NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2021, 2020 and 2019
($ in millions, except per share data, unless otherwise stated)
NOTE 1 - Basis of Presentation and Significant Accounting Policies
Business
Horace Mann Educators Corporation is a holding company for insurance subsidiaries that market and underwrite personal lines of property and casualty insurance products (primarily personal lines auto and property insurance), supplemental insurance products (primarily cancer, heart, hospital, supplemental disability and accident coverages), retirement products (primarily tax-qualified fixed and variable annuities) and life insurance products, primarily to K-12 teachers, administrators and other employees of public schools and their families (collectively, HMEC, the Company or Horace Mann).
Basis of Presentation
The accompanying audited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and with the rules and regulations of the Securities and Exchange Commission (SEC).
The Company has reclassified the presentation of certain prior period information to conform to the current year's presentation.
Consolidation
All intercompany transactions and balances between HMEC and its subsidiaries and affiliates have been eliminated.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
The most significant critical accounting estimates include valuation of hard-to-value fixed maturity securities, evaluation of credit loss impairments for fixed maturity securities, evaluation of goodwill and intangible assets for impairment, valuation of annuity and life deferred policy acquisition costs, valuation of liabilities for property and casualty unpaid claims and claim expenses and valuation of certain investment contracts and policy reserves.
Investments
Fixed Maturity Securities
The Company invests predominantly in fixed maturity securities. Fixed maturity securities include bonds, asset-backed securities (ABS), mortgage-backed securities (MBS), other structured securities and redeemable preferred stocks. MBS includes residential and commercial mortgage-backed securities. Fixed maturity securities, which may be sold prior to their contractual maturity, are designated as available for sale (AFS) and are carried at fair value of which a portion represent securities that are hard-to-value. See Note 4 – Fair Value of Financial Instruments – Investments for a detailed description of how the Company estimates fair value for its fixed maturity securities portfolio including hard-to-value securities. An adjustment for net unrealized investment gains (losses) on all fixed maturity securities available for sale and carried at fair value, is recognized as a separate component of accumulated other comprehensive income (AOCI) within shareholders’ equity, net of applicable deferred taxes and the related impact on deferred policy acquisition costs (DAC) associated with annuity contracts and life insurance products with account values that would have occurred if the securities had been sold at their aggregate fair value and the proceeds reinvested at current yields. The Company excludes accrued interest receivable from the amortized cost basis of its AFS fixed maturity securities.
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Horace Mann Educators Corporation | | Annual Report on Form 10-K 75 |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
Equity Securities
Equity securities primarily include common stocks, exchange traded and mutual funds and non-redeemable preferred stocks. Certain exchange traded and mutual funds have fixed maturity securities as their underlying investments. Equity securities are carried at fair value and have readily determinable fair values.
Limited Partnership Interests
Investments in limited partnership interests are accounted for using the equity method of accounting (EMA) and include interests in commercial mortgage funds, private equity funds, infrastructure debt funds, infrastructure equity funds and other funds.
Short-Term and Other Investments
Short-term investments, including money market funds, commercial paper, U.S. Treasury bills and other short-term investments, are carried at fair value. Other investments primarily consist of policy loans, Federal Home Loan Bank of Chicago (FHLB) common stock, mortgage loans and derivatives. Policy loans are carried at unpaid principal balances. FHLB common stock is carried at cost. Mortgage loans are carried at amortized cost, net, which represent the amount expected to be collected. Derivatives are carried at fair value.
Variable Interest Entities (VIEs)
The Company invests in fixed maturity securities and alternative investment funds that could qualify as variable interests in VIEs, including corporate securities, mortgage-backed securities and asset-backed securities. Such variable interests in VIEs have been reviewed and the Company determined that those VIEs are not subject to consolidation as the Company is not the primary beneficiary because it does not have the power to direct the activities that most significantly impact those VIEs' economic performance.
Net Investment Income
Net investment income primarily consists of interest, dividends and income from limited partnership interests. Interest is recognized on an accrual basis using the effective yield method and dividends are recorded at the ex-dividend date. ABS and MBS interest income is determined considering estimated pay-downs, including prepayments, obtained from third-party data sources and internal estimates. Actual prepayment experience is periodically reviewed, and effective yields are recalculated when differences arise between the prepayments originally anticipated and the actual prepayments received and currently anticipated. For ABS and MBS of high credit quality with fixed interest rates, the effective yield is recalculated on a retrospective basis. For all others, the effective yield is generally recalculated on a prospective basis. Net investment income for AFS fixed maturity securities includes the impact of accreting the credit loss allowance for the time value of money. Accrual of income is suspended for fixed maturity securities when the timing and amount of cash flows expected to be received is not reasonably estimable. Accrual of income is suspended for commercial mortgage loans that are in default or when full and timely collection of principal and interest payments is not probable. Accrued investment income receivable is monitored for recoverability and when not expected to be collected is written off through net investment income. Cash receipts on investments on non-accrual status are generally recorded as a reduction of amortized cost or principal. Income from limited partnership interests is recognized based upon the changes in fair value of the investee’s equity primarily determined using its net asset value and is generally recognized on a three month delay due to the availability of the related financial statements from investees.
The Company reports accrued investment income separately from AFS fixed maturity securities and has elected not to measure an allowance for credit losses for accrued investment income. Accrued investment income is written-off and recognized as a net investment loss at the time the issuer of the security defaults or is expected to default on payments.
Net Investment Gains (Losses)
Net investment gains (losses) include gains and losses on investment sales, changes in the credit loss allowances related to fixed maturity securities and mortgage loans, impairments, valuation changes of equity securities and periodic changes in fair value and settlements of derivatives. Net investment gains (losses) on investment sales are determined on a specific identification basis and are net of credit losses already recognized through an allowance.
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76 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
Credit Loss Impairments for Fixed Maturity Securities
For AFS fixed maturity securities, the difference between amortized cost, net of a credit loss allowance (i.e., amortized cost, net) and fair value, net of certain other items and deferred income taxes is reported as a component of AOCI on the Consolidated Balance Sheets and is not reflected in the operating results of any period until reclassified to net income upon the consummation of a transaction with an unrelated third party or when a credit loss allowance is recorded. The Company has a comprehensive portfolio monitoring process to evaluate fixed maturity securities (at the cusip/issuer level) on a quarterly basis that may require a credit loss allowance. These reviews, in conjunction with our investment managers’ monthly credit reports and relevant factors such as (1) the financial condition and near-term prospects of the issuer; (2) the Company’s intent to sell a security or whether it is more likely than not that the Company will be required to sell a security before the anticipated recovery in value; (3) the market leadership of the issuer; (4) the debt ratings of the issuer; and (5) the cash flows and liquidity of the issuer or the underlying cash flows for asset-backed securities , are all considered in the impairment assessment.
For each fixed maturity security in an unrealized loss position, the Company assesses whether management with the appropriate authority has made the decision to sell or whether it is more likely than not that the Company will be required to sell the security before the anticipated recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes. If a security meets either of these criteria, any existing credit loss allowance would be written-off against the amortized cost basis of the asset along with any remaining unrealized losses, with the incremental losses recorded as a net investment loss.
If the Company has not made the decision to sell the fixed maturity security and it is not more likely than not that the Company will be required to sell the fixed maturity security before the anticipated recovery of its amortized cost basis, the Company evaluates whether it expects to receive cash flows sufficient to recover the entire amortized cost basis of the security. The Company estimates the anticipated recovery value based on the best estimate of future cash flows considering past events, current conditions and reasonable and supportable forecasts. The estimated future cash flows are discounted at the security’s current effective rate and are compared to the amortized cost basis of the security. The determination of cash flow estimates is inherently subjective, and methodologies may vary depending on facts and circumstances specific to the security. All reasonably available information relevant to the collectability of the security are considered when developing the estimate of cash flows expected to be collected. That information generally includes, but is not limited to, the remaining payment terms of the security, prepayment speeds, the financial condition and future earnings potential of the issue or issuer, expected defaults, expected recoveries, the value of underlying collateral, origination vintage year, geographic concentration of underlying collateral, available reserves or escrows, current subordination levels, third-party guarantees and other credit enhancements. Other information, such as industry analyst reports and forecasts, sector credit ratings, financial condition of the bond insurer for insured fixed maturity securities, and other market data relevant to the realizability of contractual cash flows, may also be considered. The estimated fair value of collateral will be used to estimate the anticipated recovery value if the Company determines that the security is dependent on the liquidation of collateral for ultimate settlement.
If the Company does not expect to receive cash flows sufficient to recover the entire amortized cost basis of the fixed maturity security, a credit loss allowance is recorded as a net investment loss for the shortfall in expected cash flows; however, the amortized cost basis, net of the credit loss allowance, may not be lower than the fair value of the security. The portion of the unrealized loss related to factors other than credit remains classified in AOCI. If the Company determines that the fixed maturity security does not have sufficient cash flows or other information to estimate a recovery value for the security, the Company may conclude that the entire decline in fair value is deemed to be credit related and the loss is recorded as a net investment loss.
When a security is sold or otherwise disposed or the security is deemed uncollectible and written off, the Company removes amounts previously recognized in the credit loss allowance. Recoveries after write-offs are recognized when received.
Prior to the adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments on January 1, 2020, when other-than-temporary impairment was deemed to have occurred, the investment in the fixed maturity security would be written-down to fair value which became the new cost basis for the security.
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Horace Mann Educators Corporation | | Annual Report on Form 10-K 77 |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
Deferred Policy Acquisition Costs
The Company's deferred policy acquisition costs (DAC) by reporting segment were as follows:
| | | | | | | | | | | | | | |
($ in millions) | | December 31, |
| | 2021 | | 2020 |
Property & Casualty | | $ | 24.4 | | | $ | 26.1 | |
Supplemental | | 4.2 | | | 4.3 | |
Retirement | | 153.8 | | | 137.7 | |
Life | | 65.6 | | | 61.7 | |
Total | | $ | 248.0 | | | $ | 229.8 | |
DAC consists of commissions, policy issuance and other costs which are incremental and directly related to the successful acquisition of new or renewal business, which are deferred and amortized on a basis consistent with the type of insurance coverage. For property and casualty risks, DAC is amortized over the terms of the insurance policies (6 or 12 months). For supplemental policies, DAC is amortized in proportion to anticipated premiums over the terms of the insurance policies (approximately 7 years, based on an estimated average duration across all supplemental products). For all annuity contracts, DAC is amortized over 20 years in proportion to estimated gross profits. DAC is amortized in proportion to estimated gross profits over 20 years for certain life insurance products with account values and over 30 years for indexed universal life (IUL) products. For other individual life contracts, DAC is amortized in proportion to anticipated premiums over the terms of the insurance policies (10, 15, 20, 30 years).
The Company periodically reviews the assumptions and estimates used in DAC and also periodically reviews its estimations of gross profits, a process sometimes referred to as "unlocking". 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 net investment gains (losses) on fixed maturity and equity securities. For the variable deposit portion of Retirement, the Company amortizes DAC utilizing a future financial market performance assumption of an 8% reversion to the mean approach with a 200 basis point corridor around the mean during the reversion period, representing a cap and a floor on the Company's long-term assumption. The Company's practice with regard to future financial market performance assumes that long-term appreciation in the financial markets is not changed by short-term market fluctuations, but is only changed when sustained deviations are experienced. The Company monitors these fluctuations and only changes the assumption when long-term expectations change.
The most significant assumptions that are involved in the estimation of life insurance gross profits include interest rates expected to be received on investments, business persistency, and mortality. Conversions from term to permanent insurance cause an immediate write down of the associated DAC.
The most significant assumptions that are involved in the estimation of supplemental gross profits include morbidity, persistency, expenses and interest rates expected to be received on investments. When a supplemental policy lapses, there is an immediate write down of the associated DAC.
Annually, the Company performs a gross premium valuation (GPV) on life insurance policies to assess whether a loss recognition event has occurred. This involves discounting expected future benefits and expenses less expected future premiums. To the extent that this amount is greater than the liability for future benefits less the DAC asset, in aggregate for the life insurance block, a loss would be recognized by first writing off the DAC asset and then increasing the liability.
In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company may be required to recognize a material charge or credit to current period DAC amortization expense for the period in which the adjustment is made. The Company recognized the following adjustments to DAC amortization expense as a result of evaluating actual experience and prospective assumptions (i.e., the impact of unlocking):
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78 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
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($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
(Decrease) increase to DAC amortization expense: | | | | | | |
Retirement | | $ | (1.3) | | | $ | (1.8) | | | $ | 3.5 | |
Life | | (0.2) | | | (0.3) | | | (0.3) | |
Total | | $ | (1.5) | | | $ | (2.1) | | | $ | 3.2 | |
DAC for annuity contracts and life insurance products with account values are adjusted for the impact on estimated future gross profits as if net unrealized investment gains (losses) on fixed maturity securities had been realized at the reporting date. This adjustment reduced DAC by $71.9 million, $90.5 million and $41.2 million at December 31, 2021, 2020 and 2019, respectively. The after tax impact of this adjustment is included in AOCI (along with net unrealized investment gains (losses) on fixed maturity securities) within shareholders' equity.
DAC is reviewed for recoverability from future income, including net investment income, and costs that are deemed unrecoverable are expensed in the period in which the determination is made. No such costs were deemed unrecoverable during the years ended December 31, 2021, 2020 and 2019.
Intangible Assets
The value of business acquired (VOBA) represents the difference between the fair value of insurance contracts and insurance policy reserves measured in accordance with the Company's accounting policy for insurance contracts acquired. VOBA was based on an actuarial estimate of the present value of future distributable earnings for insurance in force on the acquisition date. VOBA was $76.9 million as of December 31, 2021 and is being amortized by product based on the present value of future premiums to be received. The Company estimates that it will recognize VOBA amortization of $6.2 million in 2022, $5.8 million in 2023, $5.4 million in 2024, $5.1 million in 2025 and $4.7 million in 2026.
The Company accounts for the value of distribution acquired (VODA) associated with the acquisition of NTA Life Enterprises, LLC (NTA) based on an actuarial estimate of the present value of future business to be written by the existing distribution channel. VODA was $41.8 million as of December 31, 2021 and is being amortized on a straight-line basis. The Company estimates that it will recognize VODA amortization of $2.9 million in each of the years 2022 through 2026, respectively.
The Company accounts for VODA associated with the acquisition of Benefit Consultants Group, Inc. (BCG) based on management's estimate of the present value of future business to be written by the existing distribution channel. VODA was $0.6 million as of December 31, 2021 and is being amortized based on the present value of future profits to be received. The Company estimates that it will recognize cumulative VODA amortization of $0.3 million for the years 2022 through 2026.
The Company accounts for the value of agency relationships based on the present value of commission overrides retained by NTA. Agency relationships was $10.7 million as of December 31, 2021 and is being amortized based on the present value of future premiums to be received. The Company estimates that it will recognize agency relationships amortization of $1.9 million in 2022, $1.6 million in 2023, $1.4 million in 2024, $1.2 million in 2025 and $1.0 million in 2026.
The Company accounts for the value of customer relationships based on the present value of expected profits from existing BCG customers in force at the date of acquisition. Customer relationships was $4.6 million as of December 31, 2021 and is being amortized based on the present value of future profits to be received. The Company estimates that it will recognize customer relationships amortization of $1.1 million in 2022, $0.9 million in 2023, $0.7 million in 2024, $0.6 million in 2025 and $0.5 million in 2026.
Trade names represents the present value of future savings accruing to NTA and BCG by virtue of not having to pay royalties for the use of the trade names, valued using the relief from royalty method. State licenses represents the regulatory licenses held by NTA that were valued using the cost approach. Both trade names and state licenses are indefinite-lived intangible assets that are not subject to amortization.
Annually, the Company performs a VOBA analysis on supplemental insurance policies to assess whether a loss recognition event has occurred. This initially involves comparing the historical and expected future experience on the block to the assumptions embedded in the original VOBA intangible asset. If both the experience to date and
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Horace Mann Educators Corporation | | Annual Report on Form 10-K 79 |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
current expected experience are consistently better than the initial VOBA assumptions, the remaining value in the block is sufficient to support the VOBA intangible asset and no loss recognition is necessary. If the historical and current expected assumptions are not uniformly better than the initial VOBA assumptions, a GPV is performed to assess whether a loss recognition event has occurred. This involves discounting expected future benefits and expenses less expected future premiums. To the extent that this amount is greater than the liability for future benefits less the VOBA intangible asset, in aggregate for the supplemental insurance block, a loss would be recognized by first writing off the VOBA and then increasing the liability. Currently, a GPV is not required for the acquired supplemental block. No such costs were deemed unrecoverable during the year ended December 31, 2021.
Amortizing intangible assets (i.e., VODA, agency relationships and customer relationships) are tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The carrying amount of an amortizing intangible asset is not recoverable if it exceeds the sum of undiscounted cash flows expected to result from the use and eventual disposition of the asset. If the carrying amount is not recoverable from undiscounted cash flows, the impairment is measured as the difference between the carrying amount and fair value.
Intangible assets that are not subject to amortization (i.e., trade names and state licenses) are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of an intangible asset that is not subject to amortization exceeds its fair value, an impairment loss is recognized in an amount equal to the excess.
At October 1, 2021, the Company performed both qualitative assessments and quantitative impairment tests for intangible assets and concluded that no impairments were warranted.
At October 1, 2020, the Company performed qualitative assessments to determine whether it was necessary to perform quantitative intangible asset impairment tests. Based on the assessments of qualitative factors, there were no events or circumstances that led to a determination that it is more likely than not that the fair value of an intangible asset was less than its carrying amount with exception to VODA and trade names intangible assets assigned to BCG, for which quantitative intangible asset impairment tests were performed that resulted in intangible asset impairment charges of $4.4 million in aggregate.
Goodwill
When the Company was acquired from CIGNA Corporation by HME Holdings, Inc. in 1989, intangible assets were recognized as goodwill in the application of purchase accounting. In addition, goodwill was recognized in 1994 related to the acquisition of Horace Mann Property & Casualty Insurance Company and in 2019 related to the acquisitions of BCG and NTA.
Goodwill represents the excess of the amounts paid to acquire a business over the fair value of its net assets at the date of acquisition. Goodwill is not amortized, but is tested for impairment at the reporting unit level at least annually or more frequently if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. A reporting unit is defined as an operating segment or a business unit one level below an operating segment, if separate financial information is prepared and regularly reviewed by management at that level. The Company's reporting units, for which goodwill has been allocated, are equivalent to the Company's operating segments. Refer to Note 7 for the allocation of goodwill by reporting unit as of December 31, 2021.
The goodwill impairment test, as defined in GAAP, allows an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity performs a quantitative goodwill impairment test by comparing the fair value of a reporting unit to its carrying amount for purposes of confirming and measuring an impairment. In 2019, the Company adopted guidance to eliminate Step 2 of the goodwill impairment test. Goodwill impairment is now the amount by which a reporting unit’s carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill. Any amount of goodwill determined to be impaired is recognized as an expense in the period in which the impairment determination is made.
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80 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
At October 1, 2021, the Company performed a quantitative goodwill impairment test. Based on the results of the test, there were no events or circumstances that led to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.
At October 1, 2020, the Company performed a quantitative goodwill impairment test. Based on the results of the test, there were no events or circumstances that led to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount with exception to lower than anticipated BCG wealth management sales outside of the education markets which triggered an impairment of the goodwill associated with the BCG business of the Retirement reporting unit. For the evaluation, the fair value of BCG was measured using a discounted cash flow method. The carrying amount exceeded the fair value, resulting in a $5.6 million goodwill impairment charge.
During each year from 2019 through 2021, the Company completed the required annual goodwill impairment testing. With exception to the goodwill impairment charges described in Note 7, no other goodwill impairment charges were necessary as a result of such assessments. The assessment of goodwill recoverability requires significant judgment and is subject to inherent uncertainty. The use of different assumptions, within a reasonable range, could cause the fair value of a reporting unit to fall below its carrying amount. Subsequent goodwill assessments could result in impairment, particularly for any reporting unit with at-risk goodwill, due to the impact of a volatile financial market on earnings, discount rate assumptions, liquidity and market capitalization.
Property and Equipment
Property and equipment is carried at cost less accumulated depreciation, which is calculated using the straight-line method and based on the estimated useful lives of the assets. The estimated life for real estate is identified by specific property and range from 20 to 45 years. The estimated useful lives of leasehold improvements and other property and equipment, including capitalized software, generally range from 3 to 10 years. The following amounts are included in Other assets in the Consolidated Balance Sheets:
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($ in millions) | | December 31, |
| | 2021 | | 2020 |
Property and equipment | | $ | 136.4 | | | $ | 131.3 | |
Less: accumulated depreciation | | 70.4 | | | 66.6 | |
Total | | $ | 66.0 | | | $ | 64.7 | |
Separate Account (Variable Annuity) Assets and Liabilities
Separate Account assets represent variable annuity contractholder funds invested in various mutual funds. The Separate Account assets comprise actively traded mutual funds that have daily quoted net asset values that are readily determinable for identical assets that the Company can access. Net asset values for the actively traded mutual funds in which the Separate Account assets are invested are obtained daily from the fund managers. Separate Account liabilities are equal to the estimated fair value of Separate Account assets. The investment income, gains and losses of these accounts accrue directly to the contractholders and are not included in the results of operations of the Company. The activity of the Separate Accounts is not reflected in the Consolidated Statements of Operations except for (1) contract charges earned, (2) the activity related to contract guarantees, which are benefits on existing variable annuity contracts, and (3) the impact of financial market performance on the amortization of DAC. The Company's contract charges earned include fees charged to the Separate Accounts, including mortality charges, risk charges, policy administration fees, investment management fees and surrender charges.
Investment Contract and Policy Reserves
This table summarizes the Company's investment contract and policy reserves.
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($ in millions) | | December 31, |
| | 2021 | | 2020 |
Investment contract reserves | | $ | 4,941.3 | | | $ | 4,847.6 | |
Policy reserves | | 1,636.5 | | | 1,597.7 | |
Total | | $ | 6,577.8 | | | $ | 6,445.3 | |
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Horace Mann Educators Corporation | | Annual Report on Form 10-K 81 |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
Liabilities for future benefits on supplemental, 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 supplemental and life insurance policies are computed using the net level premium method including assumptions as to investment yields, mortality, morbidity, persistency, expenses and other assumptions based on the Company's experience, including a provision for adverse deviation. These assumptions are established at the time the policy is issued and are intended to estimate the experience for the period the policy benefits are payable. If experience is less favorable than the assumptions, additional liabilities may be established, resulting in recognition of a loss for that period.
