Horace Mann Educators 10-K 2010
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the fiscal year ended December 31, 2009
For the transition period from to
Commission file number 1-10890
HORACE MANN EDUCATORS CORPORATION
(Exact name of registrant as specified in its charter)
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:
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 ¨ 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.
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, 2009, was $390.6 million.
As of February 16, 2010, 39,213,771 shares of the registrants Common Stock, par value $0.001 per share, were outstanding, net of 21,813,196 shares of treasury stock.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrants Proxy Statement for the 2010 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, 2009.
YEAR ENDED DECEMBER 31, 2009
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 private passenger 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) and Teachers Insurance Company (TIC), each of which is an Illinois corporation; Horace Mann Property & Casualty Insurance Company (HMPCIC), a California corporation; and Horace Mann Lloyds (HM Lloyds), an insurance company domiciled in Texas.
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, 2009 were $1.0 billion and net income was $73.5 million. The Companys total assets were $6.3 billion at December 31, 2009. The Companys investment portfolio had an aggregate fair value of $4.6 billion at December 31, 2009. Investments consist principally of investment grade, publicly traded fixed income securities.
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 segment accounted for 55% of the Companys insurance premiums written and contract deposits for the year ended December 31, 2009; the annuity and life insurance segments together accounted for 45% of insurance premiums written and contract deposits for the year ended December 31, 2009 (35% and 10%, respectively).
The Company is one of the largest participants in the 403(b) tax-qualified annuity market, measured by 403(b) net written premium on a statutory accounting basis. The 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 approved 403(b) payroll reduction capabilities in approximately one-third of the 15,400 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 Investor Relations section of the Companys Internet Web site, 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 Web site, www.sec.gov.
Also available in the Investor Relations section of the Companys Web site 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.
Louis G. Lower II, Chief Executive Officer of HMEC, timely submitted the Annual Section 12(a) CEO Certification to the New York Stock Exchange (NYSE) on June 25, 2009 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, 2008, the CEO and 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.
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, 2009 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.
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.
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 6.2 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 full-time agents trained to sell the Companys multiline products. As of December 31, 2009, the Company had 715 agents, approximately 75% of which are licensed by the Financial Industry Regulatory Authority (FINRA), formerly the National Association of Securities Dealers, Inc. (NASD), 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.
In 2006, the Company began the transition from a single-person agent operation to its Agency Business Model (ABM), with agents in outside offices with support personnel and licensed producers, 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. Property and casualty initiatives to support that transition and drive business growth include the Companys Educator Segmentation Model a more precise approach to pricing automobile and homeowners business and its Product Management Organization focused on localized approaches to pricing, underwriting and marketing. Also, the Company is developing a new property and casualty policy administration system with an automated point-of-sale front end. Annuity and life initiatives to support the transition to ABM included the roll out of additional Horace Mann manufactured and branded products, as described in Annuity Segment and Life Segment.
Building on the foundation of ABM, in the fourth quarter of 2008 the Company 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. These independent contractors will be 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. Throughout 2009, additional employee agents migrated and other individuals were recruited and appointed directly into the EA agreement. By December 31, 2009, 249, or 35%, of the Companys dedicated agents were EAs. Going forward, the EA agreement will be offered to additional qualified employee agents. Management expects that all future agent recruits will be under the EA agreement.
As indicated above, agents operating in the ABM model, both employee agents and EAs, utilize licensed producers in their operations. As of December 31, 2009, there were 571 licensed producers, resulting in a total of 1,286 points of distribution for the Companys products.
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, 2009, there were 832 independent agents approved to market the Companys annuity products throughout the U.S. During 2009, collected contract deposits from this distribution channel were approximately $64 million.
Geographic Composition of Business
The Companys business is geographically diversified. For the year ended December 31, 2009, 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, 7.6%; Florida, 6.9%; North Carolina, 6.7%; Illinois, 6.4%; and Texas, 5.4%.
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 2009:
Property and Casualty Segment Top Ten States
(Dollars in millions)
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 2009:
Combined Life and Annuity Segments Top Ten States
(Dollars in millions)
National, State and Local Education Associations
The Company has had a long relationship with the National Education Association (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. The Company maintains a special advisory board, primarily composed of leaders of state education associations, that meets with Company management at least annually. The NEA and its affiliated state and local associations sponsor 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 sponsorship of Company products. The Company does pay for certain special functions and advertising that appears in NEA and state education association publications.
The Company also has established relationships with a number of other educator groups, such as school administrator and principal associations, throughout the U.S. The Company does not pay these other educator groups any consideration in exchange for sponsorship of Company products. The Company does pay for certain special functions and advertising that appears in publications of these organizations.
Property and Casualty Segment
The property and casualty segment represented 55% of the Companys total insurance premiums written and contract deposits in 2009.
The primary property and casualty product offered by the Company is private passenger automobile insurance, which in 2009 represented 37% of the Companys total insurance premiums written and contract deposits and 67% of property and casualty net written premiums. As of December 31, 2009, the Company had approximately 528,000 voluntary automobile policies in force with annual premiums of approximately $375 million. 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 2009, homeowners insurance represented 18% of the Companys total insurance premiums written and contract deposits and 32% of property and casualty net written premiums. As of December 31, 2009, the Company had approximately 262,000 homeowners policies in force with annual premiums of approximately $198 million. 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.
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)
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, 2009 were as follows:
(Dollars in millions)
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 (1)
(Dollars in millions)
Property and Casualty Reserves
Property and casualty unpaid claims and claim settlement 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, 2009, 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 Settlement Expenses.
All of the Companys property and casualty reserves for unpaid claims and claim settlement 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 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.
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 a net (after reinsurance) basis. 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 are reflected in the Consolidated Balance Sheets also listed on page F-1 of this report.
Reconciliation of Property and Casualty Claims and Claim Expense Reserves
(Dollars in millions)
The claim reserve development table below illustrates the change over time in the Net Reserves (defined in footnote 2 to the table above) 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.
In evaluating the information in the table below, it should be noted that each amount includes the effects of all changes in amounts of prior periods. For example, if a claim determined in 2008 to be $150 thousand was first reserved in 1999 at $100 thousand, the $50 thousand deficiency (actual claim minus original estimate) would be included in the cumulative deficiency in each of the years 1999-2007 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)
Property and Casualty Reinsurance
All reinsurance is obtained through contracts which generally are renewed 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, 2009 were insignificant.
