================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [x]QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1997 OR [ ]TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-10890 HORACE MANN EDUCATORS CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 37-0911756 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1 Horace Mann Plaza, Springfield, Illinois 62715-0001 (Address of principal executive offices) (Zip Code) Registrant's Telephone Number, Including Area Code: 217-789-2500 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 --- --- As of October 31, 1997, 22,363,706 shares of Common Stock, par value $0.001 per share, were outstanding, net of 7,216,298 shares of treasury stock. ================================================================================
HORACE MANN EDUCATORS CORPORATION FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1997 INDEX <TABLE> <CAPTION> Page ---- PART I - FINANCIAL INFORMATION <S> <C> Item 1. Financial Statements Consolidated Balance Sheets as of September 30, 1997 and December 31, 1996............................................... 1 Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 1997 and 1996............................................................................... 2 Consolidated Statements of Changes in Shareholders' Equity for the Nine Months Ended September 30, 1997 and 1996............................................................................... 3 Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 1997 and 1996............................................................................... 4 Notes to Consolidated Financial Statements................................................ 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................. 10 PART II - OTHER INFORMATION................................................................................ 21 Item 4. Submission of Matters to a Vote of Security Holders Item 6. Exhibits and Reports on Form 8-K SIGNATURES................................................................................................. 22 </TABLE>
HORACE MANN EDUCATORS CORPORATION CONSOLIDATED BALANCE SHEETS (Dollars in thousands) <TABLE> <CAPTION> September 30, December 31, 1997 1996 ------------- ------------ <S> <C> <C> ASSETS Investments Fixed maturities, available for sale, at market (amortized cost, 1997, $2,553,344; 1996, $2,609,077)...................................... $2,640,070 $2,658,512 Short-term and other investments................................................ 132,082 125,824 ---------- ---------- Total investments......................................................... 2,772,152 2,784,336 Cash............................................................................. 14,398 13,704 Accrued investment income and premiums receivable................................ 94,835 107,682 Value of acquired insurance in force and goodwill................................ 110,561 118,638 Other assets..................................................................... 182,818 151,830 Variable annuity assets.......................................................... 936,895 684,836 ---------- ---------- Total assets.............................................................. $4,111,659 $3,861,026 ========== ========== LIABILITIES, REDEEMABLE SECURITIES AND SHAREHOLDERS' EQUITY Policy liabilities Annuity contract liabilities.................................................... $1,267,925 $1,286,110 Interest-sensitive life contract liabilities.................................... 355,306 326,955 Unpaid claims and claim expenses................................................ 335,124 358,853 Future policy benefits.......................................................... 178,942 182,336 Unearned premiums............................................................... 162,402 155,776 ---------- ---------- Total policy liabilities.................................................. 2,299,699 2,310,030 Other policyholder funds......................................................... 120,887 118,549 Other liabilities................................................................ 118,753 129,075 Short-term debt.................................................................. 42,000 34,000 Long-term debt................................................................... 99,590 99,564 Variable annuity liabilities..................................................... 933,795 684,836 ---------- ---------- Total liabilities......................................................... 3,614,724 3,376,054 ---------- ---------- Warrants, subject to redemption.................................................. 577 577 ---------- ---------- Preferred stock.................................................................. - - Common stock..................................................................... 30 29 Additional paid-in capital....................................................... 340,755 330,263 Net unrealized gains on fixed maturities and equity securities................................................ 50,914 29,736 Retained earnings................................................................ 327,559 278,669 Treasury stock, at cost.......................................................... (222,900) (154,302) ---------- ---------- Total shareholders' equity................................................ 496,358 484,395 ---------- ---------- Total liabilities, redeemable securities, and shareholders' equity................................... $4,111,659 $3,861,026 ========== ========== </TABLE> See accompanying notes to consolidated financial statements. 1
HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share data) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ------------------ ----------------- 1997 1996 1997 1996 ---- ---- ---- ---- <S> <C> <C> <C> <C> Insurance premiums written and contract deposits................. $188,911 $180,551 $563,834 $520,894 ======== ======== ======== ======== Revenues Insurance premiums and contract charges earned............. $135,078 $126,156 $402,385 $372,486 Net investment income................. 49,271 49,451 148,979 148,642 Realized investment gains (losses).... 1,585 (132) 3,230 2,603 -------- -------- -------- -------- Total revenues..................... 185,934 175,475 554,594 523,731 -------- -------- -------- -------- Benefits, losses and expenses Benefits, claims and settlement expenses................. 89,925 89,022 271,714 261,172 Interest credited..................... 24,227 23,923 73,082 71,225 Policy acquisition expenses amortized.................. 10,937 10,306 33,035 30,236 Operating expenses.................... 27,484 23,644 77,090 71,763 Amortization of intangible assets..... 2,666 2,802 8,077 8,501 Interest expense...................... 1,842 2,552 7,067 8,022 Debt retirement costs................. - - - 1,319 -------- -------- -------- -------- Total benefits, losses and expenses..................... 157,081 152,249 470,065 452,238 -------- -------- -------- -------- Income from continuing operations before income taxes and discontinued operations............... 28,853 23,226 84,529 71,493 Income tax expense...................... 7,376 5,334 22,756 19,078 -------- -------- -------- -------- Income from continuing operations....... 21,477 17,892 61,773 52,415 Discontinued operations: Loss from operations, net of applicable income tax benefits....... - (1,568) - (3,577) Loss on discontinuation, net of applicable income tax benefits....... (3,481) - (3,481) - -------- -------- -------- -------- Net income.............................. $ 17,996 $ 16,324 $ 58,292 $ 48,838 ======== ======== ======== ======== Earnings (loss) per share Income from continuing operations..... $ 0.95 $ 0.77 $ 2.67 $ 2.24 Discontinued operations: Loss from operations................. - (0.08) - (0.16) Loss on discontinuation.............. (0.15) - (0.15) - -------- -------- -------- -------- Net income.............................. $ 0.80 $ 0.69 $ 2.52 $ 2.08 ======== ======== ======== ======== Weighted average number of shares and equivalent shares (in thousands).. 22,585 23,474 23,111 23,449 </TABLE> See accompanying notes to consolidated financial statements. 2
HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in thousands, except per share data) <TABLE> <CAPTION> Nine Months Ended September 30, ----------------------- 1997 1996 ---- ---- <S> <C> <C> Common stock Beginning balance..................................... $ 29 $ 29 Options exercised, 1997, 363,212 shares; 1996, 136,000 shares................................. 1 - Conversion of Director Stock Plan units, 1997, 1,144 shares....................... - - --------- --------- Ending balance........................................ 30 29 --------- --------- Additional paid-in capital Beginning balance..................................... 330,263 323,920 Options exercised and conversion of Director Stock Plan units............................ 11,742 3,335 Catastrophe-linked equity put option premium................................... (1,250) - --------- --------- Ending balance........................................ 340,755 327,255 --------- --------- Net unrealized gains (losses) on fixed maturities and equity securities Beginning balance.................................... 29,736 76,151 Increase (decrease) for the period................... 21,178 (63,762) --------- --------- Ending balance....................................... 50,914 12,389 --------- --------- Retained earnings Beginning balance.................................... 278,669 224,366 Net income........................................... 58,292 48,838 Cash dividends, 1997, $0.405; 1996, $0.33 per share..................................... (9,402) (7,739) --------- --------- Ending balance....................................... 327,559 265,465 --------- --------- Treasury stock, at cost Beginning balance, 5,588,098 shares.................. (154,302) (154,302) Purchase of 1,449,800 shares (See note 5)............ (68,598) - --------- --------- Ending balance, 1997, 7,037,898 shares; 1996, 5,588,098 shares.............................. (222,900) (154,302) --------- --------- Shareholders' equity at end of period................. $ 496,358 $ 450,836 ========= ========= </TABLE> See accompanying notes to consolidated financial statements. 3
HORACE MANN EDUCATORS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, --------------------- --------------------- 1997 1996 1997 1996 --------- --------- --------- --------- <S> <C> <C> <C> <C> Cash flows from operating activities Premiums collected............................ $ 154,356 $ 146,670 $ 462,657 $ 427,886 Policyholder benefits paid.................... (116,508) (116,876) (353,003) (335,378) Policy acquisition and other operating expenses paid...................... (44,727) (39,220) (126,977) (121,105) Federal income taxes paid..................... (2,626) - (46,703) (10,651) Investment income collected................... 53,111 51,094 152,853 151,796 Interest expense paid......................... (2,610) (4,226) (8,423) (7,382) Other......................................... (2,853) (4,639) (4,354) (2,437) --------- --------- --------- --------- Net cash provided by operating activities.................... 38,143 32,803 76,050 102,729 --------- --------- --------- --------- Cash flows from investing activities Fixed maturities Purchases.................................... (189,029) (206,079) (768,418) (722,154) Sales........................................ 191,994 152,155 648,621 512,435 Maturities................................... 42,679 46,391 173,986 149,764 Net cash received from short-term and other investments............. (30,245) (2,321) (9,056) 33,161 --------- --------- --------- --------- Net cash provided by (used in) investing activities............. 15,399 (9,854) 45,133 (26,794) --------- --------- --------- --------- Cash flows from financing activities Dividends paid to shareholders................ (3,047) (2,580) (9,402) (7,739) Principal borrowing (payments) on Bank Credit Facility......................... - (8,000) 8,000 (25,000) Purchase of treasury stock.................... (7,163) - (68,598) - Exercise of stock options..................... 2,270 1,688 11,743 3,335 Catastrophe-linked equity put option premium........................... - - (1,250) - Proceeds from issuance of Senior Notes.............................. - - - 98,530 Retirement of Convertible Notes............... - - - (102,890) Annuity contracts, variable and fixed Deposits..................................... 42,165 36,698 143,947 122,241 Maturities and withdrawals................... (51,951) (33,355) (122,061) (99,982) Net transfer to variable annuity assets.............................. (29,938) (19,405) (84,005) (62,966) Net increase in interest-sensitive life account balances........................ 144 320 1,137 1,045 --------- --------- --------- --------- Net cash used in financing activities.................... (47,520) (24,634) (120,489) (73,426) --------- --------- --------- --------- Net increase (decrease) in cash................ 6,022 (1,685) 694 2,509 Cash at beginning of period.................... 8,376 13,712 13,704 9,518 --------- --------- --------- --------- Cash at end of period.......................... $ 14,398 $ 12,027 $ 14,398 $ 12,027 ========= ========= ========= ========= </TABLE> See accompanying notes to consolidated financial statements. 4
