MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)
(Dollars in millions, except per share data)
Measures within this MD&A that are not based on accounting principles generally accepted in the United States of America (non-GAAP) are marked by an asterisk (*) when such measures are first introduced. An explanation of these measures is contained in the Glossary of Selected Terms included as an exhibit to this Quarterly Report on Form 10-Q.
Forward-looking Information
Statements made in the following discussion that are not historical in nature are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to known and unknown risks, uncertainties and other factors. Horace Mann Educators Corporation (HMEC; and together with its subsidiaries, the Company or Horace Mann) is an insurance holding company. Horace Mann is not under any obligation to (and expressly disclaims any such obligation to) update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. It is important to note that the Company’s actual results could differ materially from those projected in forward-looking statements due to a number of risks and uncertainties inherent in the Company’s business. For additional information regarding risks and uncertainties, see Item 1A. Risk Factors in this Quarterly Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
.
Executive Summary
Through its subsidiaries, HMEC markets and underwrites personal lines of property and casualty insurance, retirement products (primarily tax-qualified annuities) and life insurance in the United States of America. The Company markets its products primarily to K-12 teachers, administrators and other employees of public schools and their families.
For the three month period ended
September 30, 2018
, the Company’s net income of
$12.5 million
decreased
$14.0 million compared to the prior year period primarily as a result of a higher level of catastrophe losses. After tax net investment gains were
$2.2 million
compared to after tax net investment losses of $2.2 million in the prior year period.
For the three month period ended
September 30, 2018
, Property and Casualty recorded a net loss of
$3.2 million
reflecting a significant level of catastrophe and non-catastrophe weather-related losses. The Property and Casualty net loss was $16.6 million lower than the
$13.4 million
of net income recorded in the prior year period. The Property and Casualty combined ratio of
110.1%
increased
14.3
points compared to the prior year period. This increase was due to an increase in catastrophe losses of $23.6 million pretax over the prior year period, partially offset by 3.1 points of improvement in the underlying auto loss ratio.
On a reported basis, the current quarter auto combined ratio of
99.5%
improved
3.9
points due to the improvement in the underlying loss ratio due to rate actions combined with continued stabilization in auto loss trends, partially offset by a
1.8
point increase in the expense ratio. The property combined ratio of
133.3%
increased
53.4
points compared to the prior year period and was attributable to an elevated level of catastrophe and non-catastrophe weather-related losses. The underlying property loss ratio* was
48.0%
in the current quarter, which reflected an increase of
1.7
points compared to the prior year period, in part due to an elevated level of non-catastrophe weather-related losses.
For the three month period ended
September 30, 2018
, total Property and Casualty written premiums* of
$182.7 million
increased
3.1%
compared to the prior year period. The growth was driven primarily by rate actions which resulted in an increase in the average premium per policy for both auto and property.
For the three month period ended
September 30, 2018
, Retirement net income of
$12.1 million
decreased
11.0% compared to the prior year period primarily due to an increase in operating and amortization expenses partially offset by higher net investment income and an increase in fee-based product income.
For the three month period ended
September 30, 2018
, the total level of Retirement sales deposits*
increased
18.2%
compared to the prior year period reflecting an increase in fee-based deposits, partially offset by a decline in spread-based products. For the
third
quarter of 2018, traditional annuity deposits of
$127.0 million
increased
10.6
% compared to the prior year period. The increase in traditional annuity deposits was related to higher sales of single premium annuity products in the current quarter. Sales deposit activity related to the Retirement Advantage
®
mutual fund products, as well as other mutual fund offerings, were strong with
$24.9 million
in the current quarter compared to
$13.7 million
in the prior year period.
For the three month period ended
September 30, 2018
, Life net income of
$5.3 million
increased
10.4%
compared to the prior year period primarily due to the lower federal income tax rate. Life sales of
$5.3 million
for the current quarter increased
65.6%
compared to the prior year period due to an increase in recurring and single premium sales.
For the
nine
month period ended
September 30, 2018
, the Company’s net income of
$38.6 million
decreased
$5.5 million
compared to the prior year period primarily due to an elevated level of catastrophe and non-catastrophe weather-related losses offset by the impact of the lower federal income tax rate on Retirement and Life earnings. After tax net investment gains were
$1.5 million
compared to after tax net investment losses of
$0.8 million
in the prior year period.
For the
nine
month period ended
September 30, 2018
, Property and Casualty recorded a net loss of
$4.4 million
compared to
$2.2 million
of net income recorded in the prior year period. The Property and Casualty combined ratio of
108.0%
increased
1.5
points compared to the prior year period. This increase was due to a 1.9 point improvement in the underlying auto loss ratio offset by a 1.8 point increase in the underlying property loss ratio and Property and Casualty catastrophe losses that were
$68.8 million
pretax in the current period compared to
$58.2 million
pretax in the prior year period.
On a reported basis, the auto combined ratio of
103.4%
improved
3.6
points and the property combined ratio of
117.9%
increased
12.3
points as compared to the prior year period. The underlying auto loss ratio of
75.1%
improved
1.9
points compared to the prior year period as a result of an increase in earned premium due to rate actions combined with continued stabilization in auto loss trends. The auto expense ratio
improved
0.2
points. The underlying property loss ratio was
51.5%
in the current period, which reflected an increase of
1.8
points compared to the prior year period due to an elevated level of non-catastrophe weather-related losses.
For the
nine
month period ended
September 30, 2018
, total Property and Casualty written premiums of
$515.1 million
increased
3.4%
compared to the prior year period. The growth was driven primarily by rate actions which resulted in an increase in the average premium per policy for both auto and property. Policy retention continues to be stable with auto and property policy retention rates for the current quarter at
82.5%
and
87.9%
, respectively.
For the
nine
month period ended
September 30, 2018
, Retirement net income of
$37.6 million
was
1.9%
higher than the prior year period and benefited from higher net investment income, an increase in fee-based product income and the lower federal income tax rate partially offset by an increase in operating expenses to support strategic initiatives.
The annualized net interest spread on fixed annuity assets under management as of September 30, 2018 was 182 basis points, which benefited from an elevated level of prepayments. Total retirement assets under management, including fee-based mutual fund products of $7.1 billion, increased 6.6% compared to a year ago, and total cash value persistency remained strong at
94.5%
for variable annuities and
94.2
% for fixed annuities.
For the
nine
month period ended
September 30, 2018
, the total level of Retirement sales deposits
increased
3.1%
compared to the prior year period reflecting an increase in fee-based deposits, partially offset by a decline in spread-based deposits. For the first nine months of 2018, traditional annuity deposits of
$326.0 million
decreased
6.6%
compared to the prior year period. The decline in traditional annuity deposits was related to lower sales of single premium annuity products in the current period. Sales deposit activity related to the Retirement Advantage
®
mutual fund products, as well as other mutual fund offerings, were strong with
$57.6 million
in the current period compared to
$29.0 million
in the prior year period.
For the
nine
month period ended
September 30, 2018
, Life net income of
$15.0 million
increased
$0.7 million
compared to the prior year period, primarily due to the lower federal income tax rate. Life sales of
$15.1 million
for the current period
increased
30.2%
compared to the prior year period due to an increase in recurring and single premium sales. Life persistency of
95.2%
was comparable to 12 months earlier.
