-----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, C34WSmntQp+jwFAwOdbrIrj+8Ys2Rw9HUcH1vlF/FCny9+bsku69HKO/Az7W77hJ RUKV6JGw97FeymVSDdSqBg== 0000950131-99-006261.txt : 19991115 0000950131-99-006261.hdr.sgml : 19991115 ACCESSION NUMBER: 0000950131-99-006261 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991112 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-Q SEC ACT: SEC FILE NUMBER: 001-10890 FILM NUMBER: 99749757 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-Q 1 FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [x]QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999 OR [ ]TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-10890 HORACE MANN EDUCATORS CORPORATION (Exact name of registrant as specified in its charter) Delaware 37-0911756 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1 Horace Mann Plaza, Springfield, Illinois 62715-0001 (Address of principal executive offices) (Zip Code) Registrant's Telephone Number, Including Area Code: 217-789-2500 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 ---- ---- As of October 29, 1999, 41,028,069 shares of Common Stock, par value $0.001 per share, were outstanding, net of 18,258,896 shares of treasury stock. ================================================================================ HORACE MANN EDUCATORS CORPORATION FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1999 INDEX
Page ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements Independent Auditors' Review Report.............................. 1 Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998....................... 2 Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 1999 and 1998........ 3 Consolidated Statements of Changes in Shareholders' Equity for the Nine Months Ended September 30, 1999 and 1998.......... 4 Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 1999 and 1998........ 5 Notes to Consolidated Financial Statements....................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......................... 13 Item 3. Quantitative and Qualitative Disclosures about Market Risk.. 26 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders......... 26 Item 6. Exhibits and Reports on Form 8-K............................ 26 SIGNATURES.................................................................... 27
INDEPENDENT AUDITORS' REVIEW REPORT The Board of Directors and Shareholders Horace Mann Educators Corporation: We have reviewed the consolidated balance sheet of Horace Mann Educators Corporation and subsidiaries as of September 30, 1999 and the related consolidated statements of operations and cash flows for the three-month and nine-month periods ended September 30, 1999 and 1998. These consolidated financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of Horace Mann Educators Corporation and subsidiaries as of December 31, 1998, and the related consolidated statements of operations, shareholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated January 26, 1999, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 1998, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/ KPMG LLP KPMG LLP Chicago, Illinois October 22, 1999 1 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED BALANCE SHEETS (Dollars in thousands)
September 30, December 31, 1999 1988 ------------- ------------ ASSETS Investments Fixed maturities, available for sale, at market (amortized cost, 1999, $2,571,599; 1998, $2,552,537)................. $2,539,358 $2,651,379 Short-term and other investments............................ 114,627 102,049 Short-term investments, loaned securities collateral........ - 87,392 ---------- ---------- Total investments....................................... 2,653,985 2,840,820 Cash......................................................... 18,746 12,044 Accrued investment income and premiums receivable............ 102,591 102,661 Value of acquired insurance in force and goodwill............ 96,003 101,055 Deferred policy acquisition costs............................ 132,537 101,658 Other assets................................................. 135,939 114,503 Variable annuity assets...................................... 1,085,116 1,122,739 ---------- ---------- Total assets............................................ $4,224,917 $4,395,480 ========== ==========
LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY
Policy liabilities Fixed annuity contract liabilities.......................... $1,239,731 $1,239,234 Interest-sensitive life contract liabilities................ 432,051 402,490 Unpaid claims and claim expenses............................ 312,892 307,387 Future policy benefits...................................... 179,008 179,693 Unearned premiums........................................... 188,711 179,194 ---------- ---------- Total policy liabilities................................ 2,352,393 2,307,998 Other policyholder funds..................................... 129,079 124,820 Other liabilities............................................ 105,298 197,292 Short-term debt.............................................. 49,000 50,000 Long-term debt............................................... 99,667 99,637 Variable annuity liabilities................................. 1,080,817 1,118,890 ---------- ---------- Total liabilities....................................... 3,816,254 3,898,637 ---------- ---------- Warrants, subject to redemption.............................. 220 220 ---------- ---------- Preferred stock.............................................. - - Common stock................................................. 59 59 Additional paid-in capital................................... 336,227 336,686 Retained earnings............................................ 430,841 420,274 Accumulated other comprehensive income (net unrealized gains (losses) on fixed maturities and equity securities)........................... (15,876) 57,327 Treasury stock, at cost...................................... (342,808) (317,723) ---------- ---------- Total shareholders' equity.............................. 408,443 496,623 ---------- ---------- Total liabilities, redeemable securities, and shareholders' equity................ $4,224,917 $4,395,480 ========== ==========
See accompanying notes to consolidated financial statements. 2 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share data)
Three Months Ended Nine Months Ended September 30, September 30, ------------------- ------------------- 1999 1998 1999 1998 ---- ---- ---- ---- Insurance premiums written and contract deposits..................... $208,305 $209,686 $614,014 $616,705 ======== ======== ======== ======== Revenues Insurance premiums and contract charges earned................. $149,283 $144,536 $444,062 $429,094 Net investment income..................... 46,573 47,781 140,480 144,458 Realized investment gains (losses)........ (423) 4,247 (8,896) 13,599 -------- -------- ------- -------- Total revenues........................ 195,433 196,564 575,646 587,151 -------- -------- ------- -------- Benefits, losses and expenses Benefits, claims and settlement expenses.. 104,067 96,563 315,994 301,308 Interest credited......................... 22,814 23,495 68,829 71,426 Policy acquisition expenses amortized..... 12,746 11,015 36,498 34,149 Operating expenses........................ 29,479 27,057 79,709 80,684 Amortization of intangible assets......... 1,639 1,856 5,052 5,593 Interest expense.......................... 2,406 2,394 7,283 7,098 Litigation settlement..................... 1,550 - 1,550 - -------- -------- -------- -------- Total benefits, losses and expenses..... 174,701 162,380 514,915 500,258 -------- -------- -------- -------- Income before income taxes................. 20,732 34,184 60,731 86,893 Income tax expense......................... 6,190 9,251 18,716 23,853 Provision for prior years' taxes........... 20,000 - 20,000 - -------- -------- ------- -------- Net income (loss).......................... $ (5,458) $ 24,933 $ 22,015 $ 63,040 ======== ======== ======== ======== Net income (loss) per share Basic..................................... $ (0.13) $ 0.58 $ 0.53 $ 1.45 ======== ======== ======== ======== Diluted................................... $ (0.12) $ 0.57 $ 0.53 $ 1.43 ======== ======== ======== ======== Weighted average number of shares and equivalent shares (in thousands) Basic................................... 41,026 42,811 41,318 43,523 Diluted................................. 41,647 43,413 41,881 44,141
See accompanying notes to consolidated financial statements. 3 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in thousands, except per share data)
