UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[x] | ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2012
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 incorporation or organization) | (I.R.S. Employer Identification No.) |
1 Horace Mann Plaza, Springfield, Illinois 62715-0001
(Address of principal executive offices, including Zip Code)
Registrants Telephone Number, Including Area Code: 217-789-2500
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class |
Name of each exchange on which registered |
|
Common Stock, par value $0.001 per share | New York Stock Exchange |
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No X
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes No X
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 has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark the registrants filer status, as such terms are defined in Rule 12b-2 of the Exchange Act.
Large accelerated filer Accelerated filer X Non-accelerated filer Smaller reporting company
Indicate by check mark whether the registrant is a shell company, as defined in Rule 12b-2 of the Act. Yes No X
The aggregate market value of the registrants Common Stock held by non-affiliates of the registrant based on the closing price of the registrants Common Stock on the New York Stock Exchange and the shares outstanding on June 30, 2012, was $688.0 million.
As of February 15, 2013, 39,615,013 shares of the registrants Common Stock, par value $0.001 per share, were outstanding, net of 22,943,925 shares of treasury stock.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrants Proxy Statement for the 2013 Annual Meeting of Shareholders are incorporated by reference into Part II Item 5 and Part III Items 10, 11, 12, 13 and 14 of Form 10-K as specified in those Items and will be filed with the Securities and Exchange Commission within 120 days after December 31, 2012.
HORACE MANN EDUCATORS CORPORATION
FORM 10-K
YEAR ENDED DECEMBER 31, 2012
Part |
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I |
1. |
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4 | ||||||||
8 | ||||||||
15 | ||||||||
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24 | ||||||||
1A. |
25 | |||||||
1B. |
39 | |||||||
2. |
40 | |||||||
3. |
40 | |||||||
4. |
40 | |||||||
II |
5. |
40 | ||||||
6. |
42 | |||||||
7. |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
42 | ||||||
7A. |
42 | |||||||
8. |
42 | |||||||
9. |
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
42 | ||||||
9A. |
43 | |||||||
9B. |
44 | |||||||
III |
10. |
44 | ||||||
11. |
44 | |||||||
12. |
Security Ownership of Certain Beneficial Owners and Management, and Related Stockholder Matters |
44 | ||||||
13. |
Certain Relationships and Related Transactions, and Director Independence |
44 | ||||||
14. |
45 | |||||||
IV |
15. |
45 | ||||||
53 | ||||||||
F-1 |
PART I
It is important to note that the Companys actual results could differ materially from those projected in forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in Item 1A. Risk Factors and in Managements Discussion and Analysis of Financial Condition and Results of Operations -- Forward-looking Information.
Overview and Available Information
Horace Mann Educators Corporation (HMEC; and together with its subsidiaries, the Company or Horace Mann) is an insurance holding company incorporated in Delaware. Through its subsidiaries, HMEC markets and underwrites personal lines of property and casualty (primarily personal lines automobile and homeowners) insurance, retirement annuities (primarily tax-qualified products) and life insurance in the United States of America (U.S.). HMECs principal insurance subsidiaries are Horace Mann Life Insurance Company (HMLIC), Horace Mann Insurance Company (HMIC), Horace Mann Property & Casualty Insurance Company (HMPCIC) and Teachers Insurance Company (TIC), each of which is an Illinois corporation, and Horace Mann Lloyds (HM Lloyds), an insurance company domiciled in Texas.
Founded by Educators for Educators ® , the Company markets its products primarily to K-12 teachers, administrators and other employees of public schools and their families. The Companys nearly one million customers typically have moderate annual incomes, with many belonging to two-income households. Their financial planning tends to focus on retirement, security, savings and primary insurance needs. Management believes that Horace Mann is the largest national multiline insurance company focused on the nations educators as its primary market.
Horace Mann markets and services its products primarily through a dedicated sales force of full-time agents trained to sell the Companys multiline products. These agents sell Horace Manns products and limited additional third-party vendor products authorized by the Company. Some of these agents are former educators or individuals with close ties to the educational community who utilize their contacts within, and knowledge of, the target market. This dedicated agent sales force is supplemented by an independent agent distribution channel for the Companys annuity products.
The Companys insurance premiums written and contract deposits for the year ended December 31, 2012 were $1.1 billion and net income was $103.9 million. The Companys total assets were $8.2 billion at December 31, 2012. The Companys investment portfolio had an aggregate fair value of $6.3 billion at December 31, 2012 and consisted principally of investment grade, publicly traded fixed maturity securities.
1
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, annuity products, and life insurance. The Company does not allocate the impact of corporate-level transactions to the insurance segments, consistent with the basis for managements evaluation of the results of those segments, but classifies those items in the fourth segment, corporate and other. The property and casualty, annuity, and life segments accounted for 52%, 39% and 9%, respectively, of the Companys insurance premiums written and contract deposits for the year ended December 31, 2012.
The Company is one of the largest participants in the K-12 portion of the 403(b) tax-qualified annuity market, measured by 403(b) net written premium on a statutory accounting basis. The Companys 403(b) tax-qualified annuities are voluntarily purchased by individuals employed by public school systems or other tax-exempt organizations through the employee benefit plans of those entities. The Company has 403(b) payroll reduction capabilities utilized by approximately one-third of the 13,600 public school districts in the U.S.
The Companys annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, and all amendments to those reports are available free of charge through the Investors section of the Companys Internet website, www.horacemann.com , as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission (SEC). The EDGAR filings of such reports are also available at the SECs website, www.sec.gov .
Also available in the Investors section of the Companys website are its corporate governance principles, code of conduct and code of ethics as well as the charters of the Boards Audit Committee, Compensation Committee, Executive Committee, Investment and Finance Committee, and Nominating and Governance Committee.
On June 21, 2012, the Chief Executive Officer (CEO) of HMEC timely submitted the Annual Section 12(a) CEO Certification to the New York Stock Exchange (NYSE) without any qualifications. The Company filed with the SEC, as exhibits to the Annual Report on Form 10-K for the year ended December 31, 2011, the CEO and Chief Financial Officer (CFO) certifications required under Section 302 of the Sarbanes-Oxley Act.
The Companys business was founded in Springfield, Illinois in 1945 by two school teachers to sell automobile insurance to other teachers within the State of Illinois. The Company expanded its business to other states and broadened its product line to include life insurance in 1949, 403(b) tax-qualified retirement annuities in 1961 and homeowners insurance in 1965. In November 1991, HMEC completed an initial public offering of its common stock (the IPO). The common stock is traded on the New York Stock Exchange under the symbol HMN.
2
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following consolidated statement of operations and balance sheet data have been derived from the consolidated financial statements of the Company, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The consolidated financial statements of the Company for each of the years in the five-year period ended December 31, 2012 have been audited by KPMG LLP, an independent registered public accounting firm. The following selected historical consolidated financial data should be read in conjunction with the consolidated financial statements of HMEC and its subsidiaries and Managements Discussion and Analysis of Financial Condition and Results of Operations. Throughout this Annual Report on Form 10-K, data for 2008 through 2011 has been adjusted to reflect the January 1, 2012 adoption and retrospective application by the Company of new accounting guidance for deferred policy acquisition costs as described in Notes to Consolidated Financial Statements -- Note 1 -- Summary of Significant Accounting Policies listed on page F-1 of this report.
Year Ended December 31, | |||||||||||||||||||||||||
2012 |
2011 |
2010 |
2009 |
2008 |
|||||||||||||||||||||
As Adjusted | As Adjusted | As Adjusted | As Adjusted | ||||||||||||||||||||||
Statement of Operations Data: | (Dollars in millions, except per share data) | ||||||||||||||||||||||||
Insurance premiums and contract charges earned |
$ | 670.5 | $ | 667.1 | $ | 672.7 | $ | 659.6 | $ | 658.5 | |||||||||||||||
Net investment income |
306.0 | 288.3 | 272.1 | 246.8 | 230.3 | ||||||||||||||||||||
Realized investment gains (losses) |
27.3 | 37.7 | 23.8 | 26.3 | (63.9 | ) | |||||||||||||||||||
Total revenues |
1,010.8 | 998.3 | 974.8 | 937.4 | 834.8 | ||||||||||||||||||||
Amortization of intangible assets (1) |
- | - | - | 0.2 | 5.3 | ||||||||||||||||||||
Interest expense |
14.2 | 14.0 | 14.0 | 14.0 | 14.5 | ||||||||||||||||||||
Income (loss) before income taxes |
149.2 | 94.9 | 110.2 | 101.8 | (1.9 | ) | |||||||||||||||||||
Net income (2) |
103.9 | 70.5 | 80.1 | 72.4 | 9.5 | ||||||||||||||||||||
Ratio of earnings to fixed charges (3) |
1.8 | x | 1.6 | x | 1.7 | x | 1.7 | x | 1.0 | x | |||||||||||||||
Per Share Data (4): |
|||||||||||||||||||||||||
Net income per share: |
|||||||||||||||||||||||||
Basic |
$ | 2.63 | $ | 1.77 | $ | 2.04 | $ | 1.85 | $ | 0.24 | |||||||||||||||
Diluted |
$ | 2.51 | $ | 1.70 | $ | 1.95 | $ | 1.79 | $ | 0.24 | |||||||||||||||
Shares of Common Stock (in millions): |
|||||||||||||||||||||||||
Weighted average - basic |
39.5 | 39.9 | 39.3 | 39.2 | 39.8 | ||||||||||||||||||||
Weighted average - diluted |
41.4 | 41.4 | 41.0 | 40.5 | 40.6 | ||||||||||||||||||||
Ending outstanding |
39.4 | 39.8 | 39.7 | 39.2 | 39.1 | ||||||||||||||||||||
Cash dividends per share |
$ | 0.5500 | $ | 0.4600 | $ | 0.3500 | $ | 0.2375 | $ | 0.3675 | |||||||||||||||
Book value per share |
$ | 31.65 | $ | 26.53 | $ | 21.36 | $ | 17.57 | $ | 10.60 | |||||||||||||||
Balance Sheet Data, at Year End: |
|||||||||||||||||||||||||
Total investments |
$ | 6,292.1 | $ | 5,677.5 | $ | 5,073.6 | $ | 4,574.6 | $ | 3,901.8 | |||||||||||||||
Total assets |
8,167.7 | 7,435.2 | 6,945.7 | 6,286.1 | 5,445.2 | ||||||||||||||||||||
Total policy liabilities |
4,736.7 | 4,401.0 | 4,068.7 | 3,794.6 | 3,563.2 | ||||||||||||||||||||
Short-term debt |
38.0 | 38.0 | 38.0 | 38.0 | 38.0 | ||||||||||||||||||||
Long-term debt |
199.8 | 199.7 | 199.7 | 199.6 | 199.5 | ||||||||||||||||||||
Total shareholders equity |
1,245.8 | 1,055.4 | 847.1 | 688.3 | 414.0 | ||||||||||||||||||||
Segment Information (5): |
|||||||||||||||||||||||||
Insurance premiums written and contract deposits |
|||||||||||||||||||||||||
Property and casualty |
$ | 550.8 | $ | 545.9 | $ | 557.1 | $ | 553.5 | $ | 545.9 | |||||||||||||||
Annuity |
417.6 | 433.9 | 395.5 | 349.8 | 311.7 | ||||||||||||||||||||
Life |
99.3 | 98.6 | 99.4 | 100.4 | 102.5 | ||||||||||||||||||||
Total |
1,067.7 | 1,078.4 | 1,052.0 | 1,003.7 | 960.1 | ||||||||||||||||||||
Net income (loss) |
|||||||||||||||||||||||||
Property and casualty |
$ | 37.1 | $ | 5.9 | $ | 27.0 | $ | 29.9 | $ | 28.0 | |||||||||||||||
Annuity |
40.5 | 30.9 | 30.8 | 20.3 | 16.3 | ||||||||||||||||||||
Life |
21.9 | 19.4 | 20.2 | 18.3 | 16.1 | ||||||||||||||||||||
Corporate and other (6) |
4.4 | 14.3 | 2.1 | 3.9 | (50.9 | ) | |||||||||||||||||||
Total |
103.9 | 70.5 | 80.1 | 72.4 | 9.5 |
(1) |
Amortization of intangible assets is comprised of amortization of acquired value of insurance in force and is the result of purchase accounting adjustments related to the 1989 acquisition of the Company. These intangible assets were fully amortized by December 31, 2009. |
(2) |
In 2008, the Companys federal income tax expense reflected a reduction of $4.2 million from the closing of tax years 2002, 2004, 2005 and 2006 with favorable resolution of the contingent tax liabilities related to those prior year taxes. |
(3) |
For the purpose of determining the ratio of earnings to fixed charges, earnings consist of income before income taxes and fixed charges, and fixed charges consist of interest expense (including amortization of debt issuance cost) and interest credited to policyholders on interest-sensitive contracts. |
(4) |
Basic earnings per share is computed based on the weighted average number of shares outstanding. Diluted earnings per share is computed based on the weighted average number of shares and common stock equivalents outstanding. The Companys common stock equivalents relate to outstanding common stock options, common stock units (related to deferred compensation for Directors and employees) and restricted stock units. |
(5) |
Information regarding assets by segment at December 31, 2012, 2011 and 2010 is contained in Notes to Consolidated Financial Statements -- Note 13 -- Segment Information listed on page F-1 of this report. |
(6) |
The corporate and other segment primarily includes interest expense on debt, the impact of realized investment gains and losses, and certain public company expenses. |
3
Corporate Strategy and Marketing
The Horace Mann Value Proposition
The Horace Mann Value Proposition articulates the Companys overarching strategy and business purpose: Provide lifelong financial well-being for educators and their families through personalized service, advice, and a full range of tailored insurance and financial products.
Target Market
Management believes that Horace Mann is the largest national multiline insurance company focused on the nations educators as its primary market. The Companys target market consists primarily of K-12 teachers, administrators and other employees of public schools and their families located throughout the U.S. The U.S. Department of Education estimates that there are approximately 6.4 million teachers, school administrators and education support personnel in public schools in the U.S.; approximately 3.2 million of these individuals are elementary and secondary teachers.
Dedicated Agency Force
A cornerstone of Horace Manns marketing strategy is its dedicated sales force of agents trained to sell the Companys multiline products. As of December 31, 2012, the Company had a combined total of 760 Exclusive Agencies and Employee Agents. Approximately 76% of the appointed agents are licensed by the Financial Industry Regulatory Authority, Inc. (FINRA) to sell variable annuities and variable universal life policies. Some individuals in the agency force were previously teachers, other members of the education profession or persons with close ties to the educational community. The Companys dedicated agents are under contract to market only the Companys products and limited additional third-party vendor products authorized by the Company. Collectively, the Companys principal insurance subsidiaries are licensed to write business in 49 states and the District of Columbia.
Approximately 90% of the Companys dedicated agency force operates in its Agency Business Model (ABM), consisting of Exclusive Agencies as well as Employee Agents in outside offices with licensed producers. In 2006, the Company began its transition from single-person agent operations to ABM, which was designed to remove capacity constraints and increase productivity. The first Agency Business School (ABS) session was conducted in October 2006, beginning the formal roll-out of this model. Subsequently, ABS attendance has been offered to those agents who meet the Companys qualifications and demonstrate they are able to successfully migrate into the ABM model or begin their association with Horace Mann directly in the ABM model. On an ongoing basis, the Company will also provide follow-up training and support to those agents who have completed the school, to further embed repeatable processes and fully maximize the potential of ABM.
4
Building on the initial foundation of ABM, in 2009 the Company expanded ABM and introduced its Exclusive Agent (EA) agreement, which is designed to place agents in the position to become business owners and invest their own capital to grow their agencies. Upon appointment, these non-employee, independent contractors are under contract and trained to market only the Companys multiline products and limited additional third-party vendor products authorized by the Company. By January 1, 2009, the first 71 individuals migrated from being Employee Agents to functioning as independent Exclusive Agents. From 2009 through 2012, additional Employee Agents migrated and other individuals were recruited and appointed directly into the EA agreement. Additionally, an independent contractor may sign multiple EA agreements with the Company and manage more than one Exclusive Agency. At December 31, 2012, approximately 90% of the combined Exclusive Agencies and Employee Agents were operating in the Agency Business Model and 82% were operating under the EA agreement. Going forward, the EA agreement will be offered to additional qualified Employee Agents. At December 31, 2012, approximately 60% of the 624 Exclusive Agencies had been formed by new appointments. As was the case since 2009, management expects that all future new agent appointments will be under the EA agreement.
Broadening Distribution Options
To complement and extend the reach of the Companys agency force and to more fully utilize its approved payroll reduction slots in school systems across the country, the Company utilizes a network of independent agents to distribute the Companys 403(b) tax-qualified annuity products. In addition to serving educators in areas where the Company does not have dedicated agents, the independent agents complement the annuity capabilities of the Companys agency force in under-penetrated areas. At December 31, 2012, there were 492 independent agents approved to market the Companys annuity products throughout the U.S. During 2012, collected contract deposits from this distribution channel were approximately $64 million. Combined with business from the Companys dedicated agency force, total annuity collected contract deposits were approximately $418 million for the year ended December 31, 2012.
5
Geographic Composition of Business
The Companys business is geographically diversified. For the year ended December 31, 2012, based on direct premiums and contract deposits for all product lines, the top five states and their portion of total direct insurance premiums and contract deposits were California, 8.9%; North Carolina, 6.7%; Texas, 5.9%; Minnesota, 5.5%; and South Carolina, 5.3%.
HMECs property and casualty subsidiaries are licensed to write business in 48 states and the District of Columbia. The following table sets forth the Companys top ten property and casualty states based on total direct premiums in 2012:
Property and Casualty Segment Top Ten States
(Dollars in millions)
Property and Casualty | ||||||||||
Segment | ||||||||||
Direct
Premiums (1) |
Percent
of Total |
|||||||||
State |
||||||||||
California |
$ | 56.6 | 10.0 | % | ||||||
North Carolina |
41.9 | 7.4 | ||||||||
Texas |
37.2 | 6.6 | ||||||||
Minnesota |
35.6 | 6.3 | ||||||||
Florida |
33.9 | 6.0 | ||||||||
Louisiana |
31.3 | 5.6 | ||||||||
South Carolina |
29.7 | 5.3 | ||||||||
Pennsylvania |
21.1 | 3.8 | ||||||||
Georgia |
18.8 | 3.3 | ||||||||
Maine |
16.3 | 2.9 | ||||||||
|
|
|
|
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Total of top ten states |
322.4 | 57.2 | ||||||||
All other areas |
241.7 | 42.8 | ||||||||
|
|
|
|
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Total direct premiums |
$ | 564.1 | 100.0 | % | ||||||
|
|
|
|
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(1) Defined as earned premiums before reinsurance as determined under statutory accounting principles. |
|
HMECs principal life insurance subsidiary is licensed to write business in 48 states and the District of Columbia. The following table sets forth the Companys top ten combined life and annuity states based on total direct premiums and contract deposits in 2012:
Combined Life and Annuity Segments Top Ten States
(Dollars in millions)
Direct Premiums and
Contract Deposits (1) |
Percent
of Total |
|||||||||
State |
||||||||||
California |
$ | 39.8 | 7.7 | % | ||||||
Illinois |
35.4 | 6.8 | ||||||||
Pennsylvania |
33.2 | 6.4 | ||||||||
North Carolina |
30.9 | 5.9 | ||||||||
Virginia |
28.8 | 5.5 | ||||||||
South Carolina |
27.5 | 5.3 | ||||||||
Texas |
26.7 | 5.1 | ||||||||
Minnesota |
24.0 | 4.6 | ||||||||
Florida |
21.5 | 4.1 | ||||||||
Tennessee |
21.4 | 4.1 | ||||||||
|
|
|
|
|||||||
Total of top ten states |
289.2 | 55.5 | ||||||||
All other areas |
231.6 | 44.5 | ||||||||
|
|
|
|
|||||||
Total direct premiums |
$ | 520.8 | 100.0 | % | ||||||
|
|
|
|
|||||||
(1) Defined as collected premiums before reinsurance as determined under statutory accounting principles. |
|
6
National, State and Local Education Associations
The Company has established relationships with a number of educator groups throughout the U.S. These groups include the National Education Association (NEA), the Association of School Business Officials International (ASBO) and various school administrator and principal associations such as the American Association of School Administrators (AASA), the National Association of Elementary School Principals (NAESP) and the National Association of Secondary School Principals (NASSP). The Company does not pay these groups any consideration in exchange for endorsement of the Company or its products. Depending on the organization, the Company does pay for certain special functions and advertising.
In recent years, the Company has developed relationships and programs to align its agents with school districts in a business to business relationship. In addition to a working relationship, in 2011 Horace Mann formed a strategic alliance with ASBO, as well as its state and regional affiliates. The Company holds an annual meeting with selected ASBO members to gain feedback on a variety of school district programs.
The Company has had its longest relationship with the NEA, the nations largest confederation of state and local teachers associations, and many of the state and local education associations affiliated with the NEA. The NEA has approximately 3.2 million members. A number of state and local associations affiliated with the NEA endorse various insurance products and services of the Company and its competitors. The Company does not pay the NEA or any affiliated associations any consideration in exchange for endorsement of Company products. The Company does pay for marketing agreements, certain special functions and advertising.
Support of Educator Programs
The Companys agents conduct state-specific State Teacher Retirement System Workshops in addition to Financial Success Workshops designed to help educators gain or increase their financial literacy. In addition, the Company offers services and products to school districts that help meet the needs of educators including payroll deduction options for individual insurance products, group life insurance and Section 125 programs. To help districts determine what programs meet their needs, the Company has developed an Employer Benefit Review Service and conducts workshops for school business officials.
Along with differentiating, value-added product features, the Company has a number of programs that demonstrate its commitment to the educator profession, while also further distinguishing Horace Mann from competitors within the K-12 educator market. Examples of these programs include: the Horace Mann-Abraham Lincoln Fellowship Program, which annually brings a group of educators from across the U.S. to the Abraham Lincoln Presidential Library and Museum in Springfield, Illinois for a five-day study of the life of the countrys 16 th President; the NEA Foundations Horace Mann Awards for Teaching Excellence honoring 5 national finalists; and, beginning in 2011, Horace Mann is one of the national sponsors of DonorsChoose.org, an online, not-for-profit organization that connects corporate and individual donors to teachers with classroom projects in need of funding.
7
The property and casualty segment represented 52% of the Companys consolidated insurance premiums written and contract deposits in 2012.
The primary property and casualty product offered by the Company is private passenger automobile insurance, which in 2012 represented 34% of the Companys total insurance premiums written and contract deposits and 65% of property and casualty net written premiums. As of December 31, 2012, the Company had approximately 484,000 voluntary automobile policies in force. The Companys automobile business is primarily preferred risk, defined as a household whose drivers have had no recent accidents and no more than one recent moving violation.
In 2012, homeowners insurance represented 18% of the Companys total insurance premiums written and contract deposits and 34% of property and casualty net written premiums. As of December 31, 2012, the Company had approximately 237,000 homeowners policies in force. The Company insures primarily residential homes.
The Company has programs in a majority of states to provide higher-risk automobile and homeowners coverages, with third-party vendors underwriting and bearing the risk of such insurance and the Company receiving commissions on the sales. As an example, in Florida the Company has authorized its agents to write certain third-party vendors homeowners policies to help control the Companys coastal risk exposure.
8
Selected Historical Financial Information For Property and Casualty Segment
The following table sets forth certain financial information with respect to the property and casualty segment for the periods indicated.
Property and Casualty Segment
Selected Historical Financial Information
(Dollars in millions)
Year Ended December 31, |
|||||||||||||||
2012 |
2011 |
2010 |
|||||||||||||
As Adjusted | As Adjusted | ||||||||||||||
Financial Data: |
|||||||||||||||
Insurance premiums written |
$550.8 | $545.9 | $557.1 | ||||||||||||
Insurance premiums earned |
546.3 | 547.5 | 555.8 | ||||||||||||
Net investment income |
36.8 | 36.9 | 36.5 | ||||||||||||
Income before income taxes |
47.9 | 0.6 | 31.3 | ||||||||||||
Net income |
37.1 | 5.9 | 27.0 | ||||||||||||
Catastrophe costs, pretax (1) |
43.3 | 86.0 | 49.2 | ||||||||||||
Operating Statistics: |
|||||||||||||||
Loss and loss adjustment expense ratio |
71.3 | % | 80.8 | % | 75.2 | % | |||||||||
Expense ratio |
27.0 | % | 25.8 | % | 25.7 | % | |||||||||
Combined loss and expense ratio |
98.3 | % | 106.6 | % | 100.9 | % | |||||||||
Effect of catastrophe costs on the combined ratio (1) |
8.0 | % | 15.7 | % | 8.8 | % | |||||||||
Automobile and Homeowners (Voluntary): |
|||||||||||||||
Insurance premiums written |
|||||||||||||||
Automobile |
$360.3 | $359.9 | $372.8 | ||||||||||||
Homeowners |
186.9 | 182.1 | 180.4 | ||||||||||||
Total |
547.2 | 542.0 | 553.2 | ||||||||||||
Insurance premiums earned |
|||||||||||||||
Automobile |
357.1 | 363.0 | 372.2 | ||||||||||||
Homeowners |
185.5 | 181.1 | 179.6 | ||||||||||||
Total |
542.6 | 544.1 | 551.8 | ||||||||||||
Policies in force (in thousands) |
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Automobile |
484 | 486 | 508 | ||||||||||||
Homeowners |
237 | 239 | 252 | ||||||||||||
Total |
721 | 725 | 760 |
(1) |
These measures are used by the Companys management to evaluate performance against historical results and establish targets on a consolidated basis. These measures are components of net income but are considered non-GAAP financial measures under applicable SEC rules because they are not displayed as separate line items in the Consolidated Statements of Operations and there is inclusion or exclusion of certain items not ordinarily included or excluded in a GAAP financial measure. In the opinion of the Companys management, a discussion of these measures is meaningful to provide investors with an understanding of the significant factors that comprise the Companys periodic results of operations. |
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Catastrophe costs - The sum of catastrophe losses and property and casualty catastrophe reinsurance reinstatement premiums. |
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Catastrophe losses - In categorizing property and casualty claims as being from a catastrophe, the Company utilizes the designations of the Property Claims Service, a subsidiary of Insurance Services Office, Inc. (ISO), and additionally beginning in 2007, includes losses from all such events that meet the definition of covered loss in the Companys primary catastrophe excess of loss reinsurance contract, and reports loss and loss adjustment expense amounts net of reinsurance recoverables. A catastrophe is a severe loss resulting from natural and man-made events within a particular territory, including risks such as hurricane, fire, earthquake, windstorm, explosion, terrorism and other similar events, that causes $25 million or more in insured property and casualty losses for the industry and affects a significant number of property and casualty insurers and policyholders. Each catastrophe has unique characteristics. Catastrophes are not predictable as to timing or amount of loss in advance. Their effects are not included in earnings or claim and claim adjustment expense reserves prior to occurrence. In the opinion of the Companys management, a discussion of the impact of catastrophes is meaningful for investors to understand the variability in periodic earnings. |
9
Catastrophe Costs
The level of catastrophe costs can fluctuate significantly from year to year. Catastrophe costs before federal income tax benefits for the Company and the property and casualty industry for the ten years ended December 31, 2012 were as follows:
Catastrophe Costs
(Dollars in millions)
Property and | |||||||||||||||
The | Casualty | ||||||||||||||
Company (1) |
Industry (2) |
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Year Ended December 31, |
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2012 |
$43.3 | $35,000.0 | |||||||||||||
2011 |
86.0 | 33,600.0 | |||||||||||||
2010 |
49.2 | 14,300.0 | |||||||||||||
2009 |
33.1 | 10,600.0 | |||||||||||||
2008 |
73.9 | 25,200.0 | |||||||||||||
2007 |
23.6 | 6,700.0 | |||||||||||||
2006 |
19.8 | 9,200.0 | |||||||||||||
2005 |
69.2 | 62,300.0 | |||||||||||||
2004 |
75.5 | 27,500.0 | |||||||||||||
2003 |
33.2 | 12,900.0 |
10
Fluctuations from year to year in the level of catastrophe losses impact a property and casualty insurance companys loss and loss adjustment expenses incurred and paid. For comparison purposes, the following table provides amounts for the Company excluding catastrophe losses:
Impact of Catastrophe Losses
(Dollars in millions)
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Claims and claim expense incurred (1) |
$ | 389.4 | $ | 442.5 | $ | 418.2 | ||||||
Amount attributable to catastrophes (2) |
43.3 | 86.0 | 49.2 | |||||||||
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Excluding catastrophes (1) |
$ | 346.1 | $ | 356.5 | $ | 369.0 | ||||||
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Claims and claim expense payments |
$ | 398.2 | $ | 462.3 | $ | 414.0 | ||||||
Amount attributable to catastrophes (2) |
47.9 | 83.4 | 42.5 | |||||||||
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Excluding catastrophes |
$ | 350.3 | $ | 378.9 | $ | 371.5 | ||||||
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(1) |
Includes the impact of development of prior years reserves as quantified in Property and Casualty Reserves. |
(2) |
Net of reinsurance and before federal income tax benefits. Includes allocated loss adjustment expenses; excludes unallocated loss adjustment expenses. |
Property and Casualty Reserves
Property and casualty unpaid claims and claim expenses (loss reserves) represent managements estimate of ultimate unpaid costs of losses and settlement expenses for claims that have been reported and claims that have been incurred but not yet reported. The Company calculates and records a single best estimate of the reserve as of each balance sheet date in conformity with generally accepted actuarial standards. For additional information regarding the process used to estimate property and casualty reserves, the risk factors involved and reserve development recorded in each of the three years ended December 31, 2012, see Notes to Consolidated Financial Statements -- Note 4 -- Property and Casualty Unpaid Claims and Claim Expenses and Managements Discussion and Analysis of Financial Condition and Results of Operations -- Critical Accounting Policies -- Liabilities for Property and Casualty Claims and Claim Expenses.
All of the Companys reserves for property and casualty unpaid claims and claim expenses are carried at the full value of estimated liabilities and are not discounted for interest expected to be earned on reserves. Due to the nature of the Companys personal lines business, the Company has no exposure to losses related 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 mold.
11
The following table is a summary reconciliation of the beginning and ending property and casualty insurance claims and claim expense reserves for each of the last three years. The table presents reserves on both gross and net (after reinsurance) bases. The total net property and casualty insurance claims and claim expense incurred amounts are reflected in the Consolidated Statements of Operations listed on page F-1 of this report. The end of the year gross reserve (before reinsurance) balances and the reinsurance recoverable balances are reflected on a gross basis in the Consolidated Balance Sheets also listed on page F-1 of this report.
Reconciliation of Property and Casualty Claims and Claim Expense Reserves
(Dollars in millions)
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Gross reserves, beginning of year (1) |
$ | 281.1 | $ | 301.6 | $ | 301.0 | ||||||
Less reinsurance recoverables |
11.5 | 12.2 | 15.8 | |||||||||
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Net reserves, beginning of year (2) |
269.6 | 289.4 | 285.2 | |||||||||
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Incurred claims and claim expenses: |
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Claims occurring in the current year |
406.6 | 452.8 | 438.7 | |||||||||
Decrease in estimated reserves for claims occurring in prior years (3) |
(17.2 | ) | (10.3 | ) | (20.5 | ) | ||||||
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Total claims and claim expenses incurred (4) |
389.4 | 442.5 | 418.2 | |||||||||
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Claims and claim expense payments for claims occurring during: |
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Current year |
271.3 | 314.8 | 281.2 | |||||||||
Prior years |
126.9 | 147.5 | 132.8 | |||||||||
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Total claims and claim expense payments |
398.2 | 462.3 | 414.0 | |||||||||
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Net reserves, end of year (2) |
260.8 | 269.6 | 289.4 | |||||||||
Plus reinsurance recoverables |
13.7 | 11.5 | 12.2 | |||||||||
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Reported gross reserves, end of year (1) |
$ | 274.5 | $ | 281.1 | $ | 301.6 | ||||||
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(1) |
Unpaid claims and claim expenses as reported in the Consolidated Balance Sheets, listed on page F-1 of this report, also include life, annuity, and group accident and health reserves of $14.9 million, $13.7 million, $14.1 million and $11.7 million at December 31, 2012, 2011, 2010 and 2009, respectively, in addition to property and casualty segment reserves. |
(2) |
Reserves net of anticipated reinsurance recoverables. |
(3) |
Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims and changes in their projected final settlement costs. For discussion of the reserve development recorded by the Company in 2012, 2011 and 2010, see Notes to Consolidated Financial Statements -- Note 4 -- Property and Casualty Unpaid Claims and Claim Expenses listed on page F-1 of this report. |
(4) |
Benefits, claims and settlement expenses as reported in the Consolidated Statements of Operations, listed on page F-1 of this report, also include life, annuity and group accident and health amounts of $58.8 million, $59.9 million and $56.6 million for the years ended December 31, 2012, 2011 and 2010, respectively, in addition to the property and casualty segment amounts. |
The claim reserve development table below illustrates the change over time in the net reserves established for property and casualty insurance claims and claim expenses at the end of various calendar years. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows the cumulative amounts of claims for which settlements have been made in cash as of the end of successive years with respect to that reserve liability. The third section, reading down, shows retroactive reestimates of the original recorded reserve as of the end of each successive year which is the result of the Company learning additional facts that pertain to the unsettled claims. The fourth section compares the latest reestimated reserve to the reserve originally established, and indicates whether or not the original reserve was adequate or inadequate to cover the estimated costs of unsettled claims. The table also presents the gross reestimated liability as of the end of the latest reestimation period, with separate disclosure of the related reestimated reinsurance recoverable. The claim reserve development table is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years.
12
In evaluating the information in the table below, it should be noted that each amount includes the effects of all changes in amounts for prior periods. For example, if a claim was first reserved in 2002 at $100 thousand and then determined in 2011 to be $150 thousand, the $50 thousand deficiency (actual claim minus original estimate) would be included in the cumulative deficiency in each of the years 2002 - 2010 shown below. This table presents development data by calendar year and does not relate the data to the year in which the accident actually occurred. Conditions and trends that have affected the development of these reserves in the past will not necessarily recur in the future. It may not be appropriate to use this cumulative history in the projection of future performance.
Property and Casualty
Claims and Claims Expense Reserve Development
(Dollars in millions)
December 31, | ||||||||||||||||||||||||||||||||||||||||||||
2002 |
2003 |
2004 |
2005 |
2006 |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
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Gross reserves for property and casualty claims and claim expenses |
$ | 275.7 | $ | 304.3 | $ | 335.0 | $ | 342.7 | $ | 317.8 | $ | 306.2 | $ | 297.8 | $ | 301.0 | $ | 301.6 | $ | 281.1 | $ | 274.5 | ||||||||||||||||||||||
Deduct: Reinsurance recoverables |
44.7 | 20.6 | 25.7 | 31.6 | 22.4 | 15.9 | 14.8 | 15.8 | 12.2 | 11.5 | 13.7 | |||||||||||||||||||||||||||||||||
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Net Reserves for property and casualty claims and claim expenses (1) |
231.0 | 283.7 | 309.3 | 311.1 | 295.4 | 290.3 | 283.0 | 285.2 | 289.4 | 269.6 | 260.8 | |||||||||||||||||||||||||||||||||
Paid cumulative as of: |
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One year later |
160.4 | 145.2 | 143.9 | 138.3 | 129.8 | 134.1 | 139.4 | 132.8 | 147.5 | 126.9 | ||||||||||||||||||||||||||||||||||
Two years later |
222.3 | 209.5 | 202.5 | 196.5 | 184.1 | 184.2 | 187.3 | 186.5 | 196.8 | |||||||||||||||||||||||||||||||||||
Three years later |
258.6 | 244.1 | 236.6 | 225.0 | 209.5 | 208.0 | 213.0 | 210.4 | ||||||||||||||||||||||||||||||||||||
Four years later |
278.7 | 264.1 | 252.7 | 239.1 | 223.5 | 220.0 | 225.2 | |||||||||||||||||||||||||||||||||||||
Five years later |
291.4 | 272.4 | 259.7 | 248.2 | 231.0 | 226.5 | ||||||||||||||||||||||||||||||||||||||
Six years later |
296.1 | 276.9 | 263.3 | 253.0 | 235.5 | |||||||||||||||||||||||||||||||||||||||
Seven years later |
298.5 | 279.0 | 266.7 | 255.9 | ||||||||||||||||||||||||||||||||||||||||
Eight years later |
299.8 | 281.3 | 268.4 | |||||||||||||||||||||||||||||||||||||||||
Nine years later |
301.1 | 281.3 | ||||||||||||||||||||||||||||||||||||||||||
Ten years later |
300.8 | |||||||||||||||||||||||||||||||||||||||||||
Net Reserves reestimated as of (1): |
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End of year |
231.0 | 283.7 | 309.3 | 311.1 | 295.4 | 290.3 | 283.0 | 285.2 | 289.4 | 269.6 | 260.8 | |||||||||||||||||||||||||||||||||
One year later |
287.3 | 287.5 | 296.2 | 291.8 | 275.4 | 272.2 | 271.3 | 264.7 | 279.1 | 252.4 | ||||||||||||||||||||||||||||||||||
Two years later |
297.1 | 283.1 | 282.7 | 279.7 | 262.1 | 263.0 | 255.7 | 258.6 | 269.9 | |||||||||||||||||||||||||||||||||||
Three years later |
297.9 | 283.5 | 278.2 | 270.2 | 255.3 | 254.0 | 254.5 | 255.6 | ||||||||||||||||||||||||||||||||||||
Four years later |
301.8 | 281.3 | 272.8 | 256.3 | 241.6 | 239.0 | 245.3 | |||||||||||||||||||||||||||||||||||||
Five years later |
300.6 | 280.6 | 268.4 | 257.3 | 242.9 | 239.8 | ||||||||||||||||||||||||||||||||||||||
Six years later |
300.2 | 281.1 | 268.3 | 259.6 | 243.0 | |||||||||||||||||||||||||||||||||||||||
Seven years later |
301.1 | 281.1 | 269.8 | 259.7 | ||||||||||||||||||||||||||||||||||||||||
Eight years later |
301.0 | 282.4 | 269.4 | |||||||||||||||||||||||||||||||||||||||||
Nine years later |
301.7 | 281.3 | ||||||||||||||||||||||||||||||||||||||||||
Ten years later |
300.9 | |||||||||||||||||||||||||||||||||||||||||||
Net Reserve redundancy (deficiency) initial net reserves in excess of (less than) reestimated reserves: |
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Amount (2) |
$ | (69.9 | ) | $ | 2.4 | $ | 39.9 | $ | 51.3 | $ | 52.4 | $ | 50.5 | $ | 37.7 | $ | 29.6 | $ | 19.5 | $ | 17.2 | |||||||||||||||||||||||
Percent |
-30.3 | % | 0.8 | % | 12.9 | % | 16.5 | % | 17.7 | % | 17.4 | % | 13.3 | % | 10.4 | % | 6.7 | % | 6.4 | % | ||||||||||||||||||||||||
Gross reestimated liability - latest |
$ | 373.4 | $ | 336.5 | $ | 331.4 | $ | 338.0 | $ | 286.3 | $ | 273.4 | $ | 281.2 | $ | 290.6 | $ | 298.9 | $ | 268.8 | ||||||||||||||||||||||||
Reestimated reinsurance recoverables - latest |
72.5 | 55.2 | 62.0 | 78.3 | 43.3 | 33.6 | 35.9 | 35.0 | 29.0 | 16.4 | ||||||||||||||||||||||||||||||||||
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Net Reserve reestimated - latest (1) |
$ | 300.9 | $ | 281.3 | $ | 269.4 | $ | 259.7 | $ | 243.0 | $ | 239.8 | $ | 245.3 | $ | 255.6 | $ | 269.9 | $ | 252.4 | ||||||||||||||||||||||||
Gross cumulative excess (deficiency) (2) |
$ | (97.7 | ) | $ | (32.2 | ) | $ | 3.6 | $ | 4.6 | $ | 31.5 | $ | 32.8 | $ | 16.6 | $ | 10.4 | $ | 2.7 | $ | 12.3 |
(1) |
Reserves net of anticipated reinsurance recoverables (Net Reserves). Net Reserves is a measure used by the Companys management to evaluate the overall adequacy of the property and casualty loss reserves and management believes it provides an alternative view of the Companys anticipated liabilities after reflecting expected recoveries from its reinsurers. This is considered a non-GAAP financial measure under applicable SEC rules because it is not displayed as a separate item in the Consolidated Balance Sheets. For balance sheet reporting, GAAP does not permit the Company to offset expected reinsurance recoveries against liabilities, yet management believes it is useful to investors to take these expected recoveries into account. These adjustments only affect the classification of these items in the Consolidated Balance Sheets and the Consolidated Statements of Cash Flows and there is no impact on the Companys benefits, claims and settlement expenses incurred as reported in the Consolidated Statements of Operations. |
(2) |
For discussion of the reserve development, see Notes to Consolidated Financial Statements -- Note 4 -- Property and Casualty Unpaid Claims and Claim Expenses listed on page F-1 of this report. |
13
Property and Casualty Reinsurance
All reinsurance is obtained through contracts which generally are entered into for each calendar year. Although reinsurance does not legally discharge the Company from primary liability for the full amount of its policies, it does allow for recovery from assuming reinsurers to the extent of the reinsurance ceded. Historically, the Companys losses from uncollectible reinsurance recoverables have been insignificant due to the Companys emphasis on the credit worthiness of its reinsurers. Past due reinsurance recoverables as of December 31, 2012 were not material.
The Company maintains catastrophe excess of loss reinsurance coverage. For 2012, the Companys catastrophe excess of loss coverage consisted of one contract in addition to the Florida Hurricane Catastrophe Fund (FHCF). The catastrophe excess of loss contract provided 95% coverage for catastrophe losses above a retention of $25.0 million per occurrence up to $175.0 million per occurrence. This contract consisted of three layers, each of which provided for one mandatory reinstatement. The layers were $25.0 million excess of $25.0 million, $40.0 million excess of $50.0 million and $85.0 million excess of $90.0 million. In addition, the Companys predominant insurance subsidiary for property and casualty business written in Florida reinsured 90% of hurricane losses in that state above an estimated retention of $5.7 million up to $20.4 million, based on the FHCFs financial resources. The FHCF contract is a one-year contract, effective June 1, 2012.
For 2013, the Companys catastrophe excess of loss coverage consists of one contract in addition to the FHCF, and the contract has the same provisions as described in the previous paragraph for 2012. The FHCF limits described in the previous paragraph continue up to June 1, 2013, at which time a new annual contract may begin.
The Company has not joined the California Earthquake Authority (CEA). The Companys exposure to losses from earthquakes is managed through its underwriting standards, its earthquake policy coverage limits and deductible levels, and the geographic distribution of its business, as well as its reinsurance program. After reviewing the exposure to earthquake losses from the Companys own policies and from what it would be with participation in the CEA, including estimated start-up and ongoing costs related to CEA participation, management believes it is in the Companys best economic interest to offer earthquake coverage directly to its homeowners policyholders.
For liability coverages, in 2012 the Company reinsured each loss above a retention of $750,000 up to $2.5 million per occurrence and $20.0 million in a clash event. (A clash cover is a reinsurance casualty excess contract requiring two or more casualty coverages or policies issued by the Company to be involved in the same loss occurrence for coverage to apply.) For property coverages, in 2012 the Company reinsured each loss above a retention of $750,000 up to $2.5 million on a per risk basis, including catastrophe losses that in the aggregate were less than the retention levels above. Also, the Company could submit to the reinsurers three per risk losses from the same occurrence for a total of $5,250,000 of property recovery in any one event. Effective January 1, 2013, for liability coverages the retention increased to $800,000 with coverage up to $2.5 million on a per occurrence basis and $20.0 million in a clash event. Retention for property coverages also increased to $800,000, with coverage up to $2.5 million on a per risk basis. The Company can submit to the reinsurers three per risk losses from the same occurrence for a total of $5,100,000 of property recovery in any one event.
14
The following table identifies the Companys most significant reinsurers under the catastrophe first event excess of loss reinsurance program, their percentage participation in this program and their ratings by A.M. Best Company (A.M. Best) and Standard & Poors Corporation (S&P or Standard & Poors) as of January 1, 2013. No other single reinsurers percentage participation in 2013 or 2012 exceeds 5%.
Property Catastrophe First Event Excess of Loss
Reinsurance Participants In Excess of 5% in Either 2013 or 2012
A.M. Best | S&P | Participation | ||||||||||||
Rating |
Rating |
Reinsurer |
Parent |
2013 | 2012 | |||||||||
A |
A+ | Lloyds of London Syndicates | 12% | 6% | ||||||||||
A+ |
AA- | Swiss Re Underwriters Agency, Inc | Swiss Re Ltd | 10% | 10% | |||||||||
A |
A | Aspen Bermuda Limited | Aspen Insurance Holdings Limited | 7% | 7% | |||||||||
A |
A | Validus Reinsurance, Ltd. | Validus Holdings, Ltd. | 6% | 1% | |||||||||
A |
A+ | Transatlantic Reinsurance Company | Alleghany Corporation | 6% | 6% | |||||||||
A+ |
A+ | Everest Reinsurance Company | Everest Re Group, Ltd. | 4% | 6% | |||||||||
A++ |
AA- | Tokio Millennium Re, Ltd. | Tokio Marine Holdings, Inc. | 4% | 8% | |||||||||
A- |
NR |
Flagstone Reassurance Suisse SA, Bermuda Branch |
Validus Holdings, Ltd. | 0% | 16% |
NR | Not rated. |
For 2012, property catastrophe reinsurers representing 100% of the Companys total reinsured catastrophe coverage were rated A- (Excellent) or above by A.M. Best. For 2013, property catastrophe reinsurers representing 96% of the Companys total reinsured catastrophe coverage were rated A- (Excellent) or above by A.M. Best with the remaining 4% of coverage provided by a reinsurer rated AA- by S&P but not formally followed by A.M. Best.
Educators in the Companys target market continue to benefit from the provisions of Section 403(b) of the Internal Revenue Code (the Code) which began in 1961. This section of the Code allows public school employees and employees of other tax-exempt organizations, such as not-for-profit private schools, to reduce their pretax income by making periodic contributions to a qualified retirement plan. (Also see Regulation -- Regulation at Federal Level.) The Company entered the educators retirement annuity market in 1961 and is one of the largest participants in the K-12 portion of the 403(b) tax-qualified annuity market, measured by 403(b) net written premium on a statutory accounting basis. The Company has 403(b) payroll reduction capabilities utilized by approximately one-third of the 13,600 public school districts in the U.S. Approximately 52% of the Companys new annuity contract deposits in 2012 were for 403(b) tax-qualified annuities; approximately 67% of accumulated annuity value on deposit is 403(b) tax-qualified. In 2012, annuities represented 39% of the Companys consolidated insurance premiums written and contract deposits.
The Company markets both fixed and variable annuity contracts, primarily on a tax-qualified basis. Fixed only annuities provide a guarantee of principal and a guaranteed minimum rate of return. These contracts are backed by the Companys general account investments. The Company bears the investment risk associated with the investments and may change the declared interest rate on these contracts subject to contract guarantees.
15
Variable annuities combine a fixed account option with equity- and bond-linked sub-account options. In general, the contractholders bear the investment risk related to the variable annuity sub-accounts and may change their allocation between the guaranteed interest rate fixed account and the wide range of variable investment options at any time. By utilizing tools that provide assistance in determining needs and making asset allocation decisions, contractholders are able to choose the investment mix that matches their personal risk tolerance and retirement goals. The Companys sub-account options also include both lifecycle funds and asset allocation funds. These all-purpose funds have assets allocated among multiple investment classes within each fund based on a specific targeted retirement date or risk tolerance.
Variable annuity contracts with a guaranteed minimum death benefit (GMDB) provide an additional benefit if the contractholder dies and the contract value is less than a contractually defined amount. The Company has a relatively low exposure to GMDB risk because approximately 31% of contract values have no guarantee; approximately 63% have only a return of premium guarantee; and only approximately 6% have a guarantee of premium roll-up at an annual rate of 3% or 5%.
As of December 31, 2012, the Companys 66 variable sub-account options included funds managed by some of the best-known names in the mutual fund industry, such as Wilshire, Fidelity, JPMorgan, T. Rowe Price, Neuberger Berman, AllianceBernstein, Rainier, Davis, BlackRock, Goldman Sachs, Dreyfus, Franklin Templeton, Ariel, Wells Fargo, Royce, Lord Abbett, Putnam, Delaware, Calvert, Ibbotson, Lazard and American Century, offering the Companys customers multiple investment options to address their personal investment objectives and risk tolerance. These funds have been selected with the help of Wilshire Associates, the Companys funds advisor, which provides oversight and input to fund manager additions and replacements. Total accumulated fixed and variable annuity cash value on deposit at December 31, 2012 was $4.8 billion.
Among the Companys annuity products, the Goal Planning Annuity offers educators a variable annuity with the Companys wide array of sub-account investment choices. It includes an optional first year premium bonus and two optional riders that enhance the death benefit feature of the product. Another product, Expanding Horizon, is a fixed interest rate annuity contract for investors who do not want investment risk exposure. This product offers educators a competitive rate of interest on their retirement dollars and a choice of bonuses to optimize their benefits at retirement.
In addition to individual annuities, beginning in 2008, the Company offers group variable and fixed annuity products that allow flexibility in customizing 403(b) annuity programs to meet the needs of school districts.
To assist agents in delivering the Horace Mann Value Proposition, the Company has entered into third-party vendor agreements with American Funds Distributors, Inc. and Fidelity Distributors Corporation to market their retail mutual funds. In addition to retail mutual funds accounts, the Companys agents can offer a 529 college savings program and Coverdell Education Savings Accounts utilizing these funds. The Company also markets 403(b)(7) tax-deferred mutual fund investment programs and fixed indexed annuities through additional third-party vendor agreements. Third-party vendors underwrite these accounts or contracts and the Company receives commissions on the sales of these products.
16
Selected Historical Financial Information For Annuity Segment
The following table sets forth certain information with respect to the Companys annuity products for the periods indicated.
Annuity Segment
Selected Historical Financial Information
(Dollars in millions, unless otherwise indicated)
Year Ended December 31, |
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2012 |
2011 |
2010 |
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As Adjusted | As Adjusted | ||||||||||||||
Financial Data: |
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Contract deposits: |
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Variable |
$ | 113.2 | $ | 109.0 | $ | 110.2 | |||||||||
Fixed |
304.4 | 324.9 | 285.3 | ||||||||||||
Total |
417.6 | 433.9 | 395.5 | ||||||||||||
Contract charges earned |
21.8 | 18.9 | 17.4 | ||||||||||||
Net investment income |
200.8 | 182.8 | 167.9 | ||||||||||||
Net interest margin (without realized investment gains and losses) |
79.4 | 69.2 | 61.6 | ||||||||||||
Income before income taxes |
59.6 | 44.4 | 43.3 | ||||||||||||
Net income |
40.5 | 30.9 | 30.8 | ||||||||||||
Operating Statistics: |
|||||||||||||||
Fixed: |
|||||||||||||||
Accumulated value |
$ | 3,364.2 | $ | 3,061.7 | $ | 2,746.9 | |||||||||
Accumulated value persistency |
95.4 | % | 94.9 | % | 94.4 | % | |||||||||
Variable: |
|||||||||||||||
Accumulated value |
$ | 1,398.3 | $ | 1,273.8 | $ | 1,375.7 | |||||||||
Accumulated value persistency |
94.3 | % | 93.5 | % | 92.6 | % | |||||||||
Number of contracts in force |
188,918 | 184,473 | 180,781 | ||||||||||||
Average accumulated cash value (in dollars) |
$ | 25,210 | $ | 23,502 | $ | 22,804 | |||||||||
Average annual deposit by contractholders (in dollars) |
$ | 2,331 | $ | 2,313 | $ | 2,319 | |||||||||
Annuity contracts terminated due to surrender, death, maturity or other: |
|||||||||||||||
Number of contracts |
7,227 | 7,419 | 8,023 | ||||||||||||
Amount |
$ | 254.8 | $ | 263.9 | $ | 274.0 | |||||||||
Fixed accumulated cash value grouped by applicable surrender charge: |
|||||||||||||||
0% |
$ | 1,437.7 | $ | 1,229.6 | $ | 1,005.7 | |||||||||
Greater than 0% but less than 5% |
220.1 | 231.6 | 238.0 | ||||||||||||
5% and greater but less than 10% |
1,541.4 | 1,458.8 | 1,361.1 | ||||||||||||
10% and greater |
46.7 | 25.1 | 28.8 | ||||||||||||
Supplementary contracts with life contingencies not subject to discretionary withdrawal |
118.3 | 116.6 | 113.3 | ||||||||||||
|
|
|
|
|
|
||||||||||
Total |
$ | 3,364.2 | $ | 3,061.7 | $ | 2,746.9 | |||||||||
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|
|
|
17
The Company entered the individual life insurance business in 1949. The Company offers traditional term and whole life insurance products and, from time to time, revises products and product features or develops new products. For instance, Life by Design is a portfolio of Horace Mann manufactured and branded life insurance products which specifically addresses the financial planning needs of educators. The Life by Design portfolio, introduced in 2006, features individual and joint whole life, and individual and joint term products, including 10-, 20- and 30-year level term policies. The Life by Design policies have premiums that are guaranteed for the duration of the contract and offer lower minimum face amounts. In 2009, the Company introduced a new discount for educator customers to improve the competitiveness of its life product portfolio. During 2010, the Company added a combination product called Life Select that mixes a base of either traditional whole life, 20-pay life or life paid-up at age 65 with a variety of term riders to allow for more flexibility in tailoring the coverage to the customers varying life insurance needs. New products and features introduced in 2011 were single premium whole life and term to age 65 products as well as a preferred plus underwriting category and a $500 thousand rate band enhancement for term products. And, in February 2013, the Company introduced Cash Value Term a term policy that builds cash value while providing the income protection of traditional level term life insurance. Along with expanded product offerings, new marketing support tools also have been introduced to aid the agency force. After December 31, 2006, the Company no longer issues new policies for its Experience Life product, a flexible, adjustable-premium life insurance contract that includes availability of an interest-bearing account.
The Companys traditional term, whole life and group life business in force consists of approximately 141,000 policies, representing approximately $10.7 billion of life insurance in force, with annual insurance premiums and contract deposits of approximately $49.0 million as of December 31, 2012. In addition, the Company also had in force approximately 61,000 Experience Life policies, representing approximately $3.9 billion of life insurance in force, with annual insurance premiums and contract deposits of approximately $48.6 million.
In 2012, the life segment represented 9% of the Companys consolidated insurance premiums written and contract deposits, including less than 1 percentage point attributable to the Companys group life and group disability income business.
During 2012, the average face amount of ordinary life insurance policies issued by the Company was $175,300 and the average face amount of all ordinary life insurance policies in force at December 31, 2012 was $85,070.
The maximum individual life insurance risk retained by the Company is $200,000 on any individual life, while either $100,000 or $125,000 is retained on each group life policy depending on the type of coverage. The excess of the amounts retained are reinsured with life reinsurers that are rated A- (Excellent) or above by A.M. Best. The Company also maintains a life catastrophe reinsurance program. In 2012, the Company reinsured 100% of the catastrophe risk in excess of $1 million up to $25 million per occurrence, with one reinstatement. For 2013, the Company reinsures 100% of the catastrophe risk in excess of $1 million up to $35 million per occurrence, with one reinstatement. The Companys life catastrophe risk reinsurance program covers acts of terrorism and includes nuclear, biological and chemical explosions but excludes other acts of war.
18
The Company has programs to offer variable universal life, fixed indexed universal life and fixed interest rate universal life insurance with two third-party vendors underwriting such insurance. Under these programs, the third-party vendors underwrite and bear the risk of these insurance policies and the Company receives a commission on the sale of that business.
Selected Historical Financial Information For Life Segment
The following table sets forth certain information with respect to the Companys life insurance products for the periods indicated.
Life Segment
Selected Historical Financial Information
(Dollars in millions, unless otherwise indicated)
Year Ended December 31, | |||||||||||||||
2012 |
2011 |
2010 |
|||||||||||||
As Adjusted | As Adjusted | ||||||||||||||
Financial Data: |
|||||||||||||||
Insurance premiums and contract deposits |
$ | 99.3 | $ | 98.6 | $ | 99.4 | |||||||||
Insurance premiums and contract charges earned |
102.4 | 100.7 | 99.5 | ||||||||||||
Net investment income |
69.4 | 69.6 | 68.7 | ||||||||||||
Income before income taxes |
34.2 | 30.8 | 31.3 | ||||||||||||
Net income |
21.9 | 19.4 | 20.2 | ||||||||||||
Operating Statistics: |
|||||||||||||||
Life insurance in force: |
|||||||||||||||
Ordinary life |
$ | 13,661 | $ | 13,136 | $ | 12,844 | |||||||||
Group life |
971 | 1,025 | 1,096 | ||||||||||||
|
|
|
|
|
|
||||||||||
Total |
$ | 14,632 | $ | 14,161 | $ | 13,940 | |||||||||
|
|
|
|
|
|
||||||||||
Number of policies in force: |
|||||||||||||||
Ordinary life |
160,585 | 161,520 | 163,505 | ||||||||||||
Group life |
40,976 | 42,685 | 44,450 | ||||||||||||
|
|
|
|
|
|
||||||||||
Total |
201,561 | 204,205 | 207,955 | ||||||||||||
|
|
|
|
|
|
||||||||||
Average face amount in force (in dollars): |
|||||||||||||||
Ordinary life |
$ | 85,070 | $ | 81,300 | $ | 78,600 | |||||||||
Group life |
23,697 | 24,000 | 24,700 | ||||||||||||
Total |
72,593 | 69,300 | 67,000 | ||||||||||||
Lapse ratio (ordinary life insurance in force) |
4.2 | % | 4.7 | % | 4.8 | % | |||||||||
Ordinary life insurance terminated due to death, surrender, lapse or other: |
|||||||||||||||
Face amount of insurance surrendered or lapsed |
$ | 540.4 | $ | 582.7 | $ | 593.6 | |||||||||
Number of policies |
4,441 | 4,726 | 4,994 | ||||||||||||
Amount of death claims opened |
$ | 42.9 | $ | 45.8 | $ | 43.6 | |||||||||
Number of death claims opened |
1,695 | 1,448 | 1,405 |
The Company operates in a highly competitive environment. The insurance industry consists of a large number of insurance companies, some of which have substantially greater financial resources, widespread advertising campaigns, more diversified product lines, greater economies of scale and/or lower-cost marketing approaches compared to the Company. In the Companys target market, management believes that the principal competitive factors in the sale of property and casualty insurance products are price, overall service, name recognition and worksite sales and service. Management believes that the principal competitive factors in the sale of annuity products and life insurance are worksite sales and service, product features, perceived stability of the insurer, price, overall service and name recognition.
