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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2004
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
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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, including Zip Code)
Registrant's Telephone Number, Including Area Code: 217-789-2500
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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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [_]
As of April 30, 2004, 42,724,477 shares of Common Stock, par value $0.001
per share, were outstanding, net of 17,503,371 shares of treasury stock.
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HORACE MANN EDUCATORS CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2004
INDEX
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Independent Auditors' Review Report.......................... 1
Consolidated Balance Sheets as of
March 31, 2004 and December 31, 2003........................ 2
Consolidated Statements of Operations for the
Three Months Ended March 31, 2004 and 2003.................. 3
Consolidated Statements of Changes in Shareholders' Equity
for the Three Months Ended March 31, 2004 and 2003.......... 4
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2004 and 2003.................. 5
Notes to Consolidated Financial Statements................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 14
Item 3. Quantitative and Qualitative Disclosures about
Market Risk.............................................. 35
Item 4. Controls and Procedures................................... 35
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders....... 35
Item 5. Other Information......................................... 35
Item 6. Exhibits and Reports on Form 8-K.......................... 36
SIGNATURES.................................................................. 37
INDEPENDENT AUDITORS' REVIEW REPORT
The Board of Directors and Shareholders
Horace Mann Educators Corporation:
We have reviewed the consolidated balance sheet of Horace Mann Educators
Corporation and subsidiaries as of March 31, 2004, and the related consolidated
statements of operations, changes in shareholders' equity and cash flows for the
three-month periods ended March 31, 2004 and 2003. These consolidated financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our review, we are not aware of any material modifications that
should be made to the consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Horace Mann Educators Corporation and subsidiaries as of December 31, 2003, and
the related consolidated statements of operations, changes in shareholders'
equity, and cash flows for the year then ended (not presented herein); and in
our report dated February 17, 2004, we expressed an unqualified opinion on those
consolidated financial statements.
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
May 5, 2004
1
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
March 31, December 31,
2004 2003
----------- ------------
(Unaudited)
ASSETS
Investments
Fixed maturities, available for sale, at fair
value (amortized cost, 2004, $3,157,141; 2003,
$3,124,861)..................................... $ 3,338,969 $ 3,258,674
Short-term and other investments................. 181,573 104,904
Short-term investments, loaned securities
collateral...................................... 386,792 22,147
----------- ------------
Total investments............................. 3,907,334 3,385,725
Cash................................................ 31,115 19,773
Accrued investment income and premiums receivable... 100,818 99,370
Deferred policy acquisition costs................... 194,782 193,703
Goodwill............................................ 47,396 47,396
Value of acquired insurance in force................ 25,778 27,259
Other assets........................................ 74,214 80,531
Variable annuity assets............................. 1,137,535 1,119,231
----------- ------------
Total assets.................................. $ 5,518,972 $ 4,972,988
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities
Fixed annuity contract liabilities............... $ 1,564,340 $ 1,526,174
Interest-sensitive life contract liabilities..... 573,933 567,209
Unpaid claims and claim expenses................. 354,616 350,501
Future policy benefits........................... 182,987 181,344
Unearned premiums................................ 193,956 198,991
----------- ------------
Total policy liabilities...................... 2,869,832 2,824,219
Other policyholder funds............................ 133,618 129,888
Liability for securities lending agreements......... 386,792 22,147
Other liabilities................................... 244,940 177,325
Short-term debt..................................... 25,000 25,000
Long-term debt...................................... 144,707 144,703
Variable annuity liabilities........................ 1,137,535 1,119,231
----------- ------------
Total liabilities............................. 4,942,424 4,442,513
----------- ------------
Preferred stock, $0.001 par value, shares
authorized 1,000,000; none issued.................. -- --
Common stock, $0.001 par value, shares authorized
75,000,000; shares issued, 2004, 60,226,072;
2003, 60,225,311................................... 60 60
Additional paid-in capital.......................... 342,324 342,306
Retained earnings................................... 473,533 456,330
Accumulated other comprehensive income (loss), net
of taxes:
Net unrealized gains on fixed
maturities and equity securities................ 110,460 81,608
Minimum pension liability adjustment............. (17,252) (17,252)
Treasury stock, at cost, 17,503,371 shares.......... (332,577) (332,577)
----------- ------------
Total shareholders' equity.................... 576,548 530,475
----------- ------------
Total liabilities and shareholders'
equity.................................... $ 5,518,972 $ 4,972,988
=========== ============
See accompanying notes to consolidated financial statements.
2
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Dollars in thousands, except per share data)
Three Months Ended
March 31,
---------------------
2004 2003
--------- ---------
Revenues
Insurance premiums and contract charges earned..... $ 167,563 $ 158,318
Net investment income.............................. 48,596 47,521
Realized investment gains (losses)................. 5,282 (4,748)
--------- ---------
Total revenues.................................. 221,441 201,091
--------- ---------
Benefits, losses and expenses
Benefits, claims and settlement expenses........... 111,455 110,877
Interest credited.................................. 26,407 25,429
Policy acquisition expenses amortized.............. 16,379 17,106
Operating expenses................................. 33,607 33,624
Amortization of intangible assets.................. 1,326 1,625
Interest expense................................... 1,680 1,552
--------- ---------
Total benefits, losses and expenses............. 190,854 190,213
--------- ---------
Income before income taxes............................ 30,587 10,878
Income tax expense.................................... 8,896 2,779
--------- ---------
Net income............................................ $ 21,691 $ 8,099
========= =========
Net income per share
Basic.............................................. $ 0.51 $ 0.19
========= =========
Diluted............................................ $ 0.51 $ 0.19
========= =========
Weighted average number of shares and equivalent
shares (in thousands)
Basic........................................... 42,722 42,700
Diluted......................................... 42,934 42,869
See accompanying notes to consolidated financial statements.
3
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
(Dollars in thousands, except per share data)
Three Months Ended
March 31,
---------------------
2004 2003
--------- ---------
Common stock
Beginning balance.................................. $ 60 $ 60
Conversion of Director Stock Plan units, 2004,
761 shares; 2003, 10,284 shares................... -- --
--------- ---------
Ending balance..................................... 60 60
--------- ---------
Additional paid-in capital
Beginning balance.................................. 342,306 342,749
Conversion of Director Stock Plan units............ 18 214
--------- ---------
Ending balance..................................... 342,324 342,963
--------- ---------
Retained earnings
Beginning balance.................................. 456,330 455,308
Net income......................................... 21,691 8,099
Cash dividends, 2004, $0.105 per share; 2003,
$0.105 per share;................................. (4,488) (4,486)
--------- ---------
Ending balance..................................... 473,533 458,921
--------- ---------
Accumulated other comprehensive income, net of taxes:
Beginning balance.................................. 64,356 63,302
Change in net unrealized gains on fixed
maturities and equity securities............... 28,852 10,839
Change in minimum pension liability
adjustment..................................... -- --
--------- ---------
Ending balance..................................... 93,208 74,141
--------- ---------
Treasury stock, at cost
Beginning and ending balance, 2004 and 2003,
17,503,371 shares................................. (332,577) (332,577)
--------- ---------
Shareholders' equity at end of period................. $ 576,548 $ 543,508
========= =========
Comprehensive income
Net income......................................... $ 21,691 $ 8,099
Other comprehensive income, net of taxes:
Change in net unrealized gains
on fixed maturities and equity securities...... 28,852 10,839
Change in minimum pension liability
adjustment..................................... -- --
--------- ---------
Other comprehensive income................... 28,852 10,839
--------- ---------
Total..................................... $ 50,543 $ 18,938
========= =========
See accompanying notes to consolidated financial statements.
4
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Dollars in thousands)
Three Months Ended
March 31,
---------------------
2004 2003
--------- ---------
Cash flows from operating activities
Premiums collected................................. $ 166,521 $ 161,833
Policyholder benefits paid......................... (106,601) (122,034)
Policy acquisition and other operating expenses
paid.............................................. (46,600) (59,549)
Federal income taxes paid.......................... -- (9,958)
Investment income collected........................ 48,070 49,513
Interest expense paid.............................. (1,086) (960)
Other.............................................. 1,212 142
--------- ---------
Net cash provided by operating activities....... 61,516 18,987
--------- ---------
Cash flows from investing activities
Fixed maturities
Purchases....................................... (324,405) (204,798)
Sales........................................... 236,922 91,999
Maturities...................................... 91,089 34,187
Net cash provided by (used for)
short-term and other investments.................. (76,642) 15,242
--------- ---------
Net cash used in investing activities........... (73,036) (63,370)
--------- ---------
Cash flows from financing activities
Dividends paid to shareholders..................... (4,488) (4,486)
Principal repayments on Bank Credit Facility....... -- --
Annuity contracts, variable and fixed
Deposits........................................ 84,212 64,262
Maturities and withdrawals...................... (24,888) (23,711)
Net transfer to variable annuity assets......... (30,540) (19,786)
Net decrease in life policy account balances....... (1,434) (1,150)
--------- ---------
Net cash provided by financing activities....... 22,862 15,129
--------- ---------
Net increase (decrease) in cash....................... 11,342 (29,254)
Cash at beginning of period........................... 19,773 60,162
--------- ---------
Cash at end of period................................. $ 31,115 $ 30,908
========= =========
See accompanying notes to consolidated financial statements.
5
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 2004 and 2003
(Dollars in thousands, except per share data)
Note 1 - Basis of Presentation
The accompanying unaudited consolidated financial statements of Horace Mann
Educators Corporation ("HMEC"; and together with its subsidiaries, the
"Company") have been prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP") and with the rules and
regulations of the Securities and Exchange Commission. Certain information and
note disclosures normally included in financial statements prepared in
accordance with GAAP have been condensed or omitted. The Company believes that
these financial statements contain all adjustments (consisting of normal
recurring accruals) necessary to present fairly the Company's consolidated
financial position as of March 31, 2004 and the consolidated results of
operations, changes in shareholders' equity and cash flows for the three months
ended March 31, 2004 and 2003.
The subsidiaries of HMEC market and underwrite tax-qualified retirement
annuities and private passenger automobile, homeowners, and life insurance
products, primarily to educators and other employees of public schools and their
families. The Company's principal operating subsidiaries are Horace Mann Life
Insurance Company, Horace Mann Insurance Company, Teachers Insurance Company,
Horace Mann Property & Casualty Insurance Company and Horace Mann Lloyds.
