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Executives

Dwayne Hallman – SVP, Finance

Lou Lower – President and CEO

Pete Heckman – EVP and CFO

Tom Wilkinson – EVP, Property and Casualty

Rick Schulenburg – VP, Field Sales Management

Analysts

Bob Glasspiegel – Langen McAlenney

Rohan Pai – Banc of America

Craig Rothman – Millennium Partners

Horace Mann Educators Corporation (HMN) Q3 2008 Earnings Call Transcript October 29, 2008 10:00 AM ET

Operator

Good morning. My name is Pam, and I will be your conference operator today. At this time, I would like to welcome everyone to the Horace Mann Educators Corporation third quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator instructions) Thank you. It is now my pleasure to turn the floor over to your host, Dwayne Hallman, Senior Vice President of Finance. Sir, you may begin your conference.

Dwayne Hallman

Thank you and good morning, everyone. Welcome to our third quarter 2008 earnings conference call. Yesterday, after the market closed, we released our earnings report, including financial statements as well as supplemental business and investment information. If you need a copy of the release, it is available on our website under Investor Relations.

Today we will cover our results for the third quarter in our prepared remarks. The following management members will make presentations today, and as usual will be available for questions later in the conference call. Lou Lower, President and Chief Executive Officer; Pete Heckman, Executive Vice President and Chief Financial Officer; Tom Wilkinson, Executive Vice President, Property and Casualty; and Rick Schulenburg, Vice President of Sales.

The following discussion may contain forward-looking statements regarding Horace Mann and its operations. Our actual results may differ materially from those projected in the forward-looking statements. These forward-looking statements are made based on management’s current expectations and beliefs as of the date and time of this call. For discussions of the risk and uncertainties that could affect actual results, please refer to the company’s public filings with the SEC and in the earnings press release issued yesterday.

We undertake no obligation to publicly update or revise such forward-looking statements to reflect the actual results or changes, assumptions, or other factors that could affect these statements. As a reminder, this call is being recorded and is available live on our website. An Internet reply will be available on our website until November 30, 2008.

Now I will turn the call over to Lou Lower for his comments.

Lou Lower

Thank you, Dwayne. Good morning everyone and thanks for participating on our call. Sizeable catastrophe losses from 11 events including hurricanes Ike and Gustav plus the impact of the worldwide financial crisis resulted in a net loss for Horace Mann in the quarter of $0.79 per share and that is made up of operating EPS of $0.17 per share more than offset by net realized capital losses of $0.96 per share.

Our net realized capital losses of $45 million pretax were somewhat less than our preannouncement while catastrophe losses were right at the midpoint of the range that we disclosed.

Given what has transpired in the financial markets since we last spoke we are going to organize our commentary this morning around two topics, our financial strength and our operations. I will provide an overview of both and following that Pete Heckman will very appropriately spend more time with you than normal discussing our investment portfolio, capital position, operating and leverage ratios. As part of his discussion Pete is going to walk you through a supplemental exhibit that we have added to our earnings release so that you have greater detail up front but as always our 10-Q will provide full transparency for your further analysis.

Following Pete’s review, we will turn to our more traditional review of operations but as we do that we will try to give you a flavor of how our business is behaving in the challenging economic environment. So, first to the balance sheet and financial strength.

The realized losses we recorded in this quarter as we preannounced are largely from the third quarter headline credits of Fannie, Freddie, Lehman, and AIG. The meaningful increase in our unrealized position is predominantly a result of the extreme and unprecedented widening of corporate bond spreads. Our considered judgment is that our realized position almost exclusively reflects a remarkably disruptive credit market that is in a crisis mode where liquidity is virtually nonexistent, developing spreads and prices being disconnected from rational valuation.

After conducting a thorough analysis along with our institutional investment advisers and managers we have assured ourselves that we do not have fundamental credit quality issues. We have always had a very conservative straightforward approach to our invested assets. And as you will hear in a detailed review of our September 30 holdings, insignificant amounts of sub prime and Alt-A, no auto manufacturers, no home builder exposure, somewhat of an overweighting to financials but largely those who are going to tap in the top becoming stronger credits.

We do believe that as the coordinated worldwide rescue efforts take hold they should unclog the credit markets, restore rationality, reduce spreads, and moderate our unrealized position. In the meantime, we fully have the ability and intent to hold through recovery. The structure of the liability is associated with most of the taxable fixed income portfolio and that is primarily annuities, is performing better than expected. Persistently actually improved again this quarter and we have positive funds flow, which I believe speaks volumes about the nature of our products, our customer base, the strong relationships our Horace Mann agents have with their clients, and the great service our customers service reps provide. And in addition, the P&C segment will continue to be a strong source of operating cash flows from underwriting and investment income.

Now having said all of that there is no denying that the double whammy of catastrophes and the financial market meltdown hurt us in the quarter. Given that 1, 2 punch; we believe we took appropriate action to ensure having a strong capital position to protect our customers, employees, and shareholders. We have always viewed our line of credit as an additional source of capital for unprecedented and unexpected circumstances, which we are clearly in now.

We made the decision to draw down part of our facility prior to the announcement of TARP, because we were frankly most concerned that if we needed it, that key piece of contingent capital might not be available. Our concern was never about Horace Mann’s liquidity it was solely about liquidity available in the financial markets. And just by way of further clarification that $75 million drawdown remains at the holding company and has not been used as a capital contribution to our insurance subsidiaries. Even without a contribution, as Pete will describe, our risk-based capital and premium to surplus ratios are solid and consistent with our ratings.

