As of December 31, 2020, we owned our headquarters of approximately 225,000 square feet located at 1 Horace Mann Plaza in Springfield, Illinois. In addition, we lease office space in suburban Dallas, Texas (approximately 114,000 of rentable square feet), suburban Raleigh, North Carolina, and Cherry Hill, New Jersey which are utilized by one or more of all five reporting segments, depending on the location. For more information on reporting segments, see Part I - Item 1, Reporting Segments of this report. We believe our properties and facilities are suitable and adequate for current operations.
Increases or decreases in this MD&A that are not meaningful are marked "N.M.".
The purpose of this MD&A is to provide an understanding of our consolidated results of operations and financial condition. This MD&A should be read in conjunction with the Consolidated Financial Statements and Notes thereto contained in Part II - Item 8 of this report.
Beginning in March 2020, the global pandemic associated with the novel coronavirus COVID-19 and related economic conditions introduced unprecedented challenges for our country. Those challenges are ongoing. We relied on our previously developed Corporate Pandemic Plan to address preparation, prevention and response measures specific to COVID-19 while allowing flexibility to quickly react to evolving circumstances and implement varying actions accordingly.
As discussed in our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2020, we successfully transitioned the organization, through our employees and agents, from one that relied on in-person experience to one that has become primarily virtual. While the current environment continues to present challenges, our operations are being conducted successfully and we continue to support our agents and serve our customers in an effective manner.
As of the end of December 2020, the majority of our employees continue to work remotely. The return to office plans are being guided by data from the Center for Disease Control. We presently limit office occupancy to
approximately half of pre-COVID-19 levels to enable effective social distancing for some time. We have also implemented other prevention strategies to reduce the potential transmission of COVID-19, such as requiring face masks in common office areas.
Taking into account the virtual work environment, we have implemented additional cybersecurity measures including increasing security and network monitoring to proactively identify and prevent potential security threats and vulnerabilities. We also are identifying and assessing critical third-party vendors and ensuring their ability to continue to perform as anticipated.
We continue to work with our network of exclusive agents to make sure they are using virtual tools that can allow them to reach current and potential educator customers when face-to-face interactions are not possible. We are implementing a variety of new and modified forums to provide access to the financial solutions we offer educators. However, growth in new sales has slowed since the pandemic began, particularly sales generated from in-person events at schools. This may be exacerbated if public school systems face budget constraints due to the economic impacts of the pandemic and/or access to "in school" events remains restricted.
For 2019, our net income increased $166.1 million compared to 2018, primarily due to the realized investment gain arising from the annuity reinsurance transaction previously noted. Lower catastrophe losses of $49.0 million after tax in Property and Casualty as well as the addition of $18.0 million of net income from the Supplemental segment also contributed to the increase in consolidated net income.
For 2020, net investment gains decreased primarily due to recognition of a pretax realized investment gain of $135.3 million in the second quarter of 2019 in connection with the transfer of investments related to the aforementioned annuity reinsurance transaction. The aforementioned transaction is what drove the increase in net investment gains in 2019 compared to 2018.
From time to time, we may sell securities subsequent to a reporting date that were considered temporarily impaired at the reporting date. Such sales are due to issuer specific events occurring subsequent to the reporting date that result in a change in our intent to hold an invested asset.
For 2020, benefits, claims and settlement expenses were lower due to favorable loss experience as a result of lower frequency of losses related to reduced driving activity due to COVID-19, partially offset by higher catastrophe losses and a full year of reported benefits and settlement expenses from the Supplemental segment. For 2019, benefits, claims and settlement expenses were lower compared to 2018, due to reduced catastrophe losses and improved automobile experience, partially offset by the inclusion of losses from the new Supplemental segment.
For 2020, interest credited decreased $8.2 million compared to 2019, driven primarily by lower interest rates and a lower level of Federal Home Loan Bank (FHLB) funding agreements. Under the deposit method of accounting, the interest credited on the reinsured annuity block continues to be reported. The average deferred annuity credited rate, excluding the reinsured block was 2.4% and 2.5% for 2020 and 2019, respectively. For 2019, interest credited increased $6.6 million compared to 2018 primarily due to higher interest costs on FHLB funding agreements.
For 2020, DAC unlocking and amortization expense decreased $9.3 million compared to 2019, primarily due to accelerated amortization of the DAC asset associated with the reinsured annuity block that occurred in Retirement in 2019 and a lower level of amortization of Property and Casualty DAC in 2020 attributed to lower levels of production. For 2019, DAC unlocking and amortization expense was comparable to 2018. For Life, DAC unlocking resulted in immaterial changes to amortization for the three years ended 2020, 2019 and 2018.
On March 27, 2020, H.R. 748, the Coronavirus Aid, Relief, and Economic Security Act, “the CARES Act”, was signed into legislation. The CARES Act includes tax provisions relevant to businesses, and some of the significant changes include allowance of a five-year carryback of net operating losses for 2018-2020 and the suspension of the 80% limitation of taxable income for net operating loss carryforwards for 2018-2020. The effects of the CARES Act are reflected in our income tax expense calculations for the year ended December 31, 2020. Accounting Standards Codification Topic 740: Income Taxes requires that the impact of the CARES Act be recognized in the period in which the law was enacted. As a result, total income tax expense for the year ended December 31, 2020, includes a benefit of $2.8 million (that reduced the effective income tax rate by 2.8 percentage points) to reflect a net operating loss carryback to taxable years for which the corporate rate was 35% as compared to the current corporate rate of 21%.
We record liabilities for uncertain tax filing positions where it is more likely than not that the position will not be sustainable upon audit by taxing authorities. These liabilities are reevaluated routinely and are adjusted appropriately based on changes in facts or law. We have no unrecorded liabilities from uncertain tax filing positions.
Net written premiums* for 2021 are anticipated to be below 2020 levels. We expect new sales* will remain under pressure while COVID-19 vaccines are being rolled out across the country, with a return to pre-pandemic sales levels likely to begin in the fourth quarter.
We expect the pandemic's impact on automobile loss costs will continue in 2021, reflecting continued lower frequency related to new driving patterns, as well as a partial offset because of the anticipated uptick in uninsured/underinsured motorist claims. Over the course of 2021, we anticipate loss ratios gradually rising toward our long-term target levels. Our outlook presumes that some changes to driving patterns will become more permanent, but those would be offset by some of the factors that increased severity in 2020. We anticipate fairly stable automobile rates in 2021. We estimate that a 10% drop in automobile frequency represents approximately $2 million in pretax earnings per month, excluding the potential for higher severity.
We expect Life to generate net income between $17 million and $19 million in 2021, reflecting modeled mortality costs and increased net investment income from the alternatives portfolio. Sales* are expected to gradually return to pre-pandemic levels.
For 2021, we expect total net investment income between $370 million and $390 million, including approximately $100 million of accreted investment income on the deposit asset on reinsurance in the Retirement segment. The return on the alternatives portfolio is expected to be in the mid to high single digits in 2021, compared with a below-target 5% in 2020 due to market volatility early in the year.
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:
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.
The fair value of a fixed maturity security is the estimated amount at which the security could be exchanged in an orderly transaction between knowledgeable, unrelated and willing parties. We utilize investment managers and our custodian bank to obtain fair value prices from independent third-party valuation service providers, broker-dealer quotes, and model prices. Each month, we obtain fair value prices from our investment managers and custodian bank, each of which use a variety of independent, nationally recognized pricing sources to determine market valuations for fixed maturity securities. Differences in prices between the sources that we consider significant are researched and we utilize the price that we consider most representative of an exit price. Typical inputs used by these pricing sources include, but are not limited to, reported trades, bids, offers, benchmark yield curves, benchmarking of like securities, rating designations, sector groupings, issuer spreads and/or estimated cash flows, prepayment and default speeds, among others. Our fixed maturity securities portfolio is primarily publicly traded, which allows for a high percentage of the portfolio to be priced through pricing services. Approximately 91.9% of the portfolio, based on fair value, was priced through pricing services or index priced using observable inputs as of December 31, 2020.
We gain assurance that our portfolio of fixed maturity securities including hard-to-value fixed maturity securities is appropriately valued through the execution of various processes and controls designed to ensure the overall reasonableness and consistent application of valuation methodologies, including inputs and assumptions, and compliance with accounting standards. Our processes and controls are designed to ensure (1) the valuation methodologies are appropriate and consistently applied, (2) the inputs and assumptions are reasonable and consistent with the objective of determining fair value, and (3) the fair values are accurately recorded. For example, on a continuing basis, we assess the reasonableness of individual fair values that have stale security prices or that exceed certain thresholds as compared to previous fair values received from valuation service providers. We perform procedures to understand and assess the methodologies, processes and controls of valuation service providers. In addition, we may validate the reasonableness of fair values by comparing information obtained from valuation service providers or broker-dealers to other third-party valuation sources for selected securities.
For fixed maturity securities that we do not intend to sell or for which it is more likely than not that we would not be required to sell before an anticipated recovery in value, we separate the credit loss component of the impairment from the amount related to all other factors and report the credit loss component in net investment gains (losses). The impairment related to all other factors (non-credit factors) is reported in other comprehensive income (OCI). The allowance is adjusted for any additional credit losses and subsequent recoveries. Upon recognizing a credit loss, the cost basis is not adjusted. Also, see Part II - Item 8, Note 1 of the Consolidated Financial Statements in this report.
We account for VODA associated with the acquisition of BCG based on our estimate of the present value of future business to be written by the existing distribution channel. VODA was $0.7 million as of December 31, 2020 and is being amortized based on the present value of future profits to be received. We estimate that we will recognize cumulative VODA amortization of $0.3 million for the years 2021 through 2025.
We account for the value of agency relationships based on the present value of commission overrides retained by NTA. Agency relationships was $12.9 million as of December 31, 2020 and is being amortized based on the present value of future premiums to be received. We estimate that we will recognize agency relationships amortization of $2.2 million in 2021, $1.9 million in 2022, $1.6 million in 2023, $1.4 million in 2024 and $1.2 million in 2025.
We account for the value of customer relationships based on the present value of expected profits from existing BCG customers in force at the date of acquisition. Customer relationships was $5.9 million as of December 31, 2020 and is being amortized based on the present value of future profits to be received. We estimate that we will recognize customer relationships amortization of $1.2 million in 2021, $1.1 million in 2022, $0.9 million in 2023, $0.7 million in 2024 and $0.6 million in 2025.
Intangible assets that are not subject to amortization (i.e., trade names and state licenses) are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of an intangible asset that is not subject to amortization exceeds its fair value, an impairment loss is to be recognized in an amount equal to that excess. The test results from our annual impairment assessment for trade names at October 1, 2020 resulted in the write-down of a certain amount for impairment. See Part II - Item 8, Note 6 of the Consolidated Financial Statements in this report for more information.
DAC, consisting of commissions, policy issuance and other costs which are incremental and directly related to the successful acquisition of new or renewal business, are deferred and amortized on a basis consistent with the type of insurance coverage. For all annuity contracts, DAC is amortized over 20 years in proportion to estimated gross profits. DAC is amortized in proportion to estimated gross profits over 20 years for certain life insurance products with account values and over 30 years for IUL. For further information, see Part II - Item 8, Note 1 of the Consolidated Financial Statements in this report.
In the event actual experience differs significantly from assumptions or assumptions are significantly revised, we may be required to record a material charge or credit to current period amortization expense for the period in which the adjustment is made. As noted above, there are key assumptions involved in the evaluation of DAC. In terms of the sensitivity of this amortization to three of the more significant assumptions, based on DAC as of December 31, 2020 and assuming all other assumptions are met, (1) a 10 basis point deviation in the annual targeted interest rate spread assumption would impact amortization between $0.3 million and $0.4 million, (2) a 1.0% deviation from the targeted financial market performance for the underlying mutual funds of our variable annuities would impact amortization between $0.3 million and $0.4 million and (3) a $1.0 million net investment gain (loss) would impact amortization by approximately $0.2 million. These results may change depending on the magnitude and direction of any actual deviations but represent a range of reasonably likely experience for the noted assumptions. Detailed discussion of the impact of adjustments to DAC amortization expense is included in Results of Operations by Segment for the Three Years Ended December 31, 2020.
Annually, we perform a gross premium valuation on life insurance policies to assess whether a loss recognition event has occurred. This involves discounting expected future benefits and expenses less expected future premiums. To the extent that this amount is greater than the liability for future benefits less the DAC asset, in aggregate for the life insurance block, a loss would be recognized by first writing off the DAC and then increasing the liability.
Valuation of Liabilities for Property and Casualty Unpaid Claims and Claim Expenses
Underwriting results of Property and Casualty are significantly influenced by estimates of our ultimate liability for insured events. There is a high degree of uncertainty inherent in the estimates of ultimate losses underlying the liabilities for unpaid claims and claim expenses. This inherent uncertainty is particularly significant for liability-related exposures due to the extended period, often many years that transpire between a loss event, receipt of related claims data from policyholders and ultimate settlement of the claim. Reserves for Property and Casualty claims include provisions for payments to be made on reported claims (case reserves), IBNR claims and associated settlement expenses (together, loss reserves).
Reserves are re-estimated quarterly. Changes to reserves are recorded in the period in which development factor changes result in reserve re-estimates. A detailed discussion of the process utilized to estimate loss reserves, risk factors considered and the impact of adjustments recorded during recent years is included in Part II - Item 8, Note 7 of the Consolidated Financial Statements in this report. Due to the nature of our personal lines
Our liabilities for unpaid claims and claim expenses for Property and Casualty were as follows:
Favorable prior years' reserve re-estimates increased net income in 2020 by approximately $10.2 million pretax, primarily the result of favorable loss trends in automobile and property for accident years 2019 and prior which includes the recognition of $4.8 million pretax of subrogation received on the 2018 Camp Fire event. The lower than expected claims emergence and resultant lower expected loss ratios caused us to lower our reserve estimate at December 31, 2020.
Liabilities for future benefits on deferred annuity contracts, excluding fixed indexed annuity (FIA) products, are carried at accumulated policyholder values without reduction for potential surrender or withdrawal charges. Liabilities for FIA products are bifurcated into an embedded derivative and a host contract. The embedded derivative is recognized at fair value and is reported in Other policyholder funds on the Consolidated Balance Sheets, and is determined using the option budget method. The host contract is accounted for as a debt instrument with the initial amount determined as the consideration amount less the initial embedded derivative, as described above. Any discount to the minimum account value is accreted over the life of the products using the effective yield method. Key assumptions used in the estimation of the liabilities for FIA products include the risk free interest rate, the value of options currently in force, the future expected option budget based on product pricing targets, mortality and lapses.
Liabilities for future benefits on payout annuity contracts are determined as the present value of expected future benefit payments. Key assumptions used in the calculation include the future investment yield and mortality, for those contracts with life contingencies.
Liabilities for future policy benefits on supplemental insurance policies are computed using the net level premium method and are based on assumptions as to future investment yields, morbidity, mortality, persistency, expenses and other assumptions based on our experience, including provisions for adverse deviation. Mortality, morbidity and lapse assumptions for all policies have been based on standard actuarial tables which are modified as appropriate to reflect our own experience. In the event actual experience is worse than the assumptions, additional reserves may be required. This would result in recognition of a loss in the period for which the increase in reserves occurred.
Results of Operations by Segment for the Three Years Ended December 31, 2020
•0.5 point improvement in the expense ratio due to expense reduction initiatives as well as lower levels of spending on travel and other expenses because of COVID-19
The following table provides certain financial information for the Property and Casualty segment for the periods indicated.
As a result of the emergence of PG&E Corporation and Pacific Gas and Electric Company (together, PG&E) from bankruptcy on July 1, 2020, we recognized favorable prior years' reserve development of $5.2 million pretax, net of reinsurance, as well as return of reinsurance reinstatement premiums of $3.7 million, for a total of $8.9 million, largely related to the 2018 Camp Fire in California.
