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EX-15 - EXHIBIT 15 - HORACE MANN EDUCATORS CORP /DE/v412324_ex15.htm
EX-11 - EXHIBIT 11 - HORACE MANN EDUCATORS CORP /DE/v412324_ex11.htm
EX-31.2 - EXHIBIT 31.2 - HORACE MANN EDUCATORS CORP /DE/v412324_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - HORACE MANN EDUCATORS CORP /DE/v412324_ex31-1.htm
EX-32.2 - EXHIBIT 32.2 - HORACE MANN EDUCATORS CORP /DE/v412324_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - HORACE MANN EDUCATORS CORP /DE/v412324_ex32-1.htm
EX-99.1 - EXHIBIT 99.1 - HORACE MANN EDUCATORS CORP /DE/v412324_ex99-1.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

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 June 30, 2015

OR

[  ]

TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the transition period from ________ to ________

 

Commission file number 1-10890

 

HORACE MANN EDUCATORS CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware 37-0911756
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer 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

 

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 has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   X   No       

 

Indicate by check mark the registrant’s filer status, as such terms are defined in Rule 12b-2 of the Act. 

Large accelerated filer     X   Accelerated filer                           
Non-accelerated filer           Smaller reporting company         

 

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Act. Yes       No    X   

 

As of July 31, 2015, 41,167,839 shares of Common Stock, par value $0.001 per share, were outstanding, net of 23,348,132 shares of treasury stock.

 

 

 

 
 

 

HORACE MANN EDUCATORS CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2015

INDEX

 

  Page
PART I - FINANCIAL INFORMATION  
     
Item 1. Financial Statements  
     
  Report of Independent Registered Public Accounting Firm 1
     
  Consolidated Balance Sheets 2
     
  Consolidated Statements of Operations 3
     
  Consolidated Statements of Comprehensive Income (Loss) 4
     
  Consolidated Statements of Changes in Shareholders’ Equity 5
     
  Consolidated Statements of Cash Flows 6
     
  Notes to Consolidated Financial Statements  
  Note 1 - Basis of Presentation 7
  Note 2 - Investments 9
  Note 3 - Fair Value of Financial Instruments 15
  Note 4 - Debt 20
  Note 5 - Reinsurance 21
  Note 6 - Commitments 21
  Note 7 - Segment Information 22
  Note 8 - Derivative Instruments 23
     
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

25

     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 50
     
Item 4. Controls and Procedures 50
     
PART II - OTHER INFORMATION  
     
Item 1A. Risk Factors 50
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 50
     
Item 5. Other Information 51
     
Item 6. Exhibits 51
     
SIGNATURES 56

 

 
 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Shareholders

Horace Mann Educators Corporation:

 

We have reviewed the consolidated balance sheet of Horace Mann Educators Corporation and subsidiaries (the Company) as of June 30, 2015, the related consolidated statements of operations and comprehensive income (loss) for the three-month and six-month periods ended June 30, 2015 and 2014, and the related consolidated statements of changes in shareholders’ equity and cash flows for the six-month periods ended June 30, 2015 and 2014. These consolidated financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), 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 U.S. generally accepted accounting principles.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Horace Mann Educators Corporation and subsidiaries as of December 31, 2014, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated March 2, 2015, we expressed an unqualified opinion on those consolidated financial statements.

 

/s/ KPMG LLP

KPMG LLP

 

Chicago, Illinois

August 7, 2015

 

1
 

 

HORACE MANN EDUCATORS CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

 

   June 30,  December 31,
   2015  2014
   (Unaudited)     
ASSETS              
Investments              
Fixed maturities, available for sale, at fair value              
(amortized cost 2015, $6,505,016; 2014, $6,375,237)    $6,897,058     $6,893,090 
Equity securities, available for sale, at fair value              
(cost 2015, $94,089; 2014, $99,904)     99,318      110,655 
Short-term and other investments     388,729      399,722 
Total investments     7,385,105      7,403,467 
Cash     46,013      11,675 
Deferred policy acquisition costs     236,176      215,082 
Goodwill     47,396      47,396 
Other assets     349,552      277,350 
Separate Account (variable annuity) assets     1,905,298      1,813,557 
Total assets    $9,969,540     $9,768,527 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY              
Policy liabilities              
Fixed annuity contract liabilities    $3,928,353     $3,774,457 
Interest-sensitive life contract liabilities     798,390      792,039 
Unpaid claims and claim expenses     338,744      325,784 
Future policy benefits     243,801      235,775 
Unearned premiums     221,846      223,413 
Total policy liabilities     5,531,134      5,351,468 
Other policyholder funds     609,289      606,738 
Other liabilities     379,178      422,362 
Short-term debt     113,000      38,000 
Long-term debt, current and noncurrent     124,969      199,939 
Separate Account (variable annuity) liabilities     1,905,298      1,813,557 
Total liabilities     8,662,868      8,432,064 
Preferred stock, $0.001 par value, authorized              
1,000,000 shares; none issued     -      - 
Common stock, $0.001 par value, authorized 75,000,000 shares;              
issued, 2015, 64,510,462; 2014, 64,245,048     65      64 
Additional paid-in capital     437,837      422,232 
Retained earnings     1,094,405      1,065,318 
Accumulated other comprehensive income (loss), net of taxes:              
Net unrealized gains on fixed maturities              
and equity securities     223,786      297,554 
Net funded status of pension and other postretirement              
benefit obligations     (12,953)     (12,953)
Treasury stock, at cost, 2015, 23,331,930 shares;              
2014, 23,308,430 shares     (436,468)     (435,752)
Total shareholders’ equity     1,306,672      1,336,463 
Total liabilities and shareholders’ equity    $9,969,540     $9,768,527 

 

See accompanying Notes to Consolidated Financial Statements.

See accompanying Report of Independent Registered Public Accounting Firm.

 

2
 

 

HORACE MANN EDUCATORS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(Dollars in thousands, except per share data)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
                 
Revenues                    
Insurance premiums and                    
contract charges earned  $182,376   $179,138   $362,115   $354,541 
Net investment income   83,995    81,405    167,308    164,449 
Net realized investment gains   1,413    3,463    7,481    5,162 
Other income   686    737    1,685    1,856 
                     
Total revenues   268,470    264,743    538,589    526,008 
                     
Benefits, losses and expenses                    
Benefits, claims and settlement expenses   132,939    127,158    246,958    239,146 
Interest credited   45,350    43,730    89,887    86,817 
Policy acquisition expenses amortized   24,007    22,517    47,691    45,550 
Operating expenses   40,036    39,211    75,964    79,158 
Interest expense   3,406    3,546    6,958    7,092 
                     
Total benefits, losses and expenses   245,738    236,162    467,458    457,763 
                     
Income before income taxes   22,732    28,581    71,131    68,245 
Income tax expense   6,549    8,129    20,673    19,427 
                     
Net income  $16,183   $20,452   $50,458   $48,818 
                     
Net income per share                    
Basic  $0.39   $0.49   $1.20   $1.18 
Diluted  $0.38   $0.48   $1.19   $1.16 
                     
Weighted average number of shares                    
and equivalent shares (in thousands)                    
Basic   41,990    41,432    42,001    41,343 
Diluted   42,425    42,310    42,366    42,213 
                     
Net realized investment gains (losses)                    
Total other-than-temporary impairment losses on securities  $(14,969)  $(452)  $(17,258)  $(452)
Portion of losses recognized in other                    
comprehensive income   (4,300)   -    (4,300)   - 
Net other-than-temporary                    
impairment losses on                    
securities recognized in earnings   (10,669)   (452)   (12,958)   (452)
Realized gains, net   12,082    3,915    20,439    5,614 
Total  $1,413   $3,463   $7,481   $5,162 

 

See accompanying Notes to Consolidated Financial Statements.

See accompanying Report of Independent Registered Public Accounting Firm.

 

3
 

 

HORACE MANN EDUCATORS CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(Dollars in thousands)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
                 
Comprehensive income (loss)                    
Net income  $16,183   $20,452   $50,458   $48,818 
Other comprehensive income (loss), net of taxes:                    
Change in net unrealized gains and losses on fixed maturities and equity securities   (111,346)   70,157    (73,768)   147,565 
Change in net funded status of pension and other postretirement benefit obligations   -    -    -    - 
Other comprehensive income (loss)   (111,346)   70,157    (73,768)   147,565 
Total  $(95,163)  $90,609   $(23,310)  $196,383 

 

See accompanying Notes to Consolidated Financial Statements.

See accompanying Report of Independent Registered Public Accounting Firm.

 

4
 

 

HORACE MANN EDUCATORS CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

(Dollars in thousands, except per share data)

 

   Six Months Ended 
   June 30, 
   2015   2014 
         
Common stock, $0.001 par value          
Beginning balance  $64   $64 
Options exercised, 2015, 74,233 shares;          
2014, 382,956 shares   -    - 
Conversion of common stock units,          
2015, 8,293 shares; 2014, 10,834 shares   -    - 
Conversion of restricted stock units,          
2015, 182,888 shares; 2014, 91,353 shares   1    - 
Ending balance   65    64 
           
Additional paid-in capital          
Beginning balance   422,232    407,056 
Options exercised and conversion of common stock          
units and restricted stock units   11,674    10,301 
Share-based compensation expense   3,931    635 
Ending balance   437,837    417,992 
           
Retained earnings          
Beginning balance   1,065,318    1,000,312 
Net income   50,458    48,818 
Cash dividends, 2015, $0.50 per share; 2014, $0.46 per share   (21,371)   (19,614)
Ending balance   1,094,405    1,029,516 
           
Accumulated other comprehensive income (loss), net of taxes          
Beginning balance   284,601    122,214 
Change in net unrealized gains and losses on          
fixed maturities and equity securities   (73,768)   147,565 
Change in net funded status of pension and          
other postretirement benefit obligations   -    - 
Ending balance   210,833    269,779 
           
Treasury stock, at cost          
Beginning balance, 2015, 23,308,430 shares;          
2014, 23,117,554 shares   (435,752)   (430,341)
Acquisition of shares, 2015, 23,500 shares;          
2014, 136,976 shares   (716)   (3,867)
Ending balance, 2015, 23,331,930 shares;          
2014, 23,254,530 shares   (436,468)   (434,208)
           
Shareholders’ equity at end of period  $1,306,672   $1,283,143 

 

See accompanying Notes to Consolidated Financial Statements.

