that the Company will
be able to obtain replacement financing for the Bank Credit Facility. The
Company cannot predict on what terms and conditions such financing would be
available, and the availability of alternative financing, in the form of
long-term debt instruments or a replacement credit facility, is always subject
to prevailing market conditions at the time of securing such financing.
Covenants
The Company is in compliance with all of the covenants contained in the
Senior Notes indenture and the Bank Credit Facility Agreement, consisting
primarily of relationships of 1) debt to capital and 2) insurance subsidiaries'
earnings to future interest charges.
F-61
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 5 - Shareholders' Equity and Stock Options
Share Repurchase Program
During 2001, the Company did not repurchase shares of its common stock
under its stock repurchase program consistent with management's stated intention
to utilize excess capital to support the Company's strategic growth initiatives.
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, 2001, $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, 2001, 2000 and 1999.
Through December 31, 2001, the Company's catastrophe reinsurance programs
were augmented by a $100,000 equity put and reinsurance agreement. This equity
put provided 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 exceeded the catastrophe reinsurance program coverage
limit. Before tax benefits, the equity put provided 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-62
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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.
At the time of this Report on Form 10-K, management is in what it believes
to be the final stages of negotiating a replacement equity put and reinsurance
agreement with a subsidiary of Swiss Reinsurance Company. The Swiss Re Group is
rated "A++ (Superior)" by A.M. Best. The terms of the three year agreement are
expected to be similar to the prior equity put and reinsurance agreement. Before
tax benefits, the proposed equity put coverage of $75,000 would provide a source
of capital for up to $115,000 of catastrophe losses above the reinsurance
coverage limit. The Company would also have the option, in place of the equity
put, to require the Swiss Re Group member to issue a 10% quota share reinsurance
coverage of all of the Company's property and casualty book of business. Fees
related to this equity put option, which are charged directly to additional
paid-in capital, are estimated to increase to 145 basis points in 2002 from 95
basis points in 2001 under the prior agreement. An additional provision of this
agreement would prevent Horace Mann's exercise of the option in the event it's
S&P financial strength rating was below "BBB" prior to a triggering event. The
Company's S&P financial strength rating was "A+" at December 31, 2001.
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, 2001, 2000 and 1999, 121,322, 113,944 and 68,822 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,
2001, 2000 and 1999, 14,303, 8,507 and 5,613 units, respectively, were
outstanding under this plan representing an equal number of common shares to be
issued in the future.
F-63
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 5 - Shareholders' Equity and Stock Options-(Continued)
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. In 2001,
the shareholders approved the 2001 Stock Incentive Plan (the "2001 Plan") and
reserved the shares of common stock remaining from the 1991 Plan for issuance
under the 2001 Plan. Under the 1991 Plan and the 2001 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.
Changes in outstanding options and shares available for grant under the
1991 Plan and the 2001 Plan 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, 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
--------- --------- ----------
Granted....................... $18.22 $16.83-$21.77 1,020,050 271,775 (1,020,050)
Vested........................ $19.72 $13.84-$33.87 -- 519,860 --
Exercised..................... $10.18 $ 9.00-$17.56 (207,575) (207,575) --
Canceled...................... $20.52 $15.32-$33.87 (136,950) (136,950) 136,950
--------- --------- ----------
At December 31, 2001............ $19.23 $11.12-$33.87 3,412,250 1,350,912 424,312
========= ========= ==========
F-64
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 5 - Shareholders' Equity and Stock Options-(Continued)
The weighted average prices of vested and exercisable options as of
December 31, 2000 and 1999 were $20.19 and $14.70, respectively. For options
outstanding at December 31, 2001, information segregated by ranges of exercise
prices was as follows:
Vested and Exercisable Options
----------------------------------------
Weighted Average Range of Total Weighted Average Weighted
Option Price Option Prices Options Option Price Average
per Share per Share Outstanding Options per share Life
---------------- ------------- ----------- --------- ---------------- ---------
$15.03 $11.12-$16.38 315,100 230,350 $14.77 3.1 years
$18.59 $16.83-$23.31 2,862,700 886,112 $19.74 8.0 years
$32.70 $25.63-$33.87 234,450 234,450 $32.70 6.3 years
--------- ---------
Total................. $19.23 $11.12-$33.87 3,412,250 1,350,912 $21.14 6.9 years
========= =========
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, 2001, 2000 and 1999 were as follows:
December 31,
--------------------------------------
2001 2000 1999
Current liability (asset) ......... $(12,469) $(10,012) $ 19,006
Deferred liability (asset) ........ 21,788 (203) (20,435)
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, 2001, 2000 and 1999 were as follows:
December 31,
------------------------------
2001 2000 1999
------- -------- --------
Deferred tax assets
Unrealized losses on securities ........................... $ -- $ 2,949 $ 21,547
Discounting of unpaid claims and
claims expense tax reserves ............................ 7,221 6,906 7,166
Life insurance future policy benefit reserve revaluation .. 10,921 13,808 17,195
Unearned premium reserve reduction ........................ 12,392 11,634 11,395
Postretirement benefits other than pension ................ 10,316 10,367 9,775
Other, net ................................................ 10,916 8,750 6,200
------- -------- --------
Total gross deferred tax assets ...................... 51,766 54,414 73,278
------- -------- --------
Deferred tax liabilities
Unrealized gains on securities ............................ 14,181 -- --
Intangible assets ......................................... 13,438 15,070 17,573
Deferred policy acquisition costs ......................... 45,935 39,141 35,270
------- -------- --------
Total gross deferred tax liabilities ................. 73,554 54,211 52,843
------- -------- --------
Net deferred tax liability (asset) ................. $21,788 $ (203) $(20,435)
======= ======== ========
F-65
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 6 - Income Taxes-(Continued)
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,
-------------------------------------
2001 2000 1999
-------- -------- -------
Current ............................. $ (7,267) $ (5,104) $35,237
Deferred ............................ 10,022 (6,016) 13,612
-------- -------- -------
Total tax expense (benefit) ....... $ 2,755 $(11,120) $48,849
======== ======== =======
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,
-------------------------------
2001 2000 1999
------- -------- --------
Expected federal tax on income .................... $ 9,920 $ 3,402 $ 32,674
Add (deduct) tax effects of:
Tax-exempt interest ............................. (3,786) (4,240) (4,293)
Tax reserve release ............................. (3,034) -- --
1994 and 1995 IRS audit - interest, net of tax .. -- (2,146) --
Goodwill ........................................ 566 566 566
Acquisition related benefits and other, net ..... 358 (20) (98)
------- -------- --------
Income tax expense (benefit) provided on income
before provision for prior years' taxes ......... 4,024 (2,438) 28,849
Provision for prior years' taxes .................. (1,269) (8,682) 20,000
------- -------- --------
Income tax expense (benefit) provided on income ... $ 2,755 $(11,120) $ 48,849
======= ======== ========
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 was included in net income for the year ended December 31, 2000. In 2001,
the Company's liability for the 1997 tax year was resolved, resulting in a
release of $1,269 that had previously been accrued for that tax year. That
amount was included in net income for the year ended December 31, 2001.
F-66
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 7 - Fair Value of Financial Instruments
Accounting principles generally accepted in the United States of America
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.
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.
F-67
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 7 - Fair Value of Financial Instruments-(Continued)
The carrying amounts and fair values of financial instruments at December
31, 2001, 2000 and 1999 consisted of the following:
December 31,
---------------------------------------------------------------------------
2001 2000 1999
----------------------- ----------------------- -----------------------
Carrying Fair Carrying Fair Carrying Fair
Amount Value Amount Value Amount Value
---------- ---------- ---------- ---------- ---------- ----------
Financial Assets
Investments
Fixed maturities ................... $2,769,867 $2,769,867 $2,607,738 $2,607,738 $2,507,280 $2,507,280
Short-term and other investments ... 107,445 109,208 99,728 102,520 122,929 125,316
Short-term investments,
loaned securities collateral ..... 98,369 98,369 204,881 204,881 -- --
---------- ---------- ---------- ---------- ---------- ----------
Total investments .............. 2,975,681 2,977,444 2,912,347 2,915,139 2,630,209 2,632,596
Cash .................................. 33,939 33,939 21,141 21,141 22,848 22,848
Financial Liabilities
Policyholder account balances on
interest-sensitive life contracts .. 94,594 92,527 94,775 92,684 94,141 92,048
Annuity contract liabilities .......... 1,278,137 1,074,525 1,217,756 1,017,044 1,238,379 1,052,732
Other policyholder funds .............. 123,434 123,434 122,233 122,233 126,530 126,530
Short-term debt ....................... 53,000 53,000 49,000 49,000 49,000 49,000
Long-term debt ........................ 99,767 101,840 99,721 92,674 99,677 89,613
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-68
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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
accounting principles generally accepted in the United States of America.
