10-K 1 v456891_10k.htm FORM 10-K

 

 

  

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

[x]  ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016

OR

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

 

Commission file number 1-10890

 

HORACE MANN EDUCATORS CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware 37-0911756
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

 

1 Horace Mann Plaza, Springfield, Illinois 62715-0001

(Address of principal executive offices, including Zip Code)

 

Registrant's Telephone Number, Including Area Code: 217-789-2500

 

Securities Registered Pursuant to Section 12(b) of the Act:

  Name of each exchange on
Title of each class which registered
Common Stock, par value $0.001 per share New York Stock Exchange

 

Securities Registered Pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes   X   No     

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes       No   X

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   X   No     

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes   X   No     

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

Indicate by check mark the registrant’s filer status, as such terms are defined in Rule 12b-2 of the Exchange Act.

Large accelerated filer   X   Accelerated filer       Non-accelerated filer       Smaller reporting company      

Indicate by check mark whether the registrant is a shell company, as defined in Rule 12b-2 of the Act. Yes       No   X

 

The aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant based on the closing price of the registrant’s Common Stock on the New York Stock Exchange and the shares outstanding on June 30, 2016, was $1,356.3 million.

 

As of February 15, 2017, 40,339,323 shares of the registrant’s Common Stock, par value $0.001 per share, were outstanding, net of 24,672,932 shares of treasury stock.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certain portions of the registrant’s Proxy Statement for the 2017 Annual Meeting of Shareholders are incorporated by reference into Part III Items 10, 11, 12, 13 and 14 of Form 10-K as specified in those Items and will be filed with the Securities and Exchange Commission within 120 days after December 31, 2016.

 

 

  

 

 

 

HORACE MANN EDUCATORS CORPORATION

FORM 10-K

YEAR ENDED DECEMBER 31, 2016

 

INDEX

 

Part Item     Page
         
I 1. Business   1
    Forward-looking Information   1
    Overview and Available Information   1
    History   2
    Selected Historical Consolidated Financial Data   3
    Corporate Strategy and Marketing   4
    Property and Casualty Segment   7
    Retirement Segment   12
    Life Segment   15
    Competition   17
    Investments   18
    Cash Flow   20
    Regulation   21
    Employees   22
  1A. Risk Factors   23
  1B. Unresolved Staff Comments   40
  2. Properties   40
  3. Legal Proceedings   40
  4. Mine Safety Disclosures   41
II 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   41
  6. Selected Financial Data   43
  7. Management's Discussion and Analysis of Financial Condition and Results of Operations   43
  7A. Quantitative and Qualitative Disclosures About Market Risk   43
  8. Consolidated Financial Statements and Supplementary Data   43
  9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   44
  9A. Controls and Procedures   44
  9B. Other Information   45
III 10. Directors, Executive Officers and Corporate Governance   45
  11. Executive Compensation   45
  12. Security Ownership of Certain Beneficial Owners and Management, and Related Stockholder Matters   46
  13. Certain Relationships and Related Transactions, and Director Independence   46
  14. Principal Accounting Fees and Services   46
IV 15. Exhibits and Financial Statement Schedules   46
         
  Signatures   52
  Index to Financial Information   F-1

 

 

 

 

PART I

 

ITEM 1.Business

 

Measures within this Annual Report on Form 10-K that are not based on accounting principles generally accepted in the United States (“non-GAAP”) are marked by an asterisk (“*”). An explanation of these measures is contained in the Glossary of Selected Terms included as Exhibit 99.1 to this Annual Report on Form 10-K.

 

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 “Item 1A. Risk Factors” and in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Forward-looking Information”.

 

Overview and Available Information

 

Horace Mann Educators Corporation (“HMEC”; and together with its subsidiaries, the “Company” or “Horace Mann”) is an insurance holding company incorporated in Delaware. Through its subsidiaries, HMEC markets and underwrites personal lines of property and casualty (primarily personal lines automobile and homeowners) insurance, retirement products (primarily tax-qualified annuities) and life insurance in the United States of America (“U.S.”). HMEC's principal insurance subsidiaries are Horace Mann Life Insurance Company (“HMLIC”), Horace Mann Insurance Company (“HMIC”), Horace Mann Property & Casualty Insurance Company (“HMPCIC”) and Teachers Insurance Company (“TIC”), each of which is an Illinois corporation, and Horace Mann Lloyds (“HM Lloyds”), an insurance company domiciled in Texas.

 

Founded by Educators for Educators®, the Company markets its products primarily to K-12 teachers, administrators and other employees of public schools and their families. The Company's nearly one million customers typically have moderate annual incomes, with many belonging to two-income households. Their financial planning tends to focus on retirement, security, savings and primary insurance needs. Management believes that Horace Mann is the largest national multiline insurance company focused on the nation's educators as its primary market.

 

Horace Mann markets and services its products primarily through a dedicated sales force of full-time agents supported by the Company’s Customer Contact Center. These agents sell Horace Mann's products and limited additional third-party vendor products. Some of these agents are former educators or individuals with close ties to the educational community who utilize their contacts within, and knowledge of, the target market. This dedicated agent sales force is supplemented by an independent agent distribution channel for the Company’s retirement products.

 

 1 

 

 

The Company's insurance premiums written and contract deposits for the year ended December 31, 2016 were $1.3 billion and net income was $83.8 million. The Company's total assets were $10.6 billion at December 31, 2016. The Company's investment portfolio had an aggregate fair value of $8.0 billion at December 31, 2016 and consisted principally of investment grade, publicly traded fixed maturity securities.

 

The Company conducts and manages its business through four segments. The three operating segments, representing the major lines of insurance business, are: Property and Casualty insurance, Retirement products, and Life insurance. The Company does not allocate the impact of corporate-level transactions to the insurance segments, consistent with the basis for management’s evaluation of the results of those segments, but classifies those items in the fourth segment, Corporate and Other. The Property and Casualty, Retirement, and Life segments accounted for 50%, 41% and 9%, respectively, of the Company's insurance premiums written and contract deposits for the year ended December 31, 2016.

 

The Company is one of the largest participants in the K-12 portion of the 403(b) tax-qualified annuity market, measured by 403(b) net written premium on a statutory accounting basis. The Company's 403(b) tax-qualified annuities are voluntarily purchased by individuals employed by public school systems or other tax-exempt organizations through the employee benefit plans of those entities. The Company has 403(b) payroll deduction capabilities utilized by approximately one-third of the 13,500 public school districts in the U.S.

 

The Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, and all amendments to those reports are available free of charge through the Investors section of the Company's Internet website, www.horacemann.com, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). The EDGAR filings of such reports are also available at the SEC's website, www.sec.gov.

 

Also available in the Investors section of the Company’s website are its corporate governance principles, code of conduct and code of ethics as well as the charters of the Board’s Audit Committee, Compensation Committee, Executive Committee, Investment and Finance Committee, and Nominating and Governance Committee.

 

On June 22, 2016, the Chief Executive Officer (“CEO”) of HMEC timely submitted the Annual Section 12(a) CEO Certification to the New York Stock Exchange (“NYSE”) without any qualifications. The Company filed with the SEC, as exhibits to the Annual Report on Form 10-K for the year ended December 31, 2015, the CEO and Chief Financial Officer (“CFO”) certifications required under Section 302 of the Sarbanes-Oxley Act.

 

History

 

The Company's business was founded in Springfield, Illinois in 1945 by two school teachers to sell automobile insurance to other teachers within the State of Illinois. The Company expanded its business to other states and broadened its product line to include life insurance in 1949, 403(b) tax-qualified retirement annuities in 1961 and homeowners insurance in 1965. In November 1991, HMEC completed an initial public offering of its common stock (the “IPO”). The common stock is traded on the New York Stock Exchange under the symbol “HMN”.

 

 2 

 

 

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

 

The following consolidated statement of operations and balance sheet data have been derived from the consolidated financial statements of the Company, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The consolidated financial statements of the Company for each of the years in the five year period ended December 31, 2016 have been audited by KPMG LLP, an independent registered public accounting firm. The following selected historical consolidated financial data should be read in conjunction with the consolidated financial statements of HMEC and its subsidiaries and “Management's Discussion and Analysis of Financial Condition and Results of Operations”.

 

   Year Ended December 31, 
     2016     2015     2014     2013     2012 
   (Dollars in millions, except per share data) 
Statement of Operations Data:                         
Insurance premiums and contract charges earned  $759.1   $731.9   $715.8   $690.9   $670.5 
Net investment income   361.2    332.6    329.8    313.6    306.0 
Net realized investment gains   4.1    12.7    10.9    22.2    27.3 
Total revenues   1,128.9    1,080.4    1,060.7    1,031.2    1,010.8 
Interest expense   11.8    13.1    14.2    14.2    14.2 
Income before income taxes   114.2    129.5    146.1    154.1    149.2 
Net income   83.8    93.5    104.2    110.9    103.9 
Ratio of earnings to fixed charges (1)   1.6x   1.7x   1.8x   1.8x   1.8x
                          
Per Share Data (2):                         
Net income per share                         
Basic  $2.04   $2.23   $2.50   $2.75   $2.63 
Diluted  $2.02   $2.20   $2.47   $2.66   $2.51 
Shares of Common Stock (in millions)                         
Weighted average - basic   41.2    41.9    41.6    40.4    39.5 
Weighted average - diluted   41.5    42.4    42.2    41.6    41.4 
Ending outstanding   40.2    40.6    40.9    40.5    39.4 
Cash dividends per share  $1.06   $1.00   $0.92   $0.78   $0.55 
Book value per share  $32.15   $31.18   $32.65   $27.14   $31.65 
                          
Balance Sheet Data, at Year End:                         
Total investments  $7,999.3   $7,648.0   $7,403.5   $6,539.5   $6,292.1 
Total assets   10,576.8    10,057.0    9,768.4    8,826.3    8,167.2 
Total policy liabilities   6,024.1    5,683.4    5,351.5    5,029.2    4,736.7 
Short-term debt   -    -    38.0    38.0    38.0 
Long-term debt   247.2    247.0    199.8    199.5    199.3 
Total shareholders’ equity   1,294.0    1,264.7    1,336.5    1,099.3    1,245.8 
                          
Segment Information (3):                         
Insurance premiums written and contract deposits                         
Property and Casualty  $634.3   $605.8   $584.4   $570.4   $550.8 
Retirement   520.2    548.0    480.6    423.0    417.6 
Life   108.0    102.7    102.7    100.8    99.3 
Total   1,262.5    1,256.5    1,167.7    1,094.2    1,067.7 
Net income (loss)                         
Property and Casualty   25.6    40.0    46.9    44.4    37.1 
Retirement   50.7    43.4    45.3    44.7    40.5 
Life   16.6    15.0    17.5    20.4    21.9 
Corporate and Other (4)   (9.1)   (4.9)   (5.5)   1.4    4.4 
Total   83.8    93.5    104.2    110.9    103.9 

 

 

(1)For the purpose of determining the ratio of earnings to fixed charges, “earnings” consist of income before income taxes and fixed charges, and “fixed charges” consist of interest expense (including amortization of debt issuance cost) and interest credited to policyholders on investment contracts and life insurance products with account values.
(2)Basic earnings per share is computed based on the weighted average number of shares outstanding plus the weighted average number of fully vested restricted stock units and common stock units payable as shares of HMEC common stock. Diluted earnings per share is computed based on the weighted average number of shares and common stock equivalents outstanding, to the extent dilutive. The Company's common stock equivalents relate to outstanding common stock options, common stock units (related to deferred compensation for Directors and employees) and restricted stock units.
(3)Information regarding assets by segment at December 31, 2016, 2015 and 2014 is contained in “Notes to Consolidated Financial Statements — Note 14 — Segment Information” listed on page F-1 of this report.
(4)The Corporate and Other segment primarily includes interest expense on debt, the impact of net realized investment gains and losses, corporate debt retirement costs, and certain public company expenses.

 

 3 

 

 

Corporate Strategy and Marketing

 

The Horace Mann Value Proposition

 

The Horace Mann Value Proposition articulates the Company's overarching strategy and business purpose: Provide lifelong financial well-being for educators and their families through personalized service, advice, and a full range of tailored insurance and financial products.

 

Target Market

 

Management believes that Horace Mann is the largest national multiline insurance company focused on the nation's educators as its primary market. The Company's target market consists primarily of K-12 teachers, administrators and other employees of public schools and their families located throughout the U.S. The U.S. Department of Education estimates that there are approximately 6.2 million teachers, school administrators and education support personnel in public schools in the U.S.; approximately 3.1 million of these individuals are elementary and secondary teachers.

 

Distribution Strategy

 

In addition to the Company’s traditional exclusive agency force, Horace Mann continues to build complementary distribution channels (i.e., on-line quoting, direct sales channel, and institutional business to business). These various channels allow customers to access Horace Mann how they choose. The Company believes that its customers will need expert advice at the point of sale at some point in their lifetime, and they will choose the advice of a trusted advisor.

 

Dedicated Agency Force

 

A cornerstone of Horace Mann’s marketing strategy is its dedicated sales force of agents, supported by the Company’s Customer Contact Center. As of December 31, 2016, the Company had a combined total of 666 Exclusive Agencies and Employee Agents. Approximately 72% of the appointed agents are licensed by the Financial Industry Regulatory Authority, Inc. (“FINRA”) to sell variable annuities and variable universal life policies. Some individuals in the agency force were previously teachers, other members of the education profession or persons with close ties to the educational community. The Company’s dedicated agents are under contract to market only the Company's products and limited additional third-party vendor products. Collectively, the Company's principal insurance subsidiaries are licensed to write business in 49 states and the District of Columbia.

 

The Company’s dedicated agency force operates in its Agency Business Model (“ABM”), consisting of Exclusive Agencies as well as a limited number of Employee Agents. The Company’s Exclusive Agent (“EA”) agreement is designed to place agents in the position to become business owners in their marketing territories and invest their own capital to grow their agencies. Exclusive Agents are non-employee, independent contractors. The Company provides ongoing training and support to agents regarding the Company’s products, as well as to further embed repeatable processes and fully maximize the potential of ABM.

 

 4 

 

 

Broadening Distribution Options

 

To complement and extend the reach of the Company’s agency force and to more fully utilize its approved payroll slots in school systems across the country, the Company utilizes a network of independent agents to distribute the Company's 403(b) tax-qualified annuity products. In addition to serving educators in areas where the Company does not have dedicated agents, the independent agents complement the annuity capabilities of the Company's agency force in under-penetrated areas. At December 31, 2016, there were 272 independent agents approved to market the Company’s annuity products throughout the U.S. During 2016, collected contract deposits from this distribution channel were approximately $46 million. Combined with business from the Company’s dedicated agency force, total annuity collected contract deposits were $520.2 million for the year ended December 31, 2016.

 

Geographic Composition of Business

 

The Company's business is geographically diversified. For the year ended December 31, 2016, based on direct premiums and contract deposits for all product lines, the top five states and their portion of total direct insurance premiums and contract deposits were California, 8.1%; Texas, 6.7%; North Carolina, 6.4%; Florida, 6.3%; and Minnesota, 5.7%.

 

HMEC's Property and Casualty subsidiaries are licensed to write business in 48 states and the District of Columbia. The following table shows the Company's top ten Property and Casualty states based on total direct premiums.

 

Property and Casualty Segment Top Ten States

(Dollars in millions)

 

 Property and Casualty
 Segment
 2016 Direct  Percent
 Premiums (1)  of Total
State        
California  $67.9    10.8%
Texas   46.5    7.4 
North Carolina   44.5    7.1 
Minnesota   39.3    6.2 
Florida   37.1    5.9 
South Carolina   32.5    5.2 
Louisiana   30.1    4.8 
Georgia   25.5    4.0 
Pennsylvania   21.6    3.4 
Maine   16.8    2.7 
Total of top ten states   361.8    57.5 
All other areas   267.7    42.5 
Total direct premiums  $629.5    100.0%

 

 

(1)Defined as earned premiums before reinsurance as determined under statutory accounting principles.

 

 5 

 

 

HMEC's principal Life insurance subsidiary is licensed to write business in 48 states and the District of Columbia. The following table shows the Company's top ten combined Life and Retirement states based on total direct premiums and contract deposits.

 

Combined Life and Retirement Segments Top Ten States

(Dollars in millions)

 

 2016 Direct   
 Premiums and  Percent
 Contract Deposits (1)  of Total
State        
Illinois  $47.8    7.6%
Florida   42.8    6.8 
Pennsylvania   41.4    6.5 
Texas   37.4    5.9 
North Carolina   36.2    5.7 
California   34.0    5.4 
Minnesota   33.1    5.2 
South Carolina   33.0    5.2 
Virginia   28.2    4.4 
Indiana   26.5    4.2 
Total of top ten states   360.4    56.9 
All other areas   272.7    43.1 
Total direct premiums  $633.1    100.0%

 

 

(1)Defined as collected premiums before reinsurance as determined under statutory accounting principles.

 

National, State and Local Education Associations

 

The Company has established relationships with a number of educator groups throughout the U.S. These groups include the National Education Association (“NEA”); The NEA Foundation; the Association of School Business Officials International (“ASBO”); and various school administrator and principal associations such as the American Association of School Administrators (“AASA”), The School Superintendents Association; the National Association of Elementary School Principals (“NAESP”); and the National Association of Secondary School Principals (“NASSP”). The Company does not pay these groups any consideration in exchange for endorsement of the Company or its products. Depending on the organization, the Company does pay for certain special functions and advertising.

 

In recent years, the Company has developed relationships and programs to align its agents with school districts in a business to business relationship. In addition to working relationships, Horace Mann has strategic alliances with AASA and ASBO, as well as ASBO’s state and regional affiliates. The Company holds an annual meeting with selected ASBO members to gain feedback on a variety of school district programs.

 

The Company has had its longest relationship with the NEA, the nation's largest confederation of state and local teachers' associations, and many of the state and local education associations affiliated with the NEA. The NEA has approximately 3.2 million members. A number of state and local associations affiliated with the NEA endorse various insurance products and services of the Company and its competitors. The Company does not pay the NEA or any affiliated associations any consideration in exchange for endorsement of Company products. The Company does pay for marketing agreements, certain special functions and advertising.

 

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Support of Educator Programs

 

The Company’s agents conduct state-specific State Teacher Retirement System Workshops in addition to Financial Success Workshops designed to help educators gain or increase their financial literacy. In addition, the Company offers services and products to school districts that help meet the needs of educators including payroll deduction options for individual insurance products, group life insurance and Section 125 programs. To help districts determine what programs meet their needs, the Company has developed an Employer Benefit Review Service and conducts workshops for school business officials.

 

Along with differentiating, value-added product features, the Company has a number of programs that demonstrate its commitment to the educator profession, while also further distinguishing Horace Mann from competitors within the K-12 educator market. Examples of these programs include: the NEA Foundation’s Horace Mann Awards for Teaching Excellence honoring 5 national finalists; Horace Mann is a national sponsor of DonorsChoose.org, an online, not-for-profit organization that connects corporate and individual donors to teachers with classroom projects in need of funding; Horace Mann sponsors ASBO’s Certified Administrator of School Finance and Operations® (“SFO®”) certification program; and Horace Mann is a sponsor of the AASA National Superintendent Certification Program and AASA’s National Conference on Education.

 

Property and Casualty Segment

 

The Property and Casualty segment represented 50% of the Company's consolidated insurance premiums written and contract deposits in 2016.

 

The primary Property and Casualty product offered by the Company is private passenger automobile insurance, which in 2016 represented 34% of the Company’s total insurance premiums written and contract deposits and 67% of Property and Casualty net written premiums. As of December 31, 2016, the Company had approximately 485,000 automobile policies in force. The Company's automobile business is primarily preferred risk, defined as a household whose drivers have had no recent accidents and no more than one recent moving violation.

 

In 2016, homeowners insurance represented 16% of the Company’s total insurance premiums written and contract deposits and 32% of Property and Casualty net written premiums. As of December 31, 2016, the Company had approximately 220,000 homeowners policies in force. The Company insures primarily residential homes.

 

The Company has programs in a majority of states to provide higher-risk automobile and homeowners coverages, as well as a number of other insurance coverages, with third-party vendors underwriting and bearing the risk of such insurance and the Company receiving commissions on the sales. Similarly, the Company has increased its offering of third-party vendor products in many areas to include coverage for small business owners and classic/collector automobile owners to meet those aspects of an educator’s needs.

 

 7 

 

 

Selected Historical Financial Information for the Property and Casualty Segment

 

The following table provides certain financial information for the Property and Casualty segment for the periods indicated.

 

Property and Casualty Segment

Selected Historical Financial Information

(Dollars in millions)

 

   Year Ended December 31, 
   2016   2015   2014 
Financial Data:               
Insurance premiums written  $634.3   $605.8   $584.4 
Insurance premiums earned   620.5    596.0    581.8 
Net investment income   39.0    33.5    36.8 
Income before income taxes   30.3    51.3    60.8 
Net income   25.6    40.0    46.9 
Catastrophe costs, pretax (1)   60.0    44.4    37.5 
                
Operating Statistics:               
Loss and loss adjustment expense ratio   74.8%   70.5%   68.7%
Expense ratio   26.7%   26.5%   27.4%
Combined loss and expense ratio   101.5%   97.0%   96.1%
Effect of catastrophe costs on the combined ratio (1)   9.7%   7.4%   6.5%
                
Automobile and Homeowners:               
Insurance premiums written               
Automobile  $425.9   $402.2   $383.8 
Homeowners   208.2    203.4    200.4 
Insurance premiums earned               
Automobile   414.3    393.6    381.4 
Homeowners   206.0    202.2    200.2 
Policies in force (in thousands)               
Automobile   485    487    481 
Homeowners   220    224    229 
Total   705    711    710 

 

 

(1)These measures are used by the Company's management to evaluate performance against historical results and establish targets on a consolidated basis. These measures are components of net income but are considered non-GAAP financial measures under applicable SEC rules because they are not displayed as separate line items in the Consolidated Statements of Operations and there is inclusion or exclusion of certain items not ordinarily included or excluded in a GAAP financial measure. In the opinion of the Company's management, a discussion of these measures is meaningful to provide investors with an understanding of the significant factors that comprise the Company's periodic results of operations.
·Catastrophe costs - The sum of catastrophe losses and Property and Casualty catastrophe reinsurance reinstatement premiums.
·Catastrophe losses - In categorizing Property and Casualty claims as being from a catastrophe, the Company utilizes the designations of the Property Claim Services, a subsidiary of Insurance Services Office, Inc. (“ISO”), and additionally beginning in 2007, includes losses from all such events that meet the definition of covered loss in the Company’s primary catastrophe excess of loss reinsurance contract, and reports loss and loss adjustment expense amounts net of reinsurance recoverables. A catastrophe is a severe loss resulting from natural and man-made events within a particular territory, including risks such as hurricane, fire, earthquake, windstorm, explosion, terrorism and other similar events, that causes $25 million or more in insured Property and Casualty losses for the industry and affects a significant number of Property and Casualty insurers and policyholders. Each catastrophe has unique characteristics. Catastrophes are not predictable as to timing or amount of loss in advance. Their effects are not included in earnings or claim and claim adjustment expense reserves prior to occurrence. In the opinion of the Company's management, a discussion of the impact of catastrophes is meaningful for investors to understand the variability in periodic earnings.

 

 8 

 

 

Catastrophe Costs

 

The level of catastrophe costs can fluctuate significantly from year to year. Catastrophe costs before federal income tax benefits for the Company for the last ten years are shown in the following table.

