ITEM 7. I Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
($ in millions, except per share data)
Measures within this MD&A that are not based on accounting principles generally accepted in the United States of America (non-GAAP) are marked with an asterisk (*) the first time they are presented within this Part II - Item 7. 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 and are reconciled to the most directly comparable measures prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) in the Appendix to the Company's Fourth Quarter 2020 Investor Supplement.
Increases or decreases in this MD&A that are not meaningful are marked "N.M.".
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 Educators Corporation (referred to in this report as "we", "our", "us", the "Company", "Horace Mann" or "HMEC") is an insurance holding company. We are not under any obligation to (and expressly disclaim 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 our actual results could differ materially from those projected in forward-looking statements due to a number of risks and uncertainties inherent in our business. See Part I - Item 1A of this Annual Report on Form 10-K for additional information regarding risks and uncertainties.
Introduction
The purpose of this MD&A is to provide an understanding of our consolidated results of operations and financial condition. This MD&A should be read in conjunction with the Consolidated Financial Statements and Notes thereto contained in Part II - Item 8 of this report.
HMEC is an insurance holding company and through its subsidiaries, we market and underwrite personal lines of property and casualty insurance products, supplemental insurance products, retirement products and life insurance products in the United States of America (U.S.). We market our products primarily to K-12 teachers, administrators and other employees of public schools and their families.
This MD&A covers our consolidated financial highlights followed by consolidated results of operations, an outlook for future performance, details about critical accounting estimates, results of operations by segment, investment results, liquidity and financial resources, future adoption of new accounting standards and effects of inflation and changes in interest rates.
COVID-19 Considerations
Beginning in March 2020, the global pandemic associated with the novel coronavirus COVID-19 and related economic conditions introduced unprecedented challenges for our country. Those challenges are ongoing. We relied on our previously developed Corporate Pandemic Plan to address preparation, prevention and response measures specific to COVID-19 while allowing flexibility to quickly react to evolving circumstances and implement varying actions accordingly.
As discussed in our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2020, we successfully transitioned the organization, through our employees and agents, from one that relied on in-person experience to one that has become primarily virtual. While the current environment continues to present challenges, our operations are being conducted successfully and we continue to support our agents and serve our customers in an effective manner.
As of the end of December 2020, the majority of our employees continue to work remotely. The return to office plans are being guided by data from the Center for Disease Control. We presently limit office occupancy to
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approximately half of pre-COVID-19 levels to enable effective social distancing for some time. We have also implemented other prevention strategies to reduce the potential transmission of COVID-19, such as requiring face masks in common office areas.
Taking into account the virtual work environment, we have implemented additional cybersecurity measures including increasing security and network monitoring to proactively identify and prevent potential security threats and vulnerabilities. We also are identifying and assessing critical third-party vendors and ensuring their ability to continue to perform as anticipated.
Horace Mann markets primarily to K-12 teachers, administrators and other employees of public schools and their families and we estimate that 80% of our customer base are educators or other individuals employed by public school systems. In our experience, educators generally remain employed during periods of economic disruption. As the country entered the 2020 - 2021 school year facing continued pandemic-related challenges, educators have largely remained employed, although they may be even busier than before, as many are being asked to devote time to both in-person teaching as well as remote learning to minimize the spread of COVID-19 in their communities.
We continue to work with our network of exclusive agents to make sure they are using virtual tools that can allow them to reach current and potential educator customers when face-to-face interactions are not possible. We are implementing a variety of new and modified forums to provide access to the financial solutions we offer educators. However, growth in new sales has slowed since the pandemic began, particularly sales generated from in-person events at schools. This may be exacerbated if public school systems face budget constraints due to the economic impacts of the pandemic and/or access to "in school" events remains restricted.
For further discussion regarding the current period and potential future impacts of COVID-19 and related economic conditions on us, see Outlook for 2021 and other content within this MD&A as well as Part I - Item 1A of this report.
In addition, over the past several years, we proactively de-risked our portfolio in anticipation of an economic downturn and believe we are well positioned for any potential market dislocation. Although we have experienced the impacts of market volatility on our fixed maturity security and limited partnership interest valuations during 2020, the investment portfolio is well diversified. It is 90.9% investment grade-rated and has an average credit quality rating of A+. Because of the annuity reinsurance transaction, the spread in our retained annuity business is achieving our targeted returns and new business is priced to do so as well. We believe our capital and reserves are adequate to address any unusual loss patterns resulting from COVID-19.
Amid rapidly changing dynamics, we are continuing to evaluate all aspects of our operations and making necessary adjustments to manage our business. Ultimately, the extent of the impact will depend on how long it takes for the economy to return to some degree of normality. To date, these steps have been effective and have maintained business continuity. Based on assumptions that we will return to a normal operating environment within 12 months, our capital and liquidity situations are expected to remain at or above target levels. We believe we are financially strong despite the potential impact of COVID-19 and continued to produce solid operating results throughout 2020.
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Consolidated Financial Highlights
Per diluted share:
For 2020, our net income decreased $51.1 million compared to 2019. The favorable automobile loss experience and full year net income contribution from Supplemental in 2020 partially offset the recognition of a $106.9 million after tax realized investment gain in the second quarter of 2019 associated with the annuity reinsurance transaction. Net income for both years was impacted by goodwill and intangible asset impairment charges in Retirement. See Part II - Item 8, Notes 1, 5 and 6 of the Consolidated Financial Statements in this report for more information regarding Supplemental, the annuity reinsurance transaction and the goodwill and intangible asset impairment charges.
For 2019, our net income increased $166.1 million compared to 2018, primarily due to the realized investment gain arising from the annuity reinsurance transaction previously noted. Lower catastrophe losses of $49.0 million after tax in Property and Casualty as well as the addition of $18.0 million of net income from the Supplemental segment also contributed to the increase in consolidated net income.
See Results of Operations by Segment for further details.
Consolidated Results of Operations
Net investment gains (losses) (2.3) 153.3 (12.5) N.M. N.M.
Intangible asset amortization expense 14.4 8.8 — 63.6 % N.M.
Other expense - goodwill and intangible asset impairments 10.0 28.0 — N.M. N.M.
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Insurance Premiums and Contract Charges Earned
For 2020, insurance premiums and contract charges earned increased $32.7 million compared to 2019, primarily due to the addition of a full year of reported earned premiums from Supplemental partially offset by lower premiums earned by Property and Casualty, including recognition of $10.2 million of automobile premium credits to our policyholders related to reduced driving activity due to COVID-19. For 2019, insurance premiums and contract charges earned increased $80.7 million compared to 2018, primarily due to the addition of Supplemental and increases in average premium per risk for both automobile and property.
Net Investment Income
Excluding accreted investment income on the deposit asset on reinsurance, 2020 net investment income decreased $34.0 million compared to 2019 for two reasons. First, we had a smaller invested asset base for full-year 2020. In 2019, the invested asset base was higher in the first quarter, prior to the transfer of $2.1 billion of invested assets as part of the annuity reinsurance transaction. Second, market weakness in early 2020 resulted in lower full-year returns from limited partnership interests.
2019 net investment income excluding accreted investment income on the deposit asset on reinsurance was $82.2 million below 2018 because of the transfer of invested assets. In addition, interest rates declined significantly in 2019 and our yield on new investments also reflected a strategic decision to further improve the quality of the portfolio. This was partially offset by stronger returns on alternative investments and increased prepayment activity.
The annualized yield on the total investment portfolio for the past three years was as follows:
During 2020, management continued to identify and purchase investments, including alternative investments, with attractive risk-adjusted yields relative to market conditions without venturing into asset classes or individual securities that would be inconsistent with our overall investment guidelines.
Net Investment Gains (Losses)
For 2020, net investment gains decreased primarily due to recognition of a pretax realized investment gain of $135.3 million in the second quarter of 2019 in connection with the transfer of investments related to the aforementioned annuity reinsurance transaction. The aforementioned transaction is what drove the increase in net investment gains in 2019 compared to 2018.
The break down of net investment gains (losses) by transaction type is shown in the following table:
($ in millions) Year Ended December 31,
Change in fair value - equity securities (0.2) 7.3 (18.3)
Net investment gains (losses) $ (2.3) $ 153.3 $ (12.5)
From time to time, we may sell securities subsequent to a reporting date that were considered temporarily impaired at the reporting date. Such sales are due to issuer specific events occurring subsequent to the reporting date that result in a change in our intent to hold an invested asset.
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Other Income
For 2020, other income increased $10.3 million due, in part, to a full year contribution from Supplemental. For 2019, other income increased $3.8 million compared to 2018, due, in part, to a six month contribution from Supplemental.
Benefits, Claims and Settlement Expenses
For 2020, benefits, claims and settlement expenses were lower due to favorable loss experience as a result of lower frequency of losses related to reduced driving activity due to COVID-19, partially offset by higher catastrophe losses and a full year of reported benefits and settlement expenses from the Supplemental segment. For 2019, benefits, claims and settlement expenses were lower compared to 2018, due to reduced catastrophe losses and improved automobile experience, partially offset by the inclusion of losses from the new Supplemental segment.
Interest Credited
For 2020, interest credited decreased $8.2 million compared to 2019, driven primarily by lower interest rates and a lower level of Federal Home Loan Bank (FHLB) funding agreements. Under the deposit method of accounting, the interest credited on the reinsured annuity block continues to be reported. The average deferred annuity credited rate, excluding the reinsured block was 2.4% and 2.5% for 2020 and 2019, respectively. For 2019, interest credited increased $6.6 million compared to 2018 primarily due to higher interest costs on FHLB funding agreements.
Operating Expenses
For 2020, operating expenses increased $3.2 million compared to 2019, primarily due to the inclusion of $42.7 million of operating expenses from Supplemental operations compared to $22.3 million in 2019, offset by expense reduction initiatives as well as lower levels of spending on travel and other expenses because of COVID-19. For 2019, operating expenses increased $29.2 million compared to 2018, driven by the inclusion of NTA and BCG operations as well as $5.5 million of severance charges incurred in 2019 pertaining to expense reduction initiatives.
DAC Unlocking and Amortization Expense
For 2020, DAC unlocking and amortization expense decreased $9.3 million compared to 2019, primarily due to accelerated amortization of the DAC asset associated with the reinsured annuity block that occurred in Retirement in 2019 and a lower level of amortization of Property and Casualty DAC in 2020 attributed to lower levels of production. For 2019, DAC unlocking and amortization expense was comparable to 2018. For Life, DAC unlocking resulted in immaterial changes to amortization for the three years ended 2020, 2019 and 2018.
Intangible Asset Amortization Expense
For 2020, intangible asset amortization expense increased $5.6 million compared to 2019, primarily due a full year of reported intangible asset amortization expense for NTA. For 2019, the increase in intangible asset amortization expense compared to 2018 was due to the acquisitions of NTA and BCG.
