FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in millions, except per share data)
Forward-looking Information
Statements made in the following discussion that are not historical in nature
are forward-looking within the meaning of the Private Securities Litigation
Reform Act of 1995 and are subject to known and unknown risks, uncertainties and
other factors. Horace Mann is not under any obligation to (and expressly
disclaims any such obligation to) update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
It is important to note that the Company's actual results could differ
materially from those projected in forward-looking statements due to, among
other risks and uncertainties inherent in the Company's business, the following
important factors:
• The impact that a prolonged economic recession may have on the Company's
investment portfolio; volume of new business for automobile, homeowners,
annuity and life products; policy renewal rates; and additional annuity
contract deposit receipts.
• Changes in the composition of the Company's assets and liabilities which may
result from occurrences such as acquisitions, divestitures, impairment in
asset values or changes in estimates of insurance reserves.
• Fluctuations in the fair value of securities in the Company's investment
portfolio and the related after-tax effect on the Company's shareholders'
equity and total capital through either realized or unrealized investment
losses, as well as the potential impact on the ability of the Company's
insurance subsidiaries to distribute cash to the holding company and/or need
for the holding company to make capital contributions to the insurance
subsidiaries. In addition, the impact of fluctuations in the financial market
on the Company's defined benefit pension plan assets and the related
after-tax effect on the Company's operating expenses, shareholders' equity
and total capital.
• Prevailing interest rate levels, including the impact of interest rates on
(1) unrealized gains and losses in the Company's investment portfolio and the
related after-tax effect on the Company's shareholders' equity and total
capital, (2) the book yield of the Company's investment portfolio, (3) the
Company's ability to maintain appropriate interest rate spreads over the
fixed rates guaranteed in the Company's life and annuity products and
(4) amortization of deferred policy acquisition costs.
• The impact of fluctuations in the financial market on the Company's variable
annuity fee revenues, amortization of deferred policy acquisition costs, and
the level of guaranteed minimum death benefit reserves.
• Defaults on interest or dividend payments in the Company's investment
portfolio due to credit issues and the resulting impact on investment income.
• The frequency and severity of catastrophes such as hurricanes, earthquakes,
storms and wildfires and the ability of the Company to provide accurate
estimates of ultimate catastrophe costs in its consolidated financial
statements in light of such factors as: the proximity of the catastrophe
occurrence date to the date of the consolidated financial statements;
potential inflation of property repair costs in the affected area; the
occurrence of multiple catastrophes in a geographic area over a relatively
short period of time; the outcome of litigation which may be filed against
the Company by policyholders, state attorneys general and other parties
relative to loss coverage disputes and loss settlement payments; and the
ability of state insurance facilities to assess participating insurers when
financial deficits occur.
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• The Company's risk exposure to catastrophe-prone areas. Based on full year
2011 property and casualty direct earned premiums, the Company's ten largest
states represented 57% of the segment total. Included in this top ten group
are certain states which are considered more prone to catastrophe
occurrences: California, North Carolina, Texas, Florida, Louisiana, South
Carolina and Georgia.
• The potential near-term, adverse impact of underwriting actions to mitigate
the Company's risk exposure to catastrophe-prone areas on premium, policy and
earnings growth.
• The ability of the Company to maintain a favorable catastrophe reinsurance
program considering both availability and cost; and the collectibility of
reinsurance receivables.
• Adverse development of property and casualty loss and loss adjustment expense
reserve experience and its impact on estimated claims and claim expenses for
losses occurring in prior years.
• Climate change, to the extent it produces rising temperatures and changes in
weather patterns, which could impact the frequency and/or severity of weather
events and wildfires, the affordability and availability of catastrophe
reinsurance coverage, and the Company's ability to make homeowners insurance
available to its customers.
• Adverse changes in market appreciation, interest spreads, business
persistency and policyholder mortality and morbidity rates and the resulting
impact on both estimated reserves and the amortization of deferred policy
acquisition costs.
• Adverse results from the assessment of the Company's goodwill asset requiring
write off of the impaired portion.
• The Company's ability to maintain favorable claims-paying ability ratings.
• The Company's ability to maintain favorable financial strength and debt
ratings.
• The impact of fluctuations in the capital markets on the Company's ability to
refinance outstanding indebtedness or repurchase shares of the Company's
common stock.
• The Company's ability to (1) develop and expand its marketing operations,
including agents and other points of distribution, and (2) maintain and
secure access to educators, as well as endorsements by and/or marketing
agreements with local, state and national education-related associations,
including various teacher, school administrator, principal and business
official associations.
• The competitive impact of Section 403(b) tax-qualified annuity regulations,
including (1) their potential to lead plan sponsors to further restrict the
number of providers and (2) the possible increased competition within the
403(b) market from larger companies experienced in 401(k) plans.
• The effects of economic forces and other issues affecting the educator market
including, but not limited to, federal, state and local budget deficits and
cut-backs and adverse changes in state and local tax revenues. The effects of
these forces include, among others, teacher layoffs and early retirements, as
well as individual concerns regarding employment and economic uncertainty.
• The Company's ability to profitably expand its property and casualty business
in highly competitive environments.
• Changes in insurance regulations, including (1) those affecting the ability
of the Company's insurance subsidiaries to distribute cash to the holding
company and (2) those impacting the Company's ability to profitably write
property and casualty insurance policies in one or more states.
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• Changes in federal and state tax laws, including changes in elements of
taxation or rates of taxation which could be in response to budget pressures
related to general economic conditions or other factors, and changes
resulting from tax audits affecting corporate tax rates.
• Changes in federal and state laws and regulations, which affect the relative
tax and other advantages of the Company's life and annuity products to
customers, including, but not limited to, changes in IRS regulations
governing Section 403(b) plans.
• Changes in federal and state laws and regulations, which affect the relative
tax advantage of certain investments or which affect the ability of debt
issuers to declare bankruptcy or restructure debt.
• The cyclicality of the insurance industry and the related effects of changes
in price competition and industry-wide underwriting results.
• The resolution of legal proceedings and related matters including the potential adverse impact on the Company's reputation and charges against the
Company's earnings resulting from legal defense costs, a settlement agreement
and/or an adverse finding or findings against the Company from the
proceedings.
• The Company's dated and complex information systems, which are difficult to
upgrade and more prone to error than advanced technology systems.
• Disruptions of the general business climate, investments, capital markets and
consumer attitudes caused by pandemics or geopolitical acts such as
terrorism, war or other similar events.
Executive Summary
Horace Mann Educators Corporation ("HMEC"; and together with its subsidiaries,
the "Company" or "Horace Mann") is an insurance holding company. Through its
subsidiaries, HMEC markets and underwrites personal lines of property and
casualty insurance, retirement annuities and life insurance in the U.S. The
Company markets its products primarily to K-12 teachers, administrators and
other employees of public schools and their families.
For the three months ended June 30, 2012, the Company's net income of $13.1
million represented an improvement of $24.9 million compared to the net loss of
$11.8 million recorded in the prior year, reflecting a lower level of property
and casualty catastrophe losses coupled with improved underlying earnings across
all three of the Company's operating segments. After-tax net realized investment
gains increased by $2.7 million between periods. For the property and casualty
segment, catastrophe losses were significant in the current period, although
less severe than experienced in the prior year. The current period net loss of
$4.1 million reflected an improvement of $21.5 million compared to a year
earlier, benefitting from decreases in catastrophe costs and Florida sinkhole
losses, as well as favorable development of prior years' reserve development,
which more than offset an increase in automobile current accident year losses.
Annuity segment net income of $7.9 million for the current period increased $0.5
million compared to the second quarter of 2011, reflecting an increase in the
interest margin earned on fixed annuity assets partially offset by the negative
impact from the evaluation of deferred policy acquisition costs - primarily due
to the decline in performance of the financial markets. Life segment net income
of $6.1 million increased $0.2 million compared to the prior year second
quarter.
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For the six months ended June 30, 2012, the Company's net income of $39.8
million represented an improvement of $25.8 million compared to the prior year,
reflecting a reduction in property and casualty catastrophe losses as well as
improved underlying earnings across all three of the Company's operating
segments. After-tax net realized investment gains decreased by $0.7 million
between periods. For the property and casualty segment, net income of $9.1
million reflected an increase of $22.3 million compared to the first half of
2011, benefitting from decreases in catastrophe costs and Florida sinkhole
losses, as well as favorable development of prior years' reserves, which more
than offset an increase in automobile current accident year losses. Including
all factors, the property and casualty combined ratio was 103.9% for the first
six months of 2012 compared to 114.7% for the same period in 2011. Annuity
segment net income of $19.5 million for the current period increased notably
compared to the first six months of 2011, primarily reflecting an increase in
the interest margin earned on fixed annuity assets. Life segment net income of
$11.3 million increased $1.2 million, primarily due to lower mortality costs in
the current period.
Premiums written and contract deposits were comparable to the first six months
of 2011. Property and casualty segment premiums written were also comparable to
the prior year, as the favorable premium impact from increases in average
premium per policy for both homeowners and automobile in the current year was
offset by the reduced level of automobile and homeowners policies in force.
Compared to increased levels of receipts in 2011, annuity deposits received in
the current period were similar to the first half of last year, as a 5% increase
in single deposit and rollover receipts in the current year was offset by a 5%
decrease in scheduled deposit receipts. Life segment insurance premiums and
contract deposits increased 1% compared to the first half of the prior year.
The Company's book value per share was $29.06 at June 30, 2012, an increase of
29% compared to 12 months earlier. This increase reflected net income for the
trailing 12 months and the improvement in unrealized investment gains and losses
due to significantly lower yields on U.S. Treasury securities and somewhat
stable credit spreads across virtually all asset classes, the combination of
which caused an increase in unrealized gains for the Company's holdings of
corporate securities, municipal securities, government securities and
mortgage-backed securities.
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Critical Accounting Policies
The preparation of consolidated financial statements in conformity with U.S.
generally accepted accounting principles ("GAAP") requires the Company's
management to make estimates and assumptions based on information available at
the time the consolidated financial statements are prepared. These estimates and
assumptions affect the reported amounts of the Company's consolidated assets,
liabilities, shareholders' equity and net income. Certain accounting estimates
are particularly sensitive because of their significance to the Company's
consolidated financial statements and because of the possibility that subsequent
events and available information may differ markedly from management's judgments
at the time the consolidated financial statements were prepared. Management has
discussed with the Audit Committee the quality, not just the acceptability, of
the Company's accounting principles as applied in its financial reporting. The
discussions generally included such matters as the consistency of the Company's
accounting policies and their application, and the clarity and completeness of
the Company's consolidated financial statements, which include related
disclosures. For the Company, the areas most subject to significant management
judgments include: fair value measurements, other-than-temporary impairment of
investments, goodwill, deferred policy acquisition costs for annuity and
interest-sensitive life products, liabilities for property and casualty claims
and claim expenses, liabilities for future policy benefits, deferred taxes and
valuation of assets and liabilities related to the defined benefit pension plan.
