Horace Mann (HMN) Ratings Affirms by Fitch Following Qtr. Results; Outlook Remains Stable

Fitch Ratings has affirmed the 'A' Insurer Financial Strength (IFS) ratings of Horace Mann Educators Corporation's (HMN) insurance subsidiaries. Fitch has also affirmed Horace Mann's Issuer Default Rating (IDR) at 'BBB+' and senior unsecured notes at 'BBB'.

The Rating Outlook is Stable. A full list of rating actions follows at the end of this press release.

KEY RATING DRIVERS

HMN's ratings reflect its solid operating results, continued very strong capitalization, a conservatively managed investment portfolio, and moderate financial leverage. The ratings also consider the company's exposure to property/casualty (P/C) catastrophe risk and above-average interest rate risk in its annuity segment, along with its small size and scale relative to larger, national peers.

HMN's capital metrics remain very strong within both the P/C and life insurance companies. The P/C companies' operating leverage at 1.3x remains well below personal lines peers and the score on Fitch's Prism capital model remained at 'very strong' at year-end 2015. The life companies' risk-based capital (RBC) ratio was 444% at year-end 2015. HMN's financial leverage ratio (FLR) was moderate at 19% at June 30, 2016.

Reported net operating income was $36 million for the first six months of 2016, compared with $46 million for the prior period. Stable and moderately growing annuity and life earnings were offset by volatility due to catastrophe losses in the P/C segment. Fixed-charge coverage was solid at 9.3x through the first six months of 2016.

HMN's bundled educator P/C business has a relatively low-risk underwriting profile, but continues to be affected by weather-related losses. The combined ratio averaged 99.8% for 2012 - 2015, but deteriorated to 102.8% for 1H16, from 97.0% the prior period, due to adverse weather trends and macro pressures in personal auto. Improvement in the homeowners' loss ratio tracked better than the industry due to rate increases and enhanced risk selection. The auto loss ratio averaged 72.3% for 2012 - 2015 remained nearly five points better than the industry as rate increases outpaced loss costs.

Annuity results have been relatively stable over recent years, with an average return on assets (ROA) of 118 bps over 2013 - 2015. However, the segment faces significant earnings headwinds due to interest margin compression over the intermediate term in a persistent low interest rate scenario. Pretax earnings declined modestly in 1H16, driven by modernization expenses. HMN's life earnings pretax operating income increased in 1H16 to $13 million from $11 million in 1H15, due to more favorable mortality experience.

The company's business concentration in fixed annuities creates an above-average exposure to interest rate risk. A large proportion of this business was written in a higher interest rate environment with higher guaranteed minimum crediting rates. Further, over half of its general account annuity reserves could be withdrawn at book value without surrender penalties at year-end 2015. However, Fitch believes HMN's sound asset liability management and emphasis on higher persistency products in the 403(b) market somewhat mitigates its disintermediation risk.

Fitch views the Department of Labor (DOL) Fiduciary Rule released in April 2016 as having only a modest impact on HMN due to its focus on the educator market. 403(b) retirement savings were scoped out of the rule, which subjects commission-based products such as VAs and FIAs to considerably more stringent compliance requirements when sold into qualified accounts. Over 75% of HMN's annuity block is non-IRA, mitigating the impact of the new regulation.

HMN's conservative asset allocation practices are reflected by a relatively low GAAP-based risky assets ratio of 35% at year-end 2015. The $7.7 billion portfolio is composed predominately of highly rated and very liquid fixed-income securities. HMN's life portfolio energy exposure was in line with the industry at 10% of its corporate bonds, but of modestly better credit quality, with 10% of its exposure below investment-grade compared with 14% for the industry.

RATING SENSITIVITIES

Key rating triggers that could lead to a downgrade include a sustained period of weak earnings with GAAP fixed-charge coverage below 8x, failure to maintain a P/C Prism capital model score that is comfortably within the 'Strong' category, financial leverage above 25%, adverse reserve development amounting to 5% of prior year surplus, and/or a significant decline in market share or distribution weakness in the 403(b) market.

Fitch views Horace Mann's ratings as limited by its small size and operating scale relative to larger, national peers.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings with a Stable Outlook:

Horace Mann
--IDR at 'BBB+';
--4.5% senior notes due December 2025 at 'BBB'.

Horace Mann Insurance Co.
Teachers Insurance Co.
Horace Mann Property & Casualty Insurance Co.
Horace Mann Lloyds
Horace Mann Life Insurance Co.
--IFS at 'A'.

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