-----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, HwyF/Ashmg9Uohdk4+S0IsOs797iVCf9n0cAbA8CFAcVBgWCuaPtGLXuBs8yg65z /IP9gsyL9/gEhRtWHRFzEw== 0001047469-98-012416.txt : 19980331 0001047469-98-012416.hdr.sgml : 19980331 ACCESSION NUMBER: 0001047469-98-012416 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 15 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: HORACE MANN EDUCATORS CORP /DE/ CENTRAL INDEX KEY: 0000850141 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 370911756 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10890 FILM NUMBER: 98578235 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 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, 1997 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, 1998, was approximately $1.5 billion. As of March 1, 1998, 44,028,744 shares of Common Stock, par value $0.001 per share, were outstanding, net of 15,193,796 shares of treasury stock. DOCUMENTS INCORPORATED BY REFERENCE Proxy Statement for the 1998 Annual Meeting of Shareholders, exclusive of disclosures made pursuant to Regulation S-K, Section 402 (i), (k) and (l). - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- HORACE MANN EDUCATORS CORPORATION FORM 10-K YEAR ENDED DECEMBER 31, 1997 INDEX
ITEM NUMBER PAGE - ------------- ----- PART I 1. Business........................................................................................ 1 2. Properties...................................................................................... 26 3. Legal Proceedings............................................................................... 26 4. Submission of Matters to a Vote of Security Holders............................................. 26 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters........................... 27 6. Selected Financial Data......................................................................... 27 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........... 28 8. Consolidated Financial Statements and Supplementary Data........................................ 28 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............ 28 PART III 10. Directors and Executive Officers of the Registrant.............................................. 28 11. Executive Compensation.......................................................................... 28 12. Security Ownership of Certain Beneficial Owners and Management.................................. 28 13. Certain Relationships and Related Transactions.................................................. 28 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................ 28 SIGNATURES...................................................................................... 32 Index to Financial Information.................................................................. F-1
PART I ITEM 1. BUSINESS FORWARD-LOOKING INFORMATION It is important to note that the Company's actual results could differ materially from those projected in forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations." OVERVIEW Horace Mann Educators Corporation (together with its subsidiaries, the "Company" or "HMEC") is an insurance holding company incorporated in Delaware. Through its subsidiaries, HMEC markets and underwrites personal lines of property and casualty and life insurance and retirement annuities. HMEC's principal insurance subsidiaries are Horace Mann Insurance Company ("HMIC"), Teachers Insurance Company ("TIC") and Horace Mann Life Insurance Company ("HMLIC"), each of which is an Illinois corporation, and Allegiance Insurance Company ("Allegiance"), a California domiciled personal lines property and casualty insurance company. The Company markets its products primarily to educators and other employees of public schools and their families. Customers of the Company typically have moderate annual incomes, with many belonging to two-income households. Their financial planning tends to focus on security, savings and primary insurance needs. The Company sells and services its products primarily through an exclusive sales force of full-time agents employed by the Company. The Company's agents sell only the Company's products. Many of the Company's agents are former educators who utilize their contacts within, and knowledge of, the target market. Compensation for sales agents includes an incentive element based upon the profitability of the business they write. The Company's insurance premiums written and contract deposits for the year ended December 31, 1997 were $771.3 million and operating income (income from continuing operations before realized investment gains and losses and debt retirement costs) was $83.6 million. The Company's total assets were $4.1 billion at December 31, 1997. The property and casualty segment accounted for 59% of the Company's insurance premiums written and contract deposits for the year ended December 31, 1997, while accounting for 62% of earnings from continuing operations before interest and taxes for the period. The annuity and life insurance segments together accounted for 41% of insurance premiums written and contract deposits for the year ended December 31, 1997 (26% and 15%, respectively), and provided 41% (25% and 16%, respectively) of earnings from continuing operations before interest and taxes for the period. In December 1996, the Company announced its strategic decision to withdraw from the group medical insurance business over the following two years. The Company stopped writing new group medical insurance policies in January 1997, terminated 95% of that business by December 1997, and will terminate the remaining group medical insurance policies in 1998. In the Company's financial statements and discussions of operating results, group medical results are reported separately as discontinued operations. In each of the last 10 years, the Company's combined loss and expense ratio for its property and casualty product lines outperformed the total property and casualty industry combined loss and expense ratio, as reported by A.M. Best Company ("A.M. Best"), an independent insurance rating agency. During this period, the Company's combined loss and expense ratio was better than the total property and casualty insurance industry combined loss and expense ratio by an average of approximately 11 percentage points per year. During the same period of time, the Company's combined loss and expense ratio was better than the personal lines insurance industry segment combined loss and expense ratio by an average of approximately 9 percentage points per year. 1 One of the reasons why the Company's property and casualty lines have performed better than the industry is the Company's property and casualty expense ratio, which has been consistently better than the industry ratio since 1983. During the last 10 years, the Company's property and casualty expense ratio has been better than the property and casualty industry personal lines average expense ratio as reported by A.M. Best by an average of 4.7 percentage points per year. The Company's property and casualty expense ratio for the year ended December 31, 1997 was 19.4%, well within the lowest 20% of expense ratios of the 100 largest property and casualty groups, based on A.M. Best's reports. At December 31, 1997, the accumulated value of annuity contracts was $2.3 billion. For the year ended December 31, 1997, 92% of the accumulated cash value of the Company's annuity business remained on deposit. All annuities issued since 1982 and approximately 75% of all outstanding fixed annuity accumulated cash values are subject in most cases to substantial early withdrawal penalties, typically ranging from 5% to 13% of the amount withdrawn. Withdrawals of outstanding variable annuities are limited to amounts less than or equal to the then current market value of the annuity. Tax-qualified annuities represented 95% of the Company's annuity policy reserves at December 31, 1997, and, generally, a penalty is imposed under the Internal Revenue Code of 1986, as amended, on amounts withdrawn from tax-qualified annuities prior to age 59 1/2. The investment portfolio of the Company, including variable annuity assets under management of $960 million, had an aggregate market value of $3.7 billion at December 31, 1997. Investments other than variable annuity assets consist principally of investment grade publicly traded fixed income securities. At December 31, 1997, investments in non-investment grade securities represented 6.0% of total investments excluding variable annuity assets. There are no significant investments in mortgage loans and real estate or privately placed securities. HISTORY The Company's business was founded in Springfield, Illinois in 1945 by two Illinois teachers to sell automobile insurance to other teachers within the State of Illinois. In 1968, INA Corporation ("INA") acquired a 25% interest in HMEC, and completed its acquisition of HMEC in 1975. In 1982, INA and Connecticut General Corporation merged to form CIGNA. In August 1989 an investor group directed by Gibbons, Green, van Amerongen, L.P. (subsequently Gibbons, Goodwin, van Amerongen) ("GGvA") and certain members of the Company's senior management acquired HMEC from CIGNA. In November 1991, HMEC completed an initial public offering of its common stock (the "IPO") which is traded on the New York Stock Exchange under the symbol "HMN." Following the initial public offering, GGvA owned approximately 44% of the outstanding shares of the common stock. Pursuant to an agreement with GGvA, in May 1995 HMEC purchased approximately one-half of the shares of its common stock owned by GGvA and in July 1995 completed a secondary public offering of most of the remaining shares of its common stock owned by GGvA. 2 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, 1997 have been audited by KPMG Peat Marwick 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, ----------------------------------------------------- 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- (Dollars in millions, except per share data) STATEMENT OF OPERATIONS DATA: Insurance premiums written and contract deposits............. $ 771.3 $ 704.8 $ 654.0 $ 637.3 $ 589.1 Insurance premiums and contract charges earned............... 542.7 502.7 485.4 472.4 437.9 Net investment income........................................ 198.9 198.6 198.4 185.3 184.2 Net investment income, after tax............................. 132.6 132.4 132.2 124.9 123.2 Realized investment gains (losses)........................... 5.3 2.5 8.6 (0.9) 26.8 Total revenues............................................... 746.9 703.8 692.4 656.8 648.9 Amortization of intangible assets(1)......................... 10.7 11.2 11.7 12.6 13.1 Interest expense............................................. 9.4 10.5 11.6 9.5 9.1 Income from continuing operations before income taxes........ 119.6 100.6 103.6 86.2 112.8 Income from continuing operations............................ 87.1 73.8 75.2 64.6 76.8 Discontinued operations(2)................................... (3.5) (9.2) (1.2) - 0.4 Income before extraordinary item............................. 83.6 64.6 74.0 64.6 77.2 Extraordinary item(3)........................................ - - - (1.7) - Net income................................................... 83.6 64.6 74.0 62.9 77.2 Operating income(4).......................................... 83.6 73.1 70.9 65.2 59.4 Ratio of earnings to fixed charges(5)........................ 13.7x 10.6x 9.9x 10.1x 13.4x PER SHARE DATA(6): Basic: Operating income(4)........................................ $ 1.82 $ 1.56 $ 1.42 $ 1.13 $ 1.03 Realized investment gains (losses), after tax.............. 0.08 0.03 0.11 (0.01) 0.30 Income from continuing operations.......................... 1.90 1.57 1.50 1.12 1.33 Discontinued operations(2)................................. (0.08) (0.19) (0.02) (0.01) - Income before extraordinary item........................... 1.82 1.38 1.48 1.11 1.33 Net income................................................. 1.82 1.38 1.48 1.09 1.33 Diluted: Operating income(4)........................................ $ 1.80 $ 1.54 $ 1.33 $ 1.08 $ 0.99 Realized investment gains (losses), after tax.............. 0.07 0.03 0.10 (0.01) 0.27 Income from continuing operations.......................... 1.87 1.55 1.41 1.07 1.26 Discontinued operations(2)................................. (0.07) (0.19) (0.02) - 0.01 Income before extraordinary item........................... 1.80 1.36 1.39 1.07 1.27 Net income................................................. 1.80 1.36 1.39 1.04 1.27 Shares of Common Stock--weighted average: Basic...................................................... 45.8 47.0 50.1 57.9 57.9 Diluted.................................................... 46.5 47.6 56.3 64.1 64.1 Cash dividends............................................... $ 0.2825 $ 0.22 $ 0.18 $ 0.145 $ 0.12 BALANCE SHEET DATA, AT YEAR END: Total investments............................................ $ 2,769.0 $ 2,784.3 $ 2,798.5 $ 2,533.4 $ 2,493.8 Total assets................................................. 4,131.9 3,861.0 3,662.3 3,285.5 3,147.6 Short-term debt.............................................. 42.0 34.0 75.0 - - Long-term debt............................................... 99.6 99.6 100.0 100.0 111.7 Total shareholders' equity................................... 506.0 484.4 470.2 412.0 429.9 Book value per share(6)(7)................................... $ 11.43 $ 10.25 $ 10.05 $ 7.11 $ 7.42 SEGMENT INFORMATION: Insurance premiums written and contract deposits Property and casualty...................................... $ 458.0 $ 427.1 $ 405.8 $ 398.8 $ 366.0 Annuity.................................................... 199.2 166.9 142.9 136.6 123.4 Life....................................................... 114.1 110.8 105.3 101.9 99.7 Total.................................................... 771.3 704.8 654.0 637.3 589.1 Operating income(4) Property and casualty...................................... $ 61.4 $ 54.0 $ 56.4 $ 52.6 $ 44.9 Annuity.................................................... 19.3 16.3 14.8 14.2 11.7 Life....................................................... 12.9 12.1 10.4 7.7 9.6 Corporate and other, including interest expense............ (10.0) (9.3) (10.7) (9.3) (6.8) Total.................................................... 83.6 73.1 70.9 65.2 59.4
(CONTINUED ON NEXT PAGE) 3 SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA--(CONTINUED)
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- (Dollars in millions, except per share data) STATUTORY OPERATING DATA(8): Property and casualty: Loss and loss adjustment expense ratio..................... 71.7% 74.1% 73.5% 73.8% 73.6% Expense ratio.............................................. 19.4% 19.4% 19.8% 19.8% 19.6% Combined loss and expense ratio(9)......................... 91.1% 93.5% 93.3% 93.7% 93.3% Industry average combined loss and expense ratio(10)....... 101.8% 105.8% 106.4% 108.4% 106.9% Personal lines industry segment average combined loss and expense ratio(10)........................................ 100.1% 104.9% 103.5% 104.5% 103.9% Annuity accumulated value on deposit......................... $ 2,314.2 $ 2,075.5 $ 1,866.0 $ 1,673.2 $ 1,584.5 Life insurance in force...................................... $ 11,188 $ 10,645 $ 10,235 $ 9,707 $ 9,281 Adjusted capital and surplus of insurance subsidiaries (includes investment reserves)(11)......................... $ 372.3 $ 404.6 $ 389.8 $ 358.3 $ 344.2
- ------------ (1) Amortization of intangible assets is comprised of amortization of goodwill and amortization of acquired value of insurance in force and is the result of purchase accounting adjustments related to the 1989 acquisition of the Company and the 1994 acquisition of Allegiance. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Year Ended December 31, 1997 Compared with Year Ended December 31, 1996." (2) In December 1996, the Company announced its strategic decision to withdraw from the group medical insurance business and during 1997 the Company accelerated the withdrawal. Group medical results net of taxes are reported separately as discontinued operations and 1997 and 1996 include additional after tax charges of $3.5 million, or $0.07 per diluted share, and $3.9 million, or $0.08 per diluted share, respectively, for estimated losses during the phase-out period. (3) The extraordinary item for the year ended December 31, 1994 represents a non-recurring loss from early retirement of debt and is net of tax benefits. (4) Income from continuing operations before realized investment gains and losses, debt retirement costs, cost of the additional rights relating to the 1995 share repurchase, discontinued operations, and extraordinary items. (5) For the purpose of determining the ratio of earnings to fixed charges, "earnings" consist of income from continuing operations before income taxes and interest expense (including amortization of debt issuance cost), and "fixed charges" consist of interest expense (including amortization of debt issuance cost). (6) Basic earnings per share is computed based on the weighted average number of shares outstanding. Diluted earnings per share is computed based on the weighted average number of shares and common stock equivalents outstanding. The Company's common stock equivalents relate to outstanding warrants, common stock options and Director Stock Plan units, and prior to their early retirement in February 1996, the convertible notes were considered potentially dilutive securities for purposes of calculating diluted earnings per share. Shares and per share amounts for all periods have been restated to reflect the Company's two-for-one stock split. (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 $62.2 million, $29.7 million and $76.2 million at December 31, 1997, 1996 and 1995, respectively, and a reduction, net of tax benefits, of $70.9 million at December 31, 1994. Excluding the FAS 115 market value accounting for investments, book value per share was $10.03, $9.62, $8.42 and $8.34 at December 31, 1997, 1996, 1995 and 1994, respectively. (8) Statutory data has been derived from the financial statements of the Company prepared in accordance with statutory accounting practices and filed with insurance regulatory authorities. (9) Property and casualty combined loss and expense ratio includes policyholder dividends. (10) Source: Best's Aggregates and Averages (1994 through 1997 Eds.). The industry averages for the year ended December 31, 1997 are from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 1998, published by A.M. Best. (11) Investment reserves were the Asset Valuation Reserves. 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, ---------------------------------------------------------------- 1997 1996 1995 -------------------- -------------------- -------------------- Property and casualty.................. $ 458.0 59.4% $ 427.1 60.6% $ 405.8 62.0% Annuity................................ 199.2 25.8 166.9 23.7 142.9 21.9 Life................................... 114.1 14.8 110.8 15.7 105.3 16.1 --------- --------- --------- --------- --------- --------- Total.......................... $ 771.3 100.0% $ 704.8 100.0% $ 654.0 100.0% --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
4 CORPORATE STRATEGY AND MARKETING The Company's target market consists of educators and other employees of public schools and their families. It is estimated that there are approximately 3 million elementary and secondary public school teachers and administrators in the United States. The Company also sells its products to other education-related customers, including private school teachers, education support personnel, and their families. In addition to changes in the number of teachers that may result from growth in the general population and changes in the number of school age children, the Company believes that turnover among the teacher population increases the size of its target market. New teachers and educational support personnel are solicited by the Company's agents and the Company attempts to retain customers who have retired or left the teaching profession. Customers of the Company typically have moderate annual incomes, with many belonging to two-income households. Their financial planning tends to focus on security, savings and primary insurance needs. EXCLUSIVE AGENCY FORCE A cornerstone of the Company's marketing strategy is its exclusive sales force of full-time agents who are employees of the Company. As of December 31, 1997, the Company employed 1,070 full-time agents. Many of these agents were previously teachers or other members of the education profession. The Company's agents market and write the full range of the Company's products. They are under contract to market and write only those products authorized by the Company. The Company's service commitment to its policyholders begins with personal contact at the point of sale between the Company's agents and potential policyholders. In addition, the Company's agents often have direct access to school premises, placing them in a position to write and service individual insurance business. Management believes that Horace Mann's name recognition and policyholder loyalties lead to new customers and cross-selling of additional insurance products. The Company's agents pre-underwrite policy applicants. The Company structures its agent compensation to provide incentives for agents to adhere to the Company's underwriting standards and practices and business growth plans. Agent compensation after an initial two-year period is comprised entirely of commissions and incentive bonuses based on profitability of insurance written, retention of customers and sales. In 1997, incentive bonuses represented 26% of compensation for agents with more than two years of experience with the Company with more than 90% of the bonuses based on profitability. The profitability related portion of agent compensation is based on loss ratios in the case of property and casualty policies, where permitted by law, and persistency in the case of life policies. Management believes that this compensation structure, which rewards the individual agent's selection of profitable business, helps to produce profitable business. ALTERNATE DISTRIBUTION PROGRAM The Company has established an alternate distribution marketing program to develop new sales channels that supplement and complement the exclusive agency force. As of December 31, 1997, the Company had established relationships with 88 educator credit unions in 31 states. At some of those credit unions, a salaried representative of the Company is available to meet with prospective customers, while other of those credit unions refer their members to the Company for their insurance needs. GEOGRAPHIC COMPOSITION OF BUSINESS The Company's business is geographically diversified. Based on direct insurance premiums earned and contract deposits for all continuing product lines for the year ended December 31, 1997, the top five states and their portion of total premium were North Carolina, 8.1%; Texas, 6.8%; Illinois, 5.2%; Minnesota, 5.2%; and California, 4.8%. 5 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 1997: PROPERTY AND CASUALTY SEGMENT TOP TEN STATES (Dollars in millions)
PROPERTY AND CASUALTY SEGMENT -------------------------- DIRECT PERCENT STATE PREMIUMS(1) OF TOTAL - --------------------------------------------------------------------- ------------- ----------- Texas................................................................ $ 33.7 7.6% North Carolina....................................................... 32.5 7.3 California........................................................... 30.8 6.9 Minnesota............................................................ 27.9 6.3 Massachusetts........................................................ 25.5 5.7 Florida.............................................................. 23.5 5.3 Pennsylvania......................................................... 22.6 5.1 South Carolina....................................................... 19.9 4.4 Michigan............................................................. 19.9 4.4 Georgia.............................................................. 15.9 3.6 ------------- ----- Total of top ten states...................................... 252.2 56.6 All other areas...................................................... 193.3 43.4 ------------- ----- Total direct premiums........................................ $ 445.5 100.0% ------------- ----- ------------- -----
- --------- (1) Defined as earned premiums before reinsurance and is determined under statutory accounting practices. HMEC's principal life insurance subsidiary writes business in 48 states and the District of Columbia. The following table sets forth the Company's top ten combined life and annuity states based on total direct premiums and contract deposits in 1997: COMBINED LIFE AND ANNUITY SEGMENTS TOP TEN STATES (Dollars in millions)
DIRECT PREMIUMS AND PERCENT STATE CONTRACT DEPOSITS(1) OF TOTAL - ------------------------------------------------------------- --------------------- ----------- North Carolina............................................... $ 27.8 9.1% Illinois..................................................... 26.1 8.6 Virginia..................................................... 17.4 5.7 Texas........................................................ 16.9 5.6 Tennessee.................................................... 16.6 5.5 Indiana...................................................... 14.9 4.9 Minnesota.................................................... 10.8 3.5 Wisconsin.................................................... 10.5 3.4 South Carolina............................................... 9.8 3.2 Pennsylvania................................................. 9.0 3.0 ------- ----- Total of top ten states.............................. 159.8 52.5 All other areas.............................................. 144.5 47.5 ------- ----- Total direct premiums................................ $ 304.3 100.0% ------- ----- ------- -----
- --------- (1) Excludes discontinued group medical business and is determined under statutory accounting practices. 6 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 2.3 million members. The Company has had a long relationship with NEA and many of the state and local education associations affiliated with NEA. The Company maintains a special advisory board, primarily composed of leaders of state education associations, that meets with Company management on a regular basis. These meetings provide management with the opportunity to better assess the present and future needs of its target market and to cultivate better relations with education association leaders. In certain states, where approved by the applicable state insurance departments, state or local association members are entitled to a discount on premiums for certain property and casualty insurance products sold by the Company. From 1984 to September 1993 and beginning again in September 1996, NEA purchased from the Company educator professional liability insurance for its members. Premium from this product represents less than 2% of all insurance premiums written and contract deposits of the Company. Between September 1993 and September 1996, the Company did not write this policy. It is the practice of NEA and affiliated state and local education associations to "sponsor" various insurance products and services, including those of the Company and its competitors. "Sponsorship" is generally determined independently by each of these organizations. Being "sponsored" generally means that NEA and such state and local associations evaluate a product, authorize the use of their names in connection with the marketing of the product and, in some instances, recommend that their membership consider buying the product. From time to time during the past 25 years, NEA has sponsored various Company products and currently sponsors the Company's homeowners policy, which was co-sponsored by 41 NEA-affiliated state associations as of December 31, 1997. In each of the Company's last three fiscal years, the Company's homeowners policy was the only product of the Company that was sponsored by NEA (exclusive of the educator professional liability insurance policy purchased by NEA in 1996 and 1997). NEA-affiliated education associations in 40 states sponsor products of the Company other than homeowners. NEA-affiliated education associations in 46 states sponsor one or more of the Company's products. In many cases, associations that sponsor one of the Company's products also sponsor competing products. The Company does not pay NEA or any affiliated associations any consideration in exchange for sponsorship of Company products. The Company does pay for advertising that appears in NEA and state education association publications. Some of the advantages of education association sponsorship include prestige and enhanced brand awareness, increased opportunity for the Company's agents to market products on school premises, and improved agent recruiting, especially among former teachers. The Company's customers decide whether to purchase the Company's products for a number of reasons, including pricing and service of the product and the customer's relationship with the selling agent--education association sponsorship may be one factor in such a decision. The American Federation of Teachers ("AFT") is the nation's second largest teachers' union representing approximately 700,000 educators. NEA and AFT have moved further in their discussions regarding creation of a new, unified organization of educators. Delegates from NEA and AFT will vote during the Summer of 1998 on whether to approve the NEA and AFT merger. If approved, the merger would be completed by the year 2002. At the present time, the Company does not have any relationship with the AFT and such a merger could expand sponsorship opportunities within the Company's target market. PROPERTY AND CASUALTY The primary property and casualty product offered by the Company is private passenger automobile insurance, which in 1997 represented 78% of property and casualty net written premiums. Homeowners insurance represented 21% of property and casualty premiums and the educator professional liability insurance represented the remaining 1% of the Company's property and casualty premiums. As of December 31, 1997, the Company had approximately 586,000 voluntary automobile 7 policies in force with annual premiums of approximately $384 million and approximately 251,000 homeowners policies in force with annual premiums of approximately $96 million. Voluntary automobile policies exclude those policies described in "Business--Regulation--Mandatory Insurance Facilities" and assigned risk policies. See "Business--Corporate Strategy and Marketing--National, State and Local Education Associations." The results of companies in the insurance industry have historically been subject to significant fluctuations due to competition, economic conditions, interest rates and other factors. In particular, the property and casualty insurance industry has historically experienced pricing and profitability cycles. With respect to these cycles, the factors most affecting current and prospective results of operations are intense price competition and aggressive marketing by property and casualty insurers, which have historically resulted in higher combined loss and expense ratios. Periods characterized by higher combined loss and expense ratios have typically been followed by withdrawal of capacity in the property and casualty industry and a firming of prices, resulting in lower combined loss and expense ratios. Because of the nature of the property and casualty cycle, it is difficult to predict future trends in the industry's overall combined loss and expense ratio. Management of the Company believes that these factors will continue to produce pricing and profitability cycles for the industry in the future. During the past ten years, the personal lines segment of the property and casualty insurance market has been less subject to the pricing and profitability cycles that have affected the commercial lines segment and the overall industry. Because virtually all the Company's property and casualty business is personal lines business, management believes the Company's operations are less subject to pricing and profitability cycles than the operations of many other insurers. Results of property insurers are also subject to weather and other conditions prevailing in an accident year. While one year may be relatively free of major weather or other disasters, another year may have numerous such events causing results for such a year to be materially worse than for other years. SELECTED HISTORICAL FINANCIAL INFORMATION FOR PROPERTY AND CASUALTY SEGMENT The following table sets forth certain financial information with respect to the property and casualty segment for the periods indicated. PROPERTY AND CASUALTY SEGMENT SELECTED HISTORICAL FINANCIAL INFORMATION (Dollars in millions)
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- STATEMENT OF OPERATIONS DATA: Insurance premiums written........................................... $ 458.0 $ 427.1 $ 405.8 Insurance premiums earned............................................ 447.2 413.2 403.8 Net investment income................................................ 41.7 46.4 48.8 Realized investment gains............................................ 1.9 0.2 2.9 Income before income taxes........................................... 80.6 70.6 75.3 Net income before realized investment gains.......................... 61.4 54.0 56.4 Net income........................................................... 62.7 54.1 58.3 Net investment income, after tax..................................... 30.4 33.5 35.0 Catastrophe losses, after tax........................................ 4.0 13.6 9.0 STATUTORY OPERATING STATISTICS: Loss and loss adjustment expense ratio............................... 71.7% 74.1% 73.5% Expense ratio........................................................ 19.4% 19.4% 19.8% Combined loss and expense ratio (including policyholder dividends)... 91.1% 93.5% 93.3% Combined loss and expense ratio before catastrophes (including policyholder dividends)............................................ 89.7% 88.5% 89.9%
(CONTINUED ON NEXT PAGE) 8 PROPERTY AND CASUALTY SEGMENT SELECTED HISTORICAL FINANCIAL INFORMATION--(CONTINUED) (Dollars in millions)
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- GAAP OPERATING STATISTICS: Loss and loss adjustment expense ratio............................... 71.7% 74.1% 73.6% Expense ratio........................................................ 19.6% 19.8% 20.1% Combined loss and expense ratio (including policyholder dividends)... 91.3% 93.9% 93.7% Combined loss and expense ratio before catastrophes (including policyholder dividends)............................................ 89.9% 88.9% 90.3% AUTOMOBILE AND HOMEOWNERS (VOLUNTARY): Insurance premiums written........................................... $ 431.0 $ 400.0 $ 381.8 Insurance premiums earned............................................ 421.5 390.0 378.9 Policies in force (in thousands)..................................... 837 786 743
PROPERTY AND CASUALTY RATIOS In each of the last 10 years, the Company's combined loss and expense ratio for its property and casualty product lines outperformed the total property and casualty industry combined loss and expense ratio, as reported by A.M. Best. During this period, the Company's combined loss and expense ratio was better than the total property and casualty insurance industry combined loss and expense ratio by an average of approximately 11 percentage points per year. During the same period of time, the Company's combined loss and expense ratio was better than the personal lines insurance industry segment combined loss and expense ratio by an average of approximately 9 percentage points per year. 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, 1997...................................................... 91.1% 100.1% 101.8% 1996...................................................... 93.5 104.9 105.8 1995...................................................... 93.3 103.5 106.4 1994...................................................... 93.7 104.5 108.4 1993...................................................... 93.3 103.9 106.9 1992...................................................... 97.1 112.5 115.7 1991...................................................... 98.4 107.1 108.8 1990...................................................... 101.8 109.8 109.6 1989...................................................... 106.9 109.9 109.2 1988...................................................... 99.6 105.5 105.4
- --------- (1) Combined loss and expense ratio includes policyholder dividends and is determined according to statutory accounting practices. (2) The Company did not have any California property and casualty business during each of the years from 1989 through 1993. (3) Source: Best's Aggregates and Averages (1989 through 1997 Eds.). 1997 is an estimate from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 1998, published by A.M. Best. 9 Catastrophe losses before federal income tax benefits for the Company and the property and casualty industry for the nine years ended December 31, 1997 were as follows: CATASTROPHE LOSSES (Dollars in millions)
PROPERTY AND THE CASUALTY COMPANY(1) INDUSTRY(2) ------------- ------------- Year Ended December 31, 1997............................................................................ $ 6.2 $ 2,560.0 1996............................................................................ 20.9 7,375.0 1995............................................................................ 13.9 7,425.0 1994............................................................................ 17.0 17,030.0 1993............................................................................ 8.5 5,705.0 1992............................................................................ 13.3 22,870.0 1991............................................................................ 10.3 4,698.0 1990............................................................................ 5.8 2,560.0 1989............................................................................ 12.2 7,371.0
