ITEM 1. BUSINESS
FORWARD-LOOKING INFORMATION
It is important to note that the Company's actual results could differ materially from those projected in forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations."
OVERVIEW
Horace Mann Educators Corporation (together with its subsidiaries, the "Company" or "HMEC") is an insurance holding company incorporated in Delaware. Through its subsidiaries, HMEC markets and underwrites personal lines of property and casualty and life insurance and retirement annuities. HMEC's principal insurance subsidiaries are Horace Mann Insurance Company ("HMIC"), Teachers Insurance Company ("TIC") and Horace Mann Life Insurance Company ("HMLIC"), each of which is an Illinois corporation, and Allegiance Insurance Company ("Allegiance"), a California domiciled personal lines property and casualty insurance company.
The Company markets its products primarily to educators and other employees of public schools and their families. Customers of the Company typically have moderate annual incomes, with many belonging to two-income households. Their financial planning tends to focus on security, savings and primary insurance needs.
The Company sells and services its products through an exclusive sales force of full-time agents employed by the Company. The Company's agents sell only the Company's products. Many of the Company's agents are former educators who utilize their contacts within, and knowledge of, the target market. Compensation for sales agents includes an incentive element based upon the profitability of the business they write.
The Company's insurance premiums written and contract deposits for the year ended December 31, 1996 were $704.8 million and operating income (income from continuing operations before realized investment gains and losses and debt retirement costs) was $73.1 million. The Company's total assets were $3.9 billion at December 31, 1996. The property and casualty segment accounted for 60% of the Company's insurance premiums written and contract deposits for the year ended December 31, 1996, while accounting for 64% of earnings from continuing operations before interest and taxes for the period. The annuity and life insurance segments together accounted for 40% of insurance premiums written and contract deposits for the year ended December 31, 1996 (24% and 16%, respectively), and provided 41% (24% and 17%, respectively) of earnings from continuing operations before interest and taxes for the period.
In December 1996, the Company announced its strategic decision to withdraw from the group medical insurance business over the following two years. The Company stopped writing new group medical insurance policies in January 1997 and intends to stop renewing group medical insurance policies in January 1998. In the Company's financial statements and discussions of operating results, group medical results are reported separately as discontinued operations.
In each of the last 10 years, the Company's combined loss and expense ratio for its property and casualty product lines outperformed the total property and casualty industry combined loss and expense ratio, as reported by A.M. Best Company ("A.M. Best"), an independent insurance rating agency. During this period, the Company's combined loss and expense ratio was better than the total property and casualty insurance industry combined loss and expense ratio by an average of approximately 11 percentage points per year. During the same period of time, the Company's combined loss and expense ratio was better than the personal lines insurance industry segment combined loss and expense ratio by an average of approximately 9 percentage points per year.
One of the reasons why the Company's property and casualty lines have performed better than the industry is the Company's property and casualty expense ratio, which has been consistently better than the industry ratio since 1983. During the last 10 years, the Company's property and casualty expense ratio has been better than the property and casualty industry personal lines average expense ratio as reported by A.M. Best by an average of 4.7 percentage points per year. The Company's property and casualty expense ratio for the year ended December 31, 1996 was 19.4%, well within the lowest 20% of expense ratios of the 100 largest property and casualty groups, based on A.M. Best's reports.
At December 31, 1996, the accumulated value of annuity contracts was $2.1 billion. For the year ended December 31, 1996, 94% of the accumulated cash value of the Company's annuity business remained on deposit. 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, typically ranging from 5% to 13% of the amount withdrawn. Withdrawals of outstanding variable annuities are limited to amounts less than or equal to the then current market value of the annuity. Tax-qualified annuities represented 95% of the Company's annuity policy reserves at December 31, 1996, and, generally, a penalty is imposed under the Internal Revenue Code of 1986, as amended, on amounts withdrawn from tax- qualified annuities prior to age 59 1/2.
The investment portfolio of the Company, including variable annuity assets under management of $685 million, had an aggregate market value of $3.5 billion at December 31, 1996. Investments other than variable annuity assets consist principally of investment grade publicly traded fixed income securities. At December 31, 1996, investments in non-investment grade securities represented 5.1% of total investments excluding variable annuity assets. There are no significant investments in mortgage loans and real estate or privately placed securities.
HISTORY
The Company's business was founded in Springfield, Illinois in 1945 by two Illinois teachers to sell automobile insurance to other teachers within the State of Illinois.
In 1968, INA Corporation ("INA") acquired a 25% interest in HMEC, and completed its acquisition of HMEC in 1975. In 1982, INA and Connecticut General Corporation merged to form CIGNA. In August 1989 an investor group directed by Gibbons, Green, van Amerongen, L.P. (subsequently Gibbons, Goodwin, van Amerongen) ("GGvA") and certain members of the Company's senior management acquired HMEC from CIGNA. In November 1991, HMEC completed an initial public offering of its common stock (the "IPO") which is traded on the New York Stock Exchange under the symbol "HMN."
Following the initial public offering, GGvA owned approximately 44% of the outstanding shares of the common stock. Pursuant to an agreement with GGvA, in May 1995 HMEC purchased approximately one-half of the shares of its common stock owned by GGvA and in July 1995 completed a secondary public offering of most of the remaining shares of its common stock owned by GGvA.
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following statement of operations and balance sheet data have been derived from the consolidated financial statements of the Company. The consolidated financial statements of the Company for each of the periods in the five year period ended December 31, 1996 have been audited by KPMG Peat Marwick LLP. The following selected historical consolidated financial data should be read in conjunction with the consolidated financial statements of HMEC and its subsidiaries and Management's Discussion and Analysis of Financial Condition and Results of Operations.
(continued on next page)
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA--(CONTINUED)
- -------- (1) Amortization of intangible assets is comprised of amortization of goodwill and amortization of acquired value of insurance in force and is the result of purchase accounting adjustments related to the 1989 acquisition of the Company and the 1994 acquisition of Allegiance. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Year Ended December 31, 1996 Compared with Year Ended December 31, 1995." (2) In December 1996, the Company announced its strategic decision to withdraw from the group medical insurance business. Group medical results net of taxes are reported separately as discontinued operations and 1996 includes an additional after tax charge of $3.9 million, or $0.17 per share, for estimated losses during the phase-out period. (3) The extraordinary items for the years ended December 31, 1994 and 1992 each represent non-recurring losses from early retirement of debt and are net of tax benefits. (4) Income from continuing operations before realized investment gains and losses, debt retirement costs, cost of the additional rights relating to the 1995 share repurchase, discontinued operations, and extraordinary items. (5) For the purpose of determining the ratio of earnings to fixed charges, "earnings" consist of income from continuing operations before income taxes and interest expense (including amortization of debt issuance cost), and "fixed charges" consist of interest expense (including amortization of debt issuance cost). (6) Earnings per share assuming full dilution is computed based on the weighted average of the fully diluted number of shares. The convertible notes, which were redeemed in February 1996, were considered potentially dilutive securities and common stock equivalents relating to outstanding warrants and common stock options are also included in the calculation of fully diluted earnings per share, to the extent dilutive by 3% or more. (7) Due to the adoption by the Company on January 1, 1994 of Financial Accounting Standard No. 115 ("FAS 115"), total shareholders' equity included an increase of $29.7 million and $76.2 million at December 31, 1996 and 1995, respectively, and a reduction of $70.9 million at December 31, 1994. Excluding the FAS 115 market value accounting for investments, book value per share was $19.25, $16.84 and $16.68 at December 31, 1996, 1995 and 1994, respectively. (8) Statutory data has been derived from the financial statements of the Company prepared in accordance with statutory accounting practices and filed with insurance regulatory authorities. (9) Property and casualty combined loss and expense ratio includes policyholder dividends. (10) Source: Best's Aggregates and Averages (1993 through 1996 Eds.). The industry averages for the year ended December 31, 1996 are from Best Week, Property/Casualty Supplement, A Special Report, January 6, 1997, published by A.M. Best. (11) Investment reserves were the Asset Valuation Reserves.
GENERAL
The Company markets and underwrites personal lines of property and casualty and life insurance and retirement annuities. The following table sets forth by segment the amount of insurance premiums written and contract deposits for the Company for the periods indicated.
INSURANCE PREMIUMS WRITTEN AND CONTRACT DEPOSITS (Dollars in millions)
CORPORATE STRATEGY AND MARKETING
The Company's target market consists of educators and other employees of public schools and their families. It is estimated that there are approximately 3 million elementary and secondary public school teachers and administrators in the United States. The Company also sells its products to other education- related customers, including private school teachers, education support personnel, and their families. In addition to changes in the number of teachers that may result from growth in the general population and changes in the number of school age children, the Company believes that turnover among the teacher population increases the size of its target market. New teachers and educational support personnel are solicited by the Company's agents and the Company attempts to retain customers who have retired or left the teaching profession. Customers of the Company typically have moderate annual incomes, with many belonging to two-income households. Their financial planning tends to focus on security, savings and primary insurance needs.
Exclusive Agency Force
A cornerstone of the Company's marketing strategy is its exclusive sales force of full-time agents who are employees of the Company. As of December 31, 1996, the Company employed 1,022 full-time agents. Many of these agents were previously teachers or other members of the education profession. The Company's agents market and write the full range of the Company's products. They are under contract to market and write only those products authorized by the Company.
The Company's service commitment to its policyholders begins with personal contact at the point of sale between the Company's agents and potential policyholders. In addition, the Company's agents often have direct access to school premises, placing them in a position to write and service individual insurance business. Management believes that Horace Mann's name recognition and policyholder loyalties lead to new customers and cross-selling of additional insurance products.
The Company's agents pre-underwrite policy applicants. The Company structures its agent compensation to provide incentives for agents to adhere to the Company's underwriting standards and practices and business growth plans. Agent compensation after an initial two-year period is comprised entirely of commissions and incentive bonuses based on profitability of insurance written, retention of customers and sales. In 1996, incentive bonuses represented 29% of agent compensation with 78% of the bonuses based on profitability and the remaining 22% based on sales. The profitability related portion of agent compensation is based on loss ratios in the case of property and casualty policies, where permitted by law, and persistency in the case of life policies. Management believes that this compensation structure, which rewards the individual agent's selection of profitable business, helps to produce more profitable business than might result under other compensation arrangements.
Alternate Distribution Program
The Company has established an Alternate Distribution program to develop new sales channels that supplement and complement the exclusive agency force. As of December 31, 1996, the Company had established relationships with 34 educator credit unions in 14 states. At some of those credit unions, a salaried representative of the Company is available to meet with prospective customers while other of those credit unions refer their members to the Company.
Geographic Composition of Business
The Company's business is geographically diversified. Based on direct insurance premiums earned and contract deposits for all continuing product lines for the year ended December 31, 1996, the top five states and their portion of total premium were North Carolina, 8.1%; Texas, 6.7%; Illinois, 5.5%; Minnesota, 5.4%; and California, 4.8%.
HMEC's property and casualty subsidiaries are licensed in 49 states, the District of Columbia and Puerto Rico. The following table sets forth the Company's top ten property and casualty states based on total direct premiums in 1996:
PROPERTY AND CASUALTY SEGMENT TOP TEN STATES (Dollars in millions)
- -------- (1) Defined as earned premiums before reinsurance and is determined under statutory accounting practices.
HMEC's principal life insurance subsidiary is licensed in 48 states and the District of Columbia. The following table sets forth the Company's top ten combined life and annuity states based on total direct premiums and contract deposits in 1996:
COMBINED LIFE AND ANNUITY SEGMENTS TOP TEN STATES (Dollars in millions)
- -------- (1) Excludes discontinued group medical business and is determined under statutory accounting practices.
National, State and Local Education Associations
The Company estimates that less than half of its policyholders are members of the National Education Association ("NEA"), the nation's largest confederation of state and local teachers' associations. NEA has approximately 2.3 million members. Management estimates that in each of the Company's last three fiscal years, less than one-half of its total revenue came from sales of insurance products to NEA members and their families.
The Company has had a long relationship with NEA and many of the state and local education associations affiliated with NEA. The Company maintains a special advisory board, primarily composed of leaders of state education associations, that meets with Company management on a regular basis. These meetings provide management with the opportunity to better assess the present and future needs of its target market and to cultivate better relations with education association leaders. In certain states, where approved by the applicable state insurance departments, state or local association members are entitled to a discount on premiums for certain property and casualty insurance products sold by the Company.
From 1984 to September 1993 and beginning again in September 1996, NEA purchased from the Company educator professional liability insurance for its members. Between September 1993 and September 1996, the Company did not write this policy.
It is the practice of NEA and affiliated state and local education associations to "sponsor" various insurance products and services, including those of the Company and its competitors. "Sponsorship" is generally determined independently by each of these organizations. Being "sponsored" generally means that NEA and such state and local associations evaluate a product, authorize the use of their names in connection with the marketing of the product and, in some instances, recommend that their membership consider buying the product. From time to time during the past 25 years, NEA has sponsored various Company products and currently sponsors the Company's homeowners policy, which was co-sponsored by 40 state associations as of December 31, 1996. In each of the Company's last three fiscal years, the Company's homeowners policy was the only product of the Company that was sponsored by NEA (exclusive of the educator professional liability insurance policy purchased by NEA in 1996). NEA-affiliated education associations in 35 states sponsor products of the Company other than homeowners. Education associations in 42 states sponsor one or more of the Company's products. In each of the last three fiscal years, premium revenues from those products of the Company sold in states where such products were sponsored accounted for approximately one-half of total revenues in each such year. Total premium revenues from sales of products sponsored by NEA and by state and local education associations were approximately $250 million for each of the three years ended December 31, 1996. In many cases, associations that sponsor one of the Company's products also sponsor competing products. The Company does not pay NEA or any affiliated associations any consideration in exchange for sponsorship of Company products. The Company does pay for advertising that appears in NEA and state education association publications.