As to our own liquidity there are no issues. We have no commercial paper obligations. Operations are funded as they always have been through operating cash flows, which remain strong. The company has no refinancing needs for several years at the earliest and only very modest at that time. Senior debt doesn’t mature until 2015 and 2016. There are no extracurricular activities at the holding company like credit default swaps. We have no outstanding securities lending. And even with the addition of the $75 million from the credit facility, our debt-to-capital ratio on a pro forma basis at September 30 incorporating the borrowing which occurred after September 30 would be approximately 31%, certainly consistent with our ratings.

So now let me shift gears and hit the highlights of our operations which Tom Wilkinson, Pete, and Rick Schulenburg will cover in greater detail.

In property and casualty, the headline story is clearly the third worst third quarter for catastrophes in the company’s history right on the heels of the worst second quarter for catastrophes. On a very positive note, however, the underlying profit fundamentals are solid. Current accident year results ex-cat improved sequentially and is better than prior year, a significant improvement in auto led by decline in frequency more than made up for an unfavorable comparison in property largely as a result of non-cat weather.

While auto educator PIF continues to increase, overall PIF is flat but high quality new and in force business along with positive retention trends continues to benefit our results. In life and annuity combined, excluding DAC and GMDB reserve changes earnings were comparable to the very strong results recorded in the first nine months of last year. Now obviously while variable account values and fees have decreased fixed account values are up both over prior year and sequentially with positive funds flow and improved persistency.

Turning to sales and distribution, as you all know, the economy has thrown a wet blanket over new car and home sales, which in turn has continued to pressure applications for both auto and property insurance industry wide. For our two lead lines, true new auto sales declined 6% roughly comparable to the second quarter on a percentage basis although up sequentially in total units. Flexible annuity sales increased 9% for the quarter for Horace Mann agents while they also delivered an increase of 4% in single premium business. More importantly for the future growth of the company during the third quarter, our AVS [ph] agents further elevated their productivity increasing it over 10% in true new auto, 28% in flex annuity, and 18% in single premium annuity. And that rate of growth especially in this economy is the most positive indicator of our future growth prospect as we continue to transition to our new distribution model.

Finally, with Doug Reynolds’ departure you will be hearing from Tom Wilkinson during the in-depth review of P&C. Tom jointed Horace Mann 6 years from Allstate. He has been at a key leader in the turnaround of our P&C operations assuming greater responsibility every year. Prior to his promotion to Executive Vice President of P&C, he had accountability for all aspects of our property and casualty business, excluding clients which also now reports to him.

So let me now turn the call over to Pete Heckman.

Pete Heckman

Thanks Lou and good morning. The unprecedented uncertainty and volatility in the financial markets continues to have both an impact on both realized and unrealized investment losses.

Pretax net realized losses where $45 million for the third quarter. Included in this amount was $33 million of impairment write-downs on securities which we continue to hold but determined to have other than temporary declines in market value as of quarter end. Of this amount approximately $23.7 million relates to impairments for which the issuers ability to pay future interest and principle based upon contractual terms has been compromised, namely Lehman brothers, Fannie, Freddie, and AIG.

The remaining amount relates to impairments primarily of financial institution securities and high yield bonds where we no longer have the intent to hold the security for a period of time necessary to recover a substantial portion of the decline in value. Also included is a $14.2 million of realized losses on impaired securities that we disposed off during the quarter primarily related to financial names such as Freddie, Fannie, Wachovia, Morgan Stanley, Goldman Sachs, and Washington Mutual. The impairment was partially offset by $2.3 million of realized gains and investment sales. The spread widening and interest rate volatility in the quarter much of it occurring in the month of September had a significant adverse affect on the fair value of our investments. We provided a supplemental exhibit at the end of our press release package this quarter, I believe that is page number six, which provides additional disclosure on our net unrealized loss trends in September 30 balance.

Net unrealized investment losses at the end of the third quarter totaled approximately $271 million pretax, up substantially from $106 million recorded at June 30. As you can see in the data the change was spread over numerous asset classes but investment grade bonds, CMBS, and financial intuition securities, bonds and preferred stocks were most impacted, accounting for $140 million of the $165 million increase. More detail on our financial institution holdings is provided on the lower half of the supplemental exhibit. Total fair-value of our financial holdings including both debt and preferred was $250 million at September 30, just under 7% of total invested assets. That sector has been on the bleeding edge of the financial markets melt down and with the current market-to-book of 82% clearly remains under stress. But there is growing evidence that this sector has been stabilized at least in relative terms due in large part to worldwide government intervention and so forth, including the TARP program in the U.S.

If you scan down the financial institution names in our supplement you will find the list broadly populated with clear our most likely survivors which have or will receive government support through TARP or a comparable international rescue program. By virtue of their preponderance of the quality names and the clear indication of ongoing external support we’re comfortable with our holdings in this sector and feel that recovery while probably slower than anyone would like, will indeed occur.

Horace Mann had approximately $305 million of CMBS book value exposure at the end of the third quarter representing about 7% of the total portfolio. While this asset class has seen significant spread widening over the last nine months increasing our unrealized loss to $47 million at September 30, we continue to feel good about the overall quality and performance of that portfolio. The overall credit quality of the CMBS portfolio is a solid AA and it is 100% investment grade.

