-----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, ME+V0BXNqAB+LBoel+no2ijdKDgJI0ko/QIjeS7z8FidOYYdHXyRh67jqjFrhlhL ErmJRfFnwXQ32s0zBktxvw== 0001193125-04-041709.txt : 20040315 0001193125-04-041709.hdr.sgml : 20040315 20040315110406 ACCESSION NUMBER: 0001193125-04-041709 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040315 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HORACE MANN EDUCATORS CORP /DE/ CENTRAL INDEX KEY: 0000850141 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 370911756 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-10890 FILM NUMBER: 04668138 BUSINESS ADDRESS: STREET 1: 1 HORACE MANN PLZ CITY: SPRINGFIELD STATE: IL ZIP: 62715-0001 BUSINESS PHONE: 2177892500 MAIL ADDRESS: STREET 1: 1 HORACE MANN PLZ CITY: SPRINGFIELD STATE: IL ZIP: 62715-0001 FORMER COMPANY: FORMER CONFORMED NAME: HORACE MANN EDUCATORS CORP DATE OF NAME CHANGE: 19920108 10-K 1 d10k.txt FORM 10-K ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 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, including 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. [_] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b - 2 of the Act). Yes [X] No [_] The aggregate market values of the voting Common Stock held by non-affiliates of the registrant based on the closing prices of the Company's Common Stock on the New York Stock Exchange and the shares outstanding on June 30, 2003 and February 27, 2004 were $689.1 million and $646.8 million, respectively. As of February 27, 2004, 42,722,701 shares of Common Stock, par value $0.001 per share, were outstanding, net of 17,503,371 shares of treasury stock. DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the Company's Proxy Statement for the 2004 Annual Meeting of Shareholders are incorporated by reference into Part II Item 5 and Part III Items 10, 11, 12, 13 and 14 of Form 10-K as specified in those Items. ================================================================================ HORACE MANN EDUCATORS CORPORATION FORM 10-K YEAR ENDED DECEMBER 31, 2003 INDEX Part Item Page - ---- ---- ---- I 1. Business...................................................... 1 Forward-looking Information................................... 1 Overview and Available Information............................ 1 History....................................................... 2 Selected Historical Consolidated Financial Data............... 3 Corporate Strategy and Marketing.............................. 4 Property and Casualty Segment................................. 6 Annuity Segment............................................... 12 Life Segment.................................................. 13 Investments................................................... 14 Cash Flow..................................................... 16 Competition................................................... 17 Regulation.................................................... 17 Employees..................................................... 19 2. Properties.................................................... 19 3. Legal Proceedings............................................. 19 4. Submission of Matters to a Vote of Security Holders........... 19 II 5. Market for Registrant's Common Equity and Related Stockholder Matters.................................. 20 6. Selected Financial Data....................................... 20 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................... 20 7A. Quantitative and Qualitative Disclosures About Market Risk.... 20 8. Consolidated Financial Statements and Supplementary Data...... 21 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......................... 21 9A. Controls and Procedures....................................... 21 III 10. Directors and Executive Officers of the Registrant............ 21 11. Executive Compensation........................................ 21 12. Security Ownership of Certain Beneficial Owners and Management................................................... 21 13. Certain Relationships and Related Transactions................ 21 14. Principal Accounting Fees and Services........................ 22 IV 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................................... 22 Signatures......................................................... 27 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 and Available Information Horace Mann Educators Corporation ("HMEC"; and together with its subsidiaries, the "Company" or "Horace Mann") 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 in the United States of America ("U.S."). HMEC's principal insurance subsidiaries are Horace Mann Insurance Company ("HMIC"), Teachers Insurance Company ("TIC") and Horace Mann Life Insurance Company ("HMLIC"), each of which is an Illinois corporation; Horace Mann Property & Casualty Insurance Company ("HMPCIC"), a California domiciled company; and Horace Mann Lloyds ("HM Lloyds"), domiciled in Texas. The Company markets its products primarily to educators and other employees of public schools and their families. The Company's one million customers typically have moderate annual incomes, with many belonging to two-income households. Their financial planning tends to focus on retirement, security, savings and primary insurance needs. Management believes that Horace Mann is the largest national multiline insurance company focused on the nation's educators as its primary market. The Company markets and services its products primarily through an exclusive sales force of full-time agents employed by the Company and trained to sell multiline products. The Company's agents sell Horace Mann's products and limited additional third-party vendor products authorized by the Company. Many of the Company's agents are former educators or individuals with close ties to the educational community who utilize their contacts within, and knowledge of, the target market. Compensation for agents includes an incentive element based upon the profitability of the business they write. This employee agent sales force is supplemented by an independent agent distribution channel for the Company's annuity products. The Company's insurance premiums written and contract deposits for the year ended December 31, 2003 were $955.5 million and net income was $19.0 million. The Company's total assets were $5.0 billion at December 31, 2003. The property and casualty segment, whose primary products are private passenger automobile and homeowners insurance, accounted for 57% of the Company's insurance premiums written and contract deposits for the year ended December 31, 2003; the annuity and life insurance segments together accounted for 43% of insurance premiums written and contract deposits for the year ended December 31, 2003 (31% and 12%, respectively). 1 The Company is one of the largest participants in the 403(b) tax-qualified annuity market, measured by 403(b) net written premium on a statutory accounting basis. The Company's 403(b) tax-qualified annuities are annuities purchased voluntarily by individuals employed by public school systems or other tax-exempt organizations. The Company has approved 403(b) payroll reduction capabilities in approximately one-third of the 15,000 public school districts in the U.S. The Company's investment portfolio had an aggregate fair value of $3.4 billion at December 31, 2003. Investments consist principally of investment grade, publicly traded fixed income securities. The Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available free of charge through the Company's Internet website, www.horacemann.com, as soon as practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission ("SEC"). The EDGAR filings of such reports are also available at the SEC's website, www.sec.gov. History The Company's business was founded in Springfield, Illinois, in 1945 by two Illinois school teachers to sell automobile insurance to other teachers within the State of Illinois. The Company expanded its business to other states and broadened its product line to include life insurance in 1949, 403(b) tax-qualified retirement annuities in 1961 and homeowners insurance in 1965. In November 1991, HMEC completed an initial public offering of its common stock (the "IPO"). The common stock is traded on the New York Stock Exchange under the symbol "HMN." 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 years in the five year period ended December 31, 2003 have been audited by KPMG LLP. The following selected historical consolidated financial data should be read in conjunction with the consolidated financial statements of HMEC and its subsidiaries and Management's Discussion and Analysis of Financial Condition and Results of Operations.
Year Ended December 31, ------------------------------------------------------------------------ 2003 2002 2001 2000 1999 ------------ ------------ ------------ ------------ ------------ Statement of Operations Data: (Dollars in millions, except per share data) Insurance premiums written and contract deposits........................................ $ 955.5 $ 899.3 $ 875.6 $ 821.7 $ 821.2 Insurance premiums and contract charges earned.......................................... 643.5 625.2 615.2 598.7 595.1 Net investment income............................ 184.7 196.0 199.3 192.4 188.3 Realized investment gains (losses)............... 25.5 (49.4) (10.0) (9.9) (8.0) Total revenues................................... 853.7 771.8 804.5 781.2 775.4 Amortization of intangible assets (1)............ 5.0 5.7 5.8 8.8 0.2 Interest expense................................. 6.3 8.5 9.3 10.2 9.7 Income before income taxes....................... 19.2 7.7 28.3 9.7 93.4 Net income (2)................................... 19.0 11.3 25.6 20.8 44.5 Ratio of earnings to fixed charges (3)........... 4.0x 1.9x 4.0x 2.0x 10.6x Per Share Data (4): Net income: Basic......................................... $ 0.44 $ 0.28 $ 0.63 $ 0.51 $ 1.08 Diluted....................................... $ 0.44 $ 0.28 $ 0.63 $ 0.51 $ 1.07 Shares of Common Stock -weighted average: Basic......................................... 42.7 40.9 40.6 40.8 41.2 Diluted....................................... 42.9 41.2 40.9 41.0 41.7 Shares of Common Stock - ending outstanding...... 42.7 42.7 40.7 40.5 41.0 Cash dividends................................... $ 0.42 $ 0.42 $ 0.42 $ 0.42 $ 0.3825 Book value per share (5)......................... $ 12.42 $ 12.39 $ 11.27 $ 10.56 $ 9.75 Balance Sheet Data, at Year End: Total investments................................ $ 3,385.7 $ 3,130.6 $ 2,975.7 $ 2,912.3 $ 2,630.2 Total assets..................................... 4,973.0 4,512.3 4,489.0 4,420.6 4,253.8 Total policy liabilities......................... 2,824.2 2,626.8 2,475.6 2,362.3 2,341.3 Short-term debt.................................. 25.0 -- 53.0 49.0 49.0 Long-term debt................................... 144.7 144.7 99.8 99.7 99.7 Total shareholders' equity....................... 530.5 528.8 459.2 428.0 400.1 Segment Information (6): Insurance premiums written and contract deposits Property and casualty......................... $ 546.5 $ 524.9 $ 519.3 $ 493.5 $ 495.1 Annuity....................................... 296.6 261.5 239.1 206.4 205.7 Life.......................................... 112.4 112.9 117.2 121.8 120.4 Total...................................... 955.5 899.3 875.6 821.7 821.2 Net income Property and casualty......................... $ (17.8) $ 19.9 $ 5.2 $ 8.9 $ 39.5 Annuity....................................... 14.4 17.0 20.6 19.3 27.3 Life.......................................... 13.4 18.9 18.7 12.9 14.6 Corporate and other (2) (7)................... 9.0 (44.5) (18.9) (20.3) (36.9) Total...................................... 19.0 11.3 25.6 20.8 44.5
- ---------- (1) Amortization of intangible assets is comprised of amortization of goodwill and amortization of acquired value of insurance in force and is the result of purchase accounting adjustments related to the 1989 acquisition of the Company and the 1994 acquisition of HMPCIC. Effective January 1, 2002, the Company adopted Financial Accounting Standard ("FAS") No. 142, "Goodwill and Other Intangible Assets." Under FAS No. 142, goodwill amortization ceases and the goodwill is annually tested for impairment. Goodwill amortization was $1.6 million in each of the years ended December 31, 2001, 2000 and 1999. (2) 1999 includes a charge of $20.0 million to record an additional federal income tax provision representing the Company's maximum exposure for disputed prior years' taxes (for tax years 1994 through 1997). 2000 includes a benefit of $8.7 million from resolution of tax years 1994 through 1996. 2001 includes a benefit of $1.3 million from resolution of tax year 1997. (3) For the purpose of determining the ratio of earnings to fixed charges, "earnings" consist of income 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). (4) Basic earnings per share is computed based on the weighted average number of shares outstanding. Diluted earnings per share is computed based on the weighted average number of shares and common stock equivalents outstanding. The Company's common stock equivalents relate to outstanding common stock options, Director Stock Plan units and Employee Stock Plan units and warrants prior to their repurchase in 1999. (5) Due to the adoption by the Company on January 1, 1994 of FAS No. 115, total shareholders' equity included an increase, net of taxes, of $81.6 million, $80.6 million and $26.3 million at December 31, 2003, 2002 and 2001 and a decrease, net of taxes, of $4.0 million and $40.0 million at December 31, 2000 and 1999, respectively. Excluding the FAS 115 fair value accounting for investments, book value per share was $10.51, $10.50, $10.62, $10.66 and $10.73 at December 31, 2003, 2002, 2001, 2000 and 1999, respectively. (6) Information regarding assets by segment at December 31, 2003, 2002 and 2001 is contained in the Company's Notes to Financial Statements listed on page F-1 of this report. (7) The corporate and other segment primarily includes interest expense on debt and the impact of realized investment gains and losses, restructuring charges, debt retirement costs, litigation charges, provision for prior years' taxes and certain public company expenses. 3 Corporate Strategy and Marketing The Horace Mann Value Proposition The Horace Mann Value Proposition articulates the Company's overarching strategy and business purpose: Provide lifelong financial well-being for educators and their families through personalized service, advice, and a full range of tailored insurance and financial products. Target Market Management believes that Horace Mann is the largest national multiline insurance company focused on the nation's educators as its primary market. The Company's target market consists of educators and other employees of public schools and their families located throughout the U.S. The U.S. Department of Education estimates that there are approximately 3.5 million elementary and secondary teachers in public and private schools in the U.S. The Company also markets its products to other education-related customers, including school administrators, education support personnel, private school teachers, community college personnel, and customer referrals. Exclusive Agency Force A cornerstone of the Company's marketing strategy is its exclusive sales force of full-time employee agents trained to sell multiline products. As of December 31, 2003, the Company employed 888 full-time agents, approximately 70% of which are licensed by the NASD to sell variable annuities. Many of the Company's agents were previously teachers, other members of the education profession or persons with close ties to the educational community. The Company's agents are under contract to market only the Company's products and limited additional third-party vendor products authorized by the Company. Collectively, the Company's principal insurance subsidiaries are licensed to write business in 49 states and the District of Columbia. Broadening Distribution Options Management has begun to broaden the Company's distribution options to complement and extend the reach of the Company's agency force. This initiative initially focuses on more fully utilizing its approved payroll deduction slots in school systems across the country which are assigned to Horace Mann. In 2001, the Company began building a network of independent agents who will comprise a second distribution channel for the Company's 403(b) tax-qualified annuity products. In addition to serving educators in areas where the Company does not have agents, the independent agents will complement and extend the annuity capabilities of the Company's agents in under-penetrated areas. As an example of the potential for this initiative, in January 2002 the Company announced that it had been selected as one of four providers of fixed and variable annuity options to Chicago, Illinois public school employees. The Chicago Public Schools is the third-largest school district in the U.S. Beginning in April 2002, the Company is partnering with an independent broker/dealer, which has been providing retirement planning services to Chicago Public School employees for more than two decades, to pursue this opportunity to bolster growth in its annuity business. At December 31, 2003, there were 465 independent agents approved to market the Company's annuity products throughout the U.S. During 2003, collected contract deposits from this distribution channel were approximately $42 million. 4 Geographic Composition of Business The Company's business is geographically diversified. For the year ended December 31, 2003, based on direct insurance premiums earned and contract deposits for all product lines, the top five states and their portion of total premiums were North Carolina, 7.8%; Illinois, 5.9%; Florida, 5.7%; Minnesota, 5.4%; and California, 5.2%. 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 2003: Property and Casualty Segment Top Ten States (Dollars in millions) Property and Casualty Segment --------------------------- Direct Percent Premiums (1) of Total ------------ ------------ State - ------------------------------------------------- North Carolina................................... $ 43.4 8.0% California....................................... 42.2 7.7 Florida.......................................... 39.8 7.3 Minnesota........................................ 39.3 7.2 Texas............................................ 26.5 4.9 Pennsylvania..................................... 23.9 4.4 Michigan......................................... 23.8 4.4 South Carolina................................... 22.1 4.1 Louisiana........................................ 22.0 4.0 Maine............................................ 17.2 3.2 ------------ ------------ Total of top ten states....................... 300.2 55.2 All other areas.................................. 243.8 44.8 ------------ ------------ Total direct premiums......................... $ 544.0 100.0% ============ ============ - ---------- (1) Defined as earned premiums before reinsurance and is determined under statutory accounting principles. 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 2003: Combined Life and Annuity Segments Top Ten States (Dollars in millions) Direct Premiums and Contract Percent Deposits (1) of Total ------------ ------------ State - ------------------------------------------------- Illinois......................................... $ 42.2 10.1% North Carolina................................... 31.4 7.5 Indiana.......................................... 23.0 5.5 Virginia......................................... 22.8 5.5 Texas............................................ 21.9 5.2 Tennessee........................................ 19.3 4.6 Pennsylvania..................................... 16.5 4.0 Florida.......................................... 14.6 3.5 South Carolina................................... 14.4 3.4 Louisiana........................................ 13.9 3.3 ------------ ------------ Total of top ten states....................... 220.0 52.6 All other areas.................................. 198.5 47.4 ------------ ------------ Total direct premiums......................... $ 418.5 100.0% ============ ============ - ---------- (1) Determined under statutory accounting principles. 5 National, State and Local Education Associations The Company has had a long relationship with the National Education Association ("NEA"), the nation's largest confederation of state and local teachers' associations, and many of the state and local education associations affiliated with the NEA. The NEA has approximately 2.7 million members. The Company maintains a special advisory board, primarily composed of leaders of state education associations, that meets with Company management on a regular basis. The NEA and its affiliated state and local associations sponsor various insurance products and services of the Company and its competitors. From 1984 to September 1993 and beginning again in September 1996, the NEA purchased from the Company educator excess professional liability insurance for all of its members. The NEA has entered into a contract to purchase this insurance from the Company through August 2007. Premium from this product represents less than 1% of all insurance premiums written and contract deposits of the Company. Property and Casualty Segment The property and casualty segment represented 57% of the Company's total insurance premiums written and contract deposits. The primary property and casualty product offered by the Company is private passenger automobile insurance, which in 2003 represented 41% of the Company's total insurance premiums written and contract deposits and 73% of property and casualty net written premiums. As of December 31, 2003, the Company had approximately 571,000 voluntary automobile policies in force with annual premiums of approximately $393 million. The Company's automobile business is primarily preferred risk, defined as a household whose drivers have had no recent accidents and no more than one recent moving violation. The Company has instituted a program in a majority of states to provide non-preferred risk automobile coverage to the educator market, with a third-party vendor underwriting such insurance and the Company receiving a commission on its sale. In 2003, homeowners insurance represented 16% of the Company's total insurance premiums written and contract deposits and 27% of property and casualty net written premiums. The Company insures primarily residential homes. As of December 31, 2003, the Company had approximately 279,000 homeowners policies in force with annual premiums of approximately $141 million. As expected, the number of homeowners policies in force decreased in 2003, reflecting initiatives to improve profitability in this product line. Educator excess professional liability insurance represented less than 1% of the Company's 2003 property and casualty premiums. See "Business -- Corporate Strategy and Marketing -- National, State and Local Education Associations." 6 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, ------------------------------------------ 2003 2002 2001 ------------ ------------ ------------ Statement of Operations Data: Insurance premiums written (1)............ $ 546.5 $ 524.9 $ 519.3 Insurance premiums earned (1)............. 533.8 519.6 508.3 Net investment income..................... 31.9 35.2 37.7 Income (loss) before income taxes......... (35.2) 23.8 1.9 Net income (loss)......................... (17.8) 19.9 5.2 Catastrophe costs, pretax................. 33.2 11.9 11.2 GAAP Operating Statistics: Loss and loss adjustment expense ratio.... 88.6% 78.9% 85.2% Expense ratio............................. 23.7% 23.0% 21.6% Combined loss and expense ratio (including policyholder dividends)....... 112.3% 101.9% 106.8% Combined loss and expense ratio before catastrophes (including policyholder dividends)............................... 106.1% 99.6% 104.6% Automobile and Homeowners (Voluntary): Insurance premiums written (1)............ $ 549.2 $ 513.2 $ 496.6 Insurance premiums earned (1)............. 534.8 504.3 485.5 Policies in force (in thousands) (1)...... 850 857 888
- ---------- (1) Effective December 31, 2001, Horace Mann ceased writing automobile insurance policies in Massachusetts. As policies in force on that date expired during the 12 months ended December 31, 2002, the following reductions were recognized in comparison to the year ended December 31, 2001: -$25.5 million insurance premiums written; -$10.8 million insurance premiums earned; -$18.9 million voluntary automobile insurance premiums written; -$8.4 million voluntary automobile insurance premiums earned; and -23 thousand voluntary automobile policies in force. For the year ended December 31, 2002, the following amounts were included in the Company's results and were reduced to zero in 2003: $1.2 million insurance premiums written; $9.9 million voluntary automobile premiums earned; $15.6 million insurance premiums earned. 7 Catastrophe Costs The level of catastrophe costs can fluctuate significantly from year to year. Catastrophe costs before federal income tax benefits for the Company and the property and casualty industry for the ten years ended December 31, 2003 were as follows: Catastrophe Costs (Dollars in millions) Property and The Casualty Company (1) Industry (2) ----------- ------------ Year Ended December 31, 2003........................................ $ 33.2 $ 12,800.0 2002........................................ 11.9 5,900.0 2001........................................ 11.2 28,100.0 2000........................................ 16.2 4,600.0 1999........................................ 19.6 8,300.0 1998........................................ 28.4 10,000.0 1997........................................ 6.2 2,600.0 1996........................................ 20.9 7,300.0 1995........................................ 13.9 8,300.0 1994........................................ 16.2 17,000.0 - ---------- (1) Net of reinsurance and before federal income tax benefits. Includes allocated loss adjustment expenses and reinsurance reinstatement premiums. The Company's individually significant catastrophe losses net of reinsurance were as follows: 2003 - $12.0 million, California wildfires; $9.6 million, May hail, tornadoes and wind; $5.0 million, Hurricane Isabel; $2.7 million early April winter storms. 2002 - $4.2 million, Hurricane Lili; $1.7 million, April Eastern states hail, tornadoes, wind and heavy rain; $1.2 million, Eastern states winter storms. 2001 - $3.7 million, June Midwest wind/hail/tornadoes; $2.3 million April tornadoes; $2.2 million Tropical Storm Allison. 2000 - $5.0 million, May tornadoes; $2.7 million December winter storms. 1999 - $5.4 million, Hurricane Floyd; $3.1 million, May tornadoes primarily in Oklahoma. 1998 - $7.9 million, May Minnesota hailstorm; $2.9 million, May Upper Midwest hailstorm; $2.0 million, June Midwest wind/hail; $1.6 million, Hurricane Georges. 1997 - $1.4 million, July wind/hail/tornadoes; $1.1 million, Denver, Colorado hailstorm. 1996 - $8.2 million, Hurricane Fran. 1995 - $2.9 million, Texas wind/hail/tornadoes; $2.2 million Hurricane Opal. 1994 - $6.0 million, Northridge, California earthquake. (2) Source: Insurance Services Office, Inc. news release dated January 14, 2004. These amounts are net of reinsurance, before federal income tax benefits, and exclude all loss adjustment expenses. Fluctuations from year to year in the level of catastrophe losses impact a property and casualty insurance company's loss and loss adjustment expenses incurred and paid. For comparison purposes, the following table provides amounts for the Company excluding catastrophe losses: Impact of Catastrophe Losses (1) (Dollars in millions) Year Ended December 31, --------------------------- 2003 2002 2001 ------- ------- ------- Claims and claim expense incurred(2).............. $ 472.9 $ 411.7 $ 433.3 Amount attributable to catastrophes............... 33.2 11.9 11.2 ------- ------- ------- Excluding catastrophes(2)...................... $ 439.7 $ 399.8 $ 422.1 ======= ======= ======= Claims and claim expense payments................. $ 424.6 $ 411.1 $ 411.1 Amount attributable to catastrophes............... 21.4 10.6 14.2 ------- ------- ------- Excluding catastrophes......................... $ 403.2 $ 400.5 $ 396.9 ======= ======= ======= - ---------- (1) Net of reinsurance and before federal income tax benefits. Includes allocated loss adjustment expenses. (2) Includes the impact of adverse development of prior years' reserves as quantified in "Property and Casualty Reserves". Property and Casualty Reserves At December 31, 2003, all of the Company's net reserves for unpaid claims and claim expenses were carried at the full value of estimated liabilities and were not discounted for interest expected to be earned on reserves. Due to the nature of the Company's personal lines business, the Company has no exposure to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses other than claims under homeowners insurance policies for environmentally related items such as toxic mold. 8 The following table is a summary reconciliation of the beginning and ending property and casualty insurance claims and claim expense reserves, displayed individually for each of the last three years. The table presents reserves on a net (after reinsurance) basis. The total net property and casualty insurance claims and claim expense amounts are reflected in the Consolidated Statements of Operations listed on page F-1 of this report. The end of the year gross reserve (before reinsurance) balances are reflected in the Consolidated Balance Sheets also listed on page F-1 of this report. Reconciliation of Property and Casualty Claims and Claim Expense Reserves (Dollars In millions) Year Ended December 31, --------------------------- 2003 2002 2001 ------- ------- ------- Gross reserves, beginning of year................. $ 317.3 $ 306.1 $ 298.9 Less reinsurance recoverables.................. 44.7 34.1 49.1 ------- ------- ------- Net reserves, beginning of year................... 272.6 272.0 249.8 ------- ------- ------- Incurred claims and claim expenses: Claims occurring in the current year........... 416.5 387.7 416.8 Increase (decrease) in estimated reserves for claims occurring in prior years (1): Policies written by the Company (2)......... 58.3 22.3 14.5 Business assumed from state reinsurance facilities................................. (1.9) 1.7 2.0 ------- ------- ------- Total increase........................... 56.4 24.0 16.5 ------- ------- ------- Total claims and claim expenses incurred (2) (3).................................... 472.9 411.7 433.3 ------- ------- ------- Claims and claim expense payments for claims occurring during: Current year................................... 240.0 244.3 255.9 Prior years.................................... 184.6 166.8 155.2 ------- ------- ------- Total claims and claim expense payments................................ 424.6 411.1 411.1 ------- ------- ------- Net reserves, end of period....................... 320.9 272.6 272.0 Plus reinsurance recoverables.................. 20.6 44.7 34.1 ------- ------- ------- Gross reserves, end of period (4)................. $ 341.5 $ 317.3 $ 306.1 ======= ======= ======= - ---------- (1) Shows the amounts by which the Company increased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims and changes in their projected final settlement costs. For discussion of the reserve strengthening recorded by the Company in 2002, 2001 and 2000 see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Results of Operations for the Three Years Ended December 31, 2003 -- Benefits, Claims and Settlement Expenses" listed on page F-1 of this report. (2) For the year ended December 31, 2002, these amounts included a $1.6 million statutory accounting charge for class action litigation which was separately reported as Litigation Charges in the Company's Consolidated Statements of Operations. (3) Benefits, claims and settlement expenses as reported in the Consolidated Statements of Operations, listed on page F-1 of this report, also include life, annuity, group accident and health and corporate amounts of $46.1 million, $40.7 million and $42.3 million for the years ended December 31, 2003, 2002 and 2001, respectively, in addition to the property and casualty amounts. (4) Unpaid claims and claim expenses as reported in the Consolidated Balance Sheets, listed on page F-1 of this report, also include life, annuity, and group accident and health reserves of $9.0 million, $9.3 million and $8.2 million at December 31, 2003, 2002 and 2001, respectively, in addition to property and casualty reserves. The claim reserve development table below illustrates the change over time of the net reserves established for property and casualty insurance claims and claim expenses at the end of various calendar years. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to that reserve liability. The third section, reading down, shows retroactive reestimates of the original recorded reserve as of the end of each successive year which is the result of the Company's learning additional facts that pertain to the unsettled claims. The fourth section compares the latest reestimated reserve to the reserve originally established, and indicates whether or not the original reserve was adequate or inadequate to cover the estimated costs of unsettled claims. The table also presents the gross reestimated liability as of the end of the latest reestimation period, with separate disclosure of the related reestimated reinsurance recoverable. The claim reserve development table is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years. 9 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 2002 to be $150 thousand was first reserved in 1993 at $100 thousand, the $50 thousand deficiency (actual claim minus original estimate) would be included in the cumulative deficiency in each of the years 1993 - 2001 shown below. This table presents development data by calendar year and does not relate the data to the year in which the accident actually occurred. Conditions and trends that have affected the development of these reserves in the past will not necessarily recur in the future. It may not be appropriate to use this cumulative history in the projection of future performance. Property and Casualty Claims and Claims Expense Reserve Development (Dollars in millions)
December 31, ------------------------------------------------------------------------------------------------- 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Gross reserves for property and casualty claims and claim expenses.................. $ 373.5 $ 389.1 $ 369.7 $ 340.4 $ 310.6 $ 298.9 $ 299.8 $ 298.9 $ 306.1 $ 317.3 $ 341.5 Deduct: Reinsurance recoverables.................... 21.6 19.5 23.8 34.1 41.3 55.9 64.4 49.1 34.1 44.7 20.6 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Net reserves for property and casualty claims and claim expenses.................. 351.9 369.6 345.9 306.3 269.3 243.0 235.4 249.8 272.0 272.6 320.9 Increase in reserves due to purchase of HMPCIC: Gross reserves for property and casualty claims and claim expenses.................. 30.6 -- -- -- -- -- -- -- -- -- Deduct: Reinsurance recoverables.............. 0.6 -- -- -- -- -- -- -- -- -- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Net reserves for property and casualty claims and claim expenses............ 30.0 -- -- -- -- -- -- -- -- -- Paid cumulative as of: One year later................ 133.4 140.8 139.3 148.6 142.0 142.5 155.6 155.2 166.8 184.7 Two years later............... 190.5 194.5 195.3 202.1 191.4 203.2 212.7 220.1 245.7 Three years later............. 218.4 224.2 223.0 225.1 223.0 233.0 248.0 262.2 Four years later.............. 234.1 237.9 233.8 240.2 236.7 251.2 269.8 Five years later.............. 241.0 243.1 241.4 245.0 246.5 262.5 Six years later............... 243.7 247.1 242.8 250.5 252.9 Seven years later............. 246.1 247.5 246.8 254.6 Eight years later............. 246.2 250.4 249.2 Nine years later.............. 248.1 252.0 Ten years later............... 249.9 Reserves reestimated as of: End of year................... 381.9 369.6 345.9 306.3 269.3 243.0 235.4 249.8 272.0 272.6 320.9 One year later................ 327.6 314.0 283.4 261.2 244.4 238.4 258.1 266.3 296.0 329.0 Two years later............... 281.9 269.2 249.6 250.2 239.3 261.2 276.9 287.3 325.1 Three years later............. 258.1 251.4 245.8 247.8 254.9 268.7 284.6 303.8 Four years later.............. 249.3 248.9 243.8 257.1 257.0 271.3 295.5 Five years later.............. 229.7 247.4 250.9 256.4 258.7 278.0 Six years later............... 246.6 252.9 250.1 258.8 262.7 Seven years later............. 250.2 252.6 252.2 261.2 Eight years later............. 250.2 255.0 254.3 Nine years later.............. 252.1 256.7 Ten years later............... 254.4 Reserve redundancy (deficiency) - initial net reserves in excess of (less than) reestimated reserves: Amount (1)................. $ 127.5 $ 112.9 $ 91.6 $ 45.1 $ 6.6 $ (35.0) $ (60.1) $ (54.0) $ (53.1) $ (56.4) Percent.................... 33.4% 30.5% 26.5% 14.7% 2.5% -14.4% -25.5% -21.6% -19.5% -20.7% Gross reestimated liability - latest.......................... $ 283.5 $ 287.4 $ 279.8 $ 291.3 $ 291.9 $ 313.4 $ 329.3 $ 337.6 $ 360.6 $ 370.1 Reestimated reinsurance recoverables - latest.......... 29.1 30.7 25.5 30.1 29.2 35.4 33.8 33.8 35.5 41.1 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Net reestimated liability - latest.......................... $ 254.4 $ 256.7 $ 254.3 $ 261.2 $ 262.7 $ 278.0 $ 295.5 $ 303.8 $ 325.1 $ 329.0 Gross cumulative excess (deficiency) (1).............. $ 120.6 $ 101.7 $ 89.9 $ 49.1 $ 18.7 $ (14.5) $ (29.5) $(38.7) $ (54.5) $ (52.8) ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
- ---------- (1) For discussion of the reserve development, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Results of Operations for the Three Years Ended December 31, 2003 -- Benefits, Claims and Settlement Expenses". 10 Property and Casualty Reinsurance All reinsurance is obtained through contracts which generally are renewed each calendar year; however, the 2003 catastrophe reinsurance program was comprised of two contracts, a three-year contract with rate guarantees effective January 1, 2001 and a one-year contract effective January 1, 2003. Although reinsurance does not legally discharge the Company from primary liability for the full amount of its policies, it does make the assuming reinsurer liable to the extent of the reinsurance ceded. Historically, the Company's losses from uncollectible reinsurance recoverables have been insignificant due to the Company's emphasis on the credit worthiness of its reinsurers. Past due reinsurance recoverables as of December 31, 2003 were insignificant. The Company maintains an excess and catastrophe treaty reinsurance program. The Company reinsured 95% of catastrophe losses above a retention of $8.5 million per occurrence up to $80 million per occurrence through December 31, 2003. Effective January 1, 2004, the retention on this coverage increased to $10.0 million. In addition, the Company's predominant insurance subsidiary for property and casualty business written in Florida reinsures 90% of hurricane losses in that state above a retention of $14.5 million up to $50.9 million with the Florida Hurricane Catastrophe Fund, based on the Fund's financial resources. These catastrophe reinsurance programs are augmented by a $75 million equity put and reinsurance agreement. Effective May 7, 2002, the Company entered into an equity put and reinsurance agreement with a subsidiary of Swiss Reinsurance Company. The Swiss Re Group is rated "A+ (Superior)" by A.M. Best. Under the 36-month agreement, which is renewable annually at the option of the Company, the equity put coverage of $75 million provides a source of capital for up to $115 million of pretax catastrophe losses above the reinsurance coverage limit. The Company also has the option, in place of the equity put, to require a Swiss Re Group member to issue a 10% quota share reinsurance coverage of all of the Company's property and casualty book of business. Annual fees related to this equity put option, which are charged directly to additional paid-in capital, are 145 basis points for the May 7, 2002 through May 7, 2004 period increasing to 150 basis points for the May 7, 2004 through May 7, 2005 period. The agreement contains certain conditions to Horace Mann's exercise of the equity put option including: (1) the Company's shareholders' equity, adjusted to exclude goodwill, can not be less than $215 million after recording the first triggering event; (2) the Company's debt as a percentage of total capital can not be more than 47.5% prior to recording the triggering event; and (3) the Company's S&P financial strength rating can not be below "BBB" prior to a triggering event. The Company's S&P financial strength rating was "A" at December 31, 2003. For liability coverages, including the educator excess professional liability policy, the Company reinsures each loss above a retention of $500,000 up to $20 million. Through December 31, 2003, the Company also reinsured each property loss above a retention of $250,000 up to $2.5 million, including catastrophe losses that in the aggregate are less than the retention levels above. Effective January 1, 2004, the retention on the property loss coverage increased to $500,000. 11 The following table identifies the Company's most significant reinsurers under the traditional catastrophe reinsurance program, their percentage participation in the Company's aggregate reinsured catastrophe coverage and their rating by A.M. Best and Standard & Poor's Corporation ("S&P" or "Standard & Poor's") as of January 1, 2004. No other single reinsurer's percentage participation in 2004 or 2003 exceeds 5%. Property Catastrophe Reinsurance Participants In Excess of 5%
Participation A.M. Best S&P --------------- Rating Rating Reinsurer Parent 2004 2003 - --------- ------ ------------------------------------ ----------------------------- ------ ------ A+ A+ IPCRe, Ltd. IPC Holdings, Ltd. 17% 5% A AA- Mapfre Reinsurance Corporation Sistema MAPFRE 12% 8% A- A Lloyd's of London Syndicates 12% * A A- Montpelier Reinsurance Ltd. Montpelier Re Holdings, Ltd. 9% 11% A- AA- AXA Reinsurance Company AXA Group 7% 14% A++ AA Transatlantic Reinsurance Company American International Group, 7% * Inc. A A Axis Specialty Limited Axis Capital Holdings, Inc. 6% 0% A+ NR Allied World Assurance Company, Ltd. Allied World Assurance Holdings, Ltd. 5% 5% A+ A Erie Insurance Exchange 0% 15% A A+ St. Paul Fire and Marine Insurance Company The St. Paul Companies, Inc. 0% 6%