Property and other written premiums* decreased slightly compared to 2019. While the number of property risks in force has declined, the average written premium per risk and average earned premium per risk increased 2.3% and 4.3%, respectively, compared to 2019. In 2019, the average written premium per risk and average earned premium per risk increased 6.2% and 5.4%, respectively, compared to 2018. Based on risks in force, the 12 month retention rate for new and renewal risks was 86.8%, 87.1% and 88.0% at December 31, 2020, 2019 and 2018, respectively. The number of educator risks has been stable relative to overall property risks over the past three years as educators represented 82.6%, 82.5% and 82.6% of the property risks in force as of December 31, 2020, 2019 and 2018, respectively.
(1) The acquisition of NTA closed on July 1, 2019. Twelve month comparisons are not applicable.
(3) Operating expense ratio and pretax profit margin measured to total revenues.
In 2020, Supplemental sales* were $7.2 million compared to $8.2 million in 2019, reflecting significantly lower sales volume, primarily due to limited school access because of COVID-19. Persistency was slightly up at 90.5%.
amortization of intangible assets recognized in connection with the purchase accounting of NTA reduced pretax net income by $12.6 million and $6.6 million in 2020 and 2019, respectively. The pretax profit margin remains above our longer-term expectations because of pandemic-related changes in policyholder behavior.
•Goodwill and intangible asset impairment charges of $10.0 million in 2020 associated with the BCG acquisition compared to a $28.0 million goodwill impairment charge in 2019 associated with the annuity business due to the reinsurance of the legacy annuity block
Compared to 2018, 2019 net income decreased $46.5 million due to the impacts of the annuity reinsurance transaction coupled with a $28.0 million goodwill impairment charge triggered by the transaction. 2019 core earnings* decreased $18.5 million compared to 2018, reflecting the impact of the annuity reinsurance transaction, which ceded $2.9 billion of fixed and variable reserves (see Part II - Item 8, Note 5 of the Consolidated Financial Statements for further details). 2019 results also include higher operating expenses from the inclusion of BCG.
For 2020, Retirement segment net income reflected an after-tax impairment charge of $8.1 million for goodwill and intangible assets associated with BCG due to lower than anticipated BCG wealth management sales outside of the education markets. Operational benefits from the BCG acquisition remain on track. In 2019, we impaired $28.0 million of goodwill that had been associated with the annuity business due to the reinsurance of the legacy annuity block.
We actively manage our interest rate risk exposure, considering a variety of factors, including earned interest rates, credited interest rates and the relationship between the expected durations of assets and liabilities. We estimate that over the next 12 months approximately $562.4 million of the combined Retirement and Life investment portfolio and related investable cash flows will be reinvested at current market rates. As interest rates remain at low levels, borrowers may prepay or redeem the securities with greater frequency in order to borrow at lower market rates, which could increase investable cash flows and exacerbate the reinvestment risk.
As a general guideline, for a 100 basis point decline in the average reinvestment rate and based on our existing policies and investment portfolio, the impact from investing in that lower interest rate environment could further reduce Retirement net investment income by approximately $2.1 million in year one and $6.4 million in year two, further reducing the annualized net interest spread by approximately 7 basis points and 21 basis points in the respective periods, compared to the current period annualized net interest spread. We could also consider potential changes in rates credited to policyholders, tempered by any restrictions on the ability to adjust policyholder rates due to minimum guaranteed crediting rates.
We will continue to be disciplined in executing strategies to mitigate the negative impact on profitability of a sustained low interest rate environment. However, the success of these strategies may be affected by the factors discussed in Part I - Item 1A and other factors of this report.
For 2020, net income decreased $7.2 million compared to 2019, reflecting higher mortality costs and lower net investment income. For 2019, net income decreased $1.2 million compared to 2018, reflecting lower net investment income and higher expenses partially offset by lower mortality costs.
For 2020, net investment income from our investment portfolio decreased $34.0 million compared to 2019 for two reasons. First, we had a smaller invested asset base for full-year 2020. In 2019, the invested asset base was higher in the first quarter, prior to the transfer of $2.1 billion of invested assets as part of the annuity reinsurance transaction. Second, market weakness in early 2020 resulted in lower full-year returns from limited partnership interests.
For 2019, net investment income from our investment portfolio was $82.2 million below 2018 because of the transfer of invested assets. In addition, interest rates declined significantly in 2019 and our yield on new investments also reflected a strategic decision to further improve the quality of our investment portfolio. This was partially offset by stronger returns on alternative investments and increased prepayment activity.
For 2020, pretax net unrealized investment gains on fixed maturity securities were up $222.0 million compared to 2019, reflecting U.S. Treasury rates that declined 101 basis points with mostly flat investment grade credit spreads. For 2019, pretax net unrealized investment gains on fixed maturity securities were up $193.3 million compared to 2018, reflecting U.S. Treasury rates that declined 76 basis points and tighter credit spreads across most asset classes.
The table below presents our fixed maturity securities portfolio by major asset class, including the ten largest sectors of our corporate bond holdings (based on fair value) as well as our equity securities portfolio.
(3)At December 31, 2020, 100% were investment grade, with an overall credit rating of AA+, and the positions were well diversified by property type, geography and sponsor.
In late 2016, we determined the economy was approaching later stages of the credit cycle and began to upgrade portfolio quality. Over the past three years, recessionary expectations were extended due to the fiscal stimulus, which lengthened the credit cycle. In 2019, we determined that we had achieved our investment initiatives and the portfolio was well positioned for any dislocation in the markets.
At December 31, 2020, the fixed maturity securities portfolio had $28.4 million of pretax gross unrealized investment losses on $985.2 million of fair value related to 431 positions. Of the investment positions with gross unrealized investment losses, there were 21 securities trading below 80.0% of the carrying value at December 31, 2020.
We view the unrealized investment losses of all of the securities at December 31, 2020 as temporary. Future changes in circumstances related to these and other securities could require subsequent recognition of OTTI.
At December 31, 2020, 2019 and 2018, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships as of December 31, 2020.
Information regarding our investment portfolio, which is comprised primarily of investment grade, fixed maturity securities, is presented in Part II - Item 7, Results of Operations by Segment for the Three Years Ended December 31, 2020, Part I - Item 1, Investments and in Part II - Item 8, Note 2 of the Consolidated Financial Statements in this report.
Our short-term liquidity requirements, within a 12 month operating cycle, are for the timely payment of claims and benefits to policyholders, operating expenses, interest payments and federal income taxes. Cash flow generated from operations has been, and is expected to be, adequate to meet our operating cash needs in the next 12 months. Cash flow in excess of operational needs has been used to fund business growth, pay dividends to shareholders and repurchase shares of our common stock. Long-term liquidity requirements, beyond one year, are principally for the payment of future insurance and annuity policy claims and benefits, as well as retirement of debt. The following table summarizes our consolidated cash flows activity for the periods indicated.
For 2020, net cash provided by financing activities increased $313.7 million compared to 2019, primarily due to cash inflows of $95.5 million from advances received under FHLB funding agreements in 2020 compared to net cash outflows of $130.0 million from advances received and principal repayments made under FHLB funding agreements in 2019.
For the majority of our Supplemental insurance operations, the estimated contractual obligations for future policyholder benefits as presented in the table above were derived from future projections of the business developed as part of the purchase accounting associated with the acquisition of NTA.
Amounts presented in the table above represent the estimated cash payments to be made to policyholders undiscounted by interest and including assumptions related to the receipt of future premiums and deposits, future interest credited, full and partial withdrawals, policy lapses, surrender charges, annuitization, mortality, morbidity, and other contingent events as appropriate to the respective product types. Additionally, coverage levels are assumed to remain unchanged from those provided under contracts in force at December 31, 2020. Separate Account (variable annuity) payments are not reflected due to the matched nature of these obligations and the fact that the contract owners maintain the investment risk on such deposits.
Our potential sources and uses of funds principally include the following activities:
As of December 31, 2020, we held $1.1 billion of cash, U.S. government and agency fixed maturity securities and public equity securities (excluding non-redeemable preferred stocks and foreign equity securities) which, under normal market conditions, could be rapidly liquidated.
Total capital was $2,227.4 million at December 31, 2020, including $437.3 million of short-term and long-term debt. Total debt represented 19.6% of total capital including net unrealized investment gains on fixed maturity securities (23.5% of total capital excluding net unrealized investment gains on fixed maturity securities*) at December 31, 2020, which was below our long-term target of 25.0%.
