Horace Mann Educators Corp (HMN) Q4 2020 Earnings Call Transcript

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Horace Mann Educators Corp (HMN 1.78%)
Q4 2020 Earnings Call
Feb 3, 2021, 9:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning and welcome to the Horace Mann Educators Fourth Quarter and Yearend 2020 Investors Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded.

I would now like to turn the conference over to Heather Wietzel, Vice President of IR. Please go ahead.

Heather J. Wietzel -- Vice President, Investor Relations and Enterprise Communications

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.

Marita Zuraitis, President and Chief Executive Officer, and Bret Conklin, Executive Vice President and Chief Financial Officer will give the formal remarks on today's call. With us for the Q&A, we have Matt Sharpe on Distribution; Mark Desrochers on P&C Wade Rugenstein on Supplemental; Mike Weckenbrock on Life and Retirement; and Ryan Greenier on Investments.

Before turning it over to Marita, I want to note that our presentation today includes forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. The company cautions investors that any forward-looking statements include risks and uncertainties and are not guarantees of future performance. These forward-looking statements are based on management's current expectations, and we assume no obligation to update them. Actual results may differ materially due to a variety of factors, which are described in our news release and SEC filings.

In our prepared remarks, we use some non-GAAP measures. Reconciliations of these measures to the most comparable GAAP measures are available in our news release.

I'll now turn the call over to Marita.

Marita Zuraitis -- President and Chief Executive Officer

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 multi-year 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. We understand the issues that educators are facing, and we provide solutions. Our business model evolves in tandem with the changing educational environment. So while we certainly couldn't have predicted that a global pandemic would reshape the way schools function for almost a year, our structure is flexible enough to address new needs of educators and school districts as they arise.

2020 was a particularly tough year for educators, students, and their families alike. Educators are worried that the difficult combination of in-person and virtual learning environments, with little time for them to prepare for changes or lean on established best practices, will mean students fall behind academically. Students without a stable home environment, already at a disadvantage, may fall even further behind. To try to address these concerns, educators are overwhelmingly working more. In a November Horace Mann research survey, 77% said they are putting in more hours than a year ago. At the same time, educators are working to balance this reality with concerns for their own health and finances.

Although educators have had more job security relative to some other professions during the pandemic, their families are collectively feeling the financial impact. In the November study, 64% of educators told Horace Mann that they have put less in or stopped paying into non-retirement savings due to COVID-19, and only 34% were confident that their employer benefits would cover unplanned time off for a health issue. In 2020, delivering on our promise to educators on addressing these concerns and supporting them both personally and professionally in this new work environment.

As the COVID-19 pandemic began closing schools across the country in the spring, we accelerated adoption of technology solutions that made it easier for agents and educators to work together online. This included transitioning programs like our financial wellness seminars to a webinar format, utilizing the same technology many educators are using for teaching. We also partnered with curriculum providers to get educators additional remote learning resources. As we shared at the time, we also proactively supported educators, our communities, and employees as they faced pandemic-related challenges outside of classrooms.

In addition, we rolled out the next generation of our Student Loan Solutions program, which helps educators receive the Public Service Loan Forgiveness they deserve, along with other resources to help manage student loan debt through online accounts. We provide these accounts for free for every public school educator nationwide. In 2020 alone, we helped to put educators on the path to $100 million in student loan forgiveness.

Recently, we launched a virtual speaker series featuring nationally known speakers presenting on topics curated specifically for an educator audience. Some events were designed to educate, like a session on financial security with Jean Chatzky of the TODAY show, while others were meant to inspire, like a session with Adam Welcome fellow for the National Association of Elementary School Principals in the Center for Innovative Leadership.

As a company, we learned a lot in 2020. We tested a number of new virtual approaches and virtual events that may not have been pursued in a typical year. The ones that worked well will be integrated in our playbook going forward. In a post-vaccine environment, these will be valuable tools to complement in-school and in-person activities. Bret will break down the details of our performance and outlook later in the call, but we are guiding to 2021 core earnings per share in the range of $3.00 to $3.20 and a return on equity in the range of 9% to 9.5%. This reflects continued progress on our strategic initiatives and keeps us on track to our long-term goal of sustainable double-digit ROE.

