Back to GetFilings.com
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 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
Securities Registered Pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------- ------------------------
Common Stock, par value $0.001 per share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b - 2 of the Act). Yes [X] No [ ]
The aggregate market values of the voting Common Stock held by
non-affiliates of the registrant based on the closing prices of the Company's
Common Stock on the New York Stock Exchange and the shares outstanding on June
28, 2002 and February 28, 2003 were $762.6 million and $588.0 million,
respectively.
As of February 28, 2003, 42,701,528 shares of Common Stock, par value
$0.001 per share, were outstanding, net of 17,503,371 shares of treasury stock.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Company's Proxy Statement for the 2003 Annual
Meeting of Shareholders are incorporated by reference into Part II Item 5 and
Part III Items 10, 11, 12 and 13 of Form 10-K as specified in those Items.
================================================================================
HORACE MANN EDUCATORS CORPORATION
FORM 10-K
YEAR ENDED DECEMBER 31, 2002
INDEX
Part Item Page
- ---- ---- ----
I 1. Business................................................................ 1
Forward-looking Information............................................. 1
Overview and Available Information...................................... 1
History................................................................. 2
Selected Historical Consolidated Financial Data......................... 3
Corporate Strategy and Marketing........................................ 4
Property and Casualty Segment........................................... 9
Annuity Segment......................................................... 17
Life Segment............................................................ 19
Investments............................................................. 21
Cash Flow............................................................... 24
Competition............................................................. 25
Insurance Financial Ratings............................................. 26
Regulation.............................................................. 28
Employees............................................................... 31
2. Properties.............................................................. 31
3. Legal Proceedings....................................................... 31
4. Submission of Matters to a Vote of Security Holders..................... 31
II 5. Market for Registrant's Common Equity and
Related Stockholder Matters........................................... 32
6. Selected Financial Data................................................. 33
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................. 33
7A. Quantitative and Qualitative Disclosures About Market Risk.............. 33
8. Consolidated Financial Statements and Supplementary Data................ 33
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................................... 33
III 10. Directors and Executive Officers of the Registrant...................... 33
11. Executive Compensation.................................................. 33
12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters....................................... 34
13. Certain Relationships and Related Transactions.......................... 34
IV 14. Controls and Procedures................................................. 34
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........ 34
Signatures.................................................................... 40
Certifications................................................................ 41
Index to Financial Information................................................ F-1
PART I
ITEM 1. Business
Forward-looking Information
It is important to note that the Company's actual results could differ
materially from those projected in forward-looking statements. Additional
information concerning factors that could cause actual results to differ
materially from those in the forward-looking statements is contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Overview and Available Information
Horace Mann Educators Corporation ("HMEC"; and together with its
subsidiaries, the "Company" or "Horace Mann") is an insurance holding company
incorporated in Delaware. Through its subsidiaries, HMEC markets and underwrites
personal lines of property and casualty and life insurance and retirement
annuities in the United States of America ("U.S."). HMEC's principal insurance
subsidiaries are Horace Mann Insurance Company ("HMIC"), Teachers Insurance
Company ("TIC") and Horace Mann Life Insurance Company ("HMLIC"), each of which
is an Illinois corporation, Horace Mann Property & Casualty Insurance Company
("HMPCIC") (formerly Allegiance Insurance Company), a California domiciled
company and Horace Mann Lloyds ("HM Lloyds"), domiciled in Texas.
The Company markets its products primarily to educators and other employees
of public schools and their families. The Company's one million customers
typically have moderate annual incomes, with many belonging to two-income
households. Their financial planning tends to focus on retirement, security,
savings and primary insurance needs. Management believes that Horace Mann is the
largest national multiline insurance company focused on the nation's educators
as its primary market.
The Company sells and services its products primarily through an exclusive
sales force of full-time agents employed by the Company and trained to sell
multiline products. The Company's agents sell Horace Mann's products and limited
additional third-party vendor products authorized by the Company. Many of the
Company's agents are former educators or individuals with close ties to the
educational community who utilize their contacts within, and knowledge of, the
target market. Compensation for agents includes an incentive element based upon
the profitability of the business they write.
The Company's insurance premiums written and contract deposits for the year
ended December 31, 2002 were $899.3 million and net income was $11.3 million.
The Company's total assets were $4.5 billion at December 31, 2002. The property
and casualty segment accounted for 58% of the Company's insurance premiums
written and contract deposits for the year ended December 31, 2002; the annuity
and life insurance segments together accounted for 42% of insurance premiums
written and contract deposits for the year ended December 31, 2002 (29% and 13%,
respectively).
The primary products of the Company's property and casualty segment are
private passenger automobile and homeowners insurance. In each of the last 5
years, the Company's combined loss and expense ratio for its property and
casualty product lines outperformed the total property and casualty industry
combined loss and expense ratio, as reported by A.M. Best Company ("A.M. Best"),
an independent insurance rating agency. During this period, the
1
Company's annual combined loss and expense ratio was better than the total
property and casualty insurance industry combined loss and expense ratio by an
average of approximately 8 percentage points. During the same period of time,
the Company's annual combined loss and expense ratio was better than the
personal lines insurance industry segment combined loss and expense ratio by an
average of approximately 6 percentage points.
The Company is one of the largest participants in the 403(b) tax-qualified
annuity market, measured by 403(b) net written premium on a statutory accounting
basis. The Company's 403(b) tax-qualified annuities are annuities purchased
voluntarily by individuals employed by public school systems or other tax-exempt
organizations. The Company has approved 403(b) payroll reduction capabilities in
approximately one-third of the 15,000 public school districts in the U.S.
Approximately 60% of the Company's new annuity contract deposits in 2002 were
for 403(b) tax-qualified annuities; approximately 75% of accumulated annuity
value on deposit as of December 31, 2002 was 403(b) tax-qualified. At December
31, 2002, the accumulated value of all of the Company's annuity contracts (tax
and non-tax qualified) was $2.4 billion, representing 147,000 contracts in
force. Total accumulated annuity funds on deposit at December 31, 2002 consisted
of 36% variable balances and 64% fixed balances. For the 2002 year, 94% of the
Company's fixed annuity accumulated cash value remained on deposit, and 92% of
the Company's variable annuity accumulated cash value remained on deposit. All
annuities issued since 1982, and approximately 79% of all outstanding fixed
accumulated cash values, are subject in most cases to substantial early
withdrawal penalties, typically ranging from 5% to 13% of the amount withdrawn.
For the Company, withdrawals of outstanding variable accumulated cash values are
limited to amounts less than or equal to the then current market value of such
accumulations, minus withdrawal penalties as applicable. Generally, a penalty is
imposed under the Internal Revenue Code on amounts withdrawn from tax-qualified
annuities prior to age 59 1/2.
The Company's investment portfolio had an aggregate fair value of $3.1
billion at December 31, 2002. Investments consist principally of investment
grade, publicly traded fixed income securities. At December 31, 2002,
investments in non-investment grade securities represented 4.0% of total
investments, with no significant investments in mortgage loans, real estate,
foreign securities, privately placed securities or common or preferred stocks.
The Company's annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those reports are available
free of charge through the Company's Internet website, www.horacemann.com, as
soon as practicable after such reports are electronically filed with, or
furnished to, the Securities and Exchange Commission ("SEC"). The EDGAR filings
of such reports are also available at the SEC's website, www.sec.gov.
History
The Company's business was founded in Springfield, Illinois, in 1945 by two
Illinois school teachers to sell automobile insurance to other teachers within
the State of Illinois. The Company expanded its business to other states and
broadened its product line to include group and individual life insurance in
1949, 403(b) tax-qualified retirement annuities in 1961 and homeowners insurance
in 1965.
In November 1991, HMEC completed an initial public offering of its common
stock (the "IPO"). The common stock is traded on the New York Stock Exchange
under the symbol "HMN."
2
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following statement of operations and balance sheet data have been
derived from the consolidated financial statements of the Company. The
consolidated financial statements of the Company for each of the years in the
five year period ended December 31, 2002 have been audited by KPMG LLP. The
following selected historical consolidated financial data should be read in
conjunction with the consolidated financial statements of HMEC and its
subsidiaries and Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Year Ended December 31,
-----------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
(Dollars in millions, except per share data)
Statement of Operations Data:
Insurance premiums written and contract deposits ..... $ 899.3 $ 875.6 $ 821.7 $ 821.2 $ 827.8
Insurance premiums and contract charges earned ....... 625.2 615.2 598.7 595.1 577.8
Net investment income ................................ 196.0 199.3 192.4 188.3 191.7
Realized investment gains (losses) ................... (49.4) (10.0) (9.9) (8.0) 9.9
Total revenues ....................................... 771.8 804.5 781.2 775.4 779.4
Amortization of intangible assets (1) ................ 5.7 5.8 8.8 0.2 6.9
Interest expense ..................................... 8.5 9.3 10.2 9.7 9.5
Income before income taxes ........................... 7.7 28.3 9.7 93.4 116.8
Net income (2) ....................................... 11.3 25.6 20.8 44.5 85.3
Ratio of earnings to fixed charges (3) ............... 1.9x 4.0x 2.0x 10.6x 13.3x
Per Share Data (4):
Net income:
Basic.............................................. $ 0.28 $ 0.63 $ 0.51 $ 1.08 $ 1.97
Diluted............................................ $ 0.28 $ 0.63 $ 0.51 $ 1.07 $ 1.95
Shares of Common Stock - weighted average:
Basic ............................................. 40.9 40.6 40.8 41.2 43.2
Diluted ........................................... 41.2 40.9 41.0 41.7 43.8
Shares of Common Stock - ending outstanding .......... 42.7 40.7 40.5 41.0 42.1
Cash dividends ....................................... $ 0.42 $ 0.42 $ 0.42 $ 0.3825 $ 0.3325
Book value per share (5) ............................. $ 12.39 $ 11.27 $ 10.56 $ 9.75 $ 11.80
Balance Sheet Data, at Year End:
Total investments .................................... $3,130.6 $2,975.7 $2,912.3 $2,630.2 $2,840.8
Total assets ......................................... 4,512.3 4,489.0 4,420.6 4,253.8 4,395.5
Total policy liabilities ............................. 2,626.8 2,475.6 2,362.3 2,341.3 2,308.0
Short-term debt ...................................... -- 53.0 49.0 49.0 50.0
Long-term debt ....................................... 144.7 99.8 99.7 99.7 99.6
Total shareholders' equity ........................... 528.8 459.2 428.0 400.1 496.6
Segment Information (6):
Insurance premiums written and contract deposits
Property and casualty ............................. $ 524.9 $ 519.3 $ 493.5 $ 495.1 $ 487.8
Annuity ........................................... 261.5 239.1 206.4 205.7 223.3
Life .............................................. 112.9 117.2 121.8 120.4 116.7
Total .......................................... 899.3 875.6 821.7 821.2 827.8
Net income
Property and casualty ............................. $ 19.9 $ 5.2 $ 8.9 $ 39.5 $ 53.2
Annuity ........................................... 17.0 20.6 19.3 27.3 23.1
Life .............................................. 18.9 18.7 12.9 14.6 12.4
Corporate and other (2) (7) ....................... (44.5) (18.9) (20.3) (36.9) (3.4)
Total (2) ...................................... 11.3 25.6 20.8 44.5 85.3
Statutory Operating Data (8):
Property and casualty:
Loss and loss adjustment expense ratio ............ 79.2% 85.2% 85.2% 76.3% 74.4%
Expense ratio ..................................... 24.4% 21.6% 20.8% 19.8% 19.3%
Combined loss and expense ratio (9) ............... 103.6% 106.8% 106.0% 96.1% 93.6%
Industry average combined loss
and expense ratio (9) (10) ..................... 105.7% 115.9% 110.1% 107.8% 105.6%
Personal lines industry segment average combined
loss and expense ratio (9) (10) ................ 105.6% 110.9% 109.9% 104.5% 102.7%
Annuity accumulated value on deposit ................. $2,360.5 $2,402.1 $2,366.9 $2,487.3 $2,475.5
Life insurance in force .............................. $ 13,197 $ 13,216 $ 12,647 $ 12,300 $ 11,799
Adjusted capital and surplus of insurance subsidiaries
(includes investment reserves) (11) ............... $ 427.8 $ 415.5 $ 405.8 $ 405.7 $ 379.8
(continued on next page)
3
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA - (continued)
- ----------
(1) Amortization of intangible assets is comprised of amortization of goodwill
and amortization of acquired value of insurance in force and is the result
of purchase accounting adjustments related to the 1989 acquisition of the
Company and the 1994 acquisition of HMPCIC. Effective January 1, 2002, the
Company adopted Financial Accounting Standard ("FAS") No. 142, "Goodwill
and Other Intangible Assets." Under FAS No. 142, goodwill amortization
ceases and the goodwill is annually tested for impairment. Goodwill
amortization was $1.6 million in each of the years ended December 31, 2001,
2000, 1999 and 1998.
(2) 1999 includes a charge of $20.0 million to record an additional federal
income tax provision representing the Company's maximum exposure for
disputed prior years' taxes (for tax years 1994 through 1997). 2000
includes a benefit of $8.7 million from resolution of tax years 1994
through 1996. 2001 includes a benefit of $1.3 million from resolution of
tax year 1997.
(3) For the purpose of determining the ratio of earnings to fixed charges,
"earnings" consist of income before income taxes and interest expense
(including amortization of debt issuance cost), and "fixed charges" consist
of interest expense (including amortization of debt issuance cost).
(4) Basic earnings per share is computed based on the weighted average number
of shares outstanding. Diluted earnings per share is computed based on the
weighted average number of shares and common stock equivalents outstanding.
The Company's common stock equivalents relate to outstanding common stock
options, Director Stock Plan units and Employee Stock Plan units and
warrants prior to their repurchase in 1999.
(5) Due to the adoption by the Company on January 1, 1994 of FAS No. 115, total
shareholders' equity included an increase, net of taxes, of $80.6 million,
$26.3 million and $57.3 million at December 31, 2002, 2001 and 1998 and a
decrease, net of taxes, of $4.0 million and $40.0 million at December 31,
2000 and 1999, respectively. Excluding the FAS 115 fair value accounting
for investments, book value per share was $10.50, $10.62, $10.66, $10.73
and $10.44 at December 31, 2002, 2001, 2000, 1999 and 1998, respectively.
(6) Information regarding assets by segment at December 31, 2002, 2001 and 2000
is contained in the Company's Notes to Financial Statements listed on page
F-1 of this report.
(7) The corporate and other segment primarily includes interest expense on debt
and the impact of realized investment gains and losses, restructuring
charges, debt retirement costs, litigation charges and provision for prior
years' taxes.
(8) Statutory data has been derived from the financial statements of the
Company prepared in accordance with statutory accounting principles and
filed with insurance regulatory authorities.
(9) Property and casualty combined loss and expense ratio includes policyholder
dividends.
(10) Source: Best's Aggregates and Averages (2002 Edition). The industry
averages for the year ended December 31, 2002 are from Review Preview, A
Special Supplement to Best's Review and BestWeek, Property/Casualty
Edition, January 2003, published by A.M. Best.
(11) Investment reserves were the Asset Valuation Reserves ("AVR"). AVR,
required under statutory accounting principles, is a reserve intended to
stabilize the surplus of life insurance companies against the effects of
fluctuations in the fair value of certain invested assets. Changes in AVR
are charged or credited directly to statutory surplus.
Corporate Strategy and Marketing
The Horace Mann Value Proposition
The Horace Mann Value Proposition articulates the Company's overarching
strategy and business purpose: Provide lifelong financial well-being for
educators and their families through personalized service, advice, and a full
range of tailored insurance and financial products.
In 2000, the Company's management announced steps to focus on the Company's
core business and accelerate growth of the Company's revenues and profits. These
initiatives are intended to:
. Grow and strengthen the agency force and make the Company's agents
more productive by improving the products, tools and support the
Company provides to them;
. Expand the Company's penetration of targeted geographic areas and new
segments of the educator market;
. Broaden the Company's distribution options to complement and extend
the reach of the Company's agency force;
. Increase cross-selling and improve retention in the existing book of
business; and
. Make the Company's products more responsive to customer needs and
preferences and expand the Company's product lines within the personal
financial services segment.
Starting in the fourth quarter of 2000, management began implementing
specific plans that address the initiatives above. New compensation and
evaluation systems were implemented to improve the performance of the Company's
agents and agency managers. The Company has begun targeting high-priority
geographic markets with agents hired and producing in the initial locations;
additional locations will follow supported by focused efforts of
cross-functional staff teams. New approaches to customer service are being
refined that will free agents to spend more
4
time selling. Additional distribution options have been initiated to capitalize
fully on the value of the Company's approved payroll deduction slots in schools
across the country. And the Company is pursuing initiatives to increase its use
of technology to improve the efficiency of its agency force and administrative
operations.
Target Market
Management believes that Horace Mann is the largest national multiline
insurance company focused on the nation's educators as its primary market. The
Company's target market through 2002 consisted of educators and other employees
of public schools and their families located throughout the U.S. The Company
also sold its products to other education-related customers, including private
school teachers, education support personnel, community college personnel and
their families, and customer referrals. In 2003 and 2004, the Company intends to
develop strategies and tactics to begin expanding its services in the educator
market by also targeting Kindergarten - 12 teachers at private schools,
principals and administrators at Kindergarten - 12 public and private schools,
faculty and staff at junior and community colleges, and college students
majoring in education.
The U.S. Department of Education estimates that there are approximately 3.5
million elementary and secondary teachers in public and private schools in the
U.S. It also estimates that the number of public and private school teachers is
growing approximately 1% annually. Recent federal and state programs which
reduce class size and add additional teachers may increase this growth rate;
however, in the near term this may be tempered by school budgetary constraints.
In addition to increases in the number of teachers that result from growth in
the general population and in the number of school age children, turnover among
the teacher population increases the size of the Company's target market. New
teachers and educational support personnel are solicited by the Company's
agents, and the Company attempts to retain customers who have retired or left
the teaching profession. The Company's one million customers typically have
moderate annual incomes, with many belonging to two-income households. Their
financial planning tends to focus on retirement, security, savings and primary
insurance needs.
Exclusive Agency Force
A cornerstone of the Company's marketing strategy is its exclusive sales
force of full-time employee agents trained to sell multiline products. As of
December 31, 2002, the Company employed 922 full-time agents, including 527
agents having more than two years of experience with the Company. Many of the
Company's agents were previously teachers, other members of the education
profession or persons with close ties to the educational community who both
understand their customers' needs and maintain relationships with current and
former educators. The Company's agents market and write the full range of the
Company's products with all agents licensed in both property and casualty and
life products and nearly 70% of the Company's agents are licensed by the NASD to
sell variable annuities. They are under contract to market and write only the
Company's products and limited additional third-party vendor products authorized
by the Company. The agency force is managed through 64 agency offices located in
38 states. Collectively, the Company's principal insurance subsidiaries are
licensed to write business in 49 states and the District of Columbia.
The Company's service commitment to its policyholders begins with personal
contact at the point of sale between the Company's agents and potential
policyholders. In addition, the Company's agents often have direct access to
school premises, placing them in an advantageous position to write and service
individual insurance business for educators. In past surveys, the Company's
customers have stated that important reasons for choosing and staying with
Horace
5
Mann are the personal service and broad array of products the Company's agents
deliver as well as education association sponsorships. Management believes that
Horace Mann's name recognition and policyholders' loyalty lead to new customers
and cross selling of additional insurance products. At December 31, 2002, 30% of
the Company's one million customers had more than one Horace Mann product.
The Company's agents pre-underwrite policy applicants, where permitted by
law. The Company structures its agent training and its agent compensation to
provide incentives for agents to adhere to the Company's underwriting standards
and practices and business growth plans. Agents' compensation after an initial
two-year period is comprised entirely of commissions and incentive compensation
based on sales, profitability of insurance written, and retention of customers.
The profitability-related component of agent compensation is based on individual
loss ratios in the case of property and casualty policies, where permitted by
law, and persistency in the case of annuity contracts and life policies. In
2002, incentive compensation represented 28% of total compensation for agents
having more than two years of experience.
The Company has modified its agent compensation and reward structure in
order to provide incentive for agent performance that is more closely aligned
with the Company's objectives. Prior to 2001, agent compensation and rewards
focused on profitability, customer service and tenure with the Company. The
revised structure continues to focus on profitability but also places a greater
emphasis on individual agent productivity, new premium growth, growth in
educator and cross-sold business and business retention. New compensation
programs for both agents and agency managers were implemented in 2001 and
reflect the revised structure. Also in 2001, the Company implemented enhanced
agent training programs to help new agents achieve production targets more
rapidly and help experienced agents sharpen and strengthen their skills, and
began providing agents with additional tools and support programs to help them
make a successful transition to their new role under the Company's Value
Proposition. Management believes that the revised compensation structure along
with other strategic initiatives are having a positive impact on agent
productivity -- average agent productivity in 2002 increased approximately 7%
compared to 2001, this in addition to improvement of approximately 40% in 2001
- -- and that these impacts will continue in the future and will continue to help
produce more profitable business.
Broadening Distribution Options
Management has begun to broaden the Company's distribution options to
complement and extend the reach of the Company's agency force. This initiative
initially focuses on more fully utilizing its approved payroll deduction slots
in school systems across the country which are assigned to Horace Mann. In 2001,
the Company began building a network of independent agents who will comprise a
second distribution channel for the Company's 403(b) tax-qualified annuity
products. In addition to serving educators in areas where the Company does not
have agents, the independent agents will complement and extend the annuity
capabilities of the Company's agents in under-penetrated areas. All agreements
with independent agents and broker/dealers include clearly defined guidelines
governing the relationship between the independent agents and the Company's
agents.
As an example of the potential for this initiative, in January 2002 the
Company announced that it had been selected as one of four providers of fixed
and variable annuity options to Chicago, Illinois public school employees. The
Chicago Public Schools is the third-largest school district in the U.S.
Beginning in April 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 growth in its annuity business.
6
During the period April through December 2002, independent agents sold
approximately 1,600 new Horace Mann flexible premium contracts in Chicago,
representing more than $7 million in annual contract deposits. In addition to
the Company's Chicago initiative, independent agents generated annualized Horace
Mann contract deposits of nearly $3 million in the last three months of 2002 in
other U.S. markets.
Geographic Composition of Business
The Company's business is geographically diversified. For the year ended
December 31, 2002, based on direct insurance premiums earned and contract
deposits for all product lines, the top five states and their portion of total
premiums were North Carolina, 7.8%; Illinois, 6.2%; Texas, 5.8%; Florida, 5.2%
and Minnesota, 5.0%.
HMEC's property and casualty subsidiaries write business in 48 states and
the District of Columbia. The following table sets forth the Company's top ten
property and casualty states based on total direct premiums in 2002:
Property and Casualty Segment Top Ten States
(Dollars in millions)
Property and Casualty
Segment
----------------------
Direct Percent
State Premiums(1) of Total
- ----- ----------- --------
North Carolina.................. $ 41.0 7.7%
California...................... 37.8 7.1
Florida......................... 35.5 6.7
Minnesota....................... 35.1 6.6
Texas........................... 31.3 5.9
Pennsylvania.................... 23.2 4.4
Massachusetts................... 22.8 4.3
Michigan........................ 22.2 4.2
South Carolina.................. 22.2 4.2
Louisiana....................... 19.0 3.6
------ -----
Total of top ten states...... 290.1 54.7
All other areas................. 240.3 45.3
------ -----
Total direct premiums........ $530.4 100.0%
====== =====
- ----------
(1) Defined as earned premiums before reinsurance and is determined under
statutory accounting principles.
HMEC's principal life insurance subsidiary writes business in 48 states and
the District of Columbia. The following table sets forth the Company's top ten
combined life and annuity states based on total direct premiums and contract
deposits in 2002:
Combined Life and Annuity Segments Top Ten States
(Dollars in millions)
Direct Premiums and Percent
State Contract Deposits(1) of Total
- ----- -------------------- --------
Illinois........................ $ 41.7 10.9%
North Carolina.................. 30.7 8.0
Virginia........................ 23.9 6.2
Texas........................... 22.0 5.7
Tennessee....................... 19.6 5.1
Pennsylvania.................... 16.8 4.4
Indiana......................... 16.0 4.2
South Carolina.................. 13.1 3.4
Louisiana....................... 12.0 3.1
Maine .......................... 11.7 3.1
------ -----
Total of top ten states...... 207.5 54.1
All other areas................. 175.9 45.9
------ -----
Total direct premiums........ $383.4 100.0%
====== =====
- ----------
(1) Determined under statutory accounting principles.
7
National, State and Local Education Associations
The Company has had a long relationship with the National Education
Association ("NEA"), the nation's largest confederation of state and local
teachers' associations, and many of the state and local education associations
affiliated with the NEA. The NEA has approximately 2.6 million members. The
Company maintains a special advisory board, primarily composed of leaders of
state education associations, that meets with Company management on a regular
basis. These meetings provide management with the opportunity to better assess
the present and future needs of its target market and to cultivate better
relations with education association leaders. In certain states, where approved
by the applicable state insurance departments, state or local association
members are entitled to a discount on premiums for certain property and casualty
insurance products sold by the Company and to additional product features and
coverages. While management views the relationship with the NEA as important, it
is estimated that less than half of the Company's policyholders are members of
the NEA.
From 1984 to September 1993 and beginning again in September 1996, the NEA
purchased from the Company educator excess professional liability insurance for
all of its members. The NEA has entered into a contract to purchase this
insurance from the Company through August 2007. Premium from this product
represents less than 1% of all insurance premiums written and contract deposits
of the Company. Between September 1993 and September 1996, the Company did not
write this policy.
It is the practice of the NEA and affiliated state and local education
associations to "sponsor" various insurance products and services, including
those of the Company and its competitors. "Sponsorship" is generally determined
independently by each of these organizations. Being "sponsored" generally means
that the NEA and such state and local associations evaluate a product, authorize
the use of their name(s) in connection with the marketing of the product and, in
some instances, recommend that their membership consider buying the product.
From time to time since 1968, the NEA has sponsored various Company products and
currently sponsors the Company's homeowners policy on a national level, which
was co-sponsored by 41 NEA-affiliated state associations as of December 31,
2002. Since 1988, the Company's homeowners policy was the only product of the
Company that was sponsored by the NEA (exclusive of the educator excess
professional liability insurance policy purchased by the NEA as described
above). NEA-affiliated education associations in 36 states sponsor products of
the Company other than homeowners. NEA-affiliated education associations in 43
states sponsor one or more of the Company's products. In many cases,
associations that sponsor one of the Company's products also sponsor competing
products. The Company does not pay the NEA or any affiliated associations any
consideration in exchange for sponsorship of Company products. The Company does
pay for advertising that appears in NEA and state education association
publications.
In addition to NEA-affiliated education associations, the Company has begun
to establish relationships with other education-related associations. As of
December 31, 2002, 29 associations representing school principals and/or
administrators in 18 states sponsored one or more of the Company's products.
8
Some of the advantages of sponsorship by education and education-related
associations include prestige and enhanced brand awareness, increased
opportunity for the Company's agents to market products on school premises, and
improved agent recruiting, especially among former teachers. The Company's
customers decide whether to purchase the Company's products for a number of
reasons, including pricing and service of the product and the customer's
relationship with the selling agent. Association sponsorship may be one factor
in such a decision.
In addition to its longstanding relationships with the NEA and affiliated
state and local education associations, the Company has established its brand
name through an annual scholarship program for dependents of public school
employees; its educator surveys; scholarships for current educators; sponsorship
of the National Teacher Hall of Fame; financial support of the Horace Mann - NEA
Foundation Award for Teaching Excellence; participation in the national
conventions of the American Association of School Administrators (AASA), the
Association of Educational Service Agencies (AESA), the Association of School
Business Officials (ASBO), the National Association of Elementary School
Principals (NAESP) and the National Association of Secondary School Principals
(NASSP); relationships with approximately 100 credit unions, predominantly
associated with educators, serving over 600,000 members in 32 states;
sponsorship of the educator and student resource website
www.reacheverychild.com; and availability of educator information on the
Company's website www.horacemann.com, as well as local agent contacts with
school districts. The Company tailors its products to the educator market,
including certain educator-specific features and hybrid products, which
distinguishes the Company's products from those of its competitors.
Property and Casualty Segment
The property and casualty segment represented 58% of the Company's total
insurance premiums written and contract deposits.
The primary property and casualty product offered by the Company is private
passenger automobile insurance, which in 2002 represented 42% of the Company's
total insurance premiums written and contract deposits and 73% of property and
casualty net written premiums. As of December 31, 2002, the Company had
approximately 573,000 voluntary automobile policies in force with annual
premiums of approximately $375 million. The Company's automobile business is
primarily preferred risk, defined as a household whose drivers have had no
recent accidents and no more than one recent moving violation. The Company has
instituted a program in a limited number of states to provide non-preferred risk
automobile coverage to the educator market, with a third-party vendor
underwriting such insurance and the Company receiving a commission on its sale.
In 2002, homeowners insurance represented 15% of the Company's total
insurance premiums written and contract deposits and 26% of property and
casualty net written premiums. The Company insures primarily residential homes.
As of December 31, 2002, the Company had approximately 284,000 homeowners
policies in force with annual premiums of approximately $129 million. As
expected, the number of homeowners policies in force decreased in 2002,
reflecting initiatives to improve profitability in this product line.
Educator excess professional liability insurance represented the remaining
1% of the Company's 2002 property and casualty premiums. See "Business --
Corporate Strategy and Marketing -- National, State and Local Education
Associations."
9
The results of companies in the insurance industry have historically been
subject to significant fluctuations due to competition, economic conditions,
interest rates and other factors. In particular, the property and casualty
insurance industry has historically experienced pricing and profitability
cycles. Generally, the personal lines segment of the property and casualty
insurance market has been less subject to the pricing and profitability cycles
that have affected the commercial lines segment and the overall industry.
Because virtually all the Company's property and casualty business is personal
lines business, management believes the Company's operations are less subject to
pricing and profitability cycles than the operations of many other insurers.
Results of property insurers are also subject to volatility due to
prevailing weather and other conditions. While one year may be relatively free
of major weather or other disasters, another year may have numerous such events,
causing results for such a year to be materially worse than for other years.
Selected Historical Financial Information For Property and Casualty Segment
The following table sets forth certain financial information with respect
to the property and casualty segment for the periods indicated.
Property and Casualty Segment
Selected Historical Financial Information
(Dollars in millions)
Year Ended December 31,
--------------------------
2002 2001 2000
------ ------- -------
Statement of Operations Data:
Insurance premiums written (1)(2) ................... $524.9 $519.3 $493.5
Insurance premiums earned (1)(2) .................... 519.6 508.3 490.0
Net investment income ............................... 35.2 37.7 35.7
Income before income taxes .......................... 23.8 1.9 3.8
Net income .......................................... 19.9 5.2 8.9
Catastrophe costs, pretax ........................... 11.9 11.2 16.2
Statutory Operating Statistics:
Loss and loss adjustment expense ratio .............. 79.2% 85.2% 85.2%
Expense ratio ....................................... 24.4% 21.6% 20.8%
Combined loss and expense ratio
(including policyholder dividends) ............... 103.6% 106.8% 106.0%
Combined loss and expense ratio before
catastrophes (including policyholder dividends) .. 101.3% 104.6% 102.7%
GAAP Operating Statistics:
Loss and loss adjustment expense ratio .............. 78.9% 85.2% 85.2%
Expense ratio ....................................... 23.0% 21.6% 20.9%
Combined loss and expense ratio
(including policyholder dividends) ............... 101.9% 106.8% 106.1%
Combined loss and expense ratio before
catastrophes (including policyholder dividends)... 99.6% 104.6% 102.8%
Automobile and Homeowners (Voluntary):
Insurance premiums written (1)(2) ................... $513.2 $496.6 $473.2
Insurance premiums earned (1)(2) .................... 504.3 485.5 469.4
Policies in force (in thousands) (2) ................ 857 888 876
- ----------
(1) After the Company's portion of the March 2000 industry settlement of
automobile insurance rate filings in North Carolina, which reduced the
Company's premiums by $2.3 million for the year ended December 31, 2000.
(2) Effective December 31, 2001, Horace Mann ceased writing automobile
insurance policies in Massachusetts. As policies in force on that date
expired during the succeeding 12 months, the following reductions were
recognized in comparison to the year ended December 31, 2002: -$25.5
million insurance premiums written; -$10.8 million insurance premiums
earned; -$18.9 million voluntary automobile insurance premiums written;
-$8.4 million voluntary automobile insurance premiums earned; and -23
thousand voluntary automobile policies in force.
10
Property and Casualty Ratios
In each of the last 5 years, the Company's combined loss and expense ratio
for its property and casualty product lines outperformed the total property and
casualty industry combined loss and expense ratio, as reported by A.M. Best.
During this period, the Company's annual combined loss and expense ratio was
better than the total property and casualty insurance industry combined loss and
expense ratio by an average of approximately 8 percentage points. During the
same period of time, the Company's annual combined loss and expense ratio was
better than the personal lines insurance industry segment combined loss and
expense ratio by an average of approximately 6 percentage points.
The table below compares the Company's combined loss and expense ratios
with published industry averages.
Property and Casualty Combined Loss and Expense Ratio(1)
Property and
The Personal Lines Casualty
Company Industry Segment(2) Industry(2)
------- ------------------- ------------
Year Ended December 31,
2002..................... 103.6% 105.6% 105.7%
2001..................... 106.8 110.9 115.9
2000..................... 106.0 109.9 110.1
1999..................... 96.1 104.5 107.8
1998..................... 93.6 102.7 105.6
- ----------
(1) Combined loss and expense ratio includes policyholder dividends and is
determined according to statutory accounting principles.
(2) Source: Best's Aggregates and Averages (2002 Edition). 2002 is an estimate
from Review Preview, A Special Supplement to Best's Review and BestWeek,
Property/Casualty Edition, January 2003, published by A.M. Best.
The level of catastrophe costs can fluctuate significantly from year to
year. Catastrophe costs before federal income tax benefits for the Company and
the property and casualty industry for the ten years ended December 31, 2002
were as follows:
Catastrophe Costs
(Dollars in millions)
Property and
The Casualty
Company(1) Industry(2)
---------- ------------
Year Ended December 31,
2002............................................. $11.9 $ 5,800.0
2001............................................. 11.2 28,100.0
2000............................................. 16.2 4,600.0
1999............................................. 19.6 8,340.0
1998............................................. 28.4 10,070.0
1997............................................. 6.2 2,600.0
1996............................................. 20.9 7,370.0
1995............................................. 13.9 8,320.0
1994............................................. 16.2 17,010.0
1993............................................. 8.3 5,620.0
- ----------
(1) Net of reinsurance and before federal income tax benefits. Includes
allocated loss adjustment expenses and reinsurance reinstatement premiums.
The Company's individually significant catastrophe losses net of
reinsurance were as follows:
2002 - $4.2 million, Hurricane Lili; $1.7 million, April Eastern
states hail, tornadoes, wind and heavy rain; $1.2 million,
Eastern states winter storms.
2001 - $3.7 million, June Midwest wind/hail/tornadoes; $2.3 million
April tornadoes; $2.2 million Tropical Storm Allison.
2000 - $5.0 million, May tornadoes; $2.7 million December winter
storms.
1999 - $5.4 million, Hurricane Floyd; $3.1 million, May tornadoes
primarily in Oklahoma.
1998 - $7.9 million, May Minnesota hailstorm; $2.9 million, May Upper
Midwest hailstorm; $2.0 million, June Midwest wind/hail; $1.6
million, Hurricane Georges.
1997 - $1.4 million, July wind/hail/tornadoes; $1.1 million, Denver,
Colorado hailstorm.
1996 - $8.2 million, Hurricane Fran.
1995 - $2.9 million, Texas wind/hail/tornadoes; $2.2 million Hurricane
Opal.
1994 - $6.0 million, Northridge, California earthquake.
1993 - $2.2 million, East Coast blizzard.
(2) Source: Insurance Services Office, Inc. news release dated February 13,
2003. These amounts are net of reinsurance, before federal income tax
benefits, and exclude all loss adjustment expenses.
11
During the last 5 years, the Company's property and casualty annual expense
ratio has been better than the property and casualty industry personal lines
average expense ratio as reported by A.M. Best by an average of 4 percentage
points per year. During the same period of time, the Company's property and
casualty annual expense ratio was better than the total property and casualty
insurance industry expense ratio by an average of approximately 6 percentage
points. The Company's property and casualty expense ratio for the year ended
December 31, 2002 was 24.4%.
The table below compares the Company's expense ratios with published
industry averages.
Property and Casualty Expense Ratio(1)
Property and
The Personal Lines Casualty
Company Industry Segment(2) Industry(2)
------- ------------------- ------------
Year ended December 31,
2002.......................... 24.4% 25.5% 25.5%
2001.......................... 21.6 24.8 26.7
2000.......................... 20.8 25.6 27.6
1999.......................... 19.8 25.6 28.0
1998.......................... 19.3 25.0 27.7
- ----------
(1) Determined according to statutory accounting principles.
(2) Source: Best's Aggregates and Averages (2002 Edition). The 2002 personal
lines result is an estimate from A.M. Best. The 2002 total industry result
is an estimate from Review Preview, A Special Supplement to Best's Review
and BestWeek, Property/Casualty Edition, January 2003, published by A.M.
Best.
Property and Casualty Reserves
At December 31, 2002, 99.3% of the Company's net reserves for claims and
claims expenses were carried at the full value of estimated liabilities and were
not discounted for interest expected to be earned on reserves. Due to the nature
of the Company's personal lines business, the Company has no exposure to claims
for toxic waste cleanup, other environmental remediation or asbestos-related
illnesses other than claims under homeowners insurance policies for
environmentally related items such as toxic mold.
The Company establishes property and casualty claim reserves to cover its
estimated ultimate liability for claims and claims adjustment expense with
respect to reported claims and claims incurred but not yet reported as of the
end of each accounting period. In accordance with applicable insurance laws and
regulations and accounting principles generally accepted in the United States of
America ("GAAP"), no reserves are established until a loss occurs, including a
loss from a catastrophe. Underwriting results of the property and casualty
segment are significantly influenced by estimates of property and casualty
claims and claims expense reserves. These reserves are an accumulation of the
estimated amounts necessary to settle all outstanding claims, including claims
which are incurred but not reported, as of the date of the financial statements.
The process by which property and casualty reserves are established
requires reliance upon estimates based on known facts and on interpretations of
circumstances, including the Company's experience with similar cases and
historical trends involving claim payment patterns, claim payments, pending
levels of unpaid claims and product mix, as well as other factors including
court decisions, economic conditions and public attitudes. The effects of
inflation are implicitly considered in the reserving process. The establishment
of reserves, including reserves for catastrophes, is an inherently uncertain
process and the ultimate cost of losses may vary materially from the recorded
reserve amounts. The Company regularly updates its reserve estimates as new
facts become known and further events occur which may impact the resolution
12
of unsettled claims. Changes in prior year reserve estimates, which may be
material, are reflected in the results of operations in the period such changes
are determined to be appropriate.
Due to the inherent uncertainty in estimating reserves for claims and
claims expenses, there can be no assurance that ultimate liabilities will not
exceed amounts reserved, with a resulting adverse effect on the Company.
Management believes that the Company's overall reserve levels at December 31,
2002 are adequate to meet its future obligations.
