-----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, ATDVVjUZjYGb+TLv9gncSo3lMlOgJG6FQVhlBTyh0l988IQD/Ccv0G1skAaRZABn q5khiR5rBmMNBz/oxyh4nQ== 0000950131-02-001286.txt : 20020415 0000950131-02-001286.hdr.sgml : 20020415 ACCESSION NUMBER: 0000950131-02-001286 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020329 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: 1934 Act SEC FILE NUMBER: 001-10890 FILM NUMBER: 02594392 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 d10k.txt 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, 2001 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, 2002, was approximately $914 million. As of March 1, 2002, 40,796,259 shares of Common Stock, par value $0.001 per share, were outstanding, net of 19,341,296 shares of treasury stock. DOCUMENTS INCORPORATED BY REFERENCE Proxy Statement for the 2002 Annual Meeting of Shareholders, exclusive of disclosures made pursuant to Regulation S-K, Section 306 and Section 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, 2001 INDEX
Item Number Page - ------ ---- PART I 1. Business Forward-looking Information................................................................. 1 Overview.................................................................................... 1 History..................................................................................... 3 Selected Historical Consolidated Financial Data............................................. 4 General..................................................................................... 6 Corporate Strategy and Marketing............................................................ 6 Property and Casualty Segment............................................................... 11 Annuity Segment............................................................................. 21 Life Segment................................................................................ 23 Investments................................................................................. 25 Cash Flow................................................................................... 27 Competition................................................................................. 28 Insurance Financial Ratings and IMSA Certification.......................................... 29 Regulation.................................................................................. 32 Employees................................................................................... 34 2. Properties..................................................................................... 34 3. Legal Proceedings.............................................................................. 35 4. Submission of Matters to a Vote of Security Holders............................................ 35 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters.......................... 35 6. Selected Financial Data........................................................................ 36 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................................................... 36 7A. Quantitative and Qualitative Disclosures About Market Risk..................................... 36 8. Consolidated Financial Statements and Supplementary Data....................................... 36 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure......................................................... 36 PART III 10. Directors and Executive Officers of the Registrant............................................. 36 11. Executive Compensation......................................................................... 37 12. Security Ownership of Certain Beneficial Owners and Management................................. 37 13. Certain Relationships and Related Transactions................................................. 37 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................... 37 SIGNATURES..................................................................................... 43 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, Horace Mann Property & Casualty Insurance Company ("HMPCIC") (formerly Allegiance Insurance Company), a California domiciled personal lines property and casualty insurance company and Horace Mann Lloyds ("HM Lloyds"), domiciled in Texas. 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 largest 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, 2001 were $875.6 million, net income was $25.6 million and operating income (net income before the after-tax impact of realized investment gains and losses, restructuring charges, litigation charges and the provision for prior years' taxes) was $35.6 million. The Company's total assets were $4.5 billion at December 31, 2001. The property and casualty segment accounted for 59% of the Company's insurance premiums written and contract deposits for the year ended December 31, 2001, while accounting for 15% of operating income for the period. The annuity and life insurance segments together accounted for 41% of insurance premiums written and contract deposits for the year ended December 31, 2001 (27% and 14%, respectively), and provided 111% (58% and 53%, 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 9 percentage points per year. One of the reasons why the Company's property and casualty lines have performed better than the industry is the Company's property and casualty expense ratio, which has been consistently better than the industry ratio since 1983. During the last 10 years, the Company's property and casualty expense ratio has been better than the property and casualty industry personal lines average expense ratio as reported by A.M. Best by an average of 4.5 percentage points per year. The Company's property and casualty expense ratio for the year ended December 31, 2001 was 21.6%. The Company is one of the 20 largest participants in the fixed and variable 403(b) tax-qualified annuity market according to information from A.M. Best for 2000. Approximately 60% of the Company's new annuity contract deposits in 2001 were for 403(b) tax-qualified annuities; approximately 75% of accumulated annuity value on deposit is 403(b) tax-qualified. At December 31, 2001, the accumulated value of all of the Company's annuity contracts (tax and non-tax qualified) was $2.4 billion, representing 139,000 contracts in force. For the 2001 year, 93% of the accumulated cash value of the Company's fixed annuity business remained on deposit, and 92% of the Company's variable annuity business remained on deposit. All annuities issued since 1982, and approximately 79% 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, minus withdrawal penalties as applicable. 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, 2001 consisted of 42% variable annuities and 58% fixed annuities. The investment portfolio of the Company, including variable annuity assets under management of $1.0 billion, had an aggregate fair value of $4.0 billion at December 31, 2001. Investments other than variable annuity assets consist principally of investment grade, publicly traded fixed income securities. At December 31, 2001, investments in non-investment grade securities represented 5.3% 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, 2001 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, --------------------------------------------------------- 2001 2000 1999 1998 1997 --------- --------- --------- -------- ----------- (Dollars in millions, except per share data) Statement of Operations Data: Insurance premiums written and contract deposits.. $ 875.6 $ 821.7 $ 821.2 $ 827.8 $ 771.3 Insurance premiums and contract charges earned.... 615.2 598.7 595.1 577.8 542.7 Net investment income............................. 199.3 192.4 188.3 191.7 198.9 Net investment income, after tax.................. 133.8 129.4 126.7 128.3 132.6 Realized investment gains (losses)................ (10.0) (9.9) (8.0) 9.9 5.3 Total revenues.................................... 804.5 781.2 775.4 779.4 746.9 Amortization of intangible assets(1).............. 5.8 8.8 0.2 6.9 10.7 Interest expense.................................. 9.3 10.2 9.7 9.5 9.4 Income from continuing operations before income taxes........................................... 28.3 9.7 93.4 116.8 119.6 Income from continuing operations(2).............. 25.6 20.8 44.5 85.3 87.1 Discontinued operations(3)........................ -- -- -- -- (3.5) Net income(2)..................................... 25.6 20.8 44.5 85.3 83.6 Ratio of earnings to fixed charges(4)............. 4.0x 2.0x 10.6x 13.3x 13.7x Per Share Data(5): Basic: Operating income(6)............................ $ 0.88 $ 0.62 $ 1.71 $ 1.82 $ 1.82 Realized investment gains (losses), after tax.. (0.16) (0.16) (0.13) 0.15 0.08 Restructuring charges, after tax............... (0.12) (0.04) -- -- -- Litigation charges, after tax.................. -- (0.12) (0.02) -- -- Provision for prior years' taxes............... 0.03 0.21 (0.48) -- -- Income from continuing operations.............. 0.63 0.51 1.08 1.97 1.90 Discontinued operations(3)..................... -- -- -- -- (0.08) Net income..................................... 0.63 0.51 1.08 1.97 1.82 Diluted: Operating income(6)............................ $ 0.87 $ 0.61 $ 1.70 $ 1.80 $ 1.80 Realized investment gains (losses), after tax.. (0.15) (0.15) (0.13) 0.15 0.07 Restructuring charges, after tax............... (0.12) (0.04) -- -- -- Litigation charges, after tax.................. -- (0.12) (0.02) -- -- Provision for prior years' taxes............... 0.03 0.21 (0.48) -- -- Income from continuing operations.............. 0.63 0.51 1.07 1.95 1.87 Discontinued operations(3)..................... -- -- -- -- (0.07) Net income..................................... 0.63 0.51 1.07 1.95 1.80 Shares of Common Stock-weighted average: Basic.......................................... 40.6 40.8 41.2 43.2 45.8 Diluted........................................ 40.9 41.0 41.7 43.8 46.5 Shares of Common Stock - ending outstanding....... 40.7 40.5 41.0 42.1 44.3 Cash dividends.................................... $ 0.42 $ 0.42 $ 0.3825 $ 0.3325 $ 0.2825 Book value per share(7)........................... $ 11.27 $ 10.56 $ 9.75 $ 11.80 $ 11.43 Balance Sheet Data, at Year End: Total investments................................. $ 2,975.7 $ 2,912.3 $2,630.2 $2,840.8 $ 2,769.0 Total assets...................................... 4,489.0 4,420.6 4,253.8 4,395.5 4,131.9 Total policy liabilities.......................... 2,475.6 2,362.3 2,341.3 2,308.0 2,278.6 Short-term debt................................... 53.0 49.0 49.0 50.0 42.0 Long-term debt.................................... 99.8 99.7 99.7 99.6 99.6 Total shareholders' equity........................ 459.2 428.0 400.1 496.6 506.0
(continued on next page) 4 SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA - (continued)
Year Ended December 31, ------------------------------------------------------------ 2001 2000 1999 1998 1997 -------- ---------- --------- --------- --------- (Dollars in millions, except per share data) Segment Information: Insurance premiums written and contract deposits Property and casualty.......................... $ 519.3 $ 493.5 $ 495.1 $ 487.8 $ 458.0 Annuity........................................ 239.1 206.4 205.7 223.3 199.2 Life........................................... 117.2 121.8 120.4 116.7 114.1 Total....................................... 875.6 821.7 821.2 827.8 771.3 Operating income(6) Property and casualty......................... $ 5.2 $ 8.9 $ 39.5 $ 53.2 $ 61.4 Annuity........................................ 20.6 19.3 27.3 23.1 19.3 Life........................................... 18.7 12.9 14.6 12.4 12.9 Corporate and other, including interest expense (8.9) (16.0) (10.7) (9.8) (10.0) Total....................................... 35.6 25.1 70.7 78.9 83.6 Statutory Operating Data(8): Property and casualty: Loss and loss adjustment expense ratio........ 85.2% 85.2% 76.3% 74.4% 71.7% Expense ratio................................. 21.6% 20.8% 19.8% 19.3% 19.4% Combined loss and expense ratio(9)............ 106.8% 106.0% 96.1% 93.6% 91.1% Industry average combined loss and expense ratio(9)(10)................... 117.0% 110.1% 107.8% 105.6% 101.6% Personal lines industry segment average combined loss and expense ratio(9)(10).............. 112.5% 109.9% 104.5% 102.7% 99.8% Annuity accumulated value on deposit............. $ 2,402.1 $ 2,366.9 $ 2,487.3 $ 2,475.5 $ 2,314.2 Life insurance in force.......................... $ 13,216 $ 12,637 $ 12,300 $ 11,799 $ 11,188 Adjusted capital and surplus of insurance subsidiaries (includes investment reserves)(11)............ $ 415.5 $ 405.8 $ 405.7 $ 379.8 $ 372.3
- ------------------ (1) Amortization of intangible assets is comprised of amortization of goodwill and amortization of acquired value of insurance in force and is the result of purchase accounting adjustments related to the 1989 acquisition of the Company and the 1994 acquisition of HMPCIC. (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 (for tax years 1994 through 1997). 2000 includes a non-recurring benefit of $8.7 million, or $0.21 per share, from resolution of tax years 1994 through 1996. 2001 includes a non-recurring benefit of $1.3 million, or $0.03 per share, from resolution of tax year 1997. (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 included an additional after-tax charge of $3.5 million, or $0.07 per diluted share, for estimated losses during the phase-out period. (4) 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). (5) 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 and warrants prior to their repurchase in 1999. (6) Income from continuing operations before the after-tax impact of realized investment gains and losses, restructuring charges, litigation charges, provision for prior years' taxes and discontinued operations. (7) Due to the adoption by the Company on January 1, 1994 of Financial Accounting Standard No. 115 ("FAS 115"), total shareholders' equity included an increase, net of taxes, of $26.3 million, $57.3 million and $62.2 million at December 31, 2001, 1998 and 1997 and a decrease, net of taxes, of $4.0 million and $40.0 million at December 31, 2000 and 1999, respectively. Excluding the FAS 115 fair value accounting for investments, book value per share was $10.62, $10.66, $10.73, $10.44 and $10.03 at December 31, 2001, 2000, 1999, 1998 and 1997, 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 (1998 through 2001 Eds.). The industry averages for the year ended December 31, 2001 are from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 2002, published by A.M. Best. (11) Investment reserves were the Asset Valuation Reserves ("AVR"). AVR, required under statutory accounting practices, is a reserve intended to stabilize the surplus of life insurance companies against the effects of fluctuations in the fair value of certain invested assets. Changes in AVR are charged or credited directly to statutory surplus. 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, ------------------------------------------------ 2001 2000 1999 -------------- -------------- -------------- Property and casualty... $519.3 59.3% $493.5 60.1% $495.1 60.3% Annuity................. 239.1 27.3 206.4 25.1 205.7 25.0 Life.................... 117.2 13.4 121.8 14.8 120.4 14.7 ------ ----- ------ ----- ------ ----- Total................ $875.6 100.0% $821.7 100.0% $821.2 100.0% ====== ===== ====== ===== ====== =====
Corporate Strategy and Marketing The Horace Mann Value Proposition The Horace Mann Value Proposition articulates the Company's overarching strategy and business purpose: Provide lifelong financial well-being for educators and their families through personalized service, advice, and a full range of tailored insurance and financial products. In 2000, the Company's management announced steps to focus on the Company's core business and accelerate growth of the Company's revenues and profits. These initiatives are intended to: . Grow and strengthen the agency force and make the Company's agents more productive by improving the products, tools and support the Company provides to them; . Expand the Company's penetration of targeted geographic areas and new segments of the educator market; . Broaden the Company's distribution options to complement and extend the reach of the Company's agency force; . Increase cross-selling and improve retention in the existing book of business; and . Make the Company's products more responsive to customer needs and preferences and expand the Company's product lines within the personal financial services segment. During the fourth quarter of 2000, management began implementing specific plans that address the initiatives above. New compensation and evaluation systems were implemented during 2001 to improve the performance of the Company's agents and agency managers. The Company has begun targeting high-priority geographic markets with dedicated staff teams. New approaches to customer service are being developed and tested that will free agents to spend more time selling. Additional distribution options are being initiated to capitalize fully on the value of the Company's payroll deduction slots in schools across the country. And, the Company will increase its use of technology to improve the efficiency of its agency force and its administrative operations. Target Market The Company's target market through 2001 consisted of educators and other employees of public schools and their families. The Company also sold its products to other education-related customers, including private school teachers, education support personnel, and their families, and 6 customer referrals. Horace Mann is the largest national multiline insurance company focused on the niche educator market. In 2002 and beyond, the Company will expand its service to the educator market by also targeting Kindergarten - 12 teachers at private schools, Kindergarten - 12 principals and administrators at both public and private schools, faculty and staff at junior and community colleges, and college students majoring in education. The U.S. Department of Education estimates that there are approximately 4 million elementary and secondary teachers in public and private schools in the United States of America. It also estimates that the number of public and private school teachers is growing approximately 1% annually. Recent federal and state programs which reduce class size and add additional teachers may increase this growth rate. 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, 2001, the Company employed 867 full-time agents, including 553 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 65% of the Company's agents licensed by the National Association of Securities Dealers, Inc. ("NASD") to sell variable annuities. They are under contract to market and write only the Company's products and supplemental products authorized by the Company. The agency force is managed through 69 agency offices in 38 states and writes business in 49 states and the District of Columbia. 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 as well as education association sponsorships. Management believes that Horace Mann's name recognition and policyholders' loyalty lead to new customers and cross selling of additional insurance products. At December 31, 2001, 34% 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 additional higher-quality business, not just additional quantities of business. Agents' compensation after an initial two-year period is comprised entirely of commissions and 7 incentive bonuses based on profitability of insurance written, retention of customers and sales. In 2001, incentive bonuses represented 23% of compensation for agents having more than two years of experience with nearly 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 annuity contracts and life policies. The Company has modified its agent compensation and reward structure, in order to provide incentive for agent performance that is more closely aligned with the Company's objectives. Prior to 2001, agent compensation and rewards focused on profitability, customer service and tenure with the Company. The revised structure continues to focus on profitability but also places a greater emphasis on individual agent productivity, new premium growth, growth in educator and cross-sold business and business retention. New compensation programs for both agents and agency managers were implemented in 2001 and reflect the revised structure. Also in 2001, the Company implemented enhanced agent training programs, to help new agents achieve production targets more rapidly and help experienced agents sharpen and strengthen their skills, and began providing agents with additional tools and support programs, to help them make a successful transition to their new role under the Company's Value Proposition. Management believes that the revised compensation structure along with other strategic initiatives are having a positive impact on agent productivity -- average agent productivity in 2001 increased approximately 40% compared to 2000 -- and that these impacts will continue in the future and will continue to help produce more profitable business. Broadening Distribution Options Management has begun to broaden the Company's distribution options to complement and extend the reach of the Company's agency force. This initiative initially focuses on more fully utilizing approximately 6,000 payroll deduction slots in school systems across the country which are assigned to Horace Mann. In 2001, the Company began building a network of independent agents who will comprise a second distribution channel for the Company's 403(b) tax-qualified annuity products. In addition to serving educators in areas where the Company does not have agents, the independent agents will complement and extend the annuity capabilities of the Company's agents in under-penetrated areas. All agreements with independent agents and broker/dealers will include clearly defined guidelines governing the relationship between independent agents and the Company's agents. As an example of the potential for this initiative, in January 2002, the Company announced that it has been selected as one of four providers of fixed and variable annuities to Chicago, Illinois, public school employees. Beginning in April 2002, the Company will partner with an independent broker/dealer, which has been providing retirement planning services to Chicago Public School employees for more than two decades, to pursue this opportunity to bolster business growth in the annuity segment. The Chicago Public Schools is the third-largest school district in the United States of America. 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, 2001, the top six states and their portion of total premiums were North Carolina, 7.8%; Texas, 5.8%; Massachusetts, 5.6%; Illinois, 5.1%; Florida, 4.9%; and Minnesota, 4.9%. 8 In October 2001, the Company reached conclusion on its strategic direction for automobile business in the state of Massachusetts. Horace Mann has formed a marketing alliance with The Commerce Group, Inc. ("Commerce") and through this alliance, by January 1, 2002, Horace Mann began providing its Massachusetts customers with Commerce automobile insurance policies, while continuing to write other Horace Mann products, including property and life insurance and retirement annuities. Horace Mann ceased writing automobile insurance policies in Massachusetts on December 31, 2001. For the full year 2001, net premiums written in Massachusetts for voluntary automobile business were $18.9 million and for involuntary residual market business were $7.8 million. Total direct premiums earned for Massachusetts automobile business were $32.2 million in 2001. In 2002, premiums written for this business will be reduced to zero, and premiums earned will be reduced significantly, reflecting run-off of the policies in force at December 31, 2001. Management anticipates that this transaction will have a positive impact on operating income of approximately $0.10 per share in 2003 and beyond. The improvement in 2002 earnings will be somewhat less reflecting the run-off of policies in force. The Company plans to utilize the benefits of this transaction to invest in its marketing, customer service and technology infrastructures. 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 2001: Property and Casualty Segment Top Ten States (Dollars in millions)
Property and Casualty Segment ---------------------- Direct Percent State Premiums(1) of Total - ----- ----------- -------- Massachusetts ................................ $ 38.7 7.5% North Carolina ............................... 37.7 7.3 California ................................... 35.0 6.8 Minnesota .................................... 32.1 6.2 Texas ........................................ 31.7 6.2 Florida ...................................... 30.7 6.0 Pennsylvania ................................. 22.7 4.4 South Carolina ............................... 22.0 4.3 Michigan ..................................... 20.5 4.0 Georgia ...................................... 16.9 3.3 ------- ----- Total of top ten states ................... 288.0 56.0 All other areas .............................. 226.6 44.0 ------- ----- Total direct premiums ..................... $ 514.6 100.0% ======= =====
- ------------------ (1) Defined as earned premiums before reinsurance and is determined under statutory accounting practices. 9 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 2001: Combined Life and Annuity Segments Top Ten States (Dollars in millions)
Direct Premiums and Percent State Contract Deposits(1) of Total - ------- -------------------- -------- Illinois ..................................... $ 30.8 8.6% North Carolina ............................... 30.3 8.4 Tennessee .................................... 22.8 6.3 Virginia ..................................... 22.7 6.3 Texas ........................................ 18.8 5.2 Indiana ...................................... 16.7 4.7 Pennsylvania ................................. 12.3 3.4 Florida ...................................... 12.0 3.3 South Carolina ............................... 11.7 3.3 Maine ........................................ 10.9 3.0 ------- ----- Total of top ten states ................... 189.0 52.5 All other areas .............................. 171.2 47.5 ------- ----- Total direct premiums ..................... $ 360.2 100.0% ======= =====
- ---------------- (1) Determined under statutory accounting practices. National, State and Local Education Associations The Company estimates that less than half of its policyholders are members of the National Education Association ("NEA"), the nation's largest confederation of state and local teachers' associations. NEA has approximately 2.6 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 to 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 2007. 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 since 1968, NEA has sponsored various Company products and currently sponsors the Company's homeowners policy, which was co-sponsored by 39 NEA-affiliated state associations 10 as of December 31, 2001. 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 36 states sponsor products of the Company other than homeowners. NEA-affiliated education associations in 43 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. In addition to NEA-affiliated education associations, the Company has begun to establish relationships with other education-related associations. As of December 31, 2001, 25 associations representing school principals and/or administrators in 16 states sponsored one or more of the Company's products. Some of the advantages of sponsorship by education and education-related associations 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. Association sponsorship may be one factor in such a decision. 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; financial support of the Horace Mann - NEA Foundation Award for Teaching Excellence; participation in the national conventions of the American Alliance for Health Physical Education Recreation & Dance (AAHPERD), the American Association of School Administrators (AASA), the Association of Educational Service Agencies (AESA), the Association of School Business Officials (ASBO), the National Association of Elementary School Principals (NAESP) and the National Association of Secondary School Principals (NASSP); relationships with approximately 100 educator credit unions serving over 500,000 members in 31 states; 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 Segment The property and casualty segment represented 59% of the Company's total insurance premiums written and contract deposits and 15% of the Company's operating income in 2001. The primary property and casualty product offered by the Company is private passenger automobile insurance, which in 2001 represented 44% of the Company's total insurance premiums written and contract deposits and 74% of property and casualty net written premiums. As of December 31, 2001, the Company had approximately 596,000 voluntary automobile policies in force with annual premiums of approximately $436 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 11 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. The Company has also implemented a tiered rating system, based on customers' credit ratings, to enhance its ability to differentiate automobile risk by price. Adopting a tiered rating system allows the Company to better match premiums to risk, so the best drivers pay the lowest rates. And, with more flexibility in pricing, the Company can write insurance for educators who in the past might not have met the Company's underwriting standards. In 2001, homeowners insurance represented 14% of the Company's total insurance premiums written and contract deposits and 25% of property and casualty net written premiums. The Company writes primarily residential homes. As of December 31, 2001, the Company had approximately 292,000 homeowners policies in force with annual premiums of approximately $130 million. A tiered rating system, based on customers' credit ratings, has also been implemented for homeowners business. The educator excess professional liability insurance represented the remaining 1% of the Company's 2001 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 through rate reductions 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. In addition to the typical cycles experienced historically, the September 11, 2001 terrorist attacks on the United States of America are having a significant effect on the property and casualty insurance industry, including the availability and pricing of reinsurance programs. 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. 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. 12 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, ------------------------------ 2001 2000 1999 -------- -------- -------- Statement of Operations Data: Insurance premiums written(1)........................ $ 519.3 $ 493.5 $ 495.1 Insurance premiums earned(1)......................... 508.3 490.0 491.1 Net investment income................................ 37.7 35.7 37.0 Operating income before income taxes................. 1.9 3.8 54.6 Operating income..................................... 5.2 8.9 39.5 Net investment income, after tax..................... 28.8 27.6 28.3 Catastrophe costs, after tax......................... 7.3 10.5 12.7 Statutory Operating Statistics: Loss and loss adjustment expense ratio............... 85.2% 85.2% 76.3% Expense ratio........................................ 21.6% 20.8% 19.8% Combined loss and expense ratio (including policyholder dividends)............... 106.8% 106.0% 96.1% Combined loss and expense ratio before catastrophes (including policyholder dividends).. 104.6% 102.7% 92.2% GAAP Operating Statistics: Loss and loss adjustment expense ratio............... 85.2% 85.2% 76.3% Expense ratio........................................ 21.6% 20.9% 19.7% Combined loss and expense ratio (including policyholder dividends)............... 106.8% 106.1% 96.0% Combined loss and expense ratio before catastrophes (including policyholder dividends).. 104.6% 102.8% 92.1% Automobile and Homeowners (Voluntary): Insurance premiums written........................... $ 496.6 $ 473.2 $ 470.7 Insurance premiums earned............................ 485.5 469.4 465.0 Policies in force (in thousands)..................... 888 876 872
- ---------- (1) After the Company's portion of the March 2000 industry settlement of automobile insurance rate filings in North Carolina, which reduced the Company's premiums by $2.3 million for the year ended December 31, 2000. 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 9 percentage points per year. 13 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, 2001.............................. 106.8% 112.5% 117.0% 2000.............................. 106.0 109.9 110.1 1999.............................. 96.1 104.5 107.8 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
- ---------- (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 1992 and 1993. (3) Source: Best's Aggregates and Averages (1993 through 2001 Eds.). 2001 is an estimate from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 2002, 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, 2001 were as follows: Catastrophe Costs (Dollars in millions)
Property and The Casualty Company(1) Industry(2) ---------- ------------ Year Ended December 31, 2001.............................. $11.2 (3) 2000.............................. 16.2 $ 4,300.0 1999.............................. 19.6 8,320.0 1998.............................. 28.4 10,070.0 1997.............................. 6.2 2,600.0 1996.............................. 20.9 7,370.0 1995.............................. 13.9 8,320.0 1994.............................. 16.2 17,010.0 1993.............................. 8.3 5,620.0 1992.............................. 13.3 22,970.0
- ---------- (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: 2001 - $3.7 million, June Midwest wind/hail/tornadoes; $2.3 million April tornadoes; $2.2 million Tropical Storm Allison. 2000 - $5.0 million, May tornadoes; $2.7 million December winter storms. 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. (2) Source: Insurance Services Office, Inc. news release dated January 23, 2001. These amounts are before reinsurance and federal income tax benefits and exclude all loss adjustment expenses. (3) Not available. 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 4.5 percentage points per year. The Company's property and casualty expense ratio for the year ended December 31, 2001 was 21.6%. 14 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, 2001.............................. 21.6% 24.9% 26.2% 2000.............................. 20.8 25.6 27.6 1999.............................. 19.8 25.6 28.0 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
- ---------- (1) Determined according to statutory accounting practices. (2) The Company did not have any California property and casualty business during 1992 and 1993. (3) Source: Best's Aggregates and Averages (1993 through 2001 Eds.). The 2001 personal lines result is an estimate from A.M. Best. The 2001 total industry result is an estimate from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 2002, published by A.M. Best. Property and Casualty Reserves In seven of the last ten years the Company's property and casualty reserves have developed cumulative redundancies. At December 31, 2001, 99.3% of the Company's net reserves for claims and claims expenses were carried at the full value of estimated liabilities and were 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 other than claims under homeowners insurance policies for environmentally related items such as toxic mold. 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 accounting principles generally accepted in the United States of America ("GAAP"), no reserves are established until a loss occurs, including a loss from a catastrophe. Underwriting results of the property and casualty segment 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. 15 In the fourth quarter of 2000, the Company conducted a comprehensive review of all components of its property and casualty reserves. As a result of that review, the Company increased total property and casualty reserves for prior years by $24.7 million at December 31, 2000. This increase consisted of approximately $6 million strengthening of prior years' direct reserves, primarily automobile, based on the further analysis of adverse trends which emerged during 2000. It also included an approximately $17 million reduction of ceded reserves resulting from the adoption of a different actuarial method to reflect more accurately prior years' loss experience. This reduction of the ceded reserves was related to automobile facility business in four states, primarily Massachusetts. Prior years' reserves for automobile and homeowners business assumed from state reinsurance facilities were also strengthened by $1.8 million at December 31, 2000. In 2001, the Company recorded a net strengthening of property and casualty reserves of $16.5 million. During the first half of 2001, the Company continued to refine its process and methods for evaluating property and casualty reserves and selected a new independent property and casualty actuarial consulting firm. During the second quarter of 2001, a comprehensive review of property and casualty loss reserving methodologies and assumptions was completed in conjunction with the new actuarial firm. Based on management's review of this further enhanced analysis and the opinion of the new actuarial firm, prior years' net reserves - predominantly related to 1999 and prior accident years - were increased by $11.0 million at June 30, 2001. This consisted primarily of an $8.0 million reduction in reserves to be ceded by the Company to its reinsurers and reinsurance facilities, including $1.5 million related to the Company's automobile residual market business, primarily in Massachusetts; $2.0 million for its voluntary automobile ceded excess liability coverage; and approximately $4.5 million related to its educators excess professional liability product. At December 31, 2001, the Company increased reserves for property and casualty claims occurring in prior years by an additional $4.7 million. Ceded and assumed reserves were strengthened by $6.4 million, primarily as a result of an updated review of subrogation recovery activity on business ceded to the state automobile insurance facility in Massachusetts. That strengthening was partially offset by $1.7 million of favorable development of reserves on the Company's direct automobile business. 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, 2001 are adequate to meet its future obligations. 16 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, ------------------------ 2001 2000 1999 ------ ------ ------ Gross reserves, beginning of year ............................. $298.9 $299.8 $298.9 Less reinsurance recoverables .............................. 49.1 64.4 55.9 ------ ------ ------ Net reserves, beginning of year ............................... 249.8 235.4 243.0 ------ ------ ------ Incurred claims and claims expense: Claims occurring in the current year ....................... 416.8 394.7 379.5 Increase (decrease) in estimated reserves for claims occurring in prior years(1): Policies written by the Company ..................... 14.5 20.9 (7.6) Business assumed from state reinsurance facilities .. 2.0 1.8 3.0 ------ ------ ------ Total increase (decrease) ........................ 16.5 22.7 (4.6) ------ ------ ------ Total claims and claims expense incurred(2) ......... 433.3 417.4 374.9 ------ ------ ------ Claims and claims expense payments for claims occurring during: Current year ............................................... 255.9 247.4 240.0 Prior years ................................................ 155.2 155.6 142.5 ------ ------ ------ Total claims and claims expense payments ............ 411.1 403.0 382.5 ------ ------ ------ Net reserves, end of period ................................... 272.0 249.8 235.4 Plus reinsurance recoverables .............................. 34.1 49.1 64.4 ------ ------ ------ Gross reserves, end of period(3) .............................. $306.1 $298.9 $299.8 ====== ====== ======
- ---------- (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. Also refer to the third paragraph preceding this table for additional information regarding the increase in reserves recorded in 2001 and 2000. (2) Benefits, claims and settlement expenses as reported in the Consolidated Statements of Operations, listed on page F-1 of this report, also include life, annuity, group accident and health and corporate amounts of $42.3 million, $48.6 million and $41.3 million for the years ended December 31, 2001, 2000 and 1999, respectively, in addition to the property and casualty amounts. (3) Unpaid claims and claims expense as reported in the Consolidated Balance Sheets, listed on page F-1 of this report, also include life, annuity, and group accident and health reserves of $8.2 million, $10.0 million and $9.8 million at December 31, 2001, 2000 and 1999, respectively, in addition to property and casualty reserves. The provision for claims and claims expenses for insured events in prior years increased by $16.5 million and $22.7 million and decreased by $4.6 million for the years ended December 31, 2001, 2000 and 1999, respectively. The reserve strengthening recorded in 2001 and 2000 are described above. The favorable claim development experienced in 1999 resulted primarily from improving trends in the frequency and severity of voluntary automobile claims. Future reserve actions, if any, will depend on claim trends. The year-end 2001 gross reserves of $306.1 million for property and casualty insurance claims and claims expense, as determined under GAAP, were $34.1 million more than the reserve balance of $272.0 million recorded on the basis of statutory accounting practices for reports provided to state regulatory authorities. The difference is the reinsurance recoverable from third parties totaling $34.1 million that reduces reserves for statutory reporting and is recorded as an asset for GAAP reporting. 17 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, ------------------------ 2001 2000 1999 ------ ------ ------ Claims and claims expense incurred ......... $433.3 $417.4 $374.9 Amount attributable to catastrophes ........ 11.2 16.1 19.4 ------ ------ ------ Excluding catastrophes .................. $422.1 $401.3 $355.5 ====== ====== ====== Claims and claims expense payments ......... $411.1 $403.0 $382.5 Amount attributable to catastrophes ........ 14.2 14.2 17.4 ------ ------ ------ Excluding catastrophes .................. $396.9 $388.8 $365.1 ====== ====== ======
- ---------- (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 fourth 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. 18 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 2000 to be $150 thousand was first reserved in 1991 at $100 thousand, the $50 thousand deficiency (actual claim minus original estimate) would be included in the cumulative deficiency in each of the years 1991 - 1999 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, --------------------------------------------------- 1991 1992 1993 1994 1995 1996 ------ ------ ------ ------ ------ ------ Gross reserves for property and casualty claims and claims expenses............ $331.5 $358.2 $373.5 $389.1 $369.7 $340.4 Deduct: Reinsurance recoverables........ 14.8 17.7 21.6 19.5 23.8 34.1 ------ ------ ------ ------ ------ ------ Net reserves for property and casualty claims and claims expenses............ 316.7 340.5 351.9 369.6 345.9 306.3 Increase in reserves due to purchase of HMPCIC: 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........................ 116.1 117.6 133.4 140.8 139.3 148.6 Two years later....................... 170.0 169.6 190.5 194.5 195.3 202.1 Three years later..................... 197.2 197.8 218.4 224.2 223.0 225.1 Four years later...................... 212.1 213.6 234.1 237.9 233.8 240.2 Five years later...................... 220.5 222.6 241.0 243.1 241.4 245.0 Six years later....................... 224.8 226.0 243.7 247.1 242.8 Seven years later..................... 227.1 227.5 246.1 247.5 Eight years later..................... 227.9 229.0 246.2 Nine years later...................... 229.0 228.9 Ten years later....................... 228.5 Reserves reestimated as of: End of year........................... 316.7 340.5 381.9 369.6 345.9 306.3 One year later........................ 297.3 306.1 327.6 314.0 283.4 261.2 Two years later....................... 272.1 267.7 281.9 269.2 249.6 250.2 Three years later..................... 246.8 246.4 258.1 251.4 245.8 247.8 Four years later...................... 235.2 233.3 249.3 248.9 243.8 257.1 Five years later...................... 232.4 229.8 229.7 247.4 250.9 256.4 Six years later....................... 230.1 230.0 246.6 252.9 250.1 Seven years later..................... 230.1 229.8 250.2 252.6 Eight years later..................... 230.0 231.9 250.2 Nine years later...................... 231.2 232.0 Ten years later....................... 231.1 Reserve redundancy (deficiency) - initial net reserves in excess of (less than) reestimated reserves: Amount(1)........................... $ 85.6 $108.5 $131.7 $117.0 $ 95.8 $ 49.9 Percent............................. 27.0% 31.9% 34.5% 31.7% 27.7% 16.3% Gross reestimated liability - latest..... $258.8 $261.7 $280.8 $283.4 $275.5 $285.9 Reestimated reinsurance recoverables - latest................................ 27.7 29.7 30.6 30.8 25.4 29.5 ------ ------ ------ ------ ------ ------ Net reestimated liability - latest.. $231.1 $232.0 $250.2 $252.6 $250.1 $256.4 Gross cumulative excess (deficiency)(1) $ 72.7 $ 96.5 $123.3 $105.7 $ 94.2 $ 54.5 ====== ====== ====== ====== ====== ====== December 31, ------------------------------------------ 1997 1998 1999 2000 2001 ------ ------ ------ ------ ------ Gross reserves for property and casualty claims and claims expenses............ $310.6 $298.9 $299.8 $298.9 $306.1 Deduct: Reinsurance recoverables........ 41.3 55.9 64.4 49.1 34.1 ------ ------ ------ ------ ------ Net reserves for property and casualty claims and claims expenses............ 269.3 243.0 235.4 249.8 272.0 Increase in reserves due to purchase of HMPCIC: Gross reserves for property and casualty claims and claims expenses................... -- -- -- -- -- Deduct: Reinsurance recoverables...................... -- -- -- -- -- ------ ------ ------ ------ ------ Net reserves for property and casualty claims and claims expenses.......................... -- -- -- -- -- Paid cumulative as of: One year later........................ 142.0 142.5 155.6 155.2 Two years later....................... 191.4 203.2 212.7 Three years later..................... 223.0 233.0 Four years later...................... 236.7 Five years later...................... Six years later....................... Seven years later..................... Eight years later..................... Nine years later...................... Ten years later....................... Reserves reestimated as of: End of year........................... 269.3 243.0 235.4 249.8 272.0 One year later........................ 244.4 238.4 258.1 266.3 Two years later....................... 239.3 261.2 276.9 Three years later..................... 254.9 268.7 Four years later...................... 257.0 Five years later...................... Six years later....................... Seven years later..................... Eight years later..................... Nine years later...................... Ten years later....................... Reserve redundancy (deficiency) - initial net reserves in excess of (less than) reestimated reserves: Amount(1)........................... $ 12.3 $(25.7) $(41.5) $(16.5) Percent............................. 4.6% -10.6% -17.6% -6.6% Gross reestimated liability - latest..... $286.8 $304.1 $309.9 $302.9 Reestimated reinsurance recoverables - latest................................ 29.8 35.4 33.0 36.6 ------ ------ ------ ------ Net reestimated liability - latest....... $257.0 $268.7 $276.9 $266.3 Gross cumulative excess (deficiency)(1).. $ 23.8 $ (5.2) $(10.1) $ (4.0) ====== ====== ====== ======
- ---------- (1) See "Business - Property and Casualty - Property and Casualty Reserves." As the table above illustrates, the Company's net reserves for property and casualty insurance claims and claims expense at the end of 2000 were strengthened in 2001 by $16.5 19 million, while gross reserves were strengthened $4.0 million. The strengthening of net reserves for property and casualty claims and claims expenses in 2001 included a reduction of ceded reserves of approximately $13 million. See "Business -- Property and Casualty -- Property and Casualty Reserves." Property and Casualty Reinsurance All reinsurance is obtained through contracts which generally are renewed each calendar year; however, the catastrophe reinsurance program effective January 1, 2001 and the educator excess professional liability contract effective January 1, 2000, are three year contracts 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, 2001 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 of America. 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 $8.5 million per occurrence up to $80 million per occurrence. In addition, the Company's predominant insurance subsidiary for property and casualty business written in Florida reinsures 90% of hurricane losses in that state above a retention of $11.0 million up to $47.4 million with the Florida Hurricane Fund, based on the Fund's resources. Through December 31, 2001, these catastrophe reinsurance programs were augmented by a $100 million equity put and reinsurance agreement. This equity put provided 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 exceeded the catastrophe reinsurance program coverage limit. Before tax benefits, the equity put provided a source of capital for up to $154 million of catastrophe losses above the reinsurance coverage limit. For liability coverages, in both 2001 and 2002, 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 $250,000 up to $2.5 million in 2001 and 2002. At the time of this Report on Form 10-K, management is in what it believes to be the final stages of negotiating a replacement equity put and reinsurance agreement with a subsidiary of Swiss Reinsurance Company. The Swiss Re Group is rated "A++ (Superior)" by A.M. Best. The terms of the three year agreement are expected to be similar to the prior equity put and reinsurance agreement. Before tax benefits, the proposed equity put coverage of $75 million 20 would provide a source of capital for up to $115 million of catastrophe losses above the reinsurance coverage limit. The Company would also have the option, in place of the equity put, to require the Swiss Re Group member to issue a 10% quota share reinsurance coverage of all of the Company's property and casualty book of business. Fees related to this equity put option, which are charged directly to additional paid-in capital, are estimated to increase to 145 basis points in 2002 from 95 basis points in 2001 under the prior agreement. An additional provision of this agreement would prevent Horace Mann's exercise of the option in the event it's S&P financial strength rating was below "BBB" prior to a triggering event. The Company's S&P financial strength rating was "A+" at December 31, 2001. 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 catastrophe 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 2002 or 2001 exceeds 5%. Property Catastrophe Reinsurance Participants In Excess of 5%
Participation S&P A.M. Best ------------- Rating Rating Reinsurer Parent 2002 2001 - ------ --------- --------- ------ ---- ---- AA A+ AXA Reinsurance Company AXA Group 17% 15% AA A++ Erie Insurance Exchange 14% 14% AA- A Mapfre Reinsurance Corporation Sistema MAPFRE 7% *** AA- A+ St. Paul Fire and Marine Insurance Company The St. Paul Companies, Inc. 6% 6% A A- Lloyd's of London Syndicates* 5% 7% A- A Continental Casualty Company** Loews Corporation *** 7% AAA A++ American Re-insurance Company Muenchener Rueckversicherungs- Gesellschaft AG (Munich Re) of Germany *** 6%
