-----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, Nr1J3GGISWANEqD/dBdnWQf2I4lY0lkOD+DoRBd8HHdwcQ9a8WVGFHNcZuQFnKqf dgdkMJ7qOzTIBLyMghHe0Q== 0000950131-00-002184.txt : 20000331 0000950131-00-002184.hdr.sgml : 20000331 ACCESSION NUMBER: 0000950131-00-002184 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 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: 584455 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 FORM 10-K ================================================================================ 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, 1999 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, 2000, was approximately $596 million. As of March 1, 2000, 41,548,157 shares of Common Stock, par value $0.001 per share, were outstanding, net of 18,258,896 shares of treasury stock. DOCUMENTS INCORPORATED BY REFERENCE Proxy Statement for the 2000 Annual Meeting of Shareholders, exclusive of disclosures made pursuant to Regulation S-K, (S) 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, 1999 INDEX
Item Number Page - ------ ---- PART I 1. Business................................................................ 1 2. Properties.............................................................. 29 3. Legal Proceedings....................................................... 29 4. Submission of Matters to a Vote of Security Holders..................... 29 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters... 30 6. Selected Financial Data................................................. 31 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................ 31 7A. Quantitative and Qualitative Disclosures About Market Risk.............. 31 8. Consolidated Financial Statements and Supplementary Data................ 31 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................. 31 PART III 10. Directors and Executive Officers of the Registrant...................... 31 11. Executive Compensation.................................................. 31 12. Security Ownership of Certain Beneficial Owners and Management.......... 31 13. Certain Relationships and Related Transactions.......................... 31 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........ 32 SIGNATURES.............................................................. 37 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", "Horace Mann" 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. The Company's 1.1 million customers 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. Horace Mann is the only national multiline insurance company focused on the niche educator market. The Company sells and services its products primarily through an exclusive sales force of full-time agents employed by the Company and trained to sell multiline products. The Company's agents sell only the Company's products and supplemental products authorized by the Company. 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, 1999 were $821.2 million and operating income (net income before the after tax impact of realized investment gains and losses, litigation settlement and the provision for prior years' taxes) was $70.7 million. The Company's total assets were $4.3 billion at December 31, 1999. The property and casualty segment accounted for 60% of the Company's insurance premiums written and contract deposits for the year ended December 31, 1999, while accounting for 56% of operating income for the period. The annuity and life insurance segments together accounted for 40% of insurance premiums written and contract deposits for the year ended December 31, 1999 (25% and 15%, respectively), and provided 59% (38% and 21%, respectively) of operating income for the period. 1 The primary products of the Company's property and casualty segment are private passenger automobile and homeowners insurance. 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 12 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 10 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 4.8 percentage points per year. The Company's property and casualty expense ratio for the year ended December 31, 1999 was 19.8%. The Company is the 14th largest provider of 403(b) tax-qualified variable annuities and one of the 20 largest participants in the fixed and variable 403(b) tax-qualified annuity market according to a 1999 A.M. Best report. Approximately 70% of the Company's new annuity contract deposits in 1999 were for 403(b) tax-qualified annuities; approximately 80% of accumulated annuity value on deposit is 403(b) tax-qualified. At December 31, 1999, the accumulated value of all of the Company's annuity contracts (tax and non-tax qualified) was $2.5 billion, representing 125,000 contracts in force. For the 1999 year, 92% of the accumulated cash value of the Company's fixed 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 such annuities. Generally, a penalty is imposed under the Internal Revenue Code on amounts withdrawn from tax-qualified annuities prior to age 59 1/2. Total accumulated annuity funds on deposit at December 31, 1999 consisted of 45% variable annuities and 55% fixed annuities. The investment portfolio of the Company, including variable annuity assets under management of $1.1 billion, had an aggregate market value of $3.8 billion at December 31, 1999. Investments other than variable annuity assets consist principally of investment grade publicly traded fixed income securities. At December 31, 1999, investments in non-investment grade securities represented 6.9% of total investments excluding variable annuity assets. There are no significant investments in mortgage loans, real estate, foreign securities or privately placed securities. 2 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. The Company expanded its business to other states and broadened its product line to include group and individual life insurance in 1949, 403(b) tax-qualified retirement annuities in 1961 and homeowners insurance in 1965. 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"). The common stock is traded on the New York Stock Exchange under the symbol "HMN." Following the 1991 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. 3 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, 1999 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, ---------------------------------------------------- 1999 1998 1997 1996 1995 --------- -------- --------- --------- --------- (Dollars in millions, except per share data) Statement of Operations Data: Insurance premiums written and contract deposits....... $ 821.2 $ 827.8 $ 771.3 $ 704.8 $ 654.0 Insurance premiums and contract charges earned......... 595.1 577.8 542.7 502.7 485.4 Net investment income.................................. 188.3 191.7 198.9 198.6 198.4 Net investment income, after tax....................... 126.7 128.3 132.6 132.4 132.2 Realized investment gains (losses)..................... (8.0) 9.9 5.3 2.5 8.6 Total revenues......................................... 775.4 779.4 746.9 703.8 692.4 Amortization of intangible assets(1)................... 0.2 6.9 10.7 11.2 11.7 Interest expense....................................... 9.7 9.5 9.4 10.5 11.6 Income from continuing operations before income taxes.. 93.4 116.8 119.6 100.6 103.6 Income from continuing operations(2)................... 44.5 85.3 87.1 73.8 75.2 Discontinued operations(3)............................. - - (3.5) (9.2) (1.2) Net income(2).......................................... 44.5 85.3 83.6 64.6 74.0 Operating income(4).................................... 70.7 78.9 83.6 73.1 70.9 Ratio of earnings to fixed charges(5).................. 10.6x 13.3x 13.7x 10.6x 9.9x Per Share Data(6): Basic: Operating income(4).................................. $ 1.71 $ 1.82 $ 1.82 $ 1.56 $ 1.42 Realized investment gains (losses), after tax........ (0.13) 0.15 0.08 0.03 0.11 Litigation settlement, after tax..................... (0.02) - - - - Provision for prior years' taxes..................... (0.48) - - - - Income from continuing operations.................... 1.08 1.97 1.90 1.57 1.50 Discontinued operations(3)........................... - - (0.08) (0.19) (0.02) Net income........................................... 1.08 1.97 1.82 1.38 1.48 Diluted: Operating income(4).................................. $ 1.70 $ 1.80 $ 1.80 $ 1.54 $ 1.33 Realized investment gains (losses), after tax........ (0.13) 0.15 0.07 0.03 0.10 Litigation settlement, after tax..................... (0.02) - - - - Provision for prior years' taxes..................... (0.48) - - - - Income from continuing operations.................... 1.07 1.95 1.87 1.55 1.41 Discontinued operations(3)........................... - - (0.07) (0.19) (0.02) Net income........................................... 1.07 1.95 1.80 1.36 1.39 Shares of Common Stock-weighted average: Basic................................................ 41.2 43.2 45.8 47.0 50.1 Diluted.............................................. 41.7 43.8 46.5 47.6 56.3 Shares of Common Stock - ending outstanding............ 41.0 42.1 44.3 47.3 46.8 Cash dividends......................................... $ 0.3825 $ 0.3325 $ 0.2825 $ 0.22 $ 0.18 Balance Sheet Data, at Year End: Total investments...................................... $2,630.2 $2,840.8 $2,769.0 $2,784.3 $2,798.5 Total assets........................................... 4,253.8 4,395.5 4,131.9 3,861.0 3,662.3 Total policy liabilities............................... 2,341.3 2,308.0 2,278.6 2,310.0 2,276.0 Short-term debt........................................ 49.0 50.0 42.0 34.0 75.0 Long-term debt......................................... 99.7 99.6 99.6 99.6 100.0 Total shareholders' equity............................. 400.1 496.6 506.0 484.4 470.2 Book value per share(7)................................ $ 9.75 $ 11.80 $ 11.43 $ 10.25 $ 10.05
(continued on next page) 4 SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA - (continued)
Year Ended December 31, ----------------------------------------------------- 1999 1998 1997 1996 1995 --------- --------- --------- --------- --------- (Dollars in millions, except per share data) Segment Information: Insurance premiums written and contract deposits Property and casualty................................. $ 495.1 $ 487.8 $ 458.0 $ 427.1 $ 405.8 Annuity............................................... 205.7 223.3 199.2 166.9 142.9 Life.................................................. 120.4 116.7 114.1 110.8 105.3 Total............................................... 821.2 827.8 771.3 704.8 654.0 Operating income(4) Property and casualty................................. $ 39.5 $ 53.2 $ 61.4 $ 54.0 $ 56.4 Annuity............................................... 27.3 23.1 19.3 16.3 14.8 Life.................................................. 14.6 12.4 12.9 12.1 10.4 Corporate and other, including interest expense....... (10.7) (9.8) (10.0) (9.3) (10.7) Total............................................... 70.7 78.9 83.6 73.1 70.9 Statutory Operating Data(8): Property and casualty: Loss and loss adjustment expense ratio................ 76.3% 74.4% 71.7% 74.1% 73.5% Expense ratio......................................... 19.8% 19.3% 19.4% 19.4% 19.8% Combined loss and expense ratio(9).................... 96.1% 93.6% 91.1% 93.5% 93.3% Industry average combined loss and expense ratio(9)(10)............................ 107.5% 105.6% 101.6% 105.8% 106.5% Personal lines industry segment average combined loss and expense ratio(9)(10)....................... 106.0% 102.7% 99.8% 104.9% 103.5% Annuity accumulated value on deposit.................... $2,487.3 $2,475.5 $2,314.2 $2,075.5 $1,866.0 Life insurance in force................................. $ 12,300 $ 11,799 $ 11,188 $ 10,645 $ 10,235 Adjusted capital and surplus of insurance subsidiaries (includes investment reserves)(11).................... $ 405.7 $ 379.8 $ 372.3 $ 404.6 $ 389.8
___________________________ (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) 1999 includes a non-recurring charge of $20.0 million, or $0.48 per share, to record an additional federal income tax provision representing the Company's maximum exposure for disputed prior years' taxes. (3) 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. (4) Income from continuing operations before the after tax impact of realized investment gains and losses, litigation settlement, provision for prior years' taxes, cost of the additional rights relating to the 1995 share repurchase and discontinued operations. (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 common stock options, Director Stock Plan units and Employee Stock Plan units, warrants prior to their repurchase in 1999 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 a decrease, net of taxes, of $40.0 million at December 31, 1999 and 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. Excluding the FAS 115 market value accounting for investments, book value per share was $10.73, $10.44, $10.03, $9.62 and $8.42 at December 31, 1999, 1998, 1997, 1996 and 1995, 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 (1996 through 1999 Eds.). The industry averages for the year ended December 31, 1999 are from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 2000, published by A.M. Best. (11) Investment reserves were the Asset Valuation Reserves. 5 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, ---------------------------------------------- 1999 1998 1997 -------------- -------------- -------------- Property and casualty........ $495.1 60.3% $487.8 58.9% $458.0 59.4% Annuity...................... 205.7 25.0 223.3 27.0 199.2 25.8 Life......................... 120.4 14.7 116.7 14.1 114.1 14.8 ------ ----- ------ ----- ------ ----- Total....................... $821.2 100.0% $827.8 100.0% $771.3 100.0% ====== ===== ====== ===== ====== =====
Corporate Strategy and Marketing The Company's target market consists of educators and other employees of public schools and their families. Horace Mann is the only national multiline insurance company focused on the niche educator market. 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, and customer referrals. The U.S. Department of Education estimates that the number of public school teachers is growing 1% annually. Recent federal programs which reduce class size and add additional teachers may increase this growth rate. Annual turnover of 8% in the educator market, combined with the 1% growth rate cited above, results in a 9% annual increase in the Company's niche market. In addition to increases in the number of teachers that result from growth in the general population and in the number of school age children, turnover among the teacher population increases the size of the Company's 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. The Company's 1.1 million customers 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 trained to sell multiline products. As of December 31, 1999, the Company employed 1,105 full- time agents, including 708 agents having more than two years of experience with the Company. Many of the Company's agents were previously teachers or other members of the education profession who both understand their customers' needs and maintain relationships with current and former educators. The Company's agents market and write the full range of the Company's products with all agents licensed in both property and casualty and life products and approximately 80% of experienced agents licensed by the National Association of Securities Dealers, Inc. ("NASD") to sell variable annuities. They are under contract to market and write only those products authorized by the Company. The agency force is managed through 63 agency offices in 47 states. 6 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 an advantageous position to write and service individual insurance business for educators. In surveys, the Company's customers have stated that important reasons for choosing and staying with Horace Mann are the personal service and broad array of products the Company's agents deliver and education association sponsorships. Management believes that Horace Mann's name recognition and policyholder loyalties lead to new customers and cross selling of additional insurance products. At December 31, 1999, 32% of the Company's 1.1 million customers had more than one Horace Mann product. The Company's agents pre-underwrite policy applicants. The Company structures its agent training and its agent compensation to provide incentives for agents to adhere to the Company's underwriting standards and practices and business growth plans. Agents' compensation increases by writing more profitable business, not just additional business. Agents' 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 1999, incentive bonuses represented 24% 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 individual and agency 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, 1999, the Company had established relationships with over 100 educator credit unions serving nearly 700,000 members 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 and its agents 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 product lines for the year ended December 31, 1999, the top five states and their portion of total premium were North Carolina, 7.9%; Texas, 6.4%; Illinois, 5.2%; Massachusetts, 5.2%; and Minnesota, 4.9%. 7 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 1999:
Property and Casualty Segment Top Ten States (Dollars in millions) Property and Casualty Segment -------------------------- Direct Percent State Premiums(1) of Total - ----- ----------- -------- North Carolina.................................... $ 36.3 7.4% Texas............................................. 34.8 7.1 Massachusetts..................................... 34.3 7.0 California........................................ 33.3 6.7 Minnesota......................................... 30.8 6.2 Florida........................................... 28.1 5.7 Pennsylvania...................................... 23.2 4.7 Michigan.......................................... 21.3 4.3 South Carolina.................................... 20.8 4.2 Georgia........................................... 16.4 3.3 ------ ----- Total of top ten states.......................... 279.3 56.6 All other areas................................... 214.5 43.4 ------ ----- Total direct premiums............................ $493.8 100.0% ====== =====
____________________ (1) Defined as earned premiums before reinsurance and is determined under statutory accounting practices. 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 1999: Combined Life and Annuity Segments Top Ten States (Dollars in millions)
Direct Premiums and Percent State Contract Deposits(1) of Total - ----- -------------------- -------- North Carolina.................................... $ 29.0 8.8% Illinois.......................................... 28.8 8.8 Virginia.......................................... 19.7 6.0 Tennessee......................................... 18.3 5.6 Texas............................................. 17.6 5.3 Indiana........................................... 15.7 4.8 Pennsylvania...................................... 10.9 3.3 Maine............................................. 10.5 3.2 Wisconsin......................................... 10.4 3.2 Louisiana......................................... 10.0 3.0 ------ ----- Total of top ten states.......................... 170.9 52.0 All other areas................................... 157.9 48.0 ------ ----- Total direct premiums............................ $328.8 100.0% ====== =====
__________________ (1) Determined under statutory accounting practices. 8 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 and additional product features and coverages. From 1984 to September 1993 and beginning again in September 1996, on a national level NEA purchased from the Company educator excess professional liability insurance for all of its members. NEA has committed to purchase this insurance from the Company through August 2002. Premium from this product represents less than 1% 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 39 NEA-affiliated state associations as of December 31, 1999. Since 1988, the Company's homeowners policy was the only product of the Company that was sponsored by NEA (exclusive of the educator excess professional liability insurance policy purchased by NEA as described above). NEA-affiliated education associations in 40 states sponsor products of the Company other than homeowners. NEA-affiliated education associations in 45 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. 9 In addition to its longstanding relationships with NEA and affiliated state and local education associations, the Company has established its brand name through its annual scholarship program for dependents of public school employees, its annual educator surveys, sponsorship of the National Teacher Hall of Fame, sponsorship of the educator and student resource website www.reacheverychild.com and availability of educator information on the Company's website www.horacemann.com as well as local agent contacts with school districts. The Company tailors its products to the educator market, including certain educator specific features and hybrid products, which distinguishes the Company's products from competitors. Property and Casualty The property and casualty segment represented 60% of the Company's total insurance premiums and contract deposits and 56% of the Company's operating income in 1999. The primary property and casualty product offered by the Company is private passenger automobile insurance, which in 1999 represented 46% of the Company's total insurance premiums written and contract deposits and 76% of property and casualty net written premiums. As of December 31, 1999, the Company had approximately 592,000 voluntary automobile policies in force with annual premiums of approximately $408 million. The Company's automobile business is primarily preferred risk, defined as a household whose drivers have no accidents and no more than one violation. The Company has instituted a program in a limited number of states to provide non-preferred risk coverage to the educator market, with a third-party vendor underwriting such insurance and the Company receiving a commission on its sale. In 1999, homeowners insurance represented 14% of the Company's total insurance premiums written and contract deposits and 23% of property and casualty premiums. The Company writes primarily residential homes. As of December 31, 1999, the Company had approximately 280,000 homeowners policies in force with annual premiums of approximately $113 million. The educator excess professional liability insurance represented the remaining 1% of the Company's 1999 property and casualty premiums. 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. Generally, 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. 10 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, ------------------------ 1999 1998 1997 ------ ------ ------ Statement of Operations Data: Insurance premiums written........................ $495.1 $487.8 $458.0 Insurance premiums earned......................... 491.1 476.4 447.2 Net investment income............................. 37.0 38.9 41.7 Operating income before income taxes.............. 54.6 66.5 78.7 Operating income.................................. 39.5 53.2 61.4 Net investment income, after tax.................. 28.3 29.0 30.4 Catastrophe costs, after tax...................... 12.7 18.5 4.0 Statutory Operating Statistics: Loss and loss adjustment expense ratio............ 76.3% 74.4% 71.7% Expense ratio..................................... 19.8% 19.3% 19.4% Combined loss and expense ratio (including policyholder dividends)............... 96.1% 93.6% 91.1% Combined loss and expense ratio before catastrophes (including policyholder dividends).. 92.2% 87.7% 89.7% GAAP Operating Statistics: Loss and loss adjustment expense ratio............ 76.3% 74.4% 71.7% Expense ratio..................................... 19.7% 19.3% 19.6% Combined loss and expense ratio (including policyholder dividends)............... 96.0% 93.7% 91.3% Combined loss and expense ratio before catastrophes (including policyholder dividends).. 92.1% 87.8% 89.9% Automobile and Homeowners (Voluntary): Insurance premiums written........................ $470.7 $459.0 $431.0 Insurance premiums earned......................... 465.0 449.9 421.5 Policies in force (in thousands).................. 872 859 837
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 12 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 10 percentage points per year. 11 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, 1999......................... 96.1% 106.0% 107.5% 1998......................... 93.6 102.7 105.6 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
__________________ (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 1990 through 1993. (3) Source: Best's Aggregates and Averages (1991 through 1999 Eds.). 1999 is an estimate from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 2000, 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, 1999 were as follows:
Catastrophe Costs (Dollars in millions) Property and The Casualty Company(1) Industry(2) ---------- ----------- Year Ended December 31, 1999...................................... $19.6 $ 8,200.0 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...................................... 16.2 17,030.0 1993...................................... 8.3 5,705.0 1992...................................... 13.3 22,870.0 1991...................................... 9.9 4,698.0 1990...................................... 7.0 2,560.0
__________________________ (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: 1999 - $5.4 million, Hurricane Floyd; $3.1 million, May tornadoes primarily in Oklahoma. 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. (2) Source: 1999 from Insurance Services Office, Inc. news release dated January 18, 2000. 1990 through 1998 from 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 4.8 percentage points per year. The Company's property and casualty expense ratio for the year ended December 31, 1999 was 19.8%. 12 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, 1999......................... 19.8% 26.2% 28.1% 1998......................... 19.3 25.0 27.7 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
______________________ (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 1990 through 1993. (3) Source: Best's Aggregates and Averages (1991 through 1999 Eds.). The 1999 personal lines result is an estimate from A.M. Best. The 1999 total industry result is an estimate from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 2000, published by A.M. Best. Property and Casualty Reserves In each of the last ten 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. Due to the nature of the Company's personal lines business, 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 claims adjustment expense 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 of losses may vary materially from the recorded reserve 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 appropriate. 13 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, 1999 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 reserves, 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, ------------------------------------- 1999 1998 1997 ------ ------ ------ Gross reserves, beginning of year...................................... $298.9 $310.6 $340.4 Less reinsurance recoverables......................................... 55.9 41.3 34.1 ------ ------ ------ Net reserves, beginning of year........................................ 243.0 269.3 306.3 ------ ------ ------ Incurred claims and claims expense: Claims occurring in the current year.................................. 379.5 379.6 365.9 Increase (decrease) in estimated reserves for claims occurring in prior years(1): Policies written by the Company..................................... (7.6) (23.3) (40.0) Business assumed from state reinsurance facilities.................. 3.0 (1.6) (5.1) ------ ------ ------ Total decrease..................................................... (4.6) (24.9) (45.1) ------ ------ ------ Total claims and claims expense incurred............................ 374.9 354.7 320.8 ------ ------ ------ Claims and claims expense payments for claims occurring during: Current year.......................................................... 240.0 239.0 209.2 Prior years........................................................... 142.5 142.0 148.6 ------ ------ ------ Total claims and claims expense payments............................ 382.5 381.0 357.8 ------ ------ ------ Net reserves, end of period............................................ 235.4 243.0 269.3 Plus reinsurance recoverables......................................... 64.4 55.9 41.3 ------ ------ ------ Gross reserves, end of period(2)....................................... $299.8 $298.9 $310.6 ====== ====== ======
____________________ (1) Shows the amounts by which the Company decreased or increased 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 expense as reported in the consolidated balance sheets also include life, annuity, and group accident and health reserves of $9.8 million, $8.5 million and $11.7 million at December 31, 1999, 1998 and 1997, respectively, in addition to property and casualty reserves. The provision for claims and claims expenses for insured events in prior years decreased by $4.6 million, $24.9 million and $45.1 million for the years ended December 31, 1999, 1998 and 1997, respectively. This favorable claim development resulted primarily from improving trends in the frequency and severity of voluntary automobile claims. Future reserve releases, if any, will depend on the continuation of favorable claim trends. The year-end 1999 gross reserves of $299.8 million for property and casualty insurance claims and claims expense, as determined under GAAP, were $64.4 million more than the reserve balance of $235.4 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 $64.4 million that reduces reserves for statutory reporting and is recorded as an asset for GAAP reporting. 14 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, ----------------------------- 1999 1998 1997 ------- ------ ------ Claims and claims expense incurred... $374.9 $354.7 $320.8 Amount attributable to catastrophes.. 19.4 28.0 6.2 ------ ------ ------ Excluding catastrophes............. $355.5 $326.7 $314.6 ====== ====== ====== Claims and claims expense payments... $382.5 $381.0 $357.8 Amount attributable to catastrophes.. 17.4 25.2 5.7 ------ ------ ------ Excluding catastrophes............. $365.1 $355.8 $352.1 ====== ====== ======
___________________________ (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 learning additional facts 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. 15 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 1998 to be $150 thousand was first reserved in 1989 at $100 thousand, the $50 thousand deficiency (actual claim minus original estimate) would be included in the cumulative deficiency in each of the years 1989 - 1997 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, ------------------------------------------------------------------------------------------------------- 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 ------ ------ ------ ------ ------ ------ ------ ------ ------ -------- ------ Gross reserves for property and casualty claims and claims expenses, beginning of year......... $320.9 $319.4 $331.5 $358.2 $373.5 $389.1 $369.7 $340.4 $310.6 $298.9 $299.8 Deduct: Reinsurance recoverables.............. 46.9 20.9 14.8 17.7 21.6 19.5 23.8 34.1 41.3 55.9 64.4 ------ ------ ------ ------ ------ ------ ------ ------ ------ -------- ------ Net reserves for property and casualty claims and claims expenses, beginning of year......... 274.0 298.5 316.7 340.5 351.9 369.6 345.9 306.3 269.3 243.0 235.4 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............ 115.0 111.3 116.1 117.6 133.4 140.8 139.3 148.6 142.0 142.5 Two years later........... 163.9 167.4 170.0 169.6 190.5 194.5 195.3 202.1 191.4 Three years later......... 192.6 197.1 197.2 197.8 218.4 224.2 223.0 225.1 Four years later.......... 208.2 212.9 212.1 213.6 234.1 237.9 233.8 Five years later.......... 216.4 220.7 220.5 222.6 241.0 243.1 Six years later........... 219.3 225.3 224.8 226.0 243.7 Seven years later......... 221.7 228.2 227.1 227.5 Eight years later......... 223.2 229.5 227.9 Nine years later.......... 224.1 229.9 Ten years later........... 224.3 Reserves reestimated as of: End of year............... 274.0 298.5 316.7 340.5 381.9 369.6 345.9 306.3 269.3 243.0 235.4 One year later............ 265.9 279.9 297.3 306.1 327.6 314.0 283.4 261.2 244.4 238.4 Two years later........... 254.5 266.7 272.1 267.7 281.9 269.2 249.6 250.2 239.3 Three years later......... 239.4 246.7 246.8 246.4 258.1 251.4 245.8 247.8 Four years later.......... 233.2 236.5 235.2 233.3 249.3 248.9 243.8 Five years later.......... 227.8 232.4 229.8 229.7 247.4 247.0 Six years later........... 225.4 230.8 230.1 230.0 246.6 Seven years later......... 224.9 231.1 230.1 229.8 Eight years later......... 225.2 231.7 230.0 Nine years later.......... 225.7 231.8 Ten years later........... 225.9 Reserve redundancy - Initial net reserves in excess of reestimated reserves: Amount................... $ 48.1 $ 66.7 $ 86.7 $110.7 $135.3 $122.6 $102.1 $ 58.5 $ 30.0 $ 4.6 Percent.................. 17.6% 22.3% 27.4% 32.5% 35.4% 33.2% 29.5% 19.1% 11.1% 1.9% Gross reestimated liability - latest........ $285.3 $281.9 $292.8 Reestimated reinsurance recoverables - latest.................... 37.5 42.6 54.4 ------ ------ ------ Net reestimated liability - latest.................. 247.8 239.3 238.4 Gross cumulative excess.... $ 55.1 $ 28.7 $ 6.1 ======= ====== ========
As the table above illustrates, the Company's net reserve for property and casualty insurance claims and claims expense at the end of 1998 developed favorably in 1999 by $4.6 million, comparable to favorable development of the gross reserves of $6.1 million. 16 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 excess 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, 1999 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, deductibles, maximum coverage limits, the purchase of catastrophe reinsurance, and the purchase of a catastrophe-linked equity put option and reinsurance agreement. 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 1999 and 2000. In addition, the Company reinsures 75% of catastrophe losses in Florida above a retention of $6.1 million. These programs are augmented by a $100 million equity put and reinsurance agreement. 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 property catastrophes 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 1999 and 2000, including the educator excess 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, including catastrophe losses that in the aggregate are less than the retention levels above, above a retention of $500,000 up to $2.5 million in 1999 and 2000. 17 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 2000 or 1999 exceeds 5%. Property Catastrophe Reinsurance Participants In Excess of 5%
Participation S&P A.M. Best ------------- Rating Rating Reinsurer Parent 2000 1999 --------- ------ --------- ------- ---- ---- AA A+ AXA Reinsurance Company AXA Group 11% 11% AA A+ St. Paul Fire and Marine Insurance Company The St. Paul Companies, Inc. 11% 11% AA A++ Erie Insurance Exchange 9% 9% AAA A++ American Re-insurance Company Muenchener Rueckversicherungs- Gesellschaft AG (Munich Re) of Germany 6% 6% AA A+ NAC Reinsurance NAC Re Corporation 6% 6% Corporation A A Continental Casualty Loews Corporation 6% 6% Company* A+ A Lloyd's of London 5% 5% Syndicates** AA+ A+ Hannover Ruckversicherungs AG HDI Haftpflicht-verband der Deutschen Industrie VaG 5% 5%
