2023-08-08 07:12:22 ET
Summary
- Horace Mann Educators reported missed earnings and revenue, largely due to challenges in the US Property & Casualty insurance sector.
- The P&C insurance sector is facing a growth paradox, inflationary pressures, and a hawkish Federal Reserve.
- Rising catastrophic losses and underperformance relative to the market warrant a cautious 'Hold' rating for investors.
Thesis
Horace Mann Educators (HMN) recently reported a GAAP EPS of -$0.31 that missed by $0.33, and revenue of $356.4M that missed by $17.13M largely due to the U.S. Property & Casualty (P&C) insurance sector which faces a complex landscape, grappling with a growth paradox, inflationary pressures, and a hawkish Federal Reserve. Escalating underwriting losses and mixed macroeconomic signals further complicate the picture. This analysis argues that while the company's long-term strategy shows promise, rising catastrophic losses and underperformance relative to the market warrant a cautious 'Hold' rating for investors.
Company Overview: "Founded by Educators for Educators"
Horace Mann Educators Corporation, headquartered in Springfield, Illinois, has made a name for itself in the U.S. insurance landscape since its founding in 1945. The company's structure includes three major segments: Property & Casualty, providing individualized coverage like auto and home insurance; Life & Retirement, targeting educators and employees of tax-exempt organizations with nuanced retirement solutions; and Supplemental & Group Benefits, expanding the scope of employer-sponsored products.
The U.S. Property & Casualty Insurance Sector: Navigating a Complex Landscape
In the world of Property & Casualty (P&C) insurance, companies grapple with a range of challenges, and recent events have underscored this reality. A review of the data, particularly from Insurance Business Magazine , paints a picture of a sector in flux, operating in an environment rife with macroeconomic and sector-specific hurdles.
1. Growth Paradox in the P&C Sector
While traditionally a cyclical industry, the P&C space experienced an unanticipated hiccup in its expected growth trajectory. The latter half of 2022, in particular, bore witness to this growth lag. A primary contributor was the Federal Reserve's decision to up the interest rates by 0.25% , pushing it to 5.5%-a level not seen in over two decades. This tightening of monetary policy rippled through key economic indicators. Housing starts were subdued, corporations reeled in their spending, and consumers hesitated on vehicle purchases. The direct ramifications? Auto, home, and business insurance sectors felt the growth pinch more acutely than anticipated.
2. The Weight of Inflation
Inflationary pressures remain at the forefront of concerns. Particularly worrying for the P&C industry are the surging replacement costs. Whether it's vehicle components or housing construction materials, the cost escalations have been steep-even if there's been a recent tapering.
Percent changes in CPI for All Urban Consumers (CPI-U): U.S. city average (U.S. BUREAU OF LABOR STATISTICS)
Just to put things into perspective, these costs soared by an eye-watering 40% since 2019. And there's more: expectations suggest long-term inflation hovering above the 2.5% mark, a scenario that promises to keep insurers on their toes. The broader consumer picture echoes these sentiments, with the Consumer Price Index for All Urban Consumers registering a 3.0% uptick over the last year.
3. A Hawkish Federal Reserve
The Federal Reserve's stance leans towards the hawkish end of the spectrum, with signals pointing towards no near-term respite. The rising bond yields coupled with this policy could cast a shadow on the recovery prospects until at least the end of 2023. For the P&C insurers, this translates into navigating a tougher macroeconomic milieu.
4. The Underwriting Dilemma
Net premiums written showed promise, buoyed by the prevailing hard market conditions. However, this silver lining was overshadowed by a rather ominous cloud: escalating underwriting losses. 2022 was a particularly painful year on this front, with the sector plunging to a net underwriting loss of $26.9 billion-the most significant deficit since 2011. To put it in stark contrast, this figure is over six times the $3.8 billion underwriting shortfall the industry experienced in 2021. And the prognosis? Challenging outcomes, especially in the personal lines, suggest that this trend is far from over.