Additional information regarding net unrealized investment gains on fixed maturity securities at December 31, 2020 is included in Part II - Item 7, Results of Operations by Segment for the Three Years Ended December 31, 2020 and Part II - Item 8, Note 2 of the Consolidated Financial Statements in this report.
On September 30, 2015, the Board authorized a share repurchase program allowing repurchases of up to $50.0 million of HMEC's common stock, par value $0.001 (Program). The Program authorizes the repurchase of common shares in open market or privately negotiated transactions, from time to time, depending on market conditions. The Program does not have an expiration date and may be limited or terminated at any time without notice. During 2020, we repurchased 52,095 shares our common stock at an average price per share of $41.17 under the Program. In total and through December 31, 2020, 899,468 shares have been repurchased under the Program at an average price of $32.68 per share. The repurchase of shares was funded through use of cash. As of December 31, 2020, $20.6 million remained authorized for future share repurchases under the Program.
(1) We designate our debt obligations as "long-term" based on maturity date at issuance.
On July 1, 2019, we utilized our senior revolving credit facility to partially fund the acquisition of NTA. As of December 31, 2020, the amount outstanding on the senior revolving credit facility was $135.0 million. The unused portion of the Bank Credit Facility is subject to a variable commitment fee, which was 0.15% on an annual basis at December 31, 2020.
To provide additional capital management flexibility, we filed a "universal shelf" registration statement on Form S-3 with the SEC on March 13, 2018. The registration statement, which registered the offer and sale from time to time of an indeterminate amount of various securities, which may include debt securities, common stock,
preferred stock, depositary shares, warrants, delayed delivery contracts and/or units that include any of these securities, was automatically effective on March 13, 2018. Unless withdrawn by us earlier, this registration statement will remain effective through March 13, 2021 and no securities associated with such registration statement have been issued. At the time of issuance of this Annual Report on Form 10-K, we expect to file another "universal shelf" registration statement on Form S-3 with the SEC in March 2021.
Our principal insurance subsidiaries are rated by A.M. Best Company, Inc. (A.M. Best), Fitch, Moody's and S&P. These rating agencies have also assigned ratings to our Senior Notes. The ratings that are assigned by these agencies, which are subject to change, can impact, among other things, our access to sources of capital, cost of capital, and competitive position. These ratings are not a recommendation to buy or hold any of our securities.
Information regarding the reinsurance programs for our Property and Casualty, Supplemental, Retirement and Life segments are located in Part I - Item 1, Reporting Segments of this report.
There is one new accounting standard that we have not adopted because the adoption date has not yet occurred. For a discussion of this new standard, see Part II - Item 8, Note 1 of the Consolidated Financial Statements in this report. The effect of implementing certain accounting standards on our financial results and financial condition is often based in part on market conditions at the time of implementation of the standard and other factors that we are unable to determine prior to implementation. For this reason, we are sometimes unable to estimate the effect of certain pending accounting standards until the relevant authoritative body finalizes these standards or until we implement them.
Our operating results are affected significantly in at least three ways by changes in interest rates and inflation. First, inflation directly affects Property and Casualty claims costs. Second, the investment income earned on our investment portfolio and the fair value of the investment portfolio are related to the yields available in the fixed income markets. An increase in interest rates will decrease the fair value of the investment portfolio, but will increase investment income as investments mature and proceeds are reinvested at higher rates. Third, as interest rates increase, competitors will typically increase crediting rates on annuity contracts and life insurance products with account values, and may lower premium rates on property and casualty lines to reflect the higher yields available in the market. The risk of interest rate fluctuation is managed through asset/liability management techniques, including cash flow analysis. In addition, an annuity reinsurance agreement entered into in the second quarter of 2019, which reinsured a $2.2 billion block of in force fixed annuities with a minimum crediting rate of 4.5%, helps mitigate the risk of not being able to generate appropriate spreads on the annuity business.
Note 16 - Comprehensive Income (Loss) and Accumulated Other Comprehensive Income (Loss)
We have audited the accompanying consolidated balance sheets of Horace Mann Educators Corporation and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedules I to IV and VI (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 3 to the consolidated financial statements, as of December 31, 2020, the Company has recorded an estimated fair value for fixed maturity securities, of which a portion represents securities that are hard-to-value, which are primarily securities that use Level 3 (unobservable) inputs. The Company estimates the fair value of hard-to-value fixed maturity securities, which includes securities that do not have observable market-based inputs or prices or that trade in markets that are less liquid. The Company uses judgment to determine the appropriate inputs and assumptions used to estimate the fair value of these hard-to-value securities. As of December 31, 2020, the estimated fair value of fixed maturity securities was $6,345.3 million.
•comparing the Company’s fair value estimates of hard-to-value securities to our independent range of fair value estimates for the same selection of securities
We identified the assessment of the estimate of reserves as a critical audit matter because it involved estimation uncertainty. Complex auditor judgment and specialized skills and knowledge were required in evaluating the selected methods and certain assumptions used to develop the estimate of reserves, including the selection of development factors and changes in claim frequency and severity trends. Additionally, subjective auditor judgment was required to assess the selected assumptions as there exists a range of potential inputs and the assumptions are sensitive to variation, such that minor changes in the assumptions could affect the reserves recorded by the Company.
•evaluating the Company’s reserving methods, procedures, key assumptions, and judgments by comparing to generally accepted actuarial standards
•developing an independent estimate for certain lines of business based on actuarial methodologies and assumptions in order to evaluate the Company’s recorded reserves
Horace Mann Educators Corporation is a holding company for insurance subsidiaries that market and underwrite personal lines of property and casualty insurance products (primarily personal lines automobile and property insurance), supplemental insurance products (primarily cancer, heart, hospital, supplemental disability and accident coverages), retirement products (primarily tax-qualified fixed and variable annuities) and life insurance products, primarily to K-12 teachers, administrators and other employees of public schools and their families (collectively, HMEC, the Company or Horace Mann).
The Company acquired NTA Life Enterprises, LLC (NTA) on July 1, 2019. As a result, the Company’s reporting segments changed in the third quarter of 2019. A new reporting segment titled "Supplemental" was added to report on the personal lines of supplemental insurance products that are marketed and underwritten by NTA.
The Company has reclassified the presentation of certain prior period information to conform to the current year's presentation.
All intercompany transactions and balances between HMEC and its subsidiaries and affiliates have been eliminated.
The Company invests predominantly in fixed maturity securities. This category includes primarily bonds and notes, but also includes redeemable preferred stocks. These securities are classified as available for sale and carried at fair value, of which a portion represent securities that are hard-to-value. See Note 3 - Fair Value of Financial Instruments - Investments for a detailed description of how the Company estimates fair value for its fixed maturity securities portfolio including hard-to-value securities.
An adjustment for net unrealized investment gains (losses) on all fixed maturity securities available for sale and carried at fair value, is recognized as a separate component of accumulated other comprehensive income (AOCI) within shareholders' equity, net of applicable deferred taxes and the related impact on deferred policy acquisition costs (DAC) associated with annuity contracts and life insurance products with account values that would have occurred if the securities had been sold at their aggregate fair value and the proceeds reinvested at current yields.
Limited partnership interests include investments in commercial mortgage loans, infrastructure, corporate credit, private equity, real estate and other funds. All investments in limited partnership interests are accounted for using the equity method of accounting.
The Company invests in fixed maturity securities and alternative investment funds that could qualify as variable interests in variable interest entities (VIEs), including corporate securities, mortgage-backed securities and asset-backed securities. Such variable interests in VIEs have been reviewed and the Company determined that those VIEs are not subject to consolidation as the Company is not the primary beneficiary because it does not have the power to direct the activities that most significantly impact those VIEs' economic performance.
The Company's methodology of assessing other-than-temporary impairments (OTTI) for fixed maturity securities is based on security-specific facts and circumstances as of the reporting date. Based on these facts, if (1) the Company has the intent to sell the security, (2) it is more likely than not the Company will be required to sell the security before the anticipated recovery of the amortized cost basis, or (3) management does not expect to recover the entire amortized cost basis of the security, OTTI is considered to have occurred. Additionally, if events become known that call into question whether the security issuer has the ability to honor its contractual commitments, such security will be evaluated to determine whether or not such security has suffered an other-than-temporary decline in fair value.
