Attached files

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EX-99.1 - EXHIBIT 99.1 - HORACE MANN EDUCATORS CORP /DE/v465344_ex99-1.htm
EX-32.2 - EXHIBIT 32.2 - HORACE MANN EDUCATORS CORP /DE/v465344_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - HORACE MANN EDUCATORS CORP /DE/v465344_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - HORACE MANN EDUCATORS CORP /DE/v465344_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - HORACE MANN EDUCATORS CORP /DE/v465344_ex31-1.htm
EX-15 - EXHIBIT 15 - HORACE MANN EDUCATORS CORP /DE/v465344_ex15.htm
EX-11 - EXHIBIT 11 - HORACE MANN EDUCATORS CORP /DE/v465344_ex11.htm
EX-10.11(B) - EXHIBIT 10.11(B) - HORACE MANN EDUCATORS CORP /DE/v465344_ex10-11b.htm
EX-10.10(A) - EXHIBIT 10.10(A) - HORACE MANN EDUCATORS CORP /DE/v465344_ex10-10a.htm
EX-10.9(A) - EXHIBIT 10.9(A) - HORACE MANN EDUCATORS CORP /DE/v465344_ex10-9a.htm
EX-10.8 - EXHIBIT 10.8 - HORACE MANN EDUCATORS CORP /DE/v465344_ex10-8.htm
EX-10.3(E) - EXHIBIT 10.3(E) - HORACE MANN EDUCATORS CORP /DE/v465344_ex10-3e.htm
EX-10.3(D) - EXHIBIT 10.3(D) - HORACE MANN EDUCATORS CORP /DE/v465344_ex10-3d.htm
EX-10.3(C) - EXHIBIT 10.3(C) - HORACE MANN EDUCATORS CORP /DE/v465344_ex10-3c.htm
EX-10.3(B) - EXHIBIT 10.3(B) - HORACE MANN EDUCATORS CORP /DE/v465344_ex10-3b.htm
EX-10.3(A) - EXHIBIT 10.3(A) - HORACE MANN EDUCATORS CORP /DE/v465344_ex10-3a.htm
EX-10.3 - EXHIBIT 10.3 - HORACE MANN EDUCATORS CORP /DE/v465344_ex10-3.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 March 31, 2017

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       
Emerging growth company           

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.       

 

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 April 30, 2017, the registrant had 40,542,562 shares of Common Stock, par value $0.001 per share, outstanding.

 

 

 

 

 

 

HORACE MANN EDUCATORS CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2017

INDEX

 

PART I - FINANCIAL INFORMATION Page
     
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 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 12
  Note 3 - Fair Value of Financial Instruments 18
  Note 4 - Derivative Instruments 22
  Note 5 - Property and Casualty Unpaid Claims and Claim Expenses 24
  Note 6 - Debt 25
  Note 7 - Reinsurance 25
  Note 8 - Commitments 26
  Note 9 - Segment Information 26
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 46
     
Item 4. Controls and Procedures 47
     
PART II - OTHER INFORMATION  
     
Item 1A. Risk Factors 47
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 48
     
Item 5. Other Information 48
     
Item 6. Exhibits 49
     
SIGNATURES 54

 

 

 

 

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 March 31, 2017, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for the three-month periods ended March 31, 2017 and 2016. 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, 2016, and the related consolidated statements of operations, comprehensive loss, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated March 1, 2017, we expressed an unqualified opinion on those consolidated financial statements.

 

 

/s/ KPMG LLP  
KPMG LLP  
   
Chicago, Illinois  
May 9, 2017  

 

1

 

 

HORACE MANN EDUCATORS CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

 

   March 31,   December 31, 
   2017   2016 
   (Unaudited)        
ASSETS
Investments                  
Fixed maturity securities, available for sale, at fair value
(amortized cost 2017, $7,173,235; 2016, $7,152,127)
    $7,510,750       $7,456,708   
Equity securities, available for sale, at fair value
(cost 2017, $143,203; 2016, $134,013)
     156,975        141,649   
Short-term and other investments     456,560        401,015   
Total investments     8,124,285        7,999,372   
Cash     6,593        16,670   
Deferred policy acquisition costs     265,612        267,580   
Goodwill     47,396        47,396   
Other assets     324,155        321,874   
Separate Account (variable annuity) assets     2,011,464        1,923,932   
Total assets    $10,779,505       $10,576,824   
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Policy liabilities                  
Investment contract and life policy reserves    $5,502,992       $5,447,969   
Unpaid claims and claim expenses     340,033        329,888   
Unearned premiums     240,816        246,274   
Total policy liabilities     6,083,841        6,024,131   
Other policyholder funds     711,395        708,950   
Other liabilities     403,714        378,620   
Long-term debt     247,273        247,209   
Separate Account (variable annuity) liabilities     2,011,464        1,923,932   
Total liabilities     9,457,687        9,282,842   
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, 2017, 65,215,048; 2016, 64,917,683
     65        65   
Additional paid-in capital     454,982        453,479   
Retained earnings     1,159,532        1,155,732   
Accumulated other comprehensive income (loss), net of taxes:                  
Net unrealized investment gains on fixed maturity
and equity securities
     198,271        175,738   
Net funded status of benefit plans     (11,817 )      (11,817 ) 
Treasury stock, at cost, 2017, 24,672,932 shares;
2016, 24,672,932 shares
     (479,215 )      (479,215 ) 
Total shareholders’ equity     1,321,818        1,293,982   
Total liabilities and shareholders’ equity    $10,779,505       $10,576,824   

 

 

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 
     March 31,   
     2017          2016   
         
Revenues          
Insurance premiums and contract charges earned  $195,722   $185,450 
Net investment income   90,711    84,659 
Net realized investment losses   (242)   (154)
Other income   1,113    1,348 
           
Total revenues   287,304    271,303 
           
Benefits, losses and expenses          
Benefits, claims and settlement expenses   144,096    119,513 
Interest credited   48,774    46,690 
Policy acquisition expenses amortized   24,886    24,052 
Operating expenses   48,756    42,796 
Interest expense   2,956    2,935 
           
Total benefits, losses and expenses   269,468    235,986 
           
Income before income taxes   17,836    35,317 
Income tax expense   2,518    10,164 
           
Net income  $15,318   $25,153 
           
Net income per share          
Basic  $0.37   $0.61 
Diluted  $0.37   $0.61 
           
Weighted average number of shares
and equivalent shares (in thousands)
          
Basic   41,135    41,297 
Diluted   41,342    41,492 
           
Net realized investment gains (losses)          
Total other-than-temporary impairment
losses on securities
  $(2,797)  $(3,673)
Portion of losses recognized in other
comprehensive income
   -    - 
Net other-than-temporary impairment losses
on securities recognized in earnings
   (2,797)   (3,673)
Realized gains, net   2,555    3,519 
Total  $(242)  $(154)

 

 

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 (UNAUDITED)

(Dollars in thousands)

 

   Three Months Ended 
     March 31,   
     2017       2016   
         
Comprehensive income          
Net income  $15,318   $25,153 
Other comprehensive income, net of taxes:          
Change in net unrealized investment gains
and losses on fixed maturity and equity securities
   22,533       69,490 
Change in net funded status of benefit plans   -    - 
Other comprehensive income   22,533    69,490 
Total  $37,851   $94,643 

 

 

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)

 

   Three Months Ended 
     March 31,   
     2017       2016   
         
Common stock, $0.001 par value          
Beginning balance  $65   $65 
Options exercised, 2017, 33,764 shares; 2016, 84,850 shares   -    - 
Conversion of common stock units,
2017, 15,981 shares; 2016, 8,538 shares
   -    - 
Conversion of restricted stock units,
2017, 247,620 shares; 2016, 165,794 shares
   -    - 
Ending balance   65    65 
           
Additional paid-in capital          
Beginning balance   453,479    442,648 
Options exercised and conversion of common stock
units and restricted stock units
   (750)      353 
Share-based compensation expense   2,253    1,910 
Ending balance   454,982    444,911 
           
