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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
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
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COMMON STOCK, PAR VALUE $0.001 PER SHARE NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 1, 1998, was approximately $1.5 billion.
As of March 1, 1998, 44,028,744 shares of Common Stock, par value $0.001 per
share, were outstanding, net of 15,193,796 shares of treasury stock.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for the 1998 Annual Meeting of Shareholders, exclusive of
disclosures made pursuant to Regulation S-K, Section 402 (i), (k) and (l).
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HORACE MANN EDUCATORS CORPORATION
FORM 10-K
YEAR ENDED DECEMBER 31, 1997
INDEX
ITEM
NUMBER PAGE
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PART I
1. Business........................................................................................ 1
2. Properties...................................................................................... 26
3. Legal Proceedings............................................................................... 26
4. Submission of Matters to a Vote of Security Holders............................................. 26
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters........................... 27
6. Selected Financial Data......................................................................... 27
7. Management's Discussion and Analysis of Financial Condition and Results of Operations........... 28
8. Consolidated Financial Statements and Supplementary Data........................................ 28
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............ 28
PART III
10. Directors and Executive Officers of the Registrant.............................................. 28
11. Executive Compensation.......................................................................... 28
12. Security Ownership of Certain Beneficial Owners and Management.................................. 28
13. Certain Relationships and Related Transactions.................................................. 28
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................ 28
SIGNATURES...................................................................................... 32
Index to Financial Information.................................................................. F-1
PART I
ITEM 1. BUSINESS
FORWARD-LOOKING INFORMATION
It is important to note that the Company's actual results could differ
materially from those projected in forward-looking statements. Additional
information concerning factors that could cause actual results to differ
materially from those in the forward-looking statements is contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
OVERVIEW
Horace Mann Educators Corporation (together with its subsidiaries, the
"Company" or "HMEC") is an insurance holding company incorporated in Delaware.
Through its subsidiaries, HMEC markets and underwrites personal lines of
property and casualty and life insurance and retirement annuities. HMEC's
principal insurance subsidiaries are Horace Mann Insurance Company ("HMIC"),
Teachers Insurance Company ("TIC") and Horace Mann Life Insurance Company
("HMLIC"), each of which is an Illinois corporation, and Allegiance Insurance
Company ("Allegiance"), a California domiciled personal lines property and
casualty insurance company.
The Company markets its products primarily to educators and other employees
of public schools and their families. Customers of the Company typically have
moderate annual incomes, with many belonging to two-income households. Their
financial planning tends to focus on security, savings and primary insurance
needs.
The Company sells and services its products primarily through an exclusive
sales force of full-time agents employed by the Company. The Company's agents
sell only the Company's products. Many of the Company's agents are former
educators who utilize their contacts within, and knowledge of, the target
market. Compensation for sales agents includes an incentive element based upon
the profitability of the business they write.
The Company's insurance premiums written and contract deposits for the year
ended December 31, 1997 were $771.3 million and operating income (income from
continuing operations before realized investment gains and losses and debt
retirement costs) was $83.6 million. The Company's total assets were $4.1
billion at December 31, 1997. The property and casualty segment accounted for
59% of the Company's insurance premiums written and contract deposits for the
year ended December 31, 1997, while accounting for 62% of earnings from
continuing operations before interest and taxes for the period. The annuity and
life insurance segments together accounted for 41% of insurance premiums written
and contract deposits for the year ended December 31, 1997 (26% and 15%,
respectively), and provided 41% (25% and 16%, respectively) of earnings from
continuing operations before interest and taxes for the period.
In December 1996, the Company announced its strategic decision to withdraw
from the group medical insurance business over the following two years. The
Company stopped writing new group medical insurance policies in January 1997,
terminated 95% of that business by December 1997, and will terminate the
remaining group medical insurance policies in 1998. In the Company's financial
statements and discussions of operating results, group medical results are
reported separately as discontinued operations.
In each of the last 10 years, the Company's combined loss and expense ratio
for its property and casualty product lines outperformed the total property and
casualty industry combined loss and expense ratio, as reported by A.M. Best
Company ("A.M. Best"), an independent insurance rating agency. During this
period, the Company's combined loss and expense ratio was better than the total
property and casualty insurance industry combined loss and expense ratio by an
average of approximately 11 percentage points per year. During the same period
of time, the Company's combined loss and expense ratio was better than the
personal lines insurance industry segment combined loss and expense ratio by an
average of approximately 9 percentage points per year.
1
One of the reasons why the Company's property and casualty lines have
performed better than the industry is the Company's property and casualty
expense ratio, which has been consistently better than the industry ratio since
1983. During the last 10 years, the Company's property and casualty expense
ratio has been better than the property and casualty industry personal lines
average expense ratio as reported by A.M. Best by an average of 4.7 percentage
points per year. The Company's property and casualty expense ratio for the year
ended December 31, 1997 was 19.4%, well within the lowest 20% of expense ratios
of the 100 largest property and casualty groups, based on A.M. Best's reports.
At December 31, 1997, the accumulated value of annuity contracts was $2.3
billion. For the year ended December 31, 1997, 92% of the accumulated cash value
of the Company's annuity business remained on deposit. All annuities issued
since 1982 and approximately 75% of all outstanding fixed annuity accumulated
cash values are subject in most cases to substantial early withdrawal penalties,
typically ranging from 5% to 13% of the amount withdrawn. Withdrawals of
outstanding variable annuities are limited to amounts less than or equal to the
then current market value of the annuity. Tax-qualified annuities represented
95% of the Company's annuity policy reserves at December 31, 1997, and,
generally, a penalty is imposed under the Internal Revenue Code of 1986, as
amended, on amounts withdrawn from tax-qualified annuities prior to age 59 1/2.
The investment portfolio of the Company, including variable annuity assets
under management of $960 million, had an aggregate market value of $3.7 billion
at December 31, 1997. Investments other than variable annuity assets consist
principally of investment grade publicly traded fixed income securities. At
December 31, 1997, investments in non-investment grade securities represented
6.0% of total investments excluding variable annuity assets. There are no
significant investments in mortgage loans and real estate or privately placed
securities.
HISTORY
The Company's business was founded in Springfield, Illinois in 1945 by two
Illinois teachers to sell automobile insurance to other teachers within the
State of Illinois.
In 1968, INA Corporation ("INA") acquired a 25% interest in HMEC, and
completed its acquisition of HMEC in 1975. In 1982, INA and Connecticut General
Corporation merged to form CIGNA. In August 1989 an investor group directed by
Gibbons, Green, van Amerongen, L.P. (subsequently Gibbons, Goodwin, van
Amerongen) ("GGvA") and certain members of the Company's senior management
acquired HMEC from CIGNA. In November 1991, HMEC completed an initial public
offering of its common stock (the "IPO") which is traded on the New York Stock
Exchange under the symbol "HMN."
Following the initial public offering, GGvA owned approximately 44% of the
outstanding shares of the common stock. Pursuant to an agreement with GGvA, in
May 1995 HMEC purchased approximately one-half of the shares of its common stock
owned by GGvA and in July 1995 completed a secondary public offering of most of
the remaining shares of its common stock owned by GGvA.
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 periods in the
five year period ended December 31, 1997 have been audited by KPMG Peat Marwick
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,
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1997 1996 1995 1994 1993
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(Dollars in millions, except per share data)
STATEMENT OF OPERATIONS DATA:
Insurance premiums written and contract deposits............. $ 771.3 $ 704.8 $ 654.0 $ 637.3 $ 589.1
Insurance premiums and contract charges earned............... 542.7 502.7 485.4 472.4 437.9
Net investment income........................................ 198.9 198.6 198.4 185.3 184.2
Net investment income, after tax............................. 132.6 132.4 132.2 124.9 123.2
Realized investment gains (losses)........................... 5.3 2.5 8.6 (0.9) 26.8
Total revenues............................................... 746.9 703.8 692.4 656.8 648.9
Amortization of intangible assets(1)......................... 10.7 11.2 11.7 12.6 13.1
Interest expense............................................. 9.4 10.5 11.6 9.5 9.1
Income from continuing operations before income taxes........ 119.6 100.6 103.6 86.2 112.8
Income from continuing operations............................ 87.1 73.8 75.2 64.6 76.8
Discontinued operations(2)................................... (3.5) (9.2) (1.2) - 0.4
Income before extraordinary item............................. 83.6 64.6 74.0 64.6 77.2
Extraordinary item(3)........................................ - - - (1.7) -
Net income................................................... 83.6 64.6 74.0 62.9 77.2
Operating income(4).......................................... 83.6 73.1 70.9 65.2 59.4
Ratio of earnings to fixed charges(5)........................ 13.7x 10.6x 9.9x 10.1x 13.4x
PER SHARE DATA(6):
Basic:
Operating income(4)........................................ $ 1.82 $ 1.56 $ 1.42 $ 1.13 $ 1.03
Realized investment gains (losses), after tax.............. 0.08 0.03 0.11 (0.01) 0.30
Income from continuing operations.......................... 1.90 1.57 1.50 1.12 1.33
Discontinued operations(2)................................. (0.08) (0.19) (0.02) (0.01) -
Income before extraordinary item........................... 1.82 1.38 1.48 1.11 1.33
Net income................................................. 1.82 1.38 1.48 1.09 1.33
Diluted:
Operating income(4)........................................ $ 1.80 $ 1.54 $ 1.33 $ 1.08 $ 0.99
Realized investment gains (losses), after tax.............. 0.07 0.03 0.10 (0.01) 0.27
Income from continuing operations.......................... 1.87 1.55 1.41 1.07 1.26
Discontinued operations(2)................................. (0.07) (0.19) (0.02) - 0.01
Income before extraordinary item........................... 1.80 1.36 1.39 1.07 1.27
Net income................................................. 1.80 1.36 1.39 1.04 1.27
Shares of Common Stock--weighted average:
Basic...................................................... 45.8 47.0 50.1 57.9 57.9
Diluted.................................................... 46.5 47.6 56.3 64.1 64.1
Cash dividends............................................... $ 0.2825 $ 0.22 $ 0.18 $ 0.145 $ 0.12
BALANCE SHEET DATA, AT YEAR END:
Total investments............................................ $ 2,769.0 $ 2,784.3 $ 2,798.5 $ 2,533.4 $ 2,493.8
Total assets................................................. 4,131.9 3,861.0 3,662.3 3,285.5 3,147.6
Short-term debt.............................................. 42.0 34.0 75.0 - -
Long-term debt............................................... 99.6 99.6 100.0 100.0 111.7
Total shareholders' equity................................... 506.0 484.4 470.2 412.0 429.9
Book value per share(6)(7)................................... $ 11.43 $ 10.25 $ 10.05 $ 7.11 $ 7.42
SEGMENT INFORMATION:
Insurance premiums written and contract deposits
Property and casualty...................................... $ 458.0 $ 427.1 $ 405.8 $ 398.8 $ 366.0
Annuity.................................................... 199.2 166.9 142.9 136.6 123.4
Life....................................................... 114.1 110.8 105.3 101.9 99.7
Total.................................................... 771.3 704.8 654.0 637.3 589.1
Operating income(4)
Property and casualty...................................... $ 61.4 $ 54.0 $ 56.4 $ 52.6 $ 44.9
Annuity.................................................... 19.3 16.3 14.8 14.2 11.7
Life....................................................... 12.9 12.1 10.4 7.7 9.6
Corporate and other, including interest expense............ (10.0) (9.3) (10.7) (9.3) (6.8)
Total.................................................... 83.6 73.1 70.9 65.2 59.4
(CONTINUED ON NEXT PAGE)
3
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA--(CONTINUED)
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(Dollars in millions, except per share data)
STATUTORY OPERATING DATA(8):
Property and casualty:
Loss and loss adjustment expense ratio..................... 71.7% 74.1% 73.5% 73.8% 73.6%
Expense ratio.............................................. 19.4% 19.4% 19.8% 19.8% 19.6%
Combined loss and expense ratio(9)......................... 91.1% 93.5% 93.3% 93.7% 93.3%
Industry average combined loss and expense ratio(10)....... 101.8% 105.8% 106.4% 108.4% 106.9%
Personal lines industry segment average combined loss and
expense ratio(10)........................................ 100.1% 104.9% 103.5% 104.5% 103.9%
Annuity accumulated value on deposit......................... $ 2,314.2 $ 2,075.5 $ 1,866.0 $ 1,673.2 $ 1,584.5
Life insurance in force...................................... $ 11,188 $ 10,645 $ 10,235 $ 9,707 $ 9,281
Adjusted capital and surplus of insurance subsidiaries
(includes investment reserves)(11)......................... $ 372.3 $ 404.6 $ 389.8 $ 358.3 $ 344.2
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(1) Amortization of intangible assets is comprised of amortization of goodwill
and amortization of acquired value of insurance in force and is the result
of purchase accounting adjustments related to the 1989 acquisition of the
Company and the 1994 acquisition of Allegiance. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-- Year Ended
December 31, 1997 Compared with Year Ended December 31, 1996."
(2) In December 1996, the Company announced its strategic decision to withdraw
from the group medical insurance business and during 1997 the Company
accelerated the withdrawal. Group medical results net of taxes are reported
separately as discontinued operations and 1997 and 1996 include additional
after tax charges of $3.5 million, or $0.07 per diluted share, and $3.9
million, or $0.08 per diluted share, respectively, for estimated losses
during the phase-out period.
(3) The extraordinary item for the year ended December 31, 1994 represents a
non-recurring loss from early retirement of debt and is net of tax benefits.
(4) Income from continuing operations before realized investment gains and
losses, debt retirement costs, cost of the additional rights relating to the
1995 share repurchase, discontinued operations, and extraordinary items.
(5) For the purpose of determining the ratio of earnings to fixed charges,
"earnings" consist of income from continuing operations before income taxes
and interest expense (including amortization of debt issuance cost), and
"fixed charges" consist of interest expense (including amortization of debt
issuance cost).
(6) Basic earnings per share is computed based on the weighted average number of
shares outstanding. Diluted earnings per share is computed based on the
weighted average number of shares and common stock equivalents outstanding.
The Company's common stock equivalents relate to outstanding warrants,
common stock options and Director Stock Plan units, and prior to their early
retirement in February 1996, the convertible notes were considered
potentially dilutive securities for purposes of calculating diluted earnings
per share. Shares and per share amounts for all periods have been restated
to reflect the Company's two-for-one stock split.
(7) Due to the adoption by the Company on January 1, 1994 of Financial
Accounting Standard No. 115 ("FAS 115"), total shareholders' equity included
an increase, net of taxes, of $62.2 million, $29.7 million and $76.2 million
at December 31, 1997, 1996 and 1995, respectively, and a reduction, net of
tax benefits, of $70.9 million at December 31, 1994. Excluding the FAS 115
market value accounting for investments, book value per share was $10.03,
$9.62, $8.42 and $8.34 at December 31, 1997, 1996, 1995 and 1994,
respectively.
(8) Statutory data has been derived from the financial statements of the Company
prepared in accordance with statutory accounting practices and filed with
insurance regulatory authorities.
(9) Property and casualty combined loss and expense ratio includes policyholder
dividends.
(10) Source: Best's Aggregates and Averages (1994 through 1997 Eds.). The
industry averages for the year ended December 31, 1997 are from Review
Preview, A Special Supplement to Best's Review and BestWeek,
Property/Casualty Edition, January 1998, published by A.M. Best.
(11) Investment reserves were the Asset Valuation Reserves.
GENERAL
The Company markets and underwrites personal lines of property and casualty
and life insurance and retirement annuities. The following table sets forth by
segment the amount of insurance premiums written and contract deposits for the
Company for the periods indicated.
INSURANCE PREMIUMS WRITTEN AND CONTRACT DEPOSITS
(Dollars in millions)
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1997 1996 1995
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Property and casualty.................. $ 458.0 59.4% $ 427.1 60.6% $ 405.8 62.0%
Annuity................................ 199.2 25.8 166.9 23.7 142.9 21.9
Life................................... 114.1 14.8 110.8 15.7 105.3 16.1
--------- --------- --------- --------- --------- ---------
Total.......................... $ 771.3 100.0% $ 704.8 100.0% $ 654.0 100.0%
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
4
CORPORATE STRATEGY AND MARKETING
The Company's target market consists of educators and other employees of
public schools and their families. It is estimated that there are approximately
3 million elementary and secondary public school teachers and administrators in
the United States. The Company also sells its products to other
education-related customers, including private school teachers, education
support personnel, and their families. In addition to changes in the number of
teachers that may result from growth in the general population and changes in
the number of school age children, the Company believes that turnover among the
teacher population increases the size of its 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. Customers of the Company typically have moderate annual incomes,
with many belonging to two-income households. Their financial planning tends to
focus on security, savings and primary insurance needs.
EXCLUSIVE AGENCY FORCE
A cornerstone of the Company's marketing strategy is its exclusive sales
force of full-time agents who are employees of the Company. As of December 31,
1997, the Company employed 1,070 full-time agents. Many of these agents were
previously teachers or other members of the education profession. The Company's
agents market and write the full range of the Company's products. They are under
contract to market and write only those products authorized by the Company.
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 a position to write and service individual
insurance business. Management believes that Horace Mann's name recognition and
policyholder loyalties lead to new customers and cross-selling of additional
insurance products.
The Company's agents pre-underwrite policy applicants. The Company
structures its agent compensation to provide incentives for agents to adhere to
the Company's underwriting standards and practices and business growth plans.
Agent compensation after an initial two-year period is comprised entirely of
commissions and incentive bonuses based on profitability of insurance written,
retention of customers and sales. In 1997, incentive bonuses represented 26% of
compensation for agents with more than two years of experience with the Company
with more than 90% of the bonuses based on profitability. The profitability
related portion of agent compensation is based on loss ratios in the case of
property and casualty policies, where permitted by law, and persistency in the
case of life policies. Management believes that this compensation structure,
which rewards the individual agent's selection of profitable business, helps to
produce profitable business.
ALTERNATE DISTRIBUTION PROGRAM
The Company has established an alternate distribution marketing program to
develop new sales channels that supplement and complement the exclusive agency
force. As of December 31, 1997, the Company had established relationships with
88 educator credit unions in 31 states. At some of those credit unions, a
salaried representative of the Company is available to meet with prospective
customers, while other of those credit unions refer their members to the Company
for their insurance needs.
GEOGRAPHIC COMPOSITION OF BUSINESS
The Company's business is geographically diversified. Based on direct
insurance premiums earned and contract deposits for all continuing product lines
for the year ended December 31, 1997, the top five states and their portion of
total premium were North Carolina, 8.1%; Texas, 6.8%; Illinois, 5.2%; Minnesota,
5.2%; and California, 4.8%.
5
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 1997:
PROPERTY AND CASUALTY SEGMENT TOP TEN STATES
(Dollars in millions)
PROPERTY AND CASUALTY
SEGMENT
--------------------------
DIRECT PERCENT
STATE PREMIUMS(1) OF TOTAL
- --------------------------------------------------------------------- ------------- -----------
Texas................................................................ $ 33.7 7.6%
North Carolina....................................................... 32.5 7.3
California........................................................... 30.8 6.9
Minnesota............................................................ 27.9 6.3
Massachusetts........................................................ 25.5 5.7
Florida.............................................................. 23.5 5.3
Pennsylvania......................................................... 22.6 5.1
South Carolina....................................................... 19.9 4.4
Michigan............................................................. 19.9 4.4
Georgia.............................................................. 15.9 3.6
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Total of top ten states...................................... 252.2 56.6
All other areas...................................................... 193.3 43.4
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Total direct premiums........................................ $ 445.5 100.0%
------------- -----
------------- -----
- ---------
(1) Defined as earned premiums before reinsurance and is determined under
statutory accounting practices.
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 1997:
COMBINED LIFE AND ANNUITY SEGMENTS TOP TEN STATES
(Dollars in millions)
DIRECT PREMIUMS AND PERCENT
STATE CONTRACT DEPOSITS(1) OF TOTAL
- ------------------------------------------------------------- --------------------- -----------
North Carolina............................................... $ 27.8 9.1%
Illinois..................................................... 26.1 8.6
Virginia..................................................... 17.4 5.7
Texas........................................................ 16.9 5.6
Tennessee.................................................... 16.6 5.5
Indiana...................................................... 14.9 4.9
Minnesota.................................................... 10.8 3.5
Wisconsin.................................................... 10.5 3.4
South Carolina............................................... 9.8 3.2
Pennsylvania................................................. 9.0 3.0
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Total of top ten states.............................. 159.8 52.5
All other areas.............................................. 144.5 47.5
------- -----
Total direct premiums................................ $ 304.3 100.0%
------- -----
------- -----
- ---------
(1) Excludes discontinued group medical business and is determined under
statutory accounting practices.
6
NATIONAL, STATE AND LOCAL EDUCATION ASSOCIATIONS
The Company estimates that less than half of its policyholders are members
of the National Education Association ("NEA"), the nation's largest
confederation of state and local teachers' associations. NEA has approximately
2.3 million members.
The Company has had a long relationship with NEA and many of the state and
local education associations affiliated with NEA. The Company maintains a
special advisory board, primarily composed of leaders of state education
associations, that meets with Company management on a regular basis. These
meetings provide management with the opportunity to better assess the present
and future needs of its target market and to cultivate better relations with
education association leaders. In certain states, where approved by the
applicable state insurance departments, state or local association members are
entitled to a discount on premiums for certain property and casualty insurance
products sold by the Company.
From 1984 to September 1993 and beginning again in September 1996, NEA
purchased from the Company educator professional liability insurance for its
members. Premium from this product represents less than 2% of all insurance
premiums written and contract deposits of the Company. Between September 1993
and September 1996, the Company did not write this policy.
It is the practice of NEA and affiliated state and local education
associations to "sponsor" various insurance products and services, including
those of the Company and its competitors. "Sponsorship" is generally determined
independently by each of these organizations. Being "sponsored" generally means
that NEA and such state and local associations evaluate a product, authorize the
use of their names in connection with the marketing of the product and, in some
instances, recommend that their membership consider buying the product. From
time to time during the past 25 years, NEA has sponsored various Company
products and currently sponsors the Company's homeowners policy, which was
co-sponsored by 41 NEA-affiliated state associations as of December 31, 1997. In
each of the Company's last three fiscal years, the Company's homeowners policy
was the only product of the Company that was sponsored by NEA (exclusive of the
educator professional liability insurance policy purchased by NEA in 1996 and
1997). NEA-affiliated education associations in 40 states sponsor products of
the Company other than homeowners. NEA-affiliated education associations in 46
states sponsor one or more of the Company's products. In many cases,
associations that sponsor one of the Company's products also sponsor competing
products. The Company does not pay NEA or any affiliated associations any
consideration in exchange for sponsorship of Company products. The Company does
pay for advertising that appears in NEA and state education association
publications.
Some of the advantages of education association sponsorship include prestige
and enhanced brand awareness, increased opportunity for the Company's agents to
market products on school premises, and improved agent recruiting, especially
among former teachers. The Company's customers decide whether to purchase the
Company's products for a number of reasons, including pricing and service of the
product and the customer's relationship with the selling agent--education
association sponsorship may be one factor in such a decision.
The American Federation of Teachers ("AFT") is the nation's second largest
teachers' union representing approximately 700,000 educators. NEA and AFT have
moved further in their discussions regarding creation of a new, unified
organization of educators. Delegates from NEA and AFT will vote during the
Summer of 1998 on whether to approve the NEA and AFT merger. If approved, the
merger would be completed by the year 2002. At the present time, the Company
does not have any relationship with the AFT and such a merger could expand
sponsorship opportunities within the Company's target market.
PROPERTY AND CASUALTY
The primary property and casualty product offered by the Company is private
passenger automobile insurance, which in 1997 represented 78% of property and
casualty net written premiums. Homeowners insurance represented 21% of property
and casualty premiums and the educator professional liability insurance
represented the remaining 1% of the Company's property and casualty premiums. As
of December 31, 1997, the Company had approximately 586,000 voluntary automobile
7
policies in force with annual premiums of approximately $384 million and
approximately 251,000 homeowners policies in force with annual premiums of
approximately $96 million. Voluntary automobile policies exclude those policies
described in "Business--Regulation--Mandatory Insurance Facilities" and assigned
risk policies. See "Business--Corporate Strategy and Marketing--National, State
and Local Education Associations."
The results of companies in the insurance industry have historically been
subject to significant fluctuations due to competition, economic conditions,
interest rates and other factors. In particular, the property and casualty
insurance industry has historically experienced pricing and profitability
cycles. With respect to these cycles, the factors most affecting current and
prospective results of operations are intense price competition and aggressive
marketing by property and casualty insurers, which have historically resulted in
higher combined loss and expense ratios. Periods characterized by higher
combined loss and expense ratios have typically been followed by withdrawal of
capacity in the property and casualty industry and a firming of prices,
resulting in lower combined loss and expense ratios. Because of the nature of
the property and casualty cycle, it is difficult to predict future trends in the
industry's overall combined loss and expense ratio. Management of the Company
believes that these factors will continue to produce pricing and profitability
cycles for the industry in the future. During the past ten years, the personal
lines segment of the property and casualty insurance market has been less
subject to the pricing and profitability cycles that have affected the
commercial lines segment and the overall industry. Because virtually all the
Company's property and casualty business is personal lines business, management
believes the Company's operations are less subject to pricing and profitability
cycles than the operations of many other insurers.
Results of property insurers are also subject to weather and other
conditions prevailing in an accident year. While one year may be relatively free
of major weather or other disasters, another year may have numerous such events
causing results for such a year to be materially worse than for other years.