- ---------- * For 2002 and 2001, the participation by Lloyd's of London in the Company's catastrophe reinsurance program is disbursed among 4 and 11 syndicates, respectively. ** Includes 2 percentage points from CNA Reinsurance Company Ltd. of London, England in 2001. *** Less than 5%. For 2002, property catastrophe reinsurers representing 100% of the Company's aggregate reinsured catastrophe coverage were rated "A- (Excellent)" or above by A.M. Best or "A" or above by S&P. Annuity Segment Educators in the Company's target market benefit from the provisions of Section 403(b) of the Internal Revenue Code. This section of the Code allows public school employees and employees of not-for-profit private schools 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 one of the 20 largest participants in the fixed and variable 403(b) tax-qualified annuity market according to information from A.M. Best for 2000. Approximately 60% of the Company's new annuity contract deposits in 2001 were for 403(b) tax-qualified annuities; approximately 75% of accumulated annuity value on deposit is 403(b) tax-qualified. In 2001, annuities represented 27% of the Company's total insurance premiums written and contract deposits and 58% of the Company's operating income. 21 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 32 mutual fund investment options. Prior to 2000, the Company had the fixed account and only seven mutual fund investment options. In both May 2001 and May 2000, the Company introduced two additional variable mutual fund investment options. In September 2000, in time for the Company's important back-to-school selling season, the Company more than tripled the number of choices available to its customers by introducing 21 new investment options in its tax-deferred annuity product line. At the same time in 2000, the Company provided its agents with proprietary asset allocation software that assists educator customers in selecting the best retirement investment options for their individual needs and circumstances. Under the fixed account option, both the principal and a rate of return are guaranteed. The 32 mutual fund options include funds managed by some of the best-known names in the mutual fund industry, such as Fidelity, Strong, J.P. Morgan, Wilshire, T. Rowe Price, Putnam, Neuberger Berman, Alliance Capital, Ranier, Davis, Credit Suisse, and Ariel, offering the Company's customers several investment options, regardless of their personal investment objectives and risk tolerance. Total accumulated fixed and variable annuity cash value on deposit at December 31, 2001 was $2.4 billion. For the year ended December 31, 2001, 93% of the total accumulated cash value of the Company's annuity business remained on deposit, compared to average retention of 77% for stock life insurance companies for 2000, as reported by A.M. Best. All annuities issued since 1982, and approximately 79% 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 43% of accumulated values subject to withdrawal penalties for stock life insurance companies for 2000, 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, minus withdrawal penalties as applicable. 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, 2001 consisted of 58% fixed annuities and 42% variable annuities. The growth of the annuity segment over the last five years has come primarily from the variable annuity product. 22 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, -------------------------------------- 2001 2000 1999 ---------- ---------- ---------- Statement of Operations Data: Contract deposits: Variable .................................................. $ 117.0 $ 121.1 $ 129.2 Fixed ..................................................... 122.1 85.3 76.5 Total .................................................. 239.1 206.4 205.7 Contract charges earned ....................................... 14.9 17.0 16.7 Net investment income ......................................... 107.7 105.4 105.3 Net interest margin (without realized gains) .................. 39.8 39.3 38.1 Net margin (includes fees and contract charges earned) ........ 57.0 59.0 57.6 Operating income before income taxes .......................... 30.7 29.2 41.8 Operating income .............................................. 20.6 19.3 27.3 Operating Statistics: Fixed annuity: Accumulated value ......................................... $ 1,393.7 $ 1,331.8 $ 1,355.6 Accumulated value persistency ............................. 93.4% 88.7% 92.3% Variable annuity: Accumulated value ......................................... $ 1,008.4 $ 1,035.1 $ 1,131.7 Accumulated value persistency ............................. 92.4% 84.1% 88.5% Number of contracts in force .................................. 139,410 128,654 125,352 Average accumulated cash value (in dollars) ................... $ 17,230 $ 18,397 $ 19,843 Average annual deposit by contractholders (in dollars) ........ $ 2,183 $ 2,282 $ 2,327 Annuity contracts terminated due to surrender, death, maturity or other: Number of contracts .................................... 7,222 10,848 8,353 Amount ................................................. $ 186.4 $ 322.0 $ 269.2 Accumulated fixed annuity value grouped by applicable surrender charge: 0% ..................................................... $ 299.1 $ 298.8 $ 315.9 5% and greater but less than 10% ....................... 901.7 852.3 841.4 10% and greater ........................................ 95.0 86.2 108.4 Supplementary contracts with life contingencies not subject to discretionary withdrawal ............. 97.9 94.5 89.9 Total accumulated fixed annuity value ........... $ 1,393.7 $ 1,331.8 $ 1,355.6
Life Segment The Company entered the individual life insurance business in 1949 with traditional term and whole life insurance products. The Company's traditional term, whole life and group life business in force consists of approximately 184,000 policies, representing approximately $7.0 billion of life insurance in force with annual insurance premiums and contract deposits of approximately $40.2 million as of December 31, 2001. 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 who want the features of a whole life policy. The Company does not charge any penalty for withdrawal of life insurance cash values. 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, 2001 the Company had in force approximately 90,000 Experience Life policies representing approximately $6.2 billion of life insurance in force with annual insurance premiums and contract deposits of approximately $69.6 million. In 2000, the Company instituted a program to offer long-term care and variable universal life policies, with two third-party vendors underwriting such insurance and the Company receiving 23 a commission on its sale. In 2001, the life segment represented 14% of the Company's total insurance premiums written and contract deposits, including approximately 1.3 percentage points attributable to the Company's group life and group disability income business, and 53% of the Company's operating income. During 2001, the average face amount of ordinary life insurance policies issued by the Company was $116,895 and the average face amount of all ordinary life insurance policies it had in force at December 31, 2001 was $58,333. The maximum individual life insurance risk retained by the Company is $200,000 on any individual life and $125,000 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, -------------------------------- 2001 2000 1999 -------- -------- -------- Statement of Operations Data: Insurance premiums and contract deposits ............... $ 117.2 $ 121.8 $ 120.4 Insurance premiums and contract charges earned ......... 92.0 91.7 87.3 Net investment income .................................. 55.2 51.2 47.0 Operating income before income taxes ................... 28.9 19.9 22.3 Operating income ....................................... 18.7 12.9 14.6 Operating Statistics: Life insurance in force: Ordinary life ...................................... $ 11,291 $ 10,967 $ 10,749 Group life ......................................... 1,925 1,680 1,551 Total ........................................... 13,216 12,647 12,300 Number of policies in force: Ordinary life ...................................... 193,560 196,361 198,898 Group life ......................................... 80,507 77,221 66,953 Total ........................................... 274,067 273,582 265,851 Average face amount in force (in dollars): Ordinary life ...................................... $ 58,333 $ 55,851 $ 54,520 Group life ......................................... 23,911 21,756 23,166 Total ........................................... 48,222 46,227 46,267 Persistency rate (ordinary life insurance in force) .... 90.9% 91.0% 91.7% Lapse ratio (ordinary life insurance in force) ......... 9.1% 9.0% 8.3% Ordinary life insurance terminated due to death, surrender, lapse or other: Face amount of insurance surrendered or lapsed... $ 944.0 $1,087.6 $ 998.9 Number of policies ........................... 11,865 13,877 13,092 Amount of death claims .......................... $ 30.1 $ 30.1 $ 26.4 Number of death claims ....................... 1,317 1,317 1,326
24 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, 2001, investments in non-investment grade securities represented 5.3% of total investments. At December 31, 2001, fixed income securities represented 96.3% of investments excluding the securities lending collateral. Of the fixed income investment portfolio, 95.4% was investment grade and 99.8% was publicly traded. The average quality of the total fixed income portfolio was A+ at December 31, 2001, and the average option adjusted duration of total investments was 5.0 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, mortgage-backed bonds, other asset-backed bonds, preferred stocks, common stocks, real estate mortgages and real estate. 25 The following table sets forth the carrying and fair values of the Company's investment portfolio as of December 31, 2001: 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 ............... 21.4% $ 635.7 $ 599.9 $ 35.8 $ 621.2 Other .................................... 2.4 71.3 55.6 15.7 68.4 Investment grade corporate and public utility bonds ............................ 46.9 1,395.3 1,201.9 193.4 1,366.8 Municipal bonds ............................. 7.8 232.2 7.6 224.6 224.2 Other mortgage-backed securities ............ 8.4 251.0 198.7 52.3 246.0 Non-investment grade corporate and public utility bonds(2) ......................... 5.3 159.4 117.0 42.4 177.7 Foreign government bonds .................... 0.7 19.5 19.5 -- 17.4 Short-term investments(3) ................... 1.0 30.1 26.0 4.1 30.1 Short-term investments, loaned securities collateral(3) ................. 3.3 98.4 97.9 0.5 98.4 ----- -------- -------- -------- -------- Total publicly traded securities ...... 97.2 2,892.9 2,324.1 568.8 2,850.2 ----- -------- -------- -------- -------- Other Investments: Private placements, investment grade(4) ..... 0.2 5.4 5.3 0.1 5.0 Private placements, non-investment grade(2)(4) -- 0.1 0.1 -- 0.1 Mortgage loans and real estate(5) ........... 0.4 10.6 10.6 -- 10.6 Policy loans and other ...................... 2.2 66.7 65.6 1.1 66.7 ----- -------- -------- -------- -------- Total other investments ............... 2.8 82.8 81.6 1.2 82.4 ----- -------- -------- -------- -------- Total investments(6) .................. 100.0% $2,975.7 $2,405.7 $ 570.0 $2,932.6 ===== ======== ======== ======== ========
- ---------- (1) Includes $183.0 million fair value of investments guaranteed by the full faith and credit of the United States government and $524.0 million fair 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. The rating agencies monitor securities, and their issuers, regularly and make changes to the ratings as necessary. The Company incorporates rating changes on a monthly basis. (3) Short-term investments mature within one year of being acquired and are carried at cost, which approximates fair value. Short-term investments include $36.5 million in asset-backed securities rated "AAA" (S&P or its equivalent), $35.9 million in money market funds rated "AAA", $30.0 million in repurchase agreements rated "AAA", $26.0 million in floating rate notes with 81% rated "AAA" and 19% rated "AA", and $0.1 million in certificates of deposit. The Company loans fixed income securities to third parties, primarily major brokerage firms. The Company separately maintains a minimum of 100% of the value of the loaned securities as collateral for each loan. (4) Fair 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 and real estate acquired in the settlement of debt is carried at the lower of cost or fair value. (6) Approximately 4% of the Company's investment portfolio, having a carrying value of $124.7 million as of December 31, 2001, consisted of securities with some form of credit support, such as insurance. All of these securities have the highest investment grade rating. 26 Fixed Maturity Securities The following table sets forth the composition of the Company's fixed maturity securities portfolio by rating as of December 31, 2001: Rating of Fixed Maturity Securities(1) (Dollars in millions)
Percent of Total Carrying Carrying Amortized Value Value Cost -------- -------- --------- AAA .................................... 36.7% $1,015.6 $ 987.6 AA ..................................... 6.3 175.9 168.0 A ...................................... 20.8 574.9 554.1 BBB .................................... 31.6 876.6 869.5 BB ..................................... 1.5 41.3 46.3 B ...................................... 2.1 57.3 62.0 CCC or lower ........................... 0.8 22.7 34.1 Not rated(2) ........................... 0.2 5.6 5.2 ----- -------- -------- Total ............................... 100.0% $2,769.9 $2,726.8 ===== ======== ========
- ---------- (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 $0.1 million of publicly traded securities not currently rated by S&P, Moody's or the NAIC and $5.5 million of private placement securities not rated by either S&P or Moody's. The NAIC has rated 92.1% of these private placement securities as investment grade. At December 31, 2001, 27.0% 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 29.8% of the total investment portfolio at December 31, 2001. 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 fair value. The net adjustment for unrealized gains and losses on securities available for sale 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. 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 related factors. 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. 27 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 2002 from all of HMEC's insurance subsidiaries without prior regulatory approval is approximately $40 million. Notwithstanding the foregoing, if insurance regulators otherwise determine that payment of a dividend or any other payment to an affiliate would be detrimental to an insurance subsidiary's policyholders or creditors, because of the financial condition of the insurance subsidiary or otherwise, the regulators may block dividends or other payments to affiliates that would otherwise be permitted without prior approval. The insurance subsidiaries' sources of funds consist primarily of premiums and contract fees, investment income and proceeds from sales and redemption of investments. Such funds are applied primarily to payment of claims, insurance operating expenses, income taxes and the purchase of investments, as well as dividends and other payments to HMEC. Competition The Company operates in a highly competitive environment. There are numerous insurance companies that compete with the Company, although management believes that the Company is the largest national multiline insurance company to target the nation's educators as its primary market. In some specific instances and geographic locations competitors have specifically targeted the educator 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, has been among the Company's major tax-qualified annuity competitors. Mutual fund families, independent agent companies and financial planners are also competitors of the Company. Management believes that the significant expansion in 2000 in the number of mutual fund choices available through the Company's tax-deferred annuity product will have a positive impact on both retention and growth of its annuity business. The Company competes with a number of national providers of automobile and homeowners insurance, such as State Farm, Allstate, Farmers 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), GEICO and USAA. 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, internet and telemarketing, compared to the Company. The Company believes that the principal competitive factors in the sale of property 28 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 and IMSA Certification The Company believes that the ratings assigned to its principal insurance subsidiaries by A.M. Best, Standard & Poor's Corporation ("Standard and Poor's" or "S&P"), Fitch, Inc. ("Fitch") and Moody's Investors Service, Inc. ("Moody's"); the ranking assigned to its principal insurance subsidiaries by The Ward's Financial Group ("Ward's"); and the certification of its principal life insurance subsidiary by the Insurance Marketplace Standards Association ("IMSA") contribute to the Company's competitiveness. A.M. Best HMIC, TIC, HMPCIC and HM Lloyds are rated "A+ (Superior)" and HMLIC is rated "A (Excellent)" by A.M. Best. A.M. Best's annual review of each of the subsidiaries' ratings is currently scheduled for April 2002. A.M. Best's 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 balance sheet strength, operating performance and business profile when compared to the quantitative and qualitative 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 balance sheet strength, operating performance and business profile when compared to the quantitative and qualitative standards established by A.M. Best and have a strong ability to meet their ongoing obligations to policyholders. In evaluating a company's balance sheet strength, operating performance and business profile, A.M. Best reviews the company's capitalization/leverage, capital structure/holding company, credit quality and appropriateness of reinsurance program, adequacy of loss/policy reserves, quality and diversification of assets, liquidity, profitability, market risk, revenue composition, management experience and objectives, 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. Standard & Poor's Each of HMEC's principal insurance subsidiaries is rated "A+ (Strong)" for financial strength by Standard & Poor's with a ratings outlook of "Stable", with the exception of HM Lloyds which is not yet rated by Standard & Poor's. As a result of factors impacting the Company's earnings for the three months ended December 31, 2000, Standard & Poor's placed the Company's financial strength ratings on "CreditWatch with negative implications" in January 2001, and in August 2001 downgraded the ratings one notch from "AA-" to "A+" and identified the outlook for the ratings as "Stable". 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 29 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. Insurer Financial Strength Ratings do not refer to an insurer's ability to meet nonpolicy obligations (i.e., debt contracts). The ratings are based on current information furnished by the insurance company or obtained by S&P from other sources it considers reliable. S&P does not perform an audit in connection with any rating and may, on occasion, rely on unaudited financial information. The ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information or based on other circumstances. Financial strength ratings are divided into two broad classifications. An insurer rated "BBB" or higher is regarded as having financial security characteristics that outweigh any vulnerabilities, and is highly likely to have the ability to meet financial commitments. An insurer rated "BB" or lower is regarded as having vulnerable characteristics that may outweigh its strengths. "BB" indicates the least degree of vulnerability within the range; "CC" the highest. Financial strength ratings are assigned at the request of the insurers and based on extensive quantitative and qualitative analysis including consideration of ownership and support factors, if applicable. The rating process includes meetings with insurers' management. Plus (+) and minus (-) signs show relative standing within the major rating categories; 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 characteristics. Insurers rated "A" offer strong financial security characteristics, but are, in S&P's opinion, somewhat more likely to be affected by adverse business conditions than are insurers with higher ratings. CreditWatch highlights the potential direction of a short- or long-term rating. It focuses on identifiable events and short-term trends that cause ratings to be placed under special surveillance by S&P's analytical staff. Ratings appear on CreditWatch when such an event or a deviation from an expected trend occurs and additional information is necessary to evaluate the current rating. A CreditWatch listing, however, does not mean a rating change is inevitable. Fitch Each of HMEC's principal insurance subsidiaries is rated "AA- (Very Strong)" for financial strength by Fitch with a ratings outlook of "Stable". As a result of factors impacting the Company's earnings for the three months ended December 31, 2000, Fitch placed the Company's "AA" financial strength ratings on "Rating Watch Negative" in February 2001, and in April 2001 downgraded the Company's "AA" ratings one notch to "AA-". Fitch reaffirmed the "AA-" rating in August 2001 and identified the outlook for the rating as "Stable". A Fitch Insurer Financial Strength Rating ("IFS Rating") provides an assessment of the financial strength of an insurance organization, and its capacity to meet senior obligations to policyholders and contractholders on a timely basis. The IFS Rating is assigned to the insurance organization itself, and no liabilities or obligations of the insurer are specifically rated unless otherwise stated. The IFS Rating is based on a comprehensive analysis of relevant factors that in large part determine an insurance organization's financial strength, including its regulatory solvency characteristics, liquidity, operating performance, financial flexibility, balance sheet strength, management quality, competitive positioning and long-term business viability. The IFS Ratings use a scale of "AAA" through "D" and may be amended with a (+) or (-) sign to show relative standing within the major rating category. Ratings of "BBB-" and higher are considered to be "Secure", and those of "BB+" and lower are considered to be "Vulnerable". The IFS Rating of "AA" is assigned to insurers that are viewed by Fitch as possessing very strong capacity to 30 meet policyholder and contract obligations. Risk factors are viewed to be modest, and the impact of any adverse business and economic factors is expected to be very small. Placing a company's ratings on "Ratings Watch Negative" reflects the apparent decline in key factors upon which the rating is based. Being placed on watch, however, does not mean a rating change is inevitable. Moody's HMLIC, HMIC, TIC and HMPCIC are rated "A2 (Good)" for financial strength by Moody's. Following the Company's preannouncement of earnings for the three months ended December 31, 2000, Moody's affirmed the Company's ratings. A Moody's Insurance Financial Strength Rating is an opinion of the ability of a company to punctually repay senior policyholder obligations and claims. Specific obligations are considered unrated unless individually rated. Moody's Insurance Financial Strength Ratings are based on qualitative factors of both the industry and the company and quantitative financial analysis. Industry analysis examines trends effecting the industry, the overall economic environment, concentration within the industry, demographics and competitive issues, the impact of financial convergence and consolidation and the accounting and regulatory environments. The analysis of a company's business fundamentals focuses primarily on organizational structure, ownership, corporate governance, strategic issues, quality of management, company franchise, distribution and product characteristics. The financial analysis includes an assessment of capital adequacy, financial leverage, profitability, asset/liability management and liquidity, asset quality, investment risk and business fundamentals. Moody's rating symbols for insurance financial strength ratings are broken down into nine distinct symbols ranging from "Aaa (Exceptional)" to "C (Lowest)". These symbols comprise two distinct groups - those with the greatest financial strength, "Aaa (Exceptional)" to "Baa (Adequate)", and those with the least financial strength, "Ba (Questionable)" to "C (Lowest)". Numeric modifiers are used to refer to the ranking within the group - "1" being the highest and "3" being the lowest. However, the financial strength of companies within a generic rating symbol is broadly the same. Insurance Companies rated "A" offer good financial security. However, elements may be present which suggest a susceptibility to impairment sometime in the future. Ward's As of 2001, Horace Mann is one of only two insurance groups that have been named to The Ward's Financial Group's Top 50 for both its property and casualty and life subsidiaries in each of the last eight years. Identified annually, the Top 50 represent benchmark groups of 50 life insurance companies and 50 property and casualty insurance companies that, over the prior five years, have in Ward's opinion excelled at balancing safety, consistency and performance. The methodology utilized by Ward's to identify the Top 50 is purely quantitative and is not intended to evaluate qualitative issues and/or other issues that may impact, or be of interest to, policyholders and/or agents and risk managers. Specific items evaluated by Ward's include average surplus and premiums, net income, risk-based capital, compound annual growth in premiums, and the five year average returns on average equity, average assets and total revenue. 31 IMSA In July 2001, Horace Mann Life Insurance Company, the Company's principal life insurance subsidiary, earned membership in the Insurance Marketplace Standards Association ("IMSA"). IMSA is an independent, voluntary association created by the life insurance industry to promote high standards of ethical market conduct in advertising, sales and service for individual life, annuity and long-term care products. To earn IMSA certification, HMLIC underwent self- and independent third-party assessments to demonstrate that it has adopted IMSA's principles of ethical behavior. HMLIC is an IMSA member for three years, after which it must demonstrate continuous improvement and repeat the self- and independent assessment process to retain its membership. As of December 31, 2001, fewer than 250 companies had earned IMSA membership. 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 2000, 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 HMPCIC were completed for the period ended December 31, 1997. A routine examination of HMPCIC for the three year period ended December 31, 2000 was initiated in December 2000; audit fieldwork has been completed with the issuance of the final examination report still pending. A routine 32 examination of HM Lloyd's for the two year period ended December 31, 2000 was completed in 2001. HM Lloyd's was formed and commenced business in 1999. Management believes that HMEC and its subsidiaries are in compliance in all material respects with all applicable regulatory requirements. The NAIC has adopted risk-based capital guidelines to evaluate the adequacy of statutory capital and surplus in relation to an insurance company's risks. State insurance regulations prohibit insurance companies from making any public statements or representations with regard to their risk-based capital levels. Based on current guidelines, the risk-based capital statutory requirements will have no negative regulatory impact on the Company's insurance subsidiaries. Assessments Against Insurers Under insurance insolvency or guaranty laws in most states in which the Company operates, insurers doing business therein can be assessed for policyholder losses related to insolvencies of other insurance companies. The amount and timing of any future assessments on the Company under these laws cannot be reasonably estimated and are beyond the control of the Company. Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurer's financial strength, and many 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 $0.6 million, $0.1 million and $0.1 million in connection with insurer insolvency proceedings for the years ended December 31, 2001, 2000 and 1999, respectively, of which $0.1, $0 and $0 million for the same periods, respectively, is recoverable as premium tax credits in future periods. The Company's payments in 2001 included $0.4 million related to the insolvency of the Reliance Insurance Group. A total charge of $1.3 million pretax, representing the Company's estimated portion of the industry assessment for this insolvency, was reflected in the Company's operating expenses for the year ended December 31, 2001. 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 2001, the Company reflected a net loss from participation in such mandatory pools and underwriting associations of $2.5 million before federal income taxes. For additional information on the Company's strategic direction for automobile business in the state of Massachusetts, see also "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Results of Operations -- Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 -- Insurance Premiums and Contract Charges, and -- Net Income." 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. 33 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 Segment -- 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. 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 Company's proprietary mutual funds and also is regulated by the SEC and the National Association of Securities Dealers. Employees At December 31, 2001, the Company had approximately 2,500 employees, including 867 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. The Company also owns buildings with an aggregate of approximately 38,000 square feet at other locations in Springfield. In addition, the Company leases buildings in Springfield with an aggregate of approximately 86,000 square feet. These properties are adequate and suitable for the Company's current and anticipated future needs. 34 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. See also "Note 11 - Contingencies - Lawsuits and Legal Proceedings" contained in the Index to Financial Information on page F-1 herein. ITEM 4. Submission of Matters to a Vote of Security Holders None. PART II ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters HMEC's common stock began trading on the New York Stock Exchange ("NYSE") in November 1991 under the symbol of HMN at a price of $9 per share. The following table sets forth the high and low sales prices of the common stock on the NYSE Composite Tape and the cash dividends paid per share of common stock during the periods indicated.
Market Price ------------------------- Dividend Fiscal Period High Low Paid - ------------- ----------- ----------- ---------- 2001: Fourth Quarter ............. $ 22.40 $ 16.25 $ 0.105 Third Quarter .............. 22.05 15.72 0.105 Second Quarter ............. 21.75 14.80 0.105 First Quarter .............. 21.375 15.25 0.105 2000: Fourth Quarter ............. $ 22.1875 $ 14.0625 $ 0.105 Third Quarter .............. 16.50 12.00 0.105 Second Quarter ............. 18.625 12.625 0.105 First Quarter .............. 21.00 12.625 0.105
As of March 1, 2002, the approximate number of holders of common stock was 5,000. In February 2002, the Company's Board of Directors announced a regular quarterly dividend of $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 8,165,100 shares, 17% of the Company's shares outstanding at December 31, 1996, at an aggregate cost of $203.7 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. However, the Company has not utilized the bank line of credit for share repurchases since the second quarter of 1999. As of December 31, 2001, $96.3 million remained authorized for future share repurchases. However, in 2001 management stated its intention to utilize excess capital to support the Company's strategic growth initiatives. 35 During 2001, options were exercised for the issuance of 207,575 shares, 0.5% of the Company's shares outstanding at December 31, 2000. As an insurance holding company, HMEC depends on dividends and other permitted payments from its insurance subsidiaries to pay cash dividends to shareholders of HMEC. The payment of dividends and such other payments to HMEC by its insurance subsidiaries is restricted by the laws of each subsidiary's state of domicile, and insurance regulators have authority in certain circumstances to block payments of dividends and other amounts by the insurance subsidiaries that would otherwise be permitted without regulatory approval. See "Business -- Cash Flow" and "Business -- Regulation." ITEM 6. Selected Financial Data The information required by Item 301 of Regulation S-K is contained in the table in Item 1--"Business--Selected Historical Consolidated Financial Data." ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required by Item 303 of Regulation S-K is contained in the Index to Financial Information on page F-1 herein. ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk The information required by Item 305 of Regulation S-K is contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in the Index to Financial Information on page F-1 herein. ITEM 8. Consolidated Financial Statements and Supplementary Data The Company's consolidated financial statements, the report of its independent accountants and the selected quarterly financial data required by Item 302 of Regulation S-K are contained in the Index to Financial Information on page F-1 herein. ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III ITEM 10. Directors and Executive Officers of the Registrant The information required by Items 401 and 405 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 2002 Annual Meeting of Shareholders. 36 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 2002 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 2002 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 2002 Annual Meeting of Shareholders. PART IV ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) The following consolidated financial statements of the Company listed below are contained in the Index to Financial Information on Page F-1 herein: Consolidated Balance Sheets as of December 31, 2001, 2000 and 1999. Consolidated Statements of Operations for the Years Ended December 31, 2001, 2000 and 1999. Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2001, 2000 and 1999. Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999. (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. 37 (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. 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. 3.1(e) Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on June 22, 2000, incorporated by reference to Exhibit 3.1(e) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed with the SEC on August 11, 2000. 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. 38 Exhibit No. Description - --- ----------- (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 10.17). (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. 10.1(a) Waiver Relating to Credit Agreement, incorporated by reference to Exhibit 10.1(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001, filed with the SEC on May 14, 2001. 10.1(b) Waiver Relating to Credit Agreement, incorporated by reference to Exhibit 10.1(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, filed with the SEC on November 14, 2001. 10.1(c) Waiver Relating to Credit Agreement, incorporated by reference to Exhibit 10.1(c) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, filed with the SEC on November 14, 2001. 10.1(d) Amendment to Credit Agreement. 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. 39 Exhibit No. Description - --- ----------- 10.4* Horace Mann Educators Corporation Deferred Compensation Plan for Employees, incorporated by reference to Exhibit 10.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1997, filed with the SEC on March 30, 1998. 10.5* Amended and Restated Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.5(a)* Amendment to Amended and Restated Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed with the SEC on August 11, 2000. 10.5(b)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5(a) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.5(c)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5(b) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.6* Horace Mann Educators Corporation 2001 Stock Incentive Plan. 10.6(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan. 10.6(b)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan. 10.7* Severance Agreements between HMEC and certain officers of HMEC. 10.7(a)* Revised Schedule to Severance Agreements between HMEC and certain officers of HMEC. 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. 40 Exhibit No. Description - --- ----------- 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* Employment Agreement entered by and between HMEC and Louis G. Lower II as of December 31, 1999, incorporated by reference to Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.12* Letter of Employment entered by and between HMEC and Peter H. Heckman effective April 10, 2000, incorporated by reference to Exhibit 10.14 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.13* Letter of Employment entered by and between HMEC and Daniel M. Jensen effective September 4, 2001. 10.14* Letter of Employment entered by and between HMEC and Douglas W. Reynolds effective November 12, 2001. 10.15* Letter of Employment entered by and between HMEC and Bret A. Conklin effective January 14, 2002. 10.16* Separation Agreement entered by and between HMEC and Larry K. Becker as of June 20, 2000, incorporated by reference to Exhibit 10.4 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed with the SEC on August 11, 2000. 10.17 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. 10.17(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. 10.17(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. 41 Exhibit No. Description - --- ----------- 10.17(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. (b) No reports on Form 8-K were filed by HMEC during the fourth quarter of 2001. (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. 42 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/ Louis G. Lower II /s/ Joseph J. Melone - ---------------------------------------------- ------------------------------------------------ Louis G. Lower II Joseph J. Melone, Chairman of the President, Board of Directors Chief Executive Officer and a Director /s/ William W. Abbott ------------------------------------------------ William W. Abbott, Director Principal Financial Officer: /s/ Mary H. Futrell ------------------------------------------------ Mary H. Futrell, Director /s/ Peter H. Heckman - ---------------------------------------------- Peter H. Heckman /s/ Donald E. Kiernan Executive Vice President and ------------------------------------------------ Chief Financial Officer Donald E. Kiernan, Director /s/ Jeffrey L. Morby ------------------------------------------------ Jeffrey L. Morby, Director Principal Accounting Officer: /s/ Shaun F. O'Malley ------------------------------------------------ /s/ Bret A. Conklin Shaun F. O'Malley, Director - ---------------------------------------------- Bret A. Conklin Senior Vice President and Controller /s/ Charles A. Parker ------------------------------------------------ Charles A. Parker, Director /s/ William J. Schoen ------------------------------------------------ William J. Schoen, Director
Dated: March 28, 2002 43 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-37 Independent Auditors' Report.......................................... F-38 Consolidated Balance Sheets........................................... F-39 Consolidated Statements of Operations................................. F-40 Consolidated Statements of Changes in Shareholders' Equity............ F-41 Consolidated Statements of Cash Flows................................. F-42 Notes to Consolidated Financial Statements Note 1 - Summary of Significant Accounting Policies............... F-43 Note 2 - Restructuring Charges.................................... F-55 Note 3 - Investments.............................................. F-57 Note 4 - Debt..................................................... F-60 Note 5 - Shareholders' Equity and Stock Options................... F-62 Note 6 - Income Taxes............................................. F-65 Note 7 - Fair Value of Financial Instruments...................... F-67 Note 8 - Statutory Surplus and Subsidiary Dividend Restrictions... F-69 Note 9 - Pension Plans and Other Postretirement Benefits.......... F-70 Note 10 - Reinsurance.............................................. F-75 Note 11 - Contingencies............................................ F-76 Note 12 - Supplementary Data on Cash Flows......................... F-77 Note 13 - Segment Information...................................... F-78 Note 14 - Unaudited Interim Information............................ F-80 Financial Statement Schedules: Schedule I - Summary of Investments-Other than Investments in Related Parties................................. F-82 Schedule II - Condensed Financial Information of Registrant........ F-83 Schedule III and VI Combined - Supplementary Insurance Information and Supplemental Information Concerning Property and Casualty Insurance Operations..................... F-87 Schedule IV - Reinsurance.......................................... F-88 F-1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in millions, except per share data) 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 affecting 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 affecting corporate tax rates or taxable income, and regulations changing the relative tax advantages of the Company's life and annuity products to customers. . The impact of fluctuations in the financial markets on the Company's variable annuity fee revenues, valuations of deferred policy acquisition costs and value of acquired insurance in force, and the level of guaranteed minimum death benefit reserves. . 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. F-2 Critical Accounting Policies The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires the Company's management to make estimates and assumptions based on information available at the time the financial statements are prepared. These estimates and assumptions affect the reported amounts of the Company's assets, liabilities, shareholders' equity and net income. Certain accounting estimates are particularly sensitive because of their significance to the Company's financial statements and because of the possibility that subsequent events and available information may differ markedly from management's judgements at the time the financial statements were prepared. For the Company, the areas most subject to significant management judgements include: reserves for property and casualty claims and claim settlement expenses, reserves for future policy benefits, deferred policy acquisition costs, value of acquired insurance in force and valuation of investments. Additional information regarding the accounting policies for each of these areas is provided within the relevant topics in "Results of Operations -- Year Ended December 31, 2001 Compared to Year Ended December 31, 2000," as well as in the Company's Notes to Consolidated Financial Statements. The Horace Mann Value Proposition The Horace Mann Value Proposition articulates the Company's overarching strategy and business purpose: Provide lifelong financial well-being for educators and their families through personalized service, advice, and a full range of tailored insurance and financial products. In 2000, the Company's management announced steps to focus on the Company's core business and accelerate growth of the Company's revenues and profits. These initiatives are intended to: . Grow and strengthen the agency force and make the Company's agents more productive by improving the products, tools and support the Company provides to them; . Expand the Company's penetration of targeted geographic areas and new segments of the educator market; . Broaden the Company's distribution options to complement and extend the reach of the Company's agency force; . Increase cross-selling and improve retention in the existing book of business; and . Make the Company's products more responsive to customer needs and preferences and expand the Company's product lines within the personal financial services segment. During the fourth quarter of 2000, management began implementing specific plans that address the initiatives above. New compensation and evaluation systems were implemented during 2001 to improve the performance of the Company's agents and agency managers. The Company has begun targeting high-priority geographic markets with dedicated staff teams. New approaches to customer service are being developed and tested that will free agents to spend more time selling. Additional distribution options are being initiated to capitalize fully on the value of the Company's payroll deduction slots in schools across the country. And, the Company will increase its use of technology to improve the efficiency of its agency force and its administrative operations. F-3 September 11, 2001 The September 11, 2001 terrorist attacks on the United States of America did not result in any material claims against the Company from either life or property and casualty insurance policies. The Company has experienced some secondary short-term impacts. In the third quarter of 2001, financial market changes had an adverse impact on variable annuity fees, valuations of deferred policy acquisition costs and value of acquired insurance in force, and the level of a guaranteed minimum death benefit reserve established during the quarter. In the fourth quarter of 2001, improvements in financial market performance offset a portion of the third quarter impact. In addition, in the weeks following the attack, the Company experienced a slowdown in new business volume for life insurance. However, during the same period of time, new business for the Company's other segments reflected an increase, compared to the same period in 2000. The credit quality of the Company's investment portfolio has not been materially impacted by the economic effects of the attack. The Company holds approximately $18 million of fixed maturity securities from five issuers related to the aviation and leisure industries. These securities had a net unrealized loss of approximately $3 million at December 31, 2001. At September 30, 2001, these securities were all investment grade. During the fourth quarter approximately $13 million, or 70%, were downgraded to below investment grade having ratings ranging from BB+ to BBB-, as assigned by Standard & Poor's Corporation, at December 31, 2001. The Company is not immune to future secondary effects of this event such as those generated by additional fluctuations in variable annuity account values and increases in reinsurance costs. Management believes these impacts will be manageable. The cost of the Company's entire property and casualty reinsurance program for 2002 increased approximately 35%, or $2.5 million, compared to 2001. Results of Operations -- Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 Insurance Premiums and Contract Charges Insurance Premiums Written and Contract Deposits
Year Ended Growth Over December 31, Prior Year --------------- ---------------- 2001 2000 Percent Amount ------ ------ ------ ------ Automobile and property (voluntary) ...... $496.6 $473.2 4.9% $ 23.4 Annuity deposits ......................... 239.1 206.4 15.8% 32.7 Life ..................................... 117.2 121.8 -3.8% (4.6) ------ ------ ------ Subtotal - core lines ............... 852.9 801.4 6.4% 51.5 Involuntary and other property & casualty .................... 22.7 20.3 11.8% 2.4 ------ ------ ------ Total ............................... $875.6 $821.7 6.6% $ 53.9 ====== ====== ======
F-4 Insurance Premiums and Contract Charges Earned (Excludes annuity and life contract deposits)
Year Ended Growth Over December 31, Prior Year --------------- --------------- 2001 2000 Percent Amount ------ ------ ------- ------ Automobile and property (voluntary) ...... $485.5 $469.4 3.4% $ 16.1 Annuity .................................. 14.9 17.0 -12.4% (2.1) Life ..................................... 92.0 91.7 0.3% 0.3 ------ ------ ------ Subtotal - core lines ............... 592.4 578.1 2.5% 14.3 Involuntary and other property & casualty .................... 22.8 20.6 10.7% 2.2 ------ ------ ------ Total ............................... $615.2 $598.7 2.8% $ 16.5 ====== ====== ======