 

Catastrophe Costs

(Dollars in millions)

 

 The
 Company (1)
Year Ended December 31, 
2016  $60.0 
2015   44.4 
2014   37.5 
2013   40.2 
2012   43.3 
2011   86.0 
2010   49.2 
2009   33.1 
2008   73.9 
2007   23.6 

 

 

(1)Net of reinsurance and before federal income tax benefits. Includes allocated loss adjustment expenses and reinsurance reinstatement premiums; excludes unallocated loss adjustment expenses. The Company's individually significant catastrophe losses net of reinsurance were as follows:
2016 -Wind/hail event in March was $3.9 million; wind/hail event in April was $9.2 million; wind/hail/tornado event in May was $3.4 million; Hurricane Matthew was $10.0 million; other weather events throughout the year were each less than $3.0 million.
2015 -Winter storm in February was $8.9 million; wind/flooding event in October was $3.0 million; other weather events throughout the year were each less than $3.0 million.
2014 -Wind/hail event in May was $8.5 million; other weather events throughout the year were each less than $3.0 million.
2013 -Wind/hail/tornado events in May, June and August were $10.1 million, $4.0 million and $7.9 million, respectively; winter storm events in February and April were $3.7 million and $3.4 million, respectively.
2012 -Wind/hail/tornado events in March, April, May and June were $6.6 million, $6.6 million, $5.8 million and $11.9 million, respectively; June tropical storm and wildfire events, $1.4 million combined; $4.0 million, Hurricane Isaac; $2.8 million, Hurricane/Superstorm Sandy.
2011 -Wind/hail/tornado events in April, May and June were $28.0 million, $17.6 million and $8.5 million, respectively; $8.0 million, Hurricane Irene.
2010 -Wind/hail/tornado events in March, May, June, July and October were $4.8 million, $8.3 million, $12.1 million, $5.5 million and $7.7 million, respectively.
2009 -$9.3 million, July wind/hail/tornadoes; $6.3 million, June wind/hail/tornadoes.
2008 -$16.5 million, Hurricane Gustav; $15.5 million, Hurricane Ike; $9.8 million, May wind/hail/tornadoes; $7.0 million, June wind/hail/tornadoes; $3.0 million, December winter storm.
2007- $4.7 million, August wind/hail/tornadoes; $4.5 million, October California wildfires; $3.5 million, June wind/hail/tornadoes.

 

 9 

 

 

Fluctuations from year to year in the level of catastrophe losses impact a property and casualty insurance company’s claims and claim adjustment expenses incurred and paid. For comparison purposes, the following table provides amounts for the Company excluding catastrophe losses.

 

Impact of Catastrophe Losses

(Dollars in millions)

 

   Year Ended December 31, 
   2016   2015   2014 
             
Claims and claim expenses incurred (1)   $464.1   $420.3   $399.5 
Deduct: amount attributable to catastrophes (2)    60.0    44.4    37.5 
Excluding catastrophes (1)   $404.1   $375.9   $362.0 
                
Claims and claim expense payments   $468.8   $436.4   $393.8 
Deduct: amount attributable to catastrophes (2)    62.0    44.6    38.2 
Excluding catastrophes   $406.8   $391.8   $355.6 

 

 

(1)Includes the impact of development of prior years’ reserves as quantified in “Property and Casualty Reserves”.
(2)Net of reinsurance and before federal income tax benefits. Includes allocated loss adjustment expenses; excludes unallocated loss adjustment expenses.

 

Property and Casualty Reserves

 

Property and Casualty unpaid claims and claim expenses (“loss reserves”) represent management’s estimate of ultimate unpaid costs of losses and settlement expenses for claims that have been reported and claims that have been incurred but not yet reported. The Company calculates and records a single best estimate of the reserve as of each balance sheet date in conformity with generally accepted actuarial standards. For additional information regarding the process used to estimate Property and Casualty reserves and the risk factors involved, as well as a summary reconciliation of the beginning and ending Property and Casualty insurance claims and claim expense reserves and reserve development recorded in each of the three years ended December 31, 2016, see “Notes to Consolidated Financial Statements — Note 5 — Property and Casualty Unpaid Claims and Claim Expenses”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Liabilities for Property and Casualty Claims and Claim Expenses” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations for the Three Years Ended December 31, 2016 — Benefits, Claims and Settlement Expenses”.

 

All of the Company's reserves for Property and Casualty unpaid claims and claim expenses are carried at the full value of estimated liabilities and are not discounted for interest expected to be earned on reserves. Due to the nature of the Company's personal lines business, the Company has no exposure to losses related to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses other than claims under homeowners insurance policies for environmentally related items such as mold.

 

 10 

 

 

Property and Casualty Reinsurance

 

All reinsurance is obtained through contracts which generally are entered into for each calendar year. Although reinsurance does not legally discharge the Company from primary liability for the full amount of its policies, it does allow for recovery from assuming reinsurers to the extent of the reinsurance ceded. Past due reinsurance recoverables as of December 31, 2016 were not material.

 

The Company maintains catastrophe excess of loss reinsurance coverage. For 2016, the Company’s catastrophe excess of loss coverage consisted of one contract in addition to a minimal amount of coverage by the Florida Hurricane Catastrophe Fund (“FHCF”). The catastrophe excess of loss contract provided 95% coverage for catastrophe losses above a retention of $25.0 million per occurrence up to $175.0 million per occurrence. This contract consisted of three layers, each of which provided for one mandatory reinstatement. The layers were $25.0 million excess of $25.0 million, $40.0 million excess of $50.0 million and $85.0 million excess of $90.0 million.

 

For 2017, the Company’s catastrophe excess of loss coverage consists of one contract in addition to a minimal amount of coverage by the FHCF. The catastrophe excess of loss contract provides 95% coverage for catastrophe losses above a retention of $25 million per occurrence up to $90 million per occurrence and 100% coverage for catastrophe losses above $90 million per occurrence up to $175 million per occurrence. This contract consists of three layers, each of which provide for one mandatory reinstatement. The layers are $25 million excess of $25 million, $40 million excess of $50 million and $85 million excess of $90 million.

 

The Company has not joined the California Earthquake Authority (“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 the Company’s own policies and from what it would be with participation in the CEA, including estimated start-up and ongoing costs related to CEA participation, management believes it is in the Company's best economic interest to offer earthquake coverage directly to its homeowners policyholders.

 

For liability coverages, in 2016 the Company reinsured each loss above a retention of $0.9 million up to $5.0 million on a per occurrence basis and $20.0 million in a clash event. (A clash cover is a reinsurance casualty excess contract requiring two or more casualty coverages or policies issued by the Company to be involved in the same loss occurrence for coverage to apply.) Effective January 1, 2017, for liability coverages the retention is $1.0 million with coverage up to $5.0 million on a per occurrence basis and $20.0 million in a clash event.

 

For property coverages, in 2016 the Company reinsured each loss above a retention of $0.9 million up to $5.0 million on a per risk basis, including catastrophe losses. Also, the Company could submit to the reinsurers two per risk losses from the same occurrence for a total of $8.2 million of property recovery in any one event. Retention for property coverage in 2017 is $1.0 million, with coverage up to $5.0 million on a per risk basis, including catastrophe losses and the Company can submit to the reinsurers two per risk losses from the same occurrence for a total of $8.0 million of property recovery in any one event.

 

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The following table identifies the Company's most significant reinsurers under the catastrophe first event excess of loss reinsurance program, their percentage participation in this program and their ratings by A.M. Best Company (“A.M. Best”) and Standard & Poor's Corporation (“S&P” or “Standard & Poor's”) as of January 1, 2017. No other single reinsurer's percentage participation in 2017 or 2016 exceeds 5%.

 

Property Catastrophe First Event Excess of Loss

Reinsurance Participants In Excess of 5%

 

A.M. Best  S&P        Participation 
Rating  Rating  Reinsurer  Parent    2017     2016 
                  
A  A+  Lloyd’s of London Syndicates      33%    27% 
A+  AA-  Swiss Re Underwriters Agency, Inc  Swiss Re Ltd   10%    10% 
NR  AA-  R+V Versicherung AG  DZ BANK AG   8%    7% 
A  AA-  SCOR Global P&C SE  SCOR SE   7%    7% 
A++  A+  Tokio Millennium Re AG  Tokio Marine Holdings, Inc.   2%    5% 

 

 

NR - Not rated.

 

For 2017 and 2016, property catastrophe reinsurers representing 92% and 93%, respectively, of the Company’s total reinsured catastrophe coverage were rated “A- (Excellent)” or above by A.M. Best with the remaining percentages provided by a reinsurer rated “AA-” by S&P but not formally followed by A.M. Best.

 

Retirement Segment

 

Effective December 31, 2016, the Company changed the name of its Annuity segment to Retirement. The name change better aligns our external reports with internally used terminology. This name change does not affect any previously reported results for the Retirement segment.

 

Educators in the Company's target market continue to benefit from the provisions of Section 403(b) of the Internal Revenue Code (the “Code”) which began in 1961. This section of the Code allows public school employees and employees of other tax-exempt organizations, such as not-for-profit private schools, to utilize pretax income to make periodic contributions to a qualified retirement plan. (Also see “Regulation — Regulation at Federal Level”.) The Company entered the educators retirement annuity market in 1961 and is one of the largest participants in the K-12 portion of the 403(b) tax-qualified annuity market, measured by 403(b) net written premium on a statutory accounting basis. The Company has 403(b) payroll deduction capabilities utilized by approximately one-third of the 13,500 public school districts in the U.S. Approximately 49% of the Company's new annuity contract deposits in 2016 were for 403(b) tax-qualified annuities; approximately 60% of accumulated annuity value on deposit is 403(b) tax-qualified. In 2016, annuities represented 41% of the Company’s consolidated insurance premiums written and contract deposits.

 

The Company markets both fixed and variable annuity contracts, primarily on a tax-qualified basis. Fixed only annuities provide a guarantee of principal and a guaranteed minimum rate of return. These contracts are backed by the Company’s general account investments. The Company bears the investment risk associated with the investments and may change the declared interest rate on these contracts subject to contract guarantees. In 2014, the Company began offering fixed indexed annuity (“FIA”) products with interest crediting strategies linked to the Standard & Poor’s 500 Index and the Dow Jones Industrial Average. These products are fixed annuities with a guaranteed minimum interest rate, as

 

 12 

 

 

described above, plus a contingent return based on equity market performance. The Company purchases call options on the applicable indices as an investment to provide the income needed to fund the annual index credits on the indexed products.

 

Variable annuities combine a fixed account option with equity- and bond-linked sub-account options. In general, the contractholders bear the investment risk related to the variable annuity sub-accounts and may change their allocation between the guaranteed interest rate fixed account and the wide range of variable investment options at any time. By utilizing tools that provide assistance in determining needs and making asset allocation decisions, contractholders are able to choose the investment mix that matches their personal risk tolerance and retirement goals. The Company’s sub-account options also include both lifecycle funds and asset allocation funds. These all-purpose funds have assets allocated among multiple investment classes within each fund based on a specific targeted retirement date or risk tolerance.

 

Variable annuity contracts with a guaranteed minimum death benefit (“GMDB”) provide an additional benefit if the contractholder dies and the contract value is less than a contractually defined amount. The Company has a relatively low exposure to GMDB risk because approximately 32% of contract values have no guarantee; approximately 62% have only a return of premium guarantee; and only approximately 6% have a guarantee of premium roll-up at an annual rate of 3% or 5%.

 

As of December 31, 2016, the Company had 80 variable sub-account options including funds managed by some of the best-known names in the mutual fund industry, such as AllianceBernstein, American Funds, Ariel, BlackRock, Calvert, Davis, Dreyfus, Fidelity, Franklin Templeton, Goldman Sachs, JPMorgan, Lord Abbett, MFS, Neuberger Berman, Putnam, T. Rowe Price, Vanguard, Wells Fargo and Wilshire, offering the Company's customers multiple investment options to address their personal investment objectives and risk tolerance. These funds have been selected with the assistance of Wilshire Associates, the Company’s fund advisor, which provides oversight and input to fund manager additions and replacements. Total accumulated fixed and variable annuity cash value on deposit at December 31, 2016 was $6.4 billion.

 

Among the Company’s annuity products, the Goal Planning Annuity offers educators a variable annuity with the Company’s wide array of sub-account investment choices. It includes an optional first year premium bonus and two optional riders that enhance the death benefit feature of the product. Another product, Expanding Horizon, is a fixed interest rate annuity contract for investors who do not want investment risk exposure. This product offers educators a competitive rate of interest on their retirement dollars and a choice of bonuses to optimize their benefits at retirement. The Destination Fixed Indexed Annuity product is designed to have potentially greater credited interest rates over the long term than traditional fixed rate annuities, because the credited interest rate will be linked to changes in an index, either the S&P 500 or the Dow Jones Industrial Average.

 

In addition to individual annuities, the Company offers group variable and fixed annuity products that allow flexibility in customizing 403(b) annuity programs to meet the needs of school districts.

 

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To assist agents in delivering the Horace Mann Value Proposition, the Company has entered into third-party vendor agreements with American Funds Distributors, Inc. and Fidelity Distributors Corporation to market their retail mutual funds and with Raymond James Financial, Inc. to market their mutual fund brokerage accounts. In addition to retail mutual fund accounts, the Company’s agents can offer a 529 college savings program and Coverdell Education Savings Accounts utilizing certain funds. The Company also markets 403(b)(7) tax-deferred mutual fund investment programs and a minimal amount of fixed indexed annuities through additional third-party vendor agreements. Third-party vendors underwrite these accounts or contracts and the Company receives commissions on the sales of these products.

 

Selected Historical Financial Information for the Retirement Segment

 

The following table provides certain information for the Retirement segment for the periods indicated.

 

Retirement Segment

Selected Historical Financial Information

(Dollars in millions, unless otherwise indicated)

 

     Year Ended December 31, 
     2016     2015     2014 
Financial Data:               
Contract deposits               
Variable   $163.6   $174.9   $140.6 
Fixed    356.6    373.1    340.0 
Total    520.2    548.0    480.6 
Contract charges earned    24.9    25.4    25.6 
Net investment income    249.4    228.4    222.1 
Net interest margin (without net realized investment gains and losses)    102.1    89.7    89.6 
Income before income taxes    71.0    63.3    66.7 
Net income   $50.7   $43.4   $45.3 
                
Operating Statistics:               
Fixed               
Accumulated value   $4,503.1   $4,197.0   $3,885.1 
Accumulated value persistency    94.6%   94.8%   94.5%
Variable               
Accumulated value   $1,923.9   $1,800.7   $1,813.6 
Accumulated value persistency    94.7%   94.3%   94.0%
Number of contracts in force    219,105    211,071    202,572 
Average accumulated value (in dollars)   $29,333   $28,415   $28,132 
Average annual deposit by contractholders (in dollars)   $2,412   $2,381   $2,352 
Annuity contracts terminated due to surrender, death, maturity or other               
Number of contracts    7,482    7,089    7,246 
Amount   $373.2   $343.5   $340.9 
Fixed accumulated value grouped by applicable surrender charge               
0%  $2,650.4   $2,318.9   $2,000.7 
Greater than 0% but less than 5%    172.9    171.2    190.9 
5% and greater but less than 10%    1,525.7    1,542.3    1,528.9 
10% and greater    33.1    44.9    45.7 
Supplementary contracts with life contingencies not subject to discretionary withdrawal    121.0    119.7    118.9 
Total   $4,503.1   $4,197.0   $3,885.1 

 

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Life Segment

 

The Company entered the individual life insurance business in 1949. The Company offers traditional term and whole life insurance products and, from time to time, revises products and product features or develops new products. For instance, the Company offers a discount for educator customers.

 

Following is a description of some of the products and other features in the Company’s life product portfolio. Life by Design is a portfolio of Horace Mann manufactured and branded life insurance products which specifically addresses the financial planning needs of educators. The Life by Design portfolio features individual whole life and individual term products, including 10-, 20- and 30-year level term policies. The Life by Design policies have premiums that are guaranteed for the duration of the contract and offer lower minimum face amounts.

 

The Company offers a combination product called Life Select that mixes a base of either traditional whole life, 20-pay life or life paid-up at age 65 with a variety of term riders to allow for more flexibility in tailoring the coverage to the customers’ varying life insurance needs. Additional products and features are single premium whole life products, as well as a preferred plus underwriting category and $500 thousand and $1 million rate band enhancements for term products. The Company offers Cash Value Term — a term policy that builds cash value while providing the income protection of traditional level term life insurance.

 

In October 2015, the Company introduced an indexed universal life (“IUL”) product with interest crediting strategies linked to the Standard & Poor’s 500 Index and the Dow Jones Industrial Average offering a contingent return based on equity market performance. Along with expanded product offerings, new marketing support tools continue to be introduced to aid the agency force. After December 31, 2006, the Company no longer issues new policies for its “Experience Life” product, a flexible, adjustable-premium life insurance contract that includes availability of an interest-bearing account.

 

The Company's traditional term, whole life and group life business in force consists of approximately 144,000 policies, representing approximately $13.5 billion of life insurance in force, with annual insurance premiums and contract deposits of approximately $52.3 million as of December 31, 2016. In addition, the Company also had in force approximately 54,000 Experience Life policies, representing approximately $3.6 billion of life insurance in force, with annual insurance premiums and contract deposits of approximately $44.2 million.

 

In 2016, the Life segment represented 9% of the Company’s consolidated insurance premiums written and contract deposits.

 

During 2016, the average face amount of ordinary life insurance policies issued by the Company was approximately $182,000 and the average face amount of all ordinary life insurance policies in force at December 31, 2016 was approximately $100,000.

 

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The maximum individual life insurance risk retained by the Company is $300,000 on any individual life, while either $100,000 or $125,000 is retained on each group life policy depending on the type of coverage. The excess of the amounts retained are reinsured with life reinsurers that are rated “A- (Excellent)” or above by A.M. Best. The Company also maintains a life catastrophe reinsurance program. In 2016, the Company reinsured 100% of the catastrophe risk in excess of $1 million up to $35 million per occurrence, with one reinstatement. For 2017, the Company’s catastrophe risk coverage is unchanged. The Company’s life catastrophe risk reinsurance program covers acts of terrorism and includes nuclear, biological and chemical explosions but excludes other acts of war.

 

Selected Historical Financial Information for the Life Segment

 

The following table provides certain information for the Life segment for the periods indicated.

 

Life Segment

Selected Historical Financial Information

(Dollars in millions, unless otherwise indicated)

 

     Year Ended December 31, 
     2016     2015     2014 
Financial Data:               
Insurance premiums and contract deposits   $108.0   $102.7   $102.7 
Insurance premiums and contract charges earned    113.7    110.5    108.4 
Net investment income    73.6    71.6    71.8 
Income before income taxes    26.3    22.9    26.9 
Net income    16.6    15.0    17.5 
                
Operating Statistics:               
Life insurance in force               
Ordinary life   $16,261   $15,589   $14,871 
Group life    764    916    930 
Total   $17,025   $16,505   $15,801 
Number of policies in force               
Ordinary life    163,056    162,670    161,759 
Group life    34,881    39,119    39,108 
Total    197,937    201,789    200,867 
Average face amount in force (in dollars)               
Ordinary life   $99,726   $95,832   $91,933 
Group life    21,903    23,416    23,780 
Total    86,012    81,793    78,664 
Lapse ratio (ordinary life insurance in force)    4.3%   4.1%   4.0%
Ordinary life insurance terminated due to death, surrender, lapse or other               
Face amount of insurance surrendered or lapsed   $674.7   $643.5   $565.2 
Number of policies    4,951    5,014    4,093 
Amount of death claims opened   $55.9   $58.6   $50.0 
Number of death claims opened    1,512    1,645    1,507 

 

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Competition

 

The Company operates in a highly competitive environment. The insurance industry consists of a large number of insurance companies, some of which have substantially greater financial resources, widespread advertising campaigns, more diversified product lines, greater economies of scale and/or lower-cost marketing approaches compared to the Company. In the Company’s target market, management believes that the principal competitive factors in the sale of the Property and Casualty segment’s insurance products are price, overall service, name recognition and worksite sales and service. Management believes that the principal competitive factors in the sale of the Retirement segment’s products and Life segment’s insurance are worksite sales and service, product features, perceived stability of the insurer, price, overall service and name recognition.

 

The Company competes in its target market with a number of national providers of personal automobile, homeowners and life insurance such as State Farm, Allstate, Farmers, Liberty Mutual and Nationwide as well as several regional companies. The Company also competes for automobile business with other companies such as GEICO, Progressive and USAA, many of which feature direct marketing distribution.

 

Among the major national providers of annuities to educators, the Company’s competitors for annuity business include The Variable Annuity Life Insurance Company (“VALIC”), a subsidiary of American International Group (“AIG”); AXA; Voya Financial, Inc.; Life Insurance Company of the Southwest, a subsidiary of National Life Insurance Company; MetLife; Security Benefit; and Teachers Insurance and Annuity Association – College Retirement Equities Fund (“TIAA-CREF”). Select mutual fund families and financial planners also compete in this marketplace.

 

The market for tax-deferred retirement products in the Company’s target market has been impacted by the revised Internal Revenue Service (“IRS”) Section 403(b) regulations, which made the 403(b) market more comparable to the 401(k) market than it was in the past. While this change has and may continue to reduce the number of competitors in this market, it has made the 403(b) market more attractive to some of the larger companies experienced in 401(k) plans, including both insurance and mutual fund companies, that had not previously been active competitors in this business.

 

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Investments

 

The Company's investments are selected to balance the objectives of protecting principal, minimizing exposure to interest rate risk and providing a high current yield. These objectives are implemented through a portfolio that emphasizes investment grade, publicly traded fixed maturity securities, which are selected to match the anticipated duration of the Company’s liabilities. When impairment of the value of an investment is considered other-than-temporary, the decrease in value is recorded and a new cost basis is established. At December 31, 2016, fixed maturity securities represented 93.2% of the Company’s total investment portfolio, at fair value. Of the fixed maturity securities portfolio, 95.6% was investment grade and 95.5% was publicly traded. At December 31, 2016, the average quality and average option-adjusted duration of the total fixed maturity securities portfolio were A and 5.9 years, respectively. At December 31, 2016, investments in non-investment grade fixed income securities represented 3.8% of the total investment portfolio, at fair value. There are no significant investments in mortgage whole loans, real estate or non-U.S. dollar-denominated foreign securities.

 

The Company has separate investment strategies and guidelines for its Property and Casualty, Retirement and Life assets, which recognize different characteristics of the associated insurance liabilities, as well as different tax and regulatory environments. The Company manages interest rate exposure for its portfolios through asset/liability management techniques which attempt to coordinate the duration of the assets with the duration of the insurance policy liabilities. Duration of assets and liabilities will generally differ only because of opportunities to significantly increase yields or because policy values are not interest-sensitive, as is the case in the Property and Casualty segment.

 

The investments of each insurance subsidiary must comply with the insurance laws of such insurance subsidiary's domiciliary state. These laws prescribe the type and amount of investments that may be purchased and held by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, mortgage-backed bonds, other asset-backed bonds, preferred stocks, common stocks, real estate mortgages, real estate, and alternative investments.

 

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The following table presents the carrying values and amortized cost of the Company's investment portfolio.

