As set forth below, Kemper Corporation and certain of its subsidiaries have both capital leases, for which the financial commitments are not material, and operating leases. For its holding company headquarters, Kemper Corporation leases from Lumbermens 32,000 sq. ft. in Long Grove, Illinois. See the two notes captioned "Related-party transactions" and "Commitments and contingent liabilities" on page 66. The Company believes its current and planned facilities are adequate for its present needs.
FKLA and KILICO lease from Lumbermens 78,000 sq. ft. of office space in Long Grove, Illinois. KILICO also has utilized 43,000 sq. ft. of office space presently leased by KFS in Chicago, although virtually all of this space is expected to be eliminated in 1997 in connection with KFS' recently executed lease.
KSI leases 241,000 sq. ft. of office space (and an additional 36,000 sq. ft. of warehouse space) in Chicago, Illinois; 115,000 sq. ft. in one location in Houston, Texas; 41,000 sq. ft. in two locations in Cleveland, Ohio; 30,000 sq. ft. in one location in Los Angeles, California; 118,000 sq. ft. in two locations in Milwaukee, Wisconsin; 38,000 sq. ft. in two locations in New York City; and 705,000 sq. ft. in 137 other locations nationwide. KSI owns a 153,000 sq. ft. building in Denver, Colorado. KCC shares office space with KSI in Milwaukee. Beta leases 44,000 sq. ft. in Milwaukee.
The real estate subsidiaries utilize portions of KFS' facilities in Chicago. KREMCO leases 29,000 sq. ft. from MLP ventures primarily in LaFayette, California.
The following table sets forth selected financial information for the Company for the five years ended December 31, 1994. Such information should be read in conjunction with the consolidated financial statements and notes thereto of the Company included in ITEM 8 of this Annual Report on Form 10-K.
During 1994, Kemper faced both an unsolicited suitor and an unsuccessful merger agreement. The resulting distractions and uncertainties negatively impacted certain of the Company's operations. The board of directors has directed Kemper management to take all appropriate actions to maximize value for stockholders.
(2) See the table on page 55 in the note captioned "Invested assets and related income." Also see the discussion captioned "INVESTMENTS--Realized investment results" on page 40.
(3) Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards ("SFAS") 109, which changed the method of accounting for deferred income taxes.
The other operations and corporate category consists of the holding company income and expenses of both Kemper and KFC. This category reported an operating loss of $35.4 million for 1994, compared with $25.7 million and $28.8 million in 1993 and 1992, respectively, before changes in accounting principles. The 1994 after-tax results included $7.3 million of expenses related to a proxy contest and a now-terminated merger agreement.
Net income from continuing operations for 1994 totaled $85.7 million, compared with net losses of $101.3 million and $214.7 million for 1993 and 1992, respectively. The net realized investment loss of $53.2 million in 1994 included a $39.7 million loss in connection with a portfolio repositioning in the life insurance segment and a $19.3 million Orange County-related charge in the asset management segment. The realized investment losses of $197.6 million and $245.3 million in 1993 and 1992, respectively, were primarily the result of real estate-related investment losses. (See "INVESTMENTS" on page 32.)
Discontinued operations primarily include the Company's former primary property-casualty insurance, reinsurance and risk management subsidiaries, all of which were divested in 1993. Net income from this category for 1994 totaled $5.7 million, compared with $336.8 million and $11.3 million in 1993 and 1992, respectively. The 1993 results included $296.8 million of gains on the sales of discontinued operations. (See the note captioned "Discontinued operations" on page 56.)
The asset management segment's operating earnings in 1994 decreased $29.8 million from the 1993 level. Operating earnings decreased primarily because of reduced management and distribution fees, lower commission income and higher amortization of commissions and sales expenses. These income reductions were partially offset by increased transfer agent revenues and reduced operating and commission expenses. In addition, the effective tax rate for 1994 was greater than for 1993, as 1993 benefited from reassessments of certain tax issues totaling $13.0 million.
In 1993, the segment's net income rose $10.8 million from 1992 because of increased management and transfer agent fee revenue and lower operating and commission expenses. These 1993 revenue increases were partially offset by lower commission income and investment and other income.
The 1993 increase of $14.8 million in investment management fee revenue was primarily attributable to the growth in bond and stock mutual fund assets under management, which have higher management fee rates (in terms of basis points) than money market fund assets under management.
In 1994, commission income decreased $27.8 million due to lower sales of most products. At INVEST, the segment's principal producer of commission revenue, commissions on sales of mutual fund products declined $30.5 million in 1994 from 1993. In addition, INVEST had reductions in commission revenue during 1994 on stock, bond and unit investment trust transactions due to lower sales. Partially offsetting these reductions were increased commissions on annuity products of $6.9 million in 1994 over 1993 due to increased sales. In 1993, the segment's commission income decreased $18.4 million compared to 1992, after increasing $26.3 million in 1992, a year when the asset management operations earned record commissions from strong sales of traditional load mutual funds.
Distribution and redemption fee revenue decreased $6.8 million in 1994 compared with 1993. Distribution fees, based on assets managed in KFS' spread load mutual funds, declined approximately $13.1 million during 1994 as spread load assets declined due to market depreciation, redemptions of mutual fund shares and conversions of spread load assets to front-end load shares which are exempt from distribution fees. Distribution fees were down $2.2 million in 1993 from 1992 as a larger percentage of spread load assets became exempt from the fees. In both 1994 and 1993, the declines in distribution fees were partially offset by receipt of contingent deferred sales charges from redemption activity.
In 1993, transfer agent revenue increased $13.4 million primarily due to a rise in the number of mutual fund shareholder accounts and related transaction activity. The 1994 and 1993 transfer agent amounts included $5.1 million and $5.2 million, respectively, in fiduciary fee revenue. Previously, the fiduciary fees were retained by Investors Fiduciary Trust Company ("IFTC"), formerly a 50 percent-owned investee of KFS. (See the note captioned "Unconsolidated investees" on page 57.) On January 31, 1995, KFS sold its 50 percent interest in IFTC to State Street Boston Corporation ("State Street") in exchange for 2,986,111 shares of State Street common stock with a market value of $98.2 million at the date of sale. IFTC accounted for $6.5 million of this segment's after-tax operating earnings in 1994.
Operating expenses decreased by $30.6 million in 1994 from the 1993 level. Expense reductions of approximately $7.2 million occurred in advertising, literature and sales promotion of mutual fund products, and personnel expenses decreased approximately $3.5 million, as fixed expense increases were more than offset by reductions in production-related compensation due to lower sales. Litigation-related expenses were $17.8 million lower in 1994, primarily due to a $10.0 million legal settlement in 1993 related to option trading activity in 1987. In addition, operating expenses declined due to the above-mentioned KSvC service reductions, the accounting for real estate management expenses in the real estate segment beginning in 1994, and expense reductions realized with the closing of Selected's operations. In 1994, KFS incurred approximately $1.0 million in registration and filing fees for the implementation of the multiple class mutual fund structure and approximately $2.4 million in connection with Kemper's merger agreement which was terminated in November 1994.
Commission expense decreased in 1994 and 1993, compared with 1992, due to lower sales, with a related decrease in the deferral of mutual fund commissions and sales expense. Amortization of deferred mutual fund commission and sales expense increased in 1994 and 1993, compared with 1992. This increase was due to increased redemption activity of
As sales of bond and stock mutual funds declined in 1993 and more so in 1994, they also represented a smaller percentage of industry wide sales based on Investment Company Institute ("ICI") data. The Company's share of the industry's non-money market mutual fund assets was 1.68 percent at December 31, 1994, 2.19 percent at December 31, 1993 and 2.77 percent at December 31, 1992. The decrease in market share primarily reflects increasing competition from securities brokerage and advisory firms, as well as from financial institutions, all emphasizing sales of their proprietary products. In addition, market share was impacted by mutual fund performance in an environment adverse to KFS' growth stock investment orientation.
Operating earnings for the life insurance segment improved in 1994 and 1993, compared with 1992, primarily due to increased spread income and favorable mortality results. Continuing a strategy implemented during 1992, the life insurance segment improved spread income by reducing crediting rates on certain existing blocks of fixed annuity and interest-sensitive life insurance products in 1993 and through most of 1994. Such reductions in crediting rates occurred as overall interest rates declined. Operating earnings improved as crediting rates declined at a faster rate than the segment's investment income. Beginning in late 1994, as a result of rising interest rates and other competitive market factors, the life insurance segment increased crediting rates on these products. Although the life insurance segment continues to manage spread revenue, further increases in crediting rates could adversely impact future operating earnings but could also help to improve sales and the overall persistency of such products.
Sales of term and other life insurance products include both renewal premiums and new product sales. Despite a slight decline in the average premium per new policy for term life products in 1994, premium revenue increased in each of the last three years due to increasing renewal premiums. The segment issued new life insurance business in 1994 of $17.2 billion in face amount, down slightly from $17.5 billion in 1993 and $21.5 billion in 1992, due in part to competitive conditions in recent years and uncertainty concerning the Company's ownership in 1994. Total life insurance in force grew to $97.5 billion at December 31, 1994, compared with $91.3 billion and $84.2 billion at December 31, 1993 and 1992, respectively.
Commissions, taxes, licenses and fees were lower in 1994, compared with 1993 and 1992, primarily reflecting lower annuity sales and reduced guaranty fund assessments. Expenses for such assessments totaled $0.0, $8.1 million and $11.0 million in 1994, 1993 and 1992, respectively. (See "LIFE INSURANCE SEGMENT--Guaranty association assessments" in ITEM 1(c) on page 10.)
The higher level of deferral of policy acquisition costs in 1994, compared with 1993, reflected an increase in the amount of imputed interest capitalized due to improvements in projected future revenue streams primarily as a result of the decline in the level of nonperforming real estate-related investments. The amortization of policy acquisition costs was favorably impacted by $13.9 million pre-tax during 1994 due to the repositioning of the segment's investment portfolio. The repositioning favorably impacted the amortization of policy acquisition costs because it resulted in current realized investment losses as well as an increase in projected future net investment income, which together are expected to increase the segment's projected future estimated gross profits in later years. Excluding the effects of the repositioning, the amortization of policy acquisition costs increased in 1994, compared with 1993 and 1992, primarily as a result of improved net income during 1994. The amortization in 1992 included approximately $22.5 million of additional amortization as a result of the above-mentioned reinsurance transaction.
The following tables reflect selected balance sheet data of the life insurance segment:
(1) National Association of Insurance Commissioners ("NAIC") -- Class 1 = A- and above -- Class 2 = BBB- through BBB+
(2) Excludes $57 million, or 0.8 percent, and $143 million, or 1.8 percent, at December 31, 1994 and 1993, respectively, of bonds carried in other real estate-related investments.
Reflective of the generally weak market conditions experienced throughout the industry in 1994, total securities brokerage revenue for the year decreased $143.7 million, or 21 percent, from the 1993 level. Market conditions coupled with uncertainty surrounding the Company's ownership in 1994 led to lower than anticipated production per investment consultant (registered representative) and lower revenue related to stock and bond underwriting activities. Commissions revenue decreased $110.9 million in 1994 from the 1993 level. Commissions in 1993 approximated the 1992 level.
In 1994 and early 1995, the segment has continued reconfiguring its operating units to focus on key business opportunities. This resizing is planned to include adjustments to production-related compensation arrangements later in 1995. Despite ongoing ownership uncertainty, the securities brokerage segment also plans to continue to recruit investment consultants and has initiated a program to attract producers specializing in sales of packaged products, including mutual funds managed by KFS.
Interest and dividend income remained relatively flat in 1994 compared with 1993. Due to the market volatility in 1994, the segment reduced its securities inventory, resulting in reduced interest income, which was offset by increased earnings from margin accounts due to higher interest rates. Despite higher rates, interest expense decreased slightly in 1994, due to reduced borrowings from the parent company due to conversion of debt to equity. The $6.8 million
decrease in interest and dividend income in 1993, compared with 1992, was offset by a corresponding decrease in interest expense of $6.1 million. These reductions were due to both lower interest rates and the disposition of mortgage-backed securities and related bonds in a special purpose subsidiary in 1993.
Excluding the $30 million pre-tax supplemental addition to the legal reserve in 1993, total expenses in 1994 decreased $102.5 million from the 1993 level, largely as a result of decreased production-based compensation and a continued focus on cost containment. Total expenses declined $29.8 million in 1993 when compared with 1992, primarily the result of a cost containment program. Excluding supplemental additions to legal reserves in 1993 and 1992, total expenses decreased $39.8 million in 1993.
Production-related compensation decreased $56.8 million in 1994 due to lower commission expense, a direct result of lower commission revenue, and reduced production-based compensation accruals. Production-related compensation decreased $8.7 million in 1993, compared with 1992, primarily the result of a reorganization of investment banking operations. Other operating expenses declined $43.5 million in 1994 as the benefits of a cost containment program took effect. Specifically, when comparing 1994 and 1993, non-production compensation, occupancy, equipment, electronic communication, professional services and general administrative expenses have all declined. In addition, other expenses decreased in part due to lower litigation-related expenses. However, the full savings impact of the above-mentioned resizing is not expected to be realized until 1995. The decline in other operating expenses of $15.0 million in 1993 compared with 1992 is due in large part to a $7.8 million reduction in non-production-related compensation and benefits.
