Horace Mann Educators Corporation (HMN) Q4 2020 Earnings Report, Transcript and Summary

Good morning and welcome to the Horace Mann Educators Fourth Quarter and Year-end 2020 Investor's Call. All participants will be in listen-only mode After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I'd now like to turn the conference over to Heather Wietzel, Vice President of IR. Please go ahead.

Thank you, and good morning, everyone. Welcome to Horace Mann's discussion of our full year and fourth quarter results. Yesterday, we issued our earnings release and investor supplement. Copies are available on the Investor page of our website along with our investor presentation, which was posted this morning.

Thanks Heather. Good morning, everyone. Last night, we reported fourth quarter core earnings of $1.13 per diluted share, a significant increase over prior year. This contributed to full-year 2020 core earnings of $3.40 per diluted share, more than 50% higher than the prior year and our highest annual core earnings ever. Core return on equity was 10.5%, up from 7.3% in 2019. In 2020, we were not alone in facing difficult challenges. COVID-19, a record number of catastrophe events, and a sustained low interest rate environment. The fact that in this environment, our company not only survived, but thrived underscores the strength of Horace Mann's mission and strategies, the dedication of our employees and agents to support our customers, and the importance of the solutions we provide to help educators protect what they have today and prepare for a successful tomorrow. We are seeing the tangible benefits of a multiyear strategic plan to better serve the education market by enhancing our product offerings, strengthening our distribution, and modernizing our infrastructure. Because of this strong foundation, we were able to stay focused on our mission and use 2020 to make progress in accelerating the integration of key transactions including making major strides toward full integration of our Supplemental segment. Horace Mann has been successful for 75 years because our business is centered around the relationships we have with the education community.

Thanks, Marita, and good morning, everyone. As Marita noted, fourth quarter core EPS was up 51% over last year. Full-year core EPS was up 55% to $3.40 compared with $2.20 in 2019. That put us well ahead of the guidance we offered last quarter and even further ahead of our original 2020 guidance range of $2.55 to $2.75. We estimate our strategic initiatives drove about one-third of the improvement over 2019, essentially tracking with our original guidance. The remaining two-thirds of the improvement was attributable to pandemic related and other factors that largely won't repeat, such as the Camp Fire subrogation recovery. Our 2021 EPS guidance of $3.00 to $3.20 presumes we will see recovery from the lingering effects of the pandemic on sales later in the year, as well as another year of progress on the product, distribution, and infrastructure initiatives that support our market share expansion. The guidance range reinforces that we expect to see another year of progress towards sustainable long-term double-digit ROEs. I'm going to dive right into the performance and outlook for each segment, and then I'll finish up returning to what 2021 and beyond holds for Horace Mann. For Property and Casualty, core earnings were up 40.9% for the year, reflecting a 3.8-point improvement in the reported combined ratio. Premiums for the year were down about 7% as lower new sales and the $10.2 million in pandemic-related premium credits in the second quarter more than offset the return of the reinstatement premiums related to the PG&E subrogation recovery in Q3. Policyholder retention remained stable for the year with rates generally stable as well. Looking at 2021, we expect new sales will remain pressured while COVID-19 vaccines are being rolled out across the country with a return to pre-pandemic sales levels starting in the fourth quarter as the country moves closer to a post-vaccine environment. P&C investment income for the year was up 2.2%. It was very strong in the fourth quarter, reflecting favorable limited partnership returns. Underwriting income and the combined ratio improved for the full year, despite the $32.4 million increase in catastrophe losses above last year's level, which added 13 points to the combined ratio compared with 7.6 points last year. The losses were in line with our implied market share as the industry experienced a record number of PCS catastrophe events in 2020. 61 of these catastrophes affected our policyholders.

Thank you, Bret. Operator, we're ready for questions.

The first question is from Matt Carletti from JMP Securities. Please go ahead.