_________________________________ * Includes 1 percentage point from CNA Reinsurance Company Ltd. of London, England. ** For 2000 and 1999, the 5% participation by Lloyd's of London in the Company's catastrophe reinsurance program is disbursed among 4 syndicates. For 2000, 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. The Company is the 14th largest provider of 403(b) tax-qualified variable annuities and one of the 20 largest participants in the fixed and variable 403(b) tax-qualified annuity market according to a 1999 A.M. Best report. Approximately 70% of the Company's new annuity contract deposits in 1999 were for 403(b) tax-qualified annuities; approximately 80% of accumulated annuity value on deposit is 403(b) tax- qualified. In 1999, annuities represented 25% of the Company's total insurance premiums written and contract deposits and 38% of the Company's operating income. 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. 18 Under the fixed account option, both the principal and a rate of return are guaranteed. The seven mutual fund options 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. The common stock fund and the combination bond and stock fund together represent 86% of the Company's variable annuity accumulations at December 31, 1999. Total accumulated fixed and variable annuity cash value on deposit at December 31, 1999 was $2,487.3 million. For the year ended December 31, 1999, 91% 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 1998, 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 45% of accumulated values subject to withdrawal penalties for stock life insurance companies for 1998, 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 such annuities. Generally, a penalty is imposed under the Internal Revenue Code on amounts withdrawn from tax-qualified annuities prior to age 59 1/2. Total accumulated annuity funds on deposit at December 31, 1999 consisted of 45% variable annuities and 55% fixed annuities. The growth of the annuity segment in the last five years has come from the variable annuity product. 19 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, ---------------------------------- 1999 1998 1997 ---------- ---------- ---------- Statement of Operations Data: Contract deposits: Variable............................................... $ 129.2 $ 138.6 $ 112.2 Fixed.................................................. 76.5 84.7 87.0 Total................................................ 205.7 223.3 199.2 Contract charges earned.................................. 16.7 15.6 12.6 Net investment income.................................... 105.3 107.7 113.1 Net interest margin (without realized gains)............. 38.1 35.7 36.6 Net margin (includes fees and contract charges earned)... 57.6 53.5 51.0 Operating income before income taxes..................... 41.8 35.4 29.8 Operating income......................................... 27.3 23.1 19.3 Operating Statistics: Fixed annuity: Accumulated value...................................... $1,355.6 $1,352.7 $1,354.5 Accumulated value persistency.......................... 92.3% 92.8% 91.7% Variable annuity accumulated value....................... $1,131.7 $1,122.8 $ 959.7 Number of contracts in force............................. 125,352 120,253 112,162 Average accumulated cash value (in dollars).............. $ 19,843 $ 20,586 $ 20,633 Average annual deposit by contractholders (in dollars)... $ 2,327 $ 2,416 $ 2,485 Maturity schedule for all annuity contracts: Matured................................................ $ 211.9 $ 205.6 $ 195.7 5 years or less........................................ 339.4 436.0 424.4 After 5 years through 10 years......................... 536.3 550.3 489.6 After 10 years through 20 years........................ 882.6 831.1 793.9 After 20 years......................................... 517.1 452.5 410.6 Total accumulated cash value......................... $2,487.3 $2,475.5 $2,314.2 Annuity contracts terminated due to surrender, death, maturity or other: Number of contracts.................................. 8,353 6,987 6,945 Amount............................................... $ 269.2 $ 224.8 $ 168.2 Accumulated fixed annuity value grouped by applicable surrender charge: 0%................................................... $ 315.9 $ 319.8 $ 326.3 5% and greater but less than 10%..................... 841.4 825.3 808.9 10% and greater...................................... 108.4 120.6 137.5 Supplementary contracts with life contingencies not subject to discretionary withdrawal............ 89.9 87.0 81.8 Total accumulated fixed annuity value............ $1,355.6 $1,352.7 $1,354.5
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, adjustable premium 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, 1999 the Company had in force approximately 98,000 Experience Life policies representing approximately $6.7 billion of life insurance in force with annual insurance premiums and contract deposits of approximately $73.5 million. The Company's traditional term, whole life and group life business in force consists of approximately 168,000 policies, representing approximately $5.6 billion of life insurance in force with annual insurance premiums and contract deposits of approximately $34.8 million as of December 31, 1999. 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 serve the needs of customers who also want limited life insurance coverage (as low as $5,000 death benefits) but 20 who want the features of a whole life policy. The Company does not charge any penalty for withdrawal of life insurance cash values. In 1999, the life segment represented 15% of the Company's total insurance premiums written and contract deposits, including approximately 1.4 percentage points attributable to the Company's group life and group disability income business, and 21% of the Company's operating income. During 1999, the average face amount of ordinary life insurance policies issued by the Company was $101,773 and the average face amount of all ordinary life insurance policies it had in force at December 31, 1999 was $54,520. The maximum individual life insurance risk retained by the Company is $200,000 on any individual life and $100,000 is retained on each group life policy. The excess of the amounts retained are reinsured with life reinsurers that are all 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. 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, ------------------------------- 1999 1998 1997 --------- --------- --------- Statement of Operations Data: Insurance premiums and contract deposits.............. $ 120.4 $ 116.7 $ 114.1 Insurance premiums and contract charges earned........ 87.3 85.8 82.9 Net investment income................................. 47.0 45.4 43.7 Operating income before income taxes.................. 22.3 19.0 19.9 Operating income...................................... 14.6 12.4 12.9 Operating Statistics: Life insurance in force: Ordinary life....................................... $ 10,749 $ 10,573 $ 10,241 Group life.......................................... 1,551 1,226 947 Total............................................. 12,300 11,799 11,188 Number of policies in force: Ordinary life....................................... 198,898 201,689 200,811 Group life.......................................... 66,953 57,010 51,895 Total............................................. 265,851 258,699 252,706 Average face amount in force (in dollars): Ordinary life....................................... $ 54,520 $ 52,422 $ 50,998 Group life.......................................... 23,166 21,505 18,248 Total............................................. 46,267 45,609 44,273 Persistency rate (ordinary life insurance in force)... 91.7% 92.8% 93.0% Lapse ratio (ordinary life insurance in force)........ 8.3% 7.2% 7.0% Ordinary life insurance terminated due to death, surrender, lapse or other: Face amount of insurance surrendered or lapsed.... $ 998.9 $ 888.2 $ 771.4 Number of policies.............................. 13,092 9,396 9,571 Amount of death claims............................ $ 26.4 $ 26.5 $ 22.0 Number of death claims.......................... 1,326 1,300 1,274
21 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 fixed income securities. 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, 1999, investments in non-investment grade securities represented 6.9% of total investments. At December 31, 1999, fixed income securities represented 95.3% of investments. Of the fixed income investment portfolio, 93.2% was investment grade and 99.8% was publicly traded. The average quality of the total fixed income portfolio was AA-/A+ at December 31, 1999, and the average option adjusted duration of total investments was 4.1 years. There are no significant investments in mortgage loans, real estate, foreign securities 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 which attempt to coordinate 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. 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. 22 The following table sets forth the carrying and market values of the Company's investment portfolio as of December 31, 1999:
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................ 18.9% $ 498.1 $ 439.0 $ 59.1 $ 506.1 Other..................................... 5.0 131.4 120.9 10.5 136.4 Investment grade corporate and public utility bonds............................. 36.5 958.9 871.2 87.7 990.0 Municipal bonds............................. 11.5 302.0 36.5 265.5 307.0 Other mortgage-backed securities............ 15.5 408.0 378.2 29.8 418.6 Non-investment grade corporate and public utility bonds(2).......................... 6.9 181.0 116.9 64.1 189.5 Foreign government bonds.................... 0.8 22.0 22.0 - 21.9 Short-term investments(3)................... 1.7 45.1 26.4 18.7 45.1 ----- -------- -------- ------ -------- Total publicly traded securities....... 96.8 2,546.5 2,011.1 535.4 2,614.6 ----- -------- -------- ------ -------- Other Investments: Private placements, investment grade(4)..... 0.2 5.8 5.7 0.1 5.8 Private placements, non-investment grade (2)(4)............... - 0.1 0.1 - 0.1 Mortgage loans and real estate(5)........... 0.7 17.6 17.6 - 17.6 Policy loans and other...................... 2.3 60.2 58.7 1.5 59.4 ----- -------- -------- ------ -------- Total other investments................ 3.2 83.7 82.1 1.6 82.9 ----- -------- -------- ------ -------- Total investments(6)................... 100.0% $2,630.2 $2,093.2 $537.0 $2,697.5 ===== ======== ======== ====== ========
_____________ (1) Includes $221.7 million market value of investments guaranteed by the full faith and credit of the United States government and $407.8 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 $45.0 million in a money market fund rated "AAA" (S&P or its equivalent) and $0.1 million in certificates of deposit. (4) Market values for private placements are estimated by the Company with the assistance of its investment advisors. (5) 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. (6) Approximately 14% of the Company's investment portfolio, having a carrying value of $369.8 million as of December 31, 1999, consisted of securities with some form of credit support, such as insurance. All of these securities have the highest investment grade rating. Fixed Maturity Securities The following table sets forth the composition of the Company's fixed maturity securities portfolio by rating as of December 31, 1999:
Rating of Fixed Maturity Securities(1) (Dollars in millions) Percent of Total Carrying Carrying Amortized Value Value Cost -------- -------- --------- AAA............................................ 46.3% $1,159.9 $1,185.5 AA............................................. 7.7 192.1 193.4 A.............................................. 20.2 507.0 516.0 BBB............................................ 18.8 471.9 495.4 BB............................................. 2.0 50.7 56.4 B.............................................. 4.7 117.4 119.7 CCC or lower................................... - 1.3 1.4 Not rated(2)................................... 0.3 7.0 7.6 ----- -------- -------- Total 100.0% $2,507.3 $2,575.4 ===== ======== ========
______________ (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 $1.1 million of publicly traded securities not currently rated by S&P, Moody's or the NAIC and $5.9 million of private placement securities not rated by either S&P or Moody's. The NAIC has rated 98.1% of these private placement securities as investment grade. 23 At December 31, 1999, 38.0% 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 34.4% of the total investment portfolio at December 31, 1999. 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. 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 2000 from all of HMEC's insurance subsidiaries without prior regulatory approval is approximately $75 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. 24 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 the only national multiline insurance company 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 have been among the Company's major tax-qualified annuity competitors. In January 2000, Nationwide announced it will exit its individual business, including the Kindergarten - 12 tax-qualified annuity market. 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 21st 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, name recognition and education association sponsorships. 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, education association sponsorships and price. 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 25 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. HMLIC is rated "AA" for claims paying ability by 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 trends 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 26 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 from individual state regulators, and further investigation or other actions may result. In 1998, no unusual ratios were reported by the principal insurance subsidiaries of HMEC. 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. In 1999, routine financial examinations of HMLIC, HMIC, TIC and Allegiance were completed for the period ended December 31, 1997. 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. 27 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 $0.1 million, $0.3 million and $0.6 million in connection with insurer insolvency proceedings for the years ended December 31, 1999, 1998 and 1997, respectively, of which $0, $0.2 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 1999, the Company reflected a net loss from participation in such mandatory pools and underwriting associations of $2.2 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 operates as an insurance company providing residential property earthquake coverage under policies sold by companies which have chosen to participate in the CEA. The participating companies 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. With the passage of the Financial Services Modernization Act of 1999, it is possible there will be increased pressure for federal regulation of the insurance industry. 28 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, 1999, the Company had approximately 2,800 employees, including 1,105 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. ITEM 4. Submission of Matters to a Vote of Security Holders None. 29 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 ------------- ------ ------- -------- 1999: Fourth Quarter............... $31 $19 1/8 $0.105 Third Quarter................ 33 24 13/16 0.0925 Second Quarter............... 27 3/16 20 1/4 0.0925 First Quarter................ 29 3/8 21 9/16 0.0925 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
As of March 1, 2000, the approximate number of holders of common stock was 9,000. In November 1999, the Board authorized the eighth consecutive increase in the Company's dividend since the Company's initial public offering in 1991 and increased the quarterly dividend by 13.5% to $0.105 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 May 1999, 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 programs announced in January 1998 and February 1997. Since early 1997, the Company repurchased 7,082,700 shares, 15% of the Company's shares outstanding at December 31, 1996, at an aggregate cost of $188.5 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, when necessary, the existing bank line of credit. The Company's share repurchase program was suspended by the Board of Directors from August 2, 1999 through February 23, 2000. During 1999, options were exercised for the issuance of 17,363 shares, less than 0.1% of the Company's shares outstanding at December 31, 1998. 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." 30 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 2000 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 2000 Annual Meeting of Shareholders. 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 2000 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 2000 Annual Meeting of Shareholders. 31 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, 1999, 1998 and 1997. Consolidated Statements of Operations for the Years Ended December 31, 1999, 1998 and 1997. Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1999, 1998 and 1997. Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997. (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. (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. 3.1(a) 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. 32 Exhibit No. Description - ---- ----------- 3.1(b) 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. 3.1(c) 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. 3.1(d) 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. 3.2 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. 3.3 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. (4) Instruments defining the rights of security holders, including indentures: 4.1 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. 4.1(a) Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.1). 4.2 Certificate of Designations for HMEC Series A Cumulative Preferred Stock (included in Exhibit 10.15). (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. 33 Exhibit No. Description - ---- ----------- 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. 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* Amended and restated Horace Mann Educators Corporation 1991 Stock Incentive Plan. 10.5(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan. 10.5(b)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan. 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. 10.6(a)* Revised Schedule to Severance Agreements between HMEC and certain officers of HMEC, incorporated by reference to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999, filed with the SEC on August 13, 1999. 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. 34 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 Employment 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. 10.11(a)* Amendment Agreement to the Amended and Restated Employment Agreement entered by and between HMEC and Paul J. Kardos as of October 6, 1998 dated as of February 1, 2000. 10.12* Employment Agreement entered by and between HMEC and Louis G. Lower II as of December 31, 1999. 10.13* Separation Agreement entered by and between HMEC and Larry K. Becker as of March 21, 2000. 10.14* Letter of Employment entered by and between HMEC and Peter H. Heckman effective April 10, 2000. 10.15 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. 10.15(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. 10.15(b) Amendment effective February 15, 1997 to Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement, incorporated by reference to Exhibit 10.12(b) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1998, filed with the SEC on March 31, 1999. 35 10.15(c) Amendment effective June 1, 1999 to Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement, incorporated by reference to Exhibit 10.1(c) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999, filed with the SEC on November 12, 1999. (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. (b) No reports on Form 8-K were filed by HMEC during the fourth quarter of 1999. (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. 36 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/ Louis G. Lower II - --------------------------------------- Louis G. Lower II 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 ----------------------------------- Paul J. Kardos, Chairman of the /s/ Louis G. Lower II Board of Directors - --------------------------------------- Louis G. Lower II President, Chief Executive Officer and a Director /s/ William W. Abbott ----------------------------------- William W. Abbott, 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 /s/ Shaun F. O'Malley ----------------------------------- Shaun F. O'Malley, Director Principal Accounting Officer: /s/ Charles A. Parker ----------------------------------- Charles A. Parker, Director /s/ Roger W. Fisher - --------------------------------------- Roger W. Fisher Senior Vice President and Controller /s/ Ralph S. Saul ----------------------------------- Ralph S. Saul, Director /s/ William J. Schoen ----------------------------------- William J. Schoen, Director Dated: March 29, 2000. 37 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-22 Independent Auditors' Report.............................................. F-23 Consolidated Balance Sheets............................................... F-24 Consolidated Statements of Operations..................................... F-25 Consolidated Statements of Changes in Shareholders' Equity.................................................... F-26 Consolidated Statements of Cash Flows..................................... F-27 Notes to Consolidated Financial Statements................................ F-28 Financial Statement Schedules: Schedule I - Summary of Investments-Other than Investments in Related Parties........................................ F-61 Schedule II - Condensed Financial Information of Registrant............. F-62 Schedule III and VI Combined - Supplementary Insurance Information and Supplemental Information Concerning Property and Casualty Insurance Operations............................ F-66 Schedule IV - Reinsurance............................................... F-67
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. . The resolution of legal proceedings and related matters. Strategic Review On August 2, 1999, the Company announced that its Board of Directors had retained Morgan Stanley Dean Witter and Credit Suisse First Boston to explore strategic alternatives available to the corporation. On November 17, 1999, the Board of Directors announced its determination that at that point in time the Company's shareholder value would be best sustained and enhanced by Horace Mann Educators Corporation remaining an independent company. At F-2 that time, the retention agreements between the Company and each of Morgan Stanley Dean Witter and Credit Suisse First Boston were terminated. Year Ended December 31, 1999 Compared With Year Ended December 31, 1998 Insurance Premiums and Contract Charges Insurance Premiums Written and Contract Deposits
Year Ended Growth Over December 31, Prior Year -------------- ---------------- 1999 1998 Percent Amount ---- ---- ------- ------ Automobile and property (voluntary).................. $470.7 $459.0 2.5% $ 11.7 Annuity deposits............... 205.7 223.3 -7.9% (17.6) Life........................... 120.4 116.7 3.2% 3.7 ------ ------ ------ Subtotal - core lines...... 796.8 799.0 -0.3% (2.2) Involuntary and other property & casualty.......... 24.4 28.8 -15.3% (4.4) ------ ------ ------ Total...................... $821.2 $827.8 -0.8% $ (6.6) ====== ====== ======
Insurance Premiums and Contract Charges Earned (Excludes annuity and life contract deposits)
Year Ended Growth Over December 31, Prior Year -------------- ---------------- 1999 1998 Percent Amount ---- ---- ------- ------ Automobile and property (voluntary).................. $465.0 $449.9 3.4% $15.1 Annuity........................ 16.7 15.6 7.1% 1.1 Life........................... 87.3 85.8 1.7% 1.5 ------ ------ ----- Subtotal - core lines...... 569.0 551.3 3.2% 17.7 Involuntary and other property & casualty.......... 26.1 26.5 -1.5% (0.4) ------ ------ ----- Total...................... $595.1 $577.8 3.0% $17.3 ====== ====== =====
The property and casualty and life segments both experienced modest premium growth for the year. Nonetheless, total insurance premiums written and contract deposits showed no growth for the year because of a decline in new annuity deposits. Annuity growth of 12.1% for 1998 benefitted from new tax legislation which contributed to a high volume of single premium and rollover deposits to tax-qualified products. In 1999, single premium annuity deposits declined significantly, (20.7%), compared to 1998. The Company ended the year with 708 experienced exclusive full-time agents, growth of 2.3% compared to 12 months earlier. The total agency force of 1,105 agents decreased 2.0% compared to a year ago as a result of fewer hires and increased terminations over the 12-month period. Modifications have been made to agent recruiting and the new agents' finance programs that management believes will have a positive impact on agent growth in future years. F-3 Total voluntary automobile and homeowners premium written growth was 2.5% for 1999, resulting from growth in the average premium per policy for both automobile and homeowners and an increase in the number of homeowners policies in force. Automobile insurance premium increased 1.0%, or $3.7 million, compared to 1998, and homeowners premium increased 7.8%, or $8.0 million. Nearly one-half of the property and casualty increase in premiums resulted from unit growth of 1.5%, bringing year-end policies in force to 872,000. Compared to December 31, 1998, total property and casualty policies in force increased 13,000, the entire increase attributable to homeowners insurance. The Company's average annual premium per policy for automobile and homeowners increased approximately 1% and 3%, respectively, compared to a year earlier. While automobile policies in force ended the year equal to 1998, the 1% increase in average premium per automobile policy kept pace with loss cost developments. Based on policies in force, the property and casualty 12-month retention rate for new and renewal policies was 88%, slightly less than for the 12 months ended December 31, 1998. The change in property and casualty retention was primarily caused by greater price competition for automobile insurance. New annuity deposits decreased 7.9% compared to 1998, with a 5.4% decline in the fourth quarter. The decline was primarily attributable to a 20.7% decrease in 1999 in single premium deposits, which in 1998 benefitted from new tax legislation which contributed to a high volume of single premium and rollover deposits to tax-qualified products. The change in new annuity deposits also included an 0.8% increase in scheduled deposits received. New deposits to variable mutual fund annuities decreased 6.8% and new deposits to fixed annuities were 9.7% lower than in 1998. Variable annuity accumulated funds on deposit at December 31, 1999 were $1.1 billion, $8.9 million more than a year ago, an 0.8% increase. However, variable annuity deposit retention decreased 4 percentage points over the 12 months to 89.4%. Deposits in the three additional mutual funds introduced by the Company in March 1997 increased to $145 million at December 31, 1999 from $70 million 12 months earlier. Fixed annuity cash value retention for the 12 months ended December 31, 1999 was 92.3%, 0.5 percentage points lower than 1998. Over the last 12 months, the number of annuity contracts outstanding increased 4.2%, or 5,000 contracts. Life premium growth was 3.2% for the year ended December 31, 1999. This 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 and reflects an insurance in force lapse ratio of 8.3%. Customer acceptance of these new products continues to grow, as they accounted for approximately half of the Company's new life sales in 1999. Net Investment Income Investment income of $188.3 million for 1999 decreased 1.8%, or $3.4 million, (1.2% after tax) compared to 1998 due to a decline in the average yield on the investment portfolio that resulted from a steady decline in interest rates from early-1997 until early-1999 and because the yield available in the bond market in 1998 and 1999 was lower than the imbedded yield of the portfolio during most of this period. There was also minimal growth in the investment portfolio. The average pretax yield on the investment portfolio was 7.0% (4.7% after tax) for 1999 compared to a pretax yield of 7.2% (4.8% after tax) for 1998, a decrease of 18 basis points, or 2.5%. Average investments (excluding the securities lending collateral) increased only slightly over the past 12 months reflecting modest growth in business, customers' preference for variable as opposed to fixed annuity contracts and the utilization of capital for the share repurchase program. F-4 All of the investment income decrease in the annuity segment was offset by a reduction in interest credited to fixed annuity deposits. Excluding the impact of the use of cash in the share repurchase program from both periods, net investment income would have increased 0.6%, or $1.3 million, compared to $202.2 million in 1998. Realized Investment Gains and Losses Net realized investment losses were $8.0 million for the year ended December 31, 1999, compared to net realized investment gains of $9.9 million in 1998. Most of the net realized gains and losses occurred in the fixed income portfolios. The net realized investment losses in 1999 were about two-thirds due to credit decisions and rate of return considerations in the Company's fixed income investment portfolio and about one-third due to the sale of U.S. Treasury securities for duration management purposes in a rising interest rate environment. Realized investment gains in 1998 included calls and tenders in the Company's bond portfolio as well as credit and rate of return decisions. Benefits, Claims and Settlement Expenses
Year Ended Growth Over December 31, Prior Year -------------- ---------------- 1999 1998 Percent Amount ---- ---- ------- ------ Property and casualty............. $374.9 $354.4 5.8% $20.5 Life.............................. 41.3 41.9 -1.4% (0.6) ------ ------ ----- Total........................... $416.2 $396.3 5.0% $19.9 ====== ====== ===== Property and casualty statutory loss ratio: Before catastrophes........... 72.4% 68.5% 3.9% After catastrophes............ 76.3% 74.4% 1.9%
Property and casualty claims and settlement costs reflect a high level of catastrophe losses in both years and an increase in fire and non-catastrophe weather claims in 1999. Although catastrophe losses in 1999 were lower than in 1998, the second quarter of 1999 was the Company's second-worst ever, trailing only the record set in the second quarter of 1998, as policyholders in 25 states incurred damages from 13 separate events. Also, Hurricane Floyd in the third quarter of 1999, with claims of $5.4 million for the Company, was the worst storm for the Company and the industry in 1999. The fourth quarter 1999 homeowners loss ratio was 55.9%, 40.5 percentage points lower than in the first nine months of 1999, reflecting the impact of weather on this line of business, and 1.8 percentage points greater than the fourth quarter of 1998. Catastrophe losses were $0.7 million in the fourth quarter of 1999 and $2.7 million in the fourth quarter of 1998. In 1999, the increase in the Company's average voluntary automobile insurance premium per policy kept pace with loss cost developments. This favorable result reflected a number of operational changes, principally savings realized to date from new claims evaluation software that was fully installed by June 1999. F-5 Property and casualty results included continuation of favorable development of prior years reserves, although at a lower level than in 1998. Favorable development of property and casualty claims occurring in prior years, excluding involuntary business, was $7.6 million in 1999, compared to $23.3 million in 1998. Favorable development of total property and casualty claims occurring in prior years was $4.6 million in 1999, compared to $24.9 million in 1998. Life mortality was slightly lower in 1999 than in 1998. The decrease in life segment benefits primarily resulted from positive experience on a small closed block of individual accident and health policies. Interest Credited to Policyholders
Year Ended Growth Over December 31, Prior Year -------------- ---------------- 1999 1998 Percent Amount ---- ---- ------- ------ Annuity............................ $67.2 $72.0 -6.7% $(4.8) Life............................... 24.4 22.8 7.0% 1.6 ----- ----- ----- Total............................ $91.6 $94.8 -3.4% $(3.2) ===== ===== =====
Interest credited to fixed annuity contracts decreased as the fixed annuity average annual interest rate credited decreased 0.4 percentage points to 5.0% in 1999, compared to a rate of 5.4% in 1998. In addition, the average accumulated deposits for the year ended December 31, 1999 increased only slightly compared to the same period in 1998. Life insurance interest credited increased as a result of continued growth in the interest-sensitive life insurance reserves. Operating Expenses For 1999, operating expenses were equal to 1998, including the deferral of additional acquisition costs. The Company began deferring additional sales- related costs in 1999 for all new life and annuity contracts, consistent with common industry accounting practices. This change increased acquisition costs deferred by $4.8 million for the year ended December 31, 1999. Excluding the deferral of additional sales-related costs, operating expenses for 1999 increased $4.8 million, or 4.4%, compared to 1998. In 1999, the Company's operating expenses included $2.3 million attributable to additional employee health insurance costs, compared to 1998. The total corporate expense ratio on a statutory accounting basis was 22.1% for the year ended December 31, 1999, 0.9 percentage points higher than in 1998. The property and casualty expense ratio, the 12th lowest of the 100 largest property and casualty insurance groups for 1998, was 19.8% for the year ended December 31, 1999, compared to 19.3% in 1998. The increase in these expense ratios primarily reflects the modest level of premium growth and additional employee health insurance expense. Amortization of Policy Acquisition Expenses and Intangible Assets For 1999, the combined amortization of policy acquisition expenses and intangible assets of $53.3 million increased by $0.9 million, or 1.7%, compared to $52.4 million for 1998. Amortization of intangible assets decreased by $6.7 million to $0.2 million for the year ended December 31, 1999, compared to $6.9 million for 1998. Recent experience and trends in the Company's annuity business produced a $6.2 million reduction in the amortization of the value F-6 of annuity business acquired in the 1989 acquisition of the Company partially offset by a $3.4 million increase in the amortization of annuity acquisition costs deferred after the 1989 acquisition of the Company. Also in 1999, the amortization of life deferred acquisition costs decreased $1.5 million to reflect current mortality estimates, resulting in higher anticipated future gross profits. The amortization of the value of property and casualty business acquired in the 1989 acquisition of the Company was completed in 1999. Income Tax Expense Excluding the $20.0 million additional provision for prior years' taxes, the effective income tax rate was 30.9% for the year ended December 31, 1999, compared to 27.0% for 1998. Income from investments in tax-advantaged securities reduced the effective income tax rate 4.6 and 3.2 percentage points for the years ended December 31, 1999 and 1998, respectively. In 1998, non- recurring tax benefits reduced the effective rate 5.6 percentage points and contributed $6.5 million, or $0.15 per share, to operating income for the year. As previously reported, the Company has been contesting proposed additional federal income taxes relating to a settlement agreement with the Internal Revenue Service ("IRS") for prior years' taxes. Based on developments in that process during the last half of 1999, it appears that the Company may be forced to litigate the issue with the IRS in order to reach a resolution of the issue acceptable to the Company. Therefore, in the third quarter of 1999, the Company recorded an additional federal income tax provision of $20 million representing the maximum exposure of the Company to the IRS with regard to the issue for all of the past tax years in question. While the ultimate resolution of the issue, through settlement or litigation, may result in the Company paying less than the maximum exposure, given the vagaries of litigation and the lack of progress in reaching an acceptable agreement with the IRS, management believed it prudent to book the maximum exposure in 1999. None of the $20 million reserve was paid as of March 29, 2000. This reserve was a charge to net income in 1999 but was excluded from the determination of reported operating income. F-7 Operating Income For the year ended December 31, 1999, operating income (net income before the after-tax impact of realized investment gains and losses and non-recurring charges) decreased 10.4%, or $8.2 million, and operating income per share on a diluted basis of $1.70 decreased 5.6%, or $0.10 per share. Results for 1999 were lower than the prior year due principally to non-recurring tax benefits in 1998 of $6.5 million, or $0.15 per share. Operating income by segment was as follows:
Year Ended Growth Over December 31, Prior Year ------------------- --------------------- 1999 1998 Percent Amount ---- ---- ------- ------ Property & casualty Before catastrophe losses and non-recurring tax benefits.......... $52.2 $65.2 -19.9% $(13.0) Catastrophe losses, after tax......... 12.7 18.5 -31.4% (5.8) Non-recurring tax benefits............ - 6.5 -100.0% (6.5) ----- ----- ------ Total including catastrophe losses and non-recurring tax benefits.... 39.5 53.2 -25.8% (13.7) Annuity................................. 27.3 23.1 18.2% 4.2 Life.................................... 14.6 12.4 17.7% 2.2 Corporate and other expense............. 4.4 3.6 0.8 Interest expense........................ 6.3 6.2 0.1 ----- ----- ------ Total............................... $70.7 $78.9 -10.4% $ (8.2) ===== ===== ====== Total before catastrophe losses and non-recurring tax benefits.... $83.4 $90.9 -8.3% $ (7.5) ===== ===== ====== Property and casualty statutory combined ratio: Before catastrophe losses........... 92.2% 87.7% 4.5% After catastrophe losses............ 96.1% 93.6% 2.5%
