ITEM 1A. I Risk Factors
Index to Risk Factors
Page
Introduction 21
Risks Related to Economic Conditions, Market Conditions and Investments 22
Risks Related to Property & Casualty Segment 23
Risks Related to Life & Retirement Segment 25
Risks Related to Supplemental & Group Benefits Segment 26
Strategic Risks 26
Operational Risks 28
Financial Strength, Credit and Counterparty Risks 30
Regulatory and Legal Risks 32
Introduction
We have identified what we believe reflect key significant risks to the organization, and in turn to our shareholders, which are outlined below. Any of the risks described below could result in a significant or material adverse effect on our results of operations or financial condition. In addition to these enumerated risks, we face numerous other strategic, operational and emerging risks that could in the aggregate lead to shortfalls to our long-term goals or add to short-term volatility in our earnings. Additionally, many risk factors are correlated, which could exacerbate the financial impact. The following review of important risk factors should not be construed as exhaustive and should be read in conjunction with the Forward-looking Information section located in Part I - Item 1 of this Annual Report on Form 10-K as well as Part II - Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K and other reports and materials we submit to the SEC. The words or phrases believe, anticipate, estimate, project, plan, expect, intend, hope, forecast, evaluate, will likely result or will continue or words or phrases of similar import generally involve forward-looking statements. All of the risks that may affect our financial or operating performance may not be material at this time but may become material in the future.
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Risks Related to Economic Conditions, Market Conditions and Investments
Volatile financial markets and adverse economic environments can affect financial market risk as well as our financial condition and results of operations.
Financial markets in the U.S. and elsewhere can experience extreme volatility and disruption for uncertain periods of time. During such times, stresses affecting the global banking system can lead to economic volatility, which can exert significant downward pressure on prices of equity securities and many other investment asset classes and result in severely constrained credit and capital markets, particularly for financial institutions, and an overall loss of investor confidence. Many states and local governments can also be impacted by adverse economic conditions, which could have an impact on both our niche market and our investment portfolio. Like other financial institutions that face significant financial market risk in their operations, we have been adversely affected by these conditions and could be adversely impacted by similar circumstances in the future. Our ability to access the capital markets to refinance outstanding indebtedness or raise capital could be impaired during significant financial market disruptions.
As discussed further in subsequent risk factors, in addition to the effects of financial markets volatility, a prolonged economic recession may have other adverse impacts on our financial condition and results of operations.
If our investment strategy is not successful, we could suffer unexpected losses.
The success of our investment strategy is crucial to the success of our business. Specifically, our fixed maturity securities portfolio is subject to a number of risks including:
•interest rate risk, which is the risk that interest rates may decline and funds reinvested would earn less than expected;
•market value risk, which is the risk that invested assets will decrease in value due to changes in yields realized on the assets and prevailing market yields for similar assets, an unfavorable change in the liquidity of the asset or an unfavorable change in the financial prospects or a downgrade in the credit rating of the issuer of the asset that would result in realized losses on funds disposed before their maturity;
•credit risk, which is the risk that the value of certain investments become impaired due to deterioration in the financial condition of one or more issuers of those instruments or the deterioration in performance or credit quality of the underlying collateral of certain structured securities and, ultimately, the risk of permanent loss in the event of default by an issuer or underlying credit;
•market fundamentals risk, which is the risk that there are changes in the market that can have an unfavorable impact on securities valuation such as availability of credit in the capital markets, re-pricing of credit risk, reduced market liquidity due to broker-dealers' unwillingness to hold inventory, and increased market volatility;
•concentration risk, which is the risk that the portfolio may be too heavily concentrated in the securities of one or more issuers, sectors or industries, which could result in a significant decrease in the value of the portfolio in the event of deterioration in the financial condition of those issuers or the market value of their securities;
•liquidity risk, which is the risk that liabilities are surrendered or mature sooner than anticipated requiring the sale of assets at an undesirable time to provide for policyholder surrenders, withdrawals or claims; and,
•regulatory risk, which is the risk that regulatory bodies or governments, in the U.S. or in other countries, may make substantial investments or take significant ownership positions in, or ultimately nationalize, financial institutions or other issuers of securities held in our investment portfolio, which could adversely impact the seniority or contractual terms of the securities. Regulatory risk could also come from changes in tax laws or bankruptcy laws that could adversely impact the valuation and/or after tax yields of certain invested assets.
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Although our defined benefit pension plan has been frozen since 2002, declining financial markets could also cause, and in the past have caused, the value of the investments in this plan to decrease, resulting in additional pension expense, a reduction in other comprehensive income and an increase in required contributions to this plan, which could have an adverse effect on our financial condition and results of operations.
The determination of fair value of our fixed maturity securities portfolio includes methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to investment valuations that may materially affect our financial condition and results of operations.
The determination of fair value is made at a specific point in time, based on available market information and judgments about financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counterparty. The use of different methodologies and assumptions may have a material effect on the estimated fair value amounts. During periods of market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain securities if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the financial environment. In such cases, fair value determination may require more subjectivity and management judgment and those fair values may differ materially from the value at which the investments could ultimately be sold. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of securities and the period-to-period changes in fair value could vary significantly. The difference between fair value and amortized cost, net of applicable deferred income taxes and the related impact on DAC associated with annuity contracts and life insurance products with account values is reflected as a component of AOCI within shareholders' equity. Decreases in the fair value of investments could have a material adverse effect on our financial condition and results of operations.
Equity method adjustments on investments in limited partnership interests as well as fair value accounting for equity securities and derivatives may reduce profitability and/or cause volatility in our results of operations.
We invest in limited partnership interests, which are accounted for using the equity method of accounting. This means that our proportionate share of the changes in fair value of the underlying net asset values are reported in net investment income in the Consolidated Statements of Operations and Comprehensive Income (Loss). As a result, the amount of net investment income recognized from these investments can vary substantially from period to period. Equity and credit market volatility may reduce net investment income from these types of investments and negatively impact the results of operations. Changes in fair value from applying fair value accounting to equity securities, which are reported in net investment gains (losses) in the Consolidated Statements of Operations and Comprehensive (Loss), may cause volatility in our results of operations.
The application of fair value accounting for derivatives and derivatives embedded in FIA and IUL products may cause volatility in our results of operations.
Risks Related to Property & Casualty Segment
Catastrophe events, as well as significant weather events not designated as catastrophes, can have a material adverse affect on our financial condition and results of operations.
Underwriting results of property and casualty insurers are subject to weather and other conditions prevailing in an accident year. While one year may be relatively free of major weather or other disasters — not all of which are designated by the insurance industry as a catastrophe, another year may have numerous such events causing results for such a year to be materially worse than for previous years.
Our Property & Casualty insurance subsidiaries have experienced, and we anticipate that in the future they will continue to experience, catastrophe losses. A catastrophe event, a series of multiple catastrophe events or a series of non-catastrophe severe weather events could have a material adverse effect on the financial condition and results of operations of our insurance subsidiaries.
Various events can cause catastrophes, including hurricanes, windstorms, hail, severe winter weather, wildfires, earthquakes, explosions and terrorism. The frequency and severity of these catastrophes are inherently
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unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposures in the area affected by the event and the severity of the event. Although catastrophes can cause losses in a variety of property and casualty lines, most of the catastrophe-related claims of our insurance subsidiaries are related to property coverages. Our ability to provide accurate estimates of ultimate catastrophe losses is based on several factors, including:
•the proximity of the catastrophe occurrence date to the date of our estimate;
•potential inflation of property repair costs in the affected area;
•supply chain interruptions resulting in cost increases, including availability of services and materials;
•the occurrence of multiple catastrophes in a geographic area over a relatively short period of time; and
•the outcome of litigation which may be filed against us by policyholders, state attorneys general and other parties relative to loss coverage disputes and loss settlement payments.
Based on 2022 direct premiums earned, 58.1% of the total annual premiums for our Property & Casualty business were for policies issued in the ten largest states in which the insurance subsidiaries write property and casualty coverage. Included in this top ten group are certain states which are considered to be more prone to catastrophe occurrences: California, Texas, North Carolina, Minnesota, South Carolina, Georgia, and Louisiana.
Our property and casualty loss reserves may not be adequate.
Our Property & Casualty insurance subsidiaries maintain loss reserves to provide for their estimated ultimate liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred as of the end of each reporting date. If these loss reserves prove inadequate, a loss is recognized and measured by the amount of the shortfall and, as a result, the financial condition and results of operations of the insurance subsidiaries may be adversely affected, potentially affecting their ability to distribute cash to us.
Reserves do not represent an exact calculation of liability. Reserves represent estimates, generally involving actuarial projections at a given time, of what the insurance subsidiaries expect the ultimate settlement and adjustment of claims will cost, net of salvage and subrogation. Estimates are based on assessments of known facts and circumstances, assumptions related to the ultimate cost to settle such claims, estimates of future trends in claims severity and frequency, changing judicial theories of liability and other factors. These variables are affected by both internal and external events, including changes in claims handling procedures, economic inflation, unpredictability of court decisions, plaintiffs' expanded theories of liability, risks inherent in major litigation and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. Significant reporting lags may exist between the occurrence of an insured event and the time it is actually reported. Our insurance subsidiaries adjust their reserve estimates regularly as experience develops and further claims are reported and settled.
The rise in inflation in recent periods has significantly increased our loss costs in our auto and property businesses. It is possible that inflation could remain at elevated levels for a prolonged period, or increase from these high levels, which could in turn lead to further increases in our loss costs. The impact of inflation on loss costs could be more pronounced for those lines of business that are considered “longer tail,” such as auto liability, as they require a relatively long period of time to finalize and settle claims for a given accident year. Recent changes in the macroeconomic environment have impacted medical labor and materials costs, the potential persistency of which could result in future loss costs which are higher than our current expectations. The estimation of loss reserves may also be more difficult during extreme events, such as a pandemic, or during volatile or uncertain economic conditions, due to unexpected changes in behavior of claimants and policyholders, including an increase in fraudulent reporting of exposures and/or losses, reduced maintenance of insured properties, increased frequency of small claims or delays in the reporting or adjudication of claims.
Due to the inherent uncertainty in estimating reserves for losses and loss adjustment expenses, we cannot be certain that the ultimate liability will not exceed amounts reserved, with a resulting adverse effect on our financial condition and results of operations.
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Risks Related to Life & Retirement Segment
A sustained period of low interest rates or interest rate fluctuations could negatively affect net interest margin derived from the difference between interest earned on investments and interest paid under fixed annuity and life insurance products with account values.
Significant changes in interest rates expose us to the risk of not earning the appropriate level of income or experiencing losses based on the differences between the interest earned on investments and the credited interest paid on outstanding fixed annuity and life insurance products with account values. Significant changes in interest rates may affect:
•the ability to maintain appropriate interest rate spreads over the rates guaranteed in fixed annuity and life products with account values;
•the book yield of the investment portfolio; and
•the net unrealized investment gains (losses) in the portfolio and the related after tax effect on shareholders' equity and total capital.
Both rising and declining interest rates can negatively affect the income derived from interest rate spreads on annuity and life insurance products with account values. During periods of falling interest rates or a sustained period of low interest rates, investment earnings will be lower because new investments in fixed maturity securities likely will bear lower interest rates. We may not be able to fully offset the decline in investment earnings with lower crediting rates on fixed annuity products, particularly in a multi-year period of low interest rates.
During periods of rising interest rates, there may be competitive pressure to increase the crediting rates on fixed annuity products. We may not, however, immediately have the ability to acquire investments with interest rates sufficient to offset an increase in crediting rates under fixed annuity products. Therefore, changes in interest rates could affect interest rate spreads.