Continued weak industry conditions and uncertainty as to the Company's ownership have had an adverse impact on securities brokerage operating results since March 1994. The Company is proceeding with its cost control program and resizing the organization. The segment's employee head count decreased 6.9 percent in 1994 and 10.9 percent in 1993.
An increased level of joint venture nonaccrual loans also reduced the Company's share of joint venture interest expense in 1994 versus the 1993 level. This in turn reduced the level of losses recorded by the Company, since the Company makes an adjustment to its joint venture operating losses to reflect nonaccrual loans of these same ventures.
Investment and other income increased in 1994, with a corresponding increase in operating expenses, because real estate management fee income and expenses were recorded in the real estate segment beginning January 1, 1994, whereas previously they were included in the asset management segment. In 1994, this segment recorded $1.1 million of real estate management fee revenue from managing real estate assets of KNIC. Such assets are being managed by a third party beginning January 1, 1995.
In 1994, sales and other transfers to third parties of certain equity investments in real estate, which had negative carrying values, generated realized gains in excess of the real estate segment's additions to reserves and write-downs. In particular, a sale of equity investments in certain multifamily residential properties to a REIT in the third quarter of 1994 resulted in the real estate segment recording realized investment gains of $15.0 million pre-tax. In 1993 and 1992, however, the realized investment losses reflected greater increases to reserves and write-downs. The segment also realizes a greater portion of the Company's additions to its provisions for real estate-related losses, because of the real estate subsidiaries' increased holdings of loans that are subordinate to loans held by the life insurance subsidiaries.
The following table reflects selected balance sheet data of the real estate segment:
The Company's invested assets predominately reflect investments of its life insurance and real estate subsidiaries. The Company's principal investment strategy is to maintain a balanced, well-diversified portfolio supporting the insurance contracts written by its life insurance subsidiaries. The Company's subsidiaries make shifts in their investment portfolios depending on, among other factors, the interest rate environment, liability durations and changes in market and business conditions.
(1) National Association of Insurance Commissioners ("NAIC"). -- Class 1 = A- and above -- Class 2 = BBB- through BBB+
The Company is carrying its fixed maturity investment portfolio, which it considers available for sale, at estimated market value, with the aggregate unrealized appreciation or depreciation being recorded within a separate component of stockholders' equity, net of any applicable income tax effect. The aggregate unrealized depreciation was $333.9 million, or $9.70 per share, at December 31, 1994, compared with unrealized appreciation of $120.6 million, net of tax, or $3.67 per share, at December 31, 1993. The Company has not recorded a deferred tax benefit for the aggregate unrealized depreciation on investments. Market values are sensitive to movements in interest rates and other economic developments and can be expected to fluctuate, at times significantly, from period to period.
During each of the last three years, the Company repositioned its fixed maturity investments and increased the relative and absolute levels of investment-grade fixed maturities and cash and short-term investments held. At December 31, 1994, investment-grade fixed maturities and cash and short-term investments accounted for 73.2 percent of the Company's invested assets and cash, compared with 72.9 percent at December 31, 1993. Approximately 73 percent of the Company's NAIC Class 1 bonds were rated AAA or equivalent at year-end 1994, up from 62 percent at year-end 1993.
Future investment income from mortgage-backed securities may be affected by the timing of principal payments and the yields on reinvestment alternatives available at the time of such payments. Due to the fact that the Company's investments in mortgage-backed securities predominately date from recent years, the current rise in interest rates is not expected to cause any material unanticipated extension of the average maturities of these investments. With the exception of the Company's September 1994 purchases of such investments (see "RESULTS OF OPERATIONS--Life insurance" above), most of these investments were purchased by the Company at discounts. Prepayment activity on such securities is not expected to result in any material losses to the Company because prepayment would generally accelerate the reporting of the discounts as investment income. Many of the Company's September 1994 purchases were at a premium. Prepayments resulting from a decline in interest rates would accelerate the amortization of premiums on such purchases which would result in reductions of investment income related to such securities. At December 31, 1994, the Company has unamortized discounts and premiums of $43.8 million and $15.4 million, respectively, related to mortgage-backed securities. Given the credit quality, liquidity and anticipated payment characteristics of the Company's investments in mortgage-backed securities, the Company believes that the associated risk can be managed without material adverse consequences on its financial statements.
Generally, at the inception of a real estate loan, the Company anticipated that it would roll over the loan and reset the interest rate at least one time in the future, although the Company is not legally committed to do so. As a result of the continued weakness in real estate markets and fairly restrictive lending practices by other lenders in this environment, the Company expects that all or most loans maturing in 1995 will be rolled over, restructured or foreclosed.
Excluding the $78.7 million of real estate owned and the $89.0 million deficit in the Company's net equity investments in joint ventures, the Company's real estate loans (including real estate-related bonds) totaled $1,381.0 million at December 31, 1994, after reserves and write-downs. Of this amount, $847.8 million are on accrual status with a weighted average interest rate of approximately 7.7 percent. Of these accrual loans, 57.9 percent have terms requiring current periodic payments of their full contractual interest, 28.8 percent require only partial payments or payments to the extent of cash flow of the borrowers, and 13.3 percent defer all interest to maturity.
The Company's real estate owned included $73.6 million of deeds in lieu of foreclosure and $5.1 million of certain purchased properties at December 31, 1994. Real estate owned was net of $132.6 million of write-downs at December 31, 1994.
(1) Net of $744.1 million reserve and write-downs. Excludes $80.7 million of real estate-related accrued interest.
(3) See the note captioned "Invested assets and related income" on page 54.
(4) The Company's real estate-related bonds, all of which are presently rated below investment-grade, are generally unsecured and were issued to the Company by real estate finance or development companies generally to provide financing for the Company's joint ventures for such purposes as land acquisition, construction/development, refinancing debt, interest and other operating expenses.
Illinois.................................................................. 28.0% California................................................................. 27.2 Texas...................................................................... 10.0 Spain...................................................................... 7.9 Hawaii..................................................................... 4.6 Ohio....................................................................... 4.6 Colorado................................................................... 2.7 Washington................................................................. 2.5 Florida.................................................................... 2.0 Other(1)................................................................... 10.5 Total................................................................100.0%
At December 31, 1994, the Company's real estate portfolio also included $110.5 million of loans carried as equity investments in real estate (net of $196.3 million of cumulative write-downs, $35.9 million of foreign currency translations and $39.8 million of cumulative operating losses) related to land for office and retail development and residential projects located in Barcelona, Spain. Such equity investments in Spain totaled $149.8 million at December 31, 1993, after accounting for fundings by Company subsidiaries of $151.3 million during 1993. The Spanish projects accounted for $55.5 million of net fundings, $102.0 million of write-downs, $20.7 million of foreign currency translation gains, operating losses of $7.8 million and dispositions of $5.7 million during 1994 and represented approximately 7.9 percent of the Company's real estate portfolio at December 31, 1994. These investments, which began in the late 1980s, accounted for $19.3 million of the December 31, 1994 off-balance-sheet legal commitments, of which the Company expects to fund approximately $14.1 million.