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,
-------------------------------
1997 1996 1995
--------- --------- ---------
STATEMENT OF OPERATIONS DATA:
Insurance premiums written........................................... $ 458.0 $ 427.1 $ 405.8
Insurance premiums earned............................................ 447.2 413.2 403.8
Net investment income................................................ 41.7 46.4 48.8
Realized investment gains............................................ 1.9 0.2 2.9
Income before income taxes........................................... 80.6 70.6 75.3
Net income before realized investment gains.......................... 61.4 54.0 56.4
Net income........................................................... 62.7 54.1 58.3
Net investment income, after tax..................................... 30.4 33.5 35.0
Catastrophe losses, after tax........................................ 4.0 13.6 9.0
STATUTORY OPERATING STATISTICS:
Loss and loss adjustment expense ratio............................... 71.7% 74.1% 73.5%
Expense ratio........................................................ 19.4% 19.4% 19.8%
Combined loss and expense ratio (including policyholder dividends)... 91.1% 93.5% 93.3%
Combined loss and expense ratio before catastrophes (including
policyholder dividends)............................................ 89.7% 88.5% 89.9%
(CONTINUED ON NEXT PAGE)
8
PROPERTY AND CASUALTY SEGMENT
SELECTED HISTORICAL FINANCIAL INFORMATION--(CONTINUED)
(Dollars in millions)
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
GAAP OPERATING STATISTICS:
Loss and loss adjustment expense ratio............................... 71.7% 74.1% 73.6%
Expense ratio........................................................ 19.6% 19.8% 20.1%
Combined loss and expense ratio (including policyholder dividends)... 91.3% 93.9% 93.7%
Combined loss and expense ratio before catastrophes (including
policyholder dividends)............................................ 89.9% 88.9% 90.3%
AUTOMOBILE AND HOMEOWNERS (VOLUNTARY):
Insurance premiums written........................................... $ 431.0 $ 400.0 $ 381.8
Insurance premiums earned............................................ 421.5 390.0 378.9
Policies in force (in thousands)..................................... 837 786 743
PROPERTY AND CASUALTY RATIOS
In each of the last 10 years, the Company's combined loss and expense ratio
for its property and casualty product lines outperformed the total property and
casualty industry combined loss and expense ratio, as reported by A.M. Best.
During this period, the Company's combined loss and expense ratio was better
than the total property and casualty insurance industry combined loss and
expense ratio by an average of approximately 11 percentage points per year.
During the same period of time, the Company's combined loss and expense ratio
was better than the personal lines insurance industry segment combined loss and
expense ratio by an average of approximately 9 percentage points per year.
The table below compares the Company's combined loss and expense ratios with
published industry averages.
PROPERTY AND CASUALTY COMBINED LOSS AND EXPENSE RATIO(1)
PROPERTY AND
THE PERSONAL LINES CASUALTY
COMPANY(2) INDUSTRY SEGMENT(3) INDUSTRY(3)
------------- --------------------- ---------------
Year Ended December 31,
1997...................................................... 91.1% 100.1% 101.8%
1996...................................................... 93.5 104.9 105.8
1995...................................................... 93.3 103.5 106.4
1994...................................................... 93.7 104.5 108.4
1993...................................................... 93.3 103.9 106.9
1992...................................................... 97.1 112.5 115.7
1991...................................................... 98.4 107.1 108.8
1990...................................................... 101.8 109.8 109.6
1989...................................................... 106.9 109.9 109.2
1988...................................................... 99.6 105.5 105.4
- ---------
(1) Combined loss and expense ratio includes policyholder dividends and is
determined according to statutory accounting practices.
(2) The Company did not have any California property and casualty business
during each of the years from 1989 through 1993.
(3) Source: Best's Aggregates and Averages (1989 through 1997 Eds.). 1997 is an
estimate from Review Preview, A Special Supplement to Best's Review and
BestWeek, Property/Casualty Edition, January 1998, published by A.M. Best.
9
Catastrophe losses before federal income tax benefits for the Company and
the property and casualty industry for the nine years ended December 31, 1997
were as follows:
CATASTROPHE LOSSES
(Dollars in millions)
PROPERTY AND
THE CASUALTY
COMPANY(1) INDUSTRY(2)
------------- -------------
Year Ended December 31,
1997............................................................................ $ 6.2 $ 2,560.0
1996............................................................................ 20.9 7,375.0
1995............................................................................ 13.9 7,425.0
1994............................................................................ 17.0 17,030.0
1993............................................................................ 8.5 5,705.0
1992............................................................................ 13.3 22,870.0
1991............................................................................ 10.3 4,698.0
1990............................................................................ 5.8 2,560.0
1989............................................................................ 12.2 7,371.0
- ---------
(1) Net of reinsurance and before federal income tax benefits. Includes
allocated loss adjustment expenses. The Company's individually significant
catastrophe losses net of reinsurance were as follows:
1997--$1.4 million, July 1997 wind/hail/tornadoes; $1.1 million, Denver,
Colorado hailstorm.
1996--$8.2 million, Hurricane Fran.
1995--$2.9 million, Texas wind/hail/tornadoes; $2.2 million Hurricane
Opal.
1994--$6.0 million, Northridge, California earthquake.
1993--$2.2 million, East Coast blizzard.
1992--$1.9 million, Hurricane Andrew.
1991--$1.0 million, Hurricane Bob.
1990--$2.8 million, Denver, Colorado hailstorm.
1989--$4.0 million, Hurricane Hugo.
(2) Source: Insurance Trends, Property--Casualty Edition, First Quarter 1998,
published by Conning & Company. These amounts are before reinsurance and
federal income tax benefits and exclude all loss adjustment expenses.
During the last 10 years, the Company's property and casualty expense ratio
has been better than the property and casualty industry personal lines average
expense ratio as reported by A.M. Best by an average of 4.7 percentage points
per year. The Company's property and casualty expense ratio for the year ended
December 31, 1997 was 19.4%, well within the lowest 20% of expense ratios of the
100 largest property and casualty groups, based on A.M. Best's reports.
10
The table below compares the Company's expense ratios with published
industry averages.
PROPERTY AND CASUALTY EXPENSE RATIO(1)
PROPERTY AND
THE PERSONAL LINES CASUALTY
COMPANY(2) INDUSTRY SEGMENT(3) INDUSTRY(3)
--------------- ----------------------- ---------------
Year ended December 31,
1997...................................................... 19.4% 24.1% 26.7%
1996...................................................... 19.4 23.4 26.3
1995...................................................... 19.8 23.7 26.1
1994...................................................... 19.8 23.5 26.0
1993...................................................... 19.6 23.9 26.2
1992...................................................... 19.6 24.4 26.5
1991...................................................... 19.8 24.7 26.4
1990...................................................... 19.1 24.3 26.0
1989...................................................... 19.0 24.5 26.0
1988...................................................... 18.7 24.4 25.7
- ---------
(1) Determined according to statutory accounting practices.
(2) The Company did not have any California property and casualty business
during each of the years from 1989 through 1993.
(3) Source: Best's Aggregates and Averages (1989 through 1997 Eds.). The 1997
personal lines result is an estimate from A.M. Best. The 1997 total industry
result is an estimate from Review Preview, A Special Supplement to Best's
Review and BestWeek, Property/Casualty Edition, January 1998, published by
A.M. Best.
PROPERTY AND CASUALTY RESERVES
In the last ten consecutive years the Company's property and casualty
reserves have developed cumulative redundancies. Reserves for claims and claims
expenses are carried at the full value of estimated liabilities and are not
discounted for interest expected to be earned on reserves. The Company has no
exposure to claims for toxic waste cleanup, other environmental remediation or
asbestos-related illnesses.
The Company establishes property and casualty claim reserves to cover its
estimated ultimate liability for claims and claim adjustment expenses with
respect to reported claims and claims incurred but not yet reported as of the
end of each accounting period. In accordance with applicable insurance laws and
regulations and generally accepted accounting principles ("GAAP"), no reserves
are established until a loss occurs, including a loss from a catastrophe.
Underwriting results of the property and casualty operations are significantly
influenced by estimates of property and casualty claims and claims expense
reserves. These reserves are an accumulation of the estimated amounts necessary
to settle all outstanding claims, including claims which are incurred but not
reported, as of the date of the financial statements.
The reserve estimates are based on known facts and on interpretations of
circumstances, including the Company's experience with similar cases and
historical trends involving claim payment patterns, claim payments, pending
levels of unpaid claims and product mix, as well as other factors including
court decisions, economic conditions and public attitudes. The effects of
inflation are implicitly considered in the reserving process. The establishment
of reserves, including reserves for catastrophes, is an inherently uncertain
process and the ultimate cost may vary materially from the recorded amounts. The
Company regularly updates its reserve estimates as new facts become known and
further events occur which may impact the resolution of unsettled claims.
Changes in prior year reserve estimates, which may be material, are reflected in
the results of operations in the period such changes are determined to be
needed.
11
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, 1997 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 reserve, 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
(before reinsurance) balances are reflected in the Consolidated Balance Sheets
also listed on page F-1 of this report.
RECONCILIATION OF PROPERTY AND CASUALTY CLAIMS AND CLAIMS EXPENSES RESERVES
(Dollars In millions)
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Gross reserves, beginning of year........................................ $ 340.4 $ 369.7 $ 389.1
Less reinsurance recoverables........................................ 34.1 23.8 19.5
--------- --------- ---------
Net reserves, beginning of year.......................................... 306.3 345.9 369.6
--------- --------- ---------
Incurred claims and claims expense:
Claims occurring in the current year................................. 365.9 368.6 352.5
Decrease in estimated reserves for claims occurring in prior
years(1):
Policies written by the Company.................................. (40.2) (56.4) (49.8)
Business assumed from state reinsurance facilities............... (4.9) (6.1) (5.8)
--------- --------- ---------
Total decrease............................................... (45.1) (62.5) (55.6)
--------- --------- ---------
Total claims and claims expenses incurred........................ 320.8 306.1 296.9
--------- --------- ---------
Claims and claims expense payments for claims occurring during:
Current year......................................................... 209.2 206.4 179.8
Prior years.......................................................... 148.6 139.3 140.8
--------- --------- ---------
Claims and claims expense payments............................... 357.8 345.7 320.6
--------- --------- ---------
Net reserves, end of period.............................................. 269.3 306.3 345.9
Plus reinsurance recoverables........................................ 41.3 34.1 23.8
--------- --------- ---------
Gross reserves, end of period(2)......................................... $ 310.6 $ 340.4 $ 369.7
--------- --------- ---------
--------- --------- ---------
- ---------
(1) Shows the amounts by which the Company decreased its reserves in each of the
periods indicated for claims occurring in previous periods to reflect
subsequent information on such claims and changes in their projected final
settlement costs. Favorable reserve development generally occurs as a result
of subsequent adjustment of reserves to reflect additional information.
(2) Unpaid claims and claim expenses as reported in the consolidated balance
sheets also include life, annuity, and group accident and health reserves of
$11.7 million, $17.2 million and $15.0 million at December 31, 1997, 1996
and 1995, respectively, in addition to property and casualty reserves.
The provision for claims and claims expenses for insured events in prior
years decreased by $45.1 million, $62.5 million and $55.6 million for the years
ended December 31, 1997, 1996 and 1995, respectively. The favorable claim
development results primarily from improving trends in the frequency and
severity of voluntary automobile claims. Future reserve releases, if any, will
depend on the continuation of the favorable claim trends.
12
The year-end 1997 gross reserves of $310.6 million for property and casualty
insurance claims and claims expenses, as determined under GAAP, were $41.3
million more than the reserve balance of $269.3 million recorded on the basis of
statutory accounting practices for reports provided to state regulatory
authorities. The difference is the reinsurance recoverable from third parties
that reduces reserves for statutory reporting and is recorded as an asset for
GAAP reporting.
The decline in reserves during 1997 reflects favorable reserve development
resulting from improving trends in the frequency and severity of voluntary
automobile claims. Other factors have contributed to the decline in reserves,
including the Company's focus on containing legal costs associated with settling
automobile liability claims, a customer service program which has accelerated
payment of property damage and collision claims by approximately 5 days,
commutation of a portion of the Company's reinsurance coverage from prior years,
and a reduction in reserves from state insurance facilities for involuntary
automobile business.
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 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 expanded awareness of
additional facts and circumstances that pertain to the unsettled claims. The
last section compares the latest reestimated reserve to the reserve originally
established, and indicates whether or not the original reserve was adequate or
inadequate to cover the estimated costs of unsettled claims. The table also
presents the gross reestimated liability as of the end of the latest
reestimation period, with separate disclosure of the related reestimated
reinsurance recoverable. The claim reserve development table is cumulative and,
therefore, ending balances should not be added since the amount at the end of
each calendar year includes activity for both the current and prior years.
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 1996 to be $150 thousand was first reserved in
1987 at $100 thousand, the $50 thousand deficiency (actual claim minus original
estimate) would be included in the cumulative deficiency in each of the years
1987 - 1995 shown below. This table presents development data by calendar year
and does not relate the data to the year in
13
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,
--------------------------------------------------------------------------------------
1987 1988 1989 1990 1991 1992 1993 1994
--------- --------- --------- --------- --------- --------- --------- ---------
Gross reserves for property and
casualty claims and claims
expenses, beginning of year........ $ 268.0 $ 307.2 $ 320.9 $ 319.4 $ 331.5 $ 358.2 $ 373.5 $ 389.1
Deduct: Reinsurance recoverables..... 25.4 29.4 46.9 20.9 14.8 17.7 21.6 19.5
--------- --------- --------- --------- --------- --------- --------- ---------
Net reserves for property and
casualty claims and claims
expenses, beginning of year........ 242.6] 277.8 274.0 298.5 316.7 340.5 351.9 369.6
Increase in reserves due to purchase
of Allegiance Insurance Company:
Gross reserves for property and
casualty claims and claims
expenses....................... - - - - - - 30.6 -
Deduct: Reinsurance
recoverables................... - - - - - - 0.6 -
--------- --------- --------- --------- --------- --------- --------- ---------
Net reserves for property and
casualty claims and claims
expenses....................... - - - - - - 30.0 -
Paid cumulative as of:
One year later................... 115.6 120.2 115.0 111.3 116.1 117.6 133.4 140.8
Two years later.................. 163.5 175.9 163.9 167.4 170.0 169.6 190.5 194.5
Three years later................ 194.3 204.3 192.6 197.1 197.2 197.8 218.4 224.2
Four years later................. 208.3 220.1 208.2 212.9 212.1 213.6 234.1
Five years later................. 215.6 227.7 216.4 220.7 220.5 222.6
Six years later.................. 218.9 232.2 219.3 225.3 224.8
Seven years later................ 220.8 234.0 221.7 228.2
Eight years later................ 221.6 235.5 223.2
Nine years later................. 222.4 236.6
Ten years later.................. 223.3
Reserves reestimated as of:
End of year...................... 242.6 277.8 274.0 298.5 316.7 340.5 381.9 369.6
One year later................... 244.1 275.6 265.9 279.9 297.3 306.1 327.6 314.0
Two years later.................. 243.1 269.2 254.5 266.7 272.1 267.7 281.9 269.2
Three years later................ 243.3 259.0 239.4 246.7 246.8 246.4 258.1 251.4
Four years later................. 235.4 243.0 233.2 236.5 235.2 233.3 249.3
Five years later................. 226.0 239.7 227.8 232.4 229.8 229.7
Six years later.................. 224.7 239.3 225.4 230.8 230.1
Seven years later................ 225.0 237.4 224.9 231.1
Eight years later................ 224.1 237.5 225.2
Nine years later................. 224.0 238.1
Ten years later.................. 224.5
Reserve redundancy--Initial net
reserves in excess of reestimated
reserves:
Amount........................... $ 18.1 $ 39.7 $ 48.8 $ 67.4 $ 86.6 $ 110.8 $ 132.6 $ 118.2
Percent.......................... 7.5% 14.3% 17.8% 22.6% 27.3% 32.5% 34.7% 32.0%
Gross reestimated
liability--latest.................. $ 282.9
Reestimated reinsurance
recoverables-- latest.............. 31.5
---------
Net reestimated liability--latest.... 251.4
Gross cumulative excess.............. $ 106.2
---------
---------
1995 1996 1997
--------- --------- ---------
Gross reserves for property and
casualty claims and claims
expenses, beginning of year........ $ 369.7 $ 340.4 $ 310.6
Deduct: Reinsurance recoverables..... 23.8 34.1 41.3
--------- --------- ---------
Net reserves for property and
casualty claims and claims
expenses, beginning of year........ 345.9 306.3 269.3
Increase in reserves due to purchase
of Allegiance Insurance Company:
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................... 139.3 148.6
Two years later.................. 195.3
Three years later................
Four years later.................
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...................... 345.9 306.3 269.3
One year later................... 283.4 261.2
Two years later.................. 249.6
Three years later................
Four years later.................
Five years later.................
Six years later..................
Seven years later................
Eight years later................
Nine years later.................
Ten years later..................
Reserve redundancy--Initial net
reserves in excess of reestimated
reserves:
Amount........................... $ 96.3 $ 45.1
Percent.......................... 27.8% 14.7%
Gross reestimated
liability--latest.................. $ 278.1 $ 298.3
Reestimated reinsurance
recoverables-- latest.............. 28.5 37.1
--------- ---------
Net reestimated liability--latest.... 249.6 261.2
Gross cumulative excess.............. $ 91.6 $ 42.1
--------- ---------
--------- ---------
As the table above illustrates, the Company's net reserve for property and
casualty insurance claims and claims expense at the end of 1996 developed
favorably in 1997 by $45.1 million, comparable to favorable development of the
gross reserves of $42.1 million.
PROPERTY AND CASUALTY REINSURANCE
All reinsurance is obtained through contracts which generally are renewed
each calendar year; however, approximately one half of the catastrophe
reinsurance program effective January 1, 1998 is a three year contract with rate
guarantees. Although reinsurance does not legally discharge the Company from
primary liability for the full amount of its policies, it does make the assuming
reinsurer liable to the
14
extent of the reinsurance ceded. Historically, the Company's losses from
uncollectible reinsurance recoverables have been insignificant. Past due
reinsurance recoverables as of December 31, 1997 were also insignificant.
The Company is a national underwriter and therefore has exposure to
catastrophic losses in certain coastal states and other regions throughout the
United States. Catastrophes can be caused by various events including
hurricanes, windstorms, earthquakes, hail, severe winter weather and fires, and
the frequency and severity of catastrophes are inherently unpredictable. The
financial impact from catastrophic losses results from both the total amount of
insured exposure in the area affected by the catastrophe as well as the severity
of the event. The Company seeks to reduce its exposure to catastrophe losses
through the geographic diversification of its insurance coverage, the purchase
of catastrophe reinsurance, and the purchase of a catastrophe-linked equity put
option.
The Company maintains an excess and catastrophe treaty reinsurance program.
The Company reinsures 95% of catastrophe losses above a retention of $7.5
million per occurrence up to $65 million per occurrence in 1997 and $80 million
in 1998. This program is augmented by a $100 million equity put that 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, individually or in the aggregate during a calendar year, exceed
the catastrophe reinsurance program coverage limit. Before tax benefits, the
equity put provides a source of capital for up to $154 million of catastrophe
losses above the reinsurance coverage limit. For liability coverages, in both
1997 and 1998, including the educator 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 $500,000 up to $1.5
million.
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 coverage and their rating by
Standard & Poor's Corporation ("S&P" or "Standard & Poor's") and A.M. Best. No
other single reinsurer's percentage participation in 1998 or 1997 exceeds 5%.
PROPERTY CATASTROPHE REINSURANCE PARTICIPANTS IN EXCESS OF 5%
PARTICIPATION
S&P A.M. BEST -----------
RATING RATING REINSURER PARENT 1998 1997
- ------ --------- --------------------------------- --------------------------------- ---- ----
A+ A Lloyd's of London Syndicates* 16% 18%
AA- A+ AXA Reinsurance Company AXA Group 13% 7%
AAA A+ St. Paul Fire and Marine The St. Paul Companies, Inc.
Insurance Company 10% 7%
AAA A++ American Re-insurance Company Muenchener Rueckversicherungs-
Gesellschaft AG (Munich Re) of
Germany 6% 0%
NR A++ Erie Insurance Exchange 5% **
A NR G.I.O. Australia Holdings, Ltd. 0% 6%
AAA A+ Munich American Reinsurance Muenchener Rueckversicherungs-
Company Gesellschaft AG (Munich Re) of
Germany 0% 5%
- ---------
NR--Not rated.
* For 1998, the 16% participation by Lloyd's of London in the Company's
catastrophe reinsurance program is disbursed among 22 syndicates, each
providing less than 5% of the Company's aggregate reinsured catastrophe
risk.
** Less than 5%.
For 1998, 95% of the Company's property catastrophe reinsurers were rated
"A- (Excellent)" or above by A.M. Best.
15
ANNUITIES
Educators in the Company's target market, as public school employees,
benefit from the provisions of Section 403(b) of the Internal Revenue Code. This
section of the Code allows public school employees to reduce their pretax income
by making periodic contributions to an individual qualified retirement plan. The
Company has offered tax-qualified annuities to its marketplace, designed to
allow contractholders to benefit from these tax provisions, since 1961, the year
Congress created this option for educators.
The Company sells fixed and variable tax-qualified annuities. Under the
fixed annuities, both the principal and a rate of return are guaranteed.
Variable annuity contract deposits are invested as designated by the
contractholder in mutual funds managed by the Company--a common stock fund, a
bond fund, a combination bond and stock fund, and a short-term fund; and
beginning in 1997--a small cap growth fund, an international equity fund, and a
socially responsible fund. Total accumulated fixed and variable annuity cash
value on deposit at December 31, 1997 of $2,314.2 million increased $238.7
million, or 11.5%, compared to December 31, 1996. This increase resulted from a
net increase in funds on deposit of 10.5% plus net increases in market value of
underlying mutual funds of $27.7 million. The liability for all annuity
contracts issued by the Company on a generally accepted accounting principles
("GAAP") basis is established at the contract's accumulated cash value before
reduction for surrender charges.
For the year ended December 31, 1997, 92% of the accumulated cash value of
the Company's annuity business remained on deposit, compared to average
retention of 90% for stock life insurance companies for 1996, as reported by
A.M. Best. All annuities issued since 1982 and approximately 75% of all
outstanding fixed annuity accumulated cash values are subject in most cases to
substantial early withdrawal penalties, typically ranging from 5% to 13% of the
amount withdrawn. Withdrawals of outstanding variable annuities are limited to
amounts less than or equal to the then current market value of the annuity.
Tax-qualified annuities represented 95% of the Company's annuity policy reserves
at December 31, 1997, and, generally, a penalty is imposed under the Internal
Revenue Code of 1986, as amended, on amounts withdrawn from tax-qualified
annuities prior to age 59 1/2.
16
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,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
STATEMENT OF OPERATIONS DATA:
Contract deposits...................................................... $ 199.2 $ 166.9 $ 142.9
Contract charges earned................................................ 12.6 9.2 6.8
Net investment income.................................................. 113.1 111.4 110.3
Net interest margin (without realized gains)........................... 36.6 34.7 35.8
Net margin (includes contract charges earned).......................... 49.2 43.9 42.6
Realized investment gains.............................................. 2.2 1.6 4.3
Income before income taxes............................................. 32.0 26.5 27.1
Net income before realized investment gains............................ 19.3 16.3 14.8
Net income............................................................. 20.7 17.4 17.6
OPERATING STATISTICS:
Fixed annuity:
Accumulated value.................................................. $ 1,354.5 $ 1,390.6 $ 1,378.4
Accumulated value persistency...................................... 91.7% 93.9% 94.5%
Variable annuity accumulated value..................................... $ 959.7 $ 684.9 $ 487.6
Number of contracts in force........................................... 112,162 106,476 101,641
Average accumulated cash value (in dollars)............................ $ 20,633 $ 19,493 $ 18,358
Average annual deposit by policyholders (in dollars)................... $ 2,485 $ 2,382 $ 2,350
Maturity schedule for all annuity contracts
Matured............................................................ $ 195.7 $ 184.4 $ 176.8
5 years or less.................................................... 424.4 397.9 371.7
After 5 years through 10 years..................................... 489.6 408.9 351.5
After 10 years through 20 years.................................... 793.9 732.8 664.9
After 20 years..................................................... 410.6 351.5 301.1
Total accumulated cash value................................... $ 2,314.2 $ 2,075.5 $ 1,866.0
Annuity contracts terminated due to surrender, death, maturity or
other:
Number of contracts................................................ 6,945 5,977 5,645
Amount............................................................. $ 116.7 $ 90.9 $ 90.0
Accumulated fixed annuity value grouped by applicable surrender charge:
0%................................................................. $ 326.3 $ 344.6 $ 364.9
5% and greater but less than 10%................................... 808.9 827.5 804.6
10% and greater.................................................... 137.5 141.2 138.2
Supplementary contracts with life contingencies not subject to
discretionary withdrawal......................................... 81.8 77.3 70.7
Total accumulated fixed annuity value.......................... $ 1,354.5 $ 1,390.6 $ 1,378.4
LIFE
The Company entered the individual life insurance business in 1949 with
traditional term and whole life insurance products. In 1984, the Company
introduced "Experience Life," a flexible 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, 1997 the
Company had in force approximately 102,000 Experience Life policies representing
approximately $6.8 billion of life insurance
17
in force with annual insurance premiums and contract deposits of approximately
$72.9 million. The Company's traditional term, whole life and group life
business in force consists of approximately 151,000 policies, representing
approximately $4.4 billion of life insurance in force with annual insurance
premiums and contract deposits of approximately $27.4 million as of December 31,
1997. In 1997, the Company introduced a new series of five limited duration term
life insurance products. The Company does not charge any penalty for withdrawal
of life insurance cash values. The life segment also includes the Company's
group life and group disability income business which represented approximately
2% of all insurance premiums written and contract deposits of the Company.
During 1997, the average face amount of ordinary life insurance policies
issued by the Company was $101,077 and the average face amount of all ordinary
life insurance policies it has in force was $50,998. A.M. Best reported that
during 1996, for stock life insurance companies, the average face amount of
ordinary life insurance policies issued was $76,193 and the average face amount
of all ordinary life insurance policies in force was $47,803. The maximum life
insurance risk retained by the Company is $200,000 combined for group and
individual coverages on any individual life. Any risk in excess of $200,000 is
reinsured. All of the Company's life reinsurers are rated "A (Excellent)" or
above by A.M. Best.
The life insurance and annuity industry, while it has not generally been
subject to the factors that produce cyclicality in the property and casualty
insurance industry, is nonetheless subject to competitive pressures and interest
rate fluctuations. As a result, the life insurance and annuity industry has
developed new products designed to shift investment and credit risk to policy or
contract holders 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.
