-----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, A8GiGDMwBQUb15Wx4Y5FiKGm230sPE6vl1GGe7ujxs/cbHHyfQgEkyNktKCjjFY5 jOCxqSYoBlGj9tyJqgg9NQ== 0001193125-04-083294.txt : 20040510 0001193125-04-083294.hdr.sgml : 20040510 20040510121123 ACCESSION NUMBER: 0001193125-04-083294 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20040331 FILED AS OF DATE: 20040510 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HORACE MANN EDUCATORS CORP /DE/ CENTRAL INDEX KEY: 0000850141 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 370911756 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-10890 FILM NUMBER: 04791753 BUSINESS ADDRESS: STREET 1: 1 HORACE MANN PLZ CITY: SPRINGFIELD STATE: IL ZIP: 62715-0001 BUSINESS PHONE: 2177892500 MAIL ADDRESS: STREET 1: 1 HORACE MANN PLZ CITY: SPRINGFIELD STATE: IL ZIP: 62715-0001 FORMER COMPANY: FORMER CONFORMED NAME: HORACE MANN EDUCATORS CORP DATE OF NAME CHANGE: 19920108 10-Q 1 d10q.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2004 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 ---------- 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [_] As of April 30, 2004, 42,724,477 shares of Common Stock, par value $0.001 per share, were outstanding, net of 17,503,371 shares of treasury stock. ================================================================================ HORACE MANN EDUCATORS CORPORATION FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2004 INDEX Page ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements Independent Auditors' Review Report.......................... 1 Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003........................ 2 Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003.................. 3 Consolidated Statements of Changes in Shareholders' Equity for the Three Months Ended March 31, 2004 and 2003.......... 4 Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003.................. 5 Notes to Consolidated Financial Statements................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 14 Item 3. Quantitative and Qualitative Disclosures about Market Risk.............................................. 35 Item 4. Controls and Procedures................................... 35 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders....... 35 Item 5. Other Information......................................... 35 Item 6. Exhibits and Reports on Form 8-K.......................... 36 SIGNATURES.................................................................. 37 INDEPENDENT AUDITORS' REVIEW REPORT The Board of Directors and Shareholders Horace Mann Educators Corporation: We have reviewed the consolidated balance sheet of Horace Mann Educators Corporation and subsidiaries as of March 31, 2004, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for the three-month periods ended March 31, 2004 and 2003. These consolidated financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of Horace Mann Educators Corporation and subsidiaries as of December 31, 2003, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated February 17, 2004, we expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP KPMG LLP Chicago, Illinois May 5, 2004 1 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED BALANCE SHEETS (Dollars in thousands) March 31, December 31, 2004 2003 ----------- ------------ (Unaudited) ASSETS Investments Fixed maturities, available for sale, at fair value (amortized cost, 2004, $3,157,141; 2003, $3,124,861)..................................... $ 3,338,969 $ 3,258,674 Short-term and other investments................. 181,573 104,904 Short-term investments, loaned securities collateral...................................... 386,792 22,147 ----------- ------------ Total investments............................. 3,907,334 3,385,725 Cash................................................ 31,115 19,773 Accrued investment income and premiums receivable... 100,818 99,370 Deferred policy acquisition costs................... 194,782 193,703 Goodwill............................................ 47,396 47,396 Value of acquired insurance in force................ 25,778 27,259 Other assets........................................ 74,214 80,531 Variable annuity assets............................. 1,137,535 1,119,231 ----------- ------------ Total assets.................................. $ 5,518,972 $ 4,972,988 =========== ============ LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities Fixed annuity contract liabilities............... $ 1,564,340 $ 1,526,174 Interest-sensitive life contract liabilities..... 573,933 567,209 Unpaid claims and claim expenses................. 354,616 350,501 Future policy benefits........................... 182,987 181,344 Unearned premiums................................ 193,956 198,991 ----------- ------------ Total policy liabilities...................... 2,869,832 2,824,219 Other policyholder funds............................ 133,618 129,888 Liability for securities lending agreements......... 386,792 22,147 Other liabilities................................... 244,940 177,325 Short-term debt..................................... 25,000 25,000 Long-term debt...................................... 144,707 144,703 Variable annuity liabilities........................ 1,137,535 1,119,231 ----------- ------------ Total liabilities............................. 4,942,424 4,442,513 ----------- ------------ Preferred stock, $0.001 par value, shares authorized 1,000,000; none issued.................. -- -- Common stock, $0.001 par value, shares authorized 75,000,000; shares issued, 2004, 60,226,072; 2003, 60,225,311................................... 60 60 Additional paid-in capital.......................... 342,324 342,306 Retained earnings................................... 473,533 456,330 Accumulated other comprehensive income (loss), net of taxes: Net unrealized gains on fixed maturities and equity securities................ 110,460 81,608 Minimum pension liability adjustment............. (17,252) (17,252) Treasury stock, at cost, 17,503,371 shares.......... (332,577) (332,577) ----------- ------------ Total shareholders' equity.................... 576,548 530,475 ----------- ------------ Total liabilities and shareholders' equity.................................... $ 5,518,972 $ 4,972,988 =========== ============ See accompanying notes to consolidated financial statements. 2 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Dollars in thousands, except per share data) Three Months Ended March 31, --------------------- 2004 2003 --------- --------- Revenues Insurance premiums and contract charges earned..... $ 167,563 $ 158,318 Net investment income.............................. 48,596 47,521 Realized investment gains (losses)................. 5,282 (4,748) --------- --------- Total revenues.................................. 221,441 201,091 --------- --------- Benefits, losses and expenses Benefits, claims and settlement expenses........... 111,455 110,877 Interest credited.................................. 26,407 25,429 Policy acquisition expenses amortized.............. 16,379 17,106 Operating expenses................................. 33,607 33,624 Amortization of intangible assets.................. 1,326 1,625 Interest expense................................... 1,680 1,552 --------- --------- Total benefits, losses and expenses............. 190,854 190,213 --------- --------- Income before income taxes............................ 30,587 10,878 Income tax expense.................................... 8,896 2,779 --------- --------- Net income............................................ $ 21,691 $ 8,099 ========= ========= Net income per share Basic.............................................. $ 0.51 $ 0.19 ========= ========= Diluted............................................ $ 0.51 $ 0.19 ========= ========= Weighted average number of shares and equivalent shares (in thousands) Basic........................................... 42,722 42,700 Diluted......................................... 42,934 42,869 See accompanying notes to consolidated financial statements. 3 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) (Dollars in thousands, except per share data) Three Months Ended March 31, --------------------- 2004 2003 --------- --------- Common stock Beginning balance.................................. $ 60 $ 60 Conversion of Director Stock Plan units, 2004, 761 shares; 2003, 10,284 shares................... -- -- --------- --------- Ending balance..................................... 60 60 --------- --------- Additional paid-in capital Beginning balance.................................. 342,306 342,749 Conversion of Director Stock Plan units............ 18 214 --------- --------- Ending balance..................................... 342,324 342,963 --------- --------- Retained earnings Beginning balance.................................. 456,330 455,308 Net income......................................... 21,691 8,099 Cash dividends, 2004, $0.105 per share; 2003, $0.105 per share;................................. (4,488) (4,486) --------- --------- Ending balance..................................... 473,533 458,921 --------- --------- Accumulated other comprehensive income, net of taxes: Beginning balance.................................. 64,356 63,302 Change in net unrealized gains on fixed maturities and equity securities............... 28,852 10,839 Change in minimum pension liability adjustment..................................... -- -- --------- --------- Ending balance..................................... 93,208 74,141 --------- --------- Treasury stock, at cost Beginning and ending balance, 2004 and 2003, 17,503,371 shares................................. (332,577) (332,577) --------- --------- Shareholders' equity at end of period................. $ 576,548 $ 543,508 ========= ========= Comprehensive income Net income......................................... $ 21,691 $ 8,099 Other comprehensive income, net of taxes: Change in net unrealized gains on fixed maturities and equity securities...... 28,852 10,839 Change in minimum pension liability adjustment..................................... -- -- --------- --------- Other comprehensive income................... 28,852 10,839 --------- --------- Total..................................... $ 50,543 $ 18,938 ========= ========= See accompanying notes to consolidated financial statements. 4 HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Dollars in thousands) Three Months Ended March 31, --------------------- 2004 2003 --------- --------- Cash flows from operating activities Premiums collected................................. $ 166,521 $ 161,833 Policyholder benefits paid......................... (106,601) (122,034) Policy acquisition and other operating expenses paid.............................................. (46,600) (59,549) Federal income taxes paid.......................... -- (9,958) Investment income collected........................ 48,070 49,513 Interest expense paid.............................. (1,086) (960) Other.............................................. 1,212 142 --------- --------- Net cash provided by operating activities....... 61,516 18,987 --------- --------- Cash flows from investing activities Fixed maturities Purchases....................................... (324,405) (204,798) Sales........................................... 236,922 91,999 Maturities...................................... 91,089 34,187 Net cash provided by (used for) short-term and other investments.................. (76,642) 15,242 --------- --------- Net cash used in investing activities........... (73,036) (63,370) --------- --------- Cash flows from financing activities Dividends paid to shareholders..................... (4,488) (4,486) Principal repayments on Bank Credit Facility....... -- -- Annuity contracts, variable and fixed Deposits........................................ 84,212 64,262 Maturities and withdrawals...................... (24,888) (23,711) Net transfer to variable annuity assets......... (30,540) (19,786) Net decrease in life policy account balances....... (1,434) (1,150) --------- --------- Net cash provided by financing activities....... 22,862 15,129 --------- --------- Net increase (decrease) in cash....................... 11,342 (29,254) Cash at beginning of period........................... 19,773 60,162 --------- --------- Cash at end of period................................. $ 31,115 $ 30,908 ========= ========= See accompanying notes to consolidated financial statements. 5 HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) March 31, 2004 and 2003 (Dollars in thousands, except per share data) Note 1 - Basis of Presentation The accompanying unaudited consolidated financial statements of Horace Mann Educators Corporation ("HMEC"; and together with its subsidiaries, the "Company") 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. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. The Company believes that these financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the Company's consolidated financial position as of March 31, 2004 and the consolidated results of operations, changes in shareholders' equity and cash flows for the three months ended March 31, 2004 and 2003. 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. It is suggested that these financial statements be read in conjunction with the financial statements and the related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. The results of operations for the three months ended March 31, 2004 are not necessarily indicative of the results to be expected for the full year. Note 2 - 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 of the Company's Annual Report on Form 10-K for the year ended December 31, 2003. 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. 6 Note 2 - Stock Based Compensation-(Continued) Alternatively, Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation", allows companies to recognize compensation cost for stock-based compensation plans, determined based on the fair value at the grant dates. If the Company had applied this alternative accounting method, net income and net income per share would have been reduced to the pro forma amounts indicated below: Three Months Ended March 31, -------------------------- 2004 2003 ------------ ------------ Net income As reported..................................... $ 21,691 $ 8,099 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)............. 1,309 1,339 ------------ ------------ Pro forma....................................... $ 20,382 $ 6,760 ============ ============ Net income per share - basic As reported..................................... $ 0.51 $ 0.19 Pro forma....................................... $ 0.48 $ 0.16 Net income per share - diluted As reported..................................... $ 0.51 $ 0.19 Pro forma....................................... $ 0.47 $ 0.16 - ---------- (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 2004 and 2003, respectively: risk-free interest rates of 4.0% and 3.8%; dividend yield of 2.7% and 3.0%; expected lives of 10 years; and volatility of 26.9% and 28.3%. The three-month expense amounts represent one-fourth of the full year expense reflecting options granted through March 31, 2004 and 2003, respectively, and vesting during the respective calendar years. 7 Note 3 - Restructuring Charges Charges related to the restructure of the Company's property and casualty claims operations were incurred and separately identified in the Statements of Operations for the year ended December 31, 2002, as described in Note 2 - Restructuring Charges of the Company's Annual Report on Form 10-K for the year ended December 31, 2003. The following table provides information about the charges taken in 2002, the balance of accrued amounts at December 31, 2003 and March 31, 2004 and payment activity during the three months ended March 31, 2004.
Original Reserve at Reserve at Pretax December 31, March 31, Charge 2003 Payments 2004 ------------ ------------ ------------ ------------ Charges to earnings: Property and Casualty Claims Operations Employee termination costs.... $ 2,542 $ 226 $ 115 $ 111 Additional defined benefit pension plan costs........... 1,179 125 11 114 Termination of lease agreements................... 502 39 12 27 ------------ ------------ ------------ ------------ Total...................... $ 4,223 $ 390 $ 138 $ 252 ============ ============ ============ ============
Note 4 - Debt Indebtedness outstanding was as follows: March 31, December 31, 2004 2003 ------------ ------------ Short-term debt: Bank Credit Facility............................ $ 25,000 $ 25,000 Long-term debt: 1.425% Senior Convertible Notes due May 14, 2032. Aggregate principal amount of $244,500 less unaccrued discount of $128,362 (3.0% imputed rate).................................. 116,138 116,138 6 5/8% Senior Notes, due January 15, 2006. Aggregate principal amount of $28,600 less unaccrued discount of $31 and $35 (6.7% imputed rate).................................. 28,569 28,565 ------------ ------------ Total........................................ $ 169,707 $ 169,703 ============ ============ 8 Note 5 - Investments Fixed Maturity Securities The following table presents the composition and value of the Company's fixed maturity securities portfolio by rating category. The Company has classified the entire fixed maturity securities portfolio as available for sale, which is carried at fair value.