Changes in interest rates may also affect business in other ways. For example, a rapidly changing interest rate environment may result in less competitive crediting rates on certain fixed rate products which could make those products less attractive, leading to lower sales and/or increases in the level of life insurance and fixed annuity product surrenders and withdrawals. New business volume also could be negatively impacted by product or agent compensation changes which we might make to mitigate the income effect of spread compression.
The Retirement business may be, and in the past has been, adversely affected by volatile or declining financial market conditions.
Conditions in the U.S. and international financial markets affect the sale and profitability of retirement products. In general, sales of fee-based products decrease when financial markets are declining or experiencing a higher than normal level of volatility over an extended period of time. Therefore, weak and/or volatile financial market performance may adversely affect sales of fee-based products to potential customers, may cause current customers to withdraw or reduce the amounts invested in fee-based products and may reduce the market value of existing customers' investments in fee-based products, in turn reducing the amount of fee-based product revenues generated. In addition, some variable annuity products offer guaranteed minimum death benefit features, which provide for a benefit if the contractholder dies and the contract value is less than a specified amount. A decline in the financial markets could cause the contract value to fall below this specified amount, increasing exposure to losses from variable annuity products featuring guaranteed minimum death benefits.
Deviations from assumptions regarding business persistency, mortality and morbidity used in calculating life and annuity reserves and DAC amortization and market risk benefits related to annuities could have a material adverse effect on our financial condition and results of operations.
The processes of calculating reserves and DAC amortization for the life and annuity businesses involve the use of a number of assumptions, including those related to business persistency (how long a contract stays with us), mortality (the relative incidence of death over a given period of time) and morbidity (the relative incidence of disability resulting from disease or physical impairment). We review, and if there is a change, update
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assumptions at least annually which could have a material adverse effect on our financial condition and results of operations.
A reduction or elimination of the tax advantages of retirement and life products and/or a change in the tax benefits of various government-authorized retirement programs, such as 403(b) products and individual retirement accounts (IRAs), could make our products less attractive to clients and adversely affect our results of operations.
A significant part of our retirement business involves fixed and variable 403(b) tax-qualified products, which are purchased voluntarily by individuals employed by public school systems or other tax-exempt organizations. Our financial condition and results of operations could be adversely affected by changes in federal and state laws and regulations that affect the relative tax and other advantages of our life and retirement products to clients or the tax benefits of programs utilized by our customers. As a result of persisting economic conditions, revenue challenges exist at federal, state and local government levels. These challenges could increase the risk of future adverse impacts on current tax-advantaged products or result in notable reforms to educator pension programs. Also, see Part I - Item 1, Regulation of this Annual Report on Form 10-K.
Current federal income tax laws generally permit the tax-deferred accumulation of earnings on the premiums paid by holders of retirement and life insurance products. Taxes, if any, are generally payable on income attributable to a distribution under the contract for the year in which the distribution is made. From time to time, Congress has considered legislation that would reduce or eliminate the benefit of such deferral of taxation on the accretion of value within life insurance and non-qualified annuity contracts. Enactment of this legislation, or other tax reform efforts could result in fewer sales of life insurance and retirement products.
Risks Related to Supplemental & Group Benefits Segment
Actual experience may differ from actuarial assumptions, which could adversely affect our results of operations and financial condition.
Historical results may not be indicative of future performance due to, among other things, changes in our mix of business, regulatory actions or changes in legal doctrine impacting our products or lines of business, or any number of economic cyclical effects including inflation. Reserves do not represent an exact calculation of future benefit liabilities but are instead actuarial and statistical-based estimates. Actual experience may differ from our reserve assumptions. There are no assurances that reserves will be sufficient to fund our future liabilities in all scenarios. Future loss development may require reserves to be increased, which could adversely affect earnings in current and future periods. Adjustments to reserve amounts may be required in the event of changes from the assumptions regarding future morbidity, mortality, persistency and interest rates used in calculating the reserve amounts, which could have a material adverse affect on our financial condition and results of operations.
Strategic Risks
The integration of Madison National may not be as successful as anticipated.
The Madison National acquisition involves numerous operational, strategic, financial, accounting, legal, tax and other risks. Difficulties in executing the acquisition strategy may cause our financial results to differ from our expectations or the expectations of the investor community. Potential difficulties that may be encountered in the integration process include, among other factors:
•the inability to successfully integrate the businesses and distribution relationships of Madison National in a manner that permits us to achieve the full revenue and cost savings desired from the acquisition;
•complexities associated with managing the larger, more complex, business;
•loss of key employees;
•disruption of, or loss of momentum in, each company's ongoing business; and,
•Madison National's distribution risk inherent in its in force block, which is highly concentrated with one distribution partner.
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Lack of successful execution on acquisition integration strategies could result in impairment of goodwill and intangible assets that could adversely affect our results of operations.
We accounted for the BCG, BCGS, NTA and Madison National acquisitions using the acquisition method of accounting, which requires that the assets acquired and liabilities assumed be recognized on our consolidated balance sheet at their respective fair values as of the acquisition date, including recognition of intangible assets. Any excess of the purchase consideration over the fair value of the acquired net tangible and intangible assets is recognized as goodwill.
As of December 31, 2022, the Company's Consolidated Balance Sheet reflected goodwill of $34.9 million and intangible assets of $171.8 million recognized in connection with the BCG, BCGS, NTA and Madison National acquisitions (see Part II - Item 8, Note 7 of the Consolidated Financial Statements for more information). To the extent the acquisitions do not provide the modeled returns, the value of goodwill or intangible assets could become impaired and thus, we may be required to recognize material non-cash charges relating to such impairment, which could adversely affect our results of operations.
The personal lines insurance and retirement markets are highly competitive and our financial condition and results of operations may be adversely affected by competitive forces.
We operate in a highly competitive environment and compete with numerous insurance companies, as well as mutual fund families, independent agent companies and financial planners. In some instances and geographic locations, competitors have specifically targeted the educator marketplace with specialized products and programs. We compete in our target market with a number of national providers of personal auto and property insurance and life insurance and retirement products.
The insurance industry consists of a large number of insurance companies, some of which have substantially greater financial resources, more diversified product lines, more sophisticated product pricing, greater economies of scale and/or lower-cost marketing approaches compared to us. In our target market, we believe that the principal competitive factors in the sale of property and casualty insurance products and supplemental insurance products are overall service, worksite sales and service, price, and name recognition. We believe that for our market, the principal competitive factors in the sale of retirement products and life insurance products are worksite sales and service, product features, perceived stability of the insurer, price, overall service and name recognition.
Particularly in the Property & Casualty business, our insurance subsidiaries have experienced pricing and profitability cycles. During these periods of intense competition, they may be unable to add policyholders and increase revenues without adversely impacting profit margins. With respect to these cycles, the factors having the greatest impact include significant and/or rapid changes in loss costs, including changes in loss frequency and/or severity, prior approval and restrictions in certain states for price increases, intense price competition, less restrictive underwriting standards, aggressive marketing, and increased advertising, which have resulted in higher industry-wide combined loss and expense ratios. During the current cycle, and potentially beyond, competition from direct writers and large, mass market carriers has been particularly aggressive, evidenced in part by their significant national advertising expenditures. In addition, advancements in vehicle technology and safety features, such as accident prevention technologies or the development of autonomous or partially autonomous vehicles — once widely available and utilized, as well as expanded availability of usage-based insurance, could materially alter the way that auto insurance is marketed, priced and underwritten. The inability of our insurance subsidiaries to effectively anticipate the impact of these issues on our business and compete successfully in the property and casualty business could adversely affect their financial condition and results of operations and the resulting ability to distribute cash to us.
In the Retirement business, there are several factors driving increased competition. First, the current IRS Section 403(b) regulations have made the 403(b) market similar to the 401(k) market. These changes have increased and could continue to increase the number of competitors in the 403(b) market, as it has become more attractive to some of the larger companies experienced in 401(k) plans, including both insurance and mutual fund companies, that had not previously been active competitors in this business. Further, while not yet widespread, there has been continued pressure in some states to adopt state-sponsored or mandated 403(b) plans with single-provider or limited-provider options; this pressure has come from competitor lobbying efforts and state legislature pension reform initiatives. The inability of our insurance subsidiaries to compete successfully in these circumstances could adversely affect their financial condition and results of operations and the resulting ability to distribute cash to us.
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If we are not able to effectively develop and expand our marketing operations, including agents and other points of distribution, our financial condition and results of operations could be adversely affected.
Our Retail Division agencies are owned primarily by non-employee, independent contractor Exclusive Distributors with most agencies operating in outside offices with licensed producers. The economic viability of each agency is directly dependent on the productivity of the agency and the success at penetrating, serving and cross-selling our educator market.
Our success in marketing and selling our products is largely dependent upon the efforts of our agent sales force and the success of their agency operations. As we expand our business, we may need to expand the number of agencies marketing our products. If we are unable to appoint additional agents, fail to retain high-producing agents, are unable to maintain the productivity of those agency operations or are unable to maintain market penetration in existing territories, sales of our products could likely decline and our financial condition and results of operations could be adversely affected.
If we are not able to maintain secure access to educators, our financial condition and results of operations could be adversely affected.
Our ability to successfully increase new business in the educator market is largely dependent on our ability to effectively access educators either in their school buildings or through other approaches. While this is especially true for the sale of 403(b) tax-qualified retirement products via payroll deduction and worksite direct sales, any significant decrease in access, either through fewer payroll slots, increased security measures, impacts of state or federal level pension reform initiatives, requirements of national and state Do Not Call registries, or for other reasons, could adversely affect the sale of all lines of business and require us to change our traditional approach to worksite marketing and promotion, as well as contact with potential customers. With the current IRS regulations regarding Section 403(b) arrangements, including retirement products, our ability to maintain and increase our share of the 403(b) market, and the access it gives for other product lines, will depend on our ability to successfully compete in this market. Some school districts and benefit consultants have placed emphasis on the relative financial strength ratings of competing companies, as well as low cost product and distribution approaches, which may put us at a competitive disadvantage relative to other more highly-rated insurance companies.
Our ability to maintain and obtain product and corporate endorsements from, and/or marketing agreements with, local, state and national education-related associations is important to our marketing strategy. In addition to teacher organizations, we have established relationships with various other educator, principal, school administrator and school business official groups. These contacts and endorsements help to establish our brand name and presence in the educational community and to enhance access to educators.
Operational Risks
A large-scale pandemic, the occurrence of terrorism or military actions may have an adverse effect on our business.
A large-scale pandemic, the occurrence of terrorism or military and other actions, may result in loss of life, property damage, and disruptions to commerce and reduced economic activity. Some of the assets in our investment portfolio may be adversely affected by declines in the equity markets, changes in interest rates, reduced liquidity and economic activity caused by a large-scale pandemic. Additionally, a large-scale pandemic or terrorist act could have a material effect on sales, liquidity and operating results.
The effects of a global pandemic on the U.S. economy, our customers, our agents, our employees, our investments and our communities, as well as any preventative or protective actions that we, our employees and agency force, our third-party service providers and suppliers, or governments may take to mitigate the impact of a global pandemic could have an adverse effect on our ability to conduct business and on our financial condition and results of operations. Impacts to our business have been and could continue to be widespread and may result in the following:
•employees contracting effects from a global pandemic;
•increased competition in hiring and retaining employees and agents;
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•sustained lack of access to schools and educators that could materially impact our sales and premium volumes;
•public school systems facing budget constraints due to the economic impacts of the pandemic that could result in educator layoffs;
•unprecedented volatility in financial markets that could materially affect our investment portfolio valuations and returns as well as our ability to generate targeted spreads on indexed products;
•regulatory mandates and/or legislative changes, including premium grace periods and premium credits;
•changes in frequency and/or severity of claims;
•supply chain interruptions resulting in cost increases, including availability of services and materials;
•increased credit risk;
•business disruption for insurance agents who market and sell our insurance products; and,
•business disruptions to third parties at which we outsource certain business functions to or on which we rely for technology.