19
The Company competes in its target market with a number of national providers of personal automobile, homeowners and life insurance such as State Farm, Allstate, Farmers, Liberty Mutual and Nationwide as well as several regional companies. The Company also competes for automobile business with other companies such as GEICO, Progressive and USAA, many of which feature direct marketing distribution.
Among the major national providers of annuities to educators, the Companys competitors for annuity business include The Variable Annuity Life Insurance Company (VALIC), a subsidiary of American International Group (AIG); AXA; ING U.S. Financial Services; Life Insurance Company of the Southwest, a subsidiary of National Life Insurance Company; MetLife; Security Benefit and Teachers Insurance and Annuity Association College Retirement Equities Fund (TIAA-CREF). Select mutual fund families and financial planners also compete in this marketplace.
The market for tax-deferred annuity products in the Companys target market has been impacted by the revised Internal Revenue Service (IRS) Section 403(b) regulations, which made the 403(b) market more comparable to the 401(k) market than it was in the past. While this change has and may continue to reduce the number of competitors in this market, it has made the 403(b) market more attractive to some of the larger companies experienced in 401(k) plans, including both insurance and mutual fund companies, that had not previously been active competitors in this business.
The Companys investments are selected to balance the objectives of protecting principal, minimizing exposure to interest rate risk and providing a high current yield. These objectives are implemented through a portfolio that emphasizes investment grade, publicly traded fixed income securities, which are selected to match the anticipated duration of the Companys liabilities. When impairment of the value of an investment is considered other than temporary, the decrease in value is recorded and a new cost basis is established. At December 31, 2012, fixed income securities represented 94.7% of the Companys total investment portfolio, at fair value. Of the fixed income investment portfolio, 94.8% was investment grade and 95.6% was publicly traded. At December 31, 2012, the average quality and average option-adjusted duration of the total fixed income portfolio were A and 6.3 years, respectively. At December 31, 2012, investments in non-investment grade fixed income securities represented 4.8% of the total investment portfolio, at fair value. There are no significant investments in mortgage whole loans, real estate, non-U.S. dollar-denominated foreign securities, or common stocks. As of December 31, 2012, the Companys securities lending program was suspended and no securities were on loan.
The Company has separate investment strategies and guidelines for its property and casualty, annuity and life assets, which recognize different characteristics of the associated insurance liabilities, as well as different tax and regulatory environments. The Company manages interest rate exposure for its portfolios through asset/liability management techniques which attempt to coordinate the duration of the assets with the duration of the insurance policy liabilities. Duration of assets and liabilities will generally differ only because of opportunities to significantly increase yields or because policy values are not interest-sensitive, as is the case in the property and casualty segment.
20
The investments of each insurance subsidiary must comply with the insurance laws of such insurance subsidiarys domiciliary state. These laws prescribe the type and amount of investments that may be purchased and held by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, mortgage-backed bonds, other asset-backed bonds, preferred stocks, common stocks, real estate mortgages, real estate, and alternative investments.
The following table sets forth the carrying values and amortized cost of the Companys investment portfolio as of December 31, 2012:
Investment Portfolio
(Dollars in millions)
Percentage
of Total Carrying Value |
||||||||||||||||||||||||||
Carrying Value | ||||||||||||||||||||||||||
Total |
Annuity
and Life |
Property and
Casualty |
Amortized
Cost or Cost |
|||||||||||||||||||||||
Publicly Traded Fixed Maturity Securities,
|
||||||||||||||||||||||||||
U.S. government and agency obligations, all investment grade (1): |
||||||||||||||||||||||||||
Mortgage-backed securities |
9.9 | % | $ | 619.6 | $ | 594.5 | $ | 25.1 | $ | 547.0 | ||||||||||||||||
Other, including U.S. Treasury securities |
6.5 | 409.4 | 396.9 | 12.5 | 371.7 | |||||||||||||||||||||
Investment grade corporate and public utility bonds |
33.2 | 2,090.2 | 1,967.5 | 122.7 | 1,814.3 | |||||||||||||||||||||
Non-investment grade corporate and public utility bonds (2) |
3.9 | 246.3 | 182.6 | 63.7 | 233.3 | |||||||||||||||||||||
Investment grade municipal bonds |
24.6 | 1,550.0 | 960.6 | 589.4 | 1,366.5 | |||||||||||||||||||||
Non-investment grade municipal bonds (2) |
0.3 | 20.8 | 10.2 | 10.6 | 20.9 | |||||||||||||||||||||
Investment grade other mortgage-backed securities (3) |
10.6 | 663.1 | 657.5 | 5.6 | 627.2 | |||||||||||||||||||||
Non-investment grade other mortgage-backed securities (2)(3) |
0.5 | 33.7 | 33.5 | 0.2 | 30.8 | |||||||||||||||||||||
Foreign government bonds, all investment grade |
0.9 | 57.9 | 55.4 | 2.5 | 48.5 | |||||||||||||||||||||
Redeemable preferred stock, all investment grade |
0.2 | 11.2 | 11.2 | - | 8.8 | |||||||||||||||||||||
Equity securities: |
||||||||||||||||||||||||||
Investment grade non-redeemable preferred stocks |
0.2 | 11.3 | 6.5 | 4.8 | 11.1 | |||||||||||||||||||||
Non-investment grade non-redeemable preferred stocks (2) |
- | 1.5 | - | 1.5 | 1.5 | |||||||||||||||||||||
Common stocks |
0.7 | 40.7 | - | 40.7 | 39.8 | |||||||||||||||||||||
Short-term investments (4) |
1.4 | 87.6 | 49.3 | 38.3 | 87.6 | |||||||||||||||||||||
|
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|
|
|
|
|
|
|
|
|||||||||||||||||
Total publicly traded securities |
92.9 | 5,843.3 | 4,925.7 | 917.6 | 5,209.0 | |||||||||||||||||||||
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|
|
|
|
|
|
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Other Invested Assets: |
||||||||||||||||||||||||||
Investment grade private placements |
4.0 | 252.6 | 252.6 | - | 235.2 | |||||||||||||||||||||
Non-investment grade private placements (2) |
0.1 | 7.4 | 7.4 | - | 7.2 | |||||||||||||||||||||
Mortgage loans (5) |
- | 0.1 | 0.1 | - | 0.1 | |||||||||||||||||||||
Policy loans |
2.1 | 134.9 | 134.9 | - | 134.9 | |||||||||||||||||||||
Other |
0.9 | 53.8 | 53.8 | - | 53.8 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
Total other invested assets |
7.1 | 448.8 | 448.8 | - | 431.2 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
Total investments (6) |
100.0 | % | $ | 6,292.1 | $ | 5,374.5 | $ | 917.6 | $ | 5,640.2 | ||||||||||||||||
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|
(1) |
Includes $188.0 million fair value of investments guaranteed by the full faith and credit of the U.S. government and $841.0 million fair value of federally sponsored agency securities which are not backed by the full faith and credit of the U.S. government. |
(2) |
A non-investment grade rating is assigned to a security when it is acquired or when it is downgraded from investment grade, primarily on the basis of the Standard & Poors Corporation (Standard & Poors or S&P) rating for such security, or if there is no S&P rating, the Moodys Investors Service, Inc. (Moodys) rating for such security, or if there is no S&P or Moodys rating, the National Association of Insurance Commissioners (the NAIC) rating for such security. The rating agencies monitor securities, and their issuers, regularly and make changes to the ratings as necessary. The Company incorporates rating changes on a monthly basis. |
(3) |
Includes commercial mortgage-backed securities, asset-backed securities, other mortgage-backed securities and collateralized debt obligations. See also Managements Discussion and Analysis of Financial Condition and Results of Operations -- Results of Operations for the Three Years Ended December 31, 2012 -- Net Realized Investment Gains and Losses listed on page F-1 of this report. |
(Continued on next page)
21
Investment Portfolio (Continued)
(4) |
Short-term investments mature within one year of being acquired and are carried at cost, which approximates fair value. Short-term investments represent $87.6 million in money market funds rated AAA. As of December 31, 2012, the Companys securities lending program was suspended and there was no securities lending collateral included in short-term investments. |
(5) |
Mortgage loans are carried at amortized cost or unpaid principal balance. |
(6) |
Approximately 9% of the Companys investment portfolio, having a carrying value of $550.7 million as of December 31, 2012, consisted of securities with some form of credit support, such as insurance. Of the securities with credit support as of December 31, 2012, municipal bonds represented $410.5 million carrying value. |
Fixed Maturity Securities and Equity Securities
At December 31, 2012, approximately 25% of the Companys fixed maturity securities portfolio was expected to mature within the next 5 years. Mortgage-backed securities, including mortgage-backed securities of U.S. governmental agencies, represented approximately 21% of the total investment portfolio at December 31, 2012. These securities typically have average lives shorter than their stated maturities due to unscheduled prepayments on the underlying mortgages. Mortgages are prepaid for a variety of reasons, including sales of existing homes, interest rate changes over time that encourage homeowners to refinance their mortgages and defaults by homeowners on mortgages that are then paid by guarantors.
For financial reporting purposes, the Company has classified the entire fixed maturity portfolio as available for sale. Fixed maturities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value. The net adjustment for unrealized gains and losses on securities available for sale is recorded as a separate component of accumulated other comprehensive income within shareholders equity, net of applicable deferred tax asset or liability and the related impact on deferred policy acquisition costs associated with interest-sensitive life and annuity contracts. Fixed maturities held for indefinite periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates, resultant prepayment risk and other related factors, other than securities that are in an unrealized loss position for which management has the stated intent to hold until recovery.
As a holding company, HMEC conducts its principal operations through its subsidiaries. Payment by HMEC of principal and interest with respect to HMECs indebtedness, and payment by HMEC of dividends to its shareholders, are dependent upon the ability of its insurance subsidiaries to pay cash dividends or make other cash payments to HMEC, including tax payments pursuant to tax sharing agreements. Restrictions on the subsidiaries ability to pay dividends or to make other cash payments to HMEC may materially affect HMECs ability to pay principal and interest on its indebtedness and dividends on its common stock. If necessary, HMEC also has other potential sources of liquidity that could provide for additional funding to meet corporate obligations or pay shareholder dividends, which include a revolving line of credit, as well as issuances of various securities. Additional information is contained in Notes to Consolidated Financial Statements -- Note 8 -- Statutory Information and Restrictions listed on page F-1 of this report.
22
The ability of the insurance subsidiaries to pay cash dividends to HMEC is subject to state insurance department regulations which generally permit dividends to be paid for any 12 month period in amounts equal to the greater of (i) net income for the preceding calendar year or (ii) 10% of surplus, determined in conformity with statutory accounting principles, as of the preceding December 31st. Any dividend in excess of these levels requires the prior approval of the Director or Commissioner of the state insurance department of the state in which the dividend paying insurance subsidiary is domiciled. The aggregate amount of dividends that may be paid in 2013 from all of HMECs insurance subsidiaries without prior regulatory approval is approximately $84 million.
Notwithstanding the foregoing, if insurance regulators otherwise determine that payment of a dividend or any other payment to an affiliate would be detrimental to an insurance subsidiarys policyholders or creditors, because of the financial condition of the insurance subsidiary or otherwise, the regulators may block dividends or other payments to affiliates that would otherwise be permitted without prior approval.
General Regulation at State Level
As an insurance holding company, HMEC is subject to extensive regulation by the states in which its insurance subsidiaries are domiciled or transact business. Some regulations, such as those addressing unclaimed property, generally apply to all corporations. In addition, the laws of the various states establish regulatory agencies with broad administrative powers to grant and revoke licenses to transact business, regulate trade practices, license agents, require statutory financial statements, and prescribe the type and amount of investments permitted.
The NAIC has adopted risk-based capital guidelines to evaluate the adequacy of statutory capital and surplus in relation to an insurance companys risks. At December 31, 2012 and 2011, statutory capital and surplus of each of the Companys insurance subsidiaries was above required levels.
Assessments Against Insurers
Under insurance insolvency or guaranty laws in most states in which the Company operates, insurers doing business therein can be assessed for policyholder losses related to insolvencies of other insurance companies. The amount and timing of any future assessments on the Company under these laws cannot be reasonably estimated and are beyond the control of the Company. Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurers financial strength, and many assessments paid by the Company pursuant to these laws may be used as credits for a portion of the Companys premium taxes in certain states. For the three years ended December 31, 2012, the Companys assessments, net of the related premium tax credits, were not significant.
Insurers also may be assessed by entities, such as the Citizens Property Insurance Corporation of Florida (Florida Citizens) and the Louisiana Citizens Property Insurance Corporation (Louisiana Citizens), as a result of significant hurricane events with insurers often permitted to, in turn, assess their policyholders in the respective states to recoup the amounts remitted to such entities.
23
Mandatory Insurance Facilities
The Company is required to participate in various mandatory insurance facilities in proportion to the amount of the Companys direct writings in the applicable state.
In 2012, 2011 and 2010, the Company reflected pretax net gains (losses) from participation in such mandatory pools and underwriting associations which were not material.
Regulation at Federal Level
Although the federal government generally does not directly regulate the insurance industry, federal initiatives often impact the insurance business. Current and proposed federal measures which may significantly affect insurance and annuity business include employee benefits regulation, controls on the costs of medical care, medical entitlement programs such as Medicare, structure of retirement plans and accounts, changes to the insurance industry anti-trust exemption, and minimum solvency requirements. Other federal regulation such as the Patient Protection and Affordable Care Act, Fair Credit Reporting Act, Gramm-Leach-Bliley Act and USA PATRIOT Act, including its anti-money laundering regulations, also impact the Companys business.
The variable annuities underwritten by HMLIC are regulated by the SEC. Horace Mann Investors, Inc., the broker-dealer subsidiary of HMEC, also is regulated by the SEC, FINRA, the Municipal Securities Rule-making Board (MSRB) and various state securities regulators.
Federal income taxation of the build-up of cash value within a life insurance policy or an annuity contract could have a materially adverse impact on the Companys ability to market and sell such products. Various legislation to this effect has been proposed in the past, but has not been enacted. Although no such legislative proposals are known to exist at this time, such proposals may be made again in the future. Changes in other federal and state laws and regulations could also affect the relative tax and other advantages of the Companys annuity and life products to customers.
Financial Regulation Legislation
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by President Obama. The law created a new Federal Insurance Office (FIO) within the U.S. Department of the Treasury. The FIO is charged with monitoring and providing specific reports on various aspects of the insurance industry, but it does not have general supervisory or regulatory authority over the business of insurance. The current law creates new opportunities for federal monitoring and limited intervention in the regulation of the insurance industry, and the FIOs reports and recommendations may create new pressures for broader federal regulatory authority over the insurance industry longer term. Management will closely monitor future developments for impact on the Company, insurers of similar size and the insurance industry as a whole.
At December 31, 2012, the Company had approximately 1,350 non-agent employees and 136 full-time employee agents. (This does not include 572 Exclusive Agent independent contractors that were part of the Companys total dedicated agency force at December 31, 2012.) The Company has no collective bargaining agreement with any employees.
24
The following are certain risk factors that could affect the Companys business, financial results and results of operations. In addition, refer to the risk factors disclosed in Managements Discussion and Analysis of Financial Condition and Results of Operations -- Forward-looking Information, listed on page F-1 of this report for certain important factors that may cause our financial condition and results of operations to differ materially from current expectations. The risks that the Company has highlighted in these two sections of this report are not the only ones that the Company faces. In this discussion, the Company is also referred to as our, we and us.
The Companys business involves various risks and uncertainties which are based on the lines of business the Company writes as well as more global risks associated with the general business and insurance industry environments.
Volatile financial markets and adverse economic environments can impact financial market risk as well as our financial condition and results of operations.
Financial markets in the U.S. and elsewhere can experience extreme volatility and disruption for uncertain periods of time. In 2008 and 2009 volatility occurred largely due to the stresses affecting the global banking system, which accelerated significantly in the second half of 2008. In those years, these circumstances exerted significant downward pressure on prices of equity securities and many other investment asset classes and resulted in substantially increased market volatility, severely constrained credit and capital markets, particularly for financial institutions, and an overall loss of investor confidence. The slow recovery from the resulting severe economic downturn has resulted in many states and local governments operating under deficits or projected deficits which could have an impact on both the Companys niche market and its investment portfolio. Like other financial institutions which face significant financial market risk in their operations, the Company was adversely affected by these conditions and could be adversely impacted by similar circumstances in the future. The Companys ability to access the capital markets to refinance outstanding indebtedness or raise capital could be impaired during significant financial market disruptions.
In addition to the effects of financial markets volatility, a prolonged economic recession may have other adverse impacts on our financial condition and results of operations.
25
If our investment strategy is not successful, we could suffer unexpected losses.
The success of our investment strategy is crucial to the success of our business. Specifically, our fixed income portfolio is subject to a number of risks including:
|
interest rate risk , which is the risk that interest rates will decline and funds reinvested will earn less than expected; |
|
market value risk , which is the risk that our invested assets will decrease in value due to a change in the yields realized on our assets and prevailing market yields for similar assets, an unfavorable change in the liquidity of the investment or an unfavorable change in the financial prospects or a downgrade in the credit rating of the issuer of the investment; |
|
credit risk , which is the risk that the value of certain investments becomes impaired due to deterioration in financial condition of one or more issuers of those instruments or the deterioration in performance or credit quality of the underlying collateral of certain structured securities and, ultimately, the risk of permanent loss in the event of default by an issuer or underlying credit; |
|
market fundamentals risk , which is the risk that there are changes in the market that can have an unfavorable impact on securities valuation such as availability of credit in the capital markets, re-pricing of credit risk, reduced market liquidity due to broker-dealers unwillingness to hold inventory, and increased market volatility; |
|
concentration risk , which is the risk that the portfolio may be too heavily concentrated in the securities of one or more issuers, sectors or industries, which could result in a significant decrease in the value of the portfolio in the event of deterioration in the financial condition of those issuers or the market value of their securities; |
|
liquidity risk , which is the risk that liabilities are surrendered or mature sooner than anticipated requiring us to sell assets at an undesirable time to provide for policyholder surrenders, withdrawals or claims; and |
|
regulatory risk , which is the risk that regulatory bodies or governments, in the U.S. or in other countries, may make substantial investments or take significant ownership positions in, or ultimately nationalize, financial institutions or other issuers of securities held in the Companys investment portfolio, which could adversely impact the seniority or contractual terms of the securities. Regulatory risk could also come from changes in tax laws or bankruptcy laws that would adversely impact the valuation of certain invested assets. |
In addition to significant steps taken to attempt to mitigate these risks through our investment guidelines, policies and procedures, we also attempt to mitigate these risks through product pricing, product features and the establishment of policy reserves, but we cannot provide assurance that assets will be properly matched to meet anticipated liabilities or that our investments will provide sufficient returns to enable us to satisfy our guaranteed fixed benefit obligations.
Although historically the Company has not been a party to these transactions, from time to time we could also enter into foreign currency, interest rate, credit derivative and other hedging transactions in an effort to manage risks. We cannot provide assurance that we will successfully structure those derivatives and hedges so as to effectively manage these risks. If our calculations are incorrect, or if we do not properly structure our derivatives or hedges, we may have unexpected losses and our assets may not be adequate to meet our needed reserves, which could adversely affect our financial condition and results of operations.
26
Although the Companys defined benefit pension plan was frozen in 2002, declining financial markets could also cause, and in the past have caused, the value of the investments in this pension plan to decrease, resulting in additional pension expense, a reduction in other comprehensive income and an increase in required contributions to the defined benefit pension plan.
The determination of the fair value of our fixed income and equity securities could include methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to investment valuations that may materially impact our financial condition and results of operations.
The determination of fair values is made at a specific point in time, based on available market information and judgments about financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counterparty. The use of different methodologies and assumptions may have a material effect on the estimated fair value amounts. During periods of market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the financial environment. In such cases, fair value determination may require more subjectivity and management judgment and those fair values may differ materially from the value at which the investments ultimately could be sold. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of securities and the period-to-period changes in value could vary significantly. The difference between amortized cost or cost and fair value, net of applicable deferred income tax asset or liability and the related impact on deferred policy acquisition costs associated with investment (annuity) and interest-sensitive life contracts, is reflected as a component of accumulated other comprehensive income within shareholders equity. Decreases in the fair value of our investments could have a material adverse effect on our financial condition and results of operations.
A sustained period of low interest rates or interest rate fluctuations could negatively affect the income we derive from the difference between the interest rates we earn on our investments and the interest we pay under our fixed annuity and interest-sensitive life contracts.
Significant changes in interest rates expose us to the risk of not earning income or experiencing losses based on the differences between the interest rates earned on our investments and the credited interest rates paid on our outstanding fixed annuity and interest-sensitive life contracts. Significant changes in interest rates may affect:
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the ability to maintain appropriate interest rate spreads over the fixed rates guaranteed in our annuity and life products; |
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the book yield of our investment portfolio; and |
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the unrealized gains and losses in our investment portfolio and the related after-tax effect on our shareholders equity and total capital. |
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Both rising and declining interest rates can negatively affect the income we derive from our annuity and life products interest rate spreads. During periods of falling interest rates or a sustained period of low interest rates, our investment earnings will be lower because new investments in fixed maturity securities likely will bear lower interest rates. We may not be able to fully offset the decline in investment earnings with lower crediting rates on our annuity contracts, particularly in a multi-year period of low interest rates. As of the time of this Annual Report on Form 10-K, new money rates continue to be at historically low levels. If interest rates were to remain low over a sustained period of time, and based on a recent pronouncement by the Federal Reserve Board that rates are likely to remain low as long as the unemployment rate remains above 6.5%, this would put additional pressure on our interest spreads, potentially resulting in an adverse impact on the evaluation of our deferred policy acquisition costs, thereby reducing net income in the affected reporting period.
During periods of rising interest rates, there may be competitive pressure to increase the crediting rates on our annuity contracts. We may not, however, immediately have the ability to acquire investments with interest rates sufficient to offset an increase in crediting rates under our annuity contracts. Although we develop and maintain asset/liability management programs and procedures designed to reduce the volatility of our income when interest rates are rising or falling, changes in interest rates can affect our interest rate spreads.
Changes in interest rates may also affect our business in other ways. For example, a rapidly changing interest rate environment may result in less competitive crediting rates on certain of our fixed-rate products which could make those products less attractive, leading to lower sales and/or increases in the level of life insurance and annuity product surrenders and withdrawals. Interest rate fluctuations may also impact the amortization of deferred policy acquisition costs.
As another example of potential interest rate impacts, our annuity and life operations participate in the cash flow testing procedures imposed by statutory insurance regulations, the purpose of which is to insure that such liabilities are adequate to meet the Companys obligations under a variety of interest rate scenarios. A continuation of the current low interest rate environment over a prolonged period of time could cause the Company to increase statutory reserves as a result of cash flow testing, which would reduce statutory surplus of the life insurance subsidiaries and potentially limit the subsidiaries ability to distribute cash to the holding company or write insurance business (as further described in a subsequent risk factor).
Regulatory initiatives, including the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), could adversely impact liquidity and volatility of financial markets in which we participate.
In response to the credit and financial crisis, U.S. and overseas governmental and regulatory authorities are considering enhanced or new regulatory requirements intended to prevent future crises or stabilize the institutions under their supervision. Such measures are likely to lead to stricter regulation of financial institutions. Potential changes from the Dodd-Frank Act and other U.S. and overseas governmental initiatives could adversely impact liquidity and increase volatility of the financial markets in which we participate and, in turn, negatively affect our financial condition or results of operations.
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Our annuity business may be, and in the past has been, adversely affected by volatile or declining financial market conditions.
Conditions in the U.S. and international financial markets affect the sale and profitability of our annuity products. In general, sales of variable annuities decrease when financial markets are declining or experiencing a higher than normal level of volatility over an extended period of time. Therefore, weak and/or volatile financial market performance may adversely affect sales of our variable annuity products to potential customers, may cause current customers to withdraw or reduce the amounts invested in our variable annuity products and may reduce the market value of existing customers investments in our variable annuity products, in turn reducing the amount of variable annuity fee revenues generated. In addition, some of our variable annuity contracts offer guaranteed minimum death benefit features, which provide for a benefit if the contractholder dies and the contract value is less than a specified amount. A decline in the financial markets could cause the contract value to fall below this specified amount, increasing our exposure to losses from variable annuity products featuring guaranteed minimum death benefits. Declining or volatile financial markets may also impact the amortization of deferred policy acquisition costs.
Losses due to defaults by others could reduce our profitability or negatively affect the value of our investments.
Third parties that owe us money, securities or other assets may not pay or perform their obligations. These parties may include the issuers whose securities we hold, customers, reinsurers, borrowers under mortgage loans, trading counterparties, counterparties under swaps and other derivative contracts, clearing agents, exchanges, clearing houses and other financial intermediaries. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, downturns in the economy or real estate values, operational failure or other reasons.
During or following an economic downturn, our municipal bond portfolio could be subject to a higher risk of default or impairment due to declining municipal tax bases and revenue. States are currently barred from seeking protection in federal bankruptcy court. However, federal legislation could possibly be enacted to allow states to declare bankruptcy in connection with deficit reductions or mounting unfunded pension liabilities, which could adversely impact the value of our investment portfolio.
The default of a major market participant could disrupt the securities markets or clearance and settlement systems in the U.S. or abroad. A failure of a major market participant could cause some clearance and settlement systems to assess members of that system, including our broker-dealer subsidiary, or could lead to a chain of defaults that could adversely affect us. A default of a major market participant could disrupt various markets, which could in turn cause market declines or volatility and negatively impact our financial condition and results of operations.
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Catastrophic events can have a material adverse effect on our financial condition and results of operations.
Underwriting results of property and casualty insurers are subject to weather and other conditions prevailing in an accident year. While one year may be relatively free of major weather or other disasters -- not all of which are designated by the insurance industry as a catastrophe, another year may have numerous such events causing results for such a year to be materially worse than for other years.
Our property and casualty insurance subsidiaries have experienced, and we anticipate that in the future they will continue to experience, catastrophe losses. A catastrophic event or a series of multiple catastrophic events could have a material adverse effect on the financial condition and results of operations of our insurance subsidiaries.
Various events can cause catastrophes, including hurricanes, windstorms, earthquakes, hail, terrorism, explosions, severe winter weather and wildfires. The frequency and severity of these catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposures in the area affected by the event and the severity of the event. Although catastrophes can cause losses in a variety of property and casualty lines, most of the catastrophe-related claims of our insurance subsidiaries are related to homeowners coverages. Our ability to provide accurate estimates of ultimate catastrophe costs is based on several factors, including:
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the proximity of the catastrophe occurrence date to the date of our estimate; |
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potential inflation of property repair costs in the affected area; |
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the occurrence of multiple catastrophes in a geographic area over a relatively short period of time; and |
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the outcome of litigation which may be filed against the Company by policyholders, state attorneys general and other parties relative to loss coverage disputes and loss settlement payments. |
Based on 2012 direct premiums earned, 57% of the total annual premiums for our property and casualty business were for policies issued in the ten largest states in which our insurance subsidiaries write property and casualty coverage. Included in this top ten group are certain states which are considered to be more prone to catastrophe occurrences: California, North Carolina, Texas, Florida, Louisiana, South Carolina and Georgia.
As an ongoing practice, we manage our exposure to catastrophes, as well as our exposure to non-catastrophe weather and other property loss risks. Reductions in property and casualty business written in catastrophe-prone areas may have a negative impact on near-term business growth and results of operations.
In addition to the potential impact on our property and casualty subsidiaries, our life subsidiary could experience claims of a catastrophic magnitude from events such as pandemics; terrorism; nuclear, biological or chemical explosions; or other acts of war.
Our insurance subsidiaries seek to reduce their exposure to catastrophe losses through their underwriting strategies and the purchase of catastrophe reinsurance. Nevertheless, reinsurance may prove inadequate under certain circumstances.
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Uncollectible reinsurance, as well as reinsurance availability and pricing, can have a material adverse effect upon our business volume and profitability.
Reinsurance is a contract by which one insurer, called a reinsurer, agrees to cover a portion of the losses incurred by a second insurer in the event a claim is made under a policy issued by the second insurer. Our insurance subsidiaries obtain reinsurance to help manage their exposure to property, casualty and life insurance risks. Although a reinsurer is liable to our insurance subsidiaries according to the terms of its reinsurance policy, the insurance subsidiaries remain primarily liable as the direct insurers on all risks reinsured. As a result, reinsurance does not eliminate the obligation of our insurance subsidiaries to pay all claims, and each insurance subsidiary is subject to the risk that one or more of its reinsurers will be unable or unwilling to honor its obligations.
Although we limit participation in our reinsurance programs to reinsurers with high financial strength ratings and also limit the amount of coverage from each reinsurer, our insurance subsidiaries cannot guarantee that their reinsurers will pay in a timely fashion, if at all. Reinsurers may become financially unsound by the time that they are called upon to pay amounts due, which may not occur for many years. In the case of the Florida Hurricane Catastrophe Fund (FHCF), financial deficits and difficulties in accessing the capital markets may require the FHCF to make additional assessments against participating insurers. Additional coverage made available by the FHCF to the insurance industry in future contract periods could increase the likelihood of assessments in periods following significant hurricane losses.
Additionally, the availability and cost of reinsurance are subject to prevailing market conditions beyond our control. For example, significant losses from hurricanes or terrorist attacks or an increase in capital requirements could have a significant adverse impact on the reinsurance market.
If one of our insurance subsidiaries is unable to obtain adequate reinsurance at reasonable rates, that insurance subsidiary would have to increase its risk exposure and/or reduce the level of its underwriting commitments, which could have a material adverse effect upon the business volume and profitability of the subsidiary. Alternately, the insurance subsidiary could elect to pay the higher than reasonable rates for reinsurance coverage, which could have a material adverse effect upon its profitability until policy premium rates could be raised, in some cases subject to approval by state regulators, to incorporate this additional cost.
Our property and casualty loss reserves may not be adequate.
Our property and casualty insurance subsidiaries maintain loss reserves to provide for their estimated ultimate liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred as of the end of each accounting period. If these loss reserves prove inadequate, we will record a loss measured by the amount of the shortfall and, as a result, the financial condition and results of operations of our insurance subsidiaries will be adversely affected, potentially affecting their ability to distribute cash to the holding company.
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Reserves do not represent an exact calculation of liability. Reserves represent estimates, generally involving actuarial projections at a given time, of what our insurance subsidiaries expect the ultimate settlement and adjustment of claims will cost, net of salvage and subrogation. Estimates are based on assessments of known facts and circumstances, assumptions related to the ultimate cost to settle such claims, estimates of future trends in claims severity and frequency, changing judicial theories of liability and other factors. These variables are affected by both internal and external events, including changes in claims handling procedures, economic inflation, unpredictability of court decisions, plaintiffs expanded theories of liability, risks inherent in major litigation and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. Significant reporting lags may exist between the occurrence of an insured event and the time it is actually reported. Our insurance subsidiaries adjust their reserve estimates regularly as experience develops and further claims are reported and settled.
Due to the inherent uncertainty in estimating reserves for losses and loss adjustment expenses, we cannot be certain that the ultimate liability will not exceed amounts reserved, with a resulting adverse effect on our financial condition and results of operations.
Changing climate conditions may adversely affect our financial condition, results of operations or cash flows.
Many scientists indicate that the worlds overall climate is getting warmer. Climate change, to the extent it produces rising temperatures and changes in weather patterns, could impact the frequency and/or severity of weather events and wildfires, the affordability and availability of our catastrophe reinsurance coverage, and our results of operations. If an increase in weather events and/or wildfires were to occur, in addition to the attendant increase in claim costs, which could adversely impact our results of operations and financial condition, concentrations of insurance risk could impact our ability to make homeowners insurance available to our customers. This could adversely impact our volume of business and our results of operations or cash flows.
Deviations from assumptions regarding future market appreciation, interest spreads, business persistency, mortality and morbidity used in calculating life and annuity reserves and deferred policy acquisition expense amounts could have a material adverse impact on our financial condition and results of operations.
The processes of calculating reserve and deferred policy acquisition expense amounts for our life and annuity businesses involve the use of a number of assumptions, including those related to market appreciation (the rate of growth in market value of the underlying variable annuity subaccounts due to price appreciation), interest spreads (the interest rates expected to be received on investments less the rate of interest credited to contractholders), business persistency (how long a contract stays with the company), mortality (the relative incidence of death over a given period of time) and morbidity (the relative incidence of disability resulting from disease or physical impairment). We periodically review the adequacy of these reserves and deferred policy acquisition expenses on an aggregate basis and, if future experience is estimated to differ significantly from previous assumptions, adjustments to reserves and deferred policy acquisition expenses may be required which could have a material adverse effect on our financial condition and results of operations.
32
An impairment of all or part of our goodwill could adversely affect our results of operations.
At December 31, 2012, we had $47.4 million of goodwill recorded on our consolidated balance sheet. Goodwill was recorded when the Company was acquired in 1989 and when Horace Mann Property & Casualty Insurance Company was acquired in 1994, in both instances reflecting the excess of cost over the fair market value of net assets acquired. The December 31, 2012 balance was evaluated for impairment, as described in Notes to Consolidated Financial Statements -- Note 1 -- Summary of Significant Accounting Policies, with no impairment charge resulting from such assessment. The evaluation of goodwill considers a number of factors including the impacts of a volatile financial market on earnings, discount rate assumptions, liquidity and the Companys market capitalization. If an evaluation of the Companys fair value or of the Companys segments fair value indicated that all or a portion of the goodwill balance was impaired, the Company would be required to write off the impaired portion. Such a write-off could have a material adverse effect on our results of operations in the period of the write-off; however, management does not anticipate a material effect on the Companys financial condition.
Any downgrade in or adverse change in outlook for our claims-paying ratings, financial strength ratings or credit ratings could adversely affect our financial condition and results of operations.
Claims-paying ratings and financial strength ratings have become an increasingly important factor in establishing the competitive position of insurance companies. In the evolving 403(b) annuity market, school districts and benefit consultants have been placing increased emphasis on the relative financial strength ratings of competing companies. Each rating agency reviews its ratings periodically and from time to time may modify its rating criteria including, among other factors, its expectations regarding capital adequacy, profitability and revenue growth. A downgrade in the ratings or adverse change in the ratings outlook of any of our insurance subsidiaries by a major rating agency could result in a substantial loss of business for that subsidiary if school districts, policyholders or independent agents move their business to other companies having higher claims-paying ratings and financial strength ratings than we do. This loss of business could have a material adverse effect on the results of operations and financial condition of that subsidiary.
A downgrade in our holding company debt rating also could adversely impact our cost and flexibility of borrowing which could have an adverse impact on our liquidity, financial condition and results of operations.
Reduction of the statutory surplus of our insurance subsidiaries could adversely affect their ability to write insurance business.
Insurance companies write business based, in part, upon guidelines including capital ratios considered by the NAIC and various rating agencies. Some of these ratios include risk-based capital ratios for both property and casualty insurance companies and life insurance companies, as well as a ratio of premiums to surplus for property and casualty insurance companies. Risk-based capital ratios measure an insurers capital adequacy and consider various risks such as underwriting, investment, credit, asset concentration and interest rate. If our insurance subsidiaries cannot maintain profitability in the future or if significant investment valuation losses are incurred, they may be required to draw on their surplus, thereby reducing capital adequacy, in order to pay dividends to us to enable us to meet our financial obligations.
33
As their surplus is reduced by the payment of dividends, continuing losses or both, our insurance subsidiaries ability to write business and maintain acceptable financial strength ratings could also be reduced. This could have a material adverse effect upon the business volume and profitability of our insurance subsidiaries.
If we are not able to effectively develop and expand our marketing operations, including agents and other points of distribution, our financial condition and results of operations could be adversely affected.
Since 2006, the Company has been transitioning from a single-person agent operation to its Agency Business Model, with agents in outside offices with licensed producers, designed to remove capacity constraints and increase productivity. Building on this foundation, in 2009 the Company began offering the opportunity for agents to be appointed by the Company as non-employee, independent contractor, Exclusive Agents. At December 31, 2012, approximately 90% of the Companys agents and agencies were operating under the Agency Business Model.
Our success in marketing and selling our products is largely dependent upon the efforts of our agent sales force and the success of their agency operations. As we expand our business, we may need to expand the number of agencies marketing our products. If we are unable to appoint additional agents, fail to retain current agents, are unable to maintain the productivity of those agency operations or are unable to maintain market penetration in existing territories, sales of our products likely would decline and our financial condition and results of operations could be adversely affected.
If we are not able to maintain and secure (1) access to educators and (2) endorsements and other relationships with the educational community, our financial condition and results of operations could be adversely affected.
Our ability to successfully increase new business in the educator market is largely dependent on our ability to effectively access educators either in their school buildings or through other approaches. While this is especially true for the sale of 403(b) tax-qualified annuity products via payroll reduction, any significant decrease in access, either through fewer payroll slots, increased security measures or for other reasons could potentially adversely affect the sale of all lines of our business and require us to change our traditional approach to worksite marketing and promotion. With the changes in the IRS regulations regarding Section 403(b) arrangements, including annuities, our ability to maintain and increase our share of the 403(b) market, and the access it gives us for other product lines, will depend on our ability to successfully compete in this market. Some school districts and benefit consultants have been placing additional emphasis on the relative financial strength ratings of competing companies, as well as low cost product and distribution approaches, which may put us at a competitive disadvantage relative to other more highly-rated insurance companies.
Our ability to maintain and obtain product and corporate endorsements from, and/or marketing agreements with, local, state and national education-related associations is important to our marketing strategy. In addition to teacher organizations, we have established relationships with various other educator, principal, school administrator and school business official groups. These contacts and endorsements help to establish our brand name and presence in the educational community and to enhance our access to educators.
34
Economic and other factors affecting our niche market could adversely impact our financial condition and results of operations.
Horace Manns strategic objective is to become the company of choice in meeting the insurance and financial services needs of the educational community. With K-12 teachers, administrators, and support personnel representing a significant percentage of our business, the financial condition and results of operations of our subsidiaries could be more prone than many of our competitors to the effects of economic forces and other issues affecting the educator market including, but not limited to, federal, state and local budget deficits and cut-backs and adverse changes in state and local tax revenues.
While the U.S. financial market and certain sectors of the economy have shown improvement over recent quarters, federal and state revenue shortages continue to pressure the budgets of many school districts. Teacher layoffs and early retirements have taken place in recent years and it is possible that additional reductions will occur in the near-term future. Similar to others in the insurance industry, the Company has experienced pressure on new business sales levels. However, despite the economic headwinds, as of the time of this Annual Report on Form 10-K, the Companys retention of annuity accumulated values remains strong; the level of annuity scheduled deposit suspension has improved significantly compared to the 2008-2009 period; and total annuity net fund flows continued to be positive in 2012, as they were throughout each year in the 2008 through 2011 period. However, there can be no assurance that these business factors will remain favorable.
The personal lines insurance and annuity markets are highly competitive and our financial condition and results of operations may be adversely affected by competitive forces.
We operate in a highly competitive environment and compete with numerous insurance companies, as well as mutual fund families, independent agent companies and financial planners. In some instances and geographic locations, competitors have specifically targeted the educator marketplace with specialized products and programs. We compete in our target market with a number of national providers of personal automobile and homeowners insurance and life insurance and annuities.
The insurance industry consists of a large number of insurance companies, some of which have substantially greater financial resources, more diversified product lines, greater economies of scale and/or lower-cost marketing approaches compared to us. In our target market, we believe that the principal competitive factors in the sale of property and casualty insurance products are price, overall service, name recognition and worksite sales and service. We believe that the principal competitive factors in the sale of annuity products and life insurance are worksite sales and service, product features, perceived stability of the insurer, price, overall service and name recognition.
35
Particularly in the property and casualty business, our insurance subsidiaries from time to time, generally on a cyclical basis, experience periods of intense competition during which they may be unable to increase policyholders and revenues without adversely impacting profit margins. During the current cycle, which has existed for the previous 24-36 months and is expected to persist through 2013 and potentially beyond, competition from direct writers and large, mass market carriers has been particularly aggressive, evidenced in part by their significant national advertising expenditures. The inability of our insurance subsidiaries to compete successfully in the property and casualty business could adversely affect the subsidiaries financial condition and results of operations and the resulting ability to distribute cash to the holding company.
In our annuity business, the revised IRS Section 403(b) regulations, which generally took effect January 1, 2009, have made the 403(b) market more similar to the 401(k) market than it was in the past. While this change has and may continue to reduce the number of competitors in this market, it has made the 403(b) market more attractive to some of the larger companies experienced in 401(k) plans, including both insurance and mutual fund companies, that had not previously been active competitors in this business. While not yet widespread, there has been continued pressure in some states to adopt state-sponsored or mandated 403(b) plans with single- or limited-provider options; this pressure has come from competitor lobbying efforts and state legislature-initiated pension reform initiatives. The inability of our insurance subsidiaries to compete successfully in these markets could adversely affect the subsidiaries financial condition and results of operations and the resulting ability to distribute cash to the holding company.
A reduction or elimination of the tax advantages of annuity and life products and/or a change in the tax benefits of various government-authorized retirement programs, such as 403(b) annuities and individual retirement accounts (IRAs), could make our products less attractive to clients and adversely affect our operating results.
A significant part of our annuity business involves fixed and variable 403(b) tax-qualified annuities, which are annuities purchased voluntarily by individuals employed by public school systems or other tax-exempt organizations. Our financial condition and results of operations could be adversely affected by changes in federal and state laws and regulations that affect the relative tax and other advantages of our life and annuity products to clients or the tax benefits of programs utilized by our customers. As a result of economic conditions from 2008 through 2012 and as of the time of this Annual Report on Form 10-K, revenue challenges exist at federal, state and local government levels. These challenges could increase the risk of future adverse impacts on current tax advantaged products. See also Business Regulation Regulation at Federal Level.
Current federal income tax laws generally permit the tax-deferred accumulation of earnings on the premiums paid by the holders of annuities and life insurance products. Taxes, if any, are payable on income attributable to a distribution under the contract for the year in which the distribution is made. From time to time, Congress has considered legislation that would reduce or eliminate the benefit of such deferral of taxation on the accretion of value with life insurance and non-qualified annuity contracts. Enactment of this legislation, including a simplified flat tax income structure with an exemption from taxation for investment income, could result in fewer sales of our life insurance and annuity products.
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The insurance industry is highly regulated.
We are subject to extensive regulation and supervision in the jurisdictions in which we do business. Each jurisdiction has a unique and complex set of laws and regulations. Furthermore, certain federal laws impose additional requirements on businesses, including insurers. Regulation generally is designed to protect the interests of policyholders, as opposed to stockholders and non-policyholder creditors. Such regulations, among other things, impose restrictions on the amount and type of investments our subsidiaries may hold. Certain states also regulate the rates insurers may charge for certain property and casualty products. Legislation and voter initiatives have expanded, in some instances, the states regulation of rates and have increased data reporting requirements. Consumer-related pressures to roll back rates, even if not enacted by legislation or upheld upon judicial appeal, may affect our ability to obtain timely rate increases or operate at desired levels of profitability. Changes in insurance regulations, including those affecting the ability of our insurance subsidiaries to distribute cash to us and those affecting the ability of our insurance subsidiaries to write profitable property and casualty insurance policies in one or more states, may adversely affect the financial condition and results of operations of our insurance subsidiaries. In addition, consumer privacy requirements may increase our cost of processing business. Our ability to comply with laws and regulations, at a reasonable cost, and to obtain necessary regulatory action in a timely manner, is and will continue to be critical to our success.
Regulation that could adversely affect our insurance subsidiaries also includes statutory surplus and risk-based capital requirements. Maintaining appropriate levels of surplus, as measured by statutory accounting principles, is considered important by state insurance regulatory authorities and the private agencies that rate insurers claims-paying abilities and financial strength. The failure of an insurance subsidiary to maintain levels of statutory surplus that are sufficient for the amount of its insurance written could result in increased regulatory scrutiny, action by state regulatory authorities or a downgrade by rating agencies.
Similarly, the NAIC has adopted a system of assessing minimum capital adequacy that is applicable to our insurance subsidiaries. This system, known as risk-based capital, is used to identify companies that may merit further regulatory action by analyzing the adequacy of the insurers surplus in relation to statutory requirements.
Because state legislatures remain concerned about the availability and affordability of property and casualty insurance and the protection of policyholders, our insurance subsidiaries expect that they will continue to face efforts by those legislatures to expand regulations to address these concerns. Resulting new legislation could adversely affect the financial condition and results of operations of our insurance subsidiaries.
In the event of the insolvency, liquidation or other reorganization of any of our insurance subsidiaries, our creditors and stockholders would have no right to proceed against any such insurance subsidiary or to cause the liquidation or bankruptcy of any such insurance subsidiary under federal or state bankruptcy laws. The insurance laws of the domiciliary state would govern such proceedings and the relevant insurance commissioner would act as liquidator or rehabilitator for the insurance subsidiary. Creditors and policyholders of any such insurance subsidiary would be entitled to payment in full from the assets of the insurance subsidiary before we, as a stockholder, would be entitled to receive any distribution.
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The financial position of our insurance subsidiaries also may be affected by court decisions that expand insurance coverage beyond the intention of the insurer at the time it originally issued an insurance policy.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by President Obama. The law created a new Federal Insurance Office (FIO) within the U.S. Department of the Treasury. The FIO is charged with monitoring and providing specific reports on various aspects of the insurance industry, but it does not have general supervisory or regulatory authority over the business of insurance. While the law creates new opportunities for federal monitoring and limited intervention in the regulation of the insurance industry, and the FIOs reports and recommendations may create new pressures for broader federal regulatory authority over the insurance industry longer term, management does not expect the current provisions of the law to have a significant effect on the Company. Management will continue to monitor developments under this law. Additional regulations could adversely affect the efficiency and effectiveness of business processes, financial condition and results of operations of the Company, insurers of similar size and/or the insurance industry as a whole.
The insurance industry is highly cyclical.
The results of companies in the insurance industry historically have been subject to significant fluctuations due to competition, economic conditions, interest rates and other factors. In particular, companies in the property and casualty insurance segment of the industry historically have experienced pricing and profitability cycles. With respect to these cycles, the factors having the greatest impact include significant and/or rapid changes in loss costs, including changes in loss frequency and/or severity; prior approval and restrictions in certain states for price increases; intense price competition; less restrictive underwriting standards; aggressive marketing; and increased advertising, which have resulted in higher industry-wide combined loss and expense ratios.
Litigation may harm our financial strength or reduce our profitability.
Companies in the insurance industry have been subject to substantial litigation resulting from claims, disputes and other matters. Most recently, they have faced expensive claims, including class action lawsuits, alleging, among other things, improper sales practices and improper claims settlement procedures. Negotiated settlements of certain such actions have had a material adverse effect on many insurance companies. The resolution of such claims against any of our insurance subsidiaries, including the potential adverse effect on our reputation and charges against the earnings of our insurance subsidiaries as a result of legal defense costs, a settlement agreement or an adverse finding or findings against our insurance subsidiaries in such a claim, could have a material adverse effect on the financial condition and results of operations of our insurance subsidiaries.
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Data security breaches or denial of service on our websites could have an adverse impact on the Companys business and reputation.
Unauthorized access to and unintentional dissemination of our confidential customer, employee or Company data or other breaches of data security in our facilities, networks or databases, or those of our agents or third-party vendors, could result in loss or theft of assets or sensitive information, data corruption or operational disruption that may expose the Company to liability and/or regulatory action and may have an adverse impact on the Companys customers, employees, reputation and business. In addition, any compromise of the security of our data or prolonged denial of service on our websites could harm the Companys business and reputation. We have designed, implemented and routinely test industry-compliant procedures for protection of confidential information and sensitive corporate data, including rapid response procedures to help contain or prevent data loss if a breach were to occur. We have also implemented multiple technical security protections and contractual obligations regarding security breaches for our agents and third-party vendors. Even with these efforts, there can be no assurance that security breaches or service disruptions will be prevented.
Successful execution of our business growth strategy is dependent on effective implementation of new or enhanced technology systems and applications.
Our ability to effectively execute our business growth strategy and leverage potential economies of scale is dependent on our ability to provide the requisite technology components for that strategy. While we have effectively upgraded our infrastructure technologies with improvements in our data center, a new communications platform and enhancements to our disaster recovery capabilities, our ability to replace or supplement dated, monolithic legacy business systems with more flexible, maintainable, and customer accessible solutions will be necessary to achieve our plans. The inherent difficulty in replacing and/or modernizing these older technologies, coupled with the Companys lack of experience in these endeavors, presents an increased risk to delivering these technology solutions in a cost effective and timely manner. Our scale will require us to develop innovative solutions to address these challenges. More modern approaches to software development and utilization of third-party vendors can augment the Companys internal capacity for these implementations, but may not adequately reduce the risks of timely and cost effective delivery.
Loss of key vendor relationships could affect our operations.
We rely on services and products provided by a number of vendors in the United States and abroad. These include, for example, vendors of computer hardware and software and vendors of services such as investment management advisement, information technology services and delivery services for customer policy-level communications. In the event that one or more of our vendors suffers a bankruptcy or otherwise becomes unable to continue to provide products or services, we may suffer operational difficulties and financial losses.
ITEM 1B. | Unresolved Staff Comments |
None.
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ITEM 2. | Properties |
HMECs home office property at 1 Horace Mann Plaza in Springfield, Illinois, consisting of an office building totaling 225,000 square feet, is owned by the Company. Also in Springfield, the Company owns and leases some smaller buildings at other locations. In addition, the Company leases office space in suburban Dallas, Texas, and Raleigh, North Carolina, for its claims operations and leases some office space related to its field marketing operations. These properties, which are utilized by all of the Companys business segments, are adequate and suitable for the Companys current and anticipated future needs.
ITEM 3. | Legal Proceedings |
At the time of this Annual Report on Form 10-K, the Company does not have pending litigation from which there is a reasonable possibility of material loss.
ITEM 4. | Mine Safety Disclosures |
Not applicable.
PART II
ITEM 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information and Dividends
HMECs common stock began trading on the NYSE in November 1991 under the symbol of HMN at a price of $9 per share. The following table sets forth the high and low sales prices of the common stock on the NYSE Composite Tape and the cash dividends paid per share of common stock during the periods indicated.
Market Price |
Dividend
Paid |
||||||||||||||
Fiscal Period |
High |
Low |
|||||||||||||
2012: |
|||||||||||||||
Fourth Quarter |
$ | 19.99 | $ | 17.44 | $ | 0.16 | |||||||||
Third Quarter |
18.88 | 16.90 | 0.13 | ||||||||||||
Second Quarter |
18.36 | 16.16 | 0.13 | ||||||||||||
First Quarter |
18.23 | 13.80 | 0.13 | ||||||||||||
2011: |
|||||||||||||||
Fourth Quarter |
$ | 14.31 | $ | 10.51 | $ | 0.13 | |||||||||
Third Quarter |
16.11 | 10.70 | 0.11 | ||||||||||||
Second Quarter |
18.22 | 14.46 | 0.11 | ||||||||||||
First Quarter |
18.43 | 15.95 | 0.11 |
The payment of dividends in the future is subject to the discretion of the Board of Directors of HMEC and will depend upon general business conditions, legal restrictions and other factors the Board of Directors may deem to be relevant. Additional information is contained in Notes to Consolidated Financial Statements -- Note 8 -- Statutory Information and Restrictions listed on page F-1 of this report and in Business -- Cash Flow.
40
Shareholder Return Performance Graph
The graph below compares cumulative total return* of Horace Mann Educators Corporation, the S&P 500 Insurance Index and the S&P 500 Index. The graph assumes $100 invested on December 31, 2007 in HMEC, the S&P 500 Insurance Index and the S&P 500 Index.
12/07 | 12/08 | 12/09 | 12/10 | 12/11 | 12/12 | |||||||||||||||||||||||||
HMEC |
$ | 100 | $ | 50 | $ | 69 | $ | 102 | $ | 80 | $ | 120 | ||||||||||||||||||
S&P 500 Insurance Index |
100 | 42 | 48 | 56 | 51 | 61 | ||||||||||||||||||||||||
S&P 500 Index |
100 | 63 | 80 | 92 | 94 | 109 |
* |
The S&P 500 Index and the S&P 500 Insurance Index, as published by Standard and Poors Corporation (S&P), assume an annual reinvestment of dividends in calculating total return. Horace Mann Educators Corporation assumes reinvestment of dividends when paid. |
Holders and Shares Issued
As of February 15, 2013, the approximate number of holders of HMECs common stock was 5,000.
During 2012, options were exercised for the issuance of 389,089 shares, 1.0% of the Companys common stock shares outstanding at December 31, 2011. The Company received $5.4 million as a result of these option exercises, including related federal income tax benefits.
The equity compensation plan information required by Item 201(d) of Regulation S-K is incorporated by reference to the Companys Proxy Statement for the 2013 Annual Meeting of Shareholders.
41
Issuer Purchases of Equity Securities
On December 7, 2011, the Companys Board of Directors authorized a new share repurchase program allowing repurchases of up to $50.0 million of Horace Mann Educators Corporations Common Stock, par value $0.001. The share repurchase program authorizes the opportunistic repurchase of common shares in open market or privately negotiated transactions, from time to time, depending on market conditions. The share repurchase program does not have an expiration date and may be limited or terminated at any time without notice. During the three months ended December 31, 2012, the Company repurchased shares of HMEC common stock as follows:
Issuer Purchases of Equity Securities
Period |
Total Number
of Shares Purchased |
Average Price Paid
Per Share |
Total Number of
Shares Purchased as Part of Publicly Announced Plans or Programs |
Maximum
Number
(or Approximate Dollar Value) of Shares That May Yet Be Purchased Under The Plans or Programs |
||||||||||||||||
October 1 October 31 |
- | - | - | $ | 34.3 million | |||||||||||||||
November 1 November 30 |
114,809 | $ | 18.23 | 114,809 | $ | 32.2 million | ||||||||||||||
December 1 December 31 |
- | - | - | $ | 32.2 million | |||||||||||||||
|
|
|
|
|||||||||||||||||
Total |
114,809 | $ | 18.23 | 114,809 | $ | 32.2 million | ||||||||||||||
|
|
|
|
ITEM 6. | Selected Financial Data |
The information required by Item 301 of Regulation S-K is contained in the table in Item 1 -- Business -- Selected Historical Consolidated Financial Data.
ITEM 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
The information required by Item 303 of Regulation S-K is listed on page F-1 of this report.
ITEM 7A. | Quantitative and Qualitative Disclosures About Market Risk |
The information required by Item 305 of Regulation S-K is contained in Managements Discussion and Analysis of Financial Condition and Results of Operations listed on page F-1 of this report.
ITEM 8. | Consolidated Financial Statements and Supplementary Data |
The Companys consolidated financial statements, financial statement schedules, the report of its independent registered public accounting firm and the selected quarterly financial data required by Item 302 of Regulation S-K are listed on page F-1 of this report.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
42
ITEM 9A. | Controls and Procedures |
a.) Managements Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) of the Securities and Exchange Act of 1934 as amended (the Exchange Act). Based on this evaluation, our chief executive officer and our chief financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2012, the end of the period covered by this Annual Report on Form 10-K.
b.) Managements Annual Report on Internal Control Over Financial Reporting
Management of Horace Mann is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that:
(i) |
Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; |
(ii) |
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and |
(iii) |
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the consolidated financial statements. |
Management of Horace Mann conducted an evaluation of the effectiveness of the Companys internal control over financial reporting as of December 31, 2012, using the criteria set forth in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Based on this evaluation, management, including our CEO and our CFO, determined that, as of December 31, 2012, the Company maintained effective internal control over financial reporting.
The effectiveness of the Companys internal control over financial reporting as of December 31, 2012 has been audited by KPMG LLP, the independent registered public accounting firm that audited the Companys consolidated financial statements, as stated in their report listed on page F-1 of this Annual Report on Form 10-K.
43
c.) Independent Registered Public Accounting Firms Report on Internal Control Over Financial Reporting
The information required by Item 308(b) of Regulation S-K is contained in the Report of Independent Registered Public Accounting Firm listed on page F-1 of this report.
d). Changes in Internal Control Over Financial Reporting
There were no changes in the Companys internal control over financial reporting that occurred during the Companys last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.
None.
PART III
ITEM 10. Directors, Executive Officers and Corporate Governance
The information required by Items 401, 405, 407(d)(4) and 407(d)(5) of Regulation S-K is incorporated by reference to the Companys Proxy Statement for the 2013 Annual Meeting of Shareholders.
Horace Mann Educators Corporation has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer and all other employees of the Company. In addition, the Board of Directors of Horace Mann Educators Corporation has adopted the code of ethics for its Board members as it applies to each Board members business conduct on behalf of the Company. The code of ethics is posted on the Companys website, www.horacemann.com , under Investors -- Corporate Governance. In addition, amendments to the code of ethics and any grant of a waiver from a provision of the code of ethics requiring disclosure under applicable SEC rules will be disclosed at the same location as the code of ethics on the Companys website.