Marita, I wanted to ask you a question about growth. It was pretty clear from your and Bret's comments throughout the opening that there is a focus on growth, returning to growth as kind of we get past the pandemic and back towards a little more normality. Can you help us put together the bigger picture? This may be a walk from pre-pandemic to pandemic and to post-pandemic, just in terms of there hasn't been kind of PIF growth for a while. Understand that maybe pre-pandemic you were working on getting the pieces in place so that it made sense to grow. Obviously, the pandemic you've spoken about a bit about, but maybe the biggest challenges there. And then what - I sense your optimism and your confidence about growth post-pandemic and what gives you that confidence that once these conditions clear, Horace Mann will be growing again?

Yes. Thanks, Matt. I love the way you sometimes answer your question while you're asking it, but we spent a lot of time putting together an investor presentation that I think is pretty transparent and includes all of our thinking. So if you look at page six in the investor deck or page eight in the investor deck, six tries to take you through the phases of our strategic progress, of our journey if you will even before we even thought about pandemic environment. And if you look at the ROE slide on eight, it really does track again ex-2020, how we thought about those phases going forward. And putting 2020 aside for a minute, if you go back and you think about that fix-and-build phase, that was really about addressing the PDI gaps that we had, product holes in our portfolio, strengthening the tools for distribution, modernizing our infrastructure, and the work that we had to do in that phase, originally '19 and '20, and we expanded that by a year, if you will, because of what occurred in 2020. That was really about the strategic initiatives, the transformational stage, how we thought about the levers in that phase, so that we could ultimately leverage a leadership position within the education market and grow this franchise. And if you go back and think about what we executed in 2019, the three strategic transactions if you will, the addition of the Supplemental segment, adding 150,000 households, bringing those agents who knew our education market and were in the education marketplace already. We all know that recruiting is difficult. We all know that onboarding is difficult. Having those NTA agents that know our space to work with wound up being even more essential than we thought. Adding B2B capabilities with BCG, doing the reinsurance transaction, I mean, we've talked about this. We assumed lower for longer. I don't know if we were as brilliant enough to assume it would be this low for this long, but that proved to be just the right transaction for us, maybe before many others have, quite frankly jumped on that bandwagon, worked really well for us. But also underneath that, during that phase, we improved our auto loss ratio. We saved more than $15 million in expenses. I feel like we actually very specifically laid out for you and the Street what we were going to do and what the economic reality of that phase would be. And it's come through almost exactly the way we thought about it. So when I step back from that, I think about what we earned in 2019 at about 20 what we earned in 2020 without non-reoccurring pandemic benefit, call it the midpoint of our range at about 266, that's a 20% increase in earnings. Take the midpoint of the range for 2021, that's another 20% ish. I think that's pretty good earnings trajectory and pretty close to what we told you we were thinking that translates again looking at page 8 to that 7.5 ROE, go into an 8.5, ROE go into about a 9.5 ROE. Now when I step back and I unpacked 2020 and I think about what occurred for us in 2020. We talk about these non-reoccurring things, but think about the camp fire subrogation. Yes, that was in our numbers that got us to the 340. But for me I step back and I say we had record earnings obviously with all the positives, the benefits, the financial benefits of COVID, but we had record earnings without it, but I think about that non-reoccurring camp fire subrogation, although that isn't going to happen again. We got a lot of benefit from that we thought on behalf of our reinsurers, we made the right choice. And I think because of that I know because of that we got below market pricing on a reinsurance renewals. So that is something that did come through when we look at 2021 and helps us there as well. Obviously, the biggest part of that non-reoccurring is auto frequency in 2021, we will still get the benefit of driving behavior patterns being different in a pandemic environment and that will gradually increase as we go through the year. The premium credit in 2020 never been done. We did it. We did it well. We did it state-by-state-by-state, which wasn't an easy thing to do, but we did it and I think we did it without skipping a beat. We had 61 caps, and our NPS scores and claims actually went up. We integrated the supplemental agents and accelerated that integration so that when we come out of this pandemic environment they are better prepared to serve our educators, we virtualized our sales process, and I think we connected with our educators more and in different ways than maybe we ever have. So I come out of this thing what we said we would do the numbers came through the way we thought they would come through and we are better positioned at the end of this period, then we were going into it. And we took the time to really work hard internally to accelerate anything that we could accelerate. So that when we come back to a more physical world, we've got all that virtualization that we built, all of those virtual touches with our clients, and then we add our physicality on top of it, and I think that's why we do get excited and you can sense that when we think about how we take advantage of. I think a pretty well laid out strategy and a very transparent financial plan that came through almost exactly the way we said it would come through.