The following table is a summary reconciliation of the beginning and ending
property and casualty insurance claims and claims expense reserves, displayed
individually for each of the last three years. The table presents reserves on a
net (after reinsurance) basis. The total net property and casualty insurance
claims and claims expense amounts are reflected in the Consolidated Statements
of Operations listed on page F-1 of this report. The end of the year gross
reserve (before reinsurance) balances are reflected in the Consolidated Balance
Sheets also listed on page F-1 of this report.
Reconciliation of Property and Casualty Claims and Claims Expense Reserves
(Dollars In millions)
Year Ended December 31,
------------------------
2002 2001 2000
------ ------ ------
Gross reserves, beginning of year ............................. $306.1 $298.9 $299.8
Less reinsurance recoverables .............................. 34.1 49.1 64.4
------ ------ ------
Net reserves, beginning of year ............................... 272.0 249.8 235.4
------ ------ ------
Incurred claims and claims expense:
Claims occurring in the current year ....................... 387.7 416.8 394.7
Increase in estimated reserves for claims
occurring in prior years (1):
Policies written by the Company (2) .................. 22.3 14.5 20.9
Business assumed from state reinsurance facilities ... 1.7 2.0 1.8
------ ------ ------
Total increase .................................... 24.0 16.5 22.7
------ ------ ------
Total claims and claims expense incurred (2)(3) ...... 411.7 433.3 417.4
------ ------ ------
Claims and claims expense payments for claims occurring during:
Current year ............................................... 244.3 255.9 247.4
Prior years ................................................ 166.8 155.2 155.6
------ ------ ------
Total claims and claims expense payments ............. 411.1 411.1 403.0
------ ------ ------
Net reserves, end of period ................................... 272.6 272.0 249.8
Plus reinsurance recoverables .............................. 44.7 34.1 49.1
------ ------ ------
Gross reserves, end of period (4) ............................. $317.3 $306.1 $298.9
====== ====== ======
- ----------
(1) Shows the amounts by which the Company increased its reserves in each of
the periods indicated for claims occurring in previous periods to reflect
subsequent information on such claims and changes in their projected final
settlement costs. For discussion of the reserve strengthening recorded by
the Company in 2002, 2001 and 2000 see "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Results of
Operations -- Year Ended December 31, 2002 Compared to Year Ended December
31, 2001 -- Benefits, Claims and Settlement Expenses" listed on page F-1 of
this report.
(2) For the year ended December 31, 2002, these amounts included a $1.6 million
statutory accounting charge for class action litigation which was
separately reported as Litigation Charges in the Company's Consolidated
Statements of Operations.
(3) Benefits, claims and settlement expenses as reported in the Consolidated
Statements of Operations, listed on page F-1 of this report, also include
life, annuity, group accident and health and corporate amounts of $40.7
million, $42.3 million and $48.6 million for the years ended December 31,
2002, 2001 and 2000, respectively, in addition to the property and casualty
amounts.
(4) Unpaid claims and claims expense as reported in the Consolidated Balance
Sheets, listed on page F-1 of this report, also include life, annuity, and
group accident and health reserves of $9.3 million, $8.2 million and $10.0
million at December 31, 2002, 2001 and 2000, respectively, in addition to
property and casualty reserves.
The provision for claims and claims expenses for insured events in prior
years increased by $24.0 million, $16.5 million and $22.7 million for the years
ended December 31, 2002, 2001 and 2000, respectively. For discussion of the
reserve strengthening recorded by the Company in 2002, 2001 and 2000 see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Year Ended December 31, 2002 Compared to
Year Ended December 31, 2001 -- Benefits, Claims and Settlement Expenses" listed
on page F-1 of this report. Future reserve actions, if any, will depend on claim
trends.
13
The year-end 2002 gross reserves of $317.3 million for property and
casualty insurance claims and claims expense, as determined under GAAP, were
$44.7 million more than the reserve balance of $272.6 million recorded on the
basis of statutory accounting principles for reports provided to state
regulatory authorities. The difference is the reinsurance recoverable from third
parties totaling $44.7 million that reduces reserves for statutory reporting and
is recorded as an asset for GAAP reporting.
Fluctuations from year to year in the level of catastrophe losses impact a
property and casualty insurance company's loss and loss adjustment expenses
incurred and paid. For comparison purposes, the following table provides amounts
for the Company excluding catastrophe losses:
Impact of Catastrophe Losses(1)
(Dollars in millions)
Year Ended December 31,
------------------------
2002 2001 2000
------ ------ ------
Claims and claims expense incurred .................. $411.7 $433.3 $417.4
Amount attributable to catastrophes ................. 11.9 11.2 16.1
------ ------ ------
Excluding catastrophes ........................... $399.8 $422.1 $401.3
====== ====== ======
Claims and claims expense payments .................. $411.1 $411.1 $403.0
Amount attributable to catastrophes ................. 10.6 14.2 14.2
------ ------ ------
Excluding catastrophes ........................... $400.5 $396.9 $388.8
====== ====== ======
- ----------
(1) Net of reinsurance and before federal income tax benefits. Includes
allocated loss adjustment expenses.
Analysis of Claims and Claims Expense Reserves
The claim reserve development table below illustrates the change over time
of the net reserves established for property and casualty insurance claims and
claims expense at the end of various calendar years. The first section shows the
reserves as originally reported at the end of the stated year. The second
section, reading down, shows the cumulative amounts paid as of the end of
successive years with respect to that reserve liability. The third section,
reading down, shows retroactive reestimates of the original recorded reserve as
of the end of each successive year which is the result of the Company's learning
additional facts that pertain to the unsettled claims. The fourth section
compares the latest reestimated reserve to the reserve originally established,
and indicates whether or not the original reserve was adequate or inadequate to
cover the estimated costs of unsettled claims. The table also presents the gross
reestimated liability as of the end of the latest reestimation period, with
separate disclosure of the related reestimated reinsurance recoverable. The
claim reserve development table is cumulative and, therefore, ending balances
should not be added since the amount at the end of each calendar year includes
activity for both the current and prior years.
14
In evaluating the information in the table below, it should be noted that
each amount includes the effects of all changes in amounts of prior periods. For
example, if a claim determined in 2001 to be $150 thousand was first reserved in
1992 at $100 thousand, the $50 thousand deficiency (actual claim minus original
estimate) would be included in the cumulative deficiency in each of the years
1992 - 2000 shown below. This table presents development data by calendar year
and does not relate the data to the year in which the accident actually
occurred. Conditions and trends that have affected the development of these
reserves in the past will not necessarily recur in the future. It may not be
appropriate to use this cumulative history in the projection of future
performance.
Property and Casualty
Claims and Claims Expense Reserve Development
(Dollars in millions)
December 31,
---------------------------------------------------
1992 1993 1994 1995 1996 1997
------ ------ ------ ------ ------ ------
Gross reserves for property and casualty
claims and claims expenses............ $358.2 $373.5 $389.1 $369.7 $340.4 $310.6
Deduct: Reinsurance recoverables........ 17.7 21.6 19.5 23.8 34.1 41.3
------ ------ ------ ------ ------ ------
Net reserves for property and casualty
claims and claims expenses............ 340.5 351.9 369.6 345.9 306.3 269.3
Increase in reserves due
to purchase of HMPCIC:
Gross reserves for property
and casualty claims and
claims expenses................. -- 30.6 -- -- -- --
Deduct: Reinsurance
recoverables...................... -- 0.6 -- -- -- --
------ ------ ------ ------ ------ ------
Net reserves for property and
casualty claims and claims
expenses........................ -- 30.0 -- -- -- --
Paid cumulative as of:
One year later........................ 117.6 133.4 140.8 139.3 148.6 142.0
Two years later....................... 169.6 190.5 194.5 195.3 202.1 191.4
Three years later..................... 197.8 218.4 224.2 223.0 225.1 223.0
Four years later...................... 213.6 234.1 237.9 233.8 240.2 236.7
Five years later...................... 222.6 241.0 243.1 241.4 245.0 246.5
Six years later....................... 226.0 243.7 247.1 242.8 250.5
Seven years later..................... 227.5 246.1 247.5 246.8
Eight years later..................... 229.0 246.2 250.4
Nine years later...................... 228.9 248.1
Ten years later....................... 230.0
Reserves reestimated as of:
End of year........................... 340.5 381.9 369.6 345.9 306.3 269.3
One year later........................ 306.1 327.6 314.0 283.4 261.2 244.4
Two years later....................... 267.7 281.9 269.2 249.6 250.2 239.3
Three years later..................... 246.4 258.1 251.4 245.8 247.8 254.9
Four years later...................... 233.3 249.3 248.9 243.8 257.1 257.0
Five years later...................... 229.8 229.7 247.4 250.9 256.4 258.7
Six years later....................... 230.0 246.6 252.9 250.1 258.8
Seven years later..................... 229.8 250.2 252.6 252.2
Eight years later..................... 231.9 250.2 255.0
Nine years later...................... 232.0 252.1
Ten years later....................... 233.5
Reserve redundancy (deficiency) -
initial net reserves in excess of
(less than) reestimated reserves:
Amount(1).......................... $107.0 $129.8 $114.6 $ 93.7 $ 47.5 $ 10.6
Percent............................ 31.4% 34.0% 31.0% 27.1% 15.5% 3.9%
Gross reestimated liability - latest $262.6 $281.8 $285.3 $277.1 $288.0 $287.0
Reestimated reinsurance recoverables -
latest................................ 29.1 29.7 30.3 24.9 29.2 28.3
------ ------ ------ ------ ------ ------
Net reestimated liability - latest....... $233.5 $252.1 $255.0 $252.2 $258.8 $258.7
Gross cumulative excess (deficiency)(1).. $ 95.6 $122.3 $103.8 $ 92.6 $ 52.4 $ 23.6
====== ====== ====== ====== ====== ======
December 31,
------------------------------------------
1998 1999 2000 2001 2002
------ ------ ------ ------ ------
Gross reserves for property and casualty
claims and claims expenses............ $298.9 $299.8 $298.9 $306.1 $317.3
Deduct: Reinsurance recoverables........ 55.9 64.4 49.1 34.1 44.7
------ ------ ------ ------ ------
Net reserves for property and casualty
claims and claims expenses............ 243.0 235.4 249.8 272.0 272.6
Increase in reserves due
to purchase of HMPCIC:
Gross reserves for property
and casualty claims and
claims expenses................. -- -- -- -- --
Deduct: Reinsurance
recoverables.................... -- -- -- -- --
------ ------ ------ ------ ------
Net reserves for property and
casualty claims and claims
expenses........................ -- -- -- -- --
Paid cumulative as of:
One year later........................ 142.5 155.6 155.2 166.8
Two years later....................... 203.2 212.7 220.1
Three years later..................... 233.0 248.0
Four years later...................... 251.2
Five years later......................
Six years later.......................
Seven years later.....................
Eight years later.....................
Nine years later......................
Ten years later.......................
Reserves reestimated as of:
End of year........................... 243.0 235.4 249.8 272.0 272.6
One year later........................ 238.4 258.1 266.3 296.0
Two years later....................... 261.2 276.9 287.3
Three years later..................... 268.7 284.6
Four years later...................... 271.3
Five years later......................
Six years later.......................
Seven years later.....................
Eight years later.....................
Nine years later......................
Ten years later.......................
Reserve redundancy (deficiency) -
initial net reserves in excess of
(less than) reestimated reserves:
Amount(1).......................... $(28.3) $(49.2) $(37.5) $(24.0)
Percent............................ -11.6% -20.9% -15.0% -8.8%
Gross reestimated liability - latest $305.3 $316.8 $320.0 $332.0
Reestimated reinsurance recoverables -
latest................................ 34.0 32.2 32.7 36.0
------ ------ ------ ------
Net reestimated liability - latest....... $271.3 $284.6 $287.3 $296.0
Gross cumulative excess (deficiency)(1).. $ (6.4) $(17.0) $(21.1) $(25.9)
====== ====== ====== ======
- ----------
(1) See "Business - Property and Casualty - Property and Casualty Reserves."
As the table above illustrates, the Company's net reserves for property and
casualty insurance claims and claims expense at the end of 2001 were
strengthened in 2002 by $24.0 million, while gross reserves were strengthened
$25.9 million. See "Management's Discussion
15
and Analysis of Financial Condition and Results of Operations -- Results of
Operations -- Year Ended December 31, 2002 Compared to Year Ended December 31,
2001 -- Benefits, Claims and Settlement Expenses" listed on page F-1 of this
report.
Property and Casualty Reinsurance
All reinsurance is obtained through contracts which generally are renewed
each calendar year; however, the 2002 catastrophe reinsurance program was
comprised of two contracts, a three-year contract with rate guarantees effective
January 1, 2001 and a one-year contract effective January 1, 2002. Also, the
educator excess professional liability contract is a three-year contract
effective January 1, 2000. Although reinsurance does not legally discharge the
Company from primary liability for the full amount of its policies, it does make
the assuming reinsurer liable to the extent of the reinsurance ceded.
Historically, the Company's losses from uncollectible reinsurance recoverables
have been insignificant due to the Company's emphasis on the credit worthiness
of its reinsurers. Past due reinsurance recoverables as of December 31, 2002
were also insignificant.
The Company is a national underwriter and therefore has exposure to
catastrophic losses in certain coastal states and other regions throughout the
U.S. Catastrophes can be caused by various events including hurricanes,
windstorms, earthquakes, hail, severe winter weather and fires, and the
frequency and severity of catastrophes are inherently unpredictable. The
financial impact from catastrophic losses results from both the total amount of
insured exposure in the area affected by the catastrophe as well as the severity
of the event. The Company seeks to reduce its exposure to catastrophe losses
through the geographic diversification of its insurance coverage, deductibles,
maximum coverage limits, the purchase of catastrophe reinsurance, and the
purchase of a catastrophe-linked equity put option and reinsurance agreement.
The Company maintains an excess and catastrophe treaty reinsurance program.
The Company reinsures 95% of catastrophe losses above a retention of $8.5
million per occurrence up to $80 million per occurrence. In addition, the
Company's predominant insurance subsidiary for property and casualty business
written in Florida reinsures 90% of hurricane losses in that state above a
retention of $13.7 million up to $51.4 million with the Florida Hurricane
Catastrophe Fund, based on the Fund's resources. Through December 31, 2001,
these catastrophe reinsurance programs were augmented by a $100 million equity
put and reinsurance agreement. This equity put provided an option to sell shares
of the Company's convertible preferred stock with a floating rate dividend at a
pre-negotiated price in the event losses from catastrophes exceeded the
catastrophe reinsurance program coverage limit. Before tax benefits, the equity
put provided a source of capital for up to $154 million of catastrophe losses
above the reinsurance coverage limit.
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, which is renewable annually at the option of the Company, the equity
put coverage of $75 million provides a source of capital for up to $115 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 was effective only for the last eight months of
the year. The agreement contains certain conditions to Horace Mann's exercise of
the equity put
16
option including: (i) the Company's shareholders' equity, adjusted to exclude
goodwill, can not be less than $215 million after recording the first triggering
event; (ii) the Company's debt as a percentage of total 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 December 31, 2002.
For liability coverages, including the educator excess professional
liability policy, the Company reinsures each loss above a retention of $500,000
up to $20 million. The Company also reinsures each property loss above a
retention of $250,000 up to $2.5 million, including catastrophe losses that in
the aggregate are less than the retention levels above.
The following table identifies the Company's most significant reinsurers
under the traditional catastrophe reinsurance program, their percentage
participation in the Company's aggregate reinsured catastrophe coverage and
their rating by A.M. Best and Standard & Poor's Corporation ("S&P" or "Standard
& Poor's") as of March 15, 2003. No other single reinsurer's percentage
participation in 2003 or 2002 exceeds 5%.
Property Catastrophe Reinsurance Participants In Excess of 5%
Participation
A.M. Best S&P -------------
Rating Rating Reinsurer Parent 2003 2002
- --------- ------ --------- ------ ---- ----
A++ A Erie Insurance Exchange 15% 14%
A AA- AXA Reinsurance Company AXA Group 14% 17%
A- NR Montpelier Reinsurance Ltd. Montpelier Re Holdings, Ltd. 11% 0%
A A+ Mapfre Reinsurance Corporation Sistema MAPFRE 8% 7%
A A+ St. Paul Fire and Marine
Insurance Company The St. Paul Companies, Inc. 6% 6%
A+ NR Allied World Assurance Company, Ltd. Allied World Assurance
Holdings, Ltd. 5% *
A+ A+ IPCRe, Ltd. IPC Holdings, Ltd. 5% *
A- A Lloyd's of London Syndicates * 5%
- ----------
NR Not rated.
* Less than 5%.
For 2003, property catastrophe reinsurers representing 100% of the
Company's aggregate reinsured catastrophe coverage were rated either "A-
(Excellent)" or above by A.M. Best or "A" or above by S&P.
Annuity Segment
Educators in the Company's target market benefit from the provisions of
Section 403(b) of the Internal Revenue Code. This section of the Code allows
public school employees and employees of other tax-exempt organizations, such as
not-for-profit private schools, to reduce their pretax income by making periodic
contributions to an individual qualified retirement plan. The Company's 403(b)
tax-qualified annuities are annuities purchased voluntarily by individuals. The
Company has offered tax-qualified annuities in its target market, designed to
allow contractholders to benefit from these tax provisions, since 1961, the year
Congress created this option for educators. The Company is one of the largest
participants in the 403(b) tax-qualified annuity market, measured by 403(b) net
written premium on a statutory accounting basis. The Company has approved 403(b)
payroll reduction capabilities in approximately one-third of the 15,000 public
school districts in the U.S. Approximately 60% of the Company's new annuity
contract deposits in 2002 were for 403(b) tax-qualified annuities; approximately
75% of accumulated annuity value on deposit is 403(b) tax-qualified. In 2002,
annuities represented 29% of the Company's total insurance premiums written and
contract deposits.
17
The Company sells tax-qualified annuities primarily under a contract which
allows the contractholder to allocate funds to both fixed and variable
alternatives. The features of the Company's annuity contract contribute to
business retention. Under the fixed account option, both the principal and a
rate of return are guaranteed. Contractholders can change at any time their
allocation of deposits between the guaranteed interest rate fixed account and
available variable investment options. The Company provides its agents with
proprietary asset allocation software that assists educator customers in
selecting the best retirement investment options based on their risk tolerance
and investment objectives.
The Company's 40 variable account options include funds managed by some of
the best-known names in the mutual fund industry, such as Fidelity, Strong, J.P.
Morgan, Wilshire, T. Rowe Price, Putnam, Neuberger Berman, Alliance Capital,
Ranier, Davis, Credit Suisse, BlackRock, Berger, Templeton and Ariel, offering
the Company's customers multiple investment options, regardless of their
personal investment objectives and risk tolerance. Total accumulated fixed and
variable annuity cash value on deposit at December 31, 2002 was $2.4 billion.
For the year ended December 31, 2002, 93% of the total accumulated cash
value of the Company's annuity business remained on deposit, compared to average
retention of 91% for stock life insurance companies for 2001, as reported by
A.M. Best. All annuities issued since 1982, and approximately 79% of all
outstanding fixed accumulated cash values, are subject in most cases to
substantial early withdrawal penalties, typically ranging from 5% to 13% of the
amount withdrawn, compared to an average of 47% of accumulated values subject to
withdrawal penalties for stock life insurance companies for 2001, as reported by
A.M. Best. For the Company, withdrawals of outstanding variable accumulated cash
values are limited to amounts less than or equal to the then current market
value of such accumulations, minus withdrawal penalties as applicable.
Generally, a penalty is imposed under the Internal Revenue Code on amounts
withdrawn from tax-qualified annuities prior to age 59 1/2. Total accumulated
annuity funds on deposit at December 31, 2002 consisted of 64% fixed balances
and 36% variable balances. Since 1997, the growth of the annuity segment has
come primarily from variable annuity contract deposits, although variable cash
values were negatively impacted in 2002 and 2001 by adverse market conditions.
18
Selected Historical Financial Information For Annuity Segment
The following table sets forth certain information with respect to the
Company's annuity products for the periods indicated.
Annuity Segment
Selected Historical Financial Information
(Dollars in millions, unless otherwise indicated)
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Statement of Operations Data:
Contract deposits:
Variable.............................................. $ 120.3 $ 122.1 $ 121.1
Fixed................................................. 141.2 117.0 85.3
Total.............................................. 261.5 239.1 206.4
Contract charges earned.................................. 14.2 14.9 17.0
Net investment income.................................... 107.7 107.7 105.4
Net interest margin (without realized gains)............. 39.3 39.8 39.3
Net margin (includes fees and contract charges earned)... 55.5 57.0 59.0
Income before income taxes............................... 23.2 30.7 29.2
Net income............................................... 17.0 20.6 19.3
Operating Statistics:
Fixed:
Accumulated value..................................... $1,506.0 $1,393.7 $1,331.8
Accumulated value persistency......................... 94.0% 93.4% 88.7%
Variable:
Accumulated value..................................... $ 854.5 $1,008.4 $1,035.1
Accumulated value persistency......................... 92.1% 92.4% 84.1%
Number of contracts in force............................. 147,084 139,410 128,654
Average accumulated cash value (in dollars).............. $ 16,048 $ 17,230 $ 18,397
Average annual deposit by contractholders (in dollars)... $ 2,317 $ 2,183 $ 2,282
Annuity contracts terminated due to surrender,
death, maturity or other:
Number of contracts ............................... 7,180 7,222 10,848
Amount............................................. $ 176.0 $ 186.4 $ 322.0
Fixed accumulated cash value grouped
by applicable surrender charge:
0%................................................. $ 316.6 $ 299.1 $ 298.8
5% and greater but less than 10%................... 992.6 901.7 852.3
10% and greater.................................... 99.1 95.0 86.2
Supplementary contracts with life contingencies
not subject to discretionary withdrawal......... 97.7 97.9 94.5
Total........................................ $1,506.0 $1,393.7 $1,331.8
Life Segment
The Company entered the individual life insurance business in 1949 with
traditional term and whole life insurance products. The Company's traditional
term, whole life and group life business in force consists of approximately
177,000 policies, representing approximately $7.2 billion of life insurance in
force with annual insurance premiums and contract deposits of approximately
$43.5 million as of December 31, 2002. In 1997, the Company introduced a new
series of five limited duration term life insurance products. In 1998, the
Company introduced a new series of whole life products designed to serve the
needs of customers who also want limited life insurance coverage (as low as
$5,000 death benefits) but who want the features of a whole life policy. The
Company does not charge any penalty for withdrawal of life insurance cash
values. In 1984, the Company introduced "Experience Life," a flexible,
adjustable premium life insurance contract which allows the customer to combine
elements of term life insurance, interest-sensitive whole life insurance and an
interest-bearing account. At December 31, 2002 the Company had in force
approximately 87,000 Experience Life policies representing approximately $6.0
billion of life insurance in force with annual insurance premiums and contract
deposits of approximately $68.5 million. In 2000, the Company instituted a
program to offer long-term care and variable universal life policies, with two
third-party vendors underwriting such insurance and the Company receiving a
commission on its sale. In 2002, the life segment represented 13% of
19
the Company's total insurance premiums written and contract deposits, including
approximately 1 percentage point attributable to the Company's group life and
group disability income business.
During 2002, the average face amount of ordinary life insurance policies
issued by the Company was $130,393 and the average face amount of all ordinary
life insurance policies in force at December 31, 2002 was $60,409.
The maximum individual life insurance risk retained by the Company is
$200,000 on any individual life and $125,000 is retained on each group life
policy. The excess of the amounts retained are reinsured with life reinsurers
that are all rated "A- (Excellent)" or above by A.M. Best. The Company also
maintains a life catastrophe reinsurance program. The Company reinsures 100% of
the catastrophe risk in excess of $1 million up to $20 million per occurrence.
This program covers acts of terrorism but excludes nuclear, biological and
chemical explosions as well as other acts of war.
The life insurance and annuity industry, while not generally subject to the
factors that produce cyclicality in the property and casualty insurance
industry, is nonetheless subject to competitive pressures and interest rate
fluctuations. As a result, the life insurance and annuity industry has developed
new products designed to shift investment and credit risk to policy or
contractholders while still providing death benefits. This trend has generally
caused profit margins to shrink on new products relative to older life insurance
and annuity products and has provided more competitive returns to the holders of
the new products than those available under other investment alternatives.
Management cannot predict whether these trends will continue in the future.
IMSA Certification
In July 2001, Horace Mann Life Insurance Company, the Company's principal
life insurance subsidiary, earned membership in the Insurance Marketplace
Standards Association ("IMSA"). IMSA is an independent, voluntary association
created by the life insurance industry to promote high standards of ethical
market conduct in advertising, sales and service for individual life, annuity
and long-term care products. To earn IMSA certification, HMLIC underwent self-
and independent third-party assessments to demonstrate that it has adopted
IMSA's principles of ethical behavior. HMLIC is an IMSA member for three years,
after which it must demonstrate continuous improvement and repeat the self- and
independent assessment process to retain its membership. As of December 31,
2002, approximately 200 of the more than 1,200 U.S. life insurance companies had
earned IMSA membership.
20
Selected Historical Financial Information For Life Segment
The following table sets forth certain information with respect to the
Company's life products for the periods indicated.
Life Segment
Selected Historical Financial Information
(Dollars in millions, unless otherwise indicated)
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Statement of Operations Data:
Insurance premiums and contract deposits................. $ 112.9 $ 117.2 $ 121.8
Insurance premiums and contract charges earned........... 91.4 92.0 91.7
Net investment income ................................... 53.9 55.2 51.2
Income before income taxes............................... 29.2 28.9 19.9
Net income............................................... 18.9 18.7 12.9
Operating Statistics:
Life insurance in force:
Ordinary life......................................... $ 11,445 $ 11,291 $ 10,967
Group life............................................ 1,752 1,925 1,680
Total.............................................. 13,197 13,216 12,647
Number of policies in force:
Ordinary life......................................... 189,459 193,560 196,361
Group life............................................ 75,018 80,507 77,221
Total.............................................. 264,477 274,067 273,582
Average face amount in force (in dollars):
Ordinary life......................................... $ 60,409 $ 58,333 $ 55,851
Group life............................................ 23,354 23,911 21,756
Total.............................................. 49,898 48,222 46,227
Lapse ratio (ordinary life insurance in force)........... 9.1% 9.1% 9.0%
Ordinary life insurance terminated due to death,
surrender, lapse or other:
Face amount of insurance surrendered or lapsed..... $ 959.0 $ 944.0 $1,087.6
Number of policies.............................. 10,799 11,865 13,877
Amount of death claims opened...................... $ 31.0 $ 30.1 $ 30.1
Number of death claims opened................... 1,263 1,317 1,317
Investments
The Company's investments are selected to balance the objectives of
protecting principal, minimizing exposure to interest rate risk and providing a
high current yield. These objectives are implemented through a portfolio that
emphasizes investment grade, publicly traded fixed income securities. When
impairment of the value of an investment is considered other than temporary, the
decrease in value is recorded and a new cost basis is established. At December
31, 2002, investments in non-investment grade securities represented 4.0% of
total investments. At December 31, 2002, fixed income securities represented
95.7% of investments excluding the securities lending collateral. Of the fixed
income investment portfolio, 95.4% was investment grade and 99.9% was publicly
traded. The average quality of the total fixed income portfolio was A+ at
December 31, 2002, and the average option adjusted duration of total investments
was 4.8 years. There are no significant investments in mortgage loans, real
estate, foreign securities, privately placed securities, or common or preferred
stocks.
The Company's investments are managed by outside managers and advisors
which follow investment guidelines established by the Company. 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
21
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.
The Company has separate investment strategies and guidelines for its
property and casualty assets and for its life and annuity assets, which
recognize different characteristics of the associated insurance liabilities, as
well as different tax and regulatory environments. The Company manages interest
rate exposure for its portfolios through asset/liability management techniques
which attempt to coordinate the duration of the assets with the duration of the
insurance policy liabilities. Duration of assets and liabilities will generally
differ only because of opportunities to significantly increase yields or because
policy values are not interest-sensitive, as is the case in the property and
casualty segment.
The investments of each insurance subsidiary must comply with the insurance
laws of such insurance subsidiary's domiciliary state. These laws prescribe the
type and amount of investments that may be made by insurance companies. In
general, these laws permit investments, within specified limits and subject to
certain qualifications, in federal, state and municipal obligations, corporate
bonds, mortgage-backed bonds, other asset-backed bonds, preferred stocks, common
stocks, real estate mortgages and real estate.
22
The following table sets forth the carrying values and amortized cost of
the Company's investment portfolio as of December 31, 2002:
Investment Portfolio
(Dollars in millions)
Percentage Carrying Value
of Total ----------------------------------
Carrying Life and Property and Amortized
Value Total Annuity Casualty Cost
----------- -------- -------- ------------ ---------
Publicly Traded Fixed Maturity Securities
and Cash Equivalents:
U.S. government and agency obligations(1):
Mortgage-backed securities............... 21.5% $ 674.0 $ 653.7 $ 20.3 $ 645.8
Other.................................... 4.4 137.5 123.2 14.3 129.6
Investment grade corporate and public
utility bonds............................ 46.1 1,441.5 1,331.2 110.3 1,365.6
Municipal bonds............................. 12.1 377.5 14.1 363.4 358.6
Other mortgage-backed securities............ 6.9 216.4 163.2 53.2 213.0
Non-investment grade corporate and public
utility bonds(2)......................... 4.0 123.8 91.5 32.3 128.8
Foreign government bonds.................... 0.5 16.0 16.0 -- 13.1
Short-term investments(3)................... 1.9 61.0 52.6 8.4 61.0
Short-term investments, loaned
securities collateral(3)................. 0.1 3.9 1.3 2.6 3.9
----- -------- -------- ------ --------
Total publicly traded securities...... 97.5 3,051.6 2,446.8 604.8 2,919.4
----- -------- -------- ------ --------
Other Investments:
Private placements, investment grade(4)..... 0.1 4.4 4.3 0.1 4.4
Private placements,
non-investment grade(2)(4)............... -- 0.1 0.1 -- 0.1
Mortgage loans and real estate(5)........... 0.2 4.9 4.9 -- 4.9
Policy loans and other...................... 2.2 69.6 69.1 0.5 69.2
----- -------- -------- ------ --------
Total other investments............... 2.5 79.0 78.4 0.6 78.6
----- -------- -------- ------ --------
Total investments(6).................. 100.0% $3,130.6 $2,525.2 $605.4 $2,998.0
===== ======== ======== ====== ========
- ----------
(1) Includes $240.9 million fair value of investments guaranteed by the full
faith and credit of the U.S. government and $570.6 million fair value of
federally sponsored agency securities.
(2) A non-investment grade rating is assigned to a security when it is
acquired, primarily on the basis of the Standard & Poor's Corporation
("Standard & Poor's" or "S&P") rating for such security, or if there is no
S&P rating, the Moody's Investors Service, Inc. ("Moody's") rating for such
security, or if there is no S&P or Moody's rating, the National Association
of Insurance Commissioners (the "NAIC") rating for such security. The
rating agencies monitor securities, and their issuers, regularly and make
changes to the ratings as necessary. The Company incorporates rating
changes on a monthly basis.
(3) Short-term investments mature within one year of being acquired and are
carried at cost, which approximates fair value. Short-term investments
include $64.0 million in money market funds rated "AAA", $0.8 million in
Australian dollars, and $0.1 million in certificates of deposit. The
Company loans fixed income securities to third parties, primarily major
brokerage firms. The Company separately maintains a minimum of 100% of the
value of the loaned securities as collateral for each loan.
(4) Fair values for private placements are estimated by the Company with the
assistance of its investment advisors.
(5) Mortgage loans are carried at amortized cost or unpaid principal balance
and real estate acquired in the settlement of debt is carried at the lower
of cost or fair value.
(6) Approximately 7% of the Company's investment portfolio, having a carrying
value of $210.5 million as of December 31, 2002, consisted of securities
with some form of credit support, such as insurance. All of these
securities have the highest investment grade rating.
23
Fixed Maturity Securities
The following table sets forth the composition of the Company's fixed
maturity securities portfolio by rating as of December 31, 2002:
Rating of Fixed Maturity Securities(1)
(Dollars in millions)
Percent
of Total
Carrying Carrying Amortized
Value Value Cost
-------- -------- ---------
AAA.......................................... 40.0% $1,196.5 $1,141.3
AA........................................... 6.8 204.2 193.1
A............................................ 24.9 743.8 699.3
BBB.......................................... 23.7 710.0 682.3
BB........................................... 2.2 65.5 71.1
B............................................ 1.3 38.1 39.4
CCC or lower................................. 1.0 28.6 28.0
Not rated(2)................................. 0.1 4.5 4.5
----- -------- --------
Total..................................... 100.0% $2,991.2 $2,859.0
===== ======== ========
- ----------
(1) Ratings are as assigned primarily by S&P when available, with remaining
ratings as assigned on an equivalent basis by Moody's. Ratings for publicly
traded securities are determined when the securities are acquired and are
updated monthly to reflect any changes in ratings.
(2) This category includes less than $0.1 million of publicly traded securities
not currently rated by S&P, Moody's or the NAIC and $4.5 million of private
placement securities not rated by either S&P or Moody's. The NAIC has rated
96.9% of these private placement securities as investment grade.
At December 31, 2002, 39.3% of the Company's fixed maturity securities
portfolio was expected to mature within the next 5 years. Mortgage-backed
securities, including mortgage-backed securities of U.S. governmental agencies,
represented 28.4% of the total investment portfolio at December 31, 2002. These
securities typically have average lives shorter than their stated maturities due
to unscheduled prepayments on the underlying mortgages. Mortgages are prepaid
for a variety of reasons, including sales of existing homes, interest rate
changes over time that encourage homeowners to refinance their mortgages and
defaults by homeowners on mortgages that are then paid by guarantors.
For financial reporting purposes, the Company has classified the entire
fixed maturity portfolio as "available for sale". Fixed maturities to be held
for indefinite periods of time and not intended to be held to maturity are
classified as available for sale and carried at fair value. The net adjustment
for unrealized gains and losses on securities available for sale is recorded as
a separate component of shareholders' equity, net of applicable deferred tax
asset or liability and the related impact on deferred policy acquisition costs
and value of acquired insurance in force associated with interest-sensitive life
and annuity contracts. Fixed maturities held for indefinite periods of time
include securities that management intends to use as part of its asset/liability
management strategy and that may be sold in response to changes in interest
rates, resultant prepayment risk and other related factors.
Cash Flow
As a holding company, HMEC conducts its principal operations through its
subsidiaries. Payment by HMEC of principal and interest with respect to HMEC's
indebtedness, and payment by HMEC of dividends to its shareholders, are
dependent upon the ability of its insurance subsidiaries to pay cash dividends
or make other cash payments to HMEC, including tax payments pursuant to tax
sharing agreements. Restrictions on the subsidiaries' ability to pay dividends
or to make other cash payments to HMEC may materially affect HMEC's ability to
pay principal and interest on its indebtedness and dividends on its common
stock.
24
The ability of the insurance subsidiaries to pay cash dividends to HMEC is
subject to state insurance department regulations which generally permit
dividends to be paid for any 12 month period in amounts equal to the greater of
(i) net gain from operations in the case of a life insurance company or net
income in the case of all other insurance companies for the preceding calendar
year or (ii) 10% of surplus as of the preceding December 31st. Any dividend in
excess of these levels requires the prior approval of the Director or
Commissioner of the state insurance department of the state in which the
dividend paying insurance subsidiary is domiciled. The aggregate amount of
dividends that may be paid in 2003 from all of HMEC's insurance subsidiaries
without prior regulatory approval is approximately $43 million.
Notwithstanding the foregoing, if insurance regulators otherwise determine
that payment of a dividend or any other payment to an affiliate would be
detrimental to an insurance subsidiary's policyholders or creditors, because of
the financial condition of the insurance subsidiary or otherwise, the regulators
may block dividends or other payments to affiliates that would otherwise be
permitted without prior approval.
The insurance subsidiaries' sources of funds consist primarily of premiums
and contract fees, investment income and proceeds from sales and redemption of
investments. Such funds are applied primarily to payment of claims and benefits
to policyholders, insurance operating expenses, income taxes and the purchase of
investments, as well as dividends and other payments to HMEC.
Competition
The insurance industry consists of a large number of insurance companies,
some of which have substantially greater financial resources, more diversified
product lines, and lower cost marketing approaches compared to the Company, such
as direct marketing, mail, internet and telemarketing. The Company believes that
the principal competitive factors in the sale of property and casualty insurance
products are price, service, name recognition and education association
sponsorships. The Company believes that the principal competitive factors in the
sale of life insurance and annuity products are product features, perceived
stability of the insurer, service, name recognition, education association
sponsorships and price.
The Company operates in a highly competitive environment. There are
numerous insurance companies that compete with the Company, although management
believes that the Company is the largest national multiline insurance company to
target the nation's educators as its primary market. In some specific instances
and geographic locations competitors have specifically targeted the educator
marketplace with specialized products and programs.
The Company competes in its target market with a number of national
providers of personal automobile and homeowners insurance and life insurance
such as State Farm, Allstate, Farmers and Nationwide as well as several regional
companies. The Company also competes for automobile business with certain direct
marketing companies, such as 21st Century, AIG, GEICO and USAA.
For annuity business, the marketplace has seen a competitive impact from
new entrants such as mutual funds and banks into the tax-deferred annuity
products market. Among the major national providers of annuities to educators,
Variable Annuity Life Insurance Company, a subsidiary of American International
Group ("AIG"), has been among the Company's major tax-qualified annuity
competitors. Mutual fund families, independent agent companies and financial
planners are also competitors of the Company.
25
Insurance Financial Ratings
The Company believes that the ratings assigned to its principal insurance
subsidiaries by A.M. Best, Standard & Poor's Corporation ("Standard and Poor's"
or "S&P"), Fitch Ratings, Ltd, ("Fitch") and Moody's Investors Service, Inc.
("Moody's") contribute to the Company's competitiveness.
A.M. Best
Each of HMEC's principal insurance subsidiaries is rated "A (Excellent)" by
A.M. Best. In 2002, A.M. Best downgraded the financial strength ratings of HMIC,
TIC, HMPCIC and HM Lloyd's 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 of each of the Company's subsidiaries as "Stable."
A.M. Best's ratings for the industry range from "A++ (Superior)" to "F (In
Liquidation)", and some companies are not rated. Publications of A.M. Best
indicate that the "A++ and A+ (Superior)" ratings are assigned to those
companies that in A.M. Best's opinion have, on balance, superior balance sheet
strength, operating performance and business profile when compared to the
quantitative and qualitative standards established by A.M. Best and have a very
strong ability to meet their ongoing obligations to policyholders. The "A and A-
(Excellent)" ratings are assigned to those companies that in A.M. Best's opinion
have, on balance, excellent balance sheet strength, operating performance and
business profile when compared to the quantitative and qualitative standards
established by A.M. Best and have a strong ability to meet their ongoing
obligations to policyholders. In evaluating a company's balance sheet strength,
operating performance and business profile, A.M. Best reviews the company's
capitalization/leverage, capital structure/holding company, credit quality and
appropriateness of reinsurance program, adequacy of loss/policy reserves,
quality and diversification of assets, liquidity, profitability, market risk,
revenue composition, management experience and objectives, competitive market
position, spread of risk and event risk. The objective of A.M. Best's rating
system is to provide an overall opinion of an insurance company's ability to
meet its obligations to policyholders.
Standard & Poor's
Each of HMEC's principal insurance subsidiaries is rated "A+ (Strong)" for
financial strength by Standard & Poor's with a ratings outlook of "Stable", with
the exception of HM Lloyds which is not yet rated by Standard & Poor's.