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. The liability also includes provisions for the unearned portion of certain policy charges.
A guaranteed minimum death benefit (GMDB) generally provides an additional benefit if the contractholder dies and the variable annuity contract value is less than a contractually defined amount. The Company has estimated and recorded a GMDB reserve on variable annuity contracts in accordance with GAAP. Contractually defined amounts vary from contract to contract based on the date the contract was entered into as well as the GMDB feature elected by the contractholder. The Company regularly monitors the GMDB reserve considering fluctuations in financial markets. The Company has relatively low exposure to GMDB risk as shown below.
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($ in millions) | | December 31, |
| | 2021 | | 2020 |
GMDB reserve | | $ | 0.1 | | | $ | 0.1 | |
Aggregate in-the-money death benefits under the GMDB provision | | 22.3 | | | 26.7 | |
Variable annuity contract value distribution based on GMDB feature: | | | | |
No guarantee | | 24 | % | | 26 | % |
Return of premium guarantee | | 71 | % | | 69 | % |
Guarantee of premium roll-up at an annual rate of 3% or 5% | | 5 | % | | 5 | % |
Total | | 100 | % | | 100 | % |
Reserves for Fixed Indexed Annuities and Indexed Universal Life Products
The Company offers fixed indexed annuity (FIA) products with interest crediting strategies linked to the Standard & Poor's (S&P) 500 Index and the Dow Jones Industrial Average (DJIA). The Company purchases call options on the applicable indices as an investment to provide the income needed to fund the annual index credits on the indexed products. These products are deferred fixed annuities with a guaranteed minimum interest rate plus a contingent return based on equity market performance and are considered hybrid financial instruments under GAAP.
The Company elected to not use hedge accounting for derivative transactions related to FIA products. As a result, the Company accounts for the purchased call options and the embedded derivative related to the provision of a contingent return at fair value, with changes in fair value recognized as Net investment gains (losses) in the Consolidated Statements of Operations. The embedded derivative is bifurcated from the host contract and included in Other policyholder funds in the Consolidated Balance Sheets. The host contract is accounted for as a debt instrument in accordance with GAAP and is included in Investment contract and life policy reserves in the Consolidated Balance Sheets with any discount to the minimum account value being accreted using the effective yield method. In the Consolidated Statements of Operations, accreted interest for FIA products and benefit claims on these products incurred during the reporting period are included in Benefits, claims and settlement expenses.
The Company offers indexed universal life (IUL) products as part of its product portfolio with interest crediting strategies linked to the S&P 500 Index and the DJIA as well as a fixed option. The Company purchases call options monthly to economically hedge the potential liabilities arising in IUL accounts. The Company elected to not use hedge accounting for derivative transactions related to the IUL products. As a result, the Company records the purchased call options and the embedded derivative related to the provision of a contingent return at fair value, with changes in fair value reported in Net investment gains (losses) in the Consolidated Statements of Operations. IUL policies with a balance in one or more indexed accounts are considered to have an
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82 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
embedded derivative. The benefit reserve for the host contract is measured using the retrospective deposit method, which for Horace Mann's IUL product is equal to the account balance. The embedded derivative is bifurcated from the host contract, carried at fair value, and included in Investment contract and life policy reserves in the Consolidated Balance Sheets.
See Note 4 for more information regarding the determination of fair value for derivatives embedded in FIA and IUL and purchased call options.
Unpaid Claims and Claim Expenses
Liabilities for Property & Casualty unpaid claims and claim expenses include provisions for payments to be made on reported claims, claims incurred but not yet reported (IBNR) and associated settlement expenses. All of the Company's reserves for Property & Casualty unpaid claims and claim expenses are carried at the full value of estimated liabilities and are not discounted for interest expected to be earned on the reserves. Estimated amounts of salvage and subrogation on unpaid Property & Casualty claims are deducted from the liability for unpaid claims. Due to the nature of the Company's personal lines business, the Company has no exposure to losses related to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses other than claims under property insurance policies for environmentally related items such as mold.
Other Policyholder Funds
Other policyholder funds includes payout annuity contracts without life contingencies and dividend accumulations, as well as balances outstanding under funding agreements with the Federal Home Loan Bank of Chicago (FHLB) and embedded derivatives related to FIA products. Except for embedded derivatives, each of these components is carried at cost. Embedded derivatives are carried at fair value. Amounts received and repaid under FHLB funding agreements are classified as financing activities in the Company's Consolidated Statements of Cash Flows.
FHLB Funding Agreements
In 2013, Horace Mann Life Insurance Company (HMLIC), and in 2019, NTA became members of FHLB, which provides both subsidiaries with access to collateralized borrowings and other FHLB products. Any borrowing from FHLB requires the purchase of FHLB activity-based common stock in an amount equal to 4.5% of the borrowing, or a lower percentage — such as 2.0% based on the Reduced Capitalization Advance Program. In 2021, HMEC's Board of Directors (Board) authorized a maximum amount equal to 15% of net aggregate admitted assets less separate account assets of the insurance subsidiaries for FHLB advances and funding agreements combined. In 2021, HMLIC and NTA collectively received advances of $554.0 million from FHLB under funding agreements and repaid $362.0 million on FHLB funding agreements. Outstanding advances under FHLB funding agreements are reported as Other policyholder funds in the Consolidated Balance Sheets and totaled $782.5 million as of December 31, 2021. Interest on the funding agreements accrues at their effective interest rates.
As of December 31, 2021, scheduled maturity dates for outstanding FHLB funding agreements were as follows:
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 83 |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | | | | | |
| | Amount | | Interest Rate | | Maturity Date |
| | $10.0 | | 0.000% | | May 16, 2022 |
| | 60.0 | | 0.489% | | January 13, 2023 |
| | 25.0 | | 0.427% | | February 10, 2023 |
| | 20.0 | | 0.446% | | November 15, 2023 |
| | 100.0 | | 0.249% | | December 15, 2023 |
| | 50.0 | | 0.449% | | January 12, 2024 |
| | 25.0 | | 0.374% | | April 3, 2024 |
| | 10.0 | | 0.393% | | May 22, 2024 |
| | 50.0 | | 0.393% | | May 22, 2024 |
| | 10.0 | | 0.530% | | February 14, 2025 |
| | 10.0 | | 0.448% | | February 28, 2025 |
| | 50.0 | | 0.448% | | February 28, 2025 |
| | 12.5 | | 0.670% | | June 26, 2025 |
| | 125.0 | | 0.570% | | September 11, 2025 |
| | 200.0 | | 0.225% | | January 16, 2026 |
| | 25.0 | | 0.298% | | September 9, 2026 |
Total | | $782.5 | | | | |
Reinsurance
The Company enters into reinsurance arrangements pursuant to which it cedes certain insurance risks to unaffiliated reinsurers. Cessions under reinsurance agreements do not discharge the Company's obligations as the primary insurer. The accounting for reinsurance arrangements depends on whether the arrangement provides indemnification against loss or liability relating to insurance risk in accordance with GAAP.
If the Company determines that a reinsurance agreement exposes the reinsurer to a reasonable possibility of a significant loss from insurance risk, the ceded unearned premiums and reinsurance balances recoverable on paid and unpaid losses and settlement expenses are reported separately as assets, instead of being netted with the related liabilities, since reinsurance does not relieve the Company of its legal liability to its policyholders. See Note 9 for further details.
If the Company determines that a reinsurance agreement does not expose the reinsurer to a reasonable possibility of a significant loss from insurance risk, the Company recognizes the reinsurance agreement using the deposit method of accounting. The assets transferred to the reinsurer as consideration paid is reported as a Deposit asset on reinsurance on the Company's Consolidated Balance Sheets. As amounts are received or paid or received, consistent with the underlying reinsured contracts, the Deposit asset on reinsurance is adjusted. The Deposit asset on reinsurance is accreted to the estimated ultimate cash flows using the interest method and the adjustment is reported as Net investment income. See Note 6 for further details.
Insurance Premiums and Contract Charges Earned
Property & Casualty insurance premiums are recognized as revenue ratably over the related contract periods in proportion to the risks insured. The unexpired portions of these Property & Casualty premiums are recorded as unearned premiums, using the monthly pro rata method.
Premiums and contract charges for life insurance contracts with account values and annuity contracts consist of charges for the cost of insurance, policy administration and withdrawals. Premiums for long-term traditional life and supplemental policies are recognized as revenues when due over the premium-paying period. Contract deposits to annuity contracts and life insurance contracts with account values represent funds deposited by policyholders and are not included in the Company's premiums or contract charges earned.
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84 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
Share-Based Compensation
The Company grants stock options and both service-based and performance-based restricted common stock units (RSUs) to executive officers, other employees and Directors in an effort to attract and retain individuals while also aligning compensation with the interests of the Company's shareholders. Additional information regarding the Company's share-based compensation plans is contained in Note 13.
Stock options are accounted for under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. The fair value of RSUs is measured at the market price of the Company's common stock on the date of grant, with the exception of market-based performance awards, for which the Company uses a Monte Carlo simulation model to determine fair value for purposes of measuring RSU expense. For the years ended December 31, 2021, 2020 and 2019, the Company recognized $1.2 million, $1.1 million, and $1.2 million, respectively, of stock option expense as a result of stock options that vested during the respective periods. For the years ended December 31, 2021, 2020 and 2019, the Company recognized $6.6 million, $4.8 million and $5.2 million, respectively, of RSU expense as a result of the performance and/or vesting of RSUs during the respective periods.
In 2021, 2020 and 2019, the Company granted stock options as quantified in the table below, which also provides the weighted average grant date fair value for stock options granted in each year. The fair value of stock options granted was estimated on the respective dates of grant using the Black-Scholes option pricing model with the weighted average assumptions shown in the following table.
| | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Number of stock options granted | | 183,272 | | | 234,248 | | | 282,040 | |
Weighted average grant date fair value of stock options granted | | $ | 7.73 | | | $ | 6.02 | | | $ | 6.26 | |
Weighted average assumptions: | | | | | | |
Risk-free interest rate | | 0.8 | % | | 0.8 | % | | 2.5 | % |
Expected dividend yield | | 3.0 | % | | 2.7 | % | | 2.9 | % |
Expected life, in years | | 5.1 | | 5.1 | | 5.0 |
Expected volatility (based on historical volatility) | | 30.1 | % | | 22.8 | % | | 21.9 | % |
The weighted average fair value of nonvested stock options outstanding on December 31, 2021 was $6.80. Total unrecognized compensation expense relating to the nonvested stock options outstanding as of December 31, 2021 was approximately $2.0 million. This amount will be recognized as expense over the remainder of the vesting period, which is scheduled to be 2022 through 2025. Expense is recognized on a straight-line basis over the vesting period for the entire award. Forfeitures of unvested amounts due to terminations and/or early retirements are recognized as a reduction to the related expenses.
Total unrecognized compensation expense relating to RSUs outstanding as of December 31, 2021 was approximately $6.6 million. This amount will be recognized as expense over the remainder of the performance and/or vesting period, which is scheduled to be 2022 through 2024. Expense is recognized on a straight-line basis from the date of grant through the end of the performance and/or vesting period for the entire award. Forfeitures of unvested amounts due to terminations are recognized as a reduction to the related expenses.
Income Taxes
The Company uses the asset and liability method for calculating deferred federal income taxes. Income tax provisions are generally based on income reported for financial statement purposes. The provisions for federal income taxes for the years ended December 31, 2021, 2020 and 2019 included amounts currently payable and deferred income taxes resulting from the cumulative differences in the Company's assets and liabilities, determined on a tax return versus financial statement basis.
Deferred tax assets and liabilities include provisions for net unrealized investment gains (losses) on fixed maturity securities as well as the net funded status of benefit plans with the changes for each period included in the respective components of AOCI within shareholders' equity.
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Horace Mann Educators Corporation | | Annual Report on Form 10-K 85 |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
Earnings Per Share
Basic earnings per share is computed based on the weighted average number of common shares outstanding plus the weighted average number of fully vested RSUs and common stock units (CSUs) payable as shares of HMEC common stock. Diluted earnings per share is computed based on the weighted average number of common shares and common stock equivalents outstanding, to the extent dilutive. The Company's common stock equivalents relate to outstanding common stock options, deferred compensation CSUs and incentive compensation RSUs, which are described in Note 13.
The computations of net income per share on both basic and diluted bases, including reconciliations of the numerators and denominators, were as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Basic: | | | | | | |
Net income for the period | | $ | 142.8 | | | $ | 133.3 | | | $ | 184.4 | |
Weighted average number of common shares during the period (in millions) | | 42.0 | | | 41.9 | | | 41.7 | |
Net income per share - basic | | $ | 3.40 | | | $ | 3.18 | | | $ | 4.42 | |
| | | | | | |
Diluted: | | | | | | |
Net income for the period | | $ | 142.8 | | | $ | 133.3 | | | $ | 184.4 | |
Weighted average number of common shares during the period (in millions) | | 42.0 | | | 41.9 | | | 41.7 | |
Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities (in millions): | | | | | | |
Stock options | | — | | | — | | | 0.1 | |
CSUs related to deferred compensation for employees | | — | | | — | | | — | |
RSUs related to incentive compensation | | 0.2 | | | 0.1 | | | 0.1 | |
Total common and common equivalent shares adjusted to calculate diluted earnings per share (in millions) | | 42.2 | | | 42.0 | | | 41.9 | |
Net income per share - diluted | | $ | 3.39 | | | $ | 3.17 | | | $ | 4.40 | |
Options to purchase 734,018 shares of common stock at $38.05 to $42.95 per share were granted in 2017, 2018, 2019, 2020 and 2021 but were not included in the computation of 2021 diluted earnings per share because of their anti-dilutive effect. These options, which expire in 2027, 2028, 2029, 2030 and 2031, were still outstanding at December 31, 2021.
Consolidated Statements of Cash Flows
For purposes of the Consolidated Statements of Cash Flows, cash constitutes cash on deposit at banks as well as restricted cash. See Note 18 for further information.
Future Adoption of New Accounting Standards
Accounting for Long-Duration Insurance Contracts
In August 2018, the FASB issued accounting and disclosure guidance that contains targeted improvements to the accounting for long-duration insurance contracts. Under the new guidance, the cash flow assumptions used to measure the liability for future policy benefits for traditional insurance contracts will be required to be updated at least annually with changes recognized as a benefit expense (i.e., assumptions will no longer be locked-in). Insurance entities will be required to use a standard discount rate to measure the liabilities that will be equivalent to the yield from a high-quality bond. The new guidance also changes the amortization of DAC to be on a constant-level basis over the expected term of the related contracts with no interest accruing on the DAC balance. The new guidance also introduces a new category of contract features associated with deposit type contracts referred to as market risk benefits (MRBs). Contract features meeting the definition of a MRB will be measured at fair value. New disclosures will be required for long-duration insurance contracts in order to provide better transparency into the exposure of insurance entities and the drivers of their results. For public business entities, the guidance is effective for annual reporting periods beginning after December 15, 2022, including
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86 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
interim periods within those years. With regards to the liability for future policy benefits and DAC, the guidance applies to contracts in force as of the beginning of the earliest period presented and may be applied retrospectively. With regards to MRBs, the guidance is to be applied retrospectively at the beginning of the earliest period presented. Early adoption is permitted. Management is evaluating the impact this guidance will have on the results of operations and financial position of the Company.
NOTE 2 - Subsequent Events
On July 14, 2021, the Company announced that it entered into a Stock Purchase Agreement (Agreement), by and among the Company and Independence Capital Corp. and Independence Holding Company (Seller) to acquire all the equity interests in Madison National Life Insurance Company, Inc., an insurance company organized under the laws of the State of Wisconsin (Madison National). Founded in 1961 and headquartered in Madison, Wisconsin, Madison National offers short- and long-term group disability, group term, and worksite solutions products, including accident, critical illness and fixed indemnity. The Agreement provided, among other things, that, upon the terms and subject to the conditions set forth in the Agreement, the Company would acquire all the equity interests in Madison National for $172.5 million. The Seller will have a potential earn-out of up to $12.5 million payable in cash, if specified financial targets are achieved by the end of 2023 and as such, the final purchase price is subject to adjustment.
Effective January 1, 2022, the Company completed its acquisition of Madison National. As a result of the acquisition, Madison National became a wholly owned subsidiary of the Company.
NOTE 3 - Investments
The components of net investment income for the following periods were as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Fixed maturity securities | | $ | 235.6 | | | $ | 232.9 | | | $ | 283.2 | |
Equity securities | | 5.3 | | | 4.7 | | | 4.9 | |
Limited partnership interests | | 79.0 | | | 20.9 | | | 25.7 | |
Short-term and other investments | | 11.6 | | | 11.4 | | | (10.1) | |
Investment expenses | | (10.1) | | | (9.6) | | | (9.4) | |
Net investment income - investment portfolio | | 321.4 | | | 260.3 | | | 294.3 | |
Investment income - deposit asset on reinsurance | | 101.1 | | | 97.3 | | | 70.8 | |
Total net investment income | | $ | 422.5 | | | $ | 357.6 | | | $ | 365.1 | |
Net Investment Gains (Losses)
Net investment gains (losses) for the following periods were as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Fixed maturity securities(1) | | $ | (7.7) | | | $ | 9.4 | | | $ | 141.4 | |
Equity securities | | (0.8) | | | 1.8 | | | 16.0 | |
Short-term investments and other | | (2.5) | | | (13.5) | | | (4.1) | |
Net investment gains (losses) | | $ | (11.0) | | | $ | (2.3) | | | $ | 153.3 | |
(1) Net investment gains on fixed maturity securities include a $135.3 million realized investment gain associated with a transfer of investments to a reinsurer as consideration paid in connection with a reinsurance transaction of a $2.9 billion block of in force fixed and variable annuity business in 2019. See Notes 6 and 18 for further information.
The Company, from time to time, sells fixed maturity securities subsequent to the reporting date that were considered temporarily impaired at such reporting date. Such sales are due to issuer specific events occurring subsequent to the reporting date that result in a change in the Company's intent or ability to hold a fixed maturity security. The types of events that may result in a sale include significant changes in the economic facts and circumstances related to the invested asset, significant unforeseen changes in liquidity needs, or changes in the Company's investment strategy.
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Horace Mann Educators Corporation | | Annual Report on Form 10-K 87 |
NOTE 3 - Investments (continued)
Net Investment Gains (Losses) by Transaction Type
The following table reconciles net investment gains (losses) pretax by transaction type:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Credit loss impairments(1) | | $ | (8.1) | | | $ | — | | | $ | (1.1) | |
Intent-to-sell impairments | | (2.3) | | | (5.3) | | | (0.3) | |
Total impairments on investments recognized in net income | | (10.4) | | | (5.3) | | | (1.4) | |
Sales and other, net | | 4.3 | | | 15.0 | | | 151.5 | |
Change in fair value - equity securities | | (2.3) | | | (0.2) | | | 7.3 | |
Change in fair value and losses realized on settlements - derivatives | | (2.6) | | | (11.8) | | | (4.1) | |
Net investment (losses) gains | | $ | (11.0) | | | $ | (2.3) | | | $ | 153.3 | |
(1) Due to the adoption of the measurement of credit losses on financial instruments accounting standard in 2020, other-than-temporary write-downs reported in 2019 are now presented as credit losses,
Allowance for Credit Loss Impairments on Fixed Maturity Securities
The following table presents changes in the allowance for credit loss impairments on fixed maturity securities classified as available for sale for the category of other asset-backed securities (no other categories of fixed maturity securities have an allowance for credit loss impairments):
| | | | | | | | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 |
Beginning balance | | $ | — | | | $ | — | |
Credit losses on fixed maturity securities for which credit losses were not previously reported(1) | | 8.1 | | | — | |
Net (increases) decreases related to credit losses previously reported | | — | | | — | |
Reduction of credit allowances related to sales | | — | | | — | |
Write-offs | | (0.4) | | | — | |
Ending balance | | $ | 7.7 | | | $ | — | |
(1) Because the standard for the measurement of credit losses on financial instruments became effective January 1, 2020, there are no allowances for credit loss impairments to report for the year ended December 31, 2019.
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88 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 3 - Investments (continued)
Fixed Maturity Securities
The Company's investment portfolio is comprised primarily of fixed maturity securities. Amortized cost, net, unrealized investment gains (losses) and fair values of all fixed maturity securities in the portfolio were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Amortized Cost, net | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
December 31, 2021 | | | | | | | | |
Fixed maturity securities | | | | | | | | |
U.S. Government and federally sponsored agency obligations:(1) | | | | | | | | |
Mortgage-backed securities | | $ | 612.1 | | | $ | 51.9 | | | $ | 1.5 | | | $ | 662.5 | |
Other, including U.S. Treasury securities | | 342.5 | | | 27.7 | | | 4.3 | | | 365.9 | |
Municipal bonds | | 1,519.7 | | | 184.4 | | | 0.7 | | | 1,703.4 | |
Foreign government bonds | | 40.2 | | | 3.4 | | | — | | | 43.6 | |
Corporate bonds | | 2,217.7 | | | 176.2 | | | 5.2 | | | 2,388.7 | |
Other asset-backed securities | | 1,065.5 | | | 16.6 | | | 6.9 | | | 1,075.2 | |
Totals | | $ | 5,797.7 | | | $ | 460.2 | | | $ | 18.6 | | | $ | 6,239.3 | |
| | | | | | | | |
December 31, 2020 | | | | | | | | |
Fixed maturity securities | | | | | | | | |
U.S. Government and federally sponsored agency obligations:(1) | | | | | | | | |
Mortgage-backed securities | | $ | 605.5 | | | $ | 79.6 | | | $ | 0.3 | | | $ | 684.8 | |
Other, including U.S. Treasury securities | | 395.0 | | | 39.2 | | | 1.0 | | | 433.2 | |
Municipal bonds | | 1,612.3 | | | 215.7 | | | 0.5 | | | 1,827.5 | |
Foreign government bonds | | 40.2 | | | 4.9 | | | — | | | 45.1 | |
Corporate bonds | | 1,905.2 | | | 221.6 | | | 3.9 | | | 2,122.9 | |
Other asset-backed securities | | 1,230.4 | | | 24.1 | | | 22.7 | | | 1,231.8 | |
Totals | | $ | 5,788.6 | | | $ | 585.1 | | | $ | 28.4 | | | $ | 6,345.3 | |
(1) Fair value includes securities issued by Federal National Mortgage Association (FNMA) of $376.7 million and $387.1 million; Federal Home Loan Mortgage Corporation (FHLMC) of $326.5 million and $344.3 million; and Government National Mortgage Association (GNMA) of $112.1 million and $132.3 million as of December 31, 2021 and 2020, respectively.