The Company has a policy and process to evaluate fixed maturity securities (at the cusip/issuer level) on a quarterly basis to assess whether there has been OTTI. These reviews, in conjunction with the Company's investment managers' monthly credit reports and relevant factors such as (1) the financial condition and near-term prospects of the issuer, (2) the length of time and extent to which the fair value has been less than the amortized cost basis (3) the Company's intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the anticipated recovery of the amortized cost basis, (4) the market leadership position of the issuer, (5) the debt ratings of the issuer, and (6) the cash flows and liquidity of the issuer or the underlying cash flows for asset-backed securities, are all considered in the impairment assessment.
credit loss component of the impairment from the amount related to all other factors and reports the credit loss component in net investment gains (losses). The impairment related to all other factors (non-credit factors) is reported in other comprehensive income (OCI). The allowance is adjusted for any additional credit losses and subsequent recoveries. Upon recognizing a credit loss, the cost basis is not adjusted. Prior to the adoption of ASU 2016-13 - Measurement of Credit Losses on Financial Instruments on January 1, 2020, when OTTI was deemed to have occurred, the investment would be written-down to fair value which became the new cost basis of the investment.
For fixed maturity securities where the Company records a credit loss, a determination is made as to the cause of the impairment and whether the Company expects a recovery in value. For fixed maturity securities where the Company expects a recovery in value, the constant effective yield method is utilized, and the investment is amortized to par.
The Company reports accrued investment income separately from fixed maturity securities, available for sale, and has elected not to measure an allowance for credit losses for accrued investment income. Accrued investment income is written off and recognized as a net investment loss at the time the issuer of the fixed maturity security defaults or is expected to default on payments.
With respect to fixed maturity securities involving securitized financial assets - primarily asset-backed and commercial mortgage-backed securities in the Company's portfolio - the underlying collateral cash flows are stress tested to determine if there has been any adverse change in the present value of cash flows below the amortized cost basis.
Mortgage-Backed Securities Not Issued By the U.S. Government or Federally Sponsored Agencies
The Company uses an estimate of future cash flows expected to be collected to evaluate its mortgage-backed securities for OTTI. The determination of cash flow estimates is inherently subjective and methodologies may vary depending on facts and circumstances specific to the security. All reasonably available information relevant to the collectability of the security, including past events, current conditions, and reasonable and supportable assumptions and forecasts, are considered when developing the estimate of future cash flows expected to be collected. Information includes, but is not limited to, debt-servicing, missed refinancing opportunities and geography.
The Company estimates the amount of the credit loss component of a fixed maturity security impairment as the difference between the amortized cost basis and the present value of the expected future cash flows of the security. Present value is determined using a best estimate of cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing a best estimate of cash flows vary depending on the type of security. Corporate fixed maturity security and municipal bond cash flow estimates are derived from scenario-based outcomes of expected restructurings or the disposition of assets using specific facts and other circumstances, including timing, security interests and loss severity and when not reasonably estimable, such securities are impaired to fair value based on management's best estimate of the present value of future cash flows. The cash flow estimates for mortgage-backed and other structured securities are based on security
specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds, and structural support, including subordination and guarantees.
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 most significant assumptions that are involved in the estimation of supplemental gross profits include morbidity, persistency, expenses and interest rates expected to be received on investments. When a supplemental policy lapses, there is an immediate write down of the associated DAC.
The Company accounts for the value of distribution acquired (VODA) associated with the acquisition of NTA based on an actuarial estimate of the present value of future business to be written by the existing distribution channel. VODA was $44.7 million as of December 31, 2020 and is being amortized on a straight-line basis. The Company estimates that it will recognize VODA amortization of $2.9 million in each of the years 2021 through 2025, respectively.
The Company accounts for the value of agency relationships based on the present value of commission overrides retained by NTA. Agency relationships was $12.9 million as of December 31, 2020 and is being amortized based on the present value of future premiums to be received. The Company estimates that it will recognize agency relationships amortization of $2.2 million in 2021, $1.9 million in 2022, $1.6 million in 2023, $1.4 million in 2024 and $1.2 million in 2025.
The Company accounts for the value of customer relationships based on the present value of expected profits from existing BCG customers in force at the date of acquisition. Customer relationships was $5.9 million as of December 31, 2020 and is being amortized based on the present value of future profits to be received. The Company estimates that it will recognize customer relationships amortization of $1.2 million in 2021, $1.1 million in 2022, $0.9 million in 2023, $0.7 million in 2024 and $0.6 million in 2025.
Annually, the Company performs a VOBA analysis on supplemental insurance policies to assess whether a loss recognition event has occurred. This initially involves comparing the historical and expected future experience on the block to the assumptions embedded in the original VOBA intangible asset. If both the experience to date and
Intangible assets that are not subject to amortization (i.e., trade names and state licenses) are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of an intangible asset that is not subject to amortization exceeds its fair value, an impairment loss is recognized in an amount equal to the excess.
At October 1, 2020, the Company performed qualitative assessments to determine whether it was necessary to perform quantitative intangible asset impairment tests. Based on the assessments of qualitative factors, there were no events or circumstances that led to a determination that it is more likely than not that the fair value of an intangible asset is less than its carrying amount with exception to VODA and trade names intangible assets assigned to BCG, for which quantitative intangible asset impairment tests were performed that resulted in intangible asset impairment charges of $4.4 million in aggregate.
When the Company was acquired from CIGNA Corporation by HME Holdings, Inc. in 1989, intangible assets were recognized as goodwill in the application of purchase accounting. In addition, goodwill was recognized in 1994 related to the acquisition of Horace Mann Property & Casualty Insurance Company and in 2019 related to the acquisitions of BCG and NTA.
Property and equipment is carried at cost less accumulated depreciation, which is calculated using the straight-line method based on the estimated useful lives of the assets. The estimated useful lives of real property range from 20 to 45 years. The estimated useful lives of leasehold improvements and other property and equipment, including capitalized software, generally range from 3 to 10 years. The following amounts are included in Other assets in the Consolidated Balance Sheets:
NOTE 1 - Basis of Presentation and Significant Accounting Policies (continued)
The Company elected to not use hedge accounting for derivative transactions related to FIA products. As a result, the Company accounts for the purchased call options and the embedded derivative related to the provision of a contingent return at fair value, with changes in fair value recognized as Net investment gains (losses) in the Consolidated Statements of Operations. The embedded derivative is bifurcated from the host contract and included in Other policyholder funds in the Consolidated Balance Sheets. The host contract is accounted for as a debt instrument in accordance with GAAP and is included in Investment contract and life policy reserves in the Consolidated Balance Sheets with any discount to the minimum account value being accreted using the effective yield method. In the Consolidated Statements of Operations, accreted interest for FIA products and benefit claims on these products incurred during the reporting period are included in Benefits, claims and settlement expenses.
Liabilities for Property and Casualty unpaid claims and claim expenses include provisions for payments to be made on reported claims, claims incurred but not yet reported (IBNR) and associated settlement expenses. All of the Company's reserves for Property and Casualty unpaid claims and claim expenses are carried at the full value of estimated liabilities and are not discounted for interest expected to be earned on the reserves. Estimated amounts of salvage and subrogation on unpaid Property and Casualty claims are deducted from the liability for unpaid claims. Due to the nature of the Company's personal lines business, the Company has no exposure to losses related to claims for toxic waste cleanup, other environmental remediation or asbestos-related illnesses other than claims under property insurance policies for environmentally related items such as mold.
The Company enters into reinsurance arrangements pursuant to which it cedes certain insurance risks to unaffiliated reinsurers. Cessions under reinsurance agreements do not discharge the Company's obligations as the primary insurer. The accounting for reinsurance arrangements depends on whether the arrangement provides indemnification against loss or liability relating to insurance risk in accordance with GAAP.
Premiums and contract charges for life insurance contracts with account values and annuity contracts consist of charges for the cost of insurance, policy administration and withdrawals. Premiums for long-term traditional life and supplemental policies are recognized as revenues when due over the premium-paying period. Contract deposits to annuity contracts and life insurance contracts with account values represent funds deposited by policyholders and are not included in the Company's premiums or contract charges earned.
