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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
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
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 ____
As of October 31, 2002, 40,853,319 shares of Common Stock, par value $0.001
per share, were outstanding, net of 19,341,296 shares of treasury stock.
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HORACE MANN EDUCATORS CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
INDEX
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Independent Auditors' Review Report .......................................... 1
Consolidated Balance Sheets as of
September 30, 2002 and December 31, 2001 .................................... 2
Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2002 and 2001 ..................... 3
Consolidated Statements of Changes in Shareholders' Equity
for the Nine Months Ended September 30, 2002 and 2001 ....................... 4
Consolidated Statements of Cash Flows for the
Three and Nine Months Ended September 30, 2002 and 2001 ..................... 5
Notes to Consolidated Financial Statements ................................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ..................................... 21
Item 3. Quantitative and Qualitative Disclosures about Market Risk ............... 54
Item 4. Controls and Procedures .................................................. 54
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders ...................... 54
Item 5. Other Information ........................................................ 54
Item 6. Exhibits and Reports on Form 8-K ......................................... 55
SIGNATURES .................................................................................. 56
CERTIFICATIONS .............................................................................. 57
INDEPENDENT AUDITORS' REVIEW REPORT
The Board of Directors and Shareholders
Horace Mann Educators Corporation:
We have reviewed the consolidated balance sheet of Horace Mann Educators
Corporation and subsidiaries as of September 30, 2002, and the related
consolidated statements of operations and cash flows for the three-month and
nine-month periods ended September 30, 2002 and 2001, and the related
consolidated statements of changes in shareholders' equity for the nine-month
periods ended September 30, 2002 and 2001. These consolidated financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our review, we are not aware of any material modifications that
should be made to the consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Horace Mann Educators Corporation and subsidiaries as of December 31, 2001, and
the related consolidated statements of operations, changes in shareholders'
equity, and cash flows for the year then ended (not presented herein); and in
our report dated February 7, 2002, we expressed an unqualified opinion on those
consolidated financial statements.
As discussed in note 5 to the consolidated financial statements, as of
January 1, 2002 the Company adopted the provisions of Statement of Financial
Accounting Standards No. 142, "Goodwill and Intangible Assets."
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
November 13, 2002
1
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
2002 2001
--------------- ---------------
ASSETS
Investments
Fixed maturities, available for sale, at fair value (amortized
cost, 2002, $2,784,020; 2001, $2,726,831) ............................... $ 2,895,549 $ 2,769,867
Short-term and other investments ......................................... 195,621 107,445
Short-term investments, loaned securities collateral ..................... 443,815 98,369
--------------- ---------------
Total investments ..................................................... 3,534,985 2,975,681
Cash ....................................................................... 10,028 33,939
Accrued investment income and premiums receivable .......................... 98,452 112,746
Deferred policy acquisition costs .......................................... 169,309 157,776
Goodwill ................................................................... 47,396 47,396
Value of acquired insurance in force ....................................... 33,107 38,393
Other assets ............................................................... 130,970 114,665
Variable annuity assets .................................................... 817,849 1,008,430
--------------- ---------------
Total assets .......................................................... $ 4,842,096 $ 4,489,026
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities
Fixed annuity contract liabilities ....................................... $ 1,352,659 $ 1,278,137
Interest-sensitive life contract liabilities ............................. 536,851 518,455
Unpaid claims and claim expenses ......................................... 319,530 314,295
Future policy benefits ................................................... 181,137 179,109
Unearned premiums ........................................................ 189,454 185,569
--------------- ---------------
Total policy liabilities .............................................. 2,579,631 2,475,565
Other policyholder funds ................................................... 124,889 123,434
Liability for securities lending agreements ................................ 443,815 98,369
Other liabilities .......................................................... 200,969 171,271
Short-term debt ............................................................ - 53,000
Long-term debt ............................................................. 187,686 99,767
Variable annuity liabilities ............................................... 817,849 1,008,430
--------------- ---------------
Total liabilities ..................................................... 4,354,839 4,029,836
--------------- ---------------
Preferred stock, $0.001 par value, shares authorized
1,000,000; none issued .................................................... - -
Common stock, $0.001 par value, shares authorized
75,000,000; shares issued, 2002, 60,194,615; 2001, 60,076,921 ............. 60 60
Additional paid-in capital ................................................. 342,149 341,052
Retained earnings .......................................................... 446,053 461,139
Accumulated other comprehensive income (loss), net of taxes:
Net unrealized gains on fixed maturities and equity securities ........... 68,484 26,336
Minimum pension liability adjustment ..................................... (11,530) (11,438)
Treasury stock, at cost, 19,341,296 shares ................................. (357,959) (357,959)
--------------- ---------------
Total shareholders' equity ............................................ 487,257 459,190
--------------- ---------------
Total liabilities and shareholders' equity .......................... $ 4,842,096 $ 4,489,026
=============== ===============
See accompanying notes to consolidated financial statements.
2
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Insurance premiums written
and contract deposits ....................................... $ 232,604 $ 224,307 $ 662,952 $ 650,304
========== ========== ========== ==========
Revenues
Insurance premiums and
contract charges earned ................................... $ 155,575 $ 155,117 $ 465,461 $ 457,024
Net investment income ...................................... 47,567 49,867 147,602 148,465
Realized investment losses ................................. (13,161) (1,853) (51,856) (2,888)
---------- ---------- ---------- ----------
Total revenues .......................................... 189,981 203,131 561,207 602,601
---------- ---------- ---------- ----------
Benefits, losses and expenses
Benefits, claims and settlement expenses ................... 112,838 118,805 338,151 361,395
Interest credited .......................................... 24,527 24,034 73,117 72,351
Policy acquisition expenses amortized ...................... 16,834 14,688 45,760 42,002
Operating expenses ......................................... 32,326 31,064 96,316 87,356
Amortization of intangible assets .......................... 1,900 2,374 4,577 6,051
Interest expense ........................................... 2,286 2,314 6,717 7,161
Restructuring charges ...................................... 4,223 - 4,223 (175)
Debt retirement costs (gains) .............................. (785) - 1,531 -
Litigation charges ......................................... - - 1,581 -
---------- ---------- ---------- ----------
Total benefits, losses and expenses ..................... 194,149 193,279 571,973 576,141
---------- ---------- ---------- ----------
Income (loss) before income taxes ............................ (4,168) 9,852 (10,766) 26,460
Income tax expense (benefit) ................................. (4,717) 2,064 (8,552) 6,900
Adjustment to the provision for prior years' taxes ........... - (1,269) - (1,269)
---------- ---------- ---------- ----------
Net income (loss) ............................................ $ 549 $ 9,057 $ (2,214) $ 20,829
========== ========== ========== ==========
Net income (loss) per share
Basic ...................................................... $ 0.02 $ 0.22 $ (0.05) $ 0.51
========== ========== ========== ==========
Diluted .................................................... $ 0.02 $ 0.22 $ (0.05) $ 0.51
========== ========== ========== ==========
Weighted average number of shares
and equivalent shares (in thousands)
Basic .................................................... 40,850 40,659 40,823 40,579
Diluted .................................................. 41,025 40,977 41,153 40,834
See accompanying notes to consolidated financial statements.
3
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
2002 2001
---------- ----------
Common stock
Beginning balance ........................................................ $ 60 $ 60
Options exercised, 2002, 107,410 shares;
2001, 188,575 shares .................................................... - -
Conversion of Director Stock Plan units,
2002, 10,284 shares; 2001, 10,293 shares ................................ - -
---------- ----------
Ending balance ........................................................... 60 60
---------- ----------
Additional paid-in capital
Beginning balance ........................................................ 341,052 338,243
Options exercised and conversion of
Director Stock Plan units ............................................... 2,185 3,494
Catastrophe-linked equity put option premium ............................. (1,088) (713)
---------- ----------
Ending balance ........................................................... 342,149 341,024
---------- ----------
Retained earnings
Beginning balance ........................................................ 461,139 452,624
Net income (loss) ........................................................ (2,214) 20,829
Cash dividends, 2002, $0.315 per share;
2001, $0.315 per share .................................................. (12,872) (12,793)
---------- ----------
Ending balance ........................................................... 446,053 460,660
---------- ----------
Accumulated other comprehensive income (loss), net of taxes:
Beginning balance ........................................................ 14,898 (4,975)
Change in net unrealized gains (losses) on
fixed maturities and equity securities ................................. 42,148 44,529
Increase in minimum pension liability adjustment ........................ (92) -
---------- ----------
Ending balance ........................................................... 56,954 39,554
---------- ----------
Treasury stock, at cost
Beginning and ending balance,
2002 and 2001, 19,341,296 shares ........................................ (357,959) (357,959)
---------- ----------
Shareholders' equity at end of period ...................................... $ 487,257 $ 483,339
========== ==========
Comprehensive income (loss)
Net income (loss) ........................................................ $ (2,214) $ 20,829
Other comprehensive income (loss), net of taxes:
Change in net unrealized gains (losses)
on fixed maturities and equity securities ............................. 42,148 44,529
Increase in minimum pension liability adjustment ....................... (92) -
---------- ----------
Other comprehensive income ......................................... 42,056 44,529
---------- ----------
Total ............................................................ $ 39,842 $ 65,358
========== ==========
See accompanying notes to consolidated financial statements.
4
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Cash flows from operating activities
Premiums collected ......................................... $ 165,743 $ 162,778 $ 496,005 $ 479,236
Policyholder benefits paid ................................. (114,529) (121,159) (354,698) (361,194)
Policy acquisition and
other operating expenses paid ............................. (51,385) (51,201) (156,587) (143,301)
Federal income taxes paid .................................. - - (10,850) -
Investment income collected ................................ 50,237 52,238 151,697 146,837
Interest expense paid ...................................... (1,801) (3,318) (7,058) (7,472)
Contribution to defined benefit
pension plan trust fund ................................... (7,455) - (7,910) -
Other ...................................................... 4,643 (321) 1,682 (1,475)
---------- ---------- ---------- ----------
Net cash provided by operating activities ............... 45,453 39,017 112,281 112,631
---------- ---------- ---------- ----------
Cash flows used in investing activities
Fixed maturities
Purchases ............................................... (286,535) (180,745) (1,137,965) (869,133)
Sales ................................................... 98,900 92,405 782,718 563,337
Maturities .............................................. 162,795 79,835 262,009 216,751
Net cash used for short-term
and other investments ..................................... (28,999) (22,031) (90,071) (14,945)
---------- ---------- ---------- ----------
Net cash used in investing activities ................... (53,839) (30,536) (183,309) (103,990)
---------- ---------- ---------- ----------
Cash flows provided by (used in) financing activities
Dividends paid to shareholders ............................. (4,293) (4,275) (12,872) (12,793)
Principal repayments on Bank Credit Facility ............... - - (53,000) -
Exercise of stock options .................................. 69 2,530 2,185 3,494
Catastrophe-linked equity put option premium ............... (150) (238) (1,088) (713)
Proceeds from issuance of Convertible Notes ................ - - 163,013 -
Repurchase of Senior Notes and Convertible Notes ........... (23,803) - (80,744) -
Annuity contracts, variable and fixed
Deposits ................................................ 61,804 54,213 190,243 174,862
Maturities and withdrawals .............................. (45,525) (42,149) (132,419) (136,028)
Net transfer from (to) variable annuity assets .......... 10,896 (12,114) (23,308) (31,239)
Net decrease in life policy account balances ............... (1,442) (1,563) (4,893) (3,849)
---------- ---------- ---------- ----------
Net cash provided by (used in)
financing activities ................................... (2,444) (3,596) 47,117 (6,266)
---------- ---------- ---------- ----------
Net increase (decrease) in cash .............................. (10,830) 4,885 (23,911) 2,375
Cash at beginning of period .................................. 20,858 18,631 33,939 21,141
---------- ---------- ---------- ----------
Cash at end of period ........................................ $ 10,028 $ 23,516 $ 10,028 $ 23,516
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
5
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 AND 2001
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Note 1 - Basis of Presentation
The accompanying unaudited consolidated financial statements of Horace Mann
Educators Corporation ("HMEC"; and together with its subsidiaries, the
"Company") have been prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP") and with the rules and
regulations of the Securities and Exchange Commission. Certain information and
note disclosures normally included in financial statements prepared in
accordance with GAAP have been condensed or omitted. The Company believes that
these financial statements contain all adjustments (consisting of normal
recurring accruals) necessary to present fairly the Company's consolidated
financial position as of September 30, 2002 and December 31, 2001 and the
consolidated results of operations, changes in shareholders' equity and cash
flows for the three and nine months ended September 30, 2002 and 2001.
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 and Horace Mann Lloyds.
It is suggested that these financial statements be read in conjunction with
the financial statements and the related notes included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2001.
The results of operations for the three and nine months ended September 30,
2002 are not necessarily indicative of the results to be expected for the full
year.
Subsequent to filing the Form 10-Q for the period ended June 30, 2002, the
Company determined that redundant reserves had been inadvertently established on
certain life insurance policies. To ensure comparability between quarterly
periods, the reduction in life segment reserves, equal to $1,470, $956 or $0.02
per share after tax, has been reflected as an adjustment to benefits, claims and
settlement expenses and income for the nine months ended September 30, 2002 and
was not reflected in results for the three months ended September 30, 2002.
Note 2 - Restructuring Charges
Restructuring charges were incurred and separately identified in the
Statements of Operations for the nine months ended September 30, 2002 and for
the years ended December 31, 2001 and 2000.
6
Note 2 - Restructuring Charges-(Continued)
Restructure of Property and Casualty Claims Operations
In July 2002, the Company recorded restructuring charges of $4,223 pretax
($2,745, or $0.07 per share, after tax) reflecting the decision to restructure
its property and casualty claims operations. The Company expects to realize
operating and cost efficiencies and also improve customer service by
consolidating claims office locations throughout the United States into 6
offices compared to the current 17, implementing a new claims administration
system, and performing certain claims reporting and adjusting functions
internally versus utilizing external service providers. The Company expects that
these claims actions will have a positive impact on earnings in 2003 and beyond.
In addition to the cost efficiencies anticipated from the new claims
environment, the restructuring is expected to have a favorable impact on
automobile and homeowners claim severity.
Approximately 135 employees with management, professional and clerical
responsibilities will be impacted by the office consolidations. Charges for
employee termination costs represent severance, vacation buy-out and related
payroll taxes. The impact of accelerated retirements on the Company's defined
benefit pension plan has been included in the restructuring charge.
The following table provides information about the charges taken in July
2002, payment activity during the three months ended September 30, 2002, and the
balance of accrued amounts at September 30, 2002.