- ---------- NR Not rated. * Less than 5%. For 2004, property catastrophe reinsurers representing 100% of the Company's aggregate reinsured catastrophe coverage were rated either "A- (Excellent)" or above by A.M. Best or "A" or above by S&P. Annuity Segment Educators in the Company's target market benefit from the provisions of Section 403(b) of the Internal Revenue Code. This section of the Code allows public school employees and employees of other tax-exempt organizations, such as not-for-profit private schools, to reduce their pretax income by making periodic contributions to an individual qualified retirement plan. The Company is one of the largest participants in the 403(b) tax-qualified annuity market, measured by 403(b) net written premium on a statutory accounting basis. The Company has approved 403(b) payroll reduction capabilities in approximately one-third of the 15,000 public school districts in the U.S. Approximately 60% of the Company's new annuity contract deposits in 2003 were for 403(b) tax-qualified annuities; approximately 75% of accumulated annuity value on deposit is 403(b) tax-qualified. In 2003, annuities represented 31% of the Company's total insurance premiums written and contract deposits. The Company markets tax-qualified annuities primarily under a contract which allows the contractholder to allocate funds to both fixed and variable alternatives. The features of the Company's annuity contract contribute to business retention. Under the fixed account option, both the principal and a rate of return are guaranteed. Contractholders can change at any time their allocation of deposits between the guaranteed interest rate fixed account and available variable investment options. The Company's 40 variable account options include funds managed by some of the best-known names in the mutual fund industry, such as Fidelity, Strong, J.P. Morgan, Wilshire, T. Rowe Price, Putnam, Neuberger Berman, Alliance Capital, Ranier, Davis, Credit Suisse, BlackRock, Berger, Templeton and Ariel, offering the Company's customers multiple investment options, regardless of their personal investment objectives and risk tolerance. Total accumulated fixed and variable annuity cash value on deposit at December 31, 2003 was $2.8 billion. 12 In 2003, to assist agents in delivering the Value Proposition, the Company entered into a third-party vendor agreement with American Funds Distributors, Inc. to market their retail mutual funds. In addition to retail mutual funds accounts, the Company's agents can also offer a 529 college savings program and Coverdell Education Savings Accounts through this marketing alliance. 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, ------------------------------- 2003 2002 2001 --------- --------- --------- Statement of Operations Data: Contract deposits: Variable................................ $ 115.3 $ 120.3 $ 122.1 Fixed................................... 181.3 141.2 117.0 Total................................ 296.6 261.5 239.1 Contract charges earned.................... 14.6 14.2 14.9 Net investment income...................... 104.4 107.7 107.7 Net interest margin (without realized gains)........................... 33.1 39.3 39.8 Net margin (includes fees and contract charges earned)........................... 49.6 55.5 57.0 Income before income taxes................. 19.8 23.2 30.7 Net income................................. 14.4 17.0 20.6 Operating Statistics: Fixed: Accumulated value....................... $ 1,650.6 $ 1,506.0 $ 1,393.7 Accumulated value persistency........... 95.1% 94.0% 93.4% Variable: Accumulated value....................... $ 1,119.2 $ 854.5 $ 1,008.4 Accumulated value persistency........... 92.8% 92.1% 92.4% Number of contracts in force............... 152,515 147,084 139,410 Average accumulated cash value (in dollars)........................ $ 18,161 $ 16,048 $ 17,230 Average annual deposit by contractholders (in dollars).............................. $ 2,303 $ 2,317 $ 2,183 Annuity contracts terminated due to surrender, death, maturity or other: Number of contracts..................... 7,019 7,180 7,222 Amount.................................. $ 171.3 $ 176.0 $ 186.4 Fixed accumulated cash value grouped by applicable surrender charge: 0%...................................... $ 528.6 $ 502.1 $ 472.5 5% and greater but less than 10%........ 968.3 846.6 752.9 10% and greater......................... 54.3 59.6 70.4 Supplementary contracts with life contingencies not subject to discretionary withdrawal............... 99.4 97.7 97.9 Total................................ $ 1,650.6 $ 1,506.0 $ 1,393.7 Life Segment The Company entered the individual life insurance business in 1949 with traditional term and whole life insurance products. The Company's traditional term, whole life and group life business in force consists of approximately 172,000 policies, representing approximately $7.6 billion of life insurance in force with annual insurance premiums and contract deposits of approximately $42.0 million as of December 31, 2003. The Company also underwrites "Experience Life," a flexible, adjustable premium life insurance contract which allows the customer to combine elements of term life insurance, interest-sensitive whole life insurance and an interest-bearing account. At December 31, 2003 the Company had in force approximately 86,000 Experience Life policies representing approximately $5.7 billion of life insurance in force with annual insurance premiums and contract deposits of approximately $66.7 million. In 2000, the Company instituted a program to offer long-term care and variable universal life policies, with two third-party vendors underwriting such insurance. In 2003, the Company expanded its third-party vendor offerings with the addition of universal life insurance underwritten by Jefferson Pilot Financial. On business underwritten by third-party vendors, the Company receives a commission on the sale of that business. In 2003, the life segment represented 12% of the Company's total insurance premiums written and contract deposits, including approximately 1 percentage point attributable to the Company's group life and group disability income business. 13 During 2003, the average face amount of ordinary life insurance policies issued by the Company was $138,224 and the average face amount of all ordinary life insurance policies in force at December 31, 2003 was $61,467. The maximum individual life insurance risk retained by the Company is $200,000 on any individual life and $100,000 or $125,000 is retained on each group life policy depending on the type of coverage. The excess of the amounts retained are reinsured with life reinsurers that are all rated "A- (Excellent)" or above by A.M. Best. The Company also maintains a life catastrophe reinsurance program. The Company reinsured 100% of the catastrophe risk in excess of $1 million up to $20 million per occurrence through December 31, 2003 and in excess of $1 million up to $15 million per occurrence effective January 1, 2004. This program covers acts of terrorism but excludes nuclear, biological and chemical explosions as well as other acts of war. 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, ------------------------------- 2003 2002 2001 --------- --------- --------- Statement of Operations Data: Insurance premiums and contract deposits... $ 112.4 $ 112.9 $ 117.2 Insurance premiums and contract charges earned.................................... 95.1 91.4 92.0 Net investment income...................... 49.6 53.9 55.2 Income before income taxes................. 20.8 29.2 28.9 Net income................................. 13.4 18.9 18.7 Operating Statistics: Life insurance in force: Ordinary life........................... $ 11,527 $ 11,445 $ 11,291 Group life.............................. 1,736 1,752 1,925 Total................................ 13,263 13,197 13,216 Number of policies in force: Ordinary life........................... 187,533 189,459 193,560 Group life.............................. 70,725 75,018 80,507 Total................................ 258,258 264,477 274,067 Average face amount in force (in dollars): Ordinary life........................... $ 61,467 $ 60,409 $ 58,333 Group life.............................. 24,546 23,354 23,911 Total................................ 51,356 49,898 48,222 Lapse ratio (ordinary life insurance in force)................................. 7.7% 9.1% 9.1% Ordinary life insurance terminated due to death, surrender, lapse or other: Face amount of insurance surrendered or lapsed........................... $ 932.6 $ 959.0 $ 944.0 Number of policies................ 7,466 10,799 11,865 Amount of death claims opened........ $ 32.0 $ 31.0 $ 30.1 Number of death claims opened..... 1,292 1,263 1,317 Investments The Company's investments are selected to balance the objectives of protecting principal, minimizing exposure to interest rate risk and providing a high current yield. These objectives are implemented through a portfolio that emphasizes investment grade, publicly traded fixed income securities. When impairment of the value of an investment is considered other than temporary, the decrease in value is recorded and a new cost basis is established. At December 31, 2003, investments in non-investment grade securities represented 5.3% of total investments. At December 31, 2003, fixed income securities represented 96.9% of investments excluding securities lending collateral. Of the fixed income investment portfolio, 94.1% was investment grade and 99.9% was publicly traded. The average quality of the total fixed income portfolio was A+ at December 31, 2003, and the average option adjusted duration of total investments was 6.0 years. There are no significant investments in 14 mortgage loans, real estate, foreign securities, privately placed securities, or common or preferred stocks. The Company has separate investment strategies and guidelines for its property and casualty assets and for its life and annuity assets, which recognize different characteristics of the associated insurance liabilities, as well as different tax and regulatory environments. The Company manages interest rate exposure for its portfolios through asset/liability management techniques which attempt to coordinate the duration of the assets with the duration of the insurance policy liabilities. 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 is the case 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 purchased and held by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, mortgage-backed bonds, other asset-backed bonds, preferred stocks, common stocks, real estate mortgages and real estate. The following table sets forth the carrying values and amortized cost of the Company's investment portfolio as of December 31, 2003: 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% $ 660.1 $ 646.6 $ 13.5 $ 647.7 Other.............................................. 8.9 300.9 248.3 52.6 295.6 Investment grade corporate and public utility bonds........................................ 43.3 1,466.6 1,415.4 51.2 1,380.5 Municipal bonds....................................... 14.9 502.9 53.2 449.7 488.1 Other mortgage-backed securities...................... 3.2 109.9 87.8 22.1 106.0 Non-investment grade corporate and public utility bonds (2).................................... 5.3 178.2 121.7 56.5 169.9 Foreign government bonds.............................. 1.1 36.2 36.2 -- 33.1 Short-term investments (3)............................ 0.7 25.3 9.0 16.3 25.3 Short-term investments, loaned securities collateral (3)............................ 0.6 22.1 22.1 -- 22.1 ---------- --------- --------- ------------ --------- Total publicly traded securities................... 97.5 3,302.2 2,640.3 661.9 3,168.3 ---------- --------- --------- ------------ --------- Other Investments: Private placements, investment grade (4).............. 0.1 3.8 3.7 0.1 3.8 Private placements, non-investment grade (2) (4)......................... -- 0.1 0.1 -- 0.1 Mortgage loans and real estate (5).................... 0.2 4.6 4.6 -- 4.6 Policy loans and other................................ 2.2 75.0 74.0 1.0 74.4 ---------- --------- --------- ------------ --------- Total other investments......................... 2.5 83.5 82.4 1.1 82.9 ---------- --------- --------- ------------ --------- Total investments (6)........................... 100.0% $ 3,385.7 $ 2,722.7 $ 663.0 $ 3,251.2 ========== ========= ========= ============ =========
- ---------- (1) Includes $302.0 million fair value of investments guaranteed by the full faith and credit of the U.S. government and $659.0 million fair value of federally sponsored agency securities. (2) A non-investment grade rating is assigned to a security when it is acquired, primarily on the basis of the Standard & Poor's Corporation ("Standard & Poor's" or "S&P") rating for such security, or if there is no S&P rating, the Moody's Investors Service, Inc. ("Moody's") rating for such security, or if there is no S&P or Moody's rating, the National Association of Insurance Commissioners (the "NAIC") rating for such security. The rating agencies monitor securities, and their issuers, regularly and make changes to the ratings as necessary. The Company incorporates rating changes on a monthly basis. (3) Short-term investments mature within one year of being acquired and are carried at cost, which approximates fair value. Short-term investments include $25.4 million in money market funds rated "AAA", $21.9 million in an asset-backed short-term bond rated "AAA", and $0.1 million in certificates of deposit. The Company loans fixed income securities to third parties, primarily major brokerage firms. The Company separately maintains a minimum of 100% of the value of the loaned securities as collateral for each loan. (4) Fair values for private placements are estimated by the Company with the assistance of its investment advisors. (5) Mortgage loans are carried at amortized cost or unpaid principal balance and real estate acquired in the settlement of debt is carried at the lower of cost or fair value. (6) Approximately 9% of the Company's investment portfolio, having a carrying value of $288.9 million as of December 31, 2003, consisted of securities with some form of credit support, such as insurance. All of these securities have the highest investment grade rating. 15 Fixed Maturity Securities The following table sets forth the composition of the Company's fixed maturity securities portfolio by rating as of December 31, 2003: Rating of Fixed Maturity Securities (1) (Dollars in millions) Percent of Total Carrying Carrying Amortized Value Value Cost -------- --------- ---------- AAA.................................. 44.6% $ 1,455.1 $ 1,422.7 AA................................... 7.7 249.5 240.8 A.................................... 23.2 757.4 710.6 BBB.................................. 18.6 605.3 567.5 BB................................... 2.0 64.8 63.0 B.................................... 3.2 104.8 101.1 CCC or lower......................... 0.6 18.0 15.4 Not rated (2)........................ 0.1 3.8 3.8 -------- --------- ---------- Total............................. 100.0% $ 3,258.7 $ 3,124.9 ======== ========= ========== - ---------- (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 $3.8 million of private placement securities not rated by either S&P or Moody's. The NAIC has rated 97.1% of these private placement securities as investment grade. At December 31, 2003, 29.3% of the Company's fixed maturity securities portfolio was expected to mature within the next 5 years. Mortgage-backed securities, including mortgage-backed securities of U.S. governmental agencies, represented 22.7% of the total investment portfolio at December 31, 2003. These securities typically have average lives shorter than their stated maturities due to unscheduled prepayments on the underlying mortgages. Mortgages are prepaid for a variety of reasons, including sales of existing homes, interest rate changes over time that encourage homeowners to refinance their mortgages and defaults by homeowners on mortgages that are then paid by guarantors. For financial reporting purposes, the Company has classified the entire fixed maturity portfolio as "available for sale". Fixed maturities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value. The net adjustment for unrealized gains and losses on securities available for sale is recorded as a separate component of shareholders' equity, net of applicable deferred tax asset or liability and the related impact on deferred policy acquisition costs and value of acquired insurance in force associated with interest-sensitive life and annuity contracts. Fixed maturities held for indefinite periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates, resultant prepayment risk and other related factors. Cash Flow As a holding company, HMEC conducts its principal operations through its subsidiaries. Payment by HMEC of principal and interest with respect to HMEC's indebtedness, and payment by HMEC of dividends to its shareholders, are dependent upon the ability of its insurance subsidiaries to pay cash dividends or make other cash payments to HMEC, including tax payments pursuant to tax sharing agreements. Restrictions on the subsidiaries' ability to pay dividends or to make other cash payments to HMEC may materially affect HMEC's ability to pay principal and interest on its indebtedness and dividends on its common stock. 16 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 2004 from all of HMEC's insurance subsidiaries without prior regulatory approval is approximately $43 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. Competition The Company operates in a highly competitive environment. 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 compared to the Company, such as direct marketing, mail, internet and telemarketing. The Company competes in its target market with a number of national providers of personal automobile and homeowners insurance and life insurance such as State Farm, Allstate, Farmers and Nationwide as well as several regional companies. The Company also competes for automobile business with other companies, such as AIG, GEICO, Progressive and USAA, many of which feature direct marketing distribution. For annuity business, the marketplace has seen 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 International Group ("AIG"), has been among the Company's major tax-qualified annuity competitors. Mutual fund families, independent agent companies and financial planners are also competitors of the Company. Regulation General Regulation at State Level As an insurance holding company, HMEC is subject to extensive regulation by the states in which its insurance subsidiaries are domiciled or transact business. 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. 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 are not expected to have a negative regulatory impact on the Company's insurance subsidiaries. 17 Assessments Against Insurers Under insurance insolvency or guaranty laws in most states in which the Company operates, insurers doing business therein can be assessed for policyholder losses related to insolvencies of other insurance companies. The amount and timing of any future assessments on the Company under these laws cannot be reasonably estimated and are beyond the control of the Company. Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurer's financial strength, and many assessments paid by the Company pursuant to these laws may be used as credits for a portion of the Company's premium taxes in certain states. For the three years ended December 31, 2003, the Company's assessments, net of the related premium tax credits, were not significant. Mandatory Insurance Facilities The Company is required to participate in various mandatory insurance facilities in proportion to the amount of the Company's direct writings in the applicable state. In 2003, the Company reflected a net loss from participation in such mandatory pools and underwriting associations of $1.6 million before federal income taxes. California Earthquake Authority The California Earthquake Authority ("CEA") was formed by the California Legislature to encourage companies to write residential property insurance in California and began operating in December 1996. All companies which write residential property insurance in California are also required to offer earthquake coverage. The CEA operates as an insurance company providing residential property earthquake coverage under policies sold by companies which have chosen to participate in the CEA. The participating companies fund the CEA and share in earthquake losses covered by the CEA in proportion to their market share. The Company has not joined the CEA. The Company's exposure to losses from earthquakes is managed through its underwriting standards, its earthquake policy coverage limits and deductible levels, and the geographic distribution of its business, as well as its reinsurance program. After reviewing the exposure to earthquake losses from its own policies and from participation in the CEA, management believes it is in the Company's best economic interest to offer earthquake coverage directly to its homeowners policyholders. See "Property and Casualty Segment -- Property and Casualty Reinsurance." Regulation at Federal Level Although the federal government generally does not directly regulate the insurance industry, federal initiatives often impact the insurance business. Current and proposed federal measures which may significantly affect insurance and annuity business include employee benefits regulation, controls on the costs of medical care, medical entitlement programs such as Medicare, structure of retirement plans and accounts, changes to the insurance industry anti-trust exemption, minimum solvency requirements and allowing national banks to engage in the insurance, annuity and mutual fund businesses. With the passage of the Financial Services Modernization Act of 1999, it is possible there will be increased pressure for federal regulation of the insurance industry. 18 Federal income taxation of the build-up of cash value within a life insurance policy or an annuity contract could have a materially 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. Changes in other federal and state laws and regulations could also affect the relative tax and other advantages of the Company's life and annuity products to customers. The variable annuities underwritten by HMLIC and the Company's proprietary mutual funds offered as investment vehicles for those products are regulated by the SEC. Horace Mann Investors, Inc., the broker-dealer subsidiary of HMEC, performs certain management functions for the Company's proprietary mutual funds and also is regulated by the SEC and the NASD. Employees At December 31, 2003, the Company had approximately 2,500 employees, including 888 full-time agents. The Company has no collective bargaining agreement with any employees. ITEM 2. Properties HMEC's home office property at 1 Horace Mann Plaza in Springfield, Illinois, consists of an office building totaling approximately 230,000 square feet which is owned by the Company. The Company also owns buildings with an aggregate of approximately 24,000 square feet at other locations in Springfield. The Company leases buildings in Springfield with an aggregate of approximately 87,000 square feet. In addition, the Company leases office space in other states related to claims and agency offices which are smaller in size. 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 routine litigation incidental to its business. See also "Note 12 - Contingencies - Lawsuits and Legal Proceedings" contained in the Index to Financial Information on page F-1 herein. ITEM 4. Submission of Matters to a Vote of Security Holders None. 19 PART II ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters HMEC's common stock began trading on the New York Stock Exchange ("NYSE") in November 1991 under the symbol of HMN at a price of $9 per share. The following table sets forth the high and low sales prices of the common stock on the NYSE Composite Tape and the cash dividends paid per share of common stock during the periods indicated. Market Price ----------------- Dividend Fiscal Period High Low Paid - ------------------------------------------------- ------- ------- -------- 2003: Fourth Quarter................................ $ 15.39 $ 12.81 $ 0.105 Third Quarter................................. 16.95 14.22 0.105 Second Quarter................................ 16.91 13.06 0.105 First Quarter................................. 16.35 12.43 0.105 2002: Fourth Quarter................................ $ 16.49 $ 13.61 $ 0.105 Third Quarter................................. 18.86 14.00 0.105 Second Quarter................................ 24.08 17.45 0.105 First Quarter................................. 23.00 19.35 0.105 As of February 27, 2004, the approximate number of holders of common stock was 5,000. In March 2004, the Company's Board of Directors announced a regular quarterly dividend of $0.105 per share. The payment of dividends in the future is subject to the discretion of the Board of Directors and will depend upon general business conditions, legal restrictions and other factors the Board of Directors of HMEC may deem to be relevant. On December 10, 2002 the Company repurchased $56.0 million aggregate principal amount of its Senior Convertible Notes, representing $26.6 million carrying value, for $26.0 million. As consideration for the repurchase, the Company issued 1,837,925 shares of its common stock. During 2003, no options were exercised for the issuance of shares of the Company's common stock. The information required by Item 201(d) of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 2004 Annual Meeting of Shareholders. ITEM 6. Selected Financial Data The information required by Item 301 of Regulation S-K is contained in the table in Item 1 -- "Business -- Selected Historical Consolidated Financial Data." ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required by Item 303 of Regulation S-K is contained in the Index to Financial Information on page F-1 herein. ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk The information required by Item 305 of Regulation S-K is contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in the Index to Financial Information on page F-1 herein. 20 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. ITEM 9A: Controls and Procedures The Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of December 31, 2003 pursuant to Exchange Act Rule 13a-15 and 15d-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic Securities and Exchange Commission filings. No significant deficiencies or material weaknesses in the Company's disclosure controls and procedures were identified in the evaluation and therefore, no corrective actions were taken. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. 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 2004 Annual Meeting of Shareholders. Horace Mann Educators Corporation has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer and all other employees of the Company. In addition, the Board of Directors of Horace Mann Educators Corporation has adopted the code of ethics for its Board members as it applies to each Board members' business conduct on behalf of the Company. The code of ethics is posted on the Company's website, www.horacemann.com, under "Investor Relations -- Corporate Governance". 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 2004 Annual Meeting of Shareholders. ITEM 12. Security Ownership of Certain Beneficial Owners and Management The information required by Items 201(d) and 403 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 2004 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 2004 Annual Meeting of Shareholders. 21 ITEM 14. Principal Accounting Fees and Services The information required by Item 9(e) of Schedule 14A is incorporated by reference to the Company's Proxy Statement for the 2004 Annual Meeting of Shareholders. PART IV ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) The following consolidated financial statements of the Company are contained in the Index to Financial Information on Page F-1 herein: Consolidated Balance Sheets as of December 31, 2003 and 2002. Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002 and 2001. Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2003, 2002 and 2001. Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001. (a)(2) The following consolidated financial statement schedules of the Company are contained in the Index to Financial Information on page F-1 herein: Schedule I - Summary of Investments - Other than Investments in Related Parties. Schedule II - Condensed Financial Information of Registrant. Schedules III and VI Combined - Supplementary Insurance Information and Supplemental Information Concerning Property and Casualty Insurance Operations. Schedule IV - Reinsurance. (a)(3) The following items are filed as Exhibits. Management contracts and compensatory plans are indicated by an asterisk (*). Exhibit No. Description - ------------- ----------------------------------------------------------------- (3) Articles of incorporation and bylaws: 3.1 Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on June 24, 2003, incorporated by reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, filed with the Securities and Exchange Commission (the "SEC") on August 14, 2003. 3.2 Form of Certificate for shares of Common Stock, $0.001 par value per share, of HMEC, incorporated by reference to Exhibit 4.5 to HMEC's Registration Statement on Form S-3 (Registration No. 33-53118) filed with the SEC on October 9, 1992. 22 Exhibit No. Description - ------------- ----------------------------------------------------------------- 3.3 Bylaws of HMEC, incorporated by reference to Exhibit 3.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, filed with the SEC on August 14, 2003. (4) Instruments defining the rights of security holders, including indentures: 4.1 Indenture dated as of January 17, 1996, between HMEC and U.S. Trust Company of California, N.A. as trustee, with regard to HMEC's 6 5/8% Senior Notes Due 2006, incorporated by reference to Exhibit 4.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1995, filed with the SEC on March 13, 1996. 4.1(a) Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.1). 4.2 Indenture dated as of May 14, 2002, between HMEC and JPMorgan Chase Bank as trustee, with regard to HMEC's 1.425% Senior Convertible Notes Due 2032, incorporated by reference to Exhibit 4.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 4.2(a) Form of 1.425% Senior Convertible Notes Due 2032 (included in Exhibit 4.2). 4.3 Certificate of Designations for HMEC Series A Cumulative Convertible Preferred Stock (included in Exhibit 10.14). (10) Material contracts: 10.1 Credit Agreement dated as of May 29, 2002 (the "Bank Credit Facility") among HMEC, certain financial institutions named therein and Bank of America, N.A., as administrative agent (the "Agent"), incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 10.2* Stock Subscription Agreement among HMEC (as successor to HME Holdings, Inc.), The Fulcrum III Limited Partnership, The Second Fulcrum III Limited Partnership and each of the Management Investors, incorporated by reference to Exhibit 10.17 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1989, filed with the SEC on April 2, 1990. 10.3* Horace Mann Educators Corporation Deferred Equity Compensation Plan for Directors, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 10.4* Horace Mann Educators Corporation Deferred Compensation Plan for Employees, incorporated by reference to Exhibit 10.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1997, filed with the SEC on March 30, 1998. 10.5* Amended and Restated Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 23 Exhibit No. Description - ------------- ----------------------------------------------------------------- 10.5(a)* Amendment to Amended and Restated Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed with the SEC on August 11, 2000. 10.5(b)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5(a) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.5(c)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5(b) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.6* Horace Mann Educators Corporation 2001 Stock Incentive Plan, incorporated by reference to Exhibit 10.6 to HMEC's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. 10.6(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan, incorporated by reference to Exhibit 10.6(a) to HMEC's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. 10.6(b)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan, incorporated by reference to Exhibit 10.6(b) to HMEC's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. 10.7* Horace Mann Educators Corporation 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 10.7(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 10.7(b)* Specimen Regular Employee Stock Option Agreement under the Horace Mann Educators Corporation 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 10.7(c)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(c) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 24 Exhibit No. Description - ------------- ----------------------------------------------------------------- 10.8* Severance Agreements between HMEC and certain officers of HMEC, incorporated by reference to Exhibit 10.7 to HMEC's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. 10.8(a)* Revised Schedule to Severance Agreements between HMEC and certain officers of HMEC. 10.9* Horace Mann Supplemental Employee Retirement Plan, 2002 Restatement, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, filed with the SEC on May 15, 2002. 10.10* Horace Mann Executive Supplemental Employee Retirement Plan, 2002 Restatement, incorporated by reference to Exhibit 10.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, filed with the SEC on May 15, 2002. 10.11* Horace Mann Nonqualified Supplemental Money Purchase Pension Plan, incorporated by reference to Exhibit 10.3 to HMEC's Quarterly Report on Form 10-Q for the Quarter Ended March 31, 2002, filed with the SEC on May 15, 2002. 10.12* Employment Agreement entered by and between HMEC and Louis G. Lower II as of December 31, 1999, incorporated by reference to Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.13* Transition, Retirement and Release Agreement entered by and between Horace Mann Service Corporation and George J. Zock as of December 31, 2003. 10.14 First Amended and Restated Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement entered by and between HMEC, Swiss Re Financial Products Corporation (Option Writer) and Swiss Reinsurance America Corporation (Reinsurance Option Writer), dated May 7, 2002, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed with the SEC on November 14, 2002. (11) Statement regarding computation of per share earnings. (12) Statement regarding computation of ratios. (21) Subsidiaries of HMEC. (23) Consent of KPMG LLP. (31) Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.1 Certification by Louis G. Lower II, Chief Executive Officer of HMEC. 31.2 Certification by Peter H. Heckman, Chief Financial Officer of HMEC. 25 (32) Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.1 Certification by Louis G. Lower II, Chief Executive Officer of HMEC. 32.2 Certification by Peter H. Heckman, Chief Financial Officer of HMEC. (b) During the fourth quarter of 2003, HMEC filed seven Current Reports on Form 8-K with the SEC as follows: 1. Dated October 27, 2003, regarding the Company's press release regarding guidance on financial results for the year ended December 31, 2003 and related October 28, 2003 Conference Call Prepared Remarks, containing an Item 9 Regulation FD Disclosure and an Item 7 Financial Statements and Exhibits. 2. Dated October 30, 2003, regarding the Company's press release reporting its financial results for the three and nine month periods ended September 30, 2003, containing an Item 12 Disclosure of Results of Operations and Financial Condition and an Item 7 Financial Statements and Exhibits. 3. Dated November 14, 2003, regarding a press release issued by A.M. Best Company regarding the financial strength and debt ratings of HMEC, containing an Item 5 Other Events and Regulation FD Disclosure and an Item 7 Financial Statements and Exhibits. 4. Dated December 2, 2003, regarding a press release issued by Moody's Investors Service, Inc., regarding the insurance financial strength and senior debt ratings of HMEC, containing an Item 5 Other Events and Regulation FD Disclosure and an Item 7 Financial Statements and Exhibits. 5. Dated December 8, 2003, regarding the Company's press release regarding guidance on financial results for the year ended December 31, 2003, containing an Item 9 Regulation FD Disclosure and an Item 7 Financial Statements and Exhibits. 6. Dated December 17, 2003, regarding a press release issued by Standard & Poor's Ratings Services regarding the insurance financial strength and senior debt ratings of HMEC, containing an Item 5 Other Events and Regulation FD Disclosure and an Item 7 Financial Statements and Exhibits. 7. Dated December 19, 2003, regarding a press release issued by A.M. Best Company regarding (1) the assignment of indicative ratings of securities of HMEC's $300 million universal shelf offering filed with the SEC on December 16, 2003 and (2) affirmation of HMEC's financial strength ratings and ratings for outstanding debt, containing an Item 5 Other Events and Regulation FD Disclosure and an Item 7 Financial Statements and Exhibits. (c) See list of exhibits in this Item 15. (d) See list of financial statement schedules in this Item 15. Copies of Exhibits and Horace Mann Educators Corporation's Code of Ethics may be obtained by writing to Investor Relations, Horace Mann Educators Corporation, 1 Horace Mann Plaza, Springfield, Illinois 62715-0001. Persons requesting copies may be charged a reasonable fee to cover reproduction and mailing expenses. 26 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Horace Mann Educators Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HORACE MANN EDUCATORS CORPORATION /s/ Louis G. Lower II - -------------------------------------- Louis G. Lower II President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Horace Mann Educators Corporation and in the capacities and on the date(s) indicated. Principal Executive Officer: Directors: /s/ Louis G. Lower II /s/ Joseph J. Melone - -------------------------------------- -------------------------------------- Louis G. Lower II Joseph J. Melone, Chairman of the President, Board of Directors Chief Executive Officer and a Director /s/ William W. Abbott -------------------------------------- William W. Abbott, Director /s/ Mary H. Futrell -------------------------------------- Mary H. Futrell, Director Principal Financial Officer: /s/ Peter H. Heckman /s/ Donald E. Kiernan - -------------------------------------- -------------------------------------- Peter H. Heckman Donald E. Kiernan, Director Executive Vice President and Chief Financial Officer /s/ Jeffrey L. Morby -------------------------------------- Jeffrey L. Morby, Director /s/ Shaun F. O'Malley -------------------------------------- Shaun F. O'Malley, Director Principal Accounting Officer: /s/ Bret A. Conklin /s/ Charles A. Parker - -------------------------------------- -------------------------------------- Bret A. Conklin Charles A. Parker, Director Senior Vice President and Controller Dated: March 15, 2004 27 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-34 Independent Auditors' Report............................................. F-35 Consolidated Balance Sheets.............................................. F-36 Consolidated Statements of Operations.................................... F-37 Consolidated Statements of Changes in Shareholders' Equity............... F-38 Consolidated Statements of Cash Flows.................................... F-39 Notes to Consolidated Financial Statements Note 1 - Summary of Significant Accounting Policies.................. F-40 Note 2 - Restructuring Charges....................................... F-51 Note 3 - Investments................................................. F-53 Note 4 - Property and Casualty Unpaid Claims and Claim Expenses...... F-57 Note 5 - Debt........................................................ F-61 Note 6 - Shareholders' Equity and Stock Options...................... F-64 Note 7 - Income Taxes................................................ F-67 Note 8 - Fair Value of Financial Instruments......................... F-68 Note 9 - Statutory Surplus and Subsidiary Dividend Restrictions...... F-70 Note 10 - Pension Plans and Other Postretirement Benefits............. F-71 Note 11 - Reinsurance................................................. F-78 Note 12 - Contingencies............................................... F-80 Note 13 - Supplementary Data on Cash Flows............................ F-80 Note 14 - Segment Information......................................... F-81 Note 15 - Unaudited Interim Information............................... F-82 Financial Statement Schedules: Schedule I - Summary of Investments-Other than Investments in Related Parties...................................................... F-83 Schedule II - Condensed Financial Information of Registrant........... F-84 Schedule III and VI Combined - Supplementary Insurance Information and Supplemental Information Concerning Property and Casualty Insurance Operations.................................... F-88 Schedule IV - Reinsurance............................................. F-89 F-1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in millions, except per share data) Forward-looking Information Statements made in the following discussion that state the Company's or management's intentions, hopes, beliefs, expectations or predictions of future events or the Company's future financial performance are forward-looking statements and involve known and unknown risks, uncertainties and other factors. 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. . Fluctuations in the market value of securities in the Company's investment portfolio and the related after-tax effect on the Company's shareholders' equity and total capital through either realized or unrealized investment losses. In addition, the impact of fluctuations in the financial markets on the Company's defined benefit pension plan assets and the related after-tax effect on the Company's operating expenses, shareholders' equity and total capital. . Prevailing interest rate levels, including the impact of interest rates on (i) unrealized gains and losses in the Company's investment portfolio and the related after-tax effect on the Company's shareholders' equity and total capital, (ii) the book yield of the Company's investment portfolio and (iii) the Company's ability to maintain appropriate interest rate spreads over the fixed rates guaranteed in the Company's life and annuity products. . Defaults on interest or dividend payments in the Company's investment portfolio due to credit issues and the resulting impact on investment income. . The impact of fluctuations in the capital markets on the Company's ability to refinance outstanding indebtedness or repurchase shares of the Company's common stock. . The frequency and severity of catastrophes such as hurricanes, earthquakes, storms and wildfires, the ability of the Company to maintain a favorable catastrophe reinsurance program and the collectibility of reinsurance receivables. . Adverse development of property and casualty loss experience and its impact on estimated claims and claim settlement expenses for losses occurring in prior years. . The cyclicality of the insurance industry. . Business risks inherent in the Company's restructuring of its property and casualty claims operation. . The risk related to the Company's dated and complex information systems, which are more prone to error than advanced technology systems. . Disruptions of the general business climate, investments, capital markets and consumer attitudes caused by geopolitical acts such as terrorism, war or other similar events. . The impact of a disaster or catastrophic event affecting the Company's employees or its home office facilities and the Company's ability to recover and resume its business operations on a timely basis. F-2 . The Company's ability to develop and expand its agent force and its direct product distribution systems, as well as the Company's ability to maintain and secure product sponsorships by local, state and national education associations. . The competitive impact of new entrants such as mutual funds and banks into the tax-deferred annuity products markets, and the Company's ability to profitably expand its property and casualty business in highly competitive environments. . Changes in insurance regulations, including (i) those affecting the ability of the Company's insurance subsidiaries to distribute cash to the holding company and (ii) those impacting the Company's ability to profitably write property and casualty insurance policies in one or more states. . Changes in federal income tax laws and changes resulting from federal tax audits affecting corporate tax rates or taxable income. . Changes in federal and state laws and regulations which affect the relative tax and other advantages of the Company's life and annuity products to customers. . The impact of fluctuations in the financial markets on the Company's variable annuity fee revenues, valuations of deferred policy acquisition costs and value of acquired insurance in force, and the level of guaranteed minimum death benefit reserves. . The Company's ability to maintain favorable claims-paying ability, financial strength and debt ratings. . Adverse changes in policyholder mortality and morbidity rates. . The resolution of legal proceedings and related matters. Executive Summary During 2001, 2002 and 2003, the Company improved the underlying operating results of its property and casualty segment and substantially increased the new sales volume and retention of business in its annuity segment. However, that underlying operating progress was more than offset by other factors which suppressed the Company's net income. In all three years, the Company recorded adverse development of prior years' property and casualty reserves, primarily related to voluntary automobile liability claims, with 2003 reflecting the most significant impact. 