Premiums written and contract deposits for the Company's core lines increased 6.4% compared to 2000, driven by double-digit growth in the annuity segment as well as accelerating growth in the property and casualty segment. This comparison includes the North Carolina settlement recorded in 2000 described below. At December 31, 2001, the Company's exclusive agency force totaled 867, an 11.3% decline from a year earlier. The number of experienced agents in the agent force, 553, was down 17.2% at December 31, 2001, compared to a year earlier. The total agent count decreased due primarily to terminations of less-productive agents. As a result, overall agent productivity continued to increase, and for the full year average agent productivity was 37.6% higher than in 2000. The Company has modified its agent compensation and reward structure, in order to provide incentive for agent performance that is more closely aligned with the Company's objectives. Prior to 2001, agent compensation and rewards focused on profitability, customer service and tenure with the Company. The revised structure continues to focus on profitability but also places a greater emphasis on individual agent productivity, new premium growth, growth in educator and cross-sold business, and business retention. In addition, the Company's agency manager compensation structure has been similarly modified, and the agency management team has been strengthened through the promotions of several of its most experienced and capable agents. The number of new agents hired during 2001 was comparable to the prior year, in spite of the Company's implementation of more stringent agent selection criteria to improve agent productivity and retention in the future. The new compensation plan for agency managers became effective January 1, 2001. The new compensation plan for all agents was implemented on August 1, 2001, and there were approximately 800 agents at the time of implementation. Also in 2001, the Company implemented enhanced agent training programs, to help new agents achieve production targets more rapidly and help experienced agents sharpen and strengthen their skills, and began providing agents with additional tools and support programs, to help them make a successful transition to their new role under the Company's Value Proposition. Management believes these actions, along with other strategic initiatives, will continue to have a positive impact on agent productivity in the future. In March 2000, following lengthy negotiations, the North Carolina Rate Bureau and that state's Commissioner of Insurance agreed to settle the outstanding 1994, 1996 and 1999 private passenger automobile insurance rate filing cases resulting in an adverse impact of approximately F-5 $250 million for the insurance industry. Horace Mann's portion of the adverse settlement was $3.0 million pretax, comprised of $2.3 million in premium refunds and $0.7 million in interest charges. North Carolina is the Company's second largest property and casualty state representing approximately 7% of total property and casualty premiums for the year ended December 31, 2001. In December 2001, the North Carolina Commissioner of Insurance (the "Commissioner") ordered a 13% reduction in private passenger automobile insurance premium rates effective in April 2002. The Commissioner's Order was in response to a request from the North Carolina Rate Bureau (the "Bureau"), which represents the insurance industry, to increase private passenger automobile insurance rates by 5%. The Bureau has voted to appeal the Commissioner's Order in the state appellate court and raise rates while the case is being heard. The difference between the rates ordered by the Commissioner and the Bureau would have an adverse impact of approximately $350 million for the insurance industry. The Company's earned premiums would be negatively impacted by approximately $2 million and $3 million in 2002 and 2003, respectively. In addition, the difference in rates between the Commissioner and the Bureau must be held in an escrow account pending the court's decision. If the court should rule in favor of the Bureau, the insurers will be entitled to the funds previously escrowed. If the court should rule in favor of the Commissioner, the escrowed funds plus interest will be refunded to the policyholders. Total voluntary automobile and homeowners premium written growth was 4.9% for 2001, including the effect of the North Carolina settlement in the prior year. The average premium per policy and the number of policies in force increased for both automobile and homeowners insurance, compared to a year earlier. Voluntary automobile insurance premium written increased 3.8% ($13.5 million) compared to 2000 and homeowners premium increased 8.5% ($9.9 million). The property and casualty increase in premiums written resulted from growth in average premium per policy of 3% for automobile and 8% for homeowners, compared to a year earlier, as the impact of rate actions began to flow through policy renewals and new business. Over the prior 12 months, unit growth was 1.4%, or 12,000, with an 8,000 unit increase in automobile and a 4,000 unit increase in homeowners. At December 31, 2001, there were 596,000 voluntary automobile and 292,000 homeowners policies in force for a total of 888,000. Based on policies in force, the property and casualty 12-month retention rate for new and renewal policies was 88%, equal to the 12 months ended December 31, 2000 despite implemented rate increases over the period. The Company plans additional rate increases in 2002 and beyond, with primary emphasis on the homeowners line, which are expected to have an adverse impact on retention of homeowners policies in force. The Company's plans to implement tiered rating systems based on customers' credit ratings for automobile and homeowners business remain on track, which management expects will have a positive impact on both loss ratios and business growth in the educator market. Tiered rating, together with price increases implemented and planned, are expected to return the Company to rate adequacy, with average premium growth keeping pace with average loss experience over time. For 2002, the Company is targeting combined ratios of approximately 96% for voluntary automobile and 108% for homeowners, as a result of the impact of rate actions coupled with other initiatives described under "Results of Operations -- Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 -- Benefits, Claims and Settlement Expenses." Growth in premiums written for involuntary and other property and casualty was primarily attributable to an atypical recovery from a state mandatory automobile insurance facility received in 2001. In February 2002, the Company announced that it obtained a five-year extension of its F-6 contract with the National Education Association to be the exclusive provider of professional liability coverage to its members through August 2007. Premiums from this product are included in the involuntary and other property and casualty category. In October 2001, the Company reached conclusion on its strategic direction for automobile business in the state of Massachusetts. Horace Mann has formed a marketing alliance with The Commerce Group, Inc. ("Commerce") and through this alliance, by January 1, 2002, Horace Mann began providing its Massachusetts customers with Commerce automobile insurance policies, while continuing to write other Horace Mann products, including property and life insurance and retirement annuities. Horace Mann ceased writing automobile insurance policies in Massachusetts on December 31, 2001. For the full year 2001, premiums written in Massachusetts for voluntary automobile business were $18.9 million and for involuntary residual market business were $7.8 million. In 2002, premiums written for this business will be reduced to zero, and premiums earned will be reduced significantly, reflecting run-off of the policies in force at December 31, 2001. For the full year 2001, claims and settlement expenses in Massachusetts for voluntary automobile business were $9.1 million and for involuntary residual market business were $11.5 million. Claims and settlement expenses in 2002 will reflect run-off of the business and a decline in exposure to loss, as the policies written as the Company's risk expire. Management anticipates that this transaction will have a positive impact on operating income of approximately $0.10 per share in 2003 and beyond. The improvement in 2002 earnings will be somewhat less reflecting the run-off of policies in force. The Company plans to utilize the benefits of this transaction to invest in its marketing, customer service and technology infrastructures. Growth in annuity contract deposits reached double-digit levels for the year ended December 31, 2001. In September 2000, the Company more than tripled the number of choices available to its customers by introducing 21 new investment options in its tax-deferred annuity product line. At the same time, the Company provided its agents with proprietary asset allocation software that helps agents assist educator customers in selecting the best retirement investment programs for their individual needs and circumstances. The fourth quarter of 2000 was the first full quarter with the expanded investment options. New annuity contract deposits of $64.2 million for the three months ended December 31, 2001, increased 7.0%, compared to contract deposits of $60.0 million for the same period in 2000. Compared to the full year 2000, new annuity deposits increased 15.8%, reflecting a 45.8% increase in new single premium and rollover deposits and a 3.8% increase in scheduled deposits received. New deposits to variable annuities decreased 3.4%, or $4.1 million, and new deposits to fixed annuities were 43.1% higher than in 2000. The Company offers a dollar cost averaging program for amounts systematically transferred from the fixed annuity option to the variable mutual fund investment options over a 12-month period. Variable annuity accumulated funds on deposit at December 31, 2001 were $1.0 billion, $26.7 million less than a year earlier, a 2.6% decrease including the impact of a decline in financial market values. Variable annuity accumulated deposit retention improved 8.3 percentage points over the 12 months to 92.4%, reflecting improvement following the Company's expansion of variable investment options and implementation of proprietary asset allocation software. Fixed annuity cash value retention for the 12 months ended December 31, 2001 was 93.4%, 4.7 percentage points better than in 2000. Fixed annuity accumulated cash value was $1.4 billion at December 31, 2001, $61.9 million, or 4.6%, more than a year earlier. The number of annuity contracts outstanding increased 7.8%, or 10,000 contracts, compared to December 31, 2000. F-7 In 2000, the Company took actions to increase the variable annuity options available to customers, as described above, and also took steps to improve the returns of its proprietary mutual funds. For the twelve months ended December 31, 2001, the amount of variable annuity surrenders was 54% lower than for the same period last year. The amount of fixed annuity surrenders decreased 41% compared to 2000. In January 2002, the Company announced that it has been selected as one of four providers of fixed and variable annuities to Chicago, Illinois, public school employees. Beginning in April 2002, the Company will partner with an independent broker/dealer, which has been providing retirement planning services to Chicago Public School employees for more than two decades, to pursue this opportunity to bolster business growth in the annuity segment. The Chicago Public Schools is the third-largest school district in the United States of America. For the twelve months ended December 31, 2001, annuity segment contract charges earned decreased 12.4%, or $2.1 million, compared to the twelve months of 2000. Improvements in retention of variable and fixed accumulated values, as described above, resulted in a decline in surrender fees earned. Also, declines in average market values reduced the Company's variable annuity fee revenues. Life segment premiums and contract deposits for the twelve months of 2001 were 3.8% lower than a year earlier, primarily reflecting a decline in disability income business. In 2001, the Company began ceding a larger portion of its disability income business as part of the group restructuring announced in the fourth quarter of 2000. Excluding the disability product from both years' results, life segment premiums written and contract deposits would be comparable to the twelve months ended December 31, 2000. The life insurance in force lapse ratio was 9.1% for the twelve months ended December 31, 2001, compared to 9.0% for the prior year. Net Investment Income Investment income of $199.3 million for 2001 increased 3.6%, or $6.9 million, (3.4% after tax) compared to the prior year due primarily to growth in the size of the investment portfolio. Average investments (excluding the securities lending collateral) increased 2.5% over the past 12 months. The average pretax yield on the investment portfolio was 7.2% (4.8% after tax) for 2001, compared to a pretax yield of 7.1% (4.8% after tax) for the prior year. Realized Investment Gains and Losses Net realized investment losses were $10.0 million for the year ended December 31, 2001, compared to net realized investment losses of $9.9 million for 2000. In the fourth quarter of 2001, the Company sold all of its holdings in securities issued by Enron Corporation and its affiliates, which resulted in a realized investment loss of $7.8 million. The remaining $2.2 million of net realized losses in 2001 primarily resulted from the sale, for credit reasons, of nine fixed income securities and the impairment of fixed income securities issued by three telecommunications companies, which were only partially offset by the first quarter full repayment of an impaired commercial mortgage loan and the release of a related reserve for uncollectible mortgages. For 2000, nearly all of the net realized gains and losses occurred in the fixed income portfolios with $8.8 million of the realized losses due to credit-related sales and impairments and the remainder resulting from normal portfolio management activity. F-8 The Company reviews the fair value of the investment portfolio on a monthly basis to determine if there are any securities that have fallen below 80% of book value. This review, in conjunction with the Company's investment managers' monthly credit reports and current market data, is the basis for determining if a security has suffered an other-than-temporary decline in value. A write-down is recorded when such decline in value is deemed to be other-than-temporary, with the realized investment loss reflected in the Statement of Operations for the period. Benefits, Claims and Settlement Expenses
Year Ended Growth Over December 31, Prior Year ---------------- ------------------ 2001 2000 Percent Amount ------ ------ ------- ------- Property and casualty ..................... $433.3 $417.4 3.8% $ 15.9 Annuity ................................... (0.8) 1.6 (2.4) Life ...................................... 41.1 47.0 -12.6% (5.9) Corporate & other ......................... 2.0 -- 2.0 ------ ------ ------ Total ................................... $475.6 $466.0 2.1% $ 9.6 ====== ====== ====== Property and casualty statutory loss ratio: Before catastrophe losses ............ 83.0% 81.9% 1.1% After catastrophe losses ............. 85.2% 85.2% --
In 2001, the Company's benefits, claims and settlement expenses were affected adversely by strengthening of prior years' reserves for property and casualty claims and by a higher level of non-catastrophe weather-related losses than the prior year. In 2000, the Company's results were also adversely affected by strengthening of prior years' property and casualty reserves. Underwriting results of the property and casualty segment are significantly influenced by estimates of the Company's ultimate liability for insured events. Reserves for property and casualty claims include provisions for payments to be made on reported claims, claims incurred but not yet reported and associated settlement expenses. The process by which these reserves are established requires reliance upon estimates based on known facts and on interpretations of circumstances, including the Company's experience with similar cases and historical trends involving claim 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. 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. Net strengthening of reserves for property and casualty claims occurring in prior years, excluding involuntary business, was $14.5 million for the full year, compared to $20.9 million in 2000. Total reserves for property and casualty claims occurring in prior years, including involuntary business, were strengthened $16.5 million in 2001, compared to $22.7 million a year earlier. F-9 During the first half of 2001, the Company continued to refine its process and methods for evaluating property and casualty reserves and selected a new independent property and casualty actuarial consulting firm. During the second quarter of 2001, a comprehensive review of property and casualty loss reserving methodologies and assumptions was completed in conjunction with the new actuarial firm. Based on management's review of this further enhanced analysis and the opinion of the new actuarial firm, prior years' net reserves - predominantly related to 1999 and prior accident years - were increased by $11 million at June 30, 2001. This consisted primarily of an $8 million reduction in reserves to be ceded by the Company to its reinsurers and reinsurance facilities, including $1.5 million related to the Company's automobile residual market business, primarily in Massachusetts; $2.0 million for its voluntary automobile ceded excess liability coverage; and approximately $4.5 million related to its educators excess professional liability product. At December 31, 2001, the Company increased reserves for property and casualty claims occurring in prior years by an additional $5 million. Ceded and assumed reserves were strengthened by $6.4 million, primarily as a result of an updated review of subrogation recovery activity on business ceded to the state automobile insurance facility in Massachusetts. That strengthening was partially offset by $1.7 million of favorable development of reserves on the Company's direct automobile business. The Company's property and casualty net reserves were $272 million and $250 million at December 31, 2001 and 2000, respectively. In October 2001, the Company reached conclusion on its strategic direction for automobile business in the state of Massachusetts. For further discussion, see "Results of Operations -- Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 -- Insurance Premiums and Contract Deposits, and -- Net Income." In 2001, the higher level of non-catastrophe property losses included claims attributable to severe weather experienced in many areas of the country, including non-catastrophe claims related to Tropical Storm Allison and wind and hail storms throughout the Midwest during the second quarter (with additional development related to these events recorded in the third quarter) as well as winter storms in the first quarter. In the fourth quarter of 2001, the Company experienced higher levels of both fire and non-catastrophe weather-related losses. Non-catastrophe weather-related losses in the fourth quarters of 2001 and 2000 were notably greater than historical experience. The non-catastrophe property loss ratio by quarter and for the full years 2001, 2000 and 1999 was as follows:
2001 2000 1999 ---- ---- ---- Non-catastrophe property loss ratio for the: Quarter ended March 31 .................. 85.1% 79.0% 81.9% Quarter ended June 30 ................... 99.4% 91.4% 72.8% Quarter ended September 30 .............. 99.7% 82.8% 78.1% Quarter ended December 31 ............... 82.8% 80.7% 53.3% Year ended December 31 .................. 91.5% 83.4% 71.0%
After determining that the increase in non-catastrophe property losses experienced in the early months of 2000 was due to underlying loss trends, rather than the normal cyclicality of the property business, management began and has continued to implement pricing, underwriting and F-10 loss control initiatives. Although the Company's actions have begun to have a positive impact, with minimal effect on policy retention through 2001, management expects that the full impact of these changes will not be realized until 2002 and beyond. In light of experience and competitive actions in 2001, future rate increases are anticipated to be more aggressive than the Company's original plans. The Company has also initiated further tightening of underwriting guidelines, expanded reunderwriting of existing policies, coverage and policy form restrictions in all states where permitted, and limited coverage of new homeowners business to educators in certain areas. In addition, due to the claims experience in the fourth quarter of 2001, the Company has initiated a significant reinspection program of its property book of business. The Company also is strengthening its homeowners policies' contract language to further protect the Company against water damage and mold claims. The Company has also begun the process of redesigning its claim handling procedures in order to better control loss costs. Management anticipates that these actions will enable the Company to improve the profitability of its existing book of homeowners business and attract new business that meets its profitability standards. For 2001, incurred catastrophe losses for all lines were $11.2 million including a net benefit of $1.1 million due to favorable development of reserves for 2000 catastrophe losses. Incurred catastrophe losses were $16.2 million in 2000. The voluntary automobile loss ratio excluding catastrophe losses was 77.6% for full year 2001, compared to 80.9% in 2000. Strengthening of prior years' reserves increased the voluntary automobile loss ratio by 2.0 and 5.4 percentage points in 2001 and 2000, respectively. The voluntary automobile loss ratio, excluding both catastrophe losses and prior years' reserve strengthening, was 75.6% in 2001, consistent with the prior year's results. The increase in average voluntary automobile premium per policy in 2001 nearly kept pace with the increase in average current accident year loss costs, due to a favorable result in the fourth quarter of 2001 wherein the growth in premiums exceeded the growth in loss costs. The annuity benefits of $(0.8) million recorded in 2001 were comprised of three components. They were: 1) a release of reserves for certain supplementary contracts recorded in the third quarter of 2001, 2) a guaranteed minimum death benefit reserve on variable annuity contracts established in the third quarter of 2001, and 3) current period mortality experience on annuity contracts in payout status. Annuity benefits were $1.6 million in 2000, including $1.3 million attributable to mortality experience on annuity contracts on payout status resulting from the application of a more refined reserving model. The primary component of the decrease in benefits for the life segment was a $2.6 million reduction in reserves recorded in 2001 related to policy coverages that are no longer in force. In addition, life segment benefits in 2001 reflected ceding of a larger portion of the Company's disability income business as part of the group restructuring announced in the fourth quarter of 2000. Life mortality experience in 2001 was slightly better than a year earlier. Liabilities for future benefits on life and annuity policies are established in amounts adequate to meet the estimated future obligations on policies in force. Liabilities for future policy benefits on certain life insurance policies are computed using the net level premium method and are based on assumptions as to future investment yield, mortality and withdrawals. Mortality and withdrawal assumptions for all policies have been based on 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. In the event actual experience F-11 varies from the estimated liabilities, adjustments are charged or credited to income for the period in which the adjustments are made. Early in 2001, management discovered some deficiencies in the tax compliance testing procedures associated with certain of the Company's life insurance policies that could jeopardize the tax status of some of those life policies. Deficiencies in the Company's computer-based monitoring of premiums, combined with the complexity of certain of the Company's life insurance products, resulted in the acceptance of too much premium for certain policies under the applicable tax test the Company was using. As a result of this discovery, the Company retained outside experts to assist with the investigation and remedy of this issue. The deficiencies in the testing procedures have been identified and corrected. The Company is still in the process of quantifying the financial impact of these errors, as well as finalizing the strategy for remedying the problems caused by them. Such a problem is not uncommon in the life insurance industry and will be cured using standard Internal Revenue Service ("IRS") procedures that have been established specifically to address this type of situation. The $2.0 million of policyholder benefits recorded in the Corporate and Other segment in 2001, as well as $1.0 million of operating expense, represent the Company's current best estimate of the costs to the Company to resolve these problems. Management anticipates that the strategy for dealing with this issue, as well as the cost amount, will be finalized in the second quarter of 2002. As a result of the tax status issue described above, the complexity of the Company's product underlying the policies in question, and the complexity of administering that product and other life products offered by the Company, management is re-examining the life product portfolio and related administrative efficiencies. Interest Credited to Policyholders
Year Ended Growth Over December 31, Prior Year ------------- ----------------- 2001 2000 Percent Amount ----- ----- ------- ------ Annuity ................................... $67.9 $66.1 2.7% $ 1.8 Life ...................................... 28.6 26.5 7.9% 2.1 ----- ----- ----- Total ................................... $96.5 $92.6 4.2% $ 3.9 ===== ===== =====
The fixed annuity average annual interest rate credited increased to 5.1% for the year ended December 31, 2001, compared to 5.0% for the prior year. In addition, the average accumulated fixed deposits increased 1.4% for the year ended December 31, 2001, compared to 2000. Life insurance interest credited increased as a result of continued growth in the interest-sensitive life insurance reserves. Operating Expenses Although operating expenses for the current year included increased costs to support business growth initiatives, for 2001, operating expenses decreased $4.2 million, or 3.3%, compared to a year earlier, primarily as a result of two items. First, expenses in 2000 included non-recurring charges of $0.7 million for interest on the North Carolina settlement and $3.6 million attributable to the chief executive officer transition. Second, in the fourth quarter of 2000 the Company wrote off $1.0 million book value of personal computers not compatible with the Company's software upgrade and $2.5 million of previously capitalized software costs. Operating F-12 expenses in 2001 included $1.3 million representing the Company's estimated portion of the industry assessment related to the insolvency of the Reliance Insurance Group. The total corporate expense ratio on a statutory accounting basis was 23.3% for the year ended December 31, 2001, 0.9 percentage points less than 2000. The property and casualty expense ratio, the 16th lowest of the 100 largest property and casualty insurance groups for 2000 (the most recent industry ranking available), was 21.6% for the year ended December 31, 2001, compared to 20.8% for the prior year. Effective April 1, 2002, current participants in the Company's defined benefit and supplemental defined benefit retirement plans will stop accruing any new benefits under these plans, but will continue to retain the benefits they have accrued to date. The settlement costs for the defined benefit plans are based upon assumptions of future events. Defined benefit plan settlement costs are anticipated to increase by approximately $3 million in 2002 due to an increase in the number of expected retirements. To the extent that actual experience differs from those assumptions, adjustments may be required with the effects of these adjustments charged or credited to income for the period in which the adjustments are made. Amortization of Policy Acquisition Expenses and Intangible Assets For 2001, the combined amortization of policy acquisition expenses and intangible assets was $63.8 million, compared to the $64.8 million recorded in 2000. Amortization of intangible assets decreased to $5.8 million for the year ended December 31, 2001, compared to $8.8 million for the same period in 2000. The decline reflected the lower level of amortization of the value of annuity business acquired in the 1989 acquisition of the Company ("Annuity VIF") comprised of the scheduled decrease in amortization reported in the Company's Form 10-K for the year ended December 31, 2000 and the favorable impact of improved persistency on the valuation of Annuity VIF. Amortization of intangible assets includes goodwill amortization of $1.6 million in both 2001 and 2000. As further described in "Recent Accounting Changes," Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," eliminates the amortization of goodwill for fiscal years beginning after December 15, 2001. Policy acquisition expenses amortized for the year ended December 31, 2001 of $58.0 million were $2.0 million more than the prior year primarily from the property and casualty segment. Over the past 12 months, this segment has experienced accelerated growth in business and the acquisition cost amortization period matches the terms of the insurance policies (six and twelve months). Policy acquisition costs, consisting of commissions, premium taxes and other costs, which vary with and are primarily related to the production of business are capitalized and amortized on a basis consistent with the type of insurance coverage. For investment (annuity) contracts, acquisition costs, and also the Annuity VIF, are amortized over 20 years in proportion to estimated future gross profits. Capitalized acquisition costs for interest-sensitive life contracts are also amortized over 20 years in proportion to estimated future gross profits. The most significant assumptions that are involved in the estimation of future gross profits include future market performance and business surrender/lapse rates. In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company may be F-13 required to record a material charge or credit to amortization expense for the period in which the adjustment is made. Income Tax Expense Excluding the benefits in both 2001 and 2000 related to the Company's dispute with the Internal Revenue Service ("IRS") regarding tax years 1994 through 1997, the effective income tax rate on income including realized investment gains and losses was 14.1% for the year ended December 31, 2001, compared to -24.7% for 2000. In 2001, the Company's tax provision was reduced by $3.0 million reflecting the release of excess tax provision previously recorded and representing a 10.7 percentage point reduction in the effective income tax rate. Interest of $2.1 million on refunds from the IRS for federal tax years 1994 and 1995 reduced the 2000 effective income tax rate 22.1 percentage points. The refunds resulted from issues separate from the Company's dispute with the IRS regarding tax years 1994 through 1997. Income from investments in tax-advantaged securities reduced the effective income tax rate 13.4 and 45.1 percentage points for the years ended December 31, 2001 and 2000, respectively. While the amount of income from investments in tax-advantaged securities in the current year was comparable to 2000, the reduced level of income before income taxes in 2000 resulted in this having a more significant impact on the effective income tax rate. 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. 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 (1994 through 1997). In the third and fourth quarters of 2000, the 1994 through 1996 exposure was resolved for an amount that was $8.7 million less than was previously accrued and that amount was included in net income for the year ended December 31, 2000. In the third quarter of 2001, the Company's liability for the 1997 tax year was resolved, resulting in a release of $1.3 million that had previously been accrued for that tax year. That amount was included in net income for the year ended December 31, 2001. The benefits of these dispute resolutions were excluded from the determination of reported operating income. Operating Income For the year ended December 31, 2001, operating income (net income before the after-tax impact of realized investment gains and losses, restructuring charges and adjustment to the provision for prior years' taxes) was adversely affected primarily by strengthening of prior years' property and casualty claim reserves and by a higher level of losses from severe weather than the prior year. Based on the Company's full year 2001 earnings and generally positive underlying trends, at the time of this Report on Form 10-K management anticipates that 2002 full year operating income will be within a range of $1.15 to $1.25 per share. As described throughout this discussion of Results of Operations, certain of the Company's significant accounting measurements require the use of estimates and assumptions. As additional information becomes available, adjustments may be required. Those adjustments are charged or credited to income for the period in which the adjustments are made. F-14 In addition to strengthening of prior years' property and casualty claim reserves and adverse homeowners loss experience, the Company's 2001 operating income reflected the following items: . An after-tax charge of $2.7 million, representing the Company's current best estimate of the costs required to remedy problems with the life insurance tax status of certain of its life policies; . An after-tax charge of $0.9 million reflecting the Company's portion of industry assessments related to the insolvency of the Reliance Insurance Group; . A $3.0 million reduction of the Company's tax provision reflecting the release of excess tax provision previously recorded; . A $1.7 million after-tax reduction in life insurance reserves related to policy coverages that are no longer in force; and . A $0.8 million after-tax reduction in reserves for supplementary contracts. Operating income by segment was as follows:
Year Ended Growth Over December 31, Prior Year --------------- ---------------- 2001 2000 Percent Amount ------ ------ ------- ------ Property & casualty Before catastrophe losses ................... $ 12.5 $ 19.4 -35.6% $(6.9) Catastrophe losses, after tax ............... (7.3) (10.5) 3.2 ------ ------ ----- Total including catastrophe losses ..... 5.2 8.9 -41.6% (3.7) Annuity ....................................... 20.6 19.3 6.7% 1.3 Life .......................................... 18.7 12.9 45.0% 5.8 Corporate and other expense ................... (3.0) (9.4) 6.4 Interest expense, after tax ................... (5.9) (6.6) 0.7 ------ ------ ----- Total .................................. $ 35.6 $ 25.1 41.8% $10.5 ====== ====== ===== Total before catastrophe losses ........ $ 42.9 $ 35.6 20.5% $ 7.3 ====== ====== ===== Property and casualty statutory combined ratio: Before catastrophe losses ................ 104.6% 102.7% 1.9% After catastrophe losses ................. 106.8% 106.0% 0.8%
Property and casualty segment operating income was lower than in 2000 due primarily to adverse experience on homeowners business. During 2001, the Company's increase in average voluntary automobile insurance premium per policy nearly kept pace with the increase in average loss costs for the current accident year. The Company's plans to implement tiered rating systems based on customers' credit ratings for automobile and homeowners business remain on track, which management expects will have a positive impact on both loss ratios and business growth for these products in the Company's target market. The Company is continuing to approach the pricing and underwriting of its homeowners products aggressively, to accelerate margin recovery. And, due to homeowners loss experience in the fourth quarter of 2001, the Company has identified additional initiatives. Actions include further tightening of underwriting guidelines, expanded reunderwriting of existing policies, coverage and policy form restrictions in all states where permitted, limited coverage of new homeowners business to educators in certain areas, reinspection of the homeowners book of business and redesign of the Company's claim handling procedures. An adverse industry settlement of outstanding automobile insurance rate filing cases F-15 for 1994, 1996 and 1999 in North Carolina, including interest, reduced the Company's property and casualty segment operating income by $1.9 million after tax in 2000. The property and casualty combined ratio before catastrophes of 104.6% was 1.9 percentage points higher than 2000, reflecting the factors cited above. Catastrophe losses in 2001 were $7.3 million after tax, including a net benefit of $0.7 million after tax due to favorable development of reserves for 2000 catastrophe losses. Incurred catastrophe losses were $10.5 million after tax in 2000. Increases in reserves for property and casualty claims occurring in prior years, excluding involuntary business, were $9.4 million after tax in 2001, compared to $13.6 million after tax in 2000. In 2001, reserves were increased $10.7 million after tax, including involuntary business, for property and casualty claims occurring in prior years, compared to an increase of $14.8 million after tax in 2000 representing a decrease of approximately 1.4 percentage points in the combined ratio including catastrophes. Annuity segment operating income in 2001 reflected reduced fee income related to decreases in both variable annuity market values and surrender charges for fixed and variable annuities. In addition, operating expenses increased in 2001, reflecting the growth in annuity business volume. For 2001, the net interest margin was slightly more than the prior year while fees and contract charges earned decreased 12.4%. These factors were offset by (i) the favorable impact of financial market performance on valuations of deferred policy acquisition costs and valuation of business acquired and (ii) the release of reserves for certain annuity contracts on payout status. In 2000, annuity segment operating income was reduced by $1.0 million due to mortality experience on annuity contracts on payout status primarily as a result of application of a more accurate reserving model. Variable annuity accumulated deposits were $1.0 billion at December 31, 2001, $26.7 million, or 2.6%, less than 12 months earlier. Fixed annuity accumulated cash value of $1.4 billion was $61.9 million, or 4.6%, greater than December 31, 2000. Life insurance earnings increased compared to 2000 due primarily to better than expected mortality and group disability results, as well as the $1.7 million reserve reduction recorded in 2001. In 2001, the Corporate and Other Expense category in the preceding table reflected (i) an after-tax charge of $2.7 million related to problems with the life insurance tax status of certain of the Company's life policies and also (ii) a $3.0 million reduction of the Company's tax provision reflecting the release of excess tax provision previously recorded. In 2000, the Corporate and Other Expense category reflected higher holding company expenses, including charges related to the chief executive officer transition. F-16 Net Income Net Income Per Share, Diluted
Year Ended Growth Over December 31, Prior Year ------------- ---------------- 2001 2000 Percent Amount ----- ---- ------- ------ Operating income ........................... $0.87 $0.61 42.6% $0.26 Realized investment losses ................. (0.15) (0.15) -- -- Restructuring charges ...................... (0.12) (0.04) (0.08) Litigation charges ......................... -- (0.12) 0.12 Adjustment to the provision for prior years' taxes ................... 0.03 0.21 (0.18) ----- ----- ----- Net income ............................ $0.63 $0.51 23.5% $0.12 ===== ===== =====
Net income, which includes realized investment gains and losses, restructuring charges, litigation charges and adjustments to the provision for prior years' taxes, for the year ended December 31, 2001 increased by $4.8 million, or 23.1%, and net income per diluted share increased by 23.5% compared to 2000. This change included the $10.5 million increase in operating income. After-tax realized investment losses were comparable for the two periods. As discussed above in "Income Tax Expense", net income reflected resolution of federal income tax exposures which increased net income by $1.3 million and $8.7 million for the years ended December 31, 2001 and 2000, respectively. In addition, net income in 2000 reflected an after-tax charge of $5.0 million due to litigation regarding the Company's disability insurance product. The Company recorded restructuring charges in both 2001 and 2000. As described in "Insurance Premiums and Contract Charges," in 2001 the Company reached conclusion on its strategic direction for automobile business in the state of Massachusetts. On December 31, 2001, Horace Mann ceased writing automobile business in that state. On October 18, 2001 the Company paid $6.4 million to the Commonwealth Automobile Reinsurers ("C.A.R.") as full payment of its proportionate liability to C.A.R. for policy years 2002 and beyond. That payment and other related expenses of approximately $1 million resulted in an after-tax charge of $4.7 million, or $0.12 per share, reflected as a non-operating income restructuring charge. All of the restructuring charges incurred in 2001 related to Massachusetts automobile business were paid by December 31, 2001. In 2000, the Company recorded an after-tax charge of $1.5 million, or $0.04 per share, as a result of the restructuring of the Company's group insurance business and its credit union marketing group. Restructuring charges have been separately identified in the Statements of Operations for the years ended December 31, 2001 and 2000. Return on shareholders' equity was 8% based on operating income and 6% based on net income for the 12 months ended December 31, 2001. Status of Litigation Regarding Disability Insurance In December 2000, the Company recorded an after-tax charge of $5.0 million, representing the Company's best estimate of the actual and anticipated costs of defending and ultimately resolving litigation brought against the Company in regards to its disability insurance product. The lawsuit is a class action on behalf of certain policyholders who purchased the Company's disability insurance product and allege that they were not adequately made aware of certain features. In F-17 July 2001, the Company submitted a settlement agreement to the court which was mutually agreed upon by all parties to this lawsuit. The settlement, which provides additional benefits for current policyholders and compensation to those who demonstrate they did not understand what they purchased, was approved by the court on October 31, 2001. The settlement was finalized on November 30, 2001 and is being administered. While the actual costs incurred by the Company to resolve this litigation could be either less or more than the liability established in 2000, management believes that, based on facts and circumstances available at this time and on the settlement agreement approved by the court in October 2001, the amount recorded will be adequate to resolve the matter. Disability insurance represented less than 1% of the Company's insurance premiums written and contract deposits for the years ended December 31, 2001 and 2000. Results of Operations -- Year Ended December 31, 2000 Compared To Year Ended December 31, 1999 Insurance Premiums and Contract Charges Insurance Premiums Written and Contract Deposits
Year Ended Growth Over December 31, Prior Year --------------- ---------------- 2000 1999 Percent Amount ------ ------ ------- ------ Automobile and property (voluntary) .... $473.2 $470.7 0.5% $ 2.5 Annuity deposits ....................... 206.4 205.7 0.3% 0.7 Life ................................... 121.8 120.4 1.2% 1.4 ------ ------ ----- Subtotal - core lines ............. 801.4 796.8 0.6% 4.6 Involuntary and other property & casualty .................. 20.3 24.4 -16.8% (4.1) ------ ------ ----- Total ............................. $821.7 $821.2 0.1% $ 0.5 ====== ====== =====
Insurance Premiums and Contract Charges Earned (Excludes annuity and life contract deposits)
Year Ended Growth Over December 31, Prior Year --------------- ---------------- 2000 1999 Percent Amount ------ ------ ------- ------ Automobile and property (voluntary) .... $469.4 $465.0 0.9% $ 4.4 Annuity ................................ 17.0 16.7 1.8% 0.3 Life ................................... 91.7 87.3 5.0% 4.4 ------ ------ ----- Subtotal - core lines ........... 578.1 569.0 1.6% 9.1 Involuntary and other property & casualty ................. 20.6 26.1 -21.1% (5.5) ------ ------ ----- Total ........................... $598.7 $595.1 0.6% $ 3.6 ====== ====== =====
F-18 In 2000, premiums written and contract deposits for the Company's core lines increased slightly compared to 1999, reflecting growth in each of the Company's segments. This comparison includes the North Carolina settlement described below. However, premiums written and contract deposits for the fourth quarter of 2000 increased 3.6% over a year earlier, including a 13.2% growth in new annuity deposits. At December 31, 2000, the Company's exclusive agency force totaled 978, an 11.5% decline from a year earlier. The number of experienced agents in the agency force, 668, was down 5.6% at December 31, 2000, compared to a year earlier. The Company had higher than normal terminations of new and experienced agents in 2000, but those agents were generally the Company's less productive agents. As a result, overall agent productivity began to increase. The Company began the process of changing what is expected from its agents. Through 2000, agent compensation focus and rewards centered around profitability, service and tenure with the Company. The new direction will continue to focus on profitability but will also place a greater emphasis on individual agent productivity, new premium growth, educator business, cross-selling and business retention. In addition, the Company's agency management team has been strengthened through the promotions of several of its most experienced and capable agents. Hiring of new agents during 2000 kept pace with the prior year. In 2000, modifications were made to agent recruiting and the new agents' finance programs. And in 2001, new compensation plans for all agents and agency managers will be implemented. Management believes these actions along with other strategic initiatives will have a positive impact on agent productivity in the future. In March 2000, following lengthy negotiations, the North Carolina Rate Bureau and that state's Commissioner of Insurance agreed to settle the outstanding 1994, 1996 and 1999 private passenger automobile insurance rate filing cases resulting in an adverse impact of approximately $250 million for the insurance industry. Horace Mann's portion of the adverse settlement, recorded in the first and fourth quarters of 2000, was $3.0 million pretax, comprised of $2.3 million premium refunds and $0.7 million interest charges. North Carolina was the Company's second largest property and casualty state representing approximately 7% of total premiums for the year ended December 31, 2000. Total voluntary automobile and homeowners premium written growth was 0.5% for 2000, including the effect of the North Carolina settlement. The average premium per policy increased for both automobile and homeowners, as did the number of homeowners policies in force. The number of automobile policies in force was slightly lower than year-earlier levels. Automobile insurance premium decreased slightly ($2.7 million, or 0.8%) compared to 1999, and homeowners premium increased 4.7% ($5.2 million). The property and casualty increase in premiums resulted from growth in average premium per policy of 1% for automobile and 2% for homeowners, compared to a year earlier. Over the prior 12 months, unit growth was 0.5%, bringing policies in force at December 31, 2000 to 876,000. Compared to December 31, 1999, total property and casualty policies in force increased 4,000 with an 8,000 unit increase in homeowners partially offset by a decrease in automobile units. Based on policies in force, the property and casualty 12-month retention rate for new and renewal policies was 88%, comparable to the 12 months ended December 31, 1999. For the first time since the fourth quarter of 1998, annuity contract deposits exceeded the same quarters in the prior year in both the third and fourth quarters of 2000. The growth of 13.2% compared to the fourth quarter of 1999 included 44.7% growth in new single premium and rollover deposits. In May 2000, the Company introduced two additional variable mutual fund investment F-19 options. In September 2000, in time for the important back-to-school selling season, the Company more than tripled the number of choices available to its customers by introducing 21 new investment options in its tax-deferred annuity product line. At the same time, the Company provided its agents with proprietary asset allocation software that assists educator customers in selecting the best retirement investment options for their individual needs and circumstances. Compared to full year 1999, new annuity deposits increased 0.3%, reflecting a 7.1% increase in new single premium and rollover deposits and a 2.1% decrease in scheduled deposits received. New deposits to variable annuities decreased 6.3% and new deposits to fixed annuities were 11.5% higher than 1999. Variable annuity accumulated funds on deposit at December 31, 2000 were $1.0 billion, $96.6 million less than a year earlier, an 8.5% decrease. Variable annuity accumulated deposit retention decreased 4.4 percentage points over the 12 months to 84.1%. However, this retention for the last three months of 2000 showed improvement at 87.3% following the Company's expansion of variable investment options and implementation of proprietary asset allocation software. Fixed annuity cash value retention for the 12 months ended December 31, 2000 was 88.7%, 3.6 percentage points lower than the same period a year earlier; also showing some improvement in the last three months of 2000 at 89.3%. Over the 12 months of 2000, the number of annuity contracts outstanding increased 3.2%, or 4,000 contracts. At December 31, 2000, approximately 71% of accumulated variable annuity funds on deposit were in the Company's Equity and Balanced mutual funds. Investment returns for these two funds were less than their comparable Lipper average returns in recent periods contributing to the higher level of surrenders in 2000 compared to 1999. In 2000, the Company took actions to increase the variable annuity options available to customers, as described above, and also took steps to improve the returns of its proprietary mutual funds. Life premium growth was 1.2% for the year ended December 31, 2000, compared to 1999. The life insurance in force lapse ratio was 9.0% for the twelve months ended December 31, 2000, compared to 8.3% for the same period a year earlier. Both premium growth and the lapse ratio reflect the shift in new business over the prior 18 months from whole life to term life insurance. Net Investment Income Investment income of $192.4 million for 2000 increased 2.2%, or $4.1 million, (2.1% after tax) compared to the prior year primarily due to growth in the size of the investment portfolio. Average investments (excluding the securities lending collateral) increased 1.1%, compared to 1999. The average pretax yield on the investment portfolio was 7.1% (4.8% after tax) for 2000, compared to a pretax yield of 7.0% (4.7% after tax) for 1999. Realized Investment Gains and Losses Net realized investment losses were $9.9 million for the year ended December 31, 2000, compared to net realized investment losses of $8.0 million for 1999. For both periods, most of the net realized gains and losses occurred in the fixed income portfolios. F-20 Benefits, Claims and Settlement Expenses
Year Ended Growth Over December 31, Prior Year --------------- ---------------- 2000 1999 Percent Amount ------ ------ ------- ------ Property and casualty............... $417.4 $374.9 11.3% $42.5 Annuity............................. 1.6 -- 1.6 Life................................ 47.0 41.3 13.8% 5.7 ------ ------ ----- Total............................ $466.0 $416.2 12.0% $49.8 ====== ====== ===== Property and casualty statutory loss ratio: Before catastrophe losses.... 81.9% 72.4% 9.5% After catastrophe losses..... 85.2% 76.3% 8.9%
In 2000, the Company's benefits, claims and settlement expenses were affected adversely by strengthening of prior years' reserves for property and casualty claims and a higher level of non-catastrophe property losses. In the fourth quarter of 2000, the Company conducted a comprehensive review of all components of its property and casualty reserves. As a result of that review, the Company increased total property and casualty reserves for prior years by $24.7 million at December 31, 2000. This increase consisted of approximately $6 million strengthening of prior years' direct reserves, primarily automobile, based on the further analysis of adverse trends which emerged during 2000. It also included an approximately $17 million reduction of ceded reserves resulting from the adoption of a different actuarial method to reflect more accurately prior years' loss experience. This reduction of the ceded reserves was related to automobile facility business in four states, primarily Massachusetts. Prior years' reserves for automobile and homeowners business assumed from state reinsurance facilities were also strengthened by $1.8 million. For the full year, net strengthening of reserves to provide for the adverse development of property and casualty claims occurring in prior years, excluding involuntary business, was $20.9 million in 2000, compared to favorable development of $7.6 million in 1999. Full year strengthening of total reserves for property and casualty claims occurring in prior years was $22.7 million in 2000, compared to favorable development of $4.6 million in 1999. F-21 In 2000, the higher level of non-catastrophe property losses included: non-catastrophe weather-related property claims; greater-than-expected fire losses; and losses on lower value homes. The fourth quarter of 2000 was affected by severe winter weather experienced in many areas of the country. The non-catastrophe property loss ratio by quarter and for the full year was as follows:
Growth Over 2000 1999 Prior Year ---- ---- ----------- Non-catastrophe property loss ratio for the: Quarter ended March 31....... 79.0% 81.9% -2.9% Quarter ended June 30........ 91.4% 72.8% 18.6% Quarter ended September 30... 82.8% 78.1% 4.7% Quarter ended December 31.... 80.7% 53.3% 27.4% Year ended December 31....... 83.4% 71.0% 12.4%
After determining that the increase in non-catastrophe property losses experienced in the early months of 2000 was due to underlying loss trends, rather than the normal cyclicality of the property business, management began and continued to implement pricing, underwriting and loss control initiatives. Although the Company's actions began to have a positive impact in 2000, management expected that the full impact of these changes would not be realized until well into 2001. Management anticipated that these actions would enable the Company to improve the profitability of its existing book of homeowners business and attract new business that meets its profitability standards. For 2000, the increase in non-catastrophe property losses more than offset the Company's decline in catastrophe losses compared to the prior year. Catastrophe losses were $16.2 million in 2000 and $19.6 million in 1999, a decrease of 17.3%. The voluntary automobile loss ratio excluding catastrophe losses was 80.9% for 2000, 8.4 percentage points higher than the prior year. This increase was primarily due to the strengthening of prior years' reserves in 2000 versus favorable reserve development in 1999, which represented 7.2 percentage points of the increase in the loss ratio. Also, on a per-policy basis for the year, average voluntary automobile premium increased 1% and average current accident year loss costs increased 2% compared to 1999. During the fourth quarter of 2000, the Company also completed a thorough review of its life and annuity reserves. The increase in annuity benefits of $1.6 million recorded in 2000 represented mortality experience on annuity contracts on payout status of which $1.3 million resulted from the application of a more refined reserving model. Life mortality experience was somewhat higher in 2000 than in 1999. The largest single item which caused the increase in life segment benefits was due to positive experience in 1999 on a small closed block of individual accident and health policies. F-22 Interest Credited to Policyholders
Year Ended Growth Over December 31, Prior Year ------------- ---------------- 2000 1999 Percent Amount ----- ----- ------- ------ Annuity................................... $66.1 $67.2 -1.6% $(1.1) Life...................................... 26.5 24.4 8.6% 2.1 ----- ----- ----- Total.................................. $92.6 $91.6 1.1% $ 1.0 ===== ===== =====
