MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in millions, except per share data)
Forward-looking Information
Statements made in the following discussion that state the Companys or managements
intentions, hopes, beliefs, expectations or predictions of future events or the Companys future financial performance are forward-looking statements and involve 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 Companys actual results
could differ materially from those projected in forward-looking statements due to, among other risks and uncertainties inherent in the Companys business, the following important factors:
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Changes in the composition of the Companys assets and liabilities which may result from occurrences such as acquisitions, divestitures, impairment in asset
values or changes in estimates of insurance reserves.
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Fluctuations in the fair value of securities in the Companys investment portfolio and the related after-tax effect on the Companys shareholders
equity and total capital through either realized or unrealized investment losses. In addition, the impact of fluctuations in the financial markets on the Companys defined benefit pension plan assets and the related after-tax effect on the
Companys operating expenses, shareholders equity and total capital.
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The impact of fluctuations in the financial markets on the Companys variable annuity fee revenues, valuations of deferred policy acquisition costs and value
of acquired insurance in force, and the level of guaranteed minimum death benefit reserves.
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The impact of fluctuations in the capital markets on the Companys ability to refinance outstanding indebtedness or repurchase shares of the Companys
common stock.
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Defaults on interest or dividend payments in the Companys investment portfolio due to credit issues and the resulting impact on investment income.
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Prevailing interest rate levels, including the impact of interest rates on (i) unrealized gains and losses in the Companys investment portfolio and the
related after-tax effect on the Companys shareholders equity and total capital, (ii) the book yield of the Companys investment portfolio, (iii) the Companys ability to maintain appropriate interest rate spreads over
the fixed rates guaranteed in the Companys life and annuity products and (iv) valuations of deferred policy acquisition costs and value of acquired insurance in force.
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The cyclicality of the insurance industry and the related effects of changes in price competition and industry-wide underwriting results.
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The frequency and severity of catastrophes such as hurricanes, earthquakes, storms and wildfires and the ability of the Company to provide accurate estimates of
ultimate catastrophe costs in its consolidated financial statements in light of such factors as: the proximity of the catastrophe occurrence date to the date of the consolidated financial statements; potential inflation of property repair costs in
the affected area; the occurrence of multiple catastrophes in a geographic area over a relatively short period of time; the outcome of litigation which may be filed against the Company by policyholders, state attorneys general and other parties
relative to loss coverage disputes and loss settlement payments; and the ability of state insurance facilities to assess participating insurers when financial deficits occur.
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15
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The Companys risk exposure to catastrophe-prone areas. Based on 2006 property and casualty direct earned premiums, the Companys 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: Florida, California, North Carolina, Texas, Louisiana and South Carolina.
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The potential near-term, adverse impact of underwriting actions to mitigate the Companys risk exposure to catastrophe-prone areas on premium, policy and
earnings growth.
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The ability of the Company to maintain a favorable catastrophe reinsurance program considering both availability and cost; and the collectibility of reinsurance
receivables.
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Adverse development of property and casualty loss and loss adjustment expense reserve experience and its impact on estimated claims and claim settlement expenses
for losses occurring in prior years.
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Adverse changes in business persistency, policyholder mortality and morbidity rates, interest spreads and market appreciation and the resulting impact on both
estimated reserves and the valuations of deferred policy acquisition costs and value of acquired insurance in force.
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Changes in insurance regulations, including (i) those affecting the ability of the Companys insurance subsidiaries to distribute cash to the holding
company and (ii) those impacting the Companys ability to profitably write property and casualty insurance policies in one or more states.
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Changes in federal income tax laws and changes resulting from federal tax audits affecting corporate tax rates or taxable income.
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Changes in federal and state laws and regulations, which affect the relative tax and other advantages of the Companys life and annuity products to customers,
including, but not limited to, changes in IRS regulations governing Section 403(b) plans.
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The resolution of legal proceedings and related matters including the potential adverse impact on the Companys reputation and charges against the
Companys earnings resulting from legal defense costs, a settlement agreement and/or an adverse finding or findings against the Company from the proceedings.
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The Companys ability to maintain favorable claims-paying ability, financial strength and debt ratings.
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The Companys ability to profitably expand its property and casualty business in highly competitive environments.
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The competitive impact of the new Section 403(b) tax-qualified annuity regulations, including 1) their potential to lead plan sponsors to restrict the number
of providers and 2) the possible entry into the 403(b) market of larger competitors experienced in 401(k) plans.
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The Companys ability to develop and expand its agency operations, including its agent force and their licensed producers and support staff, as well as the
Companys ability to maintain and secure sponsorships by local, state and national education associations.
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The Companys dated and complex information systems, which are more prone to error than advanced technology systems.
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Disruptions of the general business climate, investments, capital markets and consumer attitudes caused by pandemics or geopolitical acts such as terrorism, war or
other similar events.
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16
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 and life insurance and retirement annuities in the U.S. The Company markets its products primarily to educators and other employees of public schools and their families.
For the three months ended September 30, 2007, the Companys net income of $18.4 million decreased $1.0 million compared to the prior year,
including a $0.8 million decrease in after tax realized investment gains. Third quarter 2007 property and casualty segment net income was $4.1 million less than prior year, adversely affected by increased current accident year, non-catastrophe loss
costs, particularly in the homeowners line, higher catastrophe losses and a lower level of favorable prior years reserve development. Net income for the annuity and life segments exceeded prior year in the current quarter by $1.8 million and
$1.5 million, respectively.
For the nine months ended September 30, 2007, the Companys net income decreased $5.3 million
compared to the prior year, including a $2.0 million reduction in after tax realized investment gains. Consistent with managements expectations and industry experience, the year-to-date increase in property and casualty average loss costs per
policy exceeded the increase in average premium per policy for the current accident period, which adversely impacted the combined ratio and net income. Compared to the first nine months of 2006, results in the first nine months of 2007 were also
negatively impacted by a lower level of favorable development of prior years property and casualty non-catastrophe reserves as well as the increased cost of the Companys catastrophe reinsurance program. Net income in the first nine
months of 2007 benefited from a decrease in catastrophe costs compared to the prior year. Including all of these factors, the property and casualty combined ratio was 91.8% for the first nine months of 2007 compared to 88.3% for 2006. Annuity
segment net income increased compared to the first nine months of 2006, driven by increases in the interest margin and contract charges earned. Life segment net income increased compared to a year earlier, reflecting growth in investment income and
favorable mortality experience.
Premiums written and contract deposits increased 1% and 2% compared to the three and nine months ended
September 30, 2006, respectively. As described in Results of Operations Insurance Premiums and Contract Charges, the third quarter 2007 expiration of an educator excess professional liability policy represented an $8.6
million decrease compared to the prior year. Also, for the first nine months of 2007, the additional costs associated with the Companys property and casualty catastrophe reinsurance program represented a $1.1 million decrease to current period
premiums. Property and casualty premiums written reflected a slight decrease as a result of these two unfavorable items and a decrease in average automobile premium per policy partially offset by growth in average homeowners premium per policy and
growth in policies in force for both automobile and homeowners. Including the effect of recent initiatives, new automobile sales units increased 2% in the current period compared to the first nine months of 2006. This sales growth, along with
continued improvements in policy retention, resulted in increases in voluntary automobile policies in force compared to both December 31, 2006 and September 30, 2006. The automobile policies in force growth was driven primarily by an
increase in educator policies. Annuity contract deposits for the three and nine months ended September 30, 2007 increased 10% and 7%, respectively, each compared to a year earlier, and life segment insurance premiums and contract deposits
decreased 2% and 1% compared to the three and nine months ended September 30, 2006, respectively.
17
Critical Accounting Policies
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires the Companys 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 Companys consolidated assets, liabilities, shareholders equity and net income.
Certain accounting estimates are particularly sensitive because of their significance to the Companys consolidated financial statements and because of the possibility that subsequent events and available information may differ markedly from
managements judgements at the time the consolidated financial statements were prepared. Management has discussed with the Audit Committee the quality, not just the acceptability, of the Companys accounting principles as applied in its
financial reporting. The discussions generally included such matters as the consistency of the Companys accounting policies and their application, and the clarity and completeness of the Companys consolidated financial statements, which
include related disclosures. For the Company, the areas most subject to significant management judgements include: liabilities for property and casualty claims and claim settlement expenses, liabilities for future policy benefits, deferred policy
acquisition costs, value of acquired insurance in force for annuity and interest-sensitive life products, valuation of investments and valuation of assets and liabilities related to the defined benefit pension plan.
Liabilities for Property and Casualty Claims and Claim Settlement Expenses
Underwriting results of the property and casualty segment are significantly influenced by estimates of the Companys ultimate liability for insured
events. There is a high degree of uncertainty inherent in the estimates of ultimate losses underlying the liability for unpaid claims and claim settlement expenses. This inherent uncertainty is particularly significant for liability-related
exposures due to the extended period, often many years, that transpires between a loss event, receipt of related claims data from policyholders and ultimate settlement of the claim. Reserves for property and casualty claims include provisions for
payments to be made on reported claims (case reserves), claims incurred but not yet reported (IBNR) and associated settlement expenses (together loss reserves). The process by which these reserves are established
requires reliance upon estimates based on known facts and on interpretations of circumstances, including the Companys experience with similar cases and historical trends involving claim payments and related patterns, pending levels of unpaid
claims and product mix, as well as other factors including court decisions, economic conditions and public attitudes.