Original Reserve at
Pretax September 30,
Charge Payments 2002
---------- ---------- -------------
Charges to earnings:
Employee termination costs ................................. $ 2,542 $ 224 $ 2,318
Additional defined benefit pension plan costs .............. 1,179 - 1,179
Termination of lease agreements ............................ 502 - 502
---------- ---------- -------------
Total ................................................... $ 4,223 $ 224 $ 3,999
========== ========== =============
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 an
unaffiliated company, 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's agents are authorized to offer Massachusetts
customers automobile insurance policies written by Commerce. Horace Mann
continues to write its other products in Massachusetts, including property and
life insurance and retirement annuities.
7
Note 2 - Restructuring Charges-(Continued)
The Company's Consolidated Balance Sheets at September 30, 2002 and
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. The Company's Massachusetts automobile business represented
premiums written and earned of approximately $19,000 and $27,000 for the nine
months ended September 30, 2001 and the twelve months ended December 31, 2001,
respectively. In 2002, premiums written for the voluntary portion of this
business have been reduced to zero, and premiums earned will be reduced
significantly throughout the year 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 with
expiration of all of the policies written by the Company by December 31, 2002.
Printing Services, Group Insurance and Credit Union Marketing 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 by December 31,
2001, 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 of
charges was attributable primarily to the write-off of equipment related to this
function.
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 Company believes that
those changes will 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. By December 31, 2001, 39
individuals had been terminated with two additional terminations scheduled to
occur after September 30, 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.
8
Note 2 - Restructuring Charges-(Continued)
The following table provides information about the components of the
charges taken in December 2001 and 2000, the balance of accrued amounts at
December 31, 2001 and September 30, 2002, and payment activity during the nine
months ended September 30, 2002.
Original Reserve at Reserve at
Pretax December 31, September 30,
Charge 2001 Payments 2002
---------- ------------ ---------- -------------
Charges to earnings:
Printing Services Operations
Employee termination costs ......... $ 409 $ 396 $ 303 $ 93
Write-off of equipment ............. 41 - - -
---------- ------------ ---------- -------------
Subtotal ...................... 450 396 303 93
---------- ------------ ---------- -------------
Group Insurance and
Credit Union Marketing Operations
Employee termination costs ......... 1,827 636 298 338
Termination of lease agreements .... 285 - - -
Write-off of capitalized software .. 106 - - -
Other .............................. 18 - - -
---------- ------------ ---------- -------------
Subtotal ...................... 2,236 636 298 338
---------- ------------ ---------- -------------
Total ....................... $ 2,686 $ 1,032 $ 601 $ 431
========== ============ ========== =============
Note 3 - Debt
Indebtedness outstanding was as follows:
September 30, December 31,
2002 2001
--------------- ---------------
Short-term debt:
Bank Credit Facility ..................................................... $ - $ 53,000
Long-term debt:
1.425% Senior Convertible Notes, due May 14,
2032. Aggregate principal amount of
$313,500 less unaccrued discount of
$164,588 (3.0% imputed rate) ............................................ 148,912 -
6 5/8% Senior Notes, due January 15, 2006.
Aggregate principal amount of $38,850 and
$100,000 less unaccrued discount of $76
and $233 (6.7% imputed rate) ............................................ 38,774 99,767
--------------- ---------------
Total ............................................................... $ 187,686 $ 152,767
=============== ===============
9
Note 3 - Debt-(Continued)
Credit Agreement with Financial Institutions ("Bank Credit Facility")
On May 29, 2002, the Company entered into a new Bank Credit Agreement which
provides for unsecured borrowings of up to $25,000, with a provision that allows
the commitment amount to be increased to $35,000 (the "Current Bank Credit
Facility"). The Current Bank Credit Facility expires on May 31, 2005. Interest
accrues at varying spreads relative to corporate or eurodollar base rates and is
payable monthly or quarterly depending on the applicable base rate. No amounts
had been borrowed under the Current Bank Credit Facility and no balance was
outstanding at September 30, 2002. The unused portion of the Current Bank Credit
Facility is subject to a variable commitment fee which was 0.20% on an annual
basis at September 30, 2002. An amendment to the previous Bank Credit Agreement
was made prior to December 31, 2001, which extended the maturity from December
31, 2001 to June 30, 2002. The previous Bank Credit Agreement was terminated
when the Company entered into the Current Bank Credit Facility. The $53,000
balance outstanding under the previous Bank Credit Agreement was repaid in full
on May 14, 2002 utilizing a portion of the proceeds from the issuance of the
Convertible Notes as described below.
1.425% Senior Convertible Notes ("Convertible Notes")
On May 14, 2002, the Company issued $353,500 aggregate principal amount of
1.425% senior convertible notes due in 2032 at a discount of 52.5% resulting in
an effective yield of 3.0%. The Convertible Notes were privately offered only to
qualified institutional buyers under Rule 144A under the Securities Act of 1933
and outside the United States of America ("U.S.") to non-U.S. persons under
Regulation S under the Securities Act of 1933. A Securities and Exchange
Commission registration statement registering the Convertible Notes was declared
effective on November 4, 2002. At a meeting held on September 10 and 11, 2002,
the Company's Board of Directors authorized the Company to repurchase, from time
to time, for cash or other consideration, its Convertible Notes. As of September
30, 2002, the net proceeds from the sale of the Convertible Notes have been used
to (1) repay the balance outstanding under the previous Bank Credit Agreement,
(2) repurchase a portion of the outstanding Senior Notes, as described below,
and (3) repurchase $40,000 aggregate principal amount, $19,000 carrying value,
of the outstanding Convertible Notes at an aggregate cost of $17,115. The
remaining proceeds will be used for general corporate purposes and potentially
to further reduce corporate indebtedness.
Interest on the Convertible Notes is payable semi-annually at a rate of
1.425% beginning November 14, 2002 until May 14, 2007. After that date, cash
interest will not be paid on the Convertible Notes prior to maturity unless
contingent cash interest becomes payable. From May 15, 2007 through maturity of
the Convertible Notes, interest will be recognized at the effective rate of 3.0%
and will represent the accrual of discount, excluding any contingent cash
interest that may become payable. Contingent cash interest becomes payable if
the average market price of a Convertible Note for a five trading day
measurement period preceding the applicable six-month period equals 120% or more
of the sum of the Convertible Note's issue price, accrued original issue
discount and accrued cash interest, if any, for such Convertible Note. The
contingent cash interest payable per Convertible Note with respect to any
quarterly period within any six-month period will equal the then applicable
conversion rate multiplied by the greater of (i) $0.105 or (ii) any regular cash
dividends paid by the Company per share on HMEC's common stock during that
quarterly period.
10
Note 3 - Debt-(Continued)
The Convertible Notes will be convertible at the option of the holders, if
the conditions for conversion are satisfied, into shares of HMEC's common stock
at a conversion price of $26.74. Holders may also surrender Convertible Notes
for conversion during any period in which the credit rating assigned to the
Convertible Notes is Ba2 or lower by Moody's or BB+ or lower by S&P, the
Convertible Notes are no longer rated by either Moody's or S&P, or the credit
rating assigned to the Convertible Notes has been suspended or withdrawn by
either Moody's or S&P. The Convertible Notes will cease to be convertible
pursuant to this credit rating criteria during any period or periods in which
all of the credit ratings are increased above such levels. The Convertible Notes
are redeemable by HMEC in whole or in part, at any time on or after May 14,
2007, at redemption prices equal to the sum of the issue price plus accrued
original issue discount and accrued cash interest, if any, on the applicable
redemption date. The holders of the Convertible Notes may require HMEC to
purchase all or a portion of their Convertible Notes on either May 14, 2007,
2012, 2017, 2022, or 2027 at stated prices plus accrued cash interest, if any,
to the purchase date. HMEC may pay the purchase price in cash or shares of HMEC
common stock or in a combination of cash and shares of HMEC common stock.
6 5/8% Senior Notes ("Senior Notes")
In May and September 2002, the Company repurchased $61,150 aggregate
principal amount of its outstanding Senior Notes utilizing a portion of the
proceeds from the issuance of the Convertible Notes, as described above. The
aggregate cost of the repurchases was $63,526.
Debt Retirement Charges
The repurchases of the Convertible Notes and Senior Notes resulted in a
pretax charge to income for the nine months ended September 30, 2002 of $1,531,
which equated to $995 or $0.03 per share after tax.
11
Note 4 - Investments
The following table presents the composition and value of the Company's
fixed maturity securities portfolio by rating category. The Company has
classified the entire fixed maturity securities portfolio as available for sale,
which is carried at fair value.
Percent of
Carrying Value September 30, 2002
--------------------------- -------------------------
Rating of Fixed September 30, December 31, Carrying Amortized
Maturity Securities(1) 2002 2001 Value Cost
---------------------- ------------- ----------- ----------- -----------
AAA ................ 40.6% 36.7% $ 1,175,340 $ 1,117,734
AA ................. 6.7 6.3 193,368 178,560
A .................. 23.0 20.8 666,885 621,787
BBB ................ 25.4 31.6 737,384 733,560
BB ................. 2.0 1.5 57,117 63,393
B .................. 1.3 2.1 38,753 42,267
CCC or lower ....... 0.8 0.8 22,211 22,115
Not rated(2) ....... 0.2 0.2 4,491 4,604
------------- ----------- ----------- -----------
Total ........... 100.0% 100.0% $ 2,895,549 $ 2,784,020
============= =========== =========== ===========
(1) Ratings are as assigned primarily by Standard & Poor's Corporation ("S&P")
when available, with remaining ratings as assigned on an equivalent basis
by Moody's Investors Service, Inc. ("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 $1 of publicly traded securities not currently rated
by S&P or Moody's and $4,490 of private placement securities not rated by
either S&P or Moody's. The National Association of Insurance Commissioners
("NAIC") has rated 91.7% of these private placements as investment grade.
The following table presents a maturity schedule of the Company's fixed
maturity securities. 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 Carrying
of Total Value
---------------------------- -------------
September 30, December 31, September 30,
Scheduled Maturity 2002 2001 2002
----------------------------------- ------------- ------------ -------------
Due in 1 year or less ............. 5.9% 4.0% $ 170,895
Due after 1 year through 5 years .. 25.0 23.0 724,841
Due after 5 years through 10 years 31.2 29.9 904,608
Due after 10 years through 20 years 12.2 14.8 351,711
Due after 20 years ................ 25.7 28.3 743,494
------------- ------------ -------------
Total ........................... 100.0% 100.0% $ 2,895,549
============= ============ =============
The Company's investment portfolio includes no derivative financial
instruments (futures, forwards, swaps, option contracts or other financial
instruments with similar characteristics).
12
Note 4 - Investments-(Continued)
The Company reviews the fair value of the entire investment portfolio on a
monthly basis. This review, in conjunction with the Company's investment
managers' monthly credit reports and relevant factors such as (1) the financial
condition and near-term prospects of the issuer, (2) the Company's intent and
ability to retain the investment long enough to allow for the anticipated
recovery in market value, (3) stock price trend of the issuer, (4) market
leadership position of the issuer, (5) debt ratings of the issuer and (6) cash
flows of the issuer are all considered in the impairment assessment. 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. In 2002, as a result of these reviews,
the Company recorded pretax impairment charges of $9,876, $28,111 and $12,917
for the three months ended March 31, June 30 and September 30, respectively.
Management believes that there may be further investment impairments during
the remainder of 2002 if current economic and financial conditions persist. At
September 30, 2002, the Company's investment portfolio had fixed income
securities issued by 26 communications companies (comprised of the
telecommunications and cable sectors) with an amortized cost of $192,000 and an
after-tax unrealized loss of approximately $7,000.
The Company loans fixed income securities to third parties, primarily major
brokerage firms. Loans of securities are required at all times to be secured by
collateral from borrowers at least equal to 100% of the market value of the
securities loaned. The Company maintains effective control over the loaned
securities and, therefore, reports them as fixed maturity securities in the
Consolidated Balance Sheets.
All of the cash collateral received related to these transactions is
invested in short-term investments and reported in the Company's Consolidated
Balance Sheets as "Short-term Investments, Loaned Securities Collateral." A
corresponding liability is recorded for the obligation to return the collateral
as required by 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" and reported in the Company's Consolidated Balance Sheets as
"Liability for Securities Lending Agreements." The carrying amounts of these
short-term investments approximate fair value. As of September 30, 2002 and
December 31, 2001, the fair value of collateral held as short-term investments,
loaned securities collateral was $443,815 and $98,369, respectively. These
short-term lending arrangements generally increase investment income with
minimal investment risk.
Note 5 - Goodwill and Other Acquired Intangible Assets
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 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 was amortized over 40 years on a straight-line basis through December
31, 2001.
13
Note 5 - Goodwill and Other Acquired Intangible Assets-(Continued)
Effective January 1, 2002, the Company adopted Financial Accounting
Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets". The Company's value of acquired
insurance in force is an intangible asset with a definite life and will continue
to be amortized under the provisions of SFAS No. 142. Goodwill 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 its value may have been diminished or impaired, the goodwill asset
must be tested for impairment. The amount of goodwill determined to be impaired
will be expensed to current operations. As of June 30, 2002, the Company
completed the allocation of goodwill by business segment and the initial
impairment testing procedures which resulted in no impairment loss.
The allocation of goodwill by segment was as follows:
Balance as of
January 1, 2002
and September 30, 2002
----------------------
Annuity ...................... $ 28,025
Life ......................... 9,911
Property and casualty ........ 9,460
----------------------
Total ...................... $ 47,396
======================
Net income (loss) and net income (loss) per share exclusive of goodwill
amortization expense for the three and nine months ended September 30, 2002 and
2001 were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- ----------------------
2002 2001 2002 2001
------- --------- --------- ----------
Reported net income (loss) ........ $ 549 $ 9,057 $ (2,214) $ 20,829
Add back: Goodwill amortization .. - 405 - 1,214
------- --------- --------- ----------
Adjusted net income (loss) ...... $ 549 $ 9,462 $ (2,214) $ 22,043
======= ========= ========= ==========
Reported net income (loss)
per share-basic .................. $ 0.02 $ 0.22 $ (0.05) $ 0.51
Add back: Goodwill amortization .. - 0.01 - 0.03
------- --------- --------- ----------
Adjusted net income (loss)
per share-basic .............. $ 0.02 $ 0.23 $ (0.05) 0.54
======= ========= ========= ==========
Reported net income (loss)
per share-diluted ................ $ 0.02 $ 0.22 $ (0.05) $ 0.51
Add back: Goodwill amortization .. - 0.01 - 0.03
------- --------- --------- ----------
Adjusted net income (loss)
per share-diluted .............. $ 0.02 $ 0.23 $ (0.05) $ 0.54
======= ========= ========= ==========
14
Note 5 - Goodwill and Other Acquired Intangible Assets-(Continued)
Net income and net income per share exclusive of goodwill amortization
expense for the years ended December 31, 2001, 2000 and 1999 were as follows:
Year Ended December 31,
-------------------------------
2001 2000 1999
-------- -------- --------
Reported net income ...................... $ 25,587 $ 20,841 $ 44,505
Add back: Goodwill amortization ......... 1,618 1,618 1,618
-------- -------- --------
Adjusted net income .................... $ 27,205 $ 22,459 $ 46,123
======== ======== ========
Reported net income per share-basic ...... $ 0.63 $ 0.51 $ 1.08
Add back: Goodwill amortization ......... 0.04 0.04 0.04
-------- -------- --------
Adjusted net income per share-basic .... $ 0.67 $ 0.55 $ 1.12
======== ======== ========
Reported net income per share-diluted .... $ 0.63 $ 0.51 $ 1.07
Add back: Goodwill amortization ......... 0.04 0.04 0.04
-------- -------- --------
Adjusted net income per share-diluted .. $ 0.67 $ 0.55 $ 1.11
======== ======== ========
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, business surrender/lapse rates and
the impact of realized investment gains and losses. 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.