18
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,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
STATEMENT OF OPERATIONS DATA:
Insurance premiums and contract deposits............................... $ 114.1 $ 110.8 $ 105.3
Insurance premiums and contract charges earned......................... 82.9 80.3 74.8
Net investment income.................................................. 43.7 41.7 39.8
Realized investment gains.............................................. 1.0 0.7 1.4
Income before income taxes............................................. 20.9 19.1 17.4
Net income before realized investment gains............................ 12.9 12.1 10.4
Net income............................................................. 13.6 12.5 11.2
OPERATING STATISTICS:
Life insurance in force:
Ordinary life...................................................... $ 10,241 $ 9,682 $ 9,304
Group life......................................................... 947 963 931
Total.......................................................... 11,188 10,645 10,235
Number of policies in force:
Ordinary life...................................................... 200,811 199,031 198,541
Group life......................................................... 51,895 55,525 53,225
Total.......................................................... 252,706 254,556 251,766
Average face amount in force (in dollars):
Ordinary life...................................................... $ 50,998 $ 48,650 $ 46,900
Group life......................................................... 18,248 17,350 17,500
Total.......................................................... 44,273 41,800 40,650
Persistency rate (ordinary life insurance in force).................... 93.0% 92.0% 92.2%
Lapse ratio (ordinary life insurance in force)......................... 7.0% 8.0% 7.8%
Ordinary life insurance terminated due to death, surrender, lapse or
other:
Face amount of insurance surrendered or lapsed..................... $ 771.4 $ 862.1 $ 808.1
Number of policies............................................. 9,571 9,660 9,380
Amount of death claims............................................. $ 22.0 $ 22.4 $ 19.3
Number of death claims......................................... 1,834 1,305 1,166
Acquired Immune Deficiency Syndrome ("AIDS") is expected to affect mortality
adversely for the life insurance industry although the extent of the impact
cannot be predicted at this time. Where permitted by law, the Company has
responded by considering AIDS information in underwriting and pricing decisions.
From 1993 through 1997, the Company has paid $3.1 million in death benefits
under 80 individual life policies due to known AIDS-related deaths, representing
3% of total death benefits paid during this period.
INVESTMENTS
The Company's investments are selected to balance the objectives of
minimizing interest rate exposure, providing a high current yield and protecting
principal. These objectives are implemented through a portfolio that emphasizes
investment grade, publicly traded bonds. When impairment of the value of an
investment is considered other than temporary, the decrease in value is recorded
as an adjustment to the valuation reserve and a new cost basis is established.
At December 31, 1997,
19
investments in non-investment grade securities represented 6.0% of total
investments. There are no significant investments in mortgage loans and real
estate or privately placed securities.
The Company's investments are managed by outside managers and advisors which
follow investment guidelines established by the Company. The Company has
separate investment strategies and guidelines for its property and casualty
assets and for its life and annuity assets, which recognize different
characteristics of the associated insurance liabilities, as well as different
tax and regulatory environments. The Company manages interest rate exposure for
its portfolios through asset/liability management techniques that attempt to
match the duration of the assets with the duration of the liabilities under
insurance policies. Duration of assets and liabilities will generally differ
only because of opportunities to significantly increase yields or because policy
values are not interest-sensitive, as in the property and casualty segment.
The investments of each insurance subsidiary must comply with the insurance
laws of such insurance subsidiary's domiciliary state. These laws prescribe the
type and amount of investments that may be made by insurance companies. In
general, these laws permit investments, within specified limits and subject to
certain qualifications, in federal, state and municipal obligations, corporate
bonds, preferred stocks, common stocks, real estate mortgages and real estate.
The following table sets forth the carrying and market values of the
Company's investment portfolio as of December 31, 1997:
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............. 19.5% $ 539.2 $ 440.3 $ 98.9 $ 521.5
Other.................................. 8.2 228.0 207.1 20.9 222.8
Investment grade corporate and public
utility bonds............................ 40.8 1,131.0 972.5 158.5 1,082.2
Municipal bonds............................ 8.7 241.8 29.3 212.5 228.1
Other mortgage-backed securities........... 10.7 296.5 253.5 43.0 290.1
Non-investment grade corporate and public
utility bonds(2)......................... 6.0 164.9 101.6 63.3 155.1
Foreign government bonds................... 1.0 27.7 27.7 - 26.4
Short-term investments(3).................. 1.5 41.0 34.2 6.8 41.0
----- ---------- ---------- ------------- -----------
Total publicly traded securities... 96.4 2,670.1 2,066.2 603.9 2,567.2
----- ---------- ---------- ------------- -----------
OTHER INVESTMENTS:
Private placements, all investment
grade(4)................................. 0.4 9.7 9.5 0.2 9.4
Mortgage loans and real estate(5).......... 1.4 38.1 38.1 - 38.1
Policy loans and other..................... 1.8 51.1 49.7 1.4 51.1
----- ---------- ---------- ------------- -----------
Total other investments............ 3.6 98.9 97.3 1.6 98.6
----- ---------- ---------- ------------- -----------
Total investments(6)............... 100.0% $ 2,769.0 $ 2,163.5 $ 605.5 $ 2,665.8
----- ---------- ---------- ------------- -----------
----- ---------- ---------- ------------- -----------
- ---------
(1) Includes $364.9 million market value of investments guaranteed by the full
faith and credit of the United States government and $402.3 million market
value of federally sponsored agency securities.
(CONTINUED ON NEXT PAGE)
20
INVESTMENT PORTFOLIO--(CONTINUED)
- ---------
(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 ("S&P") RATING
FOR SUCH SECURITY, OR IF THERE IS NO S&P RATING, THE MOODY'S INVESTORS
SERVICE, INC. ("MOODY'S") RATING FOR SUCH SECURITY, OR IF THERE IS NO S&P OR
MOODY'S RATING, THE NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS (THE
"NAIC") RATING FOR SUCH SECURITY.
(3) SHORT-TERM INVESTMENTS MATURE WITHIN ONE YEAR OF BEING ACQUIRED AND ARE
CARRIED AT COST, WHICH APPROXIMATES MARKET VALUE. SHORT-TERM INVESTMENTS
INCLUDE $31.8 MILLION IN A MONEY MARKET FUND RATED "AAA" (S&P OR ITS
EQUIVALENT), $9.1 MILLION IN CORPORATE BONDS AND $0.1 MILLION IN
CERTIFICATES OF DEPOSIT.
(4) MARKET VALUES FOR PRIVATE PLACEMENTS ARE ESTIMATED BY THE COMPANY WITH THE
ASSISTANCE OF ITS INVESTMENT ADVISORS.
(5) MORTGAGE LOANS ARE CARRIED AT AMORTIZED COST OR UNPAID PRINCIPAL BALANCE
LESS VALUATION RESERVES AND REAL ESTATE ACQUIRED IN THE SETTLEMENT OF DEBT
IS CARRIED AT THE LOWER OF COST OR MARKET. CARRYING VALUE IS NET OF A $2.3
MILLION VALUATION RESERVE FOR ANTICIPATED LOSSES.
(6) APPROXIMATELY 7% OF THE COMPANY'S INVESTMENT PORTFOLIO, HAVING A CARRYING
VALUE OF $183.2 MILLION AS OF DECEMBER 31, 1997, CONSISTED OF SECURITIES
WITH SOME FORM OF CREDIT SUPPORT, SUCH AS INSURANCE. ALL OF THESE SECURITIES
HAVE THE HIGHEST INVESTMENT GRADE RATING.
FIXED MATURITY SECURITIES
The following table sets forth the composition of the Company's fixed
maturity securities portfolio by rating as of December 31, 1997:
RATING OF FIXED MATURITY SECURITIES(1)
(Dollars in millions)
PERCENT
OF TOTAL
CARRYING CARRYING AMORTIZED
VALUE VALUE COST
----------- ---------- -----------
AAA................................................................. 42.7% $ 1,126.8 $ 1,092.3
AA.................................................................. 7.1 188.3 179.3
A................................................................... 20.3 534.6 512.4
BBB................................................................. 23.3 613.8 585.3
BB.................................................................. 1.6 43.1 40.5
B................................................................... 4.0 106.2 99.7
CCC or lower........................................................ 0.1 1.4 3.2
Not rated(2)........................................................ 0.9 24.6 22.9
----- ---------- -----------
Total........................................................... 100.0% $ 2,638.8 $ 2,535.6
----- ---------- -----------
----- ---------- -----------
- ---------
(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 $14.9 million of publicly rated securities not
currently rated by S&P, Moody's or the NAIC and $9.7 million of private
placement securities not rated by either S&P or Moody's. The NAIC has rated
90.7% of these private placements as investment grade. $0.8 million of the
remaining $0.9 million of private placements were rated as investment grade
by the NAIC in 1995 and are under review for the assignment of a current
rating.
At December 31, 1997, 29.8% of the Company's fixed maturity securities
portfolio was scheduled to mature within the next 5 years. Mortgage-backed
securities, including mortgage-backed securities of United States governmental
agencies, represented 30.2% of the total investment portfolio at December 31,
1997. 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
21
to refinance their mortgages and defaults by homeowners on mortgages that are
then paid by guarantors.
For financial reporting purposes, the Company has classified the entire
fixed maturity portfolio as "available for sale". Fixed maturities to be held
for indefinite periods of time and not intended to be held to maturity are
classified as available for sale and carried at market value. Fixed maturities
held for indefinite periods of time include securities that management intends
to use as part of its asset/liability management strategy and that may be sold
in response to changes in interest rates, resultant prepayment risk and other
factors related to interest rate and resultant prepayment risk.
CASH FLOW
As a holding company, HMEC conducts its principal operations through its
subsidiaries. Payment by HMEC of principal and interest with respect to HMEC's
indebtedness, and payment by HMEC of dividends to its shareholders, are
dependent upon the ability of its insurance subsidiaries to pay cash dividends
or make other cash payments to HMEC, including tax payments pursuant to tax
sharing agreements. Restrictions on the subsidiaries' ability to pay dividends
or to make other cash payments to HMEC may materially affect HMEC's ability to
pay principal and interest on its indebtedness and dividends on its common
stock.
The ability of the insurance subsidiaries to pay cash dividends to HMEC is
subject to state insurance department regulations which generally permit
dividends to be paid for any 12 month 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 1998 from all of HMEC's insurance subsidiaries
without prior regulatory approval is approximately $82 million.
Notwithstanding the foregoing, if insurance regulators otherwise determine
that payment of a dividend or any other payment to an affiliate would be
detrimental to an insurance subsidiary's policyholders or creditors, because of
the financial condition of the insurance subsidiary or otherwise, the regulators
may block dividends or other payments to affiliates that would otherwise be
permitted without prior approval.
The insurance subsidiaries' sources of funds consist primarily of premiums
and contract fees, investment income and proceeds from sales and redemption of
investments. Such funds are applied primarily to payment of claims, insurance
operating expenses, income taxes and the purchase of investments, as well as
dividends and other payments to HMEC.
COMPETITION
The Company operates in a highly competitive environment. There are numerous
insurance companies that compete with the Company, although management believes
that the Company is one of the few multi-line insurance companies to target the
nation's teachers as its primary market . In some specific instances and
geographic locations competitors have specifically targeted the teacher
marketplace with specialized products and programs. The Company competes in its
target market with a number of national providers of personal automobile and
homeowners insurance and life insurance.
For annuity business, the marketplace has begun to see a competitive impact
from new entrants such as mutual funds and banks into the tax deferred annuity
products market. Among the major national providers of annuities to educators,
Variable Annuity Life Insurance Company, a subsidiary of American General
Corporation, and Nationwide are among the Company's major tax-qualified annuity
competitors.
The Company competes with a number of national providers of automobile and
homeowners insurance, such as State Farm, Allstate and Nationwide, and several
regional companies. The Company also competes for automobile business with
certain direct marketing companies, such as 20th Century, American International
Group (AIG) and GEICO.
22
The insurance industry consists of a large number of insurance companies,
some of which have substantially greater financial resources, more diversified
product lines, and lower cost marketing approaches, such as direct marketing,
mail and telemarketing, compared to the Company. The Company believes that the
principal competitive factors in the sale of property and casualty insurance
products are price, service and name recognition. 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 and price.
INSURANCE FINANCIAL RATINGS
The Company believes that the ratings assigned to its principal insurance
subsidiaries by Standard & Poor's, A.M. Best and Duff & Phelps Credit Rating Co.
("Duff & Phelps") contribute to the Company's competitiveness.
Each of HMEC's principal insurance subsidiaries is rated "AA- (Excellent)"
for claims-paying ability by Standard & Poor's. S&P publications define
claims-paying ability ratings as follows. A Standard & Poor's insurance
claims-paying ability rating is an opinion of an operating insurance company's
financial capacity to meet the obligations of its insurance policies 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. Claims-paying ability ratings do not
refer to an insurer's ability to meet nonpolicy obligations (i.e., debt
contracts). The claims-paying ability ratings are based on current information
furnished by the insurance company or obtained by S&P from other sources it
considers reliable. S&P does not perform an audit in connection with any rating
and may, on occasion, rely on unaudited financial information. The ratings may
be changed, suspended, or withdrawn as a result of changes in, or unavailability
of, such information or based on other circumstances. Claims-paying ability
ratings are divided into two broad classifications. Rating categories from "AAA"
to "BBB" are classified as "secure" claims-paying ability ratings and are used
to indicate insurers whose financial capacity to meet policyholder obligations
is viewed, on balance, as sound. Among factors considered in placing insurers
within the spectrum of "secure" rating categories is the time frame within which
policyholder security could be damaged by adverse economic and underwriting
conditions. That time frame grows shorter as ratings move down the "secure"
rating scale. Rating categories from "BB" to "CC" are classified as "vulnerable"
claims-paying ability ratings and are used to indicate insurers whose financial
capacity to meet policyholder obligations is viewed as vulnerable to adverse
economic and underwriting conditions. Claims-paying ability ratings are assigned
at the request of the insurers and based on extensive quantitative and
qualitative analysis including consideration of ownership and support factors,
if applicable. The rating process includes meetings with insurers' management.
Plus (+) and minus (-) signs show relative standing within a category; they do
not suggest likely upgrades or downgrades. Insurers rated "AAA" offer superior
financial security on an absolute and relative basis. Capacity to meet
policyholder obligations is overwhelming under a variety of economic and
underwriting conditions. Insurers rated "AA" offer excellent financial security.
Capacity to meet policyholder obligations is strong under a variety of economic
and underwriting conditions.
HMIC, TIC and Allegiance are rated "A+ (Superior)" and HMLIC is rated "A
(Excellent)" by A.M. Best. Ratings for the industry range from "A++ (Superior)"
to "F (In Liquidation)", and some companies are not rated. Publications of A.M.
Best indicate that the "A++ and A+ (Superior)" ratings are assigned to those
companies that in A.M. Best's opinion have, on balance, superior financial
strengths, operating performance and market profile when compared to the
standards established by A.M. Best and have a very strong ability to meet their
ongoing obligations to policyholders. The "A and A- (Excellent)" ratings are
assigned to those companies that in A.M. Best's opinion have, on balance,
excellent financial strengths, operating performance and market profile when
compared to the standards established by A.M. Best and have a strong ability to
meet their ongoing obligations to policyholders. In evaluating a company's
financial strength, operating performance and market profile, A.M. Best reviews
the company's leverage/capitalization, capital structure/holding company,
quality and appropriateness of reinsurance program, adequacy of loss/policy
reserves, quality and diversification of assets, liquidity,
23
profitability, revenue composition, management experience and objectives, market
risk, competitive market position, spread of risk and event risk. A.M. Best's
ratings are based on factors relevant to policyholders, agents, insurance
brokers and intermediaries and are not directed to the protection of investors.
HMLIC is rated "AA" for claims paying ability by Duff & Phelps. Duff &
Phelps' life insurance company Claims Paying Ability ("CPA") ratings provide
analytical insight into the ability of a company to meet its current and future
policyholder obligations on a timely basis. According to Duff & Phelps
publications, the approach used to analyze an insurance company's claims paying
ability is prospective in nature. The long duration of liabilities of the
typical life insurance company requires a forward-looking analysis of the risks
the company faces. The analytical process stresses the current financial
position of the company, as well as an assessment of how future operations and
developments will either positively or negatively affect that position. A key
part of the overall CPA rating process is an annual meeting with the senior
executives who set the future direction of the company. Regular contact with
company representatives throughout the year supplements this process. The
process used to determine a CPA rating is comprehensive and combines
quantitative and qualitative analysis of both public and non-public information.
The CPA ratings use a scale of "AAA (Highest claims paying ability--the risk
factors are negligible)" through "DD (Company is under an order of
liquidation)." The CPA rating of "AA" is assigned for very high claims paying
ability. The protection factors are strong; risk is modest, but may vary
slightly over time due to economic and/or underwriting conditions. A CPA rating
only indicates an insurance company's ability to make timely payment of
policyholder obligations. It does not refer to the ability of either the rated
company or its affiliates to meet nonpolicyholder obligations, such as debt
repayment or payment of preferred dividends. The most important factors
considered in the qualitative analysis are: the company's competitive position
and the strength of the enterprise, the insurer's various risk exposures and its
defensive characteristics, the relationship of the rated entity to either
parent, affiliate, or subsidiary, and the strengths and capabilities of the
company's management.
REGULATION
GENERAL REGULATION AT STATE LEVEL
As an insurance holding company, HMEC is subject to regulation by the states
in which its insurance subsidiaries are domiciled or transact business. Most
states have enacted legislation that requires each insurance company in a
holding company system to register with the insurance regulatory authority of
its state of domicile and furnish to it financial and other information
concerning the operations of companies within the holding company system that
may materially affect the operations, management or financial condition of the
insurers within the system. All transactions within a holding company system
affecting insurers must be fair and equitable and the insurer's policyholder
surplus following any transaction must be both reasonable in relation to its
outstanding liabilities and adequate for its needs. Notice to applicable
regulators is required prior to the consummation of certain transactions
affecting insurance subsidiaries of the holding company system.
In addition, the laws of the various states establish regulatory agencies
with broad administrative powers to grant and revoke licenses to transact
business, regulate trade practices, license agents, require statutory financial
statements, and prescribe the type and amount of investments permitted. See
"Business--Investments" for discussion of investment restrictions or limitations
imposed upon the Company under applicable insurance laws and regulations.
The NAIC annually calculates financial ratios to assist state insurance
regulators in monitoring the financial condition of insurance companies. A
"usual range" of results for each ratio is used as a benchmark. Separate ratios
are established for property and casualty and life insurance companies.
Departure from the usual range in any of the ratios could lead to inquiries from
individual state regulators, and further investigation or other actions may
result. In 1996, no unusual ratios were reported by the principal insurance
subsidiaries of HMEC.
As part of their regulatory oversight process, state insurance departments
routinely conduct detailed financial examinations (generally not more frequently
than once every three years) of the books, records and accounts of insurance
companies domiciled in their states. Typically, such examinations are conducted
concurrently by two or three states under guidelines promulgated by the NAIC.
The last
24
financial examinations for the Company's principal insurance subsidiaries,
HMLIC, HMIC and TIC, occurred during 1993 for the period ended December 31,
1992. A financial examination of Allegiance was completed for the period ended
December 31, 1994. Routine examinations of HMLIC, HMIC and TIC for the five year
period ended December 31, 1997 and of AIC for the three year period ended
December 31, 1997 were initiated in January 1998. 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 insurance company insolvencies. The amount and
timing of any future assessments on the Company under these laws cannot be
reasonably estimated and are beyond the control of the Company. Most of these
laws do provide, however, that an assessment may be excused or deferred if it
would threaten an insurer's financial strength, and most assessments paid by the
Company pursuant to these laws may be used as credits for a portion of the
Company's premium taxes. The Company paid $0.6 million, $0.8 million and $0.9
million in connection with insurer insolvency proceedings for the years ended
December 31, 1997, 1996 and 1995, respectively, of which $0.6 million, $0.6
million and $0.9 million for the same periods, respectively, is recoverable as
premium tax credits in future periods.
MANDATORY INSURANCE FACILITIES
The Company is required to participate in various mandatory insurance
facilities in amounts related to the amount of the Company's direct writings in
the applicable state. In 1997, the Company reflected a net loss from
participation in such mandatory pools and underwriting associations of $0.8
million before federal income taxes.
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 will operate 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 will fund the
CEA and share in earthquake losses covered by the CEA in proportion to their
market share.
The Company has not joined the CEA. The Company's exposure to losses from
earthquakes is managed through its underwriting standards, its earthquake policy
coverage limits and deductible levels, and the geographic distribution of its
business, as well as its reinsurance program. After reviewing the exposure to
earthquake losses from its own policies and from participation in the CEA,
management believes it is in the Company's best economic interest to offer
earthquake coverage directly to its homeowners policyholders. See "Property and
Casualty--Property and Casualty Reinsurance."
REGULATION AT FEDERAL LEVEL
Although the federal government generally does not directly regulate the
insurance business, federal initiatives often impact the insurance business.
Current and proposed federal measures which may significantly affect the
insurance business include employee benefits regulation, controls on the costs
of medical care, medical entitlement programs such as Medicare, changes to the
insurance industry anti-trust exemption, minimum solvency requirements and
allowing national banks to engage in the insurance, annuity and mutual fund
businesses.
25
Federal income taxation of the build-up of cash value within a life
insurance policy or an annuity contract could have a material adverse impact on
the Company's ability to market and sell such products. Various legislation to
this effect has been proposed in the past, but has not been enacted. Although no
such legislative proposals are known to exist at this time, such proposals may
be made again in the future.
The variable annuities underwritten by HMLIC and the mutual funds used as
investment vehicles for those products are regulated by the Securities and
Exchange Commission (the "Commission"). Horace Mann Investors, Inc., the
broker-dealer subsidiary of HMEC, performs certain management functions for the
mutual funds and also is regulated by the Commission and the National
Association of Securities Dealers.
EMPLOYEES
At December 31, 1997, the Company had approximately 2,700 employees,
including 1,070 full-time agents. The Company has no collective bargaining
agreement with any employees.
ITEM 2. PROPERTIES
HMEC's home office property at 1 Horace Mann Plaza in Springfield, Illinois
consists of an office building totaling approximately 230,000 square feet. HMEC
also owns buildings with an aggregate of approximately 209,000 square feet at
other locations in Springfield. These properties are adequate and suitable for
the Company's current and anticipated future needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently party to any material pending legal proceedings
other than ordinary routine litigation incidental to its business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
26
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. All per share amounts have been restated to reflect the
Company's December 1997 two-for-one stock split.
MARKET PRICE
-------------------- DIVIDEND
FISCAL PERIOD HIGH LOW PAID
- ------------------------------------------------------------------------ --------- --------- ---------
1997:
Fourth Quarter...................................................... $ 29 23/32 $27 $ 0.08
Third Quarter....................................................... 28 5/8 24 9/16 0.0675
Second Quarter...................................................... 25 1/2 21 0.0675
First Quarter....................................................... 23 3/4 19 5/16 0.0675
1996:
Fourth Quarter...................................................... $ 20 3/8 $15 3/4 $ 0.055
Third Quarter....................................................... 17 15/16 14 9/16 0.055
Second Quarter...................................................... 16 3/4 14 0.055
First Quarter....................................................... 17 7/8 14 5/8 0.055
As of March 1, 1998, the approximate number of holders of common stock was
12,000.
In February 1997, the Board authorized the fifth consecutive annual increase
in the Company's dividend since the Company's initial public offering in 1991
and increased the quarterly dividend by 22.7% to $0.0675 per share. In December
1997, in conjunction with the Company's two-for-one stock split, the Board of
Directors authorized the sixth increase in the Company's dividend. The regular
quarterly dividend increased by 18.5% to $0.08 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 January 1998, the Company's Board of Directors authorized the repurchase
of shares of the Company's common stock up to $100 million. Based on the market
price of the Company's common stock at the time, $100 million represented
approximately 8% of the Company's then outstanding shares. During 1997, the
Company repurchased 3,720,600 shares, 8% of the Company's shares outstanding at
December 31, 1996, at an aggregate cost of $91.8 million under a $100 million
stock repurchase program announced in February 1997. 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, if needed, the existing bank line of credit.
During 1997, options were exercised for the issuance of 731,924 shares, 1.5%
of the Company's shares outstanding at December 31, 1996.
As an insurance holding company, HMEC depends on dividends and other
permitted payments from its insurance subsidiaries to pay cash dividends to
shareholders of HMEC. The payment of dividends and such other payments to HMEC
by its insurance subsidiaries is restricted by the laws of each subsidiary's
state of domicile, and insurance regulators have authority in certain
circumstances to block payments of dividends and other amounts by the insurance
subsidiaries that would otherwise be permitted without regulatory approval. See
"Business--Cash Flow" and "Business--Regulation."
ITEM 6. SELECTED FINANCIAL DATA
The information required by Item 301 of Regulation S-K is contained in the
table in Item 1-- "Business--Selected Historical Consolidated Financial Data."
27
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 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 1998 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 1998 Annual Meeting of
Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 403 of Regulation S-K is incorporated by
reference to the Company's Proxy Statement for the 1998 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 1998 Annual Meeting of
Shareholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) The following consolidated financial statements of the Company listed
below are contained in the Index to Financial Information on Page F-1 herein:
Consolidated Balance Sheets as of December 31, 1997, 1996 and 1995.
Consolidated Statements of Operations for the Years Ended December 31,
1997, 1996 and 1995.
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows for the Years Ended December 31,
1997, 1996 and 1995.
(a)(2) The following consolidated financial statement schedules of the Company
listed below are contained in the Index to Financial Information on page F-1
herein:
Schedule I--Summary of Investments--Other than Investments in Related
Parties.
Schedule II--Condensed Financial Information of Registrant.
28
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 on November 14,
1996.
3.2 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 Securities and Exchange
Commission on November 14, 1996.
3.3 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 Securities and Exchange
Commission on November 14, 1996.
3.4 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 Securities and Exchange
Commission on November 14, 1996.
3.5 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 Securities
and Exchange Commission on October 9, 1992.
3.6 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
Securities and Exchange Commission on December 6, 1995.
(4) Instruments defining the rights of security holders, including indentures:
4.1 Warrant Agreement dated as of August 29, 1989 (the "Warrant Agreement"),
between HMEC (as successor to HME Acquisition Corporation) and Bankers Trust
Company, as warrant agent (the "Warrant Agent"), with regard to Warrants to
Purchase Common Stock, incorporated by reference to Exhibit 4.6 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1989 (the
"September 1989 Form 10-Q").