Reserves are
reestimated quarterly. Changes to reserves are recorded in the period in which development factor changes result in reserve reestimates. Detailed discussion of the process utilized to estimate loss reserves, risk factors considered and the impact of
adjustments recorded during recent years is included in Notes to Consolidated Financial Statements Note 3 Property and Casualty Unpaid Claims and Claim Expenses of the Companys Annual Report on Form 10-K for the year
ended December 31, 2006. Due to the nature of the Companys personal lines business, the Company has no exposure to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses other than claims under
homeowners insurance policies for environmentally related items such as mold.
18
Based on the Companys products and coverages, historical experience, and modeling of various
actuarial methodologies used to develop reserve estimates, the Company estimates that the potential variability of the property and casualty loss reserves, excluding the unprecedented hurricane losses experienced in 2005 and 2004, within a
reasonable probability of other possible outcomes, may be approximately plus or minus 6%, or plus or minus approximately $12 million in net income. Although this evaluation reflects the most likely outcomes, it is possible the final outcome may fall
below or above these estimates.
There are a number of assumptions involved in the determination of the Companys property and
casualty loss reserves. Among the key factors affecting recorded loss reserves for both long-tail and short-tail related coverages, claim severity and claim frequency are of particular significance. Management estimates that a 2% change in claim
severity or claim frequency for the most recent 36-month period is a reasonably likely scenario based on recent experience and would result in a change in the estimated loss reserves of between $6.0 million and $10.0 million for long-tail liability
related exposures (automobile liability coverages) and between $3.0 million and $4.0 million for short-tail liability related exposures (homeowners and automobile physical damage coverages). Actual results may change, depending on the magnitude and
direction of the deviation.
The Companys loss and loss adjustment expense actuarial analysis is discussed with management. As part
of this discussion, the indicated point estimate of the IBNR loss reserve by line of business (coverage) is reviewed. The Company actuaries also discuss any indicated changes to the underlying assumptions used to calculate the indicated point
estimate. Review of the variance between the indicated reserves from these changes in assumptions and the previously carried reserves takes place. After discussion of these analyses and all relevant risk factors, management determines whether the
reserve balances require adjustment. The Companys best estimate of loss reserves may change depending on a revision in the underlying assumptions.
The Companys liabilities for property and casualty unpaid claims and claim settlement expenses were as follows:
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September 30, 2007
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December 31, 2006
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Case
Reserves
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IBNR
Reserves
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Total (1)
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Case
Reserves
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IBNR
Reserves
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Total (1)
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Automobile liability
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$
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78.3
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$
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140.2
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$
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218.5
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$
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80.9
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$
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140.2
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$
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221.1
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Automobile other
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5.1
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1.7
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6.8
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5.7
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2.3
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8.0
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Homeowners
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12.5
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39.8
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52.3
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11.3
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41.7
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53.0
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All other
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4.0
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|
33.6
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|
37.6
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|
3.7
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|
|
32.0
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|
|
35.7
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Total
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$
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99.9
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$
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215.3
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$
|
315.2
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$
|
101.6
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|
$
|
216.2
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|
$
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317.8
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(1)
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These amounts are gross, before reduction for ceded reinsurance reserves.
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The facts and circumstances leading to the Companys reestimate of reserves relate to revisions of the development factors used to predict how losses are likely to develop from the end of a reporting period until
all claims have been paid. Reestimates occur because actual loss amounts are different than those predicted by the estimated development factors used in prior reserve estimates. At September 30, 2007, the impact of a reserve reestimation
resulting in a 1% increase in net reserves would be a decrease of approximately $2 million in net income. A reserve reestimation resulting in a 1% decrease in net reserves would increase net income by approximately $2 million.
19
Favorable reserve reestimates increased net income for the nine months ended September 30, 2007 by
approximately $9.6 million, reflecting emerging loss severity trends more favorable than previously estimated, primarily for accident years 2006 and 2005 for both the voluntary automobile and homeowners lines of business. The lower than expected
claims emergence and resultant lower expected loss ratios caused the Company to lower its reserve estimate.
Information regarding the
Companys property and casualty claims and claims settlement expense reserve development table as of December 31, 2006 is located in Business Property and Casualty Segment Property and Casualty Reserves of the
Companys Annual Report on Form 10-K for the year ended December 31, 2006.
Liabilities for Future Policy Benefits
Liabilities for future benefits on life and annuity policies are established in amounts adequate to meet the estimated future
obligations on policies in force. Liabilities for future policy benefits on certain life insurance policies are computed using the net level premium method and are based on assumptions as to future investment yield, mortality and withdrawals.
Mortality and withdrawal assumptions for all policies have been based on actuarial tables which are consistent with the Companys own experience. Liabilities for future benefits on annuity contracts and certain long-duration life insurance
contracts are carried at accumulated policyholder values without reduction for potential surrender or withdrawal charges. In the event actual experience varies from the estimated liability assumptions, adjustments are charged or credited to income
for the period in which the adjustments are made.
Deferred Policy Acquisition Costs and Value of Acquired Insurance in Force for
Annuity and Interest-Sensitive Life Products
Policy acquisition costs, consisting of commissions, policy issuance and other costs,
which vary with and are primarily related to the production of business, are capitalized and amortized on a basis consistent with the type of insurance coverage. For all investment (annuity) contracts, acquisition costs, and also the value of
annuity business acquired in the 1989 acquisition of the Company (Annuity VIF), are amortized over 20 years in proportion to estimated gross profits. Capitalized acquisition costs for interest-sensitive life contracts are also amortized
over 20 years in proportion to estimated gross profits.
The most significant assumptions that are involved in the estimation of annuity
gross profits include interest rate spreads, future financial market performance, business surrender/lapse rates, expenses and the impact of realized investment gains and losses. For the variable deposit portion of the annuity segment, the Company
amortizes policy acquisition costs and the Annuity VIF utilizing a future financial market performance assumption of a 10% reversion to the mean approach with a 200 basis point corridor around the mean. At September 30, 2007, the ratio of
capitalized annuity policy acquisition costs and the Annuity VIF asset to the total annuity accumulated cash value was approximately 4%.
In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company may be required to record a material charge or credit to amortization expense for the period in which the adjustment
is made. As noted above, there are key assumptions involved in the valuation of capitalized policy acquisition costs and the Annuity VIF. In terms of the sensitivity of this amortization to two of the more significant assumptions, assuming all other
assumptions are met, (1) a 10 basis point deviation in the annual targeted interest rate spread assumption would currently impact amortization between $0.25 million and
20
$0.35 million and (2) a 1% deviation from the targeted financial market performance for the underlying mutual funds of the Companys variable
annuities would currently impact amortization between $0.15 million and $0.25 million. These results may change depending on the magnitude and direction of the deviations but represent a range of reasonably likely experience for the noted
assumptions. Detailed discussion of the impact of adjustments to the amortization of capitalized acquisition costs and Annuity VIF is included in Results of Operations Amortization of Policy Acquisition Expenses and Intangible
Assets.
Valuation of Investments
Market valuations for the fixed maturity securities portfolio are based on prices provided by the Companys custodian bank and its investment managers. Both the custodian bank and the investment managers use a
variety of pricing sources to determine market valuations. Each designate specific pricing services or indexes for each sector of the market based upon the providers expertise. Broker-dealers are also used to price certain types of securities.
The broker-dealers valuation methodology is sometimes matrix-based, using indicative evaluation measures and adjustments for specific security characteristics and market sentiment. The Company analyzes market valuations received to verify
reasonableness. The Companys fixed maturity securities portfolio is highly liquid, which allows for a high percentage of the portfolio to be priced through pricing services. Approximately 90% of the portfolio was priced through pricing
services or index priced as of September 30, 2007.
The Companys methodology of assessing other-than-temporary impairments is
based on security-specific facts and circumstances as of the date of the reporting period. Based on these facts, if management believes it is probable that amounts due will not be collected according to the contractual terms of a debt security not
impaired at acquisition, or if the Company does not have the ability and intent to hold a debt security with an unrealized loss until it matures or recovers in value, an other-than-temporary impairment shall be considered to have occurred. As a
general rule, if the fair value of a debt security has fallen below 80% of book value for more than six months, this security will be reviewed for an other-than-temporary impairment. Additionally, if events become known that call into question
whether the security issuer has the ability to honor its contractual commitments, whether or not such security has been trading above an 80% fair value to book value relationship, such security holding will be evaluated to determine whether or not
such security has suffered an other-than-temporary decline in value.
The Company reviews the fair value of all investments in its
portfolio on a monthly basis to assess whether an other-than-temporary decline in value has occurred. These reviews, in conjunction with the Companys investment managers monthly credit reports and relevant factors such as (1) the
financial condition and near-term prospects of the issuer, (2) the Companys ability and intent to retain the investment long enough to allow for the anticipated recovery in fair value, (3) the stock price trend of the issuer,
(4) the market leadership position of the issuer, (5) the debt ratings of the issuer and (6) the cash flows of the issuer, are all considered in the impairment assessment. A write-down of an investment is recorded when a decline in
the fair value of that investment is deemed to be other-than-temporary, with a realized investment loss charged to income for the period.