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 89 |
NOTE 3 - Investments (continued)
The following table presents the fair value and gross unrealized losses for fixed maturity securities in an unrealized loss position at December 31, 2021 and 2020, respectively. The Company views the decrease in fair value of all fixed maturity securities with unrealized losses at December 31, 2021 — which was driven largely by increasing interest rates, spread widening, financial market illiquidity and/or market volatility from the date of acquisition — as temporary. As of December 31, 2021, the Company has not made the decision to sell and it is not more likely than not the Company will be required to sell the fixed maturity securities with unrealized losses before anticipated recovery in value. Therefore, it was determined that the unrealized losses on the fixed maturity securities presented in the table below were not indicative of any impairments as of December 31, 2021.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | 12 months or less | | More than 12 months | | Total |
| | Fair Value | | Gross Unrealized Losses | | Fair Value | | Gross Unrealized Losses | | Fair Value | | Gross Unrealized Losses |
December 31, 2021 | | | | | | | | | | | | |
Fixed maturity securities | | | | | | | | | | | | |
U.S. Government and federally sponsored agency obligations: | | | | | | | | | | | | |
Mortgage-backed securities | | $ | 67.4 | | | $ | 1.3 | | | $ | 3.9 | | | $ | 0.2 | | | $ | 71.3 | | | $ | 1.5 | |
Other | | 59.5 | | | 1.7 | | | 35.1 | | | 2.6 | | | 94.6 | | | 4.3 | |
Municipal bonds | | 56.8 | | | 0.7 | | | 0.6 | | | — | | | 57.4 | | | 0.7 | |
Foreign government bonds | | — | | | — | | | — | | | — | | | — | | | — | |
Corporate bonds | | 220.7 | | | 3.8 | | | 44.1 | | | 1.4 | | | 264.8 | | | 5.2 | |
Other asset-backed securities | | 379.0 | | | 3.8 | | | 128.2 | | | 3.1 | | | 507.2 | | | 6.9 | |
Total | | $ | 783.4 | | | $ | 11.3 | | | $ | 211.9 | | | $ | 7.3 | | | $ | 995.3 | | | $ | 18.6 | |
| | | | | | | | | | | | |
Number of positions with a gross unrealized loss | | 516 | | | | | 122 | | | | | 638 | | | |
Fair value as a percentage of total fixed maturities securities fair value | | 12.6 | % | | | | 3.4 | % | | | | 16.0 | % | | |
| | | | | | | | | | | | |
December 31, 2020 | | | | | | | | | | | | |
Fixed maturity securities | | | | | | | | | | | | |
U.S. Government and federally sponsored agency obligations: | | | | | | | | | | | | |
Mortgage-backed securities | | $ | 4.9 | | | $ | 0.1 | | | $ | 2.6 | | | $ | 0.2 | | | $ | 7.5 | | | $ | 0.3 | |
Other | | 95.9 | | | 1.0 | | | — | | | — | | | 95.9 | | | 1.0 | |
Municipal bonds | | 18.1 | | | 0.5 | | | — | | | — | | | 18.1 | | | 0.5 | |
Foreign government bonds | | — | | | — | | | — | | | — | | | — | | | — | |
Corporate bonds | | 126.6 | | | 3.7 | | | 10.9 | | | 0.2 | | | 137.5 | | | 3.9 | |
Other asset-backed securities | | 316.9 | | | 17.2 | | | 409.3 | | | 5.5 | | | 726.2 | | | 22.7 | |
Total | | $ | 562.4 | | | $ | 22.5 | | | $ | 422.8 | | | $ | 5.9 | | | $ | 985.2 | | | $ | 28.4 | |
| | | | | | | | | | | | |
Number of positions with a gross unrealized loss | | 308 | | | | | 123 | | | | | 431 | | | |
Fair value as a percentage of total fixed maturities securities fair value | | 8.9 | % | | | | 6.7 | % | | | | 15.6 | % | | |
Fixed maturity securities with an investment grade rating represented 69.8% of the gross unrealized losses as of December 31, 2021. With respect to fixed maturity securities involving securitized financial assets, the underlying collateral cash flows were stress tested to determine there was no adverse change in the present value of cash flows below the amortized cost basis.
| | | | | | | | |
90 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 3 - Investments (continued)
Maturities of Fixed Maturity Securities
The following table presents the distribution of the Company's fixed maturity securities portfolio by estimated expected maturity. Estimated expected maturities differ from contractual maturities, reflecting assumptions regarding borrowers' utilization of the right to call or prepay obligations with or without call or prepayment penalties. For structured securities, estimated expected maturities consider broker-dealer survey prepayment assumptions and are verified for consistency with the interest rate and economic environments.
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | December 31, 2021 |
| | Amortized Cost, net | | Fair Value | | Percent of Total Fair Value |
Estimated expected maturity: | | | | | | |
Due in 1 year or less | | $ | 245.4 | | | $ | 250.8 | | | 4.0 | % |
Due after 1 year through 5 years | | 1,613.8 | | | 1,686.2 | | | 27.0 | % |
Due after 5 years through 10 years | | 1,600.5 | | | 1,729.5 | | | 27.7 | % |
Due after 10 years through 20 years | | 1,339.9 | | | 1,488.2 | | | 23.9 | % |
Due after 20 years | | 998.1 | | | 1,084.6 | | | 17.4 | % |
Total | | $ | 5,797.7 | | | $ | 6,239.3 | | | 100.0 | % |
| | | | | | |
Average option-adjusted duration, in years | | 6.7 | | | | |
Sales of Fixed Maturity and Equity Securities
Proceeds received from sales of fixed maturity and equity securities, each determined using the specific identification method, and gross gains and gross losses realized as a result of those sales for each year were as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 | | 2019(1) |
Fixed maturity securities | | | | | | |
Proceeds received | | $ | 578.2 | | | $ | 472.9 | | | $ | 805.9 | |
Gross gains realized | | 10.5 | | | 20.5 | | | 150.9 | |
Gross losses realized | | (7.7) | | | (6.1) | | | (7.8) | |
| | | | | | |
Equity securities | | | | | | |
Proceeds received | | $ | 4.7 | | | $ | 12.7 | | | $ | 29.9 | |
Gross gains realized | | 1.5 | | | 2.2 | | | 9.2 | |
Gross losses realized | | (0.1) | | | (1.9) | | | (0.8) | |
(1) Gross gains realized presented above include a $135.3 million realized investment gain associated with a transfer of investments to a reinsurer as consideration paid during the second quarter of 2019 in connection with the reinsurance of a $2.9 billion block of in force fixed and variable annuity business. See Notes 6 and 18 for further information.
Net Unrealized Investment Gains (Losses) on Fixed Maturity Securities
The following table reconciles the net unrealized investment gains (losses) on fixed maturity securities, net of tax, included in AOCI, before the impact on DAC:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Net unrealized investment gains (losses) on fixed maturity securities, net of tax | | | | | | |
Beginning of period | | $ | 439.8 | | | $ | 264.4 | | | $ | 111.7 | |
Change in net unrealized investment (losses) gains on fixed maturity securities | | (97.6) | | | 184.2 | | | 277.1 | |
Reclassification of net investment losses (gains) on fixed maturity securities to net income | | 6.7 | | | (8.8) | | | (124.4) | |
End of period | | $ | 348.9 | | | $ | 439.8 | | | $ | 264.4 | |
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Horace Mann Educators Corporation | | Annual Report on Form 10-K 91 |
NOTE 3 - Investments (continued)
Limited Partnership Interests
All investments in limited partnership interests are accounted for using EMA and include interests in commercial mortgage loan funds, private equity funds, infrastructure debt funds, infrastructure equity funds and other funds. Principal factors influencing carrying amount appreciation or decline include operating performance, comparable public company earnings multiples, capitalization rates and the economic environment. The Company recognizes an impairment loss for equity method limited partnership interests when evidence demonstrates that the loss is other than temporary. Evidence of a loss in value that is other than temporary may include the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain a level of earnings that would justify the carrying amount of the investment. The carrying amounts of equity method limited partnership interests were as follows:
| | | | | | | | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 |
Commercial mortgage loan funds | | $ | 346.8 | | | $ | 149.6 | |
Private equity funds | | 74.0 | | | 39.6 | |
Infrastructure debt funds | | 62.4 | | | 58.3 | |
Infrastructure equity funds | | 58.3 | | | 52.1 | |
Other funds(1) | | 171.3 | | | 149.4 | |
Total | | $ | 712.8 | | | $ | 449.0 | |
(1)Other funds consist primarily of limited partnership interests in hedge funds, real estate equity and corporate mezzanine funds.
Investment in Entities Exceeding 10% of Shareholders' Equity
At December 31, 2021 and 2020, there were no investments which exceeded 10% of total shareholders' equity in entities other than obligations of the U.S. Government and federally sponsored government agencies and authorities.
Offsetting of Assets and Liabilities
The Company's derivatives are subject to enforceable master netting arrangements. Collateral support agreements associated with each master netting arrangement provide that the Company will receive or pledge financial collateral in the event minimum thresholds have been reached.
The following table presents the instruments that were subject to a master netting arrangement for the Company.
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($ in millions) | | | | Gross Amounts Offset in the Consolidated Balance Sheets | | Net Amounts of Assets/ Liabilities Presented in the Consolidated Balance Sheets | | Gross Amounts Not Offset in the Consolidated Balance Sheets | | |
| | Gross Amounts | | | | Financial Instruments | | Cash Collateral Received | | Net Amount |
December 31, 2021 | | | | | | | | | | | | |
Asset derivatives | | | | | | | | | | | | |
Free-standing derivatives | | $ | 10.7 | | | $ | — | | | $ | 10.7 | | | $ | 4.5 | | | $ | 6.4 | | | $ | (0.2) | |
| | | | | | | | | | | | |
December 31, 2020 | | | | | | | | | | | | |
Asset derivatives | | | | | | | | | | | | |
Free-standing derivatives | | $ | 16.8 | | | $ | — | | | $ | 16.8 | | | $ | 13.7 | | | $ | 2.6 | | | $ | 0.5 | |
Deposits
At December 31, 2021 and 2020, fixed maturity securities with a fair value of $26.2 million and $26.9 million, respectively, were on deposit with governmental agencies as required by law in various states for which the insurance subsidiaries of the Company conduct business. In addition, at December 31, 2021 and 2020, fixed maturity securities with a fair value of $870.1 million and $707.3 million, respectively, were on deposit with FHLB as collateral for amounts subject to funding agreements, advances and borrowings which were equal to $787.5 million and $644.5 million at the respective dates. The deposited securities are reported as Fixed maturity securities on the Company's Consolidated Balance Sheets.
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92 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 4 - Fair Value of Financial Instruments
The Company is required to disclose estimated fair values for certain financial and nonfinancial assets and liabilities. Fair values of the Company's insurance contracts other than annuity contracts (which are investment contracts) and equity method limited partnership interests are not required to be disclosed. However, the estimated fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk through the matching of investment maturities with amounts due under insurance contracts.
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between knowledgeable, unrelated and willing market participants on the measurement date. In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The Company categorizes its financial and nonfinancial assets and liabilities into a three-level hierarchy based on the priority of the inputs to the valuation technique. The three levels of inputs that may be used to measure fair value are:
| | | | | |
Level 1 | Unadjusted quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include fixed maturity and equity securities (both common stock and preferred stock) that are traded in an active exchange market, as well as U.S. Treasury securities. |
Level 2 | Unadjusted observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for the assets or liabilities. Level 2 assets and liabilities include fixed maturity securities (1) with quoted prices that are traded less frequently than exchange-traded instruments or (2) values based on discounted cash flows with observable inputs. This category generally includes certain U.S. Government and agency mortgage-backed securities, non-agency structured securities, corporate fixed maturity securities, preferred stocks, derivatives and embedded derivatives. |
Level 3 | Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, certain discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation and for which the significant inputs are unobservable. This category generally includes certain private debt and equity investments, as well as embedded derivatives. |
When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. As a result, a Level 3 fair value measurement may include inputs that are observable (Level 1 or Level 2) and unobservable (Level 3). Net transfers into or out of each of the three levels are reported as having occurred at the end of the reporting period in which the transfers were determined.
The following discussion describes the valuation methodologies used for financial assets and financial liabilities measured at fair value. The techniques utilized in estimating the fair values are affected by the assumptions used, including discount rates and estimates of the amount and timing of expected future cash flows. The use of different methodologies, assumptions and inputs may have a material effect on the estimated fair values of the Company's investment holdings. Care is exercised in deriving conclusions about the Company's business, its value or financial position based on the fair value information of financial assets and liabilities presented below.
Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial asset or financial liability, including estimates of both the timing and amount of expected future cash flows and the credit standing of the issuer. In some cases, fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial asset or financial liability. The disclosed fair values do not reflect any premium or discount that could result from offering for sale at one time an entire holding of a particular financial asset or financial liability. In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or from Level 2 to Level 3. Potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected in amounts disclosed.
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Horace Mann Educators Corporation | | Annual Report on Form 10-K 93 |
NOTE 4 - Fair Value of Financial Instruments (continued)
Investments
The fair value of a fixed maturity security is the estimated amount at which the security could be exchanged in an orderly transaction between knowledgeable, unrelated and willing parties. The Company utilizes ICE Data Pricing, its investment managers and custodian bank to obtain fair value prices from independent third-party valuation service providers, broker quotes, model prices and matrix pricing. Each month, the Company obtains fair value prices from its investment managers and custodian bank, each of which use a variety of independent, nationally recognized pricing sources to determine market valuations for fixed maturity securities. Differences in prices between the sources that the Company considers significant are researched and the Company utilizes the price that it considers most representative of an exit price. Typical inputs used by these pricing sources include, but are not limited to, reported trades, bids, offers, benchmark yield curves, benchmarking of like securities, rating designations, sector groupings, issuer spreads and/or estimated cash flows, prepayment and default speeds, among others. The Company's fixed maturity securities portfolio is primarily publicly traded, which allows for a high percentage of the portfolio to be priced through pricing services. Approximately 90.2% and 91.9% of the portfolio, based on fair value, was priced through pricing services or index priced as of December 31, 2021 and 2020, respectively. The remainder of the portfolio was priced by broker quotes, model prices or matrix pricing. When non-binding broker quotes can be corroborated by comparison to other vendor quotes, pricing models or analyses, the securities are generally classified as Level 2, otherwise they are classified as Level 3. There were no significant changes to the valuation process during 2021.
The valuation of hard-to-value fixed maturity securities (generally 150 -200 securities) is more subjective because the markets are less liquid and there is a lack of observable market-based inputs. This may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur. When the pricing sources cannot provide fair value determinations, the investment managers obtain non-binding price quotes from brokers. For those securities where the investment manager cannot obtain broker quotes, they will model the security, generally using anticipated cash flows of the underlying collateral. Brokers' valuation methodologies as well as investment managers’ modeling methodologies are sometimes matrix-based, using indicative evaluation measures and adjustments for specific security characteristics and market sentiment. The selection of the market inputs and assumptions used to estimate the fair value of hard-to-value fixed maturity securities requires judgment and includes: benchmark yield, liquidity premium, estimated cash flows, prepayment and default speeds, spreads, weighted average life, and credit rating. The extent of the use of each market input depends on the market sector and market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities, additional inputs may be necessary.
The Company gains assurance that its portfolio of fixed maturity securities including hard-to-value fixed maturity securities is appropriately valued through the execution of various processes and controls designed to ensure the overall reasonableness and consistent application of valuation methodologies, including inputs and assumptions, and compliance with accounting standards. The Company’s processes and controls are designed to ensure (1) the valuation methodologies are appropriate and consistently applied, (2) the inputs and assumptions are reasonable and consistent with the objective of determining fair value, and (3) the fair values are accurately recorded. For example, on a continuing basis, the Company assesses the reasonableness of individual fair values that have stale security prices or that exceed certain thresholds as compared to previous fair values received from valuation service providers. The Company performs procedures to understand and assess the methodologies, processes and controls of valuation service providers. In addition, the Company may validate the reasonableness of fair values by comparing information obtained from valuation service providers or brokers to other third-party valuation sources for selected securities.
To determine the fair value of equity securities, the Company utilizes its investment managers and its custodian bank to obtain fair value prices from independent third-party valuation service providers. Each month, the Company obtains fair value prices from its investment managers and custodian bank, each of which use a variety of independent, nationally recognized pricing sources to determine market valuations for equity securities.
Policy loans and mortgage loans as well as investments in limited partnership interests which are accounted for using EMA are excluded from the fair value hierarchy.
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94 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 4 - Fair Value of Financial Instruments (continued)
In summary, the following financial assets and financial liabilities are carried at fair value:
Financial assets
•Fixed maturity securities including hard-to-value fixed maturity securities, as described above.
•Equity securities, as described above.
•Short-term fixed maturity securities — Because of the nature of these assets, carrying amounts generally approximate fair values.
•Derivatives — Fair values are based on the amount of cash expected to be received to settle each derivative on the reporting date. These amounts are obtained from each of the counterparties using industry accepted valuation models and observable inputs. Significant inputs include contractual terms, underlying index prices, market volatilities, interest rates and dividend yields.
•FHLB membership and activity stocks — Fair value is based on redemption value, which is equal to par value.
Financial liabilities
•The fair value of derivatives embedded in IUL contracts is set equal to the fair value of the outstanding call options.
•The fair value of derivatives embedded in FIA contracts is determined using the option budget method for each premium received (i.e., the option budget method is used as the future account growth rate). With this method, future excess cash flows (defined as benefits in excess of required non-forfeiture benefits) are discounted at the risk-free rate and adjusted for non-performance, to determine the fair value of the embedded derivatives.
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Horace Mann Educators Corporation | | Annual Report on Form 10-K 95 |
NOTE 4 - Fair Value of Financial Instruments (continued)
Financial Instruments Measured and Carried at Fair Value on a Recurring Basis
The following table presents the Company's fair value hierarchy for financial assets and financial liabilities measured and carried at fair value on a recurring basis. At December 31, 2021, Level 3 investments comprised approximately 5.6% of the Company's total investment portfolio at fair value.
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($ in millions) | | Carrying Amount | | Fair Value | | Fair Value Measurements at Reporting Date Using |
| | | | Level 1 | | Level 2 | | Level 3 |
December 31, 2021 | | | | | | | | | | |
Financial Assets | | | | | | | | | | |
Investments | | | | | | | | | | |
Fixed maturity securities | | | | | | | | | | |
U.S. Government and federally sponsored agency obligations: | | | | | | | | | | |
Mortgage-backed securities | | $ | 662.5 | | | $ | 662.5 | | | $ | — | | | $ | 662.5 | | | $ | — | |
Other, including U.S. Treasury securities | | 365.9 | | | 365.9 | | | 17.7 | | | 348.2 | | | — | |
Municipal bonds | | 1,703.4 | | | 1,703.4 | | | — | | | 1,642.6 | | | 60.8 | |
Foreign government bonds | | 43.6 | | | 43.6 | | | — | | | 43.6 | | | — | |
Corporate bonds | | 2,388.7 | | | 2,388.7 | | | 14.9 | | | 2,163.5 | | | 210.3 | |
Other asset-backed securities | | 1,075.2 | | | 1,075.2 | | | — | | | 976.3 | | | 98.9 | |
Total fixed maturity securities | | 6,239.3 | | | 6,239.3 | | | 32.6 | | | 5,836.7 | | | 370.0 | |
Equity securities | | 147.2 | | | 147.2 | | | 35.2 | | | 110.6 | | | 1.4 | |
Short-term investments | | 157.8 | | | 157.8 | | | 157.8 | | | — | | | — | |
Other investments | | 43.6 | | | 43.6 | | | — | | | 43.6 | | | — | |
Totals | | $ | 6,587.9 | | | $ | 6,587.9 | | | $ | 225.6 | | | $ | 5,990.9 | | | $ | 371.4 | |
Separate Account (variable annuity) assets(1) | | $ | 3,441.0 | | | $ | 3,441.0 | | | $ | 3,441.0 | | | $ | — | | | $ | — | |
Financial Liabilities | | | | | | | | | | |
Investment contract and life policy reserves, embedded derivatives | | $ | 2.1 | | | $ | 2.1 | | | $ | — | | | $ | 2.1 | | | $ | — | |
Other policyholder funds, embedded derivatives | | $ | 106.6 | | | $ | 106.6 | | | $ | — | | | $ | — | | | $ | 106.6 | |
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December 31, 2020 | | | | | | | | | | |
Financial Assets | | | | | | | | | | |
Investments | | | | | | | | | | |
Fixed maturity securities | | | | | | | | | | |
U.S. Government and federally sponsored agency obligations: | | | | | | | | | | |
Mortgage-backed securities | | $ | 684.8 | | | $ | 684.8 | | | $ | — | | | $ | 673.7 | | | $ | 11.1 | |
Other, including U.S. Treasury securities | | 433.2 | | | 433.2 | | | 18.4 | | | 414.8 | | | — | |
Municipal bonds | | 1,827.5 | | | 1,827.5 | | | — | | | 1,767.9 | | | 59.6 | |
Foreign government bonds | | 45.1 | | | 45.1 | | | — | | | 45.1 | | | — | |
Corporate bonds | | 2,122.9 | | | 2,122.9 | | | 14.9 | | | 1,952.2 | | | 155.8 | |
Other asset-backed securities | | 1,231.8 | | | 1,231.8 | | | — | | | 1,103.5 | | | 128.3 | |
Total fixed maturity securities | | 6,345.3 | | | 6,345.3 | | | 33.3 | | | 5,957.2 | | | 354.8 | |
Equity securities | | 121.6 | | | 121.6 | | | 39.2 | | | 82.1 | | | 0.3 | |
Short-term investments | | 141.8 | | | 141.8 | | | 137.7 | | | 4.1 | | | — | |
Other investments | | 36.3 | | | 36.3 | | | — | | | 36.3 | | | — | |
Totals | | $ | 6,645.0 | | | $ | 6,645.0 | | | $ | 210.2 | | | $ | 6,079.7 | | | $ | 355.1 | |
Separate Account (variable annuity) assets(1) | | $ | 2,891.4 | | | $ | 2,891.4 | | | $ | 2,891.4 | | | $ | — | | | $ | — | |
Financial Liabilities | | | | | | | | | | |
Investment contract and life policy reserves, embedded derivatives | | $ | 2.5 | | | $ | 2.5 | | | $ | — | | | $ | 2.5 | | | $ | — | |
Other policyholder funds, embedded derivatives | | $ | 104.5 | | | $ | 104.5 | | | $ | — | | | $ | — | | | $ | 104.5 | |
(1) Separate Account (variable annuity) assets represent contractholder funds invested in various actively traded mutual funds that have daily quoted net asset values that are readily determinable for identical assets that the Company can access. Separate Account (variable annuity) liabilities are equal to the estimated fair value of Separate Account (variable annuity) assets.