4.2 Supplemental Warrant Agreement dated as of August 29, 1989 to the Warrant
Agreement, between HMEC and the Warrant Agent, incorporated by reference to
Exhibit 4.7 to the September 1989 Form 10-Q.
4.3 Form of Warrant (included in Exhibit 4.1).
29
EXHIBIT
NO. DESCRIPTION
- --------- ------------------------------------------------------------------------------
4.4 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 Securities and
Exchange Commission on March 13, 1996.
4.5 Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.4).
4.6 Certificate of Designations for HMEC Series A Cumulative Preferred Stock
(included in Exhibit 10.12).
(10) Material contracts:
10.1 Credit Agreement dated as of December 31, 1996 (the "Bank Credit Facility")
among HMEC, certain banks named therein and Bank of America National Trust and
Savings Association, as administrative agent (the "Agent"), incorporated by
reference to Exhibit 10.1 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1996, filed with the Securities and Exchange Commission on
March 26, 1997.
10.2* Stock Subscription Agreement among HMEC (as successor to HME Holdings, Inc.),
The Fulcrum III Limited Partnership, The Second Fulcrum III Limited
Partnership and each of the Management Investors, incorporated by reference to
Exhibit 10.17 to HMEC's Annual Report on Form 10-K for the year ended December
31, 1989, filed with the Securities and Exchange Commission 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
Securities and Exchange Commission on November 14, 1996.
10.4* Horace Mann Educators Corporation Deferred Compensation Plan for Employees.
10.5* Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.4 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1991, filed with the Securities and Exchange Commission on
March 27, 1992.
10.(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators
Corporation 1991 Stock Incentive Plan.
10.(b)* Specimen Director Stock Option Agreement under the Horace Mann Educators
Corporation 1991 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,
1991, filed with the Securities and Exchange Commission on March 27, 1992.
10.(c)* Amendment to Horace Mann Educators Corporation 1991 Stock Incentive Plan,
dated September 11, 1996, incorporated by reference to Exhibit 10.2(c) to
HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996,
filed with the Securities and Exchange Commission on November 14, 1996.
10.6* Severance Agreements between HMEC and certain officers of HMEC, incorporated
by reference to Exhibit 10.9 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1993, filed with the Securities and Exchange Commission on
March 31, 1994.
30
EXHIBIT
NO. DESCRIPTION
- --------- ------------------------------------------------------------------------------
10.7* Specimen Continuation of Employment Agreement between HMEC and certain
officers, incorporated by reference to Exhibit 10.21(a) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1994, filed with the
Securities and Exchange Commission on November 14, 1994.
10.7(a)* Schedule of Continuation of Employment Agreements between HMEC and certain
officers, incorporated by reference to Exhibit 10.21(b) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1994, filed with the
Securities and Exchange Commission on November 14, 1994.
10.8* Horace Mann Incentive Compensation Program, incorporated by reference to
Exhibit 10.7 to HMEC's Annual Report on Form 10-K for the year ended December
31, 1996, filed with the Securities and Exchange Commission on March 26, 1997.
10.9* Horace Mann Supplemental Employee Retirement Plan, 1997 Restatement,
incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997, filed with the Securities and
Exchange Commission on November 14, 1997.
10.10* Horace Mann Executive Supplemental Employee Retirement Plan, 1997 Restatement,
incorporated by reference to Exhibit 10.2 to HMEC's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997, filed with the Securities and
Exchange Commission on August 14, 1997.
10.11* Agreement entered by and between HMEC and Paul J. Kardos as of August 1, 1996,
incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form
10-Q for the quarter ended June 30, 1996, filed with the Securities and
Exchange Commission on August 13, 1996.
10.12 Catastrophe Equity Securities Issuance Option Agreement entered by and between
HMEC and Centre Reinsurance, dated February 15, 1997 and related letter from
Centre Reinsurance, incorporated by reference to Exhibit 10.12 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1996, filed with
the Securities and Exchange Commission on March 26, 1997.
(11) Statement re computation of per share earnings.
(12) Statement regarding computation of ratios.
(21) Subsidiaries of HMEC.
(23) Consent of KPMG Peat Marwick LLP.
(27) Financial Data Schedule.
(b) No Reports on Form 8-K were filed by HMEC during the fourth quarter of
1997.
(c) See list of exhibits in this Item 14.
(d) See list of financial statement schedules in this Item 14.
Copies of Exhibits may be obtained by writing to Investor Relations, Horace Mann
Educators Corporation, 1 Horace Mann Plaza, Springfield, Illinois 62715-0001.
Persons requesting copies will be charged a reasonable fee to cover reproduction
and mailing expenses.
31
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
By: /s/ Paul J. Kardos
------------------------------
Paul J. Kardos
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/ Paul J. Kardos /s/ Ralph S. Saul
- ---------------------------------------- ----------------------------------------
Paul J. Kardos Ralph S. Saul, Chairman of the Board of
President, Chief Executive Officer Directors
and a Director
Principal Financial Officer:
/s/ Larry K. Becker /s/ William W. Abbott
- ---------------------------------------- -----------------------------------------
Larry K. Becker William W. Abbott, Director
Executive Vice President and
Chief Financial Officer
Principal Accounting Officer:
/s/ Roger W. Fisher /s/ Dr. Emita B. Hill
- ---------------------------------------- -----------------------------------------
Roger W. Fisher Dr. Emita B. Hill, Director
Vice President and Controller
/s/ Donald E. Kiernan
----------------------------------------
Donald E. Kiernan, Director
/s/ Jeffrey L. Morby
---------------------------------------
Jeffrey L. Morby, Director
/s/ Shaun F. O'Malley
---------------------------------------
Shaun F. O'Malley, Director
/s/ Charles A. Parker
---------------------------------------
Charles A. Parker, Director
/s/ William J. Schoen
---------------------------------------
William J. Schoen, Director
Dated: March 30, 1998.
32
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-14
Independent Auditors' Report.............................................................................. F-15
Consolidated Balance Sheets............................................................................... F-16
Consolidated Statements of Operations..................................................................... F-17
Consolidated Statements of Changes in Shareholders' Equity................................................ F-18
Consolidated Statements of Cash Flows..................................................................... F-19
Notes to Consolidated Financial Statements................................................................ F-20
Financial Statement Schedules............................................................................. F-46
F-1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING INFORMATION
Statements made in the following discussion that state the Company's or
management's intentions, hopes, beliefs, expectations or predictions of the
future are forward-looking statements. It is important to note that the
Company's actual results could differ materially from those projected in such
forward-looking statements due to, among other risks and uncertainties inherent
in the Company's business, the following important factors:
- Changes in the composition of the Company's assets and liabilities through
acquisitions or divestitures.
- Prevailing interest rate levels, including the impact of interest rates on
(i) unrealized gains and losses on the Company's investment portfolio and
the related after-tax effect on the Company's shareholders' equity and
total capital and (ii) the book yield of the Company's investment
portfolio.
- The impact of fluctuations in the capital markets on the Company's ability
to refinance outstanding indebtedness or repurchase shares of the
Company's outstanding common stock.
- The frequency and severity of catastrophes such as hurricanes, earthquakes
and storms, and the ability of the Company to maintain a favorable
catastrophe reinsurance program.
- Future property and casualty loss experience and its impact on estimated
claims and claim adjustment expenses for losses occurring in prior years.
- The Company's ability to develop and expand its agency force and its
direct product distribution systems, as well as the Company's ability to
maintain and secure product sponsorships by local, state and national
education associations.
- The competitive impact of new entrants such as mutual funds and banks into
the tax deferred annuity products markets, and the Company's ability to
profitably expand its property and casualty business in highly competitive
environments.
- Changes in insurance regulations, including (i) those effecting 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 effecting corporate tax rates or taxable income, and regulations
changing the relative tax advantages of the Company's life and annuity
products to customers.
- The Company's ability to maintain favorable claims-paying ability ratings.
- Adverse changes in policyholder mortality and morbidity rates.
DISCONTINUED OPERATIONS
In December 1996, the Company announced its strategic decision to withdraw
from the group medical insurance business over the following two years. In
October 1997, the Company announced that it had accelerated its timetable for
withdrawal from this business. The Company stopped writing new group medical
insurance policies in January 1997, had terminated 95% of this business as of
December 31, 1997 and will terminate the remaining group medical insurance
policies in 1998. In the following discussions of results of operations, group
medical results are reported separately as discontinued operations for all
years.
F-2
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
INSURANCE PREMIUMS AND CONTRACT CHARGES EARNED
Insurance premiums and contract charges earned, which excludes annuity and
life contract deposits, increased 8.0% for the year ended December 31, 1997,
compared to 1996.
Insurance premiums written and contract deposits of $771.3 million for the
year ended December 31, 1997 increased 9.4%, compared to $704.8 million for
1996, driven principally by a 19.4% increase in annuity deposits and a 7.2%
growth in property and casualty premiums written. Insurance premiums written and
contract deposits in the Company's primary product lines, automobile (excluding
involuntary), property, annuity and life, increased 9.8% to $744.3 million for
the year ended December 31, 1997, compared to $677.7 million for 1996.
Involuntary automobile business includes allocations of business from state
mandatory automobile insurance facilities and assigned risk business.
Involuntary automobile premiums written for the year ended December 31, 1997
decreased 16.3% compared to 1996.
Automobile (excluding involuntary) and homeowners earned premiums increased
8.1% to $421.5 million for the year ended December 31, 1997, compared to $390.0
million for 1996, primarily as a result of a 6.5% increase in automobile
(excluding involuntary) and homeowners policies in force. The 837,000 automobile
(excluding involuntary) and homeowners policies in force at December 31, 1997
represented an increase of 51,000 policies since December 31, 1996.
Automobile (excluding involuntary) and homeowners premiums written increased
7.8% to $431.0 million for the year ended December 31, 1997, compared to $400.0
million for 1996. Premium rate increases which averaged approximately 2% in 1997
contributed a similar increase to the 1997 growth in premiums written. For the
year ended December 31, 1997, new direct premiums written of $49.9 million
increased 6.4% compared to $46.9 million for last year. Renewal direct premiums
written of $386.6 million for the year ended December 31, 1997 increased 8.3%
compared to $357.0 million for 1996.
Annuity contract charges earned increased 37.0% to $12.6 million for the
year ended December 31, 1997, compared to $9.2 million for 1996, due to a 40%
increase in variable annuity cash value on deposit. Total annuity deposits
received during the year ended December 31, 1997 increased 19.4% to $199.2
million, compared to $166.9 million for 1996, reflecting a $15.6 million, or
12.9%, increase in scheduled deposits for retirement annuities and a $16.7
million, or 36.5%, increase in rollover deposits from other companies and single
premiums. Three new variable annuity funds were added to the Horace Mann family
of funds in the first quarter of 1997 in response to educators' requests for
additional investment options. The addition of a small cap growth fund, an
international equity fund and a socially responsible fund brought the total
variable annuity fund options to seven.
For the year ended December 31, 1997, life insurance premiums and contract
charges earned were $82.9 million, compared to $80.3 million for 1996,
representing an increase of 3.2%. Life insurance in force on December 31, 1997
increased 5.1% compared to December 31, 1996. The lapse rate for life insurance
in force of 7.0% for the year ended December 31, 1997 improved 1.0 percentage
point compared to 8.0% reported for 1996. In the first quarter of 1997, the
Company began selling five new term life products developed to meet customer
needs. These products started to contribute to premium growth in the second
quarter of 1997 and have generated approximately $2.4 million of premium through
December 31, 1997.
NET INVESTMENT INCOME
Net investment income of $198.9 million for the year ended December 31, 1997
increased 0.2% compared to $198.6 million for 1996. The increase in net
investment income was small compared to growth in the Company's business due to
the utilization of capital for the share repurchase program and customers'
preference for variable versus fixed annuity contracts. Investments (at
amortized cost) decreased 2.6%, or $70.0 million, from December 31, 1996 due to
utilization of capital for the share repurchase program. The pretax yield on
average investments was 7.4% (4.9% after tax) for both of the years ended
December 31, 1997 and 1996.
F-3
REALIZED INVESTMENT GAINS AND LOSSES
Realized investment gains were $5.3 million for the year ended December 31,
1997, compared to $2.5 million for 1996.
BENEFITS, CLAIMS AND SETTLEMENT EXPENSES
Total benefits, claims and settlement expenses increased 3.7% to $359.4
million for the year ended December 31, 1997, compared to $346.7 million for
1996.
Property and casualty claims and settlement expenses were $320.8 million for
the year ended December 31, 1997, compared to $306.1 million for 1996. The
property and casualty loss ratio of 71.7% for the year ended December 31, 1997
was 2.4 percentage points less than the 74.1% reported for 1996. Losses from
severe weather in 1996 were higher than those incurred in 1997. Catastrophe
losses after reinsurance but before federal income tax benefits for the year
ended December 31, 1997 were $6.2 million and accounted for 1.4 points on the
loss ratio, compared to catastrophe losses of $20.9 million, 5.0 points on the
loss ratio, for 1996. The provision for claims and claim adjustment expenses for
insured events in prior years continued to reflect favorable development in both
1997 and 1996. Property and casualty claims and settlement expenses were reduced
by a decrease in estimated losses and loss adjustment expenses for claims
occurring in prior years of $45.1 million and $62.5 million for the years ended
December 31, 1997 and 1996, respectively, including $5.9 million and $15.1
million for the three months ended December 31, 1997 and 1996, respectively.
The Company's catastrophe reinsurance program covers 95% of catastrophe
losses above a retention of $7.5 million up to $80 million for each catastrophe
in 1998, $65 million in 1997. The Company's catastrophe reinsurance program is
augmented by a $100 million equity put that 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, individually or in
the aggregate during a calendar year, exceed the catastrophe reinsurance program
coverage limit. Before tax benefits, the equity put provides a source of capital
for up to $154 million of catastrophe losses above the reinsurance coverage
limit.
Life benefits were $38.6 million for the year ended December 31, 1997,
reflecting a 4.9% decrease, compared to $40.6 million for 1996. 1997 reflected
reduced individual life mortality experience compared to higher mortality in
1996. Also for the year ended December 31, 1996, claims for group disability
business were unusually low and returned to more normal levels in 1997.
INTEREST CREDITED TO POLICYHOLDERS
Interest credited to policyholders was $97.2 million for the year ended
December 31, 1997, 2.0% more than the $95.3 million interest credited for 1996.
Interest credited to fixed annuity contracts decreased $0.2 million, or 0.3%, to
$76.5 million for the year ended December 31, 1997, from $76.7 million for 1996.
The fixed annuity average annual interest rate credited was 5.6% for the year
ended December 31, 1997, compared to a rate of 5.7% for 1996. Fixed rate annuity
accumulated deposits decreased 2.6% over the 12 months ended December 31, 1997.
Life insurance interest credited increased $2.1 million, or 11.3%, to $20.7
million for the year ended December 31, 1997, compared to 1996, primarily as a
result of continued growth in the interest-sensitive whole life insurance
reserves and account balances.
POLICY ACQUISITION AND OPERATING EXPENSES
Policy acquisition and operating expenses represent the Company's insurance
underwriting expenses. For the year ended December 31, 1997, policy acquisition
and operating expenses of $150.6 million increased $12.4 million, or 9.0%,
compared to $138.2 million for 1996. The 1997 property and casualty expense
ratio of 19.4% was equal to 1996 and includes an increase in profitability
bonuses to agents based on the excellent property and casualty operating results
in 1997. This increase in agent
F-4
profitability bonuses contributed two-tenths of a percentage point to the 1997
property and casualty expense ratio.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets decreased by $0.5 million to $10.7 million
for the year ended December 31, 1997, compared to $11.2 million for 1996, as a
result of a scheduled decrease in the non-cash amortization of the value of
acquired insurance in force related to the 1989 acquisition of the Company.
INTEREST EXPENSE
The Company's interest expense of $9.4 million for the year ended December
31, 1997 was $1.1 million, or 10.5%, less than 1996 as a result of repayments of
borrowings in 1996 related to the repurchase of shares of its common stock
during the second quarter of 1995. The debt to capital ratio of 21.8% as of
December 31, 1997 was within the Company's target operating range of 20% to 25%.
INCOME TAX EXPENSE
The effective income tax rate was 27.2% for the year ended December 31, 1997
compared to the 26.6% effective income tax rate for 1996. Income from
investments in tax-advantaged securities reduced the effective income tax rate 3
percentage points in 1997 and 1996, and acquisition related tax benefits reduced
the effective rate 6 percentage points in 1997 and 1996.
OPERATING INCOME
Operating income (income from continuing operations before realized
investment gains and losses and 1996 debt retirement costs) was $83.6 million
for the year ended December 31, 1997, compared to $73.1 million for 1996, an
increase of 14.4%. Operating income in 1997 reflected favorable automobile
underwriting results, unusually mild weather which benefited property insurance
results and strong annuity results driven by business growth.
Included in the Company's operating income are non-cash charges for the
amortization of the value of acquired insurance in force and goodwill related to
the 1989 acquisition of the Company. Excluding these non-cash charges for the
amortization of intangible assets, operating income was $90.5 million for the
year ended December 31, 1997, compared to $80.4 million for 1996.
Property and casualty segment operating income was $61.4 million for the
year ended December 31, 1997, compared to $54.0 million for 1996. Favorable
automobile underwriting results and unusually mild weather which benefited
property insurance results in 1997 compared to last year contributed to these
results. For 1997, after tax catastrophe losses were $4.0 million, compared to
$13.6 million for 1996. The property and casualty combined loss and expense
ratio for the year ended December 31, 1997 was 91.1%, compared to the 93.5%
reported for 1996. Before catastrophe losses, the combined loss and expense
ratio was 89.7% for 1997, compared to 88.5% for the year ended December 31,
1996.
Annuity segment operating income of $19.3 million for the year ended
December 31, 1997 increased 18.4%, compared to the $16.3 million reported for
1996, reflecting 40.1% growth in variable annuity deposits and an increase of 12
basis points in the fixed net interest margin. Annuity segment profit continues
to shift from the interest margin on fixed annuity accumulations to fees on
variable mutual fund deposits. Variable annuity deposits of $1.0 billion at
December 31, 1997 were nearly double the amount on deposit at December 31, 1995.
Total accumulated fixed and variable annuity deposits of $2,314.2 million
increased $238.7 million, or 11.5%, compared to December 31, 1996. This increase
resulted from a net increase in variable funds on deposit of $247.3 million, or
40.1%, plus net increases in market value of underlying mutual funds of $27.7
million, and a decrease in fixed annuity funds on deposit of $36.3 million, or
2.6%.
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Life insurance segment operating income was $12.9 million for the year ended
December 31, 1997, compared to the $12.1 million reported for 1996. The 1997
life results reflect modest growth in business volume offset by a return to more
normal levels of both group disability claims and individual life mortality
experience, compared to lower-than-average disability claims and
higher-than-average life mortality in 1996.
INCOME FROM CONTINUING OPERATIONS
Income from continuing operations, which includes realized investment gains,
for the year ended December 31, 1997 was $87.1 million, or $1.87 per diluted
share, reflecting an 18.0% increase in income and a 20.6% increase in income per
diluted share compared to 1996. The Company's share repurchase program reduced
income by $2.3 million in 1997, while the program resulted in an increase of
$0.03 in 1997 earnings per share. The full impact on earnings per share will be
realized in 1998. After tax realized investment gains were $3.5 million for the
year ended December 31, 1997, compared to $1.6 million for 1996. Income from
continuing operations for the year ended December 31, 1996 also reflected the
costs of the early redemption of $100 million of convertible notes of $0.9
million, or $0.02 per diluted share.
The Company has implemented Statement of Financial Accounting Standards No.
128, "Earnings per Share," and restated all prior period earnings per share
data.
NET INCOME
Net income, which includes discontinued operations, was $83.6 million, or
$1.80 per diluted share, for the year ended December 31, 1997, compared to $64.6
million, or $1.36 per diluted share, for 1996, an increase of 32.4% on a per
share basis.
During 1997, the Company accelerated the timetable for its withdrawal from
the group medical insurance business and terminated 95% of that business by
December 1997. The remaining group medical business will be terminated in 1998.
As a result of this acceleration and higher-than-expected claims, net income for
the year ended December 31, 1997 includes an after tax charge of $3.5 million,
or $0.07 per diluted share, for anticipated additional losses during the
remainder of the phase-out period. The 1997 charge was recorded during the third
quarter.
The discontinued group medical business operating loss was $5.3 million for
the year ended December 31, 1996. The Company's net income for the year ended
December 31, 1996 also included an after tax charge of $3.9 million for
anticipated losses during the two year phase-out period for the discontinued
group medical insurance business.
YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995
INSURANCE PREMIUMS AND CONTRACT CHARGES EARNED
Insurance premiums and contract charges earned, which excludes annuity and
life contract deposits, increased 3.6% for the year ended December 31, 1996,
compared to 1995.
Insurance premiums written and contract deposits of $704.8 million for the
year ended December 31, 1996 increased 7.8%, compared to $654.0 million for
1995, driven principally by 16.8% growth in annuity deposits. The first annual
premium, of approximately $7 million, for Horace Mann's three year contract to
provide professional liability insurance for the 2.3 million members of the
National Education Association is included in the Company's total insurance
premiums written and contract deposits for the year ended December 31, 1996. No
such premium was written in 1995. Insurance premiums written and contract
deposits in the Company's primary product lines, automobile (excluding
involuntary), property, annuity and life, increased 7.6% to $677.7 million for
the year ended December 31, 1996, compared to $630.0 million for 1995.
Involuntary automobile premiums written for the year ended December 31, 1996
decreased 6.3% compared to 1995.
Automobile (excluding involuntary) and homeowners earned premiums increased
2.9% to $390.0 million for the year ended December 31, 1996, compared to $378.9
million for 1995, primarily as a result
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of a 5.8% increase in automobile (excluding involuntary) and homeowners policies
in force, partially offset by a 0.7% decrease in average premium earned per
automobile policy. The 786,000 automobile (excluding involuntary) and homeowners
policies in force at December 31, 1996 represented an increase of 43,000
policies compared to December 31, 1995.
Automobile (excluding involuntary) and homeowners premiums written increased
4.8% to $400.0 million for the year ended December 31, 1996, compared to $381.8
million for 1995. For the year ended December 31, 1996, new direct premiums
written of $46.9 million increased 26.4% compared to $37.1 million for 1995.
Renewal direct premiums written of $357.0 million for the year ended December
31, 1996 increased 2.2% compared to $349.3 million for 1995.
Annuity contract charges earned increased 35.3% to $9.2 million for the year
ended December 31, 1996, compared to $6.8 million for 1995, due to a 40%
increase in variable annuity cash value on deposit. Total annuity deposits
received during the year ended December 31, 1996 increased 16.8% to $166.9
million, compared to $142.9 million for 1995, reflecting a $7.1 million, or
6.2%, increase in scheduled deposits for retirement annuities and a $16.9
million, or 58.6%, increase in rollover deposits from other companies and single
premiums.
For the year ended December 31, 1996, life insurance premiums and contract
charges earned were $80.3 million, compared to $74.8 million for 1995,
representing an increase of 7.4%. Life insurance in force on December 31, 1996
increased 4.0% compared to a year earlier. The lapse rate for life insurance in
force of 8.0% for the year ended December 31, 1996 increased slightly compared
to 7.8% for 1995.
NET INVESTMENT INCOME
Net investment income of $198.6 million for the year ended December 31, 1996
was comparable to 1995. Investments (at amortized cost) increased 2.0%, or $52.4
million, from December 31, 1995. The pretax yield on average investments was
7.4% (4.9% after tax) for the year ended December 31, 1996 compared to a pretax
yield of 7.5% (5.0% after tax) for 1995.
REALIZED INVESTMENT GAINS AND LOSSES
Realized investment gains were $2.5 million for the year ended December 31,
1996, compared to $8.6 million for 1995.
BENEFITS, CLAIMS AND SETTLEMENT EXPENSES
Total benefits, claims and settlement expenses increased 3.3% to $346.7
million for the year ended December 31, 1996, compared to $335.7 million for
1995.
Property and casualty claims and settlement expenses were $306.1 million for
the year ended December 31, 1996, compared to $297.1 million for 1995. The
property and casualty loss ratio was 74.1% for the year ended December 31, 1996,
compared to 73.5% for 1995. For 1996, higher first quarter losses from severe
winter weather and third quarter losses from hurricanes were partially offset by
continued favorable trends in losses on voluntary automobile insurance for the
year. Property and casualty claims and settlement expenses were reduced by a
decrease in estimated losses and loss adjustment expenses for claims occurring
in prior years of $62.5 million and $55.6 million for the years ended December
31, 1996 and 1995, respectively. Catastrophe losses after reinsurance but before
federal income tax benefits for the year ended December 31, 1996 were $20.9
million, compared to catastrophe losses of $13.9 million for 1995. Hurricane
Fran, which occurred during the third quarter of 1996, represented $8.2 million
in losses.
Life benefits were $40.6 million for the year ended December 31, 1996,
reflecting a 5.2% increase, compared to $38.6 million for 1995. The increase in
life benefits was comparable to the 7.4% increase in life earned premiums with
higher than average mortality experience being more than offset by lower
dividends to life policyholders and reduced claims from group disability
business.
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INTEREST CREDITED TO POLICYHOLDERS
Interest credited to policyholders was $95.3 million for the year ended
December 31, 1996, 4.8% more than the $90.9 million interest credited for 1995.
Interest credited to fixed annuity contracts increased 3.0% to $76.7 million for
the year ended December 31, 1996, from $74.5 million for 1995. The increase
reflects a slightly higher average annual interest rate credited of 5.7% for the
year ended December 31, 1996, compared to 5.6% for 1995, and a growth of fixed
rate annuity accumulated deposits of 0.9%.
Life insurance interest credited increased $2.2 million, or 13.4%, to $18.6
million for the year ended December 31, 1996, compared to 1995, primarily as a
result of continued growth in the interest-sensitive whole life insurance
reserves and account balances.
POLICY ACQUISITION AND OPERATING EXPENSES
Policy acquisition and operating expenses represent the Company's insurance
underwriting expenses. For the year ended December 31, 1996, policy acquisition
and operating expenses of $138.2 million increased $0.6 million, or 0.4%,
compared to $137.6 million for 1995. The 1996 property and casualty expense
ratio improved to 19.4%, four-tenths of a percentage point lower than 19.8% for
1995.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets decreased by $0.5 million to $11.2 million
for the year ended December 31, 1996, compared to $11.7 million for 1995, as a
result of a scheduled decrease in the non-cash amortization of the value of
acquired insurance in force related to the 1989 acquisition of the Company.