The Company maintains catastrophe excess of loss reinsurance coverage. For 2009, the excess of loss coverage consisted of three contracts in addition to coverage with the Florida Hurricane Catastrophe Fund (FHCF). The primary contract (first event) provided 95% coverage of catastrophe losses above a retention of $25.0 million per occurrence up to $170.0 million per occurrence. This contract consisted of four layers, each of which provided for one mandatory reinstatement unless noted otherwise. The layers were $25.0 million excess of $25.0 million (82.5% provided for one mandatory reinstatement), $40.0 million excess of $50.0 million (92.25% provided for one mandatory reinstatement), $60.0 million excess of $90.0 million, and $20.0 million excess of $150.0 million. The second excess of loss contract (second event) provided 95% coverage of catastrophe losses above a retention of $15.0 million per occurrence up to $25.0 million per occurrence, after the Company retained $10.0 million of losses above $15.0 million per occurrence. The third excess of loss contract (third event) provided 95% coverage of catastrophe losses above a retention of $15.0 million per occurrence up to $25.0 million per occurrence, after the Company retained $10.0 million of losses above $15.0 million per occurrence and less than $25.0 million per occurrence, and after the second excess of loss contract described above was exhausted. Neither the second nor the third excess of loss contract provided for a reinstatement. 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 $14.4 million up to $52.4 million, based on the FHCFs financial resources. The FHCF contract is a one-year contract, effective June 1, 2009. The decrease in FHCF coverage for the 2009-2010 contract period primarily reflects the Companys election not to purchase additional coverage as it did for the 2008-2009 contract period. This election was anticipated based on the Companys increase in coverage under its primary reinsurance contracts, which were finalized and priced prior to January 1, 2009. Additional coverage made available by the FHCF to the industry in future contract periods could increase the likelihood of assessments in periods following significant hurricane losses.
For 2010, the Companys catastrophe excess of loss coverage consists of three contracts in addition to the FHCF. The primary contract (first event) provides 95% coverage of catastrophe losses above a retention of $25.0 million per occurrence up to $170.0 million per occurrence. This contract consists of three layers, each of which provide for one mandatory reinstatement. The layers are $25.0 million excess of $25.0 million, $40.0 million excess of $50.0 million, and $80.0 million excess of $90.0 million. The second excess of loss contract (second event) provides 95% coverage of catastrophe losses above a retention of $15.0 million per occurrence up to $25.0 million per occurrence, after the Company retains $10.0 million of losses above $15.0 million per occurrence. The third excess of loss contract (third event) provides 95% coverage of catastrophe losses above a retention of $15.0 million per occurrence up to $25.0 million per occurrence, after the Company retains $10.0 million of losses above $15.0 million per occurrence and less than $25.0 million per occurrence, and after the second excess of loss contract described above is exhausted. Neither the second
nor the third excess of loss contract provide for a reinstatement. The FHCF limits described in the previous paragraph continue through June 1, 2010, 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 2009 the Company reinsured each loss above a retention of $700,000 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 2009 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, 2010, the retention for liability coverages is $750,000 up to $2.5 million on a per occurrence basis and $20.0 million in a clash event. Retention for property coverages remains $750,000, with no change to the maximum limits, including the ability to submit three per risk losses from the same occurrence.
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, 2010. No other single reinsurers percentage participation in 2010 or 2009 exceeds 5%. For 2009, the Companys catastrophe second event and third event excess of loss reinsurance was each provided by four reinsurers, although not the same four for both contracts, all rated A- (Excellent) or above by A.M. Best. For 2010, the Companys catastrophe second event and third event excess of loss reinsurance is provided by four reinsurers, all rated A- (Excellent) or above by A.M. Best.
Property Catastrophe First Event Excess of Loss Reinsurance Participants In Excess of 5%
NR Not rated.
For 2010, property catastrophe reinsurers representing 100% of the Companys total reinsured catastrophe coverage were rated A- (Excellent) or above by A.M. Best.
Beginning in 1961, educators in the Companys target market benefit from the provisions of Section 403(b) of the Internal Revenue Code (the Code). This section of the Code allows public school employees and employees of other tax-exempt organizations, such as not-for-profit private schools, to reduce their pretax income by making periodic contributions to 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 403(b) tax-qualified annuity market, measured by 403(b) net written premium on a statutory accounting basis. The Company has approved 403(b) payroll reduction capabilities in approximately one-third of the 15,400 school districts in the U.S. Approximately 61% of the Companys new annuity contract deposits in 2009 were for 403(b) tax-qualified annuities; approximately 73% of accumulated annuity value on deposit is 403(b) tax-qualified. In 2009, annuities represented 35% of the Companys total insurance premiums written and contract deposits.
The Company markets tax-qualified annuities utilizing both fixed account only and combination contracts. The combination contract allows the contractholder to allocate funds to both fixed and variable alternatives. Under the fixed account option, both the principal and a rate of return are guaranteed. Contractholders of this product can change at any time their allocation of deposits between the guaranteed interest rate fixed account and available variable investment options. In general, the contractholder bears the investment risk related to funds allocated to variable investment options. Variable annuity contracts with a guaranteed minimum death benefit (GMDB) provide a 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 because approximately 27% of contract values have no guarantee; approximately 67% have only a return of premium guarantee; and only 6% have a guarantee of premium roll-up at an annual interest rate of 3% or 5%.
In 2006, the Company introduced new Horace Mann manufactured and branded annuity products. The Goal Planning Annuity (GPA) offers educators a variable annuity product with a fixed interest account option and two optional riders that enhance the death benefit feature of the product. Developed with Wilshire Associates, the Companys funds advisor, GPA provides educators the opportunity to invest with fund families such as T. Rowe Price, Fidelity, Alliance, Davis, Ariel Capital Management and Putnam, among others. By utilizing tools that provide assistance in determining needs and making asset allocation decisions, educators are able to choose the investment mix that matches their personal risk tolerance and retirement goals. Expanding Horizon is a fixed interest rate annuity contract for more conservative investors. This product offers educators a competitive rate of interest on their retirement dollars and the choice of bonuses to optimize their benefits at retirement. Also in 2006, the Company added additional investment options to its variable annuity products. This included lifecycle funds, with assets allocated among multiple investment classes within each fund based on its specific target date.
In August 2007, the Company completed development of group variable and fixed annuity products that allow greater flexibility in customizing 403(b) annuity programs to meet the needs of school districts. The first sales of these new group annuity products occurred in January 2008.
As of December 31, 2009, the Companys 56 variable 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, Credit Suisse, BlackRock, Goldman Sachs, Dreyfus, Franklin Templeton, Ariel, Wells Fargo, Royce, Lord Abbett, Putnam and Delaware, offering the Companys customers multiple investment options to address their personal investment objectives and risk tolerance. Total accumulated fixed and variable annuity cash value on deposit at December 31, 2009 was $3.7 billion.
To assist agents in delivering the Horace Mann Value Proposition, the Company has entered into a third-party vendor agreement with American Funds Distributors, Inc. (AFD) to market their retail mutual funds. In addition to retail mutual funds accounts, the Companys agents can also offer a 529 college savings program and Coverdell Education Savings Accounts utilizing AFD funds. The Company has also expanded its product offerings to include fixed indexed annuities and single premium immediate annuities through additional marketing alliances. Third-party vendors underwrite these accounts or contracts and the Company receives commissions on the sales of these products.
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.
Selected Historical Financial Information
(Dollars in millions, unless otherwise indicated)
The Company entered the individual life insurance business in 1949 with traditional term and whole life insurance products. In 2006, the Company introduced Life by Design, a new portfolio of Horace Mann manufactured and branded life insurance products to better address the financial planning needs of educators. The Life by Design portfolio features new 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. 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. In 2009, the Company introduced a new discount for educator customers to improve the competitiveness of its life product portfolio. New marketing support tools were also introduced to aid the agency force.