Thank you. That color is very helpful. One other quick one, just kind of tagging on to that, you hit on the ROE. The walk if you will. In slide 8, you gave a great color on it. Can I ask around that ROE? One is just kind of how you define ROE. I'm assuming it kind of fixed income realized gains and average equity across the year. But more importantly, Bret I caught your comment about it kind of considerations with excess capital and potential for opportunistic share repurchases across the year. Is there any assumption of that built into the ROE guidance?

Yes, so Matt, you are absolutely correct with the ROEs being calculated. I probably should mention to that our ROE guidance reflects our targeted capital levels, which you're are well aware at 425. So we ended up finishing this year with about approximately $40 million of excess capital that we generated this year and I think as we've communicated with the addition of NTA that gives us the ability to generate double what we had prior to that acquisition, but I think, maybe I'll tap dance around your question a little bit, but we've shown our willingness to effectively use capital whether that is as Marita said first and foremost, as it was the case last year, and it's again the case this year. At first and foremost focused on growth, paying a compelling dividend to our shareholders and if opportunities present themselves to buy-back shares, we will do that. So those levers remain the same, but I think where we were a year ago with. We definitely want to focus on growth and we've shown we are willing to do that organically - oriented organically.

The next question is from Meyer Shields from KBW. Please go ahead.

I just want to make sure I understand the - I guess the supplemental and the Property-Casualty guidance, are you expecting sort of like a linear recovery in claim frequency over the course of the year, or is it a little bit more steep in the back half of the year, assuming that the vaccines are distributed effectively?

Yes. I think in both P&C and Supplemental, the way we think of both return of growth, as well as loss patterns, is it's gradual, right. If you think first from a top line perspective, when we look at 2020, we had decent momentum in growth in the first quarter, and obviously, that began to slow with the onset of the pandemic and the loss of physicality. And then we did see a little bit of improvement towards the end of the year. We look at 2021 similarly; only in reverse. So we would expect the fourth quarter of 2021 to begin to show some momentum, and our guidance and our plan includes almost a repeat of top line numbers in 2021 over 2020 just in an opposite way. And we would expect that to be gradual, just as we would expect the return to a more normal life in the U.S. to be gradual. And I think loss patterns will be similar when you think about when will people feel more comfortable driving not only the same amount of miles, but during a similar pattern as before, I think that will be gradual. When will people return to care and how they will use Supplemental coverage will be as gradual as our return to a more normal life? So I mean, that's really how we're thinking about it. Bret?

Yes. And Meyer, I don't know if you were hitting on frequency as well, and Mark can maybe jump in here after I make a couple comments. But certainly we experienced about overall for the year and certainly not linear. The second quarter was about a 40% drop, I think the third quarter was about a 25% drop, and then fourth quarter around 20%. Yes, we are factoring in a reduction in auto frequency in 2021. I'll let Mark talk about that certainly not to the extent that we saw in 2020. In Supplemental as well, we are going to most likely benefit from some, COVID behavior in 2021, but here again not to the same level as 2020. And as you step back and look at 2021, really, it's P&C and Supplemental. Yes, the earnings are reduced from the current year, but still rock solid and then Life and Retirement improving from 2021 largely attributable to the increase in alternative investment income in 2021. So Mark, I don't know if you wanted to perhaps add a little color on the frequency and maybe touch upon severity as well.

