Kemper’s subsidiaries together own and occupy seven buildings located in six states consisting of approximately 25,000 square feet in the aggregate. Kemper’s subsidiaries own four buildings totaling approximately 15,000 square feet which were vacant at December 31, 2015. Kemper’s subsidiaries hold additional properties that are not occupied by Kemper or its subsidiaries solely for investment purposes.
Selected financial information as of and for the years ended December 31, 2015, 2014, 2013, 2012 and 2011 is presented below.
Net Income was $85.7 million ($1.65 per unrestricted common share) for the year ended December 31, 2015, compared to $114.5 million ($2.12 per unrestricted common share) for the year ended December 31, 2014. Income from Continuing Operations was $80.2 million ($1.55 per unrestricted common share) in 2015, compared to $112.6 million ($2.08 per unrestricted common share) in 2014.
The Company’s net income decreased $28.8 million in 2015, compared to 2014. In the Property & Casualty Insurance segment, segment net operating income increased $1.8 million due primarily to a lower amount of write-offs of internal use software, lower insurance expenses as a percentage of earned premiums and lower incurred catastrophe losses and LAE (excluding reserve development), partially offset by higher underlying losses and LAE as a percentage of earned premiums and a lower level of favorable loss and LAE reserve development. See MD&A, “Property & Casualty Insurance,” beginning on page 31 for additional discussion of the segment’s results. See MD&A, “Write-offs of Long-lived Assets,” beginning on page 51 for additional information related to the internal use software write-offs. In the Life & Health Insurance segment, segment net operating income decreased $20.1 million due primarily to a $13.9 million after-tax dividend in 2014 from an investment that had sold substantially all of its operations, an after-tax adjustment to earned premiums of $4.9 million recorded in the first quarter of 2015 to correct deferred premium reserves on certain limited pay life insurance policies, and higher policyholders’ benefits on life insurance. See MD&A, “Life & Health Insurance,” beginning on page 41 for additional discussion of the segment’s results. The Company’s results were also significantly and negatively impacted in 2015, compared to 2014, by higher net impairment losses recognized in earnings and a loss from early extinguishment of debt in 2015, partially offset by higher net realized gains on sales of investments. See MD&A, “Investment Results,” beginning on page 44 and MD&A, “Liquidity and Capital Resources,” beginning on page 52 for additional discussion.
The number of catastrophic events and catastrophe losses and LAE (excluding loss and LAE reserve development) by range of loss and business segment for the years ended December 31, 2015, 2014 and 2013 are presented below.
The Company primarily manages its exposure to catastrophes and other natural disasters through a combination of geographical diversification, management of the amount and location of risks insured in certain regions and a primary catastrophe reinsurance program for the Property & Casualty Insurance segment. Coverage for this segment’s primary catastrophe reinsurance program is provided in various layers (see Note 20, “Catastrophe Reinsurance,” to the Consolidated Financial Statements for further discussion of this program). In addition to this program, the Property & Casualty Insurance segment had a reinsurance treaty covering the three-year period that ended June 1, 2013 for catastrophe losses in North Carolina at retentions lower than its primary catastrophe reinsurance program (“the NC Program”). The Property & Casualty Insurance segment also purchases reinsurance from the FHCF for hurricane losses in Florida at retentions lower than its primary catastrophe reinsurance program. The Life & Health Insurance segment also purchases reinsurance from the FHCF for hurricane losses in Florida. Except for the coverage provided by the FHCF, the Life & Health Insurance segment has not carried any other catastrophe reinsurance since 2012, primarily due to actions taken by KHSC to reduce its exposures to catastrophes.
See MD&A, “Property & Casualty Insurance,” MD&A, “Life & Health Insurance,” and Note 6, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements for additional information on the Company’s reserve development. See MD&A, “Critical Accounting Estimates,” of this 2015 Annual Report for additional information pertaining to the Company’s process of estimating property and casualty insurance reserves for losses and LAE, and the estimated variability thereof, development of property and casualty insurance losses and LAE, and a discussion of some of the variables that may impact them.
Pursuant to the rules and regulations of the SEC, the Company is required to file consolidated financial statements prepared in accordance with the accounting principles generally accepted in the United States (“GAAP”). The Company is permitted to include non-GAAP financial measures in its filings provided that they are defined along with an explanation of their usefulness to investors, are no more prominent than the comparable GAAP financial measures and are reconciled to such GAAP financial measures.
Significant non-recurring items are excluded when (a) the nature of the charge or gain is such that it is reasonably unlikely to recur within two years, and (b) there has been no similar charge or gain within the prior two years. The most directly comparable GAAP financial measure is Income from Continuing Operations. There were no applicable significant non-recurring items that the Company excluded from the calculation of Consolidated Net Operating Income for the years ended December 31, 2015, 2014 and 2013.
The Company believes that Consolidated Net Operating Income provides investors with a valuable measure of its ongoing performance because it reveals underlying operational performance trends that otherwise might be less apparent if the items were not excluded. Net Realized Gains on Sales of Investments and Net Impairment Losses Recognized in Earnings related to investments included in the Company’s results may vary significantly between periods and are generally driven by business decisions and external economic developments such as capital market conditions that impact the values of the Company’s investments, the timing of which is unrelated to the insurance underwriting process. Loss from Early Extinguishment of Debt is driven by the Company’s financing and refinancing decisions and capital needs, as well as external economic developments such as debt market conditions, the timing of which is unrelated to the insurance underwriting process. Significant non-recurring items are excluded because, by their nature, they are not indicative of the Company’s business or economic trends.
See MD&A, “Critical Accounting Estimates,” under the caption “Property and Casualty Insurance Reserves for Losses and Loss Adjustment Expenses” beginning on page 57 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 from prior accident years, also referred to as “reserve development” in the discussion of segment results, 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.
As discussed in Note 3, “Acquisition of Business,” to the Consolidated Financial Statements, the Company completed its acquisition of Alliance United on April 30, 2015. The results of its operations have been included in the preceding tables of selected financial information for the Property & Casualty Insurance segment since the date of its acquisition. Alliance United is a provider of nonstandard personal automobile insurance in California and adds significant scale to the Property & Casualty Insurance segment’s premium base.
Earned Premiums in the Property & Casualty Insurance segment increased by $165.7 million. Excluding the $272.9 million impact from Alliance United, earned premiums decreased by $107.2 million, as lower volume accounted for a decrease of $138.4 million, while higher average earned premium accounted for an increase of $31.2 million. Excluding Alliance United, the lower volume was driven primarily by personal automobile insurance and homeowners insurance, which had volume decreases of $99.9 million and $32.0 million, respectively. Excluding Alliance United, the increase in average earned premium was driven primarily by personal automobile insurance and homeowners insurance, which had increases of $23.3 million and $5.9 million, respectively.
Insurance expenses, including write-offs of long-lived assets, were $379.2 million in 2015, compared to $408.3 million in 2014, which is a decrease of $29.1 million due primarily to the impact of write-offs of internal use software, lower variable costs in line with a general decline in the size of the Company’s legacy business and cost-cutting measures implemented by the Company, partially offset by the inclusion of Alliance United. The write-off of internal use software was $11.1 million in 2015, compared to $54.6 million in 2014. See “Write-offs of Long-lived Assets” of the MD&A for further discussion. Excluding the software write-offs, insurance expenses were $368.1 million, or 26.0% of earned premiums, in 2015, compared to $353.7 million, or 28.3% of earned premiums, in 2014. The inclusion of Alliance United accounted for a reduction of 3.0 percentage points in the segment’s overall insurance expense ratio. Insurance expenses for Alliance United include a write-off of deferred policy acquisition costs of $9.0 million due to a premium deficiency and legal expenses of $5.2 million, net of indemnification, for a certain legal matter. See Note 3, “Acquisition of Business,” to the Consolidated Financial Statements. Excluding the impact of the software write-offs and Alliance United, insurance expenses decreased by $24.2 million in 2015, compared to 2014, but increased, as a percentage of earned premiums, from 28.3% in 2014 to 28.8% in 2015. The increase in the ratio was due primarily to the reduction in legacy earned premiums outpacing the reduction in fixed costs.