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96 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 4 - Fair Value of Financial Instruments (continued)
Changes in Level 3 Fair Value Measurements
The Company did not have any transfers between Levels 1 and 2 during 2021 and 2020. The following tables present reconciliations for the periods indicated for all Level 3 financial assets and financial liabilities measured at fair value on a recurring basis.
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($ in millions) | | Financial Assets | | Financial Liabilities(1) |
| | Municipal Bonds | | Corporate Bonds | | Mortgage-Backed and Other Asset- Backed Securities(2) | | Total Fixed Maturity Securities | | Equity Securities | | Total | | |
Beginning balance, January 1, 2021 | | $ | 59.6 | | | $ | 155.8 | | | $ | 139.4 | | | $ | 354.8 | | | $ | 0.3 | | | $ | 355.1 | | | $ | 104.5 | |
Transfers into Level 3(3) | | 18.6 | | | 131.7 | | | 21.3 | | | 171.6 | | | 1.0 | | | 172.6 | | | — | |
Transfers out of Level 3(3) | | — | | | (64.4) | | | (19.2) | | | (83.6) | | | — | | | (83.6) | | | — | |
Total gains or losses | | | | | | | | | | | | | | |
Net investment gains (losses) included in net income related to financial assets | | — | | | — | | | (8.2) | | | (8.2) | | | 0.1 | | | (8.1) | | | — | |
Net investment (gains) losses included in net income related to financial liabilities | | — | | | — | | | — | | | — | | | — | | | — | | | 10.0 | |
Net unrealized investment gains (losses) included in OCI | | (2.5) | | | — | | | 8.8 | | | 6.3 | | | — | | | 6.3 | | | — | |
Purchases | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Issuances | | — | | | — | | | — | | | — | | | — | | | — | | | 4.9 | |
Sales | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Settlements | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Paydowns, maturities and distributions | | (14.9) | | | (12.8) | | | (43.2) | | | (70.9) | | | — | | | (70.9) | | | (12.8) | |
Ending balance, December 31, 2021 | | $ | 60.8 | | | $ | 210.3 | | | $ | 98.9 | | | $ | 370.0 | | | $ | 1.4 | | | $ | 371.4 | | | $ | 106.6 | |
| | | | | | | | | | | | | | |
Beginning balance, January 1, 2020 | | $ | 44.3 | | | $ | 104.0 | | | $ | 146.8 | | | $ | 295.1 | | | $ | 0.1 | | | $ | 295.2 | | | $ | 93.7 | |
Transfers into Level 3(3) | | 80.7 | | | 83.6 | | | 104.3 | | | 268.6 | | | 0.2 | | | 268.8 | | | — | |
Transfers out of Level 3(3) | | (69.1) | | | (36.6) | | | (84.6) | | | (190.3) | | | — | | | (190.3) | | | — | |
Total gains or losses | | | | | | | | | | | | | | |
Net investment gains (losses) included in net income related to financial assets | | — | | | — | | | (0.3) | | | (0.3) | | | — | | | (0.3) | | | — | |
Net investment (gains) losses included in net income related to financial liabilities | | — | | | — | | | — | | | — | | | — | | | — | | | 11.5 | |
Net unrealized investment gains (losses) included in OCI | | 4.3 | | | 1.4 | | | (10.5) | | | (4.8) | | | — | | | (4.8) | | | — | |
Purchases | | — | | | 6.9 | | | 1.9 | | | 8.8 | | | — | | | 8.8 | | | — | |
Issuances | | — | | | — | | | — | | | — | | | — | | | — | | | 8.4 | |
Sales | | — | | | — | | | 1.2 | | | 1.2 | | | — | | | 1.2 | | | — | |
Settlements | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Paydowns, maturities and distributions | | (0.6) | | | (3.5) | | | (19.4) | | | (23.5) | | | — | | | (23.5) | | | (9.1) | |
Ending balance, December 31, 2020 | | $ | 59.6 | | | $ | 155.8 | | | $ | 139.4 | | | $ | 354.8 | | | $ | 0.3 | | | $ | 355.1 | | | $ | 104.5 | |
(1) Represents embedded derivatives, all related to the Company's FIA products, reported in Other policyholder funds in the Company's Consolidated Balance Sheets.
(2) Includes U.S. Government and federally sponsored agency obligations for mortgage-backed securities and other asset-backed securities.
(3) Transfers into and out of Level 3 during the years ended December 31, 2021 and 2020 were attributable to changes in the availability of observable market information for individual fixed maturity securities and short-term investments. The Company's policy is to recognize transfers into and out of the levels as having occurred at the end of the reporting period in which the transfers were determined.
At December 31, 2021, the Company had $8.1 million of net investment losses on Level 3 financial assets that were included in net income and were primarily attributable to credit loss impairments. At December 31, 2020 the Company had $0.3 million of net investment losses on Level 3 financial assets that were included in net income. For the years ended December 31, 2021 and 2020, net investment losses of $10.0 million and $11.5 million, respectively, were included in net income that were attributable to changes in the fair value of Level 3 financial liabilities.
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Horace Mann Educators Corporation | | Annual Report on Form 10-K 97 |
NOTE 4 - Fair Value of Financial Instruments (continued)
Quantitative Information about Level 3 Fair Value Measurements
The following table provides quantitative information about the significant unobservable inputs for recurring fair value measurements categorized within Level 3.
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($ in millions) |
Financial Assets | | Fair Value at December 31, 2021 | | Valuation Technique(s) | | Unobservable Inputs | | Range (Weighted Average) and Single Point Best Estimate(1) |
Municipal bonds | | $ | 60.8 | | | discounted cash flow | | I spread(2) | | 374 - 425 bps |
Corporate bonds | | 210.3 | | | discounted cash flow | | N spread(3) | | 211 - 531 bps |
| | | | discounted cash flow | | I spread(2) | | 333 - 365 bps |
| | | | discounted cash flow | | T spread(4) | | 130 - 540 bps |
| | | | discounted cash flow | | yield | | 3.4% - 8.8% |
| | | | discounted cash flow | | discount rate | | 11.3% - 12.0% |
| | | | market comparable | | option adjusted spread | | 12.5% |
Other asset-backed securities | | 98.9 | | | vendor price | | haircut | | 3.0% - 5.0% |
| | | | discounted cash flow | | discount margin | | 14.6% |
| | | | discounted cash flow | | discount rate | | 8.5% - 20.0% |
| | | | discounted cash flow | | median comparable yield | | 7.3% - 16.1% |
| | | | market comparable | | median price | | $54.79 - $97.95 |
| | | | discounted cash flow | | N spread(3) | | 341 bps |
| | | | discounted cash flow | | T spread(4) | | 196 bps |
Equity securities | | 1.4 | | | Black-Scholes | | volatility | | low 29.0% - high 34.0% |
| | | | discounted cash flow | | variable | | $100.00 - $121.95 |
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($ in millions) |
Financial Liabilities | | Fair Value at December 31, 2021 | | Valuation Technique(s) | | Unobservable Inputs | | Range (Weighted Average) and Single Point Best Estimate(1) |
Derivatives embedded in fixed indexed annuity products | | $ | 106.6 | | | discounted cash flow | | lapse rate | | 5.3% |
| | | | | | mortality multiplier(5) | | 66.8% |
| | | | | | option budget | | 0.9% - 2.5% |
| | | | | | non-performance adjustment(6) | | 5.0% |
(1) When a range of unobservable inputs is not readily available, the Company uses a single point best estimate.
(2) "I spread" is the interpolated weighted average life point on the "on the run" (OTR) point of the curve.
(3) "N spread" is the interpolated weighted average life point on the swap curve.
(4) "T spread" is a specific point on the OTR curve.
(5) Mortality multiplier is applied to the Annuity 2000 table.
(6) Determined as a percentage of the risk-free rate.
The valuation techniques and significant unobservable inputs used in the fair value measurement for financial assets and financial liabilities classified as Level 3 are subject to the control processes as previously described in this Note. Generally, valuation techniques for fixed maturity securities include spread pricing, matrix pricing and discounted cash flow methodologies; include inputs such as quoted prices for identical or similar securities that are less liquid; and are based on lower levels of trading activity than securities classified as Level 2. The valuation techniques and significant unobservable inputs used in the fair value measurement for equity securities classified as Level 3 use similar valuation techniques and significant unobservable inputs as those used for fixed maturity securities.
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98 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 4 - Fair Value of Financial Instruments (continued)
The sensitivity of the estimated fair values to changes in the significant unobservable inputs for fixed maturity and equity securities included in Level 3 include: benchmark yield, liquidity premium, estimated cash flows, prepayment and default speeds, spreads, weighted average life, and credit rating. Significant spread widening in isolation will adversely impact the overall valuation, while significant tightening will lead to substantial valuation increases. Significant increases (decreases) in illiquidity premiums in isolation will result in substantially lower (higher) valuations. Significant increases (decreases) in expected default rates in isolation will result in substantially lower (higher) valuations.
Financial Instruments Not Carried at Fair Value
The Company has various other financial assets and financial liabilities used in the normal course of business that are not carried at fair value, but for which fair value disclosure is required. The following table presents the carrying amount, fair value and fair value hierarchy of these financial assets and financial liabilities.
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($ in millions) | | Carrying Amount | | Fair Value | | Fair Value Measurements at Reporting Date Using |
| | | | Level 1 | | Level 2 | | Level 3 |
December 31, 2021 | | | | | | | | | | |
Financial Assets | | | | | | | | | | |
Other investments | | $ | 148.8 | | | $ | 152.4 | | | $ | — | | | $ | — | | | $ | 152.4 | |
Deposit asset on reinsurance | | 2,481.5 | | | 2,935.1 | | | — | | | — | | | 2,935.1 | |
Financial Liabilities | | | | | | | | | | |
Investment contract and policy reserves, fixed annuity contracts | | 4,941.3 | | | 5,004.9 | | | — | | | — | | | 5,004.9 | |
Investment contract and life policy reserves, account values on life contracts | | 105.4 | | | 115.4 | | | — | | | — | | | 115.4 | |
Other policyholder funds | | 839.3 | | | 839.3 | | | — | | | 782.8 | | | 56.5 | |
Short-term debt | | 249.0 | | | 249.0 | | | — | | | — | | | 249.0 | |
Long-term debt | | 253.6 | | | 277.4 | | | — | | | 277.4 | | | — | |
| | | | | | | | | | |
December 31, 2020 | | | | | | | | | | |
Financial Assets | | | | | | | | | | |
Other investments | | $ | 168.3 | | | $ | 172.1 | | | $ | — | | | $ | — | | | $ | 172.1 | |
Deposit asset on reinsurance | | 2,420.9 | | | 3,030.6 | | | — | | | — | | | 3,030.6 | |
Financial Liabilities | | | | | | | | | | |
Investment contract and policy reserves, fixed annuity contracts | | 4,847.6 | | | 4,963.3 | | | — | | | — | | | 4,963.3 | |
Investment contract and life policy reserves, account values on life contracts | | 98.7 | | | 108.4 | | | — | | | — | | | 108.4 | |
Other policyholder funds | | 646.8 | | | 646.8 | | | — | | | 590.7 | | | 56.1 | |
Short-term debt | | 135.0 | | | 135.0 | | | — | | | — | | | 135.0 | |
Long-term debt | | 302.3 | | | 331.1 | | | — | | | 331.1 | | | — | |
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 99 |
NOTE 4 - Fair Value of Financial Instruments (continued)
Other Investments
Other investments includes policy loans and mortgage loans. For policy loans, fair value is based on estimates using discounted cash flow analysis and current interest rates being offered for new loans. For mortgage loans, fair value is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and similar remaining maturities.
Deposit Asset on Reinsurance
The fair value of the deposit asset on reinsurance is estimated by discounting the future cash flows that are expected to arise out of the annuity reinsurance transaction. The treasury yield curve, plus an assumed credit spread, is used to determine the appropriate discount rate.
Investment Contract and Policy Reserves
The fair values of fixed annuity contract liabilities and policyholder account balances on life contracts are equal to the discounted estimated future cash flows (using the Company's current interest rates for similar products including consideration of minimum guaranteed interest rates). The Company carries these financial liabilities at cost.
Also, included in investment contract and policy reserves are embedded derivatives related to the Company's IUL products which are carried at fair value. See Note 5 for further information.
Other Policyholder Funds
Other policyholder funds are liabilities related to supplementary contracts without life contingencies and dividend accumulations, as well as balances outstanding under funding agreements with the FHLB and embedded derivatives related to the FIA products. Except for embedded derivatives, each of these components is carried at cost, which management believes is a reasonable estimate of fair value due to the relatively short duration of these items, based on the Company's past experience.
The fair value of the embedded derivatives related to FIA products is estimated at each reporting date by (1) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (2) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for the Company's nonperformance risk related to those liabilities. The projections of policy contract values are based on the Company's best estimate assumptions for future contract growth and decrements. The assumptions for future contract growth include the expected index credits which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options that will be purchased in the future to fund index credits beyond the next contract anniversary. Projections of minimum guaranteed contract values include the same best estimate assumptions for contract decrements used to project policy contract values.
Short-term Debt
The Company carries short-term debt at amortized cost which approximates fair value.
Long-term Debt
The Company carries long-term debt at amortized cost. The fair value of long-term debt is estimated based on unadjusted quoted market prices of the Company's securities or unadjusted market prices based on similar publicly traded issues when trading activity for the Company's securities is not sufficient to provide a market price.
NOTE 5 - Derivatives
The Company offers FIA products, which are deferred fixed annuities that guarantee the return of principal to the contractholder and credit interest based on a percentage of the gain in a specified market index. The Company also offers IUL products which credit interest based on a percentage of the gain in a specified market index. When deposits are received for FIA and IUL contracts, a portion is used to purchase derivatives consisting of call options on the applicable market indices to fund the index credits due to FIA and IUL policyholders. For the Company, substantially all such call options are one-year options purchased to match the funding requirements of the underlying contracts. The call options are carried at fair value with changes in fair value included in Net investment gains (losses), a component of revenues, in the Consolidated Statements of Operations.
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100 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 5 - Derivatives (continued)
The change in fair value of derivatives includes the gains or losses recognized at the expiration of the option term or early termination and the changes in fair value for open positions. Call options are not purchased to fund the index liabilities that may arise after the next deposit anniversary date. On the respective anniversary dates of the indexed deposits, the index used to compute the annual index credit is reset and new one-year call options are purchased to fund the next annual index credit. The cost of these purchases is managed through the terms of the FIA and IUL contracts, which permit changes to index return caps, participation rates and/or asset fees, subject to guaranteed minimums on each contract's anniversary date. By adjusting the index return caps, participation rates or asset fees, crediting rates generally can be managed except in cases where the contractual features would prevent further modifications.
The future annual index credits on FIA are accounted for as a "series of embedded derivatives" over the expected life of the applicable contract with a corresponding reserve recognized. For IUL, the embedded derivative represents a single year liability for the index return.
The Company carries all derivatives at fair value in the Consolidated Balance Sheets. The Company elected to not use hedge accounting for derivative transactions related to the FIA and IUL products. As a result, the Company recognizes the purchased call options and the embedded derivatives related to the provision of a contingent return at fair value, with changes in the fair value of the derivatives recognized immediately as Net investment gains (losses) in the Consolidated Statements of Operations. The fair values of derivatives, including derivatives embedded in FIA and IUL contracts, are presented in the Consolidated Balance Sheets as follows:
| | | | | | | | | | | | | | |
($ in millions) | | December 31, |
| | 2021 | | 2020 |
Assets | | | | |
Derivatives, reported in Short-term and other investments | | $ | 10.7 | | | $ | 16.8 | |
| | | | |
Liabilities | | | | |
FIA - embedded derivatives, reported in Other policyholder funds | | 106.6 | | | 104.5 | |
IUL - embedded derivatives, reported in Investment contract and policy reserves | | 2.1 | | | 2.5 | |
In general, the change in the fair value of the embedded derivatives related to FIA will not correspond to the change in fair value of the purchased call options because the purchased call options are one-year options while the options valued in the embedded derivatives represent the rights of the policyholder to receive index credits over the entire period the FIA contracts are expected to be in force, which typically exceeds 10 years. The changes in fair value of derivatives included in the Consolidated Statements of Operations were as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Years Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Change in fair value of derivatives:(1) | | | | | | |
Revenues | | | | | | |
Net investment gains (losses) | | $ | 8.7 | | | $ | 0.2 | | | $ | 9.5 | |
| | | | | | |
Change in fair value of embedded derivatives: | | | | | | |
Revenues | | | | | | |
Net investment gains (losses) | | (11.3) | | | (12.1) | | | (13.6) | |
(1) Includes gains or losses recognized at option expiration or early termination and changes in fair value for open positions.
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 101 |
NOTE 5 - Derivatives (continued)
The Company's strategy attempts to mitigate potential risk of loss under these agreements through a regular monitoring process, which evaluates the program's effectiveness. The Company is exposed to risk of loss in the event of nonperformance by the counterparties and, accordingly, option contracts are purchased from multiple counterparties, which are evaluated for creditworthiness prior to purchase of the contracts. All of these options have been purchased from nationally recognized financial institutions with a S&P/Moody's Investors Service, Inc. (Moody's) long-term credit rating of "BBB+/A3" or higher at the time of purchase and the maximum credit exposure to any single counterparty is subject to concentration limits. The Company also obtains credit support agreements that allow it to request the counterparty to provide cash collateral when the fair value of the exposure to the counterparty exceeds specified amounts.
The notional amount and fair value of call options by counterparty and each counterparty's long-term credit ratings were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | December 31, 2021 | | December 31, 2020 |
| | Credit Rating | | Notional Amount | | Fair Value | | Notional Amount | | Fair Value |
Counterparty | | S&P | | Moody's | | | | |
Bank of America, N.A. | | A+ | | Aa2 | | $ | 193.0 | | | $ | 6.3 | | | $ | 205.2 | | | $ | 14.0 | |
Barclays Bank PLC | | A | | A1 | | 98.7 | | | 4.1 | | | 81.9 | | | 2.8 | |
Citigroup Inc. | | BBB+ | | A3 | | — | | | — | | | — | | | — | |
Credit Suisse International | | A+ | | A1 | | 14.0 | | | 0.3 | | | — | | | — | |
Societe Generale | | A | | A1 | | — | | | — | | | — | | | — | |
Total | | | | | | $ | 305.7 | | | $ | 10.7 | | | $ | 287.1 | | | $ | 16.8 | |
As of December 31, 2021 and 2020, the Company held $10.9 million and $16.3 million, respectively, of cash and financial instruments received from counterparties for derivative collateral, which is included in Other liabilities on the Consolidated Balance Sheets. This derivative collateral limits the Company's maximum amount of economic loss due to credit risk that would be incurred if parties to the call options failed completely to perform according to the terms of the contracts to $0.3 million per counterparty.
NOTE 6 - Deposit Asset on Reinsurance
The Company reinsures a $3.2 billion block of in force fixed and variable annuity business with a minimum crediting rate of 4.5%. The reinsured fixed business represents approximately 50% of the Company’s in force fixed annuity account balances. The arrangement contains investment guidelines and a trust to help meet the Company’s risk management objectives.
Under the annuity reinsurance agreement, approximately $2.4 billion of fixed annuity reserves are reinsured on a coinsurance basis. The separate account assets and liabilities of approximately $0.8 billion are reinsured on a modified coinsurance basis and thus, remain on the Company's consolidated financial statements, but the related results of operations are fully reinsured.
The annuity reinsurance agreement does not expose the reinsurer to a reasonable possibility of a significant loss from insurance risk. Therefore, the Company recognizes the annuity reinsurance agreement using the deposit method of accounting. The assets transferred to the reinsurer as consideration paid is reported as a Deposit asset on reinsurance on the Company's Consolidated Balance Sheets. As amounts are received or paid, consistent with the underlying reinsured contracts, the Deposit asset on reinsurance is adjusted. The Deposit asset on reinsurance is accreted to the estimated ultimate cash flows using the interest method and the adjustment is reported as Net investment income. Interest accreted on the Deposit asset on reinsurance was $101.1 million and $97.3 million for the years ended December 31, 2021 and 2020, respectively.
| | | | | | | | |
102 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 7 - Goodwill and Intangible Assets
The Company conducts goodwill impairment testing at the reporting unit level at least annually or more frequently if events occur or circumstances change that indicate that the carrying amount may not be recoverable. See Note 1 for further description of impairment testing.
At October 1, 2021, the Company performed a quantitative goodwill impairment test. Based on the results of the test, there were no events or circumstances that led to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.
At October 1, 2020, the Company performed a quantitative goodwill impairment test. Based on the results of the test, there were no events or circumstances that led to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount with exception to lower than anticipated BCG wealth management sales outside of the education markets which triggered an impairment of the goodwill associated with the BCG business of the Retirement reporting unit. For the evaluation, the fair value of BCG was measured using a discounted cash flow method. The carrying amount exceeded the fair value, resulting in a $5.6 million goodwill impairment charge.
In 2019, an annuity reinsurance transaction as described in Note 6 triggered a requirement to evaluate the goodwill associated with the annuity business of the Retirement reporting unit. For the evaluation, the fair value of the Retirement reporting unit was measured using a discounted cash flow method. The carrying amount exceeded the fair value, resulting in a $28.0 million goodwill impairment charge.
Goodwill impairment charges are reported as Other expense - goodwill and intangible asset impairments in the Consolidated Statements of Operations.