Interest Expense
For 2020, interest expense decreased slightly compared to 2019 due to lower interest rates. For 2019, interest expense increased $2.6 million compared to 2018, primarily due to utilizing our senior revolving credit facility in the third quarter of 2019 to partially fund the acquisition of NTA.
Other Expense - Goodwill and Intangible Asset Impairments
For 2020, other expense represents goodwill and intangible asset impairment charges with regards to BCG. For 2019, other expense represents an annuity goodwill impairment charge in Retirement resulting from the annuity reinsurance transaction. See Part II - Item 8, Note 6 of the Consolidated Financial Statements in this report for further information.
Income Tax Expense
The effective income tax rate on our pretax income, including net investment gains (losses) was 16.5%, 22.0% and 6.2% for the years ended December 31, 2020, 2019 and 2018, respectively. Income from investments in tax-advantaged securities reduced the effective income tax rates by 3.6, 2.3 and 21.2 percentage points for 2020, 2019 and 2018, respectively. The goodwill and intangible asset impairment charges in the Retirement
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segment decreased the effective income tax rate by 0.1 percentage points at December 31, 2020 and increased the effective income tax rate by 2.3 percentage points at December 31, 2019.
On March 27, 2020, H.R. 748, the Coronavirus Aid, Relief, and Economic Security Act, “the CARES Act”, was signed into legislation. The CARES Act includes tax provisions relevant to businesses, and some of the significant changes include allowance of a five-year carryback of net operating losses for 2018-2020 and the suspension of the 80% limitation of taxable income for net operating loss carryforwards for 2018-2020. The effects of the CARES Act are reflected in our income tax expense calculations for the year ended December 31, 2020. Accounting Standards Codification Topic 740: Income Taxes requires that the impact of the CARES Act be recognized in the period in which the law was enacted. As a result, total income tax expense for the year ended December 31, 2020, includes a benefit of $2.8 million (that reduced the effective income tax rate by 2.8 percentage points) to reflect a net operating loss carryback to taxable years for which the corporate rate was 35% as compared to the current corporate rate of 21%.
We record 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. We have no unrecorded liabilities from uncertain tax filing positions.
At December 31, 2020, our federal income tax returns for years prior to 2014 are no longer subject to examination by the Internal Revenue Service. We do not anticipate any assessments for tax years that remain subject to examination to have a material effect on our financial position or results of operations. See Part II - Item 8, Note 10 of the Consolidated Financial Statements in this report for further information.
Outlook for 2021
The following discussion provides outlook information for our results of operations and capital position.
The impacts of the COVID-19 pandemic and related economic conditions on the Company's results continue to be highly uncertain and outside the Company's control. The scope, duration and magnitude of the direct and indirect effects of the pandemic continue to evolve in ways that are difficult or impossible to anticipate. For additional information on the risks posed by the pandemic, see “A large-scale pandemic, the occurrence of terrorism or military actions may have an adverse effect on our business” included in Part I - Item 1A—Risk Factors in this Annual Report on Form 10-K.
At the time of issuance of this Annual Report on Form 10-K, we estimate that 2021 full year net income will be within a range of $3.00 to $3.20 per diluted share, generating a core return on equity* of over 9%. The outlook assumes a federal statutory corporate tax rate of 21%.
Property and Casualty Segment
Net written premiums* for 2021 are anticipated to be below 2020 levels. We expect new sales* will remain under pressure while COVID-19 vaccines are being rolled out across the country, with a return to pre-pandemic sales levels likely to begin in the fourth quarter.
We expect the pandemic's impact on automobile loss costs will continue in 2021, reflecting continued lower frequency related to new driving patterns, as well as a partial offset because of the anticipated uptick in uninsured/underinsured motorist claims. Over the course of 2021, we anticipate loss ratios gradually rising toward our long-term target levels. Our outlook presumes that some changes to driving patterns will become more permanent, but those would be offset by some of the factors that increased severity in 2020. We anticipate fairly stable automobile rates in 2021. We estimate that a 10% drop in automobile frequency represents approximately $2 million in pretax earnings per month, excluding the potential for higher severity.
We expect the underlying property loss ratio* will be stable in 2021 with rates expected to rise in the low-single digits.
As a result, the Property and Casualty full-year combined ratio is expected to be 95% - 96%, assuming catastrophe losses add approximately 9.5 points. Net income for Property and Casualty is anticipated to be in the range of $54 million to $58 million.
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Supplemental Segment
In 2021, we expect Supplemental's pretax profit margin will move closer to our long-term mid 20% target range, as the favorable trends in benefits paid from changes in policyholder behavior due to COVID-19 significantly decline in 2021 while sales* gradually return to pre-pandemic levels. Net investment income should continue to benefit from the portfolio repositioning. Including these factors, net income for Supplemental is anticipated to be in the range of $33 million to $35 million.
Retirement Segment
We expect Retirement to generate net income in the range of $38 million to $40 million in 2021, reflecting higher net investment income from the alternatives portfolio as well as an increase in fees on our annuity business.
Life Segment
We expect Life to generate net income between $17 million and $19 million in 2021, reflecting modeled mortality costs and increased net investment income from the alternatives portfolio. Sales* are expected to gradually return to pre-pandemic levels.
Investments
For 2021, we expect total net investment income between $370 million and $390 million, including approximately $100 million of accreted investment income on the deposit asset on reinsurance in the Retirement segment. The return on the alternatives portfolio is expected to be in the mid to high single digits in 2021, compared with a below-target 5% in 2020 due to market volatility early in the year.
As described in Critical Accounting Estimates, certain of our 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 net income for the period in which the adjustments are made and may impact actual results compared to our estimates above. Additionally, see forward-looking information in Part I - Items 1 and 1A of this Annual Report on Form 10-K concerning other important factors that could impact actual results. We believe that a projection of net income is not appropriate on a forward-looking basis because it is not possible to provide a valid forecast of net investment gains (losses), which can vary substantially from one period to another and may have a significant impact on net income.
Critical Accounting Estimates
The preparation of consolidated financial statements in conformity with GAAP requires us 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 our consolidated assets, liabilities, shareholders' equity and net income. Certain accounting estimates are particularly sensitive because of their significance to our 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. We have discussed with our Audit Committee the quality, not just the acceptability, of our accounting principles as applied in our financial reporting. The discussions generally included such matters as to the consistency of our accounting policies and their application, and the clarity and completeness of our consolidated financial statements, which include related disclosures. Information regarding our accounting policies pertaining to these topics is located in the Notes to Consolidated Financial Statements as listed in Part II - Item 8 of this report.
We have identified the following accounting estimates as critical in that they involve a higher degree of judgment and are subject to a significant degree of variability:
•Valuation of hard-to-value fixed maturity securities, including evaluation of other-than-temporary impairments
•Evaluation of goodwill and intangible assets for impairment
•Valuation of annuity and life deferred policy acquisition costs
•Valuation of liabilities for property and casualty unpaid claims and claim expenses
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•Valuation of certain investment contracts and policy reserves
Although variability is inherent in these accounting estimates, we believe the amounts provided are appropriate based upon the facts available during preparation of the consolidated financial statements.
Valuation of Hard-to-Value Fixed Maturity Securities
The fair value of a fixed maturity security is the estimated amount at which the security could be exchanged in an orderly transaction between knowledgeable, unrelated and willing parties. We utilize investment managers and our custodian bank to obtain fair value prices from independent third-party valuation service providers, broker-dealer quotes, and model prices. Each month, we obtain fair value prices from our investment managers and custodian bank, each of which use a variety of independent, nationally recognized pricing sources to determine market valuations for fixed maturity securities. Differences in prices between the sources that we consider significant are researched and we utilize the price that we consider most representative of an exit price. Typical inputs used by these pricing sources include, but are not limited to, reported trades, bids, offers, benchmark yield curves, benchmarking of like securities, rating designations, sector groupings, issuer spreads and/or estimated cash flows, prepayment and default speeds, among others. Our fixed maturity securities portfolio is primarily publicly traded, which allows for a high percentage of the portfolio to be priced through pricing services. Approximately 91.9% of the portfolio, based on fair value, was priced through pricing services or index priced using observable inputs as of December 31, 2020.
The valuation of hard-to-value fixed maturity securities (generally 100 -150 securities) is more subjective because the markets are less liquid and there is a lack of observable market-based inputs. This 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. When the pricing sources cannot provide fair value determinations, the investment managers and custodian bank obtain non-binding price quotes from broker-dealers. For those securities where the investment manager cannot obtain broker-dealer quotes, they will model the security, generally using anticipated cash flows of the underlying collateral. Broker-dealers' valuation methodologies as well as investment managers’ modeling methodologies are sometimes matrix-based, using indicative evaluation measures and adjustments for specific security characteristics and market sentiment. The selection of the market inputs and assumptions used to estimate the fair value of hard-to-value fixed maturity securities requires judgment and includes: benchmark yield, liquidity premium, estimated cash flows, prepayment and default speeds, spreads, weighted average life, and credit rating. The extent of the use of each market input depends on the market sector and 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.
We gain assurance that our portfolio of fixed maturity securities including hard-to-value fixed maturity securities is appropriately valued through the execution of various processes and controls designed to ensure the overall reasonableness and consistent application of valuation methodologies, including inputs and assumptions, and compliance with accounting standards. Our processes and controls are designed to ensure (1) the valuation methodologies are appropriate and consistently applied, (2) the inputs and assumptions are reasonable and consistent with the objective of determining fair value, and (3) the fair values are accurately recorded. For example, on a continuing basis, we assess the reasonableness of individual fair values that have stale security prices or that exceed certain thresholds as compared to previous fair values received from valuation service providers. We perform procedures to understand and assess the methodologies, processes and controls of valuation service providers. In addition, we may validate the reasonableness of fair values by comparing information obtained from valuation service providers or broker-dealers to other third-party valuation sources for selected securities.
At December 31, 2020, Level 3 invested assets comprised 5.3% of our total investment portfolio based on 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 determination of fair value.
Evaluation of Other-than-Temporary Impairments
Our methodology of assessing other-than-temporary impairment (OTTI) for fixed maturity securities is based on security-specific facts and circumstances as of the reporting date. We have a policy and process to evaluate fixed maturity securities (at the cusip/issuer level) on a quarterly basis to assess whether there has been OTTI. These reviews, in conjunction with our 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, (3) our intent to sell a security or whether it is more likely than not
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that we will be required to sell the security before the anticipated recovery of value, (4) the market leadership position of the issuer, (5) the debt ratings of the issuer, and (6) the cash flows and liquidity of the issuer or the underlying cash flows for asset-backed securities, are all considered in the impairment assessment.
For fixed maturity securities that we do not intend to sell or for which it is more likely than not that we would not be required to sell before an anticipated recovery in value, we separate the credit loss component of the impairment from the amount related to all other factors and report the credit loss component in net investment gains (losses). The impairment related to all other factors (non-credit factors) is reported in other comprehensive income (OCI). The allowance is adjusted for any additional credit losses and subsequent recoveries. Upon recognizing a credit loss, the cost basis is not adjusted. Also, see Part II - Item 8, Note 1 of the Consolidated Financial Statements in this report.