 

Investment Portfolio

December 31, 2016

(Dollars in millions)

 

   Percentage            
   of Total  Carrying Value         
   Carrying    Life and  Property and  Amortized  
   Value  Total Retirement  Casualty  Cost or Cost  
Publicly Traded Fixed Maturity Securities,                               
Equity Securities and Short-term Investments:                               
U.S. Government and agency obligations, all investment grade (1):                               
Mortgage-backed securities   5.5%  $442.4   $439.1     $3.3     $412.9   
Other, including U.S. Treasury securities   5.8    467.1    459.4      7.7      458.7   
Investment grade corporate and public utility bonds   29.7    2,375.3    2,232.6      142.7      2,249.9   
Non-investment grade corporate and public utility bonds (2)   2.3    186.2    116.7      69.5      184.7   
Investment grade municipal bonds   21.2    1,685.8    1,230.4      455.4      1,561.6   
Non-investment grade municipal bonds (2)   0.5    37.1    17.9      19.2      40.6   
Investment grade other mortgage-backed securities (3)   21.9    1,750.7    1,677.6      73.1      1,752.6   
Non-investment grade other mortgage-backed securities (2)(3)   0.7    54.7    54.6      0.1      49.2   
Foreign government bonds, all investment grade   1.2    98.7    97.4      1.3      93.9   
Redeemable preferred stock, all investment grade   0.2    19.7    19.7      -      17.6   
Equity securities:                               
Non-redeemable preferred stocks, all investment grade   0.6    50.0    46.1      3.9      52.3   
Common stocks   0.9    72.2    1.1      71.1      61.7   
Closed-end fund   0.2    19.4    19.4      -      20.0   
Short-term investments (4)   0.6    44.9    9.9      35.0      44.9   
Total publicly traded securities   91.3    7,304.2    6,421.9      882.3      7,000.6   
Other Invested Assets:                               
Investment grade private placements   4.0    319.8    319.8      -      311.7   
Non-investment grade private placements (2)   0.3    19.2    19.2      -      18.8   
Mortgage loans (5)   -     *     *      -       *   
Policy loans   1.8    151.9    151.9      -      151.9   
Other   2.6    204.2    159.2      45.0      204.2   
Total other invested assets   8.7    695.1    650.1      45.0      686.6   
Total investments (6)   100.0%  $7,999.3   $7,072.0     $927.3     $7,687.2   

 

 

*Less than $0.1 million.
(1)Includes $429.0 million fair value of investments guaranteed by the full faith and credit of the U.S. Government and $480.5 million fair value of federally sponsored agency securities which are not backed by the full faith and credit of the U.S. Government.
(2)A non-investment grade rating is assigned to a security when it is acquired or when it is downgraded from investment grade, primarily on the basis of the Standard & Poor's Corporation (“Standard & Poor’s” or “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. The rating agencies monitor securities, and their issuers, regularly and make changes to the ratings as necessary. The Company incorporates rating changes on a monthly basis.
(3)Includes commercial mortgage-backed securities, asset-backed securities, other mortgage-backed securities and collateralized debt obligations. See also “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations for the Three Years Ended December 31, 2016 — Net Realized Investment Gains and Losses” listed on page F-1 of this report.
(4)Short-term investments mature within one year of being acquired and are carried at cost, which approximates fair value. Short-term investments included $44.2 million in money market funds rated AAA and one $0.7 million corporate bond rated BBB.
(5)Mortgage loans are carried at amortized cost or unpaid principal balance.
(6)Approximately 8% of the Company's investment portfolio, having a carrying value of $628.7 million as of December 31, 2016, consisted of securities with some form of credit support, such as insurance. Of the securities with credit support as of December 31, 2016, municipal bonds represented $382.8 million carrying value.

 

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Fixed Maturity Securities and Equity Securities

 

At December 31, 2016, approximately 33% of the Company's fixed maturity securities portfolio was expected to mature within the next 5 years. Mortgage-backed securities, including mortgage-backed securities of U.S. Governmental agencies, represented approximately 30% of the total investment portfolio at December 31, 2016. These securities typically have average lives shorter than their stated maturities due to unscheduled prepayments on the underlying mortgages. Mortgages are prepaid for a variety of reasons, including sales of existing homes, interest rate changes over time that encourage homeowners to refinance their mortgages and defaults by homeowners on mortgages that are then paid by guarantors.

 

For financial reporting purposes, the Company has classified the entire fixed maturity securities portfolio as “available for sale”. Fixed maturity securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value. The net adjustment for unrealized investment gains and losses on securities available for sale is recorded as a separate component of accumulated other comprehensive income within shareholders' equity, net of applicable deferred tax assets or liabilities and the related impact on deferred policy acquisition costs associated with investment contracts and life insurance products with account values. Fixed maturity securities held for indefinite periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates, resultant prepayment risk and other related factors, other than securities that are in an unrealized loss position for which management has the stated intent to hold until recovery.

 

Cash Flow

 

Information regarding HMEC’s sources and uses of cash, including payment of principal and interest with respect to HMEC's indebtedness, and payment by HMEC of dividends to its shareholders, is contained in “Notes to Consolidated Financial Statements — Note 10 — Statutory Information and Restrictions” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Financial Resources — Cash Flow” and “— Capital Resources” listed on page F-1 of this report.

 

The ability of the insurance subsidiaries to pay cash dividends to HMEC is subject to state insurance department regulations which generally permit dividends to be paid for any 12 month period in amounts equal to the greater of (i) net income for the preceding calendar year or (ii) 10% of surplus, determined in conformity with statutory accounting principles, as of the preceding December 31st. Any dividend in excess of these levels requires the prior approval of the Director or Commissioner of the state insurance department of the state in which the dividend paying insurance subsidiary is domiciled. The aggregate amount of dividends that may be paid in 2017 from all of HMEC's insurance subsidiaries without prior regulatory approval is approximately $91 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.

 

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Regulation

 

General Regulation at State Level

 

As an insurance holding company, HMEC is subject to extensive regulation by the states in which its insurance subsidiaries are domiciled or transact business. Some regulations, such as those addressing unclaimed property, generally apply to all corporations. In addition, the laws of the various states establish regulatory agencies with broad administrative powers, which relate to a wide variety of matters, including granting and revoking licenses to transact business, regulating trade practices and rate setting, licensing agents, requiring statutory financial statements, monitoring insurer solvency and reserve adequacy, and prescribing the type and amount of investments permitted. On an ongoing basis, various state legislators and insurance regulators examine the nature and scope of state insurance regulation.

 

In addition to individual state monitoring and regulation, state regulators develop coordinated regulatory policies through the National Association of Insurance Commissioners (“NAIC”). States have adopted NAIC risk-based capital guidelines to evaluate the adequacy of statutory capital and surplus in relation to an insurance company's risks. Based on current guidelines, the risk-based capital statutory requirements are not expected to have a negative regulatory impact on HMEC’s insurance subsidiaries. At December 31, 2016 and 2015, statutory capital and surplus of each of the Company’s insurance subsidiaries was above required levels. States have also adopted the NAIC’s U.S. Own Risk and Solvency Assessment (“ORSA”) which requires insurance companies to submit their own assessment of their current and future risks and provide a consolidated group-level perspective on risk and capital formulated through an internal risk self-assessment process.

 

Assessments Against Insurers and Mandatory Insurance Facilities

 

Under insurance insolvency or guaranty laws in most states in which the Company operates, insurers doing business therein can be assessed for policyholder losses related to insolvencies of other insurance companies, and many assessments paid by the Company pursuant to these laws may be used as credits for a portion of the Company's premium taxes in certain states. Also, the Company is required to participate in various mandatory insurance facilities in proportion to the amount of the Company's direct writings in the applicable state. For the three years ended December 31, 2016, the impact of the above industry items were not material to the Company’s results of operations.

 

Regulation at Federal Level

 

Although the federal government generally does not directly regulate the insurance industry, federal initiatives often impact the insurance business. Current and proposed federal measures which may significantly affect insurance and retirement business include employee benefits regulation, standards applied to employer sponsored retirement plans, standards applied to certain financial advisors, controls on the costs of medical care, medical entitlement programs such as Medicare, structure of retirement plans and accounts, changes to the insurance industry anti-trust exemption, and minimum solvency requirements. See also “Item 1A. Risk Factors”. Other federal regulation such as the Patient Protection and Affordable Care Act, Fair Credit Reporting Act, Gramm-Leach-Bliley Act and USA PATRIOT Act, including its anti-money laundering regulations, also impact the Company’s business.

 

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The variable annuities underwritten by HMLIC are regulated by the SEC. Horace Mann Investors, Inc., the broker-dealer and Registered Investment Adviser subsidiary of HMEC, also is regulated by the SEC, FINRA, the Municipal Securities Rule-making Board (“MSRB”) and various state securities regulators.

 

Federal income taxation of the build-up of cash value within a life insurance policy or an annuity contract could have a materially adverse impact on the 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. Changes in other federal and state laws and regulations could also affect the relative tax and other advantages of the Company's annuity and life products to customers.

 

Financial Regulation Legislation

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) created the Federal Insurance Office (“FIO”) within the U.S. Department of the Treasury. The FIO studies the current insurance regulatory system and is charged with monitoring and providing specific reports on various aspects of the insurance industry. However, the FIO does not have general supervisory or regulatory authority over the business of insurance. The FIO has suggested an expanded federal role in some circumstances. The executive branch has requested a review of financial regulation, including Dodd-Frank. Management will continue to monitor these future developments for impact on the Company, insurers of similar size and the insurance industry as a whole.

 

Employees

 

At December 31, 2016, the Company had approximately 1,440 non-agent employees and 33 full-time Employee Agents. (This does not include 588 Exclusive Agent independent contractors that were part of the Company’s total dedicated agency force at December 31, 2016.) The Company has no collective bargaining agreement with any employees.

 

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ITEM 1A. Risk Factors

 

The following are certain risk factors that could affect the Company’s business, financial results and results of operations. In addition, refer to the risk factors disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Forward-looking Information”, listed on page F-1 of this report for certain important factors that may cause our financial condition and results of operations to differ materially from current expectations. The risks that the Company has highlighted in these two sections of this report are not the only ones that the Company faces. In this discussion, the Company is also referred to as “our”, “we” and “us”.

 

The Company’s business involves various risks and uncertainties which are based on the lines of business the Company writes as well as more global risks associated with the general business and insurance industry environments.

 

Volatile financial markets and adverse economic environments can impact financial market risk as well as our financial condition and results of operations.

 

Financial markets in the U.S. and elsewhere can experience extreme volatility and disruption for uncertain periods of time. During such times, stresses affecting the global banking system can lead to economic volatility which can exert significant downward pressure on prices of equity securities and many other investment asset classes and result in substantially increased market volatility, severely constrained credit and capital markets, particularly for financial institutions, and an overall loss of investor confidence. Many states and local governments can also be impacted by adverse economic conditions which could have an impact on both the Company’s niche market and its investment portfolio. Like other financial institutions which face significant financial market risk in their operations, the Company was adversely affected by these conditions and could be adversely impacted by similar circumstances in the future. The Company’s ability to access the capital markets to refinance outstanding indebtedness or raise capital could be impaired during significant financial market disruptions.

 

As discussed further in subsequent risk factors, in addition to the effects of financial markets volatility, a prolonged economic recession may have other adverse impacts on our financial condition and results of operations.

 

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If our investment strategy is not successful, we could suffer unexpected losses.

 

The success of our investment strategy is crucial to the success of our business. Specifically, our fixed income portfolio is subject to a number of risks including:

 

  ·   interest rate risk, which is the risk that interest rates will decline and funds reinvested will earn less than expected;
  ·   market value risk, which is the risk that our invested assets will decrease in value due to a change in the yields realized on our assets and prevailing market yields for similar assets, an unfavorable change in the liquidity of the investment or an unfavorable change in the financial prospects or a downgrade in the credit rating of the issuer of the investment;
  ·   credit risk, which is the risk that the value of certain investments becomes impaired due to deterioration in the financial condition of one or more issuers of those instruments or the deterioration in performance or credit quality of the underlying collateral of certain structured securities and, ultimately, the risk of permanent loss in the event of default by an issuer or underlying credit;
  ·   market fundamentals risk, which is the risk that there are changes in the market that can have an unfavorable impact on securities valuation such as availability of credit in the capital markets, re-pricing of credit risk, reduced market liquidity due to broker-dealers’ unwillingness to hold inventory, and increased market volatility;
  ·   concentration risk, which is the risk that the portfolio may be too heavily concentrated in the securities of one or more issuers, sectors or industries, which could result in a significant decrease in the value of the portfolio in the event of deterioration in the financial condition of those issuers or the market value of their securities;
  ·   liquidity risk, which is the risk that liabilities are surrendered or mature sooner than anticipated requiring us to sell assets at an undesirable time to provide for policyholder surrenders, withdrawals or claims; and
  ·   regulatory risk, which is the risk that regulatory bodies or governments, in the U.S. or in other countries, may make substantial investments or take significant ownership positions in, or ultimately nationalize, financial institutions or other issuers of securities held in the Company’s investment portfolio, which could adversely impact the seniority or contractual terms of the securities. Regulatory risk could also come from changes in tax laws or bankruptcy laws that would adversely impact the valuation and/or after tax yields of certain invested assets.

 

In addition to significant steps taken to attempt to mitigate these risks through our investment guidelines, policies and procedures, we also attempt to mitigate these risks through product pricing, product features and the establishment of policy reserves, but we cannot provide assurance that assets will be properly matched to meet anticipated liabilities or that our investments will provide sufficient returns to enable us to satisfy our guaranteed fixed benefit obligations.

 

The Company’s investment strategy and guidelines have resulted in an investment portfolio which is comprised primarily of investment grade, fixed maturity securities. Inclusion of alternative investments, even those consistent with the Company’s overall conservative investment guidelines, could result in some volatility in our financial condition and results of operations.

 

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From time to time, the Company could enter into foreign currency, interest rate, credit derivative and other hedging transactions in an effort to manage risks, including risks that may be attributable to any new products offered by the Company. For instance, the Company recently began utilizing call options to manage interest crediting risk related to its newly introduced fixed indexed annuity and indexed universal life products. We cannot provide assurance that we will successfully structure derivatives and hedges so as to effectively manage risks. If our calculations are incorrect, or if we do not properly structure our derivatives or hedges, we may have unexpected losses and our assets may not be adequate to meet our needed reserves, which could adversely affect our financial condition and results of operations.

 

Although the Company’s defined benefit pension plan is frozen, declining financial markets could also cause, and in the past have caused, the value of the investments in this pension plan to decrease, resulting in additional pension expense, a reduction in other comprehensive income and an increase in required contributions to the defined benefit pension plan, which could have an adverse effect on our financial condition and results of operations.

 

The determination of the fair value of our fixed maturity and equity securities includes methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to investment valuations that may materially impact our financial condition and results of operations.

 

The determination of fair values is made at a specific point in time, based on available market information and judgments about financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counterparty. The use of different methodologies and assumptions may have a material effect on the estimated fair value amounts. During periods of market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the financial environment. In such cases, fair value determination may require more subjectivity and management judgment and those fair values may differ materially from the value at which the investments ultimately could be sold. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of securities and the period-to-period changes in value could vary significantly. The difference between fair value and amortized cost or cost, net of applicable deferred income tax asset or liability and the related impact on deferred policy acquisition costs associated with investment (annuity) contracts and life insurance products with account values, and interest-sensitive life contracts, is reflected as a component of accumulated other comprehensive income within shareholders' equity. Decreases in the fair value of our investments could have a material adverse effect on our financial condition and results of operations.

 

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A sustained period of low interest rates or interest rate fluctuations could negatively affect the income we derive from the difference between the interest rates we earn on our investments and the interest we pay under our fixed annuity contracts and life insurance products with account values.

 

Significant changes in interest rates expose us to the risk of not earning income or experiencing losses based on the differences between the interest rates earned on our investments and the credited interest rates paid on our outstanding fixed annuity contracts and life insurance products with account values. Significant changes in interest rates may affect:

 

  ·   the ability to maintain appropriate interest rate spreads over the fixed rates guaranteed in our annuity and life products;
  ·   the book yield of our investment portfolio; and
  ·   the unrealized gains and losses in our investment portfolio and the related after tax effect on our shareholders’ equity and total capital.

 

Both rising and declining interest rates can negatively affect the income we derive from our annuity and life products’ interest rate spreads. During periods of falling interest rates or a sustained period of low interest rates, our investment earnings will be lower because new investments in fixed maturity securities likely will bear lower interest rates. We may not be able to fully offset the decline in investment earnings with lower crediting rates on our annuity contracts, particularly in a multi-year period of low interest rates. As of the time of this Annual Report on Form 10-K, new money rates remain at historically low levels. If interest rates do remain low over an extended period of time, it could pressure our net investment income by having to invest insurance cash flows and reinvest the cash flows from the investment portfolio in lower yielding securities.

 

During periods of rising interest rates, there may be competitive pressure to increase the crediting rates on our annuity contracts. We may not, however, immediately have the ability to acquire investments with interest rates sufficient to offset an increase in crediting rates under our annuity contracts. Although we develop and maintain asset/liability management programs and procedures designed to reduce the volatility of our income when interest rates are rising or falling, changes in interest rates can affect our interest rate spreads.

 

Changes in interest rates may also affect our business in other ways. For example, a rapidly changing interest rate environment may result in less competitive crediting rates on certain of our fixed rate products which could make those products less attractive, leading to lower sales and/or increases in the level of life insurance and annuity product surrenders and withdrawals. New business volume also could be negatively impacted by product or agent compensation changes which we might make to mitigate the income effect of spread compression. Interest rate fluctuations that impact future profits may also impact the amortization of deferred policy acquisition costs.

 

As another example of potential interest rate impacts, our Retirement and Life operations participate in the cash flow testing procedures imposed by statutory insurance regulations, the purpose of which is to ensure that such liabilities are adequate to meet the Company’s obligations under a variety of interest rate scenarios. A continuation of the current low interest rate environment over a prolonged period of time could cause the Company to increase statutory reserves as a result of cash flow testing, which would reduce statutory surplus of the Life insurance subsidiaries and potentially limit the subsidiaries’ ability to distribute cash to the holding company or write insurance business (as further described in a subsequent risk factor).

 

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Regulatory initiatives, including the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), could adversely impact liquidity and volatility of financial markets in which we participate.

 

In response to the credit and financial crisis, U.S. and overseas governmental and regulatory authorities are considering or implementing enhanced or new regulatory requirements intended to prevent future crises or stabilize the institutions under their supervision. Such measures are leading to stricter regulation of financial institutions. Changes from Dodd-Frank and other U.S. and overseas governmental initiatives have created uncertainty and could continue to adversely impact liquidity and increase volatility of the financial markets in which we participate and, in turn, negatively affect our financial condition or results of operations. The executive branch has requested a review of financial regulations including Dodd-Frank, which may eliminate or mitigate this risk.

 

Our Retirement business may be, and in the past has been, adversely affected by volatile or declining financial market conditions.

 

Conditions in the U.S. and international financial markets affect the sale and profitability of our annuity products. In general, sales of variable annuities decrease when financial markets are declining or experiencing a higher than normal level of volatility over an extended period of time. Therefore, weak and/or volatile financial market performance may adversely affect sales of our variable annuity products to potential customers, may cause current customers to withdraw or reduce the amounts invested in our variable annuity products and may reduce the market value of existing customers’ investments in our variable annuity products, in turn reducing the amount of variable annuity fee revenues generated. In addition, some of our variable annuity contracts offer guaranteed minimum death benefit features, which provide for a benefit if the contractholder dies and the contract value is less than a specified amount. A decline in the financial markets could cause the contract value to fall below this specified amount, increasing our exposure to losses from variable annuity products featuring guaranteed minimum death benefits. Declining or volatile financial markets that impact future profits may also impact the amortization of deferred policy acquisition costs.

 

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We may experience volatility in our results of operations and financial condition due to the fair value accounting for derivative instruments.

 

All derivative instruments, including derivative instruments embedded in fixed indexed annuity contracts and indexed universal life policies, are recognized in the balance sheet at their fair values. Changes in the fair value of these instruments are recognized immediately in our results of operations as follows:

 

  ·   Call options purchased to fund the annual index credits on our fixed indexed annuity and indexed universal life products are presented at fair value. The fair value of the call options is based on the amount of cash expected to be received to settle the call options obtained from the counterparties adjusted for the nonperformance risk of the counterparty. The change in fair value of derivatives includes the gains or losses recognized at expiration of the option term or upon early termination as well as changes in fair value for open positions.
  ·   The fixed indexed annuity contractual obligations for future annual index credits are treated as a "series of embedded derivatives" over the expected lives of the applicable contracts. Increases or decreases in the fair value of embedded derivatives generally correspond to increases or decreases in equity market performance and changes in the interest rates used to discount the excess of the projected policy contract values over the projected minimum guaranteed contract values.
  ·   The indexed universal life contractual obligations for future index credits are set equal to the fair value of outstanding 12 month derivatives held in support of the applicable contracts.

 

In future periods, the application of fair value accounting for derivatives and embedded derivatives to our fixed indexed annuity and indexed universal life business may cause volatility in our results of operations.

 

Mark-to-market adjustments on certain equity method investments may reduce our profitability and/or cause volatility in our reported results of operations.

 

We invest a portion of our invested assets in limited partnership funds, which are accounted for using the equity method with changes in fair value reported in net investment income in the Consolidated Statement of Operations. The amount and timing of income from such investment funds tend to be uneven as a result of the performance of the underlying investments. The timing of distributions from the funds, which depends on particular events relating to the underlying investments, as well as the funds’ schedules for making distributions and their needs for cash, can be difficult to predict. As a result, the amount of income that we record from these investments can vary substantially from period to period. Recent equity and credit market volatility may reduce investment income from these types of investments and negatively impact our results of operations.

 

An inability to access Federal Home Loan Bank (“FHLB”) funding could adversely affect our results of operations.

 

Any changes in requirements to retain membership in the Federal Home Loan Bank, or changes in regulation, could impact our eligibility for continued FHLB membership or our FHLB funding capacity. Any event that adversely affects amounts received from FHLB could have an adverse effect on our results of operations.

 

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Losses due to defaults by others could reduce our profitability or negatively affect the value of our investments.

 

Third-party debtors may not pay or perform their obligations. These parties may include the issuers whose securities we hold, customers, reinsurers, borrowers under mortgage loans, trading counterparties, counterparties under swaps and other derivative contracts, clearing agents, exchanges, clearing houses and other financial intermediaries. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, downturns in the economy or real estate values, operational failure or other reasons.

 

During or following an economic downturn, our municipal bond portfolio could be subject to a higher risk of default or impairment due to declining municipal tax bases and revenue. States are currently barred from seeking protection in federal bankruptcy court. However, federal legislation could possibly be enacted to allow states to declare bankruptcy in connection with deficit reductions or mounting unfunded pension liabilities, which could adversely impact the value of our investment portfolio.

 

The default of a major market participant could disrupt the securities markets or clearance and settlement systems in the U.S. or abroad. A failure of a major market participant could cause some clearance and settlement systems to assess members of that system, including our broker-dealer and Registered Investment Adviser regulatory entities, or could lead to a chain of defaults that could adversely affect us. A default of a major market participant could disrupt various markets, which could in turn cause market declines or volatility and negatively impact our financial condition and results of operations.

 

Catastrophic events, as well as significant weather events not designated as catastrophes, can have a material adverse effect on our financial condition and results of operations.

 

Underwriting results of property and casualty insurers are subject to weather and other conditions prevailing in an accident year. While one year may be relatively free of major weather or other disasters — not all of which are designated by the insurance industry as a catastrophe, another year may have numerous such events causing results for such a year to be materially worse than for other years.

 

Our Property and Casualty insurance subsidiaries have experienced, and we anticipate that in the future they will continue to experience, catastrophe losses. A catastrophic event, a series of multiple catastrophic events or a series of non-catastrophe severe weather events could have a material adverse effect on the financial condition and results of operations of our insurance subsidiaries.