Nine Months Ended September 30, ---------------------- 1999 1998 ---------- ---------- Common stock Beginning balance.......................................... $ 59 $ 59 Options exercised, 1999, 12,275 shares; 1998, 110,182 shares..................................... - - --------- --------- Ending balance............................................. 59 59 --------- --------- Additional paid-in capital Beginning balance.......................................... 336,686 340,564 Options exercised.......................................... 262 2,163 Catastrophe-linked equity put option premium............... (712) (1,475) Purchase of 13,650 warrants................................ - (4,603) Other...................................................... (9) - --------- --------- Ending balance........................................... 336,227 336,649 --------- --------- Retained earnings Beginning balance.......................................... 420,274 349,274 Net income................................................. 22,015 63,040 Cash dividends, 1999, $0.2775 per share; 1998, $0.24 per share.................................... (11,448) (10,403) --------- --------- Ending balance............................................. 430,841 401,911 --------- --------- Accumulated other comprehensive income (net unrealized gains (losses) on fixed maturities and equity securities) Beginning balance........................................ 57,327 62,167 Increase (decrease) for the period....................... (73,203) 9,497 --------- --------- Ending balance........................................... (15,876) 71,664 --------- --------- Treasury stock, at cost Beginning balance, 1999, 17,183,596 shares; 1998, 14,896,796 shares.................................. (317,723) (246,092) Purchase of 1,075,300 shares in 1999; 1,706,600 shares in 1998 (See note 4).................... (25,085) (55,154) --------- --------- Ending balance, 1999, 18,258,896 shares; 1998, 16,603,396 shares.................................. (342,808) (301,246) --------- --------- Shareholders' equity at end of period....................... $ 408,443 $ 509,037 ========= ========= Comprehensive income Net income................................................. $ 22,015 $ 63,040 Other comprehensive income................................. (73,203) 9,497 --------- --------- Total.................................................... $ (51,188) $ 72,537 ========= =========
See accompanying notes to consolidated financial statements. 4 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
Three Months Ended Nine Months Ended September 30, September 30, ---------------------- ---------------------- 1999 1998 1999 1998 ---------- ---------- ---------- ----------- Cash flows from operating activities Premiums collected................................ $ 162,803 $ 158,449 $ 465,906 $ 465,640 Policyholder benefits paid........................ (114,198) (122,320) (338,832) (349,063) Policy acquisition and other operating expenses paid......................... (42,401) (43,646) (131,465) (135,613) Federal income taxes paid......................... (100) (4,200) (12,400) (24,600) Investment income collected....................... 49,161 50,655 142,202 150,139 Interest expense paid............................. (4,018) (3,549) (8,803) (8,164) Other............................................. (5,945) (3,678) (5,499) (3,160) --------- --------- --------- --------- Net cash provided by operating activities..... 45,302 31,711 111,109 95,179 --------- --------- --------- --------- Cash flows used in investing activities Fixed maturities Purchases....................................... (120,176) (146,416) (579,148) (629,562) Sales........................................... 57,260 91,873 342,650 386,322 Maturities...................................... 67,836 85,698 215,575 282,613 Net cash received from (used for) short-term and other investments................ (30,541) (33,857) (11,214) 148 --------- --------- --------- --------- Net cash provided by (used in) investing activities.............. (25,621) (2,702) (32,137) 39,521 --------- --------- --------- --------- Cash flows used in financing activities Purchase of treasury stock........................ - (10,059) (25,085) (55,154) Dividends paid to shareholders.................... (3,796) (3,416) (11,448) (10,403) Principal borrowings (repayments) on Bank Credit Facility......................... - - (1,000) 3,000 Repurchase of common stock warrants............... - - - (4,959) Exercise of stock options......................... 139 273 262 2,163 Catastrophe-linked equity put option premium...... (237) - (712) (1,475) Annuity contracts, variable and fixed Deposits........................................ 45,491 49,914 152,671 167,313 Maturities and withdrawals...................... (64,637) (49,127) (181,581) (140,855) Net transfer from (to) variable annuity assets.. 4,770 (15,454) (4,365) (81,874) Net increase (decrease) in life policy account balances.................... (1,622) 194 (1,012) (10) --------- --------- --------- --------- Net cash used in financing activities......... (19,892) (27,675) (72,270) (122,254) --------- --------- --------- --------- Net increase (decrease) in cash.................... (211) 1,334 6,702 12,446 Cash at beginning of period........................ 18,957 11,465 12,044 353 --------- --------- --------- --------- Cash at end of period.............................. $ 18,746 $ 12,799 $ 18,746 $ 12,799 ========= ========= ========= =========
See accompanying notes to consolidated financial statements. 5 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1999 and 1998 (Dollars in thousands) Note 1 - Basis of Presentation The accompanying unaudited consolidated financial statements of Horace Mann Educators Corporation (the "Company") have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The Company believes that these financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the Company's consolidated financial position as of September 30, 1999 and December 31, 1998 and the consolidated results of operations, changes in shareholders' equity and cash flows for the three and nine months ended September 30, 1999 and 1998. It is suggested that these financial statements be read in conjunction with the financial statements and the related notes included in the Company's December 31, 1998 Form 10-K. The results of operations for the three and nine months ended September 30, 1999 are not necessarily indicative of the results to be expected for the full year. Note 2 - Debt Indebtedness outstanding was as follows:
September 30, December 31, 1999 1998 ------------- ------------ Short-term debt: $65,000 Bank Credit Facility, commitment to December 31, 2001. (IBOR + 0.325%, 5.8% as of September 30, 1999)............. $ 49,000 $ 50,000 Long-term debt: 6 5/8% Senior Notes, due January 15, 2006. Face amount less unaccrued discount of $333 and $363 (6.7% imputed rate)....... 99,667 99,637 -------- -------- Total.................................... $148,667 $149,637 ======== ========
6 Note 3 - Investments The following table presents the composition and value of the Company's fixed maturity securities portfolio by rating category. The Company has classified the entire fixed maturity securities portfolio as available for sale, which is carried at market value.
Percent of Carrying Value September 30, 1999 ---------------------------- ----------------------- Rating of Fixed September 30, December 31, Carrying Amortized Maturity Securities(1) 1999 1998 Value Cost - ---------------------- ------------- ------------ ---------- ---------- AAA................... 45.5% 44.0% $1,155,723 $1,164,782 AA.................... 8.2 8.5 209,947 209,028 A..................... 19.1 19.1 484,839 485,347 BBB................... 20.0 21.5 508,131 524,184 BB.................... 2.2 2.0 55,685 61,131 B..................... 4.6 4.1 115,981 117,731 CCC or lower.......... 0.1 0.1 1,563 1,717 Not rated(2).......... 0.3 0.7 7,489 7,679 ----- ----- ---------- ---------- Total............. 100.0% 100.0% $2,539,358 $2,571,599 ===== ===== ========== ==========
(1) Ratings are as assigned primarily by Standard & Poor's Corporation ("S&P") when available, with remaining ratings as assigned on an equivalent basis by Moody's Investors Service, Inc. ("Moody's"). Ratings for publicly traded securities are determined when the securities are acquired and are updated monthly to reflect any changes in ratings. (2) This category includes $1.4 million of publicly traded securities not currently rated by S&P or Moody's and $6.1 million of private placement securities not rated by either S&P or Moody's. The National Association of Insurance Commissioners (the "NAIC") has rated 97.2% of these private placements as investment grade. The following table presents a maturity schedule of the Company's fixed maturity securities. 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.