The Company’s book value per share was
$31.78
at
September 30, 2018
,
a decrease
of
13.8%
and
7.1%
compared to
December 31, 2017
and a year ago, respectively, due to the impact of higher interest rates and wider credit spreads on net unrealized investment gains on securities.
Critical Accounting Policies
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires the Company's management to make estimates and assumptions based on information available at the time the consolidated financial statements are prepared. These estimates and assumptions affect the reported amounts of the Company's consolidated assets, liabilities, shareholders' equity, net income and cash flows. Certain accounting estimates are particularly sensitive because of their significance to the Company's consolidated financial statements and because of the possibility that subsequent events and available information may differ markedly from management's judgments at the time the consolidated financial statements were prepared. Management has discussed with the Audit Committee the quality, not just the acceptability, of the Company's accounting principles as applied in its financial reporting. The discussions generally included such matters as the consistency of the Company's accounting policies and their application, and the clarity and completeness of the Company's consolidated financial statements, which include related disclosures. For the Company, areas most subject to significant management judgments include: fair value measurements, other-than-temporary impairment (OTTI) of investments, goodwill, deferred policy acquisition costs (DAC) for investment contracts and life insurance products with account values, liabilities for Property and Casualty claims and claim expenses and liabilities for future policy benefits.
Compared to
December 31, 2017
, at
September 30, 2018
, there were no material changes to accounting policies for areas most subject to significant management judgments identified above. In addition to disclosures in Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
, discussion of accounting policies, including certain sensitivity information, was presented in Management’s Discussion and Analysis of Financial Condition and Results of Operations -- Critical Accounting Policies in that Form 10-K.
Results of Operations
Insurance Premiums and Contract Charges
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($ in millions)
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Three Months Ended
September 30,
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Change From
Prior Year
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Nine Months Ended
September 30,
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Change From
Prior Year
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2018
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2017
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Percent
|
|
Amount
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2018
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2017
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Percent
|
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Amount
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Insurance premiums written and
contract deposits (includes annuity
and life contract deposits)
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Property and Casualty
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$
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182.7
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$
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177.2
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3.1
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%
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$
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5.5
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$
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515.1
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$
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498.0
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3.4
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%
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$
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17.1
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Retirement
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127.0
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114.8
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10.6
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%
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12.2
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326.0
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348.9
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-6.6
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%
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(22.9
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)
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Life
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28.4
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26.4
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7.6
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%
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2.0
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82.7
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79.8
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3.6
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%
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2.9
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Total
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$
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338.1
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$
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318.4
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6.2
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%
|
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$
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19.7
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$
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923.8
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$
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926.7
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-0.3
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%
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$
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(2.9
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)
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Insurance premiums and contract
charges earned (excludes annuity
and life contract deposits)
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Property and Casualty
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$
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168.6
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$
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163.2
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3.3
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%
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$
|
5.4
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$
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501.4
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$
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482.0
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4.0
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%
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$
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19.4
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Retirement
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8.0
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7.5
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6.7
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%
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0.5
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23.9
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20.8
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14.9
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%
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3.1
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Life
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30.2
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28.3
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6.7
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%
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1.9
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90.1
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87.6
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2.9
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%
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2.5
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Total
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$
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206.8
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$
|
199.0
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3.9
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%
|
|
$
|
7.8
|
|
|
$
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615.4
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|
|
$
|
590.4
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|
|
4.2
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%
|
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$
|
25.0
|
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Number of Policies and Contracts in Force
(actual counts)
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September 30, 2018
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December 31, 2017
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September 30, 2017
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Property and Casualty
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Automobile
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466,258
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478,951
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482,035
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Property and other liability
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213,762
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216,306
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217,377
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Total
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680,020
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695,257
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699,412
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Retirement
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224,094
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223,287
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221,309
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Life
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198,330
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197,889
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196,978
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For the three month period ended
September 30, 2018
, the Company’s premiums written and contract deposits* of
$338.1 million
increased
$
19.7 million
, or
6.2%
, compared to the prior year period reflecting an increase in sales of single premium annuity products in the current quarter. The Company’s premiums and contract charges earned increased
$7.8 million
, or
3.9%
, compared to the prior year period reflecting increases in average premium per policy for both property and automobile.
Total Property and Casualty premiums written
increased
3.4%
, or $
17.1 million
, in the first
nine
months of
2018
, compared to the prior year period reflecting increases in average written premium per policy for both property and automobile. Average approved rate changes during the first
nine
months of
2018
were 11.1% for automobile and 4.5% for property.
Based on policies in force, the current year automobile 12 month retention rate for new and renewal policies was
82.5%
compared to
83.0%
at
September 30, 2017
, with the decrease due to recent rate and underwriting actions. The current year property 12 month retention rate for new and renewal policies was
87.9%
compared to
87.6%
at
September 30, 2017
.
Automobile premiums written*
increased
3.9%
, or
$13.0 million
, compared to the first
nine
months of
2017
. In the first
nine
months of
2018
, the average written premium per policy and average earned premium per policy increased approximately 7.0% and 6.7%, respectively, compared to the prior year period. The number of educator policies represented approximately 85.4% of the automobile policies in force at
September 30, 2018
, 85.2% at
December 31, 2017
and 85.1% at
September 30, 2017
.
Property premiums written*
increased
2.6%
, or
$4.2 million
, compared to the first
nine
months of
2017
. While the number of property policies in force has declined, the average written premium per policy and average earned premium per policy increased approximately 4.0% and 2.6%, respectively, in the first
nine
months of
2018
compared to the prior year period. The number of educator policies represented approximately 82.4% of the property policies in force at
September 30, 2018
, 82.3% at
December 31, 2017
and 82.2% at
September 30, 2017
. The number of educator policies and total policies has been, and may continue to be, impacted by the Company’s risk mitigation programs, including actions in catastrophe-prone coastal areas, involving policies of both educators and non-educators.
The Company continues to evaluate and implement actions to further mitigate its risk exposure in catastrophe-prone areas. Such actions could include, but are not limited to, non-renewal of property policies, restricted agent geographic placement, limitations on agent new business sales, further tightening of underwriting standards and increased utilization of third-party vendor products.
For the
nine
month period ended
September 30, 2018
, total traditional annuity deposits
decreased
6.6%
, or
$22.9 million
, compared to the prior year period. New deposits to fixed accounts of
$174.7 million
decreased
21.0%
, or
$46.5 million
, and new deposits to variable accounts of
$151.3 million
increased
18.5%
, or
$23.6 million
, compared to the prior year period.
Total Retirement assets under management, including fee based mutual fund products, increased 6.6% for the
nine
month period ended
September 30, 2018
as compared to the prior year period. Annuity accumulated value on deposit of
$7.0 billion
at
September 30, 2018
increased
5.5%
compared to a year earlier reflecting an increase from new deposits received, market appreciation as well as favorable retention. Accumulated value retention for the variable annuity option was 94.5% and 95.0% for the 12 month periods ended
September 30, 2018
and
2017
, respectively; fixed annuity retention was 94.2% and 94.5% for the 12 month periods ended September 30, 2018 and 2017, respectively.