It is suggested that these financial statements be read in conjunction with
the financial statements and the related notes included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2003.
The results of operations for the three months ended March 31, 2004 are not
necessarily indicative of the results to be expected for the full year.
Note 2 - Stock Based Compensation
The Company grants stock options to executive officers, other employees and
directors. The exercise price of the option is equal to the fair market value of
the Company's common stock on the date of grant. Additional information
regarding the Company's stock-based compensation plans is contained in Note 6 -
Shareholders' Equity and Stock Options of the Company's Annual Report on Form
10-K for the year ended December 31, 2003. The Company accounts for stock option
grants using the intrinsic value based method in accordance with Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees", and accordingly, recognizes no compensation expense for the stock
option grants.
6
Note 2 - Stock Based Compensation-(Continued)
Alternatively, Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation", allows companies to recognize compensation cost for stock-based
compensation plans, determined based on the fair value at the grant dates. If
the Company had applied this alternative accounting method, net income and net
income per share would have been reduced to the pro forma amounts indicated
below:
Three Months Ended
March 31,
--------------------------
2004 2003
------------ ------------
Net income
As reported..................................... $ 21,691 $ 8,099
Add: Stock-based compensation expense,
after tax, included in reported net income.. -- --
Deduct: Stock-based compensation expense,
after tax, determined under the fair value
based method for all awards (1)............. 1,309 1,339
------------ ------------
Pro forma....................................... $ 20,382 $ 6,760
============ ============
Net income per share - basic
As reported..................................... $ 0.51 $ 0.19
Pro forma....................................... $ 0.48 $ 0.16
Net income per share - diluted
As reported..................................... $ 0.51 $ 0.19
Pro forma....................................... $ 0.47 $ 0.16
- ----------
(1) The fair value of each option grant was estimated on the date of grant
using the Modified Roll-Geske option-pricing model with the following
weighted average assumptions for 2004 and 2003, respectively: risk-free
interest rates of 4.0% and 3.8%; dividend yield of 2.7% and 3.0%; expected
lives of 10 years; and volatility of 26.9% and 28.3%. The three-month
expense amounts represent one-fourth of the full year expense reflecting
options granted through March 31, 2004 and 2003, respectively, and vesting
during the respective calendar years.
7
Note 3 - Restructuring Charges
Charges related to the restructure of the Company's property and casualty
claims operations were incurred and separately identified in the Statements of
Operations for the year ended December 31, 2002, as described in Note 2 -
Restructuring Charges of the Company's Annual Report on Form 10-K for the year
ended December 31, 2003.
The following table provides information about the charges taken in 2002,
the balance of accrued amounts at December 31, 2003 and March 31, 2004 and
payment activity during the three months ended March 31, 2004.
Original Reserve at Reserve at
Pretax December 31, March 31,
Charge 2003 Payments 2004
------------ ------------ ------------ ------------
Charges to earnings:
Property and Casualty
Claims Operations
Employee termination costs.... $ 2,542 $ 226 $ 115 $ 111
Additional defined benefit
pension plan costs........... 1,179 125 11 114
Termination of lease
agreements................... 502 39 12 27
------------ ------------ ------------ ------------
Total...................... $ 4,223 $ 390 $ 138 $ 252
============ ============ ============ ============
Note 4 - Debt
Indebtedness outstanding was as follows:
March 31, December 31,
2004 2003
------------ ------------
Short-term debt:
Bank Credit Facility............................ $ 25,000 $ 25,000
Long-term debt:
1.425% Senior Convertible Notes due May 14,
2032. Aggregate principal amount of $244,500
less unaccrued discount of $128,362 (3.0%
imputed rate).................................. 116,138 116,138
6 5/8% Senior Notes, due January 15, 2006.
Aggregate principal amount of $28,600 less
unaccrued discount of $31 and $35 (6.7%
imputed rate).................................. 28,569 28,565
------------ ------------
Total........................................ $ 169,707 $ 169,703
============ ============
8
Note 5 - Investments
Fixed Maturity Securities
The following table presents the composition and value of the Company's
fixed maturity securities portfolio by rating category. The Company has
classified the entire fixed maturity securities portfolio as available for sale,
which is carried at fair value.
Percent of Fair Value March 31, 2004
--------------------------- ---------------------------
Rating of Fixed March 31, December 31, Fair Amortized
Maturity Securities (1) 2004 2003 Value (2) Cost
- ------------------------------------ ------------ ------------ ------------ ------------
AAA.............................. 44.1% 44.6% $ 1,472,079 $ 1,427,470
AA............................... 7.5 7.7 249,409 237,629
A................................ 23.8 23.2 794,944 727,691
BBB.............................. 19.2 18.6 640,621 589,733
BB............................... 1.5 2.0 50,306 48,551
B................................ 3.3 3.2 110,506 107,587
CCC or lower..................... 0.5 0.6 17,280 14,644
Not rated (3).................... 0.1 0.1 3,824 3,836
------------ ------------ ------------ ------------
Total......................... 100.0% 100.0% $ 3,338,969 $ 3,157,141
============ ============ ============ ============
- ----------
(1) Ratings are as assigned primarily by Standard & Poor's Corporation ("S&P")
when available, with remaining ratings as assigned on an equivalent basis
by Moody's Investors Service, Inc. ("Moody's"). Ratings for publicly traded
securities are determined when the securities are acquired and are updated
monthly to reflect any changes in ratings.
(2) Fair values are based on quoted market prices, when available. Fair values
for private placements and certain other securities that are infrequently
traded are estimated by the Company with the assistance of its investment
advisors utilizing recognized valuation methodology, including cash flow
modeling.
(3) This category includes $3,824 of private placement securities not rated by
either S&P or Moody's. The National Association of Insurance Commissioners
("NAIC") has rated 97.1% of these private placement securities as
investment grade.
The following table presents the distribution of the Company's fixed
maturity securities portfolio by estimated expected maturity. Estimated expected
maturities differ from contractual maturities by reflecting assumptions
regarding borrowers' utilization of the right to call or prepay obligations with
or without call or prepayment penalties.
Fair
Percent of Total Value
------------------------- ------------
March 31, December 31, March 31,
2004 2003 2004
----------- ------------ ------------
Due in 1 year or less................. 7.0% 7.4% $ 232,984
Due after 1 year through 5 years...... 20.9 21.9 699,528
Due after 5 years through 10 years.... 42.2 41.3 1,408,228
Due after 10 years through 20 years... 10.3 8.9 342,807
Due after 20 years.................... 19.6 20.5 655,422
----------- ------------ ------------
Total.............................. 100.0% 100.0% $ 3,338,969
=========== ============ ============
The Company's investment portfolio includes no derivative financial
instruments (futures, forwards, swaps, option contracts or other financial
instruments with similar characteristics).
9
Note 5 - Investments-(Continued)
Securities Lending
The Company loans fixed income securities to third parties, primarily major
brokerage firms. As of March 31, 2004 and December 31, 2003, fixed maturities
with a fair value of $386,792 and $22,147, respectively, were on loan. Loans of
securities are required at all times to be secured by collateral from borrowers
at least equal to 100% of the market value of the securities loaned. The Company
maintains effective control over the loaned securities and therefore reports
them as Fixed Maturity Securities in the Consolidated Balance Sheets. SFAS No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities", requires the securities lending collateral to be
classified as an asset with a corresponding liability in the Company's
Consolidated Balance Sheets.
Note 6 - Pension Plans and Other Postretirement Benefits
All employees of the Company are covered by a defined contribution plan and
participate in a 401(k) plan. Employees hired on or before December 31, 1998 are
also covered under a defined benefit plan. In addition, certain employees
participate in a supplemental defined benefit plan or a supplemental defined
contribution plan or both.
Effective April 1, 2002, participants stopped accruing benefits under the
defined benefit and supplemental defined benefit plans but continue to retain
the benefits they had accrued to date. The Company's policy with respect to
funding the defined benefit plan is to contribute amounts which are actuarially
determined to provide the plan with sufficient assets to meet future benefit
payments consistent with the funding requirements of federal laws and
regulations. For the defined contribution, 401(k) and the defined benefit plans,
investments have been set aside in a trust fund; whereas the supplemental
retirement plans are non-qualified, unfunded plans.
The following table summarizes the components of net periodic pension cost
for the defined benefit plan and the supplemental retirement plans for the three
months ended March 31, 2004 and 2003.
Supplemental
Defined Benefit Plan Retirement Plans
--------------------------- ---------------------------
Three Months Ended Three Months Ended
March 31, March 31,
--------------------------- ---------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Components of net periodic
pension expense:
Service cost..................... $ -- $ -- $ 38 $ 109
Interest cost.................... 776 819 264 216
Expected return on plan assets... (678) (596) -- --
Recognized net actuarial loss.... 382 392 112 69
Settlement loss.................. 524 999 -- --
------------ ------------ ------------ ------------
Net periodic pension expense........ $ 1,004 $ 1,614 $ 414 $ 394
============ ============ ============ ============
10
Note 6 - Pension Plans and Other Postretirement Benefits-(Continued)
As disclosed in the Company's financial statements for the year ended
December 31, 2003, it expects to contribute $3,500 to the defined benefit plan
and $1,200 to the supplemental retirement plans in 2004. For the three months
ended March 31, 2004, there were no contributions to the defined benefit plan
and $278 was contributed to the supplemental retirement plans. The Company
anticipates contributing $3,500 to the defined benefit plan and an additional
$922 to the supplemental retirement plans during the remaining nine months of
2004.
In addition to providing pension benefits, the Company also provides
certain health care and life insurance benefits to retired employees and
eligible dependents. Effective January 1, 2004, only employees who were at least
age 50 with at least 15 years of service by January 1, 2004 are eligible to
participate in this program. The following table summarizes the components of
the net periodic benefit cost of postretirement benefits other than pension for
the three months ended March 31, 2004 and 2003.