Retained earnings          
Beginning balance   1,155,732    1,116,277 
Net income   15,318    25,153 
Cash dividends, 2017, $0.275 per share;
2016, $0.265 per share
   (11,518)   (11,114)
Ending balance   1,159,532    1,130,316 
           
Accumulated other comprehensive income (loss), net of taxes          
Beginning balance   163,921    163,373 
Change in net unrealized investment gains and losses on
fixed maturity and equity securities
   22,533    69,490 
Change in net funded status of benefit plans   -    - 
Ending balance   186,454    232,863 
           
Treasury stock, at cost          
Beginning balance, 2017, 24,672,932 shares;
2016, 23,971,522 shares
   (479,215)   (457,702)
Acquisition of shares, 2017, 0 shares;
2016, 474,277 shares
   -    (14,466)
Ending balance, 2017, 24,672,932 shares;
2016, 24,445,799 shares
   (479,215)   (472,168)
           
Shareholders’ equity at end of period  $1,321,818   $1,335,987 

 

 

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)

 

   Three Months Ended 
     March 31,   
     2017       2016   
Cash flows - operating activities          
Premiums collected  $172,588   $177,535 
Policyholder benefits paid   (127,823)   (116,941)
Policy acquisition and other operating expenses paid   (74,763)      (71,024)
Federal income taxes recovered   11    - 
Investment income collected   91,840    82,586 
Interest expense paid   (63)   (57)
Other   11,008    8,258 
           
Net cash provided by operating activities   72,798    80,357 
           
Cash flows - investing activities          
Fixed maturities          
Purchases   (318,629)   (317,878)
Sales   110,872    82,090 
Maturities, paydowns, calls and redemptions   190,068    241,233 
Purchase of other invested assets   (24,177)   (10,260)
Net cash provided by (used in) short-term and other investments   (42,419)   (41,403)
           
Net cash used in investing activities   (84,285)   (46,218)
           
Cash flows - financing activities          
Dividends paid to shareholders   (11,518)   (11,114)
Acquisition of treasury stock   -    (14,466)
Proceeds from exercise of stock options   723    1,727 
Withholding tax payments on RSUs tendered   (2,532)   (3,231)
Annuity contracts: variable, fixed and FHLB funding agreements          
Deposits   117,311    112,564 
Benefits, withdrawals and net transfers to
Separate Account (variable annuity) assets
   (99,757)   (85,411)
Life policy accounts          
Deposits   1,183    489 
Withdrawals and surrenders   (1,066)   (926)
Change in bank overdrafts   (2,934)   1,174 
           
Net cash provided by financing activities   1,410    806 
           
Net (decrease) increase in cash   (10,077)   34,945 
           
Cash at beginning of period   16,670    15,509 
           
Cash at end of period  $6,593   $50,454 

 

 

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)

March 31, 2017 and 2016

(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 March 31, 2017, the consolidated results of operations, comprehensive income, changes in shareholders’ equity and cash flows for the three months ended March 31, 2017 and 2016. 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.

 

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, 2016.

 

The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results to be expected for the full year.

 

The Company has reclassified the presentation of certain prior period information to conform to the 2017 presentation. See “Adopted Accounting Standards”.

 

7

 

 

Note 1 - Basis of Presentation-(Continued)

 

Investment Contract and Life Policy Reserves

 

This table summarizes the Company’s investment contract and life policy reserves.

 

   March 31,   December 31,  
   2017   2016  
                       
Investment contract reserves    $4,408,288          $4,360,456   
Life policy reserves     1,094,704        1,087,513   
Total    $5,502,992       $5,447,969   

 

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 investment gains and losses on fixed maturity and equity securities and the after tax change in net funded status of benefit plans for the period as shown in the Consolidated Statement of Changes in Shareholders’ Equity. The following tables reconcile these components.

 

 Net Unrealized            
 Investment            
 Gains and            
 Losses on            
 Fixed Maturity            
 and Equity            
 Securities (1)(2)    Benefit Plans (1)    Total (1)
                 
Beginning balance, January 1, 2017  $175,738     $(11,817)         $163,921       
Other comprehensive income (loss)
before reclassifications
   22,330      -      22,330 
Amounts reclassified from accumulated
other comprehensive income (loss)
   203      -      203 
Net current period other
comprehensive income
   22,533      -      22,533 
Ending balance, March 31, 2017  $198,271     $(11,817)    $186,454 
                    
Beginning balance, January 1, 2016  $175,167     $(11,794)    $163,373 
Other comprehensive income (loss)
before reclassifications
   69,971      -      69,971 
Amounts reclassified from accumulated
other comprehensive income (loss)
   (481)     -      (481)
Net current period other
comprehensive income
   69,490      -      69,490 
Ending balance, March 31, 2016  $244,657     $(11,794)    $232,863 

 

 
(1)All amounts are net of tax.
(2)The pretax amounts reclassified from accumulated other comprehensive income (loss), $(313) and $740, are included in net realized investment gains and losses and the related income tax expenses, $(110) and $259, are included in income tax expense in the Consolidated Statements of Operations for the three months ended March 31, 2017 and 2016, respectively.

 

8

 

 

Note 1 - Basis of Presentation-(Continued)

 

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 -- Net Unrealized Investment Gains and Losses on Fixed Maturity and Equity Securities”.

 

Adopted Accounting Standards

 

Employee Share-based Payment Accounting

 

Effective January 1, 2017, the Company adopted new accounting guidance for employee share-based payments which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The recognition and classification of the excess tax benefit provisions were applied prospectively in the results of operations. This adoption resulted in additional excess tax benefits of $2,450 which reduced the current provision for income taxes in the results of operations. The statutory tax withholding classification, which are cash payments made to taxing authorities for withheld taxes funded through tendered shares, were applied retrospectively and the Company reclassified the statutory tax withholding requirements in the statement of cash flows from Other in operating activities to Withholding tax payments on RSUs tendered in financing activities. This statutory withholding reclassification resulted in $2,532 and $3,231 being included in financing activities for the three months ended March 31, 2017 and 2016, respectively. There were no cumulative effect adjustments upon adoption of the new accounting guidance.

 

Pending Accounting Standards

 

Revenue Recognition

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued accounting guidance to provide a single comprehensive model in accounting for revenue arising from contracts with customers. The guidance applies to all contracts with customers; however, insurance contracts are specifically excluded from this updated guidance. The guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those years. Early adoption is permitted only for annual reporting periods beginning after December 15, 2016. The Company plans to adopt the guidance as of January 1, 2018. Management believes the adoption of this accounting guidance will not have a material effect on the results of operations or financial position, and related disclosures, of the Company.

 

9

 

 

Note 1 - Basis of Presentation-(Continued)

 

Recognition and Measurement of Financial Assets and Liabilities

 

In January 2016, the FASB issued accounting guidance to improve certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. Among other things, this guidance requires public entities to measure equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) at fair value with changes in fair value recognized in net income and to perform a qualitative assessment to identify impairment for equity investments without readily determinable fair values. Companies are required to apply this guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the year of adoption and, for the guidance related to equity securities without readily determinable fair values, companies are required to apply a prospective approach to equity investments that exist as of the date of adoption. The guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those years. Early application is permitted. The guidance will not have an impact on the Company’s financial position and management is evaluating the impact that this guidance will have on the Company’s results of operations.

 

Statement of Cash Flows -- Classification

 

In August 2016, the FASB issued guidance to reduce diversity in practice in the statement of cash flows between operating, investing and financing activities related to the classification of cash receipts and cash payments for eight specific issues. The FASB acknowledged that current GAAP either is unclear or does not include specific guidance on these eight cash flow classification issues: (1) debt prepayment or extinguishment costs; (2) settlement of zero-coupon bonds (pertains to issuers); (3) contingent consideration payments made after a business combination; (4) proceeds from the settlement of insurance claims (pertains to claimants); (5) proceeds from the settlement of corporate-owned life insurance policies; (6) distributions received from equity method investees; (7) beneficial interests in securitization transactions (pertains to transferors) and (8) separately identifiable cash flows and application of the predominance principle. For public business entities, the guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those years, using a retrospective approach. The guidance allows prospective adoption for individual issues if it is impracticable to apply the amendments retrospectively for those issues. Early application is permitted. Management believes the adoption of this accounting guidance will not have a material effect on the classifications in the Company’s consolidated statement of cash flows. The adoption of this accounting guidance will not have any effect on the results of operations or financial position of the Company.