The balances of value of acquired insurance in force by segment at
September 30, 2002 and December 31, 2001 were as follows:
September 30, 2002 December 31, 2001
----------------------------------- -----------------------------------
Accumulated Net Accumulated Net
Cost Amortization Balance Cost Amortization Balance
--------- ------------ -------- --------- ------------ --------
Value of acquired
insurance in force
Life ............ $ 48,746 $ 39,465 $ 9,281 $ 48,746 $ 38,151 $ 10,595
Annuity ......... 87,553 62,510 25,043 87,553 59,247 28,306
--------- ------------ -------- --------- ------------ --------
Subtotal ...... $ 136,299 $ 101,975 34,324 $ 136,299 $ 97,398 38,901
========= ============ -------- ========= ============ --------
Impact of
unrealized gains
and losses ..... (1,217) (508)
-------- --------
Total ....... $ 33,107 $ 38,393
======== ========
15
Note 5 - Goodwill and Other Acquired Intangible Assets-(Continued)
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
======= ======= ======= ======= =======
Note 6 - Shareholders' Equity
Share Repurchase Programs
The Company has not repurchased shares of its common stock under its stock
repurchase program since the third quarter of 2000, 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. The repurchase of shares was financed through use of cash
and, when necessary, its Bank Credit Facility. However, the Company has not
utilized its Bank Credit Facility for share repurchases since the second quarter
of 1999. As of September 30, 2002, $96,343 remained authorized for future share
repurchases.
16
Note 7 - Reinsurance
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 and contract deposits; premiums and contract charges earned;
and benefits, claims and settlement expenses were as follows:
Ceded to Assumed
Gross Other from State
Amount Companies Facilities Net
--------- --------- ---------- -------
Three months ended
September 30, 2002
------------------
Premiums written
and contract deposits ....... $ 233,656 $ 5,009 $ 3,957 $ 232,604
Premiums and contract
charges earned .............. 159,180 7,662 4,057 155,575
Benefits, claims and
settlement expenses ......... 115,740 6,150 3,248 112,838
Three months ended
September 30, 2001
------------------
Premiums written
and contract deposits ....... $ 225,899 $ 7,499 $ 5,907 $ 224,307
Premiums and contract
charges earned .............. 156,722 7,471 5,866 155,117
Benefits, claims and
settlement expenses ......... 120,651 6,086 4,240 118,805
Nine months ended
September 30, 2002
------------------
Premiums written
and contract deposits ....... $ 668,708 $ 14,603 $ 8,847 $ 662,952
Premiums and contract
charges earned .............. 480,321 25,530 10,670 465,461
Benefits, claims and
settlement expenses ......... 351,754 24,740 11,137 338,151
Nine months ended
September 30, 2001
------------------
Premiums written
and contract deposits ....... $ 657,133 $ 20,474 $ 13,645 $ 650,304
Premiums and contract
charges earned .............. 463,869 20,745 13,900 457,024
Benefits, claims and
settlement expenses ......... 362,699 15,247 13,943 361,395
17
Note 7 - Reinsurance-(Continued)
The Company maintains an excess and catastrophe treaty reinsurance program.
The Company reinsures 95% of catastrophe losses above a retention of $8,500 per
occurrence up to $80,000 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 $11,000 up
to $47,400 with the Florida Hurricane Catastrophe Fund, based on the Fund's
financial resources. Through December 31, 2001, these 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.
Effective May 7, 2002, the Company entered into 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. Under the 36-month
agreement, the equity put coverage of $75,000 provides a source of capital for
up to $115,000 of pretax catastrophe losses above the reinsurance coverage
limit. The Company also has the option, in place of the equity put, to require a
Swiss Re Group member to issue a 10% quota share reinsurance coverage of all of
the Company's property and casualty book of business. Annual fees related to
this equity put option, which are charged directly to additional paid-in
capital, increased to 145 basis points in 2002 from 95 basis points in 2001
under the prior agreement; however, in 2002 the agreement is effective only for
the last eight months of the year. The agreement contains certain conditions to
Horace Mann's exercise of the equity put option including: (i) the Company's
shareholders' equity, adjusted to exclude goodwill, can not be less than
$215,000 after recording the first triggering event; (ii) the Company's total
debt as a percentage of capital can not be more than 47.5% prior to recording
the triggering event; and (iii) the Company's S&P financial strength rating can
not be below "BBB" prior to a triggering event. The Company's S&P financial
strength rating was "A+" at September 30, 2002.
For liability coverages, including the educator excess professional
liability policy, the Company reinsures each loss above a retention of $500 up
to $20,000. The Company also reinsures each property loss above a retention of
$250 up to $2,500, including catastrophe losses that in the aggregate are less
than the retention levels above.
The maximum individual life insurance risk retained by the Company is $200
on any individual life and a maximum of $125 is retained on each group life
policy. Excess amounts are reinsured.
18
Note 8 - Contingencies
Lawsuits and Legal Proceedings
In June 2002, the Company recorded a pretax charge of $1,581, which equated
to $1,028 or $0.02 per share after tax, representing the Company's best estimate
of the costs of resolving class action lawsuits related to diminished value
brought against the Company. Management believes that, based on facts and
circumstances available at this time, the amount recorded will be adequate to
resolve the matters.
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.
19
Note 9 - Segment Information
The Company conducts and manages its business through four segments. The
three operating segments representing the major lines of insurance business are:
property and casualty insurance, principally personal lines automobile and
homeowners insurance; individual annuity products, principally tax-qualified;
and life insurance. The fourth segment, Corporate and Other, includes primarily
debt service and realized investment gains and losses. Summarized financial
information for these segments is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Insurance premiums and contract charges earned
Property and casualty.................................... $ 130,051 $ 128,841 $ 386,706 $ 376,941
Annuity.................................................. 3,487 3,834 10,907 11,353
Life..................................................... 22,357 22,763 68,814 69,690
Intersegment eliminations................................ (320) (321) (966) (960)
--------- --------- --------- ---------
Total.................................................. $ 155,575 $ 155,117 $ 465,461 $ 457,024
========= ========= ========= =========
Net investment income
Property and casualty..................................... $ 8,030 $ 9,453 $ 26,399 $ 27,636
Annuity................................................... 26,281 26,920 81,192 80,416
Life...................................................... 13,364 13,836 40,563 41,364
Corporate and other....................................... 185 15 330 90
Intersegment eliminations................................. (293) (357) (882) (1,041)
--------- --------- --------- ---------
Total.................................................. $ 47,567 $ 49,867 $ 147,602 $ 148,465
========= ========= ========= =========
Net income (loss)
Operating income (loss)
Property and casualty..................................... $ 5,577 $ 1,920 $ 16,016 $ 115
Annuity................................................... 3,082 5,413 12,273 14,823
Life...................................................... 4,401 3,911 13,552 13,236
Corporate and other, including interest expense........... (1,722) (2,252) (5,581) (6,851)
--------- --------- --------- ---------
Total operating income................................. 11,338 8,992 36,260 21,323
Realized investment losses, after tax..................... (8,554) (1,204) (33,706) (1,877)
Restructuring charges, after tax.......................... (2,745) - (2,745) 114
Debt retirement gains (costs), after tax.................. 510 - (995) -
Litigation charges, after tax............................. - - (1,028) -
Adjustment to the provision for prior years' taxes........ - 1,269 - 1,269
--------- --------- --------- ---------
Total.................................................. $ 549 $ 9,057 $ (2,214) $ 20,829
========= ========= ========= =========
Amortization of intangible assets
Value of acquired insurance in force
Annuity................................................... $ 1,468 $ 1,508 $ 3,263 $ 3,434
Life...................................................... 432 461 1,314 1,403
--------- --------- --------- ---------
Subtotal............................................... 1,900 1,969 4,577 4,837
Goodwill (See Note 5)...................................... - 405 - 1,214
--------- --------- --------- ---------
Total.................................................. $ 1,900 $ 2,374 $ 4,577 $ 6,051
========= ========= ========= =========
September 30, December 31,
2002 2001
------------- ------------
Assets
Property and casualty................................................... $ 786,206 $ 738,638
Annuity................................................................. 2,808,483 2,674,524
Life.................................................................... 1,161,860 1,007,345
Corporate and other..................................................... 121,689 105,215
Intersegment eliminations............................................... (36,142) (36,696)
------------- ------------
Total................................................................. $ 4,842,096 $ 4,489,026
============= ============
20
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 future
events or the Company's future financial performance are forward-looking
statements and involve known and unknown risks, uncertainties and other factors.
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.
. Fluctuations in the market value of securities within the Company's
investment portfolio due to credit issues and the related after-tax effect
on the Company's shareholders' equity and total capital through either
realized or unrealized investment losses. In addition, the impact of
fluctuations in the financial markets on the Company's defined benefit
pension plan assets and the related after-tax effect on the Company's
operating expenses, shareholders' equity and total capital.
. Prevailing interest rate levels, including the impact of interest rates on
(i) unrealized gains and losses in 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.
. Defaults on interest or dividend payments in the Company's investment
portfolio due to credit issues and the resulting impact on investment
income.
. 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, the ability of the Company to maintain a favorable catastrophe
reinsurance program, and the collectibility of reinsurance receivables.
. Future property and casualty loss experience and its impact on estimated
claims and claim adjustment expenses for losses occurring in prior years.
. The cyclicality of the insurance industry.
. Business risks inherent in the Company's restructuring of its property and
casualty claims operation.
. The risk related to the Company's dated and complex information systems,
which are more prone to error than advanced technology systems.
. 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.
21
. 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,
financial strength and debt ratings.
. Adverse changes in policyholder mortality and morbidity rates.
. The resolution of legal proceedings and related matters.
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 (loss). 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,
valuation of investments and valuation of assets and liabilities related to the
defined benefit pension plan. Additional information regarding the accounting
policies for each of these areas is provided within the relevant topics in
"Results of Operations," as well as in the Notes to Consolidated Financial
Statements in the Company's Annual Report for 2001 on Form 10-K.
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.
22
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 cross-functional 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 intends to increase its use of technology to improve
the efficiency of its agency force and its administrative operations.
RESULTS OF OPERATIONS
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
Nine Months Ended Growth Over
September 30, Prior Year
----------------- -----------------
2002 2001 Percent Amount
------- ------- ------- -------
Automobile and property (voluntary) ........ $ 382.1 $ 371.7 2.8% $ 10.4
Excluding Massachusetts automobile ....... 382.1 358.3 6.6% 23.8
Massachusetts automobile ................. - 13.4 -100.0% (13.4)
Annuity deposits ........................... 190.2 174.9 8.7% 15.3
Life ....................................... 81.5 86.1 -5.3% (4.6)
------- ------- -------
Subtotal - core lines ............. 653.8 632.7 3.3% 21.1
Subtotal - core lines, excluding
Massachusetts automobile ........ 653.8 619.3 5.6% 34.5
Involuntary and other property & casualty .. 9.2 17.6 -47.7% (8.4)
Excluding Massachusetts
automobile ........................... 7.8 11.8 -33.9% (4.0)
Massachusetts automobile .............. 1.4 5.8 -75.9% (4.4)
------- ------- -------
Total ............................. $ 663.0 $ 650.3 2.0% $ 12.7
======= ======= =======
Total, excluding Massachusetts
automobile ....................... $ 661.6 $ 631.1 4.8% $ 30.5
======= ======= =======
23
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
Nine Months Ended Growth Over
September 30, Prior Year
----------------- -----------------
2002 2001 Percent Amount
------- ------- ------- -------
Automobile and property (voluntary) ...... $ 376.7 $ 361.0 4.3% $ 15.7
Excluding Massachusetts automobile ..... 367.4 347.9 5.6% 19.5
Massachusetts automobile ............... 9.3 13.1 -29.0% (3.8)
Annuity .................................. 10.9 11.4 -4.4% (0.5)
Life ..................................... 67.8 68.7 -1.3% (0.9)
------- ------- -------
Subtotal - core lines ............. 455.4 441.1 3.2% 14.3
Subtotal - core lines, excluding
Massachusetts automobile ........ 446.1 428.0 4.2% 18.1
Involuntary and other
property & casualty .................... 10.1 15.9 -36.5% (5.8)
Excluding Massachusetts
automobile ......................... 5.1 9.7 -47.4% (4.6)
Massachusetts automobile ............ 5.0 6.2 -19.4% (1.2)
------- ------- -------
Total ............................. $ 465.5 $ 457.0 1.9% $ 8.5
======= ======= =======
Total, excluding Massachusetts
automobile ....................... $ 451.2 $ 437.7 3.1% $ 13.5
======= ======= =======
As previously disclosed, the Company restructured its presence in the
Massachusetts automobile market and ceased writing automobile insurance policies
in that state on December 31, 2001. Through a marketing alliance with an
unaffiliated company, The Commerce Group, Inc. ("Commerce"), the Company's
agents are authorized to offer Massachusetts customers automobile insurance
policies written by Commerce. Horace Mann continues to write its other products
in Massachusetts, including retirement annuities and property and life
insurance.
Premiums written and contract deposits for the Company's core lines
increased 5.6% compared to the prior year, excluding Massachusetts voluntary
automobile premiums written in the first nine months of 2001. The growth
resulted from continued strong gains in the annuity segment and rate increases
in the property and automobile lines. Voluntary property and casualty business,
a component of the Company's core lines, represents policies sold through the
Company's marketing organization and issued under the Company's underwriting
guidelines.