The changes in the carrying amount of goodwill by reportable segment for the year ended December 31, 2021 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | December 31, 2020 | | Impairments | | Acquisitions | | December 31, 2021 |
Property & Casualty | | $ | 9.5 | | | $ | — | | | $ | — | | | $ | 9.5 | |
Supplemental | | 19.6 | | | — | | | — | | | 19.6 | |
Retirement | | 4.5 | | | — | | | — | | | 4.5 | |
Life | | 9.9 | | | — | | | — | | | 9.9 | |
Total | | $ | 43.5 | | | $ | — | | | $ | — | | | $ | 43.5 | |
As of December 31, 2021, the outstanding amounts of definite-lived intangible assets subject to amortization are attributable to the acquisitions of BCG and NTA during 2019. The acquisition of BCG resulted in initial recognition of definite-lived intangible assets subject to amortization in the amount of $14.1 million and the acquisition of NTA resulted in initial recognition of definite-lived intangible assets subject to amortization in the amount of $160.4 million. As of December 31, 2021 the outstanding amounts of definite-lived intangible assets subject to amortization were as follows:
| | | | | | | | | | | | | | |
($ in millions) | | Weighted Average Useful Life (in Years) | | |
At inception: | | | | |
Value of business acquired | | 30 | | $ | 94.4 | |
Value of distribution acquired | | 17 | | 54.0 | |
Value of agency relationships | | 14 | | 17.0 | |
Value of customer relationships | | 10 | | 9.1 | |
Total | | 23 | | 174.5 | |
Accumulated amortization and impairments: | | | | |
Value of business acquired | | | | (17.6) | |
Value of distribution acquired | | | | (11.6) | |
Value of agency relationships | | | | (6.3) | |
Value of customer relationships | | | | (4.4) | |
Total | | | | (39.9) | |
Net intangible assets subject to amortization: | | | | $ | 134.6 | |
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Horace Mann Educators Corporation | | Annual Report on Form 10-K 103 |
NOTE 7 - Goodwill and Intangible Assets (continued)
In regard to the definite-lived intangible assets in the table above, the VOBA intangible asset represents the difference between the fair value of insurance contracts and insurance policy reserves measured in accordance with the Company's accounting policies for insurance contracts acquired. VOBA was based on an actuarial estimate of the present value of future distributable earnings for insurance in force as of the acquisition date. The VODA intangible asset represents the present value of future business to be written by the existing distribution channel. The value of agency relationships intangible asset represents the present value of the commission overrides retained by NTA. The value of customer relationships intangible asset represents the present value of the expected profits from existing BCG customers in force at the date of acquisition. All of the aforementioned definite-lived intangible assets were valued using the income approach.
Estimated future amortization of the Company's definite-lived intangible assets were as follows:
| | | | | | | | |
($ in millions) | | |
Year Ending December 31, | | |
2022 | | $ | 12.1 | |
2023 | | 11.2 | |
2024 | | 10.5 | |
2025 | | 9.8 | |
2026 | | 9.2 | |
Thereafter | | 81.8 | |
Total | | $ | 134.6 | |
The VOBA intangible asset is being amortized by product based on the present value of future premiums to be received. The VODA intangible asset in respect to the acquisition of NTA is being amortized on a straight-line basis. The VODA intangible asset in respect to the acquisition of BCG is being amortized based on the present value of future profits to be received. The value of agency relationships intangible asset is being amortized based on the present value of future premiums to be received. The value of customer relationships intangible asset is being amortized based on the present value of future profits to be received.
Indefinite-lived intangible assets (not subject to amortization) as of December 31, 2021 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | December 31, 2020 | | Impairments | | Acquisitions | | December 31, 2021 |
Trade names | | $ | 7.9 | | | $ | — | | | $ | — | | | $ | 7.9 | |
State licenses | | 2.9 | | | — | | | — | | | 2.9 | |
Total | | $ | 10.8 | | | $ | — | | | $ | — | | | $ | 10.8 | |
The trade names intangible asset represents the present value of future savings accruing NTA and BCG by virtue of not having to pay royalties for the use of the trade names, valued using the relief from royalty method. The state licenses intangible asset represents the regulatory licenses held by NTA that were valued using the cost approach.
The Company conducts intangible asset impairment testing at least annually, or more often if events, changes or circumstances indicate that the carrying amounts may not be recoverable. See Note 1 for further description of impairment testing.
At October 1, 2021, the Company performed a qualitative assessment to determine whether it was necessary to perform quantitative intangible asset impairment tests. Based on the assessment of qualitative factors, there were no events or circumstances that led to a determination that it is more likely than not that the fair value of an intangible asset is less than its carrying amount.
At October 1, 2020, the Company performed a qualitative assessment to determine whether it was necessary to perform quantitative intangible asset impairment tests. Based on the assessment of qualitative factors, there were no events or circumstances that led to a determination that it is more likely than not that the fair value of an intangible asset is less than its carrying amount with exception to lower than anticipated BCG wealth management sales outside of the education markets which triggered a requirement to evaluate the intangible assets associated with BCG. For the evaluation, the fair value of BCG's intangible assets were measured using discounted cash flow methods. The carrying amounts for VODA and trade names exceeded the fair values
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104 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 7 - Goodwill and Intangible Assets (continued)
resulting in a $3.6 million intangible asset impairment charge for VODA and a $0.8 million intangible asset impairment charge for trade names.
Intangible asset impairment charges are reported as Other expense - goodwill and intangible asset impairments in the Consolidated Statements of Operations.
NOTE 8 - Unpaid Claims and Claim Expenses
The following table is a summary reconciliation of the beginning and ending Property & Casualty unpaid claims and claim expense reserves for the periods indicated. The table presents reserves on both a gross and net (after reinsurance) basis. The total net Property & Casualty insurance claims and claim expense incurred amounts are reflected in the Consolidated Statements of Operations. The end of the year gross reserve (before reinsurance) balances and the reinsurance recoverable balances are reflected on a gross basis in the Consolidated Balance Sheets.
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Years Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Property & Casualty segment | | | | | | |
Gross reserves, beginning of year(1) | | $ | 372.2 | | | $ | 387.0 | | | $ | 367.2 | |
Less: reinsurance recoverables | | 112.9 | | | 120.5 | | | 89.7 | |
Net reserves, beginning of year(2) | | 259.3 | | | 266.5 | | | 277.5 | |
Incurred claims and claim expenses: | | | | | | |
Claims occurring in the current year | | 455.1 | | | 441.2 | | | 483.1 | |
Decrease in estimated reserves for claims occurring in prior years(3) | | (7.2) | | | (10.2) | | | (7.5) | |
Total claims and claim expenses incurred(4) | | 447.9 | | | 431.0 | | | 475.6 | |
Claims and claim expense payments for claims occurring during: | | | | | | |
Current year | | 307.1 | | | 291.4 | | | 329.5 | |
Prior years | | 148.0 | | | 146.8 | | | 157.1 | |
Total claims and claim expense payments | | 455.1 | | | 438.2 | | | 486.6 | |
Net reserves, end of year(2) | | 252.1 | | | 259.3 | | | 266.5 | |
Plus: reinsurance recoverables | | 110.3 | | | 112.9 | | | 120.5 | |
Gross reserves, end of year(1) | | $ | 362.4 | | | $ | 372.2 | | | $ | 387.0 | |
(1) Unpaid claims and claim expenses as reported in the Consolidated Balance Sheets also include reserves for Supplemental, Retirement and Life of $63.5 million, $66.6 million and $55.9 million as of December 31, 2021, 2020 and 2019, respectively, in addition to Property & Casualty reserves.
(2) Reserves are net of anticipated reinsurance recoverables.
(3) Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims and changes in their projected final settlement costs. Also refer to the paragraphs below for additional information regarding prior years' reserve development recognized in 2021, 2020 and 2019.
(4) Benefits, claims and settlement expenses as reported in the Consolidated Statements of Operations also include amounts for Supplemental, Retirement and Life of $169.8 million, $137.9 million, and $109.5 million for the years ended December 31, 2021, 2020 and 2019, respectively, in addition to Property & Casualty amounts.
Underwriting results for Property & Casualty are significantly influenced by estimates of the Company's ultimate liability for insured events. There is a high degree of uncertainty inherent in the estimates of ultimate losses underlying the liability for unpaid claims and claim settlement expenses. This inherent uncertainty is particularly significant for liability-related exposures due to the extended period, often many years, which transpires between a loss event, receipt of related claims data from policyholders and ultimate settlement of the claim. Reserves for Property & Casualty claims include provisions for payments to be made on reported claims (case reserves), IBNR claims 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 Company's 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, public attitudes and medical costs.
The Company believes the Property & Casualty loss reserves are appropriately established based on available facts, laws, and regulations. The Company calculates and recognizes a single best estimate of the reserve (which is equal to the actuarial point estimate) as of each reporting date, for each line of business and its coverages for reported losses and for IBNR losses and as a result, the Company believes no other estimate is
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 105 |
NOTE 8 - Unpaid Claims and Claim Expenses (continued)
better than the recognized amount. Due to uncertainties involved, the ultimate cost of losses may vary materially from recognized amounts.
The Company continually updates loss estimates using both quantitative and qualitative information from its reserving actuaries and information derived from other sources. Adjustments may be required as information develops which varies from experience, or, in some cases, augments data which previously was not considered sufficient for use in determining liabilities. The effects of these adjustments may be significant and are charged or credited to income in the period in which the adjustments are made.
Numerous risk factors will affect more than one product line. One of these factors is changes in claim department practices, including claim closure rates, number of claims closed without payment, the use of third-party claim adjusters and the level of needed case reserve estimated by the adjuster. Other risk factors include changes in claim frequency, changes in claim severity, regulatory and legislative actions, court actions, changes in economic conditions and trends (e.g., medical costs, labor rates and the cost of materials), the occurrence of unusually large or frequent catastrophic loss events, timeliness of claim reporting, the state in which the claim occurred and degree of claimant fraud. The extent of the impact of a risk factor will also vary by coverages within a product line. Individual risk factors are also subject to interactions with other risk factors within product line coverages.
While all product lines are exposed to these risks, there are some loss types or product lines for which the financial effect will be more significant. For instance, given the relatively large proportion (approximately 74.0% as of December 31, 2021) of the Company's reserves that are in the longer-tail auto liability coverages, regulatory and court actions, changes in economic conditions and trends, and medical costs could be expected to impact this product line more extensively than others.
Reserves are established for claims as they occur for each line of business based on estimates of the ultimate cost to settle the claims. The actual loss results are compared to prior estimates and differences are recorded as re-estimates. The primary actuarial techniques (development of paid loss dollars, development of reported loss dollars, methods based on expected loss ratios and methods utilizing frequency and severity of claims) used to estimate reserves and provide for losses are applied to actual paid losses and reported losses (paid losses plus individual case reserves set by claim adjusters) for an accident year to create an estimate of how losses are likely to develop over time.
An accident year refers to classifying claims based on the year in which the claims occurred. For estimating short-tail coverage reserves (e.g., homeowners and auto physical damage), which comprise approximately 26.0% of the Company's total loss reserves as of December 31, 2021, the primary actuarial technique utilized is the development of paid loss dollars due to the relatively quick claim settlement period. As it relates to estimating long-tail coverage reserves (primarily related to auto liability), which comprise approximately 74.0% of the Company's total loss reserves as of December 31, 2021, the primary actuarial technique utilized is the development of reported loss dollars due to the relatively long claim settlement period.
In all of the loss estimation techniques referred to above, a ratio (development factor) is calculated which compares current results to results in the prior period for each accident year. Various development factors, based on historical results, are multiplied by the current experience to estimate the development of losses of each accident year from the current time period into the next time period. The development factors for the next time period for each accident year are compounded over the remaining calendar years to calculate an estimate of ultimate losses for each accident year. Occasionally, unusual aberrations in loss patterns are caused by factors such as changes in claim reporting, settlement patterns, unusually large losses, process changes, legal or regulatory environment changes, and other influences. In these instances, analyses of alternate development factor selections are performed to evaluate the effect of these factors and judgment is applied to make appropriate development factor assumptions needed to develop a best estimate of ultimate losses. Paid losses are then subtracted from estimated ultimate losses to determine the indicated loss reserves. The difference between indicated reserves and recorded reserves is the amount of reserve re-estimate.
Reserves are re-estimated quarterly. When new development factors are calculated from actual losses that differ from estimated development factors used in previous reserve estimates, assumptions about losses and required reserves are revised based on the new development factors. Changes to reserves are recognized in the period in which development factor changes result in reserve re-estimates.
Claim count estimates are also established for claims as they occur for each line of business based on estimates of the ultimate claim counts. These counts are derived by counting the number of claimants by insurance
| | | | | | | | |
106 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 8 - Unpaid Claims and Claim Expenses (continued)
coverage. The primary actuarial techniques (development of paid claim counts and development of reported claim counts) used to estimate ultimate claim counts are applied to actual paid claim counts and reported claim counts (paid claims plus individual unpaid claims set by claim adjusters) for an accident year to create an estimate of how claims are likely to develop over time. An accident year refers to classifying claims based on the year in which the claim occurred. The ultimate claim count generally gives equal consideration to the results of the two actuarial techniques described.
Occasionally, unusual aberrations in claim reporting patterns or claim payment patterns may occur. In these instances, analyses of alternate development factor selections are performed to evaluate the effect of these factors and judgment is applied to make appropriate development factor assumptions needed to develop a best estimate of ultimate claims.
See tables on the following pages of Note 8 for details of the average annual percentage payout of incurred claims by age, also referred to as a history of claims duration and tables illustrating the incurred and paid claims development information by accident year on a net basis for the lines of homeowners, auto liability, and auto physical damage, which represents 99.0% of the Company's incurred losses for 2021.
Numerous actuarial estimates of the types described above are prepared each quarter to monitor losses for each line of business, including the line's individual coverages, for reported losses and IBNR. Often, several different estimates are prepared for each detailed component, incorporating alternative analyses of changing claim settlement patterns and other influences on losses, from which the Company selects the best estimate for each component, occasionally incorporating additional analyses and judgment, as described above. These estimates also incorporate the historical impact of inflation into reserve estimates, the implicit assumption being that a multi-year average development factor represents an adequate provision. Based on the Company's review of these estimates, as well as the review of independent reserve studies, the best estimate of required reserves for each line of business, including the line's individual coverages, is determined by management and is recognized for each accident year, then the required reserves for each component are summed to create the reserve balances carried on the Company's Consolidated Balance Sheets.
Based on the Company's products and coverages, historical experience, and various actuarial methodologies used to develop reserve estimates, the Company estimates that the potential variability of the Property & Casualty loss reserves within a reasonable probability of other possible outcomes may be approximately plus or minus 6.0% of reserves, which equates to plus or minus approximately $12.0 million of net income as of December 31, 2021. Although this evaluation reflects the most likely outcomes, it is possible the final outcome may fall below or above these estimates.
Net favorable development of total reserves for Property & Casualty claims occurring in prior years was $7.2 million in 2021, $10.2 million in 2020 and $7.5 million in 2019. In 2021, the favorable development was the result of favorable loss trends in auto and homeowners loss emergence for accident years 2020 and prior. In 2020, the favorable development was predominantly the result of favorable loss trends in property for accident years 2019 and prior including the recognition of $4.8 million of subrogation received on the 2018 Camp Fire event. In 2019, the favorable development was predominantly the result of favorable loss trends in auto for accident years 2018 and prior.
The Company completes a detailed study of Property & Casualty reserves based on information available at the end of each quarter and year. Trends of reported losses (paid amounts and case reserves on claims reported to the Company) for each accident year are reviewed and ultimate loss costs for those accident years are estimated. The Company engages an independent property and casualty actuarial consulting firm to prepare an independent study of the Company's Property & Casualty reserves at December 31st of each year. The result of the independent actuarial study at December 31, 2021 was consistent with management's analysis and selected estimates and did not result in any adjustments to the Company's Property & Casualty reserves recognized.
At the time each of the reserve analyses was performed, the Company believed that each estimate was based upon sound methodology and such methodologies were appropriately applied and that there were no trends which indicated the likelihood of future loss reserve development. The financial impact of the net reserve development was therefore accounted for in the period that the development was determined.
No other adjustments were made in the determination of the liabilities during the periods covered by these consolidated financial statements. Management believes that, based on data currently available, it has reasonably estimated the Company's ultimate losses.
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 107 |
NOTE 8 - Unpaid Claims and Claim Expenses (continued)
Below is the average annual percentage payout of incurred claims by age, also referred to as a history of claims duration:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance |
Years | | 1 | | 2 | | 3 | | 4 | | 5 | | 6 | | 7 | | 8 | | 9 | | 10 |
Homeowners | | 79.6 | % | | 17.1 | % | | 2.0 | % | | 0.6 | % | | 0.5 | % | | 0.2 | % | | — | | | — | | | — | | | — | |
Auto liability | | 40.0 | % | | 34.2 | % | | 14.1 | % | | 6.5 | % | | 3.3 | % | | 1.3 | % | | 0.5 | % | | 0.1 | % | | — | | | — | |
Auto physical damage | | 95.6 | % | | 4.7 | % | | (0.3) | % | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
The following tables illustrate the incurred and paid claims development by accident year on a net basis for the lines of homeowners, auto liability and auto physical damage. Conditions and trends that have affected the development of these reserves in the past will not necessarily reoccur in the future. It may not be appropriate to use this cumulative history in the projection of future performance.
The information about incurred and paid claims development for the years ended December 31, 2012 to 2020 is presented as unaudited supplementary information.