 

10

 

 

Note 1 - Basis of Presentation-(Continued)

 

Accounting for Leases

 

In February 2016, the FASB issued accounting and disclosure guidance to improve financial reporting and comparability among organizations about leasing transactions. Under the new guidance, for leases with lease terms of more than 12 months, a lessee will be required to recognize assets and liabilities on the balance sheet for the rights and obligations created by those leases. Consistent with current accounting guidance, the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or an operating lease. However, while current guidance requires only capital leases to be recognized on the balance sheet, the new guidance will require both operating and capital leases to be recognized on the balance sheet. In transition to the new guidance, companies are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within those years. Early application is permitted. Management is evaluating the impact this guidance will have on the results of operations and financial position of the Company.

 

Measurement of Credit Losses on Financial Instruments

 

In June 2016, the FASB issued guidance to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments, including reinsurance receivables, held by companies. The new guidance replaces the incurred loss impairment methodology and requires an organization to measure and recognize all current expected credit losses (“CECL”) for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Companies will need to utilize forward-looking information to better inform their credit loss estimates. Companies will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. Credit losses related to available for sale debt securities -- which represent over 90% of Horace Mann’s total investment portfolio -- will be recorded through an allowance for credit losses with this allowance having a limit equal to the amount by which fair value is below amortized cost. The guidance also requires enhanced qualitative and quantitative disclosures to provide additional information about the amounts recorded in the financial statements. For public business entities that are SEC filers, the guidance is effective for annual reporting periods beginning after December 15, 2019, including interim periods within those years, using a modified-retrospective approach. Early application is permitted for annual reporting periods, and interim periods within those years, beginning after December 15, 2018. Management is evaluating the impact this guidance will have on the results of operations and financial position of the Company.

 

11

 

 

Note 1 - Basis of Presentation-(Continued)

 

Simplifying the Test for Goodwill Impairment

 

In January 2017, the FASB issued guidance to simplify the accounting for goodwill impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The same one-step impairment test will be applied to goodwill at all reporting units, even those with zero or negative carrying amounts. Entities will be required to disclose the amount of goodwill for reporting units with zero or negative carrying amounts. Public business entities should adopt the guidance prospectively for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early application is permitted. Management believes the adoption of this accounting guidance will not have a material effect on how it tests goodwill for impairment.

 

Note 2 - Investments

 

The Company’s investment portfolio includes free-standing derivative financial instruments (currently over the counter (“OTC”) index call option contracts) to economically hedge risk associated with its fixed indexed annuity (“FIA”) and indexed universal life (“IUL”) products’ contingent liabilities. The Company’s FIA and IUL products include embedded derivative features that are discussed in “Note 1 -- Summary of Significant Accounting Policies -- Investment Contract and Life Policy Reserves -- Reserves for Fixed Indexed Annuities and Indexed Universal Life Policies” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. The Company’s investment portfolio included 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 investment or insurance products during the three months ended March 31, 2017 and 2016.

 

12

 

 

Note 2 - Investments-(Continued)

 

Fixed Maturity and Equity Securities

 

The Company’s investment portfolio is comprised primarily of fixed maturity securities and also includes 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 (“AOCI”) of all fixed maturity and equity securities in the portfolio were as follows:

 

        Unrealized    Unrealized          
   Amortized    Investment    Investment    Fair    OTTI in
   Cost or Cost    Gains    Losses    Value    AOCI (1)
March 31, 2017                                                                 
Fixed maturity securities                                            
U.S. Government and federally                                            
sponsored agency obligations (2):                                            
Mortgage-backed securities     $581,346       $33,904       $5,443       $609,807       $- 
Other, including                                            
U.S. Treasury securities      520,718        19,809        9,219        531,308        - 
Municipal bonds      1,647,314        148,319        18,206        1,777,427        - 
Foreign government bonds      93,845        5,897        56        99,686        - 
Corporate bonds      2,683,746        162,602        9,175        2,837,173        - 
Other mortgage-backed securities      1,646,266        21,755        12,672        1,655,349        1,538 
Totals     $7,173,235       $392,286       $54,771       $7,510,750       $1,538 
                                             
Equity securities (3)     $143,203       $15,743       $1,971       $156,975       $- 
                                             
December 31, 2016                                            
Fixed maturity securities                                            
U.S. Government and federally                                            
sponsored agency obligations (2):                                            
Mortgage-backed securities     $587,355       $34,256       $6,720       $614,891       $- 
Other, including                                            
U.S. Treasury securities      458,745        18,518        10,120        467,143        - 
Municipal bonds      1,648,252        143,733        22,588        1,769,397        - 
Foreign government bonds      93,864        5,102        297        98,669        - 
Corporate bonds      2,672,818        152,229        14,826        2,810,221        - 
Other mortgage-backed securities      1,691,093        21,153        15,859        1,696,387        1,618 
Totals     $7,152,127       $374,991       $70,410       $7,456,708       $1,618 
                                             
Equity securities (3)     $134,013       $13,210       $5,574       $141,649       $- 

 

 
(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 OTTI losses in AOCI which was not included in earnings; amounts also include net unrealized investment gains and 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 $283,039 and $272,668; Federal Home Loan Mortgage Corporation (“FHLMC”) of $373,017 and $378,683; and Government National Mortgage Association (“GNMA”) of $112,065 and $115,627 as of March 31, 2017 and December 31, 2016, respectively.
(3)Includes nonredeemable (perpetual) preferred stocks, common stocks and closed-end funds.

 

13

 

 

Note 2 - Investments-(Continued)

 

The following table presents the fair value and gross unrealized losses of fixed maturity and equity securities in an unrealized loss position at March 31, 2017 and December 31, 2016, respectively. The Company views the decrease in value of all of the securities with unrealized losses at March 31, 2017 -- 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 management expects to recover the entire amortized 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.

 

   12 Months or Less  More than 12 Months  Total
         Gross        Gross        Gross
   Fair Value  Unrealized
Losses
  Fair Value  Unrealized
Losses
  Fair Value  Unrealized
Losses
                                               
March 31, 2017                                          
Fixed maturity securities                                          
U.S. Government and federally                                          
sponsored agency obligations:                                          
Mortgage-backed securities    $169,786     $5,035     $3,381     $408     $173,167     $5,443 
Other     262,517      9,219      -      -      262,517      9,219 
Municipal bonds     325,610      14,754      10,082      3,452      335,692      18,206 
Foreign government bonds     1,444      56      -      -      1,444      56 
Corporate bonds     285,724      6,492      37,490      2,683      323,214      9,175 
Other mortgage-backed securities     444,102      9,060      188,904      3,612      633,006      12,672 
Total fixed                                          
maturity securities     1,489,183      44,616      239,857      10,155      1,729,040      54,771 
Equity securities (1)     37,554      1,013      8,068      958      45,622      1,971 
Combined totals    $1,526,737     $45,629     $247,925     $11,113     $1,774,662     $56,742 
                                           
Number of positions with a                                          
gross unrealized loss     560             91             651        
Fair value as a percentage of                                          
total fixed maturity and                                          
equity securities fair value     19.9%            3.2%            23.1%       
                                           
December 31, 2016                                          
Fixed maturity securities                                          
U.S. Government and federally                                          
sponsored agency obligations:                                          
Mortgage-backed securities    $186,439     $6,176     $3,235     $544     $189,674     $6,720 
Other     219,372      10,120      -      -      219,372      10,120 
Municipal bonds     408,163      19,006      9,928      3,582      418,091      22,588 
Foreign government bonds     24,182      297      -      -      24,182      297 
Corporate bonds     459,402      11,056      57,261      3,770      516,663      14,826 
Other mortgage-backed securities     640,691      10,470      229,106      5,389      869,797      15,859 
Total fixed                                          
maturity securities     1,938,249      57,125      299,530      13,285      2,237,779      70,410 
Equity securities (1)     56,676      4,567      7,956      1,007      64,632      5,574 
Combined totals    $1,994,925     $61,692     $307,486     $14,292     $2,302,411     $75,984 
                                           