Variable annuity accumulated balances of
$2.3 billion
at
September 30, 2018
increased
11.7%
compared to
September 30, 2017
, as positive impacts of deposits and favorable financial market performance and retention offset withdrawals and net transfers to the guaranteed interest rate fixed account option. Fixed annuity accumulated balances of
$4.7 billion
at
September 30, 2018
increased
2.7%
compared to
September 30, 2017
reflecting new deposits, interest credited and net transfers from the variable annuity accounts. Compared to the
nine
month period ended
September 30, 2017
, Retirement contract charges earned
increased
14.9%
, or
$3.1 million
.
Life premiums and contract deposits* for the
nine
month period ended
September 30, 2018
increased
3.6%
, or
$2.9 million
, compared to the prior year period. The ordinary life insurance in force lapse ratio was
4.8%
for the 12 months ended
September 30, 2018
, comparable to the prior year period.
Sales*
For the first
nine
months of
2018
, Property and Casualty new annualized sales premiums
decreased
4.1%
compared to the first
nine
months of
2017
, as a
5.3%
, or
$3.8 million
decline in new automobile sales was offset by growth in property sales of
2.1%
, or
$0.3 million
, compared to the prior year period.
For the
nine
month period ended
September 30, 2018
, the total level of Retirement sales deposits
increased
3.1%
compared to the prior year period reflecting an increase in fee-based deposits, partially offset by a decline in spread-based deposits. For the
nine
month period ended
September 30, 2018
, traditional annuity deposits
decreased
4.9%
, or
$16.9 million
, compared to the prior year period. New deposits to fixed accounts of
$174.7 million
decreased
20.5%
, or
$45.1 million
, and new deposits to variable accounts of
$151.3 million
increased
22.9%
, or
$28.2 million
, compared to the prior year period. Sales deposit activity related to the Retirement Advantage® mutual fund products, as well as other mutual fund offerings, were strong with
$57.6 million
in the current period compared to
$29.0 million
in the prior year period.
The Company's introduction of new educator-focused portfolios of term and whole life products in recent years, including a single premium whole life product, as well as the Company's Indexed Universal Life (IUL) product, have contributed to sales of life products. For the first
nine
months of
2018
, sales of Horace Mann's life insurance products totaled
$15.1 million
, representing an increase of
$3.5 million
, compared to the prior year period.
Distribution
At
September 30, 2018
, there was a combined total of
672
Exclusive Distributors, compared to 694 at both
December 31, 2017
and
September 30, 2017
. The Company continues to expect higher quality standards for Exclusive Distributors to focus on improving both customer experiences and agent productivity in their respective territories. The dedicated sales force is supported by the Company’s customer contact center which provides a means for educators to begin their experience directly with the Company, if that is their preference. The Customer Contact Center is also able to assist educators in territories which are not currently served by an Exclusive Distributor.
Net Investment Income
For the
three and nine
month periods ended
September 30, 2018
, net investment income of
$99.1 million
and
$288.1 million
increased
7.4%
and
4.8%
, compared to the prior year periods. Net investment income for the three and nine month periods ended September 30, 2018 benefited from a higher level of prepayments as well as favorable returns on alternative investments as compared to the prior year periods. Overall, investment results reflected continued growth in annuity asset balances along with increased alternative investment results offset by the continued low interest rate environment and a concerted effort to increase portfolio quality, which puts pressure on portfolio yield
.
The Company believes it is late in the credit cycle so the increase in portfolio quality is a proactive action to opportunistically position the portfolio for a recessionary environment and is consistent with our approach in previous credit cycles.
Average invested assets increased 2.6% over the 12 months ended
September 30, 2018
. The average pretax yield on the total investment portfolio for the
nine
month period ended
September 30, 2018
of 5.2% (4.1% after tax) was higher when compared to the prior year period. During the
nine
month period ended
September 30, 2018
, management continued to identify and purchase investments, including a modest level of alternative investments, with attractive risk-adjusted yields relative to market conditions without venturing into asset classes or individual securities that would be inconsistent with the Company’s overall conservative investment guidelines.
Net Investment Gains (Losses) - Pretax
For the three month period ended
September 30, 2018
, net investment gains were
$2.9 million
compared to net investment losses of
$3.5 million
in the prior year period and the results from the current quarter include $2.0 million of net investment gains due to the change in fair value of the equity securities portfolio.
For the
nine
month period ended
September 30, 2018
, net investment gains were $1.9 million compared to net investment losses of
$1.7 million
in the prior year period and the results from the current year period include $4.3 million of net investment losses due to the change in fair value of the equity securities portfolio.
The Company, from time to time, sells securities subsequent to the reporting date that were considered temporarily impaired at the reporting date. Such sales are due to issuer specific events occurring subsequent to the reporting date that result in a change in the Company’s intent to sell an invested asset.
Fixed Maturity and Equity Securities Portfolios
The table below presents the Company’s fixed maturity and equity securities portfolios by major asset class, including the 10 largest sectors of the Company’s corporate bond holdings (based on fair value). Compared to
December 31, 2017
, credit spreads were wider within investment grade and tighter in high yield, and the 10-year U.S. Treasury rate rose 65 basis points to 3.06%, which resulted in lower net unrealized investment gains on the fixed maturity securities portfolio at
September 30, 2018
.
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($ in millions)
|
|
September 30, 2018
|
|
|
Number of
Issuers
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|
Fair
Value
|
|
Amortized
Cost
|
|
Pretax Net
Unrealized
Investment
Gain (Loss)
|
Fixed maturity securities
|
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Corporate bonds
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Banking and Finance
|
|
126
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$
|
658.4
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|
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$
|
653.4
|
|
|
$
|
5.0
|
|
Insurance
|
|
61
|
|
|
261.9
|
|
|
249.9
|
|
|
12.0
|
|
Technology
|
|
35
|
|
|
179.7
|
|
|
179.9
|
|
|
(0.2
|
)
|
Real Estate
|
|
41
|
|
|
177.3
|
|
|
178.0
|
|
|
(0.7
|
)
|
Energy
(1)
|
|
57
|
|
|
172.0
|
|
|
166.8
|
|
|
5.2
|
|
HealthCare,Pharmacy
|
|
50
|
|
|
140.9
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|
|
139.3
|
|
|
1.6
|
|
Utilities
|
|
42
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|
|
123.2
|
|
|
112.7
|
|
|
10.5
|
|
Transportation
|
|
37
|
|
|
112.8
|
|
|
111.4
|
|
|
1.4
|
|
Telecommunications
|
|
19
|
|
|
74.9
|
|
|
70.9
|
|
|
4.0
|
|
Broadcasting and Media
|
|
17
|
|
|
71.1
|
|
|
68.3
|
|
|
2.8
|
|
All other corporates
(2)
|
|
191
|
|
|
363.3
|
|
|
359.9
|
|
|
3.4
|
|
Total corporate bonds
|
|
676
|
|
|
2,335.5
|
|
|
2,290.5
|
|
|
45.0
|
|
Mortgage-backed securities
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Government and federally sponsored agencies
|
|
237
|
|
|
435.5
|
|
|
431.5
|
|
|
4.0
|
|
Commercial
(3)
|
|
152
|
|
|
638.6
|
|
|
657.5
|
|
|
(18.9
|
)
|
Other
|
|
31
|
|
|
85.7
|
|
|
86.0
|
|
|
(0.3
|
)
|
Municipal bonds
(4)
|
|
451
|
|
|
1,883.7
|
|
|
1,783.7
|
|
|
100.0
|
|
Government bonds
|
|
|
|
|
|
|
|
|
U.S.