21
A decline in fair value below amortized cost is not assumed to be other-than-temporary for fixed maturity
investments with unrealized losses due to market conditions or industry-related events where there exists a reasonable expectation that fair value will recover versus historical cost and the Company has the intent and ability to hold the investment
until maturity or a market recovery is realized. An other-than-temporary impairment loss will be recognized based upon all relevant facts and circumstances for each investment, as appropriate.
Valuation of Assets and Liabilities Related to the Defined Benefit Pension Plan
Effective April 1, 2002, participants stopped accruing benefits under the defined benefit pension plan but continue to retain the benefits they had
accrued to that date.
The Companys cost estimates for its defined benefit pension plan are determined annually based on assumptions
which include the discount rate, expected return on plan assets, anticipated retirement rate and estimated lump sum distributions. A discount rate of 5.65% was used by the Company for estimating accumulated benefits under the plan at
December 31, 2006, which was based on the average yield for long-term, high grade securities having maturities generally consistent with the defined benefit pension payout period. To set its discount rate, the Company looks to leading
indicators, including Moodys Aa long-term bond index. The expected annual return on plan assets assumed by the Company at December 31, 2006 was 7.5%. The assumption for the long-term rate of return on plan assets was determined by
considering actual investment experience during the lifetime of the plan, balanced with reasonable expectations of future growth considering the various classes of assets and percentage allocation for each asset class. Management believes that it
has adopted reasonable assumptions for investment returns, discount rates and other key factors used in the estimation of pension costs and asset values.
To the extent that actual experience differs from the Companys assumptions, subsequent adjustments may be required, with the effects of those adjustments charged or credited to income and/or shareholders
equity for the period in which the adjustments are made. Generally, a change of 50 basis points in the discount rate would inversely impact pension expense and accumulated other comprehensive income (AOCI) by approximately $0.1 million
and $1.5 million, respectively. In addition, for every $1 million increase (decrease) in the value of pension plan assets, there is a comparable increase (decrease) in AOCI.
Results of Operations
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
(Includes annuity and life contract deposits)
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|
Nine Months Ended
September 30,
|
|
Change From
Prior Year
|
|
|
|
2007
|
|
2006
|
|
Percent
|
|
|
Amount
|
|
Property & casualty
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Automobile and property (voluntary)
|
|
$
|
401.1
|
|
$
|
396.7
|
|
1.1
|
%
|
|
$
|
4.4
|
|
Involuntary and other property & casualty
|
|
|
2.0
|
|
|
11.0
|
|
-81.8
|
%
|
|
|
(9.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total property & casualty
|
|
|
403.1
|
|
|
407.7
|
|
-1.1
|
%
|
|
|
(4.6
|
)
|
Annuity deposits
|
|
|
258.3
|
|
|
241.1
|
|
7.1
|
%
|
|
|
17.2
|
|
Life
|
|
|
74.1
|
|
|
75.1
|
|
-1.3
|
%
|
|
|
(1.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
735.5
|
|
$
|
723.9
|
|
1.6
|
%
|
|
$
|
11.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
22
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
Change From
Prior Year
|
|
|
|
2007
|
|
2006
|
|
Percent
|
|
|
Amount
|
|
Property & casualty
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Automobile and property (voluntary)
|
|
$
|
392.6
|
|
$
|
393.0
|
|
-0.1
|
%
|
|
$
|
(0.4
|
)
|
Involuntary and other property & casualty
|
|
|
6.6
|
|
|
7.8
|
|
-15.4
|
%
|
|
|
(1.2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total property & casualty
|
|
|
399.2
|
|
|
400.8
|
|
-0.4
|
%
|
|
|
(1.6
|
)
|
Annuity
|
|
|
16.4
|
|
|
14.6
|
|
12.3
|
%
|
|
|
1.8
|
|
Life
|
|
|
72.4
|
|
|
71.9
|
|
0.7
|
%
|
|
|
0.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
488.0
|
|
$
|
487.3
|
|
0.1
|
%
|
|
$
|
0.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three and nine months ended September 30, 2007, the Companys premiums written
and contract deposits increased 0.8% and 1.6%, respectively, compared to the prior year, primarily reflecting growth in annuity deposits received partially offset by the decrease in other property and casualty premiums as described below. The
additional costs associated with the Companys property and casualty catastrophe reinsurance program represented a $1.1 million decrease to premiums for the nine months ended September 30, 2007. Voluntary property and casualty business
represents policies sold through the Companys marketing organization and issued under the Companys underwriting guidelines. Involuntary property and casualty business consists of allocations of business from state mandatory insurance
facilities and assigned risk business.
The Companys exclusive agent force totaled 797 at September 30, 2007, reflecting a
decrease of 4.3% compared to 833 agents at September 30, 2006 and a decrease of 6.0% compared to 848 agents at December 31, 2006. For the first nine months of 2007, new hires decreased and terminations increased, each approximately 10%,
compared to the same period in 2006. Of the current period-end total, 221 agents were in their first 24 months with the Company, down 9.4% compared to September 30, 2006. The number of experienced agents in the agent force, 576, decreased 2.2%
compared to 12 months earlier. At the time of this Quarterly Report on Form 10-Q, management anticipates the agent count to decline somewhat over the next several quarters during the Companys transition to its new Agency Business Model, with
an increase in total points of distribution resulting from the growing number of licensed producers supporting agents who adopt the new model.
In 2006, the Company began the transition from a single-person agent operation to its new Agency Business Model, with agents in outside offices with support personnel and licensed producers, designed to remove current capacity constraints
and increase productivity. The first Agency Business School session was conducted in October 2006, beginning the formal roll-out of this model. From October 2006 through September 30, 2007, 118 of the agents at September 30, 2007 and all
of the field managers completed this training. See additional description in Business Corporate Strategy and Marketing Exclusive Agency Force of the Companys Annual Report on Form 10-K for the year ended
December 31, 2006.
23
New automobile sales units increased 2.2% compared to the nine months ended September 30, 2006. New
homeowners sales units increased 1.9% compared to the first nine months of 2006. Homeowners, and consequently auto, new business growth in 2007 has been moderated by underwriting restrictions in Florida. Annuity new business declined 7.8% compared
to the first nine months of 2006, primarily reflecting a lower level of rollover deposits and sales of fixed indexed partner products. In 2006, annuity sales benefited from increased opportunities for rollover deposits in six states that had
initiated programs allowing educators to privatize a portion of their state retirement funds. Life new business decreased 2% compared to year-to-date 2006. For the first nine months of 2007, total new business sales decreased 5.3% compared to a year
earlier. In total, career agent sales for the first nine months of 2007 decreased 6.8% compared to the same period in 2006, reflecting the lower number of agents in the current period as well as a decrease in average overall productivity per agent,
driven by the level of annuity sales. Average agent productivity is measured as new sales premiums from the exclusive agent force per the average number of exclusive agents for the period.
Total voluntary automobile and homeowners premium written increased 1.1%, or $4.4 million, in the first nine months of 2007, including the $1.1 million
reduction due to the higher cost of catastrophe reinsurance in 2007. The automobile average written premium per policy decreased while the homeowners average premium increased in the current period compared to prior year, with the change in average
premium for both lines adversely impacted by the improved quality of the books of business. At September 30, 2007, there were 535,000 voluntary automobile and 266,000 homeowners policies in force, for a total of 801,000 policies, compared to a
total of 799,000 policies at December 31, 2006 and 796,000 at September 30, 2006.
Based on policies in force, the total property
and casualty 12-month retention rate for new and renewal policies was 86% at September 30, 2007, equal to September 30, 2006. For the first nine months of 2007, approved rate increases for the Companys automobile and homeowners
business were minimal, similar to rate actions in 2006.
Voluntary automobile premium written decreased 1.0% ($2.8 million) compared to the
first nine months of 2006. Average written premium per policy and average earned premium per policy both decreased 3% compared to a year ago. Automobile policies in force at September 30, 2007 increased by 2,000 compared to December 31,
2006 and 4,000 compared to September 30, 2006, with the growth reflecting an increase in educator policies in each of the preceding ten quarters.
Homeowners premium written increased 6.0% ($7.2 million) compared to the first nine months of 2006 including the higher amount of catastrophe reinsurance premiums described above. Homeowners average written premium
per policy increased 6% compared to a year earlier, while average earned premium per policy increased 3%. Homeowners policies in force at September 30, 2007 increased by 1,000 compared to September 30, 2006 and was equal to
December 31, 2006, as growth in the number of educator policies was offset by expected reductions, primarily in non-educator policies, due to the Companys pricing and underwriting actions, including actions in catastrophe-prone coastal
areas. The Company continues to evaluate and implement actions to further mitigate its risk exposure in hurricane-prone areas. 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 development of third-party vendor marketing alliances.
24
The primary component of involuntary and other property and casualty premiums, which represented less
than 2% of total property and casualty premiums for full year 2006, has been educator excess professional liability insurance purchased by the National Education Association (NEA) for all of its members. The NEAs contract to
purchase this insurance from the Company expired on August 31, 2007 and represented approximately $8.6 million of premiums written in the three and nine months ended September 30, 2006, with approximately $0.7 million, or 1/12, of that
premium earned each month during the September 2006 through August 2007 coverage period. The Companys underwriting results from educator excess professional liability insurance have generally represented amounts which were not a material
portion of net income for the Company or for the property and casualty segment.