Carrying Percent of Total Value ---------------------------- ------------- September 30, December 31, September 30, Scheduled Maturity 1999 1998 1999 - ------------------------------------- ------------- ------------ ------------- Due in 1 year or less................ 7.6% 7.0% $ 192,004 Due after 1 year through 5 years..... 30.8 25.8 782,129 Due after 5 years through 10 years... 31.4 31.8 796,942 Due after 10 years through 20 years.. 15.4 17.3 392,947 Due after 20 years................... 14.8 18.1 375,336 ----- ----- ---------- Total............................ 100.0% 100.0% $2,539,358 ===== ===== ==========
The Company loans fixed income securities to third parties, primarily major brokerage firms. However, there were no securities on loan at September 30, 1999. At December 31, 1998, fixed maturities with a fair value of $87,392 were loaned. The Company separately maintains a minimum of 100% of the value of the loaned securities as collateral for each loan. Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 7 Note 3 -Investments-(Continued) 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," requires the securities lending collateral to be classified as investments. The corresponding liability is included in Other Liabilities in the Company's consolidated balance sheet. Note 4 - Shareholders' Equity Share Repurchase Programs During the first six months of 1999, the Company repurchased 1,075,300 shares of its common stock, or 3% of the outstanding shares on December 31, 1998, at an aggregate cost of $25,085, or an average cost of $23.33 per share, under its stock repurchase program. No shares were repurchased during the third quarter of 1999. Since early 1997, 7,082,700 shares, or 15% of the shares outstanding on December 31, 1996, have been repurchased at an aggregate cost of $188,506, equal to an average cost of $26.62 per share. Including shares repurchased in 1995, the Company has repurchased 32% of the shares outstanding on December 31, 1994. The repurchase of shares was financed through cash generated from operations and, when necessary, the Bank Credit Facility. In May 1999, an additional $100,000 share repurchase authorization was announced. As of September 30, 1999, $111,494 remained authorized for future share repurchases. On August 2, 1999, the Company announced that its Board of Directors had retained Morgan Stanley Dean Witter and Credit Suisse First Boston to explore the strategic alternatives available to the corporation. During the process of considering strategic alternatives, the Board of Directors has decided to suspend the Company's share repurchase program. Note 5 - Deferred Policy Acquisition Costs 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 in proportion to estimated gross profits for interest-sensitive life and investment (annuity) contracts and over the terms of the insurance policies for other individual life and property and casualty contracts. The Company periodically reviews the assumptions and estimates used in capitalizing policy acquisition costs. The Company began deferring additional sales-related costs in 1999 for all new life and annuity contracts, consistent with common industry accounting practices. The estimated impact of this change is an increase to net income of approximately $3,200 for 1999, of which $2,401 was recognized during the first nine months of 1999. 8 Note 6 - Income Taxes As previously reported, the Company has been contesting proposed additional federal income taxes relating to a settlement agreement with the Internal Revenue Service ("IRS") for prior years' taxes. Based on recent developments in that process, it appears that the Company may be forced to litigate the issue with the IRS in order to reach a resolution of the issue acceptable to the Company. Therefore, the Company has, in the third quarter of 1999, recorded an additional federal income tax provision of $20 million representing the maximum exposure of the Company to the IRS with regard to the issue for all of the past tax years in question. While the ultimate resolution of the issue, through settlement or litigation, may result in the Company paying less than the maximum exposure, given the vagaries of litigation and the lack of progress in reaching an acceptable agreement with the IRS, management believes it prudent to book the maximum exposure at this time. None of the $20 million reserve was paid as of November 11, 1999. This reserve was a charge to net income in the third quarter of 1999. 9 Note 7 - Reinsurance 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 -------- --------- ---------- -------- Three months ended September 30, 1999 - ----------------------- Premiums written....... $209,068 $ 5,396 $ 4,633 $208,305 Premiums earned........ 151,197 6,395 4,481 149,283 Benefits, claims and settlement expenses.. 108,302 9,178 4,943 104,067 Three months ended September 30, 1998 - ----------------------- Premiums written....... $212,259 $ 7,446 $ 4,873 $209,686 Premiums earned........ 147,150 7,068 4,454 144,536 Benefits, claims and settlement expenses.. 104,477 12,244 4,330 96,563 Nine months ended September 30, 1999 - ----------------------- Premiums written....... $618,013 $17,689 $13,690 $614,014 Premiums earned........ 449,112 18,885 13,835 444,062 Benefits, claims and settlement expenses.. 330,352 28,191 13,833 315,994 Nine months ended September 30, 1998 - ----------------------- Premiums written....... $622,946 $19,903 $13,662 $616,705 Premiums earned........ 435,145 18,864 12,813 429,094 Benefits, claims and settlement expenses.. 321,819 31,251 10,740 301,308
The Company maintains an excess and catastrophe treaty reinsurance program. The Company reinsures 95% of catastrophe losses above a retention of $7.5 million per occurrence up to $80 million per occurrence in 1999. In addition, the Company reinsures 75% of catastrophe 10 Note 7 - Reinsurance-(Continued) losses in Florida above a retention of $6.1 million. These programs are augmented by a $100 million equity put that provides an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event losses from catastrophes exceed the catastrophe reinsurance program coverage limit. Before tax benefits, the equity put provides a source of capital for up to $154 million of catastrophe losses above the reinsurance coverage limit. The fee for the equity put is charged directly to additional paid-in capital. For liability coverages, including the educator professional liability policy, the Company reinsures each loss above a retention of $0.5 million up to $20 million. The Company also reinsures each property loss above a retention of $0.5 million up to $2.5 million. 11 Note 8 - Segment Information The Company conducts and manages its business through four segments. The three operating segments representing the major lines of insurance business are: property and casualty insurance, principally personal lines automobile and homeowners insurance; individual tax-qualified annuity products; and life insurance. The fourth segment, Corporate and Other, includes primarily debt service and realized investment gains and losses. Summarized financial information for these segments is as follows:
Three Months Ended Nine Months Ended September 30, September 30, ------------------------------------ ----------------------------------- 1999 1998 1999 1998 -------------- -------------- -------------- --------------- Insurance premiums and contract charges earned Property and casualty............... $122,776 $119,588 $365,889 $ 353,219 Annuity............................. 4,273 3,926 12,533 11,474 Life................................ 22,234 21,022 65,640 64,401 -------- -------- -------- ---------- Total............................. $149,283 $144,536 $444,062 $ 429,094 ======== ======== ======== ========== Net investment income Property and casualty................. $ 9,170 $ 9,666 $ 27,561 $ 29,296 Annuity............................... 25,962 26,838 78,827 81,257 Life.................................. 11,705 11,532 34,879 34,032 Corporate and other................... 90 17 185 691 Intersegment eliminations............. (354) (272) (972) (818) -------- -------- -------- ---------- Total............................. $ 46,573 $ 47,781 $140,480 $ 144,458 ======== ======== ======== ========== Net income (loss) Operating income Property and casualty............... $ 9,414 $ 15,401 $ 25,807 $ 35,767 Annuity............................. 6,077 5,886 18,736 16,950 Life................................ 3,111 3,410 11,595 8,944 Corporate and other, including interest expense........ (2,777) (2,524) (7,333) (7,460) -------- -------- -------- ---------- Total operating income.......... 15,825 22,173 48,805 54,201 Realized investment gains (losses), after tax........................... (275) 2,760 (5,782) 8,839 Litigation settlement, after tax...... (1,008) - (1,008) - Provision for prior years' taxes...... (20,000) - (20,000) - -------- -------- -------- ---------- Total........................... $ (5,458) $ 24,933 $ 22,015 $ 63,040 ======== ======== ======== ========== Amortization of intangible assets Value of acquired insurance in force Property and casualty............... $ 203 $ 258 $ 719 $ 774 Annuity............................. 500 624 1,502 1,872 Life................................ 531 569 1,617 1,733 -------- -------- -------- ---------- Subtotal.......................... 1,234 1,451 3,838 4,379 Goodwill.............................. 405 405 1,214 1,214 -------- -------- -------- ---------- Total........................... $ 1,639 $ 1,856 $ 5,052 $ 5,593 ======== ======== ======== ========== September 30, December 31, Assets 1999 1998 ------------- ----------- Property and casualty............................................. $ 709,782 $ 737,260 Annuity........................................................... 2,580,743 2,730,092 Life.............................................................. 832,620 863,864 Corporate and other............................................... 138,477 95,579 Intersegment eliminations......................................... (36,705) (31,315) ---------- ---------- Total....................................................... $4,224,917 $4,395,480 ========== ==========
