The insurance industry is highly competitive and regulated, making it difficult to find companies that are good investments and good bargains. I came across Horace Mann Educators (HMN) which is an insurance company that provides property, casualty, life-insurance and annuities products to school teachers and others employed in the US public school districts. Using a workforce of full time employee agents as well as independent agents they focus on the niche market of educators. They face a highly competitive environment with competition from larger entities like State Farm, Allstate, Geico, etc. but are able to hold their own due to specialization; maintaining close relationships with school districts and teachers organizations and even recruiting former educators as agents to form strong ties with the teaching community. The company has a new CEO elect and has been undergoing a leadership transition which is expected to complete over the next several months.
HMN makes money through premiums on their insurance products, sales commissions as well as income and gains on the investments they make. So in order to continue to perform well they need to retain and grow their customer base while also making astute investment decisions. Their business segment shares in insurance premiums are roughly - Property and Casualty 52%, Annuity 39% and Life 9%.
Fundamentals and Valuation Multiples
HMN reported EPS of $0.39 in its Q2 2013 earnings call, continuing its streak of beating analyst expectations quarter after quarter. This was an improvement of $0.23 year over year credited to lower catastrophe losses and better Property and Casualty segment results. Total revenue of $265.6 million grew 4.5% from the same quarter last year. In the past 5 years (2008-2012) total revenue has grown at a compounded annual growth rate of 4.9%. After tax earnings in both the Property and Casualty as well as Annuity segments improved year over year, while the Life insurance segment declined. Over the previous five years HMN's annuity business has shown the most stable growth. It is a major player in the market for annuities for educators, to whom they offer both fixed and variable interest products that help them with their retirement planning.
The combined ratio, which is a performance metric for the insurance industry, improved by 5.6 points year over year in Q2 2013 to 89%. A ratio below 100 implies that the company is making profits whereas above hundred means it is paying out more in claims than it is making. Auto and property combined ratios both improved in the quarter with property being in the 70s range and auto at around 97.1%. In recent history, the company's combined ratio improved to 98.3% in 2012 after being above 100% in the past two years.
While net investment income and gains have risen by a compounded annual growth rate of 19% over the last 5 years ending December 31st 2012, in the second quarter net investment income grew only moderately on a year ago basis and net unrealized gains from investments declined due to higher rates and wider credit spreads. However, the company was able to manage some of this risk by reinvesting some of its proceeds and ending the second quarter with realized investment gains of $10 million.
Horace Mann is currently trading at a TTM P/E ratio of 9.93 (lower than some direct competitors) and a Price to Revenue ratio of about 1.08. The P/B ratio is at 1.02, which is again lower than other major competitors and suggests that the company is a good bargain, although it is up from recent past when it was trading below book value. The stock price at the time of writing is slightly below the imputed price based on recent historical average of both P/E and P/B multiples.
At present they operate as a pretty risk-averse organization reflected in their choice of target customer group. In general, one would expect public school teachers and employees to be law abiding with relatively stable jobs; more likely to drive safely and make timely payments. They are stringent with their requirements for good driving records when writing automobile policies (that comprise a significant 67% of their Property and Casualty policies). Other ways they manage risk is by letting third parties bear the risk in high risk areas such as Florida, and keeping their operations limited to making commission on the sales.
Another example is in the life insurance segment where they limit their liability at $200,000 for ordinary life insurance policies. In 2012, 3.8% of these lapsed or ended in claims; a percentage that has been stable for the last three years. Further the company maintains reinsurance with several well-known re-insurers with high credit ratings.
The other side of the equation is investments where the company is heavily skewed towards investment grade, publicly traded fixed income securities which made up almost 95% of its portfolio at the end of 2012. It has low to no investments in more volatile markets such as common stocks, foreign equities and real estate.
Opportunities and Risks
While evaluating an investment opportunity it is important to think about the viability and growth prospects of the business. The performance of most of Horace Mann's financial metrics in the past several quarters has been good. Their philosophy of focusing on a niche market seems to be a smart move in that it gives them specialized knowledge and personalized service based relationships with their customers, which can be their USP in the face of heightened price competition from larger insurance companies in the near future. Their high percentage of cross sales is a good sign for customer retention. However, their focus on public school educators only can also be a limiting factor for growth. Budget cuts and reduced funding for public school districts leading to layoffs of employees could be another headwind. For example, the company receives its highest percentage of premiums (about 9%) from California, where public school funding has suffered since the last recession, though some measures for improvement have been taken recently.
Also the company's investments face risks from both rising and falling interest rates and bond yields. While falling interest rates can lower their returns on investments, rising rates can put pressure on them to raise crediting rates on annuities and also hurt the value of their investments due to negative comparison of fixed yields to market yields. Higher interest rates can also make their fixed rate products like annuities less attractive to customers. So far the company has managed this through timely reinvestment, but rising interest rates in the last few months may be cause for some concern in the future.
Overall I think that Horace Mann Educators has a strong business, which faces some risks from changing market conditions. But it has opportunities to grow and expand its national footprint and taking advantage of its customer specialization.
Additional disclosure: I am a self taught individual investor and this article expresses my views based on my own research. I am not being influenced or paid by any organization to write this article.