INTEREST EXPENSE
The Company's interest expense of $10.5 million for the year ended December
31, 1996 was $1.1 million, or 9.5%, less than in 1995 as a result of repayments
of borrowings related to the repurchase of shares of its common stock during the
second quarter of 1995. The debt to capital ratio was reduced to 21.6% as of
December 31, 1996, within the Company's target operating range of 20% to 25%.
INCOME TAX EXPENSE
The 1996 effective income tax rate was 27%, equal to the 1995 effective
income tax rate. Income from investments in tax-advantaged securities reduced
the effective income tax rate 3 percentage points and acquisition related tax
benefits reduced the effective rate 6 percentage points in both 1996 and 1995.
The 1995 effective income tax rate also reflected the charge to income for
additional rights relating to the repurchase of shares of the Company's common
stock in 1995 that was not deductible for federal income tax purposes.
OPERATING INCOME
Operating income (income from continuing operations before realized
investment gains and losses, 1996 debt retirement costs and the 1995 cost of
additional rights related to the share repurchase) was $73.1 million for the
year ended December 31, 1996, compared to $70.9 million for 1995. Operating
income in 1996 reflected excellent voluntary automobile insurance results and an
increase in annuity segment earnings, partially offset by high first quarter
severe winter storm losses and high third quarter hurricane losses.
Included in the Company's operating income are non-cash charges for the
amortization of the value of acquired insurance in force and goodwill related to
the 1989 acquisition of the Company. Excluding these non-cash charges for the
amortization of intangible assets, operating income was $80.4 million for the
year ended December 31, 1996, compared to $78.5 million for 1995.
Property and casualty segment operating income was $54.0 million for the
year ended December 31, 1996, compared to $56.4 million for 1995. Higher first
quarter 1996 losses from severe
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winter weather and after tax catastrophe losses of $5.5 million from hurricanes
in the third quarter of 1996 were partially offset by continued favorable trends
in voluntary automobile losses. For the year, after tax catastrophe losses were
$13.6 million in 1996, compared to $9.0 million for 1995. The property and
casualty combined loss and expense ratio for the year ended December 31, 1996
was 93.5%, compared to the 93.3% reported for 1995. Before catastrophe losses,
the combined loss and expense ratio was 88.5% for 1996, compared to 89.9% for
the year ended December 31, 1995.
Annuity segment operating income of $16.3 million for the year ended
December 31, 1996 increased 10.1%, compared to 1995, resulting primarily from an
increase in cash value on deposit. Annuity segment profit has begun to shift
from the interest margin on fixed annuity accumulations to fees on variable
mutual fund deposits. During 1997, variable mutual fund deposits increased
40.5%, and fees collected on those deposits increased 35.3%, compared to the
year ended December 31, 1995. Total accumulated fixed and variable annuity cash
value on deposit of $2,075.5 million increased $209.5 million, or 11.2%,
compared to December 31, 1995. This increase resulted from a net increase in
funds on deposit of 10.0% plus net increases in market value of underlying
mutual funds of $26.7 million.
Life insurance segment operating income of $12.1 million for the year ended
December 31, 1996 increased 16.3% compared to the $10.4 million reported for
1995. The 1996 life results reflect growth in business volume and lower
dividends to life policyholders, more than offsetting higher mortality
experience, compared to 1995.
INCOME FROM CONTINUING OPERATIONS
Income from continuing operations, which includes realized investment gains,
for the year ended December 31, 1996 was $73.8 million, or $1.55 per diluted
share, reflecting a 1.9% decrease in income and a 9.9% increase in income per
share on a fully diluted basis compared to 1995. The share repurchase completed
in May 1995 and the redemption of the convertible notes in February 1996
resulted in decreases in shares and equivalent shares outstanding, increasing
income per share from continuing operations. Realized investment gains after tax
were $1.6 million for the year ended December 31, 1996, compared to $5.6 million
for 1995. Income from continuing operations for the year ended December 31, 1996
reflects a reduction of $0.9 million, or $0.02 per diluted share, for the costs
of the early redemption of $100 million of convertible notes. Income from
continuing operations for the year ended December 31, 1995 included a reduction
of $1.3 million, or $0.02 per diluted share, for the cost of the additional
rights granted in connection with the share repurchase.
NET INCOME
Net income, which includes discontinued operations, was $64.6 million, or
$1.36 per diluted share, for the year ended December 31, 1996 compared to $74.0
million, or $1.39 per diluted share, for 1995.
The discontinued group medical business operating loss was $5.3 million for
the year ended December 31, 1996, compared to an operating loss of $1.2 million
for 1995. The discontinued group medical combined loss and expense ratio
increased to 118.1% for the year ended December 31, 1996, compared to 106.4% for
1995, primarily due to an increase in claims. The Company's net income for the
fourth quarter and year ended December 31, 1996 also included an after tax
charge of $3.9 million for anticipated losses during the two year phase-out
period for the discontinued group medical insurance business.
LIQUIDITY AND FINANCIAL RESOURCES
INVESTMENTS
The Company's investment strategy emphasizes investment grade, publicly
traded fixed income securities. At December 31, 1997, fixed income securities
comprised 95.3% of total investments. Of the fixed income investment portfolio,
93.4% was investment grade and 99.6% was publicly traded. The average quality of
the total fixed income portfolio was A+ at December 31, 1997.
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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 4.3 years at December 31, 1997 and 4.4 years
at December 31, 1996. 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 75% of all outstanding fixed annuity accumulated cash values are
subject in most cases to substantial early withdrawal penalties.
CASH FLOW
The short-term liquidity requirements of the Company, within a 12-month
operating cycle, are for the timely payment of claims and benefits to
policyholders, operating expenses, interest payments and federal income taxes.
Cash flow in excess of these amounts has been used to fund business growth,
retire short-term debt, pay dividends to shareholders and repurchase shares of
the Company's common stock. Long-term liquidity requirements, beyond one year,
are principally for the payment of future insurance policy claims and benefits
and retirement of long-term notes.
OPERATING ACTIVITIES
As a holding company, HMEC conducts its principal operations in the personal
lines segment of the property and casualty and life insurance industries through
its subsidiaries. HMEC's insurance subsidiaries generate cash flow from premium
and investment income, generally well in excess of their immediate needs for
policy obligations, operating expenses and other cash requirements. Net cash
provided by operating activities was $104.4 million for the year ended December
31, 1997 compared to $139.2 million for 1996 with the decrease primarily due to
an increase in federal income tax payments. In both years, cash provided by
operating activities primarily reflected net cash generated by the insurance
subsidiaries.
Payment of principal and interest on debt, fees related to the
catastrophe-linked equity put option, dividends to shareholders and parent
company operating expenses, as well as the share repurchase program, are
dependent upon the ability of the insurance subsidiaries to pay cash dividends
or make other cash payments to HMEC, including tax payments pursuant to tax
sharing agreements. The insurance subsidiaries are subject to various regulatory
restrictions which limit the amount of annual dividends or other distributions,
including loans or cash advances, available to HMEC without prior approval of
the insurance regulatory authorities. Dividends which may be paid by the
insurance subsidiaries to HMEC during 1998 without prior approval are
approximately $82 million. In 1997, the Company received approval from the
Illinois and California Departments of Insurance for extraordinary dividends and
a total of $96 million in dividends was paid by the property and casualty
subsidiaries. HMEC used cash from the dividends primarily to repurchase shares
of the Company's common stock. Although regulatory restrictions exist, dividend
availability from subsidiaries has been, and is expected to be, more than
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 maturities portfolio as available for
sale. During 1997, net cash provided by investing activities was $66.1 million.
This net amount reflects $1,044.2 million in purchases of fixed maturity
investments, funded by net investment sales or maturities of $1,110.3 million.
FINANCING ACTIVITIES
Financing activities include primarily repurchases of the Company's common
stock, payment of scheduled dividends, the receipt and withdrawal of funds by
annuity policyholders and borrowings and
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repayments under the Company's debt facilities. Shareholder dividends paid for
the year ended December 31, 1997 were $13.0 million. In 1997, the Company paid
fees of $1.3 million related to the catastrophe-linked equity put which augments
its reinsurance program and such fees were charged directly to additional
paid-in capital.
For the year ended December 31, 1997, receipts from annuity contracts of
$199.2 million were greater than contract maturities and withdrawals of $176.1
million. Net transfers to variable annuity assets were $121.8 million during
1997 compared to $86.1 million during 1996. Interest-sensitive life account
balances increased $1.2 million during 1997.
Through December 31, 1997, the Company had repurchased 3,720,600 shares of
its common stock at an aggregate cost of $91.8 million, or $24.67 per share,
under a $100 million share repurchase program announced in February 1997. The
repurchase of these shares was financed primarily with cash from operations,
including dividends of $96 million from the property and casualty subsidiaries
which required prior regulatory approval. During the year ended December 31,
1997, the Company received $11.6 million related to the exercise of common stock
options including tax benefits.
In May 1995, the Company repurchased 13.0 million shares of its common stock
at an aggregate price of $174.9 million, financed by cash provided by operating
activities and $140.0 million borrowed under an existing bank line of credit.
Short-term borrowings under the bank line of credit were subsequently reduced to
$34 million and $75 million as of December 31, 1996 and 1995, respectively.
CAPITAL RESOURCES
Historically, the Company's insurance subsidiaries have generated capital in
excess of what has been needed to support business growth. These excess amounts
have been paid to HMEC through dividends. HMEC has then utilized these dividends
and its access to the capital markets to retire long-term debt, repurchase
shares of its common stock, increase dividends to its shareholders and fulfill
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. In January 1998, the
Company's Board of Directors adopted an additional repurchase program for shares
of the Company's common stock of up to $100 million.
The total capital of the Company was $648.2 million at December 31, 1997,
including $99.6 million of long-term debt and $42.0 million of short-term debt.
Long-term debt as a percentage of total shareholders' equity was 19.7% as of
December 31, 1997, compared to 20.6% as of December 31, 1996 with the change
including the effects of the repurchase of shares for treasury stock. Total debt
to capital at December 31, 1997 was 21.8%, well within the Company's target
operating range of 20% to 25%.
Shareholders' equity was $506.0 million at December 31, 1997, including an
unrealized gain in the Company's investment portfolio of $62.2 million after
taxes and the related impact on deferred policy acquisition costs associated
with interest-sensitive policies. In December 1997, the Company's common stock
was split two-for-one. The market value of the Company's common stock and the
market value per share were $1,258.8 million and $28 7/16, respectively, at
December 31, 1997. Book value per share was $11.43 at December 31, 1997, $10.03
excluding investment market value adjustments.
In January 1996, the Company issued $100.0 million face amount of 6 5/8%
Senior Notes ("Senior Notes"), which will mature on January 15, 2006, at a
discount of 0.5%. Interest on the Senior Notes is payable semi-annually. The
Senior Notes are redeemable in whole or in part, at any time at the Company's
option. The Senior Notes have an investment grade rating from Standard & Poor's
Corporation ("S&P") (A-), Duff & Phelps Credit Rating Co. ("Duff & Phelps") (A),
and Moody's Investors Service, Inc. ("Moody's") (Baa2) and are traded on the New
York Stock Exchange (HMN 6 5/8). The net proceeds from the sale of the Senior
Notes were used to finance the redemption of the Company's convertible notes.
As of December 31, 1997 and 1996, the Company had short-term debt comprised
of $42.0 million and $34.0 million, respectively, outstanding under the Bank
Credit Facility. The Bank Credit Facility allows unsecured borrowings of up to
$65.0 million at Interbank Offering Rates plus 0.3% to 0.5% or
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Bank of America National Trust and Savings Association reference rates. The rate
on the borrowings under the Bank Credit Facility was Interbank Offering Rate
plus 0.3%, or 6.2%, as of December 31, 1997. The commitment for the Bank Credit
Facility terminates on December 31, 2001.
The Company's ratio of earnings to fixed charges for the year ended December
31, 1997 was 13.7x compared to 10.6x for 1996.
Total shareholder dividends were $13.0 million for the year ended December
31, 1997. In February 1997, the Board authorized the fifth consecutive annual
increase in the Company's dividend since the Company's initial public offering
in 1991 and increased the quarterly dividend by 22.7% to $0.0675 per share. In
November 1997, in conjunction with the Company's two-for-one stock split, the
Board of Directors authorized the sixth increase to the Company's quarterly
dividend, the second increase in 1997. The regular quarterly dividend increased
by 19% to $0.08 per share on the post-split shares.
In January 1998, the Company's Board of Directors adopted an additional
repurchase program for shares of the Company's common stock of up to $100
million. Based on the market price of the Company's common shares at the time
the Board adopted this program, $100 million would represent approximately 8% of
the Company's outstanding shares. Shares of common stock may be purchased from
time to time through open market and private purchases, as available. The
repurchase program will be financed through use of cash and, if needed, the Bank
Credit Facility. At December 31, 1997, HMEC (the holding company) had cash and
invested assets of $19.3 million available for the share repurchase program.
During 1997, options were exercised for the issuance of 731,924 shares, 1.5%
of the Company's shares outstanding at December 31, 1996.
Beginning in 1997, the Company's catastrophe reinsurance program is
augmented by a $100 million equity put. This equity put provides for 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,
individually or in the aggregate during a calendar year, exceed $80 million, the
1998 coverage limit of the reinsurance program.
YEAR 2000
In 1990, the Company established programming standards to address the year
2000 for new computer systems. By early 1995, the Company had developed a
comprehensive plan to address the issue and began converting its existing
computer systems to be year 2000 compliant. At December 31, 1997, over 60% of
all business applications, representing more than 40% of all of the Company's
program code, were year 2000 compliant. Management anticipates completing
conversion of the remaining internal business applications by the end of 1998.
Vendors that have not already completed conversion have indicated their plans to
become year 2000 compliant by the end of 1998. During 1999, additional testing
of all systems and final reviews of individual personal computer applications
will be completed.
Costs for this compliance project represent the allocation of existing
internal information technology resources to address year 2000 compliance and
are not expected to be incremental costs to the Company. The total cost of the
compliance project is estimated to be $6 million, before tax benefits, and is
being funded through operating cash flows. The Company is expensing all costs
associated with these system changes and through 1997 has expensed $3.3 million
before tax benefits.
RECENT ACCOUNTING CHANGES
COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," which will be implemented in the Company's March 31, 1998
financial statements. SFAS No. 130 establishes
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standards for reporting and display of comprehensive income and its components
in a full set of general purpose financial statements. Comprehensive income will
represent the change in shareholders' equity during a reporting period from
transactions and other events and circumstances from non-owner sources. For the
Company, it is anticipated that comprehensive income will be substantially equal
to net income plus the change in net unrealized gains and losses on fixed
maturities and equity securities for the period as shown in the Statement of
Changes in Shareholders' Equity.
SEGMENT DISCLOSURES
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which will be implemented in the
Company's March 31, 1998 financial statements. SFAS No. 131 establishes
standards for the way public companies are to report information about operating
segments in annual financial statements and requires those companies to report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas, and major customers. The Company
anticipates that implementation of this pronouncement will not have a material
effect on the disclosures contained in its annual financial statements and
related notes but will expand its interim financial statements and related notes
to include segment information such as revenues, earnings, assets and a
reconciliation of segment earnings to consolidated earnings. The Company's
operations will continue to include the following segments consistent with
previously reported financial information: property and casualty insurance,
annuities, life insurance, and corporate and other.
EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which will be implemented in
the Company's December 31, 1998 financial statements. SFAS No. 132 will not
affect employee benefits expense or net income. SFAS No. 132 standardizes the
disclosure requirements for pensions and other postretirement benefits to the
extent practicable, requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate financial
analysis, and eliminates certain disclosures that are no longer as useful as
they were when SFAS No. 87, 88 and 106 were issued.
EFFECTS OF INFLATION AND CHANGES IN INTEREST RATES
The Company's operating results are affected significantly in at least three
ways by changes in interest rates and inflation. First, inflation directly
affects property and casualty claims costs. Second, the investment income earned
on the Company's investment portfolio and the market value of the investment
portfolio are related to the yields available in the fixed-income markets. An
increase in interest rates will decrease the market value of the investment
portfolio, but will increase investment income as investments mature and
proceeds are reinvested at higher rates. Third, as interest rates increase,
competitors will typically increase crediting rates on annuity and
interest-sensitive life products, and may lower premium rates on property and
casualty lines to reflect the higher yields available in the market. The risk of
interest rate fluctuation is managed through asset/liability management
techniques, including cash flow analysis.
EFFECTS OF RECESSION
The Company markets its products primarily to educators and other employees
of public schools and their families located throughout the United States.
Although this market is affected by school budgetary constraints, as well as
general economic downturns that result in decreased purchases of new automobiles
and homes and reductions in individual savings, management believes that this
market historically has continued to purchase insurance even in periods of
recession. Historically, despite changing economic conditions, sales of
insurance products to the Company's market have remained stable or increased,
suggesting continuation of this historical trend.
F-13
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, 1997, 1996 and 1995, and the related
consolidated statements of operations, cash flows and shareholders' equity for
the years ended December 31, 1997, 1996 and 1995 have been prepared by
management, which is responsible for their integrity and objectivity. The
statements have been prepared in accordance with generally accepted accounting
principles and include some amounts that are based upon management's best
estimates and judgements. The financial information contained elsewhere in this
annual report on Form 10-K is consistent with that contained in the financial
statements.
Management is responsible for establishing and maintaining a system of
internal control designed to provide reasonable assurance as to the integrity
and reliability of financial reporting. The concept of reasonable assurance is
based on the recognition that there are inherent limitations in all systems of
internal control, and that the cost of such systems should not exceed the
benefits derived therefrom. A professional staff of internal auditors reviews on
an ongoing basis the related internal control system design, the accounting
policies and procedures supporting this system and compliance therewith.
Management believes this system of internal control effectively meets its
objective of reliable financial reporting.
In connection with their annual audits, independent certified public
accountants perform an examination, in accordance with generally accepted
auditing standards, which includes the consideration of the system of internal
control to the extent necessary to form an independent opinion on the fairness
of presentation of the financial statements prepared by management.
The Board of Directors, through its Audit Committee composed solely of
directors who are not employees of the Company, is responsible for overseeing
the integrity and reliability of the Company's accounting and financial
reporting practices and the effectiveness of its system of internal controls.
The independent certified public accountants and internal auditors meet
regularly with, and have access to, this committee, with and without management
present, to discuss the results of their audit work.
F-14
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, 1997,
1996 and 1995, 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, 1997. 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 generally accepted auditing
standards. 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, 1997, 1996 and 1995,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 1997, in conformity with generally
accepted accounting principles. 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.
[SIG]
KPMG PEAT MARWICK LLP
Chicago, Illinois
January 26, 1998
F-15
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
1997 1996 1995
------------ ------------ ------------
ASSETS
Investments
Fixed maturities, available for sale, at market (amortized cost
1997, $2,535,538; 1996, $2,609,077; 1995, $2,527,032)........... $ 2,638,794 $ 2,658,512 $ 2,643,060
Short-term and other investments.................................. 130,252 125,824 155,489
------------ ------------ ------------
Total investments............................................. 2,769,046 2,784,336 2,798,549
Cash.................................................................. 353 13,704 9,518
Accrued investment income and premiums receivable..................... 103,951 107,682 94,359
Value of acquired insurance in force and goodwill..................... 107,976 118,638 129,843
Deferred policy acquisition costs..................................... 85,883 75,071 66,866
Other assets.......................................................... 104,943 76,759 75,576
Variable annuity assets............................................... 959,760 684,836 487,543
------------ ------------ ------------
Total assets.................................................. $ 4,131,912 $ 3,861,026 $ 3,662,254
------------ ------------ ------------
------------ ------------ ------------
LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY
Policy liabilities
Fixed annuity contract liabilities................................ $ 1,245,459 $ 1,286,110 $ 1,275,117
Interest-sensitive life contract liabilities...................... 364,205 326,955 289,310
Unpaid claims and claim expenses.................................. 322,335 357,646 384,657
Future policy benefits............................................ 179,562 183,543 185,856
Unearned premiums................................................. 166,996 155,776 141,105
------------ ------------ ------------
Total policy liabilities...................................... 2,278,557 2,310,030 2,276,045
Other policyholder funds.............................................. 122,107 118,549 119,070
Other liabilities..................................................... 126,847 129,075 133,855
Short-term debt....................................................... 42,000 34,000 75,000
Long-term debt........................................................ 99,599 99,564 100,000
Variable annuity liabilities.......................................... 956,253 684,836 487,543
------------ ------------ ------------
Total liabilities............................................. 3,625,363 3,376,054 3,191,513
------------ ------------ ------------
Warrants, subject to redemption....................................... 577 577 577
------------ ------------ ------------
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,
1997, 59,161,008; 1996, 58,426,796; 1995, 57,954,858................ 59 58 58
Additional paid-in capital............................................ 340,564 330,234 323,891
Net unrealized gains on fixed maturities and equity securities........ 62,167 29,736 76,151
Retained earnings..................................................... 349,274 278,669 224,366
Treasury stock, at cost, 1997,14,896,796 shares; 1996 and 1995,
11,176,196 shares................................................... (246,092) (154,302) (154,302)
------------ ------------ ------------
Total shareholders' equity.................................... 505,972 484,395 470,164
------------ ------------ ------------
Total liabilities, redeemable securities and shareholders'
equity...................................................... $ 4,131,912 $ 3,861,026 $ 3,662,254
------------ ------------ ------------
------------ ------------ ------------
See accompanying notes to consolidated financial statements.
F-16
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
Insurance premiums written and contract deposits...................... $ 771,319 $ 704,832 $ 653,970
------------ ------------ ------------
------------ ------------ ------------
Revenues
Insurance premiums and contract charges earned.................... $ 542,712 $ 502,699 $ 485,444
Net investment income............................................. 198,928 198,607 198,370
Realized investment gains......................................... 5,340 2,451 8,604
------------ ------------ ------------
Total revenues............................................ 746,980 703,757 692,418
------------ ------------ ------------
Benefits, losses and expenses
Benefits, claims and settlement expenses.......................... 359,441 346,691 335,705
Interest credited................................................. 97,231 95,322 90,911
Policy acquisition expenses amortized............................. 44,198 41,063 40,018
Operating expenses................................................ 106,398 97,021 97,609
Amortization of intangible assets................................. 10,662 11,205 11,666
Interest expense.................................................. 9,412 10,517 11,589
Debt retirement costs (See note 4)................................ - 1,319 -
Additional rights relating to share repurchase (See note 5)....... - - 1,347
------------ ------------ ------------
Total benefits, losses and expenses....................... 627,342 603,138 588,845
------------ ------------ ------------
Income from continuing operations before income taxes and discontinued
operations.......................................................... 119,638 100,619 103,573
Income tax expense.................................................... 32,581 26,817 28,463
------------ ------------ ------------
Income from continuing operations..................................... 87,057 73,802 75,110
Discontinued operations (See note 2):
Loss from operations, net of applicable income tax benefits of
1996, $2,764; 1995, $647........................................ - (5,280) (1,184)
Loss on discontinuation, representing provision of 1997, $5,355;
1996, $5,974 for operating losses during phase-out period, net
of applicable income tax benefits of 1997, $1,874; 1996,
$2,091.......................................................... (3,481) (3,883) -
------------ ------------ ------------
Net income............................................................ $ 83,576 $ 64,639 $ 73,926
------------ ------------ ------------
------------ ------------ ------------
Earnings (loss) per share
Basic
Income from continuing operations............................. $ 1.90 $ 1.57 $ 1.50
Discontinued operations:
Loss from operations...................................... - (0.11) (0.02)
Loss on discontinuation................................... (0.08) (0.08) -
------------ ------------ ------------
Net income.................................................... $ 1.82 $ 1.38 $ 1.48
------------ ------------ ------------
------------ ------------ ------------
Diluted
Income from continuing operations............................. $ 1.87 $ 1.55 $ 1.41
Discontinued operations:
Loss from operations...................................... - (0.11) (0.02)
Loss on discontinuation................................... (0.07) (0.08) -
------------ ------------ ------------
Net income.................................................... $ 1.80 $ 1.36 $ 1.39
------------ ------------ ------------
------------ ------------ ------------
Weighted average number of shares and equivalent shares
Basic............................................................. 45,825,410 46,957,842 50,077,060
Diluted........................................................... 46,524,532 47,577,788 56,263,210
See accompanying notes to consolidated financial statements.
F-17
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
Common stock
Beginning balance................................................... $ 58 $ 58 $ 58
Options exercised, 1997, 731,924 shares; 1996, 471,938 shares; 1995,
38,400 shares..................................................... 1 - -
Conversion of Director Stock Plan units, 1997, 2,288 shares......... - - -
------------ ------------ ------------
Ending balance...................................................... 59 58 58
------------ ------------ ------------
Additional paid-in capital
Beginning balance................................................... 330,234 323,891 323,488
Options exercised and conversion of Director Stock Plan units....... 11,580 6,343 403
Catastrophe-linked equity put option premium........................ (1,250) - -
------------ ------------ ------------
Ending balance...................................................... 340,564 330,234 323,891
------------ ------------ ------------
Net unrealized gains (losses) on fixed maturities and equity securities
Beginning balance................................................... 29,736 76,151 (70,861)
Increase (decrease) for the period.................................. 32,431 (46,415) 147,012
------------ ------------ ------------
Ending balance...................................................... 62,167 29,736 76,151
------------ ------------ ------------
Retained earnings
Beginning balance................................................... 278,669 224,366 159,278
Net income.......................................................... 83,576 64,639 73,926
Cash dividends, 1997, $0.2825 per share; 1996, $0.22 per share;
1995, $0.18 per share............................................. (12,971) (10,336) (8,838)
------------ ------------ ------------
Ending balance...................................................... 349,274 278,669 224,366
------------ ------------ ------------
Treasury stock, at cost
Beginning balance, 11,176,196 shares................................ (154,302) (154,302) -
Purchase of 3,720,600 shares in 1997 and 13,000,000 shares in 1995
(See note 5)...................................................... (91,790) - (174,870)
Issuance of 1,823,804 shares (See note 5)........................... - - 20,568
------------ ------------ ------------
Ending balance 1997, 14,896,796 shares; 1996 and 1995, 11,176,196
shares............................................................ (246,092) (154,302) (154,302)
------------ ------------ ------------
Shareholders' equity at end of period................................... $ 505,972 $ 484,395 $ 470,164
------------ ------------ ------------
------------ ------------ ------------
See accompanying notes to consolidated financial statements.