Some of the advantages of education association sponsorship include prestige and enhanced brand awareness, increased opportunity for the Company's agents to market products on school premises, and improved agent recruiting, especially among former teachers. The Company's customers decide whether to purchase the Company's products for a number of reasons, including pricing and service of the product and the customer's relationship with the selling agent--education association sponsorship may be one factor in such a decision.
PROPERTY AND CASUALTY
The primary property and casualty product offered by the Company is private passenger automobile insurance, which in 1996 represented 79% of property and casualty net written premiums. Homeowners insurance represented 19% of property and casualty premiums and the educator professional liability insurance represented the remaining 2% of the Company's property and casualty premiums. As of December 31, 1996, the Company had approximately 556,000 voluntary automobile
policies in force with annual premiums of approximately $366 million and approximately 230,000 homeowners policies in force with annual premiums of approximately $86 million. Voluntary automobile policies exclude those policies described in "Business--Regulation--Mandatory Insurance Facilities" and assigned risk policies. See "Business--Corporate Strategy and Marketing-- National, State and Local Education Associations."
The results of companies in the insurance industry have historically been subject to significant fluctuations due to competition, economic conditions, interest rates and other factors. In particular, the property and casualty insurance industry has historically experienced pricing and profitability cycles. With respect to these cycles, the factors most affecting current and prospective results of operations are intense price competition and aggressive marketing by property and casualty insurers, which have historically resulted in higher combined loss and expense ratios. Periods characterized by higher combined loss and expense ratios have typically been followed by withdrawal of capacity in the property and casualty industry and a firming of prices, resulting in lower combined loss and expense ratios. Because of the nature of the property and casualty cycle, it is difficult to predict future trends in the industry's overall combined loss and expense ratio. Management of the Company believes that these factors will continue to produce pricing and profitability cycles for the industry in the future. During the past ten years, the personal lines segment of the property and casualty insurance market has been less subject to the pricing and profitability cycles that have affected the commercial lines segment and the overall industry. Because virtually all the Company's property and casualty business is personal lines business, management believes the Company's operations are less subject to pricing and profitability cycles than the operations of many other insurers.
Results of property insurers are also 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.
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)
(continued on next page)
PROPERTY AND CASUALTY SEGMENT SELECTED HISTORICAL FINANCIAL INFORMATION--(CONTINUED) (Dollars in millions)
Property and Casualty Ratios
In each of the last 10 years, the Company's combined loss and expense ratio for its property and casualty product lines outperformed the total property and casualty industry combined loss and expense ratio, as reported by A.M. Best. During this period, the Company's combined loss and expense ratio was better than the total property and casualty insurance industry combined loss and expense ratio by an average of approximately 11 percentage points per year. During the same period of time, the Company's combined loss and expense ratio was better than the personal lines insurance industry segment combined loss and expense ratio by an average of approximately 9 percentage points per year.
The table below compares the Company's combined loss and expense ratios with published industry averages.
PROPERTY AND CASUALTY COMBINED LOSS AND EXPENSE RATIO(1)
- -------- (1) Combined loss and expense ratio includes policyholder dividends and is determined according to statutory accounting practices. (2) The Company did not have any California property and casualty business during each of the years from 1989 through 1993. (3) Source: Best's Aggregates and Averages (1988 through 1996 Eds.). 1996 is an estimate from Best Week, Property/Casualty Supplement, A Special Report, January 6, 1997, published by A.M. Best.
Catastrophe losses before federal income tax benefits for the Company and the property and casualty industry for the eight years ended December 31, 1996 were as follows:
CATASTROPHE LOSSES (Dollars in millions)
- -------- (1) Net of reinsurance and before federal income tax benefits. Includes allocated loss adjustment expenses. The Company's individually significant catastrophe losses net of reinsurance were as follows: 1996--$8.2 million, Hurricane Fran. 1995--$2.9 million, Texas wind/hail/tornadoes; $2.2 million Hurricane Opal. 1994--$6.0 million, Northridge, California earthquake. 1993--$2.2 million, East Coast blizzard. 1992--$1.9 million, Hurricane Andrew. 1991--$1.0 million, Hurricane Bob. 1990--$2.8 million, Denver, Colorado hailstorm. 1989--$4.0 million, Hurricane Hugo. (2) Source: Insurance Trends, Property-Casualty Edition, First Quarter 1997, published by Conning & Company. These amounts are before reinsurance and federal income tax benefits and exclude all loss adjustment expenses.
During the last 10 years, the Company's property and casualty expense ratio has been better than the property and casualty industry personal lines average expense ratio as reported by A.M. Best by an average of 4.7 percentage points per year. The Company's property and casualty expense ratio for the year ended December 31, 1996 was 19.4%, well within the lowest 20% of expense ratios of the 100 largest property and casualty groups, based on A.M. Best's reports.
The table below compares the Company's expense ratios with published industry averages.
PROPERTY AND CASUALTY EXPENSE RATIO(1)
- -------- (1) Determined according to statutory accounting practices. (2) The Company did not have any California property and casualty business during each of the years from 1989 through 1993. (3) Source: Best's Aggregates and Averages (1988 through 1996 Eds.). 1996 amounts are estimates from A.M. Best.
Property and Casualty Reserves
In the last ten consecutive years the Company's property and casualty reserves have developed cumulative redundancies. Reserves for losses and loss adjustment expenses ("LAE") are carried at the full value of estimated liabilities and are not discounted for interest expected to be earned on reserves. The Company's reserves for losses and LAE represent the estimated indemnity cost and loss adjustment expenses necessary to cover the ultimate net cost of investigating and settling claims. Such estimates are based upon individual case estimates for reported claims, estimates from state insurance facilities for reinsurance assumed and actuarial estimates for losses which have been incurred but not yet reported. These estimates are adjusted in the aggregate for ultimate loss expectations based upon historical experience patterns and current economic trends and experience, with any change in probable ultimate liabilities being reflected in results of operations currently. Expected inflation rates, along with other factors, are considered in estimating future claims costs and related reserves. As additional information becomes available and is reviewed, the estimates and judgments reflected in earlier reserves may be revised, which may result in adjustment to reserves for insured events of prior years. The Company has no exposure to claims for toxic waste cleanup, other environmental remediation or asbestos- related illnesses.
Due to the inherent uncertainty in estimating reserves for losses and LAE, there can be no assurance that ultimate liabilities will not exceed amounts reserved, with a resulting adverse effect on the Company. Management believes that the Company's overall reserve levels at December 31, 1996 are adequate to meet its future obligations.
The following table sets forth an analysis of loss reserves and LAE for the Company's property and casualty lines and provides a reconciliation of beginning and ending reserves for the periods indicated.
RECONCILIATION OF PROPERTY AND CASUALTY LOSS AND LAE RESERVES (Dollars in millions)
- -------- (1) Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims (continued on next page)
RECONCILIATION OF PROPERTY AND CASUALTY LOSS AND LAE RESERVES--(CONTINUED) - -------- and changes in their projected final settlement costs. Favorable reserve development generally occurs as a result of subsequent adjustment of reserves to reflect additional information. (2) Generally accepted accounting principles ("GAAP") require that insurance liabilities on the balance sheet be reported without reduction for anticipated recoverables under reinsurance contracts. These anticipated recoverables on unpaid losses and loss adjustment expenses are reported as assets on the balance sheet. Statutory accounting practices continue to permit reporting on a net basis. (3) Unpaid claims and claim expenses as reported in the consolidated balance sheets also include life, annuity, and group accident and health reserves of $18.4 million, $15.4 million and $17.6 million at December 31, 1996, 1995 and 1994, respectively, in addition to property and casualty reserves.
The provision for losses and LAE for insured events in prior years decreased by $62.5 million, $55.6 million and $54.3 million for the years ended December 31, 1996, 1995 and 1994, respectively. The favorable loss development results primarily from improving trends in the frequency and severity of voluntary automobile claims.
Analysis of Loss and LAE Reserves
The following table reflects the development of losses and LAE for the periods indicated at the end of that year and each subsequent year. The first line shows the reserves, net of reinsurance recoverables, as originally reported at the end of the stated year. Each calendar year-end reserve includes the estimated unpaid liabilities for that accident year and for all prior accident years. The section under the caption "Cumulative Amount Paid as of" shows the cumulative amounts paid of that reserve as of the end of each subsequent year. The section under the caption "Reserves Reestimated as of" shows the original recorded reserve as adjusted as of the end of each subsequent year to reflect the cumulative amounts paid and all other facts and circumstances discovered during each such year. The line "Cumulative Redundancy" reflects the difference between the latest reestimated reserve amount and the reserve amount as originally established.
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 loss determined in 1995 to be $150 thousand was first reserved in 1986 at $100 thousand, the $50 thousand deficiency (actual loss minus original estimate) would be included in the cumulative deficiency in each of the years 1986-1994 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.
ANALYSIS OF PROPERTY AND CASUALTY LOSSES AND LAE RESERVES 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 make the assuming reinsurer liable to the extent of the reinsurance ceded. Historically, the Company's losses from uncollectible reinsurance recoverables have been insignificant. Past due reinsurance recoverables as of December 31, 1996 were also insignificant.
The Company is a national underwriter and therefore has exposure to catastrophic losses in certain coastal states and other regions throughout the United States. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather and fires, and the frequency and severity of catastrophes are inherently unpredictable. The financial impact from catastrophic losses results from both the total amount of insured exposure in the area affected by the
catastrophe as well as the severity of the event. The Company seeks to reduce its exposure to catastrophe losses through the geographic diversification of its insurance coverage, the purchase of catastrophe reinsurance, and the purchase in 1997 of a catastrophe-linked equity put option.
The Company maintains an excess and catastrophe treaty reinsurance program. In 1996, the Company reinsured 95% of catastrophe losses above a retention of $5.5 million per occurrence up to $54 million per occurrence with an aggregate annual deductible of $2.0 million. With regard to liability coverages in 1996, the Company reinsured each loss up to $10 million above a retention of $500,000. The Company reinsured each property loss above a retention of $500,000 up to $1.0 million in 1996.
In 1997, the Company reinsures 95% of catastrophe losses above a retention of $7.5 million per occurrence up to $65 million per occurrence. In 1997, the Company's catastrophe reinsurance program will be augmented by a $100 million equity put. This equity put provides for an option to sell shares of the Company's convertible preferred stock at a pre-negotiated floating rate in the event of losses from a catastrophe, individually or in the aggregate, which exceed $65 million. 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.
The following table identifies the Company's most significant reinsurers under the traditional reinsurance program, their percentage participation in the Company's aggregate reinsured risk based on premiums paid by the Company and their rating by A.M. Best. No other single reinsurer's percentage participation in 1997 or 1996 exceeds 5%.
PROPERTY AND CASUALTY REINSURANCE PARTICIPANTS IN EXCESS OF 5%
- -------- NR--These foreign reinsurers are not rated by A.M. Best. * Less than 5%.
For 1997, all of the Company's property and casualty reinsurers that were rated by A.M. Best were rated "A- (Excellent)" or above. The Company has placed 37% of its reinsurance coverage with foreign reinsurers that are not rated by A.M. Best.
ANNUITIES
Educators in the Company's target market, as public school employees, benefit from the provisions of Section 403(b) of the Internal Revenue Code. This section of the Code allows public school employees to reduce their pretax income by making periodic contributions to an individual
qualified retirement plan. The Company has offered tax-qualified annuities to its marketplace, designed to allow contractholders to benefit from these tax provisions, since 1961, the year Congress created this option for educators.
The Company sells fixed and variable tax-qualified annuities. Under the fixed annuities, both the principal and a rate of return are guaranteed. Variable annuity contract deposits are invested as designated by the contractholder in mutual funds managed by the Company--a common stock fund, a bond fund, a combination bond and stock fund, and a short-term fund; and beginning in 1997--a small cap growth fund, an international equity fund, and a "socially responsible" fund. Total accumulated fixed and variable annuity cash value on deposit at December 31, 1996 of $2,075.5 million increased $209.5 million, or 11.2%, compared to December 31, 1995. This increase resulted from a net increase in funds on deposit of 10.0% plus net increases in market value of underlying mutual funds of $26.7 million. The liability for all annuity contracts issued by the Company on a generally accepted accounting principles ("GAAP") basis is established at the contract's accumulated cash value before reduction for surrender charges.
For the year ended December 31, 1996, 94% of the accumulated cash value of the Company's annuity business remained on deposit, compared to average retention of 90% for stock life insurance companies for 1995, as reported by A.M. Best. 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, typically ranging from 5% to 13% of the amount withdrawn. Withdrawals of outstanding variable annuities are limited to amounts less than or equal to the then current market value of the annuity. Tax-qualified annuities represented 95% of the Company's annuity policy reserves at December 31, 1996, and, generally, a penalty is imposed under the Internal Revenue Code of 1986, as amended, on amounts withdrawn from tax-qualified annuities prior to age 59 1/2.
Selected Historical Financial Information For Annuity Segment
The following table sets forth certain information with respect to the Company's annuity products for the periods indicated.