S&P publications define financial strength ratings as follows. A Standard &
Poor's Insurer Financial Strength Rating is a current opinion of the financial
security characteristics of an insurance organization with respect to its
ability to pay under its insurance policies and contracts in accordance with
their terms. This opinion is not specific to any particular insurance policy or
contract, nor does it address the suitability of a particular insurance policy
or contract for a specific purpose or purchaser. Furthermore, the opinion does
not take into account deductibles, surrender or cancellation penalties, the
timeliness of payment, or the likelihood of the use of a defense such as fraud
to deny claims. Insurer Financial Strength Ratings do not refer to an insurer's
ability to meet nonpolicy obligations (i.e., debt contracts). The ratings are
based on current information furnished by the insurance company or obtained by
S&P from other sources it considers reliable. S&P does not perform an audit in
connection with any rating and may, on occasion, rely on unaudited financial
information. The ratings may be changed, suspended, or withdrawn as a
26
result of changes in, or unavailability of, such information or based on other
circumstances. Financial strength ratings are divided into two broad
classifications. An insurer rated "BBB" or higher is regarded as having
financial security characteristics that outweigh any vulnerabilities, and is
highly likely to have the ability to meet financial commitments. An insurer
rated "BB" or lower is regarded as having vulnerable characteristics that may
outweigh its strengths. "BB" indicates the least degree of vulnerability within
the range; "CC" the highest. Financial strength ratings are assigned at the
request of the insurers and based on extensive quantitative and qualitative
analysis including consideration of ownership and support factors, if
applicable. The rating process includes meetings with insurers' management. Plus
(+) and minus (-) signs show relative standing within the major rating
categories; they do not suggest likely upgrades or downgrades. Insurers rated
"AAA" offer extremely strong financial security characteristics. Insurers rated
"AA" offer very strong financial security characteristics. Insurers rated "A"
offer strong financial security characteristics, but are, in S&P's opinion,
somewhat more likely to be affected by adverse business conditions than are
insurers with higher ratings. CreditWatch highlights the potential direction of
a short- or long-term rating. It focuses on identifiable events and short-term
trends that cause ratings to be placed under special surveillance by S&P's
analytical staff. Ratings appear on CreditWatch when such an event or a
deviation from an expected trend occurs and additional information is necessary
to evaluate the current rating. A CreditWatch listing, however, does not mean a
rating change is inevitable.
Fitch
Each of HMEC's principal insurance subsidiaries is rated "AA- (Very
Strong)" for financial strength by Fitch. In September 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 Company's second quarter 2002 investment losses described in Management's
Discussion and Analysis of Financial Condition and Results of Operations listed
on Page F-1 of this report, 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.
A Fitch Insurer Financial Strength Rating ("IFS Rating") provides an
assessment of the financial strength of an insurance organization and its
capacity to meet senior obligations to policyholders and contractholders on a
timely basis. The IFS Rating is assigned to the insurance organization itself,
and no liabilities or obligations of the insurer are specifically rated unless
otherwise stated. The IFS Rating is based on a comprehensive analysis of
relevant factors that in large part determine an insurance organization's
financial strength, including its regulatory solvency characteristics,
liquidity, operating performance, financial flexibility, balance sheet strength,
management quality, competitive positioning and long-term business viability.
The IFS Ratings use a scale of "AAA" through "D" and may be amended with a (+)
or (-) sign to show relative standing within the major rating category. Ratings
of "BBB-" and higher are considered to be "Secure", and those of "BB+" and lower
are considered to be "Vulnerable". The IFS Rating of "AA" is assigned to
insurers that are viewed by Fitch as possessing very strong capacity to meet
policyholder and contract obligations. Risk factors are viewed to be modest, and
the impact of any adverse business and economic factors is expected to be very
small. Placing a company's ratings on "Ratings Watch Negative" reflects the
apparent decline in key factors upon which the
27
rating is based. Being placed on ratings watch, however, does not mean a rating
change is inevitable.
Moody's
HMLIC, HMIC, TIC and HMPCIC are rated "A2 (Good)" for financial strength by
Moody's. In July 2002, Moody's affirmed the "A2 (Good)" 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 described in
Management's Discussion and Analysis of Financial Condition and Results of
Operations listed on Page F-1 of this report, as well as the Company's increased
financial leverage and the competitive nature of the annuity markets in which
the Company competes. 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.
A Moody's Insurance Financial Strength Rating is an opinion of the ability
of a company to punctually repay senior policyholder obligations and claims.
Specific obligations are considered unrated unless individually rated. Moody's
Insurance Financial Strength Ratings are based on qualitative factors of both
the industry and the company and quantitative financial analysis. Industry
analysis examines trends effecting the industry, the overall economic
environment, concentration within the industry, demographics and competitive
issues, the impact of financial convergence and consolidation and the accounting
and regulatory environments. The analysis of a company's business fundamentals
focuses primarily on organizational structure, ownership, corporate governance,
strategic issues, quality of management, company franchise, distribution and
product characteristics. The financial analysis includes an assessment of
capital adequacy, financial leverage, profitability, asset/liability management
and liquidity, asset quality, investment risk and business fundamentals. Moody's
rating symbols for insurance financial strength ratings are broken down into
nine distinct symbols ranging from "Aaa (Exceptional)" to "C (Lowest)". These
symbols comprise two distinct groups - those with the greatest financial
strength, "Aaa (Exceptional)" to "Baa (Adequate)", and those with the least
financial strength, "Ba (Questionable)" to "C (Lowest)". Numeric modifiers are
used to refer to the ranking within the group - "1" being the highest and "3"
being the lowest. However, the financial strength of companies within a generic
rating symbol is broadly the same. Insurance Companies rated "A" offer good
financial security. However, elements may be present which suggest a
susceptibility to impairment sometime in the future.
Regulation
General Regulation at State Level
As an insurance holding company, HMEC is subject to regulation by the
states in which its insurance subsidiaries are domiciled or transact business.
Most states have enacted legislation that requires each insurance company in a
holding company system to register with the insurance regulatory authority of
its state of domicile and furnish to it financial and other information
concerning the operations of companies within the holding company system that
may materially affect the operations, management or financial condition of the
insurers within the system. All transactions within a holding company system
affecting insurers must be fair and equitable and the insurer's policyholder
surplus following any transaction must be both reasonable in relation to its
outstanding liabilities and adequate for its needs. Notice to applicable
regulators is required prior to the consummation of certain transactions
affecting insurance subsidiaries of the holding company system.
28
In addition, the laws of the various states establish regulatory agencies
with broad administrative powers to grant and revoke licenses to transact
business, regulate trade practices, license agents, require statutory financial
statements, and prescribe the type and amount of investments permitted. See
"Business - Investments" for discussion of investment restrictions or
limitations imposed upon the Company under applicable insurance laws and
regulations.
The NAIC annually calculates financial ratios to assist state insurance
regulators in monitoring the financial condition of insurance companies. A
"usual range" of results for each ratio is used as a benchmark. Separate ratios
are established for property and casualty and life insurance companies.
Departure from the usual range in any of the ratios could lead to inquiries from
individual state regulators, and further investigation or other actions may
result. In 2002, some of the principal insurance subsidiaries of HMEC did report
financial ratios that were outside the usual range of results used as a
benchmark. These unusual ratios were primarily the result of increased realized
capital loss levels reported in 2002, a life reinsurance agreement entered into
during 2002 with Sun Life Reinsurance Company Limited, declines in income yields
due to the low interest rate environment, adverse property and casualty loss
reserve development from prior accident years, and growth in homeowners
premiums.
As part of their regulatory oversight process, state insurance departments
routinely conduct detailed financial examinations (generally not more frequently
than once every three years) of the books, records and accounts of insurance
companies domiciled in their states. Typically, such examinations are conducted
concurrently by two or three states under guidelines promulgated by the NAIC. In
1999, routine financial examinations of HMLIC, HMIC, TIC and HMPCIC were
completed for the period ended December 31, 1997. A routine examination of
HMPCIC for the three year period ended December 31, 2000 was initiated in
December 2000, and the final examination report was issued in 2002. A routine
examination of HM Lloyd's for the two year period ended December 31, 2000 was
completed in 2001. A routine examination of HM Lloyd's for the one year period
ended December 31, 2001 was initiated in September 2002; audit fieldwork has
been completed with issuance of the final examination report still pending. The
Company has received notification that a similar examination for HM Lloyd's for
the one year period ended December 31, 2002 will be performed in 2003. The
Company has received notification that routine examinations of HMLIC, HMIC and
TIC for the five year period ended December 31, 2002 will be conducted in 2003.
Management believes that HMEC and its subsidiaries are in compliance in all
material respects with all applicable regulatory requirements.
The NAIC has adopted risk-based capital guidelines to evaluate the adequacy
of statutory capital and surplus in relation to an insurance company's risks.
State insurance regulations prohibit insurance companies from making any public
statements or representations with regard to their risk-based capital levels.
Based on current guidelines, the risk-based capital statutory requirements will
have no negative regulatory impact on the Company's insurance subsidiaries.
Assessments Against Insurers
Under insurance insolvency or guaranty laws in most states in which the
Company operates, insurers doing business therein can be assessed for
policyholder losses related to insolvencies of other insurance companies. The
amount and timing of any future assessments on the Company under these laws
cannot be reasonably estimated and are beyond the control of the Company. Most
of these laws do provide, however, that an assessment may be excused or deferred
if it would threaten an insurer's financial strength, and many assessments paid
by the Company pursuant to these laws may be used as credits for a portion of
the Company's premium taxes in certain states. The Company paid $1.0 million,
$0.6 million and $0.1 million in connection
29
with insurer insolvency proceedings for the years ended December 31, 2002, 2001
and 2000, respectively, of which $0.3 million, $0.1 million and $0 million for
the same periods, respectively, is recoverable as premium tax credits in future
periods. The Company's payments in 2002 and 2001 included $0.7 million and $0.4
million, respectively, related to the insolvency of the Reliance Insurance
Group. A total charge of $1.3 million pretax, representing the Company's
estimated portion of the industry assessment for this insolvency, was reflected
in the Company's operating expenses for the year ended December 31, 2001.
Mandatory Insurance Facilities
The Company is required to participate in various mandatory insurance
facilities in proportion to the amount of the Company's direct writings in the
applicable state. In 2002, the Company reflected a net loss from participation
in such mandatory pools and underwriting associations of $2.4 million before
federal income taxes. For additional information on the Company's strategic
direction for automobile business in the state of Massachusetts, see also
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Year Ended December 31, 2001 Compared to
Year Ended December 31, 2000 -- Insurance Premiums and Contract Charges, and --
Net Income."
California Earthquake Authority
The California Earthquake Authority ("CEA") was formed by the California
Legislature to encourage companies to write residential property insurance in
California and began operating in December 1996. All companies which write
residential property insurance in California are also required to offer
earthquake coverage. The CEA operates as an insurance company providing
residential property earthquake coverage under policies sold by companies which
have chosen to participate in the CEA. The participating companies fund the CEA
and share in earthquake losses covered by the CEA in proportion to their market
share.
The Company has not joined the CEA. The Company's exposure to losses from
earthquakes is managed through its underwriting standards, its earthquake policy
coverage limits and deductible levels, and the geographic distribution of its
business, as well as its reinsurance program. After reviewing the exposure to
earthquake losses from its own policies and from participation in the CEA,
management believes it is in the Company's best economic interest to offer
earthquake coverage directly to its homeowners policyholders. See "Property and
Casualty Segment -- Property and Casualty Reinsurance."
Regulation at Federal Level
Although the federal government generally does not directly regulate the
insurance industry, federal initiatives often impact the insurance business.
Current and proposed federal measures which may significantly affect insurance
and annuity business include employee benefits regulation, controls on the costs
of medical care, medical entitlement programs such as Medicare, structure of
retirement plans and accounts, changes to the insurance industry anti-trust
exemption, minimum solvency requirements and allowing national banks to engage
in the insurance, annuity and mutual fund businesses. With the passage of the
Financial Services Modernization Act of 1999, it is possible there will be
increased pressure for federal regulation of the insurance industry.
30
Federal income taxation of the build-up of cash value within a life
insurance policy or an annuity contract could have a material adverse impact on
the Company's ability to market and sell such products. Various legislation to
this effect has been proposed in the past, but has not been enacted. Although no
such legislative proposals are known to exist at this time, such proposals may
be made again in the future. Changes in other federal and state laws and
regulations could also affect the relative tax and other advantages of the
Company's life and annuity products to customers.
The variable annuities underwritten by HMLIC and the Company's proprietary
mutual funds offered as investment vehicles for those products are regulated by
the Securities and Exchange Commission (the "SEC"). Horace Mann Investors, Inc.,
the broker-dealer subsidiary of HMEC, performs certain management functions for
the Company's proprietary mutual funds and also is regulated by the SEC and the
NASD.
Employees
At December 31, 2002, the Company had approximately 2,600 employees,
including 922 full-time agents. The Company has no collective bargaining
agreement with any employees, and management believes that its employee
relations are satisfactory.
ITEM 2. Properties
HMEC's home office property at 1 Horace Mann Plaza in Springfield,
Illinois, consists of an office building totaling approximately 230,000 square
feet which is owned by the Company. The Company also owns buildings with an
aggregate of approximately 38,000 square feet at other locations in Springfield.
The Company leases buildings in Springfield with an aggregate of approximately
84,000 square feet. In addition, the Company leases office space in other states
related to claims and agency offices which are smaller in size. These properties
are adequate and suitable for the Company's current and anticipated future
needs.
ITEM 3. Legal Proceedings
The Company is not currently party to any material pending legal
proceedings other than ordinary routine litigation incidental to its business.
See also "Note 12 - Contingencies - Lawsuits and Legal Proceedings" contained in
the Index to Financial Information on page F-1 herein.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
31
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
HMEC's common stock began trading on the New York Stock Exchange ("NYSE")
in November 1991 under the symbol of HMN at a price of $9 per share. The
following table sets forth the high and low sales prices of the common stock on
the NYSE Composite Tape and the cash dividends paid per share of common stock
during the periods indicated.
Market Price
---------------- Dividend
Fiscal Period High Low Paid
- ------------- ------- ------ --------
2002:
Fourth Quarter............... $ 16.49 $13.61 $0.105
Third Quarter................ 18.86 14.00 0.105
Second Quarter............... 24.08 17.45 0.105
First Quarter................ 23.00 19.35 0.105
2001:
Fourth Quarter............... $ 22.40 $16.25 $0.105
Third Quarter................ 22.05 15.72 0.105
Second Quarter............... 21.75 14.80 0.105
First Quarter................ 21.375 15.25 0.105
As of February 28, 2003, the approximate number of holders of common stock
was 5,000.
In February, 2003, the Company's Board of Directors announced a regular
quarterly dividend of $0.105 per share. The payment of dividends in the future
is subject to the discretion of the Board of Directors and will depend upon
general business conditions, legal restrictions and other factors the Board of
Directors of HMEC may deem to be relevant.
In May 1999, the Company's Board of Directors authorized the repurchase of
shares of the Company's common stock up to $100 million. This was in addition to
the $100 million stock repurchase programs announced in January 1998 and
February 1997. Since early 1997, the Company has repurchased 8,165,100 shares,
17% of the Company's shares outstanding at December 31, 1996, at an aggregate
cost of $203.7 million. Under the share repurchase program, shares of common
stock may be purchased from time to time through open market and private
purchases, as available. The repurchase of shares is financed through use of
cash and, when necessary, the existing bank line of credit. However, the Company
has not utilized the bank line of credit for share repurchases since the second
quarter of 1999. As of December 31, 2002, $96.3 million remained authorized for
future share repurchases. However, in 2001 management stated its intention to
utilize excess capital to support the Company's strategic growth initiatives.
During 2002, options were exercised for the issuance of 107,410 shares,
0.3% of the Company's shares outstanding at December 31, 2001.
On December 10, 2002 the Company repurchased $56.0 million aggregate
principal amount of its Senior Convertible Notes, representing $26.6 million
carrying value, for $26.0 million. As consideration for the repurchase, the
Company issued 1,837,925 shares of its common stock.
32
As an insurance holding company, HMEC depends on dividends and other
permitted payments from its insurance subsidiaries to pay cash dividends to
shareholders of HMEC. The payment of dividends and such other payments to HMEC
by its insurance subsidiaries is subject to the laws of each subsidiary's state
of domicile. See "Business -- Cash Flow" and "Business -- Regulation."
The information required by Item 201(d) of Regulation S-K is incorporated
by reference to the Company's Proxy Statement for the 2003 Annual Meeting of
Shareholders.
ITEM 6. Selected Financial Data
The information required by Item 301 of Regulation S-K is contained in the
table in Item 1--"Business--Selected Historical Consolidated Financial Data."
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The information required by Item 303 of Regulation S-K is contained in the
Index to Financial Information on page F-1 herein.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
The information required by Item 305 of Regulation S-K is contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contained in the Index to Financial Information on page F-1 herein.
ITEM 8. Consolidated Financial Statements and Supplementary Data
The Company's consolidated financial statements, the report of its
independent accountants and the selected quarterly financial data required by
Item 302 of Regulation S-K are contained in the Index to Financial Information
on page F-1 herein.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
ITEM 10. Directors and Executive Officers of the Registrant
The information required by Items 401 and 405 of Regulation S-K is
incorporated by reference to the Company's Proxy Statement for the 2003 Annual
Meeting of Shareholders.
ITEM 11. Executive Compensation
The information required by Item 402 of Regulation S-K is incorporated by
reference to the Company's Proxy Statement for the 2003 Annual Meeting of
Shareholders.
33
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The information required by Items 201(d) and 403 of Regulation S-K is
incorporated by reference to the Company's Proxy Statement for the 2003 Annual
Meeting of Shareholders.
ITEM 13. Certain Relationships and Related Transactions
The information required by Item 404 of Regulation S-K is incorporated by
reference to the Company's Proxy Statement for the 2003 Annual Meeting of
Shareholders.
ITEM 14. 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 Rules
13a-14 and 15d-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 in the Company's disclosure
controls and procedures 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 IV
ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) The following consolidated financial statements of the Company are
contained in the Index to Financial Information on Page F-1 herein:
Consolidated Balance Sheets as of December 31, 2002, 2001 and 2000.
Consolidated Statements of Operations for the Years Ended December 31,
2002, 2001 and 2000.
Consolidated Statements of Changes in Shareholders' Equity for the
Years Ended December 31, 2002, 2001 and 2000.
Consolidated Statements of Cash Flows for the Years Ended December 31,
2002, 2001 and 2000.
34
(a)(2) The following consolidated financial statement schedules of the
Company are contained in the Index to Financial Information on page F-1 herein:
Schedule I - Summary of Investments - Other than Investments in
Related Parties.
Schedule II - Condensed Financial Information of Registrant.
Schedules III and VI Combined - Supplementary Insurance Information
and Supplemental Information Concerning Property and Casualty Insurance
Operations.
Schedule IV - Reinsurance.
(a)(3) The following items are filed as Exhibits. Management contracts and
compensatory plans are indicated by an asterisk (*).
Exhibit
No. Description
- ------- -----------
(3) Articles of incorporation and bylaws:
3.1 Restated Certificate of Incorporation of HMEC, filed with the
Delaware Secretary of State on October 6, 1989, incorporated by
reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1996, filed with the
Securities and Exchange Commission (the "SEC") on November 14,
1996.
3.1(a) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on October 18,
1991, incorporated by reference to Exhibit 3.2 to HMEC's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1996,
filed with the SEC on November 14, 1996.
3.1(b) Certificate of Amendment to Restated Certificate of
Incorporation of HMEC, filed with the Delaware Secretary of
State on August 23, 1995, incorporated by reference to Exhibit
3.3 to HMEC's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1996, filed with the SEC on November 14,
1996.
3.1(c) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on September
23, 1996, incorporated by reference to Exhibit 3.4 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1996, filed with the SEC on November 14, 1996.
3.1(d) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on June 5,
1998, incorporated by reference to Exhibit 3.1 to HMEC's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998, filed
with the SEC on August 13, 1998.
3.1(e) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on June 22,
2000, incorporated by reference to Exhibit 3.1(e) to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000,
filed with the SEC on August 11, 2000.
35
Exhibit
No. Description
- ------- -----------
3.2 Form of Certificate for shares of Common Stock, $0.001 par value
per share, of HMEC, incorporated by reference to Exhibit 4.5 to
HMEC's Registration Statement on Form S-3 (Registration No.
33-53118) filed with the SEC on October 9, 1992.
3.3 Bylaws of HMEC, incorporated by reference to Exhibit 4.6 to HMEC's
Registration Statement on Form S-3 (Registration No. 33-80059)
filed with the SEC on December 6, 1995.
(4) Instruments defining the rights of security holders, including indentures:
4.1 Indenture dated as of January 17, 1996, between HMEC and U.S.
Trust Company of California, N.A. as trustee, with regard to
HMEC's 6 5/8% Senior Notes Due 2006, incorporated by reference to
Exhibit 4.4 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1995, filed with the SEC on March 13, 1996.
4.1(a) Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.1).
4.2 Indenture dated as of May 14, 2002, between HMEC and JPMorgan
Chase Bank as trustee, with regard to HMEC's 1.425% Senior
Convertible Notes Due 2032, incorporated by reference to Exhibit
4.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2002, filed with the SEC on August 14, 2002.
4.2(a) Form of 1.425% Senior Convertible Notes Due 2032 (included in
Exhibit 4.2).
4.3 Certificate of Designations for HMEC Series A Cumulative
Convertible Preferred Stock (included in Exhibit 10.13).
(10) Material contracts:
10.1 Credit Agreement dated as of May 29, 2002 (the "Bank Credit
Facility") among HMEC, certain financial institutions named
therein and Bank of America, N.A., as administrative agent (the
"Agent"), incorporated by reference to Exhibit 10.1 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2002,
filed with the SEC on August 14, 2002.
10.2* Stock Subscription Agreement among HMEC (as successor to HME
Holdings, Inc.), The Fulcrum III Limited Partnership, The Second
Fulcrum III Limited Partnership and each of the Management
Investors, incorporated by reference to Exhibit 10.17 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1989,
filed with the SEC on April 2, 1990.
10.3* Horace Mann Educators Corporation Deferred Equity Compensation
Plan for Directors, incorporated by reference to Exhibit 10.1 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996, filed with the SEC on November 14, 1996.
36
Exhibit
No. Description
- ------- -----------
10.4* Horace Mann Educators Corporation Deferred Compensation Plan for
Employees, incorporated by reference to Exhibit 10.4 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1997,
filed with the SEC on March 30, 1998.
10.5* Amended and Restated Horace Mann Educators Corporation 1991 Stock
Incentive Plan, incorporated by reference to Exhibit 10.5 to
HMEC's Annual Report on Form 10-K for the year ended December 31,
1999, filed with the SEC on March 30, 2000.
10.5(a)* Amendment to Amended and Restated Horace Mann Educators
Corporation 1991 Stock Incentive Plan, incorporated by reference
to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2000, filed with the SEC on August 11,
2000.
10.5(b)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.5(a) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1999, filed with the SEC on March
30, 2000.
10.5(c)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.5(b) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1999, filed with the SEC on March
30, 2000.
10.6* Horace Mann Educators Corporation 2001 Stock Incentive Plan,
incorporated by reference to Exhibit 10.6 to HMEC's Annual Report
on Form 10-K for the year ended December 31, 2001, filed with the
SEC on March 29, 2002.
10.6(a)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 2001 Stock Incentive Plan, incorporated by
reference to Exhibit 10.6(a) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 2001, filed with the SEC on March
29, 2002.
10.6(b)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 2001 Stock Incentive Plan, incorporated by
reference to Exhibit 10.6(b) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 2001, filed with the SEC on March
29, 2002.
10.7* Horace Mann Educators Corporation 2002 Incentive Compensation
Plan, incorporated by reference to Exhibit 10.2 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2002,
filed with the SEC on August 14, 2002.
37
Exhibit
No. Description
- ------- -----------
10.7(a)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 2002 Incentive Compensation Plan,
incorporated by reference to Exhibit 10.2(a) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002, filed
with the SEC on August 14, 2002.
10.7(b)* Specimen Regular Employee Stock Option Agreement under the Horace
Mann Educators Corporation 2002 Incentive Compensation Plan,
incorporated by reference to Exhibit 10.2(b) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002, filed
with the SEC on August 14, 2002.
10.7(c)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 2002 Incentive Compensation Plan,
incorporated by reference to Exhibit 10.2(c) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002, filed
with the SEC on August 14, 2002.
10.8* Severance Agreements between HMEC and certain officers of HMEC,
incorporated by reference to Exhibit 10.7 to HMEC's Annual Report
on Form 10-K for the year ended December 31, 2001, filed with the
SEC on March 29, 2002.
10.8(a)* Revised Schedule to Severance Agreements between HMEC and certain
officers of HMEC.
10.9* Horace Mann Supplemental Employee Retirement Plan, 2002
Restatement, incorporated by reference to Exhibit 10.1 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2002, filed with the SEC on May 15, 2002.
10.10* Horace Mann Executive Supplemental Employee Retirement Plan, 2002
Restatement, incorporated by reference to Exhibit 10.2 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2002, filed with the SEC on May 15, 2002.
10.11* Horace Mann Nonqualified Supplemental Money Purchase Pension Plan,
incorporated by reference to Exhibit 10.3 to HMEC's Quarterly
Report on Form 10-Q for the Quarter Ended March 31, 2002, filed
with the SEC on May 15, 2002.
10.12* Employment Agreement entered by and between HMEC and Louis G.
Lower II as of December 31, 1999, incorporated by reference to
Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1999, filed with the SEC on March 30, 2000.
10.13 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, incorporated by reference to Exhibit 10.1 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002, filed with the SEC on November 14, 2002.
38
Exhibit
No. Description
- ------- -----------
(11) Statement regarding computation of per share earnings.
(12) Statement regarding computation of ratios.
(21) Subsidiaries of HMEC.
(23) Consent of KPMG LLP.
(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) During the fourth quarter of 2002, HMEC filed three Current Reports on
Form 8-K with the SEC, each containing an Item 5 Other Events and an
Item 7 Financial Statements and Exhibits, as follows:
1. Dated November 4, 2002, regarding the Company's press release
reporting its financial results for the three and nine month
periods ended September 30, 2002.
2. Dated November 4, 2002, regarding the Company's press release
announcing the effectiveness of its Shelf Registration Statement
on Form S-3 (Registration No. 333-98043) which registers the
resale of the Company's Senior Convertible Notes due May 14, 2032
by the security holders listed in the prospectus contained in the
registration statement and the common shares issuable upon
conversion of the Senior Convertible Notes.
3. Dated December 10, 2002, regarding the Company's press release
reporting two capital transactions, one designed to improve its
capitalization at the holding company level and one to improve
the statutory surplus of its primary life insurance subsidiary.
(c) See list of exhibits in this Item 15.
(d) See list of financial statement schedules in this Item 15.
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Horace Mann Educators Corporation has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
HORACE MANN EDUCATORS CORPORATION
/s/ Louis G. Lower II
- -------------------------------------
Louis G. Lower II
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of Horace Mann
Educators Corporation and in the capacities and on the date(s) indicated.
Principal Executive Officer: Directors:
/s/ Louis G. Lower II /s/ Joseph J. Melone
- -------------------------------------- ------------------------------------
Louis G. Lower II Joseph J. Melone, Chairman of the
President, Board of Directors
Chief Executive Officer and a Director
/s/ William W. Abbott
------------------------------------
William W. Abbott, Director
/s/ Mary H. Futrell
------------------------------------
Principal Financial Officer: Mary H. Futrell, Director
/s/ Peter H. Heckman /s/ Donald E. Kiernan
- -------------------------------------- ------------------------------------
Peter H. Heckman Donald E. Kiernan, Director
Executive Vice President and
Chief Financial Officer
/s/ Jeffrey L. Morby
------------------------------------
Jeffrey L. Morby, Director
/s/ Shaun F. O'Malley
------------------------------------
Shaun F. O'Malley, Director
Principal Accounting Officer:
/s/ Bret A. Conklin /s/ Charles A. Parker
- -------------------------------------- ------------------------------------
Bret A. Conklin Charles A. Parker, Director
Senior Vice President and Controller
/s/ William J. Schoen
------------------------------------
William J. Schoen, Director
Dated: March 26, 2003
40
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 annual report on Form 10-K of Horace Mann Educators
Corporation;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officer 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 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 annual 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 annual report (the "Evaluation Date"); and
c) presented in this annual 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
functions):
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
41
6. The registrant's other certifying officer and I have indicated in this annual
report whether 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: March 26, 2003 /s/ Louis G. Lower II
------------------------ -------------------------------------
Louis G. Lower II
President and Chief Executive Officer
42
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 annual report on Form 10-K of Horace Mann Educators
Corporation;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officer 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 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 annual 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 annual report (the "Evaluation Date"); and
c) presented in this annual 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
functions):
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
43
6. The registrant's other certifying officer and I have indicated in this annual
report whether 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: March 26, 2003 /s/ Peter H. Heckman
------------------------- -------------------------------------
Peter H. Heckman
Executive Vice President and
Chief Financial Officer
44
HORACE MANN EDUCATORS CORPORATION
INDEX TO FINANCIAL INFORMATION
Page
----
Management's Discussion and Analysis of
Financial Condition and Results of Operations....................... F- 2
Report of Management Responsibility for Financial Statements........... F-51
Independent Auditors' Report........................................... F-52
Consolidated Balance Sheets............................................ F-53
Consolidated Statements of Operations.................................. F-54
Consolidated Statements of Changes in Shareholders' Equity............. F-55
Consolidated Statements of Cash Flows.................................. F-56
Notes to Consolidated Financial Statements
Note 1 - Summary of Significant Accounting Policies................ F-57
Note 2 - Restructuring Charges..................................... F-68
Note 3 - Investments............................................... F-70
Note 4 - Property and Casualty Unpaid Claims and Claim Expenses.... F-73
Note 5 - Debt...................................................... F-76
Note 6 - Shareholders' Equity and Stock Options.................... F-79
Note 7 - Income Taxes.............................................. F-82
Note 8 - Fair Value of Financial Instruments....................... F-83
Note 9 - Statutory Surplus and Subsidiary Dividend Restrictions.... F-85
Note 10 - Pension Plans and Other Postretirement Benefits........... F-86
Note 11 - Reinsurance............................................... F-91
Note 12 - Contingencies............................................. F-93
Note 13 - Supplementary Data on Cash Flows.......................... F-94
Note 14 - Segment Information....................................... F-94
Note 15 - Unaudited Interim Information............................. F-96
Financial Statement Schedules:
Schedule I - Summary of Investments-Other than
Investments in Related Parties................................... F-97
Schedule II - Condensed Financial Information of Registrant......... F-98
Schedule III and VI Combined - Supplementary Insurance
Information and Supplemental Information Concerning
Property and Casualty Insurance Operations........................ F-102
Schedule IV - Reinsurance........................................... F-103
F-1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in millions, except per share data)
Forward-looking Information
Statements made in the following discussion that state the Company's or
management's intentions, hopes, beliefs, expectations or predictions of 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.
. 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, (ii) the book yield of the
Company's investment portfolio and (iii) the Company's ability to
maintain appropriate interest rate spreads over the fixed rates
guaranteed in the Company's life and annuity products.
. 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.
. 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.
. Disruptions of the general business climate, investments, capital
markets and consumer attitudes caused by geopolitical acts such as
terrorism, war or other similar events.
. The impact of a disaster or catastrophic event affecting the Company's
employees or its home office facilities and the Company's ability to
recover and resume its business operations on a timely basis.
. 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.
F-2
. The competitive impact of new entrants such as mutual funds and banks
into the tax-deferred annuity products markets, and the Company's
ability to profitably expand its property and casualty business in
highly competitive environments.
. Changes in insurance regulations, including (i) those affecting the
ability of the Company's insurance subsidiaries to distribute cash to
the holding company and (ii) those impacting the Company's ability to
profitably write property and casualty insurance policies in one or
more states.
. Changes in federal income tax laws and changes resulting from federal
tax audits affecting corporate tax rates or taxable income.
. Changes in federal and state laws and regulations which affect the
relative tax and other 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. 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. Management has discussed with the Audit
Committee the quality, not just the acceptability, of the Company's accounting
principles as applied in its financial reporting. The discussions generally
included such matters as the consistency of the Company's accounting policies
and their application, and the clarity and completeness of the Company's
financial statements, which include related disclosures. 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.
Underwriting results of the property and casualty segment are significantly
influenced by estimates of the Company's ultimate liability for insured events.
Reserves for property and casualty claims include provisions for payments to be
made on reported claims, claims incurred but not yet reported and associated
settlement expenses. The process by which these reserves are established
requires reliance upon estimates based on known facts and on interpretations of
circumstances, including the Company's experience with similar cases and
historical trends involving claim payment patterns, claim payments, pending
levels of unpaid claims and product mix, as well as other factors including
court decisions, economic conditions and public attitudes. Adjustments may be
required as information develops which varies from experience, 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
F-3
income for the period in which the adjustments are made. Due to the nature of
the Company's personal lines business, the Company has no exposure to claims for
toxic waste cleanup, other environmental remediation or asbestos-related
illnesses other than claims under homeowners insurance policies for
environmentally related items such as toxic mold.
The Company 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 on claims reported to the Company) 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.
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.
The Company has established a guaranteed minimum death benefit ("GMDB")
reserve on variable annuity contracts and regularly monitors this reserve
considering fluctuations in the financial markets. At December 31, 2002, under
GAAP, the GMDB reserve was $0.8 million. The comparable reserve under statutory
accounting principles was $1.6 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 rate of 3% to 5%. The
aggregate in-the-money death benefits under the GMDB provision totaled $115
million at December 31, 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 currently
increase/decrease less than $0.1 million.
Policy acquisition costs, consisting of commissions, policy issue 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 December 31, 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
F-4
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 currently impact amortization between $0.1
million and $0.2 million depending on the magnitude and direction of the
deviation.
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.
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) the stock price trend of the issuer, (4) the
market leadership position of the issuer, (5) the debt ratings of the issuer and
(6) the 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 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 the Company has the intent and ability to hold the investment
until maturity or a market recovery is realized. Management believes that its
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.
F-5
The Company's cost estimates for its defined benefit pension plan are
determined based on assumptions which include the discount rate, expected return
on plan assets and anticipated lump sum distributions. A discount rate of 6.75%
was used by the Company at December 31, 2002, which was based on the average
yield for long-term, high grade securities available during the pension benefit
payout period. To set its discount rate, the Company looks to leading
indicators, including Moody's Aa long-term bond index. The expected return on
plan assets assumed by the Company at December 31, 2002 was 7.50%. Management
believes that it has adopted realistic assumptions for the discount rate and
investment return. 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.
Results of Operations -- Year Ended December 31, 2002 Compared to Year Ended
December 31, 2001
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
Year Ended Growth Over
December 31, Prior Year
--------------- ----------------
2002 2001 Percent Amount
------ ------ ------- ------
Automobile and property (voluntary)...... $513.2 $496.6 3.3% $ 16.6
Excluding Massachusetts automobile.... 513.2 477.7 7.4% 35.5
Massachusetts automobile.............. -- 18.9 -100.0% (18.9)
Annuity deposits......................... 261.5 239.1 9.4% 22.4
Life .................................... 112.9 117.2 -3.7% (4.3)
------ ------ ------
Subtotal - core lines.............. 887.6 852.9 4.1% 34.7
Subtotal - core lines, excluding
Massachusetts automobile........ 887.6 834.0 6.4% 53.6
Involuntary and other
property & casualty................... 11.7 22.7 -48.5% (11.0)
Excluding Massachusetts
automobile......................... 10.5 14.9 -29.5% (4.4)
Massachusetts automobile.............. 1.2 7.8 -84.6% (6.6)
------ ------ ------
Total.............................. $899.3 $875.6 2.7% $ 23.7
====== ====== ======
Total, excluding Massachusetts
automobile...................... $898.1 $848.9 5.8% $ 49.2
====== ====== ======
F-6
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
Year Ended Growth Over
December 31, Prior Year
--------------- ----------------
2002 2001 Percent Amount
------ ------ ------- ------
Automobile and property (voluntary)...... $504.3 $485.5 3.9% $18.8
Excluding Massachusetts automobile.... 494.4 467.2 5.8% 27.2
Massachusetts automobile.............. 9.9 18.3 -45.9% (8.4)
Annuity.................................. 14.2 14.9 -4.7% (0.7)
Life .................................... 91.4 92.0 -0.7% (0.6)
------ ------ -----
Subtotal - core lines.............. 609.9 592.4 3.0% 17.5
Subtotal - core lines, excluding...
Massachusetts automobile........ 600.0 574.1 4.5% 25.9
Involuntary and other
property & casualty................... 15.3 22.8 -32.9% (7.5)
Excluding Massachusetts
automobile...................... 9.6 14.7 -34.7% (5.1)
Massachusetts automobile.............. 5.7 8.1 -29.6% (2.4)
------ ------ -----
Total.............................. $625.2 $615.2 1.6% $10.0
====== ====== =====
Total, excluding Massachusetts
automobile...................... $609.6 $588.8 3.5% $20.8
====== ====== =====
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 agents continue to write the Company's other products in
Massachusetts, including retirement annuities and property and life insurance.
Premiums written and contract deposits for the Company's core lines
increased 6.4% compared to the prior year, excluding Massachusetts voluntary
automobile premiums written in 2001. The growth reflected continuing
productivity gains of the Company's growing agent force and the success of
initiatives to expand the Company's penetration of the educator market.
Specifically, the increase 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.
Recent improvements in agent retention as well as an 18.6% increase in new
hires for 2002 resulted in growth in the total agent count of 6.3%, compared to
last year. The growth in agent count represents the most significant annual
increase in eight years. At December 31, 2002, the Company's exclusive agency
force totaled 922. Of those, 395 were in their first 24 months with the Company,
an increase of 25.8%, compared to December 31, 2001. The number of experienced
agents in the agency force, 527, was down 4.7% at December 31, 2002, compared to
a year earlier, due primarily to terminations of less-productive agents over the
12 months. This has contributed to the 6.5% annual increase in average agent
productivity for all lines of business combined in 2002. Average agent
productivity is measured as new sales premiums per the average number of agents
for the period.
F-7
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 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 are anticipated to have an adverse impact of approximately $350
million for the insurance industry. 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. Following the April 2002 effective date, this issue
negatively impacted the Company's earned premiums and pretax income by $1.8
million for the twelve months ended December 31, 2002. The Company's 2003 earned
premiums and pretax income are expected to be negatively impacted by
approximately $3 million as a result of this dispute over 2002 rates. A similar
dispute between the Commissioner and the Bureau is also in process regarding
2003 rates, which is expected to have a further adverse impact on 2003 results
of approximately $1 million pretax.
Growth in total voluntary automobile and homeowners premium written was
7.4% for 2002, excluding Massachusetts voluntary automobile written premiums of
$18.9 million from the prior year. Voluntary automobile insurance premium
written, excluding Massachusetts, increased 7.1% ($24.9 million) compared to
2001, and homeowners premium increased 8.4% ($10.6 million). The property and
casualty increase in premiums resulted from the impact of rate increases on
average premium per policy. Average written premium was up 6% for voluntary
automobile and 14% for homeowners, compared to a year earlier, while the average
earned premium increased 6% for voluntary automobile and 11% for homeowners. As
of December 31, 2002, approved rate increases for the Company's automobile and
homeowners business were 6% and 21%, respectively. The Company's competitors
have taken similar rate increases. Over the prior 12 months and excluding a
23,000 unit decrease in Massachusetts, automobile policies in force were equal
to December 31, 2001. There were no Massachusetts voluntary automobile policies
in force at December 31, 2002. Homeowners policies in force were 8,000 less than
December 31,
F-8
2001, reflecting planned reductions. At December 31, 2002, there were 573,000
voluntary automobile and 284,000 homeowners policies in force for a total of
857,000.
