Net Income was $103.4 million ($1.75 per unrestricted common share) for the year ended December 31, 2012, compared to $74.5 million ($1.23 per unrestricted common share) for the year ended December 31, 2011. Income from Continuing Operations was $91.8 million ($1.55 per unrestricted common share) in 2012, compared to $61.7 million ($1.02 per unrestricted common share) in 2011.
Net Realized Gains on Sales of Investments were $65.4 million in 2012, compared to $33.7 million in 2011. Net Impairment Losses Recognized in Earnings for the years ended December 31, 2012 and 2011 were $6.9 million and $11.3 million, respectively. The Company cannot predict when or if similar investment gains or losses may occur in the future. See MD&A, “Investments Results,” for information pertaining to investment performance.
The Company manages its exposure to catastrophes and other natural disasters through a combination of geographical diversification, restrictions on the amount and location of new business production in certain regions and reinsurance. To limit its exposures to catastrophic events, the Company maintains various primary catastrophe reinsurance programs for its property and casualty insurance businesses. Coverage for each primary catastrophe reinsurance program is provided in various layers (see Note 20, “Catastrophe Reinsurance,” to the Consolidated Financial Statements for further discussion of these programs). In addition to these programs, the Kemper Preferred segment purchases reinsurance for catastrophe losses in North Carolina at retentions lower than the Company’s primary catastrophe reinsurance programs (“the Kemper Preferred NC Program”). The Company purchases reinsurance from the FHCF for hurricane losses in Florida at retentions lower than the Company’s primary catastrophe reinsurance programs.
Catastrophe reinsurance premiums for the Company’s primary reinsurance programs, the Kemper Preferred NC Program and the FHCF reduced earned premiums for the years ended December 31, 2012, 2011 and 2010 by the following:
The number of catastrophic events and catastrophe losses and LAE (excluding loss and LAE reserve development) by range of loss for the years ended December 31, 2012 and 2011 are presented below:
In late October 2012, Superstorm Sandy, a named catastrophe and at one point a level two hurricane while over the Atlantic ocean, caused a significant amount of damage in several northeastern states. Catastrophe losses and LAE for the year ended December 31, 2012 include $48.5 million related to Superstorm Sandy, of which $44.0 million is included in the Kemper Preferred segment.
In the second quarter of 2011, the United States experienced a high volume of spring storms, including a record level of tornadoes in April. These storms contributed significantly to the increase in the Company’s catastrophe losses and LAE in 2011, compared to 2010. In the third quarter of 2011, the Company also incurred claims related to Hurricane Irene. Catastrophe losses and LAE for the year ended December 31, 2011 includes $23.0 million related to Hurricane Irene, of which $22.1 million is included in the Kemper Preferred segment. No major hurricanes that significantly impacted the Company made landfall in the United States during 2010.
See MD&A, “Critical Accounting Estimates,” of this 2012 Annual Report for additional information pertaining to the Company’s process of estimating property and casualty insurance reserves for losses and LAE, development of property and casualty insurance losses and LAE, estimated variability of property and casualty insurance reserves for losses and LAE, and a discussion of some of the variables that may impact development of property and casualty insurance losses and LAE and the estimated variability of property and casualty insurance reserves for losses and LAE.
The following discussions for the Kemper Preferred, Kemper Specialty and Kemper Direct segments use the non-GAAP financial measures of (i) Underlying Losses and LAE and (ii) Underlying Combined Ratio. Underlying Losses and LAE (also referred to in the discussion as “Current Year Non-catastrophe Losses and LAE”) exclude the impact of catastrophe losses, and loss and LAE reserve development from the Company’s Incurred Losses and LAE, which is the most directly comparable GAAP financial measure. The Underlying Combined Ratio is computed by adding the Current Year Non-catastrophe Losses and LAE Ratio with the Incurred Expense Ratio. The most directly comparable GAAP financial measure is the combined ratio, which uses total incurred losses and LAE, including the impact of catastrophe losses, and loss and LAE reserve development. The Company believes Underlying Losses and LAE and the Underlying Combined Ratio are useful to investors and are used by management to reveal the trends in the Company’s Property and Casualty insurance businesses that may be obscured by catastrophe losses and prior year reserve development. These catastrophe losses may cause the Company’s loss trends to vary significantly between periods as a result of their incidence of occurrence and magnitude, and can have a significant impact on incurred losses and LAE and the combined ratio. Prior year reserve developments are caused by unexpected loss development on historical reserves. Because reserve development relates to the re-estimation of losses from earlier periods, it has no bearing on the performance of the Company’s insurance products in the current period. The Company believes it is useful for investors to evaluate these components separately and in the aggregate when reviewing the Company’s underwriting performance.
These non-GAAP financial measures should not be considered a substitute for the comparable GAAP financial measures, as they do not fully recognize the overall underwriting profitability of our business.
Net Investment Income in the Kemper Preferred segment decreased by $3.8 million for the year ended December 31, 2012, compared to 2011, due primarily to lower net investment income from Equity Method Limited Liability Investments. The Kemper Preferred segment reported net investment income from Equity Method Limited Liability Investments of $4.0 million in 2012, compared to $8.0 million in 2011.
Operating Loss in the Kemper Preferred segment decreased by $12.6 million before taxes for the year ended December 31, 2012, compared to the same period in 2011, due primarily to lower incurred catastrophe losses and LAE, partially offset by lower levels of favorable loss and LAE reserve development, higher underlying losses and LAE as a percentage of earned premiums and lower Net Investment Income. Underlying incurred losses and LAE exclude the impact of catastrophes and loss and LAE reserve development. Catastrophe losses and LAE (excluding development) were $105.4 million in 2012, compared to $144.2 million in 2011. Favorable loss and LAE reserve development (including catastrophe development) was $4.8 million in 2012, compared to $19.1 million in 2011. Underlying losses and LAE as a percentage of earned premiums were 69.1% in 2012, compared to 67.9% in 2011. Kemper Preferred continues to take actions intended to improve profitability, including additional rate increases, enhanced pricing segmentation, higher deductibles, in particular for wind or hail events, and other underwriting actions.
Automobile insurance incurred losses and LAE were $413.7 million, or 80.3% of automobile insurance earned premiums, for the year ended December 31, 2012, compared to $389.5 million, or 76.2% of automobile insurance earned premiums, for the same period in 2011. Automobile insurance incurred losses as a percentage of automobile earned premiums increased by 4.1% due primarily to higher underlying losses and LAE as a percentage of automobile insurance earned premiums and an unfavorable impact from a change in loss and LAE reserve development, partially offset by lower incurred catastrophe losses and LAE (excluding development). Underlying losses and LAE as a percentage of automobile insurance earned premiums were 76.4% in 2012, compared to 73.8% in 2011. Underlying losses and LAE as a percentage of automobile insurance earned premiums increased due primarily to higher frequency in bodily injury coverages and higher severity in all coverages, partially
offset by lower frequency in comprehensive and personal injury protection coverages. Unfavorable loss and LAE reserve development was $7.4 million in 2012, compared to favorable loss and LAE reserve development of $1.3 million in 2011. Catastrophe losses and LAE (excluding development) were $12.7 million in 2012, compared to $14.1 million in 2011.
The Kemper Preferred segment reported Segment Net Operating Loss of $11.2 million for the year ended December 31, 2012, compared to Segment Net Operating Loss of $17.6 million for the same period in 2011. The Kemper Preferred segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $20.2 million in 2012, compared to $24.5 million in 2011.
Net Investment Income in the Kemper Preferred segment decreased by $6.6 million for the year ended December 31, 2011, compared to 2010, due primarily to lower net investment income from Equity Method Limited Liability Investments, partially offset by higher dividends on equity securities and a higher level of allocated investments. The Kemper Preferred segment reported net investment income from Equity Method Limited Liability Investments of $8.0 million in 2011, compared to $16.2 million in 2010.
Net Investment Income in the Kemper Specialty segment decreased by $3.8 million for the year ended December 31, 2012, compared to 2011, due primarily to lower net investment income from Equity Method Limited Liability Investments and lower levels of investments allocated to Kemper Specialty. The Kemper Specialty segment reported net investment income of $1.7 million from Equity Method Limited Liability Investments in 2012, compared to $3.7 million for 2011.
Personal automobile insurance operating results decreased by $30.5 million for the year ended December 31, 2012, compared to 2011, due primarily to higher underlying incurred losses and LAE as a percentage of personal automobile insurance earned premiums, unfavorable loss and LAE reserve development, higher insurance expenses as a percentage of personal automobile insurance earned premiums and lower net investment income. Underlying incurred losses and LAE exclude the impact of catastrophes and loss and LAE reserve development. Underlying incurred losses and LAE were $312.5 million, or 83.0% of personal automobile insurance earned premiums in 2012 compared to $328.5 million, or 81.1% of personal automobile insurance earned premiums in 2011. Personal automobile insurance underlying incurred losses and LAE as a percentage of personal automobile insurance earned premiums increased due primarily to higher claims handling costs in 2012, compared to 2011. Loss and LAE reserve development on personal automobile insurance had an adverse effect of $10.3 million in 2012, compared to a favorable effect of $3.6 million in 2011, and was related primarily to the 2011 and 2010 accident years.
Commercial automobile insurance operating profit increased by $3.3 million for the year ended December 31, 2012, compared to 2011, due primarily to the favorable effects of loss and LAE reserve development, partially offset by higher underlying incurred losses and LAE as a percentage of commercial automobile insurance earned premiums. Favorable loss and LAE reserve development on commercial automobile insurance was $12.6 million in 2012, of which $5.9 million related to 2011 and 2010 accident years, with the balance of $6.7 million dispersed over several older accident years. Favorable loss and LAE reserve development was $6.1 million in 2011. Underlying incurred losses and LAE as a percentage of commercial automobile insurance earned premiums were 81.5% in 2012, compared to 74.3% in 2011, and increased due primarily to higher frequency of losses.
Earned Premiums in the Kemper Specialty segment decreased by $29.7 million for the year ended December 31, 2011, compared to 2010, due to lower earned premiums for both personal and commercial automobile insurance. Personal automobile insurance earned premiums decreased by $26.1 million in 2011, compared to 2010, due primarily to lower volume and, to a lesser extent, lower average earned premium per policy. Throughout 2010 and 2011, Kemper Specialty’s personal automobile insurance policies in force decreased due to economic conditions, increased competition and higher premium rates, particularly in California. Personal automobile insurance policies in force were approximately 329,000 at the beginning of 2011, compared to approximately 351,000 at the beginning of 2010. Commercial automobile insurance earned premiums decreased by $3.6 million in 2011, compared to 2010, due primarily to lower volume. Commercial automobile insurance volume has decreased due primarily to a smaller renewal book of business, partially offset by higher retention rates and increased new business production.
Operating Profit in the Kemper Specialty segment decreased by $1.4 million for the year ended December 31, 2011, compared to 2010, due primarily to lower operating profit in personal automobile insurance, offset by higher operating profit in commercial automobile insurance and other insurance.
Personal automobile insurance operating profit decreased by $6.9 million for the year ended December 31, 2011, compared to 2010, due primarily to higher underlying incurred losses and LAE as a percentage of personal automobile insurance earned premiums, higher insurance expenses as a percentage of personal automobile insurance earned premiums and lower net investment income, partially offset by the favorable effects of loss and LAE reserve development. Underlying incurred losses and LAE as a percentage of personal automobile insurance earned premiums increased due primarily to higher frequency of losses and, to a lesser extent, higher severity of losses in 2011, compared to 2010. Loss and LAE reserve development on personal automobile insurance had a favorable effect of $3.6 million in 2011, compared to an adverse effect of $3.7 million in 2010. Insurance expenses as a percentage of personal automobile insurance earned premiums increased due primarily to investment in policy and billing systems.
Other insurance consists of certain reinsurance pools in run-off and other personal insurance in run-off. Other insurance operating loss was $0.1 million for the year ended December 31, 2011, compared to $0.6 million in 2010. Adverse loss and LAE reserve development on certain reinsurance pools in run-off was $0.4 million in 2011, compared to $0.7 million in 2010. Excluding development from these reinsurance pools, loss and LAE reserve development on other personal insurance had an adverse effect of $0.9 million in 2010 and was almost entirely related to two liability claims, one from 2003 and the other from 2005. Insurance expenses in 2010 included a reduction of expense of $0.8 million related to a change in estimate for uncollectible reinsurance.
Segment Net Operating Income in the Kemper Specialty segment was $19.8 million for the year ended December 31, 2011, compared to $21.0 million in 2010. The Kemper Specialty segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $11.3 million in 2011, compared to $12.0 million in 2010.
Earned Premiums in the Kemper Direct segment decreased by $54.7 million for the year ended December 31, 2012, compared to the same period in 2011, due primarily to lower volume, partially offset by higher average premium rates.
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 Direct Response book of business 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.
Earned Premiums in the Kemper Direct segment decreased by $59.7 million for the year ended December 31, 2011, compared to 2010, due primarily to lower volume, partially offset by higher average premium rates.
Net Investment Income in the Kemper Direct segment decreased by $3.2 million for the year ended December 31, 2011, compared to 2010, due primarily to lower net investment income from Equity Method Limited Liability Investments. Net investment income from Equity Method Limited Liability Investments was $2.9 million in 2011, compared to $6.0 million in 2010.
The Kemper Direct segment reported Operating Loss of $47.2 million for the year ended December 31, 2011, compared to Operating Loss of $7.9 million in 2010. Operating results declined in the Kemper Direct segment in 2011, compared to 2010, due primarily to the partial write-off of an intangible asset acquired in the Kemper Direct Response acquisition, higher underlying losses and LAE as a percentage of earned premiums, higher insurance expenses as a percentage of earned premiums, higher incurred catastrophe losses and LAE (excluding development) and lower net investment income.
Incurred Losses and LAE as a percentage of earned premiums was 88.7% for the year ended December 31, 2011, compared to 79.3% in 2010. Incurred Losses and LAE as a percentage of earned premiums increased in 2011 due primarily to higher underlying losses and LAE as a percentage of earned premiums, higher incurred catastrophe losses and LAE (excluding development) and the impact of lower favorable loss and LAE reserve development. Underlying losses and LAE as a percentage of earned premiums was 87.5% in 2011, compared to 81.1% in 2010. Underlying losses and LAE as a percentage of earned premiums increased in 2011, compared to 2010, due primarily to increased severity on automobile insurance. Catastrophe losses and LAE (excluding development) was $6.7 million in 2011, compared to $1.8 million in 2010. Favorable loss and LAE reserve development was $3.9 million in 2011, compared to $6.8 million in 2010.
Kemper Direct reported a Segment Net Operating Loss of $27.5 million for the year ended December 31, 2011, compared to a Segment Net Operating Loss of $1.7 million for the same period in 2010. The Kemper Direct segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income, dividends received deductions and changes in certain recoverables that are not taxable for tax purposes. Tax-exempt investment income and dividends received deductions were $8.7 million in 2011, compared to $10.3 million in 2010.
Earned Premiums in the Life and Health Insurance segment decreased by $6.0 million for the year ended December 31, 2012, compared to the same period in 2011. Earned premiums on life insurance decreased by $1.7 million in 2012, compared to 2011, due primarily to lower volume of insurance. Earned premiums on accident and health insurance decreased by $1.1 million in 2012, compared to 2011, due primarily to lower volume of insurance resulting from the suspension of sales of certain health insurance products described below and, to a lesser extent, lower volume of Medicare supplement insurance, partially offset by higher volume of supplemental health insurance products and higher average premium. Earned premiums on property insurance decreased by $3.2 million in 2012, compared to 2011, due primarily to lower volume of insurance from the run-off and, in certain geographical areas, the non-renewal of dwelling coverage.
earned premiums from the Affected Products to decrease by approximately 20% in 2013 due to such suspension of sales and expects an increase in earned premiums from the Supplemental Products to offset much of the decline. The Life and Health segment cannot predict what impact the establishment of health insurance exchanges will have on its premiums beginning in 2014. Accordingly, there can be no assurance that the transition will fully offset the impact from suspending sales of the affected health insurance products.