Undeveloped land, including the Spanish projects, represented approximately 21.8 percent of the Company's real estate portfolio at December 31, 1994. To maximize the value of certain land and other projects, additional development is proceeding or is planned. Such development of existing projects may continue to require substantial funding, either from the Company or third parties. In the present real estate markets, third-party financing can require credit enhancing arrangements (e.g., standby financing arrangements and loan commitments) from the Company. The values of
At December 31, 1994, the Company's loans to and investments in projects with the Prime Group, Inc. or its affiliates, based in Chicago, represented approximately $403.8 million, or 29.5 percent, of the Company's real estate portfolio (including the previously mentioned Spanish projects, which are Prime Group-related). (See the note captioned "Unconsolidated investees" on page 57.) This amount reflects $194.0 million in fundings during 1994 and $261.8 million in 1993. The Company also received cash, from Prime Group-related sales/paydowns/distributions and REIT transactions, totaling $204.7 million in 1994 and $64.8 million in 1993. Prime Group-related commitments accounted for $224.3 million of the off-balance-sheet legal commitments at December 31, 1994, of which the Company expects to fund $44.7 million.
Effective January 1, 1993, the Company formed a master limited partnership (the "MLP") with Lumbermens and its subsidiaries. The assets of the MLP consist of the equity interests each partner or its subsidiaries previously owned in projects with Peter B. Bedford or his affiliates ("Bedford"), a California-based real estate developer. As MLP partners, the Company and Lumbermens have participated in funding certain cash needs of the MLP projects. During 1994, the Company provided $98.4 million of fundings to the MLP projects, compared with fundings of $103.9 million in 1993. The Company also received cash from MLP-related sales/paydowns/distributions and refinancings of $166.3 million in 1994 and $215.0 million in 1993. At December 31, 1994, projects in the MLP accounted for $117.1 million of the Company's off-balance-sheet legal commitments, of which the Company expects to fund $104.9 million. The Company's equity interests in real estate that were affected by formation of the MLP are held almost entirely in the Company's real estate segment. The Company records 50 percent of the operating results of the ventures held by the MLP. Of the Company's real estate portfolio at December 31, 1994, approximately $422.9 million, or 30.9 percent, represented loans to and investments in MLP-owned ventures.
Pursuant to agreements entered into in January 1994, Bedford transferred to the MLP and a Kemper affiliate all of Bedford's ownership interests in ventures in which Bedford, the Company, Lumbermens and their respective subsidiaries previously shared ownership interests. Bedford was released from certain recourse liabilities owed to the MLP, the ventures, Lumbermens, the Company and certain of their respective subsidiaries. Because the Company's reserve methodology does not take any credit for such recourse and because the Company in 1993 had already been recording 50 percent of the operating results of the related ventures, this transaction, which simplified the management of the Company's portfolio, did not have any material adverse impact on the Company's results of operations or financial condition.
The Company decreased the net amount of its real estate reserves and writedowns in 1994, primarily reflecting sales and transfers to third parties. While the real estate subsidiaries as equity owners recognized gains on sales and other transactions during 1994, additions to reserves and increases in write-downs have affected both the life insurance segment (where most of the Company's loans are held) and the real estate segment. The Company's real estate reserve was allocated as follows:
Current conditions in the real estate markets have been adversely affecting the financial resources of certain of the Company's joint venture partners. Every partner, however, remains active in the control of its respective joint ventures. In evaluating a partner's ability to meet its financial commitments, the Company considers the amount of all applicable debt and the value of all properties within that portion of the Company's portfolio consisting of loans to and investments in joint ventures with such partner. In 1993, the Company began recognizing 100 percent of the operating results of certain joint ventures. The additional operating results are being recorded primarily by the Company's real estate subsidiaries, which are the equity holders in such ventures.
(2) Interest more than 90 days past due but not on nonaccrual status.
(3) The Company does not accrue interest on real estate-related investments when it judges that the likelihood of collection of interest is doubtful. The 1994 decrease in nonaccrual loans primarily reflected sales and foreclosures as well as write-offs of certain fully reserved loans.
(4) The Company defines a "restructuring" of debt as an event whereby the Company, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor it would not otherwise consider. Such concessions either stem from an agreement between the Company and the debtor or are imposed by law or a court. By this definition, restructured loans do not include any loan that, upon the expiration of its term, both repays its principal and pays interest then due from the proceeds of a new loan that the Company, at its option, may extend (roll over).
(5) Real estate owned is carried at fair value and includes deeds in lieu of foreclosure and certain purchased property. Cumulative write-downs to fair value were $132.6 million and $29.3 million at December 31, 1994 and 1993, respectively.
(7) Equity investments in real estate are not defined as part of, and therefore are not taken into account in calculating, total troubled real estate because the negative carrying value of equity investments would reduce the total. The Company's equity investments also involve real estate risks. See "Real estate concentrations" above.
The following table shows each segment's contribution to the Company's net investment income:
The Company regularly monitors its investment portfolio and as part of this process reviews its assets for possible impairments of carrying value. Because the review process includes estimates, there can be no assurance that current estimates will prove accurate over time due to changing economic conditions and other factors.
The interest rate environment contributed both to a reduction in net investment income of the life insurance segment in 1993 and 1992 and, as interest rates rose during 1994, to both realized and unrealized fixed maturity investment losses in 1994. Also, lower renewal crediting rates on annuities, compared with higher new money crediting rates, have influenced certain clients to seek alternative products. The Company mitigates this risk somewhat within its life insurance segment by charging decreasing surrender fees when annuity holders withdraw funds prior to maturity on certain annuity products. Approximately one-half of the Company's fixed annuity liabilities as of December 31, 1994, however, are no longer subject to significant surrender fees.
Kemper Corporation and each of its subsidiaries carefully monitor cash and short-term money market investments to maintain adequate balances for timely payment of claims, expenses, taxes and customers' account balances. In addition, regulatory authorities establish minimum liquidity and capital standards for the asset management, life insurance and securities brokerage companies. The major ongoing sources of the Company's liquidity are asset management fees, securities brokerage commissions, collateralized bank borrowings by the securities brokerage operations, collections of life insurance premium revenue, deposits for annuities and interest-sensitive life contracts, investment income, other operating revenue and cash provided from maturing or sold investments. (See "INVESTMENTS" on page 32.)
