-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, J4MZ9xUMTOswT+/TUWLFfy+n2WSGaF96P1jAGVGpqEBzbvm4tGlKITz9iU1QSKIQ ZnM4j/SXFzJYHeKraqNk/A== 0000950131-99-001940.txt : 19990402 0000950131-99-001940.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950131-99-001940 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HORACE MANN EDUCATORS CORP /DE/ CENTRAL INDEX KEY: 0000850141 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 370911756 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10890 FILM NUMBER: 99580133 BUSINESS ADDRESS: STREET 1: 1 HORACE MANN PLZ CITY: SPRINGFIELD STATE: IL ZIP: 62715-0001 BUSINESS PHONE: 2177892500 MAIL ADDRESS: STREET 1: 1 HORACE MANN PLZ CITY: SPRINGFIELD STATE: IL ZIP: 62715-0001 FORMER COMPANY: FORMER CONFORMED NAME: HORACE MANN EDUCATORS CORP DATE OF NAME CHANGE: 19920108 10-K 1 HORACE MANN EDUCATORS CORPORATION ============================================================================= UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (MARK ONE) [x] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-10890 HORACE MANN EDUCATORS CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 37-0911756 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1 Horace Mann Plaza, Springfield, Illinois 62715-0001 (Address of principal executive offices) (Zip Code) Registrant's Telephone Number, Including Area Code: 217-789-2500 Securities Registered Pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered ------------------- ------------------------- Common Stock, par value $0.001 per share New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 1, 1999, was approximately $1.0 billion. As of March 1, 1999, 41,645,444 shares of Common Stock, par value $0.001 per share, were outstanding, net of 17,631,996 shares of treasury stock. DOCUMENTS INCORPORATED BY REFERENCE Proxy Statement for the 1999 Annual Meeting of Shareholders, exclusive of disclosures made pursuant to Regulation S-K, ss. 402 (i), (k) and (l), incorporated by reference into Part III of Form 10-K. ============================================================================= HORACE MANN EDUCATORS CORPORATION FORM 10-K YEAR ENDED DECEMBER 31, 1998 INDEX Item Number Page - ------ ---- PART I 1. Business.............................................................. 1 2. Properties............................................................ 26 3. Legal Proceedings..................................................... 26 4. Submission of Matters to a Vote of Security Holders................... 27 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters. 27 6. Selected Financial Data............................................... 28 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................... 28 7A. Quantitative and Qualitative Disclosures About Market Risk............ 28 8. Consolidated Financial Statements and Supplementary Data.............. 28 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................. 28 PART III 10. Directors and Executive Officers of the Registrant.................... 28 11. Executive Compensation................................................ 28 12. Security Ownership of Certain Beneficial Owners and Management........ 29 13. Certain Relationships and Related Transactions........................ 29 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...... 29 SIGNATURES............................................................ 35 Index to Financial Information........................................ F-1 PART I ITEM 1. Business Forward-looking Information It is important to note that the Company's actual results could differ materially from those projected in forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations." Overview Horace Mann Educators Corporation (together with its subsidiaries, the "Company" or "HMEC") is an insurance holding company incorporated in Delaware. Through its subsidiaries, HMEC markets and underwrites personal lines of property and casualty and life insurance and retirement annuities. HMEC's principal insurance subsidiaries are Horace Mann Insurance Company ("HMIC"), Teachers Insurance Company ("TIC") and Horace Mann Life Insurance Company ("HMLIC"), each of which is an Illinois corporation, and Allegiance Insurance Company ("Allegiance"), a California domiciled personal lines property and casualty insurance company. The Company markets its products primarily to educators and other employees of public schools and their families. Customers of the Company typically have moderate annual incomes, with many belonging to two-income households. Their financial planning tends to focus on security, savings and primary insurance needs. The Company sells and services its products primarily through an exclusive sales force of full-time agents employed by the Company. The Company's agents sell only the Company's products. Many of the Company's agents are former educators who utilize their contacts within, and knowledge of, the target market. Compensation for sales agents includes an incentive element based upon the profitability of the business they write. The Company's insurance premiums written and contract deposits for the year ended December 31, 1998 were $827.8 million and operating income (income from continuing operations before the after tax impact of realized investment gains and losses) was $78.9 million. The Company's total assets were $4.4 billion at December 31, 1998 . The property and casualty segment accounted for 59% of the Company's insurance premiums written and contract deposits for the year ended December 31, 1998, while accounting for 57% of earnings from continuing operations before realized investment gains and losses, interest and taxes for the period. The annuity and life insurance segments together accounted for 41% of insurance premiums written and contract deposits for the year ended December 31, 1998 (27% and 14%, respectively), and provided 47% (31% and 16%, respectively) of earnings from continuing operations before interest and taxes for the period. In December 1996, the Company announced its strategic decision to withdraw from the group medical insurance business over the following two years. The Company terminated 95% of that business by December 1997 and terminated the remaining group medical insurance policies by September 1998. In the Company's financial statements and discussions of operating results, group medical results are reported separately as discontinued operations. 1 In each of the last 10 years, the Company's combined loss and expense ratio for its property and casualty product lines outperformed the total property and casualty industry combined loss and expense ratio, as reported by A.M. Best Company ("A.M. Best"), an independent insurance rating agency. During this period, the Company's combined loss and expense ratio was better than the total property and casualty insurance industry combined loss and expense ratio by an average of approximately 11 percentage points per year. During the same period of time, the Company's combined loss and expense ratio was better than the personal lines insurance industry segment combined loss and expense ratio by an average of approximately 9 percentage points per year. One of the reasons why the Company's property and casualty lines have performed better than the industry is the Company's property and casualty expense ratio, which has been consistently better than the industry ratio since 1983. During the last 10 years, the Company's property and casualty expense ratio has been better than the property and casualty industry personal lines average expense ratio as reported by A.M. Best by an average of 4.7 percentage points per year. The Company's property and casualty expense ratio for the year ended December 31, 1998 was 19.3%, well within the lowest 20% of expense ratios of the 100 largest property and casualty groups, based on A.M. Best's reports. At December 31, 1998, the accumulated value of annuity contracts was $2.5 billion. For the year ended December 31, 1998, 93% of the accumulated cash value of the Company's annuity business remained on deposit. All annuities issued since 1982 and approximately 75% of all outstanding fixed annuity accumulated cash values are subject in most cases to substantial early withdrawal penalties, typically ranging from 5% to 13% of the amount withdrawn. Withdrawals of outstanding variable annuities are limited to amounts less than or equal to the then current market value of the annuity. Tax-qualified annuities represented 94% of the Company's annuity policy reserves at December 31, 1998, and, generally, a penalty is imposed under the Internal Revenue Code of 1986, as amended, on amounts withdrawn from tax-qualified annuities prior to age 59 1/2. The investment portfolio of the Company, including variable annuity assets under management of $1.1 billion, had an aggregate market value of $4.0 billion at December 31, 1998. Investments other than variable annuity assets consist principally of investment grade publicly traded fixed income securities. At December 31, 1998, investments in non-investment grade securities represented 6.4% of total investments excluding variable annuity assets. There are no significant investments in mortgage loans and real estate or privately placed securities. History The Company's business was founded in Springfield, Illinois in 1945 by two Illinois teachers to sell automobile insurance to other teachers within the State of Illinois. In 1968, INA Corporation ("INA") acquired a 25% interest in HMEC, and completed its acquisition of HMEC in 1975. In 1982, INA and Connecticut General Corporation merged to form CIGNA. In August 1989 an investor group directed by Gibbons, Green, van Amerongen, L.P. (subsequently Gibbons, Goodwin, van Amerongen) ("GGvA") and certain members of the Company's senior management acquired HMEC from CIGNA. In November 1991, HMEC completed an initial public offering of its common stock (the "IPO") which is traded on the New York Stock Exchange under the symbol "HMN." 2 Following the initial public offering, GGvA owned approximately 44% of the outstanding shares of the common stock. Pursuant to an agreement with GGvA, in May 1995 HMEC purchased approximately one-half of the shares of its common stock owned by GGvA and in July 1995 completed a secondary public offering of most of the remaining shares of its common stock owned by GGvA. SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA The following statement of operations and balance sheet data have been derived from the consolidated financial statements of the Company. The consolidated financial statements of the Company for each of the periods in the five year period ended December 31, 1998 have been audited by KPMG LLP. The following selected historical consolidated financial data should be read in conjunction with the consolidated financial statements of HMEC and its subsidiaries and Management's Discussion and Analysis of Financial Condition and Results of Operations.
Year Ended December 31, ----------------------------------------------------------------- 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- (Dollars in millions, except per share data) Statement of Operations Data: Insurance premiums written and contract deposits.. $ 827.8 $ 771.3 $ 704.8 $ 654.0 $ 637.3 Insurance premiums and contract charges earned.... 577.8 542.7 502.7 485.4 472.4 Net investment income............................. 191.7 198.9 198.6 198.4 185.3 Net investment income, after tax.................. 128.3 132.6 132.4 132.2 124.9 Realized investment gains (losses)................ 9.9 5.3 2.5 8.6 (0.9) Total revenues.................................... 779.4 746.9 703.8 692.4 656.8 Amortization of intangible assets(1).............. 6.9 10.7 11.2 11.7 12.6 Interest expense.................................. 9.5 9.4 10.5 11.6 9.5 Income from continuing operations before income taxes 116.8 119.6 100.6 103.6 86.2 Income from continuing operations................. 85.3 87.1 73.8 75.2 64.6 Discontinued operations(2)........................ - (3.5) (9.2) (1.2) - Income before extraordinary item.................. 85.3 83.6 64.6 74.0 64.6 Extraordinary item(3)............................. - - - - (1.7) Net income........................................ 85.3 83.6 64.6 74.0 62.9 Operating income(4)............................... 78.9 83.6 73.1 70.9 65.2 Ratio of earnings to fixed charges(5)............. 13.3x 13.7x 10.6x 9.9x 10.1x Per Share Data(6): Basic: Operating income(4)............................ $ 1.82 $ 1.82 $ 1.56 $ 1.42 $ 1.13 Realized investment gains (losses), after tax.. 0.15 0.08 0.03 0.11 (0.01) Income from continuing operations.............. 1.97 1.90 1.57 1.50 1.12 Discontinued operations(2)..................... - (0.08) (0.19) (0.02) (0.01) Income before extraordinary item............... 1.97 1.82 1.38 1.48 1.11 Net income..................................... 1.97 1.82 1.38 1.48 1.09 Diluted: Operating income(4)............................ $ 1.80 $ 1.80 $ 1.54 $ 1.33 $ 1.08 Realized investment gains (losses), after tax.. 0.15 0.07 0.03 0.10 (0.01) Income from continuing operations.............. 1.95 1.87 1.55 1.41 1.07 Discontinued operations(2)..................... - (0.07) (0.19) (0.02) - Income before extraordinary item............... 1.95 1.80 1.36 1.39 1.07 Net income..................................... 1.95 1.80 1.36 1.39 1.04 Shares of Common Stock-weighted average: Basic.......................................... 43.2 45.8 47.0 50.1 57.9 Diluted........................................ 43.8 46.5 47.6 56.3 64.1 Cash dividends.................................... $ 0.3325 $ 0.2825 $ 0.22 $ 0.18 $ 0.145 Balance Sheet Data, at Year End: Total investments................................. $ 2,840.8 $ 2,769.0 $ 2,784.3 $ 2,798.5 $ 2,533.4 Total assets...................................... 4,395.5 4,131.9 3,861.0 3,662.3 3,285.5 Short-term debt................................... 50.0 42.0 34.0 75.0 - Long-term debt.................................... 99.6 99.6 99.6 100.0 100.0 Total shareholders' equity........................ 496.6 506.0 484.4 470.2 412.0 Book value per share(7)........................... 11.80 $ 11.43 $ 10.25 $ 10.05 $ 7.11 (continued on next page)
3 SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA - (continued)
Year Ended December 31, ----------------------------------------------------------------- 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- (Dollars in millions, except per share data) Segment Information: Insurance premiums written and contract deposits Property and casualty.......................... $ 487.8 $ 458.0 $ 427.1 $ 405.8 $ 398.8 Annuity........................................ 223.3 199.2 166.9 142.9 136.6 Life........................................... 116.7 114.1 110.8 105.3 101.9 Total....................................... 827.8 771.3 704.8 654.0 637.3 Operating income(4) Property and casualty.......................... $ 53.2 $ 61.4 $ 54.0 $ 56.4 $ 52.6 Annuity........................................ 23.1 19.3 16.3 14.8 14.2 Life........................................... 12.4 12.9 12.1 10.4 7.7 Corporate and other, including interest expense (9.8) (10.0) (9.3) (10.7) (9.3) Total....................................... 78.9 83.6 73.1 70.9 65.2 Statutory Operating Data(8): Property and casualty: Loss and loss adjustment expense ratio........ 74.4% 71.7% 74.1% 73.5% 73.8% Expense ratio................................. 19.3% 19.4% 19.4% 19.8% 19.8% Combined loss and expense ratio(9)............ 93.6% 91.1% 93.5% 93.3% 93.7% Industry average combined loss and expense ratio(10)...................... 105.0% 101.6% 105.8% 106.5% 108.5% Personal lines industry segment average combined loss and expense ratio(10)........ 103.5% 99.8% 104.9% 103.5% 104.5% Annuity accumulated value on deposit............. $2,475.5 $2,314.2 $2,075.5 $1,866.0 $1,673.2 Life insurance in force.......................... $ 11,799 $ 11,188 $ 10,645 $ 10,235 $ 9,707 Adjusted capital and surplus of insurance subsidiaries (includes investment reserves)(11) $ 379.8 $ 372.3 $ 404.6 $ 389.8 $ 358.3
- ------------- (1) Amortization of intangible assets is comprised of amortization of goodwill and amortization of acquired value of insurance in force and is the result of purchase accounting adjustments related to the 1989 acquisition of the Company and the 1994 acquisition of Allegiance. (2) In December 1996, the Company announced its strategic decision to withdraw from the group medical insurance business and during 1997 the Company accelerated the withdrawal. Group medical results net of taxes are reported separately as discontinued operations and 1997 and 1996 include additional after tax charges of $3.5 million, or $0.07 per diluted share, and $3.9 million, or $0.08 per diluted share, respectively, for estimated losses during the phase-out period. (3) The extraordinary item for the year ended December 31, 1994 represents a non-recurring loss from early retirement of debt and is net of tax benefits. (4) Income from continuing operations before the after tax impact of realized investment gains and losses, debt retirement costs, cost of the additional rights relating to the 1995 share repurchase, discontinued operations, and extraordinary items. (5) For the purpose of determining the ratio of earnings to fixed charges, "earnings" consist of income from continuing operations before income taxes and interest expense (including amortization of debt issuance cost), and "fixed charges" consist of interest expense (including amortization of debt issuance cost). (6) Basic earnings per share is computed based on the weighted average number of shares outstanding. Diluted earnings per share is computed based on the weighted average number of shares and common stock equivalents outstanding. The Company's common stock equivalents relate to outstanding warrants, common stock options, Director Stock Plan units and Employee Stock Plan units, and prior to their early retirement in February 1996, the convertible notes were considered potentially dilutive securities for purposes of calculating diluted earnings per share. (7) Due to the adoption by the Company on January 1, 1994 of Financial Accounting Standard No. 115 ("FAS 115"), total shareholders' equity included an increase, net of taxes, of $57.3 million, $62.2 million , $29.7 million and $76.2 million at December 31, 1998, 1997, 1996 and 1995, respectively, and a reduction, net of tax benefits, of $70.9 million at December 31, 1994. Excluding the FAS 115 market value accounting for investments, book value per share was $10.44, $10.03, $9.62, $8.42 and $8.34 at December 31, 1998, 1997, 1996, 1995 and 1994, respectively. (8) Statutory data has been derived from the financial statements of the Company prepared in accordance with statutory accounting practices and filed with insurance regulatory authorities. (9) Property and casualty combined loss and expense ratio includes policyholder dividends. (10) Source: Best's Aggregates and Averages (1995 through 1998 Eds.). The industry averages for the year ended December 31, 1998 are from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 1999, published by A.M. Best. (11) Investment reserves were the Asset Valuation Reserves. 4 General The Company markets and underwrites personal lines of property and casualty and life insurance and retirement annuities. The following table sets forth by segment the amount of insurance premiums written and contract deposits for the Company for the periods indicated. Insurance Premiums Written and Contract Deposits (Dollars in millions)
Year Ended December 31, --------------------------------------------------- 1998 1997 1996 -------------- ------------- -------------- Property and casualty................................. $487.8 58.9% $458.0 59.4% $427.1 60.6% Annuity............................................... 223.3 27.0 199.2 25.8 166.9 23.7 Life.................................................. 116.7 14.1 114.1 14.8 110.8 15.7 ------ ----- ------ ----- ------ ----- Total.............................................. $827.8 100.0% $771.3 100.0% $704.8 100.0% ====== ===== ====== ===== ====== =====
Corporate Strategy and Marketing The Company's target market consists of educators and other employees of public schools and their families. It is estimated that there are approximately 3 million elementary and secondary public school teachers and administrators in the United States. The Company also sells its products to other education-related customers, including private school teachers, education support personnel, and their families. The U.S. Department of Education projects a net 2% annual increase in the number of public school teachers through the year 2007. In addition, recent federal programs to reduce class size and add additional teachers countrywide will further increase this growth rate. This represents additional opportunities for the Company, since it is expected that the growth rate will represent a 10% or more annual increase in new teachers offset by 8% leaving or retiring from teaching. In addition to changes in the number of teachers that may result from growth in the general population and changes in the number of school age children, the Company believes that turnover among the teacher population increases the size of its target market. New teachers and educational support personnel are solicited by the Company's agents and the Company attempts to retain customers who have retired or left the teaching profession. Customers of the Company typically have moderate annual incomes, with many belonging to two-income households. Their financial planning tends to focus on security, savings and primary insurance needs. Exclusive Agency Force A cornerstone of the Company's marketing strategy is its exclusive sales force of full-time agents who are employees of the Company. As of December 31, 1998, the Company employed 1,128 full-time agents. Many of these agents were previously teachers or other members of the education profession. The Company's agents market and write the full range of the Company's products. They are under contract to market and write only those products authorized by the Company. The Company's service commitment to its policyholders begins with personal contact at the point of sale between the Company's agents and potential policyholders. In addition, the Company's agents often have direct access to school premises, placing them in a position to write and service individual insurance business. Management believes that Horace Mann's name recognition and policyholder loyalties lead to new customers and cross selling of additional insurance products. 5 The Company's agents pre-underwrite policy applicants. The Company structures its agent compensation to provide incentives for agents to adhere to the Company's underwriting standards and practices and business growth plans. Agent compensation after an initial two-year period is comprised entirely of commissions and incentive bonuses based on profitability of insurance written, retention of customers and sales. In 1998, incentive bonuses represented 26% of compensation for agents having more than two years of experience with more than 90% of the bonuses based on profitability. The profitability related portion of agent compensation is based on loss ratios in the case of property and casualty policies, where permitted by law, and persistency in the case of life policies. Management believes that this compensation structure, which rewards the individual agent's selection of profitable business, helps to produce profitable business. Alternate Distribution Program The Company has established an alternate distribution marketing program to develop new sales channels that supplement and complement the exclusive agency force. As of December 31, 1998, the Company had established relationships with 106 educator credit unions in 35 states. At some of those credit unions, a salaried representative of the Company is available to meet with prospective customers, while other of those credit unions refer their members to the Company for their insurance needs. Geographic Composition of Business The Company's business is geographically diversified. Based on direct insurance premiums earned and contract deposits for all continuing product lines for the year ended December 31, 1998, the top five states and their portion of total premium were North Carolina, 7.8%; Texas, 6.6%; Illinois, 5.9%; Minnesota, 4.9%; and Massachusetts, 4.9%. HMEC's property and casualty subsidiaries write business in 48 states and the District of Columbia. The following table sets forth the Company's top ten property and casualty states based on total direct premiums in 1998: Property and Casualty Segment Top Ten States (Dollars in millions)
Property and Casualty Segment -------------------------- Direct Percent State Premiums(1) of Total ------- ----------- -------- Texas ...................................... $ 36.1 7.5% North Carolina............................... 35.4 7.4 California................................... 32.3 6.7 Massachusetts................................ 31.1 6.5 Minnesota.................................... 30.0 6.2 Florida...................................... 27.0 5.6 Pennsylvania................................. 23.0 4.8 Michigan..................................... 21.5 4.5 South Carolina............................... 21.3 4.4 Georgia...................................... 16.3 3.4 ------ ----- Total of top ten states................... 274.0 57.0 All other areas.............................. 206.4 43.0 ------ ----- Total direct premiums..................... $480.4 100.0% ====== =====
- ------------- (1) Defined as earned premiums before reinsurance and is determined under statutory accounting practices. 6 HMEC's principal life insurance subsidiary writes business in 48 states and the District of Columbia. The following table sets forth the Company's top ten combined life and annuity states based on total direct premiums and contract deposits in 1998: Combined Life and Annuity Segments Top Ten States (Dollars in millions)
Direct Premiums and Percent State Contract Deposits(1) of Total ------- -------------------- -------- Illinois..................................... $ 34.3 10.4% North Carolina............................... 28.3 8.6 Virginia..................................... 18.7 5.6 Texas........................................ 17.4 5.3 Tennessee.................................... 17.1 5.2 Indiana...................................... 14.5 4.4 Wisconsin.................................... 10.8 3.3 South Carolina............................... 10.1 3.0 Minnesota.................................... 10.1 3.0 Louisiana.................................... 10.1 3.0 ------ ----- Total of top ten states................... 171.4 51.8 All other areas.............................. 159.4 48.2 ------ ----- Total direct premiums..................... $330.8 100.0% ====== =====
- ------------- (1) Excludes discontinued group medical business and is determined under statutory accounting practices. National, State and Local Education Associations The Company estimates that less than half of its policyholders are members of the National Education Association ("NEA"), the nation's largest confederation of state and local teachers' associations. NEA has approximately 2.4 million members. The Company has had a long relationship with NEA and many of the state and local education associations affiliated with NEA. The Company maintains a special advisory board, primarily composed of leaders of state education associations, that meets with Company management on a regular basis. These meetings provide management with the opportunity to better assess the present and future needs of its target market and to cultivate better relations with education association leaders. In certain states, where approved by the applicable state insurance departments, state or local association members are entitled to a discount on premiums for certain property and casualty insurance products sold by the Company. From 1984 to September 1993 and beginning again in September 1996, NEA purchased from the Company educator professional liability insurance for its members. NEA has committed to purchase this insurance from the Company through August 2002. Premium from this product represents less than 2% of all insurance premiums written and contract deposits of the Company. Between September 1993 and September 1996, the Company did not write this policy. It is the practice of NEA and affiliated state and local education associations to "sponsor" various insurance products and services, including those of the Company and its competitors. "Sponsorship" is generally determined independently by each of these organizations. Being "sponsored" generally means that NEA and such state and local associations evaluate a product, authorize the use of their names in connection with the marketing of the product and, in some instances, recommend that their membership consider buying the product. From time to time during the past 30 years, NEA has sponsored various Company products and currently sponsors the Company's homeowners policy, which was co-sponsored by 40 NEA-affiliated state associations as of December 31, 1998. Since 1988, the Company's homeowners policy was the only product of the Company that was sponsored by NEA (exclusive of the educator professional liability insurance policy purchased by NEA as described above). NEA-affiliated education 7 associations in 40 states sponsor products of the Company other than homeowners. NEA-affiliated education associations in 46 states sponsor one or more of the Company's products. In many cases, associations that sponsor one of the Company's products also sponsor competing products. The Company does not pay NEA or any affiliated associations any consideration in exchange for sponsorship of Company products. The Company does pay for advertising that appears in NEA and state education association publications. Some of the advantages of education association sponsorship include prestige and enhanced brand awareness, increased opportunity for the Company's agents to market products on school premises, and improved agent recruiting, especially among former teachers. The Company's customers decide whether to purchase the Company's products for a number of reasons, including pricing and service of the product and the customer's relationship with the selling agent -- education association sponsorship may be one factor in such a decision. Property and Casualty The primary property and casualty product offered by the Company is private passenger automobile insurance, which in 1998 represented 46% of the Company's total insurance premiums written and contract deposits and 78% of property and casualty net written premiums. Homeowners insurance represented 12% of the Company's total insurance premiums written and contract deposits and 21% of property and casualty premiums. The educator professional liability insurance represented the remaining 1% of the Company's property and casualty premiums. As of December 31, 1998, the Company had approximately 592,000 voluntary automobile policies in force with annual premiums of approximately $404 million and approximately 267,000 homeowners policies in force with annual premiums of approximately $105 million. Voluntary automobile policies exclude those policies described in "Business - Regulation - Mandatory Insurance Facilities" and assigned risk policies. See "Business - Corporate Strategy and Marketing - National, State and Local Education Associations." The results of companies in the insurance industry have historically been subject to significant fluctuations due to competition, economic conditions, interest rates and other factors. In particular, the property and casualty insurance industry has historically experienced pricing and profitability cycles. With respect to these cycles, the factors most affecting current and prospective results of operations are intense price competition and aggressive marketing by property and casualty insurers, which have historically resulted in higher combined loss and expense ratios. Periods characterized by higher combined loss and expense ratios have typically been followed by withdrawal of capacity in the property and casualty industry and a firming of prices, resulting in lower combined loss and expense ratios. Because of the nature of the property and casualty cycle, it is difficult to predict future trends in the industry's overall combined loss and expense ratio. Management of the Company believes that these factors will continue to produce pricing and profitability cycles for the industry in the future. During the past ten years, the personal lines segment of the property and casualty insurance market has been less subject to the pricing and profitability cycles that have affected the commercial lines segment and the overall industry. Because virtually all the Company's property and casualty business is personal lines business, management believes the Company's operations are less subject to pricing and profitability cycles than the operations of many other insurers. 8 Results of property insurers are also subject to weather and other conditions prevailing in an accident year. While one year may be relatively free of major weather or other disasters, another year may have numerous such events causing results for such a year to be materially worse than for other years. Selected Historical Financial Information For Property and Casualty Segment The following table sets forth certain financial information with respect to the property and casualty segment for the periods indicated. Property and Casualty Segment Selected Historical Financial Information (Dollars in millions)
Year Ended December 31, ------------------------------- 1998 1997 1996 ------ ------ ------ Statement of Operations Data: Insurance premiums written........................... $487.8 $458.0 $427.1 Insurance premiums earned............................ 476.4 447.2 413.2 Net investment income................................ 38.9 41.7 46.4 Operating income before income taxes................. 66.5 78.7 70.4 Operating income..................................... 53.2 61.4 54.0 Net investment income, after tax..................... 29.0 30.4 33.5 Catastrophe losses, after tax........................ 18.5 4.0 13.6 Statutory Operating Statistics: Loss and loss adjustment expense ratio............... 74.4% 71.7% 74.1% Expense ratio........................................ 19.3% 19.4% 19.4% Combined loss and expense ratio (including policyholder dividends)............... 93.6% 91.1% 93.5% Combined loss and expense ratio before catastrophes (including policyholder dividends).. 87.7% 89.7% 88.5% GAAP Operating Statistics: Loss and loss adjustment expense ratio............... 74.4% 71.7% 74.1% Expense ratio........................................ 19.3% 19.6% 19.8% Combined loss and expense ratio (including policyholder dividends)............... 93.7% 91.3% 93.9% Combined loss and expense ratio before catastrophes (including policyholder dividends).. 87.8% 89.9% 88.9% Automobile and Homeowners (Voluntary): Insurance premiums written........................... $459.0 $431.0 $400.0 Insurance premiums earned............................ 449.9 421.5 390.0 Policies in force (in thousands)..................... 859 837 786
Property and Casualty Ratios In each of the last 10 years, the Company's combined loss and expense ratio for its property and casualty product lines outperformed the total property and casualty industry combined loss and expense ratio, as reported by A.M. Best. During this period, the Company's combined loss and expense ratio was better than the total property and casualty insurance industry combined loss and expense ratio by an average of approximately 11 percentage points per year. During the same period of time, the Company's combined loss and expense ratio was better than the personal lines insurance industry segment combined loss and expense ratio by an average of approximately 9 percentage points per year. 9 The table below compares the Company's combined loss and expense ratios with published industry averages. Property and Casualty Combined Loss and Expense Ratio(1)
Property and The Personal Lines Casualty Company(2) Industry Segment(3) Industry(3) Year Ended December 31, ---------- ------------------- ------------ 1998........................................ 93.6% 103.5% 105.0% 1997........................................ 91.1 99.8 101.6 1996........................................ 93.5 104.9 105.8 1995........................................ 93.3 103.5 106.5 1994........................................ 93.7 104.5 108.5 1993........................................ 93.3 103.9 106.9 1992........................................ 97.1 112.5 115.8 1991........................................ 98.4 107.1 108.8 1990........................................ 101.8 109.8 109.6 1989........................................ 106.9 109.9 109.2