Evaluation of Goodwill and Intangible Assets for Impairment
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 value. Goodwill impairment is the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. A goodwill impairment charge could have a material adverse effect on our results of operations. Our reporting units, for which goodwill has been allocated, are equivalent to our operating segments. As of December 31, 2020, our allocation of goodwill by reporting unit was as follows: $9.5 million, Property and Casualty; $19.6 million, Supplemental; $4.5 million, Retirement; and $9.9 million, Life. Also see Part II - Item 8, Notes 1 and 6 of the Consolidated Financial Statements in this report.
The goodwill impairment test, as defined in GAAP, allows an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying value. If an entity determines it is more likely than not that the fair value of a reporting unit is less than its carrying value, then the entity performs a quantitative goodwill impairment test by comparing the fair value of a reporting unit to its carrying value for purposes of confirming and measuring an impairment.
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 our 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 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 our reasonable expectation regarding future developments. We also consider 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 of a reporting unit 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 markets on earnings, discount rate assumptions, liquidity and market capitalization. For 2020, lower than anticipated BCG wealth management sales outside of the education markets triggered a requirement to evaluate the goodwill associated with the BCG business of the Retirement reporting unit resulting in a write-down of a certain amount of goodwill in the fourth quarter of 2020. For 2019, the annuity reinsurance transaction triggered an assessment resulting in a write-down of a certain amount of goodwill for impairment during the second quarter of 2019 (see Part II - Item 8, Note 6 of the Consolidated Financial Statements in this report for more information). There were no other events or material changes in circumstances during 2020 that indicated that an adverse material change in the fair value of our reporting units had occurred.
The value of business acquired (VOBA) represents the difference between the fair value of insurance contracts and insurance policy reserves measured in accordance with our accounting policies for insurance contracts acquired. VOBA was based on an actuarial estimate of the present value of future distributable earnings for insurance in force on the acquisition date. VOBA was $83.6 million as of December 31, 2020 and is being amortized by product based on the present value of future premiums to be received. We estimate that we will
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recognize VOBA amortization of $6.6 million in 2021, $6.2 million in 2022, $5.8 million in 2023, $5.4 million in 2024 and $5.1 million in 2025.
We account for the value of distribution acquired (VODA) associated with the acquisition of NTA based on an actuarial estimate of the present value of future business to be written by the existing distribution channel. VODA was $44.7 million as of December 31, 2020 and is being amortized on a straight-line basis. We estimate that we will recognize VODA amortization of $2.9 million in each of the years 2021 through 2025, respectively.
We account for VODA associated with the acquisition of BCG based on our estimate of the present value of future business to be written by the existing distribution channel. VODA was $0.7 million as of December 31, 2020 and is being amortized based on the present value of future profits to be received. We estimate that we will recognize cumulative VODA amortization of $0.3 million for the years 2021 through 2025.
We account for the value of agency relationships based on the present value of commission overrides retained by NTA. Agency relationships was $12.9 million as of December 31, 2020 and is being amortized based on the present value of future premiums to be received. We estimate that we will recognize agency relationships amortization of $2.2 million in 2021, $1.9 million in 2022, $1.6 million in 2023, $1.4 million in 2024 and $1.2 million in 2025.
We account for the value of customer relationships based on the present value of expected profits from existing BCG customers in force at the date of acquisition. Customer relationships was $5.9 million as of December 31, 2020 and is being amortized based on the present value of future profits to be received. We estimate that we will recognize customer relationships amortization of $1.2 million in 2021, $1.1 million in 2022, $0.9 million in 2023, $0.7 million in 2024 and $0.6 million in 2025.
Trade names represent the present value of future savings accruing to NTA and BCG by virtue of not having to pay royalties for the use of the trade names, valued using the relief from royalty method. State licenses represents the regulatory licenses held by NTA that were valued using the cost approach. Both trade names and state licenses are indefinite-lived intangibles that are not subject to amortization.
VOBA is reviewed for recoverability from future income, including net investment income, and costs which are deemed unrecoverable are expensed in the period in which the determination is made. No such costs were deemed unrecoverable during the year ended December 31, 2020.
Amortizing intangible assets (i.e., VODA, agency relationships and customer relationships) are tested for recoverability whenever events or changes in circumstances indicate that its carrying value may not be recoverable. The carrying amount of an amortizing intangible asset is not recoverable if it exceeds the sum of undiscounted cash flows expected to result from the use and eventual disposition of the asset. If the carrying amount is not recoverable from undiscounted cash flows, the impairment is measured as the difference between the carrying amount and fair value. The results from our annual impairment assessment for VODA at October 1, 2020 resulted in the write-down of a certain amount for impairment related to the 2019 acquisition of BCG. See Part II - Item 8, Note 6 of the Consolidated Financial Statements in this report for more information.
Intangible assets that are not subject to amortization (i.e., trade names and state licenses) are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of an intangible asset that is not subject to amortization exceeds its fair value, an impairment loss is to be recognized in an amount equal to that excess. The test results from our annual impairment assessment for trade names at October 1, 2020 resulted in the write-down of a certain amount for impairment. See Part II - Item 8, Note 6 of the Consolidated Financial Statements in this report for more information.
Valuation of Annuity and Life Deferred Policy Acquisition Costs
DAC, 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 annuity contracts, DAC is amortized over 20 years in proportion to estimated gross profits. DAC is amortized in proportion to estimated gross profits over 20 years for certain life insurance products with account values and over 30 years for IUL. For further information, see Part II - Item 8, Note 1 of the Consolidated Financial Statements in this report.
46 Annual Report on Form 10-K Horace Mann Educators Corporation
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 net investment gains (losses). For the variable deposit portion of Retirement, we amortize DAC utilizing a future financial market performance assumption of an 8.0% 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 our long-term assumption. Our practice with regard to future financial market performance assumes that long-term appreciation in the financial markets is not changed by short-term market fluctuations, but is only changed when sustained annual deviations are experienced. We monitor these fluctuations and only change the assumption when the long-term expectation changes. The potential effect of an increase by 100 basis points in the assumed future rate of return is reasonably likely to result in an estimated decrease in DAC amortization expense of approximately $3.5 million. The potential effect of an decrease by 100 basis points in the assumed future rate of return is reasonably likely to result in an estimated increase in DAC amortization expense of approximately $2.0 million. Although this evaluation reflects likely outcomes, it is possible an actual outcome may fall below or above these estimates. At December 31, 2020, the ratio of DAC to the total annuity accumulated cash value was 1.7%.
In the event actual experience differs significantly from assumptions or assumptions are significantly revised, we 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 DAC. In terms of the sensitivity of this amortization to three of the more significant assumptions, based on DAC as of December 31, 2020 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 $0.3 million and $0.4 million, (2) a 1.0% deviation from the targeted financial market performance for the underlying mutual funds of our variable annuities would impact amortization between $0.3 million and $0.4 million and (3) a $1.0 million net investment gain (loss) would impact amortization by approximately $0.2 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 DAC amortization expense is included in Results of Operations by Segment for the Three Years Ended December 31, 2020.
The most significant assumptions that are involved in the estimation of life insurance gross profits include interest rates expected to be received on investments, business persistency, and mortality. Conversions from term to permanent insurance cause an immediate write down of the associated DAC. The impact on amortization due to assumption changes has an immaterial impact on the results of operations.
Annually, we perform a gross premium valuation on life insurance policies to assess whether a loss recognition event has occurred. This involves discounting expected future benefits and expenses less expected future premiums. To the extent that this amount is greater than the liability for future benefits less the DAC asset, in aggregate for the life insurance block, a loss would be recognized by first writing off the DAC and then increasing the liability.
Valuation of Liabilities for Property and Casualty Unpaid Claims and Claim Expenses
Underwriting results of Property and Casualty are significantly influenced by estimates of our ultimate liability for insured events. There is a high degree of uncertainty inherent in the estimates of ultimate losses underlying the liabilities for unpaid claims and claim expenses. This inherent uncertainty is particularly significant for liability-related exposures due to the extended period, often many years that transpire 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), IBNR claims 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 our 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. We calculate and record a single best estimate of the reserve (which is equal to the actuarial point estimate) as of each reporting 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 Part II - Item 8, Note 7 of the Consolidated Financial Statements in this report. Due to the nature of our personal lines
Horace Mann Educators Corporation Annual Report on Form 10-K 47
business, we have no exposure to losses related to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses other than claims under property insurance policies for environmentally related items such as mold.
Based on our products and coverages, historical experience, and modeling of various actuarial methodologies used to develop reserve estimates, we estimate 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 6.0%, which equates to plus or minus approximately $12.0 million of net income based on net reserves as of December 31, 2020. 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 our 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. We estimate that a 2.0% 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 $5.0 million and $9.0 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 (property and automobile physical damage coverages). Actual results may differ, depending on the magnitude and direction of the deviation.
Our 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. Our 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. Our best estimate of loss reserves may change depending on a revision in the underlying assumptions.
Our liabilities for unpaid claims and claim expenses for Property and Casualty were as follows:
CaseReserves IBNRReserves Total (1) CaseReserves IBNRReserves Total (1)
(1)These amounts are gross, before reduction for ceded reinsurance reserves.
The facts and circumstances leading to our 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, 2020, the impact of a reserve re-estimation resulting in a 1.0% increase in net reserves would be a decrease of approximately $2.0 million in net income. A reserve re-estimation resulting in a 1.0% decrease in net reserves would increase net income by approximately $2.0 million.
Favorable prior years' reserve re-estimates increased net income in 2020 by approximately $10.2 million pretax, primarily the result of favorable loss trends in automobile and property for accident years 2019 and prior which includes the recognition of $4.8 million pretax of subrogation received on the 2018 Camp Fire event. The lower than expected claims emergence and resultant lower expected loss ratios caused us to lower our reserve estimate at December 31, 2020.
Valuation of Certain Investment Contracts and Policy Reserves
Liabilities for future benefits on annuity and life policies are established in amounts adequate to meet the estimated future obligations on policies in force.
48 Annual Report on Form 10-K Horace Mann Educators Corporation
Liabilities for future benefits on deferred annuity contracts, excluding fixed indexed annuity (FIA) products, are carried at accumulated policyholder values without reduction for potential surrender or withdrawal charges. Liabilities for FIA products are bifurcated into an embedded derivative and a host contract. The embedded derivative is recognized at fair value and is reported in Other policyholder funds on the Consolidated Balance Sheets, and is determined using the option budget method. The host contract is accounted for as a debt instrument with the initial amount determined as the consideration amount less the initial embedded derivative, as described above. Any discount to the minimum account value is accreted over the life of the products using the effective yield method. Key assumptions used in the estimation of the liabilities for FIA products include the risk free interest rate, the value of options currently in force, the future expected option budget based on product pricing targets, mortality and lapses.