12 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in millions) Forward-looking Information Statements made in the following discussion that state the Company's or management's intentions, hopes, beliefs, expectations or predictions of the future are forward-looking statements. It is important to note that the Company's actual results could differ materially from those projected in such forward-looking statements due to, among other risks and uncertainties inherent in the Company's business, the following important factors: . Changes in the composition of the Company's assets and liabilities through acquisitions or divestitures. . Prevailing interest rate levels, including the impact of interest rates on (i) unrealized gains and losses on the Company's investment portfolio and the related after-tax effect on the Company's shareholders' equity and total capital and (ii) the book yield of the Company's investment portfolio. . The impact of fluctuations in the capital markets on the Company's ability to refinance outstanding indebtedness or repurchase shares of the Company's outstanding common stock. . The frequency and severity of catastrophes such as hurricanes, earthquakes and storms, and the ability of the Company to maintain a favorable catastrophe reinsurance program. . Future property and casualty loss experience and its impact on estimated claims and claim adjustment expenses for losses occurring in prior years. . The Company's ability to develop and expand its agency force and its direct product distribution systems, as well as the Company's ability to maintain and secure product sponsorships by local, state and national education associations. . The competitive impact of new entrants such as mutual funds and banks into the tax deferred annuity products markets, and the Company's ability to profitably expand its property and casualty business in highly competitive environments. . Changes in insurance regulations, including (i) those effecting the ability of the Company's insurance subsidiaries to distribute cash to the holding company and (ii) those impacting the Company's ability to profitably write property and casualty insurance policies in one or more states. . Changes in federal income tax laws and changes resulting from federal tax audits effecting corporate tax rates or taxable income, and regulations changing the relative tax advantages of the Company's life and annuity products to customers. . The Company's ability to maintain favorable claims-paying ability ratings. . Adverse changes in policyholder mortality and morbidity rates. . The resolution of legal proceedings and related matters. Strategic Review On August 2, 1999, the Company announced that its Board of Directors had retained Morgan Stanley Dean Witter and Credit Suisse First Boston to explore the strategic alternatives available to the corporation. As of November 11, 1999, that process is under way and continuing. 13 Nine Months Ended September 30, 1999 Compared With Nine Months Ended September 30, 1998 Insurance Premiums and Contract Charges Insurance Premiums Written and Contract Deposits
Nine Months Ended Growth Over September 30, Prior Year ----------------- ------------------- 1999 1998 Percent Amount ------ ------ ------- --------- Automobile and property (voluntary).............. $354.9 $345.3 2.8% $ 9.6 Annuity deposits........... 152.7 167.3 -8.7% (14.6) Life insurance............. 87.1 83.9 3.8% 3.2 ------ ------ ------ Subtotal - core lines.. 594.7 596.5 -0.3% (1.8) Involuntary and other property & casualty...... 19.3 20.2 -4.5% (0.9) ------ ------ ------ Total.................. $614.0 $616.7 -0.4% $ (2.7) ====== ====== ======
Insurance Premiums and Contract Charges Earned (Excludes annuity and life contract deposits)
Nine Months Ended Growth Over September 30, Prior Year ----------------- ------------------ 1999 1998 Percent Amount ------ ------ ------- ------ Automobile and property (voluntary).............. $347.6 $335.4 3.6% $12.2 Annuity.................... 12.5 11.5 8.7% 1.0 Life....................... 65.7 64.4 2.0% 1.3 ------ ------ ----- Subtotal - core lines.. 425.8 411.3 3.5% 14.5 Involuntary and other property & casualty...... 18.3 17.8 2.8% 0.5 ------ ------ ----- Total.................. $444.1 $429.1 3.5% $15.0 ====== ====== =====
Premium growth continued in the property and casualty and life segments. Total insurance premiums written and contract deposits decreased slightly for the nine months attributable to a decline in new annuity deposits. For the first nine months of 1999, single premium annuity deposits declined significantly, - -23.6%, compared to the same period last year. 1998's annuity deposit growth benefitted from new tax legislation contributing to a high volume of single premium and rollover deposits to tax-qualified products. In total, the Company ended the first nine months with 1,053 exclusive full-time agents, compared to 1,059 agents 12 months earlier. While the total number of agents decreased slightly compared to a year ago, the number of experienced agents has increased 3.6%. The number of agents in their first two years with the Company is lower than 12 months ago as a result of fewer hires and an increase in terminations. Modifications have been made to the new agents' financing program that management believes will have a positive impact on agent growth in future years. 14 Total voluntary automobile and homeowners premium written growth was 2.8% for the first nine months of 1999, resulting from growth in both the average premium per policy and the number of automobile and homeowners policies in force. Automobile insurance premium increased 1.3%, or $3.5 million, compared to the first nine months of last year, and homeowners premium increased 8.0%, or $6.1 million. Nearly one-half of the property and casualty increase in premiums resulted from unit growth of 1.6% bringing quarter-end policies in force to 873,000. Compared to December 31, 1998, total property and casualty policies in force increased 14,000, with two-thirds of the growth from homeowners insurance and the remaining one-third from automobile insurance. The Company's average annual premium per policy for automobile and homeowners increased approximately 1% and 3%, respectively, compared to a year earlier. Including the impact of increased deductibles and reduced coverage in coastal areas, the Company's average effective premium per policy for homeowners insurance increased 5% compared to the first nine months of 1998. Based on policies in force, the property and casualty 12-month retention rate for new and renewal policies was 88%, about 1 percentage point less than the 12 months ended September 30, 1998. The change in property and casualty retention was primarily caused by greater price competition for automobile insurance. New annuity deposits decreased 8.7% compared to the first nine months of 1998, with a comparable decline in the third quarter. The decline was primarily attributable to a 23.6% decrease in the first nine months of this year in single premium deposits, which last year benefitted from new tax legislation contributing to a high volume of single premium and rollover deposits to tax- qualified products. Variable annuity accumulated funds on deposit at September 30, 1999 were $1.1 billion, $85.5 million more than a year ago, an 8.6% increase. However, variable annuity deposit retention decreased 4 percentage points over the 12 months to 90.0%. Fixed annuity cash value retention for the 12 months ended September 30, 1999 was 92.8%, an improvement of 1 percentage point compared to a year ago. Over the last 12 months, the number of annuity contracts in force grew 5.1%, or 6,000 contracts. Life premium growth was 3.8% for the first nine months of 1999. This growth included new business from term life products introduced early in 1997 and a new series of whole life products introduced late in the third quarter of 1998 and reflects an insurance in force lapse ratio of 8.1%. Customer acceptance of these new products continues to grow, as they accounted for approximately half of the Company's new life sales in the first nine months of 1999. Net Investment Income Investment income of $140.5 million for the first nine months of 1999 decreased 2.8%, or $4.0 million, (2.2% after tax) compared to last year due to a decline in interest rates and small growth in the average investment portfolio. The average pretax yield on the investment portfolio was 7.0% (4.7% after tax) for the first nine months of 1999 compared to a pretax yield of 7.3% (4.8% after tax) last year, a decrease of 25 basis points, or 3.4%. Average investments (excluding the securities lending collateral) increased only slightly over the past 12 months reflecting the utilization of capital for the share repurchase program and customers' preference for variable as opposed to fixed annuity contracts. All of the investment income decrease in the annuity segment was offset by a decline in interest credited to fixed annuity deposits. Excluding the effect of the use of cash in the share repurchase program from both periods, net investment income would have been $150.0 million, a decrease of less than 1% compared to the first nine months of 1998. 15 Realized Investment Gains and Losses Net realized investment losses were $0.4 million for the three months ended September 30, 1999, and $8.9 million for the nine months ended September 30, 1999. These losses compare to net realized investment gains of $4.2 million and $13.6 million for the same periods, respectively, in 1998. All of the net realized gains and losses occurred in the fixed income portfolios. The net realized investment losses in the first nine months of 1999 were about two- thirds due to credit decisions and rate of return considerations in the Company's fixed income investment portfolio and about one-third due to the sale of U.S. Treasury securities for duration management purposes in a rising interest rate environment. Realized investment gains in the first nine months of 1998 included calls and tenders in the Company's bond portfolio as well as credit and rate of return decisions. Benefits, Claims and Settlement Expenses