The Companys traditional term, whole life and group life business in force consists of approximately 145,000 policies, representing approximately $9.3 billion of life insurance in force, with annual insurance premiums and contract deposits of approximately $43.9 million as of December 31, 2009. In addition, the Company also had in force approximately 68,000 Experience Life policies, representing approximately $4.5 billion of life insurance in force, with annual insurance premiums and contract deposits of approximately $54.1 million.
In 2009, the life segment represented 10% of the Companys total insurance premiums written and contract deposits, including less than 1 percentage point attributable to the Companys group life and group disability income business.
During 2009, the average face amount of ordinary life insurance policies issued by the Company was $165,901 and the average face amount of all ordinary life insurance policies in force at December 31, 2009 was $75,845.
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. The Company reinsures 100% of the catastrophe risk in excess of $1 million up to $25 million per occurrence, with one reinstatement. The Companys catastrophe risk reinsurance program covers acts of terrorism and includes nuclear, biological and chemical explosions but excludes other acts of war.
The Company has programs to offer long-term care policies, variable universal life policies and fixed interest rate universal life insurance with three 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 products for the periods indicated.
Selected Historical Financial Information
(Dollars in millions, unless otherwise indicated)
The Company operates in a highly competitive environment. The insurance industry consists of a large number of insurance companies, some of which have substantially greater financial resources, more diversified product lines, greater economies of scale and/or lower-cost marketing approaches, such as direct marketing, mail, Internet and telemarketing, 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, service, name recognition and education association sponsorships. Management believes that the principal competitive factors in the sale of life insurance and annuity products are product features, perceived stability of the insurer, service, name recognition, price and education association sponsorships.
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 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, Variable Annuity Life Insurance Company (VALIC), a subsidiary of American International Group (AIG), is one of the Companys major tax-qualified annuity competitors, as are ING US Financial Services, The Hartford Financial Services Group, Inc., MetLife and Security Benefit. For independent agents distributing the Companys 403(b) tax-qualified annuity products, Life Insurance Company of the Southwest, a subsidiary of National Life Insurance Company, is a major competitor. Mutual fund families, independent agent companies and financial planners also compete in this marketplace.
The market for tax-deferred annuity products has been impacted by the new Internal Revenue Service Section 403(b) regulations, which made the 403(b) market more comparable to the 401(k) market than it has been in the past. While this may drive some competitors out of this market, it may make the 403(b) market more attractive to some of the larger 401(k) providers, 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. 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, 2009, fixed income securities represented 89.6% of the Companys total investment portfolio, at fair value. Of the fixed income investment portfolio, 94.8% was investment grade and nearly 100% was publicly traded. At December 31, 2009, the average quality and average option-adjusted duration of the total fixed income portfolio were A+ and 6.8 years, respectively. At December 31, 2009, investments in non-investment grade fixed income securities represented 4.7% of the total investment portfolio, at fair value. There are no significant investments in mortgage whole loans, real estate, foreign securities, privately placed securities, or common stocks. As of December 31, 2009 and as of the time of this Annual Report on Form 10-K, the Companys securities lending program is suspended and no securities are 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.
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 and real estate.
The following table sets forth the carrying values and amortized cost of the Companys investment portfolio as of December 31, 2009:
(Dollars in millions)
Fixed Maturity Securities and Equity Securities
The following table sets forth the composition of the Companys fixed maturity securities and equity securities portfolios by rating as of December 31, 2009:
Rating of Fixed Maturity Securities and Equity Securities(1)
(Dollars in millions)
At December 31, 2009, 25.2% 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 20.5% of the total investment portfolio at December 31, 2009. These securities typically have average lives shorter than their stated maturities due to unscheduled prepayments on the underlying mortgages. Mortgages are prepaid for a variety of reasons, including sales of existing homes, interest rate changes over time that encourage homeowners to refinance their mortgages and defaults by homeowners on mortgages that are then paid by guarantors.
For financial reporting purposes, the Company has classified the entire fixed maturity portfolio as available for sale. Fixed maturities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value. The net adjustment for unrealized gains and losses on securities available for sale is recorded as a separate component of shareholders equity, net of applicable deferred tax asset or liability and the related impact on deferred policy acquisition costs 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.
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 2010 from all of HMECs insurance subsidiaries without prior regulatory approval is approximately $64 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. 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. State insurance regulations prohibit insurance companies from making any public statements or representations with regard to their risk-based capital levels. Based on current guidelines, the risk-based capital statutory requirements are not expected to have a negative regulatory impact on the Companys insurance subsidiaries. At December 31, 2009 and 2008, 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, 2009, the Companys assessments, net of the related premium tax credits, were not significant.
Insurers may also be assessed by entities such as the Citizens Property Insurance Corporation of Florida (Florida Citizens) and the Louisiana Citizens Fair and Coastal Plan (Louisiana Citizens) as a result of significant hurricane events. Related to such assessments levied in 2005 and 2006, insurers were permitted to in turn assess its policyholders in the respective states to recoup the amounts remitted to Florida Citizens and Louisiana Citizens.
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 2009, 2008 and 2007, the Company reflected pretax net gains (losses) from participation in such mandatory pools and underwriting associations of $(0.8) million, $0.9 million and $2.3 million, respectively.
In addition to the pretax net loss from these mandatory participations in 2009, the Company recorded a pretax charge of $3.8 million to write off its equity interest in the accumulated surplus of the North Carolina Beach Plan. See Managements Discussion and Analysis of Financial Condition and Results of Operations Results of Operations for the Three Years Ended December 31, 2009 Other Income listed on page F-1 of this report.
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 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 life and annuity products to customers. For instance, new Internal Revenue Service (IRS) Section 403(b) regulations were effective January 1, 2009 with limited exceptions. The new regulations altered the nature of 403(b) arrangements causing them to more closely resemble other traditional employer sponsored plans, compared to the historical view of 403(b) arrangements being individual plans funded by salary reduction. Under the new regulations, contributions to Section 403(b) tax-qualified arrangements, including annuities, are required to be made pursuant to a written plan which includes all of the terms and conditions for eligibility, limitations and benefits under the plan, and which may incorporate other documents by reference including annuity contracts issued by approved product providers. Other highlights of the new regulations include modified distribution and transfer rules and the incorporation of numerous positions previously taken by the IRS since last issuing formal comprehensive Section 403(b) regulations in 1964. While the deadline for plan sponsors to have a formal written plan in place was extended until December 31, 2009, such plans were required to satisfy the regulations that were in effect as of January 1, 2009, and sponsors had to correct operations that were in conflict with the terms of the plan as of the plans effective date. Since the proposed new regulations were promulgated in 2004, the Company, and many other providers of 403(b) arrangements, had been adapting its administrative systems, products and services offered to better meet the changing needs of the school district sponsors of 403(b) plans. The lead time to the effective date, combined with preparations made by the Company since the new regulations were first proposed, provided time to assist the key school districts where Horace Mann has Section 403(b) payroll slots with the development of their written plans and to implement the new products and services required to enable the Company to continue to effectively serve this market.