Three Months Ended
March 31,
--------------------------
2004 2003
------------ ------------
Components of net periodic cost:
Service cost.................................... $ 26 $ 92
Interest cost................................... 456 529
Amortization of prior service cost.............. (180) --
Recognized net actuarial loss................... 34 (752)
------------ ------------
Net periodic benefit cost.......................... $ 336 $ (131)
============ ============
As disclosed in the Company's financial statements for the year ended
December 31, 2003, it expects to contribute $2,300 to the postretirement benefit
plan in 2004. For the three months ended March 31, 2004, the Company contributed
$388 to the postretirement benefit plan and anticipates contributing an
additional $1,912 to the plan during the remaining nine months of 2004.
11
Note 7 - Reinsurance
The Company recognizes the cost of reinsurance premiums over the contract
periods for such premiums in proportion to the insurance protection provided.
Amounts recoverable from reinsurers for unpaid claims and claim settlement
expenses, including estimated amounts for unsettled claims, claims incurred but
not reported and policy benefits, are estimated in a manner consistent with the
insurance liability associated with the policy. The effects of reinsurance on
premiums written and contract deposits; premiums and contract charges earned;
and benefits, claims and settlement expenses were as follows:
Gross
Amount Ceded Assumed Net
------------ ------------ ------------ ------------
Three months ended
March 31, 2004
- ------------------------------------
Premiums written and contract
deposits........................... $ 245,695 $ 5,147 $ 4,270 $ 244,818
Premiums and contract charges
earned............................. 169,012 5,950 4,501 167,563
Benefits, claims and settlement
expenses........................... 112,068 3,750 3,137 111,455
Three months ended
March 31, 2003
- ------------------------------------
Premiums written and contract
deposits........................... $ 220,832 $ 5,068 $ 3,776 $ 219,540
Premiums and contract charges
earned............................. 159,799 5,091 3,610 158,318
Benefits, claims and settlement
expenses........................... 108,087 (933) 1,857 110,877
12
Note 8 - Segment Information
The Company conducts and manages its business through four segments. The
three operating segments, representing the major lines of insurance business,
are: property and casualty insurance, principally personal lines automobile and
homeowners products; annuity products, principally individual, tax-qualified
fixed and variable deposits; and life insurance. The Company does not allocate
the impact of corporate level transactions to the insurance segments, consistent
with management's evaluation of the results of those segments, but classifies
those items in the fourth segment, Corporate and Other. Historically, in
addition to debt service, realized investment gains and losses and certain
public company expenses, such charges have included restructuring charges, debt
retirement costs, litigation charges and the provision for prior years' taxes.
Summarized financial information for these segments is as follows:
Three Months Ended
March 31,
--------------------------
2004 2003
------------ ------------
Insurance premiums written and contract deposits... $ 244,818 $ 219,540
============ ============
Insurance premiums and contract charges earned
Property and casualty........................... $ 139,600 $ 131,594
Annuity......................................... 4,157 3,227
Life............................................ 23,806 23,808
Intersegment eliminations....................... -- (311)
------------ ------------
Total........................................ $ 167,563 $ 158,318
============ ============
Net investment income
Property and casualty........................... $ 8,784 $ 8,232
Annuity......................................... 27,415 26,490
Life............................................ 12,702 13,033
Corporate and other............................. (17) 58
Intersegment eliminations....................... (288) (292)
------------ ------------
Total........................................ $ 48,596 $ 47,521
============ ============
Net income
Property and casualty........................... $ 13,073 $ 6,583
Annuity......................................... 3,905 2,264
Life............................................ 3,097 3,825
Corporate and other............................. 1,616 (4,573)
------------ ------------
Total........................................ $ 21,691 $ 8,099
============ ============
Amortization of intangible assets, pretax
(included in segment net income)
Value of acquired insurance in force
Annuity....................................... $ 936 $ 1,211
Life.......................................... 390 414
------------ ------------
Total........................................ $ 1,326 $ 1,625
============ ============
March 31, December 31,
2004 2003
------------ ------------
Assets
Property and casualty........................... $ 843,361 $ 795,579
Annuity......................................... 3,459,915 3,163,808
Life............................................ 1,161,497 947,468
Corporate and other............................. 109,034 95,505
Intersegment eliminations....................... (54,835) (29,372)
------------ ------------
Total........................................ $ 5,518,972 $ 4,972,988
============ ============
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in millions, except per share data)
Forward-looking Information
Statements made in the following discussion that state the Company's or
management's intentions, hopes, beliefs, expectations or predictions of future
events or the Company's future financial performance are forward-looking
statements and involve known and unknown risks, uncertainties and other factors.
It is important to note that the Company's actual results could differ
materially from those projected in such forward-looking statements due to, among
other risks and uncertainties inherent in the Company's business, the following
important factors:
. Changes in the composition of the Company's assets and liabilities.
. Fluctuations in the market value of securities in the Company's
investment portfolio and the related after-tax effect on the Company's
shareholders' equity and total capital through either realized or
unrealized investment losses. In addition, the impact of fluctuations in
the financial markets on the Company's defined benefit pension plan
assets and the related after-tax effect on the Company's operating
expenses, shareholders' equity and total capital.
. Prevailing interest rate levels, including the impact of interest rates
on (i) unrealized gains and losses in the Company's investment portfolio
and the related after-tax effect on the Company's shareholders' equity
and total capital, (ii) the book yield of the Company's investment
portfolio and (iii) the Company's ability to maintain appropriate
interest rate spreads over the fixed rates guaranteed in the Company's
life and annuity products.
. Defaults on interest or dividend payments in the Company's investment
portfolio due to credit issues and the resulting impact on investment
income.
. The impact of fluctuations in the capital markets on the Company's
ability to refinance outstanding indebtedness or repurchase shares of
the Company's common stock.
. The frequency and severity of catastrophes such as hurricanes,
earthquakes, storms and wildfires, the ability of the Company to
maintain a favorable catastrophe reinsurance program and the
collectibility of reinsurance receivables.
. Adverse development of property and casualty loss experience and its
impact on estimated claims and claim settlement expenses for losses
occurring in prior years.
. The cyclicality of the insurance industry.
. Business risks inherent in the Company's restructuring of its property
and casualty claims operation.
. The risk related to the Company's dated and complex information systems,
which are more prone to error than advanced technology systems.
. Disruptions of the general business climate, investments, capital
markets and consumer attitudes caused by geopolitical acts such as
terrorism, war or other similar events.
. The impact of a disaster or catastrophic event affecting the Company's
employees or its home office facilities and the Company's ability to
recover and resume its business operations on a timely basis.
. The Company's ability to develop and expand its agent 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.
14
. The competitive impact of new entrants such as mutual funds and banks
into the tax-deferred annuity products markets, and the Company's
ability to profitably expand its property and casualty business in
highly competitive environments.
. Changes in insurance regulations, including (i) those affecting the
ability of the Company's insurance subsidiaries to distribute cash to
the holding company and (ii) those impacting the Company's ability to
profitably write property and casualty insurance policies in one or more
states.
. Changes in federal income tax laws and changes resulting from federal
tax audits affecting corporate tax rates or taxable income.
. Changes in federal and state laws and regulations which affect the
relative tax and other advantages of the Company's life and annuity
products to customers.
. The impact of fluctuations in the financial markets on the Company's
variable annuity fee revenues, valuations of deferred policy acquisition
costs and value of acquired insurance in force, and the level of
guaranteed minimum death benefit reserves.
. The Company's ability to maintain favorable claims-paying ability,
financial strength and debt ratings.
. Adverse changes in policyholder mortality and morbidity rates.
. The resolution of legal proceedings and related matters.
Executive Summary
For the first three months of 2004, the Company's net income increased
compared to the prior year, primarily reflecting improved earnings in the
property and casualty segment and realized investment gains in the current
period versus realized losses in the prior year. The improvement in property and
casualty segment earnings was driven by favorable non-catastrophe claims
frequency trends and a relatively low level of catastrophe losses, along with no
adverse development of prior years' reserves. Premiums written and contract
deposits reflected a double digit increase compared to the first quarter of
2003, reflecting significant growth in new annuity deposits and rate increases
in the property and automobile lines.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America ("GAAP") requires
the Company's management to make estimates and assumptions based on information
available at the time the financial statements are prepared. These estimates and
assumptions affect the reported amounts of the Company's assets, liabilities,
shareholders' equity and net income. Certain accounting estimates are
particularly sensitive because of their significance to the Company's financial
statements and because of the possibility that subsequent events and available
information may differ markedly from management's judgements at the time the
financial statements were prepared. Management has discussed with the Audit
Committee the quality, not just the acceptability, of the Company's accounting
principles as applied in its financial reporting. The discussions generally
included such matters as the consistency of the Company's accounting policies
and their application, and the clarity and completeness of the Company's
financial statements, which include related disclosures. For the Company, the
areas most subject to significant management judgements include: liabilities for
property and casualty claims and claim settlement expenses, liabilities for
future policy benefits, deferred policy acquisition costs, value of acquired
insurance in force, valuation of investments and valuation of assets and
liabilities related to the defined benefit pension plan.
15
Liabilities for Property and Casualty Claims and Claim Settlement Expenses
Underwriting results of the property and casualty segment are significantly
influenced by estimates of the Company's ultimate liability for insured events.
There is a high degree of uncertainty inherent in the estimates of ultimate
losses underlying the liability for unpaid claims and claim settlement expenses.
This inherent uncertainty is particularly significant for liability-related
exposures due to the extended period, often many years, that transpires between
a loss event, receipt of related claims data from policyholders and ultimate
settlement of the claim. Reserves for property and casualty claims include
provisions for payments to be made on reported claims, claims incurred but not
yet reported and associated settlement expenses. The process by which these
reserves are established requires reliance upon estimates based on known facts
and on interpretations of circumstances, including the Company's experience with
similar cases and historical trends involving claim payment patterns, claim
payments, pending levels of unpaid claims and product mix, as well as other
factors including court decisions, economic conditions and public attitudes.
The Company continually updates loss estimates using both quantitative
information from its reserving actuaries and qualitative information derived
from other sources. Adjustments may be required as information develops which
varies from experience, or, in some cases, augments data which previously were
not considered sufficient for use in determining liabilities. The effects of
these adjustments may be significant and are charged or credited to income for
the period in which the adjustments are made. Detailed discussion of the impact
of adjustments recorded during recent years is included in the Company's 2003
Annual Report on Form 10-K in "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Results of Operations for the Three Years
Ended December 31, 2003 -- Benefits, Claims and Settlement Expenses". Due to the
nature of the Company's personal lines business, the Company has no exposure to
claims for toxic waste cleanup, other environmental remediation or
asbestos-related illnesses other than claims under homeowners insurance policies
for environmentally related items such as toxic mold.