Average agent productivity for all lines of business combined increased
9.5% compared to a year earlier and has increased 56.5% compared to the first
nine months of 2000. Recent improvements in agent retention as well as a 20.1%
increase in new hires for the first nine months of 2002 resulted in growth in
the total agent count of 1.9%, compared to the same period last year. The growth
in agent count represents the first 12-month gain since June 1999. Management
anticipates ending 2002 with approximately 920 agents. At September 30, 2002,
the Company's exclusive agency force totaled 869. Of those, 357 were in their
first 24 months with the Company, an increase of 24.4%, compared to September
30, 2001. The number of experienced agents in the agency force, 512, was down
9.5% at September 30, 2002, compared to a year earlier, due primarily to
terminations of less-productive agents over the prior 12 months. This, and the
strong improvement in productivity levels of agents hired in the last 12 months,
has
24
driven the increase in average agent productivity. Average agent productivity
is measured as new sales premiums per the average number of agents for the
period.
In 2001, the Company modified its agent compensation and reward structure
in order to provide an incentive for agent performance that is more closely
aligned with the Company's objectives. The revised structure continues the
historical focus on profitability but places a greater emphasis on individual
agent productivity, new premium growth, growth in educator and cross-sold
business, and business retention. The Company's agency manager compensation
structure was similarly modified, and the agency management team was
strengthened through the promotions of several of the Company's most experienced
and capable agents. The number of new agents hired during 2001 was comparable to
the prior period and the number of new hires for the first nine months of 2002
was higher than a year earlier, in spite of the Company's implementation of more
stringent agent selection criteria to improve agent productivity and retention.
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. The Company also 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 December 2001, the North Carolina Commissioner of Insurance (the
"Commissioner") ordered a 13% reduction in private passenger automobile
insurance premium rates to be 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. Following the April 2002 effective date, this issue
negatively impacted the Company's earned premiums and pretax income by $0.9
million for the nine months ended September 30, 2002. The Company's full year
earned premiums are expected to be negatively impacted by approximately $2
million and $3 million in 2002 and 2003, respectively, as a result of this
dispute over 2002 rates. 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. A similar dispute between the Commissioner and the Bureau is
also in process regarding 2003 rates, which may have a further adverse impact on
2003 results.
Growth in total voluntary automobile and homeowners premium written was
6.6% for the first nine months of 2002, excluding Massachusetts voluntary
automobile written premiums of $13.4 million from the prior year. The average
premium written per policy increased for both automobile and homeowners
insurance, compared to a year earlier. Voluntary automobile insurance premium
written, excluding Massachusetts, increased 6.8% ($17.9 million) compared to the
first nine months of 2001, and homeowners premium increased 6.2% ($5.9 million).
The property and casualty increase in premiums resulted from the impact of rate
increases on average
25
premium per policy. Average written premium was up 6% for voluntary automobile
and 12% for homeowners, compared to a year earlier, while the average earned
premium increased 6% for voluntary automobile and 11% for homeowners. As of
September 30, 2002, approved rate increases for the Company's automobile and
homeowners business were 6% and 22%, respectively. The Company's competitors
have taken similar rate increases as well. Over the prior 12 months and
excluding a 17,000 unit decrease in Massachusetts, automobile units were equal
to last year. Homeowners units were 8,000 less than both 12 months earlier and
December 31, 2001 reflecting planned reductions. At September 30, 2002, there
were 579,000 voluntary automobile and 284,000 homeowners policies in force for a
total of 863,000, including 6,000 Massachusetts voluntary automobile units which
will run off over the remaining months of 2002.
Based on policies in force, the property and casualty 12-month retention
rate for new and renewal policies was 87%, 1 percentage point lower than the 12
months ended September 30, 2001, reflecting the anticipated reductions in
homeowners policies in force and the aggressive pricing and underwriting actions
implemented during the period. The Company plans additional rate increases in
the remainder of 2002 and beyond, with primary emphasis on the homeowners line,
which are expected to have a continued adverse impact on retention of homeowners
policies in force. The Company has implemented tiered rating systems for
automobile and homeowners business based on customers' credit ratings, 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 100% for
voluntary automobile and 105% for homeowners, as a result of the impact of rate
actions coupled with other initiatives described under "Results of Operations --
Benefits, Claims and Settlement Expenses."
Involuntary property and casualty business includes allocations of business
from state mandatory insurance facilities and assigned risk business. The
decline in premiums written for involuntary and other property and casualty was
primarily attributable to a decrease in state mandatory automobile insurance
facility business assumed in the first nine months of 2002, compared to the same
period last year.
Growth in annuity contract deposits for the nine months ended September 30,
2002 reflected new business growth and better retention of existing business. 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 them 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 in place.
Compared to the first nine months of 2001, new annuity deposits increased
8.7%, reflecting an 11.6% increase in scheduled deposits received and a 4.0%
increase in single premium and rollover deposits. New deposits to fixed
annuities were 16.8%, or $14.7 million, higher than in the first nine months of
2001, and new deposits to variable annuities increased 0.7%, or $0.6 million,
compared to a year ago. 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 3-month, 6-month or 12-month periods.
26
In January 2002, the Company announced that it had been selected as one of
four providers of fixed and variable annuities to Chicago, Illinois, public
school employees. Beginning April 1, 2002, the Company is partnering 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 six months ended September 30, 2002, approximately 1,500 new
flexible premium contracts were sold through this partnership representing over
$7 million in contract deposits on an annual basis, $2.1 million of which were
received since this effort began on April 1.
Variable annuity accumulated funds on deposit at September 30, 2002 were
$0.8 billion, $32.6 million less than a year earlier, a 3.8% decrease including
the impact of financial market values. Variable annuity accumulated deposit
retention improved 1.7 percentage points over the 12 months to 92.5%, reflecting
ongoing 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 September 30, 2002 was
94.1%, 1.9 percentage points better than the same period last year. Fixed
annuity accumulated cash value was $1.5 billion at September 30, 2002, $91.2
million, or 6.6% more than a year earlier. The number of annuity contracts
outstanding increased 5.9%, or 8,000 contracts, compared to September 30, 2001.
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 nine months ended September 30,
2002, the amount of variable annuity surrenders was 7% lower than for the same
period last year. The amount of fixed annuity surrenders also decreased 7%
compared to the first nine months of 2001.
For the nine months ended September 30, 2002, annuity segment contract
charges earned decreased 4.4%, or $0.5 million, compared to the same period last
year. Improvements in retention of variable and fixed accumulated values, as
described above, resulted in a decline in surrender fees earned. In the current
period, declines in market valuations also negatively impacted fees earned on
variable annuity balances.
Life segment premiums and contract deposits for the first nine months of
2002 were 5.3% lower than a year earlier, due to a decrease in both new business
and interest-sensitive life product deposits. The life insurance in force lapse
ratio was 9.4% for the twelve months ended September 30, 2002, compared to 8.5%
for the same period last year. The lapse ratio for the term portion of the
business was comparable to the prior year, while the lapse ratio for the whole
life portion of the business increased. The increase in the overall lapse ratio
also reflects a shift in the mix of business toward a greater proportion of term
insurance.
Net Investment Income
Pretax investment income of $147.6 million for the first nine months of
2002 decreased 0.6%, or $0.9 million, (0.8%, or $0.8 million, after tax)
compared to the prior year due primarily to investment credit issues and a
decline in the portfolio yield which offset growth in the size of the investment
portfolio. Average investments (excluding the securities lending collateral)
increased 5.1% over the past 12 months. The average pretax yield on the
investment portfolio was 6.8% (4.5% after tax) for the first nine months of
2002, compared to a pretax yield of 7.2% (4.8% after
27
tax) last year. Looking to the last quarter of 2002, investment income will
continue to be under pressure due to investment credit issues, described under
"Results of Operations -- Realized Investment Gains and Losses" below, and
current reinvestment returns available.
Realized Investment Gains and Losses
Net realized investment losses were $51.9 million and $2.9 million for the
nine months ended September 30, 2002 and 2001, respectively. In the third
quarter of 2002, $13.2 million of realized investment losses were recorded, in
large part from the impairment of fixed income securities issued by companies in
the communications sector, primarily Qwest Communications International Inc. and
the NTL companies. By September 30, 2002, the Company had sold all of its
holdings of securities issued by WorldCom, Inc. In the second quarter of 2002,
$41.3 million of realized investment losses were recorded, which included a loss
of $19.4 million related to the sale and impairment of securities issued by
WorldCom, Inc. Additionally, impairment losses of $21.2 million were recognized
in the second quarter of 2002, relating primarily to holdings of fixed income
securities of other companies in the communications sector. The first quarter of
2002 included impairment charges of $9.9 million related to fixed income
securities issued by two telecommunications companies and a realized investment
loss of $2.0 million from the Company's sale of all of its holdings in
securities issued by Kmart Corporation. Partially offsetting these losses for
the nine months were gains realized from ongoing investment portfolio management
activity. The net realized losses in 2001 primarily resulted from the sale, for
credit reasons, of three fixed income securities and the impairment of one fixed
income security, 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.
Management believes that there may be further investment impairments during
the remainder of 2002 if current economic and financial conditions persist. At
September 30, 2002, the Company's investment portfolio had fixed income
securities issued by 26 communications companies (comprised of the
telecommunications and cable sectors) with an amortized cost of $192 million and
an after-tax unrealized loss of approximately $7 million. Subsequent weakening
of market conditions within the telecommunications or cable sectors or
subsequent adverse changes in a specific issuer's credit quality could result in
additional impairments.
The Company's methodology of assessing other-than-temporary impairments is
based on security-specific facts and circumstances as of the date of the
reporting period. Based on these facts, if management believes it is probable
that amounts due will not be collected according to the contractual terms of a
debt security not impaired at acquisition, or if the Company does not have the
ability or intent to hold a security with an unrealized loss until it matures or
recovers in value, an other-than-temporary impairment shall be considered to
have occurred. As a general rule, if the market value of a debt security has
fallen below 80% of book value for more than six months, this security will be
reviewed for an other-than-temporary impairment. Additionally, if events become
known that call into question whether the security issuer has the ability to
honor its contractual commitments, whether or not such security has been trading
above an 80% fair value to cost relationship, such security holding will be
evaluated to determine whether or not such security has suffered an
other-than-temporary decline in value.
28
The Company reviews the fair value of the entire investment portfolio on a
monthly basis. This review, in conjunction with the Company's investment
managers' monthly credit reports and relevant factors such as (1) the financial
condition and near-term prospects of the issuer, (2) the Company's intent and
ability to retain the investment long enough to allow for the anticipated
recovery in market value, (3) stock price trend of the issuer, (4) market
leadership position of the issuer, (5) debt ratings of the issuer and (6) cash
flows of the issuer are all considered in the impairment assessment. 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.
The securities impaired in the third quarter of 2002, including some
increases to previously recorded impairments, included seven communications
companies (Qwest, NTL, Charter Communications, International Cabletel, Telewest,
Diamond Cable, and IGC Holdings) and one energy company (Mirant). The securities
impaired in the second quarter of 2002 included four telecommunications
companies (WorldCom, partial sale of Qwest, Western Wireless, and American
Tower) and three cable companies (Adelphia, Century Communications, and
Telewest). Petrozuata Finance, which had declined in value due to political risk
associated with Venezuela, was also impaired in the second quarter of 2002. In
each of the periods, these securities were marked to market, and the write-downs
were recorded as realized capital losses in the Statement of Operations. These
impairments were deemed to be other-than-temporary for one or more of the
following reasons: the recovery of full market value was not likely, the issuer
defaulted or was likely to default due to the need to restructure its debt, or
the Company had an intent to sell the security in the near future.
The decline in value below cost is not assumed to be other than temporary
for fixed maturity investments with unrealized losses due to market conditions
or industry-related events where there exists a reasonable market recovery
expectation and where management has no positive current intent on selling and
the Company has the intent and ability to hold the investment until maturity or
a market recovery is realized. Management believes that the intent and ability
to hold a fixed maturity investment with a continuous material unrealized loss
due to market conditions or industry-related events for a period of time
sufficient to allow a market recovery or to maturity is a decisive factor when
considering an impairment loss. In the event that the Company's intent or
ability to hold a fixed maturity investment with a continuous material
unrealized loss for a period of time sufficient to allow a market recovery or to
maturity were to change, an evaluation for other than temporary impairment is
performed. An other than temporary impairment loss will be recognized based upon
all relevant facts and circumstances for each investment, as appropriate, in
accordance with Securities and Exchange Commission Staff Accounting Bulletin
("SAB") No. 59, "Accounting for Non-Current Marketable Equity Securities,"
Financial Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," and related guidance.
At September 30, 2002, the Company's diversified fixed maturity portfolio
consisted of 1,098 investment positions and totaled approximately $2.9 billion
in carrying value. The portfolio is 96% investment grade, based on market value,
with an average quality rating of A+. At September 30, 2002, the portfolio had
approximately $46 million pretax of total gross unrealized losses related to 171
positions. The following table provides information regarding fixed maturity
securities that
29
had an unrealized loss at September 30, 2002, including the length of time that
the securities have continuously been in an unrealized loss position.
Investment Positions With Unrealized Losses Segmented by Quality
and Period of Continuous Unrealized Loss
As Of September 30, 2002
Number of Cost or Pretax
Positions Fair Amortized Unrealized
(Actual Count) Value Cost Loss
-------------- --------- ----------- ------------
Investment Grade
6 Months or less ............... 41 $ 174.9 $ 185.1 $ (10.2)
7 through 12 months ............ 27 98.9 106.2 (7.3)
13 through 24 months ........... 6 31.0 35.7 (4.7)
25 through 36 months ........... 3 11.4 11.5 (0.1)
37 through 48 months ........... 10 45.8 51.8 (6.0)
Greater than 48 months ......... 1 2.4 2.4 *
-------------- --------- ----------- ------------
Total ........................ 88 $ 364.4 $ 392.7 $ (28.3)
============== ========= =========== ============
Non-investment Grade
6 Months or less ............... 46 $ 57.1 $ 63.6 $ (6.5)
7 through 12 months ............ 18 19.1 22.5 (3.4)
13 through 24 months ........... 8 5.5 6.8 (1.3)
25 through 36 months ........... - - - -
37 through 48 months ........... 8 19.2 21.8 (2.6)
Greater than 48 months ......... 2 13.8 17.9 (4.1)
-------------- --------- ----------- ------------
Total ........................ 82 $ 114.7 $ 132.6 $ (17.9)
============== ========= =========== ============
Not Rated
6 Months or less ............... - $ - $ - $ -
7 through 12 months ............ 1 - 0.1 (0.1)
13 through 24 months ........... - - - -
25 through 36 months ........... - - - -
37 through 48 months ........... - - - -
Greater than 48 months ......... - - - -
-------------- --------- ----------- ------------
Total ........................ 1 $ - $ 0.1 $ (0.1)
============== ========= =========== ============
Grand Total ................ 171 $ 479.1 $ 525.4 $ (46.3)
============== ========= =========== ============
- ----------
* Less than $0.1 million
Of the securities with unrealized losses, four issuers had pretax
unrealized losses greater than $2 million and were trading below 80% of book
value at September 30, 2002. These issuers are Tyco International Group
(unrealized loss $2.6 million), Telus Corporation (unrealized loss $2.0
million), Royal Caribbean Cruises Ltd. (unrealized loss $2.5 million), and El
Paso Corporation subsidiaries (Coastal Corp. unrealized loss $2.3 million and
Southern Natural Gas unrealized loss $1.4 million). The Company views these
decreases in value as being temporary and expect recovery in market value and
continued payments under the terms of the securities.