One immediate impact of the new Section 403(b) regulations has been that previous rules governing a participants ability to exchange one 403(b) annuity or funding agreement for another without incurring income tax liability were changed effective September 25, 2007. Under the new regulations, plan sponsors control whether such exchanges are even permitted within their plan, and which providers are eligible to receive them. The fact that this change occurred prior to the effective date of the remainder of the new regulations created some confusion among plan sponsors and product providers in the period from September 25, 2007 through December 2008, which slowed the pace of such exchanges. This contributed to both reduced sales and improved retention for the Company in 2008 and also impacted the industry as a whole. As anticipated, a return to a more normal flow of exchanges was experienced during 2009 as sponsors and providers became more comfortable with the new rules, resulting in a significant increase in overall single premium and rollover sales compared to 2008 and 2007.
Proposed Federal Oversight of Financial Institutions
As of the time of this Annual Report on Form 10-K, consideration of significant reform of the federal oversight of financial institutions is underway by the 111th Congress and the Obama Administration. A central objective of this reform is establishment of new federal oversight of the systemic risk posed by the various financial institutions and their products and services to the broader U.S. economy. The question of the extent to which the insurance industry poses such risk and whether it should be the subject of federal regulation is unsettled in these reform debates. Proposals for federal oversight of the insurance industry range from comprehensive supervision through an optional federal charter to a more circumspect approach of establishing a federal insurance information office. Management will closely monitor these developments for impact on the Company, insurers of similar size and the insurance industry as a whole.
At December 31, 2009, the Company had approximately 1,400 non-agent employees and 466 full-time employee agents. (This does not include 249 Exclusive Agent independent contractors that were part of the Companys total dedicated agency force at December 31, 2009.) The Company has no collective bargaining agreement with any employees.
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 economic environments can impact financial markets 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. The U.S. entered a severe recession that, while moderating, is likely to persist well into and perhaps even beyond 2010, despite governmental intervention in the economy. 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. Like other financial institutions, which face significant financial markets risk in their operations, the Company was adversely affected by these conditions and could be adversely impacted by similar circumstances in the future.
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 such as: our volume of new business for automobile, homeowners, annuity and life products could be diminished; our policy renewal rates could decrease; the inflow of annuity contract deposit receipts could decrease; surrenders of annuity contracts and related withdrawals of accumulated deposits could increase; property and casualty claims related to uninsured motorists, arson or fraudulent information may increase; the market value of our investment portfolio could be impacted by economic effects on the issuers of the securities we hold; and taxing authorities could increase rates or implement new tax elements in efforts to offset their declining revenues.
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:
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.
Declining financial markets could also cause, and in the past have caused, the value of the investments in our defined benefit 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.
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 valuations of deferred policy acquisition costs.
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:
Both rising and declining interest rates can negatively affect the income we derive from these interest rate spreads. During periods of falling interest rates, our investment earnings will be lower because new investments in fixed maturity securities will likely 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. During periods of rising interest rates, there may be competitive pressure to increase the crediting rates on our annuity contracts. We may not,
however, have the ability immediately 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 valuations 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, borrowers under mortgage loans, customers, trading counterparties, counterparties under swaps and other derivative contracts, reinsurers, 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.
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.
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, 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:
Based on 2009 direct premiums earned, approximately 58% 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: Florida, California, North Carolina, Texas, Louisiana, South Carolina and Georgia.
As an ongoing practice, but particularly following the significant catastrophic claims from hurricanes in 2005 and 2004, we attempt to manage our exposure to catastrophes. Reductions in property and casualty business written in catastrophe-prone areas, including an additional risk reduction program initiated in Florida in 2010, 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 if:
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, 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, as was done for the 2007 through 2009 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.
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 world 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. Our risks related to catastrophic events and reinsurance are disclosed in more detail above. 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 clients. This could adversely impact our volume of business and our results of operations or cash flows. New laws and regulations that may be implemented as a result of climate change also could have an adverse impact on our cost of doing business and our results of operations or cash flows.
Deviations from assumptions regarding future market appreciation, interest spreads, 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), 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.
An impairment of all or part of our goodwill could adversely affect our results of operations and financial condition.
At December 31, 2009, 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, 2009 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. 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 an adverse effect on our results of operations and 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 financial condition and results of operations of that subsidiary.
The financial covenants related to the Companys outstanding indebtedness, including the Bank Credit Agreement, consist primarily of relationships of (1) debt to capital, (2) insurance subsidiaries insurance financial strength ratings issued by A.M. Best and (3) net worth, as defined in the financial covenants. For instance, if the insurance subsidiaries A.M. Best financial strength rating is lowered beneath the A- rating assigned at the time of this Annual Report on Form 10-K, the Company would be in default under its Bank Credit Agreement. This could adversely impact our liquidity, financial condition and results of operations.
A downgrade in our holding company debt rating 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 a ratio of premiums to surplus for property and casualty insurance companies and a ratio of reserves to surplus for life insurance companies. 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 in order to pay dividends to us to enable us to meet our financial obligations. 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.
Our success in marketing and selling our products is largely dependent upon the efforts of our full-time, dedicated 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 or are unable to increase the productivity of agency operations, sales of our products would likely decline and our financial condition and results of operations would 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 support personnel and 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. If we and the agency force are unable to successfully implement these approaches to expanding our points of distribution and further increasing the productivity of agents, our financial condition and results of operations could be adversely affected.
If we are not able to maintain and secure (1) payroll reduction authorizations and (2) product sponsorships and other relationships with the educational community, our financial condition and results of operations could be adversely affected.
Our ability to successfully grow 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 other causes could potentially adversely affect the sale of all lines of our business and require us to change our traditional worksite marketing and advertising approach. With the changes in the IRS regulations regarding Section 403(b) arrangements, including annuities, our ability to maintain and grow our share of the 403(b) market, and the access it gives us for other product lines, will depend on our ability to successfully adapt our products, services offered, and administrative systems, which could potentially increase our cost of doing business in this market. School districts and benefit consultants have been placing additional emphasis on the relative financial strength ratings of competing companies, which may put us at a competitive disadvantage relative to other more highly-rated insurance companies. See also Business Regulation Regulation at Federal Level.
Our ability to maintain and obtain product sponsorships from local, state and national education associations is important to our marketing strategy. Horace Mann has had a long 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. In addition to these organizations, we have established relationships with various other educator, principal and school administrator groups. These contacts and endorsements help to establish our brand name and presence in the educational community and to enhance our access to educators.
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.
Examples of governmental regulation that has adversely affected the operations of our insurance subsidiaries include:
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.
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.
In 2008, the United States Treasury Department issued a report, Blueprint for Financial Regulatory Reform, including recommendations to improve regulatory oversight of the financial services sector. The report includes a proposal that would establish a federal insurance regulatory structure and allow individual insurance companies the option of obtaining a federal charter, similar to the current dual-chartering system for banking. Congress also has pending proposals regarding optional federal chartering of insurance companies and other various insurance-related matters which have been subject to congressional hearings in 2008 and 2009. Due to the volatility in the financial markets which accelerated in the last half of 2008 and continued in 2009, and in particular volatility for companies in the financial services sector, it is possible that additional oversight or regulation could be imposed at the federal and/or state levels. Management will continue to monitor the existing proposals and any new proposals. 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.