5. A Mixed Bag of Macroeconomic Signals
Synthesizing the above trends, the year's macroeconomic backdrop for P&C insurers looks mixed at best. Slow growth, inflation, and the double-edged sword of monetary policy and underwriting losses promise to shape a landscape that's anything but predictable for industry players.
Within this turbulence, certain entities like Horace Mann Educators continue to chart their own growth story. But is their resilience shining through, especially when one considers their catastrophe losses? Tallying up to $41.5 million, these losses, although substantial, matched forecasts, culminating in a quarterly segment setback. However, not all was gloom and doom. Their segment net investment income grew, clocking in at roughly 40% above the previous year's figure-a noteworthy bright spot in an otherwise challenging environment.
Weathering the Storm, Containing the Impact
In the second quarter, Horace Mann weathered 19 catastrophic events, yet the effects on their financial results were notably contained. Compared to the previous year, the impact was diminished by 4.2 points, which we'll put in the plus column as a sign of resilience in their business model.
The positive side of Horace Mann Educators' quarterly performance extends further. The company recorded a 8.2% increase in total written premiums, a commendable development.
P&C segment: Long-term profitability targets unchanged as rate and non-rate underwriting actions take effect (Horace Mann Educators Q2 2023 Investor Presentation )
According to management, this growth can be traced back to specific rate actions the company took, a tactical move that seems to signal stability in customer retention.
Driving Toward Underwriting Profits
Digging deeper into the quarter, Horace Mann finds itself at the nexus of strategic evolution and market dynamics. Recent data delineates a parallel 11.4% year-over-year augmentation in both auto and property insurance premiums. This synchronous ascent underscores a broader narrative about the flux in insurance costs and the macroeconomic factors influencing it.
Peeling back the layers on the auto insurance segment reveals Horace Mann's prescient blueprint. With eyes set firmly on 2024, the company has embarked on a strategy aimed at navigating back to underwriting profit.
Their aspirational target casts a focused beam on their trajectory: a formidable long-term benchmark of 97%-98%.
Concurrently, in the corridors of property insurance, Horace Mann's balance sheet paints a narrative of tempered steadiness. The average underlying loss ratio, anchored at 49.8%, appears to be a testament to their risk mitigation strategies.
Also, the firm intends to double its rate plan by 2024. This move aligns seamlessly with its overarching objective: a long-term combined ratio target nestled between 92%-93%.
Life, Retirement, and Supplemental Divisions
The recent quarterly performance of the Life and Retirement, Supplemental, and Group Benefits divisions has played a crucial role in stabilizing the company within the backdrop of the fluctuations in the Property & Casualty (P&C) sector.
For the Life and Retirement segment, the adjusted core earnings reached $17.5 million. Complementing this, the net annuity contract deposits in the retirement business ascended by 8.3%, culminating at $113 million for the second quarter.
The Supplemental and Group Benefits divisions, not to be overshadowed, have logged second-quarter core earnings of $11.8 million. And, looking ahead, the organization's outlook appears positive and strategically focused. There are expectations for escalated growth within the education market in the forthcoming period.
The company's leadership has not only reaffirmed their existing targets but also provided clarity on their longer-term aspirations. Specifically, a core Return on Equity (ROE) of approximately 10% has been targeted for 2024, paired with an average annual EPS growth of 10% projected for 2025 and the subsequent years
HMN's Performance
Unfortunately, this is the point where reality resurfaces, casting doubt on previously positive projected outlooks: Looking at the medium-term picture (see data below), starting at USD 33.18 in 2016 and ending at USD 28.81 in 2023 represents a noticeable decline. The annualized rate of return (w/o Div) at -1.84% gives me serious pause. Compared to the broader market (the S&P 500 Index ) performance at 10.89%, HMN's performance seems lackluster.
The dividend growth has been steady, albeit somewhat uninspiring, at an average of 3.60% over seven years. It's a consistent growth, but nothing that would set your investment portfolio ablaze.
The compound growth of 1.68% compared to 12.18% for the S&P again paints a picture of underperformance. The total growth and dividends combined result in USD 11.344K for HMN (on a hypothetical initial $10k investment) and a much more rewarding USD 23.924K for the S&P.