| | | | | | | | |
108 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 8 - Unpaid Claims and Claim Expenses (continued)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) |
Homeowners | | |
Incurred Claims and Allocated Claim Adjustment Expense, Net of Reinsurance | | | | |
Years Ended December 31, | | As of December 31, 2021 |
| | | | | | | | | | | | | | | | | | | | | | Total of Incurred- But-Not-Reported Liabilities Plus Expected Development on Reported Claims | | Cumulative Number of Reported Claims |
| | | | | | | | | | | | | | | | | | | | | | |
Accident | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | | | |
Year | | 2012 | | 2013 | | 2014 | | 2015 | | 2016 | | 2017 | | 2018 | | 2019 | | 2020 | | 2021 | | |
2012 | | $ | 108.8 | | | $ | 109.2 | | | $ | 109.4 | | | $ | 106.5 | | | $ | 106.3 | | | $ | 106.3 | | | $ | 106.0 | | | $ | 106.0 | | | $ | 106.0 | | | $ | 106.0 | | | $ | — | | | 21.6 | |
2013 | | | | 105.6 | | | 107.5 | | | 104.0 | | | 102.4 | | | 102.3 | | | 101.8 | | | 101.7 | | | 101.7 | | | 101.7 | | | — | | | 19.2 | |
2014 | | | | | | 111.6 | | | 113.5 | | | 109.1 | | | 106.8 | | | 106.6 | | | 106.6 | | | 106.4 | | | 106.4 | | | — | | | 20.1 | |
2015 | | | | | | | | 111.7 | | | 115.1 | | | 114.4 | | | 114.1 | | | 115.1 | | | 114.9 | | | 114.9 | | | — | | | 18.7 | |
2016 | | | | | | | | | | 115.9 | | | 118.6 | | | 117.0 | | | 117.9 | | | 117.9 | | | 117.9 | | | — | | | 19.9 | |
2017 | | | | | | | | | | | | 126.3 | | | 129.8 | | | 132.7 | | | 130.7 | | | 130.8 | | | 0.3 | | | 19.9 | |
2018 | | | | | | | | | | | | | | 166.8 | | | 157.4 | | | 158.9 | | | 158.1 | | | 0.4 | | | 21.1 | |
2019 | | | | | | | | | | | | | | | | 130.4 | | | 129.9 | | | 132.1 | | | 2.5 | | | 17.5 | |
2020 | | | | | | | | | | | | | | | | | | 155.7 | | | 151.9 | | | 11.1 | | | 19.6 | |
2021 | | | | | | | | | | | | | | | | | | | | 150.2 | | | 22.6 | | | 15.5 | |
| | | | | | | | | | | | | | | | | | Total | | $ | 1,270.0 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | | | |
Homeowners | | | | |
Cumulative Paid Claims and Allocated Claim Adjustment Expense, Net of Reinsurance | | | | |
Years Ended December 31, | | | | |
Accident | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | | | | | |
Year | | 2012 | | 2013 | | 2014 | | 2015 | | 2016 | | 2017 | | 2018 | | 2019 | | 2020 | | 2021 | | | | |
2012 | | $ | 84.3 | | | $ | 101.6 | | | $ | 104.2 | | | $ | 105.2 | | | $ | 105.6 | | | $ | 105.9 | | | $ | 106.0 | | | $ | 106.0 | | | $ | 106.0 | | | $ | 106.0 | | | | | |
2013 | | | | 76.9 | | | 96.6 | | | 99.4 | | | 101.0 | | | 101.5 | | | 101.7 | | | 101.7 | | | 101.7 | | | 101.7 | | | | | |
2014 | | | | | | 83.3 | | | 103.0 | | | 105.7 | | | 106.1 | | | 106.3 | | | 106.4 | | | 106.4 | | | 106.4 | | | | | |
2015 | | | | | | | | 90.7 | | | 109.3 | | | 111.9 | | | 113.3 | | | 114.6 | | | 114.9 | | | 114.7 | | | | | |
2016 | | | | | | | | | | 95.8 | | | 113.2 | | | 115.1 | | | 117.5 | | | 117.7 | | | 117.8 | | | | | |
2017 | | | | | | | | | | | | 106.8 | | | 128.5 | | | 129.8 | | | 130.0 | | | 130.5 | | | | | |
2018 | | | | | | | | | | | | | | 130.5 | | | 152.4 | | | 157.0 | | | 157.4 | | | | | |
2019 | | | | | | | | | | | | | | | | 103.8 | | | 126.2 | | | 129.1 | | | | | |
2020 | | | | | | | | | | | | | | | | | | 106.8 | | | 138.7 | | | | | |
2021 | | | | | | | | | | | | | | | | | | | | 114.9 | | | | | |
| | | | | | | | | | | | | | | Total | | 1,217.2 | | | | | |
| | | | | | | | | | | | | | | Outstanding prior to 2012 | | — | | | | | |
| | | | | | | | | | | | | | | Prior years paid | | — | | | | | |
| | | | | | | | | | | | | | | Liabilities for claims and claim adjustment expenses, net of reinsurance | | $ | 52.8 | | | | | |
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 109 |
NOTE 8 - Unpaid Claims and Claim Expenses (continued)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) |
Auto Liability | | |
Incurred Claims and Allocated Claim Adjustment Expense, Net of Reinsurance | | |
Years Ended December 31, | | As of December 31, 2021 |
| | | | | | | | | | | | | | | | | | | | | | Total of Incurred- But-Not-Reported Liabilities Plus Expected Development on Reported Claims | | Cumulative Number of Reported Claims |
| | | | | | | | | | | | | | | | | | | | | | |
Accident | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | | | |
Year | | 2012 | | 2013 | | 2014 | | 2015 | | 2016 | | 2017 | | 2018 | | 2019 | | 2020 | | 2021 | | |
2012 | | $ | 156.4 | | | $ | 153.8 | | | $ | 150.3 | | | $ | 149.3 | | | $ | 147.6 | | | $ | 145.8 | | | $ | 145.6 | | | $ | 145.5 | | | $ | 145.9 | | | $ | 145.8 | | | $ | — | | | 18.6 | |
2013 | | | | 153.9 | | | 152.9 | | | 150.7 | | | 150.7 | | | 148.1 | | | 148.0 | | | 148.1 | | | 148.3 | | | 147.7 | | | — | | | 19.4 | |
2014 | | | | | | 155.1 | | | 157.2 | | | 158.5 | | | 159.9 | | | 159.8 | | | 159.4 | | | 159.3 | | | 159.4 | | | 0.2 | | | 20.3 | |
2015 | | | | | | | | 165.5 | | | 172.6 | | | 177.0 | | | 178.3 | | | 178.7 | | | 179.2 | | | 178.9 | | | 0.4 | | | 20.8 | |
2016 | | | | | | | | | | 180.4 | | | 184.4 | | | 184.6 | | | 186.6 | | | 188.1 | | | 189.2 | | | 0.5 | | | 21.3 | |
2017 | | | | | | | | | | | | 188.0 | | | 188.8 | | | 188.6 | | | 189.1 | | | 191.7 | | | 1.9 | | | 20.1 | |
2018 | | | | | | | | | | | | | | 200.3 | | | 195.3 | | | 192.9 | | | 189.8 | | | 3.8 | | | 19.5 | |
2019 | | | | | | | | | | | | | | | | 181.1 | | | 180.1 | | | 176.7 | | | 8.9 | | | 18.9 | |
2020 | | | | | | | | | | | | | | | | | | 137.0 | | | 134.9 | | | 20.1 | | | 13.1 | |
2021 | | | | | | | | | | | | | | | | | | | | 142.2 | | | 55.3 | | | 12.8 | |
| | | | | | | | | | | | | | | | | | Total | | $ | 1,656.3 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | | | |
Auto Liability | | | | |
Cumulative Paid Claims and Allocated Claim Adjustment Expense, Net of Reinsurance | | | | |
Years Ended December 31, | | | | |
Accident | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | | | | | |
Year | | 2012 | | 2013 | | 2014 | | 2015 | | 2016 | | 2017 | | 2018 | | 2019 | | 2020 | | 2021 | | | | |
2012 | | $ | 61.3 | | | $ | 109.6 | | | $ | 127.2 | | | $ | 138.6 | | | $ | 142.9 | | | $ | 144.6 | | | $ | 145.1 | | | $ | 145.2 | | | $ | 145.3 | | | $ | 145.3 | | | | | |
2013 | | | | 62.2 | | | 108.9 | | | 131.2 | | | 140.0 | | | 145.3 | | | 146.8 | | | 147.4 | | | 147.4 | | | 147.5 | | | | | |
2014 | | | | | | 61.3 | | | 117.5 | | | 139.5 | | | 149.1 | | | 155.8 | | | 157.6 | | | 158.6 | | | 158.8 | | | | | |
2015 | | | | | | | | 70.8 | | | 134.5 | | | 158.0 | | | 170.1 | | | 174.5 | | | 176.7 | | | 177.7 | | | | | |
2016 | | | | | | | | | | 73.1 | | | 140.9 | | | 166.8 | | | 177.8 | | | 184.5 | | | 188.1 | | | | | |
2017 | | | | | | | | | | | | 70.7 | | | 139.5 | | | 166.6 | | | 179.8 | | | 185.8 | | | | | |
2018 | | | | | | | | | | | | | | 77.5 | | | 141.5 | | | 168.6 | | | 180.7 | | | | | |
2019 | | | | | | | | | | | | | | | | 69.7 | | | 129.1 | | | 155.5 | | | | | |
2020 | | | | | | | | | | | | | | | | | | 51.5 | | | 94.0 | | | | | |
2021 | | | | | | | | | | | | | | | | | | | | 52.9 | | | | | |
| | | | | | | | | | | | | | | Total | | 1,486.3 | | | | | |
| | | | | | | | | | | | | | | Outstanding prior to 2012 | | 1.5 | | | | | |
| | | | | | | | | | | | | | | Prior years paid | | — | | | | | |
| | | | | | | | | | | | | | | Liabilities for claims and claim adjustment expenses, net of reinsurance | | $ | 171.5 | | | | | |
| | | | | | | | |
110 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 8 - Unpaid Claims and Claim Expenses (continued)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) |
Auto Physical Damage | | |
Incurred Claims and Allocated Claim Adjustment Expense, Net of Reinsurance | | |
Years Ended December 31, | | As of December 31, 2021 |
| | | | | | | | | | | | | | | | | | | | | | Total of Incurred- But-Not-Reported Liabilities Plus Expected Development on Reported Claims | | Cumulative Number of Reported Claims |
| | | | | | | | | | | | | | | | | | | | | | |
Accident | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | | | |
Year | | 2012 | | 2013 | | 2014 | | 2015 | | 2016 | | 2017 | | 2018 | | 2019 | | 2020 | | 2021 | | |
2012 | | $ | 83.8 | | | $ | 82.3 | | | $ | 83.4 | | | $ | 83.4 | | | $ | 83.4 | | | $ | 83.3 | | | $ | 83.3 | | | $ | 83.3 | | | $ | 83.3 | | | $ | 83.3 | | | $ | — | | | 78.2 | |
2013 | | | | 91.4 | | | 88.9 | | | 88.7 | | | 88.6 | | | 88.5 | | | 88.5 | | | 88.5 | | | 88.5 | | | 88.4 | | | — | | | 80.9 | |
2014 | | | | | | 95.6 | | | 95.6 | | | 95.4 | | | 95.2 | | | 95.2 | | | 95.2 | | | 95.2 | | | 95.2 | | | — | | | 87.9 | |
2015 | | | | | | | | 99.3 | | | 98.0 | | | 97.6 | | | 97.5 | | | 97.6 | | | 97.6 | | | 97.6 | | | — | | | 87.5 | |
2016 | | | | | | | | | | 112.4 | | | 109.5 | | | 109.3 | | | 109.6 | | | 109.6 | | | 109.5 | | | — | | | 93.2 | |
2017 | | | | | | | | | | | | 115.5 | | | 111.8 | | | 110.5 | | | 110.6 | | | 110.5 | | | — | | | 91.3 | |
2018 | | | | | | | | | | | | | | 109.0 | | | 108.9 | | | 108.3 | | | 108.3 | | | — | | | 94.5 | |
2019 | | | | | | | | | | | | | | | | 111.6 | | | 110.5 | | | 110.0 | | | (0.2) | | | 92.2 | |
2020 | | | | | | | | | | | | | | | | | | 87.0 | | | 86.9 | | | (0.8) | | | 68.8 | |
2021 | | | | | | | | | | | | | | | | | | | | 105.0 | | | (6.7) | | | 69.7 | |
| | | | | | | | | | | | | | | | | | Total | | $ | 994.7 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | | | |
Auto Physical Damage | | | | |
Cumulative Paid Claims and Allocated Claim Adjustment Expense, Net of Reinsurance | | | | |
Years Ended December 31, | | | | |
Accident | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | Unaudited | | | | | | |
Year | | 2012 | | 2013 | | 2014 | | 2015 | | 2016 | | 2017 | | 2018 | | 2019 | | 2020 | | 2021 | | | | |
2012 | | $ | 80.5 | | | $ | 83.4 | | | $ | 83.4 | | | $ | 83.4 | | | $ | 83.3 | | | $ | 83.3 | | | $ | 83.3 | | | $ | 83.3 | | | $ | 83.3 | | | $ | 83.3 | | | | | |
2013 | | | | 85.1 | | | 88.7 | | | 88.6 | | | 88.5 | | | 88.5 | | | 88.5 | | | 88.5 | | | 88.4 | | | 88.4 | | | | | |
2014 | | | | | | 88.9 | | | 95.4 | | | 95.3 | | | 95.3 | | | 95.3 | | | 95.2 | | | 95.2 | | | 95.2 | | | | | |
2015 | | | | | | | | 92.1 | | | 97.9 | | | 97.7 | | | 97.6 | | | 97.6 | | | 97.6 | | | 97.6 | | | | | |
2016 | | | | | | | | | | 106.5 | | | 109.7 | | | 109.5 | | | 109.6 | | | 109.6 | | | 109.6 | | | | | |
2017 | | | | | | | | | | | | 105.2 | | | 110.8 | | | 110.7 | | | 110.6 | | | 110.6 | | | | | |
2018 | | | | | | | | | | | | | | 103.6 | | | 109.1 | | | 108.3 | | | 108.3 | | | | | |
2019 | | | | | | | | | | | | | | | | 106.2 | | | 110.7 | | | 110.1 | | | | | |
2020 | | | | | | | | | | | | | | | | | | 84.1 | | | 87.6 | | | | | |
2021 | | | | | | | | | | | | | | | | | | | | 97.3 | | | | | |
| | | | | | | | | | | | | | | Total | | 988.0 | | | | | |
| | | | | | | | | | | | | | | Outstanding prior to 2012 | | — | | | | | |
| | | | | | | | | | | | | | | Prior years paid | | — | | | | | |
| | | | | | | | | | | | | | | Liabilities for claims and claim adjustment expenses, net of reinsurance | | $ | 6.7 | | | | | |
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 111 |
NOTE 8 - Unpaid Claims and Claim Expenses (continued)
The reconciliation of the net incurred and paid claims development tables to the liability for claims and claim adjustment expenses in the Consolidated Balance Sheet is as follows:
| | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 |
Property & Casualty segment | | |
Net reserves | | |
Homeowners | | $ | 52.8 | |
Auto liability | | 171.5 | |
Auto physical damage | | 6.7 | |
Other short duration lines | | 2.8 | |
Total net reserves for unpaid claims and claim adjustment expense, net of reinsurance | | 233.8 | |
| | |
Reinsurance recoverable on unpaid claims | | |
Homeowners | | 1.4 | |
Auto liability | | 99.9 | |
Other short duration lines | | 9.0 | |
Total reinsurance recoverable on unpaid claims | | 110.3 | |
| | |
Insurance lines other than short duration(1) | | 63.5 | |
Unallocated claims adjustment expenses | | 18.3 | |
Total other than short duration and unallocated claims adjustment expenses | | 81.8 | |
| | |
Gross reserves, end of year(1) | | $ | 425.9 | |
(1) This line includes Supplemental, Retirement and Life reserves included in the Consolidated Balance Sheet.
NOTE 9 - Reinsurance and Catastrophes
In the normal course of business, the Company's insurance subsidiaries assume and cede reinsurance with other insurers. Reinsurance is ceded primarily to limit losses from large events and to permit recovery of a portion of direct losses; however, such a transfer does not relieve the originating insurance company of primary liability.
The Company is a national underwriter and therefore has exposure to catastrophic losses in certain coastal states and other regions throughout the U.S. Catastrophes can be caused by various events including hurricanes, windstorms, hail, severe winter weather, wildfires and earthquakes, and the frequency and severity of catastrophes are inherently unpredictable. The financial impact from catastrophic losses results from both the total amount of insured exposure in the area affected by the catastrophe as well as the severity of the event. The Company seeks to reduce its exposure to catastrophe losses through the geographic diversification of its insurance coverage, deductibles, maximum coverage limits and the purchase of catastrophe reinsurance.
The Company's catastrophe losses incurred of approximately $78.2 million, $84.4 million and $52.0 million for the years ended December 31, 2021, 2020 and 2019, respectively. For 2021, catastrophe losses were impacted by winter storm events, wind/hail/tornado events, as well as wildfires, tropical storms and hurricanes.
| | | | | | | | |
112 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 9 - Reinsurance and Catastrophes (continued)
The total amounts of reinsurance recoverable on unpaid insurance reserves classified as assets and reported in Other assets in the Consolidated Balance Sheets were as follows:
| | | | | | | | | | | | | | |
($ in millions) | | December 31, |
| | 2021 | | 2020 |
Reinsurance recoverables on reserves and unpaid claims | | | | |
Property & Casualty | | | | |
Reinsurance companies | | $ | 10.4 | | | $ | 13.2 | |
State insurance facilities | | 99.9 | | | 99.7 | |
Life and health | | 9.3 | | | 9.6 | |
Total | | $ | 119.6 | | | $ | 122.5 | |
The Company recognizes the cost of reinsurance premiums over the contract periods for such premiums in proportion to the insurance protection provided. Amounts recoverable from reinsurers for unpaid claims and claim settlement expenses, including estimated amounts for unsettled claims, IBNR claims and policy benefits, are estimated in a manner consistent with the insurance liability associated with the policy. The effects of reinsurance on premiums written and contract deposits; premiums and contract charges earned; and benefits, claims and settlement expenses were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Gross Amount | | Ceded to Other Companies(1) | | Assumed from Other Companies | | Net Amount |
Year Ended December 31, 2021 | | | | | | | | |
Premiums written and contract deposits(2) | | $ | 1,370.1 | | | $ | 23.1 | | | $ | 9.4 | | | $ | 1,356.4 | |
Premiums and contract charges earned | | 913.2 | | | 33.3 | | | 9.7 | | | 889.6 | |
Benefits, claims and settlement expenses | | 619.3 | | | 7.8 | | | 6.2 | | | 617.7 | |
| | | | | | | | |
Year Ended December 31, 2020 | | | | | | | | |
Premiums written and contract deposits(2) | | 1,369.9 | | | 20.4 | | | 9.8 | | | 1,359.3 | |
Premiums and contract charges earned | | 949.6 | | | 28.8 | | | 9.9 | | | 930.7 | |
Benefits, claims and settlement expenses | | 475.7 | | | (86.2) | | | 7.0 | | | 568.9 | |
| | | | | | | | |
Year Ended December 31, 2019 | | | | | | | | |
Premiums written and contract deposits(2) | | 1,337.8 | | | 23.9 | | | 10.6 | | | 1,324.5 | |
Premiums and contract charges earned | | 917.6 | | | 30.4 | | | 10.8 | | | 898.0 | |
Benefits, claims and settlement expenses | | 633.9 | | | 56.3 | | | 7.5 | | | 585.1 | |
(1) Excludes the annuity reinsurance agreement accounted for using the deposit method that is discussed in Note 6.
(2) This measure is not based on accounting principles generally accepted in the U.S. (non-GAAP). An explanation of this non-GAAP measure is contained in the Glossary of Selected Terms included as an exhibit in the Company's reports filed with the SEC.
There were no losses from uncollectible reinsurance recoverables in the three years ended December 31, 2021. Past due reinsurance recoverables as of December 31, 2021 were not material.
The Company maintains catastrophe excess of loss reinsurance coverage. For 2021, the Company's catastrophe excess of loss coverage consisted of one contract in addition to a minimal amount of coverage by the Florida Hurricane Catastrophe Fund (FHCF). The catastrophe excess of loss contract provided 95% coverage for catastrophe losses above a retention of $25.0 million per occurrence up to $170.0 million per occurrence. This contract consisted of three layers, each of which provided for one mandatory reinstatement. The layers were $25.0 million excess of $25.0 million, $40.0 million excess of $50.0 million and $85.0 million excess of $90.0 million.
For liability coverages, in 2021, the Company reinsured each loss above a retention of $1.0 million with coverage up to $5.0 million on a per occurrence basis and $20.0 million in a clash event. A clash cover is a reinsurance casualty excess contract requiring two or more casualty coverages or policies issued by the Company to be involved in the same loss occurrence for coverage to apply. For property coverages, in 2021, the Company reinsured each loss above a retention of $1.0 million up to $5.0 million on a per risk basis, including catastrophe
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 113 |
NOTE 9 - Reinsurance and Catastrophes (continued)
losses. Also, the Company could submit to the reinsurers two per risk losses from the same occurrence for a total of $8.0 million of property recovery in any one event.
The maximum individual life insurance risk retained by the Company is $0.5 million on any individual life, while either $0.1 million or $0.125 million is retained on each group life policy depending on the type of coverage. Excess amounts are reinsured. The Company also maintains a life catastrophe reinsurance program. For 2021, the Company reinsured 100% of the catastrophe risk in excess of $1.0 million up to $35.0 million per occurrence, with one reinstatement. The Company's life catastrophe risk reinsurance program covers acts of terrorism and includes nuclear, biological and chemical explosions but excludes other acts of war.
The Company retains all of the risk on its supplemental health product lines, including accidental death risk embedded within certain products. However, the Company’s other accidental death and dismemberment risk issued through all other policies and riders are ceded 100%.
NOTE 10 - Debt
Indebtedness and scheduled maturities consisted of the following:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Interest Rates | | Final Maturity | | December 31, |
| | | | 2021 | | 2020 |
Short-term debt | | | | | | | | |
Bank Credit Facility | | Variable | | 2026 | | $ | 249.0 | | | $ | 135.0 | |
Long-term debt(1) | | | | | | | | |
4.50% Senior Notes, Aggregate principal amount of $250.0 less unaccrued discount of $0.3 and $0.4 and unamortized debt issuance costs of $1.1 and $1.3 | | 4.50% | | 2025 | | 248.6 | | | 248.3 | |
Federal Home Loan Bank borrowing | | 0.00% | | 2022 | | 5.0 | | | 54.0 | |
Total | | | | | | $ | 502.6 | | | $ | 437.3 | |
(1) The Company designates debt obligations as "long-term" based on maturity date at issuance.
Credit Agreement with Financial Institutions (Bank Credit Facility)
Effective July 12, 2021, the Company, as borrower, amended its Credit Agreement (Bank Credit Facility). The amended Bank Credit Facility increased the amount available on the senior revolving credit facility from $225.0 million to $325.0 million. PNC Bank, National Association and JPMorgan Chase Bank, N.A. serve as joint lead arrangers under the amended Bank Credit Facility, with The Northern Trust Company, KeyBank National Association, U.S. Bank National Association, Illinois National Bank and Comerica Bank as lenders participating in the syndicate. Terms and conditions of the Bank Credit Facility are substantially consistent with the prior agreement, with an interest rate based on LIBOR plus 115 basis points.
As of December 31, 2021, the amount outstanding on the senior revolving credit facility was $249.0 million. The $76.0 million unused portion of the Bank Credit Facility is available for use and subject to a variable commitment fee, which was 0.15% on an annual basis at December 31, 2021.
On December 31, 2021, the Company utilized $114.0 million of the senior revolving credit facility to fund a portion of the acquisition of Madison National that occurred effective January 1, 2022, and the Company expects that the unused portion of the senior revolving credit facility will be available for ongoing working capital, capital expenditures and general corporate expenditures.
Senior Notes
As of December 31, 2021, the Company had outstanding $250.0 million aggregate principal amount of 4.50% Senior Notes (Senior Notes), which will mature on December 1, 2025, issued at a discount of 0.265% resulting in an effective yield of 4.53%. Interest on the Senior Notes is payable semi-annually at a rate of 4.50%. The Senior Notes are redeemable in whole or in part, at any time, at the Company's option, at a redemption price equal to the greater of (1) 100% of the principal amount of the notes being redeemed or (2) the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted, on a semi-annual basis, at the Treasury yield (as defined in the indenture) plus 35 basis points, plus, in either of the above cases, accrued interest to the date of redemption.
| | | | | | | | |
114 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 10 - Debt (continued)
Federal Home Loan Bank Borrowings
In 2017, Horace Mann Insurance Company (HMIC) became a member of the FHLB, which provides HMIC with access to collateralized borrowings and other FHLB products. As membership requires the ownership of membership stock, in June 2017, HMIC purchased common stock to meet the membership requirement. Any borrowing from the FHLB requires the purchase of FHLB activity-based common stock in an amount equal to 4.5% of the borrowing, or a lower percentage - such as 2.0% based on the Reduced Capitalization Advance Program. In the fourth quarter of 2017, HMIC purchased common stock to meet the activity-based requirement. In 2021, the Board authorized a maximum amount equal to 15% of net aggregate admitted assets less separate account assets of the insurance subsidiaries for FHLB borrowings. As of December 31, 2021, the Company had $5.0 million of borrowings outstanding with FHLB that mature on May 16, 2022. There is no interest on this borrowing. HMIC's FHLB borrowings of $5.0 million are included in Long-term debt in the Consolidated Balance Sheets.
Covenants
The Company is in compliance with all of the financial covenants contained in the Senior Notes indenture and the Bank Credit Facility agreement, consisting primarily of relationships of (1) debt to capital, (2) net worth, as defined in the financial covenants, (3) insurance subsidiaries' risk-based capital and (4) securities subject to funding agreements and repurchase agreements.
