The Company leases two floors, or approximately 65,000 square feet, in an 83-story office building in Chicago, Illinois, for its corporate headquarters. The lease expires on December 31, 2033. Kemper’s property and casualty insurance subsidiaries lease facilities with an aggregate square footage of approximately 490,000 at 28 locations in ten states. The latest expiration date of the existing leases is in May 2026. Kemper’s life and health insurance subsidiaries lease facilities with aggregate square footage of approximately 450,000 at 123 locations in 27 states. The latest expiration date of the existing leases is in January 2025. Kemper’s corporate data processing operation leases facilities with aggregate square footage of approximately 31,000 square feet at three locations in three states. The latest expiration date of the existing leases is in June 2021.
Net Income was $190.1 million ($3.25 per unrestricted common share) for the year ended December 31, 2018, compared to $120.9 million ($2.34 per unrestricted common share) for the year ended December 31, 2017. Income from Continuing Operations was $188.4 million ($3.22 per unrestricted common share) in 2018, compared to $119.9 million ($2.32 per unrestricted common share) in 2017.
A reconciliation of Net Income to Adjusted Consolidated Net Operating Income (a non-GAAP financial measure) along with the components of Adjusted Consolidated Net Operating Income is presented below for the years ended December 31, 2018, 2017 and 2016.
Earned Premiums were $3,384.4 million in 2018, compared to $2,350.0 million in 2017, an increase of $1,034.4 million driven primarily by growth in Kemper’s legacy specialty personal automobile insurance and the acquisition of Infinity. Earned Premiums increased by $1,021.7 million, $0.4 million and $12.3 million in the Specialty Property & Casualty Insurance segment, Preferred Property & Casualty Insurance Segment and Life & Health Insurance segment, respectively. See MD&A, “Specialty Property & Casualty Insurance,” beginning on page 40, MD&A, “Preferred Property & Casualty Insurance,” beginning on page 33 and MD&A, “Life & Health Insurance,” beginning on page 45 for discussion of the changes in each segment’s earned premiums.
“Contingencies.” to the Consolidated Financial Statements for additional discussion. The Company cannot make any assurance as to the additional amounts of the final judgment that will actually be collected or when they may be received. The unpaid balance of the final judgment is treated as a gain contingency for accounting purposes and accordingly, is not recognized in the Consolidated Financial Statements.
Net Realized Gains on Sales of Investments were $26.4 million in 2018, compared to $56.5 million in 2017. See MD&A, “Investment Results,” under the sub-caption “Net Realized Gains on Sales of Investments” beginning on page 52 for additional discussion. Net Impairment Losses Recognized in Earnings in 2018 and 2017 were $4.5 million and $14.3 million, respectively. See MD&A, “Investment Results,” under the sub-caption “Net Impairment Losses Recognized in Earnings” beginning on page 52 for additional discussion. The Company cannot predict when or if similar investment gains or losses may occur in the future.
Earned Premiums were $2,350.0 million in 2017, compared to $2,220.0 million in 2016, an increase of $130.0 million. Earned Premiums increased by $132.4 million and $8.8 million in the Specialty Property & Casualty Insurance and Life & Health Insurance segments, respectively. Earned Premiums decreased by $11.2 million in the Preferred Property & Casualty Insurance segment. See MD&A, “Preferred Property & Casualty Insurance,” beginning on page 33, MD&A “Specialty Property & Casualty Insurance,” beginning on page 40, and MD&A, “Life & Health Insurance,” beginning on page 45 for discussion of the changes in each segment’s earned premiums.
Catastrophes and natural disasters are inherent risks of the property and casualty insurance business. These catastrophic events and natural disasters include, without limitation, hurricanes, tornadoes, earthquakes, hailstorms, wildfires, high winds and winter storms. Such events result in insured losses that are, and will continue to be, a material factor in the results of operations and financial position of the Company’s property and casualty insurance companies. Further, because the level of these insured losses occurring in any one year cannot be accurately predicted, these losses may contribute to material year-to-year fluctuations in the results of operations and financial position of these companies. Specific types of catastrophic events are more likely to occur at certain times within the year than others. This factor adds an element of seasonality to property and casualty insurance claims. The Company has adopted the industry-wide catastrophe classifications of storms and other events promulgated by ISO to track and report losses related to catastrophes. ISO classifies a disaster as a catastrophe when the event causes $25.0 million or more in direct insured losses to property and affects a significant number of policyholders and insurers. ISO-classified catastrophes are assigned a unique serial number recognized throughout the insurance industry.
See the “Reinsurance” subsection of the “Property and Casualty Insurance Business” and “Life and Health Insurance Business” sections of Item 1(c), “Description of Business,” and Note 20, “Catastrophe Reinsurance,” to the Consolidated Financial Statements for additional information on the Company’s reinsurance programs.
The following discussions of segment results 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 prior years 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 Insurance Expense Ratio. The most directly comparable GAAP financial measure is the Combined Ratio, which is computed by adding total incurred losses and LAE, including the impact of catastrophe losses and loss and LAE reserve development from prior years, with the Insurance Expense Ratio. The Company believes Underlying Losses and LAE and the Underlying Combined Ratio are useful to investors and are used by management to reveal the trends in the Company’s Preferred Property & Casualty Insurance and Specialty Property & 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
1) Income (Loss) from Change in Fair Value of Equity and Convertible Securities;
6) Significant non-recurring or infrequent items that may not be indicative of ongoing operations.