- --------- (1) Net of reinsurance and before federal income tax benefits. Includes allocated loss adjustment expenses. The Company's individually significant catastrophe losses net of reinsurance were as follows: 1997--$1.4 million, July 1997 wind/hail/tornadoes; $1.1 million, Denver, Colorado hailstorm. 1996--$8.2 million, Hurricane Fran. 1995--$2.9 million, Texas wind/hail/tornadoes; $2.2 million Hurricane Opal. 1994--$6.0 million, Northridge, California earthquake. 1993--$2.2 million, East Coast blizzard. 1992--$1.9 million, Hurricane Andrew. 1991--$1.0 million, Hurricane Bob. 1990--$2.8 million, Denver, Colorado hailstorm. 1989--$4.0 million, Hurricane Hugo. (2) Source: Insurance Trends, Property--Casualty Edition, First Quarter 1998, published by Conning & Company. These amounts are before reinsurance and federal income tax benefits and exclude all loss adjustment expenses. During the last 10 years, the Company's property and casualty expense ratio has been better than the property and casualty industry personal lines average expense ratio as reported by A.M. Best by an average of 4.7 percentage points per year. The Company's property and casualty expense ratio for the year ended December 31, 1997 was 19.4%, well within the lowest 20% of expense ratios of the 100 largest property and casualty groups, based on A.M. Best's reports. 10 The table below compares the Company's expense ratios with published industry averages. PROPERTY AND CASUALTY EXPENSE RATIO(1)
PROPERTY AND THE PERSONAL LINES CASUALTY COMPANY(2) INDUSTRY SEGMENT(3) INDUSTRY(3) --------------- ----------------------- --------------- Year ended December 31, 1997...................................................... 19.4% 24.1% 26.7% 1996...................................................... 19.4 23.4 26.3 1995...................................................... 19.8 23.7 26.1 1994...................................................... 19.8 23.5 26.0 1993...................................................... 19.6 23.9 26.2 1992...................................................... 19.6 24.4 26.5 1991...................................................... 19.8 24.7 26.4 1990...................................................... 19.1 24.3 26.0 1989...................................................... 19.0 24.5 26.0 1988...................................................... 18.7 24.4 25.7
- --------- (1) Determined according to statutory accounting practices. (2) The Company did not have any California property and casualty business during each of the years from 1989 through 1993. (3) Source: Best's Aggregates and Averages (1989 through 1997 Eds.). The 1997 personal lines result is an estimate from A.M. Best. The 1997 total industry result is an estimate from Review Preview, A Special Supplement to Best's Review and BestWeek, Property/Casualty Edition, January 1998, published by A.M. Best. PROPERTY AND CASUALTY RESERVES In the last ten consecutive years the Company's property and casualty reserves have developed cumulative redundancies. Reserves for claims and claims expenses are carried at the full value of estimated liabilities and are not discounted for interest expected to be earned on reserves. The Company has no exposure to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses. The Company establishes property and casualty claim reserves to cover its estimated ultimate liability for claims and claim adjustment expenses with respect to reported claims and claims incurred but not yet reported as of the end of each accounting period. In accordance with applicable insurance laws and regulations and generally accepted accounting principles ("GAAP"), no reserves are established until a loss occurs, including a loss from a catastrophe. Underwriting results of the property and casualty operations are significantly influenced by estimates of property and casualty claims and claims expense reserves. These reserves are an accumulation of the estimated amounts necessary to settle all outstanding claims, including claims which are incurred but not reported, as of the date of the financial statements. The reserve estimates are based on known facts and on interpretations of circumstances, including the Company's experience with similar cases and historical trends involving claim payment patterns, claim payments, pending levels of unpaid claims and product mix, as well as other factors including court decisions, economic conditions and public attitudes. The effects of inflation are implicitly considered in the reserving process. The establishment of reserves, including reserves for catastrophes, is an inherently uncertain process and the ultimate cost may vary materially from the recorded amounts. The Company regularly updates its reserve estimates as new facts become known and further events occur which may impact the resolution of unsettled claims. Changes in prior year reserve estimates, which may be material, are reflected in the results of operations in the period such changes are determined to be needed. 11 Due to the inherent uncertainty in estimating reserves for claims and claims expenses, there can be no assurance that ultimate liabilities will not exceed amounts reserved, with a resulting adverse effect on the Company. Management believes that the Company's overall reserve levels at December 31, 1997 are adequate to meet its future obligations. The following table is a summary reconciliation of the beginning and ending property and casualty insurance claims and claims expense reserve, displayed individually for each of the last three years. The table presents reserves on a net (after reinsurance) basis. The total net property and casualty insurance claims and claims expense amounts are reflected in the Consolidated Statements of Operations listed on page F-1 of this report. The end of the year gross (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, ------------------------------- 1997 1996 1995 --------- --------- --------- Gross reserves, beginning of year........................................ $ 340.4 $ 369.7 $ 389.1 Less reinsurance recoverables........................................ 34.1 23.8 19.5 --------- --------- --------- Net reserves, beginning of year.......................................... 306.3 345.9 369.6 --------- --------- --------- Incurred claims and claims expense: Claims occurring in the current year................................. 365.9 368.6 352.5 Decrease in estimated reserves for claims occurring in prior years(1): Policies written by the Company.................................. (40.2) (56.4) (49.8) Business assumed from state reinsurance facilities............... (4.9) (6.1) (5.8) --------- --------- --------- Total decrease............................................... (45.1) (62.5) (55.6) --------- --------- --------- Total claims and claims expenses incurred........................ 320.8 306.1 296.9 --------- --------- --------- Claims and claims expense payments for claims occurring during: Current year......................................................... 209.2 206.4 179.8 Prior years.......................................................... 148.6 139.3 140.8 --------- --------- --------- Claims and claims expense payments............................... 357.8 345.7 320.6 --------- --------- --------- Net reserves, end of period.............................................. 269.3 306.3 345.9 Plus reinsurance recoverables........................................ 41.3 34.1 23.8 --------- --------- --------- Gross reserves, end of period(2)......................................... $ 310.6 $ 340.4 $ 369.7 --------- --------- --------- --------- --------- ---------
- --------- (1) Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims and changes in their projected final settlement costs. Favorable reserve development generally occurs as a result of subsequent adjustment of reserves to reflect additional information. (2) Unpaid claims and claim expenses as reported in the consolidated balance sheets also include life, annuity, and group accident and health reserves of $11.7 million, $17.2 million and $15.0 million at December 31, 1997, 1996 and 1995, respectively, in addition to property and casualty reserves. The provision for claims and claims expenses for insured events in prior years decreased by $45.1 million, $62.5 million and $55.6 million for the years ended December 31, 1997, 1996 and 1995, respectively. The favorable claim development results primarily from improving trends in the frequency and severity of voluntary automobile claims. Future reserve releases, if any, will depend on the continuation of the favorable claim trends. 12 The year-end 1997 gross reserves of $310.6 million for property and casualty insurance claims and claims expenses, as determined under GAAP, were $41.3 million more than the reserve balance of $269.3 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 that reduces reserves for statutory reporting and is recorded as an asset for GAAP reporting. The decline in reserves during 1997 reflects favorable reserve development resulting from improving trends in the frequency and severity of voluntary automobile claims. Other factors have contributed to the decline in reserves, including the Company's focus on containing legal costs associated with settling automobile liability claims, a customer service program which has accelerated payment of property damage and collision claims by approximately 5 days, commutation of a portion of the Company's reinsurance coverage from prior years, and a reduction in reserves from state insurance facilities for involuntary automobile business. 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 stated year. The second section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to that reserve liability. The third section, reading down, shows retroactive reestimates of the original recorded reserve as of the end of each successive year which is the result of the Company's expanded awareness of additional facts and circumstances that pertain to the unsettled claims. The last section compares the latest reestimated reserve to the reserve originally established, and indicates whether or not the original reserve was adequate or inadequate to cover the estimated costs of unsettled claims. The table also presents the gross reestimated liability as of the end of the latest reestimation period, with separate disclosure of the related reestimated reinsurance recoverable. The claim reserve development table is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years. 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 1996 to be $150 thousand was first reserved in 1987 at $100 thousand, the $50 thousand deficiency (actual claim minus original estimate) would be included in the cumulative deficiency in each of the years 1987 - 1995 shown below. This table presents development data by calendar year and does not relate the data to the year in 13 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, -------------------------------------------------------------------------------------- 1987 1988 1989 1990 1991 1992 1993 1994 --------- --------- --------- --------- --------- --------- --------- --------- Gross reserves for property and casualty claims and claims expenses, beginning of year........ $ 268.0 $ 307.2 $ 320.9 $ 319.4 $ 331.5 $ 358.2 $ 373.5 $ 389.1 Deduct: Reinsurance recoverables..... 25.4 29.4 46.9 20.9 14.8 17.7 21.6 19.5 --------- --------- --------- --------- --------- --------- --------- --------- Net reserves for property and casualty claims and claims expenses, beginning of year........ 242.6] 277.8 274.0 298.5 316.7 340.5 351.9 369.6 Increase in reserves due to purchase of Allegiance Insurance Company: Gross reserves for property and casualty claims and claims expenses....................... - - - - - - 30.6 - Deduct: Reinsurance recoverables................... - - - - - - 0.6 - --------- --------- --------- --------- --------- --------- --------- --------- Net reserves for property and casualty claims and claims expenses....................... - - - - - - 30.0 - Paid cumulative as of: One year later................... 115.6 120.2 115.0 111.3 116.1 117.6 133.4 140.8 Two years later.................. 163.5 175.9 163.9 167.4 170.0 169.6 190.5 194.5 Three years later................ 194.3 204.3 192.6 197.1 197.2 197.8 218.4 224.2 Four years later................. 208.3 220.1 208.2 212.9 212.1 213.6 234.1 Five years later................. 215.6 227.7 216.4 220.7 220.5 222.6 Six years later.................. 218.9 232.2 219.3 225.3 224.8 Seven years later................ 220.8 234.0 221.7 228.2 Eight years later................ 221.6 235.5 223.2 Nine years later................. 222.4 236.6 Ten years later.................. 223.3 Reserves reestimated as of: End of year...................... 242.6 277.8 274.0 298.5 316.7 340.5 381.9 369.6 One year later................... 244.1 275.6 265.9 279.9 297.3 306.1 327.6 314.0 Two years later.................. 243.1 269.2 254.5 266.7 272.1 267.7 281.9 269.2 Three years later................ 243.3 259.0 239.4 246.7 246.8 246.4 258.1 251.4 Four years later................. 235.4 243.0 233.2 236.5 235.2 233.3 249.3 Five years later................. 226.0 239.7 227.8 232.4 229.8 229.7 Six years later.................. 224.7 239.3 225.4 230.8 230.1 Seven years later................ 225.0 237.4 224.9 231.1 Eight years later................ 224.1 237.5 225.2 Nine years later................. 224.0 238.1 Ten years later.................. 224.5 Reserve redundancy--Initial net reserves in excess of reestimated reserves: Amount........................... $ 18.1 $ 39.7 $ 48.8 $ 67.4 $ 86.6 $ 110.8 $ 132.6 $ 118.2 Percent.......................... 7.5% 14.3% 17.8% 22.6% 27.3% 32.5% 34.7% 32.0% Gross reestimated liability--latest.................. $ 282.9 Reestimated reinsurance recoverables-- latest.............. 31.5 --------- Net reestimated liability--latest.... 251.4 Gross cumulative excess.............. $ 106.2 --------- --------- 1995 1996 1997 --------- --------- --------- Gross reserves for property and casualty claims and claims expenses, beginning of year........ $ 369.7 $ 340.4 $ 310.6 Deduct: Reinsurance recoverables..... 23.8 34.1 41.3 --------- --------- --------- Net reserves for property and casualty claims and claims expenses, beginning of year........ 345.9 306.3 269.3 Increase in reserves due to purchase of Allegiance Insurance Company: Gross reserves for property and casualty claims and claims expenses....................... - - - Deduct: Reinsurance recoverables................... - - - --------- --------- --------- Net reserves for property and casualty claims and claims expenses....................... - - - Paid cumulative as of: One year later................... 139.3 148.6 Two years later.................. 195.3 Three years later................ Four years later................. 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...................... 345.9 306.3 269.3 One year later................... 283.4 261.2 Two years later.................. 249.6 Three years later................ Four years later................. Five years later................. Six years later.................. Seven years later................ Eight years later................ Nine years later................. Ten years later.................. Reserve redundancy--Initial net reserves in excess of reestimated reserves: Amount........................... $ 96.3 $ 45.1 Percent.......................... 27.8% 14.7% Gross reestimated liability--latest.................. $ 278.1 $ 298.3 Reestimated reinsurance recoverables-- latest.............. 28.5 37.1 --------- --------- Net reestimated liability--latest.... 249.6 261.2 Gross cumulative excess.............. $ 91.6 $ 42.1 --------- --------- --------- ---------
As the table above illustrates, the Company's net reserve for property and casualty insurance claims and claims expense at the end of 1996 developed favorably in 1997 by $45.1 million, comparable to favorable development of the gross reserves of $42.1 million. PROPERTY AND CASUALTY REINSURANCE All reinsurance is obtained through contracts which generally are renewed each calendar year; however, approximately one half of the catastrophe reinsurance program effective January 1, 1998 is a three year contract with rate guarantees. Although reinsurance does not legally discharge the Company from primary liability for the full amount of its policies, it does make the assuming reinsurer liable to the 14 extent of the reinsurance ceded. Historically, the Company's losses from uncollectible reinsurance recoverables have been insignificant. Past due reinsurance recoverables as of December 31, 1997 were also insignificant. The Company is a national underwriter and therefore has exposure to catastrophic losses in certain coastal states and other regions throughout the United States. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather and fires, and the frequency and severity of catastrophes are inherently unpredictable. The financial impact from catastrophic losses results from both the total amount of insured exposure in the area affected by the catastrophe as well as the severity of the event. The Company seeks to reduce its exposure to catastrophe losses through the geographic diversification of its insurance coverage, the purchase of catastrophe reinsurance, and the purchase of a catastrophe-linked equity put option. The Company maintains an excess and catastrophe treaty reinsurance program. The Company reinsures 95% of catastrophe losses above a retention of $7.5 million per occurrence up to $65 million per occurrence in 1997 and $80 million in 1998. This program is augmented by a $100 million equity put that provides an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event losses from catastrophes, individually or in the aggregate during a calendar year, exceed the catastrophe reinsurance program coverage limit. Before tax benefits, the equity put provides a source of capital for up to $154 million of catastrophe losses above the reinsurance coverage limit. For liability coverages, in both 1997 and 1998, including the educator professional liability policy, the Company reinsures each loss above a retention of $500,000 up to $20 million. The Company also reinsures each property loss above a retention of $500,000 up to $1.5 million. The following table identifies the Company's most significant reinsurers under the traditional catastrophe reinsurance program, their percentage participation in the Company's aggregate reinsured coverage and their rating by Standard & Poor's Corporation ("S&P" or "Standard & Poor's") and A.M. Best. No other single reinsurer's percentage participation in 1998 or 1997 exceeds 5%. PROPERTY CATASTROPHE REINSURANCE PARTICIPANTS IN EXCESS OF 5%
PARTICIPATION S&P A.M. BEST ----------- RATING RATING REINSURER PARENT 1998 1997 - ------ --------- --------------------------------- --------------------------------- ---- ---- A+ A Lloyd's of London Syndicates* 16% 18% AA- A+ AXA Reinsurance Company AXA Group 13% 7% AAA A+ St. Paul Fire and Marine The St. Paul Companies, Inc. Insurance Company 10% 7% AAA A++ American Re-insurance Company Muenchener Rueckversicherungs- Gesellschaft AG (Munich Re) of Germany 6% 0% NR A++ Erie Insurance Exchange 5% ** A NR G.I.O. Australia Holdings, Ltd. 0% 6% AAA A+ Munich American Reinsurance Muenchener Rueckversicherungs- Company Gesellschaft AG (Munich Re) of Germany 0% 5%
- --------- NR--Not rated. * For 1998, the 16% participation by Lloyd's of London in the Company's catastrophe reinsurance program is disbursed among 22 syndicates, each providing less than 5% of the Company's aggregate reinsured catastrophe risk. ** Less than 5%. For 1998, 95% of the Company's property catastrophe reinsurers were rated "A- (Excellent)" or above by A.M. Best. 15 ANNUITIES Educators in the Company's target market, as public school employees, benefit from the provisions of Section 403(b) of the Internal Revenue Code. This section of the Code allows public school employees to reduce their pretax income by making periodic contributions to an individual qualified retirement plan. The Company has offered tax-qualified annuities to its marketplace, designed to allow contractholders to benefit from these tax provisions, since 1961, the year Congress created this option for educators. The Company sells fixed and variable tax-qualified annuities. Under the fixed annuities, both the principal and a rate of return are guaranteed. Variable annuity contract deposits are invested as designated by the contractholder in mutual funds managed by the Company--a common stock fund, a bond fund, a combination bond and stock fund, and a short-term fund; and beginning in 1997--a small cap growth fund, an international equity fund, and a socially responsible fund. Total accumulated fixed and variable annuity cash value on deposit at December 31, 1997 of $2,314.2 million increased $238.7 million, or 11.5%, compared to December 31, 1996. This increase resulted from a net increase in funds on deposit of 10.5% plus net increases in market value of underlying mutual funds of $27.7 million. The liability for all annuity contracts issued by the Company on a generally accepted accounting principles ("GAAP") basis is established at the contract's accumulated cash value before reduction for surrender charges. For the year ended December 31, 1997, 92% of the accumulated cash value of the Company's annuity business remained on deposit, compared to average retention of 90% for stock life insurance companies for 1996, as reported by A.M. Best. All annuities issued since 1982 and approximately 75% of all outstanding fixed annuity accumulated cash values are subject in most cases to substantial early withdrawal penalties, typically ranging from 5% to 13% of the amount withdrawn. Withdrawals of outstanding variable annuities are limited to amounts less than or equal to the then current market value of the annuity. Tax-qualified annuities represented 95% of the Company's annuity policy reserves at December 31, 1997, and, generally, a penalty is imposed under the Internal Revenue Code of 1986, as amended, on amounts withdrawn from tax-qualified annuities prior to age 59 1/2. 16 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, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- STATEMENT OF OPERATIONS DATA: Contract deposits...................................................... $ 199.2 $ 166.9 $ 142.9 Contract charges earned................................................ 12.6 9.2 6.8 Net investment income.................................................. 113.1 111.4 110.3 Net interest margin (without realized gains)........................... 36.6 34.7 35.8 Net margin (includes contract charges earned).......................... 49.2 43.9 42.6 Realized investment gains.............................................. 2.2 1.6 4.3 Income before income taxes............................................. 32.0 26.5 27.1 Net income before realized investment gains............................ 19.3 16.3 14.8 Net income............................................................. 20.7 17.4 17.6 OPERATING STATISTICS: Fixed annuity: Accumulated value.................................................. $ 1,354.5 $ 1,390.6 $ 1,378.4 Accumulated value persistency...................................... 91.7% 93.9% 94.5% Variable annuity accumulated value..................................... $ 959.7 $ 684.9 $ 487.6 Number of contracts in force........................................... 112,162 106,476 101,641 Average accumulated cash value (in dollars)............................ $ 20,633 $ 19,493 $ 18,358 Average annual deposit by policyholders (in dollars)................... $ 2,485 $ 2,382 $ 2,350 Maturity schedule for all annuity contracts Matured............................................................ $ 195.7 $ 184.4 $ 176.8 5 years or less.................................................... 424.4 397.9 371.7 After 5 years through 10 years..................................... 489.6 408.9 351.5 After 10 years through 20 years.................................... 793.9 732.8 664.9 After 20 years..................................................... 410.6 351.5 301.1 Total accumulated cash value................................... $ 2,314.2 $ 2,075.5 $ 1,866.0 Annuity contracts terminated due to surrender, death, maturity or other: Number of contracts................................................ 6,945 5,977 5,645 Amount............................................................. $ 116.7 $ 90.9 $ 90.0 Accumulated fixed annuity value grouped by applicable surrender charge: 0%................................................................. $ 326.3 $ 344.6 $ 364.9 5% and greater but less than 10%................................... 808.9 827.5 804.6 10% and greater.................................................... 137.5 141.2 138.2 Supplementary contracts with life contingencies not subject to discretionary withdrawal......................................... 81.8 77.3 70.7 Total accumulated fixed annuity value.......................... $ 1,354.5 $ 1,390.6 $ 1,378.4
LIFE The Company entered the individual life insurance business in 1949 with traditional term and whole life insurance products. In 1984, the Company introduced "Experience Life," a flexible life insurance contract which allows the customer to combine elements of term life insurance, interest-sensitive whole life insurance and an interest-bearing account. At December 31, 1997 the Company had in force approximately 102,000 Experience Life policies representing approximately $6.8 billion of life insurance 17 in force with annual insurance premiums and contract deposits of approximately $72.9 million. The Company's traditional term, whole life and group life business in force consists of approximately 151,000 policies, representing approximately $4.4 billion of life insurance in force with annual insurance premiums and contract deposits of approximately $27.4 million as of December 31, 1997. In 1997, the Company introduced a new series of five limited duration term life insurance products. The Company does not charge any penalty for withdrawal of life insurance cash values. The life segment also includes the Company's group life and group disability income business which represented approximately 2% of all insurance premiums written and contract deposits of the Company. During 1997, the average face amount of ordinary life insurance policies issued by the Company was $101,077 and the average face amount of all ordinary life insurance policies it has in force was $50,998. A.M. Best reported that during 1996, for stock life insurance companies, the average face amount of ordinary life insurance policies issued was $76,193 and the average face amount of all ordinary life insurance policies in force was $47,803. The maximum life insurance risk retained by the Company is $200,000 combined for group and individual coverages on any individual life. Any risk in excess of $200,000 is reinsured. All of the Company's life reinsurers are rated "A (Excellent)" or above by A.M. Best. The life insurance and annuity industry, while it has not generally been subject to the factors that produce cyclicality in the property and casualty insurance industry, is nonetheless subject to competitive pressures and interest rate fluctuations. As a result, the life insurance and annuity industry has developed new products designed to shift investment and credit risk to policy or contract holders while still providing death benefits. This trend has generally caused profit margins to shrink on new products relative to older life insurance and annuity products and has provided more competitive returns to the holders of the new products than those available under other investment alternatives. Management cannot predict whether these trends will continue in the future. 18 SELECTED HISTORICAL FINANCIAL INFORMATION FOR LIFE SEGMENT The following table sets forth certain information with respect to the Company's life products for the periods indicated. LIFE SEGMENT SELECTED HISTORICAL FINANCIAL INFORMATION (Dollars in millions, unless otherwise indicated)
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- STATEMENT OF OPERATIONS DATA: Insurance premiums and contract deposits............................... $ 114.1 $ 110.8 $ 105.3 Insurance premiums and contract charges earned......................... 82.9 80.3 74.8 Net investment income.................................................. 43.7 41.7 39.8 Realized investment gains.............................................. 1.0 0.7 1.4 Income before income taxes............................................. 20.9 19.1 17.4 Net income before realized investment gains............................ 12.9 12.1 10.4 Net income............................................................. 13.6 12.5 11.2 OPERATING STATISTICS: Life insurance in force: Ordinary life...................................................... $ 10,241 $ 9,682 $ 9,304 Group life......................................................... 947 963 931 Total.......................................................... 11,188 10,645 10,235 Number of policies in force: Ordinary life...................................................... 200,811 199,031 198,541 Group life......................................................... 51,895 55,525 53,225 Total.......................................................... 252,706 254,556 251,766 Average face amount in force (in dollars): Ordinary life...................................................... $ 50,998 $ 48,650 $ 46,900 Group life......................................................... 18,248 17,350 17,500 Total.......................................................... 44,273 41,800 40,650 Persistency rate (ordinary life insurance in force).................... 93.0% 92.0% 92.2% Lapse ratio (ordinary life insurance in force)......................... 7.0% 8.0% 7.8% Ordinary life insurance terminated due to death, surrender, lapse or other: Face amount of insurance surrendered or lapsed..................... $ 771.4 $ 862.1 $ 808.1 Number of policies............................................. 9,571 9,660 9,380 Amount of death claims............................................. $ 22.0 $ 22.4 $ 19.3 Number of death claims......................................... 1,834 1,305 1,166
Acquired Immune Deficiency Syndrome ("AIDS") is expected to affect mortality adversely for the life insurance industry although the extent of the impact cannot be predicted at this time. Where permitted by law, the Company has responded by considering AIDS information in underwriting and pricing decisions. From 1993 through 1997, the Company has paid $3.1 million in death benefits under 80 individual life policies due to known AIDS-related deaths, representing 3% of total death benefits paid during this period. INVESTMENTS The Company's investments are selected to balance the objectives of minimizing interest rate exposure, providing a high current yield and protecting principal. These objectives are implemented through a portfolio that emphasizes investment grade, publicly traded bonds. When impairment of the value of an investment is considered other than temporary, the decrease in value is recorded as an adjustment to the valuation reserve and a new cost basis is established. At December 31, 1997, 19 investments in non-investment grade securities represented 6.0% of total investments. There are no significant investments in mortgage loans and real estate or privately placed securities. The Company's investments are managed by outside managers and advisors which follow investment guidelines established by the Company. The Company has separate investment strategies and guidelines for its property and casualty assets and for its life and annuity assets, which recognize different characteristics of the associated insurance liabilities, as well as different tax and regulatory environments. The Company manages interest rate exposure for its portfolios through asset/liability management techniques that attempt to match the duration of the assets with the duration of the liabilities under insurance policies. Duration of assets and liabilities will generally differ only because of opportunities to significantly increase yields or because policy values are not interest-sensitive, as in the property and casualty segment. The investments of each insurance subsidiary must comply with the insurance laws of such insurance subsidiary's domiciliary state. These laws prescribe the type and amount of investments that may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred stocks, common stocks, real estate mortgages and real estate. The following table sets forth the carrying and market values of the Company's investment portfolio as of December 31, 1997: 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............. 19.5% $ 539.2 $ 440.3 $ 98.9 $ 521.5 Other.................................. 8.2 228.0 207.1 20.9 222.8 Investment grade corporate and public utility bonds............................ 40.8 1,131.0 972.5 158.5 1,082.2 Municipal bonds............................ 8.7 241.8 29.3 212.5 228.1 Other mortgage-backed securities........... 10.7 296.5 253.5 43.0 290.1 Non-investment grade corporate and public utility bonds(2)......................... 6.0 164.9 101.6 63.3 155.1 Foreign government bonds................... 1.0 27.7 27.7 - 26.4 Short-term investments(3).................. 1.5 41.0 34.2 6.8 41.0 ----- ---------- ---------- ------------- ----------- Total publicly traded securities... 96.4 2,670.1 2,066.2 603.9 2,567.2 ----- ---------- ---------- ------------- ----------- OTHER INVESTMENTS: Private placements, all investment grade(4)................................. 0.4 9.7 9.5 0.2 9.4 Mortgage loans and real estate(5).......... 1.4 38.1 38.1 - 38.1 Policy loans and other..................... 1.8 51.1 49.7 1.4 51.1 ----- ---------- ---------- ------------- ----------- Total other investments............ 3.6 98.9 97.3 1.6 98.6 ----- ---------- ---------- ------------- ----------- Total investments(6)............... 100.0% $ 2,769.0 $ 2,163.5 $ 605.5 $ 2,665.8 ----- ---------- ---------- ------------- ----------- ----- ---------- ---------- ------------- -----------
- --------- (1) Includes $364.9 million market value of investments guaranteed by the full faith and credit of the United States government and $402.3 million market value of federally sponsored agency securities. (CONTINUED ON NEXT PAGE) 20 INVESTMENT PORTFOLIO--(CONTINUED) - --------- (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 ("S&P") RATING FOR SUCH SECURITY, OR IF THERE IS NO S&P RATING, THE MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") RATING FOR SUCH SECURITY, OR IF THERE IS NO S&P OR MOODY'S RATING, THE NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS (THE "NAIC") RATING FOR SUCH SECURITY. (3) SHORT-TERM INVESTMENTS MATURE WITHIN ONE YEAR OF BEING ACQUIRED AND ARE CARRIED AT COST, WHICH APPROXIMATES MARKET VALUE. SHORT-TERM INVESTMENTS INCLUDE $31.8 MILLION IN A MONEY MARKET FUND RATED "AAA" (S&P OR ITS EQUIVALENT), $9.1 MILLION IN CORPORATE BONDS AND $0.1 MILLION IN CERTIFICATES OF DEPOSIT. (4) MARKET VALUES FOR PRIVATE PLACEMENTS ARE ESTIMATED BY THE COMPANY WITH THE ASSISTANCE OF ITS INVESTMENT ADVISORS. (5) MORTGAGE LOANS ARE CARRIED AT AMORTIZED COST OR UNPAID PRINCIPAL BALANCE LESS VALUATION RESERVES AND REAL ESTATE ACQUIRED IN THE SETTLEMENT OF DEBT IS CARRIED AT THE LOWER OF COST OR MARKET. CARRYING VALUE IS NET OF A $2.3 MILLION VALUATION RESERVE FOR ANTICIPATED LOSSES. (6) APPROXIMATELY 7% OF THE COMPANY'S INVESTMENT PORTFOLIO, HAVING A CARRYING VALUE OF $183.2 MILLION AS OF DECEMBER 31, 1997, CONSISTED OF SECURITIES WITH SOME FORM OF CREDIT SUPPORT, SUCH AS INSURANCE. ALL OF THESE SECURITIES HAVE THE HIGHEST INVESTMENT GRADE RATING. FIXED MATURITY SECURITIES The following table sets forth the composition of the Company's fixed maturity securities portfolio by rating as of December 31, 1997: RATING OF FIXED MATURITY SECURITIES(1) (Dollars in millions)
PERCENT OF TOTAL CARRYING CARRYING AMORTIZED VALUE VALUE COST ----------- ---------- ----------- AAA................................................................. 42.7% $ 1,126.8 $ 1,092.3 AA.................................................................. 7.1 188.3 179.3 A................................................................... 20.3 534.6 512.4 BBB................................................................. 23.3 613.8 585.3 BB.................................................................. 1.6 43.1 40.5 B................................................................... 4.0 106.2 99.7 CCC or lower........................................................ 0.1 1.4 3.2 Not rated(2)........................................................ 0.9 24.6 22.9 ----- ---------- ----------- Total........................................................... 100.0% $ 2,638.8 $ 2,535.6 ----- ---------- ----------- ----- ---------- -----------