In the life insurance segment, policyholder deposits decreased to $380.1 million during 1994 from $412.4 million during 1993, and policyholder withdrawals increased to $995.4 million during 1994 from $711.3 million during 1993, primarily due to planned reductions in crediting rates on general account annuities, increased competition, rising interest rates and uncertainty regarding the Company's ownership. The life insurance subsidiaries' late 1994 increases in crediting rates are designed to produce new policyholder deposits and to reduce future withdrawals.
The following table sets forth the consolidated short-term debt and capitalization of the Company at the dates indicated:
The parent company had $20.0 million due to banks at December 31, 1994 and 1993. Also included in short-term debt at December 31, 1994 are $30.0 million of medium-term notes due in the fourth quarter of 1995. Kemper Corporation renegotiated certain of its committed lines of credit with certain banks effective October 27, 1994. The lines of credit total $317.5 million, with $155.0 million expiring October 22, 1995 and $162.5 million expiring November 1, 1996. These lines would not be available upon a change of control of the Company. At December 31, 1994, $110 million of the aggregate amount of these lines were reserved for the sole purpose of providing funding capability respecting real estate commitments which the Company does not expect to ultimately require funding. Additionally, beginning in the first quarter of 1995 and in conjunction with the issuance of letters of credit totaling $205 million by a third-party bank syndicate to five money market mutual funds managed by KFS to credit enhance the money funds' investments in certain Orange County notes, a portion of the committed lines of credit equal to the difference between $205 million and the aggregate cash and marketable securities of the parent and its non-regulated subsidiaries will be reserved for any future fundings under the Orange County letters of credit. As of February 28, 1995, approximately $23 million of the committed lines were reserved for this purpose. Interest rates on the Company's committed lines of credit would generally approximate short-term bank corporate rates.
All of the Company's long-term debt was issued prior to 1994. The majority of the long-term debt was privately placed in 1993 at an initial interest rate of 6.875 percent. This rate increased to 7.375 percent from March 15, 1994 to December 12, 1994, when the initial rate was reinstated upon the exchange of such notes for publicly registered notes. (See the note captioned "Long-term debt and notes payable" on page 59.)
Ratings reductions for Kemper Corporation or its subsidiaries and other financial events can also trigger obligations to fund certain real-estate related commitments to take out other lenders. In such events, those lenders can be expected to renegotiate their loan terms, although they are not contractually obligated to do so. Such circumstances could accelerate or increase the Company's purchases of real estate-related assets from its regulated life insurance subsidiaries to further support their respective statutory capital positions.
A credit rating is not a recommendation to buy, sell or hold securities. Each rating is subject to revision or withdrawal at any time by the assigning organization and should be evaluated independently of any other rating. In November 1994, after the termination of a merger agreement between Kemper Corporation and Conseco, Inc. (see Part I of this Annual Report on Form 10-K), Standard & Poor's Corporation revised its BBB (adequate) senior debt and BB+ (below average) preferred stock ratings of Kemper Corporation from "CreditWatch with 'negative' implications" to "CreditWatch with 'developing' implications"; Duff & Phelps Credit Rating Co. revised its A- (high) senior debt rating of Kemper Corporation, its AA- (very high) claims-paying ability rating of FKLA and its A+ (high) claims-paying ability rating of KILICO from "Rating Watch-Down" to "Rating Watch-Uncertain"; Moody's Investors Service indicated that it continues to review for possible downgrade its Baa2 (adequate) senior debt rating and Baa3 (adequate) preferred stock rating of Kemper Corporation and its Baa1 (adequate) financial strength ratings of FKLA and KILICO; and A.M. Best did not change its A- (excellent) "under review" ratings of FKLA and KILICO. The review status of each of these ratings primarily reflects the fact that the Company is pursuing alternatives to maximize stockholder value, which alternatives may result in a change of control of the Company and/or certain of its subsidiaries.
Convertible debentures of subsidiary represent employee interests in KFC. Maturities and employee terminations during 1994 accounted for the $12.3 million reduction of convertible debentures from year-end 1993. Approximately $7.5 million of debentures are scheduled to mature in 1995. The outstanding debentures bear interest approximating the prime rate. At December 31, 1994, $24.1 million of the debentures were subject to KFC's right to call, and the remaining $9.0 million become callable in May 1995. (See the note captioned "Convertible debentures of subsidiary" on page 65.) KFC is considering calling all outstanding debentures for redemption by year-end 1995 or in early 1996.
While the board of directors intends to continue quarterly cash dividends, future declarations and amounts will depend upon, among other factors, the earnings of Kemper Corporation, its financial condition, its capital requirements and general business conditions.
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, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles. Also in our opinion, the related supplementary 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.
As discussed in the notes to the consolidated financial statements, effective January 1, 1994, the Company changed its method of accounting for investment securities to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards ("SFAS") 115, Accounting for Certain Investments in Debt and Equity Securities. Also, as discussed in the notes, effective January 1, 1993, the Company changed its method of accounting for impairment of loans receivable to adopt the provisions of SFAS 114, Accounting by Creditors for Impairment of a Loan, and changed its method of accounting for income taxes to adopt the provisions of SFAS 109, Accounting for Income Taxes. Further, as discussed in the notes, the Company adopted the provisions of SFAS 106, Employers' Accounting for Postretirement Benefits Other than Pensions in 1992.
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS The Board of Directors and Stockholders Kemper Corporation:
We consent to incorporation by reference in the Registration Statements No. 33-50736 on Form S-8 and No. 2-71680 on Form S-3 of Kemper Corporation of our report dated March 3, 1995, relating to the consolidated balance sheet of Kemper Corporation and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1994, which report appears in the December 31, 1994 Annual Report on Form 10-K of Kemper Corporation.
Revenue for the asset management segment principally consists of investment management fees and distribution fees from mutual funds, commission revenue from the sale of mutual fund and annuity products, and transfer agent fees for shareholder recordkeeping. Revenue from investment management, transfer agent and distribution fees is recognized when earned. Commission revenue is recognized on the trade date.
The assets and liabilities of the separate accounts represent segregated funds administered and invested by the life insurance companies for purposes of funding variable annuity and variable life insurance contracts (for the exclusive benefit of variable annuity and life insurance contract holders) and the pension plans of Lumbermens Mutual Casualty Company ("Lumbermens"), Kemper Corporation and certain of their subsidiaries. The Company receives administrative and investment advisory fees for managing such funds. The assets and liabilities of the separate accounts are carried at market value.
Accounts receivable from and payable to brokerage firms and customers include amounts due on cash and margin transactions. Securities owned by customers are held as collateral for receivables. Such collateral is not reflected in the consolidated financial statements.
Equity securities of nonrelated companies are generally carried at market value using the closing prices as of the balance sheet date derived from either a major securities exchange or the National Association of Securities Dealers Automated Quotations system.