Annuity deposits received for the nine months ended
September 30, 2007 increased 7.1% compared to the same period in 2006. In the first nine months of 2007, scheduled annuity deposits increased 17.1% while single premium and rollover deposits decreased 5.5%. New deposits to fixed accounts
increased 5.9%, or $8.2 million, compared to prior year-to-date and new deposits to variable accounts increased 8.8%, or $9.0 million.
The
Company utilizes a nationwide network of independent agents who comprise a supplemental distribution channel for the Companys 403(b) tax-qualified annuity products. The independent agent distribution channel included 887 authorized agents at
September 30, 2007. During the first nine months of 2007, this channel generated $27.2 million in annualized new annuity sales for the Company compared to $25.2 million for the same period in 2006.
Total annuity accumulated cash value of $3.8 billion at September 30, 2007 increased 8.1% compared to a year earlier, reflecting the increase from
new deposits received, continued favorable retention and improved financial market performance over the 12 months. At September 30, 2007, the number of annuity contracts outstanding of 164,000 decreased 0.6%, or 1,000 contracts, compared to
December 31, 2006 and increased 0.6%, or 1,000 contracts, compared to September 30, 2006.
Variable annuity accumulated balances
were 13.9% higher at September 30, 2007 than at September 30, 2006 and annuity segment contract charges earned increased 12.3%, or $1.8 million, compared to the first nine months of 2006.
Life segment premiums and contract deposits declined 1.3%, or $1.0 million, compared to the first nine months of 2006. The ordinary life insurance in
force lapse ratio was 5.6% for the 12 months ended September 30, 2007 compared to 6.0% for the twelve months ended September 30, 2006.
In 2006, the Company introduced new Horace Mann manufactured and branded products to better address the financial planning needs of educators. In February 2006, the Company introduced Life by Design, a new portfolio of life insurance
products. In March 2006, the Company introduced new fixed and variable annuity products and in May 2006, the Company added 12 new investment options to its variable annuity products. See additional description of these new products in Business
Life Segment and Business Annuity Segment of the Companys Annual Report on Form 10-K for the year ended December 31, 2006.
25
Net Investment Income
For the three months ended September 30, 2007, pretax investment income of $56.0 million increased 5.5%, or $2.9 million, (5.2%, or $1.9 million,
after tax) compared to the same period in 2006. Pretax investment income of $166.3 million for the nine months ended September 30, 2007 increased 7.4%, or $11.5 million, (7.1%, or $7.5 million, after tax) compared to prior year. For both
comparisons, the increase reflects growth in the size of the investment portfolio and a modest increase in the portfolio yield. Average invested assets (excluding securities lending collateral) increased 5.2% over the past 12 months. The average
pretax yield on the investment portfolio was 5.47% (3.72% after tax) for the first nine months of 2007, compared to a pretax yield of 5.35% (3.65% after tax) a year earlier.
Net Realized Investment Gains and Losses
For the three months ended September 30, 2007, pretax net realized investment losses were $0.5 million compared to net realized investment gains of $0.8 million in the third quarter of 2006. Net realized investment gains (pretax) were
$2.1 million for the first nine months of 2007 compared to net realized investment gains of $5.3 million in the prior year. The Company recorded impairment charges of $2.6 million and $0.1 million in the nine months ended September 30, 2007 and
2006, respectively. In the third quarter of 2007, the Company recorded impairment charges of $0.3 million related to fixed income securities from one issuer in the paper sector, and a portion of these securities were subsequently sold in October
2007. In the second quarter of 2007, the Company recorded impairment charges of $2.3 million from the home builder sector of its fixed income security portfolio, and these securities were subsequently sold in July 2007. In the nine months ended
September 30, 2006, the $0.1 million impairment charge was recorded in the third quarter and related to one issuer. Net realized investment gains in the first nine months of 2007 included $2.9 million from sales of securities for which
impairment charges were recorded in 2002, while net realized investment gains in the first nine months of 2006 included $0.3 million from sales of securities for which impairment charges were recorded in 2005. Net realized investment gains in the
first nine months of 2007 also included $0.2 million of litigation proceeds on previously impaired WorldCom, Inc. debt securities. The net gains and losses in all periods were realized from ongoing investment portfolio management activity.
26
The table below presents the Companys fixed maturity securities portfolio as of September 30,
2007 by major asset class, including the ten largest sectors of the Companys corporate bond holdings.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Issuers
|
|
Fair
Value
|
|
Amortized
Cost
|
|
Pretax
Unrealized
Gain (Loss)
|
|
Corporate bonds
|
|
|
|
|
|
|
|
|
|
|
|
|
Banking and Finance
|
|
60
|
|
$
|
426.6
|
|
$
|
431.6
|
|
$
|
(5.0
|
)
|
Energy
|
|
47
|
|
|
263.2
|
|
|
264.5
|
|
|
(1.3
|
)
|
Utilities
|
|
28
|
|
|
194.3
|
|
|
195.8
|
|
|
(1.5
|
)
|
Telecommunications
|
|
24
|
|
|
174.2
|
|
|
171.9
|
|
|
2.3
|
|
Health Care
|
|
29
|
|
|
148.9
|
|
|
152.9
|
|
|
(4.0
|
)
|
Insurance
|
|
25
|
|
|
94.2
|
|
|
93.3
|
|
|
0.9
|
|
Transportation
|
|
11
|
|
|
67.1
|
|
|
66.6
|
|
|
0.5
|
|
Automobiles
|
|
13
|
|
|
67.0
|
|
|
65.9
|
|
|
1.1
|
|
Metal and Mining
|
|
10
|
|
|
65.6
|
|
|
67.0
|
|
|
(1.4
|
)
|
Broadcasting and Media
|
|
14
|
|
|
56.7
|
|
|
56.5
|
|
|
0.2
|
|
All Other Corporates (1)
|
|
122
|
|
|
373.9
|
|
|
380.8
|
|
|
(6.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total corporate bonds
|
|
383
|
|
|
1,931.7
|
|
|
1,946.8
|
|
|
(15.1
|
)
|
Mortgage-backed securities
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government and federally sponsored agencies
|
|
417
|
|
|
896.3
|
|
|
909.7
|
|
|
(13.4
|
)
|
Other
|
|
32
|
|
|
148.5
|
|
|
153.5
|
|
|
(5.0
|
)
|
Municipal bonds
|
|
173
|
|
|
557.7
|
|
|
555.5
|
|
|
2.2
|
|
Government bonds
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
|
|
8
|
|
|
191.5
|
|
|
191.5
|
|
|
*
|
|
Foreign
|
|
10
|
|
|
25.0
|
|
|
23.8
|
|
|
1.2
|
|
Collateralized debt obligations (2)
|
|
5
|
|
|
18.8
|
|
|
22.8
|
|
|
(4.0
|
)
|
Asset-backed securities
|
|
15
|
|
|
66.6
|
|
|
66.4
|
|
|
0.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturity securities
|
|
1,043
|
|
$
|
3,836.1
|
|
$
|
3,870.0
|
|
$
|
(33.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
Less than $0.1 million.
|
(1)
|
The All Other Corporates category contains 18 additional industry classifications. Food and beverage, defense, cable, real estate, technology and manufacturing represented $285.9
million of fair value at September 30, 2007, with the remaining 12 classifications each representing less than $33 million.
|
(2)
|
All of the collateralized debt obligation securities were rated investment grade by Standard and Poors Corporation and/or Moodys Investors Service, Inc. at
September 30, 2007.
|
At September 30, 2007, the Companys diversified fixed maturity portfolio consisted of
1,360 investment positions, issued by 1,043 entities, and totaled approximately $3.8 billion in fair value. The portfolio was 94.6% investment grade, based on fair value, with an average quality rating of AA-. At September 30, 2007, the Company
had limited exposure to subprime and Alt-A mortgage loans, comprised primarily of 2 securities with a total fair value of approximately $8.5 million, both with quality ratings of AAA. At September 30, 2007, the Company did not
record any investment write-downs related to its sub-prime or Alt-A residential mortgage-backed securities. At the time of this Quarterly Report on Form 10-Q, management does not anticipate any other-than-temporary impairments of these
securities. At September 30, 2007, the total portfolio had $71.9 million pretax of gross unrealized losses related to 723 positions, including $1.2 million of unrealized loss related to the two sub-prime / Alt-A securities.
27
The following table provides information regarding fixed maturity securities that had an unrealized loss
at September 30, 2007, including the length of time that the securities have continuously been in an unrealized loss position.