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,
-----------------------------------
2001 2000 1999
--------- --------- ---------
Statutory capital and surplus of insurance subsidiaries ......... $ 403,015 $ 389,249 $ 387,081
Increase (decrease) due to:
Deferred policy acquisition costs ............................. 157,776 141,604 130,192
Difference in policyholder reserves ........................... 4,276 (2,448) (7,514)
Goodwill ...................................................... 47,396 49,014 50,632
Value of acquired insurance in force .......................... 38,393 43,246 51,436
Liability for postretirement benefits, other than pensions .... (29,602) (28,488) (27,257)
Investment fair value
adjustments on fixed maturities ............................ 43,036 (7,418) (68,123)
Difference in investment reserves ............................. 22,520 21,403 27,726
Federal income tax liability .................................. (38,341) (6,866) (158)
Non-admitted assets and other, net ............................ (4,705) 11,064 6,552
Shareholders' equity of parent company and
non-insurance subsidiaries ................................. (31,807) (33,646) (1,748)
Parent company short-term and long-term debt .................. (152,767) (148,721) (148,677)
--------- --------- ---------
Shareholders' equity as reported herein .................... $ 459,190 $ 427,993 $ 400,142
========= ========= =========
Year Ended December 31,
-----------------------------------
2001 2000 1999
--------- --------- ---------
Statutory net income of insurance subsidiaries .................. $ 15,146 $ 23,881 $ 75,722
Net loss of non-insurance companies ............................. (3,313) (17,853) (3,710)
Interest expense ................................................ (9,250) (10,204) (9,722)
Tax benefit of interest expense and other
parent company current tax adjustments ........................ 10,954 15,539 (6,928)
--------- --------- ---------
Combined net income ............................................. 13,537 11,363 55,362
Increase (decrease) due to:
Deferred policy acquisition costs ............................. 19,565 12,781 14,612
Policyholder benefits ......................................... 9,513 7,891 7,681
Federal income tax expense .................................... (13,850) (6,324) (3,090)
Provision for prior years' taxes .............................. 1,269 8,682 (20,000)
Amortization of intangible assets ............................. (5,774) (8,769) (215)
Investment reserves ........................................... 5,425 (2,067) (7,931)
Loss on group medical business, net of tax benefits ........... -- -- (376)
Other adjustments, net ........................................ (4,098) (2,716) (1,538)
--------- --------- ---------
Net income as reported herein .............................. $ 25,587 $ 20,841 $ 44,505
========= ========= =========
F-69
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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 NAIC has codified statutory accounting practices, which constitute the
only source of prescribed statutory accounting practices and were effective
January 1, 2001. Codification changed prescribed statutory accounting practices
and resulted 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. As a result of adopting the NAIC
codification, the Company's statutory surplus of its insurance subsidiaries
increased approximately $19,000 primarily due to the allowance of deferred tax
recoverables under codification.
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 2002 without prior approval is
approximately $40,000.
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.
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 defined benefit
retirement plans are based on employees' years of service and compensation for
the highest 36 consecutive months
F-70
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
of earnings under the plan. Effective April 1, 2002, current participants will
stop accruing any new benefits under the defined benefit plans but will continue
to retain the benefits they have accrued to date.
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. For employees hired prior to April 1, 1997, 6% of
compensation will be contributed until the individual reaches 15 years of
service, with contributions increasing to 7% thereafter. For employees hired
after April 1, 1997, this percentage will remain fixed at 5% regardless of their
years of service. Prior to April 1, 2002, 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% (20% beginning April 1, 2002) of eligible compensation on a
before tax basis. Through December 31, 2001, the Company contributed an amount
equal to 50% of the first 6% of eligible compensation contributed each month by
participating employees, and the Company contribution vested over 5 years at a
rate of 20% per year of service. Beginning January 1, 2002, the Company
established an automatic 3% company contribution of eligible earnings for all
employees, which is 100% vested at the time of the contribution.
Total pension and supplemental savings expense was $10,678, $11,783 and
$9,593 for the years ended December 31, 2001, 2000 and 1999, respectively.
Defined Contribution Plan
Pension benefits under the defined contribution plan were fully funded and
investments were set aside in a trust fund. None of the trust fund assets have
been invested in shares of the Company's common stock. Contributions to
employees' accounts under the defined contribution plan, which were expensed in
the Company's Consolidated Statements of Operations, and total plan assets were
as follows:
Year Ended December 31,
--------------------------------
2001 2000 1999
---------- -------- --------
Contributions to employees accounts... $ 6,012 $ 5,626 $ 5,814
Total assets at the end of the year... 103,879 92,609 85,519
F-71
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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,
-------------------------------- -------------------------------
2001 2000 1999 2001 2000 1999
-------- -------- -------- -------- -------- -------
Change in benefit obligation:
Benefit obligation at beginning of year .............. $ 50,830 $ 47,282 $ 49,446 $ 12,191 $ 8,775 $ 6,190
Service cost ......................................... 1,789 1,625 1,816 610 719 353
Interest cost ........................................ 3,518 3,525 3,351 840 855 616
Plan amendments ...................................... 980 -- -- (383) -- --
Actuarial (gain) loss ................................ 5,500 4,689 (3,291) 1,355 2,884 1,913
Benefits paid ........................................ (6,010) (6,291) (4,040) (997) (1,042) (297)
Curtailment gain ..................................... (5,680) -- -- (9) -- --
-------- -------- -------- -------- -------- -------
Benefit obligation at end of year .................... $ 50,927 $ 50,830 $ 47,282 $ 13,607 $ 12,191 $ 8,775
======== ======== ======== ======== ======== =======
Change in plan assets:
Fair value of plan assets at beginning of year ....... $ 43,401 $ 52,966 $ 50,576 $ -- $ -- $ --
Actual return on plan assets ......................... (2,822) (3,274) 6,430 -- -- --
Employer contributions ............................... -- -- -- 997 1,042 297
Benefits paid ........................................ (6,010) (6,291) (4,040) (997) (1,042) (297)