2003's results also reflected a record level of catastrophe losses for the Company. In addition, the Company experienced declining investment income, including related spread compression in its fixed annuity business, over the three years as a result of credit-related investment losses and declining investment yields. In 2002, the Company recorded a significant level of realized investment losses, due primarily to impairments of fixed income securities. Critical Accounting Policies The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires the Company's management to make estimates and assumptions based on information available at the time the financial statements are prepared. These estimates and assumptions affect the reported amounts of the Company's assets, liabilities, shareholders' equity and net income. Certain accounting estimates are particularly sensitive because of their significance to the Company's financial statements and because of the possibility that subsequent events and available information may differ markedly from management's judgements at the time the financial statements were prepared. Management has discussed with the Audit Committee the quality, not just the acceptability, of the Company's accounting principles as applied in its financial reporting. The F-3 discussions generally included such matters as the consistency of the Company's accounting policies and their application, and the clarity and completeness of the Company's financial statements, which include related disclosures. For the Company, the areas most subject to significant management judgements include: liabilities for property and casualty claims and claim settlement expenses, liabilities for future policy benefits, deferred policy acquisition costs, value of acquired insurance in force, valuation of investments and valuation of assets and liabilities related to the defined benefit pension plan. Liabilities for Property and Casualty Claims and Claim Settlement Expenses Underwriting results of the property and casualty segment are significantly influenced by estimates of the Company's ultimate liability for insured events. There is a high degree of uncertainty inherent in the estimates of ultimate losses underlying the liability for unpaid claims and claim expenses. This inherent uncertainty is particularly significant for liability-related exposures due to the extended period, often many years, that transpires between a loss event, receipt of related claims data from policyholders and ultimate settlement of the claim. Reserves for property and casualty claims include provisions for payments to be made on reported claims, claims incurred but not yet reported and associated settlement expenses. The process by which these reserves are established requires reliance upon estimates based on known facts and on interpretations of circumstances, including the Company's experience with similar cases and historical trends involving claim payment patterns, claim payments, pending levels of unpaid claims and product mix, as well as other factors including court decisions, economic conditions and public attitudes. The Company continually updates loss estimates using both quantitative information from its reserving actuaries and qualitative information derived from other sources. Adjustments may be required as information develops which varies from experience, or, in some cases, augments data which previously were not considered sufficient for use in determining liabilities. The effects of these adjustments may be significant and are charged or credited to income for the period in which the adjustments are made. Detailed discussion of the impact of adjustments recorded during 2003 is included in "Results of Operations for the Three Years Ended December 31, 2003 -- Benefits, Claims and Settlement Expenses." Due to the nature of the Company's personal lines business, the Company has no exposure to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses other than claims under homeowners insurance policies for environmentally related items such as toxic mold. The Company completes a detailed study of property and casualty reserves based on information available at the end of each quarter and year. Trends of reported losses (paid amounts and case reserves on claims reported to the Company) for each accident year are reviewed and ultimate loss costs for those accident years are estimated. The Company engages an independent property and casualty actuarial consulting firm to prepare an independent study of the Company's property and casualty reserves twice a year - at June 30 and December 31. F-4 Reserves for Future Policy Benefits Liabilities for future benefits on life and annuity policies are established in amounts adequate to meet the estimated future obligations on policies in force. Liabilities for future policy benefits on certain life insurance policies are computed using the net level premium method and are based on assumptions as to future investment yield, mortality and withdrawals. Mortality and withdrawal assumptions for all policies have been based on actuarial tables which are consistent with the Company's own experience. Liabilities for future benefits on annuity contracts and certain long-duration life insurance contracts are carried at accumulated policyholder values without reduction for potential surrender or withdrawal charges. In the event actual experience varies from the estimated liabilities, adjustments are charged or credited to income for the period in which the adjustments are made. Deferred Policy Acquisition Costs and Value of Acquired Insurance in Force for Annuity and Interest-Sensitive Life Products Policy acquisition costs, consisting of commissions, policy issuance and other costs, which vary with and are primarily related to the production of business, are capitalized and amortized on a basis consistent with the type of insurance coverage. For investment (annuity) contracts, acquisition costs, and also the value of annuity business acquired in the 1989 acquisition of the Company ("Annuity VIF"), are amortized over 20 years in proportion to estimated gross profits. Capitalized acquisition costs for interest-sensitive life contracts are also amortized over 20 years in proportion to estimated gross profits. The most significant assumptions that are involved in the estimation of annuity gross profits include future financial market performance, interest rate spreads, business surrender/lapse rates and the impact of realized investment gains and losses. For the variable deposit portion of the annuity segment, the Company amortizes policy acquisition costs and the Annuity VIF utilizing a future financial market performance assumption of a 10% reversion to the mean approach with a 200 basis point corridor around the mean. At December 31, 2003, capitalized annuity policy acquisition costs and the Annuity VIF asset represented approximately 4% of the total annuity accumulated cash value. In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company may be required to record a material charge or credit to amortization expense for the period in which the adjustment is made. As noted above, there are a number of assumptions involved in the valuation of capitalized policy acquisition costs and the Annuity VIF. Generally, if all other assumptions are met, with regard to financial market performance assumptions for the underlying mutual funds of the Company's variable annuities, a 1% deviation from the targeted financial market performance would currently impact amortization between $0.1 million and $0.2 million depending on the magnitude and direction of the deviation. Detailed discussion of the impact of adjustments to the amortization of capitalized acquisition costs and Annuity VIF is included in "Results of Operations for the Three Years Ended December 31, 2003 -- Amortization of Policy Acquisition Expenses and Intangible Assets". F-5 Valuation of Investments The Company's methodology of assessing other-than-temporary impairments is based on security-specific facts and circumstances as of the date of the reporting period. Based on these facts, if management believes it is probable that amounts due will not be collected according to the contractual terms of a debt security not impaired at acquisition, or if the Company does not have the ability or intent to hold a security with an unrealized loss until it matures or recovers in value, an other-than-temporary impairment shall be considered to have occurred. As a general rule, if the fair value of a debt security has fallen below 80% of book value for more than six months, this security will be reviewed for an other-than-temporary impairment. Additionally, if events become known that call into question whether the security issuer has the ability to honor its contractual commitments, whether or not such security has been trading above an 80% fair value to book value relationship, such security holding will be evaluated to determine whether or not such security has suffered an other-than-temporary decline in value. The Company reviews the fair value of all investments in its portfolio on a monthly basis to assess whether an other-than-temporary decline in value has occurred. These reviews, in conjunction with the Company's investment managers' monthly credit reports and relevant factors such as (1) the financial condition and near-term prospects of the issuer, (2) the Company's intent and ability to retain the investment long enough to allow for the anticipated recovery in fair value, (3) the stock price trend of the issuer, (4) the market leadership position of the issuer, (5) the debt ratings of the issuer and (6) the cash flows of the issuer, are all considered in the impairment assessment. A write-down of an investment is recorded when a decline in the fair value of that investment is deemed to be other-than-temporary, with a realized investment loss charged to income for the period. A decline in fair value below amortized cost is not assumed to be other-than-temporary for fixed maturity investments with unrealized losses due to market conditions or industry-related events where there exists a reasonable market recovery expectation and the Company has the intent and ability to hold the investment until maturity or a market recovery is realized. An other-than-temporary impairment loss will be recognized based upon all relevant facts and circumstances for each investment, as appropriate, in accordance with Securities and Exchange Commission Staff Accounting Bulletin ("SAB") No. 59, "Accounting for Non-Current Marketable Equity Securities", Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities", and related guidance. Detailed discussion of charges recorded in 2003 and 2002 for the write-down of investments due to other-than-temporary impairments is included in "Results of Operations for the Three Years Ended December 31, 2003 -- Realized Investment Gains and Losses". Valuation of Assets and Liabilities Related to the Defined Benefit Pension Plan Effective April 1, 2002, participants stopped accruing benefits under the defined benefit plan but continue to retain the benefits they had accrued to date. The Company's cost estimates for its defined benefit pension plan are determined annually based on assumptions which include the discount rate, expected return on plan assets, anticipated retirement rate and estimated lump sum distributions. A discount rate of F-6 6.25% was used by the Company at December 31, 2003, which was based on the average yield for long-term, high grade securities having maturities generally consistent with the defined benefit pension payout period. To set its discount rate, the Company looks to leading indicators, including Moody's Aa long-term bond index. The expected annual return on plan assets assumed by the Company at December 31, 2003 was 7.50%. The assumption for the long-term rate of return on plan assets was determined by considering actual investment experience during the lifetime of the plan, balanced with reasonable expectations of future growth considering the various classes of assets and percentage allocation for each asset class. Management believes that it has adopted realistic assumptions for investment returns, discount rates and other key factors used in the estimation of pension costs and asset values. To the extent that actual experience differs from the Company's assumptions, subsequent adjustments may be required, with the effects of those adjustments charged or credited to income and/or shareholders' equity for the period in which the adjustments are made. Generally, a change of 50 basis points in the discount rate would inversely impact pension expense and accumulated other comprehensive income ("AOCI") by approximately $0.2 million and $2 million, respectively. In addition, for every $1 million increase in the value of pension plan assets, there is an equal and offsetting decrease in AOCI. Results of Operations For the Three Years Ended December 31, 2003 Insurance Premiums and Contract Charges Insurance Premiums Written and Contract Deposits
Year Ended Growth Over Year Ended December 31, Prior Year December 31, ------------------- ------------------ ------------ 2003 2002 Percent Amount 2001 -------- -------- ------- -------- ------------ Automobile and property (voluntary).... $ 549.2 $ 513.2 7.0% $ 36.0 $ 496.6 Excluding Massachusetts automobile.. 549.2 513.2 7.0% 36.0 477.7 Massachusetts automobile............ -- -- -- 18.9 Annuity deposits....................... 296.6 261.5 13.4% 35.1 239.1 Life................................... 112.4 112.9 -0.4% (0.5) 117.2 -------- -------- -------- ------------ Subtotal - core lines......... 958.2 887.6 8.0% 70.6 852.9 Subtotal - core lines, excluding Massachusetts...... 958.2 887.6 8.0% 70.6 834.0 Involuntary and other property & casualty................... (2.7) 11.7 (14.4) 22.7 Excluding Massachusetts automobile...................... (2.7) 10.5 (13.2) 14.9 Massachusetts automobile......... -- 1.2 (1.2) 7.8 -------- -------- -------- ------------ Total......................... $ 955.5 $ 899.3 6.2% $ 56.2 $ 875.6 ======== ======== ======== ============ Total, excluding Massachusetts automobile................... $ 955.5 $ 898.1 6.4% $ 57.4 $ 848.9 ======== ======== ======== ============
F-7 Insurance Premiums and Contract Charges Earned (Excludes annuity and life contract deposits)
Year Ended Growth Over Year Ended December 31, Prior Year December 31, ------------------- ------------------ ------------ 2003 2002 Percent Amount 2001 -------- -------- ------- -------- ------------ Automobile and property (voluntary).... $ 534.8 $ 504.3 6.0% $ 30.5 $ 485.5 Excluding Massachusetts automobile.. 534.8 494.4 8.2% 40.4 467.2 Massachusetts automobile............ -- 9.9 -100.0% (9.9) 18.3 Annuity................................ 14.6 14.2 2.8% 0.4 14.9 Life................................... 95.1 91.4 4.0% 3.7 92.0 -------- -------- -------- ------------ Subtotal - core lines......... 644.5 609.9 5.7% 34.6 592.4 Subtotal - core lines, excluding Massachusetts automobile................... 644.5 600.0 7.4% 44.5 574.1 Involuntary and other property and casualty................. (1.0) 15.3 (16.3) 22.8 Excluding Massachusetts automobile...................... (1.2) 9.6 (10.8) 14.7 Massachusetts automobile......... 0.2 5.7 (5.5) 8.1 -------- -------- -------- ------------ Total......................... $ 643.5 $ 625.2 2.9% $ 18.3 $ 615.2 ======== ======== ======== ============ Total, excluding Massachusetts automobile................... $ 643.3 $ 609.6 5.5% $ 33.7 $ 588.8 ======== ======== ======== ============
The Company restructured its presence in the Massachusetts automobile market and ceased writing automobile insurance policies in that state on December 31, 2001. Through a marketing alliance with an unaffiliated company, The Commerce Group, Inc. ("Commerce"), the Company's agents are authorized to offer Massachusetts customers automobile insurance policies written by Commerce. Horace Mann agents continue to write the Company's other products in Massachusetts, including retirement annuities and property and life insurance. Comparisons throughout this discussion of insurance premiums and contract deposits exclude Massachusetts voluntary automobile premiums and policies in force. 2003 premiums written and contract deposits for the Company's core lines increased 8.0% over 2002 as a result of rate increases in the property and automobile lines and an increased rate of growth in new annuity deposits in the second half of 2003. 2002 premiums written and contract deposits increased 6.4% over 2001 for similar reasons. Voluntary property and casualty business, a component of the Company's core lines, represents policies sold through the Company's marketing organization and issued under the Company's underwriting guidelines. The Company's exclusive agent force totaled 888 at December 31, 2003, reflecting a decrease of 3.7% compared to 922 agents a year earlier. At December 31, 2001, the Company had 867 agents. Of the 2003 total, 378 agents were in their first 24 months with the Company, a decrease of 4.3% compared to December 31, 2002, with full year 2003 new hires equal to 2002 and terminations exceeding the prior year. The number of experienced agents in the agent force, 510, was down 3.2% at December 31, 2003 compared to a year earlier, due primarily to terminations of less-productive agents. While the year-end 2003 agent count was lower than a year earlier, the average number of agents throughout the year was 4% higher than in 2002. In 2003, average agent productivity for all lines of business combined increased slightly compared to 2002 following an increase of 6.5% in 2002, compared to 2001. Average agent productivity is measured as new sales premiums from the exclusive agent force per the average number of exclusive agents for the period. The Company continues to seek ways to improve the retention and productivity of its exclusive agent force. 2003 total sales, which include the independent agent distribution channel, increased 14.6% compared to 2002, F-8 largely due to the growing contribution of annuity business from the independent agent distribution channel. The Company's results have been impacted by ongoing and recurring proceedings in North Carolina challenging private passenger automobile rates. This has required the Company to escrow premiums received pending resolution of these proceedings, adversely impacting 2003 earned premiums and pretax income by $3.0 million and 2002 earned premiums and pretax income by $1.8 million. Total voluntary automobile and homeowners premium written increased 7.0% in 2003 and 7.4% in 2002. Voluntary automobile insurance premium written increased 6.0% ($22.6 million) from 2002 to 2003 and 7.1% ($24.9 million) from 2001 to 2002. Homeowners premium increased 9.8% ($13.4 million) from 2002 to 2003 and 8.4% ($10.6 million) from 2001 to 2002. The increases in property and casualty premiums resulted from the impact of rate increases on average premium per policy. Average written premium was up approximately 5% in 2003 and 6% in 2002 for voluntary automobile. Homeowners average written premium increased approximately 12% in 2003 and 14% in 2002. Average earned premium increased 5% and 6% for voluntary automobile and 14% and 11% for homeowners for the same periods. Through December 31, 2003, approved rate increases for the Company's automobile and homeowners business were 7% and 13%, respectively, compared to approved increases of 6% and 21%, respectively, during 2002. During 2003, automobile policies in force decreased by 2,000 compared to December 31, 2002, reflecting an increase in policies for educators which was more than offset by a decrease in non-educator policies. Automobile policies in force at December 31, 2002 were equal to year-end 2001. Homeowners policies in force decreased 5,000 during 2003 and 8,000 during 2002 reflecting expected reductions due to the Company's pricing and underwriting actions. At December 31, 2003, there were 571,000 voluntary automobile and 279,000 homeowners policies in force, for a total of 850,000. At December 31, 2002, there were 573,000 voluntary automobile and 284,000 homeowners policies in force for a total of 857,000. At December 31, 2001, there were 573,000 voluntary automobile and 292,000 homeowners policies in force for a total of 865,000. Based on policies in force, the property and casualty 12-month retention rate for new and renewal policies was 88% in 2003, 87% in 2002 and 88% in 2001. The Company plans additional rate increases in 2004 for both its automobile and homeowners lines of business, which may have an adverse impact on policy retention. Involuntary property and casualty business includes allocations of business from state mandatory insurance facilities and assigned risk business. For 2003, involuntary and other property and casualty premiums written were comparable to the prior year excluding the negative impact of adjustments made in the third and fourth quarters to anticipated premiums from state mandatory insurance facilities. New annuity deposits increased 13.4% in 2003 and 9.4% in 2002. The 2003 growth primarily reflected a 45.8% increase in single premium and rollover deposits partially offset by a 4.2% decrease in new scheduled annuity deposits. New deposits to fixed accounts were 28.4%, or $40.1 million, higher than in 2002 and new deposits to variable accounts decreased 4.2%, or $5.0 million, compared to a year earlier. The 2002 growth reflected an 8.8% increase in scheduled deposits received and a 10.4% increase in single premium and rollover deposits. 2002 new deposits to fixed accounts were 15.6%, or $19.1 million, higher than in 2001, and new deposits to variable accounts increased 2.8%, or $3.3 million, compared to 2001. F-9 In 2001, the Company began building a nationwide network of independent agents who will comprise a second distribution channel for the Company's 403(b) tax-qualified annuity products. The independent agent distribution channel, which included 465 authorized agents at December 31, 2003, generated $38.1 million in annualized new Horace Mann annuity sales during 2003, compared to $10.5 million for the full year 2002 and no sales in 2001. A significant portion of the 2002 amount, over $6 million, was produced as a result of Horace Mann being named as one of four providers for fixed and variable annuity options to Chicago, Illinois public school employees and the Company's partnering with an independent broker/dealer having two decades of experience in providing retirement planning services to Chicago Public School employees. Total annuity accumulated cash value of $2.8 billion at December 31, 2003 increased 17.3% compared to a year earlier reflecting the growth in sales during 2003, continued favorable retention and an improving equity market. Total annuity accumulated cash value of $2.4 billion at December 31, 2002 decreased 1.7% compared to a year earlier reflecting an increase in deposits to fixed accounts that was more than offset by a decrease in variable accumulated funds on deposit which were impacted by financial market values. In 2003, the number of annuity contracts outstanding increased 4.1%, or 6,000 contracts, and in 2002, the increase was 5.8%, or 8,000 contracts. In 2003, annuity segment contract charges earned increased 2.8%, or $0.4 million, following a decline of 4.7% in 2002, compared to 2001. Declines in market valuations during 2002 and the first quarter of 2003 resulted in lower variable accumulated balances in force against which contract charges are principally applied. Market appreciation in the last nine months of 2003, however, resulted in variable annuity accumulated balances at December 31, 2003 which were 31.0% higher than at December 31, 2002. Life segment premiums and contract deposits declined slightly in 2003 and decreased 3.7% in 2002. The life insurance in force lapse ratio improved to 7.7% for the twelve months ended December 31, 2003 compared to 9.1% for the same period in each of the prior two years. Consistent with the Company's Value Proposition and overall strategy to meet a broader array of consumer financial needs, the product portfolio that the Company's agents can offer was expanded in 2003 through two new marketing alliances. The first is with Jefferson Pilot Financial for universal life insurance. Jefferson Pilot was a leading issuer of universal life policies in the U.S. for 2002. The second alliance is with American Funds for retail mutual funds. Both product rollouts began in the second quarter of 2003 and are intended to help the Company reach more educators while deepening relationships with existing clients. While business that the Company's agents write through these and other partner companies is not recorded as Horace Mann premium, generally the marketing allowance received is comparable to the Company's normal underwriting margin, with no corresponding capital requirement. Net Investment Income Pretax investment income of $184.7 million for 2003 decreased 5.8%, or $11.3 million, (4.7%, or $6.2 million, after tax) compared to the prior year as a decline in the portfolio yield offset growth in the size of the investment portfolio. Pretax investment income of $196.0 million for 2002 decreased 1.7%, or $3.3 million, (1.6%, or $2.1 million after tax) compared to 2001 due primarily to lost income related to investment credit issues and a decline in the F-10 portfolio yield which offset growth in the size of the investment portfolio. Average investments (excluding securities lending collateral) increased 6.8% during 2003 and 5.0% during 2002. The average pretax yield on the investment portfolio was 5.9% (4.0% after tax) for 2003, 6.7% (4.5% after tax) for 2002 and 7.2% (4.8% after tax) for 2001. Realized Investment Gains and Losses Net realized investment gains were $25.5 million in 2003 compared to realized investment losses of $49.4 million in 2002 and $10.0 million in 2001. For the full year 2003, the Company recorded fixed income security impairment charges totaling $12.5 million, $6.2 million related to two of the Company's collateralized debt obligation ("CDO") securities, $3.1 million related to one manufactured housing asset-backed security and the remaining $3.2 million primarily related to two airline industry issuers. In 2002, the Company recorded charges of $53.9 million due to the impairment of fixed income securities primarily issued by companies in the communications sector. In 2001, $7.8 million of the $10.0 million realized loss resulted from the sale of all of the Company's holdings in fixed income securities issued by Enron Corporation, with the balance primarily attributable to credit-related sale and impairment of securities issued by companies in the communications sector. Gains realized in 2003 included $16.1 million from sales of securities for which impairment charges were recorded in 2002. Net realized investment gains and losses for 2003, 2002 and 2001 also reflected gains realized from ongoing investment portfolio management activity. In each of the periods, the impaired securities were marked to fair value, and the write-downs were recorded as realized investment losses in the Statement of Operations. These impairments were deemed to be other-than-temporary for one or more of the following reasons: the recovery of full value was not likely, the issuer defaulted or was likely to default due to the need to restructure its debt, or the Company had an intent to sell the security in the near future. F-11 The table below presents the Company's fixed maturity securities portfolio as of December 31, 2003 by major asset class, including the ten largest sectors of the Company's corporate bond holdings.
Pretax Number of Fair Amortized Unrealized Issuers Value Cost Gain(Loss) --------- --------- --------- ---------- Corporate bonds Banking and Finance.................... 34 $ 310.0 $ 285.9 $ 24.1 Energy................................. 40 219.1 205.4 13.7 Food and Beverage...................... 28 128.9 124.2 4.7 Utilities.............................. 19 128.9 123.3 5.6 Telecommunications..................... 15 108.8 101.2 7.6 Industry, Manufacturing................ 19 79.1 76.2 2.9 Insurance.............................. 10 77.4 73.8 3.6 Transportation......................... 10 77.2 76.7 0.5 Broadcasting and Media................. 21 51.4 46.6 4.8 Healthcare............................. 22 48.8 46.9 1.9 All Other Corporates (1)............... 104 418.8 393.8 25.0 --------- --------- --------- ---------- Total corporate bonds............... 322 1,648.4 1,554.0 94.4 Mortgage-backed securities Government............................. 442 660.1 647.7 12.4 Other.................................. 6 56.5 53.4 3.1 Municipal bonds........................... 154 502.9 488.1 14.8 Government bonds U.S.................................... 5 300.9 295.6 5.3 Foreign................................ 8 36.2 33.1 3.1 Collateralized debt obligations (2)....... 7 33.2 33.2 -- Asset-backed securities................... 7 20.5 19.8 0.7 --------- --------- --------- ---------- Total fixed maturity securities..... 951 $ 3,258.7 $ 3,124.9 $ 133.8 ========= ========= ========= ==========
- ---------- (1) The All Other Corporates category contains 18 additional industry classifications. Real estate, automobiles, paper, retail, defense, chemicals, consumer products and metals represented $304.0 million of fair value at December 31, 2003, with the remaining 10 classifications each representing less than $27 million of the fair value at December 31, 2003. (2) Six of the securities were rated investment grade by Standard and Poor's Corporation and/or Moody's Investors Service, Inc. at December 31, 2003. F-12 At December 31, 2003, the Company's diversified fixed maturity portfolio consisted of 1,139 investment positions and totaled approximately $3.3 billion in fair value. The portfolio was 94.1% investment grade, based on fair value, with an average quality rating of A+. At December 31, 2003, the portfolio had approximately $11 million pretax of total gross unrealized losses related to 113 positions. At December 31, 2002, the total pretax gross unrealized losses were approximately $27 million related to 137 positions. The following table provides information regarding fixed maturity securities that had an unrealized loss at December 31, 2003, including the length of time that the securities have continuously been in an unrealized loss position. Investment Positions With Unrealized Losses Segmented by Quality and Period of Continuous Unrealized Loss As of December 31, 2003
Pretax Number of Fair Amortized Unrealized Positions Value Cost Loss --------- --------- --------- ---------- Investment grade 6 Months or less....................... 65 $ 347.8 $ 352.9 $ (5.1) 7 through 12 months.................... 18 90.1 94.4 (4.3) 13 through 24 months................... 1 2.6 2.7 (0.1) 25 through 36 months................... 1 2.9 3.0 (0.1) 37 through 48 months................... -- -- -- -- Greater than 48 months................. -- -- -- -- --------- --------- --------- ---------- Total............................... 85 $ 443.4 $ 453.0 $ (9.6) ========= ========= ========= ========== Non-investment grade 6 Months or less....................... 19 $ 11.3 $ 11.7 $ (0.4) 7 through 12 months.................... -- -- -- -- 13 through 24 months................... -- -- -- -- 25 through 36 months................... 1 5.9 6.1 (0.2) 37 through 48 months................... -- -- -- -- Greater than 48 months................. 2 9.4 10.0 (0.6) --------- --------- --------- ---------- Total............................... 22 $ 26.6 $ 27.8 $ (1.2) ========= ========= ========= ========== Not rated Total, all 13 through 24 months..... 6 $ 2.5 $ 2.5 * ========= ========= ========= ========== Grand total...................... 113 $ 472.5 $ 483.3 $ (10.8) ========= ========= ========= ==========
- ---------- * Less than $0.1 million Of the securities with unrealized losses, no issuers had pretax unrealized losses greater than $2 million and no securities were trading below 80% of book value at December 31, 2003. The Company views the decrease in value of all of the securities with unrealized losses at December 31, 2003 as temporary, expects recovery in fair value, anticipates continued payments under the terms of the securities, and has the intent and ability to hold these securities until maturity or a recovery in fair value occurs. Therefore, no impairment of these securities was recorded at December 31, 2003. Future changes in circumstances related to these and other securities could require subsequent impairment in value. The Company's investment guidelines generally limit single corporate issuer concentrations to 4.0% (after tax) of shareholders' equity for "AA" or "AAA" rated securities, 2.5% (after tax) of shareholders' equity for "A" rated securities, 2.0% (after tax) of shareholders' equity for "BBB" rated securities, and 1.0% (after tax) of shareholders' equity for non-investment grade securities. F-13 Benefits, Claims and Settlement Expenses
Year Ended Growth Over Year Ended December 31, Prior Year December 31, -------------------- --------------------- ------------ 2003 2002 Percent Amount 2001 --------- --------- --------- ---------- ------------ Property and casualty..................... $ 472.9 $ 410.2 15.3% $ 62.7 $ 433.3 Annuity................................... 0.8 0.8 -- -- (0.8) Life...................................... 45.3 39.9 13.5% 5.4 41.1 Corporate & other......................... -- -- -- -- 2.0 --------- --------- --------- ---------- ------------ Total.................................. $ 519.0 $ 450.9 15.1% $ 68.1 $ 475.6 ========= ========= ========= ========== ============
Property and Casualty Claims and Claim Expenses
Year Ended December 31, ------------------------------- 2003 2002 2001 --------- --------- --------- Incurred claims and claim expenses: Claims occurring in the current year.............. $ 416.5 $ 387.7 $ 416.8 Increase (decrease) in estimated reserves for claims occurring in prior years (1): Policies written by the Company (2)............ 58.3 20.8 14.5 Business assumed from state reinsurance facilities.................................... (1.9) 1.7 2.0 --------- --------- --------- Total increase.............................. 56.4 22.5 16.5 --------- --------- --------- Total claims and claim expenses incurred (2)............................... $ 472.9 $ 410.2 $ 433.3 ========= ========= ========= Net reserves, end of period.......................... $ 320.9 $ 272.6 $ 272.0 Plus reinsurance recoverables..................... 20.6 44.7 34.1 --------- --------- --------- Gross reserves, end of period........................ $ 341.5 $ 317.3 $ 306.1 ========= ========= ========= Property and casualty GAAP loss ratio: Before catastrophe losses......................... 82.4% 76.6% 83.0% After catastrophe losses.......................... 88.6% 78.9% 85.2% Property and casualty GAAP loss ratio excluding net increases in estimated reserves for claims occurring in prior years: Before catastrophe losses...................... 71.8% 72.0% 79.8% After catastrophe losses....................... 78.0% 74.3% 82.0%
- ---------- (1) Shows the amounts by which the Company increased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims and changes in their projected final settlement costs. (2) For the year ended December 31, 2002, these amounts excluded a $1.6 million statutory accounting charge for class action litigation which was separately reported as Litigation Charges in the Company's Consolidated Statements of Operations. In 2003, the voluntary automobile loss ratio increased compared to 2002 primarily reflecting adverse development and strengthening of prior years' reserves, as described below. The Company's benefits, claims and settlement expenses also reflected underlying improvement in the homeowners loss ratio as a result of loss containment initiatives and the favorable impact of rate increases on earned premiums which was offset by an increase in catastrophe losses. In 2002, the Company's benefits, claims and settlement expenses reflected improvements in both the voluntary automobile and the homeowners loss ratios, including catastrophe losses and the impact of litigation charges, as a result of mild weather, loss containment initiatives and the favorable impact of the Company's restructuring of its Massachusetts automobile business. Favorable property and casualty current accident year loss trends were partially offset by adverse development in prior years' reserves. In 2001, the Company's benefits, claims and settlement expenses were affected adversely by strengthening of prior years' reserves for property and casualty claims and by a high level of non-catastrophe weather-related losses. F-14 Excluding involuntary business, net adverse development of reserves for property and casualty claims occurring in prior years was $58.3 million for the full year 2003, primarily related to automobile liability loss reserves from the 2001 and 2002 accident years, compared to adverse reserve development of $22.3 million in 2002 which was primarily related to (1) automobile loss reserves from accident years 2001 and years prior to 1997 and (2) loss adjustment expense reserves from the 2001 and 2000 accident years for both automobile and homeowners. Adverse development recorded in 2002 also included $1.6 million due to a provision for the costs of resolving class action lawsuits related to diminished value brought against the Company. Net adverse development of total reserves for property and casualty claims occurring in prior years, including involuntary business, was $56.4 million in 2003, $24.0 million in 2002 and $16.5 million in 2001. The Company's property and casualty reserves were $320.9 million, $272.6 million and $272.0 million at December 31, 2003, 2002 and 2001, respectively, net of anticipated reinsurance recoverables. During 2002 and 2003, the Company made changes in its property and casualty claims function including hiring of new management and claim adjusters (new hires represented over half of the Company's 300 claims employees at December 31, 2003), implementing improved processes and consolidating the previous 17 branch offices into 6 regional claims offices, which began in late-November 2002 and was completed in the first quarter of 2003. Installation and implementation of the new claims administration system, including related process changes, occurred in the third and fourth quarters of 2003 in the first two claims offices with the remaining four offices planned for the first half of 2004. As part of the claims operation redesign effort, open claim files -- particularly for automobile liability claims -- were reviewed by the new team. In the first half of 2003, these reassessments resulted in a higher projected ultimate liability for automobile liability claims from accident years 2001, 2000 and 1999 and prior. The high level of property and casualty paid and case reserve activity on older bodily injury claims that was observed in the second quarter of 2003 continued in the third quarter as the Company's new claims organization intensified their efforts to bring older claims files up to date. Furthermore, the acceleration of claim disposition rates extended into the third quarter, as the new organization also moved to reduce the backlog of older claims and handle current claims on a timely basis. As a result, the estimation of claims costs, settlement rates and severity has been complicated in recent quarters due to the degree of change involved. F-15 As a result of the factors above, and in light of the pattern of adverse prior years' reserve development observed over the five quarters ended September 30, 2003, at the end of the third quarter, the Company's management retained an independent property and casualty actuarial and claims consulting firm to conduct a detailed review of the Company's claims handling practices and their integration with the Company's reserving practices. The consultant's claims and actuarial specialists reviewed claim files as well as past and current claims handling processes and procedures, including case reserving practices, in each of the Company's six claims offices. They also performed an assessment of the Company's actuarial processes for establishing IBNR and supplemental reserves. The Company's December 31, 2003 actuarial analysis and reserve estimates incorporated the observations of the consultant's claims and reserving practices review. The low and high end of a reasonable range of reserve estimates for all of the Company's coverages indicated net claim reserve levels of $286 million and $338 million, respectively. In recording the December 31, 2003 net reserves of $320.9 million, the Company assessed the relative weight given to emerging claim trends resulting from recent business process changes, pricing and claims handling. Based upon this analysis, the Company selected a higher point in the range for reserves related to the automobile liability coverages. F-16 The following table quantifies the amount of adverse/(favorable) reserve development recorded in each quarter in 2003 for each line of business and the accident years to which the re-estimates relate: Other Voluntary Total Property & Total Automobile Property Casualty ----------- ----------- ----------- ----------- Three months ended March 31, 2003 - --------------------- Accident Years: 2002.............. $ 0.8 $ 1.1 $ (0.9) $ 0.6 2001.............. 1.4 1.7 0.6 (0.9) 2000 & Prior...... 2.1 2.8 (0.1) (0.6) ----------- ----------- ----------- ----------- Total.......... $ 4.3 $ 5.6 $ (0.4) $ (0.9) =========== =========== =========== =========== Three months ended June 30, 2003 - --------------------- Accident Years: 2002.............. $ 5.8 $ 6.4 $ (0.6) $ -- 2001.............. 0.7 1.0 (0.3) -- 2000 & Prior...... 3.4 2.8 0.2 0.4 ----------- ----------- ----------- ----------- Total.......... $ 9.9 $ 10.2 $ (0.7) $ 0.4 =========== =========== =========== =========== Three months ended September 30, 2003 - --------------------- Accident Years: 2002.............. $ 12.9 $ 10.7 $ 1.3 $ 0.9 2001.............. 8.8 9.0 0.2 (0.4) 2000 & Prior...... 8.4 7.7 0.1 0.6 ----------- ----------- ----------- ----------- Total.......... $ 30.1 $ 27.4 $ 1.6 $ 1.1 =========== =========== =========== =========== Three months ended December 31, 2003 - --------------------- Accident Years: 2002.............. $ 7.8 $ 6.9 $ 0.3 $ 0.6 2001.............. 1.9 1.9 -- -- 2000 & Prior...... 2.4 5.0 (0.2) (2.4) ----------- ----------- ----------- ----------- Total.......... $ 12.1 $ 13.8 $ 0.1 $ (1.8) =========== =========== =========== =========== During 2000, the Company noted increases in paid severities in excess of the original expectations in its direct voluntary automobile line of business. As a result, the Company continued to monitor such severity trends until such time as the Company believed that they were sufficiently credible to require adjustment to the Company's claim and claim expense reserve projections. Accordingly, the Company revised its projections in the fourth quarter of 2000 to give greater weight to the increasing trend of claim severities. F-17 In 2001, the Company refined its claim reserving methodologies and trend analyses including more detailed analyses of subrogation recovery activity on business ceded to the state automobile insurance facility in Massachusetts. The nature of the adverse trends in the second and fourth quarters of 2001 that caused the Company to increase reserves consisted primarily of the following: (1) an increase in the frequency and severity of educators excess professional liability claims; (2) the utilization of selected ultimate subrogation recoverables that were not trending with actual recoveries; and (3) the utilization of selected ultimate loss ratios in establishing reserves for ceded voluntary automobile excess liability claims and ceded Massachusetts involuntary automobile reserves that were not trending with actual results. In the third quarter of 2002, the Company increased its reserves for prior accident years primarily related to allocated claim adjustment expenses for the voluntary automobile and homeowners lines and claims for the educator excess professional liability product. The Company had noted increases in paid claims and claim expenses for prior accident years in these lines during the first and second quarters of 2002 and continued to monitor such adverse trends until such time as the Company believed that they were sufficiently credible to require adjustment of the reserves. As a result, the Company revised its loss projections in the third quarter of 2002, incorporating the higher paid claims and claim expense trends. In the fourth quarter of 2002, the Company increased its reserves for prior accident years related primarily to (1) automobile claim reserves from accident years 2001, 2000 and years prior to 1997 and (2) allocated and unallocated claim expense reserves from the 2001 accident year for both automobile and homeowners. During the third and fourth quarters of 2002, the Company continued to closely monitor emerging trends in (1) the severity of payments on previously reported losses for voluntary automobile and (2) paid claim adjustment expenses for these prior accident years until such time as the Company believed that the trends were sufficiently credible to require adjustment of the reserves. As a result, the Company revised its projections in the fourth quarter of 2002, incorporating the higher paid claims and claim expense trends. As the Company's claims operation redesign efforts progressed during 2003, the elevated level of claim payments and case reserve activity related to prior accident years continued. Consequently, the Company revised its loss projections throughout 2003, most notably in the third quarter, as greater relative weight was given to the emerging claim trends. At the time each of the reserve analyses were performed, the Company believed that each estimate was based upon sound and correct methodology, that such methodology was appropriately applied and that there were no trends which indicated the likelihood of future adverse development. The financial impact of the net reserve strengthening was therefore accounted for in the period that the change was determined. F-18 For 2003, total incurred property and casualty catastrophe losses were $33.2 million, the Company's record high, compared to $11.9 million in 2002 and $11.2 million in 2001. The 2003 increase generated approximately 4 percentage points of the increase in the property and casualty loss ratio. Homeowners claims from the California wildfires, net of anticipated reinsurance recoveries, represented $12.0 million of the 2003 losses and occurred in the fourth quarter. Claims from Hurricane Isabel, primarily in the homeowners line, represented $5.0 million of the losses and occurred in the third quarter of 2003. Incurred catastrophe losses in 2001 included a net benefit of $1.1 million due to favorable development of reserves for 2000 catastrophe losses. Including the higher level of catastrophe losses, the property loss ratio of 82.6% for 2003 increased approximately 1.5 percentage points compared to 2002 in spite of a 13 percentage point increase attributable to higher catastrophe losses in 2003. The adverse impact of catastrophes was nearly offset by an increase in average premium per policy and an improvement in loss frequency as a result of loss containment initiatives such as tightened underwriting guidelines, deductible management and an aggressive reunderwriting program. The property loss ratio was 97.0% in 2001. The voluntary automobile loss ratio for 2003 increased approximately 13 percentage points compared to the prior year. The loss ratio in 2003 included 14.5 percentage points due to adverse development of prior years' reserves compared to an impact of approximately 4 percentage points a year earlier. The voluntary automobile loss ratio for 2002 decreased approximately 2 percentage points compared to 2001. As disclosed in the Company's Annual Reports on Form 10-K for 2002 and 2001, early in 2001 management discovered deficiencies in the tax compliance testing procedures associated with certain of the Company's life insurance policies that could jeopardize the tax status of some of those life policies. Deficiencies in the Company's computer-based monitoring of premiums, combined with the complexity of certain of the Company's life insurance products, resulted in the acceptance of too much premium for certain policies under the applicable tax test the Company was using. As a result of this discovery, the Company retained outside experts to assist with the investigation and remediation of this issue. The deficiencies in the testing procedures related to compliance with Internal Revenue Code ("IRC") Section 7702 (Definition of Life Insurance) were identified and corrected. Such a problem is not uncommon in the life insurance industry and the Company pursued a remedy following Internal Revenue Service ("IRS") procedures that have been established to address this type of situation. The Company recorded $2.0 million of policyholder benefits in the Corporate and Other segment in the fourth quarter of 2001, as well as $1.0 million of operating expense, which represented the Company's best estimate of the costs to the Company to resolve these problems. In July 2003, the Company entered into agreements with the IRS resolving its compliance with IRC Section 7702 (Definition of Life Insurance). The accrual established at December 31, 2001 was adequate to cover these costs. The Company is in the process of identifying and correcting any related deficiencies in the testing procedures and quantifying any potential exposure associated with IRC Section 7702A (Modified Endowment Contracts). The Company recorded $0.8 million of operating expense in the Corporate and Other segment in the second quarter of 2003 which represents F-19 its current best estimate of the costs to the Company to complete this correction and assessment process. By the end of 2004, the Company expects to have completed implementation of its testing procedures. In 2005, the Company expects to quantify its potential exposure, if any, associated with IRC Section 7702A. Interest Credited to Policyholders Year Ended Growth Over Year Ended December 31, Prior Year December 31, ------------------- ------------------ ------------ 2003 2002 Percent Amount 2001 -------- -------- ------- -------- ------------ Annuity............. $ 71.3 $ 68.4 4.2% $ 2.9 $ 67.9 Life................ 31.7 30.0 5.7% 1.7 28.6 -------- -------- -------- ------------ Total............ $ 103.0 $ 98.4 4.7% $ 4.6 $ 96.5 ======== ======== ======== ============ Compared to the prior year, the 2003 increase in annuity segment interest credited reflected an 8.9% increase in average accumulated fixed deposits, partially offset by a 22 basis point decline in the average annual interest rate credited to 4.6%. Compared to the 2001 rate of 5.1%, the fixed annuity average annual interest rate credited decreased to 4.8% for 2002. Offsetting the decline in the rate credited, the average accumulated fixed deposits increased 6.4% for 2002 compared to 2001. Life insurance interest credited increased in both 2003 and 2002 as a result of the growth in interest-sensitive life insurance reserves. Operating Expenses In 2003, operating expenses increased $6.1 million, or 4.6%, compared to 2002 including an increase in investments in technology and property and casualty underwriting initiatives as well as fees related to the Company's life subsidiary surplus relief transaction. In 2002, operating expenses increased $7.5 million, or 6.1%, compared to 2001. The higher level of company-wide expense was due predominantly to increased employee benefits costs, including transition costs related to changes in the Company's defined benefit pension plan, and reduced employee incentive compensation expenses in 2001. Excluding these factors, operating expenses for the two periods were approximately equal. In 2001, the Company determined that it would freeze its defined benefit pension plan in 2002 and move to a defined contribution structure. Costs of transitioning to the new structure, based upon assumptions of future events, were $4.8 million and $6.2 million in 2003 and 2002, respectively, and are currently estimated to be approximately $4 million for 2004. These costs are largely as a result of settlement accounting provisions that are expected to be triggered as a result of the higher retirement rate currently being experienced by the Company, coupled with more retirees choosing lump sum distributions, and the impact of declines in the market value of the pension plan's assets in 2002 and 2001. The Company's policy with respect to funding the defined benefit pension 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. In 2002, the Company contributed $7.9 million to the defined benefit pension plan, which was greater than the $1.8 million actuarially-determined required minimum amount, reflecting a degree of conservatism which the Company believed to be appropriate in light of the then current volatility in the financial markets. In 2003, the Company contributed $8.8 million to the defined benefit pension plan, with the entire amount being in excess of the required minimum amount. Based on assumptions at the time of this Report on Form 10-K, F-20 the Company anticipates contributing approximately $3.5 million to the defined benefit pension plan in 2004. All defined benefit pension plan investments are set aside in a trust fund. The property and casualty GAAP expense ratio of 23.7% for the year ended December 31, 2003 increased approximately 1 percentage point over 2002, and the 2002 ratio increased approximately 1.5 percentage points over 2001, in both cases primarily reflecting the property and casualty segment's portion of the increase in corporate-wide expenses. Amortization of Policy Acquisition Expenses and Intangible Assets For 2003, the combined amortization of policy acquisition expenses and intangible assets was $69.3 million compared to $67.0 million recorded in 2002 and $63.8 million recorded in 2001. Amortization of intangible assets was $5.0 million for the year ended December 31, 2003 compared to $5.7 million for 2002 and $5.8 million in 2001. Amortization of goodwill, which was $1.6 million in 2001, was eliminated with the 2002 adoption of SFAS No. 142, "Goodwill and Other Intangible Assets". Amortized policy acquisition expenses of $64.3 million in 2003 were $3.0 million more than the prior year and 2002 amortization exceeded 2001 by $3.3 million, in both cases primarily related to the property and casualty segment. Income Tax Expense The effective income tax rate on the Company's pretax income, including realized investment gains and losses, was a tax of 1.0% for the year ended December 31, 2003 compared to a benefit of 46.8% for 2002 and a tax of 9.5% for 2001. Income from investments in tax-advantaged securities reduced the effective income tax rate 36.3, 76.2 and 13.4 percentage points for the years ended December 31, 2003, 2002 and 2001, respectively. While the amount of income from tax-advantaged securities in 2003 increased somewhat compared to 2002, the reduced level of income before income taxes in 2002 resulted in this having a more significant impact on the 2002 effective income tax rate. The impact of tax advantaged securities in 2002 included 13.3 percentage points from the prior year's tax return. Also in 2002 and 2001, the Company's tax provision was reduced by $0.8 million and $3.0 million, respectively, reflecting the release of excess tax provision previously recorded, representing 9.9 and 10.7 percentage points, respectively. Net Income For 2003, the Company reported net income of $19.0 million, or $0.44 per share, compared to $11.3 million, or $0.28 per share, for 2002 and $25.6 million, or $0.63 per share, in 2001. In 2003, net income was negatively impacted by adverse development and strengthening of prior years' property and casualty reserves as well as a significant level of catastrophe losses, partially offset by net realized gains on securities. 2003 net income comparisons to 2002 were also negatively impacted by decreases in investment income. These negative prior year comparisons were partially offset by the impact of property and casualty rate increases on earned premiums and favorable property loss results excluding the impact of catastrophes. F-21 Net income in 2002 as compared to 2001 benefited from positive developments in the Company's property and casualty segment including: the impact of rate increases on earned premiums; improved 2002 accident year loss trends; lower weather-related losses; and the Company's restructuring of its Massachusetts automobile business. In addition, net income in 2002 benefited from the January 1, 2002 discontinuance of goodwill amortization. These positive prior year comparisons were partially offset by greater adverse development of property and casualty prior years' reserves. Net income in 2002 was also negatively affected by (1) the significant level of realized investment losses, (2) decreases in investment income due to lost income related to investment credit issues and declining interest rates, (3) tightening margins on variable annuities resulting from adverse market conditions and (4) higher company-wide operating expenses resulting primarily from transition costs related to changes in the Company's retirement plans and lower employee incentive compensation in 2001. Net income (loss) by segment and net income per share were as follows:
Year Ended Growth Over Year Ended December 31, Prior Year December 31, --------------------------- --------------------------- ------------ 2003 2002 Percent Amount 2001 ------------ ------------ ------------ ------------ ------------ Net income (loss) Property & casualty Before catastrophe losses........... $ 3.8 $ 27.7 -86.3% $ (23.9) $ 12.5 Catastrophe losses, after tax....... (21.6) (7.8) (13.8) (7.3) ------------ ------------ ------------ ------------ Total including catastrophe losses ......................... (17.8) 19.9 (37.7) 5.2 Annuity................................ 14.4 17.0 -15.3% (2.6) 20.6 Life................................... 13.4 18.9 -29.1% (5.5) 18.7 Corporate and other (1)................ 9.0 (44.5) 53.5 (18.9) ------------ ------------ ------------ ------------ Total............................ $ 19.0 $ 11.3 68.1% $ 7.7 $ 25.6 ============ ============ ============ ============ Net income per share, diluted............. $ 0.44 $ 0.28 57.1% $ 0.16 $ 0.63 ============ ============ ============ ============ Property and casualty GAAP combined ratio: Before catastrophe losses........... 106.1% 99.6% 6.5% 104.6% After catastrophe losses............ 112.3% 101.9% 10.4% 106.8%
- ---------- (1) The Corporate and Other segment includes interest expense on debt, realized investment gains and losses, certain public company expenses and other corporate level items. The Company does not allocate the impact of corporate level transactions to the insurance segments, consistent with management's evaluation of the results of those segments Net income for the property and casualty segment has been significantly impacted by adverse development of prior years' reserves and, in 2003, catastrophe losses which are described in "Results of Operations for the Three Years Ended December 31, 2003 -- Benefits, Claims and Settlement Expenses". Annuity segment net income in 2003 decreased $2.6 million compared to 2002 which, in turn, declined by $3.6 million compared to 2001. 2003 income was adversely impacted by a reduction in the pretax net interest margin of $6.2 million, reflecting spread compression due to lower investment income. Partially offsetting this, valuation of annuity segment deferred acquisition costs and value of acquired insurance in force at December 31, 2003 resulted in a $2.6 million reduction in amortization compared to a minimal impact resulting from similar valuations a year earlier. 2002 annuity segment net income, particularly for the last half of 2002, was adversely impacted by reductions in investment income as a result of investment credit issues, declining interest rates and the increase in company-wide operating expenses. F-22 Life segment net income decreased $5.5 million compared to 2002, primarily reflecting a decline in investment income, an increase in mortality costs and fees in 2003 related to the Company's surplus relief transactions. 2002 life segment net income was comparable to 2001. The change in the 2003 net income (loss) for the Corporate and Other segment compared to 2002 primarily reflected realized investment gains in 2003 compared to realized investment losses, including impairment charges, in 2002. Interest expense on the Company's outstanding debt decreased compared to the prior year, reflecting refinancing transactions completed in the last eight months of 2002. The increase in the net loss for the corporate and other segment in 2002 compared to 2001 primarily reflected the significant increase in realized investment losses in 2002, as described above. This segment benefited from the change in accounting, which was effective January 1, 2002, that eliminated goodwill amortization. For the year ended December 31, 2001, amortization of goodwill was $1.6 million. In 2001, the loss for the corporate and other segment reflected (1) a pretax charge of $3.0 million related to problems with the life insurance tax status of certain of the Company's life policies and also (2) a $3.0 million reduction of the Company's tax provision, reflecting the release of excess tax provision previously recorded. In May, September and October 2002, the Company used a portion of the proceeds from the sale of its Convertible Notes to repay the balance outstanding under the previous Bank Credit Agreement and repurchase $71.4 million of its outstanding Senior Notes and $53.0 million aggregate principal amount, $25.2 million carrying value, of its outstanding Senior Convertible Notes. The debt retirement in 2002 resulted in a pretax charge of $2.3 million. In June 2002, the Company recorded a pretax charge of $1.6 million to income, representing the Company's best estimate of the costs of resolving class action lawsuits related to diminished value brought against the Company. In addition, in the third quarter of 2002 the Company recorded a pretax charge of $4.2 million due to restructuring of its property and casualty claim operations. These three charges were reflected in the Corporate and Other net loss for the year ended December 31, 2002. In 2001, the Company reached conclusion on its strategic direction for automobile business in the State of Massachusetts and recorded charges of $7.3 million pretax related to actions to restructure its presence in the Massachusetts automobile market. Also in 2001, the Company recorded federal income tax benefits of $1.3 million due to resolution of the Company's liability for the 1997 tax year. Return on shareholders' equity based on net income was 3%, 2% and 6% for the 12 months ended December 31, 2003, 2002 and 2001, respectively. Based on the Company's full year 2003 results and generally positive underlying operating trends, at the time of this Report on Form 10-K, management anticipates that 2004 full year net income before realized investment gains and losses will be within a range of $1.20 to $1.30 per share. This projection reflects management's anticipation of improvement in the underlying (current accident year) property and casualty combined ratio and stabilization of income from the annuity and life segments. As described in "Critical Accounting Policies," certain of the Company's significant accounting measurements require the use of estimates and assumptions. As additional information becomes available, adjustments may be required. Those adjustments are charged or credited to income for the period in which the adjustments are made and may impact actual results compared to management's current estimate. A projection of net income is not accessible on a forward-looking basis because it is not possible F-23 to provide a reliable forecast of realized investment gains and losses, which can vary substantially from one period to another and may have a significant impact on net income. Liquidity and Financial Resources Special Purpose Entities At December 31, 2003, 2002 and 2001, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. As such, the Company is not exposed to any financing, liquidity, market or credit risk that could arise if the Company had engaged in such relationships. Related Party Transactions The Company does not have any contracts or other transactions with related parties that are required to be reported under the applicable securities laws and regulations. Ariel Capital Management, Inc., HMEC's largest shareholder with 30% of the common shares outstanding per their SEC filing on Form 13F as of December 31, 2003, is the investment adviser for two of the mutual funds offered to the Company's annuity customers. In addition, T. Rowe Price Associates, Inc., HMEC's third largest shareholder with 8% of the common shares outstanding per their SEC filing on Form 13F as of December 31, 2003, is the investment advisor for two of the mutual funds offered to the Company's annuity customers. Investments Information regarding the Company's investment portfolio, which is comprised primarily of investment grade, fixed income securities, is located in "Business -- Investments". 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 debt. Operating Activities As a holding company, HMEC conducts its principal operations in the personal lines segment of the property and casualty and life insurance industries through its subsidiaries. HMEC's insurance subsidiaries generate cash flow from premium and investment income, generally well in excess of their immediate needs for policy obligations, operating expenses and other cash requirements. Cash provided by operating activities primarily reflects net cash generated by the insurance subsidiaries. For 2003, net cash provided by operating activities decreased compared to 2002 reflecting an increase in federal income taxes paid, a reduction F-24 in investment income collected, and an increase in net cash used for insurance underwriting. In 2003 and 2002, the Company made cash contributions to its defined benefit pension plan trust fund of $8.8 million and $7.9 million, respectively, both exceeding the actuarially-determined required minimum amount. Payment of principal and interest on debt, fees related to the catastrophe-linked equity put option and reinsurance agreement, dividends to shareholders and parent company operating expenses, as well as the share repurchase program, are dependent upon the ability of the insurance subsidiaries to pay cash dividends or make other cash payments to HMEC, including tax payments pursuant to tax sharing agreements. The insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. Dividends which may be paid by the insurance subsidiaries to HMEC during 2004 without prior approval are approximately $43 million. Although regulatory restrictions exist, dividend availability from subsidiaries has been, and is expected to be, adequate for HMEC's capital needs. Investing Activities HMEC's insurance subsidiaries maintain significant investments in fixed maturity securities to meet future contractual obligations to policyholders. In conjunction with its management of liquidity and other asset/liability management objectives, the Company, from time to time, will sell fixed maturity securities prior to maturity and reinvest the proceeds in other investments with different interest rates, maturities or credit characteristics. Accordingly, the Company has classified the entire fixed maturity securities portfolio as "available for sale." Financing Activities Financing activities include primarily payment of dividends, the receipt and withdrawal of funds by annuity contractholders, repurchases of the Company's common stock, and borrowings, repayments and repurchases related to its debt facilities. Fees related to the catastrophe-linked equity put option and reinsurance agreement, which augments the Company's traditional reinsurance program, have been charged directly to additional paid-in capital. For the year ended December 31, 2003, receipts from annuity contracts increased 13.4%. Annuity contract maturities and withdrawals decreased $97.0 million, or 51.1%, compared to the prior year. Cash value retentions for variable and fixed annuity options were 92.8% and 95.1%, respectively, for the 12 month period ended December 31, 2003. Net transfers to variable annuity accumulated cash values increased $95.8 million compared to the prior year. F-25 Contractual Obligations
Payments Due By Period As of December 31, 2003 ------------------------------------------------------------------------ More Than Less Than 1 - 3 Years 3 - 5 Years 5 Years 1 Year (2005 and (2007 and (2009 and Total (2004) 2006) 2008) beyond) ------------ ------------ ------------ ------------ ------------ Short-term Obligations (1): Bank Credit Facility................... $ 25,781 $ 550 $ 25,231 -- -- Long-Term Debt Obligations (1): Convertible Notes Due 2032............. 256,694 3,484 6,968 $ 1,742 $ 244,500 Senior Notes Due 2006.................. 33,337 1,895 31,442 -- -- ------------ ------------ ------------ ------------ ------------ Total............................... $ 315,812 $ 5,929 $ 63,641 $ 1,742 $ 244,500 ============ ============ ============ ============ ============
- ---------- (1) Includes principal and interest. The Company has entered into various operating lease agreements, primarily for computer equipment, computer software and real estate (agency and claims offices across the country and portions of the home office complex). These leases have varying commitment periods with most in the 1 to 3 year range. Payments on these leases were approximately $10 million in 2003 and approximately $8 million for each of the years ended December 31, 2002 and 2001. It is anticipated that the Company's payments under operating leases for the full year 2004 will be comparable to the 2003 payments. The Company does not have any other arrangements that expose it to material liability that are not recorded in the financial statements. Capital Resources The Company has determined the amount of capital which is needed to adequately fund and support business growth, primarily based on risk-based capital formulas including those developed by the National Association of Insurance Commissioners ("NAIC"). Historically, the Company's insurance subsidiaries have generated capital in excess of such needed capital. These excess amounts have been paid to HMEC through dividends. HMEC has then utilized these dividends and its access to the capital markets to service and retire long-term debt, increase and pay dividends to its shareholders, fund growth initiatives, repurchase shares of its common stock and for other corporate purposes. Management anticipates that the Company's sources of capital will continue to generate capital in excess of the needs for business growth, debt interest payments and shareholder dividends. The total capital of the Company was $700.2 million at December 31, 2003, including $144.7 million of long-term debt and $25.0 million of short-term debt outstanding. Total debt represented 27.4% of capital excluding unrealized investment gains and losses (24.2% including unrealized investment gains and losses) at December 31, 2003, slightly above the Company's long-term target of 25%. Shareholders' equity was $530.5 million at December 31, 2003, including a net unrealized gain in the Company's investment portfolio of $81.6 million after taxes and the related impact on deferred policy acquisition costs and the value of acquired insurance in force associated with annuity and interest-sensitive life policies. The market value of the Company's common stock and the market value per share were $596.8 million and $13.97, respectively, at F-26 December 31, 2003. Book value per share was $12.42 at December 31, 2003 ($10.51 excluding investment fair value adjustments). On May 14, 2002, the Company issued $353.5 million aggregate principal amount of 1.425% Senior Convertible Notes ("Senior Convertible Notes"), which will mature on May 14, 2032, at a discount of 52.5% resulting in an effective yield of 3.0%. The Senior Convertible Notes were privately offered only to qualified institutional buyers under Rule 144A under the Securities Act of 1933 and outside the U.S. to non-U.S. persons under Regulation S under the Securities Act of 1933. A Securities and Exchange Commission registration statement registering the Senior Convertible Notes was declared effective on November 4, 2002. At a meeting held on September 10 and 11, 2002, the Company's Board of Directors authorized the Company to repurchase, from time to time, for cash or other consideration, its Senior Convertible Notes. As of December 31, 2002, net proceeds from the sale of the Senior Convertible Notes had been used to (1) repay the $53.0 million balance outstanding under the previous Bank Credit Agreement on May 14, 2002, (2) repurchase a total of $71.4 million aggregate principal amount of the Company's outstanding 6 5/8% Senior Notes due January 15, 2006 ("Senior Notes") at an aggregate cost of $74.7 million, and (3) repurchase $53.0 million aggregate principal amount, $25.2 million carrying value, of the Company's outstanding Senior Convertible Notes at an aggregate cost of $22.8 million. The remaining proceeds were used for general corporate purposes. In addition to the cash repurchase transactions, in December 2002 the Company repurchased an additional $56.0 million aggregate principal amount, $26.6 million carrying value, of the outstanding Senior Convertible Notes at an aggregate cost of $26.0 million in a non-cash transaction. As consideration for this repurchase, 1.8 million shares of HMEC's common stock were issued. Interest on the Senior Convertible Notes is payable semi-annually at a rate of 1.425% from November 14, 2002 until May 14, 2007. After that date, cash interest will not be paid on the Senior Convertible Notes prior to maturity unless contingent cash interest becomes payable. From May 15, 2007 through maturity of the Senior Convertible Notes, interest will be recognized at the effective rate of 3.0% and will represent the accrual of discount, excluding any contingent cash interest that may become payable. Contingent cash interest becomes payable if the average market price of a Senior Convertible Note for a five trading day measurement period preceding the applicable six-month period equals 120% or more of the sum of the Senior Convertible Note's issue price, accrued original issue discount and accrued cash interest, if any, for such Senior Convertible Note. The contingent cash interest payable per Senior Convertible Note with respect to any quarterly period within any six-month period will equal the then applicable conversion rate multiplied by the greater of (1) $0.105 or (2) any regular cash dividends paid by the Company per share on HMEC's common stock during that quarterly period. The Senior Convertible Notes will be convertible at the option of the holders into shares of HMEC's common stock at a conversion price of $26.74, if the conditions for conversion are satisfied. Holders may also surrender Senior Convertible Notes for conversion during any period in which the credit rating assigned to the Senior Convertible Notes is Ba2 or lower by Moody's or BB+ or lower by S&P, the Senior Convertible Notes are no longer rated by either Moody's or S&P, or the credit rating assigned to the Senior Convertible Notes has been suspended or withdrawn by either Moody's or S&P. The Senior Convertible Notes will cease to be convertible pursuant to this credit rating criteria during any period or periods in which all of the credit ratings are increased above such levels. The Senior Convertible Notes are redeemable by HMEC in whole or in part, at any time on or after May 14, 2007, at redemption F-27 prices equal to the sum of the issue price plus accrued original issue discount and accrued cash interest, if any, on the applicable redemption date. The holders of the Senior Convertible Notes may require HMEC to purchase all or a portion of their Senior Convertible Notes on either May 14, 2007, 2012, 2017, 2022, or 2027 at stated prices plus accrued cash interest, if any, to the purchase date. HMEC may pay the purchase price in cash or shares of HMEC common stock or in a combination of cash and shares of HMEC common stock. The Senior Convertible Notes have an investment grade rating from Standard & Poor's Corporation ("S&P") (BBB), Moody's Investors Service, Inc. ("Moody's") (Baa3), Fitch Ratings, Ltd. ("Fitch") (BBB+), and A.M. Best Company, Inc. ("A.M. Best") (bbb-). Also see "Financial Ratings". The Senior Convertible Notes are traded in the open market (HMN 1.425). In January 1996, the Company issued $100.0 million aggregate principal amount of 6 5/8% Senior Notes ("Senior Notes") at a discount of 0.5% which will mature on January 15, 2006. In 2002, the Company repurchased $71.4 million aggregate principal amount of its outstanding Senior Notes utilizing a portion of the proceeds from the issuance of the Senior Convertible Notes, as described above. 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 S&P (BBB), Moody's (Baa3), Fitch (BBB+) and A.M. Best (bbb-). The Senior Notes are traded on the New York Stock Exchange (HMN 6 5/8). On December 31, 2003, the Company borrowed $25.0 million under its Bank Credit Agreement at an interest rate of Interbank Offering Rate plus 1.0%, or 2.2%. The Bank Credit Agreement provides for unsecured borrowings of up to $25.0 million, with a provision that allows the commitment amount to be increased to $35.0 million (the "Bank Credit Facility"). The Bank Credit Facility expires on May 31, 2005. Interest accrues at varying spreads relative to corporate or eurodollar base rates and is payable monthly or quarterly depending on the applicable base rate. The unused portion of the Bank Credit Facility is subject to a variable commitment fee, which was 0.25% on an annual basis at December 31, 2003. To provide additional capital management flexibility, the Company filed a "universal shelf" registration on Form S-3 with the SEC in December 2003. The registration statement, which registers the offer and sale by the Company from time to time of up to $300 million of various securities, which may include debt securities, preferred stock, common stock and/or depositary shares, was declared effective on December 30, 2003. No securities associated with the registration statement have been issued as of the date of this Report on Form 10-K. The Company's ratio of earnings to fixed charges for the year ended December 31, 2003 was 4.0x, reflecting the impact of $56.4 million of pretax adverse development of prior years' property and casualty reserves recorded in 2003, compared to 1.9x for the prior year which reflected $49.4 million of pretax realized investment losses recognized during 2002. Total shareholder dividends were $18.0 million for the year ended December 31, 2003. In March 2004, the Board of Directors announced a regular quarterly dividend of $0.105 per share. Information regarding the reinsurance program for the Company's property and casualty segment is located in "Business -- Property and Casualty Segment -- Property and Casualty Reinsurance". F-28 On December 31, 2003, the Company's primary life insurance subsidiary, Horace Mann Life Insurance Company ("HMLIC"), entered into a reinsurance agreement with the United States branch of Sun Life Assurance Company of Canada ("SLACC") which replaced the 2002 agreement with Sun Life Reinsurance Company Limited ("SLRCL"), a member of the Sun Life Financial Group. Under the terms of the December 31, 2003 agreement, which is expected to be in place for a five year period, HMLIC ceded to SLACC, on a combination coinsurance and modified coinsurance basis, a 75% quota share of HMLIC's in force interest-sensitive life block of business issued prior to January 1, 2002. SLACC assumes its proportional share of all risks attendant to the business reinsured such as mortality, persistency and investment risk, reducing HMLIC's liabilities under statutory accounting principles to the extent of the ceded commission. The initial ceded commission received by HMLIC was $50.0 million and resulted in a $32.5 million after-tax increase in HMLIC's statutory surplus. Subsequent growth in HMLIC's statutory surplus is expected to be reduced by approximately $6.5 million annually, as the coinsurance reserve declines over the term of the agreement. Fees related to these transactions, which are anticipated to reduce the Company's pretax GAAP income by approximately $1 million in 2004, are also expected to decline over the term of the agreement. These transactions improved the statutory operating leverage and risk-based capital ratio of HMLIC in 2003 and 2002. The agreement contains a condition whereby HMLIC must maintain an S&P financial strength rating of BBB- or higher. If this condition is not maintained for a period of more than 60 consecutive days, HMLIC may recapture the agreement without penalty after giving 30 days written notice. Financial Ratings The Company's principal insurance subsidiaries are rated by Standard & Poor's Corporation ("S&P"), Moody's Investors Service, Inc. ("Moody's"), Fitch Ratings, Ltd. ("Fitch") and A.M. Best Company, Inc. ("A.M. Best"). These rating agencies have also assigned ratings to the Company's long-term debt securities. Assigned ratings as of March 1, 2004 were as follows (the insurance financial strength ratings for the Company's property and casualty insurance subsidiaries and the Company's principal life insurance subsidiary are the same, except where indicated): Insurance Financial Strength Ratings Debt Ratings (Outlook) (Outlook) ---------------- ---------------- As of March 1, 2004 - ------------------------------- S&P (1)........................ A (negative) BBB (negative) Moody's (1).................... P&C: A3 (negative) Baa3 (negative) Life: A3 (stable) Fitch.......................... A+ (negative) BBB+ (negative) A.M. Best...................... A- (stable) bbb- (stable) - ---------- (1) This agency has not yet rated Horace Mann Lloyds. In October 2003, Fitch lowered by one notch the insurance financial strength and senior debt ratings of Horace Mann Educators Corporation. The financial strength ratings of the Company's insurance subsidiaries were lowered to "A+" from "AA-" and the senior debt ratings were lowered to "BBB+" from "A-". At that time, the outlook for each of the ratings was Stable. F-29 Fitch indicated that the rating action reflected their belief that it will be difficult for Horace Mann's property and casualty operations to return to the significantly better than industry average underwriting performance that had historically been achieved. Additionally, Fitch believed that life and annuity earnings and surplus growth for 2003 would be below historical levels due to spread compression on the fixed annuity products and lower levels of separate account assets under management. Fitch also indicated that the ratings continue to be supported by the Company's strong risk based capitalization, well defined market niche in the educator market, strong reinsurance protection and a high quality, liquid investment portfolio. Fitch noted that the Company continues to have an advantageous position in the educator marketplace and reasonable business strategies for profitable growth. On October 27, 2003, the Company pre-announced the third quarter 2003 adverse development and strengthening of property and casualty reserves and the related impact on net income for the third quarter of 2003. Following this announcement, S&P placed the Company's "BBB+" debt ratings and "A+" financial strength ratings on CreditWatch with negative implications. Moody's also placed the Company's "Baa2" debt ratings and "A2" insurance financial strength ratings on review for possible downgrade. Both rating agencies noted that they would review and update their analyses of the Company's property and casualty reserve adequacy and development trends, as well as prospective earnings, interest coverage, capitalization levels and spread compression on the Company's annuity business. In November 2003, A.M. Best lowered by one notch the Company's financial strength and debt ratings. The financial strength rating was lowered to "A-" from "A" and the debt ratings were lowered to "bbb-" from "bbb+". A.M. Best indicated that the downgrades reflected the decline in capitalization driven by unfavorable operating results in recent years in the property and casualty operations. A.M. Best also noted that, although it had declined, the property and casualty capital position continued to support the "A- (Excellent)" rating. A.M. Best's announcement also noted positive factors regarding the Company's operations, similar to the Fitch announcement in October 2003. The outlook for each of the ratings is Stable, as confirmed in a subsequent press release which A.M. Best issued in December 2003. In December 2003, Moody's lowered by one notch the Company's financial strength and debt ratings primarily as a result of the Company's ongoing struggles with adverse development of prior years' property and casualty reserves and the impact that has had on earnings and organic capital growth. The financial strength rating was lowered to "A3" from "A2" and its debt rating was lowered to "Baa3" from "Baa2". The outlook for the debt rating and the financial strength rating for the property and casualty subsidiaries remained Negative, reflecting the agency's continued concerns with the Company's ability to improve earnings over the near-term. The outlook for the financial strength rating of the principal life subsidiary is Stable. Also in December 2003, S&P lowered by one notch the Company's financial strength and debt ratings, citing reasons similar to those of Moody's. The financial strength rating was lowered to "A" from "A+" and the debt rating was lowered to "BBB" from "BBB+". Although the announcement noted a number of positive operating factors, the outlook for each of the ratings remained Negative. In February 2004, Fitch revised the outlook on the Company's "A+" financial strength ratings and "BBB+" debt ratings to Negative. The change in outlook followed the Company's announcement of fourth quarter and full year 2003 earnings which included property and F-30 casualty results that were outside of Fitch's previous expectations. Fitch reiterated that the Company's solid risk-based capitalization, sound catastrophe reinsurance program and high quality, liquid investment portfolio continue to support the ratings as assigned. Market Value Risk Market value risk, the Company's primary market risk exposure, is the risk that the Company's invested assets will decrease in value. This decrease in value may be due to a change in (1) the yields realized on the Company's assets and prevailing market yields for similar assets, (2) an unfavorable change in the liquidity of the investment, (3) an unfavorable change in the financial prospects of the issuer of the investment, or (4) a downgrade in the credit rating of the issuer of the investment. See also "Results of Operations for the Three Years Ended December 31, 2003 -- Realized Investment Gains and Losses". Significant changes in interest rates expose the Company to the risk of experiencing losses or earning a reduced level of income based on the difference between the interest rates earned on the Company's investments and the credited interest rates on the Company's insurance liabilities. The Company manages its market value risk by coordinating the projected cash inflows of assets with the projected cash outflows of liabilities. For all its assets and liabilities, the Company seeks to maintain reasonable durations, consistent with the maximization of income without sacrificing investment quality, while providing for liquidity and diversification. The investment risk associated with variable annuity deposits and the underlying mutual funds is assumed by those contractholders, and not by the Company. Certain fees that the Company earns from variable annuity deposits are based on the market value of the funds deposited. Through active investment management, the Company invests available funds with the objective of funding future obligations to policyholders, subject to appropriate risk considerations, and maximizing shareholder value. This objective is met through investments that (1) have similar characteristics to the liabilities they support; (2) are diversified among industries, issuers and geographic locations; and (3) are predominately investment-grade fixed maturity securities classified as available for sale. No derivatives are used to manage the exposure to interest rate risk in the investment portfolios. At December 31, 2003, approximately 20% of the fixed investment portfolio represented investments supporting the property and casualty operations and approximately 80% supported the life and annuity business. For a discussion regarding the Company's investments see "Business -- Investments." The Company's life and annuity earnings are affected by the spreads between interest yields on investments and rates credited or accruing on life and fixed annuity insurance liabilities. Although substantially all credited rates on fixed annuities may be changed annually (subject to minimum guaranteed rates), competitive pricing and other factors, including the impact on the level of surrenders and withdrawals, may limit the Company's ability to adjust or to maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. Using financial modeling and other techniques, the Company regularly evaluates the appropriateness of investments relative to the characteristics of the liabilities that they support. Simulations of cash flows generated from existing business under various interest rate F-31 scenarios measure the potential gain or loss in fair value of interest-rate sensitive assets and liabilities. Such estimates are used to closely match the duration of assets to the duration of liabilities. The overall duration of liabilities of the Company's multiline insurance operations combines the characteristics of its long duration interest-sensitive life and annuity liabilities with its short duration non-interest-sensitive property and casualty liabilities. Overall, at December 31, 2003, the duration of both the investment portfolio and the Company's insurance liabilities was approximately 6.0 years. The life and annuity operations participate in the cash flow testing procedures imposed by statutory insurance regulations, the purpose of which is to insure that such liabilities are adequate to meet the Company's obligations under a variety of interest rate scenarios. Based on these procedures, the Company's assets and the investment income expected to be received on such assets are adequate to meet the insurance policy obligations and expenses of the Company's insurance activities in all but the most extreme circumstances. The Company periodically evaluates its sensitivity to interest rate risk. Based on commonly used models, the Company projects the impact of interest rate changes, assuming a wide range of factors, including duration and prepayment, on the fair value of assets and liabilities. Fair value is estimated based on the net present value of cash flows or duration estimates. At December 31, 2003, assuming an immediate decrease of 100 basis points in interest rates, the net fair value of the Company's assets and liabilities would increase by approximately $6 million after tax, or 1% of shareholders' equity. A 100 basis point increase would decrease the fair value of assets and liabilities by approximately $20 million after tax, or 4% of shareholders' equity. At December 31, 2002, assuming an immediate decrease of 100 basis points in interest rates, the net fair value of the Company's assets and liabilities would have decreased by approximately $21 million after tax, or 4% of shareholders' equity. A 100 basis point increase would have decreased the fair value of assets and liabilities by $2 million after tax, or less than 1% of shareholders' equity. In each case, these changes in interest rates assume a parallel shift in the yield curve. While the Company believes that these assumed market rate changes are reasonably possible, actual results may differ, particularly as a result of any management actions that would be taken to mitigate such hypothetical losses in fair value of shareholders' equity. Based on the Company's overall exposure to interest rate risk, the Company believes that these changes in interest rates would not materially affect its consolidated near-term financial position, results of operations or cash flows. Information Systems Risk The Company administers its insurance business with information systems that are dated and complex, and require extensive manual input, calculation and control procedures. These systems are more prone to error than more advanced technology systems. To address these issues, over the past three years the Company has enhanced its existing systems and technology infrastructure and has begun installing new systems, including a new general ledger and financial reporting system which was implemented in the second quarter of 2003 and a new property and casualty claims administration system being implemented over the twelve months ending June 30, 2004. In the meantime, enhanced checks and control procedures have been established to review the output of existing information systems, including periodic internal and external third party reviews. Nevertheless, there are risks that F-32 inaccuracies in the processing of data may occur which might not be identified by those procedures and checks on a timely basis. Business Continuity Risk Given the events of September 11, 2001, the continuing threat of terrorism and the current geopolitical climate, the Company has undertaken a reassessment of its business continuity plans. While current contingency plans are felt to be adequate to restore some of the more critical business processes and the Company is aggressively working to strengthen its continuity plans, in the current environment there is believed to exist a higher than acceptable level of risk that the Company's ability to recover and resume most or all of its key business operations on a timely basis would be compromised. Recent Accounting Changes SOP 03-1 In July 2003, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts for Separate Accounts." This SOP is effective for fiscal years beginning after December 15, 2003. The new rules change accounting for separate accounts and sales inducements and change the liability model by expanding the definition of "account balance" and addressing annuitization guarantees and minimum guaranteed death benefits. The adoption of this SOP is currently not expected to have a material impact on the Company's operating results or financial position. Effects of Inflation and Changes in Interest Rates The Company's operating results are affected significantly in at least three ways by changes in interest rates and inflation. First, inflation directly affects property and casualty claims costs. Second, the investment income earned on the Company's investment portfolio and the fair value of the investment portfolio are related to the yields available in the fixed-income markets. An increase in interest rates will decrease the fair value of the investment portfolio, but will increase investment income as investments mature and proceeds are reinvested at higher rates. Third, as interest rates increase, competitors will typically increase crediting rates on annuity and interest-sensitive life products, and may lower premium rates on property and casualty lines to reflect the higher yields available in the market. The risk of interest rate fluctuation is managed through asset/liability management techniques, including cash flow analysis. F-33 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, 2003 and 2002, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for the years ended December 31, 2003, 2002 and 2001 have been prepared by management, which is responsible for their integrity and reliability. The statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include some amounts that are based upon management's best estimates and judgements. Management has discussed with the Audit Committee the quality, not just the acceptability, of the Company's accounting principles as applied in its financial reporting. The discussions generally included such matters as the consistency of the Company's accounting policies and their application, and the clarity and completeness of the Company's financial statements, which include related disclosures. The financial information contained elsewhere in this annual report on Form 10-K is consistent with that contained in the financial statements. Management is responsible for establishing and maintaining a system of internal control designed to provide reasonable assurance as to the integrity and reliability of financial reporting. The concept of reasonable assurance is based on the recognition that there are inherent limitations in all systems of internal control, and that the cost of such systems should not exceed the benefits derived therefrom. A professional staff of internal auditors reviews on an ongoing basis the related internal control system design, the accounting policies and procedures supporting this system and compliance therewith. Management believes this system of internal control effectively meets its objective of reliable financial reporting. In connection with their annual audits, independent certified public accountants perform an examination, in accordance with auditing standards generally accepted in the United States of America, which includes the consideration of the system of internal control to the extent necessary to form an independent opinion on the fairness of presentation of the financial statements prepared by management and not to provide assurance on the system of internal controls. The Board of Directors, through its Audit Committee composed solely of independent directors, is responsible for overseeing the integrity and reliability of the Company's accounting and financial reporting practices and the effectiveness of its system of internal controls. The independent certified public accountants and internal auditors meet regularly with this committee, and have access to this committee with and without management present, to discuss the results of their audit work. F-34 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, 2003 and 2002, 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, 2003. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules, as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Horace Mann Educators Corporation and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. As discussed in note 1 to the consolidated financial statements, in 2002 the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets". /s/ KPMG LLP KPMG LLP Chicago, Illinois February 17, 2004 F-35 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED BALANCE SHEETS As of December 31, 2003 and 2002 (Dollars in thousands) 2003 2002 ------------ ------------ ASSETS Investments Fixed maturities, available for sale, at fair value (amortized cost 2003, $3,124,861; 2002, $2,859,007)................ $ 3,258,674 $ 2,991,195 Short-term and other investments.............. 104,904 135,431 Short-term investments, loaned securities collateral................................... 22,147 3,937 ------------ ------------ Total investments.......................... 3,385,725 3,130,563 Cash............................................. 19,773 60,162 Accrued investment income and premiums receivable...................................... 99,370 99,954 Deferred policy acquisition costs................ 193,703 174,555 Goodwill......................................... 47,396 47,396 Value of acquired insurance in force............. 27,259 31,945 Other assets..................................... 80,531 113,244 Variable annuity assets.......................... 1,119,231 854,470 ------------ ------------ Total assets............................... $ 4,972,988 $ 4,512,289 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities Fixed annuity contract liabilities............ $ 1,526,174 $ 1,385,737 Interest-sensitive life contract liabilities.................................. 567,209 544,533 Unpaid claims and claim expenses.............. 350,501 326,575 Future policy benefits........................ 181,344 180,577 Unearned premiums............................. 198,991 189,384 ------------ ------------ Total policy liabilities................... 2,824,219 2,626,806 Other policyholder funds......................... 129,888 125,108 Liability for securities lending agreements...... 22,147 3,937 Other liabilities................................ 177,325 228,441 Short-term debt.................................. 25,000 -- Long-term debt................................... 144,703 144,685 Variable annuity liabilities..................... 1,119,231 854,470 ------------ ------------ Total liabilities.......................... 4,442,513 3,983,447 ------------ ------------ 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, 2003, 60,225,311; 2002, 60,194,615................................ 60 60 Additional paid-in capital....................... 342,306 342,749 Retained earnings................................ 456,330 455,308 Accumulated other comprehensive income (loss), net of taxes: Net unrealized gains on fixed maturities and equity securities........................ 81,608 80,567 Minimum pension liability adjustment.......... (17,252) (17,265) Treasury stock, at cost, 2003 and 2002, 17,503,371 shares............................... (332,577) (332,577) ------------ ------------ Total shareholders' equity................. 530,475 528,842 ------------ ------------ Total liabilities and shareholders' equity.................................... $ 4,972,988 $ 4,512,289 ============ ============ See accompanying notes to consolidated financial statements. F-36 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share data)
Year Ended December 31, ------------------------------------------ 2003 2002 2001 ------------ ------------ ------------ Insurance premiums written and contract deposits................................. $ 955,459 $ 899,329 $ 875,566 ============ ============ ============ Revenues Insurance premiums and contract charges earned........................ $ 643,536 $ 625,233 $ 615,242 Net investment income.................. 184,725 196,048 199,267 Realized investment gains (losses)..... 25,487 (49,407) (10,019) ------------ ------------ ------------ Total revenues...................... 853,748 771,874 804,490 ------------ ------------ ------------ Benefits, losses and expenses Benefits, claims and settlement expenses.............................. 518,978 450,866 475,583 Interest credited...................... 102,970 98,380 96,502 Policy acquisition expenses amortized............................. 64,345 61,297 58,048 Operating expenses..................... 137,318 131,339 123,679 Amortization of intangible assets...... 5,027 5,734 5,774 Interest expense....................... 6,339 8,517 9,250 Restructuring charges (adjustments).... (408) 4,223 7,312 Debt retirement costs.................. -- 2,272 -- Litigation charges..................... -- 1,581 -- ------------ ------------ ------------ Total benefits, losses and expenses........................... 834,569 764,209 776,148 ------------ ------------ ------------ Income before income taxes................ 19,179 7,665 28,342 Income tax expense (benefit).............. 204 (3,668) 2,755 ------------ ------------ ------------ Net income................................ $ 18,975 $ 11,333 $ 25,587 ============ ============ ============ Earnings per share Basic.................................. $ 0.44 $ 0.28 $ 0.63 ============ ============ ============ Diluted................................ $ 0.44 $ 0.28 $ 0.63 ============ ============ ============ Weighted average number of shares and equivalent shares Basic............................... 42,712,822 40,941,182 40,616,843 Diluted............................. 42,904,167 41,199,033 40,877,120
See accompanying notes to consolidated financial statements. F-37 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in thousands, except per share data)
Year Ended December 31, ------------------------------------------ 2003 2002 2001 ------------ ------------ ------------ Common stock Beginning balance...................... $ 60 $ 60 $ 60 Options exercised, 2002, 107,410 shares; 2001, 207,575 shares.......... -- -- -- Conversion of Director Stock Plan units, 2003, 30,696 shares; 2002, 10,284 shares; 2001, 10,293 shares.... -- -- -- ------------ ------------ ------------ Ending balance......................... 60 60 60 ------------ ------------ ------------ Additional paid-in capital Beginning balance...................... 342,749 341,052 338,243 Options exercised and conversion of Director Stock Plan units............. 645 2,183 3,759 Catastrophe-linked equity put option premium........................ (1,088) (1,088) (950) Issuance of treasury shares in 2002.... -- 602 -- ------------ ------------ ------------ Ending balance......................... 342,306 342,749 341,052 ------------ ------------ ------------ Retained earnings Beginning balance...................... 455,308 461,139 452,624 Net income............................. 18,975 11,333 25,587 Cash dividends, $0.42 per share........ (17,953) (17,164) (17,072) ------------ ------------ ------------ Ending balance......................... 456,330 455,308 461,139 ------------ ------------ ------------ Accumulated other comprehensive income (loss), net of taxes: Beginning balance...................... 63,302 14,898 (4,975) Change in net unrealized gains (losses) on fixed maturities and equity securities..................... 1,041 54,231 30,374 (Increase) decrease in minimum pension liability adjustment.......... 13 (5,827) (10,501) ------------ ------------ ------------ Ending balance......................... 64,356 63,302 14,898 ------------ ------------ ------------ Treasury stock, at cost Beginning balance, 2003,17,503,371 shares; 2002 and 2001, 19,341,296 shares................................ (332,577) (357,959) (357,959) Issuance of 1,837,925 shares in 2002... -- 25,382 -- ------------ ------------ ------------ Ending balance 2003 and 2002, 17,503,371 shares; 2001, 19,341,296 shares................................ (332,577) (332,577) (357,959) ------------ ------------ ------------ Shareholders' equity at end of period..... $ 530,475 $ 528,842 $ 459,190 ============ ============ ============ Comprehensive income Net income............................. $ 18,975 $ 11,333 $ 25,587 Other comprehensive income, net of tax: Change in net unrealized gains (losses) on fixed maturities and equity securities.................. 1,041 54,231 30,374 (Increase) decrease in minimum pension liability adjustment....... 13 (5,827) (10,501) ------------ ------------ ------------ Other comprehensive income....... 1,054 48,404 19,873 ------------ ------------ ------------ Total......................... $ 20,029 $ 59,737 $ 45,460 ============ ============ ============
See accompanying notes to consolidated financial statements. F-38 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
Year Ended December 31, ------------------------------------------ 2003 2002 2001 ------------ ------------ ------------ Cash flows from operating activities Premiums collected..................... $ 684,331 $ 663,682 $ 642,596 Policyholder benefits paid............. (500,634) (465,811) (487,619) Policy acquisition and other operating expenses paid............... (221,499) (206,457) (193,713) Federal income taxes recovered (paid)................................ (19,001) (2,055) 7,520 Investment income collected............ 185,359 197,872 195,086 Interest expense paid.................. (5,454) (9,540) (9,091) Contribution to defined benefit pension plan trust fund............... (8,780) (7,910) -- Other.................................. 3,086 (4,314) (5,922) ------------ ------------ ------------ Net cash provided by operating activities......................... 117,408 165,467 148,857 ------------ ------------ ------------ Cash flows used in investing activities Fixed maturities Purchases........................... (1,762,957) (1,546,528) (1,140,930) Sales............................... 922,699 1,117,268 732,076 Maturities.......................... 560,915 274,134 283,153 Net cash (used for) provided by short-term and other investments...... 35,437 (28,776) (2,107) ------------ ------------ ------------ Net cash used in investing activities......................... (243,906) (183,902) (127,808) ------------ ------------ ------------ Cash flows provided by (used in) financing activities Dividends paid to shareholders......... (17,953) (17,164) (17,072) Principal borrowings (repayments) on Bank Credit Facility............... 25,000 (53,000) 4,000 Exercise of stock options.............. -- 2,183 3,759 Catastrophe-linked equity put option premium............................... (1,088) (1,088) (950) Proceeds from issuance of Senior Convertible Notes..................... -- 162,654 -- Repurchase of Senior Notes and Senior Convertible Notes..................... -- (97,523) -- Annuity contracts, variable and fixed Deposits............................ 296,615 261,509 239,124 Maturities and withdrawals.......... (92,791) (189,824) (178,364) Net transfer to variable annuity assets............................. (113,074) (17,264) (53,550) Net decrease in life policy account balances.............................. (10,600) (5,825) (5,198) ------------ ------------ ------------ Net cash provided by (used in) financing activities............... 86,109 44,658 (8,251) ------------ ------------ ------------ Net increase (decrease) in cash........... (40,389) 26,223 12,798 Cash at beginning of period............... 60,162 33,939 21,141 ------------ ------------ ------------ Cash at end of period..................... $ 19,773 $ 60,162 $ 33,939 ============ ============ ============
See accompanying notes to consolidated financial statements. F-39 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share data) NOTE 1 - Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and with the rules and regulations of the Securities and Exchange Commission. 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, 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" or "Horace Mann"). HMEC and its subsidiaries have common management, share office facilities and are parties to several intercompany service agreements for management, administrative, data processing, agent commissions, agency services, utilization of personnel and investment advisory services. Under these agreements, costs have been allocated among the companies in conformity with customary insurance accounting practices consistently applied. In addition, certain of the subsidiaries have entered into intercompany reinsurance agreements. HMEC and its subsidiaries file a consolidated federal income tax return, and there are related tax sharing agreements. All significant intercompany balances and transactions have been eliminated in consolidation. The subsidiaries of HMEC market and underwrite tax-qualified retirement annuities and private passenger automobile, homeowners, and life insurance products, primarily to educators and other employees of public schools and their families. The Company's principal operating subsidiaries are Horace Mann Life Insurance Company, Horace Mann Insurance Company, Teachers Insurance Company, Horace Mann Property & Casualty Insurance Company and Horace Mann Lloyds. Investments The Company invests primarily in fixed maturity investments. These securities are classified as available for sale and carried at fair value. The net adjustment for unrealized gains and losses on securities available for sale, carried at fair value, is recorded as a separate component of shareholders' equity, net of applicable deferred tax asset or liability and the related impact on deferred policy acquisition costs and value of acquired insurance in force associated with interest-sensitive life and annuity contracts. F-40 NOTE 1 - Summary of Significant Accounting Policies-(Continued) Short-term and other investments are comprised of policy loans, carried at unpaid principal balances; short-term fixed interest securities, carried at cost which approximates fair value; mortgage loans, carried at unpaid principal less a valuation allowance for estimated uncollectible amounts; real estate acquired in the settlement of debt, carried at the lower of cost or fair value; and equity securities, carried at fair value. Interest income is recognized as earned. Investment income reflects amortization of premiums and accrual of discounts on an effective-yield basis. Realized gains and losses arising from the sale or impairment of securities are determined based upon specific identification of securities. The Company reviews the fair value of all investments in its portfolio on a monthly basis to assess whether an other-than-temporary decline in value has occurred. These reviews, in conjunction with the Company's investment managers' monthly credit reports and relevant factors such as (1) the financial condition and near-term prospects of the issuer, (2) the Company's intent and ability to retain the investment long enough to allow for the anticipated recovery in fair value, (3) the stock price trend of the issuer, (4) the market leadership position of the issuer, (5) the debt ratings of the issuer and (6) the cash flows of the issuer, are all considered in the impairment assessment. A write-down of an investment is recorded when a decline in the fair value of that investment is deemed to be other-than-temporary, with a realized investment loss charged to income for the period. The Company's methodology of assessing other-than-temporary impairments is based on security-specific facts and circumstances as of the date of the reporting period. Based on these facts, if management believes it is probable that amounts due will not be collected according to the contractual terms of a debt security not impaired at acquisition, or if the Company does not have the ability or intent to hold a security with an unrealized loss until it matures or recovers in value, an other-than-temporary impairment shall be considered to have occurred. As a general rule, if the fair value of a debt security has fallen below 80% of book value for more than six months, this security will be reviewed for an other-than-temporary impairment. Additionally, if events become known that call into question whether the security issuer has the ability to honor its contractual commitments, whether or not such security has been trading above an 80% fair value to book value relationship, such security holding will be evaluated to determine whether or not such security has suffered an other-than-temporary decline in value. F-41 NOTE 1 - Summary of Significant Accounting Policies-(Continued) A decline in fair value below amortized cost is not assumed to be other-than-temporary for fixed maturity investments with unrealized losses due to market conditions or industry-related events where there exists a reasonable market recovery expectation and the Company has the intent and ability to hold the investment until maturity or a market recovery is realized. Management believes that its intent and ability to hold a fixed maturity investment with a continuous material unrealized loss due to market conditions or industry-related events for a period of time sufficient to allow a market recovery or to maturity is a decisive factor when considering an impairment loss. In the event that the Company's intent or ability to hold a fixed maturity investment with a continuous material unrealized loss for a period of time sufficient to allow a market recovery or to maturity were to change, an evaluation for other-than-temporary impairment is performed. An other-than-temporary impairment loss will be recognized based upon all relevant facts and circumstances for each investment, as appropriate, in accordance with Securities and Exchange Commission Staff Accounting Bulletin ("SAB") No. 59, "Accounting for Non-Current Marketable Equity Securities", and No. 104, "Revenue Recognition", Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities", and related guidance. Deferred Policy Acquisition Costs Deferred policy acquisition costs net of accumulated amortization were $193,703 and $174,555 as of December 31, 2003 and 2002, respectively. Policy acquisition costs, consisting of commissions, policy issuance and other costs, which vary with and are primarily related to the production of insurance business, are capitalized and amortized on a basis consistent with the type of insurance coverage. Capitalized acquisition costs for interest-sensitive life contracts are amortized over 20 years in proportion to estimated gross profits. For other individual life contracts, acquisition costs are amortized in proportion to anticipated premiums over the terms of the insurance policies (10, 15 and 20 years). For investment (annuity) contracts, acquisition costs are amortized over 20 years in proportion to estimated gross profits. For property and casualty policies, acquisition costs are amortized over the terms of the insurance policies (six and twelve months). The Company periodically reviews the assumptions and estimates used in capitalizing policy acquisition costs and also periodically reviews its estimations of gross profits. The most significant assumptions that are involved in the estimation of annuity gross profits include future financial market performance, interest rate spreads, business surrender/lapse rates and the impact of realized investment gains and losses. In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company may be required to record a material charge or credit to amortization expense for the period in which the adjustment is made. 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. F-42 NOTE 1 - Summary of Significant Accounting Policies-(Continued) Deferred policy 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. Value of Acquired Insurance In Force and Goodwill When the Company was acquired in 1989, intangible assets were recorded in the application of purchase accounting to recognize the value of acquired insurance in force and goodwill. In addition, goodwill was recorded in 1994 related to the purchase of Horace Mann Property & Casualty Insurance Company. The value of acquired insurance in force is being amortized over the following periods, utilizing the indicated methods for life and annuity, respectively, as follows: 20 years, in proportion to coverage provided; 20 years, in proportion to estimated gross profits. Goodwill was amortized over 40 years on a straight-line basis through December 31, 2001. Goodwill, net of amortization, was $47,396 at December 31, 2001. Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets". The Company's value of acquired insurance in force is an intangible asset with a definite life and will continue to be amortized under the provisions of SFAS No. 142. Goodwill will remain on the balance sheet and not be amortized. SFAS No. 142 establishes a new method of testing goodwill for impairment. On an annual basis, and when there is reason to suspect that its value may have been diminished or impaired, the goodwill asset must be tested for impairment. The amount of goodwill determined to be impaired will be expensed to current operations. During 2002 and 2003, the Company completed the required testing under SFAS No. 142; no impairment charges were necessary as a result of such assessments. The allocation of goodwill by segment was as follows: Balance as of January 1, 2002, December 31, 2002 and December 31, 2003 --------------------- Annuity............................................ $ 28,025 Life............................................... 9,911 Property and casualty.............................. 9,460 --------------------- Total........................................... $ 47,396 ===================== F-43 NOTE 1 - Summary of Significant Accounting Policies-(Continued) Net income and net income per share exclusive of goodwill amortization expense for the years ended December 31, 2003, 2002 and 2001 were as follows: Year Ended December 31, ------------------------------- 2003 2002 2001 --------- --------- --------- Reported net income............................ $ 18,975 $ 11,333 $ 25,587 Add back: Goodwill amortization................ -- -- 1,618 --------- --------- --------- Adjusted net income......................... $ 18,975 $ 11,333 $ 27,205 ========= ========= ========= Reported net income per share-basic............ $ 0.44 $ 0.28 $ 0.63 Add back: Goodwill amortization................ -- -- 0.04 --------- --------- --------- Adjusted net income per share-basic......... $ 0.44 $ 0.28 $ 0.67 ========= ========= ========= Reported net income per share-diluted.......... $ 0.44 $ 0.28 $ 0.63 Add back: Goodwill amortization................ -- -- 0.04 --------- --------- --------- Adjusted net income per share-diluted....... $ 0.44 $ 0.28 $ 0.67 ========= ========= ========= For the amortization of the value of acquired insurance in force, the Company periodically reviews its estimates of gross profits. The most significant assumptions that are involved in the estimation of gross profits include future financial market performance, interest rate spreads, business surrender/lapse rates and the impact of realized investment gains and losses. In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company may be required to record a material charge or credit to amortization expense for the period in which the adjustment is made. The value of acquired insurance in force for investment contracts (those issued prior to August 29, 1989) is adjusted for the impact on estimated future gross profits as if net unrealized investment gains and losses had been realized at the balance sheet date. The impact of this adjustment is included in net unrealized gains and losses within shareholders' equity. The balances of value of acquired insurance in force by segment at December 31, 2003 and 2002 were as follows:
December 31, 2003 December 31, 2002 ------------------------------------- ------------------------------------ Accumulated Net Accumulated Net Cost Amortization Balance Cost Amortization Balance ---------- ------------ --------- --------- ------------ --------- Life................................. $ 48,746 $ 41,502 $ 7,244 $ 48,746 $ 39,877 $ 8,869 Annuity.............................. 87,553 66,657 20,896 87,553 63,255 24,298 ---------- ------------ --------- --------- ------------ --------- Subtotal.......................... $ 136,299 $ 108,159 28,140 $ 136,299 $ 103,132 33,167 ========== ============ --------- ========= ============ --------- Impact of unrealized investment gains and losses.................... (881) (1,222) --------- --------- Total............................. $ 27,259 $ 31,945 ========= =========
Scheduled amortization of the December 31, 2003 balances of value of acquired insurance in force by segment over the next five years is as follows:
Year Ended December 31, -------------------------------------------------------------- 2004 2005 2006 2007 2008 ---------- ---------- ---------- ---------- ---------- Scheduled amortization of value of acquired insurance in force Life................................. $ 1,537 $ 1,460 $ 1,394 $ 1,338 $ 1,292 Annuity.............................. 3,544 3,893 4,270 4,572 4,617 ---------- ---------- ---------- ---------- ---------- Total............................. $ 5,081 $ 5,353 $ 5,664 $ 5,910 $ 5,909 ========== ========== ========== ========== ==========
F-44 NOTE 1 - Summary of Significant Accounting Policies-(Continued) The amount of interest accrued on the unamortized balance of value of acquired insurance in force and the interest accrual rates were as follows: Year Ended December 31, ------------------------------------ 2003 2002 2001 ---------- ---------- ---------- Interest accrued on the unamortized balance of value of acquired insurance in force Life............................... $ 645 $ 779 $ 921 Annuity............................ 1,185 1,280 1,639 ---------- ---------- ---------- Total........................... $ 1,830 $ 2,059 $ 2,560 ========== ========== ========== Interest accrual rate Life............................... 8.0% 8.0% 8.0% Annuity............................ 5.3% 5.4% 5.7% The accumulated amortization of intangibles as of December 31, 2003 and 2002 was $157,136 and $152,109, respectively. 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. The estimated useful lives of property and equipment by asset type are generally as follows: real estate, identified by specific property, 20-45 years; furniture, 10 years; general office machines, 6 years; telephones, 5 years; vehicles, 3 years; and data processing hardware and software and personal computers, 3 years. December 31, ----------------------- 2003 2002 ---------- ---------- Property and equipment................ $ 73,506 $ 73,855 Less: accumulated depreciation....... 47,959 43,921 ---------- ---------- Total.............................. $ 25,547 $ 29,934 ========== ========== F-45 NOTE 1 - Summary of Significant Accounting Policies-(Continued) Variable Annuity Assets and Liabilities Variable annuity assets, carried at market value, and liabilities represent tax-qualified variable annuity funds invested in various mutual funds, including the seven proprietary Horace Mann mutual funds. Variable annuity assets were invested in the offered mutual funds as follows: December 31, ------------------------- 2003 2002 ----------- ----------- Horace Mann Equity Fund......................... $ 325,880 $ 274,025 Horace Mann Balanced Fund....................... 270,287 240,697 Horace Mann Socially Responsible Fund........... 73,947 58,909 Horace Mann Small Cap Growth Fund............... 57,210 34,682 Horace Mann International Equity Fund........... 35,754 26,248 Wilshire Large Company Growth Portfolio - Institutional Class and Investor Class......... 28,349 19,421 Ariel Appreciation Fund......................... 27,831 14,179 Fidelity VIP 500 Index Portfolio SC2............ 26,397 14,949 Fidelity VIP Growth Portfolio SC2............... 25,960 15,040 Wilshire 5000 Index Portfolio - Institutional Class and Investor Class....................... 24,641 16,784 Fidelity VIP Mid Cap Portfolio SC2.............. 21,719 12,836 Horace Mann Income Fund......................... 20,843 19,313 Ariel Fund...................................... 18,665 9,689 T. Rowe Price Small Cap Value Fund - Advisor Class.......................................... 15,843 9,255 Alliance Bernstein Premier Growth Portfolio..... 14,744 9,298 Fidelity VIP Investment Grade Bond Portfolio SC2............................................ 13,925 9,861 Wilshire Large Company Value Portfolio.......... 13,220 8,037 Neuberger Berman Genesis Fund Advisor Class..... 12,755 7,494 T. Rowe Price Small Cap Stock Fund - Advisor Class.......................................... 11,984 7,266 JPMorgan U.S. Large Cap Core Equity Portfolio... 11,535 6,973 Strong Opportunity Fund II...................... 8,923 5,353 Fidelity VIP Overseas Portfolio SC2............. 7,948 3,917 Rainier Small/Mid Cap Equity Portfolio.......... 7,453 4,051 Fidelity VIP Growth and Income Portfolio SC2.... 7,325 4,009 Davis Value Portfolio........................... 6,781 3,743 Strong Mid Cap Growth Fund II................... 6,557 4,086 Putnam VT Vista Fund (IB Shares)................ 5,490 3,544 Horace Mann Short-Term Investment Fund.......... 4,843 4,186 Credit Suisse Small Cap Growth Portfolio........ 4,036 2,407 Wilshire Small Company Value Portfolio.......... 2,374 1,660 Wilshire Small Company Growth Portfolio......... 1,626 847 Fidelity VIP High Income Portfolio SC2.......... 1,604 652 BlackRock Index Equity Portfolio................ 1,186 386 Putnam VT George Putnam Fund of Boston (Class IB shares)..................................... 414 167 BlackRock Temp Fund............................. 371 180 Putnam VT International Growth Fund (Class IB shares)........................................ 263 85 BlackRock Low Duration Bond Fund................ 218 118 BlackRock Core Bond Total Return Fund........... 209 85 T. Rowe Price Science & Technology Fund......... 111 -- Templeton Foreign Smaller Companies Fund (Class A)...................................... 10 2 Berger Information Technology Fund.............. -- 36 ----------- ----------- Total variable annuity assets................ $ 1,119,231 $ 854,470 =========== =========== The investment income, gains and losses of these accounts accrue directly to the policyholders and are not included in the operations of the Company. F-46 NOTE 1 - Summary of Significant Accounting Policies-(Continued) Future Policy Benefits, Interest-sensitive Life Contract Liabilities and Annuity Contract Liabilities Liabilities for future benefits on life and annuity policies are established in amounts adequate to meet the estimated future obligations on policies in force. Liabilities for future policy benefits on certain life insurance policies are computed using the net level premium method and are based on 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 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. The Company has established a guaranteed minimum death benefit ("GMDB") reserve on variable annuity contracts and regularly monitors this reserve considering fluctuations in the financial markets. At December 31, 2003 and 2002, under GAAP, the GMDB reserve was $109 and $835, respectively. The comparable reserve under statutory accounting principles was $155 and $1,557 at the respective dates. The Company has a relatively low exposure to GMDB because approximately 25% of contract values have no guarantee; approximately 70% have only a return of premium guarantee; and approximately 5% have a guarantee of premium roll-up at an annual interest rate of 3% or 5%. The aggregate in-the-money death benefits under the GMDB provision totaled $35,415 and $115,319 at December 31, 2003 and 2002, respectively. Unpaid Claims and Claim Expenses Liabilities for property and casualty unpaid claims and claim expenses include provisions for payments to be made on reported claims, claims incurred but not reported and associated settlement expenses. At December 31, 2003, all of the Company's net reserves for property and casualty unpaid claims and claim expenses were carried at the full value of estimated liabilities and were not discounted for interest expected to be earned on reserves. Estimated amounts of salvage and subrogation on unpaid property and casualty claims are deducted from the liability for unpaid claims. Due to the nature of the Company's personal lines business, the Company has no exposure to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses other than claims under homeowners insurance policies for environmentally related items such as toxic mold. F-47 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 earned. Stock Based Compensation The Company grants stock options to executive officers, other employees and directors. The exercise price of the option is equal to the fair market value of the Company's common stock on the date of grant. Additional information regarding the Company's stock-based compensation plans is contained in Note 6 - Shareholders' Equity and Stock Options. The Company accounts for stock option grants using the intrinsic value based method 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, ------------------------------ 2003 2002 2001 --------- --------- -------- Net income As reported................................. $ 18,975 $ 11,333 $ 25,587 Add: Stock-based compensation expense, after tax, included in reported net income..................... -- -- -- Deduct: Stock-based compensation expense, after tax, determined under the fair value based method for all awards (1).............................. 5,368 4,437 4,418 --------- --------- -------- Pro forma................................... $ 13,607 $ 6,896 $ 21,169 ========= ========= ======== Net income per share - basic As reported................................. $ 0.44 $ 0.28 $ 0.63 Pro forma................................... $ 0.32 $ 0.17 $ 0.52 Net income per share - diluted As reported................................. $ 0.44 $ 0.28 $ 0.63 Pro forma................................... $ 0.32 $ 0.17 $ 0.52 - ---------- (1) The fair value of each option grant was estimated on the date of grant using the Modified Roll-Geske option-pricing model with the following weighted average assumptions for 2003, 2002 and 2001, respectively: risk-free interest rates of 3.8%, 5.2% and 5.1%; dividend yield of 3.0%, 2.0% and 2.3%; expected lives of 10 years; and volatility of 28.3%, 39.2% and 46.0%. F-48 NOTE 1 - Summary of Significant Accounting Policies-(Continued) Income Taxes The Company uses the liability method for calculating deferred federal income taxes. Income tax provisions are generally based on income reported for financial statement purposes. The provisions for federal income taxes for the years ended December 31, 2003, 2002 and 2001 include amounts currently payable and deferred income taxes resulting from the cumulative differences in the Company's assets and liabilities, determined on a tax return versus financial statement basis. Deferred tax assets and liabilities include provisions for unrealized investment gains and losses as well as the minimum pension liability adjustment with the changes for each period included in the respective components of accumulated other comprehensive income (loss) in shareholders' equity. Earnings Per Share Basic earnings per share is computed based on the weighted average number of common shares outstanding. Diluted earnings per share is computed based on the weighted average number of common shares and common stock equivalents outstanding, to the extent dilutive. The common stock equivalents relate to outstanding common stock options, Director Stock Plan units and Employee Stock Plan units. The Company's Senior Convertible Notes, while potentially dilutive, are not common stock equivalents. The computations of net income per share on both basic and diluted bases, including reconciliations of the numerators and denominators, were as follows: Year Ended December 31, ------------------------------ 2003 2002 2001 --------- --------- -------- Basic - assumes no dilution: Net income for the period....................... $ 18,975 $ 11,333 $ 25,587 --------- --------- -------- Weighted average number of common shares outstanding during the period (in thousands)... 42,713 40,941 40,617 --------- --------- -------- Net income per share - basic.................... $ 0.44 $ 0.28 $ 0.63 ========= ========= ======== Diluted - assumes full dilution: Net income for the period....................... $ 18,975 $ 11,333 $ 25,587 --------- --------- -------- Weighted average number of common shares outstanding during the period (in thousands)... 42,713 40,941 40,617 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities (in thousands): Stock options................................ 16 87 125 Common stock units related to Deferred Equity Compensation Plan for Directors...... 148 140 121 Common stock units related to Deferred Compensation Plan for Employees............. 27 31 14 --------- --------- -------- Total common and common equivalent shares adjusted to calculate diluted earnings per share (in thousands)........................... 42,904 41,199 40,877 --------- --------- -------- Net income per share - diluted.................. $ 0.44 $ 0.28 $ 0.63 ========= ========= ======== F-49 NOTE 1 - Summary of Significant Accounting Policies-(Continued) Options to purchase 4,105,920 shares of common stock at $14.78 to $33.87 per share were granted in 1997 through 2003 but were not included in the computation of 2003 diluted earnings per share because the options' exercise price was greater than the average market price of the common shares during 2003. The options, which expire in 2007 through 2013, were still outstanding at December 31, 2003. Comprehensive Income Comprehensive income represents the change in shareholders' equity during a reporting period from transactions and other events and circumstances from non-shareholder sources. For the Company, comprehensive income is equal to net income plus the change in net unrealized gains and losses on fixed maturities and equity securities and the change in the minimum pension liability adjustment for the period as shown in the Statement of Changes in Shareholders' Equity. The components of comprehensive income were as follows: Year Ended December 31, ------------------------------ 2003 2002 2001 --------- --------- -------- Net income..................................... $ 18,975 $ 11,333 $ 25,587 --------- --------- -------- Other comprehensive income (loss): Change in net unrealized gains (losses) on fixed maturities and equity securities Unrealized holding gains on fixed maturities and equity securities arising during period................... 27,027 34,441 32,337 Less: reclassification adjustment for gains (losses) included in net income... 25,425 (48,991) (14,392) --------- --------- -------- Total, before tax..................... 1,602 83,432 46,729 Income tax expense.................... 561 29,201 16,355 --------- --------- -------- Total, net of tax.................. 1,041 54,231 30,374 --------- --------- -------- (Increase) decrease in minimum pension liability adjustment Before tax............................... 22 (8,965) (16,156) Income tax expense (benefit)............. 9 (3,138) (5,655) --------- --------- -------- Total, net of tax..................... 13 (5,827) (10,501) --------- --------- -------- Total comprehensive income......... $ 20,029 $ 59,737 $ 45,460 ========= ========= ======== 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 2003 presentation. F-50 NOTE 2 - Restructuring Charges Restructuring charges, as described below, were incurred and separately identified in the Statements of Operations for the years ended December 31, 2002, 2001 and 2000. The Company's Consolidated Balance Sheets at December 31, 2003 and 2002 did not reflect any accrued amounts due to the restructuring of its Massachusetts automobile business recorded in 2001. The following table provides information about the components of the other charges taken in 2002, 2001 and 2000, the balance of accrued amounts at December 31, 2003 and 2002, and payment activity during the year ended December 31, 2003. The adjustments recorded in 2003 reflect final resolution of the printing services, group insurance and credit union marketing operations restructures as well as additional data regarding the restructure of the property and casualty claims operations.