Yes. Absolutely, Bret. I think it's important when we look at how things are playing out over 2021 that it's not just about looking at frequencies, about looking at overall loss costs, and we've really shifted our focus to be on what's happening with loss costs because we believe some of what we're seeing is actually a little bit of an inverse relationship between the frequency and severity. So as we see the drop in frequency, we know that part of it is at least driven by - at least partially by the removal of smaller fender bender type losses. Now that being said, as Bret says, that as we finished out the year, we did continue to see frequency below pre-pandemic levels pretty consistent with the third quarter. And as we examine some of the driving data that we get out of HMDrive regarding our educator customers, we certainly continue to see them driving safely during the pandemic, especially compared to what we might hear anecdotally about the general population, and this is most notably true around speeding that we continue to not see those speeding events, but we're certainly not immune from the impact of shifting driving behaviors or the economy for that matter. And as a result, we have seen higher severities which have partially offset the continued decrease we're seeing an accident frequency.

And I did mean both side that in terms of production and frequency so that is tremendously helpful. On Supplemental, so we've seen obviously behavioral changes impacting profitability. Can you talk a little bit about the product flexibility in case educators decide that maybe there are some parts of the policy that maybe they can't live without, as we've seen over the course of the pandemic?

Let me start, and maybe I'll have Wade jump in as well. But as it relates to, you know the pandemic related impact on the benefits paid ratio, we ended the year down roughly about 5 percentage points. Our benefits paid ratio is just under 33, it was about 37.5 last year. And really the majority of that is related to probably approximately $6 million in COVID related benefits paid. People just not going to - to go get the care and get reimbursed for those expenses as they had the pandemic not been in place. But as far as pieces of policies that they could perhaps not you - I don't think that's the case, but I'll have Wade chime in on that, on that item.

Sure, Bret. Yes, I mean when I look at the policies, I think there is a lot of flexibility in how they're designed. I think that behavior that's changed this last year is just people aren't going into the hospital for maybe an accident, where they would in the past or maybe some disability type claims, but I don't see, outside of the gradual return to that in 2021. A lot of our coverages are around the cancer and heart coverages and I think those customers certainly have the flexibility to adjust them up and down in terms of the benefits, but I think the usage will be pretty stable as we move forward.

Yes, I think that's absolutely right. Wade. I think the products are very straightforward and the expenses that they cover will be needed just as much in a post-pandemic environment as they were before. We also believe that in this kind of environment the propensity to buy both supplemental and life insurance is probably heightened.

The next question is from John Barnidge from Piper Sandler. Please go ahead.

Thank you and congrats on the record quarter. In the last stimulus, there was a noted uptick in inflows in 2Q '20 and 3Q '20. Do you expect a similar level of behavior in 1Q '21 and 2Q '21 as a result of retirement?

John, this is Bret. And perhaps Mike Weckenbrock can chime in here too. I think as it relates to Horace Mann, we traditionally do not see the drops and flows that when there's been financial crisis, if you will or turmoil out there. I think this year is a prime example. I think it was in my prepared remarks, but we saw an increase in our contract deposits for 2020, up 4.5% and I think that's going to run contrary to the industry. I don't know Mike if there is anything you want to add to that comment.

No. I think you hit it on the, Bret. We actually saw a decrease in withdrawal transactions as well. So very strong year. I think it speaks to the educators continuing to be in the workplace and the long-term planning that they - they take under consideration.

Okay. And then another question if I could, and I get it may be scale, but what percent of schools are currently physical versus virtual in your distribution footprint? And then do you have an expectation a post pandemic world that some schools will actually just remain hybrid. I don't know maybe specifically high schools.