Investment Positions With Unrealized Losses Segmented by Quality
and Period of Continuous Unrealized Loss
As of September 30, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Positions
|
|
Fair
Value
|
|
Amortized
Cost
|
|
Pretax
Unrealized
Loss
|
|
Investment grade
|
|
|
|
|
|
|
|
|
|
|
|
|
6 Months or less
|
|
157
|
|
$
|
604.1
|
|
$
|
619.3
|
|
$
|
(15.2
|
)
|
7 through 12 months
|
|
76
|
|
|
425.5
|
|
|
437.6
|
|
|
(12.1
|
)
|
13 through 24 months
|
|
76
|
|
|
336.4
|
|
|
346.8
|
|
|
(10.4
|
)
|
25 through 36 months
|
|
162
|
|
|
800.5
|
|
|
822.0
|
|
|
(21.5
|
)
|
37 through 48 months
|
|
33
|
|
|
152.5
|
|
|
156.4
|
|
|
(3.9
|
)
|
Greater than 48 months
|
|
12
|
|
|
52.4
|
|
|
55.8
|
|
|
(3.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
516
|
|
$
|
2,371.4
|
|
$
|
2,437.9
|
|
$
|
(66.5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-investment grade
|
|
|
|
|
|
|
|
|
|
|
|
|
6 Months or less
|
|
107
|
|
$
|
74.3
|
|
$
|
76.8
|
|
$
|
(2.5
|
)
|
7 through 12 months
|
|
33
|
|
|
18.8
|
|
|
19.7
|
|
|
(0.9
|
)
|
13 through 24 months
|
|
29
|
|
|
17.1
|
|
|
17.9
|
|
|
(0.8
|
)
|
25 through 36 months
|
|
29
|
|
|
14.0
|
|
|
14.7
|
|
|
(0.7
|
)
|
37 through 48 months
|
|
1
|
|
|
0.4
|
|
|
0.4
|
|
|
*
|
|
Greater than 48 months
|
|
1
|
|
|
0.1
|
|
|
0.1
|
|
|
*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
200
|
|
$
|
124.7
|
|
$
|
129.6
|
|
$
|
(4.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Not rated
|
|
|
|
|
|
|
|
|
|
|
|
|
6 Months or less
|
|
4
|
|
$
|
0.7
|
|
$
|
1.2
|
|
$
|
(0.5
|
)
|
Greater than 48 months
|
|
3
|
|
|
0.6
|
|
|
0.6
|
|
|
*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
7
|
|
$
|
1.3
|
|
$
|
1.8
|
|
$
|
(0.5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grand total
|
|
723
|
|
$
|
2,497.4
|
|
$
|
2,569.3
|
|
$
|
(71.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
Less than $0.1 million.
|
Of the investment positions with
unrealized losses, no issuers had pretax unrealized losses greater than $1.2 million. Three fixed maturity securities were trading below 80% of book value at September 30, 2007. Two of these securities are CDOs which were priced below 80% due
to the illiquidity of the market. The other security declined in value because the issuer was unable to access the credit markets for funding purposes. The Company views the decrease in value of all of the securities with unrealized losses at
September 30, 2007 which was largely driven by the interest rate and credit environments as temporary, expects recovery in fair value, anticipates continued payments under the terms of the securities, and has the intent and
ability to hold these securities until maturity or a recovery in fair value occurs. Therefore, no impairment of these securities was recorded at September 30, 2007. Future changes in circumstances related to these and other securities could
require subsequent recognition of other-than-temporary impairment losses. The Companys investment guidelines generally limit single corporate issuer concentrations to 1.0% of invested assets for AA or AAA rated
securities, 0.75% of invested assets for A rated securities, 0.5% of invested assets for BBB rated securities, and 0.2% of invested assets for non-investment grade securities.
28
Benefits, Claims and Settlement Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
Change From
Prior Year
|
|
|
|
2007
|
|
2006
|
|
Percent
|
|
|
Amount
|
|
Property and casualty
|
|
$
|
270.3
|
|
$
|
257.6
|
|
4.9
|
%
|
|
$
|
12.7
|
|
Annuity
|
|
|
0.9
|
|
|
0.7
|
|
28.6
|
%
|
|
|
0.2
|
|
Life
|
|
|
35.8
|
|
|
34.6
|
|
3.5
|
%
|
|
|
1.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
307.0
|
|
$
|
292.9
|
|
4.8
|
%
|
|
$
|
14.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty catastrophe losses, included above (1)
|
|
$
|
17.7
|
|
$
|
18.6
|
|
-4.8
|
%
|
|
$
|
(0.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
See footnote (2) to the table below.
|
Property and
Casualty Claims and Claim Expenses (losses)
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
Incurred claims and claim expenses:
|
|
|
|
|
|
|
|
|
Claims occurring in the current year
|
|
$
|
285.1
|
|
|
$
|
274.8
|
|
Decrease in estimated reserves for claims occurring in prior years (1):
|
|
|
|
|
|
|
|
|
Policies written by the Company (2)
|
|
|
(14.8
|
)
|
|
|
(17.2
|
)
|
Business assumed from state reinsurance facilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total (2)
|
|
|
(14.8
|
)
|
|
|
(17.2
|
)
|
|
|
|
|
|
|
|
|
|
Total claims and claim expenses incurred
|
|
$
|
270.3
|
|
|
$
|
257.6
|
|
|
|
|
|
|
|
|
|
|
Property and casualty loss ratio:
|
|
|
|
|
|
|
|
|
Total
|
|
|
67.7
|
%
|
|
|
64.3
|
%
|
Effect of catastrophe costs, included above (2)
|
|
|
4.4
|
%
|
|
|
4.7
|
%
|
(1)
|
Shows the amounts by which the Company increased or 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.
|
(2)
|
(Favorable)/unfavorable development of prior years reserves was recorded as follows:
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
Three months ended
|
|
|
|
|
|
|
|
|
March 31
|
|
$
|
(5.5
|
)
|
|
$
|
(4.0
|
)
|
June 30
|
|
|
(5.6
|
)
|
|
|
(8.1
|
)
|
September 30
|
|
|
(3.7
|
)
|
|
|
(5.1
|
)
|
|
|
|
|
|
|
|
|
|
Total year-to-date
|
|
$
|
(14.8
|
)
|
|
$
|
(17.2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty catastrophe losses were incurred as follows:
|
|
|
|
|
|
|
|
|
Three months ended
|
|
|
|
|
|
|
|
|
March 31
|
|
$
|
2.5
|
|
|
$
|
3.0
|
|
June 30
|
|
|
4.9
|
|
|
|
8.4
|
|
September 30
|
|
|
10.3
|
|
|
|
7.2
|
|
|
|
|
|
|
|
|
|
|
Total year-to-date
|
|
$
|
17.7
|
|
|
$
|
18.6
|
|
|
|
|
|
|
|
|
|
|
The nine months ended September 30, 2006 included development of prior years reserves
for catastrophe losses, recorded in the second quarter, in captions related to catastrophe losses/costs as well as captions related to prior years reserve development as follows: total property and casualty, unfavorable development of $1.4
million; voluntary automobile, favorable development of $1.5 million; and total property, unfavorable development of $2.9 million.
29
For the three months ended September 30, 2007, the Companys benefits, claims and settlement
expenses of $108.6 million increased 6.3%, or $6.4 million, compared to the same period in 2006. This increase was largely due to an increase in catastrophe losses and a reduced level of favorable prior years property and casualty reserve
development. Catastrophe losses for the three months ended September 30, 2007 were due largely to storms in Minnesota. In addition, current accident year, non-catastrophe loss costs increased, particularly in the homowners line, due in large
part to the effects of non-catastrophe weather.
For the nine months ended September 30, 2007, the Companys benefits, claims and
settlement expenses increased compared to the prior year, including a modest decrease in catastrophe losses and a decrease in estimated reserves for property and casualty claims occurring in prior years, more than offset by a modest increase in auto
and property claim frequencies for the current accident period, consistent with industry experience. For the nine months, the current period favorable development of prior years reserves was the result of actual and remaining projected losses
for prior years, primarily accident years 2006 and 2005, being below the level anticipated in the December 31, 2006 loss reserve estimate for both the voluntary automobile and homeowners lines of business, which was driven primarily by emerging
claim trends related to severity. Catastrophe losses in the first nine months of 2006 included $1.4 million of adverse development of prior years catastrophe loss reserves, primarily due to increases in ultimate net settlement cost related to
two third quarter 2005 events: a severe hail storm in Minnesota and Hurricane Katrina.
For the nine months ended September 30, 2007,
the voluntary automobile loss ratio of 69.5% increased by 5.0 percentage points compared to the same period a year earlier, including a 3.1 percentage point increase due to the lower level of favorable development of prior years
non-catastrophe reserves in the current period and a 0.5 percentage point increase compared to the favorable prior years catastrophe reserve development recorded in 2006. The homeowners loss ratio of 61.2% for the nine months ended
September 30, 2007 decreased 0.2 percentage points compared to a year earlier, primarily reflecting the higher level of favorable development of prior years reserves recorded in the current period as well as the lower level of catastrophe
costs. Catastrophe costs represented 13.8 percentage points of the homeowners loss ratio for the current nine months compared to 14.6 percentage points for the prior year including adverse development of prior years catastrophe reserves
in 2006 a decrease of 0.8 percentage point. The $1.1 million increase in ceded premium in 2007 related to the Companys catastrophe reinsurance program added approximately 0.5 percentage point to the homeowners loss ratio for the nine
months ended September 30, 2007.
For the annuity segment, benefits increased by a minimal amount in the first nine months of 2007
compared to prior year. The Companys guaranteed minimum death benefits (GMDB) reserve was $0.8 million at September 30, 2007, compared to $0.7 million at both December 31, 2006 and September 30, 2006.
For the life segment, benefits were higher in the current nine months compared to prior year, reflecting liability growth which more than offset
favorable mortality costs.
30
Interest Credited to Policyholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
Change From
Prior Year
|
|
|
2007
|
|
2006
|
|
Percent
|
|
|
Amount
|
Annuity
|
|
$
|
67.2
|
|
$
|
64.2
|
|
4.7
|
%
|
|
$
|
3.0
|
Life
|
|
|
27.8
|
|
|
26.9
|
|
3.3
|
%
|
|
|
0.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
95.0
|
|
$
|
91.1
|
|
4.3
|
%
|
|
$
|
3.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended September 30, 2007, interest credited of $32.2 million increased
3.9%, or $1.2 million, consistent with the change reflected for the nine months.