Nine Months Ended Growth Over September 30, Prior Year ------------------- ----------------- 1999 1998 Percent Amount --------- -------- -------- ------- Property and casualty.... $285.1 $269.2 5.9% $15.9 Life..................... 30.9 32.1 -3.7% (1.2) ------ ------ ----- Total.................. $316.0 $301.3 4.9% $14.7 ====== ====== ===== Property and casualty statutory loss ratio: Before catastrophes.. 72.8% 69.0% 3.8% After catastrophes... 77.9% 76.3% 1.6%
Property and casualty claims and settlement costs reflect a high level of catastrophe losses in both years and higher than expected claims in property other than catastrophe claims in 1999. Although catastrophe losses in 1999 were lower than last year, the second quarter of 1999 was the Company's second-worst ever, trailing only the record set in the second quarter of 1998, as policyholders in 23 states incurred damages from 13 separate events. Excluding catastrophe losses, the third quarter 1999 property loss ratio was 78.1%, an increase of 10 percentage points compared to the same period last year including an increase in fire and other non-catastrophe weather losses. During the third quarter, the Company's average voluntary automobile insurance premium increased in excess of loss cost developments in the quarter, and the Company's third quarter 1999 voluntary automobile loss ratio excluding catastrophes of 68.7% was 3.7 percentage points lower than in the first six months of 1999. This improvement reflected an increase in average premium per policy that outpaced loss costs during the third quarter and kept pace with loss costs for the first nine months of 1999. This favorable loss ratio reflected a number of operational changes, principally savings realized to date from new claims evaluation software that was fully installed by June 1999. Automobile continues to show favorable development of prior years reserves, although at a lower level than last year and the difference represents most of the decrease in automobile pretax earnings between years after nine months. Favorable development of total property and casualty claims occurring in prior years was $8.6 million in the first nine months of 1999, 16 compared to $22.0 million in the same period in 1998. For the third quarter, favorable development of total property and casualty claims occurring in prior years was $4.1 million for the current year and $6.5 million last year. Life mortality was less than last year. The decrease in life benefits resulted from positive experience on a small closed block of individual accident and health policies. Interest Credited to Policyholders
Nine Months Ended Growth Over September 30, Prior Year ------------------- ------------------------- 1999 1998 Percent Amount -------- ------- -------- ----------- Annuity.. $50.6 $54.4 -7.0% $(3.8) Life..... 18.2 17.0 7.1% 1.2 ----- ----- ----- Total.. $68.8 $71.4 -3.6% $(2.6) ===== ===== =====
Interest credited to fixed annuity contracts decreased as the fixed annuity average annual interest rate credited decreased 0.4 percentage points to 5.1% in the first nine months of 1999, compared to a rate of 5.5% for the same period last year. In addition, the average accumulated deposits for the nine months ended September 30, 1999 increased only slightly compared to the same period in 1998. Life insurance interest credited increased as a result of continued growth in the interest-sensitive life insurance reserves. Policy Acquisition and Operating Expenses Policy acquisition and operating expenses represent the Company's insurance underwriting expenses. For the first nine months of 1999, policy acquisition and operating expenses increased $1.4 million, or 1.2%, compared to the same period last year, including the deferral of additional acquisition costs. The Company began deferring additional sales-related costs in 1999 for all new life and annuity contracts, consistent with common industry accounting practices. This increased net acquisition costs deferred by $3.7 million for the nine months ended September 30, 1999. Full year 1999 expenses are expected to include approximately $5 million of additional net deferrals. Excluding the net deferral of additional sales-related costs, policy acquisition and operating expenses for the first nine months of 1999 increased $5.1 million, or 4.4%, compared to the same period last year including a decrease in the amortization of life deferred acquisition costs of $1.9 million to reflect current mortality estimates resulting in higher anticipated future gross profits. Excluding both of these items, the Company's policy acquisition and underwriting expenses increased $7.0 million, or 6.1%, compared to the first nine months of 1998. The total corporate expense ratio on a statutory accounting basis was 21.8% for the nine months ended September 30, 1999, 0.2 percentage points higher than the same period in 1998. The property and casualty expense ratio, the 10th lowest of the 100 largest property and casualty insurance groups for 1998, was 19.2% for the nine months ended September 30, 1999, compared to 18.9% last year. The increase in these expense ratios primarily reflects the modest level of premium growth. 17 Income Tax Expense Excluding the $20.0 million additional provision for prior years' taxes, the effective income tax rate was 30.8% for the nine months ended September 30, 1999, compared to 27.5% for the same period last year. Income from investments in tax-advantaged securities reduced the effective income tax rate 4.5 and 3.7 percentage points in the nine months ended September 30, 1999 and 1998, respectively. In the first nine months of last year, non-recurring tax benefits reduced the effective rate 5.9 percentage points and contributed $4.3 million, or $0.10 per share, to operating income for that period. As previously reported, the Company has been contesting proposed additional federal income taxes relating to a settlement agreement with the Internal Revenue Service ("IRS") for prior years' taxes. Based on recent developments in that process, it appears that the Company may be forced to litigate the issue with the IRS in order to reach a resolution of the issue acceptable to the Company. Therefore, the Company has, in the third quarter of 1999, recorded an additional federal income tax provision of $20 million representing the maximum exposure of the Company to the IRS with regard to the issue for all of the past tax years in question. While the ultimate resolution of the issue, through settlement or litigation, may result in the Company paying less than the maximum exposure, given the vagaries of litigation and the lack of progress in reaching an acceptable agreement with the IRS, management believes it prudent to book the maximum exposure at this time. None of the $20 million reserve was paid as of November 11, 1999. This reserve was a charge to net income in the third quarter but was excluded from the determination of reported operating income. 18 Operating Income For the first nine months of 1999, operating income (net income before the after-tax impact of realized investment gains and losses and non-recurring charges) decreased 10.0%, or $5.4 million, and operating income per share on a diluted basis of $1.17 decreased 4.9%, or $0.06 per share. The decrease was primarily due to prior year tax benefits and voluntary automobile reserve developments partially offset by lower catastrophe losses this year. Third quarter 1999 operating income was impacted by the Company's property business, including catastrophe losses from Hurricane Floyd and higher than expected non- catastrophe property claims. Current year earnings and investment income were reduced compared to the first nine months of 1998 due to the utilization of capital in the Company's share repurchase programs. Operating income by segment was as follows:
Nine Months Ended Growth Over September 30, Prior Year -------------------- ----------------------- 1999 1998 Percent Amount ------ ------ ------- -------- Property & casualty Before catastrophe losses and non-recurring tax benefits.......... $38.0 $48.1 -21.0% $(10.1) Catastrophe losses, after tax......... 12.3 16.7 -26.3% (4.4) Non-recurring tax benefits............ - 4.3 -100.0% (4.3) ----- ----- ------ Total including catastrophe losses.. 25.7 35.7 -28.0% (10.0) Annuity................................. 18.7 17.1 9.4% 1.6 Life.................................... 11.6 8.9 30.3% 2.7 Corporate and other expense............. 2.5 2.9 (0.4) Interest expense........................ 4.7 4.6 0.1 ----- ----- ------ Total............................... $48.8 $54.2 -10.0% $ (5.4) ===== ===== ====== Total before catastrophe losses and non-recurring tax benefits.... $61.1 $66.6 -8.3% $ (5.5) ===== ===== ====== Property and casualty statutory combined ratio: Before catastrophe losses........... 92.0% 87.8% 4.2% After catastrophe losses............ 97.1% 95.1% 2.0%