|
|
41
|
|
|
782.6
|
|
|
802.5
|
|
|
(19.9
|
)
|
Foreign
|
|
15
|
|
|
95.0
|
|
|
92.9
|
|
|
2.1
|
|
Collateralized loan obligations
(5)
|
|
127
|
|
|
655.0
|
|
|
655.5
|
|
|
(0.5
|
)
|
Asset-backed securities
|
|
111
|
|
|
617.5
|
|
|
619.4
|
|
|
(1.9
|
)
|
Total fixed maturity securities
|
|
1,841
|
|
|
$
|
7,529.1
|
|
|
$
|
7,419.5
|
|
|
$
|
109.6
|
|
|
|
|
|
|
|
|
|
|
Equity securities
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-redeemable preferred stocks
|
|
12
|
|
|
$
|
58.6
|
|
|
|
|
|
Common stocks
|
|
89
|
|
|
55.4
|
|
|
|
|
|
Closed-end fund
|
|
1
|
|
|
19.2
|
|
|
|
|
|
Total equity securities
|
|
102
|
|
|
$
|
133.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
1,943
|
|
|
$
|
7,662.3
|
|
|
|
|
|
________________
|
|
(1)
|
At
September 30, 2018
, the fair value amount included $10.7 million which were non-investment grade.
|
|
|
(2)
|
The All other corporates category contains 19 additional industry sectors. Gaming, natural gas, food and beverage, metal and mining and retail represented $229.7 million of fair value at
September 30, 2018
, with the remaining 14 sectors each representing less than $28.0 million.
|
|
|
(3)
|
At
September 30, 2018
, 100% were investment grade, with an overall credit rating of AA, and the positions were well diversified by property type, geography and sponsor.
|
|
|
(4)
|
Holdings are geographically diversified, 42.3% are tax-exempt and 77.0% are revenue bonds tied to essential services, such as mass transit, water and sewer. The overall credit quality of the municipal bond portfolio was AA- at
September 30, 2018
.
|
|
|
(5)
|
Based on fair value, 97.2% of the collateralized loan obligation securities were rated investment grade by Standard and Poor’s Corporation (S&P), Moody’s Investors Service, Inc. (Moody’s) and/or Fitch Ratings (Fitch) at
September 30, 2018
.
|
At
September 30, 2018
, the Company’s diversified fixed maturity securities portfolio consisted of 2,973 investment positions, issued by
1,841
entities, and totaled approximately
$7.5 billion
in fair value. This portfolio was 96.9% investment grade, based on fair value, with an average quality rating of A+. The Company’s investment guidelines target single corporate issuer concentrations to 0.5% of invested assets for "AAA" or "AA" rated securities, 0.4% of invested assets for "A" or "BBB" rated securities, and 0.2% of invested assets for non-investment grade securities.
The following table presents the composition and value of the Company’s fixed maturity and equity securities portfolios by rating category. At
September 30, 2018
, 96.0% of these combined portfolios were investment grade, based on fair value, with an overall average quality rating of A+. At
September 30, 2018
, the Company has classified the entire fixed maturity securities portfolio as available for sale, which is carried at fair value.
Rating of Fixed Maturity Securities and Equity Securities
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
|
Percent of Portfolio
|
|
|
|
|
|
|
Fair Value
|
|
September 30, 2018
|
|
|
December 31, 2017
|
|
September 30, 2018
|
|
Fair
Value
|
|
Amortized
Cost
|
Fixed maturity securities
|
|
|
|
|
|
|
|
|
|
|
|
|
AAA
|
|
7.4
|
%
|
|
8.7
|
%
|
|
$
|
655.2
|
|
|
$
|
653.7
|
|
AA
(2)
|
|
40.4
|
|
|
41.8
|
|
|
3,144.9
|
|
|
3,124.7
|
|
A
|
|
23.8
|
|
|
23.5
|
|
|
1,775.1
|
|
|
1,714.8
|
|
BBB
|
|
24.8
|
|
|
22.7
|
|
|
1,709.5
|
|
|
1,684.1
|
|
BB
|
|
2.2
|
|
|
2.2
|
|
|
163.4
|
|
|
163.4
|
|
B
|
|
0.6
|
|
|
0.5
|
|
|
38.0
|
|
|
37.8
|
|
CCC or lower
|
|
0.1
|
|
|
0.1
|
|
|
0.7
|
|
|
0.7
|
|
Not rated
(3)
|
|
0.7
|
|
|
0.5
|
|
|
42.3
|
|
|
40.3
|
|
Total fixed maturity securities
|
|
100.0
|
%
|
|
100.0
|
%
|
|
$
|
7,529.1
|
|
|
$
|
7,419.5
|
|
Equity securities
|
|
|
|
|
|
|
|
|
|
|
|
|
AAA
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
AA
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
A
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
BBB
|
|
45.4
|
%
|
|
44.0
|
%
|
|
$
|
58.6
|
|
|
|
BB
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
B
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
CCC or lower
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
Not rated
|
|
54.6
|
|
|
56.0
|
|
|
74.6
|
|
|
|
Total equity securities
|
|
100.0
|
%
|
|
100.0
|
%
|
|
$
|
133.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
$
|
7,662.3
|
|
|
|
|
________________
|
|
(1)
|
Ratings are as assigned primarily by S&P when available, with remaining ratings as assigned on an equivalent basis by Moody’s or Fitch. Ratings for publicly traded securities are determined when the securities are acquired and are updated monthly to reflect any changes in ratings.
|
|
|
(2)
|
At
September 30, 2018
, the AA rated fair value amount included $782.6 million of U.S. Government and federally sponsored agency securities and $661.5 million of mortgage-backed and asset-backed securities issued by U.S. Government and federally sponsored agencies.
|
|
|
(3)
|
This category primarily represents private placement and municipal securities not rated by either S&P, Moody’s or Fitch.
|
At
September 30, 2018
, the fixed maturity securities portfolio had $123.6 million pretax of gross unrealized losses on $3,698.9 million of fair value related to 1,483 positions. Of the investment positions with gross unrealized losses, there were none trading below 80.0% of the carrying value at
September 30, 2018
.
The Company views the unrealized investment losses of all of the fixed maturity securities at
September 30, 2018
as temporary. Future changes in circumstances related to these and other securities could require subsequent recognition of OTTI.