The Company completes a detailed study of property and casualty reserves
based on information available at the end of each quarter and year. Trends of
reported losses (paid amounts and case reserves on claims reported to the
Company) for each accident year are reviewed and ultimate loss costs for those
accident years are estimated. The Company engages an independent property and
casualty actuarial consulting firm to prepare an independent study of the
Company's property and casualty reserves at June 30 and December 31.
Reserves for Future Policy Benefits
Liabilities for future benefits on life and annuity policies are
established in amounts adequate to meet the estimated future obligations on
policies in force. Liabilities for future policy benefits on certain life
insurance policies are computed using the net level premium method and are based
on assumptions as to future investment yield, mortality and withdrawals.
Mortality and withdrawal assumptions for all policies have been based on
actuarial tables which are consistent with the Company's own experience.
Liabilities for future benefits on annuity contracts and certain long-duration
life insurance contracts are carried at accumulated policyholder values without
reduction for potential surrender or withdrawal charges. In the event actual
experience varies from the estimated liabilities, adjustments are charged or
credited to income for the period in which the adjustments are made.
16
Deferred Policy Acquisition Costs and Value of Acquired Insurance in Force
for Annuity and Interest-Sensitive Life Products
Policy acquisition costs, consisting of commissions, policy issuance and
other costs, which vary with and are primarily related to the production of
business, are capitalized and amortized on a basis consistent with the type of
insurance coverage. For investment (annuity) contracts, acquisition costs, and
also the value of annuity business acquired in the 1989 acquisition of the
Company ("Annuity VIF"), are amortized over 20 years in proportion to estimated
gross profits. Capitalized acquisition costs for interest-sensitive life
contracts are also amortized over 20 years in proportion to estimated gross
profits.
The most significant assumptions that are involved in the estimation of
annuity gross profits include future financial market performance, interest rate
spreads, business surrender/lapse rates and the impact of realized investment
gains and losses. For the variable deposit portion of the annuity segment, the
Company amortizes policy acquisition costs and the Annuity VIF utilizing a
future financial market performance assumption of a 10% reversion to the mean
approach with a 200 basis point corridor around the mean. At March 31, 2004, the
ratio of capitalized annuity policy acquisition costs and the Annuity VIF asset
to the total annuity accumulated cash value was approximately 4%.
In the event actual experience differs significantly from assumptions or
assumptions are significantly revised, the Company may be required to record a
material charge or credit to amortization expense for the period in which the
adjustment is made. As noted above, there are a number of assumptions involved
in the valuation of capitalized policy acquisition costs and the Annuity VIF. As
one example of the volatility of this amortization, if all other assumptions are
met, a 1% deviation from the targeted financial market performance for the
underlying mutual funds of the Company's variable annuities would currently
impact amortization between $0.1 million and $0.2 million. This result may
change depending on the magnitude and direction of the deviation. Detailed
discussion of the impact of adjustments to the amortization of capitalized
acquisition costs and Annuity VIF is included in "Results of Operations --
Amortization of Policy Acquisition Expenses and Intangible Assets".
Valuation of Investments
The Company's methodology of assessing other-than-temporary impairments is
based on security-specific facts and circumstances as of the date of the
reporting period. Based on these facts, if management believes it is probable
that amounts due will not be collected according to the contractual terms of a
debt security not impaired at acquisition, or if the Company does not have the
ability or intent to hold a security with an unrealized loss until it matures or
recovers in value, an other-than-temporary impairment shall be considered to
have occurred. As a general rule, if the fair value of a debt security has
fallen below 80% of book value for more than six months, this security will be
reviewed for an other-than-temporary impairment. Additionally, if events become
known that call into question whether the security issuer has the ability to
honor its contractual commitments, whether or not such security has been trading
above an 80% fair value to book value relationship, such security holding will
be evaluated to determine whether or not such security has suffered an
other-than-temporary decline in value.
17
The Company reviews the fair value of all investments in its portfolio on a
monthly basis to assess whether an other-than-temporary decline in value has
occurred. These reviews, in conjunction with the Company's investment managers'
monthly credit reports and relevant factors such as (1) the financial condition
and near-term prospects of the issuer, (2) the Company's intent and ability to
retain the investment long enough to allow for the anticipated recovery in fair
value, (3) the stock price trend of the issuer, (4) the market leadership
position of the issuer, (5) the debt ratings of the issuer and (6) the cash
flows of the issuer, are all considered in the impairment assessment. A
write-down of an investment is recorded when a decline in the fair value of that
investment is deemed to be other-than-temporary, with a realized investment loss
charged to income for the period.
A decline in fair value below amortized cost is not assumed to be
other-than-temporary for fixed maturity investments with unrealized losses due
to market conditions or industry-related events where there exists a reasonable
market recovery expectation and the Company has the intent and ability to hold
the investment until maturity or a market recovery is realized. An
other-than-temporary impairment loss will be recognized based upon all relevant
facts and circumstances for each investment, as appropriate, in accordance with
Securities and Exchange Commission Staff Accounting Bulletin ("SAB") No. 59,
"Accounting for Non-Current Marketable Equity Securities", Financial Accounting
Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS")
No. 115, "Accounting for Certain Investments in Debt and Equity Securities", and
related guidance.
Valuation of Assets and Liabilities Related to the Defined Benefit Pension
Plan
Effective April 1, 2002, participants stopped accruing benefits under the
defined benefit plan but continue to retain the benefits they had accrued to
date.
The Company's cost estimates for its defined benefit pension plan are
determined annually based on assumptions which include the discount rate,
expected return on plan assets, anticipated retirement rate and estimated lump
sum distributions. A discount rate of 6.25% was used by the Company at December
31, 2003, which was based on the average yield for long-term, high grade
securities having maturities generally consistent with the defined benefit
pension payout period. To set its discount rate, the Company looks to leading
indicators, including Moody's Aa long-term bond index. The expected annual
return on plan assets assumed by the Company at December 31, 2003 was 7.50%. The
assumption for the long-term rate of return on plan assets was determined by
considering actual investment experience during the lifetime of the plan,
balanced with reasonable expectations of future growth considering the various
classes of assets and percentage allocation for each asset class. Management
believes that it has adopted realistic assumptions for investment returns,
discount rates and other key factors used in the estimation of pension costs and
asset values.
To the extent that actual experience differs from the Company's
assumptions, subsequent adjustments may be required, with the effects of those
adjustments charged or credited to income and/or shareholders' equity for the
period in which the adjustments are made. Generally, a change of 50 basis points
in the discount rate would inversely impact pension expense and accumulated
other comprehensive income ("AOCI") by approximately $0.2 million and $2
million, respectively. In addition, for every $1 million increase in the value
of pension plan assets, there is an equal increase in AOCI.
18
Results of Operations
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
Three Months Ended Growth Over
March 31, Prior Year
--------------------------- ---------------------------
2004 2003 Percent Amount
------------ ------------ ------------ ------------
Property & casualty
Automobile and property (voluntary)........ $ 134.0 $ 128.5 4.3% $ 5.5
Involuntary and other
property & casualty..................... 0.7 0.1 0.6
------------ ------------ ------------
Total property & casualty............ 134.7 128.6 4.7% 6.1
Annuity deposits.............................. 84.2 64.3 30.9% 19.9
Life.......................................... 25.9 26.7 -3.0% (0.8)
------------ ------------ ------------
Total................................ $ 244.8 $ 219.6 11.5% $ 25.2
============ ============ ============
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
Three Months Ended Growth Over
March 31, Prior Year
--------------------------- ---------------------------
2004 2003 Percent Amount
------------ ------------ ------------ ------------
Property & casualty
Automobile and property (voluntary)........ $ 137.5 $ 129.4 6.3% $ 8.1
Involuntary and other
property & casualty..................... 2.1 2.2 -4.5% (0.1)
------------ ------------ ------------
Total property & casualty............ 139.6 131.6 6.1% 8.0
Annuity....................................... 4.2 3.2 31.3% 1.0
Life.......................................... 23.8 23.5 1.3% 0.3
------------ ------------ ------------
Total................................ $ 167.6 $ 158.3 5.9% $ 9.3
============ ============ ============
For the first three months of 2004, the Company's premiums written and
contract deposits increased 11.5% over the prior year as a result of growth in
new annuity deposits and rate increases in the voluntary property and automobile
lines. Voluntary property and casualty business represents policies sold through
the Company's marketing organization and issued under the Company's underwriting
guidelines. Involuntary property and casualty business consists of allocations
of business from state mandatory insurance facilities and assigned risk
business.
The Company's exclusive agent force totaled 830 at March 31, 2004,
reflecting a decrease of 6.1% compared to 884 agents a year earlier. Of the
current period-end total, 334 agents were in their first 24 months with the
Company, reflecting a decrease of 13.7% compared to March 31, 2003. Current
period new hires were less than for the first three months of 2003, reflecting
the Company's more stringent selection criteria, while agent terminations were
slightly below the prior year. The number of experienced agents in the agent
force, 496, was comparable to a year earlier. Average agent productivity for all
lines of business combined increased more than 20% compared to the first three
months of 2003. Average agent productivity is measured as new sales premiums
from the exclusive agent force per the average number of exclusive agents for
the period.
19
First quarter 2004 total sales, which include the independent agent
distribution channel, increased 39.3% compared to a year earlier, largely due to
the growing contribution of annuity business from the independent agent
distribution channel and an increase in new annuity business produced by the
Company's exclusive agent force.
The Company's results have been impacted by ongoing and recurring
proceedings in North Carolina challenging private passenger automobile rates.
This has required the Company to escrow premiums received pending resolution of
these proceedings, adversely impacting earned premiums and pretax income for the
three months ended March 31, 2003 by $0.9 million. No additional escrow amounts
were required in the current period.