The weighted average fair value of nonvested stock options outstanding on December 31, 2020 was $6.31. Total unrecognized compensation expense relating to the nonvested stock options outstanding as of December 31, 2020 was approximately $2.1 million. This amount will be recognized as expense over the remainder of the vesting period, which is scheduled to be 2021 through 2024. Expense is recognized on a straight-line basis over the vesting period for the entire award. Forfeitures of unvested amounts due to terminations and/or early retirements are recognized as a reduction to the related expenses.
Total unrecognized compensation expense relating to RSUs outstanding as of December 31, 2020 was approximately $6.5 million. This amount will be recognized as expense over the remainder of the performance and/or vesting period, which is scheduled to be 2021 through 2023. Expense is recognized on a straight-line basis from the date of grant through the end of the performance and/or vesting period for the entire award. Forfeitures of unvested amounts due to terminations are recognized as a reduction to the related expenses.
Options to purchase 713,080 shares of common stock at $38.05 to $42.95 per share were granted in 2017, 2018, 2019 and 2020 but were not included in the computation of 2020 diluted earnings per share because of their anti-dilutive effect. These options, which expire in 2027, 2028, 2029 and 2030, were still outstanding at December 31, 2020.
In June 2016 , the FASB issued guidance which revised the credit loss recognition criteria for certain financial assets measured at amortized cost, including reinsurance recoverables. The new guidance replaced the existing incurred loss recognition model with an expected loss recognition model. The objective of the expected credit loss model is for a reporting entity to recognize its estimate of expected credit losses for affected financial assets in a valuation allowance that when deducted from the amortized cost basis of the related financial assets results in a net carrying value at the amount expected to be collected. A reporting entity must consider all relevant information available when estimating expected credit losses, including details about past events, current conditions, and reasonable and supportable forecasts over the life of an asset. Financial assets may be evaluated individually or on a pooled basis when they share similar risk characteristics. The measurement of credit losses for available-for-sale debt securities measured at fair value is not affected except that credit losses recognized are limited to the amount by which fair value is below amortized cost and the carrying value adjustment is recognized through a valuation allowance which may change over time but once recorded cannot subsequently be reduced to an amount below zero. The guidance was effective for reporting periods beginning after December 15, 2019, and for most affected instruments was adopted using a modified retrospective approach, with a cumulative effect adjustment recorded to beginning retained earnings.
The components of net investment income for the following periods were as follows:
The Company, from time to time, sells invested assets subsequent to the reporting date that were considered temporarily impaired at such reporting date. Such sales are due to issuer specific events occurring subsequent to the reporting date that result in a change in the Company's intent or ability to hold an invested asset. The types of events that may result in a sale include significant changes in the economic facts and circumstances related to the invested asset, significant unforeseen changes in liquidity needs, or changes in the Company's investment strategy.
The following table reconciles net investment gains (losses) pretax by transaction type:
Fixed maturity securities with an investment grade rating represented 81.2% of the gross unrealized losses as of December 31, 2020. With respect to fixed maturity securities involving securitized financial assets, the underlying collateral cash flows were stress tested to determine there was no adverse change in the present value of cash flows below the amortized cost basis.
(1) The cumulative credit loss amounts exclude OTTI losses on fixed maturity securities held as of the periods indicated that the Company intended to sell or it was more likely than not that the Company would be required to sell the security before an anticipated recovery in value.
As of December 31, 2020 and 2019, the carrying amount of equity method limited partnership interests totaled $449.0 million and $383.7 million, respectively. Principal factors influencing carrying amount appreciation or decline include operating performance, comparable public company earnings multiples, capitalization rates and the economic environment. The Company recognizes an impairment loss for equity method limited partnerships when evidence demonstrates that the loss is other than temporary. Evidence of a loss in value that is other than temporary may include the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain a level of earnings that would justify the carrying amount of the investment.
At December 31, 2020 and 2019, there were no investments which exceeded 10% of total shareholders' equity in entities other than obligations of the U.S. Government and federally sponsored government agencies and authorities.
The Company is required to disclose estimated fair values for certain financial and nonfinancial assets and liabilities. Fair values of the Company's insurance contracts other than annuity contracts (which are investment contracts) are not required to be disclosed. However, the estimated fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk through the matching of investment maturities with amounts due under insurance contracts.
The 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. The Company utilizes its investment managers and its custodian bank to obtain fair value prices from independent third-party valuation service providers, broker-dealer quotes, and model prices. Each month, the Company obtains fair value prices from its investment managers and custodian bank, each of which use a variety of independent, nationally recognized pricing sources to determine market valuations for fixed maturity securities. Differences in prices between the sources that the Company considers significant are researched and the Company utilizes the price that it considers most representative of an exit price. Typical inputs used by these pricing sources include, but are not limited to, reported trades, bids, offers, benchmark yield curves, benchmarking of like securities, rating designations, sector groupings, issuer spreads and/or estimated cash flows, prepayment and default speeds, among others. The Company's fixed maturity securities portfolio is primarily publicly traded, which allows for a high percentage of the portfolio to be priced through pricing services. Approximately 91.9% and 94.1% of the portfolio, based on fair value, was priced through pricing services or index priced as of December 31, 2020 and 2019, respectively. The remainder of the portfolio was priced by broker-dealers or pricing models. When non-binding broker-dealer quotes can be corroborated by comparison to other vendor quotes, pricing models or analyses, the securities are generally classified as Level 2, otherwise they are classified as Level 3. There were no significant changes to the valuation process during 2020.
The valuation of hard-to-value fixed maturity securities (generally 100 -150 securities) is more subjective because the markets are less liquid and there is a lack of observable market-based inputs. This may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur. When the pricing sources cannot provide fair value determinations, the investment managers and custodian bank obtain non-binding price quotes from broker-dealers. For those securities where the investment manager cannot obtain broker-dealer quotes, they will model the security, generally using anticipated cash flows of the underlying collateral. Broker-dealers' valuation methodologies as well as investment managers’ modeling
The Company gains assurance that its portfolio of fixed maturity securities including hard-to-value fixed maturity securities is appropriately valued through the execution of various processes and controls designed to ensure the overall reasonableness and consistent application of valuation methodologies, including inputs and assumptions, and compliance with accounting standards. The Company’s 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, the Company assesses 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. The Company performs procedures to understand and assess the methodologies, processes and controls of valuation service providers. In addition, the Company may validate the reasonableness of fair values by comparing information obtained from valuation service providers or broker-dealers to other third-party valuation sources for selected securities.
•Derivatives, all call options - Fair values are based on the amount of cash expected to be received to settle each derivative on the reporting date. These amounts are obtained from each of the counterparties using industry accepted valuation models and observable inputs. Significant inputs include contractual terms, underlying index prices, market volatilities, interest rates and dividend yields.
•The fair value of derivatives embedded in IUL contracts is set equal to the fair value of the outstanding call options.
The following table presents the Company's fair value hierarchy for those assets and liabilities measured and carried at fair value on a recurring basis. At December 31, 2020, Level 3 investments comprised approximately 5.3% of the Company's total investment portfolio at fair value.
The Company did not have any transfers between Levels 1 and 2 during 2020 and 2019. The following tables present reconciliations for the periods indicated for all Level 3 assets and liabilities measured at fair value on a recurring basis.
(2) Includes U.S. Government and federally sponsored agency obligations for mortgage-backed securities and other asset-backed securities.
At December 31, 2020, the Company had a $0.3 million net investment loss on Level 3 financial assets. At December 31, 2019 the Company had a $1.1 million net investment loss on Level 3 financial assets. For the years ended December 31, 2020 and 2019, net investment losses of $11.5 million and $12.6 million, respectively, were included in net income that were attributable to the changes in the fair value of Level 3 financial liabilities still held.
(1) When a range of unobservable inputs is not readily available, the Company uses a single point best estimate.
(3) "N spread" is the interpolated weighted average life point on the swap curve.
(4) "T spread" is a specific point on the OTR curve.