The full extent to which pandemics could affect the global economy, the financial markets and our business, our financial condition and our results of operations will depend on future developments and factors that cannot be predicted.
Climate change may adversely affect our financial position, results of operations and cash flows.
Climate change presents risk to us and there are concerns that the increased frequency and severity of weather-related catastrophes and other losses is indicative of changing weather patterns, whether as a result of climate-warming trends (global climate change) caused by human activities or otherwise, which could cause such events to persist. Increased weather-related catastrophes could lead to higher overall losses, which we may not be able to recoup, particularly in a highly regulated and competitive environment, and higher reinsurance costs. Certain catastrophe models assume an increase in frequency and severity of certain weather or other events, which could result in a disproportionate impact on insurers with certain geographic concentrations of risk. This could also likely increase the risks of writing property insurance in coastal areas or areas susceptible to wildfires or flooding, particularly in jurisdictions that restrict pricing and underwriting flexibility. The threat of rising sea levels or other catastrophe losses as a result of global climate change may also cause property values in coastal or such other communities to decrease, reducing the total amount of insurance coverage that is required.
In addition, global climate change could have an impact on our fixed maturity securities and limited partnership portfolios, resulting in realized and unrealized losses in future periods that could have a material adverse effect on our financial position, results of operations and cash flows. It is not possible to foresee which, if any, assets, industries or markets may be materially and adversely affected, nor is it possible to foresee the magnitude of such effect. Further, it is also possible that the legal, regulatory and social responses to climate change could have an adverse effect on our financial condition, results of operations and cash flows.
Data security breaches or denial of service on our websites could have an adverse effect on our business and reputation.
Unauthorized access to and unintentional dissemination of our confidential, highly-sensitive customer, employee or company data or other breaches of data security in our facilities, networks or databases, or those of our agents or third-party vendors - including information technology and software vendors, could result in loss or theft of assets or sensitive information, data corruption or operational disruption that may expose us to liability and/or regulatory action and may have an adverse impact on our customers, employees, investors, reputation and business. In addition, any compromise of the security of company data or prolonged denial of service on our websites could harm our business and reputation. Additionally, we recognize the increased external threats of data breaches in the marketplace resulting in non-public data of customers becoming increasingly available in the public domain.
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Successful execution of our business growth strategy is dependent on effective implementation of new or enhanced technology systems and applications.
Our ability to effectively execute our business growth strategy and leverage potential economies of scale is dependent on our ability to provide the requisite technology components for that strategy. While we have effectively upgraded our infrastructure technologies with improvements in our data center, a new communications platform and enhancements to our disaster recovery capabilities, our ability to replace or supplement dated, monolithic legacy business systems — such as our Life, Retirement and Property & Casualty policy administrative systems — with more flexible, maintainable, and customer accessible solutions will be necessary to achieve our plans. The inherent difficulty in replacing and/or modernizing these older technologies, coupled with our limited experience in these endeavors, presents an increased risk of failing to deliver these technology solutions in a cost effective and timely manner. Our scale will require us to develop innovative solutions to address these challenges, including consideration of "software as a service" arrangements and other third-party based information technology capabilities. More modern approaches to software development and utilization of third-party vendors can augment our internal capacity for these implementations, but may not adequately reduce the operational risks of timely and cost effective delivery.
Loss of key vendor relationships could affect our operations.
We increasingly rely on services and products provided by a number of vendors in the U.S. and abroad. These include, for example, vendors of computer hardware and software, including on-demand software, and vendors of services such as investment management advisement, information technology services — such as those associated with the Life, Retirement and Property & Casualty policy administrative systems — and delivery services for customer policy-level communications. In the event that one or more of our vendors suffers a bankruptcy or otherwise becomes unable to continue to provide products or services, we may suffer operational difficulties and financial losses.
Our ability to attract, develop, engage, and retain top talent, maintain optimal staffing levels, and foster/sustain a highly inclusive and engaging culture is critical to our success.
Competition from within the insurance industry and from other industries, including the technology sector, for qualified employees with highly specialized knowledge in areas such as underwriting, data and analytics, technology and e-commerce, has often been intense and we have experienced increased competition in hiring and retaining employees.
Factors that affect our ability to attract and retain such employees include:
•competitive total rewards; including compensation and benefits;
•robust training and development programs;
•reputation as a successful business with a culture of fair hiring, and of training and promoting qualified employees; and,
•recognition and responsiveness to changing trends (i.e., remote/hybrid work arrangements) and other circumstances that affect employees.
The unexpected loss of key personnel could have a material adverse impact on our business because of the loss of their skills, knowledge of our products and offerings and years of industry experience and, in some cases, the difficulty of promptly finding qualified replacement personnel. The risks to attracting and retaining the necessary talent may be exacerbated by recent labor constraints and inflationary pressures on employee wages and benefits.
Financial Strength, Credit and Counterparty Risks
Losses due to defaults by others could reduce our profitability or negatively affect the value of our investments.
Third-party debtors may not pay or perform their obligations. These parties may include the issuers whose securities we hold, customers, reinsurers, borrowers under mortgage loans, trading counterparties, derivative counterparties, clearing agents, exchanges, clearing houses and other financial intermediaries. These parties
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may default on their obligations to us due to bankruptcy, lack of liquidity, downturns in the economy or real estate values, operational failure or other reasons.
During or following an economic downturn, our municipal bond portfolio could be subject to a higher risk of default or impairment due to declining municipal tax bases and revenue. States are currently barred from seeking protection in federal bankruptcy court. However, federal legislation could possibly be enacted to allow states to declare bankruptcy in connection with deficit reductions or mounting unfunded pension liabilities, which could adversely impact the value of our municipal bond portfolio.
The default of a major market participant could disrupt the securities markets or clearance and settlement systems in the U.S. or abroad. A failure of a major market participant could cause some clearance and settlement systems to assess members of that system, including our broker-dealer and Registered Investment Adviser regulatory entities, or could lead to a chain of defaults that could adversely affect us. A default of a major market participant could disrupt various markets, which could in turn cause market declines or volatility and negatively impact our financial condition and results of operations.
Uncollectible reinsurance, as well as reinsurance availability and pricing, can have a material adverse effect on our business volume and profitability.
Reinsurance is a contract by which one insurer, called a reinsurer, agrees to cover a portion of the losses incurred by a second insurer in the event a claim is made under a policy issued by the second insurer. Although a reinsurer is liable to our insurance subsidiaries according to the terms of the reinsurance policy, the insurance subsidiaries remain primarily liable as the direct insurers on all risks reinsured. As a result, reinsurance does not eliminate the obligation of our insurance subsidiaries to pay all claims, and each insurance subsidiary is subject to the risk that one or more of its reinsurers will be unable or unwilling to honor its obligations.
Although we limit participation in our reinsurance programs to reinsurers with high financial strength ratings and also limit the amount of coverage from each reinsurer, our insurance subsidiaries cannot guarantee that their reinsurers will pay in a timely fashion, if at all. Reinsurers may become financially unsound by the time that they are called upon to pay amounts due, which may not occur for many years.
Additionally, the availability and cost of reinsurance are subject to prevailing market conditions beyond our control. For example, significant losses from hurricanes or terrorist attacks, an increase in capital requirements, or a future lapse of the provisions of the Terrorism Risk Insurance Act could have a significant adverse effect on the reinsurance market.
If one of our insurance subsidiaries is unable to obtain adequate reinsurance at reasonable rates, that insurance subsidiary would have to increase its risk exposure and/or reduce the level of its underwriting commitments, which could have a material adverse effect upon the business volume and profitability of the subsidiary. Alternatively, the insurance subsidiary could elect to pay the higher than reasonable rates for reinsurance coverage, which could have a material adverse effect upon its profitability until policy premium rates could be raised, in some cases subject to approval by state regulators, to incorporate this additional cost.
We are subject to the credit risk of our counterparties, including reinsurers who reinsure business from our insurance companies.
Our insurance subsidiaries may cede certain risks to third-party insurance companies through reinsurance. HMLIC entered into a reinsurance agreement with RGA to effectuate the reinsurance of a block of in force fixed and variable annuities on a coinsurance and modified coinsurance basis. The variable portion of the reinsured annuities is reinsured on a modified coinsurance basis and assets supporting the variable account liabilities are still held in separate accounts. Because the reinsurance agreement covers a large volume of our in force annuity business, the transaction exposes us to a concentration of credit risk with respect to this counterparty. RGA's financial obligations for the general account liabilities of the reinsured annuity contracts are secured by its assets placed in a comfort trust for our sole use and benefit. Upon RGA's material breach of the reinsurance agreement, deterioration of its risk-based capital ratio to a certain level, or certain other events, we may recapture the reinsured business. However, in the event of RGA's insolvency, our right to use the assets in the trust account may be delayed. Also, if at the time of its insolvency the comfort trust account is not funded at a level to fully discharge all its obligations, our claims to the extent not covered by the assets in the comfort trust would be those of a general creditor.
Horace Mann Educators Corporation Annual Report on Form 10-K 31
Any downgrade in or adverse change in outlook for our claims-paying ratings, financial strength ratings or credit ratings could adversely affect our financial condition and results of operations.
Claims-paying ratings and financial strength ratings have become an increasingly important factor in establishing the competitive position of insurance companies. In the evolving 403(b) retirement market, school districts and benefit consultants have placed an emphasis on the relative financial strength ratings of competing companies. Each rating agency reviews its ratings periodically and from time to time may modify its rating criteria including, among other factors, its expectations regarding capital adequacy, profitability and revenue growth. A downgrade in the ratings or adverse change in the ratings outlook of any of our insurance subsidiaries by a major rating agency could result in substantial loss of business for that subsidiary if school districts, policyholders or independent agents move their business to other companies having higher claims-paying ratings and financial strength ratings than we have. This loss of business could have a material adverse effect on the results of operations and financial condition of that subsidiary.
A downgrade of our debt rating also could adversely affect our cost and flexibility of borrowing, which could have an adverse effect on our liquidity, financial condition and results of operations.
Increases in interest rates, or volatility in the U.S. financial markets could impede access to, or increase the cost of, financing our operations.
Recent increases in interest rates have increased our cost of borrowing and volatility in U.S. financial markets could impact our access to, or further increase the cost of, financing. Past disruptions in the U.S. credit and equity markets made it more difficult for many businesses to obtain financing on acceptable terms. These conditions tended to increase the cost of borrowing and if they recur, our cost of borrowing could increase and it may be more difficult to obtain financing for our operations.
An inability to access Federal Home Loan Bank of Chicago (FHLB) funding could adversely affect our results of operations.
Any changes in requirements to retain membership in the FHLB, or changes in regulation, could impact our eligibility for continued FHLB membership or our FHLB funding capacity. Any event that adversely affects amounts received from FHLB could have an adverse effect on our results of operations. See Part II - Item 7, Financing Activities of this Annual Report on Form 10-K for more information about FHLB activities.
Regulatory and Legal Risks
The results of U.S. Presidential and Congressional elections may create significant changes in tax rates, laws or regulations which could adversely impact our financial results.
With the change in administration, there are initiatives at the federal level to reverse the corporate tax cuts in the favorable Tax Cuts and Jobs Act of 2017 (TCJA), increasing the federal corporate income tax from the current rate of 21%. Any future legislative action could increase our costs, the impact of which could be significant. We are unable to predict the outcome or effects of any of these potential actions or any other legislative or regulatory proposals as they relate to our businesses. For example, any proposals to make changes related to U.S. tax law, such as those involving a reduction or elimination of the tax advantages of retirement and life products as noted in Part I - Item 1A – Risk Factors, Risks Related to Life & Retirement Segments of this Annual Report on Form 10-K, may have a material adverse effect on our future business, financial condition, results of operations, and growth prospects.