As of September 30, approximately 80% of the portfolio was comprised of the higher quality 2005 and prior vintages, and 70% of the reminder of the portfolio is AAA rated. All of the securities in the portfolio are currently performing in line with contractual terms and did not experience any deterioration in delinquencies or foreclosures during the quarter.

For our CMBS portfolio, we rarely analyze available market information including underlying credit quality, anticipated cash flows, credit enhancements, default rates, loss severities, and position in the capital structure and at this point do not believe that the available prices are indicative of the future performance of the securities.

And finally our non financial institution investment grade bond holdings comprise a little over one-third of our total investments at the end of the third quarter. This is a well diversified A plus rated portfolio representing over 300 issuers across some 30 industry sectors. This component of the portfolio accounted for almost half of the increase in unrealized losses in the third quarter as average spreads for US intermediate credits expanded from 256 basis points in June to 427 basis points at September 30. Clearly a reflection of the panic and irrationality in the marketplace spreading to the broader economy rather than an indication of deteriorating portfolio quality.

As further evidence that the increase in unrealized losses is more indicative of recent spread widening as opposed to inherent credit quality issues in Horace Mann portfolio consider that 80% of the securities with fair-values below 80% of book value at September 30 had been below 80 for only three months or less. And we continue to have less than one-tenth of 1% of our portfolio pricing based on so-called level three inputs, another element of conservatism and transparency in our valuations.

So in terms of an overall assessment of our investment portfolio we believe the credit quality to be strong, view the current pricing in the market to be irrational and a temporary phenomenon and currently have the intent and ability to hold all securities to maturity or substantial recovery in value.

I would like to use the reminder of my time to provide some commentary on Horace Mann capital and liquidity position. While our capital was adversity impacted in the quarter by the combination of significant catastrophe losses and the unprecedented challenges of the financial markets our leverage and operating ratios remain strong both at the insurance company subsidiary and holding company levels and more than adequate in our view to support current ratings. In spite of the high level of investment losses in the third quarter we estimate our life company RBC ratio to be approximately 430% at September 30. Fund close, persistency, and liquidity are all strong and increasing, which I will elaborate on in a few moments.

We expect PMCs to RBC ratio to be about 350% and the premium to surplus ratio to be under (inaudible) at September 30. Both measures are better than where they stood at the end of 2005. Furthermore, our bank line of credit, $75 million of which is gone and being held at the holding company provides more than adequate flexibility should the need exist to contribute additional capital to our insurance subsidiaries in support of their ratings. And their current debt-to-capital ratio including the $75 million of borrowings is a little under 31% excluding FAS 115 and within a range consistent with our current ratings.

There are no liquidity issues at the statutory (inaudible) level. Our liabilities are extremely vanilla and stable. Cash or cash equivalent balances currently stand at $150 million, 90 at the life company and 60 in P&C. And we expect the life and annuity investment portfolios to throw off over $90 million in cash in the fourth quarter alone. In addition, we have a substantial amount of highly liquid assets available if needed. $840 million of agency pass-through RMBS and $150 million of U.S. government agencies in the life company and some $440 million of muni bonds, $35 million off agency pass throughs, and $12 million of U.S. government agency securities in P&C.

At the holding company as Lou mentioned there are no business operations or extracurricular activities of any type, no credit default swaps, securities lending et cetera. Our blank credit facility doesn’t expire for three years and our senior debt doesn’t begin to mature until 2015.

So our capital and liquidity positions remain strong in spite of the challenging environment we’re in and the difficult quarter we and the rest of the industry just experienced. The catastrophe and investment losses were material but very manageable. While the financial markets and investment performance were by default the headline issues of the third quarter, Horace Mann continues to experience positive underlying trends in our insurance operations. I will come back in a few moments to talk more about life and annuity but first here is Tom Wilkinson to comment on our P&C results. Tom.

Tom Wilkinson

Thanks, Pete, and good morning. As Lou mentioned, weather patterns and catastrophe continue to a significantly impact our P&C results. Total catastrophes costs for both the quarter and year-to-date are up three times our expected amount. The third quarter saw the continuation of increased tornado activity across the Midwest with almost twice as many storms as last year and the impacts of hurricane Gustav and Ike.

Let me say that our claim staff has responded to these events exceptionally well with a timely (inaudible) service to our customers. We are currently 97% closed for Gustav and about 92% closed for hurricane Ike. As I said all that activity has impacted our key profitability measures.

The total P&C combined ratio for the quarter was 109.7 up 13 points over third quarter last year. Catastrophe costs in the quarter totaled $36 million and a represented 19 points about prior year levels. We had favorable prior year reserve reversal estimates of $6.3 million or 4.7% of premium, which is almost two points better than prior year.

Our underlying combined ratio which excludes catastrophes, and the effects of prior year reserve reestimates was 87.5% about 4 points lower than the third quarter of last year. And not surprisingly year-to-date total PNC combined ratio was 103.3 up 11.5 points over last year. Catastrophic costs account for 11.5 points of the increase and the difference in prior year reserve reestimates contribute an additional nine-tenths to the increase.

Our year-to-date underlying accident year combined ratios again excluding catastrophes was 90.2% and nine-tenths of a point lower than prior year.

On the auto side, this quarter for auto accident year combined ratio, excluding catastrophes, was 89% or 7.1 points better than the prior year. Frequency was below prior year for the second consecutive quarter favorably impact by continued decreases in miles driven and severity trends remained favorable and consistent with our expectations. Year-to-date our auto underlying combined ratio was 93.7, two points below prior year.

