Preferred leases facilities with an aggregate square footage of approximately 195,000 at 9 locations in 9 states. The latest expiration date of the existing leases is in September of 2018.
Kemper’s corporate data processing operation leases facilities with aggregate square footage of approximately 36,000 square feet at 2 locations in 2 states. The latest expiration date of the existing leases is in September of 2018.
Fireside Bank leases facilities with an aggregate square footage of approximately 63,000 at 2 locations in 2 states. The latest expiration date of the existing leases is in August of 2014.
A reconciliation of Total Segment Net Operating Income to Net Income for the years ended December 31, 2011, 2010 and 2009 is presented below:
Earned Premiums were $2,173.6 million in 2011, compared to $2,289.4 million in 2010, a decrease of $115.8 million. Earned Premiums decreased by $59.7 million, $29.7 million and $28.2 million in the Direct, Specialty and Preferred segments, respectively.
Net Investment Income decreased by $27.7 million in 2011 due primarily to $39.2 million of lower net investment income from Equity Method Limited Liability Investments, partially offset by $9.2 million of higher dividends from Investments in Equity Securities and $2.8 million of higher interest from Investments in Fixed Maturities.
Total Catastrophe loss and LAE reserves, net of reinsurance recoverables, developed favorably by $6.4 million, $1.2 million and $18.1 million for the years ended December 31, 2011, 2010 and 2009, respectively. The Preferred segment reported favorable catastrophe reserve development of $5.5 million, $4.9 million and $18.3 million for the years ended December 31, 2011, 2010 and 2009, respectively. The Life and Health Insurance segment reported favorable catastrophe reserve development of $1.5 million and $0.1 million for the years ended December 31, 2011 and 2009, respectively, and adverse catastrophe reserve development of $3.4 million for the year ended December 31, 2010.
For the year ended December 31, 2010, compared to 2009, the Preferred segment experienced a higher severity of catastrophe losses, excluding development, due in part to a catastrophe loss of $12.9 million resulting from damage caused by hail in the state of Arizona in the fourth quarter of 2010. No major hurricanes that significantly impacted the Company made landfall in the United States during 2010 or 2009.
Insurance Expenses for the year ended December 31, 2009 includes a reduction of expense of $2.8 million due to a decrease in the Company’s estimate of its share of assessments from the Texas Windstorm Insurance Association (“TWIA”).
Increases (decreases) in the Company’s property and casualty loss and LAE reserves for the years ended December 31, 2011, 2010 and 2009 to recognize adverse (favorable) loss and LAE reserve development from prior accident years, hereinafter also referred to as “reserve development” in the discussion of segment results, is presented below:
The following discussions for the Preferred, Specialty and 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 is useful to investors and is 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.
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. Significant non-recurring items are excluded because, by their nature, they are not indicative of the Company’s business or economic trends.
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, 2011, 2010 and 2009.
Earned Premiums in the Preferred segment decreased by $28.2 million for the year ended December 31, 2011 compared to 2010, due to lower volume, partially offset by higher average premium rates. Volume decreased due, in part, to Preferred’s decision to maintain its underwriting discipline and increase premium rates while facing increased competition in a soft personal lines insurance market. Also contributing to the decrease in volume was Preferred’s ongoing strategy to reduce its mix of non-package and non-target market business. Earned premiums from package policies (a package policy provides both automobile and homeowners insurance coverages in a single policy) comprised 55% of earned premiums in the Preferred segment in 2011, compared to 52% in 2010. Earned premiums on automobile insurance decreased by $33.8 million for the year ended December 31, 2011, compared to 2010, due to lower volume, and, to a lesser extent, lower average premium rates. The weighted-average number of automobile insurance policies in force decreased by 7.2% for the year ended December 31, 2011, compared to 2010. Earned premiums on homeowners insurance increased by $4.9 million for the year ended December 31, 2011, compared to 2010, due primarily to higher average premium rates, partially offset by lower volume. The weighted-average number of homeowners insurance policies in force decreased by 2.5% for the year ended December 31, 2011, compared to 2010. Earned premiums on other personal insurance increased by $0.7 million for the year ended December 31, 2011, compared to 2010, due primarily to higher average premium rates, partially offset by lower volume.
Operating results in the Preferred segment decreased by $103.3 million before taxes for the year ended December 31, 2011, compared to 2010, due primarily to higher incurred catastrophe losses and LAE (excluding development), higher homeowners insurance underlying losses and LAE as a percentage of earned premiums, the impact of lower favorable loss and LAE reserve development (including catastrophe development), higher insurance expenses 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.
Homeowners insurance incurred losses and LAE were $293.5 million for the year ended December 31, 2011, compared to $210.0 million for 2010. Homeowners insurance incurred losses and LAE increased by $83.5 million for the year ended December 31, 2011, compared to 2010, due primarily to higher catastrophe losses and LAE (excluding development) and higher underlying losses and LAE, partially offset by the impact of higher favorable loss and LAE reserve development (excluding catastrophe development). Catastrophe losses and LAE (excluding development) on homeowners insurance were $124.5 million for the year ended December 31, 2011, compared to $61.4 million in 2010. The catastrophe losses and LAE in 2011 included losses from Hurricane Irene and several severe tornadoes and other storms throughout the United States. Underlying losses and LAE were $181.7 million for the year ended December 31, 2011, compared to $156.9 million for the same period in 2010. Underlying losses and LAE increased due primarily to higher average estimated frequency and severity of losses. Favorable loss and LAE reserve development (excluding catastrophe development) was $7.1 million for the year ended December 31, 2011, compared to $3.6 million for the same period in 2010.
Other personal insurance incurred losses and LAE were $26.7 million for the year ended December 31, 2011, compared to $24.5 million for 2010. Other personal insurance incurred losses and LAE increased by $2.2 million due primarily to higher catastrophe losses and LAE (excluding development), partially offset by the impact of higher favorable loss and LAE reserve development (excluding catastrophe development). Catastrophe losses and LAE (excluding development) on other personal insurance were $5.6 million for the year ended December 31, 2011, compared to $1.5 million for the same period in 2010. Favorable loss and LAE reserve development (excluding catastrophe development) was $5.2 million for the year ended December 31, 2011, compared to $3.7 million for the same period in 2010.