The insurance industry is highly regulated.
We are subject to extensive regulation and supervision in the jurisdictions in which we do business. Each jurisdiction has a unique and complex set of laws and regulations. Furthermore, certain federal laws impose additional requirements on businesses, including insurers. Regulation generally is designed to protect the interests of policyholders, as opposed to stockholders and non-policyholder creditors. Such regulations, among other things, impose restrictions on the amount and type of investments our insurance subsidiaries may hold. Certain states also regulate the rates insurers may charge for certain property and casualty products. Legislation and voter initiatives have expanded, in some instances, the states' regulation of rates and have increased data reporting requirements. Consumer-related pressures to roll back rates, even if not enacted by legislation or upheld upon judicial appeal, may affect our ability to obtain timely rate increases or operate at desired levels of
32 Annual Report on Form 10-K Horace Mann Educators Corporation
profitability. Changes in insurance regulations, including those affecting the ability of our insurance subsidiaries to distribute cash to us and those affecting the ability of our insurance subsidiaries to write profitable property and casualty insurance policies in one or more states, may adversely affect the financial condition and results of operations of the insurance subsidiaries. In addition, consumer privacy requirements may increase our cost of processing business. Our ability to comply with laws and regulations, at a reasonable cost, and to obtain necessary regulatory action in a timely manner, is and will continue to be critical to our success.
The NAIC has adopted a system of assessing minimum capital adequacy that is applicable to our insurance subsidiaries. This system, known as risk-based capital, is used to identify companies that may merit further regulatory action by analyzing the adequacy of the insurer's surplus in relation to statutory requirements. Our insurance subsidiaries could be adversely affected by regulations that change statutory surplus and risk-based capital requirements. Insurance companies write business based, in part, upon guidelines including capital ratios considered by the NAIC and various rating agencies. Some of these ratios include risk-based capital ratios for property and casualty insurance companies, supplemental insurance companies and life insurance companies, as well as a ratio of premiums to surplus for property and casualty insurance companies. Risk-based capital ratios measure an insurer's capital adequacy and consider various risks such as underwriting, investment, credit, asset concentration and interest rate. If our insurance subsidiaries cannot maintain profitability in the future or if significant investment valuation losses are incurred, they may be required to draw on their surplus, thereby reducing capital adequacy, in order to pay dividends to us to enable us to meet our financial obligations. As their surplus is reduced by the payment of dividends, continuing losses or both, our insurance subsidiaries' ability to write business and maintain acceptable financial strength ratings could also be reduced. This could have a material adverse effect upon the business volume and profitability of the insurance subsidiaries as well as result in increased regulatory scrutiny or action by state regulatory authorities.
Because state legislatures remain concerned about the availability and affordability of property and casualty insurance and the protection of policyholders, our insurance subsidiaries expect that they will continue to face efforts by those legislatures to expand regulations to address these concerns. Resulting new legislation could adversely affect the financial condition and results of operations of our insurance subsidiaries.
In the event of insolvency, liquidation or other reorganization of any of our insurance subsidiaries, our creditors and stockholders would have no right to proceed against any such insurance subsidiary or cause the liquidation or bankruptcy of any such insurance subsidiary under federal or state bankruptcy laws. The insurance laws of the domiciliary state would govern such proceedings and the relevant insurance commissioner would act as liquidator or rehabilitator for the insurance subsidiary. Creditors and policyholders of any such insurance subsidiary would be entitled to full payment from the assets of the insurance subsidiary before we, as a stockholder, would be entitled to receive any distribution.
The financial position of our insurance subsidiaries also may be affected by court decisions that expand insurance coverage beyond the intention of the insurer at the time it originally issued an insurance policy.
Dodd-Frank created FIO within the U.S. Department of the Treasury. FIO studies the current insurance regulatory system and is charged with monitoring and providing specific reports on various aspects of the insurance industry. However, FIO does not have general supervisory or regulatory authority over the business of insurance. FIO has suggested an expanded federal role in some circumstances. Additional regulations could adversely affect the efficiency and effectiveness of business processes, financial condition and results of operations of us, insurers of similar size and/or the insurance industry as a whole.
Statutory and regulatory developments could adversely impact our business by increasing costs or making our business less profitable.
The costs of running our business and its profitability could be adversely impacted by laws, rules and regulations that affect the business and financial communities, including changes to the interpretation or enforcement of laws governing standards of care applicable to broker-dealers and investment advisors. New laws, rules and regulations, or changes to the interpretation or enforcement of existing laws, rules or regulations, could also result in limitations on the products and services we offer or plan to offer to clients, modifications to our current or future business practices, compressed margins, increased capital requirements, and additional costs. The DOL recently adopted its final rule regarding ERISA fiduciary investment advice, which focuses on, among other things, the fiduciary status of rollover recommendations made by financial professionals to retirement investors. We expect that these laws, regulations and proposals could negatively impact our business, including by increasing our legal, compliance and information technology costs, and potentially other costs, including greater
Horace Mann Educators Corporation Annual Report on Form 10-K 33
risks of client lawsuits and enforcement activity by regulators. These changes may also affect the products and services we choose to offer to clients, as well as the compensation that we and our financial professionals receive in connection with such products and services, which could adversely impact our ability to recruit and retain key personnel.
It is also unclear how and whether other regulators, such as other state securities and insurance regulators may respond to, or enforce elements of, these new laws and regulations, or develop their own similar laws and regulations. The impacts, degree and timing of the effect of these laws and regulations on our business cannot now be anticipated or planned for, and may have further adverse impacts on our products and services, and the results of our operations.
Further, the Dodd-Frank Act enacted wide-ranging changes in the supervision and regulation of the financial industry providing greater oversight of financial industry participants, enhanced public company corporate governance practices and executive compensation disclosures, and greater protections to individual consumers and investors. Certain elements of the Dodd-Frank Act remain subject to implementing regulations that are yet to be adopted by the applicable regulatory agencies. Compliance with adopted regulations could affect the products and services we choose to offer and would likely result in increased compliance costs.
Our business costs and profitability may be adversely impacted by current and future rule making and enforcement activity by the various federal, state and other regulatory organizations to which we are subject.
Litigation may harm our financial strength or reduce our profitability.
Companies in the insurance industry have been subject to substantial litigation resulting from claims, disputes and other matters. Most recently, they have faced expensive claims, including class action lawsuits, alleging, among other things, improper sales practices and improper claims settlement procedures. Negotiated settlements of certain such actions have had a material adverse effect on many insurance companies. The resolution of similar future claims against any of our insurance subsidiaries, including the potential adverse effect on our reputation and charges against the earnings of our insurance subsidiaries as a result of legal defense costs, a settlement agreement or an adverse finding or findings against our insurance subsidiaries in such a claim, could have a material adverse effect on the financial condition and results of operations of our insurance subsidiaries.
Events, including those external to our operations, could damage our reputation.
There are many events which may harm our reputation, including, but not limited to, those discussed in this Item 1A regarding regulatory investigations, legal proceedings, and cyber or other information security incidents. Any negative public perception, founded or otherwise, can be widely and rapidly shared over social media or other means, and could cause damage to our reputation. Damage to our reputation could reduce demand for our insurance products, reduce our ability to recruit and retain employees, or lead to greater regulatory scrutiny of our operations.
As an insurance company, we are paid to accept certain risks. Those who conduct our business, including executive officers and members of management, employees and independent agents, do so in part by making decisions that involve exposing us to risk. These include decisions such as maintaining effective underwriting and pricing discipline, maintaining effective claims management and customer service performance, managing our investment portfolio, delivering effective technology solutions, complying with established sales practices, executing our capital management strategy, exiting a line of business and/or pursuing strategic growth initiatives, and other decisions. Although we employ controls and procedures designed to monitor business decisions and prevent us from taking excessive risks or unintentionally failing to comply with internal policies and practices, there can be no assurance that these controls and procedures will be effective. If our employees and independent agents take excessive risks and/or fail to comply with internal policies and practices, the impact of those events may damage our market position and reputation.
Individual states may impose additional cybersecurity regulations, increasing the complexity of compliance.
Our businesses must comply with regulations to control the privacy of customer, employee and third party data. State and federal regulations regarding data privacy, including the California Consumer Privacy Act, are becoming increasingly more onerous. A misuse or mishandling of confidential or proprietary information could result in legal liability, regulatory action and reputational harm. Third parties, including third party administrators
34 Annual Report on Form 10-K Horace Mann Educators Corporation
and cloud-based systems, are also subject to cyber-breaches of confidential information, along with the other risks outlined above, any one of which may result in us incurring substantial remediation costs and other negative consequences, including a material adverse effect on our business, reputation, financial condition, results of operations and liquidity.
ITEM 1B. I Unresolved Staff Comments
None.
ITEM 2. I Properties
As of December 31, 2022, we owned four buildings located in Springfield, Ill. comprised of our headquarters of approximately 225,000 square feet, a warehouse of approximately 11,000 square feet and two other buildings of approximately 39,000 square feet in aggregate. In addition, we lease office space in suburban Dallas (approximately 114,000 of rentable square feet), suburban Raleigh, N.C., Cherry Hill, N.J and Madison, Wis. which are utilized by one or more of all four reporting segments, depending on the location. For more information regarding our reporting segments, see Part I - Item 1, Reporting Segments of this Annual Report on Form 10-K. We believe our properties and facilities are suitable and adequate for current operations.
ITEM 3. I Legal Proceedings
At the time of issuance of this Annual Report on Form 10-K, we do not have pending litigation from which there is a reasonable possibility of material loss.
ITEM 4. I Mine Safety Disclosures
Not applicable.
Horace Mann Educators Corporation Annual Report on Form 10-K 35
PART II
ITEM 5. I Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information and Dividends
Our common stock is traded on the NYSE under the symbol HMN. The following table provides the high and low bid information of our common stock on the NYSE Composite Tape and the cash dividends paid per share of common stock during the periods indicated.
Market Price Dividends
Fiscal Period High Low Paid
The payment of dividends in the future is subject to the discretion of the Board and will depend upon general business conditions, legal restrictions and other factors the Board may deem to be relevant. Additional information is contained in Part I - Item 1, Cash Flow and in Part II - Item 8, Note 14 of the Consolidated Financial Statements in this Annual Report on Form 10-K.
36 Annual Report on Form 10-K Horace Mann Educators Corporation
Shareholder Return Performance Graph
The graph below sets forth the total five-year shareholder return on our common stock. The graph assumes a $100 investment as of December 31, 2017. The S&P 500 Index and the S&P 500 Insurance Index assume an annual reinvestment of dividends in calculating total return. We assume reinvestment of quarterly dividends when paid.
Comparison of Cumulative Five Year Total Return to Shareholders
Holders and Shares Issued
As of February 16, 2023, the number of holders of our common stock was approximately 50,000.
During 2022, no stock options were exercised for the issuance of our common stock.
For information required by Item 201(d) of Regulation S-K regarding the equity compensation plan, see Part III - Item 12, of this Annual Report on Form 10-K.
Horace Mann Educators Corporation Annual Report on Form 10-K 37
Issuer Purchases of Equity Securities
On May 25, 2022, our Board of Directors authorized a share repurchase program allowing repurchases of up to $50 million (i.e., the 2022 Program) to begin following the completion of the current $50 million repurchase plan which was authorized on September 30, 2015 (i.e., the 2015 Program). Both Programs authorize the repurchase of our common shares in open market or privately negotiated transactions, from time to time, depending on market conditions. The Programs do not have expiration dates and may be limited or terminated at any time without notice. During the three months ended September 30, 2022, the 2015 Program was completed and we began repurchasing shares under the 2022 Program.