Looking at property, our accident combined ratio excluding cat was 83.7% for the quarter almost three points about last year. Consistent with that the year-to-date property underlying combined ratio was 82.2%, 3.7 points about prior year. Non-cat weather impact since the beginning of the year is a major contributor to these increases. On those lines we continue to project price increases consistent with others in the industry to match our loss cost trend. Our new business quality trend remains favorable with continued focus on educator, preferred underwriting tiers, and cross selling. And we continue to expand our auto payroll deduction program with new schools adopting the program up 35% and total policies on payroll deduct up almost 60% when compared to prior year.

Now looking at some of the basic metrics around that book our policyholder retention levels continues to improve in a very competitive environment. Auto retention is up a tenth and property is up half a point over prior year. Total policies in force are flat in auto and down slightly minus 1% or 3000 [ph] in property. The decrease in property is attributable to catastrophe exposure management actions in the last few years along the east and gulf coast.

Our total coastal property policy count is down 13% in the last year and down 34% since 2005. And when we focus solely on educators in our book we see total educator PIF continue to increase countrywide with auto up 2700 sequentially this quarter now 2.5% above prior year. And property is up 500 compared to last quarter and is 2% above prior year.

As we introduced in last quarter’s call we are on pace to implement the claim consolidation of six field offices into three. Beginning in the first quarter of 2009, we will operate in two regional auto claim offices and one national property office to make our operations more scalable and further leverage investments in our technology platforms and key work processes. This will enable us to continue to make operational gains in claim severities, expenses, and customer satisfaction.

The current economic climate is significantly declining car and home sales combined with increasing industry advertising spend makes for a challenging and competitive P&C marketplace. Our focus has been and will continue to be working with our partners in marketing to develop and implement product and service enhancements that further differentiate ourselves from the competition in our educator market.

Now I would like to turn it back to Pete to talk about our life and annuity results.

Pete Heckman

Thanks, Tom. Total annuity sales were down 1% in the third quarter compared to prior year and down 9% year-to-date. However, 2008 annuity sales are exceeding our expectations and those prior year comparisons mask what I think is a pretty positive picture in this line of business especially as far as our Horace Mann agents are concerned.

As expected the IRS 403(b) transition rules have had a negative impact throughout the year and on single premium and rolled over deposits due to interim restrictions on participants upon transfers. Our independent agent channel, which accounts for only about 10% of our annuity sales energy, has been impacted more significantly. But Horace Mann agents had a strong third quarter increasing total sales by 5% over prior year, which reduce their year-to-date sales deficit to 1%. And in our bread and butter flexible premium business employee agents grew sales 9% in the third quarter and 6% year-to-date. We also began to see some recovery in Horace Mann agents’ single premium rollover sales with that component increasing 4% in the current quarter as more and more school districts completed their transition to the new 403(b) regulations.

As we have discussed on previous calls the new IRS regulations become effective on January 1 of next year and 2008 has been a year of transition in the marketplace as this process sorted itself out. During the last twelve to eighteen months, we have deployed a number of strategies to solidify our position and grow our business. We have implemented numerous contact programs, participated in joint communications and distributed informational packages to all of our school districts and trained our agents so that they can provide a high level of expertise to school administrators. While there was some concern that the level of market disruption would be significant, our experience has been that only a relatively small number of schools have utilized outside consultants and or RFP processes to significantly cut back on the number of providers or move to single provider networks.

At this point we’ve heard from approximately 60% of the over 5000 school districts having Horace Mann payroll slots and the vast majority has selected us to continue as a 403(b) provider in 2009. Similarly, we expect the overwhelming majority of our remaining schools to also maintain Horace Mann on their list of authorized providers going forward.

So overall the initial transition has been much less disruptive than expected and very importantly the impact on Horace Mann has been generally positive.

Back to the financial results, total annuity assets under management decreased 6% compared to prior year due to a 21% market performance related decline in variable annuity assets. General accounts fixed annuity assets on the other hand increased by 6% over the last 12 months. The stability and loyalty of our educator customer base and the quality of our employee agent force are among the company’s most valued assets and that has been very evident in this difficult market environment.

Annuity net fund flows, defined as premium less surrenders, debts, and maturities, have been positive throughout 2008 with sequential increases in each quarter and their 12 month account value persistency of 93% is up 1.5 points over prior year with third quarter persistency hitting the 94% level. So, our liabilities continue to be extremely stable and present absolutely no liquidity issues.

Annuity pretax income was up slightly above prior year through nine months and up about $1.4 million for the quarter. In the third quarter favorable DAC and VIF unlocking of $2.4 million pre-tax was comprised of the positive impact related to investment losses recognized in the quarter which more than offset the adverse impact of the financial markets on variable deposit fund performance.

The underlying earnings in both the quarter and year-to-date were favorably impacted by increased fixed annuity interest margins, which have been offset by decreased variable annuity charges and fees.

As a final comment on our annuity business I wanted to mention that while our variable annuity results are impacted by financial market performance Horace Mann variable products are only minimally exposed to so-called equity market guarantee risk. Approximately 70% of our in force VA account value has a simple return of premium death benefit. Nearly 25% of the business has no death benefit guarantee at all. The remaining 5% as a modest 3% or 5% roll off benefit. And our current GAAP GMDB reserve balance of only $350,000 reflects that conservative risk profile. We offer no other guarantees and have no hedging or derivate program exposure whatsoever.