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 December 31, 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
2003, with primary emphasis on the homeowners line, which are expected to have a
continued adverse impact on retention of homeowners policies. Business
initiatives, 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.
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, primarily Massachusetts, assumed in 2002, compared to the
prior year.
Growth in annuity contract deposits for the year ended December 31, 2002
reflected new business growth and improved retention of existing business.
Compared to the full year 2001, new annuity deposits increased 9.4%, reflecting
an 8.8% increase in scheduled deposits received and a 10.4% increase in single
premium and rollover deposits. New deposits to fixed accounts were 15.6%, or
$19.1 million, higher than in 2001, and new deposits to variable accounts
increased 2.8%, or $3.3 million, compared to a year earlier. The Company offers
a dollar cost averaging program for amounts systematically transferred from the
fixed investment return option to the variable investment return options over
3-month, 6-month or 12-month periods.
In January 2002, the Company announced that it had been selected as one of
four providers of fixed and variable annuity options to Chicago, Illinois public
school employees. The Chicago Public Schools is the third-largest school
district in the United States of America ("U.S."). Beginning in April 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 growth in its
annuity business. During the period April through December 2002, independent
agents sold approximately 1,600 new Horace Mann flexible premium contracts in
Chicago, representing more than $7 million in annual contract deposits, $4.3
million of which were received since this effort began on April 1. In addition
to the Company's Chicago initiative, independent agents generated annualized
Horace Mann contract deposits of nearly $3 million in the three months ended
December 31, 2002 in other U.S. markets.
Fixed accumulated cash value was $1.5 billion at December 31, 2002, $112.3
million, or 8.1% more than a year earlier. Fixed accumulated cash value
retention for the 12 months ended December 31, 2002 was 94.0%, 0.6 percentage
points better than the prior year. Variable accumulated deposit retention of
92.1% for 2002 decreased 0.3 percentage points compared to a year earlier, as
ongoing improvement following the Company's expansion of variable investment
options and implementation of proprietary asset allocation software was impacted
by fluctuations in the financial markets. Variable accumulated funds on deposit
at December 31, 2002 were $0.9 billion, $153.9 million less than a year earlier,
a 15.3% decrease including the impact of financial market values. The number of
annuity contracts outstanding increased 5.8%, or 8,000 contracts, compared to
December 31, 2001.
F-9
In 2000, the Company took actions to increase the variable annuity options
available to customers, and also took steps to improve the returns of its
proprietary mutual funds. For the year ended December 31, 2002, the dollar
amount of variable annuity surrenders was 3% lower than for the same period last
year. The dollar amount of fixed accumulated cash value surrenders also
decreased 3% compared to 2001. These further improvements follow decreases in
the dollar amount of variable and fixed accumulated cash value surrenders of 54%
and 41%, respectively, in 2001.
For the twelve months ended December 31, 2002, annuity segment contract
charges earned decreased 4.7%, or $0.7 million, compared to the same period a
year earlier. In the current period, declines in market valuations negatively
impacted fees earned on variable accumulated balances. Improvements in retention
of variable and fixed accumulated values, as described above, also resulted in a
decline in surrender fees earned.
Life segment premiums and contract deposits for 2002 were 3.7% 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 of 9.1% for the twelve
months ended December 31, 2002, was equal to the same period last year. The
lapse ratio for the term portion of the business improved slightly compared to
the prior year, while the lapse ratio for the whole life portion of the business
increased. In 2003, the Company anticipates expanding its life product portfolio
to strengthen this segment's growth potential.
Net Investment Income
Pretax investment income of $196.0 million for the twelve months ended
December 31, 2002 decreased 1.7%, or $3.3 million, (1.6%, or $2.1 million, after
tax) compared to the prior year due primarily to lost income related 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 5.0% over the past 12 months. The
average pretax yield on the investment portfolio was 6.7% (4.5% after tax) for
2002, compared to a pretax yield of 7.2% (4.8% after tax) a year earlier.
Looking to 2003, investment income will continue to be under pressure due to
lost income related to investment credit issues from 2002, described under
"Results of Operations -- Year Ended December 31, 2002 Compared to Year Ended
December 31, 2001 -- Realized Investment Gains and Losses" below, and current
reinvestment returns available.
Realized Investment Gains and Losses
Net realized investment losses were $49.4 million and $10.0 million for the
years ended December 31, 2002 and 2001, respectively. For the full year 2002,
the Company recorded charges of $53.9 million due to the impairment of fixed
income securities, primarily securities issued by companies in the
communications sector. In the fourth quarter of 2002, $2.5 million of net
realized gains were recorded, reflecting gains from portfolio sale transactions
partially offset by fixed income security impairment charges of $2.9 million. 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,
F-10
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 twelve months were gains
realized from ongoing investment portfolio management activity. In the fourth
quarter of 2001, the Company sold all of its holdings in securities issued by
Enron Corporation and its affiliates, which resulted in a realized investment
loss of $7.8 million. The remaining $2.2 million of net realized losses in 2001
primarily resulted from the sale, for credit reasons, of nine fixed income
securities and the impairment of fixed income securities issued by three
telecommunications companies, which were only partially offset by the first
quarter full repayment of an impaired commercial mortgage loan and the release
of a related reserve for uncollectible mortgages.
Management believes that there may be further investment impairments in
2003 if current economic and financial conditions persist. The table below shows
the ten largest sectors of the Company's investments in corporate securities as
of December 31, 2002.
Fair Pretax
Number of Market Amortized Unrealized
Issuers Value Cost Gain (Loss)
--------- -------- --------- -----------
Banking and Finance ......... 28 $ 243.9 $ 223.6 $20.3
Energy ...................... 27 202.1 186.8 15.3
Telecommunications .......... 18 141.5 133.1 8.4
Utilities ................... 20 131.5 133.0 (1.5)
Food and Beverage ........... 14 105.2 99.1 6.1
Automobiles ................. 5 80.7 81.4 (0.7)
Broadcasting and Media ...... 19 78.9 76.0 2.9
Industry, Manufacturing ..... 9 64.5 64.2 0.3
Transportation .............. 13 58.4 58.7 (0.3)
Chemicals ................... 10 48.0 48.3 (0.3)
All Other Corporates (1) .... 71 389.0 370.2 18.8
--- -------- -------- -----
Total corporate fixed
maturity securities ... 234 $1,543.7 $1,474.4 $69.3
=== ======== ======== =====
- -----------
(1) The All Other Corporates category contains 15 additional industry
classifications. Health care, retail, real estate, defense, cable and
insurance represented $240.5 million of the fair value at December 31,
2002, and the remaining 9 classifications each represented less than $30
million of the fair value at December 31, 2002.
The securities impaired in the fourth quarter of 2002, in addition to
increases to previously recorded impairments, were issued by two companies
outside of the communications sector (American Airlines and Oklahoma Development
Finance Authority). The securities impaired in the third quarter of 2002, also
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
F-11
declined in value due to political risk associated with Venezuela, was also
impaired in the second quarter of 2002. Securities issued by two companies in
the communications sector (NTL and Diamond Cable) were impaired in the first
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.
At December 31, 2002, the Company's diversified fixed maturity portfolio
consisted of 1,121 investment positions and totaled approximately $3.0 billion
in carrying value. The portfolio is 95.4% investment grade, based on market
value, with an average quality rating of A+. At December 31, 2002, the portfolio
had approximately $27 million pretax of total gross unrealized losses related to
137 positions. The following table provides information regarding fixed maturity
securities that had an unrealized loss at December 31, 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 December 31, 2002
Cost or Pretax
Number of Fair Amortized Unrealized
Positions Value Cost Loss
--------- ------ --------- ----------
Investment Grade
6 Months or less ................. 50 $171.8 $175.7 $ (3.9)
7 through 12 months .............. 17 55.8 59.7 (3.9)
13 through 24 months ............. 6 33.1 35.3 (2.2)
25 through 36 months ............. -- -- -- --
37 through 48 months ............. 5 30.5 33.4 (2.9)
Greater than 48 months ........... 2 4.6 5.2 (0.6)
--- ------ ------ ------
Total ......................... 80 $295.8 $309.3 $(13.5)
=== ====== ====== ======
Non-investment Grade
6 Months or less ................. 11 $ 19.3 $ 20.8 $ (1.5)
7 through 12 months .............. 22 32.5 35.4 (2.9)
13 through 24 months ............. 8 19.7 22.8 (3.1)
25 through 36 months ............. -- -- -- --
37 through 48 months ............. 6 13.7 14.7 (1.0)
Greater than 48 months ........... 4 19.4 24.3 (4.9)
--- ------ ------ ------
Total ......................... 51 $104.6 $118.0 $(13.4)
=== ====== ====== ======
Not Rated
Total, all 6 Months or less ... 6 $ 2.6 $ 2.6 *
=== ====== ====== ======
Grand Total ................ 137 $403.0 $429.9 $(26.9)
=== ====== ====== ======
- -----------
* Less than $0.1 million
F-12
Of the securities with unrealized losses, only one issuer had pretax
unrealized losses greater than $2 million and was trading below 80% of book
value at December 31, 2002. The Company views this decrease in value as being
temporary, expects recovery in market value, anticipates continued payments
under the terms of the securities, and has the intent and ability to hold this
security until maturity or a recovery in market value occurs.
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.
The Company's investments are managed by outside managers and advisors
which follow the investment guidelines established by the Company. In
conjunction with the review of investment guidelines, the Company also reviewed
its overall investment program and the performance of its investment managers.
Effective in March 2003, the Company consolidated the management of its fixed
maturity securities portfolio with BlackRock, with the exception of a small
portion allocated to a specialty high-yield manager. BlackRock has managed a
portion of the Company's fixed maturity securities portfolio since 1994.
Benefits, Claims and Settlement Expenses
Year Ended Growth Over
December 31, Prior Year
--------------- ----------------
2002 2001 Percent Amount
------ ------ ------- ------
Property and casualty.................... $410.2 $433.3 -5.3% $(23.1)
Annuity.................................. 0.8 (0.8) 1.6
Life..................................... 39.9 41.1 -2.9% (1.2)
Corporate & other........................ -- 2.0 -100.0% (2.0)
------ ------ ------
Total................................. $450.9 $475.6 -5.2% $(24.7)
====== ====== ======
Property and casualty
statutory loss ratio:
Before catastrophe losses.......... 76.9% 83.0% -6.1%
After catastrophe losses........... 79.2% 85.2% -6.0%
Impact of litigation charges (a)... 0.3% -- 0.3%
- -----------
(a) Under statutory accounting principles, the $1.6 million litigation charge
described below in "Results of Operations -- Year Ended December 31, 2002
Compared to Year Ended December 31, 2001 -- Net Income" 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.
F-13
In 2002, the Company's benefits, claims and settlement expenses reflected
improvements in both the voluntary automobile and the homeowners statutory loss
ratios, including 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.
Favorable property and casualty current accident year loss trends were partially
offset by adverse development in prior years' reserves, as described below. In
2001, the Company's benefits, claims and settlement expenses were affected
adversely by strengthening of prior years' reserves for property and casualty
claims and by a high level of non-catastrophe weather-related losses.
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 $20.7 million for the full year 2002,
primarily related to (1) automobile loss reserves from accident years 2001 and
years prior to 1997 and (2) loss adjustment expense reserves from the 2001 and
2000 accident years for both automobile and homeowners, compared to reserve
strengthening of $14.5 million 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 $24.0
million in the current year, compared to $16.5 million for the year ended
December 31, 2001. The Company's property and casualty net reserves were $272.6
million and $272.0 million at December 31, 2002 and 2001, respectively.
As discussed in the 2000 and 2001 Form 10-Ks as previously filed, the
Company's first material net reserve strengthening in more than 10 years
occurred in the fourth quarter of 2000 and 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
then 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 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.
F-14
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.
In the fourth quarter of 2002, the Company increased its reserves for prior
accident years related primarily to (1) automobile loss reserves from accident
years 2001, 2000 and years prior to 1997 and (2) allocated and unallocated loss
adjustment expense reserves from the 2001 accident year for both automobile and
homeowners. During the third and fourth quarters of 2002, the Company continued
to closely monitor emerging trends in (1) the severity of payments on previously
reported losses for voluntary automobile and (2) paid loss adjustment expenses
for these prior accident years until such time as the Company believed that the
trends were sufficiently credible to require adjustment of the reserves. As a
result, the Company revised its loss projections in the fourth 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, that
such methodology was appropriately applied and that there were no trends which
indicated the likelihood of future strengthening.
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.
F-15
The following table quantifies the amount of fourth quarter 2002, third
quarter 2002, second quarter 2001 and fourth quarter 2000 adverse/(favorable)
development for each line of business and accident years to which the
re-estimates relate:
Other
Voluntary Total Property &
Total Automobile Property Casualty
----- ---------- -------- ----------
Three months ended
December 31, 2002
- -----------------
Accident Years:
2001....................... $ 0.2 $(1.0) $ 0.7 $ 0.5
2000....................... 7.3 5.4 1.0 0.9
1999 & Prior............... 7.7 5.7 1.4 0.6
----- ----- ----- -----
Total................... $15.2 $10.1 $ 3.1 $ 2.0
===== ===== ===== =====
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
===== ===== ===== =====
F-16
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 2002,
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............... 58.3% 82.8% 80.7% 53.3%
Year ended December 31.................. 73.5% 91.5% 83.4% 71.0%
After determining that the increase in non-catastrophe property losses
experienced in the early months of 2000 was due to underlying loss trends,
rather than the normal cyclicality of the property business, management began
and has continued to implement pricing, underwriting and loss control
initiatives. The Company's actions have had a positive impact on the property
loss ratio in 2002, accompanied by an expected decline in homeowners policies in
force. Management expects that the impact of these changes will continue to be
realized in 2003 and beyond. In light of experience and competitive actions in
2001 and 2002, 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 continues to strengthen 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 from consolidation of claims
office locations throughout the U.S. into 6 offices compared to the previous 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 into the six remaining locations was completed by the end of 2002, as
scheduled, and there was notable progress in hiring additional staff needed in
these locations. Installation and implementation of the new claims
administration system, including related process changes, are planned for
mid-2003.
For 2002, incurred catastrophe losses for all lines were $11.9 million,
compared to $11.2 million in 2001. Incurred catastrophe losses in 2001 included
a net benefit of $1.1 million due to favorable development of reserves for 2000
catastrophe losses.
F-17
The voluntary automobile loss ratio excluding catastrophe losses was 76.4%
in 2002, including 0.4 percentage points due to the aforementioned class action
lawsuits, compared to 77.6% for the prior year. The increase in average
voluntary automobile premium per policy in 2002 exceeded the increase in average
current accident year loss costs, as accident frequencies trended lower and
severities increased modestly.
The annuity benefits in 2002 consisted primarily of two components: (1)
mortality charges for annuity contracts on payout status and (2) an increase in
the guaranteed minimum death benefit ("GMDB") reserve on variable annuity
contracts due to fluctuations in the financial markets. The annuity benefits
recorded in 2001 were comprised of three components: (1) a release of reserves
for certain supplementary contracts, resulting from a systems conversion,
recorded in the third quarter of 2001, (2) the establishment of a GMDB reserve
on variable annuity contracts in the third quarter of 2001 and (3) current
period mortality experience on annuity contracts on payout status.
Life mortality experience in 2002 was comparable to a year earlier. In
2001, the Company reduced life segment reserves by $2.6 million related to
policy coverages that were no longer in force.
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 related to compliance with Internal
Revenue Code ("IRC") Section 7702 (Definition of Life Insurance) 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, third and fourth
quarters of 2002, management 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 to
specifically address issues related to IRC Section 7702. The Company is also in
the process of identifying and correcting any related deficiencies and
quantifying any potential exposure associated with IRC Section 7702A (Modified
Endowment Contracts). The Company expects to make any subsequent IRS filings
determined to be required under Section 7702A by the end of 2003.
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.
F-18
Interest Credited to Policyholders
Year Ended Growth Over
December 31, Prior Year
------------- ----------------
2002 2001 Percent Amount
----- ----- ------- ------
Annuity................... $68.4 $67.9 0.7% $0.5
Life...................... 30.0 28.6 4.9% 1.4
----- ----- ----
Total.................. $98.4 $96.5 2.0% $1.9
===== ===== ====
The fixed annuity average annual interest rate credited decreased to 4.8%
for the year ended December 31, 2002, compared to 5.1% for the prior year.
Offsetting the decline in the rate credited, the average accumulated fixed
deposits increased 6.4% for the year ended December 31, 2002 compared to the
prior year. Life insurance interest credited increased as a result of the growth
in interest-sensitive life insurance reserves.
Operating Expenses
In 2002, operating expenses increased $7.5 million, or 6.1%, compared to
the prior 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,
were $6.2 million in 2002 and are currently estimated to be approximately $6.5
million for 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 cost and 2003 cost estimate were increased during 2002
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 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 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. Based on assumptions at the
time of this Report on Form 10-K, the Company anticipates contributing
approximately $6.5 million to the defined benefit pension plan in 2003. For the
defined benefit pension plan, investments have been set aside in a trust fund.
F-19
The total corporate expense ratio on a statutory accounting basis,
excluding restructuring charges, was 22.6% for the year ended December 31, 2002,
0.7 percentage points lower than in 2001. The property and casualty statutory
expense ratio was 24.4% for the year ended December 31, 2002, compared to 21.6%
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, (3) an
increase in automobile new business commissions and (4) the required statutory
classification of escrowed North Carolina rate dispute amounts.
Amortization of Policy Acquisition Expenses and Intangible Assets
For 2002, the combined amortization of policy acquisition expenses and
intangible assets was $67.0 million, compared to $63.8 million recorded in 2001.
Amortization of intangible assets was $5.7 million for the year ended
December 31, 2002, compared to $5.8 million in 2001 and scheduled amortization
of $5.5 million reported in the Company's Form 10-K for the year ended December
31, 2001. The decline 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 $1.6 million for the year
ended December 31, 2001. Partially offsetting this factor was the December 2002
valuation of annuity value of business acquired in the 1989 acquisition of the
Company ("Annuity VIF"), which resulted in an increase in amortization of $0.1
million for the year. The increase in amortization was due to lower than
expected market appreciation, partially offset by the impact of realized
investment losses and improvement in business persistency. A similar valuation
in 2001 resulted in a decrease in amortization of $2.1 million.
Policy acquisition expenses amortized for the year ended December 31, 2002
of $61.3 million were $3.3 million more than the prior 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 $0.9 million reduction in amortization for the annuity and life
segments combined primarily as a result of the current year valuation compared
to the impact of the 2001 valuation. In 2002, 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 $0.4 million for the life segment, compared to a reduction in
amortization of $0.9 million in the prior year. For the annuity segment, the
current year valuation decreased amortization $0.2 million, compared to an
increase of $1.4 million in 2001.
Income Tax Expense
The effective income tax rate on income, including realized investment
gains and losses and non-recurring items, was a benefit of 46.8% for the year
ended December 31, 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 14.1%.
F-20
Income from investments in tax-advantaged securities reduced the effective
income tax rate 76.2 and 13.4 percentage points for the years ended December 31,
2002, and 2001, respectively. While the amount of income from tax-advantaged
securities in the current year was comparable to 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 impact of tax
advantaged securities in 2002 included 13.3 percentage points from the prior
year's tax return. In 2002 and 2001, the Company's tax provision was reduced by
$0.8 million and $3.0 million, respectively, reflecting the release of excess
tax provision previously recorded representing 9.9 and 10.7 percentage points,
respectively.
The effective income tax rate on operating income, as defined below, before
income taxes was 25.2% for the year ended December 31, 2002, compared to the
effective income tax rate of 22.1% on the same basis for the prior year.
Operating Income
Operating income is a non-GAAP financial measure defined by the Company as
net income before the after-tax impact of realized investment gains and losses
and non-recurring items. Non-recurring items in 2002 were comprised of
restructuring charges, debt retirement costs and class action litigation
charges. In 2001, non-recurring items were restructuring charges partially
offset by an adjustment to the provision for prior years' taxes. A
reconciliation of Operating Income to Net Income is provided in the following
topic, "Net Income." Management utilizes the operating income measure as a gauge
of the Company's underlying and ongoing business results.
For the year ended December 31, 2002, operating income benefited from
positive developments in the Company's property and casualty segment including:
the impact of rate increases on earned premiums; improved 2002 accident year
loss trends; lower weather-related losses; and the Company's restructuring of
its Massachusetts automobile business. In addition, operating income in 2002
benefited from the January 1, 2002 discontinuance of goodwill amortization.
These positive prior year comparisons were partially offset by greater adverse
development of property and casualty prior years' reserves. Operating income in
2002 was also negatively affected by (1) decreases in investment income due to
lost income related to investment credit issues and declining interest rates,
(2) tightening margins on variable annuities resulting from adverse market
conditions 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.
Based on the Company's full year 2002 results and generally positive
operating trends, at the time of this Report on Form 10-K and consistent with
disclosure in the Company's fourth quarter earnings release management
anticipates that 2003 full year operating income will be within a range of $1.25
to $1.35 per share, which includes an approximate $0.09 reduction in per share
operating earnings as a result of the Company's capital transactions completed
in the fourth quarter of 2002. (See also "Liquidity and Financial Resources --
Capital Resources.") This projection also reflects management's anticipation of
further improvement in the property and casualty statutory combined ratio
mitigated by compression in the Company's annuity margins and pressure on
investment income. As described in "Critical Accounting Policies," 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.
F-21
Operating income by segment was as follows:
Year Ended Growth Over
December 31, Prior Year
------------- ----------------
2002 2001 Percent Amount
----- ----- ------- ------
Property & casualty
Before catastrophe losses.......................... $27.7 $12.5 $15.2
Catastrophe losses, after tax...................... (7.8) (7.3) (0.5)
----- ----- -----
Total including catastrophe losses.............. 19.9 5.2 14.7
Annuity............................................... 17.0 20.6 -17.5% (3.6)
Life ................................................. 18.9 18.7 1.1% 0.2
Corporate and other expense........................... (1.6) (3.0) 1.4
Interest expense, after tax........................... (5.5) (5.9) 0.4
----- ----- -----
Total........................................... $48.7 $35.6 36.8% $13.1
===== ===== =====
Total before catastrophe losses................. $56.5 $42.9 31.7% $13.6
===== ===== =====
Property and casualty statutory combined ratio:
Before catastrophe losses.......................... 101.3% 104.6% -3.3%
After catastrophe losses........................... 103.6% 106.8% -3.2%
Expense ratio impact of restructuring charges(a)... 0.8% -- 0.8%
Loss ratio impact of litigation charges(b)......... 0.3% -- 0.3%
----------
a) Under statutory accounting principles, the $4.2 million pretax
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 F-13.
Property and casualty segment operating income of $19.9 million for 2002
increased $14.7 million compared to the prior year. Excluding the $1.0 million
after-tax provision for class action litigation, development of prior years'
reserves decreased operating income $14.6 million after tax in 2002, primarily
recorded in the third and fourth quarters. For 2001, the Company strengthened
prior years' reserves by $10.7 million after tax, primarily recorded in the
second and fourth quarters. Compared to a year earlier, 2002 property and
casualty segment operating income primarily reflected favorable trends in
average premium versus loss costs for the 2002 accident year, favorable weather
and benefits from restructuring its Massachusetts automobile business, partially
offset by increases in claim adjustment expenses and company-wide operating
expenses. For the Company, losses from catastrophes increased slightly compared
to 2001, while non-catastrophe weather-related losses decreased.
For 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 modestly.
The Company is continuing to approach the pricing and underwriting of its
homeowners products aggressively, to accelerate margin recovery. And, due to
homeowners loss experience in the fourth quarter of 2001, the Company identified
additional initiatives. Actions include further tightening of underwriting
guidelines, expanded reunderwriting of existing policies, coverage and policy
form restrictions in all states where
F-22
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 the following topic "Net
Income.")
The property and casualty statutory combined ratio improved 3.2 percentage
points, compared to 2001. Adverse development of prior years' reserves
represented 4.6 percentage points of the combined ratio in 2002, compared to 3.2
percentage points in 2001. In spite of the increase in this factor, the
statutory loss ratio for the segment improved 6.0 percentage points compared to
the prior year. However, the statutory expense ratio increased 2.8 percentage
points, primarily reflecting 0.8 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, an increase in automobile new
business commissions and the required statutory classification of escrowed North
Carolina rate dispute amounts.
Annuity segment operating income in 2002 decreased $3.6 million compared to
the prior year. Current year income, particularly in the last six months, was
adversely impacted by reductions in investment income, due to lost income
related to investment credit issues and declining interest rates and the
increase in company-wide operating expenses. Valuation of annuity segment
deferred acquisition costs and value of acquired insurance in force at December
31, 2002, including lower than expected market appreciation offset by the impact
of realized investment losses and improved business persistency, resulted in a
minimal net impact on amortization for the year. Similar valuations a year
earlier decreased after-tax amortization $0.5 million for the year. An increase
in the GMDB reserves reduced current year operating income by $0.3 million. The
Company's GAAP GMDB reserve was initially established in the third quarter of
2001 resulting in a $0.3 million charge to operating income in that year.
Variable account fee income for the current period was slightly less than in
2001, with adverse market conditions more than offsetting the growth in annuity
deposits and improved retention. Variable accumulated funds on deposit were $0.9
billion at December 31, 2002, $153.9 million, or 15.3%, less than a year
earlier. Fixed accumulated cash value of $1.5 billion was $112.3 million, or
8.1%, greater than December 31, 2001.
Life segment operating income was comparable to the prior year. Valuation
of life segment deferred acquisition costs at December 31, 2002 resulted in a
reduction in amortization of $0.3 million after tax due to the impact of
realized investment gains and losses. In the prior year, amortization decreased
$0.6 million after tax as a result of the valuation. Mortality experience on
ordinary life business was comparable to 2001. In 2001, life segment operating
income reflected a $1.7 million after tax benefit as a result of a reserve
reduction.
The reduction in the operating loss for the corporate and other segment
compared to 2001 primarily reflected the change in accounting, which was
effective January 1, 2002, that eliminated goodwill amortization. For the year
ended December 31, 2001, amortization of goodwill was $1.6 million, or 4 cents
per share. In 2001, the operating loss for the corporate and other segment
reflected (1) an after-tax charge of $2.7 million related to problems with the
life insurance tax status of certain of the Company's life policies and also (2)
a $3.0 million reduction of the Company's tax provision reflecting the release
of excess tax provision previously recorded.
F-23
Net Income
Reconciliations of Operating Income to Net Income
Year Ended Growth Over
December 31, Prior Year
--------------- ----------------
2002 2001 Percent Amount
------ ------ ------- ------
Operating income........................................ $ 48.7 $ 35.6 36.8% $ 13.1
Realized investment losses.............................. (32.2) (6.5) (25.7)
Restructuring charges................................... (2.7) (4.8) 2.1
Debt retirement costs................................... (1.5) -- (1.5)
Litigation charges...................................... (1.0) -- (1.0)
Adjustment to the provision for prior years' taxes...... -- 1.3 (1.3)
------ ------ ------
Net income........................................ $ 11.3 $ 25.6 -55.9% $(14.3)
====== ====== ======
Per share, diluted:
Operating income..................................... $ 1.18 $ 0.87 35.6% $ 0.31
Realized investment losses........................... (0.77) (0.15) (0.62)
Restructuring charges................................ (0.07) (0.12) 0.05
Debt retirement costs................................ (0.04) -- (0.04)
Litigation charges................................... (0.02) -- (0.02)
Adjustment to the provision for prior years' taxes... -- 0.03 (0.03)
------ ------ ------
Net income........................................ $ 0.28 $ 0.63 -55.6% $(0.35)
====== ====== ======
Net income includes net realized investment gains and losses and
non-recurring items reflected in the Corporate and Other segment. After-tax
realized investment losses are described in "Results of Operations -- Year Ended
December 31, 2002 Compared to Year Ended December 31, 2001 -- 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 2002 and 2001,
totaling $(5.2) million after tax, or $(0.13) per share, and $(3.5) million
after tax, or $(0.09) 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 from consolidation of claims
office locations throughout the U.S. into 6 offices compared to the previous 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 year ended
December 31, 2002. Approximately 135 employees with management, professional and
clerical responsibilities were impacted by the office consolidations.
F-24
In May, September and October, 2002, the Company used a portion of the
proceeds from the sale of its Convertible Notes to repay the outstanding balance
under its former Bank Credit Agreement and repurchase $71.4 million of its
outstanding Senior Notes and $53.0 million aggregate principal amount, $25.2
million carrying value, of its outstanding Convertible Notes. In December 2002,
the Company also repurchased an additional $56.0 million aggregate principal
amount, $26.6 million carrying value, of its outstanding Convertible Notes. As
consideration for this repurchase, the Company issued 1.8 million shares of its
common stock. The debt retirement in 2002 resulted in a net after-tax charge of
$1.5 million, or $0.04 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. A final court hearing on this matter was held on December
18, 2002, at which time the settlement was approved and was within the amount
previously accrued by 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 2001, the Company reached conclusion on its strategic direction for
automobile business in the State of Massachusetts. As further described in
"Results of Operations -- Year Ended December 31, 2001 Compared to Year Ended
December 31, 2000 -- Net Income," the Company recorded charges of $4.8 million
after tax, or $0.12 per share, related to actions to restructure its presence
in the Massachusetts automobile market.
Also in 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.
Return on shareholders' equity based on net income was 2% for the year
ended December 31, 2002.
Results of Operations -- Year Ended December 31, 2001 Compared to Year Ended
December 31, 2000
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
Year Ended Growth Over
December 31, Prior Year
--------------- ----------------
2001 2000 Percent Amount
------ ------ ------- ------
Automobile and property (voluntary)......... $496.6 $473.2 4.9% $23.4
Annuity deposits............................ 239.1 206.4 15.8% 32.7
Life ....................................... 117.2 121.8 -3.8% (4.6)
------ ------ -----
Subtotal - core lines.................... 852.9 801.4 6.4% 51.5
Involuntary and other property & casualty... 22.7 20.3 11.8% 2.4
------ ------ -----
Total.................................... $875.6 $821.7 6.6% $53.9
====== ====== =====
F-25
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
Year Ended Growth Over
December 31, Prior Year
--------------- ----------------
2001 2000 Percent Amount
------ ------ ------- ------
Automobile and property (voluntary)......... $485.5 $469.4 3.4% $16.1
Annuity..................................... 14.9 17.0 -12.4% (2.1)
Life ....................................... 92.0 91.7 0.3% 0.3
------ ------ -----
Subtotal - core lines.................... 592.4 578.1 2.5% 14.3
Involuntary and other property & casualty... 22.8 20.6 10.7% 2.2
------ ------ -----
Total.................................... $615.2 $598.7 2.8% $16.5
====== ====== =====
Premiums written and contract deposits for the Company's core lines
increased 6.4% compared to 2000, driven by double-digit growth in the annuity
segment as well as accelerating growth in the property and casualty segment.
This comparison includes the North Carolina settlement recorded in 2000
described below.
At December 31, 2001, the Company's exclusive agency force totaled 867, an
11.3% decline from a year earlier. The number of experienced agents in the agent
force, 553, was down 17.2% at December 31, 2001, compared to a year earlier. The
total agent count decreased due primarily to terminations of less-productive
agents. As a result, overall agent productivity continued to increase, and for
the full year, average agent productivity was 37.6% higher than in 2000.
The Company has modified its agent compensation and reward structure, in
order to provide incentive for agent performance that is more closely aligned
with the Company's objectives. Prior to 2001, agent compensation and rewards
focused on profitability, customer service and tenure with the Company. The
revised structure continues to focus on profitability but also places a greater
emphasis on individual agent productivity, new premium growth, growth in
educator and cross-sold business, and business retention. In addition, the
Company's agency manager compensation structure has been similarly modified, and
the agency management team has been strengthened through the promotions of
several of its most experienced and capable agents. The number of new agents
hired during 2001 was comparable to the prior year, in spite of the Company's
implementation of more stringent agent selection criteria to improve agent
productivity and retention in the future. The new compensation plan for agency
managers became effective January 1, 2001. The new compensation plan for all
agents was implemented on August 1, 2001, and there were approximately 800
agents at the time of implementation. Also in 2001, the Company implemented
enhanced agent training programs, to help new agents achieve production targets
more rapidly and help experienced agents sharpen and strengthen their skills,
and began providing agents with additional tools and support programs, to help
them make a successful transition to their new role under the Company's Value
Proposition.
In March 2000, following lengthy negotiations, the North Carolina Rate
Bureau and that state's Commissioner of Insurance agreed to settle the
outstanding 1994, 1996 and 1999 private passenger automobile insurance rate
filing cases resulting in an adverse impact of approximately $250 million for
the insurance industry. Horace Mann's portion of the adverse settlement was $3.0
million pretax, comprised of $2.3 million in premium refunds and $0.7 million in
interest
F-26
charges. For the year ended December 31, 2001, North Carolina was the Company's
second largest property and casualty state representing approximately 7% of
total property and casualty premiums.
In December 2001, the North Carolina Commissioner of Insurance (the
"Commissioner") ordered a 13% reduction in private passenger automobile
insurance premium rates effective in April 2002. The Commissioner's Order was in
response to a request from the North Carolina Rate Bureau (the "Bureau"), which
represents the insurance industry, to increase private passenger automobile
insurance rates by 5%. The Bureau has voted to appeal the Commissioner's Order
in the state appellate court and raise rates while the case is being heard. The
difference between the rates ordered by the Commissioner and the Bureau are
anticipated to have an adverse impact of approximately $350 million for the
insurance industry. It was estimated that the Company's earned premiums would be
negatively impacted by approximately $2 million and $3 million in 2002 and 2003,
respectively. In addition, the difference in rates between the Commissioner and
the Bureau must be held in an escrow account pending the court's decision. If
the court should rule in favor of the Bureau, the insurers will be entitled to
the funds previously escrowed. If the court should rule in favor of the
Commissioner, the escrowed funds plus interest will be refunded to the
policyholders.
Total voluntary automobile and homeowners premium written growth was 4.9%
for 2001, including the effect of the North Carolina settlement in the prior
year. The average premium per policy and the number of policies in force
increased for both automobile and homeowners insurance, compared to a year
earlier. Voluntary automobile insurance premium written increased 3.8% ($13.5
million) compared to 2000 and homeowners premium increased 8.5% ($9.9 million).
The property and casualty increase in premiums written resulted from growth in
average premium per policy of 3% for automobile and 8% for homeowners, compared
to a year earlier, as the impact of rate actions began to flow through policy
renewals and new business. Over the prior 12 months, unit growth was 1.4%, or
12,000, with an 8,000 unit increase in automobile and a 4,000 unit increase in
homeowners. At December 31, 2001, there were 596,000 voluntary automobile and
292,000 homeowners policies in force for a total of 888,000.
Based on policies in force, the property and casualty 12-month retention
rate for new and renewal policies was 88%, equal to the 12 months ended December
31, 2000 despite implemented rate increases over the period. The Company plans
additional rate increases in 2002 and beyond, with primary emphasis on the
homeowners line, which are expected to have an adverse impact on retention of
homeowners policies in force. Business initiatives, 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.
Growth in premiums written for involuntary and other property and casualty
was primarily attributable to an atypical recovery from a state mandatory
automobile insurance facility received in 2001. In February 2002, the Company
announced that it obtained a five-year extension of its contract with the
National Education Association to be the exclusive provider of professional
liability coverage to its members through August 2007. Premiums from this
product are included in the involuntary and other property and casualty
category.
In October 2001, the Company changed its strategic direction for automobile
business in the state of Massachusetts, forming a marketing alliance with an
unaffiliated company, The Commerce Group, Inc. ("Commerce"). Through this
alliance, by January 1, 2002, Horace Mann's agents are authorized to offer
Massachusetts customers automobile insurance policies, written by
F-27
Commerce, while continuing to write Horace Mann's other products in
Massachusetts, including retirement annuities and property and life insurance.
Horace Mann ceased writing automobile insurance policies in Massachusetts on
December 31, 2001. For the full year 2001, premiums written in Massachusetts for
voluntary automobile business were $18.9 million and for involuntary residual
market business were $7.8 million. In 2002, premiums written for this business
were reduced to zero, and premiums earned were reduced significantly, reflecting
run-off of the policies in force at December 31, 2001. For the full year 2001,
claims and settlement expenses in Massachusetts for voluntary automobile
business were $9.1 million and for involuntary residual market business were
$11.5 million. Claims and settlement expenses in 2002 reflected run-off of the
business and a decline in exposure to loss, as the Company's policies written in
the prior 12 months expired.
Growth in annuity contract deposits reached double-digit levels for the
year ended December 31, 2001. In September 2000, the Company more than tripled
the number of choices available to its customers by introducing 21 new
investment options in its tax-deferred annuity product line. At the same time,
the Company provided its agents with proprietary asset allocation software that
assists educator customers in selecting the best retirement investment options
based on their risk tolerance and investment objectives. The fourth quarter of
2000 was the first full quarter with the expanded investment options. New
annuity contract deposits of $64.2 million for the three months ended December
31, 2001 increased 7.0%, compared to contract deposits of $60.0 million for the
same period in 2000.
Compared to the full year 2000, new annuity deposits increased 15.8%,
reflecting a 45.8% increase in new single premium and rollover deposits and a
3.8% increase in scheduled deposits received. New deposits to variable accounts
decreased 3.4%, or $4.1 million, and new deposits to fixed accounts were 43.1%
higher than in 2000. The Company offers a dollar cost averaging program for
amounts systematically transferred from the fixed investment return option to
the variable investment return options over 3-month, 6-month or 12-month
periods. Variable accumulated funds on deposit at December 31, 2001 were $1.0
billion, $26.7 million less than a year earlier, a 2.6% decrease including the
impact of a decline in financial market values. Variable accumulated deposit
retention improved 8.3 percentage points over the 12 months to 92.4%, reflecting
improvement following the Company's expansion of variable investment options and
implementation of proprietary asset allocation software. Fixed accumulated cash
value retention for the 12 months ended December 31, 2001 was 93.4%, 4.7
percentage points better than in 2000. Fixed accumulated cash value was $1.4
billion at December 31, 2001, $61.9 million, or 4.6%, more than a year earlier.
The number of annuity contracts outstanding increased 7.8%, or 10,000 contracts,
compared to December 31, 2000.
In 2000, the Company took actions to increase the variable options
available to customers, as described above, and also took steps to improve the
returns of its proprietary mutual funds. For the twelve months ended December
31, 2001, the amount of variable deposit surrenders was 54% lower than for the
same period last year. The amount of fixed deposit surrenders decreased 41%
compared to 2000.
In January 2002, the Company announced that it had been selected as one of
four providers of fixed and variable annuity options to Chicago, Illinois public
school employees. The Chicago Public Schools is the third-largest school
district in the U.S. Beginning in April 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 growth in its annuity business.
F-28
For the twelve months ended December 31, 2001, annuity segment contract
charges earned decreased 12.4%, or $2.1 million, compared to the twelve months
of 2000. Improvements in retention of variable and fixed accumulated values, as
described above, resulted in a decline in surrender fees earned. Also, declines
in average market values reduced the Company's variable deposit fee revenues.