Total voluntary automobile and homeowners premium written increased 4.3% in
the first three months of 2004. Voluntary automobile insurance premium written
increased 3.8% ($3.7 million) compared to the first quarter of 2003, and
homeowners premium increased 6.0% ($1.8 million). The increases in property and
casualty premiums resulted from the impact of rate increases on average premium
per policy. Average written premium was up approximately 4% for voluntary
automobile and approximately 7% for homeowners compared to the prior year.
Average earned premium increased 5% for voluntary automobile and 11% for
homeowners for the same period. Through March 31, 2004, approved rate increases
for the Company's automobile and homeowners business were 7% and 17%,
respectively, compared to approved increases of 7% and 19%, respectively, during
the first three months of 2003. As of March 31, 2004, automobile policies in
force decreased by 6,000 compared to both December 31, 2003 and March 31, 2003,
reflecting a decrease in non-educator policies which was partially offset by an
increase in policies for educators. Homeowners policies in force decreased 1,000
compared to December 31, 2003 and 3,000 compared to March 31, 2003, reflecting
expected reductions due to the Company's pricing and underwriting actions. At
March 31, 2004, there were 565,000 voluntary automobile and 278,000 homeowners
policies in force, for a total of 843,000.
Based on policies in force, the property and casualty 12-month retention
rate for new and renewal policies was 87% at both March 31, 2004 and 2003. The
Company plans additional rate increases in 2004 for both its automobile and
homeowners lines of business, which may have an adverse impact on policy
retention.
Compared to the first three months of 2003, new annuity deposits increased
30.9%, primarily reflecting a 90.5% increase in single premium and rollover
deposits minimally offset by a 1.6% decrease in new scheduled annuity deposits.
New deposits to fixed accounts were 32.2%, or $12.9 million, higher than in 2003
and new deposits to variable accounts increased 28.9%, or $7.0 million, compared
to a year earlier.
In 2001, the Company began building a nationwide network of independent
agents who will comprise a second distribution channel for the Company's 403(b)
tax-qualified annuity products. The independent agent distribution channel,
which included 514 authorized agents at March 31, 2004, generated $17.5 million
in annualized new Horace Mann annuity sales during the first three months of
2004, compared to $2.5 million for the first quarter of 2003 and $38.1 million
for the full year 2003.
20
Total annuity accumulated cash value of $2.8 billion at March 31, 2004
increased 18.0% compared to a year earlier, reflecting the growth in sales over
the 12 months, continued favorable retention and an improving equity market. The
number of annuity contracts outstanding increased 0.7%, or 1,000 contracts,
compared to December 31, 2003 and 4.1%, or 6,000 contracts, compared to March
31, 2003.
For the three months ended March 31, 2004, annuity segment contract charges
earned increased 31.3%, or $1.0 million, compared to a year earlier. Declines in
market valuations during 2002 and the first quarter of 2003 resulted in lower
variable accumulated balances in force against which contract charges are
principally applied. Market appreciation in the last nine months of 2003 and the
first three months of 2004, however, resulted in variable annuity accumulated
balances at March 31, 2004 which were 32.4% higher than at March 31, 2003.
Life segment premiums and contract deposits declined slightly compared to
the first three months of 2003. The ordinary life insurance in force lapse ratio
improved to 7.2% for the twelve months ended March 31, 2004 compared to 9.1% for
the same period a year earlier.
Net Investment Income
Pretax investment income of $48.6 million for the three months ended March
31, 2004 increased 2.3%, or $1.1 million, (3.1%, or $1.0 million, after tax)
compared to the prior year. Prepayments on a structured mortgage-backed security
and tender offer consent fees represented approximately $2 million of the
variance, with a decline in the portfolio yield more than offsetting growth in
the size of the investment portfolio. Average investments (excluding securities
lending collateral) increased 8.8% over the past 12 months. The average pretax
yield on the investment portfolio was 5.9% (4.0% after tax) for the first three
months of 2004 compared to a pretax yield of 6.3% (4.3% after tax) for the same
period in 2003.
Realized Investment Gains and Losses
Net realized investment gains were $5.3 million for the first quarter of
2004 compared to realized investment losses of $4.7 million in the prior year.
For the first three months of 2003, the Company recorded fixed income security
impairment charges totaling $6.1 million, $3.0 million related to one of the
Company's collateralized debt obligation ("CDO") securities and the remaining
$3.1 million primarily related to two airline industry issuers. In the current
period, there were no investment impairment charges. Net realized investment
gains and losses for both periods also reflected gains realized from ongoing
investment portfolio management activity.
In the first quarter of 2003, the impaired securities were marked to fair
value, and the write-downs were recorded as realized investment losses in the
Statement of Operations. These impairments were deemed to be
other-than-temporary for one or more of the following reasons: the recovery of
full value was not likely, the issuer defaulted or was likely to default due to
the need to restructure its debt, or the Company had an intent to sell the
security in the near future.
21
The table below presents the Company's fixed maturity securities portfolio
as of March 31, 2004 by major asset class, including the ten largest sectors of
the Company's corporate bond holdings.
Pretax
Number of Fair Amortized Unrealized
Issuers Value Cost Gain(Loss)
--------- ------------ ------------ ------------
Corporate bonds
Banking and Finance........................ 34 $ 316.2 $ 285.3 $ 30.9
Energy..................................... 42 226.1 207.1 19.0
Food and Beverage.......................... 25 138.6 130.0 8.6
Telecommunications......................... 22 133.5 119.0 14.5
Utilities.................................. 18 122.7 115.5 7.2
Transportation............................. 10 88.2 85.5 2.7
Insurance.................................. 10 85.6 79.6 6.0
Industry, Manufacturing.................... 21 77.4 72.9 4.5
Broadcasting and Media..................... 19 51.4 46.0 5.4
Real Estate................................ 6 49.2 44.4 4.8
All Other Corporates (1)................... 126 406.7 380.1 26.6
--------- ------------ ------------ ------------
Total corporate bonds................... 333 1,695.6 1,565.4 130.2
Mortgage-backed securities
Government................................. 441 724.7 709.0 15.7
Other...................................... 22 45.3 42.7 2.6
Municipal bonds............................... 164 567.5 549.3 18.2
Government bonds
U.S. ...................................... 5 196.7 187.2 9.5
Foreign.................................... 8 35.0 30.7 4.3
Collateralized debt obligations (2)........... 6 28.0 27.7 0.3
Asset-backed securities....................... 10 46.2 45.1 1.1
--------- ------------ ------------ ------------
Total fixed maturity securities......... 989 $ 3,339.0 $ 3,157.1 $ 181.9
========= ============ ============ ============
- ----------
(1) The All Other Corporates category contains 18 additional industry
classifications. Automobiles, retail, paper, healthcare, defense, consumer
products, chemicals and metals represented $310.3 million of fair value at
March 31, 2004, with the remaining 10 classifications each representing
less than $28 million of the fair value at March 31, 2004.
(2) All of the securities were rated investment grade by Standard and Poor's
Corporation and/or Moody's Investors Service, Inc. at March 31, 2004.
22
At March 31, 2004, the Company's diversified fixed maturity portfolio
consisted of 1,153 investment positions and totaled approximately $3.3 billion
in fair value. The portfolio was 94.6% investment grade, based on fair value,
with an average quality rating of AA-. At March 31, 2004, the portfolio had
approximately $5 million pretax of total gross unrealized losses related to 105
positions. At December 31, 2003, the total pretax gross unrealized losses were
approximately $11 million related to 113 positions. The following table provides
information regarding fixed maturity securities that had an unrealized loss at
March 31, 2004, including the length of time that the securities have
continuously been in an unrealized loss position.
Investment Positions With Unrealized Losses Segmented by Quality
and Period of Continuous Unrealized Loss
As of March 31, 2004
Pretax
Number of Fair Amortized Unrealized
Positions Value Cost Loss
--------- ------------ ------------ ------------
Investment grade
6 Months or less........................... 22 $ 95.8 $ 97.2 $ (1.4)
7 through 12 months........................ 26 132.1 134.3 (2.2)
13 through 24 months....................... 2 7.4 7.8 (0.4)
25 through 36 months....................... 1 2.9 3.0 (0.1)
37 through 48 months....................... -- -- -- --
Greater than 48 months..................... -- -- -- --
--------- ------------ ------------ ------------
Total................................... 51 238.2 242.3 (4.1)
--------- ------------ ------------ ------------
Non-investment grade
6 Months or less........................... 44 24.0 24.7 (0.7)
7 through 12 months........................ 1 3.0 3.0 *
13 through 24 months....................... -- -- -- --
25 through 36 months....................... -- -- -- --
37 through 48 months....................... 1 5.8 6.0 (0.2)
Greater than 48 months..................... 2 3.4 3.7 (0.3)
--------- ------------ ------------ ------------
Total................................... 48 36.2 37.4 (1.2)
--------- ------------ ------------ ------------
Not rated
Total, all 13 through 24 months......... 6 2.6 2.6 *
--------- ------------ ------------ ------------
Grand total.......................... 105 $ 277.0 $ 282.3 $ (5.3)
========= ============ ============ ============
- -------------
* Less than $(0.1) million
Of the securities with unrealized losses, no issuers had pretax unrealized
losses greater than $1 million and no securities were trading below 80% of book
value at March 31, 2004. The Company views the decrease in value of all of the
securities with unrealized losses at March 31, 2004 as temporary, expects
recovery in fair value, anticipates continued payments under the terms of the
securities, and has the intent and ability to hold these securities until
maturity or a recovery in fair value occurs. Therefore, no impairment of these
securities was recorded at March 31, 2004. Future changes in circumstances
related to these and other securities could require subsequent impairment in
value. The Company's investment guidelines generally limit single corporate
issuer concentrations to 4.0% (after tax) of shareholders' equity for "AA" or
"AAA" rated securities, 2.5% (after tax) of shareholders' equity for "A" rated
securities, 2.0% (after tax) of shareholders' equity for "BBB" rated securities,
and 1.0% (after tax) of shareholders' equity for non-investment grade
securities.