Fair Value Measurements
The fair value of a financial instrument is the estimated amount at which the
instrument could be exchanged in an orderly transaction between knowledgeable,
unrelated and willing parties. The valuation of fixed maturity securities and
equity securities is more subjective when markets are less liquid due to the
lack of market based inputs, which 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.
Valuation of Fixed Maturity and Equity Securities
For fixed maturity securities, each month the Company obtains prices from its
investment managers and custodian bank. Fair values for the Company's fixed
maturity securities are based primarily on prices provided by its investment
managers as well as its custodian bank for certain securities. The prices from
the custodian bank are compared to prices from the investment managers.
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. Both the investment managers and the custodian
bank use a variety of independent, nationally recognized pricing sources to
determine market valuations. Each designate specific pricing services or indexes
for each sector of the market based upon the provider's expertise. Typical
inputs used by these pricing sources include, but are not limited to, reported
trades, benchmark yield curves, benchmarking of like securities, sector
groupings, matrix pricing, issuer spreads, bids, offers, and/or estimated cash
flows and prepayment speeds.
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When the pricing sources cannot provide fair value determinations, the Company
obtains non-binding price quotes from broker-dealers. The broker-dealers'
valuation methodology is sometimes matrix-based, using indicative evaluation
measures and adjustments for specific security characteristics and market
sentiment. The market inputs utilized in the evaluation measures and adjustments
include: benchmark yield curves, reported trades, broker/dealer quotes, issuer
spreads, two-sided markets, benchmark securities, bids, offers, reference data,
and industry and economic events. The extent of the use of each market input
depends on the market sector and the 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 analyzes price and market valuations received to verify
reasonableness, to understand the key assumptions used and their sources, to
conclude the prices obtained are appropriate, and to determine an appropriate
fair value hierarchy level based upon trading activity and the observability of
market inputs. Based on this evaluation and investment class analysis, each
security is classified into Level 1, 2 or 3. The Company has in place certain
control processes to determine the reasonableness of the financial asset fair
values. These processes are designed to ensure the values received are
accurately recorded and that the data inputs and valuation techniques utilized
are appropriate, consistently applied, and that the assumptions are reasonable
and consistent with the objective of determining fair value. For example, on a
continuing basis, the Company assesses the reasonableness of individual security
values obtained from pricing sources that vary from certain thresholds.
Historically, the control processes have not resulted in adjustments to the
valuations provided by pricing sources. 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 91% of the
portfolio, based on fair value, was priced through pricing services or index
priced as of June 30, 2012. The remainder of the portfolio was priced by
broker-dealers or pricing models. When non-binding broker-dealer quotes could be
corroborated by comparison to other vendor quotes, pricing models or analysis
utilizing observable inputs, the securities were generally classified as Level
2. There were no significant changes to the valuation process during the first
six months of 2012.
Fair values of equity securities have been determined by the Company from
observable market quotations, when available. When a public quotation is not
available, equity securities are valued by using non-binding broker quotes or
through the use of pricing models or analysis that is based on observable market
information such as interest rates, credit spreads and liquidity. The underlying
source data for calculating the matrix of credit spreads relative to the U.S.
Treasury curve are nationally recognized indices. These inputs are based on
assumptions deemed appropriate given the circumstances and are believed to be
consistent with what some market participants would use when pricing such
securities. There were no significant changes to the valuation process in the
first six months of 2012.
At June 30, 2012, Level 3 invested assets comprised approximately 2.1% of the
Company's total investment portfolio fair value. Invested assets are classified
as Level 3 when fair value is determined based on unobservable inputs that are
supported by little or no market activity and those inputs are significant to
the fair value. For additional detail, see "Notes to Consolidated Financial
Statements - Note 3 - Fair Value of Financial Instruments".
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Other-than-temporary Impairment of Investments
The Company's methodology of assessing other-than-temporary impairments is based
on security-specific facts and circumstances as of the date of the reporting
period. Based on these facts, if (1) the Company has the intent to sell the
fixed maturity security, (2) it is more likely than not the Company will be
required to sell the fixed maturity security before the anticipated recovery of
the amortized cost basis, or (3) management does not expect to recover the
entire cost basis of the fixed maturity security, an other-than-temporary
impairment is considered to have occurred. For equity securities, if (1) the
Company does not have the ability and intent to hold the security for the
recovery of cost or (2) recovery of cost is not expected within a reasonable
period of time, an other-than-temporary impairment is considered to have
occurred. Additionally, if events become known that call into question whether
the security issuer has the ability to honor its contractual commitments, such
security holding will be evaluated to determine whether or not such security has
suffered an other-than-temporary decline in value.
The Company reviews the fair value of all investments in its portfolio on a
monthly basis to assess whether an other-than-temporary decline in value has
occurred. These reviews, in conjunction with the Company's investment managers'
monthly credit reports and relevant factors such as (1) the financial condition
and near-term prospects of the issuer, (2) the length of time and extent to
which the fair value has been less than amortized cost for fixed maturity
securities or cost for equity securities, (3) for fixed maturity securities, the
Company's intent to sell a security or whether it is more likely than not the
Company will be required to sell the security before the anticipated recovery in
the amortized cost basis; and for equity securities, the Company's ability and
intent to hold the security for the recovery of cost or if recovery of cost is
not expected within a reasonable period of time, (4) the stock price trend of
the issuer, (5) the market leadership position of the issuer, (6) the debt
ratings of the issuer, and (7) the cash flows and liquidity of the issuer or the
underlying cash flows for asset-backed securities, are all considered in the
impairment assessment. A write-down of an investment is recorded when a decline
in the fair value of that investment is deemed to be other-than-temporary, with
a realized investment loss charged to income for the period for all equity
securities and for the credit-related loss portion associated with impaired
fixed maturity securities. The amount of the total other-than-temporary
impairment related to non-credit factors for fixed maturity securities is
recognized in other comprehensive income, net of applicable taxes, unless the
Company has the intent to sell the security or if it is more likely than not the
Company will be required to sell the security before the anticipated recovery of
the amortized cost basis.
With respect to fixed income securities involving securitized financial assets -
primarily asset-backed and commercial mortgage-backed securities in the
Company's portfolio - a significant portion of the fair values is determined by
observable inputs. In addition, the securitized financial asset securities'
underlying collateral cash flows are stress tested to determine if there has
been any adverse change in the expected cash flows.
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A decline in fair value below amortized cost is not assumed to be
other-than-temporary for fixed maturity investments with unrealized losses due
to spread widening, market illiquidity or changes in interest rates where there
exists a reasonable expectation based on the Company's consideration of all
objective information available that the Company will recover the entire cost
basis of the security and the Company does not have the intent to sell the
investment before maturity or a market recovery is realized and it is more
likely than not the Company will not be required to sell the investment. An
other-than-temporary impairment loss will be recognized based upon all relevant
facts and circumstances for each investment, as appropriate.
Goodwill
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 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 one level below an operating segment. The
Company's reporting units, for which goodwill has been allocated, are equivalent
to the Company's operating segments.
Effective January 1, 2012, the goodwill impairment test, as defined in the
accounting guidance, 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 follows a two-step process. Recent accounting guidance
did not change the existing two-step process. In the first step, the fair value
of a reporting unit is compared to its carrying value. If the carrying value of
a reporting unit exceeds its fair value, the second step of the impairment test
is performed for purposes of confirming and measuring the impairment. In the
second step, the fair value of the reporting unit is allocated to all of the
assets and liabilities of the reporting unit to determine an implied goodwill
value. If the carrying amount of the reporting unit goodwill exceeds the implied
goodwill value, an impairment loss would be recognized in an amount equal to
that excess, and the charge could have a material adverse effect on the
Company's results of operations.
The Company completed its annual goodwill assessment for the individual
reporting units as of December 31, 2011 and did not early adopt the accounting
guidance that provides for an initial assessment of qualitative factors. The
first step of the Company's analysis indicated that fair value exceeded carrying
value for all reporting units other than the annuity unit. Management's
determination of the fair value of each reporting unit incorporated multiple
inputs including discounted cash flow calculations, the level of the Company's
own share price and assumptions that market participants would make in valuing
each reporting unit. Fair value estimates were based primarily on an in-depth
analysis of historical experience, projected future cash flows and relevant
discount rates, which considered market participant inputs and the relative risk
associated with the projected cash flows. Other assumptions included levels of
economic capital, future business growth, earnings projections and assets under
management for each reporting unit. Estimates of fair value are subject to
assumptions that are sensitive to change and represent the Company's reasonable
expectations regarding future developments. The Company also considered other
valuation techniques such as peer company price-to-earnings and price-to-book
multiples.
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For the annuity reporting unit, the Company determined that the reporting unit's
fair value was less than its carrying value, primarily driven by unrealized
investment gains. Accordingly, recoverability was evaluated assuming fair value
was allocated to assets and liabilities as if the reporting unit had been
acquired in a business combination. In the second step, the implied fair value
of the annuity reporting unit's goodwill was determined in the same manner as
goodwill is measured in a business combination (i.e., by measuring the fair
value of the reporting unit's assets, liabilities and unrecognized intangible
assets and determining the remaining amount attributed to goodwill) and
comparing the amount of the implied goodwill to the carrying amount of the
goodwill. The implied fair value for the annuity reporting unit's goodwill was
greater than its carrying value; therefore, goodwill was not impaired and no
write-down was required. However, the implied fair value exceeded carrying value
for the annuity reporting unit by a limited margin, which indicates a greater
risk of future impairment for this reporting unit's goodwill.
As part of the Company's December 31, 2011 goodwill analysis, the Company
compared the fair value of the aggregated reporting units to the market
capitalization of the Company. The difference between the aggregated fair value
of the reporting units and the market capitalization of the Company was
attributed to several factors, most notably market sentiment, trading volume and
transaction premium. The amount of the transaction premium was determined to be
reasonable based on insurance industry and Company-specific facts and
circumstances.
Subsequent goodwill assessments could result in impairment, particularly for
each reporting unit with at-risk goodwill, due to the impact of a volatile
financial market on earnings, discount rate assumptions, liquidity and market
capitalization. Management believes the Company's continued depressed market
capitalization is largely the result of current global financial market
conditions and is similar to companies within the annuity and life insurance
sector. There were no events or material changes in circumstances during the six
months ended June 30, 2012 that indicated that a material change in the fair
value of the Company's reporting units had occurred.
Deferred Policy Acquisition Costs for Annuity and Interest-sensitive Life
Products
Policy acquisition costs, consisting of commissions, policy issuance and other
costs which are directly related to the successful acquisition of new or renewal
business, are capitalized and amortized on a basis consistent with the type of
insurance coverage. For all investment (annuity) contracts, acquisition costs
are amortized over 20 years in proportion to estimated gross profits.
Capitalized acquisition costs for interest-sensitive life contracts also are
amortized over 20 years in proportion to estimated gross profits.