Benefits, Claims and Settlement Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
|
Three Months Ended
September 30,
|
|
Change From
Prior Year
|
|
Nine Months Ended
September 30,
|
|
Change From
Prior Year
|
|
|
2018
|
|
2017
|
|
Percent
|
|
Amount
|
|
2018
|
|
2017
|
|
Percent
|
|
Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty
|
|
$
|
140.0
|
|
|
$
|
114.9
|
|
|
21.8
|
%
|
|
$
|
25.1
|
|
|
$
|
407.7
|
|
|
$
|
384.9
|
|
|
5.9
|
%
|
|
$
|
22.8
|
|
Retirement
|
|
1.5
|
|
|
1.6
|
|
|
-6.3
|
%
|
|
(0.1
|
)
|
|
4.8
|
|
|
4.0
|
|
|
20.0
|
%
|
|
0.8
|
|
Life
|
|
20.3
|
|
|
18.4
|
|
|
10.3
|
%
|
|
1.9
|
|
|
61.2
|
|
|
56.0
|
|
|
9.3
|
%
|
|
5.2
|
|
Total
|
|
$
|
161.8
|
|
|
$
|
134.9
|
|
|
19.9
|
%
|
|
$
|
26.9
|
|
|
$
|
473.7
|
|
|
$
|
444.9
|
|
|
6.5
|
%
|
|
$
|
28.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty catastrophe
losses, included above
(1)
|
|
$
|
32.2
|
|
|
$
|
8.6
|
|
|
274.4
|
%
|
|
$
|
23.6
|
|
|
$
|
68.8
|
|
|
$
|
58.2
|
|
|
18.2
|
%
|
|
$
|
10.6
|
|
________________
|
|
|
|
|
|
|
|
|
|
(1)
Property and Casualty catastrophe losses were incurred as follows:
|
|
|
2018
|
|
2017
|
Three months ended
|
|
|
|
|
March 31
|
|
$
|
9.8
|
|
|
$
|
17.2
|
|
June 30
|
|
26.8
|
|
|
32.4
|
|
September 30
|
|
32.2
|
|
|
8.6
|
|
Total year-to-date
|
|
$
|
68.8
|
|
|
$
|
58.2
|
|
Property and Casualty Claims and Claim Expenses (Losses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Incurred claims and claim expenses:
|
|
|
|
|
|
|
|
|
|
|
Claims occurring in the current year
|
|
$
|
140.0
|
|
|
$
|
115.4
|
|
|
$
|
408.0
|
|
|
$
|
387.0
|
|
Decrease in estimated reserves for claims occurring
in prior years
(1)
|
|
—
|
|
|
(0.5
|
)
|
|
(0.3
|
)
|
|
(2.1
|
)
|
Total claims and claim expenses incurred
|
|
$
|
140.0
|
|
|
$
|
114.9
|
|
|
$
|
407.7
|
|
|
$
|
384.9
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty loss ratio:
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
83.0
|
%
|
|
70.4
|
%
|
|
81.3
|
%
|
|
79.8
|
%
|
Effect of catastrophe losses, included above
|
|
19.1
|
%
|
|
5.3
|
%
|
|
13.7
|
%
|
|
12.0
|
%
|
Effect of prior years’ reserve development,
included above
|
|
—
|
%
|
|
-0.3
|
%
|
|
-0.1
|
%
|
|
-0.4
|
%
|
________________
|
|
|
|
|
|
|
|
|
|
(1)
Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous years to reflect subsequent information on such claims and changes in their projected final settlement costs.
|
|
|
2018
|
|
2017
|
Three months ended
|
|
|
|
|
March 31
|
|
$
|
(0.3
|
)
|
|
$
|
(1.0
|
)
|
June 30
|
|
—
|
|
|
(0.6
|
)
|
September 30
|
|
—
|
|
|
(0.5
|
)
|
Total year-to-date
|
|
$
|
(0.3
|
)
|
|
$
|
(2.1
|
)
|
For the three month period ended
September 30, 2018
, the Company's benefits, claims and settlement expenses increased
$26.9 million
or
19.9%
, compared to the prior year period.
For the
nine
month period ended
September 30, 2018
, the Company's benefits, claims and settlement expenses
increased
$28.8 million
or
6.5%
, compared to the prior year period.
For the
nine
month period ended
September 30, 2018
, the automobile loss ratio of
76.7%
improved
by
3.4
points compared to the prior year period reflecting lower catastrophe losses that resulted in
1.5
points of the improvement and continued stabilization in auto loss trends. The property loss ratio of
91.1%
for the
nine
month period ended
September 30, 2018
, increased
11.9
points compared to the prior year period reflecting higher catastrophe losses that contributed 8.9 points of the increase.
Interest Credited to Policyholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
|
Three Months Ended
September 30,
|
|
Change From
Prior Year
|
|
Nine Months Ended
September 30,
|
|
Change From
Prior Year
|
|
|
2018
|
|
2017
|
|
Percent
|
|
Amount
|
|
2018
|
|
2017
|
|
Percent
|
|
Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retirement (annuity)
|
|
$
|
40.8
|
|
|
$
|
38.8
|
|
|
5.2
|
%
|
|
$
|
2.0
|
|
|
$
|
119.4
|
|
|
$
|
114.4
|
|
|
4.4
|
%
|
|
$
|
5.0
|
|
Life
|
|
11.3
|
|
|
11.3
|
|
|
—
|
%
|
|
—
|
|
|
33.8
|
|
|
33.8
|
|
|
—
|
%
|
|
—
|
|
Total
|
|
$
|
52.1
|
|
|
$
|
50.1
|
|
|
4.0
|
%
|
|
$
|
2.0
|
|
|
$
|
153.2
|
|
|
$
|
148.2
|
|
|
3.4
|
%
|
|
$
|
5.0
|
|
For the
nine
month period ended
September 30, 2018
, the increase in Retirement interest credited reflected a 2.5% increase in average accumulated fixed value on deposit. Life interest credited remained flat.
The annualized net interest spread on fixed annuity assets under management 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. The annualized net interest spread on fixed annuity assets under management as of September 30, 2018 was 182 basis points, which benefited from an elevated level of prepayments.
As of
September 30, 2018
, fixed annuity account values totaled
$4.7 billion
, including $4.5 billion of deferred annuities. As shown in the table below, for approximately 86.9%, or
$3.9 billion
of the deferred annuity account values, the credited interest rate was equal to the minimum guaranteed rate. Due to limitations on the Company’s ability to further lower interest crediting rates, coupled with the expectation for continued low reinvestment interest rates, management anticipates fixed annuity spread compression in future periods. The majority of assets backing the net interest spread on fixed annuity business are invested in fixed maturity securities.
The Company actively manages its interest rate risk exposure, considering a variety of factors, including earned interest rates, credited interest rates and the relationship between the expected durations of assets and liabilities. Management estimates that over the next 12 months approximately $476.6 million of the Retirement and Life combined investment portfolio and related investable cash flows will be reinvested at current market rates. As interest rates remain at low levels, borrowers may prepay or redeem the securities with greater frequency in order to borrow at lower market rates, which could increase investable cash flows and exacerbate the reinvestment risk
.
As a general guideline, for a 100 basis point decline in the average reinvestment rate and based on the Company’s existing policies and investment portfolio, the impact from investing in that lower interest rate environment could further reduce Retirement net investment income by approximately $1.9 million in year one and $5.6 million in year two, further reducing the annualized net interest spread by approximately 4 basis points and 11 basis points in the respective periods, compared to the current period annualized net interest spread. The Company could also consider potential changes in rates credited to policyholders, tempered by any restrictions on the ability to adjust policyholder rates due to minimum guaranteed crediting rates.
The expectation for future annualized net interest spreads is also an important component in the amortization of DAC. In terms of the sensitivity of this amortization to the annualized net interest spread, based on DAC as of
September 30, 2018
and assuming all other assumptions are met, a 10 basis point deviation in the current year targeted interest rate spread assumption would impact amortization between $0.3 million and $0.4 million. This result may change depending on the magnitude and direction of any actual deviations but represents a range of reasonably likely experience for the noted assumption.