HORACE MANN EDUCATORS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1997 and 1996 (Dollars in thousands) Note 1 - Basis of Presentation The accompanying unaudited consolidated financial statements of Horace Mann Educators Corporation (the "Company") have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The Company believes that these financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the Company's consolidated financial position as of September 30, 1997 and December 31, 1996 and the consolidated results of operations, changes in shareholders' equity and cash flows for the three and nine months ended September 30, 1997 and 1996. It is suggested that these financial statements be read in conjunction with the financial statements and the notes thereto contained in the December 31, 1996 Form 10-K filed by the Company. The results of operations for the three and nine months ended September 30, 1997 are not necessarily indicative of the results to be expected for the full year. The Company has reclassified the presentation of certain prior period information to conform with the 1997 presentation including the presentation of discontinued operations for all periods. Note 2 - Discontinued Operations In December 1996, the Company announced its strategic decision to withdraw from the group medical insurance business over the following two years. The Company's results of operations for the year ended December 31, 1996 included an accrual for anticipated losses during the phase-out period and a related income tax recoverable. The Company has accelerated the timetable for its withdrawal from the group medical insurance business anticipating termination of more than 90% of that business by December 1997 and the remaining business in 1998. As a result of this acceleration and higher-than-expected claims, net income for the three and nine months ended September 30, 1997 includes a charge of $3,481 for anticipated additional losses during the remainder of the phase-out period, net of related income tax benefits of $1,874. 5
Note 3 - Debt Indebtedness outstanding was as follows: <TABLE> <CAPTION> September 30, December 31, 1997 1996 ------------- ------------ <S> <C> <C> Short-term debt: $65,000 Bank Credit Facility, IBOR + 0.325% (6.1% as of September 30, 1997)............. $ 42,000 $ 34,000 Long-term debt: 6 5/8% Senior Notes, due January 15, 2006. Face amount less unaccrued discount of $410 and $436 (6.7% imputed rate)......... 99,590 99,564 -------- -------- Total...................................... $141,590 $133,564 ======== ======== </TABLE> Note 4 - Investments The following sets forth the composition and value of the Company's fixed maturity securities portfolio by rating category. The Company has classified the entire fixed maturity securities portfolio as available for sale, which is carried at market value. <TABLE> <CAPTION> Percent of Carrying Value September 30, 1997 ---------------------------- ---------------------- Rating of Fixed September 30, December 31, Carrying Amortized Maturity Securities(1) 1997 1996 Value Cost - ---------------------- ------------- ------------- ---------- ---------- <S> <C> <C> <C> <C> AAA..................... 40.7% 46.4% $1,073,211 $1,045,800 AA...................... 7.6 9.4 199,386 192,115 A....................... 20.1 22.3 530,342 512,617 BBB..................... 25.1 16.4 663,852 639,476 BB...................... 2.0 1.4 53,550 50,851 B....................... 3.8 3.7 100,876 94,836 CCC or lower............ - - 782 567 Not rated(2)............ 0.7 0.4 18,071 17,082 ----- ----- ---------- ---------- Total................... 100.0% 100.0% $2,640,070 $2,553,344 ===== ===== ========== ========== </TABLE> (1) Ratings are as assigned primarily by Standard & Poor's Corporation ("S&P") when available, with remaining ratings as assigned on an equivalent basis by Moody's Investors Service, Inc. ("Moody's"). Ratings for publicly traded securities are determined when the securities are acquired and are updated monthly to reflect any changes in ratings. (2) This category is comprised primarily of private placement securities not rated by either S&P or Moody's. The National Association of Insurance Commissioners (the "NAIC") has rated 86.8% of these private placements as investment grade. $0.8 million of the remaining $1.3 million of private placements were rated as investment grade by the NAIC in 1995 and are under review for the assignment of a current rating. 6
Note 4 - Investments - (Continued) The following table presents a maturity schedule of the Company's fixed maturity securities. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. <TABLE> <CAPTION> Percent Carrying of Total Value ---------------------------- -------------- September 30, December 31, September 30, Scheduled Maturity 1997 1996 1997 - ------------------ ------------- ------------ ------------- <S> <C> <C> <C> Due in 1 year or less................ 6.1% 5.7% $ 162,055 Due after 1 year through 5 years..... 24.7 28.7 652,620 Due after 5 years through 10 years... 34.2 32.9 902,085 Due after 10 years through 20 years.. 20.3 18.9 536,481 Due after 20 years................... 14.7 13.8 386,829 ----- ----- ---------- Total................................ 100.0% 100.0% $2,640,070 ===== ===== ========== </TABLE> Note 5 - Shareholders' Equity Subsequent Events-Stock Split and Dividend Increase On November 12, 1997, the Board of Directors authorized a two-for-one stock split distributable on December 15, 1997 to shareholders of record on November 28, 1997. On November 12, 1997, the Board of Directors also authorized the sixth increase in the Company's quarterly dividend since the Company's initial public offering in November 1991. The regular dividend increased by 19% to $0.16 per share on a pre-split basis. Share Repurchase Program In February 1997, the Company's Board of Directors adopted a repurchase program for shares of the Company's common stock, with an initial repurchase limit of $100 million. Based on the market price of the Company's common shares at the time the Board adopted this program, $100 million represented approximately 9% of the Company's outstanding shares. Shares of common stock may be purchased from time to time through open market and private purchases, as available. Share repurchases will be financed with cash from operations and, if needed, the Bank Credit Facility. As of September 30, 1997, the Company had repurchased 1,449,800 shares at an aggregate cost of $68,598, or $47.32 per share, which was financed primarily with cash from operations, including dividends of $80,000 from the property and casualty subsidiaries. 7