- --------- (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 $14.9 million of publicly rated securities not currently rated by S&P, Moody's or the NAIC and $9.7 million of private placement securities not rated by either S&P or Moody's. The NAIC has rated 90.7% of these private placements as investment grade. $0.8 million of the remaining $0.9 million of private placements were rated as investment grade by the NAIC in 1995 and are under review for the assignment of a current rating. At December 31, 1997, 29.8% of the Company's fixed maturity securities portfolio was scheduled to mature within the next 5 years. Mortgage-backed securities, including mortgage-backed securities of United States governmental agencies, represented 30.2% of the total investment portfolio at December 31, 1997. 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 21 to refinance their mortgages and defaults by homeowners on mortgages that are then paid by guarantors. For financial reporting purposes, the Company has classified the entire fixed maturity portfolio as "available for sale". Fixed maturities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at market value. Fixed maturities held for indefinite periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates, resultant prepayment risk and other factors related to interest rate and resultant prepayment risk. CASH FLOW As a holding company, HMEC conducts its principal operations through its subsidiaries. Payment by HMEC of principal and interest with respect to HMEC's indebtedness, and payment by HMEC of dividends to its shareholders, are dependent upon the ability of its insurance subsidiaries to pay cash dividends or make other cash payments to HMEC, including tax payments pursuant to tax sharing agreements. Restrictions on the subsidiaries' ability to pay dividends or to make other cash payments to HMEC may materially affect HMEC's ability to pay principal and interest on its indebtedness and dividends on its common stock. The ability of the insurance subsidiaries to pay cash dividends to HMEC is subject to state insurance department regulations which generally permit dividends to be paid for any 12 month period in amounts equal to the greater of (i) net gain from operations in the case of a life insurance company or net income in the case of all other insurance companies for the preceding calendar year or (ii) 10% of surplus as of the preceding December 31st. Any dividend in excess of these levels requires the prior approval of the Director or Commissioner of the state insurance department of the state in which the dividend paying insurance subsidiary is domiciled. The aggregate amount of dividends that may be paid in 1998 from all of HMEC's insurance subsidiaries without prior regulatory approval is approximately $82 million. Notwithstanding the foregoing, if insurance regulators otherwise determine that payment of a dividend or any other payment to an affiliate would be detrimental to an insurance subsidiary's policyholders or creditors, because of the financial condition of the insurance subsidiary or otherwise, the regulators may block dividends or other payments to affiliates that would otherwise be permitted without prior approval. The insurance subsidiaries' sources of funds consist primarily of premiums and contract fees, investment income and proceeds from sales and redemption of investments. Such funds are applied primarily to payment of claims, insurance operating expenses, income taxes and the purchase of investments, as well as dividends and other payments to HMEC. COMPETITION The Company operates in a highly competitive environment. There are numerous insurance companies that compete with the Company, although management believes that the Company is one of the few multi-line insurance companies to target the nation's teachers as its primary market . In some specific instances and geographic locations competitors have specifically targeted the teacher marketplace with specialized products and programs. The Company competes in its target market with a number of national providers of personal automobile and homeowners insurance and life insurance. For annuity business, the marketplace has begun to see a competitive impact from new entrants such as mutual funds and banks into the tax deferred annuity products market. Among the major national providers of annuities to educators, Variable Annuity Life Insurance Company, a subsidiary of American General Corporation, and Nationwide are among the Company's major tax-qualified annuity competitors. The Company competes with a number of national providers of automobile and homeowners insurance, such as State Farm, Allstate and Nationwide, and several regional companies. The Company also competes for automobile business with certain direct marketing companies, such as 20th Century, American International Group (AIG) and GEICO. 22 The insurance industry consists of a large number of insurance companies, some of which have substantially greater financial resources, more diversified product lines, and lower cost marketing approaches, such as direct marketing, mail and telemarketing, compared to the Company. The Company believes that the principal competitive factors in the sale of property and casualty insurance products are price, service and name recognition. The Company believes that the principal competitive factors in the sale of life insurance and annuity products are product features, perceived stability of the insurer, service, name recognition and price. INSURANCE FINANCIAL RATINGS The Company believes that the ratings assigned to its principal insurance subsidiaries by Standard & Poor's, A.M. Best and Duff & Phelps Credit Rating Co. ("Duff & Phelps") contribute to the Company's competitiveness. Each of HMEC's principal insurance subsidiaries is rated "AA- (Excellent)" for claims-paying ability by Standard & Poor's. S&P publications define claims-paying ability ratings as follows. A Standard & Poor's insurance claims-paying ability rating is an opinion of an operating insurance company's financial capacity to meet the obligations of its insurance policies 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. Claims-paying ability ratings do not refer to an insurer's ability to meet nonpolicy obligations (i.e., debt contracts). The claims-paying ability 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. Claims-paying ability ratings are divided into two broad classifications. Rating categories from "AAA" to "BBB" are classified as "secure" claims-paying ability ratings and are used to indicate insurers whose financial capacity to meet policyholder obligations is viewed, on balance, as sound. Among factors considered in placing insurers within the spectrum of "secure" rating categories is the time frame within which policyholder security could be damaged by adverse economic and underwriting conditions. That time frame grows shorter as ratings move down the "secure" rating scale. Rating categories from "BB" to "CC" are classified as "vulnerable" claims-paying ability ratings and are used to indicate insurers whose financial capacity to meet policyholder obligations is viewed as vulnerable to adverse economic and underwriting conditions. Claims-paying ability ratings are assigned at the request of the insurers and based on extensive quantitative and qualitative analysis including consideration of ownership and support factors, if applicable. The rating process includes meetings with insurers' management. Plus (+) and minus (-) signs show relative standing within a category; they do not suggest likely upgrades or downgrades. Insurers rated "AAA" offer superior financial security on an absolute and relative basis. Capacity to meet policyholder obligations is overwhelming under a variety of economic and underwriting conditions. Insurers rated "AA" offer excellent financial security. Capacity to meet policyholder obligations is strong under a variety of economic and underwriting conditions. HMIC, TIC and Allegiance are rated "A+ (Superior)" and HMLIC is rated "A (Excellent)" by A.M. Best. Ratings for the industry range from "A++ (Superior)" to "F (In Liquidation)", and some companies are not rated. Publications of A.M. Best indicate that the "A++ and A+ (Superior)" ratings are assigned to those companies that in A.M. Best's opinion have, on balance, superior financial strengths, operating performance and market profile when compared to the standards established by A.M. Best and have a very strong ability to meet their ongoing obligations to policyholders. The "A and A- (Excellent)" ratings are assigned to those companies that in A.M. Best's opinion have, on balance, excellent financial strengths, operating performance and market profile when compared to the standards established by A.M. Best and have a strong ability to meet their ongoing obligations to policyholders. In evaluating a company's financial strength, operating performance and market profile, A.M. Best reviews the company's leverage/capitalization, capital structure/holding company, quality and appropriateness of reinsurance program, adequacy of loss/policy reserves, quality and diversification of assets, liquidity, 23 profitability, revenue composition, management experience and objectives, market risk, competitive market position, spread of risk and event risk. A.M. Best's ratings are based on factors relevant to policyholders, agents, insurance brokers and intermediaries and are not directed to the protection of investors. HMLIC is rated "AA" for claims paying ability by Duff & Phelps. Duff & Phelps' life insurance company Claims Paying Ability ("CPA") ratings provide analytical insight into the ability of a company to meet its current and future policyholder obligations on a timely basis. According to Duff & Phelps publications, the approach used to analyze an insurance company's claims paying ability is prospective in nature. The long duration of liabilities of the typical life insurance company requires a forward-looking analysis of the risks the company faces. The analytical process stresses the current financial position of the company, as well as an assessment of how future operations and developments will either positively or negatively affect that position. A key part of the overall CPA rating process is an annual meeting with the senior executives who set the future direction of the company. Regular contact with company representatives throughout the year supplements this process. The process used to determine a CPA rating is comprehensive and combines quantitative and qualitative analysis of both public and non-public information. The CPA ratings use a scale of "AAA (Highest claims paying ability--the risk factors are negligible)" through "DD (Company is under an order of liquidation)." The CPA rating of "AA" is assigned for very high claims paying ability. The protection factors are strong; risk is modest, but may vary slightly over time due to economic and/or underwriting conditions. A CPA rating only indicates an insurance company's ability to make timely payment of policyholder obligations. It does not refer to the ability of either the rated company or its affiliates to meet nonpolicyholder obligations, such as debt repayment or payment of preferred dividends. The most important factors considered in the qualitative analysis are: the company's competitive position and the strength of the enterprise, the insurer's various risk exposures and its defensive characteristics, the relationship of the rated entity to either parent, affiliate, or subsidiary, and the strengths and capabilities of the company's management. 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 1996, 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. The last 24 financial examinations for the Company's principal insurance subsidiaries, HMLIC, HMIC and TIC, occurred during 1993 for the period ended December 31, 1992. A financial examination of Allegiance was completed for the period ended December 31, 1994. Routine examinations of HMLIC, HMIC and TIC for the five year period ended December 31, 1997 and of AIC for the three year period ended December 31, 1997 were initiated in January 1998. Management believes that HMEC and its subsidiaries are in compliance in all material respects with all applicable regulatory requirements. The NAIC has adopted risk-based capital guidelines to evaluate the adequacy of statutory capital and surplus in relation to an insurance company's risks. State insurance regulations prohibit insurance companies from making any public statements or representations with regard to their risk-based capital levels. Based on current guidelines, the risk-based capital statutory requirements will have no negative regulatory impact on the Company's insurance subsidiaries. ASSESSMENTS AGAINST INSURERS Under insurance insolvency or guaranty laws in most states in which the Company operates, insurers doing business therein can be assessed for policyholder losses related to insurance company insolvencies. The amount and timing of any future assessments on the Company under these laws cannot be reasonably estimated and are beyond the control of the Company. Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurer's financial strength, and most assessments paid by the Company pursuant to these laws may be used as credits for a portion of the Company's premium taxes. The Company paid $0.6 million, $0.8 million and $0.9 million in connection with insurer insolvency proceedings for the years ended December 31, 1997, 1996 and 1995, respectively, of which $0.6 million, $0.6 million and $0.9 million for the same periods, respectively, is recoverable as premium tax credits in future periods. MANDATORY INSURANCE FACILITIES The Company is required to participate in various mandatory insurance facilities in amounts related to the amount of the Company's direct writings in the applicable state. In 1997, the Company reflected a net loss from participation in such mandatory pools and underwriting associations of $0.8 million before federal income taxes. CALIFORNIA EARTHQUAKE AUTHORITY The California Earthquake Authority ("CEA") was formed by the California Legislature to encourage companies to write residential property insurance in California and began operating in December 1996. All companies which write residential property insurance in California are also required to offer earthquake coverage. The CEA will operate as an insurance company providing residential property earthquake coverage under policies sold by companies which have chosen to participate in the CEA. The participating companies will fund the CEA and share in earthquake losses covered by the CEA in proportion to their market share. The Company has not joined the CEA. The Company's exposure to losses from earthquakes is managed through its underwriting standards, its earthquake policy coverage limits and deductible levels, and the geographic distribution of its business, as well as its reinsurance program. After reviewing the exposure to earthquake losses from its own policies and from participation in the CEA, management believes it is in the Company's best economic interest to offer earthquake coverage directly to its homeowners policyholders. See "Property and Casualty--Property and Casualty Reinsurance." REGULATION AT FEDERAL LEVEL Although the federal government generally does not directly regulate the insurance business, federal initiatives often impact the insurance business. Current and proposed federal measures which may significantly affect the insurance business include employee benefits regulation, controls on the costs of medical care, medical entitlement programs such as Medicare, changes to the insurance industry anti-trust exemption, minimum solvency requirements and allowing national banks to engage in the insurance, annuity and mutual fund businesses. 25 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 "Commission"). Horace Mann Investors, Inc., the broker-dealer subsidiary of HMEC, performs certain management functions for the mutual funds and also is regulated by the Commission and the National Association of Securities Dealers. EMPLOYEES At December 31, 1997, the Company had approximately 2,700 employees, including 1,070 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. HMEC also owns buildings with an aggregate of approximately 209,000 square feet at other locations in Springfield. These properties are adequate and suitable for the Company's current and anticipated future needs. ITEM 3. LEGAL PROCEEDINGS The Company is not currently party to any material pending legal proceedings other than ordinary routine litigation incidental to its business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 26 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. All per share amounts have been restated to reflect the Company's December 1997 two-for-one stock split.
MARKET PRICE -------------------- DIVIDEND FISCAL PERIOD HIGH LOW PAID - ------------------------------------------------------------------------ --------- --------- --------- 1997: Fourth Quarter...................................................... $ 29 23/32 $27 $ 0.08 Third Quarter....................................................... 28 5/8 24 9/16 0.0675 Second Quarter...................................................... 25 1/2 21 0.0675 First Quarter....................................................... 23 3/4 19 5/16 0.0675 1996: Fourth Quarter...................................................... $ 20 3/8 $15 3/4 $ 0.055 Third Quarter....................................................... 17 15/16 14 9/16 0.055 Second Quarter...................................................... 16 3/4 14 0.055 First Quarter....................................................... 17 7/8 14 5/8 0.055
As of March 1, 1998, the approximate number of holders of common stock was 12,000. In February 1997, the Board authorized the fifth consecutive annual increase in the Company's dividend since the Company's initial public offering in 1991 and increased the quarterly dividend by 22.7% to $0.0675 per share. In December 1997, in conjunction with the Company's two-for-one stock split, the Board of Directors authorized the sixth increase in the Company's dividend. The regular quarterly dividend increased by 18.5% to $0.08 per share. The payment of dividends in the future is subject to the discretion of the Board of Directors and will depend upon general business conditions, legal restrictions and other factors the Board of Directors of HMEC may deem to be relevant. In January 1998, the Company's Board of Directors authorized the repurchase of shares of the Company's common stock up to $100 million. Based on the market price of the Company's common stock at the time, $100 million represented approximately 8% of the Company's then outstanding shares. During 1997, the Company repurchased 3,720,600 shares, 8% of the Company's shares outstanding at December 31, 1996, at an aggregate cost of $91.8 million under a $100 million stock repurchase program announced in February 1997. Under the share repurchase program, shares of common stock may be purchased from time to time through open market and private purchases, as available. The repurchase of shares is financed through use of cash and, if needed, the existing bank line of credit. During 1997, options were exercised for the issuance of 731,924 shares, 1.5% of the Company's shares outstanding at December 31, 1996. 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." 27 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 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 1998 Annual Meeting of Shareholders. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 402 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 1998 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 1998 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 1998 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, 1997, 1996 and 1995. Consolidated Statements of Operations for the Years Ended December 31, 1997, 1996 and 1995. Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1997, 1996 and 1995. Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995. (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. 28 Schedules III and VI Combined--Supplementary Insurance Information and Supplemental Information Concerning Property and Casualty Insurance Operations. Schedule IV--Reinsurance. (a)(3) The following items are filed as Exhibits. Management contracts and compensatory plans are indicated by an asterisk (*).
EXHIBIT NO. DESCRIPTION - --------- ------------------------------------------------------------------------------ (3) Articles of incorporation and bylaws: 3.1 Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on October 6, 1989, incorporated by reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission on November 14, 1996. 3.2 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on October 18, 1991, incorporated by reference to Exhibit 3.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission on November 14, 1996. 3.3 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on August 23, 1995, incorporated by reference to Exhibit 3.3 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission on November 14, 1996. 3.4 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on September 23, 1996, incorporated by reference to Exhibit 3.4 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission on November 14, 1996. 3.5 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 Securities and Exchange Commission on October 9, 1992. 3.6 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 Securities and Exchange Commission on December 6, 1995. (4) Instruments defining the rights of security holders, including indentures: 4.1 Warrant Agreement dated as of August 29, 1989 (the "Warrant Agreement"), between HMEC (as successor to HME Acquisition Corporation) and Bankers Trust Company, as warrant agent (the "Warrant Agent"), with regard to Warrants to Purchase Common Stock, incorporated by reference to Exhibit 4.6 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989 (the "September 1989 Form 10-Q"). 4.2 Supplemental Warrant Agreement dated as of August 29, 1989 to the Warrant Agreement, between HMEC and the Warrant Agent, incorporated by reference to Exhibit 4.7 to the September 1989 Form 10-Q. 4.3 Form of Warrant (included in Exhibit 4.1).
29
EXHIBIT NO. DESCRIPTION - --------- ------------------------------------------------------------------------------ 4.4 Indenture dated as of January 17, 1996, between HMEC and U.S. Trust Company of California, N.A. as trustee, with regard to HMEC's 6 5/8% Senior Notes Due 2006, incorporated by reference to Exhibit 4.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1995, filed with the Securities and Exchange Commission on March 13, 1996. 4.5 Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.4). 4.6 Certificate of Designations for HMEC Series A Cumulative Preferred Stock (included in Exhibit 10.12). (10) Material contracts: 10.1 Credit Agreement dated as of December 31, 1996 (the "Bank Credit Facility") among HMEC, certain banks named therein and Bank of America National Trust and Savings Association, as administrative agent (the "Agent"), incorporated by reference to Exhibit 10.1 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1996, filed with the Securities and Exchange Commission on March 26, 1997. 10.2* Stock Subscription Agreement among HMEC (as successor to HME Holdings, Inc.), The Fulcrum III Limited Partnership, The Second Fulcrum III Limited Partnership and each of the Management Investors, incorporated by reference to Exhibit 10.17 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1989, filed with the Securities and Exchange Commission 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 Securities and Exchange Commission on November 14, 1996. 10.4* Horace Mann Educators Corporation Deferred Compensation Plan for Employees. 10.5* Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1991, filed with the Securities and Exchange Commission on March 27, 1992. 10.(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan. 10.(b)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.6 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1991, filed with the Securities and Exchange Commission on March 27, 1992. 10.(c)* Amendment to Horace Mann Educators Corporation 1991 Stock Incentive Plan, dated September 11, 1996, incorporated by reference to Exhibit 10.2(c) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission on November 14, 1996. 10.6* Severance Agreements between HMEC and certain officers of HMEC, incorporated by reference to Exhibit 10.9 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1993, filed with the Securities and Exchange Commission on March 31, 1994.
30
EXHIBIT NO. DESCRIPTION - --------- ------------------------------------------------------------------------------ 10.7* Specimen Continuation of Employment Agreement between HMEC and certain officers, incorporated by reference to Exhibit 10.21(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, filed with the Securities and Exchange Commission on November 14, 1994. 10.7(a)* Schedule of Continuation of Employment Agreements between HMEC and certain officers, incorporated by reference to Exhibit 10.21(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, filed with the Securities and Exchange Commission on November 14, 1994. 10.8* Horace Mann Incentive Compensation Program, incorporated by reference to Exhibit 10.7 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1996, filed with the Securities and Exchange Commission 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 Securities and Exchange Commission 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 Securities and Exchange Commission on August 14, 1997. 10.11* Agreement entered by and between HMEC and Paul J. Kardos as of August 1, 1996, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, filed with the Securities and Exchange Commission on August 13, 1996. 10.12 Catastrophe Equity Securities Issuance 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 Securities and Exchange Commission on March 26, 1997.
(11) Statement re computation of per share earnings. (12) Statement regarding computation of ratios. (21) Subsidiaries of HMEC. (23) Consent of KPMG Peat Marwick LLP. (27) Financial Data Schedule. (b) No Reports on Form 8-K were filed by HMEC during the fourth quarter of 1997. (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. 31 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 By: /s/ Paul J. Kardos ------------------------------ Paul J. Kardos President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Horace Mann Educators Corporation and in the capacities and on the date(s) indicated. Principal Executive Officer: Directors: /s/ Paul J. Kardos /s/ Ralph S. Saul - ---------------------------------------- ---------------------------------------- Paul J. Kardos Ralph S. Saul, Chairman of the Board of President, Chief Executive Officer Directors and a Director Principal Financial Officer: /s/ Larry K. Becker /s/ William W. Abbott - ---------------------------------------- ----------------------------------------- Larry K. Becker William W. Abbott, Director Executive Vice President and Chief Financial Officer Principal Accounting Officer: /s/ Roger W. Fisher /s/ Dr. Emita B. Hill - ---------------------------------------- ----------------------------------------- Roger W. Fisher Dr. Emita B. Hill, Director Vice President and Controller /s/ Donald E. Kiernan ---------------------------------------- Donald E. Kiernan, Director /s/ Jeffrey L. Morby --------------------------------------- Jeffrey L. Morby, Director /s/ Shaun F. O'Malley --------------------------------------- Shaun F. O'Malley, Director /s/ Charles A. Parker --------------------------------------- Charles A. Parker, Director /s/ William J. Schoen --------------------------------------- William J. Schoen, Director
Dated: March 30, 1998. 32 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-14 Independent Auditors' Report.............................................................................. F-15 Consolidated Balance Sheets............................................................................... F-16 Consolidated Statements of Operations..................................................................... F-17 Consolidated Statements of Changes in Shareholders' Equity................................................ F-18 Consolidated Statements of Cash Flows..................................................................... F-19 Notes to Consolidated Financial Statements................................................................ F-20 Financial Statement Schedules............................................................................. F-46
F-1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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. DISCONTINUED OPERATIONS In December 1996, the Company announced its strategic decision to withdraw from the group medical insurance business over the following two years. In October 1997, the Company announced that it had accelerated its timetable for withdrawal from this business. The Company stopped writing new group medical insurance policies in January 1997, had terminated 95% of this business as of December 31, 1997 and will terminate the remaining group medical insurance policies in 1998. In the following discussions of results of operations, group medical results are reported separately as discontinued operations for all years. F-2 YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996 INSURANCE PREMIUMS AND CONTRACT CHARGES EARNED Insurance premiums and contract charges earned, which excludes annuity and life contract deposits, increased 8.0% for the year ended December 31, 1997, compared to 1996. Insurance premiums written and contract deposits of $771.3 million for the year ended December 31, 1997 increased 9.4%, compared to $704.8 million for 1996, driven principally by a 19.4% increase in annuity deposits and a 7.2% growth in property and casualty premiums written. Insurance premiums written and contract deposits in the Company's primary product lines, automobile (excluding involuntary), property, annuity and life, increased 9.8% to $744.3 million for the year ended December 31, 1997, compared to $677.7 million for 1996. Involuntary automobile business includes allocations of business from state mandatory automobile insurance facilities and assigned risk business. Involuntary automobile premiums written for the year ended December 31, 1997 decreased 16.3% compared to 1996. Automobile (excluding involuntary) and homeowners earned premiums increased 8.1% to $421.5 million for the year ended December 31, 1997, compared to $390.0 million for 1996, primarily as a result of a 6.5% increase in automobile (excluding involuntary) and homeowners policies in force. The 837,000 automobile (excluding involuntary) and homeowners policies in force at December 31, 1997 represented an increase of 51,000 policies since December 31, 1996. Automobile (excluding involuntary) and homeowners premiums written increased 7.8% to $431.0 million for the year ended December 31, 1997, compared to $400.0 million for 1996. Premium rate increases which averaged approximately 2% in 1997 contributed a similar increase to the 1997 growth in premiums written. For the year ended December 31, 1997, new direct premiums written of $49.9 million increased 6.4% compared to $46.9 million for last year. Renewal direct premiums written of $386.6 million for the year ended December 31, 1997 increased 8.3% compared to $357.0 million for 1996. Annuity contract charges earned increased 37.0% to $12.6 million for the year ended December 31, 1997, compared to $9.2 million for 1996, due to a 40% increase in variable annuity cash value on deposit. Total annuity deposits received during the year ended December 31, 1997 increased 19.4% to $199.2 million, compared to $166.9 million for 1996, reflecting a $15.6 million, or 12.9%, increase in scheduled deposits for retirement annuities and a $16.7 million, or 36.5%, increase in rollover deposits from other companies and single premiums. Three new variable annuity funds were added to the Horace Mann family of funds in the first quarter of 1997 in response to educators' requests for additional investment options. The addition of a small cap growth fund, an international equity fund and a socially responsible fund brought the total variable annuity fund options to seven. For the year ended December 31, 1997, life insurance premiums and contract charges earned were $82.9 million, compared to $80.3 million for 1996, representing an increase of 3.2%. Life insurance in force on December 31, 1997 increased 5.1% compared to December 31, 1996. The lapse rate for life insurance in force of 7.0% for the year ended December 31, 1997 improved 1.0 percentage point compared to 8.0% reported for 1996. In the first quarter of 1997, the Company began selling five new term life products developed to meet customer needs. These products started to contribute to premium growth in the second quarter of 1997 and have generated approximately $2.4 million of premium through December 31, 1997. NET INVESTMENT INCOME Net investment income of $198.9 million for the year ended December 31, 1997 increased 0.2% compared to $198.6 million for 1996. The increase in net investment income was small compared to growth in the Company's business due to the utilization of capital for the share repurchase program and customers' preference for variable versus fixed annuity contracts. Investments (at amortized cost) decreased 2.6%, or $70.0 million, from December 31, 1996 due to utilization of capital for the share repurchase program. The pretax yield on average investments was 7.4% (4.9% after tax) for both of the years ended December 31, 1997 and 1996. F-3 REALIZED INVESTMENT GAINS AND LOSSES Realized investment gains were $5.3 million for the year ended December 31, 1997, compared to $2.5 million for 1996. BENEFITS, CLAIMS AND SETTLEMENT EXPENSES Total benefits, claims and settlement expenses increased 3.7% to $359.4 million for the year ended December 31, 1997, compared to $346.7 million for 1996. Property and casualty claims and settlement expenses were $320.8 million for the year ended December 31, 1997, compared to $306.1 million for 1996. The property and casualty loss ratio of 71.7% for the year ended December 31, 1997 was 2.4 percentage points less than the 74.1% reported for 1996. Losses from severe weather in 1996 were higher than those incurred in 1997. Catastrophe losses after reinsurance but before federal income tax benefits for the year ended December 31, 1997 were $6.2 million and accounted for 1.4 points on the loss ratio, compared to catastrophe losses of $20.9 million, 5.0 points on the loss ratio, for 1996. The provision for claims and claim adjustment expenses for insured events in prior years continued to reflect favorable development in both 1997 and 1996. Property and casualty claims and settlement expenses were reduced by a decrease in estimated losses and loss adjustment expenses for claims occurring in prior years of $45.1 million and $62.5 million for the years ended December 31, 1997 and 1996, respectively, including $5.9 million and $15.1 million for the three months ended December 31, 1997 and 1996, respectively. The Company's catastrophe reinsurance program covers 95% of catastrophe losses above a retention of $7.5 million up to $80 million for each catastrophe in 1998, $65 million in 1997. The Company's catastrophe reinsurance program is augmented by a $100 million equity put that provides an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event losses from catastrophes, individually or in the aggregate during a calendar year, exceed the catastrophe reinsurance program coverage limit. Before tax benefits, the equity put provides a source of capital for up to $154 million of catastrophe losses above the reinsurance coverage limit. Life benefits were $38.6 million for the year ended December 31, 1997, reflecting a 4.9% decrease, compared to $40.6 million for 1996. 