Net Investment Income in the Preferred segment increased by $10.7 million for the year ended December 31, 2010, compared to 2009, due primarily to higher net investment income from Equity Method Limited Liability Investments. The Preferred segment reported net investment income of $15.5 million from Equity Method Limited Liability Investments for the year ended December 31, 2010, compared to $7.0 million for 2009.
Automobile insurance incurred losses and LAE were $399.1 million for the year ended December 31, 2010, compared to $409.6 million for 2009. Automobile insurance incurred losses and LAE decreased by $10.5 million due primarily to lower claim volume resulting principally from fewer automobile insurance policies in force, partially offset by the impact of lower favorable loss and LAE reserve development. Favorable loss and LAE reserve development was $11.8 million for the year ended December 31, 2010, compared to $32.5 million for 2009. Underlying losses and LAE as a percentage of earned premiums on automobile insurance were 74.1% for the year ended December 31, 2010, compared to 74.5% for 2009.
Homeowners insurance incurred losses and LAE were $210.0 million for the year ended December 31, 2010, compared to $188.8 million for 2009. Homeowners insurance incurred losses and LAE increased by $21.2 million for the year ended December 31, 2010, compared to 2009, due primarily to higher catastrophe losses and LAE (excluding development) and the impact of lower favorable loss and LAE reserve development, partially offset by lower underlying losses and LAE. Catastrophe losses and LAE (excluding development) on homeowners insurance were $61.4 million for the year ended December 31, 2010, compared to $38.8 million for 2009. Favorable loss and LAE reserve development was $8.3 million for the year ended December 31, 2010, compared to favorable development of $25.9 million for 2009. Underlying losses and LAE decreased by $19.0 million due primarily to lower average, estimated frequency and severity of losses. Underlying losses and LAE as a percentage of earned premiums on homeowners insurance were 54.1% for the year ended December 31, 2010, compared to 59.8% for 2009.
The Preferred segment reported Segment Net Operating Income of $50.6 million for the year ended December 31, 2010, compared to Segment Net Operating Income of $63.7 million for the same period in 2009. The 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 $24.7 million for the year ended December 31, 2010, compared to $23.4 million for 2009.
Net Investment Income in the Specialty segment decreased by $3.7 million for the year ended December 31, 2011, compared to 2010, due primarily to lower net investment income from Equity Method Limited Liability Investments. The Specialty segment reported net investment income of $3.5 million from Equity Method Limited Liability Investments for the year ended December 31, 2011, compared to $7.3 million for 2010.
Operating Profit in the Specialty segment decreased by $2.1 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.
Segment Net Operating Income in the Specialty segment was $18.3 million for the year ended December 31, 2011, compared to $20.2 million for 2010. The 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 $10.5 million for the year ended December 31, 2011, compared to $11.5 million in 2010.
Operating results in other insurance decreased by $1.7 million for the year ended December 31, 2010, compared to 2009, due primarily to the impact of adverse loss and LAE reserve development. Loss and LAE reserve development on certain reinsurance pools in run-off had an adverse effect of $0.7 million for the year ended December 31, 2010, compared to a favorable development of $0.2 million for 2009. Excluding development on these reinsurance pools, loss and LAE reserve development on other personal insurance had an adverse effect of $0.9 million for the year ended December 31, 2010, and was almost entirely related to two liability claims that had been previously reported, one from 2003 and the other from 2005. Loss and LAE reserve development on other personal insurance was not significant for the year ended December 31, 2009.
The Direct segment continues to roll out a newly designed product and align its marketing program to target better response and conversion rates from customers with more favorable risk characteristics. The newly designed product includes increased pricing sophistication to improve premium rate accuracy by customer segment. Actions to improve premium rate adequacy continue for all programs in line with rate level indications. The Direct segment has implemented and continues to implement rate increases across its book of business. These actions have led to a decrease in the overall premium volume, with the number of policies in force at December 31, 2011 decreasing by approximately 20% from the level at December 31, 2010.
The Direct segment reported Operating Loss of $46.7 million for the year ended December 31, 2011, compared to Operating Loss of $7.1 million for 2010. Operating results declined in the Direct segment for the year ended December 31, 2011, compared to 2010, due primarily to the partial write-off of an intangible asset acquired in the 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. Underlying losses and LAE exclude the impact of catastrophes, and loss and LAE reserve development.
Incurred Losses and LAE as a percentage of earned premiums was 88.7% for the year ended December 31, 2011, compared to 79.3% for 2010. Incurred Losses and LAE as a percentage of earned premiums increased for the year ended December 31, 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% for the year ended December 31, 2011, compared to 81.1% for the same period in 2010. Underlying losses and LAE as a percentage of earned premiums increased for the year ended December 31, 2011, compared to 2010, due primarily to increased severity on automobile insurance. Catastrophe losses and LAE (excluding
development) was $6.7 million for the year ended December 31, 2011, compared to $1.8 million for 2010. Favorable loss and LAE reserve development was $3.9 million for the year ended December 31, 2011, compared to $6.8 million for 2010.
Direct reported a Segment Net Operating Loss of $27.1 million for the year ended December 31, 2011, compared to a Segment Net Operating Loss of $1.1 million for the same period in 2010. The 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 $8.9 million for the year ended December 31, 2011, compared to $10.0 million for the same period in 2010.
Earned Premiums in the Direct segment decreased by $63.2 million for the year ended December 31, 2010, compared to 2009, due primarily to lower volume.
Direct reported Operating Loss of $7.1 million for the year ended December 31, 2010, compared to Operating Loss of $12.6 million for 2009. Operating results improved in the Direct segment for the year ended December 31, 2010, compared to 2009, due primarily to higher Net investment income and lower insurance expenses as a percentage of earned premiums, partially offset by higher incurred losses and LAE as a percentage of earned premiums.
Direct reported Segment Net Operating Loss of $1.1 million for the year ended December 31, 2010, compared to Segment Net Operating Loss of $5.3 million for 2009. Direct’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 $10.0 million for the year ended December 31, 2010, compared to $9.9 million for 2009.