Interest credited to fixed annuity contracts decreased as the average accumulated deposits for the year ended December 31, 2000 decreased 1% compared to 1999. The fixed annuity average annual interest rate credited was 5.0% for both 2000 and 1999. Life insurance interest credited increased as a result of continued growth in the interest-sensitive life insurance reserves. Operating Expenses For 2000, operating expenses increased $18.2 million, or 16.6%, compared to 1999. First, expenses in 2000 included non-recurring charges of $0.7 million for interest on the North Carolina settlement and $3.6 million, or approximately $0.06 per share after tax benefits, attributable to the chief executive officer transition. Second, in the fourth quarter of 2000 the Company wrote off $1.0 million book value of personal computers not compatible with the Company's software upgrade and $2.5 million of previously capitalized software costs. Third, operating expenses for 2000 included increased costs to support business growth initiatives. The total corporate expense ratio on a statutory accounting basis was 24.2% for the year ended December 31, 2000, 2.1 percentage points higher than in 1999. The property and casualty expense ratio was 20.8% for the year ended December 31, 2000, compared to 19.8% in 1999. The increase in these expense ratios primarily reflected the modest level of premium growth, which was lower than anticipated, while statutory expenses for the Company increased 9.7% including the items described above. Amortization of Policy Acquisition Expenses and Intangible Assets For 2000, the combined amortization of policy acquisition expenses and intangible assets of $64.8 million increased by $11.6 million, or 21.8%, compared to 1999. Amortization of intangible assets increased to $8.8 million for the year ended December 31, 2000, compared to $0.2 million for 1999, reflecting the higher level of amortization of the value of annuity business acquired in the 1989 acquisition of the Company ("Annuity VIF"). The negative amortization of Annuity VIF for the full year 1999 included a $6.2 million reduction due to favorable experience identified in 1999. The $5.2 million Annuity VIF amortization recorded for 2000 reflected the scheduled increase in amortization, the effect of higher than expected annuity surrenders in 2000 and the lower than expected market value appreciation on the in force annuity business. Annuity VIF amortization was $(4.2) million, $2.0 million and $5.6 million for the twelve months ended December 31, 1999, 1998 and 1997, respectively. The negative Annuity VIF amortization in 1999 was partially offset by a $3.4 million increase in the amortization of annuity policy acquisition costs deferred after the 1989 acquisition of the Company. The amortization of the value of property and casualty business acquired in the 1989 acquisition of the Company was completed in the third quarter of 1999; amortization was $0.7 million for 1999. F-23 Policy acquisition expenses amortized for the year ended December 31, 1999 of $53.0 million were $3.0 million lower than in 2000 including a $1.5 million reduction recorded in 1999 to reflect favorable life mortality estimates which resulted in higher anticipated future gross profits. Income Tax Expense Excluding the benefit in 2000 and the expense in 1999 related to the Company's previously announced dispute with the Internal Revenue Service ("IRS") regarding tax years 1994 though 1997, the effective income tax rate was -24.7% for the year ended December 31, 2000, compared to 30.9% for 1999. Interest of $2.1 million on refunds from the IRS for federal tax years 1994 and 1995 reduced the 2000 effective income tax rate 22.1 percentage points. The refunds resulted from issues separate from the Company's dispute with the IRS regarding tax years 1994 through 1997. Income from investments in tax-advantaged securities reduced the effective income tax rate 45.1 and 4.6 percentage points for the years ended December 31, 2000 and 1999, respectively. While the amount of income from investments in tax-advantaged securities in 2000 was comparable to a year earlier, the reduced level of income before income taxes in 2000 resulted in this having a more significant impact on the effective income tax rate. As previously reported, the Company has been contesting proposed additional federal income taxes relating to a settlement agreement with the IRS for prior years' taxes. 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 (1994 through 1997). In the third and fourth quarters of 2000, the 1994 through 1996 exposure was resolved resulting in a reduction of $8.7 million from the $20.0 million tax liability established in 1999. Both of these amounts were included in net income for the respective years but were excluded from operating income. Operating Income For the year ended December 31, 2000, operating income (net income before the after-tax impact of realized investment gains and losses, restructuring charges, litigation charges and provision for prior years' taxes) decreased 64.5%, or $45.6 million, and operating income per share on a diluted basis of $0.61 decreased 64.1%, or $1.09 per share, compared to the prior year. Full year 2000 operating income was significantly affected by the following factors that occurred in the fourth quarter. . $16.1 million after-tax strengthening of prior years' reserves for property and casualty claims; . $2.9 million after tax of additional weather-related automobile and property losses in December, compared to typical experience for that month; . $1.6 million after-tax charge related to life and annuity reserves as well as the deferred acquisition costs and value of insurance in force assets related to those segments; . An after-tax charge of $0.7 million representing all remaining expenses related to the Company's change of chief executive officer during 2000; . An after-tax write-off of $2.3 million in book value of personal computers and previously capitalized software development costs; and . A benefit of $2.1 million for interest on refunds from the IRS. F-24 Operating income for the full year 2000 was also affected adversely by five items from the first nine months of the year. (1) In the second quarter of 2000, there was a higher level of non-catastrophe property losses including: losses on lower value homes; non-catastrophe weather-related property claims; and greater-than-expected fire losses. (2) Property and casualty reserve releases in 2000 through September 30 were lower than those for the first nine months of 1999. (3) In the third quarter of 2000, there was a deterioration in voluntary automobile loss trends. (4) In the first nine months of 2000, holding company expenses were higher than the prior year including expenses attributable to the chief executive officer transition and costs to support business growth initiatives. And, (5) the Company's portion of the adverse automobile insurance rate settlement in North Carolina, as described above, of $1.6 million after tax, or approximately $0.04 per share, was recorded in the first quarter of 2000. (The full year charge was $1.9 million after tax, or $0.05 per share.) In addition, operating income comparisons to 1999 were adversely impacted by non-recurring items in the first quarter of 1999, primarily in the life segment, totaling approximately $0.04 per share, and a significant decrease in the fourth quarter of 1999 in the amortization of Annuity VIF to reflect experience and trends, which increased annuity segment operating income by approximately $0.10 per share in 1999. Operating income by segment was as follows:
Year Ended Growth Over December 31, Prior Year --------------- ---------------- 2000 1999 Percent Amount ------ ------ ------- ------ Property & casualty Before catastrophe losses................... $ 19.4 $ 52.2 -62.8% $(32.8) Catastrophe losses, after tax............... (10.5) (12.7) 2.2 ------ ------ ------ Total including catastrophe losses..... 8.9 39.5 -77.5% (30.6) Annuity ..................................... 19.3 27.3 -29.3% (8.0) Life ......................................... 12.9 14.6 -11.6% (1.7) Corporate and other expense................... (9.4) (4.4) (5.0) Interest expense, after tax................... (6.6) (6.3) (0.3) ------ ------ ------ Total.................................. $ 25.1 $ 70.7 -64.5% $(45.6) ====== ====== ====== Total before catastrophe losses............................... $ 35.6 $ 83.4 -57.3% $(47.8) ====== ====== ====== Property and casualty statutory combined ratio: Before catastrophe losses................ 102.7% 92.2% 10.5% After catastrophe losses................. 106.0% 96.1% 9.9%
Property and casualty segment operating income was lower than in 1999 primarily due to strengthening of prior years' reserves versus reserve releases in 1999, a higher level of non-catastrophe property losses, a deterioration in voluntary automobile loss trends in the third quarter of 2000, and an adverse industry settlement of outstanding automobile insurance rate filing cases for 1994, 1996 and 1999 in North Carolina. The Company's portion of this settlement, including interest, was $1.9 million after tax. Property and casualty segment earnings for 2000 also were affected negatively by lower than expected business volume in the automobile line partially offset by a $2.2 million decrease in after-tax catastrophe losses. During 2000, the Company's average voluntary automobile insurance premium per policy increased 1% while average loss costs increased 2%, compared to the prior year. The Company's plans to implement credit-based automobile and homeowners rates were on track at December 31, 2000, which management F-25 expects will have a positive impact on both loss ratios and business growth for these products in the Company's target market. The property and casualty combined ratio before catastrophes of 102.7% was 10.5 percentage points higher than 1999, reflecting the factors cited above. Full year net strengthening of reserves to provide for the adverse development of property and casualty claims occurring in prior years, excluding involuntary business, was $13.6 million after tax in 2000, compared to favorable development of $4.9 million after tax in 1999. Net strengthening of total reserves for property and casualty claims occurring in prior years was $14.8 million after tax in 2000, compared to favorable development of $3.0 million after tax in 1999, representing 5.6 percentage points of the increase in the combined ratio before catastrophes. Annuity segment operating income was below the 1999 total. In 2000, increases in both annuity interest rate spreads and contract fees for the year were offset by increased amortization expenses, higher operating expenses and higher net mortality losses on annuity contracts in payout status. The increased amortization of the value of annuity business acquired in the 1989 acquisition of the Company included the effect of the 1999 net reduction reflecting favorable experience in prior periods and higher than expected annuity surrenders during 2000. In 2000, operating expenses in the annuity segment include a higher level of new product development costs. For 2000, the net interest margin increased 3.1% and fees and contract charges earned increased 1.8%. Variable annuity accumulated deposits were $1.0 billion at December 31, 2000, $96.6 million, or 8.5%, less than 12 months earlier. Fixed annuity accumulated cash value of $1.3 billion was $23.8 million, or 1.8%, less than December 31, 1999. Life insurance earnings for the full year 1999 reflected lower expenses resulting from a decrease in the amortization of deferred policy acquisition costs to reflect favorable mortality estimates and positive experience on a small closed block of accident and health business. Excluding those items, life operating income in 2000 was comparable to a year earlier. Mortality costs for 2000 were somewhat higher than in the prior year. The 2000 Corporate and Other Expense category in the preceding table reflects higher holding company expenses, including outside consulting fees to support business growth initiatives and charges related to the chief executive officer transition. Net Income
Net Income Per Share, Diluted Year Ended Growth Over December 31, Prior Year --------------- ---------------- 2000 1999 Percent Amount ------ ------ ------- ------ Operating income........................ $ 0.61 $ 1.70 -64.1% $(1.09) Realized investment losses.............. (0.15) (0.13) (0.02) Restructuring charges................... (0.04) -- (0.04) Litigation charges...................... (0.12) (0.02) (0.10) Provision for prior years' taxes........ 0.21 (0.48) 0.69 ------ ------ ------ Net income........................... $ 0.51 $ 1.07 -52.3% $(0.56) ====== ====== ======
F-26 Net income, which includes realized investment gains and losses, restructuring charges, litigation charges and the provision for prior years' taxes, for the year ended December 31, 2000 decreased by $23.7 million, or 53.3%, and net income per diluted share decreased by 52.3% compared to 1999. This change included the $45.6 million decline in operating income partially offset by the $8.7 million benefit in 2000 related to prior years' taxes compared to the $20.0 million provision recorded in 1999 (see the description above). Net income in 2000 also reflected $6.4 million of after-tax realized investment losses, compared to $5.2 million of after-tax realized investment losses in 1999. In addition, the Company had three items that were unusual in nature and did not impact operating income. (1) The provision for prior years' taxes is described above. (2) In December 2000, the Company recorded restructuring charges of $2.2 million pretax ($1.5 million, or $0.04 per share, after tax) reflecting two changes in the Company's operations. Specifically, the Company restructured the operations of its group insurance business, thereby eliminating 39 jobs, and its credit union marketing group, eliminating 20 additional positions. The changes will improve business results and more closely align these functions with the Company's strategic direction. Employee termination costs, which represent severance, vacation buy-out and related payroll taxes, represented $1.8 million pretax of the total accrued. The eliminated positions encompass management, professional and clerical responsibilities. Termination of lease agreements for office space used by the credit union marketing group represented $0.3 million pretax of the total accrued. The remaining $0.1 million pretax was primarily attributable to the write-off of software related to these two areas. Restructuring charges have been separately identified in the Statement of Operations for the year ended December 31, 2000. None of the restructuring costs were paid as of December 31, 2000. (3) The Company recorded litigation charges in both 2000 and 1999. In December 2000, the Company recorded an after-tax charge of $5.0 million, representing the Company's best estimate of the actual and anticipated costs of defending and ultimately resolving litigation brought against the Company in regards to its disability insurance product. The lawsuit is on behalf of certain policyholders who purchased the Company's disability insurance product and allege that they were not adequately made aware of certain features. While the actual costs for the Company to resolve this issue could be either less or more than the liability established in 2000, management believes that, based on facts and circumstances available at the time, the amount recorded will be adequate to resolve the matter. Disability insurance represented less than 1% of the Company's insurance premiums written and contract deposits for the year ended December 31, 2000. During the second quarter of 2000, all remaining suits that had been filed in Alabama related to life insurance policies were settled at a cost of $0.1 million after tax and after receipt of insurance proceeds. In 1999, a charge of $1.0 million after tax and after receipt of insurance proceeds was recorded for the litigation in Alabama. Return on shareholders' equity was 6% based on operating income and 5% based on net income for the 12 months ended December 31, 2000. F-27 Liquidity and Financial Resources Special Purpose Entities At December 31, 2001, 2000 and 1999, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, the Company is not exposed to any financing, liquidity, market or credit risk that could arise if the Company had engaged in such relationships. Related Party Transactions The Company does not have any contracts or other transactions with related parties that are required to be reported under the applicable securities laws and regulations. Ariel Capital Management, Inc., HMEC's largest shareholder with 19% of the common shares outstanding, is the investment adviser for two of the mutual funds offered to the Company's annuity customers. Investments The Company's investment strategy emphasizes investment grade, publicly traded fixed income securities. At December 31, 2001, fixed income securities represented 96.3% of investments excluding the securities lending collateral. Of the fixed income investment portfolio, 95.4% was investment grade and 99.8% was publicly traded. The average quality of the total fixed income portfolio was A+ at December 31, 2001. 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 5.0 years at December 31, 2001 and 4.4 years at December 31, 2000. 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 79% of all outstanding fixed annuity accumulated cash values, are subject in most cases to substantial early withdrawal penalties. 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. F-28 Operating Activities As a holding company, HMEC conducts its principal operations in the personal lines segment of the property and casualty and life insurance industries through its subsidiaries. HMEC's insurance subsidiaries generate cash flow from premium and investment income, generally well in excess of their immediate needs for policy obligations, operating expenses and other cash requirements. Cash provided by operating activities primarily reflects net cash generated by the insurance subsidiaries. Net cash provided by operating activities was approximately $25 million more than in 2000, primarily reflecting a recovery of federal income tax amounts in the current year compared to payments made in 2000. The Company has entered into various operating lease agreements, primarily for computer equipment, computer software and real estate (agency and claims offices across the country and portions of the home office complex). These leases have varying commitment periods with most in the 1 to 3 year range. Operating cash flow reflects payments on these leases of approximately $8 million for each of the years ended December 31, 2001, 2000 and 1999. It is anticipated that the Company's payments under operating leases in 2002 will be comparable to prior years. The Company does not have any other arrangements that expose it to material liability that are not recorded in the financial statements. Payment of principal and interest on debt, fees related to the catastrophe-linked equity put option and reinsurance agreement, 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 2002 without prior approval are approximately $40 million. Although regulatory restrictions exist, dividend availability from subsidiaries has been, and is expected to be, adequate for HMEC's capital needs. Investing Activities HMEC's insurance subsidiaries maintain significant investments in fixed maturity securities to meet future contractual obligations to policyholders. In conjunction with its management of liquidity and other asset/liability management objectives, the Company, from time to time, will sell fixed maturity securities prior to maturity and reinvest the proceeds in other investments with different interest rates, maturities or credit characteristics. Accordingly, the Company has classified the entire fixed maturity securities portfolio as available for sale. Financing Activities Financing activities include primarily payment of dividends, the receipt and withdrawal of funds by annuity contractholders, repurchases of the Company's common stock, and borrowings and repayments under the Company's debt facilities. Fees related to the catastrophe-linked equity put option and reinsurance agreement, which augments its other reinsurance program, have been charged directly to additional paid-in capital. F-29 For the year ended December 31, 2001, receipts from annuity contracts increased 15.8%. Annuity contract maturities and withdrawals decreased $134.0 million, or 42.9%, compared to 2000 including decreases of 53.6% and 40.8% in surrenders of variable and fixed annuities, respectively. Reflecting continued improvement in recent quarterly trends, cash value retention for variable and fixed annuities was 92.4% and 93.4%, respectively, for the 12 month period ended December 31, 2001. Net transfers to variable annuity assets increased $82.0 million compared to 2000 reflecting the Company's expansion of its variable investment options. The Company did not repurchase shares of its common stock under its stock repurchase program during 2001, consistent with management's stated intention to utilize excess capital to support the Company's strategic growth initiatives. In 2000, 1,082,400 shares were repurchased at an aggregate cost of $15.1 million. The repurchase of shares was financed through use of cash and, when necessary, the Bank Credit Facility. However, the Company has not utilized the Bank Credit Facility for share repurchases since the second quarter of 1999. As of December 31, 2001, $96.3 million remained authorized for future share repurchases. Capital Resources The Company has determined the amount of capital which is needed to adequately fund and support business growth, primarily based on risk-based capital formulas including those developed by the National Association of Insurance Commissioners ("NAIC"). Historically, the Company's insurance subsidiaries have generated capital in excess of such needed capital. These excess amounts have been paid to HMEC through dividends. HMEC has then utilized these dividends and its access to the capital markets to service and retire long-term debt, 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 NAIC has codified statutory accounting practices, which constitute the only source of prescribed statutory accounting practices and were effective January 1, 2001. Codification changed prescribed statutory accounting practices and resulted in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements. The states of domicile of the Company's principal operating subsidiaries, Illinois, California and Texas, have adopted the NAIC's codification. As a result of adopting the NAIC codification, the Company's statutory surplus of its insurance subsidiaries increased approximately $19 million primarily due to the allowance of deferred tax recoverables under codification. The total capital of the Company was $612.0 million at December 31, 2001, including $99.8 million of long-term debt and $53.0 million of short-term debt. Total debt represented 26.1% of capital (excluding unrealized investment gains and losses) at December 31, 2001, which was slightly higher than the Company's target operating range of 20% to 25%. Shareholders' equity was $459.2 million at December 31, 2001, including an unrealized gain in the Company's investment portfolio of $26.3 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 $864.4 million and $21.22, respectively, at December 31, 2001. Book value per share was $11.27 at December 31, 2001, $10.62 excluding investment fair value adjustments. At December 31, 2000, book value per share was $10.56, $10.66 excluding F-30 investment fair value adjustments. The increase over the 12 months included the effects of unrealized investment gains and losses. Excluding these items, book value per share was slightly lower than a year earlier. 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") (BBB+), Fitch, Inc. ("Fitch") (A-), and Moody's Investors Service, Inc. ("Moody's") (Baa2) and are traded on the New York Stock Exchange (HMN 6 5/8). As a result of factors impacting the Company's earnings for the three months ended December 31, 2000, S&P placed the Company's "A-" debt rating on "CreditWatch with negative implications" and Fitch placed the Company's "A" debt rating on "Rating Watch Negative" in January 2001 and February 2001, respectively. In April 2001, Fitch reaffirmed their "A" rating and identified the outlook for the rating as "Stable". However, as a result of factors impacting the Company's earnings for the three months ended June 30, 2001, Fitch downgraded the rating to "A-" in August 2001 and identified the outlook for the rating as "Stable". In August 2001, S&P downgraded their rating to "BBB+" and identified the outlook for the rating as "Stable". Moody's issued a statement in February 2001 affirming their "Baa1" rating and identified the outlook for the rating as "Stable". However, in February 2002 Moody's downgraded the debt rating to "Baa2" and identified the outlook for the rating as "Stable". As of December 31, 2001 and December 31, 2000, the Company had short-term debt of $53.0 million and $49.0 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 through December 31, 2001. The rate on the borrowings under the Bank Credit Facility was Interbank Offering Rate plus 0.4%, or 2.4%, as of December 31, 2001. The Company's earnings in the fourth quarter of 2000 could have caused a breach of a financial covenant of the Company's Bank Credit Facility in 2001 but, in the first quarter of 2001, the lender agreed to modify that covenant for the first, second and third quarters of 2001. As a result of earnings for the second quarter of 2001, and again based on third quarter 2001 earnings, the lender agreed to further modify that covenant. The commitment for the Bank Credit Facility terminated on December 31, 2001. However, in November 2001, management completed negotiation of an amendment to the existing Bank Credit Facility extending it through June 30, 2002. The amendment extending the term of the commitment for the Bank Credit Facility also modified the rate on the borrowings under it to be Interbank Offering Rate plus 0.75%, or 2.7%, as of January 1, 2002. Management is reviewing its capital market alternatives and believes that the Company will be able to obtain replacement financing for the Bank Credit Facility. The Company cannot predict on what terms and conditions such financing would be available, and the availability of alternative financing, in the form of long-term debt instruments or a replacement credit facility, is always subject to prevailing market conditions at the time of securing such financing. The Company's ratio of earnings to fixed charges for the year ended December 31, 2001 was 4.0x compared to 2.0x for the prior year. Total shareholder dividends were $17.1 million for the year ended December 31, 2001. In February 2002, the Board of Directors announced a regular quarterly dividend of $0.105 per share. F-31 The Company reinsures 95% of catastrophe losses above a retention of $8.5 million per occurrence up to $80 million per occurrence. In addition, the Company's predominant insurance subsidiary for property and casualty business written in Florida reinsures 90% of hurricane losses in that state above a retention of $11.0 million up to $47.4 million with the Florida Hurricane Fund, based on the Fund's resources. Through December 31, 2001, these catastrophe reinsurance programs were augmented by a $100 million equity put and reinsurance agreement. This equity put provided 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 exceeded the catastrophe reinsurance program coverage limit. Before tax benefits, the equity put provided a source of capital for up to $154 million of catastrophe losses above the reinsurance coverage limit. At the time of this Report on Form 10-K, management is in what it believes to be the final stages of negotiating a replacement equity put and reinsurance agreement with a subsidiary of Swiss Reinsurance Company. The Swiss Re Group is rated "A++ (Superior)" by A.M. Best. The terms of the three year agreement are expected to be similar to the prior equity put and reinsurance agreement. Before tax benefits, the proposed equity put coverage of $75 million would provide a source of capital for up to $115 million of catastrophe losses above the reinsurance coverage limit. The Company would also have the option, in place of the equity put, to require the Swiss Re Group member to issue a 10% quota share reinsurance coverage of all of the Company's property and casualty book of business. Fees related to this equity put option, which are charged directly to additional paid-in capital, are estimated to increase to 145 basis points in 2002 from 95 basis points in 2001 under the prior agreement. An additional provision of this agreement would prevent Horace Mann's exercise of the option in the event it's S&P financial strength rating was below "BBB" prior to a triggering event. The Company's S&P financial strength rating was "A+" at December 31, 2001. The cost of the Company's catastrophe reinsurance coverage program for 2002 increased approximately 50%, or $2.0 million, compared to 2001 as a result of the effects on the reinsurance market of the September 11, 2001 terrorist attacks. However the increase was manageable and 48% of the Company's traditional coverage for catastrophe losses has rates which are fixed through 2003. The cost of the Company's entire property and casualty reinsurance program for 2002 increased approximately 35%, or $2.5 million, compared to 2001. Insurance Financial Ratings and IMSA Certification As disclosed in the 2000 Form 10-K, certain ratings of the Company's insurance subsidiaries were under review as a result of the Company's earnings for the three months ended December 31, 2000. Management also initiated discussions with each of the agencies rating its insurance subsidiaries as a result of earnings reported for the quarter ended June 30, 2001. At the time of this Report on Form 10-K, these reviews have been completed by all agencies. A.M. Best Company, Inc. ("A.M. Best") has rated each of the Company's property and casualty subsidiaries "A+ Superior" and has rated the Company's principal life insurance subsidiary "A (Excellent)." A.M. Best's annual review of Horace Mann's ratings is currently scheduled for April 2002. Moody's Investors Service, Inc. ("Moody's") affirmed the Company's financial strength ratings following the Company's January 2001 preannouncement of earnings for the three months ended December 31, 2000, and in August 2001 issued an opinion update which again affirmed F-32 those ratings. In July 2001, Moody's assigned a financial strength rating of "A2 (Good)" to Horace Mann Property and Casualty Insurance Company (formerly Allegiance Insurance Company). HMLIC, HMIC and TIC are also rated "A2 (Good)" for financial strength by Moody's. Fitch, Inc. ("Fitch") placed the Company's financial strength ratings on "Rating Watch Negative" in February 2001. Although the Company's insurance subsidiaries remain in the "AA (very strong)" rating category, in April 2001, Fitch downgraded Horace Mann's financial strength ratings one notch from "AA" to "AA-". Fitch reaffirmed its "AA-" rating in August 2001 and identified the outlook for the rating as "Stable". Standard & Poor's Corporation ("S&P") placed the Company's financial strength ratings on "CreditWatch with negative implications" in January 2001. In August 2001, S&P downgraded the Company's financial strength ratings from "AA-" to "A+" and identified the outlook for the ratings as "Stable". As of 2001, Horace Mann is one of only two insurance groups that have been named to The Ward's Financial Group's ("Wards") Top 50 for both its property and casualty and life subsidiaries in each of the last eight years. Identified annually, the Top 50 represent benchmark groups of 50 life insurance companies and 50 property and casualty insurance companies that, over the prior five years, have in Ward's opinion excelled at balancing safety, consistency and performance. In July 2001, Horace Mann Life Insurance Company, the Company's principal life insurance subsidiary, earned membership in the Insurance Marketplace Standards Association ("IMSA"). IMSA is an independent, voluntary association created by the life insurance industry to promote high standards of ethical market conduct in advertising, sales and service for individual life, annuity and long-term care products. To earn IMSA certification, HMLIC underwent self- and independent third-party assessments to demonstrate that it has adopted IMSA's principles of ethical behavior. HMLIC is an IMSA member for three years, after which it must demonstrate continuous improvement and repeat the self- and independent assessment process to retain its membership. As of December 31, 2001, fewer than 250 companies had earned IMSA membership. 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 F-33 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, 2001, 20% of the fixed investment portfolio represented investments supporting the property and casualty operations and 80% supported 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 surrenders 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, 2001, the duration of the investment portfolio was approximately 5.0 years, and the duration of insurance liabilities was approximately 4.7 years. The life and annuity operations participate in the cash flow testing procedures imposed by statutory insurance regulations, the purpose of which is to insure that such liabilities are adequate to meet the Company's obligations under a variety of interest rate scenarios. Based on these procedures, the Company's assets and the investment income expected to be received on such assets, are adequate to meet the insurance policy obligations and expenses of the Company's insurance activities in all but the most extreme circumstances. The Company periodically evaluates its sensitivity to interest rate risk. Based on commonly used models, the Company projects the impact of interest rate changes, assuming a wide range of factors, including duration and prepayment, on the fair value of assets and liabilities. Fair value is estimated based on the net present value of cash flows or duration estimates. At December 31, 2001, 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 $10 million after tax, 3% of shareholders' equity. A 100 basis point increase would decrease fair value of assets and liabilities by $16 million after tax, 5% of shareholders' equity. At December 31, 2000, 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 $9 million after tax, 3% of shareholders' equity. A 100 basis point increase would decrease fair value of assets and liabilities by $13 million after tax, 4% of shareholders' equity. In both cases, 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 F-34 interest rates would not materially affect the consolidated near-term financial position, results of operations or cash flows of the Company. Recent Accounting Changes In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", effective for all business combinations initiated after June 30, 2001, and No. 142, "Goodwill and Other Intangible Assets", effective for fiscal years beginning after December 15, 2001. SFAS No. 141 requires the purchase method of accounting be used for all business combinations. Goodwill and certain intangible assets will remain on the balance sheet and not be amortized. SFAS No. 142 establishes a new method of testing goodwill for impairment. On an annual basis, and when there is reason to suspect that their values may have been diminished or impaired, these assets must be tested for impairment. The amount of goodwill determined to be impaired will be expensed to current operations. The Company has not determined the impact, if any, that the goodwill impairment testing prescribed by these statements will have on its consolidated financial position or results of operations. Amortization of goodwill was $1.6 million for the year ended December 31, 2001. As of December 31, 2001, the Company's Consolidated Balance Sheet reflected goodwill of $47.4 million. In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations", effective for fiscal years beginning after June 15, 2002. The accounting practices in this statement apply to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset. This statement will not have a material impact on the Company because it does not own a significant amount of property and equipment. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", effective for fiscal years beginning after December 15, 2001. This statement establishes a single accounting model, based on the framework established in SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", for long-lived assets disposed of by sale, including disposal of a segment of a business. This statement is not expected to have a material impact on the Company. 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 fair value of the investment portfolio are related to the yields available in the fixed-income markets. An increase in interest rates will decrease the fair value of the investment portfolio, but will increase investment income as investments mature and proceeds are reinvested at higher rates. Third, as interest rates increase, competitors will typically increase crediting rates on annuity and interest-sensitive life products, and may lower premium rates on property and casualty lines to reflect the higher yields available in the market. The risk of interest rate fluctuation is managed through asset/liability management techniques, including cash flow analysis. F-35 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 of America. 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-36 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, 2001, 2000 and 1999, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for the years ended December 31, 2001, 2000 and 1999 have been prepared by management, which is responsible for their integrity and reliability. The statements have been prepared in accordance with accounting principles generally accepted in the United States of America 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 auditing standards generally accepted in the United States of America, which includes the consideration of the system of internal control to the extent necessary to form an independent opinion on the fairness of presentation of the financial statements prepared by management. The Board of Directors, through its Audit Committee composed solely of directors who are not employees of the Company, is responsible for overseeing the integrity and reliability of the Company's accounting and financial reporting practices and the effectiveness of its system of internal controls. The independent certified public accountants and internal auditors meet regularly with this committee, and have access to this committee with and without management present, to discuss the results of their audit work. F-37 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, 2001, 2000 and 1999, 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, 2001. 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 auditing standards generally accepted in the United States of America. 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, 2001, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. 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 February 7, 2002 F-38 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED BALANCE SHEETS As of December 31, 2001, 2000 and 1999 (Dollars in thousands)
2001 2000 1999 ----------- ----------- ----------- ASSETS Investments Fixed maturities, available for sale, at fair value (amortized cost 2001, $2,726,831; 2000, $2,615,156; 1999, $2,575,403) ........................ $ 2,769,867 $ 2,607,738 $ 2,507,280 Short-term and other investments ....................... 107,445 99,728 122,929 Short-term investments, loaned securities collateral ... 98,369 204,881 -- ----------- ----------- ----------- Total investments ................................. 2,975,681 2,912,347 2,630,209 Cash ..................................................... 33,939 21,141 22,848 Accrued investment income and premiums receivable ........ 112,746 101,405 92,755 Value of acquired insurance in force and goodwill ........ 85,789 92,260 102,068 Deferred policy acquisition costs ........................ 157,776 141,604 130,192 Other assets ............................................. 114,665 116,756 144,061 Variable annuity assets .................................. 1,008,430 1,035,067 1,131,713 ----------- ----------- ----------- Total assets ...................................... $ 4,489,026 $ 4,420,580 $ 4,253,846 =========== =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities Fixed annuity contract liabilities .................... $ 1,278,137 $ 1,217,756 $ 1,238,379 Interest-sensitive life contract liabilities .......... 518,455 481,140 443,309 Unpaid claims and claim expenses ...................... 314,295 308,881 309,604 Future policy benefits ................................ 179,109 180,049 179,157 Unearned premiums ..................................... 185,569 174,428 170,845 ----------- ----------- ----------- Total policy liabilities .......................... 2,475,565 2,362,254 2,341,294 Other policyholder funds ................................. 123,434 122,233 126,530 Other liabilities ........................................ 269,640 324,312 110,698 Short-term debt .......................................... 53,000 49,000 49,000 Long-term debt ........................................... 99,767 99,721 99,677 Variable annuity liabilities ............................. 1,008,430 1,035,067 1,126,505 ----------- ----------- ----------- Total liabilities ................................. 4,029,836 3,992,587 3,853,704 ----------- ----------- ----------- 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, 2001, 60,076,921; 2000, 59,859,053; 1999, 59,292,053 .................... 60 60 59 Additional paid-in capital ............................... 341,052 338,243 333,892 Retained earnings ........................................ 461,139 452,624 449,023 Accumulated other comprehensive income (loss), net of taxes: Net unrealized gains (losses) on fixed maturities and equity securities .................. 26,336 (4,038) (40,016) Minimum pension liability adjustment ................ (11,438) (937) -- Treasury stock, at cost, 2001 and 2000, 19,341,296 shares; 1999, 18,258,896 shares ....................... (357,959) (357,959) (342,816) ----------- ----------- ----------- Total shareholders' equity ........................ 459,190 427,993 400,142 ----------- ----------- ----------- Total liabilities and shareholders' equity ........ $ 4,489,026 $ 4,420,580 $ 4,253,846 =========== =========== ===========
See accompanying notes to consolidated financial statements. F-39 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share data)
Year Ended December 31, -------------------------------------------- 2001 2000 1999 ------------ ------------ ------------ Insurance premiums written and contract deposits ... $ 875,566 $ 821,653 $ 821,209 ============ ============ ============ Revenues Insurance premiums and contract charges earned .. $ 615,242 $ 598,714 $ 595,128 Net investment income ........................... 199,267 192,396 188,267 Realized investment losses ...................... (10,019) (9,906) (7,969) ------------ ------------ ------------ Total revenues .............................. 804,490 781,204 775,426 ------------ ------------ ------------ Benefits, losses and expenses Benefits, claims and settlement expenses ........ 475,583 466,048 416,186 Interest credited ............................... 96,502 92,561 91,629 Policy acquisition expenses amortized ........... 58,048 55,972 53,041 Operating expenses .............................. 123,679 127,910 109,694 Amortization of intangible assets ............... 5,774 8,769 215 Interest expense ................................ 9,250 10,204 9,722 Restructuring charges ........................... 7,312 2,236 -- Litigation charges .............................. -- 7,783 1,585 ------------ ------------ ------------ Total benefits, losses and expenses ......... 776,148 771,483 682,072 ------------ ------------ ------------ Income before income taxes ......................... 28,342 9,721 93,354 Income tax expense (benefit) ....................... 4,024 (2,438) 28,849 Provision for prior years' taxes ................... (1,269) (8,682) 20,000 ------------ ------------ ------------ Net income ......................................... $ 25,587 $ 20,841 $ 44,505 ============ ============ ============ Earnings per share Basic ........................................... $ 0.63 $ 0.51 $ 1.08 ============ ============ ============ Diluted ......................................... $ 0.63 $ 0.51 $ 1.07 ============ ============ ============ Weighted average number of shares and equivalent shares Basic ....................................... 40,616,843 40,782,173 41,245,633 Diluted ..................................... 40,877,120 40,966,774 41,708,439
See accompanying notes to consolidated financial statements. F-40 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in thousands, except per share data)
Year Ended December 31, ----------------------------------- 2001 2000 1999 --------- --------- --------- Common stock Beginning balance ....................................... $ 60 $ 59 $ 59 Options exercised, 2001, 207,575 shares; 2000, 557,000 shares; 1999, 17,363 shares; and shares awarded; 2000, 10,000 shares ................... -- 1 -- Conversion of Director Stock Plan units, 2001, 10,293 shares ......................................... -- -- -- --------- --------- --------- Ending balance .......................................... 60 60 59 --------- --------- --------- Additional paid-in capital Beginning balance ....................................... 338,243 333,892 336,686 Options exercised, conversion of Director Stock Plan units and shares awarded ................... 3,759 5,301 362 Catastrophe-linked equity put option premium ............ (950) (950) (950) Purchase of 8,450 warrants in 1999 ...................... -- -- (2,206) --------- --------- --------- Ending balance .......................................... 341,052 338,243 333,892 --------- --------- --------- Retained earnings Beginning balance ....................................... 452,624 449,023 420,274 Net income .............................................. 25,587 20,841 44,505 Cash dividends, 2001, $0.42 per share; 2000, $0.42 per share; 1999, $0.3825 per share .............. (17,072) (17,240) (15,756) --------- --------- --------- Ending balance .......................................... 461,139 452,624 449,023 --------- --------- --------- Accumulated other comprehensive income (loss), net of taxes: Beginning balance ..................................... (4,975) (40,016) 57,327 Change in net unrealized gains (losses) on fixed maturities and equity securities .................... 30,374 35,978 (97,343) Increase in minimum pension liability adjustment ................................ (10,501) (937) -- --------- --------- --------- Ending balance ........................................ 14,898 (4,975) (40,016) --------- --------- --------- Treasury stock, at cost Beginning balance, 2001, 19,341,296 shares, 2000, 18,258,896 shares; 1999, 17,183,596 shares ............ (357,959) (342,816) (317,723) Purchase of 1,082,400 shares in 2000; 1,075,300 shares in 1999 (See note 5) ........................... -- (15,143) (25,093) --------- --------- --------- Ending balance 2001 and 2000, 19,341,296 shares; 1999, 18,258,896 shares ............................... (357,959) (357,959) (342,816) --------- --------- --------- Shareholders' equity at end of period ...................... $ 459,190 $ 427,993 $ 400,142 ========= ========= ========= Comprehensive income (loss) Net income .............................................. $ 25,587 $ 20,841 $ 44,505 Other comprehensive income (loss), net of tax: Change in net unrealized gains (losses) on fixed maturities and equity securities ........... 30,374 35,978 (97,343) Increase in minimum pension liability adjustment ................................ (10,501) (937) -- --------- --------- --------- Other comprehensive income (loss) ................. 19,873 35,041 (97,343) --------- --------- --------- Total ........................................... $ 45,460 $ 55,882 $ (52,838) ========= ========= =========
See accompanying notes to consolidated financial statements. F-41 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
Year Ended December 31, ------------------------------------- 2001 2000 1999 ----------- --------- --------- Cash flows from operating activities Premiums collected ............................. $ 642,596 $ 618,253 $ 623,762 Policyholder benefits paid ..................... (487,619) (465,414) (453,353) Policy acquisition and other operating expenses paid ................ (193,713) (187,248) (179,951) Federal income taxes recovered (paid) .......... 7,520 (16,101) (16,600) Investment income collected .................... 195,086 191,103 186,824 Interest expense paid .......................... (9,091) (10,028) (9,523) Other .......................................... (5,922) (6,317) (3,013) ----------- --------- --------- Net cash provided by operating activities .. 148,857 124,248 148,146 ----------- --------- --------- Cash flows used in investing activities Fixed maturities Purchases .................................... (1,140,930) (750,928) (698,847) Sales ........................................ 732,076 464,305 388,644 Maturities ................................... 283,153 243,618 286,758 Net cash (used for) provided by short-term and other investments ............. (2,107) 26,814 (18,524) ----------- --------- --------- Net cash used in investing activities ...... (127,808) (16,191) (41,969) ----------- --------- --------- Cash flows used in financing activities Purchase of treasury stock ..................... -- (15,143) (25,093) Dividends paid to shareholders ................. (17,072) (17,240) (15,756) Principal borrowings (payments) on Bank Credit Facility ...................... 4,000 -- (1,000) Repurchase of common stock warrants ............ -- -- (2,426) Exercise of stock options ...................... 3,759 5,302 362 Catastrophe-linked equity put option premium ... (950) (950) (950) Annuity contracts, variable and fixed Deposits ..................................... 239,124 206,393 205,684 Maturities and withdrawals ................... (178,364) (312,365) (247,212) Net transfer (to) from variable annuity assets (53,550) 28,437 (7,676) Net decrease in interest-sensitive life account balances ........................ (5,198) (4,198) (1,306) ----------- --------- --------- Net cash used in financing activities ...... (8,251) (109,764) (95,373) ----------- --------- --------- Net increase (decrease) in cash ................... 12,798 (1,707) 10,804 Cash at beginning of period ....................... 21,141 22,848 12,044 ----------- --------- --------- Cash at end of period ............................. $ 33,939 $ 21,141 $ 22,848 =========== ========= =========
See accompanying notes to consolidated financial statements. F-42 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("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"). HMEC and its subsidiaries have common management, share office facilities and are parties to several intercompany service agreements for management, administrative, data processing, agent commissions, agency services, utilization of personnel and investment advisory services. Under these agreements, costs have been allocated among the companies in conformity with customary insurance accounting practices consistently applied. In addition, certain of the subsidiaries have entered into intercompany reinsurance agreements. HMEC and its subsidiaries file a consolidated federal income tax return, and there are related tax sharing agreements. 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. The Company's principal operating subsidiaries are Horace Mann Life Insurance Company, Horace Mann Insurance Company, Teachers Insurance Company, Horace Mann Property & Casualty Insurance Company (formerly Allegiance Insurance Company) and Horace Mann Lloyds. Investments The Company invests primarily in fixed maturity investments. These securities are classified as available for sale and carried at fair value. The net adjustment for unrealized gains and losses on securities available for sale, carried at fair value, 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. F-43 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) 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 fair 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 fair value; and equity securities, carried at fair value. Interest income is recognized as earned. Investment income reflects amortization of premiums and accrual of discounts on an effective-yield basis. Realized gains and losses arising from the sale of securities are determined based upon specific identification of securities sold. The Company reviews the fair value of the investment portfolio on a monthly basis to determine if there are any securities that have fallen below 80% of book value. This review, in conjunction with the Company's investment managers' monthly credit reports and current market data, is the basis for determining if a security has suffered an other-than-temporary decline in value. A write-down is recorded when such decline in value is deemed to be other-than-temporary, with the realized investment loss reflected in the Statement of Operations for the period. Deferred Policy Acquisition Costs Deferred policy acquisition costs net of accumulated amortization were $157,776, $141,604 and $130,192 as of December 31, 2001, 2000 and 1999, 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). The Company periodically reviews the assumptions and estimates used in capitalizing policy acquisition costs, and also periodically reviews its estimations of future gross profits. The most significant assumptions that are involved in the estimation of future gross profits include future market performance and business surrender/lapse rates. In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company may be required to record a material charge or credit to amortization expense for the period in which the adjustment is made. F-44 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) Deferred policy acquisition costs for interest-sensitive life and investment contracts are adjusted for the impact on estimated future gross profits as if net unrealized investment gains and losses had been realized at the balance sheet date. The impact of this adjustment is included in net unrealized gains and losses within shareholders' equity. Deferred acquisition costs are reviewed for recoverability from future income, including investment income, and costs which are deemed unrecoverable are expensed in the period in which the determination is made. No such costs have been deemed unrecoverable during the periods reported. When the Company was acquired in 1989, deferred acquisition costs were reduced to zero in connection with establishing the value of acquired insurance in force in the application of purchase accounting. Property and Equipment Property and equipment are carried at cost less accumulated depreciation and are included in other assets in the Consolidated Balance Sheets. Depreciation and amortization are calculated on the straight-line method based on the estimated useful lives of the assets.