 

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Various events can cause catastrophes, including hurricanes, windstorms, hail, severe winter weather, wildfires, earthquakes, explosions and terrorism. The frequency and severity of these catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposures in the area affected by the event and the severity of the event. Although catastrophes can cause losses in a variety of Property and Casualty lines, most of the catastrophe-related claims of our insurance subsidiaries are related to homeowners’ coverages. Our ability to provide accurate estimates of ultimate catastrophe costs is based on several factors, including:

 

  ·   the proximity of the catastrophe occurrence date to the date of our estimate;
  ·   potential inflation of property repair costs in the affected area;
  ·   the occurrence of multiple catastrophes in a geographic area over a relatively short period of time; and
  ·   the outcome of litigation which may be filed against the Company by policyholders, state attorneys general and other parties relative to loss coverage disputes and loss settlement payments.

 

Based on 2016 direct premiums earned, 57% of the total annual premiums for our Property and Casualty business were for policies issued in the ten largest states in which our insurance subsidiaries write property and casualty coverage. Included in this top ten group are certain states which are considered to be more prone to catastrophe occurrences: California, North Carolina, Texas, South Carolina, Florida and Louisiana.

 

As an ongoing practice, we manage our exposure to catastrophes, as well as our exposure to non-catastrophe weather and other property loss risks. Reductions in Property and Casualty business written in catastrophe-prone areas may have a negative impact on near-term business growth and results of operations.

 

In addition to the potential impact on our Property and Casualty subsidiaries, our Life subsidiary could experience claims of a catastrophic magnitude from events such as pandemics; terrorism; nuclear, biological or chemical explosions; or other acts of war.

 

Our insurance subsidiaries seek to reduce their exposure to catastrophe losses through their underwriting strategies and the purchase of catastrophe reinsurance. Nevertheless, reinsurance may prove inadequate under certain circumstances.

 

Uncollectible reinsurance, as well as reinsurance availability and pricing, can have a material adverse effect upon our business volume and profitability.

 

Reinsurance is a contract by which one insurer, called a reinsurer, agrees to cover a portion of the losses incurred by a second insurer in the event a claim is made under a policy issued by the second insurer. Our insurance subsidiaries obtain reinsurance to help manage their exposure to property, casualty and life insurance risks. Although a reinsurer is liable to our insurance subsidiaries according to the terms of its reinsurance policy, the insurance subsidiaries remain primarily liable as the direct insurers on all risks reinsured. As a result, reinsurance does not eliminate the obligation of our insurance subsidiaries to pay all claims, and each insurance subsidiary is subject to the risk that one or more of its reinsurers will be unable or unwilling to honor its obligations.

 

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Although we limit participation in our reinsurance programs to reinsurers with high financial strength ratings and also limit the amount of coverage from each reinsurer, our insurance subsidiaries cannot guarantee that their reinsurers will pay in a timely fashion, if at all. Reinsurers may become financially unsound by the time that they are called upon to pay amounts due, which may not occur for many years.

 

Additionally, the availability and cost of reinsurance are subject to prevailing market conditions beyond our control. For example, significant losses from hurricanes or terrorist attacks, an increase in capital requirements, or a future lapse of the provisions of the Terrorism Risk Insurance Act could have a significant adverse impact on the reinsurance market.

 

If one of our insurance subsidiaries is unable to obtain adequate reinsurance at reasonable rates, that insurance subsidiary would have to increase its risk exposure and/or reduce the level of its underwriting commitments, which could have a material adverse effect upon the business volume and profitability of the subsidiary. Alternately, the insurance subsidiary could elect to pay the higher than reasonable rates for reinsurance coverage, which could have a material adverse effect upon its profitability until policy premium rates could be raised, in some cases subject to approval by state regulators, to incorporate this additional cost.

 

Our Property and Casualty loss reserves may not be adequate.

 

Our Property and Casualty insurance subsidiaries maintain loss reserves to provide for their estimated ultimate liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred as of the end of each accounting period. If these loss reserves prove inadequate, we will record a loss measured by the amount of the shortfall and, as a result, the financial condition and results of operations of our insurance subsidiaries will be adversely affected, potentially affecting their ability to distribute cash to the holding company.

 

Reserves do not represent an exact calculation of liability. Reserves represent estimates, generally involving actuarial projections at a given time, of what our insurance subsidiaries expect the ultimate settlement and adjustment of claims will cost, net of salvage and subrogation. Estimates are based on assessments of known facts and circumstances, assumptions related to the ultimate cost to settle such claims, estimates of future trends in claims severity and frequency, changing judicial theories of liability, and other factors. These variables are affected by both internal and external events, including changes in claims handling procedures, economic inflation, unpredictability of court decisions, plaintiffs’ expanded theories of liability, risks inherent in major litigation and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. Significant reporting lags may exist between the occurrence of an insured event and the time it is actually reported. Our insurance subsidiaries adjust their reserve estimates regularly as experience develops and further claims are reported and settled.

 

Due to the inherent uncertainty in estimating reserves for losses and loss adjustment expenses, we cannot be certain that the ultimate liability will not exceed amounts reserved, with a resulting adverse effect on our financial condition and results of operations.

 

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Changing climate conditions may adversely affect our financial condition, results of operations or cash flows.

 

Many scientists indicate that the world’s overall climate is getting warmer. Climate change, to the extent it produces rising temperatures and changes in weather patterns, could impact the frequency and/or severity of weather events and wildfires, the affordability and availability of our catastrophe reinsurance coverage, and our results of operations. If an increase in weather events and/or wildfires were to occur, in addition to the attendant increase in claim costs, which could adversely impact our results of operations and financial condition, concentrations of insurance risk could impact our ability to make homeowners insurance available to our customers. This could adversely impact our volume of business and our results of operations or cash flows.

 

Deviations from assumptions regarding future market appreciation, interest spreads, business persistency, mortality and morbidity used in calculating life and annuity reserves and deferred policy acquisition expense amounts could have a material adverse impact on our financial condition and results of operations.

 

The processes of calculating reserve and deferred policy acquisition expense amounts for our life and annuity businesses involve the use of a number of assumptions, including those related to market appreciation (the rate of growth in market value of the underlying variable annuity subaccounts due to price appreciation), interest spreads (the interest rates expected to be received on investments less the rate of interest credited to contractholders), business persistency (how long a contract stays with the company), mortality (the relative incidence of death over a given period of time) and morbidity (the relative incidence of disability resulting from disease or physical impairment). We periodically review the adequacy of these reserves and deferred policy acquisition expenses on an aggregate basis and, if future experience is estimated to differ significantly from previous assumptions, adjustments to reserves and deferred policy acquisition expenses may be required which could have a material adverse effect on our financial condition and results of operations.

 

An impairment of all or part of our goodwill could adversely affect our results of operations.

 

At December 31, 2016, we had $47.4 million of goodwill recorded on our Consolidated Balance Sheet. Goodwill was recorded when the Company was acquired in 1989 and when Horace Mann Property & Casualty Insurance Company was acquired in 1994, in both instances reflecting the excess of cost over the fair market value of net assets acquired. In 2016, the goodwill balance was evaluated for impairment, as described in “Notes to Consolidated Financial Statements — Note 1 — Summary of Significant Accounting Policies”, with no impairment charge resulting from such assessment. The evaluation of goodwill considers a number of factors including the impacts of a volatile financial market on earnings, discount rate assumptions, liquidity and the Company’s market capitalization. If an evaluation of the Company’s fair value or of the Company’s segments’ fair value indicated that all or a portion of the goodwill balance was impaired, the Company would be required to write off the impaired portion. Such a write-off could have a material adverse effect on our results of operations in the period of the write-off; however, management does not anticipate a material effect on the Company’s financial condition.

 

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Any downgrade in or adverse change in outlook for our claims-paying ratings, financial strength ratings or credit ratings could adversely affect our financial condition and results of operations.

 

Claims-paying ratings and financial strength ratings have become an increasingly important factor in establishing the competitive position of insurance companies. In the evolving 403(b) annuity market, school districts and benefit consultants have placed an emphasis on the relative financial strength ratings of competing companies. Each rating agency reviews its ratings periodically and from time to time may modify its rating criteria including, among other factors, its expectations regarding capital adequacy, profitability and revenue growth. A downgrade in the ratings or adverse change in the ratings outlook of any of our insurance subsidiaries by a major rating agency could result in a substantial loss of business for that subsidiary if school districts, policyholders or independent agents move their business to other companies having higher claims-paying ratings and financial strength ratings than we do. This loss of business could have a material adverse effect on the results of operations and financial condition of that subsidiary.

 

A downgrade in our holding company debt rating also could adversely impact our cost and flexibility of borrowing which could have an adverse impact on our liquidity, financial condition and results of operations.

 

Reduction of the statutory surplus of our insurance subsidiaries could adversely affect their ability to write insurance business.

 

Insurance companies write business based, in part, upon guidelines including capital ratios considered by the NAIC and various rating agencies. Some of these ratios include risk-based capital ratios for both property and casualty insurance companies and life insurance companies, as well as a ratio of premiums to surplus for property and casualty insurance companies. Risk-based capital ratios measure an insurer’s capital adequacy and consider various risks such as underwriting, investment, credit, asset concentration and interest rate. If our insurance subsidiaries cannot maintain profitability in the future or if significant investment valuation losses are incurred, they may be required to draw on their surplus, thereby reducing capital adequacy, in order to pay dividends to us to enable us to meet our financial obligations. As their surplus is reduced by the payment of dividends, continuing losses or both, our insurance subsidiaries’ ability to write business and maintain acceptable financial strength ratings could also be reduced. This could have a material adverse effect upon the business volume and profitability of our insurance subsidiaries.

 

If we are not able to effectively develop and expand our marketing operations, including agents and other points of distribution, our financial condition and results of operations could be adversely affected.

 

The Company’s agencies are owned primarily by non-employee, independent contractor, Exclusive Agents and nearly all of these agencies operate under the Agency Business Model — agents in outside offices with licensed producers — which is designed to remove capacity constraints while increasing productivity. The economic viability of each agency is directly dependent of the productivity of the agency and the success at penetrating, serving and cross-selling the Company’s educator market.

 

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Our success in marketing and selling our products is largely dependent upon the efforts of our agent sales force and the success of their agency operations. As we expand our business, we may need to expand the number of agencies marketing our products. If we are unable to appoint additional agents, fail to retain high-producing agents, are unable to maintain the productivity of those agency operations or are unable to maintain market penetration in existing territories, sales of our products likely would decline and our financial condition and results of operations could be adversely affected.

 

If we are not able to maintain and secure (1) access to educators and (2) endorsements and other relationships with the educational community, our financial condition and results of operations could be adversely affected.

 

Our ability to successfully increase new business in the educator market is largely dependent on our ability to effectively access educators either in their school buildings or through other approaches. While this is especially true for the sale of 403(b) tax-qualified annuity products via payroll deduction, any significant decrease in access, either through fewer payroll slots, increased security measures, impacts of state or federal level pension reform initiatives, requirements of national and state Do Not Call registries, or for other reasons could adversely affect the sale of all lines of our business and require us to change our traditional approach to worksite marketing and promotion, as well as contact with potential customers. With the current IRS regulations regarding Section 403(b) arrangements, including annuities, our ability to maintain and increase our share of the 403(b) market, and the access it gives us for other product lines, will depend on our ability to successfully compete in this market. Some school districts and benefit consultants have placed an emphasis on the relative financial strength ratings of competing companies, as well as low cost product and distribution approaches, which may put us at a competitive disadvantage relative to other more highly-rated insurance companies.

 

Our ability to maintain and obtain product and corporate endorsements from, and/or marketing agreements with, local, state and national education-related associations is important to our marketing strategy. In addition to teacher organizations, we have established relationships with various other educator, principal, school administrator and school business official groups. These contacts and endorsements help to establish our brand name and presence in the educational community and to enhance our access to educators.

 

The Department of Labor (“DOL”) fiduciary rule and the possible adoption by the Securities and Exchange Commission (“SEC”) of a fiduciary standard of care could have a material adverse effect on our business, financial condition and results of operations.

 

On April 6, 2016, the DOL released a final regulation which more broadly defines the types of activities that will result in a person being deemed a “fiduciary” for purposes of the prohibited transaction rules of the Employee Retirement Income Security Act (“ERISA”) and Internal Revenue Code Section 4975. Section 4975 prohibits certain kinds of compensation with respect to transactions involving assets in certain accounts, including individual retirement accounts (“IRAs”).

 

The DOL regulation provides that its requirements will generally become applicable on April 10, 2017, with certain requirements becoming applicable on January 1, 2018.

 

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The DOL regulation will affect the ways in which financial services representatives can be compensated for sales to participants in ERISA employer-sponsored qualified plans and sales to IRA customers, and it will impose significant additional legal obligations and disclosure requirements. The DOL regulation could have a material adverse effect on our business and results of operations. While the regulation does not affect non-ERISA employer-sponsored qualified plans, such as public school 403(b) plans, it could have the following impacts, among others:

 

  ·   It could inhibit our ability to sell and service IRAs, resulting in a change and/or a reduction of the types of products we offer for IRAs, and impact our relationship with current clients.
  ·   It could require changes in the way that we compensate our agents, thereby impacting our agents’ business model.
  ·   It could require changes in our distribution model for financial services products and could result in a decrease in the number of our agents.
  ·   It could increase our costs of doing IRA business and increase our litigation and regulatory risks.
  ·   It could increase the cost and complexity of regulatory compliance for our Retirement segment’s products, including our recently introduced fixed indexed annuity product.

 

At the request of the executive branch, the DOL is evaluating the fiduciary role, and the related prohibited transaction exception. As a result of this review, the implementation of the rule may be delayed. At this point, however, the regulatory landscape is uncertain.

 

Further, in January 2011, under the authority of the Dodd-Frank Act, the SEC submitted a report to Congress recommending that the SEC adopt a fiduciary standard of conduct for broker-dealers. According to the SEC, notice of proposed rulemaking is anticipated in 2017. This regulatory activity by the SEC also has the potential to adversely impact our business, financial condition and results of operations.

 

Economic and other factors affecting our niche market could adversely impact our financial condition and results of operations.

 

Horace Mann's strategic objective is to become the company of choice in meeting the insurance and financial services needs of the educational community. With K-12 teachers, administrators, and support personnel representing a significant percentage of our business, the financial condition and results of operations of our subsidiaries could be more prone than many of our competitors to the effects of economic forces and other issues affecting the educator market including, but not limited to, federal, state and local budget deficits and cut-backs and adverse changes in state and local tax revenues.

 

While the U.S. financial market and certain sectors of the economy have shown improvement over recent years, federal and state revenue shortages continue to pressure the budgets of many school districts. Teacher layoffs and early retirements have taken place and it is possible that additional reductions could occur. Similar to others in the insurance industry, the Company has experienced periods with pressure on new business sales levels. However, despite the economic headwinds, as of the time of this Annual Report on Form 10-K, the Company’s retention of annuity accumulated values remains strong with continued positive total annuity net fund flows. However, there can be no assurance that these business factors will remain favorable.

 

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The personal lines insurance and annuity markets are highly competitive and our financial condition and results of operations may be adversely affected by competitive forces.

 

We operate in a highly competitive environment and compete with numerous insurance companies, as well as mutual fund families, independent agent companies and financial planners. In some instances and geographic locations, competitors have specifically targeted the educator marketplace with specialized products and programs. We compete in our target market with a number of national providers of personal automobile and homeowners insurance and life insurance and annuities.

 

The insurance industry consists of a large number of insurance companies, some of which have substantially greater financial resources, more diversified product lines, more sophisticated product pricing, greater economies of scale and/or lower-cost marketing approaches compared to us. In our target market, we believe that the principal competitive factors in the sale of property and casualty insurance products are price, overall service, name recognition and worksite sales and service. We believe that for our market the principal competitive factors in the sale of annuity products and life insurance are worksite sales and service, product features, perceived stability of the insurer, price, overall service and name recognition. And, we believe that the Company’s focus on the educator market niche, as well as the knowledge obtained regarding this niche throughout the Company’s history, contribute to our ability to effectively and profitably serve this market.

 

Particularly in the property and casualty business, our insurance subsidiaries from time to time, generally on a cyclical basis, experience periods of intense competition during which they may be unable to increase policyholders and revenues without adversely impacting profit margins. During the current cycle, and potentially beyond, competition from direct writers and large, mass market carriers has been particularly aggressive, evidenced in part by their significant national advertising expenditures. In addition, advancements in vehicle technology and safety features, such as accident prevention technologies or the development of autonomous or partially autonomous vehicles — once widely available and utilized, as well as expanded availability of usage-based insurance could materially alter the way that automobile insurance is marketed, priced and underwritten. The inability of our insurance subsidiaries to effectively anticipate the impact of these issues on our business and compete successfully in the property and casualty business could adversely affect the subsidiaries’ financial condition and results of operations and the resulting ability to distribute cash to the holding company.

 

In our Retirement business, the current IRS Section 403(b) regulations make the 403(b) market similar to the 401(k) market. These regulations have reduced and could continue to reduce the number of competitors in this market as the 403(b) market has become more attractive to some of the larger companies experienced in 401(k) plans, including both insurance and mutual fund companies, that had not previously been active competitors in this business. While not yet widespread, there has been continued pressure in some states to adopt state-sponsored or mandated 403(b) plans with single- or limited-provider options; this pressure has come from competitor lobbying efforts and state legislature-initiated pension reform initiatives. The inability of our insurance subsidiaries to compete successfully in these markets could adversely affect the subsidiaries’ financial condition and results of operations and the resulting ability to distribute cash to the holding company.

 

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A reduction or elimination of the tax advantages of annuity and life products and/or a change in the tax benefits of various government-authorized retirement programs, such as 403(b) annuities and individual retirement accounts (“IRAs”), could make our products less attractive to clients and adversely affect our operating results.

 

A significant part of our Retirement business involves fixed and variable 403(b) tax-qualified annuities, which are annuities purchased voluntarily by individuals employed by public school systems or other tax-exempt organizations. Our financial condition and results of operations could be adversely affected by changes in federal and state laws and regulations that affect the relative tax and other advantages of our life and annuity products to clients or the tax benefits of programs utilized by our customers. As a result of persisting economic conditions, revenue challenges exist at federal, state and local government levels. These challenges could increase the risk of future adverse impacts on current tax-advantaged products or result in notable reforms to educator pension programs. See also “Item 1. Business — Regulation — Regulation at Federal Level”.

 

Current federal income tax laws generally permit the tax-deferred accumulation of earnings on the premiums paid by the holders of retirement and life insurance products. Taxes, if any, are generally payable on income attributable to a distribution under the contract for the year in which the distribution is made. From time to time, Congress has considered legislation that would reduce or eliminate the benefit of such deferral of taxation on the accretion of value within life insurance and non-qualified annuity contracts. Enactment of this legislation, or other tax reform efforts, including a simplified “flat tax” income structure with an exemption from taxation for investment income, could result in fewer sales of our life insurance and annuity products.

 

The insurance industry is highly regulated.

 

We are subject to extensive regulation and supervision in the jurisdictions in which we do business. Each jurisdiction has a unique and complex set of laws and regulations. Furthermore, certain federal laws impose additional requirements on businesses, including insurers. Regulation generally is designed to protect the interests of policyholders, as opposed to stockholders and non-policyholder creditors. Such regulations, among other things, impose restrictions on the amount and type of investments our subsidiaries may hold. Certain states also regulate the rates insurers may charge for certain property and casualty products. Legislation and voter initiatives have expanded, in some instances, the states’ regulation of rates and have increased data reporting requirements. Consumer-related pressures to roll back rates, even if not enacted by legislation or upheld upon judicial appeal, may affect our ability to obtain timely rate increases or operate at desired levels of profitability. Changes in insurance regulations, including those affecting the ability of our insurance subsidiaries to distribute cash to us and those affecting the ability of our insurance subsidiaries to write profitable property and casualty insurance policies in one or more states, may adversely affect the financial condition and results of operations of our insurance subsidiaries. In addition, consumer privacy requirements may increase our cost of processing business. Our ability to comply with laws and regulations, at a reasonable cost, and to obtain necessary regulatory action in a timely manner, is and will continue to be critical to our success.

 

Regulation that could adversely affect our insurance subsidiaries also includes statutory surplus and risk-based capital requirements. Maintaining appropriate levels of surplus, as measured by statutory accounting principles, is considered important by state insurance regulatory authorities and the private agencies that rate insurers’ claims-paying abilities and financial strength. The failure of an insurance subsidiary to maintain levels of statutory surplus

 

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that are sufficient for the amount of its insurance written could result in increased regulatory scrutiny, action by state regulatory authorities or a downgrade by rating agencies.

 

Similarly, the NAIC has adopted a system of assessing minimum capital adequacy that is applicable to our insurance subsidiaries. This system, known as risk-based capital, is used to identify companies that may merit further regulatory action by analyzing the adequacy of the insurer’s surplus in relation to statutory requirements.

 

Because state legislatures remain concerned about the availability and affordability of property and casualty insurance and the protection of policyholders, our insurance subsidiaries expect that they will continue to face efforts by those legislatures to expand regulations to address these concerns. Resulting new legislation could adversely affect the financial condition and results of operations of our insurance subsidiaries.

 

In the event of the insolvency, liquidation or other reorganization of any of our insurance subsidiaries, our creditors and stockholders would have no right to proceed against any such insurance subsidiary or to cause the liquidation or bankruptcy of any such insurance subsidiary under federal or state bankruptcy laws. The insurance laws of the domiciliary state would govern such proceedings and the relevant insurance commissioner would act as liquidator or rehabilitator for the insurance subsidiary. Creditors and policyholders of any such insurance subsidiary would be entitled to payment in full from the assets of the insurance subsidiary before we, as a stockholder, would be entitled to receive any distribution.

 

The financial position of our insurance subsidiaries also may be affected by court decisions that expand insurance coverage beyond the intention of the insurer at the time it originally issued an insurance policy.

 

Dodd-Frank created the Federal Insurance Office (“FIO”) within the U.S. Department of the Treasury. The FIO studies the current insurance regulatory system and is charged with monitoring and providing specific reports on various aspects of the insurance industry. However, the FIO does not have general supervisory or regulatory authority over the business of insurance. The FIO has suggested an expanded federal role in some circumstances. Management will continue to monitor developments under Dodd-Frank, as various aspects of it continue to be addressed by governmental bodies. Additional regulations could adversely affect the efficiency and effectiveness of business processes, financial condition and results of operations of the Company, insurers of similar size and/or the insurance industry as a whole.

 

The insurance industry is highly cyclical.

 

The results of companies in the insurance industry historically have been subject to significant fluctuations due to competition, economic conditions, interest rates and other factors. In particular, companies in the property and casualty insurance segment of the industry historically have experienced pricing and profitability cycles. With respect to these cycles, the factors having the greatest impact include significant and/or rapid changes in loss costs, including changes in loss frequency and/or severity; prior approval and restrictions in certain states for price increases; intense price competition; less restrictive underwriting standards; aggressive marketing; and increased advertising, which have resulted in higher industry-wide combined loss and expense ratios.

 

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Cybersecurity Requirements for Financial Services Companies at State Level

 

Individual state regulation of Cybersecurity programs are being adopted on a state by state basis to ensure the safety and soundness of the institution and protect its customers. New York State Department of Financial Services adopted a regulation providing minimum standards for an organization’s Cybersecurity program and requiring an annual certification confirming compliance. Additional states may establish Cybersecurity regulations with varying compliance requirements.

 

Litigation may harm our financial strength or reduce our profitability.