Compared to the first nine months of 2006, the current
period increase in annuity segment interest credited reflected a 5.2% increase in average accumulated fixed deposits, partially offset by a 3 basis point decline in the average annual interest rate credited to 4.34%. Life insurance interest credited
increased as a result of the growth in interest-sensitive life insurance reserves.
The net interest spread on fixed annuity account value
on deposit measures the difference between the rate of income earned on the underlying invested assets and the rate of interest which policyholders are credited on their account values. Fixed annuity crediting rates were lowered in recent years to
reflect the decline in the rate of income on invested assets caused by lower investment rates on new and reinvested funds. The net interest spreads for the nine months ended September 30, 2007 and 2006 were 141 basis points and 125 basis
points, respectively.
As of September 30, 2007, fixed annuity account values totaled $2.1 billion, including $1.9 billion of deferred
annuities. Approximately 18% of the deferred annuity account values had minimum guaranteed interest rates of 3% or lower while approximately 71% of account values had minimum guaranteed rates of 4.5% or greater. For $1.6 billion of the deferred
annuity account values, the credited interest rate was equal to the minimum guaranteed rate. The annuity net interest spread increased 16 basis points compared to the first nine months of 2006, due to improvements in the Companys investment
portfolio yield and continued slight decreases in interest crediting rates.
Operating Expenses
For the first nine months of 2007, operating expenses decreased 3.3%, or $3.1 million, compared to the prior year, including a decrease of $3.8 million
for the three months ended September 30, 2007 compared to the third quarter of 2006. A significant portion of the variance amounts between periods was due to an employee bonus accrual adjustment in the third quarter of 2007 and a litigation
settlement charge in the prior year third quarter. The property and casualty expense ratio of 24.1% for the nine months ended September 30, 2007 increased 0.1 percentage point compared to the first nine months of 2006, including the effect on
this ratio of a reduced level of premiums earned, and was slightly below the full year 2006 expense ratio of 24.3%.
Effective
January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, which requires companies to recognize compensation cost for share-based compensation plans, determined based on
the fair value at the grant dates. The Company recognized $0.7 million and $0.5 million in expense for the nine months ended September 30, 2007 and 2006, respectively, as a result of the vesting of stock options during the respective periods.
31
Amortization of Policy Acquisition Expenses and Intangible Assets
For the three months ended September 30, 2007, amortization of policy acquisition expenses and amortization of intangible assets were comparable to a
year earlier. For the nine months ended September 30, 2007, the combined amortization of policy acquisition expenses and intangible assets was $59.7 million compared to $58.9 million recorded for the same period in the prior year.
Amortized policy acquisition expenses were $55.7 million for the first nine months of 2007 compared to $54.7 million for the same period in 2006. The
September 30, 2007 valuation of annuity deferred policy acquisition costs resulted in a decrease in amortization of $0.2 million for the nine months compared to a $0.2 million increase in amortization resulting from a similar valuation at
September 30, 2006. For the life segment, the September 30, 2007 valuation of deferred policy acquisition costs resulted in no change in amortization compared to a $0.1 million decrease from the 2006 valuation.
Amortization of intangible assets of $4.0 million for the nine months ended September 30, 2007 was $0.2 million less than the amortization for the
same period a year earlier. The September 30, 2007 valuation of Annuity VIF resulted in a $0.1 million increase in amortization for the nine months, equal to the increase for the nine months ended September 30, 2006.
Income Tax Expense
The effective
income tax rate on the Companys pretax income, including net realized investment gains, was 29.5% for the nine months ended September 30, 2007 compared to 29.8% for the nine months ended September 30, 2006. Income from investments in
tax-advantaged securities reduced the effective income tax rate 6.1 percentage points and 5.8 percentage points for the nine months ended September 30, 2007 and 2006, respectively.
The Company records liabilities for uncertain tax filing positions where it is more-likely-than-not that the position will be sustainable upon audit by
taxing authorities and reflects managements assessment of the amounts that are probable of being sustained. These liabilities are reevaluated routinely and are adjusted appropriately based upon changes in facts or law. The Company has no
unrecorded liabilities from uncertain tax filing positions.
At September 30, 2007, the Company had income tax returns for the 2002
through 2006 tax years still open and subject to adjustment upon examination by taxing authorities. The Company is currently under examination by the Internal Revenue Service for tax years 2002, 2004 and 2005. The Company has recorded $4.4 million
of uncertain tax position liabilities including interest related to all open tax years.
Net Income
For the three months ended September 30, 2007, the Companys net income of $18.4 million decreased $1.0 million compared to the prior year,
including a $0.8 million decrease in after tax realized investment gains. Third quarter 2007 property and casualty segment net income was $4.1 million less than prior year, adversely affected by increased current accident year, non-catastrophe loss
costs, particularly in the homeowners line, higher catastrophe losses and a lower level of favorable prior years reserve development. Net income for the annuity and life segments exceeded prior year in the current quarter by $1.8 million and
$1.5 million, respectively.
32
For the nine months ended September 30, 2007, the Companys net income decreased $5.3 million
compared to the prior year, including a $2.0 million reduction in after tax realized investment gains. Consistent with managements expectations and industry experience, the year-to-date increase in property and casualty average loss costs per
policy exceeded the increase in average premium per policy for the current accident period, which adversely impacted the combined ratio and net income. Compared to the first nine months of 2006, results in the first nine months of 2007 were also
negatively impacted by a lower level of favorable development of prior years property and casualty non-catastrophe reserves as well as the increased cost of the Companys catastrophe reinsurance program. Net income in the first nine
months of 2007 benefited from a decrease in catastrophe costs compared to the prior year. Including all of these factors, the property and casualty combined ratio was 91.8% for the first nine months of 2007 compared to 88.3% for 2006. Annuity
segment net income increased compared to the first nine months of 2006, driven by increases in the interest margin and contract charges earned. Life segment net income increased compared to a year earlier, reflecting growth in investment income and
favorable mortality experience.
Net income by segment and net income per share were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
|
Change From
Prior Year
|
|
|
|
2007
|
|
|
2006
|
|
|
Percent
|
|
|
Amount
|
|
Analysis of net income (loss) by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
$
|
45.1
|
|
|
$
|
53.3
|
|
|
-15.4
|
%
|
|
$
|
(8.2
|
)
|
Annuity
|
|
|
13.7
|
|
|
|
9.9
|
|
|
38.4
|
%
|
|
|
3.8
|
|
Life
|
|
|
12.7
|
|
|
|
11.0
|
|
|
15.5
|
%
|
|
|
1.7
|
|
Corporate and other (1)
|
|
|
(6.7
|
)
|
|
|
(4.1
|
)
|
|
-63.4
|
%
|
|
|
(2.6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
64.8
|
|
|
$
|
70.1
|
|
|
-7.6
|
%
|
|
$
|
(5.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of catastrophe costs, after tax, included above
|
|
$
|
(11.5
|
)
|
|
$
|
(12.5
|
)
|
|
8.0
|
%
|
|
$
|
1.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
|
|
$
|
1.45
|
|
|
$
|
1.55
|
|
|
-6.5
|
%
|
|
$
|
(0.10
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of shares and equivalent shares (in millions)
|
|
|
44.8
|
|
|
|
46.0
|
|
|
-2.6
|
%
|
|
|
(1.2
|
)
|
Property and casualty combined ratio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
91.8
|
%
|
|
|
88.3
|
%
|
|
N.M.
|
|
|
|
3.5
|
%
|
Effect of catastrophe costs, included above
|
|
|
4.4
|
%
|
|
|
4.8
|
%
|
|
N.M.
|
|
|
|
-0.4
|
%
|
(1)
|
The corporate and other segment includes interest expense on debt, realized investment gains and losses, certain public company expenses and other corporate level items. The Company
does not allocate the impact of corporate level transactions to the insurance segments, consistent with the basis for managements evaluation of the results of those segments.
|
33
For the nine months ended September 30, 2007, the changes in net income for the property and
casualty, annuity and life segments are described above.
For the corporate and other segment, the current period decline in net income
compared to the first nine months of 2006 was due primarily to a lower amount of net realized investment gains and an increase in debt interest expense.
Return on shareholders equity based on net income was 14% and 15% for the trailing 12 months ended September 30, 2007 and 2006, respectively.
At the time of this Quarterly Report on Form 10-Q, management is unable to fully assess the fourth quarter 2007 effect of the Southern California
wildfires. However, based on the current preliminary information available, management does not anticipate that these fires will have a significant impact on the previously provided estimate of 2007 full year net income before realized investment
gains and losses of between $1.80 and $1.95 per share. Included in the earnings estimate are additional costs, compared to 2006, totaling approximately $0.15 per share associated with the Companys 2007 catastrophe reinsurance program, as
described in Business Property and Casualty Segment Property and Casualty Reinsurance in the Companys Annual Report on Form 10-K for the year ended December 31, 2006, and an increased level of investment in
strategic growth initiatives, including the Agency Business Model, partially offset by improvement in annuity profit margins compared to prior year. As described in Critical Accounting Policies, certain of the Companys significant
accounting measurements require the use of estimates and assumptions. As additional information becomes available, adjustments may be required. Those adjustments are charged or credited to income for the period in which the adjustments are made and
may impact actual results compared to managements current estimate. A projection of net income including realized investment gains and losses is not accessible on a forward-looking basis because it is not possible to provide a reliable
forecast of realized investment gains and losses, which can vary substantially from one period to another and may have a significant impact on net income.