1997 reflected reduced individual life mortality experience compared to higher mortality in 1996. Also for the year ended December 31, 1996, claims for group disability business were unusually low and returned to more normal levels in 1997. INTEREST CREDITED TO POLICYHOLDERS Interest credited to policyholders was $97.2 million for the year ended December 31, 1997, 2.0% more than the $95.3 million interest credited for 1996. Interest credited to fixed annuity contracts decreased $0.2 million, or 0.3%, to $76.5 million for the year ended December 31, 1997, from $76.7 million for 1996. The fixed annuity average annual interest rate credited was 5.6% for the year ended December 31, 1997, compared to a rate of 5.7% for 1996. Fixed rate annuity accumulated deposits decreased 2.6% over the 12 months ended December 31, 1997. Life insurance interest credited increased $2.1 million, or 11.3%, to $20.7 million for the year ended December 31, 1997, compared to 1996, primarily as a result of continued growth in the interest-sensitive whole life insurance reserves and account balances. POLICY ACQUISITION AND OPERATING EXPENSES Policy acquisition and operating expenses represent the Company's insurance underwriting expenses. For the year ended December 31, 1997, policy acquisition and operating expenses of $150.6 million increased $12.4 million, or 9.0%, compared to $138.2 million for 1996. The 1997 property and casualty expense ratio of 19.4% was equal to 1996 and includes an increase in profitability bonuses to agents based on the excellent property and casualty operating results in 1997. This increase in agent F-4 profitability bonuses contributed two-tenths of a percentage point to the 1997 property and casualty expense ratio. AMORTIZATION OF INTANGIBLE ASSETS Amortization of intangible assets decreased by $0.5 million to $10.7 million for the year ended December 31, 1997, compared to $11.2 million for 1996, as a result of a scheduled decrease in the non-cash amortization of the value of acquired insurance in force related to the 1989 acquisition of the Company. INTEREST EXPENSE The Company's interest expense of $9.4 million for the year ended December 31, 1997 was $1.1 million, or 10.5%, less than 1996 as a result of repayments of borrowings in 1996 related to the repurchase of shares of its common stock during the second quarter of 1995. The debt to capital ratio of 21.8% as of December 31, 1997 was within the Company's target operating range of 20% to 25%. INCOME TAX EXPENSE The effective income tax rate was 27.2% for the year ended December 31, 1997 compared to the 26.6% effective income tax rate for 1996. Income from investments in tax-advantaged securities reduced the effective income tax rate 3 percentage points in 1997 and 1996, and acquisition related tax benefits reduced the effective rate 6 percentage points in 1997 and 1996. OPERATING INCOME Operating income (income from continuing operations before realized investment gains and losses and 1996 debt retirement costs) was $83.6 million for the year ended December 31, 1997, compared to $73.1 million for 1996, an increase of 14.4%. Operating income in 1997 reflected favorable automobile underwriting results, unusually mild weather which benefited property insurance results and strong annuity results driven by business growth. Included in the Company's operating income are non-cash charges for the amortization of the value of acquired insurance in force and goodwill related to the 1989 acquisition of the Company. Excluding these non-cash charges for the amortization of intangible assets, operating income was $90.5 million for the year ended December 31, 1997, compared to $80.4 million for 1996. Property and casualty segment operating income was $61.4 million for the year ended December 31, 1997, compared to $54.0 million for 1996. Favorable automobile underwriting results and unusually mild weather which benefited property insurance results in 1997 compared to last year contributed to these results. For 1997, after tax catastrophe losses were $4.0 million, compared to $13.6 million for 1996. The property and casualty combined loss and expense ratio for the year ended December 31, 1997 was 91.1%, compared to the 93.5% reported for 1996. Before catastrophe losses, the combined loss and expense ratio was 89.7% for 1997, compared to 88.5% for the year ended December 31, 1996. Annuity segment operating income of $19.3 million for the year ended December 31, 1997 increased 18.4%, compared to the $16.3 million reported for 1996, reflecting 40.1% growth in variable annuity deposits and an increase of 12 basis points in the fixed net interest margin. Annuity segment profit continues to shift from the interest margin on fixed annuity accumulations to fees on variable mutual fund deposits. Variable annuity deposits of $1.0 billion at December 31, 1997 were nearly double the amount on deposit at December 31, 1995. Total accumulated fixed and variable annuity deposits of $2,314.2 million increased $238.7 million, or 11.5%, compared to December 31, 1996. This increase resulted from a net increase in variable funds on deposit of $247.3 million, or 40.1%, plus net increases in market value of underlying mutual funds of $27.7 million, and a decrease in fixed annuity funds on deposit of $36.3 million, or 2.6%. F-5 Life insurance segment operating income was $12.9 million for the year ended December 31, 1997, compared to the $12.1 million reported for 1996. The 1997 life results reflect modest growth in business volume offset by a return to more normal levels of both group disability claims and individual life mortality experience, compared to lower-than-average disability claims and higher-than-average life mortality in 1996. INCOME FROM CONTINUING OPERATIONS Income from continuing operations, which includes realized investment gains, for the year ended December 31, 1997 was $87.1 million, or $1.87 per diluted share, reflecting an 18.0% increase in income and a 20.6% increase in income per diluted share compared to 1996. The Company's share repurchase program reduced income by $2.3 million in 1997, while the program resulted in an increase of $0.03 in 1997 earnings per share. The full impact on earnings per share will be realized in 1998. After tax realized investment gains were $3.5 million for the year ended December 31, 1997, compared to $1.6 million for 1996. Income from continuing operations for the year ended December 31, 1996 also reflected the costs of the early redemption of $100 million of convertible notes of $0.9 million, or $0.02 per diluted share. The Company has implemented Statement of Financial Accounting Standards No. 128, "Earnings per Share," and restated all prior period earnings per share data. NET INCOME Net income, which includes discontinued operations, was $83.6 million, or $1.80 per diluted share, for the year ended December 31, 1997, compared to $64.6 million, or $1.36 per diluted share, for 1996, an increase of 32.4% on a per share basis. During 1997, the Company accelerated the timetable for its withdrawal from the group medical insurance business and terminated 95% of that business by December 1997. The remaining group medical business will be terminated in 1998. As a result of this acceleration and higher-than-expected claims, net income for the year ended December 31, 1997 includes an after tax charge of $3.5 million, or $0.07 per diluted share, for anticipated additional losses during the remainder of the phase-out period. The 1997 charge was recorded during the third quarter. The discontinued group medical business operating loss was $5.3 million for the year ended December 31, 1996. The Company's net income for the year ended December 31, 1996 also included an after tax charge of $3.9 million for anticipated losses during the two year phase-out period for the discontinued group medical insurance business. YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995 INSURANCE PREMIUMS AND CONTRACT CHARGES EARNED Insurance premiums and contract charges earned, which excludes annuity and life contract deposits, increased 3.6% for the year ended December 31, 1996, compared to 1995. Insurance premiums written and contract deposits of $704.8 million for the year ended December 31, 1996 increased 7.8%, compared to $654.0 million for 1995, driven principally by 16.8% growth in annuity deposits. The first annual premium, of approximately $7 million, for Horace Mann's three year contract to provide professional liability insurance for the 2.3 million members of the National Education Association is included in the Company's total insurance premiums written and contract deposits for the year ended December 31, 1996. No such premium was written in 1995. Insurance premiums written and contract deposits in the Company's primary product lines, automobile (excluding involuntary), property, annuity and life, increased 7.6% to $677.7 million for the year ended December 31, 1996, compared to $630.0 million for 1995. Involuntary automobile premiums written for the year ended December 31, 1996 decreased 6.3% compared to 1995. Automobile (excluding involuntary) and homeowners earned premiums increased 2.9% to $390.0 million for the year ended December 31, 1996, compared to $378.9 million for 1995, primarily as a result F-6 of a 5.8% increase in automobile (excluding involuntary) and homeowners policies in force, partially offset by a 0.7% decrease in average premium earned per automobile policy. The 786,000 automobile (excluding involuntary) and homeowners policies in force at December 31, 1996 represented an increase of 43,000 policies compared to December 31, 1995. Automobile (excluding involuntary) and homeowners premiums written increased 4.8% to $400.0 million for the year ended December 31, 1996, compared to $381.8 million for 1995. For the year ended December 31, 1996, new direct premiums written of $46.9 million increased 26.4% compared to $37.1 million for 1995. Renewal direct premiums written of $357.0 million for the year ended December 31, 1996 increased 2.2% compared to $349.3 million for 1995. Annuity contract charges earned increased 35.3% to $9.2 million for the year ended December 31, 1996, compared to $6.8 million for 1995, due to a 40% increase in variable annuity cash value on deposit. Total annuity deposits received during the year ended December 31, 1996 increased 16.8% to $166.9 million, compared to $142.9 million for 1995, reflecting a $7.1 million, or 6.2%, increase in scheduled deposits for retirement annuities and a $16.9 million, or 58.6%, increase in rollover deposits from other companies and single premiums. For the year ended December 31, 1996, life insurance premiums and contract charges earned were $80.3 million, compared to $74.8 million for 1995, representing an increase of 7.4%. Life insurance in force on December 31, 1996 increased 4.0% compared to a year earlier. The lapse rate for life insurance in force of 8.0% for the year ended December 31, 1996 increased slightly compared to 7.8% for 1995. NET INVESTMENT INCOME Net investment income of $198.6 million for the year ended December 31, 1996 was comparable to 1995. Investments (at amortized cost) increased 2.0%, or $52.4 million, from December 31, 1995. The pretax yield on average investments was 7.4% (4.9% after tax) for the year ended December 31, 1996 compared to a pretax yield of 7.5% (5.0% after tax) for 1995. REALIZED INVESTMENT GAINS AND LOSSES Realized investment gains were $2.5 million for the year ended December 31, 1996, compared to $8.6 million for 1995. BENEFITS, CLAIMS AND SETTLEMENT EXPENSES Total benefits, claims and settlement expenses increased 3.3% to $346.7 million for the year ended December 31, 1996, compared to $335.7 million for 1995. Property and casualty claims and settlement expenses were $306.1 million for the year ended December 31, 1996, compared to $297.1 million for 1995. The property and casualty loss ratio was 74.1% for the year ended December 31, 1996, compared to 73.5% for 1995. For 1996, higher first quarter losses from severe winter weather and third quarter losses from hurricanes were partially offset by continued favorable trends in losses on voluntary automobile insurance for the year. Property and casualty claims and settlement expenses were reduced by a decrease in estimated losses and loss adjustment expenses for claims occurring in prior years of $62.5 million and $55.6 million for the years ended December 31, 1996 and 1995, respectively. Catastrophe losses after reinsurance but before federal income tax benefits for the year ended December 31, 1996 were $20.9 million, compared to catastrophe losses of $13.9 million for 1995. Hurricane Fran, which occurred during the third quarter of 1996, represented $8.2 million in losses. Life benefits were $40.6 million for the year ended December 31, 1996, reflecting a 5.2% increase, compared to $38.6 million for 1995. The increase in life benefits was comparable to the 7.4% increase in life earned premiums with higher than average mortality experience being more than offset by lower dividends to life policyholders and reduced claims from group disability business. F-7 INTEREST CREDITED TO POLICYHOLDERS Interest credited to policyholders was $95.3 million for the year ended December 31, 1996, 4.8% more than the $90.9 million interest credited for 1995. Interest credited to fixed annuity contracts increased 3.0% to $76.7 million for the year ended December 31, 1996, from $74.5 million for 1995. The increase reflects a slightly higher average annual interest rate credited of 5.7% for the year ended December 31, 1996, compared to 5.6% for 1995, and a growth of fixed rate annuity accumulated deposits of 0.9%. Life insurance interest credited increased $2.2 million, or 13.4%, to $18.6 million for the year ended December 31, 1996, compared to 1995, primarily as a result of continued growth in the interest-sensitive whole life insurance reserves and account balances. POLICY ACQUISITION AND OPERATING EXPENSES Policy acquisition and operating expenses represent the Company's insurance underwriting expenses. For the year ended December 31, 1996, policy acquisition and operating expenses of $138.2 million increased $0.6 million, or 0.4%, compared to $137.6 million for 1995. The 1996 property and casualty expense ratio improved to 19.4%, four-tenths of a percentage point lower than 19.8% for 1995. AMORTIZATION OF INTANGIBLE ASSETS Amortization of intangible assets decreased by $0.5 million to $11.2 million for the year ended December 31, 1996, compared to $11.7 million for 1995, as a result of a scheduled decrease in the non-cash amortization of the value of acquired insurance in force related to the 1989 acquisition of the Company. INTEREST EXPENSE The Company's interest expense of $10.5 million for the year ended December 31, 1996 was $1.1 million, or 9.5%, less than in 1995 as a result of repayments of borrowings related to the repurchase of shares of its common stock during the second quarter of 1995. The debt to capital ratio was reduced to 21.6% as of December 31, 1996, within the Company's target operating range of 20% to 25%. INCOME TAX EXPENSE The 1996 effective income tax rate was 27%, equal to the 1995 effective income tax rate. Income from investments in tax-advantaged securities reduced the effective income tax rate 3 percentage points and acquisition related tax benefits reduced the effective rate 6 percentage points in both 1996 and 1995. The 1995 effective income tax rate also reflected the charge to income for additional rights relating to the repurchase of shares of the Company's common stock in 1995 that was not deductible for federal income tax purposes. OPERATING INCOME Operating income (income from continuing operations before realized investment gains and losses, 1996 debt retirement costs and the 1995 cost of additional rights related to the share repurchase) was $73.1 million for the year ended December 31, 1996, compared to $70.9 million for 1995. Operating income in 1996 reflected excellent voluntary automobile insurance results and an increase in annuity segment earnings, partially offset by high first quarter severe winter storm losses and high third quarter hurricane losses. Included in the Company's operating income are non-cash charges for the amortization of the value of acquired insurance in force and goodwill related to the 1989 acquisition of the Company. Excluding these non-cash charges for the amortization of intangible assets, operating income was $80.4 million for the year ended December 31, 1996, compared to $78.5 million for 1995. Property and casualty segment operating income was $54.0 million for the year ended December 31, 1996, compared to $56.4 million for 1995. Higher first quarter 1996 losses from severe F-8 winter weather and after tax catastrophe losses of $5.5 million from hurricanes in the third quarter of 1996 were partially offset by continued favorable trends in voluntary automobile losses. For the year, after tax catastrophe losses were $13.6 million in 1996, compared to $9.0 million for 1995. The property and casualty combined loss and expense ratio for the year ended December 31, 1996 was 93.5%, compared to the 93.3% reported for 1995. Before catastrophe losses, the combined loss and expense ratio was 88.5% for 1996, compared to 89.9% for the year ended December 31, 1995. Annuity segment operating income of $16.3 million for the year ended December 31, 1996 increased 10.1%, compared to 1995, resulting primarily from an increase in cash value on deposit. Annuity segment profit has begun to shift from the interest margin on fixed annuity accumulations to fees on variable mutual fund deposits. During 1997, variable mutual fund deposits increased 40.5%, and fees collected on those deposits increased 35.3%, compared to the year ended December 31, 1995. Total accumulated fixed and variable annuity cash value on deposit of $2,075.5 million increased $209.5 million, or 11.2%, compared to December 31, 1995. This increase resulted from a net increase in funds on deposit of 10.0% plus net increases in market value of underlying mutual funds of $26.7 million. Life insurance segment operating income of $12.1 million for the year ended December 31, 1996 increased 16.3% compared to the $10.4 million reported for 1995. The 1996 life results reflect growth in business volume and lower dividends to life policyholders, more than offsetting higher mortality experience, compared to 1995. INCOME FROM CONTINUING OPERATIONS Income from continuing operations, which includes realized investment gains, for the year ended December 31, 1996 was $73.8 million, or $1.55 per diluted share, reflecting a 1.9% decrease in income and a 9.9% increase in income per share on a fully diluted basis compared to 1995. The share repurchase completed in May 1995 and the redemption of the convertible notes in February 1996 resulted in decreases in shares and equivalent shares outstanding, increasing income per share from continuing operations. Realized investment gains after tax were $1.6 million for the year ended December 31, 1996, compared to $5.6 million for 1995. Income from continuing operations for the year ended December 31, 1996 reflects a reduction of $0.9 million, or $0.02 per diluted share, for the costs of the early redemption of $100 million of convertible notes. Income from continuing operations for the year ended December 31, 1995 included a reduction of $1.3 million, or $0.02 per diluted share, for the cost of the additional rights granted in connection with the share repurchase. NET INCOME Net income, which includes discontinued operations, was $64.6 million, or $1.36 per diluted share, for the year ended December 31, 1996 compared to $74.0 million, or $1.39 per diluted share, for 1995. The discontinued group medical business operating loss was $5.3 million for the year ended December 31, 1996, compared to an operating loss of $1.2 million for 1995. The discontinued group medical combined loss and expense ratio increased to 118.1% for the year ended December 31, 1996, compared to 106.4% for 1995, primarily due to an increase in claims. The Company's net income for the fourth quarter and year ended December 31, 1996 also included an after tax charge of $3.9 million for anticipated losses during the two year phase-out period for the discontinued group medical insurance business. LIQUIDITY AND FINANCIAL RESOURCES INVESTMENTS The Company's investment strategy emphasizes investment grade, publicly traded fixed income securities. At December 31, 1997, fixed income securities comprised 95.3% of total investments. Of the fixed income investment portfolio, 93.4% was investment grade and 99.6% was publicly traded. The average quality of the total fixed income portfolio was A+ at December 31, 1997. F-9 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 4.3 years at December 31, 1997 and 4.4 years at December 31, 1996. 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 $104.4 million for the year ended December 31, 1997 compared to $139.2 million for 1996 with the decrease primarily due to an increase in federal income tax payments. In both years, cash provided by operating activities primarily reflected net cash generated by the insurance subsidiaries. Payment of principal and interest on debt, fees related to the catastrophe-linked equity put option, dividends to shareholders and parent company operating expenses, as well as the share repurchase program, are dependent upon the ability of the insurance subsidiaries to pay cash dividends or make other cash payments to HMEC, including tax payments pursuant to tax sharing agreements. The insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. Dividends which may be paid by the insurance subsidiaries to HMEC during 1998 without prior approval are approximately $82 million. In 1997, the Company received approval from the Illinois and California Departments of Insurance for extraordinary dividends and a total of $96 million in dividends was paid by the property and casualty subsidiaries. HMEC used cash from the dividends primarily to repurchase shares of the Company's common stock. 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 maturities portfolio as available for sale. During 1997, net cash provided by investing activities was $66.1 million. This net amount reflects $1,044.2 million in purchases of fixed maturity investments, funded by net investment sales or maturities of $1,110.3 million. FINANCING ACTIVITIES Financing activities include primarily repurchases of the Company's common stock, payment of scheduled dividends, the receipt and withdrawal of funds by annuity policyholders and borrowings and F-10 repayments under the Company's debt facilities. Shareholder dividends paid for the year ended December 31, 1997 were $13.0 million. In 1997, the Company paid fees of $1.3 million related to the catastrophe-linked equity put which augments its reinsurance program and such fees were charged directly to additional paid-in capital. For the year ended December 31, 1997, receipts from annuity contracts of $199.2 million were greater than contract maturities and withdrawals of $176.1 million. Net transfers to variable annuity assets were $121.8 million during 1997 compared to $86.1 million during 1996. Interest-sensitive life account balances increased $1.2 million during 1997. Through December 31, 1997, the Company had repurchased 3,720,600 shares of its common stock at an aggregate cost of $91.8 million, or $24.67 per share, under a $100 million share repurchase program announced in February 1997. The repurchase of these shares was financed primarily with cash from operations, including dividends of $96 million from the property and casualty subsidiaries which required prior regulatory approval. During the year ended December 31, 1997, the Company received $11.6 million related to the exercise of common stock options including tax benefits. In May 1995, the Company repurchased 13.0 million shares of its common stock at an aggregate price of $174.9 million, financed by cash provided by operating activities and $140.0 million borrowed under an existing bank line of credit. Short-term borrowings under the bank line of credit were subsequently reduced to $34 million and $75 million as of December 31, 1996 and 1995, respectively. CAPITAL RESOURCES Historically, the Company's insurance subsidiaries have generated capital in excess of what has been needed to support business growth. 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 dividends to its shareholders and fulfill 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. In January 1998, the Company's Board of Directors adopted an additional repurchase program for shares of the Company's common stock of up to $100 million. The total capital of the Company was $648.2 million at December 31, 1997, including $99.6 million of long-term debt and $42.0 million of short-term debt. Long-term debt as a percentage of total shareholders' equity was 19.7% as of December 31, 1997, compared to 20.6% as of December 31, 1996 with the change including the effects of the repurchase of shares for treasury stock. Total debt to capital at December 31, 1997 was 21.8%, well within the Company's target operating range of 20% to 25%. Shareholders' equity was $506.0 million at December 31, 1997, including an unrealized gain in the Company's investment portfolio of $62.2 million after taxes and the related impact on deferred policy acquisition costs associated with interest-sensitive policies. In December 1997, the Company's common stock was split two-for-one. The market value of the Company's common stock and the market value per share were $1,258.8 million and $28 7/16, respectively, at December 31, 1997. Book value per share was $11.43 at December 31, 1997, $10.03 excluding investment market value adjustments. In January 1996, the Company issued $100.0 million face amount of 6 5/8% Senior Notes ("Senior Notes"), which will mature on January 15, 2006, at a discount of 0.5%. 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). The net proceeds from the sale of the Senior Notes were used to finance the redemption of the Company's convertible notes. As of December 31, 1997 and 1996, the Company had short-term debt comprised of $42.0 million and $34.0 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 F-11 Bank of America National Trust and Savings Association reference rates. The rate on the borrowings under the Bank Credit Facility was Interbank Offering Rate plus 0.3%, or 6.2%, as of December 31, 1997. The commitment for the Bank Credit Facility terminates on December 31, 2001. The Company's ratio of earnings to fixed charges for the year ended December 31, 1997 was 13.7x compared to 10.6x for 1996. Total shareholder dividends were $13.0 million for the year ended December 31, 1997. In February 1997, the Board authorized the fifth consecutive annual increase in the Company's dividend since the Company's initial public offering in 1991 and increased the quarterly dividend by 22.7% to $0.0675 per share. In November 1997, in conjunction with the Company's two-for-one stock split, the Board of Directors authorized the sixth increase to the Company's quarterly dividend, the second increase in 1997. The regular quarterly dividend increased by 19% to $0.08 per share on the post-split shares. In January 1998, the Company's Board of Directors adopted an additional repurchase program for shares of the Company's common stock of up to $100 million. Based on the market price of the Company's common shares at the time the Board adopted this program, $100 million would represent approximately 8% of the Company's outstanding shares. Shares of common stock may be purchased from time to time through open market and private purchases, as available. The repurchase program will be financed through use of cash and, if needed, the Bank Credit Facility. At December 31, 1997, HMEC (the holding company) had cash and invested assets of $19.3 million available for the share repurchase program. During 1997, options were exercised for the issuance of 731,924 shares, 1.5% of the Company's shares outstanding at December 31, 1996. Beginning in 1997, the Company's catastrophe reinsurance program is augmented by a $100 million equity put. This equity put provides for an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event losses from catastrophes, individually or in the aggregate during a calendar year, exceed $80 million, the 1998 coverage limit of the reinsurance program. YEAR 2000 In 1990, the Company established programming standards to address the year 2000 for new computer systems. By early 1995, the Company had developed a comprehensive plan to address the issue and began converting its existing computer systems to be year 2000 compliant. At December 31, 1997, over 60% of all business applications, representing more than 40% of all of the Company's program code, were year 2000 compliant. Management anticipates completing conversion of the remaining internal business applications by the end of 1998. Vendors that have not already completed conversion have indicated their plans to become year 2000 compliant by the end of 1998. During 1999, additional testing of all systems and final reviews of individual personal computer applications will be completed. Costs for this compliance project represent the allocation of existing internal information technology resources to address year 2000 compliance and are not expected to be incremental costs to the Company. The total cost of the compliance project is estimated to be $6 million, before tax benefits, and is being funded through operating cash flows. The Company is expensing all costs associated with these system changes and through 1997 has expensed $3.3 million before tax benefits. RECENT ACCOUNTING CHANGES COMPREHENSIVE INCOME In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which will be implemented in the Company's March 31, 1998 financial statements. SFAS No. 130 establishes F-12 standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income will represent the change in shareholders' equity during a reporting period from transactions and other events and circumstances from non-owner sources. For the Company, it is anticipated that comprehensive income will be substantially equal to net income plus the change in net unrealized gains and losses on fixed maturities and equity securities for the period as shown in the Statement of Changes in Shareholders' Equity. SEGMENT DISCLOSURES In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which will be implemented in the Company's March 31, 1998 financial statements. SFAS No. 131 establishes standards for the way public companies are to report information about operating segments in annual financial statements and requires those companies to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company anticipates that implementation of this pronouncement will not have a material effect on the disclosures contained in its annual financial statements and related notes but will expand its interim financial statements and related notes to include segment information such as revenues, earnings, assets and a reconciliation of segment earnings to consolidated earnings. The Company's operations will continue to include the following segments consistent with previously reported financial information: property and casualty insurance, annuities, life insurance, and corporate and other. EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which will be implemented in the Company's December 31, 1998 financial statements. SFAS No. 132 will not affect employee benefits expense or net income. SFAS No. 132 standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligations and fair values of plan assets that will facilitate financial analysis, and eliminates certain disclosures that are no longer as useful as they were when SFAS No. 87, 88 and 106 were issued. EFFECTS OF INFLATION AND CHANGES IN INTEREST RATES The Company's operating results are affected significantly in at least three ways by changes in interest rates and inflation. First, inflation directly affects property and casualty claims costs. Second, the investment income earned on the Company's investment portfolio and the market value of the investment portfolio are related to the yields available in the fixed-income markets. An increase in interest rates will decrease the market value of the investment portfolio, but will increase investment income as investments mature and proceeds are reinvested at higher rates. Third, as interest rates increase, competitors will typically increase crediting rates on annuity and interest-sensitive life products, and may lower premium rates on property and casualty lines to reflect the higher yields available in the market. The risk of interest rate fluctuation is managed through asset/liability management techniques, including cash flow analysis. EFFECTS OF RECESSION The Company markets its products primarily to educators and other employees of public schools and their families located throughout the United States. Although this market is affected by school budgetary constraints, as well as general economic downturns that result in decreased purchases of new automobiles and homes and reductions in individual savings, management believes that this market historically has continued to purchase insurance even in periods of recession. Historically, despite changing economic conditions, sales of insurance products to the Company's market have remained stable or increased, suggesting continuation of this historical trend. F-13 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, 1997, 1996 and 1995, and the related consolidated statements of operations, cash flows and shareholders' equity for the years ended December 31, 1997, 1996 and 1995 have been prepared by management, which is responsible for their integrity and objectivity. The statements have been prepared in accordance with generally accepted accounting principles and include some amounts that are based upon management's best estimates and judgements. The financial information contained elsewhere in this annual report on Form 10-K is consistent with that contained in the financial statements. Management is responsible for establishing and maintaining a system of internal control designed to provide reasonable assurance as to the integrity and reliability of financial reporting. The concept of reasonable assurance is based on the recognition that there are inherent limitations in all systems of internal control, and that the cost of such systems should not exceed the benefits derived therefrom. A professional staff of internal auditors reviews on an ongoing basis the related internal control system design, the accounting policies and procedures supporting this system and compliance therewith. Management believes this system of internal control effectively meets its objective of reliable financial reporting. In connection with their annual audits, independent certified public accountants perform an examination, in accordance with generally accepted auditing standards, which includes the consideration of the system of internal control to the extent necessary to form an independent opinion on the fairness of presentation of the financial statements prepared by management. The Board of Directors, through its Audit Committee composed solely of directors who are not employees of the Company, is responsible for overseeing the integrity and reliability of the Company's accounting and financial reporting practices and the effectiveness of its system of internal controls. The independent certified public accountants and internal auditors meet regularly with, and have access to, this committee, with and without management present, to discuss the results of their audit work. F-14 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, 1997, 1996 and 1995, 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, 1997. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules, as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Horace Mann Educators Corporation and subsidiaries as of December 31, 1997, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. [SIG] KPMG PEAT MARWICK LLP Chicago, Illinois January 26, 1998 F-15 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
1997 1996 1995 ------------ ------------ ------------ ASSETS Investments Fixed maturities, available for sale, at market (amortized cost 1997, $2,535,538; 1996, $2,609,077; 1995, $2,527,032)........... $ 2,638,794 $ 2,658,512 $ 2,643,060 Short-term and other investments.................................. 130,252 125,824 155,489 ------------ ------------ ------------ Total investments............................................. 2,769,046 2,784,336 2,798,549 Cash.................................................................. 353 13,704 9,518 Accrued investment income and premiums receivable..................... 103,951 107,682 94,359 Value of acquired insurance in force and goodwill..................... 107,976 118,638 129,843 Deferred policy acquisition costs..................................... 85,883 75,071 66,866 Other assets.......................................................... 104,943 76,759 75,576 Variable annuity assets............................................... 959,760 684,836 487,543 ------------ ------------ ------------ Total assets.................................................. $ 4,131,912 $ 3,861,026 $ 3,662,254 ------------ ------------ ------------ ------------ ------------ ------------ LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY Policy liabilities Fixed annuity contract liabilities................................ $ 1,245,459 $ 1,286,110 $ 1,275,117 Interest-sensitive life contract liabilities...................... 364,205 326,955 289,310 Unpaid claims and claim expenses.................................. 322,335 357,646 384,657 Future policy benefits............................................ 179,562 183,543 185,856 Unearned premiums................................................. 166,996 155,776 141,105 ------------ ------------ ------------ Total policy liabilities...................................... 2,278,557 2,310,030 2,276,045 Other policyholder funds.............................................. 122,107 118,549 119,070 Other liabilities..................................................... 126,847 129,075 133,855 Short-term debt....................................................... 42,000 34,000 75,000 Long-term debt........................................................ 99,599 99,564 100,000 Variable annuity liabilities.......................................... 956,253 684,836 487,543 ------------ ------------ ------------ Total liabilities............................................. 3,625,363 3,376,054 3,191,513 ------------ ------------ ------------ Warrants, subject to redemption....................................... 577 577 577 ------------ ------------ ------------ Preferred stock, $0.001 par value, authorized 1,000,000 shares; none issued.............................................................. - - - Common stock, $0.001 par value, authorized 75,000,000 shares; issued, 1997, 59,161,008; 1996, 58,426,796; 1995, 57,954,858................ 59 58 58 Additional paid-in capital............................................ 340,564 330,234 323,891 Net unrealized gains on fixed maturities and equity securities........ 62,167 29,736 76,151 Retained earnings..................................................... 349,274 278,669 224,366 Treasury stock, at cost, 1997,14,896,796 shares; 1996 and 1995, 11,176,196 shares................................................... (246,092) (154,302) (154,302) ------------ ------------ ------------ Total shareholders' equity.................................... 505,972 484,395 470,164 ------------ ------------ ------------ Total liabilities, redeemable securities and shareholders' equity...................................................... $ 4,131,912 $ 3,861,026 $ 3,662,254 ------------ ------------ ------------ ------------ ------------ ------------