Property and casualty segment operating income was lower than in 1998 due primarily to a non-recurring tax benefit in 1998 and a lower level of favorable development of prior years' reserves than in 1998. Favorable development of property and casualty claims occurring in prior years (excluding involuntary business), was $4.9 million after tax in 1999, compared to $15.1 million after tax in 1998. Favorable development of total property and casualty claims occurring in prior years was $3.0 million after tax in 1999, compared to $16.2 million after tax in 1998. During 1999, the Company's increase in average voluntary automobile insurance premium kept pace with loss cost developments. The homeowners combined ratio of 105.8% was 5.0 percentage points better than in 1998, reflecting the decline in catastrophe losses. However, catastrophe losses in both years were significant as the second quarter of 1999 represented the Company's second-worst ever for catastrophe losses, trailing only the record set in last year's second quarter, with an unusually large number of catastrophes that were widespread across the country. Hurricane Floyd in the third quarter of 1999 with claims of $3.5 million after tax for the Company was the worst storm for the Company and the industry in 1999. The 18.2% increase in annuity segment operating income was driven by lower expenses, an increase of 7.7% in the net interest margin and a 9.6% increase in fees and contract charges earned. The reduction in expenses resulted from the deferral of additional sales-related costs and a net decrease in the amortization of the value of acquired insurance in force and deferred F-8 acquisition costs to reflect recent experience and trends. The net deferral of additional sales-related costs contributed $1.2 million to operating income for the year ended December 31, 1999. Variable annuity accumulated deposits were $1.1 billion at December 31, 1999, $8.9 million, or 0.8%, more than 12 months earlier. Fixed annuity accumulated cash value of $1.4 billion was comparable to December 31, 1998. The increase in life insurance earnings reflected slightly lower mortality costs and lower expenses. The expense reductions were due to the $1.9 million after tax net deferral of additional sales-related costs and a decrease in the amortization of deferred acquisition costs to reflect current mortality estimates. The Company's share repurchase program reduced operating income by $9.1 million for the year ended December 31, 1999, reflecting utilization of capital and the corresponding reduction of net investment income, but 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 Net Income Per Share, Diluted
Year Ended Growth Over December 31, Prior Year ------------------- ---------------------- 1999 1998 Percent Amount ------- ---------- -------- ------------ Operating income.................... $ 1.70 $1.80 -5.6% $(0.10) Realized investment gains (losses).. (0.13) 0.15 (0.28) Litigation settlement............... (0.02) - (0.02) Provision for prior years' taxes.... (0.48) - (0.48) ------ ----- ------ Net income.......................... $ 1.07 $1.95 -45.1% $(0.88) ====== ===== ======
Net income, which includes realized investment gains and losses and non- recurring charges, for the year ended December 31, 1999 decreased by 47.8% and net income per diluted share decreased by 45.1% compared to 1998. Two non- recurring charges were recorded in the third quarter of 1999 that reduced 1999 net income: an additional federal income tax provision of $20.0 million, or $0.48 per share, representing the Company's maximum exposure for disputed prior years' taxes; and a net cost of $1.0 million (after insurance proceeds), or $0.02 per share, to settle certain litigation in Alabama related to life insurance policies. The settlement of litigation in Alabama included the lawsuit in which a verdict of $12.35 million was rendered against the Company on June 25, 1999 as well as 39 other suits brought by the same law firm and 6 other cases represented by another law firm but of a similar nature. Net income also reflected $5.2 million of after tax realized investment losses for the year, compared to $6.4 million of after tax realized investment gains in 1998. Return on shareholders' equity based on operating income for the last 12 months was 16%. Based on net income, return on equity was 10% for the last 12 months. F-9 Year Ended December 31, 1998 Compared With Year Ended December 31, 1997 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....................... 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 growth in the agent force and higher agent productivity in 1998. In total, the Company ended 1998 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. 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 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. F-10 During the first quarter of 1998, the Company introduced new IRA annuities in response to new 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 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. 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 $200.9 million, a small decrease compared to 1997. F-11 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. 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. F-12 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 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. 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 approximately 3 percentage points in both 1998 and 1997. Certain tax benefits that did not recur in future years, as explained in "Year Ended December 31, 1999 Compared With Year Ended December 31, 1998 -- Income Tax Expense," reduced the effective rate approximately 6 percentage points in both 1998 and 1997. F-13 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 and non-recurring tax benefits.......... $65.2 $58.8 10.9% $ 6.4 Catastrophe losses, after tax......... 18.5 4.0 362.5% 14.5 Non-recurring tax benefits............ 6.5 6.6 -1.5% (0.1) ----- ----- ----- Total including catastrophe losses and non-recurring tax benefits.... 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 and non-recurring tax benefits.... $90.9 $81.0 12.2% $ 9.9 ===== ===== ===== 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 in 1998. 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. Favorable development of property and casualty claims occurring in prior years (excluding involuntary business), was $15.1 million after tax in 1998, compared to $26.0 million after tax in 1997. Favorable development of total property and casualty claims occurring in prior years was $16.2 million after tax in 1998, compared to $29.3 million after tax in 1997. F-14 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 million more than 12 months earlier, a 17.0% increase. Fixed annuity accumulated cash value of $1.4 billion was equal to December 31, 1997. Net Income Net Income Per Share, Diluted
Year Ended Growth Over December 31, Prior Year ------------------ ---------------- 1998 1997 Percent Amount ---- ---- ------- ------ Operating income................... $1.80 $ 1.80 - $ - Realized investment gains.......... 0.15 0.07 114.3% 0.08 ----- ------ ----- Income from continuing operations.. 1.95 1.87 4.3% 0.08 Discontinued operations: Loss on discontinuation.......... - (0.07) 0.07 ----- ------ ----- Net income......................... $1.95 $ 1.80 8.3% $0.15 ===== ====== =====
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 $6.0 million for 1998 but resulted in an increase of $0.06 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. Liquidity and Financial Resources Investments The Company's investment strategy emphasizes investment grade, publicly traded fixed income securities. At December 31, 1999, fixed income securities represented 95.3% of investments. Of the fixed income investment portfolio, 93.2% was investment grade and 99.8% was publicly traded. The average quality of the total fixed income portfolio was AA-/A+ at December 31, 1999. 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 4.1 years at December 31, 1999 and 4.4 years at December 31, 1998. 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-15 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 was greater than in 1998 primarily as a result of lower federal income taxes paid in 1999, including a $7.0 million refund of prior years' taxes. 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 2000 without prior approval are approximately $75 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-16 For the year ended December 31, 1999, receipts from annuity contracts decreased 7.9% primarily reflecting the reduced level of single premium deposits received. Annuity contract maturities and withdrawals increased $62.4 million, or 33.8%, compared to the year ended December 31, 1998 due to higher withdrawals from the variable annuity option. Variable annuity deposit retention decreased 4 percentage points over the 12 months to 89.4%. Net transfers to variable annuity assets decreased $89.2 million, or 92.1%, compared to 1998 reflecting a greater allocation of funds by customers to fixed annuities rather than variable annuities and the decrease in total annuity contract receipts. Retention of fixed annuity accumulated cash value was 92.3% for the 12 months ended December 31, 1999. During the first six months of 1999, the Company repurchased 1,075,300 shares of its common stock, or 3% of the shares outstanding on December 31, 1998, at an aggregate cost of $25.1 million, or an average cost of $23.34 per share, under its stock repurchase program. No shares were repurchased during the third and fourth quarters of 1999. Repurchases in 1999 compare to 2,286,800 shares repurchased in 1998 at an aggregate cost of $71.6 million. The repurchase of shares was financed through cash generated from operations and, when necessary, the Bank Credit Facility. In May 1999, an additional $100 million share repurchase authorization was announced. As of December 31, 1999, $111.5 million remained authorized for future share repurchases. On August 2, 1999, the Company announced that its Board of Directors had retained Morgan Stanley Dean Witter and Credit Suisse First Boston to explore strategic alternatives available to the corporation. At that time, the Board of Directors suspended the Company's share repurchase program. On February 23, 2000, the Board of Directors removed suspension of the Company's previously authorized program to repurchase its common stock from time to time in the open market, but also indicated that the levels of stock repurchase in 2000 will likely be lower than what occurred in either 1997 or 1998. During 2000 and beyond, the Company intends to allocate excess capital for share repurchase to the extent that it is not needed to realize anticipated business growth opportunities. Capital Resources The Company has determined the amount of capital which is needed to adequately fund and support business growth, primarily based on risk-based capital formulas including those developed by the National Association of Insurance Commissioners. Historically, the Company's insurance subsidiaries have generated capital in excess of such needed capital. These excess amounts have been paid to HMEC through dividends. HMEC has then utilized these dividends and its access to the capital markets to service and retire long-term debt, increase and pay dividends to its shareholders, fund growth initiatives, repurchase shares of its common stock and for other corporate purposes. Management anticipates that the Company's sources of capital will continue to generate capital in excess of the needs for business growth, debt interest payments and shareholder dividends. The total capital of the Company was $548.8 million at December 31, 1999, including $99.7 million of long-term debt and $49.0 million of short-term debt. Total debt represented 25.3% of capital (excluding unrealized investment losses) at the end of 1999, at the upper end of the Company's target operating range of 20% to 25%. F-17 Shareholders' equity was $400.1 million at December 31, 1999, including an unrealized loss in the Company's investment portfolio of $40.1 million after taxes and the related impact on deferred policy acquisition costs and the value of acquired insurance in force associated with annuity and interest-sensitive life policies. The market value of the Company's common stock and the market value per share were $805.3 million and $19 5/8, respectively, at December 31, 1999. Book value per share was $9.75 at December 31, 1999, $10.73 excluding investment market value adjustments. At December 31, 1998, book value per share was $11.80, $10.44 excluding investment market value adjustments. The decrease over the 12 months was entirely due to unrealized investment gains and losses, the non-recurring charge for prior years' taxes and share repurchases. Excluding these items, book value per share increased 10.8% over the 12-month period. 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, 1999 and 1998, the Company had short-term debt of $49.0 million and $50.0 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 6.5%, as of December 31, 1999. 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, 1999 was 10.6x compared to 13.3x for the same period in 1998, with the decline primarily attributable to realized investment losses recorded in the current period compared to realized investment gains recorded in the year ended December 31, 1998. Total shareholder dividends were $15.8 million for the year ended December 31, 1999. The Company has targeted a dividend payout ratio of approximately 15% to 20%. In November 1999, the Board of Directors authorized the eighth increase to the Company's quarterly dividend in the eight years since the Company's initial public offering in November 1991. The regular quarterly dividend increased by 13.5% to $0.105 per share. The Company reinsures 95% of catastrophe losses above a retention of $7.5 million per occurrence up to $80 million per occurrence. In addition, the Company reinsures 75% of catastrophe losses in Florida above a retention of $6.1 million. These catastrophe reinsurance programs are augmented by a $100 million equity put and reinsurance agreement. 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 the $80 million coverage limit. The equity put provides a source of capital for up to $154 million of catastrophe losses, before tax benefits, above the reinsurance coverage limit. F-18 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 coordinating 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. 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, 1999, 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), competitive pricing 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 multiline 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, 1999, the duration of fixed maturity securities was approximately 4.1 years, and the duration of insurance liabilities was approximately 4.5 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. F-19 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, 1999, assuming an immediate decrease of 100 basis points in interest rates, the net fair value of the Company's assets and liabilities would increase by approximately $21 million after tax, 5% of shareholders' equity. A 100 basis point increase would decrease fair value of assets and liabilities by $2 million after tax, less than 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 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 All of the Company's automated systems are year 2000 compliant and rollover to year 2000 was successfully completed. The Company continues to monitor and retest computer system processing for upcoming quarter-end and year-end processing accuracy. Costs for this compliance project represented the allocation of existing internal information technology resources to address year 2000 compliance and were not incremental costs to the Company. The total cost of the compliance project has been funded through operating cash flows. The Company has expensed all costs associated with these system changes and through December 31, 1999 has expensed $6.5 million before tax benefits, including a cost of $1.0 million for the year ended December 31, 1999. 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," as amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133," which is required to be adopted in 2000. This statement will not have a material impact on the Company because it does not have significant holdings of derivatives or hedges, as defined within the context of SFAS No. 133. 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 F-20 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-21 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, 1999, 1998 and 1997, and the related consolidated statements of operations, cash flows and shareholders' equity for the years ended December 31, 1999, 1998 and 1997 have been prepared by management, which is responsible for their integrity and reliability. 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. /s/ Paul J. Kardos Paul J. Kardos Chairman of the Board, President and Chief Executive Officer /s/ Larry K. Becker Larry K. Becker Executive Vice President and Chief Financial Officer Springfield, Illinois January 25, 2000 F-22 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, 1999, 1998 and 1997 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, 1999. 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, 1999, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, 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 25, 2000 F-23 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED BALANCE SHEETS As of December 31, 1999, 1998 and 1997 (Dollars in thousands)
1999 1998 1997 ---------- ---------- ---------- ASSETS Investments Fixed maturities, available for sale, at market (amortized cost 1999, $2,575,403; 1998, $2,552,537; 1997, $2,535,538)........................ $2,507,280 $2,651,379 $2,638,794 Short-term and other investments...................... 122,929 102,049 130,252 Short-term investments, loaned securities collateral.. - 87,392 - ---------- ---------- ---------- Total investments................................ 2,630,209 2,840,820 2,769,046 Cash................................................... 22,848 12,044 353 Accrued investment income and premiums receivable...... 92,755 102,661 103,951 Value of acquired insurance in force and goodwill...... 102,068 101,055 107,976 Deferred policy acquisition costs...................... 130,192 101,658 85,883 Other assets........................................... 144,061 114,503 104,943 Variable annuity assets................................ 1,131,713 1,122,739 959,760 ---------- ---------- ---------- Total assets..................................... $4,253,846 $4,395,480 $4,131,912 ========== ========== ========== LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY Policy liabilities Fixed annuity contract liabilities................... $1,238,379 $1,239,234 $1,245,459 Interest-sensitive life contract liabilities......... 443,309 402,490 364,205 Unpaid claims and claim expenses..................... 309,604 307,387 322,335 Future policy benefits............................... 179,157 179,693 179,562 Unearned premiums.................................... 170,845 179,194 166,996 ---------- ---------- ---------- Total policy liabilities......................... 2,341,294 2,307,998 2,278,557 Other policyholder funds............................... 126,530 124,820 122,107 Other liabilities...................................... 110,698 197,292 126,847 Short-term debt........................................ 49,000 50,000 42,000 Long-term debt......................................... 99,677 99,637 99,599 Variable annuity liabilities........................... 1,126,505 1,118,890 956,253 ---------- ---------- ---------- Total liabilities................................ 3,853,704 3,898,637 3,625,363 ---------- ---------- ---------- Warrants, subject to redemption........................ - 220 577 ---------- ---------- ---------- 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, 1999, 59,292,053; 1998, 59,274,690; 1997, 59,161,008................... 59 59 59 Additional paid-in capital............................. 333,892 336,686 340,564 Retained earnings...................................... 449,023 420,274 349,274 Accumulated other comprehensive income (loss) (net unrealized gains (losses) on fixed maturities and equity securities).................... (40,016) 57,327 62,167 Treasury stock, at cost, 1999, 18,258,896 shares; 1998, 17,183,596 shares; 1997, 14,896,796 shares..... (342,816) (317,723) (246,092) ---------- ---------- ---------- Total shareholders' equity....................... 400,142 496,623 505,972 ---------- ---------- ---------- Total liabilities, redeemable securities and shareholders' equity....................... $4,253,846 $4,395,480 $4,131,912 ========== ========== ==========
See accompanying notes to consolidated financial statements. F-24 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share data)
Year Ended December 31, --------------------------------------- 1999 1998 1997 ------------ ----------- ------------ Insurance premiums written and contract deposits.... $ 821,209 $ 827,787 $ 771,319 =========== =========== =========== Revenues Insurance premiums and contract charges earned.... $ 595,128 $ 577,812 $ 542,712 Net investment income............................. 188,267 191,723 198,928 Realized investment gains (losses)................ (7,969) 9,908 5,340 ----------- ----------- ----------- Total revenues................................ 775,426 779,443 746,980 ----------- ----------- ----------- Benefits, losses and expenses Benefits, claims and settlement expenses.......... 416,186 396,328 359,441 Interest credited................................. 91,629 94,776 97,231 Policy acquisition expenses amortized............. 53,041 45,477 44,198 Operating expenses................................ 109,694 109,673 106,398 Amortization of intangible assets................. 215 6,921 10,662 Interest expense.................................. 9,722 9,487 9,412 Litigation settlement............................. 1,585 - - ----------- ----------- ----------- Total benefits, losses and expenses........... 682,072 662,662 627,342 ----------- ----------- ----------- Income from continuing operations before income taxes and discontinued operations.......... 93,354 116,781 119,638 Income tax expense.................................. 28,849 31,469 32,581 Provision for prior years' taxes.................... 20,000 - - ----------- ----------- ----------- Income from continuing operations................... 44,505 85,312 87,057 Discontinued operations (See note 2): Loss on discontinuation, representing additional provision of $5,355 for operating losses during phase-out period, net of applicable income tax benefits of $1,874................... - - (3,481) ----------- ----------- ----------- Net income.......................................... $ 44,505 $ 85,312 $ 83,576 =========== =========== =========== Earnings (loss) per share Basic Income from continuing operations............... $ 1.08 $ 1.97 $ 1.90 Discontinued operations: Loss on discontinuation....................... - - (0.08) ----------- ----------- ----------- Net income...................................... $ 1.08 $ 1.97 $ 1.82 =========== =========== =========== Diluted Income from continuing operations............... $ 1.07 $ 1.95 $ 1.87 Discontinued operations: Loss on discontinuation....................... - - (0.07) ----------- ----------- ----------- Net income...................................... $ 1.07 $ 1.95 $ 1.80 =========== =========== =========== Weighted average number of shares and equivalent shares Basic......................................... 41,245,633 43,238,656 45,825,410 Diluted....................................... 41,708,439 43,838,434 46,524,532
See accompanying notes to consolidated financial statements. F-25 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in thousands, except per share data)
Year Ended December 31, ------------------------------------ 1999 1998 1997 ---------- ---------- ------------ Common stock Beginning balance................................................. $ 59 $ 59 $ 58 Options exercised, 1999, 17,363 shares; 1998, 113,682 shares; 1997, 731,924 shares............................. - - 1 Conversion of Director Stock Plan units, 1997, 2,288 shares............................................... - - - --------- --------- ----------- Ending balance.................................................... 59 59 59 --------- --------- ----------- Additional paid-in capital Beginning balance................................................. 336,686 340,564 330,234 Options exercised and conversion of Director Stock Plan units........................................ 362 2,200 11,580 Catastrophe-linked equity put option premium...................... (950) (1,475) (1,250) Purchase of 8,450 warrants in 1999 and 13,650 warrants in 1998.......................................... (2,206) (4,603) - --------- --------- ----------- Ending balance.................................................... 333,892 336,686 340,564 --------- --------- ----------- Retained earnings Beginning balance................................................. 420,274 349,274 278,669 Net income........................................................ 44,505 85,312 83,576 Cash dividends, 1999, $0.3825 per share; 1998, $0.3325 per share; 1997, $0.2825 per share....................... (15,756) (14,312) (12,971) --------- --------- ----------- Ending balance.................................................... 449,023 420,274 349,274 --------- --------- ----------- Accumulated other comprehensive income (loss) (net unrealized gains (losses) on fixed maturities and equity securities) Beginning balance................................................ 57,327 62,167 29,736 Increase (decrease) for the period............................... (97,343) (4,840) 32,431 --------- --------- ----------- Ending balance................................................... (40,016) 57,327 62,167 --------- --------- ----------- Treasury stock, at cost Beginning balance, 1999, 17,183,596 shares; 1998, 14,896,796 shares; 1997, 11,176,196 shares....................... (317,723) (246,092) (154,302) Purchase of 1,075,300 shares in 1999; 2,286,800 shares in 1998 and 3,720,600 shares in 1997 (See note 5)..................................................... (25,093) (71,631) (91,790) --------- --------- ----------- Ending balance 1999, 18,258,896 shares; 1998, 17,183,596 shares; 1997, 14,896,796 shares....................... (342,816) (317,723) (246,092) --------- --------- ----------- Shareholders' equity at end of period.............................. $ 400,142 $ 496,623 $ 505,972 ========= ========= =========== Comprehensive income (loss) Net income........................................................ $ 44,505 $ 85,312 $ 83,576 Other comprehensive income (loss) (change in net unrealized gains (losses) on fixed maturities and equity securities)........................................... (97,343) (4,840) 32,431 --------- --------- ----------- Total........................................................... $ (52,838) $ 80,472 $ 116,007 ========= ========= ===========
See accompanying notes to consolidated financial statements. F-26 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
Year Ended December 31, ----------------------------------- 1999 1998 1997 --------- --------- ----------- Cash flows from operating activities Premiums collected.............................................. $ 623,762 $ 618,419 $ 608,650 Policyholder benefits paid...................................... (453,353) (459,595) (466,150) Policy acquisition and other operating expenses paid............ (179,951) (176,054) (173,462) Federal income taxes paid....................................... (16,600) (36,441) (51,889) Investment income collected..................................... 186,824 195,599 199,306 Interest expense paid........................................... (9,523) (9,309) (9,276) Other........................................................... (3,013) (3,853) (2,743) -------- --------- ----------- Net cash provided by operating activities................. 148,146 128,766 104,436 --------- --------- ----------- Cash flows from investing activities Fixed maturities Purchases.................................................... (698,847) (842,375) (1,044,199) Sales........................................................ 388,644 487,945 874,243 Maturities................................................... 286,758 351,112 241,958 Net cash (used for) received from short-term and other investments.............................................. (18,524) 26,296 (5,882) --------- --------- ----------- Net cash (used in) provided by investing activities....... (41,969) 22,978 66,120 --------- --------- ----------- Cash flows used in financing activities Purchase of treasury stock...................................... (25,093) (71,631) (91,790) Dividends paid to shareholders.................................. (15,756) (14,312) (12,971) Principal (payments) borrowings on Bank Credit Facility......... (1,000) 8,000 8,000 Repurchase of common stock warrants............................. (2,426) (4,959) - Exercise of stock options....................................... 362 2,200 11,581 Catastrophe-linked equity put option premium.................... (950) (1,475) (1,250) Annuity contracts, variable and fixed Deposits..................................................... 205,684 223,324 199,190 Maturities and withdrawals................................... (247,212) (184,800) (176,117) Net transfer to variable annuity assets...................... (7,676) (96,905) (121,782) Net (decrease) increase in interest-sensitive life account balances.......................................... (1,306) 505 1,232 --------- --------- ----------- Net cash used in financing activities..................... (95,373) (140,053) (183,907) --------- --------- ----------- Net increase (decrease) in cash.................................... 10,804 11,691 (13,351) Cash at beginning of period........................................ 12,044 353 13,704 --------- --------- ---------- Cash at end of period.............................................. $ 22,848 $ 12,044 $ 353 ========= ========= ==========
See accompanying notes to consolidated financial statements. F-27 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (Dollars 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 and value of acquired insurance in force associated with interest-sensitive life and annuity contracts. Short-term and other investments are comprised of policy loans, carried at unpaid principal balances; short-term fixed interest securities, carried at cost which approximates market value; mortgage loans, carried at unpaid principal less a valuation allowance for estimated uncollectible amounts; 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. F-28 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) Realized gains and losses arising from the sale of securities are determined based upon specific identification of securities sold. Deferred Policy Acquisition Costs Deferred policy acquisition costs net of accumulated amortization were $130,192, $101,658 and $85,883 as of December 31, 1999, 1998 and 1997, 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, 15 and 20 years). For investment (annuity) contracts, acquisition costs are amortized over 20 years in proportion to estimated gross profits. 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. The Company periodically reviews the assumptions and estimates used in capitalizing policy acquisition costs. The Company began deferring additional sales-related costs in 1999 for all new life and annuity contracts, consistent with common industry accounting practices. The impact of this change was an increase to net income of $3,108 for 1999. 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. F-29 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) 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, ----------------------------- 1999 1998 1997 ------- ------- ------- Property and equipment.................... $60,907 $55,028 $48,548 Less: accumulated depreciation............ 30,543 26,541 23,395 ------- ------- ------- Total................................... $30,364 $28,487 $25,153 ======= ======= =======
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 1999 and 1998 operating expenses by $1,568 and $2,400, respectively, 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 was recorded in 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, ------------------------------ 1999 1998 1997 -------- -------- -------- Value of acquired insurance in force Property and casualty.................. $ - $ 719 $ 1,751 Life................................... 14,409 16,529 18,804 Annuity................................ 37,027 31,557 33,553 -------- -------- -------- Subtotal............................. 51,436 48,805 54,108 Goodwill................................. 50,632 52,250 53,868 -------- -------- -------- Total................................ $102,068 $101,055 $107,976 ======== ======== ========
The value of acquired insurance in force is being amortized over the following periods utilizing the indicated methods for life and annuity, respectively, as follows: 20 years, in proportion to coverage provided; 20 years, in proportion to estimated gross profits. Goodwill is amortized over 40 years on a straight-line basis. F-30 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) The value of acquired insurance in force for investment contracts (those issued prior to August 29, 1989) is 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. 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, 1999 balance was revised as reflected in the table below. Such amounts are evaluated annually and amortization schedules updated as indicated. Scheduled amortization of the December 31, 1999 balances of value of acquired insurance in force by segment and goodwill over the next five years is as follows:
Year Ended December 31, -------------------------------------- 2000 2001 2002 2003 2004 ------ ------ ------ ------ ------ Scheduled amortization of: Value of acquired insurance in force Life.................................. $1,975 $1,839 $1,726 $1,625 $1,537 Annuity............................... 4,576 4,557 4,214 4,000 3,669 ------ ------ ------ ------ ------ Subtotal............................ 6,551 6,396 5,940 5,625 5,206 Goodwill................................ 1,618 1,618 1,618 1,618 1,618 ------ ------ ------ ------ ------ Total............................... $8,169 $8,014 $7,558 $7,243 $6,824 ====== ====== ====== ====== ======
The accumulated amortization of intangibles as of December 31, 1999, 1998 and 1997 was $131,832, $131,617 and $124,696, 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, ----------------------------------- 1999 1998 1997 ---------- ---------- -------- Horace Mann Growth Fund................... $ 566,932 $ 605,803 $532,086 Horace Mann Balanced Fund................. 404,712 427,368 386,247 Horace Mann Small Cap Growth Fund......... 60,042 28,629 16,321 Horace Mann Socially Responsible Fund..... 59,129 35,368 9,117 Horace Mann International Equity Fund..... 26,040 10,290 5,137 Horace Mann Income Fund................... 13,237 13,952 9,651 Horace Mann Short-Term Fund............... 1,621 1,329 1,201 ---------- ---------- -------- Total variable annuity assets........... $1,131,713 $1,122,739 $959,760 ========== ========== ========
The investment income, gains and losses of these accounts accrue directly to the policyholders and are not included in the operations of the Company. F-31 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) 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 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. Due to the nature of the Company's personal lines business, 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-32 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, ------------------------------ 1999 1998 1997 -------- -------- -------- Gross reserves, beginning of year................... $298,929 $310,632 $340,411 Less reinsurance recoverables..................... 55,890 41,324 34,062 -------- -------- -------- Net reserves, beginning of year..................... 243,039 269,308 306,349 -------- -------- -------- Incurred claims and claims expense : Claims occurring in the current year.............. 379,455 379,603 365,986 Increase (decrease) in estimated reserves for claims occurring in prior years(1): Policies written by the Company............... (7,583) (23,317) (40,052) Business assumed from state reinsurance facilities...................... 3,000 (1,600) (5,100) -------- -------- -------- Total decrease............................ (4,583) (24,917) (45,152) -------- -------- -------- Total claims and claims expense incurred...... 374,872 354,686 320,834 -------- -------- -------- Claims and claims expense payments for claims occurring during: Current year.................................... 240,045 238,986 209,294 Prior years..................................... 142,473 141,969 148,581 -------- -------- -------- Total claims and claims expense payments...... 382,518 380,955 357,875 -------- -------- -------- Net reserves, end of period......................... 235,393 243,039 269,308 Plus reinsurance recoverables..................... 64,410 55,890 41,324 -------- -------- -------- Gross reserves, end of period(2).................... $299,803 $298,929 $310,632 ======== ======== ========
_______________ (1) Shows the amounts by which the Company decreased or increased 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 expense as reported in the consolidated balance sheets also include life, annuity, and group accident and health reserves of $9,801, $8,458 and $11,703 at December 31, 1999, 1998 and 1997, 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, ------------------------------ 1999 1998 1997 -------- -------- -------- Claims and claims expense incurred.................. $374,872 $354,686 $320,834 Amount attributable to catastrophes................. 19,371 28,019 6,164 -------- -------- -------- Excluding catastrophes............................ $355,501 $326,667 $314,670 ======== ======== ======== Claims and claims expense payments.................. $382,518 $380,955 $357,875 Amount attributable to catastrophes................. 17,400 25,200 5,700 -------- -------- -------- Excluding catastrophes............................ $365,118 $355,755 $352,175 ======== ======== ========
F-33 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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 executive officers, other employees and directors. 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, ----------------------------- 1999 1998 1997 ------- ------- ------- Net income As reported.......... $44,505 $85,312 $83,576 Pro forma(1)......... $42,907 $84,485 $83,283 Basic net income per share As reported.......... $ 1.08 $ 1.97 $ 1.82 Pro forma............ $ 1.04 $ 1.95 $ 1.82 Diluted net income per share As reported.......... $ 1.07 $ 1.95 $ 1.80 Pro forma............ $ 1.03 $ 1.93 $ 1.79