For the quarterly periods ended 2022 and 2021, we repurchased shares of our common stock under the Programs as follows:
Fourth Quarter — $ — — $41.3 million
ITEM 6. I [Reserved]
38 Annual Report on Form 10-K Horace Mann Educators Corporation
ITEM 7. I Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
($ 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 2022 Investor Supplement.
Increases or decreases in this MD&A that are not meaningful are marked "N.M.".
This MD&A covers the following:
Page
Introduction 39
Consolidated Financial Highlights 40
Consolidated Results of Operations 41
Application of Critical Accounting Estimates 45
Results of Operations by Segment 54
Property & Casualty 54
Life & Retirement 57
Supplemental & Group Benefits 60
Corporate & Other 61
Investment Results 61
Liquidity and Capital Resources 64
Future Adoption of New Accounting Standards 69
Effects of Inflation and Changes in Interest Rates 70
Introduction
The purpose of our MD&A is to provide an understanding of our consolidated results of operations and financial condition and should be read in conjunction with the Consolidated Financial Statements and Notes thereto contained in Part II - Item 8 of this Annual Report on Form 10-K. Our MD&A generally discusses the results of operations for the year ended December 31, 2022 compared to the year ended December 31, 2021. For a discussion of the results of operations for the year ended December 31, 2021 compared to the year ended December 31, 2020, please refer to Part II - Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the Securities and Exchange Commission (SEC) on February 25, 2022.
HMEC is an insurance holding company focused on helping America’s educators and others who serve the community achieve lifelong financial success. Through our subsidiaries, we market and underwrite individual and group insurance and financial solutions tailored to the needs of the educational community including:
•personal lines of property and casualty insurance, primarily auto and property coverages
•retirement products, primarily tax-qualified fixed and variable annuities
•life insurance, primarily traditional term and whole life insurance products
Horace Mann Educators Corporation Annual Report on Form 10-K 39
•worksite direct insurance products, including cancer, heart, hospital, supplemental disability and accident
•employer-sponsored insurance products, primarily long-term disability and short-term disability
We market our products primarily to K-12 teachers, administrators and other employees of public schools and their families, whether they engage with Horace Mann directly or through their district/employer.
Effective January 1, 2022, we acquired all the equity interests in Madison National Life Insurance Company, Inc., an insurance company organized under the laws of the State of Wisconsin (Madison National), for $172.3 million which added employer-sponsored products. The Seller has a potential earn-out of up to $12.5 million payable in cash, if specified financial targets are achieved by the end of 2023. As a result of the acquisition, Madison National became a wholly owned subsidiary of HMEC.
We conduct and manage our business in four reporting segments. The three reporting segments representing the major lines of business, are: (1) Property & Casualty (primarily personal lines of auto and property insurance products), (2) Life & Retirement (primarily tax-qualified fixed and variable annuities as well as life insurance products), and (3) Supplemental & Group Benefits (primarily cancer, heart, hospital, supplemental disability, accident, short-term and long-term group disability, and group term life coverages). We do not allocate the impact of corporate-level transactions to these reporting segments, consistent with the basis for management's evaluation of the results of those segments, but classify those items in the fourth reporting segment, Corporate & Other. In addition to ongoing transactions such as corporate debt service, net investment gains (losses) and certain public company expenses, such items also have included corporate debt retirement costs, when applicable. See Part II - Item 8, Note 19 of the Consolidated Financial Statements in this Annual Report on Form 10-K for more information.
Consolidated Financial Highlights
Per diluted share:
Net investment losses, after tax (1.06) (0.20) N.M.
Net income return on equity - last twelve months (0.2) % 8.0 % -8.2 pts
For 2022, net income decreased $145.4 million, primarily due to the impact of higher net investment losses mainly from changes in fair values of equity securities and realized losses on disposition of fixed maturity securities, higher inflation and other factors driving auto loss severity, impacts of equity market declines on deferred policy acquisition costs (DAC) unlocking, asset-based fees and returns on limited partnership interests, as well as increases in interest credited and interest expense due to the rising interest rate environment.
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Consolidated Results of Operations
Net premiums and contract charges earned $ 1,029.0 $ 889.6 15.7 %
Net investment losses (56.5) (11.0) N.M.
Benefits, claims and settlement expenses 761.6 617.7 23.3 %
DAC unlocking and amortization expense 98.7 94.7 4.2 %
Intangible asset amortization expense 16.8 13.0 29.2 %
Other expense - goodwill and intangible asset impairments 4.8 — N.M.
Income tax expense (benefit) (9.3) 32.1 -129.0 %
Net Premiums and Contract Charges Earned
For 2022, net premiums and contract charges earned increased $139.4 million, primarily due to the addition of the employer-sponsored business partially offset by lower net premiums earned in Property & Casualty.
Net Investment Income
Total net investment income in 2022 decreased $21.6 million, primarily attributable to returns below our historical average in our portfolio of limited partnership interests. Yields have risen for recent investments due to the rising interest rate environment. The annualized investment yield on the portfolio excluding limited partnership interests* was as follows:
Year Ended December 31,
During 2022, we 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 for the core portfolio. We also funded commercial mortgage loan funds and limited partnership interests in line with our intent to increase our allocation to this portion of our portfolio to increase yields while balancing protection and risk.
Horace Mann Educators Corporation Annual Report on Form 10-K 41
Net Investment Losses
For 2022, net investment losses increased $45.5 million mainly from changes in fair values of equity securities and realized losses on disposition of fixed maturity securities. The break down of net investment gains (losses) by transaction type is shown in the following table:
($ in millions) Year Ended December 31,
Credit loss and intent-to-sell impairments $ (10.7) $ (10.4)
Sales and other, net (17.8) 4.3
Change in fair value - equity securities (33.2) (2.3)
Change in fair value and losses realized on settlements - derivatives 5.2 (2.6)
Net investment losses $ (56.5) $ (11.0)
From time to time, we may sell fixed maturity securities subsequent to the reporting date that were considered temporarily impaired at the reporting date. Generally, such sales are due to issuer specific events occurring subsequent to the reporting date that result in a change in our intent to hold a fixed maturity security.
Other Income
For 2022, other income decreased $19.5 million, primarily due to an indemnification agreement associated with the employer-sponsored business.
Benefits, Claims and Settlement Expenses
For 2022, benefits, claims and settlement expenses increased $143.9 million, primarily due to an increase in auto losses and the addition of the employer-sponsored business.
Interest Credited
For 2022, interest credited increased $13.2 million, driven primarily by the impact of rising interest rates associated with advances received under 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 annuity block, was 2.5% for 2022 and 2.4% for 2021.
Operating Expenses
For 2022, operating expenses increased $64.4 million, primarily due to the addition of the employer-sponsored business.
DAC Unlocking and Amortization Expense
For 2022, DAC unlocking and amortization expense increased $4.0 million, primarily due to volatility in financial markets leading to unfavorable DAC unlocking in the Life & Retirement segment, partially offset by reduced amortization expense in the Property & Casualty segment.
Intangible Asset Amortization Expense
For 2022, intangible asset amortization expense increased $3.8 million, primarily due to the acquisition of Madison National.
Interest Expense
For 2022, interest expense increased $5.5 million, primarily due to an increase in floating interest rates on the Revolving Credit Facility.
Other Expense - Goodwill and Intangible Asset Impairments
For 2022, other expense represents goodwill and intangible asset impairment charges with regards to Benefit Consultants Group, Inc. (BCG), a reporting unit within the Retirement operating segment. See Part II - Item 8, Note 7 of the Consolidated Financial Statements in this Annual Report on Form 10-K for further information.
Income Tax Expense (Benefit)
The effective income tax rate on our pretax income (loss), including net investment gains (losses) was 78.2% and 18.4% for the years ended December 31, 2022 and 2021, respectively. Income from investments in tax-
42 Annual Report on Form 10-K Horace Mann Educators Corporation
advantaged securities reduced the effective income tax rates by 54.6 and 3.5 percentage points for 2022 and 2021, respectively. The goodwill and intangible asset impairment charges in the Life & Retirement segment decreased the effective income tax rate by 38.7 percentage points as of December 31, 2022.
In August 2022, the Inflation Reduction Act of 2022 (IRA) was passed by the U.S. Congress and signed into law by the Executive Branch. The IRA includes a new Federal alternative minimum tax (AMT), effective in 2023, that is based on the adjusted financial statement income (AFSI) set forth on the applicable financial statement (AFS) of an applicable corporation. A corporation is an applicable corporation if its rolling average pre-tax AFSI over three prior years (starting with years 2020 - 2022) is greater than $1.0 billion. For a group of related entities, the $1.0 billion threshold is determined on a group basis, and the group’s AFSI is generally treated as the AFSI for all separate taxpayers in the group. Except under limited circumstances, once a corporation is an applicable corporation, it is an applicable corporation in all future years.
An applicable corporation is not automatically subject to an AMT liability. The corporation’s tentative AMT liability is equal to 15.0% of its adjusted AFSI, and AMT is payable to the extent the tentative AMT liability exceeds regular corporate income tax. However, any AMT paid would be indefinitely available as a credit carryover that could reduce future regular tax in excess of AMT.
HMEC and its controlled group of corporations have determined that it likely will not be an applicable corporation in 2023. In making such determination, the group has made certain interpretations of, and assumptions regarding, the AMT provisions of the IRA. The U.S. Treasury Department is expected to issue guidance throughout 2023 that may differ from the group’s interpretations and assumptions and that could alter the group’s determination.
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.
The tax effects of legislation enacted in 2020 due to the Coronavirus pandemic were reflected in our income tax expense calculations as of December 31, 2020. Total income tax expense for the twelve months ended December 31, 2020, included a benefit of $2.8 million (that reduced the effective income tax rate by 1.7 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%.
As of December 31, 2022, our federal income tax returns for years prior to 2019 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 11 of the Consolidated Financial Statements in this Annual Report on Form 10-K for further information.
Outlook for 2023
The following discussion provides outlook information for our results of operations and capital position.
At the time of issuance of this Annual Report on Form 10-K, we estimate that 2023 full year net income will be within a range of $2.00 to $2.30 per diluted share, generating a core return on equity* near 6%.
Property & Casualty Segment
In 2023, net income for Property & Casualty is anticipated to be in the range of $5 million to $10 million. The primary factors in our outlook include:
•Catastrophe loss assumption of approximately 10 points on the combined ratio, in line with the 10-year average and consistent with historical frequencies and current severities applied to modeled exposures
•Property combined ratio near 100%, anticipating rate actions of 12% to 15% over the next four quarters, reflecting inflation and current loss trends, accompanied by ‘inflation guard’ increases
•Auto combined ratio of 106% to 107%, anticipating auto rates to increase by 18% to 20% over the next four quarters, supplemented by non-rate underwriting actions
Horace Mann Educators Corporation Annual Report on Form 10-K 43
•Net investment income over 30% higher in this segment than in 2022, with limited partnership returns estimated near their 10-year average
Our longer-term Property & Casualty combined ratio target remains 95-96%.
Supplemental & Group Benefits Segment
In 2023, net income for Supplemental & Group Benefits is anticipated to be in the range of $40 million to $44 million. The primary factors in our outlook include:
•Anticipates claims utilization for supplemental and disability products returning to near pre-pandemic levels, leading to a segment benefit ratio closer to our longer-term target of 43%, including a benefit ratio of approximately 35% for worksite direct products and approximately 50% for employer-sponsored products
•Higher expenses reflecting investments in the infrastructure for this business as well as a higher allocation of corporate expenses to reflect the segment’s utilization of shared staff, distribution, and other resources.