In prior years, the Life and Health Insurance segment has taken several actions to reduce its exposure to catastrophe risks. These actions have included non-renewing dwelling policies in coastal areas and areas further inland and the halting of new sales of dwelling coverage in all markets. The non-renewals were substantially completed in the second quarter of 2009. As the remaining insurance policies providing dwelling coverage run off over the next several years, the Life and Health Insurance segment expects that its exposure to catastrophe risks will continue to decline along with the related earned premiums. Earned premiums from dwelling coverage comprised 30%, 32% and 36% of the Life and Health Insurance segment’s earned premiums on property insurance for the years ended December 31, 2011, 2010 and 2009, respectively.
Segment Net Operating Income in the Life and Health Insurance segment was $108.5 million for the year ended December 31, 2011, compared to $94.9 million for the same period in 2010.
Policyholders’ Benefits and Incurred Losses and LAE decreased by $17.0 million for the year ended December 31, 2010, compared to 2009, due primarily to lower policyholders’ benefits on life insurance and lower losses and LAE on property insurance. Policyholders’ benefits on life insurance were $263.0 million for the year ended December 31, 2010, compared to $272.1 million for 2009, and decreased due primarily to better mortality experience on life insurance. Policyholders’ benefits and incurred losses and LAE on accident and health insurance were $95.7 million for the year ended December 31, 2010, compared to $98.0 million for 2009. Incurred accident and health losses as a percentage of earned premiums decreased due primarily to lower Medicare supplement claims as a percentage of earned premiums, partially offset by higher first time cancer related incurred accident and health insurance claims as a percentage of accident and health insurance earned premiums. Incurred Losses and LAE, net of reinsurance, on property insurance were $48.1 million for the year ended December 31, 2010, compared to $53.7 million for 2009, and decreased due primarily to lower catastrophe losses and LAE (excluding development) and lower non-catastrophe losses and LAE, partially offset by higher adverse loss and LAE reserve development. Catastrophe losses and LAE, net of reinsurance (excluding development), were $4.5 million for the year ended December 31, 2010, compared to $6.7 million for 2009. Adverse loss reserve development on property insurance was $4.5 million (including adverse development of $3.3 million on catastrophes) for the year ended December 31, 2010, compared to adverse development of $2.6 million (including favorable development of $0.1 million on catastrophes) for 2009.
Based on the continuing uncertainty about the impact of the Health Care Acts on Reserve National’s operations and the increased likelihood that the minimum loss ratio provisions of the Health Care Acts would apply to some of Reserve National’s non-comprehensive health insurance coverages, the Company determined that goodwill associated with Reserve National was impaired and not recoverable at September 30, 2010 and wrote off $14.8 million of goodwill in the third quarter of 2010. See Note 5, “Goodwill,” to the Consolidated Financial Statements.
Segment Net Operating Income in the Life and Health Insurance segment was $94.9 million for the year ended December 31, 2010, compared to $112.1 million for 2009.
Net Investment Income increased by $5.8 million for the year ended December 31, 2010, compared to 2009. Interest and dividends on fixed maturities increased by $2.8 million for the year ended December 31, 2010, compared to 2009, due primarily to a higher level of fixed maturities due, in part, to the Company reinvesting a portion of its short-term investments in fixed maturities. Dividends on equity securities increased by $2.8 million for the year ended December 31, 2010, compared to 2009, due primarily to higher yields on equity securities. Investment income from Equity Method Limited Liability Investments increased by $1.1 million for the year ended December 31, 2010, compared to 2009, due primarily to a higher investment base in 2010, partially offset by a lower total rate of return. Investment income from policyholder loans increased by $1.1 million for the year ended December 31, 2010, compared to the same period in 2009, due primarily to higher levels of policyholder loans outstanding.
The components of Net Impairment Losses Recognized in Earnings reported in the Consolidated Statements of Income for the years ended December 31, 2011, 2010 and 2009 were:
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, 2011, 2010 and 2009 were:
Interest and Other Expenses was $83.9 million, $68.3 million and $61.9 million for the years ended December 31, 2011, 2010 and 2009, respectively. Interest expense, excluding interest on a mortgage note payable included in real estate investment expense, was $36.9 million, $32.2 million and $32.5 million for the years ended December 31, 2011, 2010 and 2009, respectively. Other Corporate Expenses were $47.0 million, $36.1 million and $29.4 million for the years ended December 31, 2011, 2010 and 2009, respectively. Other Corporate Expenses increased by $10.9 million for the year ended December 31, 2011, compared to the same period in 2010, due primarily to higher postretirement benefit costs, costs incurred with changing the Company’s name and other corporate initiatives. Other Corporate Expenses increased by $6.7 million for the year ended December 31, 2010, compared to the same period in 2009, due primarily to higher postretirement benefit costs.
The Company’s effective income tax rate from continuing operations differs from the Federal statutory income tax rate due primarily to the effects of tax-exempt investment income and dividends received deductions, the effects of the write-off of goodwill in 2010, and the net effects of state income taxes. Tax-exempt investment income and dividends received deductions were $50.6 million, $54.4 million and $54.9 million in 2011, 2010 and 2009, respectively. The Company wrote off $14.8 million of goodwill in 2010 that is not deductible for income taxes. State income tax expense, net of federal benefit, from continuing operations was $1.2 million, $1.0 million and $0.8 million in 2011, 2010 and 2009, respectively.
Kemper has a three-year, $245 million, unsecured, revolving credit agreement, expiring October 30, 2012, with a group of financial institutions (the “2012 Credit Agreement”). The 2012 Credit Agreement provides for fixed and floating rate advances for periods up to six months at various interest rates. The 2012 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 2012 Credit Agreement may be used for general corporate purposes, including repayment of existing indebtedness.