See accompanying Report of Independent Registered Public Accounting Firm.

 

5
 

 

HORACE MANN EDUCATORS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Dollars in thousands)

 

   Six Months Ended 
   June 30, 
   2015   2014 
Cash flows - operating activities          
Premiums collected  $352,825   $351,404 
Policyholder benefits paid   (257,606)   (242,035)
Policy acquisition and other operating expenses paid   (138,303)   (135,428)
Federal income taxes paid   (18,143)   (17,363)
Investment income collected   167,738    161,033 
Interest expense paid   (6,837)   (7,005)
Other   (1,364)   (2,490)
           
Net cash provided by operating activities   98,310    108,116 
           
Cash flows - investing activities          
Fixed maturities          
Purchases   (707,886)   (657,797)
Sales   246,521    99,249 
Maturities, paydowns, calls and redemptions   287,764    177,370 
Purchase of other invested assets   (15,809)   - 
Net cash provided by short-term and other investments   35,010    139,984 
           
Net cash used in investing activities   (154,400)   (241,194)
           
Cash flows - financing activities          
Dividends paid to shareholders   (21,371)   (19,614)
Principal borrowings on Bank Credit Facility   75,000    - 
Maturity of Senior Notes due 2015   (75,000)   - 
Acquisition of treasury stock   (716)   (3,867)
Exercise of stock options   1,557    7,262 
Annuity contracts:  variable, fixed and FHLB funding agreements          
Deposits   282,897    218,331 
Benefits, withdrawals and net transfers to          
Separate Account (variable annuity) assets   (178,557)   (159,680)
Life policy accounts          
Deposits   435    476 
Withdrawals and surrenders   (1,995)   (2,410)
Cash received related to repurchase agreements   -    114,083 
Change in bank overdrafts   8,178    5,011 
           
Net cash provided by financing activities   90,428    159,592 
           
Net increase in cash   34,338    26,514 
           
Cash at beginning of period   11,675    18,189 
           
Cash at end of period  $46,013   $44,703 

 

See accompanying Notes to Consolidated Financial Statements.

See accompanying Report of Independent Registered Public Accounting Firm.

 

6
 

 

HORACE MANN EDUCATORS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

June 30, 2015 and 2014

(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” or “Horace Mann”) have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) and with the rules and regulations of the Securities and Exchange Commission (“SEC”), specifically Regulation S-X and the instructions to Form 10-Q. Certain information and note disclosures which are normally included in annual financial statements prepared in accordance with GAAP but are not required for interim reporting purposes have been omitted. The Company believes that these consolidated financial statements contain all adjustments (consisting of normal recurring accruals) which are, in the opinion of management, necessary to present fairly the Company’s consolidated financial position as of June 30, 2015, the consolidated results of operations and comprehensive income (loss) for the three and six months ended June 30, 2015 and 2014, and the consolidated changes in shareholders’ equity and cash flows for the six months ended June 30, 2015 and 2014. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect (1) the reported amounts of assets and liabilities, (2) disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and (3) the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

The subsidiaries of HMEC market and underwrite personal lines of property and casualty (primarily personal lines automobile and homeowners) insurance, retirement annuities (primarily tax-qualified products) and life insurance, primarily to K-12 teachers, administrators and other employees of public schools and their families. HMEC’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.

 

The Company has evaluated subsequent events through the date these consolidated financial statements were issued.

 

These consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes to consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

 

The results of operations for the three and six months ended June 30, 2015 are not necessarily indicative of the results to be expected for the full year.

 

7
 

 

Note 1 - Basis of Presentation-(Continued)

 

In the six months ended June 30, 2015 (specifically, in the first quarter), the Company recorded a reduction in incentive compensation expense due to an immaterial out-of-period correction of an error related to the valuation of restricted stock units. The $3,012 after tax adjustment increased net income for each of the segments as follows: property and casualty, $2,056; annuity, $519; and life, $437.

 

Accumulated Other Comprehensive Income (Loss)

 

Accumulated other comprehensive income (loss) represents the accumulated change in shareholders’ equity from transactions and other events and circumstances from non-shareholder sources. For the Company, accumulated other comprehensive income (loss) includes the after tax change in net unrealized gains and losses on fixed maturities and equity securities and the after tax change in net funded status of pension and other postretirement benefit obligations for the period as shown in the Consolidated Statement of Changes in Shareholders’ Equity. The following tables reconcile these components.

 

   Unrealized Gains          
   and Losses on          
   Fixed Maturities          
   and Equity  Defined     
   Securities (1)(2)  Benefit Plans (1)  Total (1)
                
Beginning balance, April 1, 2015    $335,132     $(12,953)    $322,179 
Other comprehensive income (loss)                     
before reclassifications     (110,185)     -      (110,185)
Amounts reclassified from accumulated                     
other comprehensive income (loss)     (1,161)     -      (1,161)
Net current period other                     
comprehensive income (loss)     (111,346)     -      (111,346)
Ending balance, June 30, 2015    $223,786     $(12,953)    $210,833 
                      
Beginning balance, January 1, 2015    $297,554     $(12,953)    $284,601 
Other comprehensive income (loss)                     
before reclassifications     (68,815)     -      (68,815)
Amounts reclassified from accumulated                     
other comprehensive income (loss)     (4,953)     -      (4,953)
Net current period other                     
comprehensive income (loss)     (73,768)     -      (73,768)
Ending balance, June 30, 2015    $223,786     $(12,953)    $210,833 

 

 

(1)All amounts are net of tax.
(2)The pretax amounts reclassified from accumulated other comprehensive income (loss), $1,786 and $7,620, are included in net realized investment gains and losses and the related tax expenses, $625 and $2,667, are included in income tax expense in the Consolidated Statements of Operations for the three and six months ended June 30, 2015, respectively.

 

8
 

 

Note 1 - Basis of Presentation-(Continued)

 

   Unrealized Gains          
   and Losses on          
   Fixed Maturities          
   and Equity  Defined     
   Securities (1)(2)  Benefit Plans (1)  Total (1)
                
Beginning balance, April 1, 2014    $211,398     $(11,776)    $199,622 
Other comprehensive income (loss)                     
before reclassifications     72,402      -      72,402 
Amounts reclassified from                     
accumulated other                     
comprehensive income (loss)     (2,245)     -      (2,245)
Net current period other                     
comprehensive income (loss)     70,157      -      70,157 
Ending balance, June 30, 2014    $281,555     $(11,776)    $269,779 
                      
Beginning balance, January 1, 2014    $133,990     $(11,776)    $122,214 
Other comprehensive income (loss)                     
before reclassifications     150,906      -      150,906 
Amounts reclassified from                     
accumulated other                     
comprehensive income (loss)     (3,341)     -      (3,341)
Net current period other                     
comprehensive income (loss)     147,565      -      147,565 
Ending balance, June 30, 2014    $281,555     $(11,776)    $269,779 

 

 

(1)All amounts are net of tax.
(2)The pretax amounts reclassified from accumulated other comprehensive income (loss), $3,455 and $5,140, are included in net realized investment gains and losses and the related tax expenses, $1,210 and $1,799, are included in income tax expense in the Consolidated Statements of Operations for the three and six months ended June 30, 2014, respectively.

 

Comparative information for elements that are not required to be reclassified in their entirety to net income in the same reporting period is located in “Note 2 — Investments — Unrealized Gains and Losses on Fixed Maturities and Equity Securities”.

 

Note 2 - Investments

 

The Company’s investment portfolio includes free-standing derivative financial instruments (currently over the counter (“OTC”) index options contracts) to economically hedge risk associated with its fixed indexed annuity product’s contingent liabilities. The Company’s fixed indexed annuity product includes embedded derivative features that are discussed in “Note 1 — Summary of Significant Accounting Policies — Policy Liabilities for Fixed Indexed Annuities” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. The Company's investment portfolio includes no other free-standing derivative financial instruments (futures, forwards, swaps, option contracts or other financial instruments with similar characteristics), and there were no other embedded derivative features related to the Company’s insurance products during the six months ended June 30, 2015 and 2014.

 

9
 

 

Note 2 - Investments-(Continued)

 

Fixed Maturities and Equity Securities

 

The Company’s investment portfolio is comprised primarily of fixed maturity securities (“fixed maturities”) and equity securities. The amortized cost or cost, unrealized investment gains and losses, fair values and other-than-temporary impairment (“OTTI”) included in accumulated other comprehensive income (loss) (“AOCI”) of all fixed maturities and equity securities in the portfolio were as follows:

 

   Amortized   Unrealized   Unrealized   Fair   OTTI in 
   Cost/Cost   Gains   Losses   Value   AOCI (1) 
June 30, 2015                         
Fixed maturity securities                         
U.S. Government and federally                         
sponsored agency obligations (2):                         
Mortgage-backed securities  $480,516   $48,405   $2,495   $526,426   $- 
Other, including                         
U.S. Treasury securities   590,465    21,156    9,034    602,587    - 
Municipal bonds   1,511,171    150,696    13,418    1,648,449    - 
Foreign government bonds   59,500    7,190    -    66,690    - 
Corporate bonds   2,470,966    186,773    15,471    2,642,268    - 
Other mortgage-backed securities   1,392,398    24,761    6,521    1,410,638    (2,728)
Totals  $6,505,016   $438,981   $46,939   $6,897,058   $(2,728)
                          
Equity securities (3)  $94,089   $8,565   $3,336   $99,318   $- 
                          
December 31, 2014                         
Fixed maturity securities                         
U.S. Government and federally                         
sponsored agency obligations (2):                         
Mortgage-backed securities  $484,561   $52,555   $1,390   $535,726   $- 
Other, including                         
U.S. Treasury securities   512,596    28,652    3,049    538,199    - 
Municipal bonds   1,462,717    189,533    4,428    1,647,822    - 
Foreign government bonds   52,552    6,984    -    59,536    - 
Corporate bonds   2,608,633    237,372    11,256    2,834,749    - 
Other mortgage-backed securities   1,254,178    28,772    5,892    1,277,058    2,879 
Totals  $6,375,237   $543,868   $26,015   $6,893,090   $2,879 
                          
Equity securities (3)  $99,904   $14,159   $3,408   $110,655   $- 

 

 

(1)Related to securities for which an unrealized loss was bifurcated to distinguish the credit related portion and the portion driven by other market factors.  Represents the amount of other-than-temporary impairment losses in AOCI which was not included in earnings; amounts also include unrealized gains/(losses) on such impaired securities relating to changes in the fair value of those securities subsequent to the impairment measurement date.
(2)Fair value includes securities issued by Federal National Mortgage Association (“FNMA”) of $252,549 and $302,222; Federal Home Loan Mortgage Corporation (“FHLMC”) of $435,304 and $432,432; and Government National Mortgage Association (“GNMA”) of $136,356 and $137,867 as of June 30, 2015 and December 31, 2014, respectively.
(3)Includes nonredeemable (perpetual) preferred stocks, common stocks and closed-end funds.