F-18
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1996 1995
-------------- ------------ ------------
Cash flows from operating activities
Premiums collected................................................ $ 608,650 $ 575,601 $ 550,596
Policyholder benefits paid........................................ (466,150) (453,687) (414,399)
Policy acquisition and other operating expenses paid.............. (173,462) (159,635) (155,336)
Federal income taxes paid......................................... (51,889) (10,651) (17,065)
Investment income collected....................................... 199,306 200,201 198,415
Interest expense paid............................................. (9,276) (8,653) (11,180)
Other............................................................. (2,743) (3,962) 2,313
-------------- ------------ ------------
Net cash provided by operating activities................. 104,436 139,214 153,344
-------------- ------------ ------------
Cash flows from investing activities
Fixed maturities
Purchases..................................................... (1,044,199) (989,009) (983,067)
Sales......................................................... 874,243 720,175 732,501
Maturities.................................................... 241,958 205,380 173,711
Net cash received from (used for) short-term and other
investments..................................................... (5,882) 30,728 41,341
-------------- ------------ ------------
Net cash provided by (used in) investing activities....... 66,120 (32,726) (35,514)
-------------- ------------ ------------
Cash flows from financing activites
Purchase of treasury stock........................................ (91,790) - (174,870)
Dividends paid to shareholders.................................... (12,971) (10,336) (8,838)
Principal borrowings (payments) on Bank Credit Facility........... 8,000 (41,000) 75,000
Exercise of stock options......................................... 11,581 6,343 403
Catastrophe-linked equity put option premium...................... (1,250) - -
Proceeds from issuance of Senior Notes............................ - 98,530 -
Retirement of Convertible Notes................................... - (102,890) -
Proceeds from issuance of common stock............................ - - 20,568
Annuity contracts, variable and fixed
Deposits...................................................... 199,190 166,871 142,885
Maturities and withdrawals.................................... (176,117) (135,212) (121,582)
Net transfer to variable annuity assets....................... (121,782) (86,097) (50,358)
Net increase in interest-sensitive life account balances.......... 1,232 1,489 2,483
-------------- ------------ ------------
Net cash used in financing activities..................... (183,907) (102,302) (114,309)
-------------- ------------ ------------
Net increase (decrease) in cash....................................... (13,351) 4,186 3,521
Cash at beginning of period........................................... 13,704 9,518 5,997
-------------- ------------ ------------
Cash at end of period................................................. $ 353 $ 13,704 $ 9,518
-------------- ------------ ------------
-------------- ------------ ------------
See accompanying notes to consolidated financial statements.
F-19
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements are prepared on the basis
of generally accepted accounting principles ("GAAP"). The preparation of
financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The consolidated financial statements include the accounts of Horace Mann
Educators Corporation and its wholly-owned subsidiaries ("HMEC"; and together
with its subsidiaries, the "Company"). All significant intercompany balances and
transactions have been eliminated in consolidation.
The subsidiaries of HMEC sell and underwrite tax-qualified retirement
annuities and private passenger automobile, homeowners, and life insurance
products, primarily to educators and other employees of public schools and their
families. In 1996, the Company discontinued its group medical business. The
Company's principal operating subsidiaries are Horace Mann Life Insurance
Company, Horace Mann Insurance Company, Teachers Insurance Company and
Allegiance Insurance Company.
INVESTMENTS
The Company invests primarily in fixed maturity investments. These
securities are classified as available for sale and carried at market value. The
net adjustment for unrealized gains and losses on securities available for sale,
carried at market, is recorded as a separate component of shareholders' equity,
net of applicable deferred tax asset or liability and the related impact on
deferred policy acquisition costs associated with interest-sensitive life and
annuity contracts.
Short-term and other investments are comprised of mortgage loans, carried at
unpaid principal less a valuation allowance for estimated uncollectible amounts;
policy loans, carried at unpaid principal balances; short-term fixed interest
securities, carried at cost which approximates market value; real estate
acquired in the settlement of debt, carried at the lower of cost or market; and
equity securities, carried at market.
Interest income is recognized as earned. Investment income reflects
amortization of premiums and accrual of discounts on an effective-yield basis.
Realized gains and losses arising from the sale of securities are determined
based upon specific identification of securities sold.
DEFERRED POLICY ACQUISITION COSTS
Deferred policy acquisition costs net of accumulated amortization were
$85,883, $75,071 and $66,866 as of December 31, 1997, 1996 and 1995,
respectively.
Acquisition costs, consisting of commissions, premium taxes and other costs,
which vary with and are primarily related to the production of insurance
business, are capitalized and amortized as follows. Capitalized acquisition
costs for interest-sensitive life contracts are amortized over 20 years in
proportion to estimated gross profits. For other individual life contracts,
acquisition costs are amortized in proportion to anticipated premiums over the
terms of the insurance policies (10 and 15 years). For
F-20
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
investment (annuity) contracts, acquisition costs are amortized in proportion to
estimated gross profits over 20 years. For property and casualty policies,
acquisition costs are amortized over the terms of the insurance policies (six
and twelve months).
Deferred policy acquisition costs for interest-sensitive life and investment
contracts are adjusted for the impact on estimated future gross profits as if
net unrealized investment gains and losses had been realized at the balance
sheet date. The impact of this adjustment is included in net unrealized gains
and losses within shareholders' equity.
Deferred acquisition costs are reviewed for recoverability from future
income, including investment income, and costs which are deemed unrecoverable
are expensed in the period in which the determination is made. No such costs
have been deemed unrecoverable during the periods reported.
When the Company was acquired in 1989, deferred acquisition costs were
reduced to zero in connection with establishing the value of acquired insurance
in force in the application of purchase accounting.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost less accumulated depreciation and
are included in other assets in the consolidated balance sheets. Depreciation
and amortization are calculated on the straight-line method based on the
estimated useful lives of the assets.
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Property and equipment............................................... $ 48,548 $ 44,562 $ 42,203
Less: accumulated depreciation....................................... 23,395 20,956 17,953
--------- --------- ---------
Total........................................................ $ 25,153 $ 23,606 $ 24,250
--------- --------- ---------
--------- --------- ---------
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 of $22,003 was recorded
in January 1994 related to the purchase of Allegiance Insurance Company.
F-21
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
The value of acquired insurance in force by operating segment and goodwill,
net of amortization, were as follows:
DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
Value of acquired insurance in force
Property and casualty........................................ $ 1,751 $ 2,783 $ 3,815
Life......................................................... 18,804 21,253 23,902
Annuity...................................................... 33,553 39,116 45,022
----------- ----------- -----------
Subtotal................................................. 54,108 63,152 72,739
Goodwill......................................................... 53,868 55,486 57,104
----------- ----------- -----------
Total.................................................... $ 107,976 $ 118,638 $ 129,843
----------- ----------- -----------
----------- ----------- -----------
The value of acquired insurance in force is being amortized over the
following periods utilizing the indicated methods for property and casualty,
life and annuity, respectively, as follows: 10 years, double declining balance;
20 years, in proportion to coverage provided; 20 years, in proportion to
projected future gross profits at the date of the acquisition of the Company.
Goodwill is amortized over 40 years on a straight-line basis.
The Company periodically reviews the value of acquired insurance in force
and goodwill. Any impairment is recognized in the period in which the
determination is made. There have been no adjustments to the carrying value of
the value of acquired insurance in force and goodwill.
Scheduled amortization of the December 31, 1997 balances of value of
acquired insurance in force by segment and goodwill over the next five years is
as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1998 1999 2000 2001 2002
--------- --------- --------- --------- ---------
Scheduled amortization of:
Value of acquired insurance in force
Property and casualty..................... $ 1,038 $ 713 $ - $ - $ -
Life...................................... 2,275 2,120 1,975 1,839 1,726
Annuity................................... 5,274 5,013 4,692 4,220 3,669
--------- --------- --------- --------- ---------
Subtotal.............................. 8,587 7,846 6,667 6,059 5,395
Goodwill...................................... 1,618 1,618 1,618 1,618 1,618
--------- --------- --------- --------- ---------
Total................................. $ 10,205 $ 9,464 $ 8,285 $ 7,677 $ 7,013
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
The accumulated amortization of intangibles as of December 31, 1997, 1996
and 1995 was $124,696, $114,034 and $102,829, respectively.
F-22
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
VARIABLE ANNUITY ASSETS AND LIABILITIES
Variable annuity assets, carried at market value, and liabilities represent
tax-qualified variable annuity funds invested in the Horace Mann mutual funds.
Variable annuity assets were invested in the Horace Mann mutual funds as
follows:
DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
Horace Mann Growth Fund.......................................... $ 532,086 $ 372,824 $ 248,320
Horace Mann Balanced Fund........................................ 386,247 299,977 227,705
Horace Mann Small Cap Growth Fund................................ 16,321 - -
Horace Mann Income Fund.......................................... 9,651 10,857 10,513
Horace Mann Socially Responsible Fund............................ 9,117 - -
Horace Mann International Equity Fund............................ 5,137 - -
Horace Mann Short-Term Fund...................................... 1,201 1,178 1,005
----------- ----------- -----------
Total variable annuity assets................................ $ 959,760 $ 684,836 $ 487,543
----------- ----------- -----------
----------- ----------- -----------
The investment income, gains and losses of these accounts accrue directly to
the policyholders and are not included in the operations of the Company.
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; are carried at the full
value of estimated liabilities; and are not discounted for interest expected to
be earned on reserves. Estimated amounts of salvage and subrogation on unpaid
property and casualty claims are deducted from the liability for unpaid claims.
The process by which liabilities are established for insured events requires
reliance upon estimates based on experience and available data. As information
develops which varies from experience, provides additional data or, in some
cases, augments data which previously were not considered
F-23
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
sufficient for use in determining liabilities, adjustments may be required. The
effects of these adjustments are charged or credited to income for the period in
which the adjustments are made. No unusual adjustments were made in the
determination of the liabilities during the periods covered by these financial
statements. The Company has no exposure to claims for toxic waste cleanup, other
environmental remediation or asbestos-related illnesses. Management believes
that, based on data currently available, it has reasonably estimated the
Company's ultimate losses.
The following table sets forth an analysis of property and casualty unpaid
claims and claim expenses and provides a reconciliation of beginning and ending
reserves for the periods indicated.
YEAR ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
Gross reserves, beginning of year................................ $ 340,411 $ 369,653 $ 389,097
Less reinsurance recoverables................................ 34,062 23,764 19,534
----------- ----------- -----------
Net reserves, beginning of year.................................. 306,349 345,889 369,563
----------- ----------- -----------
Incurred claims and claims expense:
Claims occurring in the current year......................... 365,986 368,648 352,513
Decrease in estimated reserves for claims occurring in prior
years(1):
Policies written by the Company.......................... (40,252) (56,446) (49,830)
Business assumed from state reinsurance facilities....... (4,900) (6,100) (5,800)
----------- ----------- -----------
Total decrease....................................... (45,152) (62,546) (55,630)
----------- ----------- -----------
Total claims and claims expense incurred................. 320,834 306,102 296,883
----------- ----------- -----------
Claims and claim expense payments for claims occurring during:
Current year................................................. 209,294 206,370 179,747
Prior years.................................................. 148,581 139,272 140,810
----------- ----------- -----------
Claims and claim expense payments........................ 357,875 345,642 320,557
----------- ----------- -----------
Net reserves, end of period...................................... 269,308 306,349 345,889
Plus reinsurance recoverables................................ 41,324 34,062 23,764
----------- ----------- -----------
Gross reserves, end of period(2)................................. $ 310,632 $ 340,411 $ 369,653
----------- ----------- -----------
----------- ----------- -----------
- ---------
(1) Shows the amounts by which the Company decreased its reserves in each of the
periods indicated for claims occurring in previous periods to reflect
subsequent information on such claims and changes in their projected final
settlement costs. Favorable reserve development generally occurs as a result
of subsequent adjustment of reserves to reflect additional information.
(2) Unpaid claims and claims expenses as reported in the consolidated balance
sheets also include life, annuity, and group accident and health reserves of
$11,703, $17,235 and $15,004 at December 31, 1997, 1996 and 1995,
respectively, in addition to property and casualty reserves.
F-24
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
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.
STOCK BASED COMPENSATION
The Company grants stock options to employees. The exercise price of the
option is equal to the fair market value of the Company's common stock on the
date of grant. The Company accounts for stock option grants in accordance with
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," and accordingly, recognizes no compensation expense for the stock
option grants.
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,
-------------------------------
1997 1996(1) 1995
--------- --------- ---------
Net income As reported.................... $ 83,576 $ 64,639 $ 73,926
Pro forma(2)................... $ 82,406 $ 64,639 $ 73,840
Basic net income per share As reported.................... $ 1.82 $ 1.38 $ 1.48
Pro forma...................... $ 1.80 $ 1.38 $ 1.47
Diluted net income per share As reported.................... $ 1.80 $ 1.36 $ 1.39
Pro forma...................... $ 1.77 $ 1.36 $ 1.38
- ---------
(1) No stock options were granted in 1996 (see also Note 5).
(2) The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions for
1997 and 1995, respectively: risk-free interest rates of 5.5% and 5.1%;
dividend yield of 1.0% for both years; expected lives of 10 years for both
years; and volatility of 15.8% and 15.9%.
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, 1997, 1996 and 1995 include amounts currently
F-25
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
payable and deferred income taxes resulting from the cumulative differences in
the Company's assets and liabilities, determined on a tax return and financial
statement basis.
Deferred tax assets and liabilities include provisions for unrealized
investment gains and losses with the change for each period included in net
unrealized gains and losses in shareholders' equity.
EARNINGS PER SHARE
The Company has implemented SFAS No. 128 "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 warrants, common stock options and Director Stock Plan
units, and, prior to their early retirement in February 1996, the convertible
notes described in Note 4 were considered potentially dilutive securities for
purposes of calculating diluted earnings per share.
The computations of income from continuing operations on both basic and
diluted bases, including reconciliations of the numerators and denominators, are
as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Basic--assumes no dilution:
Income from continuing operations for the period..................... $ 87,057 $ 73,802 $ 75,110
--------- --------- ---------
Weighted average number of common shares outstanding during the
period............................................................. 45,825 46,958 50,077
--------- --------- ---------
Income from continuing operations per share--basic................... $ 1.90 $ 1.57 $ 1.50
--------- --------- ---------
--------- --------- ---------
Diluted--assumes full dilution:
Income from continuing operations for the period..................... $ 87,057 $ 73,802 $ 75,110
Interest expense, net of tax, on convertible notes................. - - 4,016
--------- --------- ---------
Adjusted income from continuing operations for the period............ $ 87,057 $ 73,802 $ 79,126
--------- --------- ---------
Weighted average number of common shares outstanding during the
period............................................................. 45,825 46,958 50,077
Weighted average number of common equivalent shares to reflect the
dilutive effect of common stock equivalent securities:
Warrants......................................................... 251 236 220
Stock options.................................................... 416 378 252
Common stock units related to Deferred Equity Compensation Plan
for Directors.................................................. 33 6 -
Weighted average number of common equivalent shares to reflect the
dilutive effect of convertible notes............................... - - 5,714
--------- --------- ---------
Total common and common equivalent shares adjusted to calculate
diluted earnings per share......................................... 46,525 47,578 56,263
--------- --------- ---------
Income from continuing operations per share--diluted................. $ 1.87 $ 1.55 $ 1.41
--------- --------- ---------
--------- --------- ---------
F-26
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Options to purchase 20,000 shares of common stock at $27.46 per share were
outstanding during the last four months of 1997 but were not included in the
computation of diluted earnings per share because the options' exercise price
was greater than the average market price of the common shares. The options,
which expire on September 10, 2007, were still outstanding at December 31, 1997.
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 1997 presentation.
NOTE 2--DISCONTINUED OPERATIONS
In December 1996, the Company announced its strategic decision to withdraw
from the group medical insurance business over the following two years. During
the third quarter of 1997, the Company accelerated the timetable for its
withdrawal from the group medical insurance business and had terminated 95% of
that business by December 31, 1997. The remaining business will be terminated in
1998. As a result of the acceleration and higher-than-expected claims, net
income for the year ended December 31, 1997 included a charge of $3,481 for
anticipated additional losses during the remainder of the phase-out period, net
of related income tax benefits of $1,874. The Company's results of operations
for the year ended December 31, 1996 included an accrual of $3,883 for
anticipated losses during the phase-out period net of related income tax
recoverable of $2,091.
At December 31, 1997, the following were attributable to the discontinued
operations: $3,491 of investments, $1,393 of premiums receivable, $1,082 of
other assets, principally reinsurance recoverables, $4,063 of policy liabilities
and $1,903 of other liabilities, including the provision for operating losses
during the phase-out period.
NOTE 3--INVESTMENTS
NET INVESTMENT INCOME
The components of net investment income for the following periods were:
YEAR ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
Fixed maturities................................................. $ 191,777 $ 190,836 $ 183,845
Short-term and other investments................................. 10,967 11,931 18,101
----------- ----------- -----------
Total investment income...................................... 202,744 202,767 201,946
Less investment expenses......................................... 3,816 4,160 3,576
----------- ----------- -----------
Net investment income........................................ $ 198,928 $ 198,607 $ 198,370
----------- ----------- -----------
----------- ----------- -----------
F-27
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--INVESTMENTS--(CONTINUED)
REALIZED INVESTMENT GAINS (LOSSES)
Realized investment gains (losses) for the following periods were:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Fixed maturities.......................................................... $ 5,411 $ 1,052 $ 6,961
Short-term and other investments.......................................... (71) 1,399 1,643
--------- --------- ---------
Realized investment gains (losses).................................... $ 5,340 $ 2,451 $ 8,604
--------- --------- ---------
--------- --------- ---------
FIXED MATURITY SECURITIES
The amortized cost, unrealized investment gains and losses, and market
values of investments in debt securities as of December 31, 1997, 1996 and 1995
were as follows:
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
------------ ----------- ----------- ------------
AS OF DECEMBER 31, 1997
U.S. government and agency obligations
Mortgage-backed securities......................... $ 521,485 $ 18,061 $ 343 $ 539,203
Other.............................................. 222,797 5,249 44 228,002
Municipal bonds........................................ 228,094 13,777 106 241,765
Foreign government bonds............................... 26,397 1,714 442 27,669
Corporate bonds........................................ 1,243,948 62,333 3,376 1,302,905
Other mortgage-backed securities....................... 292,817 6,624 191 299,250
------------ ----------- ----------- ------------
Totals........................................... $ 2,535,538 $ 107,758 $ 4,502 $ 2,638,794
------------ ----------- ----------- ------------
------------ ----------- ----------- ------------
AS OF DECEMBER 31, 1996
U.S. government and agency obligations
Mortgage-backed securities......................... $ 644,197 $ 13,008 $ 3,217 $ 653,988
Other.............................................. 257,498 2,436 431 259,503
Municipal bonds........................................ 221,851 8,660 378 230,133
Foreign government bonds............................... 34,684 1,340 1 36,023
Corporate bonds........................................ 1,163,631 37,510 12,221 1,188,920
Other mortgage-backed securities....................... 287,216 4,600 1,871 289,945
------------ ----------- ----------- ------------
Totals........................................... $ 2,609,077 $ 67,554 $ 18,119 $ 2,658,512
------------ ----------- ----------- ------------
------------ ----------- ----------- ------------
AS OF DECEMBER 31, 1995
U.S. government and agency obligations
Mortgage-backed securities......................... $ 659,380 $ 23,205 $ 451 $ 682,134
Other.............................................. 260,314 11,355 181 271,488
Municipal bonds........................................ 218,776 9,766 240 228,302
Foreign government bonds............................... 39,065 3,334 - 42,399
Corporate bonds........................................ 1,105,760 68,946 6,930 1,167,776
Other mortgage-backed securities....................... 243,737 8,760 1,536 250,961
------------ ----------- ----------- ------------
Totals........................................... $ 2,527,032 $ 125,366 $ 9,338 $ 2,643,060
------------ ----------- ----------- ------------
------------ ----------- ----------- ------------
F-28
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--INVESTMENTS--(CONTINUED)
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 market value and amortized cost of fixed maturity securities at December
31, 1997, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
PERCENT OF
TOTAL MARKET MARKET AMORTIZED
VALUE VALUE COST
------------- ------------ ------------
Due in 1 year or less........................................ 5.6% $ 148,122 $ 147,500
Due after 1 year through 5 years............................. 24.2 639,868 625,745
Due after 5 years through 10 years........................... 34.8 918,555 882,726
Due after 10 years through 20 years.......................... 19.6 516,053 492,921
Due after 20 years........................................... 15.8 416,196 386,646
------ ------------ ------------
Total.............................................. 100.0% $ 2,638,794 $ 2,535,538
------ ------------ ------------
------ ------------ ------------
Proceeds from sales/maturities of fixed maturities and gross gains and gross
losses realized for each year were:
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
------------ ---------- ----------
Proceeds........................................................ $ 1,116,201 $ 925,555 $ 906,212
Gross gains realized............................................ 13,444 11,378 16,820
Gross losses realized........................................... (8,033) (10,326) (9,859)
UNREALIZED GAINS (LOSSES) ON FIXED MATURITIES
Net unrealized gains (losses) are computed as the difference between market
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,
-----------------------------------
1997 1996 1995
---------- ---------- -----------
Unrealized gains (losses) on fixed maturities
Beginning of period.......................................... $ 49,435 $ 116,028 $ (110,322)
End of period................................................ 103,256 49,435 116,028
---------- ---------- -----------
Increase (decrease) for the period....................... 53,821 (66,593) 226,350
Income taxes (benefit)........................................... 18,837 (23,308) 79,223
---------- ---------- -----------
Increase (decrease) in net unrealized gains (losses) on fixed
maturities before the valuation impact on deferred policy
acquisition costs.............................................. $ 34,984 $ (43,285) $ 147,127
---------- ---------- -----------
---------- ---------- -----------
F-29
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--INVESTMENTS--(CONTINUED)
SECURITIES LENDING
Beginning in 1997, the Company entered into a securities lending program
whereby fixed income securities are loaned to third parties, primarily major
brokerage firms. As of December 31, 1997, fixed maturities with a fair value of
$60,388 were loaned. The Company separately maintains a minimum of 100% of the
value of the loaned securities as collateral for each loan.
INVESTMENT IN ENTITIES EXCEEDING 10% OF SHAREHOLDERS' EQUITY
There were no investments which exceeded 10% of total shareholders' equity
in entities other than obligations of the United States Government and
government agencies and authorities at December 31, 1997 and 1995. At December
31, 1996, the Company's investment portfolio included $51,972 of fixed maturity
securities issued by Ford Motor Company and its affiliates representing 10.7% of
shareholders' equity at that date.
DEPOSITS
At December 31, 1997, securities with a carrying value of $13,111 were on
deposit with governmental agencies as required by law in various states in which
the insurance subsidiaries of HMEC conduct business.
NOTE 4--DEBT AND WARRANTS
Indebtedness and scheduled maturities at December 31, 1997, 1996 and 1995
consisted of the following:
EFFECTIVE DECEMBER 31,
INTEREST FINAL -------------------------------------
RATES MATURITY 1997 1996 1995
--------- ----------- ----------- ----------- -----------
Short-term debt:
Bank Credit Facility.................................... Variable 2001 $ 42,000 $ 34,000 $ 75,000
Long-term debt:
6 5/8% Senior Notes, Face amount less unaccrued discount
of $401 and $436, respectively........................ 6.7% 2006 99,599 99,564 -
4%/6 1/2% Convertible Notes, redeemed February 1996..... 5.7% 1999 - - 100,000
----------- ----------- -----------
Total............................................... $ 141,599 $ 133,564 $ 175,000
----------- ----------- -----------
----------- ----------- -----------
ISSUANCE OF 6 5/8% SENIOR NOTES ("SENIOR NOTES") AND REDEMPTION OF CONVERTIBLE
NOTES
On January 17, 1996, the Company issued $100,000 face amount of Senior Notes
at an effective yield of 6.7%, which will mature on January 15, 2006. The net
proceeds from the sale of the Senior Notes were used to finance the redemption
of the 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.
F-30
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 4--DEBT AND WARRANTS--(CONTINUED)
BANK CREDIT FACILITY
The Bank Credit Facility provides for unsecured borrowings of up to $65,000.
Interest accrues at varying spreads relative to corporate or eurodollar base
rates and is payable monthly or quarterly depending on the applicable base rate
(Interbank Offering Rate plus 0.325% at December 31, 1997). The unused portion
of the Bank Credit Facility is subject to a variable commitment fee which was
0.125% on an annual basis at December 31, 1997. The commitment for the Bank
Credit Facility terminates on December 31, 2001. The Company's obligations under
the Bank Credit Facility are unsecured.
4%/6 1/2% CONVERTIBLE NOTES ("CONVERTIBLE NOTES")
All of the outstanding Convertible Notes were redeemed on February 6, 1996
at an aggregate cost of $102,890. The early redemption of the Convertible Notes
resulted in a charge to 1996 income of $1,319 ($857 net of tax benefits).
WARRANTS
At December 31, 1997, 1996 and 1995, warrants to purchase 281,250 shares of
the Company's common stock at $2.70 per share were outstanding.
COVENANTS
The Company is in compliance with all of the covenants contained in the
Senior Notes indenture and the Bank Credit Facility Agreement.
NOTE 5--SHAREHOLDERS' EQUITY AND STOCK OPTIONS
COMMON STOCK
In December 1997, the Company's common stock was split two-for-one. All
share and per share amounts have been restated to reflect this stock split.
SHARE REPURCHASE PROGRAMS
During 1997, the Company repurchased 3,720,600 shares, 8% of the Company's
outstanding shares at December 31, 1996, at an aggregate cost of $91,790 under a
$100,000 stock repurchase program announced in February 1997. In January 1998,
the Company's Board of Directors authorized an additional repurchase of shares
of the Company's common stock up to $100,000. Based on the market price of the
Company's common shares at the time, $100,000 represented approximately 8% of
the Company's then outstanding shares. 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, if needed, the Bank
Credit Facility.