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, such as direct marketing, mail, Internet and telemarketing, 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, service, name recognition and education association sponsorships. We believe that the principal competitive factors in the sale of life insurance and annuity products are product features, perceived stability of the insurer, service, name recognition, price and education association sponsorships.
Particularly in the property and casualty business, our insurance subsidiaries have experienced, and expect to experience in the future, periods of intense competition during which they may be unable to increase policyholders and revenues without adversely impacting profit margins. The inability of an insurance subsidiary to compete successfully in the property and casualty business would adversely affect its financial condition and results of operations and its resulting ability to distribute cash to us.
In our annuity business, the new Internal Revenue Service (IRS) Section 403(b) regulations, which generally took effect January 1, 2009, make the 403(b) market more similar to the 401(k) market than it has been in the past. While this may drive some competitors out of this market, it may make the 403(b) market more attractive to some of the larger 401(k) providers, including both insurance and mutual fund companies, that had not previously been active competitors in this business. The inability of an insurance subsidiary to compete successfully in these markets would adversely affect its financial condition and results of operations and its resulting ability to distribute cash to the holding company.
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, state budget deficits and cut-backs and adverse changes in state and local tax revenues.
A reduction or elimination of the tax advantages of life and annuity 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. While the recent changes in IRS regulations governing 403(b) plans did not change the relative tax advantages of 403(b) annuities, our financial condition and results of operations could be adversely affected by changes in federal and state laws and regulations that do affect the relative tax and other advantages of our life and annuity products to clients or the tax benefits of programs utilized by our clients. As a result of economic conditions in 2008, 2009 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.
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.
Data security breaches could have an adverse impact on the Companys business and reputation.
Unauthorized access to our client or employee 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 data and information or systems interruptions that may expose the Company to liability and/or regulatory action and may have an adverse impact on the Companys clients, employees and business. In addition, any compromise of the security of our data could harm the Companys reputation and business. 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 absolute assurances that security breaches will be prevented.
Successful execution of our growth strategy is highly dependent on effective implementation of new technology solutions.
Our ability to effectively execute our growth strategy and leverage potential economies of scale is dependent on our ability to provide the requisite technology components of that strategy. While we have effectively upgraded our infrastructure technologies with improvements in our data center, a new communications platform and enhanced disaster recovery capabilities, our ability to build upon this foundation and replace dated, single-function legacy systems with fully functional, flexible, maintainable and user-friendly technology solutions, including current efforts underway to replace major components of our property and casualty administrative system, will be necessary to achieve our plans. The inherent difficulty in implementing large technology solutions, coupled with the Companys lack of experience in these types of endeavors, presents increased risk to delivering these technology solutions in a timely and cost-effective manner. Utilization of third-party vendors can augment the Companys internal capacity for these implementations, but may not 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 claim adjustment services, investment management advisement, information technology consulting and employee benefits consulting/actuarial services. 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. In addition, in some instances certain individuals working for vendors have provided services to us for extended periods of time, gaining substantial knowledge of the Company and our operations. The loss of continued service by those individuals could adversely impact our operations.
HMECs home office property at 1 Horace Mann Plaza in Springfield, Illinois, consists of an office building totaling 230,000 square feet, approximately 200,000 square feet of which is office space, which 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 office space in a number of states 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.
The Company is not currently party to any material pending legal proceedings other than routine litigation incidental to its business.
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.
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. See also Business Cash Flow.
Stock Price 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, 2004 in HMEC, the S&P 500 Insurance Index and the S&P 500 Index.
Holders and Shares Issued
As of February 16, 2010, the approximate number of holders of HMECs common stock was 2,700.
During 2009, no stock options were exercised.
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 2010 Annual Meeting of Shareholders.
The information required by Item 301 of Regulation S-K is contained in the table in Item 1 Business Selected Historical Consolidated Financial Data.
The information required by Item 303 of Regulation S-K is listed on page F-1 of this report.
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.
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.
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, 2009, 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:
Management of Horace Mann conducted an evaluation of the effectiveness of the Companys internal control over financial reporting as of December 31, 2009, 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 chief executive officer and our chief financial officer, determined that, as of December 31, 2009, the Company maintained effective internal control over financial reporting.
The Companys internal control over financial reporting as of December 31, 2009 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.
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.
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 2010 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 Web site, www.horacemann.com, under Investor Relations Corporate Governance.
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 2010 Annual Meeting of Shareholders.
The information required by Items 201(d) and 403 of Regulation S-K is incorporated by reference to the Companys Proxy Statement for the 2010 Annual Meeting of Shareholders.
The information required by Items 404 and 407(a) of Regulation S-K is incorporated by reference to the Companys Proxy Statement for the 2010 Annual Meeting of Shareholders.
The information required by Item 9(e) of Schedule 14A is incorporated by reference to the Companys Proxy Statement for the 2010 Annual Meeting of Shareholders.
(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, 2009 and 2008.
Consolidated Statements of Operations for the Years Ended December 31, 2009, 2008 and 2007.
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2009, 2008 and 2007.
Consolidated Statements of Changes in Shareholders Equity for the Years Ended December 31, 2009, 2008 and 2007.
Consolidated Statements of Cash Flows for the Years Ended December 31, 2009, 2008 and 2007.
(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.
(a)(3) The following items are filed as Exhibits. Management contracts and compensatory plans are indicated by an asterisk (*).
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 Investor Relations section of the Companys Internet Web site, 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.
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.
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.
Dated: March 1, 2010
INDEX TO FINANCIAL INFORMATION
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in millions, except per share data)
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, among other risks and uncertainties inherent in the Companys business, the following important factors:
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 2009, the Companys net income of $73.5 million represented an increase of $62.6 million compared to 2008. After-tax net realized investment gains and losses improved by $58.7 million between years. Catastrophe costs decreased $26.6 million after tax, with the entire amount in 2009 representing non-hurricane catastrophe costs which were at higher-than-average levels. Net income in 2009 was adversely impacted by an increase in large property losses, primarily sinkhole claims in Florida, and a late-year increase in automobile loss frequency. In addition, compared to 2008, net income in the current year decreased by $4.2 million due to a modest decrease in the level of favorable prior years property and casualty reserve development. Including all factors, the property and casualty combined ratio was 99.5% for 2009 compared to 100.7% for 2008. Beyond underwriting results, in 2009 net income for the property and casualty segment was reduced by $2.5 million after tax as a result of writing off the Companys equity interest in the accumulated surplus of the North Carolina Coastal Property Insurance Pool. Annuity segment net income increased $3.9 million compared to 2008, as current year improvements in the interest margin and the favorable impact of the financial markets on the valuations of deferred policy acquisition costs and the guaranteed minimum death benefit reserve offset the adverse impact of the financial markets on the level of contract charges earned during the year. Life segment net income increased $2.0 million compared to a year earlier, reflecting growth in investment income partially offset by an increase in mortality costs. As described in Results of Operations for the Three Years Ended December 31, 2009 Income Tax Expense (Benefit), in 2008 the Companys net income benefited by $4.2 million as a result of the completion of Internal Revenue Service (IRS) examination, with $2.6 million of that amount benefiting the annuity segment. The current year included transition costs of approximately $3.5 million after tax related to the Companys property and casualty claims office consolidation and distribution strategies, comparable to the amount incurred in 2008 related to the property and casualty claims office consolidation.