On November 24, 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 2012 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 and $1.6 million for the years ended December 31, 2011 and December 31, 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
Kemper’s subsidiary, Fireside Bank, is chartered as an industrial bank and is regulated by the FDIC and the CDFI. Fireside Bank had previously agreed not to pay dividends without the prior approval of the FDIC and the CDFI. Following approval from its regulators, Fireside Bank distributed $250 million of its capital to its parent company, Fireside Securities Corporation (“Fireside Securities”), in October 2011. Fireside Securities, then in turn, distributed the same amount to its parent company, Kemper. In addition to the $250 million distribution in October 2011, Fireside Bank expects to return at least $15 million of capital to Kemper. Kemper used a portion of the distribution to repay in full its borrowings under the 2012 Credit Agreement in October 2011. On October 20, 2011, Fireside Bank requested that the FDIC terminate Fireside Bank’s FDIC insurance. Such request was granted on December 8, 2011, effective March 31, 2012 at which time Fireside Bank will cease to be regulated by the FDIC and CDFI, and accordingly, will be able to pay dividends and return capital to Kemper without prior regulatory approval.
Kemper paid a quarterly dividend to shareholders of $0.24 per common share in each quarter of 2011. Dividends paid were $58.2 million for the year ended December 31, 2011.
Net Cash Used by Financing Activities increased by $1.3 million for the year ended December 31, 2011, compared to the same period in 2010. Net cash used by 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 for the same period in 2010. Kemper used $27.4 million of cash during 2011 to repurchase shares of its common stock, compared to $34.4 million of cash used to repurchase shares of its common stock in the same period of 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 the same period of 2010. The quarterly dividend rate was $0.24 per common share for each quarter of 2011, compared to $0.22 per common share for the same period in 2010.
Net Cash Used by Financing Activities decreased by $87.3 million for the year ended December 31, 2010, compared to 2009. In 2010, Kemper borrowed $140 million under the 2012 Credit Agreement and issued $250 million aggregate principal amount of senior notes for proceeds of $247.8 million, compared to borrowing $220 million under its prior revolving credit agreement during 2009. In 2010, Kemper repaid borrowings of $140 million under the 2012 Credit Agreement and retired the 2010 Senior Notes for $200 million, compared to repaying $220 million under its prior revolving credit agreement during 2009. The Company has funded its Automobile Loan Receivables through the Issuance of Certificates of Deposits. Net cash used by Repayments of Certificates of Deposits, net of Proceeds from the issuance of Certificates of Deposits, was $366.9 million for the year ended December 31, 2010, compared to net cash used of $428.5 million for 2009. Kemper did not repurchase shares of its common stock during 2009, compared to using $34.4 million of cash during 2010 to repurchase shares of its common stock. Kemper used $54.6 million of cash to pay dividends for the year ended December 31, 2010, compared to $66.6 million of cash used to pay dividends in 2009. The amount of cash used to pay dividends decreased in 2010, compared to 2009, due primarily to differences in dividend rates. The quarterly dividend rate was $0.47 per common share in the first quarter of 2009. Beginning with the second quarter of 2009, the quarterly dividend rate was lowered to $0.20 per common share. In the first quarter of 2010, the quarterly dividend rate was increased to $0.22 per common share and maintained at that level throughout 2010.
Net Cash Provided by Investing Activities increased by $31.7 million for the year ended December 31, 2010, compared to 2009. Sales of Fixed Maturities exceeded Purchases of Fixed Maturities by $174.6 million for the year ended December 31, 2010. Purchases of Fixed Maturities exceeded Sales of Fixed Maturities by $157.0 million in 2009. Purchases of Equity Securities exceeded Sales of Equity Securities by $155.3 million for the year ended December 31, 2010. Sales of Equity Securities exceeded Purchases of Equity Securities by $104.9 million for the year ended December 31, 2009. Net cash used by acquisitions of short-term investments was $7.3 million for the year ended December 31, 2010, compared to net cash of $222.2 million provided by dispositions of short-term investments in 2009. The Company did not use any cash to originate automobile loans for the year ended December 31, 2010, compared to using $77.0 million of cash to originate automobile loans in 2009. The receipts from automobile loan receivables provided $339.6 million of cash for the year ended December 31, 2010, compared to $431.9 million of cash provided in 2009. Net Cash Provided by Investing Activities in 2009 includes $190.0 million of cash used to acquire Direct Response.
Estimated cash disbursements pertaining to the Company’s contractual obligations at December 31, 2011 are as follows:
In addition to the purchase obligations included above, the Company had certain investment commitments totaling $143.8 million at December 31, 2011. The funding of such investment commitments is dependent upon a number of factors, the timing of which is indeterminate. The contractual obligations reported above also exclude the Company’s liability of $6.2 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.
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 price observability used in fair value measurements.
The fair value of the Company’s investments measured and reported at fair value was $5,175.1 million at December 31, 2011, of which $4,827.0 million, or 93%, was based on quoted market prices or significant value drivers that are observable and $348.1 million, or 7%, was based on significant value drivers that are unobservable. Fair value measurements based on 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, compared to fair value measurements based on significant unobservable inputs used in measuring fair value. The prices that the Company might realize from actual sales of investments are likely to vary from their respective estimated fair values at December 31, 2011 due to limitations inherent in the estimation process and changing market conditions.
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, 2011, would have increased by $129.9 million.
The Company’s determination of whether or not it will be required to sell the investment before a full recovery in value.
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, 2011 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.
Changes in the mix of business by state, class and policy limit within product line;
Changes in the judicial environment, including, but not limited to, the interpretation of policy provisions, the impact of jury awards and changes in case law; and
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
Development in Unitrin Business Insurance comprised all of the Company’s development reported in discontinued operations. 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 June 1, 2008, the effective date of the sale.
Over the last several years, Preferred has undergone several changes in its claims handling processes. In 2005, Preferred changed its claims handling procedures, to emphasize greater case reserve adequacy earlier in the lifecycle of a claim. The impact of these new claims handling procedures became visible in Preferred’s reserving data in late 2006 and early 2007 as evidenced by a dramatic rise in individual case loss reserve changes in excess of $100,000 at early claims maturity valuation points. These changes had the effect of producing higher average paid and incurred loss amounts than historical averages would have otherwise indicated.
Although development will emerge in all of the Company’s personal lines’ product lines, development in Preferred segment’s personal automobile insurance product line could have the most significant impact. To further illustrate the sensitivity of Preferred segment’s reserves for 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 automobile insurance. Assuming that the Preferred segment’s 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 Preferred’s automobile insurance loss and LAE reserves could have varied by $35.0 million in either direction at December 31, 2011 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 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 positive changes in one or more factors will lead to positive 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 negative changes in one or more factors will lead to negative 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.