Yes, John, I think it's a good question and I think we've all been hearing. I think what's becoming a prevailing fact in that is there isn't a replacement for physicality. All the studies that are being done drops in scores it just a fewer virtual environment doesn't provide the level of what public physical education in the U.S. provides. We have been keeping track because we have to take different approaches, just like our schools are taking different approaches, whether it's virtual, whether it's physical, whether it's hybrid, and we are operating in all of those environments, and all of those environments in a constantly changing environment, because even a school that has chosen 100% virtual goes hybrid, the next week and then goes physical and we've all seen that. But I think what this is telling all of us is that our education system works and that there isn't a replacement for physicality. I hope that our school system will do the same thing as what companies are doing across the U.S. and figuring out what are they learning. What are we - for example will snow days change? Right? I mean, all the discussion around if the snow happens, do we just go remote that day as opposed to having a school day. I'm hoping we take the benefit of what we're learning on many fronts and applying it to our new - our new approach post-pandemic. But I have no - I have no doubt that the majority of our school systems will be predominantly physical as soon as they can be. When you think about a lot of the political discussion about keep the schools open and close the bars that was probably right. And I believe that we will work really hard to get physicality in as many as schools as quickly as possible and then eventually go back to something, hopefully, even better than what we had prior to the pandemic.

All right, thank you very much. And if I could sneak possibly one more in. Historically it seems that your initial guidance is around 7 to 7.5 points on cat. This year it's 9.5 points. Is that just a realization that over the last 5 years it's averaged about 10 to 11 points, or is it based on 1Q '21 cat loss experience so far?

Not at all, not at all. When we first put that together, we didn't know anything about January. So it has absolutely nothing to do with that. It's just the math. When you run 5-year averages, 10-year averages and look at the amount of cats, obviously, the last 2 years, does push that number, it could be conservative. The only thing you know about that number if you don't know what that number is going to be, but you add 2 more pretty heavy years to that number and the actuarial number that splits out is higher. That's all that is.

Yes, and John, I think I even noted that in my prepared remarks at that actually does represent the 10-year average cat load, so that the math does support that like Marita said, will that occur - like she said it won't be right, but we feel that it's appropriate given what's happened recently.

All we know is that it won't be right.

The next question is from Gary Ransom from Dowling & Partners. Please go ahead.

If I look across the sweep of the underlying loss ratios in auto across the quarters, there's a lot of things - different things going on and I think what I'm trying to get out is that the fourth quarter seems a little bit higher than I would have expected in the sequence. You told us that it was 20% I think it was 20% frequency, and it was 25 last quarter and there may be other things going on, there is some seasonality I know. There may be is some impact from the prior efforts to improve the results. I just wondered if you could kind of unpack that what we were seeing over the course of the year and what is happening in the fourth quarter loss ratio?

Yes, I think you hit upon a lot of things, Gary, this is Bret. And I'll hand it off to Mark here in a minute. But certainly from quarter-to-quarter we can have seasonality and obviously this year we've got a few other extra things going on with COVID et cetera. But - as you look at the full year I tend to - from quarter-to-quarter you can have some variability, but to end the year 10 points below on underlying basis is a great day obviously. We would certainly target and all in total P&C 95 combined ratio to get it our targeted ROE. But as it relates to the fourth quarter, I'll let Mark comment on some of the - maybe for specific coverages if you will, that we saw a little bit of uptick in.

Yes, absolutely Bret. Gary, so - I think you made a couple of good points there is certainly some effect to seasonality that's pretty normal. And when we look at how the fourth quarter played out relative to what we thought coming into the fourth quarter. It was actually reasonably close to our expectations, but certainly the frequency probably played out a little bit better than we thought and the severity probably play-out a little bit higher. And I think some of what we're seeing is what I mentioned before about some of the smaller losses continuing to kind of disappear from the loss distribution. And then we've also seen I think Bret alluded to this in the script, we've certainly seen an uptick in UM, UIM related claims. So if we look at loss costs for the year in our accident-based coverages most of the coverages are down about say about 20%, but UM, UIM is actually flat to up even a little bit. A: We don't get a lot of debts to begin with, but we certainly seen those impacts. So it's, I think there is some effect of what is going on in the economy that's driving severity to somewhat offset what we might see in pure accident frequency.