It also reflects that 2020 results included several items that added to core EPS that will not repeat in 2021, including the effect of policyholder behavior changes due to COVID-19, the $8.7 million Camp Fire subrogation recovery, and lower corporate expenses due to the pandemic. Put more simply, our strategic initiatives drove about one-third of the improvement in 2020 over 2019, essentially tracking with our original guidance, which would itself have been a record.

We will continue to live and work and a largely pre-vaccine environment during the first part of 2021, but expect to see momentum returning later in the year. We are focused on leveraging the strategic enhancements we've made over the past several years to optimally position ourselves for growth. For example, we plan to leverage our new P&C administration system rollout in states where we have the strongest prospects for growth. The Guidewire system offers substantial benefits in the ability to implement insights into customer segmentation in our pricing structure. In addition, by accelerating the integration of Supplemental agents during 2020, we were able to fill uncovered territories, with successful agents experienced and working with school district officials and educators. These agents now have the opportunity to provide auto, property, life, and retirement products to their customers. Even more importantly, it aligns our entire agency force well ahead of our original schedule. We expect to benefit from this alignment as we enter the post-pandemic environment.

And upgrading our Section 125 benefits platform also provides potential for growth. School districts can use the Section 125 platform to provide different types of voluntary benefits to employees in their district, such as retirement savings, supplemental insurance products, or pre-tax withholdings for medical expenses. We recently moved to a unified Section 125 enrollment technology platform for Horace Mann offerings and are currently migrating existing school districts to the new platform. As part of the migration process, we are making our supplemental products available in a number of districts where we already have a strong relationship providing retirement and other products.

Additionally, we continue to test and develop other channels of communication and distribution to serve educators, including web, social media, inside sales, and direct marketing. This omnichannel approach strives to integrate with and leverage the strong foundation provided by the agency force with the goal of meeting the customer where they are and making Horace Mann as easy to do business with as possible.

Before I turn the call over to Bret, I want to take a moment to touch on another topic that is just as integral to who we are as a company; our commitment to diversity, equity, and inclusion. We haven't always called it that, but recognizing, respecting, and appreciating differences has always been a part of how our company operates. Like the educators we serve, we are a diverse group, and we are dedicated to continually assessing and improving our inclusive culture so that Horace Mann continues to be a great place to work for all.

In 2020, we took a number of steps to enhance our diversity, equity, and inclusion efforts, including establishing an employee DEI Council to help guide company initiatives and identify areas for improvement. In addition, we began to roll out unconscious bias training to all company leaders, starting with the Board of Directors, senior staff, and DEI Council members. I'm pleased to report that for the third year in a row, Horace Mann has been named to the Bloomberg Gender-Equality Index, which recognizes corporate commitment to transparency in gender reporting and advancing women's equality. Only 380 companies worldwide are included in the reference index, which measures gender equality across five pillars: female leadership and talent pipeline, equal pay and gender pay parity, inclusive culture, sexual harassment policies, and pro-women brand. I firmly believe that Horace Mann's commitment to offering an inclusive work environment, one where diversity of thought is highly valued and individual differences are recognized, respected, and appreciated, continues to be an important factor in our company's success.

2020 was a remarkable year in many ways, and we continued to advance the strategic plan for Horace Mann on all fronts. Thank you. And with that, I'll turn the call over to Bret.

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

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 toward 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. Putting the 2020 catastrophe loss activity into context, our average catastrophe loss impact has been 9.6% over the past 10 years. We took that into account in the 9.5% catastrophe load assumption we have incorporated into our 2021 guidance.

Offsetting the higher catastrophe losses, we saw progress across the board in the other factors contributing to P&C's improved underwriting income and combined ratio. Briefly, full-year reserve development was a favorable $10.2 million, which included $5.2 million pre-tax and net of reinsurance for the Camp Fire subrogation recovery in the third quarter. In the fourth quarter, we recorded a favorable $1 million recovery from prior period, ex-cat property loss reserves. We ended the year solidly in the upper half of the independent actuaries' range for total P&C reserves.