- ------------- (1) Combined loss and expense ratio includes policyholder dividends and is determined according to statutory accounting practices. (2) The Company did not have any California property and casualty business during each of the years from 1989 through 1993. (3) Source: Best's Aggregates and Averages (1990 through 1998 Eds.). 1998 is an estimate from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 1999, published by A.M. Best. Catastrophe costs before federal income tax benefits for the Company and the property and casualty industry for the ten years ended December 31, 1998 were as follows: Catastrophe Costs (Dollars in millions)
Property and The Casualty Company(1) Industry(2) ---------- ------------- Year Ended December 31, 1998........................................ $28.4 $ 9,175.0 1997........................................ 6.2 2,560.0 1996........................................ 20.9 7,375.0 1995........................................ 13.9 7,425.0 1994........................................ 17.0 17,030.0 1993........................................ 8.5 5,705.0 1992........................................ 13.3 22,870.0 1991........................................ 10.3 4,698.0 1990........................................ 5.8 2,560.0 1989........................................ 12.2 7,371.0
- ------------- (1) Net of reinsurance and before federal income tax benefits. Includes allocated loss adjustment expenses and reinsurance reinstatement premiums. The Company's individually significant catastrophe losses net of reinsurance were as follows: 1998 - $7.9 million, May Minnesota hailstorm; $2.9 million, May Upper Midwest hailstorm; $2.0 million, June Midwest wind/hail; $1.6 million, Hurricane Georges. 1997 - $1.4 million, July wind/hail/tornadoes; $1.1 million, Denver, Colorado hailstorm. 1996 - $8.2 million, Hurricane Fran. 1995 - $2.9 million, Texas wind/hail/tornadoes; $2.2 million Hurricane Opal. 1994 - $6.0 million, Northridge, California earthquake. 1993 - $2.2 million, East Coast blizzard. 1992 - $1.9 million, Hurricane Andrew. 1991 - $1.0 million, Hurricane Bob. 1990 - $2.8 million, Denver, Colorado hailstorm. 1989 - $4.0 million, Hurricane Hugo. (2) Source: Insurance Trends, Property - Casualty Edition, First Quarter 1999, published by Conning & Company. These amounts are before reinsurance and federal income tax benefits and exclude all loss adjustment expenses. During the last 10 years, the Company's property and casualty expense ratio has been better than the property and casualty industry personal lines average expense ratio as reported by A.M. Best by an average of 4.7 percentage points per year. The Company's property and casualty expense ratio for the year ended December 31, 1998 was 19.3%, well within the lowest 20% of expense ratios of the 100 largest property and casualty groups, based on A.M. Best's reports. 10 The table below compares the Company's expense ratios with published industry averages. Property and Casualty Expense Ratio(1)
Property and The Personal Lines Casualty Company(2) Industry Segment(3) Industry(3) ---------- ------------------- ------------- Year ended December 31, 1998................................... 19.3% 25.0% 27.3% 1997................................... 19.4 24.3 27.1 1996................................... 19.4 23.4 26.4 1995................................... 19.8 23.7 26.3 1994................................... 19.8 23.5 26.0 1993................................... 19.6 23.9 26.2 1992................................... 19.6 24.4 26.6 1991................................... 19.8 24.7 26.4 1990................................... 19.1 24.3 26.0 1989................................... 19.0 24.5 26.0
- ------------- (1) Determined according to statutory accounting practices. (2) The Company did not have any California property and casualty business during each of the years from 1989 through 1993. (3) Source: Best's Aggregates and Averages (1990 through 1998 Eds.). The 1998 personal lines result is an estimate from A.M. Best. The 1998 total industry result is an estimate from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 1999, published by A.M. Best. Property and Casualty Reserves In the last ten consecutive years the Company's property and casualty reserves have developed cumulative redundancies. Reserves for claims and claims expenses are carried at the full value of estimated liabilities and are not discounted for interest expected to be earned on reserves. The Company has no exposure to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses. The Company establishes property and casualty claim reserves to cover its estimated ultimate liability for claims and claim adjustment expenses with respect to reported claims and claims incurred but not yet reported as of the end of each accounting period. In accordance with applicable insurance laws and regulations and generally accepted accounting principles ("GAAP"), no reserves are established until a loss occurs, including a loss from a catastrophe. Underwriting results of the property and casualty operations are significantly influenced by estimates of property and casualty claims and claims expense reserves. These reserves are an accumulation of the estimated amounts necessary to settle all outstanding claims, including claims which are incurred but not reported, as of the date of the financial statements. The reserve estimates are based on known facts and on interpretations of circumstances, including the Company's experience with similar cases and historical trends involving claim payment patterns, claim payments, pending levels of unpaid claims and product mix, as well as other factors including court decisions, economic conditions and public attitudes. The effects of inflation are implicitly considered in the reserving process. The establishment of reserves, including reserves for catastrophes, is an inherently uncertain process and the ultimate cost may vary materially from the recorded amounts. The Company regularly updates its reserve estimates as new facts become known and further events occur which may impact the resolution of unsettled claims. Changes in prior year reserve estimates, which may be material, are reflected in the results of operations in the period such changes are determined to be needed. 11 Due to the inherent uncertainty in estimating reserves for claims and claims expenses, there can be no assurance that ultimate liabilities will not exceed amounts reserved, with a resulting adverse effect on the Company. Management believes that the Company's overall reserve levels at December 31, 1998 are adequate to meet its future obligations. The following table is a summary reconciliation of the beginning and ending property and casualty insurance claims and claims expense reserve, displayed individually for each of the last three years. The table presents reserves on a net (after reinsurance) basis. The total net property and casualty insurance claims and claims expense amounts are reflected in the Consolidated Statements of Operations listed on page F-1 of this report. The end of the year gross reserve (before reinsurance) balances are reflected in the Consolidated Balance Sheets also listed on page F-1 of this report. Reconciliation of Property and Casualty Claims and Claims Expenses Reserves (Dollars In millions)
Year Ended December 31, --------------------------------------------- 1998 1997 1996 -------- -------- -------- Gross reserves, beginning of year........................... $310.6 $340.4 $369.7 Less reinsurance recoverables............................ 41.3 34.1 23.8 ------- ------- ------- Net reserves, beginning of year............................. 269.3 306.3 345.9 ------- ------- ------- Incurred claims and claims expense: Claims occurring in the current year..................... 379.6 365.9 368.6 Decrease in estimated reserves for claims occurring in prior years(1): Policies written by the Company................... (23.9) (40.2) (56.4) Business assumed from state reinsurance facilities (1.0) (4.9) (6.1) ------- ------- ------- Total decrease................................. (24.9) (45.1) (62.5) ------- ------- ------- Total claims and claims expenses incurred......... 354.7 320.8 306.1 ------- ------- ------- Claims and claims expense payments for claims occurring during: Current year............................................. 239.0 209.2 206.4 Prior years.............................................. 142.0 148.6 139.3 ------- ------- ------- Claims and claims expense payments................ 381.0 357.8 345.7 ------- ------- ------- Net reserves, end of period................................. 243.0 269.3 306.3 Plus reinsurance recoverables............................ 55.9 41.3 34.1 ------- ------- ------- Gross reserves, end of period(2)............................ $298.9 $310.6 $340.4 ======= ======= =======
- ------------- (1) Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims and changes in their projected final settlement costs. Favorable reserve development generally occurs as a result of subsequent adjustment of reserves to reflect additional information. (2) Unpaid claims and claim expenses as reported in the consolidated balance sheets also include life, annuity, and group accident and health reserves of $8.5 million, $11.7 million and $17.2 million at December 31, 1998, 1997 and 1996 , respectively, in addition to property and casualty reserves. The provision for claims and claims expenses for insured events in prior years decreased by $24.9, $45.1 million and $62.5 million for the years ended December 31, 1998, 1997 and 1996, respectively. The favorable claim development results primarily from improving trends in the frequency and severity of voluntary automobile claims. Future reserve releases, if any, will depend on the continuation of the favorable claim trends. The year-end 1998 gross reserves of $298.9 million for property and casualty insurance claims and claims expenses, as determined under GAAP, were $55.9 million more than the reserve balance of $243.0 million recorded on the basis of statutory accounting practices for reports provided to state regulatory authorities. The difference is the reinsurance recoverable from third parties totaling $55.9 million that reduces reserves for statutory reporting and is recorded as an asset for GAAP reporting. The decline in reserves during 1998 reflects favorable reserve development resulting from improving trends in the frequency and severity of voluntary automobile claims. Other factors have contributed to the decline in reserves, including the Company's focus on containing the average 12 claim cost for automobile liability claims and a reduction in reserves from state insurance facilities for involuntary automobile business. Fluctuations from year to year in the level of catastrophe losses impact a property and casualty insurance company's loss and loss adjustment expenses incurred and paid. For comparison purposes, the following table provides amounts for the Company excluding catastrophe losses: Impact of Catastrophe Losses(1) (Dollars in millions)
Year Ended December 31, -------------------------------------------- 1998 1997 1996 -------- -------- -------- Claims and claims expense incurred.......................... $354.7 $320.8 $306.1 Amount attributable to catastrophes......................... 28.0 6.2 20.4 ------ ------ ------ Excluding catastrophes................................... $326.7 $314.6 $285.7 ====== ====== ====== Claims and claims expense payments.......................... $381.0 $357.8 $345.7 Amount attributable to catastrophes......................... 25.2 5.7 21.0 ------ ------ ------ Excluding catastrophes................................... $355.8 $352.1 $324.7 ====== ====== ======
- ------------- (1) Net of reinsurance and before federal income tax benefits. Includes allocated loss adjustment expenses. Analysis of Claims and Claims Expense Reserves The claim reserve development table below illustrates the change over time of the net reserves established for property and casualty insurance claims and claims expense at the end of various calendar years. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to that reserve liability. The third section, reading down, shows retroactive reestimates of the original recorded reserve as of the end of each successive year which is the result of the Company's expanded awareness of additional facts and circumstances that pertain to the unsettled claims. The last section compares the latest reestimated reserve to the reserve originally established, and indicates whether or not the original reserve was adequate or inadequate to cover the estimated costs of unsettled claims. The table also presents the gross reestimated liability as of the end of the latest reestimation period, with separate disclosure of the related reestimated reinsurance recoverable. The claim reserve development table is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years. 13 In evaluating the information in the table below, it should be noted that each amount includes the effects of all changes in amounts of prior periods. For example, if a claim determined in 1997 to be $150 thousand was first reserved in 1988 at $100 thousand, the $50 thousand deficiency (actual claim minus original estimate) would be included in the cumulative deficiency in each of the years 1988 - 1996 shown below. This table presents development data by calendar year and does not relate the data to the year in which the accident actually occurred. Conditions and trends that have affected the development of these reserves in the past will not necessarily recur in the future. It may not be appropriate to use this cumulative history in the projection of future performance. Property and Casualty Claims and Claims Expense Reserve Development (Dollars in millions)
December 31, --------------------------------------------------- 1988 1989 1990 1991 1992 1993 ---- ---- ---- ---- ---- ---- Gross reserves for property and casualty claims and claims expenses, beginning of year................ $307.2 $320.9 $319.4 $331.5 $358.2 $373.5 Deduct: Reinsurance recoverables... 29.4 46.9 20.9 14.8 17.7 21.6 ------ ------ ------ ------ ------ ------ Net reserves for property and casualty claims and claims expenses, beginning of year................ 277.8 274.0 298.5 316.7 340.5 351.9 Increase in reserves due to purchase of Allegiance Insurance Company: Gross reserves for property and casualty claims and claims expenses.............. - - - - - 30.6 Deduct: Reinsurance recoverables - - - - - 0.6 ------ ------ ------ ------ ------ ------ Net reserves for property and casualty claims and claims expenses... - - - - - 30.0 Paid cumulative as of: One year later................... 120.2 115.0 111.3 116.1 117.6 133.4 Two years later.................. 175.9 163.9 167.4 170.0 169.6 190.5 Three years later................ 204.3 192.6 197.1 197.2 197.8 218.4 Four years later................. 220.1 208.2 212.9 212.1 213.6 234.1 Five years later................. 227.7 216.4 220.7 220.5 222.6 241.0 Six years later.................. 232.2 219.3 225.3 224.8 226.0 Seven years later................ 234.0 221.7 228.2 227.1 Eight years later................ 235.5 223.2 229.5 Nine years later................. 236.6 224.1 Ten years later.................. 237.3 Reserves reestimated as of: End of year...................... 277.8 274.0 298.5 316.7 340.5 381.9 One year later................... 275.6 265.9 279.9 297.3 306.1 327.6 Two years later.................. 269.2 254.5 266.7 272.1 267.7 281.9 Three years later................ 259.0 239.4 246.7 246.8 246.4 258.1 Four years later................. 243.0 233.2 236.5 235.2 233.3 249.3 Five years later................. 239.7 227.8 232.4 229.8 229.7 247.4 Six years later.................. 239.3 225.4 230.8 230.1 230.0 Seven years later................ 237.4 224.9 231.1 230.1 Eight years later................ 237.5 225.2 231.7 Nine years later................. 238.1 225.7 Ten years later.................. 238.6 Reserve redundancy - Initial net reserves in excess of reestimated reserves: Amount......................... $ 39.2 $ 48.3 $ 66.8 $ 86.6 $110.5 $134.5 Percent........................ 14.1% 17.6% 22.4% 27.3% 32.5% 35.2% Gross reestimated liability - latest Reestimated reinsurance recoverables - latest........................... Net reestimated liability - latest.. Gross cumulative excess.............
December 31, ----------------------------------------- 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Gross reserves for property and casualty claims and claims expenses, beginning of year................ $389.1 $369.7 $340.4 $310.6 $298.9 Deduct: Reinsurance recoverables... 19.5 23.8 34.1 41.3 55.9 ------ ------ ------ ------ ------ Net reserves for property and casualty claims and claims expenses, beginning of year................ 369.6 345.9 306.3 269.3 243.0 Increase in reserves due to purchase of Allegiance Insurance Company: Gross reserves for property and casualty claims and claims expenses.............. - - - - - Deduct: Reinsurance recoverables - - - - - ------ ------ ------ ------ ------ Net reserves for property and casualty claims and claims expenses... - - - - - Paid cumulative as of: One year later................... 140.8 139.3 148.6 142.0 Two years later.................. 194.5 195.3 202.1 Three years later................ 224.2 223.0 Four years later................. 237.9 Five years later................. Six years later.................. Seven years later................ Eight years later................ Nine years later................. Ten years later.................. Reserves reestimated as of: End of year...................... 369.6 345.9 306.3 269.3 243.0 One year later................... 314.0 283.4 261.2 244.4 Two years later.................. 269.2 249.6 250.2 Three years later................ 251.4 245.8 Four years later................. 248.9 Five years later................. Six years later.................. Seven years later................ Eight years later................ Nine years later................. Ten years later.................. Reserve redundancy - Initial net reserves in excess of reestimated reserves: Amount......................... $120.7 $100.1 $ 56.1 $ 24.9 Percent........................ 32.7% 28.9% 18.3% 9.2% Gross reestimated liability - latest $276.2 $288.8 $286.9 Reestimated reinsurance recoverables - latest........................... 30.4 38.6 42.5 ------ ------ ------ Net reestimated liability - latest.. 245.8 250.2 244.4 Gross cumulative excess............. $ 93.5 $ 51.6 $ 23.7 ====== ====== ======
As the table above illustrates, the Company's net reserve for property and casualty insurance claims and claims expense at the end of 1997 developed favorably in 1998 by $24.9 million, comparable to favorable development of the gross reserves of $23.7 million. 14 Property and Casualty Reinsurance All reinsurance is obtained through contracts which generally are renewed each calendar year; however, the catastrophe, liability and property reinsurance program effective January 1, 1999, excluding reinsurance for the educator professional liability policy, is a three year contract with rate guarantees. Although reinsurance does not legally discharge the Company from primary liability for the full amount of its policies, it does make the assuming reinsurer liable to the extent of the reinsurance ceded. Historically, the Company's losses from uncollectible reinsurance recoverables have been insignificant due to the Company's emphasis on the credit worthiness of its reinsurers. Past due reinsurance recoverables as of December 31, 1998 were also insignificant. The Company is a national underwriter and therefore has exposure to catastrophic losses in certain coastal states and other regions throughout the United States. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather and fires, and the frequency and severity of catastrophes are inherently unpredictable. The financial impact from catastrophic losses results from both the total amount of insured exposure in the area affected by the catastrophe as well as the severity of the event. The Company seeks to reduce its exposure to catastrophe losses through the geographic diversification of its insurance coverage, the purchase of catastrophe reinsurance, and the purchase of a catastrophe-linked equity put option. The Company maintains an excess and catastrophe treaty reinsurance program. The Company reinsures 95% of catastrophe losses above a retention of $7.5 million per occurrence up to $80 million per occurrence in 1998 and 1999. This program is augmented by a $100 million equity put that provides an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event losses from catastrophes, individually or in the aggregate during a calendar year, exceed the catastrophe reinsurance program coverage limit. Before tax benefits, the equity put provides a source of capital for up to $154 million of catastrophe losses above the reinsurance coverage limit. For liability coverages, in both 1998 and 1999, including the educator professional liability policy, the Company reinsures each loss above a retention of $500,000 up to $20 million. The Company also reinsures each property loss above a retention of $500,000 up to $2.5 million in 1999 compared to $500,000 up to $1.5 million for 1998. 15 The following table identifies the Company's most significant reinsurers under the traditional catastrophe reinsurance program, their percentage participation in the Company's aggregate reinsured coverage and their rating by Standard & Poor's Corporation ("S&P" or "Standard & Poor's") and A.M. Best. No other single reinsurer's percentage participation in 1999 or 1998 exceeds 5%. Property Catastrophe Reinsurance Participants In Excess of 5%
Participation S&P A.M. Best ------------- Rating Rating Reinsurer Parent 1999 1998 ---------- ------------ --------- ------ ---- ---- AA- A+ AXA Reinsurance Company AXA Group 11% 13% AAA A+ St. Paul Fire and Marine Insurance Company The St. Paul Companies, Inc. 11% 10% AA A++ Erie Insurance Exchange 9% 5% AAA A++ American Re-insurance Company Muenchener Rueckversicherungs- Gesellschaft AG (Munich Re) of Germany 6% 6% AA- A+ NAC Reinsurance Corporation NAC Re Corporation 6% *** A+ A Continental Casualty Company* Loews Corporation 6% *** A+ A Lloyd's of London Syndicates** 5% 16% AA+ A+ Hannover Ruckversicherungs AG HDI Haftpflicht-verband der Deutschen Industrie VaG 5% ***
- ------------- * Includes 1 percentage point from CNA Reinsurance Company Ltd. of London, England. ** For 1999, the 5% participation by Lloyd's of London in the Company's catastrophe reinsurance program is disbursed among 4 syndicates, each providing less than 5% of the Company's aggregate reinsured catastrophe risk. *** Less than 5%. For 1999, all of the Company's property catastrophe reinsurers were rated "A- (Excellent)" or above by A.M. Best or "A+" or above by S&P. Annuities Educators in the Company's target market, as public school employees, benefit from the provisions of Section 403(b) of the Internal Revenue Code. This section of the Code allows public school employees to reduce their pretax income by making periodic contributions to an individual qualified retirement plan. The Company has offered tax-qualified annuities to its marketplace, designed to allow contractholders to benefit from these tax provisions, since 1961, the year Congress created this option for educators. In 1998, annuities represented 27% of the Company's total insurance premiums written and contract deposits. The Company sells fixed and variable tax-qualified annuities primarily under its combination contract which allows the contractholder to allocate funds to both fixed and variable alternatives. The features of the Company's combination fixed/variable annuity contract contribute to business retention. Contractholders can change at any time their allocation of deposits between a guaranteed interest rate fixed account and seven mutual fund investment options. The seven mutual fund options, each managed by the Company are: a common stock fund, a bond fund, a combination bond and stock fund, and a short-term fund; and beginning in 1997 --a small cap growth fund, an international equity fund, and a socially responsible fund. Both the principal and a rate of return are guaranteed under the fixed account option. Total accumulated fixed and variable annuity cash value on deposit at December 31, 1998 of $2,475.5 million increased $161.3 million, or 7.0%, compared to December 31, 1997. 16 For the year ended December 31, 1998, 93% of the accumulated cash value of the Company's annuity business remained on deposit, compared to average retention of 90% for stock life insurance companies for 1997, as reported by A.M. Best. All annuities issued since 1982 and approximately 75% of all outstanding fixed annuity accumulated cash values are subject in most cases to substantial early withdrawal penalties, typically ranging from 5% to 13% of the amount withdrawn, compared to an average of 48% of accumulated values subject to withdrawal penalties for stock life insurance companies for 1997, as reported by A.M. Best. For the Company, withdrawals of outstanding variable annuities are limited to amounts less than or equal to the then current market value of the annuity. Tax-qualified annuities represented 94% of the Company's annuity policy reserves at December 31, 1998, and, generally, a penalty is imposed under the Internal Revenue Code of 1986, as amended, on amounts withdrawn from tax-qualified annuities prior to age 59 1/2. Selected Historical Financial Information For Annuity Segment The following table sets forth certain information with respect to the Company's annuity products for the periods indicated. Annuity Segment Selected Historical Financial Information (Dollars in millions, unless otherwise indicated)
Year Ended December 31, ---------------------------------------- 1998 1997 1996 ------ ------ ------ Statement of Operations Data: Contract deposits: Variable............................................. $ 138.6 $ 112.2 $ 82.4 Fixed................................................ 84.7 87.0 84.5 Total............................................. 223.3 199.2 166.9 Contract charges earned.................................. 15.6 12.6 9.2 Net investment income.................................... 107.7 113.1 111.4 Net interest margin (without realized gains)............. 35.7 36.6 34.7 Net margin (includes contract charges earned)............ 51.3 49.2 43.9 Operating income before income taxes..................... 35.4 29.8 24.9 Operating income......................................... 23.1 19.3 16.3 Operating Statistics: Fixed annuity: Accumulated value.................................... $1,352.7 $1,354.5 $1,390.6 Accumulated value persistency........................ 92.8% 91.7% 93.9% Variable annuity accumulated value....................... $1,122.8 $ 959.7 $ 684.9 Number of contracts in force............................. 120,253 112,162 106,476 Average accumulated cash value (in dollars).............. $ 20,586 $ 20,633 $ 19,493 Average annual deposit by contractholders (in dollars)... $ 2,416 $ 2,485 $ 2,382 Maturity schedule for all annuity contracts: Matured.............................................. $ 205.6 $ 195.7 $ 184.4 5 years or less...................................... 436.0 424.4 397.9 After 5 years through 10 years....................... 550.3 489.6 408.9 After 10 years through 20 years...................... 831.1 793.9 732.8 After 20 years....................................... 452.5 410.6 351.5 Total accumulated cash value...................... $2,475.5 $2,314.2 $2,075.5 Annuity contracts terminated due to surrender, death, maturity or other: Number of contracts .............................. 6,987 6,945 5,977 Amount............................................ $ 224.8 $ 168.2 $ 133.2 Accumulated fixed annuity value grouped by applicable surrender charge: 0%................................................ $ 319.8 $ 326.3 $ 344.6 5% and greater but less than 10%.................. 825.3 808.9 827.5 10% and greater................................... 120.6 137.5 141.2 Supplementary contracts with life contingencies not subject to discretionary withdrawal........ 87.0 81.8 77.3 Total accumulated fixed annuity value...... $1,352.7 $1,354.5 $1,390.6
17 Life The Company entered the individual life insurance business in 1949 with traditional term and whole life insurance products. In 1984, the Company introduced "Experience Life," a flexible life insurance contract which allows the customer to combine elements of term life insurance, interest-sensitive whole life insurance and an interest-bearing account. At December 31, 1998 the Company had in force approximately 103,000 Experience Life policies representing approximately $6.8 billion of life insurance in force with annual insurance premiums and contract deposits of approximately $75.1 million. The Company's traditional term, whole life and group life business in force consists of approximately 156,000 policies, representing approximately $5.0 billion of life insurance in force with annual insurance premiums and contract deposits of approximately $29.0 million as of December 31, 1998. In 1997, the Company introduced a new series of five limited duration term life insurance products. In 1998, the Company introduced a new series of whole life products designed to provide products to serve the needs of customers who want limited life insurance coverage (as low as $10,000 death benefits) but who want the features of a whole life policy. The Company does not charge any penalty for withdrawal of life insurance cash values. In 1998, the life segment represented 14% of the Company's total insurance premiums written and contract deposits including approximately 1.5 percentage points attributable to the Company's group life and group disability income business. During 1998, the average face amount of ordinary life insurance policies issued by the Company was $104,925 and the average face amount of all ordinary life insurance policies it had in force at December 31, 1998 was $52,422. A.M. Best reported that during 1997, for stock life insurance companies, the average face amount of ordinary life insurance policies issued was $86,722 and the average face amount of all ordinary life insurance policies in force was $48,587. Because certain of the Company's life insurance products combine elements of insurance that are reported in the industry as separate policies, the Company's per policy statistics appear higher than the industry. However, on a comparable basis, the Company's average face amount of ordinary life insurance issued in 1998 and in force at the end of the year are lower than industry averages. The maximum life insurance risk retained by the Company is $200,000 combined for group and individual coverages on any individual life. Any risk in excess of $200,000 is reinsured. All of the Company's life reinsurers are rated "A (Excellent)" or above by A.M. Best. The life insurance and annuity industry, while it has not generally been subject to the factors that produce cyclicality in the property and casualty insurance industry, is nonetheless subject to competitive pressures and interest rate fluctuations. As a result, the life insurance and annuity industry has developed new products designed to shift investment and credit risk to policy or contractholders while still providing death benefits. This trend has generally caused profit margins to shrink on new products relative to older life insurance and annuity products and has provided more competitive returns to the holders of the new products than those available under other investment alternatives. Management cannot predict whether these trends will continue in the future. 18 Selected Historical Financial Information For Life Segment The following table sets forth certain information with respect to the Company's life products for the periods indicated. Life Segment Selected Historical Financial Information (Dollars in millions, unless otherwise indicated)
Year Ended December 31, ------------------------------------------ 1998 1997 1996 -------- -------- -------- Statement of Operations Data: Insurance premiums and contract deposits................. $ 116.7 $ 114.1 $ 110.8 Insurance premiums and contract charges earned........... 85.8 82.9 80.3 Net investment income ................................... 45.4 43.7 41.7 Operating income before income taxes..................... 19.0 19.9 18.4 Operating income......................................... 12.4 12.9 12.1 Operating Statistics: Life insurance in force: Ordinary life........................................ $ 10,573 $ 10,241 $ 9,682 Group life........................................... 1,226 947 963 Total............................................. 11,799 11,188 10,645 Number of policies in force: Ordinary life........................................ 201,689 200,811 199,031 Group life........................................... 57,010 51,895 55,525 Total............................................. 258,699 252,706 254,556 Average face amount in force (in dollars): Ordinary life........................................ $ 52,422 $ 50,998 $ 48,650 Group life........................................... 21,505 18,248 17,350 Total............................................. 45,609 44,273 41,800 Persistency rate (ordinary life insurance in force)...... 92.8% 93.0% 92.0% Lapse ratio (ordinary life insurance in force)........... 7.2% 7.0% 8.0% Ordinary life insurance terminated due to death, surrender, lapse or other: Face amount of insurance surrendered or lapsed.... $ 888.2 $ 771.4 $ 862.1 Number of policies............................. 9,396 9,571 9,660 Amount of death claims............................ $ 26.5 $ 22.0 $ 22.4 Number of death claims......................... 1,300 1,274 1,305
Investments The Company's investments are selected to balance the objectives of minimizing interest rate exposure, providing a high current yield and protecting principal. These objectives are implemented through a portfolio that emphasizes investment grade, publicly traded bonds. When impairment of the value of an investment is considered other than temporary, the decrease in value is recorded as an adjustment to the valuation reserve and a new cost basis is established. At December 31, 1998, investments in non-investment grade securities represented 6.4% of total investments. There are no significant investments in mortgage loans and real estate or privately placed securities. The Company's investments are managed by outside managers and advisors which follow investment guidelines established by the Company. The Company has separate investment strategies and guidelines for its property and casualty assets and for its life and annuity assets, which recognize different characteristics of the associated insurance liabilities, as well as different tax and regulatory environments. The Company manages interest rate exposure for its portfolios through asset/liability management techniques that attempt to match the duration of the assets with the duration of the liabilities under insurance policies. Duration of assets and liabilities will generally differ only because of opportunities to significantly increase yields or because policy values are not interest-sensitive, as in the property and casualty segment. 19 The investments of each insurance subsidiary must comply with the insurance laws of such insurance subsidiary's domiciliary state. These laws prescribe the type and amount of investments that may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred stocks, common stocks, real estate mortgages and real estate. The following table sets forth the carrying and market values of the Company's investment portfolio as of December 31, 1998: Investment Portfolio (Dollars in millions)
Percentage Carrying Value of Total ------------------------------------ Carrying Life and Property and Amortized Value Total Annuity Casualty Cost ---------- ----- -------- ------------ --------- Publicly Traded Fixed Maturity Securities and Cash Equivalents: U.S. government and agency obligations(1): Mortgage-backed securities.......... 17.9% $ 507.5 $ 439.8 $ 67.7 $ 489.8 Other............................... 7.0 199.0 183.5 15.5 192.2 Investment grade corporate and public utility bonds....................... 36.7 1,040.9 937.1 103.8 991.8 Municipal bonds........................ 11.2 319.1 40.2 278.9 301.8 Other mortgage-backed securities....... 13.1 373.1 344.6 28.5 365.5 Non-investment grade corporate and public utility bonds(2).................... 6.4 180.5 115.7 64.8 182.8 Foreign government bonds............... 0.8 23.9 23.9 - 21.8 Short-term investments(3).............. 0.7 20.9 16.6 4.3 20.9 Short-term investments, loaned securities collateral(4)............ 3.1 87.4 87.2 0.2 87.4 ----- -------- -------- ------ -------- Total publicly traded securities. 96.9 2,752.3 2,188.6 563.7 2,654.0 ----- -------- -------- ------ -------- Other Investments: Private placements, all investment grade(5) 0.3 7.4 7.3 0.1 6.8 Mortgage loans and real estate(6).......... 0.9 26.2 26.2 - 26.2 Policy loans and other..................... 1.9 54.9 54.2 0.7 54.9 ----- -------- -------- ------ -------- Total other investments.......... 3.1 88.5 87.7 0.8 87.9 ----- -------- -------- ------ -------- Total investments(7)............. 100.0% $2,840.8 $2,276.3 $564.5 $2,741.9 ===== ======== ======== ====== ========