NOTE 11 - Income Taxes
The income tax assets and liabilities included in Other assets and Other liabilities, respectively, in the Consolidated Balance Sheets were as follows:
| | | | | | | | | | | | | | |
($ in millions) | | December 31, |
| | 2021 | | 2020 |
Income tax (asset) liability | | | | |
Current | | $ | (9.5) | | | $ | (12.6) | |
Deferred | | 190.5 | | | 206.7 | |
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 115 |
NOTE 11 - Income Taxes (continued)
Deferred tax assets and liabilities are recognized for all future tax consequences attributable to "temporary differences" between the financial statement carrying value of existing assets and liabilities and their respective tax bases. There are no deferred tax liabilities that have not been recognized. The "temporary differences" that gave rise to the deferred tax balances were as follows:
| | | | | | | | | | | | | | |
($ in millions) | | December 31, |
| | 2021 | | 2020 |
Deferred tax assets | | | | |
Unearned premium reserve reduction | | $ | 11.7 | | | $ | 11.5 | |
Compensation accruals | | 9.6 | | | 9.5 | |
Impaired securities | | 2.3 | | | 2.1 | |
Other comprehensive income - net funded status of benefit plans | | 2.7 | | | 3.0 | |
Discounting of unpaid claims and claim expense tax reserves | | 2.5 | | | 2.5 | |
Intangibles | | 0.1 | | | — | |
Postretirement benefits other than pensions | | 0.3 | | | 0.3 | |
Total gross deferred tax assets | | 29.2 | | | 28.9 | |
Deferred tax liabilities | | | | |
Other comprehensive income - net unrealized gains on securities | | 101.1 | | | 124.7 | |
Deferred policy acquisition costs | | 37.3 | | | 36.3 | |
Life insurance future policy benefit reserve | | 30.7 | | | 26.7 | |
Life insurance future policy benefit reserve (transitional rule) | | 8.5 | | | 10.7 | |
Discounting of unpaid claims and claim expense tax reserves (transitional rule) | | 0.6 | | | 0.8 | |
Investment related adjustments | | 37.3 | | | 34.2 | |
Intangibles | | — | | | 0.2 | |
Other, net | | 4.2 | | | 2.0 | |
Total gross deferred tax liabilities | | 219.7 | | | 235.6 | |
Net deferred tax liability | | $ | 190.5 | | | $ | 206.7 | |
The Company evaluated sources and character of income, including historical earnings, loss carryback potential, taxable income from future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences, and taxable income from prudent and feasible tax planning strategies. Although realization of deferred tax assets is not assured, the Company believes it is more likely than not that gross deferred tax assets will be fully realized and that a valuation allowance with respect to the realization of the total gross deferred tax assets was not necessary as of December 31, 2021 and 2020.
The components of the provision for income tax expense were as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Years Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Current | | $ | 27.7 | | | $ | 16.9 | | | $ | 31.5 | |
Deferred | | 4.4 | | | 9.4 | | | 20.5 | |
Total income tax expense | | $ | 32.1 | | | $ | 26.3 | | | $ | 52.0 | |
| | | | | | | | |
116 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 11 - Income Taxes (continued)
Income tax expense for the following periods differed from the expected tax computed by applying the federal corporate tax rate of 21% for 2021, 2020 and 2019 to income before income taxes as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Years Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Expected federal tax on income | | $ | 36.7 | | | $ | 33.5 | | | $ | 49.6 | |
Add (deduct) tax effects of: | | | | | | |
Tax-exempt interest | | (3.9) | | | (4.2) | | | (4.2) | |
Dividend received deduction | | (2.2) | | | (1.5) | | | (1.4) | |
Goodwill impairment | | — | | | 0.2 | | | 5.9 | |
CARES Act net operating loss carryback | | — | | | (2.8) | | | — | |
Employee share-based compensation | | (1.3) | | | (0.5) | | | 0.3 | |
Compensation deduction limitation | | 1.5 | | | 0.7 | | | 0.7 | |
Prior year adjustments | | 0.1 | | | (0.2) | | | (0.7) | |
Other, net | | 1.2 | | | 1.1 | | | 1.8 | |
Income tax expense provided on income | | $ | 32.1 | | | $ | 26.3 | | | $ | 52.0 | |
The Company's federal income tax returns for years prior to 2014 are no longer subject to examination by the Internal Revenue Service (IRS).
The Company recognizes tax benefits from tax return positions only if it is more likely than not the position will be sustainable, upon examination, on its technical merits and any relevant administrative practices or precedents. As a result, the Company applies a more likely than not recognition threshold for all tax uncertainties.
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 upon changes in facts or law. The Company has no unrecorded liabilities from uncertain tax filing positions.
HMEC and its subsidiaries file a consolidated federal income tax return. The federal income tax sharing agreements between HMEC and its subsidiaries, as approved by the Board, provide that tax on income is charged to each subsidiary as if it were filing a separate tax return with the limitation that each subsidiary will receive the benefit of any losses or tax credits to the extent utilized in the consolidated tax return. Intercompany balances are settled quarterly with a final settlement after filing the consolidated federal income tax return with the IRS. National Teachers Associates Life Insurance Company and NTA Life Insurance Company of New York are not included in HMEC's consolidated federal income tax return and will file separate federal income tax returns until they are eligible to participate in HMEC's consolidated federal income tax return. This is expected to occur in 2025.
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 117 |
NOTE 11 - Income Taxes (continued)
A reconciliation of the beginning and ending amounts of unrecognized tax benefits, excluding interest and penalties, is as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Years Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Balance as of the beginning of the year | | $ | 2.3 | | | $ | 2.0 | | | $ | 1.8 | |
Increases related to prior year tax positions | | — | | | 0.2 | | | 0.1 | |
Decreases related to prior year tax positions | | (0.1) | | | — | | | — | |
Increases related to current year tax positions | | — | | | 0.1 | | | 0.1 | |
Settlements | | — | | | — | | | — | |
Lapse of statute | | (0.5) | | | — | | | — | |
Balance as of the end of the year | | $ | 1.7 | | | $ | 2.3 | | | $ | 2.0 | |
The Company's effective tax rate would be affected to the extent there were unrecognized tax benefits that could be recognized. There are no positions for which it is reasonably possible that the total amount of unrecognized tax benefit will significantly change within the next 12 months.
The Company classifies all tax related interest and penalties as income tax expense.
Interest and penalties were both immaterial in each of the years ended December 31, 2021, 2020 and 2019.
NOTE 12 - Operating Leases
The Company has various operating lease agreements, primarily for real estate offices. Such leases have remaining lease terms of 1 year to 4 years, some of which may include options to extend certain leases for up to an additional 25 years.
The components of lease expense were as follows:
| | | | | | | | | | | | | | |
($ in millions) | | Years Ended December 31, |
| | 2021 | | 2020 |
Operating lease cost | | $ | 4.3 | | | $ | 4.5 | |
Short-term lease cost | | 0.1 | | | 0.1 | |
Total lease cost | | $ | 4.4 | | | $ | 4.6 | |
Supplemental cash flow information related to operating leases was as follows:
| | | | | | | | | | | | | | |
($ in millions) | | Years Ended December 31, |
| | 2021 | | 2020 |
Cash paid for amounts included in the measurement of lease liabilities | | $ | 4.3 | | | $ | 4.5 | |
Supplemental balance sheet information related to operating leases were as follows:
| | | | | | | | | | | | | | |
($ in millions, except lease terms and discount rates) | | December 31, |
| | 2021 | | 2020 |
Assets: | | | | |
Right of use assets, included in Other assets | | $ | 9.0 | | | $ | 12.6 | |
Liabilities: | | | | |
Operating lease liabilities, included in Other liabilities | | $ | 10.0 | | | $ | 13.6 | |
| | | | |
Weighted average remaining lease term | | 3.07 | | 3.63 |
Weighted average discount rate | | 3.67 | % | | 3.75 | % |
| | | | | | | | |
118 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 12 - Operating Leases (continued)
Future minimum lease payments under non-cancellable operating leases as of December 31, 2021 are as follows:
| | | | | | | | |
($ in millions) | | |
Year Ending December 31, | | |
2022 | | $ | 4.2 | |
2023 | | 3.5 | |
2024 | | 2.0 | |
2025 | | 0.8 | |
2026 | | — | |
Thereafter | | — | |
Total future minimum lease payments | | 10.5 | |
Less imputed interest | | (0.5) | |
Total | | $ | 10.0 | |
NOTE 13 - Shareholders' Equity and Share-Based Compensation
Share Repurchase Program and Treasury Shares
On September 30, 2015, the Board authorized a share repurchase program allowing repurchases of up to $50.0 million of HMEC's common stock, par value $0.001 (Program). The Program authorizes the repurchase of common shares in open market or privately negotiated transactions, from time to time, depending on market conditions. The Program does not have an expiration date and may be limited or terminated at any time without notice.
During 2021, the Company repurchased 140,758 shares of its common stock, or 0.3% of the shares outstanding as of December 31, 2020, at an aggregate cost of $5.3 million, or an average price of $37.49 per share. During 2020, the Company repurchased 52,095 shares of its common stock, or 0.1% of the shares outstanding as of December 31, 2019, at an aggregate cost of $2.2 million, or an average price of $41.17 per share. During 2019, the Company did not repurchase any shares of its common stock. In total and through December 31, 2021, 1,040,226 shares were repurchased under the Program at an average price of $33.33 per share. The repurchase of shares was funded through use of cash. As of December 31, 2021, $15.3 million remained authorized for future share repurchases under the Program.
At December 31, 2021, the Company held 25,043,337 shares in treasury.
Authorization of Preferred Stock
In 1996, the shareholders of HMEC approved authorization of 1,000,000 shares of 0.001 par value preferred stock. The Board is authorized to (1) direct the issuance of the preferred stock in one or more series, (2) fix the dividend rate, conversion or exchange rights, redemption price and liquidation preference, of any series of the preferred stock, (3) fix the number of shares for any series and (4) increase or decrease the number of shares of any series. No shares of preferred stock were issued or outstanding at December 31, 2021 and 2020.
2010 Comprehensive Executive Compensation Plan
In 2010, the shareholders of HMEC approved the 2010 Comprehensive Executive Compensation Plan (the Comprehensive Plan). The purpose of the Comprehensive Plan is to aid the Company in attracting, retaining, motivating and rewarding employees and non-employee Directors; to provide for equitable and competitive compensation opportunities, including deferral opportunities; to encourage long-term service; to recognize individual contributions and reward achievement of Company goals; and to promote the creation of long-term value for the Company's shareholders by closely aligning the interests of plan participants with those of shareholders. The Comprehensive Plan authorizes share-based and cash-based incentives for plan participants. In 2012, the shareholders of HMEC approved the implementation of a fungible share pool under which grants of full value shares will count against the share limit as two and one half shares for every share subject to a full value award. In May 2021, the shareholders of HMEC approved an amendment and restatement of the Comprehensive Plan which included an increase of 2,500,000 in the number of shares of common stock reserved for issuance under the Comprehensive Plan. As of December 31, 2021, approximately 2,688,416
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 119 |
NOTE 13 - Shareholders' Equity and Share-Based Compensation (continued)
shares were available for grant under the Comprehensive Plan. Shares of common stock issued under the Comprehensive Plan may be either authorized and unissued shares of HMEC or shares that have been reacquired by HMEC; however, new shares have been issued historically.
As further described in the paragraphs below, CSUs, stock options and RSUs under the Comprehensive Plan were as follows:
| | | | | | | | | | | | | | | | | | | | |
| | December 31, |
| | 2021 | | 2020 | | 2019 |
CSUs related to deferred compensation for Directors | | 26,313 | | | 23,609 | | | 28,526 | |
CSUs related to deferred compensation for employees | | 16,571 | | | 20,467 | | | 25,194 | |
Stock options | | 1,032,128 | | | 916,287 | | | 908,557 | |
RSUs related to incentive compensation | | 834,981 | | | 823,393 | | | 889,438 | |
Total | | 1,909,993 | | | 1,783,756 | | | 1,851,715 | |
Director Common Stock Units
Deferred compensation for Directors is in the form of CSUs, which represent an equal number of common shares to be issued in the future. The outstanding units of Directors serving on the Board accrue dividends at the same rate as dividends paid to HMEC's shareholders. These dividends are reinvested into additional CSUs.
Employee Common Stock Units
Deferred compensation for employees is in the form of CSUs, which represent an equal number of common shares to be issued in the future. Distributions of employee deferred compensation are allowed to be either in common shares or cash. Through December 31, 2021, all distributions have been in cash. The outstanding units accrue dividends at the same rate as dividends paid to HMEC's shareholders. These dividends are reinvested into additional CSUs.
Stock Options
Options to purchase shares of HMEC common stock may be granted to executive officers, other employees and Directors. The options become exercisable in installments based on service generally beginning in the first year from the date of grant and generally become fully vested 4 years from the date of grant. The options generally expire 7 to 10 years from the date of grant. The exercise price of the option is equal to the market price of HMEC's common stock on the date of grant resulting in a grant date intrinsic value of $0.
Changes in outstanding options were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Weighted Average Option Price per Share | | Range of Option Prices per Share | | Options |
| | | | Outstanding | | Vested and Exercisable |
December 31, 2020 | | $38.99 | | $28.88-$42.95 | | 916,287 | | | 437,197 | |
Granted | | $40.10 | | $40.10-$40.10 | | 183,272 | | | — | |
Vested | | $41.27 | | $28.88-$42.95 | | — | | | 163,519 | |
Exercised | | $31.35 | | $31.01-$32.35 | | (8,015) | | | (8,015) | |
Forfeited | | $41.39 | | $41.10-$42.73 | | (49,411) | | | — | |
Expired | | $42.23 | | $41.83-$42.73 | | (10,005) | | | — | |
December 31, 2021 | | $39.10 | | $28.88-$42.95 | | 1,032,128 | | | 592,701 | |
| | | | | | | | |
120 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 13 - Shareholders' Equity and Share-Based Compensation (continued)
Option information segregated by ranges of exercise prices were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2021 |
| | | | Total Outstanding Options | | Vested and Exercisable Options |
| | Range of Option Prices per Share | | Options | | Weighted Average Option Price per Share | | Weighted Average Remaining Term | | Options | | Weighted Average Option Price per Share | | Weighted Average Remaining Term |
| | $28.88-$33.41 | | 195,192 | | | $30.81 | | 3.59 | | 195,192 | | | $30.81 | | 3.59 |
| | $36.04-$41.95 | | 687,556 | | | $40.61 | | 7.52 | | 285,474 | | | $40.84 | | 6.35 |
| | $42.73-$42.73 | | 149,380 | | | $42.95 | | 6.18 | | 112,035 | | | $42.95 | | 6.18 |
Total | | | | 1,032,128 | | | $39.10 | | 6.58 | | 592,701 | | | $37.94 | | 5.41 |
The weighted average exercise prices of vested and exercisable options as of December 31, 2020 and 2019 were $36.59 and $34.81, respectively.
As of December 31, 2021, based on a closing stock price of $38.70 per share, the aggregate intrinsic (in-the-money) values of vested options and all options outstanding were $1.5 million and $1.5 million, respectively.
Restricted Stock Units
RSUs may be granted to executive officers, other employees and Directors and represent an equal number of common shares to be issued in the future. The RSUs vest in installments based on service or attainment of performance criteria generally beginning in the first year from the date of grant and generally become fully vested 1 to 4 years from the date of grant. The outstanding units accrue dividends at the same rate as dividends paid to HMEC's shareholders. These dividends are reinvested into additional RSUs.
Changes in outstanding RSUs were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Total Outstanding Units | | Vested Units |
| | Units | | Weighted Average Grant Date Fair Value per Unit | | Units | | Weighted Average Grant Date Fair Value per Unit |
December 31, 2020 | | 823,393 | | | $33.88 | | 484,984 | | | $27.48 |
Granted(1) | | 205,474 | | | $41.29 | | — | | | — |
Adjustment for performance achievement | | 14,272 | | | $45.01 | | — | | | — |
Vested | | — | | | — | | 145,319 | | | $42.15 |
Forfeited | | (47,214) | | | $43.08 | | — | | | — |
Distributed(2) | | (160,944) | | | $38.43 | | (160,944) | | | — |
December 31, 2021 | | 834,981 | | | $34.50 | | 469,359 | | | $28.27 |
(1) Includes dividends reinvested into additional RSUs.
(2) Includes distributed units which were utilized to satisfy withholding taxes due on the distribution.
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 121 |
NOTE 14 - Statutory Information and Dividend Restrictions
The insurance departments of various states in which the insurance subsidiaries of HMEC are domiciled recognize as net income and surplus those amounts determined in conformity with statutory accounting principles prescribed or permitted by the insurance departments, which differ in certain respects from GAAP.
HMEC has principal insurance subsidiaries domiciled in Illinois, New York and Texas. The statutory financial statements of these subsidiaries are prepared in accordance with accounting principles prescribed or permitted by the Illinois Department of Insurance, the New York Department of Insurance and the Texas Department of Insurance, as applicable. Prescribed statutory accounting principles include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations and general administrative rules.
In converting from statutory to GAAP, typical adjustments include DAC, certain reinsurance transactions, the inclusion of statutory non-admitted assets and the inclusion of net unrealized investment gains or losses in shareholders' equity relating to fixed maturity securities.
The following table includes selected information for HMEC's insurance subsidiaries:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Consolidated net income, statutory basis | | $ | 117.2 | | | $ | 141.9 | | | $ | 62.3 | |
Consolidated capital and surplus, statutory basis(1) | | $ | 1,017.4 | | | $ | 937.3 | | | $ | 868.8 | |
(1) Subject to regulatory restrictions.
The NAIC has risk-based capital guidelines to evaluate the adequacy of statutory capital and surplus in relation to risks assumed in investments, reserving policies, and volume and types of insurance business written. At December 31, 2021 and 2020, the minimum statutory-basis capital and surplus required to be maintained by HMEC's insurance subsidiaries was $123.0 million and $113.2 million, respectively. At December 31, 2021 and 2020, statutory capital and surplus of each of the Company's insurance subsidiaries was above required levels. The restricted net assets of HMEC's insurance subsidiaries were $26.2 million and $26.9 million as of December 31, 2021 and 2020, respectively. The minimum statutory basis capital and surplus amount at each date is the total estimated authorized control level risk-based capital for all of HMEC's insurance subsidiaries combined. Authorized control level risk-based capital represents the minimum level of statutory basis capital and surplus necessary before the insurance commissioner in the respective state of domicile is authorized to take whatever regulatory actions considered necessary to protect the best interests of the policyholders and creditors of the insurer. The amount of restricted net assets represents the combined fair value of securities on deposit with governmental agencies for the insurance subsidiaries as required by law in various states in which the insurance subsidiaries of HMEC conduct business.
HMEC relies largely on dividends from its insurance subsidiaries to meet its obligations for payment of principal and interest on debt, dividends to shareholders and parent company operating expenses, including tax payments pursuant to tax sharing agreements. Payments for share repurchase programs also have this dependency. HMEC's 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. As a result, HMEC may not be able to receive dividends from such subsidiaries at times and in amounts necessary to pay desired dividends to shareholders.
NOTE 15 - Retirement Plans and Other Postretirement Benefits
The Company sponsors two qualified and three non-qualified retirement plans. Substantially all employees participate in the 401(k) plan. Both the qualified defined benefit plan and the two non-qualified supplemental defined benefit plans have been frozen since 2002. All participants in the frozen plans are 100% vested in their accrued benefit and all non-qualified supplemental defined benefit plan participants are receiving payments. Certain employees participate in a non-qualified defined contribution plan.
| | | | | | | | |
122 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 15 - Retirement Plans and Other Postretirement Benefits (continued)
Qualified Plans
All employees participate in the 401(k) plan and receive a 100% vested 3% "safe harbor" company contribution based on employees' eligible earnings. The Company matches each dollar of employee contributions up to a 5% maximum — in addition to maintaining the automatic 3% "safe harbor" contribution. The matching company contribution vests after 5 years of service. The 401(k) plan is fully funded.
The Company's policy for the frozen defined benefit plan is to contribute to the plan amounts which are actuarially determined to provide sufficient funding to meet future benefit payments as defined by federal laws and regulations.
For the two qualified plans, all assets are held in their respective plan trusts.
Non-qualified Plans
The non-qualified plans were established for specific employees whose otherwise eligible earnings exceeded the statutory limits under the qualified plans. Benefit accruals under the non-qualified supplemental defined benefit plans were frozen in 2002 and all participants are currently in payment status. Both the non-qualified frozen supplemental defined benefit plans and the non-qualified contribution plan are unfunded plans with the Company's contributions made at the time payments are made to participants.
Total Expense and Contribution Plans' Information
Total expense recognized for the non-qualified defined contribution, 401(k), defined benefit and supplemental retirement plans was $9.2 million, $10.0 million and $9.3 million for the years ended December 31, 2021, 2020 and 2019, respectively.