Life segment premiums and contract deposits for the twelve months of 2001
were 3.8% lower than a year earlier, primarily reflecting a decline in
disability income business. In 2001, the Company began ceding a larger portion
of its disability income business as part of the group restructuring announced
in the fourth quarter of 2000. Excluding the disability product from both years'
results, life segment premiums written and contract deposits would be comparable
to the twelve months ended December 31, 2000. The life insurance in force lapse
ratio was 9.1% for the twelve months ended December 31, 2001, compared to 9.0%
for the prior year.
Net Investment Income
Investment income of $199.3 million for 2001 increased 3.6%, or $6.9
million, (3.4% after tax) compared to the prior year due primarily to growth in
the size of the investment portfolio. Average investments (excluding the
securities lending collateral) increased 2.5% over the past 12 months. The
average pretax yield on the investment portfolio was 7.2% (4.8% after tax) for
2001, compared to a pretax yield of 7.1% (4.8% after tax) for the prior year.
Realized Investment Gains and Losses
Net realized investment losses were $10.0 million for the year ended
December 31, 2001, compared to net realized investment losses of $9.9 million
for 2000. In the fourth quarter of 2001, the Company sold all of its holdings in
securities issued by Enron Corporation and its affiliates, which resulted in a
realized investment loss of $7.8 million. The remaining $2.2 million of net
realized losses in 2001 primarily resulted from the sale, for credit reasons, of
nine fixed income securities and the impairment of fixed income securities
issued by three telecommunications companies, which were only partially offset
by the first quarter full repayment of an impaired commercial mortgage loan and
the release of a related reserve for uncollectible mortgages. For 2000, nearly
all of the net realized gains and losses occurred in the fixed income portfolios
with $8.8 million of the realized losses due to credit-related sales and
impairments and the remainder resulting from normal portfolio management
activity.
F-29
Benefits, Claims and Settlement Expenses
Year Ended Growth Over
December 31, Prior Year
--------------- ----------------
2001 2000 Percent Amount
------ ------ ------- ------
Property and casualty...................... $433.3 $417.4 3.8% $15.9
Annuity.................................... (0.8) 1.6 (2.4)
Life....................................... 41.1 47.0 -12.6% (5.9)
Corporate & other.......................... 2.0 -- 2.0
------ ------ -----
Total................................... $475.6 $466.0 2.1% $ 9.6
====== ====== =====
Property and casualty statutory loss ratio:
Before catastrophe losses............ 83.0% 81.9% 1.1%
After catastrophe losses............. 85.2% 85.2% --
In 2001, the Company's benefits, claims and settlement expenses were
affected adversely by strengthening of prior years' reserves for property and
casualty claims and by a higher level of non-catastrophe weather-related losses
than the prior year. In 2000, the Company's results were also adversely affected
by strengthening of prior years' property and casualty reserves.
Net strengthening of reserves for property and casualty claims occurring in
prior years, excluding involuntary business, was $14.5 million for the full
year, compared to $20.9 million in 2000. Total reserves for property and
casualty claims occurring in prior years, including involuntary business, were
strengthened $16.5 million in 2001, compared to $22.7 million a year earlier.
During the first half of 2001, the Company continued to refine its process
and methods for evaluating property and casualty reserves and selected a new
independent property and casualty actuarial consulting firm. During the second
quarter of 2001, a comprehensive review of property and casualty loss reserving
methodologies and assumptions was completed in conjunction with the new
actuarial firm. Based on management's review of this further enhanced analysis
and the opinion of the new actuarial firm, prior years' net reserves -
predominantly related to 1999 and prior accident years - were increased by $11
million at June 30, 2001. This consisted primarily of an $8 million reduction in
reserves to be ceded by the Company to its reinsurers and reinsurance
facilities, including $1.5 million related to the Company's automobile residual
market business, primarily in Massachusetts; $2.0 million for its voluntary
automobile ceded excess liability coverage; and approximately $4.5 million
related to its educators excess professional liability product.
At December 31, 2001, the Company increased reserves for property and
casualty claims occurring in prior years by an additional $5 million. Ceded and
assumed reserves were strengthened by $6.4 million, primarily as a result of an
updated review of subrogation recovery activity on business ceded to the state
automobile insurance facility in Massachusetts. That strengthening was partially
offset by $1.7 million of favorable development of reserves on the Company's
direct automobile business. The Company's property and casualty net reserves
were $272 million and $250 million at December 31, 2001 and 2000, respectively.
See also "Results of Operations -- Year Ended December 31, 2002 Compared to Year
Ended December 31, 2001 -- Benefits, Claims and Settlement Expenses."
F-30
In October 2001, the Company reached conclusion on its strategic direction
for automobile business in the state of Massachusetts. For further discussion,
see "Results of Operations -- Year Ended December 31, 2001 Compared to Year
Ended December 31, 2000 -- Insurance Premiums and Contract Deposits, and -- Net
Income."
In 2001, the higher level of non-catastrophe property losses included
claims attributable to severe weather experienced in many areas of the country,
including non-catastrophe claims related to Tropical Storm Allison and wind and
hail storms throughout the Midwest during the second quarter (with additional
development related to these events recorded in the third quarter) as well as
winter storms in the first quarter. In the fourth quarter of 2001, the Company
experienced higher levels of both fire and non-catastrophe weather-related
losses. Non-catastrophe weather-related losses in the fourth quarters of 2001
and 2000 were notably greater than historical experience. The non-catastrophe
property loss ratio by quarter and for the full years 2001, 2000 and 1999 was as
follows:
2001 2000 1999
---- ---- ----
Non-catastrophe property loss ratio for the:
Quarter ended March 31................... 85.1% 79.0% 81.9%
Quarter ended June 30.................... 99.4% 91.4% 72.8%
Quarter ended September 30............... 99.7% 82.8% 78.1%
Quarter ended December 31................ 82.8% 80.7% 53.3%
Year ended December 31................... 91.5% 83.4% 71.0%
After determining that the increase in non-catastrophe property losses
experienced in the early months of 2000 was due to underlying loss trends,
rather than the normal cyclicality of the property business, management began
and has continued to implement pricing, underwriting and loss control
initiatives. Although the Company's actions began to have a positive impact,
with minimal effect on policy retention through 2001, management anticipated
that the full impact of these changes would not be realized until 2002 and
beyond. In light of experience and competitive actions in 2001, future rate
increases were anticipated to be more aggressive than the Company's original
plans. The Company has also initiated further tightening of underwriting
guidelines, expanded reunderwriting of existing policies, coverage and policy
form restrictions in all states where permitted, and limited coverage of new
homeowners business to educators in certain areas. In addition, due to the
claims experience in the fourth quarter of 2001, the Company has initiated a
significant reinspection program of its property book of business. The Company
also is strengthening its homeowners policies' contract language to further
protect the Company against water damage and mold claims. The Company has also
begun the process of redesigning its claim handling procedures in order to
better control loss costs. Management anticipates that these actions will enable
the Company to improve the profitability of its existing book of homeowners
business and attract new business that meets its profitability standards.
For 2001, incurred catastrophe losses for all lines were $11.2 million,
including a net benefit of $1.1 million due to favorable development of reserves
for 2000 catastrophe losses. Incurred catastrophe losses were $16.2 million in
2000.
The voluntary automobile loss ratio excluding catastrophe losses was 77.6%
for full year 2001, compared to 80.9% in 2000. Strengthening of prior years'
reserves increased the voluntary automobile loss ratio by 2.0 and 5.4 percentage
points in 2001 and 2000, respectively. The
F-31
voluntary automobile loss ratio, excluding both catastrophe losses and prior
years' reserve strengthening, was 75.6% in 2001, consistent with the prior
year's results. The increase in average voluntary automobile premium per policy
in 2001 nearly kept pace with the increase in average current accident year loss
costs due to a favorable result in the fourth quarter of 2001, wherein the
growth in premiums exceeded the growth in loss costs.
The annuity benefits of $(0.8) million recorded in 2001 were comprised of
three components. They were: (1) a release of reserves for certain supplementary
contracts recorded in the third quarter of 2001, (2) a guaranteed minimum death
benefit reserve on variable annuity contracts established in the third quarter
of 2001, and (3) current period mortality experience on annuity contracts in
payout status. Annuity benefits were $1.6 million in 2000, including $1.3
million attributable to mortality experience on annuity contracts on payout
status resulting from the application of a more refined reserving model.
The primary component of the decrease in benefits for the life segment was
a $2.6 million reduction in reserves recorded in 2001 related to policy
coverages that are no longer in force. In addition, life segment benefits in
2001 reflected ceding of a larger portion of the Company's disability income
business as part of the group restructuring announced in the fourth quarter of
2000. Life mortality experience in 2001 was slightly better than a year earlier.
Early in 2001, management discovered some deficiencies in the tax
compliance testing procedures associated with certain of the Company's life
insurance policies that could jeopardize the tax status of some of those life
policies. Deficiencies in the Company's computer-based monitoring of premiums,
combined with the complexity of certain of the Company's life insurance
products, resulted in the acceptance of too much premium for certain policies
under the applicable tax test the Company was using. As a result of this
discovery, the Company retained outside experts to assist with the investigation
and remedy of this issue. The deficiencies in the testing procedures related to
compliance with IRC Section 7702 (Definition of Life Insurance) have been
identified and corrected. As of December 31, 2001, the Company was still in the
process of quantifying the financial impact of these errors, as well as
finalizing the strategy for remedying the problems caused by them. Such a
problem is not uncommon in the life insurance industry and is expected to be
cured using standard Internal Revenue Service ("IRS") procedures that have been
established specifically to address this type of situation. The $2.0 million of
policyholder benefits recorded in the Corporate and Other segment in 2001, as
well as $1.0 million of operating expense, represent the Company's current best
estimate of the costs to the Company to resolve these problems. See also
"Results of Operations -- Year Ended December 31, 2002 Compared to Year Ended
December 31, 2001 -- Benefits Claims and Settlement Expenses."
As a result of the tax status issue described above, the complexity of the
Company's product underlying the policies in question, and the complexity of
administering that product and other life products offered by the Company,
management is re-examining the life product portfolio and related administrative
system.
F-32
Interest Credited to Policyholders
Year Ended Growth Over
December 31, Prior Year
------------- ----------------
2001 2000 Percent Amount
----- ----- ------- ------
Annuity................................ $67.9 $66.1 2.7% $1.8
Life................................... 28.6 26.5 7.9% 2.1
----- ----- ----
Total............................... $96.5 $92.6 4.2% $3.9
===== ===== ====
The fixed annuity average annual interest rate credited increased to 5.1%
for the year ended December 31, 2001, compared to 5.0% for the prior year. In
addition, the average accumulated fixed deposits increased 1.4% for the year
ended December 31, 2001, compared to 2000. Life insurance interest credited
increased as a result of continued growth in the interest-sensitive life
insurance reserves.
Operating Expenses
Although operating expenses for the current year included increased costs
to support business growth initiatives, for 2001, operating expenses decreased
$4.2 million, or 3.3%, compared to a year earlier, primarily as a result of two
items. First, expenses in 2000 included non-recurring charges of $0.7 million
for interest on the North Carolina settlement and $3.6 million attributable to
the chief executive officer transition. Second, in the fourth quarter of 2000
the Company wrote off $1.0 million book value of personal computers not
compatible with the Company's software upgrade and $2.5 million of previously
capitalized software costs. Operating expenses in 2001 included $1.3 million
representing the Company's estimated portion of the industry assessment related
to the insolvency of the Reliance Insurance Group.
The total corporate expense ratio on a statutory accounting basis was 23.3%
for the year ended December 31, 2001, 0.9 percentage points less than 2000. The
property and casualty expense ratio was 21.6% for the year ended December 31,
2001, compared to 20.8% for the prior year.
Effective April 1, 2002, current participants in the Company's defined
benefit and supplemental defined benefit retirement plans stopped accruing any
new benefits under these plans, but will continue to retain the benefits they
have accrued to date. The settlement costs for the defined benefit plans are
based upon assumptions of future events. At the time the 2001 Annual Report on
Form 10-K was filed, defined benefit plan settlement costs were anticipated to
increase by approximately $3 million in 2002 due to an increase in the number of
expected retirements. To the extent that actual experience differs from those
assumptions, adjustments may be required with the effects of these adjustments
charged or credited to income for the period in which the adjustments are made.
Amortization of Policy Acquisition Expenses and Intangible Assets
For 2001, the combined amortization of policy acquisition expenses and
intangible assets was $63.8 million, compared to the $64.8 million recorded in
2000.
F-33
Amortization of intangible assets decreased to $5.8 million for the year
ended December 31, 2001, compared to $8.8 million for the same period in 2000.
The decline reflected the lower level of amortization of the value of annuity
business acquired in the 1989 acquisition of the Company ("Annuity VIF"),
comprised of the scheduled decrease in amortization reported in the Company's
Form 10-K for the year ended December 31, 2000 and the favorable impact of
improved persistency on the valuation of Annuity VIF.
Amortization of intangible assets includes goodwill amortization of $1.6
million in both 2001 and 2000. Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets," eliminates the
amortization of goodwill for fiscal years beginning after December 15, 2001.
Policy acquisition expenses amortized for the year ended December 31, 2001
of $58.0 million were $2.0 million more than the prior year primarily
attributable 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).
Income Tax Expense
Excluding the benefits in both 2001 and 2000 related to the Company's
dispute with the Internal Revenue Service ("IRS") regarding tax years 1994
through 1997, the effective income tax rate on income including realized
investment gains and losses was 14.1% for the year ended December 31, 2001,
compared to (24.7%) for 2000.
In 2001, the Company's tax provision was reduced by $3.0 million reflecting
the release of excess tax provision previously recorded and representing a 10.7
percentage point reduction in the effective income tax rate. Interest of $2.1
million on refunds from the IRS for federal tax years 1994 and 1995 reduced the
2000 effective income tax rate 22.1 percentage points. The refunds resulted from
issues separate from the Company's dispute with the IRS regarding tax years 1994
through 1997. Income from investments in tax-advantaged securities reduced the
effective income tax rate 13.4 and 45.1 percentage points for the years ended
December 31, 2001 and 2000, respectively. While the amount of income from
investments in tax-advantaged securities in the current year was comparable to
2000, the reduced level of income before income taxes in 2000 resulted in this
having a more significant impact on the effective income tax rate.
As previously reported, the Company had been contesting proposed additional
federal income taxes relating to a settlement agreement with the IRS for prior
years' taxes. In the third quarter of 1999, the Company recorded an additional
federal income tax provision of $20 million, representing the maximum exposure
of the Company to the IRS with regard to the issue for all of the past tax years
in question (1994 through 1997). In the third and fourth quarters of 2000, the
1994 through 1996 exposure was resolved for an amount that was $8.7 million less
than was previously accrued and that amount was included in net income for the
year ended December 31, 2000. In the third quarter of 2001, the Company's
liability for the 1997 tax year was resolved, resulting in a release of $1.3
million that had previously been accrued for that tax year. That amount was
included in net income for the year ended December 31, 2001. The benefits of
these dispute resolutions were excluded from the determination of reported
operating income.
F-34
Operating Income
Operating income is a non-GAAP financial measure defined by the Company as
net income before the after-tax impact of realized investment gains and losses
and non-recurring items. Non-recurring items in 2001 were restructuring charges
partially offset by an adjustment to the provision for prior years' taxes. In
2000, non-recurring items were restructuring charges and litigation charges
partially offsetting an adjustment to the provision for prior years' taxes.
Management utilizes the operating income measure as a gauge of the Company's
underlying and ongoing business results.
For the year ended December 31, 2001, operating income was adversely
affected primarily by strengthening of prior years' property and casualty claim
reserves and by a higher level of losses from severe weather than the prior
year. As described in "Critical Accounting Policies," 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.
In addition to strengthening of prior years' property and casualty claim
reserves and adverse homeowners loss experience, the Company's 2001 operating
income reflected the following items:
. An after-tax charge of $2.7 million, representing the Company's
current best estimate of the costs required to remedy problems with
the life insurance tax status of certain of its life policies;
. An after-tax charge of $0.9 million, reflecting the Company's portion
of industry assessments related to the insolvency of the Reliance
Insurance Group;
. A $3.0 million reduction of the Company's tax provision, reflecting
the release of excess tax provision previously recorded;
. A $1.7 million after-tax reduction in life insurance reserves related
to policy coverages that are no longer in force; and
. A $0.8 million after-tax reduction in reserves for supplementary
contracts.
F-35
Operating income by segment was as follows:
Year Ended Growth Over
December 31, Prior Year
-------------- ----------------
2001 2000 Percent Amount
----- ------ ------- ------
Property & casualty
Before catastrophe losses................... $12.5 $ 19.4 -35.6% $(6.9)
Catastrophe losses, after tax............... (7.3) (10.5) 3.2
----- ------ -----
Total including catastrophe losses....... 5.2 8.9 -41.6% (3.7)
Annuity........................................ 20.6 19.3 6.7% 1.3
Life .......................................... 18.7 12.9 45.0% 5.8
Corporate and other expense.................... (3.0) (9.4) 6.4
Interest expense, after tax.................... (5.9) (6.6) 0.7
----- ------ -----
Total.................................... $35.6 $ 25.1 41.8% $10.5
===== ====== =====
Total before catastrophe losses.......... $42.9 $ 35.6 20.5% $ 7.3
===== ====== =====
Property and casualty statutory combined ratio:
Before catastrophe losses................ 104.6% 102.7% 1.9%
After catastrophe losses................. 106.8% 106.0% 0.8%
Property and casualty segment operating income was lower than in 2000 due
primarily to adverse experience on homeowners business. During 2001, the
Company's increase in average voluntary automobile insurance premium per policy
nearly kept pace with the increase in average loss costs for the current
accident year. The Company continued to approach the pricing and underwriting of
its homeowners products aggressively, to accelerate margin recovery. And, due to
homeowners loss experience in the fourth quarter of 2001, the Company has
identified additional initiatives. Actions include further tightening of
underwriting guidelines, expanded reunderwriting of existing policies, coverage
and policy form restrictions in all states where permitted, limited coverage of
new homeowners business to educators in certain areas, reinspection of the
homeowners book of business and redesign of the Company's claim handling
procedures. An adverse industry settlement of outstanding automobile insurance
rate filing cases for 1994, 1996 and 1999 in North Carolina, including interest,
reduced the Company's property and casualty segment operating income by $1.9
million after tax in 2000.
The property and casualty combined ratio before catastrophes of 104.6% was
1.9 percentage points higher than 2000, reflecting the factors cited above.
Catastrophe losses in 2001 were $7.3 million after tax, including a net benefit
of $0.7 million after tax due to favorable development of reserves for 2000
catastrophe losses. Incurred catastrophe losses were $10.5 million after tax in
2000. Increases in reserves for property and casualty claims occurring in prior
years, excluding involuntary business, were $9.4 million after tax in 2001,
compared to $13.6 million after tax in 2000. In 2001, reserves were increased
$10.7 million after tax, including involuntary business, for property and
casualty claims occurring in prior years, compared to an increase of $14.8
million after tax in 2000 representing a decrease of approximately 1.4
percentage points in the combined ratio including catastrophes.
Annuity segment operating income in 2001 reflected reduced fee income
related to decreases in both variable deposit market values and surrender
charges for fixed and variable deposits. In addition, operating expenses
increased in 2001, reflecting the growth in annuity business volume. For 2001,
the net interest margin was slightly more than the prior year while
F-36
fees and contract charges earned decreased 12.4%. These factors were offset by
(1) the favorable impact of financial market performance on valuations of
deferred policy acquisition costs and valuation of business acquired and (2) the
release of reserves for certain annuity contracts on payout status. In 2000,
annuity segment operating income was reduced by $1.0 million due to mortality
experience on annuity contracts on payout status primarily as a result of
application of a more accurate reserving model. Variable accumulated funds on
deposit were $1.0 billion at December 31, 2001, $26.7 million, or 2.6%, less
than 12 months earlier. Fixed accumulated cash value of $1.4 billion was $61.9
million, or 4.6%, greater than December 31, 2000.
Life insurance earnings increased compared to 2000 due primarily to better
than expected mortality and group disability results, as well as the $1.7
million reserve reduction recorded in 2001.
In 2001, the Corporate and Other Expense category in the preceding table
reflected (1) an after-tax charge of $2.7 million related to problems with the
life insurance tax status of certain of the Company's life policies and also (2)
a $3.0 million reduction of the Company's tax provision reflecting the release
of excess tax provision previously recorded. In 2000, the Corporate and Other
Expense category reflected higher holding company expenses, including charges
related to the chief executive officer transition.
Net Income
Reconciliations of Operating Income to Net Income
Year Ended Growth Over
December 31, Prior Year
--------------- ----------------
2001 2000 Percent Amount
------ ------ ------- ------
Operating income............... $ 35.6 $ 25.1 41.8% $ 10.5
Realized investment losses..... (6.5) (6.4) (0.1)
Restructuring charges.......... (4.8) (1.5) (3.3)
Litigation charges............. -- (5.1) 5.1
Adjustment to the provision
for prior years' taxes...... 1.3 8.7 (7.4)
------ ------ ------
Net income............ $ 25.6 $ 20.8 23.1% $ 4.8
====== ====== ======
Per share, diluted:
Operating income............ $ 0.87 $ 0.61 42.6% $ 0.26
Realized investment losses.. (0.15) (0.15) -- --
Restructuring charges....... (0.12) (0.04) (0.08)
Litigation charges.......... -- (0.12) 0.12
Adjustment to the provision
for prior years' taxes... 0.03 0.21 (0.18)
------ ------ ------
Net income............ $ 0.63 $ 0.51 23.5% $ 0.12
====== ====== ======
Net income, which includes realized investment gains and losses,
restructuring charges, litigation charges and adjustments to the provision for
prior years' taxes, for the year ended December 31, 2001 increased by $4.8
million, or 23.1%, and net income per diluted share increased by 23.5% compared
to 2000. This change included the $10.5 million increase in operating income.
After-tax realized investment losses were comparable for the two periods. As
F-37
discussed above in "Income Tax Expense," net income reflected resolution of
federal income tax exposures, which increased net income by $1.3 million and
$8.7 million for the years ended December 31, 2001 and 2000, respectively. In
addition, net income in 2000 reflected an after-tax charge of $5.0 million due
to litigation regarding the Company's disability insurance product.
The Company recorded restructuring charges in both 2001 and 2000. As
described above in "Insurance Premiums and Contract Charges," in 2001 the
Company changed its strategic direction for automobile business in the state of
Massachusetts. On December 31, 2001, Horace Mann ceased writing automobile
business in that state. On October 18, 2001 the Company paid $6.4 million to the
Commonwealth Automobile Reinsurers ("C.A.R.") as full payment of its
proportionate liability to C.A.R. for policy years 2002 and beyond. That payment
and other related expenses of approximately $1 million resulted in an after-tax
charge of $4.7 million, or $0.12 per share, reflected as a non-operating income
restructuring charge. All of the restructuring charges incurred in 2001 related
to Massachusetts automobile business were paid by December 31, 2001. In 2000,
the Company recorded an after-tax charge of $1.5 million, or $0.04 per share, as
a result of the restructuring of the Company's group insurance business and its
credit union marketing group. Restructuring charges have been separately
identified in the Statements of Operations for the years ended December 31, 2001
and 2000.
Return on shareholders' equity based on net income was 6% for the year
ended December 31, 2001.
Liquidity and Financial Resources
Special Purpose Entities
At December 31, 2002, 2001 and 2000, 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 25% of the
common shares outstanding per their SEC filing on Form 13F as of December 31,
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
third largest shareholder with 8% of the common shares outstanding per their SEC
filing on Form 13F as of December 31, 2002, is the investment advisor for two of
the mutual funds offered to the Company's annuity customers.
F-38
Investments
The Company's investment strategy emphasizes investment grade, publicly
traded fixed income securities. At December 31, 2002, fixed income securities
represented 95.7% of investments excluding the securities lending collateral. Of
the fixed income investment portfolio, 95.4% was investment grade and 99.9% was
publicly traded. The average quality of the total fixed income portfolio was A+
at December 31, 2002.
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 4.8 years at December 31, 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 -- Year Ended December 31, 2002 Compared to Year Ended
December 31, 2001 -- 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 debt.
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 2002, net cash provided by
operating activities was somewhat higher than in the prior year. In 2002, the
Company made a cash contribution to its defined benefit pension plan trust fund
of $7.9 million, of which $1.8 million represented the actuarially-determined
required minimum amount.
Payment of principal and interest on debt, fees related to the
catastrophe-linked equity put option and reinsurance agreement, dividends to
shareholders and parent company operating expenses, as well as the share
repurchase program, are dependent upon the ability of the insurance subsidiaries
to pay cash dividends or make other cash payments to HMEC, including tax
payments pursuant to tax sharing agreements. The insurance subsidiaries are
subject to various regulatory restrictions which limit the amount of annual
dividends or other distributions, including loans or cash advances, available to
HMEC without prior approval of the insurance regulatory authorities. Dividends
which may be paid by the insurance subsidiaries to HMEC
F-39
during 2003 without prior approval are approximately $43 million. Although
regulatory restrictions exist, dividend availability from subsidiaries has been,
and is expected to be, adequate for HMEC's capital needs.
Investing Activities
HMEC's insurance subsidiaries maintain significant investments in fixed
maturity securities to meet future contractual obligations to policyholders. In
conjunction with its management of liquidity and other asset/liability
management objectives, the Company, from time to time, will sell fixed maturity
securities prior to maturity and reinvest the proceeds in other investments with
different interest rates, maturities or credit characteristics. Accordingly, the
Company has classified the entire fixed maturity securities portfolio as
"available for sale."
Financing Activities
Financing activities include primarily payment of dividends, the receipt
and withdrawal of funds by annuity contractholders, repurchases of the Company's
common stock, and borrowings, repayments and repurchases related to 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
December 31, 2002, net 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 $71.4 million
aggregate principal amount of the Company's outstanding 6 5/8% Senior Notes due
January 15, 2006 ("Senior Notes") at an aggregate cost of $74.7 million, and (3)
repurchase $53.0 million aggregate principal amount, $25.2 million carrying
value, of the Company's outstanding Convertible Notes at an aggregate cost of
$22.8 million. The remaining proceeds were used for general corporate purposes.
(See also "Liquidity and Financial Resources -- Capital Resources" for
additional description of the Convertible Notes, including a non-cash repurchase
completed in December 2002.)
For the year ended December 31, 2002, receipts from annuity contracts
increased 9.4%. Annuity contract maturities and withdrawals increased $11.5
million, or 6.4%, compared to the prior year, including decreases of 3% in
surrenders of both variable and fixed annuities. Reflecting continued
improvement in recent quarterly trends, cash value retention for variable and
fixed annuity options were 92.1% and 94.0%, respectively, for the 12 month
period ended December 31, 2002. Net transfers to variable annuity accumulated
cash values decreased $36.3 million compared to the prior year.
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 December 31, 2002, $96.3 million remained authorized for
future share repurchases.
F-40
Contractual Obligations
Payments Due By Period
----------------------------------------------------------
More Than
Less Than 1 - 3 Years 3 - 5 Years 5 Years
1 Year (2004 and (2006 and (2008 and
Total (2003) (2005) (2007) beyond)
----- --------- ----------- ----------- ---------
Long-Term Debt Obligations (a):
Convertible Notes Due 2032... $260.2 $3.5 $ 7.0 $ 5.2 $244.5
Senior Notes Due 2006........ 35.2 1.9 3.8 29.5 --
------ ---- ----- ----- ------
Total..................... $295.4 $5.4 $10.8 $34.7 $244.5
====== ==== ===== ===== ======
- ----------
(a) Includes principal and interest.
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.
Payments on these leases were approximately $8 million for each of the years
ended December 31, 2002, 2001 and 2000. It is anticipated that the Company's
payments under operating leases for the full year 2003 will be comparable to
prior years' payments. The Company does not have any other arrangements that
expose it to material liability that are not recorded in the financial
statements.
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 $673.5 million at December 31, 2002,
including $144.7 million of long-term debt and no short-term debt outstanding.
Total debt represented 21.5% of capital (24.4% excluding unrealized investment
gains and losses) at December 31, 2002, within the Company's long-term target of
25%.
Shareholders' equity was $528.8 million at December 31, 2002, including an
unrealized gain in the Company's investment portfolio of $80.6 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 $654.5 million and $15.33, respectively, at December 31,
2002. Book value per share was $12.39 at December 31, 2002, $10.50 excluding
investment fair value adjustments. At December 31, 2001, book value per share
was $11.27, $10.62 excluding investment fair value adjustments. The increase in
book value per share over the 12 months
F-41
included the effects of realized investment losses, unrealized investment gains
and an increase in the Company's minimum pension liability recorded at December
31, 2002.
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 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. For information regarding the use of proceeds,
see "Liquidity and Financial Resources -- Cash Flow -- Financing Activities." In
addition to the cash repurchase transactions, in December 2002 the Company
repurchased an additional $56.0 million aggregate principal amount, $26.6
million carrying value, of the outstanding Convertible Notes at an aggregate
cost of $26.0 million in a non-cash transaction. As consideration for this
repurchase, 1.8 million shares of HMEC's common stock were issued.
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 Standard &
Poor's Corporation ("S&P") (BBB+), Moody's Investors Service, Inc. ("Moody's")
(Baa2), Fitch Ratings, Ltd. ("Fitch") (A-), 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
F-42
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, described
above, as well as the Company's increased financial leverage and the competitive
nature of the annuity markets in which the Company competes. 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. The Convertible Notes are traded in the open market (HMN 1.425).
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 2002, the Company repurchased $71.4 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 S&P (BBB+), Moody's (Baa2), Fitch
(A-) 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". On September
19, 2002, Fitch confirmed its "A-" debt rating, but revised the outlook for the
rating 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 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. 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
December 31, 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
December 31, 2002.
The Company's ratio of earnings to fixed charges for the year ended
December 31, 2002 was 1.9x, reflecting the impact of $49.4 million of pretax
realized investment losses recognized during the period, compared to 4.0x for
the prior year.
Total shareholder dividends were $17.2 million for the year ended December
31, 2002. In February 2003, the Board of Directors announced a regular quarterly
dividend of $0.105 per share.
F-43
The Company maintains an excess and catastrophe treaty reinsurance program.
The Company reinsures 95% of catastrophe losses above a retention of $8.5
million per occurrence up to $80 million per occurrence. In addition, the
Company's predominant insurance subsidiary for property and casualty business
written in Florida reinsures 90% of hurricane losses in that state above a
retention of $13.7 million up to $51.4 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.
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, which is renewable annually at the option of the Company, the equity
put coverage of $75 million provides a source of capital for up to $115 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 was 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: (1) the Company's shareholders' equity,
adjusted to exclude goodwill, can not be less than $215 million after recording
the first triggering event; (2) the Company's debt as a percentage of total
capital can not be more than 47.5% prior to recording the triggering event; and
(3) 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
December 31, 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, 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.
On December 31, 2002, the Company's primary life insurance subsidiary,
Horace Mann Life Insurance Company ("HMLIC"), entered into a reinsurance
agreement with Sun Life Reinsurance Company Limited ("SLRCL"), a member of the
Sun Life Financial Group. Under the terms of the agreement, which is expected to
be in place for a five year period, HMLIC ceded to SLRCL, on a combination
coinsurance and modified coinsurance basis, a 57.7% quota share of HMLIC's in
force interest-sensitive life block of business issued prior to January 1, 2002.
SLRCL assumes its proportional share of all risks attendant to the business
reinsured such as mortality, persistency and investment risk, reducing HMLIC's
liabilities under statutory accounting principles to the extent of the ceded
commission. The initial ceded commission paid by SLRCL to HMLIC was $50.0
million and resulted in a $32.5 million after-tax increase in HMLIC's statutory
surplus. Subsequent growth in HMLIC's statutory surplus is expected to be
reduced by approximately $6.5 million annually, as the coinsurance reserve
declines over the term of the agreement. Fees related to
F-44
this transaction, which are anticipated to reduce the Company's after-tax GAAP
operating income and net income by approximately 2 cents per share in 2003, are
also expected to decline over the term of the agreement. This transaction
improved the statutory operating leverage and risk-based capital ratio of HMLIC,
partially mitigating the impact of realized investment losses recorded in 2002.
Insurance Financial Ratings
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, 2002 in "Business -- Insurance Financial
Ratings." 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 in both May 2002 and March 2003, 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 Ratings, Ltd. ("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, described above, as well as
the Company's increased financial leverage and the competitive nature of the
annuity markets in which the Company competes. 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.
F-45
Market Value Risk
Market risk is the risk that the Company will incur losses due to adverse
changes in market rates. Market value risk, the Company's primarily market risk
exposure, 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 -- Year Ended December 31, 2002 Compared to Year Ended December 31,
2001 -- 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 deposits and the underlying mutual funds is
assumed by those contractholders, and not by the Company. Certain fees that the
Company earns from variable annuity deposits are based on the market value of
the funds deposited.
Through active investment management, the Company invests available funds
with the objective of funding future obligations to policyholders, subject to
appropriate risk considerations, and maximizing shareholder value. This
objective is met through investments that (1) have similar characteristics to
the liabilities they support; (2) are diversified among industries, issuers and
geographic locations; and (3) are predominately investment-grade fixed maturity
securities classified as available for sale. No derivatives are used to manage
the exposure to interest rate risk in the investment portfolios. At December 31,
2002, 20% of the fixed investment portfolio represented investments supporting
the property and casualty operations and 80% supported the life and annuity
business. For a discussion regarding the Company's investments see "Business --
Investments."
The Company's life and annuity operating earnings are affected by the
spreads between interest yields on investments and rates credited or accruing on
life and fixed annuity insurance liabilities. Although substantially all
credited rates on fixed annuities may be changed annually (subject to minimum
guaranteed rates), competitive pricing and other factors, including the impact
on the level of surrenders and withdrawals, may limit the Company's ability to
adjust or to maintain crediting rates at levels necessary to avoid narrowing of
spreads under certain market conditions.
Using financial modeling and other techniques, the Company regularly
evaluates the appropriateness of investments relative to the characteristics of
the liabilities that they support. Simulations of cash flows generated from
existing business under various interest rate scenarios measure the potential
gain or loss in fair value of interest-rate sensitive assets and liabilities.
Such estimates are used to closely match the duration of assets to the duration
of liabilities. The overall duration of liabilities of the Company's multiline
insurance operations combines the characteristics of its long duration
interest-sensitive life and annuity liabilities with its short duration
non-interest-sensitive property and casualty liabilities. Overall, at December
31, 2002, the
F-46
duration of the investment portfolio was approximately 4.8 years, and the
duration of insurance liabilities was approximately 5.4 years.
The life and annuity operations participate in the cash flow testing
procedures imposed by statutory insurance regulations, the purpose of which is
to insure that such liabilities are adequate to meet the Company's obligations
under a variety of interest rate scenarios. Based on these procedures, the
Company's assets and the investment income expected to be received on such
assets are adequate to meet the insurance policy obligations and expenses of the
Company's insurance activities in all but the most extreme circumstances.
The Company periodically evaluates its sensitivity to interest rate risk.
Based on commonly used models, the Company projects the impact of interest rate
changes, assuming a wide range of factors, including duration and prepayment, on
the fair value of assets and liabilities. Fair value is estimated based on the
net present value of cash flows or duration estimates. At December 31, 2002,
assuming an immediate decrease of 100 basis points in interest rates, the net
fair value of the Company's assets and liabilities would decrease by
approximately $21 million after tax, or 4% of shareholders' equity. A 100 basis
point increase would decrease the fair value of assets and liabilities by $2
million after tax, or less than 1% of shareholders' equity. At December 31,
2001, assuming an immediate decrease of 100 basis points in interest rates, the
net fair value of the Company's assets and liabilities would have increased by
approximately $10 million after tax, or 3% of shareholders' equity. A 100 basis
point increase would have decreased the fair value of assets and liabilities by
$16 million after tax, or 5% of shareholders' equity. In each case, these
changes in interest rates assume a parallel shift in the yield curve.
While the Company believes that these assumed market rate changes are
reasonably possible, actual results may differ, particularly as a result of any
management actions that would be taken to mitigate such hypothetical losses in
fair value of shareholders' equity. Based on the Company's overall exposure to
interest rate risk, the Company believes that these changes in interest rates
would not materially affect its consolidated near-term financial position,
results of operations or cash flows.
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 in the second quarter of 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.
F-47
Business Continuity Risk
Given the events of September 11, 2001, the continuing threat of terrorism
and the current geopolitical climate, the Company has undertaken a reassessment
of its business continuity plans. While current contingency plans are felt to be
adequate to restore some of the more critical business processes and the Company
is aggressively working to strengthen its continuity plans, in the current
environment there is believed to exist a higher than acceptable level of risk
that the Company's ability to recover and resume most or all of its key business
operations on a timely basis would be compromised.
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 year ended
December 31, 2002, the Company recorded charges for the extinguishment of debt
and did not report the charges 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.
F-48
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.
SFAS No. 148
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123," effective for financial statements for fiscal years ending after December
15, 2002 and for financial reports containing condensed financial statements for
interim periods beginning after December 15, 2002. SFAS No. 148 provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, SFAS
No. 148 amends the disclosure requirements of SFAS No. 123 to require more
prominent and more frequent disclosures in financial statements about the
effects of stock-based compensation, including disclosures in interim financial
statements. As the Company has not elected to adopt the fair value based method
of accounting for stock-based employee compensation, this statement is not
expected to currently impact the Company except as it relates to disclosure in
interim financial statements. The required disclosures for annual financial
statements are included in the Company's Notes to Financial Statements for the
year ended December 31, 2002.
FIN No. 45
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees" ("FIN 45"). FIN 45
requires that disclosures be made by a guarantor in its interim and annual
financial statements about its obligation under certain guarantees that it has
issued. It also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. FIN 45 does not apply to certain guarantee
contracts such as those issued by insurance and reinsurance companies and
accounted for under accounting principles applicable to those companies. The
disclosure requirements are effective for financial statements for periods
ending after December 15, 2002. Recognition and measurement provisions are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The Company currently has not entered into any transactions
subject to FIN 45, and therefore FIN 45 does not currently impact the Company.
FIN No. 46
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN 46"). FIN 46 requires that companies that
absorb the majority of another entity's expected losses, receive a majority of
its expected residual returns, or both, as a result of holding variable
interests, which are ownership, contractual, or other economic interests in an
entity, consolidate that entity, referred to as a variable interest entity
("VIE"). Companies meeting this definition are considered 'primary
beneficiaries'. The consolidation requirements apply to all VIE's created after
January 31, 2003. None of the Company's investments at December 31, 2002 meet
the requirements of a primary beneficiary, and therefore FIN 46 does not
currently impact the Company.
F-49
Effects of Inflation and Changes in Interest Rates
The Company's operating results are affected significantly in at least
three ways by changes in interest rates and inflation. First, inflation directly
affects property and casualty claims costs. Second, the investment income earned
on the Company's investment portfolio and the fair value of the investment
portfolio are related to the yields available in the fixed-income markets. An
increase in interest rates will decrease the fair value of the investment
portfolio, but will increase investment income as investments mature and
proceeds are reinvested at higher rates. Third, as interest rates increase,
competitors will typically increase crediting rates on annuity and
interest-sensitive life products, and may lower premium rates on property and
casualty lines to reflect the higher yields available in the market. The risk of
interest rate fluctuation is managed through asset/liability management
techniques, including cash flow analysis.