The most significant assumptions that are involved in the estimation of annuity
gross profits include interest rate spreads, future financial market
performance, business surrender/lapse rates, expenses and the impact of realized
investment gains and losses. For the variable deposit portion of the annuity
segment, the Company amortizes policy acquisition costs utilizing a future
financial market performance assumption of a 10% 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 returns on Separate Accounts assumes that
long-term appreciation in the financial market is not changed by short-term
market fluctuations, but is only changed when sustained interim deviations are
experienced. The Company monitors these fluctuations
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and only changes the assumption when its long-term expectation changes. The
potential effect of an increase/(decrease) by 100 basis points in the assumed
future rate of return is reasonably likely to result in an estimated
decrease/(increase) in the deferred policy acquisition costs amortization
expense of approximately $1 million. Although this evaluation reflects likely
outcomes, it is possible an actual outcome may fall below or above these
estimates. At June 30, 2012, the ratio of capitalized annuity policy acquisition
costs to the total annuity accumulated cash value was approximately 3%.
In the event actual experience differs significantly from assumptions or
assumptions are significantly revised, the Company may be required to record a
material charge or credit to current period amortization expense for the period
in which the adjustment is made. As noted above, there are key assumptions
involved in the evaluation of capitalized policy acquisition costs. In terms of
the sensitivity of this amortization to two of the more significant assumptions,
based on capitalized annuity policy acquisition costs as of June 30, 2012 and
assuming all other assumptions are met, (1) a 10 basis point deviation in the
annual targeted interest rate spread assumption would impact amortization
between $0.15 million and $0.25 million and (2) a 1% deviation from the targeted
financial market performance for the underlying mutual funds of the Company's
variable annuities would impact amortization between $0.20 million and $0.30
million. These results may change depending on the magnitude and direction of
any actual deviations but represent a range of reasonably likely experience for
the noted assumptions. Detailed discussion of the impact of adjustments to the
amortization of capitalized acquisition costs is included in "Results of
Operations - Policy Acquisition Expenses Amortized". See also "Notes to
Consolidated Financial Statements - Note 1 - Basis of Presentation - Adopted
Accounting Standards - Costs Associated with Acquiring or Renewing Insurance
Contracts" regarding new accounting guidance which the Company adopted effective
January 1, 2012.
Liabilities for Property and Casualty Claims and Claim Expenses
Underwriting results of the property and casualty segment 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, that transpires between
a loss event, receipt of related claims data from policyholders and ultimate
settlement of the claim. Reserves for property and casualty claims include
provisions for payments to be made on reported claims ("case reserves"), claims
incurred but not yet reported ("IBNR") and associated settlement expenses
(together, "loss reserves"). The process by which these reserves are established
requires reliance upon estimates based on known facts and on interpretations of
circumstances, including the 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 and public attitudes. The Company calculates and
records a single best estimate of the reserve (which is equal to the actuarial
point estimate) as of each balance sheet date.
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Reserves are reestimated quarterly. Changes to reserves are recorded in the
period in which development factor changes result in reserve reestimates.
Detailed discussion of the process utilized to estimate loss reserves, risk
factors considered and the impact of adjustments recorded during recent years is
included in "Notes to Consolidated Financial Statements - Note 4 - Property and
Casualty Unpaid Claims and Claim Expenses" of the Company's Annual Report on
Form 10-K for the year ended December 31, 2011. 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 homeowners insurance policies
for environmentally related items such as mold.
Based on the Company's products and coverages, historical experience, and
modeling of various actuarial methodologies used to develop reserve estimates,
the Company estimates that the potential variability of the property and
casualty loss reserves within a reasonable probability of other possible
outcomes may be approximately plus or minus 6%, which equates to plus or minus
approximately $11 million of net income based on net reserves as of June 30,
2012. Although this evaluation reflects the most likely outcomes, it is possible
the final outcome may fall below or above these estimates.
There are a number of assumptions involved in the determination of the Company's
property and casualty loss reserves. Among the key factors affecting recorded
loss reserves for both long-tail and short-tail related coverages, claim
severity and claim frequency are of particular significance. Management
estimates that a 2% change in claim severity or claim frequency for the most
recent 36-month period is a reasonably likely scenario based on recent
experience and would result in a change in the estimated loss reserves of
between $6.0 million and $10.0 million for long-tail liability related exposures
(automobile liability coverages) and between $2.0 million and $4.0 million for
short-tail liability related exposures (homeowners and automobile physical
damage coverages). Actual results may differ, depending on the magnitude and
direction of the deviation.
The Company's loss and loss adjustment expense actuarial analysis is discussed
with management. As part of this discussion, the indicated point estimate of the
IBNR loss reserve by line of business (coverage) is reviewed. The Company
actuaries also discuss any indicated changes to the underlying assumptions used
to calculate the indicated point estimate. Any variance between the indicated
reserves from these changes in assumptions and the previously carried reserves
is reviewed. After discussion of these analyses and all relevant risk factors,
management determines whether the reserve balances require adjustment. The
Company's best estimate of loss reserves may change depending on a revision in
the underlying assumptions.
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The Company's liabilities for unpaid claims and claim expenses for the property
and casualty segment were as follows:
June 30, 2012 December 31, 2011
Case IBNR Case IBNR
Reserves Reserves Total (1) Reserves Reserves Total (1)
Automobile liability $ 69.3 $ 129.2 $ 198.5 $ 66.6 $ 129.2 $ 195.8
Automobile other 4.1 2.6 6.7 4.7 1.5 6.2
Homeowners 9.1 62.9 72.0 8.1 52.5 60.6
All other 3.0 17.0 20.0 1.7 16.8 18.5
Total $ 85.5 $ 211.7 $ 297.2 $ 81.1 $ 200.0 $ 281.1
(1) These amounts are gross, before reduction for ceded reinsurance reserves.
The facts and circumstances leading to the Company's reestimate of reserves
relate to revisions of the development factors used to predict how losses are
likely to develop from the end of a reporting period until all claims have been
paid. Reestimates occur because actual loss amounts are different than those
predicted by the estimated development factors used in prior reserve estimates.
At June 30, 2012, the impact of a reserve reestimation resulting in a 1%
increase in net reserves would be a decrease of approximately $2 million in net
income. A reserve reestimation resulting in a 1% decrease in net reserves would
increase net income by approximately $2 million.
Favorable prior years' reserve reestimates increased net income for the six
months ended June 30, 2012 by approximately $5.5 million, primarily the result
of favorable frequency and severity trends in voluntary automobile and
homeowners losses for accident year 2011. The lower than expected claims
emergence and resultant lower expected loss ratios caused the Company to lower
its reserve estimate at June 30, 2012.
Information regarding the Company's property and casualty claims and claims
expense reserve development table as of December 31, 2011 is located in
"Business - Property and Casualty Segment - Property and Casualty Reserves" of
the Company's Annual Report on Form 10-K for the year ended December 31, 2011.
Information regarding property and casualty reserve reestimates for each of the
years in the three year period ended December 31, 2011 is located in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Results of Operations for the Three Years Ended December 31, 2011 -
Benefits, Claims and Settlement Expenses" of the Company's Annual Report on Form
10-K for the year ended December 31, 2011.
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Liabilities for Future Policy Benefits
Liabilities for future benefits on life and annuity policies are established in
amounts adequate to meet the estimated future obligations on policies in force.
Liabilities for future policy benefits on certain life insurance policies are
computed using the net level premium method and are based on assumptions as to
future investment yield, mortality and withdrawals. Mortality and withdrawal
assumptions for all policies have been based on actuarial tables which are
consistent with the Company's own experience. In the event actual experience is
worse than the assumptions, additional reserves may be required. This would
result in a charge to income for the period in which the increase in reserves
occurred. 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.
Deferred Taxes
Deferred tax assets and liabilities represent the tax effect of the differences
between the financial statement carrying value of existing assets and
liabilities and their respective tax bases. The Company evaluates deferred tax
assets periodically to determine if they are realizable. Factors in the
determination include the performance of the business including the ability to
generate capital gains from a variety of sources and tax planning strategies.
If, based on available information, it is more likely than not that the deferred
income tax asset will not be realized, then a valuation allowance must be
established with a corresponding charge to net income. Charges to establish a
valuation allowance could have a material adverse effect on the Company's
results of operations and financial position.
Valuation of Assets and Liabilities Related to the Defined Benefit Pension Plan
Effective April 1, 2002, participants stopped accruing benefits under the
defined benefit pension plan but continue to retain the benefits they had
accrued to that date.
The Company's cost estimates for its defined benefit pension plan are determined
annually based on assumptions which include the discount rate, expected return
on plan assets, anticipated retirement rate and estimated lump sum
distributions. A discount rate of 3.66% was used by the Company for estimating
accumulated benefits under the plan at December 31, 2011, which was based on the
average yield for long-term, high grade securities having maturities generally
consistent with the defined benefit pension payout period. To set its discount
rate, the Company looks to leading indicators, including the Citigroup Pension
Discount Curve. The expected annual return on plan assets assumed by the Company
at December 31, 2011 was 7.5%. The assumption for the long-term rate of return
on plan assets was determined by considering actual investment experience during
the lifetime of the plan, balanced with reasonable expectations of future growth
considering the various classes of assets and percentage allocation for each
asset class. Management believes that it has adopted reasonable assumptions for
investment returns, discount rates and other key factors used in the estimation
of pension costs and asset values.
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To the extent that actual experience differs from the Company's assumptions,
subsequent adjustments may be required, with the effects of those adjustments
charged or credited to income and/or shareholders' equity for the period in
which the adjustments are made. Generally, a change of 50 basis points in the
discount rate would inversely impact pension expense and accumulated other
comprehensive income ("AOCI") by approximately $0.1 million and $1.0 million,
respectively. In addition, for every $1 million increase (decrease) in the value
of pension plan assets, there is a comparable pretax increase (decrease) in
AOCI.
Results of Operations
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
(Includes annuity and life contract deposits)
Six Months Ended Change From
June 30, Prior Year
2012 2011 Percent Amount
Property & casualty
Automobile and property (voluntary) $ 265.7 $ 265.9 -0.1 % $ (0.2 )
Involuntary and other property & casualty 1.4 1.5 -6.7 % (0.1 )
Total property & casualty 267.1 267.4 -0.1 % (0.3 )
Annuity deposits 188.4 188.8 -0.2 % (0.4 )
Life 47.5 47.2 0.6 % 0.3
Total $ 503.0 $ 503.4 -0.1 % $ (0.4 )
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
Six Months Ended Change From
June 30, Prior Year
2012 2011 Percent Amount
Property & casualty
Automobile and property (voluntary) $ 269.6 $ 273.1 -1.3 % $ (3.5 )
Involuntary and other property & casualty 1.0 0.7 42.9 % 0.3
Total property & casualty 270.6 273.8 -1.2 % (3.2 )
Annuity 10.5 9.5 10.5 % 1.0
Life 50.7 49.7 2.0 % 1.0
Total $ 331.8 $ 333.0 -0.4 % $ (1.2 )
For the three months ended June 30, 2012, the Company's premiums written and
contracts deposits of $260.2 million increased $0.9 million, or 0.3%, primarily
reflecting a comparable increase in property and casualty premiums written. For
the six months ended June 30, 2012, the Company's premiums written and contract
deposits decreased $0.4 million, or 0.1%, compared to the prior year, reflecting
minor variances in each of the operating segments. The Company's premiums and
contract charges earned were equal to the second quarter of 2011 and decreased
$1.2 million, or 0.4%, compared to the six months ended June 30, 2011, primarily
reflecting the increasing favorable impact on earned premium of the automobile
and property rate actions taken in 2011 which were more than offset by a reduced
level of property and casualty policies in force compared to the prior year,
including policy reductions due to the Florida homeowners non-renewal program
described below. Voluntary property and casualty business represents policies
sold through the Company's marketing
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organization and issued under the Company's underwriting guidelines. Involuntary
property and casualty business consists of allocations of business from state
mandatory insurance facilities and assigned risk business.