Contributions to employees' accounts under the 401(k) plan and the non-qualified defined contribution plan, as well as total assets of the plans, were as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
401(k) plan | | | | | | |
Contributions to employees' accounts | | $ | 8.2 | | | $ | 8.2 | | | $ | 8.2 | |
Total assets at the end of the year | | 246.9 | | | 228.4 | | | 206.2 | |
| | | | | | |
Non-qualified defined contribution plan | | | | | | |
Contributions to employees' accounts | | 0.1 | | | 0.1 | | | 0.1 | |
Total assets at the end of the year | | — | | | — | | | — | |
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 123 |
NOTE 15 - Retirement Plans and Other Postretirement Benefits (continued)
Defined Benefit Plan and Supplemental Retirement Plans
The following tables summarize the funded status of the defined benefit and supplemental retirement pension plans as of December 31, 2021, 2020 and 2019 (the measurement dates) and identify (1) the assumptions used to determine the projected benefit obligation and (2) the components of net pension cost for the defined benefit plan and supplemental retirement plans for the following periods:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Defined Benefit Plan | | Supplemental Defined Benefit Plans |
| | December 31, | | December 31, |
| | 2021 | | 2020 | | 2019 | | 2021 | | 2020 | | 2019 |
Change in benefit obligation: | | | | | | | | | | | | |
Projected benefit obligation at beginning of year | | $ | 24.3 | | | $ | 24.8 | | | $ | 25.1 | | | $ | 15.7 | | | $ | 15.2 | | | $ | 15.4 | |
Service cost | | 0.6 | | | 0.7 | | | 0.7 | | | — | | | — | | | — | |
Interest cost | | 0.5 | | | 0.7 | | | 1.0 | | | 0.3 | | | 0.5 | | | 0.6 | |
Actuarial loss (gain) | | (0.6) | | | 1.0 | | | — | | | (0.2) | | | 1.3 | | | 0.5 | |
Benefits paid | | (2.6) | | | (1.5) | | | (2.0) | | | (1.3) | | | (1.3) | | | (1.3) | |
Settlements | | — | | | (1.4) | | | — | | | — | | | — | | | — | |
Projected benefit obligation at end of year | | $ | 22.2 | | | $ | 24.3 | | | $ | 24.8 | | | $ | 14.5 | | | $ | 15.7 | | | $ | 15.2 | |
Change in plan assets: | | | | | | | | | | | | |
Fair value of plan assets at beginning of year | | $ | 22.0 | | | $ | 23.2 | | | $ | 22.1 | | | $ | — | | | $ | — | | | $ | — | |
Actual return on plan assets | | 1.0 | | | 2.3 | | | 3.5 | | | — | | | — | | | — | |
Employer contributions | | — | | | — | | | — | | | 1.3 | | | 1.3 | | | 1.3 | |
Benefits paid | | (2.6) | | | (1.5) | | | (2.0) | | | (1.3) | | | (1.3) | | | (1.3) | |
Expenses paid | | (0.6) | | | (0.6) | | | (0.4) | | | — | | | — | | | — | |
Settlements | | — | | | (1.4) | | | — | | | — | | | — | | | — | |
Fair value of plan assets at end of year | | $ | 19.8 | | | $ | 22.0 | | | $ | 23.2 | | | $ | — | | | $ | — | | | $ | — | |
Funded status | | $ | (2.4) | | | $ | (2.3) | | | $ | (1.6) | | | $ | (14.5) | | | $ | (15.7) | | | $ | (15.2) | |
| | | | | | | | | | | | |
Prepaid (accrued) benefit expense | | $ | 4.9 | | | $ | 5.5 | | | $ | 6.7 | | | $ | 8.7 | | | $ | (9.3) | | | $ | (9.9) | |
| | | | | | | | | | | | |
Total amount recognized in Consolidated Balance Sheets, all in Other liabilities | | $ | (2.4) | | | $ | (2.3) | | | $ | (1.7) | | | $ | (14.5) | | | $ | (15.7) | | | $ | (15.2) | |
| | | | | | | | | | | | |
Amounts recognized in accumulated other comprehensive income (loss) (AOCI): | | | | | | | | | | | | |
Prior service cost | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Net actuarial loss | | (7.3) | | | (7.8) | | | (8.3) | | | (6.5) | | | (6.4) | | | (5.3) | |
Total amount recognized in AOCI | | $ | (7.3) | | | $ | (7.8) | | | $ | (8.3) | | | $ | (6.5) | | | $ | (6.4) | | | $ | (5.3) | |
| | | | | | | | | | | | |
Information for pension plans with an accumulated benefit obligation greater than plan assets: | | | | | | | | | | | | |
Projected benefit obligation | | $ | 22.2 | | | $ | 24.3 | | | $ | 24.8 | | | $ | 14.5 | | | $ | 15.7 | | | $ | 15.2 | |
Accumulated benefit obligation | | 22.2 | | | 24.3 | | | 24.8 | | | 14.5 | | | 15.7 | | | 15.2 | |
Fair value of plan assets | | 19.8 | | | 22.0 | | | 23.2 | | | — | | | — | | | — | |
| | | | | | | | |
124 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 15 - Retirement Plans and Other Postretirement Benefits (continued)
The change in the Company's AOCI for the defined benefit plans for the year ended December 31, 2021 was primarily attributable to an increase in the discount rate and better than expected asset returns partially offset by updates to mortality assumptions, updated census dates and an updated mortality projection scale. The change in the Company's AOCI for the defined benefit plans for the year ended December 31, 2020 was primarily attributable to better than expected asset returns, updates to mortality assumptions and updated census dates partially offset by a decrease in the discount rate and an updated mortality projection scale. The change in the Company's AOCI for the defined benefit plans for the year ended December 31, 2019 was primarily attributable to better than expected asset returns, updates to mortality assumptions and updated census dates offset by a decrease in the discount rate.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Defined Benefit Plan | | Supplemental Defined Benefit Plans |
| | Year Ended December 31, | | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 | | 2021 | | 2020 | | 2019 |
Components of net periodic pension (income) expense: | | | | | | | | | | | | |
Service cost: | | | | | | | | | | | | |
Benefit accrual | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Other expenses | | 0.6 | | | 0.7 | | | 0.7 | | | — | | | — | | | — | |
Interest cost | | 0.5 | | | 0.7 | | | 1.0 | | | 0.3 | | | 0.5 | | | 0.6 | |
Expected return on plan assets | | (0.9) | | | (1.0) | | | (1.3) | | | — | | | — | | | — | |
Settlement loss | | — | | | 0.5 | | | — | | | — | | | — | | | — | |
Amortization of: | | | | | | | | | | | | |
Prior service cost | | — | | | — | | | — | | | — | | | — | | | — | |
Actuarial loss | | 0.4 | | | 0.3 | | | 0.3 | | | 0.4 | | | 0.3 | | | 0.3 | |
Net periodic pension expense | | $ | 0.6 | | | $ | 1.2 | | | $ | 0.7 | | | $ | 0.7 | | | $ | 0.8 | | | $ | 0.9 | |
| | | | | | | | | | | | |
Changes in plan assets and benefit obligations included in other comprehensive income (loss): | | | | | | | | | | | | |
Prior service cost | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Net actuarial loss (gain) | | (0.2) | | | 0.3 | | | (1.8) | | | (0.2) | | | 1.3 | | | 0.5 | |
Amortization of: | | | | | | | | | | | | |
Prior service cost | | — | | | — | | | — | | | — | | | — | | | — | |
Actuarial loss | | (0.4) | | | (0.8) | | | (0.3) | | | (0.4) | | | (0.3) | | | (0.2) | |
Total recognized in other comprehensive income (loss) | | $ | (0.6) | | | $ | (0.5) | | | $ | (2.1) | | | $ | (0.6) | | | $ | 1.0 | | | $ | 0.3 | |
| | | | | | | | | | | | |
Weighted average assumptions used to determine expense: | | | | | | | | | | | | |
Discount rate | | 2.08 | % | | 3.10 | % | | 4.20 | % | | 2.08 | % | | 3.10 | % | | 4.20 | % |
Expected return on plan assets | | 4.74 | % | | 4.80 | % | | 5.75 | % | | * | | * | | * |
Annual rate of salary increase | | * | | * | | * | | * | | * | | * |
| | | | | | | | | | | | |
Weighted average assumptions used to determine benefit obligations as of December 31: | | | | | | | | | | | | |
Discount rate | | 2.57 | % | | 2.08 | % | | 3.10 | % | | 2.57 | % | | 2.08 | % | | 3.10 | % |
Expected return on plan assets | | 4.74 | % | | 4.80 | % | | 5.75 | % | | * | | * | | * |
Annual rate of salary increase | | * | | * | | * | | * | | * | | * |
* Not applicable.
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 125 |
NOTE 15 - Retirement Plans and Other Postretirement Benefits (continued)
The discount rates at December 31, 2021 were based on the average yield for long-term, high-grade securities available during the benefit payout period. To set its discount rate, the Company looks to leading indicators, including the Mercer Above Mean Yield Curve.
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.
The Company has an investment policy for the defined benefit pension plan that aligns the assets within the plan's trust to an approximate allocation of 35% equity and 65% fixed income funds. Management believes this allocation will produce the targeted long-term rate of return on assets necessary for payment of future benefit obligations, while providing adequate liquidity for payments to current beneficiaries. Assets are reviewed against the defined benefit pension plan's investment policy and the trustee has been directed to adjust invested assets at least quarterly to maintain the target allocation percentages.
Fair values of the equity security funds and fixed income funds have been determined from public quotations. The following table presents the fair value hierarchy for the Company's defined benefit pension plan assets, excluding cash held.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | | | Fair Value Measurements at Reporting Date Using |
| | Total | | Level 1 | | Level 2 | | Level 3 |
December 31, 2021 | | | | | | | | |
Asset category | | | | | | | | |
Equity security funds(1) | | | | | | | | |
United States | | $ | 3.8 | | | $ | — | | | $ | 3.8 | | | $ | — | |
International | | 3.3 | | | — | | | 3.3 | | | — | |
Fixed income funds | | 12.4 | | | — | | | 12.4 | | | — | |
Short-term investment funds | | 0.3 | | | 0.3 | | | — | | | — | |
Total | | $ | 19.8 | | | $ | 0.3 | | | $ | 19.5 | | | $ | — | |
| | | | | | | | |
December 31, 2020 | | | | | | | | |
Asset category | | | | | | | | |
Equity security funds(1) | | | | | | | | |
United States | | $ | 4.4 | | | $ | — | | | $ | 4.3 | | | $ | — | |
International | | 4.3 | | | — | | | 4.3 | | | — | |
Fixed income funds | | 13.1 | | | — | | | 13.1 | | | — | |
Short-term investments funds | | 0.2 | | | 0.2 | | | — | | | — | |
Total | | $ | 22.0 | | | $ | 0.2 | | | $ | 21.7 | | | $ | — | |
(1) None of the trust fund assets for the defined benefit pension plan have been invested in shares of HMEC's common stock.
There were no Level 3 assets held during the years ended December 31, 2021 and 2020.
In 2022, the Company expects amortization of net losses of $0.3 million and $0.4 million for the defined benefit plan and the supplemental retirement plans, respectively, and expects no amortization of prior service cost for the supplemental retirement plans to be included in net periodic pension expense.
Postretirement Benefits Other than Pensions
As of December 31, 2006, upon discontinuation of retiree medical benefits, Health Reimbursement Accounts (HRAs) were established for eligible participants and totaled $7.3 million. As of December 31, 2021, the balance of the previously established HRAs was $1.2 million. Funding of HRAs was $0.0 million, $0.1 million and $0.1 million for the years ended December 31, 2021, 2020 and 2019, respectively.
| | | | | | | | |
126 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 15 - Retirement Plans and Other Postretirement Benefits (continued)
2022 Contributions
In 2022, there is no minimum funding requirement for the Company's defined benefit plan. The following table discloses that minimum funding requirement and the expected full year contributions for the Company's plans.
| | | | | | | | | | | | | | |
($ in millions) | | Defined Benefit Pension Plans |
| | Defined Benefit Plan | | Supplemental Defined Benefit Plans |
Minimum funding requirement for 2021 | | $ | — | | | $ | — | |
Expected contributions (approximations) for the year ended December 31, 2022 at the time of issuance of this Form 10-K(1) | | $ | — | | | $ | 1.3 | |
(1) HMEC's Annual Report on Form 10-K for the year ended December 31, 2021.
Estimated Future Benefit Payments
The Company's defined benefit plan may be subject to settlement accounting. Assumptions for both the number of individuals retiring in a calendar year and their elections regarding lump sum distributions are significant factors impacting the payout patterns for each of the plans below. Therefore, actual results could vary from the estimates shown. Estimated future benefit payments as of December 31, 2021 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in millions) | | 2022 | | 2023 | | 2024 | | 2025 | | 2026 | | 2027-2031 |
Pension plans | | | | | | | | | | | | |
Defined benefit plan | | $ | 2.3 | | | $ | 2.1 | | | $ | 2.1 | | | $ | 2.0 | | | $ | 1.8 | | | $ | 6.8 | |
Supplemental retirement plans | | 1.3 | | | 1.3 | | | 1.2 | | | 1.2 | | | 1.2 | | | 5.1 | |
NOTE 16 - Contingencies and Commitments
Lawsuits and Legal Proceedings
Companies in the insurance industry have been subject to substantial litigation resulting from claims, disputes and other matters. For instance, they have faced expensive claims, including class action lawsuits, alleging, among other things, improper sales practices and improper claims settlement procedures. Negotiated settlements of certain such actions have had a material adverse effect on many insurance companies.
At the time of issuance of this Annual Report on Form 10-K, the Company does not have pending litigation from which there is a reasonable possibility of material loss.
Assessments for Insolvencies of Unaffiliated Insurance Companies
The Company is contingently liable for possible assessments under regulatory requirements pertaining to potential insolvencies of unaffiliated insurance companies. Liabilities, which are established based upon regulatory guidance, have generally been insignificant.
Investment Commitments
The Company has outstanding commitments to fund investments primarily in limited partnership interests. Such unfunded commitments were $858.1 million and $571.9 million for the years ended December 31, 2021 and 2020, respectively.
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 127 |
NOTE 17 - Comprehensive Income (Loss) and Accumulated Other Comprehensive Income (Loss)
Comprehensive income (loss) represents the change in shareholders' equity during a reporting period from transactions and other events and circumstances from non-shareholder sources. For the Company, comprehensive income (loss) is equal to net income plus or minus the after tax change in net unrealized investment gains (losses) on fixed maturity securities and the after tax change in net funded status of benefit plans for the periods as shown in the Consolidated Statements of Changes in Shareholders' Equity. AOCI represents the accumulated change in shareholders' equity from these transactions and other events and circumstances from non-shareholder sources as shown in the Consolidated Balance Sheets.
In the Consolidated Balance Sheets, the Company recognizes the net funded status of benefit plans as a component of AOCI, net of tax.
Comprehensive Income (Loss)
The components of comprehensive income (loss) were as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Year Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Net income | | $ | 142.8 | | | $ | 133.3 | | | $ | 184.4 | |
Other comprehensive income (loss): | | | | | | |
Change in net unrealized investment gains (losses) on fixed maturity securities: | | | | | | |
Net unrealized investment gains (losses) on securities arising during the period | | (104.9) | | | 184.0 | | | 327.3 | |
Less: reclassification adjustment for net investment gains (losses) included in income before income tax | | (8.5) | | | 11.2 | | | 157.4 | |
Total, before tax | | (96.4) | | | 172.8 | | | 169.9 | |
Income tax expense (benefit) | | (20.8) | | | 36.9 | | | 36.4 | |
Total, net of tax | | (75.6) | | | 135.9 | | | 133.5 | |
Change in net funded status of benefit plans: | | | | | | |
Before tax | | 1.2 | | | (0.5) | | | 1.8 | |
Income tax expense (benefit) | | 0.2 | | | (0.1) | | | 0.4 | |
Total, net of tax | | 1.0 | | | (0.4) | | | 1.4 | |
Total comprehensive income | | $ | 68.2 | | | $ | 268.8 | | | $ | 319.3 | |
| | | | | | | | |
128 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 17 - Comprehensive Income (Loss) and Accumulated Other Comprehensive Income (Loss) (continued)
Accumulated Other Comprehensive Income (Loss)
The following table reconciles the components of AOCI for the periods indicated.
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Net Unrealized Investment Gains (Losses) on Securities(1)(2) | | Net Funded Status of Benefit Plans(1) | | Total(1) |
Beginning balance, January 1, 2021 | | $ | 366.3 | | | $ | (11.2) | | | $ | 355.1 | |
Other comprehensive income (loss) before reclassifications | | (82.3) | | | 1.0 | | | (81.3) | |
Amounts reclassified from AOCI | | 6.7 | | | — | | | 6.7 | |
Net current period other comprehensive income (loss) | | (75.6) | | | 1.0 | | | (74.6) | |
Ending balance, December 31, 2021 | | $ | 290.7 | | | $ | (10.2) | | | $ | 280.5 | |
| | | | | | |
Beginning balance, January 1, 2020 | | $ | 230.4 | | | $ | (10.8) | | | $ | 219.6 | |
Other comprehensive income (loss) before reclassifications | | 144.7 | | | (0.4) | | | 144.3 | |
Amounts reclassified from AOCI | | (8.8) | | | — | | | (8.8) | |
Net current period other comprehensive income (loss) | | 135.9 | | | (0.4) | | | 135.5 | |
Ending balance, December 31, 2020 | | $ | 366.3 | | | $ | (11.2) | | | $ | 355.1 | |
| | | | | | |
Beginning balance, January 1, 2019 | | $ | 96.9 | | | $ | (12.2) | | | $ | 84.7 | |
Other comprehensive income (loss) before reclassifications | | 257.9 | | | 1.4 | | | 259.3 | |
Amounts reclassified from AOCI | | (124.4) | | | — | | | (124.4) | |
Net current period other comprehensive income (loss) | | 133.5 | | | 1.4 | | | 134.9 | |
Ending balance, December 31, 2019 | | $ | 230.4 | | | $ | (10.8) | | | $ | 219.6 | |
(1) All amounts are net of tax.
(2) The pretax amounts reclassified from AOCI, $(8.5) million, $11.2 million and $157.4 million, are included in net investment gains (losses) and the related tax expenses, $(1.8) million, $2.4 million and $33.0 million, are included in income tax expense in the Consolidated Statements of Operations for the years ended December 31, 2021, 2020 and 2019, respectively.
Comparative information for elements that are not required to be reclassified in their entirety to net income in the same reporting period is located in Note 3.
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 129 |
NOTE 18 - Supplemental Consolidated Cash and Cash Flow Information
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Years Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Cash | | $ | 133.0 | | | $ | 21.8 | | | $ | 25.2 | |
Restricted cash | | 0.7 | | | 0.5 | | | 0.3 | |
Total cash and restricted cash shown in the Consolidated Statements of Cash Flows | | $ | 133.7 | | | $ | 22.3 | | | $ | 25.5 | |
| | | | | | |
Cash paid during the year for: | | | | | | |
Interest | | $ | 13.5 | | | $ | 15.5 | | | $ | 14.1 | |
Income taxes | | 23.7 | | | 17.3 | | | 22.9 | |
Non-cash investing activities include $2.1 billion of investments transferred to a reinsurer as consideration paid in connection with a reinsurance transaction of a $2.9 billion block of in force fixed and variable annuity business in 2019. See Note 6 for further information.
Non-cash investing activities with respect to modifications or exchanges of fixed maturity securities as well as paid-in-kind activity for policy loans were insignificant for the years ended December 31, 2021, 2020 and 2019, respectively.
NOTE 19 - Segment Information
The Company conducts and manages its business through five reporting segments. The four operating segments, representing the major lines of business, are: Property & Casualty (primarily personal lines of auto and property insurance products), Supplemental (primarily cancer, heart, hospital, supplemental disability and accident coverages), Retirement (primarily tax-qualified fixed and variable annuities) and Life (life insurance). The Company does not allocate the impact of corporate-level transactions to these operating segments, consistent with the basis for management's evaluation of the results of those segments, but classifies those items in the fifth reporting segment, Corporate & Other. In addition to ongoing transactions such as corporate debt service, net investment gains (losses) and certain public company expenses, such items also have included corporate debt retirement costs, when applicable.
The accounting policies of the segments are the same as those described in Note 1. The Company accounts for intersegment transactions, primarily the allocation of operating and agency costs from Corporate & Other to Property & Casualty, Supplemental, Retirement and Life, on a direct cost basis.
| | | | | | | | |
130 Annual Report on Form 10-K | | Horace Mann Educators Corporation |
NOTE 19 - Segment Information (continued)
Summarized financial information for these segments is as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Years Ended December 31, |
| | 2021 | | 2020 | | 2019 |
Premiums and contract charges earned | | | | | | |
Property & Casualty | | $ | 617.4 | | | $ | 650.1 | | | $ | 683.5 | |
Supplemental(1) | | 125.3 | | | 130.7 | | | 65.8 | |
Retirement | | 38.5 | | | 29.7 | | | 29.1 | |
Life | | 108.4 | | | 120.2 | | | 119.6 | |
Total | | $ | 889.6 | | | $ | 930.7 | | | $ | 898.0 | |
| | | | | | |
Net investment income | | | | | | |
Property & Casualty | | $ | 61.1 | | | $ | 42.6 | | | $ | 41.7 | |
Supplemental(1) | | 24.8 | | | 17.8 | | | 7.5 | |
Retirement | | 255.9 | | | 229.8 | | | 245.5 | |
Life | | 83.1 | | | 69.8 | | | 72.0 | |
Corporate & Other | | (0.1) | | | (0.2) | | | (0.1) | |
Intersegment eliminations | | (2.3) | | | (2.2) | | | (1.5) | |
Total | | $ | 422.5 | | | $ | 357.6 | | | $ | 365.1 | |
| | | | | | |
Net income (loss) | | | | | | |
Property & Casualty | | $ | 57.0 | | | $ | 76.5 | | | $ | 54.3 | |
Supplemental(1) | | 46.3 | | | 43.1 | | | 18.0 | |
Retirement | | 52.0 | | | 20.1 | | | (4.8) | |
Life | | 16.1 | | | 10.4 | | | 17.6 | |
Corporate & Other | | (28.6) | | | (16.8) | | | 99.3 | |
Total | | $ | 142.8 | | | $ | 133.3 | | | $ | 184.4 | |
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | December 31, |
| | 2021 | | 2020 | | 2019 |
Assets | | | | | | |
Property & Casualty | | $ | 1,243.4 | | | $ | 1,324.9 | | | $ | 1,327.1 | |
Supplemental | | 854.9 | | | 811.5 | | | 747.6 | |
Retirement | | 9,939.1 | | | 9,198.7 | | | 8,330.1 | |
Life | | 2,129.5 | | | 2,044.5 | | | 1,965.0 | |
Corporate & Other | | 281.8 | | | 182.3 | | | 173.0 | |
Intersegment eliminations | | (64.8) | | | (90.1) | | | (64.1) | |
Total | | $ | 14,383.9 | | | $ | 13,471.8 | | | $ | 12,478.7 | |
(1) Acquired on July 1, 2019. The twelve month comparison is not meaningful.
| | | | | | | | |
Horace Mann Educators Corporation | | Annual Report on Form 10-K 131 |
NOTE 19 - Segment Information (continued)
Additional significant financial information for these segments is as follows:
| | | | | | | | | | | | | | | | | | | | |
($ in millions) | | Years Ended December 31, |
| | 2021 | | 2020 | | 2019 |
DAC amortization expense | | | | | | |
Property & Casualty | | $ | 67.7 | | | $ | 74.4 | | | $ | 79.5 | |
Supplemental(1) | | 1.2 | | | 1.3 | | | 0.4 | |
Retirement | | 18.5 | | | 16.7 | | | 21.5 | |
Life | | 7.3 | | | 7.5 | | | 7.8 | |
Total | | $ | 94.7 | | | $ | 99.9 | | | $ | 109.2 | |
| | | | | | |
Income tax expense (benefit) | | | | | | |
Property & Casualty | | $ | 13.2 | | | $ | 15.4 | | | $ | 14.0 | |
Supplemental(1) | | 12.7 | | | 12.0 | | | 5.1 | |
Retirement | | 9.9 | | | 2.1 | | | 33.8 | |
Life | | 3.6 | | | 2.4 | | | 4.9 | |
Corporate & Other | | (7.3) | | | (5.6) | | | (5.8) | |
Total | | $ | 32.1 | | | $ | 26.3 | | | $ | 52.0 | |
(1) Acquired on July 1, 2019. The twelve month comparison is not meaningful.
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132 Annual Report on Form 10-K | | Horace Mann Educators Corporation |