ITEM 11. Executive Compensation
The information required by Items 402, 407(e)(4) and 407(e)(5) of Regulation S-K is incorporated by reference to the Companys Proxy Statement for the 2013 Annual Meeting of Shareholders.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management, and Related Stockholder Matters
The information required by Items 201(d) and 403 of Regulation S-K is incorporated by reference to the Companys Proxy Statement for the 2013 Annual Meeting of Shareholders.
ITEM 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Items 404 and 407(a) of Regulation S-K is incorporated by reference to the Companys Proxy Statement for the 2013 Annual Meeting of Shareholders.
44
ITEM 14. Principal Accounting Fees and Services
The information required by Item 9(e) of Schedule 14A is incorporated by reference to the Companys Proxy Statement for the 2013 Annual Meeting of Shareholders.
PART IV
ITEM 15. Exhibits and Financial Statement Schedules
(a)(1) The following consolidated financial statements of the Company are contained in the Index to Financial Information on page F-1 of this report:
Consolidated Balance Sheets as of December 31, 2012 and 2011.
Consolidated Statements of Operations for the Years Ended December 31, 2012, 2011 and 2010.
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2012, 2011 and 2010.
Consolidated Statements of Changes in Shareholders Equity for the Years Ended December 31, 2012, 2011 and 2010.
Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and 2010.
(a)(2) The following financial statement schedules of the Company are contained in the Index to Financial Information on page F-1 of this report:
Schedule I - Summary of Investments - Other than Investments in Related Parties.
Schedule II - Condensed Financial Information of Registrant.
Schedules III and VI Combined - Supplementary Insurance Information and Supplemental Information Concerning Property and Casualty Insurance Operations.
Schedule IV - Reinsurance.
45
(a)(3) The following items are filed as Exhibits. Management contracts and compensatory plans are indicated by an asterisk (*).
Exhibit | ||||
No. |
Description | |||
(3) |
Articles of incorporation and bylaws: | |||
3.1 |
Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on June 24, 2003, incorporated by reference to Exhibit 3.1 to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, filed with the Securities and Exchange Commission (the SEC) on August 14, 2003. |
|||
3.2 |
Form of Certificate for shares of Common Stock, $0.001 par value per share, of HMEC, incorporated by reference to Exhibit 4.5 to HMECs Registration Statement on Form S-3 (Registration No. 33-53118) filed with the SEC on October 9, 1992. |
|||
3.3 |
Bylaws of HMEC, incorporated by reference to Exhibit 3.2 to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, filed with the SEC on August 14, 2003. |
|||
(4) |
Instruments defining the rights of security holders, including indentures: | |||
4.1 |
Indenture, dated as of June 9, 2005, between HMEC and The Bank of New York Mellon Trust Company, N.A., as trustee (formerly JPMorgan Chase Bank, N.A. was trustee), incorporated by reference to Exhibit 4.1 to HMECs Current Report on Form 8-K dated June 6, 2005, filed with the SEC on June 9, 2005. |
|||
4.1(a) |
First Supplemental Indenture, dated as of June 9, 2005, between HMEC and The Bank of New York Mellon Trust Company, N.A., as trustee (formerly JPMorgan Chase Bank, N.A. was trustee), incorporated by reference to Exhibit 4.2 to HMECs Current Report on Form 8-K dated June 6, 2005, filed with the SEC on June 9, 2005. |
|||
4.1(b) |
Form of HMEC 6.05% Senior Notes Due 2015 (included in Exhibit 4.1(a)). |
|||
4.1(c) |
Second Supplemental Indenture, dated as of April 21, 2006, between HMEC and The Bank of New York Mellon Trust Company, N.A., as trustee (formerly JPMorgan Chase Bank, N.A. was trustee), incorporated by reference to Exhibit 4.3 to HMECs Current Report on Form 8-K dated April 18, 2006, filed with the SEC on April 21, 2006. |
|||
4.1(d) |
Form of HMEC 6.85% Senior Notes due April 15, 2016 (included in Exhibit 4.1(c)). |
46
47
Exhibit | ||||
No. |
Description | |||
|
10.5(a)* |
Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan, incorporated by reference to Exhibit 10.6(a) to HMECs Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. |
||
10.5(b)* |
Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan, incorporated by reference to Exhibit 10.6(b) to HMECs Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. |
|||
10.6* |
Horace Mann Educators Corporation Amended and Restated 2002 Incentive Compensation Plan (2002 Incentive Compensation Plan), incorporated by reference to Exhibit 10.2 to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, filed with the SEC on August 9, 2005. |
|||
10.6(a)* |
Specimen Employee Stock Option Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(a) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. |
|||
10.6(b)* |
Revised Specimen Employee Stock Option Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(b) to HMECs Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009. |
|||
10.6(c)* |
Specimen Regular Employee Stock Option Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(b) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. |
|||
10.6(d)* |
Specimen Director Stock Option Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(c) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. |
|||
10.6(e)* |
Specimen Employee Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(d) to HMECs Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on March 16, 2006. |
|||
10.6(f)* |
Revised Specimen Employee Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(f) to HMECs Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009. |
48
Exhibit | ||||
No. |
Description | |||
|
10.6(g)* |
Specimen Non-employee Director Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(e) to HMECs Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on March 16, 2006. |
||
10.6(h)* |
Revised Specimen Non-employee Director Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(h) to HMECs Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009. |
|||
10.6(i)* |
Specimen Restricted Stock Unit Deferral Election Form under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(f) to HMECs Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on March 16, 2006. |
|||
10.6(j)* |
Revised Specimen Restricted Stock Unit Deferral Election Forms under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(j) to HMECs Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009. |
|||
10.6(k)* |
Specimen Modification to Stock Options outstanding as of June 30, 2004, incorporated by reference to Exhibit 10.2(d) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, filed with the SEC on August 9, 2004. |
|||
10.7* |
HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 1 (beginning on page E-1) to HMECs Proxy Statement, filed with the SEC on April 9, 2010. |
|||
10.7(a)* |
Amendment No. 1 to the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 1 (beginning on page E-1) to HMECs Proxy Statement, filed with the SEC on April 9, 2012. |
|||
10.7(b)* |
Specimen Incentive Stock Option Agreement for Section 16 Officers under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(a) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011. |
|||
10.7(c)* |
Specimen Incentive Stock Option Agreement for Non-Section 16 Officers under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(b) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011. |
49
Exhibit | ||||
No. |
Description | |||
|
10.7(d)* |
Specimen Employee Service-Vested Restricted Stock Units Agreement under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(c) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011. |
||
10.7(e)* |
Specimen Employee Performance-Based Restricted Stock Units Agreement under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(d) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011. |
|||
10.7(f)* |
Specimen Non-Employee Director Restricted Stock Unit Agreement under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.17(a) to HMECs Current Report on Form 8-K dated May 27, 2010, filed with the SEC on June 2, 2010. |
|||
10.8* |
Horace Mann Supplemental Employee Retirement Plan, 2002 Restatement, incorporated by reference to Exhibit 10.1 to HMECs Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, filed with the SEC on May 15, 2002. |
|||
10.9* |
Horace Mann Executive Supplemental Employee Retirement Plan, 2002 Restatement, incorporated by reference to Exhibit 10.2 to HMECs Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, filed with the SEC on May 15, 2002. |
|||
10.10* |
Amended and Restated Horace Mann Nonqualified Supplemental Money Purchase Pension Plan, incorporated by reference to Exhibit 10.9 to HMECs Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009. |
|||
10.11* |
Summary of HMEC Non-Employee Director Compensation, incorporated by reference to Exhibit 10.11 to HMECs Current Report on Form 8-K dated May 25, 2011, filed with the SEC on May 27, 2011. |
|||
10.12* |
Summary of HMEC Named Executive Officer Annualized Salaries, incorporated by reference to Exhibit 10.12 to HMECs Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, filed with the SEC on May 10, 2012. |
|||
10.13* |
Form of Severance Agreement between HMEC, Horace Mann Service Corporation (HMSC) and certain officers of HMEC and/or HMSC. |
|||
10.13(a)* |
Revised Schedule to Severance Agreements between HMEC, HMSC and certain officers of HMEC and/or HMSC. |
50
Exhibit | ||||
No. |
Description | |||
10.14* |
Form of Change in Control Agreement between HMEC, HMSC and certain officers of HMEC and/or HMSC. |
|||
10.14(a)* |
Revised Schedule to Change in Control Agreement between HMEC, HMSC and certain officers of HMEC and/or HMSC. |
|||
10.15* |
HMSC Executive Change in Control Plan, incorporated by reference to Exhibit 10.15 to HMECs Current Report on Form 8-K dated February 15, 2012, filed with the SEC on February 22, 2012. |
|||
10.15(a)* |
HMSC Executive Change in Control Plan Schedule A Plan Participants. |
|||
10.16* |
HMSC Executive Severance Plan, incorporated by reference to Exhibit 10.16 to HMECs Current Report on Form 8-K dated March 7, 2012, filed with the SEC on March 13, 2012. |
|||
10.16(a)* |
First Amendment to the HMSC Executive Severance Plan, incorporated by reference to Exhibit 10.16(a) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, filed with the SEC on August 9, 2012. |
|||
10.16(b)* |
HMSC Executive Severance Plan Schedule A Participants, incorporated by reference to Exhibit 10.16(b) to HMECs Current Report on Form 8-K dated May 23, 2012, filed with the SEC on May 29, 2012. |
|||
10.17* |
Executive Transition Agreement between HMEC and Peter H. Heckman as of November 14, 2012, incorporated by reference to Exhibit 99.1 to HMECs Current Report on Form 8-K dated November 14, 2012, filed with the SEC on November 19, 2012. |
|||
(11) |
Statement regarding computation of per share earnings. | |||
(12) |
Statement regarding computation of ratios. | |||
(21) |
Subsidiaries of HMEC. | |||
(23) |
Consent of KPMG LLP. | |||
(31) |
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
31.1 |
Certification by Peter H. Heckman, Chief Executive Officer of HMEC. |
|||
31.2 |
Certification by Dwayne D. Hallman, Chief Financial Officer of HMEC. |
|||
(32) |
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |||
32.1 |
Certification by Peter H. Heckman, Chief Executive Officer of HMEC. |
|||
32.2 |
Certification by Dwayne D. Hallman, Chief Financial Officer of HMEC. |
51
Exhibit | ||||
No. |
Description | |||
(99) |
Additional exhibits | |||
99.1 | Glossary of Selected Terms. | |||
(101) |
Interactive Data File | |||
101.INS | XBRL Instance Document | |||
101.SCH | XBRL Taxonomy Extension Schema | |||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase | |||
101.DEF | XBRL Taxonomy Extension Definition Linkbase | |||
101.LAB | XBRL Taxonomy Extension Label Linkbase | |||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase | |||
(b) | See list of exhibits in this Item 15. | |||
(c) | See list of financial statement schedules in this Item 15. |
Copies of Form 10-K, Exhibits to Form 10-K, Horace Mann Educators Corporations Code of Ethics and charters of the committees of the Board of Directors are available through the Investors section of the Companys Internet website, www.horacemann.com . Copies also may be obtained by writing to Investor Relations, Horace Mann Educators Corporation, 1 Horace Mann Plaza, C-120, Springfield, Illinois 62715-0001.
52
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Horace Mann Educators Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HORACE MANN EDUCATORS CORPORATION |
/s/ Peter H. Heckman |
Peter H. Heckman |
President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Horace Mann Educators Corporation and in the capacities and on the date indicated.
Principal Executive Officer: | Directors: | |||
/s/ Peter H. Heckman |
/s/ Gabriel L. Shaheen |
|||
Peter H. Heckman | Gabriel L. Shaheen, Chairman of the Board of Directors | |||
President, Chief Executive Officer and a Director | ||||
/s/ Mary H. Futrell |
||||
Mary H. Futrell, Director | ||||
/s/ Stephen J. Hasenmiller |
||||
Principal Financial Officer: | Stephen J. Hasenmiller, Director | |||
/s/ Dwayne D. Hallman |
/s/ Ronald J. Helow |
|||
Dwayne D. Hallman | Ronald J. Helow, Director | |||
Executive Vice President and Chief Financial Officer | ||||
/s/ Roger J. Steinbecker |
||||
Roger J. Steinbecker, Director | ||||
/s/ Robert Stricker |
||||
Principal Accounting Officer: | Robert Stricker, Director | |||
/s/ Bret A. Conklin |
/s/ Charles R. Wright |
|||
Bret A. Conklin | Charles R. Wright, Director | |||
Senior Vice President and Controller |
Dated: February 28, 2013
53
HORACE MANN EDUCATORS CORPORATION
INDEX TO FINANCIAL INFORMATION
Page | ||||
Managements Discussion and Analysis of Financial Condition and Results of Operations |
F-2 | |||
F-42 | ||||
F-44 | ||||
F-45 | ||||
F-46 | ||||
F-47 | ||||
F-48 | ||||
F-49 | ||||
F-65 | ||||
F-71 | ||||
Note 4 - Property and Casualty Unpaid Claims and Claim Expenses |
F-78 | |||
F-82 | ||||
F-84 | ||||
F-87 | ||||
F-91 | ||||
F-93 | ||||
F-100 | ||||
F-102 | ||||
F-103 | ||||
F-103 | ||||
F-105 | ||||
Financial Statement Schedules: |
||||
Schedule I - Summary of Investments - Other than Investments in
|
F-106 | |||
F-107 | ||||
F-111 | ||||
F-112 |
F-1
MANAGEMENTS 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 are not historical in nature are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to known and unknown risks, uncertainties and other factors. Horace Mann is not under any obligation to (and expressly disclaims any such obligation to) update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. It is important to note that the Companys actual results could differ materially from those projected in forward-looking statements due to a number of risks and uncertainties inherent in the Companys business. For additional information regarding risks and uncertainties, see Item 1A. Risk Factors in this Annual Report on Form 10-K. That discussion includes factors such as:
|
The impact that a prolonged economic recession may have on the Companys investment portfolio; volume of new business for automobile, homeowners, annuity and life products; policy renewal rates; and additional annuity contract deposit receipts. |
|
Fluctuations in the fair value of securities in the Companys investment portfolio and the related after-tax effect on the Companys shareholders equity and total capital through either realized or unrealized investment losses. |
|
Prevailing low interest rate levels, including the impact of interest rates on (1) the Companys ability to maintain appropriate interest rate spreads over minimum fixed rates guaranteed in the Companys annuity and life products, (2) the book yield of the Companys investment portfolio, (3) unrealized gains and losses in the Companys investment portfolio and the related after-tax effect on the Companys shareholders equity and total capital, (4) amortization of deferred policy acquisition costs and (5) capital levels of the Companys life insurance subsidiaries. |
|
The frequency and severity of catastrophes such as hurricanes, storms, earthquakes and wildfires and the ability of the Company to provide accurate estimates of ultimate catastrophe costs in its consolidated financial statements. |
|
The Companys risk exposure to catastrophe-prone areas. Based on full year 2012 property and casualty direct earned premiums, the Companys ten largest states represented 57% of the segment total. Included in this top ten group are certain states which are considered more prone to catastrophe occurrences: California, North Carolina, Texas, Florida, Louisiana, South Carolina and Georgia. |
|
The ability of the Company to maintain a favorable catastrophe reinsurance program considering both availability and cost; and the collectibility of reinsurance receivables. |
|
Adverse changes in market appreciation, interest spreads, business persistency and policyholder mortality and morbidity rates and the resulting impact on both estimated reserves and the amortization of deferred policy acquisition costs. |
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Adverse results from the assessment of the Companys goodwill asset requiring write off of the impaired portion. |
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The Companys ability to refinance outstanding indebtedness or repurchase shares of the Companys common stock. |
F-2
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The Companys ability to (1) develop and expand its marketing operations, including agents and other points of distribution, and (2) maintain and secure access to educators, as well as endorsements by and/or marketing agreements with education-related associations, including various teacher, school administrator, principal and business official associations. |
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The effects of economic forces and other issues affecting the educator market including, but not limited to, federal, state and local budget deficits and cut-backs and adverse changes in state and local tax revenues. The effects of these forces include, among others, teacher layoffs and early retirements, as well as individual concerns regarding employment and economic uncertainty. |
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The Companys ability to profitably expand its property and casualty business in highly competitive environments. |
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Changes in federal and state laws and regulations, which affect the relative tax and other advantages of the Companys life and annuity products to customers, including, but not limited to, changes in IRS regulations governing Section 403(b) plans. |
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Changes in federal and state laws and regulations, which affect the relative tax advantage of certain investments or which affect the ability of debt issuers to declare bankruptcy or restructure debt. |
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The Companys ability to effectively implement new or enhanced information technology systems and applications. |
Executive Summary
Horace Mann Educators Corporation (HMEC; and together with its subsidiaries, the Company or Horace Mann) is an insurance holding company. Through its subsidiaries, HMEC markets and underwrites personal lines of property and casualty insurance, retirement annuities and life insurance in the U.S. The Company markets its products primarily to K-12 teachers, administrators and other employees of public schools and their families.
For 2012, the Companys net income of $103.9 million represented an increase of $33.4 million compared to 2011, reflecting a significant reduction in property and casualty catastrophe losses as well as an increase in underlying earnings for all three of the Companys operating segments. After-tax net realized investment gains decreased by $6.8 million between years. For the property and casualty segment, net income of $37.1 million reflected an increase of $31.2 million compared to 2011, benefitting from decreases in catastrophe costs and Florida sinkhole losses, as well as favorable development of prior years reserves, which more than offset an increase in automobile current accident year losses. Including all factors, the property and casualty combined ratio was 98.3% for 2012 compared to 106.6% for 2011. Annuity segment net income of $40.5 million for 2012 increased $9.6 million compared to 2011, primarily reflecting an increase in the interest margin earned on fixed annuity assets accompanied by the current period favorable impact of financial market performance on the evaluation of deferred policy acquisition costs, compared to the prior year adverse impact. Life segment net income of $21.9 million increased $2.5 million, primarily due to favorable mortality experience in 2012. A number of the items above, which had a favorable impact on net income for 2012, were notably more favorable than management would typically expect and are described in more detail in Results of Operations for the Three Years Ended December 31, 2012.
F-3
Premiums written and contract deposits decreased 1% compared to 2011 due to the decrease in annuity deposit receipts. Compared to a notably high level of receipts in 2011, annuity deposits received in the current year decreased 4% compared to 2011, reflecting a 2% decrease in single deposit and rollover receipts in the current year accompanied by a 5% decrease in scheduled deposit receipts. Property and casualty segment premiums written increased 1% compared to the prior year, as the favorable premium impact from increases in average premium per policy for both homeowners and automobile in the current year was offset by the reduced level of automobile and homeowners policies in force. Life segment insurance premiums and contract deposits increased 1% compared to 2011.
The Companys book value per share was $31.65 at December 31, 2012, an increase of 19% compared to 12 months earlier. This increase reflected net income for the 12 months and the improvement in net unrealized investment gains due to slightly lower yields on U.S. Treasury securities and narrower credit spreads across virtually all asset classes, the combination of which resulted in an increase in net unrealized gains for the Companys holdings of corporate securities, municipal securities, and mortgage-backed and asset-backed securities.
Critical Accounting Policies
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires the Companys management to make estimates and assumptions based on information available at the time the consolidated financial statements are prepared. These estimates and assumptions affect the reported amounts of the Companys consolidated assets, liabilities, shareholders equity and net income. Certain accounting estimates are particularly sensitive because of their significance to the Companys consolidated financial statements and because of the possibility that subsequent events and available information may differ markedly from managements judgments at the time the consolidated financial statements were prepared. Management has discussed with the Audit Committee the quality, not just the acceptability, of the Companys accounting principles as applied in its financial reporting. The discussions generally included such matters as the consistency of the Companys accounting policies and their application, and the clarity and completeness of the Companys consolidated financial statements, which include related disclosures. For the Company, the areas most subject to significant management judgments include: fair value measurements, other-than-temporary impairment of investments, goodwill, deferred policy acquisition costs for annuity and interest-sensitive life products, liabilities for property and casualty claims and claim expenses, liabilities for future policy benefits, deferred taxes and valuation of assets and liabilities related to the defined benefit pension plan.
Fair Value Measurements
The fair value of a financial instrument is the estimated amount at which the instrument could be exchanged in an orderly transaction between knowledgeable, unrelated and willing parties. The valuation of fixed maturity securities and equity securities is more subjective when markets are less liquid due to the lack of market based inputs, which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur.
F-4
Valuation of Fixed Maturity and Equity Securities
For fixed maturity securities, each month the Company obtains fair value prices from its investment managers and custodian bank. Fair values for the Companys fixed maturity securities are based primarily on prices provided by its investment managers as well as its custodian bank for certain securities. The prices from the custodian bank are compared to prices from the investment managers. Differences in prices between the sources that the Company considers significant are researched and the Company utilizes the price that it considers most representative of an exit price. Both the investment managers and the custodian bank use a variety of independent, nationally recognized pricing sources to determine market valuations. Each designate specific pricing services or indexes for each sector of the market based upon the providers expertise. Typical inputs used by these pricing sources include, but are not limited to, reported trades, benchmark yield curves, benchmarking of like securities, rating designations, sector groupings, issuer spreads, bids, offers, and/or estimated cash flows and prepayment speeds.
When the pricing sources cannot provide fair value determinations, the Company obtains non-binding price quotes from broker-dealers. The broker-dealers valuation methodology is sometimes matrix-based, using indicative evaluation measures and adjustments for specific security characteristics and market sentiment. The market inputs utilized in the evaluation measures and adjustments include: benchmark yield curves, reported trades, broker/dealer quotes, ratings and corresponding issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The extent of the use of each market input depends on the market sector and the market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities, additional inputs may be necessary.
The Company analyzes price and market valuations received to verify reasonableness, to understand the key assumptions used and their sources, to conclude the prices obtained are appropriate, and to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. Based on this evaluation and investment class analysis, each security is classified into Level 1, 2 or 3. The Company has in place certain control processes to determine the reasonableness of the financial asset fair values. These processes are designed to ensure (1) the values received are reasonable and accurately recorded, (2) the data inputs and valuation techniques utilized are appropriate and consistently applied, and (3) the assumptions are reasonable and consistent with the objective of determining fair value. For example, on a continuing basis, the Company assesses the reasonableness of individual security values obtained from pricing sources that vary from certain thresholds. The Companys fixed maturity securities portfolio is primarily publicly traded, which allows for a high percentage of the portfolio to be priced through pricing services. Approximately 88% of the portfolio, based on fair value, was priced through pricing services or index priced as of December 31, 2012. The remainder of the portfolio was priced by broker-dealers or pricing models. When non-binding broker-dealer quotes could be corroborated by comparison to other vendor quotes, pricing models or analysis utilizing observable inputs, the securities were generally classified as Level 2. There were no significant changes to the valuation process during 2012.
Fair values of equity securities have been determined by the Company from observable market quotations, when available. When a public quotation is not available, equity securities are valued by using non-binding broker quotes or through the use of pricing models or analysis that is based on observable market information such as interest rates, credit spreads and
F-5
liquidity. The underlying source data for calculating the matrix of credit spreads relative to the U.S. Treasury curve are nationally recognized indices. In addition, credit rating (or credit quality equivalent information) of securities is also factored into a pricing matrix. These inputs are based on assumptions deemed appropriate given the circumstances and are believed to be consistent with what some market participants would use when pricing such securities. There were no significant changes to the valuation process in 2012.
At December 31, 2012, Level 3 invested assets comprised approximately 2% of the Companys total investment portfolio fair value. Invested assets are classified as Level 3 when fair value is determined based on unobservable inputs that are supported by little or no market activity and those inputs are significant to the fair value. For additional detail, see Notes to Consolidated Financial Statements -- Note 3 -- Fair Value of Financial Instruments listed on page F-1 of this report.
Other-than-temporary Impairment of Investments
The Companys methodology of assessing other-than-temporary impairments is based on security-specific facts and circumstances as of the balance sheet date. Based on these facts, if (1) the Company has the intent to sell the fixed maturity security, (2) it is more likely than not the Company will be required to sell the fixed maturity security before the anticipated recovery of the amortized cost basis, or (3) management does not expect to recover the entire cost basis of the fixed maturity security, an other-than-temporary impairment is considered to have occurred. For equity securities, if (1) the Company does not have the ability and intent to hold the security for the recovery of cost or (2) recovery of cost is not expected within a reasonable period of time, an other-than-temporary impairment is considered to have occurred. Additionally, if events become known that call into question whether the security issuer has the ability to honor its contractual commitments, such security holding will be evaluated to determine whether or not such security has suffered an other-than-temporary decline in value.
The Company reviews the fair value of all investments in its portfolio on a monthly basis to assess whether an other-than-temporary decline in value has occurred. These reviews, in conjunction with the Companys investment managers monthly credit reports and relevant factors such as (1) the financial condition and near-term prospects of the issuer, (2) the length of time and extent to which the fair value has been less than amortized cost for fixed maturity securities or cost for equity securities, (3) for fixed maturity securities, the Companys intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the anticipated recovery in the amortized cost basis; and for equity securities, the Companys ability and intent to hold the security for the recovery of cost or if recovery of cost is not expected within a reasonable period of time, (4) the stock price trend of the issuer, (5) the market leadership position of the issuer, (6) the debt ratings of the issuer, and (7) the cash flows and liquidity of the issuer or the underlying cash flows for asset-backed securities, 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 for all equity securities and for the credit-related loss portion associated with impaired fixed maturity securities. The amount of the total other-than-temporary impairment related to non-credit factors for fixed maturity securities is recognized in other comprehensive income, net of applicable taxes, unless the Company has the intent to sell the security or if it is more likely than not the Company will be required to sell the security before the anticipated recovery of the amortized cost basis.
F-6
With respect to fixed income securities involving securitized financial assets -- primarily asset-backed and commercial mortgage-backed securities in the Companys portfolio -- a significant portion of the fair values is determined by observable inputs. In addition, the securitized financial asset securities underlying collateral cash flows are stress tested to determine if there has been any adverse change in the expected cash flows.
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 spread widening, market illiquidity or changes in interest rates where there exists a reasonable expectation based on the Companys consideration of all objective information available that the Company will recover the entire cost basis of the security and the Company does not have the intent to sell the investment before maturity or a market recovery is realized and it is more likely than not the Company will not be required to sell the investment. An other-than-temporary impairment loss will be recognized based upon all relevant facts and circumstances for each investment, as appropriate.
Goodwill
Goodwill represents the excess of the amounts paid to acquire a business over the fair value of its net assets at the date of acquisition. Goodwill is not amortized, but is tested for impairment at the reporting unit level at least annually or more frequently if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. A reporting unit is defined as an operating segment or a business unit one level below an operating segment. The Companys reporting units, for which goodwill has been allocated, are equivalent to the Companys operating segments. As of December 31, 2012, the Companys allocation of goodwill by reporting unit/segment was as follows: $28.0 million, annuity; $9.9 million, life; and $9.5 million, property and casualty.
Effective January 1, 2012, the goodwill impairment test, as defined in the accounting guidance, allows an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity follows a two-step process. Recent accounting guidance did not change the existing two-step process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of confirming and measuring the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss would be recognized in an amount equal to that excess, and the charge could have a material adverse effect on the Companys results of operations.
The Company completed its annual goodwill assessment for the individual reporting units as of December 31, 2012 and did not utilize the option to perform an initial assessment of qualitative factors. The first step of the Companys analysis indicated that fair value exceeded carrying value for all reporting units other than the life unit. Managements determination of the fair value of each reporting unit incorporated multiple inputs including discounted cash flow calculations, the level of the Companys own share price and assumptions that market participants would make in valuing each reporting unit. Fair value estimates were based primarily on an in-depth analysis of historical experience, projected future cash flows and
F-7
relevant discount rates, which considered market participant inputs and the relative risk associated with the projected cash flows. Other assumptions included levels of economic capital, future business growth, earnings projections and assets under management for each reporting unit. Estimates of fair value are subject to assumptions that are sensitive to change and represent the Companys reasonable expectation regarding future developments. The Company also considered other valuation techniques such as peer company price-to-earnings and price-to-book multiples.
For the life reporting unit, the Company determined that the reporting units fair value was less than its carrying value, primarily driven by unrealized investment gains combined with a decrease in anticipated net investment income assuming an extended low interest rate environment. Accordingly, recoverability was evaluated assuming fair value was allocated to assets and liabilities as if the reporting unit had been acquired in a business combination. In the second step, the implied fair value of the life reporting units goodwill was determined in the same manner as goodwill is measured in a business combination (i.e., by measuring the fair value of the reporting units assets, liabilities and unrecognized intangible assets and determining the remaining amount attributed to goodwill) and comparing the amount of the implied goodwill to the carrying amount of the goodwill. The implied fair value for the life reporting units goodwill was greater than its carrying value; therefore, goodwill was not impaired and no write-down was required. However, the implied fair value exceeded carrying value for the life reporting unit by a limited margin, which indicates a greater risk of future impairment for this reporting units goodwill.
As part of the Companys December 31, 2012 goodwill analysis, the Company compared the fair value of the aggregated reporting units to the market capitalization of the Company. The difference between the aggregated fair value of the reporting units and the market capitalization of the Company was attributed to several factors, most notably market sentiment, trading volume and transaction premium. The amount of the transaction premium was determined to be reasonable based on insurance industry and Company-specific facts and circumstances.
The assessment of goodwill recoverability requires significant judgment and is subject to inherent uncertainty. The use of different assumptions, within a reasonable range, could cause the fair value to be below carrying value. Subsequent goodwill assessments could result in impairment, particularly for each reporting unit with at-risk goodwill, due to the impact of a volatile financial market on earnings, discount rate assumptions, liquidity and market capitalization. Management believes the Companys continued depressed market capitalization is largely the result of current global financial market conditions and is similar to companies within the annuity and life insurance sector. There were no other events or material changes in circumstances during 2012 that indicated that a material change in the fair value of the Companys reporting units had occurred.
Deferred Policy Acquisition Costs for Annuity and Interest-sensitive Life Products
Policy acquisition costs, consisting of commissions, policy issuance and other costs which are incremental and directly related to the successful acquisition of new or renewal business, are capitalized and amortized on a basis consistent with the type of insurance coverage. For all investment (annuity) contracts, acquisition costs are amortized over 20 years in proportion to estimated gross profits. Capitalized acquisition costs for interest-sensitive life contracts also are amortized over 20 years in proportion to estimated gross profits.
F-8
The most significant assumptions that are involved in the estimation of annuity gross profits include interest rate spreads, future financial market performance, business surrender/lapse rates, expenses and the impact of realized investment gains and losses. For the variable deposit portion of the annuity segment, the Company amortizes policy acquisition costs utilizing a future financial market performance assumption of a 10% reversion to the mean approach with a 200 basis point corridor around the mean during the reversion period, representing a cap and a floor on the Companys long-term assumption. The Companys practice with regard to returns on Separate Accounts assumes that long-term appreciation in the financial market is not changed by short-term market fluctuations, but is only changed when sustained interim deviations are experienced. The Company monitors these fluctuations and only changes the assumption when its long-term expectation changes. The potential effect of an increase/(decrease) by 100 basis points in the assumed future rate of return is reasonably likely to result in an estimated decrease/(increase) in the deferred policy acquisition costs amortization expense of approximately $1 million. Although this evaluation reflects likely outcomes, it is possible an actual outcome may fall below or above these estimates. At December 31, 2012, the ratio of capitalized annuity policy acquisition costs to the total annuity accumulated cash value was approximately 3%.
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 current period amortization expense for the period in which the adjustment is made. As noted above, there are key assumptions involved in the evaluation of capitalized policy acquisition costs. In terms of the sensitivity of this amortization to two of the more significant assumptions, based on capitalized annuity policy acquisition costs as of December 31, 2012 and assuming all other assumptions are met, (1) a 10 basis point deviation in the annual targeted interest rate spread assumption would impact amortization between $0.15 million and $0.25 million and (2) a 1% deviation from the targeted financial market performance for the underlying mutual funds of the Companys variable annuities would impact amortization between $0.20 million and $0.30 million. These results may change depending on the magnitude and direction of any actual deviations but represent a range of reasonably likely experience for the noted assumptions. Detailed discussion of the impact of adjustments to the amortization of capitalized acquisition costs is included in Results of Operations for the Three Years Ended December 31, 2012 -- Policy Acquisition Expenses Amortized. See also Notes to Consolidated Financial Statements -- Note 1 -- Summary of Significant Accounting Policies -- Adopted Accounting Standards -- Costs Associated with Acquiring or Renewing Insurance Contracts regarding new accounting guidance which the Company adopted effective January 1, 2012.
Liabilities for Property and Casualty Claims and Claim Expenses
Underwriting results of the property and casualty segment are significantly influenced by estimates of the Companys 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 (case reserves), claims incurred but not yet reported (IBNR) and associated settlement expenses (together, loss reserves). The process by which these reserves are established requires reliance upon estimates based on known facts and on interpretations of circumstances, including the Companys experience with similar cases and
F-9
historical trends involving claim payments and related patterns, pending levels of unpaid claims and product mix, as well as other factors including court decisions, economic conditions, public attitudes and medical costs. The Company calculates and records a single best estimate of the reserve (which is equal to the actuarial point estimate) as of each balance sheet date.
Reserves are reestimated quarterly. Changes to reserves are recorded in the period in which development factor changes result in reserve reestimates. A detailed discussion of the process utilized to estimate loss reserves, risk factors considered and the impact of adjustments recorded during recent years is included in Notes to Consolidated Financial Statements -- Note 4 -- Property and Casualty Unpaid Claims and Claim Expenses listed on page F-1 of this report. Due to the nature of the Companys personal lines business, the Company has no exposure to losses related 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 mold.
Based on the Companys products and coverages, historical experience, and modeling of various actuarial methodologies used to develop reserve estimates, the Company estimates that the potential variability of the property and casualty loss reserves within a reasonable probability of other possible outcomes may be approximately plus or minus 6%, which equates to plus or minus approximately $10 million of net income based on net reserves as of December 31, 2012. Although this evaluation reflects the most likely outcomes, it is possible the final outcome may fall below or above these estimates.
There are a number of assumptions involved in the determination of the Companys property and casualty loss reserves. Among the key factors affecting recorded loss reserves for both long-tail and short-tail related coverages, claim severity and claim frequency are of particular significance. Management estimates that a 2% change in claim severity or claim frequency for the most recent 36-month period is a reasonably likely scenario based on recent experience and would result in a change in the estimated loss reserves of between $6.0 million and $10.0 million for long-tail liability related exposures (automobile liability coverages) and between $2.0 million and $4.0 million for short-tail liability related exposures (homeowners and automobile physical damage coverages). Actual results may differ, depending on the magnitude and direction of the deviation.
The Companys actuaries discuss their loss and loss adjustment expense actuarial analysis with management. As part of this discussion, the indicated point estimate of the IBNR loss reserve by line of business (coverage) is reviewed. The Company actuaries also discuss any indicated changes to the underlying assumptions used to calculate the indicated point estimate. Any variance between the indicated reserves from these changes in assumptions and the previously carried reserves is reviewed. After discussion of these analyses and all relevant risk factors, management determines whether the reserve balances require adjustment. The Companys best estimate of loss reserves may change depending on a revision in the underlying assumptions.
F-10
The Companys liabilities for unpaid claims and claim expenses for the property and casualty segment were as follows:
December 31, 2012 | December 31, 2011 | |||||||||||||||||||||||
Case | IBNR | Case | IBNR | |||||||||||||||||||||
Reserves | Reserves | Total (1) | Reserves | Reserves | Total (1) | |||||||||||||||||||
Automobile liability |
$69.7 | $128.0 | $197.7 | $66.6 | $129.2 | $195.8 | ||||||||||||||||||
Automobile other |
5.5 | 1.3 | 6.8 | 4.7 | 1.5 | 6.2 | ||||||||||||||||||
Homeowners |
8.9 | 41.0 | 49.9 | 8.1 | 52.5 | 60.6 | ||||||||||||||||||
All other |
3.4 | 16.7 | 20.1 | 1.7 | 16.8 | 18.5 | ||||||||||||||||||
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Total |
$87.5 | $187.0 | $274.5 | $81.1 | $200.0 | $281.1 | ||||||||||||||||||
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(1) | These amounts are gross, before reduction for ceded reinsurance reserves. |
The facts and circumstances leading to the Companys reestimate of reserves relate to revisions of the development factors used to predict how losses are likely to develop from the end of a reporting period until all claims have been paid. Reestimates occur because actual loss amounts are different than those predicted by the estimated development factors used in prior reserve estimates. At December 31, 2012, the impact of a reserve reestimation resulting in a 1% increase in net reserves would be a decrease of approximately $2 million in net income. A reserve reestimation resulting in a 1% decrease in net reserves would increase net income by approximately $2 million.
Favorable prior years reserve reestimates increased net income in 2012 by approximately $11.2 million, primarily the result of favorable frequency and severity trends in voluntary automobile losses for accident years 2011 and prior. The lower than expected claims emergence and resultant lower expected loss ratios caused the Company to lower its reserve estimate at December 31, 2012.
Information regarding the Companys property and casualty claims and claims expense reserve development table as of December 31, 2012 is located in Business -- Property and Casualty Segment -- Property and Casualty Reserves. Information regarding property and casualty reserve reestimates for each of the years in the three year period ended December 31, 2012 is located in -- Results of Operations for the Three Years Ended December 31, 2012 -- Benefits, Claims and Settlement Expenses.
Liabilities 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 lapses. Mortality and lapse assumptions for all policies have been based on actuarial tables which are consistent with the Companys own experience. In the event actual experience is worse than the assumptions, additional reserves may be required. This would result in a charge to income for the period in which the increase in reserves occurred. 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.
F-11
Deferred Taxes
Deferred tax assets and liabilities represent the tax effect of the differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. The Company evaluates deferred tax assets periodically to determine if they are realizable. Factors in the determination include the performance of the business including the ability to generate taxable income from a variety of sources and tax planning strategies. If, based on available information, it is more likely than not that the deferred income tax asset will not be realized, then a valuation allowance must be established with a corresponding charge to net income. Charges to establish a valuation allowance could have a material adverse effect on the Companys results of operations and financial position.
Valuation of Liabilities Related to the Defined Benefit Pension Plan
Effective April 1, 2002, participants stopped accruing benefits under the defined benefit pension plan but continue to retain the benefits they had accrued to that date.
The Companys 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 3.51% was used by the Company for estimating accumulated benefits under the plan at December 31, 2012, 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 the Mercer Above Mean Yield Curve. The expected annual return on plan assets assumed by the Company at December 31, 2012 was 7.5%. 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 reasonable 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 Companys 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 $0.1 million and $1.0 million, respectively. In addition, for every $1 million increase (decrease) in the value of pension plan assets, there is a comparable pretax increase (decrease) in AOCI.
F-12
Results of Operations for the Three Years Ended December 31, 2012
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
(Includes annuity and life contract deposits)
Year Ended
December 31, |
Change From
Prior Year |
Year Ended
December 31, |
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2012 | 2011 | Percent | Amount |
2010 |
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Property & casualty |
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Automobile and property (voluntary) |
$ | 547.2 | $ | 542.0 | 1.0 | % | $ | 5.2 | $ | 553.2 | |||||||||||||||
Involuntary and other property & casualty |
3.6 | 3.9 | -7.7 | % | (0.3 | ) | 3.9 | ||||||||||||||||||
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Total property & casualty |
550.8 | 545.9 | 0.9 | % | 4.9 | 557.1 | |||||||||||||||||||
Annuity deposits |
417.6 | 433.9 | -3.8 | % | (16.3 | ) | 395.5 | ||||||||||||||||||
Life |
99.3 | 98.6 | 0.7 | % | 0.7 | 99.4 | |||||||||||||||||||
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Total |
$ | 1,067.7 | $ | 1,078.4 | -1.0 | % | $ | (10.7 | ) | $ | 1,052.0 | ||||||||||||||
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Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
Year Ended
December 31, |
Change From
Prior Year |
Year Ended
December 31, |
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2012 | 2011 | Percent | Amount |
2010 |
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Property & casualty |
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Automobile and property (voluntary) |
$ | 542.6 | $ | 544.1 | -0.3% | $ | (1.5 | ) | $ | 551.8 | |||||||||||||||
Involuntary and other property & casualty |
3.7 | 3.4 | 8.8% | 0.3 | 4.0 | ||||||||||||||||||||
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Total property & casualty |
546.3 | 547.5 | -0.2% | (1.2 | ) | 555.8 | |||||||||||||||||||
Annuity |
21.8 | 18.9 | 15.3% | 2.9 | 17.4 | ||||||||||||||||||||
Life |
102.4 | 100.7 | 1.7% | 1.7 | 99.5 | ||||||||||||||||||||
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||||||||||||||||||
Total |
$ | 670.5 | $ | 667.1 | 0.5% | $ | 3.4 | $ | 672.7 | ||||||||||||||||
|
|
|
|
|
|
|
|
For 2012, the Companys premiums written and contract deposits of $1,067.7 million decreased $10.7 million, or 1.0%, compared to 2011, due to the decrease in annuity deposit receipts. For 2011, the Companys premiums written and contract deposits increased $26.4 million, or 2.5%, compared to 2010, driven by the increase in annuity single premium and rollover deposit receipts which was partially offset by the decrease in property and casualty premiums written. The Companys premiums and contract charges earned increased $3.4 million, or 0.5%, compared to 2011 reflecting growth from the annuity and life segments, as well as the increasing favorable impact on earned premium of the automobile and property rate actions taken in 2011 and 2012 which were more than offset by a reduced level of property and casualty policies in force compared to the prior year, including policy reductions due to the Florida homeowners non-renewal program described below. For 2011, the Companys premiums and contract charges earned decreased $5.6 million, or 0.8%, compared to 2010, primarily reflecting the decrease in property and casualty segment earned premiums, partially offset by growth in annuity contract charges earned. Voluntary property and casualty business represents policies sold through the Companys marketing organization and issued under the Companys underwriting guidelines. Involuntary property and casualty business consists of allocations of business from state mandatory insurance facilities and assigned risk business.
Total voluntary automobile and homeowners premium written increased 1.0%, or $5.2 million, in 2012. Average written premium per policy for both automobile and homeowners increased compared to the prior year, with the impact largely offset by a reduced level of automobile and homeowners policies in force in the current period. For the Companys automobile and homeowners business, rate changes effective during 2012 averaged 5% and 7%, respectively, compared to 2% and 9%, respectively, during 2011. At December 31, 2012, there were 484,000 voluntary automobile and 237,000 homeowners policies in force, for a total
F-13
of 721,000 policies, compared to a total of 725,000 policies at December 31, 2011 and 760,000 policies at December 31, 2010. Management believes that the Companys rate and risk mitigation actions have had a negative impact, in some locations, on its policy retention rates and its sales levels, particularly in its automobile line and particularly in 2010 and 2011. Consequently, during 2011, the Company developed and began implementing state-specific pricing, underwriting and marketing initiatives designed to improve automobile new sales and retention levels, with favorable results beginning to emerge in the last several months of 2011 and continuing in 2012.
Based on policies in force, the current year voluntary automobile 6-month and 12-month retention rates for new and renewal policies were 91.8% and 84.7%, respectively, compared to 90.5% and 83.0%, respectively, at December 31, 2011 and 90.5% and 83.8%, respectively, at December 31, 2010. The property 12-month new and renewal policy retention rate was 88.1%, 85.6% and 86.7% at December 31, 2012, 2011 and 2010, respectively, with the changes including the impact of the Companys risk mitigation actions described below. Particularly for voluntary automobile, the retention rate has been favorably impacted by the Companys focus on expanding the number of multiline customers and customer utilization of automatic payment plans, as well as other underwriting actions.
Voluntary automobile premium written increased 0.1%, or $0.4 million, compared to 2011. In 2011, voluntary automobile premium written decreased 3.5%, or $12.9 million compared to 2010. In 2012, the average written premium per policy and average earned premium per policy each increased approximately 1% compared to a year earlier, which was nearly offset by the decline in policies in force. In 2011, the average written and earned premium per policy increased 1% and 2%, respectively, more than offset by the decline in policies in force. Voluntary automobile policies in force at December 31, 2012 decreased 2,000 compared to December 31, 2011 and 24,000 compared to December 31, 2010. Educator policies increased slightly compared to December 31, 2011, and decreased compared to December 31, 2010. The number of educator policies represented approximately 83% of the voluntary automobile policies in force at both December 31, 2012 and 2011. The number of non-educator policies decreased compared to both December 31, 2011 and 2010.
Voluntary homeowners premium written increased 2.6%, or $4.8 million, compared to 2011, net of catastrophe reinsurance premiums ceded that were less than the prior year. In 2011, voluntary homeowners premium written increased 0.9%, or $1.7 million, compared to 2010, also net of catastrophe reinsurance premiums ceded that were less than the prior year. The average written and earned premium per policy increased 2% and 4%, respectively, in 2012 compared to a year earlier. In 2011, the average written and earned premium per policy increased 5% and 6%, respectively, compared to 2010. Homeowners policies in force at December 31, 2012 decreased 2,000 compared to December 31, 2011 and 15,000 compared to December 31, 2010. The number of educator policies represented approximately 78% and 77% of the homeowners policies in force at December 31, 2012 and 2011, respectively. Educator policies increased slightly compared to December 31, 2011. Growth in the number of educator policies that had been consistent sequentially for several years was offset somewhat beginning in the third quarter of 2010 by expected reductions due to the Companys risk mitigation programs, including actions in catastrophe-prone coastal areas, involving policies of both educators and non-educators. The Company continues to evaluate and implement actions to further mitigate its risk exposure in hurricane-prone areas, as well as other areas of the country. Such actions could include, but are not limited to, non-renewal of homeowners policies, restricted agent geographic placement, limitations on agent new
F-14
business sales, further tightening of underwriting standards and increased utilization of third-party vendor products.
As an example, in early 2010 the Company began a program to address homeowners profitability and hurricane exposure issues in Florida. On January 1, 2010, the Company ceased writing new property homeowner policies in that state and initiated a program to non-renew about 9,600 policies, over half of the Companys Florida book of property business, starting with August 2010 policy effective dates. By mid-August 2011, the non-renewal program had been completed. The Companys December 31, 2012 policy count for Florida homeowners business of less than 5,500 decreased by approximately 11,500 compared to December 31, 2009 and included virtually no remaining risk exposure in the more sinkhole-prone counties. Throughout the non-renewal program period, the Companys agents worked closely with customers to find coverage with third-party companies that underwrite property risks in Florida. This program is expected to reduce risk exposure concentration, reduce overall catastrophe reinsurance costs and improve homeowners underwriting results.
In 2012, total annuity deposits received decreased 3.8%, or $16.3 million, compared to the prior year, with the decrease attributable to both a 5.5% decrease in scheduled annuity deposit receipts and a 2.4% decrease in single premium and rollover deposit receipts. In 2011, total annuity deposits received increased 9.7%, driven by the 24.7% increase in single premium and rollover deposit receipts which more than offset the 5.4% decrease in scheduled annuity deposit receipts. In 2012, new deposits to variable accounts increased 3.9%, or $4.2 million, and new deposits to fixed accounts decreased 6.3%, or $20.5 million, compared to the prior year. In 2011, new deposits to variable accounts decreased 1.1%, or $1.2 million, and new deposits to fixed accounts increased 13.9%, or $39.6 million, compared to 2010. In addition to external contractholder deposits, annuity new deposits include contributions and transfers by the Companys employees in the Companys 401(k) group annuity contract.
Total annuity accumulated cash value of $4.8 billion at December 31, 2012 increased 9.8% compared to a year earlier, reflecting the increase from new deposits received as well as favorable retention. Cash value retentions for variable and fixed annuity options were 94.3% and 95.4%, respectively, for the 12 month period ended December 31, 2012, each reflecting improvement compared to a year earlier. At December 31, 2012, the number of annuity contracts outstanding of 189,000 increased 5,000 contracts compared to December 31, 2011 and 8,000 contracts compared to December 31, 2010.
Variable annuity accumulated balances of $1.4 billion at December 31, 2012 reflected an increase of 9.8% compared to December 31, 2011, reflecting favorable financial market performance over the 12 months (driven primarily by equity securities) partially offset by net balances transferred from the variable account option to the guaranteed interest rate fixed account option. Annuity segment contract charges earned increased 15.3%, or $2.9 million, compared to 2011. Variable annuity accumulated balances at December 31, 2011 reflected a decrease of 7.4% compared to December 31, 2010, including the unfavorable impact of financial market performance over the 12 months, particularly the performance in the third quarter of 2011. For 2011, annuity segment contract charges earned increased 8.6%, or $1.5 million, compared to 2010, primarily due to the growth in average variable annuity account values during the first six months of 2011.
F-15
Life segment premiums and contract deposits for 2012 increased $0.7 million, or 0.7%, compared to 2011. Life segment premiums and contract deposits for 2011 decreased $0.8 million, or 0.8%, compared to 2010. The ordinary life insurance in force lapse ratio was 4.2% for the 12 months ended December 31, 2012 compared to 4.7% and 4.8% for the 12 months ended December 31, 2011 and 2010, respectively.
Sales
For the Company, as well as other personal lines property and casualty companies, new business levels over the three years ended December 31, 2012 were adversely impacted by the economy and the overall lower level of automobile and home sales compared to levels preceding the 2008 financial crisis. In addition, management believes that automobile and homeowners new business levels were negatively impacted by the Companys rate actions and by the Companys underwriting actions in Florida initiated in 2010.
Despite these challenges, the Companys 2011 positive sales momentum in all lines of business carried into 2012. In 2012, true new automobile sales units -- units associated with new Horace Mann automobile policyholders -- increased 19.9% compared to full year 2011, reflecting the continued positive impact of state-specific pricing, underwriting and marketing programs implemented during the last several months of 2011. Total new automobile units, tempered by a modest increase in additional vehicles added to existing automobile policies, increased 12.1% compared to 2011. New homeowners sales units increased 15.7% compared to 2011.
The Companys 2012 annuity new business levels continued to benefit from agent training and marketing programs, which focus on retirement planning, and build on the positive, record-level results produced throughout 2011 and 2010. Total annuity sales for 2012 increased 0.8% compared to 2011. The Companys new scheduled deposit business (measured on an annualized basis at the time of sale, compared to the reporting of new contract deposits which are recorded when cash is received) increased 4.1% compared to 2011. Partially offsetting this, single premium and rollover deposits for Horace Mann annuity products decreased 2.5% compared to 2011. In 2012, sales of third-party vendor annuity products, a relatively minor component of total annuity sales, increased notably compared to 2011. Annuity sales by Horace Manns agency force increased 13.8% compared to 2011. Sales of Horace Mann products by the Independent Agent distribution channel, included in the information above, decreased 33.7% compared to 2011, a comparison impacted by current year decreases in single premium and rollover deposits. The Companys annuity sales levels in recent years have been impacted as K-12 educators respond to uncertainties regarding employment prospects during the economic recession. In situations where educator retirements increase, opportunities arise for single premium and rollover deposit business. For employed educators, uncertainty about their future employment has created challenges for new sales of scheduled deposit business. The current low interest rate environment also is a factor in educators decisions regarding retirement planning.
The Companys introduction of new educator-focused portfolios of term and whole life products in recent years has contributed to the increase in sales of proprietary life products. For 2012, the increase in total life sales of 28.8% included a 39.6% increase in sales of Horace Manns proprietary life products and a 20.3% increase in sales of third-party vendor products.
F-16
Combining these increases in all of the lines of business, the Companys total new business sales increased 4.7% compared to 2011. Total sales for Horace Manns Exclusive Agencies and Employee Agents for 2012 increased 15.0% compared to the prior year.
Distribution System
At December 31, 2012, there was a combined total of 760 Exclusive Agencies and Employee Agents, compared to 745 at December 31, 2011 and 741 at December 31, 2010, representing the fourth consecutive year in which the agency force size increased. The net increase in each year compared to a year earlier was driven by new Exclusive Agency appointments, partially offset by termination of lower producing agents. At December 31, 2012, there were 624 Horace Mann Exclusive Agencies, an increase of 75 compared to December 31, 2011. At December 31, 2012, in addition to the Exclusive Agencies, there were 136 Employee Agents. See additional description in Business -- Corporate Strategy and Marketing -- Dedicated Agency Force.
As mentioned above, the Company also utilizes a nationwide network of Independent Agents who comprise a supplemental distribution channel for the Companys 403(b) tax-qualified annuity products. The Independent Agent distribution channel included 492 authorized agents at December 31, 2012. During 2012, this channel generated $55.0 million in annualized new annuity sales for the Company compared to $83.1 million for 2011 and $70.1 million in 2010, reflecting decreases in single and rollover deposit business in the current year.
Net Investment Income
For 2012, pretax investment income of $306.0 million increased 6.1%, or $17.7 million, (5.8%, or $11.3 million, after tax) compared to 2011. For 2011, pretax investment income of $288.3 million increased 6.0%, or $16.2 million, (5.7%, or $10.5 million, after tax) compared to 2010. For both years, the increase primarily reflected growth in the size of the average investment portfolio on an amortized cost basis. Average invested assets increased 7.4% over the 12 months ended December 31, 2012. The average pretax yield on the investment portfolio was 5.63% (3.79% after tax) for 2012 compared to pretax yields of 5.70% (3.85% after tax) and 5.77% (3.91% after tax) for 2011 and 2010, respectively. During 2012, management continued to identify and secure investments with attractive risk-adjusted yields without venturing into asset classes or individual securities that would be inconsistent with the Companys conservative investment guidelines.
F-17
Net Realized Investment Gains and Losses
For 2012, net realized investment gains (pretax) were $27.3 million compared to net realized investment gains of $37.7 million and $23.8 million in 2011 and 2010, respectively. The net gains in all periods were realized from ongoing investment portfolio management activity and, when determined, the recording of impairment write-down charges.
For the year ended December 31, 2012, the Companys net realized investment gains of $27.3 million included $39.9 million of gross gains realized on security sales and calls partially offset by $12.6 million of realized losses on securities that were disposed of during 2012, primarily commercial mortgage-backed securities and also corporate securities to a lesser extent. There were no other-than-temporary impairment write-downs on securities in the current year. Gains realized on security disposals during 2012 included $4.6 million related to securities on which the Company had previously recognized other-than-temporary impairment write-downs.
For the year ended December 31, 2011, the Companys net realized investment gains of $37.7 million included $39.7 million of gross gains realized on security sales and calls partially offset by $2.0 million of realized losses on securities that were disposed of during 2011. Other-than-temporary impairment write-downs on securities were less than $0.1 million in 2011. Gains realized on security disposals during 2011 included $0.5 million related to securities on which the Company had previously recognized other-than-temporary impairment write-downs.
For the year ended December 31, 2010, the Companys net realized investment gains of $23.8 million included $51.2 million of gross gains realized on security sales and calls partially offset by $20.6 million of realized losses on securities that were disposed of during 2010 and $6.8 million of other-than-temporary impairment write-downs on securities. Gains realized on security disposals in 2010 included $5.6 million related to securities on which the Company had previously recognized other-than-temporary impairment write-downs. In the fourth quarter of 2010, losses of $15.2 million were realized on security disposals, primarily related to commercial mortgage-backed securities risk reduction actions. In 2010, the other-than-temporary impairment write-downs were related primarily to securities that the Company intended to sell.
The Company, from time to time, sells securities subsequent to the balance sheet date that were considered temporarily impaired at the balance sheet date. Such sales are generally due to issuer-specific events occurring subsequent to the balance sheet date that result in a change in the Companys intent to sell an invested asset.
F-18
Fixed Maturity Securities and Equity Securities Portfolios
The table below presents the Companys fixed maturity securities and equity securities portfolios as of December 31, 2012 by major asset class, including the ten largest sectors of the Companys corporate bond holdings (based on fair value). Compared to December 31, 2011, yields on U.S. Treasury securities decreased slightly while credit spreads narrowed across virtually all asset classes, the combination of which resulted in an increase in net unrealized gains for the Companys holdings of corporate securities, municipal securities, commercial and residential mortgage-backed securities and asset-backed securities.
Number of
Issuers |
Fair
Value |
Amortized
Cost or Cost |
Pretax Net
Unrealized Gain |
|||||||||||||||||
Fixed Maturity Securities |
||||||||||||||||||||
Corporate bonds |
||||||||||||||||||||
Banking and Finance |
67 | $ | 481.4 | $ | 431.1 | $ | 50.3 | |||||||||||||
Energy |
64 | 276.3 | 237.2 | 39.1 | ||||||||||||||||
Utilities |
45 | 271.9 | 225.3 | 46.6 | ||||||||||||||||
Insurance |
31 | 159.6 | 132.6 | 27.0 | ||||||||||||||||
Metal and Mining |
18 | 133.9 | 120.8 | 13.1 | ||||||||||||||||
Broadcasting and Media |
26 | 131.6 | 112.4 | 19.2 | ||||||||||||||||
Transportation |
22 | 127.9 | 117.1 | 10.8 | ||||||||||||||||
Health Care |
36 | 110.1 | 97.5 | 12.6 | ||||||||||||||||
Technology |
31 | 109.2 | 101.5 | 7.7 | ||||||||||||||||
Telecommunications |
21 | 95.9 | 81.8 | 14.1 | ||||||||||||||||
All Other Corporates (1) |
192 | 669.3 | 601.3 | 68.0 | ||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||
Total corporate bonds |
553 | 2,567.1 | 2,258.6 | 308.5 | ||||||||||||||||
Mortgage-backed securities |
||||||||||||||||||||
U.S. government and federally sponsored agencies |
378 | 619.6 | 547.1 | 72.5 | ||||||||||||||||
Commercial |
23 | 74.7 | 68.5 | 6.2 | ||||||||||||||||
Other |
12 | 15.3 | 11.3 | 4.0 | ||||||||||||||||
Municipal bonds |
479 | 1,586.0 | 1,402.4 | 183.6 | ||||||||||||||||
Government bonds |
||||||||||||||||||||
U.S. |
7 | 409.4 | 371.7 | 37.7 | ||||||||||||||||
Foreign |
8 | 57.9 | 48.5 | 9.4 | ||||||||||||||||
Collateralized debt obligations (2) |
31 | 115.1 | 109.0 | 6.1 | ||||||||||||||||
Asset-backed securities |
93 | 517.1 | 494.3 | 22.8 | ||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||
Total fixed maturity securities |
1,584 | $ | 5,962.2 | $ | 5,311.4 | $ | 650.8 | |||||||||||||
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|
|
|
|
|
|||||||||||||
Equity Securities |
||||||||||||||||||||
Non-redeemable preferred stocks |
9 | $ | 12.8 | $ | 12.6 | $ | 0.2 | |||||||||||||
Common stocks |
150 | 40.7 | 39.8 | 0.9 | ||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||
Total equity securities |
159 | $ | 53.5 | $ | 52.4 | $ | 1.1 | |||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||
Total |
1,743 | $ | 6,015.7 | $ | 5,363.8 | $ | 651.9 | |||||||||||||
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|
|
(1) |
The All Other Corporates category contains 20 additional industry classifications. Real estate, natural gas, consumer products, industry, retail and gaming represented $439.0 million of fair value at December 31, 2012, with the remaining 14 classifications each representing less than $47 million. |
(2) |
Based on fair value, 83.7% of the collateralized debt obligation securities were rated investment grade by Standard and Poors Corporation (S&P) and/or Moodys Investors Service, Inc. (Moodys) at December 31, 2012. |
At December 31, 2012, the Companys diversified fixed maturity securities portfolio consisted of 1,877 investment positions, issued by 1,584 entities, and totaled approximately $6.0 billion in fair value. This portfolio was 94.8% investment grade, based on fair value, with an average quality rating of A. The Companys investment guidelines generally limit single corporate issuer concentrations to 0.5% of invested assets for AA or AAA rated securities, 0.35% of invested assets for A or BBB rated securities, and 0.2% of invested assets for non-investment grade securities.