-------- -------- -------- -------- -------- -------
Fair value of plan assets at end of year ............. $ 34,569 $ 43,401 $ 52,966 $ -- $ -- $ --
======== ======== ======== ======== ======== =======
Funded status .......................................... $(16,358) $ (7,429) $ 5,684 $(13,607) $(12,191) $(8,775)
Unrecognized net actuarial (gain) loss ................. 14,967 8,304 (3,941) 2,603 1,431 493
Unrecognized prior service (asset) cost ................ -- (3,204) (3,815) -- 1,954 2,268
-------- -------- -------- -------- -------- -------
Accrued benefit cost included
in the Consolidated Balance Sheets ................... (1,391) (2,329) (2,072) (11,004) (8,806) (6,014)
Additional liability to recognize unfunded
accumulated benefit obligation ....................... (14,967) -- -- (2,630) (3,358) (2,228)
-------- -------- -------- -------- -------- -------
Total benefit cost ..................................... $(16,358) $ (2,329) $ (2,072) $(13,634) $(12,164) $(8,242)
======== ======== ======== ======== ======== =======
Amounts recognized in the Statements of
Financial Position consist of:
Accrued benefit cost .............................. $ (1,391) $ (2,329) $ (2,072) $(11,004) $ (8,806) $(6,014)
Minimum liability ................................. (14,967) -- -- (2,630) (3,358) (2,228)
Intangible asset .................................. -- -- -- -- 1,917 2,228
Accumulated other comprehensive income ............ 14,967 -- -- 2,630 1,441 --
-------- -------- -------- -------- -------- -------
Net amount recognized ........................... $ (1,391) $ (2,329) $ (2,072) $(11,004) $ (8,806) $(6,014)
======== ======== ======== ======== ======== =======
The increase in the Company's 2001 minimum pension liability of $14,967 was
attributable to the following factors: (i) a decline in asset performance, (ii)
an increase in the assumed frequency of lump sum elections, (iii) an increase in
retirement rates and (iv) a change in the discount rate from 7.50% to 7.00%.
This increase was recorded as a charge to a separate component of shareholders'
equity.
F-72
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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,
------------------------------- --------------------------
2001 2000 1999 2001 2000 1999
------- ------- ------- ------ ------ ------
Components of net periodic pension (income) expense:
Service cost .................................. $ 1,789 $ 1,625 $ 1,816 $ 610 $ 719 $ 353
Interest cost ................................. 3,518 3,525 3,351 840 855 616
Expected return on plan assets ................ (4,021) (4,283) (4,353) -- -- --
Amortization of prior service cost ............ (610) (610) (610) 314 314 313
Recognized net actuarial loss ................. -- -- -- 174 1,946 166
Curtailment (gain) loss ....................... (1,614) -- -- 1,258 -- --
------- ------- ------- ------ ------ ------
Net periodic pension (income) expense .............. $ (938) $ 257 $ 204 $3,196 $3,834 $1,448
======= ======= ======= ====== ====== ======
Weighted-average assumptions
as of December 31:
Discount rate ................................. 7.00% 7.25% 8.00% 7.00% 7.25% 8.00%
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 were eligible to receive these benefits upon retirement. Effective
January 1, 2001, the requirement increased 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 are not 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-73
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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, 2001, 2000 and 1999 reconciled
with amounts recognized in the Company's statement of financial position:
December 31,
--------------------------------
2001 2000 1999
-------- -------- --------
Change in accumulated postretirement benefit obligation:
Accumulated postretirement benefit
obligation at beginning of year ................... $ 30,766 $ 29,660 $ 34,257
Changes during fiscal year
Service cost ...................................... 475 564 628
Interest cost ..................................... 2,285 2,366 2,158
Benefits paid ..................................... (1,676) (1,749) (1,768)
Actuarial (gain) loss ............................. 3,899 (75) (5,615)
-------- -------- --------
Accumulated postretirement benefit
obligation at end of year ......................... $ 35,749 $ 30,766 $ 29,660
======== ======== ========
Unfunded status ........................................ $(35,749) $(30,766) $(29,660)
Unrecognized net loss from past
experience different from that assumed ............... 6,147 2,278 2,403
-------- -------- --------
Accrued postretirement benefit cost ............... $(29,602) $(28,488) $(27,257)
======== ======== ========
Year Ended December 31,
--------------------------------
2001 2000 1999
-------- -------- --------
Components of net periodic benefit cost:
Service cost ................................ $ 475 $ 564 $ 628
Interest cost ............................... 2,285 2,366 2,158
Amortization of prior losses ................ 30 50 218
-------- -------- --------
Net periodic benefit cost ................ $ 2,790 $ 2,980 $ 3,004
======== ======== ========
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,
------------------------
2001 2000 1999
----- ----- ------
Accumulated postretirement benefit obligation
Effect of a one percentage point increase ......... $ 967 $ 606 $ 864
Effect of a one percentage point decrease ......... (859) (546) (743)
Service and interest cost components of the net
periodic postretirement benefit expense
Effect of a one percentage point increase ...... $ 77 $ 81 $ 75
Effect of a one percentage point decrease ...... (64) (66) (60)
F-74
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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 5.5%, 5.8% and 6.1% as of December 31, 2001, 2000
and 1999, respectively. The net medical trend rates are 6.0% in 2002 grading
down to 5.0% in 2004 and thereafter. For those participants retiring after
December 31, 1993, benefits at normal retirement 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 7.00%,
7.25% and 8.00% at December 31, 2001, 2000 and 1999, 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 Consolidated Balance Sheets were as
follows:
December 31,
-----------------------------
2001 2000 1999
------- ------- -------
Reinsurance Recoverables on Unpaid Claims
Life and health ............................. $ 7,241 $ 4,619 $ 4,485
Property and casualty
State insurance facilities ............... 23,069 32,026 45,222
Other insurance companies ................ 11,035 17,030 19,188
------- ------- -------
Total .................................. $41,345 $53,675 $68,895
======= ======= =======
F-75
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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, 2001
Premiums written ............... $885,801 $27,991 $17,756 $875,566
Premiums earned ................ 625,722 28,601 18,121 615,242
Benefits, claims and
settlement expenses ......... 475,991 18,416 18,008 475,583
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
There were no losses from uncollectible reinsurance recoverables in the
three years ended December 31, 2001. Past due reinsurance recoverables as of
December 31, 2001 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 a class action 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.