Additional information regarding the interest crediting rates and balances equal to the minimum guaranteed rate for deferred annuity account values is shown below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
|
September 30, 2018
|
|
|
|
|
|
|
Deferred Annuities at
|
|
|
Total Deferred Annuities
|
|
Minimum Guaranteed Rate
|
|
|
Percent
of Total
|
|
Accumulated
Value (AV)
|
|
Percent of
Total Deferred
Annuities AV
|
|
Percent
of Total
|
|
Accumulated
Value
|
Minimum guaranteed interest rates:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 2%
|
|
25.9
|
%
|
|
$
|
1,161.1
|
|
|
53.8
|
%
|
|
16.0
|
%
|
|
$
|
624.6
|
|
Equal to 2% but less than 3%
|
|
6.8
|
|
|
304.4
|
|
|
82.9
|
%
|
|
6.5
|
|
|
252.2
|
|
Equal to 3% but less than 4%
|
|
13.7
|
|
|
614.2
|
|
|
99.9
|
%
|
|
15.7
|
|
|
613.8
|
|
Equal to 4% but less than 5%
|
|
52.4
|
|
|
2,352.8
|
|
|
100.0
|
%
|
|
60.4
|
|
|
2,352.8
|
|
5% or higher
|
|
1.2
|
|
|
53.4
|
|
|
100.0
|
%
|
|
1.4
|
|
|
53.4
|
|
Total
|
|
100.0
|
%
|
|
$
|
4,485.9
|
|
|
86.9
|
%
|
|
100.0
|
%
|
|
$
|
3,896.8
|
|
The Company will continue to be disciplined in executing strategies to mitigate the negative impact on profitability of a sustained low interest rate environment. However, the success of these strategies may be affected by the factors discussed in Item 1A. Risk Factors in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
, and other factors discussed herein.
DAC Amortization Expense
DAC amortization expense was
$26.2 million
for the three month period ended
September 30, 2018
compared to
$24.2 million
for the prior year period, reflecting a $1.4 million pretax increase in Retirement. For Retirement and Life, unlocking resulted in an immaterial change to amortization at
September 30, 2018
.
DAC amortization expense was
$79.4 million
for the
nine
month period ended
September 30, 2018
compared to
$73.9 million
for the prior year period, reflecting a $3.4 million pretax increase in Retirement. For Retirement and Life, unlocking resulted in an immaterial change to amortization at
September 30, 2018
.
Operating Expenses
For the three month period ended
September 30, 2018
, operating expenses of
$51.0 million
increased
$6.8 million
, or
15.4%
, as the Company makes continued investments in targeted strategies to enhance product, distribution, and infrastructure.
For the
nine
month period ended
September 30, 2018
, operating expenses of
$149.4 million
increased
$10.3 million
, or
7.4%
.
The Property and Casualty expense ratio of
26.7%
for
nine
month period ended
September 30, 2018
was comparable to the prior year period.
Income Tax Expense
The effective income tax rate on the Company’s pretax income, including net investment gains (losses), was 19.1% and 17.6% for the
nine
month periods ended
September 30, 2018
and
2017
, respectively. Income from investments in tax-advantaged securities reduced the effective income tax rates by 2.8% and 12.5% for the
nine
month periods ended
September 30, 2018
and
2017
, respectively. The adoption of a new accounting standard for employee share-based payments on January 1, 2017 reduced the effective income tax rate by 5.3% for the
nine
month period ended
September 30, 2017
.
On December 22, 2017, comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the Tax Act) was enacted by the U.S. government. The Tax Act is generally effective January 1, 2018, and among other changes, reduced the federal corporate income tax rate from 35% to 21%, eliminated the corporate Alternative Minimum Tax, modified numerous insurance-specific provisions, and further limited deductions for executive compensation. The Tax Act reduced the Company’s effective tax rate by 8.8% for the nine month period ended
September 30, 2018
. There have been no changes to the provisional items that were reflected in the Company’s December 31, 2017 Consolidated Financial Statements associated with the tax effects of the Tax Act related to partnership investments and discounted loss reserves. No material adjustments related to the provisional items for partnership investments are required and the Company is waiting on guidance from the U.S. Treasury regarding the tax impact on discounted loss reserves. Accounting for the tax effects associated with the Tax Act will be completed in the fourth quarter 2018.
The Company records liabilities for uncertain tax filing positions where it is more likely than not that the position will not be sustainable upon audit by taxing authorities. These liabilities are reevaluated routinely and are adjusted appropriately based on changes in facts or law. The Company has no unrecorded liabilities from uncertain tax filing positions.
At
September 30, 2018
, the Company’s federal income tax returns for years prior to 2014 are no longer subject to examination by the IRS. Management does not anticipate any assessments for tax years that remain subject to examination to have a material effect on the Company’s financial position or results of operations.
Net Income
For the three month period ended
September 30, 2018
, the Company's net income of
$12.5 million
decreased
$14.0 million
. For the
nine
month period ended
September 30, 2018
, the Company's net income of
$38.6 million
decreased
$5.5 million
. Additional detail is included in the Executive Summary at the beginning of this MD&A.
Net income (loss) by segment and net income per share were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
|
Three Months Ended
September 30,
|
|
Change From
Prior Year
|
|
Nine Months Ended
September 30,
|
|
Change From
Prior Year
|
|
|
2018
|
|
2017
|
|
Percent
|
|
Amount
|
|
2018
|
|
2017
|
|
Percent
|
|
Amount
|
Analysis of net income (loss)
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty
|
|
$
|
(3.2
|
)
|
|
$
|
13.4
|
|
|
-123.9
|
%
|
|
$
|
(16.6
|
)
|
|
$
|
(4.4
|
)
|
|
$
|
2.2
|
|
|
N.M.
|
|
|
$
|
(6.6
|
)
|
Retirement
|
|
12.1
|
|
|
13.6
|
|
|
-11.0
|
%
|
|
(1.5
|
)
|
|
37.6
|
|
|
36.9
|
|
|
1.9
|
%
|
|
0.7
|
|
Life
|
|
5.3
|
|
|
4.8
|
|
|
10.4
|
%
|
|
0.5
|
|
|
15.0
|
|
|
14.3
|
|
|
4.9
|
%
|
|
0.7
|
|
Corporate and Other
(1)
|
|
(1.7
|
)
|
|
(5.3
|
)
|
|
-67.9
|
%
|
|
3.6
|
|
|
(9.6
|
)
|
|
(9.3
|
)
|
|
-3.2
|
%
|
|
(0.3
|
)
|
Net income
|
|
$
|
12.5
|
|
|
$
|
26.5
|
|
|
-52.8
|
%
|
|
$
|
(14.0
|
)
|
|
$
|
38.6
|
|
|
$
|
44.1
|
|
|
-12.5
|
%
|
|
$
|
(5.5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of catastrophe losses, after tax,
included above
|
|
$
|
(25.4
|
)
|
|
$
|
(5.6
|
)
|
|
N.M.
|
|
|
$
|
(19.8
|
)
|
|
$
|
(54.3
|
)
|
|
$
|
(37.8
|
)
|
|
43.7
|
%
|
|
$
|
(16.5
|
)
|
Effect of net investment gains
(losses), after tax, included above
|
|
$
|
2.2
|
|
|
$
|
(2.2
|
)
|
|
N.M.
|
|
|
$
|
4.4
|
|
|
$
|
1.5
|
|
|
$
|
(0.8
|
)
|
|
N.M.