F-19
The following table presents the composition and value of the Companys fixed maturity securities and equity securities portfolios by rating category. At December 31, 2012, 94.2% of these combined portfolios were investment grade, based on fair value, with an overall average quality rating of A. The Company has classified the entire fixed maturity securities and equity securities portfolios as available for sale, which are carried at fair value.
Rating of Fixed Maturity Securities and Equity Securities(1)
(Dollars in millions)
Percent
of Total Fair Value |
Fair
Value |
Amortized
Cost or Cost |
|||||||||||||
Fixed maturity securities |
|||||||||||||||
AAA (2) |
4.2 | % | $ | 249.5 | $ | 225.7 | |||||||||
AA (2) |
33.8 | 2,015.7 | 1,787.4 | ||||||||||||
A |
25.6 | 1,525.2 | 1,329.3 | ||||||||||||
BBB |
31.2 | 1,863.5 | 1,676.8 | ||||||||||||
BB |
2.5 | 146.1 | 135.8 | ||||||||||||
B |
2.4 | 143.5 | 137.3 | ||||||||||||
CCC or lower |
0.2 | 12.3 | 12.8 | ||||||||||||
Not rated (3) |
0.1 | 6.4 | 6.3 | ||||||||||||
|
|
|
|
|
|
||||||||||
Total fixed maturity securities |
100.0 | % | $ | 5,962.2 | $ | 5,311.4 | |||||||||
|
|
|
|
|
|
||||||||||
Equity securities |
|||||||||||||||
AAA |
- | - | - | ||||||||||||
AA |
7.8 | % | $ | 4.2 | $ | 4.1 | |||||||||
A |
1.9 | 1.0 | 1.4 | ||||||||||||
BBB |
11.4 | 6.1 | 5.6 | ||||||||||||
BB |
2.8 | 1.5 | 1.5 | ||||||||||||
B |
- | - | - | ||||||||||||
CCC or lower |
- | - | - | ||||||||||||
Not rated (4) |
76.1 | 40.7 | 39.8 | ||||||||||||
|
|
|
|
|
|
||||||||||
Total equity securities |
100.0 | % | $ | 53.5 | $ | 52.4 | |||||||||
|
|
|
|
|
|
||||||||||
Total |
$ | 6,015.7 | $ | 5,363.8 | |||||||||||
|
|
|
|
(1) |
Ratings are as assigned primarily by S&P when available, with remaining ratings as assigned on an equivalent basis by Moodys. Ratings for publicly traded securities are determined when the securities are acquired and are updated monthly to reflect any changes in ratings. |
(2) |
During 2011, S&P and Moodys concluded on their respective evaluations of ratings for debt issued by the U.S. government. On August 2, 2011, Moodys affirmed its Aaa rating, with an outlook of negative. On August 5, 2011, S&P reduced its AAA long-term rating one notch to AA+, with an outlook of negative. At December 31, 2012, the AA rated fair value amount included $390.9 million of U.S. government and federally sponsored agency securities and $619.6 million of mortgage-backed securities issued by U.S. government and federally sponsored agencies. |
(3) |
Included in this category is $6.3 million fair value of private placement securities not rated by either S&P or Moodys. |
(4) |
This category represents common stocks that are not rated by either S&P or Moodys. |
At December 31, 2012, total fair value of the Companys European fixed maturity securities direct exposure was $245.7 million with a net unrealized gain of $20.2 million. The Company generally defines its country classification by issuer country of incorporation or domicile where appropriate. Given the economic, fiscal and political uncertainties surrounding a number of European countries, especially Greece, Ireland, Italy, Portugal and Spain (collectively GIIPS) and France, the Company closely monitors its direct European securities exposures. At December 31, 2012, the Company had no sovereign or equity security exposure in any European country, no exposure in the banking and finance industry in any of the GIIPS countries or France, no unfunded exposure related to its European securities holdings and no derivative or hedging instruments in its investment portfolio.
F-20
The Company also carefully monitors, and analyzes a number of factors to understand and identify, its indirect European exposure. While many factors are considered, it is difficult to know if all potential factors which may indirectly impact the Companys investment portfolio have been identified. The factors the Company considers include, but are not limited to, the issuers parent-subsidiary relationship, principal place of business, management location, source of revenue streams, industry classification and asset characteristics. At December 31, 2012, the Company did not identify significant indirect exposure to European countries in its investment portfolio.
The following table summarizes the Companys direct exposures by asset category related to selected groups of European countries and to Europe in total as of December 31, 2012.
Sovereign | Banking | Other Corporate | Asset-backed | Total | ||||||||||||||||||||||||||||||||||||||||||||||
Fair
Value |
Net
Unrealized Gain (Loss) |
Fair
Value |
Net
Unrealized Gain (Loss) |
Fair
Value |
Net
Unrealized Gain (Loss) |
Fair
Value |
Net
Unrealized Gain (Loss) |
Fair
Value |
Net
Unrealized Gain (Loss) |
|||||||||||||||||||||||||||||||||||||||||
Fixed Maturity Securities: |
||||||||||||||||||||||||||||||||||||||||||||||||||
GIIPS |
||||||||||||||||||||||||||||||||||||||||||||||||||
Greece |
$ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||||||||||||||||||||||
Ireland |
- | - | - | - | 4.7 | 0.1 | 10.0 | 0.1 | 14.7 | 0.2 | ||||||||||||||||||||||||||||||||||||||||
Italy |
- | - | - | - | - | - | - | - | - | - | ||||||||||||||||||||||||||||||||||||||||
Portugal |
- | - | - | - | - | - | - | - | - | - | ||||||||||||||||||||||||||||||||||||||||
Spain |
- | - | - | - | 10.7 | 0.7 | - | - | 10.7 | 0.7 | ||||||||||||||||||||||||||||||||||||||||
|
|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||
Total GIIPS |
- | - | - | - | 15.4 | 0.8 | 10.0 | 0.1 | 25.4 | 0.9 | ||||||||||||||||||||||||||||||||||||||||
France |
- | - | - | - | 19.6 | 2.5 | - | - | 19.6 | 2.5 | ||||||||||||||||||||||||||||||||||||||||
United Kingdom |
- | - | 4.0 | 0.6 | 104.4 | 7.6 | - | - | 108.4 | 8.2 | ||||||||||||||||||||||||||||||||||||||||
Other European |
||||||||||||||||||||||||||||||||||||||||||||||||||
Countries (1) |
- | - | 28.4 | 3.7 | 53.6 | 4.6 | 10.3 | 0.3 | 92.3 | 8.6 | ||||||||||||||||||||||||||||||||||||||||
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||
Total |
$ | - | $ | - | $ | 32.4 | $ | 4.3 | $ | 193.0 | $ | 15.5 | $ | 20.3 | $ | 0.4 | $ | 245.7 | $ | 20.2 | ||||||||||||||||||||||||||||||
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|
|
(1) |
The Other European Countries category contains 6 countries with the total fair value amount for each country representing less than $40 million. |
At December 31, 2012, the Company had $74.7 million fair value in commercial mortgage-backed securities (CMBS), all in the annuity and life portfolios, with a net unrealized gain of $6.2 million. At December 31, 2012, the Companys CMBS portfolio was 95.3% investment grade, with an overall credit rating of AA-, and well diversified by property type, geography and sponsor.
To evaluate the CMBS portfolio, the Company uses an estimate of future cash flows expected to be collected. The determination of cash flow estimates is inherently subjective and methodologies may vary depending on facts and circumstances specific to the security. All reasonably available information relevant to the collectability of the security, including past events, current conditions, and reasonable and supportable assumptions and forecasts, are considered when developing the estimate of cash flows expected to be collected. Information includes, but is not limited to, debt-servicing, missed refinancing opportunities and geography. Loan level characteristics such as issuer, payment terms, property type, and economic outlook are also utilized in financial models, along with historical performance, to estimate or measure the loans propensity to default. Additionally, financial models take into account loan age, lease rollovers, rent volatilities, vacancy rates and exposure to refinancing as additional drivers of default. For transactions where loan level data is not available, financial models use a proxy based on the collateral characteristics. Loss severity is a function of multiple factors including, but not limited to, the unpaid balance, interest rate, assessed property value at origination, change in property valuation and loan-to-value ratio at origination. Cost of capital rates and debt service ratios are also considered. The cash flows generated by the collateral securing these securities are then estimated using these default and loss severity assumptions. These collateral cash flows are then utilized, along with consideration for the issues position in the
F-21
overall structure, to estimate the cash flows associated with the commercial mortgage-backed security held by the Company.
The table below presents rating, vintage year and property type information for the Companys CMBS portfolio.
December 31, 2012 | December 31, 2011 | |||||||||||||||||||||||||||||
Number
of Positions |
Fair
Value |
Pretax
Unrealized Gain |
Number
of Positions |
Fair
Value |
Pretax
Unrealized Gain (Loss) |
|||||||||||||||||||||||||
Rating |
||||||||||||||||||||||||||||||
AAA |
5 | $ | 39.1 | $ | 3.0 | 4 | $ | 18.6 | $ | 2.2 | ||||||||||||||||||||
AA |
5 | 13.5 | 0.9 | 4 | 5.0 | 0.3 | ||||||||||||||||||||||||
A |
4 | 7.5 | 1.3 | 6 | 15.2 | * | ||||||||||||||||||||||||
BBB |
7 | 11.1 | 1.0 | 8 | 13.2 | (1.9 | ) | |||||||||||||||||||||||
BB and below |
2 | 3.5 | * | 6 | 18.8 | (9.3 | ) | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Total |
23 | $ | 74.7 | $ | 6.2 | 28 | $ | 70.8 | $ | (8.7 | ) | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Vintage year |
||||||||||||||||||||||||||||||
2003 and prior |
2 | $ | 2.7 | $ | * | 3 | $ | 4.9 | $ | 0.1 | ||||||||||||||||||||
2004 |
7 | 10.6 | 0.6 | 7 | 9.6 | (0.2 | ) | |||||||||||||||||||||||
2005 |
4 | 23.7 | 2.7 | 9 | 40.4 | (10.5 | ) | |||||||||||||||||||||||
2006 |
7 | 12.2 | 1.4 | 7 | 11.3 | 0.6 | ||||||||||||||||||||||||
2007 |
2 | 4.9 | 1.5 | 2 | 4.6 | 1.3 | ||||||||||||||||||||||||
2012 |
1 | 20.6 | * | - | - | - | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Total |
23 | $ | 74.7 | $ | 6.2 | 28 | $ | 70.8 | $ | (8.7 | ) | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Property type |
||||||||||||||||||||||||||||||
Conduit/Fusion |
20 | $ | 39.6 | $ | 4.3 | 26 | $ | 57.1 | $ | (9.7 | ) | |||||||||||||||||||
Single borrower |
3 | 35.1 | 1.9 | 2 | 13.7 | 1.0 | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Total |
23 | $ | 74.7 | $ | 6.2 | 28 | $ | 70.8 | $ | (8.7 | ) | |||||||||||||||||||
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|
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|
|
* | Less than $0.1 million. |
At December 31, 2012, the Company had $493.2 million fair value in financial institution bonds, preferred stocks and common stocks with a net unrealized gain of $50.1 million. The Companys holdings in this sector are well diversified among numerous institutions.
At December 31, 2012, the Company had $1,586.0 million fair value invested in municipal bonds with a net unrealized gain of $183.6 million. Of the geographically diversified municipal bond holdings, approximately 50% are tax-exempt and 79% are revenue bonds tied to essential services, such as mass transit, water and sewer. The overall credit quality of these securities was AA-, with approximately 26% of the value insured at December 31, 2012. This represents approximately 7% of the Companys total investment portfolio that is guaranteed by the mono-line credit insurers or other forms of guarantee. When selecting securities, the Company focuses primarily on the quality of the underlying security and does not place significant reliance on the additional insurance benefit. Excluding the effect of insurance, the credit quality of the underlying municipal bond portfolio was A+ at December 31, 2012.
At December 31, 2012, the fixed maturity securities and equity securities portfolios had a combined $11.2 million pretax of gross unrealized losses on $319.4 million fair value related to 199 positions. Of this amount, $4.1 million of pretax gross unrealized losses were on $237.7 million fair value for 148 positions that had been in a continuous unrealized loss position for 9 months or less.
F-22
Of the investment positions (fixed maturity securities and equity securities) with gross unrealized losses, 5 were trading below 80% of book value at December 31, 2012 and were not considered other-than-temporarily impaired. These positions included structured securities, corporate securities and equity securities. The 5 securities with fair values below 80% of book value at December 31, 2012 had fair value of $10.3 million, representing 0.2% of the Companys total investment portfolio at fair value, and had a gross unrealized loss of $3.2 million.
The Company views the unrealized losses of all of the securities at December 31, 2012 as temporary. For fixed maturity securities, management does not have the intent to sell the securities and it is not more likely than not the Company will be required to sell the securities before the anticipated recovery of the amortized cost bases. In addition, management expects to recover the entire cost basis of the fixed maturity securities. For equity securities, the Company has the ability and intent to hold the securities for the recovery of cost and recovery of cost is expected within a reasonable period of time. Additionally, as of the date of this Annual Report on Form 10-K, the Company is not aware of any events that call into question the ability of the issuers of the securities to honor their contractual commitments. Therefore, no impairment of these securities was recorded at December 31, 2012. Future changes in circumstances related to these and other securities could require subsequent recognition of other-than-temporary impairment losses.
F-23
Benefits, Claims and Settlement Expenses
Year Ended
December 31, |
Change From Prior
Year |
Year Ended
December 31, |
|||||||||||||||||||||||
2012 | 2011 | Percent | Amount |
2010 |
|||||||||||||||||||||
Property and casualty |
$ | 389.4 | $ | 442.5 | -12.0 | % | $ | (53.1 | ) | $ | 418.2 | ||||||||||||||
Annuity |
3.3 | 1.9 | 73.7 | % | 1.4 | 1.3 | |||||||||||||||||||
Life |
55.5 | 58.0 | -4.3 | % | (2.5 | ) | 55.3 | ||||||||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Total |
$ | 448.2 | $ | 502.4 | -10.8 | % | $ | (54.2 | ) | $ | 474.8 | ||||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Property and casualty catastrophe losses, included above (1) |
$ | 43.3 | $ | 86.0 | -49.7 | % | $ | (42.7 | ) | $ | 49.2 | ||||||||||||||
|
|
|
|
|
|
|
|
(1) | See footnote (1) to the table below. |
Property and Casualty Claims and Claim Expenses (losses)
Year Ended December 31, | |||||||||||||||
2012 |
2011 |
2010 |
|||||||||||||
Incurred claims and claim expenses: |
|||||||||||||||
Claims occurring in the current year |
$ | 406.6 | $ | 452.8 | $ | 438.7 | |||||||||
Decrease in estimated reserves for claims occurring in prior years (2) |
(17.2 | ) | (10.3 | ) | (20.5 | ) | |||||||||
|
|
|
|
|
|
||||||||||
Total claims and claim expenses incurred |
$ | 389.4 | $ | 442.5 | $ | 418.2 | |||||||||
|
|
|
|
|
|
||||||||||
Property and casualty loss ratio: |
|||||||||||||||
Total |
71.3 | % | 80.8 | % | 75.2 | % | |||||||||
Effect of catastrophe costs, included above (1) |
8.0 | % | 15.7 | % | 8.8 | % | |||||||||
Effect of prior years reserve development, included above (2) |
-3.2 | % | -1.9 | % | -3.7 | % | |||||||||
(1) Property and casualty catastrophe losses were incurred as follows: |
|
||||||||||||||
2012 |
2011 |
2010 |
|||||||||||||
Three months ended |
|||||||||||||||
March 31 |
$ | 5.9 | $ | 8.0 | $ | 6.8 | |||||||||
June 30 |
29.2 | 55.0 | 16.2 | ||||||||||||
September 30 (a) |
5.4 | 18.3 | 17.5 | ||||||||||||
December 31 |
2.8 | 4.7 | 8.7 | ||||||||||||
|
|
|
|
|
|
||||||||||
Total full year |
$ | 43.3 | $ | 86.0 | $ | 49.2 | |||||||||
|
|
|
|
|
|
(a) The three months ended September 30, 2010 included unfavorable reserve development for catastrophes occurring in the first half of 2010 as follows: first quarter $1.2 million; second quarter $6.3 million. |
|||||||||||||||
(2) Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous years to reflect subsequent information on such claims and changes in their projected final settlement costs. |
2012 |
2011 |
2010 |
|||||||||||||
Three months ended |
|||||||||||||||
March 31 |
$ | (4.0 | ) | $ | (2.7 | ) | $ | (4.5 | ) | ||||||
June 30 |
(4.5 | ) | (1.0 | ) | (2.8 | ) | |||||||||
September 30 |
(3.0 | ) | (2.0 | ) | (7.3 | ) | |||||||||
December 31 |
(5.7 | ) | (4.6 | ) | (5.9 | ) | |||||||||
|
|
|
|
|
|
||||||||||
Total full year |
$ | (17.2 | ) | $ | (10.3 | ) | $ | (20.5 | ) | ||||||
|
|
|
|
|
|
In 2012, the Companys benefits, claims and settlement expenses decreased $54.2 million, or 10.8%, compared to the prior year, primarily reflecting a $42.7 million decrease in property and casualty catastrophe losses in the current year, as well as a greater favorable impact of prior years reserve development and a notable reduction in Florida sinkhole loss costs. In 2012, automobile non-catastrophe losses increased compared to the prior year, primarily reflecting higher current accident year frequency of losses from bodily injury coverages. In 2011, the Companys benefits, claims and settlement expenses increased $27.6 million, or 5.8%, compared to 2010, primarily reflecting a $36.8 million increase in property and casualty catastrophe losses, partially offset by favorable current accident year non-catastrophe homeowners results that largely reflected improvement in Florida sinkhole loss experience. In
F-24
2011, the U.S. experienced notable tornado and storm activity, including Tropical Storm Lee and Hurricane Irene, producing 30 designated catastrophe events which impacted numerous states. In 2011, the Company also experienced an increase in automobile non-catastrophe losses reflecting higher physical damage frequency of loss, particularly in states impacted by severe weather patterns in 2011, as well as a reduced level of favorable prior years property and casualty reserve development compared to 2010.
For 2012, the favorable development of prior years property and casualty reserves of $17.2 million was the result of actual and remaining projected losses for prior years being below the level anticipated in the December 31, 2011 loss reserve estimate, primarily the result of favorable frequency and severity trends in voluntary automobile loss emergence for accident years 2011 and prior.
For 2011, the favorable development of prior years property and casualty reserves of $10.3 million was the result of actual and remaining projected losses for prior years being below the level anticipated in the December 31, 2010 loss reserve estimate, primarily the result of favorable frequency and severity trends in voluntary automobile loss emergence for accident years 2009 and prior, as well as favorable development of homeowners loss reserves for accident years 2010 and prior.
For 2010, the favorable development of prior years property and casualty reserves of $20.5 million was the result of actual and remaining projected losses for prior years being below the level anticipated in the December 31, 2009 loss reserve estimate, primarily the result of favorable frequency and severity trends in voluntary automobile loss and loss adjustment expense emergence for accident years 2008 and prior.
For 2012, the voluntary automobile loss ratio of 72.3% decreased by 1.7 percentage points compared to the prior year, including development of prior years reserves that had a 2.4 percentage point greater favorable impact in the current year, lower catastrophe losses for this line of business which represented a 0.4 percentage point decrease in the current accident year loss ratio, and the unfavorable impact of an increase in loss frequency in 2012. The homeowners loss ratio of 68.6% for 2012 decreased 25.7 percentage points compared to a year earlier, including a 23.4 percentage point decrease due to the lower level of catastrophe costs. Catastrophe costs represented 20.6 percentage points of the homeowners loss ratio for 2012 compared to 44.0 percentage points for 2011. Development of prior years homeowners reserves had a 1.1 percentage point less favorable impact in the year ended December 31, 2012. The Companys sinkhole loss costs for 2012 reflected a favorable impact from the Companys Florida homeowners policy non-renewal program. Excluding claim settlement expenses, Florida sinkhole losses incurred for the year ended December 31, 2012 were zero compared to $5.2 million and $20.1 million incurred in 2011 and 2010, respectively. For 2010, the voluntary automobile loss ratio was 68.5% and the homeowners loss ratio was 89.0%, including 25.4 percentage points due to catastrophe costs.
For the annuity segment, benefits in 2012 increased $1.4 million compared to 2011 due to increased sales of single premium immediate annuity contracts. The Companys guaranteed minimum death benefit (GMDB) reserve was $0.4 million at December 31, 2012 compared to $0.6 million at December 31, 2011 and $0.3 million at December 31, 2010. The changes in this reserve reflected the impact of financial market performance in the respective years.
F-25
For the life segment, benefits in 2012 decreased $2.5 million compared to a year earlier, primarily reflecting a decrease in mortality costs in 2012. In 2011, life segment benefits increased $2.7 million compared to a year earlier, reflecting an increase in mortality costs in 2011. This variability in the Companys life mortality experience is not unexpected considering the size of Horace Manns life insurance in force.
Interest Credited to Policyholders
Year Ended
December 31, |
Change From
Prior Year |
Year Ended
December 31, |
|||||||||||||||||||||||
2012 | 2011 | Percent | Amount |
2010 |
|||||||||||||||||||||
Annuity |
$ | 121.4 | $ | 113.6 | 6.9 | % | $7.8 | $ | 106.3 | ||||||||||||||||
Life |
42.2 | 41.3 | 2.2 | % | 0.9 | 40.4 | |||||||||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Total |
$ | 163.6 | $ | 154.9 | 5.6 | % | $8.7 | $ | 146.7 | ||||||||||||||||
|
|
|
|
|
|
|
|
Compared to 2011, the current year increase in annuity segment interest credited reflected a 10.6% increase in average accumulated fixed deposits, partially offset by a 15 basis point decline in the average annual interest rate credited to 3.86%. Compared to 2010, the 2011 increase in annuity segment interest credited reflected a 10.7% increase in average accumulated fixed deposits, partially offset by a 15 basis point decline in the average annual interest rate credited to 4.01%. Life insurance interest credited increased slightly in both 2012 and 2011 as a result of the growth in interest-sensitive life insurance reserves.
The net interest spread on fixed annuity account value on deposit measures the difference between the rate of income earned on the underlying invested assets and the rate of interest which policyholders are credited on their account values. The net interest spreads for the years ended December 31, 2012, 2011 and 2010 were 211 basis points, 202 basis points and 196 basis points, respectively. The net interest spread increases in 2012 and 2011 primarily reflected crediting rate decreases, supplemented by favorable investment yields resulting from the Companys investment portfolio management.
As of December 31, 2012, fixed annuity account values totaled $3.4 billion, including $3.1 billion of deferred annuities. For approximately 85%, or $2.6 billion of the deferred annuity account values, the credited interest rate was equal to the minimum guaranteed rate. Due to limitations on the Companys ability to further lower interest crediting rates, coupled with the expectation for continued low reinvestment interest rates, management anticipates fixed annuity spread compression in future periods. Additional information regarding the interest crediting rates and balances equal to the minimum guaranteed rate for deferred annuity account values as of December 31, 2012 is shown below.
Total Deferred Annuities |
Deferred Annuities at
Minimum Guaranteed Rate |
|||||||||||||||||||
Percent
of Total |
Accumulated
Value |
Percent
of Total |
Accumulated
Value |
|||||||||||||||||
Minimum guaranteed interest rates: |
||||||||||||||||||||
Less than 2% |
14.0 | % | $ | 433.8 | 3.1 | % | $ | 82.0 | ||||||||||||
Equal to 2% but less than 3% |
9.5 | 296.4 | 6.9 | 181.8 | ||||||||||||||||
Equal to 3% but less than 4% |
16.7 | 518.1 | 19.2 | 503.4 | ||||||||||||||||
Equal to 4% but less than 5% |
57.9 | 1,802.3 | 68.5 | 1,802.3 | ||||||||||||||||
5% or higher |
1.9 | 60.0 | 2.3 | 60.0 | ||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||
Total |
100.0 | % | $ | 3,110.6 | 100.0 | % | $ | 2,629.5 | ||||||||||||
|
|
|
|
|
|
|
|
F-26
Policy Acquisition Expenses Amortized
Amortized policy acquisition expenses were $79.5 million for 2012 compared to $83.4 million and $77.3 million for the years ended December 31, 2011 and 2010, respectively. At December 31, 2012, the evaluation of annuity deferred policy acquisition costs resulted in a decrease in amortization of $3.8 million, which primarily reflected the impact of favorable financial market performance and improved persistency; this compares to an increase in amortization of $2.5 million from a similar evaluation at December 31, 2011, which primarily reflected the impact of unfavorable financial market performance in 2011. The improvement in financial market performance in 2012 was driven primarily by equity securities. For the life segment, the December 31, 2012 evaluation of deferred policy acquisition costs resulted in a $0.8 million increase in amortization, compared to a $1.2 million increase recorded as a result of the December 31, 2011 evaluation. The December 31, 2010 evaluations of deferred policy acquisition costs resulted in a decrease of $2.0 million in annuity amortization and an increase of $0.4 million in life amortization.
Operating Expenses
In 2012, operating expenses of $156.1 million increased 5.0%, or $7.4 million, compared to 2011. Included in operating expenses for the year ended December 31, 2012 was $2.2 million attributable to the accelerated accrual of certain incentive compensation and other stock-based awards as a result of the announced retirement intentions of the Companys Chief Executive Officer. In addition, the Companys favorable results for 2012 led to an increase in incentive compensation for the current year. These 2012 costs were allocated to all of the Companys segments.
In 2011, operating expenses of $148.7 million decreased 2.0%, or $3.1 million, compared to 2010. Expenses in 2010 included a charge of $2.2 million to write off software development costs related to the Companys property insurance administrative system. This charge was borne by the property and casualty segment and represented 0.4 percentage points of that segments expense ratio for the full year. In addition, expenses in 2010 included approximately $1.8 million related to the accelerated accrual of certain pension benefits, incentive compensation and other stock-based awards earned by the Companys previous Chief Executive Officer who retired in the fourth quarter of 2010. These accelerated costs were allocated to all of the Companys segments.
The property and casualty expense ratio of 27.0% for 2012 increased 1.2 percentage points compared to the 2011 expense ratio of 25.8%, consistent with managements expectations for the current year. The property and casualty expense ratio was 25.7% in 2010.
Income Tax Expense
The effective income tax rate on the Companys pretax income, including net realized investment gains and losses, was 30.4%, 25.7% and 27.3% for the years ended December 31, 2012, 2011 and 2010, respectively. Income from investments in tax-advantaged securities reduced the effective income tax rate 6.0, 9.6 and 7.8 percentage points for 2012, 2011 and 2010, respectively. While the amount of income from tax-advantaged securities was comparable for each of the three years, the variances in the level of taxable income influenced the impact on the effective income tax rate for each year. In 2010, as further described below, the Company recorded a $1.4 million reduction in its liability for uncertain tax positions, which benefitted the annuity segment.
F-27
The Company records liabilities for uncertain tax filing positions where it is more-likely-than-not that the position will not be sustainable upon audit by taxing authorities. These liabilities are reevaluated routinely and are adjusted appropriately based upon changes in facts or law. The Company has no unrecorded liabilities from uncertain tax filing positions.
In 2010, the Internal Revenue Service (IRS) published guidance regarding separate account (variable annuity) dividend received deductions for life insurance companies in which they advised (1) they would concede appeals related to the issue and not raise the issue on audit unless the taxpayer changed its methodology for computing the deduction, and (2) any changes in law regarding this deduction would be effective prospectively. As a result, the Company believed this issue was no longer an uncertain tax position and recorded a reduction of $1.4 million in the uncertain tax position liability related to the separate account dividend received deduction in 2010.
The Companys federal income tax returns for years prior to 2007 are no longer subject to examination by the IRS. In 2011, the IRS completed an examination of the federal tax returns through 2009 resulting in additional tax expense of less than $0.1 million. Management does not anticipate any assessments for tax years that remain subject to examination to have a material effect on the Companys financial position or results of operations.
Net Income
For 2012, the Companys net income of $103.9 million represented an increase of $33.4 million compared to 2011, reflecting a significant reduction in property and casualty catastrophe losses as well as an increase in underlying earnings for all three of the Companys operating segments. After-tax net realized investment gains decreased by $6.8 million between years. For the property and casualty segment, net income of $37.1 million reflected an increase of $31.2 million compared to 2011, benefitting from decreases in catastrophe costs and Florida sinkhole losses, as well as favorable development of prior years reserves, which more than offset an increase in automobile current accident year losses. Including all factors, the property and casualty combined ratio was 98.3% for 2012 compared to 106.6% for 2011. Annuity segment net income of $40.5 million for 2012 increased $9.6 million compared to 2011, primarily reflecting an increase in the interest margin earned on fixed annuity assets accompanied by the current period favorable impact of financial market performance on the evaluation of deferred policy acquisition costs, compared to the prior year adverse impact. Life segment net income of $21.9 million increased $2.5 million, primarily due to favorable mortality experience in 2012. A number of the items above, which had a favorable impact on net income for 2012, were notably more favorable than management would typically expect and are described in more detail in the preceding discussion.
F-28
For 2011, the Companys net income of $70.5 million represented a decrease of $9.6 million, or 12%, compared to 2010 primarily due to the increase in property and casualty catastrophe losses. After-tax net realized investment gains increased by $9.0 million between years. For the property and casualty segment, net income of $5.9 million reflected a decrease of $21.1 million compared to 2010, primarily due to the increase in catastrophe costs but also reflecting a smaller benefit in 2011 from favorable prior years reserve development. Catastrophe costs increased $23.9 million after tax compared to 2010, while favorable prior years property and casualty reserve development was $6.6 million after tax lower than 2010. Excluding catastrophe losses and compared to 2010, 2011 accident year results for the property line improved while automobile 2011 accident year losses increased. For 2011, incurred sinkhole claims in Florida were less than the prior year by approximately $10 million after tax. Including all factors, the property and casualty combined ratio was 106.6% for 2011 compared to 100.9% for 2010. Annuity segment net income for 2011 increased slightly compared to 2010, reflecting the negative impact from the evaluation of deferred policy acquisition costs -- primarily due to the adverse relative performance of the financial markets and the higher level of net realized investment gains -- and a non-recurring tax benefit of $1.4 million recorded in 2010, offset by improvements in the interest margin. Compared to 2010, life segment net income decreased $0.8 million, or 4%, primarily due to higher mortality costs in 2011.
For 2010, the Companys net income was $80.1 million, including after-tax net realized investment gains of $15.4 million and after-tax catastrophe costs of $32.0 million. Annuity segment net income benefitted from the second quarter 2010 $1.4 million reduction in the Companys liability for uncertain tax positions. Life segment net income reflected higher than average mortality costs in 2010. For the property and casualty segment, 2010 net income reflected favorable 2010 accident year underwriting results in the voluntary automobile line which were offset by unfavorable 2010 year results in the property line. Property and casualty segment net income in 2010 benefitted from favorable prior years reserve development and was impacted adversely by an increase in large property losses, primarily sinkhole claims in Florida. The property and casualty segment net income for 2010 included a charge of $1.5 million after tax to write off software development costs related to its property insurance administrative system. The Companys net income for 2010 included a charge of $1.2 million after tax related to the accelerated accrual of certain pension benefits, incentive compensation and other stock-based awards earned by the previous CEO who retired in the fourth quarter. Including all factors, the property and casualty combined ratio was 100.9% for 2010.
F-29
Net income by segment and net income per share were as follows:
Year Ended | Change From | Year Ended | |||||||||||||||||||||||
December 31, | Prior Year | December 31, | |||||||||||||||||||||||
2012 | 2011 | Percent | Amount |
2010 |
|||||||||||||||||||||
Analysis of net income by segment: |
|||||||||||||||||||||||||
Property and casualty |
$ | 37.1 | $ | 5.9 | N.M. | $ | 31.2 | $ | 27.0 | ||||||||||||||||
Annuity |
40.5 | 30.9 | 31.1% | 9.6 | 30.8 | ||||||||||||||||||||
Life |
21.9 | 19.4 | 12.9% | 2.5 | 20.2 | ||||||||||||||||||||
Corporate and other (1) |
4.4 | 14.3 | -69.2% | (9.9 | ) | 2.1 | |||||||||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Net income |
$ | 103.9 | $ | 70.5 | 47.4% | $ | 33.4 | $ | 80.1 | ||||||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Effect of catastrophe costs, after tax, included above |
$ | (28.2 | ) | $ | (55.9 | ) | -49.6% | $ | 27.7 | $ | (32.0 | ) | |||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Effect of realized investment gains, after tax, included above |
$ | 17.6 | $ | 24.4 | -27.9% | $ | (6.8 | ) | $ | 15.4 | |||||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Diluted: |
|||||||||||||||||||||||||
Net income per share |
$ | 2.51 | $ | 1.70 | 47.6% | $ | 0.81 | $ | 1.95 | ||||||||||||||||
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Weighted average number of shares and equivalent shares (in millions) |
41.4 | 41.4 | - | - | 41.0 | ||||||||||||||||||||
Property and casualty combined ratio: |
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Total |
98.3 | % | 106.6 | % | N.M. | -8.3 | % | 100.9 | % | ||||||||||||||||
Effect of catastrophe costs, included above |
8.0 | % | 15.7 | % | N.M. | -7.7 | % | 8.8 | % | ||||||||||||||||
Effect of prior years reserve development, included above |
-3.2 | % | -1.9 | % | N.M. | -1.3 | % | -3.7 | % |
N.M. - Not meaningful.
(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 the basis for managements evaluation of the results of those segments. |
For the three years ended December 31, 2012, the changes in net income for the property and casualty, annuity and life segments are described in the preceding paragraphs.
As described in footnote (1) to the table above, the corporate and other segment reflects corporate-level transactions. Of those transactions, realized investment gains and losses may vary notably between reporting periods and are often the driver of fluctuations in the level of this segments net income or loss. For 2012, 2011 and 2010, net realized investment gains after tax were $17.6 million, $24.4 million and $15.4 million, respectively. For the corporate and other segment, a lower level of net realized investment gains was the primary driver of the current year decrease in net income compared to 2011.
Return on average shareholders equity based on net income was 9%, 8% and 10% for the years ended December 31, 2012, 2011 and 2010, respectively.
The accounting guidance adopted by the Company effective January 1, 2012 is described in Notes to Consolidated Financial Statements -- Note 1 -- Summary of Significant Accounting Policies -- Adopted Accounting Standards.
F-30
Outlook for 2013
At the time of this Annual Report on Form 10-K, management estimates that 2013 full year net income before realized investment gains and losses will be within a range of $1.75 to $1.95 per diluted share. This projection incorporates the Companys results for 2012 along with anticipation that life mortality costs will return to modeled levels and the impact of evaluating annuity deferred policy acquisition costs will be minimal. Compared to 2012, estimated net income for 2013 also anticipates an improvement in property and casualty segment current accident year results partially offset by a lower level of favorable development of prior years reserves. Excluding the impact of the evaluation of deferred policy acquisition costs, 2013 annuity segment net income is anticipated to be relatively consistent with 2012, as growth in assets under management is expected to offset an anticipated decline in the net interest spread. In addition to these segment-specific factors, the Company plans to incur pretax expenses of $3 million to $4 million for customer service and infrastructure improvements, which are intended to enhance the overall customer experience and support further improvement in policy retention and business cross-sale ratios. As described in Critical Accounting Policies, certain of the Companys 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 managements current estimate. Additionally, see Forward-looking Information concerning other important factors that could impact actual results. Management believes that a projection of net income including realized investment gains and losses is not appropriate on a forward-looking basis because it is not possible to provide a valid 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
Off-Balance Sheet Arrangements
At December 31, 2012, 2011 and 2010, 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.
Investments
Information regarding the Companys investment portfolio, which is comprised primarily of investment grade, fixed income securities, is located in Results of Operations for the Three Years Ended December 31, 2012 -- Net Realized Investment Gains and Losses, Business -- Investments and in the Notes to Consolidated Financial Statements -- Note 2 -- Investments listed on page F-1 of this report.
F-31
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 generated from operations has been, and is expected to be, adequate to meet the Companys operating cash needs in the next 12 months. Cash flow in excess of operational needs has been used to fund business growth, retire short-term debt, pay dividends to shareholders and repurchase shares of HMECs 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. HMECs 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 2012, net cash provided by operating activities increased compared to 2011, primarily due to an increase in investment income collected and reduced property and casualty claims payments in 2012 including the impact of catastrophe events in each year.
Payment of principal and interest on debt, dividends to shareholders and parent company operating expenses 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. Payments for share repurchase programs also have this dependency. If necessary, HMEC also has other potential sources of liquidity that could provide for additional funding to meet corporate obligations or pay shareholder dividends, which include a revolving line of credit, as well as issuances of various securities. The insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. The aggregate amount of dividends that may be paid in 2013 from all of HMECs insurance subsidiaries without prior regulatory approval is approximately $84 million. Although regulatory restrictions exist, dividend availability from subsidiaries has been, and is expected to be, adequate for HMECs capital needs. Additional information is contained in Note 8 Statutory Information and Restrictions listed on page F-1 of this report.
Investing Activities
HMECs 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 and equity securities portfolios as available for sale.
F-32
Financing Activities
Financing activities include primarily payment of dividends, the receipt and withdrawal of funds by annuity contractholders, repurchases of HMECs common stock, fluctuations in bank overdraft balances, and borrowings, repayments and repurchases related to its debt facilities.
The Companys annuity business produced net positive cash flows in 2012, although the level was less than the result for 2011. For the year ended December 31, 2012, receipts from annuity contracts decreased $16.3 million, or 3.8% compared to 2011, as described in Results of Operations for the Three Years Ended December 31, 2012 -- Insurance Premiums and Contract Charges. In total, annuity contract benefits, withdrawals and net transfers to variable annuity accumulated cash values increased $1.4 million, or 0.6%, compared to 2011.
Contractual Obligations
Payments Due By Period As of December 31, 2012 | |||||||||||||||||||||||||
Total |
Less Than
1 Year (2013) |
1 - 3 Years
(2014 and 2015) |
3 - 5 Years
(2016 and 2017) |
More Than
5 Years (2018 and beyond) |
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Fixed annuities and fixed option
|
$ | 5,048.3 | $ | 169.5 | $ | 354.6 | $ | 372.3 | $ | 4,151.9 | |||||||||||||||
Supplemental contracts (1) |
635.0 | 31.5 | 57.1 | 53.2 | 493.2 | ||||||||||||||||||||
Life insurance policies (1) |
2,371.5 | 85.1 | 176.6 | 182.1 | 1,927.7 | ||||||||||||||||||||
Property and casualty claims and claim
|
274.5 | 162.9 | 92.9 | 16.0 | 2.7 | ||||||||||||||||||||
Short-term Debt Obligations (2): |
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Bank Credit Facility
|
39.8 | 0.6 | 39.2 | - | - | ||||||||||||||||||||
Long-Term Debt Obligations (2): |
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Senior Notes Due June 15, 2015 |
86.3 | 4.5 | 81.8 | - | - | ||||||||||||||||||||
Senior Notes Due April 15, 2016 |
155.0 | 8.6 | 17.1 | 129.3 | - | ||||||||||||||||||||
Operating lease obligations (3) |
17.9 | 2.9 | 5.2 | 4.9 | 4.9 | ||||||||||||||||||||
Purchase obligations |
1.7 | 1.7 | - | - | - | ||||||||||||||||||||
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Total |
$ | 8,630.0 | $ | 467.3 | $ | 824.5 | $ | 757.8 | $ | 6,580.4 | |||||||||||||||
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(1) |
This information represents estimates of both the amounts to be paid to policyholders and the timing of such payments. |
(2) |
Includes principal and interest. |
(3) |
The Company has entered into various operating lease agreements, primarily for real estate (claims and marketing offices in a few states, as well as portions of the home office complex) and also for computer equipment and copy machines. |
F-33
Estimated Future Policy Benefit and Claim Payments - Annuity and Life Segments
The following table duplicates information above and summarizes the Companys annuity and life contractual obligations and commitments as of December 31, 2012 expected to be paid in the periods presented. Payment amounts reflect the Companys estimate of undiscounted cash flows related to these obligations and commitments. Balance sheet amounts were determined in accordance with GAAP and in many cases differ significantly from the summation of undiscounted cash flows. The most significant difference relates to future policy benefits related to life insurance, which includes discounting.
Estimated Payments by Period As of December 31, 2012 | |||||||||||||||||||||||||
Total |
Less Than
1 Year (2013) |
1 - 3 Years
(2014 and 2015) |
3 - 5 Years
(2016 and 2017) |
More Than
5 Years (2018 and beyond) |
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Fixed annuities and fixed option
|
$ | 5,048.3 | $ | 169.5 | $ | 354.6 | $ | 372.3 | $ | 4,151.9 | |||||||||||||||
Supplemental contracts |
635.0 | 31.5 | 57.1 | 53.2 | 493.2 | ||||||||||||||||||||
Life insurance policies |
2,371.5 | 85.1 | 176.6 | 182.1 | 1,927.7 | ||||||||||||||||||||
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Total |
$ | 8,054.8 | $ | 286.1 | $ | 588.3 | $ | 607.6 | $ | 6,572.8 | |||||||||||||||
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For the majority of the Companys annuity and life insurance operations, the estimated contractual obligations for future policyholder benefits as presented in the table above were derived from the annual cash flow testing analysis used to develop actuarial opinions of statutory reserve adequacy for state regulatory purposes. These cash flows are materially representative of the cash flows under generally accepted accounting principles. Actual amounts may vary, potentially in a significant manner, from the amounts indicated due to deviations between assumptions and actual results and the addition of new business in future periods.
Amounts presented in the table above represent the estimated cash payments to be made to policyholders undiscounted by interest and including assumptions related to the receipt of future premiums and deposits, future interest credited, full and partial withdrawals, policy lapses, surrender charges, annuitization, mortality, and other contingent events as appropriate to the respective product types. Additionally, coverage levels are assumed to remain unchanged from those provided under contracts in force at December 31, 2012. Separate Account (variable annuity) payments are not reflected due to the matched nature of these obligations and the fact that the contract owners maintain the investment risk on such deposits.
See Note 1 -- Summary of Significant Accounting Policies -- Future Policy Benefits, Interest-sensitive Life Contract Liabilities and Annuity Contract Liabilities listed on page F-1 of this report for a description of the Companys method for establishing life and annuity reserves in accordance with GAAP.
F-34
Estimated Claims and Claim Related Payments - Property and Casualty Segment
The table below duplicates information above and presents the amount and estimated future timing of claims and claim related payments for property and casualty insurance. Both the total liability and the estimated payments are based on actuarial projection techniques, at a given accounting date. These estimates include assumptions of the ultimate settlement and administrative costs based on the Companys assessment of facts and circumstances then known, review of historical settlement patterns, estimates of trends in claims severity, frequency and other factors. Variables in the reserve estimation process can be affected by both internal and external events, such as changes in claims handling procedures, economic inflation, legal trends and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. Additionally, there may be significant reporting lags between the occurrence of a claim and the time it is actually reported to the Company. The future cash flows related to the items contained in the table below required estimation of both amount (including severity considerations) and timing. Amount and timing are frequently estimated separately. An estimation of both amount and timing of future cash flows related to claims and claim related payments is generally reliable only in the aggregate with some unavoidable estimation uncertainty.
The following table includes estimated future claims and claims related payments at December 31, 2012. The amounts reported in the table are presented on a nominal basis, have not been discounted and represent the estimated timing of future payments for both reported and unreported claims incurred and related claim adjustment expenses.
Estimated Payments by Period As of December 31, 2012 | |||||||||||||||||||||||||
More Than | |||||||||||||||||||||||||
Less Than | 1 - 3 Years | 3 - 5 Years | 5 Years | ||||||||||||||||||||||
1 Year | (2014 and | (2016 and | (2018 and | ||||||||||||||||||||||
Total | (2013) | 2015) | 2017) | beyond) | |||||||||||||||||||||
Claims and claim adjustment expenses |
$274.5 | $162.9 | $92.9 | $16.0 | $2.7 |
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 Companys 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, pay dividends to its shareholders, fund growth initiatives, repurchase shares of its common stock and for other corporate purposes. Management anticipates that the Companys sources of capital will continue to generate sufficient capital to meet the needs for business growth, debt interest payments, shareholder dividends and its share repurchase program. Additional information is contained in Note 8 -- Statutory Information and Restrictions listed on page F-1 of this report.
The total capital of the Company was $1,483.6 million at December 31, 2012, including $199.8 million of long-term debt and $38.0 million of short-term debt outstanding. Total debt represented 21.6% of total capital excluding unrealized investment gains and losses (16.0% including unrealized investment gains and losses) at December 31, 2012, which was below the Companys long-term target of 25%.
F-35
Shareholders equity was $1,245.8 million at December 31, 2012, including a net unrealized gain in the Companys investment portfolio of $382.4 million after taxes and the related impact of deferred policy acquisition costs associated with annuity and interest-sensitive life policies. The market value of the Companys common stock and the market value per share were $785.8 million and $19.96, respectively, at December 31, 2012. Book value per share was $31.65 at December 31, 2012 ($21.93 excluding investment fair value adjustments).
Additional information regarding the net unrealized gain in the Companys investment portfolio at December 31, 2012 is included in Results of Operations for the Three Years Ended December 31, 2012 Net Realized Investment Gains and Losses.
Total shareholder dividends were $22.5 million for the year ended December 31, 2012. In March, May, September and December 2012, the Board of Directors announced regular quarterly dividends per share of $0.13, $0.13, $0.13 and $0.16, respectively, with the December dividend per share reflecting a 23.1% increase compared to the preceding quarter.
On December 7, 2011, HMECs Board of Directors authorized a share repurchase program allowing repurchases of up to $50 million. The share repurchase program authorizes the opportunistic repurchase of HMECs common shares in open market or privately negotiated transactions, from time to time, depending on market conditions. The share repurchase program does not have an expiration date and may be limited or terminated at any time without notice. During 2012, the Company repurchased 915,895 shares of its common stock, or 2.3% of the outstanding shares on December 31, 2011, at an aggregate cost of $15.7 million, or an average price per share of $17.16, under this share repurchase program. In total and through December 31, 2012, the Company had repurchased 1,070,603 shares of its common stock at an average price of $16.59 per share, under this share repurchase program. The repurchase of shares was financed through use of cash. As of December 31, 2012, $32.2 million remained authorized for future share repurchases. See also Notes to Consolidated Financial Statements -- Note 6 -- Shareholders Equity and Stock Options listed on page F-1 of this report.
As of December 31, 2012, the Company had outstanding $75.0 million aggregate principal amount of 6.05% Senior Notes (Senior Notes due 2015), which will mature on June 15, 2015, issued at a discount resulting in an effective yield of 6.098%. Interest on the Senior Notes due 2015 is payable semi-annually at a rate of 6.05%. Detailed information regarding the redemption terms of the Senior Notes due 2015 is contained in the Notes to Consolidated Financial Statements -- Note 5 -- Debt listed on page F-1 of this report. The Senior Notes due 2015 are traded in the open market (HMN 6.05).
As of December 31, 2012, the Company had outstanding $125.0 million aggregate principal amount of 6.85% Senior Notes (Senior Notes due 2016), which will mature on April 15, 2016, issued at a discount resulting in an effective yield of 6.893%. Interest on the Senior Notes due 2016 is payable semi-annually at a rate of 6.85%. Detailed information regarding the redemption terms of the Senior Notes due 2016 is contained in Notes to Consolidated Financial Statements -- Note 5 -- Debt listed on page F-1 of this report. The Senior Notes due 2016 are traded in the open market (HMN 6.85).
F-36
As of December 31, 2012, the Company had $38.0 million outstanding under its Bank Credit Facility. The Bank Credit Facility provides for unsecured borrowings of up to $150.0 million and expires on October 6, 2015. Interest accrues at varying spreads relative to prime or Eurodollar base rates and is payable monthly or quarterly depending on the applicable base rate (Eurodollar base rate plus 1.25%, which totaled 1.56%, as of December 31, 2012). The unused portion of the Bank Credit Facility is subject to a variable commitment fee, which was 0.15% on an annual basis at December 31, 2012.
To provide additional capital management flexibility, the Company filed a universal shelf registration on Form S-3 with the SEC on January 5, 2012. 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, common stock, preferred stock, depositary shares, warrants and/or delayed delivery contracts, was declared effective on January 18, 2012. Unless fully utilized or withdrawn by the Company earlier, this registration statement will remain effective through January 18, 2015. No securities associated with the registration statement have been issued as of the date of this Annual Report on Form 10-K.
The Companys ratio of earnings to fixed charges (with fixed charges including interest credited to policyholders on interest-sensitive contracts) for the years ended December 31, 2012, 2011 and 2010 was 1.8x, 1.6x and 1.7x, respectively. See also Exhibit 12 -- Statement Regarding Computation of Ratios. The Companys ratio of earnings before interest expense to interest expense was 11.5x, 7.8x and 8.9x for the years ended December 31, 2012, 2011 and 2010, respectively.
Financial Ratings
HMECs principal insurance subsidiaries are rated by S&P, Moodys and A.M. Best Company, Inc. (A.M. Best). These rating agencies have also assigned ratings to the Companys long-term debt securities. The ratings that are assigned by these agencies, which are subject to change, can impact, among other things, the Companys access to sources of capital, cost of capital and competitive position.
Assigned ratings as of February 15, 2013 were unchanged from the disclosure in the Companys Annual Report on Form 10-K for the year ended December 31, 2011. Assigned ratings were as follows (unless otherwise indicated, the insurance financial strength ratings for the Companys property and casualty insurance subsidiaries and the Companys principal life insurance subsidiary are the same):
Insurance Financial
|
Debt Ratings
(Outlook) |
|||||||||||
As of February 15, 2013 |
||||||||||||
S&P (1) |
A | (stable) | BBB | (stable) | ||||||||
Moodys (1) |
A3 | (stable) | Baa3 | (stable) | ||||||||
A.M. Best |
||||||||||||
Horace Mann Life Insurance Company |
A | (stable) | N.A. | |||||||||
HMECs property and casualty subsidiaries |
A- | (stable) | N.A. | |||||||||
HMEC |
N.A. | bbb | (stable) |
N.A. Not applicable.
(1) | This agency has not yet rated Horace Mann Lloyds. |
F-37
Reinsurance Programs
Information regarding the reinsurance program for the Companys property and casualty segment is located in Business -- Property and Casualty Segment -- Property and Casualty Reinsurance.
Information regarding the reinsurance program for the Companys life segment is located in Business -- Life Segment.
Market Value Risk
Market value risk, the Companys primary market risk exposure, is the risk that the Companys invested assets will decrease in value. This decrease in value may be due to (1) a change in the yields realized on the Companys assets and prevailing market yields for similar assets, (2) an unfavorable change in the liquidity of the investment, (3) an unfavorable change in the financial prospects of the issuer of the investment, or (4) a downgrade in the credit rating of the issuer of the investment. See also Results of Operations for the Three Years Ended December 31, 2012 -- Net 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 Companys investments and the credited interest rates on the Companys insurance liabilities. See also Results of Operations for the Three Years Ended December 31, 2012 -- Interest Credited to Policyholders.
The Company seeks to manage its market value risk by coordinating the projected cash inflows of assets with the projected cash outflows of liabilities. For all its assets and liabilities, the Company seeks to maintain reasonable durations, consistent with the maximization of income without sacrificing investment quality, while providing for liquidity and diversification. The investment risk associated with variable annuity deposits and the underlying mutual funds is assumed by those contractholders, and not by the Company. Certain fees that the Company earns from variable annuity deposits are based on the market value of the funds deposited.
Through active investment management, the Company invests available funds with the objective of funding future obligations to policyholders, subject to appropriate risk considerations, and maximizing shareholder value. This objective is met through investments that (1) have similar characteristics to the liabilities they support; (2) are diversified among industries, issuers and geographic locations; and (3) are predominately investment-grade fixed maturity securities classified as available for sale. As of the time of this Annual Report on Form 10-K, no derivatives are used to manage the exposure to interest rate risk in the investment portfolios. At December 31, 2012, approximately 14% of the fixed investment portfolio represented investments supporting the property and casualty operations and approximately 86% supported the annuity and life business. For discussions regarding the Companys investments see Results of Operations for the Three Years Ended December 31, 2012 -- Net Realized Investment Gains and Losses and Business -- Investments.
F-38
The Companys annuity and life earnings are affected by the spreads between interest yields on investments and rates credited or accruing on fixed annuity and life insurance liabilities. Although substantially all credited rates on fixed annuities may be changed annually (subject to minimum guaranteed rates), competitive pricing and other factors, including the impact on the level of surrenders and withdrawals, may limit the Companys ability to adjust or to maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. See also Results of Operations for the Three Years Ended December 31, 2012 -- Interest Credited to Policyholders.
Using financial modeling and other techniques, the Company regularly evaluates the appropriateness of investments relative to the characteristics of the liabilities that they support. Simulations of cash flows generated from existing business under various interest rate scenarios measure the potential gain or loss in fair value of interest-rate sensitive assets and liabilities. Such estimates are used to closely match the duration of assets to the duration of liabilities. The overall duration of liabilities of the Companys multiline insurance operations combines the characteristics of its long duration annuity and interest-sensitive life liabilities with its short duration non-interest-sensitive property and casualty liabilities. Overall, at December 31, 2012, the duration of the fixed income securities portfolio was estimated to be approximately 6.5 years and the duration of the Companys insurance liabilities and debt was estimated to be approximately 8.0 years.
The annuity and life operations participate in the cash flow testing procedures imposed by statutory insurance regulations, the purpose of which is to insure that such liabilities are adequate to meet the Companys obligations under a variety of interest rate scenarios. Based on these procedures, the Companys assets and the investment income expected to be received on such assets are adequate to meet the insurance policy obligations and expenses of the Companys insurance activities in all but the most extreme circumstances.
The Company periodically evaluates its sensitivity to interest rate risk. Based on commonly used models, the Company projects the impact of interest rate changes, assuming a wide range of factors, including duration and prepayment, on the fair value of assets and liabilities. Fair value is estimated based on the net present value of cash flows or duration estimates. At December 31, 2012, assuming an immediate decrease of 100 basis points in interest rates, the fair value of the Companys assets and liabilities would both increase, the net of which would result in a decrease in shareholders equity of approximately $18 million after tax, or 1%. A 100 basis point increase in interest rates would decrease the fair value of both assets and liabilities, the net of which would result in a decrease in shareholders equity of approximately $7 million after tax, or 1%. At December 31, 2011, assuming an immediate decrease of 100 basis points in interest rates, the fair value of the Companys assets and liabilities would both increase, the net of which would result in an increase in shareholders equity of approximately $40 million after tax, or 4%. A 100 basis point increase in interest rates would decrease the fair value of assets and liabilities, the net of which would result in a decrease in shareholders equity of approximately $59 million after tax, or 5%. In each case, these changes in interest rates assume a parallel shift in the yield curve. While the Company believes that these assumed market rate changes are reasonably possible, actual results may differ, particularly as a result of any management actions that would be taken to attempt to mitigate such hypothetical losses in fair value of shareholders equity.
F-39
Interest rates continue to be at historically low levels. If interest rates remain low over an extended period of time, and based on a recent pronouncement by the Federal Reserve Board that rates are likely to remain low as long as the unemployment rate remains above 6.5%, management recognizes it could pressure net investment income by having to invest insurance cash flows and reinvest the cash flows from the investment portfolio in lower yielding securities. Moreover, issuers of securities in the Companys investment portfolio may prepay or redeem fixed income securities, as well as commercial and mortgage-backed securities, with greater frequency to borrow at lower market rates. As a general guideline, management estimates that pretax income in 2013 and 2014 would decrease by approximately $3 million (by segment: Annuity $1.9 million, Life $0.7 million and Property and Casualty $0.4 million) and $9 million (by segment: Annuity $5.7 million, Life $1.9 million and Property and Casualty $1.4 million), respectively, for each 100 basis point decline in reinvestment rates, before assuming any reduction in annuity crediting rates on in-force contracts. In addition, declining interest rates also could negatively impact the amortization of deferred policy acquisition costs, as well as the recoverability of goodwill, due to the impacts on the estimated fair value of the Companys reporting segments.