Percent of Fair Value March 31, 2004 --------------------------- --------------------------- Rating of Fixed March 31, December 31, Fair Amortized Maturity Securities (1) 2004 2003 Value (2) Cost - ------------------------------------ ------------ ------------ ------------ ------------ AAA.............................. 44.1% 44.6% $ 1,472,079 $ 1,427,470 AA............................... 7.5 7.7 249,409 237,629 A................................ 23.8 23.2 794,944 727,691 BBB.............................. 19.2 18.6 640,621 589,733 BB............................... 1.5 2.0 50,306 48,551 B................................ 3.3 3.2 110,506 107,587 CCC or lower..................... 0.5 0.6 17,280 14,644 Not rated (3).................... 0.1 0.1 3,824 3,836 ------------ ------------ ------------ ------------ Total......................... 100.0% 100.0% $ 3,338,969 $ 3,157,141 ============ ============ ============ ============
- ---------- (1) Ratings are as assigned primarily by Standard & Poor's Corporation ("S&P") when available, with remaining ratings as assigned on an equivalent basis by Moody's Investors Service, Inc. ("Moody's"). Ratings for publicly traded securities are determined when the securities are acquired and are updated monthly to reflect any changes in ratings. (2) Fair values are based on quoted market prices, when available. Fair values for private placements and certain other securities that are infrequently traded are estimated by the Company with the assistance of its investment advisors utilizing recognized valuation methodology, including cash flow modeling. (3) This category includes $3,824 of private placement securities not rated by either S&P or Moody's. The National Association of Insurance Commissioners ("NAIC") has rated 97.1% of these private placement securities as investment grade. The following table presents the distribution of the Company's fixed maturity securities portfolio by estimated expected maturity. Estimated expected maturities differ from contractual maturities by reflecting assumptions regarding borrowers' utilization of the right to call or prepay obligations with or without call or prepayment penalties. Fair Percent of Total Value ------------------------- ------------ March 31, December 31, March 31, 2004 2003 2004 ----------- ------------ ------------ Due in 1 year or less................. 7.0% 7.4% $ 232,984 Due after 1 year through 5 years...... 20.9 21.9 699,528 Due after 5 years through 10 years.... 42.2 41.3 1,408,228 Due after 10 years through 20 years... 10.3 8.9 342,807 Due after 20 years.................... 19.6 20.5 655,422 ----------- ------------ ------------ Total.............................. 100.0% 100.0% $ 3,338,969 =========== ============ ============ The Company's investment portfolio includes no derivative financial instruments (futures, forwards, swaps, option contracts or other financial instruments with similar characteristics). 9 Note 5 - Investments-(Continued) Securities Lending The Company loans fixed income securities to third parties, primarily major brokerage firms. As of March 31, 2004 and December 31, 2003, fixed maturities with a fair value of $386,792 and $22,147, 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. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", requires the securities lending collateral to be classified as an asset with a corresponding liability in the Company's Consolidated Balance Sheets. Note 6 - 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. 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. 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 the defined benefit plans, investments have been set aside in a trust fund; whereas the supplemental retirement plans are non-qualified, unfunded plans. The following table summarizes the components of net periodic pension cost for the defined benefit plan and the supplemental retirement plans for the three months ended March 31, 2004 and 2003.
Supplemental Defined Benefit Plan Retirement Plans --------------------------- --------------------------- Three Months Ended Three Months Ended March 31, March 31, --------------------------- --------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Components of net periodic pension expense: Service cost..................... $ -- $ -- $ 38 $ 109 Interest cost.................... 776 819 264 216 Expected return on plan assets... (678) (596) -- -- Recognized net actuarial loss.... 382 392 112 69 Settlement loss.................. 524 999 -- -- ------------ ------------ ------------ ------------ Net periodic pension expense........ $ 1,004 $ 1,614 $ 414 $ 394 ============ ============ ============ ============
10 Note 6 - Pension Plans and Other Postretirement Benefits-(Continued) As disclosed in the Company's financial statements for the year ended December 31, 2003, it expects to contribute $3,500 to the defined benefit plan and $1,200 to the supplemental retirement plans in 2004. For the three months ended March 31, 2004, there were no contributions to the defined benefit plan and $278 was contributed to the supplemental retirement plans. The Company anticipates contributing $3,500 to the defined benefit plan and an additional $922 to the supplemental retirement plans during the remaining nine months of 2004. In addition to providing pension benefits, the Company also provides certain health care and life insurance benefits to retired employees and eligible dependents. Effective January 1, 2004, only employees who were at least age 50 with at least 15 years of service by January 1, 2004 are eligible to participate in this program. The following table summarizes the components of the net periodic benefit cost of postretirement benefits other than pension for the three months ended March 31, 2004 and 2003. Three Months Ended March 31, -------------------------- 2004 2003 ------------ ------------ Components of net periodic cost: Service cost.................................... $ 26 $ 92 Interest cost................................... 456 529 Amortization of prior service cost.............. (180) -- Recognized net actuarial loss................... 34 (752) ------------ ------------ Net periodic benefit cost.......................... $ 336 $ (131) ============ ============ As disclosed in the Company's financial statements for the year ended December 31, 2003, it expects to contribute $2,300 to the postretirement benefit plan in 2004. For the three months ended March 31, 2004, the Company contributed $388 to the postretirement benefit plan and anticipates contributing an additional $1,912 to the plan during the remaining nine months of 2004. 11 Note 7 - Reinsurance The Company recognizes the cost of reinsurance premiums over the contract periods for such premiums in proportion to the insurance protection provided. Amounts recoverable from reinsurers for unpaid claims and claim settlement expenses, including estimated amounts for unsettled claims, claims incurred but not reported and policy benefits, are estimated in a manner consistent with the insurance liability associated with the policy. The effects of reinsurance on premiums written and contract deposits; premiums and contract charges earned; and benefits, claims and settlement expenses were as follows:
Gross Amount Ceded Assumed Net ------------ ------------ ------------ ------------ Three months ended March 31, 2004 - ------------------------------------ Premiums written and contract deposits........................... $ 245,695 $ 5,147 $ 4,270 $ 244,818 Premiums and contract charges earned............................. 169,012 5,950 4,501 167,563 Benefits, claims and settlement expenses........................... 112,068 3,750 3,137 111,455 Three months ended March 31, 2003 - ------------------------------------ Premiums written and contract deposits........................... $ 220,832 $ 5,068 $ 3,776 $ 219,540 Premiums and contract charges earned............................. 159,799 5,091 3,610 158,318 Benefits, claims and settlement expenses........................... 108,087 (933) 1,857 110,877