The Property & Casualty Insurance 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 estimated indemnification recoveries recognized in earnings pursuant to the Alliance United purchase agreement. Tax-exempt investment income and dividends received
The Property & Casualty Insurance segment reported Segment Net Operating Income of $24.9 million in 2014, compared to $100.6 million in 2013. Segment Net Operating Income decreased by $75.7 million due primarily to the write-off of certain internal use software during the third quarter of 2014, higher incurred catastrophe losses and LAE (excluding reserve development), lower net investment income and higher insurance expenses as a percentage of earned premiums, partially offset by lower underlying losses and LAE as a percentage of earned premiums. See MD&A, “Write-offs of Long-lived Assets” for more information related to the internal use software write-off.
Earned Premiums in the Property & Casualty Insurance segment decreased by $143.4 million, as lower volume accounted for a decrease of $211.4 million, while higher average earned premium accounted for an increase of $68.0 million. The lower volume was driven primarily by personal automobile insurance and homeowners insurance, which had volume decreases of $167.6 million and $39.8 million, respectively. The increase in average earned premium was also driven primarily by personal automobile insurance and homeowners insurance, which had increases of $39.9 million and $26.0 million, respectively. The decrease in premium volume was on both new business production and retention levels and was due primarily to the rate and resegmentation efforts of the Company in the past few years. The Company had undertaken various actions to improve its retention and new business production, including moderating rate increases in its more recent rate filings due to the improvement in profitability of the book of business.
Net Investment Income in the Property & Casualty Insurance segment decreased by $18.2 million in 2014, compared to 2013, due primarily to lower investment income from Equity Method Limited Liability Investments, lower yields on fixed maturities and lower levels of investments resulting from a decline in the scale of the business. The Property & Casualty Insurance segment reported net investment income from Equity Method Limited Liability Investments of $8.4 million in 2014, compared to $16.5 million in 2013.
Incurred losses and LAE were $825.3 million, or 80.3% of earned premiums, in 2015, compared to $597.1 million, or 71.8% of earned premiums, in 2014. Excluding the $261.0 million impact from Alliance United, incurred losses and LAE were $564.3 million, or 74.8% of related earned premiums, in 2015, compared to $597.1 million, or 71.8% of earned premiums, in 2014. Excluding Alliance United, incurred losses and LAE as a percentage of earned premiums increased due to a lower level of favorable loss and LAE reserve development and higher underlying losses and LAE as a percentage of earned premiums on the nonstandard book of business, partially offset by lower incurred catastrophe losses and LAE (excluding reserve development) and lower underlying losses and LAE as a percentage of earned premiums on the preferred book. Excluding Alliance United, underlying losses and LAE as a percentage of related earned premiums were 75.1% in 2015, compared to 74.1% in 2014, which was an increase of 1.0 percentage point due primarily to higher frequency of claims in the nonstandard book and higher severity of losses on most coverages in the preferred book and property damage losses in the nonstandard book, partially offset by higher average earned premium across both books, lower frequency of claims on bodily injury, uninsured/underinsured motorists, property damage and comprehensive coverages in the preferred book and lower severity of bodily injury losses in the nonstandard book.
Incurred losses and LAE were $597.1 million, or 71.8% of earned premiums, in 2014, compared to $719.2 million, or 75.0% of earned premiums, in 2013. Incurred losses and LAE as a percentage of earned premiums decreased due to lower underlying losses and LAE as a percentage of earned premiums and a higher level of favorable loss and LAE reserve development, partially offset by higher incurred catastrophe losses and LAE (excluding reserve development). Underlying losses and LAE as a percentage of earned premiums were 74.1% in 2014, compared to 77.3% in 2013, which was an improvement of 3.2 percentage points due primarily to the impact of pricing and underwriting actions taken by the Company, lower severity of bodily injury losses and lower frequency of claims across most liability coverages, partially offset by higher severity of losses on most coverages except bodily injury.
Catastrophe losses and LAE (excluding reserve development) were $12.7 million in 2014, compared to $7.6 million in 2013. Favorable loss and LAE reserve development was $31.6 million in 2014, compared to $30.1 million in 2013.
Earned premiums in homeowners insurance decreased by $26.1 million as lower volume accounted for a decrease of $32.0 million, while higher average earned premium accounted for an increase of $5.9 million.
Incurred losses and LAE were $189.7 million, or 66.3% of earned premiums, in 2015, compared to $222.5 million, or 71.2% of earned premiums, in 2014. Incurred losses and LAE as a percentage of earned premiums decreased due to lower incurred catastrophe losses and LAE (excluding reserve development), partially offset by a lower level of favorable loss and LAE reserve development and higher underlying losses and LAE as a percentage of earned premiums. Underlying losses and LAE as a percentage of earned premiums were 50.7% in 2015, compared to 50.1% in 2014, which was an increase of 0.6 percentage points due primarily to higher severity of losses, partially offset by lower frequency of claims and higher average earned premium.
Incurred losses and LAE were $47.7 million, or 87.5% of earned premiums, in 2015, compared to $42.2 million, or 77.0% of earned premiums, in 2014. Incurred losses and LAE as a percentage of earned premiums increased due primarily to adverse loss and LAE reserve development in 2015, compared to favorable development in 2014 and higher underlying losses and LAE as a percentage of earned premiums. Underlying losses and LAE as a percentage of earned premiums were 83.8% in 2015, compared to 81.3% in 2014, which was an increase of 2.5 percentage points due primarily to higher frequency of losses across all coverages, particularly bodily injury, partially offset by lower severity of losses across most coverages, particularly bodily injury and comprehensive. Adverse loss and LAE reserve development was $1.8 million in 2015, compared to favorable development of $2.6 million in 2014.
Earned premiums in commercial automobile insurance increased by $2.5 million due to higher volume with average earned premium remaining consistent. Incurred losses and LAE were $42.2 million, or 77.0% of earned premiums, in 2014, compared to $40.8 million, or 78.0% of earned premiums, in 2013.
Incurred losses and LAE as a percentage of earned premiums decreased due to lower underlying losses and LAE as a percentage of earned premiums, partially offset by a lower level of favorable loss and LAE reserve development. Underlying losses and LAE as a percentage of earned premiums were 81.3% in 2014, compared to 83.5% in 2013, which was an improvement of 2.2 percentage points due primarily to lower severity of losses across most coverages, partially offset by higher frequency of claims across most coverages.
Favorable loss and LAE reserve development was $2.6 million in 2014, compared to $3.0 million in 2013.
Earned premiums in other personal insurance decreased by $4.2 million as lower volume accounted for a decrease of $5.5 million, while higher average earned premium accounted for an increase of $1.3 million.
Incurred losses and LAE were $23.5 million, or 50.3% of earned premiums, in 2015, compared to $25.5 million, or 50.1% of earned premiums, in 2014. Incurred losses and LAE as a percentage of earned premiums increased due to a lower level of favorable loss and LAE reserve development, partially offset by lower underlying losses and LAE as a percentage of earned premiums and lower catastrophe losses and LAE (excluding reserve development). Underlying losses and LAE as a percentage of earned premiums were 50.1% in 2015, compared to 55.2% in 2014, which was an improvement of 5.1 percentage points due primarily to lower frequency of umbrella claims, partially offset by higher severity of losses across all coverages.
Catastrophe losses and LAE (excluding reserve development) were $2.2 million in 2015, compared to $2.8 million in 2014. Favorable loss and LAE reserve development was $2.1 million in 2015, compared to $5.4 million in 2014.
Earned premiums in other personal insurance decreased by $4.4 million as lower volume accounted for a decrease of $6.6 million, while higher average earned premium accounted for an increase of $2.2 million.