The Company has been and continues to be proactive in its investment strategies, product designs and crediting rate strategies to mitigate the risk of unfavorable consequences in this type of interest rate environment without venturing into asset classes or individual securities that would be inconsistent with the Companys conservative investment guidelines. Lowering interest crediting rates on annuity contracts can help offset decreases in investment margins on some products. The Companys ability to lower interest crediting rates could be limited by competition, regulatory approval or contractual guarantees of minimum rates and may not match the timing or magnitude of changes in investment yields.
Based on the Companys overall exposure to interest rate risk, the Company believes that these changes in interest rates would not materially affect its consolidated near-term financial position, results of operations or cash flows.
Recent Accounting Changes
Balance Sheet Offsetting
In January 2013, the Financial Accounting Standard Board (FASB) issued accounting guidance to address implementation issues about the scope of Accounting Standards Update No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The guidance clarifies which instruments and transactions are subject to the offsetting disclosure requirements. The instruments and transactions include bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions. The guidance is effective for annual and interim periods beginning on or after January 1, 2013. Retrospective disclosures are required for all comparative periods presented. Management believes the adoption of this accounting guidance will not have an effect on the results of operations or financial position of the Company.
F-40
Comprehensive Income
In February 2013, the FASB issued accounting guidance to improve the reporting of accumulated other comprehensive income. The guidance requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required to be reclassified in its entirety to net income. When a portion of the amount reclassified out of accumulated other comprehensive income is reclassified to a balance sheet account instead of directly to income or expense in the same reporting period, the reclassification is required to be cross-referenced to other disclosures to provide additional detail about those amounts. The guidance is effective prospectively for reporting periods beginning after December 15, 2012. Early adoption is permitted. Management believes the adoption of this accounting guidance will not have an effect on the results of operations or financial position of the Company.
Effects of Inflation and Changes in Interest Rates
The Companys operating results are affected significantly in at least three ways by changes in interest rates and inflation. First, inflation directly affects property and casualty claims costs. Second, the investment income earned on the Companys investment portfolio and the fair value of the investment portfolio are related to the yields available in the fixed-income markets. An increase in interest rates will decrease the fair value of the investment portfolio, but will increase investment income as investments mature and proceeds are reinvested at higher rates. Third, as interest rates increase, competitors will typically increase crediting rates on annuity and interest-sensitive life products, and may lower premium rates on property and casualty lines to reflect the higher yields available in the market. The risk of interest rate fluctuation is managed through asset/liability management techniques, including cash flow analysis.
F-41
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Horace Mann Educators Corporation:
We have audited the accompanying consolidated balance sheets of Horace Mann Educators Corporation and subsidiaries (the Company) as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, changes in shareholders equity and cash flows for each of the years in the three-year period ended December 31, 2012. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedules I to IV and VI. We also have audited the Companys internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for these consolidated financial statements and financial statement schedules, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting (Item 9A.b.). Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules, and an opinion on the Companys internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
F-42
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in note 1 to the consolidated financial statements, effective January 1, 2012, the Company has changed its method of accounting for the costs associated with acquiring or renewing insurance contracts due to the retrospective adoption of FASB Accounting Standards Update No. 2010-26, Accounting for Costs Associated With Originating or Renewing Service Contracts.
Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
February 28, 2013
F-43
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED BALANCE SHEETS
As of December 31, 2012 and 2011
(Dollars in thousands, except per share data)
See accompanying Notes to Consolidated Financial Statements.
F-44
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
Year Ended December 31, |
||||||||||||
2012 |
2011 |
2010 |
||||||||||
As Adjusted | As Adjusted | |||||||||||
Revenues |
||||||||||||
Insurance premiums and contract charges earned |
$ | 670,527 | $ | 667,120 | $ | 672,678 | ||||||
Net investment income |
306,003 | 288,311 | 272,054 | |||||||||
Net realized investment gains |
27,298 | 37,663 | 23,769 | |||||||||
Other income |
6,986 | 5,208 | 6,213 | |||||||||
|
|
|
|
|
|
|||||||
Total revenues |
1,010,814 | 998,302 | 974,714 | |||||||||
|
|
|
|
|
|
|||||||
Benefits, losses and expenses |
||||||||||||
Benefits, claims and settlement expenses |
448,250 | 502,434 | 474,833 | |||||||||
Interest credited |
163,565 | 154,910 | 146,723 | |||||||||
Policy acquisition expenses amortized |
79,519 | 83,398 | 77,347 | |||||||||
Operating expenses |
156,058 | 148,635 | 151,690 | |||||||||
Interest expense |
14,249 | 14,007 | 13,953 | |||||||||
|
|
|
|
|
|
|||||||
Total benefits, losses and expenses |
861,641 | 903,384 | 864,546 | |||||||||
|
|
|
|
|
|
|||||||
Income before income taxes |
149,173 | 94,918 | 110,168 | |||||||||
Income tax expense |
45,307 | 24,412 | 30,037 | |||||||||
|
|
|
|
|
|
|||||||
Net income |
$ | 103,866 | $ | 70,506 | $ | 80,131 | ||||||
|
|
|
|
|
|
|||||||
Net income per share |
||||||||||||
Basic |
$ | 2.63 | $ | 1.77 | $ | 2.04 | ||||||
|
|
|
|
|
|
|||||||
Diluted |
$ | 2.51 | $ | 1.70 | $ | 1.95 | ||||||
|
|
|
|
|
|
|||||||
Weighted average number of shares and equivalent shares |
||||||||||||
Basic |
39,513,540 | 39,865,815 | 39,349,656 | |||||||||
Diluted |
41,388,368 | 41,436,512 | 41,013,163 | |||||||||
Net realized investment gains |
||||||||||||
Total other-than-temporary impairment losses on securities |
$ | - | $ | (72 | ) | $ | (7,255 | ) | ||||
Portion of losses recognized in other comprehensive income |
- | - | 459 | |||||||||
|
|
|
|
|
|
|||||||
Net other-than-temporary impairment loss write-downs on securities recognized in earnings |
- | (72 | ) | (6,796 | ) | |||||||
Realized gains, net |
27,298 | 37,735 | 30,565 | |||||||||
|
|
|
|
|
|
|||||||
Total |
$ | 27,298 | $ | 37,663 | $ | 23,769 | ||||||
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements.
F-45
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
As Adjusted | As Adjusted | |||||||||||
Comprehensive income |
||||||||||||
Net income |
$ | 103,866 | $ | 70,506 | $ | 80,131 | ||||||
Other comprehensive income (loss), net of taxes: |
||||||||||||
Change in net unrealized gains and losses on fixed maturities and equity securities |
114,178 | 156,954 | 85,200 | |||||||||
Change in net funded status of pension and other postretirement benefit obligations |
931 | (3,087 | ) | (1,612 | ) | |||||||
|
|
|
|
|
|
|||||||
Other comprehensive income |
115,109 | 153,867 | 83,588 | |||||||||
|
|
|
|
|
|
|||||||
Total |
$ | 218,975 | $ | 224,373 | $ | 163,719 | ||||||
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements.
F-46
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
(Dollars in thousands, except per share data)
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
As Adjusted | As Adjusted | |||||||||||
Common stock |
||||||||||||
Beginning balance |
$ | 62 | $ | 61 | $ | 61 | ||||||
Options exercised, 2012, 389,089 shares; 2011, 136,290 shares; 2010, 263,206 shares |
- | 1 | - | |||||||||
Conversion of common stock units, 2012, 15,084 shares; 2011, 15,715 shares; 2010, 160,876 shares |
- | - | - | |||||||||
Conversion of restricted stock units, 2012, 104,152 shares; 2011, 182,309 shares; 2010, 47,149 shares |
- | - | - | |||||||||
|
|
|
|
|
|
|||||||
Ending balance |
62 | 62 | 61 | |||||||||
|
|
|
|
|
|
|||||||
Additional paid-in capital |
||||||||||||
Beginning balance |
373,384 | 367,448 | 358,081 | |||||||||
Options exercised and conversion of common stock units and restricted stock units |
7,275 | 4,485 | 7,204 | |||||||||
Share-based compensation expense |
2,476 | 1,451 | 2,163 | |||||||||
|
|
|
|
|
|
|||||||
Ending balance |
383,135 | 373,384 | 367,448 | |||||||||
|
|
|
|
|
|
|||||||
Retained earnings |
||||||||||||
Beginning balance |
840,644 | 789,128 | 758,343 | |||||||||
Cumulative effect of adoption of accounting principle, net of taxes |
- | - | (35,058 | ) | ||||||||
Net income |
103,866 | 70,506 | 80,131 | |||||||||
Cash dividends, 2012, $0.55 per share; 2011, $0.46 per share; 2010, $0.35 per share |
(22,541 | ) | (18,990 | ) | (14,288 | ) | ||||||
|
|
|
|
|
|
|||||||
Ending balance |
921,969 | 840,644 | 789,128 | |||||||||
|
|
|
|
|
|
|||||||
Accumulated other comprehensive income (loss), net of taxes: |
||||||||||||
Beginning balance |
251,980 | 98,113 | 10,723 | |||||||||
Cumulative effect of adoption of accounting principle, net of taxes |
- | - | 3,802 | |||||||||
Change in net unrealized gains on fixed maturities and equity securities |
114,178 | 156,954 | 85,200 | |||||||||
Change in net funded status of pension and other postretirement benefit obligations |
931 | (3,087 | ) | (1,612 | ) | |||||||
|
|
|
|
|
|
|||||||
Ending balance |
367,089 | 251,980 | 98,113 | |||||||||
|
|
|
|
|
|
|||||||
Treasury stock, at cost |
||||||||||||
Beginning balance, 2012, 22,028,030 shares; 2011 and 2010, 21,813,196 shares |
(410,717 | ) | (407,663 | ) | (407,663 | ) | ||||||
Acquisition of 915,895 shares in 2012; 214,834 shares in 2011; 0 shares in 2010 |
(15,735 | ) | (3,054 | ) | - | |||||||
|
|
|
|
|
|
|||||||
Ending balance, 2012, 22,943,925 shares; 2011, 22,028,030 shares; 2010, 21,813,196 shares |
(426,452 | ) | (410,717 | ) | (407,663 | ) | ||||||
|
|
|
|
|
|
|||||||
Shareholders equity at end of period |
$ | 1,245,803 | $ | 1,055,353 | $ | 847,087 | ||||||
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements.
F-47
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Cash flows - operating activities |
||||||||||||
Premiums collected |
$ | 662,729 | $ | 661,094 | $ | 668,582 | ||||||
Policyholder benefits paid |
(484,144 | ) | (549,888 | ) | (496,339 | ) | ||||||
Policy acquisition and other operating expenses paid |
(230,072 | ) | (241,138 | ) | (232,363 | ) | ||||||
Federal income taxes paid |
(14,444 | ) | (4,130 | ) | (25,049 | ) | ||||||
Investment income collected |
303,385 | 280,963 | 270,468 | |||||||||
Interest expense paid |
(13,948 | ) | (13,515 | ) | (13,605 | ) | ||||||
Contribution to defined benefit pension plan trust fund |
(2,534 | ) | (5,926 | ) | (1,307 | ) | ||||||
Other |
(18,124 | ) | (11,581 | ) | (12,633 | ) | ||||||
|
|
|
|
|
|
|||||||
Net cash provided by operating activities |
202,848 | 115,879 | 157,754 | |||||||||
|
|
|
|
|
|
|||||||
Cash flows - investing activities |
||||||||||||
Fixed maturities |
||||||||||||
Purchases |
(1,448,219 | ) | (1,356,092 | ) | (1,711,091 | ) | ||||||
Sales |
576,708 | 587,909 | 673,882 | |||||||||
Maturities, paydowns, calls and redemptions |
585,615 | 362,210 | 608,994 | |||||||||
Purchase of other invested asset |
(50,000 | ) | - | - | ||||||||
Net cash provided by (used in) short-term and other investments |
(18,902 | ) | 102,966 | 124,141 | ||||||||
|
|
|
|
|
|
|||||||
Net cash used in investing activities |
(354,798 | ) | (303,007 | ) | (304,074 | ) | ||||||
|
|
|
|
|
|
|||||||
Cash flows - financing activities |
||||||||||||
Dividends paid to shareholders |
(22,541 | ) | (18,990 | ) | (14,288 | ) | ||||||
Acquisition of treasury stock |
(15,735 | ) | (2,047 | ) | - | |||||||
Exercise of stock options |
5,421 | 2,127 | 4,167 | |||||||||
Annuity contracts, variable and fixed |
||||||||||||
Deposits |
417,600 | 433,896 | 395,469 | |||||||||
Benefits, withdrawals and net transfers to Separate Account (variable annuity) assets |
(220,803 | ) | (219,415 | ) | (244,673 | ) | ||||||
Life policy accounts |
||||||||||||
Deposits |
1,881 | 2,078 | 2,060 | |||||||||
Withdrawals and surrenders |
(5,161 | ) | (5,343 | ) | (5,015 | ) | ||||||
Change in bank overdrafts |
(983 | ) | (3,654 | ) | 6,680 | |||||||
|
|
|
|
|
|
|||||||
Net cash provided by financing activities |
159,679 | 188,652 | 144,400 | |||||||||
|
|
|
|
|
|
|||||||
Net increase (decrease) in cash |
7,729 | 1,524 | (1,920 | ) | ||||||||
Cash at beginning of period |
7,452 | 5,928 | 7,848 | |||||||||
|
|
|
|
|
|
|||||||
Cash at end of period |
$ | 15,181 | $ | 7,452 | $ | 5,928 | ||||||
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements.
F-48
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with United States (U.S.) generally accepted accounting principles (GAAP) and with the rules and regulations of the Securities and Exchange Commission (SEC), specifically Regulation S-X and the instructions to Form 10-K. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect (1) the reported amounts of assets and liabilities, (2) disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and (3) the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The consolidated financial statements include the accounts of Horace Mann Educators Corporation and its wholly-owned subsidiaries (HMEC; and together with its subsidiaries, the Company or Horace Mann). HMEC and its subsidiaries have common management, share office facilities and are parties to several intercompany service agreements for management, administrative, data processing, agent commissions, agency services, utilization of personnel and investment advisory services. Under these agreements, costs have been allocated among the companies in conformity with GAAP. In addition, certain of the subsidiaries have entered into intercompany reinsurance agreements. HMEC and its subsidiaries file a consolidated federal income tax return, and there are related tax sharing agreements. The tax sharing agreements provide that tax on income is charged to the subsidiaries as if they were filing separate federal income tax returns and the subsidiaries receive the benefits of any losses or tax credits to the extent utilized in the consolidated return. All significant intercompany balances and transactions have been eliminated in consolidation.
The subsidiaries of HMEC market and underwrite personal lines of property and casualty (primarily personal lines automobile and homeowners) insurance, retirement annuities (primarily tax-qualified products) and life insurance, primarily to K-12 teachers, administrators and other employees of public schools and their families. HMECs 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.
The Company has evaluated subsequent events through the date these consolidated financial statements were issued.
Reclassification and Retrospective Adoption
The Company has reclassified the presentation of certain prior period information to conform with the 2012 presentation and, as described in Adopted Accounting Standards, has retrospectively applied to prior periods new accounting guidance regarding deferred policy acquisition costs adopted January 1, 2012.
F-49
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Investments
The Company invests primarily in fixed maturity securities (fixed maturities). This category includes primarily bonds and notes, but also includes redeemable preferred stocks. These securities are classified as available for sale and carried at fair value. The net adjustment for unrealized gains and losses on all securities available for sale, carried at fair value, is recorded as a separate component of accumulated other comprehensive income within shareholders equity, net of applicable deferred taxes and the related impact on deferred policy acquisition costs associated with interest-sensitive life and annuity contracts that would have occurred if the securities had been sold at their aggregate fair value and the proceeds reinvested at current yields.
Equity securities are classified as available for sale and carried at fair value. This category includes nonredeemable preferred stocks and common stocks.
Short-term and other investments are comprised of short-term fixed income securities, generally carried at cost which approximates fair value; policy loans, carried at unpaid principal balances; mortgage loans, carried at unpaid principal less a valuation allowance for estimated uncollectible amounts; and an other invested asset accounted for as an equity method investment.
The Company invests in fixed maturity securities and alternate investment funds that could qualify as variable interest entities, including corporate securities, mortgage-backed securities and asset-backed securities. The Company is not the primary beneficiary of these securities as the Company does not have the power to direct the activities that most significantly impact the entities performance.
Interest income is recognized as earned. Investment income reflects amortization of premiums and accrual of discounts on an effective-yield basis.
Realized gains and losses arising from the disposal (recorded on a trade date basis) or impairment of securities are determined based upon specific identification of securities. The Company evaluates all investments in its portfolio for other-than-temporary declines in value as described in the following section.
F-50
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Other-than-temporary Impairment of Investments
The Companys methodology of assessing other-than-temporary impairments is based on security-specific facts and circumstances as of the balance sheet date. Based on these facts, if (1) the Company has the intent to sell the fixed maturity security, (2) it is more likely than not the Company will be required to sell the fixed maturity security before the anticipated recovery of the amortized cost basis, or (3) management does not expect to recover the entire cost basis of the fixed maturity security, an other-than-temporary impairment is considered to have occurred. For equity securities, if (1) the Company does not have the ability and intent to hold the security for the recovery of cost or (2) recovery of cost is not expected within a reasonable period of time, an other-than-temporary impairment is considered to have occurred. Additionally, if events become known that call into question whether the security issuer has the ability to honor its contractual commitments, such security holding will be evaluated to determine whether or not such security has suffered an other-than-temporary decline in value.
The Company reviews the fair value of all investments in its portfolio on a monthly basis to assess whether an other-than-temporary decline in value has occurred. These reviews, in conjunction with the Companys investment managers monthly credit reports and relevant factors such as (1) the financial condition and near-term prospects of the issuer, (2) the length of time and extent to which the fair value has been less than amortized cost for fixed maturity securities or cost for equity securities, (3) for fixed maturity securities, the Companys intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the anticipated recovery in the amortized cost basis; and for equity securities, the Companys ability and intent to hold the security for the recovery of cost or if recovery of cost is not expected within a reasonable period of time, (4) the stock price trend of the issuer, (5) the market leadership position of the issuer, (6) the debt ratings of the issuer, and (7) the cash flows and liquidity of the issuer or the underlying cash flows for asset-backed securities, 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 for all equity securities and for the credit-related loss portion associated with impaired fixed maturity securities. The amount of the total other-than-temporary impairment related to non-credit factors for fixed maturity securities is recognized in other comprehensive income, net of applicable taxes, unless the Company has the intent to sell the security or if it is more likely than not the Company will be required to sell the security before the anticipated recovery of the amortized cost basis.
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 spread widening, market illiquidity or changes in interest rates where there exists a reasonable expectation based on the Companys consideration of all objective information available that the Company will recover the entire cost basis of the security and the Company does not have the intent to sell the investment before maturity or a market recovery is realized and it is more likely than not the Company will not be required to sell the investment. An other-than-temporary impairment loss will be recognized based upon all relevant facts and circumstances for each investment, as appropriate.
F-51
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Additional considerations for certain types of securities include the following:
Corporate Fixed Maturity Securities
Judgments regarding whether a corporate fixed maturity security is other-than-temporarily impaired include analyzing the issuers financial condition and whether there has been a decline in the issuers ability to service the specific security. The analysis of the security issuer is based on asset coverage, cash flow multiples or other industry standards. Several factors assessed include, but are not limited to, credit quality ratings, cash flow sustainability, liquidity, financial strength, industry and market position. Sources of information include, but are not limited to, management projections, independent consultants, external analysts research, peer analysis and the Companys internal analysis.
If the Company has concerns regarding the viability of the issuer or its ability to service the specific security after this analysis, a cash flow analysis is prepared to determine if the present value of future cash flows has declined below the amortized cost of the fixed maturity security. This analysis to determine an estimate of ultimate recovery value is combined with the estimated timing to recovery and any other applicable cash flows that are expected. If a cash flow analysis estimate is not feasible, then the markets view of cash flows implied by the period end fair value, market discount rates and effective yield are the primary factors used to estimate a recovery value.
Mortgage-Backed Securities Not Issued By the U.S. Government and Federally Sponsored Agencies
The Company uses an estimate of future cash flows expected to be collected to evaluate its mortgage-backed securities for other-than-temporary impairment. The determination of cash flow estimates is inherently subjective and methodologies may vary depending on facts and circumstances specific to the security. All reasonably available information relevant to the collectability of the security, including past events, current conditions, and reasonable and supportable assumptions and forecasts, are considered when developing the estimate of cash flows expected to be collected. Information includes, but is not limited to, debt-servicing, missed refinancing opportunities and geography. Loan level characteristics such as issuer, FICO score, payment terms, level of documentation, property or residency type, and economic outlook are also utilized in financial models, along with historical performance, to estimate or measure the loans propensity to default. Additionally, financial models take into account loan age, lease rollovers, rent volatilities, vacancy rates and exposure to refinancing as additional drivers of default. For transactions where loan level data is not available, financial models use a proxy based on the collateral characteristics. Loss severity is a function of multiple factors including, but not limited to, the unpaid balance, interest rate, mortgage insurance ratios, assessed property value at origination, change in property valuation and loan-to-value ratio at origination. Prepayment speeds, both actual and estimated, cost of capital rates and debt service ratios are also considered. The cash flows generated by the collateral securing these securities are then estimated with these default, loss severity and prepayment assumptions. These collateral cash flows are then utilized, along with consideration for the issues position in the overall structure, to estimate the cash flows associated with the residential or commercial mortgage-backed security held by the Company.
F-52
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Municipal Bonds
The Companys municipal bond portfolio consists primarily of special revenue bonds, which present unique considerations in evaluating other-than-temporary impairments, but also includes general obligation bonds. The Company evaluates special revenue bonds for other-than-temporary impairment based on guarantees associated with the repayment from revenues generated by the specified revenue-generating activity associated with the purpose of the bonds. Judgments regarding whether a municipal bond is other-than-temporarily impaired include analyzing the issuers financial condition and whether there has been a decline in the overall financial condition of the issuer or its ability to service the specific security. Security credit ratings are reviewed with emphasis on the economy, finances, debt and management of the municipal issuer. Certain securities may be guaranteed by the mono-line credit insurers or other forms of guarantee. While not relied upon in the initial security purchase decision, insurance benefits are considered in the assessments for other-than-temporary impairment, including the credit worthiness of the guarantor. Municipalities possess unique powers, along with a special legal standing and protections, that enable them to act quickly to restore budgetary balance and fiscal integrity. These powers include the sovereign power to tax, access to one-time revenue sources, capacity to issue or restructure debt, and ability to shift spending to other authorities. State governments often provide secondary support to local governments in times of financial stress and the federal government has provided assistance to state governments during recessions.
If the Company has concerns regarding the viability of the municipal issuer or its ability to service the specific security after this analysis, a cash flow analysis is prepared to determine a present value and whether it has declined below the amortized cost of the security. If a cash flow analysis is not feasible, then the markets view of the period end fair value, market discount rates and effective yield are the primary factors used to estimate the present value.
Credit Losses
The Company estimates the amount of the credit loss component of a fixed maturity security impairment as the difference between amortized cost and the present value of the expected cash flows of the security. The present value is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best estimate cash flows vary depending on the type of security. Corporate fixed maturity security and municipal bond cash flow estimates are derived from scenario-based outcomes of expected restructurings or the disposition of assets using specific facts and other circumstances, including timing, security interests and loss severity. The cash flow estimates for mortgage-backed and other structured securities are based on security specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds, and structural support, including subordination and guarantees.
F-53
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Deferred Policy Acquisition Costs
The Companys deferred policy acquisition costs asset by segment was as follows:
December 31, | |||||||||||||
2012 |
2011 |
||||||||||||
As Adjusted | |||||||||||||
Annuity |
$ | 125,437 | $ | 139,316 | |||||||||
Life |
46,798 | 54,234 | |||||||||||
Property and casualty |
24,650 | 22,906 | |||||||||||
|
|
|
|
||||||||||
Total |
$ | 196,885 | $ | 216,456 | |||||||||
|
|
|
|
Policy acquisition costs, consisting of commissions, policy issuance and other costs which are incremental and directly related to the successful acquisition of new or renewal business, are capitalized and amortized on a basis consistent with the type of insurance coverage. For all investment (annuity) contracts, acquisition costs are amortized over 20 years in proportion to estimated gross profits. Capitalized acquisition costs for interest-sensitive life contracts also are amortized over 20 years in proportion to estimated gross profits. For other individual life contracts, acquisition costs are amortized in proportion to anticipated premiums over the terms of the insurance policies (10, 15, 20 or 30 years). For property and casualty policies, acquisition costs are amortized over the terms of the insurance policies (6 or 12 months).
The Company periodically reviews the assumptions and estimates used in capitalizing policy acquisition costs and also periodically reviews its estimations of gross profits. The most significant assumptions that are involved in the estimation of annuity gross profits include interest rate spreads, future financial market performance, business surrender/lapse rates, expenses and the impact of realized investment gains and losses. For the variable deposit portion of the annuity segment, the Company amortizes policy acquisition costs utilizing a future financial market performance assumption of a 10% reversion to the mean approach with a 200 basis point corridor around the mean during the reversion period, representing a cap and a floor on the Companys long-term assumption. The Companys practice with regard to returns on Separate Accounts assumes that long-term appreciation in the financial market is not changed by short-term market fluctuations, but is only changed when sustained interim deviations are experienced. The Company monitors these fluctuations and only changes the assumption when its long-term expectation changes.
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 current period amortization expense for the period in which the adjustment is made. For the years ended December 31, 2012, 2011 and 2010, the Company recorded the following adjustments to amortization expense as a result of evaluating actual experience and prospective assumptions:
Year Ended December 31, | |||||||||||||||
2012 |
2011 |
2010 |
|||||||||||||
As Adjusted | As Adjusted | ||||||||||||||
Increase (decrease) to amortization: |
|||||||||||||||
Annuity |
$ | (3,836 | ) | $ | 2,466 | $ | (2,042 | ) | |||||||
Life |
751 | 1,159 | 353 | ||||||||||||
|
|
|
|
|
|
||||||||||
Total |
$ | (3,085 | ) | $ | 3,625 | $ | (1,689 | ) | |||||||
|
|
|
|
|
|
F-54
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Deferred policy acquisition costs (DAC) for interest-sensitive life and investment contracts are adjusted for the impact on estimated future gross profits as if net unrealized investment gains and losses had been realized at the balance sheet date. The impact of this adjustment is included in accumulated other comprehensive income (net unrealized gains and losses on fixed maturities and equity securities) within shareholders equity.
DAC is reviewed for recoverability from future income, including investment income, and costs which are deemed unrecoverable are expensed in the period in which the determination is made. No such costs were deemed unrecoverable during the years ended December 31, 2012, 2011 and 2010.
Accounting guidance defines an internal replacement of an insurance or investment contract as a modification in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a feature or coverage within a contract. Modifications that result in a replacement contract that is substantially unchanged from the replaced contract are accounted for as a continuation of the replaced contract. When modifications represent a substantial change compared to the replaced contract, the transaction is accounted for as an extinguishment of the replaced contract, and unamortized DAC and unearned revenue liabilities from the replaced contract are written off. For the years ended December 31, 2012, 2011 and 2010, internal replacements of traditional non-interest-sensitive life insurance contracts which represented substantial changes compared to the replaced contracts resulted in $137, $115 and $115 of additional DAC amortization for the respective years.
This accounting policy description reflects the adoption, effective January 1, 2012 with retrospective application, of accounting guidance that was issued to address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. See also Note 1 -- Summary of Significant Accounting Policies -- Adopted Accounting Standards -- Costs Associated with Acquiring or Renewing Insurance Contracts.
Goodwill and Value of Acquired Insurance In Force
When the Company was acquired in 1989, intangible assets were recorded in the application of purchase accounting to recognize the value of acquired insurance in force and goodwill. In addition, goodwill was recorded in 1994 related to the purchase of Horace Mann Property & Casualty Insurance Company.
Goodwill represents the excess of the amounts paid to acquire a business over the fair value of its net assets at the date of acquisition. Goodwill is not amortized, but is tested for impairment at the reporting unit level at least annually or more frequently if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. A reporting unit is defined as an operating segment or a business unit one level below an operating segment, if separate financial information is prepared and regularly reviewed by management at that level. The Companys reporting units, for which goodwill has been allocated, are equivalent to the Companys operating segments.
F-55
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Effective January 1, 2012, the goodwill impairment test, as defined in the accounting guidance, allows an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity follows a two-step process. Recent accounting guidance did not change the existing two-step process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of confirming and measuring the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss would be recognized in an amount equal to that excess.
The allocation of goodwill by reporting unit is as follows:
Annuity |
$ | 28,025 | ||
Life |
9,911 | |||
Property and casualty |
9,460 | |||
|
|
|||
Total |
$ | 47,396 | ||
|
|
The Company completed its annual goodwill assessment for the individual reporting units as of December 31, 2012 and did not utilize the option to perform an initial assessment of qualitative factors. The first step of the Companys analysis indicated that fair value exceeded carrying value for all reporting units other than the life unit. The process of evaluating goodwill for impairment requires judgments and assumptions to be made to determine the fair value of each reporting unit, including discounted cash flow calculations, the level of the Companys own share price and assumptions that market participants would make in valuing each reporting unit. Fair value estimates were based primarily on an in-depth analysis of historical experience, projected future cash flows and relevant discount rates, which considered market participant inputs and the relative risk associated with the projected cash flows. Other assumptions include levels of economic capital, future business growth, earnings projections and assets under management for each reporting unit. Estimates of fair value are subject to assumptions that are sensitive to change and represent the Companys reasonable expectation regarding future developments. The Company also considered other valuation techniques such as peer company price-to-earnings and price-to-book multiples.
F-56
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
For the life reporting unit, the Company determined that the reporting units fair value was less than its carrying value, primarily driven by unrealized investment gains combined with a decrease in anticipated net investment income assuming an extended low interest rate environment. Accordingly, recoverability was evaluated assuming fair value was allocated to assets and liabilities as if the reporting unit had been acquired in a business combination. In the second step, the implied fair value of the life reporting units goodwill was determined in the same manner as goodwill is measured in a business combination (i.e., by measuring the fair value of the reporting units assets, liabilities and unrecognized intangible assets and determining the remaining amount attributed to goodwill) and comparing the amount of the implied goodwill to the carrying amount of the goodwill. The implied fair value for the life reporting units goodwill was greater than its carrying value; therefore, goodwill was not impaired and no write-down was required. However, the implied fair value exceeded carrying value for the life reporting unit by a limited margin, which indicates a greater risk of future impairment for this reporting units goodwill.
As part of the Companys December 31, 2012 goodwill analysis, the Company compared the fair value of the aggregated reporting units to the market capitalization of the Company. The difference between the aggregated fair value of the reporting units and the market capitalization of the Company was attributed to several factors, most notably market sentiment, trading volume and transaction premium. The amount of the transaction premium was determined to be reasonable based on insurance industry and Company-specific facts and circumstances. Management believes the Companys continued depressed market capitalization is largely the result of current global financial market conditions and is similar to companies within the annuity and life insurance sector. There were no other events or material changes in circumstances during 2012 that indicated that a material change in the fair value of the Companys reporting units had occurred.
F-57
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Any amount of goodwill determined to be impaired will be recorded as an expense in the period in which the impairment determination is made. During each year from 2010 through 2012, the Company completed the required annual testing; no impairment charges were necessary as a result of such assessments. The assessment of goodwill recoverability requires significant judgment and is subject to inherent uncertainty. The use of different assumptions, within a reasonable range, could cause the fair value to be below carrying value. Subsequent goodwill assessments could result in impairment, particularly for each reporting unit with at-risk goodwill, due to the impact of a volatile financial market on earnings, discount rate assumptions, liquidity and market capitalization.
The Companys value of acquired insurance in force was an intangible asset with a definite life, was quantified for each of the Companys operating segments and was amortized over the useful lives identified for each segment. The value of acquired insurance in force related to all segments was fully amortized prior to December 31, 2009.
The accumulated amortization of intangible assets -- value of acquired insurance in force and, prior to January 1, 2002, goodwill -- as of both December 31, 2012 and 2011 was $185,276.
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation, which is calculated on the straight-line method based on the estimated useful lives of the assets. The estimated life for real estate is identified by specific property and ranges from 20 to 45 years. The estimated useful lives of leasehold improvements and other property and equipment, including capitalized software, generally range from 2 to 10 years. The following amounts are included in Other Assets in the Consolidated Balance Sheets as of December 31, 2012 and 2011:
December 31, | ||||||||||
2012 | 2011 | |||||||||
Property and equipment |
$ | 108,502 | $ | 112,438 | ||||||
Less: accumulated depreciation |
71,508 | 72,738 | ||||||||
|
|
|
|
|||||||
Total |
$ | 36,994 | $ | 39,700 | ||||||
|
|
|
|
Separate Account (Variable Annuity) Assets and Liabilities
Separate Account (variable annuity) assets and liabilities represent variable annuity contractholder funds invested in various mutual funds. Separate Account assets are recorded at fair value primarily based on market quotations of the underlying securities. The investment income, gains and losses of these accounts accrue directly to the contractholders and are not included in the operations of the Company. The activity of the Separate Accounts is not reflected in the Consolidated Statements of Operations except for (1) contract charges earned, (2) the activity related to contract guarantees, which are benefits on existing variable annuity contracts, and (3) the impact of financial market performance on the amortization of deferred policy acquisition costs. The Companys contract charges earned include fees charged to the Separate Accounts, including mortality charges, risk charges, policy administration fees, investment management fees and surrender charges.
F-58
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Future Policy Benefits, Interest-sensitive Life Contract Liabilities and Annuity Contract Liabilities
Liabilities for future benefits on life and annuity policies are established in amounts adequate to meet the estimated future obligations on policies in force.
Liabilities for future policy benefits on certain life insurance policies are computed using the net level premium method including assumptions as to investment yields, mortality, persistency, expenses and other assumptions based on the Companys experience, including a provision for adverse deviation. These assumptions are established at the time the policy is issued and are intended to estimate the experience for the period the policy benefits are payable. If experience is less favorable than the assumptions, additional liabilities may be established, resulting in a charge to income for that period. At December 31, 2012, reserve investment yield assumptions ranged from 4% to 8%.
Liabilities for future benefits on annuity contracts and certain long-duration life insurance contracts are carried at accumulated policyholder values without reduction for potential surrender or withdrawal charges. The liability also includes provisions for the unearned portion of certain policy charges.
A guaranteed minimum death benefit (GMDB) generally provides an additional benefit if the contractholder dies and the variable annuity contract value is less than a contractually defined amount. The Company has estimated and recorded a GMDB reserve on variable annuity contracts in accordance with accounting guidance. Contractually defined amounts vary from contract to contract based on the date the contract was entered into as well as the GMDB feature elected by the contractholder. The Company regularly monitors the GMDB reserve considering fluctuations in the financial market. The Company has a relatively low exposure to GMDB risk as shown below.
December 31, | ||||||||||
2012 |
2011 |
|||||||||
GMDB reserve |
$ | 392 | $ | 583 | ||||||
Aggregate in-the-money death benefits under the GMDB provision |
41,990 | 53,670 | ||||||||
Variable annuity contract value distribution based on GMDB feature: |
||||||||||
No guarantee |
31 | % | 30 | % | ||||||
Return of premium guarantee |
63 | % | 64 | % | ||||||
Guarantee of premium roll-up at an annual rate of 3% or 5% |
6 | % | 6 | % | ||||||
|
|
|
|
|||||||
Total |
100 | % | 100 | % | ||||||
|
|
|
|
Unpaid Claims and Claim Expenses
Liabilities for property and casualty unpaid claims and claim expenses include provisions for payments to be made on reported claims, claims incurred but not yet reported and associated settlement expenses. All of the Companys reserves for property and casualty unpaid claims and claim expenses are carried at the full value of estimated liabilities and are not discounted for interest expected to be earned on reserves. Estimated amounts of salvage and subrogation on unpaid property and casualty claims are deducted from the liability for unpaid claims. Due to the nature of the Companys personal lines business, the Company has no exposure to losses related 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 mold.
F-59
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Insurance Premiums and Contract Charges Earned
Property and casualty insurance premiums are recognized as revenue ratably over the related contract periods in proportion to the risks insured. The unexpired portions of these property and casualty premiums are recorded as unearned premiums, using the monthly pro rata method.
Premiums and contract charges for interest-sensitive life and investment (annuity) contracts consist of charges for the cost of insurance, policy administration and withdrawals. Premiums for long-term traditional life policies are recognized as revenues when due over the premium-paying period. Annuity and interest-sensitive life contract deposits represent funds deposited by policyholders and are not included in the Companys premiums or contract charges earned.
Stock Based Compensation
The Company grants stock options to executive officers, other employees and directors. The exercise price of the option is equal to the fair market value of the Companys common stock on the date of grant. Additional information regarding the Companys stock-based compensation plans is contained in Note 6 -- Shareholders Equity and Stock Options.
The Company recognizes compensation cost for share-based compensation plans based on the fair value at the grant dates. For the years ended December 31, 2012, 2011 and 2010, the Company recognized $2,476, $1,451 and $2,163, respectively, in expense as a result of the vesting of stock options during the respective periods.
In 2012, 2011 and 2010, the Company granted stock options as quantified in the table below, which also provides the weighted average grant date fair value for options granted in each year. The fair value of options granted was estimated on the respective dates of grant using the Black-Scholes option pricing model with the weighted-average assumptions shown in the following table.
Year Ended December 31, | ||||||||||||
2012 |
2011 |
2010 |
||||||||||
Number of options granted |
296,188 | 313,000 | 361,456 | |||||||||
Weighted average grant date fair value of options granted |
$ | 6.02 | $ | 6.20 | $ | 5.80 | ||||||
Weighted average assumptions: |
||||||||||||
Risk-free interest rate |
1.0 | % | 2.2 | % | 2.7 | % | ||||||
Expected dividend yield |
2.2 | % | 2.2 | % | 2.2 | % | ||||||
Expected life, in years |
5.8 | 5.8 | 5.9 | |||||||||
Expected volatility (based on historical volatility) |
45.1 | % | 45.0 | % | 51.5 | % |
The weighted average fair value of nonvested options outstanding on December 31, 2012 was $5.60. Total unrecognized compensation expense relating to the nonvested options outstanding as of December 31, 2012 was approximately $2,266. This amount will be recognized as expense over the remainder of the vesting period, which is scheduled to be 2013 through 2016. Expense is reflected on a straight-line basis over the vesting period for the entire award.
F-60
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Income Taxes
The Company uses the asset and liability method for calculating deferred federal income taxes. Income tax provisions are generally based on income reported for financial statement purposes. The provisions for federal income taxes for the years ended December 31, 2012, 2011 and 2010 included amounts currently payable and deferred income taxes resulting from the cumulative differences in the Companys assets and liabilities, determined on a tax return versus financial statement basis.
Deferred tax assets and liabilities include provisions for unrealized investment gains and losses as well as the net funded status of pension and other postretirement benefit obligations with the changes for each period included in the respective components of accumulated other comprehensive income (loss) within shareholders equity.
Earnings Per Share
Basic earnings per share is computed based on the weighted average number of common shares outstanding. Diluted earnings per share is computed based on the weighted average number of common shares and common stock equivalents outstanding, to the extent dilutive. The Companys common stock equivalents relate to outstanding common stock options, deferred compensation common stock units and incentive compensation restricted common stock units.
The computations of net income per share on both basic and diluted bases, including reconciliations of the numerators and denominators, were as follows:
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
As Adjusted | As Adjusted | |||||||||||
Basic - assumes no dilution: |
||||||||||||
Net income for the period |
$ | 103,866 | $ | 70,506 | $ | 80,131 | ||||||
|
|
|
|
|
|
|||||||
Weighted average number of common shares outstanding during the period (in thousands) |
39,514 | 39,866 | 39,350 | |||||||||
|
|
|
|
|
|
|||||||
Net income per share basic |
$ | 2.63 | $ | 1.77 | $ | 2.04 | ||||||
|
|
|
|
|
|
|||||||
Diluted - assumes full dilution: |
||||||||||||
Net income for the period |
$ | 103,866 | $ | 70,506 | $ | 80,131 | ||||||
|
|
|
|
|
|
|||||||
Weighted average number of common shares outstanding during the period (in thousands) |
39,514 | 39,866 | 39,350 | |||||||||
Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities (in thousands): |
||||||||||||
Stock options |
222 | 206 | 255 | |||||||||
Common stock units related to deferred compensation for Directors |
112 | 114 | 107 | |||||||||
Common stock units related to deferred compensation for Employees |
116 | 115 | 195 | |||||||||
Restricted common stock units related to incentive compensation |
1,424 | 1,136 | 1,106 | |||||||||
|
|
|
|
|
|
|||||||
Total common and common equivalent shares adjusted to calculate diluted earnings per share (in thousands) |
41,388 | 41,437 | 41,013 | |||||||||
|
|
|
|
|
|
|||||||
Net income per share diluted |
$ | 2.51 | $ | 1.70 | $ | 1.95 | ||||||
|
|
|
|
|
|
F-61
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Options to purchase 221,771 shares of common stock at $17.71 to $20.23 per share were granted in 2005 through 2012 but were not included in the computation of 2012 diluted earnings per share because the options exercise price was greater than the average market price of the common shares during 2012. The options, which expire in 2013 through 2019, were still outstanding at December 31, 2012.
Comprehensive Income (Loss)
Comprehensive income (loss) represents the change in shareholders equity during a reporting period from transactions and other events and circumstances from non-shareholder sources. For the Company, comprehensive income (loss) is equal to net income plus or minus the after tax change in net unrealized gains and losses on fixed maturities and equity securities and the after tax change in net funded status of pension and other postretirement benefit obligations for the period as shown in the Consolidated Statements of Changes in Shareholders Equity.
In the Consolidated Balance Sheets, the Company recognizes the funded status of defined benefit pension plans and other postretirement benefit plans as a component of accumulated other comprehensive income (loss), net of tax.
The components of comprehensive income were as follows:
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
As Adjusted | As Adjusted | |||||||||||
Net income |
$ | 103,866 | $ | 70,506 | $ | 80,131 | ||||||
|
|
|
|
|
|
|||||||
Other comprehensive income (loss): |
||||||||||||
Change in net unrealized gains and losses on fixed maturities and equity securities |
||||||||||||
Net unrealized holding gains and losses on fixed maturities and equity securities arising during the period |
204,460 | 281,202 | 153,743 | |||||||||
Less: reclassification adjustment for net gains included in income before income tax |
27,298 | 37,663 | 21,576 | |||||||||
|
|
|
|
|
|
|||||||
Total, before tax expense |
177,162 | 243,539 | 132,167 | |||||||||
Income tax expense |
62,984 | 86,585 | 46,967 | |||||||||
|
|
|
|
|
|
|||||||
Total, net of tax |
114,178 | 156,954 | 85,200 | |||||||||
|
|
|
|
|
|
|||||||
Change in net funded status of pension and other postretirement benefit obligations |
||||||||||||
Before tax |
1,276 | (4,801 | ) | (2,464 | ) | |||||||
Income tax expense (benefit) |
345 | (1,714 | ) | (852 | ) | |||||||
|
|
|
|
|
|
|||||||
Total, net of tax |
931 | (3,087 | ) | (1,612 | ) | |||||||
|
|
|
|
|
|
|||||||
Total comprehensive income |
$ | 218,975 | $ | 224,373 | $ | 163,719 | ||||||
|
|
|
|
|
|
Statements of Cash Flows
For purposes of the Consolidated Statements of Cash Flows, cash constitutes cash on deposit at banks.
F-62
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Adopted Accounting Standards
Costs Associated with Acquiring or Renewing Insurance Contracts
Effective January 1, 2012, the Company adopted accounting guidance which was issued to address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. The guidance allows an insurance entity to capitalize only incremental and certain direct costs related to the successful acquisition of new or renewal insurance contracts. Management elected retrospective application of the new guidance resulting in a downward adjustment to the deferred policy acquisition costs (DAC) asset with a corresponding decrease to beginning shareholders equity, net of applicable deferred taxes. The adoption of this accounting guidance reduces expense deferrals and amortization, with a minimal net effect on the Companys results of operations.
As a result of the adopted accounting change, net income (loss) per share (basic and diluted) did not change. Other financial statement amounts previously reported were revised as shown below:
As of December 31, 2011 | As of December 31, 2010 | |||||||||||||||||||||||
As
Originally Reported |
As
Adjusted |
Effect of
Change |
As
Originally Reported |
As
Adjusted |
Effect of
Change |
|||||||||||||||||||
Deferred policy acquisition costs |
$ | 265,041 | $ | 216,456 | $ | (48,585) | $ | 272,825 | $ | 222,177 | $ | (50,648) | ||||||||||||
Total assets |
7,483,737 | 7,435,169 | (48,568) | 6,996,300 | 6,945,662 | (50,638) | ||||||||||||||||||
Other liabilities |
369,800 | 352,800 | (17,000) | 304,977 | 287,252 | (17,725) | ||||||||||||||||||
Total liabilities |
6,396,811 | 6,379,816 | (16,995) | 6,116,293 | 6,098,575 | (17,718) | ||||||||||||||||||
Retained earnings |
875,069 | 840,644 | (34,425) | 823,579 | 789,128 | (34,451) | ||||||||||||||||||
Net unrealized gains and losses on fixed maturities and equity securities |
265,370 | 268,222 | 2,852 | 109,737 | 111,268 | 1,531 | ||||||||||||||||||
Total shareholders equity |
1,086,926 | 1,055,353 | (31,573) | 880,007 | 847,087 | (32,920) | ||||||||||||||||||
Year ended December 31, 2011 | Year ended December 31, 2010 | |||||||||||||||||||||||
As
Originally Reported |
As
Adjusted |
Effect of
Change |
As
Originally Reported |
As
Adjusted |
Effect of
Change |
|||||||||||||||||||
Total revenues |
$ | 998,300 | $ | 998,302 | $ | 2 | $ | 974,711 | $ | 974,714 | $ | 3 | ||||||||||||
Policy acquisition expenses amortized |
92,128 | 83,398 | (8,730) | 85,056 | 77,347 | (7,709) | ||||||||||||||||||
Operating expenses |
139,936 | 148,635 | 8,699 | 142,852 | 151,690 | 8,838 | ||||||||||||||||||
Total benefits, losses and expenses |
903,422 | 903,384 | (38) | 863,420 | 864,546 | 1,126 | ||||||||||||||||||
Income before income taxes |
94,878 | 94,918 | 40 | 111,291 | 110,168 | (1,123) | ||||||||||||||||||
Income tax expense |
24,398 | 24,412 | 14 | 30,429 | 30,037 | (392) | ||||||||||||||||||
Net income |
70,480 | 70,506 | 26 | 80,862 | 80,131 | (731) |
Goodwill
Effective January 1, 2012, the Company adopted accounting guidance allowing an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of a reporting unit. The guidance provides an entity with the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is not necessary. The adoption of this accounting guidance did not have an effect on the results of operations or financial position of the Company.
F-63
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Comprehensive Income
Effective January 1, 2012, the Company adopted accounting guidance which was issued to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. The guidance eliminates the option to present components of other comprehensive income as part of the statement of changes in shareholders equity. The guidance requires that all nonowner changes in shareholders equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements with the Statement of Comprehensive Income following the Statement of Operations. The adoption of this accounting guidance did not have an effect on the results of operations or financial position of the Company. The Company had historically reported a Statement of Comprehensive Income which directly followed the Statement of Operations resulting in no changes to disclosures as a result of adopting this accounting guidance. In December 2011, accounting guidance was issued that deferred the disclosures related to the presentation of reclassifications of items out of accumulated other comprehensive income. In February 2013, accounting guidance was issued finalizing the disclosure requirements related to these reclassification adjustments and the guidance will be adopted prospectively for the Companys interim and annual financial statements for the year ended December 31, 2013.
Fair Value Measurements
Effective January 1, 2012, the Company adopted accounting guidance which revised the wording used (1) to describe the requirements for measuring fair value and (2) for disclosing information about fair value measurements. The guidance is largely consistent with existing fair value measurement principles. For many of the requirements, the Financial Accounting Standards Board (FASB) did not intend for the amendments to result in a change in the application of the existing requirements. Generally, the amendments clarified the FASBs intent about the application of existing fair value measurement requirements, such as specifying that the concepts of highest and best use and valuation premise in a fair value measurement are relevant only when measuring the fair value of nonfinancial assets. Certain disclosures in the Companys Notes to Consolidated Financial Statements have been expanded to address additional information required by this guidance. The adoption of this accounting guidance did not have an effect on the results of operations or financial position of the Company.
Embedded Credit Derivatives
Effective July 1, 2010, the Company adopted accounting guidance that clarifies the scope exception for embedded credit-derivative features. Embedded credit-derivative features, related only to the transfer of credit risk in the form of subordination of one financial instrument to another, are not subject to potential bifurcation and separate accounting. Other embedded credit-derivative features in financial instruments do not qualify for the scope exception and are required to be analyzed to determine whether they must be accounted for separately.
F-64
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
As of July 1, 2010 and December 31, 2010, the Company had one security containing an embedded credit-derivative feature that did not qualify for the scope exception. The Company elected the fair value option to account for this security. The cumulative effect of adoption, net of deferred tax, was a decrease in retained earnings of $1,338 with an offsetting increase in accumulated other comprehensive income of $1,338. And, as a result of electing the fair value option to account for this security, the Company recorded a realized investment gain of $1,088 pretax for the year ended December 31, 2010.
Net Investment Income
The components of net investment income for the following periods were:
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Fixed maturities |
$ | 297,042 | $ | 285,782 | $ | 266,894 | ||||||
Equity securities |
2,814 | 1,685 | 4,070 | |||||||||
Short-term and other investments |
8,109 | 7,891 | 8,588 | |||||||||
Other invested asset |
5,892 | - | - | |||||||||
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Total investment income |
313,857 | 295,358 | 279,552 | |||||||||
Investment expenses |
(7,854 | ) | (7,047 | ) | (7,498 | ) | ||||||
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Net investment income |
$ | 306,003 | $ | 288,311 | $ | 272,054 | ||||||
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Realized Investment Gains (Losses)
Realized investment gains (losses) for the following periods were:
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Fixed maturities |
$ | 23,218 | $ | 37,466 | $ | 21,796 | ||||||
Equity securities |
4,080 | 197 | (220 | ) | ||||||||
Short-term and other investments |
- | - | 2,193 | |||||||||
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Realized investment gains |
$ | 27,298 | $ | 37,663 | $ | 23,769 | ||||||
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The Company, from time to time, sells invested assets subsequent to the balance sheet date that were considered temporarily impaired at the balance sheet date. Such sales are generally due to issuer-specific events occurring subsequent to the balance sheet date that result in a change in the Companys intent or ability to hold an invested asset. The types of events that may result in a sale include significant changes in the economic facts and circumstances related to the invested asset, significant unforeseen changes in liquidity needs, or changes in the Companys investment strategy.
For the year ended December 31, 2012, the Companys net realized investment gains of $27,298 included $39,941 of gross gains realized on security sales and calls partially offset by $12,643 of realized losses on securities that were disposed of during 2012. There were no other-than-temporary impairment write-downs on securities in the current period.
F-65
NOTE 2 - Investments-(Continued)
For the year ended December 31, 2011, the Companys net realized investment gains of $37,663 included $39,709 of gross gains realized on security sales and calls partially offset by $1,974 of realized losses on securities that were disposed of during 2011 and $72 of other-than-temporary impairment write-downs on securities. In 2011, the other-than-temporary impairment write-downs were related primarily to further impairment on securities the Company had previously impaired.
For the year ended December 31, 2010, the Companys net realized investment gains of $23,769 included $51,220 of gross gains realized on security sales and calls partially offset by $20,655 of realized losses on securities that were disposed of during 2010 and $6,796 of other-than-temporary impairment write-downs on securities. In the fourth quarter of 2010, losses of $15,152 were realized on security disposals, primarily related to commercial mortgage-backed securities risk reduction actions. In 2010, the other-than-temporary impairment write-downs were related primarily to securities that the Company intended to sell.
F-66
NOTE 2 - Investments-(Continued)
Fixed Maturities and Equity Securities
At December 31, 2012, the combined gross unrealized loss in the fixed maturities and equity securities portfolios was $11,180 (199 positions, the fair value of which represented 5.3% of total fixed maturities and equity securities fair value). The following table presents the fair value and gross unrealized losses of fixed maturity securities and equity securities in an unrealized loss position at December 31, 2012 and 2011, respectively. The Company views the decrease in value of all of the securities with unrealized losses at December 31, 2012 -- which was driven largely by spread widening, financial market illiquidity, market volatility and changes in interest rates from the date of acquisition -- as temporary. For fixed maturity securities, management does not have the intent to sell the securities and it is not more likely than not the Company will be required to sell the securities before the anticipated recovery of the amortized cost bases. In addition, management expects to recover the entire cost basis of the fixed maturity securities. For equity securities, the Company has the ability and intent to hold the securities for the recovery of cost and recovery of cost is expected within a reasonable period of time. Therefore, no impairment of these securities was recorded at December 31, 2012.
12 months or less | More than 12 months | Total | ||||||||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||||||||
Fair Value | Losses | Fair Value | Losses | Fair Value | Losses | |||||||||||||||||||||||||
December 31, 2012 |
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Fixed maturity securities |
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U.S. government and federally sponsored agency obligations: |
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Mortgage-backed securities |
$ | 11,006 | $ | 124 | $ | 50 | $ | 1 | $ | 11,056 | $ | 125 | ||||||||||||||||||
Other |
9,944 | 135 | - | - | 9,944 | 135 | ||||||||||||||||||||||||
Municipal bonds |
108,578 | 2,605 | 3,990 | 43 | 112,568 | 2,648 | ||||||||||||||||||||||||
Foreign government bonds |
- | - | - | - | - | - | ||||||||||||||||||||||||
Corporate bonds |
56,481 | 875 | 26,725 | 4,075 | 83,206 | 4,950 | ||||||||||||||||||||||||
Other mortgage-backed securities |
58,218 | 621 | 25,014 | 1,411 | 83,232 | 2,032 | ||||||||||||||||||||||||
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Total fixed maturity securities |
244,227 | 4,360 | 55,779 | 5,530 | 300,006 | 9,890 | ||||||||||||||||||||||||
Equity securities (1) |
19,344 | 1,288 | 9 | 2 | 19,353 | 1,290 | ||||||||||||||||||||||||
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Combined totals |
$ | 263,571 | $ | 5,648 | $ | 55,788 | $ | 5,532 | $ | 319,359 | $ | 11,180 | ||||||||||||||||||
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Number of positions with a gross unrealized loss |
156 | 43 | 199 | |||||||||||||||||||||||||||
Fair value as a percentage of total fixed maturities and equity securities fair value |
4.4 | % | 0.9 | % | 5.3 | % | ||||||||||||||||||||||||
December 31, 2011 |
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Fixed maturity securities |
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U.S. government and federally sponsored agency obligations: |
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Mortgage-backed securities |
$ | 3,519 | $ | 133 | $ | 1,511 | $ | 11 | $ | 5,030 | $ | 144 | ||||||||||||||||||
Other |
- | - | - | - | - | - | ||||||||||||||||||||||||
Municipal bonds |
24,047 | 270 | 19,309 | 750 | 43,356 | 1,020 | ||||||||||||||||||||||||
Foreign government bonds |
- | - | - | - | - | - | ||||||||||||||||||||||||
Corporate bonds |
273,209 | 9,752 | 26,977 | 6,346 | 300,186 | 16,098 | ||||||||||||||||||||||||
Other mortgage-backed securities |
115,986 | 3,222 | 36,944 | 12,569 | 152,930 | 15,791 | ||||||||||||||||||||||||
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Total fixed maturity securities |
416,761 | 13,377 | 84,741 | 19,676 | 501,502 | 33,053 | ||||||||||||||||||||||||
Equity securities (1) |
- | - | 4,865 | 326 | 4,865 | 326 | ||||||||||||||||||||||||
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Combined totals |
$ | 416,761 | $ | 13,377 | $ | 89,606 | $ | 20,002 | $ | 506,367 | $ | 33,379 | ||||||||||||||||||
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Number of positions with a gross unrealized loss |
159 | 44 | 203 | |||||||||||||||||||||||||||
Fair value as a percentage of total fixed maturities and equity securities fair value |
7.7 | % | 1.6 | % | 9.3 | % |
(1) | Includes nonredeemable (perpetual) preferred stocks and common stocks. |
F-67
NOTE 2 - Investments-(Continued)
Fixed maturities and equity securities with an investment grade rating represented 74% of the gross unrealized loss as of December 31, 2012. The largest single unrealized loss was $2,505 on a floating-rate corporate bond rated BBB issued by a large U.S. financial institution, which was purchased in 2007. The fixed maturities and equity securities portfolio included 43 securities that have been in an unrealized loss position for greater than 12 months, with an unrealized loss totaling $5,532. With respect to fixed income securities involving securitized financial assets, the underlying collateral cash flows were stress tested to determine there was no adverse change in the present value of cash flows below the amortized cost basis.