12 Note 8 - Segment Information The Company conducts and manages its business through four segments. The three operating segments, representing the major lines of insurance business, are: property and casualty insurance, principally personal lines automobile and homeowners products; annuity products, principally individual, tax-qualified fixed and variable deposits; and life insurance. 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, but classifies those items in the fourth segment, Corporate and Other. Historically, in addition to debt service, realized investment gains and losses and certain public company expenses, such charges have included restructuring charges, debt retirement costs, litigation charges and the provision for prior years' taxes. Summarized financial information for these segments is as follows: Three Months Ended March 31, -------------------------- 2004 2003 ------------ ------------ Insurance premiums written and contract deposits... $ 244,818 $ 219,540 ============ ============ Insurance premiums and contract charges earned Property and casualty........................... $ 139,600 $ 131,594 Annuity......................................... 4,157 3,227 Life............................................ 23,806 23,808 Intersegment eliminations....................... -- (311) ------------ ------------ Total........................................ $ 167,563 $ 158,318 ============ ============ Net investment income Property and casualty........................... $ 8,784 $ 8,232 Annuity......................................... 27,415 26,490 Life............................................ 12,702 13,033 Corporate and other............................. (17) 58 Intersegment eliminations....................... (288) (292) ------------ ------------ Total........................................ $ 48,596 $ 47,521 ============ ============ Net income Property and casualty........................... $ 13,073 $ 6,583 Annuity......................................... 3,905 2,264 Life............................................ 3,097 3,825 Corporate and other............................. 1,616 (4,573) ------------ ------------ Total........................................ $ 21,691 $ 8,099 ============ ============ Amortization of intangible assets, pretax (included in segment net income) Value of acquired insurance in force Annuity....................................... $ 936 $ 1,211 Life.......................................... 390 414 ------------ ------------ Total........................................ $ 1,326 $ 1,625 ============ ============ March 31, December 31, 2004 2003 ------------ ------------ Assets Property and casualty........................... $ 843,361 $ 795,579 Annuity......................................... 3,459,915 3,163,808 Life............................................ 1,161,497 947,468 Corporate and other............................. 109,034 95,505 Intersegment eliminations....................... (54,835) (29,372) ------------ ------------ Total........................................ $ 5,518,972 $ 4,972,988 ============ ============ 13 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. . 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. 14 . 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 For the first three months of 2004, the Company's net income increased compared to the prior year, primarily reflecting improved earnings in the property and casualty segment and realized investment gains in the current period versus realized losses in the prior year. The improvement in property and casualty segment earnings was driven by favorable non-catastrophe claims frequency trends and a relatively low level of catastrophe losses, along with no adverse development of prior years' reserves. Premiums written and contract deposits reflected a double digit increase compared to the first quarter of 2003, reflecting significant growth in new annuity deposits and rate increases in the property and automobile lines. 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 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. 15 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 settlement 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 recent years is included in the Company's 2003 Annual Report on Form 10-K in "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". 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 at June 30 and December 31. 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. 16 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 March 31, 2004, the ratio of capitalized annuity policy acquisition costs and the Annuity VIF asset to the total annuity accumulated cash value was approximately 4%. 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. As one example of the volatility of this amortization, if all other assumptions are met, a 1% deviation from the targeted financial market performance for the underlying mutual funds of the Company's variable annuities would currently impact amortization between $0.1 million and $0.2 million. This result may change 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 -- Amortization of Policy Acquisition Expenses and Intangible Assets". 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. 17 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. 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 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 increase in AOCI. 18 Results of Operations Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits Three Months Ended Growth Over March 31, Prior Year --------------------------- --------------------------- 2004 2003 Percent Amount ------------ ------------ ------------ ------------ Property & casualty Automobile and property (voluntary)........ $ 134.0 $ 128.5 4.3% $ 5.5 Involuntary and other property & casualty..................... 0.7 0.1 0.6 ------------ ------------ ------------ Total property & casualty............ 134.7 128.6 4.7% 6.1 Annuity deposits.............................. 84.2 64.3 30.9% 19.9 Life.......................................... 25.9 26.7 -3.0% (0.8) ------------ ------------ ------------ Total................................ $ 244.8 $ 219.6 11.5% $ 25.2 ============ ============ ============
Insurance Premiums and Contract Charges Earned (Excludes annuity and life contract deposits) Three Months Ended Growth Over March 31, Prior Year --------------------------- --------------------------- 2004 2003 Percent Amount ------------ ------------ ------------ ------------ Property & casualty Automobile and property (voluntary)........ $ 137.5 $ 129.4 6.3% $ 8.1 Involuntary and other property & casualty..................... 2.1 2.2 -4.5% (0.1) ------------ ------------ ------------ Total property & casualty............ 139.6 131.6 6.1% 8.0 Annuity....................................... 4.2 3.2 31.3% 1.0 Life.......................................... 23.8 23.5 1.3% 0.3 ------------ ------------ ------------ Total................................ $ 167.6 $ 158.3 5.9% $ 9.3 ============ ============ ============
For the first three months of 2004, the Company's premiums written and contract deposits increased 11.5% over the prior year as a result of growth in new annuity deposits and rate increases in the voluntary property and automobile lines. Voluntary property and casualty business represents policies sold through the Company's marketing organization and issued under the Company's underwriting guidelines. Involuntary property and casualty business consists of allocations of business from state mandatory insurance facilities and assigned risk business. The Company's exclusive agent force totaled 830 at March 31, 2004, reflecting a decrease of 6.1% compared to 884 agents a year earlier. Of the current period-end total, 334 agents were in their first 24 months with the Company, reflecting a decrease of 13.7% compared to March 31, 2003. Current period new hires were less than for the first three months of 2003, reflecting the Company's more stringent selection criteria, while agent terminations were slightly below the prior year. The number of experienced agents in the agent force, 496, was comparable to a year earlier. Average agent productivity for all lines of business combined increased more than 20% compared to the first three months of 2003. Average agent productivity is measured as new sales premiums from the exclusive agent force per the average number of exclusive agents for the period. 