Most significantly for the year, the underlying auto loss ratio was 10.2 points better than 2019, primarily because loss costs continue to reflect changes in driving patterns due to the pandemic. We also continue to see benefits from the progress we've made over several years to enhance our pricing segmentation and improve our long-term model profitability. The impact of the pandemic on loss cost reflects lower frequency related to the new driving patterns as well as a partial offset because of the anticipated uptick in UM/UIM claims. In addition, we're receiving fewer small claims.

Over the course of 2021, we anticipate loss ratios gradually rising toward our long-term target levels. We are presuming some changes to driving patterns become permanent, but those would be offset by some of the factors that increased severity in 2020. We anticipate fairly stable rates in 2021. In addition, the underlying property loss ratio improved 2.9 points for the full year, primarily due to the return of reinsurance reinstatement premium in the third quarter. Over the course of 2020, the mix of perils reflected higher non-weather, water, and fire losses, including four larger fire losses in the fourth quarter. We're confident we're seeing normal variations and loss patterns as our analysis continues to find no concentration by geography, by agent, or by costs.

For 2021, we anticipate the underlying property loss ratio will be stable with rates expected to rise in the low-single digits. Finally, the full-year expense ratio improved by half a point benefiting from expense reduction initiatives as well as lower spending due to the pandemic. The slight uptick in the ratio in the fourth quarter was due to normal year-end accruals. The fundamental progress we've made in P&C supports our outlook for $54 million to $58 million in 2021 segment earnings with the full-year combined ratio in line with our longer-term target of 95% to 96%.

Turning to Supplemental. In its first full year as part of Horace Mann, the segment added $130.7 million in premiums and $43.1 million to core earnings, reflecting favorable trends in reserves and the short-term benefit of changes in policyholder behavior due to COVID-19. Net investment income on the Supplemental portfolio reflects the solid progress we are making in improving the Supplemental investment yield.

Supplemental sales were $1.4 million in both the third and fourth quarters. They remained well below last year because Supplemental products have traditionally been sold through a worksite enrollment model across the industry. We expect sales to begin to return to a more normal trajectory over the coming quarters. Premium persistency rose to 90.5% in this environment, with about 287,000 policies in force. As we've said, policyholder retention for this business is relatively stable. Our outlook for Supplemental's 2021 core earnings of $33 million to $35 million reflects the expectation that the full-year pre-tax profit margin will move closer to our longer-term target of mid-20%. The segment continues to illustrate the diversification benefit it has brought to Horace Mann.

For the Life segment, sales were below last year in the fourth quarter, although the lapse ratio improved slightly and policy count remains consistent with pre-pandemic levels. The number of issued recurring term and whole life policies was in line with pre-pandemic levels, although sales declined of complex products such as indexed universal life and larger single-premium policies which require more customer interaction to complete the sales process. Core earnings reflected mortality trends that were in line with actuarial expectations versus the favorable mortality trends we saw in 2019. The volume of claims related to COVID-19 remains very low, with face values averaging below $40,000. In addition, operating expenses reflected the ongoing benefits of our expense optimization efforts, as well as lower expenses due to the pandemic declining 6.6% from 2019. 2020 core earnings, ex-DAC, were on track with our expectations at $10.2 million. As I'll cover in a moment, we expect the alternative portfolio to deliver mid-to-high single-digit returns in 2021, which supports our expectation for Life 2021 core earnings to rise to the range of $17 million to $19 million.

For the Retirement segment, full-year core earnings, ex DAC unlocking, improved almost $1 million over last year. Operating expenses declined $8.7 million, reflecting expense initiatives put in place last year and savings related to the pandemic. Those savings were largely offset by the lower net interest margin on our retained annuity portfolio. However, the net interest spread improved to 212 bps for the year, reflecting the benefit of the reinsurance transaction and is above our threshold for double-digit returns in this business.