Liabilities for future benefits on payout annuity contracts are determined as the present value of expected future benefit payments. Key assumptions used in the calculation include the future investment yield and mortality, for those contracts with life contingencies.
Liabilities for future policy benefits on supplemental insurance policies are computed using the net level premium method and are based on assumptions as to future investment yields, morbidity, mortality, persistency, expenses and other assumptions based on our experience, including provisions for adverse deviation. Mortality, morbidity and lapse assumptions for all policies have been based on standard actuarial tables which are modified as appropriate to reflect our own experience. In the event actual experience is worse than the assumptions, additional reserves may be required. This would result in recognition of a loss in the period for which the increase in reserves occurred.
Liabilities for future policy benefits on life insurance policies, excluding indexed universal life (IUL) products, 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 our own experience. In the event actual experience is worse than the assumptions, additional reserves may be required. This would result in recognition of a loss in the period for which the increase in reserves occurred. Also, see Part II - Item 8, Note 1 of the Consolidated Financial Statements in this report. Liabilities for IUL products are bifurcated into an embedded derivative and a host contract. The embedded derivative is recognized at fair value and is set equal to the fair value of the current call options purchased to hedge the liability. The host contract is measured using the retrospective deposit method which is equal to the account balance.
Results of Operations by Segment for the Three Years Ended December 31, 2020
Consolidated financial results primarily reflect the results of four operating segments as well as the corporate and other line. These segments are defined based on financial information management uses to evaluate performance and to determine the allocation of resources (see Part II - Item 8, Note 1 of this report for a description of changes to our reporting segments).
•Property and Casualty
•Supplemental
•Retirement
•Life
•Corporate and Other
The determination of segment data is described in more detail in Part II - Item 8, Note 18 of the Consolidated Financial Statements in this report. The following sections provide analysis and discussion of results of operations for each of the reporting segments as well as investment results.
Horace Mann Educators Corporation Annual Report on Form 10-K 49
Property and Casualty
2020 net income reflected the following factors:
•Written premiums* and earned premiums reduced by lower new business and $10.2 million of COVID-19 related premium credits
•8.2 points of improvement in the Property and Casualty underlying loss ratio* driven by lower automobile loss frequency
•3.3 points of improvement in the reported loss ratio as the lower automobile loss frequency and a $5.2 million property subrogation recovery more than offset a 5.4 point increase from catastrophe losses
•0.5 point improvement in the expense ratio due to expense reduction initiatives as well as lower levels of spending on travel and other expenses because of COVID-19
•A one-time tax benefit of $2.8 million as a result of the CARES Act
2019 core earnings reflected 12.8 points of improvement in the Property and Casualty combined ratio for the year due to lower catastrophe losses, favorable prior years' reserve development and improved automobile underwriting results compared to 2018. 2018 results included losses from the Camp Fire in California, which was our largest single catastrophe event since Hurricane Katrina in 2005. The Camp Fire generated gross losses of $150.0 million, and, net costs after reinsurance of $37.9 million pretax in 2018.
50 Annual Report on Form 10-K Horace Mann Educators Corporation
The following table provides certain financial information for the Property and Casualty segment for the periods indicated.
Financial Data:
Written premiums*:
Change in unearned insurance premiums (14.6) (0.4) 15.8 N.M. -102.5 %
Incurred claims and claims expenses:
Prior years' reserve development (10.2) (7.5) (0.3) 36.0 % N.M.
Income (loss) before income taxes 91.9 66.7 (20.9) 37.8 % N.M.
Operating Statistics:
Total Property and Casualty
Loss and loss adjustment expense ratio 66.3 % 69.6 % 82.3 % -3.3 pts -12.7 pts
Prior years' reserve development -1.6 % -1.1 % — % -0.5 pts -1.1 pts
Automobile
Loss and loss adjustment expense ratio 61.2 % 70.6 % 76.3 % -9.4 pts -5.7 pts
Prior years' reserve development -0.5 % -1.2 % — % 0.7 pts -1.2 pts
Property
Loss and loss adjustment expense ratio 76.1 % 67.4 % 95.4 % 8.7 pts -28.0 pts
Prior years' reserve development -3.7 % -0.9 % -0.1 % -2.8 pts -0.8 pts
Risks in force (in thousands)
Horace Mann Educators Corporation Annual Report on Form 10-K 51
Catastrophe costs incurred were as follows:
($ in millions) Year Ended December 31,
Three months ended
As a result of the emergence of PG&E Corporation and Pacific Gas and Electric Company (together, PG&E) from bankruptcy on July 1, 2020, we recognized favorable prior years' reserve development of $5.2 million pretax, net of reinsurance, as well as return of reinsurance reinstatement premiums of $3.7 million, for a total of $8.9 million, largely related to the 2018 Camp Fire in California.
On a reported basis, the 9.6 points of improvement in the automobile combined ratio in 2020 was mainly attributable to a 10.2 point reduction in the automobile underlying loss ratio*, reflecting lower automobile loss frequency as well as the ongoing benefit of profitability initiatives. We experienced a lower level of automobile loss frequency resulting from temporary changes in policyholder driving patterns due to COVID-19. The average decline in automobile loss frequency experienced in 2020 was approximately 20% lower than in 2019. The reported property combined ratio increased 7.8 points in 2020 due to a 14.4 point increase in catastrophe losses. In 2020, the underlying property loss ratio* improved 2.9 points, primarily due to the return of reinsurance reinstatement premiums of $3.7 million.
In 2020, total written premiums* decreased $47.6 million compared to 2019, primarily due to a reduction in automobile written premiums*. In 2020, average approved rate changes were 0.5% for automobile and 1.0% for property. Growth in sales* slowed in 2020 due to COVID-19.
Automobile written premiums* decreased $44.9 million compared to 2019, primarily due to lower automobile risks in force and a lower level of rate increases implemented as well as $10.2 million of COVID-19 related premium credits. In 2020, the number of automobile risks in force declined and the average written premium per risk and average earned premium per risk declined 2.5% and 1.0%, respectively, compared to 2019. In 2019, automobile premiums written decreased $8.2 million compared to 2018. In 2019, the average written premium per risk and average earned premium per risk increased 4.1% and 5.3%, respectively, compared to 2018. Based on risks in force, the automobile 12 month retention rate for new and renewal risks was 81.2%, 81.1% and 81.9% at December 31, 2020, 2019 and 2018, respectively, with the decrease due to recent rate and underwriting actions. The number of educator risks has been stable relative to overall automobile risks over the past three years as educators represented 85.2%, 85.5% and 85.5% of the automobile risks in force as of December 31, 2020, 2019 and 2018, respectively.
Property and other written premiums* decreased slightly compared to 2019. While the number of property risks in force has declined, the average written premium per risk and average earned premium per risk increased 2.3% and 4.3%, respectively, compared to 2019. In 2019, the average written premium per risk and average earned premium per risk increased 6.2% and 5.4%, respectively, compared to 2018. Based on risks in force, the 12 month retention rate for new and renewal risks was 86.8%, 87.1% and 88.0% at December 31, 2020, 2019 and 2018, respectively. The number of educator risks has been stable relative to overall property risks over the past three years as educators represented 82.6%, 82.5% and 82.6% of the property risks in force as of December 31, 2020, 2019 and 2018, respectively.
The Property and Casualty expense ratio was 26.4%, 26.9% and 27.0% for 2020, 2019 and 2018, respectively.
We continue to evaluate and implement actions to further mitigate our risk exposure. Such actions could include, but are not limited to, non-renewal of property risks, restricted agent geographic placement, limitations on agent new business sales, further tightening of underwriting standards and increased utilization of third-party vendor products.
52 Annual Report on Form 10-K Horace Mann Educators Corporation
Supplemental
The Supplemental segment was formed when we acquired NTA in July 2019.
2020 net income reflected the following factors:
•12 month contribution to net income compared to a six month contribution in 2019
•Favorable trends in benefits from temporary changes in policyholder behavior due to COVID-19
•Improved investment yield resulting from portfolio repositioning
The following table provides certain information for the Supplemental segment for the periods indicated.
Financial Data:
Insurance premiums and contract deposits* $ 130.3 $ 65.7 N/A N/A N/A
Insurance premiums and contract charges earned 130.7 65.8 N/A N/A N/A
Net investment income 17.8 7.5 N/A N/A N/A
Benefits and settlement expenses 38.2 21.7 N/A N/A N/A
Intangible asset amortization expense 12.6 6.6 N/A N/A N/A
Income before income taxes 55.1 23.0 N/A N/A N/A
Net income 43.1 18.0 N/A N/A N/A
Core earnings* 43.1 18.0 N/A N/A N/A
Operating Statistics:
Supplemental insurance in force (thousands) 287 297 N/A N/A N/A
Benefits ratio (2) 32.8 % 37.5 % N/A N/A N/A
Operating expense ratio (3) 26.7 % 27.3 % N/A N/A N/A
Pretax profit margin (3) 36.4 % 30.8 % N/A N/A N/A
Persistency 90.5 % 89.3 % N/A N/A N/A
(1) The acquisition of NTA closed on July 1, 2019. Twelve month comparisons are not applicable.
(2) Benefits ratio measured to earned premium.
(3) Operating expense ratio and pretax profit margin measured to total revenues.
In 2020, Supplemental sales* were $7.2 million compared to $8.2 million in 2019, reflecting significantly lower sales volume, primarily due to limited school access because of COVID-19. Persistency was slightly up at 90.5%.
In 2020, Supplemental contributed $43.1 million to net income, reflecting favorable trends in reserves and some short-term benefit from changes in policyholder behavior due to COVID-19. The non-cash impact from
Horace Mann Educators Corporation Annual Report on Form 10-K 53
amortization of intangible assets recognized in connection with the purchase accounting of NTA reduced pretax net income by $12.6 million and $6.6 million in 2020 and 2019, respectively. The pretax profit margin remains above our longer-term expectations because of pandemic-related changes in policyholder behavior.
Retirement
2020 net income reflected the following factors:
•Lower levels of net investment income in 2020, reflecting lower invested asset levels resulting from the prior year annuity reinsurance transaction and subsequent use of capital to purchase NTA, as well as lower returns on limited partnership interests
•$1.8 million pretax of favorable DAC unlocking in 2020 compared to $3.5 million of unfavorable DAC unlocking in 2019 due to accelerated amortization of the DAC asset associated with the reinsured annuity block
•Goodwill and intangible asset impairment charges of $10.0 million in 2020 associated with the BCG acquisition compared to a $28.0 million goodwill impairment charge in 2019 associated with the annuity business due to the reinsurance of the legacy annuity block
Compared to 2018, 2019 net income decreased $46.5 million due to the impacts of the annuity reinsurance transaction coupled with a $28.0 million goodwill impairment charge triggered by the transaction. 2019 core earnings* decreased $18.5 million compared to 2018, reflecting the impact of the annuity reinsurance transaction, which ceded $2.9 billion of fixed and variable reserves (see Part II - Item 8, Note 5 of the Consolidated Financial Statements for further details). 2019 results also include higher operating expenses from the inclusion of BCG.