 

Compared to December 31, 2014, the decrease in net unrealized gains at June 30, 2015 was due to higher yields on U.S. Treasury securities and wider credit spreads across most asset classes, the combination of which resulted in a decrease in net unrealized gains for virtually all classes of the Company’s fixed maturity securities holdings.

 

10
 

 

Note 2 - Investments-(Continued)

 

The following table presents the fair value and gross unrealized losses of fixed maturities and equity securities in an unrealized loss position at June 30, 2015 and December 31, 2014, respectively. The Company views the decrease in value of all of the securities with unrealized losses at June 30, 2015 — which was driven largely by changes in interest rates, spread widening, financial market illiquidity and/or market volatility from the date of acquisition — as temporary. For fixed maturity securities, management does not have the intent to sell the securities and it is not more likely than not the Company will be required to sell the securities before the anticipated recovery of the amortized cost bases, and the present value of future cash flows exceeds the amortized cost bases. In addition, management expects to recover the entire cost bases of the fixed maturity securities. For equity securities, the Company has the ability and intent to hold the securities for the recovery of cost and recovery of cost is expected within a reasonable period of time. Therefore, no impairment of these securities was recorded at June 30, 2015.

 

   12 Months or Less  More than 12 Months  Total
      Gross       Gross       Gross
   Fair Value  Unrealized
Losses
  Fair Value  Unrealized
Losses
  Fair Value  Unrealized
Losses
June 30, 2015                                        
Fixed maturity securities                                        
U.S. Government and federally                                        
sponsored agency obligations:                                        
Mortgage-backed securities  $56,123     $2,287     $1,545     $208     $57,668     $2,495 
Other   267,749      8,888      1,853      146      269,602      9,034 
Municipal bonds   219,191      7,541      20,870      5,877      240,061      13,418 
Foreign government bonds   -      -      -      -      -      - 
Corporate bonds   454,925      11,940      39,875      3,531      494,800      15,471 
Other mortgage-backed securities   471,024      5,929      79,074      592      550,098      6,521 
Total fixed maturity securities   1,469,012      36,585      143,217      10,354      1,612,229      46,939 
Equity securities (1)   33,888      2,559      6,699      777      40,587      3,336 
Combined totals  $1,502,900     $39,144     $149,916     $11,131     $1,652,816     $50,275 
                                         
Number of positions with a                                        
gross unrealized loss   514             59             573        
Fair value as a percentage of                                        
total fixed maturities and                                        
equity securities fair value   21.5%            2.1%            23.6%       
                                         
December 31, 2014                                        
Fixed maturity securities                                        
U.S. Government and federally                                        
sponsored agency obligations:                                        
Mortgage-backed securities  $2     $-     $39,809     $1,390     $39,811     $1,390 
Other   10,317      34      117,615      3,015      127,932      3,049 
Municipal bonds   31,821      200      59,715      4,228      91,536      4,428 
Foreign government bonds   -      -      -      -      -      - 
Corporate bonds   213,612      6,883      76,099      4,373      289,711      11,256 
Other mortgage-backed securities   477,877      4,797      88,663      1,095      566,540      5,892 
Total fixed maturity securities   733,629      11,914      381,901      14,101      1,115,530      26,015 
Equity securities (1)   12,955      2,568      6,635      840      19,590      3,408 
Combined totals  $746,584     $14,482     $388,536     $14,941     $1,135,120     $29,423 
                                         
Number of positions with a                                        
gross unrealized loss   234             112             346        
Fair value as a percentage of                                        
total fixed maturities and                                        
equity securities fair value   10.7%            5.5%            16.2%       

 

 

(1)Includes nonredeemable (perpetual) preferred stocks, common stocks and closed-end funds.

 

11
 

 

Note 2 - Investments-(Continued)

 

Fixed maturities and equity securities with an investment grade rating represented 82% of the gross unrealized loss as of June 30, 2015. With respect to fixed income securities involving securitized financial assets, the underlying collateral cash flows were stress tested to determine there was no adverse change in the present value of cash flows below the amortized cost basis.

 

Credit Losses

 

The following table summarizes the cumulative amounts related to the Company’s credit loss component of the other-than-temporary impairment losses on fixed maturity securities held as of June 30, 2015 and 2014 that the Company did not intend to sell as of those dates, and it was not more likely than not that the Company would be required to sell the securities before the anticipated recovery of the amortized cost bases, for which the non-credit portions of the other-than-temporary impairment losses were recognized in other comprehensive income (loss):

 

   Six Months Ended 
   June 30, 
   2015   2014 
Cumulative credit loss (1)          
Beginning of period  $2,877   $4,097 
New credit losses   4,998    280 
Losses related to securities sold or paid down during the period   -    - 
End of period  $7,875   $4,377 

 

 

(1)The cumulative credit loss amounts exclude other-than-temporary impairment losses on securities held as of the periods indicated that the Company intended to sell or it was more likely than not that the Company would be required to sell the security before the recovery of the amortized cost basis.

 

12
 

 

Note 2 - Investments-(Continued)

 

Maturities/Sales of Fixed Maturities and Equity Securities

 

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, reflecting assumptions regarding borrowers’ utilization of the right to call or prepay obligations with or without call or prepayment penalties. For structured securities, including mortgage-backed securities and other asset-backed securities, estimated expected maturities consider broker-dealer survey prepayment assumptions and are verified for consistency with the interest rate and economic environments.

 

   Percent of Total Fair Value    June 30, 2015 
   June 30,    December 31,    Fair   Amortized 
   2015    2014    Value   Cost 
Estimated expected maturity:                        
Due in 1 year or less   3.1%     4.0%    $211,874   $199,830 
Due after 1 year through 5 years   23.6      23.4      1,625,073    1,532,701 
Due after 5 years through 10 years   39.1      40.1      2,698,675    2,545,277 
Due after 10 years through 20 years   21.3      20.1      1,471,576    1,387,929 
Due after 20 years   12.9      12.4      889,860    839,279 
Total   100.0%     100.0%    $6,897,058   $6,505,016 
                         
Average option-adjusted duration, in years   5.9      5.8             

 

Proceeds received from sales of fixed maturities and equity securities, each determined using the specific identification method, and gross gains and gross losses realized as a result of those sales for each period were:

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
Fixed maturity securities                    
Proceeds received  $165,201   $46,309   $246,521   $99,249 
Gross gains realized   10,577    2,600    12,231    4,127 
Gross losses realized   (1,282)   (303)   (1,745)   (978)
                     
Equity securities                    
Proceeds received  $6,840   $4,843   $20,809   $8,491 
Gross gains realized   596    995    5,198    1,474 
Gross losses realized   (107)   (64)   (117)   (181)

 

13
 

 

Note 2 - Investments-(Continued)

 

Unrealized Gains and Losses on Fixed Maturities and Equity Securities

 

Net unrealized gains and losses are computed as the difference between fair value and amortized cost for fixed maturities or cost for equity securities. The following table reconciles the net unrealized investment gains and losses, net of tax, included in accumulated other comprehensive income (loss), before the impact on deferred policy acquisition costs:

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
Net unrealized investment gains (losses)                    
on fixed maturity securities, net of tax                    
Beginning of period  $381,244   $238,854   $336,604   $146,489 
Change in unrealized investment                    
gains and losses   (122,709)   80,577    (77,223)   173,802 
Reclassification of net realized                    
investment (gains) losses                    
to net income   (3,708)   (1,640)   (4,554)   (2,500)
End of period  $254,827   $317,791   $254,827   $317,791 
                     
Net unrealized investment gains (losses)                    
on equity securities, net of tax                    
Beginning of period  $3,384   $5,695   $6,988   $4,618 
Change in unrealized investment                    
gains and losses   (2,532)   2,865    (3,190)   4,178 
Reclassification of net realized                    
investment (gains) losses                    
to net income   2,547    (605)   (399)   (841)
End of period  $3,399   $7,955   $3,399   $7,955 

 

Offsetting of Assets and Liabilities

 

The Company’s derivative instruments (call options) are subject to enforceable master netting arrangements. Collateral support agreements associated with each master netting arrangement provide that the Company will receive or pledge financial collateral in the event minimum thresholds have been reached.

 

The following table presents the instruments that were subject to a master netting arrangement for the Company.