December 31, ----------------------------- 2001 2000 1999 ------- ------- ------- Property and equipment .................. $68,160 $62,652 $60,907 Less: accumulated depreciation .......... 38,625 33,025 30,543 ------- ------- ------- Total ................................. $29,535 $29,627 $30,364 ======= ======= =======
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 Horace Mann Property & Casualty Insurance Company (formerly Allegiance Insurance Company). The value of acquired insurance in force by operating segment and goodwill, net of amortization, were as follows:
December 31, -------------------------------- 2001 2000 1999 ------- ------- -------- Value of acquired insurance in force Life .................................... $10,595 $12,434 $ 14,409 Annuity ................................. 27,798 30,812 37,027 ------- ------- -------- Subtotal ............................. 38,393 43,246 51,436 Goodwill .................................. 47,396 49,014 50,632 ------- ------- -------- Total ................................ $85,789 $92,260 $102,068 ======= ======= ========
F-45 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) 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 has been amortized over 40 years on a straight-line basis through December 31, 2001. In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets", effective for fiscal years beginning after December 15, 2001. Goodwill and certain intangible assets will remain on the balance sheet and not be amortized. SFAS No. 142 establishes a new method of testing goodwill for impairment. On an annual basis, and when there is reason to suspect that their values may have been diminished or impaired, these assets must be tested for impairment. The amount of goodwill determined to be impaired will be expensed to current operations. The Company has not determined the impact, if any, that the goodwill impairment testing prescribed by these statements will have on its consolidated financial position or results of operations. Goodwill amortization was $1,618 for each of the years ended December 31, 2001, 2000 and 1999. For the amortization of the value of acquired insurance in force, the Company periodically reviews its estimates of future gross profits. The most significant assumptions that are involved in the estimation of future gross profits include future market performance and business surrender/lapse rates. In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company may be required to record a material charge or credit to amortization expense for the period in which the adjustment is made. 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. Scheduled amortization of the December 31, 2001 balances of value of acquired insurance in force by segment over the next five years is as follows:
Year Ended December 31, ------------------------------------------ 2002 2003 2004 2005 2006 ------ ------ ------ ------ ------ Scheduled amortization of: Value of acquired insurance in force Life ............................ $1,726 $1,625 $1,537 $1,460 $1,394 Annuity ......................... 3,779 3,785 3,917 4,037 4,140 ------ ------ ------ ------ ------ Total ......................... $5,505 $5,410 $5,454 $5,497 $5,534 ====== ====== ====== ====== ======
F-46 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) The amount of interest accrued on the unamortized balance of value of acquired insurance in force and the interest accrual rates were as follows:
Year Ended December 31, --------------------------- 2001 2000 1999 ------ ------ ------- Interest accrued on the unamortized balance of value of acquired insurance in force Life ........................................ $ 906 $1,069 $1,248 Annuity ..................................... 1,639 1,754 2,052 ------ ------ ------ Total ..................................... $2,545 $2,823 $3,300 ====== ====== ====== Interest accrual rate Life ........................................... 7.9% 8.0% 8.1% Annuity ........................................ 5.7% 5.6% 5.6%
The accumulated amortization of intangibles as of December 31, 2001, 2000 and 1999 was $146,375, $140,601 and $131,832, respectively. F-47 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) Variable Annuity Assets and Liabilities Variable annuity assets, carried at market value, and liabilities represent tax-qualified variable annuity funds invested in various mutual funds, including the Horace Mann mutual funds. In September 2000, the Company introduced 21 new investment options in its tax-deferred annuity product line. Variable annuity assets were invested in the offered mutual funds as follows:
December 31, ------------------------------------ 2001 2000 1999 ---------- ---------- ---------- Horace Mann Equity Fund (formerly Horace Mann Growth Fund) .......................... $ 376,081 $ 428,821 $ 566,932 Horace Mann Balanced Fund ..................................... 292,126 315,015 404,712 Horace Mann Socially Responsible Fund ......................... 71,610 75,782 59,129 Horace Mann Small Cap Growth Fund ............................. 58,395 83,304 60,042 Horace Mann International Equity Fund ......................... 33,491 42,512 26,040 Wilshire Large Company Growth Portfolio - Institutional and Investment ................................ 22,823 19,036 -- Wilshire 5000 Index Portfolio - Institutional and Investment... 19,806 16,829 -- Fidelity VIP Growth Portfolio ................................. 14,852 7,041 -- Horace Mann Income Fund ....................................... 13,996 11,376 13,237 Fidelity VIP Index 500 Portfolio .............................. 12,105 4,915 -- Fidelity VIP Mid Cap Portfolio ................................ 11,368 4,690 -- Alliance Premier Growth Portfolio ............................. 9,270 4,142 -- J.P. Morgan U.S. Disciplined Equity Portfolio ................. 5,738 1,845 -- Wilshire Large Company Value Portfolio ........................ 5,546 500 -- T. Rowe Price Small-Cap Stock Fund ............................ 5,303 1,251 -- Strong Opportunity Fund II .................................... 5,079 1,299 -- T. Rowe Price Small Cap Value Fund ............................ 4,932 343 -- Strong Mid Cap Growth Fund II ................................. 4,919 3,397 -- Putnam VT Vista Fund .......................................... 4,502 2,869 -- Neuberger Berman Genesis Assets Account ....................... 4,369 252 -- Ariel Appreciation Fund ....................................... 4,351 -- -- Fidelity VIP Investment Grade Bond Portfolio .................. 3,797 312 -- Rainier Small/Mid Cap Equity Portfolio ........................ 3,579 1,444 -- Davis Value Portfolio ......................................... 3,566 1,489 -- Fidelity VIP Overseas Portfolio ............................... 3,339 1,410 -- Fidelity VIP Growth & Income Portfolio ........................ 3,152 820 -- Credit Suisse Small Cap Growth Portfolio ...................... 2,926 1,640 -- Horace Mann Short-Term Investment Fund ........................ 2,797 2,274 1,621 Ariel Fund .................................................... 2,499 -- -- Wilshire Small Company Value Portfolio ........................ 1,279 70 -- Wilshire Small Company Growth Portfolio ....................... 428 128 -- Fidelity VIP High Income Portfolio ............................ 406 261 -- ---------- ---------- ---------- Total variable annuity assets ............................... $1,008,430 $1,035,067 $1,131,713 ========== ========== ==========
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-48 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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. At December 31, 2001, 99.3% of the Company's liabilities for property and casualty unpaid claims and claim expenses were carried at the full value of estimated liabilities and were 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. In the fourth quarter of 2000, the Company conducted a comprehensive review of all components of its property and casualty reserves. As a result of that review, the Company recorded a net strengthening of these reserves in 2000 of $22,658, as shown in the reconciliation of beginning and ending reserves located within this Note to Financial Statements. The strengthening primarily reflected a $17,000 reduction of ceded reserves. This reduction of the ceded reserves was related to automobile facility business in four states, primarily Massachusetts. F-49 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) The remaining net strengthening of prior years' reserves was primarily in the automobile line of business and was based on the further analysis of adverse trends which emerged in 2000. In 2001, the Company recorded a net strengthening of property and casualty reserves of $16,574. During the first half of 2001, the Company continued to refine its process and methods for evaluating property and casualty reserves and selected a new independent property and casualty actuarial consulting firm. During the second quarter of 2001, a comprehensive review of property and casualty loss reserving methodologies and assumptions was completed in conjunction with the new actuarial firm. Based on management's review of this further enhanced analysis and the opinion of the new actuarial firm, prior years' net reserves, predominantly related to 1999 and prior accident years, were increased by $11,000 at June 30, 2001. This consisted primarily of an $8,000 reduction in reserves to be ceded by the Company to its reinsurers and reinsurance facilities, including $1,500 related to the Company's automobile residual market business, primarily in Massachusetts; $2,000 for its voluntary automobile ceded excess liability coverage; and approximately $4,500 related to its educators excess professional liability product. At December 31, 2001, the Company increased reserves for property and casualty claims occurring in prior years by an additional $4,700. Ceded and assumed reserves were strengthened by $6,400, primarily as a result of an updated review of subrogation recovery activity on business ceded to the state automobile insurance facility in Massachusetts. That strengthening was partially offset by $1,700 of favorable development of reserves on the Company's direct automobile business. No other 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 other than claims under homeowners insurance policies for environmentally-related items such as toxic mold. Management believes that, based on data currently available, it has reasonably estimated the Company's ultimate losses. F-50 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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, ------------------------------- 2001 2000 1999 -------- -------- --------- Gross reserves, beginning of year ................... $298,896 $299,803 $ 298,929 Less reinsurance recoverables ..................... 49,056 64,410 55,890 -------- -------- --------- Net reserves, beginning of year ..................... 249,840 235,393 243,039 -------- -------- --------- Incurred claims and claims expense: Claims occurring in the current year .............. 416,770 394,711 379,455 Increase (decrease) in estimated reserves for claims occurring in prior years(1): Policies written by the Company .............. 14,574 20,858 (7,583) Business assumed from state reinsurance facilities ..................... 2,000 1,800 3,000 -------- -------- --------- Total increase (decrease) ................ 16,574 22,658 (4,583) -------- -------- --------- Total claims and claims expense incurred(2)... 433,344 417,369 374,872 -------- -------- --------- Claims and claims expense payments for claims occurring during: Current year ................................... 255,939 247,286 240,045 Prior years .................................... 155,208 155,636 142,473 -------- -------- --------- Total claims and claims expense payments ..... 411,147 402,922 382,518 -------- -------- --------- Net reserves, end of period ......................... 272,037 249,840 235,393 Plus reinsurance recoverables ..................... 34,104 49,056 64,410 -------- -------- --------- Gross reserves, end of period(3) .................... $306,141 $298,896 $ 299,803 ======== ======== =========
- ---------- (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. Also refer to the second paragraph preceding this table for additional information regarding the increases in reserves recorded in 2001 and 2000. (2) Benefits, claims and settlement expenses as reported in the Consolidated Statements of Operations also include life, annuity, group accident and health and corporate amounts of $42,239, $48,679 and $41,314 for the years ended December 31, 2001, 2000 and 1999, respectively, in addition to the property and casualty amounts. (3) Unpaid claims and claims expense as reported in the Consolidated Balance Sheets also include life, annuity, and group accident and health reserves of $8,154, $9,985 and $9,801 at December 31, 2001, 2000 and 1999, respectively, in addition to property and casualty reserves. F-51 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) 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, ------------------------------ 2001 2000 1999 -------- -------- -------- Claims and claims expense incurred ...... $433,344 $417,369 $374,872 Amount attributable to catastrophes ..... 11,215 16,122 19,371 -------- -------- -------- Excluding catastrophes ................ $422,129 $401,247 $355,501 ======== ======== ======== Claims and claims expense payments ...... $411,147 $402,922 $382,518 Amount attributable to catastrophes ..... 14,200 14,200 17,400 -------- -------- -------- Excluding catastrophes ................ $396,947 $388,722 $365,118 ======== ======== ========
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 earned. 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. F-52 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) 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, --------------------------------- 2001 2000 1999 --------- --------- --------- Net income As reported................ $ 25,587 $ 20,841 $ 44,505 Pro forma(1)............... $ 21,169 $ 18,995 $ 42,907 Basic net income per share As reported................ $ 0.63 $ 0.51 $ 1.08 Pro forma.................. $ 0.52 $ 0.47 $ 1.04 Diluted net income per share As reported................ $ 0.63 $ 0.51 $ 1.07 Pro forma.................. $ 0.52 $ 0.46 $ 1.03
- ---------- (1) The fair value of each option grant was estimated on the date of grant using the Modified Roll-Geske option-pricing model with the following weighted average assumptions for 2001, 2000 and 1999, respectively: risk-free interest rates of 5.1%, 5.9% and 5.9%; dividend yield of 2.3%, 2.4% and 1.9%; expected lives of 10 years; and volatility of 46.0%, 53.2% and 50.3%. 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, 2001, 2000 and 1999 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 versus financial statement basis. Deferred tax assets and liabilities include provisions for unrealized investment gains and losses with the change for each period included in the net unrealized gains and losses component of accumulated other comprehensive income (loss) 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. F-53 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies-(Continued) The computations of net income per share on both basic and diluted bases, including reconciliations of the numerators and denominators, were as follows:
Year Ended December 31, --------------------------- 2001 2000 1999 ------- ------- ------- Basic - assumes no dilution: Net income for the period ........................ $25,587 $20,841 $44,505 ------- ------- ------- Weighted average number of common shares outstanding during the period ........... 40,617 40,782 41,246 ------- ------- ------- Net income per share - basic .................... $ 0.63 $ 0.51 $ 1.08 ======= ======= ======= Diluted - assumes full dilution: Net income for the period ........................ $25,587 $20,841 $44,505 ------- ------- ------- Weighted average number of common shares outstanding during the period .................. 40,617 40,782 41,246 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: Stock options ............................... 125 62 387 Common stock units related to Deferred Equity Compensation Plan for Directors . 121 114 69 Common stock units related to Deferred Compensation Plan for Employees ........ 14 9 6 ------- ------- ------- Total common and common equivalent shares adjusted to calculate diluted earnings per share ....... 40,877 40,967 41,708 ------- ------- ------- Net income per share - diluted ................... $ 0.63 $ 0.51 $ 1.07 ======= ======= =======
Options to purchase 1,101,025 shares of common stock at $19.34 to $33.87 per share were granted during 1997, 1998, 1999 and 2001 but were not included in the computation of 2001 diluted earnings per share because the options' exercise price was greater than the average market price of the common shares during 2001. The options, which expire in 2007, 2008, 2009 and 2011, were still outstanding at December 31, 2001. 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 and the change in the minimum pension liability adjustment for the period as shown in the Statement of Changes in Shareholders' Equity. F-54 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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, ------------------------------- 2001 2000 1999 -------- -------- --------- Net income ................................................. $ 25,587 $ 20,841 $ 44,505 -------- -------- --------- Other comprehensive income (loss): Change in net unrealized gains (losses) on fixed maturities and equity securities Unrealized holding gains (losses) on fixed maturities and equity securities arising during period ....... 32,337 43,177 (158,423) Less: reclassification adjustment for losses included in net income ..................... (14,392) (12,174) (8,664) -------- -------- --------- Total, before tax ............................... 46,729 55,351 (149,759) Income tax expense (benefit) .................... 16,355 19,373 (52,416) -------- -------- --------- Total, net of tax ............................. 30,374 35,978 (97,343) -------- -------- --------- Increase in minimum pension liability adjustment Before tax .......................................... (16,156) (1,441) -- Income tax benefit .................................. (5,655) (504) -- -------- -------- --------- Total, net of tax ............................. (10,501) (937) -- -------- -------- --------- Total comprehensive income (loss) ............. $ 45,460 $ 55,882 $ (52,838) ======== ======== =========
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 2001 presentation. NOTE 2 - Restructuring Charges Restructuring charges were incurred and separately identified in the Statements of Operations for the years ended December 31, 2001 and 2000. Massachusetts Automobile Business In October 2001, the Company recorded restructuring charges of $7,290 pretax ($4,738, or $0.12 per share, after tax) reflecting a change in the Company's presence in the Massachusetts automobile market. On October 18, 2001, Horace Mann announced that it had formed a marketing alliance with The Commerce Group, Inc. ("Commerce") for the sale of automobile insurance in the state of Massachusetts. Through this alliance, and by January 1, 2002, Horace Mann began providing its Massachusetts customers with Commerce automobile insurance policies, while continuing to write other Horace Mann products, including property and life insurance and retirement annuities. F-55 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 2 - Restructuring Charges-(Continued) Horace Mann ceased writing automobile insurance policies in Massachusetts by December 31, 2001, and on October 18, 2001 paid $6,438 to the Commonwealth Automobile Reinsurers ("C.A.R.") as full payment of its proportionate liability to C.A.R. for policy years 2002 and beyond. The Company also paid legal and other related consulting costs totaling $506 pretax. The remaining $346 was attributable primarily to the write-off of software used only to process Massachusetts automobile business. The Company anticipates that this restructuring will result in elimination of approximately 30 positions, primarily in a claims-handling office located in Massachusetts, although specific termination plans were not determined by December 31, 2001. The Company's Consolidated Balance Sheet at December 31, 2001 did not reflect any accrued amounts due to the restructure of its Massachusetts automobile business. The Company expects that this transaction will have a positive impact on operating income of approximately $0.10 per share in 2003 and beyond. The improvement in 2002 earnings will be somewhat less reflecting the run-off of current policies in force. The Company plans to utilize the benefits of this transaction to invest in its marketing, customer service and technology infrastructures. On a full year basis, the Company's Massachusetts automobile business has represented premiums written and earned of approximately $27,000 in 2001. In 2002, premiums written for this business will be reduced to zero, and premiums earned will be reduced significantly reflecting run-off of the policies in force at December 31, 2001. For the full year 2001, claims and settlement expenses in Massachusetts for voluntary automobile business were $9,137 and for involuntary residual market business were $11,455. Claims and settlement expenses in 2002 will reflect run-off of the business and a decline in exposure to loss, as the policies written as the Company's risk expire. Printing Services Operations In November 2001, the Company recorded restructuring charges of $450 pretax ($293, less than $0.01 per share, after tax) reflecting the decision to close its on-site printing services operations based on a cost benefit analysis. Employee termination costs, for termination of 13 individuals, which represented severance, vacation buy-out and related payroll taxes represented $409 of the total charge. The eliminated positions encompass management, technical and clerical responsibilities. The remaining $41 was attributable primarily to the write-off of equipment related to this function. Group Insurance and Credit Union Marketing Operations In December 2000, the Company recorded restructuring charges of $2,236 pretax ($1,453, or $0.04 per share, after tax) reflecting two changes in the Company's operations. Specifically, the Company restructured the operations of its group insurance business, thereby eliminating 39 jobs, and its credit union marketing group, eliminating 20 additional positions. The changes will F-56 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 2 - Restructuring Charges-(Continued) improve business results and more closely align these functions with the Company's strategic direction. Employee termination costs, for termination of an estimated 50 individuals, represented severance, vacation buy-out and related payroll taxes. The eliminated positions encompass management, professional and clerical responsibilities. As of December 31, 2001, 39 individuals have been terminated with two additional terminations scheduled in 2002. Termination of lease agreements represented office space used by the credit union marketing group. The remaining charge was attributable primarily to the write-off of software related to these two areas. The following table provides information about the components of the charge taken in December 2000, the balance of accrued amounts at December 31, 2000 and 2001, and payment activity during the year ended December 31, 2001. The adjustment to employee termination costs during the year ended December 31, 2001 reflected placement of nine individuals from terminated positions into other open positions within the Company.
Original Reserve at Reserve at Pretax December 31, December 31, Charge 2000 Payments Adjustments 2001 -------- ------------ -------- ----------- ------------ Charges to earnings: Employee termination costs ........ $ 1,827 $ 1,827 $ (970) $ (221) $ 636 Termination of lease agreements ...................... 285 285 (50) (235) -- Write-off of capitalized software ........................ 106 -- -- -- -- Other ............................. 18 18 (49) 31 -- ------- ------- ------- ------- ------- Total ........................ $ 2,236 $ 2,130 $(1,069) $ (425) $ 636 ======= ======= ======= ======= =======
NOTE 3 - Investments Net Investment Income The components of net investment income for the following periods were:
Year Ended December 31, ------------------------------ 2001 2000 1999 -------- -------- -------- Fixed maturities .............................. $192,547 $185,745 $182,561 Short-term and other investments .............. 10,346 10,220 9,212 -------- -------- -------- Total investment income ..................... 202,893 195,965 191,773 Less investment expenses ...................... 3,626 3,569 3,506 -------- -------- -------- Net investment income ....................... $199,267 $192,396 $188,267 ======== ======== ========
F-57 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 3 - Investments-(Continued) Realized Investment Gains (Losses) Realized investment gains (losses) for the following periods were:
Year Ended December 31, -------------------------------- 2001 2000 1999 -------- -------- -------- Fixed maturities ........................... $(14,371) $(12,906) $ (9,777) Short-term and other investments ........... 4,352 3,000 1,808 -------- -------- -------- Realized investment gains (losses) ....... $(10,019) $ (9,906) $ (7,969) ======== ======== ========
Fixed Maturity Securities The amortized cost, unrealized investment gains and losses, and fair values of investments in debt securities as of December 31, 2001, 2000 and 1999 were as follows:
Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ---------- ---------- As of December 31, 2001 U.S. government and agency obligations Mortgage-backed securities ........ $ 621,249 $ 15,353 $ 860 $ 635,742 Other ............................. 68,334 3,054 83 71,305 Municipal bonds ...................... 224,172 9,335 1,362 232,145 Foreign government bonds ............. 17,411 2,088 47 19,452 Corporate bonds ...................... 1,549,631 50,284 39,643 1,560,272 Other mortgage-backed securities ..... 246,034 6,748 1,831 250,951 ---------- ---------- ---------- ---------- Totals .......................... $2,726,831 $ 86,862 $ 43,826 $2,769,867 ========== ========== ========== ========== As of December 31, 2000 U.S. government and agency obligations Mortgage-backed securities ........ $ 495,696 $ 10,564 $ 1,655 $ 504,605 Other ............................. 124,611 2,507 1,060 126,058 Municipal bonds ...................... 286,384 10,329 1,658 295,055 Foreign government bonds ............. 29,310 1,873 563 30,620 Corporate bonds ...................... 1,280,269 24,682 54,329 1,250,622 Other mortgage-backed securities ..... 398,886 4,764 2,872 400,778 ---------- ---------- ---------- ---------- Totals .......................... $2,615,156 $ 54,719 $ 62,137 $2,607,738 ========== ========== ========== ========== 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 ========== ========== ========== ==========
The Company's investment portfolio includes no derivative financial instruments (futures, forwards, swaps, option contracts or other financial instruments with similar characteristics). F-58 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 3 - Investments-(Continued) Maturity/Sales Of Investments The fair value and amortized cost of fixed maturity securities at December 31, 2001, 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 Fair Fair Amortized Value Value Cost ---------- ---------- ---------- Due in 1 year or less .................... 4.0% $ 110,117 $ 108,597 Due after 1 year through 5 years ......... 23.0 638,089 625,401 Due after 5 years through 10 years ....... 29.9 826,615 814,228 Due after 10 years through 20 years ...... 14.8 410,305 405,401 Due after 20 years ....................... 28.3 784,741 773,204 ----- ---------- ---------- Total .................................. 100.0% $2,769,867 $2,726,831 ===== ========== ==========
Proceeds from sales/maturities of fixed maturities and gross gains and gross losses realized for each year were:
Year Ended December 31, ----------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Proceeds ..................... $ 1,015,229 $ 707,923 $ 675,402 Gross gains realized ......... 16,945 4,940 3,941 Gross losses realized ........ (31,316) (17,846) (13,718)
Unrealized Gains (Losses) on Fixed Maturities Net unrealized gains (losses) are computed as the difference between fair 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, ----------------------------------- 2001 2000 1999 --------- --------- --------- Unrealized gains (losses) on fixed maturities Beginning of period .............................. $ (7,418) $ (68,123) $ 98,842 End of period .................................... 43,036 (7,418) (68,123) --------- --------- --------- Increase (decrease) for the period ............ 50,454 60,705 (166,965) Income taxes (benefit) ............................. 17,659 21,247 (58,438) --------- --------- --------- 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 ................... $ 32,795 $ 39,458 $(108,527) ========= ========= =========
F-59 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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. As of December 31, 2001 and 2000, fixed maturities with a fair value of $98,369 and $204,881, respectively, were on loan. There were no securities on loan at December 31, 1999. The Company separately maintains a minimum of 100% of the value of the loaned securities as collateral for each loan. SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," as amended by SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," requires the securities lending collateral to be classified as investments with a corresponding liability included in Other Liabilities in the Company's Consolidated Balance Sheet. Investment in Entities Exceeding 10% of Shareholders' Equity At December 31, 2001, there were no investments which exceeded 10% of total shareholders' equity in entities other than obligations of the United States Government and government agencies and authorities. At December 31, 2000 and 1999, the Company's investment portfolio included $53,706 and $42,087, respectively, of fixed maturity securities issued by Ford Motor Company and its affiliates representing 12.5% and 10.5%, respectively, of shareholders' equity at those dates 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. Deposits At December 31, 2001, securities with a carrying value of $15,055 were on deposit with governmental agencies as required by law in various states in which the insurance subsidiaries of HMEC conduct business. NOTE 4 - Debt Indebtedness and scheduled maturities at December 31, 2001, 2000 and 1999 consisted of the following:
Effective December 31, Interest Final ------------------------------ Rates Maturity 2001 2000 1999 --------- -------- -------- -------- -------- Short-term debt: Bank Credit Facility ................... Variable 2002 $ 53,000 $ 49,000 $ 49,000 Long-term debt: 6 5/8% Senior Notes, Face amount less unaccrued discount of $233, $279 and $323, respectively .............. 6.7% 2006 99,767 99,721 99,677 -------- -------- -------- Total .......................... $152,767 $148,721 $148,677 ======== ======== ========
F-60 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 4 - Debt-(Continued) Issuance of 6 5/8% Senior Notes ("Senior Notes") and Redemption of Convertible Notes On January 17, 1996, the Company issued $100,000 face amount of Senior Notes at an effective yield of 6.7%, which will mature on January 15, 2006. The net proceeds from the sale of the Senior Notes were used to finance the redemption of the 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. The Company's earnings in the fourth quarter of 2000 could have caused a breach of a financial covenant of the Company's Bank Credit Facility in 2001 but, in the first quarter of 2001, the lender agreed to modify that covenant for the first, second and third quarters of 2001. As a result of earnings for the second quarter of 2001, and again based on third quarter 2001 earnings, the lender agreed to further modify that covenant. An amendment to the Bank Credit Agreement was made prior to December 31, 2001, which extended the maturity from December 31, 2001 to June 30, 2002. 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 0.4% at December 31, 2001, increasing to Interbank Offering Rate plus 0.75% effective January 1, 2002). The unused portion of the Bank Credit Facility is subject to a variable commitment fee which was 0.15% on an annual basis at December 31, 2001. The Company's obligations under the Bank Credit Facility are unsecured. The commitment for the Bank Credit Facility terminates on June 30, 2002. Management is reviewing its capital market alternatives and believes that the Company will be able to obtain replacement financing for the Bank Credit Facility. The Company cannot predict on what terms and conditions such financing would be available, and the availability of alternative financing, in the form of long-term debt instruments or a replacement credit facility, is always subject to prevailing market conditions at the time of securing such financing. Covenants The Company is in compliance with all of the covenants contained in the Senior Notes indenture and the Bank Credit Facility Agreement, consisting primarily of relationships of 1) debt to capital and 2) insurance subsidiaries' earnings to future interest charges. F-61 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 5 - Shareholders' Equity and Stock Options Share Repurchase Program During 2001, the Company did not repurchase shares of its common stock under its stock repurchase program consistent with management's stated intention to utilize excess capital to support the Company's strategic growth initiatives. Since early 1997, 8,165,100 shares, or 17% of the shares outstanding on December 31, 1996, have been repurchased at an aggregate cost of $203,657, equal to an average cost of $24.94 per share. Including shares repurchased in 1995, the Company has repurchased 33% 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. However, the Company has not utilized the Bank Credit Facility for share repurchases since the second quarter of 1999. As of December 31, 2001, $96,343 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, 2001, 2000 and 1999. Through December 31, 2001, the Company's catastrophe reinsurance programs were augmented by a $100,000 equity put and reinsurance agreement. This equity put provided 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 exceeded the catastrophe reinsurance program coverage limit. Before tax benefits, the equity put provided a source of capital for up to $154,000 of catastrophe losses above the reinsurance coverage limit. Fees related to this equity put option were charged directly to additional paid-in capital. In connection with the equity put described in the preceding paragraph, the Board of Directors has designated a series of preferred stock to be available for use in the put. The Series so designated is Series A Cumulative Convertible Preferred Stock (the "Series A Stock") and 100,000 shares have been assigned to this series. None are currently issued or outstanding. The Series A Stock is dividend paying, at a floating rate which varies with movements in the London Interbank Offered Rate and with changes in the risk rating of the Series A Stock as determined by Standard & Poor's Corporation. The Series A Stock does not require any sinking fund or similar mechanism regarding payment of such dividends. Beginning on the fourth anniversary of the issuance of Series A Stock, the holders thereof have the right to demand conversion of the Series A Stock into common stock of the Company at a conversion rate based on then prevailing F-62 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 5 - Shareholders' Equity and Stock Options-(Continued) market prices for the common stock; however, upon receipt of a conversion demand, the Company has the right to redeem the Series A Stock prior to such conversion. The Series A Stock has liquidation rights which place the Series A Stock ahead of the common stock in priority. The Series A Stock has no voting rights other than the requirement that the Series A Stock approve any changes in the Series A Stock, the creation of any other class of stock on a par with or superior to the Series A Stock and certain extraordinary transactions such as certain mergers involving the Company. At the time of this Report on Form 10-K, management is in what it believes to be the final stages of negotiating a replacement equity put and reinsurance agreement with a subsidiary of Swiss Reinsurance Company. The Swiss Re Group is rated "A++ (Superior)" by A.M. Best. The terms of the three year agreement are expected to be similar to the prior equity put and reinsurance agreement. Before tax benefits, the proposed equity put coverage of $75,000 would provide a source of capital for up to $115,000 of catastrophe losses above the reinsurance coverage limit. The Company would also have the option, in place of the equity put, to require the Swiss Re Group member to issue a 10% quota share reinsurance coverage of all of the Company's property and casualty book of business. Fees related to this equity put option, which are charged directly to additional paid-in capital, are estimated to increase to 145 basis points in 2002 from 95 basis points in 2001 under the prior agreement. An additional provision of this agreement would prevent Horace Mann's exercise of the option in the event it's S&P financial strength rating was below "BBB" prior to a triggering event. The Company's S&P financial strength rating was "A+" at December 31, 2001. 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, 2001, 2000 and 1999, 121,322, 113,944 and 68,822 units, respectively, were outstanding under this plan representing an equal number of common shares to be issued in the future. Employee Stock Plan In 1997, the Board of Directors of HMEC approved the Deferred Compensation Plan for Employees ("Employee Stock Plan"). Shares of the Company's common stock issued under the Employee Stock Plan may be either authorized and unissued shares or shares that have been reacquired by the Company. As of December 31, 2001, 2000 and 1999, 14,303, 8,507 and 5,613 units, respectively, were outstanding under this plan representing an equal number of common shares to be issued in the future. F-63 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 5 - Shareholders' Equity and Stock Options-(Continued) Stock Options In 1991, the shareholders approved the 1991 Stock Incentive Plan (the "1991 Plan") and reserved 4,000,000 shares of common stock for issuance under the 1991 Plan. In 2000, the shareholders approved an increase of 2,000,000 in the number of shares of common stock reserved for issuance under the 1991 Plan. In 2001, the shareholders approved the 2001 Stock Incentive Plan (the "2001 Plan") and reserved the shares of common stock remaining from the 1991 Plan for issuance under the 2001 Plan. Under the 1991 Plan and the 2001 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 under the 1991 Plan and the 2001 Plan 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, 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 --------- --------- ---------- Increase in options available for grant........ -- -- 2,000,000 Granted....................... $17.24 $13.84-$18.08 1,469,300 42,350 (1,469,300) Vested........................ $22.42-$33.87 -- 176,234 -- Exercised..................... $ 9.06 $ 9.00-$15.15 (557,000) (557,000) -- Canceled...................... $28.59 $22.42-$34.53 (27,650) (27,650) 27,650 ---------- ---------- ----------- At December 31, 2000............ $18.98 $ 9.00-$33.87 2,736,725 903,802 1,307,412 --------- --------- ---------- Granted....................... $18.22 $16.83-$21.77 1,020,050 271,775 (1,020,050) Vested........................ $19.72 $13.84-$33.87 -- 519,860 -- Exercised..................... $10.18 $ 9.00-$17.56 (207,575) (207,575) -- Canceled...................... $20.52 $15.32-$33.87 (136,950) (136,950) 136,950 --------- --------- ---------- At December 31, 2001............ $19.23 $11.12-$33.87 3,412,250 1,350,912 424,312 ========= ========= ==========
F-64 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 5 - Shareholders' Equity and Stock Options-(Continued) The weighted average prices of vested and exercisable options as of December 31, 2000 and 1999 were $20.19 and $14.70, respectively. For options outstanding at December 31, 2001, information segregated by ranges of exercise prices was as follows:
Vested and Exercisable Options ---------------------------------------- Weighted Average Range of Total Weighted Average Weighted Option Price Option Prices Options Option Price Average per Share per Share Outstanding Options per share Life ---------------- ------------- ----------- --------- ---------------- --------- $15.03 $11.12-$16.38 315,100 230,350 $14.77 3.1 years $18.59 $16.83-$23.31 2,862,700 886,112 $19.74 8.0 years $32.70 $25.63-$33.87 234,450 234,450 $32.70 6.3 years --------- --------- Total................. $19.23 $11.12-$33.87 3,412,250 1,350,912 $21.14 6.9 years ========= =========
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, 2001, 2000 and 1999 were as follows:
December 31, -------------------------------------- 2001 2000 1999 Current liability (asset) ......... $(12,469) $(10,012) $ 19,006 Deferred liability (asset) ........ 21,788 (203) (20,435)
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, 2001, 2000 and 1999 were as follows:
December 31, ------------------------------ 2001 2000 1999 ------- -------- -------- Deferred tax assets Unrealized losses on securities ........................... $ -- $ 2,949 $ 21,547 Discounting of unpaid claims and claims expense tax reserves ............................ 7,221 6,906 7,166 Life insurance future policy benefit reserve revaluation .. 10,921 13,808 17,195 Unearned premium reserve reduction ........................ 12,392 11,634 11,395 Postretirement benefits other than pension ................ 10,316 10,367 9,775 Other, net ................................................ 10,916 8,750 6,200 ------- -------- -------- Total gross deferred tax assets ...................... 51,766 54,414 73,278 ------- -------- -------- Deferred tax liabilities Unrealized gains on securities ............................ 14,181 -- -- Intangible assets ......................................... 13,438 15,070 17,573 Deferred policy acquisition costs ......................... 45,935 39,141 35,270 ------- -------- -------- Total gross deferred tax liabilities ................. 73,554 54,211 52,843 ------- -------- -------- Net deferred tax liability (asset) ................. $21,788 $ (203) $(20,435) ======= ======== ========
F-65 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 6 - Income Taxes-(Continued) Based on the Company's historical earnings, future expectations of adjusted taxable income, as well as reversing gross deferred tax liabilities, the Company believes it is more likely than not that gross deferred tax assets will be fully realized and that a valuation allowance with respect to the realization of the total gross deferred tax assets is not necessary. The components of federal income tax expense (benefit) were as follows:
Year Ended December 31, ------------------------------------- 2001 2000 1999 -------- -------- ------- Current ............................. $ (7,267) $ (5,104) $35,237 Deferred ............................ 10,022 (6,016) 13,612 -------- -------- ------- Total tax expense (benefit) ....... $ 2,755 $(11,120) $48,849 ======== ======== =======
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, ------------------------------- 2001 2000 1999 ------- -------- -------- Expected federal tax on income .................... $ 9,920 $ 3,402 $ 32,674 Add (deduct) tax effects of: Tax-exempt interest ............................. (3,786) (4,240) (4,293) Tax reserve release ............................. (3,034) -- -- 1994 and 1995 IRS audit - interest, net of tax .. -- (2,146) -- Goodwill ........................................ 566 566 566 Acquisition related benefits and other, net ..... 358 (20) (98) ------- -------- -------- Income tax expense (benefit) provided on income before provision for prior years' taxes ......... 4,024 (2,438) 28,849 Provision for prior years' taxes .................. (1,269) (8,682) 20,000 ------- -------- -------- Income tax expense (benefit) provided on income ... $ 2,755 $(11,120) $ 48,849 ======= ======== ========
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. In the third quarter of 1999, the Company recorded an additional federal income tax provision of $20,000 representing the maximum exposure of the Company to the IRS with regard to the issue for all of the past tax years in question (1994 through 1997). In 2000, the Company reached a final resolution with the IRS for the tax years 1994, 1995 and 1996 in an amount that was $8,682 less than was previously accrued. That amount was included in net income for the year ended December 31, 2000. In 2001, the Company's liability for the 1997 tax year was resolved, resulting in a release of $1,269 that had previously been accrued for that tax year. That amount was included in net income for the year ended December 31, 2001. F-66 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 7 - Fair Value of Financial Instruments Accounting principles generally accepted in the United States of America 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-67 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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, 2001, 2000 and 1999 consisted of the following:
December 31, --------------------------------------------------------------------------- 2001 2000 1999 ----------------------- ----------------------- ----------------------- Carrying Fair Carrying Fair Carrying Fair Amount Value Amount Value Amount Value ---------- ---------- ---------- ---------- ---------- ---------- Financial Assets Investments Fixed maturities ................... $2,769,867 $2,769,867 $2,607,738 $2,607,738 $2,507,280 $2,507,280 Short-term and other investments ... 107,445 109,208 99,728 102,520 122,929 125,316 Short-term investments, loaned securities collateral ..... 98,369 98,369 204,881 204,881 -- -- ---------- ---------- ---------- ---------- ---------- ---------- Total investments .............. 2,975,681 2,977,444 2,912,347 2,915,139 2,630,209 2,632,596 Cash .................................. 33,939 33,939 21,141 21,141 22,848 22,848 Financial Liabilities Policyholder account balances on interest-sensitive life contracts .. 94,594 92,527 94,775 92,684 94,141 92,048 Annuity contract liabilities .......... 1,278,137 1,074,525 1,217,756 1,017,044 1,238,379 1,052,732 Other policyholder funds .............. 123,434 123,434 122,233 122,233 126,530 126,530 Short-term debt ....................... 53,000 53,000 49,000 49,000 49,000 49,000 Long-term debt ........................ 99,767 101,840 99,721 92,674 99,677 89,613
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-68 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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 accounting principles generally accepted in the United States of America. 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, ----------------------------------- 2001 2000 1999 --------- --------- --------- Statutory capital and surplus of insurance subsidiaries ......... $ 403,015 $ 389,249 $ 387,081 Increase (decrease) due to: Deferred policy acquisition costs ............................. 157,776 141,604 130,192 Difference in policyholder reserves ........................... 4,276 (2,448) (7,514) Goodwill ...................................................... 47,396 49,014 50,632 Value of acquired insurance in force .......................... 38,393 43,246 51,436 Liability for postretirement benefits, other than pensions .... (29,602) (28,488) (27,257) Investment fair value adjustments on fixed maturities ............................ 43,036 (7,418) (68,123) Difference in investment reserves ............................. 22,520 21,403 27,726 Federal income tax liability .................................. (38,341) (6,866) (158) Non-admitted assets and other, net ............................ (4,705) 11,064 6,552 Shareholders' equity of parent company and non-insurance subsidiaries ................................. (31,807) (33,646) (1,748) Parent company short-term and long-term debt .................. (152,767) (148,721) (148,677) --------- --------- --------- Shareholders' equity as reported herein .................... $ 459,190 $ 427,993 $ 400,142 ========= ========= =========
Year Ended December 31, ----------------------------------- 2001 2000 1999 --------- --------- --------- Statutory net income of insurance subsidiaries .................. $ 15,146 $ 23,881 $ 75,722 Net loss of non-insurance companies ............................. (3,313) (17,853) (3,710) Interest expense ................................................ (9,250) (10,204) (9,722) Tax benefit of interest expense and other parent company current tax adjustments ........................ 10,954 15,539 (6,928) --------- --------- --------- Combined net income ............................................. 13,537 11,363 55,362 Increase (decrease) due to: Deferred policy acquisition costs ............................. 19,565 12,781 14,612 Policyholder benefits ......................................... 9,513 7,891 7,681 Federal income tax expense .................................... (13,850) (6,324) (3,090) Provision for prior years' taxes .............................. 1,269 8,682 (20,000) Amortization of intangible assets ............................. (5,774) (8,769) (215) Investment reserves ........................................... 5,425 (2,067) (7,931) Loss on group medical business, net of tax benefits ........... -- -- (376) Other adjustments, net ........................................ (4,098) (2,716) (1,538) --------- --------- --------- Net income as reported herein .............................. $ 25,587 $ 20,841 $ 44,505 ========= ========= =========