54 Annual Report on Form 10-K Horace Mann Educators Corporation
The following table provides certain information for the Retirement segment for the periods indicated.
Financial Data:
Net interest margin - Reinsured block (3.6) (3.4) — -5.9 % N.M.
Mortality loss and other reserve charges (5.3) (5.3) (7.6) — % 30.3 %
Other expenses - goodwill and intangible asset impairments 10.0 28.0 — N.M. N.M.
Income (loss) before income taxes 22.2 (1.8) 51.7 N.M. -103.5 %
Operating Statistics:
Annuity contract deposits*
Assets under administration (AUA)
Recordkeeping assets under administration (2) 1,518.1 1,499.2 — 1.3 % N.M.
Persistency
Fixed spread - YTD annualized (basis points) 212 194 171 18 bps 23 bps
(1) Amount reported as of December 31, 2020 excludes $752.1 million of assets under management held under modified coinsurance reinsurance.
(2) 2019 includes the results of BCG acquired on January 2, 2019.
For 2020, Retirement segment net income reflected an after-tax impairment charge of $8.1 million for goodwill and intangible assets associated with BCG due to lower than anticipated BCG wealth management sales outside of the education markets. Operational benefits from the BCG acquisition remain on track. In 2019, we impaired $28.0 million of goodwill that had been associated with the annuity business due to the reinsurance of the legacy annuity block.
For 2020, annuity contract deposits* increased $20.9 million compared to 2019. Variable and fixed annuity deposits increased $8.9 million and $12.0 million, respectively, as educators continue to find value in our retirement savings products, including our competitively priced annuity products. Compared to 2018, variable and fixed annuity deposits increased $11.5 million and $11.9, respectively.
Horace Mann Educators Corporation Annual Report on Form 10-K 55
At December 31, 2020, annuity assets under management were $462.2 million above a year ago, driven primarily by positive net inflows and market appreciation. Assets under administration, which includes broker and advisory as well as recordkeeping assets added through the acquisition of BCG in 2019, were up 5.0% from December 31, 2019. The full-year 2020 annualized net interest spread on fixed annuities, excluding reinsurance, increased 18 basis points, reflecting the benefits of the 2019 annuity reinsurance transaction.
We actively manage our 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. We estimate that over the next 12 months approximately $562.4 million of the combined Retirement and Life 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 our existing policies and investment portfolio, the impact from investing in that lower interest rate environment could further reduce Retirement net investment income by approximately $2.1 million in year one and $6.4 million in year two, further reducing the annualized net interest spread by approximately 7 basis points and 21 basis points in the respective periods, compared to the current period annualized net interest spread. We 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 annualized net interest spreads is also an important component in the amortization of DAC. In terms of the sensitivity of this amortization to the annualized net interest spread, based on DAC as of December 31, 2020 and assuming all other assumptions are met, a 10 basis point deviation in the current year targeted annualized net interest rate spread assumption would impact amortization between $0.3 million and $0.4 million. This result may change depending on the magnitude and direction of any actual deviations but represents a range of reasonably likely experience for the noted assumption.
Because of the annuity reinsurance transaction, the spread in our retained annuity business is achieving our targeted returns and new business is priced to do so as well. Information regarding the interest crediting rates and balances equal to the minimum guaranteed rate for deferred annuity account values is shown below.
($ in millions) December 31, 2020
Deferred Annuities at
Total Deferred Annuities Minimum Guaranteed Rate
Minimum guaranteed interest rates:
We 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 Part I - Item 1A and other factors of this report.
56 Annual Report on Form 10-K Horace Mann Educators Corporation
Life
For 2020, net income decreased $7.2 million compared to 2019, reflecting higher mortality costs and lower net investment income. For 2019, net income decreased $1.2 million compared to 2018, reflecting lower net investment income and higher expenses partially offset by lower mortality costs.
The ordinary life insurance in force lapse ratio was 4.2%, 4.6% and 4.6% for 2020, 2019 and 2018, respectively.
The following table provides certain information for the Life segment for the periods indicated.
Financial Data:
DAC amortization expense, excluding unlocking 7.7 8.1 7.3 -4.9 % 11.0 %
DAC unlocking (0.3) (0.3) 0.3 — % N.M.
Operating Statistics:
Number of policies in force* (in thousands) 202 201 199 0.5 % 1.0 %
Lapse ratio (ordinary life insurance in force) 4.2 % 4.6 % 4.6 % -0.4 pts — pts
Horace Mann Educators Corporation Annual Report on Form 10-K 57
Corporate and Other
The following table provides certain financial information for Corporate and Other for the periods indicated.
Net investment gains (losses) pretax (2.3) 153.3 (12.5) N.M. N.M.
Tax on net investment gains (losses) (0.6) 33.1 (2.4) N.M. N.M.
Net investment gains (losses) after tax (1.7) 120.2 (10.1) N.M. N.M.
Net income in 2020 decreased from the prior year primarily due to recognition of a $106.9 million after tax realized investment gain in 2019 with respect to the transfer of investments as consideration with the annuity reinsurance transaction. In 2019, core earnings* decreased $3.1 million compared to 2018, driven by increased interest expense as we utilized our senior revolving credit facility on July 1, 2019 to partially fund the acquisition of NTA.
Investment Results
Our investment strategy is primarily focused on generating income to support product liabilities and balances principal protection and risk. Total net investment income includes net investment income from our investment portfolio as well as accreted investment income from the deposit asset on reinsurance related to our reinsured block of approximately $2.9 billion of policy liabilities related to legacy individual annuities written in 2002 or earlier that was effective April 1, 2019.
Investment income - deposit asset on reinsurance 97.3 70.8 — 37.4 % N.M.
Pretax net investment gains (losses) (2.3) 153.3 (12.5) N.M. N.M.
For 2020, net investment income from our investment portfolio decreased $34.0 million compared to 2019 for two reasons. First, we had a smaller invested asset base for full-year 2020. In 2019, the invested asset base was higher in the first quarter, prior to the transfer of $2.1 billion of invested assets as part of the annuity reinsurance transaction. Second, market weakness in early 2020 resulted in lower full-year returns from limited partnership interests.
For 2019, net investment income from our investment portfolio was $82.2 million below 2018 because of the transfer of invested assets. In addition, interest rates declined significantly in 2019 and our yield on new investments also reflected a strategic decision to further improve the quality of our investment portfolio. This was partially offset by stronger returns on alternative investments and increased prepayment activity.
For 2020, pretax net unrealized investment gains on fixed maturity securities were up $222.0 million compared to 2019, reflecting U.S. Treasury rates that declined 101 basis points with mostly flat investment grade credit spreads. For 2019, pretax net unrealized investment gains on fixed maturity securities were up $193.3 million compared to 2018, reflecting U.S. Treasury rates that declined 76 basis points and tighter credit spreads across most asset classes.
58 Annual Report on Form 10-K Horace Mann Educators Corporation
Fixed Maturity and Equity Securities Portfolios
The table below presents our fixed maturity securities portfolio by major asset class, including the ten largest sectors of our corporate bond holdings (based on fair value) as well as our equity securities portfolio.
($ in millions) December 31, 2020
Number ofIssuers FairValue AmortizedCost orCost Pretax NetUnrealizedGain (Loss)
Fixed maturity securities
Corporate bonds
Mortgage-backed securities
Government bonds
Equity securities
Non-redeemable preferred stocks 23 $ 90.7
Closed-end fund 1 23.0
(1)At December 31, 2020, the fair value amount included $15.6 million which were non-investment grade.
(2)The All Other Corporates category contains 19 additional industry classifications. Broadcasting and media, telecommunications, consumer products, metal and mining, and industry manufacturing represented $243.2 million of fair value at December 31, 2020, with the remaining 14 classifications each representing less than $218.7 million.
(3)At December 31, 2020, 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, 51.9% are tax-exempt and 76.9% 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, 2020.
(5)Based on fair value, 94.1% of the collateralized loan obligation securities were rated investment grade by Standard & Poor's Global Inc. (S&P), Moody's Investors Service, Inc. (Moody's) and/or Fitch Ratings, Inc. (Fitch) at December 31, 2020.
Horace Mann Educators Corporation Annual Report on Form 10-K 59
At December 31, 2020, our diversified fixed maturity securities portfolio consisted of 3,558 investment positions, issued by 2,257 entities, and totaled approximately $6.3 billion in fair value. This portfolio was 91.4% investment grade, based on fair value, with an average credit quality rating of A+. Our 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.
Fixed Maturity Securities - COVID-19 Related Impacts
In late 2016, we determined the economy was approaching later stages of the credit cycle and began to upgrade portfolio quality. Over the past three years, recessionary expectations were extended due to the fiscal stimulus, which lengthened the credit cycle. In 2019, we determined that we had achieved our investment initiatives and the portfolio was well positioned for any dislocation in the markets.
That proactive effort to improve portfolio quality resulted in a significant reduction in BBB-rated corporate credit, high yield and below-investment-grade structured securities. During this same period, purchases focused on government agency and agency mortgage-backed securities and high quality corporate bonds and municipal securities. Today, that proactive flight to quality has our investment portfolio in all insurance subsidiaries well positioned for market disruptions with ample liquidity.
Further, we believe our investment portfolio is well positioned to withstand an extended period of elevated investment market volatility, and have relatively modest exposure to asset sectors that we expect to be most impacted by the public health response to COVID-19. While we expect other segments of the economy may be disrupted, we believe these effects could be most acute in the sectors listed below. These sectors have experienced more pronounced price dislocation due to their perceived exposure to COVID-19 related impacts. Exposure to these sectors totals 7.4% of our investment portfolio, and as of December 31, 2020, informed by extensive stress testing and portfolio review, we continue to hold the following securities:
($ in millions) December 31, 2020
Fixed maturity securities (1)
(1) Below investment grade and non-rated securities included in this population account for $40.2 million of amortized cost, $40.5 million of fair value, and $0.3 million of net unrealized investment gains. There are 97 issuers with an average rating of BB-. The majority of these securities are concentrated in the travel and leisure and retail sectors.
60 Annual Report on Form 10-K Horace Mann Educators Corporation
Rating of Fixed Maturity Securities and Equity Securities (1)
The following table presents the composition and fair value of our fixed maturity and equity securities portfolios by rating category. At December 31, 2020, 90.9% of these combined portfolios were investment grade, based on fair value, with an overall average credit quality rating of A+. We have classified the entire fixed maturity securities portfolio as available for sale, which is carried at fair value.