Note 6 - Reinsurance The Company recognizes the cost of reinsurance premiums over the contract periods for such premiums in proportion to the insurance protection provided. Amounts recoverable from reinsurers for unpaid claims and claim settlement expenses, including estimated amounts for unsettled claims, claims incurred but not reported and policy benefits are estimated in a manner consistent with the insurance liability associated with the policy. The effect of reinsurance on premiums written; premiums earned; and benefits, claims and settlement expenses were as follows: <TABLE> <CAPTION> Ceded to Assumed Gross Other from State Amount Companies Facilities Net -------- --------- ----------- -------- <S> <C> <C> <C> <C> Three months ended September 30, 1997 - ------------------ Premiums written................. $195,463 $ 6,429 $ (123) $188,911 Premiums earned.................. 136,904 6,035 4,209 135,078 Benefits, claims and settlement expenses............. 94,065 7,961 3,821 89,925 Three months ended September 30, 1996 - ------------------ Premiums written................. $178,628 $ 5,507 $ 7,430 $180,551 Premiums earned.................. 124,864 5,636 6,928 126,156 Benefits, claims and settlement expenses............. 88,771 6,969 7,220 89,022 Nine months ended September 30, 1997 - ------------------ Premiums written................. $572,842 $17,390 $ 8,382 $563,834 Premiums earned.................. 402,404 16,011 15,992 402,385 Benefits, claims and settlement expenses............. 280,178 25,169 16,705 271,714 Nine months ended September 30, 1996 - ------------------ Premiums written................. $516,584 $17,095 $21,405 $520,894 Premiums earned.................. 368,428 17,447 21,505 372,486 Benefits, claims and settlement expenses............. 259,076 20,647 22,743 261,172 </TABLE> 8
Note 6 - Reinsurance - (Continued) The Company maintains an excess and catastrophe treaty reinsurance program for its property and casualty subsidiaries. In 1997, the Company reinsures 95% of catastrophe losses above a retention of $7.5 million per occurrence up to $65 million per occurrence. The Company's catastrophe reinsurance program is augmented by a $100 million equity put. This equity put provides for an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event of losses from a catastrophe, individually or in the aggregate, which exceed $65 million. The fee for the equity put has been charged directly to additional paid-in capital. For liability coverages, including the educator professional liability policy, the Company reinsures each loss up to $20 million above a retention of $500,000. The Company reinsures each property loss up to $1.5 million above a retention of $500,000. 9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-looking Information Statements made in the following discussion that state the Company's or management's intentions, hopes, beliefs, expectations or predictions of the future are forward-looking statements. It is important to note that the Company's actual results could differ materially from those projected in such forward-looking statements due to, among other risks and uncertainties inherent in the Company's business, the following important factors: . Changes in the composition of the Company's assets and liabilities through acquisitions or divestitures. . Prevailing interest rate levels, including the impact of interest rates on (i) unrealized gains and losses on the Company's investment portfolio and the related after-tax effect on the Company's shareholders' equity and total capital and (ii) the book yield of the Company's investment portfolio. . The impact of fluctuations in the capital markets on the Company's ability to refinance outstanding indebtedness or repurchase shares of the Company's outstanding common stock. . The frequency and severity of catastrophes such as hurricanes, earthquakes and storms, and the ability of the Company to maintain a favorable catastrophe reinsurance program. . The Company's ability to develop and expand its agency force and its direct product distribution systems, as well as the Company's ability to maintain and secure product sponsorships by local, state and national education associations. . The competitive impact of new entrants such as mutual funds and banks into the tax deferred annuity products markets, and the Company's ability to profitably expand its property and casualty business in highly competitive environments. . Changes in insurance regulations, including (i) those effecting the ability of the Company's insurance subsidiaries to distribute cash to the holding company and (ii) those impacting the Company's ability to profitably write property and casualty insurance policies in one or more states. . Changes in federal income tax laws and changes resulting from federal tax audits effecting corporate tax rates or taxable income, and regulations changing the relative tax advantages of the Company's life and annuity products to customers. . The Company's ability to maintain favorable claims-paying ability ratings. . Adverse changes in policyholder mortality and morbidity rates. 10