ANNUITY SEGMENT SELECTED HISTORICAL FINANCIAL INFORMATION (Dollars in millions, unless otherwise indicated)
LIFE
The Company entered the individual life insurance business in 1949 with traditional term and whole life insurance products. In 1984, the Company introduced "Experience Life," a flexible life insurance contract which allows the customer to combine elements of term life insurance, interest-sensitive whole life insurance and an interest-bearing account. At December 31, 1996 this business consisted of approximately 99,000 Experience Life policies representing approximately $6.6 billion of life insurance in force with annual insurance premiums and contract deposits of approximately $69.6 million. The Company's traditional term, whole life and group life business in force consists of
approximately 156,000 policies, representing approximately $4.0 billion of life insurance in force with annual insurance premiums and contract deposits of approximately $26.3 million as of December 31, 1996. In 1997, the Company introduced a new series of five limited duration term life insurance products. The Company does not charge any penalty for withdrawal of life insurance cash values. The life segment also includes the Company's group life and group disability income business which represented approximately 2% of all insurance premiums written and contract deposits of the Company.
During 1996, the average face amount of ordinary life insurance policies issued by the Company was $102,196 and the average face amount of all ordinary life insurance policies it has in force was $48,650. A.M. Best reported that during 1995, for stock life insurance companies, the average face amount of ordinary life insurance policies issued was $70,056 and the average face amount of all ordinary life insurance policies in force was $46,852. The maximum life insurance risk retained by the Company is $200,000 combined for group and individual coverages on any individual life. Any risk in excess of $200,000 is reinsured. All of the Company's life reinsurers are rated "A (Excellent)" or above by A.M. Best.
The life insurance and annuity industry, while it has not generally been subject to the factors that produce cyclicality in the property and casualty insurance industry, is nonetheless subject to competitive pressures and interest rate fluctuations. As a result, the life insurance and annuity industry has developed new products designed to shift investment and credit risk to policy or contract holders while still providing death benefits. This trend has generally caused profit margins to shrink on new products relative to older life insurance and annuity products and has provided more competitive returns to the holders of the new products than those available under other investment alternatives. Management cannot predict whether these trends will continue in the future.
Selected Historical Financial Information For Life Segment
The following table sets forth certain information with respect to the Company's life products for the periods indicated.
LIFE SEGMENT SELECTED HISTORICAL FINANCIAL INFORMATION (Dollars in millions, unless otherwise indicated)
Acquired Immune Deficiency Syndrome ("AIDS") is expected to affect mortality adversely for the life insurance industry although the extent of the impact cannot be predicted at this time. Where permitted by law, the Company has responded by considering AIDS information in underwriting and pricing decisions. From 1992 through 1996, the Company has paid $3.6 million in death benefits under 95 individual life policies due to known AIDS-related deaths, representing 4% of total death benefits paid during this period.
INVESTMENTS
The Company's investments are selected to balance the objectives of minimizing interest rate exposure, providing a high current yield and protecting principal. These objectives are implemented through a portfolio that emphasizes high quality investment grade, publicly traded bonds. When impairment of the value of an investment is considered other than temporary, the decrease in value is recorded as an adjustment to the valuation reserve and a new cost basis is established. At December 31, 1996, investments in non- investment grade securities represented 5.1% of total investments. There are no significant investments in mortgage loans and real estate or privately placed securities.
The Company's investments are managed by outside managers and advisors which follow investment guidelines established by the Company. The Company has separate investment strategies and guidelines for its property and casualty assets and for its life and annuity assets, which recognize different characteristics of the associated insurance liabilities, as well as different tax and regulatory environments. The Company manages interest rate exposure for its portfolios through asset/liability management techniques that attempt to match the duration of the assets with the duration of the liabilities under insurance policies. 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 in the property and casualty segment.
The investments of each insurance subsidiary must comply with the insurance laws of such insurance subsidiary's domiciliary state. These laws prescribe the type and amount of investments that may be made 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, preferred stocks, common stocks, real estate mortgages and real estate.
The following table sets forth the carrying and market values of the Company's investment portfolio as of December 31, 1996:
INVESTMENT PORTFOLIO (Dollars in millions)
- -------- (1) Includes $468.2 million market value of investments guaranteed by the full faith and credit of the United States government and $445.3 million market value of federally sponsored agency securities. (continued on next page)
INVESTMENT PORTFOLIO--(CONTINUED) - -------- (2) A non-investment grade rating is assigned to a security when it is acquired, primarily on the basis of the Standard & Poor's Corporation ("S&P") rating for such security, or if there is no S&P rating, the Moody's Investors Service, Inc. ("Moody's") rating for such security, or if there is no S&P or Moody's rating, the National Association of Insurance Commissioners (the "NAIC") rating for such security. (3) Short-term investments mature within one year of being acquired and are carried at cost, which approximates market value. Short-term investments include $27.8 million in a money market fund rated "AAA" (S&P or its equivalent), $4.2 million in a Federal National Mortgage Association Note, $2.5 million in a Federal Home Loan Mortgage Corporation Note, $2.3 million in a Federal Home Loan Bank Discount Note and $0.1 million in certificates of deposit. (4) Market values for private placements are estimated by the Company with the assistance of its investment advisors. (5) Mortgage loans are carried at amortized cost or unpaid principal balance less valuation reserves and real estate acquired in the settlement of debt is carried at the lower of cost or market. Carrying value is net of a $2.6 million valuation reserve for anticipated losses. (6) Approximately 5% of the Company's investment portfolio, having a carrying value of $145.4 million as of December 31, 1996, consisted of securities with some form of credit support, such as insurance. All of these securities have the highest investment grade rating.
Fixed Maturity Securities
The following table sets forth the composition of the Company's fixed maturity securities portfolio by rating as of December 31, 1996:
RATING OF FIXED MATURITY SECURITIES(1) (Dollars in millions)
- -------- (1) Ratings are as assigned primarily by S&P when available, with remaining ratings as assigned on an equivalent basis by Moody's. Ratings for publicly traded securities are determined when the securities are acquired and are updated monthly to reflect any changes in ratings. (2) This category is comprised primarily of private placement securities not rated by either S&P or Moody's. The NAIC has rated 71.4% of these private placements as investment grade. $0.9 million of the remaining $1.7 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.
At December 31, 1996, 34.4% of the Company's fixed maturity securities portfolio was scheduled to mature within the next 5 years. Mortgage-backed securities, including mortgage-backed securities of United States governmental agencies, represented 33.8% of the total investment portfolio at December 31, 1996. These securities typically have effective maturities shorter than their scheduled 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 market value. 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 factors related to interest rate and resultant prepayment risk.
CASH FLOW
As a holding company, HMEC conducts its principal operations through its subsidiaries. Payment by HMEC of principal and interest with respect to HMEC's indebtedness, and payment by HMEC of dividends to its shareholders, are dependent upon the ability of its insurance subsidiaries to pay cash dividends or make other cash payments to HMEC, including tax payments pursuant to tax sharing agreements. Restrictions on the subsidiaries' ability to pay dividends or to make other cash payments to HMEC may materially affect HMEC's ability to pay principal and interest on its indebtedness and dividends on its common stock.
The ability of the insurance subsidiaries to pay cash dividends to HMEC is subject to state insurance department regulations which generally permit dividends to be paid for any 12 month period in amounts equal to the greater of (i) net gain from operations in the case of a life insurance company or net income in the case of all other insurance companies for the preceding calendar year or (ii) 10% of surplus as of the preceding December 31st. Any dividend in excess of these levels requires the prior approval of the Director or Commissioner of the state insurance department of the state in which the dividend paying insurance subsidiary is domiciled. The aggregate amount of dividends that may be paid in 1997 from all of HMEC's insurance subsidiaries without prior regulatory approval is approximately $89 million.
Notwithstanding the foregoing, if insurance regulators otherwise determine that payment of a dividend or any other payment to an affiliate would be detrimental to an insurance subsidiary's policyholders or creditors, because of the financial condition of the insurance subsidiary or otherwise, the regulators may block dividends or other payments to affiliates that would otherwise be permitted without prior approval.
The insurance subsidiaries' sources of funds consist primarily of premiums and contract fees, investment income and proceeds from sales and redemption of investments. Such funds are applied primarily to payment of claims, insurance operating expenses, income taxes and the purchase of investments, as well as dividends and other payments to HMEC.
COMPETITION
The Company operates in a highly competitive environment. There are numerous insurance companies that compete with the Company, although management believes that the Company is one of the few multi-line insurance companies to target teachers as its primary business nationally. In some specific instances and geographic locations competitors have specifically targeted the teacher marketplace with specialized products and programs. The Company competes in its target market with a number of national providers of personal automobile and homeowners insurance and life insurance.
For annuity business, the marketplace has begun to see a competitive impact from new entrants such as mutual funds and banks into the tax deferred annuity products market. Among the major national providers of annuities to educators, Variable Annuity Life Insurance Company, a subsidiary of American General Corporation, and Nationwide are among the Company's major tax-qualified annuity competitors.
The Company competes with a number of national providers of automobile and homeowners insurance, such as State Farm, Allstate and Nationwide, and several regional companies. The Company also competes for automobile business with certain direct marketing companies, such as 20th Century, American International Group (AIG) and GEICO.
The insurance industry consists of a large number of insurance companies, some of which have substantially greater financial resources, more diversified product lines, and lower cost marketing approaches, such as direct marketing, mail and telemarketing, compared to the Company. The Company believes that the principal competitive factors in the sale of property and casualty insurance products are price, service and name recognition. The Company 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 and price.
INSURANCE FINANCIAL RATINGS
The Company believes that the ratings assigned to its principal insurance subsidiaries by Standard & Poor's, A.M. Best and Duff & Phelps Credit Rating Co. ("Duff & Phelps") contribute to the Company's competitiveness.
Each of HMEC's principal insurance subsidiaries is rated "AA- (Excellent)" for claims-paying ability by Standard & Poor's. The S&P claims-paying ability ratings definitions from Standard & Poor's Internet Website, February 1997, are as follows. A Standard & Poor's insurance claims-paying ability rating is an opinion of an operating insurance company's financial capacity to meet the obligations of its insurance policies in accordance with their terms. This opinion is not specific to any particular insurance policy or contract, nor does it address the suitability of a particular insurance policy or contract for a specific purpose or purchaser. Furthermore, the opinion does not take into account deductibles, surrender or cancellation penalties, the timeliness of payment, or the likelihood of the use of a defense such as fraud to deny claims. Claims-paying ability ratings do not refer to an insurer's ability to meet nonpolicy obligations (i.e., debt contracts). The claims-paying ability ratings are based on current information furnished by the insurance company or obtained by S&P from other sources it considers reliable. S&P does not perform an audit in connection with any rating and may, on occasion, rely on unaudited financial information. The ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information or based on other circumstances. Claims-paying ability ratings are divided into two broad classifications. Rating categories from "AAA" to "BBB" are classified as "secure" claims-paying ability ratings and are used to indicate insurers whose financial capacity to meet policyholder obligations is viewed, on balance, as sound. Among factors considered in placing insurers within the spectrum of "secure" rating categories is the time frame within which policyholder security could be damaged by adverse economic and underwriting conditions. That time frame grows shorter as ratings move down the "secure" rating scale. Rating categories from "BB" to "CCC" are classified as "vulnerable" claims-paying ability ratings and are used to indicate insurers whose financial capacity to meet policyholder obligations is viewed as vulnerable to adverse economic and underwriting conditions. Claims-paying ability ratings are assigned at the request of the insurers and based on extensive quantitative and qualitative analysis including consideration of ownership and support factors, if applicable. The rating process includes meetings with insurers' management. Plus (+) and minus (-) signs show relative standing within a category; they do not suggest likely upgrades or downgrades. Insurers rated "AAA" offer superior financial security on an absolute and relative basis. Capacity to meet policyholder obligations is overwhelming under a variety of economic and underwriting conditions. Insurers rated "AA" offer excellent financial security. Capacity to meet policyholder obligations is strong under a variety of economic and underwriting conditions.
HMIC, TIC and Allegiance are rated "A+ (Superior)" and HMLIC is rated "A (Excellent)" by A.M. Best. Ratings for the industry range from "A++ (Superior)" to "F (In Liquidation)", and some companies are not rated. Publications of A.M. Best indicate that the "A++ and A+ (Superior)" ratings are assigned to those companies that in A.M. Best's opinion have demonstrated superior overall performance when compared to the standards established by A.M. Best and have a very strong ability to meet their obligations to policyholders over a long period of time. The "A and A- (Excellent)" ratings are assigned to those companies that in A.M. Best's opinion have demonstrated excellent overall performance when compared to the standards established by A.M. Best and have a strong ability to meet their obligations to policyholders over a long period of time. In evaluating a company's financial and operating
performance, A.M. Best reviews the company's profitability, leverage and liquidity as well as the company's spread of risk, the quality and appropriateness of its reinsurance, the quality and diversification of its assets, the adequacy of its policy or loss reserves, the adequacy of its surplus, its capital structure, the experience and objectives of its management, and market presence. A.M. Best's ratings are based on factors relevant to policyholders, agents, insurance brokers and intermediaries and are not directed to the protection of investors.
HMLIC is rated "AA" for claims paying ability by Duff & Phelps. Duff & Phelps' life insurance company Claims Paying Ability ("CPA") ratings provide analytical insight into the ability of a company to meet its policyholder obligations in a timely manner. According to Duff & Phelps "Claims Paying Ability Rating Methodology for Life Insurers," 1995, the approach used to analyze an insurance company's claims paying ability is prospective in nature. The long duration of liabilities of the typical life insurance company requires a forward-looking analysis of the risks the company faces. The analytical process stresses not only the current financial position of the company, but puts considerable weight on the company's future direction and expected financial performance. A key part of the overall CPA rating process is an annual meeting with the senior executives who set the future direction of the company. Regular contact with company representatives throughout the year supplements this process. The process used to determine a CPA rating is comprehensive and combines quantitative and qualitative analysis of both public and non-public information. The CPA ratings use a scale of "AAA (Highest claims paying ability--the risk factors are negligible)" through "DD (Company is under an order of liquidation)." The CPA rating of "AA" is assigned for very high claims paying ability. The protection factors are strong; risk is modest, but may vary slightly over time due to economic and/or underwriting conditions. A CPA rating only indicates an insurance company's ability to make timely payment of policyholder obligations. It does not refer to the ability of either the rated company or its affiliates to meet nonpolicyholder obligations, such as debt repayment or payment of preferred dividends. The most important factors considered in the qualitative analysis are: economic fundamentals of the company's principal insurance lines, the company's competitive position, management's capability, the relationship of the rated entity to either parent, affiliate, or subsidiary, asset/liability and liquidity management practices and investment quality and management.