F-69 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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, California and Texas. The statutory financial statements of these subsidiaries are prepared in accordance with accounting practices prescribed or permitted by the Illinois Department of Insurance, the California Department of Insurance and the Texas 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 NAIC has codified statutory accounting practices, which constitute the only source of prescribed statutory accounting practices and were effective January 1, 2001. Codification changed prescribed statutory accounting practices and resulted in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements. The states of domicile of the Company's principal operating subsidiaries, Illinois, California and Texas, have adopted the NAIC's codification. As a result of adopting the NAIC codification, the Company's statutory surplus of its insurance subsidiaries increased approximately $19,000 primarily due to the allowance of deferred tax recoverables under codification. 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 2002 without prior approval is approximately $40,000. 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 defined benefit retirement plans are based on employees' years of service and compensation for the highest 36 consecutive months F-70 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued) of earnings under the plan. Effective April 1, 2002, current participants will stop accruing any new benefits under the defined benefit plans but will continue to retain the benefits they have accrued to date. 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. For employees hired prior to April 1, 1997, 6% of compensation will be contributed until the individual reaches 15 years of service, with contributions increasing to 7% thereafter. For employees hired after April 1, 1997, this percentage will remain fixed at 5% regardless of their years of service. Prior to April 1, 2002, retirement benefits to employees are paid first from their accumulated accounts under the defined contribution plan with the balance funded by the defined benefit and supplemental retirement plans. The Company's policy with respect to funding the defined benefit plan is to contribute amounts which are actuarially determined to provide the plan with sufficient assets to meet future benefit payments consistent with the funding requirements of federal laws and regulations. For the defined benefit plan, investments have been set aside in a trust fund. The supplemental retirement plans are non-qualified, unfunded plans. 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% (20% beginning April 1, 2002) of eligible compensation on a before tax basis. Through December 31, 2001, the Company contributed an amount equal to 50% of the first 6% of eligible compensation contributed each month by participating employees, and the Company contribution vested over 5 years at a rate of 20% per year of service. Beginning January 1, 2002, the Company established an automatic 3% company contribution of eligible earnings for all employees, which is 100% vested at the time of the contribution. Total pension and supplemental savings expense was $10,678, $11,783 and $9,593 for the years ended December 31, 2001, 2000 and 1999, respectively. Defined Contribution Plan Pension benefits under the defined contribution plan were fully funded and investments were set aside in a trust fund. None of the trust fund assets have been invested in shares of the Company's common stock. Contributions to employees' accounts under the defined contribution plan, which were expensed in the Company's Consolidated Statements of Operations, and total plan assets were as follows:
Year Ended December 31, -------------------------------- 2001 2000 1999 ---------- -------- -------- Contributions to employees accounts... $ 6,012 $ 5,626 $ 5,814 Total assets at the end of the year... 103,879 92,609 85,519
F-71 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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, -------------------------------- ------------------------------- 2001 2000 1999 2001 2000 1999 -------- -------- -------- -------- -------- ------- Change in benefit obligation: Benefit obligation at beginning of year .............. $ 50,830 $ 47,282 $ 49,446 $ 12,191 $ 8,775 $ 6,190 Service cost ......................................... 1,789 1,625 1,816 610 719 353 Interest cost ........................................ 3,518 3,525 3,351 840 855 616 Plan amendments ...................................... 980 -- -- (383) -- -- Actuarial (gain) loss ................................ 5,500 4,689 (3,291) 1,355 2,884 1,913 Benefits paid ........................................ (6,010) (6,291) (4,040) (997) (1,042) (297) Curtailment gain ..................................... (5,680) -- -- (9) -- -- -------- -------- -------- -------- -------- ------- Benefit obligation at end of year .................... $ 50,927 $ 50,830 $ 47,282 $ 13,607 $ 12,191 $ 8,775 ======== ======== ======== ======== ======== ======= Change in plan assets: Fair value of plan assets at beginning of year ....... $ 43,401 $ 52,966 $ 50,576 $ -- $ -- $ -- Actual return on plan assets ......................... (2,822) (3,274) 6,430 -- -- -- Employer contributions ............................... -- -- -- 997 1,042 297 Benefits paid ........................................ (6,010) (6,291) (4,040) (997) (1,042) (297) -------- -------- -------- -------- -------- ------- Fair value of plan assets at end of year ............. $ 34,569 $ 43,401 $ 52,966 $ -- $ -- $ -- ======== ======== ======== ======== ======== ======= Funded status .......................................... $(16,358) $ (7,429) $ 5,684 $(13,607) $(12,191) $(8,775) Unrecognized net actuarial (gain) loss ................. 14,967 8,304 (3,941) 2,603 1,431 493 Unrecognized prior service (asset) cost ................ -- (3,204) (3,815) -- 1,954 2,268 -------- -------- -------- -------- -------- ------- Accrued benefit cost included in the Consolidated Balance Sheets ................... (1,391) (2,329) (2,072) (11,004) (8,806) (6,014) Additional liability to recognize unfunded accumulated benefit obligation ....................... (14,967) -- -- (2,630) (3,358) (2,228) -------- -------- -------- -------- -------- ------- Total benefit cost ..................................... $(16,358) $ (2,329) $ (2,072) $(13,634) $(12,164) $(8,242) ======== ======== ======== ======== ======== ======= Amounts recognized in the Statements of Financial Position consist of: Accrued benefit cost .............................. $ (1,391) $ (2,329) $ (2,072) $(11,004) $ (8,806) $(6,014) Minimum liability ................................. (14,967) -- -- (2,630) (3,358) (2,228) Intangible asset .................................. -- -- -- -- 1,917 2,228 Accumulated other comprehensive income ............ 14,967 -- -- 2,630 1,441 -- -------- -------- -------- -------- -------- ------- Net amount recognized ........................... $ (1,391) $ (2,329) $ (2,072) $(11,004) $ (8,806) $(6,014) ======== ======== ======== ======== ======== =======
The increase in the Company's 2001 minimum pension liability of $14,967 was attributable to the following factors: (i) a decline in asset performance, (ii) an increase in the assumed frequency of lump sum elections, (iii) an increase in retirement rates and (iv) a change in the discount rate from 7.50% to 7.00%. This increase was recorded as a charge to a separate component of shareholders' equity. F-72 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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, ------------------------------- -------------------------- 2001 2000 1999 2001 2000 1999 ------- ------- ------- ------ ------ ------ Components of net periodic pension (income) expense: Service cost .................................. $ 1,789 $ 1,625 $ 1,816 $ 610 $ 719 $ 353 Interest cost ................................. 3,518 3,525 3,351 840 855 616 Expected return on plan assets ................ (4,021) (4,283) (4,353) -- -- -- Amortization of prior service cost ............ (610) (610) (610) 314 314 313 Recognized net actuarial loss ................. -- -- -- 174 1,946 166 Curtailment (gain) loss ....................... (1,614) -- -- 1,258 -- -- ------- ------- ------- ------ ------ ------ Net periodic pension (income) expense .............. $ (938) $ 257 $ 204 $3,196 $3,834 $1,448 ======= ======= ======= ====== ====== ====== Weighted-average assumptions as of December 31: Discount rate ................................. 7.00% 7.25% 8.00% 7.00% 7.25% 8.00% 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. 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. Through December 31, 2000, employees with ten years of service were eligible to receive these benefits upon retirement. Effective January 1, 2001, the requirement increased to age 55 and 20 years of service for employees to be eligible to receive these benefits upon retirement. Employees hired on January 1, 2001 or after are not eligible for postretirement medical benefits. Employees who were at least age 55 and had 10 years of service in the year 2000 were not affected by this change. Postretirement benefits other than pensions of active and retired employees are accrued as expense over the employees' service years. F-73 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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, 2001, 2000 and 1999 reconciled with amounts recognized in the Company's statement of financial position:
December 31, -------------------------------- 2001 2000 1999 -------- -------- -------- Change in accumulated postretirement benefit obligation: Accumulated postretirement benefit obligation at beginning of year ................... $ 30,766 $ 29,660 $ 34,257 Changes during fiscal year Service cost ...................................... 475 564 628 Interest cost ..................................... 2,285 2,366 2,158 Benefits paid ..................................... (1,676) (1,749) (1,768) Actuarial (gain) loss ............................. 3,899 (75) (5,615) -------- -------- -------- Accumulated postretirement benefit obligation at end of year ......................... $ 35,749 $ 30,766 $ 29,660 ======== ======== ======== Unfunded status ........................................ $(35,749) $(30,766) $(29,660) Unrecognized net loss from past experience different from that assumed ............... 6,147 2,278 2,403 -------- -------- -------- Accrued postretirement benefit cost ............... $(29,602) $(28,488) $(27,257) ======== ======== ========
Year Ended December 31, -------------------------------- 2001 2000 1999 -------- -------- -------- Components of net periodic benefit cost: Service cost ................................ $ 475 $ 564 $ 628 Interest cost ............................... 2,285 2,366 2,158 Amortization of prior losses ................ 30 50 218 -------- -------- -------- Net periodic benefit cost ................ $ 2,790 $ 2,980 $ 3,004 ======== ======== ========
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, ------------------------ 2001 2000 1999 ----- ----- ------ Accumulated postretirement benefit obligation Effect of a one percentage point increase ......... $ 967 $ 606 $ 864 Effect of a one percentage point decrease ......... (859) (546) (743) Service and interest cost components of the net periodic postretirement benefit expense Effect of a one percentage point increase ...... $ 77 $ 81 $ 75 Effect of a one percentage point decrease ...... (64) (66) (60)
F-74 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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 5.5%, 5.8% and 6.1% as of December 31, 2001, 2000 and 1999, respectively. The net medical trend rates are 6.0% in 2002 grading down to 5.0% in 2004 and thereafter. For those participants retiring after December 31, 1993, benefits at normal retirement 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 7.00%, 7.25% and 8.00% at December 31, 2001, 2000 and 1999, 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 Consolidated Balance Sheets were as follows:
December 31, ----------------------------- 2001 2000 1999 ------- ------- ------- Reinsurance Recoverables on Unpaid Claims Life and health ............................. $ 7,241 $ 4,619 $ 4,485 Property and casualty State insurance facilities ............... 23,069 32,026 45,222 Other insurance companies ................ 11,035 17,030 19,188 ------- ------- ------- Total .................................. $41,345 $53,675 $68,895 ======= ======= =======
F-75 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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, 2001 Premiums written ............... $885,801 $27,991 $17,756 $875,566 Premiums earned ................ 625,722 28,601 18,121 615,242 Benefits, claims and settlement expenses ......... 475,991 18,416 18,008 475,583 Year ended December 31, 2000 Premiums written ............... 829,437 24,078 16,294 821,653 Premiums earned ................ 605,252 23,105 16,567 598,714 Benefits, claims and settlement expenses ......... 461,396 13,736 18,388 466,048 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
There were no losses from uncollectible reinsurance recoverables in the three years ended December 31, 2001. Past due reinsurance recoverables as of December 31, 2001 were not material. NOTE 11 - Contingencies Lawsuits and Legal Proceedings In December 2000, the Company recorded an after-tax charge of $5,000, representing the Company's best estimate of the actual and anticipated costs of defending and ultimately resolving litigation brought against the Company in regards to its disability insurance product. The lawsuit is a class action on behalf of certain policyholders who purchased the Company's disability insurance product and allege that they were not adequately made aware of certain features. In July 2001, the Company submitted a settlement agreement to the court which was mutually agreed upon by all parties to this lawsuit. The settlement, which provides additional benefits for current policyholders and compensation to those who demonstrate they did not understand what they purchased, was approved by the court on October 31, 2001. The settlement was finalized F-76 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 11 - Contingencies-(Continued) on November 30, 2001 and is being administered. While the actual costs incurred by the Company to resolve this litigation could be either less or more than the liability established in 2000, management believes that, based on facts and circumstances available at this time and on the settlement agreement approved by the court in October 2001, the amount recorded will be adequate to resolve the matter. Disability insurance represented less than 1% of the Company's insurance premiums written and contract deposits for the years ended December 31, 2001 and 2000. There are various other lawsuits and legal proceedings against the Company. Management and legal counsel are of the opinion that the ultimate disposition of such other 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 generally been insignificant. In December 2001, the Company recorded a pretax charge of $1,314 representing its estimated portion of the industry assessment related to the insolvency of the Reliance Insurance Group. 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, ----------------------------------- 2001 2000 1999 --------- --------- --------- Cash flows from operating activities Net income ........................................... $ 25,587 $ 20,841 $ 44,505 Adjustments to reconcile net income to net cash provided by operating activities: Realized investment losses ...................... 10,019 9,906 7,969 Depreciation and amortization ................... 8,300 6,761 (1,013) Increase in insurance liabilities ............... 124,830 113,616 76,401 (Increase) decrease in premium receivables ...... (7,160) (7,357) 11,357 Increase in deferred policy acquisition costs.... (19,565) (12,781) (14,612) (Increase) decrease in reinsurance recoverable... (5,850) 3,364 (3,078) Increase (decrease) in federal income tax liabilities ........................ 3,179 (27,655) 32,409 (Decrease) increase in liabilities for restructuring and litigation charges ...... (3,127) 9,919 -- Other ........................................... 12,644 7,634 (5,792) --------- --------- --------- Total adjustments ............................. 123,270 103,407 103,641 --------- --------- --------- Net cash provided by operating activities.... $ 148,857 $ 124,248 $ 148,146 ========= ========= =========
F-77 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) 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 net income (loss) before the after-tax impact of realized investment gains and losses, restructuring charges, litigation charges and provision for prior years' taxes. F-78 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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, -------------------------------- 2001 2000 1999 -------- -------- -------- Insurance premiums and contract charges earned Property and casualty .................................... $508,345 $489,952 $491,060 Annuity .................................................. 14,906 17,017 16,706 Life ..................................................... 93,272 92,998 87,618 Intersegment eliminations ................................ (1,281) (1,253) (256) -------- -------- -------- Total ............................................... $615,242 $598,714 $595,128 ======== ======== ======== Net investment income Property and casualty .................................... $ 37,749 $ 35,695 $ 37,012 Annuity .................................................. 107,583 105,340 105,224 Life ..................................................... 55,226 51,264 47,005 Corporate and other ...................................... 98 1,295 319 Intersegment eliminations ................................ (1,389) (1,198) (1,293) -------- -------- -------- Total ............................................... $199,267 $192,396 $188,267 ======== ======== ======== Net income Operating income Property and casualty ................................. $ 5,184 $ 8,969 $ 39,537 Annuity ............................................... 20,619 19,274 27,320 Life .................................................. 18,646 12,880 14,570 Corporate and other, including interest expense ....... (8,866) (16,013) (10,712) -------- -------- -------- Total operating income .............................. 35,583 25,110 70,715 Realized investment losses, after tax .................... (6,512) (6,439) (5,180) Restructuring charges, after tax ......................... (4,753) (1,453) -- Litigation charges, after tax ............................ -- (5,059) (1,030) Provision for prior years' taxes ......................... 1,269 8,682 (20,000) -------- -------- -------- Total ............................................... $ 25,587 $ 20,841 $ 44,505 ======== ======== ======== Amortization of intangible assets Value of acquired insurance in force Property and casualty.................................. $ -- $ -- $ 719 Annuity ............................................... 2,317 5,176 (4,242) Life .................................................. 1,839 1,975 2,120 -------- -------- -------- Subtotal ............................................ 4,156 7,151 (1,403) Goodwill ................................................. 1,618 1,618 1,618 -------- -------- -------- Total ............................................... $ 5,774 $ 8,769 $ 215 ======== ======== ========
December 31, ------------------------------------ 2001 2000 1999 ---------- ---------- ---------- Assets Property and casualty ........ $ 738,638 $ 733,922 $ 681,432 Annuity ...................... 2,674,524 2,639,872 2,611,766 Life ......................... 1,007,345 969,181 840,594 Corporate and other .......... 105,215 115,584 153,493 Intersegment eliminations .... (36,696) (37,979) (33,439) ---------- ---------- ---------- Total ................... $4,489,026 $4,420,580 $4,253,846 ========== ========== ==========
F-79 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (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, ------------ ------------- -------- --------- 2001 - ---- Insurance premiums written and contract deposits........... $225,262 $224,307 $218,225 $207,772 Total revenues............................................. 201,889 203,131 196,106 203,364 Restructuring charges, after tax........................... (4,867) -- 114 -- Adjustment to the provision for prior years' taxes......... -- 1,269 -- -- Net income (loss).......................................... 4,758 9,057 (4,926) 16,698 Per share information Basic Realized investment gains (losses), after tax....... $ (0.11) $ (0.04) $ (0.08) $ 0.07 Restructuring charges, after tax.................... (0.12) -- -- -- Adjustment to the provision for prior years' taxes.. -- 0.03 -- -- Net income (loss)................................... 0.12 0.22 (0.12) 0.41 Diluted Realized investment gains (losses), after tax....... $ (0.11) $ (0.03) $ (0.08) $ 0.07 Restructuring charges, after tax.................... (0.12) -- -- -- Adjustment to the provision for prior years' taxes.. -- 0.03 -- -- Net income (loss)................................... 0.12 0.22 (0.12) 0.41 2000 - ---- Insurance premiums written and contract deposits........... $212,673 $210,002 $204,466 $194,512 Total revenues............................................. 192,941 197,566 198,395 192,302 Restructuring charges, after tax........................... (1,453) -- -- -- Litigation charges, after tax.............................. (4,994) -- (65) -- Adjustment to the provision for prior years' taxes......... 5,882 2,800 -- -- Net income (loss).......................................... (13,774) 12,207 9,682 12,726 Per share information Basic Realized investment gains (losses), after tax....... $ (0.10) $ (0.02) $ 0.01 $ (0.04) Restructuring charges, after tax.................... (0.04) -- -- -- Litigation charges, after tax....................... (0.12) -- -- -- Adjustment to the provision for prior years' taxes.. 0.15 0.07 -- -- Net income (loss)................................... (0.34) 0.30 0.24 0.31 Diluted Realized investment gains (losses), after tax....... $ (0.10) $ (0.02) $ -- $ (0.04) Restructuring charges, after tax.................... (0.04) -- -- -- Litigation charges, after tax....................... (0.12) -- -- -- Adjustment to the provision for prior years' taxes.. 0.14 0.07 -- -- Net income (loss)................................... (0.34) 0.30 0.23 0.31
F-80 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data) NOTE 14 - Unaudited Interim Information-(Continued)
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 charges, after tax............................. (22) (1,008) -- -- Provision for prior years' taxes.......................... -- (20,000) -- -- 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 charges, after tax...................... -- (0.02) -- -- Provision for prior years' taxes................... -- (0.48) -- -- 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 charges, after tax...................... -- (0.02) -- -- Provision for prior years' taxes................... -- (0.48) -- -- Net income (loss).................................. 0.54 (0.12) 0.25 0.40
F-81 SCHEDULE I HORACE MANN EDUCATORS CORPORATION SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 2001 (Dollars in thousands)
Amount shown in Fair Balance Type of Investments Cost(1) Value Sheet ------------------- ---------- ---------- ---------- Fixed maturities: U.S. Government and U.S. Government agencies and authorities ............................... $ 689,583 $ 707,047 $ 707,047 States, municipalities and political subdivisions 224,172 232,145 232,145 Foreign government bonds ........................ 17,411 19,452 19,452 Public utilities ................................ 120,062 120,720 120,720 Other corporate bonds ........................... 1,675,603 1,690,503 1,690,503 ---------- ---------- ---------- Total fixed maturity securities ............. 2,726,831 $2,769,867 2,769,867 ---------- ========== ---------- Mortgage loans and real estate ....................... 10,639 XXX 10,639 Short-term investments ............................... 30,079 XXX 30,079 Short-term investments, loaned securities ............ 98,369 XXX 98,369 Policy loans and other ............................... 66,378 XXX 66,727 ---------- ---------- Total investments ........................... $2,932,296 XXX $2,975,681 ========== ==========
- ---------- (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-82 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION BALANCE SHEETS As of December 31, 2001, 2000 and 1999 (Dollars in thousands, except per share data)
2001 2000 1999 --------- --------- --------- ASSETS Investments and cash ....................................... $ 9,319 $ 8,565 $ 21,734 Investment in subsidiaries ................................. 554,811 521,563 478,748 Other assets ............................................... 50,891 49,668 51,417 --------- --------- --------- Total assets ........................................ $ 615,021 $ 579,796 $ 551,899 ========= ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Short-term debt ............................................ $ 53,000 $ 49,000 $ 49,000 Long-term debt ............................................. 99,767 99,721 99,677 Other liabilities .......................................... 3,064 3,082 3,080 --------- --------- --------- Total liabilities ................................... 155,831 151,803 151,757 --------- --------- --------- 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, 2001, 60,076,921; 2000, 59,859,053; 1999, 59,292,053 ...................................... 60 60 59 Additional paid-in capital ................................. 341,052 338,243 333,892 Retained earnings .......................................... 461,139 452,624 449,023 Accumulated other comprehensive income (loss), net of taxes: Net unrealized gains (losses) on fixed maturities and equity securities ............................... 26,336 (4,038) (40,016) Minimum pension liability adjustment .................. (11,438) (937) -- Treasury stock, at cost, 2001 and 2000, 19,341,296 shares; 1999, 18,258,896 shares ............................... (357,959) (357,959) (342,816) --------- --------- --------- Total shareholders' equity .......................... 459,190 427,993 400,142 --------- --------- --------- Total liabilities and shareholders' equity .......... $ 615,021 $ 579,796 $ 551,899 ========= ========= =========
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-83 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION STATEMENTS OF OPERATIONS (Dollars in thousands)
Year Ended December 31, ------------------------------ 2001 2000 1999 -------- -------- -------- Revenues Net investment income ...................... $ 100 $ 1,292 $ 318 Realized investment gains .................. 219 242 481 -------- -------- -------- Total revenues ......................... 319 1,534 799 -------- -------- -------- Expenses Interest ................................... 9,250 10,204 9,722 Amortization of goodwill ................... 1,618 1,618 1,618 Other ...................................... 3,802 1,101 1,479 -------- -------- -------- Total expenses ......................... 14,670 12,923 12,819 -------- -------- -------- Loss before income taxes and equity in net earnings of subsidiaries.. (14,351) (11,389) (12,020) Income tax benefit .............................. (4,099) (3,058) (3,686) -------- -------- -------- Loss before equity in net earnings of subsidiaries ............ (10,252) (8,331) (8,334) Equity in net earnings of subsidiaries .......... 35,839 29,172 52,839 -------- -------- -------- Net income ...................................... $ 25,587 $ 20,841 $ 44,505 ======== ======== ========
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-84 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION STATEMENTS OF CASH FLOWS (Dollars in thousands)
Year Ended December 31, -------------------------------- 2001 2000 1999 -------- -------- -------- Cash flows from operating activities Interest expense paid ................................... $ (9,091) $(10,028) $ (9,523) Federal income taxes (paid) recovered ................... (12) 7,483 6,901 Cash dividends received from subsidiaries ............... 28,650 36,500 63,500 Other, net .............................................. (4,032) 693 421 -------- -------- -------- Net cash provided by operating activities ........... 15,515 34,648 61,299 -------- -------- -------- Cash flows provided by (used in) investing activities Net (increase) decrease in investments .................. 5,707 7,214 (12,306) Capital contributions to subsidiaries ................... (4,500) (20,000) -- -------- -------- -------- Net cash provided by (used in) investing activities.. 1,207 (12,786) (12,306) -------- -------- -------- Cash flows used in financing activities Purchase of treasury stock .............................. -- (15,143) (25,093) Dividends paid to shareholders .......................... (17,072) (17,240) (15,756) Principal borrowings (payments) on Bank Credit Facility.. 4,000 -- (1,000) Repurchase of common stock warrants ..................... -- -- (2,426) Exercise of stock options ............................... 3,759 5,302 362 Catastrophe-linked equity put option premium ............ (950) (950) (950) -------- -------- -------- Net cash used in financing activities ............... (10,263) (28,031) (44,863) -------- -------- -------- Net increase (decrease) in cash .............................. 6,459 (6,169) 4,130 Cash at beginning of period .................................. 1,874 8,043 3,913 -------- -------- -------- Cash at end of period ........................................ $ 8,333 $ 1,874 $ 8,043 ======== ======== ========
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-85 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION NOTE TO CONDENSED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 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-86 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, 2001 Property and casualty ......... $ 18,957 $ 306,141 $ 0 $177,023 $ -- $ 508,345 $ 37,749 Annuity ....................... 54,791 1,279,891 xxx -- 113,780 14,906 107,583 Life .......................... 84,028 701,964 xxx 8,546 9,654 93,272 55,226 Other, including consolidating eliminations... N/A 2,000 xxx N/A N/A (1,281) (1,291) -------- ---------- -------- -------- --------- ---------- Total ..................... $157,776 $2,289,996 xxx $185,569 $123,434 $ 615,242 $ 199,267 ======== ========== ======== ======== ========= ========= Year Ended December 31, 2000 Property and casualty ......... $ 16,936 $ 298,896 $ 0 $166,202 $ -- $ 489,952 $ 35,695 Annuity ....................... 46,434 1,220,334 xxx -- 111,511 17,017 105,340 Life .......................... 78,234 668,596 xxx 8,226 10,722 92,998 51,264 Other, including consolidating eliminations... N/A N/A xxx N/A N/A (1,253) 97 -------- ---------- -------- -------- --------- ---------- Total ..................... $141,604 $2,187,826 xxx $174,428 $122,233 $ 598,714 $ 192,396 ======== ========== ======== ======== ========= ========= 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 ======== ========== ======== ======== ========= ========= 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 expenses year years costs expenses expenses written ---------- -------- -------- ------------ --------- ---------- -------- Year Ended December 31, 2001 Property and casualty ......... $ 433,344 $416,770 $ 16,574 $ 47,780 $ 63,042 $411,147 $519,167 Annuity ....................... 66,901 xxx xxx 3,498 21,368 xxx xxx Life .......................... 69,840 xxx xxx 8,232 41,531 xxx xxx Other, including consolidating eliminations... 2,000 xxx xxx (1,462) 20,074 xxx xxx --------- -------- -------- Total ..................... $ 572,085 xxx xxx $ 58,048 $146,015 xxx xxx ========= ======== ======== Year Ended December 31, 2000 Property and casualty ......... $ 417,369 $394,711 $ 22,658 $ 45,983 $ 58,416 $402,922 $493,364 Annuity ....................... 67,758 xxx xxx 4,694 20,741 xxx xxx Life .......................... 73,482 xxx xxx 6,725 44,168 xxx xxx Other, including consolidating eliminations... N/A xxx xxx (1,430) 33,577 xxx xxx --------- -------- -------- Total ..................... $ 558,609 xxx xxx $ 55,972 $156,902 xxx xxx ========= ======== ======== 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 ========= ======== ========
N/A Not applicable. See accompanying Independent Auditor's Report. F-87 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, 2001 Life insurance in force ......... $13,216,146 $1,035,477 -- $12,180,669 -- Premiums Property and casualty ......... $ 514,574 $ 24,350 $18,121 $ 508,345 3.6% Annuity ....................... 14,906 -- -- 14,906 -- Life .......................... 97,523 4,251 -- 93,272 -- Other, including consolidating eliminations... (1,281) -- -- (1,281) -- ----------- ---------- -------- ----------- Total premiums ............ $ 625,722 $ 28,601 $18,121 $ 615,242 2.9% =========== ========== ======== =========== Year ended December 31, 2000 Life insurance in force ......... $12,646,371 $ 746,447 -- $11,899,924 -- Premiums Property and casualty ......... $ 494,539 $ 21,154 $16,567 $ 489,952 3.4% Annuity ....................... 17,017 -- -- 17,017 -- Life .......................... 94,949 1,951 -- 92,998 -- Other, including consolidating eliminations... (1,253) -- -- (1,253) -- ----------- ---------- -------- ----------- Total premiums ............ $ 605,252 $ 23,105 $16,567 $ 598,714 2.8% =========== ========== ======== =========== 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% =========== ========== ======== ===========
- ---------- NOTE: Premiums above include insurance premiums earned and contract charges earned. See accompanying Independent Auditors' Report F-88 ================================================================================ HORACE MANN EDUCATORS CORPORATION EXHIBITS To FORM 10-K For the Year Ended December 31, 2001 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, 2001. Management contracts and compensatory plans are indicated by an asterisk(*). EXHIBIT INDEX 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. 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. 3.1(e) Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on June 22, 2000, incorporated by reference to Exhibit 3.1(e) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed with the SEC on August 11, 2000. 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. Exhibit No. Description - --- ----------- 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 10.17). (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. 10.1(a) Waiver Relating to Credit Agreement, incorporated by reference to Exhibit 10.1(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001, filed with the SEC on May 14, 2001. 10.1(b) Waiver Relating to Credit Agreement, incorporated by reference to Exhibit 10.1(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, filed with the SEC on November 14, 2001. 10.1(c) Waiver Relating to Credit Agreement, incorporated by reference to Exhibit 10.1(c) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, filed with the SEC on November 14, 2001. 10.1(d) Amendment to Credit Agreement. 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. Exhibit No. Description - --- ----------- 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, incorporated by reference to Exhibit 10.5 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.5(a)* Amendment to Amended and Restated Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed with the SEC on August 11, 2000. 10.5(b)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5(a) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.5(c)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5(b) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.6* Horace Mann Educators Corporation 2001 Stock Incentive Plan. 10.6(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan. 10.6(b)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan. 10.7* Severance Agreements between HMEC and certain officers of HMEC. 10.7(a)* Revised Schedule to Severance Agreements between HMEC and certain officers of HMEC. Exhibit No. Description - --- ----------- 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* Employment Agreement entered by and between HMEC and Louis G. Lower II as of December 31, 1999, incorporated by reference to Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.12* Letter of Employment entered by and between HMEC and Peter H. Heckman effective April 10, 2000, incorporated by reference to Exhibit 10.14 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.13* Letter of Employment entered by and between HMEC and Daniel M. Jensen effective September 4, 2001. 10.14* Letter of Employment entered by and between HMEC and Douglas W. Reynolds effective November 12, 2001. 10.15* Letter of Employment entered by and between HMEC and Bret A. Conklin effective January 14, 2002. 10.16* Separation Agreement entered by and between HMEC and Larry K. Becker as of June 20, 2000, incorporated by reference to Exhibit 10.4 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed with the SEC on August 11, 2000. 10.17 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. Exhibit No. Description - --- ----------- 10.17(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. 10.17(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. 10.17(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. EX-10.1(D) 3 dex101d.txt AMENDMENT TO CREDIT AGREEMENT Exhibit 10.1(d) AMENDMENT TO CREDIT AGREEMENT ----------------------------- AMENDMENT, dated as of October 31, 2001, between HORACE MANN EDUCATORS CORPORATION, (the "Borrower"), and BANK OF AMERICA, N.A. (Successor in interest to Bank of America National Trust and Savings Association and Bank of America Illinois) (the "Lender"). WHEREAS, the Borrower and the Lender are parties to a Credit Agreement dated as of December 31, 1996, and as at any time further amended, supplemented or modified, (the "Agreement"); and WHEREAS, the Borrower and the Lender desire to amend the Agreement as hereinafter set forth; NOW, THEREFORE, in consideration of the mutual promises herein contained, the Borrower and the Lender agree as follows: 1. All capitalized terms used herein which are defined in the Agreement shall have the meanings provided therefor in the Agreement unless otherwise defined herein. 2. The Agreement is amended as follows: (a) All references in the Agreement to "Bank of America National Trust and Savings Association" and "Bank of America Illinois" are deleted and replaced with "Bank of America, N.A.." (b) Section 1.1 is amended for the quarter beginning January 1, 2002 by deleting the definitions of "Applicable Eurodollar Interest Rate Margin" and "Applicable Non-Use Fee Rate" in their entirety and substituting the following in place thereof: "Applicable Eurodollar Interest Rate Margin" shall mean at any time ------------------------------------------ 0.75 percent per annum. "Applicable Non-Use Fee Rate" shall mean at any time 0.15 per cent per --------------------------- annum. (c) Section 1.1 is further amended by deleting "December 31, 2001" from the definition of "Commitment Termination Date" and substituting "June 30, 2002" in place thereof. (d) A new Section 3.3.1 (c) is added as follows: "(c) At any time the Borrower shall receive net proceeds from any issuance or sale of debt securities, 100% of such net proceeds (net of attorneys' fees, investment banking fees, accountants' fees, underwriting discounts and commissions and other customary fees and expenses actually incurred in connection therewith) shall be applied on such date toward prepayment of the Loans and shall permanently reduce the Commitment Amount." -1- (e) Section 8.2.1 is amended by deleting "forty percent (40%)" and substituting "thirty percent (30%)" in place thereof. 3. This Amendment shall be limited precisely as written and shall not be deemed to (i) be a consent to the modification or waiver of any other term or condition of the Agreement or of any of the instruments or agreements referred to therein or (ii) prejudice any right which the Lender may now have under or in connection with the Agreement, as amended by this Amendment. Except as expressly modified hereby, all of the terms and provisions of the Agreement shall continue in full force and effect; and the Borrower hereby confirms each and every one of its obligations under the Agreement, as amended by this Amendment. Whenever the term "Agreement" is used in the Agreement and whenever the Agreement is referred to in any of the instruments, agreements or other documents or papers executed and delivered in connection therewith, it shall be deemed to mean the Agreement, as amended by this Amendment. 4. This Amendment shall be effective as of the date set forth above and upon (i) payment to the Lender of an advisory/amendment fee of $10,000 and (ii) the delivery to the Lender of this Amendment, signed by the Borrower and the Lender. 5. THIS AMENDMENT SHALL BE CONSTRUED IN ACCORDANCE WITH AND BE GOVERNED BY THE LAWS OF THE STATE OF ILLINOIS. 6. The Borrower hereby represents and warrants to the Lender that on and as of the date hereof after giving effect to this Amendment there shall exist no Event of Default or Default and all representations and warranties contained in the Agreement or otherwise made in writing in connection herewith or therewith (as though made in connection with a request for a Loan under the Agreement) shall be true and correct with the same effect as though such representations and warranties had been made on and as of the date hereof, except that any representation made as of a particular date shall be true and correct as of such date. IN WITNESS WHEREOF, the parties hereto have executed this Amendment by their duly authorized officers as of the date and year first above written. HORACE MANN EDUCATORS CORPORATION By: /s/ Peter H. Heckman ------------------------- Title: EVP/CFO ---------------------- BANK OF AMERICA, N.A. By: /s/ Debra Basler ------------------------- Title: VP ---------------------- -2- EX-10.6 4 dex106.txt 2001 STOCK INCENTIVE PLAN Exhibit 10.6 HORACE MANN EDUCATORS CORPORATION 2001 STOCK INCENTIVE PLAN -1- Page ---- Table of Contents
Article 1. Establishment, Objectives and Duration 1.1. Establishment of the Plan. ................................. 1 1.2. Objectives of the Plan. .................................... 1 1.3. Duration of the Plan. ...................................... 1 Article 2. Definitions ................. 1 Article 3. Administration 3.1. Board and Committee ........................................ 5 3.2. Powers of the Board ........................................ 6 Article 4. Shares Subject to the Plan 4.1. Number of Shares Available. ................................ 7 4.2. Adjustments in Authorized Shares. .......................... 7 4.3. Newly Issued Shares or Treasury Shares ..................... 8 Article 5. Eligibility and General Conditions of Awards 5.1. Eligibility ................................................ 8 5.2. Grant Date ................................................. 8 5.3. Maximum Term ............................................... 8 5.4. Award Agreement ............................................ 8 5.5. Restrictions on Share Transferability ...................... 8 5.6. Termination of Affiliation ................................. 8 5.7. Nontransferability of Awards ............................... 10 Article 6. Stock Options 6.1. Grant of Options ........................................... 11 6.2. Award Agreement ............................................ 11 6.3. Option Price ............................................... 11 6.4. Grant of Incentive Stock Options ........................... 12 6.5. Exercise of Options ........................................ 13 Article 7. Stock Appreciation Rights 7.1. Grant of SARs .............................................. 13 7.2. Exercise of SARs ........................................... 14 7.3. Payment of SAR Benefit ..................................... 14 Article 8. Restricted Shares 8.1. Grant of Restricted Shares ................................. 14 8.2. Award Agreement ............................................ 14 8.3. Consideration .............................................. 14 8.4. Effect of Forfeiture ....................................... 15 8.5. Escrow; Legends ............................................ 15
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Article 9. Bonus Shares and Deferred Shares 9.1. Bonus Shares .................................................. 15 9.2. Deferred Shares ............................................... 15 Article 10. Beneficiary Designation .............. 15 Article 11. Deferrals ..................... 16 Article 12. Rights of Employees/Directors 12.1. Employment .................................................... 16 12.2. Participation ................................................. 16 Article 13. Amendment, Modification, and Termination 13.1. Amendment, Modification, and Termination ...................... 16 13.2. Adjustments Upon Certain Unusual or Nonrecurring Events ....... 16 13.3. Awards Previously Granted ..................................... 16 Article 14. Withholding 14.1. Mandatory Tax Withholding ..................................... 16 14.2. Notification under Code Section 83(b) ......................... 17 Article 15. Additional Provisions 15.1. Successors .................................................... 17 15.2. Gender and Number ............................................. 17 15.3. Severability .................................................. 17 15.4. Requirements of Law ........................................... 17 15.5. Securities Law Compliance ..................................... 18 15.6. No Rights as a Shareholder .................................... 18 15.7. Nature of Payments ............................................ 18 15.8. Governing Law ................................................. 19