Now turning to the life segment, third quarter and year-to-date sales were down over 10% compared to prior year reflecting the impact of the economy on discretionary spending along with perhaps a greater relative emphasis on auto and annuity sales. Life premiums and contract deposits were slightly ahead of last year.

In terms of earnings life segment pretax income was down $1.5 million in the quarter and $400,000 year-to-date compared to prior year. Mortality costs were $2 million greater than last year in the quarter and $3 million higher year-to-date which offset the growth in investment income and earned premiums in both periods.

As mentioned in our press release excluding the impact of DAC unlocking and change in the minimum death benefit reserve year-to-date pre-tax income for the combined life and annuity segments was comparable to a very strong prior year and is exceeding our expectations.

So with that let me turn it over to Rick Schulenburg for his comments on sales and distribution.

Rick Schulenburg

Thank you, Pete, and good morning to everyone. Today I’ll focus on the momentum we continue to build with the agency business model initiative, the changes in our agent status relative to the model and our quarter and year-to-date sales results. As we have reported in the past, results of our agents working in the Agency Business Model or ABM continues to gain traction. ABM agents have gone through our agency business school and have adopted or in the process of adopting documented repeatable processes in their operations that include conducting business in an outside office with licensed producers and other support staff.

We continue to grow the number of agents operating in outside offices with licensed producers while continuing to decrease the number of agents working out of their home. We now have over 450 agents operating in an outside office and over 250 of them with licensed producers and 200 graduates of our agency business school. On average, ABM agents are collectively outperforming all other agents in all core lines, especially in our two lead lines, true new auto sales and flexible annuity sales. These lines serve as a barometer for our success with the ABM initiative.

Taking a look at our third quarter results, overall average true new auto productivity increased by approximately 8% with our ABM agents leading the increase with an approximate 11% increase as a group. For the year, average productivity increased 1% with our ABM agents up 4%. Flexible annuity average productivity was up around 25% for the third quarter and 18% for the year. Again, our ABM agents had the most influence on this increase. Their average flexible annuity sales increased by approximately 20% in the third quarter bringing the year-to-date results to 24% and single annuity sales productivity is up approximately 20% for the quarter and 9% for the year for all agents with our ABM agents improving their productivity nearly 18% for the quarter and 4% for the year. Again this quarter, ABM agents’ first year commissions continue to grow, a key factor in their ability to be successful in the model. In addition, through greater gains and productivity as you will recall ABM agents produced substantially more business in all categories than their non-ABM counterparts.

While we continue to bring our agents to the agency business school who are willing to begin operating in the agency business model, we are also bringing graduates from our first agency business school to a new Agency Business School II. We have built an advanced curriculum and learning experience for them designed to reinforce the repeatable business practices and processes and help them totally embed these processes in the respective operations. At the same time, we have also developed and introduced workshops for licensed producers who work for agents to elevate their skill sets, improve their effectiveness and sales ability and increase their economic benefits that they deliver for our agents.

While still very early, indications are agents who have attend ABM II and or had their licensed producers attend workshops have seen an initial increase in their productivity.

We ended the quarter with 690 agents down from 721 agents at the end of the second quarter but during that time our agents have increased their licensed producers from 322 producers to 360 to a total increase in points of distribution from 1043 to 1050.

Our terminations are relatively consistent compared with 2007 as is the makeup of our terminations with the majority coming from agents working inside their home with substantially lower productivity. As you will recall, we installed a more rigorous standard to our hiring process earlier in the year which initially reduced the pipeline with new agent candidates and hires. As our new process has become embedded and our field sales leaders operate we have begun to rebound to more normalized monthly hiring numbers but with an increased degree of confidence that our new hiring classes will have a higher degree of success and retention in the future.

Now moving on to sales results in spite of our reduction in agent count and in face of challenging economic times with fierce competition we have held our own thanks predominantly to our ABM initiative.

While total auto sales decreased 2% in the quarter, true new auto was down 5.9%. While still not on par with last year, the results are less adverse to the 6 months, an improvement sequentially. Annuity sales were up slightly from last year’s third quarter down 1.3% and up 9% for the year, which showed a significant improvement sequentially, up over 40% compared to this year’s second quarter.

Looking just at Horace Mann agents in the third quarter, they delivered an increase of 4.6% and within that a 9% increase in flexible annuity sales, an encouraging sign that our core 403(b) business is on solid footing.

Property sales were up approximately 9% for the third quarter and year, but almost a 19% improvement sequentially. If we exclude Florida property sales we are of pace with 2007 by only 6%.

In conclusion, despite the challenges with the economy and a different agent count, we continue to be encouraged by positive gains being made by our ABM agents and overall positive impact this distribution strategy contributes to our growth. We will continue to transition those agents who are capable of operating in outside offices, engaged to our licensed producer staff, and embed repeatable processes that are core to being far more successful in our niche market.

And thank you. And with that, I’ll turn it over to Dwayne.

Dwayne Hallman

Thanks, Rick. And that concludes our prepared remarks. Obviously, we allocated some additional time for our remarks, but given the current environment we certainly believe that it was warranted. So Pam, if you would please move to the question and answer session.

Question-and-Answer Session

Operator

(Operator instructions) Thank you. Your first question is coming from Bob Glasspiegel with Langen McAlenney.

Bob Glasspiegel - Langen McAlenney

Hi, good morning. Could you refresh me again where your RBC ratios are relative to your target, I know you gave the number but I missed it?