REGULATION
General Regulation at State Level
As an insurance holding company, HMEC is subject to regulation by the states in which its insurance subsidiaries are domiciled or transact business. Most states have enacted legislation that requires each insurance company in a holding company system to register with the insurance regulatory authority of its state of domicile and furnish to it financial and other information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. All transactions within a holding company system affecting insurers must be fair and equitable and the insurer's policyholder surplus following any transaction must be both reasonable in relation to its outstanding liabilities and adequate for its needs. Notice to applicable regulators is required prior to the consummation of certain transactions affecting insurance subsidiaries of the holding company system.
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. See "Business--Investments" for discussion of investment restrictions or limitations imposed upon the Company under applicable insurance laws and regulations.
The NAIC annually calculates financial ratios to assist state insurance regulators in monitoring the financial condition of insurance companies. A "usual range" of results for each ratio is used as a benchmark. Separate ratios are established for property and casualty and life insurance companies. Departure from the usual range in any of the ratios could lead to inquiries from individual state
regulators, and further investigation or other actions may result. In 1995, no unusual ratios were reported by the principal insurance subsidiaries of HMEC.
As part of their regulatory oversight process, state insurance departments routinely conduct detailed financial examinations (generally not more frequently than once every three years) of the books, records and accounts of insurance companies domiciled in their states. Typically, such examinations are conducted concurrently by two or three states under guidelines promulgated by the NAIC. The last financial examinations for the Company's principal insurance subsidiaries, HMLIC, HMIC and TIC, occurred during 1993 for the period ended December 31, 1992. A financial examination of Allegiance was completed for the period ended December 31, 1994. Management believes that HMEC and its subsidiaries are in compliance in all material respects with all applicable regulatory requirements.
The NAIC has adopted risk-based capital guidelines to evaluate the adequacy of statutory capital and surplus in relation to an insurance company's risks. State insurance regulations prohibit insurance companies from making any public statements or representations with regard to their risk-based capital levels. Based on current guidelines, the risk-based capital statutory requirements will have no negative regulatory impact on the Company's insurance subsidiaries.
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 insurance company insolvencies. The amount and timing of any future assessments on the Company under these laws cannot be reasonably estimated and are beyond the control of the Company. Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurer's financial strength, and most assessments paid by the Company pursuant to these laws may be used as credits for a portion of the Company's premium taxes. The Company paid $0.8 million, $0.9 million and $1.2 million in connection with insurer insolvency proceedings for the years ended December 31, 1996, 1995 and 1994, respectively, of which $0.6 million, $0.9 million and $1.2 million for the same periods, respectively, is recoverable as premium tax credits in future periods.
Mandatory Insurance Facilities
The Company is required to participate in various mandatory insurance facilities in amounts related to the amount of the Company's direct writings in the applicable state. In 1996, the Company reflected a net loss from participation in such mandatory pools and underwriting associations of $1.0 million before federal income taxes.
California Earthquake Authority
The California Earthquake Authority ("CEA") was formed by the California Legislature to encourage companies to write residential property insurance in California and began operating in December 1996. All companies which write residential property insurance in California are also required to offer earthquake coverage. The CEA will operate as an insurance company providing residential property earthquake coverage under policies sold by companies which have chosen to participate in the CEA. The participating companies will fund the CEA and share in earthquake losses covered by the CEA in proportion to their market share.
The Company has not joined the CEA. The Company's exposure to losses from earthquakes is managed through its underwriting standards, its earthquake policy coverage limits and deductible levels, and the geographic distribution of its business, as well as its reinsurance program. After reviewing the exposure to earthquake losses from its own policies and from participation in the CEA, management believes it is in the Company's best economic interest to offer earthquake coverage directly to its homeowners policyholders. See "Property and Casualty--Property and Casualty Reinsurance."
Regulation at Federal Level
Although the federal government generally does not directly regulate the insurance business, federal initiatives often impact the insurance business. Current and proposed federal measures which may significantly affect the insurance business include employee benefits regulation, controls on the costs of medical care, medical entitlement programs such as Medicare, changes to the insurance industry anti-trust exemption, minimum solvency requirements and allowing national banks to engage in the insurance, annuity and mutual fund businesses.
Federal income taxation of the build-up of cash value within a life insurance policy or an annuity contract could have a material adverse impact on the Company's ability to market and sell such products. Various legislation to this effect has been proposed in the past, but has not been enacted. Although no such legislative proposals are known to exist at this time, such proposals may be made again in the future.
The variable annuities underwritten by HMLIC and the mutual funds used as investment vehicles for those products are regulated by the Securities and Exchange Commission (the "Commission"). Horace Mann Investors, Inc., the broker-dealer subsidiary of HMEC, performs certain management functions for the mutual funds and also is regulated by the Commission and the National Association of Securities Dealers.
EMPLOYEES
At December 31, 1996, the Company had approximately 2,700 employees, including 1,022 full-time agents. The Company has no collective bargaining agreement with any employees.
ITEM 2.

ITEM 2. PROPERTIES
HMEC's home office property at 1 Horace Mann Plaza in Springfield, Illinois consists of an office building totaling approximately 230,000 square feet. HMEC also owns buildings with an aggregate of approximately 209,000 square feet at other locations in Springfield. These properties are adequate and suitable for the Company's current and anticipated future needs.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
The Company is not currently party to any material pending legal proceedings other than ordinary routine litigation incidental to its business.
ITEM 4.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
HMEC's common stock began trading on the New York Stock Exchange ("NYSE") in November 1991 under the symbol of HMN at a price of $18 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.
As of March 1, 1997, the approximate number of holders of common stock was 4,500.
In February 1997, the Board of Directors authorized the fifth consecutive annual increase in the Company's dividend. The regular quarterly dividend increased by 23% to $0.135 per share. The payment of dividends in the future is subject to the discretion of the Board of Directors and will depend upon general business conditions, legal restrictions and other factors the Board of Directors of HMEC may deem to be relevant.
In February 1997, the Company's Board of Directors adopted a repurchase program for shares of the Company's common stock of up to $100 million. Based on the market price of the Company's common shares at the time the Board adopted this program, $100 million would represent 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. The repurchase program will be financed through use of cash and, if needed, the existing bank line of credit.
As an insurance holding company, HMEC depends on dividends and other permitted payments from its insurance subsidiaries to pay cash dividends to shareholders of HMEC. The payment of dividends and such other payments to HMEC by its insurance subsidiaries is restricted by the laws of each subsidiary's state of domicile, and insurance regulators have authority in certain circumstances to block payments of dividends and other amounts by the insurance subsidiaries that would otherwise be permitted without regulatory approval. See "Business--Cash Flow" and "Business--Regulation."
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
The information required by Item 301 of Regulation S-K is contained in the table in Item 1 - -"Business--Selected Historical Consolidated Financial Data."
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information required by Item 303 of Regulation S-K is contained in the Index to Financial Information on page herein.
ITEM 8.

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements, the report of its independent accountants and the selected quarterly financial data required by Item 302 of Regulation S-K are contained in the Index to Financial Information on page herein.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Items 401 and 405 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 402 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 403 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 404 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 1997 Annual Meeting of Shareholders.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) The following consolidated financial statements of the Company listed below are contained in the Index to Financial Information on Page herein:
Consolidated Balance Sheets as of December 31, 1996, 1995 and 1994.
Consolidated Statements of Operations for the Years Ended December 31, 1996, 1995 and 1994.
Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994.
(a)(2) The following consolidated financial statement schedules of the Company listed below are contained in the Index to Financial Information on page herein:
Schedule I--Summary of Investments--Other than Investments in Related Parties.
Schedule II--Condensed Financial Information of Registrant.
Schedules III and VI Combined--Supplementary Insurance Information and Supplemental Information Concerning Property and Casualty Insurance Operations.
Schedule IV--Reinsurance.
(a)(3) The following items are filed as Exhibits. Management contracts and compensatory plans are indicated by an asterisk (*).
(11) Statement re computation of per share earnings.
(12) Statement regarding computation of ratios.
(21) Subsidiaries of HMEC.
(23) Consent of KPMG Peat Marwick LLP.
(27) Financial Data Schedule.
(28) Information from reports furnished to state insurance regulatory authorities:
(b) No Reports on Form 8-K were filed by HMEC during the fourth quarter of 1996.
(c) See list of exhibits in this Item 14.
(d) See list of financial statement schedules in this Item 14.
Copies of Exhibits may be obtained by writing to Investor Relations, Horace Mann Educators Corporation, 1 Horace Mann Plaza, Springfield, Illinois 62715- 0001. Persons requesting copies will be charged a reasonable fee to cover reproduction and mailing expenses.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Horace Mann Educators Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HORACE MANN EDUCATORS CORPORATION
/s/ Paul J. Kardos By: _________________________________ Paul J. Kardos President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Horace Mann Educators Corporation and in the capacities and on the date(s) indicated.
Dated: March 25, 1997.
HORACE MANN EDUCATORS CORPORATION
INDEX TO FINANCIAL INFORMATION
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.
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. The Company stopped writing new group medical insurance policies in January 1997 and intends to stop renewing group medical insurance policies in January 1998. In the following discussions of results of operations, group medical results are reported separately as discontinued operations for all years.
YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995
Insurance Premiums and Contract Charges Earned
Insurance premiums and contract charges earned, which excludes annuity and life contract deposits, increased 3.6% for the year ended December 31, 1996, compared to 1995.
Insurance premiums written and contract deposits of $704.8 million for the year ended December 31, 1996 increased 7.8%, compared to $654.0 million for 1995, driven principally by 16.8% growth in annuity deposits. The first annual premium, of approximately $7 million, for Horace Mann's three year
contract to provide professional liability insurance for the 2.3 million members of the National Education Association is included in the Company's total insurance premiums written and contract deposits for the year ended December 31, 1996. No such premium was written in 1995. Insurance premiums written and contract deposits in the Company's primary product lines, automobile (excluding involuntary), property, annuity and life, increased 7.6% to $677.7 million for the year ended December 31, 1996, compared to $630.0 million for 1995. Involuntary automobile business includes allocations of business from state mandatory automobile insurance facilities and assigned risk business. Involuntary automobile premiums written for the year ended December 31, 1996 decreased 6.3% compared to 1995.
Automobile (excluding involuntary) and homeowners earned premiums increased 2.9% to $390.0 million for the year ended December 31, 1996, compared to $378.9 million for 1995, primarily as a result of a 5.8% increase in automobile (excluding involuntary) and homeowners policies in force, partially offset by a 0.7% decrease in average premium earned per automobile policy. The 786,000 automobile (excluding involuntary) and homeowners policies in force at December 31, 1996 represented an increase of 43,000 policies since December 31, 1995.
Automobile (excluding involuntary) and homeowners premiums written increased 4.8% to $400.0 million for the year ended December 31, 1996, compared to $381.8 million for 1995. Fourth quarter 1996 premium growth reflected an 8.8% increase compared to the same period in 1995 reflecting growth in the number of policies in force including new policies from the Florida state homeowners insurance pool. For the year ended December 31, 1996, new direct premiums written of $46.9 million increased 26.4% compared to $37.1 million for last year. Renewal direct premiums written of $357.0 million for the year ended December 31, 1996 increased 2.2% compared to $349.3 million for 1995.
For the year ended December 31, 1996, life insurance premiums and contract charges earned were $80.3 million, compared to $74.8 million for 1995, representing an increase of 7.4%. Life insurance in force on December 31, 1996 increased 4.0% compared to a year earlier. The lapse rate of 8.0% for the year ended December 31, 1996 increased slightly compared to 7.8% for 1995.
Annuity contract charges earned increased 35.3% to $9.2 million for the year ended December 31, 1996, compared to $6.8 million for 1995, due to a 40% increase in variable annuity cash value on deposit. Total annuity deposits received during the year ended December 31, 1996 increased 16.8% to $166.9 million, compared to $142.9 million for 1995, reflecting a $7.1 million, or 6.2%, increase in scheduled deposits for retirement annuities and a $16.9 million, or 58.6%, increase in single premiums and rollover deposits from other companies. For the fourth quarter of 1996, annuity deposits received of $44.7 million were 10.9% greater than the same period in 1995 reflecting growth in single premiums and rollover deposits from other companies which was somewhat lower than the full year growth rate.
Net Investment Income
Net investment income of $198.6 million for the year ended December 31, 1996 was comparable to 1995. Investments (at amortized cost) increased 2.0%, or $52.4 million, from December 31, 1995. The pretax yield on average investments was 7.4% (4.9% after tax) for the year ended December 31, 1996 compared to a pretax yield of 7.5% (5.0% after tax) for 1995.
Realized Investment Gains and Losses
Realized investment gains were $2.5 million for the year ended December 31, 1996, compared to $8.6 million for 1995.
Benefits, Claims and Settlement Expenses
Total benefits, claims and settlement expenses increased 3.3% to $346.7 million for the year ended December 31, 1996, compared to $335.7 million for 1995.