Liquidity and Financial Resources
Off-Balance Sheet Arrangements
At September 30, 2007 and 2006, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities
often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. As such, the Company is not
exposed to any financing, liquidity, market or credit risk that could arise if the Company had engaged in such relationships.
Investments
Information regarding the Companys investment portfolio, which is comprised primarily of investment
grade, fixed income securities, is located in Results of Operations Net Realized Investment Gains and Losses and in the Notes to Consolidated Financial Statements Note 3 Investments.
34
Cash Flow
The short-term liquidity requirements of the Company, within a 12-month operating cycle, are for the timely payment of claims and benefits to policyholders, operating expenses, interest payments and federal income
taxes. Cash flow generated from operations has been, and is expected to be, adequate to meet the Companys operating cash needs in the next 12 months. Cash flow in excess of operational needs has been used to fund business growth, retire
short-term debt, pay dividends to shareholders and repurchase shares of the Companys common stock. Long-term liquidity requirements, beyond one year, are principally for the payment of future insurance policy claims and benefits and retirement
of long-term debt.
Operating Activities
As a holding company, HMEC conducts its principal operations in the personal lines segment of the property and casualty and life insurance industries through its subsidiaries. HMECs insurance subsidiaries
generate cash flow from premium and investment income, generally well in excess of their immediate needs for policy obligations, operating expenses and other cash requirements. Cash provided by operating activities primarily reflects net cash
generated by the insurance subsidiaries. For the first nine months of 2007, net cash provided by operating activities increased compared to the same period in 2006, primarily reflecting an increase in investment income collected.
Payment of principal and interest on debt, dividends to shareholders and parent company operating expenses are dependent upon the ability of the
insurance subsidiaries to pay cash dividends or make other cash payments to HMEC, including tax payments pursuant to tax sharing agreements. Payments for the share repurchase program also have this dependency. The insurance subsidiaries are subject
to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. Dividends which may be paid by
the insurance subsidiaries to HMEC during 2007 without prior approval are approximately $106 million, of which $18 million was paid during the nine months ended September 30, 2007 and an additional $10 million was declared in September 2007 and
subsequently paid in October 2007. Although regulatory restrictions exist, dividend availability from subsidiaries has been, and is expected to be, adequate for HMECs capital needs.
Investing Activities
HMECs insurance
subsidiaries maintain significant investments in fixed maturity securities to meet future contractual obligations to policyholders. In conjunction with its management of liquidity and other asset/liability management objectives, the Company, from
time to time, will sell fixed maturity securities prior to maturity and reinvest the proceeds in other investments with different interest rates, maturities or credit characteristics. Accordingly, the Company has classified the entire fixed maturity
securities portfolio as available for sale.
Financing Activities
Financing activities include primarily payment of dividends, the receipt and withdrawal of funds by annuity contractholders, repurchases of the
Companys common stock, fluctuations in bank overdraft balances, and borrowings, repayments and repurchases related to its debt facilities.
35
For the nine months ended September 30, 2007, receipts from annuity contracts increased $17.2
million, or 7.1%, compared to the prior year. Annuity contract benefits and withdrawals increased $37.5 million, or 33.9%, compared to the prior year. Cash value retentions for variable and fixed annuity options were 90.8% and 91.9%, respectively,
for the 12 month period ended September 30, 2007. Net transfers to variable annuity accumulated cash values increased $19.9 million, or 22.7%, compared to the prior year.
On May 14, 2007, pursuant to provisions of the indenture, the Company redeemed all of its outstanding 1.425% Senior Convertible Notes (Senior
Convertible Notes), $68.6 million aggregate principal amount, utilizing a portion of the proceeds from the issuance of the Senior Notes due 2016. The aggregate cost of the redemption was $32.6 million. Detailed information regarding the Senior
Convertible Notes is contained in the Notes to Consolidated Financial Statements Note 4 Debt of the Companys Annual Report on Form 10-K for the year ended December 31, 2006.
Contractual Obligations
The annual
disclosure of the Companys contractual obligations was provided in Managements Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Financial Resources Contractual Obligations
in the Companys Annual Report on Form 10-K for the year ended December 31, 2006. With the exception of the Companys long-term debt obligations, the Companys contractual obligations at September 30, 2007 were not
materially different than those at December 31, 2006. Discussion of the recent changes in the Companys long-term debt obligations is included in Capital Resources. The table below identifies the future payments due on debt
obligations that were outstanding as of September 30, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due By Period As of September 30, 2007
|
|
|
Total
|
|
Less
Than
1 Year
(2007)(1)
|
|
1 - 3
Years
(2008 and
2009)
|
|
3 - 5
Years
(2010 and
2011)
|
|
More
Than
5 Years
(2012 and
beyond)
|
Long-Term Debt Obligations (2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior Notes Due June 15, 2015
|
|
$
|
111.3
|
|
$
|
2.2
|
|
$
|
9.1
|
|
$
|
9.1
|
|
$
|
90.9
|
Senior Notes Due April 15, 2016
|
|
|
202.0
|
|
|
4.3
|
|
|
17.1
|
|
|
17.1
|
|
|
163.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
313.3
|
|
$
|
6.5
|
|
$
|
26.2
|
|
$
|
26.2
|
|
$
|
254.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
October 1, 2007 through December 31, 2007.
|
(2)
|
Includes principal and interest.
|
36
Capital Resources
The Company has determined the amount of capital which is needed to adequately fund and support business growth, primarily based on risk-based capital formulas including those developed by the National Association of
Insurance Commissioners (NAIC). Historically, the Companys insurance subsidiaries have generated capital in excess of such needed capital. These excess amounts have been paid to HMEC through dividends. HMEC has then utilized these
dividends and its access to the capital markets to service and retire long-term debt, pay dividends to its shareholders, fund growth initiatives, repurchase shares of its common stock and for other corporate purposes. Management anticipates that the
Companys sources of capital will continue to generate capital in excess of the needs for business growth, debt interest payments and shareholder dividends.
The total capital of the Company was $880.4 million at September 30, 2007, including $199.5 million of long-term debt and no short-term debt outstanding. Total debt represented 22.1% of total capital excluding
unrealized investment gains and losses (22.7% including unrealized investment gains and losses) at September 30, 2007, which was below the Companys long-term target of 25%.
Shareholders equity was $680.9 million at September 30, 2007, including a net unrealized loss in the Companys investment portfolio of
$20.6 million after taxes and the related impact on deferred policy acquisition costs and the value of acquired insurance in force associated with annuity and interest-sensitive life policies. The market value of the Companys common stock and
the market value per share were $853.3 million and $19.71, respectively, at September 30, 2007. Book value per share was $15.73 at September 30, 2007 ($16.21 excluding investment fair value adjustments).
In September 2007, HMECs Board of Directors authorized a new $50 million share repurchase program and ended the May 1999 authorization. The new
program authorizes the repurchase of common shares in open market or privately negotiated transactions, from time to time, depending on market conditions. As of September 30, 2007, no shares were repurchased under the new program. See also
Notes to Consolidated Financial Statements Note 4 Share Repurchase Program and Treasury Shares.
As of
September 30, 2007, the Company had outstanding $75.0 million aggregate principal amount of 6.05% Senior Notes (Senior Notes due 2015), which will mature on June 15, 2015, issued at a discount resulting in an effective yield of
6.1%. Interest on the Senior Notes due 2015 is payable semi-annually at a rate of 6.05%. Detailed information regarding the redemption terms of the Senior Notes due 2015 is contained in the Notes to Consolidated Financial Statements
Note 4 Debt of the Companys Annual Report on Form 10-K for the year ended December 31, 2006.
The Senior Notes due
2015 have an investment grade rating from S&P (BBB), Moodys (Baa3), and A.M. Best (bbb-). See also Financial Ratings. The Senior Notes due 2015 are traded in the open market (HMN 6.05).
37
As of September 30, 2007, the Company had outstanding $125.0 million aggregate principal amount of
6.85% Senior Notes (Senior Notes due 2016), which will mature on April 15, 2016, issued at a discount of 0.305% resulting in an effective yield of 6.893%. Interest on the Senior Notes due 2016 is payable semi-annually at a rate of
6.85%. Detailed information regarding the redemption terms of the Senior Notes due 2016 is contained in the Notes to Consolidated Financial Statements Note 4 Debt of the Companys Annual Report on Form 10-K for the
year ended December 31, 2006.
The Senior Notes due 2016 have an investment grade rating from S&P (BBB), Moodys (Baa3), and
A.M. Best (bbb-). See also Financial Ratings. The Senior Notes due 2016 are traded in the open market (HMN 6.85).
As of
September 30, 2007, the Company had no balance outstanding under its Bank Credit Facility. The Bank Credit Facility provides for unsecured borrowings of up to $125.0 million and expires on December 19, 2011. Interest accrues at varying
spreads relative to corporate or Eurodollar base rates and is payable monthly or quarterly depending on the applicable base rate. The unused portion of the Bank Credit Facility is subject to a variable commitment fee, which was 0.125% on an annual
basis at September 30, 2007.