19 First quarter 2004 total sales, which include the independent agent distribution channel, increased 39.3% compared to a year earlier, largely due to the growing contribution of annuity business from the independent agent distribution channel and an increase in new annuity business produced by the Company's exclusive agent force. 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 earned premiums and pretax income for the three months ended March 31, 2003 by $0.9 million. No additional escrow amounts were required in the current period. Total voluntary automobile and homeowners premium written increased 4.3% in the first three months of 2004. Voluntary automobile insurance premium written increased 3.8% ($3.7 million) compared to the first quarter of 2003, and homeowners premium increased 6.0% ($1.8 million). 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 4% for voluntary automobile and approximately 7% for homeowners compared to the prior year. Average earned premium increased 5% for voluntary automobile and 11% for homeowners for the same period. Through March 31, 2004, approved rate increases for the Company's automobile and homeowners business were 7% and 17%, respectively, compared to approved increases of 7% and 19%, respectively, during the first three months of 2003. As of March 31, 2004, automobile policies in force decreased by 6,000 compared to both December 31, 2003 and March 31, 2003, reflecting a decrease in non-educator policies which was partially offset by an increase in policies for educators. Homeowners policies in force decreased 1,000 compared to December 31, 2003 and 3,000 compared to March 31, 2003, reflecting expected reductions due to the Company's pricing and underwriting actions. At March 31, 2004, there were 565,000 voluntary automobile and 278,000 homeowners policies in force, for a total of 843,000. Based on policies in force, the property and casualty 12-month retention rate for new and renewal policies was 87% at both March 31, 2004 and 2003. 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. Compared to the first three months of 2003, new annuity deposits increased 30.9%, primarily reflecting a 90.5% increase in single premium and rollover deposits minimally offset by a 1.6% decrease in new scheduled annuity deposits. New deposits to fixed accounts were 32.2%, or $12.9 million, higher than in 2003 and new deposits to variable accounts increased 28.9%, or $7.0 million, compared to a year earlier. 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 514 authorized agents at March 31, 2004, generated $17.5 million in annualized new Horace Mann annuity sales during the first three months of 2004, compared to $2.5 million for the first quarter of 2003 and $38.1 million for the full year 2003. 20 Total annuity accumulated cash value of $2.8 billion at March 31, 2004 increased 18.0% compared to a year earlier, reflecting the growth in sales over the 12 months, continued favorable retention and an improving equity market. The number of annuity contracts outstanding increased 0.7%, or 1,000 contracts, compared to December 31, 2003 and 4.1%, or 6,000 contracts, compared to March 31, 2003. For the three months ended March 31, 2004, annuity segment contract charges earned increased 31.3%, or $1.0 million, compared to a year earlier. 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 and the first three months of 2004, however, resulted in variable annuity accumulated balances at March 31, 2004 which were 32.4% higher than at March 31, 2003. Life segment premiums and contract deposits declined slightly compared to the first three months of 2003. The ordinary life insurance in force lapse ratio improved to 7.2% for the twelve months ended March 31, 2004 compared to 9.1% for the same period a year earlier. Net Investment Income Pretax investment income of $48.6 million for the three months ended March 31, 2004 increased 2.3%, or $1.1 million, (3.1%, or $1.0 million, after tax) compared to the prior year. Prepayments on a structured mortgage-backed security and tender offer consent fees represented approximately $2 million of the variance, with a decline in the portfolio yield more than offsetting growth in the size of the investment portfolio. Average investments (excluding securities lending collateral) increased 8.8% over the past 12 months. The average pretax yield on the investment portfolio was 5.9% (4.0% after tax) for the first three months of 2004 compared to a pretax yield of 6.3% (4.3% after tax) for the same period in 2003. Realized Investment Gains and Losses Net realized investment gains were $5.3 million for the first quarter of 2004 compared to realized investment losses of $4.7 million in the prior year. For the first three months of 2003, the Company recorded fixed income security impairment charges totaling $6.1 million, $3.0 million related to one of the Company's collateralized debt obligation ("CDO") securities and the remaining $3.1 million primarily related to two airline industry issuers. In the current period, there were no investment impairment charges. Net realized investment gains and losses for both periods also reflected gains realized from ongoing investment portfolio management activity. In the first quarter of 2003, 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. 21 The table below presents the Company's fixed maturity securities portfolio as of March 31, 2004 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 $ 316.2 $ 285.3 $ 30.9 Energy..................................... 42 226.1 207.1 19.0 Food and Beverage.......................... 25 138.6 130.0 8.6 Telecommunications......................... 22 133.5 119.0 14.5 Utilities.................................. 18 122.7 115.5 7.2 Transportation............................. 10 88.2 85.5 2.7 Insurance.................................. 10 85.6 79.6 6.0 Industry, Manufacturing.................... 21 77.4 72.9 4.5 Broadcasting and Media..................... 19 51.4 46.0 5.4 Real Estate................................ 6 49.2 44.4 4.8 All Other Corporates (1)................... 126 406.7 380.1 26.6 --------- ------------ ------------ ------------ Total corporate bonds................... 333 1,695.6 1,565.4 130.2 Mortgage-backed securities Government................................. 441 724.7 709.0 15.7 Other...................................... 22 45.3 42.7 2.6 Municipal bonds............................... 164 567.5 549.3 18.2 Government bonds U.S. ...................................... 5 196.7 187.2 9.5 Foreign.................................... 8 35.0 30.7 4.3 Collateralized debt obligations (2)........... 6 28.0 27.7 0.3 Asset-backed securities....................... 10 46.2 45.1 1.1 --------- ------------ ------------ ------------ Total fixed maturity securities......... 989 $ 3,339.0 $ 3,157.1 $ 181.9 ========= ============ ============ ============
- ---------- (1) The All Other Corporates category contains 18 additional industry classifications. Automobiles, retail, paper, healthcare, defense, consumer products, chemicals and metals represented $310.3 million of fair value at March 31, 2004, with the remaining 10 classifications each representing less than $28 million of the fair value at March 31, 2004. (2) All of the securities were rated investment grade by Standard and Poor's Corporation and/or Moody's Investors Service, Inc. at March 31, 2004. 22 At March 31, 2004, the Company's diversified fixed maturity portfolio consisted of 1,153 investment positions and totaled approximately $3.3 billion in fair value. The portfolio was 94.6% investment grade, based on fair value, with an average quality rating of AA-. At March 31, 2004, the portfolio had approximately $5 million pretax of total gross unrealized losses related to 105 positions. At December 31, 2003, the total pretax gross unrealized losses were approximately $11 million related to 113 positions. The following table provides information regarding fixed maturity securities that had an unrealized loss at March 31, 2004, 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 March 31, 2004 Pretax Number of Fair Amortized Unrealized Positions Value Cost Loss --------- ------------ ------------ ------------ Investment grade 6 Months or less........................... 22 $ 95.8 $ 97.2 $ (1.4) 7 through 12 months........................ 26 132.1 134.3 (2.2) 13 through 24 months....................... 2 7.4 7.8 (0.4) 25 through 36 months....................... 1 2.9 3.0 (0.1) 37 through 48 months....................... -- -- -- -- Greater than 48 months..................... -- -- -- -- --------- ------------ ------------ ------------ Total................................... 51 238.2 242.3 (4.1) --------- ------------ ------------ ------------ Non-investment grade 6 Months or less........................... 44 24.0 24.7 (0.7) 7 through 12 months........................ 1 3.0 3.0 * 13 through 24 months....................... -- -- -- -- 25 through 36 months....................... -- -- -- -- 37 through 48 months....................... 1 5.8 6.0 (0.2) Greater than 48 months..................... 2 3.4 3.7 (0.3) --------- ------------ ------------ ------------ Total................................... 48 36.2 37.4 (1.2) --------- ------------ ------------ ------------ Not rated Total, all 13 through 24 months......... 6 2.6 2.6 * --------- ------------ ------------ ------------ Grand total.......................... 105 $ 277.0 $ 282.3 $ (5.3) ========= ============ ============ ============