 

           Net Amounts             
           of Assets/             
       Gross   Liabilities   Gross Amounts Not Offset     
       Amounts   Presented   in the Consolidated     
       Offset in the   in the   Balance Sheet     
       Consolidated   Consolidated       Cash     
   Gross   Balance   Balance   Financial   Collateral   Net 
   Amounts   Sheet   Sheet   Instruments   Received   Amount 
June 30, 2015                              
Asset derivatives:                              
Free-standing derivatives  $1,946     -   $1,946     -   $2,117    $(171)
                               
December 31, 2014                              
Asset derivatives:                              
Free-standing derivatives   2,458    -    2,458    -    1,955    503 

  

14
 

 

Note 2 - Investments-(Continued)

 

Deposits

 

At June 30, 2015 and December 31, 2014, securities with a fair value of $18,377 and $18,361, respectively, were on deposit with governmental agencies as required by law in various states in which the insurance subsidiaries of HMEC conduct business. In addition, at June 30, 2015 and December 31, 2014, securities with a fair value of $537,865 and $539,235, respectively, were on deposit with the Federal Home Loan Bank of Chicago (“FHLB”) as collateral for amounts subject to funding agreements which were equal to $500,000 at both of the respective dates. The deposited securities are included in fixed maturities on the Company’s Consolidated Balance Sheets.

 

Note 3 - Fair Value of Financial Instruments

 

The Company is required under GAAP to disclose estimated fair values for certain financial and nonfinancial assets and liabilities. Fair values of the Company’s insurance contracts other than annuity contracts are not required to be disclosed. However, the estimated fair values of liabilities under all insurance contracts are taken into consideration in the Company’s overall management of interest rate risk through the matching of investment maturities with amounts due under insurance contracts.

 

Information regarding the three-level hierarchy presented below and the valuation methodologies utilized by the Company to estimate fair values at a point in time is included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, specifically in “Note 3 — Fair Value of Financial Instruments”.

 

15
 

 

Note 3 - Fair Value of Financial Instruments-(Continued)

 

Financial Instruments Measured and Carried at Fair Value

 

The following table presents the Company’s fair value hierarchy for those assets and liabilities measured and carried at fair value on a recurring basis. At June 30, 2015, these Level 3 invested assets comprised 2.5% of the Company’s total investment portfolio fair value.

 

   Carrying   Fair   Fair Value Measurements at
Reporting Date Using
 
   Amount   Value   Level 1   Level 2   Level 3 
June 30, 2015                         
Financial Assets                         
Investments                         
Fixed maturities                         
U.S. Government and federally                         
sponsored agency obligations:                         
Mortgage-backed securities  $526,426   $526,426   $-   $526,426   $- 
Other, including                         
U.S. Treasury securities   602,587    602,587    16,251    586,336    - 
Municipal bonds   1,648,449    1,648,449    -    1,618,780    29,669 
Foreign government bonds   66,690    66,690    -    66,690    - 
Corporate bonds   2,642,268    2,642,268    10,207    2,559,337    72,724 
Other mortgage-backed securities   1,410,638    1,410,638    -    1,325,938    84,700 
Total fixed maturities   6,897,058    6,897,058    26,458    6,683,507    187,093 
Equity securities   99,318    99,318    85,543    13,769    6 
Short-term investments   117,779    117,779    117,779    -    - 
Other investments   11,946    11,946    -    11,946    - 
Totals   7,126,101    7,126,101    229,780    6,709,222    187,099 
Separate Account                         
(variable annuity) assets (1)   1,905,298    1,905,298    1,905,298    -    - 
Financial Liabilities                         
Other policyholder funds,                         
embedded derivatives   26,719    26,719    -    -    26,719 
                          
December 31, 2014                         
Financial Assets                         
Investments                         
Fixed maturities                         
U.S. Government and federally                         
sponsored agency obligations:                         
Mortgage-backed securities  $535,726   $535,726   $-   $535,726   $- 
Other, including                         
U.S. Treasury securities   538,199    538,199    17,857    520,342    - 
Municipal bonds   1,647,822    1,647,822    -    1,634,194    13,628 
Foreign government bonds   59,536    59,536    -    59,536    - 
Corporate bonds   2,834,749    2,834,749    10,524    2,749,508    74,717 
Other mortgage-backed securities   1,277,058    1,277,058    -    1,194,109    82,949 
Total fixed maturities   6,893,090    6,893,090    28,381    6,693,415    171,294 
Equity securities   110,655    110,655    92,140    18,509    6 
Short-term investments   142,039    142,039    142,039    -    - 
Other investments   12,458    12,458    -    12,458    - 
Totals   7,158,242    7,158,242    262,560    6,724,382    171,300 
Separate Account                         
(variable annuity) assets (1)   1,813,557    1,813,557    1,813,557    -    - 
Financial Liabilities                         
Other policyholder funds,                         
embedded derivatives   20,049    20,049    -    -    20,049 

 

 

(1)Separate Account (variable annuity) liabilities are set equal to Separate Account (variable annuity) assets.

 

16
 

 

Note 3 - Fair Value of Financial Instruments-(Continued)

 

The Company did not have any transfers between Levels 1 and 2 during the six months ended June 30, 2015. The following tables present reconciliations for the periods indicated for all Level 3 assets and liabilities measured at fair value on a recurring basis.

 

      Financial 
   Financial Assets  Liabilities(1) 
   Municipal
Bonds
    Corporate
Bonds
   

Other
Mortgage-
Backed
Securities
    Total
Fixed
Maturities
    Equity
Securities
    Total     
                                           
Beginning balance, April 1, 2015    $13,885     $72,278     $72,594     $158,757     $6     $158,763     $22,040 
Transfers into Level 3 (2)     16,326      3,834      14,719      34,879      -      34,879      - 
Transfers out of Level 3 (2)     -      (1,350)     -      (1,350)     -      (1,350)     - 
Total gains or losses                                                 
Net realized gains (losses)                                                 
included in net income     -      -      -      -      -      -      (28)
Net unrealized gains (losses)                                                 
included in other                                                 
comprehensive income     (485)     (1,436)     (438)     (2,359)     -      (2,359)     - 
Purchases     -      -      -      -      -      -      - 
Issuances     -      -      -      -      -      -      4,948 
Sales     -      (476)     -      (476)     -      (476)     - 
Settlements     -      -      -      -      -      -      - 
Paydowns, maturities                                                 
and distributions     (57)     (126)     (2,175)     (2,358)     -      (2,358)     (241)
Ending balance, June 30, 2015    $29,669     $72,724     $84,700     $187,093     $6     $187,099     $26,719 
                                                  
Beginning balance, January 1, 2015    $13,628     $74,717     $82,949     $171,294     $6     $171,300     $20,049 
Transfers into Level 3 (2)     16,326      5,729      15,180      37,235      -      37,235      - 
Transfers out of Level 3 (2)     -      (1,350)     (9,664)     (11,014)     -      (11,014)     - 
Total gains or losses                                                 
Net realized gains (losses)                                                 
included in net income     -      -      -      -      -      -      (467)
Net unrealized gains (losses)                                                 
included in other                                                 
comprehensive income     (105)     (1,084)     (435)     (1,624)     -      (1,624)     - 
Purchases     -      -      -      -      -      -      - 
Issuances     -      -      -      -      -      -      7,912 
Sales     -      (476)     -      (476)     -      (476)     - 
Settlements     -      -      -      -      -      -      - 
Paydowns, maturities                                                 
and distributions     (180)     (4,812)     (3,330)     (8,322)     -      (8,322)     (775)
Ending balance, June 30, 2015    $29,669     $72,724     $84,700     $187,093     $6     $187,099     $26,719 

 

 

(1)Represents embedded derivatives, all related to the Company’s fixed indexed annuity (“FIA”) products, reported in Other Policyholder Funds in the Company’s Consolidated Balance Sheets.
(2)Transfers into and out of Level 3 during the three and six months ended June 30, 2015 and 2014 were attributable to changes in the availability of observable market information for individual fixed maturity securities. The Company’s policy is to recognize transfers into and transfers out of the levels as having occurred at the end of the reporting period in which the transfers were determined.
17
 

 

Note 3 - Fair Value of Financial Instruments-(Continued)

 

        Financial  
    Financial Assets   Liabilities(1)  
    Municipal
Bonds
    Corporate
Bonds
    Other
Mortgage-
Backed
Securities
    Total
Fixed
Maturities
    Equity
Securities
    Total      
                                                         
Beginning balance, April 1, 2014     $ 12,779       $ 60,204       $ 52,551       $ 125,534       $ 6       $ 125,540       $ 2,747  
Transfers into Level 3 (2)       -         12,452         -         12,452         -         12,452         -  
Transfers out of Level 3 (2)       -         -         -         -         -         -         -  
Total gains or losses                                                                      
Net realized gains (losses)                                                                      
included in net income       -         -         (26 )       (26 )       -         (26 )       57  
Net unrealized gains (losses)                                                                      
included in other                                                                      
comprehensive income       337         1,546         108         1,991         -         1,991         -  
Purchases       -         -         -         -         -         -         -  
Issuances       -         -         -         -         -         -         4,121  
Sales       -         -         -         -         -         -         -  
Settlements       -         -         -         -         -         -         -  
Paydowns, maturities                                                                      
and distributions       (62 )       (276 )       (111 )       (449 )       -         (449 )       (10 )
Ending balance, June 30, 2014     $ 13,054       $ 73,926       $ 52,522       $ 139,502       $ 6       $ 139,508       $ 6,915  
                                                                       
Beginning balance, January 1, 2014     $ 2,694       $ 60,826       $ 46,009       $ 109,529       $ 6       $ 109,535       $ -  
Transfers into Level 3 (2)       10,056         12,452         7,109         29,617         -         29,617         -  
Transfers out of Level 3 (2)       -         -         (519 )       (519 )       -         (519 )       -  
Total gains or losses                                                                      
Net realized gains (losses)                                                                      
included in net income       -         -         (26 )       (26 )       -         (26 )       69  
Net unrealized gains (losses)                                                                      
included in other                                                                      
comprehensive income       434         2,560         292         3,286         -         3,286         -  
Purchases       -         -         -         -         -         -         -  
Issuances       -         -         -         -         -         -         6,856  
Sales       -         -         -         -         -         -         -  
Settlements       -         -         -         -         -         -         -  
Paydowns, maturities                                                                      
and distributions       (130 )       (1,912 )       (343 )       (2,385 )       -         (2,385 )       (10 )
Ending balance, June 30, 2014     $ 13,054       $ 73,926       $ 52,522       $ 139,502       $ 6       $ 139,508       $ 6,915  

 

 

(1)Represents embedded derivatives, all related to the Company’s FIA products, reported in Other Policyholder Funds in the Company’s Consolidated Balance Sheets.
(2)Transfers into and out of Level 3 during the three and six months ended June 30, 2014 were attributable to changes in the availability of observable market information for individual fixed maturity securities. The Company’s policy is to recognize transfers into and transfers out of the levels as having occurred at the end of the reporting period in which the transfers were determined.