- ------------- (1) Includes $283.4 million market value of investments guaranteed by the full faith and credit of the United States government and $423.1 million market value of federally sponsored agency securities. (2) A non-investment grade rating is assigned to a security when it is acquired, primarily on the basis of the Standard & Poor's Corporation ("Standard & Poor's" or "S&P") rating for such security, or if there is no S&P rating, the Moody's Investors Service, Inc. ("Moody's") rating for such security, or if there is no S&P or Moody's rating, the National Association of Insurance Commissioners (the "NAIC") rating for such security. (3) Short-term investments mature within one year of being acquired and are carried at cost, which approximates market value. Short-term investments include $20.8 million in a money market fund rated "AAA" (S&P or its equivalent) and $0.1 million in certificates of deposit. (4) The Company loans fixed income securities to third parties, primarily major brokerage firms. The Company separately maintains a minimum of 100% of the value of the loaned securities as collateral for each loan. (5) Market values for private placements are estimated by the Company with the assistance of its investment advisors. (6) Mortgage loans are carried at amortized cost or unpaid principal balance less valuation reserves and real estate acquired in the settlement of debt is carried at the lower of cost or market. Carrying value is net of a $1.8 million valuation reserve for anticipated losses. (7) Approximately 11% of the Company's investment portfolio, having a carrying value of $321.5 million as of December 31, 1998, consisted of securities with some form of credit support, such as insurance. All of these securities have the highest investment grade rating. 20 Fixed Maturity Securities The following table sets forth the composition of the Company's fixed maturity securities portfolio by rating as of December 31, 1998: Rating of Fixed Maturity Securities(1) (Dollars in millions)
Percent of Total Carrying Carrying Amortized Value Value Cost --------- -------- ---------- AAA......................................................... 44.0% $1,165.3 $1,123.8 AA.......................................................... 8.5 224.7 214.0 A........................................................... 19.1 507.4 478.1 BBB......................................................... 21.5 569.9 550.9 BB.......................................................... 2.0 54.3 55.4 B........................................................... 4.1 109.7 110.3 CCC or lower................................................ 0.1 2.2 2.1 Not rated(2)................................................ 0.7 17.9 17.9 ----- -------- -------- Total.................................................... 100.0% $2,651.4 $2,552.5 ===== ======== ========
- ------------- (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) This category includes $10.5 million of publicly traded securities not currently rated by S&P, Moody's or the NAIC and $7.4 million of private placement securities not rated by either S&P or Moody's. The NAIC has rated 97.3% of these private placements as investment grade. $0.1 million of the remaining $0.2 million of private placements were rated as investment grade by the NAIC in 1995 and are under review for the assignment of a current rating. At December 31, 1998, 32.8% of the Company's fixed maturity securities portfolio was scheduled to mature within the next 5 years. Mortgage-backed securities, including mortgage-backed securities of United States governmental agencies, represented 31.0% of the total investment portfolio at December 31, 1998. These securities typically have average lives shorter than their stated maturities due to unscheduled prepayments on the underlying mortgages. Mortgages are prepaid for a variety of reasons, including sales of existing homes, interest rate changes over time that encourage homeowners to refinance their mortgages and defaults by homeowners on mortgages that are then paid by guarantors. For financial reporting purposes, the Company has classified the entire fixed maturity portfolio as "available for sale". Fixed maturities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at market value. Fixed maturities held for indefinite periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates, resultant prepayment risk and other factors related to interest rate and resultant prepayment risk. Cash Flow As a holding company, HMEC conducts its principal operations through its subsidiaries. Payment by HMEC of principal and interest with respect to HMEC's indebtedness, and payment by HMEC of dividends to its shareholders, are dependent upon the ability of its insurance subsidiaries to pay cash dividends or make other cash payments to HMEC, including tax payments pursuant to tax sharing agreements. Restrictions on the subsidiaries' ability to pay dividends or to make other cash payments to HMEC may materially affect HMEC's ability to pay principal and interest on its indebtedness and dividends on its common stock. 21 The ability of the insurance subsidiaries to pay cash dividends to HMEC is subject to state insurance department regulations which generally permit dividends to be paid for any 12 month period in amounts equal to the greater of (i) net gain from operations in the case of a life insurance company or net income in the case of all other insurance companies for the preceding calendar year or (ii) 10% of surplus as of the preceding December 31st. Any dividend in excess of these levels requires the prior approval of the Director or Commissioner of the state insurance department of the state in which the dividend paying insurance subsidiary is domiciled. The aggregate amount of dividends that may be paid in 1999 from all of HMEC's insurance subsidiaries without prior regulatory approval is approximately $67 million. Notwithstanding the foregoing, if insurance regulators otherwise determine that payment of a dividend or any other payment to an affiliate would be detrimental to an insurance subsidiary's policyholders or creditors, because of the financial condition of the insurance subsidiary or otherwise, the regulators may block dividends or other payments to affiliates that would otherwise be permitted without prior approval. The insurance subsidiaries' sources of funds consist primarily of premiums and contract fees, investment income and proceeds from sales and redemption of investments. Such funds are applied primarily to payment of claims, insurance operating expenses, income taxes and the purchase of investments, as well as dividends and other payments to HMEC. Competition The Company operates in a highly competitive environment. There are numerous insurance companies that compete with the Company, although management believes that the Company is one of the few multiline insurance companies to target the nation's teachers as its primary market. In some specific instances and geographic locations competitors have specifically targeted the teacher marketplace with specialized products and programs. The Company competes in its target market with a number of national providers of personal automobile and homeowners insurance and life insurance. For annuity business, the marketplace has begun to see a competitive impact from new entrants such as mutual funds and banks into the tax deferred annuity products market. Among the major national providers of annuities to educators, Variable Annuity Life Insurance Company, a subsidiary of American General Corporation, and Nationwide are among the Company's major tax-qualified annuity competitors. The Company competes with a number of national providers of automobile and homeowners insurance, such as State Farm, Allstate and Nationwide, and several regional companies. The Company also competes for automobile business with certain direct marketing companies, such as 20th Century, American International Group (AIG) and GEICO. The insurance industry consists of a large number of insurance companies, some of which have substantially greater financial resources, more diversified product lines, and lower cost marketing approaches, such as direct marketing, mail and telemarketing, compared to the Company. The Company believes that the principal competitive factors in the sale of property and casualty insurance products are price, service and name recognition. The Company believes that the principal competitive factors in the sale of life insurance and annuity products are product features, perceived stability of the insurer, service, name recognition and price. 22 Insurance Financial Ratings The Company believes that the ratings assigned to its principal insurance subsidiaries by Standard & Poor's, A.M. Best and Duff & Phelps Credit Rating Co. ("Duff & Phelps") contribute to the Company's competitiveness. Each of HMEC's principal insurance subsidiaries is rated "AA- (Very Strong)" for financial strength by Standard & Poor's. S&P publications define financial strength ratings as follows. A Standard & Poor's Insurer Financial Strength Rating is a current opinion of the financial security characteristics of an insurance organization with respect to its ability to pay under its insurance policies and contracts in accordance with their terms. This opinion is not specific to any particular insurance policy or contract, nor does it address the suitability of a particular insurance policy or contract for a specific purpose or purchaser. Furthermore, the opinion does not take into account deductibles, surrender or cancellation penalties, the timeliness of payment, or the likelihood of the use of a defense such as fraud to deny claims. Financial strength ratings do not refer to an insurer's ability to meet nonpolicy obligations (i.e., debt contracts). The financial strength ratings are based on current information furnished by the insurance company or obtained by S&P from other sources it considers reliable. S&P does not perform an audit in connection with any rating and may, on occasion, rely on unaudited financial information. The ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information or based on other circumstances. Financial strength ratings are divided into two broad classifications. An insurer rated "BBB" or higher is regarded as having financial security characteristics that outweigh any vulnerabilities, and is highly likely to have the ability to meet financial commitments. An insurer rated "BB" or lower is regarded as having vulnerable characteristics that may outweigh its strengths. "BB" indicates the least degree of vulnerability within the range; "CC" the highest. Financial strength ratings are assigned at the request of the insurers and based on extensive quantitative and qualitative analysis including consideration of ownership and support factors, if applicable. The rating process includes meetings with insurers' management. Plus (+) and minus (-) signs show relative standing within a category; they do not suggest likely upgrades or downgrades. Insurers rated "AAA" offer extremely strong financial security characteristics. Insurers rated "AA" offer very strong financial security. The financial securities characteristics of an insurer rated "AA" differ only slightly from those of companies rated "AAA". HMIC, TIC and Allegiance are rated "A+ (Superior)" and HMLIC is rated "A (Excellent)" by A.M. Best. Ratings for the industry range from "A++ (Superior)" to "F (In Liquidation)", and some companies are not rated. Publications of A.M. Best indicate that the "A++ and A+ (Superior)" ratings are assigned to those companies that in A.M. Best's opinion have, on balance, superior financial strengths, operating performance and market profile when compared to the standards established by A.M. Best and have a very strong ability to meet their ongoing obligations to policyholders. The "A and A- (Excellent)" ratings are assigned to those companies that in A.M. Best's opinion have, on balance, excellent financial strengths, operating performance and market profile when compared to the standards established by A.M. Best and have a strong ability to meet their ongoing obligations to policyholders. In evaluating a company's financial strength, operating performance and market profile, A.M. Best reviews the company's leverage/capitalization, capital structure/holding company, quality and appropriateness of reinsurance program, adequacy of loss/policy reserves, quality and diversification of assets, liquidity, profitability, revenue composition, management experience and objectives, market risk, competitive market position, spread of risk and event risk. The objective of A.M. Best's rating system is to provide an overall opinion of an insurance company's ability to meet its obligations to policyholders. 23 HMLIC is rated "AA" for claims paying ability by Duff & Phelps Credit Rating Co. ("Duff & Phelps"). Duff & Phelps' analysis of life insurance company claims paying ability ("CPA") involves judgment in the assessment of quantitative and qualitative factors. The CPA rating process emphasizes analysis of the company's current and future ability to pay, when due, its policy and contract obligations. Critical considerations are confidence in an insurer's long-term solvency and its ability to maintain adequate liquidity. In order to be prospective, Duff & Phelps' appraisal is influenced not only by the current, absolute measures but also by trend and volatility. The advent of interest rate sensitive products within the life and annuity industry has heightened the importance of both the asset/liability management and liquidity components of rating reviews. Duff & Phelps considers such qualitative factors as product design and pricing and crediting rate practices, investment policies and management techniques used to control interest rate risk, as well as quantitative factors such as specific asset and liability mismatches and sensitivity analysis. Together these give the basis to determine the adequacy of a company's adjusted surplus relative to these volatility considerations. A key part of the overall CPA rating process is an annual meeting with the senior executives who set the future direction of the company. Regular contact with company representatives throughout the year supplements this process. The CPA ratings use a scale of "AAA (Highest claims paying ability -- the risk factors are negligible)" through "DD (Company is under an order of liquidation)." The CPA rating of "AA" is assigned for very high claims paying ability. The protection factors are strong; risk is modest, but may vary slightly over time due to economic and/or underwriting conditions. A CPA rating only indicates an insurance company's ability to make timely payment of policyholder obligations. It does not refer to the ability of either the rated company or its affiliates to meet nonpolicyholder obligations, such as debt repayment or payment of preferred dividends. Regulation General Regulation at State Level As an insurance holding company, HMEC is subject to regulation by the states in which its insurance subsidiaries are domiciled or transact business. Most states have enacted legislation that requires each insurance company in a holding company system to register with the insurance regulatory authority of its state of domicile and furnish to it financial and other information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. All transactions within a holding company system affecting insurers must be fair and equitable and the insurer's policyholder surplus following any transaction must be both reasonable in relation to its outstanding liabilities and adequate for its needs. Notice to applicable regulators is required prior to the consummation of certain transactions affecting insurance subsidiaries of the holding company system. In addition, the laws of the various states establish regulatory agencies with broad administrative powers to grant and revoke licenses to transact business, regulate trade practices, license agents, require statutory financial statements, and prescribe the type and amount of investments permitted. See "Business - Investments" for discussion of investment restrictions or limitations imposed upon the Company under applicable insurance laws and regulations. The NAIC annually calculates financial ratios to assist state insurance regulators in monitoring the financial condition of insurance companies. A "usual range" of results for each ratio is used as a benchmark. Separate ratios are established for property and casualty and life insurance companies. Departure from the usual range in any of the ratios could lead to inquiries 24 from individual state regulators, and further investigation or other actions may result. In 1997, no unusual ratios were reported by the principal insurance subsidiaries of HMEC other than one ratio each in HMIC and AIC. For each company, the unusual ratio was the result of extraordinary dividend payments to HMEC which were preapproved by the appropriate states of domicile. As part of their regulatory oversight process, state insurance departments routinely conduct detailed financial examinations (generally not more frequently than once every three years) of the books, records and accounts of insurance companies domiciled in their states. Typically, such examinations are conducted concurrently by two or three states under guidelines promulgated by the NAIC. The last financial examinations for the Company's principal insurance subsidiaries, HMLIC, HMIC and TIC, occurred during 1993 for the period ended December 31, 1992. A financial examination of Allegiance was completed for the period ended December 31, 1994. Routine examinations of HMLIC, HMIC and TIC for the five year period ended December 31, 1997 and of AIC for the three year period ended December 31, 1997 were initiated in January 1998. Management believes that HMEC and its subsidiaries are in compliance in all material respects with all applicable regulatory requirements. The NAIC has adopted risk-based capital guidelines to evaluate the adequacy of statutory capital and surplus in relation to an insurance company's risks. State insurance regulations prohibit insurance companies from making any public statements or representations with regard to their risk-based capital levels. Based on current guidelines, the risk-based capital statutory requirements will have no negative regulatory impact on the Company's insurance subsidiaries. Assessments Against Insurers Under insurance insolvency or guaranty laws in most states in which the Company operates, insurers doing business therein can be assessed for policyholder losses related to insolvencies of other insurance companies. The amount and timing of any future assessments on the Company under these laws cannot be reasonably estimated and are beyond the control of the Company. Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurer's financial strength, and most assessments paid by the Company pursuant to these laws may be used as credits for a portion of the Company's premium taxes. The Company paid $0.3 million, $0.6 million and $0.8 million in connection with insurer insolvency proceedings for the years ended December 31, 1998, 1997 and 1996, respectively, of which $0.2 million, $0.6 million and $0.6 million for the same periods, respectively, is recoverable as premium tax credits in future periods. Mandatory Insurance Facilities The Company is required to participate in various mandatory insurance facilities in amounts related to the amount of the Company's direct writings in the applicable state. In 1998, the Company reflected a net loss from participation in such mandatory pools and underwriting associations of $2.1 million before federal income taxes. California Earthquake Authority The California Earthquake Authority ("CEA") was formed by the California Legislature to encourage companies to write residential property insurance in California and began operating in December 1996. All companies which write residential property insurance in California are also required to offer earthquake coverage. The CEA will operate as an insurance company providing 25 residential property earthquake coverage under policies sold by companies which have chosen to participate in the CEA. The participating companies will fund the CEA and share in earthquake losses covered by the CEA in proportion to their market share. The Company has not joined the CEA. The Company's exposure to losses from earthquakes is managed through its underwriting standards, its earthquake policy coverage limits and deductible levels, and the geographic distribution of its business, as well as its reinsurance program. After reviewing the exposure to earthquake losses from its own policies and from participation in the CEA, management believes it is in the Company's best economic interest to offer earthquake coverage directly to its homeowners policyholders. See "Property and Casualty--Property and Casualty Reinsurance." Regulation at Federal Level Although the federal government generally does not directly regulate the insurance business, federal initiatives often impact the insurance business. Current and proposed federal measures which may significantly affect the insurance business include employee benefits regulation, controls on the costs of medical care, medical entitlement programs such as Medicare, changes to the insurance industry anti-trust exemption, minimum solvency requirements and allowing national banks to engage in the insurance, annuity and mutual fund businesses. Federal income taxation of the build-up of cash value within a life insurance policy or an annuity contract could have a material adverse impact on the Company's ability to market and sell such products. Various legislation to this effect has been proposed in the past, but has not been enacted. Although no such legislative proposals are known to exist at this time, such proposals may be made again in the future. The variable annuities underwritten by HMLIC and the mutual funds used as investment vehicles for those products are regulated by the Securities and Exchange Commission (the "SEC"). Horace Mann Investors, Inc., the broker-dealer subsidiary of HMEC, performs certain management functions for the mutual funds and also is regulated by the SEC and the National Association of Securities Dealers. Employees At December 31, 1998, the Company had approximately 2,800 employees, including 1,128 full-time agents. The Company has no collective bargaining agreement with any employees. ITEM 2. Properties HMEC's home office property at 1 Horace Mann Plaza in Springfield, Illinois consists of an office building totaling approximately 230,000 square feet which is owned by the Company. HMEC also owns buildings with an aggregate of approximately 209,000 square feet at other locations in Springfield. These properties are adequate and suitable for the Company's current and anticipated future needs. ITEM 3. Legal Proceedings The Company is not currently party to any material pending legal proceedings other than ordinary routine litigation incidental to its business. 26 ITEM 4. Submission of Matters to a Vote of Security Holders None. PART II ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters HMEC's common stock began trading on the New York Stock Exchange ("NYSE") in November 1991 under the symbol of HMN at a price of $9 per share. The following table sets forth the high and low sales prices of the common stock on the NYSE Composite Tape and the cash dividends paid per share of common stock during the periods indicated.
Market Price ----------------------- Dividend Fiscal Period High Low Paid ------------- ---- --- -------- 1998: Fourth Quarter................................. $32 3/8 $26 1/2 $0.0925 Third Quarter.................................. 35 3/4 26 1/16 0.08 Second Quarter................................. 37 3/8 28 1/8 0.08 First Quarter.................................. 37 5/8 28 0.08 1997: Fourth Quarter................................. $29 23/32 $27 $0.08 Third Quarter.................................. 28 5/8 24 9/16 0.0675 Second Quarter................................. 25 1/2 21 0.0675 First Quarter.................................. 23 3/4 19 5/16 0.0675
As of March 1, 1999, the approximate number of holders of common stock was 10,000. In December 1998, the Board authorized the seventh consecutive increase in the Company's dividend since the Company's initial public offering in 1991 and increased the quarterly dividend by 15.6% to $0.0925 per share. The payment of dividends in the future is subject to the discretion of the Board of Directors and will depend upon general business conditions, legal restrictions and other factors the Board of Directors of HMEC may deem to be relevant. In January 1998, the Company's Board of Directors authorized the repurchase of shares of the Company's common stock up to $100 million. This was in addition to the $100 million stock repurchase program announced in February 1997. During 1998 and 1997, the Company repurchased 6,007,400 shares, 13% of the Company's shares outstanding at December 31, 1996, at an aggregate cost of $163.4 million. Under the share repurchase program, shares of common stock may be purchased from time to time through open market and private purchases, as available. The repurchase of shares is financed through use of cash and, if needed, the existing bank line of credit. During 1998, options were exercised for the issuance of 113,682 shares, 0.3% of the Company's shares outstanding at December 31, 1997. 27 As an insurance holding company, HMEC depends on dividends and other permitted payments from its insurance subsidiaries to pay cash dividends to shareholders of HMEC. The payment of dividends and such other payments to HMEC by its insurance subsidiaries is restricted by the laws of each subsidiary's state of domicile, and insurance regulators have authority in certain circumstances to block payments of dividends and other amounts by the insurance subsidiaries that would otherwise be permitted without regulatory approval. See "Business - Cash Flow" and "Business - Regulation." ITEM 6. Selected Financial Data The information required by Item 301 of Regulation S-K is contained in the table in Item 1--"Business--Selected Historical Consolidated Financial Data." ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required by Item 303 of Regulation S-K is contained in the Index to Financial Information on page F-1 herein. ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk The information required by Item 305 of Regulation S-K is contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in the Index to Financial Information on page F-1 herein. ITEM 8. Consolidated Financial Statements and Supplementary Data The Company's consolidated financial statements, the report of its independent accountants and the selected quarterly financial data required by Item 302 of Regulation S-K are contained in the Index to Financial Information on page F-1 herein. ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III ITEM 10. Directors and Executive Officers of the Registrant The information required by Items 401 and 405 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 1999 Annual Meeting of Shareholders. ITEM 11. Executive Compensation The information required by Item 402 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 1999 Annual Meeting of Shareholders. 28 ITEM 12. Security Ownership of Certain Beneficial Owners and Management The information required by Item 403 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 1999 Annual Meeting of Shareholders. ITEM 13. Certain Relationships and Related Transactions The information required by Item 404 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 1999 Annual Meeting of Shareholders. PART IV ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) The following consolidated financial statements of the Company listed below are contained in the Index to Financial Information on Page F-1 herein: Consolidated Balance Sheets as of December 31, 1998, 1997 and 1996. Consolidated Statements of Operations for the Years Ended December 31, 1998, 1997, and 1996. Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1998, 1997 and 1996. Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996. (a)(2) The following consolidated financial statement schedules of the Company listed below are contained in the Index to Financial Information on page F-1 herein: Schedule I - Summary of Investments - Other than Investments in Related Parties. Schedule II - Condensed Financial Information of Registrant. Schedules III and VI Combined - Supplementary Insurance Information and Supplemental Information Concerning Property and Casualty Insurance Operations. Schedule IV - Reinsurance. 29 (a)(3) The following items are filed as Exhibits. Management contracts and compensatory plans are indicated by an asterisk (*). Exhibit No. Description - ------- ----------- (3) Articles of incorporation and bylaws: 3.1 Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on October 6, 1989, incorporated by reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission (the "SEC") on November 14, 1996. 3.2 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on October 18, 1991, incorporated by reference to Exhibit 3.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 3.3 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on August 23, 1995, incorporated by reference to Exhibit 3.3 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 3.4 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on September 23, 1996, incorporated by reference to Exhibit 3.4 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 3.5 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on June 5, 1998, incorporated by reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998, filed with the SEC on August 13, 1998. 3.6 Form of Certificate for shares of Common Stock, $0.001 par value per share, of HMEC, incorporated by reference to Exhibit 4.5 to HMEC's Registration Statement on Form S-3 (Registration No. 33-53118) filed with the SEC on October 9, 1992. 3.7 Bylaws of HMEC, incorporated by reference to Exhibit 4.6 to HMEC's Registration Statement on Form S-3 (Registration No. 33-80059) filed with the SEC on December 6, 1995. 30 Exhibit No. Description - ------- ----------- (4) Instruments defining the rights of security holders, including indentures: 4.1 Warrant Agreement dated as of August 29, 1989 (the "Warrant Agreement"), between HMEC (as successor to HME Acquisition Corporation) and Bankers Trust Company, as warrant agent (the "Warrant Agent"), with regard to Warrants to Purchase Common Stock, incorporated by reference to Exhibit 4.6 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989 (the "September 1989 Form 10-Q"), filed with the SEC on November 14, 1989. 4.2 Supplemental Warrant Agreement dated as of August 29, 1989 to the Warrant Agreement, between HMEC and the Warrant Agent, incorporated by reference to Exhibit 4.7 to the September 1989 Form 10-Q, filed with the SEC on November 14, 1989. 4.3 Form of Warrant (included in Exhibit 4.1). 4.4 Indenture dated as of January 17, 1996, between HMEC and U.S. Trust Company of California, N.A. as trustee, with regard to HMEC's 6 5/8% Senior Notes Due 2006, incorporated by reference to Exhibit 4.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1995, filed with the SEC on March 13, 1996. 4.5 Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.4). 4.6 Certificate of Designations for HMEC Series A Cumulative Preferred Stock (included in Exhibit 10.12). (10) Material contracts: 10.1 Credit Agreement dated as of December 31, 1996 (the "Bank Credit Facility") among HMEC, certain banks named therein and Bank of America National Trust and Savings Association, as administrative agent (the "Agent"), incorporated by reference to Exhibit 10.1 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1996, filed with the SEC on March 26, 1997. 10.2* Stock Subscription Agreement among HMEC (as successor to HME Holdings, Inc.), The Fulcrum III Limited Partnership, The Second Fulcrum III Limited Partnership and each of the Management Investors, incorporated by reference to Exhibit 10.17 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1989, filed with the SEC on April 2, 1990. 10.3* Horace Mann Educators Corporation Deferred Equity Compensation Plan for Directors, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 31 Exhibit No. Description - ------- ----------- 10.4* Horace Mann Educators Corporation Deferred Compensation Plan for Employees, incorporated by reference to Exhibit 10.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1997, filed with the SEC on March 30, 1998. 10.5* Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1991, filed with the SEC on March 27, 1992. 10.5(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5(a) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1997, filed with the SEC on March 30, 1998. 10.5(b)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.1(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, filed with the SEC on November 13, 1998. 10.5(c)* Amendment to Horace Mann Educators Corporation 1991 Stock Incentive Plan, dated September 11, 1996, incorporated by reference to Exhibit 10.2(c) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 10.5(d)* Amendment to Horace Mann Educators Corporation 1991 Stock Incentive Plan, dated September 18, 1998, incorporated by reference to Exhibit 10.1(d) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, filed with the SEC on November 13, 1998. 10.6* Severance Agreements between HMEC and certain officers of HMEC, incorporated by reference to Exhibit 10.9 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1993, filed with the SEC on March 31, 1994. 10.7* Specimen Continuation of Employment Agreement between HMEC and certain officers, incorporated by reference to Exhibit 10.21(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, filed with the SEC on November 14, 1994. 10.7(a)* Schedule of Continuation of Employment Agreements between HMEC and certain officers, incorporated by reference to Exhibit 10.21(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, filed with the SEC on November 14, 1994. 10.8* Horace Mann Incentive Compensation Program, incorporated by reference to Exhibit 10.7 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1996, filed with the SEC on March 26, 1997. 32 Exhibit No. Description - ------- ----------- 10.9* Horace Mann Supplemental Employee Retirement Plan, 1997 Restatement, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30,1997, filed with the SEC on November 14, 1997. 10.10* Horace Mann Executive Supplemental Employee Retirement Plan, 1997 Restatement, incorporated by reference to Exhibit 10.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, filed with the SEC on August 14, 1997. 10.11* Amended and restated agreement entered by and between HMEC and Paul J. Kardos as of October 6, 1998, incorporated by reference to Exhibit 10.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, filed with the SEC on November 13, 1998. 10.12 Catastrophe Equity Securities Issuance Option Agreement (Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement) entered by and between HMEC and Centre Reinsurance, dated February 15, 1997 and related letter from Centre Reinsurance, incorporated by reference to Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1996, filed with the SEC on March 26, 1997. 10.12(a) Amendment effective February 15, 1997 to Catastrophe Equity Securities Issuance Option Agreement (Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement), incorporated by reference to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998, filed with the SEC on May 15, 1998. 10.12(b) Amendment effective February 15, 1997 to Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement. (11) Statement regarding computation of per share earnings. (12) Statement regarding computation of ratios. (21) Subsidiaries of HMEC. (23) Consent of KPMG LLP. (27) Financial Data Schedule. 33 (b) On October 29, 1998, HMEC filed with the Securities and Exchange Commission a Current Report on Form 8-K dated October 29, 1998 regarding the effects of a routine Internal Revenue Service audit of the Company's 1994 and 1995 federal income tax returns on the Company's effective corporate tax rate in 1999 and beyond. See also within this Form 10-K "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Year Ended December 31, 1998 Compared With Year Ended December 31, 1997 -- Income Tax Expense". (c) See list of exhibits in this Item 14. (d) See list of financial statement schedules in this Item 14. Copies of Exhibits may be obtained by writing to Investor Relations, Horace Mann Educators Corporation, 1 Horace Mann Plaza, Springfield, Illinois 62715-0001. Persons requesting copies will be charged a reasonable fee to cover reproduction and mailing expenses. 34 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Horace Mann Educators Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HORACE MANN EDUCATORS CORPORATION /s/ Paul J. Kardos - ------------------------------------ Paul J. Kardos Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Horace Mann Educators Corporation and in the capacities and on the date(s) indicated.