Property and casualty claims and settlement expenses were $306.1 million for the year ended December 31, 1996, compared to $297.1 million for 1995. The property and casualty loss ratio was 74.1% for the year ended December 31, 1996, compared to 73.5% for 1995. For 1996, higher first quarter losses from severe winter weather and third quarter losses from hurricanes were partially offset by continued favorable trends in losses on voluntary automobile insurance for the year. The provision for losses and loss adjustment expenses for insured events in prior years decreased by $62.5 million and $55.6 million for the years ended December 31, 1996 and 1995, respectively. The favorable loss development results primarily from improving trends in the frequency and severity of voluntary automobile claims. Catastrophe losses after reinsurance but before federal income tax benefits for the year ended December 31, 1996 were $20.9 million, compared to catastrophe losses of $13.9 million for 1995. Hurricane Fran, which occurred during the third quarter of 1996, represented $8.2 million in losses.
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 will be augmented by a $100 million equity put. This equity put provides for an option to sell shares of the Company's convertible preferred stock at a pre-negotiated floating rate in the event of losses from a catastrophe, individually or in the aggregate, which exceed $65 million.
Life benefits were $40.6 million for the year ended December 31, 1996, reflecting a 5.2% increase, compared to $38.6 million for 1995. The increase in life benefits was comparable to the 7.4% increase in life earned premiums.
Interest Credited to Policyholders
Interest credited to policyholders was $95.3 million for the year ended December 31, 1996, 4.8% more than the $90.9 million interest credited for 1995. Interest credited to fixed annuity contracts increased 3.0% to $76.7 million for the year ended December 31, 1996, from $74.5 million for 1995. The increase reflects a slightly higher average annual interest rate credited of 5.7% for the year ended December 31, 1996, compared to 5.6% for 1995, and a growth of fixed rate annuity accumulated deposits of 0.9%.
Life insurance interest credited increased $2.2 million, or 13.4%, to $18.6 million for the year ended December 31, 1996, compared to 1995, 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 year ended December 31, 1996, policy acquisition and operating expenses of $138.2 million increased $0.6 million, or 0.4%, compared to $137.6 million for 1995. The 1996 property and casualty expense ratio improved to 19.4%, four tenths of a percentage point lower than 19.8% for 1995.
Amortization of Intangible Assets
Amortization of intangible assets decreased by $0.5 million to $11.2 million for the year ended December 31, 1996, compared to $11.7 million for 1995, 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 $10.5 million for the year ended December 31, 1996 was $1.1 million, or 9.5%, less than in 1995 as a result of repayments of borrowings related to the repurchase
of shares of its common stock during the second quarter of 1995. Interest expense of $2.5 million for the fourth quarter of 1996 was $0.7 million less than the $3.2 million reported for the same period in 1995 as the debt to capital ratio was reduced to 21.6%, within the Company's target operating range of 20% to 25%.
Income Tax Expense
The 1996 effective income tax rate was 27%, equal to the 1995 effective income tax rate. Income from investments in tax-advantaged securities reduced the effective income tax rate 3 percentage points and acquisition related tax benefits reduced the effective rate 6 percentage points in both 1996 and 1995. The 1995 effective income tax rate also reflected the charge to income for additional rights relating to the repurchase of shares of the Company's common stock in 1995 that was not deductible for federal income tax purposes.
Operating Income
Operating income (income from continuing operations before realized investment gains and losses, 1996 debt retirement costs and the 1995 cost of additional rights related to the share repurchase) was $73.1 million for the year ended December 31, 1996, compared to $70.9 million for 1995. Operating income in 1996 reflected excellent voluntary automobile insurance results and an increase in annuity segment earnings, partially offset by high first quarter severe winter storm losses and high third quarter hurricane losses.
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 $80.4 million for the year ended December 31, 1996 compared to $78.5 million for 1995.
Property and casualty segment operating income was $54.0 million for the year ended December 31, 1996, compared to $56.4 million for 1995. Higher first quarter 1996 losses from severe winter weather and after tax catastrophe losses of $5.5 million from hurricanes in the third quarter of 1996 were partially offset by continued favorable trends in voluntary automobile losses. For the year, after tax catastrophe losses were $13.6 million in 1996, compared to $9.0 million for 1995. The property and casualty combined loss and expense ratio for the year ended December 31, 1996 was 93.5%, compared to the 93.3% reported for 1995.
Life insurance segment operating income of $12.1 million for the year ended December 31, 1996 increased 16.3% compared to the $10.4 million reported for 1995. The 1996 life results reflect growth in business volume and lower dividends to life policyholders, more than offsetting higher mortality experience, compared to 1995.
Annuity segment operating income of $16.3 million for the year ended December 31, 1996 increased 10.1%, compared to 1995, resulting primarily from an increase in cash value on deposit. Total accumulated fixed and variable annuity cash value on deposit of $2,075.5 million increased $209.5 million, or 11.2%, compared to December 31, 1995. This increase resulted from a net increase in funds on deposit of 10.0% plus net increases in market value of underlying mutual funds of $26.7 million.
Income from Continuing Operations
Income from continuing operations, which includes realized investment gains, for the year ended December 31, 1996 was $73.8 million, or $3.14 per share, reflecting a 1.9% decrease in income and a 12.5% increase in income per share on a fully diluted basis compared to 1995. The share repurchase completed in May 1995 and the redemption of the convertible notes in February 1996 resulted in decreases in shares and equivalent shares outstanding, increasing income per share from continuing
operations. Realized investment gains after tax were $1.6 million for the year ended December 31, 1996, compared to $5.6 million for 1995. Income from continuing operations for the year ended December 31, 1996 reflects a reduction of $0.9 million, or $0.04 per share, for the costs of the early redemption of $100 million of convertible notes. Income from continuing operations for the year ended December 31, 1995 included a reduction of $1.3 million, or $0.05 per share, for the cost of the additional rights granted in connection with the share repurchase.
Net Income
Net income, which includes discontinued operations, was $64.6 million for the year ended December 31, 1996 compared to $74.0 million for 1995, representing $2.75 per share for both periods.
The discontinued group medical business operating loss was $5.3 million for the year ended December 31, 1996, compared to an operating loss of $1.2 million for 1995. The discontinued group medical combined loss and expense ratio increased to 118.1% for the year ended December 31, 1996, compared to 106.4% for 1995, primarily due to an increase in claims. The Company's net income for the fourth quarter and year ended December 31, 1996 also 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.
YEAR ENDED DECEMBER 31, 1995 COMPARED WITH YEAR ENDED DECEMBER 31, 1994
Insurance Premiums and Contract Charges Earned
Insurance premiums and contract charges earned increased 2.8% for the year ended December 31, 1995 compared to 1994. Insurance premiums written and contract deposits in the Company's primary product lines, automobile (excluding involuntary), property, annuity and life, reflected growth of 3.1%, increasing to $630.0 million for the year ended December 31, 1995, compared to $611.2 million for 1994. For all product lines, insurance premiums written and contract deposits of $654.0 million for the year ended December 31, 1995 increased 2.6%, compared to $637.3 million for 1994. This increase was less than the growth in insurance premiums written and contract deposits for the Company's primary product lines primarily due to reduced allocation of business from state mandatory automobile insurance facilities. Involuntary automobile business includes assigned risk business as well as state mandatory insurance facilities.
Automobile (excluding involuntary) and homeowners earned premiums increased 2.6% to $378.9 million for the year ended December 31, 1995, compared to $369.3 million for 1994, primarily as a result of a 1% increase in average premium earned per automobile policy and a 1% increase in automobile (excluding involuntary) and homeowners policies in force. The 743,000 automobile (excluding involuntary) and homeowners policies in force at December 31, 1995 represented an increase of 10,000 policies since December 31, 1994.
Automobile (excluding involuntary) and homeowners premiums written increased 2.4% to $381.8 million for the year ended December 31, 1995 compared to $372.7 million for 1994. For the year ended December 31, 1995, new direct premiums written of $37.1 million were equal to 1994. Renewal premiums written of $349.3 million for the year ended December 31, 1995 increased 2.4% compared to 1994. Partially offsetting this growth was an 8.0% decrease in involuntary automobile and other property and casualty premiums written to $24.0 million for 1995, compared to $26.1 million for 1994.
For the year ended December 31, 1995, life insurance premiums and contract charges earned were $74.8 million compared to $72.0 million for 1994, representing an increase of 3.9%. Life insurance in force increased 5.4% compared to December 31, 1994. These results reflect a lapse rate of 7.8% for the year ended December 31, 1995, compared to 7.9% for 1994.
Annuity contract charges earned increased 25.9% to $6.8 million for the year ended December 31, 1995, compared to $5.4 million for 1994, primarily due to a 46% increase in variable annuity cash
value on deposit. Total annuity deposits received during the year ended December 31, 1995 increased 4.6% to $142.9 million, compared to $136.6 million for 1994, reflecting a 6.5% increase in scheduled deposits for retirement annuities offset by a decline in rollover deposits from other companies and single premiums. Annuity deposits received in the second half of 1995 were 11.9% greater than the amounts received during the same period in 1994. This increase in the second half of 1995 contrasts to a decrease of 1.9% for the first six months of 1995 compared to the first six months of 1994.
Net Investment Income
Net investment income of $198.4 million for the year ended December 31, 1995 increased 7.1% compared to the prior year. Investments (at amortized cost) increased 1.5%, or $38.7 million, from December 31, 1994. The pretax yield on average investments increased to 7.5% for the year ended December 31, 1995 from 7.2% for 1994. After tax investment income increased 5.8% to $132.2 million for the year ended December 31, 1995, the result of a 5.0% after tax yield, compared to $124.9 million and a 4.8% after tax yield for 1994.
Realized Investment Gains and Losses
Realized investment gains were $8.6 million for the year ended December 31, 1995 compared to realized investment losses of $0.9 million for 1994.
Benefits, Claims and Settlement Expenses
Total benefits, claims and settlement expenses increased 1.3% to $335.7 million for the year ended December 31, 1995, compared to $331.5 million for 1994, reflecting lower losses from catastrophes in 1995 and no increase in life benefits.
Property and casualty claims and settlement expenses increased 1.8% to $297.1 million for the year ended December 31, 1995 from $291.9 million for 1994. Reflecting continued strong underwriting results in the automobile and homeowners lines, the property and casualty loss ratio, including catastrophe losses, was 73.5% for the year ended December 31, 1995, compared to 73.8% for 1994. Catastrophe losses after reinsurance but before federal income tax benefits were $13.9 million for 1995 compared to $17.0 million reported in 1994. For 1995, the Company's catastrophe losses included hailstorms in Texas during May, Hurricane Opal in October and a number of smaller weather-related events. The Company's 1994 catastrophe losses consisted of $6.0 million of losses from the Northridge, California earthquake and $11.0 million due to severe winter weather and a series of tornadoes and wind storms.
Life benefits were $38.6 million for the year ended December 31, 1995, compared to $39.6 million for 1994. The decrease was attributable to no increase in individual life benefits and a lower volume of business for group life and group disability income compared to 1994.
Interest Credited to Policyholders
Interest credited to policyholders was $90.9 million for the year ended December 31, 1995, 8.2% more than the $84.0 million interest credited for 1994. Interest credited to annuity contracts increased 6.9% to $74.5 million for the year ended December 31, 1995 from $69.7 million for 1994. The increase reflects a higher average annual interest rate credited of 5.6% for the year ended December 31, 1995, compared to 5.4% for 1994, and a growth of fixed accumulated deposits of 2.9%.
Life insurance interest credited increased $2.1 million, or 14.7%, to $16.4 million for the year ended December 31, 1995, compared to 1994, primarily as a result of 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 year ended December 31, 1995, policy acquisition and operating expenses increased 3.5%, or $4.6 million, to $137.6 million, compared to $133.0 million for 1994, primarily due to business growth and inflation. For the year ended December 31, 1995, the property and casualty expense ratio of 19.8% was equal to 1994.
Amortization of Intangible Assets
Amortization of intangible assets decreased by $0.9 million to $11.7 million for the year ended December 31, 1995, compared to $12.6 million for 1994. The lower amortization was due to the scheduled decrease in the amortization of the value of acquired insurance in force related to the 1989 acquisition of the Company.
Interest Expense
As a result of borrowings on the Bank Credit Facility related to the repurchase of shares of its common stock during the second quarter of 1995, the Company's interest expense of $11.6 million for the year ended December 31, 1995 was $2.1 million, or 22.1%, greater than in 1994.
Income Tax Expense
The 1995 effective income tax rate of 27% was higher than the 1994 effective income tax rate of 25% due to a decrease in tax-advantaged securities and the earnings charge for additional rights relating to the repurchase of shares of the Company's common stock in 1995 that is not deductible for federal income tax purposes. Income from investments in tax-advantaged securities reduced the 1995 effective income tax rate 4 percentage points compared to a reduction of 5 percentage points in 1994. Acquisition related tax benefits reduced the effective income tax rate 6 percentage points in 1995 and 5 percentage points in 1994.
Operating Income
Operating income (income from continuing operations before realized investment gains and losses, the 1995 cost of additional rights related to the share repurchase, and the extraordinary item in 1994) increased 8.7% to $70.9 million for the year ended December 31, 1995 compared to $65.2 million for 1994, primarily due to growth in property and casualty operating income (including a reduction in catastrophe losses) and improvement in operating earnings of the life and annuity segments. Costs of the share repurchase completed in 1995 reduced operating income as a result of increased interest expense and reductions to net investment income. Excluding the share repurchase, operating income for 1995 would have been $76.2 million, which would have represented a 16.9% increase compared to 1994.
Property and casualty segment operating income increased 7.2% to $56.4 million for the year ended December 31, 1995, compared to $52.6 million for 1994, due to strong underwriting results and a decrease in catastrophe losses of $2.1 million after tax. Strong property and casualty underwriting results were reflected in the combined loss and expense ratio, excluding catastrophe losses, for the year ended December 31, 1995 of 89.9%, compared to the 89.5% reported for 1994, with the increase primarily attributable to higher levels of losses from involuntary state insurance pools. Including catastrophe losses, the property and casualty combined loss and expense ratio was 93.3% for the year ended December 31, 1995 compared to 93.7% for 1994.