Net Investment Income in the Preferred Property & Casualty Insurance segment increased by $2.9 million in 2018, compared to 2017, due primarily to higher levels of fixed maturity investments and higher income from fixed maturity investments, partially offset by lower income from Alternative Investments. The Preferred Property & Casualty Insurance segment reported Net Investment Income from Alternative Investments of $18.6 million 2018, compared to $22.5 million in 2017.
Insurance expenses were $225.5 million, or 30.9% of earned premiums, in 2018, an increase of 1.1 percentage points compared to 2017, driven primarily by increased ceded premiums in 2018 under the Company’s aggregate property catastrophe reinsurance contract.
Earned premiums in the Preferred Property & Casualty Insurance segment decreased by $11.2 million in 2017, compared to 2016 as lower volume accounted for a decrease of $32.6 million, while higher average earned premium accounted for an increase of $21.4 million. The lower volume was driven primarily by preferred personal automobile insurance and homeowners insurance, which had volume decreases of $16.6 million and $13.2 million, respectively.
Selected financial information for the homeowners insurance product line is presented below.
Earned premiums in homeowners insurance decreased by $14.7 million in 2018, compared to 2017, as lower volume accounted for a decrease of $15.5 million, while higher average earned premium accounted for an increase of $0.8 million. Incurred losses and LAE were $209.9 million, or 83.9% of earned premiums, in 2018, compared to $287.8 million, or 108.7% of earned premiums, in 2017. Incurred losses and LAE as a percentage of earned premiums decreased due to reinsurance recoveries from the Company’s 2018 catastrophe aggregate reinsurance program, partially offset by an unfavorable change in loss and LAE reserve development and higher underlying losses and LAE as a percentage of earned premiums. Underlying losses and LAE as a percentage of earned premiums were 52.5% in 2018, compared to 48.9% in 2017, a deterioration of 3.6 percentage points due primarily to higher severity of losses, and to a lesser extent, higher frequency of claims, partially offset by higher average earned premium. Catastrophe losses and LAE (excluding reserve development) were $75.2 million in 2018, compared to $157.3 million in 2017. This decrease was driven primarily by fewer catastrophe losses and LAE (excluding reserve development) from events with greater than $20.0 million in losses and LAE and reinsurance recoveries under the Company’s 2018 aggregate property catastrophe reinsurance program. Loss and LAE reserve development was adverse by $3.2 million in 2018, compared to $1.0 million in 2017.
Other personal insurance products include umbrella, dwelling fire, inland marine, earthquake, boat owners and other liability coverages. Selected financial information for other personal insurance product lines is presented below.
Earned premiums in other personal insurance decreased by $2.3 million in 2018, compared to 2017, as lower volume accounted for a decrease of $3.4 million, while higher average earned premium accounted for an increase of $1.1 million. Incurred losses and LAE were $18.3 million, or 45.3% of earned premiums, in 2018, compared to $22.1 million, or 51.8% of earned premiums, in 2017. Incurred losses and LAE as a percentage of earned premiums decreased due to lower underlying losses and LAE as a percentage of earned premiums and a higher level of favorable loss and LAE reserve development. Underlying losses and LAE as a percentage of earned premiums were 47.3% in 2018, compared to 51.1% in 2017, which was an improvement of 3.8 percentage points due primarily to lower frequency of claims and higher average earned premiums, partially offset by higher severity of losses. Favorable loss and LAE reserve development was $5.7 million in 2018, compared to $4.6 million in 2017.
As discussed in Note 3, “Acquisition of Business,” to the Consolidated Financial Statements, the Company completed its acquisition of Infinity on July 2, 2018. The results of its operations have been included in the preceding tables of selected financial information for the Specialty Property & Casualty Insurance segment from the date of its acquisition and forward. Infinity is a national provider of auto insurance focused on serving the specialty, nonstandard segment. With approximately 10,600 independent agents and $1.4 billion in 2017 direct written premiums, Infinity is one of the largest specialty auto insurers in the United States.
The Specialty Property & Casualty Insurance segment reported Segment Net Operating Income of $115.8 million for the year ended December 31, 2018, compared to $56.3 million in 2017. Segment net operating results improved by $59.5 million due primarily to the impact of lower underlying losses and LAE as a percentage of earned premiums on a higher level of earned premiums, particularly in the Company’s specialty personal automobile insurance business, higher net investment income and lower levels of adverse loss and LAE reserve development, partially offset by the impact of higher insurance expenses as a percentage of earned premiums on a higher level of earned premiums and driven by the amortization of purchase accounting adjustments associated with Kemper’s acquisition of Infinity.
Net Investment Income in the Specialty Property & Casualty Insurance segment increased by $24.2 million in 2018, compared to 2017, due primarily to higher levels of investments due in large part to growth in Kemper’s legacy specialty automobile insurance business and the acquisition of Infinity, partially offset by lower income from Alternative Investments. The Specialty Property & Casualty Insurance segment reported Net Investment Income from Alternative Investments of $19.1 million in 2018, compared to $14.9 million in 2017.
The Specialty Property & Casualty Insurance segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $11.5 million in 2018, compared to $11.7 million in 2017.
Net Investment Income in the Specialty Property & Casualty Insurance segment increased by $10.1 million in 2017, compared to 2016, due primarily to higher investment income from Alternative Investments, and to a lesser extent, higher levels of non-alternative investments. The Specialty Property & Casualty Insurance segment reported Net Investment Income from Alternative Investments of $14.9 million in 2017, compared to $7.6 million in 2016.
Insurance expenses were $165.0 million, or 16.4% of earned premiums, in 2017, an improvement of 1.5 percentage points compared to 2016, driven primarily by earned premium growth outpacing variable costs.