($ in millions) December 31, 2020
Percentof TotalFairValue FairValue AmortizedCost or Cost
Fixed maturity securities
Equity securities
AAA — —
AA — —
B — —
CCC or lower — —
(1)Ratings are as assigned primarily by S&P when available, with remaining ratings as assigned on an equivalent basis by Moody's or Fitch. 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, 2020, the AA rated fair value amount included $429.3 million of U.S. Government and federally sponsored agency securities and $669.0 million of mortgage-backed 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, Moody's or Fitch.
At December 31, 2020, the fixed maturity securities portfolio had $28.4 million of pretax gross unrealized investment losses on $985.2 million of fair value related to 431 positions. Of the investment positions with gross unrealized investment losses, there were 21 securities trading below 80.0% of the carrying value at December 31, 2020.
We view the unrealized investment losses of all of the securities at December 31, 2020 as temporary. Future changes in circumstances related to these and other securities could require subsequent recognition of OTTI.
Horace Mann Educators Corporation Annual Report on Form 10-K 61
Liquidity and Financial Resources
Off-Balance Sheet Arrangements
At December 31, 2020, 2019 and 2018, we 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, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships as of December 31, 2020.
Investments
Information regarding our investment portfolio, which is comprised primarily of investment grade, fixed maturity securities, is presented in Part II - Item 7, Results of Operations by Segment for the Three Years Ended December 31, 2020, Part I - Item 1, Investments and in Part II - Item 8, Note 2 of the Consolidated Financial Statements in this report.
Cash Flow
Our short-term liquidity requirements, 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 our 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 our 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 debt. The following table summarizes our consolidated cash flows activity for the periods indicated.
Net (decrease) increase in cash (3.2) 13.6 4.3 N.M. N.M.
Operating Activities
As a holding company, we conduct our principal operations in the personal lines portion of the property and casualty, supplemental and life insurance industries through our subsidiaries. Our 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 flows generated by the insurance subsidiaries.
For 2020, net cash provided by operating activities increased $132.2 million compared to 2019, primarily due to lower claims paid on insurance policies in the current year partially offset by lower investment income collected as a result of a $2.1 billion reduction of invested assets from investments transferred under the annuity reinsurance transaction in the second quarter of 2019.
Investing Activities
Our insurance subsidiaries maintain significant investments in fixed maturity securities to meet future contractual obligations to policyholders. In conjunction with our management of liquidity and other asset/liability management objectives, we, from time to time, will sell fixed maturity securities prior to maturity, and reinvest the proceeds into other investments with different interest rates, maturities or credit characteristics. Accordingly, we have classified the entire fixed maturity securities portfolio as available for sale.
62 Annual Report on Form 10-K Horace Mann Educators Corporation
Financing Activities
Financing activities include primarily payment of dividends, receipt and withdrawal of funds by annuity contractholders, issuances and repurchases of our common stock, fluctuations in book overdraft balances, and borrowings, repayments and repurchases related to debt facilities.
For 2020, net cash provided by financing activities increased $313.7 million compared to 2019, primarily due to cash inflows of $95.5 million from advances received under FHLB funding agreements in 2020 compared to net cash outflows of $130.0 million from advances received and principal repayments made under FHLB funding agreements in 2019.
The following table shows activity from FHLB funding agreements for the periods indicated.
($ in millions) Year Ended December 31,
Balance at beginning of the year $ 495.0 $ 625.0
Advances received from FHLB funding agreements 95.5 175.0
Principal repayment on FHLB funding agreements — (305.0)
Contractual Obligations
The following table reflects our contractual obligations, as well as the projected timing of payments.
($ in millions) Payments Due By Period as of December 31, 2020
(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 $590.5 million obligation for FHLB funding agreements plus interest.
(3)Includes principal and interest.
(4)Includes $54.0 million obligation for FHLB borrowings plus interest.
(5)We have entered into various operating lease agreements, primarily for real estate offices.
Estimated Future Policy Benefit and Claim Payments - Supplemental, Retirement and Life
This discussion addresses the following contractual obligations disclosed above: fixed annuities and fixed option of variable annuities, payout annuity contracts and supplemental and life insurance policies. Payment amounts reflect our estimate of undiscounted future 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.
Horace Mann Educators Corporation Annual Report on Form 10-K 63
For the majority of our 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 future 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.
For the majority of our Supplemental insurance operations, the estimated contractual obligations for future policyholder benefits as presented in the table above were derived from future projections of the business developed as part of the purchase accounting associated with the acquisition of NTA.
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, morbidity, 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, 2020. Separate Account (variable annuity) payments are not reflected due to the matched nature of these obligations and the fact that the contract owners maintain the investment risk on such deposits.
See Part II - Item 8, Note 1 of the Consolidated Financial Statements in this report for a description of our methods for establishing supplemental, life and annuity reserves in accordance with GAAP.
Estimated Claims and Claim Adjustment Expenses - Property and Casualty
This discussion addresses claims and claim adjustment expenses as disclosed above. The amounts reported in the table are presented on a nominal basis, have not been discounted and represent the estimated timing of future payments for both reported and unreported claims incurred and related claim adjustment expenses. Both the total liability and the estimated payments are based on actuarial projection techniques, at a given reporting date. These estimates include assumptions of the ultimate settlement and administrative costs based on our assessment of facts and circumstances then known, review of historical settlement patterns, estimates of trends in claims severity, frequency and other factors. Variables in the reserve estimation process can be affected by both internal and external events, such as changes in claims handling procedures, economic inflation, legal trends and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. Additionally, there may be significant reporting lags between the occurrence of a claim and the time it is actually reported to us. The future cash flows related to the items contained in the table above required estimation of both amount (including severity considerations) and timing. Amount and timing are frequently estimated separately. An estimation of both amount and timing of future cash flows related to claims and claim adjustment expenses is generally reliable only in the aggregate with some unavoidable estimation uncertainty.
64 Annual Report on Form 10-K Horace Mann Educators Corporation
Liquidity Sources and Uses
Our potential sources and uses of funds principally include the following activities:
Property and Casualty Supplemental Retirement Life Corporate and Other
Activities for potential sources of funds
Receipt of insurance premiums, contractholder charges and fees ☑ ☑ ☑ ☑
Recurring service fees, commissions and overrides ☑ ☑ ☑ ☑ ☑
Contractholder fund deposits ☑ ☑ ☑
Reinsurance and indemnification program recoveries ☑ ☑ ☑ ☑
Receipts of principal, interest and dividends on investments ☑ ☑ ☑ ☑ ☑
Sales of investments ☑ ☑ ☑ ☑ ☑
Funds from FHLB and line of credit agreements ☑ ☑ ☑ ☑ ☑
Intercompany loans ☑ ☑ ☑ ☑ ☑
Capital contributions from parent ☑ ☑ ☑ ☑
Dividends or return of capital from subsidiaries ☑
Tax refunds/settlements ☑ ☑ ☑ ☑ ☑
Funds from periodic issuance of additional securities ☑
Proceeds from debt issuances ☑
Receipt of intercompany settlements related to employee benefit plans ☑
Activities for potential uses of funds
Payment of claims and related expenses ☑ ☑ ☑ ☑
Payment of contract benefits, surrenders and withdrawals ☑ ☑ ☑
Reinsurance cessions and indemnification program payments ☑ ☑ ☑ ☑
Operating costs and expenses ☑ ☑ ☑ ☑ ☑
Purchase of investments ☑ ☑ ☑ ☑ ☑
Repayment of FHLB and line of credit agreements ☑ ☑ ☑ ☑ ☑
Payment or repayment of intercompany loans ☑ ☑ ☑ ☑ ☑
Capital contributions to subsidiaries ☑
Dividends or return of capital to shareholders/parent company ☑ ☑ ☑ ☑ ☑
Tax payments/settlements ☑ ☑ ☑ ☑ ☑
Common share repurchases ☑
Debt service expenses and repayment ☑
Payments related to employee benefit plans ☑
Payments for acquisitions ☑
Horace Mann Educators Corporation Annual Report on Form 10-K 65
We actively manage our financial position and liquidity levels in light of changing market, economic and business conditions. Liquidity is managed at both the entity and enterprise level across HMEC and is assessed on both base and stressed level liquidity needs. We believe we have sufficient liquidity to meet these needs. Additionally, we have existing intercompany agreements in place that facilitate liquidity management across HMEC to enhance flexibility.
As of December 31, 2020, we held $1.1 billion of cash, U.S. government and agency fixed maturity securities and public equity securities (excluding non-redeemable preferred stocks and foreign equity securities) which, under normal market conditions, could be rapidly liquidated.
Certain remote events and circumstances could constrain our liquidity. Those events and circumstances include, for example, a catastrophe resulting in extraordinary losses, a downgrade of our Senior Notes rating to non-investment grade status or a downgrade in our insurance subsidiaries' financial strength ratings. The rating agencies also consider the interdependence of our individually rated entities; therefore, a rating change in one entity could potentially affect the ratings of other related entities.
Capital Resources
We have determined the amount of capital which is needed to adequately fund and support business growth, primarily based on risk-based capital formulas including those developed by the NAIC. Historically, our insurance subsidiaries have generated capital in excess of such needed levels. These excess amounts have been paid to us through dividends. We have then utilized these dividends and our access to the capital markets to service and retire debt, pay dividends to our shareholders, fund growth initiatives, repurchase shares of our common stock and for other corporate purposes. If necessary, we also have 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 us without prior approval of the insurance regulatory authorities. The aggregate amount of dividends that may be paid in 2021 from all of our insurance subsidiaries without prior regulatory approval is $248.7 million, excluding the impact and timing of prior year dividends, of which $155.0 million was paid during the year ended December 31, 2020. We anticipate that our sources of capital will continue to generate sufficient capital to meet the needs for business growth, debt interest payments, shareholder dividends and our share repurchase program. Additional information is contained in Part II - Item 8, Note 13 of the Consolidated Financial Statements in this report.
Total capital was $2,227.4 million at December 31, 2020, including $437.3 million of short-term and long-term debt. Total debt represented 19.6% of total capital including net unrealized investment gains on fixed maturity securities (23.5% of total capital excluding net unrealized investment gains on fixed maturity securities*) at December 31, 2020, which was below our long-term target of 25.0%.
Shareholders' equity was $1,790.1 million at December 31, 2020, including net unrealized investment gains on fixed maturity securities of $366.3 million after taxes and the related impact of DAC associated with annuity contracts and life insurance products with account values. The market value of our common stock and the market value per share were $1,741.1 million and $42.04, respectively, at December 31, 2020. Book value per share was $43.22 at December 31, 2020 ($34.38 excluding net unrealized investment gains on fixed maturity securities*).
Additional information regarding net unrealized investment gains on fixed maturity securities at December 31, 2020 is included in Part II - Item 7, Results of Operations by Segment for the Three Years Ended December 31, 2020 and Part II - Item 8, Note 2 of the Consolidated Financial Statements in this report.