23
Benefits, Claims and Settlement Expenses
Three Months Ended Growth Over
March 31, Prior Year
---------------------- ---------------------
2004 2003 Percent Amount
--------- ---------- --------- ---------
Property and casualty......... $ 99.6 $ 99.3 0.3% $ 0.3
Annuity....................... 0.1 0.5 -80.0% (0.4)
Life.......................... 11.8 11.1 6.3% 0.7
--------- ---------- ---------
Total...................... $ 111.5 $ 110.9 0.5% $ 0.6
========= ========== =========
Property and Casualty Claims and Claim Expenses
Three Months Ended
March 31,
---------------------------
2004 2003
------------ ------------
Incurred claims and claim expenses:
Claims occurring in the current year..................... $ 99.6 $ 95.0
Increase in estimated reserves for claims
occurring in prior years (1):
Policies written by the Company....................... -- 3.8
Business assumed from state reinsurance facilities.... -- 0.5
------------ ------------
Total increase..................................... -- 4.3
------------ ------------
Total claims and claim expenses incurred........... $ 99.6 $ 99.3
============ ============
Net reserves, end of period................................. $ 326.9 $ 275.7
Plus reinsurance recoverables............................ 20.4 31.1
------------ ------------
Gross reserves, end of period............................... $ 347.3 $ 306.8
============ ============
Property and casualty GAAP loss ratio:
Before catastrophe losses................................ 70.4% 73.9%
After catastrophe losses................................. 71.3% 75.5%
Property and casualty GAAP loss ratio excluding net
increases in estimated reserves for claims
occurring in prior years:
Before catastrophe losses................................ 70.4% 70.6%
After catastrophe losses................................. 71.3% 72.2%
- ----------
(1) Shows the amounts by which the Company increased its reserves in each of
the periods indicated for claims occurring in previous periods to reflect
subsequent information on such claims and changes in their projected final
settlement costs.
For the three months ended March 31, 2004, the voluntary automobile loss
ratio decreased by 2.9 percentage points compared to a year earlier, primarily
reflecting adverse development and strengthening of prior years' reserves
recorded in 2003 as described below. The Company's benefits, claims and
settlement expenses also reflected a 14.1 percentage point improvement in the
homeowners loss ratio as a result of the Company's claims initiatives, focused
on loss and expense control, the favorable impact of rate increases on earned
premiums and relatively mild weather in the current period.
24
Excluding involuntary business, net adverse development of reserves for
property and casualty claims occurring in prior years was $3.8 million for the
first three months of 2003, primarily related to automobile liability loss
reserves from accident years 2001 and prior, compared to no adverse reserve
development in the current period. The Company's property and casualty reserves
were $326.9 million and $320.9 million at March 31, 2004 and December 31, 2003,
respectively, net of anticipated reinsurance recoverables.
For the first three months of 2004, total incurred property and casualty
catastrophe losses were $1.2 million, compared to $2.1 million a year earlier.
The current period decrease generated approximately 1 percentage point of the
improvement in the property and casualty loss ratio.
The property loss ratio of 60.0% for the first three months of 2004
decreased 14.1 percentage points compared to a year earlier. This improvement
reflected an increase in average premium per policy, benefits of the Company's
claims initiatives and an improvement in loss frequency as a result of loss
containment initiatives such as tightened underwriting guidelines, deductible
management and an aggressive reunderwriting program. In addition, the weather
was relatively mild during the first three months of 2004.
For the three months ended March 31, 2004, the voluntary automobile loss
ratio of 73.4% decreased 2.9 percentage points compared to the prior year. The
loss ratio in 2003 included 5.9 percentage points due to adverse development of
prior years' reserves compared to no impact in the current period.
Effective January 1, 2004, the Company adopted American Institute of
Certified Public Accountants ("AICPA") Statement of Position ("SOP") 03-1,
"Accounting and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts for Separate Accounts". The new rules changed the
accounting for separate accounts and sales inducements and changed the liability
model by expanding the definition of "account balance" and addressing
annuitization guarantees and guaranteed minimum death benefits ("GMDB")
reserves. The adoption of this SOP reduced the Company's GAAP GMDB reserve from
$0.1 million at December 31, 2003 to zero at March 31, 2004.
Interest Credited to Policyholders
Three Months Ended Growth Over
March 31, Prior Year
---------------------- ---------------------
2004 2003 Percent Amount
--------- ---------- --------- ---------
Annuity....................... $ 18.3 $ 17.7 3.4% $ 0.6
Life.......................... 8.1 7.7 5.2% 0.4
--------- ---------- ---------
Total...................... $ 26.4 $ 25.4 3.9% $ 1.0
========= ========== =========
Compared to the prior year, the current period increase in annuity segment
interest credited reflected a 9.8% increase in average accumulated fixed
deposits, partially offset by a 24 basis point decline in the average annual
interest rate credited to 4.5%. Life insurance interest credited increased as a
result of the growth in interest-sensitive life insurance reserves.
25
Operating Expenses
For the first three months of 2004, operating expenses were equal to the
prior year. The property and casualty GAAP expense ratio of 22.2% for the three
months ended March 31, 2004 decreased 1.8 percentage points compared to the
prior year, primarily reflecting the growth in premium for the property and
casualty segment.
Amortization of Policy Acquisition Expenses and Intangible Assets
For the three months ended March 31, 2004, the combined amortization of
policy acquisition expenses and intangible assets was $17.7 million compared to
$18.7 million recorded in the prior year. Amortization of intangible assets was
$1.3 million for the three months ended March 31, 2004 compared to $1.6 million
for the same period a year earlier. The March 31, 2003 valuation of Annuity VIF
resulted in a $0.3 million increase in amortization compared to no impact from a
similar valuation at March 31, 2004.
Amortized policy acquisition expenses of $16.4 million for the first three
months of 2004 were $0.7 million less than the prior year, primarily related to
the annuity segment. The March 31, 2004 valuation of annuity deferred policy
acquisition costs resulted in a $0.4 million reduction in amortization compared
to a $0.7 million increase in amortization resulting from a similar valuation at
March 31, 2003.
Income Tax Expense
The effective income tax rate on the Company's pretax income, including
realized investment gains and losses, was 29.1% for the three months ended March
31, 2004 compared to 25.7% for the same period in 2003.
Income from investments in tax-advantaged securities reduced the effective
income tax rate 5.4 and 12.7 percentage points for the three months ended March
31, 2004 and 2003, respectively. While the amount of income from tax-advantaged
securities in the current period increased compared to a year earlier, the
reduced level of income before income taxes in 2003 resulted in this having a
more significant impact on the 2003 effective income tax rate.
26
Net Income
Net income (loss) by segment and net income per share were as follows:
Three Months Ended Growth Over
March 31, Prior Year
--------------------------- ---------------------------
2004 2003 Percent Amount
------------ ------------ ------------ ------------
Net income (loss)
Property & casualty
Before catastrophe losses............... $ 13.9 $ 8.0 73.8% $ 5.9
Catastrophe losses, after tax........... (0.8) (1.4) 0.6
------------ ------------ ------------
Total including catastrophe losses... 13.1 6.6 98.5% 6.5
Annuity.................................... 3.9 2.3 69.6% 1.6
Life....................................... 3.1 3.8 -18.4% (0.7)
Corporate and other (1).................... 1.6 (4.6) 6.2
------------ ------------ ------------
Total................................ $ 21.7 $ 8.1 167.9% $ 13.6
============ ============ ============
Net income per share, diluted................. $ 0.51 $ 0.19 168.4% $ 0.32
============ ============ ============
Property and casualty GAAP combined ratio:
Before catastrophe losses............... 92.6% 97.9% -5.3%
After catastrophe losses................ 93.5% 99.5% -6.0%
Property and casualty GAAP combined ratio
excluding net increases in estimated reserves
for claims occurring in prior years:
Before catastrophe losses............... 92.6% 94.6% -2.0%
After catastrophe losses................ 93.5% 96.2% -2.7%
- ----------
(1) The Corporate and Other segment includes interest expense on debt, realized
investment gains and losses, certain public company expenses and other
corporate level items. The Company does not allocate the impact of
corporate level transactions to the insurance segments, consistent with
management's evaluation of the results of those segments.
For the first three months of 2004, net income for the property and
casualty segment improved compared to the prior year, driven by favorable
non-catastrophe frequency trends for automobile and property claims, a
relatively low level of catastrophe losses, the impact of the Company's claims
initiatives focused on loss and expense control, an improving expense ratio, and
no adverse development of prior years' reserves.
Current period annuity segment net income increased compared to a year
earlier, driven by growth in contract fees and favorable adjustments from the
March 31, 2004 valuations of Annuity VIF, deferred acquisition costs and
guaranteed minimum death benefit reserves, compared to unfavorable adjustments
resulting from similar valuations a year earlier. The growth in contract fees
was due to growth in the underlying accumulated amounts on deposit.
Life segment net income decreased compared to the first quarter of 2003,
due primarily to a decline in group insurance earnings, lower investment income
and valuation of deferred policy acquisition costs.
27
The change in the net income (loss) for the Corporate and Other segment
compared to the first quarter of 2003 primarily reflected realized investment
gains in the current period compared to realized investment losses, including
impairment charges, in the prior year.
Return on shareholders' equity based on net income was 6% and 1% for the 12
months ended March 31, 2004 and 2003, respectively.
Based on the Company's full year 2003 generally positive underlying
operating trends and first quarter 2004 results, at the time of this Report on
Form 10-Q management anticipates that 2004 full year net income before realized
investment gains and losses will be within a range of $1.20 to $1.30 per share.
This projection reflects management's anticipation of improvement compared to
2003 in the underlying (current accident year) property and casualty combined
ratio and stabilization of income from the annuity and life segments. As
described in "Critical Accounting Policies", certain of the Company's
significant accounting measurements require the use of estimates and
assumptions. As additional information becomes available, adjustments may be
required. Those adjustments are charged or credited to income for the period in
which the adjustments are made and may impact actual results compared to
management's current estimate. A projection of net income is not accessible on a
forward-looking basis because it is not possible to provide a reliable forecast
of realized investment gains and losses, which can vary substantially from one
period to another and may have a significant impact on net income.
Liquidity and Financial Resources
Special Purpose Entities
At March 31, 2004 and 2003, the Company did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or for other contractually narrow or limited purposes. As such, the Company is
not exposed to any financing, liquidity, market or credit risk that could arise
if the Company had engaged in such relationships.
Related Party Transactions
The Company does not have any contracts or other transactions with related
parties that are required to be reported under the applicable securities laws
and regulations.