F-50
REPORT OF MANAGEMENT RESPONSIBILITY FOR FINANCIAL STATEMENTS
Horace Mann Educators Corporation
The consolidated balance sheets of Horace Mann Educators Corporation and
subsidiaries as of December 31, 2002, 2001 and 2000, and the related
consolidated statements of operations, changes in shareholders' equity, and cash
flows for the years ended December 31, 2002, 2001 and 2000 have been prepared by
management, which is responsible for their integrity and reliability. The
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America and include some amounts that are based
upon management's best estimates and judgements. Management has discussed with
the Audit Committee the quality, not just the acceptability, of the Company's
accounting principles as applied in its financial reporting. The discussions
generally included such matters as the consistency of the Company's accounting
policies and their application, and the clarity and completeness of the
Company's financial statements, which include related disclosures. The financial
information contained elsewhere in this annual report on Form 10-K is consistent
with that contained in the financial statements.
Management is responsible for establishing and maintaining a system of
internal control designed to provide reasonable assurance as to the integrity
and reliability of financial reporting. The concept of reasonable assurance is
based on the recognition that there are inherent limitations in all systems of
internal control, and that the cost of such systems should not exceed the
benefits derived therefrom. A professional staff of internal auditors reviews on
an ongoing basis the related internal control system design, the accounting
policies and procedures supporting this system and compliance therewith.
Management believes this system of internal control effectively meets its
objective of reliable financial reporting.
In connection with their annual audits, independent certified public
accountants perform an examination, in accordance with auditing standards
generally accepted in the United States of America, which includes the
consideration of the system of internal control to the extent necessary to form
an independent opinion on the fairness of presentation of the financial
statements prepared by management and not to provide assurance on the system of
internal controls.
The Board of Directors, through its Audit Committee composed solely of
directors who are not employees of the Company, is responsible for overseeing
the integrity and reliability of the Company's accounting and financial
reporting practices and the effectiveness of its system of internal controls.
The independent certified public accountants and internal auditors meet
regularly with this committee, and have access to this committee with and
without management present, to discuss the results of their audit work.
F-51
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Horace Mann Educators Corporation:
We have audited the accompanying consolidated balance sheets of Horace Mann
Educators Corporation and subsidiaries (the Company) as of December 31, 2002,
2001 and 2000, and the related consolidated statements of operations, changes in
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 2002. In connection with our audits of the
consolidated financial statements, we also have audited the financial statement
schedules, as listed in the accompanying index. These consolidated financial
statements and financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedules based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Horace Mann
Educators Corporation and subsidiaries as of December 31, 2002, 2001 and 2000,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the related financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present fairly,
in all material respects, the information set forth therein.
As discussed in note 1 to the consolidated financial statements, in 2002
the Company adopted the provisions of Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets."
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
February 6, 2003
F-52
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED BALANCE SHEETS
As of December 31, 2002, 2001 and 2000
(Dollars in thousands)
2002 2001 2000
---------- ---------- ----------
ASSETS
Investments
Fixed maturities, available for sale, at fair value
(amortized cost 2002, $2,859,007;
2001, $2,726,831; 2000, $2,615,156)................ $2,991,195 $2,769,867 $2,607,738
Short-term and other investments...................... 135,431 107,445 99,728
Short-term investments, loaned securities collateral.. 3,937 98,369 204,881
---------- ---------- ----------
Total investments.................................. 3,130,563 2,975,681 2,912,347
Cash .................................................... 60,162 33,939 21,141
Accrued investment income and premiums receivable........ 99,954 112,746 101,405
Deferred policy acquisition costs........................ 174,555 157,776 141,604
Goodwill................................................. 47,396 47,396 49,014
Value of acquired insurance in force..................... 31,945 38,393 43,246
Other assets............................................. 113,244 114,665 116,756
Variable annuity assets.................................. 854,470 1,008,430 1,035,067
---------- ---------- ----------
Total assets....................................... $4,512,289 $4,489,026 $4,420,580
========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities
Fixed annuity contract liabilities.................... $1,385,737 $1,278,137 $1,217,756
Interest-sensitive life contract liabilities.......... 544,533 518,455 481,140
Unpaid claims and claim expenses...................... 326,575 314,295 308,881
Future policy benefits................................ 180,577 179,109 180,049
Unearned premiums..................................... 189,384 185,569 174,428
---------- ---------- ----------
Total policy liabilities .......................... 2,626,806 2,475,565 2,362,254
Other policyholder funds................................. 125,108 123,434 122,233
Liability for securities lending agreements.............. 3,937 98,369 204,881
Other liabilities........................................ 228,441 171,271 119,431
Short-term debt.......................................... -- 53,000 49,000
Long-term debt........................................... 144,685 99,767 99,721
Variable annuity liabilities............................. 854,470 1,008,430 1,035,067
---------- ---------- ----------
Total liabilities.................................. 3,983,447 4,029,836 3,992,587
---------- ---------- ----------
Preferred stock, $0.001 par value, authorized
1,000,000 shares; none issued......................... -- -- --
Common stock, $0.001 par value, authorized
75,000,000 shares; issued, 2002, 60,194,615;
2001, 60,076,921; 2000, 59,859,053 ................... 60 60 60
Additional paid-in capital............................... 342,749 341,052 338,243
Retained earnings ....................................... 455,308 461,139 452,624
Accumulated other comprehensive income
(loss), net of taxes:
Net unrealized gains (losses) on fixed
maturities and equity securities................ 80,567 26,336 (4,038)
Minimum pension liability adjustment............... (17,265) (11,438) (937)
Treasury stock, at cost, 2002, 17,503,371 shares;
2001 and 2000, 19,341,296 shares...................... (332,577) (357,959) (357,959)
---------- ---------- ----------
Total shareholders' equity......................... 528,842 459,190 427,993
---------- ---------- ----------
Total liabilities and shareholders' equity......... $4,512,289 $4,489,026 $4,420,580
========== ========== ==========
See accompanying notes to consolidated financial statements.
F-53
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
Year Ended December 31,
---------------------------------------
2002 2001 2000
----------- ----------- -----------
Insurance premiums written and contract deposits.... $ 899,329 $ 875,566 $ 821,653
=========== =========== ===========
Revenues
Insurance premiums and contract charges earned... $ 625,233 $ 615,242 $ 598,714
Net investment income............................ 196,048 199,267 192,396
Realized investment losses....................... (49,407) (10,019) (9,906)
----------- ----------- -----------
Total revenues................................ 771,874 804,490 781,204
----------- ----------- -----------
Benefits, losses and expenses
Benefits, claims and settlement expenses......... 450,866 475,583 466,048
Interest credited................................ 98,380 96,502 92,561
Policy acquisition expenses amortized............ 61,297 58,048 55,972
Operating expenses............................... 131,339 123,679 127,910
Amortization of intangible assets................ 5,734 5,774 8,769
Interest expense................................. 8,517 9,250 10,204
Restructuring charges............................ 4,223 7,312 2,236
Debt retirement costs............................ 2,272 -- --
Litigation charges............................... 1,581 -- 7,783
----------- ----------- -----------
Total benefits, losses and expenses........... 764,209 776,148 771,483
----------- ----------- -----------
Income before income taxes.......................... 7,665 28,342 9,721
Income tax expense (benefit)........................ (3,668) 4,024 (2,438)
Adjustment to the provision for prior years' taxes.. -- (1,269) (8,682)
----------- ----------- -----------
Net income.......................................... $ 11,333 $ 25,587 $ 20,841
=========== =========== ===========
Earnings per share
Basic ........................................... $ 0.28 $ 0.63 $ 0.51
=========== =========== ===========
Diluted.......................................... $ 0.28 $ 0.63 $ 0.51
=========== =========== ===========
Weighted average number of shares and equivalent
shares
Basic...................................... 40,941,182 40,616,843 40,782,173
Diluted.................................... 41,199,033 40,877,120 40,966,774
See accompanying notes to consolidated financial statements.
F-54
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share data)
Year Ended December 31,
---------------------------------
2002 2001 2000
--------- --------- ---------
Common stock
Beginning balance .............................................. $ 60 $ 60 $ 59
Options exercised, 2002, 107,410 shares; 2001,
207,575 shares; 2000, 557,000 shares; and
shares awarded, 2000, 10,000 shares ......................... -- -- 1
Conversion of Director Stock Plan units, 2002,
10,284 shares; 2001, 10,293 shares .......................... -- -- --
--------- --------- ---------
Ending balance ................................................. 60 60 60
--------- --------- ---------
Additional paid-in capital
Beginning balance .............................................. 341,052 338,243 333,892
Options exercised, conversion of Director
Stock Plan units and shares awarded ......................... 2,183 3,759 5,301
Catastrophe-linked equity put option premium ................... (1,088) (950) (950)
Issuance of treasury shares in 2002 ............................ 602 -- --
--------- --------- ---------
Ending balance ................................................. 342,749 341,052 338,243
--------- --------- ---------
Retained earnings
Beginning balance .............................................. 461,139 452,624 449,023
Net income ..................................................... 11,333 25,587 20,841
Cash dividends, 2002, $0.42 per share; 2001, $0.42
per share; 2000, $0.42 per share ............................ (17,164) (17,072) (17,240)
--------- --------- ---------
Ending balance ................................................. 455,308 461,139 452,624
--------- --------- ---------
Accumulated other comprehensive income (loss), net of taxes:
Beginning balance .............................................. 14,898 (4,975) (40,016)
Change in net unrealized gains (losses) on fixed
maturities and equity securities ............................ 54,231 30,374 35,978
Increase in minimum pension liability adjustment ............... (5,827) (10,501) (937)
--------- --------- ---------
Ending balance ................................................. 63,302 14,898 (4,975)
--------- --------- ---------
Treasury stock, at cost
Beginning balance, 2002 and 2001, 19,341,296
shares; 2000, 18,258,896 shares ............................. (357,959) (357,959) (342,816)
Issuance of 1,837,925 shares in 2002 ........................... 25,382 -- --
Purchase of 1,082,400 shares in 2000 ........................... -- -- (15,143)
--------- ---------- ---------
Ending balance 2002, 17,503,371 shares,
2001 and 2000, 19,341,296 shares ............................ (332,577) (357,959) (357,959)
--------- --------- ---------
Shareholders' equity at end of period ............................. $ 528,842 $ 459,190 $ 427,993
========= ========= =========
Comprehensive income
Net income ..................................................... $ 11,333 $ 25,587 $ 20,841
Other comprehensive income, net of tax:
Change in net unrealized gains (losses)
on fixed maturities and equity securities ................ 54,231 30,374 35,978
Increase in minimum pension liability adjustment ............ (5,827) (10,501) (937)
--------- --------- ---------
Other comprehensive income ............................ 48,404 19,873 35,041
--------- --------- ---------
Total .............................................. $ 59,737 $ 45,460 $ 55,882
========= ========= =========
See accompanying notes to consolidated financial statements.
F-55
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- ---------
Cash flows from operating activities
Premiums collected ............................................. $ 663,682 $ 642,596 $ 618,253
Policyholder benefits paid ..................................... (465,811) (487,619) (465,414)
Policy acquisition and other operating expenses paid ........... (206,457) (193,713) (187,248)
Federal income taxes recovered (paid) .......................... (2,055) 7,520 (16,101)
Investment income collected .................................... 197,872 195,086 191,103
Interest expense paid .......................................... (9,540) (9,091) (10,028)
Contribution to defined benefit pension plan trust fund ........ (7,910) -- --
Other .......................................................... (4,314) (5,922) (6,317)
----------- ----------- ---------
Net cash provided by operating activities ................ 165,467 148,857 124,248
----------- ----------- ---------
Cash flows used in investing activities
Fixed maturities
Purchases ................................................... (1,546,528) (1,140,930) (750,928)
Sales ....................................................... 1,117,268 732,076 464,305
Maturities .................................................. 274,134 283,153 243,618
Net cash (used for) provided by
short-term and other investments ............................ (28,776) (2,107) 26,814
----------- ----------- ---------
Net cash used in investing activities .................... (183,902) (127,808) (16,191)
----------- ----------- ---------
Cash flows provided by (used in) financing activities
Purchase of treasury stock ..................................... -- -- (15,143)
Dividends paid to shareholders ................................. (17,164) (17,072) (17,240)
Principal (repayments) borrowings
on Bank Credit Facility ..................................... (53,000) 4,000 --
Exercise of stock options ...................................... 2,183 3,759 5,302
Catastrophe-linked equity put option premium ................... (1,088) (950) (950)
Proceeds from issuance of Convertible Notes .................... 162,654 -- --
Repurchase of Senior Notes and Convertible Notes ............... (97,523) -- --
Annuity contracts, variable and fixed
Deposits .................................................... 261,509 239,124 206,393
Maturities and withdrawals .................................. (189,824) (178,364) (312,365)
Net transfer (to) from variable annuity assets .............. (17,264) (53,550) 28,437
Net decrease in life policy account balances ................... (5,825) (5,198) (4,198)
----------- ----------- ---------
Net cash provided by (used in) financing activities ...... 44,658 (8,251) (109,764)
----------- ----------- ---------
Net increase (decrease) in cash ................................... 26,223 12,798 (1,707)
Cash at beginning of period ....................................... 33,939 21,141 22,848
----------- ----------- ---------
Cash at end of period ............................................. $ 60,162 $ 33,939 $ 21,141
=========== =========== =========
See accompanying notes to consolidated financial statements.
F-56
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2002, 2001 and 2000
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements 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. The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
The consolidated financial statements include the accounts of Horace Mann
Educators Corporation and its wholly-owned subsidiaries ("HMEC"; and together
with its subsidiaries, the "Company" or "Horace Mann"). HMEC and its
subsidiaries have common management, share office facilities and are parties to
several intercompany service agreements for management, administrative, data
processing, agent commissions, agency services, utilization of personnel and
investment advisory services. Under these agreements, costs have been allocated
among the companies in conformity with customary insurance accounting practices
consistently applied. In addition, certain of the subsidiaries have entered into
intercompany reinsurance agreements. HMEC and its subsidiaries file a
consolidated federal income tax return, and there are related tax sharing
agreements. All significant intercompany balances and transactions have been
eliminated in consolidation.
The subsidiaries of HMEC sell and underwrite tax-qualified retirement
annuities and private passenger automobile, homeowners, and life insurance
products, primarily to educators and other employees of public schools and their
families. The Company's principal operating subsidiaries are Horace Mann Life
Insurance Company, Horace Mann Insurance Company, Teachers Insurance Company,
Horace Mann Property & Casualty Insurance Company and Horace Mann Lloyds.
Investments
The Company invests primarily in fixed maturity investments. These
securities are classified as available for sale and carried at fair value. The
net adjustment for unrealized gains and losses on securities available for sale,
carried at fair value, is recorded as a separate component of shareholders'
equity, net of applicable deferred tax asset or liability and the related impact
on deferred policy acquisition costs and value of acquired insurance in force
associated with interest-sensitive life and annuity contracts.
F-57
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Short-term and other investments are comprised of policy loans, carried at
unpaid principal balances; short-term fixed interest securities, carried at cost
which approximates fair value; mortgage loans, carried at unpaid principal less
a valuation allowance for estimated uncollectible amounts; real estate acquired
in the settlement of debt, carried at the lower of cost or fair value; and
equity securities, carried at fair value.
Interest income is recognized as earned. Investment income reflects
amortization of premiums and accrual of discounts on an effective-yield basis.
Realized gains and losses arising from the sale or impairment of securities
are determined based upon specific identification of securities. 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) the stock price trend of the issuer, (4) the market leadership
position of the issuer, (5) the debt ratings of the issuer and (6) the 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 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.
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 the Company has the intent and ability to hold the investment
until maturity or a market recovery is realized. Management believes that its
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
F-58
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," and related guidance.
Deferred Policy Acquisition Costs
Deferred policy acquisition costs net of accumulated amortization were
$174,555, $157,776 and $141,604 as of December 31, 2002, 2001 and 2000,
respectively.
Acquisition costs, consisting of commissions, policy issue and other costs,
which vary with and are primarily related to the production of insurance
business, are capitalized and amortized as follows. Capitalized acquisition
costs for interest-sensitive life contracts are amortized over 20 years in
proportion to estimated gross profits. For other individual life contracts,
acquisition costs are amortized in proportion to anticipated premiums over the
terms of the insurance policies (10, 15 and 20 years). For investment (annuity)
contracts, acquisition costs are amortized over 20 years in proportion to
estimated gross profits. For property and casualty policies, acquisition costs
are amortized over the terms of the insurance policies (six and twelve months).
The Company periodically reviews the assumptions and estimates used in
capitalizing policy acquisition costs and also periodically reviews its
estimations of future gross profits. The most significant assumptions that are
involved in the estimation of future gross profits include future market
performance, 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.
Deferred policy acquisition costs for interest-sensitive life and
investment contracts are adjusted for the impact on estimated future gross
profits as if net unrealized investment gains and losses had been realized at
the balance sheet date. The impact of this adjustment is included in net
unrealized gains and losses within shareholders' equity.
Deferred acquisition costs are reviewed for recoverability from future
income, including investment income, and costs which are deemed unrecoverable
are expensed in the period in which the determination is made. No such costs
have been deemed unrecoverable during the periods reported.
When the Company was acquired in 1989, deferred acquisition costs were
reduced to zero in connection with establishing the value of acquired insurance
in force in the application of purchase accounting.
F-59
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation
and are included in Other Assets in the Consolidated Balance Sheets.
Depreciation and amortization are calculated on the straight-line method based
on the estimated useful lives of the assets. The estimated useful lives of
property and equipment by asset type are generally as follows: real estate,
identified by specific property, 20-45 years; furniture, 10 years; general
office machines, 6 years; telephones, 5 years; vehicles, 3 years; and data
processing hardware and software and personal computers, 3 years.
December 31,
---------------------------
2002 2001 2000
------- ------- -------
Property and equipment ........................ $73,855 $68,160 $62,652
Less: accumulated depreciation ................ 43,921 38,625 33,025
------- ------- -------
Total ...................................... $29,934 $29,535 $29,627
======= ======= =======
Value of Acquired Insurance In Force and Goodwill
When the Company was acquired in 1989, intangible assets were recorded in
the application of purchase accounting to recognize the value of acquired
insurance in force and goodwill. In addition, goodwill was recorded in 1994
related to the purchase of Horace Mann Property & Casualty Insurance Company
(formerly Allegiance Insurance Company). The value of acquired insurance in
force 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. Goodwill, net of amortization, was $47,396 and $49,014 at December 31,
2001 and 2000, respectively.
Effective January 1, 2002, the Company adopted 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 December 31, 2002
---------------------
Annuity ....................................... $28,025
Life .......................................... 9,911
Property and casualty ......................... 9,460
-------
Total ...................................... $47,396
=======
F-60
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Net income and net income per share exclusive of goodwill amortization
expense for the years ended December 31, 2002, 2001 and 2000 were as follows:
Year Ended December 31,
---------------------------
2002 2001 2000
------- ------- -------
Reported net income ........................ $11,333 $25,587 $20,841
Add back: Goodwill amortization ........... -- 1,618 1,618
------- ------- -------
Adjusted net income ..................... $11,333 $27,205 $22,459
======= ======= =======
Reported net income per share-basic ........ $ 0.28 $ 0.63 $ 0.51
Add back: Goodwill amortization ........... -- 0.04 0.04
------- ------- -------
Adjusted net income per share-basic ..... $ 0.28 $ 0.67 $ 0.55
======= ======= =======
Reported net income per share-diluted ...... $ 0.28 $ 0.63 $ 0.51
Add back: Goodwill amortization ........... -- 0.04 0.04
------- ------- -------
Adjusted net income per share-diluted ... $ 0.28 $ 0.67 $ 0.55
======= ======= =======
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 December
31, 2002, 2001 and 2000 were as follows:
December 31, 2002 December 31, 2001
--------------------------------- ---------------------------------
Accumulated Net Accumulated Net
Cost Amortization Balance Cost Amortization Balance
-------- ------------ ------- -------- ------------ -------
Value of acquired
insurance in force
Life ................ $ 48,746 $ 39,877 $ 8,869 $ 48,746 $38,151 $10,595
Annuity ............. 87,553 63,255 24,298 87,553 59,247 28,306
-------- -------- ------- -------- ------- -------
Subtotal ......... $136,299 $103,132 33,167 $136,299 $97,398 38,901
======== ======== ------- ======== ======= -------
Impact of
unrealized gains
and losses ....... (1,222) (508)
------- -------
Total ......... $31,945 $38,393
======= =======
December 31, 2000
---------------------------------
Accumulated Net
Cost Amortization Balance
-------- ------------ -------
Value of acquired
insurance in force
Life ................ $ 48,746 $36,312 $12,434
Annuity ............. 87,553 56,930 30,623
-------- ------- -------
Subtotal ......... $136,299 $93,242 43,057
======== ======= -------
Impact of
unrealized gains
and losses ....... 189
-------
Total ............ $43,246
=======
F-61
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Scheduled amortization of the December 31, 2002 balances of value of
acquired insurance in force by segment over the next five years is as follows:
Year Ended December 31,
------------------------------------------
2003 2004 2005 2006 2007
------ ------ ------ ------ ------
Scheduled amortization of:
Value of acquired insurance in force
Life.............................. $1,625 $1,537 $1,460 $1,394 $1,338
Annuity........................... 3,650 3,812 3,970 4,116 4,280
------ ------ ------ ------ ------
Total.......................... $5,275 $5,349 $5,430 $5,510 $5,618
====== ====== ====== ====== ======
The amount of interest accrued on the unamortized balance of value of
acquired insurance in force and the interest accrual rates were as follows:
Year Ended December 31,
------------------------
2002 2001 2000
------ ------ ------
Interest accrued on the unamortized balance
of value of acquired insurance in force
Life.................................. $ 779 $ 921 $1,074
Annuity............................... 1,280 1,639 1,754
------ ------ ------
Total.............................. $2,059 $2,560 $2,828
====== ====== ======
Interest accrual rate
Life..................................... 8.0% 8.0% 8.0%
Annuity.................................. 5.4% 5.7% 5.6%
The accumulated amortization of intangibles as of December 31, 2002, 2001
and 2000 was $152,109, $146,375 and $140,601, respectively.
F-62
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Variable Annuity Assets and Liabilities
Variable annuity assets, carried at market value, and liabilities represent
tax-qualified variable annuity funds invested in various mutual funds, including
the seven proprietary Horace Mann mutual funds. The Company introduced 21 and 8
new investment options in its tax-deferred annuity product line in September
2000 and April 2002, respectively. Variable annuity assets were invested in the
offered mutual funds as follows:
December 31,
----------------------------------
2002 2001 2000
-------- ---------- ----------
Horace Mann Equity Fund............................................ $274,025 $ 376,081 $ 428,821
Horace Mann Balanced Fund.......................................... 240,697 292,126 315,015
Horace Mann Socially Responsible Fund.............................. 58,909 71,610 75,782
Horace Mann Small Cap Growth Fund.................................. 34,682 58,395 83,304
Horace Mann International Equity Fund.............................. 26,248 33,491 42,512
Wilshire Large Company Growth Portfolio -
Institutional Class and Investor Class.......................... 19,421 22,823 19,036
Horace Mann Income Fund............................................ 19,313 13,996 11,376
Wilshire 5000 Index Portfolio -
Institutional Class and Investor Class.......................... 16,784 19,806 16,829
Fidelity VIP Growth Portfolio SC2.................................. 15,040 14,852 7,041
Fidelity VIP 500 Index Portfolio SC2............................... 14,949 12,105 4,915
Ariel Appreciation Fund............................................ 14,179 4,351 --
Fidelity VIP Mid Cap Portfolio SC2................................. 12,836 11,368 4,690
Fidelity VIP Investment Grade Bond Portfolio SC2................... 9,861 3,797 312
Ariel Fund......................................................... 9,689 2,499 --
Alliance Premier Growth Portfolio.................................. 9,298 9,270 4,142
T. Rowe Price Small Cap Value Fund - Advisor Class................. 9,255 4,932 343
Wilshire Large Company Value Portfolio............................. 8,037 5,546 500
Neuberger Berman Genesis Fund Advisor Class........................ 7,494 4,369 252
T. Rowe Price Small Cap Stock Fund - Advisor Class................. 7,266 5,303 1,251
J.P. Morgan U.S. Disciplined Equity Portfolio...................... 6,973 5,738 1,845
Strong Opportunity Fund II......................................... 5,353 5,079 1,299
Horace Mann Short-Term Investment Fund............................. 4,186 2,797 2,274
Strong Mid Cap Growth Fund II...................................... 4,086 4,919 3,397
Rainier Small/Mid Cap Equity Portfolio............................. 4,051 3,579 1,444
Fidelity VIP Growth and Income Portfolio SC2....................... 4,009 3,152 820
Fidelity VIP Overseas Portfolio SC2................................ 3,917 3,339 1,410
Davis Value Portfolio.............................................. 3,743 3,566 1,489
Putnam VT Vista Fund (IB Shares)................................... 3,544 4,502 2,869
Credit Suisse Small Cap Growth Portfolio........................... 2,407 2,926 1,640
Wilshire Small Company Value Portfolio............................. 1,660 1,279 70
Wilshire Small Company Growth Portfolio............................ 847 428 128
Fidelity VIP High Income Portfolio SC2............................. 652 406 261
BlackRock Index Equity Portfolio................................... 386 -- --
BlackRock Temp Fund................................................ 180 -- --
Putnam VT George Putnam Fund of Boston (Class IB shares)........... 167 -- --
BlackRock Low Duration Bond Fund................................... 118 -- --
Putnam VT International Growth Fund (Class IB shares).............. 85 -- --
BlackRock Core Bond Total Return Fund.............................. 85 -- --
Berger Information Technology Fund................................. 36 -- --
Templeton Foreign Smaller Companies Fund (Class A)................. 2 -- --
-------- ---------- ----------
Total variable annuity assets................................... $854,470 $1,008,430 $1,035,067
======== ========== ==========
The investment income, gains and losses of these accounts accrue directly
to the policyholders and are not included in the operations of the Company.
F-63
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Future Policy Benefits, Interest-sensitive Life Contract Liabilities and
Annuity Contract Liabilities
Liabilities for future benefits on life and annuity policies are
established in amounts adequate to meet the estimated future obligations on
policies in force. Liabilities for future policy benefits on certain life
insurance policies are computed using the net level premium method and are based
upon assumptions as to future investment yield, mortality and withdrawals. As a
result of the application of purchase accounting, future policy benefits for
direct individual life insurance policies issued through August 29, 1989 were
revalued using interest rates of 9% graded to 8% over 10 years. For policies
issued from August 30, 1989 through December 31, 1992, future policy benefits
are computed using an interest rate of 6.5%. An interest rate of 5.5% is used to
compute future policy benefits for policies issued after December 31, 1992.
Mortality and withdrawal assumptions for all policies have been based on various
actuarial tables which are consistent with the Company's own experience.
Liabilities for future benefits on annuity contracts and certain long-duration
life insurance contracts are carried at accumulated policyholder values without
reduction for potential surrender or withdrawal charges. The liability also
includes provisions for the unearned portion of certain policy charges.
Unpaid Claims and Claim Expenses
Liabilities for property and casualty unpaid claims and claim expenses
include provisions for payments to be made on reported claims, claims incurred
but not reported and associated settlement expenses. At December 31, 2002, 99.3%
of the Company's liabilities for property and casualty unpaid claims and claim
expenses were carried at the full value of estimated liabilities and were not
discounted for interest expected to be earned on reserves. Estimated amounts of
salvage and subrogation on unpaid property and casualty claims are deducted from
the liability for unpaid claims. Due to the nature of the Company's personal
lines business, the Company has no exposure to claims for toxic waste cleanup,
other environmental remediation or asbestos-related illnesses other than claims
under homeowners insurance policies for environmentally related items such as
toxic mold.
F-64
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Insurance Premiums and Contract Charges Earned
Property and casualty insurance premiums are recognized as revenue ratably
over the related contract periods in proportion to the risks insured. The
unexpired portions of these property and casualty premiums are recorded as
unearned premiums, using the monthly pro rata method.
Premiums and contract charges for interest-sensitive life and annuity
contracts consist of charges for the cost of insurance, policy administration
and withdrawals. Premiums for long-term traditional life policies are recognized
as revenues when due over the premium-paying period. Annuity and
interest-sensitive life contract deposits represent funds deposited by
policyholders and are not included in the Company's premiums or contract charges
earned.
Stock Based Compensation
The Company grants stock options to executive officers, other employees and
directors. The exercise price of the option is equal to the fair market value of
the Company's common stock on the date of grant. Additional information
regarding the Company's stock-based compensation plans is contained in
Note 6 - Shareholders' Equity and Stock Options. The Company accounts for stock
option grants using the intrinsic value based method in accordance with
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," and accordingly, recognizes no compensation expense for the stock
option grants.
Alternatively, SFAS No. 123, "Accounting for Stock-Based Compensation,"
allows companies to recognize compensation cost for stock-based compensation
plans, determined based on the fair value at the grant dates. If the Company had
applied this alternative accounting method, net income and net income per share
would have been reduced to the pro forma amounts indicated below:
Year Ended December 31,
---------------------------
2002 2001 2000
------- ------- -------
Net income
As reported......................................... $11,333 $25,587 $20,841
Add: Stock-based compensation expense,
after tax, included in reported net income.... -- -- --
Deduct: Stock-based compensation expense,
after tax, determined under the fair value
based method for all awards(1)................ 4,437 4,418 1,846
------- ------- -------
Pro forma........................................... $ 6,896 $21,169 $18,995
======= ======= =======
Basic net income per share
As reported......................................... $ 0.28 $ 0.63 $ 0.51
Pro forma........................................... $ 0.17 $ 0.52 $ 0.47
Diluted net income per share
As reported......................................... $ 0.28 $ 0.63 $ 0.51
Pro forma........................................... $ 0.17 $ 0.52 $ 0.46
- ----------
(1) The fair value of each option grant was estimated on the date of grant
using the Modified Roll-Geske option-pricing model with the following
weighted average assumptions for 2002, 2001 and 2000, respectively:
risk-free interest rates of 5.2%, 5.1% and 5.9%; dividend yield of 2.0%,
2.3% and 2.4%; expected lives of 10 years; and volatility of 39.2%, 46.0%
and 53.2%.
F-65
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Income Taxes
The Company uses the liability method for calculating deferred federal
income taxes. Income tax provisions are generally based on income reported for
financial statement purposes. The provisions for federal income taxes for the
years ended December 31, 2002, 2001 and 2000 include amounts currently payable
and deferred income taxes resulting from the cumulative differences in the
Company's assets and liabilities, determined on a tax return versus financial
statement basis.
Deferred tax assets and liabilities include provisions for unrealized
investment gains and losses as well as the minimum pension liability adjustment
with the changes for each period included in the respective components of
accumulated other comprehensive income (loss) in shareholders' equity.
Earnings Per Share
Basic earnings per share is computed based on the weighted average number
of shares outstanding. Diluted earnings per share is based on the weighted
average number of shares and common stock equivalents outstanding. The common
stock equivalents relate to outstanding common stock options, Director Stock
Plan units and Employee Stock Plan units. The Company's Convertible Notes, while
potentially dilutive, are not common stock equivalents.
The computations of net income per share on both basic and diluted bases,
including reconciliations of the numerators and denominators, were as follows:
Year Ended December 31,
---------------------------
2002 2001 2000
------- ------- -------
Basic - assumes no dilution:
Net income for the period................................... $11,333 $25,587 $20,841
------- ------- -------
Weighted average number of common
shares outstanding during the period (in thousands)...... 40,941 40,617 40,782
------- ------- -------
Net income per share - basic............................... $ 0.28 $ 0.63 $ 0.51
======= ======= =======
Diluted - assumes full dilution:
Net income for the period................................... $11,333 $25,587 $20,841
------- ------- -------
Weighted average number of common shares
outstanding during the period (in thousands)............. 40,941 40,617 40,782
Weighted average number of common equivalent
shares to reflect the dilutive effect of common
stock equivalent securities (in thousands):
Stock options......................................... 87 125 62
Common stock units related to Deferred
Equity Compensation Plan for Directors............. 140 121 114
Common stock units related to Deferred
Compensation Plan for Employees.................... 31 14 9
------- ------- -------
Total common and common equivalent shares adjusted
to calculate diluted earnings per share (in thousands)... 41,199 40,877 40,967
------- ------- -------
Net income per share - diluted.............................. $ 0.28 $ 0.63 $ 0.51
======= ======= =======
F-66
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Options to purchase 2,341,625 shares of common stock at $18.51 to $33.87
per share were granted during 1997, 1998, 1999, 2001 and 2002 but were not
included in the computation of 2002 diluted earnings per share because the
options' exercise price was greater than the average market price of the common
shares during 2002. The options, which expire in 2007, 2008, 2009, 2011 and 2012
were still outstanding at December 31, 2002.
Comprehensive Income
Comprehensive income represents the change in shareholders' equity during a
reporting period from transactions and other events and circumstances from
non-shareholder sources. For the Company, comprehensive income is equal to net
income plus the change in net unrealized gains and losses on fixed maturities
and equity securities and the change in the minimum pension liability adjustment
for the period as shown in the Statement of Changes in Shareholders' Equity.
The components of comprehensive income were as follows:
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Net income.................................................. $ 11,333 $ 25,587 $ 20,841
-------- -------- --------
Other comprehensive income (loss):
Change in net unrealized gains (losses) on fixed
maturities and equity securities
Unrealized holding gains on fixed maturities
and equity securities arising during period..... 34,441 32,337 43,177
Less: reclassification adjustment for
losses included in net income................... (48,991) (14,392) (12,174)
-------- -------- --------
Total, before tax............................ 83,432 46,729 55,351
Income tax expense........................... 29,201 16,355 19,373
-------- -------- --------
Total, net of tax......................... 54,231 30,374 35,978
-------- -------- --------
Increase in minimum
pension liability adjustment
Before tax......................................... (8,965) (16,156) (1,441)
Income tax benefit................................. (3,138) (5,655) (504)
-------- -------- --------
Total, net of tax......................... (5,827) (10,501) (937)
-------- -------- --------
Total comprehensive income............. $ 59,737 $ 45,460 $ 55,882
======== ======== ========
Statements of Cash Flows
For purposes of the Statements of Cash Flows, cash constitutes cash on
deposit at banks.
Reclassification
The Company has reclassified the presentation of certain prior period
information to conform with the 2002 presentation.
F-67
NOTE 2 - Restructuring Charges
Restructuring charges were incurred and separately identified in the
Statements of Operations for the years ended December 31, 2002, 2001 and 2000.
Restructure of Property and Casualty Claims Operations
In July 2002, the Company recorded restructuring charges of $4,223 pretax,
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 of America ("U.S.") into 6 offices compared to the
previous 17, implementing a new claims administration system, and performing
certain claims reporting and adjusting functions internally versus utilizing
external service providers.
Approximately 135 employees with management, professional and clerical
responsibilities were 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. Termination
of lease agreements represented office space for each of the previous claims
office locations.
The following table provides information about the charges taken in July
2002, payment activity during the six months ended December 31, 2002, and the
balance of accrued amounts at December 31, 2002.
Original Reserve at
Pretax December 31,
Charge Payments 2002
-------- -------- ------------
Charges to earnings:
Employee termination costs........................ $2,542 $613 $1,929
Additional defined benefit pension plan costs..... 1,179 -- 1,179
Termination of lease agreements................... 502 77 425
------ ---- ------
Total.......................................... $4,223 $690 $3,533
====== ==== ======
Massachusetts Automobile Business
In October 2001, the Company recorded restructuring charges of $7,290
pretax reflecting a change in the Company's strategic direction 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 agents continue to write the Company's
other products in Massachusetts, including retirement annuities and property and
life insurance.
F-68
NOTE 2 - Restructuring Charges-(Continued)
Horace Mann ceased writing automobile insurance policies in Massachusetts
by December 31, 2001, and on October 18, 2001 paid $6,438 to the Commonwealth
Automobile Reinsurers ("C.A.R.") as full payment of its proportionate liability
to C.A.R. for policy years 2002 and beyond. The Company also paid legal and
other related consulting costs totaling $506 pretax. The remaining $346 was
attributable primarily to the write-off of software used only to process
Massachusetts automobile business. All of the costs related to this
restructuring were paid as of December 31, 2001, and consequently the Company's
Consolidated Balance Sheet at December 31, 2001 did not reflect any accrued
amounts due to the restructure of its Massachusetts automobile business.
On a full year basis, the Company's Massachusetts automobile business
represented premiums written and earned of approximately $27,000 in 2001. In
2002, premiums written for this business were reduced to zero, and premiums
earned were reduced significantly, reflecting run-off of the policies in force
at December 31, 2001. For the full year 2001, claims and claim settlement
expenses in Massachusetts for voluntary automobile business were $9,137 and for
involuntary residual market business were $11,455. Claims and claim settlement
expenses in 2002 reflected run-off of the business and a decline in exposure to
loss, as the Company's policies written in the prior 12 months expired.
Printing Services, Group Insurance and Credit Union Marketing Operations
In November 2001, the Company recorded restructuring charges of $450 pretax
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, comprised $409 of the total charge. The eliminated
positions encompassed 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 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. Employee termination costs, for termination of
approximately 50 individuals, represented severance, vacation buy-out and
related payroll taxes. The eliminated positions encompassed management,
professional and clerical responsibilities. By December 31, 2001, 39 individuals
had been terminated with two additional terminations scheduled to occur after
December 31, 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.
F-69
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 2002, and payment activity during the year ended December
31, 2002.
Original Reserve at Reserve at
Pretax December 31, December 31,
Charge 2001 Payments 2002
-------- ------------ -------- ------------
Charges to earnings:
Printing Services Operations
Employee termination costs............ $ 409 $ 396 $358 $ 38
Write-off of equipment................ 41 -- -- --
------ ------ ---- ----
Subtotal........................... 450 396 358 38
------ ------ ---- ----
Group Insurance and
Credit Union Marketing Operations
Employee termination costs......... 1,827 636 345 291
Termination of lease agreements.... 285 -- -- --
Write-off of capitalized software.. 106 -- -- --
Other.............................. 18 -- -- --
------ ------ ---- ----
Subtotal........................ 2,236 636 345 291
------ ------ ---- ----
Total........................ $2,686 $1,032 $703 $329
====== ====== ==== ====
NOTE 3 - Investments
Net Investment Income
The components of net investment income for the following periods were:
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Fixed maturities........................... $192,077 $192,547 $185,745
Short-term and other investments........... 7,650 10,346 10,220
-------- -------- --------
Total investment income................. 199,727 202,893 195,965
Less investment expenses................... 3,679 3,626 3,569
-------- -------- --------
Net investment income................... $196,048 $199,267 $192,396
======== ======== ========
Realized Investment Gains (Losses)
Realized investment gains (losses) for the following periods were:
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Fixed maturities........................... $(48,925) $(14,371) $(12,906)
Short-term and other investments........... (482) 4,352 3,000
-------- -------- --------
Realized investment losses.............. $(49,407) $(10,019) $ (9,906)
======== ======== ========
In 2002, as a result of reviews of the investment portfolio, the Company
recorded pretax impairment charges of $9,876, $28,111, $12,917 and $2,935 for
the three months ended March 31, June 30, September 30 and December 31,
respectively.