Premiums written and contract deposits of $1.0 billion increased 5% compared to 2008, primarily reflecting an increase in annuity single premium and rollover deposit receipts in 2009. Total annuity contract deposits received increased 12% compared to 2008. New automobile sales units for 2009 were 4% less than 2008, although average agent true new automobile sales productivity increased compared to a year earlier. The automobile new business decrease was offset by favorable policy retention and growth in average premium per policy. Life segment insurance premiums and contract deposits decreased 2% compared to 2008.
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 judgements 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 judgements include: fair value measurements, other-than-temporary impairment of investments, goodwill, deferred policy acquisition costs for annuity and interest-sensitive life products, deferred taxes, liabilities for property and casualty claims and claim settlement expenses, liabilities for future policy benefits and valuation of assets and liabilities related to the defined benefit pension plan.
Fair Value Measurements
The Company utilizes the prescribed framework for measuring fair value that includes a hierarchy for classifying the inputs used in measuring fair value. The hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three levels. 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. The levels of the fair value hierarchy are as follows:
At December 31, 2009, Level 3 invested assets comprised approximately 0.2% of the Companys total investment portfolio 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.
Valuation of Fixed Maturity and Equity Securities
For fixed maturity securities, each month the Company receives prices from its custodian bank and investment manager. Fair values for the Companys fixed maturity securities are based on prices provided by its investment manager. The prices from the custodian bank are compared to prices from the investment manager. 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 yields, 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 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 price 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 the values received are accurately recorded and that the data inputs and valuation techniques utilized are appropriate, consistently applied, and that 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. Historically, the control processes have not resulted in adjustments to the valuations provided by pricing sources. 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 93% of the portfolio was priced through pricing services or index priced as of December 31, 2009. The remainder of the portfolio was priced by broker-dealers, and these inputs were generally Level 2. There were no significant changes to the valuation process during 2009.
Fair values of equity securities have been determined by the Company from observable market quotations, when available. Private placement securities and equity securities where a public quotation is not available are valued by using non-binding broker quotes or through the use of internal models or analysis. 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.
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 date of the reporting period. Based on these facts, if the Company has the intent to sell the debt security, or if it is more likely than not the Company will be required to sell the debt security before the anticipated recovery in fair value or if management does not expect to recover the entire cost basis of the debt security, an other-than-temporary impairment is considered to have occurred. For equity securities, if the Company does not have the ability and intent to hold the security for the recovery of cost within a reasonable period of time or if 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 debt 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 fair value or maturity; and for equity securities, the Companys ability and intent to hold the security for the recovery of cost within a reasonable period of time 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 credit related losses associated with impaired debt securities. The amount of the total other-than-temporary impairment related to non-credit factors for debt securities is recognized in other comprehensive income, net of applicable taxes.
With respect to fixed income securities involving securitized financial assets primarily asset backed and commercial mortgage-backed securities in the Companys portfolio all fair values are 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 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 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 one level below an operating segment. The Companys reporting units, for which goodwill has been allocated, are equivalent to the Companys operating segments.
The goodwill impairment test, as defined in the accounting guidance, follows a 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 and financial position.
The Company completed its annual goodwill assessment for the individual reporting units as of December 31, 2009. The first step of the Companys analysis indicated that fair value exceeded carrying value for each reporting 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 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.
As part of the Companys December 31, 2009 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 transaction premium. The amount of the transaction premium was determined to be reasonable based on insurance industry and Company-specific facts and circumstances.
Subsequent reviews of goodwill could result in impairment due to the impact of volatile financial markets on earnings, discount rate assumptions, liquidity and market capitalization (stock price).
Deferred Policy Acquisition Costs for Annuity and Interest-sensitive Life Products
Policy acquisition costs, consisting of commissions, policy issuance and other costs, which vary with and are primarily related to the production of business, are capitalized and amortized on a basis consistent with the type of insurance coverage. For 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 are also amortized over 20 years in proportion to estimated gross profits.
The most significant assumptions that are involved in the estimation of annuity gross profits include 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 equity markets is not changed by short-term market fluctuations, but is only changed when sustained interim deviations are experienced. The Company monitors these changes and only changes the assumption when its long-term expectation changes. The effect of an increase/(decrease) by 100 basis points in the assumed future rate of return is reasonably likely to result in a decrease/(increase) in the deferred policy acquisition costs amortization expense of approximately $1 million. At December 31, 2009, the ratio of capitalized annuity policy acquisition costs to the total annuity accumulated cash value was approximately 4%.
In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company may be required to record a material charge or credit to amortization expense for the period in which the adjustment is made. As noted above, there are key assumptions involved in the valuation of capitalized policy acquisition costs. In terms of the sensitivity of this amortization to two of the more significant assumptions, assuming all other assumptions are met, (1) a 10 basis point deviation in the annual targeted interest rate spread assumption would currently impact amortization between $0.10 million and $0.20 million and (2) a 1% deviation from the targeted financial market performance for the underlying mutual funds of the Companys variable annuities would currently impact amortization between $0.15 million and $0.25 million. These results may change depending on the magnitude and direction of the 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, 2009 Policy Acquisition Expenses Amortized.
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 capital gains 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.
Liabilities for Property and Casualty Claims and Claim Settlement Expenses
Underwriting results of the property and casualty segment are significantly influenced by estimates of the 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 and public attitudes.
Reserves are reestimated quarterly. Changes to reserves are recorded in the period in which development factor changes result in reserve reestimates. 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 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 $12 million of net income based on reserves as of December 31, 2009. 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 $3.0 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 loss and loss adjustment expense actuarial analysis is discussed 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. Review of the variance between the indicated reserves from these changes in assumptions and the previously carried reserves takes place. 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.
The Companys liabilities for property and casualty unpaid claims and claim settlement expenses were as follows:
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, 2009, 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 2009 by approximately $7.6 million, primarily the result of favorable frequency and severity trends in voluntary automobile loss and loss adjustment expense emergence for accident years 2006 and prior. The lower than expected claims and expense emergence and resultant lower expected loss ratios caused the Company to lower its reserve estimate at December 31, 2009.
Information regarding the Companys property and casualty claims and claims settlement expense reserve development table as of December 31, 2009 is located in Business Property and Casualty Segment Property and Casualty Reserves. Information regarding property and casualty reserve reestimates for each of the three years ended December 31, 2009 is located in Results of Operations for the Three Years Ended December 31, 2009 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 withdrawals. Mortality and withdrawal 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.
Valuation of Assets and 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 5.27% was used by the Company for estimating accumulated benefits under the plan at December 31, 2009, 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 Citigroup Pension Discount Curve. The expected annual return on plan assets assumed by the Company at December 31, 2009 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 increase (decrease) in AOCI.