 

At June 30, 2015 and 2014, there were no realized gains or losses included in earnings that were attributable to changes in the fair value of Level 3 assets still held. For the three and six months ended June 30, 2015, realized gains/(losses) of $28 and $467, respectively, were included in earnings that were attributable to the changes in the fair value of Level 3 liabilities (embedded derivatives) still held; for the three and six months ended June 30, 2014, the respective amounts were $(57) and $(69).

 

18
 

 

Note 3 - Fair Value of Financial Instruments-(Continued)

 

The valuation techniques and significant unobservable inputs used in the fair value measurement for financial assets classified as Level 3 are subject to the control processes as described in “Note 3 — Fair Value of Financial Instruments — Investments” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. Generally, valuation for fixed maturity securities include spread pricing, matrix pricing and discounted cash flow methodologies; include inputs such as quoted prices for identical or similar securities that are less liquid; and are based on lower levels of trading activity than securities classified as Level 2. The valuation techniques and significant unobservable inputs used in the fair value measurement for equity securities classified as Level 3 use similar valuation techniques and significant unobservable inputs as fixed maturities.

 

The sensitivity of the estimated fair values to changes in the significant unobservable inputs for fixed maturities and equity securities included in Level 3 generally relate to interest rate spreads, illiquidity premiums and default rates. Significant spread widening in isolation will adversely impact the overall valuation, while significant spread tightening will lead to substantial valuation increases. Significant increases (decreases) in illiquidity premiums in isolation will result in substantially lower (higher) valuations. Significant increases (decreases) in expected default rates in isolation will result in substantially lower (higher) valuations.

 

Financial Instruments Not Carried at Fair Value; Disclosure Required

 

The Company has various other financial assets and financial liabilities used in the normal course of business that are not carried at fair value, but for which fair value disclosure is required. The following table presents the carrying value, fair value and fair value hierarchy of these financial assets and financial liabilities.

 

           Fair Value Measurements at 
   Carrying   Fair   Reporting Date Using 
   Amount   Value   Level 1   Level 2   Level 3 
June 30, 2015                         
Financial Assets                         
Investments                         
Other investments  $146,988   $151,416   $-   $-   $151,416 
Financial Liabilities                         
Fixed annuity contract liabilities   3,928,353    3,841,621    -    -    3,841,621 
Policyholder account balances on                         
interest-sensitive life contracts   77,067    81,095    -    -    81,095 
Other policyholder funds   582,570    582,570    -    500,081    82,489 
Short-term debt   113,000    113,000    -    113,000    - 
Long-term debt   124,969    129,750    129,750    -    - 
                          
December 31, 2014                         
Financial Assets                         
Investments                         
Other investments  $145,409   $149,792   $-   $-   $149,792 
Financial Liabilities                         
Fixed annuity contract liabilities   3,774,457    3,691,123    -    -    3,691,123 
Policyholder account balances on                         
interest-sensitive life contracts   77,415    81,461    -    -    81,461 
Other policyholder funds   586,689    586,689    -    500,080    86,609 
Short-term debt   38,000    38,000    -    38,000    - 
Long-term debt   199,939    209,495    209,495    -    - 

 

19
 

 

Note 4 - Debt

 

Indebtedness outstanding was as follows:

 

   June 30,  December 31,
   2015  2014
Short-term debt:              
Bank Credit Facility, expires July 30, 2019    $113,000     $38,000 
Long-term debt, current and noncurrent (1):              
6.05% Senior Notes, due June 15, 2015.  Aggregate              
principal amount of $75,000 less unaccrued discount              
of $0 and $11 (6.1% imputed rate)     -      74,989 
6.85% Senior Notes, due April 15, 2016.  Aggregate              
principal amount of $125,000 less unaccrued discount              
of $31 and $50 (6.9% imputed rate)     124,969      124,950 
Total    $237,969     $237,939 

  

 

(1) The Company designates debt obligations as “long-term” based on maturity date at issuance.

 

The Credit Agreement with Financial Institutions (“Bank Credit Facility”), 6.05% Senior Notes due 2015 (“Senior Notes due 2015”) and 6.85% Senior Notes due 2016 (“Senior Notes due 2016”) are described in “Notes to Consolidated Financial Statements — Note 5 — Debt” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

 

Maturity of Senior Notes due 2015

 

On June 15, 2015, the Senior Notes due 2015 matured and the Company repaid the $75,000 aggregate principal amount utilizing $75,000 of additional borrowing under the existing Bank Credit Facility.

 

Debt Retirement Charges

 

The repayment of the Senior Notes due 2015 resulted in no pretax charges to income for the three and six months ended June 30, 2015.

 

Universal Shelf Registration

 

To provide additional capital management flexibility, the Company filed a “universal shelf” registration on Form S-3 with the SEC on March 12, 2015. The registration statement, which registered the offer and sale by the Company from time to time of an indeterminate amount of various securities, which may include debt securities, common stock, preferred stock, depositary shares, warrants, delayed delivery contracts and/or units that include any of these securities, was automatically effective on March 12, 2015. Unless withdrawn by the Company earlier, this registration statement will remain effective through March 12, 2018. No securities associated with the registration statement have been issued as of the date of this Quarterly Report on Form 10-Q. In addition to the Form S-3 entry to the capital markets, HMEC met the requirements of a “well-known seasoned issuer”, as defined by the SEC, as of December 31, 2014.

 

20
 

 

Note 5 - 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 yet 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:

 

        Ceded to  Assumed   
   Gross    Other  from Other  Net
   Amount    Companies  Companies  Amount
                                         
Three months ended June 30, 2015                              
Premiums written and contract deposits    $324,597       $6,184     $981     $319,394 
Premiums and contract charges earned     187,809        6,332      899      182,376 
Benefits, claims and settlement expenses     140,038        7,793      694      132,939 
                               
Three months ended June 30, 2014                              
Premiums written and contract deposits    $298,163       $6,712     $942     $292,393 
Premiums and contract charges earned     185,169        6,893      862      179,138 
Benefits, claims and settlement expenses     129,163        2,684      679      127,158 
                               
Six months ended June 30, 2015                              
Premiums written and contract deposits    $635,644       $12,308     $1,793     $625,129 
Premiums and contract charges earned     373,005        12,647      1,757      362,115 
Benefits, claims and settlement expenses     255,878        10,363      1,443      246,958 
                               
Six months ended June 30, 2014                              
Premiums written and contract deposits    $564,600       $13,343     $1,411     $552,668 
Premiums and contract charges earned     366,902        13,786      1,425      354,541 
Benefits, claims and settlement expenses     244,040        6,129      1,235      239,146 

 

Note 6 - Commitments

 

Investment Commitments

 

From time to time, the Company has outstanding commitments to purchase investments and/or commitments to lend funds under bridge loans. Unfunded commitments were as follows:

 

   June 30,    December 31,
   2015    2014
Outstanding commitments to:                
Purchase investments    $29,472       $39,689 
Lend funds under bridge loans     10,412        10,567 
Total    $39,884       $50,256 

 

21
 

 

Note 7 - 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, primarily personal lines automobile and homeowners products; retirement annuity products, primarily 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 the basis for management’s evaluation of the results of those segments, but classifies those items in the fourth segment, corporate and other. In addition to ongoing transactions such as corporate debt service, realized investment gains and losses and certain public company expenses, such items have also included corporate debt retirement costs/gains, when applicable. Summarized financial information for these segments is as follows:

 

   Three Months Ended  Six Months Ended
   June 30,  June 30,
     2015      2014        2015     2014 
                     
Insurance premiums and                        
contract charges earned                        
Property and casualty    $147,657   $144,658     $294,406   $288,550 
Annuity     6,516    6,453      12,739    12,377 
Life     28,203    28,027      54,970    53,614 
Total    $182,376   $179,138     $362,115   $354,541 
                         
Net investment income                        
Property and casualty    $9,007   $9,455     $18,440   $18,740 
Annuity     57,183    54,338      113,575    110,195 
Life     18,022    17,842      35,730    35,976 
Corporate and other     6    2      12    4 
Intersegment eliminations     (223)   (232)     (449)   (466)
Total    $83,995   $81,405     $167,308   $164,449 
                         
Net income (loss)                        
Property and casualty    $3,244   $4,895     $20,867   $18,922 
Annuity     11,747    11,573      24,257    23,812 
Life     3,643    5,015      7,028    8,897 
Corporate and other     (2,451)   (1,031)     (1,694)   (2,813)
Total    $16,183   $20,452     $50,458   $48,818 

 

   June 30,  December 31,
   2015  2014
Assets                     
Property and casualty     $1,110,927      $1,107,962 
Annuity     6,860,029      6,683,473 
Life     1,886,005      1,858,150 
Corporate and other     143,281      155,678 
Intersegment eliminations     (30,702)     (36,736)
Total    $9,969,540     $9,768,527 

 

22
 

 

NOTE 8 - Derivative Instruments

 

In February 2014, the Company began offering fixed indexed annuity (“FIA”) products, which are deferred fixed annuities that guarantee the return of principal to the contractholder and credit interest based on a percentage of the gain in a specified market index. When fixed indexed annuity deposits are received, a portion of the deposit is used to purchase derivatives consisting of call options on the applicable market indices to fund the index credits due to fixed indexed annuity contractholders. For the Company, substantially all such call options are one-year options purchased to match the funding requirements of the underlying contracts. The call options are carried at fair value with the change in fair value included in Net Realized Investment Gains (Losses), a component of revenues, in the Consolidated Statements of Operations. The change in fair value of derivatives includes the gains or losses recognized at the expiration of the option term or early termination and the changes in fair value for open positions. On the respective anniversary dates of the indexed deposits, the index used to compute the annual index credit is reset and new one-year call options are purchased to fund the next annual index credit. The cost of these purchases is managed through the terms of the fixed indexed annuities, which permit changes to index return caps, participation rates and/or asset fees, subject to guaranteed minimums on each contract’s anniversary date. By adjusting the index return caps, participation rates or asset fees, crediting rates generally can be managed except in cases where the contractual features would prevent further modifications.