F-70
NOTE 3 - Investments-(Continued)
Fixed Maturity Securities
The amortized cost, unrealized investment gains and losses, and fair values
of investments in debt securities as of December 31, 2002, 2001 and 2000 were as
follows:
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
As of December 31, 2002
U.S. government and agency obligations
Mortgage-backed securities................... $ 645,787 $ 28,253 $ -- $ 674,040
Other........................................ 129,584 7,919 -- 137,503
Municipal bonds................................. 358,636 19,283 455 377,464
Foreign government bonds........................ 13,131 2,845 -- 15,976
Corporate bonds................................. 1,498,481 94,192 23,266 1,569,407
Other mortgage-backed securities................ 213,388 6,569 3,152 216,805
---------- -------- ------- ----------
Totals.................................... $2,859,007 $159,061 $26,873 $2,991,195
========== ======== ======= ==========
As of December 31, 2001
U.S. government and agency obligations
Mortgage-backed securities................... $ 621,249 $ 15,353 $ 860 $ 635,742
Other........................................ 68,334 3,054 83 71,305
Municipal bonds................................. 224,172 9,335 1,362 232,145
Foreign government bonds........................ 17,411 2,088 47 19,452
Corporate bonds................................. 1,549,631 50,284 39,643 1,560,272
Other mortgage-backed securities................ 246,034 6,748 1,831 250,951
---------- -------- ------- ----------
Totals.................................... $2,726,831 $ 86,862 $43,826 $2,769,867
========== ======== ======= ==========
As of December 31, 2000
U.S. government and agency obligations
Mortgage-backed securities................... $ 495,696 $ 10,564 $ 1,655 $ 504,605
Other........................................ 124,611 2,507 1,060 126,058
Municipal bonds................................. 286,384 10,329 1,658 295,055
Foreign government bonds........................ 29,310 1,873 563 30,620
Corporate bonds................................. 1,280,269 24,682 54,329 1,250,622
Other mortgage-backed securities................ 398,886 4,764 2,872 400,778
---------- -------- ------- ----------
Totals.................................... $2,615,156 $ 54,719 $62,137 $2,607,738
========== ======== ======= ==========
The Company's investment portfolio includes no derivative financial
instruments (futures, forwards, swaps, option contracts or other financial
instruments with similar characteristics).
Maturity/Sales Of Investments
The amortized cost and fair value of fixed maturity securities at December
31, 2002, by estimated expected maturity, are shown below. Estimated expected
maturities differ from contractual maturities reflecting assumptions regarding
borrowers' utilization of the right to call or prepay obligations with or
without call or prepayment penalties.
Percent of
Amortized Fair Total Fair
Cost Value Value
---------- ---------- -----------
Due in 1 year or less.............................. $ 364,495 $ 381,348 12.8%
Due after 1 year through 5 years................... 758,136 793,189 26.5
Due after 5 years through 10 years................. 936,127 979,409 32.7
Due after 10 years through 20 years................ 213,946 223,838 7.5
Due after 20 years................................. 586,303 613,411 20.5
---------- ---------- -----
Total........................................... $2,859,007 $2,991,195 100.0%
========== ========== =====
F-71
NOTE 3 - Investments-(Continued)
Proceeds from sales/maturities of fixed maturities and gross gains and
gross losses realized for each year were:
Year Ended December 31,
----------------------------------
2002 2001 2000
---------- ---------- --------
Proceeds................................................... $1,391,402 $1,015,229 $707,923
Gross gains realized....................................... 40,402 16,945 4,940
Gross losses realized...................................... (35,551) (31,316) (17,846)
Unrealized Gains (Losses) on Fixed Maturities
Net unrealized gains (losses) are computed as the difference between fair
value and amortized cost for fixed maturities. A summary of the net increase
(decrease) in unrealized investment gains (losses) on fixed maturities, less
applicable income taxes, is as follows:
Year Ended December 31,
-----------------------------
2002 2001 2000
-------- ------- --------
Unrealized gains (losses) on fixed maturities
Beginning of period..................................... $ 43,036 $(7,418) $(68,123)
End of period........................................... 132,188 43,036 (7,418)
-------- ------- --------
Increase for the period.............................. 89,152 50,454 60,705
Income taxes............................................... 31,203 17,659 21,247
-------- ------- --------
Increase in net unrealized gains (losses)
on fixed maturities before the valuation impact
on deferred policy acquisition costs and value
of acquired insurance in force.......................... $ 57,949 $32,795 $ 39,458
======== ======= ========
Securities Lending
The Company loans fixed income securities to third parties, primarily major
brokerage firms. As of December 31, 2002, 2001 and 2000, fixed maturities with a
fair value of $3,937, $98,369 and $204,881, respectively, were on loan. 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. SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities," as amended by SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,"
requires the securities lending collateral to be classified as investments with
a corresponding liability in the Company's Consolidated Balance Sheets.
Investment in Entities Exceeding 10% of Shareholders' Equity
At December 31, 2002 and 2001, there were no investments which exceeded 10%
of total shareholders' equity in entities other than obligations of the U.S.
Government and government agencies and authorities. At December 31, 2000, the
Company's investment portfolio included $53,706 of fixed maturity securities
issued by Ford Motor Company and its affiliates representing 12.5% of
shareholders' equity at that date, and other than obligations of the U.S.
Government and government agencies and authorities, there were no other
investments which exceeded 10% of total shareholders' equity.
F-72
NOTE 3 - Investments-(Continued)
Deposits
At December 31, 2002, securities with a carrying value of $16,319 were on
deposit with governmental agencies as required by law in various states in which
the insurance subsidiaries of HMEC conduct business.
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses
The following table sets forth an analysis of property and casualty unpaid
claims and claim expenses and provides a reconciliation of beginning and ending
reserves for the periods indicated.
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Gross reserves, beginning of year .......................... $306,141 $298,896 $299,803
Less reinsurance recoverables ........................... 34,104 49,056 64,410
-------- -------- --------
Net reserves, beginning of year ............................ 272,037 249,840 235,393
-------- -------- --------
Incurred claims and claim expenses:
Claims occurring in the current year .................... 387,747 416,770 394,711
Increase in estimated reserves for
claims occurring in prior years (1):
Policies written by the Company (2) ............... 22,295 14,574 20,858
Business assumed from state
reinsurance facilities ......................... 1,700 2,000 1,800
-------- -------- --------
Total increase .............................. 23,995 16,574 22,658
-------- -------- --------
Total claims and claim expenses incurred (2)(3) ... 411,742 433,344 417,369
-------- -------- --------
Claims and claim expense payments
for claims occurring during:
Current year ......................................... 244,396 255,939 247,286
Prior years .......................................... 166,763 155,208 155,636
-------- -------- --------
Total claims and claim expense payments ........... 411,159 411,147 402,922
-------- -------- --------
Net reserves, end of period ................................ 272,620 272,037 249,840
Plus reinsurance recoverables ........................... 44,701 34,104 49,056
-------- -------- --------
Gross reserves, end of period (4) .......................... $317,321 $306,141 $298,896
======== ======== ========
- ------------
(1) Shows the amounts by which the Company increased its reserves in each of
the periods indicated for claims occurring in previous periods to reflect
subsequent information on such claims and changes in their projected final
settlement costs. Also refer to the paragraphs below for additional
information regarding the increases in reserves recorded in 2002, 2001 and
2000.
(2) For the year ended December 31, 2002, these amounts included a $1,581
statutory accounting charge for class action litigation which was
separately reported as Litigation Charges in the Company's Consolidated
Statements of Operations.
(3) Benefits, claims and settlement expenses as reported in the Consolidated
Statements of Operations also include life, annuity, group accident and
health and corporate amounts of $40,705, $42,239 and $48,679 for the years
ended December 31, 2002, 2001 and 2000, respectively, in addition to the
property and casualty amounts.
(4) Unpaid claims and claim expenses as reported in the Consolidated Balance
Sheets also include life, annuity, and group accident and health reserves
of $9,254, $8,154 and $9,985 at December 31, 2002, 2001 and 2000,
respectively, in addition to property and casualty reserves.
F-73
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued)
Fluctuations from year to year in the level of catastrophe claims impact a
property and casualty insurance company's claims and claim settlement expenses
incurred and paid. For comparison purposes, the following table provides amounts
for the Company excluding catastrophe losses.
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Claims and claims expense incurred .......... $411,742 $433,344 $417,369
Amount attributable to catastrophes ......... 11,939 11,215 16,122
-------- -------- --------
Excluding catastrophes ................... $399,803 $422,129 $401,247
======== ======== ========
Claims and claims expense payments .......... $411,159 $411,147 $402,922
Amount attributable to catastrophes ......... 10,600 14,200 14,200
-------- -------- --------
Excluding catastrophes ................... $400,559 $396,947 $388,722
======== ======== ========
Underwriting results of the property and casualty segment are significantly
influenced by estimates of the Company's ultimate liability for insured events.
The process by which these reserves are established requires reliance upon
estimates based on known facts and on interpretations of circumstances,
including the Company's experience with similar cases and historical trends
involving claim payment patterns, claim payments, pending levels of unpaid
claims and product mix, as well as other factors including court decisions,
economic conditions and public attitudes. Adjustments may be required as
information develops which varies from experience, 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 $1,581 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 $20,714 for the year ended December
31, 2002, primarily related to (1) automobile loss reserves from accident years
2001 and years prior to 1997 and (2) claim adjustment expense reserves from the
2001 and 2000 accident years for both automobile and homeowners, compared to
reserve strengthening of $14,574 in 2001. Total reserves for property and
casualty claims occurring in prior years, including involuntary business and the
$1,581 provision in 2002 for class action litigation, were strengthened $23,995
in 2002, compared to $16,574 in 2001.
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 claims (paid amounts
and case reserves on claims reported to the Company) 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.
F-74
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued)
The Company's first material net reserve strengthening in more than 10
years occurred in the fourth quarter of 2000 and 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 then 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 claim and claim
expense reserve projections. As a result, the Company revised its projections in
the fourth quarter of 2000 to give greater weight to the increasing trend of
claim severities.
In 2001, the Company continued to review its claim reserving methodologies
and 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 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) in the preceding paragraph
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 claim expenses for the voluntary
automobile and homeowners lines and claims for the educator excess professional
liability product. The Company had noted increases in paid claims and claim
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 claims and claim expense
trends.
F-75
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued)
In the fourth quarter of 2002, the Company increased its reserves for prior
accident years related primarily to (1) automobile claim reserves from accident
years 2001, 2000 and years prior to 1997 and (2) allocated and unallocated claim
expense reserves from the 2001 accident year for both automobile and homeowners.
During the third and fourth quarters of 2002, the Company continued to closely
monitor emerging trends in (1) the severity of payments on previously reported
losses for voluntary automobile and (2) paid claims adjustment expenses for
these prior accident years until such time as the Company believed that the
trends were sufficiently credible to require adjustment of the reserves. As a
result, the Company revised its projections in the fourth quarter of 2002,
incorporating the higher paid claims and claims 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.
No other unusual adjustments were made in the determination of the
liabilities during the periods covered by these financial statements. Management
believes that, based on data currently available, it has reasonably estimated
the Company's ultimate losses.
NOTE 5 - Debt
Indebtedness and scheduled maturities at December 31, 2002, 2001 and 2000
consisted of the following:
Effective December 31,
Interest Final ------------------------------
Rates Maturity 2002 2001 2000
--------- -------- -------- -------- --------
Short-term debt:
Bank Credit Facility .......................... Variable 2005 $ -- $ 53,000 $ 49,000
Long-term debt:
1.425% Senior Convertible Notes, Face amount
less unaccrued discount of $128,362 ........ 3.0% 2032 116,138 -- --
6 5/8% Senior Notes, Face amount
less unaccrued discount of $53, $233
and $279, respectively ..................... 6.7% 2006 28,547 99,767 99,721
-------- -------- --------
Total ................................... $144,685 $152,767 $148,721
======== ======== ========
F-76
NOTE 5 - 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 December 31, 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 December 31, 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 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 December 31, 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 $53,000
aggregate principal amount, $25,175 carrying value, of the outstanding
Convertible Notes at an aggregate cost of $22,770. The remaining proceeds were
used for general corporate purposes. In addition to these cash transactions, in
December 2002 the Company repurchased an additional $56,000 aggregate principal
amount, $26,600 carrying value, of the outstanding Convertible Notes at an
aggregate cost of $25,984 in a non-cash transaction. As consideration for this
repurchase, 1,837,925 shares of HMEC's common stock were issued.
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)
F-77
NOTE 5 - Debt-(Continued)
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.
6 5/8% Senior Notes ("Senior Notes")
On January 17, 1996, the Company issued $100,000 face amount of Senior
Notes at an effective yield of 6.7%, which will mature on January 15, 2006. The
net proceeds from the sale of the Senior Notes were used to finance the
redemption of the Company's 4% / 6 1/2% Convertible Notes. Interest on the
Senior Notes is payable semi-annually at a rate of 6 5/8%. The Senior Notes are
redeemable in whole or in part, at any time, at the Company's option, at a
redemption price equal to the greater of (i) 100% of their principal amount and
(ii) the sum of the present values of the remaining scheduled payments of
principal and interest thereon discounted, on a semi-annual basis, at the
Treasury yield (as defined in the indenture) plus 15 basis points, together with
accrued interest to the date of redemption.
In 2002, the Company repurchased $71,400 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 $74,650.
Debt Retirement Charges
The repurchases of the Convertible Notes and Senior Notes resulted in a
pretax charge to income for the year ended December 31, 2002 of $2,272.
Covenants
The Company is in compliance with all of the covenants contained in the
Convertible Notes indenture, the Senior Notes indenture and the Bank Credit
Facility Agreement, consisting primarily of relationships of (1) debt to capital
and (2) insurance subsidiaries' earnings to future interest charges.
F-78
NOTE 6 - Shareholders' Equity and Stock Options
Share Repurchase Program and Treasury Shares Held
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. The repurchase of shares has been financed through use of
cash and, when necessary, the Bank Credit Facility. However, the Company has not
utilized its Bank Credit Facility for share repurchases since the second quarter
of 1999. As of December 31, 2002, $96,343 remained authorized for future share
repurchases.
At December 31, 2001, the Company held 19,341,296 shares in treasury. In
December 2002, the Company issued 1,837,925 of the treasury shares as
consideration for the repurchase of a portion of its outstanding Convertible
Notes. At December 31, 2002, the Company held 17,503,371 shares in treasury.
Authorization of Preferred Stock
In 1996, the shareholders of HMEC approved authorization of 1,000,000
shares of $0.001 par value preferred stock. The Board of Directors is authorized
to (i) direct the issuance of the preferred stock in one or more series, (ii)
fix the dividend rate, conversion or exchange rights, redemption price and
liquidation preference, of any series of the preferred stock, (iii) fix the
number of shares for any series and (iv) increase or decrease the number of
shares of any series. No shares of preferred stock were outstanding at December
31, 2002, 2001 and 2000.
The Company's catastrophe reinsurance program is augmented by a $75,000
equity put and reinsurance agreement. The equity put provides an option to sell
shares of the Company's convertible preferred stock with a floating rate
dividend at a pre-negotiated price in the event losses from catastrophes exceed
the catastrophe reinsurance program coverage limit. Before tax benefits, the
equity put provides a source of capital for up to $115,000 of catastrophe losses
above the reinsurance coverage limit. The agreement contains certain conditions
to Horace Mann's exercise of the equity put option as disclosed in Note 11 -
Reinsurance. Fees related to this equity put option totaled $1,088 for the year
ended December 31, 2002 and were charged directly to additional paid-in capital.
In connection with the equity put described in the preceding paragraph, the
Board of Directors has designated a series of preferred stock to be available
for use in the put. The Series so designated is Series A Cumulative Convertible
Preferred Stock (the "Series A Stock") and 100,000 shares have been assigned to
this series. None are currently issued or outstanding. The Series A Stock is
dividend paying, at a floating rate which varies with movements in the London
Interbank Offered Rate and with changes in the risk rating of the Series A Stock
as determined by Standard & Poor's Corporation. The Series A Stock does not
require any sinking fund or similar mechanism regarding payment of such
dividends. Beginning on the fourth anniversary of the issuance of Series A
Stock, the holders thereof have the right to demand conversion of the Series A
Stock into common stock of the Company at a conversion rate based on then
prevailing market prices for the common stock; however, upon receipt of a
conversion demand, the Company has the right to redeem the Series A Stock prior
to such conversion. The Series A Stock has liquidation rights which place the
Series A Stock ahead of the common stock in priority.
F-79
NOTE 6 - Shareholders' Equity and Stock Options-(Continued)
The Series A Stock has no voting rights other than the requirement that the
Series A Stock approve any changes in the Series A Stock, the creation of any
other class of stock on a par with or superior to the Series A Stock and certain
extraordinary transactions such as certain mergers involving the Company.
Director Stock Plan
In 1996, the shareholders of HMEC approved the Deferred Equity Compensation
Plan ("Director Stock Plan") for directors of the Company and reserved 600,000
shares for issuance pursuant to the Director Stock Plan. Shares of the Company's
common stock issued under the Director Stock Plan may be either authorized and
unissued shares or shares that have been reacquired by the Company. As of
December 31, 2002, 2001 and 2000, 139,867, 121,322 and 113,944 units,
respectively, were outstanding under this plan representing an equal number of
common shares to be issued in the future.
Employee Stock Plan
In 1997, the Board of Directors of HMEC approved the Deferred Compensation
Plan for Employees ("Employee Stock Plan"). Shares of the Company's common stock
issued under the Employee Stock Plan may be either authorized and unissued
shares or shares that have been reacquired by the Company. As of December 31,
2002, 2001 and 2000, 30,585, 14,303 and 8,507 units, respectively, were
outstanding under this plan representing an equal number of common shares to be
issued in the future.
Stock Options
In 1991, the shareholders approved the 1991 Stock Incentive Plan (the "1991
Plan") and reserved 4,000,000 shares of common stock for issuance under the 1991
Plan. In 2000, the shareholders approved an increase of 2,000,000 in the number
of shares of common stock reserved for issuance under the 1991 Plan. In 2001,
the shareholders approved the 2001 Stock Incentive Plan (the "2001 Plan") and
reserved the shares of common stock remaining from the 1991 Plan for issuance
under the 2001 Plan. In 2002, the shareholders approved the 2002 Incentive
Compensation Plan (the "2002 Plan") and reserved 3,000,000 shares of common
stock for issuance under the 2002 Plan in addition to reserving the shares of
common stock remaining from the 1991 Plan and the 2001 Plan. Under the 1991
Plan, the 2001 Plan and the 2002 Plan, options to purchase shares of HMEC common
stock may be granted to executive officers, other employees and directors. The
options are exercisable in installments generally beginning in the first year
from the date of grant and expiring 10 years from the date of grant.
F-80
NOTE 6 - Shareholders' Equity and Stock Options-(Continued)
Changes in outstanding options and shares available for grant under the
1991 Plan, the 2001 Plan and the 2002 Plan were as follows:
Options
Weighted Average Range of --------------------------------------
Option Price Option Prices Vested and Available
per Share per Share Outstanding Exercisable for Grant
---------------- ------------- ----------- ----------- ----------
At December 31, 1999........ $17.52 $ 9.00-$34.53 1,852,075 1,269,868 749,062
--------- --------- ----------
Increase in options
available for grant... -- -- 2,000,000
Granted.................. $17.24 $13.84-$18.08 1,469,300 42,350 (1,469,300)
Vested................... $22.42-$33.87 -- 176,234 --
Exercised................ $ 9.06 $ 9.00-$15.15 (557,000) (557,000) --
Canceled................. $28.59 $22.42-$34.53 (27,650) (27,650) 27,650
--------- --------- ----------
At December 31, 2000........ $18.98 $ 9.00-$33.87 2,736,725 903,802 1,307,412
--------- --------- ----------
Granted.................. $18.22 $16.83-$21.77 1,020,050 271,775 (1,020,050)
Vested................... $19.72 $13.84-$33.87 -- 519,860 --
Exercised................ $10.18 $ 9.00-$17.56 (207,575) (207,575) --
Canceled................. $20.52 $15.32-$33.87 (136,950) (136,950) 136,950
--------- --------- ----------
At December 31, 2001........ $19.23 $11.12-$33.87 3,412,250 1,350,912 424,312
--------- --------- ----------
Increase in options
available for grant... -- -- 3,000,000
Granted.................. $20.72 $15.92-$21.64 1,375,950 116,944 (1,375,950)
Vested................... $18.20 $13.84-$33.87 -- 724,488 --
Exercised................ $16.57 $11.13-$22.42 (107,410) (107,410) --
Canceled................. $22.01 $15.15-$33.87 (131,370) (131,370) 131,370
--------- --------- ----------
At December 31, 2002........ $19.66 $11.12-$33.87 4,549,420 1,953,564 2,179,732
========= ========= ==========
The weighted average grant date fair values were $8.99, $8.55 and $8.35
for options granted in 2002, 2001 and 2000, respectively. The weighted average
prices of vested and exercisable options as of December 31, 2001 and 2000 were
$19.23 and $20.19, respectively. For options outstanding at December 31, 2002,
information segregated by ranges of exercise prices was as follows:
Vested and Exercisable Options
-----------------------------------------
Weighted Average Range of Total Weighted Average Weighted
Option Price Option Prices Options Option Price Average
per Share per Share Outstanding Options per share Life
----------------- ------------- ----------- --------- ----------------- ---------
At December 31, 2002
$15.51 $11.12-$16.38 283,475 208,100 $15.29 3.2 years
$19.28 $16.83-$23.31 4,053,645 1,533,414 $19.18 7.6 years
$32.58 $25.63-$33.87 212,300 212,050 $32.58 5.3 years
--------- ---------
Total............... $19.66 $11.12-$33.87 4,549,420 1,953,564 $20.22 6.9 years
========= =========
F-81
NOTE 7 - Income Taxes
The federal income tax liabilities and recoverables included in Other
Liabilities and Other Assets, respectively, in the Consolidated Balance Sheets
as of December 31, 2002, 2001 and 2000 were as follows:
December 31,
-----------------------------
2002 2001 2000
------- -------- --------
Current (liability) asset...................... $14,698 $(12,469) $(10,012)
Deferred liability (asset)..................... 14,761 21,788 (203)
Deferred tax assets and liabilities are recognized for all future tax
consequences attributable to "temporary differences" between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. The "temporary differences" that give rise to the deferred
tax balances at December 31, 2002, 2001 and 2000 were as follows:
December 31,
----------------------------
2002 2001 2000
-------- ------- -------
Deferred tax assets
Unrealized losses on securities.......................... $ -- $ -- $ 2,949
Discounting of unpaid claims and
claims expense tax reserves........................... 7,103 7,221 6,906
Life insurance future policy benefit reserve
revaluation. ......................................... 26,599 13,650 16,458
Unearned premium reserve reduction....................... 12,664 12,392 11,634
Postretirement benefits other than pension............... 10,890 10,316 10,367
Unutilized net operating loss carryforward............... 1,060 -- --
Unutilized capital loss carryforward..................... 4,638 -- --
Impaired securities...................................... 17,512 3,268 1,576
Other, net............................................... 11,542 4,919 4,524
-------- ------- -------
Total gross deferred tax assets...................... 92,008 51,766 54,414
-------- ------- -------
Deferred tax liabilities
Unrealized gains on securities........................... 43,382 14,181 -
Intangible assets........................................ 11,181 13,438 15,070
Deferred policy acquisition costs........................ 52,206 45,935 39,141
-------- ------- -------
Total gross deferred tax liabilities.................. 106,769 73,554 54,211
-------- ------- -------
Net deferred tax liability (asset)................. $ 14,761 $21,788 $ (203)
======== ======= =======
Based on the Company's historical earnings, future expectations of adjusted
taxable income, as well as reversing gross deferred tax liabilities, the Company
believes it is more likely than not that gross deferred tax assets will be fully
realized and that a valuation allowance with respect to the realization of the
total gross deferred tax assets is not necessary.
At December 31, 2002, the Company had available $1,060 of net tax operating
loss carryforwards for federal income tax purposes. These carryforwards will
expire beginning in 2016 thru 2017. In addition, the Company had available
$4,638 of capital loss carryforwards which will expire beginning in 2006 thru
2007.
The components of federal income tax expense (benefit) were as follows:
Year Ended December 31,
-----------------------------
2002 2001 2000
-------- ------- --------
Current........................................ $ 29,423 $(8,536) $ (5,104)
Deferred....................................... (33,091) 11,291 (6,016)
-------- ------- --------
Total tax expense (benefit)................. $ (3,668) $ 2,755 $(11,120)
======== ======= ========
F-82
NOTE 7 - Income Taxes-(Continued)
Income tax expense for the following periods differed from the expected tax
computed by applying the federal corporate tax rate of 35% to income before
income taxes as follows:
Year Ended December 31,
----------------------------
2002 2001 2000
------- ------- --------
Expected federal tax on income............................. $ 2,683 $ 9,920 $ 3,402
Add (deduct) tax effects of:
Tax-exempt interest..................................... (3,928) (3,826) (4,125)
Tax reserve release..................................... -- (3,034) --
1994 and 1995 IRS audit - interest, net of tax.......... -- -- (2,146)
Goodwill................................................ -- 566 566
Dividend received deduction............................. (2,608) (904) (258)
Other, net.............................................. 185 1,302 123
------- ------- --------
Income tax expense (benefit) provided on income before
adjustment to the provision for prior years' taxes...... (3,668) 4,024 (2,438)
Adjustment to the provision for prior years' taxes......... -- (1,269) (8,682)
------- ------- --------
Income tax expense (benefit) provided on income............ $(3,668) $ 2,755 $(11,120)
======= ======= ========
As previously reported, the Company had been contesting proposed additional
federal income taxes relating to a settlement agreement with the Internal
Revenue Service ("IRS") for prior years' taxes. In the third quarter of 1999,
the Company recorded an additional federal income tax provision of $20,000
representing the maximum exposure of the Company to the IRS with regard to the
issue for all of the past tax years in question (1994 through 1997). In 2000,
the Company reached a final resolution with the IRS for the tax years 1994, 1995
and 1996 in an amount that was $8,682 less than was previously accrued. That
amount was included in net income for the year ended December 31, 2000. In 2001,
the Company's liability for the 1997 tax year was resolved, resulting in a
release of $1,269 that had previously been accrued for that tax year. That
amount was included in net income for the year ended December 31, 2001.
NOTE 8 - Fair Value of Financial Instruments
The Company is required under GAAP to disclose estimated fair values for
certain financial instruments. Fair values of the Company's insurance contracts
other than annuity contracts are not required to be disclosed. However, the fair
values of liabilities under all insurance contracts are taken into consideration
in the Company's overall management of interest rate risk through the matching
of investment maturities with amounts due under insurance contracts. The
following methods and assumptions were used to estimate the fair value of
financial instruments.
Investments - For fixed maturities and short-term and other investments,
fair value equals quoted market price, if available. If a quoted market price is
not available, fair value is estimated using quoted market prices for similar
securities, adjusted for differences between the quoted securities and the
securities being valued. The fair value of policy loans is based on estimates
using discounted cash flow analysis and current interest rates being offered for
new loans. The fair value of mortgage loans is estimated by discounting the
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and the same remaining maturities. The
carrying value of real estate is an estimate of fair value based on discounted
cash flows from operations.
F-83
NOTE 8 - Fair Value of Financial Instruments-(Continued)
Annuity Contract Liabilities and Policyholder Account Balances on
Interest-sensitive Life Contracts - The fair values of annuity contract
liabilities and policyholder account balances on interest-sensitive life
contracts are equal to the discounted estimated future cash flows (using the
Company's current interest rates for similar products including consideration
of minimum guaranteed interest rates) including an adjustment for risk that the
timing or amount of cash flows will vary from management's estimate.
Other Policyholder Funds - Other policyholder funds are supplementary
contract reserves and dividend accumulations which represent deposits that do
not have defined maturities. The carrying value of these funds is used as a
reasonable estimate of fair value.
Long-term Debt - The fair value of long-term debt is estimated based on
quoted market prices of publicly traded issues.
The carrying amounts and fair values of financial instruments at December
31, 2002, 2001 and 2000 consisted of the following:
December 31,
---------------------------------------------------------------------------
2002 2001 2000
----------------------- ----------------------- -----------------------
Carrying Fair Carrying Fair Carrying Fair
Amount Value Amount Value Amount Value
---------- ---------- ---------- ---------- ---------- ----------
Financial Assets
Investments
Fixed maturities................... $2,991,195 $2,991,195 $2,769,867 $2,769,867 $2,607,738 $2,607,738
Short-term and other investments... 135,431 138,734 107,445 109,208 99,728 102,520
Short-term investments,
loaned securities collateral.... 3,937 3,937 98,369 98,369 204,881 204,881
---------- ---------- ---------- ---------- ---------- ----------
Total investments............ 3,130,563 3,133,866 2,975,681 2,977,444 2,912,347 2,915,139
Cash.................................. 60,162 60,162 33,939 33,939 21,141 21,141
Financial Liabilities
Policyholder account balances on
interest-sensitive life contracts.. 93,435 91,359 94,594 92,527 94,775 92,684
Annuity contract liabilities.......... 1,385,737 1,236,478 1,278,137 1,074,525 1,217,756 1,017,044
Other policyholder funds.............. 125,108 125,108 123,434 123,434 122,233 122,233
Short-term debt....................... -- -- 53,000 53,000 49,000 49,000
Long-term debt........................ 144,685 137,692 99,767 101,840 99,721 92,674
Fair value estimates shown above are dependent upon subjective assumptions
and involve significant uncertainties resulting in variability in estimates with
changes in assumptions. Fair value assumptions are based upon subjective
estimates of market conditions and perceived risks of financial instruments at a
certain point in time. The disclosed fair values do not reflect any premium or
discount that could result from offering for sale at one time an entire holding
of a particular financial instrument. In addition, potential taxes and other
expenses that would be incurred in an actual sale or settlement are not
reflected in amounts disclosed.
F-84
NOTE 9 - Statutory Surplus and Subsidiary Dividend Restrictions
The insurance departments of various states in which the insurance
subsidiaries of HMEC are domiciled recognize as net income and surplus those
amounts determined in conformity with statutory accounting principles prescribed
or permitted by the insurance departments, which differ in certain respects from
GAAP.
Reconciliations of statutory capital and surplus and net income, as
determined using statutory accounting principles, to the amounts included in the
accompanying financial statements are as follows:
December 31,
---------------------------------
2002 2001 2000
--------- --------- ---------
Statutory capital and surplus of insurance subsidiaries ..... $ 427,737 $ 403,015 $ 389,249
Increase (decrease) due to:
Deferred policy acquisition costs ........................ 174,555 157,776 141,604
Difference in policyholder reserves ...................... (39,784) 4,276 (2,448)
Goodwill ................................................. 47,396 47,396 49,014
Value of acquired insurance in force ..................... 31,945 38,393 43,246
Liability for postretirement benefits, other than
pensions .............................................. (30,253) (29,602) (28,488)
Investment fair value
adjustments on fixed maturities ....................... 132,188 43,036 (7,418)
Difference in investment reserves ........................ 19,448 22,520 21,403
Federal income tax liability ............................. (38,962) (38,341) (6,866)
Minimum pension liability adjustment ..................... (26,563) (17,597) (1,441)
Non-admitted assets and other, net ....................... 5,216 12,892 12,505
Shareholders' equity of parent company and
non-insurance subsidiaries ............................ (29,396) (31,807) (33,646)
Parent company short-term and long-term debt ............. (144,685) (152,767) (148,721)
--------- --------- ---------
Shareholders' equity as reported herein ............... $ 528,842 $ 459,190 $ 427,993
========= ========= =========
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Statutory net income of insurance subsidiaries.............. $(28,741) $ 15,146 $ 23,881
Net loss of non-insurance companies......................... (3,831) (3,313) (17,853)
Interest expense............................................ (8,517) (9,250) (10,204)
Tax benefit of interest expense and other
parent company current tax adjustments................... 5,731 10,954 15,539
-------- -------- --------
Combined net income......................................... (35,358) 13,537 11,363
Increase (decrease) due to:
Deferred policy acquisition costs........................ 21,821 19,565 12,781
Policyholder benefits.................................... (42,708) 9,513 7,891
Federal income tax expense............................... 32,859 (13,850) (6,324)
Provision for prior years' taxes......................... -- 1,269 8,682
Amortization of intangible assets........................ (5,734) (5,774) (8,769)
Investment reserves...................................... 9,009 5,425 (2,067)
Other adjustments, net................................... 31,444 (4,098) (2,716)
-------- -------- --------
Net income as reported herein......................... $ 11,333 $ 25,587 $ 20,841
======== ======== ========
The Company has principal insurance subsidiaries domiciled in Illinois,
California and Texas. The statutory financial statements of these subsidiaries
are prepared in accordance with accounting principles prescribed or permitted by
the Illinois Department of Insurance, the California Department of Insurance and
the Texas Department of Insurance, as applicable. Prescribed statutory
accounting principles include a variety of publications of the National
Association of Insurance Commissioners ("NAIC"), as well as state laws,
regulations and general administrative rules.
F-85
NOTE 9 - Statutory Surplus and Subsidiary Dividend Restrictions-(Continued)
The NAIC has codified statutory accounting principles, which constitute the
only source of prescribed statutory accounting principles and were effective
January 1, 2001. Codification changed prescribed statutory accounting principles
and resulted in changes to the accounting principles that insurance enterprises
use to prepare their statutory financial statements. The states of domicile of
the Company's principal operating subsidiaries, Illinois, California and Texas,
have adopted the NAIC's codification. As a result of adopting the NAIC
codification, the Company's statutory surplus of its insurance subsidiaries
increased approximately $23,000, primarily due to the allowance of deferred tax
recoverables under codification.
The insurance subsidiaries are subject to various regulatory restrictions
which limit the amount of annual dividends or other distributions, including
loans or cash advances, available to HMEC without prior approval of the
insurance regulatory authorities. The aggregate amount of dividends that may be
paid by the insurance subsidiaries to HMEC during 2003 without prior approval is
approximately $43,000.
The NAIC has adopted risk-based capital guidelines that establish minimum
levels of statutory capital and surplus based on risk assumed in investments,
reserving policies, and volume and types of insurance business written. State
insurance regulations prohibit insurance companies from making any public
statements or representations with regard to their risk-based capital levels.
Based on current guidelines, the risk-based capital statutory requirements will
have no negative regulatory impact on the Company's insurance subsidiaries.
On December 31, 2002, the Company's primary life insurance subsidiary,
Horace Mann Life Insurance Company ("HMLIC"), entered into a reinsurance
agreement with Sun Life Reinsurance Company Limited ("SLRCL"), a member of the
Sun Life Financial Group. Under the terms of the agreement, which is expected to
be in place for a five year period, HMLIC ceded to SLRCL, on a combination
coinsurance and modified coinsurance basis, a 57.7% quota share of HMLIC's in
force interest-sensitive life block of business issued prior to January 1, 2002.
SLRCL assumes its proportional share of all risks attendant to the business
reinsured such as mortality, persistency and investment risk, reducing HMLIC's
liabilities under statutory accounting principles to the extent of the ceded
commission. The initial ceded commission paid by SLRCL to HMLIC was $50,000 and
resulted in a $32,500 after-tax increase in HMLIC's statutory surplus. This
transaction improved the statutory operating leverage and risk-based capital
ratio of HMLIC, partially mitigating the impact of realized investment losses
recorded in 2002.
NOTE 10 - Pension Plans and Other Postretirement Benefits
All employees of the Company are covered by a defined contribution plan and
participate in a 401(k) plan. Employees hired on or before December 31, 1998 are
also covered under a defined benefit plan. Certain employees participate in a
supplemental defined benefit plan or a supplemental defined contribution plan or
both.
Under the defined contribution plan, the Company makes a contribution to
each participant's account based on compensation and years of service.
Participants are 100% vested in this plan after 5 years of service.
F-86
NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued)
All employees of the Company participate in a 401(k) plan. Beginning
January 1, 2002, the Company automatically contributes 3% of eligible
compensation in each employee's account, which is 100% vested at the time of the
contribution. Each participant may contribute up to 20% of eligible compensation
into their account. Prior to December 31, 2001, the Company contributed an
amount equal to 50% of the first 6% of eligible compensation contributed by the
employee, and the Company contribution vested over 5 years at a rate of 20% per
year of service.
Amounts earned under the defined benefit and supplemental defined benefit
plans are based on years of service and the highest average 36 consecutive
months earnings under the plan through March 31, 2002. Effective April 1, 2002,
participants stopped accruing benefits under the defined benefit and
supplemental defined benefit plans but continue to retain the benefits they had
accrued to date. Participants are 100% vested in these plans after 5 years of
service.
The Company's policy with respect to funding the defined benefit plan is to
contribute amounts which are actuarially determined to provide the plan with
sufficient assets to meet future benefit payments consistent with the funding
requirements of federal laws and regulations. For the defined contribution,
401(k) and defined benefit plans, investments have been set aside in a trust
fund; whereas the supplemental retirement plans are non-qualified, unfunded
plans.
Total expense recorded for the defined contribution, 401(k), defined
benefit and supplemental plans was $19,259, $10,678 and $11,783 for the years
ended December 31, 2002, 2001 and 2000, respectively.