Property and casualty segment operating income was lower than the first nine months of last year including higher than expected claims in property other than catastrophe claims. Also, 1998 included a non-recurring tax benefit. Property and casualty results continue to show favorable development of prior years reserves, although at a lower level than last year. Favorable development of total property and casualty claims occurring in prior years was $5.6 million after tax in the first nine months of 1999, compared to $14.3 million after tax in the same period last year. Automobile results for the first nine months of 1999 produced a combined ratio of 91.1%, 3.4 percentage points higher than the same period last year. During the third quarter of 1999, the Company's average voluntary automobile insurance premium increased in excess of loss cost developments in the quarter, and its automobile loss ratio in the third quarter was lower than the loss ratio for the first half of the year. The homeowners combined ratio of 116.9% was 6.8 percentage points better than the first nine months of 1998, reflecting the decline in catastrophe losses. However, catastrophe losses in both years were significant as the second quarter of 1999 represented the Company's second-worst ever for catastrophe losses, trailing only the record set in last year's second quarter, with an unusually large number of catastrophes that were 19 widespread across the country. Excluding catastrophe losses, the third quarter 1999 property loss ratio increased 10 percentage points compared to the same period in 1998, including an increase in fire and other non-catastrophe weather losses, representing about $0.04 per share. The 9.4% increase in annuity segment operating income was driven by an 8.6% growth in variable annuity funds on deposit, 5.2% growth in the interest margin on fixed annuity funds and deferral of additional sales-related costs. The net deferral of additional sales-related costs contributed $1.0 million to operating income for the first nine months of 1999. Variable annuity accumulated deposits were $1.1 billion at September 30, 1999, $85.5 million more than 12 months earlier. Fixed annuity accumulated cash value of $1.4 billion increased slightly compared to September 30, 1998. Life insurance earnings showed solid growth with life mortality costs less than last year. The increase in life operating earnings was partly due to the $1.4 million net deferral of additional sales-related costs and the impact of better mortality versus prior assumptions in the amortization of deferred acquisition costs. Net Income Net Income Per Share, Diluted
Nine Months Ended Growth Over September 30, Prior Year ------------------ ----------------------- 1999 1998 Percent Amount ------- ------ ------- ------- Operating income.................... $ 1.17 $ 1.23 -4.9% $(0.06) Realized investment gains (losses).. (0.14) 0.20 (0.34) Litigation settlement............... (0.02) - (0.02) Provision for prior years' taxes.... (0.48) - (0.48) ------ ------ ------ Net income.......................... $ 0.53 $ 1.43 -62.9% $(0.90) ====== ====== ======
Net income, which includes realized investment gains and losses and non- recurring charges, for the first nine months of 1999 decreased by 65.1% and net income per diluted share decreased by 62.9% compared to the same period in 1998. Net income in the third quarter and first nine months of 1999 reflected non- recurring charges for a $20.0 million provision for the maximum liability of Horace Mann with regard to an IRS examination of past tax years ($0.48 per share) and a cost of $1.0 million after tax and after receipt of insurance proceeds for the settlement of certain litigation related to life insurance policies in Alabama ($0.02 per share). The settlement of litigation in Alabama includes the lawsuit in which a verdict of $12.35 million was rendered against the Company on June 25, 1999 as well as 39 other suits brought by the same law firm. Net income also reflected $5.8 million of after tax realized investment losses for the nine months, compared to $8.8 million of after tax realized investment gains in the same period last year. The net realized investment losses in the first nine months of 1999 were about two-thirds due to credit decisions and rate of return considerations in the Company's fixed income investment portfolio and about one-third due to the sale of U.S. Treasury securities for duration management purposes in a rising interest rate environment. Realized investment gains in the first nine months of 1998 included calls and tenders in the bond portfolio as well as credit and rate of 20 return decisions. The Company's share repurchase program reduced net income by $6.2 million for the first nine months of 1999 reflecting utilization of capital and the corresponding reduction of net investment income, but resulted in an increase of $0.04 in earnings per share for the period due to the reduction in the number of shares outstanding. Return on shareholders' equity based on operating income for the last 12 months was 16%. After including realized investment losses and non-recurring charges, return on equity based on net income was 10% for the last 12 months. Liquidity and Financial Resources Investments The Company's investment strategy emphasizes investment grade, publicly traded fixed income securities. At September 30, 1999, fixed income securities represented 95.7% of investments excluding the securities lending collateral. Of the fixed income investment portfolio, 92.8% was investment grade and 99.8% was publicly traded. The average quality of the total fixed income portfolio was AA-/A+ at September 30, 1999. The duration of the investment portfolio is managed to provide cash flow to satisfy policyholder liabilities as they become due. The average option adjusted duration of total investments was 4.2 years at September 30, 1999 and 4.4 years at December 31, 1998. The Company has included in its annuity products substantial surrender penalties to reduce the likelihood of unexpected increases in policy or contract surrenders. All annuities issued since 1982 and approximately 75% of all outstanding fixed annuity accumulated cash values are subject in most cases to substantial early withdrawal penalties. Cash Flow The short-term liquidity requirements of the Company, within a 12-month operating cycle, are for the timely payment of claims and benefits to policyholders, operating expenses, interest payments and federal income taxes. Cash flow in excess of these amounts has been used to fund business growth, retire short-term debt, pay dividends to shareholders and repurchase shares of the Company's common stock. Long-term liquidity requirements, beyond one year, are principally for the payment of future insurance policy claims and benefits and retirement of long-term notes. Operating Activities As a holding company, HMEC conducts its principal operations in the personal lines segment of the property and casualty and life insurance industries through its subsidiaries. HMEC's insurance subsidiaries generate cash flow from premium and investment income, generally well in excess of their immediate needs for policy obligations, operating expenses and other cash requirements. Net cash provided by operating activities was greater than the first nine months of 1998 primarily as a result of lower federal income taxes paid. Cash provided by operating activities primarily reflects net cash generated by the insurance subsidiaries. Payment of principal and interest on debt, fees related to the catastrophe- linked equity put option, dividends to shareholders and parent company operating expenses, as well as the share repurchase program, are dependent upon the ability of the insurance subsidiaries to pay cash 21 dividends or make other cash payments to HMEC, including tax payments pursuant to tax sharing agreements. The insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. Dividends which may be paid by the insurance subsidiaries to HMEC during 1999 without prior approval are approximately $67 million. Although regulatory restrictions exist, dividend availability from subsidiaries has been, and is expected to be, more than adequate for HMEC's capital needs. Investing Activities HMEC's insurance subsidiaries maintain significant investments in fixed maturity securities to meet future contractual obligations to policyholders. In conjunction with its management of liquidity and other asset/liability management objectives, the Company, from time to time, will sell fixed maturity securities prior to maturity and reinvest the proceeds in other investments with different interest rates, maturities or credit characteristics. Accordingly, the Company has classified the entire fixed maturity securities portfolio as available for sale. For the nine months ended September 30, 1999, purchases and sales of fixed maturity securities were comparable to last year while maturities decreased reflecting timing of scheduled maturities and a higher level of calls during the first nine months of 1998 due to market conditions conducive to refinancing securities compared to the previous several years. Financing Activities Financing activities include primarily repurchases of the Company's common stock, payment of dividends, the receipt and withdrawal of funds by annuity policyholders and borrowings and repayments under the Company's debt facilities. Fees related to the catastrophe-linked equity put which augments its reinsurance program have been charged directly to additional paid-in capital. For the first nine months of 1999, receipts from annuity contracts decreased 8.7% reflecting the reduced level of single premium deposits received. Annuity contract maturities and withdrawals increased $40.7 million, or 28.9%, compared to the first nine months of 1998 due to higher withdrawals from the variable annuity option. Variable annuity deposit retention decreased 4 percentage points over the 12 months to 90.0%. Retention of fixed annuity accumulated cash value was 92.8% for the 12 months ended September 30, 1999. During the first six months of 1999, the Company repurchased 1,075,300 shares of its common stock, or 3% of the shares outstanding on December 31, 1998, at an aggregate cost of $25.1 million, or an average cost of $23.33 per share, under its stock repurchase program. No shares were repurchased during the third quarter of 1999. This year's repurchases compare to 1,706,600 shares repurchased in the first nine months of 1998 at an aggregate cost of $55.2 million. The repurchase of shares was financed through cash generated from operations and, when necessary, the Bank Credit Facility. In May 1999, an additional $100 million share repurchase authorization was announced. As of September 30, 1999, $111.5 million remained authorized for future share repurchases. On August 2, 1999, the Company announced that its Board of Directors had retained Morgan Stanley Dean Witter and Credit Suisse First Boston to explore the strategic alternatives available to the corporation. During the process of considering strategic alternatives, the Board of Directors has decided to suspend the Company's share repurchase program. 