30
Historically, the Company's investment guidelines have limited single
corporate issuer exposure to 1% of invested assets. Based on current financial
market conditions, the Company has revised its guidelines to limit the single
corporate issuer exposure to 4.0% (after tax) of shareholders' equity for "AA"
or "AAA" rated securities, 2.5% (after tax) of shareholders' equity for "A"
rated securities, 2.0% (after tax) of shareholders' equity for "BBB" rated
securities, and 1.0% (after tax) of shareholders' equity for non-investment
grade securities. The change in the investment guidelines became effective in
the third quarter of 2002 for new purchases of securities. It is anticipated
that the existing portfolio will be brought into compliance with the new
guidelines by the end of 2003. Additional sub-sector limitations were also
developed as part of the revised guidelines.
Benefits, Claims and Settlement Expenses
Nine Months Ended Growth Over
September 30, Prior Year
------------------------- ------------------------
2002 2001 Percent Amount
-------- -------- ------- --------
Property and casualty............................... $ 305.7 $ 328.7 -7.0% $ (23.0)
Annuity............................................. 1.9 (0.5) 2.4
Life................................................ 30.6 33.2 -7.8% (2.6)
-------- -------- --------
Total............................................. $ 338.2 $ 361.4 -6.4% $ (23.2)
======== ======== ========
Property and casualty statutory loss ratio:
Before catastrophe losses...................... 78.0% 84.3% -6.3%
After catastrophe losses....................... 79.6% 87.2% -7.6%
Impact of litigation charges (a)............... 0.4% - 0.4%
- ----------
(a) Under statutory accounting practices, the $1.6 million litigation
charge is reflected in property and casualty claims and settlement
expenses. On a GAAP basis, this item is reported separately in the
Statement of Operations as litigation charges in the Corporate and
Other segment.
In the first nine months of 2002, the Company's benefits, claims and
settlement expenses reflected improvements in both the voluntary automobile and
the homeowners loss ratios, excluding catastrophe losses and the impact of
litigation charges, as a result of favorable weather, loss containment
initiatives and the favorable impact of the Company's restructuring of its
Massachusetts automobile business. The continued emergence of favorable property
and casualty current accident year loss trends was partially offset by adverse
development in prior years' reserves, as described below. In the first nine
months of 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 high level of non-catastrophe weather-related losses.
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
31
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. Adjustments may be required 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. The effects of these adjustments may be
significant and are charged or credited to income for the period in which the
adjustments are made.
Excluding the $1.6 million provision for the costs of resolving class
action lawsuits related to diminished value brought against the Company, net
strengthening of reserves for property and casualty claims occurring in prior
years, excluding involuntary business, was $7.0 million for the first nine
months of 2002, primarily related to loss adjustment expense and educator excess
professional liability reserves, compared to reserve strengthening of $11.1
million for the same period in 2001. Total reserves for property and casualty
claims occurring in prior years, including involuntary business and the $1.6
million provision in 2002 for class action litigation, were strengthened $8.8
million in the current period, compared to $11.8 million for the nine months
ended September 30, 2001. The reserve strengthening in 2001 was recorded
primarily in the three months ended June 30. The Company's property and casualty
net reserves were $273.2 million and $274.6 million at September 30, 2002 and
2001, respectively.
The Company completes a detailed study of property and casualty reserves
based on information available at the end of each quarter and year using
comparable procedures for each period. Trends of reported losses (paid amounts
and case reserves) for each accident year are reviewed and ultimate loss costs
for those accident years are estimated. The Company engages an independent
property and casualty actuarial consulting firm to prepare an independent study
of the Company's property and casualty reserves twice a year - at June 30 and
December 31.
As discussed in the 2000 and 2001 Form 10-Ks as previously filed, the net
reserve strengthening in the fourth quarter of 2000 was related to a reduction
of ceded reserves and an increase in reserves for the automobile line of
business. The changes in the recorded amounts were based on analyses, which were
impacted by recent adverse claims emergence. Specifically with regard to the
reduction of ceded reserves, prior to the fourth quarter of 2000, the Company
analyzed ceded reserves related to four states' mandatory automobile facility
business on an aggregate basis. As a result of unanticipated adverse ceded
reserve development throughout the second and third quarters of 2000, additional
analysis was performed which isolated differing claims emergence patterns in the
Massachusetts automobile facility business, which was growing as a percentage of
total facility business, as compared to the other three states. Based on this
disaggregated analysis, the Company concluded that additional reserves were
required. In addition, during the second and third quarters of 2000 the Company
noted increases in paid severities in excess of the original expectations in its
direct voluntary automobile line of business. The Company continued to monitor
such severity trends until such time as the Company believed that they were
sufficiently credible to require adjustment to the Company's loss and loss
expense reserve projections. As a result, the Company revised its loss
projections in the fourth quarter of 2000 to give greater weight to the
increasing trend of loss severities.
In 2001, the Company continued to review its loss reserving methodologies
and loss trend analyses including more detailed analyses of subrogation recovery
activity on business ceded to the state automobile insurance facility in
Massachusetts. The nature of the adverse trends in the second and fourth
quarters of 2001 that caused the Company to increase reserves consisted
primarily of the following: (1) an increase in the frequency and severity of
educators excess
32
professional liability claims; (2) the utilization of selected
ultimate subrogation recoverables that were not trending with actual recoveries;
and (3) the utilization of selected ultimate loss ratios in establishing
reserves for ceded voluntary automobile excess liability claims and ceded
Massachusetts involuntary automobile reserves that were not trending with actual
results.
The assumptions used by the Company prior to the change in estimate at
December 31, 2001 as they relate to items (2) and (3) above were based on
selected ultimate loss ratios that were approximately 30 percentage points
higher than the actual results of the second and fourth quarters of 2001. Based
upon the subsequent emergence of claims experience, estimates were revised and
assumptions were changed to lower the selected ultimate loss ratios in the ceded
business.
In the third quarter of 2002, the Company increased its reserves for prior
accident years primarily related to allocated loss adjustment expenses for the
voluntary automobile and homeowners lines and losses for the educator excess
professional liability product. The Company had noted increases in paid losses
and loss adjustment expenses for prior accident years in these lines during the
first and second quarters of 2002 and continued to monitor such adverse trends
until such time as the Company believed that they were sufficiently credible to
require adjustment of the reserves. As a result, the Company revised its loss
projections in the third quarter of 2002, incorporating the higher paid loss and
loss adjustment expense trends.
At the time each of the reserve analyses were performed, the Company
believed that each estimate was based upon sound and correct methodology and
such methodology was appropriately applied and that there were no trends which
indicated the likelihood of future strengthenings.
As a result of the above activities in 2000, 2001, and 2002, the resulting
net reserve strengthening was considered to be a change in estimate, which
resulted from new information and subsequent developments from prior reporting
periods and therefore, from better insight and judgment. The net reserve
strengthening did not result from a mathematical mistake, a mistake in the
application of accounting principles, or from oversight or misuse of facts that
existed at the time the financial statements were prepared. The financial impact
of the net reserve strengthening was therefore accounted for in the period that
the change was determined, rather than adjusting prior period financial
statements.
33
The following table quantifies the amount of third quarter 2002, second
quarter 2001 and fourth quarter 2000 reserve strengthening/(favorable
development) for each line of business and the accident years to which the
re-estimates relate:
Other
Voluntary Total Property &
Total Automobile Property Casualty
--------- ---------- -------- ----------
Three months ended September 30, 2002
-------------------------------------
Accident Years:
2001............................................ $ 7.6 $ 4.4 $ 1.2 $ 2.0
2000............................................ (3.3) (2.9) (0.2) (0.2)
1999 & Prior.................................... 2.0 2.5 0.1 (0.6)
--------- ---------- -------- ----------
Total........................................ $ 6.3 $ 4.0 $ 1.1 $ 1.2
========= ========== ======== ==========
Three months ended June 30, 2001
--------------------------------
Accident Years:
2000............................................ $ 1.6 $ (0.7) $ 0.7 $ 1.6
1999............................................ 3.7 3.1 - 0.6
1998 & Prior.................................... 5.7 2.3 - 3.4
--------- ---------- -------- ----------
Total........................................ $ 11.0 $ 4.7 $ 0.7 $ 5.6
========= ========== ======== ==========
Three months ended December 31, 2000
------------------------------------
Accident Years:
1999............................................ $ 5.5 $ 3.6 $ (0.1) $ 2.0
1998............................................ 6.4 6.0 0.4 -
1997 & Prior.................................... 12.8 12.8 1.8 (1.8)
--------- ---------- -------- ----------
Total........................................ $ 24.7 $ 22.4 $ 2.1 $ 0.2
========= ========== ========= ==========
Non-catastrophe weather-related losses in the first and second quarters of
2001 were notably greater than historical experience, and the third quarter of
2001 reflected additional development related to these events. The statutory
non-catastrophe property loss ratio by quarter and for the full years 2001, 2000
and 1999 was as follows:
2002 2001 2000 1999
--------- ---------- -------- ----------
Non-catastrophe property loss ratio for the:
Quarter ended March 31......................... 78.5% 85.1% 79.0% 81.9%
Quarter ended June 30.......................... 75.4% 99.4% 91.4% 72.8%
Quarter ended September 30..................... 83.7% 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%
34
After determining that the increase in non-catastrophe property losses
experienced in the early months of 2000 was due to underlying loss trends,
rather than the normal cyclicality of the property business, management began
and has continued to implement pricing, underwriting and loss control
initiatives. The Company's actions have had a positive impact on the property
loss ratio in the first nine months of 2002, accompanied by an expected decline
in homeowners policies in force. Management expects that the full impact of
these changes will be realized later in 2002 and beyond. In light of experience
and competitive actions in 2001, the Company is continuing to aggressively
increase homeowners rates. The Company has also initiated further tightening of
underwriting guidelines, expanded reunderwriting of existing policies,
implemented coverage and policy form restrictions in all states where permitted,
and limited new homeowners business to educators in certain areas. In addition,
due to the claims experience in the fourth quarter of 2001, the Company is
conducting a program to reinspect a significant portion 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.
In July 2002, the Company announced the restructuring of its property and
casualty claims operations. The Company expects to realize operating and cost
efficiencies and also improve customer service by consolidating claims office
locations throughout the United States into 6 offices compared to the current
17, implementing a new claims administration system, and performing certain
claims reporting and adjusting functions internally versus utilizing external
service providers. In addition to the cost efficiencies anticipated from the new
claims environment, the restructuring is expected to have a favorable impact on
automobile and homeowners claim severity. The process of consolidating the
offices and hiring new staff in the six remaining locations is on schedule, with
completion expected by the end of 2002. Installation and implementation of the
new claims administration system, including related process changes, is also on
schedule for the planned conversion in the second quarter of 2003.
For the first nine months of 2002, incurred catastrophe losses for all
lines were $6.0 million, compared to $10.8 million for the same period last
year. Incurred catastrophe losses in the first nine months of 2001 included a
net benefit of $1.4 million due to favorable development of reserves for 2000
catastrophe losses.
The voluntary automobile loss ratio excluding catastrophe losses was 76.1%
for the first nine months of 2002, including 0.6 percentage points due to the
aforementioned class action lawsuits, compared to 77.9% for the same period last
year. The increase in average voluntary automobile premium per policy in the
first nine months of 2002 exceeded the increase in average current accident year
loss costs, as accident frequencies trended lower and severities increased only
modestly.
The annuity benefits in the first nine months of 2002 primarily represented
mortality charges for annuity contracts on payout status. In addition, the
guaranteed minimum death benefit ("GMDB") reserve on variable annuity contracts
was increased $0.7 million in the nine months ended September 30, 2002, as a
result of fluctuations in the financial markets. The annuity benefits of $(0.5)
million recorded in the first nine months of 2001 were comprised of three
components: (1) current period mortality experience on annuity contracts on
payout status, (2)
35
a GMDB reserve on variable annuity contracts of $1.1 million
established in the third quarter of 2001 as a result of fluctuations in the
financial markets, and (3) a release of reserves for supplementary contracts,
resulting from a systems conversion, recorded in the third quarter of 2001.
At September 30, 2002, under accounting principles generally accepted in
the United States of America, the GMDB reserve was $1.0 million. The comparable
reserve under statutory accounting practices was $1.9 million. The Company has a
relatively low exposure to GMDB because approximately 25% of contract values
have no guarantee; approximately 70% have only a return of premium guarantee;
and approximately 5% have a guarantee of premium at an annual interest of 3% to
5%. The aggregate in-the-money death benefits under the GMDB provision totaled
$140 million at September 30, 2002. Regarding the sensitivity of the GMDB
reserve to market fluctuations, an approximation for the impact on the GMDB is:
for each 1 point of negative/positive market performance for the underlying
mutual funds of the Company's variable annuities, the GMDB reserve would
increase/decrease less than $0.1 million.
Life mortality experience in the current period was comparable to a year
earlier.
Subsequent to filing the Form 10-Q for the period ended June 30, 2002, the
Company determined that redundant reserves had been inadvertently established on
certain life insurance policies. To ensure comparability between the quarterly
periods, the reduction in life segment reserves, equal to $1.5 million, has been
reflected as an adjustment to the year-to-date 2002 results and was not
reflected in third quarter of 2002.
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 varies from the estimated liabilities, adjustments are charged or
credited to income for the period in which the adjustments are made.