Total voluntary automobile and homeowners premium written decreased 0.1%, or
$0.2 million, in the first six months of 2012. Homeowners average written
premium per policy increased compared to the prior year, with the impact more
than offset by a reduced level of automobile and homeowners policies in force in
the current period. For the Company's automobile and homeowners business, rate
changes effective during the first six months of 2012 averaged 4% and 7%,
respectively, compared to 2% and 10%, respectively, during the same period in
2011. At June 30, 2012, there were 485,000 voluntary automobile and 238,000
homeowners policies in force, for a total of 723,000 policies, compared to a
total of 725,000 policies at December 31, 2011 and 737,000 policies at June 30,
2011. Management believes that the Company's rate and risk mitigation actions
have had a negative impact, in some locations, on its policy retention rates and
its sales levels, particularly in its automobile line. Consequently, during
2011, the Company developed and began implementing state-specific pricing,
underwriting and marketing initiatives designed to improve automobile new sales
and retention levels.
Based on policies in force, the voluntary automobile 6-month and 12-month
retention rates for new and renewal policies were 91.4% and 83.7%, respectively,
at June 30, 2012 compared to 90.5% and 82.8%, respectively, at June 30, 2011.
The property 12-month new and renewal policy retention rate was 87.5% at
June 30, 2012 compared to 85.4% at June 30, 2011, with the change including the
impact of the Company's risk mitigation actions described below.
Voluntary automobile premium written decreased 1.6%, or $2.8 million, compared
to the first half of 2011. In the first six months of 2012, the average written
premium per policy was equal to a year earlier, while the average earned premium
per policy increased approximately 1%, which was more than offset by the decline
in policies in force. Voluntary automobile policies in force at June 30, 2012
decreased 1,000 compared to December 31, 2011 and 9,000 compared to June 30,
2011. Educator policies increased slightly compared to December 31, 2011, and
decreased compared to June 30, 2011. The number of educator policies represented
approximately 83% and 82% of the voluntary automobile policies in force at
June 30, 2012 and 2011, respectively. The number of non-educator policies
decreased compared to both December 31, 2011 and June 30, 2011.
Voluntary homeowners premium written increased 3.0%, or $2.6 million, compared
to the first half of 2011, net of catastrophe reinsurance premiums ceded that
were less than the prior year. The average written and earned premium per policy
increased 4% and 5%, respectively, in the first half of 2012 compared to a year
earlier. Homeowners policies in force at June 30, 2012 decreased 1,000 compared
to December 31, 2011 and 5,000 compared to June 30, 2011. The number of educator
policies represented approximately 78% and 77% of the homeowners policies in
force at June 30, 2012 and 2011, respectively. Educator policies increased
slightly compared to December 31, 2011. Growth in the number of educator
policies that had been consistent sequentially for several years was offset
somewhat beginning in the third quarter of 2010 by expected reductions due to
the Company's risk mitigation programs, including actions in catastrophe-prone
coastal areas, involving policies of both educators and non-educators. The
Company continues to evaluate and implement actions to further mitigate its risk
exposure in hurricane-prone areas, as well as other areas of the country. Such
actions
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could include, but are not limited to, non-renewal of homeowners policies,
restricted agent geographic placement, limitations on agent new business sales,
further tightening of underwriting standards and increased utilization of
third-party vendor products.
As an example, in early 2010 the Company began a program to address homeowners
profitability and hurricane exposure issues in Florida. On January 1, 2010, the
Company ceased writing new homeowner (including home, condo, renters and
dwelling fire) policies in that state and initiated a program to non-renew about
9,600 policies, over half of the Company's Florida book of property business,
starting with August 2010 policy effective dates. By mid-August 2011, the
non-renewal program had been completed, including approximately 3,600 policies
terminated prior to non-renewal at the customers' request. In total, the
Company's June 30, 2012 policy count for Florida homeowners business of less
than 6,000 decreased by approximately 11,000 compared to December 31, 2009 and
included virtually no remaining risk exposure in the more sinkhole-prone
counties. Throughout the non-renewal program period, the Company's agents worked
closely with customers to find coverage with third-party companies that
underwrite property risks in Florida. This program is expected to reduce risk
exposure concentration, reduce overall catastrophe reinsurance costs and improve
homeowners underwriting results.
For the six months ended June 30, 2012, total annuity deposits received
decreased 0.2%, or $0.4 million, compared to the prior year, as a 4.7% increase
in single premium and rollover deposit receipts was more than offset by a 4.8%
decrease in scheduled annuity deposit receipts. In the first six months of 2012,
new deposits to variable accounts increased 3.2%, or $1.8 million, and new
deposits to fixed accounts decreased 1.7%, or $2.2 million, compared to the
prior year. In addition to external contractholder deposits, annuity new
deposits include contributions and transfers by the Company's employees in the
Company's 401(k) group annuity contract.
Total annuity accumulated cash value of $4.5 billion at June 30, 2012 increased
7.0% compared to a year earlier, reflecting the increase from new deposits
received as well as favorable retention. Cash value retentions for variable and
fixed annuity options were 94.0% and 95.1%, respectively, for the 12 month
period ended June 30, 2012. At June 30, 2012, the number of annuity contracts
outstanding of 186,000 increased 2,000 contracts compared to December 31, 2011
and 4,000 contracts compared to June 30, 2011.
Variable annuity accumulated balances of $1.3 billion at June 30, 2012 reflected
a decrease of 1.7% compared to June 30, 2011, as favorable financial market
performance over the 12 months was more than offset by net balances transferred
from the variable account option to the guaranteed interest rate fixed account
option. Annuity segment contract charges earned increased 10.5%, or $1.0
million, compared to the first six months of 2011.
Life segment premiums and contract deposits for the first six months of 2012
increased $0.3 million, or 0.6%, compared to the prior year. The ordinary life
insurance in force lapse ratio was 4.5% for the 12 months ended June 30, 2012
compared to 4.7% for the 12 months ended June 30, 2011.
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Sales
For the Company, as well as other personal lines property and casualty
companies, new business levels have been adversely impacted by the economy and
the overall lower level of automobile and home sales compared to levels
preceding the 2008 financial crisis. In addition, management believes that
automobile and homeowners new business levels have been negatively impacted by
the Company's rate actions and by the Company's underwriting actions in Florida
which were initiated in 2010.
Despite these challenges, the Company's 2011 positive sales momentum in all
lines of business carried into the first half of 2012. For the first six months
of 2012, true new automobile sales units - units associated with new Horace Mann
automobile policyholders - increased 34.8% compared to the first half of 2011,
reflecting the continued positive impact of state-specific pricing, underwriting
and marketing initiatives implemented during the last several months of 2011.
Total new automobile units, tempered by a modest increase in additional vehicles
added to existing automobile policies, increased 18.3% compared to the prior
year. New homeowners sales units increased 17.8% compared to the prior year.
The Company's 2012 annuity new business levels continued to benefit from agent
training and marketing programs, which focus on retirement planning, and build
on the positive, record-level results produced throughout 2011 and 2010. Total
annuity sales for the six months ended June 30, 2012 increased 12.1% compared to
2011. Single premium and rollover deposits for Horace Mann annuity products
increased 4.7% compared to the same period in 2011. In addition, the Company's
new scheduled deposit business (measured on an annualized basis at the time of
sale, compared to the reporting of new contract deposits which are recorded when
cash is received) increased 8.9% compared to the first half of 2011. In the
first six months of 2012, sales of third-party vendor annuity products, a
relatively minor component of total annuity sales, increased notably compared to
the first half of 2011. Sales of Horace Mann products by the Independent Agent
distribution channel, included in the information above, decreased 19.5%
compared to the prior year, a comparison impacted by current period decreases in
single premium and rollover deposits. The Company's annuity sales levels in
recent years have been impacted as K-12 educators respond to uncertainties
regarding employment prospects during the economic recession. In situations
where educator retirements increase, opportunities arise for single premium and
rollover deposit business. For employed educators, uncertainty about their
future employment has created challenges for new sales of scheduled deposit
business.
The Company's introduction of new educator-focused portfolios of term and whole
life products in the third quarters of 2009, 2010 and 2011 has contributed to
the increase in sales of proprietary life products. For the six months ended
June 30, 2012, the increase in total life sales of 44.1% included a 36.6%
increase in sales of Horace Mann's proprietary life products and a 49.7%
increase in sales of third-party vendor products.
Combining these increases in all of the lines of business, the Company's total
new business sales increased 14.1% compared to the first six months of 2011.
Total sales for Horace Mann's Exclusive Agencies and Employee Agents for the
first six months of 2012 increased 22.1% compared to the prior year.
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Distribution System
At June 30, 2012, there was a combined total of 712 Exclusive Agencies and
Employee Agents, compared to 745 at December 31, 2011 and 732 at June 30, 2011.
The net declines compared to 2011 were largely driven by termination of lower
producing agents, partially offset by new Exclusive Agency appointments. At
June 30, 2012, there were 557 Horace Mann Exclusive Agencies, an increase of 62
compared to June 30, 2011. At June 30, 2012, in addition to the Exclusive
Agencies, there were 155 Employee Agents. See additional description in
"Business - Corporate Strategy and Marketing - Dedicated Agency Force" of the
Company's Annual Report on Form 10-K for the year ended December 31, 2011.
As mentioned above, the Company utilizes a nationwide network of Independent
Agents who comprise a supplemental distribution channel for the Company's 403(b)
tax-qualified annuity products. The Independent Agent distribution channel
included 600 authorized agents at June 30, 2012. During the first six months of
2012, this channel generated $23.5 million in annualized new annuity sales for
the Company compared to $29.2 million for the first six months of 2011,
reflecting decreases in single and rollover deposit business in the current
period.
Net Investment Income
For the three months ended June 30, 2012, pretax investment income of $76.3
million increased 6.4%, or $4.6 million, (6.0%, or $2.9 million, after tax)
compared to the prior year. Pretax investment income of $152.0 million for the
six months ended June 30, 2012 increased 6.9%, or $9.8 million, (6.6%, or $6.3
million, after tax) compared to the prior year. The increase primarily reflected
growth in the size of the average investment portfolio on an amortized cost
basis. Average invested assets increased 7.7% over the 12 months ended June 30,
2012. The average pretax yield on the investment portfolio was 5.72% (3.85%
after tax) for the first six months of 2012 compared to pretax yields of 5.76%
(3.89% after tax) a year earlier. The decline in average pretax yield was
primarily due to portfolio turnover, including calls and prepayments, and lower
re-investment yield, partially offset by the favorable impact of reductions in
short-term investments in both periods, as funds were invested in
higher-yielding fixed maturity and equity securities.