Fourth quarter results reflected strong investments returns driven by the limited partnerships. We continue to see Retirement segment growth as our solutions for augmenting retirement savings remain a core need for educators. Annuity contract deposits were up 4.5% for the year and essentially flat in the fourth quarter with slightly less single-premium rollover activity than in last year's fourth quarter. Our educator customers continue to see annuities as an important way to achieve their financial objectives and they are complemented by our suite of fee-based products. Based on our outlook for 2021, alternative portfolio performance, and our expectations that we will see higher fees on our annuity business, we anticipate next year's Retirement core earnings, ex-DAC unlocking, will be in the range of $38 million to $40 million.

Turning to Investments. Total net investment income on the managed portfolio was $260.3 million for the year. This was above our most recent guidance as the market recovery continued to drive improving valuations for our alternatives portfolio, which generally reports on a one quarter lag and resulted in 17.9% growth in net investment income in the fourth quarter. The strong equity market resulted in positive marks across various private equity funds. In addition, valuations continued to recover in the structured security funds that were most impacted earlier in the year. We remain confident in continuing to allocate to this asset class, even though this year's return of 5% was below our longer-term target for the alternatives portfolio.

Our core fixed maturity portfolio remains well positioned to weather market volatility and any additional COVID-19 induced economic downturns. The core portfolio had a yield of 4.25% in the fourth quarter compared with 4.36% a year ago. For most of the second half of 2020, we focused our core portfolio purchases on high-quality municipals, corporate and government agency securities. The core new money rate was 3.75% for the year and 3.35% in the fourth quarter. Based on current market conditions, we anticipate a core new money rate of about 3% in 2021.

On a full-year basis, net realized losses of $2.3 million included $5.3 million of impairment losses related to intent to sell decisions. Those reflected our proactive responses throughout the year to COVID-related pressure on various travel-related and energy issuers. For 2021, we expect total net investment income will be between $370 million and $380 million, including approximately $100 million of accreted investment income on the deposit asset on reinsurance. This expectation for investment income is captured in the segment by segment outlook summarized in our investor presentation and in our core EPS guidance range of $3.00 to $3.20.

Before I turn the call over to Heather for Q&A, I wanted to reiterate what we believe is the most significant takeaway from today's call, that our targets for 2021 represent another step on the steady, upward trajectory we've been on for the past several years toward our long-term objective of sustainable double-digit ROE. Our strong performance is translating into capital generation that we will use to accelerate shareholder value creation when the time is right. Our priorities remain first: growing our business at returns that meet or exceed our ROE targets; second, returning a significant portion of annual earnings back to shareholders via compelling dividend; and finally, buying back shares opportunistically when market conditions warrant. We're on the right track despite the challenges of this unusual environment, and we are excited about what lies ahead.

Thank you. And with that, I'll turn it back to Heather.

Heather J. Wietzel -- Vice President, Investor Relations and Enterprise Communications

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

Questions and Answers:

Operator

[Operator Instructions] The first question is from Matt Carletti from JMP Securities. Please go ahead.

Matthew Carletti -- JMP Securities LLC -- Analyst

Thanks, good morning.

Marita Zuraitis -- President and Chief Executive Officer

Morning, Matt.

Matthew Carletti -- JMP Securities LLC -- Analyst

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's a focus on growth, returning to growth as kind of we get past the pandemic and back toward 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.

Marita Zuraitis -- President and Chief Executive Officer

Yeah. 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 $2.20, what we earned in 2020 without non-reoccurring pandemic benefit, call it, the midpoint of our range at about $2.66, 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 eight to that 7.5% ROE going to an 8.5% ROE, going to about a 9.5% ROE.

Now when I step back and I unpack 2020 and I think about what occurred for us in 2020, we talked about these non-reoccurring things, but think about the Camp Fire subrogation. Yes, that was in our numbers that got us to the $3.40, 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. When 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 fought 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 our 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 cats 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 saying we did what we said we would do, the numbers came through the way we thought they would come through, and we're better positioned at the end of this period than 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 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 it 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.