Principal Executive Officer: Directors: /s/ Paul J. Kardos /s/ William W. Abbott - ------------------------------------------- ------------------------------------------- Paul J. Kardos William W. Abbott, Director Chairman of the Board, President, Chief Executive Officer and a Director /s/ Dr. Emita B. Hill ------------------------------------------- Dr. Emita B. Hill, Director Principal Financial Officer: /s/ Donald E. Kiernan /s/ Larry K. Becker ------------------------------------------- - ------------------------------------------- Donald E. Kiernan, Director Larry K. Becker Executive Vice President and Chief Financial Officer /s/ Jeffrey L. Morby ------------------------------------------- Jeffrey L. Morby, Director Principal Accounting Officer: /s/ Shaun F. O'Malley /s/ Roger W. Fisher ------------------------------------------- - ------------------------------------------- Shaun F. O'Malley, Director Roger W. Fisher Senior Vice President, Financial Information and Control /s/ Charles A. Parker ------------------------------------------- Charles A. Parker, Director Dated: March 30, 1999. /s/ Ralph S. Saul ------------------------------------------- Ralph S. Saul, Director /s/ William J. Schoen ------------------------------------------- William J. Schoen, Director
35 THIS PAGE LEFT BLANK INTENTIONALLY 36 HORACE MANN EDUCATORS CORPORATION INDEX TO FINANCIAL INFORMATION Page ---- Management's Discussion and Analysis of Financial Condition and Results of Operations............... F-2 Report of Management Responsibility for Financial Statements........................................ F-20 Independent Auditors' Report.................................. F-21 Consolidated Balance Sheets................................... F-22 Consolidated Statements of Operations......................... F-23 Consolidated Statements of Changes in Shareholders' Equity........................................ F-24 Consolidated Statements of Cash Flows......................... F-25 Notes to Consolidated Financial Statements.................... F-26 Financial Statement Schedules................................. F-59 F-1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in millions) Forward-looking Information Statements made in the following discussion that state the Company's or management's intentions, hopes, beliefs, expectations or predictions of the future are forward-looking statements. It is important to note that the Company's actual results could differ materially from those projected in such forward-looking statements due to, among other risks and uncertainties inherent in the Company's business, the following important factors: - Changes in the composition of the Company's assets and liabilities through acquisitions or divestitures. - Prevailing interest rate levels, including the impact of interest rates on (i) unrealized gains and losses on the Company's investment portfolio and the related after-tax effect on the Company's shareholders' equity and total capital and (ii) the book yield of the Company's investment portfolio. - The impact of fluctuations in the capital markets on the Company's ability to refinance outstanding indebtedness or repurchase shares of the Company's outstanding common stock. - The frequency and severity of catastrophes such as hurricanes, earthquakes and storms, and the ability of the Company to maintain a favorable catastrophe reinsurance program. - Future property and casualty loss experience and its impact on estimated claims and claim adjustment expenses for losses occurring in prior years. - The Company's ability to develop and expand its agency force and its direct product distribution systems, as well as the Company's ability to maintain and secure product sponsorships by local, state and national education associations. - The competitive impact of new entrants such as mutual funds and banks into the tax deferred annuity products markets, and the Company's ability to profitably expand its property and casualty business in highly competitive environments. - Changes in insurance regulations, including (i) those effecting the ability of the Company's insurance subsidiaries to distribute cash to the holding company and (ii) those impacting the Company's ability to profitably write property and casualty insurance policies in one or more states. - Changes in federal income tax laws and changes resulting from federal tax audits effecting corporate tax rates or taxable income, and regulations changing the relative tax advantages of the Company's life and annuity products to customers. - The Company's ability to maintain favorable claims-paying ability ratings. - Adverse changes in policyholder mortality and morbidity rates. F-2 Year Ended December 31, 1998 Compared With Year Ended December 31, 1997 The results for 1998 represent a 17% return on equity, equal to the Company's five-year average. Results would have been even better but for a series of severe storms during the second quarter that produced a record level of catastrophe claims for that quarter for the property-casualty insurance industry and for Horace Mann. The Company's consistently high return on equity is one of the best measures of management's ability to produce shareholder value and reflects their long-standing commitment to profitable growth and "best use of capital" philosophy. Insurance Premiums and Contract Charges Insurance Premiums Written and Contract Deposits
Year Ended Growth Over December 31, Prior Year --------------------- -------------------------- 1998 1997 Percent Amount ---- ---- ------- ------ Automobile and property (voluntary).................................... $459.0 $431.0 6.5% $28.0 Annuity deposits.................................. 223.3 199.2 12.1% 24.1 Life insurance.................................... 116.7 114.1 2.3% 2.6 ------ ------ ----- Subtotal - core lines...................... 799.0 744.3 7.3% 54.7 Involuntary and other property & casualty............................ 28.8 27.0 6.7% 1.8 ------ ------ ----- Total...................................... $827.8 $771.3 7.3% $56.5 ====== ====== =====
Insurance Premiums and Contract Charges Earned (Excludes annuity and life contract deposits)
Year Ended Growth Over December 31, Prior Year --------------------- -------------------------- 1998 1997 Percent Amount ---- ---- ------- ------ Automobile and property (voluntary).................................... $449.9 $421.5 6.7% $28.4 Annuity........................................... 15.6 12.6 23.8% 3.0 Life.............................................. 85.8 82.9 3.5% 2.9 ------ ------ ----- Subtotal - core lines...................... 551.3 517.0 6.6% 34.3 Involuntary and other property & casualty............................ 26.5 25.7 3.1% 0.8 ------ ------ ----- Total...................................... $577.8 $542.7 6.5% $35.1 ====== ====== =====
Insurance premiums written and contract deposit growth of 7.3% was principally driven by the continuing growth in the agent force and higher agent productivity. In total, the Company ended the year with a record 1,128 exclusive full-time agents, an increase of 5.4% compared to 1,070 agents 12 months earlier. Particularly significant was the 3.7% increase in the number of experienced agents, reflecting the success of the Company's efforts to improve agent recruitment, training and retention. F-3 The growth in new annuity deposits of 12.1% included a 23.5% increase in new deposits to variable mutual fund annuities while new deposits to fixed annuities decreased 2.6%. 1998 represented the third consecutive year of double-digit growth in new annuity deposits. Annuity contributions received through payroll deduction increased approximately 10% for both the fourth quarter and the full year. Total new annuity deposits including single premiums increased 1.3% in the fourth quarter as single premium deposits declined reflecting the volatility in the stock market in the third quarter of 1998, as well as the exceptionally strong 54.6% growth in single premium deposits achieved in fourth quarter 1997. Variable annuity accumulated funds on deposit at December 31, 1998 were $1.1 billion, $163 million more than a year ago, a 17.0% increase. The number of annuity contracts in force increased 7.1%, or 8,000 contracts, compared to last December 31. During the first quarter of 1998, the Company introduced new IRA annuities in response to recent tax legislation. While the 403(b) annuity remains a better alternative for most educators, initial sales of these IRA products generated 3.0 percentage points of the 12.1% growth in new annuity deposits. The new IRA retirement options have created heightened customer interest and an opportunity for agents to meet with both potential and existing customers. Beginning in March 1997, three additional mutual funds - a small cap fund, an international equity fund, and a socially responsible fund - were made available to annuity customers. At December 31, 1998, there were $70 million of customer deposits in these three new funds, compared to approximately $30 million at December 31, 1997. Voluntary automobile and homeowners premium written growth was 6.5% for 1998. Automobile insurance premium increased 5.5%, or $18.7 million, compared to 1997, and homeowners premium increased 10.0%, or $9.3 million. Approximately one-third of the property and casualty increase in premiums resulted from unit growth of 2.6% bringing year-end policies in force to 859,000. Compared to September 30, 1998, total property and casualty policies in force showed no growth as the 4,000 increase in homeowners policies was offset by the 4,000 decline in automobile policies resulting from greater price competition for automobile insurance. The Company's average annual premium per policy for both automobile and homeowners increased approximately 4% compared to 1997. Including the impact of increased deductibles and reduced coverage in coastal areas, the Company's average effective premium per policy for homeowners insurance increased 7% compared to 1997. For the fourth quarter of 1998, the Company's increase in average premium per automobile policy, while comparable to the industry, was lower than in the first part of 1998. Life premium growth was 2.3% for the year ended December 31, 1998 notwithstanding a decline in new deposits to policy side funds which reduced the growth rate by approximately 1 percentage point. The 1998 growth included new business from term life products introduced early in 1997 and a new series of whole life products introduced late in the third quarter of 1998. Retention of business continues to be strong in each of the Company's segments. Over the last 12 months based on policies in force, the property and casualty retention rate for new and renewal policies was 88%, ordinary life insurance 95% and annuity 94%. The annuity and life retention rates were equal to 1997, while property and casualty was about 1 percentage point less than 1997. The change in property and casualty retention was primarily caused by greater price competition for automobile insurance. F-4 Net Investment Income Investment income of $191.7 million for 1998 decreased 3.6%, or $7.2 million, (3.2% after tax) compared to 1997 due to the decline in interest rates and a decrease in the investment portfolio. The average pretax yield on the investment portfolio was 7.2% (4.8% after tax) for 1998 compared to a pretax yield of 7.4% (4.9% after tax) for 1997, a decrease of 18 basis points, or 2.4%. Average investments (excluding the securities lending collateral) decreased 1.5% over the past 12 months reflecting the utilization of capital for the share repurchase program and customers' preference for variable as opposed to fixed annuity contracts. Approximately $4 million, about half, of the investment income decrease was offset by a decline in interest credited to fixed annuity deposits, moderating the effect on operating earnings. Excluding the effect of the use of cash in the share repurchase program, net investment income would have been $199.3 million, a small decrease compared to 1997. Realized Investment Gains and Losses The higher level of realized gains in 1998 resulted from an increase in fixed maturity security calls and tenders in the current low interest rate environment. Benefits, Claims and Settlement Expenses
Year Ended Growth Over December 31, Prior Year --------------------- -------------------------- 1998 1997 Percent Amount ---- ---- ------- ------ Property and casualty............................. $354.4 $320.8 10.5% $33.6 Life.............................................. 41.9 38.6 8.5% 3.3 ------- ------- ------- Total.......................................... $396.3 $359.4 10.3% $36.9 ======= ======= ======= Property and casualty statutory loss ratio: Before catastrophes............................ 68.5% 70.3% -1.8% After catastrophes............................. 74.4% 71.7% 2.7%
Improvements in non-weather related frequency and severity of claims were reflected in a lower property and casualty loss ratio before catastrophes despite a decrease in the favorable development of claims occurring in prior years of $24.9 million in 1998 compared to $45.1 million in 1997. Weather-related catastrophe losses in 1998 more than offset these underwriting improvements. A series of severe storms struck the Northern Plains, Upper Midwest, Southeast and Northeast during the second quarter of 1998, with Minnesota being the hardest hit state, resulting in a record level of weather-related catastrophe claims for the property-casualty insurance industry and for the Company. Catastrophe losses in Minnesota during this period were the worst in that state's history for the industry as well as the Company and reduced the Company's 1998 after tax operating earnings by $5.2 million. The increase in life benefits reflected higher individual life mortality experience compared to 1997. F-5 Interest Credited to Policyholders
Year Ended Growth Over December 31, Prior Year --------------------- -------------------------- 1998 1997 Percent Amount ---- ---- ------- ------ Annuity........................................... $72.0 $76.5 -5.9% $(4.5) Life.............................................. 22.8 20.7 10.1% 2.1 ------ ------ ------ Total.......................................... $94.8 $97.2 -2.5% $(2.4) ====== ====== ======
Interest credited to fixed annuity contracts decreased as average accumulated deposits decreased 1.4% over the 12 months ended December 31, 1998. In addition, the fixed annuity average annual interest rate credited decreased 0.2 percentage points to 5.4% in 1998, compared to a rate of 5.6% in 1997. Life insurance interest credited increased as a result of continued growth in the interest-sensitive whole life insurance reserves. Policy Acquisition and Operating Expenses Policy acquisition and operating expenses represent the Company's insurance underwriting expenses. For 1998, policy acquisition and operating expenses increased $4.5 million, or 3.0%, compared to 1997. The corporate expense ratio on a statutory accounting basis was 21.2% for 1998, 0.9 percentage points better than 1997. The property and casualty expense ratio, the 15th lowest of the 100 largest property and casualty insurance groups for 1997, improved to 19.3% for the year ended December 31, 1998, compared to 19.4% for 1997. At the beginning of 1998, the Company adopted the accounting treatment required by the American Institute of Certified Public Accountants' Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." Adoption of this statement decreased the Company's 1998 operating expenses by $2.4 million before income taxes as costs incurred to develop internal-use software were capitalized and depreciated over their expected useful lives. Amortization of Intangible Assets Amortization of intangible assets decreased by $3.8 million to $6.9 million for the year ended December 31, 1998, compared to $10.7 million for 1997. This decrease resulted from lower amortization of the value of annuity business acquired in the 1989 acquisition of the Company. The value of annuity business acquired is amortized in relation to the present value of the estimated future gross profit amounts expected to be realized over the life of the book of contracts. The estimates of expected gross profit are evaluated annually, and the amortization is adjusted when actual experience or other evidence suggests that earlier estimates should be revised. Significant appreciation and the retention of the Company's annuity business in recent years have favorably impacted projected future gross profits for this business. Accordingly, the amortization has been decreased as the estimated expected future gross profits of the business have increased. F-6 Income Tax Expense The effective income tax rate was 27.0% for the year ended December 31, 1998 compared to 27.2% for 1997. Income from investments in tax-advantaged securities reduced the effective income tax rate 3 percentage points in both 1998 and 1997. Certain tax benefits that are not expected to recur in future years, as explained below, reduced the effective rate 6 percentage points in both 1998 and 1997. The Internal Revenue Service (the "IRS") regularly audits the Company's federal income tax returns and is currently conducting an audit of the Company's 1994 and 1995 tax returns. As a result of this audit, certain tax benefits which the Company has realized in the past are no longer available to the Company after 1998. Therefore, the Company's effective corporate tax rate is expected to be approximately 33% in 1999 and beyond (an increase from approximately 27% in 1998), assuming that the Company's level of tax-exempt investment income remains about the same. In addition, in the course of the current audit, the IRS is taking the position thus far that it is not bound by certain documented understandings contained in the Revenue Agent's Reports (the "RARs") pertaining to the audits of the Company's 1989 through 1993 tax returns. The Company is vigorously contesting the IRS' position and believes the IRS should honor the understandings documented in the RARs. The Company's tax advisors, KPMG LLP, concur with the Company's interpretation of the RARs. The outcome of this matter is uncertain. Therefore, the Company has not accrued a liability in the financial statements with regard to this matter. The maximum amount of additional taxes, with respect to the 1994 through 1998 tax years, if any, that might be due as a result of the resolution of this matter would be less than 5% of the Company's shareholders' equity as of December 31, 1998. Such additional taxes, if any, would increase the Company's income tax expense and effective corporate tax rate only in the year of payment of such taxes. F-7 Operating Income For the year ended December 31, 1998, excluding the impact of catastrophes, operating income (income from continuing operations before the after tax impact of realized investment gains and losses) increased 11.2%. The Company's after-tax catastrophe losses for the year ended December 31, 1998 set a new record high -- and followed a year in which its catastrophe losses were at a near-record low. Current year earnings and investment income were also reduced compared to 1997 due to the utilization of capital in the Company's share repurchase programs. Operating income by segment was as follows:
Year Ended Growth Over December 31, Prior Year ------------------------- ------------------------ 1998 1997 Percent Amount ---- ---- ------- ------ Property & casualty: Before catastrophe losses...................... $71.7 $65.4 9.6% $ 6.3 Catastrophe losses, after tax.................. 18.5 4.0 362.5% 14.5 ------ ------ ------ Including catastrophe losses................... 53.2 61.4 -13.4% 8.2 Annuity........................................... 23.1 19.3 19.7% 3.8 Life.............................................. 12.4 12.9 -3.9% 0.5 Corporate and other expense....................... 3.6 3.9 0.3 Interest expense.................................. 6.2 6.1 0.1 ------ ------ ------ Total...................................... $78.9 $83.6 -5.6% $ 4.7 ====== ====== ====== Total before catastrophe losses............ $97.4 $87.6 11.2% $ 9.8 ====== ====== ====== Property and casualty statutory combined ratio: Before catastrophes............................ 87.7% 89.7% -2.0% After catastrophes............................. 93.6% 91.1% 2.5%
Property and casualty segment operating income was primarily impacted by the significant increase in weather-related catastrophe losses. The property and casualty combined loss and expense ratio for 1998 reflected an improvement in underwriting results offset by the higher weather-related claims. Property and casualty segment operating income was also adversely affected by a reduction in investment income in the year ended December 31, 1998 as compared to the same period in 1997 which resulted from an increase in the operating leverage and corresponding reduction in capital allocated to the Company's property and casualty operations as well as the lower interest rate environment. Despite higher catastrophe losses, automobile results for the year produced a combined ratio of 88.9%, 1.2 percentage points better than 1997. 1998 automobile claim severity was less than in 1997 and rate increases kept pace with loss costs. Due to unprecedented levels of weather-related losses, the 1998 homeowners combined ratio of 110.8% was 17.4 percentage points higher than in 1997. Strong growth in variable annuity deposits produced an increase in annuity earnings compared to 1997. The 1998 interest margin on fixed annuity deposits was comparable to 1997, while fees collected on variable annuity business grew by 23.8% compared to 1997 as a result of growth in the variable annuity business. Variable annuity accumulated deposits were $1.1 billion at December 31, 1998, $163.1 more than 12 months earlier, a 17.0% increase. Fixed annuity accumulated cash value of $1.4 billion was equal to December 31, 1997. F-8 Net Income Net income, which includes realized investment gains and discontinued operations, for the year ended December 31, 1998 increased by 2.0% and net income per diluted share increased by 8.3% compared to 1997. The Company's share repurchase program reduced net income by $5.0 million for 1998 but resulted in an increase of $0.08 in earnings per share for the period due to the reduction in the number of shares outstanding. Net income for 1997 included an after tax charge of $3.5 million, or $0.07 per share, for anticipated additional losses during the remainder of the phase-out period as a result of accelerating the timetable for the Company's withdrawal from the group medical insurance business and higher-than-expected claims. By August 31, 1998, all of the group medical business had been terminated. Year Ended December 31, 1997 Compared With Year Ended December 31, 1996 The results for 1997 represented an 18% return on equity. Insurance Premiums and Contract Charges Insurance Premiums Written and Contract Deposits
Year Ended Growth Over December 31, Prior Year --------------------- ------------------------ 1997 1996 Percent Amount ---- ---- ------- ------ Automobile and property (voluntary).................................... $431.0 $400.0 7.8% $31.0 Annuity deposits.................................. 199.2 166.9 19.4% 32.3 Life insurance.................................... 114.1 110.8 3.0% 3.3 ------ ------ ----- Subtotal - core lines...................... 744.3 677.7 9.8% 66.6 Involuntary and other property & casualty............................ 27.0 27.1 -0.4% (0.1) ------ ------ ----- Total...................................... $771.3 $704.8 9.4% $66.5 ====== ====== =====
Insurance Premiums and Contract Charges Earned (Excludes annuity and life contract deposits)
Year Ended Growth Over December 31, Prior Year --------------------- ------------------------ 1997 1996 Percent Amount ---- ---- ------- ------ Automobile and property (voluntary).................................... $421.5 $390.0 8.1% $31.5 Annuity........................................... 12.6 9.2 37.0% 3.4 Life.............................................. 82.9 80.3 3.2% 2.6 ------ ------ ----- Subtotal - core lines...................... 517.0 479.5 7.8% 37.5 Involuntary and other property & casualty............................ 25.7 23.2 10.8% 2.5 ------ ------ ----- Total...................................... $542.7 $502.7 8.0% $40.0 ====== ====== =====
F-9 Insurance premiums written and contract deposit growth of 9.4% was principally driven by the continuing growth in the agent force and higher agent productivity. Bolstering the productivity gains, the number of experienced agents was 7.6% higher than December 31, 1996. In total, the Company ended 1997 with 1,070 exclusive full-time agents compared to 1,022 agents 12 months earlier, an increase of 5.0%. The growth in new annuity deposits of 19.4% included a 36.1% increase in new deposits to variable mutual fund annuities and a 3.0% increase in new deposits to fixed annuities. 1997 was the second year of double-digit growth in new annuity deposits. Annuity contributions received through payroll deduction increased approximately 13% for the fourth quarter of 1997 and 12.9% for the full year. Single premiums received in 1997 exceeded the prior year by 54.6% for the fourth quarter and 36.5% for the full year. Variable annuity accumulated funds on deposit at December 31, 1997, were $1 billion, $275 million more than a year earlier, a 40.1% increase. The number of annuity contracts in force increased 5.7%, or 6,000 contracts, compared to December 31, 1996. Beginning in March 1997, three additional mutual funds - a small cap fund, an international equity fund, and a socially responsible fund - were made available to annuity customers. At December 31, 1997, there were nearly $30 million of customer deposits in these three new funds. Voluntary automobile and homeowners written premium growth was 7.8% for 1997. Automobile insurance premium increased 6.8%, or $21.5 million, compared to 1996, and homeowners premium increased 11.3%, or $9.5 million. Approximately three-fourths of the property and casualty increase in premiums resulted from unit growth of 6.5% bringing year-end policies in force to 837,000. The Company's average annual premium per policy for both automobile and homeowners increased approximately 2% compared to the year ended December 31, 1996. Including the impact of increased deductibles and reduced coverage in coastal areas, the Company's average effective premium per policy for homeowners insurance increased 5% compared to 1996. Life premium growth was 3.0% for 1997. This growth included new business from term life products introduced early in 1997. Retention of business continued to be strong in each of the Company's segments. For the 12 months ended December 31, 1997 based on policies in force, the property and casualty retention rate was 89%, ordinary life insurance 95% and annuity 94%. The property and casualty and life retention rates were equal to 1996, while annuity was 0.5 percentage points less than 1996 due to retention of 92% on a large block of older contracts that attained a no-penalty surrender option during the last half of 1997. Net Investment Income Investment income of $198.9 million for the year increased 0.2%, or $0.3 million, compared to 1996. The increase in investment income was small compared to growth in the Company's business due to a decrease in the investment portfolio. Average investments (excluding the securities lending collateral) decreased 1.9% over the year reflecting the utilization of capital for the share repurchase program and customers' preference for variable as opposed to fixed annuity contracts. The average pretax yield on the investment portfolio was 7.4% (4.9% after tax) for both 1997 and 1996. F-10 Realized Investment Gains and Losses Realized gains were $5.3 million in 1997, compared to $2.5 million for 1996. Benefits, Claims and Settlement Expenses
Year Ended Growth Over December 31, Prior Year --------------------- ------------------------ 1997 1996 Percent Amount ---- ---- ------- ------ Property and casualty............................. $320.8 $306.1 4.8% $14.7 Life.............................................. 38.6 40.6 -4.9% (2.0) ------ ------ ----- Total.......................................... $359.4 $346.7 3.7% $12.7 ====== ====== ===== Property and casualty statutory loss ratio: Before catastrophes............................ 70.3% 69.1% 1.2% After catastrophes............................. 71.7% 74.1% -2.4%
Property and casualty losses from severe weather in 1996 were higher than those incurred in 1997 as 1997 catastrophe losses were at a near-record low. The favorable development of claims occurring in prior years was $45.1 million in 1997 compared to $62.5 million in 1996. The decrease in life benefits reflected reduced individual life mortality experience compared to 1996. Also for 1996, claims for group disability business were unusually low and returned to more normal levels in 1997. Interest Credited to Policyholders
Year Ended Growth Over December 31, Prior Year --------------------- ------------------------ 1997 1996 Percent Amount ---- ---- ------- ------ Annuity........................................... $76.5 $76.7 -0.3% $(0.2) Life.............................................. 20.7 18.6 11.3% 2.1 ----- ----- ----- Total.......................................... $97.2 $95.3 2.0% $ 1.9 ===== ===== =====
Interest credited to fixed annuity contracts decreased as average accumulated deposits decreased 2.6% over the 12 months ended December 31, 1997. The fixed annuity average annual interest rate credited was 5.6% in 1997, compared to a rate of 5.7% in 1996. Life insurance interest credited increased as a result of continued growth in the interest-sensitive whole life insurance reserves. Policy Acquisition and Operating Expenses Policy acquisition and operating expenses represent the Company's insurance underwriting expenses. For 1997, policy acquisition and operating expenses increased $12.4 million, or 9.0%, compared to 1996. The corporate expense ratio on a statutory accounting basis was 22.1% for 1997, 0.3 percentage points higher than 1996. The property and casualty expense ratio, one of F-11 the best in the industry, of 19.4% was equal to 1996 and included an increase in profitability bonuses to agents based on the excellent property and casualty operating results in 1997. This increase in agent profitability bonuses contributed two-tenths of a percentage point to the 1997 property and casualty expense ratio. Amortization of Intangible Assets Amortization of intangible assets decreased by $0.5 million to $10.7 million for the year ended December 31, 1997, compared to $11.2 million for 1996, as a result of a scheduled decrease in the non-cash amortization of the value of acquired insurance in force related to the 1989 acquisition of the Company. Income Tax Expense The effective income tax rate was 27.2% for 1997 compared to 26.6% for 1996. Income from investments in tax-advantaged securities reduced the effective income tax rate 3 percentage points in 1997 and 1996, and acquisition related tax benefits that are not expected to recur beyond 1998, as explained in "Year Ended December 31, 1998 Compared with Year Ended December 31, 1997," reduced the effective rate 6 percentage points in 1997 and 1996. Operating Income For 1997, excluding the impact of catastrophes, operating income (income from continuing operations before the after tax impact of realized investment gains and losses and debt retirement costs) increased 1.0%. Earnings and investment income for 1997 were reduced compared to 1996 due to the utilization of capital in the Company's share repurchase programs. Operating income by segment was as follows:
Year Ended Growth Over December 31, Prior Year --------------------- ----------------------- 1997 1996 Percent Amount ---- ---- ------- ------ Property & casualty: Before catastrophe losses...................... $65.4 $67.6 -3.3% $(2.2) Catastrophe losses, after tax.................. 4.0 13.6 -70.6% (9.6) ----- ----- ------ Including catastrophe losses................... 61.4 54.0 13.7% 7.4 Annuity........................................... 19.3 16.3 18.4% 3.0 Life.............................................. 12.9 12.1 6.6% 0.8 Corporate and other expense....................... 3.9 2.5 1.4 Interest expense.................................. 6.1 6.8 (0.7) ----- ----- ----- Total...................................... $83.6 $73.1 14.4% $10.5 ===== ===== ===== Total before catastrophe losses............ $87.6 $86.7 1.0% $ 0.9 ===== ===== ===== Property and casualty statutory combined ratio: Before catastrophes........................ 89.7% 88.5% 1.2% After catastrophes......................... 91.1% 93.5% -2.4%