Life & Retirement Segment
In 2023, net income for Life & Retirement is anticipated in the range of $67 million to $70 million. This guidance includes the adoption of LTDI effective January 1, 2023. The spread on the fixed annuity business is expected to be in the range of 220 to 230 basis points. Mortality is anticipated to remain within actuarial expectations and increase slightly from 2022.
Corporate & Other Segment
Corporate interest expense is expected to be in the range of $26 million to $27 million in 2023 due to rising interest rates.
Investments
For 2023, we expect total net investment income of between $434 million and $444 million, including approximately $104 million of accreted investment income on the deposit asset on reinsurance in Retirement. The expectation of full-year net investment income from the managed portfolio of between $330 million and $340 million reflects stronger returns from our commercial mortgage loan portfolio as well as the benefits of the rising rate environment over the past 12 months. Limited partnership returns are estimated near their 10-year average of 8.5%.
As described in Application of 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.
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Application of 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 set forth in Part II - Item 8 of this Annual Report on Form 10-K.
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
•Evaluation of credit loss impairments for fixed maturity securities
•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 expense reserves
•Valuation of liabilities for group benefits unpaid claims and claim expense reserves
•Valuation of certain investment contracts and policy reserves
•Valuation of long-duration contracts under the new accounting guidance in ASU 2018-12
•Valuation of assets acquired and liabilities assumed under purchase accounting
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 ICE Pricing Data, our investment managers and custodian bank to obtain fair value prices from independent third-party valuation service providers, broker quotes, model prices and matrix pricing. 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 speeds and default rates as well as the Bloomberg Spread Matrix, among others. Our fixed maturity securities portfolio is primarily publicly traded, which allows for a high percentage of the fixed maturity securities portfolio to be priced through pricing services. Approximately 88.6% of the fixed maturity securities portfolio, based on fair value, was priced through pricing services or index priced using observable inputs as of December 31, 2022.
The valuation of hard-to-value fixed maturity securities (generally 75 - 125 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 obtain non-binding price quotes from brokers. For those securities where the investment manager cannot obtain broker quotes, they will model the security, generally using estimated cash flows of the underlying collateral.
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Brokers' 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 speeds and default rates, 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 GAAP. 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 brokers to other third-party valuation sources for selected securities.
As of December 31, 2022, Level 3 invested assets comprised 7.8% 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 Credit Loss Impairments for Fixed Maturity Securities
For fixed maturity securities classified as available for sale, the difference between amortized cost, net of a credit loss allowance (i.e., amortized cost, net) and fair value, net of certain other items and deferred income taxes (as disclosed in Part II - Item 8, Note 3 of the Consolidated Financial Statements in this Annual Report on Form 10-K) is reported as a component of accumulated other comprehensive income (loss) (i.e., AOCI) on the Consolidated Balance Sheets and is not reflected in the operating results of any period until reclassified to net income upon the consummation of a transaction with an unrelated third party or when a credit loss allowance is recorded. We have a comprehensive portfolio monitoring process to evaluate fixed maturity securities (at the cusip/issuer level) on a quarterly basis that may require a credit loss allowance. These reviews, in conjunction with our investment managers’ quarterly credit reports and relevant factors such as (1) has the security missed any scheduled principal or interest payments in the current quarter; (2) has the security been downgraded to below investment grade by rating agencies or if the security was below investment grade at time of purchase, has the security been downgraded by two or more notches since acquisition; (3) has the security declined in value by more than 10% compared to the prior quarter; (4) has the market yield changed by more than 50 basis points; are all considered in the impairment assessment process.
For each fixed maturity security in an unrealized loss position, we assess whether management with the appropriate authority has made the decision to sell or whether it is more likely than not we will be required to sell the security before the anticipated recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes. If a security meets either of these criteria, any existing credit loss allowance would be written-off against the amortized cost basis of the asset along with any remaining unrealized losses, with the incremental losses recorded as a net investment loss.
If we have not made the decision to sell the fixed maturity security and it is not more likely than not we will be required to sell the fixed maturity security before the anticipated recovery of its amortized cost basis, we evaluate whether we expect to receive cash flows sufficient to recover the entire amortized cost basis of the security. We estimate the anticipated recovery value based on the best estimate of future cash flows considering past events, current conditions and reasonable and supportable forecasts. The estimated future cash flows are discounted at the security’s current effective rate and are compared to the amortized cost basis of the security. The determination of cash flow estimates is inherently subjective, and methodologies may vary depending on facts and circumstances specific to the security. Our investment managers will calculate the anticipated recovery value of the security by performing a discounted cash flow analysis based on the present value of future cash flows. The discount rate is generally the effective interest rate of the security at the time of purchase
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for fixed-rate securities. We will then review the assumptions/methodologies for reasonableness. That information generally includes, but is not limited to, the remaining payment terms of the security, prepayment speeds, the financial condition and future earnings potential of the issue or issuer, expected defaults, expected recoveries, the value of underlying collateral, origination vintage year, geographic concentration of underlying collateral, available reserves or escrows, current subordination levels, third-party guarantees and other credit enhancements. Other information, such as industry analyst reports and forecasts, sector credit ratings, financial condition of the bond insurer for insured fixed maturity securities, and other market data relevant to the realizability of contractual cash flows, may also be considered. The estimated fair value of collateral will be used to estimate the anticipated recovery value if we determine that the security is dependent on the liquidation of collateral for ultimate settlement.
If we do not expect to receive cash flows sufficient to recover the entire amortized cost basis of the fixed maturity security, a credit loss allowance is recorded as a net investment loss for the shortfall in expected cash flows; however, the amortized cost basis, net of the credit loss allowance, may not be lower than the fair value of the security. The portion of the unrealized loss related to factors other than credit remains classified in AOCI. If we determine that the fixed maturity security does not have sufficient cash flows or other information to estimate the anticipated recovery value for the security, we may conclude that the entire decline in fair value is deemed to be credit related and the loss is recognized as a net investment loss.
When a security is sold or otherwise disposed or the security is deemed uncollectible and written-off, we reverse amounts previously recognized in the credit loss allowance through net investment gains (losses). Recoveries after write-offs are recognized when received.
For additional detail on credit loss impairments, see Part II - Item 8, Note 3 of the Consolidated Financial Statements in this Annual Report on Form 10-K.
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 amount. Goodwill impairment is the amount by which a reporting unit’s carrying amount 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. As of December 31, 2022, our allocation of goodwill on a net basis by reporting segment was as follows: Property & Casualty; $9.5 million, Life & Retirement; $12.4 million, and Supplemental & Group Benefits; $32.4 million. Also, see Part II - Item 8, Notes 1 and 7 of the Consolidated Financial Statements in this Annual Report on Form 10-K.
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 amount. If an entity determines it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity performs a quantitative goodwill impairment test by comparing the fair value of a reporting unit to its carrying amount 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 its carrying amount. Subsequent goodwill assessments could result in impairment, particularly for each reporting unit with at-risk goodwill, due to the impact of volatile financial markets on earnings, discount rate assumptions, liquidity and market capitalization. For 2022, lower than anticipated BCG revenues triggered a
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requirement to evaluate the goodwill associated with the BCG reporting unit within the Retirement operating segment resulting in a write-down of a certain amount of goodwill in 2022. For 2021, there were no events or material changes in circumstances that indicated that an adverse material change in the fair value of our reporting units occurred. For 2020, lower than anticipated wealth management sales for BCG Securities, Inc. (BCGS) outside of the education markets triggered a requirement to evaluate the goodwill associated with the BCGS reporting unit within the Retirement operating segment resulting in a write-down of a certain amount of goodwill in 2020. See Part II - Item 8, Note 7 of the Consolidated Financial Statements in this Annual Report on Form 10-K for more information.
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 policy 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 $70.7 million as of December 31, 2022 and is being amortized by product based on the present value of future premiums to be received. We estimate that we will recognize VOBA amortization of $5.8 million in 2023, $5.4 million in 2024, $5.1 million in 2025, $4.7 million in 2026 and $4.4 million in 2027.
We account for the value of distribution acquired associated with the acquisition of NTA (NTA VODA) based on an actuarial estimate of the present value of future business to be written by the existing distribution channel. NTA VODA was $39.3 million as of December 31, 2022 and is being amortized on a straight-line basis. We estimate that we will recognize NTA VODA amortization of $2.9 million in each of the years 2023 through 2027, respectively.
VOBA is reviewed for recoverability from future income which is primarily comprised of future premiums, benefits to be paid and net investment income. 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, 2022.
NTA VODA is tested for recoverability whenever events or changes in circumstances indicate that its carrying amount 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 test results from our annual impairment assessment for NTA VODA at October 1, 2022 indicated there was no impairment.
The value of customer relationships intangible assets are being amortized based on the present value of future profits to be received for BCG and based on the present value of future premiums for Madison National. The test results from our annual impairment assessments for customer relationships at October 1, 2022 indicated there was an impairment for the BCG reporting unit within the Retirement operating segment.
See Part II - Item 8, Note 7 of the Consolidated Financial Statements in this Annual Report on Form 10-K 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 Annual Report on Form 10-K.
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 Life & Retirement, we amortize DAC utilizing a future financial market performance assumption of a gross 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
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future rate of return is reasonably likely to result in an estimated decrease in DAC amortization expense of approximately $2.5 million. The potential effect of a 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 $3.5 million. Although this evaluation reflects likely outcomes, it is possible an actual outcome may fall below or above these estimates. As of December 31, 2022, the ratio of DAC to the total annuity accumulated cash value was 4.1%.
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, 2022 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 between $0.1 million and $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.
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 & Casualty Unpaid Claims and Claim Expense Reserves
Underwriting results of Property & 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 & Casualty claims include provisions for payments to be made on reported claims (case reserves), incurred but not yet reported (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 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 8 of the Consolidated Financial Statements in this Annual Report on Form 10-K. Due to the nature of our personal lines 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, there is the potential of variability of the Property & Casualty loss reserves.
There are a number of assumptions involved in the determination of our Property & 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
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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 (auto liability coverages) and between $1.0 million and $3.0 million for short-tail liability related exposures (property and auto 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 expense reserves for Property & 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. As of December 31, 2022, 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.
Unfavorable prior years' reserve re-estimates decreased net income in 2022 by approximately $22.0 million pretax, primarily the result of unfavorable loss trends in auto for accident years 2021 and prior.
Valuation of Liabilities for Group Benefits Unpaid Claims and Claim Expense Reserves
Our Group Benefits has short-duration contracts that are generated from specialty health and group disability lines of business, and are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims, including losses incurred for which claims have not been reported. Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.
We maintain loss reserves for these lines of business to cover our estimated liability for unpaid losses and loss adjustment expenses, where material, (including legal, other fees, and costs not associated with specific claims but related to the claims payment function) for reported and unreported claims incurred as of the end of each accounting period. These loss reserves are based on actuarial assumptions. Many factors could affect these reserves, including economic and social conditions, frequency and severity of claims, medical trends resulting from the influences of underlying cost inflation, changes in utilization and demand for medical services, and changes in doctrines of legal liability and damage awards in litigation. Therefore, our reserves are necessarily based on estimates, assumptions and analysis of historical experience. Our results depend upon the variation between actual claims experience and the assumptions used in determining reserves and pricing products. Reserve assumptions and estimates require significant judgment and, therefore, are inherently uncertain. We cannot determine with precision the ultimate amounts that will be paid for actual claims or the timing of those payments. Our estimate of loss represents management's best estimate of our liability at the balance sheet date.