Unallocated Reserves are reinsured by an insurance subsidiary of SCOR (see Note 6, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements). The Company does not anticipate that any variability of these reserves will have a financial impact on the Company’s reported results of operations or liquidity and, accordingly, has not estimated any potential variability to these reserves. The Company does not allocate these reserves to its business segments.
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 2011 Annual Report under the heading “Property and Casualty Loss and Loss Adjustment Expense Reserves.”
The process of estimating the Company’s pension benefit obligations and pension benefit costs is inherently uncertain and the actual cost of benefits may vary materially from the estimates recorded. These liabilities are particularly volatile due to their long-term nature and are based on several assumptions. The main assumptions used in the valuation of the Company’s pension benefit obligations are:
ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts;
Consolidated Statements of Income for the Years Ended December 31, 2011, 2010 and 2009
The Notes to the Consolidated Financial Statements are an integral part of these financial statements.
On August 25, 2011, Unitrin, Inc. changed its name to Kemper Corporation and began trading on the New York Stock Exchange under a new ticker symbol, KMPR. The Consolidated Financial Statements included herein have been prepared on the basis of accounting principles generally accepted in the United States (“GAAP”) and include the accounts of Kemper Corporation, formerly known as Unitrin, Inc. (“Kemper”), and its subsidiaries (individually and collectively referred to herein as the “Company”). All significant intercompany accounts and transactions have been eliminated. The presentation of certain prior year amounts and disclosures have been reclassified to conform to the presentation for the current year.
On February 13, 2009, Kemper’s subsidiary, Trinity, completed its acquisition of Direct Response in a cash transaction for a total purchase price of $201.6 million. The results of Direct Response are included in the Consolidated Financial Statements from the date of acquisition and are reported in the Company’s Direct segment.
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 partnership interests in limited liability partnerships in which the Company’s interests are deemed minor and exchange traded funds. The Company’s share of distributed earnings from other equity interests is recognized as dividend income when received.
Level 2 - Observable inputs other than Level 1, quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and model-derived prices whose inputs are observable or whose significant value drivers are observable; and
The cost of an acquired entity over the fair value of net assets acquired is reported as Goodwill. Goodwill is not amortized, but rather is tested annually for recoverability or when certain triggering events require testing. See discussion below under the caption “Accounting Standards Not Yet Adopted” regarding a pending change in accounting that will impact the nature and frequency of the Company’s assessment of Goodwill for recoverability in 2012.
The Company accounts for the present value of the future profits embedded in Property and Casualty Insurance customer relationships acquired (“P&C Customer Relationships”) based on the present value of estimated future profits from the customer relationships acquired. P&C Customer Relationships was $20.8 million and $38.5 million at December 31, 2011 and 2010, respectively. P&C Customer Relationships is amortized using the effective interest method. P&C Customer Relationships are tested for recoverability using undiscounted projections of future cash flows and written down to estimated fair value if the carrying value exceeds the sum of such projections of undiscounted cash flows. The Company recorded a loss of $13.5 million before tax for the year ended December 31, 2011 to write down the carrying value of P&C Customer Relationships related to the acquisition of Direct Response to its estimated fair value.
In the normal course of business, Kemper’s insurance subsidiaries reinsure certain risks above certain retention levels with other insurance enterprises. These reinsurance agreements do not relieve Kemper’s insurance subsidiaries of their legal obligations to the policyholder. Amounts recoverable from reinsurers for benefits and losses are included in Other Receivables.
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 $125.6 million and $155.0 million at December 31, 2011 and 2010, 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.
Included in the fair value of Mortgage and Asset-backed investments at December 31, 2010 are $5.0 million of collateralized debt obligations, $1.9 million of non-governmental residential mortgage-backed securities, $1.2 million of other asset-backed securities and $0.2 million of commercial mortgage-backed securities.
The estimated fair values of the Company’s Investments in Fixed Maturities at December 31, 2011 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, 2011 consisted of securities issued by the Government National Mortgage Association with a fair value of $255.8 million, securities issued by the Federal National Mortgage Association with a fair value of $27.7 million, securities issued by the Federal Home Loan Mortgage Corporation with a fair value of $0.8 million and securities of other issuers with a fair value of $5.1 million.
Unrealized losses on fixed maturities, which the Company determined to be temporary at December 31, 2010, were $32.2 million, of which $11.5 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, 2010 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” or the heading “12 Months or Longer.” Included in the preceding table under the heading “12 Months or Longer” are unrealized losses of $0.1 million at December 31, 2010 related to securities for which the Company has recognized foreign currency losses in earnings. Investment-grade fixed maturity investments comprised $28.1 million and below-investment-grade fixed maturity investments comprised $4.1 million of the unrealized losses on investments in fixed maturities at December 31, 2010. Unrealized losses for below-investment-grade fixed maturities included unrealized losses totaling $0.1 million for one issuer that the Company recognized foreign currency impairment losses in earnings for the year ended December 31, 2010. 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, 2010, 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, 2010 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.
dividend rate during the twelve-month period preceding the evaluation date. The Company concluded that the declines in the fair values of these perpetual preferred stocks were temporary in nature, largely driven by market conditions, and since the Company intends to hold the securities until recovery, these investments were not considered to be other-than-temporarily impaired at December 31, 2010. The Company concluded that the unrealized losses on its investments in common stocks at December 31, 2010 were temporary based on the relative short length and magnitude of the losses. 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 described above that the Company considers when determining whether a decline in the fair value of an investment in equity securities is other than temporary, the Company concluded that the declines in the fair values of the Company’s investments in equity securities were temporary at December 31, 2010.
The following table sets forth the pre-tax amount of OTTI credit losses, recognized in Retained Earnings for Investments in Fixed Maturities held by the Company as of December 31, 2011, 2010 and 2009, for which a portion of the OTTI loss has been recognized in Accumulated Other Comprehensive Income, and the corresponding changes in such amounts.