Matthew Carletti -- JMP Securities LLC -- Analyst

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, on slide eight. You gave a great color on it. Could I ask around that ROE, one is just kind of how you define ROE? I'm assuming it's kind of ex fixed income, realized gains, and average equity across the year. But more importantly, Bret, I caught your comment about 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?

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

Yeah. So, Matt, you are absolutely correct with the ROE being calculated ex AOCI. I probably should mention, too, that our ROE guidance reflects our targeted capital levels, which you're well aware are at 4.25%. 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, it's first and foremost focus on growth, paying a compelling dividend to our shareholders, an if opportunities present themselves to buy back shares, we will do that. So those levers remain the same, but I think we're where we were a year ago. We definitely want to focus on growth, and we've shown we are willing to do that organically or inorganically.

Matthew Carletti -- JMP Securities LLC -- Analyst

Great. Thank you. Best of luck going forward.

Marita Zuraitis -- President and Chief Executive Officer

Thanks, Matt.

Operator

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

Meyer Shields -- Keefe, Bruyette & Woods, Inc. -- Analyst

Thanks. Good morning, all. I just want to make sure I understand I guess the Supplemental and the Property and 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?

Marita Zuraitis -- President and Chief Executive Officer

Yeah. 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 toward 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?

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

Yeah. 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.

Mark R. Desrochers -- Senior Vice President, Property and Casualty and Chief Corporate Actuary

Yeah. 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 examined 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 impacts 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 in accident frequency.

Meyer Shields -- Keefe, Bruyette & Woods, Inc. -- Analyst

Okay. No, that's helpful. And I did mean both sides 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 live without, as they've seen over the course of the pandemic?

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

Meyer, let me start, and maybe I'll have Wade jump in as well. But as it relates to 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 benefit. People just not going to go get the care and get reimbursed for those expenses, as they had, had the pandemic not been in place. But as far as pieces of policies that they could perhaps -- I don't think that's the case, but I'll have Wade chime in on that item.

Wade A. Rugenstein -- Executive Vice President, Supplemental and Operations

Sure, Bret. Yeah, when I look at the policies, I think there's a lot of flexibility in how they're designed. I think the 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.

Marita Zuraitis -- President and Chief Executive Officer

Yeah, 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.

Meyer Shields -- Keefe, Bruyette & Woods, Inc. -- Analyst

Yeah, that makes sense. Okay, great. Thank you very much.

Marita Zuraitis -- President and Chief Executive Officer

Thanks, Meyer.

Operator

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

John Barnidge -- Piper Sandler & Co. -- Analyst

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?

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

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 in flows 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's anything you want to add to that comment.

Mike Weckenbrock -- Senior Vice President, Retirement and Life

No, I think you hit it on the head, Bret. We actually saw 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 take under consideration.

John Barnidge -- Piper Sandler & Co. -- Analyst

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

Marita Zuraitis -- President and Chief Executive Officer

Yeah, John, I think it's a good question, and I think we've all been hearing I think what's becoming a prevailing fact and that is there isn't a replacement for physicality. All the studies that are being done, drops in scores, it's 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. 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 approach post pandemic, but 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'll 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.

John Barnidge -- Piper Sandler & Co. -- Analyst

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

Marita Zuraitis -- President and Chief Executive Officer

Not at all. Not at all. We didn't -- 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 five-year averages, 10-year averages, and look at the amount of cats, obviously, the last two years does push that number. It could be conservative. The only thing you know about that number is you don't know what that number is going to be, but you add two more pretty heavy years to that number, and the actuarial number that spits out is higher. That's all that is.

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

Yeah. And, John, I think I even noted that in my prepared remarks that 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.

Marita Zuraitis -- President and Chief Executive Officer

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

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

Right.

John Barnidge -- Piper Sandler & Co. -- Analyst

Thank you very much for your answers.

Marita Zuraitis -- President and Chief Executive Officer

You're welcome.

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

Sure. Thanks, Jeff.

Operator

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

Gary Ransom -- Dowling & Partners Securities LLC -- Analyst

Good morning. 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 what I'm trying to get at 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's some seasonality I know. There maybe 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's happening in the fourth quarter loss ratio.

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

Yeah. 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 a underlying basis is a great day. Obviously, we would certainly target an all-in total P&C 95% combined ratio to get at our targeted ROE. But as it relates to the fourth quarter, I'll let Mark comment on some of the specific coverage is, if you will, that we saw a little bit of uptick in.

Mark R. Desrochers -- Senior Vice President, Property and Casualty and Chief Corporate Actuary

Yeah, absolutely, Bret. Gary, so I think you make a couple good points. There is certainly some effect of 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 played 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. So we've definitely seen that, which is sort of what we predicted early on in the pandemic that the long-term effects of economy would have on UM/UIM.

And then also to a lesser extent, we have seen an increase over the last half of the year and a little bit more so in the fourth quarter with increased death claims. But that's a small impact. We don't get a lot of deaths to begin with, but we've certainly seen those impacts. So I think there is some effect of what's going on in the economy that's driving severity to somewhat offset what we might see in pure accident frequency.

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

Yeah. And 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 4 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.

Marita Zuraitis -- President and Chief Executive Officer

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 '21.

Gary Ransom -- Dowling & Partners Securities LLC -- Analyst

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?

Mark R. Desrochers -- Senior Vice President, Property and Casualty and Chief Corporate Actuary

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, but our drivers are not, right. Our teachers are employed. They still have higher BI limits and higher UM limits. So when they're struck by someone with a minimum limit policy, whereas maybe they more typically would be struck by some of the higher limit policy that creates more UIM claims.

Gary Ransom -- Dowling & Partners Securities LLC -- Analyst

All right, thanks. Can I get some 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?

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

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 with 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.

Gary Ransom -- Dowling & Partners Securities LLC -- Analyst

Okay, fair enough. Changing subjects. 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're 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's as you expected, but can you give us some thoughts on that?

Marita Zuraitis -- President and Chief Executive Officer

Yeah. 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 selling in almost a virtual worksite 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 due to COVID-19. And from an infrastructure standpoint, interestingly enough, it brought some opportunities. For example, 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 in advance to the P, the D, and the I, and all those things are coming through exactly the way we thought they would come through. You know 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. 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 territories 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.

Gary Ransom -- Dowling & Partners Securities LLC -- Analyst

All right. Thank you very much.

Marita Zuraitis -- President and Chief Executive Officer

You're welcome.

Operator

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

John Barnidge -- Piper Sandler & Co. -- Analyst

The last question took care of it. Thanks a lot.

Marita Zuraitis -- President and Chief Executive Officer

You're welcome.

Operator

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

Heather J. Wietzel -- Vice President, Investor Relations and Enterprise Communications

Yeah. Thank you, everyone, for joining us today. I'll be available for the rest of the week if there is additional follow-ups, 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 AIFA virtual events. So we look forward to talking to people as the months go on. So thank you again.

Marita Zuraitis -- President and Chief Executive Officer

Thanks, everybody.

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

[Operator Closing Remarks]

Duration: 52 minutes

Call participants:

Heather J. Wietzel -- Vice President, Investor Relations and Enterprise Communications

Marita Zuraitis -- President and Chief Executive Officer

Bret A. Conklin -- Executive Vice President and Chief Financial Officer

Mark R. Desrochers -- Senior Vice President, Property and Casualty and Chief Corporate Actuary

Wade A. Rugenstein -- Executive Vice President, Supplemental and Operations

Mike Weckenbrock -- Senior Vice President, Retirement and Life

Matthew Carletti -- JMP Securities LLC -- Analyst

Meyer Shields -- Keefe, Bruyette & Woods, Inc. -- Analyst

John Barnidge -- Piper Sandler & Co. -- Analyst

Gary Ransom -- Dowling & Partners Securities LLC -- Analyst

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