F-12 Property and casualty segment operating income in 1997 benefited from favorable automobile underwriting results and unusually mild weather compared to 1996. Automobile results for 1997 produced a combined ratio of 90.1%, an increase of 2 percentage points compared to 1996. Due to the low level of weather-related losses in 1997, the 1997 homeowners combined ratio of 93.4% was 20.4 percentage points better than the 113.8% result in 1996. Strong growth of 40.1% in variable annuity deposits produced an increase in annuity earnings compared to 1996. The 1997 interest margin on fixed annuity deposits increased 12 basis points compared to 1996. Variable annuity deposits of $1.0 billion at December 31, 1997 were nearly double the amount on deposit at December 31, 1995. Net Income Net income, which includes realized investment gains and discontinued operations, increased 29.4% and net income per diluted share increased 32.4% compared to 1996. The Company's share repurchase program reduced net income by $2.3 million for 1997, while the program resulted in an increase of $0.03 in earnings per share for the period due to the reduction in the number of shares outstanding. Net income for the year ended December 31, 1997 included an after tax charge of $3.5 million, or $0.07 per share, for anticipated additional losses during the remainder of the phase-out period as a result of accelerating the timetable for the Company's withdrawal from the group medical insurance business and higher-than-expected claims. The discontinued group medical business operating loss was $5.3 million for the year ended December 31, 1996. The Company's net income for the year ended December 31, 1996 also included an after tax charge of $3.9 million for anticipated losses during the two year phase-out period for the discontinued group medical insurance business. Net income for the year ended December 31, 1996 also reflected the costs of the early redemption of $100 million of convertible notes of $0.9 million, or $0.02 per diluted share. Liquidity and Financial Resources Investments The Company's investment strategy emphasizes investment grade, publicly traded fixed income securities. At December 31, 1998, fixed income securities represented 96.3% of investments excluding the securities lending collateral. Of the fixed income investment portfolio, 93.1% was investment grade and 99.7% was publicly traded. The average quality of the total fixed income portfolio was A+ at December 31, 1998. The duration of the investment portfolio is managed to provide cash flow to satisfy policyholder liabilities as they become due. The average option adjusted duration of total investments was 4.4 years at December 31, 1998 and 4.3 years at December 31, 1997. The Company has included in its annuity products substantial surrender penalties to reduce the likelihood of unexpected increases in policy or contract surrenders. All annuities issued since 1982 and approximately 75% of all outstanding fixed annuity accumulated cash values are subject in most cases to substantial early withdrawal penalties. F-13 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 in excess of these amounts 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 notes. 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. Net cash provided by operating activities increased compared to 1997 primarily due to a decrease in federal income tax payments. Cash provided by operating activities primarily reflects net cash generated by the insurance subsidiaries. Payment of principal and interest on debt, fees related to the catastrophe-linked equity put option, dividends to shareholders and parent company operating expenses, as well as the share repurchase program, 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. The insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. Dividends which may be paid by the insurance subsidiaries to HMEC during 1999 without prior approval are approximately $67 million. Although regulatory restrictions exist, dividend availability from subsidiaries has been, and is expected to be, more than 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 portfolio as available for sale. Financing Activities Financing activities include primarily repurchases of the Company's common stock, payment of dividends, the receipt and withdrawal of funds by annuity policyholders and borrowings and repayments under the Company's debt facilities. Fees related to the catastrophe-linked equity put which augments its reinsurance program have been charged directly to additional paid-in capital. F-14 For the year ended December 31, 1998, receipts from annuity contracts were greater than contract maturities and withdrawals, and net transfers to variable annuity assets decreased compared to 1997. Life policy account balances increased slightly compared to last December. During 1998, the Company repurchased 2,286,800 shares of its common stock, or 5% of the outstanding shares on December 31, 1997, at an aggregate cost of $71.6 million, or an average cost of $31.32 per share, under its stock repurchase program. Of the amount purchased, $8 million completed the $100 million share repurchase authorization announced in February 1997. The remainder was acquired under an additional $100 million share repurchase authorization announced in January 1998. Since early 1997, 6,007,400 shares, or 13% of the shares outstanding on December 31, 1996, have been repurchased at an aggregate cost of $163.4 million, equal to an average cost of $27.20 per share. Including shares repurchased in 1995, the Company has repurchased 30% of the shares outstanding on December 31, 1994. Shares of common stock may be purchased from time to time through open market and private purchases, as available. The repurchase of shares was financed through cash generated from operations and, if needed, the Bank Credit Facility. As of December 31, 1998, $36.6 million remained authorized for share repurchases. During 1998, the Company received $2.2 million related to the exercise of common stock options including tax benefits. During the second quarter of 1998, the Company also repurchased 60% of its outstanding common stock warrants for $5.0 million. Capital Resources The Company has determined the amount of capital which is needed to adequately fund and support business growth, based on risk-based capital formulas including those developed by the NAIC. Historically, the Company's insurance subsidiaries have generated capital in excess of such needed capital. These excess amounts have been paid to HMEC through dividends. HMEC has then utilized these dividends and its access to the capital markets to retire long-term debt, repurchase shares of its common stock, increase and pay dividends to its shareholders and for other corporate purposes. Management anticipates that the Company's sources of capital will continue to generate capital in excess of the needs for business growth, debt interest payments and shareholder dividends. The total capital of the Company was $646.4 million at December 31, 1998, including $99.6 million of long-term debt and $50.0 million of short-term debt. Total debt represented 23.1% of capital at the end of 1998, within the Company's target operating range of 20% to 25%. Shareholders' equity was $496.6 million at December 31, 1998, including an unrealized gain in the Company's investment portfolio of $57.3 million after taxes and the related impact on deferred policy acquisition costs associated with annuity and interest-sensitive life policies. In December 1997, the Company's common stock was split two-for-one. The market value of the Company's common stock and the market value per share were $1,199.6 million and $28 1/2, respectively, at December 31, 1998. Book value per share was $11.80 at December 31, 1998, $10.44 excluding investment market value adjustments. The Company was added to the S&P MidCap 400 Index after the close of trading on January 29, 1999. Certain mutual funds that seek to replicate this index have added the Company's common stock to their investment portfolio. Standard & Poor's Corporation ("S&P") indicated that the Company was selected for this index due to its market capitalization (over $1 F-15 billion) and its uniqueness in the financial services sector as a multiline, national insurance company with a strong position in a niche market and solid financial credentials. In January 1996, the Company issued $100.0 million face amount of 6 5/8% Senior Notes ("Senior Notes") at a discount of 0.5% which will mature on January 15, 2006. Interest on the Senior Notes is payable semi-annually. The Senior Notes are redeemable in whole or in part, at any time at the Company's option. The Senior Notes have an investment grade rating from Standard & Poor's Corporation ("S&P") (A-), Duff & Phelps Credit Rating Co. ("Duff & Phelps") (A), and Moody's Investors Service, Inc. ("Moody's") (Baa2) and are traded on the New York Stock Exchange (HMN 6 5/8). As of December 31, 1998 and 1997, the Company had short-term debt of $50.0 million and $42.0 million, respectively, outstanding under the Bank Credit Facility. The Bank Credit Facility allows unsecured borrowings of up to $65.0 million at Interbank Offering Rates plus 0.3% to 0.5% or Bank of America National Trust and Savings Association reference rates. The rate on the borrowings under the Bank Credit Facility was Interbank Offering Rate plus 0.3%, or 5.6%, as of December 31, 1998. The commitment for the Bank Credit Facility terminates on December 31, 2001. The Company's ratio of earnings to fixed charges for the year ended December 31, 1998 was 13.3x compared to 13.7x for 1997. Total shareholder dividends were $14.3 million for the year ended December 31, 1998. In November 1998, the Board of Directors authorized the seventh increase to the Company's quarterly dividend. The regular quarterly dividend increased by 16% to $0.0925 per share. The Company's catastrophe reinsurance program is augmented by a $100 million equity put. This equity put provides an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event losses from catastrophes, individually or in the aggregate during a calendar year, exceed $80 million, the 1998 coverage limit of the reinsurance program. Market Risk Market risk is the risk that the Company will incur losses due to adverse changes in market rates. The Company's primary market risk exposure is the risk that the Company will incur economic losses due to adverse changes in interest rates. This risk arises as the Company's profitability is affected by the spreads between interest yields on investments and rates credited on insurance liabilities. The Company manages its market risk by matching the projected cash outflows 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 and providing for liquidity and diversification. The risks associated with mutual fund investments supporting variable annuity products are assumed by those contractholders, and not by the Company. F-16 Through active investment management, the Company invests available funds with the objective of funding future obligations to policyholders, subject to appropriate risk considerations, and maximizing shareholder value. This objective is met through investments that 1) have similar characteristics to the liabilities they support; 2) are diversified among industries, issuers and geographic locations; and 3) are predominately investment-grade fixed maturity securities. No derivatives are used to manage the exposure to interest rate risk in the investment portfolios. At December 31, 1998, 20% of the fixed investment portfolio represents investments supporting the property and casualty operations and 80% support the life and annuity business. For a discussion regarding the Company's investments see "Business-Investments." The Company's life and annuity operating earnings are affected by the spreads between interest yields on investments and rates credited or accruing on life and fixed annuity insurance liabilities. Although substantially all credited rates on fixed annuities may be changed annually (subject to minimum guaranteed rates), changes in competition and other factors, including the impact on the level of surrender and withdrawals, may limit the Company's ability to adjust or to maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. Using financial modeling and other techniques, the Company regularly evaluates the appropriateness of investments relative to the characteristics of the liabilities that they support. Simulations of cash flows generated from existing business under various interest rate scenarios measure the potential gain or loss in fair value of interest-rate sensitive assets and liabilities. Such estimates are used to closely match the duration of assets to the duration of liabilities. The overall duration of liabilities of the Company's multi-line insurance operations combines the characteristics of its long duration interest-sensitive life and annuity liabilities with its short duration non interest-sensitive property and casualty liabilities. Overall, at December 31, 1998, the duration of fixed maturity securities was approximately 4.1 years, and the duration of insurance liabilities was approximately 5.0 years. The life and annuity operations participate in the cash flow testing procedures imposed by statutory insurance regulations, the purpose of which is to insure that such liabilities are adequate to meet the Company's obligations under a variety of interest rate scenarios. Based on these procedures, the Company's assets and the investment income expected to be received on such assets, are adequate to meet the insurance policy obligations and expenses of the Company's insurance activities in all but the most extreme circumstances. The Company periodically evaluates its sensitivity to interest rate risk. Based on commonly used models, the Company projects the impact of interest rate changes, assuming a wide range of factors, including duration and prepayment, on the fair value of assets and liabilities. Fair value is estimated based on the net present value of cash flows or duration estimates. At December 31, 1998, assuming an immediate decrease of 100 basis points in interest rates, the net fair value of the Company's assets and liabilities would decrease by approximately $16 million after tax, 3% of shareholders' equity, and with a 100 basis point increase would decrease fair value of assets and liabilities by $3 million after tax, 1% of shareholders' equity. These changes in interest rates assume a parallel shift in the yield curve. While the Company believes that these assumed market rate changes are reasonably possible, actual results may differ, particularly as a result of any management actions that would be taken to mitigate such hypothetical losses in fair value of shareholders' equity. Based on the F-17 Company's overall exposure to interest rate risk, the Company believes that these changes in interest rates would not materially affect the consolidated near-term financial position, results of operations or cash flows of the Company. Year 2000 At December 31, 1998, all of the Company's mainframe computer systems critical to its business were year 2000 compliant, including the new life processing system which the Company plans to implement during the second quarter of 1999. The Company has sent letters to its vendors inquiring with regard to their year 2000 compliance status and plans and the Company has received responses indicating that most major vendors believe that they are, or will be before the end of 1999, year 2000 compliant. In the remainder of 1999, additional testing of systems, final review of individual personal computer applications and contingency plans will be completed. Because of the extent of systems conversion already completed, the Company believes the worst-case scenario would be limited to a failure to implement the new life processing system (the existing life processing system is not year 2000 compliant) and major vendor conversions that fail to achieve compliance by the end of 1999. The result of this worst-case scenario would be to limit the Company's ability to process business transactions which could have a significant effect on its business, results of operations and financial condition. However, as noted above, the Company expects to complete the implementation of its new life processing system during the second quarter of 1999. In addition, non-system contingency plans will be developed during 1999 for possible lapse in service from utility suppliers and other third party service providers. These contingency plans will include efforts to minimize business interruption through action plans which will encompass back-up processes that utilize alternative suppliers and third party service providers, where appropriate. Costs for this compliance project represent the allocation of existing internal information technology resources to address year 2000 compliance and are not incremental costs to the Company. The total cost of the compliance project is estimated to be $6 million, before tax benefits, and is being funded through operating cash flows. The Company is expensing all costs associated with these system changes and through December 31, 1998 has expensed $5.4 million before tax benefits, including a cost of $2.1 million for the year ended December 31, 1998. Recent Accounting Changes In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is required to be adopted in 2000. This statement does not apply to the Company because it does not have any derivatives or hedges, as defined within the context of SFAS No. 133. F-18 Effects of Inflation and Changes in Interest Rates The Company's operating results are affected significantly in at least three ways by changes in interest rates and inflation. First, inflation directly affects property and casualty claims costs. Second, the investment income earned on the Company's investment portfolio and the market value of the investment portfolio are related to the yields available in the fixed-income markets. An increase in interest rates will decrease the market value of the investment portfolio, but will increase investment income as investments mature and proceeds are reinvested at higher rates. Third, as interest rates increase, competitors will typically increase crediting rates on annuity and interest-sensitive life products, and may lower premium rates on property and casualty lines to reflect the higher yields available in the market. The risk of interest rate fluctuation is managed through asset/liability management techniques, including cash flow analysis. Effects of Recession The Company markets its products primarily to educators and other employees of public schools and their families located throughout the United States. Although this market is affected by school budgetary constraints, as well as general economic downturns that result in decreased purchases of new automobiles and homes and reductions in individual savings, management believes that this market historically has continued to purchase insurance even in periods of recession. Historically, despite changing economic conditions, sales of insurance products to the Company's market have remained stable or increased, suggesting continuation of this historical trend. F-19 REPORT OF MANAGEMENT RESPONSIBILITY FOR FINANCIAL STATEMENTS Horace Mann Educators Corporation The consolidated balance sheets of Horace Mann Educators Corporation and subsidiaries as of December 31, 1998, 1997 and 1996, and the related consolidated statements of operations, cash flows and shareholders' equity for the years ended December 31, 1998, 1997 and 1996 have been prepared by management, which is responsible for their integrity and objectivity. The statements have been prepared in accordance with generally accepted accounting principles and include some amounts that are based upon management's best estimates and judgements. The financial information contained elsewhere in this annual report on Form 10-K is consistent with that contained in the financial statements. Management is responsible for establishing and maintaining a system of internal control designed to provide reasonable assurance as to the integrity and reliability of financial reporting. The concept of reasonable assurance is based on the recognition that there are inherent limitations in all systems of internal control, and that the cost of such systems should not exceed the benefits derived therefrom. A professional staff of internal auditors reviews on an ongoing basis the related internal control system design, the accounting policies and procedures supporting this system and compliance therewith. Management believes this system of internal control effectively meets its objective of reliable financial reporting. In connection with their annual audits, independent certified public accountants perform an examination, in accordance with generally accepted auditing standards, which includes the consideration of the system of internal control to the extent necessary to form an independent opinion on the fairness of presentation of the financial statements prepared by management. The Board of Directors, through its Audit Committee composed solely of directors who are not employees of the Company, is responsible for overseeing the integrity and reliability of the Company's accounting and financial reporting practices and the effectiveness of its system of internal controls. The independent certified public accountants and internal auditors meet regularly with this committee, and have access to this committee with and without management present, to discuss the results of their audit work. F-20 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders Horace Mann Educators Corporation: We have audited the accompanying consolidated balance sheets of Horace Mann Educators Corporation and subsidiaries (the Company) as of December 31, 1998, 1997 and 1996 and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1998. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules, as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Horace Mann Educators Corporation and subsidiaries as of December 31, 1998, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. /s/ KPMG LLP KPMG LLP Chicago, Illinois January 26, 1999 F-21 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED BALANCE SHEETS As of December 31, 1998, 1997 and 1996 (Amounts in thousands, except share data)
1998 1997 1996 -------- -------- -------- ASSETS Investments Fixed maturities, available for sale, at market (amortized cost 1998, $2,552,537; 1997, $2,535,538; 1996, $2,609,077).............................. $2,651,379 $2,638,794 $2,658,512 Short-term and other investments.............................. 102,049 130,252 125,824 Short-term investments, loaned securities collateral.......... 87,392 - - ---------- ---------- ---------- Total investments....................................... 2,840,820 2,769,046 2,784,336 Cash............................................................... 12,044 353 13,704 Accrued investment income and premiums receivable.................. 102,661 103,951 107,682 Value of acquired insurance in force and goodwill.................. 101,055 107,976 118,638 Deferred policy acquisition costs.................................. 101,658 85,883 75,071 Other assets....................................................... 114,503 104,943 76,759 Variable annuity assets............................................ 1,122,739 959,760 684,836 ---------- ---------- ---------- Total assets............................................ $4,395,480 $4,131,912 $3,861,026 ========== ========== ========== LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY Policy liabilities Fixed annuity contract liabilities............................ $1,239,234 $1,245,459 $1,286,110 Interest-sensitive life contract liabilities.................. 402,490 364,205 326,955 Unpaid claims and claim expenses.............................. 307,387 322,335 357,646 Future policy benefits........................................ 179,693 179,562 183,543 Unearned premiums............................................. 179,194 166,996 155,776 ---------- ---------- ---------- Total policy liabilities ............................... 2,307,998 2,278,557 2,310,030 Other policyholder funds........................................... 124,820 122,107 118,549 Other liabilities.................................................. 197,292 126,847 129,075 Short-term debt.................................................... 50,000 42,000 34,000 Long-term debt..................................................... 99,637 99,599 99,564 Variable annuity liabilities....................................... 1,118,890 956,253 684,836 ---------- ---------- ---------- Total liabilities....................................... 3,898,637 3,625,363 3,376,054 ---------- ---------- ---------- Warrants, subject to redemption.................................... 220 577 577 ---------- ---------- ---------- Preferred stock, $0.001 par value, authorized 1,000,000 shares; none issued................................. - - - Common stock, $0.001 par value, authorized 75,000,000 shares; issued, 1998, 59,274,690; 1997, 59,161,008; 1996, 58,426,796 ........................... 59 59 58 Additional paid-in capital......................................... 336,686 340,564 330,234 Retained earnings ................................................. 420,274 349,274 278,669 Accumulated other comprehensive income (net unrealized gains on fixed maturities and equity securities)............................. 57,327 62,167 29,736 Treasury stock, at cost, 1998, 17,183,596 shares; 1997, 14,896,796 shares; 1996, 11,176,196 shares................ (317,723) (246,092) (154,302) ---------- ---------- ---------- Total shareholders' equity.............................. 496,623 505,972 484,395 ---------- ---------- ---------- Total liabilities, redeemable securities and shareholders' equity............................ $4,395,480 $4,131,912 $3,861,026 ========== ========== ==========
See accompanying notes to consolidated financial statements. F-22 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands, except per share data)
Year Ended December 31, --------------------------------------------- 1998 1997 1996 -------- -------- -------- Insurance premiums written and contract deposits................... $ 827,787 $ 771,319 $ 704,832 ============ ============ ============ Revenues Insurance premiums and contract charges earned................ $ 577,812 $ 542,712 $ 502,699 Net investment income......................................... 191,723 198,928 198,607 Realized investment gains..................................... 9,908 5,340 2,451 ------------ ------------ ------------ Total revenues.......................................... 779,443 746,980 703,757 ------------ ------------ ------------ Benefits, losses and expenses Benefits, claims and settlement expenses...................... 396,328 359,441 346,691 Interest credited............................................. 94,776 97,231 95,322 Policy acquisition expenses amortized......................... 45,477 44,198 41,063 Operating expenses............................................ 109,673 106,398 97,021 Amortization of intangible assets............................. 6,921 10,662 11,205 Interest expense.............................................. 9,487 9,412 10,517 Debt retirement costs (See note 4)............................ - - 1,319 ------------ ------------ ------------ Total benefits, losses and expenses..................... 662,662 627,342 603,138 ------------ ------------ ------------ Income from continuing operations before income taxes and discontinued operations............... 116,781 119,638 100,619 Income tax expense................................................. 31,469 32,581 26,817 ------------ ------------ ------------ Income from continuing operations.................................. 85,312 87,057 73,802 Discontinued operations (See note 2): Loss from operations, net of applicable income tax benefits of 1996, $2,764............................... - - (5,280) Loss on discontinuation, representing provision of 1997, $5,355; 1996, $5,974 for operating losses during phase-out period, net of applicable income tax benefits of 1997, $1,874; 1996, $2,091................. - (3,481) (3,883) ------------ ------------ ------------ Net income......................................................... $ 85,312 $ 83,576 $ 64,639 ============ ============= ============ Earnings (loss) per share Basic Income from continuing operations.......................... $ 1.97 $ 1.90 $ 1.57 Discontinued operations: Loss from operations.................................... - - (0.11) Loss on discontinuation................................. - (0.08) (0.08) ------------ ------------ ------------ Net income................................................. $ 1.97 $ 1.82 $ 1.38 ============ ============ ============ Diluted Income from continuing operations.......................... $ 1.95 $ 1.87 $ 1.55 Discontinued operations: Loss from operations.................................... - - (0.11) Loss on discontinuation................................. - (0.07) (0.08) ------------ ------------ ------------ Net income................................................. $ 1.95 $ 1.80 $ 1.36 ============ ============ ============ Weighted average number of shares and equivalent shares Basic................................................... 43,238,656 45,825,410 46,957,842 Diluted................................................. 43,838,434 46,524,532 47,577,788
See accompanying notes to consolidated financial statements. F-23 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Amounts in thousands, except per share data)
Year Ended December 31, --------------------------------------------- 1998 1997 1996 -------- -------- -------- Common stock Beginning balance............................................. $ 59 $ 58 $ 58 Options exercised, 1998, 113,682 shares; 1997, 731,924 shares; 1996, 471,938 shares....................... - 1 - Conversion of Director Stock Plan units, 1997, 2,288 shares......................................... - - - ------------- ------------- ------------- Ending balance................................................ 59 59 58 ------------- ------------- ------------- Additional paid-in capital Beginning balance............................................. 340,564 330,234 323,891 Options exercised and conversion of Director Stock Plan units.................................. 2,200 11,580 6,343 Catastrophe-linked equity put option premium.................. (1,475) (1,250) - Purchase of 13,650 warrants................................... (4,603) - - ------------- ------------- ------------- Ending balance................................................ 336,686 340,564 330,234 ------------- ------------- ------------- Retained earnings Beginning balance............................................. 349,274 278,669 224,366 Net income.................................................... 85,312 83,576 64,639 Cash dividends, 1998, $0.3325 per share; 1997, $0.2825 per share; 1996, $0.22 per share................... (14,312) (12,971) (10,336) ------------- ------------- ------------- Ending balance................................................ 420,274 349,274 278,669 ------------- ------------- ------------- Accumulated other comprehensive income (net unrealized gains (losses) on fixed maturities and equity securities) Beginning balance.......................................... 62,167 29,736 76,151 Increase (decrease) for the period......................... (4,840) 32,431 (46,415) ------------- ------------- ------------- Ending balance............................................. 57,327 62,167 29,736 ------------- ------------- ------------- Treasury stock, at cost Beginning balance, 1998, 14,896,796 shares; 1997 and 1996, 11,176,196 shares........................... (246,092) (154,302) (154,302) Purchase of 2,286,800 shares in 1998 and 3,720,600 shares in 1997 (See note 5)...................... (71,631) (91,790) - ------------- ------------- ------------- Ending balance 1998, 17,183,596 shares; 1997, 14,896,796 shares; 1996, 11,176,196 shares................. (317,723) (246,092) (154,302) ------------- ------------- ------------- Shareholders' equity at end of period.............................. $ 496,623 $ 505,972 $ 484,395 ============= ============= ============= Comprehensive income Net income.................................................... $ 85,312 $ 83,576 $ 64,639 Other comprehensive income (change in net unrealized gains (losses) on fixed maturities and equity securities)..................................... (4,840) 32,431 (46,415) ------------- ------------- ------------- Total................................................... $ 80,472 $ 116,007 $ 18,224 ============= ============= =============
See accompanying notes to consolidated financial statements. F-24 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands)
Year Ended December 31, --------------------------------------------- 1998 1997 1996 -------- -------- -------- Cash flows from operating activities Premiums collected............................................ $ 618,419 $ 608,650 $ 575,601 Policyholder benefits paid.................................... (459,595) (466,150) (453,687) Policy acquisition and other operating expenses paid.............................. (176,054) (173,462) (159,635) Federal income taxes paid..................................... (36,441) (51,889) (10,651) Investment income collected................................... 195,599 199,306 200,201 Interest expense paid......................................... (9,309) (9,276) (8,653) Other......................................................... (3,853) (2,743) (3,962) ---------- ---------- ---------- Net cash provided by operating activities............... 128,766 104,436 139,214 ---------- ---------- ---------- Cash flows from investing activities Fixed maturities Purchases.................................................. (842,375) (1,044,199) (989,009) Sales...................................................... 487,945 874,243 720,175 Maturities................................................. 351,112 241,958 205,380 Net cash received from (used for) short-term and other investments........................... 26,296 (5,882) 30,728 ---------- ---------- ---------- Net cash provided by (used in) investing activities...................... 22,978 66,120 (32,726) ---------- ---------- ---------- Cash flows used in financing activities Purchase of treasury stock.................................... (71,631) (91,790) - Dividends paid to shareholders................................ (14,312) (12,971) (10,336) Principal borrowings (payments) on Bank Credit Facility.................................... 8,000 8,000 (41,000) Repurchase of common stock warrants........................... (4,959) - - Exercise of stock options..................................... 2,200 11,581 6,343 Catastrophe-linked equity put option premium.................. (1,475) (1,250) - Proceeds from issuance of Senior Notes........................ - - 98,530 Retirement of Convertible Notes............................... - - (102,890) Annuity contracts, variable and fixed Deposits................................................... 223,324 199,190 166,871 Maturities and withdrawals................................. (184,800) (176,117) (135,212) Net transfer to variable annuity assets.................... (96,905) (121,782) (86,097) Net increase in interest-sensitive life account balances...................................... 505 1,232 1,489 ---------- ---------- ---------- Net cash used in financing activities................... (140,053) (183,907) (102,302) ---------- ---------- ---------- Net increase (decrease) in cash.................................... 11,691 (13,351) 4,186 Cash at begining of period......................................... 353 13,704 9,518 ---------- ---------- ---------- Cash at end of period.............................................. $ 12,044 $ 353 $ 13,704 ========== ========== ==========
See accompanying notes to consolidated financial statements. F-25 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements are prepared on the basis of generally accepted accounting principles ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The consolidated financial statements include the accounts of Horace Mann Educators Corporation and its wholly-owned subsidiaries ("HMEC"; and together with its subsidiaries, the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. The subsidiaries of HMEC sell and underwrite tax-qualified retirement annuities and private passenger automobile, homeowners, and life insurance products, primarily to educators and other employees of public schools and their families. In 1996, the Company discontinued its group medical business. The Company's principal operating subsidiaries are Horace Mann Life Insurance Company, Horace Mann Insurance Company, Teachers Insurance Company and Allegiance Insurance Company. Investments The Company invests primarily in fixed maturity investments. These securities are classified as available for sale and carried at market value. The net adjustment for unrealized gains and losses on securities available for sale, carried at market, is recorded as a separate component of shareholders' equity, net of applicable deferred tax asset or liability and the related impact on deferred policy acquisition costs associated with interest-sensitive life and annuity contracts. Short-term and other investments are comprised of mortgage loans, carried at unpaid principal less a valuation allowance for estimated uncollectible amounts; policy loans, carried at unpaid principal balances; short-term fixed interest securities, carried at cost which approximates market value; real estate acquired in the settlement of debt, carried at the lower of cost or market; and equity securities, carried at market. Interest income is recognized as earned. Investment income reflects amortization of premiums and accrual of discounts on an effective-yield basis. Realized gains and losses arising from the sale of securities are determined based upon specific identification of securities sold. F-26 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) Deferred Policy Acquisition Costs Deferred policy acquisition costs net of accumulated amortization were $101,658, $85,883 and $75,071 as of December 31, 1998, 1997 and 1996, respectively. Acquisition costs, consisting of commissions, premium taxes and other costs, which vary with and are primarily related to the production of insurance business, are capitalized and amortized as follows. Capitalized acquisition costs for interest-sensitive life contracts are amortized over 20 years in proportion to estimated gross profits. For other individual life contracts, acquisition costs are amortized in proportion to anticipated premiums over the terms of the insurance policies (10 and 15 years). For investment (annuity) contracts, acquisition costs are amortized in proportion to estimated gross profits over 20 years. For property and casualty policies, acquisition costs are amortized over the terms of the insurance policies (six and twelve months). Deferred policy acquisition costs for interest-sensitive life and investment contracts are adjusted for the impact on estimated future gross profits as if net unrealized investment gains and losses had been realized at the balance sheet date. The impact of this adjustment is included in net unrealized gains and losses within shareholders' equity. Deferred acquisition costs are reviewed for recoverability from future income, including investment income, and costs which are deemed unrecoverable are expensed in the period in which the determination is made. No such costs have been deemed unrecoverable during the periods reported. When the Company was acquired in 1989, deferred acquisition costs were reduced to zero in connection with establishing the value of acquired insurance in force in the application of purchase accounting. Property and Equipment Property and equipment are carried at cost less accumulated depreciation and are included in other assets in the consolidated balance sheets. Depreciation and amortization are calculated on the straight-line method based on the estimated useful lives of the assets.