See accompanying notes to consolidated financial statements. F-16 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Insurance premiums written and contract deposits...................... $ 771,319 $ 704,832 $ 653,970 ------------ ------------ ------------ ------------ ------------ ------------ Revenues Insurance premiums and contract charges earned.................... $ 542,712 $ 502,699 $ 485,444 Net investment income............................................. 198,928 198,607 198,370 Realized investment gains......................................... 5,340 2,451 8,604 ------------ ------------ ------------ Total revenues............................................ 746,980 703,757 692,418 ------------ ------------ ------------ Benefits, losses and expenses Benefits, claims and settlement expenses.......................... 359,441 346,691 335,705 Interest credited................................................. 97,231 95,322 90,911 Policy acquisition expenses amortized............................. 44,198 41,063 40,018 Operating expenses................................................ 106,398 97,021 97,609 Amortization of intangible assets................................. 10,662 11,205 11,666 Interest expense.................................................. 9,412 10,517 11,589 Debt retirement costs (See note 4)................................ - 1,319 - Additional rights relating to share repurchase (See note 5)....... - - 1,347 ------------ ------------ ------------ Total benefits, losses and expenses....................... 627,342 603,138 588,845 ------------ ------------ ------------ Income from continuing operations before income taxes and discontinued operations.......................................................... 119,638 100,619 103,573 Income tax expense.................................................... 32,581 26,817 28,463 ------------ ------------ ------------ Income from continuing operations..................................... 87,057 73,802 75,110 Discontinued operations (See note 2): Loss from operations, net of applicable income tax benefits of 1996, $2,764; 1995, $647........................................ - (5,280) (1,184) Loss on discontinuation, representing provision of 1997, $5,355; 1996, $5,974 for operating losses during phase-out period, net of applicable income tax benefits of 1997, $1,874; 1996, $2,091.......................................................... (3,481) (3,883) - ------------ ------------ ------------ Net income............................................................ $ 83,576 $ 64,639 $ 73,926 ------------ ------------ ------------ ------------ ------------ ------------ Earnings (loss) per share Basic Income from continuing operations............................. $ 1.90 $ 1.57 $ 1.50 Discontinued operations: Loss from operations...................................... - (0.11) (0.02) Loss on discontinuation................................... (0.08) (0.08) - ------------ ------------ ------------ Net income.................................................... $ 1.82 $ 1.38 $ 1.48 ------------ ------------ ------------ ------------ ------------ ------------ Diluted Income from continuing operations............................. $ 1.87 $ 1.55 $ 1.41 Discontinued operations: Loss from operations...................................... - (0.11) (0.02) Loss on discontinuation................................... (0.07) (0.08) - ------------ ------------ ------------ Net income.................................................... $ 1.80 $ 1.36 $ 1.39 ------------ ------------ ------------ ------------ ------------ ------------ Weighted average number of shares and equivalent shares Basic............................................................. 45,825,410 46,957,842 50,077,060 Diluted........................................................... 46,524,532 47,577,788 56,263,210
See accompanying notes to consolidated financial statements. F-17 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Common stock Beginning balance................................................... $ 58 $ 58 $ 58 Options exercised, 1997, 731,924 shares; 1996, 471,938 shares; 1995, 38,400 shares..................................................... 1 - - Conversion of Director Stock Plan units, 1997, 2,288 shares......... - - - ------------ ------------ ------------ Ending balance...................................................... 59 58 58 ------------ ------------ ------------ Additional paid-in capital Beginning balance................................................... 330,234 323,891 323,488 Options exercised and conversion of Director Stock Plan units....... 11,580 6,343 403 Catastrophe-linked equity put option premium........................ (1,250) - - ------------ ------------ ------------ Ending balance...................................................... 340,564 330,234 323,891 ------------ ------------ ------------ Net unrealized gains (losses) on fixed maturities and equity securities Beginning balance................................................... 29,736 76,151 (70,861) Increase (decrease) for the period.................................. 32,431 (46,415) 147,012 ------------ ------------ ------------ Ending balance...................................................... 62,167 29,736 76,151 ------------ ------------ ------------ Retained earnings Beginning balance................................................... 278,669 224,366 159,278 Net income.......................................................... 83,576 64,639 73,926 Cash dividends, 1997, $0.2825 per share; 1996, $0.22 per share; 1995, $0.18 per share............................................. (12,971) (10,336) (8,838) ------------ ------------ ------------ Ending balance...................................................... 349,274 278,669 224,366 ------------ ------------ ------------ Treasury stock, at cost Beginning balance, 11,176,196 shares................................ (154,302) (154,302) - Purchase of 3,720,600 shares in 1997 and 13,000,000 shares in 1995 (See note 5)...................................................... (91,790) - (174,870) Issuance of 1,823,804 shares (See note 5)........................... - - 20,568 ------------ ------------ ------------ Ending balance 1997, 14,896,796 shares; 1996 and 1995, 11,176,196 shares............................................................ (246,092) (154,302) (154,302) ------------ ------------ ------------ Shareholders' equity at end of period................................... $ 505,972 $ 484,395 $ 470,164 ------------ ------------ ------------ ------------ ------------ ------------
See accompanying notes to consolidated financial statements. F-18 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------------------ 1997 1996 1995 -------------- ------------ ------------ Cash flows from operating activities Premiums collected................................................ $ 608,650 $ 575,601 $ 550,596 Policyholder benefits paid........................................ (466,150) (453,687) (414,399) Policy acquisition and other operating expenses paid.............. (173,462) (159,635) (155,336) Federal income taxes paid......................................... (51,889) (10,651) (17,065) Investment income collected....................................... 199,306 200,201 198,415 Interest expense paid............................................. (9,276) (8,653) (11,180) Other............................................................. (2,743) (3,962) 2,313 -------------- ------------ ------------ Net cash provided by operating activities................. 104,436 139,214 153,344 -------------- ------------ ------------ Cash flows from investing activities Fixed maturities Purchases..................................................... (1,044,199) (989,009) (983,067) Sales......................................................... 874,243 720,175 732,501 Maturities.................................................... 241,958 205,380 173,711 Net cash received from (used for) short-term and other investments..................................................... (5,882) 30,728 41,341 -------------- ------------ ------------ Net cash provided by (used in) investing activities....... 66,120 (32,726) (35,514) -------------- ------------ ------------ Cash flows from financing activites Purchase of treasury stock........................................ (91,790) - (174,870) Dividends paid to shareholders.................................... (12,971) (10,336) (8,838) Principal borrowings (payments) on Bank Credit Facility........... 8,000 (41,000) 75,000 Exercise of stock options......................................... 11,581 6,343 403 Catastrophe-linked equity put option premium...................... (1,250) - - Proceeds from issuance of Senior Notes............................ - 98,530 - Retirement of Convertible Notes................................... - (102,890) - Proceeds from issuance of common stock............................ - - 20,568 Annuity contracts, variable and fixed Deposits...................................................... 199,190 166,871 142,885 Maturities and withdrawals.................................... (176,117) (135,212) (121,582) Net transfer to variable annuity assets....................... (121,782) (86,097) (50,358) Net increase in interest-sensitive life account balances.......... 1,232 1,489 2,483 -------------- ------------ ------------ Net cash used in financing activities..................... (183,907) (102,302) (114,309) -------------- ------------ ------------ Net increase (decrease) in cash....................................... (13,351) 4,186 3,521 Cash at beginning of period........................................... 13,704 9,518 5,997 -------------- ------------ ------------ Cash at end of period................................................. $ 353 $ 13,704 $ 9,518 -------------- ------------ ------------ -------------- ------------ ------------
See accompanying notes to consolidated financial statements. F-19 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying consolidated financial statements are prepared on the basis of generally accepted accounting principles ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The consolidated financial statements include the accounts of Horace Mann Educators Corporation and its wholly-owned subsidiaries ("HMEC"; and together with its subsidiaries, the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. The subsidiaries of HMEC sell and underwrite tax-qualified retirement annuities and private passenger automobile, homeowners, and life insurance products, primarily to educators and other employees of public schools and their families. In 1996, the Company discontinued its group medical business. The Company's principal operating subsidiaries are Horace Mann Life Insurance Company, Horace Mann Insurance Company, Teachers Insurance Company and Allegiance Insurance Company. INVESTMENTS The Company invests primarily in fixed maturity investments. These securities are classified as available for sale and carried at market value. The net adjustment for unrealized gains and losses on securities available for sale, carried at market, is recorded as a separate component of shareholders' equity, net of applicable deferred tax asset or liability and the related impact on deferred policy acquisition costs associated with interest-sensitive life and annuity contracts. Short-term and other investments are comprised of mortgage loans, carried at unpaid principal less a valuation allowance for estimated uncollectible amounts; policy loans, carried at unpaid principal balances; short-term fixed interest securities, carried at cost which approximates market value; real estate acquired in the settlement of debt, carried at the lower of cost or market; and equity securities, carried at market. Interest income is recognized as earned. Investment income reflects amortization of premiums and accrual of discounts on an effective-yield basis. Realized gains and losses arising from the sale of securities are determined based upon specific identification of securities sold. DEFERRED POLICY ACQUISITION COSTS Deferred policy acquisition costs net of accumulated amortization were $85,883, $75,071 and $66,866 as of December 31, 1997, 1996 and 1995, respectively. Acquisition costs, consisting of commissions, premium taxes and other costs, which vary with and are primarily related to the production of insurance business, are capitalized and amortized as follows. Capitalized acquisition costs for interest-sensitive life contracts are amortized over 20 years in proportion to estimated gross profits. For other individual life contracts, acquisition costs are amortized in proportion to anticipated premiums over the terms of the insurance policies (10 and 15 years). For F-20 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) investment (annuity) contracts, acquisition costs are amortized in proportion to estimated gross profits over 20 years. For property and casualty policies, acquisition costs are amortized over the terms of the insurance policies (six and twelve months). Deferred policy acquisition costs for interest-sensitive life and investment contracts are adjusted for the impact on estimated future gross profits as if net unrealized investment gains and losses had been realized at the balance sheet date. The impact of this adjustment is included in net unrealized gains and losses within shareholders' equity. Deferred acquisition costs are reviewed for recoverability from future income, including investment income, and costs which are deemed unrecoverable are expensed in the period in which the determination is made. No such costs have been deemed unrecoverable during the periods reported. When the Company was acquired in 1989, deferred acquisition costs were reduced to zero in connection with establishing the value of acquired insurance in force in the application of purchase accounting. PROPERTY AND EQUIPMENT Property and equipment are carried at cost less accumulated depreciation and are included in other assets in the consolidated balance sheets. Depreciation and amortization are calculated on the straight-line method based on the estimated useful lives of the assets.
DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Property and equipment............................................... $ 48,548 $ 44,562 $ 42,203 Less: accumulated depreciation....................................... 23,395 20,956 17,953 --------- --------- --------- Total........................................................ $ 25,153 $ 23,606 $ 24,250 --------- --------- --------- --------- --------- ---------
VALUE OF ACQUIRED INSURANCE IN FORCE AND GOODWILL When the Company was acquired in 1989, intangible assets were recorded in the application of purchase accounting to recognize the value of acquired insurance in force and goodwill. In addition, goodwill of $22,003 was recorded in January 1994 related to the purchase of Allegiance Insurance Company. F-21 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) The value of acquired insurance in force by operating segment and goodwill, net of amortization, were as follows:
DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Value of acquired insurance in force Property and casualty........................................ $ 1,751 $ 2,783 $ 3,815 Life......................................................... 18,804 21,253 23,902 Annuity...................................................... 33,553 39,116 45,022 ----------- ----------- ----------- Subtotal................................................. 54,108 63,152 72,739 Goodwill......................................................... 53,868 55,486 57,104 ----------- ----------- ----------- Total.................................................... $ 107,976 $ 118,638 $ 129,843 ----------- ----------- ----------- ----------- ----------- -----------
The value of acquired insurance in force is being amortized over the following periods utilizing the indicated methods for property and casualty, life and annuity, respectively, as follows: 10 years, double declining balance; 20 years, in proportion to coverage provided; 20 years, in proportion to projected future gross profits at the date of the acquisition of the Company. Goodwill is amortized over 40 years on a straight-line basis. The Company periodically reviews the value of acquired insurance in force and goodwill. Any impairment is recognized in the period in which the determination is made. There have been no adjustments to the carrying value of the value of acquired insurance in force and goodwill. Scheduled amortization of the December 31, 1997 balances of value of acquired insurance in force by segment and goodwill over the next five years is as follows:
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 1998 1999 2000 2001 2002 --------- --------- --------- --------- --------- Scheduled amortization of: Value of acquired insurance in force Property and casualty..................... $ 1,038 $ 713 $ - $ - $ - Life...................................... 2,275 2,120 1,975 1,839 1,726 Annuity................................... 5,274 5,013 4,692 4,220 3,669 --------- --------- --------- --------- --------- Subtotal.............................. 8,587 7,846 6,667 6,059 5,395 Goodwill...................................... 1,618 1,618 1,618 1,618 1,618 --------- --------- --------- --------- --------- Total................................. $ 10,205 $ 9,464 $ 8,285 $ 7,677 $ 7,013 --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
The accumulated amortization of intangibles as of December 31, 1997, 1996 and 1995 was $124,696, $114,034 and $102,829, respectively. F-22 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS 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 the Horace Mann mutual funds. Variable annuity assets were invested in the Horace Mann mutual funds as follows:
DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Horace Mann Growth Fund.......................................... $ 532,086 $ 372,824 $ 248,320 Horace Mann Balanced Fund........................................ 386,247 299,977 227,705 Horace Mann Small Cap Growth Fund................................ 16,321 - - Horace Mann Income Fund.......................................... 9,651 10,857 10,513 Horace Mann Socially Responsible Fund............................ 9,117 - - Horace Mann International Equity Fund............................ 5,137 - - Horace Mann Short-Term Fund...................................... 1,201 1,178 1,005 ----------- ----------- ----------- Total variable annuity assets................................ $ 959,760 $ 684,836 $ 487,543 ----------- ----------- ----------- ----------- ----------- -----------
The investment income, gains and losses of these accounts accrue directly to the policyholders and are not included in the operations of the Company. FUTURE POLICY BENEFITS, INTEREST-SENSITIVE LIFE CONTRACT LIABILITIES AND ANNUITY CONTRACT LIABILITIES Liabilities for future benefits on life and annuity policies are established in amounts adequate to meet the estimated future obligations on policies in force. Liabilities for future policy benefits on certain life insurance policies are computed using the net level premium method and are based upon assumptions as to future investment yield, mortality and withdrawals. As a result of the application of purchase accounting, future policy benefits for direct individual life insurance policies issued through August 29, 1989 were revalued using interest rates of 9% graded to 8% over 10 years. For policies issued from August 30, 1989 through December 31, 1992, future policy benefits are computed using an interest rate of 6.5%. An interest rate of 5.5% is used to compute future policy benefits for policies issued after December 31, 1992. Mortality and withdrawal assumptions for all policies have been based on various actuarial tables which are consistent with the Company's own experience. Liabilities for future benefits on annuity contracts and certain long-duration life insurance contracts are carried at accumulated policyholder values without reduction for potential surrender or withdrawal charges. The liability also includes provisions for the unearned portion of certain policy charges. UNPAID CLAIMS AND CLAIM EXPENSES Liabilities for property and casualty unpaid claims and claim expenses include provisions for payments to be made on reported claims, claims incurred but not reported and associated settlement expenses; are carried at the full value of estimated liabilities; and are not discounted for interest expected to be earned on reserves. Estimated amounts of salvage and subrogation on unpaid property and casualty claims are deducted from the liability for unpaid claims. The process by which liabilities are established for insured events requires reliance upon estimates based on experience and available data. As information develops which varies from experience, provides additional data or, in some cases, augments data which previously were not considered F-23 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) sufficient for use in determining liabilities, adjustments may be required. The effects of these adjustments are charged or credited to income for the period in which the adjustments are made. No unusual adjustments were made in the determination of the liabilities during the periods covered by these financial statements. The Company has no exposure to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses. Management believes that, based on data currently available, it has reasonably estimated the Company's ultimate losses. 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, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Gross reserves, beginning of year................................ $ 340,411 $ 369,653 $ 389,097 Less reinsurance recoverables................................ 34,062 23,764 19,534 ----------- ----------- ----------- Net reserves, beginning of year.................................. 306,349 345,889 369,563 ----------- ----------- ----------- Incurred claims and claims expense: Claims occurring in the current year......................... 365,986 368,648 352,513 Decrease in estimated reserves for claims occurring in prior years(1): Policies written by the Company.......................... (40,252) (56,446) (49,830) Business assumed from state reinsurance facilities....... (4,900) (6,100) (5,800) ----------- ----------- ----------- Total decrease....................................... (45,152) (62,546) (55,630) ----------- ----------- ----------- Total claims and claims expense incurred................. 320,834 306,102 296,883 ----------- ----------- ----------- Claims and claim expense payments for claims occurring during: Current year................................................. 209,294 206,370 179,747 Prior years.................................................. 148,581 139,272 140,810 ----------- ----------- ----------- Claims and claim expense payments........................ 357,875 345,642 320,557 ----------- ----------- ----------- Net reserves, end of period...................................... 269,308 306,349 345,889 Plus reinsurance recoverables................................ 41,324 34,062 23,764 ----------- ----------- ----------- Gross reserves, end of period(2)................................. $ 310,632 $ 340,411 $ 369,653 ----------- ----------- ----------- ----------- ----------- -----------
- --------- (1) Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims and changes in their projected final settlement costs. Favorable reserve development generally occurs as a result of subsequent adjustment of reserves to reflect additional information. (2) Unpaid claims and claims expenses as reported in the consolidated balance sheets also include life, annuity, and group accident and health reserves of $11,703, $17,235 and $15,004 at December 31, 1997, 1996 and 1995, respectively, in addition to property and casualty reserves. F-24 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) INSURANCE PREMIUMS AND CONTRACT CHARGES EARNED Property and casualty insurance premiums are recognized as revenue ratably over the related contract periods in proportion to the risks insured. The unexpired portions of these property and casualty premiums are recorded as unearned premiums, using the monthly pro rata method. Premiums and contract charges for interest-sensitive life and annuity contracts consist of charges for the cost of insurance, policy administration and withdrawals. Premiums for long-term traditional life policies are recognized as revenues when due over the premium-paying period. Annuity and interest- sensitive life contract deposits represent funds deposited by policyholders and are not included in the Company's premiums or contract charges. STOCK BASED COMPENSATION The Company grants stock options to employees. The exercise price of the option is equal to the fair market value of the Company's common stock on the date of grant. The Company accounts for stock option grants in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and accordingly, recognizes no compensation expense for the stock option grants. Alternatively, 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, ------------------------------- 1997 1996(1) 1995 --------- --------- --------- Net income As reported.................... $ 83,576 $ 64,639 $ 73,926 Pro forma(2)................... $ 82,406 $ 64,639 $ 73,840 Basic net income per share As reported.................... $ 1.82 $ 1.38 $ 1.48 Pro forma...................... $ 1.80 $ 1.38 $ 1.47 Diluted net income per share As reported.................... $ 1.80 $ 1.36 $ 1.39 Pro forma...................... $ 1.77 $ 1.36 $ 1.38
- --------- (1) No stock options were granted in 1996 (see also Note 5). (2) The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions for 1997 and 1995, respectively: risk-free interest rates of 5.5% and 5.1%; dividend yield of 1.0% for both years; expected lives of 10 years for both years; and volatility of 15.8% and 15.9%. 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, 1997, 1996 and 1995 include amounts currently F-25 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) payable and deferred income taxes resulting from the cumulative differences in the Company's assets and liabilities, determined on a tax return and financial statement basis. Deferred tax assets and liabilities include provisions for unrealized investment gains and losses with the change for each period included in net unrealized gains and losses in shareholders' equity. EARNINGS PER SHARE The Company has implemented SFAS No. 128 "Earnings Per Share." Basic earnings per share is computed based on the weighted average number of shares outstanding. Diluted earnings per share is based on the weighted average number of shares and common stock equivalents outstanding. The common stock equivalents relate to outstanding warrants, common stock options and Director Stock Plan units, and, prior to their early retirement in February 1996, the convertible notes described in Note 4 were considered potentially dilutive securities for purposes of calculating diluted earnings per share. The computations of income from continuing operations on both basic and diluted bases, including reconciliations of the numerators and denominators, are as follows:
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Basic--assumes no dilution: Income from continuing operations for the period..................... $ 87,057 $ 73,802 $ 75,110 --------- --------- --------- Weighted average number of common shares outstanding during the period............................................................. 45,825 46,958 50,077 --------- --------- --------- Income from continuing operations per share--basic................... $ 1.90 $ 1.57 $ 1.50 --------- --------- --------- --------- --------- --------- Diluted--assumes full dilution: Income from continuing operations for the period..................... $ 87,057 $ 73,802 $ 75,110 Interest expense, net of tax, on convertible notes................. - - 4,016 --------- --------- --------- Adjusted income from continuing operations for the period............ $ 87,057 $ 73,802 $ 79,126 --------- --------- --------- Weighted average number of common shares outstanding during the period............................................................. 45,825 46,958 50,077 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: Warrants......................................................... 251 236 220 Stock options.................................................... 416 378 252 Common stock units related to Deferred Equity Compensation Plan for Directors.................................................. 33 6 - Weighted average number of common equivalent shares to reflect the dilutive effect of convertible notes............................... - - 5,714 --------- --------- --------- Total common and common equivalent shares adjusted to calculate diluted earnings per share......................................... 46,525 47,578 56,263 --------- --------- --------- Income from continuing operations per share--diluted................. $ 1.87 $ 1.55 $ 1.41 --------- --------- --------- --------- --------- ---------
F-26 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) Options to purchase 20,000 shares of common stock at $27.46 per share were outstanding during the last four months of 1997 but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares. The options, which expire on September 10, 2007, were still outstanding at December 31, 1997. 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 1997 presentation. NOTE 2--DISCONTINUED OPERATIONS In December 1996, the Company announced its strategic decision to withdraw from the group medical insurance business over the following two years. During the third quarter of 1997, the Company accelerated the timetable for its withdrawal from the group medical insurance business and had terminated 95% of that business by December 31, 1997. The remaining business will be terminated in 1998. As a result of the acceleration and higher-than-expected claims, net income for the year ended December 31, 1997 included a charge of $3,481 for anticipated additional losses during the remainder of the phase-out period, net of related income tax benefits of $1,874. The Company's results of operations for the year ended December 31, 1996 included an accrual of $3,883 for anticipated losses during the phase-out period net of related income tax recoverable of $2,091. At December 31, 1997, the following were attributable to the discontinued operations: $3,491 of investments, $1,393 of premiums receivable, $1,082 of other assets, principally reinsurance recoverables, $4,063 of policy liabilities and $1,903 of other liabilities, including the provision for operating losses during the phase-out period. NOTE 3--INVESTMENTS NET INVESTMENT INCOME The components of net investment income for the following periods were:
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Fixed maturities................................................. $ 191,777 $ 190,836 $ 183,845 Short-term and other investments................................. 10,967 11,931 18,101 ----------- ----------- ----------- Total investment income...................................... 202,744 202,767 201,946 Less investment expenses......................................... 3,816 4,160 3,576 ----------- ----------- ----------- Net investment income........................................ $ 198,928 $ 198,607 $ 198,370 ----------- ----------- ----------- ----------- ----------- -----------
F-27 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS 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, ------------------------------- 1997 1996 1995 --------- --------- --------- Fixed maturities.......................................................... $ 5,411 $ 1,052 $ 6,961 Short-term and other investments.......................................... (71) 1,399 1,643 --------- --------- --------- Realized investment gains (losses).................................... $ 5,340 $ 2,451 $ 8,604 --------- --------- --------- --------- --------- ---------
FIXED MATURITY SECURITIES The amortized cost, unrealized investment gains and losses, and market values of investments in debt securities as of December 31, 1997, 1996 and 1995 were as follows:
AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ------------ ----------- ----------- ------------ AS OF DECEMBER 31, 1997 U.S. government and agency obligations Mortgage-backed securities......................... $ 521,485 $ 18,061 $ 343 $ 539,203 Other.............................................. 222,797 5,249 44 228,002 Municipal bonds........................................ 228,094 13,777 106 241,765 Foreign government bonds............................... 26,397 1,714 442 27,669 Corporate bonds........................................ 1,243,948 62,333 3,376 1,302,905 Other mortgage-backed securities....................... 292,817 6,624 191 299,250 ------------ ----------- ----------- ------------ Totals........................................... $ 2,535,538 $ 107,758 $ 4,502 $ 2,638,794 ------------ ----------- ----------- ------------ ------------ ----------- ----------- ------------ AS OF DECEMBER 31, 1996 U.S. government and agency obligations Mortgage-backed securities......................... $ 644,197 $ 13,008 $ 3,217 $ 653,988 Other.............................................. 257,498 2,436 431 259,503 Municipal bonds........................................ 221,851 8,660 378 230,133 Foreign government bonds............................... 34,684 1,340 1 36,023 Corporate bonds........................................ 1,163,631 37,510 12,221 1,188,920 Other mortgage-backed securities....................... 287,216 4,600 1,871 289,945 ------------ ----------- ----------- ------------ Totals........................................... $ 2,609,077 $ 67,554 $ 18,119 $ 2,658,512 ------------ ----------- ----------- ------------ ------------ ----------- ----------- ------------ AS OF DECEMBER 31, 1995 U.S. government and agency obligations Mortgage-backed securities......................... $ 659,380 $ 23,205 $ 451 $ 682,134 Other.............................................. 260,314 11,355 181 271,488 Municipal bonds........................................ 218,776 9,766 240 228,302 Foreign government bonds............................... 39,065 3,334 - 42,399 Corporate bonds........................................ 1,105,760 68,946 6,930 1,167,776 Other mortgage-backed securities....................... 243,737 8,760 1,536 250,961 ------------ ----------- ----------- ------------ Totals........................................... $ 2,527,032 $ 125,366 $ 9,338 $ 2,643,060 ------------ ----------- ----------- ------------ ------------ ----------- ----------- ------------
F-28 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 3--INVESTMENTS--(CONTINUED) The Company's investment portfolio includes no derivative financial instruments (futures, forwards, swaps, option contracts or other financial instruments with similar characteristics). MATURITY/SALES OF INVESTMENTS The market value and amortized cost of fixed maturity securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
PERCENT OF TOTAL MARKET MARKET AMORTIZED VALUE VALUE COST ------------- ------------ ------------ Due in 1 year or less........................................ 5.6% $ 148,122 $ 147,500 Due after 1 year through 5 years............................. 24.2 639,868 625,745 Due after 5 years through 10 years........................... 34.8 918,555 882,726 Due after 10 years through 20 years.......................... 19.6 516,053 492,921 Due after 20 years........................................... 15.8 416,196 386,646 ------ ------------ ------------ Total.............................................. 100.0% $ 2,638,794 $ 2,535,538 ------ ------------ ------------ ------ ------------ ------------
Proceeds from sales/maturities of fixed maturities and gross gains and gross losses realized for each year were:
YEAR ENDED DECEMBER 31, ------------------------------------ 1997 1996 1995 ------------ ---------- ---------- Proceeds........................................................ $ 1,116,201 $ 925,555 $ 906,212 Gross gains realized............................................ 13,444 11,378 16,820 Gross losses realized........................................... (8,033) (10,326) (9,859)
UNREALIZED GAINS (LOSSES) ON FIXED MATURITIES Net unrealized gains (losses) are computed as the difference between market and amortized cost for fixed maturities. A summary of the net increase (decrease) in unrealized investment gains (losses) on fixed maturities, less applicable income taxes, is as follows:
YEAR ENDED DECEMBER 31, ----------------------------------- 1997 1996 1995 ---------- ---------- ----------- Unrealized gains (losses) on fixed maturities Beginning of period.......................................... $ 49,435 $ 116,028 $ (110,322) End of period................................................ 103,256 49,435 116,028 ---------- ---------- ----------- Increase (decrease) for the period....................... 53,821 (66,593) 226,350 Income taxes (benefit)........................................... 18,837 (23,308) 79,223 ---------- ---------- ----------- Increase (decrease) in net unrealized gains (losses) on fixed maturities before the valuation impact on deferred policy acquisition costs.............................................. $ 34,984 $ (43,285) $ 147,127 ---------- ---------- ----------- ---------- ---------- -----------
F-29 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 3--INVESTMENTS--(CONTINUED) SECURITIES LENDING Beginning in 1997, the Company entered into a securities lending program whereby fixed income securities are loaned to third parties, primarily major brokerage firms. As of December 31, 1997, fixed maturities with a fair value of $60,388 were loaned. The Company separately maintains a minimum of 100% of the value of the loaned securities as collateral for each loan. INVESTMENT IN ENTITIES EXCEEDING 10% OF SHAREHOLDERS' EQUITY 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, 1997 and 1995. At December 31, 1996, the Company's investment portfolio included $51,972 of fixed maturity securities issued by Ford Motor Company and its affiliates representing 10.7% of shareholders' equity at that date. DEPOSITS At December 31, 1997, securities with a carrying value of $13,111 were on deposit with governmental agencies as required by law in various states in which the insurance subsidiaries of HMEC conduct business. NOTE 4--DEBT AND WARRANTS Indebtedness and scheduled maturities at December 31, 1997, 1996 and 1995 consisted of the following:
EFFECTIVE DECEMBER 31, INTEREST FINAL ------------------------------------- RATES MATURITY 1997 1996 1995 --------- ----------- ----------- ----------- ----------- Short-term debt: Bank Credit Facility.................................... Variable 2001 $ 42,000 $ 34,000 $ 75,000 Long-term debt: 6 5/8% Senior Notes, Face amount less unaccrued discount of $401 and $436, respectively........................ 6.7% 2006 99,599 99,564 - 4%/6 1/2% Convertible Notes, redeemed February 1996..... 5.7% 1999 - - 100,000 ----------- ----------- ----------- Total............................................... $ 141,599 $ 133,564 $ 175,000 ----------- ----------- ----------- ----------- ----------- -----------
ISSUANCE OF 6 5/8% SENIOR NOTES ("SENIOR NOTES") AND REDEMPTION OF CONVERTIBLE NOTES On January 17, 1996, the Company issued $100,000 face amount of Senior Notes at an effective yield of 6.7%, which will mature on January 15, 2006. The net proceeds from the sale of the Senior Notes were used to finance the redemption of the Convertible Notes. Interest on the Senior Notes is payable semi-annually at a rate of 6 5/8%. The Senior Notes are redeemable in whole or in part, at any time, at the Company's option, at a redemption price equal to the greater of (i) 100% of their principal amount and (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted, on a semi-annual basis, at the Treasury yield (as defined in the indenture) plus 15 basis points, together with accrued interest to the date of redemption. F-30 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 4--DEBT AND WARRANTS--(CONTINUED) BANK CREDIT FACILITY The Bank Credit Facility provides for unsecured borrowings of up to $65,000. Interest accrues at varying spreads relative to corporate or eurodollar base rates and is payable monthly or quarterly depending on the applicable base rate (Interbank Offering Rate plus 0.325% at December 31, 1997). The unused portion of the Bank Credit Facility is subject to a variable commitment fee which was 0.125% on an annual basis at December 31, 1997. The commitment for the Bank Credit Facility terminates on December 31, 2001. The Company's obligations under the Bank Credit Facility are unsecured. 4%/6 1/2% CONVERTIBLE NOTES ("CONVERTIBLE NOTES") All of the outstanding Convertible Notes were redeemed on February 6, 1996 at an aggregate cost of $102,890. The early redemption of the Convertible Notes resulted in a charge to 1996 income of $1,319 ($857 net of tax benefits). WARRANTS At December 31, 1997, 1996 and 1995, warrants to purchase 281,250 shares of the Company's common stock at $2.70 per share were outstanding. COVENANTS The Company is in compliance with all of the covenants contained in the Senior Notes indenture and the Bank Credit Facility Agreement. NOTE 5--SHAREHOLDERS' EQUITY AND STOCK OPTIONS COMMON STOCK In December 1997, the Company's common stock was split two-for-one. All share and per share amounts have been restated to reflect this stock split. SHARE REPURCHASE PROGRAMS During 1997, the Company repurchased 3,720,600 shares, 8% of the Company's outstanding shares at December 31, 1996, at an aggregate cost of $91,790 under a $100,000 stock repurchase program announced in February 1997. In January 1998, the Company's Board of Directors authorized an additional repurchase of shares of the Company's common stock up to $100,000. Based on the market price of the Company's common shares at the time, $100,000 represented approximately 8% of the Company's then outstanding shares. Shares of common stock may be purchased from time to time through open market and private purchases, as available. The repurchase of shares is financed through use of cash and, if needed, the Bank Credit Facility. AUTHORIZATION OF PREFERRED STOCK In 1996, the shareholders of HMEC approved authorization of 1,000,000 shares of $0.001 par value preferred stock. The Board of Directors is authorized to (i) direct the issuance of the preferred stock in one or more series, (ii) fix the dividend rate, conversion or exchange rights, redemption price and liquidation preference, of any series of the preferred stock, (iii) fix the number of shares for any series and F-31 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 5--SHAREHOLDERS' EQUITY AND STOCK OPTIONS--(CONTINUED) (iv) increase or decrease the number of shares of any series. No shares of preferred stock were outstanding at December 31, 1997 and 1996. Beginning in 1997, the Company's catastrophe reinsurance program is augmented by a $100,000 equity put that provides an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event losses from catastrophes, individually or in the aggregate during a calendar year, exceed the catastrophe reinsurance program coverage limit. Before tax benefits, the equity put provides a source of capital for up to $154 million of catastrophe losses above the reinsurance coverage limit. Fees related to this equity put option were charged directly to additional paid-in capital. In connection with the equity put described in the preceding paragraph, the Board of Directors has designated a series of preferred stock to be available for use in the put. The Series so designated is Series A Cumulative Convertible Preferred Stock (the "Series A Stock") and 100,000 shares have been assigned to this series. None are currently issued or outstanding. The Series A Stock is dividend paying, at a floating rate which varies with movements in the London Interbank Offered Rate and with changes in the risk rating of the Series A Stock as determined by Standard & Poor's. The Series A Stock does not require any sinking fund or similar mechanism regarding payment of such dividends. Beginning on the fourth anniversary of the issuance of Series A Stock, the holders thereof have the right to demand conversion of the Series A Stock into common stock of the Company at a conversion rate based on then prevailing market prices for the common stock; however, upon receipt of a conversion demand, the Company has the right to redeem the Series A Stock prior to such conversion. The Series A Stock has liquidation rights which place the Series A Stock ahead of the common stock in priority. The Series A Stock has no voting rights other than the requirement that the Series A Stock approve any changes in the Series A Stock, the creation of any other class of stock on a par with or superior to the Series A Stock and certain extraordinary transactions such as certain mergers involving the Company. DIRECTOR STOCK PLAN In 1996, the shareholders of HMEC approved the Deferred Equity Compensation Plan ("Director Stock Plan") for directors of the Company and reserved 600,000 shares, including the effect of the 1997 two-for-one stock split, 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, 1997 and 1996, 32,685 units and 18,393 units, respectively, were outstanding under this plan representing an equal number of common shares to be issued in the future. 1995 PURCHASE OF THE COMPANY'S COMMON STOCK On May 3, 1995, the Company repurchased 13.0 million shares of common stock. The shares were purchased at a price of $169,000, before a contingent payment and expenses of the transaction. The Company borrowed $140,000 of the purchase price under its existing Bank Credit Facility and the balance was paid from cash on hand. In July 1995, the Company sold 1,823,804 shares in a secondary public offering, the $20,568 net proceeds of which were used to reduce borrowings under the Bank Credit Facility. F-32 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 5--SHAREHOLDERS' EQUITY AND STOCK OPTIONS--(CONTINUED) STOCK OPTIONS In 1991, HMEC adopted and the shareholders approved the 1991 Stock Incentive Plan (the "1991 Plan") and reserved 4 million shares, including the effect of the 1997 two-for-one stock split, of common stock for issuance under the 1991 Plan. Under the 1991 Plan, options to purchase shares of HMEC common stock may be granted to executive officers, other employees and certain directors. The options are exercisable in installments beginning in the first year from the date of grant and expiring 10 years from the date of grant. Changes in outstanding options and shares available for grant were as follows:
OPTIONS WEIGHTED AVERAGE RANGE OF --------------------------------------- OPTION PRICE OPTION PRICES VESTED AND AVAILABLE PER SHARE PER SHARE OUTSTANDING EXERCISABLE FOR GRANT ------------------ ---------------- ------------ ------------ ----------- At December 31, 1994............. $ 11.20 $ 9.00-$15.15 2,276,444 1,861,444 1,698,000 ------------ ------------ ----------- Granted...................... $ 11.12 40,000 10,000 (40,000) Vested....................... $ 11.69-$15.15 - 208,750 - Exercised.................... $ 9.00 (38,400) (38,400) - ------------ ------------ ----------- At December 31, 1995............. $ 11.24 $ 9.00-$15.15 2,278,044 2,041,794 1,658,000 ------------ ------------ ----------- Vested....................... $ 11.12-$15.15 - 211,250 - Exercised.................... $ 11.04 $ 9.00-$15.15 (471,938) (471,938) - ------------ ------------ ----------- At December 31, 1996............. $ 11.29 $ 9.00-$15.15 1,806,106 1,781,106 1,658,000 ------------ ------------ ----------- Granted...................... $ 22.87 $ 22.42-$27.46 224,400 56,100 (224,400) Vested....................... $ 11.12-$12.03 - 15,000 - Exercised.................... $ 12.28 $ 9.00-$22.42 (731,924) (731,924) - ------------ ------------ ----------- At December 31, 1997............. $ 12.73 $ 9.00-$27.46 1,298,582 1,120,282 1,433,600 ------------ ------------ ----------- ------------ ------------ -----------
As of December 31, 1997, the weighted average life of vested and exercisable options was 5.1 years and the weighted average price of such options was $11.05 per option. The weighted average prices of vested and exercisable options as of December 31, 1996 and 1995 were $11.29 and $10.86, respectively. F-33 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) 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, 1997, 1996 and 1995 were as follows:
DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Current liability (asset)............................................ $ (7,615) $ 27,995 $ 15,174 Deferred liability................................................... 35,530 7,193 32,870
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, 1997, 1996 and 1995 were as follows:
DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Deferred tax assets Discounting of unpaid claims and claims expense tax reserves..... $ 3,087 $ 8,066 $ 13,172 Life insurance future policy benefit reserve revaluation......... 19,282 22,436 16,198 Unearned premium reserve reduction............................... 11,248 10,528 9,521 Postretirement benefits other than pension....................... 8,406 8,003 7,715 Investment valuation reserves.................................... 813 907 924 --------- --------- --------- Total gross deferred tax assets.............................. 42,836 49,940 47,530 --------- --------- --------- Deferred tax liabilities Unrealized gains on securities................................... 33,473 16,010 41,004 Amortization of intangible assets................................ 19,831 20,074 20,508 Deferred policy acquisition costs................................ 24,849 19,982 16,211 Other, net....................................................... 213 1,067 2,677 --------- --------- --------- Total gross deferred tax liabilities......................... 78,366 57,133 80,400 --------- --------- --------- Net deferred tax liability............................... $ 35,530 $ 7,193 $ 32,870 --------- --------- --------- --------- --------- ---------
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, ------------------------------- 1997 1996 1995 --------- --------- --------- Current.............................................................. $ 21,707 $ 27,502 $ 12,982 Deferred............................................................. 10,874 (685) 15,481 --------- --------- --------- Total tax expense before discontinued operations................. $ 32,581 $ 26,817 $ 28,463 --------- --------- --------- --------- --------- ---------
F-34 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 6--INCOME TAXES--(CONTINUED) 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, ------------------------------- 1997 1996 1995 --------- --------- --------- Expected federal tax on income from continuing operations............ $ 41,873 $ 35,217 $ 36,257 Add (deduct) tax effects of: Tax-exempt interest.............................................. (3,310) (3,322) (3,293) Goodwill......................................................... 566 566 566 Cost of additional rights relating to share repurchase........... - - 471 Acquisition related benefits and other, net...................... (6,548) (5,644) (5,538) --------- --------- --------- Income tax expense provided on income from continuing operations..... $ 32,581 $ 26,817 $ 28,463 --------- --------- --------- --------- --------- ---------
NOTE 7--FAIR VALUE OF FINANCIAL INSTRUMENTS Generally accepted accounting principles require that the Company disclose estimated fair values for certain financial instruments. Fair values of the Company's insurance contracts other than annuity contracts are not required to be disclosed. However, the fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk through the matching of investment maturities with amounts due under insurance contracts. The following methods and assumptions were used to estimate the fair value of financial instruments. INVESTMENTS--For fixed maturities and short-term and other investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities, adjusted for differences between the quoted securities and the securities being valued. The fair value of mortgage loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and the same remaining maturities. The fair value of policy loans is based on estimates using discounted cash flow analysis and current interest rates being offered for new loans. The carrying value of real estate is an estimate of fair value based on discounted cash flows from operations. 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-35 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS 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, 1997, 1996 and 1995 consisted of the following:
DECEMBER 31, ---------------------------------------------------------------------- 1997 1996 1995 ---------------------- ---------------------- ---------------------- CARRYING FAIR CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE ---------- ---------- ---------- ---------- ---------- ---------- Financial Assets Investments Fixed maturities............... $2,638,794 $2,638,794 $2,658,512 $2,658,512 $2,643,060 $2,643,060 Short-term and other investments.................. 130,252 130,629 125,824 124,571 155,489 155,646 ---------- ---------- ---------- ---------- ---------- ---------- Total investments........ 2,769,046 2,769,423 2,784,336 2,783,083 2,798,549 2,798,706 Cash............................. 353 353 13,704 13,704 9,518 9,518 Financial Liabilities Policyholder account balances on interest-sensitive life contracts...................... 91,322 84,034 89,987 83,712 88,141 83,362 Annuity contract liabilities..... 1,245,459 1,112,479 1,286,110 1,136,494 1,275,117 1,132,742 Other policyholder funds......... 122,107 122,107 118,549 118,549 119,070 119,070 Short-term debt.................. 42,000 42,000 34,000 34,000 75,000 75,000 Long-term debt................... 99,599 99,580 99,564 96,500 100,000 102,890
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. NOTE 8--STATUTORY SURPLUS AND SUBSIDIARY DIVIDEND RESTRICTIONS The insurance departments of various states in which the insurance subsidiaries of HMEC are domiciled recognize as net income and surplus those amounts determined in conformity with statutory accounting practices prescribed or permitted by the insurance departments, which differ in certain respects from generally accepted accounting principles. F-36 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 8--STATUTORY SURPLUS AND SUBSIDIARY DIVIDEND RESTRICTIONS--(CONTINUED) 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, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Statutory capital and surplus of insurance subsidiaries....... $ 355,357 $ 377,337 $ 361,775 Increase (decrease) due to: Deferred policy acquisition costs......................... 85,883 75,071 66,866 Difference in policyholder reserves....................... 334 (4,054) 12,180 Goodwill.................................................. 53,868 55,486 57,104 Value of acquired insurance in force...................... 54,108 63,152 72,739 Liability for postretirement benefits, other than pensions................................................ (24,574) (22,877) (22,043) Investment market value adjustments on fixed maturities... 103,256 49,435 116,028 Difference in investment reserves......................... 27,994 36,967 37,440 Federal income tax liability.............................. (24,839) (3,599) (51,242) Liability for discontinued operations, net of tax benefits................................................ (2,031) (3,883) - Non-admitted assets and other, net........................ 3,301 4,070 6,379 Shareholders' equity of parent company and non-insurance subsidiaries............................................ 14,914 (9,146) (12,062) Parent company short-term and long-term debt.............. (141,599) (133,564) (175,000) ------------ ------------ ------------ Shareholders' equity as reported herein............... $ 505,972 $ 484,395 $ 470,164 ------------ ------------ ------------ ------------ ------------ ------------
YEAR ENDED DECEMBER 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Statutory net income of insurance subsidiaries................ $ 82,771 $ 72,924 $ 90,981 Net loss of non-insurance companies........................... (1,307) (2,417) (2,473) Interest expense.............................................. (9,412) (10,517) (11,589) Tax benefit of interest expense and other parent company current tax adjustments..................................... 7,565 5,372 3,598 ------------ ------------ ------------ Combined net income........................................... 79,617 65,362 80,517 Increase (decrease) due to: Deferred policy acquisition costs......................... 15,952 11,973 7,771 Policyholder benefits..................................... 2,527 826 2,080 Federal income tax expense (benefit)...................... (6,888) 2,137 (9,131) Amortization of intangible assets......................... (10,662) (11,205) (11,666) Investment reserves....................................... 1,316 366 6,191 Loss on group medical business, net of tax benefits....... 1,849 (3,883) - Other adjustments, net.................................... (135) (937) (1,836) ------------ ------------ ------------ Net income as reported herein......................... $ 83,576 $ 64,639 $ 73,926 ------------ ------------ ------------ ------------ ------------ ------------
F-37 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 8--STATUTORY SURPLUS AND SUBSIDIARY DIVIDEND RESTRICTIONS--(CONTINUED) The Company has principal insurance subsidiaries domiciled in Illinois and California. The statutory financial statements of these subsidiaries are prepared in accordance with accounting practices prescribed or permitted by the Illinois Department of Insurance and the California Department of Insurance as applicable. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. The maximum dividend which may be paid by the insurance subsidiaries to HMEC during 1998 without prior approval is approximately $82 million. The NAIC has adopted risk-based capital guidelines that establish minimum adequate levels of statutory capital and surplus based on risk assumed in investments, reserving policies, and volume and types of insurance business written. State insurance regulations prohibit insurance companies from making any public statements or representations with regard to their risk-based capital levels. Based on current guidelines, the risk-based capital statutory requirements will have no negative regulatory impact on the Company's insurance subsidiaries. NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS All employees of the Company are covered under a defined benefit plan and a defined contribution plan, and certain employees participate in supplemental retirement plans. Benefits under the defined benefit and supplemental retirement plans are based on employees' years of service and compensation for the highest 36 consecutive months of earnings under the plan. Under the defined contribution plan, contributions are made to employees' accounts based on a percentage of compensation that is determined by the employees' years of service. Retirement benefits to employees are paid first from their accumulated accounts under the defined contribution plan with the balance funded by the defined benefit and supplemental retirement plans. The Company's policy with respect to funding the defined benefit plan is to contribute amounts which are actuarially determined to provide the plan with sufficient assets to meet future benefit payments consistent with the funding requirements of federal laws and regulations. Employees of the Company are also eligible to participate in the Supplemental Retirement and Savings Plan, a 401(k) plan, and may generally contribute up to 10% of eligible compensation on a before tax basis. The Company contributes an amount equal to 50% of the first 6% of eligible compensation contributed each month by participating employees. Total pension expense was $8,885, $7,855 and $7,768 for the years ended December 31, 1997, 1996 and 1995, respectively. F-38 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED) DEFINED CONTRIBUTION PLAN Pension benefits under the defined contribution plan were fully funded and investments were set aside in a trust fund. Contributions to employees' accounts under the defined contribution plan, which were expensed in the Company's statements of operations, and total plan assets were as follows:
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Contributions to employees accounts.................................. $ 5,645 $ 5,199 $ 4,859 Total assets at the end of the year.................................. 70,762 62,113 55,050
DEFINED BENEFIT PLAN AND SUPPLEMENTAL RETIREMENT PLANS The following table summarizes 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.
SUPPLEMENTAL DEFINED BENEFIT PLAN RETIREMENT PLANS ------------------------------- ------------------------------- DECEMBER 31, DECEMBER 31, ------------------------------- ------------------------------- 1997 1996 1995 1997 1996 1995 --------- --------- --------- --------- --------- --------- Actuarial present value of benefit obligations Vested benefit obligation......................... $ 34,784 $ 32,941 $ 32,808 $ 5,024 $ 4,351 $ 3,446 Nonvested benefit obligation...................... 2,861 2,916 2,692 324 496 275 --------- --------- --------- --------- --------- --------- Accumulated benefit obligation........................ 37,645 35,857 35,500 5,348 4,847 3,721 Effect of projecting future salary increases on past service.................................... 5,709 3,508 5,086 258 411 1,167 --------- --------- --------- --------- --------- --------- Projected benefit obligation.......................... 43,354 39,365 40,586 5,606 5,258 4,888 Plan assets at market value........................... 46,097 42,262 41,137 - - - --------- --------- --------- --------- --------- --------- Plan assets in excess of (less than) projected benefit obligation.......................................... $ 2,743 $ 2,897 $ 551 $ (5,606) $ (5,258) $ (4,888) --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Assumptions: Discount rate..................................... 7.25% 7.50% 7.00% 7.25% 7.50% 7.00% Expected return on assets......................... 8.75% 8.75% 8.75% 8.75% 8.75% 8.75% Rate of salary increases.......................... 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%
The defined benefit plan is fully funded and investments have been set aside in a trust fund. The supplemental retirement plans are non-qualified, unfunded plans. F-39 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED) Components of net pension cost for the defined benefit plan and supplemental retirement plans for the following periods are:
SUPPLEMENTAL DEFINED BENEFIT PLAN RETIREMENT PLANS ------------------------------- ------------------------------- YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, ------------------------------- ------------------------------- 1997 1996 1995 1997 1996 1995 --------- --------- --------- --------- --------- --------- Service cost-benefits earned during the year........... $ 1,724 $ 1,686 $ 1,447 $ 298 $ 353 $ 274 Interest accrued on projected benefit obligation....... 2,938 2,779 2,715 328 320 324 Actual return on assets................................ (6,370) (3,688) (7,888) - - - Net amortization and deferral.......................... 2,122 (449) 4,368 174 235 197 --------- --------- --------- --------- --------- --------- Net periodic pension cost.......................... $ 414 $ 328 $ 642 $ 800 $ 908 $ 795 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
The pension liabilities of the defined benefit plan and supplemental retirement plans were as follows:
SUPPLEMENTAL DEFINED BENEFIT PLAN RETIREMENT PLANS ------------------------------- ------------------------------- DECEMBER 31, DECEMBER 31, ------------------------------- ------------------------------- 1997 1996 1995 1997 1996 1995 --------- --------- --------- --------- --------- --------- Plan assets in excess of (less than) projected benefit obligation........................................... $ 2,743 $ 2,897 $ 551 $ (5,606) $ (5,258) $ (4,888) Unrecognized prior service (asset) cost................ (5,035) (5,645) (6,255) 2,895 3,209 3,522 Unrecognized net (gain) loss from past experience different from that assumed.......................... 488 1,358 4,642 (1,418) (1,342) (1,159) --------- --------- --------- --------- --------- --------- Pension liability included in the consolidated balance sheets............................................... (1,804) (1,390) (1,062) (4,129) (3,391) (2,525) Additional liability to recognize unfunded accumulated benefit obligation................................... - - - (1,219) (1,474) (1,321) --------- --------- --------- --------- --------- --------- Pension liability...................................... $ (1,804) $ (1,390) $ (1,062) $ (5,348) $ (4,865) $ (3,846) --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS In addition to providing pension benefits, the Company also provides certain health care and life insurance benefits to retired employees and eligible dependents. Employees with ten years of service are eligible to receive these benefits upon retirement. Postretirement benefits other than pensions of active and retired employees are accrued as expense over the employees' service years. 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, F-40 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED) 1997, 1996 and 1995 reconciled with amounts recognized in the Company's statement of financial position:
DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Accumulated postretirement benefit obligation: Retirees......................................................... $ 14,752 $ 12,830 $ 10,534 Fully eligible active plan participants.......................... 2,466 2,049 1,488 Other active plan participants................................... 12,366 10,274 11,028 --------- --------- --------- Total unfunded accumulated postretirement benefit obligation......... 29,584 25,153 23,050 Unrecognized net gain (loss) from past experience different from that assumed............................................................ (5,010) (2,276) (1,007) --------- --------- --------- Accrued postretirement benefit cost.............................. $ 24,574 $ 22,877 $ 22,043 --------- --------- --------- --------- --------- ---------
Components of the cost of postretirement benefits other than pensions for the following periods were:
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Service cost-benefits earned during the year......................... $ 845 $ 801 $ 600 Interest accrued on accumulated benefit obligation................... 2,117 1,845 1,330 --------- --------- --------- Net expense...................................................... $ 2,962 $ 2,646 $ 1,930 --------- --------- --------- --------- --------- ---------
The assumed annual rates of increase in the per capita cost of covered benefits for participants in the plan who retired prior to January 1, 1994 were 6.8%, 7.8% and 8.1% as of December 31, 1997, 1996 and 1995, respectively. For those participants retiring after December 31, 1993, benefits are provided at a level amount of $10.00 per month per year of employment. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.25%, 7.50% and 7.00% at December 31, 1997, 1996 and 1995, respectively. A one percentage point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation at December 31, 1997 by approximately $2,038 and the sum of the service and interest cost components of the net periodic postretirement expense for the year ended December 31, 1997 would increase by approximately $198. 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 F-41 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 10--REINSURANCE--(CONTINUED) frequency and severity of catastrophes are inherently unpredictable. The financial impact from catastrophic losses results from both the total amount of insured exposure in the area affected by the catastrophe as well as the severity of the event. The Company seeks to reduce its exposure to catastrophe losses through the geographic diversification of its insurance coverage, the purchase of catastrophe reinsurance, and the purchase of a catastrophe-linked equity put option (also see Note 5). The total amounts of reinsurance recoverable on unpaid claims classified as assets and reported in other assets in the balance sheets were as follows:
DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Reinsurance Recoverables on Unpaid Claims Life and health.................................................. $ 3,326 $ 2,863 $ 1,369 Property and casualty State insurance facilities................................... 25,968 24,445 19,903 Other insurance companies.................................... 15,356 9,617 3,861 --------- --------- --------- Total.................................................... $ 44,650 $ 36,925 $ 25,133 --------- --------- --------- --------- --------- ---------
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, 1997 Premiums written............................... $ 775,964 $ 23,535 $ 18,890 $ 771,319 Premiums earned................................ 542,605 22,572 22,679 542,712 Benefits, claims and settlement expenses....... 371,220 34,365 22,586 359,441 YEAR ENDED DECEMBER 31, 1996 Premiums written............................... 699,701 23,214 28,345 704,832 Premiums earned................................ 497,705 23,887 28,881 502,699 Benefits, claims and settlement expenses....... 347,352 32,159 31,498 346,691 YEAR ENDED DECEMBER 31, 1995 Premiums written............................... 647,390 22,656 29,236 653,970 Premiums earned................................ 481,192 20,499 24,751 485,444 Benefits, claims and settlement expenses....... 341,538 27,669 21,836 335,705
There were no losses from uncollectible reinsurance recoverables in the three years ended December 31, 1997. Past due reinsurance recoverables as of December 31, 1997 were not material. F-42 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 11--CONTINGENCIES LAWSUITS AND LEGAL PROCEEDINGS There are various lawsuits and other legal proceedings against the Company. Management and legal counsel are of the opinion that the ultimate disposition of such litigation will have no material adverse effect on the Company's financial position or results of operations. ASSESSMENTS FOR INSOLVENCIES OF UNAFFILIATED INSURANCE COMPANIES The Company is also contingently liable for possible assessments under regulatory requirements pertaining to potential insolvencies of unaffiliated insurance companies. Liabilities, which are established based upon regulatory guidance, have been insignificant. 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, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Cash flows from operating activities Net income................................................... $ 83,576 $ 64,639 $ 73,926 Adjustments to reconcile net income to net cash provided by operating activities: Realized investment gains................................ (5,340) (2,451) (8,604) Depreciation and amortization............................ 10,605 13,050 15,595 Increase in insurance liabilities........................ 61,837 74,621 79,739 (Increase) decrease in premium receivables............... 4,083 (14,397) (9,651) Increase in deferred policy acquisition costs............ (15,932) (11,973) (7,771) Increase in accrued interest expense..................... 1 1,769 731 (Increase) decrease in reinsurance recoverable........... (2,744) (2,030) 52 Increase (decrease) in federal income tax liabilities.... (24,735) 12,136 10,693 Increase (decrease) in accrued loss on discontinued operations............................................. (2,833) 5,974 - Loss from early retirement of debt....................... - 1,319 - Other.................................................... (4,082) (3,443) (1,366) ----------- ----------- ----------- Total adjustments.................................... 20,860 74,575 79,418 ----------- ----------- ----------- Net cash provided by operating activities............ $ 104,436 $ 139,214 $ 153,344 ----------- ----------- ----------- ----------- ----------- -----------
The Company's early retirement of debt in 1996 resulted in noncash financing benefits of $1,571. F-43 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 13--SEGMENT INFORMATION The Company's operations include the following segments: 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 both fixed and variable tax-qualified annuity products. The life insurance segment includes primarily interest-sensitive life and traditional life products. Summarized financial information for these segments is as follows:
YEAR ENDED DECEMBER 31, ------------------------------------------------------------ 1997 1996 % CHANGE 1995 % CHANGE ---------- ---------- ----------- ---------- ----------- Revenues Property and casualty......................... $ 490,902 $ 459,783 6.8% $ 455,578 0.9% Annuity....................................... 127,926 122,251 4.6% 121,375 0.7% Life.......................................... 127,614 122,667 4.0% 115,932 5.8% Other......................................... 538 (944) (467) ---------- ---------- ---------- Total................................. $ 746,980 $ 703,757 6.1% $ 692,418 1.6% ---------- ---------- ---------- ---------- ---------- ---------- Realized investment gains Property and casualty......................... $ 1,948 $ 201 $ 2,940 Annuity....................................... 2,194 1,584 4,367 Life.......................................... 1,044 666 1,297 Other......................................... 154 - - ---------- ---------- ---------- Total................................. $ 5,340 $ 2,451 $ 8,604 ---------- ---------- ---------- ---------- ---------- ---------- Income (loss) from continuing operations before income taxes, discontinued operations and extraordinary item Property and casualty......................... $ 80,545 $ 70,522 14.2% $ 75,261 -6.3% Annuity....................................... 31,967 26,546 20.4% 27,117 -2.1% Life.......................................... 20,990 19,129 9.7% 17,428 9.8% Interest expense and other.................... (13,864) (15,578) (16,233) ---------- ---------- ---------- Total................................. $ 119,638 $ 100,619 18.9% $ 103,573 -2.9% ---------- ---------- ---------- ---------- ---------- ---------- Amortization of intangible assets Value of acquired insurance in force Property and casualty......................... $ 1,032 $ 1,032 - $ 1,032 - Annuity....................................... 5,563 5,906 -5.8% 6,144 -3.9% Life.......................................... 2,449 2,649 -7.6% 2,872 -7.8% ---------- ---------- ---------- Subtotal.............................. 9,044 9,587 10,048 -4.6% Goodwill........................................ 1,618 1,618 - 1,618 - ---------- ---------- ---------- Total amortization of intangible assets.............................. $ 10,662 $ 11,205 -4.8% $ 11,666 -4.0% ---------- ---------- ---------- ---------- ---------- ---------- Assets Property and casualty......................... $ 657,035 $ 712,419 -7.8% $ 712,979 -0.1% Annuity and Life.............................. 3,338,679 3,011,538 10.9% 2,851,543 5.6% Other......................................... 136,198 137,069 -0.6% 97,732 40.2% ---------- ---------- ---------- Total................................. $4,131,912 $3,861,026 7.0% $3,662,254 5.4% ---------- ---------- ---------- ---------- ---------- ----------
Revenues include insurance premiums and contract charges earned, net investment income and realized investment gains and losses. Total assets are not allocated among the annuity and life segments. Capital expenditures and depreciation expense were not material. F-44 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 14--UNAUDITED INTERIM INFORMATION Summary quarterly financial data is presented below. The per share amounts for all periods have been restated to reflect the Company's two-for-one stock split and adoption of SFAS No. 128 "Earnings Per Share" (also see Note 1).