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
F-31
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 5--SHAREHOLDERS' EQUITY AND STOCK OPTIONS--(CONTINUED)
(iv) increase or decrease the number of shares of any series. No shares of
preferred stock were outstanding at December 31, 1997 and 1996.
Beginning in 1997, the Company's catastrophe reinsurance program is
augmented by a $100,000 equity put that 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, individually or in
the aggregate during a calendar year, exceed the catastrophe reinsurance program
coverage limit. Before tax benefits, the equity put provides a source of capital
for up to $154 million of catastrophe losses above the reinsurance coverage
limit. Fees related to this equity put option were charged directly to
additional paid-in capital.
In connection with the equity put described in the preceding paragraph, the
Board of Directors has designated a series of preferred stock to be available
for use in the put. The Series so designated is Series A Cumulative Convertible
Preferred Stock (the "Series A Stock") and 100,000 shares have been assigned to
this series. None are currently issued or outstanding. The Series A Stock is
dividend paying, at a floating rate which varies with movements in the London
Interbank Offered Rate and with changes in the risk rating of the Series A Stock
as determined by Standard & Poor's. 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. 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, including the effect of the 1997 two-for-one stock split, 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, 1997 and
1996, 32,685 units and 18,393 units, respectively, were outstanding under this
plan representing an equal number of common shares to be issued in the future.
1995 PURCHASE OF THE COMPANY'S COMMON STOCK
On May 3, 1995, the Company repurchased 13.0 million shares of common stock.
The shares were purchased at a price of $169,000, before a contingent payment
and expenses of the transaction. The Company borrowed $140,000 of the purchase
price under its existing Bank Credit Facility and the balance was paid from cash
on hand. In July 1995, the Company sold 1,823,804 shares in a secondary public
offering, the $20,568 net proceeds of which were used to reduce borrowings under
the Bank Credit Facility.
F-32
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 5--SHAREHOLDERS' EQUITY AND STOCK OPTIONS--(CONTINUED)
STOCK OPTIONS
In 1991, HMEC adopted and the shareholders approved the 1991 Stock Incentive
Plan (the "1991 Plan") and reserved 4 million shares, including the effect of
the 1997 two-for-one stock split, of common stock for issuance under the 1991
Plan. Under the 1991 Plan, options to purchase shares of HMEC common stock may
be granted to executive officers, other employees and certain directors. The
options are exercisable in installments beginning in the first year from the
date of grant and expiring 10 years from the date of grant.
Changes in outstanding options and shares available for grant 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, 1994............. $ 11.20 $ 9.00-$15.15 2,276,444 1,861,444 1,698,000
------------ ------------ -----------
Granted...................... $ 11.12 40,000 10,000 (40,000)
Vested....................... $ 11.69-$15.15 - 208,750 -
Exercised.................... $ 9.00 (38,400) (38,400) -
------------ ------------ -----------
At December 31, 1995............. $ 11.24 $ 9.00-$15.15 2,278,044 2,041,794 1,658,000
------------ ------------ -----------
Vested....................... $ 11.12-$15.15 - 211,250 -
Exercised.................... $ 11.04 $ 9.00-$15.15 (471,938) (471,938) -
------------ ------------ -----------
At December 31, 1996............. $ 11.29 $ 9.00-$15.15 1,806,106 1,781,106 1,658,000
------------ ------------ -----------
Granted...................... $ 22.87 $ 22.42-$27.46 224,400 56,100 (224,400)
Vested....................... $ 11.12-$12.03 - 15,000 -
Exercised.................... $ 12.28 $ 9.00-$22.42 (731,924) (731,924) -
------------ ------------ -----------
At December 31, 1997............. $ 12.73 $ 9.00-$27.46 1,298,582 1,120,282 1,433,600
------------ ------------ -----------
------------ ------------ -----------
As of December 31, 1997, the weighted average life of vested and exercisable
options was 5.1 years and the weighted average price of such options was $11.05
per option. The weighted average prices of vested and exercisable options as of
December 31, 1996 and 1995 were $11.29 and $10.86, respectively.
F-33
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 6--INCOME TAXES
The federal income tax liabilities and recoverables included in other
liabilities and other assets, respectively, in the consolidated balance sheets
as of December 31, 1997, 1996 and 1995 were as follows:
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Current liability (asset)............................................ $ (7,615) $ 27,995 $ 15,174
Deferred liability................................................... 35,530 7,193 32,870
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, 1997, 1996 and 1995 were as follows:
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Deferred tax assets
Discounting of unpaid claims and claims expense tax reserves..... $ 3,087 $ 8,066 $ 13,172
Life insurance future policy benefit reserve revaluation......... 19,282 22,436 16,198
Unearned premium reserve reduction............................... 11,248 10,528 9,521
Postretirement benefits other than pension....................... 8,406 8,003 7,715
Investment valuation reserves.................................... 813 907 924
--------- --------- ---------
Total gross deferred tax assets.............................. 42,836 49,940 47,530
--------- --------- ---------
Deferred tax liabilities
Unrealized gains on securities................................... 33,473 16,010 41,004
Amortization of intangible assets................................ 19,831 20,074 20,508
Deferred policy acquisition costs................................ 24,849 19,982 16,211
Other, net....................................................... 213 1,067 2,677
--------- --------- ---------
Total gross deferred tax liabilities......................... 78,366 57,133 80,400
--------- --------- ---------
Net deferred tax liability............................... $ 35,530 $ 7,193 $ 32,870
--------- --------- ---------
--------- --------- ---------
Based on the Company's historical earnings, future expectations of adjusted
taxable income, as well as reversing gross deferred tax liabilities, the Company
believes it is more likely than not that gross deferred tax assets will be fully
realized and that a valuation allowance with respect to the realization of the
total gross deferred tax assets is not necessary.
The components of federal income tax expense (benefit) were as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Current.............................................................. $ 21,707 $ 27,502 $ 12,982
Deferred............................................................. 10,874 (685) 15,481
--------- --------- ---------
Total tax expense before discontinued operations................. $ 32,581 $ 26,817 $ 28,463
--------- --------- ---------
--------- --------- ---------
F-34
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 6--INCOME TAXES--(CONTINUED)
Income tax expense for the following periods differed from the expected tax
computed by applying the federal corporate tax rate of 35% to income before
income taxes as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Expected federal tax on income from continuing operations............ $ 41,873 $ 35,217 $ 36,257
Add (deduct) tax effects of:
Tax-exempt interest.............................................. (3,310) (3,322) (3,293)
Goodwill......................................................... 566 566 566
Cost of additional rights relating to share repurchase........... - - 471
Acquisition related benefits and other, net...................... (6,548) (5,644) (5,538)
--------- --------- ---------
Income tax expense provided on income from continuing operations..... $ 32,581 $ 26,817 $ 28,463
--------- --------- ---------
--------- --------- ---------
NOTE 7--FAIR VALUE OF FINANCIAL INSTRUMENTS
Generally accepted accounting principles require that the Company disclose
estimated fair values for certain financial instruments. Fair values of the
Company's insurance contracts other than annuity contracts are not required to
be disclosed. However, the fair values of liabilities under all insurance
contracts are taken into consideration in the Company's overall management of
interest rate risk through the matching of investment maturities with amounts
due under insurance contracts. The following methods and assumptions were used
to estimate the fair value of financial instruments.
INVESTMENTS--For fixed maturities and short-term and other investments, fair
value equals quoted market price, if available. If a quoted market price is not
available, fair value is estimated using quoted market prices for similar
securities, adjusted for differences between the quoted securities and the
securities being valued. The fair value of 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 fair value of policy loans is based on estimates using
discounted cash flow analysis and current interest rates being offered for new
loans. The carrying value of real estate is an estimate of fair value based on
discounted cash flows from operations.
ANNUITY CONTRACT LIABILITIES AND POLICYHOLDER ACCOUNT BALANCES ON
INTEREST-SENSITIVE LIFE CONTRACTS-- The fair values of annuity contract
liabilities and policyholder account balances on interest-sensitive life
contracts are equal to the discounted estimated future cash flows (using the
Company's current interest rates earned on its investments) including an
adjustment for risk that the timing or amount of cash flows will vary from
management's estimate.
OTHER POLICYHOLDER FUNDS--Other policyholder funds are supplementary
contract reserves and dividend accumulations which represent deposits that do
not have defined maturities. The carrying value of these funds is used as a
reasonable estimate of fair value.
LONG-TERM DEBT--The fair value of long-term debt is estimated based on
quoted market prices of publicly traded issues.
F-35
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 7--FAIR VALUE OF FINANCIAL INSTRUMENTS--(CONTINUED)
The carrying amounts and fair values of financial instruments at December
31, 1997, 1996 and 1995 consisted of the following:
DECEMBER 31,
----------------------------------------------------------------------
1997 1996 1995
---------------------- ---------------------- ----------------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE
---------- ---------- ---------- ---------- ---------- ----------
Financial Assets
Investments
Fixed maturities............... $2,638,794 $2,638,794 $2,658,512 $2,658,512 $2,643,060 $2,643,060
Short-term and other
investments.................. 130,252 130,629 125,824 124,571 155,489 155,646
---------- ---------- ---------- ---------- ---------- ----------
Total investments........ 2,769,046 2,769,423 2,784,336 2,783,083 2,798,549 2,798,706
Cash............................. 353 353 13,704 13,704 9,518 9,518
Financial Liabilities
Policyholder account balances on
interest-sensitive life
contracts...................... 91,322 84,034 89,987 83,712 88,141 83,362
Annuity contract liabilities..... 1,245,459 1,112,479 1,286,110 1,136,494 1,275,117 1,132,742
Other policyholder funds......... 122,107 122,107 118,549 118,549 119,070 119,070
Short-term debt.................. 42,000 42,000 34,000 34,000 75,000 75,000
Long-term debt................... 99,599 99,580 99,564 96,500 100,000 102,890
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.
NOTE 8--STATUTORY SURPLUS AND SUBSIDIARY DIVIDEND RESTRICTIONS
The insurance departments of various states in which the insurance
subsidiaries of HMEC are domiciled recognize as net income and surplus those
amounts determined in conformity with statutory accounting practices prescribed
or permitted by the insurance departments, which differ in certain respects from
generally accepted accounting principles.
F-36
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 8--STATUTORY SURPLUS AND SUBSIDIARY DIVIDEND RESTRICTIONS--(CONTINUED)
Reconciliations of statutory capital and surplus and net income, as
determined using statutory accounting practices, to the amounts included in the
accompanying financial statements are as follows:
DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
Statutory capital and surplus of insurance subsidiaries....... $ 355,357 $ 377,337 $ 361,775
Increase (decrease) due to:
Deferred policy acquisition costs......................... 85,883 75,071 66,866
Difference in policyholder reserves....................... 334 (4,054) 12,180
Goodwill.................................................. 53,868 55,486 57,104
Value of acquired insurance in force...................... 54,108 63,152 72,739
Liability for postretirement benefits, other than
pensions................................................ (24,574) (22,877) (22,043)
Investment market value adjustments on fixed maturities... 103,256 49,435 116,028
Difference in investment reserves......................... 27,994 36,967 37,440
Federal income tax liability.............................. (24,839) (3,599) (51,242)
Liability for discontinued operations, net of tax
benefits................................................ (2,031) (3,883) -
Non-admitted assets and other, net........................ 3,301 4,070 6,379
Shareholders' equity of parent company and non-insurance
subsidiaries............................................ 14,914 (9,146) (12,062)
Parent company short-term and long-term debt.............. (141,599) (133,564) (175,000)
------------ ------------ ------------
Shareholders' equity as reported herein............... $ 505,972 $ 484,395 $ 470,164
------------ ------------ ------------
------------ ------------ ------------
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
Statutory net income of insurance subsidiaries................ $ 82,771 $ 72,924 $ 90,981
Net loss of non-insurance companies........................... (1,307) (2,417) (2,473)
Interest expense.............................................. (9,412) (10,517) (11,589)
Tax benefit of interest expense and other parent company
current tax adjustments..................................... 7,565 5,372 3,598
------------ ------------ ------------
Combined net income........................................... 79,617 65,362 80,517
Increase (decrease) due to:
Deferred policy acquisition costs......................... 15,952 11,973 7,771
Policyholder benefits..................................... 2,527 826 2,080
Federal income tax expense (benefit)...................... (6,888) 2,137 (9,131)
Amortization of intangible assets......................... (10,662) (11,205) (11,666)
Investment reserves....................................... 1,316 366 6,191
Loss on group medical business, net of tax benefits....... 1,849 (3,883) -
Other adjustments, net.................................... (135) (937) (1,836)
------------ ------------ ------------
Net income as reported herein......................... $ 83,576 $ 64,639 $ 73,926
------------ ------------ ------------
------------ ------------ ------------
F-37
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 8--STATUTORY SURPLUS AND SUBSIDIARY DIVIDEND RESTRICTIONS--(CONTINUED)
The Company has principal insurance subsidiaries domiciled in Illinois and
California. The statutory financial statements of these subsidiaries are
prepared in accordance with accounting practices prescribed or permitted by the
Illinois Department of Insurance and the California Department of Insurance as
applicable. Prescribed statutory accounting practices include a variety of
publications of the National Association of Insurance Commissioners ("NAIC"), as
well as state laws, regulations and general administrative rules. Permitted
statutory accounting practices encompass all accounting practices not so
prescribed.
The insurance subsidiaries are subject to various regulatory restrictions
which limit the amount of annual dividends or other distributions, including
loans or cash advances, available to HMEC without prior approval of the
insurance regulatory authorities. The maximum dividend which may be paid by the
insurance subsidiaries to HMEC during 1998 without prior approval is
approximately $82 million.
The NAIC has adopted risk-based capital guidelines that establish minimum
adequate levels of statutory capital and surplus based on risk assumed in
investments, reserving policies, and volume and types of insurance business
written. State insurance regulations prohibit insurance companies from making
any public statements or representations with regard to their risk-based capital
levels. Based on current guidelines, the risk-based capital statutory
requirements will have no negative regulatory impact on the Company's insurance
subsidiaries.
NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
All employees of the Company are covered under a defined benefit plan and a
defined contribution plan, and certain employees participate in supplemental
retirement plans.
Benefits under the defined benefit and supplemental retirement plans are
based on employees' years of service and compensation for the highest 36
consecutive months of earnings under the plan. Under the defined contribution
plan, contributions are made to employees' accounts based on a percentage of
compensation that is determined by the employees' years of service. Retirement
benefits to employees are paid first from their accumulated accounts under the
defined contribution plan with the balance funded by the defined benefit and
supplemental retirement plans.
The Company's policy with respect to funding the defined benefit plan is to
contribute amounts which are actuarially determined to provide the plan with
sufficient assets to meet future benefit payments consistent with the funding
requirements of federal laws and regulations.
Employees of the Company are also eligible to participate in the
Supplemental Retirement and Savings Plan, a 401(k) plan, and may generally
contribute up to 10% of eligible compensation on a before tax basis. The Company
contributes an amount equal to 50% of the first 6% of eligible compensation
contributed each month by participating employees.
Total pension expense was $8,885, $7,855 and $7,768 for the years ended
December 31, 1997, 1996 and 1995, respectively.
F-38
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED)
DEFINED CONTRIBUTION PLAN
Pension benefits under the defined contribution plan were fully funded and
investments were set aside in a trust fund. Contributions to employees' accounts
under the defined contribution plan, which were expensed in the Company's
statements of operations, and total plan assets were as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Contributions to employees accounts.................................. $ 5,645 $ 5,199 $ 4,859
Total assets at the end of the year.................................. 70,762 62,113 55,050
DEFINED BENEFIT PLAN AND SUPPLEMENTAL RETIREMENT PLANS
The following table summarizes the funding status of the defined benefit and
supplemental retirement pension plans at the end of each year and identifies the
assumptions used to determine the projected benefit obligation.
SUPPLEMENTAL
DEFINED BENEFIT PLAN RETIREMENT PLANS
------------------------------- -------------------------------
DECEMBER 31, DECEMBER 31,
------------------------------- -------------------------------
1997 1996 1995 1997 1996 1995
--------- --------- --------- --------- --------- ---------
Actuarial present value of benefit obligations
Vested benefit obligation......................... $ 34,784 $ 32,941 $ 32,808 $ 5,024 $ 4,351 $ 3,446
Nonvested benefit obligation...................... 2,861 2,916 2,692 324 496 275
--------- --------- --------- --------- --------- ---------
Accumulated benefit obligation........................ 37,645 35,857 35,500 5,348 4,847 3,721
Effect of projecting future salary increases on
past service.................................... 5,709 3,508 5,086 258 411 1,167
--------- --------- --------- --------- --------- ---------
Projected benefit obligation.......................... 43,354 39,365 40,586 5,606 5,258 4,888
Plan assets at market value........................... 46,097 42,262 41,137 - - -
--------- --------- --------- --------- --------- ---------
Plan assets in excess of (less than) projected benefit
obligation.......................................... $ 2,743 $ 2,897 $ 551 $ (5,606) $ (5,258) $ (4,888)
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Assumptions:
Discount rate..................................... 7.25% 7.50% 7.00% 7.25% 7.50% 7.00%
Expected return on assets......................... 8.75% 8.75% 8.75% 8.75% 8.75% 8.75%
Rate of salary increases.......................... 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%
The defined benefit plan is fully funded and investments have been set aside
in a trust fund. The supplemental retirement plans are non-qualified, unfunded
plans.
F-39
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED)
Components of net pension cost for the defined benefit plan and supplemental
retirement plans for the following periods are:
SUPPLEMENTAL
DEFINED BENEFIT PLAN RETIREMENT PLANS
------------------------------- -------------------------------
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
------------------------------- -------------------------------
1997 1996 1995 1997 1996 1995
--------- --------- --------- --------- --------- ---------
Service cost-benefits earned during the year........... $ 1,724 $ 1,686 $ 1,447 $ 298 $ 353 $ 274
Interest accrued on projected benefit obligation....... 2,938 2,779 2,715 328 320 324
Actual return on assets................................ (6,370) (3,688) (7,888) - - -
Net amortization and deferral.......................... 2,122 (449) 4,368 174 235 197
--------- --------- --------- --------- --------- ---------
Net periodic pension cost.......................... $ 414 $ 328 $ 642 $ 800 $ 908 $ 795
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
The pension liabilities of the defined benefit plan and supplemental
retirement plans were as follows:
SUPPLEMENTAL
DEFINED BENEFIT PLAN RETIREMENT PLANS
------------------------------- -------------------------------
DECEMBER 31, DECEMBER 31,
------------------------------- -------------------------------
1997 1996 1995 1997 1996 1995
--------- --------- --------- --------- --------- ---------
Plan assets in excess of (less than) projected benefit
obligation........................................... $ 2,743 $ 2,897 $ 551 $ (5,606) $ (5,258) $ (4,888)
Unrecognized prior service (asset) cost................ (5,035) (5,645) (6,255) 2,895 3,209 3,522
Unrecognized net (gain) loss from past experience
different from that assumed.......................... 488 1,358 4,642 (1,418) (1,342) (1,159)
--------- --------- --------- --------- --------- ---------
Pension liability included in the consolidated balance
sheets............................................... (1,804) (1,390) (1,062) (4,129) (3,391) (2,525)
Additional liability to recognize unfunded accumulated
benefit obligation................................... - - - (1,219) (1,474) (1,321)
--------- --------- --------- --------- --------- ---------
Pension liability...................................... $ (1,804) $ (1,390) $ (1,062) $ (5,348) $ (4,865) $ (3,846)
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
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. Employees with ten years of service are eligible to receive these
benefits upon retirement. Postretirement benefits other than pensions of active
and retired employees are accrued as expense over the employees' service years.
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,
F-40
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED)
1997, 1996 and 1995 reconciled with amounts recognized in the Company's
statement of financial position:
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Accumulated postretirement benefit obligation:
Retirees......................................................... $ 14,752 $ 12,830 $ 10,534
Fully eligible active plan participants.......................... 2,466 2,049 1,488
Other active plan participants................................... 12,366 10,274 11,028
--------- --------- ---------
Total unfunded accumulated postretirement benefit obligation......... 29,584 25,153 23,050
Unrecognized net gain (loss) from past experience different from that
assumed............................................................ (5,010) (2,276) (1,007)
--------- --------- ---------
Accrued postretirement benefit cost.............................. $ 24,574 $ 22,877 $ 22,043
--------- --------- ---------
--------- --------- ---------
Components of the cost of postretirement benefits other than pensions for
the following periods were:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Service cost-benefits earned during the year......................... $ 845 $ 801 $ 600
Interest accrued on accumulated benefit obligation................... 2,117 1,845 1,330
--------- --------- ---------
Net expense...................................................... $ 2,962 $ 2,646 $ 1,930
--------- --------- ---------
--------- --------- ---------
The assumed annual rates of increase in the per capita cost of covered
benefits for participants in the plan who retired prior to January 1, 1994 were
6.8%, 7.8% and 8.1% as of December 31, 1997, 1996 and 1995, respectively. For
those participants retiring after December 31, 1993, benefits are provided at a
level amount of $10.00 per month per year of employment. The weighted average
discount rate used in determining the accumulated postretirement benefit
obligation was 7.25%, 7.50% and 7.00% at December 31, 1997, 1996 and 1995,
respectively.
A one percentage point increase in the assumed health care cost trend rate
for each year would increase the accumulated postretirement benefit obligation
at December 31, 1997 by approximately $2,038 and the sum of the service and
interest cost components of the net periodic postretirement expense for the year
ended December 31, 1997 would increase by approximately $198.
NOTE 10--REINSURANCE
In the normal course of business, the insurance subsidiaries assume and cede
reinsurance with other insurers. Reinsurance is ceded primarily to limit losses
from large exposures and to permit recovery of a portion of direct losses;
however, such a transfer does not relieve the originating insurance company of
contingent liability.
The Company is a national underwriter and therefore has exposure to
catastrophic losses in certain coastal states and other regions throughout the
United States. Catastrophes can be caused by various events including
hurricanes, windstorms, earthquakes, hail, severe winter weather, and fires, and
the
F-41
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 10--REINSURANCE--(CONTINUED)
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, the purchase
of catastrophe reinsurance, and the purchase of a catastrophe-linked equity put
option (also see Note 5).
The total amounts of reinsurance recoverable on unpaid claims classified as
assets and reported in other assets in the balance sheets were as follows:
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Reinsurance Recoverables on Unpaid Claims
Life and health.................................................. $ 3,326 $ 2,863 $ 1,369
Property and casualty
State insurance facilities................................... 25,968 24,445 19,903
Other insurance companies.................................... 15,356 9,617 3,861
--------- --------- ---------
Total.................................................... $ 44,650 $ 36,925 $ 25,133
--------- --------- ---------
--------- --------- ---------
The Company recognizes the cost of reinsurance premiums over the contract
periods for such premiums in proportion to the insurance protection provided.
Amounts recoverable from reinsurers for unpaid claims and claim settlement
expenses, including estimated amounts for unsettled claims, claims incurred but
not reported and policy benefits are estimated in a manner consistent with the
insurance liability associated with the policy. The effect of reinsurance on
premiums written, premiums earned, and benefits, claims and settlement expenses
were as follows:
CEDED TO ASSUMED
GROSS OTHER FROM STATE
AMOUNT COMPANIES FACILITIES NET
----------- ----------- ----------- -----------
YEAR ENDED DECEMBER 31, 1997
Premiums written............................... $ 775,964 $ 23,535 $ 18,890 $ 771,319
Premiums earned................................ 542,605 22,572 22,679 542,712
Benefits, claims and settlement expenses....... 371,220 34,365 22,586 359,441
YEAR ENDED DECEMBER 31, 1996
Premiums written............................... 699,701 23,214 28,345 704,832
Premiums earned................................ 497,705 23,887 28,881 502,699
Benefits, claims and settlement expenses....... 347,352 32,159 31,498 346,691
YEAR ENDED DECEMBER 31, 1995
Premiums written............................... 647,390 22,656 29,236 653,970
Premiums earned................................ 481,192 20,499 24,751 485,444
Benefits, claims and settlement expenses....... 341,538 27,669 21,836 335,705
There were no losses from uncollectible reinsurance recoverables in the
three years ended December 31, 1997. Past due reinsurance recoverables as of
December 31, 1997 were not material.
F-42
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 11--CONTINGENCIES
LAWSUITS AND LEGAL PROCEEDINGS
There are various lawsuits and other legal proceedings against the Company.
Management and legal counsel are of the opinion that the ultimate disposition of
such litigation will have no material adverse effect on the Company's financial
position or results of operations.
ASSESSMENTS FOR INSOLVENCIES OF UNAFFILIATED INSURANCE COMPANIES
The Company is also contingently liable for possible assessments under
regulatory requirements pertaining to potential insolvencies of unaffiliated
insurance companies. Liabilities, which are established based upon regulatory
guidance, have been insignificant.
NOTE 12--SUPPLEMENTARY DATA ON CASH FLOWS
A reconciliation of net income to net cash provided by operating activities
as presented in the consolidated statements of cash flows is as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
Cash flows from operating activities
Net income................................................... $ 83,576 $ 64,639 $ 73,926
Adjustments to reconcile net income to net cash provided by
operating activities:
Realized investment gains................................ (5,340) (2,451) (8,604)
Depreciation and amortization............................ 10,605 13,050 15,595
Increase in insurance liabilities........................ 61,837 74,621 79,739
(Increase) decrease in premium receivables............... 4,083 (14,397) (9,651)
Increase in deferred policy acquisition costs............ (15,932) (11,973) (7,771)
Increase in accrued interest expense..................... 1 1,769 731
(Increase) decrease in reinsurance recoverable........... (2,744) (2,030) 52
Increase (decrease) in federal income tax liabilities.... (24,735) 12,136 10,693
Increase (decrease) in accrued loss on discontinued
operations............................................. (2,833) 5,974 -
Loss from early retirement of debt....................... - 1,319 -
Other.................................................... (4,082) (3,443) (1,366)
----------- ----------- -----------
Total adjustments.................................... 20,860 74,575 79,418
----------- ----------- -----------
Net cash provided by operating activities............ $ 104,436 $ 139,214 $ 153,344
----------- ----------- -----------
----------- ----------- -----------
The Company's early retirement of debt in 1996 resulted in noncash financing
benefits of $1,571.