As disclosed in the Company's Annual Report on Form 10-K for 2001, early in
that year 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 were identified and corrected. Such a
problem is not uncommon in the life insurance industry and is expected to be
cured using Internal Revenue Service ("IRS") procedures that have been
established specifically to address this type of situation. The Company recorded
$2.0 million of policyholder benefits in the Corporate and Other segment in the
fourth quarter of 2001, as well as $1.0 million of operating expense, which
represented the Company's current best estimate of the costs to the Company to
resolve these problems. In the second and third quarters of 2002, management
36
further refined its analysis and confirmed that the charge recorded in the
fourth quarter of 2001 continues to be its best estimate of the costs to the
Company to resolve these problems. In October 2002, the Company filed documents
with the IRS under the established procedures.
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-evaluating its life product portfolio and related
administrative system.
Interest Credited to Policyholders
Nine Months Ended Growth Over
September 30, Prior Year
----------------- ----------------
2002 2001 Percent Amount
------- ------- ------- ------
Annuity............................................. $ 50.8 $ 50.9 -0.2% $ (0.1)
Life................................................ 22.3 21.5 3.7% 0.8
------- ------- ------
Total............................................. $ 73.1 $ 72.4 1.0% $ 0.7
======= ======= ======
The fixed annuity average annual interest rate credited decreased to 4.8%
for the nine months ended September 30, 2002, compared to 5.1% for the same
period last year. Nearly offsetting the decline in the rate credited, the
average accumulated fixed deposits increased 5.6% for the first nine months of
2002, compared to the same period in 2001. Life insurance interest credited
increased as a result of continued growth in interest-sensitive life insurance
reserves.
Operating Expenses
For the first nine months of 2002, operating expenses increased $9.1
million, or 10.4%, compared to last year. The higher level of company-wide
expense was due predominantly to increased employee benefits costs, including
transition costs related to changes in the Company's pension plan, and reduced
employee incentive compensation expenses in 2001. Excluding these factors,
operating expenses for the two periods were approximately equal. The increase in
these company-wide expenses impacted each of the Company's insurance segments.
In 2001, the Company determined that it would freeze its defined benefit
pension plan in 2002 and move to a defined contribution structure. Costs of
transitioning to the new structure, based upon assumptions of future events, are
currently estimated to be approximately $6.5 million for each of the full years
2002 and 2003, largely as a result of settlement accounting provisions that are
expected to be triggered as a result of the higher retirement rate currently
being experienced by the Company, coupled with more retirees choosing lump sum
distributions, and the impact of declines in the market value of the pension
plan's assets. The 2002 and 2003 cost estimates were recently increased due to
an updated review of the assumptions, particularly the market value of the
plan's assets and anticipated lump sum distributions. Management believes that
it has adopted realistic assumptions for investment returns, discount rates and
mortality. To the extent that actual experience differs from the Company's
assumptions, further adjustments may be required with the effects of these
adjustments charged or credited to income and/or shareholders' equity for the
period in which the adjustments are made. The plan freeze in 2002 is anticipated
to reduce the Company's pension expense by approximately $3 million per year
beginning in 2004.
37
The Company's policy with respect to funding the defined benefit pension
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. In the first nine months
of 2002, the Company contributed $7.9 million to the defined benefit pension
plan, which was greater than the $1.8 million actuarially-determined required
minimum amount, reflecting a degree of conservatism which the Company believes
to be appropriate in light of the current volatility in the financial markets.
For the defined benefit pension plan, investments have been set aside in a trust
fund.
The total corporate expense ratio on a statutory accounting basis,
excluding restructuring charges, was 24.2% for the nine months ended September
30, 2002, 1.3 percentage points higher than the same period in 2001, reflecting
the expense items discussed above. The property and casualty statutory expense
ratio, the 19th lowest of the 100 largest property and casualty insurance groups
for 2001 (the most recent industry ranking available), was 23.7% for the nine
months ended September 30, 2002, compared to 20.5% last year. The increase in
the property and casualty statutory expense ratio primarily reflected (1)
severance and other charges related to the restructure of the property and
casualty claims operation, (2) the property and casualty segment's portion of
the increase in company-wide operating expenses and (3) an increase in
automobile new business commissions.
Amortization of Policy Acquisition Expenses and Intangible Assets
For the first nine months of 2002, the combined amortization of policy
acquisition expenses and intangible assets was $50.4 million, compared to the
$48.1 million recorded for the same period in 2001.
Amortization of intangible assets decreased to $4.6 million for the nine
months ended September 30, 2002, compared to $6.1 million for the same period in
2001. The decline primarily reflected the elimination of amortization of
goodwill as the result of the adoption of Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill
and Other Intangible Assets." Amortization of goodwill was $1.2 million and $1.6
million for the nine months ended September 30, 2001 and the year ended December
31, 2001, respectively. In addition, the September 2002 valuation of annuity
value of business acquired in the 1989 acquisition of the Company ("Annuity
VIF") resulted in an increase in amortization of $0.5 million and $0.4 million
scheduled for the three and nine months, respectively. The increase in
amortization was due to lower than expected market performance, partially offset
by the impact of realized investment losses.
Policy acquisition expenses amortized for the nine months ended September
30, 2002 of $45.8 million were $3.8 million more than the same period last year
primarily related to 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). The increase in amortization for the property and casualty
segment was partially offset by a $0.1 million reduction in amortization for the
annuity and life segments combined as a result of the current year valuation.
The favorable impact of realized investment losses in the valuation was nearly
offset by lower than expected market performance in the annuity segment. The
current year valuation reduced amortization $0.9 million for the life segment,
while there were no amortization adjustments in the prior year. For the annuity
segment, the current year valuation increased amortization $0.8 million,
compared to an increase of $0.5 million for the same period last year.
38
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 value of annuity business acquired in the 1989 acquisition of the
Company ("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, business
surrender/lapse rates and the impact of realized investment gains and losses.
For the annuity segment, the Company amortizes policy acquisition costs and the
Annuity VIF utilizing a 10% reversion to the mean approach with a maximum rate
of 12%. At September 30, 2002, capitalized annuity policy acquisition costs and
the Annuity VIF asset represented approximately 4% of the total annuity
accumulated cash value. 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. As noted above, there are a number of
assumptions involved in the valuation of capitalized policy acquisition costs
and the Annuity VIF. With regard to market performance assumptions for the
underlying mutual funds of the Company's variable annuities, a 1% deviation from
the targeted market performance would impact amortization between $0.1 million
and $0.2 million depending on the magnitude and direction of the deviation.
Income Tax Expense
The effective income tax rate on income (loss), including realized
investment gains and losses and non-recurring items, was a benefit of 79.6% for
the nine months ended September 30, 2002. In 2001, excluding the benefit related
to the Company's dispute with the Internal Revenue Service regarding tax years
1994 through 1997, the effective income tax rate was 26.4%.
In the third quarter of 2002, income taxes were reduced $1.6 million due to
an updated estimate of the current year tax rate. This benefit was reflected in
both net income and operating income. Income from investments in tax-advantaged
securities reduced the effective income tax rate 24.4 and 11.1 percentage points
for the nine months ended September 30, 2002, and 2001, respectively. While the
amount of income from tax-advantaged securities in the current year was slightly
less than in the first nine months of 2001, the reduced level of income before
income taxes in the current period resulted in this having a more significant
impact on the effective income tax rate.
The effective income tax rate on operating income, as defined below, before
income taxes was 25.1% for the nine months ended September 30, 2002, compared to
the effective income tax rate of 26.9% on the same basis for the prior year.
Operating Income
The Company defines operating income as net income before the after-tax
impact of realized investment gains and losses and non-recurring items.
Non-recurring items in 2002 included restructuring charges, debt retirement
costs and class action litigation charges. For the first nine months of 2001,
non-recurring items included an adjustment to the provision for prior years'
taxes and a restructuring reserve adjustment.
39
For the first nine months of 2002, operating income benefited from mild
weather; improved property and casualty loss trends for the 2002 accident year,
strengthened by the impact of rate increases on earned premiums; and the
Company's restructuring of its Massachusetts automobile business. These positive
prior year comparisons in the Company's property and casualty segment were
partially offset in the third quarter of 2002 by adverse development of prior
years' reserves. For the first nine months of 2002, prior years' reserve
strengthening was somewhat less than in the comparable period in 2001. Operating
income in 2002 was also adversely impacted by (1) decreases in investment income
due to investment credit issues, (2) tightening margins on variable annuities
resulting from declining market valuations, and (3) higher company-wide
operating expenses resulting primarily from transition costs related to changes
in the Company's retirement plans and lower employee incentive compensation in
2001. In addition, operating income in 2002 benefited from a $1.6 million
reduction in federal income taxes, due to an updated estimate of the current
year tax rate, and also from the January 1, 2002 discontinuance of goodwill
amortization.
Consistent with previous indications, at the time of this Report on Form
10-Q management anticipates that 2002 full year operating income will be at the
lower end of its original guidance range of $1.15 to $1.25 per share, due to
earnings pressure caused by the recent turmoil in the financial markets. As was
experienced in the third quarter of 2002, in the fourth quarter of 2002
management anticipates a lower level of investment income, due to investment
credit issues, and tightening margins on variable annuities resulting from
declining market valuations. 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 and may
impact actual results compared to management's current estimate.
40
Operating income by segment was as follows:
Nine Months Ended Growth Over
September 30, Prior Year
----------------------- ---------------------
2002 2001 Percent Amount
---------- ---------- ---------- --------
Property & casualty
Before catastrophe losses ........................... $ 20.0 $ 7.2 $ 12.8
Catastrophe losses, after tax ....................... (3.9) (7.0) 3.1
---------- ---------- --------
Total including catastrophe losses ................ 16.1 0.2 15.9
Annuity .............................................. 12.3 14.8 -16.9% (2.5)
Life ................................................. 13.5 13.2 2.3% 0.3
Corporate and other expense .......................... (1.2) (2.3) 1.1
Interest expense, after tax .......................... (4.4) (4.6) 0.2
---------- ---------- --------
Total ............................................. $ 36.3 $ 21.3 70.4% 15.0
========== ========== ========
Total before catastrophe losses ................... $ 40.2 $ 28.3 42.0% $ 11.9
========== ========== ========
Property and casualty statutory combined ratio:
Before catastrophe losses ........................... 101.7% 104.8% -3.1%
After catastrophe losses ............................ 103.3% 107.7% -4.4%
Expense ratio impact of restructuring charges(a) .... 1.1% - 1.1%
Loss ratio impact of litigation charges(b) .......... 0.4% - 0.4%
- ----------
(a) Under statutory accounting practices, the $4.2 million restructuring
charge is reflected in property and casualty operating expenses. On a
GAAP basis, this item is reported separately in the Statement of
Operations as restructuring charges in the Corporate and Other segment.
(b) See footnote (a) on page 31.
Property and casualty segment operating income of $16.1 million for the
first nine months of 2002 increased $15.9 million compared to the same period
last year. Excluding the $1.0 million after-tax provision for class action
litigation, development of prior years' reserves decreased operating income $4.7
million after tax for the first nine months of 2002, primarily recorded in the
three months ended September 30. For the first nine months of 2001, the Company
strengthened prior years' reserves by $7.7 million after tax, nearly all
recorded in the three months ended June 30. Compared to a year earlier, 2002
property and casualty segment operating income primarily reflected favorable
weather, favorable trends in average premium versus loss costs for the 2002
accident year, and benefits from restructuring its Massachusetts automobile
business, partially offset by increases in claim adjustment expenses and
company-wide operating expenses.
For the first nine months of 2002, the Company's increase in average
voluntary automobile insurance premium per policy exceeded the increase in
average current accident year loss costs, as accident frequencies trended lower
and severities increased only modestly. The Company has implemented tiered
rating systems based on customers' credit ratings for automobile and homeowners
business, 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
41
accelerate margin recovery. And, due to homeowners loss experience in the fourth
quarter of 2001, the Company 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. (See also "Results of Operations -- Net
Income (Loss).")
The property and casualty statutory combined ratio was 103.3% for the first
nine months of 2002, compared to 107.7% for the same period in 2001. The
statutory loss ratio for the segment improved compared to the prior year;
however, the statutory expense ratio increased 3.2 percentage points, primarily
reflecting 1.1 percentage points due to charges related to the restructure of
the claims operation, as well as this segment's portion of the increase in
company-wide operating expenses and an increase in automobile new business
commissions.
Annuity segment operating income in the first nine months of 2002 decreased
$2.5 million compared to the prior year. Current year income, particularly in
the third quarter, was adversely impacted by reductions in investment income due
to investment credit issues, reserve increases due to improved mortality of our
annuity business in payout status, and the increase in company-wide operating
expenses. In addition, valuation of annuity segment deferred acquisition costs
and value of acquired insurance in force at September 30, 2002, including lower
than expected market appreciation partially offset by the impact of realized
investment losses, resulted in an after-tax increase in amortization of $0.8
million for the nine months. Similar valuations a year earlier increased
after-tax amortization $0.4 million for the nine months. An increase in reserves
for GMDB reduced current year operating income by $0.4 million. The Company's
GAAP GMDB reserve was initially established in the third quarter of 2001
resulting in a $0.7 million charge to operating income in that period. Variable
annuity fee income for the current period was slightly less than in the first
nine months of 2001. Variable annuity accumulated funds on deposit were $0.8
billion at September 30, 2002, $32.6 million, or 3.8%, less than 12 months
earlier. Fixed annuity accumulated cash value of $1.5 billion was $91.2 million,
or 6.6%, greater than September 30, 2001.
Life segment operating income increased $0.3 million compared to the first
nine months of 2001. Mortality experience on ordinary life business was
comparable to the first nine months of 2001. Valuation of life segment deferred
acquisition costs at September 30, 2002 resulted in a reduction in amortization
of $0.6 million after tax due to the impact of realized investment losses. There
were no amortization adjustments in 2001.
Subsequent to filing the Form 10-Q for the period ended June 30, 2002, the
Company determined that redundant reserves had been inadvertently established on
certain life insurance policies. To ensure comparability between quarterly
periods, the reduction in life segment reserves, equal to $0.9 million after
tax, or 2 cents per share, has been reflected as an adjustment to operating
income for the nine months ended September 30, 2002 and was not reflected in
third quarter 2002 operating income.
The reduction in the operating loss for the corporate and other segment
compared to the first nine months of 2001 primarily reflected the change in
accounting, which was effective January 1, 2002, that eliminated goodwill
amortization. For the nine months ended September 30, 2001, amortization of
goodwill was $1.2 million, or 3 cent per share.