The Specialty Property & Casualty insurance segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $11.7 million in 2017, compared to $10.0 million in 2016.
Earned Premiums on specialty personal automobile insurance increased by $935.2 million in 2018, compared to 2017. Infinity accounted for $670.4 million of the increase, while higher volume and higher average earned premium on Kemper’s legacy business accounted for increases of $202.9 million and $61.9 million, respectively. Incurred losses and LAE were $1,427.6 million, or 75.6% of earned premiums, in 2018, compared to $758.1 million, or 79.4% of earned premiums, in 2017. Incurred losses and LAE as a percentage of earned premiums decreased due primarily to lower underlying losses and LAE as a percentage of earned premiums. Underlying losses and LAE as a percentage of related earned premiums were 75.1% in 2018, compared to 78.6% in 2017, an improvement of 3.5 percentage points due primarily to the inclusion of Infinity and higher average earned premium and lower frequency of claims in Kemper’s legacy business, partially offset by higher severity of losses on most coverages in Kemper’s legacy business. Catastrophe losses and LAE (excluding reserve development) were $3.9 million in 2018, compared to $4.8 million in 2017. Adverse loss and LAE reserve development was $5.5 million in 2018, compared to $2.9 million in 2017.
Earned premiums in commercial automobile insurance increased by $86.5 million in 2018, compared to 2017. Infinity accounted $87.8 million of the increase, while higher average earned premium on Kemper legacy business accounted for an increase of $2.8 million, partially offset by lower volume of $4.1 million. Incurred losses and LAE were $96.2 million, or 69.8% of earned premiums, in 2018, compared to $42.4 million, or 82.5% of earned premiums, in 2017. Incurred losses and LAE as a percentage of earned premiums decreased due primarily to lower underlying losses and LAE as a percentage of earned premiums and a favorable change in loss and LAE reserve development. Underlying losses and LAE as a percentage of earned premiums were 72.0% in 2018, compared to 79.4% in 2017, an improvement of 7.4 percentage points due primarily to the inclusion of Infinity and higher average earned premium and lower frequency of claims, partially offset by higher severity of losses. Favorable loss and LAE reserve development was $3.8 million in 2018, compared to adverse development of $0.9 million in 2017.
Earned premiums in commercial automobile insurance decreased by $1.9 million in 2017, compared to 2016, as lower volume accounted for a decrease of $6.1 million, while higher average earned premium accounted for an increase of $4.2 million. Incurred losses and LAE were $42.4 million, or 82.5% of earned premiums, in 2017, compared to $47.2 million, or 88.6% of earned premiums, in 2016. Incurred losses and LAE as a percentage of earned premiums decreased due primarily to lower underlying losses and LAE as a percentage of earned premiums and a lower level of adverse loss and LAE reserve development. Underlying losses and LAE as a percentage of earned premiums were 79.4% in 2017, compared to 82.6% in 2016, which was an improvement of 3.2 percentage points due primarily to higher average earned premium and lower frequency of claims, partially offset by higher severity of losses. Adverse loss and LAE reserve development was $0.9 million in 2017, compared to $2.4 million in 2016.
Earned Premiums in the Life & Health Insurance segment increased by $12.3 million for the year ended December 31, 2018, compared to 2017, due primarily to higher volume from accident and health insurance products offered by Reserve National, partially offset by lower volume from life products offered by Reserve National and property insurance products offered by Kemper Home Service Companies (“KHSC”).
Earned premiums on life insurance decreased by $1.3 million in 2018, compared to 2017, due primarily to lower volume on products offered by Reserve National, offset by slightly higher premium for KHSC. Policyholders’ benefits and incurred losses and LAE on life insurance were $279.4 million in 2018, compared to $274.1 million in 2017, an increase of $5.3 million due primarily to higher incurred claims on life policies offered by KHSC, partially offset by the favorable impact on policyholders’ benefits due to the reduction in Reserve National’s life business. Insurance expenses decreased by $0.2 million in 2018, compared to 2017.
Earned premiums on accident and health insurance increased by $12.3 million in 2017, compared to 2016, due primarily to higher volume on accident and health insurance products offered by Reserve National and, to a lesser extent, lower accrued medical loss ratio (“MLR”) premium rebates. Incurred accident and health insurance losses and LAE were $88.7 million, or 54.9% of accident and health insurance earned premiums, in 2017, compared to $80.3 million, or 53.7% of accident and health insurance earned premiums, in 2016. Incurred accident and health insurance losses increased as a percentage of earned premiums due primarily to deterioration in the ratios on critical illness and hospital indemnity products. Insurance expenses increased by $4.1 million in 2017, compared to 2016, due primarily to higher commission expense for Reserve National due in part to a higher volume of earned premium.
The components of Total Comprehensive Investment Gains (Losses) for the years ended December 31, 2018, 2017 and 2016 are presented below.
The components of Loss from Change in Fair Value of Equity and Convertible Securities for the year ended December 31, 2018 are presented below.
The components of Net Realized Gains on Sales of Investments for the years ended December 31, 2018, 2017 and 2016 are presented below.
Net Impairment Losses Recognized in the Consolidated Statements of Income for the year ended December 31, 2018 related to Investments in Fixed Maturities were due to the Company’s intent to sell or requirement to sell.
Net Impairment Losses Recognized in the Consolidated Statements of Income for the year ended December 31, 2017 related to Investments in Fixed Maturities include losses of $10.4 million due to the Company’s intent to sell or requirement to sell bonds of eight issuers and credit losses of $1.7 million from other-than-temporary declines in the fair values of investments in fixed maturities of two issuers.