Yes, I think, Gary. I would add and I think you may have noted it in your note that even though elevated from the third quarter, it's still below roughly four points from the fourth quarter a year ago. And I know as Mark said, fourth quarter auto can be not our strongest quarter for the year where kind of opposite way property sometimes can be very, very good in the fourth quarter.

But there was nothing we saw in that fourth quarter analysis that concerned us to the point where it would affect how we thought about the profitability of the line, the restoration of the profitability and the strong guidance that we put forward for 2021.

Am I to take from the UM, UIM claim activity that there is a lot more uninsured drivers out on the roads at this point? Is that why that's happening?

I think it's somewhat uninsured. But it's a lot of under-insured, Gary right. So people are in this environment perhaps buying less coverage.

Right.

.:

All right, thanks. Can I get some - an extension or I'm sorry a question on the expense ratio, you said Bret in your script that it was up for normal accruals. Can you remind us what those normal accruals are at year-end?

Certainly one is with the results for the year we trued up our incentive compensation accruals as part of it. And just any with some of the initiatives that we have going on just - but expenses for modernization, consulting et cetera. So, nothing out of the normal I would say, certainly we true up all of our incentive comp in the fourth quarter to reflect actual results.

Okay, fair enough. Changing subjects on the supplemental business is performing very well. Can you give us a little bit of a view of how you thought about that business at the time of the acquisition and what you expected from it versus what you are seeing now? I'm asking the question in the context that it seems like it's turning out better than you thought, but maybe it as you expected, but can you give us some thoughts on that?

Yes, I mean I think when we looked at potential inorganic activity to advance our strategy. We went back to our PDI strategy, and NTA was an organization that hit on all three of those pillars, it brought a product that our educators needed and bought that we didn't offer, it brought distribution in that these were agents with relationships in schools on selling and almost a virtual work site environment similar to the way the product is sold in the rest of the industry, which is why we saw some softness in the sales due to COVID-19. And from an infrastructure standpoint, interestingly enough, it brought some opportunities, for example, our integration of our life systems using the same life and health system across both organizations, the ability to not have two investment arms, the ability to not have two HR operations. So when I thought about NTA it advanced the P, the D and the, I and all those things are coming through exactly the way we thought they would come through. We are conservative when we think about our financials. We didn't get ahead of our skis as far as what the benefits of that business would be, but we knew they would be there. And what I get very excited about is we haven't even begun to scratch the surface on the cross-sell opportunity. I mean, look we cross-sell about 50% better than the industry. There is no reason to believe that we won't be able to build this into our repeatable sales process and offer supplemental, and we're seeing it. We took this acceleration opportunity during this year and we're seeing the NTA agents that joined us and now Horace Mann agents with their own territory is writing auto, writing retirement, writing life as a matter of fact. Our November agent of the month in auto was a previous NTA supplemental agent. So we are seeing that start to come through and the Horace Mann agents are now including supplemental in their annual policy reviews and offering that coverage. So yes, is it performing better than we financially modeled? It is, but make no mistake we knew what the benefit of this would be when we built it into our strategy and our repeatable sales process as an organization.

The next question is a follow-up from John Barnidge from Piper Sandler. Please go ahead.

Last question took care of it. Thanks a lot.

You're welcome.

Right, this concludes our question-and-answer session. I would like to turn the conference back over to Heather Wietzel for any closing remarks.

Yes, thank you everyone for joining us today. I'll be available to the rest of the week, if there is additional follow-up, and I will remind all that we will be continuing to do virtual investor meetings over the course of the coming months. In particular we'll be participating in the virtual events. So, we look forward to talking to people and what's going on. So thank you again.

Thanks everybody.

Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.