On June 10, 2010, Kemper’s subsidiary, Trinity, entered into a pre-arranged trading plan (the “Trading Plan”) with UBS Financial Services Inc. (“UBS”) in accordance with SEC Rule 10b5-1 promulgated under the Securities Exchange Act of 1934, as amended, covering the sale over a period of one year of up to 1.5 million shares of Intermec common stock that were owned by Trinity. During the second quarter of 2010, Trinity sold 255,904 shares of Intermec common stock under the Trading Plan. During the third quarter of 2010, Trinity sold an additional 1,244,096 shares of Intermec common stock, thereby completing the Trading Plan. 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, beginning with the Company’s September 30, 2010 interim consolidated financial statements, the Company’s investment in Intermec common stock was included in Investments in Equity Securities and was reported at its fair value. Prior to discontinuing the use of the equity method of accounting for Intermec, the Company used a reporting lag of three months to report its proportionate share of Intermec’s results. Accordingly, Equity in Net Loss of Investee for the year ended December 31, 2010 relates to the Company’s proportionate share of results that Intermec reported for the nine months ended June 30, 2010. During the fourth quarter of 2010, Trinity sold an additional 293,760 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 Intermec common stock. During the first nine months of 2011, the Company sold 3,554,240 shares of Intermec common stock in open market transactions at a gain of $8.3 million. On September 14, 2011, the Company contributed its remaining holdings of 7,309,764 shares of Intermec common and cash to the Company’s pension plan. The Company recognized a realized loss of $7.0 million on the contribution of Intermec common stock. See Note 14, “Income from Investments,” and Note 17, “Pension Benefits,” to the Consolidated Financial Statements.
The carrying values of the Company’s Other Investments at December 31, 2011 and 2010 were:
Goodwill activity by business segment for the year ended December 31, 2010 is presented below.
The Company tested goodwill associated with each of its reporting units for recoverability on January 1, 2010. The quoted value of Kemper’s common stock was significantly below the book value per share of the Company at September 30, 2010 and December 31, 2010. Accordingly, the Company also tested goodwill associated with each of its reporting units for recoverability at these intervening interim dates. However, no goodwill was associated with, and, accordingly, no testing was required for the Direct segment at any of the aforementioned dates in 2010. The Company principally used projections of discounted future cash flows to estimate the fair values of the reporting units tested. Except for the Company’s Reserve National reporting unit, for each reporting unit tested, the estimated fair value exceeded the carrying value of the reporting unit, and the Company concluded that the associated goodwill was recoverable at each aforementioned date tested.
With respect to the Company’s Reserve National reporting unit, included in the Company’s Life and Health Insurance segment, the estimated fair value, based on a projection of discounted future cash flows, exceeded the carrying value of the reporting unit at January 1, 2010. Accordingly, the Company concluded that the goodwill associated with its Reserve National reporting unit was recoverable at January 1, 2010. Reserve National focuses on providing non-comprehensive health insurance coverages. During the first quarter of 2010, the Health Care Acts were signed into law. The Company determined that the Health Care Acts could have an adverse impact on Reserve National’s prospects. Accordingly, the Company tested goodwill associated with Reserve National for recoverability at March 31, 2010. During the first quarter of 2010, the Company also began a process to
During the third quarter of 2010, the sales process continued with several potential buyers conducting on-site due diligence reviews. On September 23, 2010, the NAIC published for comment a model regulation containing the definitions and methodologies for calculating the medical loss ratios under the Health Care Acts. On October 21, 2010, the NAIC voted to adopt a model regulation containing such definitions and methodologies and authorized the delivery of such model regulation to the U.S. Department of Health and Human Services (“HHS”) for certification. Based on these proposed regulations, the Company concluded that it was more likely than previously believed that the minimum loss ratio provisions under the Health Care Acts would apply to Reserve National’s non-comprehensive health insurance coverages. Accordingly, based on the status of the sales process to date, the continuing uncertainty about the impact of the Health Care Acts on Reserve National’s operations and the increased likelihood that the minimum loss ratio provisions of the Health Care Acts would apply to Reserve National’s non-comprehensive health insurance coverages, the Company concluded that the sales process was unlikely to result in a sales price that would exceed the carrying value of Reserve National, which included the associated goodwill, at September 30, 2010. Accordingly, an additional evaluation was necessary to determine the amount of implied goodwill that would result from a pro forma allocation of the estimated fair value of Reserve National to the fair value of the assets and liabilities of Reserve National as if it had been acquired in a business combination on the evaluation date. The Company assumed that no value would be assigned to goodwill in a pro forma allocation. Thus, the Company determined that all of the goodwill associated with Reserve National was impaired and not recoverable at September 30, 2010 and wrote off $14.8 million of goodwill in the third quarter of 2010.
Property and Casualty Insurance Reserve activity for the years ended December 31, 2011, 2010 and 2009 was:
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 losses and LAE reserves developed favorably by $21.6 million and commercial lines insurance losses and LAE reserves developed favorably by $3.3 million. The personal lines insurance losses and LAE reserves developed favorably due primarily to the emergence of more favorable loss trends than expected for the 2009, 2007 and 2006 accident years, partially offset by adverse development on certain hurricanes.
Interest Expense on Notes Payable, including facility fees and accretion of discount, for the years ended December 31, 2011, 2010 and 2009 was:
In the fourth quarter of 2010, Kemper borrowed $140 million under the 2012 Credit Agreement. As discussed below, Kemper used a portion of the proceeds from the issuance of its 2015 Senior Notes to repay in full the borrowings under the 2012 Credit Agreement.
On November 24, 2010, Kemper issued $250 million of its 6.00% senior notes due November 30, 2015. 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 2012 Credit Agreement and to make a capital contribution of $60 million to its subsidiary, United Insurance.
Future minimum lease payments under capital and operating leases at December 31, 2011 were:
The total of minimum rentals to be received in the future under non-cancelable subleases was $10.5 million at December 31, 2011.
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, 2011 and 2010. There were 60,248,582 shares and 61,066,587 shares of common stock outstanding at December 31, 2011 and 2010, respectively. Common stock outstanding included 289,659 shares and 218,156 shares at December 31, 2011 and 2010, 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 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. Kemper did not repurchase any of its common stock in open market transactions in 2009. Common Stock, Paid-in Capital and Retained Earnings were reduced on a pro rata basis for the cost of the repurchased shares.
loans or advances. Kemper’s insurance subsidiaries paid dividends of $70.5 million in cash to Kemper in 2011. In 2012, Kemper’s insurance subsidiaries would be able to pay approximately $175 million in dividends to Kemper without prior regulatory approval. Fireside Bank previously agreed not to pay dividends without the prior approval of its regulators, the FDIC and CDFI. Following approval from its regulators, Fireside Bank distributed $250 million of its capital to its parent company, Fireside Securities, in October 2011. Fireside Securities, then in turn, distributed the same amount to its parent company, Kemper. Fireside Bank had capital of $16.1 million at December 31, 2011. Fireside Bank will be able to distribute its capital without regulatory approval on April 1, 2012.
The Compensation Committee of the Board of Directors, or the Board’s authorized designee, has sole discretion to determine the persons to whom awards under the Omnibus Plan are granted, and the material terms of the awards. For stock options, material terms include the number of shares covered by such options and the exercise price, vesting and expiration dates of such options. Options are non-transferable and are exercisable in installments. Stock options to purchase Kemper’s common stock are granted at prices equal to the fair value of Kemper’s common stock on the date of grant. Prior to 2003, only non-qualified stock options had been granted. Beginning in 2003, options granted to employees were coupled with tandem stock appreciation rights (“SARs”), settled in Kemper common stock. Employee options generally vest over a period of three and one-half years and expire ten years from the date of grant. Each new member of the Board of Directors who is not employed by the Company
The Company uses the Black-Scholes option pricing model to estimate the fair value of each option on the date of grant. The expected terms of options are developed by considering the Company’s historical share option exercise experience, demographic profiles, historical share retention practices of employees and assumptions about their propensity for early exercise in the future. Further, the Company aggregates individual awards into relatively homogenous groups that exhibit similar exercise behavior to obtain a more refined estimate of the expected term of options. Expected volatility is estimated using weekly historical volatility. The Company believes that historical volatility is currently the best estimate of expected volatility. For original option grants made in 2009, the dividend yield assumed was the average, annualized dividend yield computed over the twenty consecutive quarters preceding the date of grant. Each quarterly dividend yield was calculated by dividing the amount of declared dividend per share during each quarter by the closing price of Kemper common stock at the end of such quarter. The quarterly yields were then annualized and averaged to arrive at the dividend yield assumed. In light of the economic conditions at the beginning of 2009, the Company believed that basing dividend yield over a longer historical period of time was likely to be more consistent with the actual yield during the expected life of the option rather than the then current dividend yield. For original option grants made in 2010, the dividend yield assumed was the annualized continuous dividend yield on Kemper common stock on the date of grant. The dividend yield in 2011 and 2010 was calculated by taking the natural logarithm of the annualized yield divided by the Kemper common stock price on the date of grant. The Company believes that basing the dividend yield on the current annualized yield is likely to be more consistent with the actual yield during the expected life of the option. No Restorative Options were granted in 2011, 2010 or 2009. The risk free interest rate was the yield on the grant date of U.S. Treasury zero coupon issues with a maturity comparable to the expected term of the option.
Option and SAR activity for the year ended December 31, 2011 is presented below:
The weighted-average grant-date fair values of options granted during 2011, 2010 and 2009 were $9.11, $7.60 and $3.11, respectively. Total intrinsic value of stock options exercised was $0.3 million and $0.3 million for the years ended December 31, 2011 and 2010, respectively. Cash received from option exercises was $0.2 million and $0.5 million for the years ended December 31, 2011 and 2010, respectively. Total tax benefits realized for tax deductions from option exercises were $0.1 million and $0.1 million for the years ended December 31, 2011 and 2010, respectively. No options were exercised during 2009.
Recipients of restricted stock are entitled to full dividend and voting rights on the same basis as all other outstanding shares of Kemper common stock and all awards are subject to forfeiture until certain restrictions have lapsed. Prior to February 3, 2009, only awards of time-vested restricted stock had been granted under the restricted stock plan. Beginning on February 3, 2009, in addition to time-vested restricted stock granted to certain employees and officers, the Company began awarding performance-based restricted stock to certain officers and employees under the restricted stock plan. The initial number of shares awarded to each participant represents the shares that would vest if the performance goals were achieved at the “target” performance level. The final payout of these awards 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 (“Peer Group”).
is below the “target” performance level, only a portion of the shares of performance-based restricted stock originally issued to the award recipient will vest; or
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. The grant date fair values of the performance-based restricted stock awards are determined using the Monte Carlo simulation method.
The Monte Carlo simulation model produces a risk-neutral simulation of the daily returns on the common stock of Kemper and each of the other companies included in the Peer Group. Returns generated by the simulation depend on the risk-free interest rate used and the volatilities of, and the correlation between, these stocks. The model simulates stock prices and dividend payouts to the end of the three-year performance period. Total shareholder returns are generated for each of these stocks based on the simulated prices and dividend payouts. The total shareholder returns are then ranked, and Kemper’s simulated ranking is converted to a payout percentage based on the terms of the performance-based restricted stock 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.
Activity related to restructuring costs from continuing operations for the years ended December 31, 2011, 2010 and 2009 is presented below:
As discussed in Note 1, “Basis of Presentation and Significant Estimates,” to the Consolidated Financial Statements, Kemper’s subsidiary, Trinity, completed its acquisition of Direct Response on February 13, 2009. The results of Direct Response’s operations are included in the Direct segment. The Direct segment recognized restructuring expenses of $2.4 million, $0.9 million and $7.2 million in 2011, 2010 and 2009, in part, due to integrating Direct Response’s operations into its operations.
The dilutive effect of Investee Equivalent Shares on Income from Continuing Operations was not significant for the years ended December 31, 2010 and 2009.
Other Comprehensive Income for the years ended December 31, 2011, 2010 and 2009 was:
The components of Accumulated Other Comprehensive Income at December 31, 2011 and 2010 were:
Other Receivables includes accrued investment income of $76.1 million and $72.8 million at December 31, 2011 and 2010, respectively.
Current and Deferred Income Tax Assets at December 31, 2011 and 2010 were:
The components of Liabilities for Income Taxes at December 31, 2011 and 2010 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, 2011 and 2010 were:
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 $2.5 million, $2.1 million and $4.2 million at December 31, 2011, 2010 and 2009, respectively. Tax expense for the year ended December 31, 2011 includes an interest expense of $0.4 million related to unrecognized tax benefits for prior years. Tax expense for the year ended December 31, 2010 includes an 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. Tax benefit for the year ended December 31, 2009 includes an interest benefit of $1.8 million, which is comprised of an interest benefit of $2.9 million resulting from the expiration of the statutes of limitations referred to above, and interest expense of $1.1 million on unrecognized tax benefits for prior years.
The components of Income Tax Benefit (Expense) from Continuing Operations for the years ended December 31, 2011, 2010 and 2009 were:
The Company sponsors two qualified defined benefit pension plans (the “Pension Plans”) covering approximately 3,000 retired and 3,200 active employees. The Pension Plans are generally non-contributory, but participation in one of the Pension Plans 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 Plans 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 Plans are based on years of service and final average pay, as defined. The Company funds the Pension Plans in accordance with the requirements of ERISA.
The measurement dates of the assets and liabilities at end of year presented in the preceding table under the headings, “2011” and “2010” were December 31, 2011 and December 31, 2010, respectively.
Fair value measurements for the Pension Plans’ assets at December 31, 2010 is summarized below:
The components of Comprehensive Pension (Benefit) Expense for the years ended December 31, 2011, 2010 and 2009 were:
The Company estimates that Pension Expense for the year ended December 31, 2012 will include expense of $18.5 million resulting from the amortization of the related accumulated actuarial loss included in Accumulated Other Comprehensive Income at December 31, 2011.
Total Pension Expense Recognized presented in the preceding table includes service cost benefits earned and reported in discontinued operations of $0.6 million, $0.5 million and $0.7 million for the years ended December 31, 2011, 2010 and 2009, respectively.
The Company also sponsors several defined contribution benefit plans covering most of its employees. The Company made contributions to those plans of $7.3 million, $6.8 million and $6.6 million in 2011, 2010 and 2009, 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, President 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 $16.5 million, or 5.9% of the total investments in the defined contribution benefit plans at December 31, 2011. The fair value of participants’ investments in the Dreyfus Appreciation Fund was $19.1 million, or 6.8% of the total investments in the defined contribution benefit plans at December 31, 2011.
Changes in Fair Value of Plan Assets and Changes in Accumulated Benefit Obligation for the years ended December 31, 2011 and 2010 were:
The Company estimates that OPEB Expense for the year ended December 31, 2012 will include income of $0.5 million resulting from the amortization of the related accumulated actuarial gain included in Accumulated Other Comprehensive Income at December 31, 2011.
The actuarial assumptions used to develop the components of the OPEB Expense for the years ended December 31, 2011, 2010 and 2009 were:
The Company expects to contribute $4.4 million, net of expected Modernization Act Subsidy, to its OPEB Plan to fund benefit payments in 2012.
The Preferred segment provides preferred and standard risk personal automobile insurance, homeowners insurance and other personal insurance through independent agents. The 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. Direct markets personal automobile, homeowners and renters insurance through a variety of direct-to-consumer websites, including its own websites, marketing partners, employer and other affinity-sponsored relationships. The Life and Health Insurance segment provides individual life, accident, health and property insurance.
Segment Revenues for the years ended December 31, 2011, 2010 and 2009 were:
Segment Operating Profit for the years ended December 31, 2011, 2010 and 2009 was:
Amortization of Deferred Policy Acquisition Costs by Operating Segment for the years ended December 31, 2011, 2010 and 2009 was:
Earned Premiums by product line for the years ended December 31, 2011, 2010 and 2009 were:
The catastrophe reinsurance program for the Preferred segment in 2011 also includes 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 Direct segments in 2011 also includes 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 is provided in various layers as presented below:
Coverage for each catastrophe reinsurance program effective January 1, 2009 is provided in various layers as presented below:
The catastrophe reinsurance program for the Life and Health Insurance and Direct segments in 2009 also includes reinsurance coverage from FHCF for hurricane losses in Florida at retentions lower than those described above.
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 and $0.7 million for the years ended December 31, 2010 and 2009, respectively, to reinstate coverage following certain hurricanes.
The valuation of assets measured at fair value in the Company’s Consolidated Balance Sheet at December 31, 2010 is summarized below:
The Company investigates significant differences related to the values provided. On completion of its investigation, management exercises judgment to determine the price selected and whether adjustments, if any, to the price obtained from the Company’s primary pricing provider would warrant classification of the price as Level 3. In instances where a measurement cannot be obtained from either pricing provider, the Company generally will evaluate bid prices from one or more binding quotes obtained from market makers to value investments in inactive markets and classified by the Company as Level 2. The Company generally classifies securities when it receives non-binding quotes or indications as Level 3 securities unless the Company can validate the quote or indication against recent transactions in the market. For securities classified as Level 3, the Company either uses valuations provided by third party fund managers, third party appraisers or the Company’s own internal valuations. These valuations typically employ valuation techniques, including earning multiples based on comparable public securities, industry specific non-earnings based multiples or discounted cash flow models. Valuations classified as Level 3 by the Company generally consist of investments in various private placement securities of non-rated entities. In rare cases, if the private placement security has only been outstanding for a short amount of time, the Company, after considering the initial assumptions used in acquiring an investment, considers the original purchase price as representative of the fair value.
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, 2010 is presented below:
December 31, 2011, 2010 and 2009, respectively, representing 7%, 6% and 7% of the total amount invested in the Company’s defined contribution plans at December 31, 2011, 2010 and 2009, respectively.
Kemper’s Life and Health Insurance segment paid $0.2 million, $0.1 million and $0.2 million to Intermec for the years ended December 31, 2011, 2010 and 2009, respectively, for the maintenance of hand held computers previously purchased from the Company’s former investee, Intermec.
We have audited the accompanying consolidated balance sheets of Kemper Corporation (formerly Unitrin, Inc.) and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of income, shareholders' equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2011. 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, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. 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. Our responsibility is to express an opinion on these financial statements and financial statement schedules and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audits.
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of recognizing and presenting other-than-temporary impairments in 2009.