 

The Company carries all derivative instruments as assets or liabilities in the Consolidated Balance Sheets at fair value. The Company elected to not use hedge accounting for derivative transactions related to the FIA products. As a result, the Company records the purchased call options and the embedded derivative related to the provision of a contingent return at fair value, with changes in the fair value of the derivatives recognized immediately in the Consolidated Statements of Operations. The fair values of derivative instruments, including derivative instruments embedded in fixed indexed annuity contracts, presented in the Consolidated Balance Sheets were as follows:

 

   June 30,    December 31,
   2015    2014
Assets                
Derivative instruments, included in Short-term                
and Other Investments    $1,946       $2,458 
                 
Liabilities                
Fixed indexed annuities - embedded derivatives,                
included in Other Policyholder Funds     26,719        20,049 

 

The changes in fair value of derivatives included in the Consolidated Statements of Operations were as follows:

 

   Three Months Ended    Six Months Ended
   June 30,        June 30,
     2015   2014       2015   2014 
Change in fair value of derivatives (1):                          
Revenues                          
Net realized investment gains (losses)    $(402)  $77       $(607)  $91 
                           
Change in fair value of embedded derivatives:                          
Revenues                          
Net realized investment gains (losses)     28    (57)       467    (69)

  

 

(1)Includes the gains or losses recognized at the expiration of the option term or early termination and the changes in fair value for open options.

 

23
 

  

NOTE 8 - Derivative Instruments-(Continued)

 

The Company’s strategy attempts to mitigate any potential risk of loss under these agreements through a regular monitoring process, which evaluates the program's effectiveness. The Company is exposed to risk of loss in the event of nonperformance by the counterparties and, accordingly, option contracts are purchased from multiple counterparties, which are evaluated for creditworthiness prior to purchase of the contracts. All of these options have been purchased from nationally recognized financial institutions with a Standard and Poor's/Moody’s long-term credit rating of “BBB+”/“Baa1” or higher at the time of purchase and the maximum credit exposure to any single counterparty is subject to concentration limits. The Company also obtains credit support agreements that allow it to request the counterparty to provide collateral when the fair value of the exposure to the counterparty exceeds specified amounts.

 

The notional amount and fair value of call options by counterparty and each counterparty's long-term credit ratings were as follows:

 

   June 30, 2015  December 31, 2014
   Credit Rating (1)  Notional  Fair  Notional  Fair
Counterparty  S&P  Moody’s  Amount  Value  Amount      Value
                               
Bank of America, N.A.  A  A1    $17,000     $269     $8,700     $439 
Barclays Bank PLC   A-  A2     5,000      72      5,000      70 
Citigroup Inc.   A-       Baa1     4,200      48      -      - 
Credit Suisse International  A  A1     21,300      646      27,500      1,193 
Societe Generale  A  A2     50,100      911      25,400      756 
                                   
Total          $97,600     $1,946     $66,600     $2,458 

 

 

(1)As assigned by Standard & Poor’s Corporation (“S&P”) and Moody’s Investors Service, Inc. (“Moody’s”).

 

As of June 30, 2015 and December 31, 2014, the Company held $2,117 and $1,955, respectively, of cash received from counterparties for derivative collateral, which is included in Other Liabilities on the Consolidated Balance Sheets. This derivative collateral limited the Company’s maximum amount of economic loss due to credit risk that would be incurred if parties to the call options failed completely to perform according to the terms of the contracts to $0 and $503 at June 30, 2015 and December 31, 2014, respectively.

 

The future annual index credits on fixed indexed annuities are treated as a "series of embedded derivatives" over the expected life of the applicable contract. Call options are not purchased to fund the index liabilities which may arise after the next annuity deposit anniversary date. Call options and the related forward embedded options in the annuity contracts are carried at fair value.

 

24
 

 

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS (“MD&A”)

(Dollars in millions, except per share data)

 

Forward-looking Information

 

Statements made in the following discussion that are not historical in nature are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to known and unknown risks, uncertainties and other factors. Horace Mann is not under any obligation to (and expressly disclaims any such obligation to) update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. It is important to note that the Company's actual results could differ materially from those projected in forward-looking statements due to a number of risks and uncertainties inherent in the Company's business. For additional information regarding risks and uncertainties, see “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. That discussion includes factors such as:

·The impact that a prolonged economic recession may have on the Company’s investment portfolio; volume of new business for automobile, homeowners, annuity and life products; policy renewal rates; and additional annuity contract deposit receipts.
·Fluctuations in the fair 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.
·Prevailing low interest rate levels, including the impact of interest rates on (1) the Company's ability to maintain appropriate interest rate spreads over minimum fixed rates guaranteed in the Company's annuity and life products, (2) the book yield of the Company's investment portfolio, (3) 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, (4) amortization of deferred policy acquisition costs and (5) capital levels of the Company’s life insurance subsidiaries.
·The frequency and severity of events such as hurricanes, storms, earthquakes and wildfires, and the ability of the Company to provide accurate estimates of ultimate claim costs in its consolidated financial statements.
·The Company’s risk exposure to catastrophe-prone areas. Based on full year 2014 property and casualty direct earned premiums, the Company’s ten largest states represented 58% of the segment total. Included in this top ten group are certain states which are considered more prone to catastrophe occurrences: California, North Carolina, Texas, Florida, South Carolina and Louisiana.
·The ability of the Company to maintain a favorable catastrophe reinsurance program considering both availability and cost; and the collectibility of reinsurance receivables.
·Adverse changes in market appreciation, interest spreads, business persistency and policyholder mortality and morbidity rates and the resulting impact on both estimated reserves and the amortization of deferred policy acquisition costs.
·Adverse results from the assessment of the Company’s goodwill asset requiring write off of the impaired portion.
·The Company's ability to refinance outstanding indebtedness or repurchase shares of the Company’s common stock.

 

25
 

 

·The Company's ability to (1) develop and expand its marketing operations, including agents and other points of distribution, and (2) maintain and secure access to educators, school administrators, principals and school business officials.
·The effects of economic forces and other issues affecting the educator market including, but not limited to, federal, state and local budget deficits and cut-backs and adverse changes in state and local tax revenues. The effects of these forces can include, among others, teacher layoffs and early retirements, as well as individual concerns regarding employment and economic uncertainty.
·The Company's ability to profitably expand its property and casualty business in highly competitive environments.
·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, including, but not limited to, changes in IRS regulations governing Section 403(b) plans and the U.S. Department of Labor’s recent proposed rule defining who is a “fiduciary” of a qualified retirement plan.
·Changes in public employee retirement programs as a result of federal and/or state level pension reform initiatives.
·Changes in federal and state laws and regulations, which affect the relative tax advantage of certain investments or which affect the ability of debt issuers to declare bankruptcy or restructure debt.
·The Company's ability to effectively implement new or enhanced information technology systems and applications.

 

Executive Summary

 

Horace Mann Educators Corporation (“HMEC”; and together with its subsidiaries, the “Company” or “Horace Mann”) is an insurance holding company. Through its subsidiaries, HMEC markets and underwrites personal lines of property and casualty insurance, retirement annuities and life insurance in the U.S. The Company markets its products primarily to K-12 teachers, administrators and other employees of public schools and their families.

 

For the three months ended June 30, 2015, the Company’s net income of $16.2 million decreased $4.2 million compared to the prior year, reflecting the impact of adverse weather on the property and casualty segment and an increase in life mortality costs, accompanied by a modest decrease in realized investment gains. After tax net realized investment gains of $0.8 million were $1.4 million less than a year earlier. For the property and casualty segment, net income of $3.3 million decreased $1.6 million compared to the second quarter of 2014. While current year-to-date automobile results are in line with the prior year, the second quarter did reflect an increase in physical damage severity of losses, while loss frequency remained relatively stable. Annuity segment net income of $11.8 million for the current period increased $0.3 million compared to the second quarter of 2014, despite the pressures of the interest rate environment. Unlocking of deferred policy acquisition costs had an immaterial impact on net income. Life segment net income of $3.6 million decreased $1.4 million compared to the second quarter of 2014.

 

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For the six months ended June 30, 2015, the Company’s net income of $50.5 million increased $1.7 million compared to the prior year, including an increase in realized investment gains. After tax net realized investment gains of $4.8 million were $1.5 million higher than a year earlier. For the property and casualty segment, net income of $20.9 million increased $2.0 million compared to the first half of 2014. The property and casualty combined ratio was 97.0% for the first six months of 2015, a 1.2 percentage point improvement compared to 98.2% for the same period in 2014, primarily reflecting continued improvement in current accident year non-catastrophe results for homeowners and stable automobile results on the same basis. Catastrophe losses increased in the current period, representing a $1.2 million after tax decrease to net income compared to the first six months of 2014. Annuity segment net income of $24.3 million for the current period increased $0.5 million compared to the first six months of 2014, and despite the pressures of the interest rate environment the net interest margin increased 1%. Assets under management increased and disciplined crediting rate management continues. For the first six months of 2015 and 2014, unlocking of deferred policy acquisition costs had an immaterial impact on net income. Life segment net income of $7.0 million decreased $1.9 million compared to the first six months of 2014 primarily due to a higher level of mortality losses in the current period. In the first quarter of 2015, the Company recorded a reduction in incentive compensation expense due to the correction of an immaterial out-of-period adjustment. The majority of the cost reduction benefitted the property and casualty segment, increasing that segment’s net income by approximately $2 million and decreasing the combined ratio by approximately 1 percentage point for the six months ended June 30, 2015. The benefit to the annuity and life segments was approximately $0.5 million after tax for each segment. See also “Notes to Consolidated Financial Statements — Note 1 — Basis of Presentation”.