Incurred losses and LAE were $25.5 million, or 50.1% of earned premiums, in 2014, compared to $20.8 million, or 37.6% of earned premiums, in 2013. Incurred losses and LAE as a percentage of earned premiums increased due to higher underlying losses and LAE as a percentage of earned premiums and higher catastrophe losses and LAE (excluding reserve development), partially offset by a higher level of favorable loss and LAE reserve development. Underlying losses and LAE as a percentage of earned premiums were 55.2% in 2014, compared to 44.1% in 2013, which was an increase of 11.1 percentage points due primarily to higher severity of losses and frequency of claims across most coverages.
Operating Profit in the Life & Health Insurance segment was $109.7 million before income taxes for the year ended December 31, 2015, compared to $141.9 million in 2014. Policyholders’ Benefits and Incurred Losses and LAE increased by $6.9 million in 2015 due primarily to higher policyholders’ benefits on life insurance and higher incurred losses and LAE on property insurance. Policyholders’ benefits on life insurance were $274.9 million in 2015, compared to $268.7 million in 2014, an increase of $6.2 million due primarily to higher death claims and a lower lapse ratio related to insurance policies issued by KHSC and higher volume of insurance from policies issued by Reserve National. Incurred accident and health insurance losses were $80.8 million, or 55.8% of accident and health insurance earned premiums, in 2015, compared to $81.1 million, or 54.6% of accident and health insurance earned premiums, in 2014. Incurred accident and health insurance losses increased as a percentage of earned premiums due primarily to higher average claim costs, partially offset by the impact of a change in business mix resulting from the non-renewal and run-off of certain health insurance products with higher loss ratios and the issuance of supplemental insurance products with lower loss ratios. Incurred losses and LAE on property insurance were $25.6 million, or 34.0% of property insurance earned premiums, in 2015, compared to $24.6 million, or 32.2% of property insurance earned premiums, in 2014. Underlying losses and LAE on property insurance were $20.4 million, or 27.1% of property insurance earned premiums, in 2015, compared to $21.7 million, or 28.4% of property insurance earned premiums, in 2014 and decreased due primarily to lower frequency and severity of fire insurance losses, partially offset by higher severity of losses from storms that were not large enough to be classified as a catastrophe by ISO. Catastrophe losses and LAE (excluding development) were $3.8 million in 2015, compared to $2.0 million in 2014. Unfavorable loss and LAE reserve development was $1.4 million in 2015, compared to $0.9 million in 2014. Insurance Expenses in the Life & Health Insurance segment increased by $4.0 million due primarily to higher legal costs and costs incurred in connection with a project to digitize historical records, partially offset by lower salary expenses from a lower level of field staff managers and district managers resulting from a consolidation of The Kemper Home Service Companies’ field operations substantially completed in the first quarter of 2015 and lower agent incentive conference expense. Segment Net Operating Income in the Life & Health Insurance segment was $71.7 million for the year ended December 31, 2015, compared to $91.8 million in 2014.
premiums in 2013. Earned premiums on property insurance decreased by $2.3 million in 2014, compared to 2013, due primarily to lower volume, partially offset by higher average premium.
Net Investment Income increased by $8.8 million for the year ended December 31, 2014, compared to 2013, due primarily to higher investment income from other equity interests, partially offset by lower investment income from Equity Method Limited Liability Investments and lower book yields on fixed maturities. Investment income from other equity interests in 2014 included dividend income of $21.4 million from one company that had sold substantially all of its operations. Net investment loss from Equity Method Limited Liability Investments was $0.4 million in 2014, compared to net investment income of $8.4 million in 2013.
Net Investment Income decreased by $5.6 million for the year ended December 31, 2014, compared to 2013, due primarily to lower income on Equity Method Limited Liability Investments and lower Interest and Dividends on Fixed Maturities, partially offset by higher dividends on Equity Securities. Investment income from Equity Method Limited Liability Investments decreased by $17.4 million due to lower investment returns. Interest and Dividends on Fixed Maturities decreased by $8.1 million due primarily to lower yields and, to a lesser extent, lower levels of Fixed Maturities. Dividends on Equity Securities in 2014 included dividend income of $21.8 million from one company that had sold substantially all of its operations. Interest income from loans to policyholders increased by $0.7 million in 2014, compared to 2013, due to a higher level of loans outstanding. Net investment income from real estate decreased by $1.7 million in 2014, compared to 2013, due primarily to income from the early termination of one tenant’s lease in 2013.
In 2013, the Company sold certain common stocks to accelerate the utilization of net operating loss carryforwards. Net Realized Gains on Sales of Equity Securities for the year ended December 31, 2013 include realized gains of $19.8 million from such sales.
Other sales activity in 2015, 2014 and 2013 was due to normal portfolio management.
The Company regularly reviews its investment portfolio for factors that may indicate that a decline in the fair value of an investment is other-than-temporary. Losses arising from other-than-temporary declines in fair value are reported in the Consolidated Statements of Income in the period that the declines are determined to be other-than-temporary. Information pertaining to Net Impairment Losses Recognized in Earnings reported in the Consolidated Statements of Income for the years ended December 31, 2015, 2014 and 2013 is presented below.
Net Impairment Losses Recognized in the Consolidated Statements of Income for the year ended December 31, 2013 related to Investments in Fixed Maturities include losses of $0.8 million due to the Company’s intent to sell or requirement to sell bonds of two issuers and credit losses of $9.5 million from other-than-temporary declines in the fair values of investments in fixed maturities of three issuers.
Gross unrealized losses on the Company’s investments in below-investment-grade fixed maturities were $16.5 million and $5.6 million at December 31, 2015 and 2014, respectively.
The Company’s short-term investments primarily consist of U.S Treasuries, overnight repurchase agreements, money market funds, overnight interest bearing accounts and certificates of deposit. At December 31, 2015, the Company had $84.6 million invested in overnight repurchase agreements primarily collateralized by securities issued by the U.S. government and government agencies and authorities, $50.1 million of certificates of deposit issued by a single bank, $78.7 million invested in overnight interest bearing accounts with one of the Company’s custodial banks and $21.6 million invested in money market funds which primarily invest in U.S. Treasury securities. At the time of borrowing, the repurchase agreements generally require the borrower to provide collateral to the Company at least equal to the amount borrowed from the Company. The Company bears some investment risk in the event that a borrower defaults and the value of collateral falls below the amount borrowed. The Company does not have any investments in sovereign debt securities issued by foreign governments.
The following table summarizes the fair value of the Company’s investments in non-governmental fixed maturities by industry at December 31, 2015 and 2014:
The following table summarizes the fair value of the Company’s ten largest exposures, excluding investments in U.S. Government and Government Agencies and Authorities, pre-refunded municipal bonds and Short-term Investments, at December 31, 2015.
In 2013, Kemper’s subsidiary, One East Wacker LLC (“One East”), sold the building where Kemper’s corporate offices are headquartered for a gain of $43.6 million before taxes. In connection with the sale, Kemper entered into a long-term operating lease for five floors of the 41-story office building, with naming and signage rights. One East’s proceeds from the sale before taxes, net of repayment of a $45 million mortgage held by Trinity and an advance of $4.0 million from Kemper, and payment of other transaction costs and liabilities, were approximately $50 million. In 2013, One East distributed $48 million of its capital in cash to Kemper. The undistributed net assets of Kemper’s non-insurance subsidiaries were not material at December 31, 2015.
On April 30, 2015, Kemper completed its acquisition of Alliance United in a cash transaction for a total purchase price of $71.0 million, subject to certain post-closing indemnifications. After completing the transaction, Kemper contributed $75.0 million to support the book of business acquired. Kemper contributed $30 million of additional capital in the fourth quarter of 2015 due
Kemper paid a quarterly dividend to shareholders of $0.24 per common share in each quarter of 2015. Dividends paid were $49.7 million for the year ended December 31, 2015.