Defined Contribution Plan and 401(k) Plan
Pension benefits under the defined contribution plan were fully funded and
investments were set aside in a trust fund. None of the trust fund assets for
the defined contribution plan have been invested in shares of the Company's
common stock. The 401(k) plan was fully funded and investments were set aside
through an annuity contract underwritten by the Company's principal life
insurance subsidiary. The annuity contract includes a fixed return account
option and several variable return account options, with the account options
selected by the individual plan participants. One of the variable return account
options invests in shares of HMEC common stock. Contributions to employees'
accounts under the defined contribution plan and the 401(k) plan, which were
expensed in the Company's Consolidated Statements of Operations, and total
assets of the plans were as follows:
Year Ended December 31,
----------------------------
2002 2001 2000
-------- ------- -------
Defined contribution plan:
Contributions to employees accounts .... $ 6,280 $ 6,012 $ 5,626
Total assets at the end of the year .... 105,454 97,967 92,609
401(k) plan:
Contributions to employees accounts .... 3,543 2,372 2,235
Total assets at the end of the year .... 81,806 92,189 96,599
F-87
NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued)
Defined Benefit Plan and Supplemental Retirement Plans
The following two tables summarize both the funding status of the defined
benefit and supplemental retirement pension plans and identifies the assumptions
used to determine the projected benefit obligation and the components of net
pension cost for the defined benefit plan and supplemental retirement plans for
the following periods:
Supplemental
Defined Benefit Plan Retirement Plans
----------------------------- ------------------------------
December 31, December 31,
----------------------------- ------------------------------
2002 2001 2000 2002 2001 2000
-------- -------- ------- -------- -------- --------
Change in benefit obligation:
Benefit obligation at beginning of year ......... $ 50,927 $ 50,830 $47,282 $ 13,607 $ 12,191 $ 8,775
Service cost .................................... 696 1,789 1,625 671 610 719
Interest cost ................................... 3,453 3,518 3,525 907 840 855
Plan amendments ................................. -- 980 -- -- (383) --
Actuarial loss .................................. 7,056 5,500 4,689 1,839 1,355 2,884
Benefits paid ................................... (1,484) (6,010) (6,291) (1,010) (997) (1,042)
Curtailment gain ................................ -- (5,680) -- -- (9) --
Settlements ..................................... (10,246) -- -- -- -- --
-------- -------- ------- -------- -------- --------
Benefit obligation at end of year ............... $ 50,402 $ 50,927 $50,830 $ 16,014 $ 13,607 $ 12,191
======== ======== ======= ======== ======== ========
Change in plan assets:
Fair value of plan assets at beginning of year .. $ 34,569 $ 43,401 $52,966 $ -- $ -- $ --
Actual return on plan assets .................... (2,644) (2,822) (3,274) -- -- --
Employer contributions .......................... 7,910 -- -- 1,010 997 1,042
Benefits paid ................................... (1,484) (6,010) (6,291) (1,010) (997) (1,042)
Settlements ..................................... (10,246) -- -- -- -- --
-------- -------- ------- -------- -------- --------
Fair value of plan assets at end of year ........ $ 28,105 $ 34,569 $43,401 $ -- $ -- $ --
======== ======== ======= ======== ======== ========
Funded status ...................................... $(22,297) $(16,358) $(7,429) $(16,014) $(13,607) $(12,191)
Unrecognized net actuarial loss .................... 22,393 14,967 8,304 4,136 2,603 1,431
Unrecognized prior service (asset) cost ............ -- -- (3,204) -- -- 1,954
-------- -------- ------- -------- -------- --------
Accrued benefit cost included
in the Consolidated Balance Sheets .............. 96 (1,391) (2,329) (11,878) (11,004) (8,806)
Additional liability to recognize unfunded
accumulated benefit obligation .................. (22,393) (14,967) -- (4,170) (2,630) (3,358)
-------- -------- ------- -------- -------- --------
Total benefit cost ................................. $(22,297) $(16,358) $(2,329) $(16,048) $(13,634) $(12,164)
======== ======== ======= ======== ======== ========
Amounts recognized in the Statements of
Financial Position consist of:
Accrued benefit cost ......................... $ 96 $ (1,391) $(2,329) $(11,878) $(11,004) $ (8,806)
Minimum liability ............................ (22,393) (14,967) -- (4,170) (2,630) (3,358)
Intangible asset ............................. -- -- -- -- -- 1,917
Accumulated other comprehensive income ....... 22,393 14,967 -- 4,170 2,630 1,441
-------- -------- ------- -------- -------- --------
Net amount recognized ..................... $ 96 $ (1,391) $(2,329) $(11,878) $(11,004) $ (8,806)
======== ======== ======= ======== ======== ========
F-88
NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued)
The increase in the Company's 2002 minimum pension liability for the
defined benefit plan of $7,426 was attributable to the following factors: (i) a
decline in asset performance, (ii) an increase in the assumed frequency of lump
sum elections, (iii) an increase in retirement rates and (iv) a change in the
discount rate from 7.00% to 6.75%. The increase in the Company's 2001 minimum
pension liability for the defined benefit plan of $14,967 was attributable to
the following factors: (i), (ii) and (iii) as noted in the previous sentence and
(iv) a change in the discount rate from 7.25% to 7.00%. These increases were
recorded as charges to a separate component of shareholders' equity.
Supplemental
Defined Benefit Plan Retirement Plans
--------------------------- ------------------------
Year Ended December 31, Year Ended December 31,
--------------------------- ------------------------
2002 2001 2000 2002 2001 2000
------- ------- ------- ------ ------ ------
Components of net periodic pension
(income) expense:
Service cost............................ $ 696 $ 1,789 $ 1,625 $ 671 $ 610 $ 719
Interest cost........................... 3,453 3,518 3,525 907 840 855
Expected return on plan assets.......... (2,798) (4,021) (4,283) -- -- --
Amortization of prior service cost...... -- (610) (610) -- 314 314
Recognized net actuarial loss........... 980 -- -- 307 174 1,946
Curtailment (gain) loss................. -- (1,614) -- -- 1,258 --
Settlement loss......................... 4,093 -- -- -- -- --
------- ------- ------- ------ ------ ------
Net periodic pension (income) expense......... $ 6,424 $ (938) $ 257 $1,885 $3,196 $3,834
======= ======= ======= ====== ====== ======
Weighted-average assumptions
as of December 31:
Discount rate........................... 6.75% 7.00% 7.25% 6.75% 7.00% 7.25%
Expected return on plan assets.......... 7.50% 8.75% 8.75% * * *
Rate of salary increase................. * 4.00% 4.00% * 4.00% 4.00%
- ----------
* Not applicable.
In 2001, HMEC's Board of Directors approved the proposal for the defined
benefit plan curtailment, and management initiated steps to accomplish this
including communication of the changes to employees. In accordance with SFAS No.
88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination of Benefits," the curtailment gain was
recognized in 2001, the period in which the pension plan was amended.
Postretirement Benefits Other than Pensions
In addition to providing pension benefits, the Company also provides
certain health care and life insurance benefits to retired employees and
eligible dependents. Through December 31, 2000, employees with ten years of
service were eligible to receive these benefits upon retirement. Effective
January 1, 2001, the eligibility requirement increased to age 55 and 20 years of
service. Employees hired on or after January 1, 2001 are not eligible for
postretirement medical benefits. Employees who were at least age 55 and had 10
years of service in the year 2000 were not affected by this change.
Postretirement benefits other than pensions of active and retired employees are
accrued as expense over the employees' service years.
F-89
NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued)
The following table presents the funded status of postretirement benefits
other than pensions of active and retired employees (including employees on
disability more than 2 years) as of December 31, 2002, 2001 and 2000 reconciled
with amounts recognized in the Company's Consolidated Balance Sheets:
December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Change in accumulated postretirement benefit obligation:
Accumulated postretirement benefit
obligation at beginning of year....................... $ 35,749 $ 30,766 $ 29,660
Changes during fiscal year
Service cost.......................................... 396 475 564
Interest cost......................................... 2,231 2,285 2,366
Benefits paid......................................... (1,976) (1,676) (1,749)
Actuarial (gain) loss................................. 687 3,899 (75)
-------- -------- --------
Accumulated postretirement benefit
obligation at end of year............................. $ 37,087 $ 35,749 $ 30,766
======== ======== ========
Unfunded status............................................. $(37,087) $(35,749) $(30,766)
Unrecognized net loss from past
experience different from that assumed................... 6,834 6,147 2,278
-------- -------- --------
Accrued postretirement benefit cost................... $(30,253) $(29,602) $(28,488)
======== ======== ========
Year Ended December 31,
------------------------
2002 2001 2000
------ ------ ------
Components of net periodic benefit cost:
Service cost..................................... $ 396 $ 475 $ 564
Interest cost.................................... 2,231 2,285 2,366
Amortization of prior losses..................... -- 30 50
------ ------ ------
Net periodic benefit cost..................... $2,627 $2,790 $2,980
====== ====== ======
Sensitivity Analysis
A one percentage point change in the assumed health care cost trend rate
for each year would change the accumulated postretirement benefit obligation as
follows:
December 31,
---------------------
2002 2001 2000
----- ----- -----
Accumulated postretirement benefit obligation
Effect of a one percentage point increase........... $ 904 $ 967 $ 606
Effect of a one percentage point decrease........... (805) (859) (546)
Service and interest cost components of the net
periodic postretirement benefit expense
Effect of a one percentage point increase........ $ 45 $ 77 $ 81
Effect of a one percentage point decrease........ (40) (64) (66)
The assumed net weighted annual average medical rates of increase in the
per capita cost of covered benefits for participants in the plan who retired
prior to January 1, 1994 were 7.4%, 5.5% and 5.8% as of December 31, 2002, 2001
and 2000, respectively. The net medical trend rates were 12.0% in 2002 grading
down to 5.5% in 2009 and thereafter. For those participants retiring after
December 31, 1993, the weighted average discount rate used in determining the
accumulated postretirement benefit obligation was 6.75%, 7.00% and 7.25% at
December 31, 2002, 2001 and 2000, respectively. The discount rate of 6.75% at
December 31, 2002 is based on the average yield for long-term, high-grade
securities available during the benefit payout period. To set the discount rate,
the Company looks to leading indicators, including Moody's Aa long-term bond
index.
F-90
NOTE 11 - Reinsurance
In the normal course of business, the insurance subsidiaries assume and
cede reinsurance with other insurers. Reinsurance is ceded primarily to limit
losses from large exposures and to permit recovery of a portion of direct
losses; however, such a transfer does not relieve the originating insurance
company of contingent liability.
The Company is a national underwriter and therefore has exposure to
catastrophic losses in certain coastal states and other regions throughout the
U.S. Catastrophes can be caused by various events including hurricanes,
windstorms, earthquakes, hail, severe winter weather and fires, and the
frequency and severity of catastrophes are inherently unpredictable. The
financial impact from catastrophic losses results from both the total amount of
insured exposure in the area affected by the catastrophe as well as the severity
of the event. The Company seeks to reduce its exposure to catastrophe losses
through the geographic diversification of its insurance coverage, deductibles,
maximum coverage limits, the purchase of catastrophe reinsurance, and the
purchase of a catastrophe-linked equity put option and reinsurance agreement,
described below.
The total amounts of reinsurance recoverable on unpaid insurance reserves
classified as assets and reported in Other Assets in the Consolidated Balance
Sheets were as follows:
December 31,
---------------------------
2002 2001 2000
------- ------- -------
Reinsurance Recoverables on Reserves and Unpaid Claims
Life and health........................................ $ 9,534 $ 7,241 $ 4,619
Property and casualty
State insurance facilities.......................... 36,780 23,069 32,026
Other insurance companies........................... 7,921 11,035 17,030
------- ------- -------
Total............................................ $54,235 $41,345 $53,675
======= ======= =======
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
-------- --------- ---------- --------
Year ended December 31, 2002
Premiums written and contract deposits.......... $905,674 $20,750 $14,405 $899,329
Premiums and contract charges earned............ 642,310 33,567 16,490 625,233
Benefits, claims and settlement expenses........ 462,476 26,784 15,174 450,866
Year ended December 31, 2001
Premiums written and contract deposits.......... 885,801 27,991 17,756 875,566
Premiums and contract charges earned............ 625,722 28,601 18,121 615,242
Benefits, claims and settlement expenses........ 475,991 18,416 18,008 475,583
Year ended December 31, 2000
Premiums written and contract deposits.......... 829,437 24,078 16,294 821,653
Premiums and contract charges earned............ 605,252 23,105 16,567 598,714
Benefits, claims and settlement expenses........ 461,396 13,736 18,388 466,048
F-91
NOTE 11 - Reinsurance-(Continued)
There were no losses from uncollectible reinsurance recoverables in the
three years ended December 31, 2002. Past due reinsurance recoverables as of
December 31, 2002 were not material.
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 $13,700 up
to $51,400 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, which is renewable annually at the option of the Company, 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 was 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 debt as a percentage of total 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
December 31, 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. The Company also maintains a life
catastrophe reinsurance program. The Company reinsures 100% of the catastrophe
risk in excess of $1,000 up to $20,000 per occurrence. This program covers acts
of terrorism but excludes nuclear, biological and chemical explosions as well as
other acts of war.
F-92
NOTE 12 - Contingencies
Lawsuits and Legal Proceedings
In June 2002, the Company recorded a pretax charge of $1,581 representing
the Company's best estimate of the costs of resolving class action lawsuits
related to diminished value brought against the Company. A final court hearing
on this matter was held on December 18, 2002, at which time the settlement was
approved and was within the amount previously accrued by 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 December 2000, the Company recorded a pretax charge of $7,692,
representing the Company's best estimate of the actual and anticipated costs of
defending and ultimately resolving litigation brought against the Company in
regards to its disability insurance product. The settlement was finalized on
November 30, 2001, within the amount previously accrued by the Company, and is
being administered. Disability insurance represented less than 1% of the
Company's insurance premiums written and contract deposits for the years ended
December 31, 2002, 2001 and 2000.
There are various other lawsuits and legal proceedings against the Company.
Management and legal counsel are of the opinion that the ultimate disposition of
such other litigation will have no material adverse effect on the Company's
financial position or results of operations.
Assessments for Insolvencies of Unaffiliated Insurance Companies
The Company is also contingently liable for possible assessments under
regulatory requirements pertaining to potential insolvencies of unaffiliated
insurance companies. Liabilities, which are established based upon regulatory
guidance, have generally been insignificant. In December 2001, the Company
recorded a pretax charge of $1,314 representing its estimated portion of the
industry assessment related to the insolvency of the Reliance Insurance Group.
F-93
NOTE 13 - Supplementary Data on Cash Flows
A reconciliation of net income to net cash provided by operating activities
as presented in the Consolidated Statements of Cash Flows is as follows:
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Cash flows from operating activities
Net income ........................................... $ 11,333 $ 25,587 $ 20,841
Adjustments to reconcile net income to net
cash provided by operating activities:
Realized investment losses ........................ 49,407 10,019 9,906
Depreciation and amortization ..................... 12,512 8,300 6,761
Increase in insurance liabilities ................. 91,429 124,830 113,616
(Increase) decrease in premium receivables ........ 10,968 (7,160) (7,357)
Increase in deferred policy acquisition costs ..... (21,822) (19,565) (12,781)
(Increase) decrease in reinsurance recoverable .... 4,279 (5,850) 3,364
Increase (decrease) in federal
income tax liabilities ......................... (9,061) 3,179 (27,655)
(Decrease) increase in liabilities
for restructuring and litigation charges ....... (170) (3,127) 9,919
Other ............................................. 16,592 12,644 7,634
-------- -------- --------
Total adjustments .............................. 154,134 123,270 103,407
-------- -------- --------
Net cash provided by operating activities ... $165,467 $148,857 $124,248
======== ======== ========
The Company's repurchases of debt in 2002 resulted in non-cash financing
charges of $1,731.
NOTE 14 - Segment Information
The Company's operations include the following operating segments which
have been determined on the basis of insurance products sold: property and
casualty, annuity and life insurance. The property and casualty insurance
segment includes primarily personal lines automobile and homeowners products.
The annuity segment includes primarily fixed and variable tax-qualified annuity
products. The life insurance segment includes primarily interest-sensitive life
and traditional life products.
The accounting policies of the segments are the same as those described in
Note 1 - Summary of Significant Accounting Policies. The Company accounts for
intersegment transactions, primarily the allocation of agent and overhead costs
from the corporate and other segment to the property and casualty, annuity and
life segments, on a cost basis. The Company does not allocate the impact of
corporate level decisions to the insurance segments consistent with management's
evaluation of the results of those segments. For instance, see footnote (a) to
the table below.
F-94
NOTE 14 - Segment Information-(Continued)
Summarized financial information for these segments is as follows:
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Insurance premiums and contract charges earned
Property and casualty ........................ $519,546 $508,345 $489,952
Annuity ...................................... 14,247 14,906 17,017
Life ......................................... 92,707 93,272 92,998
Intersegment eliminations .................... (1,267) (1,281) (1,253)
-------- -------- --------
Total .................................. $625,233 $615,242 $598,714
======== ======== ========
Net investment income
Property and casualty ........................ $ 35,180 $ 37,749 $ 35,695
Annuity ...................................... 107,731 107,583 105,340
Life ......................................... 53,925 55,226 51,264
Corporate and other .......................... 387 98 1,295
Intersegment eliminations .................... (1,175) (1,389) (1,198)
-------- -------- --------
Total .................................. $196,048 $199,267 $192,396
======== ======== ========
Net income
Property and casualty ........................ $ 19,943 $ 5,184 $ 8,969
Annuity ...................................... 16,963 20,619 19,274
Life ......................................... 18,899 18,646 12,880
Corporate and other (a) ...................... (44,472) (18,862) (20,282)
-------- -------- --------
Total .................................. $ 11,333 $ 25,587 $ 20,841
======== ======== ========
Amortization of intangible assets
Value of acquired insurance in force
Annuity ................................... $ 4,008 $ 2,317 $ 5,176
Life ...................................... 1,726 1,839 1,975
-------- -------- --------
Subtotal ............................... 5,734 4,156 7,151
Goodwill ..................................... -- 1,618 1,618
-------- -------- --------
Total .................................. $ 5,734 $ 5,774 $ 8,769
======== ======== ========
December 31,
------------------------------------
2002 2001 2000
---------- ---------- ----------
Assets
Property and casualty ........................ $ 773,362 $ 738,638 $ 733,922
Annuity ...................................... 2,628,083 2,674,524 2,639,872
Life ......................................... 1,036,078 1,007,345 969,181
Corporate and other .......................... 112,102 105,215 115,584
Intersegment eliminations .................... (37,336) (36,696) (37,979)
---------- ---------- ----------
Total .................................. $4,512,289 $4,489,026 $4,420,580
========== ========== ==========
- ----------
(a) The corporate and other segment includes interest expense on debt and the
impact of realized investment gains and losses, restructuring charges, debt
retirement costs, litigation charges and provision for prior years' taxes.
F-95
NOTE 15 - Unaudited Interim Information
Summary quarterly financial data is presented below.
Three Months Ended
------------------------------------------------------
December 31, September 30, June 30, March 31,
------------ ------------- -------- ---------
2002
- ----
Insurance premiums written and contract deposits........ $236,377 $232,604 $218,600 $211,748
Total revenues.......................................... 210,667 189,981 163,406 207,820
Net income (loss)....................................... 13,547 549 (18,334)(a) 15,571
Per share information
Basic
Net income (loss)................................. $ 0.33 $ 0.02 $ (0.45)(a) $ 0.38
Shares of common stock - weighted average (b)..... 41,293 40,850 40,838 40,780
Diluted
Net income (loss)................................. $ 0.33 $ 0.02 $ (0.45)(a) $ 0.38
Shares of common stock and equivalent shares -
weighted average (b)........................... 41,466 41,025 41,294 41,231
2001
- ----
Insurance premiums written and contract deposits........ $225,262 $224,307 $218,225 $207,772
Total revenues.......................................... 201,889 203,131 196,106 203,364
Net income (loss)....................................... 4,758 9,057 (4,926) 16,698
Per share information
Basic
Net income (loss)................................. $ 0.12 $ 0.22 $ (0.12) $ 0.41
Shares of common stock - weighted average (b)..... 40,728 40,659 40,554 40,524
Diluted
Net income (loss)................................. $ 0.12 $ 0.22 $ (0.12) $ 0.41
Shares of common stock and equivalent shares -
weighted average (b)........................... 41,016 40,977 40,874 40,747
2000
- ----
Insurance premiums written and contract deposits........ $212,673 $210,002 $204,466 $194,512
Total revenues.......................................... 192,941 197,566 198,395 192,302
Net income (loss)....................................... (13,774) 12,207 9,682 12,726
Per share information
Basic
Net income (loss)................................. $ (0.34) $ 0.30 $ 0.24 $ 0.31
Shares of common stock - weighted average (b)..... 40,516 40,550 40,913 41,156
Diluted
Net income (loss)................................. $ (0.34) $ 0.30 $ 0.23 $ 0.31
Shares of common stock and equivalent shares -
weighted average (b)........................... 40,717 40,708 41,085 41,325
- ----------
(a) 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 pretax, has been reflected as an adjustment to benefits, claims and
settlement expenses and income for the three months ended June 30, 2002.
The net loss and net loss per share as previously reported for the three
months ended June 30, 2002 were $(19,287) and $(0.47).
(b) Rounded to thousands.
F-96
SCHEDULE I
HORACE MANN EDUCATORS CORPORATION
SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 2002
(Dollars in thousands)
Amount
shown in
Fair Balance
Type of Investments Cost(1) Value Sheet
------------------- ---------- ---------- ----------
Fixed maturities:
U.S. Government and U.S. Government agencies
and authorities .................................. $ 775,371 $ 811,543 $ 811,543
States, municipalities and political subdivisions ... 358,636 377,464 377,464
Foreign government bonds ............................ 13,131 15,976 15,976
Public utilities .................................... 133,020 131,503 131,503
Other corporate bonds ............................... 1,578,849 1,654,709 1,654,709
---------- ---------- ----------
Total fixed maturity securities ............... 2,859,007 $2,991,195 2,991,195
---------- ========== ----------
Mortgage loans and real estate ......................... 4,926 XXX 4,926
Short-term investments ................................. 60,933 XXX 60,933
Short-term investments, loaned securities .............. 3,937 XXX 3,937
Policy loans and other ................................. 69,185 XXX 69,572
---------- ----------
Total investments ............................. $2,997,988 XXX $3,130,563
========== ==========
- ----------
(1) Bonds at original cost reduced by repayments and adjusted for amortization
of premiums or accrual of discounts and impairment in value of specifically
identified investments.
See accompanying Independent Auditors' Report.
F-97
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
BALANCE SHEETS
As of December 31, 2002, 2001 and 2000
(Dollars in thousands, except per share data)
2002 2001 2000
--------- --------- ---------
ASSETS
Investments and cash ........................................... $ 10,913 $ 9,319 $ 8,565
Investment in subsidiaries ..................................... 608,164 554,811 521,563
Other assets ................................................... 55,764 50,891 49,668
--------- --------- ---------
Total assets ............................................. $ 674,841 $ 615,021 $ 579,796
========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Short-term debt ................................................ $ -- $ 53,000 $ 49,000
Long-term debt ................................................. 144,685 99,767 99,721
Other liabilities .............................................. 1,314 3,064 3,082
--------- --------- ---------
Total liabilities ........................................ 145,999 155,831 151,803
--------- --------- ---------
Preferred stock, $0.001 par value, authorized
1,000,000 shares; none issued ............................... -- -- --
Common stock, $0.001 par value, authorized 75,000,000
shares; issued, 2002, 60,194,615; 2001, 60,076,921;
2000, 59,859,053 ............................................ 60 60 60
Additional paid-in capital ..................................... 342,749 341,052 338,243
Retained earnings .............................................. 455,308 461,139 452,624
Accumulated other comprehensive income (loss), net of taxes:
Net unrealized gains (losses) on fixed maturities
and equity securities .................................... 80,567 26,336 (4,038)
Minimum pension liability adjustment ........................ (17,265) (11,438) (937)
Treasury stock, at cost, 2002, 17,503,371 shares;
2001 and 2000, 19,341,296 shares ............................ (332,577) (357,959) (357,959)
--------- --------- ---------
Total shareholders' equity ............................... 528,842 459,190 427,993
--------- --------- ---------
Total liabilities and shareholders' equity ............... $ 674,841 $ 615,021 $ 579,796
========= ========= =========
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-98
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF OPERATIONS
(Dollars in thousands)
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Revenues
Net investment income......................... $ 386 $ 100 $ 1,292
Realized investment gains (losses)............ (430) 219 242
-------- -------- --------
Total revenues............................. (44) 319 1,534
-------- -------- --------
Expenses
Interest...................................... 8,517 9,250 10,204
Debt retirement costs......................... 2,272 -- --
Amortization of goodwill...................... -- 1,618 1,618
Other......................................... 1,755 3,802 1,101
-------- -------- --------
Total expenses............................. 12,544 14,670 12,923
-------- -------- --------
Loss before income taxes
and equity in net earnings of subsidiaries.... (12,588) (14,351) (11,389)
Income tax benefit............................... (3,954) (4,099) (3,058)
-------- -------- --------
Loss before equity
in net earnings of subsidiaries............... (8,634) (10,252) (8,331)
Equity in net earnings of subsidiaries........... 19,967 35,839 29,172
-------- -------- --------
Net income....................................... $ 11,333 $ 25,587 $ 20,841
======== ======== ========
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-99
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Cash flows from operating activities
Interest expense paid..................................... $ (9,540) $ (9,091) $(10,028)
Contribution to defined benefit pension plan trust fund... (7,910) -- --
Federal income taxes (paid) recovered..................... 7,793 (12) 7,483
Cash dividends received from subsidiaries................. 5,900 28,650 36,500
Other, net................................................ 9,296 (4,032) 693
-------- -------- --------
Net cash provided by operating activities.............. 5,539 15,515 34,648
-------- -------- --------
Cash flows provided by (used in) investing activities
Net (increase) decrease in investments.................... (2,477) 5,707 7,214
Capital contributions to subsidiaries..................... -- (4,500) (20,000)
-------- -------- --------
Net cash provided by (used in) investing activities.... (2,477) 1,207 (12,786)
-------- -------- --------
Cash flows used in financing activities
Purchase of treasury stock................................ -- -- (15,143)
Dividends paid to shareholders............................ (17,164) (17,072) (17,240)
Principal borrowings (payments) on Bank Credit Facility... (53,000) 4,000 --
Exercise of stock options................................. 2,183 3,759 5,302
Catastrophe-linked equity put option premium.............. (1,088) (950) (950)
Proceeds from issuance of Convertible Notes............... 162,654 -- --
Repurchase of Senior Notes and Convertible Notes.......... (97,523) -- --
-------- -------- --------
Net cash used in financing activities.................. (3,938) (10,263) (28,031)
-------- -------- --------
Net increase (decrease) in cash.............................. (876) 6,459 (6,169)
Cash at beginning of period.................................. 8,333 1,874 8,043
-------- -------- --------
Cash at end of period........................................ $ 7,457 $ 8,333 $ 1,874
======== ======== ========
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-100
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
NOTE TO CONDENSED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000
The accompanying condensed financial statements should be read in
conjunction with the Consolidated Financial Statements and the accompanying
notes thereto.
See accompanying Independent Auditors' Report.
F-101
SCHEDULE III & VI (COMBINED)
HORACE MANN EDUCATORS CORPORATION
SCHEDULE III: SUPPLEMENTARY INSURANCE INFORMATION
SCHEDULE VI: SUPPLEMENTAL INFORMATION CONCERNING PROPERTY AND CASUALTY
INSURANCE OPERATIONS
(Dollars in thousands)
Column identification for
Schedule III: A B C D E F G
Schedule VI : A B C D E F G
Discount, Other
Deferred Future policy if any, policy Premium
policy benefits, deducted in claims and revenue/ Net
acquisition claims and previous Unearned benefits premium investment
Segment costs claims expenses column premiums payable earned income
- -------------------------------- ----------- --------------- ----------- -------- ---------- -------- ----------
Year Ended December 31, 2002
Property and casualty ....... $ 21,388 $ 317,321 $ 0 $180,509 $ -- $519,546 $ 35,180
Annuity ..................... 63,643 1,389,498 xxx -- 116,489 14,247 107,731
Life ........................ 89,524 728,603 xxx 8,875 8,619 92,707 53,925
Other, including
consolidating
eliminations ............. NA 2,000 xxx NA NA (1,267) (788)
-------- ---------- -------- -------- -------- --------
Total ................. $174,555 $2,437,422 xxx $189,384 $125,108 $625,233 $196,048
======== ========== ======== ======== ======== ========
Year Ended December 31, 2001
Property and casualty ....... $ 18,957 $ 306,141 $ 0 $177,023 $ -- $508,345 $ 37,749
Annuity ..................... 54,791 1,279,891 xxx -- 113,780 14,906 107,583
Life ........................ 84,028 701,964 xxx 8,546 9,654 93,272 55,226
Other, including
consolidating
eliminations ............. N/A 2,000 xxx N/A N/A (1,281) (1,291)
-------- ---------- -------- -------- -------- --------
Total ................. $157,776 $2,289,996 xxx $185,569 $123,434 $615,242 $199,267
======== ========== ======== ======== ======== ========
Year Ended December 31, 2000
Property and casualty ....... $ 16,936 $ 298,896 $ 0 $166,202 $ -- $489,952 $ 35,695
Annuity ..................... 46,434 1,220,334 xxx -- 111,511 17,017 105,340
Life ........................ 78,234 668,596 xxx 8,226 10,722 92,998 51,264
Other, including
consolidating
eliminations ............. N/A N/A xxx N/A N/A (1,253) 97
-------- ---------- -------- -------- -------- --------
Total ................. $141,604 $2,187,826 xxx $174,428 $122,233 $598,714 $192,396
======== ========== ======== ======== ======== ========
Column identification for
Schedule III: A H I J K
Schedule VI: A H I J K
Claims and claims
Benefits, adjustment expense Amortization Paid
claims incurred related to of deferred claims
and ------------------- policy Other and claims
settlement Current Prior acquisition operating adjustment Premiums
Segment expenses year years costs expenses expense written
- -------------------------------- ---------- -------- -------- ------------ --------- ---------- --------
Year Ended December 31, 2002
Property and casualty ....... $410,161 $387,747 $23,995(1) $51,804 $ 68,969 $411,159 $524,877
Annuity ..................... 69,233 xxx xxx 2,740 26,784 xxx xxx
Life ........................ 69,852 xxx xxx 8,020 39,597 xxx xxx
Other, including
consolidating
eliminations ............. -- xxx xxx (1,267) 18,316 xxx xxx
-------- ------- --------
Total ................. $549,246 xxx xxx $61,297 $153,666 xxx xxx
======== ======= ========
Year Ended December 31, 2001
Property and casualty ....... $433,344 $416,770 $16,574 $47,780 $ 63,042 $411,147 $519,167
Annuity ..................... 66,901 xxx xxx 3,498 21,368 xxx xxx
Life ........................ 69,840 xxx xxx 8,232 41,531 xxx xxx
Other, including
consolidating
eliminations ............. 2,000 xxx xxx (1,462) 20,074 xxx xxx
-------- ------- --------
Total ................. $572,085 xxx xxx $58,048 $146,015 xxx xxx
======== ======= ========
Year Ended December 31, 2000
Property and casualty ....... $417,369 $394,711 $22,658 $45,983 $ 58,416 $402,922 $493,364
Annuity ..................... 67,758 xxx xxx 4,694 20,741 xxx xxx
Life ........................ 73,482 xxx xxx 6,725 44,168 xxx xxx
Other, including
consolidating
eliminations ............. N/A xxx xxx (1,430) 33,577 xxx xxx
-------- ------- --------
Total ................. $558,609 xxx xxx $55,972 $156,902 xxx xxx
======== ======= ========
- ----------
(1) Property and casualty segment claims and claims adjustment expense incurred
related to prior years includes a $1,581 statutory accounting charge for
class action litigation which was separately reported as Litigation Charges
in the Company's Consolidated Statements of Operations.
N/A Not applicable.
See accompanying Independent Auditors' Report
F-102
SCHEDULE IV
HORACE MANN EDUCATORS CORPORATION
REINSURANCE
(Dollars in thousands)
Column A Column B Column C Column D Column E Column F
- -------- ----------- ---------- ---------- ----------- --------------
Ceded to Assumed Percentage
Gross Other from State of Amount
Amount Companies Facilities Net Assumed to Net
----------- ---------- ---------- ----------- --------------
Year ended December 31, 2002
Life insurance in force ........... $13,196,369 $1,286,109 -- $11,910,260 --
Premiums
Property and casualty .......... $ 530,253 $ 27,197 $16,490 $ 519,546 3.2%
Annuity ........................ 14,247 -- -- 14,247 --
Life ........................... 99,077 6,370 -- 92,707 --
Other, including
consolidating eliminations... (1,267) -- -- (1,267) --
----------- ---------- ------- -----------
Total premiums ........... $ 642,310 $ 33,567 $16,490 $ 625,233 2.6%
=========== ========== ======= ===========
Year ended December 31, 2001
Life insurance in force ........... $13,216,146 $1,035,477 -- $12,180,669 --
Premiums
Property and casualty .......... $ 514,574 $ 24,350 $18,121 $ 508,345 3.6%
Annuity ........................ 14,906 -- -- 14,906 --
Life ........................... 97,523 4,251 -- 93,272 --
Other, including
consolidating eliminations (1,281) -- -- (1,281) --
----------- ---------- ------- -----------
Total premiums ........... $ 625,722 $ 28,601 $18,121 $ 615,242 2.9%
=========== ========== ======= ===========
Year ended December 31, 2000
Life insurance in force ........... $12,646,371 $ 746,447 -- $11,899,924 --
Premiums
Property and casualty .......... $ 494,539 $ 21,154 $16,567 $ 489,952 3.4%
Annuity ........................ 17,017 -- -- 17,017 --
Life ........................... 94,949 1,951 -- 92,998 --
Other, including
consolidating eliminations (1,253) -- -- (1,253) --
----------- ---------- ------- -----------
Total premiums ........... $ 605,252 $ 23,105 $16,567 $ 598,714 2.8%
=========== ========== ======= ===========
- ----------
NOTE: Premiums above include insurance premiums earned and contract charges
earned.
See accompanying Independent Auditors' Report
F-103
================================================================================
HORACE MANN EDUCATORS CORPORATION
EXHIBITS
To
FORM 10-K
For the Year Ended December 31, 2002
VOLUME 1 OF 1
================================================================================
The following items are filed as Exhibits to Horace Mann Educators
Corporation's Annual Report on Form 10-K for the year ended December 31, 2002.
Management contracts and compensatory plans are indicated by an asterisk(*).
EXHIBIT INDEX
Exhibit
No. Description
- ------- -----------
(3) Articles of incorporation and bylaws:
3.1 Restated Certificate of Incorporation of HMEC, filed with the
Delaware Secretary of State on October 6, 1989, incorporated by
reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1996, filed with the
Securities and Exchange Commission (the "SEC") on November 14,
1996.
3.1(a) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on October 18,
1991, incorporated by reference to Exhibit 3.2 to HMEC's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1996,
filed with the SEC on November 14, 1996.
3.1(b) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on August 23,
1995, incorporated by reference to Exhibit 3.3 to HMEC's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1996,
filed with the SEC on November 14, 1996.
3.1(c) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on September
23, 1996, incorporated by reference to Exhibit 3.4 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1996, filed with the SEC on November 14, 1996.
3.1(d) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on June 5,
1998, incorporated by reference to Exhibit 3.1 to HMEC's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998, filed
with the SEC on August 13, 1998.
3.1(e) Certificate of Amendment to Restated Certificate of Incorporation
of HMEC, filed with the Delaware Secretary of State on June 22,
2000, incorporated by reference to Exhibit 3.1(e) to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000,
filed with the SEC on August 11, 2000.
3.2 Form of Certificate for shares of Common Stock, $0.001 par value
per share, of HMEC, incorporated by reference to Exhibit 4.5 to
HMEC's Registration Statement on Form S-3 (Registration No.
33-53118) filed with the SEC on October 9, 1992.
Exhibit
No. Description
- ------- -----------
3.3 Bylaws of HMEC, incorporated by reference to Exhibit 4.6 to HMEC's
Registration Statement on Form S-3 (Registration No. 33-80059)
filed with the SEC on December 6, 1995.
(4) Instruments defining the rights of security holders, including indentures:
4.1 Indenture dated as of January 17, 1996, between HMEC and U.S.
Trust Company of California, N.A. as trustee, with regard to
HMEC's 6 5/8% Senior Notes Due 2006, incorporated by reference to
Exhibit 4.4 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1995, filed with the SEC on March 13, 1996.
4.1(a) Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.1).
4.2 Indenture dated as of May 14, 2002, between HMEC and JPMorgan
Chase Bank as trustee, with regard to HMEC's 1.425% Senior
Convertible Notes Due 2032, incorporated by reference to Exhibit
4.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2002, filed with the SEC on August 14, 2002.
4.2(a) Form of 1.425% Senior Convertible Notes Due 2032 (included in
Exhibit 4.2).
4.3 Certificate of Designations for HMEC Series A Cumulative
Convertible Preferred Stock (included in Exhibit 10.13).
(10) Material contracts:
10.1 Credit Agreement dated as of May 29, 2002 (the "Bank Credit
Facility") among HMEC, certain financial institutions named
therein and Bank of America, N.A., as administrative agent (the
"Agent"), incorporated by reference to Exhibit 10.1 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2002,
filed with the SEC on August 14, 2002.
10.2* Stock Subscription Agreement among HMEC (as successor to HME
Holdings, Inc.), The Fulcrum III Limited Partnership, The Second
Fulcrum III Limited Partnership and each of the Management
Investors, incorporated by reference to Exhibit 10.17 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1989,
filed with the SEC on April 2, 1990.
10.3* Horace Mann Educators Corporation Deferred Equity Compensation
Plan for Directors, incorporated by reference to Exhibit 10.1 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996, filed with the SEC on November 14, 1996.
Exhibit
No. Description
- ------- -----------
10.4* Horace Mann Educators Corporation Deferred Compensation Plan for
Employees, incorporated by reference to Exhibit 10.4 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1997,
filed with the SEC on March 30, 1998.
10.5* Amended and Restated Horace Mann Educators Corporation 1991 Stock
Incentive Plan, incorporated by reference to Exhibit 10.5 to
HMEC's Annual Report on Form 10-K for the year ended December 31,
1999, filed with the SEC on March 30, 2000.
10.5(a)* Amendment to Amended and Restated Horace Mann Educators
Corporation 1991 Stock Incentive Plan, incorporated by reference
to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2000, filed with the SEC on August 11,
2000.
10.5(b)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.5(a) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1999, filed with the SEC on March
30, 2000.
10.5(c)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.5(b) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1999, filed with the SEC on March
30, 2000.
10.6* Horace Mann Educators Corporation 2001 Stock Incentive Plan,
incorporated by reference to Exhibit 10.6 to HMEC's Annual Report
on Form 10-K for the year ended December 31, 2001, filed with the
SEC on March 29, 2002.
10.6(a)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 2001 Stock Incentive Plan, incorporated by
reference to Exhibit 10.6(a) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 2001, filed with the SEC on March
29, 2002.
10.6(b)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 2001 Stock Incentive Plan, incorporated by
reference to Exhibit 10.6(b) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 2001, filed with the SEC on March
29, 2002.
Exhibit
No. Description
- ------- -----------
10.7* Horace Mann Educators Corporation 2002 Incentive Compensation
Plan, incorporated by reference to Exhibit 10.2 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002, filed with the SEC on August 14, 2002.
10.7(a)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 2002 Incentive Compensation Plan,
incorporated by reference to Exhibit 10.2(a) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002, filed
with the SEC on August 14, 2002.
10.7(b)* Specimen Regular Employee Stock Option Agreement under the
Horace Mann Educators Corporation 2002 Incentive Compensation
Plan, incorporated by reference to Exhibit 10.2(b) to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002, filed with the SEC on August 14, 2002.
10.7(c)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 2002 Incentive Compensation Plan,
incorporated by reference to Exhibit 10.2(c) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002, filed
with the SEC on August 14, 2002.
10.8* Severance Agreements between HMEC and certain officers of HMEC,
incorporated by reference to Exhibit 10.7 to HMEC's Annual
Report on Form 10-K for the year ended December 31, 2001, filed
with the SEC on March 29, 2002.
10.8(a)* Revised Schedule to Severance Agreements between HMEC and
certain officers of HMEC.
10.9* Horace Mann Supplemental Employee Retirement Plan, 2002
Restatement, incorporated by reference to Exhibit 10.1 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2002, filed with the SEC on May 15, 2002.
10.10* Horace Mann Executive Supplemental Employee Retirement Plan,
2002 Restatement, incorporated by reference to Exhibit 10.2 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended March
31, 2002, filed with the SEC on May 15, 2002.
10.11* Horace Mann Nonqualified Supplemental Money Purchase Pension
Plan, incorporated by reference to Exhibit 10.3 to HMEC's
Quarterly Report on Form 10-Q for the Quarter Ended March 31,
2002, filed with the SEC on May 15, 2002.
Exhibit
No. Description
- ------- -----------
10.12* Employment Agreement entered by and between HMEC and Louis G.
Lower II as of December 31, 1999, incorporated by reference to
Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1999, filed with the SEC on March 30, 2000.
10.13 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, incorporated by reference to Exhibit 10.1 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002, filed with the SEC on November 14, 2002.
(11) Statement regarding computation of per share earnings.
(12) Statement regarding computation of ratios.
(21) Subsidiaries of HMEC.
(23) Consent of KPMG LLP.
(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.