Valuation
The blended P/E of 22.62x vis-à-vis a normal P/E ratio of 21.79x shows that HMN is trading at a slightly premium level. Now, some investors might find this concerning, but in my eyes, this isn't necessarily a red flag. It signifies the market's heightened expectations from the company. The question remains, can HMN deliver? Based on a consistent growth rate data, I'm actually inclined to say yes.
An adjusted operating earnings growth rate of 6.63% might not be earth-shattering, but consistency is key here. If you're thinking growth, think long-term. HMN's steady, if not spectacular, earnings growth is indicative of underlying stability.
Risks & Headwinds
Seeking Alpha
Where there's a silver lining, there's often a cloud.
Seeking Alpha readers may have noticed the warning label on Horace Mann Educators' summary page that point out its 3M Price Performance - a -13.67%, with the Financials sector median at 5.53% which is indicative of structural weaknesses and the D- grade in momentum compared to its peers in the sector doesn't leave much room for interpretation.
Also, glancing at the 9M, 6M, and 1Y price performances with grades ranging from D to D+ underscore a persistent, troubling trend. The -25.90% over 9M and -24.51% over 6M suggest a firm that's not merely lagging; it's falling behind.
The longer-term view is equally bleak, with a 1Y Price Performance of -14.67%.
Next, circling back to HMN's recent Q2 , the Property and Casualty (P&C) segment provided insight into the dance between expectations and reality. While catastrophe losses took their toll, as noted earlier, leading to a quarterly loss, the impact, to reiterate, was less pronounced than the previous year. However, it would be unwise for investors to ignore the residual effects that still linger as this year's turmoil in the P&C segment, marked by an increase in catastrophic events, carves an impression that may not easily be smoothed away.
Then comes the nuanced issue of the auto combined ratio, which is expected to exceed the initially targeted 107. Primarily, this deviation can be attributed to weather-related frequency. What this statistic unveils, when investors brush away the surface layers, is a subtext of profitability challenges.
HMN's Q2 2023 Investor Presentation
Reflecting further on the P&C segment (representing 47% of revenues), I think it's also crucial to absorb the projected core loss, nestled between $27 million and $32 million for the full year. It's a figure that, standing alone, tells a story of impact, but also echoes the greater theme of catastrophe losses within the industry.
Drifting towards the Life and Retirement segment, we find another piece of a challenging puzzle. The annualized net interest spread on fixed annuity business shifted down from 303 basis points to 203 basis points, a dynamic influenced by lower limited partnership portfolio returns.
Longer-term target for fixed annuity spread (HMN's Q2 2023 Investor Presentation)
Here, investors should be reminded of the intricate financial mechanisms that reveal themselves in a decline that is far from inconsequential. Add to this the cash value persistency's slight dip to 92.2%, mainly outside of core 403(b) accounts, and a layered picture emerges to add to HMN's challenges and adjustments.
HMN's investment portfolio (HMN's Q2 2023 Investor Presentation)
Next, the net unrealized investment loss position of the fixed maturity securities portfolio rose to $501 million pre-tax at quarter-end. This development, it should be said, unveils yet another potential vulnerability to changing market conditions.
Lastly, the matter of the company's $17 million in net investment losses in the second quarter shouldn't be glossed over. Occurring as the firm repositioned its portfolio to enhance book yield, this episode calls attention to some level of financial instability in the short term. Here we find ourselves at the intersection of strategy and consequence, where actions, even those aimed at improvement, carry their own ripples.
Final Takeaway
I rate HMN as a "Hold".
While the company has shown resilience in a turbulent P&C sector, highlighting specific growth in premiums and solid strategies targeting underwriting profits, the broader landscape paints a concerning picture with rising catastrophic losses and challenges in profitability. Furthermore, their underperformance relative to the broader market and existing challenges in the P&C segment make it hard to wholeheartedly endorse as a 'buy'. However, their long-term strategy and consistent growth, albeit slow, does not warrant a 'sell' either. Given these mixed signals of both negative and positive trends, it's prudent to wait and watch.
For further details see:
Horace Mann Educators: Earnings Report Falls Flat