 

Companies in the insurance industry have been subject to substantial litigation resulting from claims, disputes and other matters. Most recently, they have faced expensive claims, including class action lawsuits, alleging, among other things, improper sales practices and improper claims settlement procedures. Negotiated settlements of certain such actions have had a material adverse effect on many insurance companies. The resolution of similar future claims against any of our insurance subsidiaries, including the potential adverse effect on our reputation and charges against the earnings of our insurance subsidiaries as a result of legal defense costs, a settlement agreement or an adverse finding or findings against our insurance subsidiaries in such a claim, could have a material adverse effect on the financial condition and results of operations of our insurance subsidiaries.

 

Data security breaches or denial of service on our websites could have an adverse impact on the Company’s business and reputation.

 

Unauthorized access to and unintentional dissemination of our confidential, highly-sensitive customer, employee or Company data or other breaches of data security in our facilities, networks or databases, or those of our agents or third-party vendors — including information technology and software vendors, could result in loss or theft of assets or sensitive information, data corruption or operational disruption that may expose the Company to liability and/or regulatory action and may have an adverse impact on the Company’s customers, employees, investors, reputation and business. In addition, any compromise of the security of our data or prolonged denial of service on our websites could harm the Company’s business and reputation. We have designed, implemented and routinely test industry-compliant procedures for protection of confidential information and sensitive corporate data, including rapid response procedures to help contain or prevent data loss if a breach were to occur. We have also implemented multiple technical security protections and contractual obligations regarding security breaches for our agents and third-party vendors. Even with these efforts, there can be no assurance that security breaches or service disruptions will be prevented.

 

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Successful execution of our business growth strategy is dependent on effective implementation of new or enhanced technology systems and applications.

 

Our ability to effectively execute our business growth strategy and leverage potential economies of scale is dependent on our ability to provide the requisite technology components for that strategy. While we have effectively upgraded our infrastructure technologies with improvements in our data center, a new communications platform and enhancements to our disaster recovery capabilities, our ability to replace or supplement dated, monolithic legacy business systems — such as our life, annuity and property and casualty policy administrative systems — with more flexible, maintainable, and customer accessible solutions will be necessary to achieve our plans. The inherent difficulty in replacing and/or modernizing these older technologies, coupled with the Company’s limited experience in these endeavors, presents an increased risk to delivering these technology solutions in a cost effective and timely manner. Our scale will require us to develop innovative solutions to address these challenges, including consideration of “software as a service” arrangements and other third-party based information technology capabilities. More modern approaches to software development and utilization of third-party vendors can augment the Company’s internal capacity for these implementations, but may not adequately reduce the operational risks of timely and cost effective delivery.

 

Loss of key vendor relationships could affect our operations.

 

We increasing rely on services and products provided by a number of vendors in the United States and abroad. These include, for example, vendors of computer hardware and software, including on-demand software, and vendors of services such as investment management advisement, information technology services — such as those associated with our life, annuity and property and casualty policy administrative systems — and delivery services for customer policy-level communications. In the event that one or more of our vendors suffers a bankruptcy or otherwise becomes unable to continue to provide products or services, we may suffer operational difficulties and financial losses.

 

ITEM 1B.    Unresolved Staff Comments

 

None.

 

ITEM 2.       Properties

 

HMEC's home office property at 1 Horace Mann Plaza in Springfield, Illinois, consisting of an office building totaling 225,000 square feet, is owned by the Company. Also in Springfield, the Company owns and leases some smaller buildings at other locations. In addition, the Company leases office space in suburban Dallas, Texas, and Raleigh, North Carolina, for its claims operations and leases some office space related to its field marketing operations. These properties, which are utilized by all of the Company’s business segments, are adequate and suitable for the Company's current and anticipated future needs.

 

ITEM 3.       Legal Proceedings

 

At the time of this Annual Report on Form 10-K, the Company does not have pending litigation from which there is a reasonable possibility of material loss.

 

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ITEM 4.       Mine Safety Disclosures

 

Not applicable.

 

PART II

 

ITEM 5.      Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information and Dividends

 

HMEC's common stock is traded on the NYSE under the symbol of HMN. The following table provides the high and low closing prices of the common stock on the NYSE Composite Tape and the cash dividends paid per share of common stock during the periods indicated.

  

     Market Price   Dividend
Fiscal Period    High     Low   Paid
2016:                               
Fourth Quarter  $43.30   $33.30   $0.265 
Third Quarter   37.36    33.40    0.265 
Second Quarter   34.51    30.36    0.265 
First Quarter   32.30    27.59    0.265 
2015:               
Fourth Quarter  $36.42   $32.42   $0.250 
Third Quarter   37.74    31.84    0.250 
Second Quarter   37.04    33.97    0.250 
First Quarter   34.29    30.38    0.250 

 

The payment of dividends in the future is subject to the discretion of the Board of Directors of HMEC and will depend upon general business conditions, legal restrictions and other factors the Board of Directors may deem to be relevant. Additional information is contained in “Notes to Consolidated Financial Statements — Note 10 — Statutory Information and Restrictions” listed on page F-1 of this report and in “Item 1. Business — Cash Flow”.

 

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Shareholder Return Performance Graph

 

The graph below compares cumulative total return* of Horace Mann Educators Corporation’s common stock, the S&P 500 Insurance Index and the S&P 500 Index. The graph assumes $100 invested on December 31, 2011 in HMEC, the S&P 500 Insurance Index and the S&P 500 Index.

 

 

 

   12/11  12/12  12/13  12/14  12/15  12/16
                               
HMEC   $100   $150   $242   $262   $270   $357 
S&P 500 Insurance Index    100    119    174    188    193    226 
S&P 500 Index    100    116    153    174    176    197 

 

 

*The S&P 500 Index and the S&P 500 Insurance Index, as published by S&P, assume an annual reinvestment of dividends in calculating total return. Horace Mann Educators Corporation assumes reinvestment of quarterly dividends when paid.

 

Holders and Shares Issued

 

As of February 15, 2017, the approximate number of holders of HMEC’s common stock was 12,000.

 

During 2016, options were exercised for the issuance of 142,203 shares, 0.4% of the Company’s common stock shares outstanding at December 31, 2015. The Company received $3.0 million as a result of these option exercises, including related federal income tax benefits, which was used for general corporate purposes.

 

Regarding the equity compensation plan information required by Item 201(d) of Regulation S-K, see “Item 12. Security Ownership of Certain Beneficial Owners and Management, and Related Stockholder Matters”.

 

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Issuer Purchases of Equity Securities

 

On December 7, 2011, the Company’s Board of Directors (the “Board”) authorized a share repurchase program allowing repurchases of up to $50.0 million of Horace Mann Educators Corporation’s Common Stock, par value $0.001 (the “2011 Plan”). On September 30, 2015, the Board authorized an additional share repurchase program allowing repurchases of up to $50.0 million to begin following the completion of the 2011 Plan and utilization of that authorization began in January 2016. Both share repurchase programs authorize the repurchase of common shares in open market or privately negotiated transactions, from time to time, depending on market conditions. The current share repurchase program does not have an expiration date and may be limited or terminated at any time without notice. During the three months ended December 31, 2016, the Company did not repurchase shares of HMEC common stock. As of December 31, 2016, $29.5 million remained authorized for future share repurchases.

 

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.       Management's Discussion and Analysis of Financial Condition and Results of Operations

 

The information required by Item 303 of Regulation S-K is listed on page F-1 of this report.

 

ITEM 7A.     Quantitative and Qualitative Disclosures About Market Risk

 

The information required by Item 305 of Regulation S-K is contained under the heading “Market Value Risk” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” listed on page F-1 of this report.

 

ITEM 8.       Consolidated Financial Statements and Supplementary Data

 

The Company's consolidated financial statements, financial statement schedules, the report of its independent registered public accounting firm and the selected quarterly financial data required by Item 302 of Regulation S-K are listed on page F-1 of this report.

 

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ITEM 9.     Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

ITEM 9A.    Controls and Procedures

 

a.)   Management’s Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) of the Securities and Exchange Act of 1934 as amended (the “Exchange Act”) as of December 31, 2016. Based on this evaluation, our chief executive officer and our chief financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2016, the end of the period covered by this Annual Report on Form 10-K.

 

b.)   Management’s Annual Report on Internal Control Over Financial Reporting

 

Management of Horace Mann is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that:

 

(i)Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
(ii)Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
(iii)Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the consolidated financial statements.

 

Management of Horace Mann conducted an evaluation of the effectiveness of the Company's internal control over financial reporting as of December 31, 2016, using the criteria set forth in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Based on this evaluation, management, including our CEO and our CFO, determined that, as of December 31, 2016, the Company maintained effective internal control over financial reporting.

 

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The effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 has been audited by KPMG LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements, as stated in their report listed on page F-1 of this Annual Report on Form 10-K.

 

c.)   Independent Registered Public Accounting Firm’s Report on Internal Control Over Financial Reporting

 

The information required by Item 308(b) of Regulation S-K is contained in the “Report of Independent Registered Public Accounting Firm” listed on page F-1 of this report.

 

d.)   Changes in Internal Control Over Financial Reporting

 

There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

ITEM 9B.    Other Information

 

None.

 

PART III

 

ITEM 10.     Directors, Executive Officers and Corporate Governance

 

The information required by Items 401, 405, 406, 407(c)(3), 407(d)(4) and 407(d)(5) of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 2017 Annual Meeting of Shareholders.

 

Horace Mann Educators Corporation has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer and all other employees of the Company. In addition, the Board of Directors of Horace Mann Educators Corporation has adopted the code of ethics for its Board members as it applies to each Board member’s business conduct on behalf of the Company. The code of ethics is posted on the Company’s website, www.horacemann.com, under “Investors — Corporate Overview — Governance Documents”. In addition, amendments to the code of ethics and any grant of a waiver from a provision of the code of ethics requiring disclosure under applicable SEC rules will be disclosed at the same location as the code of ethics on the Company’s website.

 

ITEM 11.     Executive Compensation

 

The information required by Items 402, 407(e)(4) and 407(e)(5) of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 2017 Annual Meeting of Shareholders.

 

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ITEM 12.   Security Ownership of Certain Beneficial Owners and Management, and Related Stockholder Matters

 

The information required by Items 201(d) and 403 of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 2017 Annual Meeting of Shareholders.

 

ITEM 13.     Certain Relationships and Related Transactions, and Director Independence

 

The information required by Items 404 and 407(a) of Regulation S-K is incorporated by reference to the Company's Proxy Statement for the 2017 Annual Meeting of Shareholders.

 

ITEM 14.     Principal Accounting Fees and Services

 

The information required by Item 9(e) of Schedule 14A is incorporated by reference to the Company’s Proxy Statement for the 2017 Annual Meeting of Shareholders.

 

PART IV

 

ITEM 15.     Exhibits and Financial Statement Schedules

 

(a)(1)        The following consolidated financial statements of the Company are contained in the Index to Financial Information on page F-1 of this report:

 

Consolidated Balance Sheets as of December 31, 2016 and 2015.

 

Consolidated Statements of Operations for the Years Ended December 31, 2016, 2015 and 2014.

 

Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2016, 2015 and 2014.

 

Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2016, 2015 and 2014.

 

Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014.

 

(a)(2)        The following financial statement schedules of the Company are contained in the Index to Financial Information on page F-1 of this report:

 

Schedule I - Summary of Investments - Other than Investments in Related Parties.

 

Schedule II - Condensed Financial Information of Registrant.

 

Schedules III and VI Combined - Supplementary Insurance Information and Supplemental Information Concerning Property and Casualty Insurance Operations.

 

Schedule IV - Reinsurance.

 

 46 

 

 

(a)(3)       The following items are filed as Exhibits. Management contracts and compensatory plans are indicated by an asterisk (*).

 

Exhibit    
No.   Description
     
(3) Articles of incorporation and bylaws:
     
  3.1 Restated Certificate of Incorporation of HMEC, filed with the Delaware Secretary of State on June 24, 2003, incorporated by reference to Exhibit 3.1 to HMEC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, filed with the Securities and Exchange Commission (the “SEC”) on August 14, 2003.
     
  3.2 Form of Certificate for shares of Common Stock, $0.001 par value per share, of HMEC, incorporated by reference to Exhibit 4.5 to HMEC’s Registration Statement on Form S-3 (Registration No. 33-53118) filed with the SEC on October 9, 1992.
     
  3.3 Bylaws of HMEC, incorporated by reference to Exhibit 3.2 to HMEC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, filed with the SEC on August 14, 2003.
     
(4) Instruments defining the rights of security holders, including indentures:
     
  4.1 Indenture, dated as of November 23, 2015, by and between HMEC and The Bank of New York Mellon Trust Company, N.A., as trustee, incorporated by reference to Exhibit 4.1 to HMEC’s Current Report on Form 8-K dated November 18, 2015, filed with the SEC on November 23, 2015.
     
  4.1(a) Form of HMEC 4.5000% Senior Notes due 2025, incorporated by reference to Exhibit 4.2 to HMEC’s Current Report on Form 8-K dated November 18, 2015, filed with the SEC on November 23, 2015.
     
  4.2 Certificate of Designations for HMEC Series A Cumulative Convertible Preferred Stock, incorporated by reference to Exhibit 4.3 to HMEC’s Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on March 16, 2006.
     
(10) Material contracts:
     
  10.1 Amended and Restated Credit Agreement dated as of July 30, 2014 among HMEC, certain financial institutions named therein and JPMorgan Chase Bank, N.A., as administrative agent, incorporated by reference to Exhibit 10.1 to HMEC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, filed with the SEC on August 8, 2014.

 

 47 

 

 

Exhibit    
No.   Description
     
  10.1(a) First Amendment to Credit Agreement dated as of November 16, 2015 among HMEC, certain financial institutions named therein and JPMorgan Chase Bank, N.A., as administrative agent, incorporated by reference to Exhibit 10.1(a) to HMEC’s Annual Report on Form 10-K for the year ended December 31, 2015, filed with the SEC on February 29, 2016.
     
  10.2* Horace Mann Educators Corporation Amended and Restated 2002 Incentive Compensation Plan (“2002 Incentive Compensation Plan”), incorporated by reference to Exhibit 10.2 to HMEC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, filed with the SEC on August 9, 2005.
     
  10.2(a)* Revised Specimen Employee Stock Option Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(b) to HMEC’s Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009.
     
  10.2(b)* Specimen Employee Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(d) to HMEC’s Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on March 16, 2006.
     
  10.2(c)* Revised Specimen Employee Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(f) to HMEC’s Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009.
     
  10.2(d)* Specimen Non-employee Director Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(e) to HMEC’s Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on March 16, 2006.
     
  10.2(e)* Revised Specimen Non-employee Director Restricted Stock Unit Agreement under the 2002 Incentive Compensation Plan, incorporated by reference to Exhibit 10.6(h) to HMEC’s Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009.
     
  10.3* HMEC 2010 Comprehensive Executive Compensation Plan As Amended and Restated, incorporated by reference to Exhibit 1 (beginning on page E-1) to HMEC’s Proxy Statement, filed with the SEC on April 8, 2015.
     
  10.3(a)* Specimen Incentive Stock Option Agreement for Section 16 Officers under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(a) to HMEC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011.

 

 48 

 

 

Exhibit    
No.   Description
     
  10.3(b)* Specimen Incentive Stock Option Agreement for Non-Section 16 Officers under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(b) to HMEC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011.
     
  10.3(c)* Specimen Employee Service-Vested Restricted Stock Units Agreement under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(c) to HMEC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011.
     
  10.3(d)* Specimen Employee Performance-Based Restricted Stock Units Agreement under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.7(d) to HMEC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed with the SEC on August 9, 2011.
     
  10.3(e)* Specimen Employee Performance-Based Restricted Stock Units Agreement - Key Strategic Grantee under the HMEC 2010 Comprehensive Executive Compensation Plan incorporated by reference to Exhibit 10.3(e) to HMEC’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2016, filed with the SEC on May 6, 2016.
     
  10.3(f)* Specimen Non-employee Director Restricted Stock Unit Agreement under the HMEC 2010 Comprehensive Executive Compensation Plan, incorporated by reference to Exhibit 10.17(a) to HMEC’s Current Report on Form 8-K dated May 27, 2010, filed with the SEC on June 2, 2010.
     
  10.4* Horace Mann Supplemental Employee Retirement Plan, 2002 Restatement, incorporated by reference to Exhibit 10.1 to HMEC’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, filed with the SEC on May 15, 2002.
     
  10.5* Horace Mann Executive Supplemental Employee Retirement Plan, 2002 Restatement, incorporated by reference to Exhibit 10.2 to HMEC’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, filed with the SEC on May 15, 2002.
     
  10.6* Amended and Restated Horace Mann Nonqualified Supplemental Money Purchase Pension Plan, incorporated by reference to Exhibit 10.9 to HMEC’s Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009.
     
  10.7* Summary of HMEC Non-employee Director Compensation, incorporated by reference to Exhibit 10.7 to HMEC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, filed with the SEC on August 5, 2016.

 

 49 

 

 

Exhibit    
No.   Description
     
  10.8* Summary of HMEC Named Executive Officer Annualized Salaries incorporated by reference to Exhibit 10.8 to HMEC’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2016, filed with the SEC on May 6, 2016.
     
  10.9* Form of Severance Agreement between HMEC, Horace Mann Service Corporation (“HMSC”) and certain officers of HMEC and/or HMSC, incorporated by reference to Exhibit 10.13 to HMEC’s Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on February 28, 2013.
     
  10.9(a)* Revised Schedule to Severance Agreements between HMEC, HMSC and certain officers of HMEC and/or HMSC, incorporated by reference to Exhibit 10.9(a) to HMEC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, filed with the SEC on August 5, 2016.
     
  10.10* HMSC Executive Change in Control Plan, incorporated by reference to Exhibit 10.15 to HMEC’s Current Report on Form 8-K dated February 15, 2012, filed with the SEC on February 22, 2012.
     
  10.10(a)* HMSC Executive Change in Control Plan Schedule A Plan Participants incorporated by reference to Exhibit 10.10(a) to HMEC’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2016, filed with the SEC on May 6, 2016.
     
  10.11* HMSC Executive Severance Plan, incorporated by reference to Exhibit 10.16 to HMEC’s Current Report on Form 8-K dated March 7, 2012, filed with the SEC on March 13, 2012.
     
  10.11(a)* First Amendment to the HMSC Executive Severance Plan, incorporated by reference to Exhibit 10.16(a) to HMEC’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, filed with the SEC on August 9, 2012.
     
  10.11(b)* HMSC Executive Severance Plan Schedule A Participants incorporated by reference to Exhibit 10.11(b) to HMEC’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2016, filed with the SEC on May 6, 2016.
     
(11) Statement regarding computation of per share earnings.
   
(12) Statement regarding computation of ratios.
   
(21) Subsidiaries of HMEC.
   
(23) Consent of KPMG LLP.

 

 50 

 

 

Exhibit    
No.   Description
     
(31) Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
  31.1 Certification by Marita Zuraitis, Chief Executive Officer of HMEC.
     
  31.2 Certification by Bret A. Conklin, Senior Vice President and Acting Chief Financial Officer of HMEC.
     
(32) Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
  32.1 Certification by Marita Zuraitis, Chief Executive Officer of HMEC.
     
  32.2 Certification by Bret A. Conklin, Senior Vice President and Acting Chief Financial Officer of HMEC.
     
(99) Additional exhibits
     
  99.1 Glossary of Selected Terms.
     
(101) Interactive Data File
     
  101.INS XBRL Instance Document
     
  101.SCH XBRL Taxonomy Extension Schema
     
  101.CAL XBRL Taxonomy Extension Calculation Linkbase
     
  101.DEF XBRL Taxonomy Extension Definition Linkbase
     
  101.LAB XBRL Taxonomy Extension Label Linkbase
     
  101.PRE XBRL Taxonomy Extension Presentation Linkbase

 

Copies of Form 10-K, Exhibits to Form 10-K, Horace Mann Educators Corporation’s Code of Ethics and charters of the committees of the Board of Directors are available through the Investors section of the Company’s Internet website, www.horacemann.com. Copies also may be obtained by writing to Investor Relations, Horace Mann Educators Corporation, 1 Horace Mann Plaza, Springfield, Illinois 62715-0001.

 

 51 

 

 

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/ Marita Zuraitis  
Marita Zuraitis  
President and Chief Executive Officer  

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Horace Mann Educators Corporation and in the capacities and on the date indicated.

 

Principal Executive Officer:   Directors:
     
  /s/ Marita Zuraitis     /s/ Gabriel L. Shaheen
Marita Zuraitis   Gabriel L. Shaheen, Chairman of the Board of Directors
President, Chief Executive Officer and a Director    
      /s/ Daniel A. Domenech
    Daniel A. Domenech, Director
     
      /s/ Stephen J. Hasenmiller
Principal Financial and Accounting Officer:   Stephen J. Hasenmiller, Director
     
  /s/ Bret A. Conklin     /s/ Ronald J. Helow
Bret A. Conklin   Ronald J. Helow, Director
Senior Vice President and Acting Chief Financial Officer    
      /s/ Beverley J. McClure
    Beverley J. McClure, Director
     
      /s/ H. Wade Reece
    H. Wade Reece, Director
     
      /s/ Robert Stricker
    Robert Stricker, Director
     
      /s/ Steven O. Swyers
    Steven O. Swyers, Director
     

Dated: March 1, 2017

 

 52 

 

 

HORACE MANN EDUCATORS CORPORATION

 

INDEX TO FINANCIAL INFORMATION

 

 
    Page  
   
Management's Discussion and Analysis of Financial Condition and Results of Operations F-2
   
Report of Independent Registered Public Accounting Firm F-34
   
Consolidated Balance Sheets F-36
   
Consolidated Statements of Operations F-37
   
Consolidated Statements of Comprehensive Income (Loss) F-38
   
Consolidated Statements of Changes in Shareholders' Equity F-39
   
Consolidated Statements of Cash Flows F-40
   
Notes to Consolidated Financial Statements  
Note 1 - Summary of Significant Accounting Policies F-41
Note 2 - Investments F-62
Note 3 - Fair Value of Financial Instruments F-68
Note 4 - Derivative Instruments F-76
Note 5 - Property and Casualty Unpaid Claims and Claim Expenses F-78
Note 6 - Reinsurance and Catastrophes F-86
Note 7 - Debt F-88
Note 8 - Income Taxes F-90
Note 9 - Shareholders' Equity and Common Stock Equivalents F-92
Note 10 - Statutory Information and Restrictions F-96
Note 11 - Pension Plans and Other Postretirement Benefits F-98
Note 12 - Contingencies and Commitments F-106
Note 13 - Supplementary Data on Cash Flows F-107
Note 14 - Segment Information F-108
Note 15 - Unaudited Selected Quarterly Financial Data F-109
   
Financial Statement Schedules  
Schedule I - Summary of Investments - Other than Investments in Related Parties F-110
Schedule II - Condensed Financial Information of Registrant F-111
Schedule III and VI Combined - Supplementary Insurance Information and Supplemental Information Concerning Property and Casualty Insurance Operations F-115
Schedule IV - Reinsurance F-116

 

 F-1  

 

 

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS (“MD&A”)

(Dollars in millions, except per share data)

 

Forward-looking Information

 

Statements made in the following discussion that are not historical in nature are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to known and unknown risks, uncertainties and other factors. Horace Mann is not under any obligation to (and expressly disclaims any such obligation to) update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. It is important to note that the Company’s actual results could differ materially from those projected in forward-looking statements due to a number of risks and uncertainties inherent in the Company’s business. For additional information regarding risks and uncertainties, see “Item 1A. Risk Factors”. That discussion includes factors such as:

·The impact that a prolonged economic recession may have on the Company’s investment portfolio; volume of new business for automobile, homeowners, retirement and life products; policy renewal rates; and additional annuity contract deposit receipts.
·Fluctuations in the fair value of securities in the Company’s investment portfolio and the related after tax effect on the Company’s shareholders’ equity and total capital through either realized or unrealized investment losses.
·Prevailing low interest rate levels, including the impact of interest rates on (1) the Company’s ability to maintain appropriate interest rate spreads over minimum fixed rates guaranteed in the Company’s annuity and life products, (2) the book yield of the Company’s investment portfolio, (3) unrealized gains and losses in the Company’s investment portfolio and the related after tax effect on the Company’s shareholders’ equity and total capital, (4) amortization of deferred policy acquisition costs and (5) capital levels of the Company’s life insurance subsidiaries.
·The frequency and severity of events such as hurricanes, storms, earthquakes and wildfires, and the ability of the Company to provide accurate estimates of ultimate claim costs in its consolidated financial statements.
·The Company’s risk exposure to catastrophe-prone areas. Based on full year 2016 Property and Casualty direct earned premiums, the Company’s ten largest states represented 57% of the segment total. Included in this top ten group are certain states which are considered more prone to catastrophe occurrences: California, North Carolina, Texas, South Carolina, Florida and Louisiana.
·The ability of the Company to maintain a favorable catastrophe reinsurance program considering both availability and cost; and the collectibility of reinsurance receivables.
·Adverse changes in market appreciation, interest spreads, business persistency and policyholder mortality and morbidity rates and the resulting impact on both estimated reserves and the amortization of deferred policy acquisition costs.
·The Company’s ability to refinance outstanding indebtedness or repurchase shares of the Company’s common stock.
·The Company’s ability to (1) develop and expand its marketing operations, including agents and other points of distribution, (2) maintain and secure access to educators, school administrators, principals and school business officials; and (3) profitably expand its Property and Casualty business in highly competitive environments.