- ------------- * Less than $(0.1) million Of the securities with unrealized losses, no issuers had pretax unrealized losses greater than $1 million and no securities were trading below 80% of book value at March 31, 2004. The Company views the decrease in value of all of the securities with unrealized losses at March 31, 2004 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 March 31, 2004. 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. 23 Benefits, Claims and Settlement Expenses Three Months Ended Growth Over March 31, Prior Year ---------------------- --------------------- 2004 2003 Percent Amount --------- ---------- --------- --------- Property and casualty......... $ 99.6 $ 99.3 0.3% $ 0.3 Annuity....................... 0.1 0.5 -80.0% (0.4) Life.......................... 11.8 11.1 6.3% 0.7 --------- ---------- --------- Total...................... $ 111.5 $ 110.9 0.5% $ 0.6 ========= ========== ========= Property and Casualty Claims and Claim Expenses
Three Months Ended March 31, --------------------------- 2004 2003 ------------ ------------ Incurred claims and claim expenses: Claims occurring in the current year..................... $ 99.6 $ 95.0 Increase in estimated reserves for claims occurring in prior years (1): Policies written by the Company....................... -- 3.8 Business assumed from state reinsurance facilities.... -- 0.5 ------------ ------------ Total increase..................................... -- 4.3 ------------ ------------ Total claims and claim expenses incurred........... $ 99.6 $ 99.3 ============ ============ Net reserves, end of period................................. $ 326.9 $ 275.7 Plus reinsurance recoverables............................ 20.4 31.1 ------------ ------------ Gross reserves, end of period............................... $ 347.3 $ 306.8 ============ ============ Property and casualty GAAP loss ratio: Before catastrophe losses................................ 70.4% 73.9% After catastrophe losses................................. 71.3% 75.5% Property and casualty GAAP loss ratio excluding net increases in estimated reserves for claims occurring in prior years: Before catastrophe losses................................ 70.4% 70.6% After catastrophe losses................................. 71.3% 72.2%
- ---------- (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 the three months ended March 31, 2004, the voluntary automobile loss ratio decreased by 2.9 percentage points compared to a year earlier, primarily reflecting adverse development and strengthening of prior years' reserves recorded in 2003 as described below. The Company's benefits, claims and settlement expenses also reflected a 14.1 percentage point improvement in the homeowners loss ratio as a result of the Company's claims initiatives, focused on loss and expense control, the favorable impact of rate increases on earned premiums and relatively mild weather in the current period. 24 Excluding involuntary business, net adverse development of reserves for property and casualty claims occurring in prior years was $3.8 million for the first three months of 2003, primarily related to automobile liability loss reserves from accident years 2001 and prior, compared to no adverse reserve development in the current period. The Company's property and casualty reserves were $326.9 million and $320.9 million at March 31, 2004 and December 31, 2003, respectively, net of anticipated reinsurance recoverables. For the first three months of 2004, total incurred property and casualty catastrophe losses were $1.2 million, compared to $2.1 million a year earlier. The current period decrease generated approximately 1 percentage point of the improvement in the property and casualty loss ratio. The property loss ratio of 60.0% for the first three months of 2004 decreased 14.1 percentage points compared to a year earlier. This improvement reflected an increase in average premium per policy, benefits of the Company's claims initiatives 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. In addition, the weather was relatively mild during the first three months of 2004. For the three months ended March 31, 2004, the voluntary automobile loss ratio of 73.4% decreased 2.9 percentage points compared to the prior year. The loss ratio in 2003 included 5.9 percentage points due to adverse development of prior years' reserves compared to no impact in the current period. Effective January 1, 2004, the Company adopted American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts for Separate Accounts". The new rules changed the accounting for separate accounts and sales inducements and changed the liability model by expanding the definition of "account balance" and addressing annuitization guarantees and guaranteed minimum death benefits ("GMDB") reserves. The adoption of this SOP reduced the Company's GAAP GMDB reserve from $0.1 million at December 31, 2003 to zero at March 31, 2004. Interest Credited to Policyholders Three Months Ended Growth Over March 31, Prior Year ---------------------- --------------------- 2004 2003 Percent Amount --------- ---------- --------- --------- Annuity....................... $ 18.3 $ 17.7 3.4% $ 0.6 Life.......................... 8.1 7.7 5.2% 0.4 --------- ---------- --------- Total...................... $ 26.4 $ 25.4 3.9% $ 1.0 ========= ========== ========= Compared to the prior year, the current period increase in annuity segment interest credited reflected a 9.8% increase in average accumulated fixed deposits, partially offset by a 24 basis point decline in the average annual interest rate credited to 4.5%. Life insurance interest credited increased as a result of the growth in interest-sensitive life insurance reserves. 25 Operating Expenses For the first three months of 2004, operating expenses were equal to the prior year. The property and casualty GAAP expense ratio of 22.2% for the three months ended March 31, 2004 decreased 1.8 percentage points compared to the prior year, primarily reflecting the growth in premium for the property and casualty segment. Amortization of Policy Acquisition Expenses and Intangible Assets For the three months ended March 31, 2004, the combined amortization of policy acquisition expenses and intangible assets was $17.7 million compared to $18.7 million recorded in the prior year. Amortization of intangible assets was $1.3 million for the three months ended March 31, 2004 compared to $1.6 million for the same period a year earlier. The March 31, 2003 valuation of Annuity VIF resulted in a $0.3 million increase in amortization compared to no impact from a similar valuation at March 31, 2004. Amortized policy acquisition expenses of $16.4 million for the first three months of 2004 were $0.7 million less than the prior year, primarily related to the annuity segment. The March 31, 2004 valuation of annuity deferred policy acquisition costs resulted in a $0.4 million reduction in amortization compared to a $0.7 million increase in amortization resulting from a similar valuation at March 31, 2003. Income Tax Expense The effective income tax rate on the Company's pretax income, including realized investment gains and losses, was 29.1% for the three months ended March 31, 2004 compared to 25.7% for the same period in 2003. Income from investments in tax-advantaged securities reduced the effective income tax rate 5.4 and 12.7 percentage points for the three months ended March 31, 2004 and 2003, respectively. While the amount of income from tax-advantaged securities in the current period increased compared to a year earlier, the reduced level of income before income taxes in 2003 resulted in this having a more significant impact on the 2003 effective income tax rate. 26 Net Income Net income (loss) by segment and net income per share were as follows:
Three Months Ended Growth Over March 31, Prior Year --------------------------- --------------------------- 2004 2003 Percent Amount ------------ ------------ ------------ ------------ Net income (loss) Property & casualty Before catastrophe losses............... $ 13.9 $ 8.0 73.8% $ 5.9 Catastrophe losses, after tax........... (0.8) (1.4) 0.6 ------------ ------------ ------------ Total including catastrophe losses... 13.1 6.6 98.5% 6.5 Annuity.................................... 3.9 2.3 69.6% 1.6 Life....................................... 3.1 3.8 -18.4% (0.7) Corporate and other (1).................... 1.6 (4.6) 6.2 ------------ ------------ ------------ Total................................ $ 21.7 $ 8.1 167.9% $ 13.6 ============ ============ ============ Net income per share, diluted................. $ 0.51 $ 0.19 168.4% $ 0.32 ============ ============ ============ Property and casualty GAAP combined ratio: Before catastrophe losses............... 92.6% 97.9% -5.3% After catastrophe losses................ 93.5% 99.5% -6.0% Property and casualty GAAP combined ratio excluding net increases in estimated reserves for claims occurring in prior years: Before catastrophe losses............... 92.6% 94.6% -2.0% After catastrophe losses................ 93.5% 96.2% -2.7%
- ---------- (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. For the first three months of 2004, net income for the property and casualty segment improved compared to the prior year, driven by favorable non-catastrophe frequency trends for automobile and property claims, a relatively low level of catastrophe losses, the impact of the Company's claims initiatives focused on loss and expense control, an improving expense ratio, and no adverse development of prior years' reserves. Current period annuity segment net income increased compared to a year earlier, driven by growth in contract fees and favorable adjustments from the March 31, 2004 valuations of Annuity VIF, deferred acquisition costs and guaranteed minimum death benefit reserves, compared to unfavorable adjustments resulting from similar valuations a year earlier. The growth in contract fees was due to growth in the underlying accumulated amounts on deposit. Life segment net income decreased compared to the first quarter of 2003, due primarily to a decline in group insurance earnings, lower investment income and valuation of deferred policy acquisition costs. 27 The change in the net income (loss) for the Corporate and Other segment compared to the first quarter of 2003 primarily reflected realized investment gains in the current period compared to realized investment losses, including impairment charges, in the prior year. Return on shareholders' equity based on net income was 6% and 1% for the 12 months ended March 31, 2004 and 2003, respectively. Based on the Company's full year 2003 generally positive underlying operating trends and first quarter 2004 results, at the time of this Report on Form 10-Q 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 compared to 2003 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 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 March 31, 2004 and 2003, 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 three 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 "Realized Investment Gains and Losses" and in the Notes to Financial Statements, "Note 5 -- Investments". 28 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 the first three months of 2004, net cash provided by operating activities increased compared to the same period in 2003 reflecting increased insurance underwriting cash flow and an absence of federal income tax payments in the current period. 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, of which $5.0 million was paid during the three months ended March 31, 2004. 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. 29 For the three months ended March 31, 2004, receipts from annuity contracts increased 30.9%. Annuity contract maturities and withdrawals were comparable to the prior year. Cash value retentions for variable and fixed annuity options were 92.9% and 95.2%, respectively, for the 12 month period ended March 31, 2004. Net transfers to variable annuity accumulated cash values increased $10.7 million compared to the prior year. 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. 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 $746.2 million at March 31, 2004, including $144.7 million of long-term debt and $25.0 million of short-term debt outstanding. Total debt represented 26.7% of capital excluding unrealized investment gains and losses (22.7% including unrealized investment gains and losses) at March 31, 2004, slightly above the Company's long-term target of 25%. 30 Shareholders' equity was $576.5 million at March 31, 2004, including a net unrealized gain in the Company's investment portfolio of $110.5 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 $671.6 million and $15.72, respectively, at March 31, 2004. Book value per share was $13.50 at March 31, 2004 ($10.91 excluding investment fair value adjustments). As of March 31, 2004, the Company had outstanding $244.5 million aggregate principal amount of 1.425% Senior Convertible Notes ("Senior Convertible Notes"), which will mature on May 14, 2032, issued at a discount of 52.5% resulting in an effective yield of 3.0%. 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 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). 31 As of March 31, 2004, the Company had outstanding $28.6 million aggregate principal amount of 6 5/8% Senior Notes ("Senior Notes") issued at a discount of 0.5% which will mature on January 15, 2006. Interest on the Senior Notes is payable semi-annually. The Senior Notes are redeemable in whole or in part, at any time, at the Company's option. The Senior Notes have an investment grade rating from 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). As of March 31, 2004, the Company had outstanding $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 March 31, 2004. 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-Q. The Company's ratio of earnings to fixed charges for the three months ended March 31, 2004 was 19.0x, compared to 7.8x for the same period in 2003, which reflected $4.7 million of pretax realized investment losses and $4.3 million of adverse development of prior years' property and casualty reserves recognized during the period. Total shareholder dividends were $4.5 million for the three months ended March 31, 2004. 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 the Company's 2003 Annual Report on Form 10-K in "Business -- Property and Casualty Segment -- Property and Casualty Reinsurance". Information regarding the interest-sensitive life reinsurance program for the Company's life segment is located in the Company's 2003 Annual Report on Form 10-K in "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Financial Resources -- Capital Resources". 32 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 May 1, 2004, which were unchanged from the disclosure in the Company's 2003 Annual Report on Form 10-K, 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 May 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. 