Net Realized Investment Gains and Losses
For the three months ended June 30, 2012, net realized investment gains (pretax)
were $9.9 million compared to net realized investment gains of $5.7 million in
the same period in the prior year. For the six months, net realized investment
gains (pretax) were $10.3 million in 2012 compared to $11.5 million in the prior
year. The net gains in both periods were realized from ongoing investment
portfolio management activity.
For the first half of 2012, the Company's net realized investment gains of $10.3
million included $22.4 million of gross gains realized on security sales and
calls partially offset by $12.1 million of realized losses on securities that
were disposed of during the six months, primarily commercial mortgage-backed
securities, as further described below, and also corporate securities to a
lesser extent. There were no other-than-temporary impairment write-downs on
securities in the current period. Gains realized on security disposals during
the first half of 2012 included $3.5 million related to securities on which the
Company had previously recognized other-than-temporary impairment write-downs.
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For the first half of 2011, the Company's net realized investment gains of $11.5
million included $11.7 million of gross gains realized on security sales and
calls partially offset by $0.2 million of realized losses on securities that
were disposed of during the six months. There were no other-than-temporary
impairment write-downs on securities in that period. Gains realized on security
disposals during the first half of 2011 included $0.3 million related to
securities on which the Company had previously recognized other-than-temporary
impairment write-downs.
The Company, from time to time, sells securities subsequent to the balance sheet
date that were considered temporarily impaired at the balance sheet date. Such
sales are generally due to events occurring subsequent to the balance sheet date
that result in a change in the Company's intent to sell an invested asset.
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Fixed Maturity Securities and Equity Securities Portfolios
The table below presents the Company's fixed maturity securities and equity
securities portfolios as of June 30, 2012 by major asset class, including the
ten largest sectors of the Company's corporate bond holdings (based on fair
value) and the sectors of the equity securities holdings. Compared to
December 31, 2011, yields on U.S. Treasury securities decreased while credit
spreads narrowed across virtually all asset classes, with the Company's
corporate bond portfolio showing the most significant improvement in net
unrealized gains.
Amortized Pretax Net
Number of Fair Cost or Unrealized
Issuers Value Cost Gain (Loss)
Fixed Maturity Securities
Corporate bonds
Banking and Finance 61 $ 422.5 $ 395.4 $ 27.1
Energy 63 267.3 239.4 27.9
Utilities 45 265.8 224.9 40.9
Insurance 29 146.5 125.9 20.6
Metal and Mining 16 115.5 105.5 10.0
Health Care 34 110.0 97.5 12.5
Broadcasting and Media 18 109.3 95.5 13.8
Transportation 20 103.0 95.3 7.7
Telecommunications 25 99.0 89.0 10.0
Real Estate 16 93.4 86.0 7.4
All Other Corporates (1) 203 682.2 620.4 61.8
Total corporate bonds 530 2,414.5 2,174.8 239.7
Mortgage-backed securities
U.S. government and federally
sponsored agencies 377 629.5 552.1 77.4
Commercial 22 51.3 47.8 3.5
Other 14 14.4 12.2 2.2
Municipal bonds 458 1,509.5 1,349.8 159.7
Government bonds
U.S. 7 489.0 452.0 37.0
Foreign 8 55.6 48.5 7.1
Collateralized debt obligations (2) 24 41.8 38.8 3.0
Asset-backed securities 90 489.1 470.8 18.3
Total fixed maturity securities 1,530 $ 5,694.7 $
5,146.8 $ 547.9
Equity Securities
Non-redeemable preferred stocks
Banking and Finance 4 $ 9.2 $ 9.6 $ (0.4 )
Utilities 2 4.3 3.9 0.4
Insurance 3 2.9 2.7 0.2
Real Estate 2 1.2 1.1 0.1
Common stocks
Healthcare, Pharmacy 10 2.6 2.5 0.1
Banking and Finance 19 2.6 2.6 *
Technology 18 2.5 2.1 0.4
Food and Beverages 12 2.1 1.9 0.2
Retail 13 1.5 1.6 (0.1 )
Insurance 15 1.4 1.4 *
Energy 5 1.0 1.0 *
Telecommunications 4 0.9 0.8 0.1
Utilities 8 0.8 0.8 *
Consumer Products 10 0.8 0.9 (0.1 )
All other common stocks 42 4.2 4.3 (0.1 )
Total equity securities 167 $ 38.0 $ 37.2 $ 0.8
Total 1,697 $ 5,732.7 $ 5,184.0 $ 548.7
* Less than $0.1 million.
(1) The All Other Corporates category contains 19 additional industry
classifications. Natural gas, technology, consumer products, gaming, retail
and industry manufacturing represented $438.3 million of fair value at
June 30, 2012, with the remaining 13 classifications each representing less
than $47 million.
(2) Based on fair value, 76.6% of the collateralized debt obligation securities
were rated investment grade by Standard and Poor's Corporation ("S&P") and/or
Moody's Investors Service, Inc. ("Moody's") at June 30, 2012.
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At June 30, 2012, the Company's diversified fixed maturity securities portfolio
consisted of 1,829 investment positions, issued by 1,530 entities, and totaled
approximately $5.7 billion in fair value. This portfolio was 95.0% investment
grade, based on fair value, with an average quality rating of A. The Company's
investment guidelines generally limit single corporate issuer concentrations to
0.5% of invested assets for "AA" or "AAA" rated securities, 0.35% of invested
assets for "A" or "BBB" rated securities, and 0.2% of invested assets for
non-investment grade securities.
The following table presents the composition and value of the Company's fixed
maturity securities and equity securities portfolios by rating category. At
June 30, 2012, 94.6% of these combined portfolios were investment grade, with an
overall average quality rating of A. The Company has classified the entire fixed
maturity securities and equity securities portfolios as available for sale,
which are carried at fair value.
Rating of Fixed Maturity Securities and Equity Securities(1)
(Dollars in millions)
Percent of Portfolio
Fair Value June 30, 2012
December 31, June 30, Fair Amortized
2011 2012 Value Cost or Cost
Fixed maturity securities
AAA (2) 4.9 % 4.1 % $ 235.6 $ 211.8
AA (2) 39.6 36.5 2,078.8 1,863.8
A 24.8 25.2 1,437.7 1,270.0
BBB 25.5 29.1 1,656.5 1,524.0
BB 2.8 2.8 157.7 151.7
B 2.1 2.0 113.7 110.5
CCC or lower 0.3 0.3 14.6 15.0
Not rated (3) - - 0.1 *
Total fixed maturity securities 100.0 % 100.0 % $ 5,694.7 $ 5,146.8
Equity securities
AAA - - - -
AA 15.7 % 11.1 % $ 4.2 $ 4.1
A 12.7 11.8 4.5 5.1
BBB 44.0 19.7 7.5 6.6
BB 26.1 4.0 1.5 1.5
B - - - -
CCC or lower - - - -
Not rated (4) 1.5 53.4 20.3 19.9
Total equity securities 100.0 % 100.0 % $ 38.0 $ 37.2
Total $ 5,732.7 $ 5,184.0
* Less than $0.1 million.
(1) Ratings are as assigned primarily by S&P when available, with remaining
ratings as assigned on an equivalent basis by Moody's. Ratings for publicly
traded securities are determined when the securities are acquired and are
updated monthly to reflect any changes in ratings.
(2) During 2011, S&P and Moody's concluded on their respective evaluations of
ratings for debt issued by the U.S. government. On August 2, 2011, Moody's
affirmed its Aaa rating, with an outlook of negative. On August 5, 2011, S&P
reduced its AAA long-term rating one notch to AA+, with an outlook of
negative. At June 30, 2012, the AA rated fair value amount included $471.6
million of U.S. government and federally sponsored agency securities and
$629.5 million of mortgage-backed securities issued by U.S. government and
federally sponsored agencies.
(3) Included in this category is $0.1 million fair value of private placement
securities not rated by either S&P or Moody's.
(4) This category represents common stocks that are not rated by either S&P or
Moody's.
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At June 30, 2012, total fair value of the Company's European fixed maturity
securities direct exposure was $194.4 million with a net unrealized gain of $8.6
million. The Company generally defines its country classification by issuer
country of incorporation or domicile where appropriate. Given the economic,
fiscal and political uncertainties surrounding a number of European countries,
especially Greece, Ireland, Italy, Portugal and Spain (collectively "GIIPS") and
France, the Company closely monitors its direct European securities exposures.
At June 30, 2012, the Company had no sovereign or equity security exposure in
any European country, no exposure in the banking and finance industry in any of
the GIIPS countries or France, no unfunded exposure related to its European
securities holdings and no derivative or hedging instruments in its investment
portfolio.
The Company also carefully monitors its indirect European securities exposure
and analyzes a number of factors to understand and identify its indirect
European exposure. While many factors are considered, it is difficult to know if
all potential factors which may indirectly impact the Company's investment
portfolio have been identified. The factors the Company considers include, but
are not limited to, the issuer's parent-subsidiary relationship, principal place
of business, management location, source of revenue streams, industry
classification and asset characteristics. At June 30, 2012, the Company did not
identify significant indirect exposure to European countries in its investment
portfolio.
The following table summarizes the Company's direct exposures by asset category
related to selected groups of European countries and to Europe in total as of
June 30, 2012.
Sovereign Banking Other Corporate Asset-backed Total
Net Net Net Net Net
Unrealized Unrealized Unrealized Unrealized Unrealized
Fair Gain Fair Gain Fair Gain Fair Gain Fair Gain
Value (Loss) Value (Loss) Value (Loss) Value (Loss) Value (Loss)
Fixed Maturity Securities
GIIPS
Greece $ - $ - $ - $ - $ - $ - $ - $ - $ - $ -
Ireland - - - - 3.3 0.1 10.0 * 13.3 0.1
Italy - - - - - - - - - -
Portugal - - - - - - - - - -
Spain - - - - 8.7 (1.2 ) - - 8.7 (1.2 )
Total GIIPS - - - - 12.0 (1.1 ) 10.0 * 22.0 (1.1 )
France - - - - 18.2 1.1 - - 18.2 1.1
United Kingdom - - 3.7 0.2 68.4 5.0 - - 72.1 5.2
Other European Countries (1) - - 25.7 1.0 44.7 2.1 11.7 0.3 82.1 3.4
Total $ - $ - $ 29.4 $ 1.2 $ 143.3 $ 7.1 $ 21.7 $ 0.3 $ 194.4 $ 8.6
* Less than $0.1 million.
(1) The Other European Countries category contains 5 countries with the total
fair value amount for each country representing less than $40 million.