December 31, ------------------------------------------- 1998 1997 1996 -------- -------- -------- Property and equipment..................................... $55,028 $48,548 $44,562 Less: accumulated depreciation............................. 26,541 23,395 20,956 ------- ------- ------- Total................................................... $28,487 $25,153 $23,606 ======= ======= =======
F-27 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) At the beginning of 1998, the Company adopted the accounting treatment required by the American Institute of Certified Public Accountants' Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." Adoption of this statement decreased the Company's 1998 operating expenses by $2,400 before income taxes as costs incurred to develop internal-use software are capitalized and depreciated over their expected useful lives. Value of Acquired Insurance In Force and Goodwill When the Company was acquired in 1989, intangible assets were recorded in the application of purchase accounting to recognize the value of acquired insurance in force and goodwill. In addition, goodwill of $22,003 was recorded in January 1994 related to the purchase of Allegiance Insurance Company. The value of acquired insurance in force by operating segment and goodwill, net of amortization, were as follows:
December 31, --------------------------------------------- 1998 1997 1996 -------- -------- -------- Value of acquired insurance in force Property and casualty................................... $ 719 $ 1,751 $ 2,783 Life.................................................... 16,529 18,804 21,253 Annuity................................................. 31,557 33,553 39,116 -------- -------- -------- Subtotal............................................ 48,805 54,108 63,152 Goodwill................................................... 52,250 53,868 55,486 -------- -------- -------- Total............................................... $101,055 $107,976 $118,638 ======== ======== ========
The value of acquired insurance in force is being amortized over the following periods utilizing the indicated methods for property and casualty, life and annuity, respectively, as follows: 10 years, double declining balance; 20 years, in proportion to coverage provided; 20 years, in proportion to projected future gross profits. Goodwill is amortized over 40 years on a straight-line basis. Significant appreciation and the resultant growth in annuity assets and the retention of the Company's annuity business in recent years have favorably impacted projected future gross profits for the business. Therefore, previously scheduled annual amortization of the December 31, 1998 balance was revised as reflected in the table below. Such amounts are evaluated annually and amortization schedules updated as indicated. F-28 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) Scheduled amortization of the December 31, 1998 balances of value of acquired insurance in force by segment and goodwill over the next five years is as follows:
Year Ended December 31, ------------------------------------------------ 1999 2000 2001 2002 2003 ---- ---- ---- ---- ---- Scheduled amortization of: Value of acquired insurance in force Property and casualty............................... $ 719 $ - $ - $ - $ - Life................................................ 2,120 1,975 1,839 1,726 1,625 Annuity............................................. 2,500 3,363 3,857 3,539 3,306 ------ ------ ------ ------ ------ Subtotal......................................... 5,339 5,338 5,696 5,265 4,931 Goodwill................................................ 1,618 1,618 1,618 1,618 1,618 ------ ------ ------ ------ ------ Total............................................ $6,957 $6,956 $7,314 $6,883 $6,549 ====== ====== ====== ====== ======
The accumulated amortization of intangibles as of December 31, 1998, 1997 and 1996 was $131,617, $124,696 and $114,034, respectively. Variable Annuity Assets and Liabilities Variable annuity assets, carried at market value, and liabilities represent tax-qualified variable annuity funds invested in the Horace Mann mutual funds. Variable annuity assets were invested in the Horace Mann mutual funds as follows:
December 31, -------------------------------------------- 1998 1997 1996 -------- -------- -------- Horace Mann Growth Fund.................................... $ 605,803 $532,086 $372,824 Horace Mann Balanced Fund.................................. 427,368 386,247 299,977 Horace Mann Socially Responsible Fund...................... 35,368 9,117 - Horace Mann Small Cap Growth Fund.......................... 28,629 16,321 - Horace Mann Income Fund.................................... 13,952 9,651 10,857 Horace Mann International Equity Fund...................... 10,290 5,137 - Horace Mann Short-Term Fund................................ 1,329 1,201 1,178 ---------- -------- -------- Total variable annuity assets........................... $1,122,739 $959,760 $684,836 ========== ======== ========
The investment income, gains and losses of these accounts accrue directly to the policyholders and are not included in the operations of the Company. Future Policy Benefits, Interest-sensitive Life Contract Liabilities and Annuity Contract Liabilities 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 upon assumptions as to future investment yield, mortality and withdrawals. As a result of the application of purchase accounting, future policy benefits for direct individual life insurance F-29 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) policies issued through August 29, 1989 were revalued using interest rates of 9% graded to 8% over 10 years. For policies issued from August 30, 1989 through December 31, 1992, future policy benefits are computed using an interest rate of 6.5%. An interest rate of 5.5% is used to compute future policy benefits for policies issued after December 31, 1992. Mortality and withdrawal assumptions for all policies have been based on various actuarial tables which are consistent with the Company's own experience. Liabilities for future benefits on annuity contracts and certain long-duration life insurance contracts are carried at accumulated policyholder values without reduction for potential surrender or withdrawal charges. The liability also includes provisions for the unearned portion of certain policy charges. Unpaid Claims and Claim Expenses Liabilities for property and casualty unpaid claims and claim expenses include provisions for payments to be made on reported claims, claims incurred but not reported and associated settlement expenses; are carried at the full value of estimated liabilities; and are not discounted for interest expected to be earned on reserves. Estimated amounts of salvage and subrogation on unpaid property and casualty claims are deducted from the liability for unpaid claims. The process by which liabilities are established for insured events requires reliance upon estimates based on experience and available data. As information develops which varies from experience, provides additional data or, in some cases, augments data which previously were not considered sufficient for use in determining liabilities, adjustments may be required. The effects of these adjustments are charged or credited to income for the period in which the adjustments are made. No unusual adjustments were made in the determination of the liabilities during the periods covered by these financial statements. The Company has no exposure to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses. Management believes that, based on data currently available, it has reasonably estimated the Company's ultimate losses. F-30 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) The following table sets forth an analysis of property and casualty unpaid claims and claim expenses and provides a reconciliation of beginning and ending reserves for the periods indicated.
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- Gross reserves, beginning of year.......................... $310,632 $340,411 $369,653 Less reinsurance recoverables........................... 41,324 34,062 23,764 -------- -------- -------- Net reserves, beginning of year............................ 269,308 306,349 345,889 -------- -------- -------- Incurred claims and claims expense : Claims occurring in the current year.................... 379,603 365,986 368,648 Decrease in estimated reserves for claims occurring in prior years(1): Policies written by the Company.................. (23,917) (40,252) (56,446) Business assumed from state reinsurance facilities........................ (1,000) (4,900) (6,100) -------- -------- -------- Total decrease............................ (24,917) (45,152) (62,546) -------- -------- -------- Total claims and claims expense incurred......... 354,686 320,834 306,102 -------- -------- -------- Claims and claim expense payments for claims occurring during: Current year........................................ 238,986 209,294 206,370 Prior years......................................... 141,969 148,581 139,272 -------- -------- -------- Claims and claim expense payments................ 380,955 357,875 345,642 -------- -------- -------- Net reserves, end of period................................ 243,039 269,308 306,349 Plus reinsurance recoverables........................... 55,890 41,324 34,062 -------- -------- -------- Gross reserves, end of period(2)........................... $298,929 $310,632 $340,411 ======== ======== ========
- ------------ (1) Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims and changes in their projected final settlement costs. Favorable reserve development generally occurs as a result of subsequent adjustment of reserves to reflect additional information. (2) Unpaid claims and claims expenses as reported in the consolidated balance sheets also include life, annuity, and group accident and health reserves of $8,458, $11,703 and $17,235 at December 31, 1998, 1997 and 1996, respectively, in addition to property and casualty reserves. Fluctuations from year to year in the level of catastrophe claims impact a property and casualty insurance company's claims and claims adjustment expenses incurred and paid. For comparison purposes, the following table provides amounts for the Company excluding catastrophe losses.
Year Ended December 31, ------------------------------------------- 1998 1997 1996 -------- -------- -------- Claims and claim expense incurred.......................... $354,686 $320,834 $306,102 Amount attributable to catastrophes........................ 28,019 6,164 20,410 -------- -------- -------- Excluding catastrophes.................................. $326,667 $314,670 $285,692 ======== ======== ======== Claims and claim expense payments.......................... $380,955 $357,875 $345,642 Amount attributable to catastrophes........................ 25,200 5,700 21,000 -------- -------- -------- Excluding catastrophes.................................. $355,755 $352,175 $324,642 ======== ======== ========
F-31 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) Insurance Premiums and Contract Charges Earned Property and casualty insurance premiums are recognized as revenue ratably over the related contract periods in proportion to the risks insured. The unexpired portions of these property and casualty premiums are recorded as unearned premiums, using the monthly pro rata method. Premiums and contract charges for interest-sensitive life and annuity contracts consist of charges for the cost of insurance, policy administration and withdrawals. Premiums for long-term traditional life policies are recognized as revenues when due over the premium-paying period. Annuity and interest-sensitive life contract deposits represent funds deposited by policyholders and are not included in the Company's premiums or contract charges. Stock Based Compensation The Company grants stock options to employees. The exercise price of the option is equal to the fair market value of the Company's common stock on the date of grant. The Company accounts for stock option grants in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and accordingly, recognizes no compensation expense for the stock option grants. Alternatively, Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," allows companies to recognize compensation cost for stock-based compensation plans, determined based on the fair value at the grant dates. If the Company had applied this alternative accounting method, net income and net income per share would have been reduced to the pro forma amounts indicated below:
Year Ended December 31, ----------------------------------------- 1998 1997 1996(1) ------- ------- ------- Net income As reported................ $85,312 $83,576 $64,639 Pro forma(2)............... $83,175 $82,406 $64,639 Basic net income per share As reported................ $ 1.97 $ 1.82 $ 1.38 Pro forma.................. $ 1.92 $ 1.80 $ 1.38 Diluted net income per share As reported................ $ 1.95 $ 1.80 $ 1.36 Pro forma.................. $ 1.90 $ 1.77 $ 1.36
- ------------ (1) No stock options were granted in 1996 (see also Note 5). (2) The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions for 1998 and 1997, respectively: risk-free interest rates of 5.6% and 5.5%; dividend yield of 1.3% and 1.0%; expected lives of 10 years; and volatility of 26.2% and 15.8%. F-32 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) Income Taxes The Company uses the liability method for calculating deferred federal income taxes. Income tax provisions are generally based on income reported for financial statement purposes. The provisions for federal income taxes for the years ended December 31, 1998, 1997 and 1996 include amounts currently payable and deferred income taxes resulting from the cumulative differences in the Company's assets and liabilities, determined on a tax return and financial statement basis. Deferred tax assets and liabilities include provisions for unrealized investment gains and losses with the change for each period included in net unrealized gains and losses in shareholders' equity. Earnings Per Share Basic earnings per share is computed based on the weighted average number of shares outstanding. Diluted earnings per share is based on the weighted average number of shares and common stock equivalents outstanding. The common stock equivalents relate to outstanding warrants, common stock options, Director Stock Plan units and Employee Stock Plan units. F-33 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) The computations of income from continuing operations on both basic and diluted bases, including reconciliations of the numerators and denominators, were as follows:
Year Ended December 31, ----------------------------------------- 1998 1997 1996 ------ ------ ------- Basic - assumes no dilution: Income from continuing operations for the period........... $85,312 $87,057 $73,802 ------- ------- ------- Weighted average number of common shares outstanding during the period.................... 43,239 45,825 46,958 ------- ------- ------- Income from continuing operations per share - basic........ $ 1.97 $ 1.90 $ 1.57 ======= ======= ======= Diluted - assumes full dilution: Income from continuing operations for the period........... $85,312 $87,057 $73,802 ------- ------- ------- Weighted average number of common shares outstanding during the period........................... 43,239 45,825 46,958 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: Warrants............................................ 98 251 236 Stock options....................................... 451 416 378 Common stock units related to Deferred Equity Compensation Plan for Directors........... 49 33 6 Common stock units related to Deferred Compensation Plan for Employees.................. 1 - - ------- ------- ------- Total common and common equivalent shares adjusted to calculate diluted earnings per share................. 43,838 46,525 47,578 ------- ------- ------- Income from continuing operations per share - diluted...... $ 1.95 $ 1.87 $ 1.55 ======= ======= =======
Options to purchase 224,400 shares of common stock at $32.69 to $34.53 per share were granted during 1998 but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares. The options, which expire in 2008, were still outstanding at December 31, 1998. Comprehensive Income Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and display of comprehensive income. Comprehensive income represents the change in shareholders' equity during a reporting period from transactions and other events and circumstances from non-shareholder sources. For the Company, comprehensive income is equal to net income plus the change in net unrealized gains and losses on fixed maturities and equity securities for the period as shown in the Statement of Changes in Shareholders' Equity. The adoption of SFAS No. 130 resulted in revised and additional disclosures but had no effect on the financial position, results of operations, or liquidity of the Company. F-34 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) The components of comprehensive income were as follows:
Year Ended December 31, ------------------------------------------ 1998 1997 1996 ------- -------- -------- Net income................................................. $85,312 $ 83,576 $ 64,639 ------- -------- -------- Other comprehensive income: Unrealized holding gains (losses) on fixed maturities and equity securities arising during period......... 3,855 55,299 (69,364) Less: reclassification adjustment for gains (losses) included in net income.............................. 11,301 5,405 2,044 ------- -------- -------- Other comprehensive income, before tax.................. (7,446) 49,894 (71,408) Income tax expense (benefit)............................ (2,606) 17,463 (24,993) ------- -------- -------- Total............................................... (4,840) 32,431 (46,415) ------- -------- -------- Total comprehensive income....................... $80,472 $116,007 $ 18,224 ======= ======== ========
Statements of Cash Flows For purposes of the statements of cash flows, cash constitutes cash on deposit at banks. Reclassification The Company has reclassified the presentation of certain prior period information to conform with the 1998 presentation. NOTE 2 - Discontinued Operations In December 1996, the Company announced its strategic decision to withdraw from the group medical insurance business over the following two years. During the third quarter of 1997, the Company accelerated the timetable for its withdrawal from the group medical insurance business and had terminated 95% of that business by December 31, 1997. The remaining business was terminated as of August 31, 1998. As a result of the acceleration and higher-than-expected claims, net income for the year ended December 31, 1997 included a charge of $3,481 for anticipated additional losses during the remainder of the phase-out period, net of related income tax benefits of $1,874. The Company's results of operations for the year ended December 31, 1996 included an accrual of $3,883 for anticipated losses during the phase-out period net of related income tax recoverable of $2,091. At December 31, 1998, the following were attributable to the discontinued operations: $506 of investments, $470 of other assets, principally reinsurance recoverables, $823 of policy liabilities and $153 of other liabilities, including the provision for operating losses during the phase-out period. F-35 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 3 - Investments Net Investment Income The components of net investment income for the following periods were:
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- Fixed maturities........................................... $185,271 $191,777 $190,836 Short-term and other investments........................... 10,700 10,967 11,931 ---------- ---------- ---------- Total investment income................................. 195,971 202,744 202,767 Less investment expenses................................... 4,248 3,816 4,160 ---------- ---------- ---------- Net investment income................................... $191,723 $198,928 $198,607 ========== ========== ==========
Realized Investment Gains (Losses) Realized investment gains (losses) for the following periods were:
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- Fixed maturities........................................... $ 10,537 $5,411 $1,052 Short-term and other investments........................... (629) (71) 1,399 -------- ------ ------ Realized investment gains (losses)...................... $ 9,908 $5,340 $2,451 ======== ====== ======
F-36 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 3 - Investments-(Continued) Fixed Maturity Securities The amortized cost, unrealized investment gains and losses, and market values of investments in debt securities as of December 31, 1998, 1997 and 1996 were as follows:
Amortized Unrealized Unrealized Market Cost Gains Losses Value --------- ---------- ---------- ------ As of December 31, 1998 U.S. government and agency obligations Mortgage-backed securities................. $ 489,752 $ 17,741 $ 24 $ 507,469 Other...................................... 192,166 7,106 248 199,024 Municipal bonds................................ 301,751 17,430 40 319,141 Foreign government bonds....................... 21,829 2,827 706 23,950 Corporate bonds................................ 1,180,452 59,118 12,047 1,227,523 Other mortgage-backed securities............... 366,587 9,042 1,357 374,272 ---------- -------- -------- ---------- Totals.................................. $2,552,537 $113,264 $ 14,422 $2,651,379 ========== ======== ======== ========== As of December 31, 1997 U.S. government and agency obligations Mortgage-backed securities................. $ 521,485 $ 18,061 $ 343 $ 539,203 Other...................................... 222,797 5,249 44 228,002 Municipal bonds................................ 228,094 13,777 106 241,765 Foreign government bonds....................... 26,397 1,714 442 27,669 Corporate bonds................................ 1,243,948 62,333 3,376 1,302,905 Other mortgage-backed securities............... 292,817 6,624 191 299,250 ---------- -------- -------- ---------- Totals.................................. $2,535,538 $107,758 $ 4,502 $2,638,794 ========== ======== ======== ========== As of December 31, 1996 U.S. government and agency obligations Mortgage-backed securities................. $ 644,197 $ 13,008 $ 3,217 $ 653,988 Other...................................... 257,498 2,436 431 259,503 Municipal bonds................................ 221,851 8,660 378 230,133 Foreign government bonds....................... 34,684 1,340 1 36,023 Corporate bonds................................ 1,163,631 37,510 12,221 1,188,920 Other mortgage-backed securities............... 287,216 4,600 1,871 289,945 ---------- -------- -------- ---------- Totals.................................. $2,609,077 $ 67,554 $ 18,119 $2,658,512 ========== ======== ======== ==========
The Company's investment portfolio includes no derivative financial instruments (futures, forwards, swaps, option contracts or other financial instruments with similar characteristics). F-37 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 3 - Investments-(Continued) Maturity/Sales Of Investments The market value and amortized cost of fixed maturity securities at December 31, 1998, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Percent of Total Market Market Amortized Value Value Cost ------------ ------ --------- Due in 1 year or less...................................... 7.0% $ 186,892 $ 185,819 Due after 1 year through 5 years........................... 25.8 683,127 667,096 Due after 5 years through 10 years......................... 31.8 842,744 813,405 Due after 10 years through 20 years........................ 17.3 459,594 437,439 Due after 20 years......................................... 18.1 479,022 448,778 ----- ---------- ---------- Total................................................... 100.0% $2,651,379 $2,552,537 ===== ========== ==========
Proceeds from sales/maturities of fixed maturities and gross gains and gross losses realized for each year were:
Year Ended December 31, --------------------------------------------- 1998 1997 1996 -------- -------- -------- Proceeds................................................... $839,057 $1,116,201 $925,555 Gross gains realized....................................... 18,081 13,444 11,378 Gross losses realized...................................... (7,544) (8,033) (10,326)
Unrealized Gains (Losses) on Fixed Maturities Net unrealized gains (losses) are computed as the difference between market and amortized cost for fixed maturities. A summary of the net increase (decrease) in unrealized investment gains (losses) on fixed maturities, less applicable income taxes, is as follows:
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- Unrealized gains (losses) on fixed maturities Beginning of period..................................... $103,256 $ 49,435 $116,028 End of period........................................... 98,842 103,256 49,435 -------- -------- -------- Increase (decrease) for the period.................. (4,414) 53,821 (66,593) Income taxes (benefit)..................................... (1,545) 18,837 (23,308) -------- -------- -------- Increase (decrease) in net unrealized gains (losses) on fixed maturities before the valuation impact on deferred policy acquisition costs.................... $ (2,869) $ 34,984 $(43,285) ======== ======== ========
F-38 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 3 - Investments-(Continued) Securities Lending The Company loans fixed income securities to third parties, primarily major brokerage firms. As of December 31, 1998 and 1997, fixed maturities with a fair value of $87,392 and $60,388, respectively, were loaned. The Company separately maintains a minimum of 100% of the value of the loaned securities as collateral for each loan. Effective beginning in 1998, SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," required the securities lending collateral to be classified as investments with a corresponding liability included in Other Liabilities in the Company's consolidated balance sheet. Restatement of prior period financial statements to show consistent presentation in earlier years was not permitted. Investment in Entities Exceeding 10% of Shareholders' Equity At December 31, 1998 and 1997, there were no investments which exceeded 10% of total shareholders' equity in entities other than obligations of the United States Government and government agencies and authorities. At December 31, 1996, the Company's investment portfolio included $51,972 of fixed maturity securities issued by Ford Motor Company and its affiliates representing 10.7% of shareholders' equity at that date. Deposits At December 31, 1998, securities with a carrying value of $13,178 were on deposit with governmental agencies as required by law in various states in which the insurance subsidiaries of HMEC conduct business. NOTE 4 - Debt and Warrants Indebtedness and scheduled maturities at December 31, 1998, 1997 and 1996 consisted of the following:
Effective December 31, Interest Final ------------------------------ Rates Maturity 1998 1997 1996 --------- -------- ---- ---- ---- Short-term debt: Bank Credit Facility........................... Variable 2001 $ 50,000 $ 42,000 $ 34,000 Long-term debt: 6 5/8% Senior Notes, Face amount less unaccrued discount of $363, $401 and $436, respectively..................... 6.7% 2006 99,637 99,599 99,564 4%/6 1/2% Convertible Notes, redeemed February 1996..................... 5.7% 1999 - - - -------- -------- -------- Total................................... $149,637 $141,599 $133,564 ======== ======== ========
F-39 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 4 - Debt and Warrants-(Continued) Issuance of 6 5/8% Senior Notes ("Senior Notes") and Redemption of Convertible Notes On January 17, 1996, the Company issued $100,000 face amount of Senior Notes at an effective yield of 6.7%, which will mature on January 15, 2006. The net proceeds from the sale of the Senior Notes were used to finance the redemption of the Convertible Notes. Interest on the Senior Notes is payable semi-annually at a rate of 6 5/8%. The Senior Notes are redeemable in whole or in part, at any time, at the Company's option, at a redemption price equal to the greater of (i) 100% of their principal amount and (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted, on a semi-annual basis, at the Treasury yield (as defined in the indenture) plus 15 basis points, together with accrued interest to the date of redemption. Bank Credit Facility The Bank Credit Facility provides for unsecured borrowings of up to $65,000. Interest accrues at varying spreads relative to corporate or eurodollar base rates and is payable monthly or quarterly depending on the applicable base rate (Interbank Offering Rate plus 0.325% at December 31, 1998). The unused portion of the Bank Credit Facility is subject to a variable commitment fee which was 0.125% on an annual basis at December 31, 1998. The commitment for the Bank Credit Facility terminates on December 31, 2001. The Company's obligations under the Bank Credit Facility are unsecured. 4%/6 1/2% Convertible Notes ("Convertible Notes") All of the outstanding Convertible Notes were redeemed on February 6, 1996 at an aggregate cost of $102,890. The early redemption of the Convertible Notes resulted in a charge to 1996 income of $1,319 ($857 net of tax benefits). Warrants During 1998, the Company repurchased 61.8% of its then outstanding warrants, representing 173,713 shares of the Company's common stock, for $4,959. At December 31, 1998, warrants to purchase 107,537 shares of the Company's common stock at $2.70 per share were outstanding. Warrants to purchase 281,250 shares of the Company's common stock at $2.70 per share were outstanding at December 31, 1997 and 1996. Covenants The Company is in compliance with all of the covenants contained in the Senior Notes indenture and the Bank Credit Facility Agreement. F-40 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 5 - Shareholders' Equity and Stock Options Share Repurchase Program During 1998, the Company repurchased 2,286,800 shares, 5% of the Company's outstanding shares on December 31, 1997, at an aggregate cost of $71,631 under its stock repurchase program. Of the amount purchased, $8,210 completed the $100 million share repurchase authorization announced in February 1997. The remainder were acquired under an additional $100 million share repurchase authorization announced in January 1998. Since early 1997, 6,007,400 shares, or 13% of the shares outstanding on December 31, 1996, have been repurchased at an aggregate cost of $163,421, equal to an average cost of $27.20 per share. Shares of common stock may be purchased from time to time through open market and private purchases, as available. The repurchase of shares was financed through use of cash and, if needed, the Bank Credit Facility. Authorization of Preferred Stock In 1996, the shareholders of HMEC approved authorization of 1,000,000 shares of $0.001 par value preferred stock. The Board of Directors is authorized to (i) direct the issuance of the preferred stock in one or more series, (ii) fix the dividend rate, conversion or exchange rights, redemption price and liquidation preference, of any series of the preferred stock, (iii) fix the number of shares for any series and (iv) increase or decrease the number of shares of any series. No shares of preferred stock were outstanding at December 31, 1998, 1997 and 1996. Beginning in 1997, the Company's catastrophe reinsurance program is augmented by a $100,000 equity put that provides an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event losses from catastrophes, individually or in the aggregate during a calendar year, exceed the catastrophe reinsurance program coverage limit. Before tax benefits, the equity put provides a source of capital for up to $154 million of catastrophe losses above the reinsurance coverage limit. Fees related to this equity put option were charged directly to additional paid-in capital. In connection with the equity put described in the preceding paragraph, the Board of Directors has designated a series of preferred stock to be available for use in the put. The Series so designated is Series A Cumulative Convertible Preferred Stock (the "Series A Stock") and 100,000 shares have been assigned to this series. None are currently issued or outstanding. The Series A Stock is dividend paying, at a floating rate which varies with movements in the London Interbank Offered Rate and with changes in the risk rating of the Series A Stock as determined by Standard & Poor's Corporation. The Series A Stock does not require any sinking fund or similar mechanism regarding payment of such dividends. Beginning on the fourth anniversary of the issuance of Series A Stock, the holders thereof have the right to demand conversion of the Series A Stock into common stock of the Company at a conversion rate based on then prevailing F-41 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 5 - Shareholders' Equity and Stock Options-(Continued) market prices for the common stock; however, upon receipt of a conversion demand, the Company has the right to redeem the Series A Stock prior to such conversion. The Series A Stock has liquidation rights which place the Series A Stock ahead of the common stock in priority. The Series A Stock has no voting rights other than the requirement that the Series A Stock approve any changes in the Series A Stock, the creation of any other class of stock on a par with or superior to the Series A Stock and certain extraordinary transactions such as certain mergers involving the Company. Director Stock Plan In 1996, the shareholders of HMEC approved the Deferred Equity Compensation Plan ("Director Stock Plan") for directors of the Company and reserved 600,000 shares for issuance pursuant to the Director Stock Plan. Shares of the Company's common stock issued under the Director Stock Plan may be either authorized and unissued shares or shares that have been reacquired by the Company. As of December 31, 1998, 1997 and 1996, 48,689 units, 32,685 units and 18,393 units, respectively, were outstanding under this plan representing an equal number of common shares to be issued in the future. Employee Stock Plan In 1997, the Board of Directors of HMEC approved the Deferred Compensation Plan for Employees ("Employee Stock Plan"). Shares of the Company's common stock issued under the Employee Stock Plan may be either authorized and unissued shares or shares that have been reacquired by the Company. As of December 31, 1998, 2,489 units were outstanding under this plan representing an equal number of common shares to be issued in the future, and no units were outstanding as of December 31, 1997. Stock Options In 1991, the shareholders approved the 1991 Stock Incentive Plan (the "1991 Plan") and reserved 4 million shares of common stock for issuance under the 1991 Plan. Under the 1991 Plan, options to purchase shares of HMEC common stock may be granted to executive officers, other employees and certain directors. The options are exercisable in installments beginning in the first year from the date of grant and expiring 10 years from the date of grant. F-42 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 5 - Shareholders' Equity and Stock Options-(Continued) Changes in outstanding options and shares available for grant were as follows:
Options Weighted Average Range of --------------------------------------------- Option Price Option Prices Vested and Available per Share per Share Outstanding Exercisable for Grant ---------------- ------------- ----------- ----------- --------- At December 31, 1995............ $11.24 $ 9.00-$15.15 2,278,044 2,041,794 1,658,000 --------- --------- --------- Vested....................... $ 11.12-$15.15 - 211,250 - Exercised.................... $11.04 $ 9.00-$15.15 (471,938) (471,938) - --------- --------- --------- At December 31, 1996............ $11.29 $ 9.00-$15.15 1,806,106 1,781,106 1,658,000 --------- --------- --------- Granted...................... $22.87 $ 22.42-$27.46 224,400 56,100 (224,400) Vested....................... $ 11.12-$12.03 - 15,000 - Exercised.................... $12.28 $ 9.00-$22.42 (731,924) (731,924) - --------- --------- --------- At December 31, 1997............ $12.73 $ 9.00-$27.46 1,298,582 1,120,282 1,433,600 --------- --------- --------- Granted...................... $33.70 $ 29.21-$34.53 233,950 65,462 (233,950) Vested....................... $ 11.12-$27.46 - 65,350 - Exercised.................... $12.79 $ 9.00-$33.87 (113,682) (113,682) - Canceled..................... $15.15 $15.15 (30,000) (30,000) 30,000 --------- --------- --------- At December 31, 1998............ $16.21 $ 9.00-$34.53 1,388,850 1,107,412 1,229,650 ========= ========= =========