In July 2001, the Company submitted a settlement agreement to the court which
was mutually agreed upon by all parties to this lawsuit. The settlement, which
provides additional benefits for current policyholders and compensation to those
who demonstrate they did not understand what they purchased, was approved by the
court on October 31, 2001. The settlement was finalized
F-76
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 11 - Contingencies-(Continued)
on November 30, 2001 and is being administered. While the actual costs incurred
by the Company to resolve this litigation could be either less or more than the
liability established in 2000, management believes that, based on facts and
circumstances available at this time and on the settlement agreement approved by
the court in October 2001, 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 years ended December 31, 2001 and
2000.
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 generally been insignificant. In December 2001, the Company
recorded a pretax charge of $1,314 representing its estimated portion of the
industry assessment related to the insolvency of the Reliance Insurance Group.
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,
-----------------------------------
2001 2000 1999
--------- --------- ---------
Cash flows from operating activities
Net income ........................................... $ 25,587 $ 20,841 $ 44,505
Adjustments to reconcile net income to net
cash provided by operating activities:
Realized investment losses ...................... 10,019 9,906 7,969
Depreciation and amortization ................... 8,300 6,761 (1,013)
Increase in insurance liabilities ............... 124,830 113,616 76,401
(Increase) decrease in premium receivables ...... (7,160) (7,357) 11,357
Increase in deferred policy acquisition costs.... (19,565) (12,781) (14,612)
(Increase) decrease in reinsurance recoverable... (5,850) 3,364 (3,078)
Increase (decrease) in federal
income tax liabilities ........................ 3,179 (27,655) 32,409
(Decrease) increase in liabilities
for restructuring and litigation charges ...... (3,127) 9,919 --
Other ........................................... 12,644 7,634 (5,792)
--------- --------- ---------
Total adjustments ............................. 123,270 103,407 103,641
--------- --------- ---------
Net cash provided by operating activities.... $ 148,857 $ 124,248 $ 148,146
========= ========= =========
F-77
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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-78
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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,
--------------------------------
2001 2000 1999
-------- -------- --------
Insurance premiums and contract charges earned
Property and casualty .................................... $508,345 $489,952 $491,060
Annuity .................................................. 14,906 17,017 16,706
Life ..................................................... 93,272 92,998 87,618
Intersegment eliminations ................................ (1,281) (1,253) (256)
-------- -------- --------
Total ............................................... $615,242 $598,714 $595,128
======== ======== ========
Net investment income
Property and casualty .................................... $ 37,749 $ 35,695 $ 37,012
Annuity .................................................. 107,583 105,340 105,224
Life ..................................................... 55,226 51,264 47,005
Corporate and other ...................................... 98 1,295 319
Intersegment eliminations ................................ (1,389) (1,198) (1,293)
-------- -------- --------
Total ............................................... $199,267 $192,396 $188,267
======== ======== ========
Net income
Operating income
Property and casualty ................................. $ 5,184 $ 8,969 $ 39,537
Annuity ............................................... 20,619 19,274 27,320
Life .................................................. 18,646 12,880 14,570
Corporate and other, including interest expense ....... (8,866) (16,013) (10,712)
-------- -------- --------
Total operating income .............................. 35,583 25,110 70,715
Realized investment losses, after tax .................... (6,512) (6,439) (5,180)
Restructuring charges, after tax ......................... (4,753) (1,453) --
Litigation charges, after tax ............................ -- (5,059) (1,030)
Provision for prior years' taxes ......................... 1,269 8,682 (20,000)
-------- -------- --------
Total ............................................... $ 25,587 $ 20,841 $ 44,505
======== ======== ========
Amortization of intangible assets
Value of acquired insurance in force
Property and casualty.................................. $ -- $ -- $ 719
Annuity ............................................... 2,317 5,176 (4,242)
Life .................................................. 1,839 1,975 2,120
-------- -------- --------
Subtotal ............................................ 4,156 7,151 (1,403)
Goodwill ................................................. 1,618 1,618 1,618
-------- -------- --------
Total ............................................... $ 5,774 $ 8,769 $ 215
======== ======== ========
December 31,
------------------------------------
2001 2000 1999
---------- ---------- ----------
Assets
Property and casualty ........ $ 738,638 $ 733,922 $ 681,432