 

Premiums written and contract deposits increased 13% compared to the first six months of 2014 primarily due to an increase in the amount of annuity deposits received in the current period, as well as the favorable premium impact from increases in average premium per policy for both homeowners and automobile. Annuity deposits received were 30% greater than the prior year, including amounts related to the Company’s 401(k) group annuity contract as further explained in “Results of Operations — Insurance Premiums and Contract Charges”. Excluding this item, consolidated and annuity segment growth were 7% and 15%, respectively. Property and casualty segment premiums written increased 3% compared to the prior year. Life segment insurance premiums and contract deposits were comparable to the first half of 2014.

 

The Company’s book value per share was $31.73 at June 30, 2015, an increase of 1% compared to 12 months earlier. This increase reflected net income for the trailing 12 months partially offset by a decrease in net unrealized investment gains due to higher yields on intermediate and long maturity U.S. Treasury securities and wider credit spreads across most asset classes, the combination of which resulted in a decrease in net unrealized gains for the Company’s holdings of fixed income and equity securities. At June 30, 2015, book value per share excluding investment fair value adjustments was $26.30, representing a 7% increase compared to 12 months earlier.

 

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Critical Accounting Policies

 

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires the Company's management to make estimates and assumptions based on information available at the time the consolidated financial statements are prepared. These estimates and assumptions affect the reported amounts of the Company's consolidated assets, liabilities, shareholders' equity and net income. Certain accounting estimates are particularly sensitive because of their significance to the Company's consolidated financial statements and because of the possibility that subsequent events and available information may differ markedly from management's judgments at the time the consolidated 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 consolidated financial statements, which include related disclosures. For the Company, the areas most subject to significant management judgments include: fair value measurements, other-than-temporary impairment of investments, goodwill, deferred policy acquisition costs for annuity and interest-sensitive life products, liabilities for property and casualty claims and claim expenses, liabilities for future policy benefits, deferred taxes and valuation of assets and liabilities related to the defined benefit pension plan.

 

Compared to December 31, 2014, at June 30, 2015 there were no material changes to the accounting policies for the areas most subject to significant management judgments identified above. In addition to disclosures in “Notes to Consolidated Financial Statements” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, discussion of accounting policies, including certain sensitivity information, was presented in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” in that Form 10-K.

 

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Results of Operations

 

Insurance Premiums and Contract Charges

 

   Six Months Ended   Change From 
   June 30,   Prior Year 
   2015   2014   Percent   Amount 
Insurance premiums written and contract deposits (includes annuity and life contract deposits)                    
Property & casualty (1)  $293.0   $285.4    2.7%  $7.6 
Annuity deposits   282.9    218.3    29.6%   64.6 
Life   49.2    49.0    0.4%   0.2 
Total  $625.1   $552.7    13.1%  $72.4 
                     
Insurance premiums and contract charges earned (excludes annuity and life contract deposits)                    
Property & casualty (1)  $294.4   $288.5    2.0%  $5.9 
Annuity   12.7    12.4    2.4%   0.3 
Life   55.0    53.6    2.6%   1.4 
Total  $362.1   $354.5    2.1%  $7.6 

 

 

(1)Includes voluntary business and an immaterial amount of involuntary business. Voluntary business represents policies sold through the Company's marketing organization and issued under the Company's underwriting guidelines. Involuntary business consists of allocations of business from state mandatory insurance facilities and assigned risk business.

 

Number of Policies and Contracts in Force

(actual counts)

 

   June 30,   December 31,   June 30, 
   2015   2014   2014 
Property and casualty (voluntary)               
Automobile   482,563    480,702    480,120 
Property   226,391    229,072    232,329 
Total   708,954    709,774    712,449 
Annuity   206,055    202,572    197,380 
Life   200,654    200,867    200,134 

 

For the three months ended June 30, 2015, the Company’s premiums written and contract deposits of $319.4 million increased $27.0 million, or 9.2%, compared to the prior year, reflecting growth primarily in the Company’s annuity segment.

 

For the first six months of 2015, the Company’s premiums written and contract deposits of $625.1 million increased $72.4 million, or 13.1%, compared to the prior year, reflecting growth in each of the Company’s three segments, led by the annuity segment. Changes in the Company’s employee retirement savings plans which were effective beginning in 2015 led to $31.2 million of the $72.4 million increase for the six months; consolidated and annuity segment growth were 7.5% and 15.3%, respectively, excluding this item. The Company’s premiums and contract charges earned increased $3.3 million, or 1.8%, compared to the second quarter of 2014 and increased $7.6 million, or 2.1%, compared to the six months ended June 30, 2014, primarily due to increases in average premium per policy for both homeowners and automobile.

 

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Total property and casualty premiums written increased 2.7%, or $7.6 million, in the first six months of 2015, compared to the prior year. Average written premium per policy for both automobile and homeowners increased compared to the prior year, with the impact partially offset by a reduced level of homeowners policies in force in the current period. For 2015, the Company’s full year rate plan anticipates mid-single digit average rate increases (including states with no rate actions) for both automobile and homeowners; average approved rate changes during the first six months of 2015 were consistent with those plans at 4% for automobile and 6% for homeowners.

 

Based on policies in force, the current year voluntary automobile 12 month retention rate for new and renewal policies was 84.9% compared to 84.5% at June 30, 2014. The property 12 month new and renewal policy retention rate was 87.6% at June 30, 2015 compared to 88.8% at June 30, 2014. Although the property retention rate is modestly lower than 12 months earlier, the 2015 retention rates have been favorably impacted by the Company’s focus on expanding the number of multiline customers and customer utilization of automatic payment plans, particularly for voluntary automobile business.

 

Voluntary automobile premiums written increased 4.0%, or $7.5 million, compared to the first half of 2014. In the first six months of 2015, the average written premium per policy and average earned premium per policy each increased approximately 3% compared to a year earlier, which was augmented by the modest increase in policies in force. The number of educator policies increased more than the total policy count over the period and represented approximately 85% of the voluntary automobile policies in force at June 30, 2015 and 84% at both December 31, 2014 and June 30, 2014.

 

Homeowners premiums written decreased 0.2%, or $0.2 million, compared to the first half of 2014. The average written premium per policy and average earned premium per policy increased approximately 2% and 4%, respectively, in the first half of 2015 compared to a year earlier. In addition, reduced catastrophe reinsurance costs benefitted the current period by approximately $0.9 million. The number of educator policies declined less than the total homeowners policy count and represented approximately 81% of the homeowners policies in force at June 30, 2015, compared to approximately 80% and 79% at December 31, 2014 and June 30, 2014, respectively. The number of educator policies and total policies has been, and may continue to be, impacted by the Company’s risk mitigation programs, including actions in catastrophe-prone coastal areas, involving policies of both educators and non-educators.

 

The Company continues to evaluate and implement actions to further mitigate its risk exposure in hurricane-prone areas, as well as other areas of the country. Such actions could include, but are not limited to, non-renewal of homeowners policies, restricted agent geographic placement, limitations on agent new business sales, further tightening of underwriting standards and increased utilization of third-party vendor products. In 2014 the Company initiated a program to further address homeowners profitability and hurricane exposure issues in Florida. The Company identified for non-renewal about 4,800 policies, approximately 95% of its December 31, 2013 Florida book of property business, starting with June 2014 policy effective dates. As of June 30, 2015, all of the policies in the non-renewal program had been terminated. While this program has impacted the overall policy in force count and premiums in the short-term, it is expected to reduce risk exposure concentration, reduce overall catastrophe reinsurance costs and improve homeowners longer-term underwriting results. The Company continues to write policies for tenants in Florida. The Company also has authorized its agents to write certain third-party vendors’ homeowners policies in Florida.

 

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For the six months ended June 30, 2015, total annuity deposits received increased 29.6%, or $64.6 million, compared to the prior year, including a 38.7% increase in recurring deposit receipts and a 22.7% increase in single premium and rollover deposit receipts. In addition to external contractholder deposits, annuity new recurring deposits include contributions and transfers by Horace Mann’s employees into the Company’s 401(k) group annuity contract. And, included in the current six month increase is $31.2 million attributable to changes in the Company’s employee retirement saving plans, representing 14.3 percentage points of the current period increase. The majority of the $31.2 million 401(k) related increase was due to employees’ elections to rollover amounts from a previously terminated, fully funded defined contribution plan third-party investment vehicle into their 401(k) accounts. The Company’s employee retirement savings plans are described in “Notes to Consolidated Financial Statements — Note 9 — Pension Plans and Other Postretirement Benefits” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. Note that deposits into the Company’s employee 401(k) group annuity contract are not reported as “sales”.

 

As further described in “Sales” below, the Company’s fixed indexed annuity contract contributed to the favorable result in 2015. In the first six months of 2015, new deposits to fixed accounts of $187.6 million increased 24.6%, or $37.0 million, and new deposits to variable accounts of $95.3 million increased 40.8%, or $27.6 million, compared to the prior year.

 

Total annuity accumulated value on deposit of $6.0 billion at June 30, 2015 increased 7.3% compared to a year earlier, reflecting the increase from new deposits received as well as favorable retention and financial market performance. Accumulated value retention for the variable annuity option was 94.0% and 94.1% for the 12 month periods ended June 30, 2015 and 2014, respectively; fixed annuity retention was 94.7% and 94.9% for the respective periods.

 

Variable annuity accumulated balances of $1.9 billion at June 30, 2015 increased 5.0% compared to June 30, 2014, reflecting favorable financial market performance over the 12 months (driven primarily by equity securities) and net positive cash flows partially offset by net balances transferred from the variable account option to the guaranteed interest rate fixed account option. Annuity segment contract charges earned increased 2.4%, or $0.3 million, compared to the first six months of 2014.