We believe that its liability for policy benefits and claims is reasonable and adequate to satisfy its ultimate liability. We primarily use our own loss development experience, but will also supplement that with data from outside actuaries, reinsurers and industry loss experience as warranted. To illustrate the impact that loss ratios
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have on our loss reserves and related expenses, each hypothetical 1.0% change in the loss ratio for the group disability business (i.e., the ratio of insurance benefits, claims and settlement expenses to earned group disability premiums) for the year ended December 31, 2022, would increase reserves (in the case of a higher ratio) or decrease reserves (in the case of a lower ratio) by approximately $0.7 million with a corresponding increase or decrease to Benefits, claims and settlement expenses in our Consolidated Statement of Operations and Comprehensive Income (Loss).
For the specialty health line of business, IBNR claims liabilities plus expected development on reported claims are calculated using standard actuarial methods and practices. The “primary” assumption in the determination of specialty health reserves is that historical claim development patterns are representative of future claim development patterns. Factors that may affect this assumption include changes in claim payment processing times and procedures, changes in time delay in submission of claims, and the incidence of unusually large claims. Liabilities for claims for specialty health coverages are computed using completion factors and expected net loss ratios derived from actual historical premium and claim data. The reserving analysis includes a review of claim processing statistical measures and large claim early notifications; the potential impacts of any changes in these factors are not material. We have business that is serviced by third-party administrators. From time to time, there are changes in the timing of claims processing due to any number of factors including, but not limited to, system conversions and staffing changes during the year. These changes are monitored by us and the effects of these changes are taken into consideration during the claim reserving process. While these calculations are based on standard methodologies, they are estimates based on historical patterns. To the extent that actual claim payment patterns differ from historical patterns, such estimated reserves may be redundant or inadequate. The effects of such deviations are evaluated by considering claim backlog statistics and reviewing the reasonableness of projected claim ratios. Other factors which may affect the accuracy of policy benefits and claim estimates include the proportion of large claims which may take longer to adjudicate, changes in billing patterns by providers and changes in claim management practices such as hospital bill audits. Since our analysis considers a variety of outcomes related to these factors, we do not believe that any reasonably likely change in these factors will have a material effect.
With regards to our group disability line of business, the two “primary” assumptions on which disability policy benefits and claims are based are: (i) morbidity levels; and (ii) recovery rates. If morbidity levels increase, for example due to an epidemic or a recessionary environment, we would increase reserves because there would be more new claims than expected. With regards to the assumed recovery rate, if disabled lives recover more quickly than anticipated then the existing claims reserves would be reduced; if less quickly, the existing claims reserves would be increased. Advancements in medical treatments could affect future recovery, termination, and mortality rates.
Our liabilities for unpaid claims and claim expense reserves for Group Benefits were as follows:
($ in millions) December 31, 2022
Case Reserves IBNR Reserves Total(1)
Specialty health $ — $ 17.0 $ 17.0
(1)These amounts are gross, before reduction for ceded reinsurance reserves.
Favorable prior years' reserve re-estimates increased pretax income in 2022 by approximately $11.1 million, primarily the result of favorable loss trends in specialty health and group disability for loss years 2021 and prior.
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.
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
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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 Annual Report on Form 10-K. 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.
Valuation of Long-Duration Contracts Under the New Accounting Guidance in ASU 2018-12
In August 2018, the FASB issued targeted improvements to the accounting and disclosure guidance for long-duration insurance contracts (i.e., ASU 2018-12). The guidance in ASU 2018-12 (ASU) significantly changes how insurers account for long-duration insurance contracts. The Company will adopt the ASU effective January 1, 2023, using the modified retrospective transition method and apply the guidance as of January 1, 2021 (and record transition adjustments as of January 1, 2021) in the Company’s 2023 consolidated financial statements.
Under ASU 2018-12, a liability for future policy benefits, which is the present value of estimated future policy benefits to be paid to or on behalf of policyholders and certain related expenses less the present value of estimated future net premiums to be collected from policyholders, is accrued as premium revenue is recognized. The liability was estimated using assumptions that include discount rate, mortality, lapses, and expenses. The discount rate assumption was sourced from Bloomberg and other assumptions were based on judgments that consider our historical experience, industry data, and other factors.
For traditional and limited-payment contracts, contracts were grouped into cohorts by contract type and issue year. The liability was adjusted for differences between actual and expected experience. We reviewed our historical and future cash flow assumptions and updated the net premium ratio used to calculate the liability each time the assumptions were changed. These updated cash flows were used to calculate the revised net premiums and net premium ratio, which was used to derive an updated liability for future policy benefits as of the transition date and subsequent periods, discounted at the original contract issuance discount rate. This amount was then compared to the carrying amount of the liability as of that same date, before the updating of cash flow assumptions, to determine the change in liability estimate.
For traditional and limited-payment contracts, a standard discount rate was used to remeasure the liabilities that is equivalent to market level yields for upper-medium-grade (low credit risk) fixed income instruments. The discount rate assumption will be updated quarterly and used to remeasure the liability at the reporting date, with the resulting change reflected in other comprehensive income. For liability cash flows that are projected beyond the duration of market-observable level yields for upper-medium-grade (low credit risk) fixed income instruments, we use the last market-observable level yield and use linear interpolation to determine yield assumptions for durations that do not have market-observable yields.
52 Annual Report on Form 10-K Horace Mann Educators Corporation
We estimated that the transition date impact from remeasuring the liability for future policy benefits (LFPB) should result in a decrease in accumulated other comprehensive income (AOCI) of $499.3 million. This is due primarily to updating the LFPB discount rate assumptions previously locked-in for reserves held at the transition date to rates determined by reference to the transition date market level yields for upper-medium-grade (low credit risk) fixed income instruments as of December 31, 2020. As of December 31, 2022, the inception to date increase in AOCI from the use of a current market rate is estimated to be in the range of $55 million to $65 million.
Based on the reserves as of the transition date, the potential effect of a decrease of 50 basis points in the discount rate would result in an increase to the liability for future policy benefits by approximately $166 million and the potential effect of an increase of 50 basis points in the discount rate would result in a decrease to the liability for future policy benefits by approximately $148 million.
See Part II – Item 8, Note 1 of the Consolidated Financial Statements in this Annual Report on Form 10-K for more information.
Valuation of Assets Acquired and Liabilities Assumed under Purchase Accounting
In accounting for the acquisition of Madison National Life Insurance Company, Inc. (Madison National), assets acquired and liabilities assumed are recognized based on estimated fair values as of the date of acquisition. The excess of the purchase price when compared to the fair value of the net tangible and identifiable intangible assets acquired is recognized as goodwill. A significant amount of judgment is involved in estimating the individual fair values of tangible assets, intangible assets, and other assets and liabilities. We used all available information to make these fair value determinations and engaged third-party consultants for valuation assistance. The fair value of assets and liabilities as of the acquisition date were estimated using a combination of approaches, including the income approach, which requires us to project future cash flows and apply an appropriate discount rate; the cost approach, which required estimates of replacement costs and depreciation and obsolescence estimates; and the market approach. The estimates used in determining fair values were based on assumptions believed to be reasonable but which are inherently uncertain. Accordingly, actual results may differ materially from the projected results used to determine fair value.
The value of customer relationships acquired intangible asset was valued based on the actuarial appraisal method net of VOBA. This represents expected future premiums arising from ongoing relationships and includes assumed growth in premium in the first projection year as well as all premiums in projection years two through ten. The valuation of Madison National's policy reserves represents the present value of expected future benefits and expenses associated with the policies, valued using the actuarial appraisal approach to project and discount the future cash flows to estimate fair value.
The valuation of the assets acquired and liabilities assumed of Madison National required management to make multiple judgments and assumptions. Assumptions included future policy and contract charges, premiums, morbidity and mortality, and persistency by product, as well as expenses, investment returns, growth rates and other factors. One of the most significant inputs in these calculations is the discount rate used to arrive at the present value of the net cash flows. Actual experience on the purchased business may vary from these projections and the recovery of the net assets recorded is dependent upon the future profitability of the related business.
Horace Mann Educators Corporation Annual Report on Form 10-K 53
Results of Operations by Segment
Consolidated financial results primarily reflect the results of Property & Casualty, Life & Retirement, and Supplemental & Group Benefits reporting segments as noted in the Introduction and Outlook for 2023 sections of this MD&A, as well as the Corporate & Other reporting segment. These segments are defined based on financial information management uses to evaluate performance and to determine the allocation of resources.
The determination of segment data is described in more detail in Part II - Item 8, Note 19 of the Consolidated Financial Statements in this Annual Report on Form 10-K. The following sections provide analysis and discussion of results of operations for each of the reporting segments as well as investment results.
Property & Casualty
2022 net loss reflected the following factors:
•Significant increase in the auto loss ratio reflecting the impact on severity of overall inflation, including higher medical costs, increased usage of medical services and the current judicial environment
•Significant decrease in net investment income due to lower than historical returns on limited partnership interests in the current year versus outsized returns on limited partnership interests in the prior year
•Significant unfavorable prior years' reserve development in the current year versus favorable prior years' reserve development in the prior year
54 Annual Report on Form 10-K Horace Mann Educators Corporation
The following table provides certain financial information for Property & Casualty for the years indicated.
($ in millions, unless otherwise indicated) Year Ended December 31, 2022-2021
Financial Data:
Net premiums written*:
Change in unearned net premiums (9.3) 9.6 N.M.
Incurred claims and claims expenses:
Prior years' reserve development(1) 22.0 (7.2) N.M.
Total claims and claim expenses incurred 534.3 447.9 19.3 %
Operating expenses, including DAC amortization 166.9 164.8 1.3 %
Underwriting gain (loss) (93.0) 4.7 N.M.
Income (loss) before income taxes (58.2) 70.2 N.M
Net income (loss) (44.4) 57.0 N.M.
Core earnings (loss)* (44.4) 57.0 N.M.
Operating Statistics:
Auto
Loss and loss adjustment expense ratio 91.8 % 69.4 % 22.4 pts
Prior years' reserve development(1) 7.2 % -1.2 % 8.4 pts
Catastrophe losses 1.8 % 1.6 % 0.2 pts
Property
Loss and loss adjustment expense ratio 80.7 % 78.5 % 2.2 pts
Prior years' reserve development(1) -2.8 % -1.0 % -1.8 pts
Catastrophe losses 33.4 % 33.6 % -0.2 pts
Underlying combined ratio* 78.2 % 72.8 % 5.4 pts
Risks in force (in thousands)
(1) (Favorable) unfavorable.
(2) Includes assumed risks in force of 4.
Horace Mann Educators Corporation Annual Report on Form 10-K 55
Catastrophe losses incurred were as follows:(1)
($ in millions) Year Ended December 31,
Three months ended
(1) See Part I - Item 1 - Reporting Segments - Property & Casualty for further details regarding catastrophe losses for the past five years.
On a reported basis, the 22.9 point increase in the auto combined ratio in 2022 was mainly attributable to a 13.8 point increase in the auto underlying loss ratio* and an 8.4 point unfavorable increase in prior years' reserve development. Although frequency continues to trend back up toward pre-pandemic levels as miles driven continues to increase, higher severity is the primary driver of the increase in auto loss costs. This reflects the challenges being faced by the entire industry, including the unprecedented level of inflation that is driving higher replacement costs; the trend toward more severe accidents; and increased usage and costs of medical services. We continue to implement rate and other underwriting changes that address these trends. Unfavorable prior years' auto reserve development of $28.0 million was reported for 2022, reflecting the impact on severity of overall inflation, including higher medical costs, increased usage of medical services and the current judicial environment.
The reported property combined ratio increased 3.4 points in 2022, driven by frequency and severity of fire losses and non-weather losses related to water that continue to be above prior years. Favorable prior years' reserve development of $6.0 million benefited the reported property combined ratio by 2.8 points for 2022.
In 2022, total Property & Casualty net premiums written* increased $9.7 million as rate actions and inflation adjustments to coverage values for property more that offset declines in risks in force. The benefit of stronger retention is being offset by new business volumes that still remain below historical levels due to the lingering effect of the pandemic on sales*.