Operating Profit in the Life and Health Insurance segment was $152.3 million for year ended December 31, 2011, compared to$141.9 million in 2010. Operating Profit increased due primarily to lower Policyholders’ Benefits and Incurred Losses and LAE and the impact of a charge to write off goodwill in 2010, partially offset by the lower net investment income and higher insurance expenses. Policyholders’ Benefits and Incurred Losses and LAE decreased by $21.2 million in 2011, compared to 2010, due primarily to lower policyholders’ benefits on life insurance, lower accident and health insurance losses as a percentage of accident and health earned premiums and the favorable impact of Loss and LAE reserve development on property insurance, partially offset by higher catastrophe losses and LAE (excluding development) on property insurance. Policyholders’ benefits on life insurance were $253.2 million in 2011, compared to $263.0 million in 2010, a decrease of $9.8 million. Policyholder benefits on life insurance decreased due primarily to reserve adjustments in 2011 associated with correcting expiry dates for certain extended term life insurance policies and better mortality experience, partially offset by higher reserve additions for persisting policies. Incurred accident and health insurance losses were $88.9 million, or 53.5% of accident and health insurance earned premiums, in 2011, compared to $95.7 million, or 59.1% of accident and health insurance earned premiums, in 2010. Incurred accident and health insurance losses as a percentage of accident and health insurance earned premiums decreased due primarily to lower frequency and severity of health claims. Incurred Losses and LAE on property insurance were $43.5 million in 2011, compared to $48.1 million in 2010. Favorable loss reserve development on property insurance was $2.6 million (including favorable development of $1.5 million on catastrophes) in 2011, compared to adverse development of $4.5 million (including adverse development of $3.4 million on catastrophes) in 2010. Catastrophe losses and LAE (excluding development) were $9.1 million in 2011, compared to $4.5 million in 2010. Insurance Expenses in the Life and Health Insurance segment increased by $14.8 million in 2011, compared to 2010, due primarily to higher commission and fringe benefit expenses, partially attributable to an increase in the number of career agents employed, and higher amortization of deferred policy acquisition costs. The Company wrote off $14.8 million of goodwill in 2010 related to Reserve National.
Net Investment Income decreased by $27.7 million for the year ended December 31, 2011, compared to 2010. Investment income from Equity Method Limited Liability Investments decreased by $39.2 million in 2011, compared to 2010, due primarily to a lower total rate of return. Dividends on equity securities increased by $9.2 million in 2011, compared to 2010, due primarily to higher levels of income producing equity securities. Interest and dividends on fixed maturities and policyholder loans increased by $2.8 million and $1.2 million, respectively in 2011, compared to 2010.
In the third quarter of 2012, the Company sold $320.1 million of municipal securities to take advantage of attractive pricing for such securities and for tax planning and other portfolio management purposes. Realized Gains on Sales of Fixed Maturities for the year ended December 31, 2012 include realized gains of $44.9 million from such sales.
Total Comprehensive Investment Gains are comprised of Net Realized Gains on Sales of Investments and Net Impairment Losses Recognized in Earnings reported in the Consolidated Statements of Income and unrealized investment gains and losses that are not reported in the Consolidated Statements of Income, but rather are reported in the Consolidated Statements of Comprehensive Income. The components of Total Comprehensive Investment Gains for the years ended December 31, 2012, 2011 and 2010 were:
Company’s investment in Intermec common stock was included in Investments in Equity Securities and was reported at its fair value. See Note 14, “Income from Investments,” to the Consolidated Financial Statements. Investment gains recognized in Other Comprehensive Income for the year ended December 31, 2011, included an other comprehensive loss of $50.6 million from disposing of all of the Company’s holding of Intermec common stock. Other Comprehensive Income from Equity Securities for the year ended December 31, 2010 include other comprehensive gains of $50.6 million related to the Company’s investment in the common stock of Intermec.
The following table summarizes the fair value of the Company’s investments in non-governmental fixed maturities by industry at December 31, 2012 and 2011:
The following table summarizes the fair value of the Company’s ten largest exposures to issuers of investment securities, excluding exposures to short term investments and investments in U.S. Government and Government Agencies and Authorities and Pre-refunded Municipal Bonds, at December 31, 2012:
In April 2012, the Special Value Continuation Fund, LLC, which was previously accounted for under the equity method of accounting and reported in Equity Method Limited Liability Investments, converted from a Delaware limited liability company to a Delaware corporation and became a publicly-traded company. Accordingly, the Company’s investment was converted to common stock and is now reported in Equity Securities at December 31, 2012.
The Company does not directly participate, as either a lender or borrower of securities, in any securities lending program. The Company does not participate directly in credit default swaps. The Company does not engage directly in hedging activities, including, but not limited to, activities involving interest rate swaps, forward foreign currency contracts, commodities contracts, exchange traded and over-the-counter options or warrants. The Company has limited exposure to such programs and activities by virtue of an investment of $1.0 million at December 31, 2012 included in Other under the heading “Reported as Other Equity Interests and Reported at Fair Value” in the preceding table. Such investment consists solely of restricted assets that are being redeemed over several periods.
On March 7, 2012, Kemper entered into a new four-year, $325.0 million, unsecured, revolving credit agreement, expiring March 7, 2016 (the “2016 Credit Agreement”), with a group of financial institutions. The 2016 Credit Agreement replaced Kemper’s $245.0 million, unsecured, revolving credit agreement which was scheduled to expire on October 30, 2012 (the “Former Credit Agreement”) and was terminated on March 7, 2012. There were no borrowings under the Former Credit Agreement at either December 31, 2011 or at its termination. The 2016 Credit Agreement provides for fixed and floating rate advances for periods up to six months at various interest rates. The 2016 Credit Agreement contains various financial covenants, including limits on total debt to total capitalization, consolidated net worth and minimum risk-based capital ratios for Kemper’s largest insurance subsidiaries, United Insurance and Trinity. Proceeds from advances under the 2016 Credit Agreement may be used for general corporate purposes, including repayment of existing indebtedness. There were no outstanding borrowings under the 2016 Credit Agreement at December 31, 2012, and accordingly, $325.0 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 2010, Kemper issued $250 million of its 6.00% senior notes due November 30, 2015 (the “2015 Senior Notes”). The 2015 Senior Notes are unsecured and may be redeemed in whole at any time or in part from time to time at Kemper’s option at specified redemption prices. Kemper issued the 2015 Senior Notes for proceeds of $247.8 million, net of transaction costs, for an effective yield of 6.21%. Kemper used a portion of the proceeds from the sale of the 2015 Senior Notes to repay borrowings of $140 million under the Former Credit Agreement and to make a capital contribution of $60.0 million to its subsidiary, United Insurance. Interest expense under the 2015 Senior Notes was $15.4 million, $15.4 million and $1.6 million for the years ended December 31, 2012, 2011 and 2010, respectively.
In 2007, Kemper issued $360 million of its 6.00% senior notes due May 15, 2017 (the “2017 Senior Notes”). The 2017 Senior Notes are unsecured and may be redeemed in whole at any time or in part from time to time at Kemper’s option at specified redemption prices. Kemper issued the 2017 Senior Notes for proceeds of $354.8 million, net of transaction costs, for an effective yield of 6.19%. Kemper used a portion of the proceeds from the sale of the 2017 Senior Notes to repay the $300 million aggregate principal amount of its 5.75% senior notes which matured on July 1, 2007. Interest expense under the 2017 Senior Notes was $22.1 million for the year ended December 31, 2012 and $22.0 million for each of the annual periods ended December 31, 2011, and 2010, respectively.
Various state insurance laws restrict the ability of Kemper’s insurance subsidiaries to pay dividends without regulatory approval. Such insurance laws generally restrict the amount of dividends paid in an annual period to the greater of statutory net income from the previous year or 10% of statutory capital and surplus. Kemper’s direct insurance subsidiaries paid dividends consisting of $95.0 million in cash to Kemper during 2012. In 2013, Kemper estimates that its direct insurance subsidiaries would be able to pay $179.0 million in dividends to Kemper without prior regulatory approval.
Kemper paid a quarterly dividend to shareholders of $0.24 per common share in each quarter of 2012. Dividends paid were $56.9 million for the year ended December 31, 2012.
Kemper directly held cash and investments totaling $190.2 million at December 31, 2012, compared to $217.0 million at December 31, 2011. Sources available for the repayment of indebtedness, repurchases of common stock, future shareholder dividend payments, and the payment of interest on Kemper’s senior notes include cash and investments directly held by Kemper, receipt of dividends from Kemper’s subsidiaries and borrowings under the 2016 Credit Agreement. The primary sources of funds for Kemper’s insurance subsidiaries are premiums, investment income and proceeds from the sales and maturity of investments. The primary uses of funds are the payment of policyholder benefits under life insurance contracts, claims under property and casualty insurance contracts and accident and health insurance contracts, the payment of commissions and general expenses and the purchase of investments. Generally, there is a time lag between when premiums are collected and when policyholder benefits and insurance claims are paid. Changes in the legal environment relative to state enforcement of unclaimed property laws and related insurance claims handling practices could result in changes in the manner in which Kemper's life insurance companies administer life insurance death benefits and escheat unclaimed benefits to the states, and could have a significant effect on, including decreasing such time lag due to an acceleration of, the payment and/or escheatment of such benefits relative to what is currently contemplated by Kemper. See Item 1A., Risk Factors,” under the caption “Changes in state enforcement of unclaimed property laws and related insurance claims handling practices could have a significant effect on (including an acceleration of) the payment and/or escheatment of life insurance death benefits relative to what is currently contemplated by Kemper and significantly increase claims handling costs,” Note 23, “Contingencies,” to the Consolidated Financial Statements and MD&A, “Life and Health Insurance” for additional information about these matters. During periods of growth, insurance companies typically experience positive operating cash flows and are able to invest a portion of their operating cash flows to fund future policyholder benefits and claims. During periods in which premium revenues decline, insurance companies may experience negative cash flows from operations and may need to sell investments to fund payments to policyholders and claimants. In addition, if the Company’s property and casualty insurance subsidiaries
Net Cash Used by Financing Activities increased by $1.3 million for the year ended December 31, 2011, compared to 2010. In 2011, net cash used for the Repayments of Certificates of Deposits was $321.8 million for the year ended December 31, 2011, compared to net cash used of $366.9 million in 2010. Kemper used $27.4 million of cash during 2011 to repurchase shares of its common stock, compared to $34.4 million in 2010. Kemper used $58.2 million of cash to pay dividends for the year ended December 31, 2011, compared to $54.6 million of cash used to pay dividends in 2010. The quarterly dividend rate was $0.24 per common share for each quarter of 2011, compared to $0.22 per common share in 2010.
Net Cash Provided by Investing Activities increased by $245.3 million for the year ended December 31, 2011, compared to the same period of 2010. Purchases of Fixed Maturities exceeded Sales of Fixed Maturities by $13.1 million for the year ended December 31, 2011. Sales of Fixed Maturities exceeded Purchases of Fixed Maturities by $174.6 million in the same period of 2010. Sales of Equity Securities exceeded Purchases of Equity Securities by $49.1 million for the year ended December 31, 2011. Purchases of Equity Securities exceeded Sales of Equity Securities by $155.3 million for the year ended December 31, 2010. Net cash provided by dispositions of short-term investments was $155.5 million for the year ended December 31, 2011, compared to net cash of $7.3 million used by acquisitions of short-term investments in 2010. Net proceeds from the sale of Fireside’s active portfolio of automobile loan receivables provided $220.7 million of cash for the year ended December 31, 2011. Receipts from Automobile Loan Receivables provided $166.5 million of cash for the year ended December 31, 2011, compared to $339.6 million of cash provided in 2010. Receipts from the disposition of a business provided $4.1 million of cash for the year ended December 31, 2010.
Estimated cash disbursements pertaining to the Company’s contractual obligations at December 31, 2012 are as follows:
In addition to the purchase obligations included above, the Company had certain investment commitments totaling $155.4 million at December 31, 2012. The funding of such investment commitments is dependent on a number of factors, the timing of which is indeterminate. The contractual obligations reported above also exclude the Company’s liability of $6.4 million for unrecognized tax benefits. The Company cannot make a reasonably reliable estimate of the amount and period of related future payments for such liability. Other Contractual Obligations Reflected in Long Term Liabilities on the Consolidated Balance Sheet under GAAP primarily consist of interest obligations related to Long Term Debt Obligations.
Kemper’s subsidiaries conduct their businesses in two industries: property and casualty insurance and life and health insurance. Accordingly, the Company is subject to several industry-specific accounting principles under accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in accordance with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The process of estimation is inherently uncertain. Accordingly, actual results could ultimately differ materially from the estimated amounts reported in a company’s financial statements. Different assumptions are likely to result in different estimates of reported amounts. The Company’s critical accounting policies most sensitive to estimates include the valuation of investments, the valuation of property and casualty insurance reserves for losses and LAE, the assessment of recoverability of goodwill and the valuation of pension benefit obligations.
The classification of a company’s investment in a financial instrument may affect its reported results. For investments classified as trading, a company is required to recognize changes in the fair values into income for the period reported. Both the reported and fair value of the Company’s investments classified as trading were $4.5 million at December 31, 2012. For investments in fixed maturities classified as held to maturity, a company is required to carry the investment at amortized cost, with only amortization occurring during the period recognized into income. None of the Company’s investments in fixed maturities were classified as held to maturity at December 31, 2012. Changes in the fair value of investments in fixed maturities classified as available for sale, investments in equity securities classified as available for sale and an insurance entity’s investments in equity securities without readily determinable fair values are not recognized to income during the period, but rather are recognized as a separate component of Accumulated Other Comprehensive Income until realized. All of the Company’s investments in fixed maturities were classified as available for sale at December 31, 2012. Except for investments accounted for under the equity method of accounting or classified as trading, all of the Company’s investments in equity securities at December 31, 2012 were required to be reported at fair value with changes in fair value reported in Accumulated Other Comprehensive Income until realized. The Company’s investments accounted for under the equity method of accounting consist of the Company’s investments in Equity Method Limited Liability Investments and are valued at cost plus cumulative undistributed comprehensive earnings or losses, and not at fair value.
Under GAAP, a company may elect to use the fair value option for some or all of its investments in financial instruments. Under the fair value option, a company is required to recognize changes in the fair values into income for the period reported. The Company has not elected the fair value option for any of its investments in financial instruments. Had the Company elected the fair value option for all of its investments in financial instruments, the Company’s reported net income for the year ended December 31, 2012, would have increased by $63.3 million.
Changes in these factors from one evaluation date to the next evaluation date could result in the Company determining that a temporary decline in the fair value of an investment at December 31, 2012 is no longer temporary at a subsequent evaluation date. Such determination would result in an impairment loss recognized in earnings in the period such determination is made.
The Company’s Property and Casualty Insurance Reserves are reported using the Company’s estimate of its ultimate liability for losses and LAE for claims that occurred prior to the end of any given accounting period but have not yet been paid. The Company had $970.6 million and $1,029.1 million of gross loss and LAE reserves at December 31, 2012 and 2011, respectively. Property and Casualty Insurance Reserves for the Company’s business segments at December 31, 2012 and 2011 were:
development patterns relied upon in the incurred loss development methodology and paid loss development methodology. In those circumstances, the Company’s actuaries must make adjustments to these loss reserving estimation methodologies or use additional generally accepted actuarial estimation methodologies. In those circumstances, the Company’s actuaries, using their professional judgment, may place more weight on the adjusted loss reserving estimation methodologies or other generally accepted actuarial estimation methodologies until the newer development patterns fully emerge and the Company’s actuaries can fully rely on the unadjusted loss reserving estimation methodologies. In the event of a wide variation among results generated by the different projection methodologies, the Company’s actuaries further analyze the data using additional techniques.
The Company’s goal is to ensure that its total reserves for property and casualty insurance losses and LAE are adequate to cover all costs, while sustaining minimal variation from the time reserves for losses and LAE are initially estimated until losses and LAE are fully developed. Changes in the Company’s estimates of these losses and LAE over time, also referred to as “development,” will occur and may be material. Favorable development is recognized and reported in the consolidated financial statements when the Company decreases its previous estimate of ultimate losses and LAE and results in an increase in net income in the period recognized, whereas adverse development is recognized and reported in the Consolidated Financial Statements when the Company increases its previous estimate of ultimate losses and LAE and results in a decrease in net income. The Company reported total favorable development of $31.5 million, $33.1 million and $24.9 million before tax for the years ended December 31, 2012, 2011 and 2010, respectively. Development for each of the Company’s continuing business segments and Unitrin Business Insurance for the years ended December 31, 2012, 2011 and 2010, was:
A change in any one or more of these assumptions is likely to result in an ultimate liability different from the original actuarial estimate. Such changes in estimates may be material. For example, a one-percentage point decrease in the Company’s estimated discount rate would increase the pension benefit obligation at December 31, 2012 by $86.1 million, while a one-percentage point increase in the rate would decrease the pension benefit obligation at December 31, 2012 by $69.1 million. A one-percentage point decrease in the Company’s estimated long-term rate of return on plan assets would increase the pension expense for the year ended December 31, 2012 by $4.3 million, while a one-percentage point increase in the rate would decrease pension expense by $4.3 million for the same period.