42
Net Income (Loss)
Net Income (Loss) Per Share, Diluted
Nine Months Ended Growth Over
September 30, Prior Year
----------------------- -----------------------
2002 2001 Percent Amount
---------- ---------- ---------- ----------
Operating income ..................................... $ 0.88 $ 0.52 69.2% $ 0.36
Realized investment losses ........................... (0.81) (0.04) (0.77)
Restructuring charges ................................ (0.07) - (0.07)
Debt retirement costs ................................ (0.03) - (0.03)
Litigation charges ................................... (0.02) - (0.02)
Adjustment to the provision for prior
years' taxes ........................................ - 0.03 (0.03)
---------- ---------- ----------
Net income (loss) .................................. $ (0.05) $ 0.51 $ (0.56)
========== ========== ==========
Net income (loss), includes net realized investment gains and losses and
non-recurring items reflected in the Corporate and Other segment. For the nine
months ended September 30, 2002, the Company reported a net loss of $2.2
million, or $0.05 per share, including after-tax realized investment losses of
$33.8 million, or $0.81 per share. For the first nine months of 2001, net income
was $20.8 million, or $0.51 per share, including after-tax realized investment
losses of $1.9 million, or $0.04 per share. After-tax realized investment losses
are described in "Results of Operations -- Realized Investment Gains and
Losses."
In addition to the changes in after-tax realized investment losses and
operating income, the Company recorded non-recurring items in the first nine
months of 2002 and 2001, totaling $(4.7) million after tax, or $(0.12) per
share, and $1.4 million after tax, or $0.03 per share, respectively.
In July 2002, the Company announced the restructuring of its property and
casualty claims operations. The Company expects to realize operating and cost
efficiencies and also improve customer service by consolidating claims office
locations throughout the United States into 6 offices compared to the current
17, implementing a new claims administration system, and performing certain
claims reporting and adjusting functions internally versus utilizing external
service providers. The Company expects that these claims actions will have a
positive impact on earnings in 2003 and beyond. In addition to the cost
efficiencies anticipated from the new claims environment, the restructuring is
expected to have a favorable impact on automobile and homeowners claim severity.
Charges of $2.7 million after tax, or $0.07 per share, for employee termination
costs, representing severance, vacation buy-out, related payroll taxes and the
impact of accelerated retirements on the Company's defined benefit pension plan,
and other costs related to the office closures were recorded as a non-operating
restructuring charge in the Company's financial statements for the three and
nine months ended September 30, 2002. Approximately 135 employees with
management, professional and clerical responsibilities will be impacted by the
office consolidations.
In May and September 2002, the Company used a portion of the proceeds from
the sale of its Convertible Notes to repay the outstanding balance under the
previous Bank Credit Agreement and repurchase $61.2 million of its outstanding
Senior Notes and $40.0 million aggregate principal amount, $19.0 million
carrying value, of its outstanding Senior Convertible
43
Notes. The debt retirement resulted in a net after-tax charge of $1.0 million,
or $0.03 per share, which was reflected in net income. See also "Liquidity and
Financial Resources -- Capital Resources."
In June 2002, the Company recorded an after-tax charge of $1.0 million, or
$0.02 per share, to net income, representing the Company's best estimate of the
costs of resolving class action lawsuits related to diminished value brought
against the Company. Management believes that, based on facts and circumstances
available at this time, the amount recorded will be adequate to resolve the
matters.
In the first nine months of 2001, the Company recorded non-operating
federal income tax benefits of $1.3 million, or $0.03 per share, due to
resolution of the Company's liability for the 1997 tax year and an after-tax
reduction to restructuring reserves of $0.1 million, less than $0.01 per share.
Return on shareholders' equity was 11% based on operating income and less
than 1% based on net income for the 12 months ended September 30, 2002.
LIQUIDITY AND FINANCIAL RESOURCES
Special Purpose Entities
At September 30, 2002 and 2001, 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 for 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 23% of the
common shares outstanding per their SEC filing on Form 13F as of June 30, 2002,
is the investment adviser for two of the mutual funds offered to the Company's
annuity customers. In addition, T. Rowe Price Associates, Inc., HMEC's second
largest shareholder with 8% of the common shares outstanding per their SEC
filing on Form 13F as of June 30, 2002, is the investment advisor 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 September 30, 2002, fixed income securities
represented 93.7% of investments excluding the securities lending collateral. Of
the fixed income investment portfolio, 95.8% was investment grade and 99.8% was
publicly traded. The average quality of the total fixed income portfolio was A+
at September 30, 2002.
44
The duration of the investment portfolio is managed to provide cash flow to
satisfy policyholder liabilities as they become due. The average option adjusted
duration of total investments was 4.6 years at September 30, 2002 and 5.0 years
at December 31, 2001. 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.
Additional discussion of the Company's investment guidelines is included in
"Results of Operations -- Realized Investment Gains and Losses."
Cash Flow
The short-term liquidity requirements of the Company, within a 12-month
operating cycle, are for the timely payment of claims and benefits to
policyholders, operating expenses, interest payments and federal income taxes.
Cash flow in excess of these amounts has been used to fund business growth,
retire short-term debt, pay dividends to shareholders and repurchase shares of
the Company's common stock. Long-term liquidity requirements, beyond one year,
are principally for the payment of future insurance policy claims and benefits
and retirement of long-term notes.
Operating Activities
As a holding company, HMEC conducts its principal operations in the
personal lines segment of the property and casualty and life insurance
industries through its subsidiaries. HMEC's insurance subsidiaries generate cash
flow from premium and investment income, generally well in excess of their
immediate needs for policy obligations, operating expenses and other cash
requirements. Cash provided by operating activities primarily reflects net cash
generated by the insurance subsidiaries. For the first nine months of 2002, net
cash provided by operating activities was comparable to the prior year, as
improvements from underlying insurance operating activities were offset by (1)
an increase in federal income taxes paid in the current year and (2) a
contribution to the Company's defined benefit pension plan trust fund of $7.9
million, of which $1.8 million represented the actuarially-determined required
minimum amount.
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 $6
million for both the nine months ended September 30, 2002 and 2001. It is
anticipated that the Company's payments under operating leases for the full year
2002 will be comparable to prior years' payments of approximately $8 million.
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,
45
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, of which $5 million had been paid as of September 30,
2002. 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.
In May 2002, the Company issued $353.5 million aggregate principal amount
of 1.425% Senior Convertible Notes ("Convertible Notes"), which will mature on
May 14, 2032, at a discount of 52.5%. At a meeting held on September 10 and 11,
2002, the Company's Board of Directors authorized the Company to repurchase,
from time to time, for cash or other consideration, its Convertible Notes. As of
September 30, 2002, proceeds from the sale of the Convertible Notes have been
used to (1) repay the $53.0 million balance outstanding under the previous Bank
Credit Agreement on May 14, 2002, (2) repurchase a total of $61.2 million
aggregate principal amount of the Company's outstanding 6 5/8% Senior Notes due
January 15, 2006 ("Senior Notes") in May and September 2002 at an aggregate cost
of $63.5 million, and (3) repurchase $40.0 million aggregate principal amount,
$19.0 million carrying value, of the Company's outstanding Convertible Notes in
September 2002 at an aggregate cost of $17.1 million. Subsequently, in October
2002, the Company repurchased an additional $10.3 million aggregate principal
amount of its outstanding Senior Notes at an aggregate cost of $11.1 million and
$13.0 million aggregate principal amount, $6.2 million carrying value, of its
outstanding Convertible Notes at an aggregate cost of $5.7 million. The October
2002 repurchases are not reflected in the September 30, 2002 financial
statements. The remaining proceeds will be used for general corporate purposes
and potentially to further reduce corporate indebtedness. (See also "Liquidity
and Financial Resources -- Capital Resources" for additional description of the
Convertible Notes.)
For the first nine months ended September 30, 2002, receipts from annuity
contracts increased 8.7%. Annuity contract maturities and withdrawals decreased
$3.6 million, or 2.6%, compared to the same period last year including decreases
of 7% in surrenders of both variable and fixed annuities. Reflecting continued
improvement in recent quarterly trends, cash value retention for variable and
fixed annuities was 92.5% and 94.1%, respectively, for the 12 month period ended
September 30, 2002. Net transfers to variable annuity assets decreased $7.9
million compared to the same period last year.
46
The Company has not repurchased shares of its common stock under its stock
repurchase program since the third quarter of 2000, consistent with management's
stated intention to utilize excess capital to support the Company's strategic
growth initiatives. Historically, the repurchase of shares was financed through
use of cash and, when necessary, its Bank Credit Facility. However, the Company
has not utilized its Bank Credit Facility for share repurchases since the second
quarter of 1999. As of September 30, 2002, $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 total capital of the Company was $675.0 million at September 30, 2002,
including $187.7 million of long-term debt and no short-term debt outstanding.
Total debt represented 27.8% of capital (30.9% excluding unrealized investment
gains and losses) at September 30, 2002, which exceeded the Company's long-term
operating target of approximately 25%. The Company further reduced indebtedness
in October 2002 and anticipates reducing its debt to capital ratio to the 25% to
26% range by December 31, 2002.
Shareholders' equity was $487.3 million at September 30, 2002, including an
unrealized gain in the Company's investment portfolio of $68.5 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 $600.5 million and $14.70, respectively, at September 30,
2002. Book value per share was $11.93 at September 30, 2002, $10.25 excluding
investment fair value adjustments. At September 30, 2001, book value per share
was $11.87, $10.88 excluding investment fair value adjustments. The decrease
over the 12 months included the effects of realized and unrealized investment
losses and an increase in the Company's minimum pension liability recorded at
December 31, 2001.
On May 14, 2002, the Company issued $353.5 million aggregate principal
amount of 1.425% senior convertible notes due in 2032 ("Convertible Notes") at a
discount of 52.5% resulting in an effective yield of 3.0%. The Convertible Notes
were privately offered only to qualified institutional buyers under Rule 144A
under the Securities Act of 1933 and outside the United States of America
("U.S.") to non-U.S. persons under Regulation S under the Securities Act of
1933. A Securities and Exchange Commission registration statement registering
the Convertible Notes was declared effective on November 4, 2002. At a meeting
held on September 10 and 11, 2002, the Company's Board of Directors authorized
the Company to repurchase, from time to time, for cash or other consideration,
its Convertible Notes. The net proceeds from the sale of the Convertible Notes
have been used to (1) repay the balance outstanding under the
47
previous Bank Credit Agreement, (2) repurchase a portion of the outstanding
Senior Notes, as described below, and (3) repurchase $40.0 million aggregate
principal amount, $19.0 million carrying value, of the Company's outstanding
Convertible Notes in September 2002 at an aggregate cost of $17.1 million.
Subsequently, in October 2002, the Company repurchased an additional $10.3
million aggregate principal amount of its outstanding Senior Notes at an
aggregate cost of $11.1 million and $13.0 million aggregate principal amount,
$6.2 million carrying value, of its outstanding Convertible Notes at an
aggregate cost of $5.7 million. The October 2002 repurchases are not reflected
in the September 30, 2002 financial statements. The remaining proceeds will be
used for general corporate purposes and potentially to further reduce corporate
indebtedness.
Interest on the Convertible Notes is payable semi-annually at a rate of
1.425% beginning November 14, 2002 until May 14, 2007. After that date, cash
interest will not be paid on the Convertible Notes prior to maturity unless
contingent cash interest becomes payable. From May 15, 2007 through maturity of
the Convertible Notes, interest will be recognized at the effective rate of 3.0%
and will represent the accrual of discount, excluding any contingent cash
interest that may become payable. Contingent cash interest becomes payable if
the average market price of a Convertible Note for a five trading day
measurement period preceding the applicable six-month period equals 120% or more
of the sum of the Convertible Note's issue price, accrued original issue
discount and accrued cash interest, if any, for such Convertible Note. The
contingent cash interest payable per Convertible Note with respect to any
quarterly period within any six-month period will equal the then applicable
conversion rate multiplied by the greater of (i) $0.105 or (ii) any regular cash
dividends paid by the Company per share on HMEC's common stock during that
quarterly period.
The Convertible Notes will be convertible at the option of the holders, if
the conditions for conversion are satisfied, into shares of HMEC's common stock
at a conversion price of $26.74. Holders may also surrender Convertible Notes
for conversion during any period in which the credit rating assigned to the
Convertible Notes is Ba2 or lower by Moody's or BB+ or lower by S&P, the
Convertible Notes are no longer rated by either Moody's or S&P, or the credit
rating assigned to the Convertible Notes has been suspended or withdrawn by
either Moody's or S&P. The Convertible Notes will cease to be convertible
pursuant to this credit rating criteria during any period or periods in which
all of the credit ratings are increased above such levels. The Convertible Notes
are redeemable by HMEC in whole or in part, at any time on or after May 14,
2007, at redemption prices equal to the sum of the issue price plus accrued
original issue discount and accrued cash interest, if any, on the applicable
redemption date. The holders of the Convertible Notes may require HMEC to
purchase all or a portion of their Convertible Notes on either May 14, 2007,
2012, 2017, 2022, or 2027 at stated prices plus accrued cash interest, if any,
to the purchase date. HMEC may pay the purchase price in cash or shares of HMEC
common stock or in a combination of cash and shares of HMEC common stock.
The Convertible Notes have an investment grade rating from S&P (BBB+),
Moody's (Baa2) and A.M. Best (bbb+). S&P and A.M. Best have indicated the
outlook for their rating is "Stable." On July 25, 2002, Moody's affirmed its
Baa2 rating, but revised the outlook for the rating to "Negative" from "Stable."
This change in outlook was the result of the Company's second quarter 2002
investment losses stemming from the impact on the financial markets from the
announced SEC investigation into the accounting practices of WorldCom, Inc.
Moody's announcement indicated that material adverse deviations from the
Company's expected level of capital growth and earnings could trigger a
subsequent ratings downgrade. On September 19, 2002, Fitch confirmed its "A-"
debt rating, but revised the outlook for the rating from "Stable" to "Negative."
48
The September 2002 change in outlook was the result of the second quarter 2002
investment losses described above as well as the Company's increased financial
leverage and the competitive nature of the annuity markets in which the Company
competes. Fitch's announcement indicated that the key expectations for the
Company to maintain its existing rating include a return to its long-term
financial leverage targets while maintaining its existing NAIC risk-based
capital ratios, the continued demonstration of better than industry underwriting
performance in the Company's property and casualty subsidiaries and no
unexpected deterioration in the Company's asset quality. A material adverse
deviation from these expectations could trigger a subsequent ratings downgrade.
In January 1996, the Company issued $100.0 million aggregate principal
amount of 6 5/8% Senior Notes ("Senior Notes") at a discount of 0.5% which will
mature on January 15, 2006. In May and September 2002, the Company repurchased a
total of $61.2 million aggregate principal amount of its outstanding Senior
Notes utilizing a portion of the proceeds from the issuance of the Convertible
Notes, as described above. 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-),
Moody's Investors Service, Inc. ("Moody's") (Baa2), and A.M. Best Company, Inc.