______________ (1) 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 1999, 1998 and 1997, respectively: risk-free interest rates of 5.9%, 5.6% and 5.5%; dividend yield of 1.9%, 1.3% and 1.0%; expected lives of 10 years; and volatility of 50.3%, 26.2% and 15.8%. F-34 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, 1999, 1998 and 1997 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 common stock options, Director Stock Plan units and Employee Stock Plan units and in 1998 and 1997 also warrants. F-35 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, --------------------------------- 1999 1998 1997 ------- ------- ------- Basic - assumes no dilution: Income from continuing operations for the period......... $44,505 $85,312 $87,057 ------- ------- ------- Weighted average number of common shares outstanding during the period................... 41,246 43,239 45,825 ------- ------- ------- Income from continuing operations per share - basic...... $ 1.08 $ 1.97 $ 1.90 ======= ======= ======= Diluted - assumes full dilution: Income from continuing operations for the period......... $44,505 $85,312 $87,057 ------- ------- ------- Weighted average number of common shares outstanding during the period.......................... 41,246 43,239 45,825 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: Stock options........................................ 387 451 416 Common stock units related to Deferred Equity Compensation Plan for Directors............. 69 49 33 Common stock units related to Deferred Compensation Plan for Employees.................... 6 1 - Warrants............................................. - 98 251 ------- ------- ------- Total common and common equivalent shares adjusted to calculate diluted earnings per share................ 41,708 43,838 46,525 ------- ------- ------- Income from continuing operations per share - diluted.... $ 1.07 $ 1.95 $ 1.87 ======= ======= =======
Options to purchase 262,950 shares of common stock at $25.63 to $34.53 per share were granted during 1997, 1998 and 1999 but were not included in the computation of 1999 diluted earnings per share because the options' exercise price was greater than the average market price of the common shares during 1999. The options, which expire in 2007, 2008 and 2009, were still outstanding at December 31, 1999. Comprehensive Income (Loss) Comprehensive income (loss) represents the change in shareholders' equity during a reporting period from transactions and other events and circumstances from non-shareholder sources. For the Company, comprehensive income (loss) is equal to net income plus 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. F-36 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) The components of comprehensive income (loss) were as follows:
Year Ended December 31, --------------------------------- 1999 1998 1997 --------- ------- -------- Net income............................................... $ 44,505 $85,312 $ 83,576 --------- ------- -------- Other comprehensive income (loss): Unrealized holding gains (losses) on fixed maturities and equity securities arising during period.......... (158,423) 3,855 55,299 Less: reclassification adjustment for gains (losses) included in net income............................... (8,664) 11,301 5,405 --------- ------- -------- Other comprehensive income (loss), before tax.......... (149,759) (7,446) 49,894 Income tax expense (benefit)........................... (52,416) (2,606) 17,463 --------- ------- -------- Total................................................ (97,343) (4,840) 32,431 --------- ------- -------- Total comprehensive income (loss).................. $ (52,838) $80,472 $116,007 ========= ======= ========
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 1999 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, 1999, there were no assets or liabilities attributable to the discontinued operations. F-37 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, ------------------------------ 1999 1998 1997 -------- -------- --------- Fixed maturities.................................................... $182,561 $185,271 $191,777 Short-term and other investments.................................... 9,212 10,700 10,967 -------- -------- -------- Total investment income.......................................... 191,773 195,971 202,744 Less investment expenses............................................ 3,506 4,248 3,816 -------- -------- -------- Net investment income............................................ $188,267 $191,723 $198,928 ======== ======== ========
Realized Investment Gains (Losses) Realized investment gains (losses) for the following periods were:
Year Ended December 31, ------------------------------ 1999 1998 1997 -------- -------- -------- Fixed maturities.................................................... $ (9,777) $ 10,537 $ 5,411 Short-term and other investments.................................... 1,808 (629) (71) -------- -------- -------- Realized investment gains (losses)............................... $ (7,969) $ 9,908 $ 5,340 ======== ======== ========
F-38 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, 1999, 1998 and 1997 were as follows:
Amortized Unrealized Unrealized Market Cost Gains Losses Value ---------- ---------- ---------- ---------- As of December 31, 1999 U.S. government and agency obligations Mortgage-backed securities............ $ 506,132 $ 3,587 $11,604 $ 498,115 Other................................. 136,400 330 5,304 131,426 Municipal bonds......................... 307,045 3,348 8,343 302,050 Foreign government bonds................ 21,875 439 327 21,987 Corporate bonds......................... 1,184,792 9,362 49,046 1,145,108 Other mortgage-backed securities........ 419,159 1,302 11,867 408,594 ---------- -------- ------- ---------- Totals.............................. $2,575,403 $ 18,368 $86,491 $2,507,280 ========== ======== ======= ========== 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 ========== ======== ======= ==========
The Company's investment portfolio includes no derivative financial instruments (futures, forwards, swaps, option contracts or other financial instruments with similar characteristics). F-39 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, 1999, 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% $ 175,546 $ 175,500 Due after 1 year through 5 years..................... 31.0 777,538 781,547 Due after 5 years through 10 years................... 31.5 788,829 812,070 Due after 10 years through 20 years.................. 15.9 399,394 409,796 Due after 20 years................................... 14.6 365,973 396,490 ----- ---------- ---------- Total............................................... 100.0% $2,507,280 $2,575,403 ===== ========== ==========
Proceeds from sales/maturities of fixed maturities and gross gains and gross losses realized for each year were:
Year Ended December 31, ------------------------------------- 1999 1998 1997 -------- -------- ---------- Proceeds............................................. $675,402 $839,057 $1,116,201 Gross gains realized................................. 3,941 18,081 13,444 Gross losses realized................................ (13,718) (7,544) (8,033)
Unrealized Gains (Losses) on Fixed Maturities Net unrealized gains (losses) are computed as the difference between market value 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, ------------------------------------- 1999 1998 1997 --------- -------- -------- Unrealized gains (losses) on fixed maturities Beginning of period................................. $ 98,842 $103,256 $ 49,435 End of period....................................... (68,123) 98,842 103,256 --------- -------- -------- Increase (decrease) for the period................ (166,965) (4,414) 53,821 Income taxes (benefit)................................ (58,438) (1,545) 18,837 --------- -------- -------- Increase (decrease) in net unrealized gains (losses) on fixed maturities before the valuation impact on deferred policy acquisition costs and value of acquired insurance in force...................... $(108,527) $ (2,869) $ 34,984 ========= ======== ========
F-40 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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. However, there were no securities on loan at December 31, 1999. As of December 31, 1998 and 1997, fixed maturities with a fair value of $87,392 and $60,388, respectively, were on loan. 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, 1999, the Company's investment portfolio included $42,087 of fixed maturity securities issued by Ford Motor Company and its affiliates representing 10.5% of shareholders' equity at that date and other than obligations of the United States Government and government agencies and authorities there were no other investments which exceeded 10% of total 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. Deposits At December 31, 1999, securities with a carrying value of $13,512 were on deposit with governmental agencies as required by law in various states in which the insurance subsidiaries of HMEC conduct business. F-41 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 4 - Debt and Warrants Indebtedness and scheduled maturities at December 31, 1999, 1998 and 1997 consisted of the following:
Effective December 31, Interest Final ------------------------------- Rates Maturity 1999 1998 1997 -------- -------- -------- -------- -------- Short-term debt: Bank Credit Facility......................... Variable 2001 $ 49,000 $ 50,000 $ 42,000 Long-term debt: 6 5/8% Senior Notes, Face amount less unaccrued discount of $323, $363 and $401, respectively......................... 6.7% 2006 99,677 99,637 99,599 -------- -------- -------- Total.................................... $148,677 $149,637 $141,599 ======== ======== ========
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 Company's 4%/6 1/2% 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, 1999). 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, 1999. The commitment for the Bank Credit Facility terminates on December 31, 2001. The Company's obligations under the Bank Credit Facility are unsecured. F-42 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 4 - Debt and Warrants-(Continued) Warrants No warrants were outstanding at December 31, 1999. During 1999, the Company repurchased all remaining warrants, representing 107,537 shares of the Company's common stock, for $2,427. 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 and 1997, warrants to purchase 107,537 shares and 281,250 shares, respectively, of the Company's common stock at $2.70 per share were outstanding. Covenants The Company is in compliance with all of the covenants contained in the Senior Notes indenture and the Bank Credit Facility Agreement. NOTE 5 - Shareholders' Equity and Stock Options Share Repurchase Program During the first six months of 1999, the Company repurchased 1,075,300 shares of its common stock, or 3% of the outstanding shares on December 31, 1998, at an aggregate cost of $25,092, or an average cost of $23.34 per share, under its stock repurchase program. No shares were repurchased during the third and fourth quarters of 1999. Since early 1997, 7,082,700 shares, or 15% of the shares outstanding on December 31, 1996, have been repurchased at an aggregate cost of $188,513, equal to an average cost of $26.62 per share. Including shares repurchased in 1995, the Company has repurchased 32% 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 use of cash and, when necessary, the Bank Credit Facility. In May 1999, an additional $100,000 share repurchase authorization was announced. As of December 31, 1999, $111,487 remained authorized for future share repurchases. 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, 1999, 1998 and 1997. F-43 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 5 - Shareholders' Equity and Stock Options-(Continued) Beginning in 1997, the Company's catastrophe reinsurance program is augmented by a $100,000 equity and reinsurance agreement. The 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 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 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, 1999, 1998 and 1997, 68,822 units, 48,689 units and 32,685 units, respectively, were outstanding under this plan representing an equal number of common shares to be issued in the future. F-44 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 5 - Shareholders' Equity and Stock Options-(Continued) 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, 1999 and 1998, 5,613 and 2,489 units, respectively, 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 directors. The options are exercisable in installments generally beginning in the first year from the date of grant and expiring 10 years from the date of grant. 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, 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 --------- --------- --------- Granted................... $21.42 $19.53-$25.63 484,600 68,689 (484,600) Vested.................... $22.42-$34.53 - 115,142 - Exercised................. $18.50 $15.15-$23.31 (17,363) (17,363) - Canceled.................. $29.07 $22.42-$33.87 (4,012) (4,012) 4,012 --------- --------- --------- At December 31, 1999........ $17.52 $ 9.00-$34.53 1,852,075 1,269,868 749,062 ========= ========= =========
F-45 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 5 - Shareholders' Equity and Stock Options-(Continued) As of December 31, 1999, the weighted average life of vested and exercisable options was 3.8 years and the weighted average price of such options was $14.70 per option. The weighted average prices of vested and exercisable options as of December 31, 1998 and 1997 were $12.84 and $11.05, 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, 1999, 1998 and 1997 were as follows:
December 31, ------------------------------ 1999 1998 1997 --------- --------- -------- Current liability (asset)..................................... $ 19,006 $(2,971) $(7,615) Deferred liability (asset).................................... (20,435) 21,549 35,530
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, 1999, 1998 and 1997 were as follows:
December 31, --------------------------- 1999 1998 1997 -------- ------- ------- Deferred tax assets Unrealized losses on securities............................. $ 21,547 $ - $ - Discounting of unpaid claims and claims expense tax reserves............................... 7,166 8,277 3,087 Life insurance future policy benefit reserve revaluation.... 17,195 21,346 19,282 Unearned premium reserve reduction.......................... 11,395 12,037 11,248 Postretirement benefits other than pension.................. 9,775 9,102 8,406 Other, net.................................................. 6,200 3,181 600 -------- ------- ------- Total gross deferred tax assets......................... 73,278 53,943 42,623 -------- ------- ------- Deferred tax liabilities Unrealized gains on securities.............................. - 30,867 33,473 Amortization of intangible assets........................... 17,573 18,197 19,831 Deferred policy acquisition costs........................... 35,270 26,428 24,849 -------- ------- ------- Total gross deferred tax liabilities.................... 52,843 75,492 78,153 -------- ------- ------- Net deferred tax liability (asset).................... $(20,435) $21,549 $35,530 ======== ======= =======
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. F-46 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 6 - Income Taxes-(Continued) The components of federal income tax expense (benefit) were as follows:
Year Ended December 31, --------------------------- 1999 1998 1997 ------- -------- ------- Current................................................. $35,237 $ 42,844 $21,707 Deferred................................................ 13,612 (11,375) 10,874 ------- -------- ------- Total tax expense before discontinued operations...... $48,849 $ 31,469 $32,581 ======= ======== =======
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, --------------------------- 1999 1998 1997 ------- ------- ------- Expected federal tax on income from continuing operations............................ $32,674 $40,874 $41,873 Add (deduct) tax effects of: Tax-exempt interest................................... (4,293) (3,706) (3,310) Goodwill.............................................. 566 566 566 Acquisition related benefits and other, net........... (98) (6,265) (6,548) ------- ------- ------- Income tax expense provided on income from continuing operations before provision for prior years' taxes................................ 28,849 31,469 32,581 Provision for prior years' taxes........................ 20,000 - - ------- ------- ------- Income tax expense provided on income from continuing operations............................ $48,849 $31,469 $32,581 ======= ======= =======
As previously reported, the Company has been contesting proposed additional federal income taxes relating to a settlement agreement with the Internal Revenue Service ("IRS") for prior years' taxes. Based on developments in that process during the last half of 1999, it appears that the Company may be forced to litigate the issue with the IRS in order to reach a resolution of the issue acceptable to the Company. Therefore, in the third quarter of 1999, the Company recorded an additional federal income tax provision of $20 million representing the maximum exposure of the Company to the IRS with regard to the issue for all of the past tax years in question. While the ultimate resolution of the issue, through settlement or litigation, may result in the Company paying less than the maximum exposure, given the vagaries of litigation and the lack of progress in reaching an acceptable agreement with the IRS, management believed it prudent to book the maximum exposure in 1999. None of the $20 million reserve was paid as of December 31, 1999. This reserve was a charge to net income in 1999. F-47 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) 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 policy loans is based on estimates using discounted cash flow analysis and current interest rates being offered for new loans. 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 carrying value of real estate is an estimate of fair value based on discounted cash flows from operations. 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. F-48 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 7 - Fair Value of Financial Instruments-(Continued) The carrying amounts and fair values of financial instruments at December 31, 1999, 1998 and 1997 consisted of the following:
December 31, ---------------------------------------------------------------------- 1999 1998 1997 ---------------------- ---------------------- ---------------------- Carrying Fair Carrying Fair Carrying Fair Amount Value Amount Value Amount Value ---------- ---------- ---------- ---------- ---------- ---------- Financial Assets Investments Fixed maturities................... $2,507,280 $2,507,280 $2,651,379 $2,651,379 $2,638,794 $2,638,794 Short-term and other investments... 122,929 125,316 102,049 105,859 130,252 133,844 Short-term investments, loaned securities collateral..... - - 87,392 87,392 - - ---------- ---------- ---------- ---------- ---------- ---------- Total investments.............. 2,630,209 2,632,596 2,840,820 2,844,630 2,769,046 2,772,638 Cash................................. 22,848 22,848 12,044 12,044 353 353 Financial Liabilities Policyholder account balances on interest-sensitive life contracts.. 94,141 92,048 91,719 89,576 91,322 84,034 Annuity contract liabilities......... 1,238,379 1,052,732 1,239,234 1,142,859 1,245,459 1,112,479 Other policyholder funds............. 126,530 126,530 124,820 124,820 122,107 122,107 Short-term debt...................... 49,000 49,000 50,000 50,000 42,000 42,000 Long-term debt....................... 99,677 89,613 99,637 101,525 99,599 99,580
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-49 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, ---------------------------------- 1999 1998 1997 ---------- ---------- ---------- Statutory capital and surplus of insurance subsidiaries...... $ 387,081 $ 363,130 $ 355,357 Increase (decrease) due to: Deferred policy acquisition costs........................... 130,192 101,658 85,883 Difference in policyholder reserves......................... (7,514) (2,498) 334 Goodwill.................................................... 50,632 52,250 53,868 Value of acquired insurance in force........................ 51,436 48,805 54,108 Liability for postretirement benefits, other than pensions.. (27,257) (26,021) (24,574) Investment market value adjustments on fixed maturities............................ (68,123) 98,842 103,256 Difference in investment reserves........................... 27,726 33,733 27,994 Federal income tax liability................................ (158) (15,611) (24,839) Liability for discontinued operations, net of tax benefits.. - - (2,031) Non-admitted assets and other, net.......................... 6,552 5,054 3,301 Shareholders' equity of parent company and non-insurance subsidiaries................................. (1,748) (13,082) 14,914 Parent company short-term and long-term debt................ (148,677) (149,637) (141,599) --------- --------- --------- Shareholders' equity as reported herein.................... $ 400,142 $ 496,623 $ 505,972 ========= ========= ========= Year Ended December 31, --------------------------------- 1999 1998 1997 --------- --------- --------- Statutory net income of insurance subsidiaries............... $ 75,722 $ 67,865 $ 82,771 Net loss of non-insurance companies.......................... (3,710) (380) (1,307) Interest expense............................................. (9,722) (9,487) (9,412) Tax benefit of interest expense and other parent company current tax adjustments...................... (6,928) 2,893 7,565 --------- --------- --------- Combined net income.......................................... 55,362 60,891 79,617 Increase (decrease) due to: Deferred policy acquisition costs........................... 14,612 18,408 15,952 Policyholder benefits....................................... 7,681 1,852 2,527 Federal income tax expense (benefit)........................ (3,090) 5,256 (6,888) Provision for prior years' taxes............................ (20,000) - - Amortization of intangible assets........................... (215) (6,921) (10,662) Investment reserves......................................... (7,931) 6,061 1,316 Loss on group medical business, net of tax benefits......... (376) 1,738 1,849 Other adjustments, net...................................... (1,538) (1,973) (135) --------- --------- --------- Net income as reported herein.............................. $ 44,505 $ 85,312 $ 83,576 ========= ========= =========
F-50 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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 aggregate amount of dividends that may be paid by the insurance subsidiaries to HMEC during 2000 without prior approval is approximately $75 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 by a defined contribution plan and are eligible to participate in the Supplemental Retirement Savings (401(k)) Plan. Certain employees also participate in a supplemental defined contribution plan. Employees hired on or before December 31, 1998 are also covered under a defined benefit plan, with certain employees covered under a supplemental defined benefit plan. 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. F-51 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued) 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. 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 and supplemental savings expense was $9,593, $9,471 and $8,885 for the years ended December 31, 1999, 1998 and 1997, 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, ------------------------- 1999 1998 1997 ------- ------- ------- Contributions to employees accounts.. $ 5,814 $ 5,919 $ 5,645 Total assets at the end of the year.. 85,519 77,820 70,762
F-52 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, ------------------------------- ---------------------------- 1999 1998 1997 1999 1998 1997 --------- --------- --------- -------- -------- -------- Change in benefit obligation: Benefit obligation at beginning of year......... $49,446 $43,354 $39,365 $ 6,190 $ 5,606 $ 5,258 Service cost.................................... 1,816 1,563 1,724 353 341 263 Interest cost................................... 3,351 3,081 2,938 616 382 363 Actuarial (gain) loss........................... (3,291) 5,058 1,925 1,913 (65) (216) Benefits paid................................... (4,040) (3,610) (2,598) (297) (74) (62) ------- ------- ------- ------- ------- ------- Benefit obligation at end of year............... $47,282 $49,446 $43,354 $ 8,775 $ 6,190 $ 5,606 ======= ======= ======= ======= ======= ======= Change in plan assets: Fair value of plan assets at beginning of year.. $50,576 $46,097 $42,262 $ - $ - $ - Actual return on plan assets.................... 6,430 8,089 6,433 - - - Employer contributions.......................... - - - 297 74 62 Benefits paid................................... (4,040) (3,610) (2,598) (297) (74) (62) ------- ------- ------- ------- ------- ------- Fair value of plan assets at end of year........ $52,966 $50,576 $46,097 $ - $ - $ - ======= ======= ======= ======= ======= ======= Funded status..................................... $ 5,684 $ 1,130 $ 2,743 $(8,775) $(6,190) $(5,606) Unrecognized net actuarial (gain) loss............ (3,941) 1,426 488 493 (1,255) (1,418) Unrecognized prior service (asset) cost........... (3,815) (4,424) (5,035) 2,268 2,582 2,895 ------- ------- ------- ------- ------- ------- Accrued benefit cost included in the consolidated balance sheets.............. (2,072) (1,868) (1,804) (6,014) (4,863) (4,129) Additional liability to recognize unfunded accumulated benefit obligation.................. - - - (2,228) (1,107) (1,219) ------- ------- ------- ------- ------- ------- Accrued benefit cost.............................. $(2,072) $(1,868) $(1,804) $(8,242) $(5,970) $(5,348) ======= ======= ======= ======= ======= ======= Amounts recognized in the statement of financial position consist of: Accrued benefit cost.......................... $(2,072) $(1,868) $(1,804) $(6,014) $(4,863) $(4,129) Minimum liability............................. - - - (2,228) (1,107) (1,219) Intangible asset.............................. - - - 2,228 1,107 1,219 ------- ------- ------- ------- ------- ------- Net amount recognized....................... $(2,072) $(1,868) $(1,804) $(6,014) $(4,863) $(4,129) ======= ======= ======= ======= ======= =======
F-53 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, ---------------------------- ----------------------------- 1999 1998 1997 1999 1998 1997 -------- -------- -------- --------- ---------- ------ Components of net periodic benefit cost: Service cost............................ $ 1,816 $ 1,563 $ 1,724 $ 353 $ 341 $ 263 Interest cost........................... 3,351 3,081 2,938 616 382 363 Expected return on plan assets.......... (4,353) (3,969) (3,638) - - - Amortization of prior service cost...... (610) (611) (610) 313 313 313 Recognized net actuarial loss (gain).... - - - 166 (228) (139) ------- ------- ------- ------ ----- ----- Net periodic benefit cost................. $ 204 $ 64 $ 414 $1,448 $ 808 $ 800 ======= ======= ======= ====== ===== ===== Weighted-average assumptions as of December 31: Discount rate......................... 8.00% 6.75% 7.25% 8.00% 6.75% 7.25% 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-54 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, 1999, 1998 and 1997 reconciled with amounts recognized in the Company's statement of financial position:
December 31, ------------------------------- 1999 1998 1997 --------- --------- --------- Change in accumulated postretirement benefit obligation: Accumulated postretirement benefit obligation at beginning of year......................... $ 34,257 $ 29,584 $ 25,153 Changes during fiscal year Service cost............................................ 628 552 845 Interest cost........................................... 2,158 2,043 1,995 Benefits paid........................................... (1,768) (1,231) (1,265) Actuarial (gain) loss Change due to a change in assumptions.................. (5,615) 3,144 446 Change due to demographic changes...................... - 165 219 Valuation model enhancements........................... - - 2,191 -------- -------- -------- Total actuarial (gain) loss........................... (5,615) 3,309 2,856 -------- -------- -------- Accumulated postretirement benefit obligation at end of year............................... $ 29,660 $ 34,257 $ 29,584 ======== ======== ======== Unfunded status........................................... $(29,660) $(34,257) $(29,584) Unrecognized net loss from past experience different from that assumed................... 2,403 8,236 5,010 -------- -------- -------- Accrued postretirement benefit cost..................... $(27,257) $(26,021) $(24,574) ======== ======== ======== Year Ended December 31, ------------------------------ 1999 1998 1997 -------- -------- -------- Components of net periodic benefit cost: Service cost............................................. $ 628 $ 552 $ 845 Interest cost............................................ 2,158 2,043 1,995 Amortization of prior (gains) losses..................... 218 83 122 -------- -------- -------- Net periodic benefit cost............................... $ 3,004 $ 2,678 $ 2,962 ======== ======== ========
Sensitivity Analysis A one percentage point change in the assumed health care cost trend rate for each year would change the accumulated postretirement benefit obligation as follows:
December 31, ------------------------------ 1999 1998 1997 -------- -------- -------- Accumulated postretirement benefit obligation Effect of a one percentage point increase............... $ 864 $ 1,379 $ 2,038 Effect of a one percentage point decrease............... (743) (1,351) (1,907) Service and interest cost components of the net periodic postretirement benefit expense Effect of a one percentage point increase............. $ 75 $ 203 $ 198 Effect of a one percentage point decrease............. (60) (177) (185)
F-55 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued) The assumed net weighted annual average medical rates of increase in the per capita cost of covered benefits for participants in the plan who retired prior to January 1, 1994 were 6.1%, 6.3% and 6.8% as of December 31, 1999, 1998 and 1997, respectively. The net medical trend rates are 7.0% in 2000 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 8.00%, 6.75% and 7.25% at December 31, 1999, 1998 and 1997, 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, deductibles, maximum coverage limits, the purchase of catastrophe reinsurance, and the purchase of a catastrophe-linked equity put option and reinsurance agreement (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, ------------------------- 1999 1998 1997 ------- ------- ------- Reinsurance Recoverables on Unpaid Claims Life and health.......................... $ 4,485 $ 3,890 $ 3,326 Property and casualty State insurance facilities............. 45,222 35,988 25,968 Other insurance companies.............. 19,188 19,902 15,356 ------- ------- ------- Total................................ $68,895 $59,780 $44,650 ======= ======= =======
F-56 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, 1999 Premiums written............ $825,328 $23,891 $19,772 $821,209 Premiums earned............. 599,949 25,308 20,487 595,128 Benefits, claims and settlement expenses....... 435,605 39,183 19,764 416,186 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
There were no losses from uncollectible reinsurance recoverables in the three years ended December 31, 1999. Past due reinsurance recoverables as of December 31, 1999 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-57 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, ------------------------------- 1999 1998 1997 --------- --------- --------- Cash flows from operating activities Net income......................................... $ 44,505 $ 85,312 $ 83,576 Adjustments to reconcile net income to net cash provided by operating activities: Realized investment (gains) losses............. 7,969 (9,908) (5,340) Depreciation and amortization.................. (1,013) 5,342 10,605 Increase in insurance liabilities.............. 76,401 74,900 61,837 (Increase) decrease in premium receivables..... 11,357 (2,296) 4,083 Increase in deferred policy acquisition costs.. (14,615) (18,408) (15,932) Increase in reinsurance recoverable............ (3,078) (1,997) (2,744) Increase (decrease) in federal income tax liabilities....................... 32,409 (6,731) (24,735) Increase (decrease) in accrued loss on discontinued operations................... - (2,689) (2,833) Other.......................................... (5,789) 5,241 (4,081) -------- -------- -------- Total adjustments............................ 103,641 43,454 20,860 -------- -------- -------- Net cash provided by operating activities.. $148,146 $128,766 $104,436 ======== ======== ========
NOTE 13 - Segment Information 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 realized investment gains and losses, after tax, the 1999 provision for prior years' taxes and the 1999 litigation settlement cost, after tax. F-58 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) NOTE 13 - Segment Information-(Continued) Summarized financial information for these segments is as follows:
Year Ended December 31, --------------------------------------- 1999 1998 1997 ----------- ----------- ------------- Insurance premiums and contract charges earned Property and casualty...................................... $ 491,060 $ 476,458 $ 447,252 Annuity.................................................... 16,706 15,556 12,597 Life....................................................... 87,618 85,798 82,863 Intersegment eliminations.................................. (256) - - ---------- ---------- ---------- Total.................................................. $ 595,128 $ 577,812 $ 542,712 ========== ========== ========== Net investment income Property and casualty...................................... $ 37,012 $ 38,900 $ 41,702 Annuity.................................................... 105,224 107,698 113,135 Life....................................................... 47,005 45,453 43,707 Corporate and other........................................ 319 761 1,487 Intersegment eliminations.................................. (1,293) (1,089) (1,103) ---------- ---------- ---------- Total.................................................. $ 188,267 $ 191,723 $ 198,928 ========== ========== ========== Net income Operating income Property and casualty.................................... $ 39,537 $ 53,282 $ 61,319 Annuity.................................................. 27,320 23,048 19,301 Life..................................................... 14,570 12,345 12,934 Corporate and other, including interest expense.......... (10,712) (9,803) (9,968) ---------- ---------- ---------- Total operating income................................. 70,715 78,872 83,586 Realized investment gains (losses), after tax.............. (5,180) 6,440 3,471 Litigation settlement, after tax........................... (1,030) - - Provision for prior years' taxes........................... (20,000) - - ---------- ---------- ---------- Income from continuing operations.......................... 44,505 85,312 87,057 Discontinued operations: Loss on discontinuation.................................. - - (3,481) ---------- ---------- ---------- Total.................................................. $ 44,505 $ 85,312 $ 83,576 ========== ========== ========== Amortization of intangible assets Value of acquired insurance in force Property and casualty.................................... $ 719 $ 1,032 $ 1,032 Annuity.................................................. (4,242) 1,996 5,563 Life..................................................... 2,120 2,275 2,449 ---------- ---------- ---------- Subtotal............................................... (1,403) 5,303 9,044 Goodwill................................................... 1,618 1,618 1,618 ---------- ---------- ---------- Total.................................................. $ 215 $ 6,921 $ 10,662 ========== ========== ========== December 31, -------------------------------------- 1999 1998 1997 ---------- ---------- ---------- Assets Property and casualty...................................... $ 681,432 $ 737,260 $ 742,487 Annuity.................................................... 2,611,766 2,730,092 2,531,309 Life....................................................... 840,594 863,864 777,488 Corporate and other........................................ 153,493 95,579 125,624 Intersegment eliminations.................................. (33,439) (31,315) (44,996) ---------- ---------- ---------- Total.................................................. $4,253,846 $4,395,480 $4,131,912 ========== ========== ==========