Original Reserve at Reserve at Pretax December 31, December 31, Charge 2002 Payments Adjustments 2003 ------------ ------------ ------------ ------------ ------------ Charges to earnings: Property and Casualty Claims Operations Employee termination costs.... $ 2,542 $ 1,929 $ 1,759 $ 56 $ 226 Additional defined benefit pension plan costs........... 1,179 1,179 956 (98) 125 Termination of lease agreements................... 502 425 209 (177) 39 ------------ ------------ ------------ ------------ ------------ Subtotal................... 4,223 3,533 2,924 (219) 390 ------------ ------------ ------------ ------------ ------------ Printing Services Operations Employee termination costs.... 409 38 40 2 -- Write-off of equipment........ 41 -- -- -- -- ------------ ------------ ------------ ------------ ------------ Subtotal................... 450 38 40 2 -- ------------ ------------ ------------ ------------ ------------ Group Insurance and Credit Union Marketing Operations Employee termination costs.... 1,827 291 100 (191) -- Termination of lease agreements................... 285 -- -- -- -- Write-off of capitalized software..................... 106 -- -- -- -- Other......................... 18 -- -- -- -- ------------ ------------ ------------ ------------ ------------ Subtotal................... 2,236 291 100 (191) -- ------------ ------------ ------------ ------------ ------------ Total...................... $ 6,909 $ 3,862 $ 3,064 $ (408) $ 390 ============ ============ ============ ============ ============
Restructure of Property and Casualty Claims Operations In July 2002, the Company recorded restructuring charges of $4,223 pretax, reflecting the decision to restructure its property and casualty claims operations. The principal restructuring activities included consolidating claims offices, implementing a new claims administration system, and performing certain claims reporting and adjusting functions internally versus utilizing external service providers. F-51 NOTE 2 - Restructuring Charges-(Continued) Approximately 135 employees with management, professional and clerical responsibilities were impacted by the office consolidations. Charges for employee termination costs represent severance, vacation buy-out and related payroll taxes. The impact of accelerated retirements on the Company's defined benefit pension plan has been included in the restructuring charge. Termination of lease agreements represented office space for each of the previous claims office locations. Massachusetts Automobile Business In October 2001, the Company recorded restructuring charges of $7,290 pretax reflecting a change in the Company's strategic direction in the Massachusetts automobile market. On October 18, 2001, Horace Mann announced that it had formed a marketing alliance with an unaffiliated company, The Commerce Group, Inc. ("Commerce"), for the sale of automobile insurance in the state of Massachusetts. Through this alliance, and by January 1, 2002, Horace Mann's agents are authorized to offer Massachusetts customers automobile insurance policies written by Commerce. Horace Mann agents continue to write the Company's other products in Massachusetts, including retirement annuities and property and life insurance. Horace Mann ceased writing automobile insurance policies in Massachusetts by December 31, 2001, and on October 18, 2001 paid $6,438 to the Commonwealth Automobile Reinsurers ("C.A.R.") as full payment of its proportionate liability to C.A.R. for policy years 2002 and beyond. The Company also paid legal and other related consulting costs totaling $506 pretax. The remaining $346 was attributable primarily to the write-off of software used only to process Massachusetts automobile business. All of the costs related to this restructuring were paid as of December 31, 2001, and consequently the Company's Consolidated Balance Sheet at December 31, 2001 did not reflect any accrued amounts due to the restructure of its Massachusetts automobile business. Printing Services, Group Insurance and Credit Union Marketing Operations In November 2001, the Company recorded restructuring charges of $450 pretax reflecting the decision to close its on site printing services operations based on a cost benefit analysis. Employee termination costs, for termination of 13 individuals by December 31, 2001, which represented severance, vacation buy-out and related payroll taxes, comprised $409 of the total charge. The eliminated positions encompassed management, technical and clerical responsibilities. The remaining $41 of charges was attributable primarily to the write-off of equipment related to this function. In December 2000, the Company recorded restructuring charges of $2,236 pretax reflecting two changes in the Company's operations. Specifically, the Company restructured the operations of its group insurance business, thereby eliminating 39 jobs, and its credit union marketing group, eliminating 20 additional positions. Employee termination costs, for termination of approximately 50 individuals, represented severance, vacation buy-out and related payroll taxes. The eliminated positions encompassed management, professional and clerical responsibilities. Termination of lease agreements represented office space used by the credit union marketing group. The remaining charge was attributable primarily to the write-off of software related to these two areas. F-52 NOTE 3 - Investments Net Investment Income The components of net investment income for the following periods were: Year Ended December 31, ------------------------------------------ 2003 2002 2001 ------------ ------------ ------------ Fixed maturities.................. $ 181,716 $ 192,077 $ 192,547 Short-term and other investments...................... 7,059 7,650 10,346 ------------ ------------ ------------ Total investment income........ 188,775 199,727 202,893 Less investment expenses.......... 4,050 3,679 3,626 ------------ ------------ ------------ Net investment income.......... $ 184,725 $ 196,048 $ 199,267 ============ ============ ============ Realized Investment Gains (Losses) Realized investment gains (losses) for the following periods were: Year Ended December 31, ------------------------------------------ 2003 2002 2001 ------------ ------------ ------------ Fixed maturities.................. $ 21,753 $ (48,925) $ (14,371) Short-term and other investments...................... 3,734 (482) 4,352 ------------ ------------ ------------ Realized investment gains (losses)...................... $ 25,487 $ (49,407) $ (10,019) ============ ============ ============ Fixed Maturity Securities At December 31, 2003, the fair value and gross unrealized losses of investments in debt securities segregated between securities having an unrealized loss for less than 12 months and securities having an unrealized loss for 12 months or longer were as follows:
Less than 12 months 12 months or longer Total --------------------------- --------------------------- --------------------------- Unrealized Unrealized Unrealized Fair Value Losses Fair Value Losses Fair Value Losses ------------ ------------ ------------ ------------ ------------ ------------ As of December 31, 2003 U.S. government and agency obligations Mortgage-backed securities....... $ 63,308 $ 1,672 $ -- $ -- $ 63,308 $ 1,672 Other............................ 75,160 1,280 -- -- 75,160 1,280 Municipal bonds..................... 94,419 2,133 -- -- 94,419 2,133 Foreign government bonds............ 3,715 329 -- -- 3,715 329 Corporate bonds..................... 188,105 3,741 18,581 740 206,686 4,481 Other mortgage-backed securities.... 24,528 550 4,683 371 29,211 921 ------------ ------------ ------------ ------------ ------------ ------------ Totals........................ $ 449,235 $ 9,705 $ 23,264 $ 1,111 $ 472,499 $ 10,816 ============ ============ ============ ============ ============ ============
F-53 NOTE 3 - Investments-(Continued) At December 31, 2003, the gross unrealized loss position in the investment portfolio was $10,816 (113 positions and less than 0.5% of the investment portfolio). There were no securities trading below 80% of amortized cost. Securities with an investment grade rating represented 88% of the unrealized loss. The largest single unrealized loss was $809 on a long-term U.S. treasury bond purchased in June 2003 when interest rates hit 40 year lows. The majority of the unrealized losses were due to changes in interest rates. The portfolio included 11 securities that have been in an unrealized loss position for greater than 12 months, totaling $1,111. Securities issued by Royal Caribbean, Green Tree Financial, Southern Natural Gas, Sutton Bridge and CSAM Funding CDO represented $1,088 of the total. The Company views the decrease in value of all of the securities with unrealized losses at December 31, 2003 as temporary, expects recovery in fair value, anticipates continued payments under the terms of the securities, and has the intent and ability to hold these securities until maturity or a recovery in fair value occurs. Therefore, no impairment of these securities was recorded at December 31, 2003. The amortized cost, unrealized investment gains and losses, and fair values of investments in debt securities as of December 31, 2003 and 2002 were as follows:
Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ------------ ------------ ------------ As of December 31, 2003 U.S. government and agency obligations Mortgage-backed securities............. $ 647,746 $ 14,076 $ 1,672 $ 660,150 Other.................................. 295,629 6,563 1,280 300,912 Municipal bonds........................... 488,081 16,964 2,133 502,912 Foreign government bonds.................. 33,134 3,389 329 36,194 Corporate bonds........................... 1,553,959 98,878 4,481 1,648,356 Other mortgage-backed securities.......... 106,312 4,759 921 110,150 ------------ ------------ ------------ ------------ Totals................................. $ 3,124,861 $ 144,629 $ 10,816 $ 3,258,674 ============ ============ ============ ============ As of December 31, 2002 U.S. government and agency obligations Mortgage-backed securities............. $ 645,787 $ 28,253 $ -- $ 674,040 Other.................................. 129,584 7,919 -- 137,503 Municipal bonds........................... 358,636 19,283 455 377,464 Foreign government bonds.................. 13,131 2,845 -- 15,976 Corporate bonds........................... 1,498,481 94,192 23,266 1,569,407 Other mortgage-backed securities.......... 213,388 6,569 3,152 216,805 ------------ ------------ ------------ ------------ Totals................................. $ 2,859,007 $ 159,061 $ 26,873 $ 2,991,195 ============ ============ ============ ============
The Company's investment portfolio includes no derivative financial instruments (futures, forwards, swaps, option contracts or other financial instruments with similar characteristics). F-54 NOTE 3 - Investments-(Continued) Maturities/Sales Of Investments The amortized cost and fair value of fixed maturity securities at December 31, 2003, by estimated expected maturity, are shown below. Estimated expected maturities differ from contractual maturities reflecting assumptions regarding borrowers' utilization of the right to call or prepay obligations with or without call or prepayment penalties. Percent of Amortized Fair Total Fair Cost Value Value ------------ ------------ ------------ Due in 1 year or less............... $ 231,759 $ 241,683 7.4% Due after 1 year through 5 years.... 682,752 711,989 21.9 Due after 5 years through 10 years........................... 1,291,604 1,346,914 41.3 Due after 10 years through 20 years........................... 279,656 291,631 8.9 Due after 20 years.................. 639,090 666,457 20.5 ------------ ------------ ------------ Total............................ $ 3,124,861 $ 3,258,674 100.0% ============ ============ ============ Proceeds from sales/maturities of fixed maturities and gross gains and gross losses realized for each year were: Year Ended December 31, ---------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Proceeds............................ $ 1,483,614 $ 1,391,402 $ 1,015,229 Gross gains realized................ 50,907 40,402 16,945 Gross losses realized............... (12,903) (35,551) (31,316) Unrealized Gains (Losses) on Fixed Maturities Net unrealized gains (losses) are computed as the difference between fair value and amortized cost for fixed maturities. A summary of the net increase (decrease) in unrealized investment gains (losses) on fixed maturities, less applicable income taxes, is as follows: Year Ended December 31, ---------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Unrealized gains (losses) on fixed maturities Beginning of period.............. $ 132,188 $ 43,036 $ (7,418) End of period.................... 133,813 132,188 43,036 ------------ ------------ ------------ Increase for the period....... 1,625 89,152 50,454 Income taxes........................ 569 31,203 17,659 ------------ ------------ ------------ Increase in net unrealized gains (losses) on fixed maturities before the valuation impact on deferred policy acquisition costs and value of acquired insurance in force................. $ 1,056 $ 57,949 $ 32,795 ============ ============ ============ F-55 NOTE 3 - Investments-(Continued) Securities Lending The Company loans fixed income securities to third parties, primarily major brokerage firms. As of December 31, 2003 and 2002, fixed maturities with a fair value of $22,147 and $3,937, respectively, were on loan. Loans of securities are required at all times to be secured by collateral from borrowers at least equal to 100% of the market value of the securities loaned. The Company maintains effective control over the loaned securities and therefore reports them as Fixed Maturity Securities in the Consolidated Balance Sheets. SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", as amended by SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", requires the securities lending collateral to be classified as investments with a corresponding liability in the Company's Consolidated Balance Sheets. Investment in Entities Exceeding 10% of Shareholders' Equity At December 31, 2003 and 2002, there were no investments which exceeded 10% of total shareholders' equity in entities other than obligations of the U.S. Government and government agencies and authorities. Deposits At December 31, 2003, securities with a carrying value of $17,173 were on deposit with governmental agencies as required by law in various states in which the insurance subsidiaries of HMEC conduct business. F-56 NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses 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, ---------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Gross reserves, beginning of year..... $ 317,321 $ 306,141 $ 298,896 Less reinsurance recoverables...... 44,701 34,104 49,056 ------------ ------------ ------------ Net reserves, beginning of year....... 272,620 272,037 249,840 ------------ ------------ ------------ Incurred claims and claim expenses: Claims occurring in the current year.............................. 416,473 387,747 416,770 Increase (decrease) in estimated reserves for claims occurring in prior years (1): Policies written by the Company (2).................... 58,270 22,295 14,574 Business assumed from state reinsurance facilities......... (1,900) 1,700 2,000 ------------ ------------ ------------ Total increase............... 56,370 23,995 16,574 ------------ ------------ ------------ Total claims and claim expenses incurred (2)(3)....... 472,843 411,742 433,344 ------------ ------------ ------------ Claims and claim expense payments for claims occurring during: Current year....................... 239,950 244,396 255,939 Prior years........................ 184,632 166,763 155,208 ------------ ------------ ------------ Total claims and claim expense payments............... 424,582 411,159 411,147 ------------ ------------ ------------ Net reserves, end of period........... 320,881 272,620 272,037 Plus reinsurance recoverables...... 20,615 44,701 34,104 ------------ ------------ ------------ Gross reserves, end of period (4)........................... $ 341,496 $ 317,321 $ 306,141 ============ ============ ============ - ---------- (1) Shows the amounts by which the Company increased or 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. Also refer to the paragraphs below for additional information regarding the increases in reserves recorded in 2003, 2002 and 2001. (2) For the year ended December 31, 2002, these amounts included a $1,581 statutory accounting charge for class action litigation which was separately reported as Litigation Charges in the Company's Consolidated Statements of Operations. (3) Benefits, claims and settlement expenses as reported in the Consolidated Statements of Operations also include life, annuity, group accident and health and corporate amounts of $46,135, $40,705 and $42,239 for the years ended December 31, 2003, 2002 and 2001, respectively, in addition to the property and casualty amounts. (4) Unpaid claims and claim expenses as reported in the Consolidated Balance Sheets also include life, annuity, and group accident and health reserves of $9,005, $9,254 and $8,154 at December 31, 2003, 2002 and 2001, respectively, in addition to property and casualty reserves. Underwriting results of the property and casualty segment are significantly influenced by estimates of the Company's ultimate liability for insured events. There is a high degree of uncertainty inherent in the estimates of ultimate losses underlying the liability for unpaid claims and claim expenses. This inherent uncertainty is particularly significant for liability-related exposures due to the extended period, often many years, that transpires between a loss event, receipt of related claims data from policyholders and ultimate settlement of the claim. Reserves for property and casualty claims include provisions for payments to be made on reported claims, claims incurred but not yet reported and associated settlement expenses. The process by which these reserves are established requires reliance upon estimates based on known facts and on interpretations of circumstances, including the Company's experience with similar cases and historical trends involving claim payment patterns, claim payments, pending levels of unpaid claims and product mix, as well as other factors including court decisions, economic conditions and public attitudes. The Company continually updates loss estimates using both quantitative information from its reserving actuaries and qualitative information derived from other sources. Adjustments may be required as information develops F-57 NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued) which varies from experience, or, in some cases, augments data which previously were not considered sufficient for use in determining liabilities. The effects of these adjustments may be significant and are charged or credited to income for the period in which the adjustments are made. Excluding involuntary business, net adverse development of reserves for property and casualty claims occurring in prior years was $58,270 for the full year 2003, primarily related to automobile liability loss reserves from the 2001 and 2002 accident years, compared to adverse reserve development of $22,295 in 2002 which was primarily related to (1) automobile loss reserves from accident years 2001 and years prior to 1997 and (2) loss adjustment expense reserves from the 2001 and 2000 accident years for both automobile and homeowners. Adverse development recorded in 2002 also included $1,581 due to a provision for the costs of resolving class action lawsuits related to diminished value brought against the Company. Net adverse development of total reserves for property and casualty claims occurring in prior years, including involuntary business, was $56,370 in 2003, $23,995 in 2002 and $16,574 in 2001. The Company's property and casualty reserves were $320,881 and $272,620 at December 31, 2003 and 2002, respectively, net of anticipated reinsurance recoverables. The Company completes a detailed study of property and casualty reserves based on information available at the end of each quarter and year. Trends of reported losses (paid amounts and case reserves on claims reported to the Company) for each accident year are reviewed and ultimate loss costs for those accident years are estimated. The Company engages an independent property and casualty actuarial consulting firm to prepare an independent study of the Company's property and casualty reserves twice a year - at June 30 and December 31. During 2002 and 2003, the Company made changes in its property and casualty claims function including hiring of new management and claim adjusters (new hires represented over half of the Company's 300 claims employees at December 31, 2003), implementing improved processes, and consolidating the previous 17 branch offices into 6 regional claims offices, which began in late-November 2002 and was completed in the first quarter of 2003. Installation and implementation of the new claims administration system, including related process changes, occurred in the third and fourth quarters of 2003 in the first two claims offices with the remaining four offices planned for the first half of 2004. As part of the claims operation redesign effort, open claim files -- particularly for automobile liability claims -- were reviewed by the new team. In the first half of 2003, these reassessments resulted in a higher projected ultimate liability for automobile liability claims from accident years 2001, 2000 and 1999 and prior. The high level of property and casualty paid and case reserve activity on older bodily injury claims that was observed in the second quarter of 2003 continued in the third quarter as the Company's new claims organization intensified their efforts to bring older claims files up to date. Furthermore, the acceleration of claim disposition rates extended into the third quarter, as the new organization also moved to reduce the backlog of older claims and handle current claims on a timely basis. As a result, the estimation of claims costs, settlement rates and severity has been complicated in recent quarters due to the degree of change involved. F-58 NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued) As a result of the factors above, and in light of the pattern of adverse prior years' reserve development observed over the five quarters ended September 30, 2003, at the end of the third quarter, the Company's management retained an independent property and casualty actuarial and claims consulting firm to conduct a detailed review of the Company's claims handling practices and their integration with the Company's reserving practices. The consultant's claims and actuarial specialists reviewed claim files as well as past and current claims handling processes and procedures, including case reserving practices, in each of the Company's six claims offices. They also performed an assessment of the Company's actuarial processes for establishing IBNR and supplemental reserves. The Company's December 31, 2003 actuarial analysis and reserve estimates incorporated the observations of the consultant's claims and reserving practices review. The low and high end of a reasonable range of reserve estimates for all of the Company's coverages indicated net claim reserve levels of $286,000 and $338,000, respectively. In recording the December 31, 2003 net reserves of $320,881, the Company assessed the relative weight given to emerging claim trends resulting from recent business process changes, pricing and claims handling. Based upon this analysis, the Company selected a higher point in the range for reserves related to the automobile liability coverages. F-59 NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued) During 2000, the Company noted increases in paid severities in excess of the original expectations in its direct voluntary automobile line of business. As a result, the Company continued to monitor such severity trends until such time as the Company believed that they were sufficiently credible to require adjustment to the Company's claim and claim expense reserve projections. Accordingly, the Company revised its projections in the fourth quarter of 2000 to give greater weight to the increasing trend of claim severities. In 2001, the Company refined its claim reserving methodologies and trend analyses including more detailed analyses of subrogation recovery activity on business ceded to the state automobile insurance facility in Massachusetts. The nature of the adverse trends in the second and fourth quarters of 2001 that caused the Company to increase reserves consisted primarily of the following: (1) an increase in the frequency and severity of educators excess professional liability claims; (2) the utilization of selected ultimate subrogation recoverables that were not trending with actual recoveries; and (3) the utilization of selected ultimate loss ratios in establishing reserves for ceded voluntary automobile excess liability claims and ceded Massachusetts involuntary automobile reserves that were not trending with actual results. In the third quarter of 2002, the Company increased its reserves for prior accident years primarily related to allocated claim adjustment expenses for the voluntary automobile and homeowners lines and claims for the educator excess professional liability product. The Company had noted increases in paid claims and claim expenses for prior accident years in these lines during the first and second quarters of 2002 and continued to monitor such adverse trends until such time as the Company believed that they were sufficiently credible to require adjustment of the reserves. As a result, the Company revised its loss projections in the third quarter of 2002, incorporating the higher paid claims and claim expense trends. F-60 NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued) In the fourth quarter of 2002, the Company increased its reserves for prior accident years related primarily to (1) automobile claim reserves from accident years 2001, 2000 and years prior to 1997 and (2) allocated and unallocated claim expense reserves from the 2001 accident year for both automobile and homeowners. During the third and fourth quarters of 2002, the Company continued to closely monitor emerging trends in (1) the severity of payments on previously reported losses for voluntary automobile and (2) paid claims adjustment expenses for these prior accident years until such time as the Company believed that the trends were sufficiently credible to require adjustment of the reserves. As a result, the Company revised its projections in the fourth quarter of 2002, incorporating the higher paid claims and claim expense trends. As the Company's claims operation redesign efforts progressed during 2003, the elevated level of claim payments and case reserve activity related to prior accident years continued. Consequently, the Company revised its loss projections throughout 2003, most notably in the third quarter, as greater relative weight was given to the emerging claim trends. At the time each of the reserve analyses were performed, the Company believed that each estimate was based upon sound and correct methodology and such methodology was appropriately applied and that there were no trends which indicated the likelihood of future adverse development. The financial impact of the net reserve strengthening was therefore accounted for in the period that the change was determined. No other unusual adjustments were made in the determination of the liabilities during the periods covered by these financial statements. Management believes that, based on data currently available, it has reasonably estimated the Company's ultimate losses. NOTE 5 - Debt Indebtedness and scheduled maturities at December 31, 2003 and 2002 consisted of the following:
Effective December 31, Interest Final ---------------------- Rates Maturity 2003 2002 --------- -------- ---------- ---------- Short-term debt: Bank Credit Facility................................. Variable 2005 $ 25,000 $ -- Long-term debt: 1.425% Senior Convertible Notes, Face amount less unaccrued discount of $128,362.......... 3.0% 2032 116,138 116,138 6 5/8% Senior Notes, Face amount less unaccrued discount of $35 and $53, respectively............... 6.7% 2006 28,565 28,547 ---------- ---------- Total............................................. $ 169,703 $ 144,685 ========== ==========
F-61 NOTE 5 - Debt-(Continued) Credit Agreement with Financial Institutions ("Bank Credit Facility") On May 29, 2002, the Company entered into a new Bank Credit Agreement which provides for unsecured borrowings of up to $25,000, with a provision that allows the commitment amount to be increased to $35,000 (the "Current Bank Credit Facility"). The Current Bank Credit Facility expires on May 31, 2005. 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 1.0%, or 2.2%, at December 31, 2003). The unused portion of the Current Bank Credit Facility is subject to a variable commitment fee, which was 0.25% and 0.20% on an annual basis at December 31, 2003 and 2002, respectively. 1.425% Senior Convertible Notes ("Senior Convertible Notes") On May 14, 2002, the Company issued $353,500 aggregate principal amount of 1.425% senior convertible notes due in 2032 at a discount of 52.5% resulting in an effective yield of 3.0%. In 2002, the Company repurchased $53,000 aggregate principal amount, $25,175 carrying value, of the outstanding Senior Convertible Notes at an aggregate cost of $22,770. In addition to these cash transactions, in December 2002 the Company repurchased an additional $56,000 aggregate principal amount, $26,600 carrying value, of the outstanding Senior Convertible Notes at an aggregate cost of $25,984 in a non-cash transaction. As consideration for this repurchase, 1,837,925 shares of HMEC's common stock were issued. Interest on the Senior Convertible Notes is payable semi-annually at a rate of 1.425% beginning November 14, 2002 until May 14, 2007. After that date, cash interest will not be paid on the Senior Convertible Notes prior to maturity unless contingent cash interest becomes payable. From May 15, 2007 through maturity of the Senior Convertible Notes, interest will be recognized at the effective rate of 3.0% and will represent the accrual of discount, excluding any contingent cash interest that may become payable. Contingent cash interest becomes payable if the average market price of a Senior Convertible Note for a five trading day measurement period preceding the applicable six-month period equals 120% or more of the sum of the Senior Convertible Note's issue price, accrued original issue discount and accrued cash interest, if any, for such Senior Convertible Note. The contingent cash interest payable per Senior Convertible Note with respect to any quarterly period within any six-month period will equal the then applicable conversion rate multiplied by the greater of (i) $0.105 or (ii) any regular cash dividends paid by the Company per share on HMEC's common stock during that quarterly period. F-62 NOTE 5 - Debt-(Continued) The Senior Convertible Notes will be convertible at the option of the holders into shares of HMEC's common stock at a conversion price of $26.74 if the conditions for conversion are satisfied. Holders may also surrender Senior Convertible Notes for conversion during any period in which the credit rating assigned to the Senior Convertible Notes is Ba2 or lower by Moody's or BB+ or lower by S&P, the Senior Convertible Notes are no longer rated by either Moody's or S&P, or the credit rating assigned to the Senior Convertible Notes has been suspended or withdrawn by either Moody's or S&P. The Senior Convertible Notes will cease to be convertible pursuant to this credit rating criteria during any period or periods in which all of the credit ratings are increased above such levels. The Senior Convertible Notes are redeemable by HMEC in whole or in part, at any time on or after May 14, 2007, at redemption prices equal to the sum of the issue price plus accrued original issue discount and accrued cash interest, if any, on the applicable redemption date. The holders of the Senior Convertible Notes may require HMEC to purchase all or a portion of their Senior Convertible Notes on either May 14, 2007, 2012, 2017, 2022, or 2027 at stated prices plus accrued cash interest, if any, to the purchase date. HMEC may pay the purchase price in cash or shares of HMEC common stock or in a combination of cash and shares of HMEC common stock. 6 5/8% Senior Notes ("Senior 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. 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 (1) 100% of their principal amount and (2) 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. In 2002, the Company repurchased $71,400 aggregate principal amount of its outstanding Senior Notes utilizing a portion of the proceeds from the issuance of the Senior Convertible Notes, as described above. The aggregate cost of the repurchases was $74,650. Universal Shelf Registration To provide additional capital management flexibility, the Company filed a "universal shelf" registration on Form S-3 with the SEC in December 2003. The registration statement, which registers the offer and sale by the Company from time to time of up to $300,000 of various securities, which may include debt securities, preferred stock, common stock and/or depositary shares, was declared effective on December 30, 2003. No securities associated with the registration statement have been issued as of the date of this Report on Form 10-K. Debt Retirement Charges The repurchases of the Senior Convertible Notes and Senior Notes resulted in a pretax charge to income for the year ended December 31, 2002 of $2,272. F-63 NOTE 5 - Debt-(Continued) Covenants The Company is in compliance with all of the covenants contained in the Senior Convertible Notes indenture, the Senior Notes indenture and the Bank Credit Facility Agreement, consisting primarily of relationships of (1) debt to capital and (2) insurance subsidiaries' earnings to future interest charges. NOTE 6 - Shareholders' Equity and Stock Options Share Repurchase Program and Treasury Shares Held At December 31, 2001, the Company held 19,341,296 shares in treasury. In December 2002, the Company issued 1,837,925 of the treasury shares as consideration for the repurchase of a portion of its outstanding Senior Convertible Notes. At December 31, 2003, the Company held 17,503,371 shares in treasury. As of December 31, 2003, $96,343 remained authorized for future share repurchases. Authorization of Preferred Stock In 1996, the shareholders of HMEC approved authorization of 1,000,000 shares of $0.001 par value preferred stock. The Board of Directors is authorized to (1) direct the issuance of the preferred stock in one or more series, (2) fix the dividend rate, conversion or exchange rights, redemption price and liquidation preference, of any series of the preferred stock, (3) fix the number of shares for any series and (4) increase or decrease the number of shares of any series. No shares of preferred stock were outstanding at December 31, 2003, 2002 and 2001. The Company's catastrophe reinsurance program is augmented by a $75,000 equity put and reinsurance agreement. The equity put provides an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event losses from catastrophes exceed the catastrophe reinsurance program coverage limit. Before tax benefits, the equity put provides a source of capital for up to $115,000 of catastrophe losses above the reinsurance coverage limit. The agreement contains certain conditions to Horace Mann's exercise of the equity put option as disclosed in Note 11 - Reinsurance. Fees related to this equity put option totaled $1,088 for the year ended December 31, 2003 and were charged directly to additional paid-in capital. F-64 NOTE 6 - Shareholders' Equity and Stock Options-(Continued) 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 of these shares are currently issued or outstanding. The Series A Stock is dividend paying, at a floating rate which varies with movements in the London Interbank Offered Rate and with changes in the risk rating of the Series A Stock as determined by Standard & Poor's Corporation. The Series A Stock does not require any sinking fund or similar mechanism regarding payment of such dividends. Beginning on the fourth anniversary of the issuance of Series A Stock, the holders thereof have the right to demand conversion of the Series A Stock into common stock of the Company at a conversion rate based on then prevailing market prices for the common stock; however, upon receipt of a conversion demand, the Company has the right to redeem the Series A Stock prior to such conversion. The Series A Stock has liquidation rights which place the Series A Stock ahead of the common stock in priority. The Series A Stock has no voting rights other than the requirement that the Series A Stock approve any changes in the Series A Stock, the creation of any other class of stock on a par with or superior to the Series A Stock and certain extraordinary transactions such as certain mergers involving the Company. Director Stock Plan In 1996, the shareholders of HMEC approved the Deferred Equity Compensation Plan ("Director Stock Plan") for directors of the Company and reserved 600,000 shares for issuance pursuant to the Director Stock Plan. Shares of the Company's common stock issued under the Director Stock Plan may be either authorized and unissued shares or shares that have been reacquired by the Company. As of December 31, 2003, 2002 and 2001, 147,529, 139,867 and 121,322 units, respectively, were outstanding under this plan representing an equal number of common shares to be issued in the future. Employee Stock Plan In 1997, the Board of Directors of HMEC approved the Deferred Compensation Plan for Employees ("Employee Stock Plan"). Shares of the Company's common stock issued under the Employee Stock Plan may be either authorized and unissued shares or shares that have been reacquired by the Company. As of December 31, 2003, 2002 and 2001, 27,231, 30,585 and 14,303 units, respectively, were outstanding under this plan representing an equal number of common shares to be issued in the future. Stock Options The shareholders of HMEC approved the 1991 Stock Incentive Plan (the "1991 Plan"), the 2001 Stock Incentive Plan (the "2001 Plan") and the 2002 Incentive Compensation Plan (the "2002 Plan") and reserved a total of 9,000,000 shares of common stock for issuance under these plans. Under the 1991 Plan, the 2001 Plan and the 2002 Plan, options to purchase shares of HMEC common stock may be granted to executive officers, other employees and directors. The options are exercisable in installments generally beginning in the first year from the date of grant and generally expiring 10 years from the date of grant. F-65 NOTE 6 - Shareholders' Equity and Stock Options-(Continued) Changes in outstanding options and shares available for grant under the 1991 Plan, the 2001 Plan and the 2002 Plan were as follows:
Weighted Options Average Range of ------------------------------------------ Option Price Option Prices Vested and Available per Share per Share Outstanding Exercisable for Grant ------------ ------------- ------------ ------------ ------------ At December 31, 2000...... $ 18.98 $ 9.00-$33.87 2,736,725 903,802 1,307,412 ------------ ------------ ------------ Granted................ $ 18.22 $16.83-$21.77 1,020,050 271,775 (1,020,050) Vested................. $ 19.72 $13.84-$33.87 -- 519,860 -- Exercised.............. $ 10.18 $ 9.00-$17.56 (207,575) (207,575) -- Canceled............... $ 20.52 $15.32-$33.87 (136,950) (136,950) 136,950 ------------ ------------ ------------ At December 31, 2001...... $ 19.23 $11.12-$33.87 3,412,250 1,350,912 424,312 ------------ ------------ ------------ Increase in options available for grant... -- -- 3,000,000 Granted................ $ 20.72 $15.92-$21.64 1,375,950 116,944 (1,375,950) Vested................. $ 18.20 $13.84-$33.87 -- 724,488 -- Exercised.............. $ 16.57 $11.13-$22.42 (107,410) (107,410) -- Canceled............... $ 22.01 $15.15-$33.87 (131,370) (131,370) 131,370 ------------ ------------ ------------ At December 31, 2002...... $ 19.66 $11.12-$33.87 4,549,420 1,953,564 2,179,732 ------------ ------------ ------------ Granted................ $ 13.95 $13.88-$15.33 593,700 153,841 (593,700) Vested................. $ 18.80 $14.78-$33.87 -- 852,582 -- Canceled............... $ 19.42 $13.88-$33.87 (473,150) (473,150) 473,150 ------------ ------------ ------------ At December 31, 2003...... $ 18.96 $11.12-$33.87 4,669.970 2,486,837 2,059,182 ============ ============ ============
The weighted average grant date fair values were $3.98, $8.99 and $8.55 for options granted in 2003, 2002 and 2001, respectively. The weighted average prices of vested and exercisable options as of December 31, 2002 and 2001 were $20.22 and $19.23, respectively. For options outstanding at December 31, 2003, information segregated by ranges of exercise prices was as follows:
Vested and Exercisable Options ------------------------------------------ Weighted Weighted Average Range of Total Average Weighted Option Price Option Prices Options Option Price Average per Share per Share Outstanding Options per share Life ------------ ------------- ------------ ------------ ------------ ------------ At December 31, 2003 $ 14.35 $11.12-$16.38 749,275 265,316 $ 14.67 7.8 years $ 19.24 $16.83-$23.31 3,750,395 2,051,221 $ 18.99 6.8 years $ 33.05 $25.63-$33.87 170,300 170,300 $ 33.05 4.4 years ------------ ------------ Total..................... $ 18.96 $11.12-$33.87 4,669,970 2,486,837 $ 19.49 6.8 years ============ ============