 

 F-2  

 

 

·The effects of economic forces and other issues affecting the educator market including, but not limited to, federal, state and local budget deficits and cut-backs and adverse changes in state and local tax revenues. The effects of these forces can include, among others, teacher layoffs and early retirements, as well as individual concerns regarding employment and economic uncertainty.
·Changes in federal and state laws and regulations, which affect the relative tax and other advantages of the Company’s life and annuity products to customers, including, but not limited to, changes in IRS regulations governing Section 403(b) plans.
·Changes in public employee retirement programs as a result of federal and/or state level pension reform initiatives.
·Changes in federal and state laws and regulations, which affect the relative tax advantage of certain investments or which affect the ability of debt issuers to declare bankruptcy or restructure debt.
·The Company’s ability to effectively implement new or enhanced information technology systems and applications.
·Changes in Cybersecurity regulations as a result of state level requirements.

 

Executive Summary

 

Horace Mann Educators Corporation (“HMEC”; and together with its subsidiaries, the “Company” or “Horace Mann”) is an insurance holding company. Through its subsidiaries, HMEC markets and underwrites personal lines of property and casualty insurance, annuities and life insurance in the U.S. The Company markets its products primarily to K-12 teachers, administrators and other employees of public schools and their families.

 

For 2016, the Company’s net income of $83.8 million decreased $9.7 million compared to 2015. After tax net realized investment gains were $2.3 million compared to $8.6 million a year earlier. For the Property and Casualty segment, net income of $25.6 million decreased $14.4 million compared to 2015. The Property and Casualty combined ratio was 101.5% for 2016, 4.5 percentage points higher than the 97.0% in 2015, primarily as a result of a 2.3 point increase in catastrophe losses, or an increase of $15.6 million on pretax basis. One percentage increase, or $5.5 million pretax basis, was related to a lower level of favorable prior years’ reserve development in 2016 compared to the full year 2015. On an underlying basis, the combined ratio increased 1.2 percentage points to 92.9%. The underlying auto combined ratio increased 2.4 percentage points, to 105.1%, primarily as a result of higher loss frequency and severity. This increase was somewhat offset by a 1.7 percentage point improvement in the underlying property combined ratio, which for the full year 2016 was 68.6%. The improvement in property results was primarily driven by the impacts of profitability improvement initiatives, as well as, lower catastrophe reinsurance costs. The Retirement segment’s net income was $50.7 million for 2016 which increased $7.3 million compared to 2015, primarily due to an increase in investment income that drove improvement in the net interest spread offset by costs related to the Company’s continued infrastructure and strategic investments. The net interest margin amount (without net realized investment gains/losses) increased $8.1 million after tax compared to 2015, including increases in investment prepayment activity. The impact of unlocking deferred policy acquisition costs increased income by $2.4 million compared to 2015. In addition, income tax expense was reduced by approximately $0.9 million related to the filing of the prior calendar year tax return. Annuity assets under management of $6.4 billion increased 7.2% compared to a year earlier and disciplined crediting rate management continues. Life segment net income of $16.6 million increased $1.6 million compared to 2015 primarily as a result of an increase in investment income and a decrease in mortality expenses in 2016.

 

 F-3  

 

 

Premiums written and contract deposits* increased slightly compared to 2015 as growth in the Property and Casualty and Life segments was offset by a decrease in the amount of annuity deposits received in 2016. Property and Casualty segment premiums written increased 4.7% compared to the prior year, primarily due to the favorable impacts from increases in average premium per policy for homeowners and automobile, accompanied by reductions in catastrophe reinsurance costs. Life segment insurance premiums and contract deposits increased 5.2% compared to 2015. Annuity deposits received for Retirement decreased 5.1%, due to the inclusion of a favorable impact of non-recurring deposits in 2015 related to changes in the Company’s employee retirement savings plans as further explained in “Results of Operations — Insurance Premiums and Contract Charges”.

 

The Company’s book value per share was $32.15 at December 31, 2016, an increase of 3.1% compared to 12 months earlier.

 

Critical Accounting Policies

 

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires the Company's management to make estimates and assumptions based on information available at the time the consolidated financial statements are prepared. These estimates and assumptions affect the reported amounts of the Company's consolidated assets, liabilities, shareholders' equity and net income. Certain accounting estimates are particularly sensitive because of their significance to the Company's consolidated financial statements and because of the possibility that subsequent events and available information may differ markedly from management's judgments at the time the consolidated financial statements were prepared. Management has discussed with the Audit Committee the quality, not just the acceptability, of the Company's accounting principles as applied in its financial reporting. The discussions generally included such matters as the consistency of the Company's accounting policies and their application, and the clarity and completeness of the Company's consolidated financial statements, which include related disclosures. For the Company, areas most subject to significant management judgments include: fair value measurements, other-than-temporary impairment of investments, goodwill, deferred policy acquisition costs for investment contracts and life insurance products with account values, liabilities for property and casualty claims and claim expenses, liabilities for future policy benefits, deferred taxes and valuation of assets and liabilities related to the defined benefit pension plan.

 

Information regarding the Company’s accounting policies pertaining to these topics is located in the “Notes to Consolidated Financial Statements” as listed on page F-1 of this report and is not repeated in the discussion below.

 

Fair Value Measurements

 

The fair value of a financial instrument is the estimated amount at which the instrument could be exchanged in an orderly transaction between knowledgeable, unrelated and willing parties. The valuation of fixed maturity securities and equity securities is more subjective when markets are less liquid due to the lack of market based inputs, which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur. See also “Notes to Consolidated Financial Statements — Note 3 — Fair Value of Financial Instruments”.

 

 F-4  

 

 

Valuation of Fixed Maturity and Equity Securities

 

The fair value of the Company’s fixed maturity securities portfolio was $7,456.7 million at December 31, 2016. For fixed maturity securities, each month the Company obtains fair value prices from its investment managers and custodian bank, each of which use a variety of independent, nationally recognized pricing sources to determine market valuations. Typical inputs used by these pricing sources include, but are not limited to, reported trades, benchmark yield curves, benchmarking of like securities, rating designations, sector groupings, issuer spreads, bids, offers, and/or estimated cash flows and prepayment speeds. The Company’s fixed maturity securities portfolio is primarily publicly traded, which allows for a high percentage of the portfolio to be priced through pricing services. Approximately 90% of the portfolio, based on fair value, was priced through pricing services or index priced using observable inputs as of December 31, 2016. The remainder of the portfolio was priced by broker-dealers or pricing models.

 

When the pricing sources cannot provide fair value determinations, the Company obtains non-binding price quotes from broker-dealers. The broker-dealers’ valuation methodology is sometimes matrix-based, using indicative evaluation measures and adjustments for specific security characteristics and market sentiment. The market inputs utilized in the evaluation measures and adjustments include: benchmark yield curves, reported trades, broker/dealer quotes, ratings and corresponding issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The extent of the use of each market input depends on the market sector and the market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities, additional inputs may be necessary.

 

The Company analyzes price and market valuations received and has in place certain control processes to determine the reasonableness of the financial asset fair values. These processes are designed to ensure (1) the values received are reasonable and accurately recorded, (2) the data inputs and valuation techniques utilized are appropriate and consistently applied, and (3) the assumptions are reasonable and consistent with the objective of determining fair value.

 

The fair value of the Company’s equity securities portfolio was $141.6 million at December 31, 2016. All of the portfolio was priced from observable market quotations at December 31, 2016. Fair values of equity securities have been determined by the Company from observable market quotations, when available. When a public quotation is not available, equity securities are valued by using non-binding broker quotes or through the use of pricing models or analysis that is based on market information regarding interest rates, credit spreads and liquidity. The underlying source data for calculating the matrix of credit spreads relative to the U.S. Treasury curve are nationally recognized indices. In addition, credit rating (or credit quality equivalent information) of securities is also factored into a pricing matrix. These inputs are based on assumptions deemed appropriate given the circumstances and are believed to be consistent with what other market participants would use when pricing such securities.

 

At December 31, 2016, Level 3 invested assets comprised approximately 3% of the Company’s total investment portfolio fair value. Invested assets are classified as Level 3 when fair value is determined based on unobservable inputs that are supported by little or no market activity and those inputs are significant to the fair value.

 

 F-5  

 

 

Other-than-temporary Impairment of Investments

 

The Company's methodology of assessing other-than-temporary impairments is based on security-specific facts and circumstances as of the balance sheet date. The Company reviews the fair value of all investments in its portfolio on a monthly basis to assess whether an other-than-temporary decline in value has occurred. These reviews, in conjunction with the Company's investment managers' monthly credit reports and relevant factors such as (1) the financial condition and near-term prospects of the issuer, (2) the length of time and extent to which the fair value has been less than amortized cost for fixed maturity securities or cost for equity securities, (3) for fixed maturity securities, the Company’s intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the anticipated recovery of the amortized cost basis; and for equity securities, the Company’s ability and intent to hold the security for the recovery of cost or if recovery of cost is not expected within a reasonable period of time, (4) the stock price trend of the issuer, (5) the market leadership position of the issuer, (6) the debt ratings of the issuer, and (7) the cash flows and liquidity of the issuer or the underlying cash flows for asset-backed securities, are all considered in the impairment assessment.

 

When an other-than-temporary impairment is deemed to have occurred, the investment is written-down to fair value, with a realized loss charged to income for the period for the full loss amount for all equity securities and the credit-related loss portion associated with impaired fixed maturity securities. The amount of the total other-than-temporary impairment related to non-credit factors for fixed maturity securities is recognized in other comprehensive income, net of applicable taxes, in which the Company has the intent to sell the security or if it is more likely than not the Company will be required to sell the security before the anticipated recovery of the amortized cost basis. See also “Notes to Consolidated Financial Statements — Note 1 — Summary of Significant Accounting Policies — Other-than-temporary Impairment of Investments”.

 

Goodwill

 

Goodwill represents the excess of the amounts paid to acquire a business over the fair value of its net assets at the date of acquisition. Goodwill is not amortized, but is tested for impairment at the reporting unit level at least annually or more frequently if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss would be recognized in an amount equal to that excess; the charge could have a material adverse effect on the Company’s results of operations. The Company’s reporting units, for which goodwill has been allocated, are equivalent to the Company’s operating segments. As of December 31, 2016, the Company’s allocation of goodwill by reporting unit/segment was as follows: $28.0 million, Retirement; $9.9 million, Life; and $9.5 million, Property and Casualty. Also see “Notes to Consolidated Financial Statements — Note 1 — Summary of Significant Accounting Policies — Goodwill”.

 

The process of evaluating goodwill for impairment requires management to make multiple judgments and assumptions to determine the fair value of each reporting unit, including discounted cash flow calculations, the level of the Company’s own share price and assumptions that market participants would make in valuing each reporting unit. Fair value estimates are based primarily on an in-depth analysis of historical experience, projected future cash flows and relevant discount rates, which consider market participant inputs and the relative risk associated with the projected cash flows. Other assumptions include levels of

 

 F-6  

 

 

 

economic capital, future business growth, earnings projections and assets under management for each reporting unit. Estimates of fair value are subject to assumptions that are sensitive to change and represent the Company’s reasonable expectation regarding future developments. The Company also considers other valuation techniques such as peer company price-to-earnings and price-to-book multiples.

 

The assessment of goodwill recoverability requires significant judgment and is subject to inherent uncertainty. The use of different assumptions, within a reasonable range, could cause the fair value to be below carrying value. Subsequent goodwill assessments could result in impairment, particularly for each reporting unit with at-risk goodwill, due to the impact of a volatile financial market on earnings, discount rate assumptions, liquidity and market capitalization. There were no events or material changes in circumstances during 2016 that indicated that a material change in the fair value of the Company’s reporting units had occurred.

 

Deferred Policy Acquisition Costs for Investment Contracts and Life Insurance Products with Account Values

 

Policy acquisition costs, consisting of commissions, policy issuance and other costs which are incremental and directly related to the successful acquisition of new or renewal business, are deferred and amortized on a basis consistent with the type of insurance coverage. For all investment (annuity) contracts, deferred policy acquisition costs are amortized over 20 years in proportion to estimated gross profits. Deferred policy acquisition costs are amortized in proportion to estimated gross profits over 20 years for certain life insurance products with account values and over 30 years for indexed universal life contracts (“IUL”). See also “Notes to Consolidated Financial Statements — Note 1 — Summary of Significant Accounting Policies — Deferred Policy Acquisition Costs”.

 

The most significant assumptions that are involved in the estimation of annuity gross profits include interest rate spreads, future financial market performance, business surrender/lapse rates, expenses and the impact of realized investment gains and losses. For the variable deposit portion of the Retirement segment, the Company amortizes deferred policy acquisition costs utilizing a future financial market performance assumption of a 10% reversion to the mean approach with a 200 basis point corridor around the mean during the reversion period, representing a cap and a floor on the Company’s long-term assumption. The Company’s practice with regard to returns on Separate Accounts assumes that long-term appreciation in the financial market is not changed by short-term market fluctuations, but is only changed when sustained annual deviations are experienced. The Company monitors these fluctuations and only changes the assumption when the long-term expectation changes. The potential effect of an increase/ (decrease) by 100 basis points in the assumed future rate of return is reasonably likely to result in an estimated decrease/ (increase) in the deferred policy acquisition costs amortization expense of approximately $1 million. Although this evaluation reflects likely outcomes, it is possible an actual outcome may fall below or above these estimates. At December 31, 2016, the ratio of deferred annuity policy acquisition costs to the total annuity accumulated cash value was approximately 3%.

 

 F-7  

 

 

In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company may be required to record a material charge or credit to current period amortization expense for the period in which the adjustment is made. As noted above, there are key assumptions involved in the evaluation of deferred policy acquisition costs. In terms of the sensitivity of this amortization to two of the more significant assumptions, based on deferred annuity policy acquisition costs as of December 31, 2016 and assuming all other assumptions are met, (1) a 10 basis point deviation in the annual targeted interest rate spread assumption would impact amortization between $0.25 million and $0.35 million and (2) a 1% deviation from the targeted financial market performance for the underlying mutual funds of the Company’s variable annuities would impact amortization between $0.20 million and $0.30 million. These results may change depending on the magnitude and direction of any actual deviations but represent a range of reasonably likely experience for the noted assumptions. Detailed discussion of the impact of adjustments to the amortization of deferred acquisition costs is included in “Results of Operations for the Three Years Ended December 31, 2016 — Policy Acquisition Expenses Amortized”.

 

Liabilities for Property and Casualty Claims and Claim Expenses

 

Underwriting results of the Property and Casualty segment are significantly influenced by estimates of the Company's ultimate liability for insured events. There is a high degree of uncertainty inherent in the estimates of ultimate losses underlying the liability for unpaid claims and claim settlement expenses. This inherent uncertainty is particularly significant for liability-related exposures due to the extended period, often many years that transpires between a loss event, receipt of related claims data from policyholders and ultimate settlement of the claim. Reserves for Property and Casualty claims include provisions for payments to be made on reported claims (“case reserves”), claims incurred but not yet reported (“IBNR”) and associated settlement expenses (together, “loss reserves”).

 

The process by which these reserves are established requires reliance upon estimates based on known facts and on interpretations of circumstances, including the Company's experience with similar cases and historical trends involving claim payments and related patterns, pending levels of unpaid claims and product mix, as well as other factors including court decisions, economic conditions, public attitudes and medical costs. The Company calculates and records a single best estimate of the reserve (which is equal to the actuarial point estimate) as of each balance sheet date.

 

Reserves are re-estimated quarterly. Changes to reserves are recorded in the period in which development factor changes result in reserve re-estimates. A detailed discussion of the process utilized to estimate loss reserves, risk factors considered and the impact of adjustments recorded during recent years is included in “Notes to Consolidated Financial Statements — Note 5 — Property and Casualty Unpaid Claims and Claim Expenses”. Due to the nature of the Company’s personal lines business, the Company has no exposure to losses related to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses other than claims under homeowners insurance policies for environmentally related items such as mold.

 

 F-8  

 

 

Based on the Company’s products and coverages, historical experience, and modeling of various actuarial methodologies used to develop reserve estimates, the Company estimates that the potential variability of the Property and Casualty loss reserves within a reasonable probability of other possible outcomes may be approximately plus or minus 6%, which equates to plus or minus approximately $10 million of net income based on net reserves as of December 31, 2016. Although this evaluation reflects the most likely outcomes, it is possible the final outcome may fall below or above these estimates.

 

There are a number of assumptions involved in the determination of the Company’s Property and Casualty loss reserves. Among the key factors affecting recorded loss reserves for both long-tail and short-tail related coverages, claim severity and claim frequency are of particular significance. Management estimates that a 2% change in claim severity or claim frequency for the most recent 36 month period is a reasonably likely scenario based on recent experience and would result in a change in the estimated net reserves of between $6.0 million and $10.0 million for long-tail liability related exposures (automobile liability coverages) and between $1.0 million and $3.0 million for short-tail liability related exposures (homeowners and automobile physical damage coverages). Actual results may differ, depending on the magnitude and direction of the deviation.

 

The Company’s actuaries discuss their loss and loss adjustment expense actuarial analysis with management. As part of this discussion, the indicated point estimate of the IBNR loss reserve by line of business (coverage) is reviewed. The Company’s actuaries also discuss any indicated changes to the underlying assumptions used to calculate the indicated point estimate. Any variance between the indicated reserves from these changes in assumptions and the previously carried reserves is reviewed. After discussion of these analyses and all relevant risk factors, management determines whether the reserve balances require adjustment. The Company’s best estimate of loss reserves may change depending on a revision in the underlying assumptions.

 

The Company’s liabilities for unpaid claims and claim expenses for the Property and Casualty segment were as follows:

 

    December 31, 2016   December 31, 2015
    Case   IBNR       Case   IBNR    
    Reserves   Reserves   Total (1)   Reserves   Reserves   Total (1)
                                     
Automobile liability     $ 95.2       $ 152.5       $ 247.7       $ 92.5       $ 139.5       $ 232.0  
Automobile other       6.9         1.8         8.7         8.4         1.5         9.9  
Homeowners       11.2         26.2         37.4         15.3         30.7         46.0  
All other       2.9         11.1         14.0         4.7         9.0         13.7  
Total     $ 116.2       $ 191.6       $ 307.8       $ 120.9       $ 180.7       $ 301.6  

 

 

(1)These amounts are gross, before reduction for ceded reinsurance reserves.

 

The facts and circumstances leading to the Company’s re-estimate of reserves relate to revisions of the development factors used to predict how losses are likely to develop from the end of a reporting period until all claims have been paid. Re-estimates occur because actual loss amounts are different than those predicted by the estimated development factors used in prior reserve estimates. At December 31, 2016, the impact of a reserve re-estimation resulting in a 1% increase in net reserves would be a decrease of approximately $2 million in net income. A reserve re-estimation resulting in a 1% decrease in net reserves would increase net income by approximately $2 million.

 

 F-9  

 

 

Favorable prior years’ reserve reestimates increased net income in 2016 by approximately $5 million, primarily the result of favorable severity trends in property for accident years 2014 and prior. The lower than expected claims emergence and resultant lower expected loss ratios caused the Company to lower its reserve estimate at December 31, 2016.

 

Investment Contract and Life Policy Reserves

 

Liabilities for future benefits on life and annuity policies are established in amounts adequate to meet the estimated future obligations on policies in force. Liabilities for future policy benefits on certain life insurance policies are computed using the net level premium method and are based on assumptions as to future investment yield, mortality and lapses. Mortality and lapse assumptions for all policies have been based on actuarial tables which are consistent with the Company's own experience. In the event actual experience is worse than the assumptions, additional reserves may be required. This would result in a charge to income for the period in which the increase in reserves occurred. Liabilities for future benefits on annuity contracts and certain long-duration life insurance contracts are carried at accumulated policyholder values without reduction for potential surrender or withdrawal charges. See also “Notes to Consolidated Financial Statements — Note 1 — Summary of Significant Accounting Policies — Investment Contract and Life Policy Reserves”.

 

Deferred Taxes

 

Deferred tax assets and liabilities represent the tax effect of the differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. The Company evaluates deferred tax assets periodically to determine if they are realizable. Factors in the determination include the performance of the business including the ability to generate taxable income from a variety of sources and tax planning strategies. If, based on available information, it is more likely than not that the deferred income tax asset will not be realized, then a valuation allowance must be established with a corresponding charge to net income. Charges to establish a valuation allowance could have a material adverse effect on the Company’s results of operations and financial position. See also “Notes to Consolidated Financial Statements — Note 8 — Income Taxes”.

 

Valuation of Liabilities Related to the Defined Benefit Pension Plan

 

The Company's cost estimates for its frozen defined benefit pension plan are determined annually based on assumptions which include the discount rate, expected return on plan assets, anticipated retirement rate and estimated lump sum distributions. A discount rate of 3.90% was used by the Company for estimating accumulated benefits under the plan at December 31, 2016, which was based on the average yield for long-term, high grade securities having maturities generally consistent with the defined benefit pension payout period. To set its discount rate, the Company looks to leading indicators, including the Mercer Above Mean Yield Curve. The expected annual return on plan assets assumed by the Company at December 31, 2016 was 6.50%. The assumption for the long-term rate of return on plan assets was determined by considering actual investment experience during the lifetime of the plan, balanced with reasonable expectations of future growth considering the various classes of assets and percentage allocation for each asset class. Management believes that it has adopted reasonable assumptions for investment returns, discount rates and other key factors used in the estimation of pension costs and asset values.

 

 F-10  

 

 

To the extent that actual experience differs from the Company's assumptions, subsequent adjustments may be required, with the effects of those adjustments charged or credited to income and/or shareholders' equity for the period in which the adjustments are made. Generally, a change of 50 basis points in the discount rate would inversely impact pension expense and accumulated other comprehensive income (“AOCI”) by approximately $0.1 million and $1.1 million, respectively. In addition, for every $1 million increase (decrease) in the value of pension plan assets, there is a comparable pretax increase (decrease) in AOCI. See also “Notes to Consolidated Financial Statements — Note 11 — Pension Plans and Other Postretirement Benefits”.