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--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 outflows of assets with the projected cash outflows of liabilities. For all its assets and liabilities, the Company seeks to maintain reasonable durations, consistent with the maximization of income without sacrificing investment quality, 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. A more detailed description of the Company's exposure to market value risks and the management of those risks is presented in the Company's Annual Report on Form 10-K for 2003 "Management's Discussion and Analysis of Financial Condition and Results of Operations--Market Value Risk". 33 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 whose implementation was completed in April 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 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 Consensus Regarding EITF Issue No. 03-1 In March 2004, the Financial Accounting Standards Board's Emerging Issues Task Force ("EITF") issued a Consensus regarding EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments", which is effective for reporting periods beginning after June 15, 2004. The Consensus effectively codifies the provisions of SEC Staff Accounting Bulletin No. 59, "Accounting for Noncurrent Marketable Equity Securities", and includes detailed criteria for evaluating whether to record a realized investment loss related to debt and equity securities carried at amounts higher than the securities' fair value. The Consensus also includes requirements to disclose additional information about unrealized investment losses. The adoption of this Consensus is currently not expected to have a material impact on the Company's operating results or financial position. 34 Item 3: Quantitative and Qualitative Disclosures About Market Risk The information required by Item 305 of Regulation S-K is contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in this Quarterly Report on Form 10-Q. Item 4: 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 March 31, 2004 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 II: OTHER INFORMATION Item 4: Submission of Matters to a Vote of Security Holders None. Item 5: Other Information In compliance with Section 202 of the Sarbanes-Oxley Act of 2002, the Audit Committee of the Board of Directors of Horace Mann Educators Corporation has preapproved the continuing provision of certain non-audit services by KPMG LLP, Horace Mann Educators Corporation's independent auditor. Such services relate primarily to tax consultation. The Audit Committee has determined that the services provided by KPMG LLP under non-audit services are compatible with maintaining the auditor's independence. 35 Item 6: Exhibits and Reports on Form 8-K Exhibit No. Description ----------- ----------- (a) The following items are filed as Exhibits. Management contracts and compensatory plans are indicated by an asterisk (*). (10) Material contracts. 10.1* 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. 10.1(a)* Revised Schedule to Severance Agreements between HMEC and certain officers of HMEC. (11) Statement re computation of per share earnings. (15) KPMG LLP letter regarding unaudited interim financial information. (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. (b) During the first quarter of 2004, HMEC filed one Current Report on Form 8-K with the SEC as follows: 1. Dated February 17, 2004, regarding the Company's press release reporting its financial results for the three and twelve month periods ended December 31, 2003, containing an Item 12 Disclosure of Results of Operations and Financial Condition and an Item 7 Financial Statements and Exhibits. 36 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HORACE MANN EDUCATORS CORPORATION (Registrant) Date May 10, 2004 /s/ Louis G. Lower II -------------------------------------- Louis G. Lower II President and Chief Executive Officer Date May 10, 2004 /s/ Peter H. Heckman -------------------------------------- Peter H. Heckman Executive Vice President and Chief Financial Officer Date May 10, 2004 /s/ Bret A. Conklin -------------------------------------- Bret A. Conklin Senior Vice President and Controller 37 ================================================================================ HORACE MANN EDUCATORS CORPORATION EXHIBITS To FORM 10-Q For the Quarter Ended March 31, 2004 VOLUME 1 OF 1 ================================================================================ The following items are filed as Exhibits to Horace Mann Educators Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. Management contracts and compensatory plans are indicated by an asterisk (*). EXHIBIT INDEX Exhibit No. Description - ------- ----------- (10) Material contracts. 10.1* 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. 10.1(a)* Revised Schedule to Severance Agreements between HMEC and certain officers of HMEC. (11) Statement re computation of per share earnings. (15) KPMG LLP letter regarding unaudited interim financial information. (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-10.1.A 2 dex101a.txt REVISED SCHEDULE TO SEVERANCE AGREEMNET Exhibit 10.1(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 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-11 3 dex11.txt COMPUTATION OF NET INCOME PER SHARE Exhibit 11 Horace Mann Educators Corporation Computation of Net Income per Share For the Three Months Ended March 31, 2004 and 2003 (Amounts in thousands, except per share data) Three Months Ended March 31, ----------------------- 2004 2003 ---------- ---------- Basic - assumes no dilution: Net income for the period............................. $ 21,691 $ 8,099 ---------- ---------- Weighted average number of common shares outstanding during the period.................................... 42,722 42,700 ---------- ---------- Net income per share - basic.......................... $ 0.51 $ 0.19 ========== ========== Diluted - assumes full dilution: Net income for the period............................. $ 21,691 $ 8,099 ---------- ---------- Weighted average number of common shares outstanding during the period.................................... 42,722 42,700 Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: Stock options...................................... 34 5 Common stock units related to Deferred Equity Compensation Plan for Directors................... 151 134 Common stock units related to Deferred Compensation Plan for Employees................... 27 30 ---------- ---------- Total common and common equivalent shares adjusted to calculate diluted earnings per share................. 42,934 42,869 ---------- ---------- Net income per share - diluted........................ $ 0.51 $ 0.19 ========== ========== EX-15 4 dex15.txt KPMG LETTER REGARDING UNAUDITED INTERIM FINANCIAL INFORMATION Exhibit 15 Horace Mann Educators Corporation Springfield, Illinois Re: Registration Statements on Forms S-3 and S-8 With respect to the subject registration statements, we acknowledge our awareness of the use therein of our report dated May 5, 2004, related to our review of interim financial information. Pursuant to Rule 436 under the Securities Act of 1933 (the "Act"), such report is not considered part of a registration statement prepared or certified by an accountant, or a report prepared or certified by an accountant within the meaning of Sections 7 and 11 of the Act. /s/ KPMG LLP KPMG LLP Chicago, Illinois May 10, 2004 EX-31.1 5 dex311.txt CEO CERTIFICATION 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 quarterly report on Form 10-Q 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: May 10, 2004 EX-31.2 6 dex312.txt CFO CERTIFICATION 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 quarterly report on Form 10-Q 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: May 10, 2004 EX-32.1 7 dex321.txt CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 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 Quarterly Report of Horace Mann Educators Corporation (the "Company") on Form 10-Q for the period ended March 31, 2004 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: May 10, 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 8 dex322.txt CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 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 Quarterly Report of Horace Mann Educators Corporation (the "Company") on Form 10-Q for the period ended March 31, 2004 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: May 10, 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-----