Number of positions with a                                          
gross unrealized loss     629             102             731        
Fair value as a percentage of                                          
total fixed maturity and                                          
equity securities fair value     26.3%            4.0%            30.3%       

 

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

 

14

 

 

Note 2 - Investments-(Continued)

 

Fixed maturity and equity securities with an investment grade rating represented 90% of the gross unrealized losses as of March 31, 2017. With respect to fixed maturity 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 OTTI losses on fixed maturity securities held as of March 31, 2017 and 2016 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 OTTI losses were recognized in other comprehensive income:

 

     Three Months Ended
       March 31, 
       2017     2016 
Cumulative credit loss (1)              
Beginning of period    $13,703         $7,844 
New credit losses     -      1,824 
Increases to previously recognized credit losses     726      - 
Gains related to securities sold or paid down during the period     (2)     - 
End of period    $14,427     $9,668 

 

 
(1)The cumulative credit loss amounts exclude OTTI 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.

 

15

 

 

Note 2 - Investments-(Continued)

 

Maturities/Sales of Fixed Maturity 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  March 31, 2017  
   March 31,  December 31,  Fair   Amortized  
   2017  2016  Value   Cost  
Estimated expected maturity:                              
Due in 1 year or less     3.8%     3.9%    $284,164     $271,394   
Due after 1 year through 5 years     28.1      28.7      2,109,683      2,014,879   
Due after 5 years through 10 years     34.1      35.2      2,562,229      2,447,089   
Due after 10 years                              
through 20 years     21.1      19.5      1,582,732      1,511,608   
Due after 20 years     12.9      12.7      971,942      928,265   
Total     100.0%     100.0%    $7,510,750     $7,173,235   
                               
Average option-adjusted                              
duration, in years     6.0      5.9                 

 

Proceeds received from sales of fixed maturity 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
       March 31, 
     2017     2016 
Fixed maturity securities              
Proceeds received    $110,872     $82,090 
Gross gains realized     2,489      2,476 
Gross losses realized     (881)           (492)
               
Equity securities              
Proceeds received    $5,489     $6,147 
Gross gains realized     1,048      520 
Gross losses realized     (192)     (646)

 

16

 

 

Note 2 - Investments-(Continued)

 

Net Unrealized Investment Gains and Losses on Fixed Maturity and Equity Securities

 

Net unrealized investment gains and losses are computed as the difference between fair value and amortized cost for fixed maturity securities 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   
      March 31,   
       2017         2016    
Net unrealized investment gains and losses           
on fixed maturity securities, net of tax           
Beginning of period   $197,978   $198,714 
Change in net unrealized investment           
gains and losses    21,891    78,341 
Reclassification of net realized           
investment gains to net income    (484)     (674)
End of period   $219,385   $276,381 
            
Net unrealized investment gains and losses           
on equity securities, net of tax           
Beginning of period   $4,963   $2,649 
Change in net unrealized investment           
gains and losses    3,302    2,188 
Reclassification of net realized           
investment losses to net income    687    193 
End of period   $8,952   $5,030 

 

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 are 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 Sheets      
         Consolidated  Consolidated        Cash      
   Gross  Balance  Balance  Financial  Collateral  Net
   Amounts  Sheets  Sheets  Instruments  Received  Amount
                                     
March 31, 2017                                          
Asset derivatives:                                          
Free-standing derivatives    $9,932     $-     $9,932     $-     $10,449     $(517)
                                           
December 31, 2016                                          
Asset derivatives:                                          
Free-standing derivatives     8,694      -      8,694      -      8,824      (130)

 

17

 

 

Note 2 - Investments-(Continued)

 

Deposits

 

At March 31, 2017 and December 31, 2016, fixed maturity securities with a fair value of $18,089 and $18,119, 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 March 31, 2017 and December 31, 2016, fixed maturity securities with a fair value of $621,544 and $620,489, 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 $575,000 at both of the respective dates. The deposited securities are included in Fixed maturity securities 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, 2016, specifically in “Note 3 -- Fair Value of Financial Instruments”.

 

18

 

 

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 March 31, 2017, Level 3 invested assets comprised 3.1% of the Company’s total investment portfolio fair value.

 

       Fair Value Measurements at
   Carrying   Fair  Reporting Date Using
   Amount  Value  Level 1  Level 2  Level 3
March 31, 2017                                 
Financial Assets                         
Investments                         
Fixed maturity securities                         
U.S. Government and federally                         
sponsored agency obligations:                         
Mortgage-backed securities  $609,807   $609,807   $-   $605,863   $3,944 
Other, including                         
U.S. Treasury securities   531,308    531,308    13,619    517,689    - 
Municipal bonds   1,777,427    1,777,427    -    1,723,965    53,462 
Foreign government bonds   99,686    99,686    -    99,686    - 
Corporate bonds   2,837,173    2,837,173    14,173    2,740,505    82,495 
Other mortgage-backed securities   1,655,349    1,655,349    -    1,546,499    108,850 
Total fixed maturity securities   7,510,750    7,510,750    27,792    7,234,207    248,751 
Equity securities   156,975    156,975    102,573    54,396    6 
Short-term investments   81,064    81,064    79,859    1,205    - 
Other investments   21,432    21,432    -    21,432    - 
Totals  $7,770,221   $7,770,221   $210,224   $7,311,240   $248,757 
Financial Liabilities                         
Investment contract and life policy                         
reserves, embedded derivatives  $236   $236   $-   $236   $- 
Other policyholder funds,                         
embedded derivatives   64,261    64,261    -    -    64,261 
                          
December 31, 2016                         
Financial Assets                         
Investments                         
Fixed maturity securities                         
U.S. Government and federally                         
sponsored agency obligations:                         
Mortgage-backed securities  $614,891   $614,891   $-   $611,476   $3,415 
Other, including                         
U.S. Treasury securities   467,143    467,143    13,631    453,512    - 
Municipal bonds   1,769,397    1,769,397    -    1,722,900    46,497 
Foreign government bonds   98,669    98,669    -    98,669    - 
Corporate bonds   2,810,221    2,810,221    13,532    2,736,498    60,191 
Other mortgage-backed securities   1,696,387    1,696,387    -    1,595,143    101,244 
Total fixed maturity securities   7,456,708    7,456,708    27,163    7,218,198    211,347 
Equity securities   141,649    141,649    98,632    43,011    6 
Short-term investments   44,918    44,918    44,167    -    751 
Other investments   20,194    20,194    -    20,194    - 
Totals  $7,663,469   $7,663,469   $169,962   $7,281,403   $212,104 
Financial Liabilities                         
Investment contract and life policy                         
reserves, embedded derivatives  $158   $158   $-   $158   $- 
Other policyholder funds,                         
embedded derivatives   59,393    59,393    -    -    59,393 

 

19

 

 

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

 

During the three months ended March 31, 2017, an equity security was transferred into Level 1 from Level 2 as a result of increased liquidity in the market and a sustained increase in the market activity for this asset. The following table presents 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 (2)
  Total
Fixed
Maturity
Securities
  Equity
Securities
  Short-term
Investments
  Total      
                                                   