Ariel Capital Management, Inc., HMEC's largest shareholder with 30% of the
common shares outstanding per their SEC filing on Form 13F as of December 31,
2003, is the investment adviser for two of the mutual funds offered to the
Company's annuity customers. In addition, T. Rowe Price Associates, Inc., HMEC's
third largest shareholder with 8% of the common shares outstanding per their SEC
filing on Form 13F as of December 31, 2003, is the investment advisor for three
of the mutual funds offered to the Company's annuity customers.
Investments
Information regarding the Company's investment portfolio, which is
comprised primarily of investment grade, fixed income securities, is located in
"Realized Investment Gains and Losses" and in the Notes to Financial Statements,
"Note 5 -- Investments".
28
Cash Flow
The short-term liquidity requirements of the Company, within a 12-month
operating cycle, are for the timely payment of claims and benefits to
policyholders, operating expenses, interest payments and federal income taxes.
Cash flow in excess of these amounts has been used to fund business growth,
retire short-term debt, pay dividends to shareholders and repurchase shares of
the Company's common stock. Long-term liquidity requirements, beyond one year,
are principally for the payment of future insurance policy claims and benefits
and retirement of long-term debt.
Operating Activities
As a holding company, HMEC conducts its principal operations in the
personal lines segment of the property and casualty and life insurance
industries through its subsidiaries. HMEC's insurance subsidiaries generate cash
flow from premium and investment income, generally well in excess of their
immediate needs for policy obligations, operating expenses and other cash
requirements. Cash provided by operating activities primarily reflects net cash
generated by the insurance subsidiaries. For the first three months of 2004, net
cash provided by operating activities increased compared to the same period in
2003 reflecting increased insurance underwriting cash flow and an absence of
federal income tax payments in the current period.
Payment of principal and interest on debt, fees related to the
catastrophe-linked equity put option and reinsurance agreement, dividends to
shareholders and parent company operating expenses, as well as the share
repurchase program, are dependent upon the ability of the insurance subsidiaries
to pay cash dividends or make other cash payments to HMEC, including tax
payments pursuant to tax sharing agreements. The insurance subsidiaries are
subject to various regulatory restrictions which limit the amount of annual
dividends or other distributions, including loans or cash advances, available to
HMEC without prior approval of the insurance regulatory authorities. Dividends
which may be paid by the insurance subsidiaries to HMEC during 2004 without
prior approval are approximately $43 million, of which $5.0 million was paid
during the three months ended March 31, 2004. Although regulatory restrictions
exist, dividend availability from subsidiaries has been, and is expected to be,
adequate for HMEC's capital needs.
Investing Activities
HMEC's insurance subsidiaries maintain significant investments in fixed
maturity securities to meet future contractual obligations to policyholders. In
conjunction with its management of liquidity and other asset/liability
management objectives, the Company, from time to time, will sell fixed maturity
securities prior to maturity and reinvest the proceeds in other investments with
different interest rates, maturities or credit characteristics. Accordingly, the
Company has classified the entire fixed maturity securities portfolio as
"available for sale".
Financing Activities
Financing activities include primarily payment of dividends, the receipt
and withdrawal of funds by annuity contractholders, repurchases of the Company's
common stock, and borrowings, repayments and repurchases related to its debt
facilities. Fees related to the catastrophe-linked equity put option and
reinsurance agreement, which augments the Company's traditional reinsurance
program, have been charged directly to additional paid-in capital.
29
For the three months ended March 31, 2004, receipts from annuity contracts
increased 30.9%. Annuity contract maturities and withdrawals were comparable to
the prior year. Cash value retentions for variable and fixed annuity options
were 92.9% and 95.2%, respectively, for the 12 month period ended March 31,
2004. Net transfers to variable annuity accumulated cash values increased $10.7
million compared to the prior year.
Contractual Obligations
Payments Due By Period
As of December 31, 2003
-------------------------------------------------------------------
More Than
Less Than 1 - 3 Years 3 - 5 Years 5 Years
1 Year (2005 and (2007 and (2009 and
Total (2004) 2006) 2008) beyond)
----------- ----------- ----------- ----------- -----------
Short-term Obligations (1):
Bank Credit Facility......... $ 25,781 $ 550 $ 25,231 -- --
Long-Term Debt Obligations (1):
Convertible Notes Due 2032... 256,694 3,484 6,968 $ 1,742 $ 244,500
Senior Notes Due 2006........ 33,337 1,895 31,442 -- --
----------- ----------- ----------- ----------- -----------
Total..................... $ 315,812 $ 5,929 $ 63,641 $ 1,742 $ 244,500
=========== =========== =========== =========== ===========
- -----------
(1) Includes principal and interest.
The Company has entered into various operating lease agreements, primarily
for computer equipment, computer software and real estate (agency and claims
offices across the country and portions of the home office complex). These
leases have varying commitment periods with most in the 1 to 3 year range.
Payments on these leases were approximately $10 million in 2003. It is
anticipated that the Company's payments under operating leases for the full year
2004 will be comparable to the 2003 payments. The Company does not have any
other arrangements that expose it to material liability that are not recorded in
the financial statements.
Capital Resources
The Company has determined the amount of capital which is needed to
adequately fund and support business growth, primarily based on risk-based
capital formulas including those developed by the National Association of
Insurance Commissioners ("NAIC"). Historically, the Company's insurance
subsidiaries have generated capital in excess of such needed capital. These
excess amounts have been paid to HMEC through dividends. HMEC has then utilized
these dividends and its access to the capital markets to service and retire
long-term debt, increase and pay dividends to its shareholders, fund growth
initiatives, repurchase shares of its common stock and for other corporate
purposes. Management anticipates that the Company's sources of capital will
continue to generate capital in excess of the needs for business growth, debt
interest payments and shareholder dividends.
The total capital of the Company was $746.2 million at March 31, 2004,
including $144.7 million of long-term debt and $25.0 million of short-term debt
outstanding. Total debt represented 26.7% of capital excluding unrealized
investment gains and losses (22.7% including unrealized investment gains and
losses) at March 31, 2004, slightly above the Company's long-term target of 25%.
30
Shareholders' equity was $576.5 million at March 31, 2004, including a net
unrealized gain in the Company's investment portfolio of $110.5 million after
taxes and the related impact on deferred policy acquisition costs and the value
of acquired insurance in force associated with annuity and interest-sensitive
life policies. The market value of the Company's common stock and the market
value per share were $671.6 million and $15.72, respectively, at March 31, 2004.
Book value per share was $13.50 at March 31, 2004 ($10.91 excluding investment
fair value adjustments).
As of March 31, 2004, the Company had outstanding $244.5 million aggregate
principal amount of 1.425% Senior Convertible Notes ("Senior Convertible
Notes"), which will mature on May 14, 2032, issued at a discount of 52.5%
resulting in an effective yield of 3.0%. Interest on the Senior Convertible
Notes is payable semi-annually at a rate of 1.425% from November 14, 2002 until
May 14, 2007. After that date, cash interest will not be paid on the Senior
Convertible Notes prior to maturity unless contingent cash interest becomes
payable. From May 15, 2007 through maturity of the Senior Convertible Notes,
interest will be recognized at the effective rate of 3.0% and will represent the
accrual of discount, excluding any contingent cash interest that may become
payable. Contingent cash interest becomes payable if the average market price of
a Senior Convertible Note for a five trading day measurement period preceding
the applicable six-month period equals 120% or more of the sum of the Senior
Convertible Note's issue price, accrued original issue discount and accrued cash
interest, if any, for such Senior Convertible Note. The contingent cash interest
payable per Senior Convertible Note with respect to any quarterly period within
any six-month period will equal the then applicable conversion rate multiplied
by the greater of (1) $0.105 or (2) any regular cash dividends paid by the
Company per share on HMEC's common stock during that quarterly period.
The Senior Convertible Notes will be convertible at the option of the
holders into shares of HMEC's common stock at a conversion price of $26.74 if
the conditions for conversion are satisfied. Holders may also surrender Senior
Convertible Notes for conversion during any period in which the credit rating
assigned to the Senior Convertible Notes is Ba2 or lower by Moody's or BB+ or
lower by S&P, the Senior Convertible Notes are no longer rated by either Moody's
or S&P, or the credit rating assigned to the Senior Convertible Notes has been
suspended or withdrawn by either Moody's or S&P. The Senior Convertible Notes
will cease to be convertible pursuant to this credit rating criteria during any
period or periods in which all of the credit ratings are increased above such
levels. The Senior Convertible Notes are redeemable by HMEC in whole or in part,
at any time on or after May 14, 2007, at redemption prices equal to the sum of
the issue price plus accrued original issue discount and accrued cash interest,
if any, on the applicable redemption date. The holders of the Senior Convertible
Notes may require HMEC to purchase all or a portion of their Senior Convertible
Notes on either May 14, 2007, 2012, 2017, 2022, or 2027 at stated prices plus
accrued cash interest, if any, to the purchase date. HMEC may pay the purchase
price in cash or shares of HMEC common stock or in a combination of cash and
shares of HMEC common stock.
The Senior Convertible Notes have an investment grade rating from Standard
& Poor's Corporation ("S&P") (BBB), Moody's Investors Service, Inc. ("Moody's")
(Baa3), Fitch Ratings, Ltd. ("Fitch") (BBB+), and A.M. Best Company, Inc. ("A.M.
Best") (bbb-). Also see "Financial Ratings". The Senior Convertible Notes are
traded in the open market (HMN 1.425).
31
As of March 31, 2004, the Company had outstanding $28.6 million aggregate
principal amount of 6 5/8% Senior Notes ("Senior Notes") issued at a discount of
0.5% which will mature on January 15, 2006. Interest on the Senior Notes is
payable semi-annually. The Senior Notes are redeemable in whole or in part, at
any time, at the Company's option. The Senior Notes have an investment grade
rating from S&P (BBB), Moody's (Baa3), Fitch (BBB+) and A.M. Best (bbb-). The
Senior Notes are traded on the New York Stock Exchange (HMN 6 5/8).