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At June 30, 2012, the Company had $51.3 million fair value in commercial
mortgage-backed securities ("CMBS"), all in the annuity and life portfolios,
with gross unrealized losses of $0.8 million and a net unrealized gain of $3.5
million, resulting in an overall fair value to amortized cost ratio of 107.4%,
compared to 101.8% at June 30, 2011. CMBS spreads widened notably in 2011
followed by narrowing in the first half of 2012. The concern over current
economic weakness and its impact on commercial real estate values and rising
commercial mortgage loan delinquencies has resulted in downward price pressure
for certain CMBS securities. As a result of risk reduction actions since 2009,
the Company reduced its holdings of conduit/fusion CMBS securities by $154
million of amortized cost, or 82%, compared to December 31, 2009. These
disposals resulted in a net realized loss of $10.3 million for the six months
ended June 30, 2012 and a net realized loss of $17.2 million for the two years
ended December 31, 2011. At June 30, 2012, the Company's CMBS portfolio was 93%
investment grade, with an overall credit rating of A+, and well diversified by
property type, geography and sponsor.
To evaluate the CMBS portfolio, the Company uses an estimate of future cash
flows expected to be collected. 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, including past events, current
conditions, and reasonable and supportable assumptions and forecasts, are
considered when developing the estimate of cash flows expected to be collected.
Information includes, but is not limited to, debt-servicing, missed refinancing
opportunities and geography. Loan level characteristics such as issuer, payment
terms, property type, and economic outlook are also utilized in financial
models, along with historical performance, to estimate or measure the loan's
propensity to default. Additionally, financial models take into account loan
age, lease rollovers, rent volatilities, vacancy rates and exposure to
refinancing as additional drivers of default. For transactions where loan level
data is not available, financial models use a proxy based on the collateral
characteristics. Loss severity is a function of multiple factors including, but
not limited to, the unpaid balance, interest rate, assessed property value at
origination, change in property valuation and loan-to-value ratio at
origination. Cost of capital rates and debt service ratios are also considered.
The cash flows generated by the collateral securing these securities are
estimated using these default and loss severity assumptions. These collateral
cash flows are then utilized, along with consideration for the issue's position
in the overall structure, to estimate the cash flows associated with the
commercial mortgage-backed security held by the Company.
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The table below presents rating, vintage year and property type information for
the Company's CMBS portfolio.
June 30, 2012 December 31, 2011
Pretax Pretax
Number Unrealized Number Unrealized
of Fair Gain of Fair Gain
Positions Value (Loss) Positions Value (Loss)
Rating
AAA 3 $ 16.4 $ 2.1 4 $ 18.6 $ 2.2
AA 4 5.2 0.4 4 5.0 0.3
A 7 17.0 0.8 6 15.2 *
BBB 6 9.2 0.3 8 13.2 (1.9 )
BB and below 2 3.5 (0.1 ) 6 18.8 (9.3 )
Total 22 $ 51.3 $ 3.5 28 $ 70.8 $ (8.7 )
Vintage year
2003 and prior 2 $ 2.8 $ * 3 $ 4.9 $ 0.1
2004 7 9.9 * 7 9.6 (0.2 )
2005 4 22.0 1.0 9 40.4 (10.5 )
2006 7 11.8 1.0 7 11.3 0.6
2007 2 4.8 1.5 2 4.6 1.3
Total 22 $ 51.3 $ 3.5 28 $ 70.8 $ (8.7 )
Property type
Conduit/Fusion 20 $ 37.5 $ 2.4 26 $ 57.1 $ (9.7 )
Single borrower 2 13.8 1.1 2 13.7 1.0
Total 22 $ 51.3 $ 3.5 28 $ 70.8 $ (8.7 )
* Less than $0.1 million.
At June 30, 2012, the Company had $434.3 million fair value in financial
institution bonds and preferred stocks with a net unrealized gain of $26.7
million. The Company's holdings in this sector are primarily large,
well-recognized institutions, which were broadly supported by government
intervention and credit enhancement programs during the 2008 credit crisis.
At June 30, 2012, the Company had $1,509.5 million fair value invested in
municipal bonds with a net unrealized gain of $159.7 million. Of the
geographically diversified municipal bond holdings, approximately 49% are
tax-exempt and 78% are revenue bonds tied to essential services, such as mass
transit, water and sewer. The overall credit quality of these securities was
AA-, with approximately 26% of the value insured at June 30, 2012. This
represents approximately 7% of the Company's total investment portfolio that is
guaranteed by the mono-line credit insurers or other forms of guarantee. When
selecting securities, the Company focuses primarily on the quality of the
underlying security and does not place significant reliance on the additional
insurance benefit. Excluding the effect of insurance, the credit quality of the
underlying municipal bond portfolio was A+ at June 30, 2012.
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At June 30, 2012, the fixed maturity securities and equity securities portfolios
had a combined $17.4 million pretax of gross unrealized losses on $331.8 million
fair value related to 226 positions. Of this amount, $6.8 million of pretax
gross unrealized losses were on $234.0 million fair value for 168 positions that
had been in a continuous unrealized loss position for 9 months or less.
Of the investment positions (fixed maturity securities and equity securities)
with gross unrealized losses, 12 were trading below 80% of book value at
June 30, 2012 and were not considered other-than-temporarily impaired. These
positions included structured securities, corporate securities and equity
securities. The 12 securities with fair values below 80% of book value at
June 30, 2012 had fair value of $14.9 million, representing 0.3% of the
Company's total investment portfolio at fair value, and had a gross unrealized
loss of $6.1 million.
The persisting global uncertainty and concern over prolonged economic weakness
continue to have an adverse effect on the liquidity and fair value of certain
investments. With respect to fixed income securities involving securitized
financial assets, the underlying collateral cash flows were stress tested to
determine there was no adverse change in the expected cash flows at June 30,
2012.
The Company views the decrease in value of all of the securities with unrealized
losses at June 30, 2012 as temporary. For fixed maturity securities, management
does not have the intent to sell the securities and it is not more likely than
not the Company will be required to sell the securities before the anticipated
recovery of the amortized cost bases. In addition, management expects to recover
the entire cost basis of the fixed maturity securities. For equity securities,
the Company has the ability and intent to hold the securities for the recovery
of cost and recovery of cost is expected within a reasonable period of time.
Additionally, as of the date of this Quarterly Report on Form 10-Q, the Company
is not aware of any events that call into question the ability of the issuers of
the securities to honor their contractual commitments. Therefore, no impairment
of these securities was recorded at June 30, 2012. Future changes in
circumstances related to these and other securities could require subsequent
recognition of other-than-temporary impairment losses.
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Benefits, Claims and Settlement Expenses
Six Months Ended Change From
June 30, Prior Year
2012 2011 Percent Amount
Property and casualty $ 209.7 $ 244.6 -14.3 % $ (34.9 )
Annuity 1.1 1.0 10.0 % 0.1
Life 28.1 28.8 -2.4 % (0.7 )
Total $ 238.9 $ 274.4 -12.9 % $ (35.5 )
Property and casualty catastrophe losses,
included above (1) $ 35.1 $ 63.0 -44.3 % $ (27.9 )
(1) See footnote (1) to the table below.
Property and Casualty Claims and Claim Expenses ("losses")
Six Months Ended
June 30,
2012 2011
Incurred claims and claim expenses:
Claims occurring in the current year $ 218.2$ 248.3
Decrease in estimated reserves for claims occurring in
prior years (2)
(8.5 )
(3.7 )
Total claims and claim expenses incurred $ 209.7
$ 244.6
Property and casualty loss ratio:
Total 77.5 % 89.3 %
Effect of catastrophe costs, included above (1) 12.9 % 23.0 %
Effect of prior years' reserve development, included above
(2) -3.0 % -1.4 %
(1) Property and casualty catastrophe losses were incurred as follows:
2012 2011
Three months ended
March 31 $ 5.9 $ 8.0
June 30 29.2 55.0
Total year-to-date $ 35.1 $ 63.0
(2) Shows the amounts by which the Company decreased its reserves in each of the
periods indicated for claims occurring in previous years to reflect
subsequent information on such claims and changes in their projected final
settlement costs.
2012 2011
Three months ended
March 31 $ (4.0 ) $ (2.7 )
June 30 (4.5 ) (1.0 )
Total year-to-date $ (8.5 ) $ (3.7 )
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For the three months ended June 30, 2012, the Company's benefits, claims and
settlement expenses decreased $32.8 million, or 20.0%, compared to the prior
year, primarily reflecting a $25.8 million decrease in property and casualty
catastrophe losses in the current period, as well as a reduction in property
non-catastrophe losses. In the second quarter of 2012, the Company also
experienced an increase in automobile non-catastrophe losses, reflecting higher
frequency of loss for the current accident year - predominantly from bodily
injury coverages.
For the six months ended June 30, 2012, the Company's benefits, claims and
settlement expenses decreased $35.5 million, or 12.9%, compared to the prior
year, primarily reflecting a $27.9 million decrease in property and casualty
catastrophe losses in the current period, as well as a notable reduction in
Florida sinkhole loss costs. For the first half of 2012, automobile
non-catastrophe losses increased compared to the prior year, primarily
reflecting higher current accident year frequency of losses from bodily injury
coverages.
For the first half of 2012, the favorable development of prior years' property
and casualty reserves of $8.5 million was the result of actual and remaining
projected losses for prior years being below the level anticipated in the
December 31, 2011 loss reserve estimate, primarily the result of favorable
frequency and severity trends in voluntary automobile and homeowners loss
emergence for accident year 2011.
For the six months ended June 30, 2011, the favorable development of prior
years' property and casualty reserves of $3.7 million was the result of actual
and remaining projected losses for prior years being below the level anticipated
in the December 31, 2010 loss reserve estimate, primarily the result of
favorable frequency and severity trends in voluntary automobile loss emergence
for accident years 2009 and prior, as well as favorable development of
homeowners loss reserves for accident years 2010 and prior.
For the six months ended June 30, 2012, the voluntary automobile loss ratio of
73.2% increased by 1.9 percentage points compared to the prior year, including
development of prior years' reserves that had a 2.3 percentage point greater
favorable impact in the current period, lower catastrophe losses for this line
of business which represented a 0.3 percentage point decrease in the current
accident year loss ratio, and the unfavorable impact of an increase in loss
frequency in 2012. The homeowners loss ratio of 85.5% for the six months ended
June 30, 2012 decreased 40.9 percentage points compared to a year earlier,
including a 31.5 percentage point decrease due to the lower level of catastrophe
costs. Catastrophe costs represented 34.5 percentage points of the homeowners
loss ratio for the current period compared to 66.0 percentage points for the
prior year. Development of prior years' homeowners reserves had a 0.8 percentage
point greater favorable impact in the six months ended June 30, 2012. The
Company's sinkhole loss costs for the current period reflected a favorable
impact from the Company's Florida homeowners policy non-renewal program.
Excluding claim settlement expenses, Florida sinkhole losses incurred for both
the three and six months ended June 30, 2012 were zero compared to $1.9 million
and $6.6 million incurred in the respective prior year periods.
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For the annuity segment, benefits in the first half of 2012 were comparable to
the prior year. The Company's guaranteed minimum death benefit ("GMDB") reserve
was $0.5 million at June 30, 2012 compared to $0.6 million at December 31, 2011
and $0.4 million at June 30, 2011. The changes in this reserve in both the
current period and 2011 reflected the impact of financial market performance.