To provide additional capital management flexibility, the Company filed a universal shelf
registration on Form S-3 with the SEC in December 2003. The registration statement, which registers the offer and sale by the Company from time to time of up to $300 million of various securities, which may include debt securities, preferred stock,
common stock and/or depositary shares, was declared effective on December 30, 2003. Unless fully utilized or withdrawn by the Company earlier, this registration statement will remain effective through December 1, 2008. The $75.0 million
face amount of Senior Notes due 2015 and $125.0 million face amount of Senior Notes due 2016 were issued utilizing this registration statement. No other securities associated with the registration statement have been issued as of the date of this
Quarterly Report on Form 10-Q.
Total shareholder dividends were $13.8 million for the nine months ended September 30, 2007. In March,
May and September 2007, the Board of Directors announced regular quarterly dividends of $0.105 per share.
For the Companys property
and casualty subsidiaries, effective January 1, 2007, the Company purchased both catastrophe excess of loss and catastrophe aggregate reinsurance coverage. The excess of loss coverage consists of two contracts in addition to the Florida
Hurricane Catastrophe Fund (FHCF) described below. The primary contract (first event) provides 95% coverage of catastrophe losses above a retention of $25.0 million per occurrence up to $130.0 million per occurrence. This
contract consists of three layers, each of which provide for one mandatory reinstatement. The layers are $25.0 million excess of $25.0 million, $40.0 million excess of $50.0 million, and $40.0 million excess of $90.0 million. The other excess of
loss contract (second and third events) provides 95% coverage of catastrophe losses above a retention of $15.0 million per occurrence up to $25.0 million per occurrence, after the Company retains $10.0 million of losses above $15.0
million per occurrence. This contract also provides for one mandatory reinstatement. Coverage for any event under this contract is conditional on the size of the industry loss associated with that event being less than $20.1 billion. The
Companys predominant insurance subsidiary for property and casualty business written in Florida reinsures 90% of hurricane losses in that state above an estimated retention of $14.7 million up to $87.2 million with the FHCF, based on the
FHCFs financial resources. The FHCF contract is a one-year contract, effective June 1, 2007. The Companys FHCF coverage reflects the acquisition, in the
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current period, of additional coverage made available to the industry by the FHCF for the 2007-2008 contract period which resulted in changes to attachment
points under the Companys primary reinsurance contract. The increased coverage made available to the industry in 2007 by the FHCF could increase the likelihood of future assessments in periods following significant hurricane losses. The
catastrophe aggregate contract provides 95% coverage of the Companys 2007 catastrophe losses, capped at $10.0 million per occurrence, above an annual retention of $21.0 million, up to an annual limit of $40.0 million. Additional information
regarding the reinsurance program for the Companys property and casualty segment is located in Business Property and Casualty Segment Property and Casualty Reinsurance of the Companys Annual Report on Form 10-K
for the year ended December 31, 2006.
Information regarding the reinsurance program for the Companys life segment is located in
Business Life Segment of the Companys Annual Report on Form 10-K for the year ended December 31, 2006.
Financial Ratings
The Companys principal insurance subsidiaries are rated by Standard & Poors Corporation (S&P),
Moodys Investors Service, Inc. (Moodys) and A.M. Best Company, Inc. (A.M. Best). These rating agencies have also assigned ratings to the Companys long-term debt securities.
Assigned ratings as of October 31, 2007, which were unchanged from the disclosure in the Companys Annual Report on Form 10-K for the year
ended December 31, 2006, were as follows:
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Insurance
Financial
Strength Ratings (1)
(Outlook)
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Debt Ratings
(Outlook)
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As of October 31, 2007
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S&P (2)
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A(stable)
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BBB(stable)
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Moodys (2)
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A3(stable)
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Baa3(stable)
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A.M. Best
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A-(stable)
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bbb-(stable)
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(1)
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The insurance financial strength ratings for the Companys property and casualty insurance subsidiaries and the Companys principal life insurance subsidiary are the same.
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(2)
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This agency has not yet rated Horace Mann Lloyds.
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Market Value Risk
Market value risk, the Companys primary market risk exposure, is the risk that the Companys invested assets will decrease
in value. This decrease in value may be due to (1) a change in the yields realized on the Companys assets and prevailing market yields for similar assets, (2) an unfavorable change in the liquidity of the investment, (3) an
unfavorable change in the financial prospects of the issuer of the investment, or (4) a downgrade in the credit rating of the issuer of the investment. See also Results of Operations Net Realized Investment Gains and Losses.
Significant changes in interest rates expose the Company to the risk of experiencing losses or earning a reduced level of income based on
the difference between the interest rates earned on the Companys investments and the credited interest rates on the Companys insurance liabilities. See also Results of Operations Interest Credited to Policyholders.
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The Company seeks to manage its market value risk by coordinating the projected cash inflows of assets
with the projected cash outflows of liabilities. For all its assets and liabilities, the Company seeks to maintain reasonable durations, consistent with the maximization of income without sacrificing investment quality, while providing for liquidity
and diversification. The investment risk associated with variable annuity deposits and the underlying mutual funds is assumed by those contractholders, and not by the Company. Certain fees that the Company earns from variable annuity deposits are
based on the market value of the funds deposited.
More detailed descriptions of the Companys exposure to market value risks and the
management of those risks is presented in Managements Discussion and Analysis of Financial Condition and Results of Operations Market Value Risk of the Companys Annual Report on Form 10-K for the year ended
December 31, 2006.
Recent Accounting Changes
SFAS No. 159
In February 2007, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115. This standard will be
effective as of the beginning of an entitys first fiscal year that begins after November 15, 2007, which for the Company will be January 1, 2008. SFAS No. 159 permits all entities to choose to elect, at specified election dates,
to measure eligible financial instruments, as defined in SFAS No. 159, at fair value. Changes in unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings at each subsequent reporting
date and upfront costs and fees related to those items will be reported in earnings as incurred and not deferred. At adoption, for those financial assets and financial liabilities which management has elected to carry at fair value, an entity shall
report the effect of the first remeasurement to fair value as a cumulative-effect adjustment to the opening balance of retained earnings. Management is currently assessing the impact of this SFAS to determine whether it will elect to measure any of
its eligible financial assets or financial liabilities at fair value. An election to measure any or all of its eligible financial instruments at fair value could have a material effect on the results of operations or financial position of the
Company. In any event, the Company will not be electing to early adopt SFAS No. 159 and, as a result, retrospective application will be prohibited.
SFAS No. 157
In September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements. This standard will be effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Generally, the provisions of this statement are to be applied
prospectively as of the beginning of the fiscal year of adoption. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. This
pronouncement does not require any new fair value measurements. Management is currently assessing the impact of this SFAS but anticipates that its adoption will not have a material effect on the results of operations or financial position of the
Company.
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The Pension Protection Act of 2006
In the third quarter of 2006, the federal government enacted the Pension Protection Act of 2006 (the Act) which changes the manner in which
pension funding is determined. The new rules are effective for funding beginning in 2008. Management does not expect the Act to have a material impact on the Companys funding activity.
The Companys funding policy for the defined benefit pension plan is to contribute amounts which are actuarially determined to provide the plan with
sufficient assets to meet future benefit payments consistent with the funding requirements of federal laws and regulations. There was no minimum funding requirement for the defined benefit pension plan as of September 30, 2007. The
Companys obligations have not changed as a result of these developments.
Other Matters
Section 403(b) Regulations
On
July 26, 2007, final new Internal Revenue Service (IRS) Section 403(b) regulations were published in the Federal Register. The new regulations largely parallel those proposed in November 2004 and disclosed in Business
Regulation Regulation at Federal Level in the Companys Annual Reports on Form 10-K for the years ended December 31, 2006, 2005 and 2004. The effective date of the new regulations is generally January 1, 2009
with limited exceptions. Beginning with that date, contributions to Section 403(b) tax-qualified arrangements, including annuities, will need to be made pursuant to a written plan which includes all of the terms and conditions for
eligibility, limitations and benefits under the plan, and which may incorporate other documents by reference including annuity contracts issued by approved product providers. Other highlights of the new regulations include modified
distribution and transfer rules and the incorporation of numerous positions previously taken by the IRS since last issuing formal comprehensive Section 403(b) regulations in 1964. The lead time to the effective date, combined with preparations
made by the Company since the new regulations were first proposed, should permit ample time to assist the key school districts where Horace Mann has Section 403(b) payroll slots with the development of their written plans and to implement
the new products and services required to enable the Company to continue to effectively serve this market.
One immediate impact of the new
Section 403(b) regulations is that previous rules governing a participants ability to exchange, without incurring income tax liability, one 403(b) annuity or funding agreement for another were changed effective September 24, 2007.
New rules require that exchanges be limited to the product providers authorized in the sponsors written plan or that have entered into an information sharing agreement with the sponsor. Many school district sponsors have been willing to enter
into these information sharing agreements to allow participants the right to exchange contracts while their written plans are being completed; other districts have chosen to temporarily suspend their participants right to make such exchanges
until they are more comfortable in their understanding of the new requirements or their written plans are complete. During this period of uncertainty, new sales related to 403(b) exchanges could be adversely impacted; conversely, an industry-wide
reduction in exchanges should provide a temporary increase in retention ratios.
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Other
Ariel Capital Management, LLC, HMECs largest shareholder with 17.0% of the common shares outstanding per their SEC filing on Form 13G as of June 30, 2007, is the investment adviser for two of the mutual
funds offered to the Companys annuity customers.