("A.M. Best") (bbb+). S&P and A.M. Best have indicated the outlook for their
rating is "Stable." On July 25, 2002, Moody's affirmed its Baa2 rating, but
revised the outlook for the rating to "Negative" from "Stable" and on September
19, 2002, Fitch affirmed its A- rating, but revised the outlook for the rating
to "Negative" from "Stable", as described above in the paragraph regarding the
Convertible Notes. The Senior Notes are traded on the New York Stock Exchange
(HMN 6 5/8).
As of December 31, 2001, the Company had short-term debt of $53.0 million
outstanding under the previous Bank Credit Agreement. The $53.0 million balance
outstanding under the previous Bank Credit Agreement was repaid in full on May
14, 2002 utilizing a portion of the proceeds from the issuance of the
Convertible Notes, as described above. On May 29, 2002, the Company entered into
a new Bank Credit Agreement which provides for unsecured borrowings of up to
$25.0 million, with a provision that allows the commitment amount to be
increased to $35.0 million (the "Current Bank Credit Facility"). The Current
Bank Credit Facility expires on May 31, 2005. Interest accrues at varying
spreads relative to corporate or eurodollar base rates and is payable monthly or
quarterly depending on the applicable base rate. No amounts had been borrowed
under the Current Bank Credit Facility and no balance was outstanding at
September 30, 2002. The unused portion of the Current Bank Credit Facility is
subject to a variable commitment fee which was 0.20% on an annual basis at
September 30, 2002.
The Company's ratio of earnings to fixed charges for the nine months ended
September 30, 2002 was 0x, reflecting the impact of $51.9 million of pretax
realized investment losses recognized during the period, compared to 4.7x for
the same period in 2001.
Total shareholder dividends were $12.9 million for the nine months ended
September 30, 2002. In February 2002, May 2002 and August 2002, the Board of
Directors announced regular quarterly dividends of $0.105 per share.
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
49
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 Catastrophe Fund, based on the Fund's financial 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.
Effective May 7, 2002, the Company entered into 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. Under the 36-month
agreement, the equity put coverage of $75.0 million provides a source of capital
for up to $115.0 million of pretax catastrophe losses above the reinsurance
coverage limit. The Company also has the option, in place of the equity put, to
require a Swiss Re Group member to issue a 10% quota share reinsurance coverage
of all of the Company's property and casualty book of business. Annual fees
related to this equity put option, which are charged directly to additional
paid-in capital, increased to 145 basis points in 2002 from 95 basis points in
2001 under the prior agreement; however, in 2002 the agreement is effective only
for the last eight months of the year. The agreement contains certain conditions
to Horace Mann's exercise of the equity put option including: (i) the Company's
shareholders' equity, adjusted to exclude goodwill, can not be less than $215.0
million after recording the first triggering event; (ii) the Company's total
debt as a percentage of capital can not be more than 47.5% prior to recording
the triggering event; and (iii) the Company's S&P financial strength rating can
not be below "BBB" prior to a triggering event. The Company's S&P financial
strength rating was "A+" at September 30, 2002.
For liability coverages, including the educator excess professional
liability policy, the Company reinsures each loss above a retention of $500
thousand up to $20 million. The Company also reinsures each property loss above
a retention of $250 thousand up to $2.5 million in 2001 and 2002, including
catastrophe losses that in the aggregate are less than the retention levels
above.
The cost of the Company's catastrophe reinsurance coverage program for the
full year 2002 increased approximately 50%, or $2.0 million, compared to full
year 2001 as a result of the effects on the reinsurance market of the September
11, 2001 terrorist attacks. However the impact on the Company was mitigated due
to the fact that 38% of the Company's catastrophe coverage is under a three-year
contract from January 1, 2001 through December 31, 2003. The cost of the
Company's entire property and casualty reinsurance program for the full year
2002 increased approximately 35%, or $2.5 million, compared to full year 2001.
At a meeting held on September 10 and 11, 2002, the Company's Board of
Directors authorized the Company to enter into new life reinsurance agreements
in order to provide additional statutory surplus to the Company's life insurance
subsidiaries. No such agreements have been entered into as of the date of this
Report on Form 10-Q.
50
INSURANCE FINANCIAL RATINGS AND IMSA CERTIFICATION
The Company's principal insurance subsidiaries are rated by various rating
agencies. Additional information regarding the rating processes and ratings
definitions for each agency is included in the Company's Annual Report on Form
10-K for the year ended December 31, 2001 in "Business -- Insurance Financial
Ratings and IMSA Certification." Each of the ratings below is unchanged from
December 31, 2001 with the exception of A.M. Best's rating for the Company's
property and casualty subsidiaries and the outlooks of Fitch and Moody's for the
Company's financial strength ratings.
On May 9, 2002 following its annual review of Horace Mann's ratings, A.M.
Best Company, Inc. ("A.M. Best") announced that it was affirming the "A
(Excellent)" financial strength rating of the Company's principal life insurance
subsidiary. A.M. Best downgraded the financial strength ratings of the Company's
property and casualty subsidiaries one notch from "A+ (Superior)" to "A
(Excellent)" reflecting capitalization of these subsidiaries being below A.M.
Best's standard for the Superior rating and the impact on earnings in 2000 and
2001 of prior years' reserve strengthening. A.M. Best has identified the outlook
for the ratings as "Stable."
As affirmed on May 2, 2002, each of HMEC's principal insurance subsidiaries
is rated "A+ (Strong)" for financial strength by Standard & Poor's Corporation
("S&P") with a ratings outlook of "Stable", with the exception of Horace Mann
Lloyds which is not yet rated by S&P.
Each of HMEC's principal insurance subsidiaries is rated "AA- (Very
Strong)" for financial strength by Fitch, Inc. ("Fitch"). On September 19, 2002,
Fitch confirmed its "AA-" financial strength ratings, but revised the outlook
for the ratings from "Stable" to "Negative." The September 2002 change in
outlook was the result of the second quarter 2002 investment losses described
above as well as the Company's increased financial leverage and the competitive
nature of the annuity markets in which the Company competes. Fitch's
announcement indicated that the key expectations for the Company to maintain its
existing ratings include a return to its long-term financial leverage targets
while maintaining its existing NAIC risk-based capital ratios, the continued
demonstration of better than industry underwriting performance in the Company's
property and casualty subsidiaries and no unexpected deterioration in the
Company's asset quality. A material adverse deviation from these expectations
could trigger a subsequent ratings downgrade.
Moody's Investors Service, Inc. ("Moody's") has assigned a financial
strength rating of "A2 (Good)" to each of HMEC's principal subsidiaries, with
the exception of Horace Mann Lloyds which is not yet rated by Moody's. On July
25, 2002, Moody's affirmed these ratings, but revised the outlook for the
ratings to "Negative" from "Stable." This change in outlook was the result of
the Company's second quarter 2002 investment losses stemming from the impact on
the financial markets from the announced SEC investigation into the accounting
practices of WorldCom, Inc. Moody's announcement indicated that material adverse
deviations from the Company's expected level of capital growth and earnings
could trigger a subsequent ratings downgrade.
In July 2001, Horace Mann Life Insurance Company, the Company's principal
life insurance subsidiary, earned membership in the Insurance Marketplace
Standards Association ("IMSA"). 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 September 30,
2002, fewer than 250 companies had earned IMSA membership.
51
MARKET VALUE RISK
Market value risk is the risk that the Company's invested assets will
decrease in value. This decrease in value may be due to a change in (1) the
yields realized on the Company's assets and prevailing market yields for similar
assets, (2) an unfavorable change in the liquidity of the investment, (3) an
unfavorable change in the financial prospects of the issuer of the investment,
or (4) a downgrade in the credit rating of the issuer of the investment. See
also "Results of Operations -- Realized Investment Gains and Losses."
Significant changes in interest rates expose the Company to the risk of
experiencing losses or earning a reduced level of income based on the difference
between the interest rates earned on the Company's investments and the credited
interest rates on the Company's insurance liabilities.
The Company manages its market value 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 while providing for liquidity and diversification. The investment risk
associated with variable annuity products and the underlying mutual funds is
assumed by those contractholders, and not by the Company.
A more detailed description of the Company's exposure to market value risks
and the management of those risks is presented in the Company's 2001 Form 10-K
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Market Risk."
INFORMATION SYSTEMS RISK
The Company administers its insurance business with information systems
that are dated and complex, and require extensive manual input, calculation and
control procedures. These systems are more prone to error than more advanced
technology systems. To address these issues, over the past two years the Company
has enhanced its existing systems and technology infrastructure and begun
installing new systems, including a new general ledger and financial reporting
system, which is expected to be operational on January 1, 2003. In the meantime,
enhanced checks and control procedures have been established to review the
output of existing information systems, including periodic internal and external
third party reviews. Nevertheless, there are risks that inaccuracies in the
processing of data may occur which might not be identified by those procedures
and checks.
For example, subsequent to filing the Form 10-Q for the period ended June
30, 2002, the Company determined that redundant reserves had been inadvertently
established on certain life insurance policies. To ensure comparability between
the quarterly periods, the reduction in life segment reserves, equal to $1.5
million, $0.9 million or $0.02 per share after tax, has been reflected as an
adjustment to the results for the nine months ended September 30, 2002 and was
not reflected in results for the three months ended September 30, 2002.
52
RECENT ACCOUNTING CHANGES
SFAS No. 143
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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.
SFAS No. 145
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections," effective for fiscal years beginning after May 15, 2002. Under
SFAS No. 4, all gains and losses from the extinguishment of debt, exclusive of
an exception identified in SFAS No. 64, were required to be aggregated and, if
material, classified as an extraordinary item, net of related income tax effect.
With adoption of SFAS No. 145, gains and losses from extinguishment of debt
should be classified as extraordinary only if they meet the criteria of
Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations
- - Reporting the Effects of Disposal of a Segment of a Business, Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." Applying the
provisions of Opinion No. 30 will distinguish transactions that are part of an
entity's recurring operations from those that are unusual or infrequent or that
meet the criteria for classification as an extraordinary item. In the six months
ended June 30, 2002, the Company recorded a charge for the extinguishment of
debt and did not report this charge as an extraordinary item.
SFAS No. 44 was not applicable to the Company. Although the evaluation of
the impact of the remaining provisions of SFAS No. 145 is not yet complete, at
this time management anticipates that the impact will not be material.
SFAS No. 146
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," effective for exit or disposal
activities that are initiated after December 31, 2002. This statement nullifies
Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." The principal difference
between SFAS No. 146 and EITF No. 94-3 relates to the requirements for
recognition of a liability for a cost associated with an exit or disposal
activity. SFAS No. 146 requires that such liability be recognized when the
liability is incurred. Under EITF No. 94-3, a liability for defined exit costs
was recognized at the date of an entity's commitment to an exit plan. Currently,
management anticipates that the impact of this statement will not be material.
53
ITEM 3: 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 this Form 10-Q.
ITEM 4: CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) required to be
included in the Company's periodic Securities and Exchange Commission filings.
No significant deficiencies or material weaknesses were identified in the
evaluation and therefore, no corrective actions were taken. There were no
significant changes in the Company's internal controls or in other factors that
could significantly affect these controls subsequent to the date of their
evaluation.
PART II: OTHER INFORMATION
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5: OTHER INFORMATION
In compliance with Section 202 of the Sarbanes-Oxley Act of 2002, the
Audit Committee of the Board of Directors of Horace Mann Educators Corporation
has preapproved the continuing provision of certain non-audit services by KPMG
LLP, Horace Mann Educators Corporation's independent auditor. Such services
consist of audit-related services, primarily related to statutory regulatory
requirements and SEC registration statement review services, and
non-audit-related services, related to tax consultation and employee compliance
affirmations.
The Audit Committee has determined that the services provided by KPMG
LLP under non-audit services are compatible with maintaining the auditor's
independence.
54
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
Exhibit
No. Description
- -------- -----------
(a) The following items are filed as Exhibits.
(10) Material contracts:
10.1 First Amended and Restated Catastrophe Equity Securities
Issuance Option and Reinsurance Option Agreement entered by
and between HMEC, Swiss Re Financial Products Corporation
(Option Writer) and Swiss Reinsurance America Corporation
(Reinsurance Option Writer), dated May 7, 2002.
(11) Statement re computation of per share earnings.
(15) KPMG LLP letter regarding unaudited interim financial information.
(99) Additional exhibits:
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
Louis G. Lower II, Chief Executive Officer of Horace Mann
Educators Corporation.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
Peter H. Heckman, Chief Financial Officer of Horace Mann
Educators Corporation.
(b) The Company did not file any reports on Form 8-K during the three months
ended September 30, 2002.
55
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HORACE MANN EDUCATORS CORPORATION
(Registrant)
Date November 13, 2002 /s/ Louis G. Lower II
-----------------------------------------
Louis G. Lower II
President and Chief Executive Officer
Date November 13, 2002 /s/ Peter H. Heckman
-----------------------------------------
Peter H. Heckman
Executive Vice President
and Chief Financial Officer
Date November 13, 2002 /s/ Bret A. Conklin
-----------------------------------------
Bret A. Conklin
Senior Vice President
and Controller
56
CERTIFICATIONS
CHIEF EXECUTIVE OFFICER CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-
OXLEY ACT OF 2002
I, Louis G. Lower II, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Horace Mann Educators
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
57
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /s/ Louis G. Lower II
-----------------------------------------
Louis G. Lower II
Chief Executive Officer
58
CHIEF FINANCIAL OFFICER CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-
OXLEY ACT OF 2002
I, Peter H. Heckman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Horace Mann Educators
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
59
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /s/ Peter H. Heckman
-----------------------------------------
Peter H. Heckman
Chief Financial Officer
60
================================================================================
HORACE MANN EDUCATORS CORPORATION
EXHIBITS
To
FORM 10-Q
For the Quarter Ended September 30, 2002
VOLUME 1 OF 1
================================================================================
The following items are filed as Exhibits to Horace Mann Educators
Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30,
2002. Management contracts and compensatory plans are indicated by an
asterisk(*).
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
- -------- -----------
(10) Material contracts:
10.1 First Amended and Restated Catastrophe Equity Securities Issuance
Option and Reinsurance Option Agreement entered by and between
HMEC, Swiss Re Financial Products Corporation (Option Writer) and
Swiss Reinsurance America Corporation (Reinsurance Option Writer),
dated May 7, 2002.
(11) Statement re computation of per share earnings.
(15) KPMG LLP letter regarding unaudited interim financial information.
(99) Additional exhibits:
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Louis G.
Lower II, Chief Executive Officer of Horace Mann Educators
Corporation.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Peter H.
Heckman, Chief Financial Officer of Horace Mann Educators
Corporation.