In 2022, auto net premiums written* decreased $0.5 million, primarily due to the continuing decline in auto risks in force partially offset by rate actions taken in the third and fourth quarters. For 2022, average net premium written and average net premium earned increased 2.7% and 0.2%, respectively. Planned auto rate changes will average a total of 18% to 20% in 2023 supplemented by non-rate underwriting actions. The number of educator risks has been over 80% relative to overall auto risks in force over the past two years.
In 2022, property and other net premiums written* increased $10.2 million due to increases in average net premium written and average net premium earned which increased 8.4% and 5.7% respectively, as inflation adjustments to coverage values continue to take effect. With inflationary pressure continuing, we expect rate actions in property of 12% to 15% over the next four quarters. When combined with the impact of "inflation guard", these actions should result in an increase in average renewal premium by 17% to 20% in 2023. The number of educator risks has been at or above 80% relative to overall property risks in force over the past two years.
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.
56 Annual Report on Form 10-K Horace Mann Educators Corporation
Life & Retirement
2022 net income reflected the following factors:
•A decline of 44 basis points in the annualized net interest spread on fixed annuities
•Volatility in financial markets leading to unfavorable DAC unlocking and lower charges and fees earned on variable annuities and asset-based accounts
•Life results benefited from lower mortality costs during 2022
Horace Mann Educators Corporation Annual Report on Form 10-K 57
The following table provides certain information for the Life & Retirement segment for the years indicated.
Life & Retirement
Net premiums written and contract deposits* $ 544.8 $ 563.0 -3.2 %
Net premiums and contract charges earned 145.3 144.2 0.8 %
DAC amortization expense, excluding DAC unlocking 27.7 27.0 2.6 %
DAC unlocking(1) 5.1 (1.5) N.M.
Intangible asset amortization expense 1.1 1.3 -15.4 %
Other expenses - goodwill and intangible asset impairments 4.8 — N.M.
Life policies in force (in thousands) 162 163 -0.6 %
Life persistency - LTM 96.0 % 96.5 % -0.5 pts
Annuity contracts in force (in thousands) 228 230 -0.9 %
Horace Mann Retirement Advantage® contracts in force (in thousands) 17 15 13.3 %
Cash value persistency - LTM 93.7 % 94.4 % -0.7 %
(1) (Favorable) unfavorable.
For 2022, life annualized sales* were slightly higher and life persistency remained strong at 96.0%. Life & Retirement net income reflected an after-tax impairment charge of $3.8 million for goodwill and intangible assets due to lower than anticipated revenues associated with the BCG business of the Retirement operating segment.
For 2022, net annuity contract deposits* for variable and fixed annuities decreased $19.5 million, or 4.3%, from strong prior year levels. Educators continue to begin their relationship with Horace Mann through 403(b) retirement savings products, including attractive annuity products, which provide encouraging cross-sell opportunities. Cash value persistency remained strong at 93.7%.
As of December 31, 2022, annuity assets under management were down $461.4 million, or 8.6%, compared to a year ago primarily due to market depreciation. Assets under administration, which includes Horace Mann Retirement Advantage® and other advisory and recordkeeping assets, were down $1.3 billion, or 14.2%, from a year ago largely due to the effect of equity market performance on assets under management. The full-year 2022 annualized net interest spread on fixed annuities, excluding reinsurance, decreased 44 basis points, primarily reflecting lower net returns from the investment portfolios.
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 $649.8 million of the Life & Retirement investment portfolio and related investable cash flows will be reinvested at current market rates.
58 Annual Report on Form 10-K Horace Mann Educators Corporation
Interest rates rose swiftly throughout 2022. However, the risk of a deep recession or shock to the economy, such as a global pandemic, could result in a return to historically low interest rates. The current environment of higher interest rates have afforded us the opportunity to invest insurance cash flows and reinvested cash flows at higher yields, which could be a benefit to net investment income, but the higher interest rates have caused an increase to both realized investment losses when securities are sold, and to net unrealized investment losses in the remaining portfolios.
As a general guideline, based on our existing policies and investment portfolio, the impact from a 100 basis point decline in the average reinvestment rate would reduce Life & Retirement net investment income by approximately $2.5 million in year one and $7.5 million in year two, reducing the annualized net interest spread by approximately 9 basis points and 25 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.
We reinsure a $2.5 billion block of in force fixed annuities with a minimum crediting rate of 4.5% which helps mitigate the risk of not being able to generate appropriate spreads on the annuity business. Information regarding the interest crediting rates and balances equal to the guaranteed minimum crediting rates for deferred annuity account values excluding the reinsured block is shown below.
($ in millions) December 31, 2022
Total Deferred Annuities Deferred Annuities atMinimum Crediting Rate
Guaranteed minimum crediting rates:
Horace Mann Educators Corporation Annual Report on Form 10-K 59
Supplemental & Group Benefits
2022 net income reflected the following factors:
•Inclusion of results from the newly acquired employer-sponsored business
•Sales* of worksite direct products were up $2.8 million, or 43.8%, and sales* of employer-sponsored products added another $6.9 million
•The benefit ratio on worksite direct products decreased sequentially due to a higher level of reserves released on lapsed policies
The following table provides certain information for Supplemental & Group Benefits for the years indicated.
Supplemental & Group Benefits
Net premiums and contract charges earned $ 275.5 $ 128.0 115.2 %
Other income (13.4) 2.6 N.M.
Benefits, settlement expenses and change in reserves 99.8 41.0 143.4 %
Interest credited 1.3 0.3 N.M.
Intangible asset amortization expense 15.7 11.7 34.2 %
Operating expense ratio(2) 35.2 % 28.4 % 6.8 pts
Worksite direct products benefits ratio 30.1 % 31.9 % -1.8 pts
Worksite direct premium persistency (rolling 12 months) 90.4 % 92.5 % -2.1 pts
Employer-sponsored products benefits ratio 41.9 % — % N.M.
(1) Ratio of benefits to net premiums earned.
(2) Ratio of operating expenses to total revenues.
(3) Ratio of income before income taxes to total revenues.
For 2022, total sales* were $16.1 million. Sales of worksite direct products* were $9.2 million representing an increase of 41.5%. Worksite direct persistency, while down slightly, still remains very strong at 90.4%. Sales of employer-sponsored products* added another $6.9 million.
60 Annual Report on Form 10-K Horace Mann Educators Corporation
The current year includes the results from the newly acquired employer-sponsored business which is driving increases in (1) benefits, settlement expenses and change in reserves, (2) operating expenses (includes DAC unlocking and amortization), and (3) intangible asset amortization expense. The non-cash impact of amortization of intangible assets under purchase accounting reduced pretax net income by $15.7 million and $11.7 million in 2022 and 2021, respectively. Pretax profit margin reflects a combination of worksite direct and employer-sponsored products.
Corporate & Other
The following table provides certain financial information for Corporate & Other for the years indicated.
Net investment losses, pretax (56.5) (11.0) N.M.
Net investment losses, after tax (44.5) (8.6) N.M.
For 2022, the net loss increased due to net investment losses which are mainly from changes in fair values of equity securities and realized losses on disposition of fixed maturity securities as well as an increase in interest expense on the Revolving Credit Facility.
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 $2.5 billion of fixed annuity liabilities related to legacy individual annuities written in 2002 or earlier.
Net investment income - investment portfolio $ 297.4 $ 321.4 -7.5 %
Investment income - deposit asset on reinsurance 103.5 101.1 2.4 %
Pretax net investment losses (56.5) (11.0) N.M.
For 2022, net investment income from our investment portfolio decreased $24.0 million, primarily due to yields on our portfolio of limited partnership interests returning to near-historical averages. In 2021, returns on our portfolio of limited partnership interests were well above historical averages. Investment yields on our portfolio excluding limited partnership interests, remained near 4.25% for 2022, with new money yields continuing to exceed yields in our core fixed maturity securities portfolio.
For 2022, pretax net investment losses increased $45.5 million primarily due to changes in fair values of equity securities and realized losses on disposition of fixed maturity securities. Pretax net unrealized investment losses on fixed maturity securities as of December 31, 2022 were $571.9 million compared to pretax net unrealized investment gains of $441.6 million as of December 31, 2021, reflecting a 236 basis point increase in the 10-year U.S. Treasury yield partially offset by wider credit spreads across most asset classes.
Horace Mann Educators Corporation Annual Report on Form 10-K 61
Fixed Maturity and Equity Securities Portfolios
The table below presents our fixed maturity and equity securities portfolio by major asset class, including the 10 largest sectors of our corporate bond holdings (based on fair value).
($ in millions) December 31, 2022
Number ofIssuers FairValue AmortizedCost orCost Pretax NetUnrealizedLoss
Fixed maturity securities
Corporate bonds
Mortgage-backed securities
U.S. Government and federally sponsored agencies 242 370.2 416.5 (46.3)
Government bonds
Equity securities
Non-redeemable preferred stocks 26 $ 81.8
Common stocks 5 1.1
Closed-end fund 1 16.7
Total equity securities 32 $ 99.6
(1)The All Other Corporates category contains 18 additional industry classifications. Food and beverage, natural gas, telecommunications, broadcasting and media, and industry manufacturing represented $226.1 million of fair value as of December 31, 2022, with the remaining 13 classifications each representing less than $211.0 million.
(2)As of December 31, 2022, 100% were investment grade, with an overall credit rating of AA+, and the positions were well diversified by property type, geography and sponsor.
(3)Holdings are geographically diversified, 45.1% are tax-exempt and 74.4% 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- as of December 31, 2022.
(4)Based on fair value, 93.5% of the collateralized loan obligation securities were rated investment grade based on ratings assigned by a nationally recognized statistical ratings organization (NRSRO - S&P, Moody's, Fitch, Dominion, A.M. Best, Morningstar, Egan Jones and Kroll).
62 Annual Report on Form 10-K Horace Mann Educators Corporation
As of December 31, 2022, our diversified fixed maturity securities portfolio consisted of 3,724 investment positions, issued by 2,421 entities, and totaled approximately $5.2 billion in fair value. This portfolio was 92.0% investment grade, based on fair value, with an average credit quality rating of A+. Our investment guidelines target 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 $5.0 million for non-investment grade securities.
Rating of Fixed Maturity Securities and Equity Securities (1)
The following table presents the composition and fair value of our fixed maturity and equity securities portfolios by rating category. As of December 31, 2022, 91.6% of these combined portfolios were investment grade, based on fair value, with an overall average credit quality rating of A+. We have classified the entire fixed maturity securities portfolio as available for sale, which is carried at fair value.
($ in millions) December 31, 2022
Percentof TotalFairValue FairValue AmortizedCost, net
Fixed maturity securities
CCC or lower — 1.5 1.6
Equity securities
AAA — —
AA — —
A — —
B — —
CCC or lower — —
Total equity securities 100.0 % $ 99.6
(1)Ratings are as assigned by a NRSRO when available. If no rating is available from a NRSO, then an internally developed rating is used. Ratings for publicly traded securities are determined when the securities are acquired and are updated monthly to reflect any changes in ratings.
(2)As of December 31, 2022, the AA rated fair value amount included $342.6 million of U.S. Government and federally sponsored agency securities and $561.0 million of mortgage-backed and other 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 a NRSO.
As of December 31, 2022, the fixed maturity securities portfolio had $606.9 million of pretax gross unrealized investment losses on $4,267.9 million of fair value related to 3,102 positions. Of the investment positions with gross unrealized investment losses, there were 547 securities trading below 80.0% of the carrying amount as of December 31, 2022. See Part II - Item 8, Note 3 of the Consolidated Financial Statements in this Annual Report on Form 10-K for more information.