F-66 NOTE 7 - Income Taxes The federal income tax liabilities included in Other Liabilities in the Consolidated Balance Sheets as of December 31, 2003 and 2002 were as follows: December 31, --------------------------- 2003 2002 ------------ ------------ Current liability......................... $ 2,803 $ 14,698 Deferred liability........................ 8,426 14,761 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. There are no deferred tax liabilities that have not been recognized. The "temporary differences" that give rise to the deferred tax balances at December 31, 2003 and 2002 were as follows: December 31, --------------------------- 2003 2002 ------------ ------------ Deferred tax assets Discounting of unpaid claims and claim expenses tax reserves........... $ 8,862 $ 7,103 Life insurance future policy benefit reserve revaluation................... 29,296 26,599 Unearned premium reserve reduction..... 13,314 12,664 Postretirement benefits other than pension............................... 10,585 10,890 Unutilized net operating loss carryforward.......................... 17,586 1,060 Unutilized capital loss carryforward... 9,342 4,638 Impaired securities.................... 3,544 17,512 Compensation accruals ................. 6,619 5,609 North Carolina premium escrow.......... 1,715 646 Other, net............................. 4,262 5,287 ------------ ------------ Total gross deferred tax assets..... 105,125 92,008 ------------ ------------ Deferred tax liabilities Unrealized gains on securities......... 43,943 43,382 Intangible assets...................... 9,849 11,181 Deferred policy acquisition costs...... 59,759 52,206 ------------ ------------ Total gross deferred tax liabilities........................ 113,551 106,769 ------------ ------------ Net deferred tax liability....... $ 8,426 $ 14,761 ============ ============ 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. At December 31, 2003, the Company had available $50,245 (pretax) of net tax operating loss carryforwards for federal income tax purposes. These carryforwards will expire beginning in 2016 thru 2018. In addition, the Company had available $26,694 (pretax) of capital loss carryforwards which will expire beginning in 2006 thru 2008. The components of federal income tax expense (benefit) were as follows: Year Ended December 31, ------------------------------------------ 2003 2002 2001 ------------ ------------ ------------ Current.......................... $ 7,106 $ 29,423 $ (8,536) Deferred......................... (6,902) (33,091) 11,291 ------------ ------------ ------------ Total tax expense (benefit)... $ 204 $ (3,668) $ 2,755 ============ ============ ============ F-67 NOTE 7 - 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, ------------------------------------------ 2003 2002 2001 ------------ ------------ ------------ Expected federal tax on income... $ 6,713 $ 2,683 $ 9,920 Add (deduct) tax effects of: Tax-exempt interest........... (5,027) (3,928) (3,826) Tax reserve release........... -- -- (3,034) Goodwill...................... -- -- 566 Dividend received deduction... (1,918) (2,608) (904) Other, net.................... 436 185 1,302 ------------ ------------ ------------ Income tax expense (benefit) provided on income before adjustment to the provision for prior years' taxes.......... 204 (3,668) 4,024 Adjustment to the provision for prior years' taxes.......... -- -- (1,269) ------------ ------------ ------------ Income tax expense (benefit) provided on income.............. $ 204 $ (3,668) $ 2,755 ============ ============ ============ As previously reported, the Company had been contesting proposed additional federal income taxes relating to a settlement agreement with the Internal Revenue Service ("IRS") for prior years' taxes. In the third quarter of 1999, the Company recorded an additional federal income tax provision of $20,000 representing the maximum exposure of the Company to the IRS with regard to the issue for all of the past tax years in question (1994 through 1997). In 2000, the Company reached a final resolution with the IRS for the tax years 1994, 1995 and 1996 in an amount that was $8,682 less than was previously accrued. That amount was included in net income for the year ended December 31, 2000. In 2001, the Company's liability for the 1997 tax year was resolved, resulting in a release of $1,269 that had previously been accrued for that tax year. That amount was included in net income for the year ended December 31, 2001. NOTE 8 - Fair Value of Financial Instruments The Company is required under GAAP to disclose estimated fair values for certain financial instruments. Fair values of the Company's insurance contracts other than annuity contracts are not required to be disclosed. However, the fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk through the matching of investment maturities with amounts due under insurance contracts. The following methods and assumptions were used to estimate the fair value of financial instruments. Investments - For fixed maturities and short-term and other investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities, adjusted for differences between the quoted securities and the securities being valued. The fair value of policy loans is based on estimates using discounted cash flow analysis and current interest rates being offered for new loans. The fair value of mortgage loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and the same remaining maturities. The carrying value of real estate is an estimate of fair value based on discounted cash flows from operations. F-68 NOTE 8 - Fair Value of Financial Instruments-(Continued) Annuity Contract Liabilities and Policyholder Account Balances on Interest-sensitive Life Contracts - The fair values of annuity contract liabilities and policyholder account balances on interest-sensitive life contracts are equal to the discounted estimated future cash flows (using the Company's current interest rates for similar products including consideration of minimum guaranteed interest rates) 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 liabilities related to supplementary contracts without life contingencies and dividend accumulations which represent deposits that do not have defined maturities. The carrying value of these funds is used as a reasonable estimate of fair value. Long-term Debt - The fair value of long-term debt is estimated based on quoted market prices of publicly traded issues. The carrying amounts and fair values of financial instruments at December 31, 2003 and 2002 consisted of the following:
December 31, ------------------------------------------------------ 2003 2002 -------------------------- -------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ------------ ------------ ------------ ------------ Financial Assets Investments Fixed maturities................... $ 3,258,674 $ 3,258,674 $ 2,991,195 $ 2,991,195 Short-term and other investments... 104,904 109,877 135,431 138,734 Short-term investments, loaned securities collateral....... 22,147 22,147 3,937 3,937 ------------ ------------ ------------ ------------ Total investments............... 3,385,725 3,390,698 3,130,563 3,133,866 Cash.................................. 19,773 19,773 60,162 60,162 Financial Liabilities Policyholder account balances on interest-sensitive life contracts.... 87,249 85,302 93,435 91,359 Annuity contract liabilities.......... 1,526,174 1,361,788 1,385,737 1,236,478 Other policyholder funds.............. 129,888 129,888 125,108 125,108 Short-term debt....................... 25,000 25,000 -- -- Long-term debt........................ 144,703 142,916 144,685 137,692
Fair value assumptions are based upon subjective estimates of market conditions and perceived risks of financial instruments at a certain point in time. The disclosed fair values do not reflect any premium or discount that could result from offering for sale at one time an entire holding of a particular financial instrument. In addition, potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected in amounts disclosed. F-69 NOTE 9 - 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 principles prescribed or permitted by the insurance departments, which differ in certain respects from GAAP. Reconciliations of statutory capital and surplus and net income, as determined using statutory accounting principles, to the amounts included in the accompanying financial statements are as follows: December 31, -------------------------- 2003 2002 ------------ ------------ Statutory capital and surplus of insurance subsidiaries................... $ 438,856 $ 427,737 Increase (decrease) due to: Deferred policy acquisition costs...... 193,703 174,555 Difference in policyholder reserves.... (40,600) (39,784) Goodwill............................... 47,396 47,396 Value of acquired insurance in force... 27,259 31,945 Liability for postretirement benefits, other than pensions......... (29,871) (30,253) Investment fair value adjustments on fixed maturities....... 133,813 132,188 Difference in investment reserves...... 30,866 19,448 Federal income tax liability........... (43,493) (38,962) Minimum pension liability adjustment... (26,541) (26,563) Non-admitted assets and other, net..... 1,733 5,216 Shareholders' equity of parent company and non-insurance subsidiaries.......................... (32,943) (29,396) Parent company short-term and long-term debt........................ (169,703) (144,685) ------------ ------------ Shareholders' equity as reported herein................................ $ 530,475 $ 528,842 ============ ============ Year Ended December 31, ------------------------------------ 2003 2002 2001 ---------- ------------ ---------- Statutory net income (loss) of insurance subsidiaries................. $ 12,616 $ (28,741) $ 15,146 Net loss of non-insurance companies..... (4,337) (3,831) (3,313) Interest expense........................ (6,339) (8,517) (9,250) Tax benefit of interest expense and other parent company current tax adjustments............................ (2,087) 5,731 10,954 ---------- ------------ ---------- Combined net income (loss).............. (147) (35,358) 13,537 Increase (decrease) due to: Deferred policy acquisition costs.... 19,836 21,821 19,565 Policyholder benefits................ 126,999 (42,708) 9,513 Reserve adjustment on life reinsurance ceded................... (118,813) 50,000 -- Federal income tax expense........... 5,101 32,859 (13,850) Provision for prior years' taxes..... -- -- 1,269 Amortization of intangible assets.... (5,027) (5,734) (5,774) Investment reserves.................. 6,446 9,009 5,425 Other adjustments, net............... (15,420) (18,556) (4,098) ---------- ------------ ---------- Net income as reported herein..... $ 18,975 $ 11,333 $ 25,587 ========== ============ ========== The Company has principal insurance subsidiaries domiciled in Illinois, California and Texas. The statutory financial statements of these subsidiaries are prepared in accordance with accounting principles prescribed or permitted by the Illinois Department of Insurance, the California Department of Insurance and the Texas Department of Insurance, as applicable. Prescribed statutory accounting principles include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations and general administrative rules. F-70 NOTE 9 - Statutory Surplus and Subsidiary Dividend Restrictions-(Continued) The Company's insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. The aggregate amount of dividends that may be paid by the insurance subsidiaries to HMEC during 2004 without prior approval is approximately $43,000. The NAIC has adopted risk-based capital guidelines to evaluate the adequacy of statutory capital and surplus in relation to risks 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 are not expected to have a negative regulatory impact on the Company's insurance subsidiaries. At December 31, 2003 and 2002, statutory capital and surplus of each of the Company's insurance subsidiaries was above required levels. On December 31, 2003, the Company's primary life insurance subsidiary, Horace Mann Life Insurance Company ("HMLIC"), entered into a reinsurance agreement with the United States branch of Sun Life Assurance Company of Canada ("SLACC") which replaced the 2002 agreement with Sun Life Reinsurance Company Limited ("SLRCL"), a member of the Sun Life Financial Group. Under the terms of the December 31, 2003 agreement, which is expected to be in place for a five year period, HMLIC ceded to SLACC, on a combination coinsurance and modified coinsurance basis, a 75% quota share of HMLIC's in force interest-sensitive life block of business issued prior to January 1, 2002. SLACC assumes its proportional share of all risks attendant to the business reinsured such as mortality, persistency and investment risk, reducing HMLIC's liabilities under statutory accounting principles to the extent of the ceded commission. The initial ceded commission received by HMLIC was $50,000 and resulted in a $32,500 after-tax increase in HMLIC's statutory surplus. Subsequent growth in HMLIC's statutory surplus is expected to be reduced by approximately $6,500 annually, as the coinsurance reserve declines over the term of the agreement. Fees related to these transactions, which are anticipated to reduce the Company's pretax GAAP income by approximately $1,000 in 2004, are also expected to decline over the term of the agreement. These transactions improved the statutory operating leverage and risk-based capital ratio of HMLIC in 2003 and 2002. The agreement contains a condition whereby HMLIC must maintain an S&P financial strength rating of BBB- or higher. If this condition is not maintained for a period of more than 60 consecutive days, HMLIC may recapture the agreement without penalty after giving 30 days written notice. NOTE 10 - Pension Plans and Other Postretirement Benefits All employees of the Company are covered by a defined contribution plan and participate in a 401(k) plan. Employees hired on or before December 31, 1998 are also covered under a defined benefit plan. In addition, certain employees participate in a supplemental defined benefit plan or a supplemental defined contribution plan or both. Under the defined contribution plan, the Company makes a contribution to each participant's account based on compensation and years of service. Participants are 100% vested in this plan after 5 years of service. F-71 NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued) All employees of the Company participate in a 401(k) plan. Beginning January 1, 2002, the Company automatically contributes 3% of eligible compensation to each employee's account, which is 100% vested at the time of the contribution. In addition, each participant may contribute up to 20% of eligible compensation into their account. Prior to December 31, 2001, the Company contributed an amount equal to 50% of the first 6% of eligible compensation contributed by the employee, and the Company contribution vested over 5 years at a rate of 20% per year of service. Amounts earned under the defined benefit and supplemental defined benefit plans are based on years of service and the highest average 36 consecutive months earnings under the plan through March 31, 2002. Effective April 1, 2002, participants stopped accruing benefits under the defined benefit and supplemental defined benefit plans but continue to retain the benefits they had accrued to date. Participants are 100% vested in these plans after 5 years of service. The Company's policy with respect to funding the defined benefit plan is to contribute amounts which are actuarially determined to provide the plan with sufficient assets to meet future benefit payments consistent with the funding requirements of federal laws and regulations. For the defined contribution, 401(k) and defined benefit plans, investments have been set aside in a trust fund; whereas the supplemental retirement plans are non-qualified, unfunded plans. Total expense recorded for the defined contribution, 401(k), defined benefit and supplemental plans was $15,347, $19,259 and $10,678 for the years ended December 31, 2003, 2002 and 2001, respectively. Defined Contribution Plan and 401(k) Plan Pension benefits under the defined contribution plan were fully funded and investments were set aside in a trust fund. None of the trust fund assets for the defined contribution plan have been invested in shares of HMEC's common stock. The 401(k) plan was fully funded and investments were set aside through an annuity contract underwritten by the Company's principal life insurance subsidiary. The annuity contract includes a fixed return account option and several variable return account options, with the account options selected by the individual plan participants. One of the variable return account options invests in shares of HMEC common stock. Contributions to employees' accounts under the defined contribution plan and the 401(k) plan, which were expensed in the Company's Consolidated Statements of Operations, and total assets of the plans were as follows: Year Ended December 31, ------------------------------------- 2003 2002 2001 ----------- ------------ ---------- Defined contribution plan: Contributions to employees accounts... $ 5,818 $ 6,254 $ 6,012 Total assets at the end of the year... 112,795 105,431 97,967 401(k) plan: Contributions to employees accounts... 3,814 3,471 2,301 Total assets at the end of the year... 93,977 81,751 92,189 F-72 NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued) Defined Benefit Plan and Supplemental Retirement Plans The following tables summarize both the funding status of the defined benefit and supplemental retirement pension plans and identify the assumptions used to determine the projected benefit obligation and the components of net pension cost for the defined benefit plan and supplemental retirement plans for the following periods:
Supplemental Defined Benefit Plan Retirement Plans ------------------------------------ ------------------------------------ December 31, December 31, ------------------------------------ ------------------------------------ 2003 2002 2001 2003 2002 2001 ---------- ---------- ---------- ---------- ---------- ---------- Change in benefit obligation: Projected benefit obligation at beginning of year...................................... $ 50,402 $ 50,927 $ 50,830 $ 16,014 $ 13,607 $ 12,191 Service cost.................................. -- 696 1,789 555 671 610 Interest cost................................. 3,258 3,453 3,518 1,019 907 840 Plan amendments............................... -- -- 980 -- -- (383) Actuarial loss (gains)........................ 8,569 7,056 5,500 (103) 1,839 1,355 Benefits paid................................. (2,022) (1,484) (6,010) (1,219) (1,010) (997) Curtailment gain.............................. -- -- (5,680) -- -- (9) Settlements................................... (6,946) (10,246) -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Projected benefit obligation at end of year... $ 53,261 $ 50,402 $ 50,927 $ 16,266 $ 16,014 $ 13,607 ========== ========== ========== ========== ========== ========== Change in plan assets: Fair value of plan assets at beginning of year...................................... $ 28,105 $ 34,569 $ 43,401 $ -- $ -- $ -- Actual return on plan assets.................. 5,812 (2,644) (2,822) -- -- -- Employer contributions........................ 8,780 7,910 -- 1,219 1,010 997 Benefits paid................................. (2,022) (1,484) (6,010) (1,219) (1,010) (997) Settlements................................... (6,946) (10,246) -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Fair value of plan assets at end of year...... $ 33,729 $ 28,105 $ 34,569 $ -- $ -- $ -- ========== ========== ========== ========== ========== ========== Funded status.................................... $ (19,532) $ (22,297) $ (16,358) $ (16,266) $ (16,014) $ (13,607) Unrecognized net actuarial loss.................. 22,860 22,393 14,967 3,681 4,136 2,603 ---------- ---------- ---------- ---------- ---------- ---------- Accrued benefit cost included in the Consolidated Balance Sheets..................... 3,328 96 (1,391) (12,585) (11,878) (11,004) Additional liability to recognize unfunded accumulated benefit obligation.................. (22,860) (22,393) (14,967) (3,681) (4,170) (2,630) ---------- ---------- ---------- ---------- ---------- ---------- Total benefit cost............................... $ (19,532) $ (22,297) $ (16,358) $ (16,266) $ (16,048) $ (13,634) ========== ========== ========== ========== ========== ========== Aimounts recognized in the Statements of Financial Position consist of: Accrued benefit cost.......................... $ 3,328 $ 96 $ (1,391) $ (12,585) $ (11,878) $ (11,004) Minimum liability............................. (22,860) (22,393) (14,967) (3,681) (4,170) (2,630) Accumulated other comprehensive income........ 22,860 22,393 14,967 3,681 4,170 2,630 ---------- ---------- ---------- ---------- ---------- ---------- Net amount recognized...................... $ 3,328 $ 96 $ (1,391) $ (12,585) $ (11,878) $ (11,004) ========== ========== ========== ========== ========== ========== Information for pension plans with an accumulated benefit obligation greater than plan assets: Projected benefit obligation.................. $ 53,261 $ 50,402 $ 50,927 $ 16,266 $ 16,014 $ 13,607 Accumulated benefit obligation................ 53,261 50,402 50,927 16,266 16,014 13,607 Fair value of plan assets..................... 33,729 28,105 34,569 -- -- --
F-73 NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued) The increase in the Company's 2002 minimum pension liability for the defined benefit plan of $7,426 was attributable to the following factors: (1) a decline in asset performance, (2) an increase in the assumed frequency of lump sum elections, (3) an increase in retirement rates and (4) a change in the discount rate from 7.00% to 6.75%. The increase in the Company's 2001 minimum pension liability for the defined benefit plan of $14,967 was attributable to the following factors: (1), (2) and (3) as noted in the previous sentence and (4) a change in the discount rate from 7.25% to 7.00%. These increases were recorded as charges to a separate component of shareholders' equity.
Supplemental Defined Benefit Plan Retirement Plans --------------------------------- ------------------------------ Year Ended December 31, Year Ended December 31, --------------------------------- ------------------------------ 2003 2002 2001 2003 2002 2001 --------- --------- --------- -------- -------- -------- Components of net periodic pension (income) expense: Service cost.................................. $ -- $ 696 $ 1,789 $ 555 $ 671 $ 610 Interest cost................................. 3,258 3,453 3,518 1,019 907 840 Expected return on plan assets................ (2,490) (2,798) (4,021) -- -- -- Amortization of prior service cost............ -- -- (610) -- -- 314 Recognized net actuarial loss................. 1,675 980 -- 352 307 174 Curtailment (gain) loss....................... -- -- (1,614) -- -- 1,258 Settlement loss............................... 3,104 4,093 -- -- -- -- --------- --------- --------- -------- -------- -------- Net periodic pension (income) expense............ $ 5,547 $ 6,424 $ (938) $ 1,926 $ 1,885 $ 3,196 ========= ========= ========= ======== ======== ======== Weighted-average assumptions used to determine expense: Discount rate................................. 6.38% 6.81% 7.25% 6.75% 7.00% 7.25% Expected return on plan assets................ 7.50% 7.81% 8.75% * * * Annual rate of salary increase................ * 4.00% 4.00% * 4.00% 4.00% Weighted-average assumptions used to determine benefit obligations as of December 31: Discount rate................................. 6.25% 6.75% 7.00% 6.25% 6.75% 7.00% Expected return on plan assets................ 7.50% 7.50% 8.75% * * * Annual rate of salary increase................ * * 4.00% * * 4.00%
- ---------- * Not applicable. The assumption for the long-term rate of return on plan assets was determined by considering actual investment experience during the lifetime of the plan, balanced with reasonable expectations of future growth considering the various classes of assets and percentage allocation for each asset class. In 2001, HMEC's Board of Directors approved a proposal for the curtailment of the Company's defined benefit plans. In accordance with SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination of Benefits", the curtailment gain was recognized in 2001, the period in which the pension plan was amended. F-74 NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued) The allocation by asset category of the Company's defined benefit pension plan assets at December 31, 2003, 2002 and 2001 (the measurement dates) were as follows: December 31, --------------------------- 2003 2002 2001 -------- -------- ------- Asset category Equity securities (1)......................... 71.3% 55.6% 72.2% Debt securities............................... 26.7 23.1 27.3 Cash and short-term investments............... 2.0 21.3 0.5 -------- -------- ------- Total...................................... 100.0% 100.0% 100.0% ======== ======== ======= - ---------- (1) None of the trust fund assets for the defined benefit pension plan have been invested in shares of HMEC's common stock. In 2002, the Company adopted an investment policy for the defined benefit pension plan that aligns the assets within the plan's trust to a 70% equity and 30% stable value funds allocation. Management believes this allocation will produce the targeted long-term rate of return on assets necessary for payment of future benefit obligations, while providing adequate liquidity for payments to current beneficiaries. During 2003, assets were rebalanced to reflect the defined benefit pension plan's investment policy and the trustee has been directed to review and adjust invested assets at least quarterly to maintain the target allocation percentages. The Company expects to contribute $3,500 to the defined benefit plan and $1,200 to the supplemental retirement plan in 2004. Postretirement Benefits Other than Pensions In addition to providing pension benefits, the Company also provides certain health care and life insurance benefits to retired employees and eligible dependents. Through December 31, 2000, employees with ten years of service were eligible to receive these benefits upon retirement. Effective January 1, 2001, the eligibility requirement increased to age 55 and 20 years of service. Employees hired on or after January 1, 2001 are not eligible for postretirement medical benefits. Effective January 1, 2004, only employees who are at least age 50 with at least 15 years of service are eligible to participate in this program. Postretirement benefits other than pensions of active and retired employees are accrued as expense over the employees' service years. F-75 NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued) The following table presents the funded status of postretirement benefits other than pensions of active and retired employees (including employees on disability more than 2 years) as of December 31, 2003, 2002 and 2001 (the measurement dates) reconciled with amounts recognized in the Company's Consolidated Balance Sheets: December 31, --------------------------------- 2003 2002 2001 --------- --------- --------- Change in accumulated postretirement benefit obligation: Accumulated postretirement benefit obligation at beginning of year...... $ 37,087 $ 35,749 $ 30,766 Changes during fiscal year Service cost....................... 248 396 475 Interest cost...................... 1,972 2,231 2,285 Plan amendments.................... (3,947) -- -- Benefits paid...................... (2,301) (1,976) (1,676) Actuarial (gain) loss.............. (2,822) 687 3,899 --------- --------- --------- Accumulated postretirement benefit obligation at end of year............ $ 30,237 $ 37,087 $ 35,749 ========= ========= ========= Unfunded status.......................... $ (30,237) $ (37,087) $ (35,749) Unrecognized prior service cost.......... (3,588) -- -- Unrecognized net loss from past experience different from that assumed.. 3,954 6,834 6,147 --------- --------- --------- Accrued postretirement benefit cost... $ (29,871) $ (30,253) $ (29,602) ========= ========= ========= Year Ended December 31, --------------------------------- 2003 2002 2001 --------- --------- --------- Components of net periodic benefit cost: Service cost.......................... $ 248 $ 396 $ 475 Interest cost......................... 1,972 2,231 2,285 Amortization of prior service cost (359) -- -- Amortization of prior losses.......... 58 -- 30 --------- --------- --------- Net periodic benefit cost.......... $ 1,919 $ 2,627 $ 2,790 ========= ========= ========= The Company expects to contribute $2,300 to the postretirement benefit plan in 2004. F-76 NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued) Sensitivity Analysis A one percentage point change in the assumed health care cost trend rate for each year would change the accumulated postretirement benefit obligation as follows: December 31, --------------------------------- 2003 2002 2001 --------- --------- --------- Accumulated postretirement benefit obligation Effect of a one percentage point increase............................. $ 799 $ 904 $ 967 Effect of a one percentage point decrease............................. (710) (805) (859) Service and interest cost components of the net periodic postretirement benefit expense Effect of a one percentage point increase............................. $ 54 $ 45 $ 77 Effect of a one percentage point decrease............................. (48) (40) (64) Healthcare cost trend rate assumed....... 11.0% 12.0% 6.5% Rate to which the cost trend rate is assumed to decline (ultimate trend rate)................................... 5.5% 5.5% 5.0% Year the rate is assumed to reach the ultimate trend rate..................... 2009 2009 2004 Weighed-average assumptions used to determine benefit obligation and net benefit cost as of December 31, Discount rate......................... 6.25% 6.75% 7.00% Expected return on plan assets........ * * * - ---------- * Not applicable. The discount rate of 6.25% at December 31, 2003 is based on the average yield for long-term, high-grade securities available during the benefit payout period. To set its discount rate, the Company looks to leading indicators, including Moody's Aa long-term bond index. The Company acknowledges the existence of the new government Medicare Prescription Drug Program. The table above does not give consideration to this new program. Any effects of this program on the postretirement health care plan of the Company are being deferred while guidance is still pending on the accounting for the federal subsidy in this new program. Guidance, when issued, could require the Company to change previously reported information; however, the impact of this program is not expected to be material to the Company. F-77 NOTE 11 - Reinsurance In the normal course of business, the Company's 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 U.S. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather and fires, and the frequency and severity of catastrophes are inherently unpredictable. The financial impact from catastrophic losses results from both the total amount of insured exposure in the area affected by the catastrophe as well as the severity of the event. The Company seeks to reduce its exposure to catastrophe losses through the geographic diversification of its insurance coverage, deductibles, maximum coverage limits, the purchase of catastrophe reinsurance, and the purchase of a catastrophe-linked equity put option and reinsurance agreement, described below. The total amounts of reinsurance recoverable on unpaid insurance reserves classified as assets and reported in Other Assets in the Consolidated Balance Sheets were as follows: December 31, --------------------- 2003 2002 --------- --------- Reinsurance Recoverables on Reserves and Unpaid Claims Life and health....................... $ 8,161 $ 9,534 Property and casualty State insurance facilities............ 9,582 36,780 Other insurance companies............. 11,033 7,921 --------- --------- Total.............................. $ 28,776 $ 54,235 ========= ========= 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 and contract deposits, premiums and contract charges 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, 2003 Premiums written and contract deposits............................. $ 971,213 $ 23,038 $ 7,284 $ 955,459 Premiums and contract charges earned............................... 658,171 22,249 7,614 643,536 Benefits, claims and settlement expenses............................. 523,205 8,342 4,115 518,978 Year ended December 31, 2002 Premiums written and contract deposits............................. 905,674 20,750 14,405 899,329 Premiums and contract charges earned............................... 642,310 33,567 16,490 625,233 Benefits, claims and settlement expenses............................. 462,476 26,784 15,174 450,866 Year ended December 31, 2001 Premiums written and contract deposits............................. 885,801 27,991 17,756 875,566 Premiums and contract charges earned............................... 625,722 28,601 18,121 615,242 Benefits, claims and settlement expenses............................. 475,991 18,416 18,008 475,583
F-78 NOTE 11 - Reinsurance-(Continued) There were no losses from uncollectible reinsurance recoverables in the three years ended December 31, 2003. Past due reinsurance recoverables as of December 31, 2003 were not material. The Company maintains an excess and catastrophe treaty reinsurance program. The Company reinsured 95% of catastrophe losses above a retention of $8,500 per occurrence up to $80,000 per occurrence through December 31, 2003. Effective January 1, 2004, the retention on this coverage increased to $10,000. In addition, the Company's predominant insurance subsidiary for property and casualty business written in Florida reinsures 90% of hurricane losses in that state above a retention of $14,500 up to $50,900 with the Florida Hurricane Catastrophe Fund, based on the Fund's financial resources. These catastrophe reinsurance programs are augmented by a $75,000 equity put and reinsurance agreement. This equity put provides an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event losses from catastrophes exceed the catastrophe reinsurance program coverage limit. Effective May 7, 2002, the Company entered into an equity put and reinsurance agreement with a subsidiary of Swiss Reinsurance Company. The Swiss Re Group is rated "A+ (Superior)" by A.M. Best. Under the 36-month agreement, which is renewable annually at the option of the Company, the equity put coverage of $75,000 provides a source of capital for up to $115,000 of pretax catastrophe losses above the reinsurance coverage limit. The Company also has the option, in place of the equity put, to require a Swiss Re Group member to issue a 10% quota share reinsurance coverage of all of the Company's property and casualty book of business. Annual fees related to this equity put option, which are charged directly to additional paid-in capital, are 145 basis points for the May 7, 2002 through May 7, 2004 period increasing to 150 basis points for the May 7, 2004 through May 7, 2005 period. The agreement contains certain conditions to Horace Mann's exercise of the equity put option including: (1) the Company's shareholders' equity, adjusted to exclude goodwill, can not be less than $215,000 after recording the first triggering event; (2) the Company's debt as a percentage of total capital can not be more than 47.5% prior to recording the triggering event; and (3) the Company's S&P financial strength rating can not be below "BBB" prior to a triggering event. The Company's S&P financial strength rating was "A" at December 31, 2003. For liability coverages, including the educator excess professional liability policy, the Company reinsures each loss above a retention of $500 up to $20,000. Through December 31, 2003, the Company also reinsured each property loss above a retention of $250 up to $2,500, including catastrophe losses that in the aggregate are less than the retention levels above. Effective January 1, 2004, the retention on the property loss coverage increased to $500. The maximum individual life insurance risk retained by the Company is $200 on any individual life and a maximum of $100 or $125 is retained on each group life policy depending on the type of coverage. Excess amounts are reinsured. The Company also maintains a life catastrophe reinsurance program. The Company reinsured 100% of the catastrophe risk in excess of $1,000 up to $20,000 per occurrence through December 31, 2003 and in excess of $1,000 up to $15,000 per occurrence effective January 1, 2004. This program covers acts of terrorism but excludes nuclear, biological and chemical explosions as well as other acts of war. F-79 NOTE 12 - Contingencies Lawsuits and Legal Proceedings In June 2002, the Company recorded a pretax charge of $1,581 representing the Company's best estimate of the costs of resolving class action lawsuits related to diminished value brought against the Company. A final court hearing on this matter was held on December 18, 2002, at which time the settlement was approved and was within the amount previously accrued by the Company. There are various other lawsuits and legal proceedings against the Company. Management and legal counsel are of the opinion that the ultimate disposition of such other litigation will have no material adverse effect on the Company's financial position or results of operations. Assessments for Insolvencies of Unaffiliated Insurance Companies The Company is also contingently liable for possible assessments under regulatory requirements pertaining to potential insolvencies of unaffiliated insurance companies. Liabilities, which are established based upon regulatory guidance, have generally been insignificant. In December 2001, the Company recorded a pretax charge of $1,314 representing its estimated portion of the industry assessment related to the insolvency of the Reliance Insurance Group. NOTE 13 - 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, --------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Cash flows from operating activities Net income............................................... $ 18,975 $ 11,333 $ 25,587 Adjustments to reconcile net income to net cash provided by operating activities: Realized investment (gains) losses.................... (25,487) 49,407 10,019 Depreciation and amortization......................... 11,082 12,512 8,300 Increase in insurance liabilities..................... 147,502 91,429 124,830 (Increase) decrease in premium receivables............ 634 10,968 (7,160) Increase in deferred policy acquisition costs......... (19,835) (21,822) (19,565) (Increase) decrease in reinsurance recoverable........ 1,110 4,279 (5,850) Increase (decrease) in federal income tax liabilities.......................................... (18,791) (9,061) 3,179 Decrease in liabilities for restructuring and litigation charges................................... (3,101) (170) (3,127) Other................................................. 5,319 16,592 12,644 ----------- ----------- ----------- Total adjustments.................................. 98,433 154,134 123,270 ----------- ----------- ----------- Net cash provided by operating activities....... $ 117,408 $ 165,467 $ 148,857 =========== =========== ===========
The Company's repurchases of debt in 2002 resulted in non-cash financing charges of $1,731. F-80 NOTE 14 - Segment Information The Company's operations include the following operating segments which have been determined on the basis of insurance products sold: property and casualty, annuity and life insurance. The property and casualty insurance segment includes primarily personal lines automobile and homeowners products. The annuity segment includes primarily fixed and variable tax-qualified annuity products. The life insurance segment includes primarily interest-sensitive life and traditional life products. The accounting policies of the segments are the same as those described in Note 1 - Summary of Significant Accounting Policies. The Company accounts for intersegment transactions, primarily the allocation of agent and overhead costs from the corporate and other segment to the property and casualty, annuity and life segments, on a cost basis. The Company does not allocate the impact of corporate level transactions to the insurance segments, consistent with management's evaluation of the results of those segments. Summarized financial information for these segments is as follows:
Year Ended December 31, --------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Insurance premiums and contract charges earned Property and casualty.................................... $ 533,761 $ 519,546 $ 508,345 Annuity.................................................. 14,588 14,247 14,906 Life..................................................... 96,004 92,707 93,272 Intersegment eliminations................................ (817) (1,267) (1,281) ----------- ----------- ----------- Total.............................................. $ 643,536 $ 625,233 $ 615,242 =========== =========== =========== Net investment income Property and casualty.................................... $ 31,892 $ 35,180 $ 37,749 Annuity.................................................. 104,380 107,731 107,583 Life..................................................... 49,605 53,925 55,226 Corporate and other...................................... 10 387 98 Intersegment eliminations................................ (1,162) (1,175) (1,389) ----------- ----------- ----------- Total.............................................. $ 184,725 $ 196,048 $ 199,267 =========== =========== =========== Net income Property and casualty.................................... $ (17,805) $ 19,943 $ 5,184 Annuity.................................................. 14,353 16,963 20,619 Life..................................................... 13,431 18,899 18,646 Corporate and other (a).................................. 8,996 (44,472) (18,862) ----------- ----------- ----------- Total.............................................. $ 18,975 $ 11,333 $ 25,587 =========== =========== =========== Amortization of intangible assets Value of acquired insurance in force Annuity.................................................. $ 3,402 $ 4,008 $ 2,317 Life..................................................... 1,625 1,726 1,839 ----------- ----------- ----------- Subtotal.............................................. 5,027 5,734 4,156 Goodwill................................................. -- -- 1,618 ----------- ----------- ----------- Total.............................................. $ 5,027 $ 5,734 $ 5,774 =========== =========== ===========
December 31, ------------------------- 2003 2002 ----------- ----------- Assets Property and casualty................. $ 795,579 $ 773,362 Annuity............................... 3,163,808 2,628,083 Life.................................. 947,468 1,036,078 Corporate and other................... 95,505 112,102 Intersegment eliminations............. (29,372) (37,336) ----------- ----------- Total.............................. $ 4,972,988 $ 4,512,289 =========== =========== - ---------- (a) The corporate and other segment includes interest expense on debt and the impact of realized investment gains and losses, restructuring charges, debt retirement costs, litigation charges, provision for prior years' taxes and certain public company expenses. F-81 NOTE 15 - Unaudited Interim Information Summary quarterly financial data is presented below.