22 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 NAIC. Historically, the Company's insurance subsidiaries have generated capital in excess of such needed capital. These excess amounts have been paid to HMEC through dividends. HMEC has then utilized these dividends and its access to the capital markets to retire long-term debt, repurchase shares of its common stock, increase and pay dividends to its shareholders and for other corporate purposes. Management anticipates that the Company's sources of capital will continue to generate capital in excess of the needs for business growth, debt interest payments and shareholder dividends. The total capital of the Company was $557.3 million at September 30, 1999, including $99.7 million of long-term debt and $49.0 million of short-term debt. Total debt represented 26.7% of capital at the end of September, exceeding the upper end of the Company's target operating range of 20% to 25% due to the provision for prior years' taxes recorded in September. Shareholders' equity was $408.4 million at September 30, 1999, including an unrealized loss in the Company's investment portfolio of $15.9 million after taxes and the related impact on deferred policy acquisition costs associated with annuity and interest-sensitive life policies. The market value of the Company's common stock and the market value per share were $1,059.0 million and $25 13/16, respectively, at September 30, 1999. Book value per share was $9.96 at September 30, 1999, $10.35 excluding investment market value adjustments. At September 30, 1998, book value per share was $11.93, $10.25 excluding investment market value adjustments. The decrease over the 12 months was entirely due to the share repurchases, unrealized investment gains and losses and the non- recurring charge for prior years' taxes. Excluding these items, book value per share increased 11.4% over the 12-month period. In January 1996, the Company issued $100.0 million face amount of 6 5/8% Senior Notes ("Senior Notes") at a discount of 0.5% which will mature on January 15, 2006. Interest on the Senior Notes is payable semi-annually. The Senior Notes are redeemable in whole or in part, at any time at the Company's option. The Senior Notes have an investment grade rating from Standard & Poor's Corporation ("S&P") (A-), Duff & Phelps Credit Rating Co. ("Duff & Phelps") (A), and Moody's Investors Service, Inc. ("Moody's") (Baa2) and are traded on the New York Stock Exchange (HMN 6 5/8). As of September 30, 1999 and December 31, 1998, the Company had short-term debt of $49.0 million and $50.0 million, respectively, outstanding under the Bank Credit Facility. The Bank Credit Facility allows unsecured borrowings of up to $65.0 million at Interbank Offering Rates plus 0.3% to 0.5% or Bank of America National Trust and Savings Association reference rates. The rate on the borrowings under the Bank Credit Facility was Interbank Offering Rate plus 0.3%, or 5.8%, as of September 30, 1999. The commitment for the Bank Credit Facility terminates on December 31, 2001. The Company's ratio of earnings to fixed charges for the nine months ended September 30, 1999 was 9.3x compared to 13.2x for the same period in 1998, with the decline primarily attributable to realized investment losses recorded in the current period compared to realized investment gains recorded in the first nine months of 1998. 23 Total shareholder dividends were $11.4 million for the first nine months of 1999. The Company has targeted a dividend payout ratio of approximately 15%. In November 1998, the Board of Directors authorized the seventh increase to the Company's quarterly dividend since the Company's initial public offering in November 1991. The regular quarterly dividend increased by 16% to $0.0925 per share. The Company reinsures 95% of catastrophe losses above a retention of $7.5 million per occurrence up to $80 million per occurrence in 1999. In addition, the Company reinsures 75% of catastrophe losses in Florida above a retention of $6.1 million. These catastrophe reinsurance programs are augmented by a $100 million equity put. This equity put provides an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre- negotiated price in the event losses from catastrophes, individually or in the aggregate during a calendar year, exceed the $80 million coverage limit. The equity put provides a source of capital for up to $154 million of catastrophe losses, before tax benefits, above the reinsurance coverage limit. At September 30, 1999, warrants to purchase 107,537 shares of the Company's common stock at $2.70 per share were outstanding. During the fourth quarter of 1999, the Company will repurchase all of its remaining outstanding warrants for $2.4 million. Market Risk Market risk is the risk that the Company will incur losses due to adverse changes in market rates. The Company's primary market risk exposure is the risk that the Company will incur economic losses due to adverse changes in interest rates. This risk arises as the Company's profitability is affected by the spreads between interest yields on investments and rates credited on insurance liabilities. The Company manages its market risk by matching the projected cash outflows of assets with the projected cash outflows of liabilities. For all its assets and liabilities, the Company seeks to maintain reasonable durations to pay future policyholder obligations as they become due, 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, not by the Company. There have been no material changes during the first nine months of 1999 in the market risks the Company is exposed to and the management of those risks, which are described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's 1998 Form 10-K. Year 2000 All of the Company's mainframe computer systems critical to its business are year 2000 compliant. The Company has contacted its vendors inquiring with regard to their year 2000 compliance status and plans and the Company has received responses indicating that major vendors believe that they are, or will be before the end of 1999, year 2000 compliant. In the remainder of 1999, additional testing of systems, final review of individual personal computer applications and contingency plans will be completed. 24 Because of the extent of systems conversion already completed, the Company believes the worst-case scenario would be limited to major vendor conversions that fail to achieve compliance by the end of 1999. The result of this worst- case scenario would be to interrupt the Company's ability to process certain business transactions which could have a significant effect on its business, results of operations and financial condition. Contingency plans are being completed to mitigate the risks of vendor failures to achieve compliance by the end of the year. In addition, non-system contingency plans have been developed for possible lapse in service from utility suppliers and other third party service providers. These contingency plans include efforts to minimize business interruption through back-up processes that utilize alternative suppliers and third party service providers, where appropriate. Costs for this compliance project represent the allocation of existing internal information technology resources to address year 2000 compliance and are not incremental costs to the Company. The total cost of the compliance project is being funded through operating cash flows. The Company is expensing all costs associated with these system changes and through September 30, 1999 has expensed $6.3 million before tax benefits, including a cost of $0.9 million for the first nine months of 1999. Costs to complete the remaining testing and contingency planning are estimated to be less than $0.5 million before tax benefits. 25 Item 3: 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 this Form 10-Q. PART II: OTHER INFORMATION Item 4: Submission of Matters to a Vote of Security Holders None. Item 6: Exhibits and Reports on Form 8-K Exhibit No. Description -------- ----------- (a) The following items are filed as Exhibits. (10) Material contracts: 10.1 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. 10.1(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. 10.1(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. 10.1(c) Amendment effective June 1, 1999 to Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement. (11) Statement re computation of per share earnings. (27) Financial Data Schedule. (b) No reports on Form 8-K were filed by the Company during the third quarter of 1999. 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HORACE MANN EDUCATORS CORPORATION (Registrant) Date November 11, 1999 /s/ Paul J. Kardos ------------------------------ ------------------------------- Paul J. Kardos Chairman of the Board, President and Chief Executive Officer Date November 11, 1999 /s/ Larry K. Becker ----------------------------- ------------------------------ Larry K. Becker Executive Vice President and Chief Financial Officer Date November 11, 1999 /s/ Roger W. Fisher ------------------------------ ----------------------------- Roger W. Fisher Senior Vice President, Financial Information and Control 27 EX-10.1(C) 2 CATASTROPHE EQUITY SECURITIES ISSUANCE OPTION Exhibit 10.1 (c) AMENDMENT NO. 3 TO, AND ASSIGNMENT OF, CATASTROPHE EQUITY SECURITIES ISSUANCE OPTION AND REINSURANCE OPTION AGREEMENT This Amendment No. 3 to, and Assignment of, Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement (the "Amendment No. 3") is entered into and effective as of June 1, 1999 between Horace Mann Educators Corporation, a Delaware corporation ("HM"), Centre Reinsurance (U.S.) Limited, a Bermuda corporation ("Centre Re"), and Zurich Insurance Company, a corporation organized under the laws of Switzerland ("Zurich"), as assignee of Centre Re, with respect to that certain Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement dated February 15, 1997, as amended by Amendment No. 1 and Amendment No. 2 between HM and Centre Re (as the same may be further amended, supplemented, and restated or otherwise modified, together with all the Exhibits and Schedules and all ancillary, related or supporting documents, the "Agreement"). Unless otherwise defined herein or the context otherwise