The primary sources of funds for Kemper’s insurance subsidiaries are premiums and fees from policyholders, investment income and proceeds from the sales and maturity of investments, advances from the FHLBs of Dallas and Chicago, and capital contributions from Kemper. The primary uses of funds are the payment of policyholder benefits under life insurance contracts, claims and claims-related expenses under property and casualty insurance contracts and accident and health insurance contracts, the payment of commissions and general expenses, the purchase of investments, repayments of advances from the FHLBs of Dallas and Chicago and payment of dividends to Kemper. 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 application of state 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 remittance of such benefits to the states under their unclaimed property laws relative to what is currently contemplated by Kemper. See Item 1A., “Risk Factors,” under the caption “Unclaimed Property Risk Factor” MD&A, “Life & Health Insurance,” and Note 23, “Contingencies,” to the Consolidated Financial Statements 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 experience several significant catastrophic events over a relatively short period of time, investments may have to be sold in advance of their maturity dates to fund payments, which could result in either investment gains or losses. Management believes that its property and casualty insurance subsidiaries maintain adequate levels of liquidity in the event that they were to experience several future catastrophic events over a relatively short period of time.
Net Cash Used by Financing Activities was $100.8 million for the year ended December 31, 2015, compared to $19.7 million for the same period in 2014. Kemper used $357.3 million of cash to repay debt for the year ended December 31, 2015, of which $258.8 million was used to redeem the 2015 Senior Notes and $98.5 million to repay the FHLB advances. Net proceeds from the issuance of debt provided $345.8 million for the year ended December 31, 2015, of which $247.3 million was related to the
Net Cash Used by Investing Activities increased by $109.1 million for the year ended December 31, 2014, compared to 2013. Sales of Fixed Maturities exceeded Purchases of Fixed Maturities by $20.7 million in 2014. Purchases of Fixed Maturities exceeded Sales of Fixed Maturities by $80.1 million in 2013. Sales of Equity Securities exceeded Purchases of Equity Securities by $10.1 million in 2014. Purchases of Equity Securities exceeded Sales of Equity Securities by $31.3 million in 2013. Purchases of Fair Value Option Investments exceeded Sales of Fair Value Option Investments by $54.0 million in 2014. There were no purchases or sales of Fair Value Option Investments in 2013. In 2014, the Company made an initial purchase of $33.5 million of Corporate-owned Life Insurance. There were no purchases or sales of Corporate-owned Life Insurance for the same period in 2013. Cash provided by the sale of investment real estate was $0.9 million in 2014 compared to $102.7 million in 2013. Net cash used by acquisitions of short-term investments was $63.9 million in 2014, compared to net cash of $41.8 million provided by dispositions of short-term investments in 2013.
The Company has no material obligations under guarantee contracts. The Company has no material retained or contingent interests in assets transferred to an unconsolidated entity. The Company has no material obligations, including contingent obligations, under contracts that would be accounted for as derivative instruments. The Company has no obligations, including contingent obligations, arising out of a variable interest in an unconsolidated entity held by, and material to, the Company, where such entity provides financing, liquidity, market risk or credit risk support to, or engages in leasing, hedging or research and development services with the Company. Accordingly, the Company has no material off-balance sheet arrangements.
The reported value of the Company’s investments was $6,429.5 million at December 31, 2015, of which $5,544.7 million, or 86%, was reported at fair value, $190.6 million, or 3%, was reported under the equity method of accounting, $288.4 million, or 5%, was reported at unpaid principal balance and $405.8 million, or 6%, was reported at cost or depreciated cost. Investments, in general, are exposed to various risks, such as interest rate risk, credit risk and overall market volatility risk. Accordingly, it is reasonably possible that changes in the fair values of the Company’s investments reported at fair value will occur in the near term and such changes could materially affect the amounts reported in the financial statements. Also, it is reasonably possible that changes in the carrying values of the Company’s Equity Method Limited Liability Investments will occur in the near term and such changes could materially affect the amounts reported in the financial statements because these issuers follow specialized industry accounting rules which require that they report all of their investments at fair value (See Item 1A., “Risk
Factors” under the title “The Company’s investment portfolio is exposed to a variety of risks that may negatively impact net investment income and cause realized and unrealized losses”).
As more fully described under the heading, “Fair Value Measurements,” in Note 2, “Summary of Accounting Policies and Accounting Changes,” to the Consolidated Financial Statements, the Company uses a hierarchal framework which prioritizes and ranks the market observability used in fair value measurements.
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. 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, 2015, would have decreased by $115.4 million.
Changes in these factors from their December 31, 2015 evaluation date could result in the Company determining that a temporary decline in the fair value of an investment held and evaluated at December 31, 2015 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 actuaries generally review the results of at least four of the estimation methodologies, two based on paid data and two based on incurred data, to initially estimate the ultimate losses and LAE for the current accident quarter and re-estimate the ultimate losses and LAE for previous accident quarters to determine if changes in the previous estimates of the ultimate losses and LAE are indicated by the most recent data. In some cases, the methodologies produce a cluster of estimates with a tight band of indicated possible outcomes. In other cases, however, the methodologies produce conflicting results and wider bands of indicated possible outcomes, and the Company’s actuaries perform additional analyses before making their final
Development for the years ended December 31, 2015, 2014 and 2013, was:
Although development will emerge in all of the Company’s product lines, development in the Company’s personal automobile insurance product line could have the most significant impact due to the relative size of its loss and LAE reserves. To further illustrate the sensitivity of the Company’s reserves for personal automobile insurance losses and LAE to changes in the cumulative development factors, for each quarterly evaluation point the Company’s actuaries calculated the variability of cumulative development factors observed in the incurred loss development methodology using one standard deviation. The Company believes that one standard deviation of variability is a reasonably likely scenario to measure variability for its loss and LAE reserves under the incurred development method for personal automobile insurance. Assuming that the Company’s personal automobile insurance loss and LAE reserves were based solely on the incurred loss development methodology and the variability in the cumulative development factors occurred within one standard deviation, the Company estimates that the Company’s personal automobile insurance loss and LAE reserves could have varied by $65.2 million in either direction at December 31, 2015 for all accident years combined under this scenario. In addition to the factors described above, other factors may also impact loss reserve development in future periods. These factors include governmental actions, including court decisions interpreting existing laws, regulations or policy provisions, developments related to insurance policy claims and coverage issues, adverse or favorable outcomes in pending claims litigation, the number and severity of insurance claims, the impact of inflation on insurance claims and the impact of required participation in windpools and joint underwriting associations and residual market assessments. Although the Company’s actuaries do not make specific numerical assumptions about these factors, changes in these factors from past patterns will impact historical loss development factors and, in turn, future loss reserve development. Significant favorable changes in one or more factors will lead to favorable future loss reserve development, which could result in the actual loss developing closer to, or even below, the lower end of the Company’s estimated reserve variability. Significant unfavorable changes in one or more factors will lead to unfavorable loss reserve development, which could result in the actual loss developing closer to, or even above, the higher end of the Company’s estimated reserve variability. Accordingly, due to these factors and the other factors enumerated throughout the MD&A and the inherent limitations of the loss reserving estimation methodologies, the estimated and illustrated reserve variability may not necessarily be indicative of the Company’s future reserve variability, which could ultimately be greater than the estimated and illustrated variability. In addition, as previously noted, development will emerge in all of the Company’s product lines over time. Accordingly, the Company’s future reserve variability could ultimately be greater than the illustrated variability. Additional information pertaining to the estimation of, and development of, the Company’s Property and Casualty Insurance Reserves is contained in Item 1 of Part I of this 2015 Annual Report under the heading “Property and Casualty Loss and Loss Adjustment Expense Reserves.”
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2015, 2014 and 2013
The fair values of the Company’s Investments in Fixed Maturities, Investments in Equity Securities, Fair Value Option Investments, Short-term Investments, Trading Securities and Debt are estimated using a hierarchal framework which prioritizes and ranks market price observability. The carrying amounts reported in the Consolidated Balance Sheets approximate fair value for Cash, Short-term Investments and certain other assets and other liabilities because of their short-term nature. The actual value at which financial instruments could actually be sold or settled with a willing buyer or seller may differ from estimated fair values depending on a number of factors, including, but not limited to, current and future economic conditions, the quantity sold or settled, the presence of an active market and the availability of a willing buyer or seller.
Investments in Equity Securities include common and non-redeemable preferred stocks and other equity interests and are reported at fair value. Investments in common and non-redeemable preferred stocks with readily determinable fair values are classified as available for sale. Dividend income on investments in common and non-redeemable preferred stocks is recognized on the ex-dividend date. Other equity interests primarily consist of exchange traded funds and interests in limited liability companies and limited partnerships in which the Company’s interests are deemed minor. The Company’s share of distributed earnings from other equity interests is recognized as dividend income when received.
Unrealized appreciation or depreciation, net of applicable deferred income taxes, on fixed maturities and equity securities classified as available for sale is reported in AOCI included in Shareholders’ Equity.
Observable inputs are based on market data obtained from independent sources, while unobservable inputs are based on the Company’s market assumptions. Unobservable inputs require significant management judgment or estimation. In some cases, the inputs used to measure an asset or liability may fall into different levels of the fair value hierarchy. In those cases, the fair value measurement is categorized in its entirety in the same level of the fair value hierarchy as the lowest level of input that is significant to the entire measurement. Such determination requires significant management judgment. However, in accordance with GAAP, the Company is not permitted to use management judgment to adjust quoted market prices in an active market.
related policies in proportion to the ratio of the annual premiums to the total premiums anticipated, which is estimated using the same assumptions used in calculating policy reserves.
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 (“IBNR”) 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.
For traditional life insurance products, the reserves for future policy benefits are estimated on the net level premium method using assumptions as of the issue date for mortality, interest, policy lapses and expenses, including provisions for adverse mortality. These assumptions vary by such characteristics as plan, age at issue and policy duration. Mortality assumptions are based on the Company’s historical experience and industry standards. Interest rate assumptions principally range from 3% to 7%. Lapse rate assumptions are based on actual and industry experience. Insurance Reserves for life insurance products also includes an estimate of the Company’s liability for unpaid life insurance claims and claims adjustment expenses, which includes an estimate for IBNR life insurance claims. Except when required by applicable law, the Company does not utilize a database of reported deaths maintained by the Social Security Administration or a comparable database in its operations, including to determine its IBNR liability for life insurance products. Instead of using such a database, the Company calculates its IBNR liability for life insurance products using Company-specific historical information, which includes analyzing average paid claims and the average lag between date of death and the date reported to the Company for claims that due proof of death has been provided.
Insurance licenses acquired in business combinations and other indefinite life intangibles are not amortized, but rather tested periodically for recoverability. Insurance Expenses for the year ended December 31, 2013 includes a charge of $1.4 million to write down the value of insurance licenses acquired for one of Kemper’s insurance subsidiaries to its estimated fair value.
The Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken, or expected to be taken, in an income tax return. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense.
In January 2015, the Financial Accounting Standards Board (“FASB”) issued ASU 2015-01, Income Statement-Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. The Company adopted ASU 2015-01 in the first quarter of 2015 and applied its provisions retrospectively. The retrospective application had no impact on the Company’s previously issued financial statements.
In April 2015, the FASB issued ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 simplifies the presentation of debt issuance costs by requiring that they be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by ASU 2015-03. The Company adopted ASU 2015-03 in the first quarter of 2015 and applied its provisions retrospectively. The retrospective application had no impact on the Company’s previously issued financial statements.
On April 30, 2015, Kemper acquired 100% of the outstanding common stock of Alliance United Group and its wholly-owned subsidiaries, Alliance United Insurance Company and Alliance United Insurance Services, (individually and collectively referred to herein as “Alliance United”) in a cash transaction for a total purchase price of $71.0 million, of which $17.5 million is being held in escrow to secure the sellers’ potential indemnification obligations under the purchase agreement. After completing the transaction, Kemper contributed $75.0 million to support the book of business acquired and commuted a quota share reinsurance agreement whereby Alliance United ceded a portion of its business to an unaffiliated reinsurer. The results of Alliance United are included in the Consolidated Financial Statements from the date of acquisition and are reported in the Company’s Property & Casualty Insurance segment. Alliance United is a provider of nonstandard personal automobile insurance in California. As a result of the acquisition, the Company increased its presence in the California nonstandard automobile insurance market by gaining access to additional brokers and gained expertise in serving the Hispanic market.
The carrying amount, net of accumulated amortization, of the intangible assets acquired by class at December 31, 2015 and the acquisition date are presented below.
P & C Broker Relationships are being amortized over 15 years on a straight-line basis. Value of In Force Policies (“P & C VIF”) is being amortized pro ratably as premiums are earned over the remaining terms of the underlying policies. Other intangible assets acquired are generally being amortized on a straight-line basis over 2 years to 5 years.
Included in the fair value of Other Mortgage- and Asset-backed investments at December 31, 2014 are $3.9 million of collateralized debt obligations, $1.3 million of non-governmental residential mortgage-backed securities and $0.2 million of other asset-backed securities.
Accrued Expenses and Other Liabilities included unsettled purchases of Investments in Fixed Maturities of $5.6 million at December 31, 2015, all of which settled in the following month. There were no unsettled purchases of Investments in Fixed Maturities at December 31, 2014. There were no unsettled sales of Investments in Fixed Maturities at either December 31, 2015 or December 31, 2014.
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 Mortgage-
There were no unsettled purchases or sales of Investments in Equity Securities at either December 31, 2015 or December 31, 2014.
An aging of unrealized losses on the Company’s Investments in Fixed Maturities and Equity Securities at December 31, 2015 is presented below.
Unrealized losses on fixed maturities, which the Company has determined to be temporary at December 31, 2015, were $50.0 million, of which $16.9 million was related to fixed maturities that were in an unrealized loss position for 12 months or longer. There were $0.2 million unrealized losses at December 31, 2015 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “Less Than 12 Months”. There were no unrealized losses at December 31, 2015 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “12 Months or Longer.” Investment-grade fixed maturity investments comprised $33.5 million and below-investment-grade fixed maturity investments comprised $16.5 million of the unrealized losses on investments in fixed maturities at December 31, 2015. For below-investment-grade fixed maturity investments in an unrealized loss position, the unrealized loss amount, on average, was approximately 8% of the amortized cost basis of the investment. At December 31, 2015, 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, 2015 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.
Unrealized losses on fixed maturities, which the Company determined to be temporary at December 31, 2014, were $19.7 million, of which $13.2 million was related to fixed maturities that were in an unrealized loss position for 12 months or longer. There were no unrealized losses at December 31, 2014 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “Less Than 12 Months” or “12 Months or Longer.” Investment-grade fixed maturity investments comprised $14.1 million and below-investment-grade fixed maturity investments comprised $5.6 million of the unrealized losses on investments in fixed maturities at December 31, 2014. For 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, 2014, 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, 2014 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.
Goodwill in the Property & Casualty Insurance segment increased by $11.2 million due to the acquisition of Alliance United. See Note 3, “Acquisition of Business” to the Consolidated Financial Statements for additional information pertaining to the acquisition of Alliance United.
Property and Casualty Insurance Reserve activity for the years ended December 31, 2015, 2014 and 2013 was:
In 2014, the Company reduced its property and casualty insurance reserves by $57.1 million to recognize favorable development of losses and LAE from prior accident years. Personal lines insurance loss and LAE reserves developed favorably by $50.9 million and commercial lines insurance loss and LAE reserves developed favorably by $6.2 million. Personal
automobile insurance loss and LAE reserves developed favorably by $31.6 million, homeowners insurance loss and LAE reserves developed favorably by $14.8 million and other personal lines loss and LAE reserves developed favorably by $4.5 million. The personal lines insurance losses and LAE reserves developed favorably due primarily to the emergence of more favorable loss patterns than expected for the three most recent prior accident years. Commercial lines insurance loss and LAE reserves included favorable development of $2.6 million from continuing operations and $3.6 million from discontinued operations. Commercial lines insurance losses and LAE reserves developed favorably from continuing operations due primarily to the emergence of more favorable loss patterns than expected for the 2013, 2011 and 2010 accident years.
Total amortized cost of debt outstanding at December 31, 2015 and 2014 was:
Interest Expense, including facility fees, accretion of discount and amortization of issuance costs, for the years ended December 31, 2015, 2014 and 2013 was:
On June 2, 2015, Kemper amended and restated its $225.0 million, unsecured, revolving credit agreement to, among other things, extend the expiration date to June 2, 2020. Prior to the amendment, the credit agreement was scheduled to expire on March 7, 2016. The credit agreement, as amended and restated, provides for fixed and floating rate advances for periods up to six months at various interest rates. The credit agreement, as amended and restated, 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, Trinity and United Insurance. Proceeds from advances under the credit agreement, as amended and restated, may be used for general corporate purposes, including repayment of existing indebtedness. There were no outstanding borrowings under the credit agreement at either December 31, 2015 or December 31, 2014.
On February 24, 2015, Kemper issued $250.0 million of its 4.35% senior notes due February 15, 2025 (the “2025 Senior Notes”). The net proceeds of the issuance were $247.3 million, net of discount and transaction costs, for an effective yield of
4.49%. The 2025 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 used the net proceeds from the sale of the 2025 Senior Notes, together with available cash, to redeem in full the $250.0 million outstanding principal amount of its 6.00% senior notes due November 30, 2015. Kemper recognized a loss of $9.1 million before income taxes in the first quarter of 2015 from the early redemption of these senior notes.
On February 27, 2014, Kemper issued $150.0 million of its 7.375% subordinated debentures due February 27, 2054 (the “2054 Debentures”). The net proceeds of the issuance were $144.0 million, net of discount and transaction costs, for an effective yield of 7.69%. The subordinated debentures are unsecured and are subordinated and junior to the senior indebtedness of Kemper. Interest on the subordinated debentures is payable quarterly. As long as no event of default has occurred, Kemper may defer interest payments on the subordinated debentures for up to five consecutive years without giving rise to an event of default. During a deferral period, interest will continue to accrue at the stated interest rate compounded quarterly. Kemper is permitted to redeem some or all of the subordinated debentures on or after February 27, 2019, at a redemption price that is equal to their principal amount plus accrued and unpaid interest. Kemper is permitted to redeem the subordinated debentures in whole, but not in part, at any time prior to February 27, 2019, within 90 days of the occurrence of certain tax events or rating agency events, at specified redemption prices.
“Long-Term Equity-based Compensation,” to the Consolidated Financial Statements for a discussion of the restrictions and vesting provisions.
Kemper repurchased and retired 1.2 million shares of its common stock in open market transactions at an aggregate cost of $43.5 million in 2015. Kemper repurchased and retired 3.2 million shares of its common stock in open market transactions at an aggregate cost of $115.5 million in 2014. Kemper repurchased and retired 3.0 million shares of its common stock in open market transactions at an aggregate cost of $100.4 million in 2013.
Kemper’s insurance subsidiaries are also required to hold minimum levels of statutory capital and surplus to satisfy regulatory requirements. The minimum statutory capital and surplus, or company action level RBC, necessary to satisfy regulatory requirements for the Company’s life and health insurance subsidiaries collectively was $134.4 million at December 31, 2015. The minimum statutory capital and surplus necessary to satisfy regulatory requirements for the Company’s property and casualty insurance subsidiaries collectively was $335.9 million at December 31, 2015. Company action level RBC is the level at which a company is required to file a corrective action plan with its regulators and is equal to 200% of the authorized control level RBC.
In 2015, Kemper paid dividends of $49.7 million to its shareholders. Except for certain financial covenants under the 2016 Credit Agreement or during any period in which Kemper elects to defer interest payments, 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, 2015. Kemper had the ability to pay without restrictions $287 million in dividends to its shareholders and still be in compliance with all financial covenants under the 2016 Credit Agreement at December 31, 2015.
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 equity-based compensation awards with a graded vesting schedule, the Company recognizes compensation expense on a straight-line basis over the requisite service period for each separately-vesting portion of the awards as if each award were, in substance, multiple awards. Compensation expense is recognized only for those awards expected to vest, with forfeitures estimated at the date of grant based on the Company’s historical experience and future expectations. Equity-based compensation expense was $6.5 million, $6.4 million and $5.5 million for the years ended December 31, 2015, 2014 and 2013, respectively. Total unamortized compensation expense related to nonvested awards at December 31, 2015 was $5.8 million, which is expected to be recognized over a weighted-average period of 1.9 years.
Under the Non-employee Director compensation programs in effect for 2015, 2014 and 2013, each Non-employee Director receives an initial option award to purchase 4,000 shares of Kemper common stock immediately upon becoming a director, and in addition, on the date of each annual meeting of Kemper’s shareholders, automatically receives an annual option award to purchase 4,000 shares of common stock. Prior to May 1, 2013, such options granted to Non-employee Directors were exercisable one year from the date of grant at an exercise price equal to the fair value of Kemper’s common stock on the date of grant and expired ten years from the date of grant. Effective May 1, 2013, new grants of such options are fully vested and exercisable on the date of grant at an exercise price equal to the fair value of Kemper’s common stock on the date of grant. In addition to the annual option awards, under the compensation programs in effect for 2015, 2014 and 2013, annual awards to each Non-employee Director include 500 DSUs. The DSUs granted to Non-employee Directors are fully vested on the date of grant. Conversion of the DSUs into shares of Kemper’s common stock is deferred until the date a director’s board service terminates.
Prior to creation of the Omnibus Plan, all of the Company’s previous stock option plans included provisions, subject to certain limitations, to automatically grant restorative, or reload stock options (“Restorative Options”), to replace shares of previously owned Kemper common stock that an exercising option holder surrenders, either actually or constructively, to satisfy the exercise price and/or tax withholding obligations relating to the exercise. The restorative feature was eliminated prospectively for original option awards granted on or after February 3, 2009. Restorative Options may still be granted, subject to certain limitations, in connection with the exercise of original options granted before February 3, 2009. Restorative Options are subject to the same terms and conditions as the original options, including the expiration date, except that the exercise price is equal to the fair value of Kemper common stock on the date of grant of a Restorative Option and cannot be exercised until six months after the date of grant. The grant of a Restorative Option does not result in an increase in the total number of shares and options held by an employee, but changes the mix of the two.
Information pertaining to Tandem Awards outstanding at December 31, 2015 is presented below.
Prior to February 3, 2009, only awards of time-vested restricted stock had been granted. Beginning on February 3, 2009, in addition to time-vested restricted stock granted to certain employees and officers, the Company began making performance-based restricted awards to certain officers and employees. The initial number of shares or RSUs awarded to each participant of a performance-based award represents the shares that would vest, or, in the case of a RSU, that would vest and would be issued, if the performance level attained were to be at the “target” performance level. For performance above the target level, each participant would receive a grant of additional shares of stock up to a maximum of 100% of the initial number of shares or RSUs awarded to the participant. The final payout of these awards, and any forfeitures of shares for performance below the “target” performance level, will be determined based on Kemper’s total shareholder return over a three-year performance period relative to a peer group comprised of all the companies in the S&P Supercomposite Insurance Index. If, at the end of the applicable performance period, the Company’s relative performance:
ranked, and Kemper’s simulated ranking is converted to a payout percentage based on the terms of the performance-based restricted stock and performance-based RSU awards. The payout percentage is applied to the simulated stock price at the end of the performance period, reinvested dividends are added back, and the total is discounted to the valuation date at the risk-free rate. This process is repeated approximately ten thousand times, and the grant date fair value is equal to the average of the results from these trials.