Three Months Ended ------------------------------------------------------------ December 31, September 30, June 30, March 31, ------------- ------------- ------------- ------------ 2003 - ---- Insurance premiums written and contract deposits...... $ 249,723 $ 251,436 $ 234,760 $ 219,540 Total revenues........................................ 232,436 211,014 209,207 201,091 Net income (loss)..................................... 23,059 (14,266) 2,083 8,099 Per share information Basic Net income (loss)............................... $ 0.54 $ (0.34) $ 0.05 $ 0.19 Shares of common stock - weighted average (a)... 42,722 42,722 42,707 42,700 Diluted Net income (loss)............................... $ 0.54 $ (0.34) $ 0.05 $ 0.19 Shares of common stock and equivalent shares - weighted average (a).................. 42,900 42,933 42,901 42,869 2002 - ---- Insurance premiums written and contract deposits...... $ 236,377 $ 232,604 $ 218,600 $ 211,748 Total revenues........................................ 210,667 189,981 163,406 207,820 Net income (loss)..................................... 13,547 549 (18,334) 15,571 Per share information Basic Net income (loss)............................... $ 0.33 $ 0.02 $ (0.45) $ 0.38 Shares of common stock - weighted average (a)... 41,293 40,850 40,838 40,780 Diluted Net income (loss)............................... $ 0.33 $ 0.02 $ (0.45) $ 0.38 Shares of common stock and equivalent shares - weighted average (a).................. 41,466 41,025 41,294 41,231 2001 - ---- Insurance premiums written and contract deposits...... $ 225,262 $ 224,307 $ 218,225 $ 207,772 Total revenues........................................ 201,889 203,131 196,106 203,364 Net income (loss)..................................... 4,758 9,057 (4,926) 16,698 Per share information Basic Net income (loss)............................... $ 0.12 $ 0.22 $ (0.12) $ 0.41 Shares of common stock - weighted average (a)... 40,728 40,659 40,554 40,524 Diluted Net income (loss)............................... $ 0.12 $ 0.22 $ (0.12) $ 0.41 Shares of common stock and equivalent shares - weighted average (a).................. 41,016 40,977 40,874 40,747
- ---------- (a) Rounded to thousands. F-82 SCHEDULE I HORACE MANN EDUCATORS CORPORATION SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 2003 (Dollars in thousands) Amount shown in Fair Balance Type of Investments Cost(1) Value Sheet - ---------------------------------------- ----------- ----------- ----------- Fixed maturities: U.S. Government and U.S. Government agencies and authorities............ $ 943,375 $ 961,062 $ 961,062 States, municipalities and political subdivisions........................ 488,081 502,912 502,912 Foreign government bonds............. 33,134 36,194 36,194 Public utilities..................... 123,293 128,854 128,854 Other corporate bonds................ 1,536,978 1,629,652 1,629,652 ----------- ----------- ----------- Total fixed maturity securities... 3,124,861 $ 3,258,674 3,258,674 ----------- =========== ----------- Mortgage loans and real estate.......... 4,557 XXX 4,557 Short-term investments.................. 25,367 XXX 25,367 Short-term investments, loaned securities............................. 22,147 XXX 22,147 Policy loans and other.................. 74,270 XXX 74,980 ----------- ----------- Total investments................. $ 3,251,202 XXX $ 3,385,725 =========== =========== - ---------- (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-83 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION BALANCE SHEETS As of December 31, 2003 and 2002 (Dollars in thousands, except per share data) December 31, --------------------------- 2003 2002 ------------ ------------ ASSETS Investments and cash.............................. $ 7,311 $ 10,913 Investment in subsidiaries........................ 640,886 608,164 Other assets...................................... 53,297 55,764 ------------ ------------ Total assets................................ $ 701,494 $ 674,841 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Short-term debt................................... $ 25,000 $ -- Long-term debt.................................... 144,703 144,685 Other liabilities................................. 1,316 1,314 ------------ ------------ Total liabilities........................... 171,019 145,999 ------------ ------------ 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, 2003, 60,225,311; 2002, 60,194,615................................. 60 60 Additional paid-in capital........................ 342,306 342,749 Retained earnings................................. 456,330 455,308 Accumulated other comprehensive income (loss), net of taxes: Net unrealized gains on fixed maturities and equity securities......................... 81,608 80,567 Minimum pension liability adjustment........... (17,252) (17,265) Treasury stock, at cost, 2003 and 2002, 17,503,371 shares................................ (332,577) (332,577) ------------ ------------ Total shareholders' equity.................. 530,475 528,842 ------------ ------------ Total liabilities and shareholders' equity..................................... $ 701,494 $ 674,841 ============ =========== See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-84 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION STATEMENTS OF OPERATIONS (Dollars in thousands) Year Ended December 31, ------------------------------ 2003 2002 2001 -------- -------- -------- Revenues Net investment income....................... $ 19 $ 386 $ 100 Realized investment gains (losses).......... 62 (430) 219 -------- -------- -------- Total revenues........................... 81 (44) 319 -------- -------- -------- Expenses Interest.................................... 6,339 8,517 9,250 Debt retirement costs....................... -- 2,272 -- Amortization of goodwill.................... -- -- 1,618 Other....................................... 4,629 1,755 3,802 -------- -------- -------- Total expenses........................... 10,968 12,544 14,670 -------- -------- -------- Loss before income taxes and equity in net earnings of subsidiaries................. (10,887) (12,588) (14,351) Income tax benefit............................. (4,131) (3,954) (4,099) -------- -------- -------- Loss before equity in net earnings of subsidiaries............................... (6,756) (8,634) (10,252) Equity in net earnings of subsidiaries......... 25,731 19,967 35,839 -------- -------- -------- Net income..................................... $ 18,975 $ 11,333 $ 25,587 ======== ======== ======== See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-85 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION STATEMENTS OF CASH FLOWS (Dollars in thousands)
Year Ended December 31, --------------------------------- 2003 2002 2001 --------- --------- --------- Cash flows from operating activities Interest expense paid...................................... $ (5,454) $ (9,540) $ (9,091) Contribution to defined benefit pension plan trust fund.... (8,780) (7,910) -- Federal income taxes (paid) recovered...................... 6,344 7,793 (12) Cash dividends received from subsidiaries.................. 23,300 5,900 28,650 Other, net................................................. 2,534 9,296 (4,032) --------- --------- --------- Net cash provided by operating activities............... 17,944 5,539 15,515 --------- --------- --------- Cash flows provided by (used in) investing activities Net (increase) decrease in investments..................... (3,368) (2,477) 5,707 Capital contributions to subsidiaries...................... (27,500) -- (4,500) --------- --------- --------- Net cash provided by (used in) investing activities..... (30,868) (2,477) 1,207 --------- --------- --------- Cash flows provided by (used in) financing activities Dividends paid to shareholders............................. (17,953) (17,164) (17,072) Principal borrowings (payments) on Bank Credit Facility.... 25,000 (53,000) 4,000 Exercise of stock options.................................. -- 2,183 3,759 Catastrophe-linked equity put option premium............... (1,088) (1,088) (950) Proceeds from issuance of Senior Convertible Notes......... -- 162,654 -- Repurchase of Senior Notes and Senior Convertible Notes.... -- (97,523) -- --------- --------- --------- Net cash provided by (used in) financing activities..... 5,959 (3,938) (10,263) --------- --------- --------- Net increase (decrease) in cash............................... (6,965) (876) 6,459 Cash at beginning of period................................... 7,457 8,333 1,874 --------- --------- --------- Cash at end of period......................................... $ 492 $ 7,457 $ 8,333 ========= ========= =========
See accompanying note to condensed financial statements. See accompanying Independent Auditors' Report. F-86 SCHEDULE II HORACE MANN EDUCATORS CORPORATION (Parent Company Only) CONDENSED FINANCIAL INFORMATION NOTE TO CONDENSED FINANCIAL STATEMENTS 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-87 SCHEDULE III & VI (COMBINED) HORACE MANN EDUCATORS CORPORATION SCHEDULE III: SUPPLEMENTARY INSURANCE INFORMATION SCHEDULE VI: SUPPLEMENTAL INFORMATION CONCERNING PROPERTY AND CASUALTY INSURANCE OPERATIONS (Dollars in thousands)
Column identification for Schedule III: A B C D E F G Schedule VI: A B C D E F G Discount, Other Deferred Future policy if any, policy Premium policy benefits, deducted in claims and revenue/ Net acquisition claims and previous Unearned benefits premium investment Segment costs claims expenses column premiums payable earned income - -------------------------------- ----------- --------------- ----------- ---------- ---------- ---------- ---------- Year Ended December 31, 2003 Property and casualty........ $ 19,022 $ 341,496 $ 0 $ 190,204 $ -- $ 533,761 $ 31,892 Annuity...................... 80,469 1,528,516 xxx -- 122,104 14,588 104,380 Life......................... 94,212 755,216 xxx 8,787 7,784 96,004 49,605 Other, including consolidating eliminations N/A -- xxx N/A N/A (817) (1,152) ----------- --------------- ---------- ---------- ---------- ---------- Total..................... $ 193,703 $ 2,625,228 xxx $ 198,991 $ 129,888 $ 643,536 $ 184,725 =========== =============== ========== ========== ========== ========== Year Ended December 31, 2002 Property and casualty........ $ 21,388 $ 317,321 $ 0 $ 180,509 $ -- $ 519,546 $ 35,180 Annuity...................... 63,643 1,389,498 xxx -- 116,489 14,247 107,731 Life......................... 89,524 728,603 xxx 8,875 8,619 92,707 53,925 Other, including consolidating eliminations NA 2,000 xxx NA NA (1,267) (788) ----------- --------------- ---------- ---------- ---------- ---------- Total..................... $ 174,555 $ 2,437,422 xxx $ 189,384 $ 125,108 $ 625,233 $ 196,048 =========== =============== ========== ========== ========== ========== Year Ended December 31, 2001 Property and casualty......... $ 18,957 $ 306,141 $ 0 $ 177,023 $ -- $ 508,345 $ 37,749 Annuity....................... 54,791 1,279,891 xxx -- 113,780 14,906 107,583 Life.......................... 84,028 701,964 xxx 8,546 9,654 93,272 55,226 Other, including consolidating eliminations N/A 2,000 xxx N/A N/A (1,281) (1,291) ----------- --------------- ---------- ---------- ---------- ---------- Total..................... $ 157,776 $ 2,289,996 xxx $ 185,569 $ 123,434 $ 615,242 $ 199,267 =========== =============== ========== ========== ========== ========== Column identification for Schedule III: A H I J K Schedule VI: A H I J K Claims and claims Benefits, adjustment expense Amortization Paid claims incurred related to of deferred claims and --------------------- policy Other and claims settlement Current Prior acquisition operating adjustment Premiums Segment expenses year years costs expenses expense written - -------------------------------- ---------- ---------- --------- ------------ ---------- ---------- ---------- Year Ended December 31, 2003 Property and casualty........ $ 472,843 $ 416,473 $ 56,370 $ 56,904 $ 71,078 $ 424,582 $ 546,510 Annuity...................... 72,076 xxx xxx 767 26,359 xxx xxx Life......................... 77,029 xxx xxx 7,491 40,313 xxx xxx Other, including consolidating eliminations -- xxx xxx (817) 10,526 xxx xxx ---------- ------------ ---------- Total..................... $ 621,948 xxx xxx $ 64,345 $ 148,276 xxx xxx ========== ============ ========== Year Ended December 31, 2002 Property and casualty........ $ 410,161 $ 387,747 $ 23,995(1) $ 51,804 $ 68,969 $ 411,159 $ 524,877 Annuity...................... 69,233 xxx xxx 2,740 26,784 xxx xxx Life......................... 69,852 xxx xxx 8,020 39,597 xxx xxx Other, including consolidating eliminations -- xxx xxx (1,267) 18,316 xxx xxx ---------- ------------ ---------- $ 549,246 xxx xxx $ 61,297 $ 153,666 xxx xxx Total..................... ========== ============ ========== Year Ended December 31, 2001 Property and casualty......... $ 433,344 $ 416,770 $ 16,574 $ 47,780 $ 63,042 $ 411,147 $ 519,167 Annuity....................... 66,901 xxx xxx 3,498 21,368 xxx xxx Life.......................... 69,840 xxx xxx 8,232 41,531 xxx xxx Other, including consolidating eliminations 2,000 xxx xxx (1,462) 20,074 xxx xxx ---------- ------------ ---------- Total..................... $ 572,085 xxx xxx $ 58,048 $ 146,015 xxx xxx ========== ============ ==========
- ---------- (1) Property and casualty segment claims and claims adjustment expense incurred related to prior years includes a $1,581 statutory accounting charge for class action litigation which was separately reported as Litigation Charges in the Company's Consolidated Statements of Operations. N/A Not applicable. See accompanying Independent Auditors' Report. F-88 SCHEDULE IV HORACE MANN EDUCATORS CORPORATION REINSURANCE (Dollars in thousands)
Column A Column B Column C Column D Column E Column F Ceded to Assumed Percentage Gross Other from State of Amount Amount Companies Facilities Net Assumed to Net ------------ ------------ ------------ ------------ -------------- Year ended December 31, 2003 Life insurance in force............ $ 13,263,273 $ 1,333,005 -- $ 11,930,268 -- Premiums Property and casualty........... $ 542,500 $ 16,353 $ 7,614 $ 533,761 1.4% Annuity......................... 14,588 -- -- 14,588 -- Life............................ 101,900 5,896 -- 96,004 -- Other, including consolidating eliminations..... (817) -- -- (817) -- ------------ ------------ ------------ ------------ Total premiums............... $ 658,171 $ 22,249 $ 7,614 $ 643,536 1.2% ============ ============ ============ ============ Year ended December 31, 2002 Life insurance in force............ $ 13,196,369 $ 1,286,109 -- $ 11,910,260 -- Premiums Property and casualty........... $ 530,253 $ 27,197 $ 16,490 $ 519,546 3.2% Annuity......................... 14,247 -- -- 14,247 -- Life............................ 99,077 6,370 -- 92,707 -- Other, including consolidating eliminations..... (1,267) -- -- (1,267) -- ------------ ------------ ------------ ------------ Total premiums............... $ 642,310 $ 33,567 $ 16,490 $ 625,233 2.6% ============ ============ ============ ============ Year ended December 31, 2001 Life insurance in force............ $ 13,216,146 $ 1,035,477 -- $ 12,180,669 -- Premiums Property and casualty........... $ 514,574 $ 24,350 $ 18,121 $ 508,345 3.6% Annuity......................... 14,906 -- -- 14,906 -- Life............................ 97,523 4,251 -- 93,272 Other, including consolidating eliminations..... (1,281) -- -- (1,281) -- ------------ ------------ ------------ ------------ Total premiums............... $ 625,722 $ 28,601 $ 18,121 $ 615,242 2.9% ============ ============ ============ ============
- ---------- NOTE: Premiums above include insurance premiums earned and contract charges earned. See accompanying Independent Auditors' Report F-89 ================================================================================ - -------------------------------------------------------------------------------- HORACE MANN EDUCATORS CORPORATION EXHIBITS To FORM 10-K For the Year Ended December 31, 2003 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, 2003. Management contracts and compensatory plans are indicated by an asterisk (*). EXHIBIT INDEX Exhibit No. Description - ----------- --------------------------------------------------------------- (3) Articles of incorporation and bylaws: 3.1 Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on June 24, 2003, incorporated by reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, filed with the Securities and Exchange Commission (the "SEC") on August 14, 2003. 3.2 Form of Certificate for shares of Common Stock, $0.001 par value per share, of HMEC, incorporated by reference to Exhibit 4.5 to HMEC's Registration Statement on Form S-3 (Registration No. 33-53118) filed with the SEC on October 9, 1992. 3.3 Bylaws of HMEC, incorporated by reference to Exhibit 3.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, filed with the SEC on August 14, 2003. (4) Instruments defining the rights of security holders, including indentures: 4.1 Indenture dated as of January 17, 1996, between HMEC and U.S. Trust Company of California, N.A. as trustee, with regard to HMEC's 6 5/8% Senior Notes Due 2006, incorporated by reference to Exhibit 4.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1995, filed with the SEC on March 13, 1996. 4.1(a) Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.1). 4.2 Indenture dated as of May 14, 2002, between HMEC and JPMorgan Chase Bank as trustee, with regard to HMEC's 1.425% Senior Convertible Notes Due 2032, incorporated by reference to Exhibit 4.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 4.2(a) Form of 1.425% Senior Convertible Notes Due 2032 (included in Exhibit 4.2). 4.3 Certificate of Designations for HMEC Series A Cumulative Convertible Preferred Stock (included in Exhibit 10.14). Exhibit No. Description - ------------- --------------------------------------------------------------- (10) Material contracts: 10.1 Credit Agreement dated as of May 29, 2002 (the "Bank Credit Facility") among HMEC, certain financial institutions named therein and Bank of America, N.A., as administrative agent (the "Agent"), incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 10.2* Stock Subscription Agreement among HMEC (as successor to HME Holdings, Inc.), The Fulcrum III Limited Partnership, The Second Fulcrum III Limited Partnership and each of the Management Investors, incorporated by reference to Exhibit 10.17 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1989, filed with the SEC on April 2, 1990. 10.3* Horace Mann Educators Corporation Deferred Equity Compensation Plan for Directors, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, filed with the SEC on November 14, 1996. 10.4* Horace Mann Educators Corporation Deferred Compensation Plan for Employees, incorporated by reference to Exhibit 10.4 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1997, filed with the SEC on March 30, 1998. 10.5* Amended and Restated Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.5(a)* Amendment to Amended and Restated Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, filed with the SEC on August 11, 2000. 10.5(b)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5(a) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.5(c)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 1991 Stock Incentive Plan, incorporated by reference to Exhibit 10.5(b) to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.6* Horace Mann Educators Corporation 2001 Stock Incentive Plan, incorporated by reference to Exhibit 10.6 to HMEC's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. Exhibit No. Description - ------------- --------------------------------------------------------------- 10.6(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan, incorporated by reference to Exhibit 10.6(a) to HMEC's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. 10.6(b)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan, incorporated by reference to Exhibit 10.6(b) to HMEC's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. 10.7* Horace Mann Educators Corporation 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 10.7(a)* Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(a) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 10.7(b)* Specimen Regular Employee Stock Option Agreement under the Horace Mann Educators Corporation 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(b) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 10.7(c)* Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(c) to HMEC's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. 10.8* Severance Agreements between HMEC and certain officers of HMEC, incorporated by reference to Exhibit 10.7 to HMEC's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. 10.8(a)* Revised Schedule to Severance Agreements between HMEC and certain officers of HMEC. 10.9* Horace Mann Supplemental Employee Retirement Plan, 2002 Restatement, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, filed with the SEC on May 15, 2002. 10.10* Horace Mann Executive Supplemental Employee Retirement Plan, 2002 Restatement, incorporated by reference to Exhibit 10.2 to HMEC's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, filed with the SEC on May 15, 2002. Exhibit No. Description - ------------- --------------------------------------------------------------- 10.11* Horace Mann Nonqualified Supplemental Money Purchase Pension Plan, incorporated by reference to Exhibit 10.3 to HMEC's Quarterly Report on Form 10-Q for the Quarter Ended March 31, 2002, filed with the SEC on May 15, 2002. 10.12* Employment Agreement entered by and between HMEC and Louis G. Lower II as of December 31, 1999, incorporated by reference to Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the SEC on March 30, 2000. 10.13* Transition, Retirement and Release Agreement entered by and between Horace Mann Service Corporation and George J. Zock as of December 31, 2003. 10.14 First Amended and Restated Catastrophe Equity Securities Issuance Option and Reinsurance Option Agreement entered by and between HMEC, Swiss Re Financial Products Corporation (Option Writer) and Swiss Reinsurance America Corporation (Reinsurance Option Writer), dated May 7, 2002, incorporated by reference to Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed with the SEC on November 14, 2002. (11) Statement regarding computation of per share earnings. (12) Statement regarding computation of ratios. (21) Subsidiaries of HMEC. (23) Consent of KPMG LLP. (31) Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.1 Certification by Louis G. Lower II, Chief Executive Officer of HMEC. 31.2 Certification by Peter H. Heckman, Chief Financial Officer of HMEC. (32) Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.1 Certification by Louis G. Lower II, Chief Executive Officer of HMEC. 32.2 Certification by Peter H. Heckman, Chief Financial Officer of HMEC. EX-10.8(A) 3 dex108a.txt REVISED SCHEDULE TO SEVERANCE AGREEMENTS BETWEEN HMEC AND CERTAIN OFFICERS Exhibit 10.8(a) Revised Schedule to Severance Agreement Horace Mann Educators Corporation ("HMEC") entered into severance agreements with the following persons on the dates shown. These agreements are substantially identical to the one included as Exhibit 10.7 to HMEC's Annual Report on Form 10-K for the year ended December 31, 2001 except that (1) the multiple of the highest annual compensation received by the employee in the five preceding years used to determine a one-time cash payment is equal to the duration listed below and (2) the specified period during which such employee's insurance benefits would continue is equal to the duration below, and except as indicated in footnote (a). Employee Duration Agreement Date - --------------------- --------- -------------- Louis G. Lower II (a) 3 years 02-01-2000 Ann M. Caparros 2.9 years 03-07-1994 Peter H. Heckman 2.9 years 04-10-2000 H. Albert Inkel 2.9 years 12-27-1991 Daniel M. Jensen 2.9 years 09-04-2001 Douglas W. Reynolds 2.9 years 11-12-2001 Paul D. Andrews 2 years 07-02-2001 Ronnie H. Byers 2 years 03-16-2000 Valerie A. Chrisman 2 years 12-27-1991 Bret A. Conklin 2 years 01-14-2002 Dwayne D. Hallman 2 years 01-21-2003 William S. Hinkle 2 years 07-19-1999 Deborah F. Kretchmar 2 years 06-17-2002 Ricky A. Renner 2 years 07-09-2001 Robert E. Rich 2 years 02-19-2001 Peter M. Titone 2 years 01-08-2001 - ---------- (a) HMEC entered into a severance agreement with Louis G. Lower II as set forth in the Lower Employment Agreement contained in Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year ended December 31, 1999. EX-10.13 4 dex1013.txt TRANSITION, RETIREMENT AND RELEASE AGREEMENT BETWEEN HMSC AND GEORGE ZOCK Exhibit 10.13 TRANSITION, RETIREMENT AND RELEASE AGREEMENT -------------------------------------------- This TRANSITION, RETIREMENT AND RELEASE AGREEMENT (this "Agreement") is made and entered into by and between Horace Mann Service Corporation ("Horace Mann"), an Illinois corporation, and George J. Zock ("Zock") to provide an orderly and amicable arrangement with respect to Zock's performance of transitional duties preliminary to his retirement from Horace Mann. In consideration for the mutual promises provided herein, the parties hereby agree as follows: 1) Change of Current Duties; Conditions While Performing Consulting Duties; Retirement Date a) Zock shall cease his current duties, salary, responsibilities, title and office as Executive Vice President effective on December 31, 2003. i) On or about each of December 15, 2003 and December 31, 2003, Zock will receive a gross salary payment of Twelve Thousand Eighty Three and 50/100 Dollars ($12,083.50) and continue to be eligible for normal employee benefits. ii) From January 1, 2004 until his Retirement Date as such term is defined in Paragraph 1.C. below, (such period referred to herein as the "Consulting Period") Zock shall remain employed on the payroll of Horace Mann paid at a salary rate of Fourteen Thousand One Hundred Twenty Eight and no/100 Dollars ($14,128.00) per month which will be paid in semi-monthly installments in the amount of Seven Thousand Sixty Four and no/100 Dollars ($7,064.00 per pay) in accordance with Horace Mann's payroll practices. iii) Zock shall be eligible for bonus consideration for his service in 2003, calculated using 2003 salary earnings, and otherwise in accordance with the terms of the Annual Incentive Program for Officers as detailed in Exhibit A, if any is payable in 2004. iv) Prior to his Retirement Date, Zock shall be eligible to continue participation in the Long Term Incentive Plan ("LTIP"), as such may be amended from time to time. Further, Zock will be eligible for payment in 2005 of two-thirds (2/3) of the LTIP bonus payment for the 2002-2004 measurement period which will be calculated based on two thirds (2/3) of the achieved performance results multiplied by the target opportunity as detailed on Exhibit B, as such may be amended from time to time. v) All stock option awards previously granted will continue to vest as detailed in the specific Stock Option Agreements applicable to him which have been issued prior to December 31, 2003. vi) Zock shall be eligible to remove any freestanding office furniture in his office, to include desk, chairs, coffee table, and couch. In addition, Zock is eligible to take the laptop computer, docking station, monitor, keyboard and mouse assigned to him, provided that all Horace Mann proprietary, confidential and the like information and software is removed from the computer. The removal of such is Zock's responsibility and at his cost and will be done at a mutually agreeable time and manner. vii) Horace Mann continue to pay for Zock's membership to the Sangamo Club through Zock's Retirement Date. viii) Other than the payments provided for in paragraph 1(a)(ii), Zock shall not be eligible for any bonus consideration, vacation or vacation pay, stock option awards or any other remuneration or compensation during the Consulting Period. During the Consulting Period, Zock shall otherwise remain eligible for benefits available under the Horace Mann Benefit Programs consistent with a salary rate of Fourteen Thousand One Hundred Twenty Eight and no/100 Dollars ($14,128.00) per month. b) During the Consulting Period, Zock shall, at the discretion of the President and Chief Executive Officer ("CEO") of Horace Mann, perform limited consulting responsibilities ("Consulting Duties") as assigned and deemed appropriate by such CEO with such responsibilities being performed at mutually agreeable locations. It is expected such duties will focus primarily on transitional advice relating to matters in which Zock participated while actively employed. Zock's good faith performance of such duties to the best of his abilities shall constitute compliance with this requirement. Any reasonable and necessary business expenses incurred in connection with such Consulting Duties assigned shall be reimbursed in accordance with Horace Mann's normal expense reimbursement policies. During the Consulting Period, Zock shall owe Horace Mann the same duty of loyalty owed to Horace Mann by an officer of Horace Mann, and he shall not engage in any competing business or other activities that are detrimental to the interests or welfare of Horace Mann. Provided, however, Zock may, with the advance written approval of the CEO of Horace Mann, consult, become employed by, or act as an independent contractor for business entities whose interests do not directly conflict with those of Horace Mann. c) Zock will retire from Horace Mann on November 15, 2005 (such date referred to herein as "Retirement Date") and he will complete all documents necessary to effectuate such retirement. Zock states that this retirement is voluntary; that he understands that his employment (and this Agreement) with Horace Mann shall cease on his Retirement Date (or upon his death); that he shall not accrue any further benefits thereafter; nor shall he be eligible for any other salary payments after such date. Zock shall be eligible for retirement benefits and other benefits in effect at his Retirement Date and due to him under Horace Mann's benefit plans attributable to service prior to his Retirement Date, including any applicable death benefits. Provided, however, he acknowledges that he is not eligible for any severance payments. 2) Releases and Covenants Not To Sue. a) Zock, for himself, his agents, legal representatives, assigns, heirs, distributees, devisees, legatees, administrators, personal representatives and executors (the "Releasing Parties"), hereby releases and forever discharges Horace Mann, its present or past parent corporations, subsidiaries, divisions and affiliates, or related companies, successors or assigns, and their respective present or past officers, trustees, directors, employees and agents of each of them (the "Released Parties"), from any and all claims, demands, actions, liabilities and other claims for relief and remuneration whatsoever, whether known or unknown arising or which could have arisen up to and including the date of his execution of this Agreement, including, without limitation, those arising out of or relating to Zock's employment and cessation of employment, his change in employment duties, consulting status and his retirement from Horace Mann on or before November 15, 2005, and any claims arising under Title VII of the Civil Rights Act of 1964 (as amended by the Civil Rights Act of 1991), the Americans With Disabilities Act, the Rehabilitation Act of 1973, the Equal Pay Act, the Fair Labor Standards Act, the Older Workers Benefits Protection Act, the Age Discrimination in Employment Act, the Illinois Human Rights Act, the Illinois Wage Payment - 2 - and Collection Act, the Employee Retirement Income Security Act ("ERISA"), as such acts have been amended, or any other federal, state, or local statute, law, ordinance, regulation, code or executive order, any tort or contract claims, and any of the claims, matters and issues which could have been asserted by Zock against Horace Mann, provided that the Releasing Parties do not release potential claims arising under ERISA to any benefits to which Zock is entitled in accordance with the Horace Mann Benefit Programs by virtue of his employment with Horace Mann prior to his Retirement Date. b) Zock further agrees not to assert any claim, suit or other legal proceeding against the Released Parties, in any court, based on any events, whether known or unknown, which are the subject of the release contained in section A. of this Paragraph 2. Zock further agrees that if any entity or person shall bring any claim that has been released in section A. of this Paragraph 2 on his behalf, he shall not accept any recovery or remedy with respect to any such claim. 3) Confidentiality. a) Except as required by law, Zock agrees not to discuss, divulge, publicize, publish or use any information he received or used in the course of his employment with Horace Mann which is not publicly available. Zock further agrees not to disclose, divulge, publicize or publish the terms of this Agreement or the facts or circumstances that led to this Agreement, except to his counsel, spouse or financial advisor, or as required by law, or as required to enforce the terms of this Agreement. In addition, Zock will require his spouse, current or any future attorneys or professional tax preparers or other financial advisor, or their employees, as a condition of discussing this Agreement or any of the matters described in the Agreement with them to execute a Confidentiality Acknowledgment in a form attached hereto as Exhibit C and to send a copy of such form in a confidential envelope to Ann Caparros, Esq., General Counsel, (or her successor) Horace Mann Service Corporation, 1 Horace Mann Plaza, Springfield, Illinois 62715-0001. Zock shall instruct his present or future attorney, spouse, tax preparer or other financial advisor, as the case may be, that they are subject to the same requirements. b) Zock further agrees that if he is subpoenaed to testify or produce documents or any other information relating in any way to the subject matter of this Agreement, or if he is otherwise in a position in which he feels he is required by law to make a disclosure otherwise prohibited by Paragraph 3., he or his attorneys shall immediately notify Horace Mann in care of Ann M. Caparros, Esq., General Counsel (or her successor), at Horace Mann Service Corporation, 1 Horace Mann Plaza, Springfield, Illinois 62715-0001, by telephone (217.788.5757) and in writing of this fact and before he complies with any such subpoena or otherwise make such disclosure in order to permit Horace Mann to take steps to protect its interests in this regard. In addition, Zock will cooperate with Horace Mann in all reasonable respects necessary to effectuate a motion to quash any subpoena or production request in this regard, and to cooperate with Horace Mann's opposition to such disclosure. Zock's reasonable costs, expenses and attorney's fees in this regard shall be paid by Horace Mann, but provided, further, that no such costs, fees or expenses shall be committed or expended without Horace Mann's express written approval. If after following the procedures set forth in this paragraph, Zock nevertheless is compelled by court order or otherwise required by law to testify or produce documents. Zock's compliance shall not constitute or be construed as a breach of this Agreement. - 3 - c) Zock further agrees and understands that if he fails to comply with the requirements of Paragraph 3 of this Agreement, Horace Mann shall be entitled to cease all further payments or benefits which would otherwise be due to Zock under this Agreement, as well as any other remedy for breach of this Agreement, as permitted by law. 4) No Reinstatement; No Reapplication. Zock waives any rights to reinstatement or re-employment with Horace Mann or any related entity after the completion of the Consulting Period. He further agrees not to reapply for employment to such entities in the future. Horace Mann and its affiliates shall not be required to consider any application for employment or re-employment by Zock. 5) Return of Horace Mann Materials and Property. Zock hereby acknowledges that at the conclusion of the Consulting Period, he will return or destroy all Horace Mann materials and property, including all intellectual property to Horace Mann. Zock further agrees not to make or keep any copies, electronic or paper, of any Horace Mann documents or other intellectual property. 6) Voluntary Agreement; Legal Counsel; 21 Day Consideration Period. Zock acknowledges and states that he has read this Agreement; that he has had opportunity to, and has been advised orally and in writing hereby, to consult with legal counsel prior to executing this Agreement, that he understands the legal effect and binding nature of this Agreement; and that he is acting voluntarily and with full knowledge of his actions in executing this Agreement. Further, Zock acknowledges and states that he has been given at least 21 days to fully consider entering into this Agreement before its execution. 7) Revocation. This Agreement may be revoked by Zock within seven (7) days following his execution of this Agreement, in which case this Agreement shall not become effective or enforceable and all terms within the Agreement shall become null and void. If not revoked during this seven (7) day revocation period, this Agreement shall be and remain in full force and effect. 8) Assignment. This Agreement shall not be assigned by Zock, but it is binding upon and shall inure to the benefit of Horace Mann and its successors and assigns. 9) Governing Law; Disputes. This Agreement shall be governed by, and construed and enforced in accordance with, the laws of the State of Illinois, without giving effect to its conflict or choice of law provisions. Any action brought to enforce this Agreement shall be brought in a state or federal court of competent jurisdiction located in Springfield, Illinois. All parties agree that if any action is brought to enforce this Agreement in a state or federal court outside of Illinois, that all parties hereby consent to a transfer to a court located in Springfield, Illinois. 10) Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by Zock and Horace Mann. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. This Agreement shall be enforced in accordance with its terms and shall not be construed against either party. 11) Counterparts. This Agreement may be executed in two counterparts, each of which shall be deemed to be an original but both of which together will constitute one and the same instrument. - 4 - 12) Withholding. Horace Mann shall withhold benefits otherwise due or payable hereunder in order to comply with any federal, state, local or other income or other tax laws requiring withholding with respect to compensation and benefits provided to Zock pursuant to this Agreement. 13) Entire Agreement; Termination of Prior Agreements. This Agreement contains the entire agreement between the parties hereto with respect to the transactions contemplated hereby and supersedes, terminates and discharges all previous oral and written agreements relating to the subject matters herein, including the Severance Agreement between himself, Horace Mann Educators Corporation and Horace Mann Service Corporation which was effective December 27, 1991 ("Severance Agreement") attached as Exhibit D. Zock hereby acknowledges and agrees to sign an amendment terminating the Severance Agreement in accordance with the terms of the Severance Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date written below. HORACE MANN SERVICE CORPORATION Dated: December 31, 2003 By: /s/ Valerie A. Chrisman ------------------------------ ----------------------------------- Name: Valerie A. Chrisman Title: Senior Vice President - Employee and Corporate Services GEORGE J. ZOCK Dated: December 31, 2003 By: /s/ George J. Zock ------------------------------ ----------------------------------- Name: George J. Zock, Title: Executive Vice President - 5 - Exhibit A CLIENT, FINANCIAL & INFORMATION TECHNOLOGY SERVICES PERFORMANCE MEASURES FOR THE ANNUAL INCENTIVE PLAN 2003 MEASURE WEIGHTING - --------------------------------------------------------------- Corporate Performance Measures 50% Business Measurements Roll-Up 50% Property and Casualty 15% Life/Annuity 20% Marketing 15% No awards greater than target will be paid unless threshold EPS is achieved ($1.24). George Zock - 50% Bonus Opportunity Exhibit B.1 Participant: George Zock Three year cash award opportunity at target: $540,000 Three year stock option opportunity: 110,000 option shares Threshold Target Maximum % $$ % $$ % $$ 2002 Actual 9% $ 48,600 9% $ 48,600 9% $ 48,600 2003 Opportunity 15% $ 81,000 30% $ 162,000 60% $ 324,000 2004 Opportunity 25% $ 135,000 50% $ 270,000 100% $ 540,000 - -------------------------------------------------------------------------------- Total 2003-2004 49% $ 264,600 89% $ 480,600 169% $ 912,600 2002-2004 Stock Option Performance 9,900 vested shares at $20.80 per Vesting: share 2002-2004 Long Term Incentive Plan - 3-year performance period Cash payment made in 2005 after the end of the performance period Must be employed at the end of the performance period to receive payment Exceptions for retirement, death, and disability Exhibit B.2 CORPORATE PERFORMANCE MEASURES FOR THE LONG TERM INCENTIVE PLAN 2002-2004
Measure Weight 2002 (20% Vesting) 2003 (30% Vesting) 2004 (50% Vesting) - ------------------------------------------------------------------------------------------------------------------------- Thres. Target Max. Thres. Target Max. Thres. Target Max. ----------------------------------------------------------------------------------- GAAP Operating EPS/(1)(2)/ 50% $ 1.10 $ 1.20 $ 1.40 $ 1.24 $ 1.34 $ 1.53/(3)/ $ 1.44 $ 1.53 $ 1.72/(3)/ Net Income ROAE/(2)/ 50% 10.0% 11.0% 12.5% 11.0% 12.0% 13.0% 12.0% 12.5% 13.5%
Note: Threshold payout is at 50%. Target payout is at 100%. Maximum payout is at 200%. /(1)/ 2002 threshold-target-max consistent with AIP levels. 2003 and 2004 targets 15% annual increases (rounded) from 2002 target. 2003 and 2004 ranges around target consistent with 2002. /(2)/ Excludes any change in DOLI charges from 12/31/01 level ($2.7 million after tax), and any release of escrowed NC auto premiums. /(3)/ Adjusted from original measures for the impact of share dilution created by the 2002 recapitalization of the company. 2002 Actual ----------- December Percent of Weighted Measure Weight Actual Target Result - ---------------------------------------------------------------------------- GAAP Operating EPS/(1)(2)/ 50% $ 1.18 90.00% 45.00% Net Income ROAE/(2)/ 50% 2.4% 0.00% 00.00% Total 100% 45.00% 2002 Target Opportunity 20% 9.00% EXHIBIT C CONFIDENTIALITY ACKNOWLEDGMENT The undersigned has received a copy of, seen or discussed matters leading to the Transition, Retirement and Release Agreement between George J. Zock and Horace Mann Service Corporation (hereinafter "the Agreement"). Except as required by law, the undersigned hereby agrees that he/she will not disclose any of the terms or conditions of the Agreement or any of the matters described in the Agreement to any person or entity who is not a party to the Agreement or this Confidentiality Acknowledgment. The undersigned further agrees that if subpoenaed, requested or noticed to testify or produce documents relating in any way to the subject matter of the Agreement, before he/she complies he/she shall notify Horace Mann Service Corporation, c/o Ann M. Caparros, Esq., General Counsel, 1 Horace Mann Plaza, Springfield, Illinois 62715-0001 (217/788-5757) (or her successor), of the return date, time and location before complying with such subpoena, request or notice. ---------------------------------------- [Name] Title: --------------------------------- Date: --------------------------------- EX-11 5 dex11.txt STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS Exhibit 11 Horace Mann Educators Corporation Computation of Net Income per Share For the Years Ended December 31, 2003, 2002 and 2001 (Amounts in thousands, except per share data) Year Ended December 31, ------------------------------------ 2003 2002 2001 ---------- ---------- ---------- Basic - assumes no dilution: Net income for the period............... $ 18,975 $ 11,333 $ 25,587 ---------- ---------- ---------- Weighted average number of common shares outstanding during the period... 42,713 40,941 40,617 ---------- ---------- ---------- Net income per share - basic............ $ 0.44 $ 0.28 $ 0.63 ========== ========== ========== Diluted - assumes full dilution: Net income for the period............... $ 18,975 $ 11,333 $ 25,587 ---------- ---------- ---------- Weighted average number of common shares outstanding during the period... 42,713 40,941 40,617 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: Stock options........................ 16 87 125 Common stock units related to Deferred Equity Compensation Plan for Directors.................. 148 140 121 Common stock units related to Deferred Compensation Plan for Employees........................... 27 31 14 ---------- ---------- ---------- Total common and common equivalent shares adjusted to calculate diluted earnings per share............. 42,904 41,199 40,877 ---------- ---------- ---------- Net income per share - diluted.......... $ 0.44 $ 0.28 $ 0.63 ========== ========== ========== Percentage of dilution compared to basic net income per share............. 0.0% 0.0% 0.0% EX-12 6 dex12.txt STATEMENT REGARDING COMPUTATION OF RATIOS Exhibit 12 Horace Mann Educators Corporation Computation of Ratio of Earnings to Fixed Charges For the Years Ended December 31, 2003, 2002, 2001, 2000 and 1999 (Dollars in millions)
Year Ended December 31, -------------------------------------------------------------- 2003 2002 2001 2000 1999 ---------- ---------- ---------- ---------- ---------- Income before income taxes........... $ 19.2 $ 7.7 $ 28.3 $ 9.7 $ 93.4 Interest expense..................... 6.3 8.5 9.3 10.2 9.7 ---------- ---------- ---------- ---------- ---------- Earnings.......................... $ 25.5 $ 16.2 $ 37.6 $ 19.9 $ 103.1 ========== ========== ========== ========== ========== Fixed charges - interest expense..... $ 6.3 $ 8.5 $ 9.3 $ 10.2 $ 9.7 Ratio of earnings to fixed charges... 4.0x 1.9x 4.0x 2.0x 10.6x
EX-21 7 dex21.txt SUBSIDIARIES OF HMEC Exhibit 21 Horace Mann Educators Corporation Insurance Subsidiaries, Other Significant Subsidiaries and Their Respective States of Incorporation or Organization December 31, 2003 Insurance Subsidiaries: Allegiance Life Insurance Company - Illinois Educators Life Insurance Company of America - Arizona Horace Mann Insurance Company - Illinois Horace Mann Life Insurance Company - Illinois Horace Mann Lloyds - Texas Horace Mann Property & Casualty Insurance Company - California Teachers Insurance Company - Illinois Other Significant Subsidiaries: Horace Mann Educator Benefits Consulting Corporation - Illinois Horace Mann General Agency - Texas Horace Mann Investors, Inc. - Maryland Horace Mann Service Corporation - Illinois EX-23 8 dex23.txt CONSENT OF KPMG LLP Exhibit 23 The Board of Directors Horace Mann Educators Corporation: We consent to the incorporation by reference in the registration statements (No. 33-47066, No. 33-45152, No. 333-16473, No. 333-74686 and No. 333-98917) on Form S-8 and the registration statements (No. 333-98043 and No. 333-111234) on Form S-3 of Horace Mann Educators Corporation and subsidiaries (the Company) of our report dated February 17, 2004, with respect to the consolidated balance sheets of the Company as of December 31, 2003 and 2002, 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, 2003, and all related financial statement schedules, which report appears in the December 31, 2003 annual report on Form 10-K of the Company. As discussed in note 1 to the consolidated financial statements, in 2002 the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." /s/ KPMG LLP KPMG LLP Chicago, Illinois March 15, 2004 EX-31.1 9 dex311.txt CEO CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT Exhibit 31.1 Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Louis G. Lower II, certify that: 1. I have reviewed this annual report on Form 10-K of Horace Mann Educators Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors: a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Louis G. Lower II - ---------------------------------------- Louis G. Lower II, Chief Executive Officer, Horace Mann Educators Corporation Date: March 15, 2004 ----------------------------------- EX-31.2 10 dex312.txt CFO CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT Exhibit 31.2 Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Peter H. Heckman, certify that: 1. I have reviewed this annual report on Form 10-K of Horace Mann Educators Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors: a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Peter H. Heckman - ---------------------------------------- Peter H. Heckman, Chief Financial Officer, Horace Mann Educators Corporation Date: March 15, 2004 ----------------------------------- EX-32.1 11 dex321.txt CEO CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT Exhibit 32.1 Horace Mann Educators Corporation CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Horace Mann Educators Corporation (the "Company") on Form 10-K for the year ended December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Louis G. Lower II, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Louis G. Lower II - ---------------------------------------- Louis G. Lower II Chief Executive Officer Date: March 15, 2004 ----------------------------------- A signed original of this written statement required by Section 906 has been provided to Horace Mann Educators Corporation and will be retained by Horace Mann Educators Corporation and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.2 12 dex322.txt CFO CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT Exhibit 32.2 Horace Mann Educators Corporation CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Horace Mann Educators Corporation (the "Company") on Form 10-K for the year ended December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Peter H. Heckman, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Peter H. Heckman - ---------------------------------------- Peter H. Heckman Chief Financial Officer Date: March 15, 2004 ----------------------------------- A signed original of this written statement required by Section 906 has been provided to Horace Mann Educators Corporation and will be retained by Horace Mann Educators Corporation and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----