-ii- Horace Mann Educators Corporation 2001 Stock Incentive Plan Article 1. Establishment, Objectives and Duration 1.1. Establishment of the Plan. Horace Mann Educators Corporation, a ------------------------- Delaware corporation (the "Company"), hereby establishes an incentive compensation plan to be known as the Horace Mann Educators Corporation 2001 Stock Incentive Plan (the "Plan"). The Plan was adopted by the Board of Directors of the Company (the "Board"), by unanimous written consent and was thereafter approved by the shareholders of the Company on May 18, 2001. The Plan is effective as of June 1, 2001 (the "Effective Date"). 1.2. Objectives of the Plan. The Plan is intended to allow employees, ---------------------- officers and directors (as well as prospective employees, officers and directors) of the Company and its Subsidiaries to acquire or increase equity ownership in the Company, or to be compensated under the Plan based on growth in the Company's equity value, thereby strengthening their commitment to the success of the Company and stimulating their efforts on behalf of the Company, and to assist the Company and its Subsidiaries in attracting new employees and directors and retaining existing employees and directors. The Plan is also intended to optimize the profitability and growth of the Company through incentives which are consistent with the Company's goals; to provide incentives for excellence in individual performance; and to promote teamwork. 1.3 Duration of the Plan. The Plan shall commence on the Effective Date -------------------- and shall remain in effect, subject to the right of the Board to amend or terminate the Plan at any time pursuant to Article 13 hereof, until all Shares subject to it shall have been purchased or acquired according to the Plan's provisions. However, in no event may an Incentive Stock Option be granted under the Plan on or after the date ten (10) years following the earlier of (a) the date the Plan was adopted and (b) the date the Plan was approved by stockholders of the Company. Article 2. Definitions Whenever used in the Plan, the following terms shall have the meanings set forth below: 2.1. "Article" means an Article of this Plan. ------- 2.2. "Award" means Options (including Incentive Stock Options), SARs, ----- Restricted Shares, Bonus Shares, and Deferred Shares granted under the Plan. 2.3. "Award Agreement" means a written agreement by which an Award is --------------- evidenced. 2.4. "Beneficial Owner" has the meaning specified in Rule 13d3 of the SEC ---------------- under the Exchange Act. 2.5. "Board" has the meaning set forth in Section 1.1. ----- -1- 2.6 "Bonus Shares" means Shares that are awarded to a Grantee without ------------ cost and without restrictions in recognition of past performance (whether determined by reference to another employee benefit plan of the Company or otherwise) or as an incentive to become an employee or director of the Company or a Subsidiary. 2.7. "Cause" means, unless otherwise defined in an Award Agreement, ----- (a) a Grantee's conviction of any felony under federal law or the law of the state in which the act occurred; (b) dishonesty by the Grantee in the course of fulfilling his or her employment duties; or (c) willful and deliberate failure on the part of the Grantee to perform his or her employment duties in any material respect. 2.8. "Change of Control" means, unless otherwise defined in an Award ----------------- Agreement, any one or more of the following: (a) (1) approval by the shareholders of the Company of a merger, reorganization, consolidation, or similar transaction, in which the Company is not the continuing or the surviving corporation, or pursuant to which Shares would be converted into cash, securities or other property, other than a merger of the Company in which no 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 a series of related transactions) of all, or substantially all, of the assets of the Company; (b) the shareholders of the Company approve any plan or proposal for the liquidation or dissolution of the Company which is part of a sale of assets, merger, or reorganization of the Company or other similar transaction; or (c) any "person", as such term is defined in Sections 13(d) and 14(d) of the Exchange Act, 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 (d) the Incumbent Directors (determined using the Effective Date as the baseline date) cease for any reason to constitute at least a majority of the directors of the Company then serving. 2.9. "Change of Control Value" means the Fair Market Value of a Share on ----------------------- the date of a Change of Control. 2.10. "Code" means the Internal Revenue Code of 1986, as amended from time ---- to time, and regulations and rulings thereunder. References to a particular section of the Code include references to successor provisions of the Code or any successor statute. -2- 2.11. "Committee" has the meaning set forth in Article 3. --------- 2.12. "Company" has the meaning set forth in Section 1.1. ------- 2.13. "Deferred Shares" means Shares that are awarded to a Grantee on a --------------- deferred basis pursuant to Section 10.2. 2.14. "Disability" means a permanent and total disability, within the ---------- meaning of Code Section 22(e)(3), as determined by the Committee in good faith, upon receipt of medical advice from one or more individuals, selected by the Committee, who are qualified to give professional medical advice. 2.15. "Effective Date" has the meaning set forth in Section 1.1. -------------- 2.16. "Eligible Person" means (a) any employee (including any officer) or --------------- prospective employee of the Company or any Subsidiary, including any such employee who is on an approved leave of absence or has been subject to a disability which does not qualify as a Disability and (b) any director or prospective director of the Company or any Subsidiary. 2.17. "Exchange Act" means the Securities Exchange Act of 1934, as ------------ amended. References to a particular section of the Exchange Act include references to successor provisions. 2.18. "Fair Market Value" means (a) with respect to any property other ----------------- than Shares, the fair market value of such property determined by such methods or procedures as shall be established from time to time by the Committee, and (b) with respect to Shares, unless otherwise determined by the Committee, as of any date, (1) the mean between the highest and lowest trading prices of the Shares on such date on the New York Stock Exchange Composite Transactions Tape (or, if no sale of Shares was reported for such date, on the next preceding date on which a sale of Shares was reported) or (2) if the Shares are not listed on the New York Stock Exchange, the mean of the highest and lowest trading prices of the Shares on such other national exchange on which the Shares are principally traded or as reported by the National Market System, or other similar organization; or (3) in the event that there shall be no public market for the Shares, the fair market value of the Shares as determined by the Committee. 2.19. "Grant Date" has the meaning set forth in Section 5.2. ---------- 2.20. "Grantee" means an individual who has been granted an Award. ------- 2.21. "Incentive Stock Option" means an Option that is intended to meet ---------------------- the requirements of Section 422 of the Code or any successor provisions thereto. 2.22. "including" or "includes" mean "including, without limitation," or --------- -------- "includes, without limitation", respectively. 2.23. "Incumbent Directors" means, as of any specified baseline date, ------------------- individuals then serving as members of the Board who were members of the Board as of the date immediately preceding such baseline date; provided that any subsequently-appointed or elected member of -3- the Board whose election, or nomination for election by shareholders of the Company or the Surviving Corporation, as applicable, was approved by a vote or written consent of a majority of the directors then comprising the Incumbent Directors shall also thereafter be considered an Incumbent Director, unless the initial assumption of office of such subsequently-elected or appointed director was in connection with (a) an actual or threatened election contest, including a consent solicitation, relating to the election or removal of one or more members of the Board, (b) a "tender offer" (as such term is used in Section 14(d) of the Exchange Act), or (c) a proposed Reorganization Transaction. 2.24. "Mature Shares" means Shares for which the holder thereof has good ------------- title, free and clear of all liens and encumbrances, and which such holder either (a) has held for at least six (6) months or (b) has purchased on the open market. 2.25. "Option" means an option granted under Article 6 of the Plan, ------ including an Incentive Stock Option. 2.26. "Option Price" means the price at which a Share may be purchased by ------------ a Grantee pursuant to an Option. 2.27. "Option Term" means the period beginning on the Grant Date of an ----------- Option and ending on the expiration date of such Option, as specified in the Award Agreement for such Option and as may, consistent with the provisions of the Plan, be extended from time to time by the Board prior to the expiration date of such Option then in effect. 2.28. "Outside Director" means a member of the Board who is not an ---------------- employee of the Company or any Subsidiary. 2.29. "Period of Restriction" means the period during which the transfer --------------------- of Restricted Shares is limited in some way (based on the passage of time, the achievement of performance goals, or upon the occurrence of other events as determined by the Board) or the Shares are subject to a substantial risk of forfeiture, as provided in Article 8. 2.30. "Person" shall have the meaning ascribed to such term in Section ------ 3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) thereof. 2.31. "Plan" has the meaning set forth in Section 1.1. ---- 2.32. "Required Withholding" has the meaning set forth in Article 14. -------------------- 2.33. "Restricted Shares" means Shares that are subject to transfer ----------------- restrictions and are subject to forfeiture if conditions specified in the Award Agreement applicable to such Shares are not satisfied. 2.34. "Retirement" means retirement from active employment with the ---------- Company or Subsidiary pursuant to the early or normal retirement provisions of the Company's or Subsidiary's qualified retirement plan. -4- 2.35. "Rule 16b3" means Rule 16b3 promulgated by the SEC under the --------- Exchange Act, together with any successor rule, as in effect from time to time. 2.36. "SAR" means a stock appreciation right granted under Article 7 of --- the Plan. 2.37. "SEC" means the United States Securities and Exchange Commission, or --- any successor thereto. 2.38. "Section" means, unless the context otherwise requires, a Section of ------- the Plan. 2.39. "Section 16 Person" means a person who is subject to obligations ----------------- under Section 16 of the Exchange Act with respect to transactions involving equity securities of the Company. 2.40. "Share" means a common share, $0.001 par value, of the Company. ----- 2.41. "Strike Price" of any SAR shall equal 100% of the Fair Market Value ------------ of a Share on the Grant Date of such SAR; provided that the Board may specify a higher Strike Price in the Award Agreement. 2.42. "Subsidiary" means, for purposes of grants of Incentive Stock ---------- Options, a corporation as defined in Section 424(f) of the Code (with the Company being treated as the employer corporation for purposes of this definition) and, for all other purposes, a United States or foreign corporation with respect to which the Company owns, directly or indirectly, 50% (or such lesser percentage as the Committee may specify, which percentage may be changed from time to time and may be different for different entities) or more of the Voting Power of such corporation. 2.43. "Termination of Affiliation" occurs on the first day on which an -------------------------- individual is for any reason no longer providing services to the Company or any Subsidiary in the capacity of an employee or director, or with respect to an individual who is an employee or director of a Subsidiary, the first day on which such entity ceases to be a Subsidiary. 2.44. "Voting Power" means the combined voting power of the ------------ then-outstanding securities of a corporation entitled to vote generally in the election of directors. Article 3. Administration 3.1. Board and Committee. Subject to Article 13, and to Section 3.2, the ------------------- Plan shall be administered by the Board, or a committee of the Board appointed by the Board to administer the Plan ("Plan Committee"). To the extent the Board considers it desirable for compensation delivered pursuant to Awards to be eligible to comply with or qualify under Rule 16b-3 or qualify for an exemption from the limit on tax deductibility of compensation under Section 162(m) of the Code, the Plan Committee shall consist of two or more directors of the Company, all of whom are Outside Directors. The number of members of the Plan Committee shall from time to time be increased or decreased, and shall be subject to such conditions, including, but not limited to having exclusive authority to make certain grants of Awards or to perform such other acts, in each case as the Board deems appropriate to permit transactions in Shares pursuant to the Plan to satisfy such conditions of Rule 16b-3 or Code Section 162(m) as then in effect. -5- Any references herein to "Board" are, except as the context requires otherwise, references to the Board or the Plan Committee, as applicable. 3.2. Powers of the Board. Subject to the express provisions of the Plan, ------------------- the Board has full and final authority and sole discretion as follows: (a) taking into consideration the reasonable recommendations of management, to determine when, to whom and in what types and amounts Awards should be granted and the terms and conditions applicable to each Award, including the Option Price, the Option Term, the benefit payable under any SAR, and whether or not specific Awards shall be granted in connection with other specific Awards, and if so whether they shall be exercisable cumulatively with, or alternatively to, such other specific Awards; (b) to determine the amount, if any, that a Grantee shall pay for Restricted Shares, whether and on what terms to permit or require the payment of cash dividends thereon to be deferred, when Restricted Shares (including Restricted Shares acquired upon the exercise of an Option) shall be forfeited and whether such shares shall be held in escrow; (c) to construe and interpret the Plan and to make all determinations necessary or advisable for the administration of the Plan; (d) to make, amend, and rescind rules relating to the Plan, including rules with respect to the exercisability and nonforfeitability of Awards upon the Termination of Affiliation of a Grantee; (e) to determine the terms and conditions of all Award Agreements (which need not be identical) and, with the consent of the Grantee, to amend any such Award Agreement at any time, among other things, to permit transfers of such Awards to the extent permitted by the Plan; provided that the consent of the Grantee shall not be required for any amendment which (1) does not adversely affect the rights of the Grantee, or (2) is necessary or advisable (as determined by the Board) to carry out the purpose of the Award as a result of any new or change in existing applicable law; (f) to cancel, with the consent of the Grantee, outstanding Awards and to grant new Awards in substitution therefor; (g) to accelerate the exercisability (including exercisability within a period of less than six (6) months after the Grant Date) of, and to accelerate or waive any or all of the terms and conditions applicable to, any Award or any group of Awards for any reason and at any time, including in connection with a Termination of Affiliation; (h) subject to Sections 1.3 and 5.3, to extend the time during which any Award or group of Awards may be exercised; (i) to make such adjustments or modifications to Awards to Grantees who are working outside the United States as are advisable to fulfill the purposes of the Plan or to comply with applicable local law; -6- (j) to delegate to officers, employees or independent contractors of the Company matters involving the routine administration of the Plan and which are not specifically required by any provision of this Plan of to be performed by the Board of Directors of the Company; (k) to impose such additional terms and conditions upon the grant, exercise or retention of Awards as the Board may, before or concurrently with the grant thereof, deem appropriate, including limiting the percentage of Awards which may from time to time be exercised by a Grantee; and (l) to take any other action with respect to any matters relating to the Plan for which it is responsible. All determinations on any matter relating to the Plan or any Award Agreement may be made in the sole and absolute discretion of the Board, and all such determinations of the Board shall be final, conclusive and binding on all Persons. No member of the Board shall be liable for any action or determination made with respect to the Plan or any Award. Article 4. Shares Subject to the Plan 4.1. Number of Shares Available. -------------------------- (a) Plan Limit. Subject to Section 4.3 and to adjustment as provided in Section 4.2, the number of Shares hereby reserved for delivery under the Plan is 700,000. If any Shares subject to an Award granted hereunder are forfeited or an Award or any portion thereof otherwise terminates or is settled without the issuance of Shares, or in the case of SARs, without the payment of cash, the Shares subject to such Award, to the extent of any such forfeiture, termination or settlement, shall again be available for grant under the Plan. If any Shares are withheld for the payment of taxes related to an Award, such Shares, to the extent of any such withholding, shall again be available or shall increase the number of Shares available, as applicable, for grant under the Plan. The Board may from time to time determine the appropriate methodology for calculating the number of Shares issued pursuant to the Plan. (b) Individual Limit. No Grantee may be granted Options, Restricted Shares, Bonus Stock or Deferred Shares, or any combination thereof, in an aggregate number of Shares under the Plan that exceeds 500,000 shares in any calendar year. 4.2. Adjustments in Authorized Shares. In the event that the Board -------------------------------- determines that any dividend or other distribution (whether in the form of cash, Shares, other securities, or other property), recapitalization, share split, reverse share split, subdivision, consolidation or reduction of capital, reorganization, merger, scheme of arrangement, split-up, spin-off or combination involving the Company or repurchase or exchange of Shares or other rights to purchase Shares or other securities of the Company, or other similar corporate transaction or event affects the Shares such that any adjustment is determined by the Board to be appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan, then the Committee shall, in such manner as it may deem equitable, adjust any or all of (a) the number and type of Shares (or other securities or property) with respect to which Awards -7- may be granted, (b) the number and type of Shares (or other securities or property) subject to outstanding Awards, and (c) the grant or exercise price with respect to any Award or, if deemed appropriate, make provision for a cash payment to the holder of an outstanding Award or the substitution of other property for Shares subject to an outstanding Award; provided, in each case that with respect to Awards of Incentive Stock Options no such adjustment shall be authorized to the extent that such adjustment would cause the Plan to violate Section 422(b)(1) of the Code or any successor provision thereto; and provided further, that the number of Shares subject to any Award denominated in Shares shall always be a whole number. 4.3. Newly Issued Shares or Treasury Shares. Shares delivered in connection -------------------------------------- with Awards may be newly issued or may be treasury shares. Article 5. Eligibility and General Conditions of Awards 5.1. Eligibility. The Board may grant Awards to any Eligible Person, ----------- whether or not he or she has previously received an Award. 5.2. Grant Date. The Grant Date of an Award shall be the date on which --------- the Board grants the Award or such later date as specified by the Board in the Award Agreement. 5.3. Maximum Term. The Option Term or other period during which an ------------ Award may be outstanding shall not extend more than ten (10) years after the Grant Date, and shall be subject to earlier termination as herein specified; provided, however, that any deferral of a cash payment or of the delivery of Shares that is permitted or required by the Board pursuant to Article 11 may, if so permitted or required by the Board, extend more than ten (10) years after the Grant Date of the Award to which the deferral relates. 5.4. Award Agreement. To the extent not set forth in the Plan, the terms --------------- and conditions of each Award (which need not be the same for each grant or for each Grantee) shall be set forth in an Award Agreement. 5.5. Restrictions on Share Transferability. The Board may include in the ------------------------------------- Award Agreement such restrictions on any Shares acquired pursuant to the exercise or vesting of an Award as it may deem advisable, including restrictions under applicable federal securities laws. 5.6. Termination of Affiliation. Except as otherwise provided in an -------------------------- Award Agreement, and subject to the provisions of Section 13.1, the extent to which the Grantee shall have the right to exercise, vest in, or receive payment in respect of an Award following Termination of Affiliation shall be determined in accordance with the following provisions of this Section 5.6. (a) For Cause. If a Grantee has a Termination of Affiliation for --------- Cause: (1) the Grantee's Restricted Shares and Deferred Shares that are forfeitable immediately before such Termination of Affiliation shall automatically be forfeited on such date, subject in the case of Restricted Shares to the provisions of Section 8.4 regarding repayment of certain amounts to the Grantee; -8- (2) the Grantee's Deferred Shares that were vested immediately before such Termination of Affiliation shall promptly be settled by delivery to such Grantee of a number of unrestricted Shares equal to the aggregate number of such vested Deferred Shares, and (3) any unexercised Option or SAR shall terminate effective immediately upon such Termination of Affiliation. (b) On Account of Death or Disability. If a Grantee has a Termination --------------------------------- of Affiliation on account of death or Disability: (1) the Grantee's Restricted Shares that were forfeitable immediately before such Termination of Affiliation shall thereupon become nonforfeitable; (2) the Grantee's Deferred Shares that were forfeitable immediately before such Termination of Affiliation shall thereupon become nonforfeitable and the Company shall, unless otherwise provided in an Award Agreement, promptly settle all Deferred Shares, whether or not forfeitable, by delivery to the Grantee (or, after his or her death, to his or her personal representative or beneficiary designated in accordance with Article 10) of a number of unrestricted Shares equal to the aggregate number of the Grantee's Deferred Shares; and (3) any unexercised Option or SAR, whether or not exercisable immediately before such Termination of Affiliation, shall be fully exercisable and may be exercised, in whole or in part, at any time up to one (1) year after such Termination of Affiliation (but only during the Option Term) by the Grantee or, after his or her death, by (i) his or her personal representative or the person to whom the Option or SAR, as applicable, is transferred by will or the applicable laws of descent and distribution, or (ii) the Grantee's beneficiary designated in accordance with Article 10. (c) On Account of Retirement. If a Grantee has a Termination of ------------------------ Affiliation on account of Retirement: (1) the Grantee's Restricted Shares that were forfeitable immediately before such Termination of Affiliation shall thereupon become nonforfeitable; (2) the Grantee's Deferred Shares that were forfeitable immediately before such Termination of Affiliation shall thereupon become nonforfeitable and the Company shall, unless otherwise provided in an Award Agreement, promptly settle all Deferred Shares, whether or not forfeitable, by delivery to the Grantee (or, after his or her death, to his or her personal representative or beneficiary designated in accordance with Article 10) of a number of unrestricted Shares equal to the aggregate number of the Grantee's Deferred Shares; and (3) any unexercised Option or SAR, whether or not exercisable immediately before such Termination of Affiliation, shall be fully exercisable and may be exercised, in whole or in part, at any time up to three (3) months after -9- such Termination of Affiliation (but only during the Option Term) by the Grantee or, after his or her death, by (i) his or her personal representative or the person to whom the Option or SAR, as applicable, is transferred by will or the applicable laws of descent and distribution, or (ii) the Grantee's beneficiary designated in accordance with Article 10. (d) Change of Control Period. If a Grantee has a Termination of ------------------------ Affiliation during the period commencing on a Change of Control and ending on the first anniversary of the Change of Control ("Change of Control Period"), which Termination of Affiliation is initiated by the Company or a Subsidiary other than for Cause, then: (1) the Grantee's Restricted Shares that were forfeitable shall thereupon become nonforfeitable; (2) the Grantee's Deferred Shares that were forfeitable shall thereupon become nonforfeitable and the Company shall immediately settle all Deferred Shares, whether or not previously forfeitable, by delivery to such Grantee of a number of unrestricted Shares equal to the aggregate number of the Grantee's Deferred Shares; and (3) any unexercised Option or SAR, whether or not exercisable on the date of such Termination of Affiliation, shall thereupon be fully exercisable and may be exercised, in whole or in part for three (3) months following such Termination of Affiliation (but only during the Option Term) by the Grantee or, after his or her death, by (i) his or her personal representative or the person to whom the Option or SAR, as applicable, is transferred by will or the applicable laws of descent and distribution, or (ii) the Grantee's beneficiary designated in accordance with Article 10. (e) Any Other Reason. If a Grantee has a Termination of Affiliation ---------------- for any reason not specified in Sections 5.6(a)(b),(c) or(d), then: (1) the Grantee's Restricted Shares and Deferred Shares, to the extent forfeitable immediately before such Termination of Affiliation, shall thereupon automatically be forfeited, subject in the case of Restricted Shares to the provisions of Section 8.4 regarding repayment of certain amounts to the Grantee; and (2) any unexercised Option or SAR, to the extent exercisable immediately before such Termination of Affiliation, shall remain exercisable in whole or in part for three (3) months after such Termination of Affiliation (but only during the Option Term) by the Grantee or, after his or her death, by (i) his or her personal representative or the person to whom the Option or SAR, as applicable, is transferred by will or the applicable laws of descent and distribution, or (ii) the Grantee's beneficiary designated in accordance with Article 10. 5.7. Nontransferability of Awards. ---------------------------- -10- (a) Except as provided in Section 5.7(c) below, each Award, and each right under any Award, shall be exercisable only by the Grantee during the Grantee's lifetime, or, if permissible under applicable law, by the Grantee's guardian or legal representative. (d) Except as provided in Section 5.7(c) below, no Award (prior to the time, if applicable, Shares are issued in respect of such Award), and no right under any Award, may be assigned, alienated, pledged, attached, sold or otherwise transferred or encumbered by a Grantee otherwise than by will or by the laws of descent and distribution (or in the case of Restricted Shares, to the Company) and any such purported assignment, alienation, pledge, attachment, sale, transfer or encumbrance shall be void and unenforceable against the Company or any Subsidiary; provided, that the designation of a beneficiary shall not constitute an assignment, alienation, pledge, attachment, sale, transfer or encumbrance. (c) To the extent and in the manner permitted by the Board, and subject to such terms and conditions as may be prescribed by the Board, a Grantee may transfer an Award to (1) a spouse, sibling, parent, child or grandchild (including adoptive relationships) (any of which, an "Immediate Family Member") of the Grantee; (2) a trust, the primary beneficiaries of which consist exclusively of the Grantee or Immediate Family Members of the Grantee; or (3) a corporation, partnership or similar entity, the owners of which consist exclusively of the Grantee or Immediate Family Members of the Grantee. Article 6. Stock Options 6.1. Grant of Options. Subject to the terms and provisions of the Plan, ---------------- Options may be granted to any Eligible Person in such number, and upon such terms, and at any time and from time to time as shall be determined by the Board. Without limiting the generality of the foregoing, the Board may grant to any Eligible Person, or permit any Eligible Person to elect to receive, an Option in lieu of or in substitution for any other compensation (whether payable currently or on a deferred basis, and whether payable under this Plan or otherwise) which such Eligible Person may be eligible to receive from the Company or a Subsidiary. 6.2. Award Agreement. Each Option grant shall be evidenced by an Award --------------- Agreement that shall specify the Option Price, the Option Term, the number of shares to which the Option pertains, the time or times at which such Option shall be exercisable and such other provisions as the Board shall determine. 6.3. Option Price. The Option Price of an Option under this Plan shall be ------------ determined by the Board, and shall be no less than 100% of the Fair Market Value of a Share on the Grant Date; provided, however, that any Option ("Substitute Option") that is (a) granted to a Grantee in connection with the acquisition ("Acquisition"), however effected, by the Company of another corporation or entity ("Acquired Entity") or the assets thereof, (b) associated with an option to purchase shares of stock or other equity interest of the Acquired Entity or an affiliate thereof ("Acquired Entity Option") held by such Grantee immediately prior to such Acquisition, and (c) intended to preserve for the Grantee the economic value of all or a portion of such Acquired -11- Entity Option, may, to the extent necessary to achieve such preservation of economic value, be granted with such Option Price as the Board determines. 6.4. Grant of Incentive Stock Options. At the time of the grant of any -------------------------------- Option to an Eligible Person who is an employee of the Company or a Subsidiary, the Board may designate that such Option shall be made subject to additional restrictions to permit it to qualify as an Incentive Stock Option under the requirements of Section 422 of the Code. Any Option designated as an Incentive Stock Option shall: (a) if granted to a 10% Owner, have an Option Price not less than 110% of the Fair Market Value of a Share on its Grant Date; (b) be exercisable for a period of not more than ten (10) years (five (5) years in the case of an Incentive Stock Option granted to a 10% Owner) from its Grant Date, and be subject to earlier termination as provided herein or in the applicable Award Agreement; (c) not have an aggregate Fair Market Value (determined for each Incentive Stock Option at its Grant Date) of Shares with respect to which Incentive Stock Options are exercisable for the first time by such Grantee during any calendar year (under the Plan and any other employee stock option plan of the Grantee's employer or any parent or Subsidiary thereof ("Other Plans")), determined in accordance with the provisions of Section 422 of the Code, which exceeds $100,000 (the "$100,000 Limit"); (d) if the aggregate Fair Market Value of a Share (determined on the Grant Date) with respect to the portion of such grant which is exercisable for the first time during any calendar year ("Current Grant") and all incentive stock options previously granted under the Plan and any Other Plans which are exercisable for the first time during a calendar year ("Prior Grants") would exceed the $100,000 Limit, be exercisable as follows: (1) the portion of the Current Grant which would, when added to any Prior Grants, be exercisable with respect to Shares which would have an aggregate Fair Market Value (determined as of the respective Grant Date for such options) in excess of the $100,000 Limit shall, notwithstanding the terms of the Current Grant, be exercisable for the first time by the Grantee in the first subsequent calendar year or years in which it could be exercisable for the first time by the Grantee when added to all Prior Grants without exceeding the $100,000 Limit; and (2) if, viewed as of the date of the Current Grant, any portion of a Current Grant could not be exercised under the preceding provisions of this Subsection (d) during any calendar year commencing with the calendar year in which it is first exercisable through and including the last calendar year in which it may by its terms be exercised, such portion of the Current Grant shall not be an incentive -12- stock option, but shall be exercisable as a separate Option at such date or dates as are provided in the Current Grant; (e) be granted within ten (10) years from the earlier of the date the Plan is adopted or the date the Plan is approved by the shareholders of the Company; (f) shall require the Grantee to notify the Board of any disposition of any Shares issued pursuant to the exercise of the Incentive Stock Option under the circumstances described in Section 421(b) of the Code (relating to certain disqualifying dispositions), within ten (10) days of such disposition; and (g) shall by its terms not be assignable or transferable other than by will or the laws of descent and distribution and may be exercised, during the Grantee's lifetime, only by the Grantee; provided, however, that the Grantee may, to the extent provided in the Plan in any manner specified by the Board, designate in writing a beneficiary to exercise his Incentive Stock Option after the Grantee's death. Notwithstanding the foregoing, the Board may, without the consent of the Grantee, at any time before the exercise of an option (whether or not an incentive stock option), take any action necessary to prevent such option from being treated as an incentive stock option. 6.5. Exercise of Options. Options granted under this Article 6 shall be ------------------- exercised by the delivery of a written notice of exercise to the Company, setting forth the number of Shares with respect to which the Option is to be exercised, accompanied by full payment for the Shares made by any one or more of the following means subject to the approval of the Committee: (a) cash, personal check or wire transfer; (b) Mature Shares, valued at their Fair Market Value on the date of exercise; (c) Restricted Shares held by the Grantee for at least six (6) months prior to the exercise of the Option, each such Share valued at the Fair Market Value of a Share on the date of exercise; or (d) subject to applicable law, pursuant to procedures approved by the Committee, through the sale of the Shares acquired on exercise of the Option through a brokerdealer to whom the Grantee has submitted an irrevocable notice of exercise and irrevocable instructions to deliver promptly to the Company the amount of sale or loan proceeds sufficient to pay for such Shares, together with, if requested by the Company, the amount of federal, state, local or foreign withholding taxes payable by Grantee by reason of such exercise. If any Restricted Shares ("Tendered Restricted Shares") are used to pay the Option Price, a number of Shares acquired on exercise of the Option equal to the number of Tendered Restricted Shares shall be subject to the same restrictions as the Tendered Restricted Shares, determined as of the date of exercise of the Option. -13- Article 7. Stock Appreciation Rights 7.1. Grant of SARs. Subject to the terms and conditions of the Plan, SARs ------------- may be granted to any Eligible Person at any time and from time to time as shall be determined by the Board. Each grant of an SAR shall be evidenced by an Award Agreement, which shall specify the number of SARs granted to each Grantee (subject to Article 4), the Strike Price thereof, and, consistent with the other provisions of this Article 7 and of the Plan, such other terms and conditions pertaining to such SARs as the Board may determine. 7.2. Exercise of SARs. SARs shall be exercised by the delivery of a ---------------- written notice of exercise to the Company, setting forth the number of Shares over which the SAR is to be exercised. 7.3. Payment of SAR Benefit. Upon exercise of an SAR, the Grantee shall ---------------------- be entitled to receive payment from the Company in an amount determined by multiplying: (a) the excess of the Fair Market Value of a Share on the date of exercise over the Strike Price; by (b) the number of Shares with respect to which the SAR is exercised; provided that the Board may provide in the Award Agreement that the benefit payable on exercise of an SAR shall not exceed such percentage of the Fair Market Value of a Share on the Grant Date as the Board shall specify. As determined by the Board, the payment upon SAR exercise may be in cash, in Shares which have an aggregate Fair Market Value (as of the date of exercise of the SAR) equal to the amount of the payment, or in some combination thereof, as set forth in the Award Agreement. Article 8. Restricted Shares 8.1. Grant of Restricted Shares. Subject to the terms and provisions of -------------------------- the Plan, the Board, at any time and from time to time, may grant Restricted Shares to any Eligible Person in such amounts as the Board shall determine. 8.2. Award Agreement. Each grant of Restricted Shares shall be evidenced --------------- by an Award Agreement, which shall specify the Period(s) of Restriction, the number of Restricted Shares granted, and such other provisions as the Board shall determine. The Board may impose such conditions or restrictions on any Restricted Shares as it may deem advisable, including restrictions based upon the achievement of specific performance goals (Company-wide, divisional, Subsidiary or individual), time-based restrictions on vesting or restrictions under applicable securities laws. 8.3. Consideration. The Board shall determine the amount, if any, that a ------------- Grantee shall pay for Restricted Shares. Such payment shall be made in full by the Grantee before the delivery of the Shares and in any event no later than ten (10) business days after the Grant Date for such Shares. -14- 8.4 Effect of Forfeiture. If Restricted Shares are forfeited, and if -------------------- the Grantee was required to pay for such Shares or acquired such Restricted Shares upon the exercise of an Option, the Grantee shall be deemed to have resold such Restricted Shares to the Company at a price equal to the lesser of (a) the amount paid by the Grantee for such Restricted Shares, or (b) the Fair Market Value of a Share on the date of such forfeiture. The Company shall pay to the Grantee the required amount as soon as is administratively practical. Such Restricted Shares shall cease to be outstanding, and shall no longer confer on the Grantee thereof any rights as a shareholder of the Company, from and after the date of the event causing the forfeiture, whether or not the Grantee accepts the Company's tender of payment for such Restricted Shares. 8.5 Escrow; Legends. The Board may provide that the certificates for --------------- any Restricted Shares (a) shall be held (together with a stock power executed in blank by the Grantee) in escrow by the Secretary of the Company until such Restricted Shares become nonforfeitable or are forfeited or (b) shall bear an appropriate legend restricting the transfer of such Restricted Shares. If any Restricted Shares become nonforfeitable, the Company shall cause certificates for such shares to be issued without such legend. Article 9. Bonus Shares and Deferred Shares 9.1 Bonus Shares. Subject to the terms of the Plan, the Board may ------------ grant Bonus Shares to any Eligible Person, in such amount and upon such terms and at any time and from time to time as shall be determined by the Board. 9.2 Deferred Shares. Subject to the terms and provisions of the Plan, --------------- Deferred Shares may be granted to any Eligible Person in such amounts and upon such terms, and at any time and from time to time, as shall be determined by the Board. The Board may impose such conditions or restrictions on any Deferred Shares as it may deem advisable, including time-vesting restrictions and deferred payment features. The Board may cause the Company to establish a grantor trust to hold Shares subject to Deferred Share Awards. Without limiting the generality of the foregoing, the Board may grant to any Eligible Person, or permit any Eligible Person to elect to receive, Deferred Shares in lieu of or in substitution for any other compensation (whether payable currently or on a deferred basis, and whether payable under this Plan or otherwise) which such Eligible Person may be eligible to receive from the Company or a Subsidiary. Article 10. Beneficiary Designation Each Grantee under the Plan may, from time to time, name any beneficiary or beneficiaries (who may be named contingently or successively) to whom any benefit under the Plan is to be paid in case of the Grantee's death before he or she receives any or all of such benefit. Each such designation shall revoke all prior designations by the same Grantee, shall be in a form prescribed by the Company, and will be effective only when filed by the Grantee in writing with the Company during the Grantee's lifetime. In the absence of any such designation, benefits remaining unpaid at the Grantee's death shall be paid to the Grantee's estate. -15- Article 11. Deferrals The Board may permit or require a Grantee to defer receipt of the payment of cash or the delivery of Shares that would otherwise be due by virtue of the exercise of an Option or SAR, the lapse or waiver of restrictions with respect to Restricted Shares, the grant of Bonus Shares or the expiration of the deferral period for Deferred Shares. If any such deferral is required or permitted, the Board shall establish rules and procedures for such deferrals. Article 12. Rights of Employees/Directors 12.1 Employment. Nothing in the Plan shall interfere with or limit in ---------- any way the right of the Company to terminate any Grantee's employment or directorship at any time, nor confer upon any Grantee the right to continue in the employ or as a director of the Company. 12.2 Participation. No employee shall have the right to be selected ------------- to receive an Award, or, having been so selected, to be selected to receive a future Award. Article 13. Amendment, Modification, and Termination 13.1 Amendment, Modification, and Termination. Subject to the terms ---------------------------------------- of the Plan, the Board of Directors of the Company may at any time and from time to time, alter, amend, suspend or terminate the Plan in whole or in part without the approval of the Company's shareholders, except to the extent the Board of Directors of the Company determines it is desirable to obtain approval of the Company's shareholders, to retain eligibility for exemption from the limitations of Code Section 162(m), to have available the ability for Options to qualify as Incentive Stock Options, to comply with the requirements for listing on any exchange where the Company's Shares are listed, or for any other purpose the Board of Directors of the Company deems appropriate. 13.2 Adjustments Upon Certain Unusual or Nonrecurring Events. The ------------------------------------------------------- Board may make adjustments in the terms and conditions of Awards in recognition of unusual or nonrecurring events (including the events described in Section 4.2) affecting the Company or the financial statements of the Company or of changes in applicable laws, regulations, or accounting principles, whenever the Board determines that such adjustments are appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan. 13.3 Awards Previously Granted. Notwithstanding any other provision ------------------------- of the Plan to the contrary, no termination, amendment or modification of the Plan shall adversely affect in any material way any Award previously granted under the Plan, without the written consent of the Grantee of such Award. Article 14. Withholding 14.1 Mandatory Tax Withholding. ------------------------- (a) Whenever under the Plan, Shares are to be delivered upon exercise or payment of an Award or upon Restricted Shares becoming nonforfeitable, or any other -16- event with respect to rights and benefits hereunder, the Company shall be entitled to require (1) that the Grantee remit an amount in cash, or if determined by the Committee, Mature Shares, sufficient to satisfy all federal, state, local and foreign tax withholding requirements related thereto ("Required Withholding"), (2) the withholding of such Required Withholding from compensation otherwise due to the Grantee or from any Shares or other payment due to the Grantee under the Plan or (3) any combination of the foregoing. (b) Any Grantee who makes a Disqualifying Disposition or an election under Section 83(b) of the Code shall remit to the Company an amount sufficient to satisfy all resulting Required Withholding; provided that, in lieu of or in addition to the foregoing, the Company shall have the right to withhold such Required Withholding from compensation otherwise due to the Grantee or from any Shares or other payment due to the Grantee under the Plan. 14.2. Notification under Code Section 83(b). If the Grantee, in ------------------------------------- connection with the exercise of any Option, or the grant of Restricted Shares, makes the election permitted under Section 83(b) of the Code to include in such Grantee's gross income in the year of transfer the amounts specified in Section 83(b) of the Code, then such Grantee shall notify the Company of such election within ten (10) days of filing the notice of the election with the Internal Revenue Service, in addition to any filing and notification required pursuant to regulations issued under Section 83(b) of the Code. The Board may, in connection with the grant of an Award or at any time thereafter prior to such an election being made, prohibit a Grantee from making the election described above. Article 15. Additional Provisions 15.1 Successors. All obligations of the Company under the Plan ---------- with respect to Awards granted hereunder shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation, or otherwise of all or substantially all of the business or assets of the Company. 15.2 Gender and Number. Except where otherwise indicated by the ----------------- context, any masculine term used herein also shall include the feminine; the plural shall include the singular and the singular shall include the plural. 15.3 Severability. If any part of the Plan is declared by any ------------ court or governmental authority to be unlawful or invalid, such unlawfulness or invalidity shall not invalidate any other part of the Plan. Any Section or part of a Section so declared to be unlawful or invalid shall, if possible, be construed in a manner which will give effect to the terms of such Section or part of a Section to the fullest extent possible while remaining lawful and valid. 15.4 Requirements of Law. The granting of Awards and the issuance ------------------- of Shares under the Plan shall be subject to all applicable laws, rules, and regulations, and to such approvals by any governmental agencies or stock exchanges as may be required. Notwithstanding any provision of the Plan or any Award, Grantees shall not be entitled to exercise, or receive benefits under, any Award, and the Company shall not be obligated to deliver any Shares or other -17- benefits to a Grantee, if such exercise or delivery would constitute a violation by the Grantee or the Company of any applicable law or regulation. 15.5. Securities Law Compliance. ------------------------- (a) If the Board deems it necessary to comply with any applicable securities law, or the requirements of any stock exchange upon which Shares may be listed, the Board may impose any restriction on Shares acquired pursuant to Awards under the Plan as it may deem advisable. All certificates for Shares delivered under the Plan pursuant to any Award or the exercise thereof shall be subject to such stop transfer orders and other restrictions as the Board may deem advisable under the rules, regulations and other requirements of the SEC, any stock exchange upon which Shares are then listed, any applicable securities law, and the Board may cause a legend or legends to be placed on any such certificates to refer to such restrictions. If so requested by the Company, the Grantee shall represent to the Company in writing that he or she will not sell or offer to sell any Shares unless a registration statement shall be in effect with respect to such Shares under the Securities Act of 1993 or unless he or she shall have furnished to the Company evidence satisfactory to the Company that such registration is not required. (b) If the Board determines that the exercise of, or delivery of benefits pursuant to, any Award would violate any applicable provision of securities laws or the listing requirements of any stock exchange upon which any of the Company's equity securities are then listed, then the Board may postpone any such exercise or delivery, as applicable, but the Company shall use all reasonable efforts to cause such exercise or delivery to comply with all such provisions at the earliest practicable date. 15.6. No Rights as a Shareholder. A Grantee shall not have any -------------------------- rights as a shareholder with respect to the Shares (other than Restricted Shares) which may be deliverable upon exercise or payment of such Award until such shares have been delivered to him or her. Restricted Shares, whether held by a Grantee or in escrow by the Secretary of the Company, shall confer on the Grantee all rights of a shareholder of the Company, except as otherwise provided in the Plan or Award Agreement. Unless otherwise determined by the Board at the time of a grant of Restricted Shares, any cash dividends that become payable on Restricted Shares shall be deferred and, if the Board so determines, reinvested in additional Restricted Shares. Except as otherwise provided in an Award Agreement, any share dividends and deferred cash dividends issued with respect to Restricted Shares shall be subject to the same restrictions and other terms as apply to the Restricted Shares with respect to which such dividends are issued. The Board may provide for payment of interest on deferred cash dividends. 15.7. Nature of Payments. Awards shall be special incentive ------------------ payments to the Grantee and shall not be taken into account in computing the amount of salary or compensation of the Grantee for purposes of determining any pension, retirement, death or other benefit under (a) any pension, retirement, profitsharing, bonus, insurance or other employee benefit plan of the Company or any Subsidiary or (b) any agreement between the Company or any Subsidiary and the Grantee, except as such plan or agreement shall otherwise expressly provide. -18- 15.8. Governing Law. The Plan shall be construed in accordance ------------ with and governed by the laws of the State of Delaware other than its laws respecting choice of law. -19- EX-10.6(A) 5 dex106a.txt EMPLOYEE STOCK OPTION AGREEMENT Exhibit 10.6(a) HORACE MANN EDUCATORS CORPORATION 2001 STOCK INCENTIVE PLAN NOTICE OF AWARD (Incentive Stock Option) Horace Mann Educators Corporation (the "Company") hereby grants to ________________________ an option (the "Option") to purchase that number of the Company's common shares, $0.001 par value per share ("Shares"), set forth below, subject to the terms and conditions in the attached Exhibit A and in the Horace Mann Educators Corporation 2001 Stock Incentive Plan, as may from time to time be amended (the "Plan"), a copy of which is attached. Please refer to the Plan documents for definitions of terms used in this Agreement and Exhibit A. Grant Date ____________________, 2001 Expiration Date ____________________, 2011 Number of Shares ____________________ Option Price $___________________ Annual Vesting Rate beginning with Grant Date ____________________ Horace Mann Educators Corporation By: __________________________________ Title: _______________________________ -1- EXHIBIT A to HORACE MANN EDUCATORS CORPORATION 2001 STOCK INCENTIVE PLAN NOTICE OF AWARD 1. Manner of Exercise. This Option may be exercised by delivering to the ------------------ Company (in care of Vice President, Corporate Benefits), during the period in which the Option is exercisable, written notice of the specific number of Shares under this Option you wish to purchase and full payment of the Option Price together with applicable federal, state, local or foreign withholding taxes ("Required Withholding"). Payment of the Option Price and the Required Withholding shall be made by any one or more of (a), (b), (c) or (d), below: (a) cash, personal check or electronic wire transfer, or (b) Mature Shares already owned by you, or (c) the sale of the Shares acquired on exercise of this Option through a broker dealer to whom you have submitted an irrevocable notice of exercise and irrevocable instructions to deliver promptly to the Company the amount of sale or loan proceeds sufficient to pay for the Shares and/or Required Withholding, or (d) Shares with a Fair Market Value equal to the Required Withholding, at your election, may be retained by the Company upon exercise to satisfy the Required Withholding and you will receive the number of Shares you elected to purchase reduced by the Shares retained by the Company. The exercise will become effective on the date on which both such notice and full payment have been actually received by the Company, which date must be before the Expiration Date shown in this Stock Option Agreement. You will not have any rights as a shareholder of the Company with respect to the Shares which you receive upon exercise of this Option until the Shares have been registered in your name. 2. Upon Death or Disability or Retirement. This Option shall become fully -------------------------------------- exercisable upon your Termination of Affiliation due to death, Disability, or Retirement. Disability and Retirement are defined in the Plan. 3. Vesting in Case of Change of Control. This Option shall become fully ------------------------------------ exercisable upon a Termination of Affiliation initiated by the Company or Subsidiary by which you were employed, other than for Cause, if your Termination of Affiliation occurs within the one-year period following a Change of Control. Change of Control and Cause are defined in the Plan. -1- 4. Termination for Cause. This Option shall terminate immediately and any --------------------- unexercised portion shall be forfeited immediately upon your Termination of Affiliation for Cause. Cause is defined in the Plan. 5. Exercise After Termination. This Option may be exercised only while you -------------------------- are employed with the Company or a Subsidiary, except as follows: (a) if you have a Termination of Affiliation due to Disability, you (or the executor or administrator of your estate, your heirs or legatees, or beneficiary designated in accordance with the Plan, as applicable) may exercise this Option at any time during the first twelve (12) months after your Termination of Affiliation; (b) if you have a Termination of Affiliation due to death, the executor or administrator of your estate, your heirs or legatees, or beneficiary designated in accordance with the Plan, as applicable, may exercise this Option at any time during the first twelve (12) months after your Termination of Affiliation; and (c) if you have a Termination of Affiliation due to any other reason (other than a termination for Cause), you (or the executor or administrator of your estate, your heirs or legatees, or beneficiary designated in accordance with the Plan, as applicable) may exercise this Option at any time during the first three (3) months after your Termination of Affiliation; provided, however, that except as otherwise provided in Section 2 or 3 of this Exhibit A, this Option can be exercised after your Termination of Affiliation only to the extent it is exercisable on the date of your Termination of Affiliation and, provided further that, under no circumstances can this Option be exercised on or after the Expiration Date. 6. Option Non-Transferable. This Option is not transferable except to: (a) ----------------------- your spouse, sibling, parent, child or grandchild (including adoptive relationships), (b) a trust primarily for your benefit or the benefit of the persons described in (a), or (c) a corporation or other entity exclusively owned by you or by persons described in (a). 