Compared to December 31, 2011, the 2012 improvement in unrealized investment gains and losses was due to slightly lower yields on U.S. Treasury securities and narrowing credit spreads across virtually all asset classes, the combination of which resulted in an increase in net unrealized gains for the Companys holdings of corporate securities, municipal securities, commercial and residential mortgage-backed securities and asset-backed securities. The amortized cost or cost, unrealized investment gains and losses, fair values and other-than-temporary impairment (OTTI) included in accumulated other comprehensive income (loss) (AOCI) of all fixed maturities and equity securities in the portfolio as of December 31, 2012 and 2011 were as follows:
Amortized | Unrealized | Unrealized | Fair | OTTI in | |||||||||||||||||||||
Cost or Cost | Gains | Losses | Value | AOCI (2) | |||||||||||||||||||||
December 31, 2012 |
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Fixed maturity securities |
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U.S. government and federally sponsored agency obligations (1): |
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Mortgage-backed securities |
$ | 547,040 | $ | 72,644 | $ | 125 | $ | 619,559 | $ | - | |||||||||||||||
Other, including |
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U.S. Treasury securities |
371,706 | 37,857 | 135 | 409,428 | - | ||||||||||||||||||||
Municipal bonds |
1,402,424 | 186,261 | 2,648 | 1,586,037 | - | ||||||||||||||||||||
Foreign government bonds |
48,476 | 9,393 | - | 57,869 | - | ||||||||||||||||||||
Corporate bonds |
2,258,554 | 313,430 | 4,950 | 2,567,034 | - | ||||||||||||||||||||
Other mortgage-backed securities |
683,257 | 41,080 | 2,032 | 722,305 | 3,214 | ||||||||||||||||||||
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Totals |
$ | 5,311,457 | $ | 660,665 | $ | 9,890 | $ | 5,962,232 | $ | 3,214 | |||||||||||||||
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Equity securities |
$ | 52,396 | $ | 2,397 | $ | 1,290 | $ | 53,503 | $ | - | |||||||||||||||
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December 31, 2011 |
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Fixed maturity securities |
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U.S. government and federally sponsored agency obligations (1): |
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Mortgage-backed securities |
$ | 532,554 | $ | 71,402 | $ | 144 | $ | 603,812 | $ | - | |||||||||||||||
Other, including |
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U.S. Treasury securities |
560,036 | 43,705 | - | 603,741 | - | ||||||||||||||||||||
Municipal bonds |
1,291,281 | 122,857 | 1,020 | 1,413,118 | - | ||||||||||||||||||||
Foreign government bonds |
44,529 | 5,095 | - | 49,624 | - | ||||||||||||||||||||
Corporate bonds |
1,967,229 | 205,413 | 16,098 | 2,156,544 | - | ||||||||||||||||||||
Other mortgage-backed securities |
588,760 | 22,024 | 15,791 | 594,993 | 2,136 | ||||||||||||||||||||
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Totals |
$ | 4,984,389 | $ | 470,496 | $ | 33,053 | $ | 5,421,832 | $ | 2,136 | |||||||||||||||
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Equity securities |
$ | 23,070 | $ | 4,030 | $ | 326 | $ | 26,774 | $ | - | |||||||||||||||
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(1) |
Fair value includes securities issued by Federal National Mortgage Association (FNMA) of $375,111 and $547,521; Federal Home Loan Mortgage Corporation (FHLMC) of $418,174 and $374,361; and Government National Mortgage Association (GNMA) of $136,998 and $124,515 as of December 31, 2012 and 2011, respectively. |
(2) |
Represents the amount of other-than-temporary impairment losses in AOCI which, beginning April 1, 2009, was not included in earnings under current accounting guidance. Amounts also include unrealized gains/(losses) on impaired securities relating to changes in the fair value of such securities subsequent to the impairment measurement date. |
F-68
NOTE 2 - Investments-(Continued)
The Companys investment portfolio includes no free-standing derivative financial instruments (futures, forwards, swaps, option contracts or other financial instruments with similar characteristics).
Credit Losses
The following table summarizes the cumulative amounts related to the Companys credit loss component of the other-than-temporary impairment losses on fixed maturity securities held as of December 31, 2012 and 2011 that the Company did not intend to sell as of those dates, and it was not more likely than not that the Company would be required to sell the securities before the anticipated recovery of the amortized cost bases, for which the non-credit portions of the other-than-temporary impairment losses were recognized in other comprehensive income:
Year Ended December 31, | ||||||||||
2012 |
2011 |
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Cumulative credit loss (1) |
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Beginning of period |
$ | 3,957 | $ | 4,518 | ||||||
New credit losses |
- | - | ||||||||
Losses related to securities sold or paid down during the period |
(1,080 | ) | (561 | ) | ||||||
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End of period |
$ | 2,877 | $ | 3,957 | ||||||
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(1) |
The cumulative credit loss amounts exclude other-than-temporary impairment losses on securities held as of the periods indicated that the Company intended to sell or it was more likely than not that the Company would be required to sell the security before the recovery of the amortized cost basis. |
Maturities/Sales of Fixed Maturities and Equity Securities
The following table presents the distribution of the Companys fixed maturities portfolio as of December 31, 2012 by estimated expected maturity. Estimated expected maturities differ from contractual maturities, reflecting assumptions regarding borrowers utilization of the right to call or prepay obligations with or without call or prepayment penalties. For structured securities, including mortgage-backed securities and other asset-backed securities, estimated expected maturities consider broker dealer survey prepayment assumptions and are verified for consistency with the interest rate and economic environments.
December 31, 2012 | |||||||||||||||
Percent of | |||||||||||||||
Amortized | Fair | Total Fair | |||||||||||||
Cost | Value | Value | |||||||||||||
Estimated expected maturity: |
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Due in 1 year or less |
$ | 228,109 | $ | 256,057 | 4.3 | % | |||||||||
Due after 1 year through 5 years |
1,104,146 | 1,239,429 | 20.8 | ||||||||||||
Due after 5 years through 10 years |
2,037,645 | 2,287,304 | 38.4 | ||||||||||||
Due after 10 years through 20 years |
993,533 | 1,115,264 | 18.7 | ||||||||||||
Due after 20 years |
948,024 | 1,064,178 | 17.8 | ||||||||||||
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Total |
$ | 5,311,457 | $ | 5,962,232 | 100.0 | % | |||||||||
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Average option-adjusted duration, in years |
6.3 |
F-69
NOTE 2 - Investments-(Continued)
Proceeds received from sales of fixed maturities and equity securities, each determined using the specific identification method, and gross gains and gross losses realized as a result of those sales for each year were:
Year Ended December 31, | |||||||||||||||
2012 | 2011 | 2010 | |||||||||||||
Fixed maturity securities |
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Proceeds received |
$ | 576,708 | $ | 587,909 | $ | 673,882 | |||||||||
Gross gains realized |
32,532 | 39,463 | 39,939 | ||||||||||||
Gross losses realized |
(11,971 | ) | (2,047 | ) | (18,495 | ) | |||||||||
Equity securities |
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Proceeds received |
$ | 6,057 | $ | 1,078 | $ | 35,499 | |||||||||
Gross gains realized |
231 | 247 | 1,520 | ||||||||||||
Gross losses realized |
(438 | ) | - | (1,801 | ) |
Unrealized Gains and Losses on Fixed Maturities and Equity Securities
Net unrealized gains and losses are computed as the difference between fair value and amortized cost for fixed maturities or cost for equity securities. The following table reconciles the net unrealized investment gains and losses, net of tax, included in accumulated other comprehensive income (loss), before the impact on deferred policy acquisition costs:
Year Ended December 31, | |||||||||||||||
2012 | 2011 | 2010 | |||||||||||||
Net unrealized investment gains (losses) on
|
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Beginning of period |
$ | 284,338 | $ | 118,498 | $ | 24,599 | |||||||||
Change in unrealized investment gains and losses |
153,758 | 190,193 | 108,066 | ||||||||||||
Reclassification of net realized investment (gains) losses to net income |
(15,092 | ) | (24,353 | ) | (14,167 | ) | |||||||||
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End of period |
$ | 423,004 | $ | 284,338 | $ | 118,498 | |||||||||
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Net unrealized investment gains (losses) on equity securities, net of tax |
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Beginning of period |
$ | 2,408 | $ | 2,139 | $ | (1,189 | ) | ||||||||
Change in unrealized investment gains and losses |
964 | 397 | 3,185 | ||||||||||||
Reclassification of net realized investment (gains) losses to net income |
(2,652 | ) | (128 | ) | 143 | ||||||||||
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End of period |
$ | 720 | $ | 2,408 | $ | 2,139 | |||||||||
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Securities Lending
The Company has a program in place whereby it may loan fixed income securities to third parties, primarily major brokerage firms; however, the Companys securities lending program was suspended as of December 31, 2012. During the years ended and as of December 31, 2012 and 2011, there were no fixed income securities on loan.
Investment in Entities Exceeding 10% of Shareholders Equity
At December 31, 2012 and 2011, there were no investments which exceeded 10% of total shareholders equity in entities other than obligations of the U.S. Government and federally sponsored government agencies and authorities.
F-70
NOTE 2 - Investments-(Continued)
Deposits
At December 31, 2012 and 2011, securities with a fair value of $18,565 and $18,779, respectively, were on deposit with governmental agencies as required by law in various states in which the insurance subsidiaries of HMEC conduct business.
NOTE 3 - Fair Value of Financial Instruments
The Company is required under GAAP to disclose estimated fair values for certain financial and non-financial assets and liabilities. Fair values of the Companys insurance contracts other than annuity contracts are not required to be disclosed. However, the estimated fair values of liabilities under all insurance contracts are taken into consideration in the Companys overall management of interest rate risk through the matching of investment maturities with amounts due under insurance contracts.
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between knowledgeable, unrelated and willing market participants on the measurement date. In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The Company categorizes its financial and non-financial assets and liabilities into a three-level hierarchy based on the priority of the inputs to the valuation technique. The three levels of inputs that may be used to measure fair value are:
Level 1 |
Unadjusted quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include fixed maturity and equity securities (both common stock and preferred stock) that are traded in an active exchange market, as well as U.S. Treasury securities. |
|
Level 2 |
Unadjusted observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for the assets or liabilities. Level 2 assets and liabilities include fixed maturity securities with quoted prices that are traded less frequently than exchange-traded instruments. This category generally includes certain U.S. Government and agency mortgage-backed securities, non-agency structured securities, corporate fixed maturity securities and preferred stocks. |
|
Level 3 |
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, certain discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation and for which the significant inputs are unobservable. This category generally includes certain private debt and equity investments. |
F-71
NOTE 3 - Fair Value of Financial Instruments-(Continued)
When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. As a result, a Level 3 fair value measurement may include inputs that are observable (Level 1 or Level 2) and unobservable (Level 3). Net transfers into or out of Level 3 are reported as having occurred at the end of the reporting period in which the transfers were determined.
The following discussion describes the valuation methodologies used for financial assets and financial liabilities measured at fair value. The techniques utilized in estimating the fair values are affected by the assumptions used, including discount rates and estimates of the amount and timing of future cash flows. The use of different methodologies, assumptions and inputs may have a material effect on the estimated fair values of the Companys securities holdings. Care should be exercised in deriving conclusions about the Companys business, its value or financial position based on the fair value information of financial and nonfinancial assets and liabilities presented below.
Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial asset or financial liability, including estimates of timing, amount of expected future cash flows and the credit standing of the issuer. In some cases, the fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial asset or financial liability. The disclosed fair values do not reflect any premium or discount that could result from offering for sale at one time an entire holding of a particular financial asset or financial liability. In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or from Level 2 to Level 3. Potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected in amounts disclosed.
Investments
For fixed maturity securities, each month the Company obtains fair value prices from its investment managers and custodian bank. Fair values for the Companys fixed maturity securities are based primarily on prices provided by its investment managers as well as its custodian bank for certain securities. The prices from the custodian bank are compared to prices from the investment managers. Differences in prices between the sources that the Company considers significant are researched and the Company utilizes the price that it considers most representative of an exit price. Both the investment managers and the custodian bank use a variety of independent, nationally recognized pricing sources to determine market valuations. Each designate specific pricing services or indexes for each sector of the market based upon the providers expertise. Typical inputs used by these pricing sources include, but are not limited to, reported trades, benchmark yield curves, benchmarking of like securities, ratings designations, sector groupings, issuer spreads, bids, offers, and/or estimated cash flows and prepayment speeds.
F-72
NOTE 3 - Fair Value of Financial Instruments-(Continued)
When the pricing sources cannot provide fair value determinations, the Company obtains non-binding price quotes from broker-dealers. The broker-dealers valuation methodology is sometimes matrix-based, using indicative evaluation measures and adjustments for specific security characteristics and market sentiment. The market inputs utilized in the evaluation measures and adjustments include: benchmark yield curves, reported trades, broker/dealer quotes, ratings and corresponding issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The extent of the use of each market input depends on the market sector and the market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities, additional inputs may be necessary.
The Company analyzes price and market valuations received to verify reasonableness, to understand the key assumptions used and their sources, to conclude the prices obtained are appropriate, and to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. Based on this evaluation and investment class analysis, each security is classified into Level 1, 2, or 3. The Company has in place certain control processes to determine the reasonableness of the financial asset fair values. These processes are designed to ensure (1) the values received are reasonable and accurately recorded, (2) the data inputs and valuation techniques utilized are appropriate and consistently applied, and (3) the assumptions are reasonable and consistent with the objective of determining fair value. For example, on a continuing basis, the Company assesses the reasonableness of individual security values received from pricing sources that vary from certain thresholds. The Companys fixed maturity securities portfolio is primarily publicly traded, which allows for a high percentage of the portfolio to be priced through pricing services. Approximately 88% and 91% of the portfolio, based on fair value, was priced through pricing services or index priced as of December 31, 2012 and 2011, respectively. The remainder of the portfolio was priced by broker-dealers or pricing models. When non-binding broker-dealer quotes could be corroborated by comparison to other vendor quotes, pricing models or analysis, the securities were generally classified as Level 2. There were no significant changes to the valuation process during 2012.
Fair values of equity securities have been determined by the Company from observable market quotations, when available. When a public quotation is not available, equity securities are valued by using non-binding broker quotes or through the use of pricing models or analysis that is based on market information regarding interest rates, credit spreads and liquidity. The underlying source data for calculating the matrix of credit spreads relative to the U.S. Treasury curve are nationally recognized indices. In addition, credit rating (or credit quality equivalent information) of securities is also factored into a pricing matrix. These inputs are based on assumptions deemed appropriate given the circumstances and are believed to be consistent with what other market participants would use when pricing such securities. There were no significant changes to the valuation process in 2012.
F-73
NOTE 3 - Fair Value of Financial Instruments-(Continued)
Short-term and other investments are comprised of short-term fixed income securities, policy loans and mortgage loans. For short-term fixed income securities, because of the nature of these assets, carrying amounts generally approximate fair values, which have been determined from public quotations, when available. The fair value of policy loans is based on estimates using discounted cash flow analysis and current interest rates being offered for new loans. The fair value of mortgage loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and the same remaining maturities.
Separate Account (Variable Annuity) Assets
Separate Account (variable annuity) assets are carried at fair value and represent variable annuity contractholder funds invested in various mutual funds. Fair values of these assets are based primarily on market quotations of the underlying securities. Investment performance related to these assets is fully offset by corresponding amounts credited to contractholders with the liability reflected within Separate Account (variable annuity) liabilities. Separate Account liabilities are equal to the estimated fair value of Separate Account assets.
Fixed Annuity Contract Liabilities and Policyholder Account Balances on Interest-sensitive Life Contracts
The fair values of fixed annuity contract liabilities and policyholder account balances on interest-sensitive life contracts are equal to the discounted estimated future cash flows (using the Companys current interest rates for similar products including consideration of minimum guaranteed interest rates). The Company carries these financial liabilities at cost.
Other Policyholder Funds
Other policyholder funds are liabilities related to supplementary contracts without life contingencies and dividend accumulations, which represent deposits that do not have defined maturities. Other policyholder funds are carried at cost, which management believes is a reasonable estimate of fair value due to the relatively short duration of these deposits, based on the Companys past experience.
Short-term Debt
Short-term debt is carried at amortized cost, which management believes is a reasonable estimate of fair value due to the liquidity and short duration of these variable rate instruments.
Long-term Debt
The Company carries long-term debt at amortized cost. The fair value of long-term debt is estimated based on unadjusted quoted market prices of identical publicly traded issues.
F-74
NOTE 3 - Fair Value of Financial Instruments-(Continued)
Financial Instruments Measured and Carried at Fair Value
The following table presents the Companys fair value hierarchy for those assets and liabilities measured and carried at fair value on a recurring basis as of December 31, 2012 and 2011. At December 31, 2012, Level 3 invested assets comprised approximately 2% of the Companys total investment portfolio fair value.
Fair Value Measurements
at
Reporting Date Using |
||||||||||||||||||||
Carrying | Fair | |||||||||||||||||||
Amount | Value | Level 1 | Level 2 | Level 3 | ||||||||||||||||
December 31, 2012 |
||||||||||||||||||||
Financial Assets |
||||||||||||||||||||
Investments |
||||||||||||||||||||
Fixed maturities |
||||||||||||||||||||
U.S. government and federally sponsored agency obligations: |
||||||||||||||||||||
Mortgage-backed securities |
$ | 619,559 | $ | 619,559 | $ | - | $ | 619,559 | $ | - | ||||||||||
Other, including |
||||||||||||||||||||
U.S. Treasury securities |
409,428 | 409,428 | 18,594 | 390,834 | - | |||||||||||||||
Municipal bonds |
1,586,037 | 1,586,037 | - | 1,573,762 | 12,275 | |||||||||||||||
Foreign government bonds |
57,869 | 57,869 | - | 57,869 | - | |||||||||||||||
Corporate bonds |
2,567,034 | 2,567,034 | 11,934 | 2,469,378 | 85,722 | |||||||||||||||
Other mortgage-backed securities |
722,305 | 722,305 | - | 689,133 | 33,172 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total fixed maturities |
5,962,232 | 5,962,232 | 30,528 | 5,800,535 | 131,169 | |||||||||||||||
Equity securities |
53,503 | 53,503 | 43,704 | 9,459 | 340 | |||||||||||||||
Short-term investments |
87,561 | 87,561 | 87,561 | - | - | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Totals |
6,103,296 | 6,103,296 | 161,793 | 5,809,994 | 131,509 | |||||||||||||||
Separate Account |
||||||||||||||||||||
(variable annuity) assets (1) |
1,398,281 | 1,398,281 | - | 1,398,281 | - | |||||||||||||||
Financial Liabilities |
- | - | - | - | - | |||||||||||||||
December 31, 2011 |
||||||||||||||||||||
Financial Assets |
||||||||||||||||||||
Investments |
||||||||||||||||||||
Fixed maturities |
||||||||||||||||||||
U.S. government and federally sponsored agency obligations: |
||||||||||||||||||||
Mortgage-backed securities |
$ | 603,812 | $ | 603,812 | $ | - | $ | 603,812 | $ | - | ||||||||||
Other, including |
||||||||||||||||||||
U.S. Treasury securities |
603,741 | 603,741 | 64,444 | 539,297 | - | |||||||||||||||
Municipal bonds |
1,413,118 | 1,413,118 | - | 1,413,118 | - | |||||||||||||||
Foreign government bonds |
49,624 | 49,624 | - | 49,624 | - | |||||||||||||||
Corporate bonds |
2,156,544 | 2,156,544 | 25,486 | 2,042,802 | 88,256 | |||||||||||||||
Other mortgage-backed securities |
594,993 | 594,993 | - | 590,461 | 4,532 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total fixed maturities |
5,421,832 | 5,421,832 | 89,930 | 5,239,114 | 92,788 | |||||||||||||||
Equity securities |
26,774 | 26,774 | 9,036 | 17,353 | 385 | |||||||||||||||
Short-term investments |
100,442 | 100,442 | 97,929 | 2,513 | - | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Totals |
5,549,048 | 5,549,048 | 196,895 | 5,258,980 | 93,173 | |||||||||||||||
Separate Account |
||||||||||||||||||||
(variable annuity) assets (1) |
1,273,764 | 1,273,764 | - | 1,273,764 | - | |||||||||||||||
Financial Liabilities |
- | - | - | - | - |
(1) | Separate Account (variable annuity) liabilities are set equal to Separate Account (variable annuity) assets. |
F-75
NOTE 3 - Fair Value of Financial Instruments-(Continued)
The Company did not have any transfers between Levels 1 and 2 during the year ended December 31, 2012. The following tables present reconciliations for the years ended December 31, 2012 and 2011 for all Level 3 assets measured at fair value on a recurring basis.
Municipal
Bonds |
Corporate
Bonds |
Other
Mortgage- Backed Securities |
Total
Fixed Maturities |
Equity
Securities |
Total | |||||||||||||||||||||||||
Financial Assets |
||||||||||||||||||||||||||||||
Beginning balance, January 1, 2012 |
$ | - | $ | 88,256 | $ | 4,532 | $ | 92,788 | $ | 385 | $ | 93,173 | ||||||||||||||||||
Transfers into Level 3 (1) |
12,297 | 47,799 | 29,548 | 89,644 | - | 89,644 | ||||||||||||||||||||||||
Transfers out of Level 3 (1) |
- | (50,707 | ) | - | (50,707 | ) | - | (50,707 | ) | |||||||||||||||||||||
Total gains or losses |
||||||||||||||||||||||||||||||
Net realized gains (losses) included in net income |
- | - | (2 | ) | (2 | ) | - | (2 | ) | |||||||||||||||||||||
Net unrealized gains (losses) included in other comprehensive income |
(22 | ) | 1,013 | 200 | 1,191 | (45 | ) | 1,146 | ||||||||||||||||||||||
Purchases |
- | - | - | - | - | - | ||||||||||||||||||||||||
Issuances |
- | - | - | - | - | - | ||||||||||||||||||||||||
Sales |
- | - | - | - | - | - | ||||||||||||||||||||||||
Settlements |
- | - | - | - | - | - | ||||||||||||||||||||||||
Paydowns, maturities and distributions |
- | (639 | ) | (1,106 | ) | (1,745 | ) | - | (1,745 | ) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Ending balance, December 31, 2012 |
$ | 12,275 | $ | 85,722 | $ | 33,172 | $ | 131,169 | $ | 340 | $ | 131,509 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Beginning balance, January 1, 2011 |
$ | - | $ | 45,244 | $ | 945 | $ | 46,189 | $ | 396 | $ | 46,585 | ||||||||||||||||||
Transfers into Level 3 (1) |
- | 53,617 | 3,872 | 57,489 | - | 57,489 | ||||||||||||||||||||||||
Transfers out of Level 3 (1) |
- | (13,725 | ) | - | (13,725 | ) | - | (13,725 | ) | |||||||||||||||||||||
Total gains or losses |
||||||||||||||||||||||||||||||
Net realized gains (losses) included in net income |
- | - | - | - | - | - | ||||||||||||||||||||||||
Net unrealized gains (losses) included in other comprehensive income |
- | 4,036 | 85 | 4,121 | (11 | ) | 4,110 | |||||||||||||||||||||||
Purchases |
- | - | - | - | - | - | ||||||||||||||||||||||||
Issuances |
- | - | - | - | - | - | ||||||||||||||||||||||||
Sales |
- | - | - | - | - | - | ||||||||||||||||||||||||
Settlements |
- | - | - | - | - | - | ||||||||||||||||||||||||
Paydowns, maturities and distributions |
- | (916 | ) | (370 | ) | (1,286 | ) | - | (1,286 | ) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
Ending balance, December 31, 2011 |
$ | - | $ | 88,256 | $ | 4,532 | $ | 92,788 | $ | 385 | $ | 93,173 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
Transfers into and out of Level 3 during the years ended December 31, 2012 and 2011 were attributable to changes in the availability of observable market information for individual fixed maturity securities. The Companys policy is to recognize transfers into and transfers out of the levels as of the ending date of the reporting period. |
At December 31, 2012 and 2011, there were no net realized gains or losses included in earnings that were attributable to changes in the fair value of Level 3 assets still held.
The valuation techniques and significant unobservable inputs used in the fair value measurement for financial instruments classified as Level 3 are subject to the control processes as previously described in this note for Investments. Generally, valuation for fixed maturity securities include matrix pricing and discounted cash flow methodologies, inputs such as quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified as Level 2, as well as independent non-binding broker quotations. The valuation techniques and significant unobservable inputs used in the fair value measurement for equity securities classified as Level 3 use the same valuation techniques and significant unobservable inputs as fixed maturities. The fair value of the other investments above is based on the net asset values.
F-76
NOTE 3 - Fair Value of Financial Instruments-(Continued)
The sensitivity of the estimated fair values to changes in the significant unobservable inputs for fixed maturities and equity securities included in Level 3 generally relate to interest rate spreads, illiquidity premiums and default rates. Significant spread widening in isolation will adversely impact the overall valuation, while significant spread tightening will lead to substantial valuation increases. Significant increases (decreases) in illiquidity premiums in isolation will result in substantially lower (higher) valuations. Significant increases (decreases) in expected default rates in isolation will result in substantially lower (higher) valuations.
Financial Instruments Disclosed, But Not Carried, at Fair Value
The Company has various other financial assets and financial liabilities used in the normal course of business that are not carried at fair value, but for which fair value disclosure is required. The following table presents the carrying value, fair value and fair value hierarchy of these financial assets and financial liabilities at December 31, 2012 and 2011.
Fair Value Measurements at | ||||||||||||||||||||
Carrying | Fair | Reporting Date Using | ||||||||||||||||||
Amount | Value | Level 1 | Level 2 | Level 3 | ||||||||||||||||
December 31, 2012 |
||||||||||||||||||||
Financial Assets |
||||||||||||||||||||
Investments |
||||||||||||||||||||
Other investments |
$ | 134,985 | $ | 135,121 | $ | - | $ | - | $ | 135,121 | ||||||||||
Financial Liabilities |
||||||||||||||||||||
Fixed annuity contract liabilities |
3,257,758 | 3,070,111 | - | - | 3,070,111 | |||||||||||||||
Policyholder account balances on interest-sensitive life contracts |
79,017 | 78,519 | - | - | 78,519 | |||||||||||||||
Other policyholder funds |
103,227 | 103,227 | - | - | 103,227 | |||||||||||||||
Short-term debt |
38,000 | 38,000 | - | 38,000 | - | |||||||||||||||
Long-term debt |
199,809 | 219,319 | 219,319 | - | - | |||||||||||||||
December 31, 2011 |
||||||||||||||||||||
Financial Assets |
||||||||||||||||||||
Investments |
||||||||||||||||||||
Other investments |
$ | 128,460 | $ | 132,522 | $ | - | $ | - | $ | 132,522 | ||||||||||
Financial Liabilities |
||||||||||||||||||||
Fixed annuity contract liabilities |
2,945,107 | 2,699,295 | - | - | 2,699,295 | |||||||||||||||
Policyholder account balances on interest-sensitive life contracts |
79,305 | 76,370 | - | - | 76,370 | |||||||||||||||
Other policyholder funds |
114,530 | 114,530 | - | - | 114,530 | |||||||||||||||
Short-term debt |
38,000 | 38,000 | - | 38,000 | - | |||||||||||||||
Long-term debt |
199,744 | 214,218 | 214,218 | - | - |
F-77
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses
The following table sets forth an analysis of property and casualty unpaid claims and claim expenses and provides a reconciliation of beginning and ending reserves for the periods indicated.
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Property and casualty segment |
||||||||||||
Gross reserves, beginning of year (1) |
$ | 281,080 | $ | 301,622 | $ | 300,975 | ||||||
Less reinsurance recoverables |
11,463 | 12,225 | 15,769 | |||||||||
|
|
|
|
|
|
|||||||
Net reserves, beginning of year (2) |
269,617 | 289,397 | 285,206 | |||||||||
|
|
|
|
|
|
|||||||
Incurred claims and claim expenses: |
||||||||||||
Claims occurring in the current year |
406,605 | 452,827 | 438,784 | |||||||||
Decrease in estimated reserves for claims occurring in prior years (3) |
(17,175 | ) | (10,310 | ) | (20,530 | ) | ||||||
|
|
|
|
|
|
|||||||
Total claims and claim expenses incurred (4) |
389,430 | 442,517 | 418,254 | |||||||||
|
|
|
|
|
|
|||||||
Claims and claim expense payments for claims occurring during: |
||||||||||||
Current year |
271,286 | 314,759 | 281,270 | |||||||||
Prior years |
126,924 | 147,539 | 132,793 | |||||||||
|
|
|
|
|
|
|||||||
Total claims and claim expense payments |
398,210 | 462,298 | 414,063 | |||||||||
|
|
|
|
|
|
|||||||
Net reserves, end of year (2) |
260,837 | 269,617 | 289,397 | |||||||||
Plus reinsurance recoverables |
13,705 | 11,463 | 12,225 | |||||||||
|
|
|
|
|
|
|||||||
Gross reserves, end of year (1) |
$ | 274,542 | $ | 281,080 | $ | 301,622 | ||||||
|
|
|
|
|
|
(1) |
Unpaid claims and claim expenses as reported in the Consolidated Balance Sheets also include reserves for the life and annuity segments of $14,853, $13,729, $14,073 and $11,763 as of December 31, 2012, 2011, 2010 and 2009, respectively, in addition to property and casualty segment reserves. |
(2) |
Reserves net of anticipated reinsurance recoverables. |
(3) |
Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims and changes in their projected final settlement costs. Also refer to the paragraphs below for additional information regarding the reserve development recorded in 2012, 2011 and 2010. |
(4) |
Benefits, claims and settlement expenses as reported in the Consolidated Statements of Operations also include amounts for the life and annuity segments of $58,820, $59,917 and $56,579 for the years ended December 31, 2012, 2011* and 2010*, respectively, in addition to the property and casualty segment amounts. *As adjusted. |
Underwriting results of the property and casualty segment are significantly influenced by estimates of the Companys 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 (case reserves), claims incurred but not yet reported (IBNR) and associated settlement expenses (together, loss reserves). The process by which these reserves are established requires reliance upon estimates based on known facts and on interpretations of circumstances, including the Companys experience with similar cases and historical trends involving claim payments and related patterns, pending levels of unpaid claims and product mix, as well as other factors including court decisions, economic conditions, public attitudes and medical costs.
F-78
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued)
The Company believes the property and casualty loss reserves are appropriately established based on available facts, laws, and regulations. The Company calculates and records a single best estimate of the reserve (which is equal to the actuarial point estimate) as of each balance sheet date, for each line of business and its components (coverages and perils) for reported losses and for IBNR losses and as a result believes no other estimate is better than the recorded amount. Due to uncertainties involved, the ultimate cost of losses may vary materially from recorded amounts.
The Company continually updates loss estimates using both quantitative and qualitative information from its reserving actuaries and 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 in the period in which the adjustments are made.
Numerous risk factors will affect more than one product line. One of these factors is changes in claim department practices, including claim closure rates, number of claims closed without payment, the use of third-party claims adjusters and the level of needed case reserve estimated by the adjuster. Other risk factors include changes in claim frequency, changes in claim severity, regulatory and legislative actions, court actions, changes in economic conditions and trends (e.g. medical costs, labor rates and the cost of materials), the occurrence of unusually large or frequent catastrophic loss events, timeliness of claim reporting, the state in which the claim occurred and degree of claimant fraud. The extent of the impact of a risk factor will also vary by coverages within a product line. Individual risk factors are also subject to interactions with other risk factors within product line coverages.
While all product lines are exposed to these risks, there are some loss types or product lines for which the financial effect will be more significant. For instance, the use of third-party adjusters for large catastrophe losses adds a level of risk to this loss type not present when employee adjusters handle claims. Also, given the relatively large proportion (approximately 70% as of December 31, 2012) of the Companys reserves that are in the longer-tail automobile liability coverages, regulatory and court actions, changes in economic conditions and trends, and medical costs could be expected to impact this product line more extensively than others.
F-79
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued)
Reserves are established for claims as they occur for each line of business based on estimates of the ultimate cost to settle the claims. The actual loss results are compared to prior estimates and differences are recorded as reestimates. The primary actuarial techniques (development of paid loss dollars, development of reported loss dollars, methods based on expected loss ratios and methods utilizing frequency and severity of claims) used to estimate reserves and provide for losses are applied to actual paid losses and reported losses (paid losses plus individual case reserves set by claim adjusters) for an accident year or a calendar year to create an estimate of how losses are likely to develop over time. An accident year refers to classifying claims based on the year in which the claim occurred. A calendar year refers to classifying claims based on the year in which the claims are reported. Both classifications are used to prepare estimates of required reserves for payments to be made in the future. For estimating short-tail coverage reserves (e.g. homeowners and automobile physical damage), which comprise approximately 20% of the Companys total loss reserves as of December 31, 2012, the primary actuarial technique utilized is the development of paid loss dollars due to the relatively quick claim settlement period. As it relates to estimating long-tail coverage reserves (primarily related to automobile liability), which comprise approximately 80% of the Companys total loss reserves as of December 31, 2012, the primary actuarial technique utilized is the development of reported loss dollars due to the relatively long claim settlement period.
In all of the loss estimation techniques referred to above, a ratio (development factor) is calculated which compares current results to results in the prior period for each accident year. Various development factors, based on historical results, are multiplied by the current experience to estimate the development of losses of each accident year from the current time period into the next time period. The development factors for the next time period for each accident year are compounded over the remaining calendar years to calculate an estimate of ultimate losses for each accident year. Occasionally, unusual aberrations in loss patterns are caused by factors such as changes in claim reporting, settlement patterns, unusually large losses, process changes, legal or regulatory environment changes, and other influences. In these instances, analyses of alternate development factor selections are performed to evaluate the effect of these factors, and actuarial judgment is applied to make appropriate development factor assumptions needed to develop a best estimate of ultimate losses. Paid losses are then subtracted from estimated ultimate losses to determine the indicated loss reserves. The difference between indicated reserves and recorded reserves is the amount of reserve reestimate.
Reserves are reestimated quarterly. When new development factors are calculated from actual losses, and they differ from estimated development factors used in previous reserve estimates, assumptions about losses and required reserves are revised based on the new development factors. Changes to reserves are recorded in the period in which development factor changes result in reserve reestimates.
F-80
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued)
Numerous actuarial estimates of the types described above are prepared each quarter to monitor losses for each line of business and its components (coverages and perils) and for reported losses and IBNR. Often, several different estimates are prepared for each detailed component, incorporating alternative analyses of changing claim settlement patterns and other influences on losses, from which the Company selects the best estimate for each component, occasionally incorporating additional analyses and actuarial judgment, as described above. These estimates also incorporate the historical impact of inflation into reserve estimates, the implicit assumption being that a multi-year average development factor represents an adequate provision. Based on the Companys review of these estimates, as well as the review of the independent reserve studies, the best estimate of required reserves for each line of business and its components (coverages and perils) is determined by management and is recorded for each accident year, and the required reserves for each component are summed to create the reserve balances carried on the Companys Consolidated Balance Sheets.
Based on the Companys products and coverages, historical experience, and modeling of various actuarial methodologies used to develop reserve estimates, the Company estimates that the potential variability of the property and casualty loss reserves within a reasonable probability of other possible outcomes may be approximately plus or minus 6% of reserves, which equates to plus or minus approximately $10,000 of net income as of December 31, 2012. Although this evaluation reflects the most likely outcomes, it is possible the final outcome may fall below or above these estimates.
Net favorable development of total reserves for property and casualty claims occurring in prior years was $17,175 in 2012, primarily the result of favorable frequency and severity trends in voluntary automobile loss and claim settlement expense emergence for accident years 2011 and prior. In 2011, net favorable development of total reserves for property and casualty claims occurring in prior years was $10,310, primarily the result of favorable frequency and severity trends in voluntary automobile loss and claim settlement expense emergence for accident years 2009 and prior, as well as favorable development of homeowners loss reserves for accident years 2010 and prior. In 2010, net favorable development of total reserves for property and casualty claims occurring in prior years was $20,530, primarily the result of favorable frequency and severity trends in voluntary automobile loss and claim settlement expense emergence for accident years 2008 and prior.
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 Companys property and casualty reserves at December 31 of each year, supplemented by other analyses throughout the year. The result of the independent actuarial study at December 31, 2012 was consistent with managements analyses and selected estimates and did not result in any adjustments to the Companys recorded property and casualty reserves.
F-81
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued)
Based on an assessment of the relative weight given to emerging trends resulting from recent business process changes, pricing, underwriting and claims handling, at both December 31, 2012 and 2011 the Company recorded property and casualty reserves toward the higher end (upper quartile) of a reasonable range of reserve estimates.
At the time each of the reserve analyses was performed, the Company believed that each estimate was based upon sound and correct methodology and such methodology was appropriately applied and that there were no trends which indicated the likelihood of future loss reserve development. The financial impact of the net reserve development was therefore accounted for in the period that the development was determined.
No other adjustments were made in the determination of the liabilities during the periods covered by these consolidated financial statements. Management believes that, based on data currently available, it has reasonably estimated the Companys ultimate losses.
Indebtedness and scheduled maturities as of December 31, 2012 and 2011 consisted of the following:
Effective
Interest Rates |
Final
Maturity |
December 31, |
||||||||||||||||||
2012 |
2011 |
|||||||||||||||||||
Short-term debt: |
||||||||||||||||||||
Bank Credit Facility |
Variable | 2015 | $ 38,000 | $ 38,000 | ||||||||||||||||
Long-term debt: |
||||||||||||||||||||
6.05% Senior Notes, Face amount of $75,000 less unaccrued discount of $65 and $92 |
6.1% | 2015 | 74,935 | 74,908 | ||||||||||||||||
6.85% Senior Notes, Face amount of $125,000 less unaccrued discount of $126 and $164 |
6.9% | 2016 | 124,874 | 124,836 | ||||||||||||||||
Total |
$237,809 | $237,744 |
Credit Agreement with Financial Institutions (Bank Credit Facility)
On October 7, 2011, HMEC entered into a Bank Credit Agreement (the Bank Credit Facility) that replaced a previous bank credit agreement which was scheduled to expire on December 19, 2011. On October 7, 2011, there was no change to HMECs short-term debt balance. HMEC borrowed $38,000 under the Bank Credit Facility and used the proceeds to repay the $38,000 balance outstanding under the previous bank credit agreement.
The Bank Credit Facility is by and between HMEC, certain financial institutions named therein and JPMorgan Chase Bank, N.A., as administrative agent, provides for unsecured borrowings of up to $150,000 and expires on October 6, 2015. Interest accrues at varying spreads relative to prime or Eurodollar base rates and is payable monthly or quarterly depending on the applicable base rate (Eurodollar base rate plus 1.25%, which totaled 1.56%, as of December 31, 2012). The unused portion of the Bank Credit Facility is subject to a variable commitment fee, which was 0.15% on an annual basis at December 31, 2012.
F-82
NOTE 5 - Debt-(Continued)
6.05% Senior Notes due 2015 (Senior Notes due 2015)
On June 9, 2005, the Company issued $75,000 aggregate principal amount of 6.05% senior notes, which will mature on June 15, 2015, issued at a discount of 0.357% resulting in an effective yield of 6.098%. Interest on the Senior Notes due 2015 is payable semi-annually at a rate of 6.05%. The Senior Notes due 2015 are redeemable in whole or in part, at any time, at the Companys option, at a redemption price equal to the greater of (1) 100% of the principal amount of the notes being redeemed or (2) the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted, on a semi-annual basis, at the Treasury yield (as defined in the indenture) plus 30 basis points, plus, in either of the above cases, accrued interest to the date of redemption.
6.85% Senior Notes due 2016 (Senior Notes due 2016)
On April 21, 2006, the Company issued $125,000 aggregate principal amount of 6.85% senior notes, which will mature on April 15, 2016, issued at a discount of 0.305% resulting in an effective yield of 6.893%. Interest on the Senior Notes due 2016 is payable semi-annually at a rate of 6.85%. The Senior Notes due 2016 are redeemable in whole or in part, at any time, at the Companys option, at a redemption price equal to the greater of (1) 100% of the principal amount of the notes being redeemed or (2) the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted, on a semi-annual basis, at the Treasury yield (as defined in the indenture) plus 30 basis points, plus, in either of the above cases, accrued interest to the date of redemption.
Universal Shelf Registration
To provide additional capital management flexibility, the Company filed a universal shelf registration on Form S-3 with the SEC on January 5, 2012. The registration statement, which registers the offer and sale by the Company from time to time of up to $300,000 of various securities, which may include debt securities, common stock, preferred stock, depositary shares, warrants and/or delayed delivery contracts, was declared effective on January 18, 2012. Unless fully utilized or withdrawn by the Company earlier, this registration statement will remain effective through January 18, 2015. No securities associated with the registration statement have been issued as of the date of this Annual Report on Form 10-K. The Companys prior universal shelf registration was terminated upon effectiveness of the January 2012 Form S-3; no securities associated with that registration statement were issued.
Covenants
The Company is in compliance with all of the financial covenants contained in the Senior Notes due 2015 indenture, the Senior Notes due 2016 indenture and the Bank Credit Facility agreement, consisting primarily of relationships of (1) debt to capital, (2) net worth, as defined in the financial covenants, and (3) insurance subsidiaries risk based capital.
F-83
NOTE 6 - Shareholders Equity and Stock Options
Share Repurchase Program and Treasury Shares Held (Common Stock)
On December 7, 2011, HMECs Board of Directors (the Board) authorized a share repurchase program allowing repurchases of up to $50,000. The share repurchase program authorizes the opportunistic repurchase of HMECs common shares in open market or privately negotiated transactions, from time to time, depending on market conditions. The share repurchase program does not have an expiration date and may be limited or terminated at any time without notice.
From December 7, 2011 through December 31, 2011, the Company repurchased 154,708 shares of its common stock, or 0.4% of the outstanding shares on December 31, 2010, at an aggregate cost of $2,047, or an average price of $13.21 per share, under this share repurchase program. During 2012, the Company repurchased 915,895 shares of its common stock, or 2.3% of the outstanding shares on December 31, 2011, at an aggregate cost of $15,735, or an average price of $17.16 per share, under this share repurchase program. In total and through December 31, 2012, 1,070,603 shares have been repurchased under the $50,000 program at an average price of $16.59 per share. The repurchase of shares was financed through use of cash. As of December 31, 2012, $32,239 remained authorized for future share repurchases.
In accordance with the terms of the Companys incentive compensation plans, in 2011 HMEC received 60,126 shares of its common stock in connection with the conversion of restricted stock units. The shares were received in satisfaction of withholding taxes due on the distributions.
At December 31, 2012, the Company held 22,943,925 shares in treasury.
Authorization of Preferred Stock
In 1996, the shareholders of HMEC approved authorization of 1,000,000 shares of $0.001 par value preferred stock. The Board of Directors is authorized to (1) direct the issuance of the preferred stock in one or more series, (2) fix the dividend rate, conversion or exchange rights, redemption price and liquidation preference, of any series of the preferred stock, (3) fix the number of shares for any series and (4) increase or decrease the number of shares of any series. No shares of preferred stock were outstanding at December 31, 2012 and 2011.
F-84
NOTE 6 - Shareholders Equity and Stock Options-(Continued)
2010 Comprehensive Executive Compensation Plan
In 2010, the shareholders of HMEC approved the 2010 Comprehensive Executive Compensation Plan (the Comprehensive Plan). The Comprehensive Plan is a consolidation of the HMEC Amended and Restated 2002 Incentive Compensation Plan, the Amended and Restated HMEC Deferred Equity Compensation Plan for Directors and the Amended and Restated HMEC Deferred Compensation Plan for Employees (collectively, the Preexisting Plans). Previously, shareholders had approved and authorized 9,000,000 shares of common stock under prior incentive compensation plans and 600,000 shares of common stock under directors deferred compensation plans. Authorized shares that remained available for issuance under the Preexisting Plans were authorized and made available under the Comprehensive Plan, but no additional shares were reserved under the Comprehensive Plan at that time. In 2012, the shareholders of HMEC approved an increase of 2,200,000 in the number of shares of common stock reserved for issuance under the Comprehensive Plan. Shareholders also approved the implementation of a fungible share pool under which grants of full value shares will count against the share limit as two and one half shares for every share subject to a full value award. As of December 31, 2012, approximately 3.3 million shares were available for grant under the Comprehensive Plan. Shares of common stock issued under the Comprehensive Plan may be either authorized and unissued shares of HMEC or shares that have been reacquired by HMEC; however, new shares have been issued historically.
As further described in the paragraphs below, stock units and stock options under the Comprehensive Plan which were outstanding as of December 31, 2012, 2011 and 2010 were as follows:
December 31, | |||||||||||||||
2012 |
2011 |
2010 |
|||||||||||||
Common stock units related to deferred compensation for Directors |
111,928 | 113,502 | 106,845 | ||||||||||||
Common stock units related to deferred compensation for employees |
116,174 | 115,087 | 195,088 | ||||||||||||
Stock options |
1,882,939 | 2,600,583 | 2,773,115 | ||||||||||||
Restricted common stock units related to incentive compensation |
1,423,611 | 1,135,840 | 1,106,166 | ||||||||||||
|
|
|
|
|
|
||||||||||
Total |
3,534,652 | 3,965,012 | 4,181,214 | ||||||||||||
|
|
|
|
|
|
Director Common Stock Units
Deferred compensation of directors is in the form of common stock units, which represent an equal number of common shares to be issued in the future. The outstanding units of directors serving on the Board accrue dividends at the same rate as dividends paid to HMECs shareholders; outstanding units of retired directors do not accrue dividends. These dividends are reinvested into additional common stock units.
F-85
NOTE 6 - Shareholders Equity and Stock Options-(Continued)
Employee Common Stock Units
Deferred compensation of employees is in the form of common stock units, which represent an equal number of common shares to be issued in the future. Distributions of employee deferred compensation are allowed to be either in common shares or cash. Through December 31, 2012, all distributions have been in cash. The outstanding units accrue dividends at the same rate as dividends paid to HMECs shareholders. These dividends are reinvested into additional common stock units.
Stock Options
Options to purchase shares of HMEC common stock may be granted to executive officers, other employees and directors. The options become exercisable in installments based on service generally beginning in the first year from the date of grant and generally become fully vested 4 to 5 years from the date of grant. The options generally expire 7 to 10 years from the date of grant. The exercise price of the option is equal to the market price of HMECs common stock on the date of grant resulting in a grant date intrinsic value of $0.
Changes in outstanding options were as follows:
Weighted Average
Option Price per Share |
Range of
Option Prices per Share |
Options | |||||||||||||||||||
Outstanding |
Vested and
Exercisable |
||||||||||||||||||||
December 31, 2011 |
$15.13 | $ | 6.91-$21.64 | 2,600,583 | 1,873,149 | ||||||||||||||||
Granted |
$17.34 | $ | 17.32-$18.20 | 296,188 | - | ||||||||||||||||
Vested |
$13.81 | $ | 6.91-$17.71 | - | 302,386 | ||||||||||||||||
Exercised |
$11.77 | $ | 6.91-$19.16 | (389,089 | ) | (389,089 | ) | ||||||||||||||
Forfeited |
$17.01 | $ | 13.83-$20.80 | (42,193 | ) | (42,193 | ) | ||||||||||||||
Expired |
$19.67 | $ | 18.76-$21.64 | (582,550 | ) | (582,550 | ) | ||||||||||||||
|
|
|
|
||||||||||||||||||
December 31, 2012 |
$14.73 | $ | 6.91-$20.23 | 1,882,939 | 1,161,703 | ||||||||||||||||
|
|
|
|
For options outstanding as of December 31, 2012, information segregated by ranges of exercise prices was as follows:
Total Outstanding Options | Vested and Exercisable Options | ||||||||||||||||||||||||||||||||||
Range of
Option Prices per Share |
Options |
Weighted
Average Option Price per Share |
Weighted
Average Remaining Term |
Options |
Weighted
Average Option Price per Share |
Weighted
Average Remaining Term |
|||||||||||||||||||||||||||||
$ | 6.91-$ 9.04 | 415,346 | $ | 7.95 | 3.1 years | 338,572 | $ | 8.19 | 3.0 years | ||||||||||||||||||||||||||
$ | 13.83-$16.81 | 687,185 | $ | 15.14 | 3.0 years | 538,409 | $ | 15.44 | 2.7 years | ||||||||||||||||||||||||||
$ | 17.01-$20.23 | 780,408 | $ | 17.97 | 4.5 years | 284,722 | $ | 19.31 | 2.2 years | ||||||||||||||||||||||||||
|
|
|
|
||||||||||||||||||||||||||||||||
Total |
$ | 6.91-$20.23 | 1,882,939 | $ | 14.73 | 3.6 years | 1,161,703 | $ | 14.28 | 2.7 years | |||||||||||||||||||||||||
|
|
|
|
The weighted average exercise prices of vested and exercisable options as of December 31, 2011 and 2010 were $15.57 and $17.03, respectively.
As of December 31, 2012, based on a closing stock price of $19.96 per share, the aggregate intrinsic (in-the-money) values of vested options and all options outstanding were $6,656 and $9,906, respectively.
F-86
NOTE 6 - Shareholders Equity and Stock Options-(Continued)
Restricted Common Stock Units
Restricted common stock units may be granted to executive officers, other employees and directors and represent an equal number of common shares to be issued in the future. The restricted common stock units vest in installments based on service or attainment of performance criteria generally beginning in the first year from the date of grant and generally become fully vested 1 to 5 years from the date of grant. On the date of grant, the fair value of restricted common stock units is equal to the market price of HMECs common stock on that date. The outstanding units accrue dividends at the same rate as dividends paid to HMECs shareholders. These dividends are reinvested into additional restricted common stock units.
Changes in outstanding restricted common stock units were as follows:
Total Outstanding Units | Vested Units | |||||||||||||||||||
Units |
Weighted Average
Grant Date Fair Value per Unit |
Units |
Weighted Average
Grant Date Fair Value per Unit |
|||||||||||||||||
December 31, 2011 |
1,135,840 | $ | 14.07 | 189,228 | $ | 15.35 | ||||||||||||||
Granted (1) |
460,178 | $ | 18.17 | - | - | |||||||||||||||
Vested |
- | - | 264,272 | $ | 9.42 | |||||||||||||||
Forfeited |
(30,314 | ) | $ | 12.29 | - | - | ||||||||||||||
Distributed (2) |
(142,093 | ) | $ | 9.15 | (142,093 | ) | $ | 9.15 | ||||||||||||
|
|
|
|
|||||||||||||||||
December 31, 2012 |
1,423,611 | $ | 15.93 | 311,407 | $ | 13.15 | ||||||||||||||
|
|
|
|
(1) | Includes dividends reinvested into additional restricted common stock units. |
(2) | Includes distributed units which were utilized to satisfy withholding taxes due on the distribution. |
The income tax assets and liabilities included in Other Assets and Other Liabilities, respectively, in the Consolidated Balance Sheets as of December 31, 2012 and 2011 were as follows:
December 31, | ||||||||||
2012 |
2011 |
|||||||||
As Adjusted | ||||||||||
Income tax (asset) liability |
||||||||||
Current |
$ | 4,575 | $ | (5,857 | ) | |||||
Deferred |
286,726 | 204,421 |
F-87
NOTE 7 - Income Taxes-(Continued)
Deferred tax assets and liabilities are recognized for all future tax consequences attributable to temporary differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. There are no deferred tax liabilities that have not been recognized. The temporary differences that gave rise to the deferred tax balances as of December 31, 2012 and 2011 were as follows:
December 31, | ||||||||||
2012 |
2011 |
|||||||||
As Adjusted | ||||||||||
Deferred tax assets |
||||||||||
Unearned premium reserve reduction |
$ 14,952 | $ 14,336 | ||||||||
Compensation accruals |
13,592 | 8,304 | ||||||||
Other comprehensive income net funded status of pension and other postretirement benefit obligations |
8,352 | 8,798 | ||||||||
Discounting of unpaid claims and claim expenses tax reserves |
4,825 | 5,388 | ||||||||
Postretirement benefits other than pensions |
2,333 | 2,743 | ||||||||
Impaired securities |
1,268 | 5,410 | ||||||||
Unutilized net operating loss carryforward |
- | 8,394 | ||||||||
Total gross deferred tax assets |
45,322 | 53,373 | ||||||||
Deferred tax liabilities |
||||||||||
Other comprehensive income net unrealized gains on fixed maturities and equity securities |
228,159 | 155,941 | ||||||||
Deferred policy acquisition costs |
62,411 | 66,820 | ||||||||
Life insurance future policy benefit reserve |
18,620 | 15,704 | ||||||||
Investment related adjustments |
15,375 | 13,984 | ||||||||
Intangible assets |
4,262 | 4,262 | ||||||||
Other, net |
3,221 | 1,083 | ||||||||
Total gross deferred tax liabilities |
332,048 | 257,794 | ||||||||
Net deferred tax liability |
$286,726 | $204,421 |
The Company evaluated sources and character of income, including historical earnings, loss carryback potential, taxable income from future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences, and taxable income from prudent and feasible tax-planning strategies. Although realization of deferred tax assets is not assured, the Company believes it is more-likely-than-not that gross deferred tax assets will be fully realized and that a valuation allowance with respect to the realization of the total gross deferred tax assets was not necessary as of December 31, 2012 and 2011.
At December 31, 2012, the Company did not have any loss carryforwards or credits.
The components of income tax expense were as follows:
Year Ended December 31, | |||||||||||||||
2012 |
2011 |
2010 |
|||||||||||||
As Adjusted | As Adjusted | ||||||||||||||
Current |
$26,331 | $18,211 | $13,609 | ||||||||||||
Deferred |
18,976 | 6,201 | 16,428 | ||||||||||||
|
|
|
|
|
|
||||||||||
Total income tax expense |
$45,307 | $24,412 | $30,037 | ||||||||||||
|
|
|
|
|
|
F-88
NOTE 7 - Income Taxes-(Continued)
Income tax expense for the following periods differed from the expected tax computed by applying the federal corporate tax rate of 35% to income before income taxes as follows:
Year Ended December 31, | |||||||||||||||
2012 |
2011 |
2010 |
|||||||||||||
As Adjusted | As Adjusted | ||||||||||||||
Expected federal tax on income |
$52,210 | $33,221 | $38,560 | ||||||||||||
Add (deduct) tax effects of: |
|||||||||||||||
Tax-exempt interest |
(6,836 | ) | (7,072 | ) | (7,034 | ) | |||||||||
Dividend received deduction |
(2,132 | ) | (2,010 | ) | (1,660 | ) | |||||||||
Resolution of contingent tax liabilities |
- | - | (1,429 | ) | |||||||||||
Other, net |
2,065 | 273 | 1,600 | ||||||||||||
Income tax expense provided on income |
$45,307 | $24,412 | $30,037 |
The Companys federal income tax returns for years prior to 2007 are no longer subject to examination by the Internal Revenue Service (IRS). In 2011, the IRS completed an examination of the federal returns through 2009 resulting in additional tax expense of $22.
In 2010, the IRS published guidance regarding Separate Account (variable annuity) dividend received deductions for life insurance companies in which they advised (1) they would concede appeals related to the issue and not raise the issue on audit unless the taxpayer changed its methodology for computing the deduction, and (2) any changes in law regarding this deduction would be effective prospectively. As a result, the Company believed this issue was no longer an uncertain tax position and recorded a reduction of $1,429 in the uncertain tax position liability related to the separate account dividend received deduction in 2010.
The Company recognizes tax benefits from tax return positions only if it is more likely than not the position will be sustainable, upon examination, on its technical merits and any relevant administrative practices or precedents. As a result, the Company applies a more-likely-than-not recognition threshold for all tax uncertainties.
The Company records liabilities for uncertain tax filing positions where it is more-likely-than-not that the position will not be sustainable upon audit by taxing authorities. These liabilities are reevaluated routinely and are adjusted appropriately based upon changes in facts or law. The Company has no unrecorded liabilities from uncertain tax filing positions.
HMEC and its subsidiaries file a consolidated federal income tax return. The federal income tax sharing agreement between HMEC and its subsidiaries, as approved by the Board of Directors, provides that tax on income is charged to each subsidiary as if it were filing a separate tax return with the limitation that each subsidiary will receive the benefit of any losses or tax credits to the extent utilized in the consolidated tax return. Intercompany balances are settled quarterly with a final settlement after filing the consolidated federal income tax return with the IRS.
F-89
NOTE 7 - Income Taxes-(Continued)
A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest and penalties, is as follows:
Year Ended December 31, | ||||||||||
2012 |
2011 |
|||||||||
Balance as of the beginning of the year |
$ - | $ 38 | ||||||||
Additions based on tax positions related to the current year |
- | - | ||||||||
Settlements in tax positions for prior years |
- | (38 ) | ||||||||
Balance as of the end of the year |
$ - | $ - |
The Companys effective tax rate would be affected to the extent there were unrecognized tax benefits that could be recognized. There are no positions for which it is reasonably possible that the total amount of unrecognized tax benefit will significantly increase within the next 12 months.
The Company classifies all tax related interest and penalties as income tax expense.
Interest and penalties were as follows:
Year Ended December 31, | |||||||||||||||
2012 | 2011 | 2010 | |||||||||||||
Interest and penalties expense (benefit), net of releases of previous provisions, recognized in the Consolidated Statements of Operations: |
|||||||||||||||
Gross |
$ | 468 | $ | (279 | ) | $ | 27 | ||||||||
Net of tax |
304 | (181 | ) | 16 | |||||||||||
December 31, | |||||||||||||||
2012 | 2011 | ||||||||||||||
Interest and penalties (asset) liability included in Other Assets or Other Liabilities in the Consolidated Balance Sheets |
$ | 307 | $ | 3 |
F-90
NOTE 8 - Statutory Information and Restrictions
The insurance departments of various states in which the insurance subsidiaries of HMEC are domiciled recognize as net income and surplus those amounts determined in conformity with statutory accounting principles prescribed or permitted by the insurance departments, which differ in certain respects from GAAP.