The sensitivity of the estimated fair values to changes in the significant unobservable inputs for fixed maturity and equity securities included in Level 3 include: benchmark yield, liquidity premium, estimated cash flows, prepayment and default speeds, spreads, weighted average life, and credit rating. Significant spread widening in isolation will adversely impact the overall valuation, while significant tightening will lead to substantial valuation increases. Significant increases (decreases) in illiquidity premiums in isolation will result in substantially lower (higher) valuations. Significant increases (decreases) in expected default rates in isolation will result in substantially lower (higher) valuations.
The fair value of the deposit asset on reinsurance is estimated by discounting the future cash flows that are expected to arise out of the annuity reinsurance transaction. The treasury yield curve, plus an assumed credit spread, is used to determine the appropriate discount rate.
Other policyholder funds are liabilities related to supplementary contracts without life contingencies and dividend accumulations, as well as balances outstanding under funding agreements with the FHLB and embedded derivatives related to the FIA products. Except for embedded derivatives, each of these components is carried at cost, which management believes is a reasonable estimate of fair value due to the relatively short duration of these items, based on the Company's past experience.
During the second quarter of 2019, the Company reinsured a $2.9 billion block of in force fixed and variable annuity business with a minimum crediting rate of 4.5%. This represented approximately 50% of the Company’s in force fixed annuity account balances. The arrangement contains investment guidelines and a trust to help meet the Company’s risk management objectives.
The Company conducts goodwill impairment testing at least annually, or more often if events, changes or circumstances indicate that the carrying amount may not be recoverable. See Note 1 for further description of impairment testing.
In 2019, the annuity reinsurance transaction described in Note 5 triggered a requirement to evaluate the goodwill associated with the annuity business of the Retirement reporting unit. For the evaluation, the fair value of the Retirement reporting unit was measured using a discounted cash flow method. The carrying amount exceeded the fair value, resulting in a $28.0 million goodwill impairment charge during the second quarter of 2019. In the second quarter of 2019, the Company adopted guidance to eliminate Step 2 of the goodwill impairment test and as such, the goodwill impairment charge represented the entire balance of the goodwill associated with the annuity business of the Retirement reporting unit.
Goodwill impairment charges are reported as Other expense - goodwill and intangible asset impairments in the Consolidated Statements of Operations.
The changes in the carrying amount of goodwill by reportable segment for the year ended December 31, 2020 were as follows:
The VOBA intangible asset is being amortized by product based on the present value of future premiums to be received. The VODA intangible asset in respect to the acquisition of NTA is being amortized on a straight-line basis. The VODA intangible asset in respect to the acquisition of BCG is being amortized based on the present value of future profits to be received. The value of agency relationships intangible asset is being amortized based on the present value of future premiums to be received. The value of customer relationships intangible asset is being amortized based on the present value of future profits to be received.
Indefinite-lived intangible assets (not subject to amortization) as of December 31, 2020 were as follows:
At October 1, 2020, the Company performed a qualitative assessment to determine whether it was necessary to perform quantitative intangible asset impairment tests. Based on the assessment of qualitative factors, there were no events or circumstances that led to a determination that it is more likely than not that the fair value of an intangible asset is less than its carrying amount with exception to lower than anticipated BCG wealth management sales outside of the education markets which triggered a requirement to evaluate the intangible assets associated with BCG. For the evaluation, the fair value of BCG's intangible assets were measured using discounted cash flow methods. The carrying amounts for VODA and trade names exceeded the fair values resulting in a $3.6 million intangible asset impairment charge for VODA and a $0.8 million intangible asset impairment charge for trade names.
Intangible asset impairment charges are reported as Other expense - goodwill and intangible asset impairments in the Consolidated Statements of Operations.
The following table is a summary reconciliation of the beginning and ending Property and Casualty unpaid claims and claim expense reserves for the periods indicated. The table presents reserves on both a gross and net (after reinsurance) basis. The total net Property and Casualty insurance claims and claim expense incurred amounts are reflected in the Consolidated Statements of Operations. The end of the year gross reserve (before reinsurance) balances and the reinsurance recoverable balances are reflected on a gross basis in the Consolidated Balance Sheets.
The Company continually updates loss estimates using both quantitative and qualitative information from its reserving actuaries and information derived from other sources. Adjustments may be required as information develops which varies from experience, or, in some cases, augments data which previously was not considered sufficient for use in determining liabilities. The effects of these adjustments may be significant and are charged or credited to income in the period in which the adjustments are made.
An accident year refers to classifying claims based on the year in which the claims occurred. For estimating short-tail coverage reserves (e.g., homeowners and automobile physical damage), which comprise approximately 26.0% of the Company's total loss reserves as of December 31, 2020, the primary actuarial technique utilized is the development of paid loss dollars due to the relatively quick claim settlement period. As it relates to estimating long-tail coverage reserves (primarily related to automobile liability), which comprise approximately 74.0% of the Company's total loss reserves as of December 31, 2020, the primary actuarial technique utilized is the development of reported loss dollars due to the relatively long claim settlement period.
Numerous actuarial estimates of the types described above are prepared each quarter to monitor losses for each line of business, including the line's individual coverages, for reported losses and IBNR. Often, several different estimates are prepared for each detailed component, incorporating alternative analyses of changing claim settlement patterns and other influences on losses, from which the Company selects the best estimate for each component, occasionally incorporating additional analyses and judgment, as described above. These estimates also incorporate the historical impact of inflation into reserve estimates, the implicit assumption being that a multi-year average development factor represents an adequate provision. Based on the Company's review of these estimates, as well as the review of independent reserve studies, the best estimate of required reserves for each line of business, including the line's individual coverages, is determined by management and is recognized for each accident year, then the required reserves for each component are summed to create the reserve balances carried on the Company's Consolidated Balance Sheets.
Based on the Company's products and coverages, historical experience, and various actuarial methodologies used to develop reserve estimates, the Company estimates that the potential variability of the Property and Casualty loss reserves within a reasonable probability of other possible outcomes may be approximately plus or minus 6.0% of reserves, which equates to plus or minus approximately $12.0 million of net income as of December 31, 2020. Although this evaluation reflects the most likely outcomes, it is possible the final outcome may fall below or above these estimates.
In the normal course of business, the Company's insurance subsidiaries assume and cede reinsurance with other insurers. Reinsurance is ceded primarily to limit losses from large events and to permit recovery of a portion of direct losses; however, such a transfer does not relieve the originating insurance company of primary liability.
The Company's catastrophe losses incurred of approximately $84.4 million, $52.0 million and $107.3 million for the years ended December 31, 2020, 2019 and 2018, respectively. For 2020, catastrophe losses were impacted by winter storm events, wind/hail/tornado and derecho events, as well as tropical storms and hurricanes.
(1) Excludes the annuity reinsurance agreement accounted for using the deposit method that is discussed in Note 5.
There were no losses from uncollectible reinsurance recoverables in the three years ended December 31, 2020. Past due reinsurance recoverables as of December 31, 2020 were not material.
For liability coverages, in 2020, the Company reinsured each loss above a retention of $1.0 million with coverage up to $5.0 million on a per occurrence basis and $20.0 million in a clash event. (A clash cover is a reinsurance casualty excess contract requiring two or more casualty coverages or policies issued by the Company to be involved in the same loss occurrence for coverage to apply.) For property coverages, in 2020, the Company reinsured each loss above a retention of $1.0 million up to $5.0 million on a per risk basis, including catastrophe
In 2017, Horace Mann Insurance Company (HMIC) became a member of the FHLB, which provides HMIC with access to collateralized borrowings and other FHLB products. As membership requires the ownership of membership stock, in June 2017, HMIC purchased common stock to meet the membership requirement. Any borrowing from the FHLB requires the purchase of FHLB activity-based common stock in an amount equal to 4.5% of the borrowing, or a lower percentage - such as 2.0% based on the Reduced Capitalization Advance Program. In the fourth quarter of 2017, HMIC purchased common stock to meet the activity-based requirement. In 2019, the Board authorized a maximum amount equal to 15% of net aggregate admitted assets less separate account assets of the insurance subsidiaries for FHLB borrowings. During the fourth quarter of 2017, the Company received $50.0 million in executed borrowings for HMIC. Of the total $50.0 million received, $25.0 million matures on October 5, 2022 and $25.0 million matures on December 2, 2022. Interest on the borrowings accrues at an annual weighted average rate of 0.44% as of December 31, 2020. In May 2020, the Company received a $4.0 million COVID relief advance for HMIC that matures May 17, 2021. There is no interest on this borrowing. HMIC's FHLB borrowings of $54.0 million are included in Long-term debt in the Consolidated Balance Sheets.