Pete Heckman

Yes, Bob the estimated September 30 number, and we haven’t finalized statutory results yet but these are pretty close. It is about 350% for P&C and about 430% for life.

Bob Glasspiegel - Langen McAlenney

And what is your target?

Pete Heckman

Well, we certainly look to have the life RBC ratio above the 400 mark; although I think our current ratings could be supported with something a bit below that. P&C, we look probably as much because the premium, the surplus ratio in combination with RBC and again the premium surplus ratio is going to end up being about 1.9 or so, just a little bit above 1.9 and we have been as high as 2.5 in fact 3 or 4 years ago and supported the current ratings. So, we feel both are comfortably within our targets.

Bob Glasspiegel - Langen McAlenney

If the market grew and you could actually raise rates and grow units, I would say it tightened for whatever reason; you have got the balance sheet to be able to support growth there?

Pete Heckman

Yes, we do.

Bob Glasspiegel - Langen McAlenney

Okay, on the investment side. Obviously you formed it up with a third-party and you sort of went through sort of what went wrong in the quarter but I think you seem to suggest you are comfortable with the overall risk profile of the portfolio, are you comfortable with outsourcing it and what it did -- whether some mistakes and how much risk was taken and is there a move to dial it back?

Dwayne Hallman

Hi Bob, this is Dwayne Hallman. Obviously an excellent question, (inaudible) utilized three outside managers, BlackRock (inaudible) for our core plus five accounts, and (inaudible) for the high yield portfolio. Obviously, in our realized gains we did have some exposure to Lehman that accounted for a substantial loss for us and it was a high exposure. Although we did, we were able to reduce that exposure by about $8m over a 3 to 4 month period, basically no gain or loss, we did attempt to continue to sell outs (inaudible) but leading up to the demise of the Lehman but in the marketplace, we were just not able to move that paper. Having said that, I believe overall the managers were comfortable with Lehman with the idea that either they would be purchased and the debt with go with the acquirer. I don’t know if there was some speculation in the marketplace that they could result in bankruptcy, but I believe overall felt there would be some residual value left once prices become sort of depreciated. But it was one of our higher exposures. We do have policy guidelines that resulted in significantly less exposure per issuer than I think at least one of our mangers, will someone have an opinion that is a bit low, but given that we are comfortable with our issuers and our exposure. We aren’t in prime times, but we work very close with our investment managers in all their risk analysis and exposure.

Bob Glasspiegel - Langen McAlenney

So, no plans to derisk the portfolio from here.

Pete Heckman

Not substantially as you can see from some of the investment details that was acquired, we do not have exposure, very minimal exposure to a lot of the toxic buckets but to the extent of our financing and institution exposure that has been decreased over the last year but at this point that does makes sense to realize losses on (inaudible) means that they crossed crisis.

Bob Glasspiegel - Langen McAlenney

How much annualized loss investment income has it been in P&C and life company, the hit you have taken so far?

Pete Heckman

On an annual basis approximately $2 million to $2.5 million.

Bob Glasspiegel - Langen McAlenney

That is company wide or --

Lou Lower

That is correct.

Bob Glasspiegel - Langen McAlenney

So, P&C would get whatever their percentage or is that built into more to the life company?

Pete Heckman

Bob you could assume that is a little bit more to the life company.

Bob Glasspiegel - Langen McAlenney

Okay, the last question is that was a pretty phenomenal underlying results ex -- I guess that was the plan just looking but you are -- are you going to factor that into underwriting, then we were in a little bit of a different environment. I know we had sort of third quarter, you had the higher gas prices, fourth quarter you are going to have weaker economy enduring [ph] and less people driving to work, although the future may not be impacted and that I guess I will be badging fewer cars. What are your underwriters doing on the market?

Tom Wilkinson

We feel pretty good about the quality of our business. A lot of the programs we put over the last couple of years as we focused those back on the educator market and we think that frequency trends still look pretty good. I doubt that given that given that gas prices have already changed the trend a little bit I don’t know if the frequency trends are going to be as good going forward but we still look pretty favorable there. We think, unfortunately the economy might have some impact on everybody else who is driving and we might have less cars that hit out there. We feel -- we feel pretty optimistic going forward. We increased our rate activity over the last few quarters, not exorbitant, not a lot, but enough to help us with our cost and you know we are still investing heavily in the claims department and our claims results have been pretty good.

Bob Glasspiegel - Langen McAlenney

So, you are not going to factor in the pricing, it sounds like?

Tom Wilkinson

No, not exactly that is not yet.

Bob Glasspiegel - Langen McAlenney

Okay, thank you very much.

Operator

Thank you. Your next question is coming from Rohan Pai with Banc of America. Please go ahead.

Rohan Pai - Banc of America

Hi, good morning. First question has to do with the auto combined ratio, I think a couple of quarters ago you said that you don’t expect the benefits of frequency could be that much because features tend to drive to work regardless, I mean, I think the 89% combined ratio was one of the largest sequential improvements we have seen, was it just the frequency or is there is anything that maybe one-time that helped in the third quarter that might not be ongoing.

Pete Heckman

In the third quarter, we also in addition to the declines in frequency, we also got some benefit from prior quarters’ developments also hitting us, helping us out in the third quarter.

Rohan Pai - Banc of America

Yes, talking about the underlying. So, excluding cats and the reserve adjustments, the underlying combined ratio seems to have improved at 5 or 6 points sequentially.