66 Annual Report on Form 10-K Horace Mann Educators Corporation
Total shareholder dividends paid were $49.6 million for the year ended December 31, 2020. In March, May, September and December 2020, the Board declared regular quarterly dividends of $0.30 per share. Compared to the full year per share dividends paid in 2019 of $1.15, the total 2020 dividends paid per share of $1.20 represented an increase of 4.3%.
On September 30, 2015, the Board authorized a share repurchase program allowing repurchases of up to $50.0 million of HMEC's common stock, par value $0.001 (Program). The Program authorizes the repurchase of common shares in open market or privately negotiated transactions, from time to time, depending on market conditions. The Program does not have an expiration date and may be limited or terminated at any time without notice. During 2020, we repurchased 52,095 shares our common stock at an average price per share of $41.17 under the Program. In total and through December 31, 2020, 899,468 shares have been repurchased under the Program at an average price of $32.68 per share. The repurchase of shares was funded through use of cash. As of December 31, 2020, $20.6 million remained authorized for future share repurchases under the Program.
The following table summarizes our debt obligations.
($ in millions) EffectiveInterestRates FinalMaturity December 31,
Short-term debt
Long-term debt (1)
(1) We designate our debt obligations as "long-term" based on maturity date at issuance.
As of December 31, 2020, we had outstanding $250.0 million aggregate principal amount of 4.50% Senior Notes (Senior Notes), which mature on December 1, 2025, issued at a discount resulting in an effective yield of 4.53%. Interest on the Senior Notes is payable semi-annually at a rate of 4.50%. Detailed information regarding the redemption terms of the Senior Notes is contained in Part II - Item 8, Note 9 of the Consolidated Financial Statements in this report. The Senior Notes are traded in the open market (HMN 4.50).
As of December 31, 2020, we had $54.0 million of borrowings outstanding with FHLB. The Board has authorized a maximum amount equal to 15% of net aggregate admitted assets less separate account assets of the insurance subsidiaries for FHLB borrowing and funding agreements which is below our maximum FHLB borrowing capacity. For the total $54.0 million received, $4.0 million matures on May 17, 2021, $25.0 million matures on October 5, 2022 and $25.0 million matures on December 2, 2022. Interest on the borrowings accrue at an annual weighted average rate of 0.44% as of December 31, 2020. The $54.0 million of FHLB borrowings is reported as Long-term debt in the Consolidated Balance Sheets.
On June 21, 2019, we, as borrower, replaced our current line of credit with a new five-year Credit Agreement (Bank Credit Facility). The new Bank Credit Facility increased the amount available on this senior revolving credit facility to $225.0 million from $150.0 million. PNC Capital Markets, LLC and JPMorgan Chase Bank, N.A. served as joint leads on the new agreement, with The Northern Trust Company, U.S. Bank National Association, KeyBank National Association, Comerica Bank and Illinois National Bank participating in the syndicate. Terms and conditions of the new Bank Credit Facility are substantially consistent with the prior agreement, with an interest rate based on LIBOR plus 115 basis points.
On July 1, 2019, we utilized our senior revolving credit facility to partially fund the acquisition of NTA. As of December 31, 2020, the amount outstanding on the senior revolving credit facility was $135.0 million. The unused portion of the Bank Credit Facility is subject to a variable commitment fee, which was 0.15% on an annual basis at December 31, 2020.
To provide additional capital management flexibility, we filed a "universal shelf" registration statement on Form S-3 with the SEC on March 13, 2018. The registration statement, which registered the offer and sale from time to time of an indeterminate amount of various securities, which may include debt securities, common stock,
Horace Mann Educators Corporation Annual Report on Form 10-K 67
preferred stock, depositary shares, warrants, delayed delivery contracts and/or units that include any of these securities, was automatically effective on March 13, 2018. Unless withdrawn by us earlier, this registration statement will remain effective through March 13, 2021 and no securities associated with such registration statement have been issued. At the time of issuance of this Annual Report on Form 10-K, we expect to file another "universal shelf" registration statement on Form S-3 with the SEC in March 2021.
On March 13, 2018, we filed a "shelf" registration statement on Form S-4 with the SEC which became effective on May 2, 2018. Under this registration statement, we may from time to time offer and issue up to 5,000,000 shares of our common stock in connection with future acquisitions of other businesses, assets or securities. Unless withdrawn by us, this registration statement remains effective indefinitely. No securities associated with the registration statement have been issued at the time of issuance of this Annual Report on Form 10-K.
COVID-19 Liquidity and Capital Resources Considerations
The various impacts of COVID-19 on the U.S. economy, our operations and our investment portfolio have been material. Nonetheless, we believe that the liquidity available to our holding company and its operating subsidiaries remains adequate and we do not foresee a need to suspend ordinary dividends or seek additional sources of capital at this time. Our current forecast assumes a return to a normal operating environment within 12 months, and as such, capital and liquidity are expected to remain at or near target levels during that period.
Financial Ratings
Our principal insurance subsidiaries are rated by A.M. Best Company, Inc. (A.M. Best), Fitch, Moody's and S&P. These rating agencies have also assigned ratings to our Senior Notes. The ratings that are assigned by these agencies, which are subject to change, can impact, among other things, our access to sources of capital, cost of capital, and competitive position. These ratings are not a recommendation to buy or hold any of our securities.
All four agencies currently have assigned the same insurance financial strength ratings to our Property and Casualty and Life insurance subsidiaries. Only A.M Best currently rates our Supplemental segment's subsidiaries. Assigned ratings and respective affirmation/review dates as of February 18, 2021 were as follows:
HMEC (parent company) N.A. bbb (stable)
HMEC's Life A (stable) N.A.
HMEC's Property and Casualty subsidiaries A (stable) N.A.
HMEC's Supplemental subsidiaries A- (stable) N.A.
Fitch A (stable) BBB (stable) 9/22/2020
S&P A (stable) BBB (stable) 2/18/2021
Reinsurance Programs
Information regarding the reinsurance programs for our Property and Casualty, Supplemental, Retirement and Life segments are located in Part I - Item 1, Reporting Segments of this report.
Future Adoption of New Accounting Standards
There is one new accounting standard that we have not adopted because the adoption date has not yet occurred. For a discussion of this new standard, see Part II - Item 8, Note 1 of the Consolidated Financial Statements in this report. The effect of implementing certain accounting standards on our financial results and financial condition is often based in part on market conditions at the time of implementation of the standard and other factors that we are unable to determine prior to implementation. For this reason, we are sometimes unable to estimate the effect of certain pending accounting standards until the relevant authoritative body finalizes these standards or until we implement them.
68 Annual Report on Form 10-K Horace Mann Educators Corporation
Effects of Inflation and Changes in Interest Rates
Our operating results are affected significantly in at least three ways by changes in interest rates and inflation. First, inflation directly affects Property and Casualty claims costs. Second, the investment income earned on our investment portfolio and the fair value of the investment portfolio are related to the yields available in the fixed income markets. An increase in interest rates will decrease the fair value of the investment portfolio, but will increase investment income as investments mature and proceeds are reinvested at higher rates. Third, as interest rates increase, competitors will typically increase crediting rates on annuity contracts and life insurance products with account values, and may lower premium rates on property and casualty lines to reflect the higher yields available in the market. The risk of interest rate fluctuation is managed through asset/liability management techniques, including cash flow analysis. In addition, an annuity reinsurance agreement entered into in the second quarter of 2019, which reinsured a $2.2 billion block of in force fixed annuities with a minimum crediting rate of 4.5%, helps mitigate the risk of not being able to generate appropriate spreads on the annuity business.
ITEM 7A. I Quantitative and Qualitative Disclosures about Market Risk
Market value risk, our primary market risk exposure, is the risk that our invested assets will decrease in value. This decrease in value may be due to (1) a change in the yields realized on our assets and prevailing market yields for similar assets, (2) an unfavorable change in the liquidity of an investment, (3) an unfavorable change in the financial prospects of the issuer of an investment, or (4) a downgrade in the credit rating of the issuer of an investment. Also, see Part II - Item 7, Results of Operations by Segment for the Three Years Ended December 31, 2020 of this report regarding net investment gains (losses).
Significant changes in interest rates expose us to the risk of experiencing losses or earning a reduced level of investment income based on the difference between the interest rates earned on our investments and the credited interest rates on our insurance liabilities. Also, see Part II - Item 7, Results of Operations by Segment for the Three Years Ended December 31, 2020 of this report regarding interest credited to policyholders.
We seek to manage our market value risk by coordinating the projected cash inflows of assets with the projected cash outflows of liabilities. For all our assets and liabilities, we seek to maintain reasonable durations, consistent with the maximization of income without sacrificing investment quality, while providing for liquidity and diversification. The investment risk associated with variable annuity deposits and the underlying mutual funds is assumed by our contractholders, and not by us. Certain fees that we earn from variable annuity deposits are based on the market value of the funds deposited.
Through active investment management, we invest available funds with the objective of funding future obligations to policyholders, subject to appropriate risk considerations, and maximizing shareholder value. This objective is met through investments that (1) have similar characteristics to the liabilities they support, (2) are diversified among industries, issuers and geographic locations, and (3) are predominantly investment-grade fixed maturity securities classified as available for sale. As of the time of issuance of this Annual Report on Form 10-K, derivatives are only used to manage the interest crediting rate risk within our FIA and IUL products. At December 31, 2020, approximately 13.7% of the fixed maturity securities portfolio supported Property and Casualty, 9.2% supported Supplemental, and 77.2% supported Retirement and Life. For discussions regarding our investments see Part II - Item 7, Results of Operations by Segment for the Three Years Ended December 31, 2020 of this report regarding net investment gains (losses) and Part I - Item 1, Investments of this report.
Our Retirement and Life earnings are affected by the spreads between investment yields and rates credited or accruing on fixed annuity and life insurance liabilities with account values. Although credited rates on fixed annuities may be changed annually (subject to minimum guaranteed rates), competitive pricing and other factors, including the impact on the level of surrenders and withdrawals, may limit our ability to adjust or maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. However, because of the annuity reinsurance transaction, the spread in our retained annuity business is achieving our targeted returns and new business is priced to do so as well. Also, see Part II - Item 7, Results of
Horace Mann Educators Corporation Annual Report on Form 10-K 69
Operations by Segment for the Three Years Ended December 31, 2020 of this report regarding interest credited to policyholders.
Using financial modeling and other techniques, we regularly evaluate the appropriateness of investments relative to the characteristics of the liabilities that they support. Simulations of cash flows generated from existing business under various interest rate scenarios measure the potential gain or loss in fair value of interest rate sensitive assets and liabilities. Such estimates are used to closely match the duration of assets to the duration of liabilities. The overall duration of liabilities of our multiline insurance operations combines the characteristics of our long duration annuity and interest rate sensitive life liabilities with our short duration non-interest rate sensitive Property and Casualty liabilities. Overall, at December 31, 2020, the duration of the fixed maturity securities portfolio was estimated to be approximately 6.4 years and the duration of our insurance liabilities and debt was estimated to be approximately 5.7 years.