Annuity ...................... 2,674,524 2,639,872 2,611,766
Life ......................... 1,007,345 969,181 840,594
Corporate and other .......... 105,215 115,584 153,493
Intersegment eliminations .... (36,696) (37,979) (33,439)
---------- ---------- ----------
Total ................... $4,489,026 $4,420,580 $4,253,846
========== ========== ==========
F-79
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(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,
------------ ------------- -------- ---------
2001
- ----
Insurance premiums written and contract deposits........... $225,262 $224,307 $218,225 $207,772
Total revenues............................................. 201,889 203,131 196,106 203,364
Restructuring charges, after tax........................... (4,867) -- 114 --
Adjustment to the provision for prior years' taxes......... -- 1,269 -- --
Net income (loss).......................................... 4,758 9,057 (4,926) 16,698
Per share information
Basic
Realized investment gains (losses), after tax....... $ (0.11) $ (0.04) $ (0.08) $ 0.07
Restructuring charges, after tax.................... (0.12) -- -- --
Adjustment to the provision for prior years' taxes.. -- 0.03 -- --
Net income (loss)................................... 0.12 0.22 (0.12) 0.41
Diluted
Realized investment gains (losses), after tax....... $ (0.11) $ (0.03) $ (0.08) $ 0.07
Restructuring charges, after tax.................... (0.12) -- -- --
Adjustment to the provision for prior years' taxes.. -- 0.03 -- --
Net income (loss)................................... 0.12 0.22 (0.12) 0.41
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) --
Adjustment to the 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) -- -- --
Adjustment to the 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) -- -- --
Adjustment to the provision for prior years' taxes.. 0.14 0.07 -- --
Net income (loss)................................... (0.34) 0.30 0.23 0.31
F-80
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
NOTE 14 - Unaudited Interim Information-(Continued)
Three Months Ended
---------------------------------------------------
December 31, September 30, June 30, March 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
F-81
SCHEDULE I
HORACE MANN EDUCATORS CORPORATION
SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 2001
(Dollars in thousands)
Amount
shown in
Fair Balance
Type of Investments Cost(1) Value Sheet
------------------- ---------- ---------- ----------
Fixed maturities:
U.S. Government and U.S. Government agencies
and authorities ............................... $ 689,583 $ 707,047 $ 707,047
States, municipalities and political subdivisions 224,172 232,145 232,145
Foreign government bonds ........................ 17,411 19,452 19,452
Public utilities ................................ 120,062 120,720 120,720
Other corporate bonds ........................... 1,675,603 1,690,503 1,690,503
---------- ---------- ----------
Total fixed maturity securities ............. 2,726,831 $2,769,867 2,769,867
---------- ========== ----------
Mortgage loans and real estate ....................... 10,639 XXX 10,639
Short-term investments ............................... 30,079 XXX 30,079
Short-term investments, loaned securities ............ 98,369 XXX 98,369
Policy loans and other ............................... 66,378 XXX 66,727
---------- ----------
Total investments ........................... $2,932,296 XXX $2,975,681
========== ==========
- ----------
(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-82
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
BALANCE SHEETS
As of December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
2001 2000 1999
--------- --------- ---------
ASSETS
Investments and cash ....................................... $ 9,319 $ 8,565 $ 21,734
Investment in subsidiaries ................................. 554,811 521,563 478,748
Other assets ............................................... 50,891 49,668 51,417
--------- --------- ---------
Total assets ........................................ $ 615,021 $ 579,796 $ 551,899
========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Short-term debt ............................................ $ 53,000 $ 49,000 $ 49,000
Long-term debt ............................................. 99,767 99,721 99,677
Other liabilities .......................................... 3,064 3,082 3,080
--------- --------- ---------
Total liabilities ................................... 155,831 151,803 151,757
--------- --------- ---------
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, 2001, 60,076,921; 2000, 59,859,053;
1999, 59,292,053 ...................................... 60 60 59
Additional paid-in capital ................................. 341,052 338,243 333,892
Retained earnings .......................................... 461,139 452,624 449,023
Accumulated other comprehensive income (loss), net of taxes:
Net unrealized gains (losses) on fixed maturities
and equity securities ............................... 26,336 (4,038) (40,016)
Minimum pension liability adjustment .................. (11,438) (937) --
Treasury stock, at cost, 2001 and 2000, 19,341,296 shares;
1999, 18,258,896 shares ............................... (357,959) (357,959) (342,816)
--------- --------- ---------
Total shareholders' equity .......................... 459,190 427,993 400,142
--------- --------- ---------
Total liabilities and shareholders' equity .......... $ 615,021 $ 579,796 $ 551,899
========= ========= =========