Results of Operations for the Three Years Ended December 31, 2009
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
(Includes annuity and life contract deposits)
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
For 2009, the Companys premiums written and contract deposits increased $43.6 million, or 4.5%, compared to 2008, primarily reflecting increases in annuity single premium and rollover deposit receipts in 2009. For 2008, the Companys premiums written and contract deposits decreased $14.6 million, or 1.5%, compared to 2007, largely due to decreases in single premium annuity deposit receipts in 2008. The reduced costs associated with the Companys property and casualty catastrophe reinsurance program, as described below, represented a $6.9 million increase to premiums for 2008. 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.
The Companys dedicated agency force totaled 715 at December 31, 2009, reflecting an increase of 6.7% compared to 670 agents at December 31, 2008. At December 31, 2007, the Company had 790 agents. In addition to agents, the Companys total points of distribution include licensed producers who work with the agents. At December 31, 2009, there were 571 licensed producers, compared to 394 at December 31, 2008 and 253 at December 31, 2007.
Including these licensed producers, the Companys total points of distribution increased to 1,286 at December 31, 2009, a growth of 20.9% compared to 12 months earlier. At the time of this Annual Report on Form 10-K, management anticipates that the year-end 2010 agent count will increase modestly as the Company continues its transition to its Agency Business Model and Exclusive Agent agreement, with a further increase in total points of distribution resulting from the growing number of licensed producers supporting agents who adopt the new models.
In 2006, the Company began the transition from a single-person agent operation to its Agency Business Model, with agents in outside offices with support personnel and licensed producers, designed to remove capacity constraints and increase productivity. Building on the foundation of the Agency Business Model, in the fourth quarter of 2008 the Company introduced its Exclusive Agent agreement which is designed to place agents in the position to become business owners and invest their own capital to grow their agencies. By January 1, 2009, the first 71 individuals migrated from being employee agents to functioning as independent Exclusive Agents. By December 31, 2009, 249 individuals were appointed as Exclusive Agents, including both individuals migrating from employee agent status and individuals newly appointed to market the Companys products. See additional description in Business Corporate Strategy and Marketing Dedicated Agency Force.
For the Company, as well as other personal lines property and casualty companies, new business levels have been impacted by the economy and the overall decreases in automobile and home sales. In 2009, total new automobile sales units were 4.1% less than the prior year, including a 1.7% decrease in true new automobile sales units. Fourth quarter 2009 true new automobile sales units were 4.0% greater than the same period in 2008, helping to narrow the gap for the full year comparison. New homeowners sales units decreased 1.4% compared to 2008, after also reflecting positive sales growth in the fourth quarter of 2009. Annuity new business increased 31.4% compared to 2008, reflecting new business growth in the Companys core scheduled deposit business (on an annualized basis at the time of sale, compared to the reporting of new contract deposits which are recorded when cash is received) of 21.9% coupled with a 34.5% increase in single premium and rollover deposits, including both Horace Mann and third-party vendor products. Both the Companys dedicated agency force and the independent agent distribution channel contributed to the growth in sales of Horace Mann annuity products. Growth in annuity new business has been supported by the Companys approved 403(b) payroll reduction capabilities. The Company has payroll slots in approximately one-third of the 15,400 public school districts in the United States. Sales of new life insurance products have been adversely impacted by current economic conditions industry wide. In spite of these conditions, the Companys introduction of a new educator-focused portfolio of term and whole life products in the third quarter of 2009 led to life new business levels for 2009 that were comparable to 2008. Within that 2009 life sales comparison, a decline in sales of third-party vendor products more than offset the 4.1% increase in sales of Horace Manns life products. For 2009, total new business sales increased 22.8% compared to 2008. In total, dedicated agent sales for 2009 increased 11.4% compared to the prior year. Average overall productivity per agent increased compared to 2008, reflecting improvements in the Companys lead lines of business voluntary automobile and annuity. Average agent productivity is measured as new sales premiums or new business units from the dedicated agent force per the average number of dedicated agents for the period.
Total voluntary automobile and homeowners premium written increased 1.5%, or $8.0 million, in 2009, including a $3.2 million increase in catastrophe reinsurance premiums for 2009. The automobile and homeowners average written premium per policy each increased compared to 2008, with the change in average premium for both lines moderated by the improved quality of the books of business. For 2009, approved rate increases for the Companys automobile and homeowners business were minimal, but slightly more than rate actions in 2008. At December 31, 2009, there were 528,000 voluntary automobile and 262,000 homeowners policies in force, for a total of 790,000 policies, compared to a total of 798,000 policies at December 31, 2008 and 801,000 at December 31, 2007.
Based on policies in force, the voluntary automobile 6-month retention rate for new and renewal policies was 91.3% at December 31, 2009 compared to 91.1% at December 31, 2008 and 91.0% at December 31, 2007. The property 12-month new and renewal policy retention rate was 88.8% at December 31, 2009 compared to 88.6% and 88.3% at December 31, 2008 and 2007, respectively.
Voluntary automobile premium written increased 1.3% ($4.7 million) compared to 2008. In 2008, voluntary automobile premium written increased 0.7% ($2.5 million) compared to 2007. In 2009, the premium growth was driven by a modest increase in average written premium per policy. Average earned premium per policy also increased modestly. In 2008, automobile average written premium per policy and average earned premium per policy increased modestly, while policies in force were equal to December 31, 2007. Automobile policies in force at December 31, 2009 decreased 7,000 compared to both December 31, 2008 and December 31, 2007. The number of educator policies increased throughout the periods.
Voluntary homeowners premium written increased 1.9% ($3.3 million) compared to 2008 including the higher amount of catastrophe reinsurance premiums noted above. In 2008, voluntary homeowners premium written increased 5.5% ($9.1 million) compared to 2007 including a reduction in catastrophe reinsurance premiums of $6.9 million benefitting the 2008 comparison. Homeowners average written and earned premium per policy each increased 4% in 2009 compared to 2008. Homeowners average written premium per policy increased 3% in 2008, while average earned premium per policy increased 5% in 2008. Homeowners policies in force at December 31, 2009 decreased 1,000 compared to December 31, 2008; and homeowners policies in force at December 31, 2008 decreased 3,000 compared to December 31, 2007. Over both years, growth in the number of educator policies was offset by expected reductions, primarily in non-educator policies, due to the Companys risk mitigation programs, including actions in catastrophe-prone coastal areas. 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 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. The Company ceased writing new homeowner (including home, condo, renters and dwelling fire) 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. The Companys dedicated agents will continue to work closely with customers to find coverage with other third-party companies that are continuing to underwrite property risks in Florida. While this action will likely impact the overall policy in force count and premiums in the short-term, it is expected
to reduce risk exposure concentration, reduce overall catastrophe reinsurance costs and improve underwriting results by 2012.
During 2009, ongoing and recurring proceedings occurred in North Carolina challenging private passenger automobile rates. Notification received by the Company indicates that the proceedings are complete, resulting in a rate increase for the Company that is slightly lower than the rate the Company submitted. For 2009, the Company escrowed $0.6 million of premiums received related to these proceedings which will be refunded to policyholders.