Beginning balance, January 1, 2017    $46,497       $60,191         $104,659       $211,347       $6       $751       $212,104       $59,393 
Transfers into Level 3 (3)     5,214      29,918        15,039      50,171      -      -      50,171      - 
Transfers out of Level 3 (3)     -      (6,110)       -      (6,110)     -      (751)     (6,861)     - 
Total gains or losses                                                          
Net realized investment gains                                                          
(losses) included in net                                                          
income related to                                                          
financial assets     -      -        -      -      -      -      -      - 
Net realized (gains) losses                                                          
included in net income                                                          
related to financial liabilities     -      -        -      -      -      -      -      2,308 
Net unrealized investment gains                                                          
(losses) included in other                                                          
comprehensive income     1,871      96        (771)     1,196      -      -      1,196      - 
Purchases     -      -        -      -      -      -      -      - 
Issuances     -      -        -      -      -      -      -      3,389 
Sales     -      -        -      -      -      -      -      - 
Settlements     -      -        -      -      -      -      -      - 
Paydowns, maturities                                                          
and distributions     (120)     (1,600)       (6,133)     (7,853)     -      -      (7,853)     (829)
Ending balance, March 31, 2017    $53,462     $82,495       $112,794     $248,751     $6     $-     $248,757     $64,261 
                                                           
Beginning balance, January 1, 2016    $30,379     $67,575       $75,466     $173,420     $6     $-     $173,426     $39,021 
Transfers into Level 3 (3)     14,751      6,059        11,642      32,452      -      -      32,452      - 
Transfers out of Level 3 (3)     -      -        -      -      -      -      -      - 
Total gains or losses                                                          
Net realized investment gains                                                          
(losses) included in net                                                          
income related to                                                          
financial assets     -      -        -      -      -      -      -      - 
Net realized (gains) losses                                                          
included in net income                                                          
related to financial liabilities     -      -        -      -      -      -      -      674 
Net unrealized investment gains                                                          
(losses) included in other                                                          
comprehensive income     1,484      388        (7)     1,865      -      -      1,865      - 
Purchases     -      -        -      -      -      -      -      - 
Issuances     -      -        -      -      -      -      -      3,491 
Sales     -      -        -      -      -      -      -      - 
Settlements     -      -        -      -      -      -      -      - 
Paydowns, maturities                                                          
and distributions     (121)     (3,951)       (3,280)     (7,352)     -      -      (7,352)     (1,101)
Ending balance, March 31, 2016    $46,493     $70,071       $83,821     $200,385     $6     $-     $200,391     $42,085 

 

 
(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)Includes U.S. Government and federally sponsored agency obligations for mortgage-backed securities and other mortgage-backed securities.
(3)Transfers into and out of Level 3 during the three months ended March 31, 2017 and 2016 were attributable to changes in the availability of observable market information for individual fixed maturity securities and short-term investments. 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 March 31, 2017 and 2016, there were no net realized investment gains or losses included in earnings that were attributable to changes in the fair value of Level 3 assets still held. For the three months ended March 31, 2017 and 2016, net realized losses of $2,308 and $674, respectively, were included in earnings that were attributable to the changes in the fair value of Level 3 liabilities (embedded derivatives) still held.

 

20

 

 

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, 2016. Generally, valuation techniques 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 those used for fixed maturity securities.

 

The sensitivity of the estimated fair values to changes in the significant unobservable inputs for fixed maturity and equity securities included in Level 3 generally relates 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
March 31, 2017                                   
Financial Assets                                   
Investments                                   
Other investments    $151,537     $156,089     $-     $-     $156,089 
Financial Liabilities                                   
Investment contract and life policy                                   
reserves, fixed annuity contracts     4,408,288      4,317,991      -      -      4,317,991 
Investment contract and life policy                                   
reserves, account values on life contracts     80,484      85,945      -      -      85,945 
Other policyholder funds     647,134      647,134      -      575,342      71,792 
Long-term debt     247,273      259,698      259,698      -      - 
                                    
December 31, 2016                                   
Financial Assets                                   
Investments                                   
Other investments    $151,965     $156,536     $-     $-     $156,536 
Financial Liabilities                                   
Investment contract and life policy                                   
reserves, fixed annuity contracts     4,360,456      4,280,528      -      -      4,280,528 
Investment contract and life policy                                   
reserves, account values on life contracts     79,591      85,066      -      -      85,066 
Other policyholder funds     649,557      649,557      -      575,253      74,304 
Long-term debt     247,209      248,191      248,191      -      - 

 

21

 

 

Note 4 - Derivative Instruments

 

In February 2014, the Company began offering 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. In October 2015, the Company began offering IUL products, which also credit interest based on a percentage of the gain in a specified market index. When deposits are received for FIA and IUL contracts, a portion is used to purchase derivatives consisting of OTC call options on the applicable market indices to fund the index credits due to FIA and IUL policyholders. For the Company, substantially all of 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 changes in fair value included in Net realized investment gains and 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. Call options are not purchased to fund the index liabilities which may arise after the next deposit anniversary date. 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 FIA and IUL contracts, 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 future annual index credits on FIA contracts are treated as a “series of embedded derivatives” over the expected life of the applicable contract with a corresponding reserve recorded. For the IUL contracts, the embedded derivative represents a single year liability for the index return.

 

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 and IUL products. As a result, the Company records the purchased call options and the embedded derivatives 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 FIA and IUL contracts, presented in the Consolidated Balance Sheets were as follows:

 

   March 31,  December 31,
   2017  2016
Assets              
Derivative instruments, included in Short-term              
and other investments    $9,932     $8,694 
               
Liabilities              
FIA - embedded derivatives,              
included in Other policyholder funds     64,261      59,393 
IUL - embedded derivatives,              
included in Investment contract and life policy reserves     236      158 

 

22

 

 

Note 4 - Derivative Instruments-(Continued)

 

In general, the change in the fair value of the embedded derivatives related to FIA contracts will not correspond to the change in fair value of the purchased call options because the purchased call options are one-year options while the options valued in those embedded derivatives represent the rights of the policyholder to receive index credits over the entire period the FIA contracts are expected to be in force, which typically exceeds 10 years. The changes in fair value of derivatives included in the Consolidated Statements of Operations were as follows:

 

   Three Months Ended
   March 31,
   2017  2016
Change in fair value of derivatives (1):              
Revenues              
Net realized investment gains (losses)    $2,437     $(218)
               
Change in fair value of embedded derivatives:              
Revenues              
Net realized investment losses     (2,366)     (676)

 

 
(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.

 

The Company’s strategy attempts to mitigate 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:

 

   March 31, 2017  December 31, 2016
   Credit Rating (1)  Notional  Fair  Notional  Fair
Counterparty  S&P  Moody’s  Amount  Value  Amount  Value
                               
Bank of America, N.A.  A+  A1    $25,200     $601     $38,500     $1,934 
Barclays Bank PLC  A-  A1     80,900      2,332      66,800      1,543 
Citigroup Inc.  BBB+  Baa1     -      -      -      - 
Credit Suisse International  A  A1     57,700      5,164      65,200      4,281 
Societe Generale  A  A2     40,200      1,835      15,600      936 
                                   
Total          $204,000     $9,932     $186,100     $8,694 

 

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

 

23

 

 

Note 4 - Derivative Instruments-(Continued)

 

As of March 31, 2017 and December 31, 2016, the Company held $10,449 and $8,824, respectively, of cash received from counterparties for derivative collateral, which is included in Other liabilities on the Consolidated Balance Sheets. This derivative collateral limits 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 $250 per counterparty.

 

Note 5 - Property and Casualty Unpaid Claims and Claim Expenses

 

The following table is a summary reconciliation of the beginning and ending Property and Casualty unpaid claims and claim expense reserves for the periods indicated. The table presents reserves on both gross and net (after reinsurance) bases. The total net Property and Casualty insurance claims and claim expense incurred amounts are reflected in the Consolidated Statements of Operations. The end of the period gross reserve (before reinsurance) balances and the reinsurance recoverable balances are reflected on a gross basis in the Consolidated Balance Sheets.