For the life segment, benefits in the current six months decreased $0.7 million
compared to a year earlier, including a decrease in mortality costs in the
current period.
Interest Credited to Policyholders
Six Months Ended Change From
June 30, Prior Year
2012 2011 Percent Amount
Annuity $ 59.5 $ 55.1 8.0 % $ 4.4
Life 20.9 20.6 1.5 % 0.3
Total $ 80.4 $ 75.7 6.2 % $ 4.7
For the three months ended June 30, 2012, interest credited of $40.4 million
increased 5.5%, or $2.1 million, compared to the same period in 2011, comparable
to the percentage increase reflected for the six months.
Compared to the first six months of 2011, the current year increase in annuity
segment interest credited reflected an 11.4% increase in average accumulated
fixed deposits, partially offset by a 13 basis point decline in the average
annual interest rate credited to 3.93%. Life insurance interest credited
increased slightly as a result of the growth in interest-sensitive life
insurance reserves.
The net interest spread on fixed annuity account value on deposit measures the
difference between the rate of income earned on the underlying invested assets
and the rate of interest which policyholders are credited on their account
values. The net interest spreads for the six months ended June 30, 2012 and 2011
were 211 basis points and 203 basis points, respectively. The net interest
spread increase reflected both improvements in the Company's investment income
earned and crediting rate decreases.
As of June 30, 2012, fixed annuity account values totaled $3.2 billion,
including $2.9 billion of deferred annuities. Of the deferred annuity account
values, 33% had minimum guaranteed interest rates of 3% or lower while 59% had
minimum guaranteed rates of 4.5% or greater. For $2.4 billion, or approximately
82%, of the deferred annuity account values, the credited interest rate was
equal to the minimum guaranteed rate. Due to limitations on the Company's
ability to further lower interest crediting rates, coupled with the expectation
for continued low reinvestment interest rates, management anticipates that fixed
annuity spread compression in future periods is likely.
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Policy Acquisition Expenses Amortized
Amortized policy acquisition expenses were $22.3 million for the three months
ended June 30, 2012 compared to $20.5 million for the same period in 2011. The
$1.8 million increase between the quarterly periods was largely due to the
change in impacts of evaluations of annuity deferred policy acquisition costs.
Amortized policy acquisition expenses were $40.1 million for the first six
months of 2012 compared to $39.7 million for the same period in 2011. At
June 30, 2012, the evaluation of annuity deferred policy acquisition costs
resulted in a decrease in amortization of $0.8 million, which primarily
reflected the impact of favorable financial market performance; this compares to
a decrease in amortization of $0.1 million from a similar evaluation at June 30,
2011. For the life segment, the June 30, 2012 evaluation of deferred policy
acquisition costs resulted in a $0.2 million increase in amortization, compared
to a $0.3 million increase recorded as a result of the June 30, 2011 evaluation.
Operating Expenses
For the three months ended June 30, 2012, operating expenses of $38.5 million
increased 7.5%, or $2.7 million, compared to the second quarter of 2011.
For the first six months of 2012, operating expenses of $76.4 million increased
4.8%, or $3.5 million, compared to the same period in the prior year. The
property and casualty expense ratio of 26.4% for the six months ended June 30,
2012 increased 1.0 percentage point compared to the prior year expense ratio of
25.4%, consistent with management's expectations for the current year.
Income Tax Expense
The effective income tax rate on the Company's pretax income, including net
realized investment gains and losses, was 28.8% and 30.3% for the six months
ended June 30, 2012 and 2011, respectively. Income from investments in
tax-advantaged securities reduced the effective income tax rate 7.6 and 5.7
percentage points for the six months ended June 30, 2012 and 2011, respectively.
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.
At June 30, 2012, the Company had federal income tax returns for the 2007
through 2011 tax years open and subject to adjustment upon examination by taxing
authorities. In 2011, the IRS completed an examination of tax years through 2009
resulting in additional tax expense of less than $0.1 million. The Company has
recorded less than $0.1 million of uncertain tax position liabilities, including
interest related to all open tax years, as of June 30, 2012.
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Net Income
For the three months ended June 30, 2012, the Company's net income of $13.1
million represented an improvement of $24.9 million compared to the net loss of
$11.8 million recorded in the prior year, reflecting a lower level of property
and casualty catastrophe losses coupled with improved underlying earnings across
all three of the Company's operating segments. After-tax net realized investment
gains increased by $2.7 million between periods. For the property and casualty
segment, catastrophe losses were significant in the current period, although
less severe than experienced in the prior year. The current period net loss of
$4.1 million reflected an improvement of $21.5 million compared to a year
earlier, benefitting from decreases in catastrophe costs and Florida sinkhole
losses, as well as favorable development of prior years' reserve development,
which more than offset an increase in automobile current accident year losses.
Annuity segment net income of $7.9 million for the current period increased $0.5
million compared to the second quarter of 2011, reflecting an increase in the
interest margin earned on fixed annuity assets partially offset by the negative
impact from the evaluation of deferred policy acquisition costs - primarily due
to the decline in performance of the financial markets. Life segment net income
of $6.1 million increased $0.2 million compared to the prior year second
quarter.
For the six months ended June 30, 2012, the Company's net income of $39.8
million represented an improvement of $25.8 million compared to the prior year,
reflecting a reduction in property and casualty catastrophe losses as well as
improved underlying earnings across all three of the Company's operating
segments. After-tax net realized investment gains decreased by $0.7 million
between periods. For the property and casualty segment, net income of $9.1
million reflected an increase of $22.3 million compared to the first half of
2011, benefitting from decreases in catastrophe costs and Florida sinkhole
losses, as well as favorable development of prior years' reserves, which more
than offset an increase in automobile current accident year losses. Including
all factors, the property and casualty combined ratio was 103.9% for the first
six months of 2012 compared to 114.7% for the same period in 2011. Annuity
segment net income of $19.5 million for the current period increased notably
compared to the first six months of 2011, primarily reflecting an increase in
the interest margin earned on fixed annuity assets. Life segment net income of
$11.3 million increased $1.2 million, primarily due to lower mortality costs in
the current period.
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Net income (loss) by segment and net income per share were as follows:
Six Months Ended Change From
June 30, Prior Year
2012 2011 Percent Amount
Analysis of net income (loss) by segment:
Property and casualty $ 9.1 $ (13.2 ) N.M. $ 22.3
Annuity 19.5 15.8 23.4 % 3.7
Life 11.3 10.1 11.9 % 1.2
Corporate and other (1) (0.1 ) 1.3 N.M. (1.4 )
Net income $ 39.8 $ 14.0 184.3 % $ 25.8
Effect of catastrophe costs, after tax,
included above $ (22.8 ) $ (41.0 ) -44.4 % $ 18.2
Effect of realized investment gains, after
tax, included above $ 6.7 $ 7.4 -9.5 % $ (0.7 )
Diluted:
Net income per share $ 0.96 $ 0.34 182.4 % $ 0.62
Weighted average number of shares and
equivalent shares (in millions) 41.4 41.4 - -
Property and casualty combined ratio:
Total 103.9 % 114.7 % N.M. -10.8 %
Effect of catastrophe costs, included above 12.9 % 23.0 % N.M. -10.1 %
Effect of prior years' reserve development,
included above -3.0 % -1.4 % N.M. -1.6 %
N.M. - Not meaningful.
(1) The corporate and other segment includes interest expense on debt, realized
investment gains and losses, certain public company expenses and other
corporate level items. The Company does not allocate the impact of corporate
level transactions to the insurance segments, consistent with the basis for
management's evaluation of the results of those segments.
For the six months ended June 30, 2012, the changes in net income for the
property and casualty, annuity and life segments are described in the preceding
paragraphs.
As described in footnote (1) to the table above, the corporate and other segment
reflects corporate level transactions. Of those transactions, realized
investment gains and losses may vary notably between reporting periods and are
often the driver of fluctuations in the level of this segment's net income or
loss. For the six months ended June 30, 2012 and 2011, net realized investment
gains after tax were $6.7 million and $7.4 million, respectively.
For the corporate and other segment, a lower level of net realized investment
gains was the primary driver of the net loss in the current period compared to
net income for the first half of 2011.
Return on average shareholders' equity based on net income was 9% and 5% for the
trailing 12 months ended June 30, 2012 and 2011, respectively.
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The accounting guidance adopted by the Company effective January 1, 2012 is
described in "Notes to Consolidated Financial Statements - Note 1 - Basis of
Presentation - Adopted Accounting Standards".
Outlook for 2012
At the time of this Quarterly Report on Form 10-Q, management estimates that
2012 full year net income before realized investment gains and losses will be
within a range of $1.55 to $1.75 per diluted share. This projection incorporates
the Company's results for the first six months of the year - which included
property and casualty weather-related catastrophe costs which exceeded
expectations - and assumes catastrophe losses for the remaining six months of
the year will be in a more normal range, consistent with management's initial
expectations for that period. Consistent with the initial guidance for 2012,
this earnings guidance incorporates the impact of the January 1, 2012 adoption
of accounting guidance related to deferral of costs associated with acquiring or
renewing insurance contracts which is described in "Notes to Consolidated
Financial Statements - Note 1 - Basis of Presentation - Adopted Accounting
Standards". As described in "Critical Accounting Policies", certain of the
Company's significant accounting measurements require the use of estimates and
assumptions. As additional information becomes available, adjustments may be
required. Those adjustments are charged or credited to income for the period in
which the adjustments are made and may impact actual results compared to
management's current estimate. Additionally, see "Forward-looking Information"
concerning other important factors that could impact actual results. Management
believes that a projection of net income including realized investment gains and
losses is not appropriate on a forward-looking basis because it is not possible
to provide a valid forecast of realized investment gains and losses, which can
vary substantially from one period to another and may have a significant impact
on net income.
Liquidity and Financial Resources
Off-Balance Sheet Arrangements
At June 30, 2012 and 2011, the Company did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or for other contractually narrow or limited purposes. As such, the Company is
not exposed to any financing, liquidity, market or credit risk that could arise
if the Company had engaged in such relationships.
Investments
Information regarding the Company's investment portfolio, which is comprised
primarily of investment grade, fixed income securities, is located in "Results
of Operations - Net Realized Investment Gains and Losses" and in the "Notes to
Consolidated Financial Statements - Note 2 - Investments".
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Cash Flow
The short-term liquidity requirements of the Company, within a 12-month
operating cycle, are for the timely payment of claims and benefits to
policyholders, operating expenses, interest payments and federal income taxes.
Cash flow generated from operations has been, and is expected to be, adequate to
meet the Company's operating cash needs in the next 12 months. Cash flow in
excess of operational needs has been used to fund business growth, retire
short-term debt, pay dividends to shareholders and repurchase shares of the
Company's common stock. Long-term liquidity requirements, beyond one year, are
principally for the payment of future insurance policy claims and benefits and
retirement of long-term debt.