Reconciliations of statutory capital and surplus and net income, as determined using statutory accounting principles, to the amounts included in the accompanying consolidated financial statements are as follows:
December 31, | ||||||||
2012 | 2011 | |||||||
As Adjusted | ||||||||
Statutory capital and surplus of insurance subsidiaries |
$ | 754,153 | $ | 711,983 | ||||
Increase (decrease) due to: |
||||||||
Deferred policy acquisition costs |
196,885 | 216,456 | ||||||
Difference in policyholder reserves |
67,582 | 58,517 | ||||||
Goodwill |
47,396 | 47,396 | ||||||
Liability for postretirement benefits other than pensions |
(2,862 | ) | (3,326 | ) | ||||
Investment fair value adjustments on fixed maturities |
651,071 | 439,944 | ||||||
Difference in investment reserves |
101,276 | 84,519 | ||||||
Federal income tax liability |
(317,875 | ) | (247,019 | ) | ||||
Net funded status of pension and other postretirement benefit obligations |
(23,862 | ) | (25,137 | ) | ||||
Non-admitted assets and other, net |
10,660 | 10,831 | ||||||
Shareholders equity (deficit) of parent company and non-insurance subsidiaries |
(812 | ) | (1,067 | ) | ||||
Parent company short-term and long-term debt |
(237,809 | ) | (237,744 | ) | ||||
|
|
|
|
|||||
Shareholders equity as reported herein |
$ | 1,245,803 | $ | 1,055,353 | ||||
|
|
|
|
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
As Adjusted | As Adjusted | |||||||||||
Statutory net income of insurance subsidiaries |
$ | 93,299 | $ | 63,986 | $ | 77,235 | ||||||
Net loss of non-insurance companies |
(4,726 | ) | (10,164 | ) | (4,211 | ) | ||||||
Interest expense |
(14,249 | ) | (14,007 | ) | (13,953 | ) | ||||||
Tax benefit of interest expense and other parent company current tax adjustments |
9,308 | 4,603 | 5,411 | |||||||||
|
|
|
|
|
|
|||||||
Combined net income |
83,632 | 44,418 | 64,482 | |||||||||
Increase (decrease) due to: |
||||||||||||
Deferred policy acquisition costs |
16,595 | 8,989 | 11,557 | |||||||||
Policyholder benefits |
15,574 | 14,428 | 13,024 | |||||||||
Federal income tax expense |
(19,843 | ) | (6,639 | ) | (17,595 | ) | ||||||
Investment reserves |
14,021 | 9,903 | 16,167 | |||||||||
Other adjustments, net |
(6,113 | ) | (593 | ) | (7,504 | ) | ||||||
|
|
|
|
|
|
|||||||
Net income as reported herein |
$ | 103,866 | $ | 70,506 | $ | 80,131 | ||||||
|
|
|
|
|
|
F-91
NOTE 8 - Statutory Information and Restrictions-(Continued)
HMEC has principal insurance subsidiaries domiciled in Illinois and Texas. The statutory financial statements of these subsidiaries are prepared in accordance with accounting principles prescribed or permitted by the Illinois Department of Insurance and the Texas Department of Insurance, as applicable. Prescribed statutory accounting principles include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations and general administrative rules.
The NAIC has adopted risk-based capital guidelines to evaluate the adequacy of statutory capital and surplus in relation to risks assumed in investments, reserving policies, and volume and types of insurance business written. Based on current guidelines, the risk-based capital statutory requirements are not expected to have a negative regulatory impact on HMECs insurance subsidiaries. At December 31, 2012 and 2011, the minimum statutory-basis capital and surplus required to be maintained by HMECs insurance subsidiaries was $117,684 and $107,740, respectively. At December 31, 2012 and 2011, statutory capital and surplus of each of the Companys insurance subsidiaries was above required levels. The restricted net assets of HMECs insurance subsidiaries were $18,565 and $18,779 as of December 31, 2012 and 2011, respectively.
HMEC relies largely on dividends from its insurance subsidiaries to meet its obligations for payment of principal and interest on debt, dividends to shareholders and parent company operating expenses, including tax payments pursuant to tax sharing agreements. Payments for share repurchase programs also have this dependency. HMECs 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. As a result, HMEC may not be able to receive dividends from such subsidiaries at times and in amounts necessary to pay desired dividends to shareholders. The aggregate amount of dividends that may be paid in 2013 from all of HMECs insurance subsidiaries without prior regulatory approval is approximately $84,000.
As disclosed in the reconciliation of the statutory capital and surplus of insurance subsidiaries to the consolidated GAAP shareholders equity, the insurance subsidiaries have statutory capital and surplus of $754,153 as of December 31, 2012, which is subject to regulatory restrictions. The parent company equity is not restricted. At December 31, 2012, HMEC had $29,554 of liquid assets, comprised of investments and cash, which could be used to fund debt interest, general corporate obligations, as well as dividend payments to shareholders. If necessary, HMEC also has other potential sources of liquidity that could provide for additional funding to meet corporate obligations or pay shareholder dividends, which include a revolving line of credit, as well as issuances of various securities.
At the time of this Annual Report on Form 10-K and during each of the years in the three year period ended December 31, 2012, the Company had no financial reinsurance agreements in effect.
F-92
NOTE 9 - Pension Plans and Other Postretirement Benefits
The Company has the following retirement plans: a defined contribution plan; a 401(k) plan; a defined benefit plan for employees hired on or before December 31, 1998; and certain employees participate in a supplemental defined contribution plan or a supplemental defined benefit plan or both.
After completing the first year of employment, all employees participate in the defined contribution plan. Under this plan, the Company makes contributions to each participants account based on eligible compensation and years of service. As of the time of this Annual Report on Form 10-K, contribution percentages are as follows: (1) employees hired on or after April 1, 1997, 5% of eligible compensation; (2) employees hired prior to April 1, 1997 with less than 15 years of service, 6% of eligible compensation; and (3) employees hired prior to April 1, 1997 with 15 or more years of service, 7% of eligible compensation. Participants are 100% vested in this plan after 3 years of service.
All employees of the Company participate in a 401(k) plan. Beginning January 1, 2002, the Company automatically contributes 3% of eligible compensation to each employees account, which is 100% vested at the time of the contribution. In addition, employees may voluntarily contribute up to 20% of their eligible compensation into their account. And, employees who are age 50 or over at the end of a calendar year may make additional elective deferral contributions (commonly referred to as catch-up contributions) up to the catch-up contribution limit specified by the IRS.
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. Amounts earned under the defined benefit and supplemental defined benefit plans were frozen based on years of service and the highest 36 consecutive months of earnings while under the plan (through March 31, 2002). Participants are 100% vested in these defined benefit plans.
The Companys policy with respect to funding the defined benefit plan is to contribute to the plan trust amounts which are actuarially determined to provide the plan with sufficient assets to meet future benefit payments consistent with the funding requirements of federal laws and regulations. For the defined contribution, 401(k) and defined benefit plans, investments have been set aside in separate trust funds. The supplemental retirement plans are unfunded, non-qualified plans.
Employees whose compensation exceeds the limits covered under the qualified plans participate in an unfunded, non-qualified defined contribution plan. The Company accrues an amount for each participant based on their compensation, years of service and account balance. Participants are 100% vested in this plan after 3 years of service.
Total expense recorded for the qualified and non-qualified defined contribution, 401(k), defined benefit and supplemental retirement plans was $10,415, $12,353 and $10,427 for the years ended December 31, 2012, 2011 and 2010, respectively.
F-93
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
Qualified Defined Contribution Plan, 401(k) Plan and Non-qualified Defined Contribution Plan
Pension benefits under the qualified defined contribution plan are fully funded. Contributions to employees accounts under this plan were expensed in the Companys Consolidated Statements of Operations. Investments for this plan are set aside in a trust fund and none of the trust fund assets for the plan have been invested in shares of HMECs common stock.
The 401(k) plan is fully funded. The Companys contributions to employees accounts under this plan were expensed in its Consolidated Statements of Operations. Investments for this plan are set aside through an annuity contract underwritten by the Companys principal life insurance subsidiary. The annuity contract includes a fixed return account option and several variable return account options, with the account options selected by the individual plan participants for both the Company and participant portions contributed. One of the variable return account options invests in shares of HMEC common stock.
The non-qualified defined contribution plan is an unfunded plan. Under this plan, distributions are funded at the time payments are made to retirees.
Contributions to employees accounts under the qualified defined contribution plan, the 401(k) plan and the non-qualified defined contribution plan, as well as total assets of the plans, were as follows:
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Qualified defined contribution plan: |
||||||||||||
Contributions to employees accounts |
$ | 4,148 | $ | 4,864 | $ | 5,252 | ||||||
Total assets at the end of the year |
141,286 | 149,675 | 148,897 | |||||||||
401(k) plan: |
||||||||||||
Contributions to employees accounts |
2,753 | 2,856 | 3,011 | |||||||||
Total assets at the end of the year |
118,073 | 111,370 | 117,814 | |||||||||
Non-qualified defined contribution plan: |
||||||||||||
Contributions to employees accounts |
- | - | - | |||||||||
Total assets at the end of the year |
- | - | - |
F-94
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
Defined Benefit Plan and Supplemental Retirement Plans
The following tables summarize the funded status of the defined benefit and supplemental retirement pension plans as of December 31, 2012, 2011 and 2010 (the measurement dates) and identify (1) the assumptions used to determine the projected benefit obligation and (2) the components of net pension cost for the defined benefit plan and supplemental retirement plans for the following periods:
Supplemental | ||||||||||||||||||||||||
Defined Benefit Plan | Defined Benefit Plans | |||||||||||||||||||||||
December 31, | December 31, | |||||||||||||||||||||||
2012 | 2011 | 2010 | 2012 | 2011 | 2010 | |||||||||||||||||||
Change in benefit obligation: |
||||||||||||||||||||||||
Projected benefit obligation at beginning of year |
$ | 41,736 | $ | 39,553 | $ | 38,488 | $ | 18,012 | $ | 16,801 | $ | 15,707 | ||||||||||||
Service cost |
- | - | - | - | - | - | ||||||||||||||||||
Interest cost |
1,427 | 1,658 | 1,877 | 676 | 799 | 841 | ||||||||||||||||||
Plan amendments |
- | - | - | - | - | - | ||||||||||||||||||
Actuarial loss |
2,046 | 4,650 | 2,817 | 817 | 1,755 | 1,401 | ||||||||||||||||||
Benefits paid |
(1,664 | ) | (1,664 | ) | (3,629 | ) | (1,313 | ) | (1,343 | ) | (1,148 | ) | ||||||||||||
Settlements |
(2,551 | ) | (2,461 | ) | - | - | - | - | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Projected benefit obligation at end of year |
$ | 40,994 | $ | 41,736 | $ | 39,553 | $ | 18,192 | $ | 18,012 | $ | 16,801 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Change in plan assets: |
||||||||||||||||||||||||
Fair value of plan assets at beginning of year |
$ | 31,653 | $ | 29,273 | $ | 29,006 | $ | - | $ | - | $ | - | ||||||||||||
Actual return on plan assets |
3,168 | 911 | 2,812 | - | - | - | ||||||||||||||||||
Employer contributions |
2,534 | 5,926 | 1,307 | 1,313 | 1,343 | 1,148 | ||||||||||||||||||
Benefits paid |
(1,664 | ) | (1,664 | ) | (3,629 | ) | (1,313 | ) | (1,343 | ) | (1,148 | ) | ||||||||||||
Expenses paid |
(383 | ) | (332 | ) | (223 | ) | - | - | - | |||||||||||||||
Settlements |
(2,551 | ) | (2,461 | ) | - | - | - | - | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Fair value of plan assets at end of year |
$ | 32,757 | $ | 31,653 | $ | 29,273 | $ | - | $ | - | $ | - | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Funded status |
$ | (8,237 | ) | $ | (10,083 | ) | $ | (10,280 | ) | $ | (18,192 | ) | $ | (18,012 | ) | $ | (16,801 | ) | ||||||
Prepaid (accrued) benefit expense |
$ | 11,188 | $ | 11,594 | $ | 8,270 | $ | (12,855 | ) | $ | (13,197 | ) | $ | (12,918 | ) | |||||||||
Total amount recognized in Consolidated Balance Sheets, all in other liabilities |
$ | (8,237 | ) | $ | (10,083 | ) | $ | (10,280 | ) | $ | (18,192 | ) | $ | (18,012 | ) | $ | (16,801 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Amounts recognized in accumulated other comprehensive income (loss) (AOCI): |
||||||||||||||||||||||||
Prior service cost |
$ | - | $ | - | $ | - | $ | 124 | $ | 249 | $ | 373 | ||||||||||||
Net actuarial loss |
19,425 | 21,677 | 18,550 | 5,213 | 4,566 | 3,510 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total amount recognized in AOCI |
$ | 19,425 | $ | 21,677 | $ | 18,550 | $ | 5,337 | $ | 4,815 | $ | 3,883 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Information for pension plans with an accumulated benefit obligation greater than plan assets: |
||||||||||||||||||||||||
Projected benefit obligation |
$ | 40,994 | $ | 41,736 | $ | 39,553 | $ | 18,192 | $ | 18,012 | $ | 16,801 | ||||||||||||
Accumulated benefit obligation |
40,994 | 41,736 | 39,553 | 18,192 | 18,012 | 16,801 | ||||||||||||||||||
Fair value of plan assets |
32,757 | 31,653 | 29,273 | - | - | - |
F-95
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
The change in the Companys AOCI for the defined benefit plan for the year ended December 31, 2012 was primarily attributable to revisions of the discount rate assumption, partially offset by the performance of the plan assets. The changes in the Companys AOCI for the defined benefit plan for the years ended December 31, 2011 and 2010 were primarily related to revisions of the discount rate assumption.
Supplemental | ||||||||||||||||||||||||
Defined Benefit Plan | Defined Benefit Plans | |||||||||||||||||||||||
Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||||||
2012 | 2011 | 2010 | 2012 | 2011 | 2010 | |||||||||||||||||||
Components of net periodic pension (income) expense: |
||||||||||||||||||||||||
Service cost: |
||||||||||||||||||||||||
Benefit accrual |
$ | - | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||||
Other expenses |
360 | 250 | 250 | - | - | - | ||||||||||||||||||
Interest cost |
1,427 | 1,658 | 1,877 | 676 | 799 | 841 | ||||||||||||||||||
Expected return on plan assets |
(2,423 | ) | (2,419 | ) | (2,388 | ) | - | - | - | |||||||||||||||
Settlement loss |
1,209 | 1,290 | - | - | - | - | ||||||||||||||||||
Amortization of: |
||||||||||||||||||||||||
Prior service cost |
- | - | - | 124 | 125 | 124 | ||||||||||||||||||
Actuarial loss |
2,367 | 1,824 | 1,045 | 171 | 698 | 246 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Net periodic pension expense |
$ | 2,940 | $ | 2,603 | $ | 784 | $ | 971 | $ | 1,622 | $ | 1,211 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Changes in plan assets and benefit obligations included in other comprehensive income (loss): |
||||||||||||||||||||||||
Prior service cost |
$ | - | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||||
Net actuarial loss |
115 | 4,951 | 2,365 | 817 | 1,755 | 1,401 | ||||||||||||||||||
Amortization of: |
||||||||||||||||||||||||
Prior service cost |
- | - | - | (124 | ) | (125 | ) | (124 | ) | |||||||||||||||
Actuarial loss |
(2,367 | ) | (1,824 | ) | (1,045 | ) | (171 | ) | (698 | ) | (246 | ) | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total recognized in other comprehensive income (loss) |
$ | (2,252 | ) | $ | 3,127 | $ | 1,320 | $ | 522 | $ | 932 | $ | 1,031 | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Weighted-average assumptions used to determine expense: |
||||||||||||||||||||||||
Discount rate |
3.66 | % | 4.58 | % | 5.27 | % | 3.86 | % | 4.92 | % | 5.54 | % | ||||||||||||
Expected return on plan assets |
7.50 | % | 7.50 | % | 7.50 | % | * | * | * | |||||||||||||||
Annual rate of salary increase |
* | * | * | * | * | * | ||||||||||||||||||
Weighted-average assumptions used to determine benefit obligations as of December 31: |
||||||||||||||||||||||||
Discount rate |
3.51 | % | 3.66 | % | 4.58 | % | 3.51 | % | 3.86 | % | 4.92 | % | ||||||||||||
Expected return on plan assets |
7.50 | % | 7.50 | % | 7.50 | % | * | * | * | |||||||||||||||
Annual rate of salary increase |
* | * | * | * | * | * |
* | Not applicable. |
The discount rates at December 31, 2012 were based on the average yield for long-term, high-grade securities available during the benefit payout period. To set its discount rate, the Company looks to leading indicators, including the Mercer Above Mean Yield Curve.
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.
F-96
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
The Company has an investment policy for the defined benefit pension plan that aligns the assets within the plans trust to an approximate allocation of 50% equity and 50% fixed income funds. Management believes this allocation will produce the targeted long-term rate of return on assets necessary for payment of future benefit obligations, while providing adequate liquidity for payments to current beneficiaries. Assets are reviewed against the defined benefit pension plans investment policy and the trustee has been directed to adjust invested assets at least quarterly to maintain the target allocation percentages.
Fair values of the equity security funds and fixed income funds have been determined from public quotations. The following table presents the fair value hierarchy for the Companys defined benefit pension plan assets, excluding cash held, as of December 31, 2012 and 2011.
Fair Value Measurements at | ||||||||||||||||||||
Reporting Date Using | ||||||||||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||||||||||
December 31, 2012 |
||||||||||||||||||||
Asset category |
||||||||||||||||||||
Equity security funds (1) |
||||||||||||||||||||
United States |
$ | 13,199 | $ | - | $ | 13,199 | $ | - | ||||||||||||
International |
3,290 | - | 3,290 | - | ||||||||||||||||
Fixed income funds |
16,125 | - | 16,125 | - | ||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||
Total |
$ | 32,614 | $ | - | $ | 32,614 | $ | - | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||
December 31, 2011 |
||||||||||||||||||||
Asset category |
||||||||||||||||||||
Equity security funds (1) |
||||||||||||||||||||
United States |
$ | 12,784 | $ | - | $ | 12,784 | $ | - | ||||||||||||
International |
2,968 | - | 2,968 | - | ||||||||||||||||
Fixed income funds |
15,756 | - | 15,756 | - | ||||||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||
Total |
$ | 31,508 | $ | - | $ | 31,508 | $ | - | ||||||||||||
|
|
|
|
|
|
|
|
(1) |
None of the trust fund assets for the defined benefit pension plan have been invested in shares of HMECs common stock. |
There were no Level 3 assets held during the years ended December 31, 2012 and 2011.
In 2013, the Company expects amortization of net losses of $1,602 and $203 for the defined benefit plan and the supplemental retirement plans, respectively, and expects amortization of prior service cost of $124 for the supplemental retirement plans to be included in net periodic pension expense.
F-97
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
Postretirement Benefits Other than Pensions
In addition to providing pension benefits, the Company also provides certain health care and life insurance benefits to a closed group of eligible employees. Postretirement benefits other than pensions of active and retired employees are accrued as expense over the employees service years. Effective January 1, 2007, the Company eliminated the previous group health insurance benefits for retirees 65 years of age and over, including elimination of pharmacy benefits for Medicare eligible retirees, and established a Health Reimbursement Account (HRA) for each eligible participant in that closed group. Health care benefits for eligible retirees under 65 years of age will continue to be provided as a bridge to Medicare eligibility. Eligible participants will receive a one-time credit of $10 to their HRA account to use for covered expenses incurred on or after age 65. As of December 31, 2006, HRA accounts were established for eligible participants and totaled $7,310. As of December 31, 2012, the balance of the HRA accounts was $2,907. Funding of HRA accounts was $168, $184 and $315 for the years ended December 31, 2012, 2011 and 2010, respectively. Also, the new plan does not provide life insurance benefits to individuals who retired after December 31, 1993.
As a result of the changes in the plan for other postretirement benefits, the Company recorded a reduction in its expenses of $431, $379 and $350 for the years ended December 31, 2012, 2011 and 2010, respectively.
The following table presents the funded status of postretirement benefits other than pensions of active and retired employees (including employees on disability more than 2 years) as of December 31, 2012, 2011 and 2010 (the measurement dates) reconciled with amounts recognized in the Companys Consolidated Balance Sheets:
December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Change in accumulated postretirement benefit obligations: |
||||||||||||
Accumulated postretirement benefit obligations at beginning of year |
$ | 3,326 | $ | 3,489 | $ | 4,470 | ||||||
Changes during fiscal year |
||||||||||||
Service cost |
- | - | - | |||||||||
Interest cost |
91 | 122 | 170 | |||||||||
Medicare prescription reimbursements |
- | - | - | |||||||||
Employer payments net of participant contributions |
(488 | ) | (526 | ) | (744 | ) | ||||||
Actuarial (gain) loss |
(67 | ) | 241 | (407 | ) | |||||||
|
|
|
|
|
|
|||||||
Accumulated postretirement benefit obligations at end of year |
$ | 2,862 | $ | 3,326 | $ | 3,489 | ||||||
|
|
|
|
|
|
|||||||
Unfunded status |
$ | (2,862 | ) | $ | (3,326 | ) | $ | (3,489 | ) | |||
Total amount recognized in Consolidated Balance Sheets, all in other liabilities |
$ | (2,862 | ) | $ | (3,326 | ) | $ | (3,489 | ) | |||
|
|
|
|
|
|
|||||||
Amounts recognized in accumulated other comprehensive income (loss) (AOCI): |
||||||||||||
Prior service credit |
$ | - | $ | - | $ | - | ||||||
Net actuarial gain |
(900 | ) | (1,355 | ) | (2,097 | ) | ||||||
|
|
|
|
|
|
|||||||
Total amount recognized in AOCI |
$ | (900 | ) | $ | (1,355 | ) | $ | (2,097 | ) | |||
|
|
|
|
|
|
|||||||
Year Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Components of net periodic benefit: |
||||||||||||
Service cost |
$ | - | $ | - | $ | - | ||||||
Interest cost |
91 | 122 | 170 | |||||||||
Amortization of prior service cost |
- | - | - | |||||||||
Amortization of prior gain |
(522 | ) | (501 | ) | (520 | ) | ||||||
|
|
|
|
|
|
|||||||
Net periodic income |
$ | (431 | ) | $ | (379 | ) | $ | (350 | ) | |||
|
|
|
|
|
|
F-98
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
In 2013, the Company expects amortization of net gains of $236 to be included in net periodic pension expense.
Sensitivity Analysis and Assumptions for Postretirement Benefits Other than Pensions
A one percentage point change in the assumed health care cost trend rate for each year would change the accumulated postretirement benefit obligations as follows:
December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Accumulated postretirement benefit obligations |
||||||||||||
Effect of a one percentage point increase |
$ | 45 | $ | 53 | $ | 59 | ||||||
Effect of a one percentage point decrease |
(43 | ) | (50 | ) | (56 | ) | ||||||
Service and interest cost components of the net periodic postretirement benefit expense |
||||||||||||
Effect of a one percentage point increase |
$ | 1 | $ | 2 | $ | 2 | ||||||
Effect of a one percentage point decrease |
(1 | ) | (1 | ) | (2 | ) | ||||||
Weighted-average assumptions used to determine benefit obligations as of December 31: |
||||||||||||
Discount rate |
3.51 | % | 2.95 | % | 3.68 | % | ||||||
Healthcare cost trend rate |
7.50 | % | 8.00 | % | 8.00 | % | ||||||
Rate to which the cost trend rate is assumed to decline (ultimate trend rate) |
5.00 | % | 5.00 | % | 5.00 | % | ||||||
Year the rate is assumed to reach the ultimate trend rate |
2022 | 2022 | 2021 | |||||||||
Expected return on plan assets |
* | * | * | |||||||||
Weighted-average assumptions used to determine net periodic benefit cost for the years ended December 31: |
||||||||||||
Discount rate |
2.95 | % | 3.68 | % | 4.49 | % | ||||||
Healthcare cost trend rate |
8.00 | % | 8.00 | % | 8.50 | % | ||||||
Rate to which the cost trend rate is assumed to decline (ultimate trend rate) |
5.00 | % | 5.00 | % | 5.00 | % | ||||||
Year the rate is assumed to reach the ultimate trend rate |
2022 | 2021 | 2017 | |||||||||
Expected return on plan assets |
* | * | * |
* | Not applicable. |
The discount rates at December 31, 2012 were based on the average yield for long-term, high-grade securities available during the benefit payout period. To set its discount rate, the Company looks to leading indicators, including the Mercer Above Mean Yield Curve.
F-99
NOTE 9 - Pension Plans and Other Postretirement Benefits-(Continued)
2013 Contributions
In 2013, there is no minimum funding requirement for the Companys defined benefit plan. The following table discloses that minimum funding requirement and the expected full year contributions for the Companys plans.
Defined Benefit Pension Plans | |||||||||||||||
Defined | Supplemental | Other | |||||||||||||
Benefit | Defined Benefit | Postretirement | |||||||||||||
Plan | Plans | Benefits | |||||||||||||
Minimum funding requirement for 2013 |
$ | - | N/A | N/A | |||||||||||
Expected contributions (approximations) for the year ended December 31, 2013 as of the time of this Form 10-K (1) |
$ | 2,500 | $ | 1,320 | $ | 480 |
N/A - Not applicable.
(1) | HMECs Annual Report on Form 10-K for the year ended December 31, 2012. |
Estimated Future Benefit Payments
The Companys defined benefit plan may be subject to settlement accounting. Assumptions for both the number of individuals retiring in a calendar year and their elections regarding lump sum distributions are significant factors impacting the payout patterns for each of the plans below. Therefore, actual results could vary from the estimates shown. Estimated future benefit payments as of December 31, 2012 are as follows:
2013 | 2014 | 2015 | 2016 | 2017 | 2018-2022 | |||||||||||||||||||
Pension plans: |
||||||||||||||||||||||||
Defined benefit plan |
$ | 3,971 | $ | 3,850 | $ | 3,539 | $ | 3,234 | $ | 2,803 | $ | 13,432 | ||||||||||||
Supplemental retirement plans |
1,320 | 1,310 | 1,300 | 1,291 | 1,276 | 6,071 | ||||||||||||||||||
Other postretirement benefits |
480 | 434 | 427 | 368 | 369 | 892 |
NOTE 10 - Reinsurance and Catastrophes
In the normal course of business, the Companys insurance subsidiaries assume and cede reinsurance with other insurers. Reinsurance is ceded primarily to limit losses from large exposures and to permit recovery of a portion of direct losses; however, such a transfer does not relieve the originating insurance company of primary liability.
The Company is a national underwriter and therefore has exposure to catastrophic losses in certain coastal states and other regions throughout the U.S. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather and wildfires, and the frequency and severity of catastrophes are inherently unpredictable. The financial impact from catastrophic losses results from both the total amount of insured exposure in the area affected by the catastrophe as well as the severity of the event. The Company seeks to reduce its exposure to catastrophe losses through the geographic diversification of its insurance coverage, deductibles, maximum coverage limits and the purchase of catastrophe reinsurance.
F-100
NOTE 10 - Reinsurance and Catastrophes-(Continued)
The Companys net catastrophe losses incurred of approximately $43,319 for the year ended December 31, 2012 reflected losses primarily from wind/hail/tornado events in the spring and summer months, as well as from Hurricane Isaac. The Companys net catastrophe losses incurred of approximately $86,000 for the year ended December 31, 2011 reflected losses primarily from wind/hail/tornado events in the spring and summer months, as well as from Hurricane Irene. The Companys net catastrophe losses incurred of approximately $49,189 for the year ended December 31, 2010 reflected losses primarily from wind/hail/tornado events throughout the year.
The total amounts of reinsurance recoverable on unpaid insurance reserves classified as assets and reported in Other Assets in the Consolidated Balance Sheets were as follows:
December 31, | ||||||||
2012 | 2011 | |||||||
Reinsurance recoverables on reserves and unpaid claims |
||||||||
Property and casualty |
||||||||
Reinsurance companies |
$ | 10,419 | $ | 8,913 | ||||
State insurance facilities |
3,286 | 2,550 | ||||||
Life and health |
10,344 | 9,722 | ||||||
|
|
|
|
|||||
Total |
$ | 24,049 | $ | 21,185 | ||||
|
|
|
|
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 expenses, including estimated amounts for unsettled claims, claims incurred but not yet 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:
Ceded to | Assumed | |||||||||||||||||||
Gross | Other | from Other | Net | |||||||||||||||||
Amount | Companies | Companies | Amount | |||||||||||||||||
As Adjusted | As Adjusted | |||||||||||||||||||
Year ended December 31, 2012 |
||||||||||||||||||||
Premiums written and contract deposits |
$1,093,937 | $ | 29,691 | $ | 3,481 | $ | 1,067,727 | |||||||||||||
Premiums and contract charges earned |
696,721 | 29,634 | 3,440 | 670,527 | ||||||||||||||||
Benefits, claims and settlement expenses |
457,332 | 12,177 | 3,095 | 448,250 | ||||||||||||||||
Year ended December 31, 2011 |
||||||||||||||||||||
Premiums written and contract deposits |
1,106,012 | 31,271 | 3,708 | 1,078,449 | ||||||||||||||||
Premiums and contract charges earned |
695,264 | 31,940 | 3,796 | 667,120 | ||||||||||||||||
Benefits, claims and settlement expenses |
519,935 | 20,767 | 3,266 | 502,434 | ||||||||||||||||
Year ended December 31, 2010 |
||||||||||||||||||||
Premiums written and contract deposits |
1,082,100 | 35,035 | 4,896 | 1,051,961 | ||||||||||||||||
Premiums and contract charges earned |
702,930 | 35,057 | 4,805 | 672,678 | ||||||||||||||||
Benefits, claims and settlement expenses |
479,716 | 8,934 | 4,051 | 474,833 |
There were no losses from uncollectible reinsurance recoverables in the three years ended December 31, 2012. Past due reinsurance recoverables as of December 31, 2012 were not material.
F-101
NOTE 10 - Reinsurance and Catastrophes-(Continued)
The Company maintains catastrophe excess of loss reinsurance coverage. For 2012, the Companys catastrophe excess of loss coverage consisted of one contract in addition to the Florida Hurricane Catastrophe Fund (FHCF). The catastrophe excess of loss contract provided 95% coverage for catastrophe losses above a retention of $25,000 per occurrence up to $175,000 per occurrence. This contract consisted of three layers, each of which provided for one mandatory reinstatement. The layers were $25,000 excess of $25,000, $40,000 excess of $50,000 and $85,000 excess of $90,000. In addition, the Companys predominant insurance subsidiary for property and casualty business written in Florida reinsured 90% of hurricane losses in that state above an estimated retention of $5,700 up to $20,400, based on the FHCFs financial resources. The FHCF contract is a one-year contract, effective June 1, 2012.
For liability coverages, in 2012 the Company reinsured each loss above a retention of $750 up to $2,500 per occurrence and $20,000 in a clash event. (A clash cover is a reinsurance casualty excess contract requiring two or more casualty coverages or policies issued by the Company to be involved in the same loss occurrence for coverage to apply.) For property coverages, in 2012 the Company reinsured each loss above a retention of $750 up to $2,500 on a per risk basis, including catastrophe losses that in the aggregate were less than the retention levels above. Also, the Company could submit to the reinsurers three per risk losses from the same occurrence for a total of $5,250 of property recovery in any one event.
The maximum individual life insurance risk retained by the Company is $200 on any individual life, while either $100 or $125 is retained on each group life policy depending on the type of coverage. Excess amounts are reinsured. The Company also maintains a life catastrophe reinsurance program. The Company reinsured 100% of the catastrophe risk in excess of $1,000 up to $25,000 per occurrence, with one reinstatement in 2012. The Companys life catastrophe risk reinsurance program covers acts of terrorism and includes nuclear, biological and chemical explosions but excludes other acts of war.
NOTE 11 - Contingencies and Commitments
Lawsuits and Legal Proceedings
Companies in the insurance industry have been subject to substantial litigation resulting from claims, disputes and other matters. Most recently, they have faced expensive claims, including class action lawsuits, alleging, among other things, improper sales practices and improper claims settlement procedures. Negotiated settlements of certain such actions have had a material adverse effect on many insurance companies.
At the time of this Annual Report on Form 10-K, the Company does not have pending litigation from which there is a reasonable possibility of material loss.
Assessments for Insolvencies of Unaffiliated Insurance Companies
The Company is also contingently liable for possible assessments under regulatory requirements pertaining to potential insolvencies of unaffiliated insurance companies. Liabilities, which are established based upon regulatory guidance, have generally been insignificant.
F-102
NOTE 11 - Contingencies and Commitments-(Continued)
Leases
The Company has entered into various operating lease agreements, primarily for real estate (claims and marketing offices in a few states, as well as portions of the home office complex) and also for computer equipment and copy machines. Rental expenses were $2,882, $2,883 and $3,370 for the years ended December 31, 2012, 2011 and 2010, respectively. Future minimum lease payments under leases expiring subsequent to December 31, 2012 are as follows:
As of December 31, 2012 | ||||||||||||||||||||||||||||
2013 | 2014 | 2015 | 2016 | 2017 |
2018
2022 |
2023 and
beyond |
||||||||||||||||||||||
Minimum operating lease payments |
$ | 2,928 | $ | 2,587 | $ | 2,620 | $ | 2,449 | $ | 2,412 | $ | 4,875 | $ | 0 |
NOTE 12 - Supplementary Data on Cash Flows
A reconciliation of net income to net cash provided by operating activities as presented in the Consolidated Statements of Cash Flows is as follows:
Year Ended December 31, | |||||||||||||||
2012 |
2011 |
2010 |
|||||||||||||
As Adjusted | As Adjusted | ||||||||||||||
Cash flows from operating activities |
|||||||||||||||
Net income |
$ | 103,866 | $ | 70,506 | $ | 80,131 | |||||||||
Adjustments to reconcile net income to net cash provided by operating activities: |
|||||||||||||||
Realized investment gains |
(27,298 | ) | (37,663 | ) | (23,769 | ) | |||||||||
Increase in accrued investment income |
(2,618 | ) | (7,348 | ) | (1,586 | ) | |||||||||
Increase (decrease) in accrued expenses |
13,589 | (9,203 | ) | (865 | ) | ||||||||||
Depreciation and amortization |
7,892 | 8,577 | 8,318 | ||||||||||||
Increase in insurance liabilities |
127,992 | 105,576 | 126,868 | ||||||||||||
Increase in premium receivables |
(5,638 | ) | (1,263 | ) | (2,797 | ) | |||||||||
Increase in deferred policy acquisition costs |
(13,989 | ) | (6,258 | ) | (9,539 | ) | |||||||||
(Increase) decrease in reinsurance recoverable |
872 | (2,877 | ) | (203 | ) | ||||||||||
Increase in income tax liabilities |
29,752 | 17,953 | 1,184 | ||||||||||||
Other |
(31,572 | ) | (22,121 | ) | (19,988 | ) | |||||||||
|
|
|
|
|
|
||||||||||
Total adjustments |
98,982 | 45,373 | 77,623 | ||||||||||||
|
|
|
|
|
|
||||||||||
Net cash provided by operating activities |
$ | 202,848 | $ | 115,879 | $ | 157,754 | |||||||||
|
|
|
|
|
|
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, primarily personal lines automobile and homeowners products; retirement annuity products, primarily 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 the basis for managements evaluation of the results of those segments, but classifies those items in the fourth segment, corporate and other. In addition to ongoing transactions such as debt service, realized investment gains and losses and certain public company expenses, within the past ten years such items have included debt retirement costs/gains.
F-103
NOTE 13 - Segment Information-(Continued)
The accounting policies of the segments are the same as those described in Note 1 -- Summary of Significant Accounting Policies. The Company accounts for intersegment transactions, primarily the allocation of agent and overhead costs from the corporate and other segment to the property and casualty, annuity and life segments, on a direct cost basis.
Summarized financial information for these segments is as follows:
Year Ended December 31, | ||||||||||||
2012 |
2011 |
2010 |
||||||||||
As Adjusted | As Adjusted | |||||||||||
Insurance premiums and contract charges earned |
||||||||||||
Property and casualty |
$ | 546,339 | $ | 547,540 | $ | 555,825 | ||||||
Annuity |
21,794 | 18,883 | 17,346 | |||||||||
Life |
102,394 | 100,697 | 99,507 | |||||||||
|
|
|
|
|
|
|||||||
Total |
$ | 670,527 | $ | 667,120 | $ | 672,678 | ||||||
|
|
|
|
|
|
|||||||
Net investment income |
||||||||||||
Property and casualty |
$ | 36,792 | $ | 36,886 | $ | 36,474 | ||||||
Annuity |
200,785 | 182,806 | 167,879 | |||||||||
Life |
69,409 | 69,633 | 68,718 | |||||||||
Corporate and other |
2 | (3 | ) | 18 | ||||||||
Intersegment eliminations |
(985 | ) | (1,011 | ) | (1,035 | ) | ||||||
|
|
|
|
|
|
|||||||
Total |
$ | 306,003 | $ | 288,311 | $ | 272,054 | ||||||
|
|
|
|
|
|
|||||||
Net income |
||||||||||||
Property and casualty |
$ | 37,043 | $ | 5,844 | $ | 26,996 | ||||||
Annuity |
40,527 | 30,906 | 30,747 | |||||||||
Life |
21,912 | 19,435 | 20,323 | |||||||||
Corporate and other |
4,384 | 14,321 | 2,065 | |||||||||
|
|
|
|
|
|
|||||||
Total |
$ | 103,866 | $ | 70,506 | $ | 80,131 | ||||||
|
|
|
|
|
|
December 31, | ||||||||||||
2012 |
2011 |
2010 |
||||||||||
As Adjusted | As Adjusted | |||||||||||
Assets |
||||||||||||
Property and casualty |
$ | 1,016,368 | $ | 957,266 | $ | 943,406 | ||||||
Annuity |
5,380,780 | 4,926,204 | 4,530,927 | |||||||||
Life |
1,663,696 | 1,459,919 | 1,369,475 | |||||||||
Corporate and other |
131,449 | 115,367 | 130,191 | |||||||||
Intersegment eliminations |
(24,567 | ) | (23,587 | ) | (28,337 | ) | ||||||
|
|
|
|
|
|
|||||||
Total |
$ | 8,167,726 | $ | 7,435,169 | $ | 6,945,662 | ||||||
|
|
|
|
|
|
Additional significant financial information for these segments is as follows:
Year Ended December 31, | ||||||||||||
2012 |
2011 |
2010 |
||||||||||
As Adjusted | As Adjusted | |||||||||||
Policy acquisition expenses amortized |
||||||||||||
Property and casualty |
$ | 63,768 | $ | 61,374 | $ | 60,866 | ||||||
Annuity |
6,868 | 12,334 | 7,026 | |||||||||
Life |
8,883 | 9,690 | 9,455 | |||||||||
|
|
|
|
|
|
|||||||
Total |
$ | 79,519 | $ | 83,398 | $ | 77,347 | ||||||
|
|
|
|
|
|
|||||||
Income tax expense (benefit) |
||||||||||||
Property and casualty |
$ | 10,849 | $ | (5,183 | ) | $ | 4,291 | |||||
Annuity |
19,046 | 13,499 | 12,580 | |||||||||
Life |
12,305 | 11,366 | 10,986 | |||||||||
Corporate and other |
3,107 | 4,730 | 2,180 | |||||||||
|
|
|
|
|
|
|||||||
Total |
$ | 45,307 | $ | 24,412 | $ | 30,037 | ||||||
|
|
|
|
|
|
F-104
NOTE 14 - Unaudited Selected Quarterly Financial Data
Selected quarterly financial data is presented below.
Three Months Ended | ||||||||||||||||||||
December 31, | September 30, | June 30, | March 31, | |||||||||||||||||
2012 |
||||||||||||||||||||
Insurance premiums written and contract deposits |
$ | 279,479 | $ | 285,206 | $ | 260,289 | $ | 242,753 | ||||||||||||
Total revenues |
255,417 | 256,548 | 254,226 | 244,623 | ||||||||||||||||
Net income |
31,826 | 32,266 | 13,103 | 26,671 | ||||||||||||||||
Per share information |
||||||||||||||||||||
Basic |
||||||||||||||||||||
Net income |
$ | 0.81 | $ | 0.82 | $ | 0.33 | $ | 0.67 | ||||||||||||
Shares of common stock - weighted average (1) |
39,339 | 39,381 | 39,544 | 39,794 | ||||||||||||||||
Diluted |
||||||||||||||||||||
Net income |
$ | 0.77 | $ | 0.78 | $ | 0.32 | $ | 0.64 | ||||||||||||
Shares of common stock and equivalent shares - weighted average (1) |
41,272 | 41,138 | 41,304 | 41,546 | ||||||||||||||||
2011 As Adjusted |
||||||||||||||||||||
Insurance premiums written and contract deposits |
$ | 276,113 | $ | 298,910 | $ | 259,324 | $ | 244,102 | ||||||||||||
Total revenues |
247,645 | 260,833 | 245,351 | 244,473 | ||||||||||||||||
Net income (loss) |
32,913 | 23,637 | (11,851 | ) | 25,807 | |||||||||||||||
Per share information |
||||||||||||||||||||
Basic |
||||||||||||||||||||
Net income (loss) |
$ | 0.82 | $ | 0.59 | $ | (0.30 | ) | $ | 0.65 | |||||||||||
Shares of common stock - weighted average (1) |
39,900 | 39,919 | 39,893 | 39,749 | ||||||||||||||||
Diluted |
||||||||||||||||||||
Net income (loss) |
$ | 0.79 | $ | 0.57 | $ | (0.30 | ) | $ | 0.62 | |||||||||||
Shares of common stock and equivalent shares - weighted average (1) |
41,414 | 41,451 | 39,893 | 41,699 | ||||||||||||||||
2010 As Adjusted |
||||||||||||||||||||
Insurance premiums written and contract deposits |
$ | 269,173 | $ | 289,316 | $ | 254,766 | $ | 238,706 | ||||||||||||
Total revenues |
237,997 | 250,030 | 248,014 | 238,673 | ||||||||||||||||
Net income |
14,592 | 19,886 | 23,381 | 22,272 | ||||||||||||||||
Per share information |
||||||||||||||||||||
Basic |
||||||||||||||||||||
Net income |
$ | 0.37 | $ | 0.50 | $ | 0.60 | $ | 0.57 | ||||||||||||
Shares of common stock - weighted average (1) |
39,514 | 39,411 | 39,263 | 39,206 | ||||||||||||||||
Diluted |
||||||||||||||||||||
Net income |
$ | 0.35 | $ | 0.48 | $ | 0.57 | $ | 0.54 | ||||||||||||
Shares of common stock and equivalent shares - weighted average (1) |
41,253 | 41,115 | 40,929 | 40,900 |
(1) | Rounded to thousands. |
F-105
HORACE MANN EDUCATORS CORPORATION
SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 2012
(Dollars in thousands)
Amount | ||||||||||||
shown in | ||||||||||||
Fair | Balance | |||||||||||
Type of Investments |
Cost(1) | Value | Sheet | |||||||||
Fixed maturities: |
||||||||||||
U.S. Government and federally sponsored agency obligations |
$ 918,746 | $1,028,987 | $1,028,987 | |||||||||
States, municipalities and political subdivisions |
1,402,424 | 1,586,037 | 1,586,037 | |||||||||
Foreign government bonds |
48,476 | 57,869 | 57,869 | |||||||||
Public utilities |
225,260 | 271,901 | 271,901 | |||||||||
Other corporate bonds |
2,716,551 | 3,017,438 | 3,017,438 | |||||||||
Total fixed maturity securities |
5,311,457 | 5,962,232 | 5,962,232 | |||||||||
Equity securities: |
||||||||||||
Non-redeemable preferred stocks |
12,587 | 12,819 | 12,819 | |||||||||
Common stocks |
39,809 | 40,684 | 40,684 | |||||||||
Total equity securities |
52,396 | 53,503 | 53,503 | |||||||||
Mortgage loans |
93 | XXX | 93 | |||||||||
Short-term investments |
87,561 | XXX | 87,561 | |||||||||
Policy loans |
134,892 | XXX | 134,892 | |||||||||
Other |
50,000 | XXX | 53,816 | |||||||||
Total investments |
$5,636,399 | XXX | $6,292,097 |
(1) | Bonds at original cost reduced by repayments and adjusted for amortization of premiums or accrual of discounts and impairment in value of specifically identified investments. |
See accompanying Report of Independent Registered Public Accounting Firm.
F-106
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
As of December 31, 2012 and 2011
(Dollars in thousands, except per share data)
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-107
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS
(Dollars in thousands)
Year Ended December 31, | |||||||||||||||
2012 |
2011 |
2010 |
|||||||||||||
As Adjusted | As Adjusted | ||||||||||||||
Revenues |
|||||||||||||||
Net investment income |
$ | 2 | $ | (3 | ) | $ | 18 | ||||||||
Realized investment gains |
- | - | 232 | ||||||||||||
|
|
|
|
|
|
||||||||||
Total revenues |
2 | (3 | ) | 250 | |||||||||||
|
|
|
|
|
|
||||||||||
Expenses |
|||||||||||||||
Interest |
14,249 | 14,007 | 13,953 | ||||||||||||
Other |
4,576 | 3,590 | 4,598 | ||||||||||||
|
|
|
|
|
|
||||||||||
Total expenses |
18,825 | 17,597 | 18,551 | ||||||||||||
|
|
|
|
|
|
||||||||||
Loss before income taxes and equity in net earnings of subsidiaries |
(18,823 | ) | (17,600 | ) | (18,301 | ) | |||||||||
Income tax benefit |
(6,196 | ) | (8,197 | ) | (5,690 | ) | |||||||||
|
|
|
|
|
|
||||||||||
Loss before equity in net earnings of subsidiaries |
(12,627 | ) | (9,403 | ) | (12,611 | ) | |||||||||
Equity in net earnings of subsidiaries |
116,493 | 79,909 | 92,742 | ||||||||||||
|
|
|
|
|
|
||||||||||
Net income |
$ | 103,866 | $ | 70,506 | $ | 80,131 | |||||||||
|
|
|
|
|
|
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-108
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31, | |||||||||||||||
2012 | 2011 | 2010 | |||||||||||||
Cash flows operating activities |
|||||||||||||||
Interest expense paid |
$ | (13,948 | ) | $ | (13,515 | ) | $ | (13,605 | ) | ||||||
Federal income taxes (paid) recovered |
(118 | ) | 12,058 | 4,876 | |||||||||||
Cash dividends received from subsidiaries |
50,000 | 26,000 | 44,000 | ||||||||||||
Other, net |
7,703 | (10,012 | ) | 359 | |||||||||||
|
|
|
|
|
|
||||||||||
Net cash provided by operating activities |
43,637 | 14,531 | 35,630 | ||||||||||||
|
|
|
|
|
|
||||||||||
Cash flows - investing activities |
|||||||||||||||
Net (increase) decrease in investments |
(10,762 | ) | 4,240 | (1,641 | ) | ||||||||||
Capital contributions to subsidiaries |
- | - | (24,000 | ) | |||||||||||
|
|
|
|
|
|
||||||||||
Net cash provided by (used in) investing activities |
(10,762 | ) | 4,240 | (25,641 | ) | ||||||||||
|
|
|
|
|
|
||||||||||
Cash flows - financing activities |
|||||||||||||||
Dividends paid to shareholders |
(22,541 | ) | (18,990 | ) | (14,288 | ) | |||||||||
Acquisition of treasury stock |
(15,735 | ) | (2,047 | ) | - | ||||||||||
Exercise of stock options |
5,421 | 2,127 | 4,167 | ||||||||||||
|
|
|
|
|
|
||||||||||
Net cash used in financing activities |
(32,855 | ) | (18,910 | ) | (10,121 | ) | |||||||||
|
|
|
|
|
|
||||||||||
Net increase (decrease) in cash |
20 | (139 | ) | (132 | ) | ||||||||||
Cash at beginning of period |
129 | 268 | 400 | ||||||||||||
|
|
|
|
|
|
||||||||||
Cash at end of period |
$ | 149 | $ | 129 | $ | 268 | |||||||||
|
|
|
|
|
|
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-109
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTE TO CONDENSED FINANCIAL STATEMENTS
The accompanying condensed financial statements should be read in conjunction with the Consolidated Financial Statements and the accompanying notes thereto.
F-110
HORACE MANN EDUCATORS CORPORATION
SCHEDULE III: SUPPLEMENTARY INSURANCE INFORMATION
SCHEDULE VI: SUPPLEMENTAL INFORMATION CONCERNING PROPERTY AND CASUALTY INSURANCE OPERATIONS
(Dollars in thousands)
Column identification for |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Schedule III: A |
B | C | D | E | F | G | I | J | K | |||||||||||||||||||||||||||||||||||||||||||||||
Schedule VI: A |
B | C | D | E | F | G | H | H | I | J | K | |||||||||||||||||||||||||||||||||||||||||||||
Deferred
policy acquisition costs |
Future policy
benefits, claims and claims expenses |
Discount,
if any, deducted in previous column |
Unearned
premiums |
Other
policy claims and benefits payable |
Premium
revenue/ premium earned |
Net
investment income |
Benefits,
claims and settlement expenses |
Claims and claims
adjustment expense incurred related to |
Amortization
of deferred policy acquisition costs |
Other
operating expenses |
Paid
claims and claims adjustment expense |
Premiums
written |
||||||||||||||||||||||||||||||||||||||||||||
Segment |
Current
year |
Prior
years |
||||||||||||||||||||||||||||||||||||||||||||||||||||||
Year Ended December 31, 2012 |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Property and casualty |
$ | 24,650 | $ | 274,542 | $ | 0 | $ | 209,431 | $ | - | $ | 546,339 | $ | 36,792 | $ | 389,430 | $ | 406,605 | $ | (17,175 | ) | $ | 63,768 | $ | 83,579 | $ | 398,210 | $ | 550,774 | |||||||||||||||||||||||||||
Annuity |
125,437 | 3,264,128 | xxx | 526 | 99,603 | 21,794 | 200,785 | 124,693 | xxx | xxx | 6,868 | 34,148 | xxx | xxx | ||||||||||||||||||||||||||||||||||||||||||
Life |
46,798 | 984,716 | xxx | 3,311 | 3,624 | 102,394 | 69,409 | 97,692 | xxx | xxx | 8,883 | 33,589 | xxx | xxx | ||||||||||||||||||||||||||||||||||||||||||
Other, including consolidating eliminations |
N/A | - | xxx | N/A | N/A | - | (983 | ) | - | xxx | xxx | - | 18,991 | xxx | xxx | |||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||||||||||
Total |
$ | 196,885 | $ | 4,523,386 | xxx | $ | 213,268 | $ | 103,227 | $ | 670,527 | $ | 306,003 | $ | 611,815 | xxx | xxx | $ | 79,519 | $ | 170,307 | xxx | xxx | |||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||||||||||
Year Ended December 31, 2011 As Adjusted |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Property and casualty |
$ | 22,906 | $ | 281,080 | $ | 0 | $ | 204,996 | $ | - | $ | 547,540 | $ | 36,886 | $ | 442,517 | $ | 452,827 | $ | (10,310 | ) | $ | 61,374 | $ | 80,133 | $ | 462,298 | $ | 545,950 | |||||||||||||||||||||||||||
Annuity |
139,316 | 2,951,004 | xxx | 34 | 110,734 | 18,883 | 182,806 | 115,468 | xxx | xxx | 12,334 | 31,802 | xxx | xxx | ||||||||||||||||||||||||||||||||||||||||||
Life |
54,234 | 959,931 | xxx | 3,933 | 3,796 | 100,697 | 69,633 | 99,359 | xxx | xxx | 9,690 | 33,135 | xxx | xxx | ||||||||||||||||||||||||||||||||||||||||||
Other, including consolidating eliminations |
N/A | - | xxx | N/A | N/A | - | (1,014 | ) | - | xxx | xxx | - | 17,572 | xxx | xxx | |||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||||||||||
Total |
$ | 216,456 | $ | 4,192,015 | xxx | $ | 208,963 | $ | 114,530 | $ | 667,120 | $ | 288,311 | $ | 657,344 | xxx | xxx | $ | 83,398 | $ | 162,642 | xxx | xxx | |||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||||||||||
Year Ended December 31, 2010 As Adjusted |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Property and casualty |
$ | 21,927 | $ | 301,622 | $ | 0 | $ | 206,586 | $ | - | $ | 555,825 | $ | 36,474 | $ | 418,254 | $ | 438,784 | $ | (20,530 | ) | $ | 60,866 | $ | 82,231 | $ | 414,063 | $ | 557,074 | |||||||||||||||||||||||||||
Annuity |
140,095 | 2,621,524 | xxx | - | 125,432 | 17,346 | 167,879 | 107,529 | xxx | xxx | 7,026 | 30,553 | xxx | xxx | ||||||||||||||||||||||||||||||||||||||||||
Life |
60,155 | 934,297 | xxx | 4,711 | 3,815 | 99,507 | 68,718 | 95,773 | xxx | xxx | 9,455 | 34,352 | xxx | xxx | ||||||||||||||||||||||||||||||||||||||||||
Other, including consolidating eliminations |
N/A | - | xxx | N/A | N/A | - | (1,017 | ) | - | xxx | xxx | - | 18,507 | xxx | xxx | |||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||||||||||
Total |
$ | 222,177 | $ | 3,857,443 | xxx | $ | 211,297 | $ | 129,247 | $ | 672,678 | $ | 272,054 | $ | 621,556 | xxx | xxx | $ | 77,347 | $ | 165,643 | xxx | xxx | |||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
N/A - Not applicable.
See accompanying Report of Independent Registered Public Accounting Firm.
F-111
HORACE MANN EDUCATORS CORPORATION
REINSURANCE
(Dollars in thousands)
Column A |
Column B | Column C | Column D | Column E | Column F | ||||||||||||||||||||
Ceded to | Assumed | Percentage | |||||||||||||||||||||||
Gross | Other | from Other | Net | of Amount | |||||||||||||||||||||
Amount | Companies | Companies | Amount | Assumed to Net | |||||||||||||||||||||
Year ended December 31, 2012 |
|||||||||||||||||||||||||
Life insurance in force |
$ | 14,632,272 | $ | 3,070,951 | - | $ | 11,561,321 | - | |||||||||||||||||
Premiums |
|||||||||||||||||||||||||
Property and casualty |
$ | 566,853 | $ | 23,954 | $ | 3,440 | $ | 546,339 | 0.6 | % | |||||||||||||||
Annuity |
21,794 | - | - | 21,794 | - | ||||||||||||||||||||
Life |
108,074 | 5,680 | - | 102,394 | - | ||||||||||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Total premiums |
$ | 696,721 | $ | 29,634 | $ | 3,440 | $ | 670,527 | 0.5 | % | |||||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Year ended December 31, 2011 - As Adjusted |
|||||||||||||||||||||||||
Life insurance in force |
$ | 14,161,408 | $ | 2,836,731 | - | $ | 11,324,677 | - | |||||||||||||||||
Premiums |
|||||||||||||||||||||||||
Property and casualty |
$ | 570,264 | $ | 26,520 | $ | 3,796 | $ | 547,540 | 0.7 | % | |||||||||||||||
Annuity |
18,883 | - | - | 18,883 | - | ||||||||||||||||||||
Life |
106,117 | 5,420 | - | 100,697 | - | ||||||||||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Total premiums |
$ | 695,264 | $ | 31,940 | $ | 3,796 | $ | 667,120 | 0.6 | % | |||||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Year ended December 31, 2010 - As Adjusted |
|||||||||||||||||||||||||
Life insurance in force |
$ | 13,939,851 | $ | 2,548,774 | - | $ | 11,391,077 | - | |||||||||||||||||
Premiums |
|||||||||||||||||||||||||
Property and casualty |
$ | 580,512 | $ | 29,492 | $ | 4,805 | $ | 555,825 | 0.9 | % | |||||||||||||||
Annuity |
17,346 | - | - | 17,346 | - | ||||||||||||||||||||
Life |
105,072 | 5,565 | - | 99,507 | - | ||||||||||||||||||||
|
|
|
|
|
|
|
|
||||||||||||||||||
Total premiums |
$ | 702,930 | $ | 35,057 | $ | 4,805 | $ | 672,678 | 0.7 | % | |||||||||||||||
|
|
|
|
|
|
|
|
Note: Premiums above include insurance premiums earned and contract charges earned.
See accompanying Report of Independent Registered Public Accounting Firm.
F-112
HORACE MANN EDUCATORS CORPORATION
EXHIBITS
To
FORM 10-K
For the Year Ended December 31, 2012
VOLUME 1 OF 1
The following items are filed as Exhibits to Horace Mann Educators Corporations (HMEC) Annual Report on Form 10-K for the year ended December 31, 2012. Management contracts and compensatory plans are indicated by an asterisk (*).