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-83
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF OPERATIONS
(Dollars in thousands)
Year Ended December 31,
------------------------------
2001 2000 1999
-------- -------- --------
Revenues
Net investment income ...................... $ 100 $ 1,292 $ 318
Realized investment gains .................. 219 242 481
-------- -------- --------
Total revenues ......................... 319 1,534 799
-------- -------- --------
Expenses
Interest ................................... 9,250 10,204 9,722
Amortization of goodwill ................... 1,618 1,618 1,618
Other ...................................... 3,802 1,101 1,479
-------- -------- --------
Total expenses ......................... 14,670 12,923 12,819
-------- -------- --------
Loss before income taxes
and equity in net earnings of subsidiaries.. (14,351) (11,389) (12,020)
Income tax benefit .............................. (4,099) (3,058) (3,686)
-------- -------- --------
Loss before equity
in net earnings of subsidiaries ............ (10,252) (8,331) (8,334)
Equity in net earnings of subsidiaries .......... 35,839 29,172 52,839
-------- -------- --------
Net income ...................................... $ 25,587 $ 20,841 $ 44,505
======== ======== ========
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-84
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
--------------------------------
2001 2000 1999
-------- -------- --------
Cash flows from operating activities
Interest expense paid ................................... $ (9,091) $(10,028) $ (9,523)
Federal income taxes (paid) recovered ................... (12) 7,483 6,901
Cash dividends received from subsidiaries ............... 28,650 36,500 63,500
Other, net .............................................. (4,032) 693 421
-------- -------- --------
Net cash provided by operating activities ........... 15,515 34,648 61,299
-------- -------- --------
Cash flows provided by (used in) investing activities
Net (increase) decrease in investments .................. 5,707 7,214 (12,306)
Capital contributions to subsidiaries ................... (4,500) (20,000) --
-------- -------- --------
Net cash provided by (used in) investing activities.. 1,207 (12,786) (12,306)
-------- -------- --------
Cash flows used in financing activities
Purchase of treasury stock .............................. -- (15,143) (25,093)
Dividends paid to shareholders .......................... (17,072) (17,240) (15,756)
Principal borrowings (payments) on Bank Credit Facility.. 4,000 -- (1,000)
Repurchase of common stock warrants ..................... -- -- (2,426)
Exercise of stock options ............................... 3,759 5,302 362
Catastrophe-linked equity put option premium ............ (950) (950) (950)
-------- -------- --------
Net cash used in financing activities ............... (10,263) (28,031) (44,863)
-------- -------- --------
Net increase (decrease) in cash .............................. 6,459 (6,169) 4,130
Cash at beginning of period .................................. 1,874 8,043 3,913
-------- -------- --------
Cash at end of period ........................................ $ 8,333 $ 1,874 $ 8,043
======== ======== ========
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-85
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
NOTE TO CONDENSED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
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-86
SCHEDULE III & VI (COMBINED)
HORACE MANN EDUCATORS CORPORATION
SUPPLEMENTARY INSURANCE INFORMATION
(Dollars in thousands)
Discount, Other
Deferred Future policy if any, policy Premium
policy benefits, deducted in claims and revenue/ Net
acquisition claims and previous Unearned benefits premium investment
Segment costs claims expenses column premiums payable earned income
------- ----------- --------------- ----------- -------- ---------- --------- ----------
Year Ended December 31, 2001
Property and casualty ......... $ 18,957 $ 306,141 $ 0 $177,023 $ -- $ 508,345 $ 37,749
Annuity ....................... 54,791 1,279,891 xxx -- 113,780 14,906 107,583
Life .......................... 84,028 701,964 xxx 8,546 9,654 93,272 55,226
Other, including
consolidating eliminations... N/A 2,000 xxx N/A N/A (1,281) (1,291)
-------- ---------- -------- -------- --------- ----------
Total ..................... $157,776 $2,289,996 xxx $185,569 $123,434 $ 615,242 $ 199,267
======== ========== ======== ======== ========= =========
Year Ended December 31, 2000
Property and casualty ......... $ 16,936 $ 298,896 $ 0 $166,202 $ -- $ 489,952 $ 35,695
Annuity ....................... 46,434 1,220,334 xxx -- 111,511 17,017 105,340
Life .......................... 78,234 668,596 xxx 8,226 10,722 92,998 51,264
Other, including
consolidating eliminations... N/A N/A xxx N/A N/A (1,253) 97
-------- ---------- -------- -------- --------- ----------
Total ..................... $141,604 $2,187,826 xxx $174,428 $122,233 $ 598,714 $ 192,396
======== ========== ======== ======== ========= =========
Year Ended December 31, 1999
Property and casualty ......... $ 16,705 $ 299,803 $ 0 $162,793 $ -- $ 491,060 $ 37,012
Annuity ....................... 41,558 1,240,757 xxx -- 114,611 16,706 105,224
Life .......................... 71,929 629,889 xxx 8,052 11,919 87,618 47,005
Other, including
consolidating eliminations... N/A N/A xxx N/A N/A (256) (974)
-------- ---------- -------- -------- --------- ----------
Total ..................... $130,192 $2,170,449 xxx $170,845 $126,530 $ 595,128 $ 188,267