Net Impairment Losses Recognized in the Consolidated Statements of Income for the year ended December 31, 2016 related to Investments in Fixed Maturities include losses of $23.9 million due to the Company’s intent to sell or requirement to sell bonds of 11 issuers and credit losses of $2.7 million from other-than-temporary declines in the fair values of investments in fixed maturities of one issuer.
The Company did not recognize any impairment losses related to Investments in Real Estate in the Consolidated Statements of Income for the years ended December 31, 2018 or 2017.
Net Impairment Losses Recognized in the Consolidated Statements of Income for the year ended December 31, 2016 related to Investments in Real Estate includes a loss of $0.5 million due to the Company’s intent to sell one property.
The following table summarizes the credit quality of the fixed maturity investment portfolio at December 31, 2018 and 2017.
Gross unrealized losses on the Company’s investments in below-investment-grade fixed maturities were $17.1 million and $6.9 million at December 31, 2018 and 2017, respectively.
The following table summarizes the fair value of the Company’s investments in non-governmental fixed maturities by industry at December 31, 2018 and 2017.
The Company owns investments in various limited liability investment companies and limited partnerships that primarily invest in mezzanine debt, hedge funds and distressed debt. As of January 1, 2018 the Company’s investments in these limited liability investment companies and limited partnerships are reported either as Equity Method Limited Liability Investments, Equity Securities at Fair Value, or Equity Securities at Modified Cost depending on the accounting method used to report the investment. Prior to January 1, 2018 and the Company’s adoption of ASU 2016-01, the Company’s investments in limited liability investment companies and limited partnerships were reported either as Equity Method Limited Liability Investments, Other Equity Interests and included in Equity Securities, or Fair Value Option Investments depending on the accounting method used to report the investment. See Note 2, “Summary of Accounting Policies and Accounting Changes,” to the Consolidated Financial Statements. Additional information pertaining to these investments at December 31, 2018 and 2017 is presented below.
Insurance Expenses increased by $256.2 million for the year ended December 31, 2018, compared to 2017, due primarily to the acquisition of Infinity and the amortization of purchase accounting adjustments in 2018. Insurance Expenses decreased by $3.0 million for the year ended December 31, 2017, compared to 2016, due primarily to growth in business, partially offset by lower amortization of insurance in force.
No. 118 (“SAB 118”), the Company recorded certain provisional amounts for the estimated income tax effects of the Tax Act on deferred income taxes.
In 2018, the Company finalized its determination of the effects of the Tax Act on deferred income taxes based on information received from third parties, completion of actuarial tax computations that impacted the amount of deductions related to reserves reportable for federal income tax purposes for tax years prior to 2018, and other items. As a result, the Company recorded an income tax benefit of $26.4 million for the year ended December 31, 2018 in connection with the finalization of the tax effects, which was primarily attributable to the effect of the updated actuarial tax computations.
On June 8, 2018, the Company entered into an amended and extended credit agreement and term loan facility. The amended and extended credit agreement increased the borrowing capacity of the existing unsecured credit agreement to $300.0 million and extended the maturity date to June 8, 2023. The term loan facility includes a delayed draw feature with borrowing capacity of $250.0 million and a maturity date two years from the borrowing date. Furthermore, the amended and extended credit agreement provides for an accordion feature whereby the Company can increase either the revolving credit or term loan borrowing capacity by $100.0 million. On June 29, 2018, the Company borrowed $250.0 million on the delayed draw term loan facility to facilitate the funding of the acquisition of Infinity. The proceeds from the term loan facility, net of debt issuance costs, were $249.4 million. On December 28, 2018, the Company repaid $215.0 million of the outstanding term loan. There were no outstanding borrowings at December 31, 2018 or December 31, 2017 under the revolving credit agreement.
Infinity’s liabilities at the acquisition date included $275.0 million principal amount, 5.0% Senior Notes due September 19, 2022 (the “2022 Infinity Senior Notes”). The 2022 Senior Notes were recorded at a fair value of $282.1 million as of the acquisition date, with the $7.1 million premium being amortized as a reduction to interest expense over the remaining term, resulting in an effective interest rate of 4.4%. On November 30, 2018 Kemper executed a guarantee to fully and unconditionally guarantee the payment and performance obligations of the 2022 Infinity Senior Notes.
In June of 2018, United Insurance received advances of $55.0 million from the FHLB of Chicago and Trinity received advances of $55.0 million from the FHLB of Dallas. The advances, which were repaid in full on July 13, 2018, were made to facilitate the funding of the acquisition of Infinity.
There were no advances from the FHLB of Chicago or the FHLB of Dallas outstanding at December 31, 2017.
On July 2, 2018, Kemper acquired 100% of the outstanding common stock of Infinity, pursuant to the terms of the merger agreement dated February 13, 2018, with total cash, stock and equity-based compensation consideration paid to Infinity shareholders of approximately $1.5 billion. In conjunction with closing the acquisition, Kemper issued 13,184,107 shares, with an aggregate fair value of $982.5 million based on Kemper’s July 2, 2018 stock price of $74.53, and paid $564.6 million in cash consideration to Infinity’s shareholders. In addition, Kemper issued 44,010 restricted units under Kemper’s equity-based compensation plan to replace Infinity restricted shares that were outstanding immediately prior to the closing. The aggregate fair value of such Kemper restricted units granted was $3.3 million at July 2, 2018, of which $1.6 million is attributed to service provided prior to the closing and included in consideration paid. The remaining amount of $1.7 million is attributed to future service and will be recognized in compensation expense primarily over a period of two years. The cash consideration was funded by cash on hand as of July 2, 2018, inclusive of $250.0 million in borrowings under the Company’s delayed draw term loan facility and $110.0 million of Kemper subsidiary borrowings from the FHLB of Dallas and FHLB of Chicago. On July 13, 2018, Kemper subsidiaries repaid in full the $110.0 million of FHLB borrowings, plus accrued interest. On December 28, 2018, Kemper repaid $215.0 million of the delayed draw term loan facility. See Note 3, “Acquisition of Business,” and Note 7, “Debt,” to the Consolidated Financial Statements for additional information. Infinity is a national provider of auto insurance focused on serving the specialty automobile market. With approximately 10,600 independent agents and $1.4 billion in 2017 direct written premiums, Infinity is one of the largest nonstandard auto insurers in the United States.