Except for rules and interpretive releases of the SEC under authority of federal securities laws and a limited number of grandfathered standards, the FASB Accounting Standards Codification (“ASC”) is the sole source of authoritative GAAP recognized by the Financial Accounting Standards Board (“FASB”) and applicable to the Company. The FASB issues Accounting Standards Updates (“ASUs”) to amend the authoritative literature in ASC. There were seven ASUs issued in 2012 that amend the original text of ASC. These ASU’s are not expected to have an impact on the Company.
Consolidated Statements of Income for the Years Ended December 31, 2012, 2011 and 2010
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2012, 2011 and 2010
The process of determining whether an asset is impaired or recoverable relies on projections of future cash flows, operating results and market conditions. Projections are inherently uncertain and, accordingly, actual future cash flows may differ materially from projected cash flows. As a result, the Company’s assessment of the impairment of long-lived assets is susceptible to the risk inherent in making such projections.
Gains and losses on sales of investments are computed on the specific identification method and are reported in the Consolidated Statements of Income in the period in which the sales occur. The Company regularly reviews its investment portfolio for factors that may indicate that a decline in fair value of an investment is other than temporary. Losses are computed on the specific identification method and reported in the Consolidated Statements of Income in the period that the decline is determined to be other than temporary. The portion of an impairment of an investment in a fixed maturity attributed to a credit loss is reported in Net Impairment Losses Recognized in Earnings in the Consolidated Statement of Income, with the balance of such impairment reported in Accumulated Other Comprehensive Income.
The Company uses a hierarchal framework which prioritizes and ranks the market price observability used in fair value measurements. Market price observability is affected by a number of factors, including the type of asset or liability and the characteristics specific to the asset or liability being measured. Assets and liabilities with readily available, active, quoted market prices or for which fair value can be measured from actively quoted prices generally are deemed to have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. The Company classifies the inputs used to measure fair value into one of three levels as follows:
Reserves for losses and LAE on property and casualty insurance coverage and health insurance coverage represent the estimated claim cost and loss adjustment expense necessary to cover the ultimate net cost of investigating and settling all losses incurred and unpaid. Such estimates are based on individual case estimates for reported claims and estimates for incurred but not reported losses. These estimates are adjusted in the aggregate for ultimate loss expectations based on historical experience patterns and current economic trends, with any change in the estimated ultimate liabilities being reported in the Consolidated Statements of Income in the period of change. Changes in such estimates may be material.
Other Assets primarily include property and equipment, internal use software, insurance licenses acquired in business combinations, the value of other intangible assets acquired and prepaid expenses. Property and equipment is depreciated over the useful lives of the assets, generally using the straight-line or double declining balance methods of depreciation depending on the asset involved. Internal use software is primarily amortized over the useful life of the asset using the straight-line method of amortization. Insurance licenses acquired in business combinations and other indefinite life intangibles are not amortized, but rather tested periodically for recoverability.
The Company accounts for the present value of the future profits embedded in life insurance in force acquired (“Life VIF”) based on actuarial estimates of the present value of estimated net cash flows. Life VIF was $46.4 million and $52.1 million at December 31, 2012 and 2011, respectively. Life VIF is amortized using the effective interest method using interest rates consistent with the rates in the underlying insurance contracts. The Company estimates that it will record Life VIF amortization, net of interest, of $5.2 million in 2013, $4.6 million in 2014, $4.2 million in 2015, $3.7 million in 2016 and $3.2 million in 2017. The Company evaluates the Life VIF for recoverability annually.
The following line items presented in the Consolidated Balance Sheets at December 31, 2012 and 2011 were affected by the adoption of the new accounting standard:
The following line items in the Consolidated Statement of Income for the year ended December 31, 2012 were affected by the adoption of the new accounting standard:
The following line items in the Consolidated Statement of Income for the year ended December 31, 2011 were affected by the adoption of the new accounting standard:
The following line items in the Consolidated Statement of Income for the year ended December 31, 2010 were affected by the adoption of the new accounting standard:
The following line items presented in the Consolidated Statements of Comprehensive Income for the years ended December 31, 2012, 2011 and 2010 were affected by the adoption of the new accounting standard:
Line items presented in the Investing Activities and Financing Activities sections of the Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010 were unaffected by the adoption of the new accounting standard.
Requirements. The standard is effective for the first interim or annual period beginning on or after December 15, 2011. The new
In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment. The standard is effective for the first
Goodwill and Other, and gives companies the option to first perform a qualitative assessment to determine whether it is more
In December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of
Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The
The FASB issues ASUs to amend the authoritative literature in ASC. There were seven ASUs issued in 2012 that amend the original text of the ASC. The ASUs are not expected to have a material impact on the Company.
Summary financial information included in Income from Discontinued Operations for the years ended December 31, 2012, 2011 and 2010 is presented below:
During the first four months of 2011, all of the Certificates of Deposits that were outstanding at December 31, 2010 either matured or were redeemed by Fireside in advance of their respective maturity dates. On March 31, 2012, Kemper’s subsidiary, Fireside, converted from an industrial bank to a general business corporation. Accordingly, Fireside is no longer regulated by the Federal Depository Insurance Corporation or the California Department of Financial Institutions.
During 2011, Fireside sold its active portfolio of automobile loan receivables at a gain of $4.5 million, net of transaction and other costs, while retaining its inactive portfolio of loans that had been previously charged-off (the “Inactive Portfolio”). The Inactive Portfolio was not carried on the Company’s Consolidated Balance Sheet. During 2012, Fireside sold $283 million of loans in the Inactive Portfolio at a gain of $12.9 million, net of transaction, shutdown and other costs of $13.3 million, of which $3.7 million was unpaid at December 31, 2012.
Included in the fair value of Mortgage and Asset-backed investments at December 31, 2012 are $2.3 million of collateralized debt obligations, $1.3 million of non-governmental residential mortgage-backed securities and $0.3 million of other asset-backed securities.
The amortized cost and estimated fair values of the Company’s Investments in Fixed Maturities at December 31, 2012 by contractual maturity were:
The expected maturities of the Company’s Investments in Fixed Maturities may differ from the contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Investments in Asset-backed Securities Not Due at a Single Maturity Date at December 31, 2012 consisted of securities issued by the Government National Mortgage Association with a fair value of $189.3 million, securities issued by the Federal National Mortgage Association with a fair value of $19.6 million, securities issued by the Federal Home Loan Mortgage Corporation with a fair value of $0.6 million and securities of other issuers with a fair value of $3.9 million.
There were no unsettled sales of Investments in Fixed Maturities at December 31, 2012. Accrued Expenses and Other Liabilities at December 31, 2012 includes a payable of $1.5 million for purchases of Investments in Fixed Maturities that settled in January 2013. There were no unsettled sales or purchases of Investments in Fixed Maturities at December 31, 2011.
An aging of unrealized losses on the Company’s Investments in Fixed Maturities and Equity Securities at December 31, 2012 is presented below:
The Company concluded that the unrealized losses on its investments in preferred and common stocks at December 31, 2012 were temporary based on the relative short length and magnitude of the losses and overall market volatility. The Company’s investments in other equity interests include investments in limited liability partnerships that primarily invest in distressed debt, mezzanine debt and secondary transactions. By the nature of their underlying investments, the Company believes that its investments in the limited liability partnerships also exhibit debt-like characteristics which, among other factors, the Company considers when evaluating these investments for impairment. Based on evaluations of the factors in the preceding paragraph, the Company concluded that the declines in the fair values of the Company’s investments in equity securities were temporary at December 31, 2012.
An aging of unrealized losses on the Company’s Investments in Fixed Maturities and Equity Securities at December 31, 2011 is presented below:
Unrealized losses on fixed maturities, which the Company determined to be temporary at December 31, 2011, were $11.1 million, of which $5.9 million was related to fixed maturities that were in an unrealized loss position for 12 months or longer. Unrealized losses at December 31, 2011 related to securities for which the Company has recognized credit losses in earnings in the preceding table under either the heading “Less Than 12 Months” were insignificant. There were no unrealized losses at December 31, 2011 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “12 Months or Longer.” Included in the preceding table under the heading “12 Months or Longer” are unrealized losses of $0.2 million at December 31, 2011 related to securities for which the Company has recognized foreign currency losses in earnings. Investment-grade fixed maturity investments comprised $5.7 million and below-investment-grade fixed maturity investments comprised $5.4 million of the unrealized losses on investments in fixed maturities at December 31, 2011. Unrealized losses for below-investment-grade fixed maturities included unrealized losses totaling $0.2 million for one issuer that the Company recognized foreign currency impairment losses in earnings for the year ended December 31, 2011. For the other remaining below-investment-grade fixed maturity investments in an unrealized loss position, the unrealized loss amount, on average, was less than 4% of the amortized cost basis of the investment. At December 31, 2011, the Company did not have the intent to sell these investments and it was not more likely than not that the Company would be required to sell these investments before recovery of its amortized cost basis, which may be at maturity. Based on the Company’s evaluation at December 31, 2011 of the prospects of the issuers, including, but not limited to, the credit ratings of the issuers of the investments in the fixed maturities, and the Company’s intention to not sell and its determination that it would not be required to sell before recovery of the amortized cost of such investments, the Company concluded that the declines in the fair values of the Company’s investments in fixed maturities presented in the preceding table were temporary at the evaluation date.
The vast majority of the Company’s preferred stocks in an unrealized loss position at December 31, 2011 were perpetual preferred stocks of financial institutions. The Company considers the debt-like characteristics of perpetual preferred stocks along with issuer ratings when evaluating impairment. All such preferred stocks paid dividends at the stated dividend rate
With respect to the Company’s Reserve National reporting unit, the Company evaluated the goodwill associated with it at four different evaluation dates - January 1, 2010, March 31, 2010, June 30, 2010 and September 30, 2010. The company concluded that the associated goodwill was recoverable at each of the first three aforementioned dates tested. With respect to the September 30, 2010 test date, the Company determined that the goodwill was not recoverable and wrote off the entire $14.8 million of goodwill associated with Reserve National.
Property and Casualty Insurance Reserve activity for the years ended December 31, 2012, 2011 and 2010 was:
In 2012, the Company reduced its property and casualty insurance reserves by $31.5 million to recognize favorable development of losses and LAE from prior accident years. Personal lines insurance loss and LAE reserves developed favorably by $12.6 million and commercial lines insurance loss and LAE reserves developed favorably by $18.9 million. Personal automobile insurance loss and LAE reserves developed adversely by $2.2 million, homeowners insurance loss and LAE reserves developed favorably by $11.7 million and other personal lines loss and LAE reserves developed favorably by $3.1 million. Personal automobile loss and LAE reserves developed adversely for the 2011 accident year and developed favorably for the 2010, 2009 and 2008 accident years. Homeowners insurance loss and LAE reserves developed favorably due primarily to the emergence of more favorable loss patterns than expected for the 2011, 2010 and 2009 accident years and favorable
In 2010, the Company reduced its property and casualty insurance reserves by $24.9 million to recognize favorable development of losses and LAE from prior accident years. Personal lines insurance loss and LAE reserves developed favorably by $21.6 million and commercial lines insurance loss and LAE reserves developed favorably by $3.3 million. Personal lines insurance loss and LAE reserves developed favorably due primarily to the emergence of more favorable loss patterns than expected for the 2009, 2007 and 2006 accident years, partially offset by adverse development on certain hurricanes.
Reinsurance and indemnification recoverables on property and casualty insurance reserves were $66.2 million and $74.5 million at December 31, 2012 and 2011, respectively. These recoverables are concentrated with several reinsurers, the vast majority of which are highly rated by one or more of the principal investor and/or insurance company rating agencies. While most of these recoverables were unsecured at December 31, 2012 and 2011, the agreements with the reinsurers generally provide for some form of collateralization upon the occurrence of certain events. The largest recoverable on property and casualty insurance is from General Security National Insurance Company (“GSNIC”), a subsidiary of SCOR and is unsecured. In 2002, the Company acquired two insurance companies from SCOR. Under the agreement governing the acquisition of these insurance companies, SCOR and/or GSNIC are responsible for all liabilities of these insurance companies incurred prior to the acquisition. Recoverables at December 31, 2012 and 2011 included $16.9 million and $21.8 million, respectively, from GSNIC.
Net rental expense for operating leases for the years ended December 31, 2012, 2011 and 2010 was:
Future minimum lease payments under capital and operating leases at December 31, 2012 were:
The total of minimum rentals to be received in the future under non-cancelable subleases was $6.5 million at December 31, 2012.
Kemper is authorized to issue 20 million shares of $0.10 par value preferred stock and 100 million shares of $0.10 par value common stock. No preferred shares were issued or outstanding at December 31, 2012 and 2011. There were 58,454,390 shares and 60,248,582 shares of common stock outstanding at December 31, 2012 and 2011, respectively. Common stock outstanding included 313,424 shares and 289,659 shares at December 31, 2012 and 2011, respectively, that have been issued, subject to certain vesting and other requirements, in connection with the Company’s long-term equity compensation plans. See Note 10, “Long-Term Equity-based Compensation,” to the Consolidated Financial Statements for an additional discussion of the restrictions and vesting provisions.
Kemper repurchased and retired 2.0 million shares of its common stock in open market transactions at an aggregate cost of $60.7 million in 2012. Kemper repurchased and retired 0.9 million shares of its common stock in open market transactions at an aggregate cost of $27.4 million in 2011. Kemper repurchased and retired 1.4 million shares of its common stock in open market transactions at an aggregate cost of $34.4 million in 2010.
Various state insurance laws restrict the amount that an insurance subsidiary may pay in the form of dividends, loans or advances without the prior approval of regulatory authorities. Also, that portion of an insurance subsidiary’s net equity which results from differences between statutory insurance accounting practices and GAAP would not be available for cash dividends, loans or advances. Kemper’s insurance subsidiaries paid dividends of $95.0 million in cash to Kemper in 2012. In 2013, Kemper’s insurance subsidiaries would be able to pay $179 million in dividends to Kemper without prior regulatory approval. Kemper’s insurance subsidiaries had net assets of $2.5 billion, determined in accordance with GAAP, that were restricted from payment to Kemper without prior regulatory approval at December 31, 2012.
Kemper’s insurance subsidiaries are required to file financial statements prepared on the basis of statutory insurance accounting practices which is a comprehensive basis of accounting other than GAAP. Statutory capital and surplus for the Company’s life and health insurance subsidiaries was $457.8 million and $475.1 million at December 31, 2012 and 2011, respectively. Statutory net income for the Company’s life and health insurance subsidiaries was $102.0 million, $116.2 million and $80.4 million for the years ended December 31, 2012, 2011 and 2010, respectively. Statutory capital and surplus for the Company’s property and casualty insurance subsidiaries was $844.8 million and $829.6 million at December 31, 2012 and 2011, respectively. Statutory net income for the Company’s property and casualty insurance subsidiaries was $40.6 million, $30.6 million and $117.3 million for the years ended December 31, 2012, 2011 and 2010, respectively. Statutory capital and surplus and statutory net income exclude Fireside and parent company operations.
In 2012, Kemper paid dividends of $56.9 million to its shareholders. Except for certain financial covenants under the 2016 Credit Agreement, there are no restrictions on Kemper’s ability to pay dividends to its shareholders. Certain financial covenants, namely minimum net worth and a maximum debt to total capitalization ratio, under the 2016 Credit Agreement could limit the amount of dividends that Kemper may pay to shareholders at December 31, 2012. Kemper had the ability to pay without restrictions $332 million in dividends to its shareholders and still be in compliance with all financial covenants under the 2016 Credit Agreement at December 31, 2012.
On May 4, 2011, Kemper’s shareholders approved the 2011 Omnibus Equity Plan (“Omnibus Plan”). The Omnibus Plan replaced the Company’s previous employee stock option plans, director stock option plan and restricted stock plan (collectively, the “Prior Plans”). Awards previously granted under the Prior Plans remain outstanding in accordance with their original terms. Beginning May 4, 2011, equity-based compensation awards may only be granted under the Omnibus Plan. A maximum number of 10,000,000 shares of Kemper common stock may be issued under the Omnibus Plan (the “Share Authorization”). As of December 31, 2012, there were 9,278,531 common shares available for future grants under the Omnibus Plan, of which 561,225 shares were reserved for future grants based on the achievement of performance goals under the terms of outstanding performance-based restricted stock awards.
The assumptions used in the Black-Scholes pricing model for options granted during the years ended December 31, 2012, 2011 and 2010, were as follows:
Option and SAR activity for the year ended December 31, 2012 is presented below:
The weighted-average grant-date fair values of options granted during 2012, 2011 and 2010 were $9.40, $9.11 and $7.60, respectively. Total intrinsic value of stock options exercised was $3.0 million, $0.3 million and $0.3 million for the years ended December 31, 2012, 2011 and 2010, respectively. Cash received from option exercises was $1.3 million, $0.2 million and $0.5 million for the years ended December 31, 2012, 2011 and 2010, respectively. Total tax benefits realized for tax deductions from option exercises were $1.0 million, $0.1 million and $0.1 million for the years ended December 31, 2012, 2011 and 2010, respectively.
The grant-date fair values of time-based restricted stock awards are determined using the closing price of Kemper common stock on the date of grant. Activity related to nonvested time-based restricted stock for the year ended December 31, 2012 was as follows:
The total fair value of restricted stock, including the 2009 Additional Shares, that vested during the year ended December 31, 2012 was $4.0 million and the tax benefits for tax deductions realized from the vesting on such restricted stock was $1.4 million. The total fair value of restricted stock that vested during the year ended December 31, 2011 was $1.4 million and the tax benefits for tax deductions realized from the vesting on such restricted stock was $0.5 million. The total fair value of restricted stock that vested during the year ended December 31, 2010 was $2.2 million and the tax benefits for tax deductions realized from the vesting on such restricted stock was $0.8 million.
Activity related to restructuring costs from continuing operations for the years ended December 31, 2012, 2011 and 2010 is presented below:
Options outstanding to purchase 2.8 million, 3.3 million and 4.1 million shares of Kemper common stock were excluded from the computation of Kemper Equity-based Compensation Equivalent Shares and Weighted-Average Common Shares and Equivalent Shares Outstanding Assuming Dilution for the years ended December 31, 2012, 2011 and 2010, respectively, because the exercise price exceeded the average market price.
The components of Other Comprehensive Income Before Income Taxes for the years ended December 31, 2012, 2011 and 2010 was:
The components of Other Comprehensive Income Tax Benefit (Expense) for the years ended December 31, 2012, 2011 and 2010 was:
Other Receivables includes accrued investment income of $72.4 million and $76.1 million at December 31, 2012 and 2011, respectively.
The components of Net Realized Gains on Sales of Investments for the years ended December 31, 2012, 2011 and 2010 were:
During the second and third quarters of 2010, Trinity sold a total of 1.5 million shares of Intermec common stock. As a result of these sales, the Company’s approximate voting percentage in Intermec was reduced to 18% at September 30, 2010. As a result of this change in ownership and other qualitative factors, the Company determined that its investment in the common stock of Intermec no longer qualified for the equity method of accounting. Accordingly, Equity in Net Loss of Former Investee for the year ended December 31, 2010 relates to the Company’s proportionate share of results that Intermec reported for a portion of the year. During the fourth quarter of 2010, Trinity sold an additional 0.3 million shares of Intermec common stock. Net Realized Gains on Sales of Investments includes gains of $5.4 million arising from the sales of Intermec common stock for the year ended December 31, 2010, of which $0.8 million has been reported as net realized gains on sales of investee and $4.6 million has been included in net realized gains on sales of equity securities. In 2011, the Company disposed of its remaining
holdings of 10.9 million shares of Intermec common stock, of which 3.6 million shares were sold in open market transactions at a gain of $8.3 million and 7.3 million shares were contributed to Company’s pension plan at a loss of $7.0 million. See Note 17, “Pension Benefits,” to the Consolidated Financial Statements.
Insurance Expenses for the years ended December 31, 2012, 2011 and 2010 were:
Current and Deferred Income Tax Assets at December 31, 2012 and 2011 were:
The components of Liabilities for Income Taxes at December 31, 2012 and 2011 were:
The tax effects of temporary differences that give rise to significant portions of the Company’s Net Deferred Income Tax Assets (Liabilities) at December 31, 2012 and 2011 were:
Deferred Income Tax Assets include Net Operating Loss (“NOL”) Carryforwards of $100.7 million and $98.1 million at December 31, 2012 and 2011, respectively, which include federal net operating loss carryforwards of $94.4 million and $91.2 million, respectively, and state net operating loss carryforwards of $6.3 million and $6.9 million, respectively. The expiration of the federal net operating loss carryforwards and the related deferred income tax assets is presented below by year of expiration.
Except for the net operating losses scheduled to expire in 2031 through 2032, all of the federal net operating loss carryforwards were acquired in connection with business acquisitions made in prior years and are subject to annual usage limitations under the Internal Revenue Code. The Company expects to fully utilize these federal net operating loss carryforwards. The state net operating loss carryforwards relate to Fireside, the majority of which are scheduled to expire in 2029. Deferred tax asset valuation allowances of $6.6 million and $6.8 million were required at December 31, 2012 and 2011, respectively, and relate to state income taxes for Fireside.
A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2012, 2011 and 2010 is as follows:
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. In connection with the audit, the Company extended the federal statute of limitations related to the 2007 and 2008 tax years until December 31, 2013. The Company does not anticipate a material modification to the filed returns or the refunds that were received.
During the third quarter of 2012, the Illinois Department of Revenue began an audit of the 2009 and 2010 tax years. The Company does not anticipate a material modification to the filed returns.
The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense. The liability for unrecognized tax benefits included accrued interest of $2.9 million, $2.5 million and $2.1 million at December 31, 2012, 2011 and 2010, respectively. Tax expense for the year ended December 31, 2012 includes interest expense of $0.4 million related to unrecognized tax benefits for prior years. Tax expense for the year ended December 31, 2011 includes interest expense of $0.4 million related to unrecognized tax benefits for prior years. Tax expense for the year ended December 31, 2010 includes a net interest benefit of $2.1 million, which is comprised of an interest benefit of $2.8 million resulting from the expiration of the statutes of limitations referred to above, and interest expense of $0.7 million on unrecognized tax benefits for prior years.
Comprehensive Income Tax Expense included in the Consolidated Financial Statements for the years ended December 31, 2012, 2011 and 2010 was:
The Company sponsored two qualified defined benefit pension plans which merged on December 31, 2012 (the “Pension Plan”). The Pension Plan covers approximately 3,100 retired and 2,800 active employees. The Pension Plan is generally non-contributory, but participation requires or required some employees to contribute 3% of pay, as defined, per year. Benefits for participants who are or were required to contribute to the Pension Plan are based on compensation during plan participation and the number of years of participation. Benefits for the vast majority of participants who are not required to contribute to the Pension Plan are based on years of service and final average pay, as defined. Prior to the merger of the plans, participants in one of the plans were no longer accruing benefits and their benefits were frozen. The Company funds the Pension Plan in accordance with the requirements of ERISA.
The actuarial assumptions used to develop the components of the Projected Benefit Obligation at December 31, 2012 and 2011 were:
The trust investment committee for the Pension Plan, along with its third party fiduciary advisor, periodically reviews the performance of the Pension Plan’s investments and asset allocation. Several external investment managers, one of which is Fayez Sarofim & Co. (“FS&C”), manage the equity investments of the trust for the Pension Plan. One of Kemper’s directors, Mr. Fayez Sarofim, is Chairman of the Board, Chief Executive Officer and the majority shareholder of FS&C, a registered investment advisory firm (see Note 24, “Related Parties,” to the Consolidated Financial Statements). Each manager is allowed to exercise investment discretion, subject to limitations, if any, established by the trust investment committee for the Pension Plan. An independent fiduciary had sole investment discretion with respect to shares of Intermec common stock contributed by the Company to one of the pension plans in 2011 until such shares were fully disposed of in 2012. All other investment decisions are made by the Company, subject to general guidelines as set by the trust investment committee for the Pension Plan.
The Company determines its Expected Long Term Rate of Return on Plan Assets based primarily on the Company’s expectations of future returns for the Pension Plan’s investments, based on target allocations of the Pension Plan’s investments. Additionally, the Company considers historical returns on comparable fixed income investments and equity investments and adjusts its estimate as deemed appropriate.