Pete Heckman

Right, it was in the current accident year with just a couple in the last quarter and a quarter ago that helped the third quarter underlying results as well.

Lou Lower

(inaudible)

Rohan Pai - Banc of America

There were reserve adjustments from the prior two quarters that came in?

Pete Heckman

Yes.

Rohan Pai - Banc of America

Okay, okay.

Lou Lower

Probably the place to look is more to the year-to-date numbers Rohan.

Rohan Pai - Banc of America

Okay, that is helpful. That is very helpful. Thank you. The expense ratio on the P&C side seems to be a little better than we were expecting and better sequentially, anything that is one-time nature there or is that something that might be ongoing?

Pete Heckman

Well, we certainly look to our expense control programs but there was an adjustment in incentive comp accruals in the quarter that was more along the lines of the one-time adjustment that helped that ratio?

Rohan Pai - Banc of America

Okay good. On the --

Lou Lower

(inaudible) adjustments we like to see on the ongoing basis as you might imagine.

Rohan Pai - Banc of America

That is right. Then on the capital position do you have the stat surplus for the life operation?

Lou Lower

Yes, again this is going to be preliminary but we think adjusted capital and surplus will end September between $250 million to $260 million.

Rohan Pai - Banc of America

And what was it at the end of the second quarter if you can just remind me.

Lou Lower

275.

Rohan Pai - Banc of America

Okay, and you know Fitch had some negative comments a week or two ago. What are the rating agencies saying, like are they bothered about the unrealized losses in any way or do they agree with your view that this is money good and some point it has to all come back?

Lou Lower

Obviously we have been in contact with the rating agencies since the draw down on our bank line and also communicated not only the rationale behind that borrowing, which they totally agreed with but also communicated our third quarter projections for operating results and investment results as well, and those projections we provided were consistent with our actual third quarter results. We recently provided them as you can imagine with extensive additional detail on our investment portfolio, which we understand is being requested of most or all licensures and are pro actively providing supplemental information and responding to their questions. At this point in time, we are not aware of any specific ongoing concerns they have with Horace Mann, although their review of our information and the significant volume of industry data is clearly still work in process. But again I think agencies such as Fitch have come out with overall negative outlooks on the life industry in general and I think they have downgraded of us was generally reflective of that as much as anything specific with regard to Horace Mann.

Rohan Pai - Banc of America

Okay, and then on the -- thanks for the investment disclosure, that was helpful. Just looking at the unrealized marks, the corporate bond portfolio seems to have been written down by about 7%. It was back on the envelope in the third quarter, we would have expected a AA or A portfolio to be down maybe 5%. Is there something that was different about your portfolio that we should have possibly taken in consideration?

Lou Lower

Not aware of anything Rohan.

Rohan Pai - Banc of America

Okay and then --

Pete Heckman

Obviously the financial institution overwriting is there.

Rohan Pai - Banc of America

And that is right, yes.

Pete Heckman

On that it is fairly diversified.

Rohan Pai - Banc of America

Okay, and I guess -- is it fair to assume that October unrealized losses were net negative so far.

Pete Heckman

Yes, I think that is a fair assumption. You recall, I quoted in my comments the movement in the kind of aggregate US intermediate credit spreads going from 256 basis points at the end of June to 427 at the end of September. Earlier this week they moved up to 545. So, you are certainly right that October would see additional growth in unrealized. And we expect the unrealized in this environment to be bouncing around quite substantially. One we will affirm that you know, it is generally something that is probably useable is that the sensitivity of our unrealized to changes in spreads basically are generally for each 50 basis point change in overall spread our unrealized would change maybe by little over $100 million.

Rohan Pai - Banc of America

Okay, that is helpful. Thanks a lot. Those were the questions I had.

Pete Heckman

Thank you.

Operator

Your next question is coming from --

Lou Lower

Hello Pam, what is going on, we couldn’t hear the question. Pam. If anyone is on the line, we are going to be checking out what appeared to be some technical difficulties, hopefully we will get back on line momentarily.

Operator

Mr. Hallman, can you hear me?

Dwayne Hallman

Yes, Pam, you are back on line.

Operator

Okay, Mr. Rothman, can you hear me? Just a moment please. Mr. Rothman, can you hear me? Mr. Rothman, can you hear me?

Craig Rothman - Millennium Partners

Yes, hello.

Operator

And Mr. Hallman, can you hear me?

Dwayne Hallman

Yes, Pam, we can.

Operator

Thank you. I apologize for the inconvenience. Mr. Rothman, Millennium Partners. You may begin your question.

Craig Rothman - Millennium Partners

Hi, guys. Can you talk about where you are seeing fixed annuity spreads in the current environment?

Lou Lower

Well, the spreads we are getting on our new policy issued are up in the 220 to 225 basis points range. As far as the overall portfolio, we do have a substantial amount of our in force business with 4% or 4.5% guarantees, which is putting some pressure on in force spreads. But having said that those have definitely widened over the last couple or three years and spreads on the entire fixed annuity block were 126 basis points in ’06, 143 in ’07, and year-to-date in ’08 they are up to 156. So, that is creating the widening interest margins that I referred to in my comments.

Craig Rothman - Millennium Partners

Okay, great. And you said the new spreads were in the 200s.

Lou Lower

220 to 230.