At December 31, 1994 and 1993, total impaired loans amounted to $414.5 million and $547.7 million, respectively. Impaired loans with reserves were $282.6 million and $360.6 million, with corresponding reserves of $111.9 million and $216.3 million, at December 31, 1994 and 1993, respectively. In determining reserves relative to impaired loans, the Company also considered the deficit in equity investments in real estate of $125.9 million and $138.3 million at
The amortized cost of fixed maturities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization is included in net interest income. Amortization of the discount or premium from mortgage-backed securities is recognized using a level effective yield method which considers the estimated timing and amount of prepayments of the underlying mortgage loans and is adjusted to reflect differences which arise between the prepayments originally anticipated and the actual prepayments received and currently anticipated. To the extent that the estimated lives of mortgage-backed securities change as a result of changes in prepayment rates, the adjustment is also included in net investment income. The Company does not accrue interest income on fixed maturities deemed to be impaired on an other-than-temporary basis, or on mortgage loans, real estate-related bonds and other real estate loans where the likelihood of collection of interest is doubtful.
Generally, the Company's currency translations to the respective functional currency are charged or credited to net income. Translation adjustments for financial reporting in U.S. dollars are direct charges or credits, net of deferred income tax, to a separate component of stockholders' equity. Foreign exchange results included in net income for 1994, 1993 and 1992 were not material.
Primary earnings per share is based on net income available to common stockholders divided by the weighted average number of common shares and common share equivalents outstanding for the period. Fully diluted earnings per share is based on net income available to common stockholders (adjusted to add back dividends on convertible preferred stock), divided by the weighted average number of common shares and common share equivalents adjusted to reflect the conversion of the convertible preferred stock (when not anti-dilutive). (See the note captioned "Computation of consolidated net income (loss) per share" on page 62.)
At December 31, 1994, the Company had outstanding 14,526 shares of Series A Cumulative Convertible Preferred Stock, certain rights to purchase up to 500,000 shares of Series B Junior Participating Preferred Stock, 2,000,000 shares of Series C Cumulative Preferred Stock, 66,638.5 shares of Series D Index Exchangeable Preferred Stock and 4,600,000 shares of Series E Cumulative Convertible Preferred Stock.
The Company issued Series B preferred stock purchase rights pursuant to a stockholder rights plan adopted in 1990. One right is attached to each share of common stock currently outstanding or issued prior to the rights becoming exercisable. The rights become exercisable and trade separately from the common stock only upon the occurrence of certain events related to a change in control of the Company, which is generally defined as when a person accumulates 20 percent or more, or begins a tender or exchange offer for 30 percent or more, of the Company's common stock. Once exercisable, each right would entitle the holder (other than the acquiring person) to purchase 1/200th of a share of the Company's Series B Junior Participating Preferred Stock or, in certain circumstances, including a merger or major asset sale, the Company's or the acquiring person's securities or other property having a value of twice the $220 exercise price per right. If issued, each full share of such preferred stock is nonredeemable, ranks junior to all other preferred stock of the Company and is approximately equal in dividend and voting rights to 200 shares of common stock. The Company has reserved 500,000 preferred shares for issuance upon exercise of the rights. All rights expire July 29, 2000, unless redeemed earlier.
At December 31, 1994, securities of the life insurance subsidiaries, carried at approximately $8.3 million, were on deposit with governmental agencies as required by law. Policy loans, which are included in "Other loans and investments," were $383.5 million and $364.9 million at December 31, 1994 and 1993, respectively.
On August 2, 1993, Kemper Corporation closed a stock exchange transaction with Lumbermens. Under the tax-free exchange transaction, Kemper Corporation received approximately 17.4 million shares of Kemper Corporation common stock previously owned by Lumbermens. In exchange, Lumbermens received Kemper Reinsurance Company and its subsidiaries as well as National Loss Control Service Corporation, with a combined book value of $409.2 million. The tax-free exchange transaction was valued at $610.2 million, resulting in a net gain of $204.7 million. The gain includes $32.4 million of after-tax realized investment gains from disposition of investments in connection with the exchange transaction. The shares received from Lumbermens became treasury shares, reducing Kemper Corporation's book value by $437.9 million. Book value per common share increased approximately $5.46, or 15.5 percent, as a result of this transaction. The transaction reduced Kemper Corporation's common stock then outstanding to approximately 32.5 million shares from 49.9 million shares. Lumbermens' ownership of Kemper Corporation common stock is now approximately 1.25 million shares, or less than 4 percent. In connection with the stock exchange transaction, certain assets (primarily real estate-related) of the reinsurance subsidiary, with a carrying value of approximately $136.3 million at December 31, 1992, were guaranteed by Kemper Corporation. By August 2, 1996, the Company and Lumbermens will make a final settlement with respect to such assets based on the above-stated value, taking into account any dispositions of such assets during the three-year period and the gains or losses realized thereon. At December 31, 1994, the guarantee has decreased to $70.1 million ($61.3 million in real estate-related investments) due to dispositions.
On August 31, 1993, the Company sold Economy Fire & Casualty Company ("Economy") to St. Paul Fire and Marine Insurance Company in a transaction valued at $420 million, receiving approximately two-thirds in cash and one-third in assets (primarily real estate-related) distributed from Economy's investment portfolio. The book value of Economy was $305.1 million at the closing date, and an after-tax net gain of $82.9 million was recorded. This gain included $10.6 million of after-tax realized investment gains from disposition of investments in connection with the sale.
The following table sets forth selected financial information regarding the divested companies:
At December 31, 1994, subsidiaries of the Company directly held partnership interests in a number of real estate joint ventures and a 50 percent ownership in IFTC Holdings, Inc. ("IFTC"). (See discussion of the 1995 sale of IFTC in the note captioned "Subsequent event" on page 71.) Also, subsidiaries of each of the Company and Lumbermens are partners in a master limited partnership (the "MLP") formed, effective January 1, 1993, to hold the equity interests each partner's organization separately held previously in joint ventures with Peter B. Bedford or his affiliates ("Bedford"), and in January 1994, the MLP acquired substantially all of Bedford's interests in such joint ventures. The Company and Lumbermens each own 50 percent of the MLP.
The Company's direct and indirect real estate joint venture investments are accounted for utilizing the equity method, with the Company recording its share of the operating results of the respective partnerships. Beginning in 1993, the Company recorded 100 percent of the operating results of certain non-MLP partnerships and 50 percent of the MLP's results (although the Company's indirect ownership of the MLP-owned ventures was generally 25 percent from January 1, 1993 until January 1994). The Company, as an equity owner, has the ability to fund, and historically has elected to fund, operating requirements of certain of the joint ventures. Consolidation accounting methods are not utilized as the Company, in most instances, does not own more than 50 percent, and, in any event, major decisions of the partnerships must be made jointly by all partners.