requires, capitalized terms used herein have the meanings specified in the Agreement. RECITALS WHEREAS, Centre Re and Zurich wish to transfer and assign the Agreement, such that Centre Re will have no further obligations or liabilities to HM under the Agreement in respect of the period commencing 12:00 A.M., Central Time, June 1, 1999 through to 11:59:59 P.M., Central Time, December 31, 1999, and all Agreement Years commencing thereafter; WHEREAS, HM wishes to consent to such assignment; and WHEREAS, in the event of multiple Events taking place during the Agreement Year commencing 12:00 A.M. Central Time, January 1, 1999 ("Agreement Year 1999") which develop into a Qualifying Catastrophic Event, and such multiple Events take place both prior to 12:00 A.M. Central Time June 1, 1999 and after 12:00 A.M. Central Time, June 1, 1999 (but during Agreement Year 1999), this Amendment No. 3 shall not prohibit HM from exercising the Securities Issuance Option because such multiple Events happened both prior to 12:00 A.M. Central Time June 1, 1999 and after 12:00 A.M. Central Time, June 1, 1999. NOW, THEREFORE, for good and valuable consideration, receipt of which is hereby acknowledged, HM, Centre Re and Zurich agree as follows: AGREEMENT 1. Assignment and Assumption. Effective at 12:00 A.M. Central Time on June 1, 1999, Centre Re and Zurich agree that (A) Centre Re hereby transfers and assigns to Zurich, and (B) Zurich hereby assumes and undertakes from Centre Re, without recourse and without representation or warranty (except as provided in this Amendment No. 3), (i) 100% of all obligations, duties, liabilities, and promises, whether contingent or otherwise, of Centre Re under and in connection with the Agreement in respect of, arising out of, or related to (a) the period commencing 12:00 A.M., Central Time, June 1, 1999 through 11:59:59 P.M., Central Time, 1 December 31, 1999, and (b) the Agreement Year commencing 12:00 A.M., Central Time, January 1, 2000 ("Agreement Year 2000"), and the Agreement Year commencing 12:00 A.M., Central Time, January 1, 2001 ("Agreement Year 2001"), and (c) the period thereafter, if any, and (ii) 100% of all related rights and benefits under and in connection with the Agreement in respect of, arising out of, or related to (a) the period commencing 12:00 A.M., Central Time, June 1, 1999 through to 11:59:59 P.M., Central Time, December 31, 1999, and (b) Agreement Years 2000 and 2001, and (c) the period thereafter, if any, including the right to receive the Option Fee and Option Exercise Fee, if any, in respect of the period commencing 12:00 A.M., Central Time, June 1, 1999 through to 11:59:59 P.M., Central Time, December 31, 1999, and Agreement Years 2000 and 2001, and the period thereafter, if any. For purposes of clarification, with respect to any exercise of the Securities Issuance Option relating to multiple events occurring both prior to 12:00AM Central Time, June 1, 1999 and after 12:00 AM Central Time, June 1, 1999 (but during Agreement Year 1999) which develop into a Qualifying Catastrophic Event, such exercise shall be made against Zurich, or an affiliate of Zurich, as such designation and/or assignment by Zurich may be permitted under the Agreement. Accordingly, the Agreement is hereby amended by substituting all previous references to Centre Re with Zurich. 2. Payments; Correspondence. Centre Re and Zurich agree and acknowledge that all payments of the Option Fee, Option Exercise Fee, if any, and any other amounts due or that may become due in connection with, or relating to the period commencing 12:00 A.M., Central Time, June 1, 1999 through to 11:59:59 P.M., Central Time, December 31, 1999, and Agreement Years 2000 and 2001 (collectively or individually the "Payments") are the property of Zurich and not Centre Re and HM shall remit all such Payments to Zurich or to any entity designated in writing by Zurich. HM shall also send any and all notices, advices or other correspondence in connection with the Agreement affecting or relating to the period commencing 12:00 A.M., Central Time, June 1, 1999 through to 11:59:59 P.M., Central Time, December 31, 1999, or the Agreement Year 2000, or the Agreement Year 2001 and Zurich's rights and obligations in respect of such periods to Zurich or to any entity designated in writing by Zurich. 3. Release. HM consents to and acknowledges such assignment to, and assumption by, Zurich of all of the rights, benefits, obligations and liabilities of Centre Re under the Agreement, as set forth in this Amendment No. 3, and HM hereby releases Centre Re from any and all obligations, duties, liabilities, claims, and promises, whether contingent or otherwise, of Centre Re under and in connection with the Agreement in respect of, arising out of, or related to the period commencing 12:00 A.M., Central Time, June 1, 1999 through to 11:59:59 P.M., Central Time, December 31, 1999, and Agreement Year 2000, and Agreement Year 2001, and the period thereafter, if any. 4. No Warranty or Recourse. The transfer and assignment of the Agreement in respect of the period commencing 12:00 A.M., Central Time, June 1, 1999 through to 11:59:59 P.M., Central Time, December 31, 1999, and the Agreement Year 2000, and the Agreement Year 2001, 2 and the period thereafter, if any, is made without warranty or recourse against Centre Re of any kind, except for the willful misconduct, gross negligence, or fraud of Centre Re, and except that Centre Re warrants that it has not sold or otherwise transferred any other interest in the Agreement in respect of the period commencing 12:00 A.M., Central Time, June 1, 1999 through to 11:59:59 P.M., Central Time, December 31, 1999, the Agreement Year 2000, and the Agreement Year 2001 to any other party. 5. Covenants and Warranties. HM, Centre Re and Zurich each warrants and covenants with respect to itself that (a) it is validly existing and organized and in good standing under the laws of its jurisdiction; (b) it is duly authorized to execute, deliver, and perform this Amendment No. 3; (c) the execution, delivery and performance of this Amendment No. 3 does not conflict with any provision of law or of the charter or by-laws (or equivalent constituent documents) of such party, or of any agreement binding upon it; and (d) this Amendment No. 3 constitutes the legal, valid and binding obligation of HM, Centre Re and Zurich, enforceable in accordance with its terms. 6. Successors and Assigns. This Amendment No. 3 shall be binding on the parties hereto and their respective permitted successors and assigns. This Amendment No. 3 may be amended, changed, modified, altered or terminated only upon the written consent of the parties hereto (or their permitted successors and assigns). This Amendment No. 3 shall be assigned to any entity to which the Agreement is assigned in accordance with the terms of the Agreement. 7. Counterparts. This Amendment No. 3 may be executed in one or more counterparts, each of which when so executed and delivered shall be an original, but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the undersigned parties have caused this Amendment No. 3 to be duly executed as of the date first written above. Horace Mann Educators Corporation Centre Reinsurance (U.S.) Limited By: /s/ Paul J. Kardos By: /s/ Paul Hellmers ------------------------------- --------------------------------- Printed Name: Paul J. Kardos Printed Name: Paul Hellmers ----------------------- ----------------------- Title: President & CEO Title: President ----------------------------- ------------------------------ 3 By: /s/ George J. Zock ---------------------------------- Printed Name: George Zock ----------------------- Title: Executive Vice President ------------------------------ Zurich Insurance Company By: /s/ Dirk Lohmann ---------------------------------- Printed Name: Dirk Lohmann ----------------------- Title: CEO - Reinsurance ------------------------------- 4 EX-11 3 COMPUTATION OF NET INCOME PER SHARE Exhibit 11 Horace Mann Educators Corporation Computation of Net Income per Share For the Three and Nine Months Ended September 30, 1999 and 1998 (Amounts in thousands, except per share data)
Three Months Ended Nine Months Ended September 30, September 30, ------------------- ------------------ 1999 1998 1999 1998 --------- -------- -------- -------- Basic - assumes no dilution: Net income (loss) for the period $(5,458) $24,933 $22,015 $63,040 ------- ------- ------- ------- Weighted average number of common shares outstanding during the period 41,026 42,811 41,318 43,523 ------- ------- ------- ------- Net income (loss) per share - basic $ (0.13) $ 0.58 $ 0.53 $ 1.45 ======= ======= ======= ======= Diluted - assumes full dilution: Net income (loss) for the period $(5,458) $24,933 $22,015 $63,040 ------- ------- ------- ------- Weighted average number of common shares outstanding during the period 41,026 42,811 41,318 43,523 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: Warrants 98 98 96 99 Stock options 451 456 395 472 Common stock units related to Deferred Equity Compensation Plan for Directors 66 46 66 46 Common stock units related to Deferred Compensation Plan for Employees 6 2 6 1 ------- ------- ------- ------- Total common and common equivalent shares adjusted to calculate diluted earnings per share 41,647 43,413 41,881 44,141 ------- ------- ------- ------- Net income (loss) per share - diluted $ (0.12) $ 0.57 $ 0.53 $ 1.43 ======= ======= ======= ======= Percentage of dilution compared to basic net income (loss) per share 7.7% 1.7% 0.0% 1.4%
EX-27 4 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AND THE CONSOLIDATED STATEMENT OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 2,539,358 0 0 0 17,310 159 2,653,985 18,746 0 132,537 4,224,917 2,163,682 188,711 0 129,079 148,667 0 0 59 408,384 4,224,917 444,062 140,480 (8,896) 0 315,994 36,498 79,709 60,731 38,716 22,015 0 0 0 22,015 0.53 0.53 0 0 0 0 0 0 0 Refer to Note 3 - Investments of the Company's Consolidated Notes to Financial Statements for September 30, 1999. Refer to the Company's Consolidated Balance Sheet as of September 30, 1999.
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