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 our obligations under a variety of interest rate scenarios. Based on these procedures, our assets and the investment income expected to be received on such assets are adequate to meet the insurance policy obligations and expenses of our insurance activities in all but the most extreme circumstances.
We periodically evaluate our sensitivity to interest rate risk. Based on commonly used models, we project the impact of interest rate changes, assuming a wide range of factors, including duration and prepayment, on the fair value of assets and liabilities. Fair value is estimated based on the net present value of cash flows or duration estimates. Based on the most recent study, assuming an immediate decrease of 100 basis points in interest rates, the fair value of our assets and liabilities would both increase, the net of which would result in an increase in shareholders' equity of approximately $30.0 million after tax, or 1.7%. Assuming an immediate increase of 100 basis points in interest rates, the fair value of our assets and liabilities would both decrease, the net of which would result in a decrease in shareholders' equity of approximately $70.3 million after tax, or 3.9%. In each case, these changes in interest rates assume a parallel shift in the yield curve. While we believe that these assumed market rate changes are reasonably possible, actual results may differ, particularly as a result of any actions that we would take to attempt to mitigate such hypothetical losses in fair value of shareholders' equity.
Interest rates continue to be at historically low levels. If interest rates remain low over an extended period of time, we recognize it could pressure investment income by having to invest insurance cash flows and reinvest the cash flows from the investment portfolio in lower yielding securities. Moreover, issuers of securities in our investment portfolio may prepay or redeem fixed maturity securities, as well as asset-backed and commercial and mortgage-backed securities, with greater frequency to borrow at lower market rates. As a general guideline, we estimate that pretax net income in 2021 and 2022 would decrease by approximately $2.6 million for each 100 basis point decline in reinvestment rates, before assuming any reduction in annuity crediting rates on in force contracts. In addition, declining interest rates also could negatively impact the amortization of DAC, as well as the recoverability of goodwill and certain intangible assets, due to the impacts on the estimated fair value of our operating segments.
We have been and continue to be proactive in our investment strategies, product designs and crediting rate strategies to mitigate the risk of unfavorable consequences in this type of interest rate environment without venturing into asset classes or individual securities that would be inconsistent with our investment guidelines. Lowering interest crediting rates on annuity contracts and cap and participation rates on fixed indexed annuity contracts can help offset decreases in investment margins on some products. Our ability to lower interest crediting rates could be limited by competition, regulatory approval or contractual guarantees of minimum rates and may not match the timing or magnitude of changes in investment yields.
Based on our overall exposure to interest rate risk, we believe that these changes in interest rates would not materially affect our consolidated near-term financial position, results of operations or cash flows.
70 Annual Report on Form 10-K Horace Mann Educators Corporation
ITEM 8. I Financial Statements and Supplementary Data
HORACE MANN EDUCATORS CORPORATION
INDEX TO FINANCIAL INFORMATION
Page
Report of Independent Registered Public Accounting Firm 72
Consolidated Balance Sheets 75
Consolidated Statements of Operations 76
Consolidated Statements of Comprehensive Income (Loss) 77
Consolidated Statements of Changes in Shareholders' Equity 78
Consolidated Statements of Cash Flows 79
Notes to Consolidated Financial Statements 80
Note 1 - Basis of Presentation and Significant Accounting Policies 80
Note 2 - Investments 93
Note 3 - Fair Value of Financial Instruments 98
Note 4 - Derivatives 105
Note 5 - Deposit Asset on Reinsurance 107
Note 6 - Goodwill and Intangible Assets 108
Note 7 - Unpaid Claims and Claim Expenses 110
Note 8 - Reinsurance and Catastrophes 116
Note 10 - Income Taxes 119
Note 11 - Operating Leases 122
Note 12 - Shareholders' Equity and Share-Based Compensation 123
Note 13 - Statutory Information and Dividend Restrictions 126
Note 14 - Retirement Plans and Other Postretirement Benefits 126
Note 15 - Contingencies and Commitments 131
Note 17 - Supplemental Consolidated Cash and Cash Flow Information 134
Note 18 - Segment Information 134
Note 19 - Unaudited Selected Quarterly Financial Data 137
Horace Mann Educators Corporation Annual Report on Form 10-K 71
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Horace Mann Educators Corporation:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Horace Mann Educators Corporation and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedules I to IV and VI (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 26, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
72 Annual Report on Form 10-K Horace Mann Educators Corporation
Fair value for hard-to-value fixed maturity securities
As discussed in Note 3 to the consolidated financial statements, as of December 31, 2020, the Company has recorded an estimated fair value for fixed maturity securities, of which a portion represents securities that are hard-to-value, which are primarily securities that use Level 3 (unobservable) inputs. The Company estimates the fair value of hard-to-value fixed maturity securities, which includes securities that do not have observable market-based inputs or prices or that trade in markets that are less liquid. The Company uses judgment to determine the appropriate inputs and assumptions used to estimate the fair value of these hard-to-value securities. As of December 31, 2020, the estimated fair value of fixed maturity securities was $6,345.3 million.
We identified the assessment of the Company’s estimate of the fair value of hard-to-value fixed maturity securities as a critical audit matter. Significant measurement uncertainty associated with the fair value of such securities existed because the markets for the hard-to-value securities are less liquid and there is a lack of observable market-based inputs. As such, there was a high degree of subjectivity and judgment in evaluating the fair value and, specifically, the benchmark yield used in the valuation. Additionally, evaluation of the benchmark yield used in the estimation of fair value required specialized skills and knowledge.
The following are the primary procedures we performed to address this critical audit matter. We, with involvement of valuation professionals with specialized skills and knowledge, evaluated the design and tested the operating effectiveness of certain internal controls over the Company’s process to measure fair value of hard-to-value securities. This included controls related to the Company’s selection of pricing assumptions, including the benchmark yield used to value, for hard-to-value fixed maturity securities. We involved valuation professionals with specialized skills and knowledge, who assisted in:
•developing an independent range of fair value estimates using information from the Company, market data sources, models, and key assumptions derived by the valuation professional for a selection of securities
•comparing the Company’s fair value estimates of hard-to-value securities to our independent range of fair value estimates for the same selection of securities
Valuation of the liability for property and casualty unpaid claims and claim expenses
As discussed in Notes 1 and 7 of the consolidated financial statements, the Company employs actuarial techniques to estimate the liability for property and casualty unpaid claims and claims expenses (reserves). The Company develops reserves based on the application of actuarial methods and best estimate assumptions to historical claim experience. The reserves are continually updated by the Company as experience develops and new information becomes known. The Company recorded an estimated liability of $259.3 million for property and casualty unpaid claims and claim expenses as of December 31, 2020.
We identified the assessment of the estimate of reserves as a critical audit matter because it involved estimation uncertainty. Complex auditor judgment and specialized skills and knowledge were required in evaluating the selected methods and certain assumptions used to develop the estimate of reserves, including the selection of development factors and changes in claim frequency and severity trends. Additionally, subjective auditor judgment was required to assess the selected assumptions as there exists a range of potential inputs and the assumptions are sensitive to variation, such that minor changes in the assumptions could affect the reserves recorded by the Company.
Horace Mann Educators Corporation Annual Report on Form 10-K 73
The following are the primary procedures we performed to address this critical audit matter. We, with involvement of actuarial professionals with specialized skills and knowledge, evaluated the design and tested the operating effectiveness of certain internal controls over the Company’s process for the development of the estimate of reserves. This included controls related to the methods and assumptions used for the Company’s best estimate. We also involved actuarial professionals with specialized skills and knowledge, who assisted in:
•evaluating the Company’s reserving methods, procedures, key assumptions, and judgments by comparing to generally accepted actuarial standards
•developing an independent estimate for certain lines of business based on actuarial methodologies and assumptions in order to evaluate the Company’s recorded reserves
•examining the methods and certain assumptions used in and results of the Company’s internal actuarial analyses for certain remaining lines of business
•developing a range of reserves based on actuarial methodologies and assumptions in order to evaluate the Company’s consolidated reserves
•assessing movement of the Company’s consolidated reserves within the range of reserves
/s/ KPMG LLP
KPMG LLP
We have served as the Company’s auditor since 1989.
Chicago, Illinois
February 26, 2021
74 Annual Report on Form 10-K Horace Mann Educators Corporation
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED BALANCE SHEETS
As of December 31, 2020 and 2019
($ in thousands, except share data)
December 31,
ASSETS
Investments
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities
Preferred stock, $0.001 par value, authorized1,000,000 shares; none issued — —
Accumulated other comprehensive income (loss), net of tax:
Net unrealized investment gains on fixed maturity securities 366,285 230,448
Net funded status of benefit plans (11,165) (10,767)
See accompanying Notes to Consolidated Financial Statements.
Horace Mann Educators Corporation Annual Report on Form 10-K 75
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
($ in thousands, except per share data)
Year Ended December 31,
Revenues
Benefits, losses and expenses
Intangible asset amortization expense 14,381 8,790 —
Other expense - goodwill and intangible asset impairments 10,000 28,025 —
Net income per share
Weighted average number of shares and equivalent shares
Net investment gains (losses)
Portion of losses recognized in other comprehensive income (loss) — — —
Change in fair value - equity securities (167) 7,308 (18,323)
See accompanying Notes to Consolidated Financial Statements.
76 Annual Report on Form 10-K Horace Mann Educators Corporation
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
($ in thousands)
Year Ended December 31,
Comprehensive income (loss)
Other comprehensive income (loss), net of tax:
Change in net funded status of benefit plans (398) 1,418 1,032
Cumulative effect of change in accounting principle — — (15,041)
See accompanying Notes to Consolidated Financial Statements.
Horace Mann Educators Corporation Annual Report on Form 10-K 77
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
($ in thousands, except per share data)
Year Ended December 31,
Common stock, $0.001 par value
Beginning balance $ 66 $ 66 $ 65
Options exercised — — —
Conversion of common stock units — — —
Conversion of restricted common stock units — — 1
Additional paid-in capital
Retained earnings
Cumulative effect of change in accounting principle (509) — 15,041
Accumulated other comprehensive income (loss), net of tax:
Change in net funded status of benefit plans (398) 1,418 1,032
Cumulative effect of change in accounting principles — — (15,041)
Treasury stock, at cost
See accompanying Notes to Consolidated Financial Statements.
78 Annual Report on Form 10-K Horace Mann Educators Corporation
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in thousands)
Year Ended December 31,
Cash flows from operating activities
Adjustments to reconcile net income to net cash providedby operating activities:
Other expense - goodwill and intangible asset impairments 10,000 28,025 —
Changes in:
Cash flows from investing activities
Fixed maturity securities
Equity securities
Limited partnership interests
Acquisition of businesses, net of cash acquired — (421,516) —
Cash flows from financing activities
Principal borrowings on Bank Credit Facility — 135,000 —