Discontinued Operations On December 9, 1996, the Company announced its strategic decision to withdraw from the group medical insurance business over the following two years. Announcing in October, 1997 that it was accelerating the withdrawal, the Company anticipates termination of more than 90% of that business by December 1997 and the remaining business in 1998. In the following discussions of results of operations, group medical results are reported separately as discontinued operations for all periods. Nine Months Ended September 30, 1997 Compared With Nine Months Ended September 30, 1996 Insurance Premiums and Contract Charges Earned Insurance premiums and contract charges earned, which excludes annuity and life contract deposits, increased 8.0% for the nine months ended September 30, 1997, compared to the same period in 1996. Insurance premiums written and contract deposits of $563.8 million for the nine months ended September 30, 1997 increased 8.3%, compared to $520.8 million for the same period in 1996, driven principally by a 17.8% increase in annuity deposits and a 5.8% growth in property and casualty premiums written. Insurance premiums written and contract deposits in the Company's primary product lines, automobile (excluding involuntary), property, annuity and life, increased 9.8% to $546.9 million for the nine months ended September 30, 1997, compared to $498.3 million for the same period in 1996. Involuntary automobile business includes allocations of business from state mandatory automobile insurance facilities and assigned risk business. Involuntary automobile premiums written for the nine months ended September 30, 1997 decreased 24.9% compared to the same period in 1996. Automobile (excluding involuntary) and homeowners earned premiums increased 7.7% to $312.1 million for the nine months ended September 30, 1997, compared to $289.8 million for the same period in 1996, primarily as a result of a 7.1% increase in automobile (excluding involuntary) and homeowners policies in force. The 828,000 automobile (excluding involuntary) and homeowners policies in force at September 30, 1997 represented an increase of 55,000 policies since September 30, 1996 and an increase of 42,000 policies since December 31, 1996. Automobile (excluding involuntary) and homeowners premiums written increased 8.2% to $321.1 million for the nine months ended September 30, 1997, compared to $296.9 million for the same period in 1996. For the nine months ended September 30, 1997, new direct premiums written of $37.0 million increased 16.4% compared to $31.8 million for the same period last year. Renewal direct premiums written of $287.9 million for the nine months ended September 30, 1997 increased 7.3% compared to $268.4 million for the same period in 1996. For the nine months ended September 30, 1997, life insurance premiums and contract charges earned were $61.9 million, compared to $59.6 million for the same period in 1996, 11
representing an increase of 3.9%. Life insurance in force on September 30, 1997 increased 4.7% compared to September 30, 1996. The lapse rate of 7.5% for the nine months ended September 30, 1997 improved 0.5 percentage points compared to 8.0% reported for the same period in 1996. In the first quarter of 1997, the Company began selling five new term life products developed to meet customer needs. These products started to contribute to premium growth in the second quarter of 1997 and have generated approximately $1.7 million of premium through September 30, 1997. Annuity contract charges earned increased 36.9% to $8.9 million for the nine months ended September 30, 1997, compared to $6.5 million for the same period in 1996, due to a 53% increase in variable annuity cash value on deposit. Total annuity deposits received during the nine months ended September 30, 1997 increased 17.8% to $143.9 million, compared to $122.2 million for the same period in 1996, reflecting an $11.6 million, or 13.1%, increase in scheduled deposits for retirement annuities and a $10.1 million, or 30.0%, increase in rollover deposits from other companies and single premiums. Three new variable annuity funds were added to the Horace Mann family of funds in the first quarter of 1997 in response to educators' requests for additional investment options. The addition of a small cap fund, an international equity fund and a socially responsible fund brings the total variable annuity fund options to seven. Net Investment Income Net investment income of $149.0 million for the nine months ended September 30, 1997 increased 0.3% compared to $148.6 million for the same period in 1996. Investments (at amortized cost) decreased 1.2%, or $33.5 million, from September 30, 1996. The pretax yield on average investments was 7.4% (4.9% after tax) for both the nine months ended September 30, 1997 and the same period in 1996. Realized Investment Gains and Losses Realized investment gains were $3.2 million for the nine months ended September 30, 1997, compared to $2.6 million for the same period in 1996. Benefits, Claims and Settlement Expenses Total benefits, claims and settlement expenses increased 4.0% to $271.7 million for the nine months ended September 30, 1997, compared to $261.2 million for the same period in 1996. Property and casualty claims and settlement expenses were $243.3 million for the nine months ended September 30, 1997, compared to $231.3 million for the same period in 1996. The property and casualty loss ratio of 73.4% for the nine months ended September 30, 1997 was 2.1 percentage points less than the 75.5% reported for the same period in 1996. For the first nine months of 1996, losses from severe weather were higher than those incurred in the current year. Catastrophe losses after reinsurance but before federal income tax benefits for the nine months ended September 30, 1997 were $6.2 million and accounted for 1.9 points on the loss ratio, compared to catastrophe losses of $19.3 million, 6.3 points on the loss ratio, for the same period 12
in 1996. The provision for losses and loss adjustment expenses for insured events in prior years continued to reflect favorable development. Income before income taxes benefited by $39.2 million and $47.4 million for the nine months ended September 30, 1997 and 1996, respectively, including $12.3 million and $14.3 million for the three months ended September 30, 1997 and 1996, respectively, as a result of a reduction in the estimated amounts needed to settle prior years' claims. The Company increased its catastrophe reinsurance coverage for 1997. The 1997 reinsurance program covers 95% of catastrophe losses in excess of $7.5 million up to $65 million for each catastrophe. The Company's catastrophe reinsurance program is augmented by a $100 million equity put. This equity put provides for an option to sell shares of the Company's convertible preferred stock with a floating rate dividend at a pre-negotiated price in the event of losses from a catastrophe, individually or in the aggregate, which exceed $65 million. Life benefits were $28.4 million for the nine months ended September 30, 1997, reflecting a 5.0% decrease, compared to $29.9 million for the same period in 1996. For the nine months ended September 30, 1996, claims for group disability business were unusually low and returned to more normal levels in the