Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) ($ in millions, except per share data)
The purpose of this MD&A is to provide an understanding of the Company’s consolidated results of operations and financial condition. This MD&A should be read in conjunction with Item 1, Item 6 and Item 8 of this report. This MD&A begins with the Company’s consolidated financial highlights followed by segment highlights and consolidated results of operations, an outlook for future performance, details about critical accounting estimates and the results of operations by segment. The Company's strategy is described in Item 1 of this report.
The Company provides projections and other forward-looking information in the following discussions that are not historical in nature and are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. The Company’s actual results could differ materially from those projected in the forward-looking statements due to the number of risks and uncertainties inherent in the Company’s business. Horace Mann undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. For additional information regarding risk and uncertainties, see Item 1A of this report.
For 2018, net income excluding deferred policy acquisition costs (DAC) unlocking decreased $44.3 million compared to 2017, primarily due to the benefit of a $39.5 million DTL re-measurement occurring in 2017, a $7.0 million pretax decrease in net interest margin and higher operating expenses to support long-term retirement infrastructure. For 2017, net income excluding DAC unlocking increased $38.6 million compared to 2016, primarily due to the DTL re-measurement benefit that occurred in 2017 and a $6.4 million pretax increase in net interest margin offset by higher operating expenses driven by strategic investments in technology, products and distribution.
For 2018, benefits, claims and settlement expenses increased compared to 2017, driven primarily by elevated catastrophe costs in Property and Casualty. For 2017, benefits, claims and settlement expenses increased compared to 2016, driven primarily by elevated weather-related losses in Property and Casualty.
Within Property and Casualty, planned premium rate increases, as well as continued underwriting initiatives, are expected to improve the underlying automobile loss ratio* by about 2 points and the underlying property loss ratio* by around 3 points. Management increased the estimate used for catastrophe costs by 20% to be between $45 million and $55 million or 7 to 7.5 points. The expense ratio is expected to be consistent with 2018 and is expected to remain around 27%.
The Company continues to evaluate and implement actions to further mitigate its risk exposure in hurricane-prone areas, as well as other areas of the country. Such actions could include, but are not limited to, non-renewal of property policies, restricted agent geographic placement, limitations on agent new business sales, further tightening of underwriting standards and increased utilization of third-party vendor products.
The Company invests in fixed maturity securities and alternative investment funds that could qualify as variable interest entities, including corporate securities, mortgage-backed securities and asset-backed securities. Such securities have been reviewed and determined not to be subject to consolidation as the Company is not the primary beneficiary of these securities because it does not have the power to direct the activities that most significantly impact the entities' economic performance.
DAC consists of commissions, policy issuance and other costs which are incremental and directly related to the successful acquisition of new or renewal business, which are deferred and amortized on a basis consistent with the type of insurance coverage. For all investment (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 indexed universal life (IUL) contracts. For other individual life contracts, DAC is amortized in proportion to anticipated premiums over the terms of the insurance policies (10, 15, 20, 30 years). For property and casualty policies, DAC is amortized over the terms of the insurance policies (6 or 12 months).
As part of the Company's October 1, 2018 goodwill analysis, the Company compared the fair value of the aggregated reporting units to the market capitalization of the Company. The difference between the aggregated fair value of the reporting units and the market capitalization of the Company was attributed to several factors, most notably market sentiment, trading volume and transaction premium. The amount of the transaction premium was determined to be reasonable based on insurance industry and Company-specific facts and circumstances. There were no other events or material changes in circumstances during 2018 that indicated that a material change in the fair value of the Company's reporting units had occurred.
Property and Casualty insurance premiums are recognized as revenue ratably over the related contract periods in proportion to the risks insured. The unexpired portions of these Property and Casualty premiums are recorded as unearned premiums, using the monthly pro rata method.
Income tax expense for the following periods differed from the expected tax computed by applying the federal corporate tax rate of 21% for 2018 and 35% for 2017 and 2016 to income before income taxes as follows: