In 2013, the Company sold the building where Kemper’s corporate and business executive offices and the home office of Kemper Direct are headquartered. In connection with the sale, the Company leased back five floors, or approximately 67,000 square feet of the 41-story office building.
Catastrophe losses and LAE from continuing operations (excluding loss and LAE reserve development from prior accident years) were $50.7 million before tax for the year ended December 31, 2013, compared to $124.5 million in 2012, a decrease of $73.8 million. Catastrophe losses and LAE before tax decreased by $64.3 million and $6.0 million, in the Kemper Preferred and Kemper Direct segments, respectively. The Company reported Income from Discontinued Operations of $3.2 million and $11.6 million for the years ended December 31, 2013 and 2012, respectively.
Net Investment Income increased by $18.8 million in 2013 due primarily to $17.1 million in higher net investment income from Equity Method Limited Liability Investments and $12.3 million in higher net investment income from Dividends on Equity Securities, partially offset by $10.6 million of lower net investment income from Interest and Dividends on Fixed Maturities.
Earned Premiums in the Kemper Preferred segment decreased by $2.7 million for the year ended December 31, 2013, compared to 2012, due primarily to lower volume of $44.3 million, partially offset by higher average premium of $41.6 million. Earned premiums on automobile insurance decreased by $11.9 million in 2013, compared to 2012, due primarily to lower volume of $24.8 million, partially offset by higher average premium of $12.9 million. Earned premiums on homeowners insurance increased by $9.4 million in 2013, compared to 2012, due primarily to higher average premium of $26.6 million, partially offset by lower volume of $17.2 million. Earned premiums on other personal insurance decreased by $0.2 million in 2013, compared to 2012, due primarily to lower volume of $2.3 million, partially offset by higher average premium of $2.1 million.
Incurred losses and LAE were $62.5 million, or 50.6% as a percentage of earned premiums, for the year ended December 31, 2013, compared to $129.5 million, or 77.1% as a percentage of earned premiums, in 2012. Incurred losses and LAE decreased in 2013, due primarily to the impact of lower earned premiums, lower underlying losses and LAE as a percentage of earned premiums, higher levels of favorable loss and LAE reserve development and lower catastrophe losses and LAE (excluding reserve development). Underlying losses and LAE as a percentage of earned premiums were 69.5% in 2013, compared to 82.8% in 2012. Underlying losses and LAE as a percentage of earned premiums decreased due primarily to lower severity of automobile insurance losses and lower frequency of automobile insurance claims. Favorable loss and LAE reserve development was $25.6 million in 2013, compared to $17.8 million in 2012. Catastrophe losses and LAE (excluding reserve development) were $2.3 million in 2013, compared to $8.3 million in 2012.
The Incurred Expense Ratio, including Write-off of Intangible Asset, was 34.0% of earned premiums for the year ended December 31, 2012, compared to 40.3% of earned premiums in 2011. In 2011, the book of business acquired in connection with the acquisition of Direct Response was not improving at the rate that Kemper Direct had initially expected, and Kemper Direct determined that the customer relationships intangible asset related to the Direct Response acquisition was impaired at December 31, 2011 and recognized a charge of $13.5 million in 2011 to write down the asset to its estimated fair value. Insurance Expenses as a percentage of earned premiums were 34.0% in 2012, compared to 34.3% of earned premiums in 2011. Insurance Expenses as a percentage of earned premiums decreased due primarily to reduced acquisition and marketing related expenses, partially offset by other underwriting costs not declining at the same pace as earned premiums.
products to offset much of the decline. Earned premiums on property insurance decreased by $2.5 million in 2013, compared to 2012, due primarily to lower volume of insurance from the run-off and, in certain geographical areas, the non-renewal of insurance policies providing dwelling coverage (“Dwelling Policies”), partially offset by the impact of non-renewing the Life and Health Insurance segment’s catastrophe reinsurance program. Catastrophe reinsurance premiums reduced earned premiums by $2.0 million for the year ended December 31, 2012 with no such reduction in 2013. Given the actions taken by KHSC to reduce its exposures to catastrophes and except for catastrophe reinsurance provided by the FHCF, KHSC did not renew its catastrophe reinsurance program in 2013. The Life and Health Insurance segment has been intentionally running off Dwelling Policies to reduce its exposure to catastrophe risks. Over the last several years, the Life and Health Insurance segment has halted new sales of Dwelling Policies in all markets and non-renewed Dwelling Policies in certain geographical, mainly coastal, areas while continuing to renew policies in other geographical areas. Earned premiums from dwelling coverage comprised 23%, 26% and 30% of the Life and Health Insurance segment’s earned premiums on property insurance in 2013, 2012 and 2011, respectively.
Net Investment Income increased by $3.8 million for the year ended December 31, 2012, compared to 2011, due primarily to higher investment income from Equity Method Limited Liability Investments, partially offset by lower book yields on fixed maturities and lower levels of capital allocated to the segment. Net investment income from Equity Method Limited Liability Investments was income of $1.8 million in 2012, compared to a loss of $6.3 million in 2011.
Kemper did not borrow under its credit agreements during 2013 and 2012. Kemper borrowed and repaid $95.0 million under the Former Credit Agreement in 2011. There were no outstanding borrowings under the 2016 Credit Agreement at December 31, 2013, and accordingly, $225.0 million was available for future borrowings. Management estimates that it could borrow the full amount under the 2016 Credit Agreement and still meet the financial covenants therein.
In connection with the finalization of their FHLB memberships, United Insurance and Trinity purchased capital stock in the FHLBs of Chicago and Dallas, respectively. In addition, to complete Trinity’s membership in the FHLB of Dallas, which became effective as of December 31, 2013, Trinity and the FHLB of Dallas entered into agreements pursuant to which Trinity may obtain extensions of credit (“FHLB Advances”) from the FHLB of Dallas. The amount of FHLB Advances that may be obtained by Trinity will be determined as of any particular date based on a multiple of the amount of capital stock in the FHLB of Dallas that has been purchased by Trinity as of such date. FHLB Advances are subject to collateral requirements as specified in the agreements. There were no FHLB Advances outstanding at December 31, 2013.
The final step in the quarterly loss and LAE reserving process involves a comprehensive review of the actuarial indications by the Company’s corporate actuary and corporate management who apply their collective judgment and determine the appropriate estimated level of reserves to record. Numerous factors are considered in this determination process, including, but not limited to, the assessed reliability of key loss trends and assumptions that may be significantly influencing the current actuarial indications, changes in claim handling practices or other changes that affect the timing of payment or development patterns, changes in the mix of business, the maturity of the accident year, pertinent trends observed over the recent past, the level of volatility within a particular line of business, the improvement or deterioration of actuarial indications in the current period as compared to prior periods, and the amount of reserves related to third party pools for which the Company does not have access to the underlying data and, accordingly, relies on calculations provided by such pools.
The following table sets forth the pre-tax amount of OTTI credit losses, recognized in Retained Earnings for Investments in Fixed Maturities held by the Company as of December 31, 2013, 2012 and 2011, for which a portion of the OTTI loss has been recognized in Accumulated Other Comprehensive Income, and the corresponding changes in such amounts.
The design of the Omnibus Plan provides for fungible use of shares to determine the number of shares available for future grants, with a fungible conversion factor of three to one, such that the Share Authorization will be reduced at two different rates, depending on the type of award granted. Each share of Kemper common stock issuable upon the exercise of stock options or stock appreciation rights will reduce the number of shares available for future grant under the Share Authorization by one share, while each share of Kemper common stock issued pursuant to “full value awards” will reduce the number of shares available for future grant under the Share Authorization by three shares. “Full value awards” are awards, other than stock options or stock appreciation rights, that are settled by the issuance of shares of Kemper common stock and include restricted stock, restricted stock units, performance shares, performance units, if settled with stock, and other stock-based awards.
A reconciliation of the numerator and denominator used in the calculation of Basic Income from Continuing Operations Per Unrestricted Share and Diluted Income from Continuing Operations Per Unrestricted Share for the years ended December 31, 2013, 2012 and 2011 is as follows:
The components of Other Comprehensive Income Tax Benefit (Expense) for the years ended December 31, 2013, 2012 and 2011 were:
During the first quarter of 2012, the Internal Revenue Service (“IRS”) began an audit of the Company’s 2009 and 2010 federal income tax returns. The Company reported a capital loss and a net operating loss in its 2009 federal income tax return and a net operating loss in its 2010 federal income tax return. The Company has carried these losses back to earlier tax years. Even though the Company has already received the refunds from carrying these losses back to such earlier tax years, approval by the Joint Committee on Taxation (“JCT”) is still required by law. The JCT has requested that the IRS perform an audit of these years before approving the refunds. During the second quarter of 2013, the Company extended the federal statute of limitations related to its 2007 through 2010 tax years to December 31, 2014. The extension was requested by the IRS to provide additional time for the IRS to finish processing its audit of the Company’s 2009 and 2010 federal income tax returns and related refund claims and for the IRS to prepare the necessary documentation for the JCT’s review required by statute. The Company does not anticipate a material modification to the filed returns or the related refunds that have been received.
The Company investigates significant differences related to the values provided. On completion of its investigation, management exercises judgment to determine the price selected and whether adjustments, if any, to the price obtained from the Company’s primary pricing provider would warrant classification of the price as Level 3. In instances where a measurement cannot be obtained from either pricing provider, the Company generally will evaluate bid prices from one or more binding quotes obtained from market makers to value investments in inactive markets and classified by the Company as Level 2. The Company generally classifies securities when it receives non-binding quotes or indications as Level 3 securities unless the Company can validate the quote or indication against recent transactions in the market. For securities classified as Level 3, the Company either uses valuations provided by third party fund managers, third party appraisers, the Company’s own internal valuations or net asset values provided for Limited Liability Companies and Limited Partnerships. These valuations typically employ various valuation techniques, including earnings multiples based on comparable public securities, comparable market yields as well as industry specific non-earnings based multiples or discounted cash flow models. Valuations classified as Level 3 by the Company generally consist of investments in various private placement securities of non-rated entities. In rare cases, if the private placement security has only been outstanding for a short amount of time, the Company, after considering the initial assumptions used in acquiring an investment, considers the original purchase price as representative of the fair value.
Over the last several years, certain state insurance regulators, legislators, treasurers/controllers, and their respective agents have been involved in an array of initiatives that seek, in various ways, to impose new duties on life insurance companies to proactively search for deaths of their insureds and contact the insureds’ beneficiaries even though such beneficiaries may not have submitted claims, including due proof of death, as required under the terms of state-approved life insurance policy forms.
Mr. Fayez Sarofim, who served as a director of Kemper until May 1, 2013, is the Chairman of the Board, Chief Executive Officer and the majority shareholder of FS&C, a registered investment advisory firm. Mr. Christopher B. Sarofim, who currently is a director of Kemper and was elected as a director of Kemper on May 1, 2013, is Vice Chairman of FS&C. Kemper’s subsidiary, Trinity, is party to an agreement with FS&C whereby FS&C provides investment management services with respect to certain assets of Trinity for a fee based on the fair market value of the assets under management. Such agreement is terminable by either party at any time upon 30 days advance written notice. Trinity had $154.7 million, $125.2 million and $115.2 million in assets managed by FS&C at December 31, 2013, 2012 and 2011, respectively. Investment Expenses incurred in connection with such agreement were $0.4 million, $0.3 million and $0.3 million for the years ended December 31, 2013, 2012 and 2011, respectively.