The income tax assets and liabilities included in Other assets and Other liabilities, respectively, in the Consolidated Balance Sheets were as follows:
The components of the provision for income tax expense (benefit) were as follows:
The Company's effective tax rate would be affected to the extent there were unrecognized tax benefits that could be recognized. There are no positions for which it is reasonably possible that the total amount of unrecognized tax benefit will significantly change within the next 12 months.
The Company classifies all tax related interest and penalties as income tax expense.
The Company has various operating lease agreements, primarily for real estate offices. Such leases have remaining lease terms of 1 year to 5 years, some of which may include options to extend certain leases for up to an additional 25 years.
Supplemental cash flow information related to operating leases was as follows:
Supplemental balance sheet information related to operating leases were as follows:
Future minimum lease payments under non-cancellable operating leases as of December 31, 2020 are as follows:
In 1996, the shareholders of HMEC approved authorization of 1,000,000 shares of 0.001 par value preferred stock. The Board is authorized to (1) direct the issuance of the preferred stock in one or more series, (2) fix the dividend rate, conversion or exchange rights, redemption price and liquidation preference, of any series of the preferred stock, (3) fix the number of shares for any series and (4) increase or decrease the number of shares of any series. No shares of preferred stock were issued or outstanding at December 31, 2020 and 2019.
In 2010, the shareholders of HMEC approved the 2010 Comprehensive Executive Compensation Plan (the Comprehensive Plan). The purpose of the Comprehensive Plan is to aid the Company in attracting, retaining, motivating and rewarding employees and non-employee Directors; to provide for equitable and competitive compensation opportunities, including deferral opportunities; to encourage long-term service; to recognize individual contributions and reward achievement of Company goals; and to promote the creation of long-term value for the Company's shareholders by closely aligning the interests of plan participants with those of shareholders. The Comprehensive Plan authorizes share-based and cash-based incentives for plan participants. In 2012, the shareholders of HMEC approved the implementation of a fungible share pool under which grants of full value shares will count against the share limit as two and one half shares for every share subject to a full value award. In 2015, the shareholders of HMEC approved an amendment and restatement of the
Comprehensive Plan which included an increase of 3,250,000 in the number of shares of common stock reserved for issuance under the Comprehensive Plan. As of December 31, 2020, approximately 751,661 shares were available for grant under the Comprehensive Plan. Shares of common stock issued under the Comprehensive Plan may be either authorized and unissued shares of HMEC or shares that have been reacquired by HMEC; however, new shares have been issued historically.
Deferred compensation for employees is in the form of CSUs, which represent an equal number of common shares to be issued in the future. Distributions of employee deferred compensation are allowed to be either in common shares or cash. Through December 31, 2020, all distributions have been in cash. The outstanding units accrue dividends at the same rate as dividends paid to HMEC's shareholders. These dividends are reinvested into additional CSUs.
Option information segregated by ranges of exercise prices were as follows:
As of December 31, 2020, based on a closing stock price of $42.04 per share, the aggregate intrinsic (in-the-money) values of vested options and all options outstanding were $2.5 million and $2.9 million, respectively.
(2) Includes distributed units which were utilized to satisfy withholding taxes due on the distribution.
In converting from statutory to GAAP, typical adjustments include DAC, certain reinsurance transactions, the inclusion of statutory non-admitted assets and the inclusion of net unrealized investment gains or losses in shareholders' equity relating to fixed maturity securities.
The NAIC has risk-based capital guidelines to evaluate the adequacy of statutory capital and surplus in relation to risks assumed in investments, reserving policies, and volume and types of insurance business written. At December 31, 2020 and 2019, the minimum statutory-basis capital and surplus required to be maintained by HMEC's insurance subsidiaries was $113.2 million and $108.1 million, respectively. At December 31, 2020 and 2019, statutory capital and surplus of each of the Company's insurance subsidiaries was above required levels. The restricted net assets of HMEC's insurance subsidiaries were $26.9 million and $26.0 million as of December 31, 2020 and 2019, respectively. The minimum statutory basis capital and surplus amount at each date is the total estimated authorized control level risk-based capital for all of HMEC's insurance subsidiaries combined. Authorized control level risk-based capital represents the minimum level of statutory basis capital and surplus necessary before the insurance commissioner in the respective state of domicile is authorized to take whatever regulatory actions considered necessary to protect the best interests of the policyholders and creditors of the insurer. The amount of restricted net assets represents the combined fair value of securities on deposit with governmental agencies for the insurance subsidiaries as required by law in various states in which the insurance subsidiaries of HMEC conduct business.
HMEC relies largely on dividends from its insurance subsidiaries to meet its obligations for payment of principal and interest on debt, dividends to shareholders and parent company operating expenses, including tax payments pursuant to tax sharing agreements. Payments for share repurchase programs also have this dependency. HMEC's insurance subsidiaries are subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to HMEC without prior approval of the insurance regulatory authorities. As a result, HMEC may not be able to receive dividends from such subsidiaries at times and in amounts necessary to pay desired dividends to shareholders. The maximum amount of dividends that may be paid in 2021 from all of HMEC's insurance subsidiaries without prior regulatory approval is $248.7 million, excluding the impact and timing of prior year dividends.
Total expense recognized for the non-qualified defined contribution, 401(k), defined benefit and supplemental retirement plans was $10.0 million, $9.3 million and $8.9 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Contributions to employees' accounts under the 401(k) plan and the non-qualified defined contribution plan, as well as total assets of the plans, were as follows:
The change in the Company's AOCI for the defined benefit plans for the year ended December 31, 2020 was primarily attributable to better than expected asset returns, updates to mortality assumptions and updated census dates partially offset by a decrease in the discount rate and an updated mortality projection scale. The change in the Company's AOCI for the defined benefit plans for the year ended December 31, 2019 was primarily attributable to better than expected asset returns, updates to mortality assumptions and updated census dates offset by a decrease in the discount rate. The change in the Company's AOCI for the defined benefit plans for the year ended December 31, 2018 was primarily attributable to lower than expected asset returns and updates to mortality assumptions and an increase in the discount rate.
There were no Level 3 assets held during the years ended December 31, 2020 and 2019.
In 2021, the Company expects amortization of net losses of $0.5 million and $0.4 million for the defined benefit plan and the supplemental retirement plans, respectively, and expects no amortization of prior service cost for the supplemental retirement plans to be included in net periodic pension expense.
In 2021, there is no minimum funding requirement for the Company's defined benefit plan. The following table discloses that minimum funding requirement and the expected full year contributions for the Company's plans.
The Company's defined benefit plan may be subject to settlement accounting. Assumptions for both the number of individuals retiring in a calendar year and their elections regarding lump sum distributions are significant factors impacting the payout patterns for each of the plans below. Therefore, actual results could vary from the estimates shown. Estimated future benefit payments as of December 31, 2020 were as follows:
From time to time, the Company has outstanding commitments to fund investments in limited partnership interests, commercial mortgage loans and bank loans. Such unfunded commitments were $571.9 million and $306.2 million for the years ended December 31, 2020 and 2019, respectively.
Comparative information for elements that are not required to be reclassified in their entirety to net income in the same reporting period is located in Note 2.
The accounting policies of the segments are the same as those described in Note 1. The Company accounts for intersegment transactions, primarily the allocation of operating and agency costs from Corporate and Other to Property and Casualty, Supplemental, Retirement and Life, on a direct cost basis.
(2) This measure is not based on accounting principles generally accepted in the United States of America (non-GAAP). An explanation of this measure is contained in the Glossary of Selected Terms included as an exhibit in the Company's reports filed with the SEC.
(3) Excludes the annuity reinsurance transaction accounted for under the deposit method that is discussed in Note 5.