THREE MONTHS ENDED ------------------------------------------------------ DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, -------------- -------------- --------- ----------- 1997 Insurance premiums written and contract deposits.......... $ 207,485 $ 188,911 $ 195,053 $ 179,870 Total revenues............................................ 192,386 185,934 186,597 182,063 Income from continuing operations......................... 25,284 21,477 20,896 19,400 Discontinued operations, after tax........................ - (3,481) - - Net income................................................ 25,284 17,996 20,896 19,400 Per share information Basic Realized investment gains, after tax.............. $ 0.03 $ 0.03 $ 0.01 $ 0.01 Income from continuing operations................. 0.56 0.48 0.45 0.41 Net income........................................ 0.56 0.40 0.45 0.41 Diluted Realized investment gains, after tax.............. 0.03 0.02 0.01 0.01 Income from continuing operations................. 0.56 0.46 0.45 0.40 Net income........................................ 0.56 0.39 0.45 0.40 1996 Insurance premiums written and contract deposits.......... $ 183,938 $ 180,551 $ 176,395 $ 163,948 Total revenues............................................ 180,026 175,475 174,407 173,849 Income from continuing operations......................... 21,387 17,892 18,097 16,426 Discontinued operations, after tax........................ (5,586) (1,568) (1,016) (993) Net income................................................ 15,801 16,324 17,081 15,433 Per share information Basic Realized investment gains (losses), after tax..... $ (0.01) - $ 0.01 $ 0.03 Income from continuing operations................. 0.45 $ 0.38 0.39 0.35 Net income........................................ 0.34 0.35 0.36 0.33 Diluted Realized investment gains (losses), after tax..... - (0.01) 0.01 0.03 Income from continuing operations................. 0.45 0.37 0.38 0.35 Net income........................................ 0.33 0.35 0.36 0.32 1995 Insurance premiums written and contract deposits.......... $ 171,440 $ 163,417 $ 161,869 $ 157,244 Total revenues............................................ 176,540 171,894 174,022 169,962 Income from continuing operations......................... 22,012 19,674 16,238 17,186 Discontinued operations, after tax........................ (589) (517) (8) (70) Net income................................................ 21,423 19,157 16,230 17,116 Per share information Basic Realized investment gains, after tax.............. $ 0.04 $ 0.02 $ 0.06 $ 0.01 Income from continuing operations................. 0.47 0.43 0.33 0.30 Net income........................................ 0.46 0.41 0.33 0.30 Diluted Realized investment gains, after tax.............. 0.03 0.01 0.04 - Income from continuing operations................. 0.43 0.39 0.31 0.28 Net income........................................ 0.42 0.38 0.31 0.28
F-45 SCHEDULE I HORACE MANN EDUCATORS CORPORATION SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1997 (AMOUNTS IN THOUSANDS)
AMOUNT SHOWN MARKET IN BALANCE TYPE OF INVESTMENTS COST(1) VALUE SHEET - -------------------------------------------------------------------- ------------- ------------- ------------- Fixed maturities: U.S. Government and U.S. Government agencies and authorities.... $ 378,572 $ 390,103 $ 390,103 Foreign government bonds........................................ 26,397 27,669 27,669 States, municipalities and political subdivisions............... 594,500 619,566 619,566 Public utilities................................................ 24,723 25,585 25,585 Other corporate bonds........................................... 1,511,346 1,575,871 1,575,871 ------------- ------------- ------------- Total fixed maturity securities............................. 2,535,538 $ 2,638,794 2,638,794 ------------- ------------- Mortgage loans and real estate...................................... 38,131 xxx 38,131 Short-term investments.............................................. 41,017 xxx 41,021 Policy loans and other.............................................. 51,100 xxx 51,100 ------------- ------------- Total investments........................................... $ 2,665,786 xxx $ 2,769,046 ------------- ------------- ------------- -------------
- --------- (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-46 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (PARENT COMPANY ONLY) CONDENSED FINANCIAL INFORMATION BALANCE SHEETS AS OF DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
1997 1996 1995 ------------ ------------ ------------ ASSETS Investments and cash.................................................... $ 19,271 $ 13,339 $ 8,066 Investment in subsidiaries.............................................. 574,009 547,889 581,400 Other assets............................................................ 57,911 71,277 71,380 ------------ ------------ ------------ Total assets.................................................... $ 651,191 $ 632,505 $ 660,846 ------------ ------------ ------------ ------------ ------------ ------------ LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY Mortgage loan payable to subsidiary..................................... $ - $ 10,834 $ 10,951 Short-term debt......................................................... 42,000 34,000 75,000 Long-term debt.......................................................... 99,599 99,564 100,000 Other liabilities....................................................... 3,043 3,135 4,154 ------------ ------------ ------------ Total liabilities............................................... 144,642 147,533 190,105 ------------ ------------ ------------ Warrants, subject to redemption......................................... 577 577 577 ------------ ------------ ------------ Preferred stock, $0.001 par value, authorized 1,000,000 shares; none issued................................................................ - - - Common stock, $0.001 par value, authorized 75,000,000 shares; issued, 1997, 59,161,008; 1996, 58,426,796; 1995, 57,954,858.................. 59 58 58 Additional paid-in capital.............................................. 340,564 330,234 323,891 Net unrealized gains on fixed maturities and equity securities.......... 62,167 29,736 76,151 Retained earnings....................................................... 349,274 278,669 224,366 Treasury stock, at cost, 1997, 14,896,796 shares; 1996 and 1995, 11,176,196 shares..................................................... (246,092) (154,302) (154,302) ------------ ------------ ------------ Total shareholders' equity...................................... 505,972 484,395 470,164 ------------ ------------ ------------ Total liabilities, redeemable securities and shareholders' equity........................................................ $ 651,191 $ 632,505 $ 660,846 ------------ ------------ ------------ ------------ ------------ ------------
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-47 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (PARENT COMPANY ONLY) CONDENSED FINANCIAL INFORMATION STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Revenues Net investment income...................................................... $ 1,487 $ 165 $ 659 Realized investment gains.................................................. 154 - - --------- --------- --------- Total revenues......................................................... 1,641 165 659 --------- --------- --------- Expenses Interest................................................................... 9,412 10,517 11,589 Amortization of goodwill................................................... 1,618 1,618 1,618 Other...................................................................... 541 689 700 Debt retirement costs...................................................... - 1,319 - Cost of additional rights relating to share repurchase..................... - - 1,347 --------- --------- --------- Total expenses......................................................... 11,571 14,143 15,254 --------- --------- --------- Income (loss) from continuing operations before income taxes and equity in net earnings of subsidiaries..................................................... (9,930) (13,978) (14,595) Income tax expense (benefit)................................................... (2,845) (3,862) (3,600) --------- --------- --------- Income (loss) from continuing operations before equity in net earnings of subsidiaries................................................................. (7,085) (10,116) (10,995) Equity in net earnings of subsidiaries......................................... 94,142 83,918 86,105 --------- --------- --------- Income from continuing operations.............................................. 87,057 73,802 75,110 Discontinued operations: Loss from operations, net of applicable income tax benefits of 1996, $2,764; 1995, $647....................................................... - (5,280) (1,184) Loss on discontinuation, representing provision of 1997, $5,355; 1996, $5,974 for operating losses during phase-out period, net of applicable income tax benefits of 1997, $1,874; 1996, $2,091........................ (3,481) (3,883) - --------- --------- --------- Net income..................................................................... $ 83,576 $ 64,639 $ 73,926 --------- --------- --------- --------- --------- ---------
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-48 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (PARENT COMPANY ONLY) CONDENSED FINANCIAL INFORMATION STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31, --------------------------------------- 1997 1996 1995 ----------- ------------ ------------ Cash flows from operating activities Interest expense paid................................................ $ (9,276) $ (8,653) $ (11,180) Federal income taxes recovered (paid)................................ 1,391 (10,154) 21,509 Cash dividends received from subsidiaries............................ 107,300 72,700 75,471 Other, net........................................................... (7,208) 3,342 324 ----------- ------------ ------------ Net cash provided by operating activities........................ 92,207 57,235 86,124 ----------- ------------ ------------ Cash flows from investing activities Net (increase) decrease in investments............................... (10,102) (4,705) 5,321 Capital expenditures for property and equipment...................... - (2,609) (1,776) ----------- ------------ ------------ Net cash provided by (used in) investing activities.............. (10,102) (7,314) 3,545 ----------- ------------ ------------ Cash flows from financing activities Purchase of treasury stock........................................... (91,790) - (174,870) Dividends paid to shareholders....................................... (12,971) (10,336) (8,838) Principal borrowings (payments) on Bank Credit Facility.............. 8,000 (41,000) 75,000 Exercise of stock options............................................ 11,581 6,343 403 Catastrophe-linked equity put option premium......................... (1,250) - - Proceeds from issuance of Senior Notes............................... - 98,530 - Retirement of Convertible Notes...................................... - (102,890) - Proceeds from issuance of common stock............................... - - 20,568 ----------- ------------ ------------ Net cash used in financing activities............................ (86,430) (49,353) (87,737) ----------- ------------ ------------ Net increase (decrease) in cash.......................................... (4,325) 568 1,932 Cash at beginning of period.............................................. 4,325 3,757 1,825 ----------- ------------ ------------ Cash at end of period.................................................... $ 0 $ 4,325 $ 3,757 ----------- ------------ ------------ ----------- ------------ ------------
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-49 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (PARENT COMPANY ONLY) CONDENSED FINANCIAL INFORMATION NOTE TO CONDENSED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996, AND 1995 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-50 SCHEDULE III & VI (COMBINED) HORACE MANN EDUCATORS CORPORATION SUPPLEMENTARY INSURANCE INFORMATION (AMOUNTS IN THOUSANDS)
OTHER DEFERRED FUTURE POLICY DISCOUNT, POLICY PREMIUM POLICY BENEFITS, IF ANY, CLAIMS AND REVENUE/ ACQUISITION CLAIMS AND DEDUCTED IN UNEARNED BENEFITS PREMIUM SEGMENT COSTS CLAIMS EXPENSES PREVIOUS COLUMN PREMIUMS PAYABLE EARNED - --------------------------------------- ----------- ---------------- --------------- ----------- ----------- ----------- YEAR ENDED DECEMBER 31, 1997 Property and casualty.............. $ 15,230 $ 310,632 $ 0 $ 161,205 $ 305 $ 447,252 Annuity............................ 19,699 1,246,948 xxx - 107,538 12,597 Life............................... 50,954 553,981 xxx 5,791 14,264 82,863 Other.............................. N/A N/A xxx N/A N/A N/A ----------- ---------------- ----------- ----------- ----------- Total.......................... $ 85,883 $ 2,111,561 xxx $ 166,996 $ 122,107 $ 542,712 ----------- ---------------- ----------- ----------- ----------- ----------- ---------------- ----------- ----------- ----------- YEAR ENDED DECEMBER 31, 1996 Property and casualty.............. $ 13,855 $ 340,411 $ 0 $ 150,368 $ 305 $ 413,219 Annuity............................ 14,230 1,287,815 xxx - 102,681 9,191 Life............................... 46,986 526,028 xxx 5,408 15,563 80,289 Other.............................. N/A N/A xxx N/A N/A N/A ----------- ---------------- ----------- ----------- ----------- Total.......................... $ 75,071 $ 2,154,254 xxx $ 155,776 $ 118,549 $ 502,699 ----------- ---------------- ----------- ----------- ----------- ----------- ---------------- ----------- ----------- ----------- YEAR ENDED DECEMBER 31, 1995 Property and casualty.............. $ 12,515 $ 369,653 $ 0 $ 136,441 $ 305 $ 403,796 Annuity............................ 12,497 1,276,227 xxx - 101,943 6,798 Life............................... 41,854 489,060 xxx 4,664 16,822 74,850 Other.............................. N/A N/A xxx N/A N/A N/A ----------- ---------------- ----------- ----------- ----------- Total.......................... $ 66,866 $ 2,134,940 xxx $ 141,105 $ 119,070 $ 485,444 ----------- ---------------- ----------- ----------- ----------- ----------- ---------------- ----------- ----------- ----------- CLAIMS AND CLAIM BENEFITS, ADJUSTMENT EXPENSES AMORTIZATION CLAIMS INCURRED RELATED TO OF DEFERRED PAID CLAIMS NET AND ------------------------ POLICY OTHER AND CLAIM INVESTMENT SETTLEMENT CURRENT ACQUISITION OPERATING ADJUSTMENT SEGMENT INCOME EXPENSES YEAR PRIOR YEARS COSTS EXPENSES EXPENSES - --------------------------------------- ----------- ----------- ----------- ----------- ------------- ----------- ----------- YEAR ENDED DECEMBER 31, 1997 Property and casualty.............. $ 41,702 $ 320,834 $ 365,986 $ (45,152) $ 40,515 $ 49,012 $ 357,875 Annuity............................ 113,135 76,486 xxx xxx 100 19,373 xxx Life............................... 43,707 59,352 xxx xxx 3,583 43,685 xxx Other.............................. 384 N/A xxx xxx N/A 14,402 xxx ----------- ----------- ------------- ----------- Total.......................... $ 198,928 $ 456,672 xxx xxx $ 44,198 $ 126,472 xxx ----------- ----------- ------------- ----------- ----------- ----------- ------------- ----------- YEAR ENDED DECEMBER 31, 1996 Property and casualty.............. $ 46,363 $ 306,102 $ 368,648 $ (62,546) $ 36,652 $ 46,507 $ 345,642 Annuity............................ 111,476 76,762 xxx xxx 1,300 17,643 xxx Life............................... 41,712 59,149 xxx xxx 3,111 41,278 xxx Other.............................. (944) N/A xxx xxx N/A 13,315 xxx ----------- ----------- ------------- ----------- Total.......................... $ 198,607 $ 442,013 xxx xxx $ 41,063 $ 118,743 xxx ----------- ----------- ------------- ----------- ----------- ----------- ------------- ----------- YEAR ENDED DECEMBER 31, 1995 Property and casualty.............. $ 48,842 $ 297,078 $ 352,513 $ (55,630) $ 36,405 $ 46,834 $ 320,557 Annuity............................ 110,210 74,424 xxx xxx 71 19,763 xxx Life............................... 39,785 55,114 xxx xxx 3,542 39,848 xxx Other.............................. (467) N/A xxx xxx N/A 14,419 xxx ----------- ----------- ------------- ----------- Total.......................... $ 198,370 $ 426,616 xxx xxx $ 40,018 $ 120,864 xxx ----------- ----------- ------------- ----------- ----------- ----------- ------------- ----------- PREMIUMS SEGMENT WRITTEN - --------------------------------------- ----------- YEAR ENDED DECEMBER 31, 1997 Property and casualty.............. $ 458,088 Annuity............................ xxx Life............................... xxx Other.............................. xxx Total.......................... xxx YEAR ENDED DECEMBER 31, 1996 Property and casualty.............. $ 427,146 Annuity............................ xxx Life............................... xxx Other.............................. xxx Total.......................... xxx YEAR ENDED DECEMBER 31, 1995 Property and casualty.............. $ 405,795 Annuity............................ xxx Life............................... xxx Other.............................. xxx Total.......................... xxx
- ------------- N/A Not applicable. See accompanying Independent Auditors' Report. F-51 SCHEDULE IV HORACE MANN EDUCATORS CORPORATION REINSURANCE (AMOUNTS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F CEDED TO ASSUMED OTHER FROM STATE PERCENTAGE OF GROSS AMOUNT COMPANIES FACILITIES NET AMOUNT ASSUMED -------------- ----------- ----------- -------------- --------------- YEAR ENDED DECEMBER 31, 1997 Life insurance in force.............. $ 11,187,925 $ 310,833 $ - $ 10,877,092 - Premiums Property and casualty............ $ 445,468 $ 20,895 $ 22,679 $ 447,252 5.1% Annuity.......................... 12,597 - - 12,597 - Life............................. 84,540 1,677 - 82,863 - -------------- ----------- ----------- -------------- Total premiums............... $ 542,605 $ 22,572 $ 22,679 $ 542,712 4.2% -------------- ----------- ----------- -------------- -------------- ----------- ----------- -------------- YEAR ENDED DECEMBER 31, 1996 Life insurance in force.............. $ 10,645,393 $ 222,611 $ - $ 10,422,782 - Premiums Property and casualty............ $ 406,778 $ 22,440 $ 28,881 $ 413,219 7.0% Annuity.......................... 9,191 - - 9,191 - Life............................. 81,736 1,447 - 80,289 - -------------- ----------- ----------- -------------- Total premiums............... $ 497,705 $ 23,887 $ 28,881 $ 502,699 5.7% -------------- ----------- ----------- -------------- -------------- ----------- ----------- -------------- YEAR ENDED DECEMBER 31, 1995 Life insurance in force.............. $ 10,234,655 $ 174,002 $ - $ 10,060,653 - Premiums Property and casualty............ $ 398,639 $ 19,594 $ 24,751 $ 403,796 6.1% Annuity.......................... 6,798 - - 6,798 - Life............................. 75,755 905 - 74,850 - -------------- ----------- ----------- -------------- Total premiums............... $ 481,192 $ 20,499 $ 24,751 $ 485,444 5.1% -------------- ----------- ----------- -------------- -------------- ----------- ----------- --------------
- --------- NOTE: Premiums above include insurance premiums earned and contract charges earned. See accompanying Independent Auditors' Report. F-52 [LOGO] WWW.HORACEMANN.COM HA-C00313 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- HORACE MANN EDUCATORS CORPORATION EXHIBITS To FORM 10-K For the Year Ended December 31, 1997 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, 1997. Management contracts and compensatory plans are indicated by an asterisk(*). EXHIBIT INDEX
SEQUENTIAL EXHIBIT PAGE NO. DESCRIPTION NUMBER - ---- ----------- ---------- (3) Articles of incorporation and bylaws: 3.1 Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on October 6, 1989, incorporated by reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission on November 14, 1996. 3.2 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on October 18, 1991, incorporated by reference to Exhibit 3.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission on November 14, 1996. 3.3 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on August 23, 1995, incorporated by reference to Exhibit 3.3 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission on November 14, 1996. 3.4 Certificate of Amendment to Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on September 23, 1996, incorporated by reference to Exhibit 3.4 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission on November 14, 1996. 3.5 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 Securities and Exchange Commission on October 9, 1992. -1- SEQUENTIAL EXHIBIT PAGE NO. DESCRIPTION NUMBER - ---- ----------- ---------- 3.6 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 Securities and Exchange Commission on December 6, 1995. (4) Instruments defining the rights of security holders, including indentures: 4.1 Warrant Agreement dated as of August 29, 1989 (the "Warrant Agreement"), between HMEC (as successor to HME Acquisition Corporation) and Bankers Trust Company, as warrant agent (the "Warrant Agent"), with regard to Warrants to Purchase Common Stock, incorporated by reference to Exhibit 4.6 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989 (the "September 1989 Form 10-Q"). 4.2 Supplemental Warrant Agreement dated as of August 29, 1989 to the Warrant Agreement, between HMEC and the Warrant Agent, incorporated by reference to Exhibit 4.7 to the September 1989 Form 10-Q. 4.3 Form of Warrant (included in Exhibit 4.1). 4.4 Indenture dated as of January 17, 1996, between HMEC and U.S. Trust Company of California, N.A. as trustee, with regard to HMEC's 6 5/8% Senior Notes Due 2006, incorporated by reference to Exhibit 4.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1995, filed with the Securities and Exchange Commission on March 13, 1996. 4.5 Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.4). 4.6 Certificate of Designations for HMEC Series A Cumulative Preferred Stock (included in Exhibit 10.12). -2- SEQUENTIAL EXHIBIT PAGE NO. DESCRIPTION NUMBER - ---- ----------- ---------- (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 Securities and Exchange Commission on March 26, 1997. 10.2* Stock Subscription Agreement among HMEC (as successor to HME Holdings, Inc.), The Fulcrum III Limited Partnership, The Second Fulcrum III Limited Partnership and each of the Management Investors, incorporated by reference to Exhibit 10.17 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1989, filed with the Securities and Exchange Commission 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 Securities and Exchange Commission on November 14, 1996. 10.4* Horace Mann Educators Corporation Deferred Compensation Plan for Employees. 10.5* Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1991, filed with the Securities and Exchange Commission on March 27, 1992. 10.5(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan. 10.5(b)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.6 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1991, filed with the Securities and Exchange Commission on March 27, 1992. -3- SEQUENTIAL EXHIBIT PAGE NO. DESCRIPTION NUMBER - ---- ----------- ---------- 10.5(c)* Amendment to Horace Mann Educators Corporation 1991 Stock Incentive Plan, dated September 11, 1996, incorporated by reference to Exhibit 10.2(c) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the Securities and Exchange Commission on November 14, 1996. 10.6* Severance Agreements between HMEC and certain officers of HMEC, incorporated by reference to Exhibit 10.9 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1993, filed with the Securities and Exchange Commission on March 31, 1994. 10.7* Specimen Continuation of Employment Agreement between HMEC and certain officers, incorporated by reference to Exhibit 10.21(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, filed with the Securities and Exchange Commission on November 14, 1994. 10.7(a)* Schedule of Continuation of Employment Agreements between HMEC and certain officers, incorporated by reference to Exhibit 10.21(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, filed with the Securities and Exchange Commission on November 14, 1994. 10.8* Horace Mann Incentive Compensation Program, incorporated by reference to Exhibit 10.7 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1996, filed with the Securities and Exchange Commission 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 Securities and Exchange Commission 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 Securities and Exchange Commission on August 14, 1997. -4- SEQUENTIAL EXHIBIT PAGE NO. DESCRIPTION NUMBER - ---- ----------- ---------- 10.11* Agreement entered by and between HMEC and Paul J. Kardos as of August 1, 1996, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, filed with the Securities and Exchange Commission on August 13, 1996. 10.12 Catastrophe Equity Securities Issuance 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 Securities and Exchange Commission on March 26, 1997. (11) Statement re computation of per share earnings. (12) Statement regarding computation of ratios. (21) Subsidiaries of HMEC. (23) Consent of KPMG Peat Marwick LLP. (27) Financial Data Schedule.