 

   March 31,  March 31,
   2017  2016
Property and Casualty segment              
Gross reserves, beginning of year (1)    $307,757     $301,569 
Less: reinsurance recoverables     61,199      50,332 
Net reserves, beginning of year (2)     246,558      251,237 
Incurred claims and claim expenses:              
Claims occurring in the current year     123,204      103,206 
Decrease in estimated reserves for              
claims occurring in prior years (3)     (1,000)     (2,000)
Total claims and claim expenses incurred (4)     122,204      101,206 
Claims and claim expense payments              
for claims occurring during:              
Current year     52,380      39,081 
Prior years     62,013      54,515 
Total claims and claim expense payments     114,393      93,596 
Net reserves, end of year (2)     254,369      258,847 
Plus: reinsurance recoverables     61,804      60,429 
Gross reserves, end of year (1)    $316,173     $319,276 

 

 
(1)Unpaid claims and claim expenses as reported in the Consolidated Balance Sheets also include reserves for the Life and Retirement segments of $23,860 and $24,993 as of March 31, 2017 and 2016, respectively, in addition to Property and Casualty segment reserves.
(2)Reserves net of anticipated reinsurance recoverables.
(3)Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims and changes in their projected final settlement costs.
(4)Benefits, claims and settlement expenses as reported in the Consolidated Statements of Operations also include amounts for the Life and Retirement segments of $21,892 and $18,307 as of March 31, 2017 and 2016, respectively, in addition to the Property and Casualty segment amounts.

 

24

 

 

Note 5 - Property and Casualty Unpaid Claims and Claim Expenses-(continued)

 

Net favorable development of total reserves for Property and Casualty claims occurring in prior years was $1,000 and $2,000 for the three month periods ended March 31, 2017 and 2016, respectively. The favorable development for both of the three month periods ended March 31, 2017 and 2016 was predominantly the result of favorable severity trends in homeowners loss emergence for accident years 2014 and prior.

 

Note 6 - Debt

 

Indebtedness outstanding was as follows:

 

   March 31,  December 31,  
   2017 2016  
Short-term debt:           
Bank Credit Facility, expires July 30, 2019    $-     $-   
                 
Long-term debt:                
4.50% Senior Notes, due December 1, 2025. Aggregate                
principal amount of $250,000 less unaccrued discount of                
$589 and $603 (4.5% imputed rate) and unamortized                
debt issuance costs of $2,138 and $2,188     247,273      247,209   

 

The Credit Agreement with Financial Institutions (“Bank Credit Facility”) and 4.50% Senior Notes due 2025 (“Senior Notes due 2025”) are described in “Notes to Consolidated Financial Statements -- Note 7 -- Debt” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

 

Note 7 - Reinsurance

 

The Company recognizes the cost of reinsurance premiums over the contract periods for such premiums in proportion to the insurance protection provided. Amounts recoverable from reinsurers for unpaid claims and claim settlement expenses, including estimated amounts for unsettled claims, claims incurred but not 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 March 31, 2017                                
Premiums written and contract deposits  $301,512       $5,510       $730     $296,732   
Premiums and contract charges earned   200,455        5,534        801      195,722   
Benefits, claims and settlement expenses   147,271        3,883        708      144,096   
                                 
Three months ended March 31, 2016                                
Premiums written and contract deposits  $287,992       $5,768       $945     $283,169   
Premiums and contract charges earned   190,233        5,769        986      185,450   
Benefits, claims and settlement expenses   131,240        12,662        935      119,513   

 

25

 

 

Note 8 - 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 to purchase investments were $140,516 and $135,054 at March 31, 2017 and December 31, 2016, respectively.

 

Note 9 - Segment Information

 

The Company conducts and manages its business through four segments. The three operating segments, representing the major lines of insurance business, are: Property and Casualty segment, primarily personal lines automobile and homeowners products; Retirement segment, primarily tax-qualified fixed and variable annuities; and Life segment, life insurance. The Company does not allocate the impact of corporate-level transactions to these operating 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, net realized investment gains and losses and certain public company expenses, such items also have included corporate debt retirement costs/gains, when applicable. Summarized financial information for these segments is as follows:

 

     Three Months Ended   
     March 31,   
     2017       2016   
Insurance premiums and contract charges earned          
Property and Casualty  $158,318   $152,120 
Retirement   6,601    6,068 
Life   30,803    27,262 
Total  $195,722   $185,450 
           
Net investment income          
Property and Casualty  $9,177   $8,828 
Retirement   63,442    58,049 
Life   18,288    17,984 
Corporate and Other   12    15 
Intersegment eliminations   (208)   (217)
Total  $90,711   $84,659 
           
Net income (loss)          
Property and Casualty  $2,735   $13,795 
Retirement   11,530    10,553 
Life   3,885    3,867 
Corporate and Other   (2,832)  (3,062)
Total  $15,318   $25,153 
           
   March 31,  December 31,
   2017  2016
Assets         
Property and Casualty  $1,117,764  $1,110,958 
Retirement   7,622,077    7,449,777 
Life   1,941,372    1,912,771 
Corporate and Other   126,745    140,104 
Intersegment eliminations   (28,453)   (36,786)
Total  $10,779,505   $10,576,824 
26

 

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

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

(Dollars in millions, except per share data)

 

Measures within this MD&A that are not based on accounting principles generally accepted in the United States (“non-GAAP”) are marked by an asterisk (“*”). An explanation of these measures is contained in the Glossary of Selected Terms included as an exhibit to this Quarterly Report on Form 10-Q.

 

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 this Quarterly Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. 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, retirement 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 2016 Property and Casualty direct earned premiums, the Company’s ten largest states represented 57% 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, South Carolina, Florida 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.
·The Company’s ability to refinance outstanding indebtedness or repurchase shares of the Company’s common stock.

 

27

 

 

·The Company’s ability to (1) develop and expand its marketing operations, including agents and other points of distribution, (2) maintain and secure access to educators, school administrators, principals and school business officials; and (3) profitably expand its Property and Casualty business in highly competitive environments.
·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.
·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.
·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.
·Changes in Cybersecurity regulations as a result of state level requirements.

 

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, 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 March 31, 2017, the Company’s net income of $15.3 million decreased $9.9 million compared to a year ago reflecting a record level of catastrophic losses in the quarter, as well as elevated non-catastrophic weather-related losses.

 

Property and Casualty segment net income of $2.7 million was $11.1 million lower compared to a year ago with a combined ratio of 105.5%, reflecting a record level of catastrophe losses in the quarter, as well as elevated non-catastrophe weather-related losses. Catastrophe losses of $17.2 million pretax were $4.5 million higher than the first quarter of 2016, representing 2.5 points of the combined ratio increase. Prior years’ reserves continue to develop favorably; however, the favorable development in the current quarter was $1.0 million pretax lower than the amount a year ago, representing 0.7 points of the combined ratio increase.

 

On an underlying basis, the auto loss ratio of 76.7% was in line with the prior period result on a developed basis, and was in line with full year 2016 results despite the elevated level of weather losses in the first quarter of 2017. The Company remains confident that it is on the right track for 1 point of underlying auto combined ratio improvement for the full year 2017. For property, the increase in the underlying loss ratio from 35.9% for the first quarter of 2016 to 46.9% for the first quarter of 2017 was largely related to the impact of higher non-catastrophe weather-related losses.

 

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Retirement segment net income of $11.5 million increased $0.9 million, or 9%, compared to a year ago which was primarily due to a $3.4 million pretax increase in net interest margin offset by a $2.6 million pretax increase in operating expenses including costs related to the Company’s continued infrastructure and strategic investments. The annualized net interest spread on fixed annuity assets was 183 basis points for the first quarters of 2017 and 2016, which reflects the continued low interest rate environment. Total Retirement assets under management of $6.6 billion increased 9% from a year ago, and total cash value persistency remained strong at approximately 95%.

 

Life segment net income was $3.9 million for the first quarter of 2017 and comparable to a year ago. In the current quarter, Life segment insurance premiums and contract deposits of $26.5 million increased 11%, or $2.6 million, compared to the prior year period. Life sales of $4.7 million increased $1.7 million, or 57%, compared to the prior year period, primarily due to an increase in single premium sales. Life persistency of 96% was comparable to 12 months earlier.

 

Premiums written and contract deposits* increased $13.5 million, or 4.8%, compared to a year ago. Property and Casualty premiums written increased $6.2 million, or 4.2%, primarily attributable to rate increases in average premium per policy for homeowners and automobile. Life premiums and contract deposits increased $2.6 million, or 10.9%, compared to a year ago. Annuity deposits received for Retirement increased $4.7 million, or 4.2%, and was attributable to $2.2 million of single premium and $2.5 million of recurring deposits received in 2017.