The components of Other Comprehensive Income (Loss) Before Income Taxes for the years ended December 31, 2015, 2014 and 2013 were:
The components of Other Comprehensive Income Tax Benefit (Expense) for the years ended December 31, 2015, 2014 and 2013 were:
Net Investment Income for the years ended December 31, 2015, 2014 and 2013 was:
The components of Net Impairment Losses Recognized in Earnings reported in the Consolidated Statements of Income for the years ended December 31, 2015, 2014 and 2013 were:
Current and Deferred Income Tax Assets at December 31, 2015 and December 31, 2014 were:
The tax effects of temporary differences that give rise to significant portions of the Company’s Net Deferred Income Tax Assets and Deferred Income Tax Liabilities at December 31, 2015 and 2014 were:
Except for the NOL carryforward scheduled to expire in 2032, all of the NOL 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 NOL carryforwards.
The statute of limitations related to Kemper and its eligible subsidiaries’ consolidated Federal income tax returns is closed for all tax years up to and including 2011. The expiration of the statute of limitations related to the various state income tax returns that Kemper and its subsidiaries file varies by state.
Unrecognized Tax Benefits at December 31, 2015, 2014 and 2013 include $3.3 million, $3.4 million and $3.4 million, respectively, for tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred income tax accounting, other than for interest and penalties, the disallowance of the shorter deductibility period would not affect the effective income tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.
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 $0.5 million, $3.8 million and $3.4 million at December 31, 2015, 2014 and 2013, respectively. Tax expense includes a net interest benefit of $3.3 million, interest expense of $0.4 million and interest expense of $0.4 million and related to unrecognized tax benefits for the years ended December 31, 2015, 2014 and 2013, respectively.
The components of Income Tax Expense from Continuing Operations for the years ended December 31, 2015, 2014 and 2013 were:
Changes in Fair Value of Plan Assets and Changes in Projected Benefit Obligation for the Pension Plan for the years ended December 31, 2015 and 2014 is presented below.
The weighted-average discount rate and rate of increase in future compensation levels used to estimate the components of the Projected Benefit Obligation for the Pension Plan at December 31, 2015 and 2014 were:
Weighted-average asset allocations for the Pension Plan at December 31, 2015 and 2014 by asset category were:
Additional information pertaining to the changes in the fair value of the Pension Plan’s assets classified as Level 3 for the year ended December 31, 2015 is presented below.
Fair value measurements for the Pension Plan’s assets at December 31, 2014 are summarized below.
The components of Comprehensive Pension Expense (Income) for the Pension Plan for the years ended December 31, 2015, 2014 and 2013 were:
The Company estimates that Pension Expense for the Pension Plan for the year ended December 31, 2016 will include expense of $11.8 million resulting from the amortization of the related accumulated actuarial loss included in AOCI at December 31, 2015.
The weighted-average discount rate, rate of increase in future compensation levels and expected long-term rate of return on plan assets used to develop the components of Pension Expense for the Pension Plan for the years ended December 31, 2015, 2014 and 2013 were:
The following benefit payments (net of participant contributions), which consider expected future service, as appropriate, are expected to be paid from the Pension Plan:
The Company also sponsors a non-qualified supplemental defined benefit pension plan (the “Supplemental Plan”). The unfunded liability related to the Supplemental Plan was $30.4 million and $31.0 million at December 31, 2015 and 2014, respectively. Pension expense for the Supplemental Plan was $2.1 million, $1.8 million and $1.8 million for the years ended December 31, 2015, 2014 and 2013, respectively. An actuarial gain of $1.5 million before taxes, an actuarial loss of $7.0 million before taxes and an actuarial gain of $1.5 million before taxes are included in Other Comprehensive Income (Loss) for the years ended December 31, 2015, 2014 and 2013, respectively.
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 $7.3 million in 2015, 2014 and 2013, respectively.
The assumed health care cost trend rate used in measuring the Accumulated Postretirement Benefit Obligation at December 31, 2015 was 7.0% for 2016, gradually declining to 5.0% in the year 2024 and remaining at that level thereafter for medical benefits and 11.0% for 2016, gradually declining to 5.0% in the year 2024 and remaining at that level thereafter for prescription drug benefits. The assumed health care cost trend rate used in measuring the Accumulated Postretirement Benefit Obligation at December 31, 2014 was 8.0% for 2015, gradually declining to 5.0% in the year 2023 and remaining at that level thereafter for medical benefits and 7.5% for 2015, gradually declining to 5.0% in the year 2023 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 have increased the Accumulated Postretirement Benefit Obligation at December 31, 2015 by $1.5 million and 2015 OPEB expense by $0.1 million. A one-percentage point increase in the assumed health care cost trend rate for each year would have increased the Accumulated Postretirement Benefit Obligation at December 31, 2014 by $1.7 million and 2014 OPEB expense by $0.1 million.
The Company expects to contribute $3.3 million, net of the expected Medicare Part D subsidy, to its OPEB Plan to fund benefit payments in 2016.
The Property & Casualty Insurance segment’s principal products are personal automobile insurance, both standard and nonstandard risks, homeowners insurance, other personal insurance and commercial automobile insurance. These products are distributed primarily through independent agents and brokers. The Life & Health Insurance segment’s principal products are individual life, accident, health and property insurance. These products are distributed by career agents employed by the Company and independent agents and brokers.
Segment Operating Profit, including a reconciliation to Income from Continuing Operations before Income Taxes, for the years ended December 31, 2015, 2014 and 2013 was:
Amortization of Deferred Policy Acquisition Costs by Operating Segment for the years ended December 31, 2015, 2014 and 2013 was:
In 2008, the Company sold its Unitrin Business Insurance operations. The Company retained Property and Casualty Insurance Reserves for unpaid insured losses that occurred prior to the date of the sale. Property and Casualty Insurance Reserves reported in the Company’s Consolidated Balance Sheets include $50.3 million and $69.3 million at December 31, 2015 and 2014, respectively, for the retained liabilities. In accordance with GAAP, changes in the Company’s estimate of such retained liabilities after the sale are reported as a separate component of the results of discontinued operations. See Note 6, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements.
Coverage for the Property & Casualty Insurance segment’s primary catastrophe reinsurance program effective January 1, 2015 to December 31, 2015 is provided in various layers as presented below.
Catastrophe losses and LAE (including reserve development), net of reinsurance recoveries, for the years ended December 31, 2015, 2014 and 2013 by business segment are presented below.
Trinity and Capitol County Mutual Fire Insurance Company (“Capitol”) are parties to a quota share reinsurance agreement whereby Trinity assumes 100% of the business written by Capitol, subject to a cap, for ceded losses for dwelling coverage. Earned Premiums assumed by Trinity from Capitol were $21.8 million, $21.9 million and $22.4 million for the years ended December 31, 2015, 2014 and 2013, respectively. Capitol is a mutual insurance company and, accordingly, is owned by its policyholders. Trinity and Old Reliable Casualty Company (“ORCC”), a subsidiary of Capitol, are parties to a quota share reinsurance agreement whereby Trinity assumes 100% of the business written by ORCC, subject to a cap for ceded losses for dwelling coverage. Earned Premiums assumed by Trinity from ORCC were $6.5 million, $6.7 million and $7.2 million for the years ended December 31, 2015, 2014 and 2013, respectively.
At December 31, 2015, the Company had unfunded commitments to invest an additional $107.6 million in certain limited liability investment companies and limited partnerships that will be included in Other Equity Interests when funded.
applications and models. The Company generally validates the measurements obtained from its primary pricing provider by comparing them with measurements obtained from one additional pricing provider that provides either prices from recent market transactions or quotes in inactive markets or evaluations based on its own proprietary models.
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.