Life insurance segment operating income increased $2.7 million for the year ended December 31, 1995 to $10.4 million, compared to $7.7 million for 1994, due primarily to higher net investment income and a 2.5% decrease in benefits compared to a 3.9% increase in premiums and contract charges earned.
The Company maintained strong annuity net margins in 1995 although the net margin percentage declined slightly compared to 1994. Annuity segment operating income of $14.8 million for the year ended December 31, 1995 increased 4.2% compared to 1994 resulting from an increase in cash value on deposit. Total accumulated fixed and variable annuity cash value on deposit of $1,866.0 million increased $192.8 million, or 11.5%, compared to December 31, 1994. This increase resulted from a net increase in funds on deposit of 7.3% plus net increases in market value of underlying mutual funds of $68.1 million.
Income from Continuing Operations
Income from continuing operations, which includes realized investment gains and losses, for the year ended December 31, 1995 was $75.2 million, or $2.79 per share on a fully diluted basis, reflecting a 16.4% increase in income and a 31.0% increase in income per share compared to 1994. The share repurchase completed in 1995 contributed to the increase in income per share from continuing operations. Excluding the share repurchase, income per share from continuing operations would have been $2.66, which would have represented a 24.9% increase compared to 1994. Income from continuing operations for the year ended December 31, 1994 was reduced by $11.1 million, or $0.34 per share, due to claims from the Northridge, California earthquake, severe winter weather and a series of tornadoes and wind storms; by comparison, catastrophe claims in 1995 reduced the Company's income from continuing operations by $9.0 million, or $0.32 per share. Realized investment gains after tax were $0.20 per share for the year ended December 31, 1995, compared to realized investment losses after tax of $0.02 per share for 1994. Income from continuing operations for the year ended December 31, 1995 also included a reduction of $1.3 million, or $0.05 per share, for the cost of the additional rights granted in connection with the share repurchase.
Net Income
Net income, which includes discontinued operations and extraordinary charges, was $74.0 million, or $2.75 per share on a fully diluted basis, for the year ended December 31, 1995 compared to $62.9 million, or $2.08 per share, for 1994.
The discontinued group medical business reported an operating loss of $1.2 million for 1995 compared to break-even results for the year ended December 31, 1994. The combined loss and expense ratio for the discontinued group medical business increased to 106.4% for the year ended December 31, 1995, compared to 101.6% for 1994.
Net income for the year ended December 31, 1994 reflected an extraordinary charge of $1.7 million after tax, or $0.05 per share, as a result of the early redemption of $47.1 million of subordinated debentures.
LIQUIDITY AND FINANCIAL RESOURCES
Investments
The Company's investment strategy emphasizes high quality investment grade, publicly traded fixed income securities. At December 31, 1996, fixed income securities comprised 95.5% of total investments. Of the fixed income investment portfolio, 94.4% was investment grade and 99.5% was publicly traded. The average quality of the total fixed income portfolio was AA- at December 31, 1996.
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 4.4 years at December 31, 1996, 1995 and 1994. 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 and retire short-term debt. 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 $139.2 million for the year ended December 31, 1996 compared to $153.3 million for 1995. In both years, cash provided by operating activities primarily reflected net cash generated by the insurance subsidiaries.
Payment of principal and interest on long-term debt, 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. These payments from insurance subsidiaries, net of federal income taxes paid by HMEC, were $60.2 million in 1996 compared to $95.0 million in 1995 with the decrease due primarily to the timing of tax sharing payments.
The insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. Dividends which may be paid by the insurance subsidiaries to HMEC during 1997 without prior approval are approximately $89 million. Although regulatory restrictions exist, dividend availability from subsidiaries has been, and is expected to be, more than adequate for parent Company 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 1996, net cash used in investing activities was $32.7 million. This net amount reflects $989.0 million in purchases of fixed maturity investments, funded by investment sales or maturities of $956.3 million and net cash provided by operating activities.
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 year ended December 31, 1996 were $10.3 million.
For the year ended December 31, 1996, receipts from annuity contracts of $166.9 million were greater than contract maturities and withdrawals of $135.2 million. Net transfers to variable annuity assets were $86.1 million during 1996 compared to $50.4 million during 1995. Interest-sensitive life account balances increased $1.5 million during 1996.
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%. The net proceeds from the sale of the Senior Notes were used to finance most of the cost of the full redemption of the $100.0 million of outstanding convertible notes at an aggregate cost of $102.9 million. The redemption of the convertible notes extended the maturity of the Company's long-term debt and eliminated the potential dilutive impact of these securities.
Interest on the Senior Notes is payable semi-annually at a rate of 6 5/8%. The Senior Notes are redeemable in whole or in part, at any time at the Company's option, at a redemption price equal to the greater of (i) 100% of their principal amount and (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted, on a semi- annual basis, at the Treasury yield (as defined in the indenture) plus 15 basis points, together with accrued interest to the date of redemption. The Senior Notes have an investment grade rating from both Standard & Poor's Corporation ("S&P") (A-) and Moody's Investors Service, Inc. ("Moody's") (Baa2) and are traded on the New York Stock Exchange (HMN 6 5/8).
In May 1995, the Company repurchased 6.5 million shares of its common stock at an aggregate price of $174.9 million, financed by cash provided by operating activities and $140.0 million borrowed under an existing bank line of credit. Short-term borrowings under the bank line of credit were subsequently reduced to $34 million and $75 million as of December 31, 1996 and 1995, respectively.
Capital Resources
The total capital of the Company was $618.6 million at December 31, 1996, including $99.6 million of long-term debt and $34.0 million of short-term debt. Long-term debt as a percentage of total shareholders' equity was 20.6% as of December 31, 1996, compared to 21.3% as of December 31, 1995.
Shareholders' equity was $484.4 million at December 31, 1996, including an unrealized gain in the Company's investment portfolio of $29.7 million after taxes and the related impact on deferred policy acquisition costs. The market value of the Company's common stock and the market value per share were $953.9 million and $40 3/8, respectively, at December 31, 1996. Book value per share was $20.50 at December 31, 1996, $19.25 excluding investment market value adjustments.
As of December 31, 1996, the Company had short-term debt comprised of $34.0 million outstanding under the Bank Credit Facility. The Bank Credit Facility, as amended in December 1996, 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 5.9%, as of December 31, 1996. The commitment for the Bank Credit Facility terminates on December 31, 2001.
The Company's ratio of earnings to fixed charges for 1996 was 10.6x compared to 9.9x for 1995.
Total shareholder dividends were $10.3 million for the year ended December 31, 1996. In February 1997, the Board of Directors authorized the fifth consecutive annual increase in the Company's dividend. The regular quarterly dividend increased by 23% to $0.135 per share.
In February 1997, the Company's Board of Directors adopted a repurchase program for shares of the Company's common stock of up to $100 million. Based on the market price of the Company's common shares at the time the Board adopted this program, $100 million would represent 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. The repurchase program will be financed through use of cash and, if needed, the Bank Credit Facility.
In 1997, the Company's catastrophe reinsurance program will be augmented by a $100 million equity put. This equity put provides for an option to sell shares of the Company's convertible preferred
stock at a pre-negotiated floating rate in the event of losses from a catastrophe, individually or in the aggregate, which exceed $65 million.
EFFECTS OF INFLATION AND CHANGES IN INTEREST RATES
The Company's operating results are affected significantly in at least three ways by changes in interest rates and inflation. First, inflation directly affects property and casualty claims costs. Second, the investment income earned on the Company's investment portfolio and the market value of the investment portfolio are related to the yields available in the fixed-income markets. An increase in interest rates will decrease the market value of the investment portfolio, but will increase investment income as investments mature and proceeds are reinvested at higher rates. Third, as interest rates increase, competitors will typically increase crediting rates on annuity and interest- sensitive life products, and may lower premium rates on property and casualty lines to reflect the higher yields available in the market. The risk of interest rate fluctuation is controlled through asset/liability management techniques, including cash flow analysis.
EFFECTS OF RECESSION
The Company markets its products primarily to educators and other employees of public schools and their families located throughout the United States. Although this market is affected by school budgetary constraints, as well as general economic downturns that result in decreased purchases of new automobiles and homes and reductions in individual savings, management believes that this market historically has continued to purchase insurance even in periods of recession. Historically, despite changing economic conditions, sales of insurance products to the Company's market have remained stable or increased, suggesting continuation of this historical trend.
REPORT OF MANAGEMENT RESPONSIBILITY FOR FINANCIAL STATEMENTS
HORACE MANN EDUCATORS CORPORATION
The consolidated balance sheets of Horace Mann Educators Corporation and subsidiaries as of December 31, 1996, 1995 and 1994, and the related consolidated statements of operations, cash flows and shareholders' equity for the years ended December 31, 1996, 1995 and 1994 have been prepared by management, which is responsible for their integrity and objectivity. The statements have been prepared in accordance with generally accepted accounting principles and include some amounts that are based upon management's best estimates and judgements. The financial information contained elsewhere in this annual report on Form 10-K is consistent with that contained in the financial statements.
Management is responsible for establishing and maintaining a system of internal control designed to provide reasonable assurance as to the integrity and reliability of financial reporting. The concept of reasonable assurance is based on the recognition that there are inherent limitations in all systems of internal control, and that the cost of such systems should not exceed the benefits derived therefrom. A professional staff of internal auditors reviews on an ongoing basis the related internal control system design, the accounting policies and procedures supporting this system and compliance therewith. Management believes this system of internal control effectively meets its objective of reliable financial reporting.
In connection with their annual audits, independent certified public accountants perform an examination, in accordance with generally accepted auditing standards, which includes the consideration of the system of internal control to the extent necessary to form an independent opinion on the fairness of presentation of the financial statements prepared by management.
The Board of Directors, through its Audit Committee composed solely of directors who are not employees of the Company, is responsible for overseeing the integrity and reliability of the Company's accounting and financial reporting practices and the effectiveness of its system of internal controls. The independent certified public accountants and internal auditors meet regularly with, and have access to, this committee, with and without management present, to discuss the results of their audit work.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders Horace Mann Educators Corporation:
We have audited the accompanying consolidated balance sheets of Horace Mann Educators Corporation and subsidiaries (the Company) as of December 31, 1996, 1995 and 1994, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules, as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Horace Mann Educators Corporation and subsidiaries as of December 31, 1996, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
LOGO KPMG PEAT MARWICK LLP
Chicago, Illinois January 27, 1997
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying notes to consolidated financial statements.
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
See accompanying notes to consolidated financial statements.
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
See accompanying notes to consolidated financial statements.
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
See accompanying notes to consolidated financial statements.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements are prepared on the basis of generally accepted accounting principles ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The consolidated financial statements include the accounts of Horace Mann Educators Corporation and its wholly-owned subsidiaries ("HMEC"; and together with its subsidiaries, the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation.
The subsidiaries of HMEC sell and underwrite tax-qualified retirement annuities and private passenger automobile, homeowners, and life insurance products, primarily to educators and other employees of public schools and their families. In 1996, the Company discontinued its group medical business. The Company's principal operating subsidiaries are Horace Mann Life Insurance Company, Horace Mann Insurance Company, Teachers Insurance Company and Allegiance Insurance Company.
Investments
The Company invests primarily in fixed maturity investments. Effective January 1, 1994, the Company adopted Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and classified the fixed maturity investment securities as available for sale. The carrying value of fixed maturity securities, which had previously been carried at the lower of aggregate amortized cost or market value, was changed to market value. The net adjustment for unrealized gains and losses on securities available for sale, carried at market, is recorded as a separate component of shareholders' equity, net of applicable deferred tax asset or liability.
Short-term and other investments are comprised of mortgage loans, carried at unpaid principal less a valuation allowance for estimated uncollectible amounts; policy loans, carried at unpaid principal balances; short-term fixed interest securities, carried at cost which approximates market value; real estate acquired in the settlement of debt, carried at the lower of cost or market; and equity securities, carried at market.
Interest income is recognized as earned. Investment income reflects amortization of premiums and accrual of discounts on an effective-yield basis.
Realized gains and losses arising from the sale of securities are determined based upon specific identification of securities sold.
Deferred Policy Acquisition Costs
Deferred policy acquisition costs net of accumulated amortization are included in other assets in the consolidated balance sheets and were $75,071, $66,866 and $59,095 as of December 31, 1996, 1995 and 1994, respectively.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Acquisition costs, consisting of commissions, premium taxes and other costs, which vary with and are primarily related to the production of insurance business, are capitalized and amortized as follows. Capitalized acquisition costs for interest-sensitive life contracts are amortized over 20 years in proportion to estimated gross profits. For other individual life contracts, acquisition costs are amortized in proportion to anticipated premiums over the terms of the insurance policies (10 and 15 years). For investment (annuity) contracts, acquisition costs are amortized in proportion to estimated gross profits over 20 years. For property and casualty policies, acquisition costs are amortized over the terms of the insurance policies (six and twelve months).
Deferred policy acquisition costs for interest-sensitive life and investment contracts are adjusted for the impact on estimated future gross profits as if net unrealized investment gains and losses had been realized at the balance sheet date. The impact of this adjustment is included in net unrealized gains and losses within shareholders' equity.
Deferred acquisition costs are reviewed for recoverability from future income, including investment income, and costs which are deemed unrecoverable are expensed in the period in which the determination is made. No such costs have been deemed unrecoverable during the periods reported.
When the Company was acquired in 1989, deferred acquisition costs were reduced to zero in connection with establishing the value of acquired insurance in force in the application of purchase accounting.