F-59 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1999, 1998 and 1997 (Dollars 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, ------------ ------------- -------- --------- 1999 - ---- Insurance premiums written and contract deposits... $207,195 $208,305 $207,644 $198,065 Total revenues..................................... 199,780 195,433 190,182 190,031 Litigation settlement, after tax................... (22) (1,008) - - Provision for prior years' taxes................... - (20,000) - - Income (loss) from continuing operations........... 22,490 (5,458) 10,422 17,051 Net income (loss).................................. 22,490 (5,458) 10,422 17,051 Per share information Basic Realized investment gains (losses), after tax.. $ 0.02 $ (0.01) $ (0.09) $ (0.05) Litigation settlement, after tax............... - (0.02) - - Provision for prior years' taxes............... - (0.48) - - Income (loss) from continuing operations....... 0.55 (0.13) 0.25 0.41 Net income (loss).............................. 0.55 (0.13) 0.25 0.41 Diluted Realized investment gains (losses), after tax.. $ 0.01 $ - $ (0.09) $ (0.05) Litigation settlement, after tax............... - (0.02) - - Provision for prior years' taxes............... - (0.48) - - Income (loss) from continuing operations....... 0.54 (0.12) 0.25 0.40 Net income (loss).............................. 0.54 (0.12) 0.25 0.40 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 (losses), 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 (losses), 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
F-60 SCHEDULE I HORACE MANN EDUCATORS CORPORATION SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1999 (Dollars 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................................... $ 642,532 $ 629,541 $ 629,541 States, municipalities and political subdivisions.. 307,045 302,050 302,050 Foreign government bonds........................... 21,875 21,987 21,987 Public utilities................................... 11,904 11,848 11,848 Other corporate bonds.............................. 1,592,047 1,541,854 1,541,854 ---------- ---------- ---------- Total fixed maturity securities.................. 2,575,403 $2,507,280 2,507,280 ---------- ========== ---------- Mortgage loans and real estate...................... 17,550 xxx 17,550 Short-term investments.............................. 45,082 xxx 45,082 Policy loans and other.............................. 59,471 xxx 60,297 ---------- ---------- Total investments................................ $2,697,506 xxx $2,630,209 ========== ==========
________________ (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-61 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION BALANCE SHEETS As of December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data)
1999 1998 1997 --------- --------- --------- ASSETS Investments and cash........................................... $ 21,734 $ 5,580 $ 19,271 Investment in subsidiaries..................................... 478,748 589,964 574,009 Other assets................................................... 51,417 53,989 57,911 --------- --------- --------- Total assets............................................... $ 551,899 $ 649,533 $ 651,191 ========= ========= ========= LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY Short-term debt................................................ $ 49,000 $ 50,000 $ 42,000 Long-term debt................................................. 99,677 99,637 99,599 Other liabilities.............................................. 3,080 3,053 3,043 --------- --------- --------- Total liabilities.......................................... 151,757 152,690 144,642 --------- --------- --------- Warrants, subject to redemption................................ - 220 577 --------- --------- --------- 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, 1999, 59,292,053; 1998, 59,274,690; 1997, 59,161,008............................................. 59 59 59 Additional paid-in capital..................................... 333,892 336,686 340,564 Retained earnings.............................................. 449,023 420,274 349,274 Accumulated other comprehensive income (loss) (net unrealized gains (losses) on fixed maturities and equity securities).... (40,016) 57,327 62,167 Treasury stock, at cost, 1999, 18,258,896 shares; 1998, 17,183,596 shares; 1997, 14,896,796 shares................... (342,816) (317,723) (246,092) --------- --------- --------- Total shareholders' equity................................. 400,142 496,623 505,972 --------- --------- --------- Total liabilities, redeemable securities and shareholders' equity................................. $ 551,899 $ 649,533 $ 651,191 ========= ========= =========
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 STATEMENTS OF OPERATIONS (Dollars in thousands)
Year Ended December 31, ----------------------------- 1999 1998 1997 --------- -------- -------- Revenues Net investment income....................................... $ 318 $ 759 $ 1,487 Realized investment gains................................... 481 1,123 154 -------- ------- ------- Total revenues.......................................... 799 1,882 1,641 -------- ------- ------- Expenses Interest.................................................... 9,722 9,487 9,412 Amortization of goodwill.................................... 1,618 1,618 1,618 Other....................................................... 1,479 713 541 -------- ------- ------- Total expenses.......................................... 12,819 11,818 11,571 -------- ------- ------- Income (loss) from continuing operations before income taxes and equity in net earnings of subsidiaries.................. (12,020) (9,936) (9,930) Income tax expense (benefit).................................. (3,686) (2,766) (2,845) -------- ------- ------- Income (loss) from continuing operations before equity in net earnings of subsidiaries............................. (8,334) (7,170) (7,085) Equity in net earnings of subsidiaries........................ 52,839 92,482 94,142 -------- ------- ------- Income from continuing operations............................. 44,505 85,312 87,057 Discontinued operations: Loss on discontinuation, representing additional provision of $5,355 for operating losses during phase-out period, net of applicable income tax benefits of $1,874........... - - (3,481) -------- ------- ------- Net income.................................................... $ 44,505 $85,312 $83,576 ======== ======= =======
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-63 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION STATEMENTS OF CASH FLOWS (Dollars in thousands)
Year Ended December 31, ------------------------------- 1999 1998 1997 --------- --------- --------- Cash flows from operating activities Interest expense paid.................................... $ (9,523) $ (9,309) $ (9,276) Federal income taxes recovered........................... 6,901 5,672 1,391 Cash dividends received from subsidiaries................ 63,500 62,100 107,300 Other, net............................................... 421 9,588 (7,208) -------- -------- -------- Net cash provided by operating activities............ 61,299 68,051 92,207 -------- -------- -------- Cash flows from investing activities Net (increase) decrease in investments................... (12,306) 18,039 (10,102) -------- -------- -------- Net cash (used in) provided by investing activities.. (12,306) 18,039 (10,102) -------- -------- -------- Cash flows used in financing activities Purchase of treasury stock............................... (25,093) (71,631) (91,790) Dividends paid to shareholders........................... (15,756) (14,312) (12,971) Principal (payments) borrowings on Bank Credit Facility.. (1,000) 8,000 8,000 Repurchase of common stock warrants...................... (2,426) (4,959) - Exercise of stock options................................ 362 2,200 11,581 Catastrophe-linked equity put option premium............. (950) (1,475) (1,250) -------- -------- -------- Net cash used in financing activities................ (44,863) (82,177) (86,430) -------- -------- -------- Net increase (decrease) in cash............................ 4,130 3,913 (4,325) Cash at beginning of period................................ 3,913 0 4,325 -------- -------- -------- Cash at end of period...................................... $ 8,043 $ 3,913 $ 0 ======== ======== ========
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-64 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION NOTE TO CONDENSED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 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-65 SCHEDULE III & VI (COMBINED) HORACE MANN EDUCATORS CORPORATION SUPPLEMENTARY INSURANCE INFORMATION (Dollars in thousands)
Discount, Other Deferred Future policy if any, policy Premium policy benefits, deducted in claims and revenue/ Net acquisition claims and previous Unearned benefits premium investment Segment costs claims expenses column premiums payable earned income ------- ----------- --------------- ----------- -------- ---------- -------- ---------- Year Ended December 31, 1999 Property and casualty.............. $ 16,705 $ 299,803 $ 0 $162,793 $ - $491,060 $ 37,012 Annuity............................ 41,558 1,240,757 xxx - 114,611 16,706 105,224 Life............................... 71,929 629,889 xxx 8,052 11,919 87,618 47,005 Other, including consolidating eliminations........ N/A N/A xxx N/A N/A (256) (974) --------- ---------- -------- -------- -------- -------- Total........................... $130,192 $2,170,449 xxx $170,845 $126,530 $595,128 $188,267 ========= ========== ======== ======== ======== ======== Year Ended December 31, 1998 Property and casualty.............. $ 16,048 $ 298,929 $ 0 $172,474 $ - $476,458 $ 38,900 Annuity............................ 25,818 1,240,987 xxx - 111,754 15,556 107,698 Life............................... 59,792 588,888 xxx 6,720 13,066 85,798 45,453 Other, including consolidating eliminations........ N/A N/A xxx N/A N/A N/A (328) --------- ---------- -------- -------- -------- -------- Total........................... $101,658 $2,128,804 xxx $179,194 $124,820 $577,812 $191,723 ========= ========== ======== ======== ======== ======== Year Ended December 31, 1997 Property and casualty.............. $ 15,230 $ 310,632 $ 0 $161,205 $ 305 $447,252 $ 41,702 Annuity............................ 19,699 1,246,948 xxx - 107,538 12,597 113,135 Life............................... 50,954 553,981 xxx 5,791 14,264 82,863 43,707 Other, including consolidating eliminations........ N/A N/A xxx N/A N/A N/A 384 --------- ---------- -------- -------- -------- -------- Total........................... $ 85,883 $2,111,561 xxx $166,996 $122,107 $542,712 $198,928 ========= ========== ======== ======== ======== ======== Claims and claims Benefits, adjustment expense Amortization Paid claims incurred related to of deferred claims and -------------------- policy Other and claims settlement Current Prior acquisition operating adjustment Premiums Segment expenses year years costs expenses expense written ------- ---------- ------- ------- ----------- --------- ---------- -------- Year Ended December 31, 1999 Property and casualty............... $374,872 $379,455 $ (4,583) $44,227 $ 54,453 $382,518 $495,075 Annuity............................. 67,078 xxx xxx 5,820 7,208 xxx xxx Life................................ 65,865 xxx xxx 3,286 43,178 xxx xxx Other, including consolidating eliminations......... N/A xxx xxx (292) 16,377 xxx xxx -------- ------- -------- Total............................ $507,815 xxx xxx $53,041 $121,216 xxx xxx ======== ======= ======== Year Ended December 31, 1998 Property and casualty.............. $354,381 $379,603 $(24,917) $42,779 $ 51,699 $380,955 $487,727 Annuity............................ 71,996 xxx xxx (700) 16,558 xxx xxx Life............................... 64,727 xxx xxx 3,398 44,167 xxx xxx Other, including consolidating eliminations........ N/A xxx xxx N/A 13,657 xxx xxx -------- ------- -------- Total........................... $491,104 xxx xxx $45,477 $126,081 xxx xxx ======== ======= ======== Year Ended December 31, 1997 Property and casualty.............. $320,834 $365,986 $(45,152) $40,515 $ 49,012 $357,875 $458,088 Annuity............................ 76,486 xxx xxx 100 19,373 xxx xxx Life............................... 59,352 xxx xxx 3,583 43,685 xxx xxx Other, including consolidating eliminations........ N/A xxx xxx N/A 14,402 xxx xxx -------- ------- -------- Total........................... $456,672 xxx xxx $44,198 $126,472 xxx xxx ======== ======= ========
- -------------- N/A Not applicable. See accompanying Independent Auditors' Report. F-66 SCHEDULE IV HORACE MANN EDUCATORS CORPORATION REINSURANCE (Dollars 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, 1999 Life insurance in force........ $12,300,704 $783,527 - $11,517,177 - Premiums Property and casualty......... $ 493,804 $ 23,231 $20,487 $ 491,060 4.2% Annuity....................... 16,706 - - 16,706 - Life.......................... 89,695 2,077 - 87,618 - Other, including consolidating eliminations.. (256) - - (256) - ----------- -------- -------- ----------- Total premiums............. $ 599,949 $ 25,308 $20,487 $ 595,128 3.4% =========== ======== ======== =========== 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% =========== ======== ======== ===========
____________ NOTE: Premiums above include insurance premiums earned and contract charges earned. See accompanying Independent Auditors' Report F-67 ================================================================================ HORACE MANN EDUCATORS CORPORATION EXHIBITS To FORM 10-K For the Year Ended December 31, 1999 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, 1999. 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. 3.1(a) 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. 3.1(b) 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. 3.1(c) 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. 3.1(d) 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. 3.2 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. 3.3 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 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. 4.1(a) Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.1). 4.2 Certificate of Designations for HMEC Series A Cumulative Preferred Stock (included in Exhibit 10.15). (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. 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* Amended and restated Horace Mann Educators Corporation 1991 Stock Incentive Plan. 10.5(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan. 10.5(b)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan. 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.
2
Sequential Exhibit Page No. Description Number - ------ ----------- ---------- 10.6(a)* Revised Schedule to Severance Agreements between HMEC and certain officers of HMEC, incorporated by reference to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999, filed with the SEC on August 13, 1999. 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. 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 Employment 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. 10.11(a)* Amendment Agreement to the Amended and Restated Employment Agreement entered by and between HMEC and Paul J. Kardos as of October 6, 1998 dated as of February 1, 2000. 10.12* Employment Agreement entered by and between HMEC and Louis G. Lower II as of December 31, 1999. 10.13* Separation Agreement entered by and between HMEC and Larry K. Becker as of March 21, 2000. 10.14* Letter of Employment entered by and between HMEC and Peter H. Heckman effective April 10, 2000.
3
Sequential Exhibit Page No. Description Number - ------ ----------- ---------- 10.15 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. 10.15(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. 10.15(b) Amendment effective February 15, 1997 to Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement, incorporated by reference to Exhibit 10.12(b) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1998, filed with the SEC on March 31, 1999. 10.15(c) Amendment effective June 1, 1999 to Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement, incorporated by reference to Exhibit 10.1(c) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999, filed with the SEC on November 12, 1999. (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.
4 EX-10.5 2 AMENDED & RESTATED 1991 STOCK INCENTIVE PLAN Exhibit 10.5 HORACE MANN EDUCATORS CORPORATION 1991 STOCK INCENTIVE PLAN AMENDED AND RESTATED EFFECTIVE DECEMBER 31, 1999 SECTION 1. Purpose; Definitions. The purpose of the Plan is to enable existing and prospective officers, employees and directors of the Company, its subsidiaries and affiliates to participate in the Company's future and to enable the Company to attract and retain such persons by offering them proprietary interests in the Company. For purposes of the Plan, the following terms are defined as set forth below: a. "Affiliate" means a corporation or other entity controlled by the Company and designated by the Committee as such. b. "Award" means a Stock Appreciation Right, Stock Option, or Common Stock with or without restrictions. c. "Board" means the Board of Directors of the Company. d. "Cause" has the meaning set forth in Section 5(i). e. "Change in Control" has the meaning set forth in Section 8(b). f. "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto. g. "Commission" means the Securities and Exchange Commission or any successor agency. h. "Committee" means the Committee referred to in Section 2. i. "Common Stock" means common stock, $.001 per share par value, of the Company. j. "Company" means Horace Mann Educators Corporation. k. "Disability" means permanent and total disability as determined under procedures established by the Committee for purposes of the Plan. l. "Early Retirement" means retirement from active employment with the Company, a subsidiary or Affiliate pursuant to the early retirement provisions of the applicable tax qualified pension plan of such employer. m. "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time, and any successor thereto. n. "Fair Market Value" means, except as provided in Sections 5(j) and 6(b)(ii)(2), the mean, as of any given date, between the highest and lowest reported sales prices of the Common Stock on the New York Stock Exchange Composite Tape or, if not listed on such exchange, on any other national exchange on which the Common Stock is listed or on NASDAQ. If there is no regular public trading market for such Common Stock, the Fair Market Value of the Common Stock shall be determined by the Committee in good faith. o. "Incentive Stock Options" means any Stock Option intended to be and designated as an "incentive stock option" within the meaning of Section 422 of the Code. p. "Non-Qualified Stock Option" means any Stock Option that is not an Incentive Stock Option. q. "Normal Retirement" means retirement from active employment with the Company, a subsidiary or Affiliate, pursuant to the normal retirement provisions of the applicable tax qualified pension plan of such employer. r. "Outside Director" shall mean a director who satisfies both (i) the requirements for an "outside director" as set forth in Section 162m of the Code and Treasury Reg. Section 1.162- 27(e)(3)(i) promulgated thereunder and (ii) the requirements for a "non-employee director" set forth in Rule 16b-3 under the Securities Exchange Act of 1934, as amended, or successor requirements thereto. s. "Plan" means the Horace Mann Educators Corporation 1991 Stock Incentive Plan, as set forth herein and as hereinafter amended from time to time. t. "Retirement" means Normal or Early Retirement. u. "Rule 16b-3" means Rule 16b-3, as promulgated by the Commission under Section 16(b) of the Exchange Act, as amended from time to time. v. "Stock Appreciation Right" means a right granted under Section 6. w. "Stock Option" or "Option" means an option granted under Section 5. x. "Termination of Employment" means the termination of the participant's employment with the Company and any Affiliate. A participant employed by an Affiliate shall also be deemed to incur a Termination of Employment if the Affiliate ceases to be an Affiliate and the participant does not immediately thereafter become an employee of the Company or another Affiliate. -2- y. "Vested" or "Vesting" means (i) with respect to an Option or Stock Appreciation Right, that it is exercisable subject to whatever or restrictions on exercise may exist by the terms of this Plan or the option agreement; and (ii) with respect to Common Stock, that no longer has any restrictions. In addition, certain other terms used herein have definitions given to them in the first place on which they are used. SECTION 2. Administration. The Plan shall be administered by a Committee of the Board, composed of not less than two Outside Directors, appointed by and serving at the pleasure of the Board. If at any time no Committee shall be in office, the functions of the Committee specified in the Plan shall be exercised by the Board. The Committee shall have plenary authority to grant Awards to existing and prospective officers, employees and directors of the Company or an Affiliate. Among other things, the Committee shall have the authority, subject to the terms of the Plan: (a) to select the existing and prospective officers, employees and directors to whom Awards may from time to time be granted; (b) to determine whether and to what extend Incentive Stock Options, Non-Qualified Stock Options, Stock Appreciation Rights and Common Stock or any combination thereof are to be granted hereunder; (c) to determine the number of shares of Common Stock to be covered by each Award granted hereunder; (d) to determine the terms and conditions of any Award granted hereunder (including, but not limited to, the share price, any Vesting restriction or limitation and any Vesting acceleration or forfeiture waiver regarding any Award and the shares of Common Stock relating thereto, based on such factors as the Committee shall determine); (e) to adjust the terms and conditions, at any time or from time to time, of any Award, including with respect to performance goals and measurements applicable to performance-based Awards pursuant to the terms of the Plan; and (f) to determine to what extent and under what circumstances Common Stock and other amounts payable with respect to an Award shall be deferred. The Committee shall have the authority to adopt, alter and repeal such administrative rules, guidelines and practices governing the Plan as it shall, from time to time, deem advisable, to -3- interpret the terms and provisions of the Plan and any Award issued under the Plan (and any agreement relating thereto) and to otherwise supervise the administration of the Plan. The Committee may act only by a majority of its members then in office, except that the members thereof may authorize any one or more of their number or any officer of the Company to execute and deliver documents on behalf of the Committee. Any determination made by the Committee pursuant to the provisions of the Plan with respect to any Award shall be made in its sole discretion at the time of the grant of the Award or, unless in contravention of any express term of the Plan, at any time thereafter. All decisions made by the Committee pursuant to the provisions of the Plan shall be final and binding on all persons, including the Company and Plan participants. SECTION 3. Common Stock Subject to Plan. Initially, the total number of shares of Common Stock reserved and available for distribution pursuant to Awards under the Plan was 2,000,000 shares. Pursuant to the 2-for-1 split of Common Stock effective December 15, 1997, an additional 2,000,000 shares of Common Stock were reserved and available for distribution pursuant to Awards under the Plan. Such shares may consist, in whole or in part, of authorized and unissued shares or treasury shares. The number of shares with respect to which Stock Options or Stock Appreciation Rights may be granted during any calendar year to any one person (awards of Stock Options and of Stock Appreciation Rights granted in tandem with each other being deemed to have been granted with respect to the same shares) shall not in the aggregate exceed 500,000. Subject to Section 6(b)(iv), if any shares of Common Stock that have been optioned cease to be subject to a Stock Option, if any shares of Common Stock that are subject to any Award are forfeited or if any Award otherwise terminates without a payment being made to the participant in the form of Common Stock, such shares shall again be available for distribution in connection with Awards under the Plan; provided, the person holding such Award received no benefits of ownership (within the meaning of Rule 16b-3 while holding such Award). In the event of any merger, reorganization, consolidation, recapitalization, stock dividend, spin-off, stock split, extraordinary distribution with respect to the Common Stock or other similar change in corporate structure affecting the Common Stock, such substitution or adjustments shall be made in the aggregate number of shares reserved for issuance under the Plan, in the number and option price of shares subject to outstanding Stock Options and Stock Appreciation Rights, and the number of shares subject to other outstanding Awards granted under the Plan as may be determined to be appropriate by the Committee, in its sole discretion; provided, however, that the number of shares subject to any Award shall always be a whole number. Such adjusted option price shall also be used to determine the amount payable by the Company upon the exercise of any Stock Appreciation Right associated with any Stock Option. -4- SECTION 4. Eligibility. Existing and prospective officers, employees and directors of the Company and its Affiliates who are or who are expected to be responsible for or contribute to the management, growth and profitability of the business of the Company and its Affiliates are eligible to be granted Awards under the Plan. SECTION 5. Stock Options. Stock options may be granted alone or in addition to other Awards granted under the Plan and may be of two types: Incentive Stock Options and Non- Qualified Stock Options. Any Stock Option granted under the Plan shall be in such form as the Committee may from time to time approve. The committee shall have the authority to grant any optionee Incentive Stock Options, Non-Qualified Stock Options or both types of Stock Options (in each case with or without Stock Appreciation Rights). Incentive Stock Options may be granted only to employees of the Company and its subsidiaries (within the meaning of Section 425(f) of the Code). To the extent that any Stock Option is not designated as an Incentive Stock Option or even if so designated does not qualify as an Incentive Stock Option, it shall constitute a Non-Qualified Stock Option. Stock Options shall be evidenced by option agreements, the terms and provisions of which may differ. An option agreement shall indicate on its face whether it is an agreement for an Incentive Stock Option or a Non- Qualified Stock Option. The grant of a Stock Option shall occur on the date the Committee by resolution selects an individual to be a participant in any grant of a Stock Option, determines the number of shares of Common Stock to be subject to such Stock Option to be granted to such individual and specifies the terms and provisions of the option agreement. The Company shall notify a participant of any grant of a Stock Option, and a written option agreement or agreements shall be duly executed and delivered by the Company to the participant. Such agreement or agreements shall become effective upon execution by the participant. Anything in the Plan to the contrary notwithstanding, no term of the Plan relating to Incentive Stock Options shall be interpreted, amended or altered nor shall any discretion or authority granted under the Plan be exercised so as to disqualify the Plan under Section 422 of the Code or, without the consent of the optionee affected, to disqualify any Incentive Stock Option under such Section 422. Options granted under the Plan shall be subject to the following terms and conditions and shall contain such additional terms and conditions as the Committee shall deem desirable: (a) Option Price. The option price per share of Common Stock purchasable under an Incentive Stock Option shall not be less than the Fair Market Value of the Common Stock subject to the Option at time of grant. The option price of a Non-Qualified Stock Option shall be the Fair Market Value of the Common Stock subject to the Option on the -5- date of grant. (b) Option Term. The term of each Stock Option shall be fixed by the Committee, but no Stock Option shall be exercisable more than 10 years after the date the Option is granted. (c) Vesting. Subject to Section 5(a) and 8(a)(i), Stock Options shall be Vested at such time or times and subject to such terms and conditions as shall be determined by the Committee. If the Committee provides that any Stock Option is Vested only in installments, the Committee may at any time waive such installment Vesting provisions, in whole or in part, based on such factors as the Committee may determine. In addition, the Committee may at any time accelerate the Vesting of any Stock Option. (d) Method of Exercise. Subject to the provisions of this Section 5, Stock Options may be exercised, in whole or in part, at any time during the option period by giving written notice of exercise to the Company specifying the number of shares of Common Stock subject to the Stock Option to be purchased. Such notice shall be accompanied by payment in full of the purchase price by certified or bank check or such other instrument as the Company may accept. If approved by the Committee, payment in full or in part may also be made in the form of unrestricted Common Stock already owned by the optionee of the same class as the Common Stock subject to the Stock Option and, in the case of the exercise of a Non-qualified Stock Option, Common Stock with restrictions subject to an Award hereunder which is of the same class as the Common Stock subject to the Stock Option (based, in each case, on the Fair Market Value of the Common Stock on the date the Stock Option is exercised); provided, however, that, in the case of an Incentive Stock Option, the right to make a payment in the form of already owned shares of Common Stock of the same class as the Common Stock subject to the Stock Option may be authorized only at the time the Stock Option is granted. If payment of the option exercise price of a Non-Qualified Stock Option is made in whole or in part in the form of Common Stock with restrictions, the number of shares of Common Stock to be received upon such exercise equal to the number of shares of such Common Stock with restrictions used for payment of the option exercise price shall be subject to the same forfeiture restrictions or deferral limitations to which such Common Stock with restrictions was subject, unless otherwise determined by the Committee. No shares of Common Stock shall be issued until full payment therefor has been made. Subject to any forfeiture restrictions or deferral limitations that may apply if a Stock Option is exercised using Common Stock with restrictions, an optionee shall have all of the rights of a stockholder of the Company holding the class or series of Common Stock that is subject to such Stock Option (including, if applicable, the right to vote the shares and the right to receive dividends), when the optionee has given written notice of -6- exercise, has paid in full for such shares and, if requested, has given the representation described in Section 11(a). (e) Non-transferability of Options. No Stock Option shall be transferable by the optionee other than by will or by the laws of descent and distribution, and all Stock Options shall be exercisable, during the optionee's lifetime, only by the optionee or by the guardian or legal representative of the optionee, it being understood that the terms "holder" and "optionee" include the guardian and legal representative of the optionee named in the option agreement and any person to whom an option is transferred by will or the laws of descent and distribution. Notwithstanding the foregoing, a Stock Option which is granted to a Director may be transferred to the spouse or lineal descendant of the Director optionee or to the trustee of a trust for the primary benefit of a spouse or lineal descendent. Such assignee shall be subject to all of the terms and provisions of the Plan. (f) Termination by Death. If an optionee incurs a Termination of Employment by reason of death, any Stock Option held by such optionee may thereafter be exercised, to the extent that Vested or such other option outstanding and not Vested for which Vesting may be accelerated as the Committee may determine, for a period of one year (or such shorter period as the Committee may specify at grant) from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (g) Termination by Reason of Disability. If an optionee incurs a Termination of Employment by reason of Disability, any Stock Option held by such optionee may thereafter be exercised by the optionee, to the extent it was Vested at the time of termination or such other option outstanding and not Vested for which Vesting may be accelerated as the Committee may determine, for a period of one year (or such shorter period as the committee may specify as grant) from the date of such Termination of Employment or until the expiration of the stated term of such Stock Option, whichever period is the shorter; provided, however, that if the optionee dies within such one-year period (or such shorter period), any unexercised Stock Option held by such optionee shall, notwithstanding the expiration of such one-year (or such shorter) period, continue to be Vested to the extent to which it was Vested at the time of death for a period of 12 months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. In the event of Termination of Employment by reason of Disability, if an Incentive Stock Option is exercised after the expiration of the exercise periods that apply for purposes of Section 422 of the Code, such Stock Option will thereafter be treated as a Non- Qualified Stock Option. (h) Termination by Reason of Retirement. If an optionee incurs a Termination of Employment by reason of Retirement, any Stock Option held by such optionee which was unvested at the time of such Retirement, will become Vested one year after the optionee's date of Termination by reason of Retirement. Further, such optionee may exercise such Stock Options for a period of one year thereafter or until the expiration of the stated term of such Stock Option, whichever period is the shorter; provided, however, that if the optionee dies within such one-year (or such shorter) period any unexercised Stock Option held by such optionee shall, notwithstanding the expiration of such one- -7- year (or such shorter) period, continue to be Vested to the extent to which it was Vested at the time of death for a period of 12 months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. In the event of Termination of Employment by reason of Retirement, if an Incentive Stock Option is exercised after the expiration of the exercise periods that apply for purposes of Section 422 of the Code, such Stock Option will thereafter be treated as a Non-Qualified Stock Option. (i) Other Termination. Unless otherwise determined by the Committee, if an optionee incurs a Termination of Employment for any reason other than death, Disability or Retirement, any Stock Option held by such optionee shall thereupon terminate, except that if such Termination of Employment of the optionee is involuntary and without Cause, such Stock Option shall be fully Vested and may be exercised within the lesser of six months from the date of such Termination of Employment or the balance of such Stock Option's term. Notwithstanding the foregoing, if an optionee incurs a Termination of Employment at or after a Change in Control (as defined in Section 8(b)), other than by reason of death, Disability or Retirement, any Stock Option held by such optionee shall be Vested and may be exercised within the lesser of (1) six months and one day from the date of such Termination of Employment, and (2) the balance of such Stock Option's term. Unless otherwise determined by the Committee, for the purposes of the Plan "Cause" shall mean (1) the conviction of the optionee for committing a felony under Federal law or the law of the state in which such action occurred, (2) dishonesty in the course of fulfilling the optionee's employment duties or (3) willful and deliberate failure on the part of the optionee to perform his employment duties in any material respect. SECTION 6. Stock Appreciation Rights (a) Grant and Exercise. Stock Appreciation Rights may be granted in conjunction with all or part of any Stock Option granted under the Plan. In the case of a Non-Qualified Stock Option, such rights may be granted either at or after the time of grant of such Stock Option. In the case of an Incentive Stock Option, such rights may be granted only at the time of grant of such Stock Option. A Stock Appreciation Right shall terminate and no longer be exercisable upon the termination or exercise of the related Stock Option. A Stock Appreciation Right may be exercised by an optionee in accordance with Section 6(b) by surrendering the applicable portion of the related Stock Option in accordance with procedures established by the Committee. Upon such exercise and surrender, the optionee shall be entitled to receive an amount determined in the manner prescribed in Section 6(b). Stock Options which have been so surrendered shall no longer be exercisable to the extent the related Stock Appreciation Rights have been exercised. (b) Terms and Conditions. Stock Appreciation Rights shall be subject to such terms and conditions as shall be determined by the Committee, including the following: (i) Stock Appreciation Rights shall be exercisable only at such time or times and to the -8- extent that the Stock Options to which they relate are Vested in accordance with the provisions of Section 5 and this Section 6; provided, however, that a Stock Appreciation Right shall not be Vested during the first six months of its term by an optionee who is actually