 

Results of Operations for the Three Years Ended December 31, 2016

 

Insurance Premiums and Contract Charges

 

   Year Ended     Change From   Year Ended 
   December 31,     Prior Year   December 31, 
   2016   2015   Percent  Amount     2014   
Insurance premiums written and contract deposits (includes annuity and life contract deposits)                           
Property and Casualty   $634.3   $605.8    4.7%  $28.5   $584.4   
Retirement (annuity)    520.2    548.0    -5.1%   (27.8)   480.6   
Life    108.0    102.7    5.2%   5.3    102.7   
Total   $1,262.5   $1,256.5    0.5%  $6.0   $1,167.7   
                            
Insurance premiums and contract charges earned (excludes annuity and life contract deposits)                           
Property and Casualty   $620.5   $596.0    4.1%  $24.5   $581.8   
Retirement (annuity)    24.9    25.4    -2.0%   (0.5)   25.6   
Life    113.7    110.5    2.9%   3.2    108.4   
Total   $759.1   $731.9    3.7%  $27.2   $715.8   

 

Number of Policies and Contracts in Force

(actual counts)

 

   As of December 31, 
   2016   2015   2014 
Property and Casualty               
Automobile    484,915    486,939    480,777 
Property    220,137    224,531    229,072 
Total    705,052    711,470    709,849 
Retirement    219,105    211,071    202,572 
Life    197,937    201,789    200,867 

 

For 2016, the Company’s premiums written and contract deposits* of $1,262.5 million increased $6.0 million, or 0.5%. For 2015, the Company’s premiums written and contract deposits of $1,256.5 million increased $88.8 million, or 7.6%, compared to a year earlier, led by growth in the Retirement segment as well as growth in the Property and Casualty segment. Changes in the Company’s employee retirement savings plans which were effective beginning in 2015 led to approximately $30 million of the $88.8 million increase in 2015; consolidated and Retirement segment growth were approximately 5% and 7%, respectively, in 2015 excluding this item. The Company’s premiums and contract charges earned increased $27.2 million, or 3.7%, compared to 2015, primarily due to increases in average premium per policy for both homeowners and automobile. For 2015, the Company’s premiums and contract charges earned increased $16.1 million, or 2.2%, compared to 2014 primarily due to increases in average premium per policy for both homeowners and automobile.

 

 F-11  

 

 

Total Property and Casualty premiums written* increased 4.7%, or $28.5 million, in 2016, compared to 2015, primarily due to increases in average written premium per policy for both homeowners and automobile. For 2016, the Company’s full year rate plan anticipated mid-single digit average rate increases (including states with no rate actions) for both automobile and homeowners; average approved rate changes during 2016 were consistent with those plans at 6.5% for automobile and 5% for homeowners.

 

Based on policies in force, the automobile 12 month retention rate for new and renewal policies was 83.5% compared to 84.7% at both December 31, 2015 and 2014, respectively, with the decrease due to recent rate and underwriting actions. The property 12 month new and renewal policy retention rate was 87.8%, 88.3% and 87.9% at December 31, 2016, 2015 and 2014, respectively, with decrease due to recent rate and underwriting actions.

 

Automobile premiums written* increased 5.9%, or $23.7 million, compared to 2015. In 2016, the average written premium per policy and average earned premium per policy increased approximately 5% and 4%, respectively, compared to a year earlier. In 2015, automobile premiums written increased 4.8%, or $18.4 million, compared to 2014. In 2015, the average written premium per policy and average earned premium per policy increased approximately 3% and 2%, respectively, compared to a year earlier, which was augmented by the 2015 increase in policies in force. The number of educator policies increased more than the total policy count over the three year period and represented approximately 85%, 85% and 84% of the automobile policies in force at December 31, 2016, 2015 and 2014, respectively.

 

Homeowners premiums written* increased 2.4%, or $4.8 million, compared to 2015. Homeowners premiums written increased 1.5%, or $3.0 million, compared to 2014. While the number of homeowners policies in force has declined, the average written premium per policy and average earned premium per policy each increased approximately 4%, in 2016 compared to a year earlier. In addition, reduced catastrophe reinsurance costs benefited the current period premiums written by approximately $1.4 million. In 2015, while the number of homeowners policies in force declined, the average written premium per policy and average earned premium per policy each increased approximately 3% compared to a year earlier. The number of educator policies represented approximately 82% of the homeowners policies in force at December 31, 2016, compared to approximately 81% at December 31, 2015 and 80% at December 31, 2014, respectively, and has reflected more moderate declines than the overall homeowner policies in force count. The number of educator policies and total policies has been, and may continue to be, impacted by the Company’s risk mitigation programs, including actions in catastrophe-prone coastal areas, involving policies of both educators and non-educators.

 

The Company continues to evaluate and implement actions to further mitigate its risk exposure in hurricane-prone areas, as well as other areas of the country. Such actions could include, but are not limited to, non-renewal of homeowners policies, restricted agent geographic placement, limitations on agent new business sales, further tightening of underwriting standards and increased utilization of third-party vendor products. By June 30, 2015, the Company completed a non-renewal program to further address homeowners profitability and hurricane exposure issues in Florida. While this program impacted the overall policy in force count and premiums in the short-term, it reduced risk exposure concentration, reduced overall catastrophe reinsurance costs and is expected to improve homeowners longer-term underwriting results. The Company continues to write policies for tenants in Florida. The Company also authorized its agents to write certain third-party vendors’ homeowners policies in Florida.

 

 F-12  

 

 

For 2016, total annuity deposits* received decreased 5.1%, or $27.8 million, compared to the prior year, primarily due to changes in the Company’s employee retirement savings plans which resulted in non-recurring deposits received in 2015. The 2016 decrease reflected a 7.6% decrease in recurring deposit receipts and a 3.3% decrease in single premium and rollover deposit receipts. Excluding the 2015 non-recurring item, the remaining 2016 decrease was minimal. For 2015, total annuity deposits received increased 14.0%, or $67.4 million, compared to the prior year, including a 22.6% increase in recurring deposit receipts and an 8.7% increase in single premium and rollover deposit receipts.

 

In addition to external contractholder deposits, annuity new recurring deposits include contributions and transfers by Horace Mann’s employees into the Company’s 401(k) group annuity contract. The Company’s employee retirement savings plans are described in “Notes to Consolidated Financial Statements — Note 11 — Pension Plans and Other Postretirement Benefits”. Note that deposits into the Company’s employee 401(k) group annuity contract are not reported as “sales”.

 

In 2016, new deposits to fixed accounts of $356.6 million decreased 4.4%, or $16.5 million, and new deposits to variable accounts of $163.6 million decreased 6.5%, or $11.3 million, compared to the prior year, including the impact of the 2015 non-recurring employee retirement savings plans item described above. In 2015, new deposits to fixed accounts of $373.1 million increased 9.7%, or $33.1 million, and new deposits to variable accounts of $174.9 million increased 24.4%, or $34.3 million, compared to the prior year.

 

Total annuity accumulated value on deposit of $6.4 billion at December 31, 2016 increased 7.2% compared to a year earlier, reflecting the increase from new deposits received as well as favorable retention. Accumulated value retention for the variable annuity option was 94.7%, 94.3% and 94.0% for the 12 month periods ended December 31, 2016, 2015 and 2014, respectively; fixed annuity retention was 94.6%, 94.8% and 94.5% for the respective periods.

 

Variable annuity accumulated balances of $1.9 billion at December 31, 2016 increased 6.8% compared to December 31, 2015, reflecting a positive impact from financial market performance over the 12 months partially offset by net balances transferred from the variable account option to the guaranteed interest rate fixed account option. Compared to 2015, Retirement segment contract charges earned decreased 2.0%, or $0.5 million. Variable annuity accumulated balances of $1.8 billion at December 31, 2015 decreased 0.7% compared to December 31, 2014, reflecting minimal impact from financial market performance over the 12 months and net balances transferred from the variable account option to the guaranteed interest rate fixed account option partially offset by net positive cash flows. Retirement segment contract charges earned decreased 0.8%, or $0.2 million, compared to 2014.

 

Life segment premiums and contract deposits* for 2016 increased 5.2%, or $5.3 million, compared to the prior year, including the favorable impact of new ordinary life business growth. Life segment premiums and contract deposits for 2015 were equal to the prior year, including the favorable impact of new ordinary life business growth offset by a modest decline in group life premiums. The ordinary life insurance in force lapse ratio was 4.3%, 4.1% and 4.0% for the 12 months ended December 31, 2016, 2015 and 2014, respectively.

 

 F-13  

 

 

Sales*

 

For 2016, Property and Casualty new annualized sales premiums increased 5.5% compared to 2015, as 5.7%, or $4.8 million, growth in new automobile sales was accompanied by growth in homeowners sales of 4.7%, or $0.8 million, compared to the prior year.

 

While the 2016 annuity new business levels were lower than in the prior year period, the Company’s Retirement segment new business levels continued to benefit from agent training and marketing programs, which focus on retirement planning, and build on the positive results produced in recent years. Annuity sales by Horace Mann’s agency force decreased 2.1% compared to 2015, primarily due to the impact in 2015 of non-recurring, non 401(k) rollover deposits from the Company’s employee retirement savings plans. Sales from the independent agent distribution channel, which represent approximately 9.2% of total annuity sales in 2016 and are largely single premium and rollover annuity deposits, decreased approximately 17.6% compared to a year earlier. As a result, total Horace Mann annuity sales from the combined distribution channels decreased 3.7%, or $13.8, compared to 2015.

 

Overall, the Company’s new recurring deposit business (measured on an annualized basis at the time of sale, compared to the reporting of new contract deposits which are recorded when cash is received) decreased 6.3% compared to 2015, and single premium and rollover deposits decreased 3.3% compared to the prior year. In February 2014, the Company expanded its annuity product portfolio by introducing a fixed indexed annuity contract. This new product continues to be well received by the Company’s customers and represented approximately one-third of total annuity sales for both 2016 and 2015. Previously, the Company offered indexed annuity products underwritten by third-party vendors.

 

The Company’s introduction of new educator-focused portfolios of term and whole life products in recent years, including a single premium whole life product, as well as the October 2015 introduction of the Company’s IUL product have contributed to an increase in sales of proprietary life products. For 2016, sales of Horace Mann’s proprietary life insurance products totaled $15.6 million, representing an increase of 43.1%, or $4.7 million, compared to the prior year, including an increase of $3.8 million for single premium sales.

 

Distribution

 

At December 31, 2016, there was a combined total of 666 Exclusive Agencies and Employee Agents, compared to 735 at December 31, 2015 and 755 at December 31, 2014. The Company continues to expect higher quality standards for agents and agencies to focus on improving both customer experiences and agent productivity in their respective territories. Growth in new automobile sales and life sales reflects improvement in average agency productivity. The dedicated sales force is supported by the Company’s Customer Contact Center which provides a means for educators to begin their experience directly with the Company, if that is their preference. The Customer Contact Center is also able to assist educators in territories which are not currently served by an Exclusive Agency.

 

As mentioned above, the Company also utilizes a nationwide network of Independent Agents who comprise an additional distribution channel for the Company’s 403(b) tax-qualified annuity products. The Independent Agent distribution channel included 272 authorized agents at December 31, 2016. During 2016, this channel generated $32.8 million in annualized new annuity sales for the Company compared to $39.8 million for 2015 and $34.4 million for 2014, with the new business primarily comprised of single and rollover deposit business over the three year period.

 

 F-14  

 

 

Net Investment Income

 

For 2016, pretax net investment income of $361.2 million increased 8.6%, or $28.6 million, (7.9%, or $17.7 million, after tax) compared to 2015. While asset balances in the Retirement segment continue to grow, overall investment results reflected an increase in investment prepayment activity and favorable returns on alternative investments, partially offset by the impact of the current low interest rate environment. For 2015, pretax net investment income of $332.6 million increased 0.8%, or $2.8 million, (0.7%, or $1.5 million, after tax) compared to 2014. Average invested assets increased 5.6% over the 12 months ended December 31, 2016. The average pretax yield on the total investment portfolio was 5.21% (3.47% after tax) for 2016, compared to the pretax yield of 5.06% (3.39% after tax) and 5.32% (3.57% after tax) for 2015 and 2014, respectively. During 2016, management continued to identify and purchase investments, including a modest level of alternative investments, with attractive risk-adjusted yields without venturing into asset classes or individual securities that would be inconsistent with the Company’s overall conservative investment guidelines.

 

Net Realized Investment Gains and Losses (Pretax)

 

For 2016, net realized investment gains were $4.1 million compared to net realized investment gains of $12.7 million and $10.9 million in 2015 and 2014, respectively. The net gains and losses in all periods were realized primarily from ongoing investment portfolio management activity and, when determined, the recognition of other-than-temporary impairment.

 

For the year ended December 31, 2016, the Company’s net realized investment gains of $4.1 million included $23.3 million of gross gains realized on security sales and calls partially offset by $8.1 million of realized losses primarily on securities that were disposed of during 2016 and $11.1 million of other-than-temporary impairment charges recorded largely on Puerto Rico and energy sector fixed maturity securities, as well as some equity securities.

 

For the year ended December 31, 2015, the Company’s net realized investment gains of $12.7 million included $39.6 million of gross gains realized on security sales and calls partially offset by $7.4 million of realized losses on securities that were disposed of during 2015 and $19.5 million of other-than-temporary impairment charges recorded largely on energy sector and Puerto Rico fixed maturity securities and one unrelated equity security.

 

For the year ended December 31, 2014, the Company’s net realized investment gains of $10.9 million included $26.7 million of gross gains realized on security sales and calls partially offset by $9.4 million of realized losses on securities that were disposed of during 2014, primarily mortgage-backed and municipal securities, and the $6.4 million other-than-temporary charge recorded largely on energy sector securities in the fourth quarter.

 

The Company, from time to time, sells securities subsequent to the balance sheet date that were considered temporarily impaired at the balance sheet date. Such sales are due to issuer specific events occurring subsequent to the balance sheet date that result in a change in the Company’s intent to sell an invested asset.

 

 F-15  

 

 

Fixed Maturity Securities and Equity Securities Portfolios

 

The table below presents the Company’s fixed maturity securities and equity securities portfolios by major asset class, including the ten largest sectors of the Company’s corporate bond holdings (based on fair value). Compared to December 31, 2015, credit spreads were tighter across most asset classes at December 31, 2016 and U.S. Treasury rates increased, which resulted in net unrealized investment gains to be flat in the Company’s fixed maturity securities holdings.

 

    December 31, 2016
                Amortized   Pretax Net
    Number of   Fair   Cost or   Unrealized
    Issuers   Value   Cost   Gain (Loss)
Fixed maturity securities                                      
Corporate bonds                                      
Banking and Finance     97       $ 709.8       $ 682.3       $ 27.5  
Insurance     51         260.9         240.8         20.1  
Energy (1)     48         221.8         208.7         13.1  
Healthcare, Pharmacy     39         168.2         161.6         6.6  
Real estate     35         162.5         156.8         5.7  
Technology     28         161.8         158.8         3.0  
Utilities     39         159.3         140.9         18.4  
Transportation     22         156.3         150.4         5.9  
Telecommunications     23         123.8         115.8         8.0  
Natural gas     19         96.5         93.1         3.4  
All Other Corporates (2)     180         589.4         563.7         25.7  
Total corporate bonds     581         2,810.3         2,672.9         137.4  
Mortgage-backed securities                                    
U.S. Government and federally sponsored agencies 359 442.4 412.9       29.5  
Commercial (3)     121         503.8         508.5         (4.7 )
Other     29         70.4         69.2         1.2  
Municipal bonds (4)     593         1,769.4         1,648.3         121.1  
Government bonds                                      
U.S.     10         467.1         458.7         8.4  
Foreign     17         98.7         93.9         4.8  
Collateralized debt obligations (5)     112         667.7         662.9         4.8  
Asset-backed securities     107         626.9         624.8         2.1  
Total fixed maturity securities     1,929       $ 7,456.7       $ 7,152.1       $ 304.6  
                                       
Equity securities                                      
Non-redeemable preferred stocks     14       $ 50.0       $ 52.3       $ (2.3 )
Common stocks     177         72.2         61.7         10.5  
Closed-end fund     1         19.4         20.0         (0.6 )
Total equity securities     192       $ 141.6       $ 134.0       $ 7.6  
                                       
Total     2,121       $ 7,598.3       $ 7,286.1       $ 312.2  

 

 

(1)At December 31, 2016, the fair value amount included $13.9 million which were non-investment grade.
(2)The All Other Corporates category contains 19 additional industry classifications. Gaming, broadcast and media, food and beverage, consumer products and retail represented $428.9 million of fair value at December 31, 2016, with the remaining 13 classifications each representing less than $34.0 million.
(3)At December 31, 2016, 100% were investment grade, with an overall credit rating of AA, and the positions were well diversified by property type, geography and sponsor.
(4)Holdings are geographically diversified, approximately 40% are tax-exempt and 78% are revenue bonds tied to essential services, such as mass transit, water and sewer. The overall credit quality of the municipal bond portfolio was AA- at December 31, 2016.
(5)Based on fair value, 96% of the collateralized debt obligation securities were rated investment grade by Standard and Poor’s Corporation (“S&P”) and/or Moody’s Investors Service, Inc. (“Moody’s”) at December 31, 2016.

 

 F-16  

 

 

At December 31, 2016, the Company’s diversified fixed maturity securities portfolio consisted of 2,465 investment positions, issued by 1,929 entities, and totaled approximately $7.5 billion in fair value. This portfolio was 95.9% investment grade, based on fair value, with an average quality rating of A. The Company’s investment guidelines generally limit single corporate issuer concentrations to 0.5% of invested assets for “AA” or “AAA” rated securities, 0.35% of invested assets for “A” or “BBB” rated securities, and 0.2% of invested assets for non-investment grade securities.

 

The following table presents the composition and value of the Company’s fixed maturity securities and equity securities portfolios by rating category. At December 31, 2016, 94.7% of these combined portfolios were investment grade, based on fair value, with an overall average quality rating of A. The Company has classified the entire fixed maturity securities and equity securities portfolios as available for sale, which are carried at fair value.

 

Rating of Fixed Maturity Securities and Equity Securities (1)

(Dollars in millions)

 

    December 31, 2016  
    Percent          
    of Total          
    Fair   Fair   Amortized
    Value   Value   Cost or Cost
Fixed maturity securities                            
AAA     8.3 %     $ 620.8       $ 611.6  
AA (2)     35.5         2,648.4         2,533.5  
A     23.6         1,759.6         1,663.9  
BBB     28.4         2,118.7         2,038.5  
BB     2.4         176.4         174.7  
B     1.0         76.3         79.5  
CCC or lower     0.2         10.9         10.6  
Not rated (3)     0.6         45.6         39.8  
Total fixed maturity securities     100.0 %     $ 7,456.7       $ 7,152.1  
Equity securities                            
AAA     -         -         -  
AA     -         -         -  
A     -         -         -  
BBB     35.3 %     $ 50.0       $ 52.3  
BB     -         -         -  
B     -         -         -  
CCC or lower     -         -         -  
Not rated     64.7         91.6         81.7  
Total equity securities     100.0 %     $ 141.6       $ 134.0  
                             
Total             $ 7,598.3       $ 7,286.1  

 

 

(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)At December 31, 2016, the AA rated fair value amount included $467.1 million of U.S. Government and federally sponsored agency securities and $522.8 million of mortgage- and asset-backed securities issued by U.S. Government and federally sponsored agencies.
(3)This category primarily represents private placement and municipal securities not rated by either S&P or Moody’s.

 

At December 31, 2016, the fixed maturity securities and equity securities portfolios had a combined $76.0 million pretax of gross unrealized investment losses on $2,302.4 million fair value related to 731 positions. Of the investment positions (fixed maturity securities and equity securities) with gross unrealized investment losses, 12 were trading below 80% of the carrying value at December 31, 2016 and were not considered other-than-temporarily impaired. These positions had fair value of $15.2 million, representing 0.2% of the Company’s total investment portfolio at fair value, and had a gross unrealized investment loss of $6.6 million.

 

 F-17  

 

 

The Company views the unrealized investment losses of all of the securities at December 31, 2016 as temporary. Future changes in circumstances related to these and other securities could require subsequent recognition of other-than-temporary impairment.

 

Benefits, Claims and Settlement Expenses

 

 

Year Ended

December 31,

 

Change From

Prior Year

 

Year Ended

December 31,

  2016   2015   Percent   Amount     2014    
                             
Property and Casualty   $ 464.1       $ 420.3       10.4 %     $ 43.8       $ 399.5    
Retirement (annuity)     3.9         3.2       21.9 %       0.7         2.2    
Life     73.1         72.9       0.3 %       0.2           66.7    
Total   $ 541.1       $ 496.4       9.0 %     $ 44.7       $ 468.4    
                                                 
Property and Casualty catastrophe losses,
included above (1)
  $ 60.0       $ 44.4       35.1 %     $ 15.6       $ 37.5    

 

 

(1)See footnote (1) to the table below.

 

Property and Casualty Claims and Claim Expenses (“losses”)

 

  Year Ended December 31,  
  2016   2015   2014  
Incurred claims and claim expenses:                              
Claims occurring in the current year   $ 471.1       $ 432.8       $ 416.5    
Decrease in estimated reserves for claims occurring in prior years (2)     (7.0 )       (12.5 )       (17.0 )  
Total claims and claim expenses incurred   $ 464.1       $ 420.3       $ 399.5    
                                 
Property and Casualty loss ratio:                              
Total     74.8 %       70.5 %       68.7 %  
Effect of catastrophe costs, included above (1)     9.7 %       7.4 %       6.5 %  
Effect of prior years’ reserve development, included above (2)     -1.1 %       -2.1 %       -2.9 %  

 

 

 

(1)Property and Casualty catastrophe losses were incurred as follows:

 

    2016   2015   2014  
  Three months ended                              
  March 31   $ 12.7       $ 10.5       $ 6.3    
  June 30     27.3         21.3         23.5    
  September 30     8.4         5.0         5.7    
  December 31     11.6         7.6         2.0    
  Total full year   $ 60.0       $ 44.4       $ 37.5    

 

(2)Shows the amounts by which the Company decreased its reserves in each of the periods indicated for claims occurring in previous years to reflect subsequent information on such claims and changes in their projected final settlement costs indicating that the actual and remaining projected losses for prior years are below the level anticipated in the previous December 31 loss reserve estimate.

 

    2016   2015   2014  
  Three months ended                              
  March 31   $ (2.0 )     $ (4.0 )     $ (4.0 )  
  June 30     (1.6 )       (3.2 )       (3.0 )  
  September 30     (0.7 )       (2.8 )       (4.4 )  
  December 31     (2.7 )       (2.5 )       (5.6 )  
  Total full year   $ (7.0 )     $ (12.5 )     $ (17.0 )  

 

 F-18  

 

 

For 2016, the Company’s benefits, claims and settlement expenses increased $44.7 million, or 9.0%, compared to the prior year primarily reflecting increases in Property and Casualty current accident year loss severity and frequency — specifically, in automobile — and catastrophe costs, partially offset by a reduction in homeowners current accident year non-catastrophe losses and a $4.0 million decrease in life mortality costs. In 2015, the Company’s benefits, claims and settlement expenses increased $28.0 million, or 6.0%, compared to the prior year primarily reflecting increases in Property and Casualty current accident year loss severity — specifically, in automobile — and catastrophe costs, as well as a $4.5 million increase in life mortality costs.