Fair value measurements for the Pension Plans’ assets at December 31, 2012 are summarized below:
The Company estimates that Pension Expense for the year ended December 31, 2013 will include expense of $23.9 million resulting from the amortization of the related accumulated actuarial loss included in Accumulated Other Comprehensive Income at December 31, 2012.
Total Pension Expense Recognized as presented in the preceding table includes service cost benefits earned and reported in discontinued operations of $0.5 million, $0.6 million and $0.5 million for the years ended December 31, 2012, 2011 and 2010, respectively.
The actuarial assumptions used to develop the components of the Pension Expense for the years ended December 31, 2012, 2011 and 2010 were:
The Company does not expect that it will be required to contribute to its Pension Plan in 2013, but could make a voluntary contribution pursuant to the maximum funding limits under ERISA.
The Company also sponsors several defined contribution benefit plans covering most of its employees. The Company made contributions to those plans of $7.8 million, $7.3 million and $6.8 million in 2012, 2011 and 2010, respectively. Under these plans, the participants have several investment alternatives, including Kemper’s common stock held through the Kemper Employee Stock Ownership Plan (“ESOP”) Fund and the Dreyfus Appreciation Fund. FS&C is a sub-investment advisor of the Dreyfus Appreciation Fund. One of Kemper’s directors, Mr. Fayez Sarofim, is the Chairman of the Board, Chief Executive Officer and majority shareholder of FS&C (see Note 24, “Related Parties,” to the Consolidated Financial Statements). The fair value of participants’ investments in Kemper’s ESOP Fund was $15.0 million, or 5.0% of the total investments in the defined contribution benefit plans at December 31, 2012. The fair value of participants’ investments in the Dreyfus Appreciation Fund was $20.1 million, or 6.7% of the total investments in the defined contribution benefit plans at December 31, 2012.
Changes in Fair Value of Plan Assets and Changes in Accumulated Benefit Obligation for the years ended December 31, 2012 and 2011 were:
The measurement dates of the assets and liabilities at end of year in the preceding table under the headings “2012” and “2011” were December 31, 2012 and December 31, 2011, respectively.
The assumed health care cost trend rate used in measuring the Accumulated Benefit Obligation at December 31, 2012 was 7.0% for 2013, gradually declining to 5.0% in the year 2017 and remaining at that level thereafter for medical benefits and 8.5% for 2013, gradually declining to 5.0% in the year 2020 and remaining at that level thereafter for prescription drug benefits. The assumed health care cost trend rate used in measuring the Accumulated Benefit Obligation at December 31, 2011 was 7.5% for 2012, gradually declining to 5.0% in the year 2017 and remaining at that level thereafter for medical benefits and 9.0% for 2012, gradually declining to 5.0% in the year 2020 and remaining at that level thereafter for prescription drug benefits.
A one-percentage point increase in the assumed health care cost trend rate for each year would increase the Accumulated Benefit Obligation at December 31, 2012 by $2.8 million and 2012 OPEB expense by $0.1 million. A one-percentage point increase in the assumed health care cost trend rate for each year would increase the Accumulated Benefit Obligation at December 31, 2011 by $2.8 million and 2011 OPEB expense by $0.1 million.
The components of Comprehensive OPEB Expense for the years ended December 31, 2012, 2011 and 2010 were:
The actuarial assumptions used to develop the components of the OPEB Expense for the years ended December 31, 2012, 2011 and 2010 were:
The Kemper Preferred segment provides preferred and standard risk personal automobile insurance, homeowners insurance and other personal insurance through independent agents. The Kemper Specialty segment provides automobile insurance to individuals and businesses in the non-standard and specialty market through independent agents. The non-standard automobile insurance market consists of individuals and companies that have difficulty obtaining standard or preferred risk insurance, usually because of their adverse driving records or claim or credit histories. The Kemper Direct segment currently distributes personal automobile, homeowners and renters insurance products through employer-sponsored voluntary benefit programs and other affinity relationships. Prior to ceasing direct-to-consumer marketing activities in the third quarter of 2012, Kemper Direct also distributed its products directly to consumers through a variety of direct-to-consumer websites, including its own websites. The Life and Health Insurance segment provides individual life, accident, health and property insurance.
Segment Revenues for the years ended December 31, 2012, 2011 and 2010 were:
Catastrophes and storms are inherent risks of the property and casualty insurance business. These catastrophic events and natural disasters include, without limitation, hurricanes, tornadoes, earthquakes, hailstorms, wildfires, high winds and winter storms. Such events result in insured losses that are, and will continue to be, a material factor in the results of operations and financial position of the Company’s property and casualty insurance companies. Further, because the level of these insured losses occurring in any one year cannot be accurately predicted, these losses may contribute to material year-to-year fluctuations in the results of the operations and financial position of these companies. Specific types of catastrophic events are more likely to occur at certain times within the year than others. This factor adds an element of seasonality to property and casualty insurance claims. The Company has adopted the industry-wide catastrophe classifications of storms and other events promulgated by ISO to track and report losses related to catastrophes. ISO classifies a disaster as a catastrophe when the event causes $25.0 million or more in direct losses to property and affects a significant number of policyholders and insurers. ISO-classified catastrophes are assigned a unique serial number recognized throughout the insurance industry. The discussions that follow utilize ISO’s definition of catastrophes.
The Company manages its exposure to catastrophes and other natural disasters through a combination of geographical diversification, restrictions on the amount and location of new business production in such regions, and reinsurance. To limit its exposures to catastrophic events, the Company maintains various catastrophe reinsurance programs for its property and casualty insurance businesses.
Coverage for each catastrophe reinsurance program effective January 1, 2012 to December 31, 2012 is provided in various layers as presented below:
Coverage for each catastrophe reinsurance program effective January 1, 2011 to December 31, 2011 is provided in various layers as presented below:
The catastrophe reinsurance program for the Kemper Preferred segment in 2011 also included reinsurance coverage for catastrophe losses in North Carolina at retentions lower than those described above. The catastrophe reinsurance program for the Life and Health Insurance and Kemper Direct segments in 2011 also included reinsurance coverage from FHCF for hurricane losses in Florida at retentions lower than those described above.
Coverage for each catastrophe reinsurance program effective January 1, 2010 to December 31, 2010 is provided in various layers as presented below:
Catastrophe reinsurance premiums for the year ended December 31, 2011 for the Life and Health Insurance segment in the preceding table includes a reduction of $0.2 million in the Company’s estimated reinsurance reinstatement premiums for prior years. Catastrophe reinsurance premiums for the Life and Health Insurance segment in the preceding table includes reinsurance reinstatement premiums of $0.6 million for the year ended December 31, 2010 to reinstate coverage following certain hurricanes.
Catastrophe losses and LAE (including development), net of reinsurance recoveries, for the years ended December 31, 2012, 2011 and 2010 by business segment are presented below.
Earned Premiums ceded on long-duration and short-duration policies were not material for the years ended December 31, 2012, 2011 and 2010. Certain insurance subsidiaries assume business from other insurance companies and involuntary pools. Earned Premiums assumed on long-duration and short-duration policies for the years ended December 31, 2012, 2011 and 2010 were:
The table below presents quantitative information about the significant unobservable inputs utilized by the Company in determining fair values for investments in corporate bonds and notes classified as Level 3.
used in the valuation are considered Level 2 measurements. The fair value of Short-term Investments is estimated using inputs that are considered Level 1 measurements.
The Company cannot predict which states, if any, may enact legislation of this type or the outcome of other initiatives by state officials. The Company does not use, nor does it believe it is required under applicable law or the terms of its life insurance policies to use, the SSA Death Master File. The Company cannot reasonably estimate the amount of loss, if any, that the Company would recognize if it were not to ultimately prevail in this matter.
One of Kemper’s directors, Mr. Fayez Sarofim, is the Chairman of the Board, Chief Executive Officer and the majority shareholder of FS&C, a registered investment advisory firm. In the second quarter of 2010, Kemper’s subsidiary, Trinity, entered into 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. At December 31, 2012, Trinity had $125.2 million in assets managed by FS&C. Investment Expenses incurred in connection with such agreement were $0.3 million, $0.3 million and $0.1 million for the years ended December 31, 2012, 2011 and 2010, respectively.