 

Life segment premiums and contract deposits for the first six months of 2015 increased 0.4%, or $0.2 million, compared to the prior year, primarily due to the favorable impact of new business growth. The ordinary life insurance in force lapse ratio was 4.1% for both the 12 months ended June 30, 2015 and June 30, 2014.

 

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Sales

 

For the first six months of 2015, property and casualty new annualized sales premiums increased 4.8% compared to the first half of 2014, as 4.3%, or $1.6 million, growth in new automobile sales was accompanied by growth in homeowners sales of 6.8%, or $0.5 million, compared to the prior year.

 

For sales by Horace Mann’s agency force, the Company’s annuity new business levels continued to benefit from agent training and marketing programs, which focus on retirement planning, and build on the positive results produced in recent years resulting in a 23.0% increase compared to the first half of 2014. Sales from the independent agent distribution channel, which represent approximately 10% of total annuity sales and are largely single premium and rollover annuity deposits, increased 6.9% compared to a year earlier. As a result, total Horace Mann annuity sales from the combined distribution channels increased 21.0% compared to the six months ended June 30, 2014, including continued growth in sales of the Company’s fixed indexed annuity product as described below. Overall, the Company’s new recurring deposit business (measured on an annualized basis at the time of sale, compared to the reporting of new contract deposits which are recorded when cash is received) increased 9.6% compared to the first half of 2014, and single premium and rollover deposits increased 22.8% compared to the prior year. In February 2014, the Company expanded its annuity product portfolio by introducing a fixed indexed annuity contract. This new product has been well received by the Company’s customers and represented approximately one-third of total annuity sales for the first six months of 2015, largely single premium and rollover deposits. Previously, the Company had entered into third-party vendor agreements to offer an indexed annuity product underwritten by the third parties.

 

The Company’s introduction of new educator-focused portfolios of term and whole life products in recent years, including a single premium whole life product, has contributed to the overall increase in sales of proprietary life products over the last few years. For the six months ended June 30, 2015, sales of Horace Mann’s proprietary life insurance products totaled $4.8 million, representing a decrease of 4.0%, or $0.2 million, due to variability of sales levels for the single premium product compared to the prior year.

 

Distribution System

 

At June 30, 2015, there was a combined total of 703 Exclusive Agencies and Employee Agents, compared to 755 at December 31, 2014 and 707 at June 30, 2014. The Company continues to expect higher quality standards for agents and agencies focused on improving both customer experiences and agent productivity. The dedicated sales force is supported by the Company’s Customer Contact Center.

 

As mentioned above, the Company also utilizes a nationwide network of Independent Agents who comprise an additional distribution channel for the Company’s 403(b) tax-qualified annuity products. The Independent Agent distribution channel included 489 authorized agents at June 30, 2015. During the first six months of 2015, this channel generated $18.6 million in annualized new annuity sales for the Company compared to $17.4 million for the first six months of 2014, with the new business primarily comprised of single and rollover deposit business in both periods.

 

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Net Investment Income

 

For the three months ended June 30, 2015, pretax investment income of $84.0 million increased 3.2%, or $2.6 million, (2.9%, or $1.6 million, after tax) compared to the prior year. Pretax investment income of $167.3 million for the six months ended June 30, 2015 increased 1.8%, or $2.9 million, (1.6%, or $1.8 million, after tax) compared to the prior year. The increase reflected growth in the size of the average investment portfolio on an amortized cost basis and continued strong performance in the fixed maturity and alternative investment portfolios, partially offset by a decline in the average portfolio yield. Average invested assets increased 5.2% over the 12 months ended June 30, 2015. The average pretax yield on the investment portfolio was 5.20% (3.49% after tax) for the first six months of 2015, compared to the pretax yield of 5.38% (3.61% after tax) a year earlier. During the first six months of 2015, management continued to identify and secure investments, including a modest level of alternative investments, with attractive risk-adjusted yields without venturing into asset classes or individual securities that would be inconsistent with the Company’s overall conservative investment guidelines.

 

Net Realized Investment Gains and Losses

 

For the three months ended June 30, 2015, net realized investment gains (pretax) were $1.4 million compared to realized investment gains of $3.5 million in the same period in the prior year. For the six months, net realized investment gains (pretax) were $7.5 million compared to net realized investment gains of $5.2 million in the prior year. The net gains and losses in both periods were realized primarily from ongoing investment portfolio management activity and, when determined, the recording of impairment write-down charges.

 

For the first half of 2015, the Company’s net realized investment gains of $7.5 million included $23.6 million of gross gains realized on security sales and calls partially offset by $3.1 million of realized losses on securities that were disposed of during the six months and $13.0 million of impairment charges recorded largely on Puerto Rico and energy sector fixed maturity securities and one unrelated equity security. Of those impairment charges, $10.7 million was recorded in the second quarter of 2015.

 

For the first half of 2014, the Company’s net realized investment gains of $5.2 million included $6.9 million of gross gains realized on security sales and calls partially offset by $1.2 million of realized losses on securities that were disposed of during the six months, primarily municipal securities, and $0.5 million of impairment charges recorded on five securities.

 

The Company, from time to time, sells securities subsequent to the balance sheet date that were considered temporarily impaired at the balance sheet date. Such sales are due to issuer-specific events occurring subsequent to the balance sheet date that result in a change in the Company’s intent to sell an invested asset.

 

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Fixed Maturity Securities and Equity Securities Portfolios

 

The table below presents the Company’s fixed maturity securities and equity securities portfolios by major asset class, including the ten largest sectors of the Company’s corporate bond holdings (based on fair value). Compared to December 31, 2014, yields on intermediate and long maturity U.S. Treasury securities increased and credit spreads were wider across most asset classes during the first six months of 2015, the combination of which resulted in a decrease in net unrealized gains for virtually all classes of the Company’s fixed maturity securities holdings.

 

   June 30, 2015 
           Amortized   Pretax Net 
   Number of   Fair   Cost or   Unrealized 
   Issuers   Value   Cost   Gain (Loss) 
Fixed maturity securities                    
Corporate bonds                    
Banking and Finance   84   $517.2   $484.2   $33.0 
Energy   66    253.1    233.0    20.1 
Insurance   48    231.6    208.6    23.0 
Utilities   35    180.6    156.3    24.3 
Real estate   35    167.8    158.6    9.2 
Technology   34    167.3    163.6    3.7 
Telecommunications   27    142.0    136.0    6.0 
Transportation   28    139.3    132.5    6.8 
Broadcasting and Media   33    114.7    105.0    9.7 
Metal and Mining   17    110.2    108.9    1.3 
All Other Corporates (1)   192    618.6    584.3    34.3 
Total corporate bonds   599    2,642.4    2,471.0    171.4 
Mortgage-backed securities                    
U.S. Government and federally                    
sponsored agencies   382    526.4    480.5    45.9 
Commercial (2)   56    213.3    213.1    0.2 
Other   24    48.1    45.8    2.3 
Municipal bonds (3)   540    1,648.4    1,511.1    137.3 
Government bonds                    
U.S.   9    602.6    590.5    12.1 
Foreign   11    66.7    59.5    7.2 
Collateralized debt obligations (4)   99    583.2    578.8    4.4 
Asset-backed securities   102    566.0    554.7    11.3 
Total fixed maturity securities   1,822   $6,897.1   $6,505.0   $392.1 
                     
Equity securities                    
Non-redeemable preferred stocks   9   $15.7   $16.2   $(0.5)
Common stocks   165    65.0    57.9    7.1 
Closed-end fund   1    18.6    20.0    (1.4)
Total equity securities   175   $99.3   $94.1   $5.2 
                     
Total   1,997   $6,996.4   $6,599.1   $397.3 

 

 

(1)The All Other Corporates category contains 19 additional industry classifications. Health care, consumer products, food and beverage, natural gas, retail, and gaming represented $449.2 million of fair value at June 30, 2015, with the remaining 13 classifications each representing less than $33 million.
(2)At June 30, 2015, 100% were investment grade, with an overall credit rating of AA, and the positions were well diversified by property type, geography and sponsor.
(3)Holdings are geographically diversified, approximately 48% are tax-exempt and 80% are revenue bonds tied to essential services, such as mass transit, water and sewer. The overall credit quality of the municipal bond portfolio was AA- at June 30, 2015.
(4)Based on fair value, 97.0% of the collateralized debt obligation securities were rated investment grade by Standard and Poor’s Corporation (“S&P”) and/or Moody’s Investors Service, Inc. (“Moody’s”) at June 30, 2015.

 

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At June 30, 2015, the Company’s diversified fixed maturity securities portfolio consisted of 2,273 investment positions, issued by 1,822 entities, and totaled approximately $6.9 billion in fair value. This portfolio was 96.7% investment grade, based on fair value, with an average quality rating of A. The Company’s investment guidelines generally limit single corporate issuer concentrations to 0.5% of invested assets for “AA” or “AAA” rated securities, 0.35% of invested assets for “A” or “BBB” rated securities, and 0.2% of invested assets for non-investment grade securities.

 

The following table presents the composition and value of the Company’s fixed maturity securities and equity securities portfolios by rating category. At June 30, 2015, 95.8% of these combined portfolios were investment grade, based on fair value, with an overall average quality rating of A. The Company has classified the entire fixed maturity securities and equity securities portfolios as available for sale, which are carried at fair value.

 

Rating of Fixed Maturity Securities and Equity Securities (1)

(Dollars in millions)

 

   Percent of Portfolio         
   Fair Value   June 30, 2015 
   December 31,   June 30,   Fair   Amortized 
   2014   2015   Value   Cost or Cost 
Fixed maturity securities                    
AAA   6.8%   7.1%  $490.3   $476.6 
AA (2)   36.5    36.6    2,522.9    2,368.0 
A   24.5    25.7    1,771.6    1,646.6 
BBB   28.5    27.3    1,885.4    1,784.0 
BB   1.9    1.7    115.5    113.9 
B   1.4    1.1    78.8    79.1 
CCC or lower   0.1    0.2    12.2    16.5 
Not rated (3)   0.3    0.3    20.4    20.3 
Total fixed maturity securities   100.0%