As of December 31, 1998, the weighted average life of vested and exercisable options was 4.0 years and the weighted average price of such options was $12.84 per option. The weighted average prices of vested and exercisable options as of December 31, 1997 and 1996 were $11.05 and $11.29, respectively. NOTE 6 - Income Taxes The federal income tax liabilities and recoverables included in other liabilities and other assets, respectively, in the consolidated balance sheets as of December 31, 1998, 1997 and 1996 were as follows:
December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- Current liability (asset).................................. $ (2,971) $(7,615) $27,995 Deferred liability......................................... 21,549 35,530 7,193
F-43 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 6 - Income Taxes-(Continued) Deferred tax assets and liabilities are recognized for all future tax consequences attributable to "temporary differences" between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The "temporary differences" that give rise to the deferred tax balances at December 31, 1998, 1997 and 1996 were as follows:
December 31, --------------------------------------------- 1998 1997 1996 -------- -------- ------- Deferred tax assets Discounting of unpaid claims and claims expense tax reserves......................... $ 8,277 $ 3,087 $ 8,066 Life insurance future policy benefit reserve revaluation 21,346 19,282 22,436 Unearned premium reserve reduction...................... 12,037 11,248 10,528 Postretirement benefits other than pension.............. 9,102 8,406 8,003 Other, net.............................................. 3,181 600 - ------- ------- ------- Total gross deferred tax assets.................. 53,943 42,623 49,033 ------- ------- ------- Deferred tax liabilities Unrealized gains on securities.......................... 30,867 33,473 16,010 Amortization of intangible assets....................... 18,197 19,831 20,074 Deferred policy acquisition costs....................... 26,428 24,849 19,982 Other, net.............................................. - - 160 ------- ------- ------- Total gross deferred tax liabilities............. 75,492 78,153 56,226 ------- ------- ------- Net deferred tax liability.................... $21,549 $35,530 $ 7,193 ======= ======= =======
Based on the Company's historical earnings, future expectations of adjusted taxable income, as well as reversing gross deferred tax liabilities, the Company believes it is more likely than not that gross deferred tax assets will be fully realized and that a valuation allowance with respect to the realization of the total gross deferred tax assets is not necessary. The components of federal income tax expense (benefit) were as follows:
Year Ended December 31, --------------------------------------------- 1998 1997 1996 -------- ------- ------- Current.................................................... $ 42,844 $21,707 $27,502 Deferred................................................... (11,375) 10,874 (685) -------- ------- ------- Total tax expense before discontinued operations........ $ 31,469 $32,581 $26,817 ======== ======= =======
Income tax expense for the following periods differed from the expected tax computed by applying the federal corporate tax rate of 35% to income before income taxes as follows:
Year Ended December 31, -------------------------------------------- 1998 1997 1996 ------- ------- ------- Expected federal tax on income from continuing operations.............................. $40,874 $41,873 $35,217 Add (deduct) tax effects of: Tax-exempt interest..................................... (3,706) (3,310) (3,322) Goodwill................................................ 566 566 566 Acquisition related benefits and other, net............. (6,265) (6,548) (5,644) ------- ------- ------- Income tax expense provided on income from continuing operations.............................. $31,469 $32,581 $26,817 ======= ======= =======
F-44 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 6 - Income Taxes-(Continued) The Internal Revenue Service (the "IRS") regularly audits the Company's federal income tax returns and is currently conducting an audit of the Company's 1994 and 1995 tax returns. As a result of this audit, certain tax benefits which the Company has realized in the past will not be available to the Company after 1998. In addition, in the course of the current audit, the IRS is taking the position thus far that it is not bound by certain documented understandings contained in the Revenue Agent's Reports (the "RARs") pertaining to the audits of the Company's 1989 through 1993 tax returns. The Company is vigorously contesting the IRS' position and believes the IRS should honor the understandings documented in the RARs. The Company's tax advisors, KPMG LLP, concur with the Company's interpretation of the RARs. The outcome of this matter is uncertain. Therefore, the Company has not accrued a liability in the financial statements with regard to this matter. The maximum amount of additional taxes, with respect to the 1994 through 1998 tax years, if any, that might be due as a result of the resolution of this matter would be less than 5% of the Company's shareholders' equity as of December 31, 1998. Such additional taxes, if any, would increase the Company's income tax expense and effective corporate tax rate only in the year of payment of such taxes. NOTE 7 - Fair Value of Financial Instruments Generally accepted accounting principles require that the Company disclose estimated fair values for certain financial instruments. Fair values of the Company's insurance contracts other than annuity contracts are not required to be disclosed. However, the fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk through the matching of investment maturities with amounts due under insurance contracts. The following methods and assumptions were used to estimate the fair value of financial instruments. Investments - For fixed maturities and short-term and other investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities, adjusted for differences between the quoted securities and the securities being valued. The fair value of mortgage loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and the same remaining maturities. The fair value of policy loans is based on estimates using discounted cash flow analysis and current interest rates being offered for new loans. The carrying value of real estate is an estimate of fair value based on discounted cash flows from operations. F-45 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 7 - Fair Value of Financial Instruments-(Continued) Annuity Contract Liabilities and Policyholder Account Balances on Interest-sensitive Life Contracts - The fair values of annuity contract liabilities and policyholder account balances on interest-sensitive life contracts are equal to the discounted estimated future cash flows (using the Company's current interest rates earned on its investments) including an adjustment for risk that the timing or amount of cash flows will vary from management's estimate. Other Policyholder Funds - Other policyholder funds are supplementary contract reserves and dividend accumulations which represent deposits that do not have defined maturities. The carrying value of these funds is used as a reasonable estimate of fair value. Long-term Debt - The fair value of long-term debt is estimated based on quoted market prices of publicly traded issues. The carrying amounts and fair values of financial instruments at December 31, 1998, 1997 and 1996 consisted of the following:
December 31, -------------------------------------------------------------------- 1998 1997 1996 ------------------- ------------------- -------------------- Carrying Fair Carrying Fair Carrying Fair Amount Value Amount Value Amount Value -------- ----- -------- ----- -------- ----- Financial Assets Investments Fixed maturities.................. $2,651,379 $2,651,379 $2,638,794 $2,638,794 $2,658,512 $2,658,512 Short-term and other investments.. 102,049 105,859 130,252 133,844 125,824 128,921 Short-term investments, loaned securities collateral... 87,392 87,392 - - - - ---------- ---------- ---------- ---------- ---------- ---------- Total investments........... 2,840,820 2,844,630 2,769,046 2,772,638 2,784,336 2,787,433 Cash.................................. 12,044 12,044 353 353 13,704 13,704 Financial Liabilities Policyholder account balances on interest-sensitive life contracts. 91,719 89,576 91,322 84,034 89,987 83,712 Annuity contract liabilities.......... 1,239,234 1,142,859 1,245,459 1,112,479 1,286,110 1,136,494 Other policyholder funds.............. 124,820 124,820 122,107 122,107 118,549 118,549 Short-term debt....................... 50,000 50,000 42,000 42,000 34,000 34,000 Long-term debt........................ 99,637 101,525 99,599 99,580 99,564 96,500
Fair value estimates shown above are dependent upon subjective assumptions and involve significant uncertainties resulting in variability in estimates with changes in assumptions. Fair value assumptions are based upon subjective estimates of market conditions and perceived risks of financial instruments at a certain point in time. The disclosed fair values do not reflect any premium or discount that could result from offering for sale at one time an entire holding of a particular financial instrument. In addition, potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected in amounts disclosed. F-46 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 8 - Statutory Surplus and Subsidiary Dividend Restrictions The insurance departments of various states in which the insurance subsidiaries of HMEC are domiciled recognize as net income and surplus those amounts determined in conformity with statutory accounting practices prescribed or permitted by the insurance departments, which differ in certain respects from generally accepted accounting principles. Reconciliations of statutory capital and surplus and net income, as determined using statutory accounting practices, to the amounts included in the accompanying financial statements are as follows:
December 31, --------------------------------------------- 1998 1997 1996 -------- -------- -------- Statutory capital and surplus of insurance subsidiaries.... $ 363,130 $ 355,357 $ 377,337 Increase (decrease) due to: Deferred policy acquisition costs....................... 101,658 85,883 75,071 Difference in policyholder reserves..................... (2,498) 334 (4,054) Goodwill................................................ 52,250 53,868 55,486 Value of acquired insurance in force.................... 48,805 54,108 63,152 Liability for postretirement benefits, other than pensions (25,702) (24,574) (22,877) Investment market value adjustments on fixed maturities..................... 98,842 103,256 49,435 Difference in investment reserves....................... 33,733 27,994 36,967 Federal income tax liability............................ (15,611) (24,839) (3,599) Liability for discontinued operations, net of tax benefits - (2,031) (3,883) Non-admitted assets and other, net...................... 2,466 3,301 4,070 Shareholders' equity of parent company and non-insurance subsidiaries.......................... (10,813) 14,914 (9,146) Parent company short-term and long-term debt............ (149,637) (141,599) (133,564) --------- --------- --------- Shareholders' equity as reported herein............. $ 496,623 $ 505,972 $ 484,395 ========= ========= =========
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- Statutory net income of insurance subsidiaries............. $ 67,865 $ 82,771 $ 72,924 Net loss of non-insurance companies........................ (380) (1,307) (2,417) Interest expense........................................... (9,487) (9,412) (10,517) Tax benefit of interest expense and other parent company current tax adjustments.................. 2,893 7,565 5,372 --------- --------- --------- Combined net income........................................ 60,891 79,617 65,362 Increase (decrease) due to: Deferred policy acquisition costs....................... 18,408 15,952 11,973 Policyholder benefits................................... 1,852 2,527 826 Federal income tax expense (benefit).................... 5,256 (6,888) 2,137 Amortization of intangible assets....................... (6,921) (10,662) (11,205) Investment reserves..................................... 6,061 1,316 366 Loss on group medical business, net of tax benefits..... 1,738 1,849 (3,883) Other adjustments, net.................................. (1,973) (135) (937) --------- --------- --------- Net income as reported herein....................... $ 85,312 $ 83,576 $ 64,639 ========= ========= =========
F-47 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 8 - Statutory Surplus and Subsidiary Dividend Restrictions-(Continued) The Company has principal insurance subsidiaries domiciled in Illinois and California. The statutory financial statements of these subsidiaries are prepared in accordance with accounting practices prescribed or permitted by the Illinois Department of Insurance and the California Department of Insurance as applicable. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. 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 maximum dividend which may be paid by the insurance subsidiaries to HMEC during 1999 without prior approval is approximately $67 million. The NAIC has adopted risk-based capital guidelines that establish minimum levels of statutory capital and surplus based on risk assumed in investments, reserving policies, and volume and types of insurance business written. State insurance regulations prohibit insurance companies from making any public statements or representations with regard to their risk-based capital levels. Based on current guidelines, the risk-based capital statutory requirements will have no negative regulatory impact on the Company's insurance subsidiaries. NOTE 9 - Pension Plans and Other Postretirement Benefits All employees of the Company are covered under a defined benefit plan and a defined contribution plan, and certain employees participate in supplemental retirement plans. Benefits under the defined benefit and supplemental retirement plans are based on employees' years of service and compensation for the highest 36 consecutive months of earnings under the plan. Under the defined contribution plan, contributions are made to employees' accounts based on a percentage of compensation that is determined by the employees' years of service. Retirement benefits to employees are paid first from their accumulated accounts under the defined contribution plan with the balance funded by the defined benefit and supplemental retirement plans. The Company's policy with respect to funding the defined benefit plan is to contribute amounts which are actuarially determined to provide the plan with sufficient assets to meet future benefit payments consistent with the funding requirements of federal laws and regulations. F-48 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued) Employees of the Company are also eligible to participate in the Supplemental Retirement and Savings Plan, a 401(k) plan, and may generally contribute up to 10% of eligible compensation on a before tax basis. The Company contributes an amount equal to 50% of the first 6% of eligible compensation contributed each month by participating employees. Total pension expense was $9,471, $8,885 and $7,855 for the years ended December 31, 1998, 1997 and 1996, respectively. Defined Contribution Plan Pension benefits under the defined contribution plan were fully funded and investments were set aside in a trust fund. Contributions to employees' accounts under the defined contribution plan, which were expensed in the Company's statements of operations, and total plan assets were as follows:
Year Ended December 31, ------------------------------------------ 1998 1997 1996 -------- -------- -------- Contributions to employees accounts........................ $ 5,919 $ 5,645 $ 5,199 Total assets at the end of the year........................ 77,820 70,762 62,113
F-49 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued) Defined Benefit Plan and Supplemental Retirement Plans The following table summarizes both the funding status of the defined benefit and supplemental retirement pension plans at the end of each year and identifies the assumptions used to determine the projected benefit obligation and the components of net pension cost for the defined benefit plan and supplemental retirement plans for the following periods:
Supplemental Defined Benefit Plan Retirement Plans -------------------------- -------------------------- December 31, December 31, -------------------------- -------------------------- 1998 1997 1996 1998 1997 1996 ---- ---- ---- ---- ---- ---- Change in benefit obligation: Benefit obligation at beginning of year........ $43,354 $39,365 $40,586 $ 5,606 $ 5,258 $ 4,888 Service cost................................... 1,563 1,724 1,687 341 263 353 Interest cost.................................. 3,081 2,938 2,779 382 363 320 Actuarial (gain) loss.......................... 5,058 1,925 (3,123) (65) (216) (262) Benefits paid.................................. (3,610) (2,598) (2,564) (74) (62) (41) ------- ------- ------- ------- ------- ------- Benefit obligation at end of year.............. $49,446 $43,354 $39,365 $ 6,190 $ 5,606 $ 5,258 ======= ======= ======= ======= ======= ======= Change in plan assets: Fair value of plan assets at beginning of year. $46,097 $42,262 $41,137 $ - $ - $ - Actual return on plan assets................... 8,089 6,433 3,689 - - - Employer contributions......................... - - - 74 62 41 Benefits paid.................................. (3,610) (2,598) (2,564) (74) (62) (41) ------- ------- ------- ------- ------- ------- Fair value of plan assets at end of year....... $50,576 $46,097 $42,262 $ - $ - $ - ======= ======= ======= ======= ======= ======= Funded status..................................... $ 1,130 $ 2,743 $ 2,897 $(6,190) $(5,606) $(5,258) Unrecognized net actuarial (gain) loss............ 1,426 488 1,358 (1,255) (1,418) (1,342) Unrecognized prior service (asset) cost........... (4,424) (5,035) (5,645) 2,582 2,895 3,209 ------- ------- ------- ------- ------- ------- Accrued benefit cost included in the consolidated balance sheets............. (1,868) (1,804) (1,390) (4,863) (4,129) (3,391) Additional liability to recognize unfunded accumulated benefit obligation................. - - - - (1,219) (1,474) ------- ------- ------- ------- ------- ------- Accrued benefit cost.............................. $(1,868) $(1,804) $(1,390) $(4,863) $(5,348) $(4,865) ======= ======= ======= ======= ======= ======= Amounts recognized in the statement of financial position consist of: Accrued benefit cost....................... $(1,868) $(1,804) $(1,390) $(4,863) $(4,129) $(3,391) Minimum liability.......................... - - - (1,107) (1,219) (1,474) Intangible asset........................... - - - 1,107 1,219 1,474 ------- ------- ------- ------- ------- ------- Net amount recognized................... $(1,868) $(1,804) $(1,390) $(4,863) $(4,129) $(3,391) ======= ======= ======= ======= ======= =======
F-50 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
Supplemental Defined Benefit Plan Retirement Plans -------------------- ---------------- Year Ended December 31, Year Ended December 31, ------------------------ --------------------------- 1998 1997 1996 1998 1997 1996 ---- ---- ---- ---- ---- ---- Components of net periodic benefit cost: Service cost................................... $ 1,563 $ 1,724 $ 1,686 $ 341 $ 263 $353 Interest cost.................................. 3,081 2,938 2,779 382 363 320 Expected return on plan assets................. (3,969) (3,638) (3,547) - - - Amortization of prior service cost............. (611) (610) (610) 313 313 313 Recognized net actuarial loss.................. - - 20 (228) (139) (78) ------- ------- ------- ----- ----- ---- Net periodic benefit cost.................. $ 64 $ 414 $ 328 $ 808 $ 800 $908 ======= ======= ======= ===== ===== ==== Weighted-average assumptions as of December 31: Discount rate.............................. 6.75% 7.25% 7.50% 6.75% 7.25% 7.50% Expected return on plan assets............. 8.75% 8.75% 8.75% * * * Rate of salary increase.................... 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%
- ------------- * Not applicable. The defined benefit plan is fully funded and investments have been set aside in a trust fund. The supplemental retirement plans are non-qualified, unfunded plans. Postretirement Benefits Other than Pensions In addition to providing pension benefits, the Company also provides certain health care and life insurance benefits to retired employees and eligible dependents. Employees with ten years of service are eligible to receive these benefits upon retirement. Postretirement benefits other than pensions of active and retired employees are accrued as expense over the employees' service years. F-51 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued) The following table presents the funded status of postretirement benefits other than pensions of active and retired employees (including employees on disability more than 2 years) as of December 31, 1998, 1997 and 1996 reconciled with amounts recognized in the Company's statement of financial position:
December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- Change in accumulated postretirement benefit obligation: Accumulated postretirement benefit obligation at beginning of year....................... $ 29,584 $ 25,153 $ 23,050 Changes during fiscal year Service cost.......................................... 552 845 801 Interest cost......................................... 2,043 1,995 1,752 Benefits paid......................................... (1,231) (1,265) (1,812) Actuarial (gain) loss Change due to a change in assumptions.............. 3,144 446 (1,527) Change due to demographic changes.................. 165 219 2,889 Valuation model enhancements....................... - 2,191 - -------- -------- -------- Total........................................... 3,309 2,856 1,362 -------- -------- -------- Accumulated postretirement benefit obligation at end of year............................. $ 34,257 $ 29,584 $ 25,153 ======== ======== ======== Unfunded status.............................................. $(34,257) $(29,584) $(25,153) Unrecognized net loss from past experience different from that assumed.................... 8,236 5,010 2,276 -------- -------- -------- Accrued postretirement benefit cost................... $(26,021) $(24,574) $(22,877) ======== ======== ======== Year Ended December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- Components of net periodic benefit cost: Service cost.............................................. $ 552 $ 845 $ 801 Interest cost............................................. 2,043 1,995 1,752 Amortization of prior (gains) losses...................... 83 122 93 -------- -------- -------- Net periodic benefit cost............................. $ 2,678 $ 2,962 $ 2,646 ======== ======== ========
Sensitivity Analysis A one percentage point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as follows:
December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- Accumulated postretirement benefit obligations Effect of a one percentage point increase................. $ 1,379 $ 2,038 $ 1,733 Effect of a one percentage point decrease................. (1,351) (1,907) (1,621) Service and interest cost components of the net periodic postretirement benefit expense Effect of a one percentage point increase............. $ 203 $ 198 $ 122 Effect of a one percentage point decrease............. (177) (185) (116)
F-52 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued) The assumed annual rates of increase in the per capita cost of covered benefits for participants in the plan who retired prior to January 1, 1994 were 6.4%, 6.8% and 7.8% as of December 31, 1998, 1997 and 1996, respectively, and 7.5% in 1999 grading down to 5.0% in 2004 and thereafter. For those participants retiring after December 31, 1993, benefits are provided at a level amount of $10.00 per month per year of employment. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 6.75%, 7.25% and 7.50% at December 31, 1998, 1997 and 1996, respectively. NOTE 10 - Reinsurance In the normal course of business, the insurance subsidiaries assume and cede reinsurance with other insurers. Reinsurance is ceded primarily to limit losses from large exposures and to permit recovery of a portion of direct losses; however, such a transfer does not relieve the originating insurance company of contingent liability. The Company is a national underwriter and therefore has exposure to catastrophic losses in certain coastal states and other regions throughout the United States. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather, and fires, and the frequency and severity of catastrophes are inherently unpredictable. The financial impact from catastrophic losses results from both the total amount of insured exposure in the area affected by the catastrophe as well as the severity of the event. The Company seeks to reduce its exposure to catastrophe losses through the geographic diversification of its insurance coverage, the purchase of catastrophe reinsurance, and the purchase of a catastrophe-linked equity put option (also see Note 5). The total amounts of reinsurance recoverable on unpaid claims classified as assets and reported in other assets in the balance sheets were as follows:
December 31, ------------------------------------------- 1998 1997 1996 ------- ------- ------- Reinsurance Recoverables on Unpaid Claims Life and health......................................... $ 3,890 $ 3,326 $ 2,863 Property and casualty State insurance facilities.......................... 35,988 25,968 24,445 Other insurance companies........................... 19,902 15,356 9,617 ------- ------- -------- Total............................................ $59,780 $44,650 $36,925 ======= ======= =======
F-53 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 10 - Reinsurance-(Continued) The Company recognizes the cost of reinsurance premiums over the contract periods for such premiums in proportion to the insurance protection provided. Amounts recoverable from reinsurers for unpaid claims and claim settlement expenses, including estimated amounts for unsettled claims, claims incurred but not reported and policy benefits are estimated in a manner consistent with the insurance liability associated with the policy. The effect of reinsurance on premiums written, premiums earned, and benefits, claims and settlement expenses were as follows:
Ceded to Assumed Gross Other from State Amount Companies Facilities Net -------- --------- ----------- --- Year ended December 31, 1998 Premiums written............................... $832,231 $27,174 $22,730 $827,787 Premiums earned................................ 583,637 26,024 20,199 577,812 Benefits, claims and settlement expenses........................ 420,788 41,284 16,824 396,328 Year ended December 31, 1997 Premiums written............................... 775,964 23,535 18,890 771,319 Premiums earned................................ 542,605 22,572 22,679 542,712 Benefits, claims and settlement expenses........................ 371,220 34,365 22,586 359,441 Year ended December 31, 1996 Premiums written............................... 699,701 23,214 28,345 704,832 Premiums earned................................ 497,705 23,887 28,881 502,699 Benefits, claims and settlement expenses........................ 347,352 32,159 31,498 346,691
There were no losses from uncollectible reinsurance recoverables in the three years ended December 31, 1998. Past due reinsurance recoverables as of December 31, 1998 were not material. NOTE 11 - Contingencies Lawsuits and Legal Proceedings There are various lawsuits and other legal proceedings against the Company. Management and legal counsel are of the opinion that the ultimate disposition of such litigation will have no material adverse effect on the Company's financial position or results of operations. Assessments for Insolvencies of Unaffiliated Insurance Companies The Company is also contingently liable for possible assessments under regulatory requirements pertaining to potential insolvencies of unaffiliated insurance companies. Liabilities, which are established based upon regulatory guidance, have been insignificant. F-54 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 12 - Supplementary Data on Cash Flows A reconciliation of net income to net cash provided by operating activities as presented in the consolidated statements of cash flows is as follows:
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- Cash flows from operating activities Net income.............................................. $ 85,312 $ 83,576 $ 64,639 Adjustments to reconcile net income to net cash provided by operating activities: Realized investment gains........................ (9,908) (5,340) (2,451) Depreciation and amortization.................... 5,342 10,605 13,050 Increase in insurance liabilities................ 74,900 61,837 74,621 (Increase) decrease in premium receivables....... (2,296) 4,083 (14,397) Increase in deferred policy acquisition costs.... (18,408) (15,932) (11,973) Increase in accrued interest expense............. 9 1 1,769 Increase in reinsurance recoverable.............. (1,997) (2,744) (2,030) Increase (decrease) in federal income tax liabilities........................ (6,731) (24,735) 12,136 Increase (decrease) in accrued loss on discontinued operations.................... (2,689) (2,833) 5,974 Loss from early retirement of debt............... - - 1,319 Other............................................ 5,232 (4,082) (3,443) ---------- --------- --------- Total adjustments............................. 43,454 20,860 74,575 ---------- --------- --------- Net cash provided by operating activities. $ 128,766 $ 104,436 $ 139,214 ========== ========= =========
The Company's early retirement of debt in 1996 resulted in noncash financing benefits of $1,571. F-55 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 13 - Segment Information Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 specifies the presentation and disclosure of operating segment information reported in the annual and interim reports issued to shareholders and requires that reported segment information be consistent with what the Company's management uses to make operating decisions and assess performance. The adoption of SFAS No. 131 had no effect on the financial position, results of operations, or liquidity of the Company. Adoption of SFAS No. 131 also resulted in no changes in the way the Company has reported its segment results with the exception of realized investment gains and losses which are managed in the aggregate and accordingly have been reclassified to the Corporate and Other segment. Segment information for prior periods has been restated to conform to this presentation. The Company's operations include the following operating segments which have been determined on the basis of insurance products sold: property and casualty, annuity and life insurance. The property and casualty insurance segment includes primarily personal lines automobile and homeowners products. The annuity segment includes primarily fixed and variable tax-qualified annuity products. The life insurance segment includes primarily interest-sensitive life and traditional life products. The accounting policies of the segments are the same as those described in Note 1 - Summary of Significant Accounting Policies. The Company accounts for intersegment transactions, primarily the allocation of agent and overhead costs from the Corporate and Other segment to the property and casualty, annuity and life segments, on a cost basis. Operating income is equal to income from continuing operations before the after tax impact of realized investment gains and losses and debt retirement costs. F-56 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 13 - Segment Information-(Continued) Summarized financial information for these segments is as follows:
Year Ended December 31, ------------------------------------------- 1998 1997 1996 ------ ------ ------ Insurance premiums and contract charges earned Property and casualty................................... $ 476,458 $ 447,252 $ 413,219 Annuity................................................. 15,556 12,597 9,191 Life.................................................... 85,798 82,863 80,289 ----------- ----------- ----------- Total............................................ $ 577,812 $ 542,712 $ 502,699 =========== =========== =========== Net investment income Property and casualty................................... $ 38,900 $ 41,702 $ 46,363 Annuity................................................. 107,698 113,135 111,476 Life.................................................... 45,453 43,707 41,712 Corporate and other..................................... 761 1,487 172 Intersegment eliminations............................... (1,089) (1,103) (1,116) ----------- ----------- ----------- Total............................................ $ 191,723 $ 198,928 $ 198,607 =========== =========== =========== Net income Operating income Property and casualty............................... $ 53,282 $ 61,319 $ 53,936 Annuity............................................. 23,048 19,301 16,381 Life................................................ 12,345 12,934 12,130 Corporate and other, including interest expense..... (9,803) (9,968) (9,381) ----------- ----------- ----------- Total operating income........................... 78,872 83,586 73,066 Realized investment gains, after tax.................... 6,440 3,471 1,593 Debt retirement costs, after tax........................ - - (857) ----------- ----------- ----------- Income from continuing operations....................... 85,312 87,057 73,802 Discontinued operations: Loss on operations.................................. - - (5,280) Loss on discontinuation............................. - (3,481) (3,883) ----------- ----------- ----------- Total............................................ $ 85,312 $ 83,576 $ 64,639 =========== =========== =========== Amortization of intangible assets Value of acquired insurance in force Property and casualty............................... $ 1,032 $ 1,032 $ 1,032 Annuity............................................. 1,996 5,563 5,906 Life................................................ 2,275 2,449 2,649 ----------- ----------- ----------- Subtotal......................................... 5,303 9,044 9,587 Goodwill................................................ 1,618 1,618 1,618 ----------- ----------- ----------- Total............................................ $ 6,921 $ 10,662 $ 11,205 =========== =========== =========== December 31, ------------------------------------------- 1998 1997 1996 ------ ------ ------ Assets Property and casualty................................... $ 737,260 $ 742,487 $ 797,871 Annuity................................................. 2,730,092 2,531,309 2,243,278 Life.................................................... 863,864 777,488 738,521 Corporate and other..................................... 95,579 125,624 109,841 Intersegment eliminations............................... (31,315) (44,996) (28,485) ---------- ---------- ---------- Total............................................ $4,395,480 $4,131,912 $3,861,026 ========== ========== ==========
F-57 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data) NOTE 14 - Unaudited Interim Information Summary quarterly financial data is presented below.