Annuity deposits received increased 12.2% in 2009 after decreasing 7.5% in 2008, compared to the respective prior years. In both comparisons, the primary driver was the change in single premium and rollover deposit receipts. In 2009, single premium and rollover deposits increased 42.3%, more than offsetting the 3.2% decline in scheduled annuity deposit receipts. In 2009, new deposits to variable accounts decreased 16.5%, or $22.2 million, and new deposits to fixed accounts increased 34.0%, or $60.3 million, compared to the prior year. Management continues to see benefits of becoming a stronger presence in the educator annuity market subsequent to the implementation of new Internal Revenue Service Section 403(b) regulations, effective January 1, 2009. Also, management believes that educators view the Company as having a recognized brand and providing personalized advice through agents with a local presence, leading to new business growth and strong annuity business persistency. In 2008, new deposits to variable accounts decreased 10.3%, or $15.5 million, and new deposits to fixed accounts decreased 5.3%, or $9.9 million, compared to 2007. 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.
The Company 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 832 authorized agents at December 31, 2009. During 2009, this channel generated $52.6 million in annualized new annuity sales for the Company compared to $21.3 million in 2008 and $32.9 million in 2007, reflecting increases in single and rollover deposit business as well as scheduled deposit business.
Total annuity accumulated cash value of $3.7 billion at December 31, 2009 increased 13.8% compared to a year earlier, as the increase from new deposits received and favorable retention were accompanied by favorable financial market performance over the 12 months. Total annuity accumulated cash value of $3.3 billion at December 31, 2008 decreased 12.2% compared to a year earlier, as the increase from new deposits received and favorable retention was more than offset by unfavorable financial market performance over the 12 months ended December 31, 2008. At December 31, 2009, the number of annuity contracts outstanding of 178,000 increased 4.1%, or 7,000 contracts, compared to December 31, 2008 and increased 6.6%, or 11,000 contracts, compared to December 31, 2007.
Variable annuity accumulated balances at December 31, 2009 reflected growth of 27.1% compared to December 31, 2008, reflecting financial market performance which improved somewhat during the second and third quarters of 2009, followed by more notable improvement in the fourth quarter. Full year annuity segment contract charges earned decreased 18.1%, or $3.2 million, compared to 2008, reflecting the reduced account values throughout much of 2009. Variable annuity accumulated balances were 38.2% lower at December 31, 2008 than at December 31, 2007, primarily reflecting financial market performance, and annuity segment contract charges earned decreased 18.8%, or $4.1 million, compared to 2007.
Life segment premiums and contract deposits decreased 2.0% compared to 2008. In 2008, life segment premiums and contract deposits were comparable to 2007. The ordinary life insurance in force lapse ratio was 5.4% for both the 12 months ended December 31, 2009 and 2008, compared to 5.8% for the 12 months ended December 31, 2007.
Net Investment Income
For 2009, pretax investment income of $246.8 million increased 7.2%, or $16.5 million, (7.2%, or $11.2 million, after tax) compared to 2008. For 2008, pretax investment income of $230.3 million increased 2.9%, or $6.5 million, (2.8%, or $4.2 million, after tax) compared to 2007. The increase in 2009 primarily reflected growth in the size of the average investment portfolio on an amortized cost basis, and was accompanied by improvement in the average pretax yield. Average invested assets (excluding securities lending collateral) increased 5.2% over the 12 months ended December 31, 2009. The average pretax yield on the investment portfolio was 5.63% (3.82% after tax) for 2009, compared to a pretax yield of 5.52% (3.75% after tax) and 5.53% (3.76% after tax) for 2008 and 2007, respectively. For 2009, the Companys investment portfolio yield reflected the adverse impact of the elevated level of short-term investments in the portfolio related to the Companys opportunistic capital gains programs during the year, selective reinvestment of the sales proceeds and strong operational cash flows throughout the year. While the short-term position was somewhat reduced during the fourth quarter of 2009, management anticipates reinvesting the majority of these funds in intermediate and long term bonds throughout 2010.
Net Realized Investment Gains and Losses
For 2009, net realized investment gains (pretax) were $26.3 million compared to net realized investment losses of $63.9 million in 2008 and $3.4 million in 2007. The net gains and losses in all periods were realized from the recording of impairment charges and ongoing investment portfolio management activity. In addition, 2009, 2008 and 2007 included $1.5 million, $1.1 million and $0.3 million, respectively, of litigation proceeds primarily on previously impaired Enron Corp. and WorldCom, Inc. debt securities.
In the fourth quarter of 2009, pretax net realized investment gains of $4.6 million included (1) a $0.2 million credit-related impairment write-down related to one issuer and (2) $2.3 million of realized impairment losses on securities that were disposed of during the quarter. The impairment amounts were more than offset by $5.7 million of realized gains on other security disposals, including $1.4 million of realized gains on previously impaired securities that were disposed of during the quarter primarily financial sector securities, and $1.4 million of litigation proceeds on debt securities.
In the third quarter of 2009, pretax net realized investment gains of $11.5 million included (1) $1.3 million of impairment write-downs, attributable to three issuers, and (2) $0.5 million of realized impairment losses on securities that were disposed of during the quarter. The impairment amounts were more than offset by $13.3 million of realized gains on other security disposals.
In the second quarter of 2009, pretax net realized investment gains were $11.0 million, which included (1) $3.4 million of credit related impairment write-downs, primarily related to a single collateralized debt obligation security, (2) $0.6 million of impairment write-downs on equity securities and securities the Company intended to sell, and (3) $4.1 million of realized losses on securities that were disposed of during the quarter, primarily financial institution and telecommunications sector securities. The impairment amounts were largely offset by $6.1 million of realized gains on previously impaired securities that were disposed of during the quarter, primarily financial sector securities. In addition, the second quarter reflected $13.0 million of realized gains on other security disposals.
In the first quarter of 2009, pretax net realized investment losses were $0.8 million, including $15.8 million of impairment charges. These charges were comprised of $13.4 million of impairment write-downs, primarily below investment grade perpetual preferred stocks, and $2.4 million of impairments on securities that the Company no longer intended to hold until the value fully recovered, primarily high-yield bonds. In addition, the Company recorded $1.9 million of realized losses on securities that were disposed of during the quarter, primarily high-yield investments. These losses were largely offset by $16.9 million of realized gains on security disposals.
The fourth quarter 2008 write-downs of $5.8 million were related primarily to high-yield and preferred stock investments that the Company no longer intended to hold for a period of time necessary to recover the decline in value, with the remainder related to securities for which impairment write-downs were previously recorded.
The third quarter 2008 write-downs of $33.4 million included approximately $23.7 million related to fixed maturity security and preferred stock impairments for which the issuers ability to pay future interest and principal based upon contractual terms was compromised namely, Lehman Brothers Holdings, Inc., the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and American International Group, Inc. The remaining amount of write-downs primarily of financial institution securities and high yield bonds was primarily attributable to the Company no longer having the intent to hold the securities for a period of time necessary to recover the decline in value. In addition, net realized losses in the third quarter of 2008 included $14.2 million of realized impairment losses primarily on financial institution securities that were disposed of during the qu