The Company generally strives to maintain a diversified invested asset portfolio; however, certain concentrations of credit risk exist, including mortgage-backed securities and real estate. These concentrations are discussed in "INVESTMENTS" beginning on page 32.
Long-term debt (which consists primarily of the Company's $200.0 million of 6.875% Notes Due 2003, $110.75 million of 8.80% Notes Due 1998 and $35.5 million of medium-term notes), maturity and annual weighted average interest rate at December 31, 1994 were as follows:
The actual income tax (benefit) for 1994, 1993 and 1992 differed from the "expected" tax (benefit) for those years as displayed below. "Expected" tax (benefit) was computed by applying the U.S. federal corporate tax rate of 35 percent for 1994 and 1993 and 34 percent for 1992 to earnings (loss) from continuing operations before income tax (benefit).
Upon adoption of SFAS 109, a valuation allowance was established to reduce the deferred federal tax asset related to real estate and other investments to the amount that, based upon available evidence, is, in management's judgment, more likely than not to be realized. Any reversals of the valuation allowance are contingent upon the recognition of future
capital gains in the Company's federal income tax return or a change in circumstances which causes the recognition of the benefits to become more likely than not. During 1994, the valuation allowance was increased by $129.9 million. This increase in the valuation allowance is primarily attributable to the increase in the net deferred federal tax asset from unrealized losses on investments.
The tax returns through the year 1986 have been examined by the Internal Revenue Service ("IRS"). Changes proposed are not material to the Company's financial position. The tax returns for the years 1987 through 1990 are currently under examination by the IRS.
Federal income tax paid for the years ended December 31, 1994, 1993 and 1992 amounted to $17.8 million, $94.5 million and $95.0 million, respectively. Interest payments for the same three years totaled $77.2 million, $67.8 million and $81.1 million, respectively.
In determining the December 31, 1993 accumulated benefit obligation, the following assumptions were made: an 8.5 percent expected long-term rate of return on plan assets, a 7.0 percent discount rate and rate of increase in future compensation levels, and a salary scale of 9.0 percent, 7.5 percent and 6.0 percent dependent on age group, respectively.
Expenses of other employee benefit plans, excluding postretirement benefits, for the three years ended December 31, 1994, were as follows:
The status of the plan as of December 31, 1994 and 1993, was as follows:
A one percentage point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as of December 31, 1994 and 1993, by $3.2 million and $4.7 million, respectively, and the net postretirement health care interest and service costs for the years ended December 31, 1994 and 1993 by $0.6 million and $0.7 million, respectively.
Stock option prices are not less than the fair market value at the date of grant. Generally, shares underlying the options had been subject to exercise in installments of one-third or one-fourth beginning with the first anniversary of the grant. However, in June 1994, all options became immediately exercisable in connection with Kemper Corporation's execution of a now-terminated merger agreement. The options generally expire after ten years. At December 31, 1994, 2.7 million option shares remained available for future grants. If all options were exercised, Kemper Corporation would receive proceeds of $83.2 million.
In the ordinary course of business, the life insurance subsidiaries enter into reinsurance agreements for the purpose of limiting their exposure to loss on any one single insured or to diversify their risk and limit their overall financial exposure to certain blocks of fixed-rate annuities. For individual life products, the life insurance subsidiaries have generally retained only the first $300,000 (face amount) on the life of any one individual, with the excess portions of life insurance risk ceded to reinsurers. For its fixed-rate annuity reinsurance agreements, the life insurance subsidiaries generally have ceded 100 percent of the related annuity liabilities. Although these reinsurance agreements contractually obligate the reinsurers to reimburse the life insurance subsidiaries, they do not discharge the life insurance subsidiaries from their primary liabilities and obligations to policyholders. As such, these amounts paid or deemed to have been paid are recorded on the Company's consolidated balance sheet as reinsurance recoverables and ceded life policy benefits.
The following is a summary of the reinsurance activities of the Company's life insurance subsidiaries for the three years ended December 31, 1994:
In 1992 and 1991, Kemper Investors Life Insurance Company ("KILICO") entered into 100 percent indemnity reinsurance agreements ceding $515.7 million and $416.3 million, respectively, of its fixed-rate annuity liabilities to FLA. FLA shares common management with KILICO and FKLA and certain common board members with the Company. The 1992 reinsurance agreement resulted in the sale to FLA of approximately $500 million of certain assets, including $151 million of mortgage loans, while the 1991 agreement was all cash. FLA also has been the primary reinsurer of the mortality coverages issued by FKLA prior to 1992. As of December 31, 1994, the reinsurance recoverable related to the fixed-rate annuity liabilities and the life products ceded to FLA amounted to approximately $643 million and $43 million, respectively.
The Company had outstanding $33.1 million and $45.7 million of convertible debentures issued by Kemper Financial Companies, Inc. ("KFC") at December 31, 1994 and 1993, respectively. Debentures bear interest at a fluctuating rate per annum, which on average approximates prime. Interest on the debentures is payable quarterly. The debentures mature in the sixth through tenth year from the date issued. The future maturity payments required based upon debentures outstanding as of December 31, 1994, are as follows: 1995, $7.5 million; 1996, $9.3 million; 1997, $5.7 million; 1998-2000, $10.6 million.
At its option, KFC may call the debentures in connection with a public offering of its common stock or at any time on or after the fifth anniversary of the date the debentures were issued. At December 31, 1994, $24.1 million of the debentures are subject to KFC's right to call, and the remainder becomes callable after May 10, 1995.
Significant related-party transactions, other than those described elsewhere in these consolidated financial statements, are described below.
Lumbermens owned approximately 38 percent of the common stock of Kemper Corporation at December 31, 1992. Lumbermens, American Motorists Insurance Company, American Protection Insurance Company, and American Manufacturers Mutual Insurance Company are collectively referred to as the Kemper National Insurance Companies. As a result of the exchange transaction with Lumbermens involving the transfer of Kemper Reinsurance Company and its subsidiaries as well as National Loss Control Service Corporation, Lumbermens' ownership of Kemper Corporation was reduced to less than 4 percent in August 1993, at which time Lumbermens ceased being a related party. (See the note captioned "Discontinued operations" on page 56.)
Effective January 1, 1993, the Company, Lumbermens and certain of their respective subsidiaries formed a master limited partnership to hold certain equity real estate investments. (See the note captioned "Unconsolidated investees" on page 57.) In connection with the formation, Lumbermens also acquired from the Company 50 percent of Kemper Real Estate Management Company at a consideration approximating book value.
The Company has operating leases that have initial or remaining noncancellable lease terms in excess of one year at December 31, 1994. The future minimum rental payments required under such leases are as follows: 1995, $49.4 million; 1996, $47.9 million; 1997, $35.6 million; 1998, $29.5 million; 1999, $25.7 million; 2000-2005, $111.6 million. Rental expenses associated with operating leases were $60.9 million, $64.1 million and $60.6 million for 1994, 1993 and 1992, respectively. (See the preceding note captioned "Related-party transactions".)
The Company is involved in various legal actions for which it establishes liabilities where appropriate. In the opinion of the Company's management, based upon the advice of legal counsel, the resolution of such litigation is not expected to have a material adverse effect on the consolidated financial statements.
In connection with the December 1994 bankruptcy filing by Orange County, California, the Company provided credit enhancements for $198 million of Orange County notes held by five money market mutual funds managed by Kemper Financial Services, Inc. The Company has therefore assumed the risk of loss associated with the notes. The notes mature July 10, 1995. The Company recorded a $29.7 million charge ($19.3 million after tax) in the fourth quarter of 1994 and will include in its results of operations future changes in the estimated market value of the notes. Although not legally required, the Company took actions to credit enhance the notes to prevent the money funds' net asset values from falling below one dollar per share. There can be no assurance that the Company would or would not take such actions in the future with respect to any other mutual fund investments.
Although no Company subsidiary or joint venture project has been identified as a "potentially responsible party" under federal environmental guidelines, inherent in the ownership of or lending to real estate projects is the possibility that environmental pollution conditions may exist on or near or relate to properties owned or previously owned or properties securing loans. Where the Company has presently identified remediation costs, they have been taken into account in determining the cash flows and resulting valuations of the related real estate assets. Based on the Company's receipt and review of environmental reports on most of the projects in which it is involved, the Company believes its environmental exposure would be immaterial to its consolidated results of operations. However, the Company may be required in the future to take actions to remedy environmental exposures, and there can be no assurance that material environmental exposures will not develop or be identified in the future. The amount of future environmental costs is impossible to estimate due to, among other factors, the unknown magnitude of possible exposures, the unknown timing and extent of corrective actions that may be required, the determination of the Company's liability in proportion to others and the extent such costs may be covered by insurance or various environmental indemnification agreements.
See the note captioned "Financial instruments--off-balance-sheet risk" on the following page for a discussion regarding the Company's loan commitments and standby financing agreements.
At December 31, 1994, the Company had loan commitments and standby financing agreements totaling $510.8 million to support the financing needs of various real estate investments. To the extent these arrangements are called upon, amounts loaned would be secured by assets of the joint ventures, including first mortgage liens on the real estate. The Company's criteria in making these arrangements are the same as for its mortgage loans and other real estate investments. The Company presently expects to fund approximately $194.4 million of these arrangements. These commitments are included in the Company's analysis of real estate-related reserves and write-downs. The fair values of loan commitments and standby financing agreements are estimated in conjunction with and using the same methodology as the fair value estimates of mortgage loans and other real estate-related investments.
The securities brokerage operations use exchange-traded forward and futures contracts to hedge exposures in trading activities that contain varying degrees of off-balance-sheet risk whereby changes in the market values of the underlying securities or other financial instruments may be in excess of the amounts reflected in the consolidated financial statements. In light of this strategy, the Company does not expect any material losses relating to such derivative investments that would not be offset with corresponding gains on the securities hedged. These securities are carried on the consolidated balance sheet at their market values. Gains and losses, both realized and unrealized, from both the derivatives and the hedged securities are included in income currently. Net trading profits, including from derivatives, during 1994, 1993 and 1992 totaled $17.6 million, $42.6 million and $41.2 million, respectively.
payments made under the first swap is approximately offset by the market fluctuations related to the second swap. The Company records realized and unrealized gains and losses on such investments in net income on a current basis. The amounts of the gain included in net income during 1994, 1993 and 1992 totaled $0.0 million, $1.5 million and $1.0 million, respectively.
The life insurance subsidiaries' hedges relating to foreign currency exposure are implemented using forward contracts on foreign currencies. These are generally short duration contracts with U.S. money-center banks. The Company records realized and unrealized gains and losses on such investments in net income on a current basis. The amounts of gain (loss) included in net income during 1994, 1993 and 1992 totaled $6.4 million, $(2.8) million and $(2.4) million, respectively.
The SPEX is a convertible security which, depending on the performance of the Company's common stock relative to the S&P 500 Index, can have varying effects on fully diluted earnings per share. To mitigate the potential per share impact, the Company hedges the exposure to the performance of the S&P 500 Index using exchange-traded futures contracts. The hedge has been implemented with the expectation that after-tax gain or loss on these investments will approximately offset changes to the fully diluted earnings per share calculation resulting from changes in the SPEX conversion ratio caused by changes in the S&P 500 Index. The Company records realized and unrealized gains and losses on such investments in net income on a current basis. The amounts of gain included in net income during 1994 and 1993 totaled $0.9 million and $0.7 million, respectively.
Fair value estimates are determined for existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and certain liabilities that are not considered financial instruments. Accordingly, the aggregate fair value estimates presented do not represent the underlying value of the Company. For example, the Company's subsidiaries are not considered financial instruments, and their value has not been incorporated into the fair value estimates. In addition, tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
Mortgage loans and other real estate-related investments: Fair values for mortgage loans and other real estate-related investments were estimated on a project-by-project basis. Generally, the projected cash flows of the collateral are discounted using a discount rate of 10 to 12 percent. The resulting collateral estimates were then used to determine the value of the Company's real estate-related investments. The estimate of fair value should be used with care given the inherent difficulty of estimating the fair value of real estate due to the lack of a liquid quotable market.
Other loans and investments: The carrying amounts reported in the consolidated balance sheet for these instruments approximate fair values. The fair values of policy loans were estimated by discounting the expected future cash flows using an interest rate charged on policy loans for similar policies currently being issued.
Securities purchased (sold) under agreements to resell (repurchase): As these securities (obligations) are short-term in nature, the carrying values approximate fair values.
Securities held by brokerage firm subsidiaries: The carrying amounts reported in the consolidated balance sheet for these instruments approximate fair values.
Securities sold but not yet purchased: The carrying amounts reported in the consolidated balance sheet for these financial instruments approximate fair values.
Interest rate swaps: Fair values for these financial instruments were estimated by discounting the projected interest rate spread over the lives of the swaps.
Credit enhancement related to Orange County notes: Fair value was determined to be the excess of the face amount of the obligation over the estimated market value of the underlying Orange County securities. Such excess has been recorded in the consolidated financial statements as a realized loss.
Retained earnings includes $47.0 million in gross undistributed income of unconsolidated companies, net of income tax, at December 31, 1994.
On January 31, 1995, Kemper Financial Services, Inc. completed the sale of its 50 percent ownership interest in IFTC to State Street Boston Corporation ("State Street") in exchange for 2,986,111 shares of State Street common stock, subject to certain resale restrictions. The Company recorded an after-tax gain of approximately $12.0 million in the first quarter of 1995 from the sale.