Three Months Ended -------------------------------------------------------------- December 31, September 30, June 30, March 31, ------------ ------------- -------- --------- 1998 - ---- Insurance premiums written and contract deposits.......... $211,082 $209,686 $210,065 $196,954 Total revenues............................................ 192,292 196,564 194,489 196,098 Income from continuing operations......................... 22,271 24,934 15,648 22,459 Net income................................................ 22,271 24,934 15,648 22,459 Per share information Basic Realized investment gains, after tax.............. $ (0.05) $ 0.06 $ 0.04 $ 0.10 Income from continuing operations................. 0.52 0.58 0.36 0.51 Net income........................................ 0.52 0.58 0.36 0.51 Diluted Realized investment gains, after tax.............. $ (0.05) $ 0.06 $ 0.05 $ 0.09 Income from continuing operations................. 0.52 0.57 0.36 0.50 Net income........................................ 0.52 0.57 0.36 0.50 1997 - ---- Insurance premiums written and contract deposits.......... $207,485 $188,911 $195,053 $179,870 Total revenues............................................ 192,386 185,934 186,597 182,063 Income from continuing operations......................... 25,284 21,477 20,896 19,400 Discontinued operations, after tax........................ - (3,481) - - Net income................................................ 25,284 17,996 20,896 19,400 Per share information Basic Realized investment gains, after tax.............. $ 0.03 $ 0.03 $ 0.01 $ 0.01 Income from continuing operations................. 0.56 0.48 0.45 0.41 Net income........................................ 0.56 0.40 0.45 0.41 Diluted Realized investment gains, after tax.............. 0.03 0.02 0.01 0.01 Income from continuing operations................. 0.56 0.46 0.45 0.40 Net income........................................ 0.56 0.39 0.45 0.40 1996 - ---- Insurance premiums written and contract deposits.......... $183,938 $180,551 $176,395 $163,948 Total revenues............................................ 180,026 175,475 174,407 173,849 Income from continuing operations......................... 21,387 17,892 18,097 16,426 Discontinued operations, after tax........................ (5,586) (1,568) (1,016) (993) Net income................................................ 15,801 16,324 17,081 15,433 Per share information Basic Realized investment gains (losses), after tax..... $ (0.01) - $ 0.01 $ 0.03 Income from continuing operations................. 0.45 $ 0.38 0.39 0.35 Net income........................................ 0.34 0.35 0.36 0.33 Diluted Realized investment gains (losses), after tax..... - (0.01) 0.01 0.03 Income from continuing operations................. 0.45 0.37 0.38 0.35 Net income........................................ 0.33 0.35 0.36 0.32
F-58 SCHEDULE 1 HORACE MANN EDUCATORS CORPORATION SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1998 (Amounts in thousands)
Amount shown in Market Balance Type of Investments Cost(1) Value Sheet ------------------- ------- ------ -------- Fixed maturities: U.S. Government and U.S. Government agencies and authorities............................................ $ 681,918 $ 706,493 $ 706,493 States, municipalities and political subdivisions............. 301,751 319,141 319,141 Foreign government bonds...................................... 21,829 23,950 23,950 Public utilities.............................................. 6,002 6,907 6,907 Other corporate bonds......................................... 1,541,037 1,594,888 1,594,888 ---------- ---------- ---------- Total fixed maturity securities......................... 2,552,537 $2,651,379 2,651,379 ========== Mortgage loans and real estate..................................... 26,192 XXX 26,192 Short-term investments............................................. 20,915 XXX 20,915 Short-term investments, loaned securities collateral............... 87,392 XXX 87,392 Policy loans and other ............................................ 54,817 XXX 54,942 ---------- ---------- Total investments....................................... $2,741,853 XXX $2,840,820 ========== ==========
- ----------- (1) Bonds at original cost reduced by repayments and adjusted for amortization of premiums or accrual of discounts and impairment in value of specifically identified investments. See accompanying Independent Auditors' Report. F-59 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION BALANCE SHEETS As of December 31, 1998, 1997 and 1996 (Amounts in thousands, except share data)
1998 1997 1996 -------- -------- -------- ASSETS Investments and cash............................................... $ 5,580 $ 19,271 $ 13,339 Investment in subsidiaries......................................... 589,964 574,009 547,889 Other assets....................................................... 53,989 57,911 71,277 ----------- ----------- ----------- Total assets............................................... $ 649,533 $ 651,191 $ 632,505 =========== =========== =========== LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY Mortgage loan payable to subsidiary................................ $ - $ - $ 10,834 Short-term debt.................................................... 50,000 42,000 34,000 Long-term debt..................................................... 99,637 99,599 99,564 Other liabilities.................................................. 3,053 3,043 3,135 ----------- ----------- ----------- Total liabilities.......................................... 152,690 144,642 147,533 ----------- ----------- ----------- Warrants, subject to redemption.................................... 220 577 577 ----------- ----------- ----------- Preferred stock, $0.001 par value, authorized 1,000,000 shares; none issued................................. - - - Common stock, $0.001 par value, authorized 75,000,000 shares; issued, 1998, 59,274,690; 1997, 59,161,008; 1996, 58,426,796.............................................. 59 59 58 Additional paid-in capital......................................... 336,686 340,564 330,234 Retained earnings.................................................. 420,274 349,274 278,669 Accumulated other comprehensive income (net unrealized gains on fixed maturities and equity securities).............. 57,327 62,167 29,736 Treasury stock, at cost, 1998, 17,183,596 shares; 1997, 14,896,796 shares; 1996, 11,176,196 shares.................... (317,723) (246,092) (154,302) ----------- ----------- ----------- Total shareholders' equity................................. 496,623 505,972 484,395 ----------- ----------- ----------- Total liabilities, redeemable securities and shareholders' equity................................ $ 649,533 $ 651,191 $ 632,505 =========== =========== ===========
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-60 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION STATEMENTS OF OPERATIONS (Amounts in thousands)
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- Revenues Net investment income......................................... $ 759 $ 1,487 $ 165 Realized investment gains..................................... 1,123 154 - --------- -------- -------- Total revenues.......................................... 1,882 1,641 165 --------- -------- -------- Expenses Interest...................................................... 9,487 9,412 10,517 Amortization of goodwill...................................... 1,618 1,618 1,618 Other ........................................................ 713 541 689 Debt retirement costs......................................... - - 1,319 --------- -------- -------- Total expenses.......................................... 11,818 11,571 14,143 --------- -------- -------- Income (loss) from continuing operations before income taxes and equity in net earnings of subsidiaries.................... (9,936) (9,930) (13,978) Income tax expense (benefit)....................................... (2,766) (2,845) (3,862) --------- -------- -------- Income (loss) from continuing operations before equity in net earnings of subsidiaries............................... (7,170) (7,085) (10,116) Equity in net earnings of subsidiaries............................. 92,482 94,142 83,918 --------- -------- -------- Income from continuing operations.................................. 85,312 87,057 73,802 Discontinued operations: Loss from operations, net of applicable income tax benefits of 1996, $2,764............................................ - - (5,280) Loss on discontinuation, representing provision of 1997, $5,355; 1996, $5,974 for operating losses during phase-out period, net of applicable income tax benefits of 1997, $1,874; 1996, $2,091............................................... - (3,481) (3,883) --------- -------- -------- Net income ........................................................ $ 85,312 $ 83,576 $ 64,639 ========= ======== ========
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-61 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION STATEMENTS OF CASH FLOWS (Amounts in thousands)
Year Ended December 31, ------------------------------------------- 1998 1997 1996 ------ ------ ----- Cash flows from operating activities Interest expense paid......................................... $ (9,309) $ (9,276) $ (8,653) Federal income taxes recovered (paid)......................... 5,672 1,391 (10,154) Cash dividends received from subsidiaries..................... 62,100 107,300 72,700 Other, net.................................................... 9,588 (7,208) 3,342 --------- --------- ---------- Net cash provided by operating activities............... 68,051 92,207 57,235 --------- --------- ---------- Cash flows from investing activities Net (increase) decrease in investments........................ 18,039 (10,102) (4,705) Capital expenditures for property and equipment............... - - (2,609) --------- --------- ---------- Net cash provided by (used in) investing activities..... 18,039 (10,102) (7,314) --------- --------- ---------- Cash flows used in financing activities Purchase of treasury stock.................................... (71,631) (91,790) - Dividends paid to shareholders................................ (14,312) (12,971) (10,336) Principal borrowings (payments) on Bank Credit Facility....... 8,000 8,000 (41,000) Repurchase of common stock warrants........................... (4,959) - - Exercise of stock options..................................... 2,200 11,581 6,343 Catastrophe-linked equity put option premium.................. (1,475) (1,250) - Proceeds from issuance of Senior Notes........................ - - 98,530 Retirement of Convertible Notes............................... - - (102,890) --------- --------- ---------- Net cash used in financing activities................... (82,177) (86,430) (49,353) --------- --------- ---------- Net increase (decrease) in cash.................................... 3,913 (4,325) 568 Cash at beginning of period........................................ 0 4,325 3,757 --------- --------- ---------- Cash at end of period.............................................. $ 3,913 $ 0 $ 4,325 ========= ========= ==========
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-62 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION NOTE TO CONDENSED FINANCIAL STATEMENTS December 31, 1998, 1997 and 1996 The accompanying condensed financial statements should be read in conjunction with the Consolidated Financial Statements and the accompanying notes thereto. See accompanying Independent Auditors' Report. F-63 SCHEDULE III & VI (COMBINED) HORACE MANN EDUCATORS CORPORATION SUPPLEMENTARY INSURANCE INFORMATION (Amounts in thousands)
Discount, Other Benefits, Deferred Future policy if any, policy Premium claims policy benefits, deducted in claims and revenue/ Net and acquisition claims and previous Unearned benefits premium investment settlement Segment costs claims expenses column premiums payable earned income expenses - ------------------- ----------- --------------- ------------ -------- ---------- -------- ---------- ---------- Year Ended December 31, 1998 Property and casualty $ 16,048 $ 298,929 $ 0 $172,474 $ - $476,458 $ 38,900 $354,381 Annuity ........... 25,818 1,240,987 xxx - 111,754 15,556 107,698 71,996 Life .............. 59,792 588,888 xxx 6,720 13,066 85,798 45,453 64,727 Other ............. N/A N/A xxx N/A N/A N/A (328) N/A -------- ---------- -------- --------- -------- --------- -------- Total........... $101,658 $2,128,804 xxx $179,194 $ 124,820 $577,812 $ 191,723 $491,104 ======== ========== ======== ========= ======== ========= ======== Year Ended December 31, 1997 Property and casualty $ 15,230 $ 310,632 $ 0 $161,205 $ 305 $447,252 $ 41,702 $320,834 Annuity ........... 19,699 1,246,948 xxx - 107,538 12,597 113,135 76,486 Life .............. 50,954 553,981 xxx 5,791 14,264 82,863 43,707 59,352 Other ............. N/A N/A xxx N/A N/A N/A 384 N/A -------- ---------- -------- --------- -------- --------- -------- Total........... $ 85,883 $2,111,561 xxx $166,996 $ 122,107 $542,712 $ 198,928 $456,672 ======== ========== ======== ========= ======== ========= ======== Year Ended December 31, 1996 Property and casualty $ 13,855 $ 340,411 $ 0 $150,368 $ 305 $413,219 $ 46,363 $306,102 Annuity ........... 14,230 1,287,815 xxx - 102,681 9,191 111,476 76,762 Life .............. 46,986 526,028 xxx 5,408 15,563 80,289 41,712 59,149 Other ............. N/A N/A xxx N/A N/A N/A (944) N/A -------- ---------- -------- --------- -------- --------- -------- Total........... $ 75,071 $2,154,254 xxx $155,776 $ 118,549 $502,699 $ 198,607 $442,013 ======== ========== ======== ========= ======== ========= ========
Claims and claim adjustment expenses Amortization Paid incurred related to of deferred claims ------------------- policy Other and claim Current Prior acquisition operating adjustment Premiums Segment year years costs expenses expenses written ------- ------- ------ ------------ --------- ---------- --------- Year Ended December 31, 1998 Property and casualty $379,603 $(24,917) $42,779 $ 51,699 $380,955 $487,727 Annuity ........... xxx xxx (700) 16,558 xxx xxx Life .............. xxx xxx 3,398 44,167 xxx xxx Other.............. xxx xxx N/A 13,657 xxx xxx ------- -------- Total........... xxx xxx $45,477 $126,081 xxx xxx ======= ======== Year Ended December 31, 1997 Property and casualty $365,986 $(45,152) $40,515 $ 49,012 $357,875 $458,088 Annuity ........... xxx xxx 100 19,373 xxx xxx Life .............. xxx xxx 3,583 43,685 xxx xxx Other ............. xxx xxx N/A 14,402 xxx xxx ------- -------- Total........... xxx xxx $44,198 $126,472 xxx xxx ======= ======== Year Ended December 31, 1996 Property and casualty $368,648 $(62,546) $36,652 $ 46,507 $345,642 $427,146 Annuity ........... xxx xxx 1,300 17,643 xxx xxx Life .............. xxx xxx 3,111 41,278 xxx xxx Other ............. xxx xxx N/A 13,315 xxx xxx ------- -------- Total........... xxx xxx $41,063 $118,743 xxx xxx ======= ========
- ------------ N/A Not applicable. See accompanying Independent Auditors' Report. F-64 SCHEDULE IV HORACE MANN EDUCATORS CORPORATION REINSURANCE (Amounts in thousands)
Column A Column B Column C Column D Column E Column F Ceded to Assumed Percentage Gross Other from State of Amount Amount Companies Facilities Net Assumed to Net ------ --------- ---------- --- -------------- Year ended December 31, 1998 Life insurance in force............... $ 11,798,613 $ 643,910 - $11,154,703 - Premiums Property and casualty.............. $ 480,447 $ 24,188 $20,199 $ 476,458 4.2% Annuity............................ 15,556 - - 15,556 - Life............................... 87,634 1,836 - 85,798 - ------------- --------- ------- ----------- Total premiums.................. $ 583,637 $ 26,024 $20,199 $ 577,812 3.5% ============= ========= ======= =========== Year ended December 31, 1997 Life insurance in force............... $ 11,187,925 $ 310,833 $ - $10,877,092 - Premiums Property and casualty.............. $ 445,468 $ 20,895 $22,679 $ 447,252 5.1% Annuity............................ 12,597 - - 12,597 - Life............................... 84,540 1,677 - 82,863 - ------------- --------- ------- ----------- Total premiums.................. $ 542,605 $ 22,572 $22,679 $ 542,712 4.2% ============= ========= ======= =========== Year ended December 31, 1996 Life insurance in force............... $10,645,393 $ 222,611 $ - $10,422,782 - Premiums Property and casualty.............. $ 406,778 $ 22,440 $28,881 $ 413,219 7.0% Annuity............................ 9,191 - - 9,191 - Life............................... 81,736 1,447 - 80,289 - --------------- --------- ------- ----------- Total premiums.................. $ 497,705 $ 23,887 $28,881 $ 502,699 5.7% ============= ========= ======= ===========
- ------------ NOTE: Premiums above include insurance premiums earned and contract charges earned. See accompanying Independent Auditors' Report F-65 HORACE MANN - ---------------------------------------- Insuring America's Educational Community The Horace Mann Companies 1 Horace Mann Plaza Springfield, Illinois 62715-0001 217-789-2500 www.horacemann.com HA-C00322 ============================================================================= HORACE MANN EDUCATORS CORPORATION EXHIBITS To FORM 10-K For the Year Ended December 31, 1998 VOLUME 1 OF 1 ============================================================================= The following items are filed as Exhibits to Horace Mann Educators Corporation's Annual Report on Form 10-K for the year ended December 31, 1998. Management contracts and compensatory plans are indicated by an asterisk(*). EXHIBIT INDEX Sequential Exhibit Page No. Description Number - ------- ---------- ---------- (3) Articles of incorporation and bylaws: 3.1 Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on October 6, 1989, incorporated by reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission (the "SEC") on November 14, 1996. 3.2 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on October 18, 1991, incorporated by reference to Exhibit 3.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 3.3 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on August 23, 1995, incorporated by reference to Exhibit 3.3 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 3.4 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on September 23, 1996, incorporated by reference to Exhibit 3.4 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 3.5 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on June 5, 1998, incorporated by reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998, filed with the SEC on August 13, 1998. 3.6 Form of Certificate for shares of Common Stock, $0.001 par value per share, of HMEC, incorporated by reference to Exhibit 4.5 to HMEC's Registration Statement on Form S-3 (Registration No. 33-53118) filed with the SEC on October 9, 1992. 3.7 Bylaws of HMEC, incorporated by reference to Exhibit 4.6 to HMEC's Registration Statement on Form S-3 (Registration No. 33-80059) filed with the SEC on December 6, 1995. 1 Sequential Exhibit Page No. Description Number - ------- ---------- ---------- (4) Instruments defining the rights of security holders, including indentures: 4.1 Warrant Agreement dated as of August 29, 1989 (the "Warrant Agreement"), between HMEC (as successor to HME Acquisition Corporation) and Bankers Trust Company, as warrant agent (the "Warrant Agent"), with regard to Warrants to Purchase Common Stock, incorporated by reference to Exhibit 4.6 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989 (the "September 1989 Form 10-Q"), filed with the SEC on November 14, 1989. 4.2 Supplemental Warrant Agreement dated as of August 29, 1989 to the Warrant Agreement, between HMEC and the Warrant Agent, incorporated by reference to Exhibit 4.7 to the September 1989 Form 10-Q, filed with the SEC on November 14, 1989. 4.3 Form of Warrant (included in Exhibit 4.1). 4.4 Indenture dated as of January 17, 1996, between HMEC and U.S. Trust Company of California, N.A. as trustee, with regard to HMEC's 6 5/8% Senior Notes Due 2006, incorporated by reference to Exhibit 4.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1995, filed with the SEC on March 13, 1996. 4.5 Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.4). 4.6 Certificate of Designations for HMEC Series A Cumulative Preferred Stock (included in Exhibit 10.12). (10) Material contracts: 10.1 Credit Agreement dated as of December 31, 1996 (the "Bank Credit Facility") among HMEC, certain banks named therein and Bank of America National Trust and Savings Association, as administrative agent (the "Agent"), incorporated by reference to Exhibit 10.1 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1996, filed with the SEC on March 26, 1997. 10.2* Stock Subscription Agreement among HMEC (as successor to HME Holdings, Inc.), The Fulcrum III Limited Partnership, The Second Fulcrum III Limited Partnership and each of the Management Investors, incorporated by reference to Exhibit 10.17 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1989, filed with the SEC on April 2, 1990. 2 Sequential Exhibit Page No. Description Number - ------- ---------- ---------- 10.3* Horace Mann Educators Corporation Deferred Equity Compensation Plan for Directors, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 10.4* Horace Mann Educators Corporation Deferred Compensation Plan for Employees, incorporated by reference to Exhibit 10.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1997, filed with the SEC on March 30, 1998. 10.5* Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1991, filed with the SEC on March 27, 1992. 10.5(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5(a) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1997, filed with the SEC on March 30, 1998. 10.5(b)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.1(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, filed with the SEC on November 13, 1998. 10.5(c)* Amendment to Horace Mann Educators Corporation 1991 Stock Incentive Plan, dated September 11, 1996, incorporated by reference to Exhibit 10.2(c) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 10.5(d)* Amendment to Horace Mann Educators Corporation 1991 Stock Incentive Plan, dated September 18, 1998, incorporated by reference to Exhibit 10.1(d) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, filed with the SEC on November 13, 1998. 10.6* Severance Agreements between HMEC and certain officers of HMEC, incorporated by reference to Exhibit 10.9 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1993, filed with the SEC on March 31, 1994. 10.7* Specimen Continuation of Employment Agreement between HMEC and certain officers, incorporated by reference to Exhibit 10.21(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, filed with the SEC on November 14, 1994. 3 Sequential Exhibit Page No. Description Number - ------- ---------- ---------- 10.7(a)* Schedule of Continuation of Employment Agreements between HMEC and certain officers, incorporated by reference to Exhibit 10.21(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, filed with the SEC on November 14, 1994. 10.8* Horace Mann Incentive Compensation Program, incorporated by reference to Exhibit 10.7 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1996, filed with the SEC on March 26, 1997. 10.9* Horace Mann Supplemental Employee Retirement Plan, 1997 Restatement, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30,1997, filed with the SEC on November 14, 1997. 10.10* Horace Mann Executive Supplemental Employee Retirement Plan, 1997 Restatement, incorporated by reference to Exhibit 10.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, filed with the SEC on August 14, 1997. 10.11* Amended and restated agreement entered by and between HMEC and Paul J. Kardos as of October 6, 1998, incorporated by reference to Exhibit 10.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, filed with the SEC on November 13, 1998. 10.12 Catastrophe Equity Securities Issuance Option Agreement (Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement) entered by and between HMEC and Centre Reinsurance, dated February 15, 1997 and related letter from Centre Reinsurance, incorporated by reference to Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1996, filed with the SEC on March 26, 1997. 10.12(a) Amendment effective February 15, 1997 to Catastrophe Equity Securities Issuance Option Agreement (Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement), incorporated by reference to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998, filed with the SEC on May 15, 1998. 10.12(b) Amendment effective February 15, 1997 to Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement. 4 Sequential Exhibit Page No. Description Number - ------- ---------- ---------- (11) Statement regarding computation of per share earnings. (12) Statement regarding computation of ratios. (21) Subsidiaries of HMEC. (23) Consent of KPMG LLP. (27) Financial Data Schedule. EX-10.12.B 2 AMEND NO.2 TO CATASTROPHE EQUITY SECURITY ISSUANCE Exhibit 10.12(b) AMENDMENT NO. 2 TO CATASTROPHE EQUITY SECURITIES ISSUANCE OPTION AND REINSURANCE OPTION AGREEMENT This Amendment No. 2 to Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement (this "Amendment") is entered into and effective as of February 15, 1997 with respect to that certain Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement dated February 15, 1997, as amended (together with all the Exhibits and Schedules and all ancillary, related or supporting documents, the "Agreement") between Horace Mann Educators Corporation, a Delaware corporation ("HM") and Centre Reinsurance (U.S.) Limited, a Bermuda corporation ("Centre Re"). RECITALS WHEREAS, HM and Centre Re are parties to the Agreement which has been previously amended by that certain Amendment No. 1 to Catastrophe Equity Securities Issuance Option Agreement dated as of February 15, 1997 between HM and Centre Re; WHEREAS, HM and Centre Re wish to further amend the terms of Sections 1.9 and 2.1 of the Agreement as set forth in this Amendment; NOW, THEREFORE, for good and valuable consideration, receipt of which is hereby acknowledged, HM and Centre Re agree as follows: AGREEMENT 1. Section 1.9. In accordance with Section 1.9, the Exposure Period is hereby extended to 12:00 A.M. Central Time on January 1, 2002. 2. Section 2.1. Clause (b) of the first sentence of Section 2.1 is hereby amended by replacing "for all subsequent Agreement Years, 1.475%" with "for the second Agreement Year 1.475%, and for all subsequent Agreement Years 0.95%,". The second sentence of Section 2.1 is hereby amended by replacing "and subsequent Option Fee payments shall be delivered on January 1 (or, if such day is not a business day, the next following business day) of 1998 and each subsequent year within the Exposure Period (as it may be extended)" with "the second Option Fee payment shall be delivered on January 1, 1998 (or, if such day is not a business day, the next following business day), and subsequent Option Fee payments shall be paid in four equal quarterly installments on February 15, May 15, August 15 and November 15 (or, in each case, if such date is not a business day, the next following business day) of the Agreement Year within the Exposure Period (as it may be extended) to which such Option Fee applies. 3. Conformed Copies. The amendments to the Agreement described in the Amendment shall be contained in conformed copies of the Agreement, its Exhibits and Schedules to be exchanged between the parties. No conformed copies of any ancillary, 1 supporting or related documents or instruments other than the Exhibits and Schedules shall be delivered, it being agreed that any such ancillary, supporting or related documents or instruments remain in full force and effect subject to the amendments set forth in Sections 1 and 2 above. 4. Counterparts. This Amendment may be executed in one or more counterparts, each of which when so executed and delivered shall be an original, but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the undersigned parties have caused this Amendment to be duly executed as of the date first written above. Horace Mann Educators Corporation Centre Reinsurance (U.S.) Limited By: /s/ Paul J. Kardos By: /s/ Tara Leonard ---------------------------- ------------------------------ Printed Name: Paul J. Kardos Printed Name: Tara Leonard ------------------ ------------------- Title: President Title: SVP & CAN ------------------------- -------------------------- By: /s/ George Zock ---------------------------- Printed Name: George Zock ------------------- Title: Executive Vice President -------------------------- 2 EX-11 3 COMPUTATION OF NET INCOME PER SHARE Exhibit 11 Horace Mann Educators Corporation Computation of Net Income per Share For the Years Ended December 31, 1998, 1997 and 1996 (Amounts in thousands, except per share data)
Year Ended December 31, -------------------------- 1998 1997 1996 ---- ---- ---- Basic - assumes no dilution: Net income for the period ...................... $85,312 $83,576 $64,639 ------- ------- ------- Weighted average number of common shares outstanding during the period ........ 43,239 45,825 46,958 ------- ------- ------- Net income per share - basic ................... $ 1.97 $ 1.82 $ 1.38 ======= ======= ======= Diluted - assumes full dilution: Net income for the period ...................... $85,312 $83,576 $64,639 ------- ------- ------- Weighted average number of common shares outstanding during the period ........ 43,239 45,825 46,958 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: Warrants ................................. 98 251 236 Stock options ............................ 451 416 378 Common stock units related to Deferred Equity Compensation Plan for Directors 49 33 6 Common stock units related to Deferred Equity Compensation Plan for Employees 1 -- -- ------- ------- ------- Total common and common equivalent shares adjusted to calculate diluted earnings per share .......................... 43,838 46,525 47,578 ------- ------- ------- Net income per share - diluted ................. $ 1.95 $ 1.80 $ 1.36 ======= ======= ======= Percentage of dilution compared to basic net income per share .................. 1.0% 1.1% 1.4%
EX-12 4 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES Exhibit 12 Horace Mann Educators Corporation Computation of Ratio of Earnings to Fixed Charges For the Years Ended December 31, 1998, 1997, 1996, 1995 and 1994 (Dollars in millions)
Year Ended December 31, --------------------------------------------------- 1998 1997 1996 1995 1994 ------- -------- -------- -------- -------- Income from continuing operations before income taxes $116.8 $119.6 $100.6 $103.6 $86.2 Interest expense 9.5 9.4 10.5 11.6 9.5 ------ ------ ------ ------ ----- Earnings $126.3 $129.0 $111.1 $115.2 $95.7 ====== ====== ====== ====== ===== Fixed charges - interest expense $ 9.5 $ 9.4 $ 10.5 $ 11.6 $ 9.5 Ratio of earnings to fixed charges 13.3x 13.7x 10.6x 9.9x 10.1x
EX-21 5 SIGNIFICANT SUBSIDIARIES Exhibit 21 Horace Mann Educators Corporation Significant Subsidiaries and Their Respective States of Incorporation December 31, 1998 Allegiance Insurance Company - California Allegiance Life Insurance Company - Illinois Horace Mann Life Insurance Company - Illinois Horace Mann Insurance Company - Illinois Teachers Insurance Company - Illinois Horace Mann Investors, Inc. - Maryland Horace Mann Service Corporation - Illinois EX-23 6 CONSENT OF KPMG LLP Exhibit 23 The Board of Directors Horace Mann Educators Corporation: We consent to incorporation by reference in the registration statements (No. 33-47066 and No. 33-45152) on Form S-8 of Horace Mann Educators Corporation and subsidiaries (the Company) of our report dated January 26, 1999, relating to the consolidated balance sheets of the Company as of December 31, 1998, 1997 and 1996, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1998, and all related schedules, which report appears in the December 31, 1998 annual report on Form 10-K of the Company. /s/ KPMG LLP KPMG LLP Chicago, Illinois March 30, 1999 EX-27 7 FINANCIAL DATA SCHEDULE
7 THE SCHEDULE CONTAINS SUMMARY FIINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AND THE CONSOLIDATED STATEMENT OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS YEAR DEC-31-1998 DEC-31-1998 2,651,379 0 0 0 26,019 173 2,840,820 12,044 0 101,658 4,395,480 2,128,804 179,194 0 124,820 149,637 0 0 59 496,564 4,395,480 577,812 191,723 9,908 0 396,328 45,477 109,673 116,781 31,469 85,312 0 0 0 85,312 1.97 1.95 269,308 379,603 (24,917) 238,986 141,969 243,039 24,917 Refer to the Company's Consolidated Balance Sheet as of December 31, 1998. These balances are net of reinsurance recoverables. See also Note 1 - Significant Accounting Policies of the Company's Consolidated Notes to Financial Statements for December 31, 1998.
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