or potentially subject to Section 16(b) of the Exchange Act. (ii) Upon the exercise of a Stock Appreciation Right, an optionee shall be entitled to receive an amount in cash, shares of Common Stock or both equal in value to the excess of the Fair Market Value of one share of Common Stock over the option price per share specified in the related Stock Option multiplied by the number of shares in respect of which the Stock Appreciation Right shall have been exercised, with the Committee having the right to determine the form of payment. In the case of Stock Appreciation Rights relating to Stock Options held by optionees who are actually or potentially subject to Section 16(b) of the Exchange Act, the Committee: (1) may require that such Stock Appreciation Rights be exercised only in accordance with the applicable "window period" provisions of Rule 16b-3; and (2) in the case of Stock Appreciation Rights relating to Non- Qualified Stock Options, may provide that the amount to be paid upon exercise of such Stock Appreciation Rights during a Rule 16b-3 "window period" shall be based on the highest mean sales price of the Common Stock on the New York Stock Exchange on any day during such "window period". (iii) Stock Appreciation Rights shall be transferable only when and to the extent that the underlying Stock Option would be transferable under Section 5(e). (iv) Upon the exercise of a Stock Appreciation Right, the Stock Option or part thereof to which such Stock Appreciation Right is related shall be deemed to have been exercised for the purpose of the limitation set forth in Section 3 on the number of shares of Common Stock to be issued under the Plan, but only to the extent of the number of shares covered by the Stock Appreciation Right at the time of exercise based on the value of the Stock Appreciation Right at such time. SECTION 7. Common Stock Awards (a) Administration. Shares of Common Stock with or without specified restrictions may be awarded either alone or in addition to other Awards granted under the Plan. The Committee shall determine the existing and prospective officers, employees and directors to whom and the time or times at which grants of Common Stock will be awarded, the number of shares to be awarded to any participant, the time or times within which such Awards may be subject to forfeiture and any other terms and conditions of the Awards, in addition to those continued in Section 7(c). -9- The Committee may condition the grant of Common Stock upon the attainment of specified performance goals of the participant or of the Company or subsidiary, division or department of the Company for or within which the participant is primarily employed or upon such other factors or criteria as the Committee shall determine. The provisions of Common Stock Awards need not be the same with respect to each recipient. (b) Awards and Certificates. Each participant receiving an Award of Common Stock shall be issued a certificate in respect of such shares of Common Stock. Such certificate shall be registered in the name of such participant. Each participant receiving an Award of Common Stock with restrictions shall be issued a certificate in respect of such shares of Common Stock. Such certificate shall be registered in the name of such participant and shall bear an appropriate legend referring to the terms, conditions, and restrictions applicable to such Award, substantially in the following form: "The transferability of this certificate and the shares of stock represented hereby are subject to the terms and conditions (including forfeiture) of the Horace Mann Educators Corporation 1991 Stock Incentive Plan and a Restricted Stock Agreement. Copies of such Plan and Agreement are on file at the offices of Horace Mann Educators Corporation, 1 Horace Mann Plaza, Springfield, IL 62715." The Committee may be required that the certificates evidencing such shares of Common Stock with restrictions be held in custody by the Company until the restrictions thereon shall have lapsed and that, as a condition of any such Award, the participant shall have delivered a stock power, endorsed in blank, relating to the Common Stock covered by such Award. (c) Terms and Conditions. Shares of Common Stock with restrictions shall be subject to the following terms and conditions: (i) Subject to the provisions of the Plan and the Restricted Stock Agreement referred to in Section 7(c)(vi), during a period set by the Committee, commencing with the date of such Award (the "Restriction Period"), the participant shall not be permitted to sell, assign, transfer, pledge or otherwise encumber shares of such Stock. Within these limits, the Committee may provide for the Vesting of such shares in installments and may accelerate Vesting, in whole or in part, based on service, performance of the participant or of the Company or the subsidiary, division or department for which the participant is employed or such other factors or criteria as the Committee may determine. (ii) Except as provided in this paragraph (ii) and Section 7(c)(i), the participant shall have, with respect to the shares of such Stock, all of the rights of a stockholder of the Company holding the class or series of Common Stock that is the subject of the restrictions, including, if applicable, the right to vote the shares and the right to receive any cash dividends. Unless otherwise determined by the Committee and subject to Section 11(f) of the Plan, (1) cash dividends on the class or series of -10- Common Stock that is the subject of the restrictions shall be automatically deferred and reinvested in additional Common Stock with the same or similar restrictions, and (2) dividends on the class or series of Common Stock that is the subject of the restrictions payable in Common Stock shall be paid in the form of Common Stock of the same class with the same restrictions on which such dividend was paid. (iii) Except for the extend otherwise provided in the applicable Restricted Stock Agreement for Sections 7(c)(i), 7(c)(iv) and 8(a)(ii), upon a participant's Termination of Employment for any reason during the Restriction Period, all shares still subject to restriction shall be forfeited by the participant. (iv) Except to the extent otherwise provided in Section 8(a)(ii), in the event that a participant involuntarily incurs a Termination of Employment (other than for Cause), the Committee shall have the discretion to waive in whole or in part any or all remaining restrictions with respect to any or all of such participant's shares of Common Stock. (v) If and when the Restriction Period expires without a prior forfeiture of the Common Stock subject to such Restriction Period, unlegended certificates for such Vested shares shall be delivered to the participant. (vi) Each Award shall be confirmed by, and be subject to the terms of, a Restricted Stock Agreement. SECTION 8. Change In Control Provisions. (a) Impact of Event. Notwithstanding any other provision of the Plan to the contrary, in the event of a Change in Control (as defined in Section 8(b)), with regard to existing (not prospective) officers, employees and directors of the Company or an Affiliate: (i) Any Stock Appreciation Rights and Stock Options outstanding as of the date such Change in Control is determined to have occurred and not then Vested shall become fully Vested; provided, however, that, in the case of the holder of Stock Appreciation Rights who is actually subject to Section 16(b) of the Exchange Act, such Stock Appreciation Rights shall have been outstanding for at least six months prior to exercise. (ii) The restrictions and deferral limitations applicable to any Common Stock with restrictions shall lapse, and such Common Stock shall become free of all restrictions and become fully Vested and transferable to the full extent of the original grant. (b) Definition of Change in Control. For purposes of the Plan, a "Change in Control" shall mean the happening of any of the following events: (i) there shall be consummated (1) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation, or pursuant to which shares of the Company's Common Stock would be converted into cash, securities or other property, other than a merger of the company in which no -11- Company shareholder's ownership percentage in the surviving corporation immediately after the merger is less than such shareholder's ownership percentage in the Company immediately prior to such merger by ten percent (10%) or more; or (2) any sale, lease exchange or other transfer (in one transaction or in a series of related transactions) of all, or substantially all, of the assets of the Company; (ii) the shareholders of the Company approve any plan or proposal for the liquidation or dissolution of the Company which is a part of a sale of assets, merger, or reorganization of the Company or other similar transaction; (iii) any "person" as such term is used in Sections 13(d) and 14(d) of the Exchange Act, other than The Fulcrum III Limited Partnership, The Second Fulcrum III Limited Partnership and Gibbons, Goodwin, van Amerongen L.P., is or becomes, directly or indirectly, the "beneficial owner," as defined in Rule 13d-3 under the Exchange Act, of securities of the Company that represent 51% or more of the combined voting power of the Company's then outstanding securities; or (iv) a majority of the members of the Company's Board of Directors are persons who are then serving on the Board of Directors without being elected by the Board of Directors or having been nominated by the Company for election by its shareholders. SECTION 9. Amendments and Termination. The Board may amend, alter, or discontinue the Plan, but no amendment, alteration or discontinuation shall be made which would (i) impair the rights of an optionee under a Stock Option or a recipient of a Stock Appreciation Right and Common Stock Award theretofore granted without the optionee's or recipient's consent, except such an amendment made to cause the Plan to qualify for the exemption provided by Rule16b-3 or (ii) disqualify the Plan from the exemption provided by Rule 16b-3. In addition, no such amendment shall be made without the approval of the Company's stockholders to the extent such approval is required by law or agreement. The Committee may amend the terms of any Stock Option or other Award theretofore granted, prospectively or retroactively, but no such amendment shall impair the rights of any holder without the holder's consent, except such an amendment made to cause the Plan or Award to qualify for the exemption provided by Rule 16b-3. The Committee may also substitute new Stock Options for previously granted Stock Options, including previously granted Stock Options having higher option prices. Subject to the above provisions, the Board shall have authority to amend the Plan to take into account changes in law and tax and accounting rules, as well as other developments and to grant Awards which qualify for beneficial treatment under such rules without shareholder approval. SECTION 10. Unfunded Status of Plan. It is presently intended that the Plan constitute an "unfunded" plan for incentive and deferred -12- compensation. The Committee may authorize the creation of trusts or other arrangements to meet the obligations created under the Plan to deliver Common Stock or make payments; provided, however, that, unless the Committee otherwise determines, the existence of such trusts or other arrangements is consistent with the "unfunded" status of the Plan. SECTION 11. General Provisions. (a) The Committee may require each person purchasing or receiving shares pursuant to an Award to represent to and agree with the Company in writing that such person is acquiring the shares without a view to the distribution thereof. The certificates for such shares may include any legend which the Committee deems appropriate to reflect any restrictions on transfer. All certificates for shares of Common Stock or other securities delivered under the Plan shall be subject to such stock transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations and other requirements of the Commission, any stock exchange upon which the Common Stock is then listed and any applicable Federal or state securities law, and the Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. (b) Nothing contained in the Plan shall prevent the Company or an Affiliate from adopting other or additional compensation arrangements for its employees. (c) The adoption of the Plan shall not confer upon any employee any right to continue employment nor shall it interfere in any way with the right of the Company or an Affiliate to terminate the employment of any employee at any time. (d) No later than the date as of which an amount first becomes includible in the gross income of the participant for Federal income tax purposes with respect to any Award under the Plan, the participant shall pay the Company, or make arrangements satisfactory to the Company regarding the payment of, any Federal, state, local or foreign taxes of any kind required by law to be withheld with respect to such amount. Unless otherwise determined by the Company, withholding obligations may be settled with Common Stock, including Common Stock that is part of the Award that gives rise to the withholding requirement. The obligations of the Company under the Plan shall be conditional on such payment or arrangements, and the Company and its Affiliates shall, to the extent permitted by law, have the right to deduct any such taxes from any payment otherwise due to the participant. (e) At the time of grant, the Committee may provide in connection with any grant made under the Plan that the shares of Common Stock received as a result of such grant shall be subject to a right of first refusal pursuant to which the participant shall be required to offer to the Company any shares that the participant wishes to sell at the then Fair Market Value of the Common Stock, subject to such other terms and conditions as the Committee may specify at the time of grant. -13- (f) The reinvestment of dividends in additional Common Stock with restrictions at the time of any dividend payment shall only be permissible if sufficient shares of Common Stock are available under Section 3 for such reinvestment (taking into account then outstanding Stock Options and other Awards). (g) The Committee shall establish such procedures as it deems appropriate for a participant to designate a beneficiary to whom any amounts payable in the event of the participant's death are to be paid. (h) Pursuant to this Plan, the Company is vested with authority to assist an optionee to whom an Award is granted hereunder (including any director or officer of the Company or any of its Affiliates who is also an optionee) in the payment of the purchase price or other amounts payable in connection with the receipt or exercise of that Award, by leading such amounts to such optionee on such terms and at such rates of interest and upon such security (or unsecured) as shall have been authorized by the Board or the Committee. (i) The Plan and all Awards made and actions taken thereunder shall be governed by and construed in accordance with the laws of the State of Delaware. SECTION 12. Effective Date of Plan. The Plan shall be effective on October 15, 1991. This Plan document amends and restates the 1991 Stock Incentive Plan and is effective December 31, 1999. -14- EX-10.5(A) 3 SPECIMEN EMPLOYEE STOCK OPTON AGREEMENT Exhibit 10.5(a) HORACE MANN EDUCATORS CORPORATION STOCK OPTION AGREEMENT (1991 Stock Incentive Plan) (EMPLOYEE VERSION) This Stock Option Agreement ("Agreement") is made and entered into as of the Date of Grant indicated below by and between Horace Mann Educators Corporation, a Delaware corporation (the "Company"), and the person named below as Employee. WHEREAS, the Company has offered shares of common stock, par value $.001 per share, of the Company (the "Common Stock") to the public; and WHEREAS, Employee is an employee of the Company and/or one or more of its Affiliates; and WHEREAS, pursuant to the Company's 1991 Employee Stock Incentive Plan (the "Plan"), the committee of the Board of Directors of the Company administering the Plan (the "Committee") has approved the grant to Employee of an option to purchase shares of Common Stock, on the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the foregoing recitals and the covenants set forth herein, the parties hereto hereby agree as follows: 1. Grant of Option; Certain Terms and Conditions. The Company hereby grants to Employee, and Employee hereby accepts, as of the Date of Grant, an option to purchase the number of shares of Common Stock indicated below (the "Option Shares") at the Exercise Price per share indicated below, which option shall expire at 5:00 o'clock p.m. (local time at the Company's principal executive office) on the Expiration Date indicated below and shall be subject to all of the terms and conditions set forth in this Agreement (the "Option"). On the Date of Grant and on each of the first, second, and third anniversaries of the Date of Grant, the Option shall be Vested as to that number of Option Shares (rounded to the nearest whole share) equal to the total number of Option Shares multiplied by the Annual Vesting Rate indicated below. Employee: - -------- Date of Grant: - ------------- Number of - --------- Option Shares: - ------------- Exercise Price - -------------- per Option Share: - ---------------- Expiration Date: - --------------- Annual Vesting Rate: - -------------- The Option is intended to be an Incentive Stock Option to the extent permitted by Section 422(d) of the Code. That part of the Option which cannot qualify as an Incentive Stock Option shall be a Non-Qualified Stock Option. 2. Acceleration and Termination of Option. (a) Termination by Death. If an Employee incurs a Termination of Employment by reason of death, any Stock Option held by such Employee will become fully Vested on the date of Death and may thereafter be exercised, for a period of one year (or such other period as the Committee may specify) from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (b) Termination by Reason of Disability. If an employee incurs a Termination of Employment by reason of Disability, any Stock Option held by such Employee may thereafter be exercised by the Employee, to the extent it was Vested at the time of termination, for a period of one year from the date of such Termination of Employment or until the expiration of the stated term of such Stock Option, whichever period is the shorter; provided, however, that if the Employee dies within such one-year period, any unexercised Stock Option held by such Employee shall, notwithstanding the expiration of such one-year period, continue to be exercisable for a period of 12 months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (c) Termination by Reason of Retirement. If an Employee incurs a Termination of Employment by reason of Retirement, any Stock Option held by such Employee will become fully Vested one year after the date of Retirement (First Year Retirement Anniversary Date) and may thereafter be exercised by the Employee, for a period of one year from the date of the First Year Retirement Anniversary Date or until the expiration of the stated term of such Stock Option, whichever period is the shorter. If the Employee dies prior to the First Year Retirement Anniversary Date, any Stock Option held by the Employee shall be fully Vested on the date of death and any unexercised Stock Option shall continue to be exercisable for a period of 12 months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (d) Other Termination. Unless otherwise determined by the Committee, if an Employee incurs a Termination of Employment for any reason other than death, Disability or Retirement, any Stock Option held by such Employee shall thereupon terminate, except that if such Termination of Employment of the Employee is involuntary and without Cause, such Stock Option shall be fully Vested and may be exercised within the lesser of six months from the date of such Termination of Employment or the balance of such Stock Option's term. Notwithstanding the foregoing, if an Employee incurs a Termination of Employment at or after a Change in Control, other than by reason of death, Disability or Retirement, any Stock Option held by such Employee shall be Vested and may be exercised within the lesser of (1) six months and one day from the date of such Termination of Employment, and (2) the balance of such Stock Option's term. -2- 3. Adjustments. In the event of any merger, reorganization, consolidation, recapitalization, stock dividend, spin-off, stock split, extraordinary distribution with respect to the Common Stock or other similar change in corporate structure affecting the Common Stock, such substitution or adjustments shall be made in the aggregate number of shares reserved for issuance under the Plan, in the number and option price of shares subject to outstanding Stock Options and Stock Appreciation Rights, and the number of shares subject to other outstanding Awards granted under the Plan as may be determined to be appropriate by the Committee, in its sole discretion; provided, however, that the number of shares subject to any Award shall always be a whole number. 4. Exercise. The Option shall be exercisable during Employee's lifetime only by Employee or by his or her guardian or legal representative, and after Employee's death only by the person or entity entitled to do so under Employee's last will and testament or applicable intestate law. The Option may only be exercised by the delivery to the Company of a written notice of such exercise, which notice shall specify the number of Option Shares to be purchased (the "Purchased Shares") and the aggregate Exercise Price for such shares (the "Exercise Notice"), together with payment in full of such aggregate Exercise Price in cash or by bank check payable to the Company; provided, however, that payment of such aggregate Exercise Price may instead be made, in whole or in part, by the delivery to the Company of a certificate or certificates representing shares of Common Stock, duly endorsed or accompanied by a duly executed stock powers, which delivery effectively transfers to the Company good and valid title to such shares, free and clear of any pledge, commitment, lien, claim or other encumbrance (such shares to be valued on the basis of the aggregate Fair Market Value thereof on the date of such exercise), provided that the Company is not then prohibited from purchasing or acquiring such shares of Common Stock. Such notice shall also specify the number of Purchased Shares which are acquired pursuant to the exercise of an Incentive Stock Option and pursuant to the exercise of a Non-Qualified Stock Option. In the absence of such designation, Purchased Shares shall be deemed to be acquired first from the exercise of an Incentive Stock Option. 5. Payment of Withholding Taxes. If the Company is obligated to withhold an amount on account of any federal, state or local tax imposed as a result of the exercise of the Option, including, without limitation, any federal, state or other income tax, or any F.I.C.A., state disability insurance tax or other employment tax, then Employee shall, concurrently with such exercise, pay such amount to the Company in cash or by check payable to the Company or by reducing the number of shares of Common Stock to be issued and delivered to Employee upon such exercise (such reduction to be valued on the basis of the aggregate Fair Market Value (determined on the date of such exercise) of the additional shares of Common Stock that would otherwise have been issued and delivered upon such exercise), provided that the Company is not then prohibited from purchasing or acquiring such additional shares of Common Stock. 6. Stock Exchange Requirements; Applicable Laws. All certificates for shares of Common Stock or other securities delivered under this Agreement shall be subject to such stock transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations and other requirements of the Commission, any stock exchange upon which the Common Stock is then listed and any applicable Federal or state securities law, and the Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. -3- 7. Nontransferability. Neither the Option nor any interest therein may be sold, assigned, conveyed, gifted, pledged, hypothecated or otherwise transferred in any manner other than by will or the laws of descent and distribution. 8. Plan. The Option is granted pursuant to the Plan, as in effect on the Date of Grant, and is subject to all the terms and conditions of the Plan, as the same may be amended from time to time, and the Plan's definitions are hereby incorporated by reference herein; provided, however, that no such amendment shall deprive Employee, without his or her consent, of the Option or of any Employee's rights under this Agreement. The interpretation and construction by the Committee of the Plan, this Agreement, the Option and such rules and regulations as may be adopted by the Committee for the purpose of administering the Plan shall be final and binding upon Employee. Until the Option shall expire, terminate or be exercised in full, the Company shall, upon written request therefor, send a copy of the Plan, in its then-current form, to Employee or any other person or entity then entitled to exercise the Option. 9. Stockholder Rights. No person or entity shall be entitled to vote, receive dividends or be deemed for any purpose the holder of any Option Shares until the Option shall have been duly exercised to purchase such Option Shares in accordance with the provisions of this Agreement. 10. Employment Rights. No provision of this Agreement or of the Option granted hereunder shall (a) confer upon Employee any right to continue in the employ of the Company or any of its subsidiaries, (b) affect the right of the Company and each of its subsidiaries to terminate the employment of Employee, with or without cause, or (c) confer upon Employee any right to participate in any employee welfare or benefit plan or other program of the Company or any of its subsidiaries other than the Plan. 11. Governing Law. This Agreement and the Option granted hereunder shall be governed by and construed and enforced in accordance with the laws of the State of Delaware. 12. Investment Representation and Agreement. The Committee may require Employee to furnish to the Company, prior to the issuance of any shares upon the exercise of all or any part of this option, an agreement (in such form as such Committee may specify) in which Employee represents that the shares acquired by him upon exercise are being acquired for investment and not with a view to the sale or distribution thereof. 13. Entire Agreement. This Agreement, together with the Plan, constitutes the entire obligation of the parties hereto with respect to the subject matter hereof and shall supersede any prior expressions of intent or understanding with respect to this transaction. Employee hereby acknowledges receipt of a copy of the Plan. 14. Amendment. Any amendment hereto shall be in writing and signed by the parties hereto. -4- 15. Waiver; Cumulative Rights. The failure or delay of either party to require performance by the other party of any provision hereof shall not affect its right to require performance of such provision unless and until such performance has been waived in writing. Each and every right hereunder is cumulative and may be exercised in part or in whole from time to time. 16. Counterparts. This Agreement may be signed in two counterparts. 17. Headings. The headings contained in this Agreement are for reference purposes only and shall not affect the meaning or interpretation of this Agreement. IN WITNESS WHEREOF, the Company and Employee have duly executed this Agreement as of the Date of Grant. HORACE MANN EDUCATORS CORPORATION By: ------------------------------------ Name: Louis Lower II Title: President and Chief Executive Officer ---------------------------------------- Employee -5- EX-10.5(B) 4 SPECIMEN DIRECTOR STOCK OPTION AGREEMENT Exhibit 10.5(b) HORACE MANN EDUCATORS CORPORATION STOCK OPTION AGREEMENT (1991 Stock Incentive Plan) (DIRECTOR VERSION) This Stock Option Agreement ("Agreement") is made and entered into as of the Date of Grant indicated below by and between Horace Mann Educators Corporation, a Delaware corporation (the "Company"), and the person named below as Director. WHEREAS, the Company has offered shares of common stock, par value $.001 per share, of the Company (the "Common Stock") to the public; WHEREAS, the Company wishes to give its Directors an opportunity to acquire shares of the Common Stock and to provide an incentive for its Directors to join or remain with the Company; and WHEREAS, pursuant to the Company's 1991 Employee Stock Incentive Plan (the "Plan"), the committee of the Board of Directors of the Company administering the Plan (the "Committee") has approved the grant to Director of an option to purchase shares of Common Stock, on the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the foregoing recitals and the covenants set forth herein, the parties hereby agree as follows: 1. Grant of Option; Certain Terms and Conditions. The Company hereby grants to Director, and Director hereby accepts, as of the Date of Grant, an option to purchase the number of shares of Common Stock indicated below (the "Option Shares") at the Exercise Price per share indicated below, which option shall expire at 5:00 o'clock p.m. (local time at the Company's principal executive office) on the Expiration Date indicated below and shall be subject to all of the terms and conditions set forth in this Agreement (the "Option"). The Option shall be Vested as to all of the Option Shares immediately upon the Date of Grant. Director: - -------- Date of Grant: - ------------- Number of - --------- Option Shares: - ------------- Exercise Price - -------------- per Option Share: - ---------------- Expiration Date: - --------------- The Option is not intended to qualify as an incentive stock option under Section 422 of the Internal Revenue Code. 2. Adjustments. In the event of any merger, reorganization, consolidation, recapitalization, stock dividend, spin-off, extraordinary distribution, with respect to the Common Stock, such substitution or adjustments shall be made in the aggregate number of shares subject to other outstanding Stock Options and Stock Appreciation Rights, and the number of shares subject to other outstanding Awards granted under the Plan as may be determined to be appropriate by the Committee, in its sole discretion; provided, however, that the number of shares subject to any Award shall always be a whole number. 3. Exercise. The Option shall be exercisable during Director's lifetime only by Director or by his or her guardian or legal representative, and after Director's death only by the person or entity entitled to do so under Director's last will and testament or applicable intestate law, except as otherwise provided for in this Agreement (see Section 6 Nontransferability.) The Option may only be exercised by the delivery to the Company of a written notice of such exercise, which notice shall specify the number of Option Shares to be purchased (the "Purchased Shares") and the aggregate exercise Price for such shares (the "Exercise Notice"), together with payment in full of such aggregate Exercise Price in cash or by bank check payable to the Company; provided, however, that payment of such aggregate Exercise Price may instead be made, in whole or in part, by the delivery to the Company of a certificate or certificates representing shares of Common Stock, duly endorsed and accompanied by a duly executed stock power, which delivery effectively transfers to the Company good and valid title to such shares, free and clear of any pledge, commitment, lien, claim or other encumbrance (such shares to be valued on the basis of the aggregate Fair Market Value thereof on the date of such exercise), provided that the Company is not then prohibited from purchasing or acquiring such shares of Common Stock. 4. Payment of Withholding Taxes. If the Company is obligated to withhold an amount on account of any federal, state, or local tax imposed as a result of the exercise of the option, including, without limitation, any federal, state or other income tax, or any F.I.C.A., state disability insurance tax or other employment tax, then Director shall, concurrently with such exercise, pay such amount to the Company in cash or by check payable to the Company, or by reducing the number of shares of Common stock to be issued and delivered to Director upon such exercise (such reduction to be valued on the basis of the aggregate Fair Market Value (determined on the date of such exercise) of the additional shares of Common Stock that would otherwise have been issued and delivered upon such exercise), provided that the Company is not then prohibited from purchasing or acquiring such additional shares of Common Stock. 5. Stock Exchange Requirements; Applicable Laws. All certificates for shares of Common Stock or other securities delivered under this Agreement shall be subject to such stock transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations and other requirements of the Commission, any stock exchange upon which the Common Stock is then listed and any applicable Federal or state securities law, and the Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. 6. Nontransferability. Neither the Option nor any interest therein may be sold, assigned, conveyed, gifted, pledged, hypothecated or otherwise transferred in any manner other than by will or the laws of descent and distribution. Any attempted sale, assignment, conveyance, gift, pledge, or hypothecation or other disposition of the Option, other than in accordance with the terms set forth herein, shall be void and of no effect. Notwithstanding the foregoing, the Option may be transferred to the spouse or lineal descendant of Director or to the trustee of a trust for the primary benefit of a spouse or lineal descendent. Such assignee shall be subject to all of the terms and provisions of the Plan and of this Agreement. -2- 7. Plan. The Option is granted pursuant to the Plan, as in effect on the Date of Grant, and is subject to all the terms and conditions of the Plan, as the same may be amended from time to time, and the Plan's definitions are hereby incorporated by reference herein; provided, however, that no such amendment shall deprive Director, without his or her consent, of the Option or of any of Director's rights under this Agreement. The interpretation and construction by the Committee of the Plan, this Agreement, the Option and such rules and regulations as may be adopted by the Committee for the purpose of administering the Plan shall be final and binding upon Director. Until the Option shall expire, terminate or be exercised in full, the Company shall, upon written request therefor, send a copy of the Plan, in its then-current form, to Director or any other person or entity then entitled to exercise the Option. 8. Stockholder Rights. No person or entity shall be entitled to vote, receive dividends, or be deemed for any purpose the holder of any Options Shares until the Option shall have been duly exercised to purchase such Option Shares in accordance with the provisions of this Agreement. 9. Service. No provision of this Agreement or of the Option granted hereunder shall (a) confer upon Director any right to continue in the service of the Company or any of its subsidiaries or (b) confer upon Director any right to participate in any employee welfare or benefit plan or other program of the Company of any of its subsidiaries other than the Plan. 10. Governing Law. This Agreement and the Option granted hereunder shall be governed by and construed and enforced in accordance with the laws of the State of Delaware. 11. Investment Representation and Agreement. The Committee may require Director to furnish to the Company, prior to the issuance of any shares upon the exercise of all or any part of this option, an agreement (in such form as such committee may specify) in which Director represents that the shares acquired by him upon exercise are being acquired for investment and not with a view to the sale or distribution thereof. 12. Entire Agreement. This Agreement, together with the Plan, constitutes the entire obligation of the parties hereto with respect to the subject matter hereof and shall supersede any prior expressions of intent or understanding with respect to this transaction. 13. Amendment. Any amendment hereto shall be in writing and signed by the parties hereto. 14. Waiver; Cumulative Rights. The failure or delay of either party to require performance by the other party of any provision unless and until such performance has been waived in writing. Each and every right hereunder is cumulative and may be exercised in part or in whole from time to time. 15. Counterparts. This Agreement may be signed in two counterparts. 16. Headings. The headings contained in this Agreement are for reference purposes only and shall not affect the meaning or interpretation of this Agreement. -3- IN WITNESS WHEREOF, the Company and Director have duly executed this Agreement as of the Date of Grant. HORACE MANN EDUCATORS CORPORATION By -------------------------------------- Name: Paul J. Kardos Title: Chairman of the Board ----------------------------------------- Director -4- EX-10.11(A) 5 PAUL J. KARDOS AMENDED & RESTATED EMPLOYMENT AGREEMENT Exhibit 10.11(a) Execution Copy -------------- AMENDMENT AGREEMENT ------------------- THIS AMENDMENT AGREEMENT, dated as of February 1, 2000, by and between HORACE MANN EDUCATORS CORPORATION, a Delaware corporation (the "Company"), and PAUL J. KARDOS, an individual residing at 709 Clipper Road, Springfield, IL 62707 (the "Executive"). WHEREAS, the Company and the Executive are parties to an Amended and Restated Employment Agreement dated October 6, 1998 (the "Employment Agreement"), which they hereby wish to amend. NOW, THEREFORE, in consideration of the mutual covenants contained in the Employment Agreement and this Agreement, the parties hereto agree as follows: 1. All capitalized terms not defined herein shall have the meanings assigned thereto in the Employment Agreement. 