7. Incentive Stock Option. This Option has been designated by the ---------------------- Committee as an Incentive Stock Option. 8. Taxes. The Company is not required to issue Shares upon the exercise of ----- this Option unless you first pay, in cash or by Share withholding to the Company such amount, if any, of Required Withholding. 9. No Right to Affiliation. Nothing in the Agreement shall interfere with ----------------------- or limit in any way the right of the Company or any Subsidiary to terminate your employment at any time, nor confer upon you the right to continue in the employ of the Company or any Subsidiary. 10. Amendments. This Agreement may be amended only by a writing executed by ---------- the Company and you which specifically states that it is amending this Agreement; provided that this Agreement is subject to the power of the Board to amend the Plan as provided therein. -2- Except as otherwise provided in the Plan, no such amendment shall materially adversely affect your rights under this Agreement without your consent. 11. Notices. Any notice to be given under the terms of this Agreement to ------- the Company shall be addressed to Horace Mann Educators Corporation, in care of the Vice President, Human Resources. Any notice to be given to you shall be addressed to you at the address listed in the Company's records. By a notice given pursuant to this Section, either party may designate a different address for notices. Any notice shall have been deemed given when actually delivered. 12. Severability. If any part of this Agreement is declared by any court or ------------ governmental authority to be unlawful or invalid, such unlawfulness or invalidity shall not serve to invalidate any part of this Agreement not declared to be unlawful or invalid. Any part so declared unlawful or invalid shall, if possible, be construed in a manner which gives effect to the terms of such part to the fullest extent possible while remaining lawful and valid. 13. Applicable Law. This Agreement shall be governed by the substantive -------------- laws of Delaware. -3- EX-10.6(B) 6 dex106b.txt DIRECTOR STOCK OPTION AGREEMENT Exhibit 10.6(b) HORACE MANN EDUCATORS CORPORATION 2001 STOCK INCENTIVE PLAN NOTICE OF AWARD (Non-Qualified Stock Option) Horace Mann Educators Corporation (the "Company") hereby grants to _____________________________ an option (the "Option") to purchase that number of the Company's common shares, $0.001 par value per share ("Shares"), set forth below, subject to the terms and conditions in the attached Exhibit A and in the Horace Mann Educators Corporation 2001 Stock Incentive Plan, as may from time to time be amended (the "Plan"), a copy of which is attached. Please refer to the Plan documents for definitions of terms used in this Agreement and Exhibit A. Grant Date _______________, 2001 Expiration Date _______________, 2011 Number of Shares _______________ Option Price $______________ When Option first exercisable Immediately on the Grant Date Horace Mann Educators Corporation By: _______________________________ Title: ____________________________ -1- EXHIBIT A to HORACE MANN EDUCATORS CORPORATION 2001 STOCK INCENTIVE PLAN NOTICE OF AWARD 1. Manner of Exercise. This Option may be exercised by delivering to the ------------------ Company (in care of Vice President, Corporate Benefits), during the period in which the Option is exercisable, written notice of the specific number of Shares under this Option you wish to purchase and full payment of the Option Price together with applicable federal, state, local or foreign withholding taxes ("Required Withholding"). Payment of the Option Price and the Required Withholding shall be made by any one or more of (a), (b), (c) or (d), below: (a) cash, personal check or electronic wire transfer, or (b) Mature Shares already owned by you, or (c) Restricted Shares held by the Grantee for at least six (6) months prior to the exercise of the Option, each such Share valued at the Fair Market Value of a Share on the date of exercise; or (d) subject to applicable law, pursuant to procedures approved by the Committee, through the sale of the Shares acquired on exercise of the Option through a broker dealer to whom the Grantee has submitted an irrevocable notice of exercise and irrevocable instructions to deliver promptly to the Company the amount of sale or loan proceeds sufficient to pay for such Shares, together with, if requested by the Company, the amount of federal, state, local or foreign withholding taxes payable by Grantee by reason of such exercise. The exercise will become effective on the date on which both such notice and full payment have been actually received by the Company, which date must be before the Expiration Date shown in this Stock Option Agreement. You will not have any rights as a shareholder of the Company with respect to the Shares which you receive upon exercise of this Option until the Shares have been registered in your name. 2. Termination for Cause. This Option shall terminate immediately and any --------------------- unexercised portion shall be forfeited immediately upon your Termination of Affiliation for Cause. Cause is defined in the Plan. 3. Exercise After Termination. This Option may be exercised only while you -------------------------- are employed or are a director with the Company or a Subsidiary, except as follows: (a) if you have a Termination of Affiliation due to Disability, you (or the executor or administrator of your estate, your heirs or legatees, or beneficiary designated in accordance with the Plan, as applicable) may exercise this Option at any time during the first twelve (12) months after your Termination of Affiliation; -1- (b) if you have a Termination of Affiliation due to death, the executor or administrator of your estate, your heirs or legatees, or beneficiary designated in accordance with the Plan, as applicable, may exercise this Option at any time during the first twelve (12) months after your Termination of Affiliation; and (c) if you have a Termination of Affiliation due to any other reason (other than a termination for Cause), you (or the executor or administrator of your estate, your heirs or legatees, or beneficiary designated in accordance with the Plan, as applicable) may exercise this Option at any time during the first three (3) months after your Termination of Affiliation; provided, however, that except as otherwise provided in Section 2 or 3 of this Exhibit A, this Option can be exercised after your Termination of Affiliation only to the extent it is exercisable on the date of your Termination of Affiliation and, provided further that, under no circumstances can this Option be exercised on or after the Expiration Date. 4. Option Non-Transferable. This Option is not transferable except to: (a) ----------------------- your spouse, sibling, parent, child or grandchild (including adoptive relationships), (b) a trust primarily for your benefit or the benefit of the persons described in (a), or (c) a corporation or other entity exclusively owned by you or by persons described in (a). 5. Non-Qualified Stock Option. This Option has been designated by the -------------------------- Committee as a Non-Qualified Stock Option; it does not qualify as an Incentive Stock Option. 6. Taxes. The Company is not required to issue Shares upon the exercise of ----- this Option unless you first pay, in cash or by Share withholding to the Company such amount, if any, of Required Withholding. 7. No Right to Affiliation. Nothing in the Agreement shall interfere with ----------------------- or limit in any way the right of the Company or any Subsidiary to terminate your employment or status as a director at any time, nor confer upon you the right to continue in the employ of the Company or any Subsidiary or to continue as a director of the Company or any Subsidiary. 8. Amendments. This Agreement may be amended only by a writing executed by ---------- the Company and you which specifically states that it is amending this Agreement; provided that this Agreement is subject to the power of the Board to amend the Plan as provided therein. Except as otherwise provided in the Plan, no such amendment shall materially adversely affect your rights under this Agreement without your consent. 9. Notices. Any notice to be given under the terms of this Agreement to ------- the Company shall be addressed to Horace Mann Educators Corporation, in care of the Vice President, Corporate Benefits. Any notice to be given to you shall be addressed to you at the address listed in the Company's records. By a notice given pursuant to this Section, either party may designate a different address for notices. Any notice shall have been deemed given when actually delivered. 10. Severability. If any part of this Agreement is declared by any court or ------------ governmental authority to be unlawful or invalid, such unlawfulness or invalidity shall not serve -2- to invalidate any part of this Agreement not declared to be unlawful or invalid. Any part so declared unlawful or invalid shall, if possible, be construed in a manner which gives effect to the terms of such part to the fullest extent possible while remaining lawful and valid. 11. Applicable Law. This Agreement shall be governed by the substantive -------------- laws of Delaware. -3- EX-10.7 7 dex107.txt SEVERANCE AGREEMENT Exhibit 10.7 SEVERANCE AGREEMENT This SEVERANCE AGREEMENT (this "Agreement"), dated as of __________, is made and entered into by and between Horace Mann Educators Corporation ("HMEC"), a Delaware corporation (the "Parent Company"), Horace Mann Service Corporation ("HMSC"), an Illinois corporation (the "Employer Company"), (HMEC and HMSC collectively referred to as the "Company"), and __________ (the "Executive"). WHEREAS, the Company considers the maintenance of a sound and vital senior management to be essential to protecting and enhancing the interests of the Parent Company and its subsidiaries, including the Employer Company, hereinafter collectively referred to as the "Group"; WHEREAS, the Company recognizes that, as is the case with many publicly owned corporations, the possibility of a change in control of the Group may arise and that such possibility, and the uncertainty and questions which it may raise among senior management, may result in the departure or distraction of senior management personnel to the detriment of the Group; and WHEREAS, accordingly the Company has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company's senior management to their assigned duties and long-range responsibilities without distraction in circumstances arising from the possibility of a change in control of the Group; and WHEREAS, the Company believes it important and in the best interests of the Group, should the Group face the possibility of a change in control, that the senior management of the Company be able to assess and advise the Board of Directors of the Company whether such a proposed change in control would be in the best interests of the Group and to take such other action regarding such a proposal as the Board of Directors might determine to be appropriate, without senior management being influenced by the uncertainties of their own employment situations; and WHEREAS, in order to induce the Executive to remain in the employ of the Company in the event of any actual or threatened change in control of the Group, the Company has determined to set forth the severance benefits which the Company will provide to the Executive under the circumstances set forth below; NOW THEREFORE, in consideration of the foregoing recitals, and the mutual covenants and agreements contained in this Agreement and for other good and valuable consideration, the parties hereto agree as follows: 1. Definitions Terms not otherwise defined in this Agreement shall have the meanings set forth in this Section 1. (a) Base Year The "Base Year" shall be the twelve (12) month period immediately preceding a Change in Control. (b) Cash Compensation "Cash Compensation" shall mean the sum of (I) the Executive's annual base salary and (ii) the cash bonus paid to the Executive under the Horace Mann Incentive Compensation Program (or similar program that may replace the Incentive Compensation Program) for whichever of the five (5) fiscal years immediately preceding the year in which the Date of Termination occurs that will result in the highest amount of Cash Compensation. (c) Cause For purposes of this Agreement, "Cause" shall mean serious, willful misconduct by the Executive such as, for example, the commission by the Executive of a felony arising from specific conduct of the Executive which reasonably relates to his qualification or ability (personal or professional) to perform his duties to the Company or its Subsidiaries or a perpetration by the Executive of a common law fraud against the Company or its Subsidiaries. Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than two-thirds of the entire membership of the Company's Board of Directors at a meeting of the Board called and held for the purpose of considering his termination for Cause (after reasonable notice to the Executive and an opportunity for the Executive, together with the Executive's counsel, to be heard before the Board). The resolution of the Board shall contain a finding that in the good faith opinion of the Board the Executive was guilty of the conduct set forth above and specifying the particulars thereof in detail. Notwithstanding the foregoing, the Executive shall have the right to contest his termination for Cause. (d) Change in Control A "Change in Control" shall be deemed to have occurred if (I) there shall be consummated (1) any consolidation or merger of HMEC in which HMEC is not the continuing or surviving corporation, or pursuant to which shares of HMEC's Common Stock would be converted into cash, securities or other property, other than a merger of HMEC in which no HMEC shareholder's ownership percentage in the surviving corporation immediately after the merger is less than such shareholder's ownership percentage in HMEC immediately prior to such merger by ten percent (10%) or more, or (2) any sale, lease exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of HMEC; (ii) the shareholders of HMEC approve any plan or proposal for the liquidation or dissolution of HMEC which is a part of a sale of assets, merger, or reorganization of HMEC or other similar transaction; (iii) any "Person" as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is or becomes, directly or indirectly, the "beneficial owner," as defined in Rule 13d-3 under the Exchange Act, of securities of HMEC that represent 51% or more of the combined voting power of HMEC'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 having been elected by the Board of Directors or having been nominated by the Company for election of its shareholders. -2- (e) Constructive Termination "Constructive Termination" shall mean the following events: (1) any material adverse change or diminution in the Executive's duties or responsibilities to the Group; (2) any relocation of the Executive from his present work site to another site more than fifty (50) miles from the present work site; (3) a diminution in the Executive's annual base salary of more than ten percent (10%) below the Executive's salary for the Base Year; (4) a diminution in the Executive's annual cash bonus under the Horace Mann Incentive Compensation Program (or similar program that may replace the Incentive Compensation Program) of more than fifty percent (50%) below that paid to the Executive for the Base Year, except in the event that such diminution is comparable to the diminution in the cash bonus paid to other employees of the same business segment as the Executive due to the performance of that business segment; or (5) any material diminution in disability, life, accident or health insurance benefits which the Executive received during the Base Year (including coverage for dependents); provided, however, that none of the above shall constitute a Constructive Termination if the Executive consents to the event. (f) Date of Termination "Date of Termination" shall mean the date of the Notice of Termination delivered pursuant to Section 2(b); provided, however, that if, within thirty (30) days after the Notice of Termination is delivered to the Executive by the Company, the Executive notifies the Company that a dispute exists concerning termination of the Executive's employment, the Date of Termination (except for purposes of Section 1(b)) shall be the date on which the dispute is finally resolved, either by mutual written agreement of the parties or by a final judgment, order or decree of a court of competent jurisdiction (the time for appeal therefrom having expired and no appeal having been perfected). 2. Termination Following Change in Control (a) Termination of Employment If a Change in Control shall have occurred while the Executive is still an employee of the Company, the Executive shall be entitled to the compensation provided in Section 3 if, within 3 years after the Change in Control, the Executive's employment is terminated by (i) the Company without Cause or (ii) the Executive due to Constructive Termination. (b) Notice of Termination Any purported termination of the Executive's employment by the Company or the Executive shall be communicated by a Notice of Termination to the other party in accordance with Section 10 hereof. The Notice of Termination shall set forth in reasonable detail the reasons for termination and, if termination is for Cause, the facts and circumstances claimed to provide a basis for termination of the Executive's employment. -3- 3. Severance Compensation upon Termination of Employment If the Executive becomes entitled to compensation pursuant to Section 2(a), then the Company shall: (i) pay to the Executive as severance pay in a lump sum, in cash, on the fifth day following the Date of Termination, an amount equal to 2 times the Executive's Cash Compensation; (ii) arrange to provide to the Executive for 2 years (or such shorter period as the Executive may elect) disability, life, accident and health insurance substantially similar to those insurance benefits, if any, which the Executive was receiving immediately prior to the Notice of Termination (including coverage for dependents at the same per person cost as the Executive was then paying); and (iii) pay to Executive a single lump sum on or before the (5th) day following the Date of Termination (or such earlier date as required by applicable law) equal to the present value of his accrued benefit as the Date of Termination under any nonqualified supplemental pension plan sponsored by the Company. Any benefit paid pursuant to this Section 3(iii) shall be offset against any amount payable under such nonqualified supplemental pension plan. 4. Indemnification for Excise Tax (a) Indemnification In addition to the amounts specified in Section 3, the Company agrees that it will pay or cause to be paid to the Executive, at the time specified in paragraph (b) below, an amount in cash (the "Additional Amount") as determined by the following formula: Additional Amount = Excise Taxes + Attributable Taxes "Excise Taxes" shall mean all federal and state excise taxes, if any, payable under Section 4999 of the Internal Revenue Code (the "Code") and any state counterparts, with respect to the benefits received by the Executive pursuant to Section 3 of this Agreement. "Attributable Taxes" shall mean all taxes, including any federal and state income taxes and any federal and state excise taxes under Section 4999 of the Code and its state counterparts, that become payable by the Executive as a result of the receipt of the Additional Amount. (b) Preparation of Tax Return; Notice to the Company The Company, at its expense, agrees to supply the Executive with advice from a tax practitioner as to whether the Executive must reflect an excise tax under Section 4999 of the Code and any state counterparts on the filing of any income tax return of the Executive relating to the period or periods in which the Executive received payments or benefits under this Agreement. If such tax practitioner advises that such excise tax must be reflected on such tax return, the Executive agrees to so reflect and, unless such tax was previously withheld from payments to the Executive, pay such tax and the Company will reimburse the Executive in accordance with Section 4(a) above as soon as practicable after receipt of proof of payment (or, in the case of tax that was previously withheld, proof that such return was filed as required) from the Executive. If such tax practitioner advises that such excise tax need not be reflected on such tax return, the Executive agrees to prepare and file his tax return in accordance with such advice. The Executive shall notify the Company in writing no less than thirty (30) days prior -4- to the time the Executive is required to file each tax return, and shall promptly provide to the tax practitioner selected by the Company such information as it may request in connection with establishing the existence of an obligation to withhold tax pursuant to Section 16 hereof or an obligation pursuant to this Section 4. If the Executive provides such notice and information and prepares the relevant tax return as provided in this paragraph (b), the Company shall indemnify the Executive in accordance with Section 4(a) of this Agreement for any subsequent assessment of Excise Taxes or Attributable Taxes by the IRS or any state taxing authority, and any interest, penalties, and additions to tax directly relating to such Excise Taxes. If the Executive fails to comply fully with the requirements of this paragraph (b), then the Company's obligations will not include indemnification or any interest, penalties or additions to tax. In the event the Executive's liability for Excise Taxes is determined upon audit by the IRS or the relevant state taxing authority, the Company shall pay to the Executive the amount determined in accordance with paragraph (a) and this paragraph (b) at such time as the Company determines that it no longer desires to contest the Executive's liability pursuant to paragraph (c); provided, however, that in all events the Company will indemnify the Executive for interest, penalties and additions to tax, directly relating to Excise Taxes, which accrue after such time the Company receives notice of a proposed assessment of Excise Taxes resulting from an audit of the Executive's tax return. (c) Duty to Cooperate The Executive agrees to notify the Company promptly in the event of any audit by the IRS or any state taxing authority in which the IRS or the state taxing authority asserts that any Excise Tax should be assessed against the Executive and to cooperate with the Company in contesting (at the Company's expense) any such proposed assessment. The Executive agrees not to settle or compromise any such assessment without the Company's consent. The Executive will promptly provide to the Company all information requested by the Company in connection with its contest of a proposed final assessment of Excise Taxes. 5. Mitigation of Damages; Effect of Plan on Other Contractual Rights (a) The Executive shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for under this Agreement be reduced by any compensation earned by the Executive as a result of employment by another employer or by retirement benefits received after the Date of Termination, or otherwise. (b) The provisions of this Agreement, and any payment provided for hereunder, shall not reduce any amounts otherwise payable, or in any way diminish the Executive's existing rights, or rights that would accrue solely as a result of the passage of time, under any benefit plan, employment agreement or other contract, plan or arrangement. 6. Term This Agreement shall terminate three (3) years after the date of a Change in Control. Termination or amendment of this Agreement shall not affect any obligation of the Company under this Agreement which has accrued and is unpaid as of the effective date of such termination or amendment. -5- 7. At-Will Employment Nothing in this Agreement shall confer upon the Executive any right to continue in the employ of the Company prior to a Change in Control of the Company or shall interfere with or restrict in any way the rights of the Company, which are hereby expressly reserved, to discharge the Executive at any time prior to the date of a Change in Control of the Company for any reason whatsoever, with or without cause. 8. Successors (a) The Company will require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, expressly, absolutely and unconditionally to assume and agree in writing to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. Failure of the Company to obtain such written agreement of any such successor shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as the Executive would be entitled hereunder if such succession had not occurred, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination. As used in this Agreement, "Company" shall mean the Company as defined above and any successor or assign to its business and/or assets which executes and delivers the agreement provided for in this Section 8 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. (b) This Agreement shall inure to the benefit of and be enforceable by the Executive's personal and legal representatives, executors, administrators, successors, heirs, distributees, devises and legatees. If the Executive should die while any amounts are still payable to him hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's devisee, legatee or other designee or, if there be no such designee, to the Executive's estate. 9. Governing Law; Arbitration; Attorneys' Fees (a) This Agreement shall be governed by, and construed and enforced in accordance with, the internal laws of the State of Delaware, without giving effect to its conflict or choice of laws provisions. (b) If any controversies, disputes or claims arise out of, in connection with, or in relation to, the interpretation, performance or breach of this Agreement, all such controversies, disputes or claims shall be settled, at the request of any party hereto, by arbitration conducted in Springfield, Illinois, in accordance with the then existing rules of the American Arbitration Association. The decision rendered by the arbitrators as to all issues of law and fact shall be final and binding without right of appeal on all parties hereto who receive notice of such arbitration and the opportunity to participate therein. Judgment upon any award rendered in such arbitration may be entered by an state or federal court having jurisdiction over the matter. -6- (c) Should any party hereto institute any action or proceeding to enforce any provision of this Agreement, the prevailing party shall be entitled to receive from the losing party reasonable attorneys' fees and costs incurred in such action or proceeding, whether or not such action or proceeding is prosecuted to judgment. 10. Notice For purposes of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or two days after deposit in the mail by United States registered mail, return receipt requested, postage prepaid, as follows: if to the Company, to Horace Mann Service Corporation, 1 Horace Mann Plaza, Springfield, Illinois 62715, attention: Chief Executive Officer (except if such notice is sent by the Chief Executive Officer, in which case such notice shall be sent to the attention of the Chairman of the Board of Directors), and if to the Executive at the address specified at the end of this Agreement. Notice may also be given at such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 11. Miscellaneous No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision 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 either party which are not set forth expressly in this Agreement. 12. Validity The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 13. Counterparts This Agreement may be executed in two counterparts, each of which shall be deemed to be an original but both of which together will constitute one and the same instrument. 14. Gender In this Agreement (unless the content requires otherwise), use of any masculine term shall include the feminine. 15. Entire Agreement This Agreement contains the entire agreement between the parties hereto with respect to the transactions contemplated hereby and supercedes all previous oral and written and all contemporaneous oral negotiations, commitments and understandings. 16. Withholding The Company shall withhold benefits otherwise due or payable hereunder in order to comply with any federal, state, local or other income or other tax laws requiring withholding with respect to benefits provided to the Executive pursuant to this Agreement. -7- IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. HORACE MANN EDUCATORS CORPORATION By: _____________________________________________ Name: Joseph J. Melone Title: Chairman of the Board By: _____________________________________________ Name: Louis G. Lower II Title: President and Chief Executive Officer EXECUTIVE _________________________________________________ ___________________ 1 Horace Mann Plaza Springfield, IL 62715-0001 -8- EX-10.7(A) 8 dex107a.txt REVISED SCHEDULE TO SEVERANCE AGREEMENT Exhibit 10.7(a) Revised Schedule to Severance Agreement Horace Mann Educators Corporation ("HMEC") entered into severance agreements with the following persons on the dates shown. These agreements are substantially identical to the one included herein as Exhibit 10.7 to HMEC's Annual Report on Form 10-K for the year ended December 31, 2001 except that (1) the multiple of the highest annual compensation received by the employee in the five preceding years used to determine a one-time cash payment is equal to the duration listed below and (2) the specified period during which such employee's insurance benefits would continue is equal to the duration below, and except as indicated in footnote (a). Employee Duration Agreement Date Louis G. Lower II(a) 3 years 02-01-2000 Peter H. Heckman 2.9 years 04-10-2000 George J. Zock 2.9 years 12-27-1991 Ann M. Caparros 2.9 years 03-07-1994 Daniel M. Jensen 2.9 years 09-04-2001 Douglas W. Reynolds 2.9 years 11-12-2001 H. Albert Inkel 2.9 years 12-27-1991 Valerie A. Chrisman 2 years 12-27-1991 William S. Hinkle 2 years 07-19-1999 J. Michael Orr 2 years 07-19-1999 J. Michael Henderson 2 years 09-02-1997 Robert E. Rich 2 years 02-19-2001 Peter M. Titone 2 years 01-08-2001 Kathleen A. McNulty 2 years 11-06-2000 Ronnie H. Byers 2 years 03-16-2000 Bret A. Conklin 2 years 01-14-2002 Paul D. Andrews 2 years 07-02-2001 Ricky A. Renner 2 years 07-09-2001 ___________ (a) HMEC entered into a severance agreement with Louis G. Lower II as set forth in the Lower Employment Agreement contained in Exhibit 10.11 to HMEC's Annual Report on Form 10-K for the year ended December 31, 2001. -1- EX-10.13 9 dex1013.txt LETTER OF EMPLOYMENT - DANIEL M. JENSEN Exhibit 10.13 August 20, 2001 Daniel M. Jensen 2384 Calypso Lane League City, TX 77573 Dear Dan: We are pleased to offer you employment as Executive Vice President and Chief Marketing Officer with an initial monthly salary of $18,750 ($225,000 annually). We would like you to begin as soon as reasonably possible. You will be eligible to participate in the officers bonus program which consists of the three elements outlined below. Opportunity for award payment from this program would be in 2002, based on 2001 results prorated to reflect your partial year of employment. 1. An annual bonus 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 corporate and divisional results (0 to 2 times target percentage). You are guaranteed ---------- $150,000 for 2001, payable in 2002. 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 increase or decrease based on corporate results (0 to 2 times target percentage). As part of the long term incentive bonus program, there are stock ownership guideline requirements which must be met. The long term plan is a vehicle to help you achieve the targeted stock ownership percentage. I have attached a summary of the guidelines for your review. 3. Annual stock option grants based on corporate results and individual ------------------- performance equivalent to 50% of your base salary. In addition, under the HMEC Incentive Stock Plan (The Plan), 150,000 options of HMEC stock will be granted to you, based on board approval, at the Board Meeting following your hire date. The options vest in four equal portions; the first 37,500 shares on the grant date and the remaining three (3) pieces vest on the first, second and third year anniversaries of the grant date. The option price for all shares will be equal to the fair market value as of the date of board approval. -1- Daniel M. Jensen Page 2 August 20, 2001 A change of control severance agreement is included with this offer. A copy is attached for your review. Full relocation benefits will also be provided. A copy of those benefits is included. I've also enclosed an employment application for your completion and return as soon as possible. Dan, we're excited about the opportunity for you to be a part of the Horace Mann team. I look forward to hearing from you next week. Sincerely, /s/ Val Chrisman Valerie A. Chrisman Sr. Vice President Customer and Employee Services Division VC:jel Enclosures cc: Louis G. Lower Mike Vignola To confirm your acceptance of this offer, please sign this letter and return it to me. The enclosed copy is for your records. /s/ Dan M. Jensen 08/22/2001 - ---------------------------- ---------------------------------------- (Signature) (Date) -2- Stock Ownership Guidelines Name: Dan Jensen Tier Level: 2 Salary Multiple: 200% . 33% of the LTIP bonus will be required to be deferred into the Deferred Compensation Plan, each year until Tier level of ownership (as shown below) is met or exceeded. After target ownership is met, further LTIP payments would be made in cash. . Compliance with guidelines would be measured each year end; if not at designated level of ownership; then a % of LTIP bonus will be automatically deferred into the DCP. . An additional percentage over and above the required 33% could also be deferred. . Compliance with ownership guidelines would be waived only for the following reasons: written notice of retirement to occur within 12 months; written notice of resignation to occur within 12 months; or placement on permanent long term disability leave. . Deferrals in to the DCP will not be distributed until the retirement, termination, death, or permanent disability of the participant. . Ownership level will include any current stock already owned. . Ownership level would be adjusted with increase in scheduled salary and/or tier adjustment. . Ownership level would be adjusted with stock price fluctuations. . Ownership level could be met by the exercise and holding of stock options and the use of personal resources to purchase shares. . Current units in the Deferred Compensation Plan will be considered in meeting ownership levels. . Ownership by immediate family members (spouse and children) will be considered in meeting ownership levels. . Participation in the 401k HMEC Stock Fund and unexercised stock options will not be considered. -3- EX-10.14 10 dex1014.txt LETTER OF EMPLOYMENT - DOULAS W. REYNOLDS Exhibit 10.14 October 16, 2001 Douglas W. Reynolds 5235 Hilltop Road Long Grove, IL 60047 E-mail: douglasw41575@yahoo.com Dear Doug: We are pleased to offer you employment as Executive Vice President, Property and Casualty, with an initial monthly salary of $25,000 ($300,000 annually). In addition, we will pay to you by December 1, 2001 a sign-on bonus in the amount of $50,000. We would like you to begin as soon as reasonably possible but no later than November 26, 2001. You will be eligible to participate in the officers bonus program which consists of the three elements outlined below. Opportunity for award payment from this program would be in 2003, based on 2002 results. 1. An annual bonus 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 corporate and divisional results (0 to 2 times target percentage). You will receive a guaranteed target bonus of $150,000 payable around March, 2003. ---------- 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 increase or decrease based on corporate results (0 to 2 times target percentage). As part of the long term incentive bonus program, there are stock ownership guideline requirements which must be met. The long term plan is a vehicle to help you achieve the targeted stock ownership percentage. I have attached a summary of the guidelines for your review. 3. Annual stock option grants based on corporate results and individual ------------------- performance equivalent to 50% of your base salary. In addition, under the HMEC Incentive Stock Plan (The Plan), 150,000 options of HMEC stock will be granted to you, based on board approval, at the Board Meeting following your hire date. The options vest in four equal portions; the first 37,500 shares on the grant date and the remaining three (3) pieces vest on the first, second and third year anniversaries of the grant date. The option price for all shares will be equal to the fair market value as of the date of board approval. -1- Douglas W. Reynolds Page 2 October 16, 2001 A change of control severance agreement is included with this offer. A copy is attached for your review. In addition, the employee benefits program and relocation benefits will be provided. I will send information regarding these programs to your home address. Doug, we're pleased that you are considering joining the Horace Mann team. I look forward to hearing from you. Please fax the signed letter to my attention at 217.535.7277. Sincerely, /s/ Val Valerie A. Chrisman Sr. Vice President Employee and Corporate Services Division VC:jel Enclosures cc: Louis G. Lower To confirm your acceptance of this offer, please sign this letter and return it to me. The enclosed copy is for your records. /s/ Douglas W. Reynolds October 29, 2001 - ----------------------------------- -------------------------------- (Signature) (Date) -2- Stock Ownership Guidelines Name: Doug Reynolds Tier Level: 2 Salary Multiple: 200% . 33% of the LTIP bonus will be required to be deferred into the Deferred Compensation Plan, each year until Tier level of ownership (as shown below) is met or exceeded. After target ownership is met, further LTIP payments would be made in cash. . Compliance with guidelines would be measured each year end; if not at designated level of ownership; then a % of LTIP bonus will be automatically deferred into the DCP. . An additional percentage over and above the required 33% could also be deferred. . Compliance with ownership guidelines would be waived only for the following reasons: written notice of retirement to occur within 12 months; written notice of resignation to occur within 12 months; or placement on permanent long term disability leave. . Deferrals in to the DCP will not be distributed until the retirement, termination, death, or permanent disability of the participant. . Ownership level will include any current stock already owned. . Ownership level would be adjusted with increase in scheduled salary and/or tier adjustment. . Ownership level would be adjusted with stock price fluctuations. . Ownership level could be met by the exercise and holding of stock options and the use of personal resources to purchase shares. . Current units in the Deferred Compensation Plan will be considered in meeting ownership levels. . Ownership by immediate family members (spouse and children) will be considered in meeting ownership levels. . Participation in the 401k HMEC Stock Fund and unexercised stock options will not be considered. -3- EX-10.15 11 dex1015.txt LETTER OF EMPLOYMENT - BRET A. CONKLIN Exhibit 10.15 December 3, 2001 Bret Conklin 1020 White Pine Drive Cary, IL 60013 Dear Bret: We are pleased to offer you employment as Senior Vice President and Controller, with an initial monthly salary of $15,000 ($180,000 annually). In addition, we will pay to you by February 1, 2002 a sign-on bonus in the amount of $80,000. We would like you to begin as soon as possible after the first of the year. You will be eligible to participate in the officers bonus program which consists of the three elements outlined below. Opportunity for award payment from this program would be in 2003, based on 2002 results. 1. An annual bonus based on meeting specific corporate and divisional --------------- measures. Your position provides for a target bonus opportunity of 30% of your annual salary but could increase or decrease based on corporate and divisional results (0 to 2 times target percentage). 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 25% of your annual salary but could increase or decrease based on corporate results (0 to 2 times target percentage). As part of the long term incentive bonus program, there are stock ownership guideline requirements which must be met. The long term plan is a vehicle to help you achieve the targeted stock ownership percentage. I have attached a summary of the guidelines for your review. 3. Annual stock option grants based on corporate results and individual ------------------- performance equivalent to 30% of your base salary. In addition, under the HMEC Incentive Stock Plan (The Plan), 50,000 options of HMEC stock will be granted to you, based on board approval, at the Board Meeting following your hire date. The options vest in four equal portions; the first 12,500 shares on the grant date and the remaining three (3) pieces vest on the first, second and third year anniversaries of the grant date. The option price for all shares will be equal to the fair market value as of the date of board approval. -1- Bret Conklin Page 2 December 3, 2001 A change of control severance agreement is included with this offer. A copy is attached for your review. In addition, the employee benefits program and full relocation benefits, which includes temporary housing expenses up to six months from the date of hire, will be provided. A copy of these programs was previously sent to you. In order to substantiate your identity and employment eligibility in accordance with federal law, I would like you to bring documentation with you on your first day. Samples of acceptable identification and authorization are enclosed. I've also enclosed an employment application for your completion and return as soon as possible. Bret, we're pleased that you are considering joining the Horace Mann team. I look forward to hearing from you. I will mail the original letter and attachments to your home address and e-mail a copy of the letter to you. Once you've received the e-mail, please return a signed copy, by way of fax, to my attention at 217.535.7277. Sincerely, /s/ Val Valerie A. Chrisman Sr. Vice President Customer and Employee Services Division VC:jel Enclosures cc: Louis G. Lower Pete Heckman To confirm your acceptance of this offer, please sign this letter and return it to me. The enclosed copy is for your records. /s/ Bret A. Conklin 12/03/2001 - ------------------------------- ------------------- (Signature) (Date) -2- Stock Ownership Guidelines Name: Bret Conklin Tier Level: 4 Salary Multiple: 50% . 33% of the LTIP bonus will be required to be deferred into the Deferred Compensation Plan, each year until Tier level of ownership (as shown below) is met or exceeded. After target ownership is met, further LTIP payments would be made in cash. . Compliance with guidelines would be measured each year end; if not at designated level of ownership; then a % of LTIP bonus will be automatically deferred into the DCP. . An additional percentage over and above the required 33% could also be deferred. . Compliance with ownership guidelines would be waived only for the following reasons: written notice of retirement to occur within 12 months; written notice of resignation to occur within 12 months; or placement on permanent long term disability leave. . Deferrals in to the DCP will not be distributed until the retirement, termination, death, or permanent disability of the participant. . Ownership level will include any current stock already owned. . Ownership level would be adjusted with increase in scheduled salary and/or tier adjustment. . Ownership level would be adjusted with stock price fluctuations. . Ownership level could be met by the exercise and holding of stock options and the use of personal resources to purchase shares. . Current units in the Deferred Compensation Plan will be considered in meeting ownership levels. . Ownership by immediate family members (spouse and children) will be considered in meeting ownership levels. . Participation in the 401k HMEC Stock Fund and unexercised stock options will not be considered. -3- EX-11 12 dex11.txt 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, 2001, 2000 1999 (Amounts in thousands, except per share data)
Year Ended December 31, ---------------------------------------------- 2001 2000 1999 ---- ---- ---- Basic - assumes no dilution: Net income for the period $ 25,587 $ 20,841 $ 44,505 --------- --------- -------- Weighted average number of common shares outstanding during the period 40,617 40,782 41,246 --------- --------- -------- Net income per share - basic $ 0.63 $ 0.51 $ 1.08 ========= ========= ======== Diluted - assumes full dilution: Net income for the period $ 25,587 $ 20,841 $ 44,505 --------- --------- -------- Weighted average number of common shares outstanding during the period 40,617 40,782 41,246 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: Stock options 125 62 387 Common stock units related to Deferred Equity Compensation Plan for Directors 121 114 69 Common stock units related to Deferred Compensation Plan for Employees 14 9 6 --------- --------- -------- Total common and common equivalent shares adjusted to calculate diluted earnings per share 40,877 40,967 41,708 --------- --------- -------- Net income per share - diluted $ 0.63 $ 0.51 $ 1.07 ========= ========= ======== Percentage of dilution compared to basic net income per share 0.0% 0.0% 0.9%
EX-12 13 dex12.txt STATEMENT RE COMPUTATION OF RATIOS Exhibit 12 Horace Mann Educators Corporation Computation of Ratio of Earnings to Fixed Charges For the Years Ended December 31, 2001, 2000, 1999, 1998 and 1997 (Dollars in millions)
Year Ended December 31, ---------------------------------------------------- 2001 2000 1999 1998 1997 ------- ------ ------- ------- ------- Income from continuing operations before income taxes $28.3 $ 9.7 $ 93.4 $116.8 $ 119.6 Interest expense 9.3 10.2 9.7 9.5 9.4 ------- ------ ------- ------- ------- Earnings $37.6 $ 19.9 $ 103.1 $126.3 $ 129.0 ======= ====== ======= ======= ======= Fixed charges - interest expense $ 9.3 $ 10.2 $ 9.7 $ 9.5 $ 9.4 Ratio of earnings to fixed charges 4.0x 2.0x 10.6x 13.3x 13.7x
EX-21 14 dex21.txt SUBSIDIARIES OF THE REGISTRANT Exhibit 21 Horace Mann Educators Corporation Insurance Subsidiaries, Other Significant Subsidiaries and Their Respective States of Incorporation or Organization December 31, 2001 Insurance Subsidiaries: 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 Horace Mann Property & Casualty Insurance Company - California Teachers Insurance Company - Illinois Other Significant Subsidiaries: Horace Mann Educator Benefits Consulting Corporation - Illinois Horace Mann General Agency - Texas Horace Mann Investors, Inc. - Maryland Horace Mann Service Corporation - Illinois EX-23 15 dex23.txt CONSENT OF KPMG LLP Exhibit 23 The Board of Directors Horace Mann Educators Corporation: We consent to the incorporation by reference in the registration statements (No. 33-47066, No. 33-45152, 333-16473, and No. 333-74686) on Form S-8 of Horace Mann Educators Corporation and subsidiaries (the Company) of our report dated February 7, 2002, with respect to the consolidated balance sheets of the Company as of December 31, 2001, 2000, and 1999, 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, 2001, and all related financial statement schedules, which report appears in the December 31, 2001 annual report on Form 10-K of the Company. /s/ KPMG LLP KPMG LLP Chicago, Illinois March 28, 2002 -----END PRIVACY-ENHANCED MESSAGE-----