Operating Activities
As a holding company, HMEC conducts its principal operations in the personal
lines segment of the property and casualty and life insurance industries through
its subsidiaries. HMEC's insurance subsidiaries generate cash flow from premium
and investment income, generally well in excess of their immediate needs for
policy obligations, operating expenses and other cash requirements. Cash
provided by operating activities primarily reflects net cash generated by the
insurance subsidiaries. For the first six months of 2012, net cash provided by
operating activities increased compared to the same period in 2011, primarily
due to a lower level of benefit and claim payments largely reflecting the
reduction in catastrophe losses in the current period.
Payment of principal and interest on debt, dividends to shareholders and parent
company operating expenses are dependent upon the ability of the insurance
subsidiaries to pay cash dividends or make other cash payments to HMEC,
including tax payments pursuant to tax sharing agreements. Payments for share
repurchase programs also have this dependency. The insurance subsidiaries are
subject to various regulatory restrictions which limit the amount of annual
dividends or other distributions, including loans or cash advances, available to
HMEC without prior approval of the insurance regulatory authorities. The
aggregate amount of dividends that may be paid in 2012 from all of HMEC's
insurance subsidiaries without prior regulatory approval is approximately $71
million, of which $18 million was paid during the six months ended June 30,
2012. Although regulatory restrictions exist, dividend availability from
subsidiaries has been, and is expected to be, adequate for HMEC's capital needs.
Investing Activities
HMEC's insurance subsidiaries maintain significant investments in fixed maturity
securities to meet future contractual obligations to policyholders. In
conjunction with its management of liquidity and other asset/liability
management objectives, the Company, from time to time, will sell fixed maturity
securities prior to maturity and reinvest the proceeds in other investments with
different interest rates, maturities or credit characteristics. Accordingly, the
Company has classified the entire fixed maturity securities and equity
securities portfolios as "available for sale".
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Financing Activities
Financing activities include primarily payment of dividends, the receipt and
withdrawal of funds by annuity contractholders, repurchases of the Company's
common stock, fluctuations in bank overdraft balances, and borrowings,
repayments and repurchases related to its debt facilities.
The Company's annuity business produced net positive cash flows in the first six
months of 2012. For the six months ended June 30, 2012, receipts from annuity
contracts decreased $0.4 million, or 0.2%, compared to the same period in the
prior year, as described in "Results of Operations - Insurance Premiums and
Contract Charges". In total, annuity contract benefits, withdrawals and net
transfers to variable annuity accumulated cash values increased $0.3 million, or
0.3%, compared to the prior year.
Capital Resources
The Company has determined the amount of capital which is needed to adequately
fund and support business growth, primarily based on risk-based capital formulas
including those developed by the National Association of Insurance Commissioners
("NAIC"). Historically, the Company's insurance subsidiaries have generated
capital in excess of such needed capital. These excess amounts have been paid to
HMEC through dividends. HMEC has then utilized these dividends and its access to
the capital markets to service and retire long-term debt, pay dividends to its
shareholders, fund growth initiatives, repurchase shares of its common stock and
for other corporate purposes. Management anticipates that the Company's sources
of capital will continue to generate sufficient capital to meet the needs for
business growth, debt interest payments, shareholder dividends and its share
repurchase program.
The total capital of the Company was $1,381.3 million at June 30, 2012,
including $199.8 million of long-term debt and $38.0 million of short-term debt
outstanding. Total debt represented 22.7% of total capital excluding unrealized
investment gains and losses (17.2% including unrealized investment gains and
losses) at June 30, 2012, which was below the Company's long-term target of 25%.
Shareholders' equity was $1,143.5 million at June 30, 2012, including a net
unrealized gain in the Company's investment portfolio of $334.6 million after
taxes and the related impact of deferred policy acquisition costs associated
with annuity and interest-sensitive life policies. The market value of the
Company's common stock and the market value per share were $688.0 million and
$17.48, respectively, at June 30, 2012. Book value per share was $29.06 at
June 30, 2012 ($20.55 excluding investment fair value adjustments).
Additional information regarding the net unrealized gain in the Company's
investment portfolio at June 30, 2012 is included in "Results of Operations -
Net Realized Investment Gains and Losses".
Total shareholder dividends were $10.7 million for the six months ended June 30,
2012. In March and May 2012, the Board of Directors announced regular quarterly
dividends of $0.13 per share.
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During the first six months of 2012, the Company repurchased 705,057 shares of
its common stock, or 1.8% of the outstanding shares on December 31, 2011, at an
aggregate cost of $12.0 million, or an average price per share of $16.93 under
its $50.0 million share repurchase program, which is further described in "Notes
to Consolidated Financial Statements - Note 6 - Shareholders' Equity and Stock
Options" of the Company's Annual Report on Form 10-K for the year ended
December 31, 2011. The repurchase of shares was financed through use of cash. As
of June 30, 2012, $36.0 million remained authorized for future share
repurchases.
As of June 30, 2012, the Company had outstanding $75.0 million aggregate
principal amount of 6.05% Senior Notes ("Senior Notes due 2015"), which will
mature on June 15, 2015, issued at a discount resulting in an effective yield of
6.1%. Interest on the Senior Notes due 2015 is payable semi-annually at a rate
of 6.05%. Detailed information regarding the redemption terms of the Senior
Notes due 2015 is contained in the "Notes to Consolidated Financial Statements -
Note 5 - Debt" of the Company's Annual Report on Form 10-K for the year ended
December 31, 2011. The Senior Notes due 2015 are traded in the open market (HMN
6.05).
As of June 30, 2012, the Company had outstanding $125.0 million aggregate
principal amount of 6.85% Senior Notes ("Senior Notes due 2016"), which will
mature on April 15, 2016, issued at a discount resulting in an effective yield
of 6.893%. Interest on the Senior Notes due 2016 is payable semi-annually at a
rate of 6.85%. Detailed information regarding the redemption terms of the Senior
Notes due 2016 is contained in the "Notes to Consolidated Financial Statements -
Note 5 - Debt" of the Company's Annual Report on Form 10-K for the year ended
December 31, 2011. The Senior Notes due 2016 are traded in the open market (HMN
6.85).
As of June 30, 2012, the Company had $38.0 million outstanding under its Bank
Credit Facility. The Bank Credit Facility provides for unsecured borrowings of
up to $150.0 million and expires on October 6, 2015. Interest accrues at varying
spreads relative to prime or Eurodollar base rates and is payable monthly or
quarterly depending on the applicable base rate (Eurodollar base rate plus
1.25%, which totaled 1.49%, as of June 30, 2012). The unused portion of the Bank
Credit Facility is subject to a variable commitment fee, which was 0.15% on an
annual basis at June 30, 2012. During the six months ended June 30, 2012, there
was no change in the amount outstanding under the Company's Bank Credit
Facility.
To provide additional capital management flexibility, the Company filed a
"universal shelf" registration on Form S-3 with the SEC on January 5, 2012. The
registration statement, which registers the offer and sale by the Company from
time to time of up to $300 million of various securities, which may include debt
securities, common stock, preferred stock, depositary shares, warrants and/or
delayed delivery contracts, was declared effective on January 18, 2012. Unless
fully utilized or withdrawn by the Company earlier, this registration statement
will remain effective through January 18, 2015. No securities associated with
the registration statement have been issued as of the date of this Quarterly
Report on Form 10-Q.
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Financial Ratings
HMEC's principal insurance subsidiaries are rated by S&P, Moody's and A.M. Best
Company, Inc. ("A.M. Best"). These rating agencies have also assigned ratings to
the Company's long-term debt securities. The ratings that are assigned by these
agencies, which are subject to change, can impact, among other things, the
Company's access to sources of capital, cost of capital, and competitive
position.
Assigned ratings as of July 31, 2012 were unchanged from the disclosure in the
Company's Annual Report on Form 10-K for the year ended December 31, 2011.
Assigned ratings were as follows (unless otherwise indicated, the insurance
financial strength ratings for the Company's property and casualty insurance
subsidiaries and the Company's principal life insurance subsidiary are the
same):
Insurance Financial
Strength Ratings Debt Ratings
(Outlook) (Outlook)
As of July 31, 2012
S&P (1) A (stable) BBB (stable)
Moody's (1) A3 (stable) Baa3 (stable)
A.M. Best
Horace Mann Life Insurance Company A (stable) N.A.
HMEC's property and casualty subsidiaries A- (stable) N.A.
HMEC N.A. bbb (stable)
N.A. - Not applicable.
(1) This agency has not yet rated Horace Mann Lloyds.
Reinsurance Programs
Information regarding the reinsurance program for the Company's property and
casualty segment is located in "Business - Property and Casualty Segment -
Property and Casualty Reinsurance" of the Company's Annual Report on Form 10-K
for the year ended December 31, 2011. All components of the Company's property
and casualty reinsurance program remain consistent with the Form 10-K
disclosure, with the exception of the Florida Hurricane and Catastrophe Fund
("FHCF") coverage. Subsequent to the February 29, 2012SEC filing of the
Company's recent Form 10-K, information received from the FHCF indicated that
the Company's maximum for the 2011-2012 contract period had been revised to
$23.2 million from $22.7 million, based on the FHCF's financial resources, with
no change in the retention, for the Company's predominant insurance subsidiary
for property and casualty business written in Florida. The FHCF contract is a
one-year contract. Effective June 1, 2012, the new contract with the FHCF, for
the Company's predominant insurance subsidiary for property and casualty
business written in Florida, reinsures 90% of hurricane losses in Florida above
an estimated retention of $5.7 million up to $20.4 million based on the FHCF's
financial resources. Compared to the 2011-2012 contract period, the reduced
maximum coverage is largely due to the Company's reduction in Florida policies
in force and resulting lower risk exposure as described in "Results of
Operations - Insurance Premiums and Contract Charges".
Information regarding the reinsurance program for the Company's life segment is
located in "Business - Life Segment" of the Company's Annual Report on Form 10-K
for the year ended December 31, 2011.
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Market Value Risk
Market value risk, the Company's primary market risk exposure, is the risk that
the Company's invested assets will decrease in value. This decrease in value may
be due to (1) a change in the yields realized on the Company's assets and
prevailing market yields for similar assets, (2) an unfavorable change in the
liquidity of the investment, (3) an unfavorable change in the financial
prospects of the issuer of the investment, or (4) a downgrade in the credit
rating of the issuer of the investment. See also "Results of Operations - Net
Realized Investment Gains and Losses".
Significant changes in interest rates expose the Company to the risk of
experiencing losses or earning a reduced level of income based on the difference
between the interest rates earned on the Company's investments and the credited
interest rates on the Company's insurance liabilities. See also "Results of
Operations - Interest Credited to Policyholders".
The Company seeks to manage its market value risk by coordinating the projected
cash inflows of assets with the projected cash outflows of liabilities. For all
its assets and liabilities, the Company seeks to maintain reasonable durations,
consistent with the maximization of income without sacrificing investment
quality, while providing for liquidity and diversification. The investment risk
associated with variable annuity deposits and the underlying mutual funds is
assumed by those contractholders, and not by the Company. Certain fees that the
Company earns from variable annuity deposits are based on the market value of
the funds deposited.
More detailed descriptions of the Company's exposure to market value risks and
the management of those risks is presented in "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Market Value Risk"
of the Company's Annual Report on Form 10-K for the year ended December 31,
2011.