Kemper paid a quarterly dividend to shareholders of $0.24 per common share in each quarter of 2018 and 2017. Dividends paid were $56.4 million and $49.5 million for the years ended December 31, 2018 and 2017, respectively.
Kemper directly held cash and investments totaling $100.6 million at December 31, 2018, compared to $197.3 million at December 31, 2017. Sources available for the repayment of indebtedness, repurchases of common stock, future shareholder dividend payments, additional capitalization of its direct insurance subsidiaries, and the payment of interest on Kemper’s senior notes and subordinated debentures include cash and investments directly held by Kemper, receipt of dividends from Kemper’s subsidiaries and borrowings under the credit agreement.
During periods of growth, insurance companies typically experience positive operating cash flows and are able to invest a portion of their operating cash flows to fund future policyholder benefits and claims. During periods in which premium revenues decline, insurance companies may experience negative cash flows from operations and may need to sell investments to fund payments to policyholders and claimants. In addition, if the Company’s property and casualty insurance subsidiaries experience several significant catastrophic events over a relatively short period of time, investments may have to be sold in advance of their maturity dates to fund payments, which could result in either investment gains or losses. Management believes that its property and casualty insurance subsidiaries maintain adequate levels of liquidity in the event that they were to experience several future catastrophic events over a relatively short period of time.
Net Cash Provided by Operating Activities increased by $298.6 million for the year ended December 31, 2018, compared to 2017. Net Cash Provided by Operating Activities increased by $0.1 million for the year ended December 31, 2017, compared to 2016.
Net Cash Used by Financing Activities was $205.2 million for the year ended December 31, 2017, compared to $48.4 million for the same period in 2016. Kemper used $360.0 million of cash to repay long-term debt for the year ended December 31, 2017. Net proceeds from the issuance of long-term debt provided $200.2 million of cash for the year ended December 31, 2017. Kemper did not use any cash during 2017 to repurchase shares of its common stock, compared to $3.8 million of cash to repurchase shares of its common stock in 2016. Kemper used $49.5 million of cash to pay dividends for the year ended December 31, 2017, compared to $49.2 million in 2016. The quarterly dividend rate was $0.24 per common share for each quarter of 2017 and 2016.
Cash available for investment activities in total is dependent on cash flow from Operating Activities and Financing Activities and the level of cash the Company elects to maintain. Net Cash Used by Investing Activities was $497.6 million for the year ended December 31, 2018, compared to $105.4 million in 2017. Net cash provided by dispositions of short-term investments was $52.7 million for the year ended December 31, 2018, compared to $39.4 million in 2017. Fixed Maturities investing activities used net cash of $230.1 million for the year ended December 31, 2018, compared to $181.9 million in 2017. Equity Securities investing activities used net cash of $126.6 million for the year ended December 31, 2018, compared to $0.7 million in 2017. Equity Method Limited Liability Investments investing activities used net cash of $29.0 million for the year ended December 31, 2018, compared to providing net cash of $20.2 million in 2017. As of January 1, 2018, with the adoption of new accounting guidance, the Company’s historical Fair Value Option Investments are now carried as Equity Securities at Fair Value or Equity Securities at Modified Cost. Accordingly, no activity was recorded for Fair Value Option Investments for the year ended December 31, 2018, compared net cash provided by Fair Value Option Investing Activities of $35.2 million in 2017.
Net Cash Used by Investing Activities was $105.4 million for the year ended December 31, 2017, compared to $238.1 million in 2016. Net cash provided by dispositions of short-term investments was $39.4 million for the year ended December 31, 2017, compared to net cash used by acquisitions of short-term investments of $18.0 million in 2016. Fixed Maturities investing activities used net cash of $181.9 million for the year ended December 31, 2017, compared to $318.0 million in 2016. Equity Securities investing activities used net cash of $0.7 million for the year ended December 31, 2017, compared to providing net cash of $68.8 million in 2016. Equity Method Limited Liability Investments investing activities provided net cash of $20.2 million for the year ended December 31, 2017, compared to $6.4 million in 2016. Net cash provided by Fair Value Option Investments investing activities was $35.2 million for the year ended December 31, 2017, compared to $51.2 million in 2016. The Company did not use cash to purchase Corporate-owned Life Insurance during the year ended December 31, 2017, compared to purchases of $7.5 million in 2016.
In addition to the purchase obligations included above, the Company had certain investment commitments totaling $275.4 million at December 31, 2018. The funding of such investment commitments is dependent on a number of factors, the timing of which is indeterminate. The contractual obligations reported above also exclude the Company’s liability of $4.4 million for unrecognized tax benefits. The Company cannot make a reasonably reliable estimate of the amount and period of related future payments, if any, 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.
The reported value of the Company’s investments was $8,069.5 million at December 31, 2018, of which $7,140.1 million, or 88%, was reported at fair value, $187.0 million, or 2%, was reported under the equity method of accounting, $300.6 million, or 4%, was reported at unpaid principal balance and $441.8 million, or 6%, was reported at cost, modified cost or depreciated cost. Investments, in general, are exposed to various risks, such as interest rate risk, credit risk and overall market volatility risk. Accordingly, it is reasonably possible that changes in the fair values of the Company’s investments reported at fair value will occur in the near term and such changes could materially affect the amounts reported in the financial statements. Also, it is reasonably possible that changes in the carrying values of the Company’s Equity Method Limited Liability Investments will occur in the near term and such changes could materially affect the amounts reported in the financial statements because these issuers follow specialized industry accounting rules which require that they report all of their investments at fair value (See Item 1A., “Risk Factors” under the title “The Company’s investment portfolio is exposed to a variety of risks that may negatively impact net investment income and cause realized and unrealized losses”).
The Company regularly reviews its fixed maturity investment portfolio and holdings in Equity Securities at Modified Cost for factors that may indicate that a decline in the fair value of an investment below its cost, amortized cost or modified cost basis is other than temporary. Such reviews are inherently uncertain in that the value of the investment may not fully recover or may decline further in future periods. Some factors considered in evaluating whether or not a decline in fair value of an investment is other than temporary include, but are not limited to, the following:
The Company’s actuaries generally estimate reserves at least quarterly for most product lines and/or coverage levels using accident quarters or years spanning 10 or more years, depending on the product line and/or coverage level or emerging issues relating to them. The Company’s actuaries use a variety of generally accepted actuarial loss reserving estimation methodologies, including, but not limited to, the following:
The Company’s actuaries generally review the results of at least four of the estimation methodologies, two based on paid data and two based on incurred data, to initially estimate the ultimate losses and LAE for the current accident quarter or year and re-estimate the ultimate losses and LAE for previous accident quarters or years to determine if changes in the previous estimates of the ultimate losses and LAE are indicated by the most recent data. In some cases, the methodologies produce a cluster of estimates with a tight band of indicated possible outcomes. In other cases, however, the methodologies produce conflicting results and wider bands of indicated possible outcomes, and the Company’s actuaries perform additional analyses before making their final selections. However, such bands do not necessarily constitute a range of outcomes, nor does the Company’s management or the Company’s actuaries calculate a range of outcomes.
At a minimum, the Company’s actuaries analyze 70 product and/or coverage levels for either 40 accident quarters or 10 accident years for both losses and LAE using many of the loss reserving estimation methodologies identified above as well as other generally accepted actuarial estimation methodologies. In all, there are more than 10,000 combinations of accident quarters or years, coverage levels, and generally accepted actuarial estimation methodologies used to estimate the Company’s unpaid losses and LAE. In some cases, the Company’s actuaries make adjustments to the loss reserving estimation methodologies identified above or use additional generally accepted actuarial estimation methodologies to estimate ultimate losses and LAE.
For each accident quarter or year, the point estimate selected by the Company’s actuaries is not necessarily one of the points produced by any particular one of the methodologies utilized, but often is another point selected by the Company’s actuaries, using their professional judgment, that takes into consideration each of the points produced by the several loss reserving estimation methodologies used. In some cases, for a particular product, the current accident quarter or year may not have enough paid claims data to rely upon, leading the Company’s actuaries to conclude that the incurred loss development methodology provides a better estimate than the paid loss development methodology. Therefore, the Company’s actuaries may give more weight to the incurred loss development methodology for that particular accident quarter or year. As an accident quarter or year ages for that same product, the actuary may gain more confidence in the paid loss development methodology and begin to give more weight to the paid loss development methodology. The Company’s actuaries’ quarterly selections are summed by product and/or coverage levels to create the actuarial indication of the ultimate losses. More often than not, the actuarial indication for a particular product line and accident quarter is most heavily weighted toward the incurred loss development methodology, particularly for short-tail lines such as personal automobile insurance. Historically, the incurred loss development methodology has been more reliable in predicting ultimate losses for short-tail lines, especially in the more recent accident quarters or years, compared with the paid loss development methodology. However, in some circumstances changes can occur which impact numerous variables, including, but not limited to, those variables identified below that are difficult to quantify and/or impact the predictive value of prior development patterns relied upon in the incurred loss development methodology and paid loss development methodology. In those circumstances, the Company’s actuaries must make adjustments to these loss reserving estimation methodologies or use additional generally accepted actuarial estimation methodologies. In those circumstances, the Company’s actuaries, using their professional judgment, may place more weight on the adjusted loss reserving estimation methodologies or other generally accepted actuarial estimation methodologies until the newer development patterns fully emerge and the Company’s actuaries can fully rely on the unadjusted loss reserving estimation methodologies. In the event of a wide variation among results generated by the different projection methodologies, the Company’s actuaries further analyze the data using additional techniques.
The final step in the quarterly loss and LAE reserving process involves a comprehensive review of the actuarial indications by the Company’s corporate actuary and corporate management who apply their collective judgment and determine the appropriate estimated level of reserves to record. Numerous factors are considered in this determination process, including, but not limited to, the assessed reliability of key loss trends and assumptions that may be significantly influencing the current actuarial indications, changes in claim handling practices or other changes that affect the timing of payment or development patterns, changes in the mix of business, the maturity of the accident quarter or year, pertinent trends observed over the recent past, the level of volatility within a particular line of business, the improvement or deterioration of actuarial indications in the current period as compared to prior periods, and the amount of reserves related to third party pools for which the Company does not have access to the underlying data and, accordingly, relies on calculations provided by such pools.
Development for the years ended December 31, 2018, 2017 and 2016, was:
See MD&A, “Loss and LAE Reserve Development,” “Preferred Property & Casualty Insurance,” “Specialty Property & Casualty Insurance,” and “Life & Health Insurance,” for further information on development reported in the Consolidated Financial Statements.
The Company tests goodwill for impairment annually, or whenever events or circumstances indicate the carrying amount of goodwill may not be recoverable. Goodwill is tested for impairment at the reporting unit level. In 2018, the Company changed the date on which it performs the annual goodwill impairment test from January 1 to October 1, moving the test date closer to year-end. Accordingly, the Company performed two goodwill impairment tests in 2018, the first as of January 1, 2018 and the second as of October 1, 2018. The Company performed qualitative goodwill impairment assessments on both dates for all reporting units with goodwill. The qualitative assessment takes into consideration changes in macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, changes in management or key personnel, changes in strategy and changes in our stock price since the last quantitative assessment, which was performed on January 1, 2017. For each reporting unit tested, we determined that it is more likely than not that the fair value of the reporting unit significantly exceeded the carrying value of the reporting unit, and the Company concluded that the associated goodwill was recoverable.
The Company has adopted all recently issued accounting pronouncements with effective dates prior to January 1, 2019. See Note 2, “Summary of Accounting Policies and Accounting Changes” to the Consolidated Financial Statements for discussion on adoption of these ASUs and impacts to the Company’s financial statements, which were not material. For all recently issued accounting pronouncements with effective dates after December 31, 2018, the Company does not expect adoption to have a material impact on its financial statements, with the possible exceptions of ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and ASU 2018-12, Financial Services - Insurance (Topic 944): Targeted Improvements to Accounting for Long-Duration Contracts.
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 (“Kemper”) and its subsidiaries (individually and collectively referred to herein as the “Company”). All significant intercompany accounts and transactions have been eliminated.
The fair values of the Company’s Investments in Fixed Maturities, Investments in Convertible Securities at Fair Value, Investments in Equity Securities at Fair Value and Debt are estimated using a hierarchical framework which prioritizes and ranks market price observability. The carrying amounts reported in the Consolidated Balance Sheets approximate fair value for Cash, Short-term Investments and certain other assets and other liabilities because of their short-term nature. The actual value at which financial instruments could be sold or settled with a willing buyer or seller may differ from estimated fair values depending on a number of factors, including, but not limited to, current and future economic conditions, the quantity sold or settled, the presence of an active market and the availability of a willing buyer or seller.
In the fourth quarter of 2018, the Company changed its reportable segments as disclosed in Note 18, “Business Segments,” to the Consolidated Financial Statements, to include the Preferred Property & Casualty Insurance segment, Specialty Property & Casualty Insurance segment and Life & Health Insurance segment. As a result of continued transformational change, including the acquisition of Infinity, the Company’s chief operating decision maker began reviewing performance of the business, setting operating budgets and evaluating resource and capital allocations using the new reportable segments. Accordingly, the Company has restated prior-period segment data within Note 18, “Business Segments,” to the Consolidated Financial Statements.
Short-term Investments include certificates of deposits and other fixed maturities that mature within one year from the date of purchase, U.S. Treasury bills, money market mutual funds and overnight interest bearing accounts. Short-term Investments are reported at cost, which approximates fair value.
Reserves for losses and LAE on property and casualty insurance coverage and health insurance coverage represent the estimated claim cost and loss adjustment expense necessary to cover the ultimate net cost of investigating and settling all losses incurred and unpaid at the end of any given accounting period. Such estimates are based on individual case estimates for reported claims and estimates for incurred but not reported (“IBNR”) losses, including expected development on reported claims. These estimates are adjusted in the aggregate for ultimate loss expectations based on historical experience patterns and current economic trends, with any change in the estimated ultimate liabilities being reported in the Consolidated Statements of Income in the period of change. Changes in such estimates may be material.
For traditional life insurance products, the reserves for future policy benefits are estimated on the net level premium method using assumptions as of the issue date for mortality, interest, policy lapses and expenses, including provisions for adverse mortality. These assumptions vary by such characteristics as plan, age at issue and policy duration. Mortality assumptions are based on the Company’s historical experience and industry standards. Interest rate assumptions principally range from 3% to 7%. Lapse rate assumptions are based on actual and industry experience. Insurance Reserves for life insurance products are comprised of reserves for future policy benefits plus an estimate of the Company’s liability for unpaid life insurance claims and claims adjustment expenses, which includes an estimate for IBNR life insurance claims. Prior to the third quarter of 2016, except when required by applicable law, the Company did not utilize the database of reported deaths maintained by the Social Security Administration or any other comparable database (a “Death Master File” or “DMF”) in its operations, including to determine its IBNR liability for life insurance products. Instead of using such a database, the Company calculated its IBNR liability for life insurance products using Company-specific historical information, which included analyzing average paid claims and the average lag between date of death and the date reported to the Company for claims for which proof of death had been provided. In the third quarter of 2016, the Company initiated a voluntary enhancement of its claims handling procedures for its life insurance policies. The Company is now utilizing a DMF to identify potential situations where the Company has yet to be notified of an insured’s death and, as appropriate, initiating an outreach process to identify and contact beneficiaries and settle claims. Policyholders’ Benefits and Incurred Losses and Loss Adjustment Expenses for the year ended December 31, 2016 include a charge of $77.8 million to recognize the initial impact of using a DMF in the Company’s operations, including to determine its IBNR liability for unpaid claims and claims adjustment expenses for life insurance products. No such charge was recorded during the years ended December 31, 2018 or 2017.