F-43
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 13--SEGMENT INFORMATION
The Company's operations include the following segments: 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 both
fixed and variable tax-qualified annuity products. The life insurance segment
includes primarily interest-sensitive life and traditional life products.
Summarized financial information for these segments is as follows:
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1997 1996 % CHANGE 1995 % CHANGE
---------- ---------- ----------- ---------- -----------
Revenues
Property and casualty......................... $ 490,902 $ 459,783 6.8% $ 455,578 0.9%
Annuity....................................... 127,926 122,251 4.6% 121,375 0.7%
Life.......................................... 127,614 122,667 4.0% 115,932 5.8%
Other......................................... 538 (944) (467)
---------- ---------- ----------
Total................................. $ 746,980 $ 703,757 6.1% $ 692,418 1.6%
---------- ---------- ----------
---------- ---------- ----------
Realized investment gains
Property and casualty......................... $ 1,948 $ 201 $ 2,940
Annuity....................................... 2,194 1,584 4,367
Life.......................................... 1,044 666 1,297
Other......................................... 154 - -
---------- ---------- ----------
Total................................. $ 5,340 $ 2,451 $ 8,604
---------- ---------- ----------
---------- ---------- ----------
Income (loss) from continuing operations before
income taxes, discontinued operations and
extraordinary item
Property and casualty......................... $ 80,545 $ 70,522 14.2% $ 75,261 -6.3%
Annuity....................................... 31,967 26,546 20.4% 27,117 -2.1%
Life.......................................... 20,990 19,129 9.7% 17,428 9.8%
Interest expense and other.................... (13,864) (15,578) (16,233)
---------- ---------- ----------
Total................................. $ 119,638 $ 100,619 18.9% $ 103,573 -2.9%
---------- ---------- ----------
---------- ---------- ----------
Amortization of intangible assets
Value of acquired insurance in force
Property and casualty......................... $ 1,032 $ 1,032 - $ 1,032 -
Annuity....................................... 5,563 5,906 -5.8% 6,144 -3.9%
Life.......................................... 2,449 2,649 -7.6% 2,872 -7.8%
---------- ---------- ----------
Subtotal.............................. 9,044 9,587 10,048 -4.6%
Goodwill........................................ 1,618 1,618 - 1,618 -
---------- ---------- ----------
Total amortization of intangible
assets.............................. $ 10,662 $ 11,205 -4.8% $ 11,666 -4.0%
---------- ---------- ----------
---------- ---------- ----------
Assets
Property and casualty......................... $ 657,035 $ 712,419 -7.8% $ 712,979 -0.1%
Annuity and Life.............................. 3,338,679 3,011,538 10.9% 2,851,543 5.6%
Other......................................... 136,198 137,069 -0.6% 97,732 40.2%
---------- ---------- ----------
Total................................. $4,131,912 $3,861,026 7.0% $3,662,254 5.4%
---------- ---------- ----------
---------- ---------- ----------
Revenues include insurance premiums and contract charges earned, net
investment income and realized investment gains and losses. Total assets are not
allocated among the annuity and life segments. Capital expenditures and
depreciation expense were not material.
F-44
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 14--UNAUDITED INTERIM INFORMATION
Summary quarterly financial data is presented below. The per share amounts
for all periods have been restated to reflect the Company's two-for-one stock
split and adoption of SFAS No. 128 "Earnings Per Share" (also see Note 1).
THREE MONTHS ENDED
------------------------------------------------------
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
-------------- -------------- --------- -----------
1997
Insurance premiums written and contract deposits.......... $ 207,485 $ 188,911 $ 195,053 $ 179,870
Total revenues............................................ 192,386 185,934 186,597 182,063
Income from continuing operations......................... 25,284 21,477 20,896 19,400
Discontinued operations, after tax........................ - (3,481) - -
Net income................................................ 25,284 17,996 20,896 19,400
Per share information
Basic
Realized investment gains, after tax.............. $ 0.03 $ 0.03 $ 0.01 $ 0.01
Income from continuing operations................. 0.56 0.48 0.45 0.41
Net income........................................ 0.56 0.40 0.45 0.41
Diluted
Realized investment gains, after tax.............. 0.03 0.02 0.01 0.01
Income from continuing operations................. 0.56 0.46 0.45 0.40
Net income........................................ 0.56 0.39 0.45 0.40
1996
Insurance premiums written and contract deposits.......... $ 183,938 $ 180,551 $ 176,395 $ 163,948
Total revenues............................................ 180,026 175,475 174,407 173,849
Income from continuing operations......................... 21,387 17,892 18,097 16,426
Discontinued operations, after tax........................ (5,586) (1,568) (1,016) (993)
Net income................................................ 15,801 16,324 17,081 15,433
Per share information
Basic
Realized investment gains (losses), after tax..... $ (0.01) - $ 0.01 $ 0.03
Income from continuing operations................. 0.45 $ 0.38 0.39 0.35
Net income........................................ 0.34 0.35 0.36 0.33
Diluted
Realized investment gains (losses), after tax..... - (0.01) 0.01 0.03
Income from continuing operations................. 0.45 0.37 0.38 0.35
Net income........................................ 0.33 0.35 0.36 0.32
1995
Insurance premiums written and contract deposits.......... $ 171,440 $ 163,417 $ 161,869 $ 157,244
Total revenues............................................ 176,540 171,894 174,022 169,962
Income from continuing operations......................... 22,012 19,674 16,238 17,186
Discontinued operations, after tax........................ (589) (517) (8) (70)
Net income................................................ 21,423 19,157 16,230 17,116
Per share information
Basic
Realized investment gains, after tax.............. $ 0.04 $ 0.02 $ 0.06 $ 0.01
Income from continuing operations................. 0.47 0.43 0.33 0.30
Net income........................................ 0.46 0.41 0.33 0.30
Diluted
Realized investment gains, after tax.............. 0.03 0.01 0.04 -
Income from continuing operations................. 0.43 0.39 0.31 0.28
Net income........................................ 0.42 0.38 0.31 0.28
F-45
SCHEDULE I
HORACE MANN EDUCATORS CORPORATION
SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1997
(AMOUNTS IN THOUSANDS)
AMOUNT SHOWN
MARKET IN BALANCE
TYPE OF INVESTMENTS COST(1) VALUE SHEET
- -------------------------------------------------------------------- ------------- ------------- -------------
Fixed maturities:
U.S. Government and U.S. Government agencies and authorities.... $ 378,572 $ 390,103 $ 390,103
Foreign government bonds........................................ 26,397 27,669 27,669
States, municipalities and political subdivisions............... 594,500 619,566 619,566
Public utilities................................................ 24,723 25,585 25,585
Other corporate bonds........................................... 1,511,346 1,575,871 1,575,871
------------- ------------- -------------
Total fixed maturity securities............................. 2,535,538 $ 2,638,794 2,638,794
-------------
-------------
Mortgage loans and real estate...................................... 38,131 xxx 38,131
Short-term investments.............................................. 41,017 xxx 41,021
Policy loans and other.............................................. 51,100 xxx 51,100
------------- -------------
Total investments........................................... $ 2,665,786 xxx $ 2,769,046
------------- -------------
------------- -------------
- ---------
(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-46
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION
BALANCE SHEETS
AS OF DECEMBER 31, 1997, 1996 AND 1995
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
1997 1996 1995
------------ ------------ ------------
ASSETS
Investments and cash.................................................... $ 19,271 $ 13,339 $ 8,066
Investment in subsidiaries.............................................. 574,009 547,889 581,400
Other assets............................................................ 57,911 71,277 71,380
------------ ------------ ------------
Total assets.................................................... $ 651,191 $ 632,505 $ 660,846
------------ ------------ ------------
------------ ------------ ------------
LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY
Mortgage loan payable to subsidiary..................................... $ - $ 10,834 $ 10,951
Short-term debt......................................................... 42,000 34,000 75,000
Long-term debt.......................................................... 99,599 99,564 100,000
Other liabilities....................................................... 3,043 3,135 4,154
------------ ------------ ------------
Total liabilities............................................... 144,642 147,533 190,105
------------ ------------ ------------
Warrants, subject to redemption......................................... 577 577 577
------------ ------------ ------------
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,
1997, 59,161,008; 1996, 58,426,796; 1995, 57,954,858.................. 59 58 58
Additional paid-in capital.............................................. 340,564 330,234 323,891
Net unrealized gains on fixed maturities and equity securities.......... 62,167 29,736 76,151
Retained earnings....................................................... 349,274 278,669 224,366
Treasury stock, at cost, 1997, 14,896,796 shares; 1996 and 1995,
11,176,196 shares..................................................... (246,092) (154,302) (154,302)
------------ ------------ ------------
Total shareholders' equity...................................... 505,972 484,395 470,164
------------ ------------ ------------
Total liabilities, redeemable securities and shareholders'
equity........................................................ $ 651,191 $ 632,505 $ 660,846
------------ ------------ ------------
------------ ------------ ------------
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-47
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Revenues
Net investment income...................................................... $ 1,487 $ 165 $ 659
Realized investment gains.................................................. 154 - -
--------- --------- ---------
Total revenues......................................................... 1,641 165 659
--------- --------- ---------
Expenses
Interest................................................................... 9,412 10,517 11,589
Amortization of goodwill................................................... 1,618 1,618 1,618
Other...................................................................... 541 689 700
Debt retirement costs...................................................... - 1,319 -
Cost of additional rights relating to share repurchase..................... - - 1,347
--------- --------- ---------
Total expenses......................................................... 11,571 14,143 15,254
--------- --------- ---------
Income (loss) from continuing operations before income taxes and equity in net
earnings of subsidiaries..................................................... (9,930) (13,978) (14,595)
Income tax expense (benefit)................................................... (2,845) (3,862) (3,600)
--------- --------- ---------
Income (loss) from continuing operations before equity in net earnings of
subsidiaries................................................................. (7,085) (10,116) (10,995)
Equity in net earnings of subsidiaries......................................... 94,142 83,918 86,105
--------- --------- ---------
Income from continuing operations.............................................. 87,057 73,802 75,110
Discontinued operations:
Loss from operations, net of applicable income tax benefits of 1996,
$2,764; 1995, $647....................................................... - (5,280) (1,184)
Loss on discontinuation, representing provision of 1997, $5,355; 1996,
$5,974 for operating losses during phase-out period, net of applicable
income tax benefits of 1997, $1,874; 1996, $2,091........................ (3,481) (3,883) -
--------- --------- ---------
Net income..................................................................... $ 83,576 $ 64,639 $ 73,926
--------- --------- ---------
--------- --------- ---------
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-48
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
----------- ------------ ------------
Cash flows from operating activities
Interest expense paid................................................ $ (9,276) $ (8,653) $ (11,180)
Federal income taxes recovered (paid)................................ 1,391 (10,154) 21,509
Cash dividends received from subsidiaries............................ 107,300 72,700 75,471
Other, net........................................................... (7,208) 3,342 324
----------- ------------ ------------
Net cash provided by operating activities........................ 92,207 57,235 86,124
----------- ------------ ------------
Cash flows from investing activities
Net (increase) decrease in investments............................... (10,102) (4,705) 5,321
Capital expenditures for property and equipment...................... - (2,609) (1,776)
----------- ------------ ------------
Net cash provided by (used in) investing activities.............. (10,102) (7,314) 3,545
----------- ------------ ------------
Cash flows from financing activities
Purchase of treasury stock........................................... (91,790) - (174,870)
Dividends paid to shareholders....................................... (12,971) (10,336) (8,838)
Principal borrowings (payments) on Bank Credit Facility.............. 8,000 (41,000) 75,000
Exercise of stock options............................................ 11,581 6,343 403
Catastrophe-linked equity put option premium......................... (1,250) - -
Proceeds from issuance of Senior Notes............................... - 98,530 -
Retirement of Convertible Notes...................................... - (102,890) -
Proceeds from issuance of common stock............................... - - 20,568
----------- ------------ ------------
Net cash used in financing activities............................ (86,430) (49,353) (87,737)
----------- ------------ ------------
Net increase (decrease) in cash.......................................... (4,325) 568 1,932
Cash at beginning of period.............................................. 4,325 3,757 1,825
----------- ------------ ------------
Cash at end of period.................................................... $ 0 $ 4,325 $ 3,757
----------- ------------ ------------
----------- ------------ ------------
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-49
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION
NOTE TO CONDENSED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
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-50
SCHEDULE III & VI (COMBINED)
HORACE MANN EDUCATORS CORPORATION
SUPPLEMENTARY INSURANCE INFORMATION
(AMOUNTS IN THOUSANDS)
OTHER
DEFERRED FUTURE POLICY DISCOUNT, POLICY PREMIUM
POLICY BENEFITS, IF ANY, CLAIMS AND REVENUE/
ACQUISITION CLAIMS AND DEDUCTED IN UNEARNED BENEFITS PREMIUM
SEGMENT COSTS CLAIMS EXPENSES PREVIOUS COLUMN PREMIUMS PAYABLE EARNED
- --------------------------------------- ----------- ---------------- --------------- ----------- ----------- -----------
YEAR ENDED DECEMBER 31, 1997
Property and casualty.............. $ 15,230 $ 310,632 $ 0 $ 161,205 $ 305 $ 447,252
Annuity............................ 19,699 1,246,948 xxx - 107,538 12,597
Life............................... 50,954 553,981 xxx 5,791 14,264 82,863
Other.............................. N/A N/A xxx N/A N/A N/A
----------- ---------------- ----------- ----------- -----------
Total.......................... $ 85,883 $ 2,111,561 xxx $ 166,996 $ 122,107 $ 542,712
----------- ---------------- ----------- ----------- -----------
----------- ---------------- ----------- ----------- -----------
YEAR ENDED DECEMBER 31, 1996
Property and casualty.............. $ 13,855 $ 340,411 $ 0 $ 150,368 $ 305 $ 413,219
Annuity............................ 14,230 1,287,815 xxx - 102,681 9,191
Life............................... 46,986 526,028 xxx 5,408 15,563 80,289
Other.............................. N/A N/A xxx N/A N/A N/A
----------- ---------------- ----------- ----------- -----------
Total.......................... $ 75,071 $ 2,154,254 xxx $ 155,776 $ 118,549 $ 502,699
----------- ---------------- ----------- ----------- -----------
----------- ---------------- ----------- ----------- -----------
YEAR ENDED DECEMBER 31, 1995
Property and casualty.............. $ 12,515 $ 369,653 $ 0 $ 136,441 $ 305 $ 403,796
Annuity............................ 12,497 1,276,227 xxx - 101,943 6,798
Life............................... 41,854 489,060 xxx 4,664 16,822 74,850
Other.............................. N/A N/A xxx N/A N/A N/A
----------- ---------------- ----------- ----------- -----------
Total.......................... $ 66,866 $ 2,134,940 xxx $ 141,105 $ 119,070 $ 485,444
----------- ---------------- ----------- ----------- -----------
----------- ---------------- ----------- ----------- -----------
CLAIMS AND CLAIM
BENEFITS, ADJUSTMENT EXPENSES AMORTIZATION
CLAIMS INCURRED RELATED TO OF DEFERRED PAID CLAIMS
NET AND ------------------------ POLICY OTHER AND CLAIM
INVESTMENT SETTLEMENT CURRENT ACQUISITION OPERATING ADJUSTMENT
SEGMENT INCOME EXPENSES YEAR PRIOR YEARS COSTS EXPENSES EXPENSES
- --------------------------------------- ----------- ----------- ----------- ----------- ------------- ----------- -----------
YEAR ENDED DECEMBER 31, 1997
Property and casualty.............. $ 41,702 $ 320,834 $ 365,986 $ (45,152) $ 40,515 $ 49,012 $ 357,875
Annuity............................ 113,135 76,486 xxx xxx 100 19,373 xxx
Life............................... 43,707 59,352 xxx xxx 3,583 43,685 xxx
Other.............................. 384 N/A xxx xxx N/A 14,402 xxx
----------- ----------- ------------- -----------
Total.......................... $ 198,928 $ 456,672 xxx xxx $ 44,198 $ 126,472 xxx
----------- ----------- ------------- -----------
----------- ----------- ------------- -----------
YEAR ENDED DECEMBER 31, 1996
Property and casualty.............. $ 46,363 $ 306,102 $ 368,648 $ (62,546) $ 36,652 $ 46,507 $ 345,642
Annuity............................ 111,476 76,762 xxx xxx 1,300 17,643 xxx
Life............................... 41,712 59,149 xxx xxx 3,111 41,278 xxx
Other.............................. (944) N/A xxx xxx N/A 13,315 xxx
----------- ----------- ------------- -----------
Total.......................... $ 198,607 $ 442,013 xxx xxx $ 41,063 $ 118,743 xxx
----------- ----------- ------------- -----------
----------- ----------- ------------- -----------
YEAR ENDED DECEMBER 31, 1995
Property and casualty.............. $ 48,842 $ 297,078 $ 352,513 $ (55,630) $ 36,405 $ 46,834 $ 320,557
Annuity............................ 110,210 74,424 xxx xxx 71 19,763 xxx
Life............................... 39,785 55,114 xxx xxx 3,542 39,848 xxx
Other.............................. (467) N/A xxx xxx N/A 14,419 xxx
----------- ----------- ------------- -----------
Total.......................... $ 198,370 $ 426,616 xxx xxx $ 40,018 $ 120,864 xxx
----------- ----------- ------------- -----------
----------- ----------- ------------- -----------
PREMIUMS
SEGMENT WRITTEN
- --------------------------------------- -----------
YEAR ENDED DECEMBER 31, 1997
Property and casualty.............. $ 458,088
Annuity............................ xxx
Life............................... xxx
Other.............................. xxx
Total.......................... xxx
YEAR ENDED DECEMBER 31, 1996
Property and casualty.............. $ 427,146
Annuity............................ xxx
Life............................... xxx
Other.............................. xxx
Total.......................... xxx
YEAR ENDED DECEMBER 31, 1995
Property and casualty.............. $ 405,795
Annuity............................ xxx
Life............................... xxx
Other.............................. xxx
Total.......................... xxx
- -------------
N/A Not applicable.
See accompanying Independent Auditors' Report.
F-51
SCHEDULE IV
HORACE MANN EDUCATORS CORPORATION
REINSURANCE
(AMOUNTS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
CEDED TO ASSUMED
OTHER FROM STATE PERCENTAGE OF
GROSS AMOUNT COMPANIES FACILITIES NET AMOUNT ASSUMED
-------------- ----------- ----------- -------------- ---------------
YEAR ENDED DECEMBER 31, 1997
Life insurance in force.............. $ 11,187,925 $ 310,833 $ - $ 10,877,092 -
Premiums
Property and casualty............ $ 445,468 $ 20,895 $ 22,679 $ 447,252 5.1%
Annuity.......................... 12,597 - - 12,597 -
Life............................. 84,540 1,677 - 82,863 -
-------------- ----------- ----------- --------------
Total premiums............... $ 542,605 $ 22,572 $ 22,679 $ 542,712 4.2%
-------------- ----------- ----------- --------------
-------------- ----------- ----------- --------------
YEAR ENDED DECEMBER 31, 1996
Life insurance in force.............. $ 10,645,393 $ 222,611 $ - $ 10,422,782 -
Premiums
Property and casualty............ $ 406,778 $ 22,440 $ 28,881 $ 413,219 7.0%
Annuity.......................... 9,191 - - 9,191 -
Life............................. 81,736 1,447 - 80,289 -
-------------- ----------- ----------- --------------
Total premiums............... $ 497,705 $ 23,887 $ 28,881 $ 502,699 5.7%
-------------- ----------- ----------- --------------
-------------- ----------- ----------- --------------
YEAR ENDED DECEMBER 31, 1995
Life insurance in force.............. $ 10,234,655 $ 174,002 $ - $ 10,060,653 -
Premiums
Property and casualty............ $ 398,639 $ 19,594 $ 24,751 $ 403,796 6.1%
Annuity.......................... 6,798 - - 6,798 -
Life............................. 75,755 905 - 74,850 -
-------------- ----------- ----------- --------------
Total premiums............... $ 481,192 $ 20,499 $ 24,751 $ 485,444 5.1%
-------------- ----------- ----------- --------------
-------------- ----------- ----------- --------------
- ---------
NOTE: Premiums above include insurance premiums earned and contract charges
earned.
See accompanying Independent Auditors' Report.
F-52
[LOGO]
WWW.HORACEMANN.COM
HA-C00313
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
HORACE MANN EDUCATORS CORPORATION
EXHIBITS
To
FORM 10-K
For the Year Ended December 31, 1997
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,
1997. Management contracts and compensatory plans are indicated by an
asterisk(*).
EXHIBIT INDEX
SEQUENTIAL
EXHIBIT PAGE
NO. DESCRIPTION NUMBER
- ---- ----------- ----------
(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 on November 14, 1996.
3.2 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 Securities
and Exchange Commission on November 14, 1996.
3.3 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 Securities and
Exchange Commission on November 14, 1996.
3.4 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 Securities
and Exchange Commission on November 14, 1996.
3.5 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 Securities and Exchange
Commission on October 9, 1992.
-1-
SEQUENTIAL
EXHIBIT PAGE
NO. DESCRIPTION NUMBER
- ---- ----------- ----------
3.6 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 Securities and Exchange Commission on
December 6, 1995.
(4) Instruments defining the rights of security holders, including
indentures:
4.1 Warrant Agreement dated as of August 29, 1989 (the "Warrant
Agreement"), between HMEC (as successor to HME Acquisition
Corporation) and Bankers Trust Company, as warrant agent (the
"Warrant Agent"), with regard to Warrants to Purchase Common
Stock, incorporated by reference to Exhibit 4.6 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended September
30, 1989 (the "September 1989 Form 10-Q").
4.2 Supplemental Warrant Agreement dated as of August 29, 1989 to
the Warrant Agreement, between HMEC and the Warrant Agent,
incorporated by reference to Exhibit 4.7 to the September 1989
Form 10-Q.
4.3 Form of Warrant (included in Exhibit 4.1).
4.4 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 Securities and
Exchange Commission on March 13, 1996.
4.5 Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit
4.4).
4.6 Certificate of Designations for HMEC Series A Cumulative
Preferred Stock (included in Exhibit 10.12).
-2-
SEQUENTIAL
EXHIBIT PAGE
NO. DESCRIPTION NUMBER
- ---- ----------- ----------
(10) Material contracts:
10.1 Credit Agreement dated as of December 31, 1996 (the "Bank
Credit Facility") among HMEC, certain banks named therein and
Bank of America National Trust and Savings Association, as
administrative agent (the "Agent"), incorporated by reference
to Exhibit 10.1 to HMEC's Annual Report on Form 10-K for the
year ended December 31, 1996, filed with the Securities and
Exchange Commission on March 26, 1997.
10.2* Stock Subscription Agreement among HMEC (as successor to HME
Holdings, Inc.), The Fulcrum III Limited Partnership, The
Second Fulcrum III Limited Partnership and each of the
Management Investors, incorporated by reference to Exhibit
10.17 to HMEC's Annual Report on Form 10-K for the year ended
December 31, 1989, filed with the Securities and Exchange
Commission 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 Securities and Exchange
Commission on November 14, 1996.
10.4* Horace Mann Educators Corporation Deferred Compensation Plan
for Employees.
10.5* Horace Mann Educators Corporation 1991 Stock Incentive Plan,
incorporated by reference to Exhibit 10.4 to HMEC's Annual
Report on Form 10-K for the year ended December 31, 1991,
filed with the Securities and Exchange Commission on March 27,
1992.
10.5(a)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan.
10.5(b)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 1991 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, 1991, filed with the
Securities and Exchange Commission on March 27, 1992.
-3-
SEQUENTIAL
EXHIBIT PAGE
NO. DESCRIPTION NUMBER
- ---- ----------- ----------
10.5(c)* Amendment to Horace Mann Educators Corporation 1991 Stock
Incentive Plan, dated September 11, 1996, incorporated by
reference to Exhibit 10.2(c) to HMEC's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1996, filed with
the Securities and Exchange Commission on November 14, 1996.
10.6* Severance Agreements between HMEC and certain officers of
HMEC, incorporated by reference to Exhibit 10.9 to HMEC's
Annual Report on Form 10-K for the year ended December 31,
1993, filed with the Securities and Exchange Commission on
March 31, 1994.
10.7* Specimen Continuation of Employment Agreement between HMEC and
certain officers, incorporated by reference to Exhibit
10.21(a) to HMEC's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1994, filed with the Securities
and Exchange Commission on November 14, 1994.
10.7(a)* Schedule of Continuation of Employment Agreements between HMEC
and certain officers, incorporated by reference to Exhibit
10.21(b) to HMEC's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1994, filed with the Securities
and Exchange Commission on November 14, 1994.
10.8* Horace Mann Incentive Compensation Program, incorporated by
reference to Exhibit 10.7 to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1996, filed with the
Securities and Exchange Commission on March 26, 1997.
10.9* Horace Mann Supplemental Employee Retirement Plan, 1997
Restatement, incorporated by reference to Exhibit 10.1 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended
September 30,1997, filed with the Securities and Exchange
Commission on November 14, 1997.
10.10* Horace Mann Executive Supplemental Employee Retirement Plan,
1997 Restatement, incorporated by reference to Exhibit 10.2 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1997, filed with the Securities and Exchange
Commission on August 14, 1997.
-4-
SEQUENTIAL
EXHIBIT PAGE
NO. DESCRIPTION NUMBER
- ---- ----------- ----------
10.11* Agreement entered by and between HMEC and Paul J. Kardos as of
August 1, 1996, incorporated by reference to Exhibit 10.1 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1996, filed with the Securities and Exchange
Commission on August 13, 1996.
10.12 Catastrophe Equity Securities Issuance Option Agreement
entered by and between HMEC and Centre Reinsurance, dated
February 15, 1997 and related letter from Centre Reinsurance,
incorporated by reference to Exhibit 10.12 to HMEC's Annual
Report on Form 10-K for the year ended December 31, 1996,
filed with the Securities and Exchange Commission on March 26,
1997.
(11) Statement re computation of per share earnings.
(12) Statement regarding computation of ratios.
(21) Subsidiaries of HMEC.
(23) Consent of KPMG Peat Marwick LLP.
(27) Financial Data Schedule.
- 5 -