Craig Rothman - Millennium Partners

Okay great. And then follow up on Rohan’s question. Looking at your disclosure here and some of the marks you took like JP Morgan for example, it looks like you took a 25% mark in the -- from the third quarter based on the spread. It just seems very conservative frankly because JP Morgan mostly seems to be trading in the 90s and I don’t know, maybe you have some of the very elongated stuffs. Can you just talk about who you are using to determine these marks and maybe if you can kind of clarify what types of debt you are holding?

Dwayne Hallman

Hi, this is Dwayne Hallman. As far as the marks are concerned that is from pricing services. I would agree with you that some of the pricings are actually suspect. I think the number of (inaudible) in some cases, but those are available in quoted prices from different dealers and or other pricing services. So, as far as the market is concerned and the disclosure that it would be consistent with what we would see from our investment managers as a result of those services. In the case of JP Morgan, there might be some longer dated papers there, but unfortunately at this point in time that is the public price, level 2 [ph] type price.

Craig Rothman - Millennium Partners

Okay, and then of the $45 million in realized losses, how much of that in ‘08?

Dwayne Hallman; I think ballpark probably about 70% or so.

Craig Rothman - Millennium Partners

So, how much more in realized losses could you take in (inaudible) before you needed to move certain capital down from the holding company.

Lou Lower

No, it is hard to tell what -- at this point what amount that is without getting a better sense of where the rating agencies are heading with capital requirements. And again, we -- the life statutory surplus as I mentioned in response to a prior question decreased about $20 million between quarters and the ratio of the RBC ratio is still well above 400. So, I guess it is my perspective; we have got way to go still.

Craig Rothman - Millennium Partners

Okay, and then worst case scenario, I guess would be way down the road, but have you guys ever looked at, you know, even more capital by using some reinsurance on the life side?

Pete Heckman

We actually did have surplus reinsurance transaction dating back to the 2003, 2004 time frame which was I think around ’05 or thereabouts and kind of talking through that with the rating agencies, at least a couple of them. They frankly admitted to us, they didn’t really give that too much credibility. So, in light of that.

Lou Lower

Clearly they just understand that it is -- and they felt that it was kind of artificial as opposed to real solid capital for whatever reason, but so in light of that, if it is not going to serve the rating purpose or get full credit, we are a little bit maybe thinking twice about that if we were to need something, but again we are always away from needing additional help like that.

Craig Rothman - Millennium Partners

Okay, all right. Thanks a lot guys.

Lou Lower

You bet.

Operator

Thank you. (Operator instructions) You have a follow up question coming from Robert Glasspiegel with Langen McAlenney. Please go ahead.

Bob Glasspiegel – Langen McAlenney

Lou where do you see your new cash flow going, just going to continue to build equity at the holding company, are you going to pay down any of the commercial paper borrowing?

Lou Lower

We don’t have any commercial paper borrowing but we could -- but we would build a --

Bob Glasspiegel – Langen McAlenney

Credit facility.

Lou Lower

We would use it for a combination of building more capital at the holding company and or to the extent that we don’t need it, then we don’t need it right now, reducing the letter of credit, paying that back, but if you, the question was, should you anticipate the continuation of share repurchase activity in the immediate future, I would say the answer to that was no.

Bob Glasspiegel – Langen McAlenney

Then that wasn’t where I was going. It was repaying what you are borrowing here?

Lou Lower

I think you understand the rationale behind that. We were just -- we just wanted to make sure that that money which we have always viewed as our contingent capital was on our side of the fence.

Bob Glasspiegel – Langen McAlenney

And what is the rate on that?

Pete Heckman

It is LIBOR plus about 0.6. So, I think the effective rate for 3 months is 4.7 or so.

Bob Glasspiegel – Langen McAlenney

Okay and what are you doing with it.

Pete Heckman

It is at the holding company.

Bob Glasspiegel – Langen McAlenney

How are you investing at the holding company.

Pete Heckman

Treasuries primarily.

Bob Glasspiegel – Langen McAlenney

I mean what duration.

Pete Heckman

Relatively short.

Dwayne Hallman

At the time we -- it is Dwayne Hallman. At the time we drew down the facility obviously there was still quite a bit of turmoil in money markets and such.

Bob Glasspiegel – Langen McAlenney

So, you are still grabbing some of the juicy minus 0.25% yields when they are available?

Pete Heckman

I am loving it.

Bob Glasspiegel – Langen McAlenney

Are you really sure to take it [ph].

Pete Heckman

We are.

Bob Glasspiegel – Langen McAlenney

Okay, thank you.

Pete Heckman

You bet.

Operator

Thank you. There are no further questions at this time. The Q&A session has now concluded. I like to now turn the floor back over to Mr. Lou Lower for any closing or additional remarks.

Lou Lower

Well just to wrap it up, let me reiterate first that we have a strong capital position with solid RBC ratios backed up by financial flexibility at the holding company if needed. Second, the increase in the unrealized position in our investment portfolio is driven by the systemic widening of spreads in a dysfunctional market, not risky assets. Third, while the market sorts itself out and returns to more rational valuations, the nature of our liabilities and cash flow from operations absolutely backs up our ability and intent to hold our investments to recovery. Fourth, there is no liquidity issue at Horace Mann. Fifth, underlying profitability in both P&C and life and annuity are solid. And finally, and very importantly for our future prospects our strategic growth initiatives to make our marketing and distribution more powerful are improving everyday. And that concludes our call. Thanks for joining us.

Operator

Thank you. And this concludes today’s Horace Mann Educators Corporation’s third quarter earnings release conference call. You may now disconnect your lines and have a pleasant afternoon.

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