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation and are included in other assets in the consolidated balance sheets. Depreciation and amortization are calculated on the straight-line method based on the estimated useful lives of the assets.
Value of Acquired Insurance In Force and Goodwill
When the Company was acquired in 1989, intangible assets were recorded in the application of purchase accounting to recognize the value of acquired insurance in force and goodwill. In addition, goodwill of $22,003 was recorded in January 1994 related to the purchase of Allegiance Insurance Company.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
The value of acquired insurance in force by operating segment and goodwill, net of amortization, were as follows:
The value of acquired insurance in force is being amortized over the following periods utilizing the indicated methods for property and casualty, life and annuity, respectively, as follows: 10 years, double declining balance; 20 years, in proportion to coverage provided; 20 years, in proportion to projected future gross profits at the date of the acquisition of the Company. Goodwill is amortized over 40 years on a straight-line basis.
The Company reviews the value of acquired insurance in force and goodwill for impairment under the standards established by SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Any impairment is recognized in the period in which the determination is made. There have been no adjustments to the carrying value of the value of acquired insurance in force and goodwill.
Scheduled amortization of the December 31, 1996 balances of value of acquired insurance in force by segment and goodwill over the next five years is as follows:
The accumulated amortization of intangibles as of December 31, 1996, 1995 and 1994 was $114,034, $102,829 and $91,163, respectively.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Variable Annuity Assets and Liabilities
Variable annuity assets, carried at market value, and liabilities represent tax-qualified variable annuity funds invested in the Horace Mann mutual funds. Variable annuity assets were invested in the Horace Mann mutual funds as follows:
The investment income, gains and losses of these accounts accrue directly to the policyholders and are not included in the operations of the Company.
Future Policy Benefits, Interest-sensitive Life Contract Liabilities and Annuity Contract Liabilities
Liabilities for future benefits on life and annuity policies are established in amounts adequate to meet the estimated future obligations on policies in force. Liabilities for future policy benefits on certain life insurance policies are computed using the net level premium method and are based upon assumptions as to future investment yield, mortality and withdrawals. Estimated liabilities are established for policies that contain experience rating provisions. As a result of the application of purchase accounting, future policy benefits for direct individual life insurance policies issued through August 29, 1989 were revalued using interest rates of 9% graded to 8% over 10 years. For policies issued from August 30, 1989 through December 31, 1992, future policy benefits are computed using an interest rate of 6.5%. An interest rate of 5.5% is used to compute future policy benefits for policies issued after December 31, 1992. Mortality and withdrawal assumptions for all policies have been based on various actuarial tables which are consistent with the Company's own experience. Liabilities for future benefits on annuity contracts and certain long-duration life insurance contracts are carried at accumulated policyholder values without reduction for potential surrender or withdrawal charges. The liability also includes provisions for the unearned portion of certain policy charges.
Unpaid Claims and Claim Expenses
Liabilities for property and casualty unpaid claims and claim expenses include provisions for payments to be made on reported losses, losses incurred but not reported and associated settlement expenses; are carried at the full value of estimated liabilities; and are not discounted for interest expected to be earned on reserves. Estimated amounts of salvage and subrogation on unpaid property and casualty losses are deducted from the liability for unpaid claims.
The process by which liabilities are established for insured events requires reliance upon estimates based on experience and available data. As information develops which varies from experience, provides additional data or, in some cases, augments data which previously were not considered sufficient for use in determining liabilities, adjustments may be required. The effects of
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
these adjustments are charged or credited to income for the period in which the adjustments are made. No unusual adjustments were made in the determination of the liabilities during the periods covered by these financial statements. The Company has no exposure to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses. Management believes that, based on data currently available, it has reasonably estimated the Company's ultimate losses.
The following table sets forth an analysis of property and casualty unpaid claims and claim expenses and provides a reconciliation of beginning and ending reserves for the periods indicated.
- -------- (1) Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous periods to reflect subsequent information on such claims and changes in their projected final settlement costs. Favorable reserve development generally occurs as a result of subsequent adjustment of reserves to reflect additional information. (2) Unpaid claims and claims expenses as reported in the consolidated balance sheets also include life, annuity, and group accident and health reserves of $18,442, $15,411 and $17,564 at December 31, 1996, 1995 and 1994, respectively, in addition to property and casualty reserves.
The provision for losses and LAE for insured events in prior years decreased by $62,546, $55,630 and $54,371 for the years ended December 31, 1996, 1995 and 1994, respectively. The favorable loss
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
development results primarily from improving trends in the frequency and severity of voluntary automobile claims.
Insurance Premiums and Contract Charges Earned
Property and casualty insurance premiums are recognized as revenue ratably over the related contract periods in proportion to the risks insured. The unexpired portions of these property and casualty premiums are recorded as unearned premiums, using the monthly pro rata method.
Premiums and contract charges for interest-sensitive life and annuity contracts consist of charges for the cost of insurance, policy administration and withdrawals. Premiums for long-term traditional life policies are recognized as revenues when due over the premium-paying period. Annuity and interest-sensitive life contract deposits represent funds deposited by policyholders and are not included in the Company's premiums or contract charges.
Stock Based Compensation
The Company grants stock options for a fixed number of shares to employees with an exercise price which has generally been equal to the fair market value of the shares on the date of grant. The Company accounts for stock option grants in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and accordingly, recognizes no compensation expense for the stock option grants.
Income Taxes
The Company uses the liability method for calculating deferred federal income taxes. Income tax provisions are generally based on income reported for financial statement purposes. The provisions for federal income taxes for the years ended December 31, 1996, 1995 and 1994 include amounts currently payable and deferred income taxes resulting from the cumulative differences in the Company's assets and liabilities, determined on a tax return and financial statement basis.
Deferred tax assets and liabilities include provisions for unrealized investment gains and losses with the change for each period included in net unrealized gains and losses in shareholders' equity.
Earnings Per Share
Earnings per share assuming no dilution is computed based on the weighted average number of shares outstanding. Prior to their early retirement in February 1996, convertible notes described in Note 4 were considered potentially dilutive securities for purposes of calculating earnings per share assuming full dilution. Common stock equivalents relating to outstanding warrants and common stock options are also included in the calculation of earnings per share, to the extent dilutive.
Statements of Cash Flows
For purposes of the statements of cash flows, cash constitutes cash on deposit at banks.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Reclassification
The Company has reclassified the presentation of certain prior period information to conform with the 1996 presentation including the presentation of discontinued operations for all periods (also see Note 2).
NOTE 2--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. The Company stopped writing new group medical insurance policies in January 1997 and intends to stop renewing group medical insurance policies in January 1998. The Company's results of operations for the year ended December 31, 1996 include an accrual of $5,974 for anticipated losses during the phase- out period and a related income tax recoverable of $2,091.
The consolidated statements of operations and related disclosures for all years have been restated to separately report discontinued operations. Premiums written from the discontinued group medical business were $47,382, $47,512 and $55,447 for the years ended December 31, 1996, 1995 and 1994, respectively. The losses from operations from the discontinued group medical business were $5,280, $1,184 and $61 for the years ended December 31, 1996, 1995 and 1994, respectively, exclusive of the accrual for anticipated losses during the phase-out period recorded in 1996.
At December 31, 1996, the following were attributable to the discontinued operations: $12,490 of investments, $4,090 of premiums receivable, $2,030 of ceded policy liabilities (classified as Other Assets in the Consolidated Balance Sheet), $143 of other assets, $12,533 of policy liabilities and $6,220 of other liabilities, including the provision for operating losses during the phase-out period.
NOTE 3--INVESTMENTS
Net Investment Income
The components of net investment income for the following periods were:
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--INVESTMENTS--(CONTINUED)
Fixed Maturity Securities
The amortized cost, unrealized investment gains and losses, and market values of investments in debt securities as of December 31, 1996, 1995 and 1994 were as follows:
The Company's investment portfolio includes no derivative financial instruments (futures, forwards, swaps, option contracts or other financial instruments with similar characteristics).
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--INVESTMENTS--(CONTINUED)
Maturity/Sales Of Investments
The market value and amortized cost of fixed maturity securities at December 31, 1996, by contractual maturity, are shown below. 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.
Proceeds from sales/maturities of fixed maturities and gross gains and gross losses realized for each year were:
Unrealized Gains (Losses) on Fixed Maturities
Net unrealized gains (losses) are computed as the difference between market and amortized cost for fixed maturities. A summary of the net increase (decrease) in unrealized investment gains (losses) on fixed maturities, less applicable income taxes, is as follows:
Investment in Entities Exceeding 10% of Shareholders' Equity
At December 31, 1996, the Company's investment portfolio included $51,972 of fixed maturity securities issued by Ford Motor Company and its affiliates. There were no other investments which exceeded 10% of total shareholders' equity in entities other than obligations of the United States Government and government agencies and authorities at December 31, 1996 and there were no such investments at December 31, 1995 and 1994.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--INVESTMENTS--(CONTINUED)
Deposits
At December 31, 1996, securities with a carrying value of $13,019 were on deposit with governmental agencies as required by law in various states in which the insurance subsidiaries of HMEC conduct business.
NOTE 4--DEBT AND WARRANTS
Indebtedness and scheduled maturities at December 31, 1996, 1995 and 1994 consisted of the following:
Issuance of 6 5/8% Senior Notes ("Senior Notes") and Redemption of Convertible Notes
On January 17, 1996, the Company issued $100,000 face amount of Senior Notes at an effective yield of 6.7%, which will mature on January 15, 2006. The net proceeds from the sale of the Senior Notes were used to finance the redemption of the Convertible Notes. Interest on the Senior Notes is payable semi- annually at a rate of 6 5/8%. The Senior Notes are redeemable in whole or in part, at any time, at the Company's option, at a redemption price equal to the greater of (i) 100% of their principal amount and (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted, on a semi-annual basis, at the Treasury yield (as defined in the indenture) plus 15 basis points, together with accrued interest to the date of redemption.
Bank Credit Facility
The Bank Credit Facility, as amended in December 1996, provides for unsecured borrowings of up to $65,000. Interest accrues at varying spreads relative to corporate or eurodollar base rates and is payable monthly or quarterly depending on the applicable base rate (Interbank Offering Rate plus 0.325% at December 31, 1996). The unused portion of the Bank Credit Facility is subject to a variable commitment fee which was 0.1% on an annual basis at December 31, 1996. The commitment for the Bank Credit Facility terminates on December 31, 2001. The Company's obligations under the Bank Credit Facility are unsecured.
4%/6 1/2% Convertible Notes ("Convertible Notes")
All of the outstanding Convertible Notes were redeemed on February 6, 1996 at an aggregate cost of $102,890. The early redemption of the Convertible Notes resulted in a charge to 1996 income of $1,319 ($857 net of tax benefits).
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 4--DEBT AND WARRANTS--(CONTINUED)
15.00% Subordinated Debentures ("Debentures")
In August 1994, all of the outstanding Debentures, in the aggregate principal amount of $47,073, were redeemed at an aggregate cost to HMEC of $50,603. The early redemption of the Debentures resulted in an extraordinary charge to income in 1994 of $1,704 net of tax benefits.
Warrants
At December 31, 1996, 1995 and 1994, warrants to purchase 140,625 shares of the Company's common stock at $5.40 per share were outstanding.
Covenants
The Company is in compliance with all of the covenants contained in the Senior Notes indenture and the Bank Credit Facility Agreement.
NOTE 5--SHAREHOLDERS' EQUITY AND STOCK OPTIONS
Share Repurchase Program
In February 1997, the Company's Board of Directors adopted a repurchase program for shares of the Company's common stock of up to $100,000. Based on the market price of the Company's common shares at the time the Board adopted this program, $100,000 would represent 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. The repurchase program will be financed through use of cash and, if needed, the Bank Credit Facility.
Authorization of Preferred Stock
In September 1996, the shareholders of HMEC approved authorization of 1,000,000 shares of $0.001 par value preferred stock. The Board of Directors is authorized to (i) direct the issuance of the preferred stock in one or more series, (ii) fix the dividend rate, conversion or exchange rights, redemption price and liquidation preference, of any series of the preferred stock, (iii) fix the number of shares for any series and (iv) increase or decrease the number of shares of any series. No shares of preferred stock were outstanding at December 31, 1996.
In 1997, the Company's catastrophe reinsurance program will be augmented by a $100,000 equity put. This equity put provides for an option to sell shares of the Company's convertible preferred stock at a pre-negotiated floating rate in the event of losses from a catastrophe, individually or in the aggregate, which exceed $65,000.
In connection with the equity put described in the preceding paragraph, the Board of Directors has designated a series of preferred stock to be available for use in the put. The Series so designated is Series A Cumulative Convertible Preferred Stock (the "Series A Stock") and 100,000 shares have been assigned to this series. None are currently issued or outstanding. The Series A Stock is dividend paying, at a floating rate which varies with movements in the London Interbank Offered Rate and with changes in the risk rating of the Series A Stock as determined by Standard & Poor's. The Series A
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 5--SHAREHOLDERS' EQUITY AND STOCK OPTIONS--(CONTINUED)
Stock does not require any sinking fund or similar mechanism regarding payment of such dividends. The Series A Stock is redeemable by the Company beginning one year after its issuance at rates declining from an initial rate of 102% of the purchase price of the Series A Stock and accumulated unpaid dividends to 100% of such sum (beginning three years after issuance). The Series A Stock must be redeemed by the Company if there is a change in control of the Company and the holders of that stock request redemption. Beginning on the fourth anniversary of the issuance of Series A Stock, the holders thereof have the right to demand conversion of the Series A Stock into common stock of the Company at a conversion rate based on then prevailing market prices for the common stock; however, upon receipt of a conversion demand, the Company has the right to redeem the Series A Stock prior to such conversion. The Series A Stock has liquidation rights which place the Series A Stock ahead of the common stock in priority. The Series A Stock has no voting rights other than the requirement that the Series A Stock approve any changes in the Series A Stock, the creation of any other class of stock on a par with or superior to the Series A Stock and certain extraordinary transactions such as certain mergers involving the Company.