2. The first sentence of Section 1 of the Employment Agreement is amended to read as follows: "The Company hereby employs the Executive for a term (the "Term") expiring on May 31, 2000, at which point the Executive will retire from employment with the Company." 3. Section 2 of the Employment Agreement is amended to read as follows: "From February 1, 2000 through May 25, 2000, the Executive shall perform the duties of Chairman of the Board of Directors of the Company. From May 26, 2000 through the end of the Term, the Executive shall perform such duties for the Company as are reasonably requested by the Company. During the Term, the Executive shall also serve as an officer and/or director of such one or more affiliates and subsidiaries of the Company as the Company's Board of Directors shall request, and shall be entitled to no additional remuneration for such services. During the Term, the Executive will also diligently assist in managing an orderly transition of leadership of the Company from the Executive to his successor as Chief Executive Officer of the Company. During the Term the Executive shall devote substantially all of his business time and efforts to the business and affairs of the Company and will not engage in any activity which interferes with the performance of his duties hereunder." 4. Section 3.2 of the Employment Agreement is amended to read as follows: "In addition to the Base Salary, the Executive shall be entitled to a cash bonus on or before March 31, 2000, with the amount thereof at the discretion of the Board of Directors and payable in accordance with the standard policies of the Company in existence from time to time, subject to any deductions required by law, provided, however, that such cash bonus shall not be less than Four Hundred Thousand Dollars ($400,000). In addition, to the extent that the bonus that would have been payable to the Executive under the Company's Short Term Incentive Compensation Program in March 2001, if he was employed by the Company on that date, exceeds Four Hundred Thousand Dollars ($400,000), the Executive shall be entitled to a cash bonus on or before March 31, 2001 equal to five-twelfths (5/12) of the excess of such hypothetical bonus over Four Hundred Thousand Dollars ($400,000). In addition, to the extent that a bonus would have been payable to the Executive under the Company's Long Term Incentive Compensation Program in March 2001, if he was employed by the Company on that date, the Executive shall be entitled to a cash bonus on or before March 31, 2001 equal to five-twelfths (5/12) of such hypothetical bonus." 5. On May 31, 2000, the Company shall pay to the Executive a non-refundable, lump sum payment of One Million One Hundred Eleven Thousand Six Hundred Sixty-Six Dollars ($1,111,666) (the "Advance Payment"), subject to any deductions required by law. 6. Notwithstanding Section 4.1(a) of the Employment Agreement, the Company may terminate the Employment Agreement, without Cause, only upon the death of the Executive. 7. The reference in Section 4.2(a) to the "Bonus" shall be construed as a reference to the bonuses payable to the Executive pursuant to Section 3.2. 8. Section 4.2(b) of the Employment Agreement is amended to read as follows: "In the event of termination pursuant to Section 4.1(b), the Executive shall promptly receive, in cash and without discount, the Advance Payment and the aggregate amount of the Base Salary that he would have been entitled to receive through the date which would have been the last day of the Term. In addition, the Executive shall receive, on the dates specified in Section 3.2, the bonuses specified therein." 9. Section 5.1 of the Employment Agreement is amended to read as follows: "At all times during the Term, the Executive shall not commit any of the Prohibited Acts." 10. Notwithstanding the terms of the Change of Control Agreement and the Change of Control Continuation of Employment Agreement (together, the "Ancillary Agreements") currently in effect between the Executive and the Company, none of the provisions of either such agreement shall be applicable to a change of control (as defined in each such agreement) which occurs after May 31, 2000. 11. Except as specifically amended hereby, the terms of the Employment Agreement and the Ancillary Agreements shall remain in full force and effect. After the date hereof, all references to the Employment Agreement shall mean references to the Employment Agreement as amended hereby. 12. This Amendment Agreement shall be governed by and construed in accordance with the domestic substantive laws of the State of Illinois without giving effect to any choice or conflict of laws provision or rule that would cause the application of the domestic substantive laws of any other jurisdiction. 13. This Amendment Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, each of the parties hereto has duly executed this Amendment Agreement as of the date first above written. /s/ Paul J. Kardos ----------------------------------------- PAUL J. KARDOS HORACE MANN EDUCATORS CORPORATION By:/s/ Louis G. Lower II -------------------------------------- Name: Louis G. Lower II Title: President 30109298_2.Doc EX-10.12 6 LOUIS G. LOWER II EMPLOYMENT AGREEMENT Exhibit 10.12 Execution Copy EMPLOYMENT AGREEMENT -------------------- As of December 31, 1999, Horace Mann Educators Corporation, a Delaware corporation ("Employer"), and Louis G. Lower II, an individual residing at 76 Woodley Road, Winnetka, IL 60093 ("Employee"), agree as follows: 1. Term. Employer hereby employs Employee, and Employee hereby accepts employment, on the terms and conditions hereinafter set forth. The term of this Agreement (the "Term") shall commence on February 1, 2000 and shall terminate on December 31, 2000; provided, however; that unless Employer gives notice to Employee of its intention to have this agreement expire ("Employer Notice of Non-Renewal") prior to September 1 of any year during the Term, or Employee gives notice to Employer of his intention to have this agreement expire ("Employee Notice of Non-Renewal") prior to September 1 of any year during the Term, then, on such September 1, the Term shall be extended to the December 31 of the year succeeding the year in which such September 1 occurs. Said Term may be sooner terminated as hereinafter provided, and if the Term is so terminated, all references herein to the "Term" of this Agreement shall mean the original Term as so shortened, except where the context otherwise requires. 2. Duties. Employee agrees to serve Employer as its President and Chief Executive Officer and, subject to election by the shareholders of Employer, as a member of its Board of Directors. Employee also agrees to serve as a director and/or executive officer of corporations which are subsidiaries of Employer as requested by the Board of Directors of Employer. During the term of this Agreement, Employee will devote his full working time and exclusive attention to, and use his best efforts to advance, the business and welfare of Employer. During the term of this Agreement, Employee will not engage in any other employment activities for any direct or indirect remuneration without the prior written consent of Employer and will not engage in any activities which interfere with the performance of his duties hereunder. 3. Confidential Information. (a) Employee hereby agrees that, during the Term and thereafter, he proprietary or confidential information or knowledge, including without limitation, trade secrets, processes, records of research, proposals, reports, methods, techniques, computer software or programming or budgets or other 1 financial information, regarding Employer, its business, properties or affairs obtained by him at any time prior to or subsequent to the execution of this Agreement, except to the extent required by his performance of assigned duties for Employer or as required by law or legal process. (b) Upon termination of employment Employee will deliver to Employer all tangible displays and repositories of processes, records of research, proposals, reports, memoranda, computer software and programming, budgets and other financial information, and other materials or records or writings of any other type (including any copies thereof) made, used or obtained by Employee in connection with his employment by Employer. (c) Employee agrees that the remedy at law for any breach by him of any of the covenants and agreements set forth in this Section 3 will be inadequate and that, in the event of any such breach, Employer may, in addition to the other remedies which may be available to it at law, obtain injunctive relief prohibiting him (together with all those persons associated with him) from the breach of such covenants and agreements. 4. Base Salary and Benefits. 4.1 Base Salary. During the Term, Employer shall pay Employee a salary at the rate of Five Hundred Thousand Four Dollars ($500,004) per annum, payable in accordance with the standard policies of the Company in existence from time to time, subject to any payroll deductions as may be necessary or customary in respect of Employer's salaried employees. 4.2 Vacation. Employee shall be entitled to such amount of paid vacation during each year during the Term as shall be afforded to the other senior executives of the Company. 4.3 Non-Pension Benefits. During the Term, Employer shall furnish Employee with the same fringe benefit programs other than stock option and supplemental pension plans as are made available generally to Employer's senior employees, including participating in such group life, disability, health and other similar benefit or insurance programs as are now or hereafter made available generally to such employees and participating in Employer's 401(k) plan, subject to the terms of such programs. 4.4 Pension Benefits. Employer shall provide for Employee's participation in Employer's pension plan and an additional non-qualified pension plan at no cost to Employee so that the following retirement benefits will be payable to Employee during his lifetime by Employer, in aggregate, pursuant to such plans: 2 Last Date of Employment Annual Benefit - ----------------------- -------------- On or prior to December 31, 2000 $0 January 1, 2001 to December 31, 2001 $45,000 January 1, 2002 to December 31, 2002 $90,000 January 1, 2003 to December 31, 2003 $135,000 January 1, 2004 or later $180,000. 5. Expenses. (a) Employer will pay or reimburse Employee for such reasonable travel, entertainment and other expenses as he may incur at the request of Employer during the term of this Agreement in connection with the performance of his duties hereunder. Employee shall furnish Employer with such evidence that such expenses were incurred as Employer reasonably requires or requests. (b) Employer will pay or reimburse Employee for reasonable costs associated with his purchase of a second home in the Springfield, IL area (the "Second Home"), including without limitation fees and commissions of real estate brokers and agents and points incurred in financing the Second Home, but not including the actual cost of the Second Home and its contents and costs of financing the purchase of the Second Home, other than points. Employer will also pay or reimburse Employee for reasonable temporary living expenses in the Springfield, IL area until such time as he occupies the Second Home. (c) If, prior to January 17, 2003, the Term ends as a result of a Termination Without Cause (as defined herein), an Employer Notice of Non-Renewal or a Change of Control Termination (as defined herein) and Employee sells the Second Home within six (6) months of such end of the Term (the "Resale"), Employer will pay to Employee in cash an amount equal to Employee's purchase price of the Second Home, less the gross sales price of the Second Home in the Resale, if such amount is greater than zero (0); provided that Employee shall make reasonable good faith efforts to obtain the best sales price in the Resale available within such six (6) month period. 6. Incentive Compensation. In addition to the base salary to which Employee is entitled pursuant to Section 4.1 hereof, Employer will pay to Employee additional compensation in accordance with the following terms and conditions: 6.1 Stock Grant. On the first day of employment hereunder, Employer shall cause to be issued to Employee a certificate for 10,000 shares of common stock of Employer. Such certificate shall be in the name of Employee and shall represent 3 full ownership of such shares. Such shares shall have been registered under the Securities Act of 1933 and will be freely tradable in the public markets, subject to applicable legal restrictions. Employee represents to Employer that he is acquiring such securities for investment purposes and not with an intent to distribute such securities. 6.2 Stock Options. Employer shall enter into stock option agreements with Employee, (a) in the form attached hereto as Exhibit A, concurrent with the complete execution of this Agreement, and (b) in the form attached hereto as Exhibit B, on the first day of Employee's employment hereunder (together, the "Stock Option Agreements"). 6.3 STIP. Employee shall participate in Employer's Short-Term Incentive Plan (the "STIP") and successor plans thereto. 6.4 LTIP. Employee shall participate in Employer's Long-Term Incentive Plan (the "LTIP") and successor plans thereto 6.5 One-Time Bonus. Simultaneous with the payment by Employer of bonuses payable under the STIP with regard to performance in calendar year 2000 ("2000 STIP Bonuses") and payable under the LTIP with regard to performance in and prior to calendar year 2000 ("2000 LTIP Bonuses"), Employer shall pay to Employee a one-time bonus equal to the sum of (a) the greater of Employee's 2000 STIP Bonus or Four Hundred Thousand Dollars ($400,000), less Employee's 2000 STIP Bonus and (b) the greater of Employee's 2000 LTIP Bonus or Three Hundred Thousand Dollars ($300,000), less Employee's 2000 LTIP Bonus. 7. Disability of Employee. If Employee becomes disabled by reason of illness or other incapacity so that Employee is unable to perform his duties hereunder for ninety (90) out of one hundred twenty (120) consecutive days, as determined by a doctor selected by Employer's Board of Directors and reasonably acceptable to Employee, Employer shall thereupon have the right to terminate this Agreement. Upon such a termination, Employer's obligations hereunder shall be limited to payment to Employee of salary due to Employee to such date of termination and subsequent payment to Employee of a pro-rata share of any incentive compensation bonuses pursuant to Section 6.3, 6.4 and 6.5, based on the portion of the performance year in question during which Employee was employed, with such pro-rata portions payable when such bonuses are regularly paid to the Employer's employees. 4 8. Death of Employee. If Employee dies during the term of this Agreement, Employee's employment under this Agreement shall automatically terminate. Upon such a termination, Employer's obligations hereunder shall be limited to payment to Employee's estate of salary due to Employee through the date which is one year after such termination and subsequent payment to Employee's estate of a pro-rata share of any incentive compensation bonuses pursuant to Section 6.3, 6.4 and 6.5, based on the portion of the performance year in question during which Employee was employed, with such pro-rata portions payable when such bonuses are regularly paid to the Employer's employees. 9. Termination for Cause. Employee's employment under this Agreement may be terminated by Employer for "good cause" (a "Termination for Cause"). The term "good cause" is defined as any one or more of the following occurrences: (a) Employee's breach of any of the covenants contained in Section 3 of this Agreement; (b) Employee's conviction by, or entry of a plea of guilty or nolo contendere in, a court of competent and final jurisdiction for any felony crime; (c) Employee's commission of an act of fraud, whether prior to or subsequent to the date hereof, upon Employer; or (d) Employee's continuing failure or refusal to perform his duties as required by this Agreement to the reasonable satisfaction of Employer's Board of Directors, provided, however, that termination of Employee's employment pursuant to this subparagraph (d) shall not constitute valid termination "for cause" unless Employee shall have first received written notice from the Board of Directors of Employer stating with specificity the nature of such failure or refusal and stating the required cure action and affording Employee at least forty-five (45) days to correct the act or omission complained of. Upon a Termination for Cause, Employer's obligations hereunder shall be limited to payment to Employee of salary due to Employee through the date of termination and subsequent payment to Employee of a pro-rata share of any incentive compensation bonuses pursuant to Section 6.3, 6.4 and 6.5, based on the portion of the performance year in question during which Employee was employed, with such pro-rata portions payable when such bonuses are regularly paid to the Employer's employees. 5 10. Other Terminations. (a) Employer may, at any time during the Term, upon sixty (60) days prior written notice to Employee, terminate this Agreement without cause (a "Termination Without Cause"). (b) Employee may, at any time during the Term, upon sixty (60) days prior written notice to Employer, terminate this Agreement without cause (a "Resignation"). (c) A Resignation shall, for purposes of this Agreement, be treated as a Termination for Cause on the date which is sixty (60) days after the notice of Resignation. (d) An Employer Notice of Non-Renewal shall, for purposes of this Agreement, be treated as a Termination Without Cause on December 31 of the year in which such notice is given. (e) An Employee Notice of Non-Renewal shall, for purposes of this Agreement, be treated as a Termination for Cause on December 31 of the year in which such notice is given (f) Upon a Termination Without Cause, Employer's obligations hereunder shall be limited to (i) payment to Employee of salary due to Employee through the date which is two (2) years after the date of termination, (ii) continuation of benefits pursuant to Section 4.3 through the date which is two years after the date of termination and (iii) payment to Employee, on or before the date which is thirty (30) days after the date of termination, of a lump-sum cash amount equal to two (2) times the aggregate target incentive compensation bonuses pursuant to Section 6.3, 6.4 and 6.5 for the Employee with regard to the performance year in which the date of termination occurred. (g) If, during the Term, (i) there is a significant adverse change or diminution in Employee's duties, working conditions or status as an employee, (ii) Employer breaches its obligations hereunder or (iii) Employee is required to perform his duties hereunder in a location other than Springfield, Illinois which is more than one hundred fifty (150) miles away from Winnetka, Illinois (any of such events, a "Material Change"), Employee may elect, by written notice to Employer, to treat such Material Change as a Termination Without Cause on the date of such notice. Thereupon, the Employee's rights shall be as described in subsection (f) above and in subsection 5(c) above. 11. Change of Control. If, during the Term, any individual, entity or group of persons acting in concert own voting securities of Employer which, in the aggregate, have more than 50% 6 of the voting power of outstanding voting securities of Employer entitled to vote for the election of directors of Employer, such shall constitute a "Change of Control." If, within three (3) years of a Change of Control, (a) there is a Termination Without Cause, (b) there is a Material Change or (c) there is an Employer Notice of Non-Renewal, then this Agreement shall terminate (a "Change of Control Termination") and Employer shall immediately pay to Employee a lump-sum cash amount equal to the sum of (x) three (3) times the greater of (i) Employee's highest annual cash compensation from Employer in any calendar year, as reported on Form W-2 for such year, or (ii) One Million Two Hundred Thousand Dollars ($1,200,000) and (y) the actuarially determined present value of the benefits payable to Employee pursuant to Section 4.4 for his expected remaining life, calculated on the basis of Employee having been employed by Employer until the date which is three (3) years after the Change of Control Termination. In addition, Employer shall continue his benefits pursuant to Section 4.3 for three (3) years after the Change of Control Termination. In addition, in the event it shall be determined that any payment or distribution by Employer to or for the benefit of Employee pursuant to the terms of this Agreement, including without limitation an Excise Tax Payment (as defined below) (a "Payment") would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended, or any interest or penalties with respect to such excise tax (such excise tax, together with any such interest and penalties, collectively the "Excise Tax"), then Employee shall be entitled to receive from Employer an additional payment (the "Excise Tax Payment") in an amount equal to the Excise Tax imposed upon the Payments. 12. Miscellaneous. 12.1 Modification and Waiver of Breach. No waiver or modification of this Agreement shall be binding unless it is in writing signed by the parties hereto. No waiver of a breach hereof shall be deemed to constitute a waiver of a future breach, whether of a similar or dissimilar nature. 12.2 Assignment. The rights of Employer under this Agreement may, without the consent of Employee, be assigned by Employer, in its sole and unfettered discretion, to any person, firm, corporation, or other business entity which at any time, whether by purchase, merger, or otherwise, directly or indirectly, acquires all or substantially all of the assets or business of Employer; provided that such assignment shall not alter or limit Employee's rights hereunder, including without limitation all rights pursuant to Sections 10(g) and 11 which arise as a result of such assignment. 7 12.3 Notices. All notices and other communications required or permitted under this Agreement shall be in writing, served personally on, sent by telecopy or overnight courier to, or mailed by certified or registered United States mail to, the party to be charged with receipt thereof. Notices and other communications served by mail shall be deemed given hereunder seventy-two (72) hours after deposit of such notice or communication in the United States Post Office as certified or registered mail with postage prepaid and duly addressed to whom such notice or communication is to be given, in the case of (a) Employer, Horace Mann Educators Corporation, 1 Horace Mann Plaza, Springfield, IL 62715 Attention: General Counsel, with a copy to Gibson, Dunn & Crutcher LLP, 200 Park Avenue, New York, NY 10166-0193, Attention: Conor D. Reilly, or (b) Employee, to the home address indicated above, with a copy to Dowd, Bloch & Bennett, Suite 3100, 8 Michigan Avenue, Chicago, IL 60603-3320, Attention: Barry M. Bennett. Either party may change said party's address for purposes of this Section by giving to the party intended to be bound thereby, in the manner provided herein, a written notice of such change. 12.4 Counterparts. This instrument may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same Agreement. 12.5 Construction of Agreement. This Agreement shall be construed in accordance with, and governed by, the laws of the State of Illinois applicable to agreements executed and to be performed in Illinois. 12.6 Complete Agreement. This Agreement, together with the Stock Option Agreements, contains the entire agreement between the parties hereto with respect to the transactions contemplated by this Agreement and supersedes all previous oral and written and all contemporaneous oral negotiations, commitments, writings and understandings. 12.7 Non-Transferability of Interest. None of the rights of Employee to receive any form of compensation payable pursuant to this Agreement shall be assignable or transferable except through a testamentary disposition or by the laws of descent and distribution upon the death of Employee. Any attempted assignment, transfer, conveyance or other disposition (other than as aforesaid) of any interest in the rights of Employee to receive any form of compensation to be made by Employer pursuant to this Agreement shall be void. 8 12.8 Arbitration. In the event that there shall be a dispute between the parties hereto arising out of or relating to this Agreement, or the breach thereof, the parties agree that such dispute shall be resolved by final and binding arbitration in Chicago, Illinois administered by the American Arbitration Association (the "AAA") in accordance with the AAA's commercial arbitration rules for individual employment disputes then in effect. Any award issued as a result of such arbitration shall be final and binding between the parties thereto and shall be enforceable by any court having jurisdiction over the party against whom enforcement is sought. The arbitrator(s) shall allocate the cost of the legal fees and related costs of the prevailing party in such arbitration to the other party if and only if a determination is made that such other party's position asserted in the arbitration was unreasonable. 12.9 Survival of Certain Obligations. Except as may otherwise be specifically provided for herein, the obligations of the parties pursuant to Sections 3 and 11 shall survive the termination of this Agreement. 12.10 Captions. The captions appearing in this Agreement are inserted only as a matter of convenience and as a reference and in no way define, limit or describe the scope or intent of this Agreement or any of the provisions hereof. 9 IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the day and year first above written. EMPLOYEE: EMPLOYER: HORACE MANN EDUCATORS CORPORATION /s/ Louis G. Lower II By: /s/ Paul J. Kardos - ---------------------- ---------------------- Name: Paul J. Kardos Title: Chairman, President & CEO 10 Execution Copy Exhibit A --------- STOCK OPTION AGREEMENT PURSUANT TO THE HORACE MANN EDUCATORS CORPORATION 1991 STOCK INCENTIVE PLAN THIS STOCK OPTION AGREEMENT (this "Agreement") is made as of December 31, 1999 (the "Effective Date"), between Horace Mann Educators Corporation, a Delaware corporation (the "Company"), and Louis G. Lower II (the "Optionee"). R E C I T A L S A. The Optionee is expected to serve the Company as its President and Chief Executive Officer pursuant to an Employment Agreement dated as of December 31, 1999 (the "Employment Agreement"); B. The Employment Agreement calls for the Company to enter into this Agreement on the date of complete execution of the Employment Agreement. C. This Agreement relates to the granting of stock options to the Optionee under the Company's 1991 Stock Incentive Plan (the "Plan"), a copy of which is attached hereto as Exhibit A. D. In accordance with the Plan, the Committee (as defined in the Plan) has, as of the Effective Date, granted to the Optionee an option to purchase shares of Common Stock, $0.001 par value, of the Company (the "Common Stock"), subject to the terms and conditions of the Plan and this Agreement. AGREEMENTS 1. Definitions. Capitalized terms not defined herein shall have the meanings ascribed thereto in the Employment Agreement. Other capitalized terms used herein shall have the following meanings: "Act" is defined in Section 8. "Agreement" means this Stock Option Agreement. "Change of Control" is defined in the Plan. "Committee" is defined in the Plan. "Common Stock" is defined in recital D. "Company" is defined in the preamble. "Effective Date" is defined in the preamble. 1 "Employment Agreement" is defined in recital A. "Exercise Price" is defined in Section 2. "Option" is defined in Section 2. "Optionee" is defined in the preamble. "Option Shares" is defined in Section 2. "Plan" is defined in recital C. "Termination Date" means the date on which the Optionee ceases to be employed by the Company for any reason. 2. Grant of Option. The Company hereby grants to the Optionee the right and option (the "Option") to purchase up to 250,000 shares of Common Stock (the "Option Shares"), at a per share purchase price equal to the mean between the highest and lowest reported sales prices of a share of Common Stock on the New York Stock Exchange Composite Tape on the Effective Date (as such amount may be adjusted, the "Exercise Price"), on the terms and conditions set forth herein. 3. Exercisability. The Optionee's right to exercise the Option shall vest as follows if the Optionee is employed by the Company on the relevant dates of vesting: Number of Option Shares Date of Vesting ----------------------- --------------- 50,000 January 1, 2001 50,000 January 1, 2002 50,000 January 1, 2003 50,000 January 1, 2004 50,000 January 1, 2005. Notwithstanding the foregoing, in the event of a Termination Without Cause, an Employer Notice of Non-Renewal or a Material Change, the Optionee shall, for purposes of this Section 3, be treated as having been employed by the Company until the date which is one (1) year after the Termination Date. Further, notwithstanding the foregoing, in the event of a Change of Control which occurs after the Optionee's employment with the Company has begun, all unvested Option Shares shall thereupon immediately vest. 4. Expiration. The vested portion of the Option shall expire upon the earlier of (1) the tenth (10th) anniversary of the Effective Date, or (2) (i) in the event of a Termination for Cause, a Resignation which is not a Retirement (as defined in the Plan) or an Employee Notice of Non-Renewal, the day which is ninety (90) days after the Termination Date unless, on the seventy-fifth (75th) day after the Termination Date, the Optionee is, in the reasonable judgment of outside counsel to the Company, in possession of non-public material information regarding the Company, in which case the expiry date shall be the day which is thirty (30) days after notice is given to the Optionee by the Company that, in the reasonable judgment of outside counsel to the Company, the Optionee is no longer in possession of such information or (ii) if the Optionee ceases to be an officer or employee of the Company due to death, a Retirement (as defined in the Plan), a Termination Without Cause, an Employer Notice of Non-Renewal or a Material Change or pursuant to Section 7 of the Employment Agreement, the two-year anniversary of the Termination Date. All provisions of this Section 4 shall apply regardless of whether or not a Change of Control has occurred. 5. Nontransferability. The Option shall not be transferable by the Optionee 2 other than by will or by the laws of descent and distribution and the Option shall be exercisable, during Optionee's lifetime, only by Optionee or by his guardian or legal representative, it being understood that the term "Optionee" herein shall include the guardian and legal representative of Optionee and any person to whom an option is transferred by will or by the laws of descent and distribution. Notwithstanding the foregoing, the Option may be transferred to the spouse or lineal descendant of Optionee or to the trustee of a trust for the primary benefit of a spouse or lineal descendent of Optionee. Such assignee shall be subject to all of the terms and provisions of the Plan. 6. Adjustments. If the shares of the Common Stock are changed into or exchanged for a different number or kind of shares or securities, as the result of any one or more reorganizations, recapitalizations, mergers, acquisitions, stock splits, reverse stock splits, stock dividends or similar events, or in the event of a rights offering to purchase Common Stock at a price substantially below its fair market value, an appropriate adjustment shall be made in the number and kind of shares or other securities subject to the Option, and the price for each share or other unit of any securities subject to this Agreement, in accordance with the Plan. No fractional interests shall be issued on account of any such adjustment unless the Committee specifically determines to the contrary; provided, however, that in lieu of fractional interests, the Optionee, upon the exercise of the Option in whole or part, shall receive cash in an amount equal to the amount by which the fair market value of such fractional interests exceeds the Exercise Price attributable to such fractional interests. 7. Exercise of the Option. Prior to the expiration thereof, the Optionee may exercise the vested portion of the Option from time to time in whole or in part, provided that unless the Committee in its sole discretion shall determine otherwise, each such exercise, other than an exercise for all remaining shares pursuant to this Agreement, shall be for no fewer than one hundred (100) shares. Upon electing to exercise the Option, the Optionee shall deliver to the Secretary of the Company a written and signed notice of such election setting forth the number of Option Shares the Optionee has elected to purchase and shall at the time of delivery of such notice tender cash or a cashier's or certified bank check to the order of the Company for the full Exercise Price of such Option Shares and any amount required pursuant to Section 13 hereof. 8. Compliance with Legal Requirements. No Option Shares shall be issued or transferred pursuant to this Agreement unless and until all legal requirements applicable to such issuance or transfer have, in the reasonable opinion of counsel to the Company, been satisfied. Such requirements may include, but are not limited to, registering or qualifying such Shares under any state or federal law, satisfying any applicable law relating to the transfer of unregistered securities or demonstrating the availability of an exemption from applicable laws, placing a legend on the Shares to the effect that they were issued in reliance upon an exemption from registration under the Securities Act of 1933, as amended (the "Act"), and may not be transferred other than in reliance upon Rule 144 or Rule 701 promulgated under the Act, if available, or upon another exemption from the Act, or obtaining the consent or approval of any governmental regulatory body. 9. No Interest in Shares Subject to Option. Neither the Optionee (individually or as a member of a group) nor any beneficiary or other person claiming under or through the Optionee shall have any right, title, interest, or privilege in or to any shares of stock allocated or reserved for the purpose of the Plan or subject to this Agreement except as to such Option Shares, if any, as shall have been issued to such person upon exercise of this Option or any part of it. 10. Plan Controls. The Option hereby granted is subject to, and the Company and the Optionee agree to be bound by, all of the terms and conditions of the Plan as the same may be amended from time to time in accordance with the terms thereof, but no such amendment shall be effective as to the Option without the Optionee's consent insofar as it may adversely affect the Optionee's rights under this Agreement. 3 11. Not an Employment Contract. Nothing in the Plan, in this Agreement or any other instrument executed pursuant thereto shall confer upon the Optionee any right to employment by the Company or any Subsidiary or shall affect the rights of the parties to the Employment Agreement with regard to the terms thereof. 12. Governing Law. All terms of and rights under this Agreement shall be governed by and construed in accordance with the internal laws of the State of Delaware, without giving effect to principles of conflicts of law. 13. Taxes. The Committee may, in its discretion, make such provisions and take such steps as it may deem necessary or appropriate for the withholding of all federal, state, local and other taxes required by law to be withheld with respect to the issuance or exercise of the Option including, but not limited to, deducting the amount of any such withholding taxes from any other amount then or thereafter payable to the Optionee, requiring the Optionee to pay to the Company the amount required to be withheld or to execute such documents as the Committee deems necessary or desirable to enable it to satisfy its withholding obligations, or any other means provided in the Plan. 14. Notices. All notices, requests, demands and other communications pursuant to this Agreement shall be in writing and shall be given in accordance with the procedures set forth in Section 12.3 of the Employment Agreement. 15. Amendments and Waivers. This Agreement may be amended, and any provision hereof may be waived, only by a writing signed by both parties hereto. 16. Entire Agreement. This Agreement, together with the Plan, sets forth the entire agreement and understanding between the parties as to the subject matter hereof and supersedes all prior oral and written and all contemporaneous oral discussions, agreements and understandings of any kind or nature. 17. Separability. In the event that any provision of this Agreement is declared to be illegal, invalid or otherwise unenforceable by a court of competent jurisdiction, such provision shall be reformed, if possible, to the extent necessary to render it legal, valid and enforceable, or otherwise deleted, and the remainder of this Agreement shall not be affected except to the extent necessary to reform or delete such illegal, invalid or unenforceable provision. 18. Headings. The headings preceding the text of the sections hereof are inserted solely for convenience of reference, and shall not constitute a part of this Agreement, nor shall they affect its meaning, construction or effect. 