As of March 31, 2004, the Company had outstanding $25.0 million under its
Bank Credit Agreement at an interest rate of Interbank Offering Rate plus 1.0%,
or 2.2%. The Bank Credit Agreement provides for unsecured borrowings of up to
$25.0 million, with a provision that allows the commitment amount to be
increased to $35.0 million (the "Bank Credit Facility"). The Bank Credit
Facility expires on May 31, 2005. Interest accrues at varying spreads relative
to corporate or eurodollar base rates and is payable monthly or quarterly
depending on the applicable base rate. The unused portion of the Bank Credit
Facility is subject to a variable commitment fee, which was 0.25% on an annual
basis at March 31, 2004.
To provide additional capital management flexibility, the Company filed a
"universal shelf" registration on Form S-3 with the SEC in December 2003. The
registration statement, which registers the offer and sale by the Company from
time to time of up to $300 million of various securities, which may include debt
securities, preferred stock, common stock and/or depositary shares, was declared
effective on December 30, 2003. No securities associated with the registration
statement have been issued as of the date of this Report on Form 10-Q.
The Company's ratio of earnings to fixed charges for the three months ended
March 31, 2004 was 19.0x, compared to 7.8x for the same period in 2003, which
reflected $4.7 million of pretax realized investment losses and $4.3 million of
adverse development of prior years' property and casualty reserves recognized
during the period.
Total shareholder dividends were $4.5 million for the three months ended
March 31, 2004. In March 2004, the Board of Directors announced a regular
quarterly dividend of $0.105 per share.
Information regarding the reinsurance program for the Company's property
and casualty segment is located in the Company's 2003 Annual Report on Form 10-K
in "Business -- Property and Casualty Segment -- Property and Casualty
Reinsurance".
Information regarding the interest-sensitive life reinsurance program for
the Company's life segment is located in the Company's 2003 Annual Report on
Form 10-K in "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Financial Resources -- Capital
Resources".
32
Financial Ratings
The Company's principal insurance subsidiaries are rated by Standard &
Poor's Corporation ("S&P"), Moody's Investors Service, Inc. ("Moody's"), Fitch
Ratings, Ltd. ("Fitch") and A.M. Best Company, Inc. ("A.M. Best"). These rating
agencies have also assigned ratings to the Company's long-term debt securities.
Assigned ratings as of May 1, 2004, which were unchanged from the
disclosure in the Company's 2003 Annual Report on Form 10-K, were as follows
(the insurance financial strength ratings for the Company's property and
casualty insurance subsidiaries and the Company's principal life insurance
subsidiary are the same, except where indicated):
Insurance
Financial
Strength Ratings Debt Ratings
(Outlook) (Outlook)
-------------------- -----------------
As of May 1, 2004
- -----------------
S&P (1)............... A (negative) BBB (negative)
Moody's (1)........... P&C: A3 (negative) Baa3 (negative)
Life: A3 (stable)
Fitch................. A+ (negative) BBB+ (negative)
A.M. Best............. A- (stable) bbb- (stable)
- ----------
(1) This agency has not yet rated Horace Mann Lloyds.
Market Value Risk
Market value risk, the Company's primary market risk exposure, is the risk
that the Company's invested assets will decrease in value. This decrease in
value may be due to a change in (1) the yields realized on the Company's assets
and prevailing market yields for similar assets, (2) an unfavorable change in
the liquidity of the investment, (3) an unfavorable change in the financial
prospects of the issuer of the investment, or (4) a downgrade in the credit
rating of the issuer of the investment. See also "Results of
Operations--Realized Investment Gains and Losses".
Significant changes in interest rates expose the Company to the risk of
experiencing losses or earning a reduced level of income based on the difference
between the interest rates earned on the Company's investments and the credited
interest rates on the Company's insurance liabilities.
The Company manages its market value risk by coordinating the projected
cash outflows of assets with the projected cash outflows of liabilities. For all
its assets and liabilities, the Company seeks to maintain reasonable durations,
consistent with the maximization of income without sacrificing investment
quality, while providing for liquidity and diversification. The investment risk
associated with variable annuity deposits and the underlying mutual funds is
assumed by those contractholders, and not by the Company. Certain fees that the
Company earns from variable annuity deposits are based on the market value of
the funds deposited.
A more detailed description of the Company's exposure to market value risks
and the management of those risks is presented in the Company's Annual Report on
Form 10-K for 2003 "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Market Value Risk".
33
Information Systems Risk
The Company administers its insurance business with information systems
that are dated and complex, and require extensive manual input, calculation and
control procedures. These systems are more prone to error than more advanced
technology systems. To address these issues, over the past three years the
Company has enhanced its existing systems and technology infrastructure and has
begun installing new systems, including a new general ledger and financial
reporting system which was implemented in the second quarter of 2003 and a new
property and casualty claims administration system whose implementation was
completed in April 2004. In the meantime, enhanced checks and control procedures
have been established to review the output of existing information systems,
including periodic internal and external third party reviews. Nevertheless,
there are risks that inaccuracies in the processing of data may occur which
might not be identified by those procedures and checks on a timely basis.
Business Continuity Risk
Given the events of September 11, 2001, the continuing threat of terrorism
and the current geopolitical climate, the Company has undertaken a reassessment
of its business continuity plans. While current contingency plans are felt to be
adequate to restore some of the more critical business processes and the Company
is aggressively working to strengthen its continuity plans, in the current
environment there is believed to exist a higher than acceptable level of risk
that the Company's ability to recover and resume most or all of its key business
operations on a timely basis would be compromised.
Recent Accounting Changes
Consensus Regarding EITF Issue No. 03-1
In March 2004, the Financial Accounting Standards Board's Emerging Issues
Task Force ("EITF") issued a Consensus regarding EITF Issue No. 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments", which is effective for reporting periods beginning after June 15,
2004. The Consensus effectively codifies the provisions of SEC Staff Accounting
Bulletin No. 59, "Accounting for Noncurrent Marketable Equity Securities", and
includes detailed criteria for evaluating whether to record a realized
investment loss related to debt and equity securities carried at amounts higher
than the securities' fair value. The Consensus also includes requirements to
disclose additional information about unrealized investment losses. The adoption
of this Consensus is currently not expected to have a material impact on the
Company's operating results or financial position.
34
Item 3: Quantitative and Qualitative Disclosures About Market Risk
The information required by Item 305 of Regulation S-K is contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contained in this Quarterly Report on Form 10-Q.
Item 4: Controls and Procedures
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures as of
March 31, 2004 pursuant to Exchange Act Rule 13a-15 and 15d-15. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Company's periodic
Securities and Exchange Commission filings. No significant deficiencies or
material weaknesses in the Company's disclosure controls and procedures were
identified in the evaluation and therefore, no corrective actions were taken.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation.
PART II: OTHER INFORMATION
Item 4: Submission of Matters to a Vote of Security Holders
None.
Item 5: Other Information
In compliance with Section 202 of the Sarbanes-Oxley Act of 2002, the Audit
Committee of the Board of Directors of Horace Mann Educators Corporation has
preapproved the continuing provision of certain non-audit services by KPMG LLP,
Horace Mann Educators Corporation's independent auditor. Such services relate
primarily to tax consultation.
The Audit Committee has determined that the services provided by KPMG LLP
under non-audit services are compatible with maintaining the auditor's
independence.
35
Item 6: Exhibits and Reports on Form 8-K
Exhibit No. Description
----------- -----------
(a) The following items are filed as Exhibits. Management contracts
and compensatory plans are indicated by an asterisk (*).
(10) Material contracts.
10.1* Severance Agreements between HMEC and certain
officers of HMEC, incorporated by reference to
Exhibit 10.7 to HMEC's Annual Report on Form 10-K
for the year ended December 31, 2001, filed with
the SEC on March 29, 2002.
10.1(a)* Revised Schedule to Severance Agreements between
HMEC and certain officers of HMEC.
(11) Statement re computation of per share earnings.
(15) KPMG LLP letter regarding unaudited interim financial
information.
(31) Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.1 Certification by Louis G. Lower II, Chief Executive
Officer of HMEC.
31.2 Certification by Peter H. Heckman, Chief Financial
Officer of HMEC.
(32) Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification by Louis G. Lower II, Chief Executive
Officer of HMEC.
32.2 Certification by Peter H. Heckman, Chief Financial
Officer of HMEC.
(b) During the first quarter of 2004, HMEC filed one Current Report
on Form 8-K with the SEC as follows:
1. Dated February 17, 2004, regarding the Company's press
release reporting its financial results for the three and
twelve month periods ended December 31, 2003, containing an
Item 12 Disclosure of Results of Operations and Financial
Condition and an Item 7 Financial Statements and Exhibits.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HORACE MANN EDUCATORS CORPORATION
(Registrant)
Date May 10, 2004 /s/ Louis G. Lower II
--------------------------------------
Louis G. Lower II
President and Chief Executive Officer
Date May 10, 2004 /s/ Peter H. Heckman
--------------------------------------
Peter H. Heckman
Executive Vice President and Chief
Financial Officer
Date May 10, 2004 /s/ Bret A. Conklin
--------------------------------------
Bret A. Conklin
Senior Vice President and Controller
37
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HORACE MANN EDUCATORS CORPORATION
EXHIBITS
To
FORM 10-Q
For the Quarter Ended March 31, 2004
VOLUME 1 OF 1
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The following items are filed as Exhibits to Horace Mann Educators
Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31,
2004. Management contracts and compensatory plans are indicated by an asterisk
(*).
EXHIBIT INDEX
Exhibit
No. Description
- ------- -----------
(10) Material contracts.
10.1* Severance Agreements between HMEC and certain officers of
HMEC, incorporated by reference to Exhibit 10.7 to HMEC's
Annual Report on Form 10-K for the year ended December 31,
2001, filed with the SEC on March 29, 2002.
10.1(a)* Revised Schedule to Severance Agreements between HMEC and
certain officers of HMEC.
(11) Statement re computation of per share earnings.
(15) KPMG LLP letter regarding unaudited interim financial information.
(31) Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.1 Certification by Louis G. Lower II, Chief Executive Officer of
HMEC.
31.2 Certification by Peter H. Heckman, Chief Financial Officer of
HMEC.
(32) Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.1 Certification by Louis G. Lower II, Chief Executive Officer of
HMEC.
32.2 Certification by Peter H. Heckman, Chief Financial Officer of
HMEC.