Director Stock Plan
In September 1996, the shareholders of HMEC approved the Deferred Equity Compensation Plan ("Director Stock Plan") for directors of the Company and reserved 300,000 shares for issuance pursuant to the Director Stock Plan. Shares of the Company's common stock issued under the Director Stock Plan may be either authorized and unissued shares or shares that have been reacquired by the Company. As of December 31, 1996, 9,197 units had been awarded under this plan representing an equal number of common shares to be issued in the future.
1995 Purchase of the Company's Common Stock
On May 3, 1995, the Company repurchased 6.5 million shares of common stock. The shares were purchased at a price of $169,000, before a contingent payment and expenses of the transaction. The Company borrowed $140,000 of the purchase price under its existing Bank Credit Facility and the balance was paid from cash on hand. In July 1995, the Company sold 911,902 shares in a secondary public offering, the $20,568 net proceeds of which were used to reduce borrowings under the Bank Credit Facility.
Stock Options
In 1991, HMEC adopted and the shareholders approved the 1991 Stock Incentive Plan (the "1991 Plan") and reserved 2 million shares of common stock for issuance under the 1991 Plan. Under the 1991 Plan, options to purchase shares of HMEC common stock may be granted to executive officers, other employees and certain directors. The options are exercisable in installments beginning in the first year from the date of grant and expiring 10 years from the date of grant. No options were granted during 1996 and 20,000 options were granted during 1995.
The Company accounts for the 1991 Plan in accordance with APB Opinion No. 25, under which no compensation cost has been recognized. Had compensation cost been recognized under SFAS No. 123 "Accounting for Stock-Based Compensation," the Company has determined the effects on 1996 and 1995 net income to be immaterial.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 5--SHAREHOLDERS' EQUITY AND STOCK OPTIONS--(CONTINUED)
Changes in outstanding options and shares available for grant were as follows:
As of December 31, 1996, the weighted average life of vested and exercisable options was 5.5 years and the weighted average price of such options was $22.58 per option. The weighted average prices of vested and exercisable options as of December 31, 1995 and 1994 were $21.72 and $20.72, respectively.
NOTE 6--INCOME TAXES
The federal income tax liabilities and recoverables included in other liabilities and other assets, respectively, in the consolidated balance sheets as of December 31, 1996, 1995 and 1994 were as follows:
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 6--INCOME TAXES--(CONTINUED)
Deferred tax assets and liabilities are recognized for all future tax consequences attributable to "temporary differences" between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The "temporary differences" that give rise to the deferred tax balances at December 31, 1996, 1995 and 1994 were as follows:
Based on the Company's historical earnings, future expectations of adjusted taxable income, as well as reversing gross deferred tax liabilities, the Company believes it is more likely than not that gross deferred tax assets will be fully realized and that a valuation allowance with respect to the realization of the total gross deferred tax assets is not necessary.
The components of federal income tax expense (benefit) were as follows:
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 6--INCOME TAXES--(CONTINUED)
Income tax expense for the following periods differed from the expected tax computed by applying the federal corporate tax rate of 35% to income before income taxes as follows:
NOTE 7--FAIR VALUE OF FINANCIAL INSTRUMENTS
Generally accepted accounting principles require that the Company disclose estimated fair values for certain financial instruments. Fair values of the Company's insurance contracts other than annuity contracts are not required to be disclosed. However, the fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk through the matching of investment maturities with amounts due under insurance contracts. The following methods and assumptions were used to estimate the fair value of financial instruments.
Investments--For fixed maturities and short-term and other investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities, adjusted for differences between the quoted securities and the securities being valued. The fair value of mortgage loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and the same remaining maturities. The fair value of policy loans is based on estimates using discounted cash flow analysis and current interest rates being offered for new loans. The carrying value of real estate is an estimate of fair value based on discounted cash flows from operations.
Annuity Contract Liabilities and Policyholder Account Balances on Interest- sensitive Life Contracts--The fair values of annuity contract liabilities and policyholder account balances on interest-sensitive life contracts are equal to the discounted estimated future cash flows (using the Company's current interest rates earned on its investments) including an adjustment for risk that the timing or amount of cash flows will vary from management's estimate.
Other Policyholder Funds--Other policyholder funds are supplementary contract reserves and dividend accumulations which represent deposits that do not have defined maturities. The carrying value of these funds is used as a reasonable estimate of fair value.
Long-term Debt--The fair value of long-term debt is estimated based on quoted market prices of publicly traded issues.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 7--FAIR VALUE OF FINANCIAL INSTRUMENTS--(CONTINUED)
The carrying amounts and fair values of financial instruments at December 31, 1996, 1995 and 1994 consisted of the following:
Fair value estimates shown above are dependent upon subjective assumptions and involve significant uncertainties resulting in variability in estimates with changes in assumptions. Fair value assumptions are based upon subjective estimates of market conditions and perceived risks of financial instruments at a certain point in time. The disclosed fair values do not reflect any premium or discount that could result from offering for sale at one time an entire holding of a particular financial instrument. In addition, potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected in amounts disclosed.
NOTE 8--STATUTORY SURPLUS AND SUBSIDIARY DIVIDEND RESTRICTIONS
The insurance departments of various states in which the insurance subsidiaries of HMEC are domiciled recognize as net income and surplus those amounts determined in conformity with statutory accounting practices prescribed or permitted by the insurance departments, which differ in certain respects from generally accepted accounting principles.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 8--STATUTORY SURPLUS AND SUBSIDIARY DIVIDEND RESTRICTIONS--(CONTINUED)
Reconciliations of statutory capital and surplus and net income, as determined using statutory accounting practices, to the amounts included in the accompanying financial statements are as follows:
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 8--STATUTORY SURPLUS AND SUBSIDIARY DIVIDEND RESTRICTIONS--(CONTINUED)
The Company has principal insurance subsidiaries domiciled in Illinois and California. The statutory financial statements of these subsidiaries are prepared in accordance with accounting practices prescribed or permitted by the Illinois Department of Insurance and the California Department of Insurance as applicable. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed.
The insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. The maximum dividend which may be paid by the insurance subsidiaries to HMEC during 1997 without prior approval is approximately $89 million.
The NAIC has adopted risk-based capital guidelines that establish minimum adequate levels of statutory capital and surplus based on risk assumed in investments, reserving policies, and volume and types of insurance business written. State insurance regulations prohibit insurance companies from making any public statements or representations with regard to their risk-based capital levels. Based on current guidelines, the risk-based capital statutory requirements will have no negative regulatory impact on the Company's insurance subsidiaries.
NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
All employees of the Company are covered under a defined benefit plan and a defined contribution plan, and certain employees participate in supplemental retirement plans.
Benefits under the defined benefit and supplemental retirement plans are based on employees' years of service and compensation for the highest 36 consecutive months of earnings under the plan. Under the defined contribution plan, contributions are made to employees' accounts based on a percentage of compensation that is determined by the employees' years of service. Retirement benefits to employees are paid first from their accumulated accounts under the defined contribution plan with the balance funded by the defined benefit and supplemental retirement plans.
The Company's policy with respect to funding the defined benefit plan is to contribute amounts which are actuarially determined to provide the plan with sufficient assets to meet future benefit payments consistent with the funding requirements of federal laws and regulations.
Employees of the Company are also eligible to participate in the Supplemental Retirement and Savings Plan, a 401(k) plan, and may generally contribute up to 10% of eligible compensation on a before tax basis. The Company contributes an amount equal to 50% of the first 6% of eligible compensation contributed each month by participating employees.
Total pension expense was $7,855, $7,768 and $8,064 for the years ended December 31, 1996, 1995 and 1994, respectively.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED)
Defined Contribution Plan
Pension benefits under the defined contribution plan were fully funded. Contributions to employees' accounts under the defined contribution plan, which were expensed in the Company's statements of operations, and total plan assets were as follows:
Defined Benefit Plan and Supplemental Retirement Plans
The following table summarizes the funding status of the defined benefit and supplemental retirement pension plans at the end of each year and identifies the assumptions used to determine the projected benefit obligation.
The defined benefit plan is fully funded and investments have been set aside in a trust fund. The supplemental retirement plans are non-qualified, unfunded plans.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED)
Components of net pension cost for the defined benefit plan and supplemental retirement plans for the following periods are:
Postretirement Benefits Other than Pensions
In addition to providing pension benefits, the Company also provides certain health care and life insurance benefits to retired employees and eligible dependents. Employees with ten years of service are eligible to receive these benefits upon retirement. Postretirement benefits other than pensions of active and retired employees are accrued as expense over the employees' service years.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS--(CONTINUED)
The following table presents the funded status of postretirement benefits other than pensions of active and retired employees (including employees on disability more than 2 years) as of December 31, 1996, 1995 and 1994 reconciled with amounts recognized in the Company's statement of financial position:
The assumed annual rates of increase in the per capita cost of covered benefits for participants in the plan who retired prior to January 1, 1994 were 7.8%, 8.1% and 8.3% as of December 31, 1996, 1995 and 1994, respectively. For those participants retiring after December 31, 1993, benefits are provided at a level amount of $10.00 per month per year of employment. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.50%, 7.00% and 8.50% at December 31, 1996, 1995 and 1994, respectively.
A one percentage point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation at December 31, 1996 by approximately $1,733 and the sum of the service and interest cost components of the net periodic postretirement expense for the year ended December 31, 1996 would increase by approximately $122.
NOTE 10--REINSURANCE
In the normal course of business, the insurance subsidiaries assume and cede reinsurance with other insurers. Reinsurance is ceded primarily to limit losses from large exposures and to permit recovery of a portion of direct losses; however, such a transfer does not relieve the originating insurance company of contingent liability.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 10--REINSURANCE--(CONTINUED)
The Company is a national underwriter and therefore has exposure to catastrophic losses in certain coastal states and other regions throughout the United States. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather, and fires, and the frequency and severity of catastrophes are inherently unpredictable. The financial impact from catastrophic losses results from both the total amount of insured exposure in the area affected by the catastrophe as well as the severity of the event. The Company seeks to reduce its exposure to catastrophe losses through the geographic diversification of its insurance coverage, the purchase of catastrophe reinsurance, and the purchase in 1997 of a catastrophe-linked equity put option (also see Note 5).
The total amounts of reinsurance recoverable on unpaid losses classified as assets and reported in other assets in the balance sheets were as follows:
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:
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 10--REINSURANCE--(CONTINUED)
There were no losses from uncollectible reinsurance recoverables in the three years ended December 31, 1996. Past due reinsurance recoverables as of December 31, 1996 were not material.
NOTE 11--CONTINGENCIES
Lawsuits and Legal Proceedings
There are various lawsuits and other legal proceedings against the Company. Management and legal counsel are of the opinion that the ultimate disposition of such litigation will have no material adverse effect on the Company's financial position or results of operations.
Assessments for Insolvencies of Unaffiliated Insurance Companies
The Company is also contingently liable for possible assessments under regulatory requirements pertaining to potential insolvencies of unaffiliated insurance companies. Liabilities, which are established based upon regulatory guidance, have been insignificant.
NOTE 12--SUPPLEMENTARY DATA ON CASH FLOWS
A reconciliation of net income to net cash provided by operating activities as presented in the consolidated statements of cash flows is as follows:
The Company's early retirement of debt in 1996 and 1994 resulted in noncash financing (benefits) and charges of ($1,571) and $1,742, respectively.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 13--SEGMENT INFORMATION
The Company's operations include the following segments: property and casualty, annuity and life insurance.
The property and casualty insurance segment includes primarily personal lines automobile and homeowners products. The annuity segment includes both fixed and variable tax-qualified annuity products. The life insurance segment includes primarily interest-sensitive life and traditional life products.
Summarized financial information for these segments is as follows:
Revenues include insurance premiums and contract charges earned, net investment income and realized investment gains and losses. Total assets are not allocated among the annuity and life segments. Capital expenditures and depreciation expense were not material.
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996, 1995 AND 1994
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 14--UNAUDITED INTERIM INFORMATION
Summary quarterly financial data is presented below. All periods have been restated to reflect group medical results as discontinued operations (also see Note 2).
SCHEDULE I
HORACE MANN EDUCATORS CORPORATION
SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1996
(AMOUNTS IN THOUSANDS)
- -------- (1) Bonds at original cost reduced by repayments and adjusted for amortization of premiums or accrual of discounts and impairment in value of specifically identified investments.
See accompanying Independent Auditors' Report.
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION
BALANCE SHEETS
AS OF DECEMBER 31, 1996, 1995 AND 1994 (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS)
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION
NOTE TO CONDENSED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 AND 1994
The accompanying condensed financial statements should be read in conjunction with the Consolidated Financial Statements and the accompanying notes thereto.
See accompanying Independent Auditors' Report.
SCHEDULE III & VI (COMBINED) HORACE MANN EDUCATORS CORPORATION
SUPPLEMENTARY INSURANCE INFORMATION
(AMOUNTS IN THOUSANDS)
- ----- N/A Not applicable.
See accompanying Independent Auditors' Report.
SCHEDULE IV
HORACE MANN EDUCATORS CORPORATION
REINSURANCE
(AMOUNTS IN THOUSANDS)
- -------- NOTE: Premiums above include insurance premiums earned and contract charges earned.
See accompanying Independent Auditors' Report.
LOGO HA-C00302