 

The Company’s book value per share was $32.60 at March 31, 2017, an increase of 1.4% compared to December 31, 2016 and a decrease of 1.5% compared to a year ago.

 

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, areas most subject to significant management judgments include: fair value measurements, other-than-temporary impairment of investments, goodwill, deferred policy acquisition costs for investment contracts and life insurance products with account values, 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.

 

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Compared to December 31, 2016, at March 31, 2017, there were no material changes to accounting policies for 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, 2016, 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.

 

Results of Operations

 

Insurance Premiums and Contract Charges

 

   Three Months Ended   Change From
   March 31,   Prior Year
       2017      2016      Percent   Amount
Insurance premiums written and contract deposits                                  
(includes annuity and life contract deposits)                                  
Property & Casualty      $152.9     $146.7        4.2%      $6.2 
Retirement (annuity)       117.3      112.6        4.2%       4.7 
Life       26.5      23.9        10.9%       2.6 
Total      $296.7     $283.2        4.8%      $13.5 
                                   
Insurance premiums and contract charges earned                                  
(excludes annuity and life contract deposits)                                  
Property & Casualty      $158.3     $152.1        4.1%      $6.2 
Retirement (annuity)       6.6      6.1        8.2%       0.5 
Life       30.8      27.3        12.8%       3.5 
Total      $195.7     $185.5        5.5%      $10.2 

 

Number of Policies and Contracts in Force

(actual counts)

 

     March 31,    December 31,    March 31,
       2017       2016       2016 
Property and Casualty                     
Automobile     483,683      484,915      486,682 
Property     219,017      220,137      223,653 
Total     702,700      705,052      710,335 
Retirement     220,284      219,105      212,397 
Life     197,900      197,937      201,480 

 

For the first three months of 2017, the Company’s premiums written and contract deposits* of $296.7 million increased $13.5 million, or 4.8%. The Company’s premiums and contract charges earned increased $10.2 million, or 5.5%, compared to the prior year, primarily due to increases in average premium per policy for both homeowners and automobile.

 

Total Property and Casualty premiums written* increased 4.2%, or $6.2 million, in the first three months of 2017, compared to the prior year, primarily due to increases in average written premium per policy for both homeowners and automobile. For 2017, the Company’s full year rate plan anticipates high-single digit average rate increases for automobile and mid-single digit average rate increases for homeowners (including states with no rate actions for both automobile and homeowners); average approved rate changes during the first three months of 2017 were consistent with those plans at 9.0% for automobile and 4.4% for homeowners.

 

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Based on policies in force, the current year automobile 12 month retention rate for new and renewal policies was 83.0% compared to 84.5% at March 31, 2016, with the decrease due to recent rate and underwriting actions. The current year homeowner 12 month retention rate for new and renewal policies was 87.5% at March 31, 2017 compared to 88.4% at March 31, 2016 with the decrease due to recent rate and underwriting actions.

 

Automobile premiums written* increased 5.5%, or $5.7 million, compared to the first quarter of 2016. In the first quarter of 2017, the average written premium per policy and average earned premium per policy increased approximately 5% and 6%, respectively, compared to a year earlier. The number of educator policies represented approximately 85% of the automobile policies in force at March 31, 2017, December 31, 2016 and March 31, 2016.

 

Homeowners premiums written* increased 1.2%, or $0.5 million, compared to the first quarter of 2016. While the number of homeowners policies in force has declined, the average written premium per policy and average earned premium per policy increased approximately 2% and 4%, respectively, in the first quarter of 2017 compared to a year earlier. The number of educator policies represented approximately 82% of the homeowners policies in force at March 31, 2017, December 31, 2016 and March 31, 2016, and has reflected more moderate declines than the overall homeowner policies in force count. 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. By June 30, 2015, the Company completed a non-renewal program to further address homeowners profitability and hurricane exposure issues in Florida. While this program impacted the overall policy in force count and premiums in the short-term, it reduced risk exposure concentration, reduced overall catastrophe reinsurance costs and is expected to improve homeowners longer-term underwriting results. The Company continues to write policies for tenants in Florida. The Company also authorized its agents to write certain third-party vendors’ homeowners policies in Florida.

 

For the three months ended March 31, 2017, total annuity deposits* received by Retirement increased 4.2%, or $4.7 million, compared to the prior year period. For the first quarter of 2017, the increase reflected a 4.9% increase in recurring deposit receipts and a 3.6% increase in single premium and rollover deposit receipts.

 

In the first three months of 2017, new deposits to fixed accounts of $71.9 million decreased 3.7%, or $2.8 million, and new deposits to variable accounts of $45.4 million increased 19.8%, or $7.5 million, compared to the prior year.

 

Total annuity accumulated value on deposit of $6.6 billion at March 31, 2017 increased 9% compared to a year earlier, reflecting the increase from new deposits received as well as favorable retention. Accumulated value retention for the variable annuity option was 94.7% and 94.5% for the 12 month periods ended March 31, 2017 and 2016, respectively; fixed annuity retention was 94.4% and 94.9% for the respective periods.

 

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Variable annuity accumulated balances of $2.0 billion at March 31, 2017 increased 13.8% compared to March 31, 2016, as positive impacts of deposits and favorable financial market performance offset withdrawals and net transfers to the guaranteed interest rate fixed account option. Compared to the first quarter of 2016, Retirement contract charges earned increased 8.2%, or $0.5 million.

 

Life premiums and contract deposits* for the first three months of 2017 increased 10.9%, or $2.6 million, compared to the prior year period. The ordinary life insurance in force lapse ratio was 4.5% for the 12 months ended March 31, 2017 compared to 4.2% for the 12 months ended March 31, 2016.

 

Sales*

 

For the first three months of 2017, Property and Casualty new annualized sales premiums increased 8.6% compared to the first quarter of 2016, as 9.2%, or $1.9 million, growth in new automobile sales was accompanied by growth in homeowners sales of 5.3%, or $0.2 million, compared to the prior year period.

 

During the first quarter 2017, the Retirement segment’s 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. Annuity sales by Horace Mann’s Exclusive Distributors increased 7.5% compared to the first quarter of 2016. Sales from the Independent Agent distribution channel, which represent approximately 8.8% of total annuity sales in the current period and are largely single premium and rollover annuity deposits, decreased approximately 21.4% compared to a year earlier. As a result, total Horace Mann annuity sales from the combined distribution channels increased 4.2%, or $4.7 million, compared to the first quarter of 2016. It should be noted that historically, reported annuity sales for HM products were determined based on annualized new recurring deposits as well as single deposits/rollovers. Effective January 1, 2017, reported annuity sales are now determined based on total recurring deposits as well as single deposits/rollovers. All historical annuity sales information presented has been revised to conform to the new reporting methodology.

 

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, as well as the October 2015 introduction of the Company’s Indexed Universal Life (“IUL”) product have contributed to an increase in sales of proprietary life products. For the current quarter, sales of Horace Mann’s proprietary life insurance products totaled $4.7 million, representing an increase of 56.7%, or $1.7 million, compared to the prior year quarter, including an increase of $1.8 million for single premium sales.

 

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Distribution

 

At March 31, 2017, there was a combined total of 697 Exclusive Distributors, compared to 683 at December 31, 2016 and 711 at March 31, 2016. The Company continues to expect higher quality standards for Exclusive Distributors to focus on improving both customer experiences and agent productivity in their respective territories. Growth in new automobile sales and life sales reflects improvement in average Exclusive Distributor productivity. The dedicated sales force is supported by the Company’s customer contact center which provides a means for educators to begin their experience directly with the Company, if that is their preference. The customer contact center is also able to assist educators in territories which are not currently served by Exclusive Distributors.

 

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 273 authorized agents at March 31, 2017. During the three months ended March 31, 2017, this channel generated $10.3 million in annuity sales for the Company compared to $13.1 million for the first quarter of 2016, with the new business primarily comprised of single and rollover deposit business in both periods.