EXHIBIT INDEX
Exhibit
|
Description |
-1-
Exhibit
|
Description |
-2-
Exhibit
|
Description |
10.5* |
Horace Mann Educators Corporation 2001 Stock Incentive Plan, incorporated by reference to Exhibit 10.6 to HMECs Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. |
|||
10.5(a)* |
Specimen Employee Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan, incorporated by reference to Exhibit 10.6(a) to HMECs Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. |
|||
10.5(b)* |
Specimen Director Stock Option Agreement under the Horace Mann Educators Corporation 2001 Stock Incentive Plan, incorporated by reference to Exhibit 10.6(b) to HMECs Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. |
|||
10.6* |
Horace Mann Educators Corporation Amended and Restated 2002 Incentive Compensation Plan (2002 Incentive Compensation Plan), incorporated by reference to Exhibit 10.2 to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, filed with the SEC on August 9, 2005. |
|||
10.6(a)* |
Specimen Employee Stock Option Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(a) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. |
|||
10.6(b)* |
Revised Specimen Employee Stock Option Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(b) to HMECs Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009. |
|||
10.6(c)* |
Specimen Regular Employee Stock Option Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(b) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. |
|||
10.6(d)* |
Specimen Director Stock Option Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.2(c) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, filed with the SEC on August 14, 2002. |
|||
10.6(e)* |
Specimen Employee Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(d) to HMECs Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on March 16, 2006. |
-3-
Exhibit
|
Description |
10.6(f)* |
Revised Specimen Employee Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(f) to HMECs Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009. |
|||
10.6(g)* |
Specimen Non-employee Director Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(e) to HMECs Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on March 16, 2006. |
|||
10.6(h)* |
Revised Specimen Non-employee Director Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(h) to HMECs Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009. |
|||
10.6(i)* |
Specimen Restricted Stock Unit Deferral Election Form under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(f) to HMECs Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on March 16, 2006. |
|||
10.6(j)* |
Revised Specimen Restricted Stock Unit Deferral Election Forms under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(j) to HMECs Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009. |
|||
10.6(k)* |
Specimen Modification to Stock Options outstanding as of June 30, 2004, incorporated by reference to Exhibit 10.2(d) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, filed with the SEC on August 9, 2004. |
|||
10.7* |
HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 1 (beginning on page E-1) to HMECs Proxy Statement, filed with the SEC on April 9, 2010. |
|||
10.7(a)* |
Amendment No. 1 to the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 1 (beginning on page E-1) to HMECs Proxy Statement, filed with the SEC on April 9, 2012. |
|||
10.7(b)* |
Specimen Incentive Stock Option Agreement for Section 16 Officers under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(a) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011. |
-4-
Exhibit
|
Description |
10.7(c)* |
Specimen Incentive Stock Option Agreement for Non-Section 16 Officers under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(b) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011. |
|||
10.7(d)* |
Specimen Employee Service-Vested Restricted Stock Units Agreement under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(c) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011. |
|||
10.7(e)* |
Specimen Employee Performance-Based Restricted Stock Units Agreement under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(d) to HMECs Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011. |
|||
10.7(f)* |
Specimen Non-Employee Director Restricted Stock Unit Agreement under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.17(a) to HMECs Current Report on Form 8-K dated May 27, 2010, filed with the SEC on June 2, 2010. |
|||
10.8* |
Horace Mann Supplemental Employee Retirement Plan, 2002 Restatement, incorporated by reference to Exhibit 10.1 to HMECs Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, filed with the SEC on May 15, 2002. |
|||
10.9* |
Horace Mann Executive Supplemental Employee Retirement Plan, 2002 Restatement, incorporated by reference to Exhibit 10.2 to HMECs Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, filed with the SEC on May 15, 2002. |
|||
10.10* |
Amended and Restated Horace Mann Nonqualified Supplemental Money Purchase Pension Plan, incorporated by reference to Exhibit 10.9 to HMECs Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009. |
|||
10.11* |
Summary of HMEC Non-Employee Director Compensation, incorporated by reference to Exhibit 10.11 to HMECs Current Report on Form 8-K dated May 25, 2011, filed with the SEC on May 27, 2011. |
|||
10.12* |
Summary of HMEC Named Executive Officer Annualized Salaries, incorporated by reference to Exhibit 10.12 to HMECs Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, filed with the SEC on May 10, 2012. |
-5-
Exhibit
|
Description |
-6-
Exhibit
|
Description |
(31) |
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|||
31.1 |
Certification by Peter H. Heckman, Chief Executive Officer of HMEC. |
|||
31.2 |
Certification by Dwayne D. Hallman, Chief Financial Officer of HMEC. |
|||
(32) |
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|||
32.1 |
Certification by Peter H. Heckman, Chief Executive Officer of HMEC. |
|||
32.2 |
Certification by Dwayne D. Hallman, Chief Financial Officer of HMEC. |
|||
(99) |
Additional exhibits |
|||
99.1 |
Glossary of Selected Terms. |
|||
(101) |
Interactive Data File |
|||
101.INS |
XBRL Instance Document |
|||
101.SCH |
XBRL Taxonomy Extension Schema |
|||
101.CAL |
XBRL Taxonomy Extension Calculation Linkbase |
|||
101.DEF |
XBRL Taxonomy Extension Definition Linkbase |
|||
101.LAB |
XBRL Taxonomy Extension Label Linkbase |
|||
101.PRE |
XBRL Taxonomy Extension Presentation Linkbase |
-7-
Exhibit 10.13
FORM OF SEVERANCE AGREEMENT
This SEVERANCE AGREEMENT (this Agreement), dated as of December 28, 2011, is an amendment and restatement of a severance agreement made and entered into by and between Horace Mann Educators Corporation (HMEC), a Delaware corporation (the Parent Company), Horace Mann Service Corporation (HMSC), an Illinois corporation (the Employer Company), (HMEC and HMSC collectively referred to as the Company), and x (the Executive).
WHEREAS , the Company considers the maintenance of a sound and vital senior management to be essential to protecting and enhancing the interests of the Parent Company and its subsidiaries, including the Employer Company, hereinafter collectively referred to as the Group;
WHEREAS , the Company recognizes that, as is the case with many publicly owned corporations, the possibility of a change in control of the Group may arise and that such possibility, and the uncertainty and questions which it may raise among senior management, may result in the departure or distraction of senior management personnel to the detriment of the Group;
WHEREAS , accordingly the Company has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Companys senior management to their assigned duties and long-range responsibilities without distraction in circumstances arising from the possibility of a change in control of the Group;
WHEREAS , the Company believes it important and in the best interests of the Group, should the Group face the possibility of a change in control, that the senior management of the Company be able to assess and advise the Board of Directors of the Company whether such a proposed change in control would be in the best interests of the Group and to take such other action regarding such a proposal as the Board of Directors might determine to be appropriate, without senior management being influenced by the uncertainties of their own employment situations; and
WHEREAS , in order to induce the Executive to remain in the employ of the Company in the event of any actual or threatened change in control of the Group, the Company has determined to set forth the severance benefits which the Company will provide to the Executive under the circumstances set forth below;
NOW THEREFORE , in consideration of the foregoing recitals, and the mutual covenants and agreements contained in this Agreement and for other good and valuable consideration, the parties hereto agree as follows:
1. Definitions . Terms not otherwise defined in this Agreement shall have the meanings set forth in this Section 1.
(a) Base Year . The Base Year shall be the twelve (12) month period immediately preceding a Change in Control.
(b) Cash Compensation . Cash Compensation shall mean the sum of (i) the Executives annual base salary and (ii) the cash bonus paid to the Executive under the Horace Mann Incentive Compensation Program (or similar program that may replace the Incentive Compensation Program) for whichever of the five (5) fiscal years immediately preceding the year in which the Date of Termination occurs that will result in the highest amount of Cash Compensation.
(c) Cause . For purposes of this Agreement, Cause shall mean serious, willful misconduct by the Executive such as, for example, the commission by the Executive of a felony arising from specific conduct of the Executive which reasonably relates to his qualification or ability (personal or professional) to perform his duties to the Company or its Subsidiaries or a perpetration by the Executive of a common law fraud against the Company or its Subsidiaries. Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than two-thirds of the entire membership of the Companys Board of Directors at a meeting of the Board called and held for the purpose of considering his termination for Cause (after reasonable notice to the Executive and an opportunity for the Executive, together with the Executives counsel, to be heard before the Board). The resolution of the Board shall contain a finding that in the good faith opinion of the Board the Executive was guilty of the conduct set forth above and specifying the particulars thereof in detail. Notwithstanding the foregoing, the Executive shall have the right to contest his termination for Cause.
(d) Change in Control . A Change in Control shall be deemed to have occurred if (i) there shall be consummated (1) any consolidation or merger of HMEC in which HMEC is not the continuing or surviving corporation, or pursuant to which shares of HMECs Common Stock would be converted into cash, securities or other property, other than a merger of HMEC in which no HMEC shareholders ownership percentage in the surviving corporation immediately after the merger is less than such shareholders ownership percentage in HMEC immediately prior to such merger by ten percent (10%) or more, or (2) any sale, lease exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of HMEC; (ii) the shareholders of HMEC approve any plan or proposal for the liquidation or dissolution of HMEC which is a part of a sale of assets, merger, or reorganization of HMEC or other similar transaction; (iii) any Person as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the Exchange Act), is or becomes, directly or indirectly, the beneficial owner, as defined in Rule 13d-3 under the Exchange Act, of securities of HMEC that represent 51% or more of the combined voting power of HMECs then outstanding securities; or (iv) a majority of the members of the Companys Board of Directors are persons who are then serving on the Board of Directors without having been elected by the Board of Directors or having been nominated by the Company for election of its shareholders.
(e) Constructive Termination . Constructive Termination shall mean the following events:
-2-
(1) any material diminution in the Executives duties or responsibilities to the Group;
(2) any required relocation of the Executive from his present work site to another site more than fifty (50) miles from the present work site;
(3) any material diminution in the Executives annual base compensation (salary and annual cash bonus) below that paid to the Executive for the Base Year, except in the event that such diminution in cash bonus is comparable to the diminution in the cash bonus paid to other employees of the same business segment as the Executive due to the performance of that business segment, such diminution shall not be deemed material; or
(4) failure of a successor to assume this agreement as required by Section 8.
Notwithstanding the preceding, a Constructive Termination shall not be deemed to have occurred until and unless the Executive provides written notice to the Company within ninety (90) days after the initial existence of one of the above conditions, the Company is provided thirty (30) days to remedy the condition and fails to do so, and the Executive separates from service within 6 months thereafter.
(f) Date of Termination. Date of Termination shall mean the effective date of the Notice of Termination which results (on such effective date) in the Executives separation from service as defined in Section 17(f).
2. |
Termination Following Change in Control. |
(a) Termination of Employment . If a Change in Control shall have occurred while the Executive is still an employee of the Company, the Executive shall be entitled to the compensation provided in Section 3 if, within 3 years after the Change in Control, the Executives employment is terminated by (i) the Company without Cause or (ii) the Executive due to Constructive Termination.
(b) Notice of Termination . Any purported termination of the Executives employment by the Company or the Executive shall be communicated by a Notice of Termination to the other party in accordance with Section 10 hereof. The Notice of Termination shall set forth in reasonable detail the reasons for termination and, if termination is for Cause, the facts and circumstances claimed to provide a basis for termination of the Executives employment and, in the case of a Constructive Termination, the information specified in Section 1(e).
3. Severance Compensation upon Termination of Employment . If the Executive becomes entitled to compensation pursuant to Section 2(a), then the Company shall:
(i) pay to the Executive as severance pay in a lump sum, in cash, an amount equal to x times the Executives Cash Compensation;
(ii) arrange to provide to the Executive for x years and x months (or such shorter period as the Executive may elect) disability, life, accident and health insurance
-3-
substantially similar to those insurance benefits, if any, which the Executive was receiving immediately prior to the Notice of Termination (including coverage for dependents at the same per person cost as the Executive was then paying); and
(iii) fully vest the Executive in the Executives benefit in any nonqualified supplemental pension plan sponsored by the Company.
Subject to Section 17(d) and (g), payments pursuant to this Section 3 shall be made on the fifth day after the Date of Termination.
4. |
Indemnification for Excise Tax. |
(a) Indemnification . In addition to the amounts specified in Section 3, the Company agrees that it will pay or cause to be paid to the Executive, at the time specified in paragraph (b) below, an amount in cash (the Additional Amount) as determined by the following formula;
Additional Amount = Excise Taxes + Attributable Taxes
Excise Taxes shall mean all federal and state excise taxes, if any, payable under Section 4999 of the Internal Revenue Code (the Code) and any state counterparts, with respect to the benefits received by the Executive pursuant to Section 3 of this Agreement. Attributable Taxes shall mean all taxes, including any federal and state income taxes and any federal and state excise taxes under Section 4999 of the Code and its state counterparts, that become payable by the Executive as a result of the receipt of the Additional Amount.
(b) Preparation of Tax Return; Notice to the Company . The Company, at its expense, agrees to supply the Executive with advice from a tax practitioner as to whether the Executive must reflect an excise tax under Section 4999 of the Code and any state counterparts on the filing of any income tax return of the Executive relating to the period or periods in which the Executive received payments or benefits under this Agreement. If such tax practitioner advises that such excise tax must be reflected on such tax return, the Executive agrees to so reflect and, unless such tax was previously withheld from payments to the Executive, pay such tax and the Company will reimburse the Executive in accordance with Section 4(a) above as soon as practicable after receipt of proof of payment (or, in the case of tax that was previously withheld, proof that such return was filed as required) from the Executive. If such tax practitioner advises that such excise tax need not be reflected on such tax return, the Executive agrees to prepare and file his tax return in accordance with such advice. The Executive shall notify the Company in writing no less than thirty (30) days prior to the time the Executive is required to file each tax return, and shall promptly provide to the tax practitioner selected by the Company such information as it may request in connection with establishing the existence of an obligation to withhold tax pursuant to Section 16 hereof or an obligation pursuant to this Section 4. If the Executive provides such notice and information and prepares the relevant tax return as provided in this paragraph (b), the Company shall indemnify the Executive in accordance with Section 4(a) of this Agreement for any subsequent assessment of Excise Taxes or Attributable Taxes by the IRS or any state taxing
-4-
authority, and any interest, penalties, and additions to tax directly relating to such Excise Taxes. If the Executive fails to comply fully with the requirements of this paragraph (b), then the Companys obligations will not include indemnification or any interest, penalties or additions to tax. In the event the Executives liability for Excise Taxes is determined upon audit by the IRS or the relevant state taxing authority, the Company shall pay to the Executive the amount determined in accordance with paragraph (a) and this paragraph (b) at such time as the Company determines that it no longer desires to contest the Executives liability pursuant to paragraph (c); provided, however, that in all events the Company will indemnify the Executive for interest, penalties and additions to tax, directly relating to Excise Taxes, which accrue after such time the Company receives notice of a proposed assessment of Excise Taxes resulting from an audit of the Executives tax return.
(c) Duty to Cooperate . The Executive agrees to notify the Company promptly in the event of any audit by the IRS or any state taxing authority in which the IRS or the state taxing authority asserts that any Excise Tax should be assessed against the Executive and to cooperate with the Company in contesting (at the Companys expense) any such proposed assessment. The Executive agrees not to settle or compromise any such assessment without the Companys consent. The Executive will promptly provide to the Company all information requested by the Company in connection with its contest of a proposed final assessment of Excise Taxes.
(d) Payment . Any tax indemnification payment shall be made no later than the December 31 of the year following the calendar year in which the Executive remits the related tax. If any tax indemnification provision in this Agreement permits the discretionary reduction of payments due to the Executive, no payment of deferred compensation (as defined under Section 409A of the Code, after giving effect to the exemptions thereunder) shall be reduced to the extent that a reduction can be made to compensation that is not deferred compensation as so defined.
5. |
Mitigation of Damages; Effect of Plan on Other Contractual Rights. |
(a) The Executive shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for under this Agreement be reduced by any compensation earned by the Executive as a result of employment by another employer or by retirement benefits received after the Date of Termination, or otherwise.
(b) The provisions of this Agreement, and any payment provided for hereunder, shall not reduce any amounts otherwise payable, or in any way diminish the Executives existing rights, or rights that would accrue solely as a result of the passage of time, under any benefit plan, employment agreement or other contract, plan or arrangement. Notwithstanding the foregoing, the Executive shall not be eligible for benefits under any other Agreement or arrangement providing severance or termination benefits in the event of a Change in Control, however defined.
6. Term . This Agreement shall terminate three (3) years after the date of a Change in Control. Termination or amendment of this Agreement shall not affect any obligation of the
-5-
Company under this Agreement which has accrued and is unpaid as of the effective date of such termination or amendment.
7. At-Will Employment . Nothing in this Agreement shall confer upon the Executive any right to continue in the employ of the Company prior to a Change in Control of the Company or shall interfere with or restrict in any way the rights of the Company, which are hereby expressly reserved, to discharge the Executive at any time prior to the date of a Change in Control of the Company for any reason whatsoever, with or without cause.
8. |
Successors. |
(a) The Company will require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, expressly, absolutely and unconditionally to assume and agree in writing to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. As used in this Agreement, Company shall mean the Company as defined above and any successor or assign to its business and/or assets which executes and delivers the agreement provided for in this Section 8 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law.
(b) This Agreement shall inure to the benefit of and be enforceable by the Executives personal and legal representatives, executors, administrators, successors, heirs, distributees, devises and legatees. If the Executive should die while any amounts are still payable to him hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executives devisee, legatee or other designee or, if there be no such designee, to the Executives estate.
9. |
Governing Law; Arbitration; Attorneys Fees. |
(a) This Agreement shall be governed by, and construed and enforced in accordance with, the internal laws of the State of Delaware, without giving effect to its conflict or choice of laws provisions.
(b) If any controversies, disputes or claims arise out of, in connection with, or in relation to, the interpretation, performance or breach of this Agreement, all such controversies, disputes or claims shall be settled, at the request of any party hereto, by arbitration conducted in Springfield, Illinois, in accordance with the then existing rules of the American Arbitration Association. The decision rendered by the arbitrators as to all issues of law and fact shall be final and binding without right of appeal on all parties hereto who receive notice of such arbitration and the opportunity to participate therein. Judgment upon any award rendered in such arbitration may be entered by any state or federal court having jurisdiction over the matter.
(c) Should any party hereto institute any action or proceeding to enforce any provision of this Agreement, the prevailing party shall be entitled to receive from the losing party reasonable attorneys fees and costs incurred in such action or proceeding, whether or not such action or proceeding is prosecuted to judgment.
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10. Notice . For purposes of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or two days after deposit in the mail by United States registered mail, return receipt requested, postage prepaid, as follows: if to the Company, to Horace Mann Service Corporation, 1 Horace Mann Plaza, Springfield, Illinois 62715, attention: Chief Executive Officer (except if such notice is sent by the Chief Executive Officer, in which case such notice shall be sent to the attention of the Chairman of the Board of Directors), and if to the Executive at the address specified at the end of this Agreement. Notice may also be given at such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt.
11. Miscellaneous . No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provisions of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement.
12. Validity . The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect.
13. Counterparts . This Agreement may be executed in two counterparts, each of which shall be deemed to be an original but both of which together will constitute one and the same instrument.
14. Gender . In this Agreement (unless the content requires otherwise), use of any masculine term shall include the feminine.
15. Entire Agreement . This Agreement contains the entire agreement between the parties hereto with respect to the transactions contemplated hereby and supersedes all previous oral and written and all contemporaneous oral negotiations, commitments and understandings.
16. Withholding . The Company shall withhold benefits otherwise due or payable hereunder in order to comply with any federal, state, local or other income or other tax laws requiring withholding with respect to benefits provided to the Executive pursuant to this Agreement.
17. |
409A Provisions. |
(a) To the extent this Agreement provides for compensation that is deferred compensation subject to Section 409A of the Code, it is intended that the Executive not be subject to the imposition of taxes and penalties (409A Penalties) under Section 409A of the Code, and shall be construed in accordance with that intent.
(b) For purposes of the limitations on nonqualified deferred compensation under Section 409A of the Code, each payment of compensation under the Agreement shall be
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treated as a separate payment of compensation for purposes of applying the Section 409A of the Code deferral election rules and the exclusion from Section 409A of the Code for certain short-term deferral amounts.
(c) Any amounts payable solely on account of an involuntary separation from service within the meaning of Section 409A of the Code shall be excludible from the requirements of Section 409A of the Code, either as involuntary separation pay or as short-term deferral amounts (e.g., amounts payable under the schedule prior to March 15 of the calendar year following the calendar year of involuntary separation) to the maximum possible extent.
(d) If, as of the date of his separation from service (as determined under Section 409A), the Executive is a specified employee as determined by the Company, then to the extent that any amount or benefit that would be paid or provided to the Executive under this Agreement within six (6) months of his separation from service constitutes an amount of deferred compensation for purposes of Section 409A and is considered for purposes of Section 409A to be owed to the Executive by virtue of his separation from service, then such amount or benefit will not be paid or provided during the six-month period following the date of the Executives separation from service and instead shall be paid or provided on the first business day that is more six (6) months following the date of the Executives separation from service, except to the extent that, in the Companys reasonable judgment, payment during such six-month period would not cause the Executive to incur additional tax, interest or penalties under Section 409A. In the case of taxable benefits that constitute deferred compensation, the Company, in lieu of a delay in payment, may require the Executive to pay the full costs of such benefits during the period described in the preceding sentence and reimburse the Executive for said costs within thirty (30) calendar days after the end of such period. With respect to any reimbursements under this Agreement, such reimbursement shall be made on or before the last of the calendar year following the calendar year in which the expense was incurred by the Executive.
(e) Any reimbursements or in-kind benefits provided under the Agreement shall be made or provided in accordance with the requirements of Section 409A of the Code, including, where applicable, the requirement that (i) any reimbursement is for expenses incurred during the period of time specified in the Agreement, (ii) the amount of expenses eligible for reimbursement, or in-kind benefits provided, during a calendar year may not affect the expenses eligible for reimbursement, or in-kind benefits to be provided, in any other calendar year, (iii) the reimbursement of an eligible expense will be made no later than the last day of the calendar year following the year in which the expense is incurred, and (iv) the right reimbursement or in-kind benefits is not subject to liquidation or exchange for another benefit.
(f) Date of Termination, termination of employment, retirement, resignation or words of similar import, as used in this Agreement shall mean, with respect to any payments of deferred compensation subject to Section 409A of the Code, the Executives separation from service as defined in Section 409A of the Code.
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(g) If payment of any amount of deferred compensation (as defined under Section 409A of the Code, after giving effect to the exemptions thereunder) is triggered by a separation from services that occurs while the Executive is a specified employee with respect to the Company (as defined under Section 409A of the Code and determined in good faith), and if such amount is scheduled to be paid within six (6) months after such separation from service, the amount shall accrue without interest and shall be paid the first business day after the end of such six-month period, or, if earlier, within 15 days after the appointment of the personal representative or executor of the Executives estate following the Executives death.
(h) The Executive acknowledges and agrees that notwithstanding this provision or any other provision of this Agreement, the Company and its affiliates are not providing him with any tax advice with respect to Section 409A of the Code or otherwise and are not making any guarantees or other assurances of any kind to him with respect to the tax consequences or treatment of any amounts paid or payable to him under this Agreement. The Executive is solely responsible for payment of any and all taxes on amounts payable under this Agreement.
IN WITNESS WHEREOF , the parties have executed this Agreement as of the date first above written.
HORACE MANN EDUCATORS CORPORATION | ||||
By: |
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Peter H. Heckman | ||||
President & Chief Executive Officer | ||||
HORACE MANN SERVICE CORPORATION | ||||
By: |
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Ann Caparrós | ||||
Corporate Secretary | ||||
EXECUTIVE | ||||
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Executive Name |
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Exhibit 10.13(a)
Revised Schedule to Severance Agreement
Horace Mann Educators Corporation (HMEC) and Horace Mann Service Corporation (HMSC) entered into severance agreements for change of control with the following persons on the dates shown. These agreements are substantially similar to the one included as Exhibit 10.13 to HMECs Annual Report on Form 10-K for the year ended December 31, 2012 except that 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.
Employee |
Duration |
Original Agreement Date |
Replacement Agreement Date |
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Ann M. Caparrós |
2.9 years | March 1994 | December 2011 | |||||||||
Paul D. Andrews |
2 years | July 2001 | December 2011 | |||||||||
Bret A. Conklin |
2 years | January 2002 | December 2011 | |||||||||
Dwayne D. Hallman |
2 years | January 2003 | December 2011 | |||||||||
Ricky A. Renner |
2 years | July 2001 | December 2011 | |||||||||
Robert E. Rich |
2 years | February 2001 | December 2011 |
Exhibit 10.14
FORM OF CHANGE IN CONTROL AGREEMENT
This CHANGE IN CONTROL AGREEMENT (this Agreement) dated as of December 28, 2011, is an amendment and restatement of a severance agreement made and entered into by and among Horace Mann Educators Corporation, a Delaware corporation (HMEC or the Parent Company), Horace Mann Service Corporation, an Illinois corporation (the Employer Company and, together with HMEC, the Company), and x (the Executive).
WHEREAS , the Company considers the maintenance of a sound and vital senior management to be essential to protecting and enhancing the interests of the Parent Company and its subsidiaries, including the Employer Company, hereinafter collectively referred to as the Group;
WHEREAS , the Company recognizes that, as is the case with many publicly owned corporations, the possibility of a change in control of the Group may arise and that such possibility, and the uncertainty and questions that it may raise among senior management, may result in the departure or distraction of senior management personnel to the detriment of the Group;
WHEREAS , accordingly the Company has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Companys senior management to their assigned duties and long-range responsibilities without distraction in circumstances arising from the possibility of a change in control of the Group;
WHEREAS , the Company believes it important and in the best interests of the Group, should the Group face the possibility of a change in control, that the senior management of the Company be able to assess and advise the Board of Directors of the Company (the Board) whether such a proposed change in control would be in the best interests of the Group and to take such other action regarding such a proposal as the Board might determine to be appropriate, without senior management being influenced by the uncertainties of their own employment situations;
WHEREAS , the Executive is an employee of the Company; and
WHEREAS , in order to induce the Executive to remain in the employ of the Company in the event of any actual or threatened change in control of the Group, the Company has determined to set forth the severance benefits that the Company will provide to the Executive under the circumstances set forth below;
NOW THEREFORE , in consideration of the foregoing recitals, and the mutual covenants and agreements contained in this Agreement and for other good and valuable consideration, the parties hereto agree as follows:
1. Definitions . Terms not otherwise defined in this Agreement shall have the meanings set forth in this Section 1.
(a) Base Year . The Base Year shall be the twelve (12) month period immediately preceding a Change in Control.
(b) Cash Compensation . Cash Compensation shall mean the sum of (i) the Executives annual base salary for the year in which the Date of Termination occurs and (ii) an
amount equal to the average of the annual cash bonus paid to the Executive under the Horace Mann Incentive Compensation Program (or such similar program as may replace the Incentive Compensation Program) in the three (3) fiscal years (or such fewer years) as the Executive may have been employed by the Company immediately preceding the year in which the Date of Termination occurs.
(c) Cause . Cause shall mean serious, willful misconduct by the Executive such as, for example, the commission by the Executive of a felony arising from specific conduct of the Executive that reasonably relates to his or her qualification or ability (personal or professional) to perform his or her duties to the Group or a perpetration by the Executive of a common law fraud against the Group. Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than two-thirds of the entire membership of the Board at a meeting of the Board called and held for the purpose of considering his or her termination for Cause (after reasonable notice to the Executive and an opportunity for the Executive, together with the Executives counsel, to be heard before the Board). The resolution of the Board shall contain a finding that in the good faith opinion of the Board the Executive was guilty of conduct constitutes Cause as defined above and specifying the particulars thereof in detail. Notwithstanding the foregoing, the Executive shall have the right to contest his or her termination for Cause.
(d) Change in Control . A Change in Control shall mean the first to occur of any of the following events:
(i) the consummation of any merger, consolidation or reorganization or sale or other disposition of all or substantially all of the assets of HMEC (a Business Combination), in each case, unless, immediately following such Business Combination, all or substantially all of the individuals and entities that were the beneficial owners of outstanding voting securities of HMEC immediately prior to such Business Combination beneficially own, directly or indirectly, more than 50% of the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors of the company resulting from such Business Combination (including, without limitation, a company that, as a result of such transaction, owns HMEC or all or substantially all of HMECs assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination, of the outstanding voting securities of HMEC;
(ii) the approval by the shareholders of HMEC of any plan or proposal for the complete liquidation or dissolution of HMEC;
(iii) any Person (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the Exchange Act)), excluding for this purpose (x) HMEC or any subsidiary of HMEC, and (y) any employee benefit plan of HMEC or any subsidiary of HMEC, or any person or entity organized, appointed or established by the Company for or pursuant to the terms of any such plan that acquires beneficial ownership of voting securities of HMEC, is or becomes, directly or indirectly, the beneficial owner (as defined in Rule 13d-3 under the Exchange Act), of securities of HMEC that represent more than 50% of the combined voting power of HMECs then
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outstanding securities; provided, however, that no Change in Control shall be deemed to have occurred as a result of a change in ownership percentage resulting solely from an acquisition of securities by the Company; or
(iv) the persons who constitute the Board as of the date hereof (the Incumbent Directors) cease for any reason, including, without limitation, as a result of a tender offer, proxy contest, merger or similar transaction, to constitute at least a majority thereof; provided, however, that any person becoming a member of the Board subsequent to the date hereof shall be considered an Incumbent Director if such persons election or nomination for election was approved by a vote of at least 50% of the members of the Board who were Incumbent Directors at the date of such election giving effect to the provisions of this clause; provided, further, that any such person whose initial assumption of office is in connection with an actual or threatened election contest relating to the election of members of the Board or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board, including by reason of agreement intended to avoid or settle any such actual or threatened contest or solicitation, shall not be considered an Incumbent Director.
(e) Constructive Termination . Constructive Termination shall mean any of the following events:
(i) any material diminution in the Executives duties or responsibilities to the Group;
(ii) any required relocation of the Executive from his or her present work site to another site more than fifty (50) miles from the present work site;
(iii) any material diminution in the Executives annual base compensation (salary and annual cash bonus) below the Executives compensation for the Base Year; or
(iv) failure of a successor to assume this agreement as required by Section 8.
Notwithstanding the preceding, a Constructive Termination shall not be deemed to have occurred until and unless the Executive provides written notice to the Company within ninety (90) days after the initial existence of one of the above conditions, the Company is provided thirty (30) days to remedy the condition and fails to do so, and the Executive separates from service within 6 months thereafter.
(f) Date of Termination . Date of Termination shall mean the effective date of the Notice of Termination which results (on such effective date) in the Executives separation from service as defined in Section 16(f).
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2. Termination Following Change in Control.
(a) Termination of Employment . If a Change in Control shall have occurred while the Executive is still an employee of the Company the Executive shall be entitled to the compensation provided in Section 3 if, within two (2) years after the Change in Control, the Executives employment is terminated by (i) the Company without Cause or (ii) the Executive due to Constructive Termination.
(b) Notice of Termination . Any purported termination of the Executives employment by the Company or the Executive shall be communicated by a Notice of Termination to the other party in accordance with Section 10. The Notice of Termination shall set forth in reasonable detail the reasons for termination and, if termination is for Cause, the facts and circumstances claimed to provide a basis for termination of the Executives employment and, in the case of a Constructive Termination, the information specified in Section 1(e).
3. Severance Compensation upon Termination of Employment . If the Executive becomes entitled to compensation pursuant to Section 2(a), then the Company shall:
(a) pay to the Executive as severance pay in a lump sum, in cash, an amount equal to x times the Executives Cash Compensation;
(b) to the extent permitted under the Companys group term life insurance policy, pay for a period of x months after the Date of Termination (or such shorter period provided in the policy) the costs of converted term life insurance continued by the Executive at the level substantially similar to those insurance benefits, if any, that the Executive was receiving immediately prior to the Date of Termination (including the coverage for the Executives dependents);
(c) pay for x months after the Date of Termination any premiums for group medical or dental coverage for the Executive and/or the Executives eligible dependents, provided the Executive timely elects and maintains such coverage in accordance with the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) and satisfies all other eligibility requirements under COBRA; and
(d) fully vest the Executive in the Executives benefit in the Horace Mann Nonqualified Supplemental Money Purchase Pension Plan.
Subject to Section 15(d) and (g), payments pursuant to this Section 3 shall be made on the fifth day after the Date of Termination.
4. Indemnification for Excise Tax.
(a) Indemnification . In addition to the amounts specified in Section 3, the Company agrees that it will pay or cause to be paid to the Executive, at the time specified in Section 4(b), an amount in cash (the Additional Amount) as determined by the following formula:
Additional Amount = Excise Taxes + Attributable Taxes
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Excise Taxes shall mean all federal and state excise taxes, if any, payable under Section 4999 of the Internal Revenue Code of 1986, as amended (the Code), and any state counterparts, with respect to the benefits received by the Executive pursuant to Section 3.
Attributable Taxes shall mean all taxes, including any federal and state income taxes and any federal and state excise taxes under Section 4999 of the Code and its state counterparts, that become payable by the Executive as a result of the receipt of the Additional Amount.
(b) Preparation of Tax Return; Notice to the Company . The Company, at its expense, agrees to supply the Executive with advice from a tax practitioner as to whether the Executive must reflect an excise tax under Section 4999 of the Code and any state counterparts on the filing of any income tax return of the Executive relating to the period or periods in which the Executive received payments or benefits under this Agreement. If such tax practitioner advises that such excise tax must be reflected on such tax return, the Executive agrees to so reflect and, unless such tax was previously withheld from payments to the Executive, pay such tax and the Company will reimburse the Executive in accordance with Section 4(a) above as soon as practicable after receipt of proof of payment (or, in the case of tax that was previously withheld, proof that such return was filed as required) from the Executive. If such tax practitioner advises that such excise tax need not be reflected on such tax return, the Executive agrees to prepare and file his or her tax return in accordance with such advice. The Executive shall notify the Company in writing no less than thirty (30) days prior to the time the Executive is required to file each tax return, and shall promptly provide to the tax practitioner selected by the Company such information as it may request in connection with establishing the existence of an obligation to withhold tax pursuant to Section 16 or an obligation pursuant to this Section 4. If the Executive provides such notice and information and prepares the relevant tax return as provided in this Section 4(b), the Company shall indemnify the Executive in accordance with Section 4(a) for any subsequent assessment of Excise Taxes or Attributable Taxes by the Internal Revenue Service (IRS) or any state taxing authority, and any interest, penalties, and additions to tax directly relating to such Excise Taxes. If the Executive fails to comply fully with the requirements of this Section 4(b), then the Companys obligations will not include indemnification or any interest, penalties or additions to tax. In the event the Executives liability for Excise Taxes is determined upon audit by the IRS or the relevant state taxing authority, the Company shall pay to the Executive the amounts determined in accordance with Section 4(a) and this Section 4(b) at such time as the Company determines that it no longer desires to contest the Executives liability pursuant to Section 4(c); provided, however, that in all events the Company will indemnify the Executive for interest, penalties and additions to tax, directly relating to Excise Taxes, that accrue after such time the Company receives notice of a proposed assessment of Excise Taxes resulting from an audit of the Executives tax return.
(c) Duty to Cooperate . The Executive agrees to notify the Company promptly in the event of any audit by the IRS or any state taxing authority in which the IRS or the state taxing authority asserts that any Excise Tax should be assessed against the Executive and to cooperate with the Company in contesting (at the Companys expense) any such proposed assessment. The Executive agrees not to settle or compromise any such assessment without the Companys consent. The Executive will promptly provide to the Company all information requested by the Company in connection with its contest of a proposed final assessment of Excise Taxes.
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(d) Payment . Any tax indemnification payment shall be made no later than the December 31 of the year following the calendar year in which the Executive remits the related tax. If any tax indemnification provision in this Agreement permits the discretionary reduction of payments due to the Executive, no payment of deferred compensation (as defined under Section 409A of the Code, after giving effect to the exemptions thereunder) shall be reduced to the extent that a reduction can be made to compensation that is not deferred compensation as so defined.
5. Mitigation of Damages; Effect of Plan on Other Contractual Rights.
(a) The Executive shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for under this Agreement be reduced by any compensation earned by the Executive as a result of employment by another employer or by retirement benefits received after the Date of Termination, or otherwise.
(b) The provisions of this Agreement, and any payment provided for hereunder, shall not reduce any amounts otherwise payable, or in any way diminish the Executives existing rights, or rights that would accrue solely as a result of the passage of time, under any benefit plan, employment agreement or other contract, plan or arrangement. Notwithstanding the foregoing, the Executive shall not be eligible for benefits under any other plan or arrangement providing severance or termination benefits in the event of a Change in Control, however defined.
6. Term . The term of this Agreement (the Term) shall commence on the date hereof and shall terminate on x (which is the expiration of the current term under the original agreement of which this Agreement is an amendment and restatement); provided , however , that unless previously terminated in accordance herewith, the Term shall be extended for additional three year periods unless the Company gives notice to the Executive of its intention to have this Agreement expire no less than 90 days prior to the end of the then current Term. Notwithstanding the foregoing, if a Change in Control shall have occurred at any time during the Term, then the Term shall continue for two (2) years after the date of occurrence of such Change in Control and shall terminate immediately thereafter. A termination or amendment of this Agreement (other than an amendment pursuant to Section 16) shall not affect any obligation of the Company under this Agreement that has accrued and is unpaid as of the effective date of such termination or amendment.
7. At-Will Employment . Nothing in this Agreement shall confer upon the Executive any right to continue in the employ of the Company prior to or after a Change in Control of the Company or shall interfere with or restrict in any way the rights of the Company, which are hereby expressly reserved, to discharge the Executive at any time prior to or after a Change in Control of the Company for any reason whatsoever, with or without Cause.
8. Successors.
(a) The Company will require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, expressly, absolutely and unconditionally to assume and agree in writing
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to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession or assignment had taken place. As used in this Agreement, Company shall mean the Company as defined above and any successor or assign to its business and/or assets that executes and delivers the agreement provided for in this Section 8 or that otherwise becomes bound by all the terms and provisions of this Agreement by operation of law.
(b) This Agreement shall inure to the benefit of and be enforceable by the Executives personal and legal representatives, executors, administrators, successors, heirs, distributees, devises and legatees. If the Executive should die while any amounts are still payable to him or her hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executives devisee, legatee or other designee or, if there be no such designee, to the Executives estate.
9. Governing Law; Arbitration; Attorneys Fees.
(a) This Agreement shall be governed by, and construed and enforced in accordance with, the internal laws of the State of Delaware, without giving effect to its conflict or choice of laws provisions.
(b) If any controversies, disputes or claims arise out of, in connection with, or in relation to, the interpretation, performance or breach of this Agreement, all such controversies, disputes or claims shall be settled, at the request of any party hereto, by arbitration conducted in Springfield, Illinois, in accordance with the then existing rules of the American Arbitration Association. The decision rendered by the arbitrators as to all issues of law and fact shall be final and binding without right of appeal on all parties hereto who receive notice of such arbitration and the opportunity to participate therein. Judgment upon any award rendered in such arbitration may be entered by any state or federal court having jurisdiction over the matter.
(c) Should any party hereto institute any action or proceeding to enforce any provision of this Agreement, the prevailing party shall be entitled to receive from the losing party reasonable attorneys fees and costs incurred in such action or proceeding, whether or not such action or proceeding is prosecuted to judgment.
10. Notice . Notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or two days after deposit in the mail by United States registered mail, return receipt requested, postage prepaid, as follows: if to the Company, to Horace Mann Service Corporation, 1 Horace Mann Plaza, Springfield, Illinois 62715, attention: Chief Executive Officer (except if such notice is sent by the Chief Executive Officer, in which case such notice shall be sent to the attention of the Chairman of the Board of Directors), and if to the Executive at the address specified at the end of this Agreement. Notice may also be given at such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt.
11. Miscellaneous . No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party
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hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party, shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party that are not set forth expressly in this Agreement.
12. Validity . The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect.
13. Entire Agreement . This Agreement contains the entire agreement between the parties hereto with respect to the transactions contemplated hereby and supersedes all previous oral and written and all contemporaneous oral negotiations, commitments and understandings.
14. Withholding . The Company shall withhold benefits otherwise due or payable hereunder in order to comply with any federal, state, local or other income or other tax laws requiring withholding with respect to benefits provided to the Executive pursuant to this Agreement.
15. 409A Provisions.
(a) To the extent this Agreement provides for compensation that is deferred compensation subject to Section 409A of the Code, it is intended that the Executive not be subject to the imposition of taxes and penalties (409A Penalties) under Section 409A of the Code, and shall be construed in accordance with that intent.
(b) For purposes of the limitations on nonqualified deferred compensation under Section 409A of the Code, each payment of compensation under the Agreement shall be treated as a separate payment of compensation for purposes of applying the Section 409A of the Code deferral election rules and the exclusion from Section 409A of the Code for certain short-term deferral amounts.
(c) Any amounts payable solely on account of an involuntary separation from service within the meaning of Section 409A of the Code shall be excludible from the requirements of Section 409A of the Code, either as involuntary separation pay or as short-term deferral amounts (e.g., amounts payable under the schedule prior to March 15 of the calendar year following the calendar year of involuntary separation) to the maximum possible extent.
(d) If, as of the date of his separation from service (as determined under Section 409A), the Executive is a specified employee as determined by the Company, then to the extent that any amount or benefit that would be paid or provided to the Executive under this Agreement within six (6) months of his separation from service constitutes an amount of deferred compensation for purposes of Section 409A and is considered for purposes of Section 409A to be owed to the Executive by virtue of his separation from service, then such amount or benefit will not be paid or provided during the six-month period following the date of the Executives separation from service and instead shall be paid or provided on the first business day that is more than six (6) months following the date of the Executives separation from service, except to the extent that, in the Companys reasonable judgment, payment during such six-month period would not cause the Executive to incur additional tax, interest or penalties
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under Section 409A. In the case of taxable benefits that constitute deferred compensation, the Company, in lieu of a delay in payment, may require the Executive to pay the full costs of such benefits during the period described in the preceding sentence and reimburse the Executive for said costs within thirty (30) calendar days after the end of such period. With respect to any reimbursements under this Agreement, such reimbursement shall be made on or before the last day of the calendar year following the calendar year in which the expense was incurred by the Executive.
(e) Any reimbursements or in-kind benefits provided under the Agreement shall be made or provided in accordance with the requirements of Section 409A of the Code, including, where applicable, the requirement that (i) any reimbursement is for expenses incurred during the period of time specified in the Agreement, (ii) the amount of expenses eligible for reimbursement, or in-kind benefits provided, during a calendar year may not affect the expenses eligible for reimbursement, or in-kind benefits to be provided, in any other calendar year, (iii) the reimbursement of an eligible expense will be made no later than the last day of the calendar year following the year in which the expense is incurred, and (iv) the right to reimbursement or in-kind benefits is not subject to liquidation or exchange for another benefit.
(f) Date of Termination, termination of employment, retirement, resignation or words of similar import, as used in this Agreement shall mean, with respect to any payments of deferred compensation subject to Section 409A of the Code, the Executives separation from service as defined in Section 409A of the Code.
(g) If payment of any amount of deferred compensation (as defined under Section 409A of the Code, after giving effect to the exemptions thereunder) is triggered by a Separation from Service that occurs while the Executive is a specified employee with respect to the Company (as defined under Section 409A of the Code and determined in good faith), and if such amount is scheduled to be paid within six (6) months after such Separation from Service, the amount shall accrue without interest and shall be paid the first business day after the end of such six-month period, or, if earlier, within 15 days after the appointment of the personal representative or executor of the Executives estate following the Executives death.
(h) The Executive acknowledges and agrees that notwithstanding this provision or any other provision of this Agreement, the Company and its affiliates are not providing him with any tax advice with respect to Section 409A of the Code or otherwise and are not making any guarantees or other assurances of any kind to him with respect to the tax consequences or treatment of any amounts paid or payable to him under this Agreement. The Executive is solely responsible for payment of any and all taxes on amounts payable under this Agreement.
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IN WITNESS WHEREOF , the parties have executed this Agreement as of the date first above written.
HORACE MANN EDUCATORS
CORPORATION |
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By: |
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Peter H. Heckman | ||
President & Chief Executive Secretary | ||
HORACE MANN SERVICE CORPORATION | ||
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Ann Caparrós | ||
Corporate Secretary | ||
EXECUTIVE | ||
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Executive Name |
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Exhibit 10.14(a)
Revised Schedule to Change in Control Agreement
Horace Mann Educators Corporation (HMEC) and Horace Mann Service Corporation (HMSC) entered into Change in Control Agreements with the following persons on the dates shown. These agreements are substantially similar to the one included as Exhibit 10.14 to HMECs Annual Report on Form 10-K for the year ended December 31, 2012, except that the multiple of the annual base salary and average of annual cash bonus paid to the employee in the last three years is equal to the duration listed below.
Original | Replacement | |||||
Employee |
Duration |
Agreement Date |
Agreement Date |
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Stephen P. Cardinal |
2 years | December 2008 | December 2011 | |||
Richard R. Schulenburg |
2 years | December 2007 | December 2011 | |||
Thomas C. Wilkinson |
2 years | September 2008 | December 2011 |
Exhibit 10.15(a)
HORACE MANN SERVICE CORPORATION
EXECUTIVE CHANGE IN CONTROL PLAN
SCHEDULE A PARTICIPANTS
Note: The effective date of entry shall be subject to Section 4.2(a).
NAME OR TITLE |
EFFECTIVE DATE OF PARTICIPATION* | |||
TIER I PARTICIPANTS | ||||
President and CEO |
November 14, 2012 | |||
TIER II PARTICIPANTS |
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EVP and CFO | ** | |||
EVP and Chief Marketing Officer | ** | |||
EVP, Property and Casualty | ** | |||
EVP, Annuity, Life, Group | February 15, 2012 |
* Subject to acceptance within 30 days of effective date of participation
** Subject to Section 4.2(b) of the Plan
Exhibit 11
Horace Mann Educators Corporation
Computation of Net Income per Share
For the Years Ended December 31, 2012, 2011 and 2010
(Amounts in thousands, except per share data)
Year Ended December 31, | ||||||||||||
2012 |
2011 |
2010 |
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Basic - assumes no dilution: |
As Adjusted As Adjusted | |||||||||||
Net income for the period |
$ | 103,866 | $ | 70,506 | $ | 80,131 | ||||||
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Weighted average number of common shares outstanding during the period |
39,514 | 39,866 | 39,350 | |||||||||
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Net income per share - basic |
$ | 2.63 | $ | 1.77 | $ | 2.04 | ||||||
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Diluted - assumes full dilution: |
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Net income for the period |
$ | 103,866 | $ | 70,506 | $ | 80,131 | ||||||
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Weighted average number of common shares outstanding during the period |
39,514 | 39,866 | 39,350 | |||||||||
Weighted average number of common equivalent shares to reflect the dilutive effect of common stock equivalent securities: |
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Stock options |
222 | 206 | 255 | |||||||||
Common stock units related to deferred compensation for Directors |
112 | 114 | 107 | |||||||||
Common stock units related to deferred compensation for Employees |
116 | 115 | 195 | |||||||||
Restricted common stock units related to incentive compensation |
1,424 | 1,136 | 1,106 | |||||||||
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Total common and common equivalent shares adjusted to calculate diluted earnings per share |
41,388 | 41,437 | 41,013 | |||||||||
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Net income per share diluted |
$ | 2.51 | $ | 1.70 | $ | 1.95 | ||||||
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Percentage of dilution compared to basic net income per share |
4.6 | % | 4.0 | % | 4.4 | % |
Exhibit 12
Horace Mann Educators Corporation
Statement Regarding Computation of Ratios
Computation of Ratio of Earnings to Fixed Charges
For the Years Ended December 31, 2012, 2011, 2010, 2009 and 2008
(Dollars in millions)
Year Ended December 31, | ||||||||||||||||||||
2012 | 2011 | 2010 | 2009 | 2008 | ||||||||||||||||
As Adjusted |
As Adjusted |
As Adjusted |
As Adjusted |
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Fixed charges: |
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Interest expense |
$ | 14.2 | $ | 14.0 | $ | 14.0 | $ | 14.0 | $ | 14.5 | ||||||||||
Interest credited to policyholders on interest-sensitive contracts |
163.6 | 154.9 | 146.7 | 139.4 | 131.8 | |||||||||||||||
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Total fixed charges |
$ | 177.8 | $ | 168.9 | $ | 160.7 | $ | 153.4 | $ | 146.3 | ||||||||||
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Earnings: |
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Income before income taxes |
$ | 149.2 | $ | 94.9 | $ | 110.2 | $ | 101.8 | $ | (1.9 | ) | |||||||||
Add: Interest expense |
14.2 | 14.0 | 14.0 | 14.0 | 14.5 | |||||||||||||||
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Subtotal earnings before interest expense |
163.4 | 108.9 | 124.2 | 115.8 | 12.6 | |||||||||||||||
Add: Interest credited to policyholders on interest-sensitive contracts |
163.6 | 154.9 | 146.7 | 139.4 | 131.8 | |||||||||||||||
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Earnings before fixed charges |
$ | 327.0 | $ | 263.8 | $ | 270.9 | $ | 255.2 | $ | 144.4 | ||||||||||
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Ratio of earnings to fixed charges |
1.8 | x | 1.6 | x | 1.7 | x | 1.7 | x | 1.0 | x | ||||||||||
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Supplemental information (A): |
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Ratio of earnings before interest expense to interest expense |
11.5 | x | 7.8 | x | 8.9 | x | 8.3 | x | 0.9 | x | ||||||||||
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Fixed charges and earnings in this calculation do not include interest credited to policyholders on interest-sensitive contracts. This adjusted coverage ratio is not required, but is provided as supplemental information because it is commonly used by individuals who analyze the Companys results. |
Exhibit 21
Horace Mann Educators Corporation
Insurance Subsidiaries, Other Significant Subsidiaries and
Their Respective States of Incorporation or Organization
December 31, 2012
Insurance Subsidiaries:
Educators Life Insurance Company of America - Illinois
Horace Mann Insurance Company - Illinois
Horace Mann Life Insurance Company - Illinois
Horace Mann Lloyds - Texas
Horace Mann Property & Casualty Insurance Company - Illinois
Teachers Insurance Company - Illinois
Other Subsidiaries:
ABM Service Corporation - Delaware
Horace Mann General Agency, Inc. - Texas
Horace Mann Investors, Inc. - Maryland
Horace Mann Lloyds Management Corporation - Texas
Horace Mann MGA and Brokerage of Florida Inc. - Florida
Horace Mann Service Corporation - Illinois
Exhibit 23
Consent of Independent Registered Public Accounting Firm
Board of Directors
Horace Mann Educators Corporation
We consent to the incorporation by reference in the registration statements (No. 33-47066, No. 33-45152, No. 333-16473, No. 333-74686, No. 333-98917, No. 333-171384 and No. 333-185231) on Form S-8 and the registration statement (No. 333-178898) on Form S-3 of Horace Mann Educators Corporation and subsidiaries (the Company) of our report dated February 28, 2013, with respect to the consolidated balance sheets of the Company as of December 31, 2012 and 2011 and the related consolidated statements of operations, comprehensive income, changes in shareholders equity and cash flows for each of the years in the three-year period ended December 31, 2012, and all related financial statement schedules and the effectiveness of internal control over financial reporting as of December 31, 2012, which report appears in the December 31, 2012 annual report on Form 10-K of the Company.
Our report dated February 28, 2013, contains an explanatory paragraph that states that effective January 1, 2012, the Company has changed its method of accounting for the costs associated with acquiring or renewing insurance contracts due to the retrospective adoption of FASB Accounting Standards Update No. 2010-26, Accounting for Costs Associated With Originating or Renewing Service Contracts.
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
February 28, 2013
Exhibit 31.1
Chief Executive Officer Certification
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Peter H. Heckman, certify that:
1. I have reviewed this Annual Report on Form 10-K for the year ended December 31, 2012 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 registrants 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
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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) |
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c) |
Evaluated the effectiveness of the registrants 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 |
d) |
Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and |
5. The registrants other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants 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 registrants 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 registrants internal control over financial reporting. |
/s/ Peter H. Heckman |
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Peter H. Heckman, Chief Executive Officer | ||
Horace Mann Educators Corporation |
Date: |
February 28, 2013 |
Exhibit 31.2
Chief Financial Officer Certification
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Dwayne D. Hallman, certify that:
1. I have reviewed this Annual Report on Form 10-K for the year ended December 31, 2012 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 registrants 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
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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) |
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c) |
Evaluated the effectiveness of the registrants 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 |
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Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and |
5. The registrants other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants 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 registrants 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 registrants internal control over financial reporting. |
/s/ Dwayne D. Hallman |
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Dwayne D. Hallman, Chief Financial Officer | ||
Horace Mann Educators Corporation |
Date: |
February 28, 2013 |
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Horace Mann Educators Corporation (the Company) on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Peter H. Heckman, 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/ Peter H. Heckman |
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Peter H. Heckman | ||
Chief Executive Officer |
Date: |
February 28, 2013 |
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.
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Horace Mann Educators Corporation (the Company) on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Dwayne D. Hallman, 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/ Dwayne D. Hallman |
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Dwayne D. Hallman | ||
Chief Financial Officer |
Date: |
February 28, 2013 |
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.
Exhibit 99.1
Glossary of Selected Terms
The following measures are used by the Companys management to evaluate performance against historical results and establish targets on a consolidated basis. A number of these measures are components of net income or the balance sheet but, in some cases, may be considered non-GAAP financial measures under applicable SEC rules because they are not displayed as separate line items in the Consolidated Statement of Operations or Consolidated Balance Sheets, and in some cases, there is inclusion or exclusion of certain items not ordinarily included or excluded in a GAAP financial measure. In the opinion of the Companys management, a discussion of these measures is meaningful to provide investors with an understanding of the significant factors that comprise the Companys periodic results of operations and financial condition.
Agent - A licensed representative of an insurer in marketing insurance products.
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Exclusive Agency - A local Horace Mann agency created and owned by an independent contractor who has signed an Exclusive Agent agreement with the Company (an Exclusive Agent ). That agreement states that only the Companys products and limited additional third-party vendor products authorized by the Company will be marketed by the agency. An independent contractor may sign multiple Exclusive Agent agreements with the Company and manage more than one Exclusive Agency. |
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Employee Agents - Agents who have employee status with the Company and by contract market only the Companys products and limited additional third-party vendor products authorized by the Company. |
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Independent Agents - Non-exclusive independent contractors who are under contract with the Company to market the Companys annuity products but who are not restricted to writing only the Companys products and products authorized by the Company. |
Book value per share excluding the fair value adjustment for investments - The result of dividing total shareholders equity excluding after tax net unrealized gains and losses on fixed maturities and equity securities, including the related effect on certain deferred policy acquisition costs and value of acquired insurance in force, by ending shares outstanding. Book value per share is the most directly comparable GAAP measure. Management believes it is useful to consider the trend in book value per share excluding unrealized net investment gains and losses in conjunction with book value per share to identify and analyze the change in net worth. Management also believes the non-GAAP measure is useful to investors because it eliminates the effect of items that can fluctuate significantly from period to period and are generally driven by economic developments, primarily financial market conditions, the magnitude and timing of which are generally not influenced by the Companys underlying insurance operations.
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Catastrophe costs The sum of catastrophe losses and property and casualty catastrophe reinsurance reinstatement premiums.
Catastrophe losses - In categorizing property and casualty claims as being from a catastrophe, the Company utilizes the designations of the Property Claims Service, a subsidiary of Insurance Services Office, Inc., and additionally beginning in 2007, includes losses from all such events that meet the definition of covered loss in the Companys primary catastrophe excess of loss reinsurance contract, and reports loss and loss adjustment expense amounts net of reinsurance recoverables. A catastrophe is a severe loss resulting from natural and man-made events within a particular territory, including risks such as hurricane, fire, earthquake, windstorm, explosion, terrorism and other similar events, that causes $25 million or more in insured property and casualty losses for the industry and affects a significant number of property and casualty insurers and policyholders. Each catastrophe has unique characteristics. Catastrophes are not predictable as to timing or amount of loss in advance. Their effects are not included in earnings or claim and claim adjustment expense reserves prior to occurrence. In the opinion of the Companys management, a discussion of the impact of catastrophes is meaningful for investors to understand the variability in periodic earnings.
Insurance premiums written and contract deposits - Premiums written represent (1) the amount charged for policies issued during a fiscal period for property and casualty business, such amounts may be earned and included in financial results over future fiscal periods, and (2) the amount charged for policies in force during a fiscal period for traditional life and group life business. Amounts are reported net of reinsurance, unless otherwise specified. Contract deposits include amounts received from customers on deposit-type contracts, such as annuities and interest-sensitive life policy accounts, including deposit amounts and any related contract or policy fees. Management utilizes this non-GAAP measure, which is based on statutory accounting principles, in analyzing and evaluating the business growth of its operating segments. Insurance premiums and contract charges earned is the most directly comparable GAAP measure.
Net Reserves - Property and casualty unpaid claim and claim expense reserves net of anticipated reinsurance recoverables.
Operating income or Net income before realized investment gains and losses - Net income adjusted to exclude after tax realized investment gains and losses. Net income is the most directly comparable GAAP measure. Management believes the measure provides investors with a valuable measure of the Companys ongoing performance because it reveals trends in the business that may be obscured by the net effect of realized investment gains and losses. Realized investment gains and losses may vary significantly between periods and are generally driven by business decisions and external economic developments that are unrelated to the insurance underwriting process. Operating income is used by management along with other components of net income to assess their performance and adjusted measures of operating income and operating income per diluted share are used in incentive compensation programs. Management believes that a projection of net income including after tax realized investment gains and losses is not appropriate on a forward-looking basis because it is not possible to provide a valid 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.
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Prior Years Reserve Development - A measure which the Company reports for its property and casualty segment which identifies the increase or decrease in net incurred claim and claim adjustment expense reserves at successive valuation dates for claims which occurred in previous calendar years. In the opinion of the Companys management, a discussion of prior years loss reserve development is useful to investors as it allows them to assess the impact on current period earnings of incurred claims experience from the current calendar year and previous calendar years.
Property and casualty operating statistics - Operating measures utilized by the Company and the insurance industry regarding the relative profitability of property and casualty underwriting results.
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Loss Ratio or Loss and Loss Adjustment Expense Ratio - The ratio of (1) the sum of net incurred losses and loss adjustment expenses to (2) net earned premiums. |
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Expense Ratio - The ratio of (1) the sum of operating expenses and the amortization of policy acquisition costs to (2) net earned premiums. |
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Combined Ratio - The sum of the Loss Ratio and the Expense Ratio. A Combined Ratio less than 100% generally indicates profitable underwriting prior to the consideration of investment income. |
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Combined Ratio Excluding Catastrophes and Prior Years Reserve Development or Underlying Combined Ratio - The sum of the Loss Ratio and the Expense Ratio adjusted to remove the effect of catastrophe costs and prior years reserve development. The Combined Ratio is the most directly comparable GAAP measure. Management believes this ratio provides a valuable measure of the Companys underlying underwriting performance that may be obscured by the effects of catastrophe costs and prior years reserve development, the amounts of which may be significant and may vary significantly between periods. |
Return on equity - The ratio of (1) trailing 12-month net income to (2) the average of ending shareholders equity for the current quarter end and the preceding four quarter ends.
Sales or Annualized New Sales - Sales represent the amount of new business sold during the period and exclude renewal of policies sold in previous periods. Sales are measured by the Company as premiums and deposits to be collected over the 12 months following the sale of a new policy, and this time period may extend into the following calendar year. In addition to the Companys products, sales data includes authorized products sold by Employee Agents, Exclusive Agents, and their licensed staff which are underwritten by third-party vendors. Sales should not be viewed as a substitute for any financial measure determined in accordance with GAAP, including sales as it relates to non-insurance companies, and the Companys definition of sales might differ from that used by other companies. The Company utilizes sales information as a performance measure that indicates the productivity of its agency force. Sales are also a leading indicator of future revenue trends.
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