======== ========== ======== ======== ========= =========
Claims and claims
Benefits adjustment expense Amortization Paid
claims incurred related to of deferred claims
and ------------------- policy Other and claims
settlement Current Prior acquisition operating adjustment Premiums
expenses year years costs expenses expenses written
---------- -------- -------- ------------ --------- ---------- --------
Year Ended December 31, 2001
Property and casualty ......... $ 433,344 $416,770 $ 16,574 $ 47,780 $ 63,042 $411,147 $519,167
Annuity ....................... 66,901 xxx xxx 3,498 21,368 xxx xxx
Life .......................... 69,840 xxx xxx 8,232 41,531 xxx xxx
Other, including
consolidating eliminations... 2,000 xxx xxx (1,462) 20,074 xxx xxx
--------- -------- --------
Total ..................... $ 572,085 xxx xxx $ 58,048 $146,015 xxx xxx
========= ======== ========
Year Ended December 31, 2000
Property and casualty ......... $ 417,369 $394,711 $ 22,658 $ 45,983 $ 58,416 $402,922 $493,364
Annuity ....................... 67,758 xxx xxx 4,694 20,741 xxx xxx
Life .......................... 73,482 xxx xxx 6,725 44,168 xxx xxx
Other, including
consolidating eliminations... N/A xxx xxx (1,430) 33,577 xxx xxx
--------- -------- --------
Total ..................... $ 558,609 xxx xxx $ 55,972 $156,902 xxx xxx
========= ======== ========
Year Ended December 31, 1999
Property and casualty ......... $ 374,872 $379,455 $ (4,583) $ 44,227 $ 54,453 $382,518 $495,075
Annuity ....................... 67,078 xxx xxx 5,820 7,208 xxx xxx
Life .......................... 65,865 xxx xxx 3,286 43,178 xxx xxx
Other, including
consolidating eliminations... N/A xxx xxx (292) 16,377 xxx xxx
--------- -------- --------
Total ..................... $ 507,815 xxx xxx $ 53,041 $121,216 xxx xxx
========= ======== ========
N/A Not applicable.
See accompanying Independent Auditor's Report.
F-87
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, 2001
Life insurance in force ......... $13,216,146 $1,035,477 -- $12,180,669 --
Premiums
Property and casualty ......... $ 514,574 $ 24,350 $18,121 $ 508,345 3.6%
Annuity ....................... 14,906 -- -- 14,906 --
Life .......................... 97,523 4,251 -- 93,272 --
Other, including
consolidating eliminations... (1,281) -- -- (1,281) --
----------- ---------- -------- -----------
Total premiums ............ $ 625,722 $ 28,601 $18,121 $ 615,242 2.9%
=========== ========== ======== ===========
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%
=========== ========== ======== ===========
- ----------
NOTE: Premiums above include insurance premiums earned and contract charges
earned.
See accompanying Independent Auditors' Report
F-88
================================================================================
HORACE MANN EDUCATORS CORPORATION
EXHIBITS
To
FORM 10-K
For the Year Ended December 31, 2001
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, 2001.
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.
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.
Exhibit
No. Description
- --- -----------
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 10.17).
(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.
10.1(a) Waiver Relating to Credit Agreement, incorporated by reference
to Exhibit 10.1(b) to HMEC's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2001, filed with the SEC on May 14,
2001.
10.1(b) Waiver Relating to Credit Agreement, incorporated by reference
to Exhibit 10.1(b) to HMEC's Quarterly Report on Form 10-Q for
the quarter ended September 30, 2001, filed with the SEC on
November 14, 2001.
10.1(c) Waiver Relating to Credit Agreement, incorporated by reference
to Exhibit 10.1(c) to HMEC's Quarterly Report on Form 10-Q for
the quarter ended September 30, 2001, filed with the SEC on
November 14, 2001.
10.1(d) Amendment to Credit Agreement.
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.
Exhibit
No. Description
- --- -----------
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.
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* Horace Mann Educators Corporation 2001 Stock Incentive Plan.
10.6(a)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 2001 Stock Incentive Plan.
10.6(b)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 2001 Stock Incentive Plan.
10.7* Severance Agreements between HMEC and certain officers of HMEC.
10.7(a)* Revised Schedule to Severance Agreements between HMEC and
certain officers of HMEC.
Exhibit
No. Description
- --- -----------
10.8* 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.
10.9* 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.
10.10* 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.
10.11* 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* 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.
10.13* Letter of Employment entered by and between HMEC and Daniel M.
Jensen effective September 4, 2001.
10.14* Letter of Employment entered by and between HMEC and Douglas W.
Reynolds effective November 12, 2001.
10.15* Letter of Employment entered by and between HMEC and Bret A.
Conklin effective January 14, 2002.
10.16* 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.
10.17 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.
Exhibit
No. Description
- --- -----------
10.17(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.
10.17(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.
10.17(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.