current year. The first nine months of 1997 also reflected average individual life mortality experience compared to higher mortality in the same period last year. Interest Credited to Policyholders Interest credited to policyholders was $73.1 million for the nine months ended September 30, 1997, 2.7% more than the $71.2 million interest credited for the same period in 1996. Interest credited to fixed annuity contracts increased 0.3% to $57.7 million for the nine months ended September 30, 1997, from $57.5 million for the same period in 1996. The fixed annuity average annual interest rate credited was 5.6% for the nine months ended September 30, 1997 and 1996. Fixed rate annuity accumulated deposits decreased 0.9% over the 12 months ended September 30, 1997. Life insurance interest credited increased $1.7 million, or 12.4%, to $15.4 million for the nine months ended September 30, 1997, compared to the same period in 1996, primarily as a result of continued growth in the interest- sensitive whole life insurance reserves and account balances. Policy Acquisition and Operating Expenses Policy acquisition and operating expenses represent the Company's insurance underwriting expenses. For the nine months ended September 30, 1997, policy acquisition and operating expenses of $110.1 million increased $8.1 million, or 7.9%, compared to $102.0 million for the first nine months of 1996. The 1997 property and casualty expense ratio was 19.3%, compared to 19.2% for the same period in 1996. 13
Amortization of Intangible Assets Amortization of intangible assets decreased by $0.4 million to $8.1 million for the nine months ended September 30, 1997, compared to $8.5 million for the same period in 1996, as a result of a scheduled decrease in the non-cash amortization of the value of acquired insurance in force related to the 1989 acquisition of the Company. Interest Expense The Company's interest expense of $7.1 million for the nine months ended September 30, 1997 was $0.9 million, or 11.3%, less than the same period in 1996 as a result of repayments of borrowings related to the repurchase of shares of its common stock during the second quarter of 1995. The debt to capital ratio of 22.2% as of September 30, 1997 was within the Company's target operating range of 20% to 25%. Income Tax Expense The effective income tax rate was 26.9% for the nine months ended September 30, 1997 compared to the 26.7% effective income tax rate for the same period last year. Income from investments in tax-advantaged securities reduced the effective income tax rate 3 percentage points in 1997 and 1996 and acquisition related tax benefits reduced the effective rate 6 percentage points in 1997 and 1996. Operating Income Operating income (income from continuing operations before realized investment gains and losses and 1996 debt retirement costs) was $59.7 million for the nine months ended September 30, 1997, compared to $51.6 million for the same period in 1996, an increase of 15.7%. Operating income in 1997 benefited from mild weather. Included in the Company's operating income are non-cash charges for the amortization of the value of acquired insurance in force and goodwill related to the 1989 acquisition of the Company. Excluding these non-cash charges for the amortization of intangible assets, operating income was $65.0 million for the nine months ended September 30, 1997, compared to $57.1 million for the same period in 1996. Property and casualty segment operating income was $43.0 million for the nine months ended September 30, 1997, compared to $36.5 million for the same period in 1996. Milder weather compared to the same period last year contributed to these results. For the first nine months, after tax catastrophe losses were $4.1 million in 1997, compared to $12.5 million for 1996. The property and casualty combined loss and expense ratio for the nine months ended September 30, 1997 was 92.7%, compared to the 94.7% reported for the same period in 1996. Life insurance segment operating income was $9.4 million for the nine months ended September 30, 1997, compared to the $9.2 million reported for the same period in 1996. The 14
1997 life results reflect modest growth in business volume offset by a return to more normal levels of both group disability claims and individual life mortality experience, compared to lower-than-average disability claims and higher-than- average life mortality in the first nine months of 1996. Annuity segment operating income of $13.9 million for the nine months ended September 30, 1997 increased 14.9%, compared to the $12.1 million reported for the same period in 1996, reflecting strong growth in variable annuity deposits and an increase in the fixed net interest margin. Annuity segment profit continues to shift from the interest margin on fixed annuity accumulations to fees on variable mutual fund deposits. Total accumulated fixed and variable annuity deposits of $2,313.1 million increased $310.8 million, or 15.5%, compared to September 30, 1996. This increase resulted from a net increase in funds on deposit of 9.0% plus net increases in market value of underlying mutual funds of $139.5 million. Income from Continuing Operations Income from continuing operations, which includes realized investment gains, for the nine months ended September 30, 1997 was $61.8 million, or $2.67 per share, reflecting a 17.9% increase in income and a 19.2% increase in income per share compared to the same period in 1996. The Company's share repurchase program had a minimal impact on earnings and earnings per share for the first nine months of 1997; however, the impact will be recognized more fully in future quarters. After tax realized investment gains were $2.1 million for the nine months ended September 30, 1997, compared to $1.7 million for the same period in 1996. Income from continuing operations for the nine months ended September 30, 1996 also reflected the costs of the early redemption of $100 million of convertible notes of $0.9 million, or $0.04 per share. Net Income Net income, which includes discontinued operations, was $58.3 million, or $2.52 per share, for the nine months ended September 30, 1997, compared to $48.8 million, or $2.08 per share, for the same period in 1996, an increase of 21.2% on a per share basis. The Company has accelerated the timetable for its withdrawal from the group medical insurance business anticipating termination of more than 90% of that business by December 1997 and the remaining business in 1998. As a result of this acceleration and higher-than-expected claims, net income for the three and nine months ended September 30, 1997 includes an after tax charge of $3.5 million, or $0.15 per share, for anticipated additional losses during the remainder of the phase-out period. The discontinued group medical business operating loss was $3.6 million for the nine months ended September 30, 1996. The Company's net income for the year ended December 31, 1996 included an after tax charge of $3.9 million for anticipated losses during the two year phase-out period for the discontinued group medical insurance business. 15