 

For 2016, 2015 and 2014, the favorable development of prior years’ Property and Casualty reserves of $7.0 million, $12.5 million and $17.0 million, respectively, for each year was the result of actual and remaining projected losses for prior years being below the level anticipated in the immediately preceding December 31 loss reserve estimate. In 2016, the favorable development was predominantly the result of favorable severity trends in property for accident years 2014 and prior. For 2015, the favorable development was primarily for accident years 2013 and prior and predominantly the result of favorable severity trends in homeowners loss emergence, accompanied by favorable severity and frequency trends in automobile loss emergence. For 2014, the favorable development was primarily for accident years 2011 and prior and predominantly the result of favorable frequency and severity trends in automobile loss emergence.

 

For 2016, the automobile loss ratio of 80.2% increased by 4.8 percentage points compared to the prior year, including (1) the impact of catastrophe costs that resulted in a 1.7 percentage point increase, (2) the impacts of higher current accident year non-catastrophe losses for 2016 primarily driven by loss severity and accompanied by an increase in loss frequencies and (3) development of prior years’ reserves that had a 0.8 percentage point less favorable impact in the current year, partially offset by the favorable impact of rate actions taken in recent years. The homeowners loss ratio of 63.9% for 2016 increased 2.4 percentage points compared to a year earlier, including favorable current accident year non-catastrophe experience offset by development of prior years’ reserves that had a 0.8 percentage point less favorable impact in the current year and high catastrophe costs. Catastrophe costs represented 24.2 percentage points of the homeowners loss ratio for 2016 compared to 20.4 percentage points for 2015.

 

Interest Credited to Policyholders

 

  Year Ended   Change From   Year Ended
  December 31,   Prior Year   December 31,
  2016   2015   Percent   Amount       2014    
                                 
Retirement (annuity)   $ 147.3       $ 138.7         6.2 %     $ 8.6         $ 132.5    
Life     44.7         44.1         1.4 %       0.6           43.6    
Total   $ 192.0       $ 182.8         5.0 %     $ 9.2         $ 176.1    

 

Compared to 2015, the 2016 increase in Retirement segment interest credited reflected a 7.6% increase in average accumulated fixed deposits, at an average crediting rate of 3.55%. Compared to a year earlier, the 2015 increase in Retirement segment interest credited reflected a 7.7% increase in average accumulated fixed deposits, partially offset by a 6 basis point decline in the average annual interest rate credited to 3.56%. Life insurance interest credited increased slightly in both 2016 and 2015 as a result of the growth in reserves for life insurance products with account values.

 

 F-19  

 

 

The net interest spread on fixed annuity assets under management measures the difference between the rate of income earned on the underlying invested assets and the rate of interest which policyholders are credited on their account values. The net interest spreads for the years ended December 31, 2016, 2015 and 2014, were 193 basis points, 184 basis points and 204 basis points, respectively. The interest spread increased due to an increase in investment prepayment activity as well as favorable returns within the Company’s alternative investment portfolio and a continuation of disciplined crediting rate management, partially offset by pressures of the low interest rate environment.

 

As of December 31, 2016, fixed annuity account values totaled $4.5 billion, including $4.3 billion of deferred annuities. As shown in the table below, for approximately 87%, or $3.7 billion of the deferred annuity account values, the credited interest rate was equal to the minimum guaranteed rate. Due to limitations on the Company’s ability to further lower interest crediting rates, coupled with the expectation for continued low reinvestment interest rates, management anticipates fixed annuity spread compression in future periods. The majority of assets backing the net interest spread on fixed annuity business is invested in fixed maturity securities.

 

The Company actively manages its interest rate risk exposure, considering a variety of factors, including earned interest rates, credited interest rates and the relationship between the expected durations of assets and liabilities. Management estimates that over the next 12 months approximately $530 million of the Retirement segment and Life segment combined investment portfolio and related investable cash flows will be reinvested at current market rates. As interest rates remain at low levels, borrowers may prepay or redeem the securities with greater frequency in order to borrow at lower market rates, which could increase investable cash flows and exacerbate the reinvestment risk.

 

As a general guideline, for a 100 basis point decline in the average reinvestment rate and based on the Company’s existing policies and investment portfolio, the impact from investing in that lower interest rate environment could further reduce Retirement segment net investment income by approximately $1.5 million in year one and $5.3 million in year two, further reducing the net interest spread by approximately 3 basis points and 11 basis points in the respective periods, compared to the current period annualized net interest spread. The Company could also consider potential changes in rates credited to policyholders, tempered by any restrictions on the ability to adjust policyholder rates due to minimum guaranteed crediting rates.

 

The expectation for future net interest spreads is also an important component in the amortization of deferred policy acquisition costs. In terms of the sensitivity of this amortization to the net interest spread, based on deferred policy acquisition costs as of December 31, 2016 and assuming all other assumptions are met, a 10 basis point deviation in the current year targeted interest rate spread assumption would impact amortization between $0.25 million and $0.35 million. This result may change depending on the magnitude and direction of any actual deviations but represents a range of reasonably likely experience for the noted assumption.

 

 F-20  

 

 

Additional information regarding the interest crediting rates and balances equal to the minimum guaranteed rate for deferred annuity account values is shown below.

 

    December 31, 2016
                    Deferred Annuities at
    Total Deferred Annuities   Minimum Guaranteed Rate
                Percent of            
    Percent   Accumulated   Total Deferred   Percent   Accumulated
    of Total   Value (“AV”)   Annuities AV   of Total   Value
Minimum guaranteed interest rates:                                                
Less than 2%     23.5       $ 1,003.6         48.2 %       13.1 %     $ 483.8  
Equal to 2% but less than 3%     7.2         308.6         82.8 %       6.9         255.4  
Equal to 3% but less than 4%     14.2         606.7         99.8 %       16.4         605.1  
Equal to 4% but less than 5%     53.7         2,290.2         100.0 %       62.1         2,290.2  
5% or higher     1.4 %       55.5         100.0 %       1.5       55.5  
Total     100.0 %     $ 4,264.6         86.5 %       100.0 %     $ 3,690.0  

 

The Company will continue to be disciplined in executing strategies to mitigate the negative impact on profitability of a sustained low interest rate environment. However, the success of these strategies may be affected by the factors discussed in “Item 1A. Risk Factors” in this Annual Report on Form 10-K and other factors discussed herein.

 

Policy Acquisition Expenses Amortized

 

Amortized policy acquisition expenses were $96.7 million for 2016 compared to $98.9 million and $93.8 million for the years ended December 31, 2015 and 2014, respectively. The decrease in 2016 was largely attributable to the Retirement segment including the impact of the unlocking of deferred policy acquisition costs (“unlocking”) offset by the growth in premiums and related commissions for the Property and Casualty segment. At December 31, 2016, Retirement segment unlocking resulted in a $0.3 million decrease in amortization compared to a $3.4 million increase in amortization a year earlier. For the prior period, the impact was largely due to financial market performance. For the Life segment, unlocking resulted in an immaterial change in amortization at December 31, 2016, 2015 and 2014.

 

Operating Expenses

 

In 2016, operating expenses of $173.1 million increased $15.7 million, or 10.0%, compared to 2015. In 2015, expenses reflected a reduction in incentive compensation expense with the majority of the cost reduction benefiting the Property and Casualty segment. The 2016 expense level was consistent with management’s expectations as the Company makes expenditures related to customer service and infrastructure improvements, which are intended to enhance the overall customer experience and support favorable policy retention and business cross-sale ratios. In 2015, operating expenses of $157.4 million decreased $4.7 million, or 2.9%, compared to 2014.

 

The Property and Casualty expense ratio of 26.7% for 2016 increased 0.2 percentage points compared to the prior year expense ratio of 26.5%, or slightly below management’s expectations for 2016. The 2015 incentive compensation expense reduction reduced the expense ratio for 2015 by 0.4 percentage points. The Property and Casualty expense ratio was 27.4% for 2014.

 

 F-21  

 

 

Interest Expense and Debt Retirement Costs

 

In June 2015, the Company repaid its outstanding $75.0 million 6.05% Senior Notes upon maturity initially utilizing funds borrowed under its existing Bank Credit Facility. In November 2015, the Company issued $250.0 million face amount of 4.50% Senior Notes due 2025. The Company used the net proceeds from this issuance to redeem all its outstanding 6.85% Senior Notes due April 15, 2016 and to repay in full the $113.0 million of outstanding borrowings under its Bank Credit Facility. The combined impact of these transactions reduced interest expense in 2016 by $1.3 million compared to 2015 and $1.1 million in 2015, compared to 2014.

 

The redemption of the 6.85% Senior Notes in 2015 resulted in a pretax charge of $2.3 million, largely due to the make-whole premium.

 

Income Tax Expense

 

The effective income tax rate on the Company’s pretax income, including net realized investment gains and losses, was 26.6%, 27.8% and 28.7% for the years ended December 31, 2016, 2015 and 2014, respectively. Income from investments in tax-advantaged securities reduced the effective income tax rates 8.5, 7.9 and 7.1 percentage points for 2016, 2015 and 2014, respectively. In 2016, income tax expense was reduced by approximately $0.9 million related to the filing of the prior calendar year tax return; this item primarily benefited the Retirement segment.

 

The Company records liabilities for uncertain tax filing positions where it is more likely than not that the position will not be sustainable upon audit by taxing authorities. These liabilities are reevaluated routinely and are adjusted appropriately based on changes in facts or law. The Company has no unrecorded liabilities from uncertain tax filing positions.

 

At December 31, 2016, the Company’s federal income tax returns for years prior to 2013 are no longer subject to examination by the IRS. Management does not anticipate any assessments for tax years that remain subject to examination to have a material effect on the Company’s financial position or results of operations.

 

Net Income

 

For 2016, the Company’s net income of $83.8 million decreased $9.7 million compared to 2015. After tax net realized investment gains were $2.3 million compared to $8.6 million a year earlier. Additional detail is included in the “Executive Summary” at the beginning of this MD&A.

 

For 2015, the Company’s net income of $93.5 million represented a decrease of $10.7 million compared to 2014 reflecting improvement in current accident year non-catastrophe results for homeowners, pressure on automobile results primarily due to loss severity, a higher level of life mortality losses and a negative impact due to the unlocking of Retirement segment deferred policy acquisition costs. Net income in 2015 was also reduced by debt retirement costs.

 

For 2014, the Company’s net income of $104.2 million declined $6.7 million compared to 2013, as improvements in Property and Casualty segment and Retirement segment results, as well as solid earnings in the Life segment, were offset by a decrease in net realized investment gains. After tax net realized investment

 

 F-22  

 

 

gains of $6.9 million were $7.5 million less than in 2013. For the Property and Casualty segment, net income of $46.9 million increased $2.5 million compared to 2013. The Property and Casualty combined ratio was 96.1% for 2014, a 0.2 percentage point improvement compared to 96.3% for 2013.

 

Net income (loss) by segment and net income per share were as follows:

 

    Year Ended   Change From   Year Ended  
    December 31,   Prior Year   December 31,  
    2016     2015   Percent   Amount     2014    
Analysis of net income (loss) by segment:                                                        
Property and Casualty     $ 25.6       $ 40.0       -36.0 %       $ (14.4 )       $ 46.9      
Retirement       50.7         43.4       16.8 %         7.3           45.3      
Life       16.6         15.0       10.7 %         1.6           17.5      
Corporate and Other (1)       (9.1 )       (4.9 )     -85.7 %         (4.2 )         (5.5 )    
Net income     $ 83.8       $ 93.5       -10.4 %       $ (9.7 )       $ 104.2      
                                                         
Effect of catastrophe costs, after tax, included above     $ (39.1 )     $ (28.9 )     35.3 %       $ 10.2         $ (24.4 )    
Effect of net realized investment gains, after tax,
included above
    $ 2.3       $ 8.6       -73.3 %       $ (6.3 )       $ 6.9      
Effect of debt retirement costs, after tax, included above     $ -       $ (1.5 )     N.M.         $ (1.5 )       $ -      
                                                         
Diluted:                                                        
Net income per share     $ 2.02       $ 2.20       -8.2 %       $ (0.18 )       $ 2.47      
Weighted average number of shares and equivalent shares (in millions)       41.5         42.4       -2.1 %         (0.9 )         42.2      
                                                         
Property and Casualty combined ratio:                                                        
Total       101.5 %       97.0 %     N.M.           4.5 %         96.1 %    
Effect of catastrophe costs, included above       9.7 %       7.4 %     N.M.           2.3 %         6.5 %    
Effect of prior years’ reserve development, included above       -1.1 %       -2.1 %     N.M.           1.0 %         -2.9 %    

 

 

N.M. - Not meaningful.

(1)The Corporate and Other segment includes interest expense on debt, realized investment gains and losses, corporate debt retirement costs, certain public company expenses and other corporate-level items. The Company does not allocate the impact of corporate-level transactions to the insurance segments, consistent with the basis for management’s evaluation of the results of those segments.

 

As described in footnote (1) to the table above, the Corporate and Other segment reflects corporate-level transactions. Of those transactions, net realized investment gains and losses may vary notably between reporting periods and are often the driver of fluctuations in the level of this segment’s net income or loss. For 2016, 2015 and 2014, net realized investment gains after tax were $2.3 million, $8.6 million and $6.9 million, respectively. In addition, 2016 reflected a $1.3 million pretax reduction in debt interest expense as a result of the refinancing transactions completed in 2015. The debt redemption in 2015 resulted in a pretax charge of $2.3 million, partially offset by a $1.1 million reduction in debt interest expense compared to 2014.

 

Return on average shareholders’ equity based on net income was 6.2%, 7.1% and 8.4% for the years ended December 31, 2016, 2015 and 2014, respectively.

 

 F-23  

 

 

Outlook for 2017

 

At the time of this Annual Report on Form 10-K, management estimates that 2017 full year net income before net realized investment gains and losses will be within a range of $1.95 to $2.15 per diluted share. This projection incorporates the Company’s results for 2016 and anticipates continued improvement in the Company’s underlying automobile combined ratio, modeled catastrophe losses as well as modestly lower earnings in the Retirement and Life segments reflecting lower net interest spreads, and approximately $0.10 cents of continued strategic investing in our Retirement business that we expect will accelerate growth momentum related to the Company’s continued modernization of technology and infrastructure. As a result of the continued low interest rate environment, management expects the Company’s overall portfolio yield to decline by approximately 10 basis points over the course of 2017, impacting each of the three business segments. Within the Property and Casualty segment, both approved and planned premium rate increases, as well as underwriting initiatives, are expected to improve profitability margins for the automobile line compared to 2016. The property line is anticipated to produce solid profitability, although at a reduced level that assumes non-catastrophe weather related losses return to a more normalized level than the comparison to 2016; and, catastrophe losses are estimated to be lower than the 2016 level. Net income for the Retirement segment will continue to be impacted by the prolonged interest rate environment and the 2016 net interest spread of 193 basis points is anticipated to grade down to the low 180s through the course of 2017. Assuming mortality costs consistent with the Company’s actuarial models, Life segment net income is expected to decrease compared to 2016, due to net investment income pressure and the increase in expenses. In addition to the segment-specific factors, the Company’s initiatives for customer service and infrastructure improvements, as well as enhanced training and education for the Company’s agency force, all intended to enhance the overall customer experience and support further improvement in policy retention and business cross-sale ratios, will continue and result in a moderate increase in expense levels compared to 2016.

 

As described in “Critical Accounting Policies”, certain of the Company’s significant accounting measurements require the use of estimates and assumptions. As additional information becomes available, adjustments may be required. Those adjustments are charged or credited to income for the period in which the adjustments are made and may impact actual results compared to management’s estimate above. Additionally, see “Forward-looking Information” and “Item 1A. Risk Factors” in this Annual Report on Form 10-K concerning other important factors that could impact actual results. Management believes that a projection of net income including net realized investment gains and losses* is not appropriate on a forward-looking basis because it is not possible to provide a valid forecast of net realized investment gains and losses, which can vary substantially from one period to another and may have a significant impact on net income.

 

Liquidity and Financial Resources

 

Off-Balance Sheet Arrangements

 

At December 31, 2016, 2015 and 2014, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. As such, the Company is not exposed to any financing, liquidity, market or credit risk that could arise if the Company had engaged in such relationships.

 

 F-24  

 

 

Investments

 

Information regarding the Company’s investment portfolio, which is comprised primarily of investment grade, fixed maturity securities, is located in “Results of Operations for the Three Years Ended December 31, 2016 — Net Realized Investment Gains and Losses”, “Item 1. Business — Investments” and in the “Notes to Consolidated Financial Statements — Note 2 — Investments” listed on page F-1 of this report.

 

Cash Flow

 

The short-term liquidity requirements of the Company, within a 12 month operating cycle, are for the timely payment of claims and benefits to policyholders, operating expenses, interest payments and federal income taxes. Cash flow generated from operations has been, and is expected to be, adequate to meet the Company’s operating cash needs in the next 12 months. Cash flow in excess of operational needs has been used to fund business growth, pay dividends to shareholders and repurchase shares of HMEC’s common stock. Long-term liquidity requirements, beyond one year, are principally for the payment of future insurance and annuity policy claims and benefits, as well as retirement of long-term debt.

 

Operating Activities

 

As a holding company, HMEC conducts its principal operations in the personal lines segment of the property and casualty and life insurance industries through its subsidiaries. HMEC's insurance subsidiaries generate cash flow from premium and investment income, generally well in excess of their immediate needs for policy obligations, operating expenses and other cash requirements. Cash provided by operating activities primarily reflects net cash generated by the insurance subsidiaries. For 2016, net cash provided by operating activities increased slightly compared to 2015, largely due to a decrease in claims and policyholder benefits paid in 2016, partially offset by a decrease in premiums collected and an increase in investment income collected in 2016.

 

Payment of principal and interest on debt, dividends to shareholders and parent company operating expenses is largely dependent on the ability of the insurance subsidiaries to pay cash dividends or make other cash payments to HMEC, including tax payments pursuant to tax sharing agreements. Payments for share repurchase programs also have this dependency. If necessary, HMEC also has other potential sources of liquidity that could provide for additional funding to meet corporate obligations or pay shareholder dividends, which include a revolving line of credit, as well as issuances of various securities. The insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. The aggregate amount of dividends that may be paid in 2017 from all of HMEC’s insurance subsidiaries without prior regulatory approval is approximately $91 million. Although regulatory restrictions exist, dividend availability from subsidiaries has been, and is expected to be, adequate for HMEC's capital needs. Additional information is contained in “Notes to Consolidated Financial Statements — Note 10 — Statutory Information and Restrictions” listed on page F-1 of this report.

 

 F-25  

 

 

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, as well as equity securities, and reinvest the proceeds in other investments with different interest rates, maturities or credit characteristics. Accordingly, the Company has classified the entire fixed maturity securities and equity securities portfolios as “available for sale”.

 

Financing Activities

 

Financing activities include primarily payment of dividends, the receipt and withdrawal of funds by annuity contractholders, issuances and repurchases of HMEC’s common stock, fluctuations in bank overdraft balances, and borrowings, repayments and repurchases related to its debt facilities.

 

In 2013, one of the Company’s subsidiaries became a member of the Federal Home Loan Bank of Chicago (“FHLB”). That subsidiary received $250.0 million under a funding agreement in December 2013, received an additional $250.0 million in September 2014, and received an additional $75.0 million in December 2015 with receipt of those funds reflected in Annuity Contracts: Variable, Fixed and FHLB Funding Agreements, Deposits as a component of the Company’s financing activities for the respective years. Exclusive of these transactions, the Company’s annuity business produced net positive cash flows in 2016, 2015 and 2014. For the year ended December 31, 2016, receipts from annuity contracts, also excluding the FHLB transactions, decreased $27.8 million, or 5.1%, compared to 2015, as described in “Results of Operations for the Three Years Ended December 31, 2016 — Insurance Premiums and Contract Charges”. In total, annuity contract benefits, withdrawals and net transfers to variable annuity accumulated cash values decreased $4.8 million, or 1.4%, compared to the prior year.

 

The Company’s Senior Notes due 2015 matured on June 15, 2015 and the Company repaid the $75.0 million initially utilizing funds borrowed under its existing Bank Credit Facility. Repayment of the Senior Notes due 2015 resulted in no debt retirement costs impacting the Company’s net income for 2015. In November 2015, the Company issued $250.0 million aggregate principal amount of 4.50% Senior Notes due 2025 and used the net proceeds to redeem all of its outstanding 6.85% Senior Notes due April 15, 2016 and fully repay the $113.0 million of outstanding borrowings under the Company’s Bank Credit Facility. Repayment of the Senior Notes due 2016 resulted in $2.3 million pretax of debt retirement costs impacting the Company’s net income for 2015, nearly all of which required cash. The remaining net proceeds from the issuance of the Senior Notes due 2025 were available for general corporate purposes.

 

 F-26  

 

 

Contractual Obligations

 

The following table shows the Company’s contractual obligations, as well as the projected timing of payments.

 

    Payments Due By Period as of December 31, 2016  
          Less Than   1 - 3 Years   3 - 5 Years  

More Than

5 Years

 
          1 Year   (2018 and   (2020 and   (2022 and  
    Total   (2017)   2019)   2021)   beyond)  
Fixed annuities and fixed option of variable
annuities (1)
    $ 6,901.2       $ 248.8       $ 507.5       $ 521.2       $ 5,623.7    
Supplemental contracts (1)(2)       1,058.0         27.1         299.3         43.2         688.4    
Life insurance policies (1)       2,564.0         87.2         180.2         184.7         2,111.9    
Property and casualty claims and claim adjustment
expenses (1)
      246.6         161.4         76.0         8.4         0.8    
Long-term debt obligations                                                    
Senior Notes due December 1, 2025       351.3         11.3         22.5         22.5         295.0    
Operating lease obligations (4)       11.9         2.6         5.0         2.7         1.6    
                                                     
Total     $ 11,133.0       $ 538.4       $ 1,090.5       $ 782.7       $ 8,721.4    

 

 

(1)This information represents estimates of both the amounts to be paid to policyholders and the timing of such payments and is net of anticipated reinsurance recoveries.
(2)Includes $575.0 million obligation to FHLB plus interest.
(3)Includes principal and interest.
(4)The Company has entered into various operating lease agreements, primarily for real estate (claims and marketing offices in a few states, as well as portions of the home office complex) and also for computer equipment and copy machines.

 

Estimated Future Policy Benefit and Claim Payments - Retirement and Life Segments

 

This discussion addresses the following contractual obligations disclosed above: fixed annuities and fixed option of variable annuities, supplemental contracts and life insurance policies. Payment amounts reflect the Company’s estimate of undiscounted cash flows related to these obligations and commitments. Balance sheet amounts were determined in accordance with GAAP, including the effect of discounting, and consequently in many cases differ significantly from the summation of undiscounted cash flows.

 

For the majority of the Company’s Retirement and Life insurance operations, the estimated contractual obligations for future policyholder benefits as presented in the table above were derived from the annual cash flow testing analysis used to develop actuarial opinions of statutory reserve adequacy for state regulatory purposes. These cash flows are materially representative of the cash flows under GAAP. Actual amounts may vary, potentially in a significant manner, from the amounts indicated due to deviations between assumptions and actual results and the addition of new business in future periods.

 

Amounts presented in the table above represent the estimated cash payments to be made to policyholders undiscounted by interest and including assumptions related to the receipt of future premiums and deposits, future interest credited, full and partial withdrawals, policy lapses, surrender charges, annuitization, mortality, and other contingent events as appropriate to the respective product types. Additionally, coverage levels are assumed to remain unchanged from those provided under contracts in force at December 31, 2016. Separate Account (variable annuity) payments are not reflected due to the matched nature of these obligations and the fact that the contract owners maintain the investment risk on such deposits.

 

 F-27  

 

 

See “Notes to Consolidated