|
|
|
$
|
2.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
|
|
$
|
0.30
|
|
|
$
|
0.64
|
|
|
-53.1
|
%
|
|
$
|
(0.34
|
)
|
|
$
|
0.93
|
|
|
$
|
1.06
|
|
|
-12.3
|
%
|
|
$
|
(0.13
|
)
|
Weighted average number of
common and common equivalent shares (in millions)
|
|
41.9
|
|
|
41.6
|
|
|
0.7
|
%
|
|
0.3
|
|
|
41.7
|
|
|
41.5
|
|
|
0.5
|
%
|
|
0.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty
combined ratio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
110.1
|
%
|
|
95.8
|
%
|
|
|
|
14.3 pts
|
|
|
108.0
|
%
|
|
106.5
|
%
|
|
|
|
1.5 pts
|
|
Effect of catastrophe losses,
included above
|
|
19.1
|
%
|
|
5.3
|
%
|
|
|
|
13.8 pts
|
|
|
13.7
|
%
|
|
12.0
|
%
|
|
|
|
1.7 pts
|
|
Effect of prior years’ reserve
development,included above
|
|
—
|
%
|
|
-0.3
|
%
|
|
|
|
+0.3 pts
|
|
|
-0.1
|
%
|
|
-0.4
|
%
|
|
|
|
+0.3 pts
|
|
________________
N.M. - Not meaningful.
|
|
(1)
|
Corporate and Other includes interest expense on corporate debt, net investment gains (losses), corporate debt retirement costs, certain public company expenses and other corporate-level items. The Company does not allocate the impact of corporate-level transactions to the operating segments, consistent with the basis for management’s evaluation of the results of those segments.
|
As described in footnote (1) to the table above, Corporate and Other reflects corporate-level transactions. Of those transactions, net investment gains (losses) may vary notably between reporting periods and are often the driver of fluctuations in the level of this segment’s net income or loss. For the
nine
month period ended
September 30, 2018
, net investment gains after tax were
$1.5 million
, compared to net investment losses after tax of
$0.8 million
for the prior year period.
Outlook for
2018
At the time of this Quarterly Report on Form 10-Q, management expects full-year 2018 core earnings* will be in the range of $1.45 to $1.60 per diluted share, which is an update from the previous guidance of $1.90 to $2.10 per diluted share. This projection was revised to account for the significant level of catastrophe and other weather-related losses the Company experienced in the second and third quarters.
Within Property and Casualty, both approved and planned premium rate increases will contribute to a 4 to 5 percent growth in net written premiums. The underlying automobile loss ratio is anticipated to improve by 1.5 to 2.0 points. The underlying property loss ratio is expected to be slightly elevated compared to 2017 due to the higher weather losses. In addition, the contribution of catastrophe losses to the Property and Casualty combined ratio now is expected to be around 11 points.
Net income for Retirement is anticipated to be between $49 to $50 million, reflecting a reduced level of prepayments in the fourth quarter along with the continued impact on the portfolio yield from the low interest rate environment of recent years.
Life net income is expected to be between $18 and $19 million.
Management’s expectations for full-year 2018 core earnings anticipate the Company’s continued initiatives to enhance the customer experience as well as improve infrastructure. This will result in a modest increase in expense levels for all segments compared to 2017 and is in line with the original guidance. In the Property and Casualty segment, the full-year expense ratio is expected to increase to 27 percent.
Management’s full-year expectations also encompass the impacts of the Tax Cuts and Jobs Act of 2017, which is expected to result in an overall effective tax rate of between 16% and 18%.
As described in Critical Accounting Policies, certain of the Company's significant accounting measurements require the use of estimates and assumptions. As additional information becomes available, adjustments may be required. Those adjustments are charged or credited to income for the period in which the adjustments are made and may impact actual results compared to management's estimates above. Additionally, see Forward-looking Information in this Quarterly Report on Form 10-Q and Item 1A. Risk Factors in the Company's Annual Report on Form 10-K for the year ended December 31, 2017 concerning other important factors that could impact actual results. Management believes that a projection of net income is not appropriate on a forward-looking basis because it is not possible to provide a valid forecast of net investment gains (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, 2018
and
2017
, 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 engaged in such relationships.
Investments
Information regarding the Company’s investment portfolio, which is comprised primarily of investment grade, fixed maturity securities, is located in Results of Operations -- Net Investment Gains (Losses) - Pretax and in the Notes to Consolidated Financial Statements -- Note 2 -- Investments.
Cash Flow
Operating Activities
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 Company’s operating cash needs in the next 12 months. Cash flow in excess of operational needs has been used to fund business growth, pay dividends to shareholders and repurchase shares of HMEC's common stock. Long-term liquidity requirements, beyond one year, are principally for the payment of future insurance and annuity policy claims and benefits, as well as retirement of long-term debt.
As a holding company, HMEC conducts its principal operations in the personal lines segment of the Property and Casualty and Life insurance industries through its subsidiaries. HMEC’s insurance subsidiaries generate cash flow from premiums, contract deposits 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
nine
month period ended
September 30, 2018
, net cash provided by operating activities decreased $19.7 million, or 8.3%, compared to the prior year period.
Payments of principal and interest on debt, dividends to shareholders and parent company operating expenses is largely dependent on 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 share repurchase programs also have this dependency. If necessary, HMEC also has other potential sources of liquidity that could provide for additional funding to meet corporate obligations or pay shareholder dividends, which include a revolving line of credit, as well as issuances of various securities. The insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. The aggregate amount of dividends that may be paid in
2018
from all of HMEC’s insurance subsidiaries without prior regulatory approval is approximately $94.0 million, of which $42.0 million was paid during the
nine
month period ended
September 30, 2018
. Although regulatory restrictions exist, dividend availability from subsidiaries has been, and is expected to be, adequate for HMEC’s capital needs. Additional information is contained in Notes to Consolidated Financial Statements -- Note 10 -- Statutory Information and Restrictions of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
.
Investing Activities
HMEC’s insurance subsidiaries maintain significant investments in fixed maturity securities to meet future contractual obligations to policyholders. In conjunction with its management of liquidity and other asset/liability management objectives, the Company, from time to time, will sell fixed maturity securities prior to maturity, and reinvest the proceeds in other investments with different interest rates, maturities or credit characteristics. Accordingly, the Company has classified the entire fixed maturity securities portfolio as available for sale.
Financing Activities
Financing activities include primarily payment of dividends, the receipt and withdrawal of funds by annuity contractholders, issuances and repurchases of HMEC’s common stock, fluctuations in bank overdraft balances, and borrowings, repayments and repurchases related to its debt facilities.
The Company’s annuity business produced net negative cash flows in the first
nine
months of
2018
. For the
nine
month period ended
September 30, 2018
, receipts from annuity contracts decreased $22.9 million, or 6.6%, compared to the prior year period, as described in Results of Operations -- Insurance Premiums and Contract Charges. In total, annuity contract benefits, withdrawals and net transfers to variable annuity accumulated cash values increased $38.4 million, or 13.0%, compared to the prior year period.
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 (the NAIC). Historically, the Company’s insurance subsidiaries have generated capital in excess of such needed capital. These excess amounts have been paid to HMEC through dividends. HMEC has then utilized these dividends and its access to the capital markets to service and retire long-term debt, pay dividends to its shareholders, fund growth initiatives, repurchase shares of its common stock and for other corporate purposes. Management anticipates that the Company’s sources of capital will continue to generate sufficient capital to meet the needs for business growth, debt interest payments, shareholder dividends and its share repurchase program. Additional information is contained in Notes to Consolidated Financial Statements -- Note 10 -- Statutory Information and Restrictions of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
.