The Company’s Investments in Fixed Maturities that are classified as Level 3 in the two preceding tables primarily consist of privately placed securities not rated by a Nationally Recognized Statistical Rating Organization and are priced primarily using a market yield approach. A market yield approach uses a risk-free rate plus a credit spread depending on the underlying credit profile of the security. For floating rate securities, the risk-free rate used in the market yield is the contractual floating rate of the security. For each individual security, the Company or the Company’s third party appraiser gathers information from market sources, relevant credit information, perceived market movements and sector news and determines an appropriate market yield for each security. The market yield selected is then used to discount the estimated future cash flows of the security to determine the fair value. The Company separately evaluates market yields based upon asset class to assess the reasonableness of the recorded fair value. For non-investment-grade Investments in Fixed Maturities that are classified as Level 3, the two primary asset classes are senior debt and junior debt. Senior debt includes those securities that receive first priority in a liquidation and junior debt includes any fixed maturity security with other than first priority in a liquidation.
The table below presents quantitative information about the significant unobservable inputs utilized by the Company in determining fair values for fixed maturity investments in corporate securities classified as Level 3 at December 31, 2015.
The table below presents quantitative information about the significant unobservable inputs utilized by the Company in determining fair values for fixed maturity investments in corporate securities classified as Level 3 at December 31, 2014.
Information by security type pertaining to the changes in the fair value of the Company’s investments classified as Level 3 for the year ended December 31, 2015 is presented below.
Information by security type pertaining to the changes in the fair value of the Company’s investments classified as Level 3 for the year ended December 31, 2014 is presented below.
Over the last several years, certain state insurance regulators, legislators, treasurers/controllers, and their respective agents have aggressively pursued 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 regulator-approved policy forms. These initiatives together comprise a set of circumstances involving potential changes in the law or changes in the interpretation of existing laws that could have the effect of altering the terms of Kemper’s life insurance subsidiaries’ (the “Life Companies”) existing life insurance contracts by imposing new requirements that did not exist and were not contemplated at the time the Life Companies entered into such contracts.
Legislation and related litigation. One type of initiative involves legislation (the “DMF Statutes”). DMF Statutes have been enacted in nine states, with varying effective dates, that require life insurance companies to compare on a regular basis their records for all in-force policies (including policies issued prior to the effective dates of the DMF Statute) against the database of reported deaths maintained by the Social Security Administration or a comparable database (a “Death Master File” or “DMF”). In contrast, four other states have enacted DMF Statutes that also require such comparisons, but exempt life insurance companies, like the Life Companies, that have not previously utilized a Death Master File, and instead only require that such companies conduct DMF comparisons for policies issued and delivered in each of those states after the DMF Statute’s effective date. Six additional states have enacted DMF Statutes that require comparisons, but only with respect to policies issued on or after their respective effective dates, without regard to prior DMF use. With respect to those DMF Statutes that apply retroactively and would likely have an adverse effect on the Company’s operations and financial
Unclaimed property compliance audits and related litigation. A second type of initiative involves an unclaimed property compliance audit of the Life Companies (the “Treasurers’ Audit”) being conducted by a private audit firm (the “Audit Firm”) retained by the treasurers/controllers of more than thirty states and related litigation. In July 2013, the California State Controller (the “CA Controller”) filed a complaint for injunctive relief against the Life Companies in state court in California, seeking an order requiring the Life Companies to produce all of their in-force policy records to the Audit Firm to enable the firm to perform a comparison of such records against a DMF and to ascertain whether any of the insureds under such policies may be deceased; as described below, the Life Companies have filed a counterclaim in this case. In December 2013, the CA Controller filed a motion for preliminary injunction seeking the same injunctive relief; that motion was continued until the California Court of Appeal ruled in a similar case involving an unaffiliated insurance company (the “ANICO Appeal”). In July 2014, the trial court granted a motion by the CA Controller to stay the litigation against the Life Companies pending a decision in the ANICO Appeal. In March 2015, the California Court of Appeal reversed the order granting the preliminary injunction to the CA Controller in the ANICO Appeal. In light of the result in the ANICO Appeal, the stay of the litigation involving the Life Companies was lifted and the CA Controller withdrew its motion for preliminary injunction; discovery activity has resumed and the matter is set for trial in early 2017. Pending the outcome of this litigation, the Life Companies have not produced their in-force policy records to the CA Controller.
Examinations by insurance regulators and related litigation. A third type of initiative involves examinations by state insurance regulators. The Life Companies are the subject of a pending multi-state market conduct examination by five state insurance regulators that is focused on the Life Companies’ claim settlement and policy administration practices, and specifically their compliance with state unclaimed property statutes (the “Multi-State Exam”). The Multi-State Exam originated in June 2012 as
Conclusion. The results of the aforementioned legislative actions, Treasurers’ Audit, Multi-State Exam and the related litigation cannot currently be predicted. The Life Companies continue to maintain that states lack the legal authority to establish new requirements that would effectively change the terms of existing life insurance contracts with regard to basic claims handling obligations and processes. If state officials are able to impose such new requirements retroactively upon the Life Companies’ existing life insurance policies, it will fundamentally alter the nature and timing of the Life Companies’ responsibilities under such policies by eliminating the effect of contractual terms that condition claim settlement and payment on the receipt of a claim, including “due proof of death” of an insured. The outcomes of the various initiatives and related litigation could result in changes in the law that could effectively alter the terms of the Life Companies’ existing life insurance contracts by imposing new requirements that have a significant impact on, including acceleration of, the Life Companies’ payment and/or escheatment of policy benefits, and materially increase claims handling costs. Any attempt to predict the ultimate outcomes (including any estimate of the resulting effect on the Life Companies claim liabilities and reserves for future policy benefits) of these efforts to change the law would entail predicting on a state-by-state-basis numerous uncertainties including, but not limited to:
Whether and to what extent any such laws would be applied retroactively; and
Mr. Christopher B. Sarofim, a director of Kemper, is Vice Chairman and a member of the board of directors of Fayez Sarofim & Co. (“FS&C”), a registered investment advisory firm. FS&C provided investment management services with respect to certain assets of Kemper’s subsidiary, Trinity, under an agreement between the parties. Trinity had $85.8 million and $154.7 million in assets managed by FS&C at December 31, 2014 and 2013, respectively. In 2014, Trinity began reducing the amount of assets managed by FS&C. Trinity completed the disposal of all the assets managed by FS&C in 2015. Investment Expenses incurred in connection with such agreement were $0.1 million, $0.3 million and $0.4 million for the years ended December 31, 2015, 2014 and 2013, respectively.
FS&C also provides investment management services with respect to certain funds of the Company’s Pension Plan. The Company’s Pension Plan had $137.2 million, $159.2 million and $148.6 million in assets managed by FS&C at December 31, 2015, 2014 and 2013, respectively, under an agreement with FS&C whereby FS&C provides investment management services. Investment Expenses incurred in connection with such agreement were $0.4 million, $0.4 million and $0.3 million for the years ended December 31, 2015, 2014 and 2013, respectively.
As described in Note 21, “Other Reinsurance,” to the Consolidated Financial Statements, the Company also has certain relationships with Capitol, a mutual insurance company which is owned by its policyholders, and its subsidiary, ORCC.
The sum of quarterly per share amounts does not equal per share amounts for the year due to differences in weighted-average shares and/or equivalent shares outstanding for each of the periods presented.
We have audited the accompanying consolidated balance sheets of Kemper Corporation and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. Our audits also included the financial statement schedules listed in Item 15. We also have audited the Company’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in the Management Report on Internal Control Over Financial Reporting, management excluded from its assessment the internal control over financial reporting at Alliance United, which was acquired on April 30, 2015 and whose financial statements constitute 7% of consolidated assets, 12% of consolidated revenues, and -14% of consolidated net income as of and for the year ended December 31, 2015. Accordingly, our audit did not include the internal control over financial reporting at Alliance United. The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and financial statement schedules and an opinion on the Company’s internal control over financial reporting based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kemper Corporation and subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.