- 5 - EX-10.4 2 EXHIBIT 10.4 EXHIBIT 10.4 HORACE MANN EDUCATORS CORPORATION DEFERRED COMPENSATION PLAN FOR EMPLOYEES SECTION 1. INTRODUCTION 1.1 ESTABLISHMENT OF PLAN. Horace Mann Educators Corporation, a Delaware corporation (the "Company"), hereby establishes the Horace Mann Educators Corporation Deferred Compensation Plan for Employees (the "Plan") for those employees of the Company who are eligible for the Long Term Incentive Plan Bonus payments (the LTIP Employees). The Plan provides the opportunity for LTIP Employees to defer receipt of all or a part of their Short Term Incentive Plan bonus compensation and/or their Long Term Incentive Plan bonus cash compensation on a pretax basis. 1.2 PURPOSES. The Plan is unfunded and is maintained by the Company primarily for the purpose of providing deferred compensation for a select group of management highly compensated employees. More particularly, the purposes of the Plan are to align the interests of LTIP Employees more closely with the interests of other shareholders of the Company, to encourage the highest level of LTIP Employee performance by providing the LTIP Employees with a direct interest in the Company's attainment of its financial goals and to help attract and retain qualified LTIP Employees. 1.3 EFFECTIVE DATE. This Plan shall be effective December 01, 1997. To the extent an investment or distribution of cash or Stock may be made under the Plan, the Plan is intended to qualify for the exemption from short swing profits liability under Section 16(b) of the Exchange Act, provided by Rule 16b-3 of the Securities and Exchange Commission as now in effect or hereafter amended. SECTION 2. DEFINITIONS 2.1 DEFINITIONS. THE FOLLOWING TERMS SHALL HAVE THE MEANINGS SET FORTH BELOW: (a) "Administrator" means the person designated in Section 3 to administer the Plan. (b) "Annual Bonus Compensation" means the bonus payable under the Company's Short Term Incentive Plan. (c) "Board" means the Board of Directors of the Company. (d) "Change in Control" means either of the events set forth below: (i) any person, as defined in Sections 3(a)(9) and 13(d)(3) of the Exchange Act, becomes the "beneficial owner" (as defined in Rule 13d-3 promulgated pursuant to the Exchange Act), directly or indirectly, of securities of the Company having 25% or more of the voting power in the election of directors of the Company; or (ii) the occurrence within any twelve-month period during the term of the Plan of a change in the Board with the result that the Incumbent Members do not constitute a majority of the Company's Board. 1 (e) "Common Stock Equivalent" means a hypothetical share of Stock which shall have a value on any date equal to the Fair Market Value of one share of Stock on that date. (f) "Deferred Stock Equivalent Account" means the bookkeeping account established by the Company in respect to each LTIP Employee pursuant to Section 5.3 hereof and to which shall be credited the amounts of Annual Bonus Compensation and/or Long Term Bonus Compensation deferred by the LTIP Employee as provided in the Plan and the Common Stock Equivalents into which such deferred compensation are deemed invested pursuant to the Plan. (g) "LTIP Employee" means an employee who is eligible to participate in the Company's Long Term Incentive Plan. (h) "Long Term Compensation" means the bonus payable under the Company's Long Term Incentive Plan. (i) "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time. (j) "Fair Market Value" means as of any applicable date the closing sale price of a share of Stock on the Composite Tape for New York Stock Exchange-Listed Stocks, or, if Stock is not quoted on the Composite Tape, on the New York Stock Exchange, or, if Stock is not listed on such Exchange, on the principal United States securities exchange registered under the Exchange Act on which Stock is listed, or, if Stock is not listed on any such exchange, the last closing bid quotation with respect to a share of Stock immediately preceding the time in question on the National Association of Securities Dealers, Inc. Automated Quotations System or any system then in use (or any other system of reporting or ascertaining quotations then available), or if Stock is not so quoted, the fair market value at the time in question of a share of Stock as determined by the Board in good faith. (k) "Incumbent Members" means the members of the Board on the date immediately preceding the commencement of a twelve-month period, provided that any person becoming a Director during such twelve-month period whose election or nomination for election was approved by a majority of the Directors who, on the date of such election or nomination for election, comprised the Incumbent Members shall be considered one of the Incumbent Members in respect of such twelve-month period. (l) "Internal Revenue Code" means the Internal Revenue Code of 1986, as amended from time to time. (m) "Payment Date" means the dates in the same calendar year in which the Company pays the Annual Bonus Compensation and/or the Long Term Bonus Compensation to LTIP Employees. (n) "Stock" means the $0.001 par value common stock of the Company. 2.2 GENDER AND NUMBER. Except when otherwise indicated by the context, the masculine gender shall also include the feminine gender, and the definitions of any term herein in the singular shall also include the plural. 2 SECTION 3. PLAN ADMINISTRATION The Plan shall be administered by the Human Resources Benefits Officer of the Company. Subject to the limitations of the Plan, the Administrator shall have the sole and complete authority: (i) to impose such limitations, restrictions and conditions as he shall deem appropriate, (ii) to interpret the Plan and to adopt, amend and rescind administrative guidelines and other rules and regulations relating to the Plan and (iii) to make all other determinations and to take all other actions necessary or advisable for the implementation and administration of the Plan. Notwithstanding the foregoing, the Administrator shall have no authority, discretion or power to alter any terms or conditions specified in the Plan. The Administrator's determinations on matters within its authority shall be conclusive and binding upon the Company, the LTIP Employees and all other persons. SECTION 4. STOCK SUBJECT TO THE PLAN 4.1 NUMBER OF SHARES. The Company shall at all times during the term of the Plan retain as authorized and unissued Stock at least the number of shares from time to time required under the provisions of the Plan, or otherwise assure itself of its ability to perform its obligations hereunder. The shares of Stock issuable hereunder shall be authorized and unissued shares or previously issued and outstanding shares of Stock reacquired by the Company. 4.2 ADJUSTMENTS UPON CHANGES IN STOCK. If there shall be any change in the Stock, through merger, consolidation, reorganization, recapitalization, stock dividend, stock split, spinoff, split up, dividend in kind or other change in the corporate structure or distribution to the shareholders, appropriate adjustments shall be made by the Administrator (or if the Company is not the surviving corporation in any such transaction, the board of directors of the surviving corporation) in the aggregate number and kind of shares subject to the Plan and the number and kind of shares which may be issued under the Plan. Appropriate adjustments may also be made by the Administrator in the terms of Common Stock Equivalents under the Plan to reflect such changes and to modify any other terms on an equitable basis as the Administrator in his or her discretion determines. SECTION 5. DEFERRALS AND DISTRIBUTIONS 5.1 DEFERRAL ELECTIONS. An LTIP Employee may elect to defer receipt of all or a specified portion of his Annual Bonus Compensation and/or his Long Term Bonus Compensation. An LTIP Employee may make the elections permitted hereunder by giving written notice to the Company in a form approved by the Administrator. The notice shall include: (i) the percentage of each applicable Annual Bonus Compensation payment to be deferred and the percentage of each applicable Long Term Bonus Compensation payment to be deferred (ii) subject to the limitations of this Section 5, the year(s) in which the applicable distribution is to commence and the form(s) (i.e., lump sum or installments in cash over a stated number of years) of the applicable distribution. Amounts deferred by an LTIP Employee pursuant to this Section 5.1 shall be converted into Common Stock Equivalents in accordance with Section 5.3 on the Payment Date. Annual Bonus Compensation and Long Term Bonus Compensation that share the same Payment Date shall share the same commencement of and manner of distribution. 3 5.2 TIME FOR ELECTING DEFERRAL AND CHANGE IN ELECTION. An election to defer Annual Bonus Compensation and/or Long Term Bonus Compensation shall be made in the first instance within 30 days of the establishment of the Plan, thereafter, prior to the latest to occur of the following: (i) the beginning of the calendar year (or with the respect to the Long Term Incentive Plan, the beginning of the first calendar year in the performance period)for which the Bonus Compensation is to be earned; or (ii) the thirtieth day following the date the LTIP Employee first becomes eligible to participate in the Plan; provided that, an election made on or after the first day of a calendar year shall only apply to Annual Bonus Compensation and Long Term Bonus Compensation amounts payable after the date of the election. An election to defer, once made, is irrevocable except as provided in Section 5.11 hereof. 5.3 DEFERRED STOCK EQUIVALENT ACCOUNTS. A Deferred Stock Equivalent Account shall be established for each LTIP Employee. Annual Bonus Compensation and/or Long Term Bonus Compensation deferred by an LTIP Employee shall be credited to such Account as of the Payment Date, and shall be converted into Common Stock Equivalents based on Fair Market Value as of such date. An LTIP Employee's Deferred Stock Equivalent Account shall also be credited with dividend equivalents and other distributions pursuant to Section 5.4. The Deferred Stock Equivalent Account will be reduced by the amount of any distributions which amount shall be converted into common stock equivalents based on Fair Market Value as of the date of distribution. 5.4 DIVIDEND EQUIVALENTS. Dividends and other distributions with respect to Common Stock Equivalents shall be deemed to have been paid as if such Common Stock Equivalents were actual shares of Stock issued and outstanding on the respective record or distribution dates. Common Stock Equivalents shall be credited to an LTIP Employee's Deferred Stock Equivalent Account in respect of cash dividends and any other securities or property distributed with respect to the Stock in connection with reclassifications, spinoffs and the like on the basis of the value of the dividend or other asset distributed and the Fair Market Value of the Common Stock Equivalents on the record date of the dividend or asset distribution, all at the same time and in the same amount as dividends or other distributions are paid or distributed with respect to the Stock. Fractional shares shall be credited to the LTIP Employee's Deferred Stock Equivalent Account cumulatively, but the balance of shares of Common Stock Equivalents in a LTIP Employee's Deferred Stock Equivalent Account shall be rounded to the next highest whole share for any distribution to such LTIP Employee pursuant to this Section 5. 5.5 STATEMENT OF ACCOUNTS. A statement as to the balance of his or her Deferred Stock Equivalent Account will be sent to each LTIP Employee at least once each calendar year. 5.6 PAYMENT OF ACCOUNTS. Subject to this Section 5, as soon as practicable, an LTIP Employee shall receive a distribution of his Deferred Stock Equivalent Account as directed by the LTIP Employee in the applicable election deferral notice. Either a lump sum of cash or HMEC stock or the first of a stated number of equal annual cash installments shall be paid in the year selected for distribution. Succeeding cash installments (if any) shall be paid on July 01 of each calendar year following the calendar year in which the first payment was made. Such distribution shall consist of cash or one share of Stock for each Common Stock Equivalent credited to such LTIP Employee's Deferred Stock Equivalent Account. In the event a distribution occurs after a cash dividend record date but before its dividend payment date, the Deferred Stock Equivalent Account as of the dividend record date will be credited with Common Stock Equivalents equal to the cash dividend. 4 5.7 PAYMENTS FOLLOWING THE TERMINATION OR DEATH OF AN LTIP EMPLOYEE. In the event an LTIP employee dies while employed or terminates employment prior to retirement as defined in the Horace Mann Pension Plan, as amended from time to time, before the balance of his Deferred Stock Equivalent Account is fully paid, payment of the balance of the LTIP Employee's Deferred Stock Equivalent Account shall as soon as practicable be made to the LTIP Employee or his or her beneficiary or beneficiaries, as the case may be, in a lump sum cash distribution. In the event a retired LTIP Employee dies before the balance of his Deferred Stock Equivalent Account is fully paid, payment of the balance of the retired LTIP Employee's Deferred Stock Equivalent Account shall then be made to the retired LTIP Employee's beneficiary or beneficiaries, at such time or times and in such manner as payments were being made to the retired LTIP Employee prior to his death. The Administrator may, in his discretion, take into account the application of any retired LTIP Employee's designated beneficiary and direct that the balance of the retired LTIP Employee's Deferred Stock Equivalent Account be paid to such beneficiary in the manner requested by such application. 5.8 DESIGNATION OF BENEFICIARY. An LTIP Employee shall file with the Administrator a written designation of one or more persons as the beneficiary who shall be entitled to receive the amount, if any, payable hereunder after the LTIP Employee's death. An LTIP Employee may, from time to time, revoke or change his beneficiary designation without the consent of any prior beneficiary by filing a new designation with the Administrator. The last such designation received by the Administrator shall be controlling; provided, however, that no designation, or change or revocation thereof, shall be effective unless received by the Administrator prior to the LTIP Employee's death and in no event shall it be effective as of a date prior to its receipt. If no such beneficiary designation is in effect at the time of the LTIP Employee's death, or if no designated beneficiary survives the LTIP Employee, the LTIP Employee's estate shall be deemed to have been designated his beneficiary and the executor or administrator thereof shall receive the amount, if any, payable hereunder after the LTIP Employee's death. If the Administrator is in doubt as to the right of any person to receive all or part of such amount, the Company may retain such amount until the rights thereto are determined, or the Company may pay such amount into any court of appropriate jurisdiction and such payment shall be a complete discharge of the liability of the Company therefor. 5.9 CHANGE IN CONTROL. Notwithstanding any provision of this Plan to the contrary, in the event of a Change in Control, each LTIP Employee shall receive as directed by the LTIP Employee, within ten (10) days of the date of such Change in Control, a lump sum distribution of his Deferred Stock Equivalent Account in cash or if available, the number of shares of Stock equal to the number of Common Stock Equivalents credited to such LTIP Employee's Deferred Stock Equivalent Account as of the date of the Change in Control. 5.10 EMERGENCY PAYMENTS. In the event of an "unforeseeable emergency" as defined herein, the Administrator may determine the value of the Deferred Stock Equivalent Account and pay all or a part of such amounts in cash without regard to the payment dates otherwise determined pursuant to Sections 5.6 and 5.7, to the extent the Administrator determines that such action is necessary in light of immediate and substantial needs of the LTIP Employee (or his beneficiary) occasioned by severe financial hardship. For the purposes of this Section, an "unforeseeable emergency" is a severe financial hardship to the LTIP Employee resulting from a sudden and unexpected illness or accident of the LTIP Employee or beneficiary, or of a dependent (as defined in Section 152(a) of the Internal Revenue Code) of the LTIP Employee or beneficiary, loss of the LTIP Employee's or beneficiary's property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the LTIP Employee or beneficiary. Payments shall not be made pursuant to this Section to the extent that such hardship is or may be relieved: (a) through reimbursement or compensation by insurance or 5 otherwise, (b) by liquidation of the LTIP Employee's or beneficiary's assets, to the extent the liquidation of such assets would not itself cause severe financial hardship or (c) by cessation of the LTIP Employee's deferrals under the Plan. Such action shall be taken only if the LTIP Employee (or a LTIP Employee's legal representatives or successors) signs an application describing fully the circumstances which are deemed to justify the payment, together with an estimate of the amounts necessary to prevent such hardship, which application shall be approved by the Administrator after making such inquiries as the Administrator deems necessary or appropriate. 5.11 PAYMENT OF TAXABLE AMOUNT. Notwithstanding any other provision of this Section 5 or any payment schedule directed by an LTIP Employee and regardless of whether payments have commenced under this Section 5, in the event that the Internal Revenue Service should finally determine that part or all of the value of a LTIP Employee's Deferred Stock Equivalent Account which has not actually been distributed to the LTIP Employee is nevertheless required to be included in the LTIP Employee's or beneficiary's gross income for federal income tax purposes, then the balance of the Deferred Account or the part thereof that was determined to be includable in gross income shall be distributed (as directed by the LTIP Employee in his most recent election deferral notice) in cash or shares of Stock to the LTIP Employee or beneficiary, as the case may be, in a lump sum as soon as practicable after such determination, without any action or approval by the Administrator. A "final determination" of the Internal Revenue Service for purposes of this Section is a determination in writing by said Service ordering the payment of additional tax, reporting of additional gross income or otherwise requiring Plan amounts to be included in gross income, which is not appealable or which the LTIP Employee or beneficiary does not appeal within the time prescribed for appeals. 5.12 WITHHOLDING The Company, at the time of any deferral or distribution under this Plan, shall withhold benefits otherwise due or payable 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 LTIP Employee under this Plan. SECTION 6. GENERAL CREDITOR STATUS Each participating LTIP Employee and beneficiary designated by a LTIP Employee shall be and remain an unsecured general creditor of the Company with respect to any payments due and owing to such LTIP Employee or beneficiary hereunder. All payments to persons entitled to benefits hereunder shall be made out of the general assets and shall be solely the obligation of the Company. The Plan is a promise by the Company to pay benefits in the future and it is the intention of the Company and participating LTIP Employees that the Plan be "unfunded" for tax purposes (and for the purposes of Title I of the Employee Retirement Income Security Act of 1974 ("ERISA")). SECTION 7. CLAIMS PROCEDURES If a claim for benefits made by any person (the "Applicant") is denied, the Administrator shall furnish to the Applicant, within 90 days after its receipt of such claim (or within 180 days after such receipt if special circumstances require an extension of time), a written notice which: (i) specifies the reasons for the denial, (ii) refers to the pertinent provisions of the Plan on which the denial is based, (iii) describes any additional material or information necessary for the perfection of the claim and explains why such material or information is necessary, and (iv) explains the claim review procedures. Upon the written request of the Applicant submitted within 60 days after receipt of such written notice, the Administrator shall afford the Applicant a full and fair review of the decision denying the claim and, if so requested: (i) permit the Applicant to review any documents which are pertinent to the claim, (ii) permit the Applicant to submit to the Administrator issues and comments in writing and (iii) afford the Applicant an opportunity to meet with the Administrator as a part of the review procedure. Within 60 days after his receipt of a request for review (or within 120 days after such receipt if special circumstances, such as the need to hold a hearing, require an extension of time) the 6 Administrator shall notify the Applicant in writing of his decision and the reasons for his decision and shall refer the Applicant to the provisions of the Plan which form the basis for his decision. SECTION 8. ASSIGNABILITY The right of a LTIP Employee and his beneficiary to receive payments or distributions hereunder shall not be subject in any manner to anticipation, alienation, sale, transfer (other than by will or the laws of descent and distribution), assignment, pledge, encumbrance, attachment, or garnishment by creditors of a participating LTIP Employee or his beneficiary. SECTION 9. PLAN TERMINATION, AMENDMENT AND MODIFICATION The Board may at any time terminate, and from time to time may amend or modify the Plan, provided, however, that no amendment or modification may become effective without approval of the amendment or modification by the shareholders if shareholder approval is required to enable the Plan to satisfy any applicable federal or state statutory or regulatory requirements, and, provided further that no termination, amendment or modification shall reduce the then existing balance of any LTIP Employee's Deferred Stock Equivalent Account or otherwise adversely change the terms and conditions thereof without the LTIP Employee's consent. SECTION 10. GOVERNING LAW/PLAN CONSTRUCTION The Plan and all agreements hereunder shall be construed in accordance with and governed by the laws of the State of Illinois. Nothing in this document shall be construed as an employment agreement or in any way impairing the right of the Company to terminate the employment of an LTIP Employee. 7 EX-10.5A 3 EXHIBIT 10.5A EXHIBIT 10.5(a) HORACE MANN EDUCATORS CORPORATION STOCK OPTION AGREEMENT (1991 Stock Incentive Plan) (EMPLOYEE VERSION) This Stock Option Agreement ("Agreement") is made and entered into as of the Date of Grant indicated below by and between Horace Mann Educators Corporation, a Delaware corporation (the "Company"), and the person named below as Employee. WHEREAS, the Company has offered shares of common stock, par value $.001 per share, of the Company (the "Common Stock") to the public; and WHEREAS, Employee is an employee of the Company and/or one or more of its Affiliates; and WHEREAS, pursuant to the Company's 1991 Employee Stock Incentive Plan (the "Plan"), the committee of the Board of Directors of the Company administering the Plan (the "Committee") has approved the grant to Employee of an option to purchase shares of Common Stock, on the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the foregoing recitals and the covenants set forth herein, the parties hereto hereby agree as follows: 1. GRANT OF OPTION; CERTAIN TERMS AND CONDITIONS. The Company hereby grants to Employee, and Employee hereby accepts, as of the Date of Grant, an option to purchase the number of shares of Common Stock indicated below (the "Option Shares") at the Exercise Price per share indicated below, which option shall expire at 5:00 o'clock p.m. (local time at the Company's principal executive office) on the Expiration Date indicated below and shall be subject to all of the terms and conditions set forth in this Agreement (the "Option"). On the Date of Grant and on each of the first, second, and third anniversaries of the Date of Grant, the Option shall be Vested as to that number of Option Shares (rounded to the nearest whole share) equal to the total number of Option Shares multiplied by the Annual Vesting Rate indicated below. EMPLOYEE: DATE OF GRANT: NUMBER OF OPTION SHARES: EXERCISE PRICE PER OPTION SHARE: EXPIRATION DATE: ANNUAL VESTING RATE: 25% The Option is intended to be an Incentive Stock Option to the extent permitted by Section 422(d) of the Code. That part of the Option which cannot qualify as an Incentive Stock Option shall be a Non-Qualified Stock Option. 2. ACCELERATION AND TERMINATION OF OPTION. (a) TERMINATION BY DEATH. If an Employee incurs a Termination of Employment by reason of death, any Stock Option held by such Employee will become fully Vested on the date of Death and may thereafter be exercised, for a period of one year (or such other period as the Committee may specify) from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (b) TERMINATION BY REASON OF DISABILITY. If an employee incurs a Termination of Employment by reason of Disability, any Stock Option held by such Employee may thereafter be exercised by the Employee, to the extent it was Vested at the time of termination, for a period of one year from the date of such Termination of Employment or until the expiration of the stated term of such Stock Option, whichever period is the shorter; provided, however, that if the Employee dies within such one-year period, any unexercised Stock Option held by such Employee shall, notwithstanding the expiration of such one-year period, continue to be exercisable for a period of 12 months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (c) TERMINATION BY REASON OF RETIREMENT. If an Employee incurs a Termination of Employment by reason of Retirement, any Stock Option held by such Employee will become fully Vested one year after the date of Retirement (First Year Retirement Anniversary Date) and may thereafter be exercised by the Employee, for a period of one year from the date of the First Year Retirement Anniversary Date or until the expiration of the stated term of such Stock Option, whichever period is the shorter. If the Employee dies prior to the First Year Retirement Anniversary Date, any Stock Option held by the Employee shall be fully Vested on the date of death and any unexercised Stock Option shall continue to be exercisable for a period of 12 months from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is the shorter. (d) OTHER TERMINATION. Unless otherwise determined by the Committee, if an Employee incurs a Termination of Employment for any reason other than death, Disability or Retirement, any Stock Option held by such Employee shall thereupon terminate, except that if such Termination of Employment of the Employee is involuntary and without Cause, such Stock Option shall be fully Vested and may be exercised within the lesser of six months from the date of such Termination of Employment or the balance of such Stock Option's term. Notwithstanding the foregoing, if an Employee incurs a Termination of Employment at or after a Change in Control, other than by reason of death, Disability or Retirement, any Stock Option held by such Employee shall be Vested and may be exercised within the lesser of (1) six months and one day from the date of such Termination of Employment, and (2) the balance of such Stock Option's term. 3. ADJUSTMENTS. In the event of any merger, reorganization, consolidation, recapitalization, stock dividend, spin-off, stock split, extraordinary distribution with respect to the Common Stock or other similar change in corporate structure affecting the Common Stock, such substitution or adjustments shall be made in the aggregate number of shares reserved for issuance under the Plan, in the number and option price of shares subject to outstanding Stock Options and Stock Appreciation Rights, and the number of shares subject to other outstanding Awards granted under the Plan as may be determined to be appropriate by the Committee, in its sole discretion; provided, however, that the number of shares subject to any Award shall always be a whole number. 4. EXERCISE. The Option shall be exercisable during Employee's lifetime only by Employee or by his or her guardian or legal representative, and after Employee's death only by the person or entity entitled to do so under Employee's last will and testament or applicable intestate law. The Option may only be exercised by the - 2 - delivery to the Company of a written notice of such exercise, which notice shall specify the number of Option Shares to be purchased (the "Purchased Shares") and the aggregate Exercise Price for such shares (the "Exercise Notice"), together with payment in full of such aggregate Exercise Price in cash or by bank check payable to the Company; provided, however, that payment of such aggregate Exercise Price may instead be made, in whole or in part, by the delivery to the Company of a certificate or certificates representing shares of Common Stock, duly endorsed or accompanied by a duly executed stock powers, which delivery effectively transfers to the Company good and valid title to such shares, free and clear of any pledge, commitment, lien, claim or other encumbrance (such shares to be valued on the basis of the aggregate Fair Market Value thereof on the date of such exercise), provided that the Company is not then prohibited from purchasing or acquiring such shares of Common Stock. Such notice shall also specify the number of Purchased Shares which are acquired pursuant to the exercise of an Incentive Stock Option and pursuant to the exercise of a Non-Qualified Stock Option. In the absence of such designation, Purchased Shares shall be deemed to be acquired first from the exercise of an Incentive Stock Option. 5. PAYMENT OF WITHHOLDING TAXES. If the Company is obligated to withhold an amount on account of any federal, state or local tax imposed as a result of the exercise of the Option, including, without limitation, any federal, state or other income tax, or any F.I.C.A., state disability insurance tax or other employment tax, then Employee shall, concurrently with such exercise, pay such amount to the Company in cash or by check payable to the Company or by reducing the number of shares of Common Stock to be issued and delivered to Employee upon such exercise (such reduction to be valued on the basis of the aggregate Fair Market Value (determined on the date of such exercise) of the additional shares of Common Stock that would otherwise have been issued and delivered upon such exercise), provided that the Company is not then prohibited from purchasing or acquiring such additional shares of Common Stock. 6. STOCK EXCHANGE REQUIREMENTS; APPLICABLE LAWS. All certificates for shares of Common Stock or other securities delivered under this Agreement shall be subject to such stock transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations and other requirements of the Commission, any stock exchange upon which the Common Stock is then listed and any applicable Federal or state securities law, and the Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. 7. NONTRANSFERABILITY. Neither the Option nor any interest therein may be sold, assigned, conveyed, gifted, pledged, hypothecated or otherwise transferred in any manner other than by will or the laws of descent and distribution. 8. PLAN. The Option is granted pursuant to the Plan, as in effect on the Date of Grant, and is subject to all the terms and conditions of the Plan, as the same may be amended from time to time, and the Plan's definitions are hereby incorporated by reference herein; PROVIDED, HOWEVER, that no such amendment shall deprive Employee, without his or her consent, of the Option or of any Employee's rights under this Agreement. The interpretation and construction by the Committee of the Plan, this Agreement, the Option and such rules and regulations as may be adopted by the Committee for the purpose of administering the Plan shall be final and binding upon Employee. Until the Option shall expire, terminate or be exercised in full, the Company shall, upon written request therefor, send a copy of the Plan, in its then-current form, to Employee or any other person or entity then entitled to exercise the Option. 9. STOCKHOLDER RIGHTS. No person or entity shall be entitled to vote, receive dividends or be deemed for any purpose the holder of any Option Shares until the Option shall have been duly exercised to purchase such Option Shares in accordance with the provisions of this Agreement. - 3 - 10. EMPLOYMENT RIGHTS. No provision of this Agreement or of the Option granted hereunder shall (a) confer upon Employee any right to continue in the employ of the Company or any of its subsidiaries, (b) affect the right of the Company and each of its subsidiaries to terminate the employment of Employee, with or without cause, or (c) confer upon Employee any right to participate in any employee welfare or benefit plan or other program of the Company or any of its subsidiaries other than the Plan. 11. GOVERNING LAW. This Agreement and the Option granted hereunder shall be governed by and construed and enforced in accordance with the laws of the State of Delaware. 12. INVESTMENT REPRESENTATION AND AGREEMENT. The Committee may require Employee to furnish to the Company, prior to the issuance of any shares upon the exercise of all or any part of this option, an agreement (in such form as such Committee may specify) in which Employee represents that the shares acquired by him upon exercise are being acquired for investment and not with a view to the sale or distribution thereof. 13. ENTIRE AGREEMENT. This Agreement, together with the Plan, constitutes the entire obligation of the parties hereto with respect to the subject matter hereof and shall supersede any prior expressions of intent or understanding with respect to this transaction. Employee hereby acknowledges receipt of a copy of the Plan. 14. AMENDMENT. Any amendment hereto shall be in writing and signed by the parties hereto. 15. WAIVER; CUMULATIVE RIGHTS. The failure or delay of either party to require performance by the other party of any provision hereof shall not affect its right to require performance of such provision unless and until such performance has been waived in writing. Each and every right hereunder is cumulative and may be exercised in part or in whole from time to time. 16. COUNTERPARTS. This Agreement may be signed in two counterparts. 17. HEADINGS. The headings contained in this Agreement are for reference purposes only and shall not affect the meaning or interpretation of this Agreement. IN WITNESS WHEREOF, the Company and Employee have duly executed this Agreement as of the Date of Grant. HORACE MANN EDUCATORS CORPORATION By: ------------------------------ Name: Paul J. Kardos Title: President and Chief Executive Officer ---------------------------------------- Employee - 4 - EX-11 4 EXHIBIT 11 EXHIBIT 11 HORACE MANN EDUCATORS CORPORATION COMPUTATION OF NET INCOME PER SHARE FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---- ---- ---- Basic - assumes no dilution: Net income for the period $83,576 $64,639 $73,926 ------- ------- ------- Weighted average number of common shares outstanding during the period 45,825 46,958 50,077 ------- ------- ------- Net income per share - basic $ 1.82 $ 1.38 $ 1.48 ------- ------- ------- ------- ------- ------- Diluted - assumes full dilution: Net income for the period $83,576 $64,639 $73,926 Interest expense, net of tax, on convertible notes - - 4,016 ------- ------- ------- Adjusted net income for the period $83,576 $64,639 $77,942 ------- ------- ------- Weighted average number of common shares outstanding during the period 45,825 46,958 50,077 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: Warrants 251 236 220 Stock options 416 378 252 Common stock units related to Deferred Equity Compensation Plan for Directors 33 6 - Weighted average number of common equivalent shares to reflect the dilutive effect of convertible notes - - 5,714 ------- ------- ------- Total common and common equivalent shares adjusted to calculate diluted earnings per share 46,525 47,578 56,263 ------- ------- ------- Net income per share - diluted $ 1.80 $ 1.36 $ 1.39 ------- ------- ------- ------- ------- ------- Percentage of dilution compared to basic net income per share 1.1% 1.4% 6.1%
EX-12 5 EXHIBIT 12 EXHIBIT 12 HORACE MANN EDUCATORS CORPORATION COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, 1995, 1994 AND 1993 (DOLLARS IN MILLIONS)
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ Income from continuing operations before income taxes $119.6 $100.6 $103.6 $86.2 $112.8 Interest expense 9.4 10.5 11.6 9.5 9.1 ------ ------ ------ ------ ------ Earnings $129.0 $111.1 $115.2 $95.7 $121.9 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Fixed charges - interest expense $9.4 $ 10.5 $ 11.6 $ 9.5 $9.1 Ratio of earnings to fixed charges 13.7x 10.6x 9.9x 10.1x 13.4x
EX-21 6 EXHIBIT 21 EXHIBIT 21 HORACE MANN EDUCATORS CORPORATION SIGNIFICANT SUBSIDIARIES AND THEIR RESPECTIVE STATES OF INCORPORATION DECEMBER 31, 1997 Allegiance Insurance Company - California Allegiance Life Insurance Company - Illinois Horace Mann Life Insurance Company - Illinois Horace Mann Insurance Company - Illinois Teachers Insurance Company - Illinois Horace Mann Investors, Inc. - Maryland Horace Mann Service Corporation - Illinois EX-23 7 EXHIBIT 23 EXHIBIT 23 The Board of Directors Horace Mann Educators Corporation: We consent to incorporation by reference in the registration statements (No. 33-47066 and No. 33-45152) on Form S-8 of Horace Mann Educators Corporation and subsidiaries (the Company) of our report dated January 26, 1998, relating to the consolidated balance sheets of the Company as of December 31, 1997, 1996 and 1995, 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, 1997, and all related schedules, which report appears in the December 31, 1997 annual report on Form 10-K of the Company. KPMG Peat Marwick LLP Chicago, Illinois March 30, 1998 EX-27.1 8 EXHIBIT 27.1
7 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AND THE CONSOLIDATED STATEMENT OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS 1,000 YEAR DEC-31-1997 DEC-31-1997 2,638,794 0 0 0 32,107 6,024 2,769,046 353 0 85,883 4,131,912 2,111,561 166,996 0 122,107 141,599 0 0 59 505,913 4,131,912 542,712 198,928 5,340 0 359,441 44,198 106,398 119,638 32,581 87,057 (3,481) 0 0 83,576 1.82 1.80 306,349 365,986 (45,152) 209,294 148,581 269,308 45,152 Refer to the Company's Consolidated Balance Sheet as of December 31, 1997. These balances are net of reinsurance recoverables. See also Note 1 - Significant Accounting Policies of the Company's Consolidated Notes to Financial Statements for December 31, 1997.
EX-27.2 9 EXHIBIT 27.2
7 THE 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-31-1997 SEP-30-1997 2,640,070 0 0 0 34,501 7,664 2,772,152 14,398 0 81,882 4,111,659 2,137,297 162,402 0 120,887 141,590 0 0 59 496,299 4,111,659 402,385 148,979 3,230 0 271,714 33,035 77,090 84,529 22,756 61,773 (3,481) 0 0 58,292 1.26 1.24 0 0 0 0 0 0 0 Refer to the Company's Consolidated Balance Sheet as of September 30, 1997. The SEC does not require this disclosure for interim reporting.
EX-27.3 10 EXHIBIT 27.3
7 THE 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 6-MOS DEC-31-1997 JUN-30-1997 2,643,078 0 0 0 34,827 7,673 2,744,769 8,376 0 81,866 3,968,416 2,163,894 153,984 0 119,091 141,581 0 0 59 466,155 3,968,416 267,307 99,708 1,645 0 181,789 22,098 49,606 55,676 15,380 40,296 0 0 0 40,296 0.86 0.85 0 0 0 0 0 0 0 Refer to the Company's Consolidated Balance Sheet as of June 30, 1997. The SEC does not require this disclosure for interim reporting.
EX-27.4 11 EXHIBIT 27.4
7 THE 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 3-MOS DEC-31-1997 MAR-31-1997 2,614,091 0 0 0 35,109 7,681 2,748,843 5,850 0 82,344 3,859,767 2,157,750 153,887 0 120,281 133,573 0 0 58 467,096 3,859,767 131,419 49,787 857 0 90,500 10,840 24,509 26,670 7,270 19,400 0 0 0 19,400 0.41 0.40 0 0 0 0 0 0 0 Refer to the Company's Consolidated Balance Sheet as of March 31, 1997. The SEC does not require this disclosure for interim reporting.
EX-27.5 12 EXHIBIT 27.5
7 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AND THE CONSOLIDATED STATEMENT OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS 1,000 YEAR DEC-31-1996 DEC-31-1996 2,658,512 0 0 0 35,416 7,592 2,784,336 13,704 0 75,071 3,861,026 2,154,254 155,776 0 118,549 133,564 0 0 58 484,337 3,861,026 502,699 198,607 2,451 0 346,691 41,063 97,021 100,619 26,817 73,802 (9,163) 0 0 64,639 1.38 1.36 345,889 368,648 (62,546) 206,370 139,272 306,349 62,546 Refer to the Company's Consolidated Balance Sheet as of December 31, 1996. These balances are net of reinsurance recoverables. See also Note 1 - Significant Accounting Policies of the Company's Consolidated Notes to Financial Statements for December 31, 1996.
EX-27.6 13 EXHIBIT 27.6
7 THE 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-31-1996 SEP-30-1996 2,614,742 0 0 0 42,894 8,549 2,737,968 12,027 0 75,173 3,746,285 2,151,705 154,489 0 120,516 149,555 0 0 58 450,778 3,746,285 372,486 148,642 2,603 0 261,172 30,236 71,763 71,493 19,078 52,415 (3,577) 0 0 48,838 1.04 1.03 0 0 0 0 0 0 0 Refer to the Company's Consolidated Balance Sheet as of September 30, 1996. The SEC does not require this disclosure for interim reporting.
EX-27.7 14 EXHIBIT 27.7
7 THE 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 6-MOS DEC-31-1996 JUN-30-1996 2,589,559 0 0 0 43,228 10,373 2,709,992 13,712 0 71,796 3,676,497 2,150,964 140,968 0 119,705 157,546 0 0 58 426,941 3,676,497 246,330 99,191 2,735 0 172,150 19,930 48,119 48,267 13,744 34,523 (2,009) 0 0 32,514 0.69 0.68 0 0 0 0 0 0 0 Refer to the Company's Consolidated Balance Sheet as of June 30, 1996. The SEC does not require this disclosure for interim reporting.
EX-27.8 15 EXHIBIT 27.8
7 THE 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 3-MOS DEC-31-1996 MAR-31-1996 2,617,581 0 0 0 43,760 10,218 2,746,206 11,415 0 68,786 3,655,823 2,143,182 139,368 0 120,009 166,538 0 0 58 430,933 3,655,823 121,875 49,920 2,054 0 86,919 9,946 23,459 22,977 6,551 16,426 (993) 0 0 15,433 0.33 0.32 0 0 0 0 0 0 0 Refer to the Company's Consolidated Balance Sheet as of March 31, 1996. The SEC does not require this disclosure for interim reporting.
-----END PRIVACY-ENHANCED MESSAGE-----