The total capital of the Company was
$1,602.0 million
at
September 30, 2018
, including
$297.7 million
of long-term debt. Total long-term debt represented 19.5% of total capital excluding net unrealized investment gains on securities (
18.6%
including net unrealized investment gains on securities) at
September 30, 2018
, which was below the Company’s long-term target of 25%.
Shareholders’ equity was
$1,304.3 million
at
September 30, 2018
, including net unrealized investment gains on securities in the Company’s investment portfolio of $76.0 million after taxes and the related impact of DAC associated with investment contracts and life insurance products with account values. The market value of the Company’s common stock and the market value per share were $1,842.7 million and $44.90, respectively, at
September 30, 2018
. Book value per share was
$31.78
at
September 30, 2018
(
$29.93
excluding net unrealized investment gains on securities).
Additional information regarding net unrealized investment gains on securities in the Company’s investment portfolio at
September 30, 2018
is included in Note 2 - Investments - Net Unrealized Investment Gains (Losses) on Securities contained in this Quarterly Report on Form 10-Q.
Total dividends paid to shareholders was $35.0 million for the
nine
month period ended
September 30, 2018
. In March, May and September
2018
, the Board of Directors announced regular quarterly dividends of
$0.285
per share.
For the
nine
month period ended
September 30, 2018
, the Company repurchased 2,161 shares of its common stock at an average price per share of $39.53 under its share repurchase program, which is further described in Notes to Consolidated Financial Statements -- Note 9 -- Shareholders’ Equity and Common Stock Equivalents of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
. As of
September 30, 2018
, $27.8 million remained authorized for future share repurchases under the repurchase program.
As of
September 30, 2018
, the Company had outstanding
$250.0 million
aggregate principal amount of 4.50% Senior Notes (Senior Notes due 2025), which will mature on December 1, 2025, issued at a discount resulting in an effective yield of 4.53%. Interest on the Senior Notes due 2025 is payable semi-annually at a rate of 4.50%. Detailed information regarding the redemption terms of the Senior Notes due 2025 is contained in the Notes to Consolidated Financial Statements -- Note 7 -- Debt of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
. The Senior Notes due 2025 are traded in the open market (HMN 4.50).
As of
September 30, 2018
, the Company had $50.0 million outstanding with Federal Home Loan Bank (FHLB). In 2017, HMIC purchased common stock to meet the activity-based requirement for membership. For FHLB borrowings, the Board has authorized a maximum amount equal to the greater of 10% of admitted assets or 20% of surplus of the consolidated property and casualty companies. For the total $50.0 million received, $25.0 million matures on October 5, 2022 and $25.0 million matures on December 2, 2022. Interest on the borrowings accrues at an annual weighted average rate of 2.4% as of
September 30, 2018
. HMIC's FHLB borrowings of $50.0 million are included in Long-term debt on the Consolidated Balance Sheet.
Effective June 27, 2018, the Bank Credit Facility was amended and restated to extend the commitment termination date to June 27, 2023 from the previous termination date of July 30, 2019. As of
September 30, 2018
, the Company had no balance outstanding under its Bank Credit Facility. The Bank Credit Facility provides for unsecured borrowings of up to $150.0 million and expires on June 27, 2023. Interest accrues at varying spreads relative to prime 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 0.15% on an annual basis at
September 30, 2018
.
To provide additional capital management flexibility, the Company filed a "universal shelf" registration statement on Form S-3 with the Securities and Exchange Commission (SEC) on March 13, 2018. The registration statement, which registered the offer and sale by the Company from time to time of an indeterminate amount of various securities, which may include debt securities, common stock, preferred stock, depositary shares, warrants, delayed delivery contracts and/or units that include any of these securities, was automatically effective on March 13, 2018. Unless withdrawn by the Company earlier, this registration statement will remain effective through March 13, 2021. No securities associated with the registration statement have been issued as of the date of this Quarterly Report on Form 10-Q.
On March 13, 2018, the Company filed a "shelf" registration statement on Form S-4 with the SEC which became effective on May 2, 2018. Under this registration statement, the Company may from time to time offer and issue up to 5,000,000 shares of its common stock in connection with future acquisitions of other businesses, assets or securities. Unless withdrawn by the Company, this registration statement will remain effective indefinitely. No securities associated with the registration statement have been issued as of the date of this Quarterly Report on Form 10-Q.
Financial Ratings
HMEC’s principal insurance subsidiaries are rated by S&P, Moody’s, A.M. Best Company, Inc. (A.M. Best) and Fitch. These rating agencies have also assigned ratings to the Company’s long-term debt securities. The ratings that are assigned by these agencies, which are subject to change, can impact, among other things, the Company’s access to sources of capital, cost of capital, and competitive position. These ratings are not a recommendation to buy or hold any of the Company’s securities.
Assigned ratings as of
October 31, 2018
were unchanged from the disclosure in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
with the exception of Moody's. In October 2018, Moody's upgraded Horace Mann's rating on the Senior Notes from Baa3 with a positive outlook to Baa2 with a stable outlook. They also upgraded the Property and Casualty and Life ratings from A3 with a positive outlook to A2 with a stable outlook. Assigned ratings were as follows (the insurance financial strength ratings for the Company’s Property and Casualty insurance subsidiaries and the Company’s principal Life insurance subsidiary are the same):
|
|
|
|
|
|
|
|
|
|
|
|
Insurance Financial
|
|
|
|
|
Strength Ratings (Outlook)
|
|
Debt Ratings (Outlook)
|
As of October 31, 2018
|
|
|
|
|
S&P
|
|
A
|
|
(stable)
|
|
BBB
|
|
(stable)
|
Moody’s
|
|
A2
|
|
(stable)
|
|
Baa2
|
|
(stable)
|
A.M. Best
|
|
A
|
|
(stable)
|
|
bbb
|
|
(stable)
|
Fitch
|
|
A
|
|
(stable)
|
|
BBB
|
|
(stable)
|
Reinsurance Programs
Information regarding the reinsurance program for the Company’s Property and Casualty segment is located in Business -- Property and Casualty Segment -- Property and Casualty Reinsurance of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
.
Information regarding the reinsurance program for the Company’s Life segment is located in Business -- Life Segment of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
.
Market Value Risk
Market value risk, the Company’s primary market risk exposure, is the risk that the Company’s invested assets will decrease in value. This decrease in value may be due to (1) a change in the yields realized on the Company’s assets and prevailing market yields for similar assets, (2) an unfavorable change in the liquidity of the investment, (3) an unfavorable change in the financial prospects of the issuer of the investment, or (4) a downgrade in the credit rating of the issuer of the investment. See also Results of Operations -- Net Investment Gains (Losses) - Pretax.
Significant changes in interest rates expose the Company to the risk of experiencing losses or earning a reduced level of income based on the difference between the interest rates earned on the Company’s investments and the credited interest rates on the Company’s insurance and investment contract liabilities. See also Results of Operations -- Interest Credited to Policyholders.
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 Company’s exposure to market value risks and the management of those risks is presented in Management’s Discussion and Analysis of Financial Condition and Results of Operations -- Market Value Risk of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
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