 

Net Investment Income

 

For the three months ended March 31, 2017, pretax net investment income of $90.7 million increased 7.1%, or $6.0 million, (6.9%, or $3.9 million, after tax) compared to the prior year period. In addition to reflecting higher asset balances in the Retirement segment, investment results reflected an increase in investment prepayment activity and favorable returns on alternative investments, partially offset by the impact of the current low interest rate environment. Average invested assets increased 5.4% over the 12 months ended March 31, 2017. The average pretax yield on the total investment portfolio was 5.1% (3.4% after tax) for the first quarter of 2017, compared to the average pretax yield of 5.0% (3.3% after tax) a year earlier. During the first quarter of 2017, management continued to identify and purchase 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.

 

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Net Realized Investment Gains and Losses (Pretax)

 

For the first three months of 2017, net realized investment losses were $0.2 million and comparable to a year ago. The net losses in both periods were realized primarily from ongoing investment portfolio management activity and, when determined, the recognition of other-than-temporary impairment (“OTTI”).

 

For the first three months of 2017, the Company’s net realized investment losses of $0.2 million included $5.0 million of gross gains realized on security sales partially offset by $2.4 million of gross realized losses primarily on disposal of securities and expiration of call options during the quarter and $2.8 million of OTTI charges recorded on certain equity and fixed maturity securities.

 

For the first three months of 2016, the Company’s net realized investment losses of $0.2 million included $5.6 million of gross gains realized on security sales and calls partially offset by $2.1 million of realized losses primarily on securities that were disposed of during the quarter and $3.7 million of OTTI charges recorded largely on Puerto Rico and energy sector fixed maturity 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 and Equity Securities Portfolios

 

The table below presents the Company’s fixed maturity 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, 2016, credit spreads were tighter across most asset classes and U.S. Treasury rates declined, which resulted in net unrealized investment gains to be higher in the Company’s fixed maturity securities holdings at March 31, 2017.

 

   March 31, 2017
              Pretax Net
         Amortized  Unrealized
   Number of  Fair  Cost or  Investment
   Issuers  Value  Cost  Gain (Loss)
Fixed maturity securities                          
Corporate bonds                          
Banking and Finance   98     $707.7     $676.4     $31.3 
Insurance   54      272.6      248.2      24.4 
Energy (1)   47      224.8      212.0      12.8 
Technology   32      172.8      168.2      4.6 
Healthcare, Pharmacy   42      168.5      160.6      7.9 
Real estate   37      165.2      158.2      7.0 
Utilities   39      159.0      140.9      18.1 
Transportation   24      158.4      151.8      6.6 
Telecommunications   27      126.2      118.5      7.7 
Natural gas   20      91.3      85.9      5.4 
All other corporates (2)   197      590.7      563.1      27.6 
Total corporate bonds   617      2,837.2      2,683.8      153.4 
Mortgage-backed securities                          
U.S. Government and federally                          
sponsored agencies   355      430.0      400.5      29.5 
Commercial (3)   127      528.4      531.1      (2.7)
Other   31      75.4      74.4      1.0 
Municipal bonds (4)   601      1,777.4      1,647.3      130.1 
Government bonds                          
U.S.   11      531.3      520.7      10.6 
Foreign   17      99.7      93.9      5.8 
Collateralized debt obligations (5)   102      583.2      577.4      5.8 
Asset-backed securities   109      648.1      644.1      4.0 
Total fixed maturity securities   1,970     $7,510.7     $7,173.2     $337.5 
                           
Equity securities                          
Non-redeemable preferred stocks   14     $62.6     $62.8     $(0.2)
Common stocks   180      74.3      60.4      13.9 
Closed-end fund   1      20.1      20.0      0.1 
Total equity securities   195     $157.0     $143.2     $13.8 
                           
Total   2,165     $7,667.7     $7,316.4     $351.3 

 

 
(1)At March 31, 2017, the fair value amount included $11.8 million which were non-investment grade.
(2)The All other corporates category contains 19 additional industry sectors. Food and beverage, broadcasting and media, consumer products, gaming, lodging and dining, retail and metal and mining represented $426.6 million of fair value at March 31, 2017, with the remaining 13 sectors each representing less than $32.3 million.
(3)At March 31, 2017, 100% were investment grade, with an overall credit rating of AA, and the positions were well diversified by property type, geography and sponsor.
(4)Holdings are geographically diversified, approximately 40% are tax-exempt and 78% 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 March 31, 2017.
(5)Based on fair value, 96% 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 March 31, 2017.

 

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At March 31, 2017, the Company’s diversified fixed maturity securities portfolio consisted of 2,547 investment positions, issued by 1,970 entities, and totaled approximately $7.5 billion in fair value. This portfolio was 95.9% investment grade, based on fair value, with an average quality rating of A. The Company’s investment guidelines target 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 and equity securities portfolios by rating category. At March 31, 2017, 94.8% 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 and equity securities portfolios as available for sale, which are carried at fair value.

 

Rating of Fixed Maturity and Equity Securities (1)

(Dollars in millions)

 

   Percent of Portfolio        
   Fair Value  March 31, 2017
   December 31,  March 31,  Fair  Amortized
   2016  2017  Value  Cost or Cost
Fixed maturity securities                      
AAA   8.3%   8.6%    $645.0     $630.2 
AA (2)   35.5    35.2      2,642.5      2,520.1 
A   23.6    23.8      1,786.0      1,686.5 
BBB   28.4    28.3      2,124.0      2,029.2 
BB   2.4    2.4      176.6      173.5 
B   1.0    0.9      70.6      73.3 
CCC or lower   0.2    0.1      9.8      9.9 
Not rated (3)   0.6    0.7      56.2      50.5 
Total fixed maturity securities   100.0%   100.0%    $7,510.7     $7,173.2 
Equity securities                        
AAA   -    -      -      - 
AA   -    -      -      - 
A   -    -      -      - 
BBB   35.3%   39.7%    $62.4     $62.7 
BB   -    -      *      * 
B   -    -      -      - 
CCC or lower   -    -      -      - 
Not rated   64.7    60.3      94.6      80.5 
Total equity securities   100.0%   100.0%    $157.0     $143.2 
                         
Total              $7,667.7     $7,316.4 

 

 
*Less than $0.1 million.
(1)Ratings are as assigned primarily by S&P when available, with remaining ratings as assigned on an equivalent basis by Moody’s. Ratings for publicly traded securities are determined when the securities are acquired and are updated monthly to reflect any changes in ratings.
(2)At March 31, 2017, the AA rated fair value amount included $519.5 million of U.S. Government and federally sponsored agency securities and $517.4 million of mortgage- and asset-backed securities issued by U.S. Government and federally sponsored agencies.
(3)This category primarily represents private placement and municipal securities not rated by either S&P or Moody’s.

 

At March 31, 2017, the fixed maturity and equity securities portfolios had a combined $56.7 million pretax of gross unrealized investment losses on $1,775 million fair value related to 651 positions. Of the investment positions (fixed maturity and equity securities) with gross unrealized investment losses, 9 were trading below 80% of the carrying value at March 31, 2017 and were not considered other-than-temporarily impaired. These positions had fair value of $12.5 million, representing 0.2% of the Company’s total investment portfolio at fair value, and had a gross unrealized investment loss of $4.4 million.

 

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The Company views the gross unrealized investment losses of all of the securities at March 31, 2017 as temporary. Future changes in circumstances related to these and other securities could require subsequent recognition of OTTI.

 

Benefits, Claims and Settlement Expenses

 

   Three Months Ended  Change From
   March 31,  Prior Year
   2017  2016  Percent  Amount
                    
Property and casualty    $122.2     $101.2    20.8%    $21.0 
Annuity     1.1          0.9        22.2%         0.2 
Life     20.8      17.4    19.5%     3.4 
Total    $144.1     $119.5    20.6%    $24.6 
                           
Property and casualty catastrophe losses, included above    $17.2     $12.7    35.4%    $4.5 
                           
Property and Casualty Claims and Claim Expenses (“losses”)
                           
   Three Months Ended