19. Counterparts. This Agreement may be executed in two counterparts, each of which shall be deemed an original, but which together shall constitute one and the same instrument. 20. Further Assurances. Each party shall cooperate and take such action as may be reasonably requested by another party in order to carry out the provisions and purposes of this Agreement. 21. Binding Effect. This Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective permitted successors and assigns. 4 22. Arbitration. In the event that there shall be a dispute between the parties hereto arising out of or relating to this Agreement or the breach thereof, the parties agree that such dispute shall be resolved in accordance with Section 12.8 of the Employment Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement as of the Effective Date. HORACE MANN EDUCATORS CORPORATION By: /s/ Paul J. Kardos ------------------------------------- Name: Paul J. Kardos Title: Chairman OPTIONEE /s/ Louis G. Lower II ---------------------------------------- Louis G. Lower II 80101362_10.Doc Exhibit B --------- STOCK OPTION AGREEMENT PURSUANT TO THE HORACE MANN EDUCATORS CORPORATION 1991 STOCK INCENTIVE PLAN THIS STOCK OPTION AGREEMENT (this "Agreement") is made as of February 1, 2000 (the "Effective Date"), between Horace Mann Educators Corporation, a Delaware corporation (the "Company"), and Louis G. Lower II (the "Optionee"). R E C I T A L S - - - - - - - - A. The Optionee presently serves the Company as its President and Chief Executive Officer pursuant to an Employment Agreement dated as of December 31, 1999 (the "Employment Agreement"); B. The Employment Agreement calls for the Company to enter into this Agreement on the first day of the Optionee's employment with the Company. C. This Agreement relates to the granting of stock options to the Optionee under the Company's 1991 Stock Incentive Plan (the "Plan"), a copy of which is attached hereto as Exhibit A. D. In accordance with the Plan, the Committee (as defined in the Plan) has, as of the Effective Date, granted to the Optionee an option to purchase shares of Common Stock, $0.001 par value, of the Company (the "Common Stock"), subject to the terms and conditions of the Plan and this Agreement. Such option is intended to qualify to the maximum extent permitted by law as an incentive stock option under Section 422 of the Internal Revenue Code of 1986, as amended. AGREEMENTS ---------- 1. Definitions. Capitalized terms not defined herein shall have the meanings ascribed thereto in the Employment Agreement. Other capitalized terms used herein shall have the following meanings: "Act" is defined in Section 8. "Agreement" means this Stock Option Agreement. "Change of Control" is defined in the Plan. "Committee" is defined in the Plan. "Common Stock" is defined in recital D. "Company" is defined in the preamble. "Effective Date" is defined in the preamble. "Employment Agreement" is defined in recital A. "Exercise Price" is defined in Section 2. "Option" is defined in Section 2. "Optionee" is defined in the preamble. "Option Shares" is defined in Section 2. "Plan" is defined in recital C. "Termination Date" means the date on which the Optionee ceases to be employed by the Company for any reason. 2. Grant of Option. The Company hereby grants to the Optionee the right and option (the "Option") to purchase up to 500,000 shares of Common Stock (the "Option Shares"), at a per share purchase price equal to the mean between the highest and lowest reported sales prices of a share of Common Stock on the New York Stock Exchange Composite Tape on the Effective Date (as such amount may be adjusted, the "Exercise Price"), on the terms and conditions set forth herein. 3. Exercisability. The Optionee's right to exercise the Option shall vest as follows if the Optionee is employed by the Company on the relevant dates of vesting: Number of Option Shares Date of Vesting ----------------------- --------------- 100,000 January 1, 2001 100,000 January 1, 2002 100,000 January 1, 2003 100,000 January 1, 2004 100,000 January 1, 2005. Notwithstanding the foregoing, in the event of a Termination Without Cause, an Employer Notice of Non-Renewal or a Material Change, the Optionee shall, for purposes of this Section 3, be treated as having been employed by the Company until the date which is one (1) year after the Termination Date. Further, notwithstanding the foregoing, in the event of a Change of Control, all unvested Option Shares shall thereupon immediately vest. 4. Expiration. The vested portion of the Option shall expire upon the earlier of (1) the tenth (10th) anniversary of the Effective Date, or (2) (i) in the event of a Termination for Cause, a Resignation which is not a Retirement (as defined in the Plan) or an Employee Notice of Non-Renewal, the day which is ninety (90) days after the Termination Date unless, on the seventy-fifth (75th) day after the Termination Date, the Optionee is, in the reasonable judgment of outside counsel to the Company, in possession of non-public material information regarding the Company, in which case the expiry date shall be the day which is thirty (30) days after notice is given to the Optionee by the Company that, in the reasonable judgment of outside counsel to the Company, the Optionee is no longer in possession of such information or (ii) if the Optionee ceases to be an officer or employee of the Company due to death, a Retirement (as defined in the Plan), a Termination Without Cause, an Employer Notice of Non-Renewal or a Material Change or pursuant to Section 7 of the Employment Agreement, the two-year anniversary of the Termination Date. All provisions of this Section 4 shall apply regardless of whether or not a Change of Control has occurred. 2 5. Nontransferability. The Option shall not be transferable by the Optionee other than by will or by the laws of descent and distribution and the Option shall be exercisable, during Optionee's lifetime, only by Optionee or by his guardian or legal representative, it being understood that the term "Optionee" herein shall include the guardian and legal representative of Optionee and any person to whom an option is transferred by will or by the laws of descent and distribution. Notwithstanding the foregoing, the Option may be transferred to the spouse or lineal descendant of Optionee or to the trustee of a trust for the primary benefit of a spouse or lineal descendent of Optionee. Such assignee shall be subject to all of the terms and provisions of the Plan. 6. Adjustments. If the shares of the Common Stock are changed into or exchanged for a different number or kind of shares or securities, as the result of any one or more reorganizations, recapitalizations, mergers, acquisitions, stock splits, reverse stock splits, stock dividends or similar events, or in the event of a rights offering to purchase Common Stock at a price substantially below its fair market value, an appropriate adjustment shall be made in the number and kind of shares or other securities subject to the Option, and the price for each share or other unit of any securities subject to this Agreement, in accordance with the Plan. No fractional interests shall be issued on account of any such adjustment unless the Committee specifically determines to the contrary; provided, however, that in lieu of fractional interests, the Optionee, upon the exercise of the Option in whole or part, shall receive cash in an amount equal to the amount by which the fair market value of such fractional interests exceeds the Exercise Price attributable to such fractional interests. 7. Exercise of the Option. Prior to the expiration thereof, the Optionee may exercise the vested portion of the Option from time to time in whole or in part, provided that unless the Committee in its sole discretion shall determine otherwise, each such exercise, other than an exercise for all remaining shares pursuant to this Agreement, shall be for no fewer than one hundred (100) shares. Upon electing to exercise the Option, the Optionee shall deliver to the Secretary of the Company a written and signed notice of such election setting forth the number of Option Shares the Optionee has elected to purchase and shall at the time of delivery of such notice tender cash or a cashier's or certified bank check to the order of the Company for the full Exercise Price of such Option Shares and any amount required pursuant to Section 13 hereof. 8. Compliance with Legal Requirements. No Option Shares shall be issued or transferred pursuant to this Agreement unless and until all legal requirements applicable to such issuance or transfer have, in the reasonable opinion of counsel to the Company, been satisfied. Such requirements may include, but are not limited to, registering or qualifying such Shares under any state or federal law, satisfying any applicable law relating to the transfer of unregistered securities or demonstrating the availability of an exemption from applicable laws, placing a legend on the Shares to the effect that they were issued in reliance upon an exemption from registration under the Securities Act of 1933, as amended (the "Act"), and may not be transferred other than in reliance upon Rule 144 or Rule 701 promulgated under the Act, if available, or upon another exemption from the Act, or obtaining the consent or approval of any governmental regulatory body. 9. No Interest in Shares Subject to Option. Neither the Optionee (individually or as a member of a group) nor any beneficiary or other person claiming under or through the Optionee shall have any right, title, interest, or privilege in or to any shares of stock allocated or reserved for the purpose of the Plan or subject to this Agreement except as to such Option Shares, if any, as shall have been issued to such person upon exercise of this Option or any part of it. 10. Plan Controls. The Option hereby granted is subject to, and the Company and the Optionee agree to be bound by, all of the terms and conditions of the Plan as the same may be amended from time to time in accordance with the terms thereof, but no such amendment shall be effective as to the Option without the Optionee's consent insofar as it may adversely affect the Optionee's rights under this Agreement. 3 11. Not an Employment Contract. Nothing in the Plan, in this Agreement or any other instrument executed pursuant thereto shall confer upon the Optionee any right to employment by the Company or any Subsidiary or shall affect the rights of the parties to the Employment Agreement with regard to the terms thereof. 12. Governing Law. All terms of and rights under this Agreement shall be governed by and construed in accordance with the internal laws of the State of Delaware, without giving effect to principles of conflicts of law. 13. Taxes. The Committee may, in its discretion, make such provisions and take such steps as it may deem necessary or appropriate for the withholding of all federal, state, local and other taxes required by law to be withheld with respect to the issuance or exercise of the Option including, but not limited to, deducting the amount of any such withholding taxes from any other amount then or thereafter payable to the Optionee, requiring the Optionee to pay to the Company the amount required to be withheld or to execute such documents as the Committee deems necessary or desirable to enable it to satisfy its withholding obligations, or any other means provided in the Plan. 14. Notices. All notices, requests, demands and other communications pursuant to this Agreement shall be in writing and shall be given in accordance with the procedures set forth in Section 12.3 of the Employment Agreement. 15. Amendments and Waivers. This Agreement may be amended, and any provision hereof may be waived, only by a writing signed by both parties hereto. 16. Entire Agreement. This Agreement, together with the Plan, sets forth the entire agreement and understanding between the parties as to the subject matter hereof and supersedes all prior oral and written and all contemporaneous oral discussions, agreements and understandings of any kind or nature. 17. Separability. In the event that any provision of this Agreement is declared to be illegal, invalid or otherwise unenforceable by a court of competent jurisdiction, such provision shall be reformed, if possible, to the extent necessary to render it legal, valid and enforceable, or otherwise deleted, and the remainder of this Agreement shall not be affected except to the extent necessary to reform or delete such illegal, invalid or unenforceable provision. 18. Headings. The headings preceding the text of the sections hereof are inserted solely for convenience of reference, and shall not constitute a part of this Agreement, nor shall they affect its meaning, construction or effect. 19. Counterparts. This Agreement may be executed in two counterparts, each of which shall be deemed an original, but which together shall constitute one and the same instrument. 20. Further Assurances. Each party shall cooperate and take such action as may be reasonably requested by another party in order to carry out the provisions and purposes of this Agreement. 21. Binding Effect. This Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective permitted successors and assigns. 22. SAR Contingency. With regard to 200,000 of the Option Shares (the "Authorized Option Shares"), those shares are within the current authorized shares under the Plan and are therefore granted under the Plan without contingency. The Authorized Option Shares shall constitute the Option Shares which first vest pursuant to Section 3 hereof. With regard to the Option 4 Shares over and above the Authorized Option Shares (the "Contingent Option Shares"), the Option as it relates to such Option Shares is granted hereby subject to the condition that, at the 2000 Annual Meeting of Shareholders of the Company, the shareholders approve an amendment to the Plan authorizing sufficient additional shares of Common Stock under the Plan to permit the Contingent Option Shares to be granted thereunder or, prior to that Annual Meeting, sufficient shares of Common Stock otherwise become available under the Plan to permit the Contingent Option Shares to be granted thereunder. If such condition is not met, the Contingent Option Shares shall thereupon immediately be converted to stock appreciation rights granted under the Plan, with the terms and conditions thereof such as to approximate as closely as possible the economic value of the Contingent Option Shares to the Optionee. The Company shall then issue to the Optionee a new stock option agreement relating to the Authorized Option Shares to replace this Agreement and a stock appreciation rights agreement relating to the stock appreciation rights so granted. 23. Arbitration. In the event that there shall be a dispute between the parties hereto arising out of or relating to this Agreement or the breach thereof, the parties agree that such dispute shall be resolved in accordance with Section 12.8 of the Employment Agreement. 5 IN WITNESS WHEREOF, the parties have executed this Agreement as of the Effective Date. HORACE MANN EDUCATORS CORPORATION By:/s/ Paul J. Kardos ----------------------------------------- Name: Paul J. Kardos Title: Chairman OPTIONEE /s/ Louis G. Lower II ----------------------------------------- Louis G. Lower II 80102595_4.Doc 6 EX-10.13 7 LARRY K. BECKER SEPARATION AGREEMENT Exhibit 10.13 Execution Copy SEPARATION AGREEMENT -------------------- This Separation Agreement (this "Agreement") is made and entered into this 21 day of March, 2000, by and among Horace Mann Educators Corporation, a Delaware corporation ("HMEC"), Horace Mann Service Corporation, an Illinois corporation ("HMSC"), and Larry K. Becker, an Illinois resident ("Employee"). HMEC and HMSC are collectively referred to herein as the "Company." 1. Resignation. Employee hereby resigns as an employee of the Company and as an officer and director of the Company and all affiliated companies effective June 22, 2000 and the Company hereby accepts such resignation. Notwithstanding any public statements by the Employee or the Company regarding the termination of the Employee's employment with the Company, the Employee understands and acknowledges that he is not "retiring" from employment with the Company as that term is used in any of the Company's benefit, pension or compensation plans. Employee shall be paid his salary through June 22, 2000 and shall be treated under all employee plans of the Company as an employee who has resigned from the Company on such date, provided, however, that (i) all options to purchase Common Stock of HMEC granted to Employee prior to June 22, 2000 ("Stock Options") which have not vested prior to June 22, 2000 will vest on the first to occur of (v) June 22, 2001 or (w) the date of Employee's death and (ii) Employee (or his estate) shall be entitled to exercise all vested Stock Options until the earlier of (x) June 22, 2002, (y) the one-year anniversary of the date of Employee's death or (z) the date of expiry of such options. Employee's agreement to the provisions of this Agreement provided for below is made in consideration of the Company's agreement to the extended period of option exercise provided for above. Employee's resignation shall not affect his rights to indemnification by the Company by reason of his being an officer, director or employee of the Company or any of its subsidiaries or affiliates, pursuant to the Company's corporate documents and otherwise. 2. Releases and Covenant Not to Sue. (a) Employee, for himself, his agents, legal representatives, assigns, heirs, distributees, devisees, legatees, administrators, personal representatives and executors (the "Releasing Parties"), hereby releases and forever discharges the Company, its present and past subsidiaries and affiliates, successors and assigns, and their respective present and past officers, directors, employees and agents (the "Released Parties"), from any and all claims, demands, actions, liabilities and other claims for relief and remuneration whatsoever, whether known or unknown, arising or which could have arisen up to and including June 22, 2000, including without limitation those arising out of or relating to Employee's employment and cessation of employment and any claims arising under Title VII of the Civil Rights Act of 1964 (as amended by the Civil Rights Act of 1991), the Equal Pay Act, the Fair Labor Standards Act, the Older Workers Benefits Protection Act, the Age Discrimination in Employment Act, the Illinois Human Rights Act, the Illinois Wage Payment and Collection Act, the Employee Retirement Income Security Act ("ERISA") or any other federal, state or local statute, law, ordinance, regulation, code or executive order, any tort or contract claims, and any of the claims, matters and issues which could have been asserted by Employee against the Company in any legal, administrative or other proceeding, provided that the Releasing Parties do not release potential claims (i) for failure of the Company to comply with Section 1 of this Agreement, (ii) arising under ERISA or otherwise with regard to any benefits to which Employee is entitled in accordance with the Company's benefit programs by virtue of his employment with the Company or (iii) arising from any fraud or criminal activity committed by the Company. (b) Employee further agrees not to assert any claim, charge or other legal proceeding against the Released Parties, in any forum, based on any events, whether known or unknown, which are the subject of the release contained in section (a) above. If Employee brings any such proceeding, Employee shall immediately forfeit any right to continued compensation or other consideration from the Company pursuant to section 1 of this Agreement. (c) The Released Parties hereby release and forever discharge Employee and the other Releasing Parties from any and all claims, demands, actions, liabilities and other claims for relief and remuneration whatsoever, whether known or unknown, arising out of or relating to Employee's employment, cessation of employment or the performance of his duties on behalf of the Company. The Released Parties hereby covenant not to file any charge, action, complaint or claim whatsoever against Employee which are based upon the claims released by them hereunder. However, notwithstanding anything contained in this Agreement, including this section, the Released Parties reserve the right to file a claim or lawsuit to enforce this Agreement and the right to bring any action against Employee arising from any fraud or criminal activity committed by him while employed by the Company. 3. Restrictive Covenants. (a) Employee agrees that, through June 22, 2001, Employee will not knowingly, directly or indirectly, solicit any person who, at any time during the one year period ending on June 22, 2000 was employed or retained by the Company, to terminate such person's employment or retention by the Company for the purpose of becoming employed or retained by Employee or any other person to perform the same or similar services that such person performed for the Company or the Company's successors or assigns. (b) Employee agrees that he will not, at any time, disclose to any person, or otherwise use or exploit, any of the proprietary or confidential information or knowledge, including without limitation trade secrets, research proposals, reports, methods, techniques, computer programming or budgets or other financial information, regarding the Company, its business, properties or affairs obtained by him at any time except as required by law or legal process. On June 22, 2000, Employee will promptly deliver to the Company all documents and materials of any nature pertaining to the Company which contain any such information and will not take with him any documents or materials or copies thereof containing any such information. (c) Employee covenants, agrees and recognizes that because the breach or threatened breach of the covenants and agreements set forth in this Section 3, or any of them, will result in immediate and irreparable injury to the Company, the Company shall be entitled to an injunction restraining Employee from any violation of this Section 3 to the fullest extent allowed by law. Employee further covenants, agrees and recognizes that in the event of a violation of any of the covenants and agreements set forth in this Section 3, the Company shall be entitled to receive all such amounts to which the Company would be entitled as damages under law or at equity. Nothing herein shall be construed as prohibiting the Company from pursuing any other legal or equitable remedies that may be available to it for such breach, including the recovery of damages from Employee. (d) Employee expressly acknowledges and agrees that (i) the covenants and agreements set forth in this Section 3 are reasonable and are necessary to protect the legitimate business and competitive interests of the Company and (ii) each of the covenants and agreements set forth in 2 this Section 4 is separately and independently given, and each such covenant and agreement is intended to be enforceable separately and independently of the other such covenants and agreements, including without limitation enforcement by injunction; in the event that any provision of this Agreement shall be held invalid or unenforceable by a court of competent jurisdiction, such invalidity or unenforceability shall attach only to the particular aspect of such provision found invalid or unenforceable as applied and shall not render invalid or unenforceable any other provisions of this Agreement which shall be construed as if the provision or other basis on which this Agreement has been challenged had been more narrowly drafted so as not to be invalid or unenforceable. 4. Voluntary Agreement. Employee acknowledges and states that he has read this Agreement, that he has had opportunity to, and has been advised, orally and in writing hereby, to consult with legal counsel prior to executing this Agreement, that he understands the legal effect and binding nature of this Agreement and that he is acting voluntarily and with full knowledge of his actions in executing this Agreement. Further, Employee acknowledges and states that he has been given at least twenty-one days to consider entering into this Agreement before its execution. 5. Revocation. This Agreement may be revoked by Employee within seven days following his execution of this Agreement, in which case this Agreement shall not become effective or enforceable and all terms within this Agreement shall become null and void, provided that such shall not revoke the first two sentences of Section 1 of this Agreement. If not revoked during this seven day revocation period, this Agreement shall be and remain in full force and effect. 6. Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Illinois, without giving effect to its conflict or choice of law provisions. 3 7. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the parties hereto. No waiver by any party hereto at any time of any breach by any other party hereto of, or compliance with, any condition or provisions of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by any party which are not set forth expressly in this Agreement. Headings in this Agreement are for convenience only and shall not be used to interpret or construe its provisions. This Agreement may be executed in counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. This Agreement constitutes the entire agreement among the parties hereto regarding the subject matter hereof. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. HORACE MANN EDUCATORS CORPORATION By /s/ Louis G. Lower II ----------------------- Name: Louis G. Lower II Title: President HORACE MANN SERVICE CORPORATION By /s/ Paul J. Kardos ----------------------- Name: Paul J. Kardos Title: President EMPLOYEE /s/ Larry K. Becker -------------------------- LARRY K. BECKER 4 EX-10.14 8 PETER H. HECKMAN LETTER OF EMPLOYMENT Exhibit 10.14 March 20, 2000 Peter H. Heckman 125 Surrey Lane Lake Forest, IL 60045 Dear Peter: We are pleased to offer you employment as Executive Vice President, Finance & Planning effective no later than April 10, 2000 with an initial monthly base salary of $25,000. Your initial responsibilities will include managing all financial functions (including Investments, Accounting, Investor Relations, Treasury, Mergers & Acquisitions, Financial Planning, and Financial & Operational Analysis); Corporate Marketing/Market Strategy and Corporate Strategy and Strategic Planning. You will also be eligible to participate in the officer bonus program which consists of three elements: 1. An annual bonus opportunity based on meeting specific corporate and divisional measures. Your position provides for a target bonus opportunity of 50% of your annual salary but could increase or decrease based on the corporate and divisional results (0 to 2 times target percentage). As agreed, you will receive a first year employment minimum guarantee of target ($150,000) payable on or around March 1, 2001. The payment will not be pro-rated based on effective date of hire after January 1, 2000. 2. Long term incentive bonus opportunity based on specific corporate measures over a rolling four (4) year period of time. Your position provides for a target bonus payment opportunity of 50% of your annual salary but could also increase or decrease based on corporate results (0 to 2 times target percentage). As agreed, you will receive a first year employment minimum guarantee of target ($150,000) payable on or around March 1, 2001. The payment will not be pro-rated based on effective date of hire after January 1, 2001. 3. Annual Stock Option grants based on corporate, divisional and individual performance results. You will receive 250,000 option shares, under the HMEC Incentive Stock Plan (the Plan), with vesting over a five (5) year period (at year end) and an option price equal to the volume weighted average on your effective date of employment. With regard to 190,000 of these options shares, those shares are within the current authorized shares under the Plan and will be granted under the Plan without contingency. With regard to the remaining 60,000 option shares (the "Contingent Option Shares), such Option Shares will be granted subject to the condition that, at the 2000 Annual Meeting of Shareholders, the shareholders approve an amendment to the Plan authorizing Peter H. Heckman Page 2 March 6, 2000 sufficient additional shares of Common Stock under the Plan to permit the Contingent Option Shares to be granted. If such condition is not met, the Contingent Option Shares shall be converted to stock appreciation rights under the Plan, with terms and conditions such as to approximate as closely as possible the economic value of the Contingent Option Shares. In addition to the change of control agreement, of which you already have a sample copy, if your employment is terminated within the first five (5) years by (I) the company without Cause or (ii) by you due to Constructive Termination, we will provide you with your then current base salary for the next twelve (12) months plus your target short term and long term payouts. If your employment terminates without Cause or due to Constructive Termination during the five (5) year period, you agree to release and forever discharge the Horace Mann Companies and affiliates from any and all claims, demands, actions and liabilities. The terms "Cause" and "Constructive Termination" referenced in this paragraph are as defined in the change of control agreement. Full relocation benefits and additional agreed upon relocation items will be provided (see attached) as well as the complete Employee Benefit Program which includes the eligibility for 1 month (22 work days) vacation. In order to substantiate your identity and employment eligibility in accordance with federal law, I would like for you to bring documentation with you on your first day. Samples of acceptable identification and authorization are enclosed. As this is a federal law, failure to comply with this regulation would be cause for us to reconsider our offer of employment. On your first day, please stop by my office and we will coordinate your employment orientation. We are truly excited about your joining Horace Mann and I look forward to working with you. Sincerely, /s/ Valerie Chrisman Valerie A. Chrisman Senior Vice President Customer & Employee Services Division Enclosures cc: Paul Kardos Lou Lower To confirm your acceptance of this offer, please sign this letter and return it to me by Thursday, March 9, 2000. The enclosed copy is for your records. - ------------------------------------------------------ -------------------- (Signature) (Date) MOVING ASSISTANCE ----------------- (Section 1) Payment of full benefits of the Moving Assistance policy will include reimbursement of the following: A. Cost of moving household goods, including replacement value coverage. B. Cost of packing; also unpacking if desired. C. Normal costs of servicing appliances, including telephone installation charge. Deposits which will eventually be refunded are not reimbursable. D. Expense of no more than two exploratory trips for both employee and spouse from former to new location to locate new housing. E. When an employee is required to report to the new location prior to the arrival of his/her dependents, normal living expenses will be paid. This period is approved from April through August. F. When an employee has reported to a new location and has not sold his/her home in the old location, the company will reimburse the expenses of a monthly trip home. G. Expense of transportation of the family to the new location via personal car or public transportation including living expenses en route. If personal car is used, 27 cents per mile will be paid. All toll and parking charges are also reimbursable. H. Temporary living expenses while awaiting occupancy of permanent living accommodations at the new location or awaiting for the household goods to arrive not to exceed 30 days. I. Miscellaneous Moving Expense Allowance (two month's salary (taxable) upon closing on home in Springfield. J. Cost of storing furniture and possessions up to 30 days pending access to new home. Tax Requirements - ---------------- The company will reimburse the employee for taxes on the portion of total moving expense reimbursements which exceed the amount allowed as a deduction under Section 217 of the Internal Revenue Code. This reimbursement will be determined by the Corporate Tax Section of the Controllers Department and processed through the December 15th and 31st pay cycles. The employee will not receive this amount in cash. It will be credited to withholding tax for the year. The tax reimbursement will be based on a rate which will reimburse the employee for federal and state income taxes, and FICA tax on both the moving expense reimbursement and the tax reimbursement, which is also taxable. MORTGAGE ASSISTANCE ------------------- (Section 2) Payment of full benefits of the Mortgage Assistance Policy on the purchase of a new home will include reimbursement the following: A. Loan Origination and/or Commitment Fees B. Attorney Fees or Escrow Department Closing Fees C. Title Policy (Mortgagee ALTA Form is included) D. Appraisal E. Survey F. Credit Reports G. Revenue Stamps Tax Requirements - ---------------- Refer to Section I REAL ESTATE PLAN ---------------- (Section 3) Payment of full benefits of the Real Estate Policy will include reimbursement of the following: A. Commission at established rate (Listing Contact) - maximum of 7% B. Preparation of Deed C. Penalty Charges for prepayment of present mortgage to a maximum of 3% of the existing balance D. Mortgage points or discount charge that is the responsibility of the Seller to a maximum of 3 points E. Attorney, recording, filing and Escrow closing fees F. Title Policy (ALTA Form) G. Termite Inspection H. Survey of Property I. Revenue Stamps Tax Requirements - ---------------- Refer to Section I EX-11 9 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS Exhibit 11 Horace Mann Educators Corporation Computation of Net Income per Share For the Years Ended December 31, 1999, 1998 and 1997 (Amounts in thousands, except per share data) Year Ended December 31, ------------------------------- 1999 1998 1997 ---- ---- ---- Basic - assumes no dilution: Net income for the period $44,505 $85,312 $83,576 ------- ------- ------- Weighted average number of common shares outstanding during the period 41,246 43,239 45,825 ------- ------- ------- Net income per share - basic $ 1.08 $ 1.97 $ 1.82 ======= ======= ======= Diluted - assumes full dilution: Net income for the period $44,505 $85,312 $83,576 ------- ------- ------- Weighted average number of common shares outstanding during the period 41,246 43,239 45,825 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: Stock options 387 451 416 Common stock units related to Deferred Equity Compensation Plan for Directors 69 49 33 Common stock units related to Deferred Compensation Plan for Employees 6 1 - Warrants - 98 251 ------- ------- ------- Total common and common equivalent shares adjusted to calculate diluted earnings per share 41,708 43,838 46,525 ------- ------- ------- Net income per share - diluted $ 1.07 $ 1.95 $ 1.80 ======= ======= ======= Percentage of dilution compared to basic net income per share 0.9% 1.0% 1.1% EX-12 10 STATEMENT REGARDING COMPUTATION OF RATIOS Exhibit 12 Horace Mann Educators Corporation Computation of Ratio of Earnings to Fixed Charges For the Years Ended December 31, 1999, 1998, 1997, 1996 and 1995 (Dollars in millions) Year Ended December 31, ------------------------------------------------- 1999 1998 1997 1996 1995 ------ ------ ------ ------ ------ Income from continuing operations before income taxes $ 93.4 $116.8 $119.6 $100.6 $103.6 Interest expense 9.7 9.5 9.4 10.5 11.6 ------ ------- ------ ------ ------ Earnings $103.1 $126.3 $129.0 $111.1 $115.2 ====== ======= ====== ====== ====== Fixed charges - interest expense $ 9.7 $ 9.5 $ 9.4 $ 10.5 $ 11.6 Ratio of earnings to fixed charges 10.6x 13.3x 13.7x 10.6x 9.9x EX-21 11 SUBSIDIARIES Exhibit 21 Horace Mann Educators Corporation Insurance Subsidiaries, Other Significant Subsidiaries and Their Respective States of Incorporation or Organization December 31, 1999 Insurance Subsidiaries: Allegiance Insurance Company - California Allegiance Life Insurance Company - Illinois Educators Life Insurance Company of America - Arizona Horace Mann Insurance Company - Illinois Horace Mann Life Insurance Company - Illinois Horace Mann Lloyds - Texas Teachers Insurance Company - Illinois Other Significant Subsidiaries: Horace Mann General Agency - Texas Horace Mann Investors, Inc. - Maryland Horace Mann Service Corporation - Illinois EX-23 12 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 25, 2000, relating to the consolidated balance sheets of the Company as of December 31, 1999, 1998 and 1997, 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, 1999, and all related schedules, which report appears in the December 31, 1999 annual report on Form 10-K of the Company. /s/ KPMG LLP KPMG LLP Chicago, Illinois March 29, 2000 EX-27 13 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL 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. 1,000 YEAR DEC-31-1999 DEC-31-1999 2,507,280 0 0 0 17,396 154 2,630,209 22,848 0 130,192 4,253,846 2,170,449 170,845 0 126,530 148,677 0 0 59 400,083 4,253,846 595,128 188,267 (7,969) 0 416,186 53,041 109,694 93,354 48,849 44,505 0 0 0 44,505 1.08 1.07 243,039 379,455 (4,583) 240,045 142,473 235,393 4,583 REFER TO THE COMPANY'S CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1999. INCLUDES $20,000 PROVISION FOR PRIOR YEARS' TAXES. REFER TO THE COMPANY'S CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1999. 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, 1999.
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