Liquidity and Financial Resources Investments The Company's investment strategy emphasizes high quality investment grade, publicly traded fixed income securities. At September 30, 1997, fixed income securities comprised 95.2% of total investments. Of the fixed income investment portfolio, 93.5% was investment grade and 99.6% was publicly traded. The average quality of the total fixed income portfolio was A+ at September 30, 1997. The duration of the investment portfolio is managed to provide cash flow to satisfy policyholder liabilities as they become due. The average option adjusted duration of total investments was 4.3 years at September 30, 1997 and 4.4 years at December 31, 1996. The Company has included in its annuity products substantial surrender penalties to reduce the likelihood of unexpected increases in policy or contract surrenders. All annuities issued since 1982 and approximately 70% of all outstanding fixed annuity accumulated cash values are subject in most cases to substantial early withdrawal penalties. Cash Flow The short-term liquidity requirements of the Company, within a 12-month operating cycle, are for the timely payment of claims and benefits to policyholders, operating expenses, interest payments and federal income taxes. Cash flow in excess of these amounts has been used to pay dividends to shareholders, retire short-term debt and repurchase shares of the Company's common stock. Long-term liquidity requirements, beyond one year, are principally for the payment of future insurance policy claims and benefits and retirement of long-term notes. Operating Activities As a holding company, HMEC conducts its principal operations in the personal lines segment of the property and casualty and life insurance industries through its subsidiaries. HMEC's insurance subsidiaries generate cash flow from premium and investment income, generally well in excess of their immediate needs for policy obligations, operating expenses and other cash requirements. Net cash provided by operating activities was $76.1 million for the nine months ended September 30, 1997 compared to $102.7 million for the same period in 1996 with the decrease primarily due to an increase in federal income tax payments. In both years, cash provided by operating activities primarily reflected net cash generated by the insurance subsidiaries. Payment of principal and interest on debt, fees related to the catastrophe- linked equity put option, dividends to shareholders and parent company operating expenses, as well as the share repurchase program, are dependent upon the ability of the insurance subsidiaries to pay cash dividends or make other cash payments to HMEC, including tax payments pursuant to tax sharing agreements. The insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available 16
to HMEC without prior approval of the insurance regulatory authorities. Dividends which may be paid by the insurance subsidiaries to HMEC during 1997 without prior approval are approximately $89 million. In 1997, the Company received approval from the Illinois and California Departments of Insurance for extraordinary dividends and a total of $70 million in extraordinary dividends have been paid by the property and casualty subsidiaries. HMEC used cash from the extraordinary dividends primarily to repurchase shares of the Company's common stock. Although regulatory restrictions exist, dividend availability from subsidiaries has been, and is expected to be, more than adequate for HMEC's capital needs. Investing Activities HMEC's insurance subsidiaries maintain significant investments in fixed maturity securities to meet future contractual obligations to policyholders. In conjunction with its management of liquidity and other asset/liability management objectives, the Company, from time to time, will sell fixed maturity securities prior to maturity and reinvest the proceeds in other investments with different interest rates, maturities or credit characteristics. Accordingly, the Company has classified the entire fixed maturities portfolio as available for sale. During the first nine months of 1997, net cash provided by investing activities was $45.1 million. This net amount reflects $768.4 million in purchases of fixed maturity investments, funded by net investment sales or maturities of $813.5 million. Financing Activities Financing activities include the receipt and withdrawal of funds by annuity policyholders, payment of scheduled dividends, transactions related to the Company's common stock and borrowings and repayments under the Company's debt facilities. Shareholder dividends paid for the nine months ended September 30, 1997 were $9.4 million. In 1997, the Company paid fees of $1.3 million related to the catastrophe-linked equity put which augments its reinsurance program and such fees were charged directly to additional paid-in capital. For the nine months ended September 30, 1997, receipts from annuity contracts of $143.9 million were greater than contract maturities and withdrawals of $122.0 million. Net transfers to variable annuity assets were $84.0 million during the first nine months of 1997 compared to $63.0 million during the same period in 1996. Interest-sensitive life account balances increased $1.1 million during the first nine months of 1997. Through September 30, 1997, the Company had repurchased 1,449,800 shares at an aggregate cost of $68.6 million, or $47.32 per share, which was financed primarily with cash from operations, including extraordinary dividends of $70.0 million from the property and casualty subsidiaries. Of these treasury shares, 293,200, 1,026,900 and 129,700 were repurchased during the first, second and third quarters, respectively, of 1997. During the nine months ended September 30, 1997, the Company received $11.7 million related to the exercise of common stock options. 17
Capital Resources Historically, the Company's insurance subsidiaries have generated capital in excess of what has been needed to support business growth. These excess amounts have been paid to HMEC through dividends. HMEC has then utilized these dividends and its access to the capital markets to retire long-term debt, repurchase shares of its common stock, increase dividends to its shareholders and fulfill other corporate purposes. Management anticipates that the Company's sources of capital will continue to generate capital in excess of the needs for business growth, debt interest payments and shareholder dividends. The total capital of the Company was $638.6 million at September 30, 1997, including $99.6 million of long-term debt and $42.0 million of short-term debt. Long-term debt as a percentage of total shareholders' equity was 20.1% as of September 30, 1997, compared to 20.6% as of December 31, 1996 with the change including the effects of the repurchase of shares for treasury stock. Total debt-to-capital at September 30, 1997 was 22.2%, well within the Company's target operating range of 20% to 25%. Shareholders' equity was $496.4 million at September 30, 1997, including an unrealized after tax gain in the Company's investment portfolio of $50.9 million and the related impact on deferred policy acquisition costs associated with interest-sensitive policies. The market value of the Company's common stock and the market value per share were $1,265.0 million and $56 1/8, respectively, at September 30, 1997. Book value per share was $22.02 at September 30, 1997, $19.76 excluding investment market value adjustments. In January 1996, the Company issued $100.0 million face amount of 6 5/8% Senior Notes ("Senior Notes"), which will mature on January 15, 2006, at a discount of 0.5%. Interest on the Senior Notes is payable semi-annually. The Senior Notes are redeemable in whole or in part, at any time at the Company's option. The net proceeds from the sale of the Senior Notes were used to finance the redemption of the Company's convertible notes. As of September 30, 1997 and December 31, 1996, the Company had short-term debt comprised of $42.0 million and $34.0 million, respectively, outstanding under the Bank Credit Facility. The Bank Credit Facility allows unsecured borrowings of up to $65.0 million at Interbank Offering Rates plus 0.3% to 0.5% or Bank of America National Trust and Savings Association reference rates. The rate on the borrowings under the Bank Credit Facility was Interbank Offering Rate plus 0.3%, or 6.1%, as of September 30, 1997. The commitment for the Bank Credit Facility terminates on December 31, 2001. The Company's ratio of earnings to fixed charges for the nine months ended September 30, 1997 was 12.9x compared to 9.9x for the same period in 1996. Total shareholder dividends were $9.4 million for the nine months ended September 30, 1997. 18
Recent Accounting Changes Earnings Per Share In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." SFAS No. 128 supersedes previous accounting guidance on this subject and specifies the computation, presentation and disclosure requirements for earnings per share ("EPS"). SFAS No. 128 will be implemented in the Company's December 31, 1997 financial statements; earlier application is not permitted. Upon implementation, SFAS No. 128 requires restatement of all prior-period EPS data presented. SFAS No. 128 requires dual presentation of EPS replacing primary EPS with a presentation of basic EPS and replacing fully diluted EPS with diluted EPS. The effects on the Company's EPS of implementing SFAS No. 128 are not anticipated to be material. Capital Structure Disclosures In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information about Capital Structure" which will be implemented in the Company's 1997 financial statements. It is not anticipated that the implementation of SFAS No. 129 will require significant revision of prior disclosures because the information required by SFAS No. 129 had been covered in previous accounting guidance. Comprehensive Income In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income" which will be implemented in the Company's March 31, 1998 financial statements. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income will represent the change in shareholders' equity during a reporting period from transactions and other events and circumstances from non-owner sources. For the Company, it is anticipated that comprehensive income will be substantially equal to net income plus the change in net unrealized gains and losses on fixed maturities and equity securities for the period. Segment Disclosures In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" which will be implemented in the Company's March 31, 1998 financial statements. SFAS No. 131 establishes standards for the way public companies are to report information about operating segments in annual financial statements and requires those companies to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company anticipates that implementation of this pronouncement will not have a material effect on the disclosures contained in its annual 19
financial statements and related notes but will expand its interim financial statements and related notes to include segment information such as revenues, earnings, assets and a reconciliation of segment earnings to consolidated earnings. The Company's operations will continue to include the following segments consistent with previously reported financial information: property and casualty insurance, annuities, life insurance, and corporate and other. 20
PART II: OTHER INFORMATION Item 4: Submission of Matters to a Vote of Security Holders None. Item 6: Exhibits and Reports on Form 8-K (a) The following items are filed as Exhibits. Management contracts and compensatory plans are indicated by an asterisk (*). (10) Material contracts: 10.1* Horace Mann Supplemental Employee Retirement Plan, 1997 Restatement. (11) Statement re computation of per share earnings. (27) Financial Data Schedule. (b) No reports on Form 8-K were filed by the Company during the third quarter of 1997. 21
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HORACE MANN EDUCATORS CORPORATION (Registrant) Date November 14, 1997 Paul J. Kardos --------------------------- --------------------------------- Paul J. Kardos, President and Chief Executive Officer Date November 14, 1997 Larry K. Becker --------------------------- --------------------------------- Larry K. Becker, Executive Vice President and Chief Financial Officer 22