The Company accounts for the value of business acquired (“VOBA”) based on actuarial estimates of the present value of future cash flows embedded in insurance in force as of an acquisition date. VOBA was $30.2 million and $26.0 million at December 31, 2018 and 2017, respectively. VOBA is amortized over the expected profit emergence period of the policies in force as of the acquisition date. The Company estimates that it will record VOBA amortization of $6.3 million in 2019, $4.0 million in 2020, $2.8 million in 2021, $2.2 million in 2022 and $1.8 million in 2023. The Company evaluates VOBA assets for recoverability annually.
The Company accounts for the future profits embedded in customer relationships (“Customer Relationships”) acquired based on the present value of estimated future cash flows from such relationships. Customer Relationships was $6.7 million and $7.3 million at December 31, 2018 and 2017, respectively, and are amortized on a straight-line basis over the estimated useful life of the relationship. 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 accounts for the present value of the future profits embedded in broker or agent relationships acquired (“Agent Relationships”) based on the present value of estimated future cash flows from such acquired relationships or, using the cost recovery method, which estimates the ultimate cost to build a comparable distribution network. Agent Relationships was $68.0 million and $15.6 million at December 31, 2018 and 2017, respectively and are amortized on a straight-line basis over the estimated useful life of the relationship. Agent 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.
Traditional life insurance premiums are recognized as revenue when due. Policyholders’ benefits are associated with related premiums to result in recognition of profits over the periods for which the benefits are provided using the net level premium method.
Deferred income tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. A valuation allowance, if any, is maintained for the portion of deferred income tax assets that the Company does not expect to recover. Increases, if any, in the valuation allowance for deferred income tax assets are recognized as income tax expense. Decreases, if any, in the valuation allowance for deferred income tax assets are recognized as income tax benefit. The effect on deferred income tax assets and liabilities of a change in tax law including a change in tax rates is recognized in income from continuing operations in the period in which the change is enacted.
The Company applied the modified retrospective transition method, except for the provisions regarding equity investments without readily determinable fair values, which were applied on a prospective basis, with no impact on the Company’s Total Shareholders’ Equity. The Company recognized a $17.7 million increase to Retained Earnings, and a corresponding reduction to AOCI, as of January 1, 2018, which represents the accumulated net unrealized gains on Equity Securities at Fair Value immediately prior to the adoption of ASU 2016-01. The Company has recorded equity investments without readily-determinable fair values under the caption Equity Securities at Modified Cost in the Consolidated Balance Sheets. As a result of adopting ASU 2016-01, the Company revised its accounting policy as of January 1, 2018 and no longer classifies equity investments as available-for-sale or trading securities. Equity securities with readily-determinable fair values, including equity securities which the Company previously classified as Fair Value Option Investments, are classified as Equity Securities at Fair Value in the Consolidated Balance Sheet at December 31, 2018 with changes in fair value recorded as Income from Change in
On January 1, 2018, the Company early adopted ASU 2018-02, Reclassification of Certain Income Tax Effects from Accumulated Other Comprehensive Income. ASU 2018-02 provides companies the option to reclassify tax effects stranded in AOCI, as a result of the 2017 Tax Cuts and Jobs Act (the “Tax Act”), to retained earnings. The Company elected to reclassify tax effects stranded in AOCI and recognized a decrease to Retained Earnings and a corresponding increase to AOCI of $35.9 million as of January 1, 2018. The adoption of ASU 2018-02 had no impact on Total Shareholders’ Equity.
On January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those services. ASU 2014-09 specifically excludes insurance contracts, lease contracts and investments from its scope. Accordingly, the adoption of ASU 2014-09 had no material impact on the Company’s net income or its financial position.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that utilizes expected credit losses to provide for an allowance for credit losses for financial instruments and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments in this ASU require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The income statement includes the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. Credit losses on available-for-sale debt securities are measured in a manner similar to current GAAP, although the ASU requires that they be presented as an allowance rather than as a write-down. In situations where the estimate of credit loss on an available-for-sale debt security declines, entities will be able to record the reversal to income in the current period, which GAAP currently prohibits. ASU 2016-13 is effective for annual periods beginning after December 15, 2019 and interim periods within those annual periods with early adoption permitted for fiscal years beginning after December 31, 2018 and interim periods within such year. The Company is currently evaluating the impact of this guidance on its financial statements.
The Company has adopted all recently issued accounting pronouncements with effective dates prior to January 1, 2019. There were no adoptions of such accounting pronouncements in 2018 that had a material impact on the Company’s Consolidated Financial Statements. With the possible exceptions of ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and ASU 2018-12, Financial Services-Insurance (Topic 944): Targeted Improvement to Account for Long Duration Contracts, the Company does not expect the adoption of all other recently issued accounting pronouncements with effective dates after December 31, 2018 to have a material impact on the Company’s financial statements.
On July 2, 2018, Kemper acquired 100% of the outstanding common stock of Infinity Property and Casualty Corporation (“Infinity”), pursuant to the terms of the merger agreement dated February 13, 2018, with total cash, stock and equity-based compensation consideration paid to Infinity shareholders of approximately $1.5 billion. In conjunction with closing the acquisition, Kemper issued 13,184,107 shares, with an aggregate fair value of $982.5 million based on Kemper’s July 2, 2018 stock price of $74.53 per share, and paid $564.6 million in cash consideration to Infinity’s shareholders. In addition, Kemper issued 44,010 restricted units under Kemper’s equity-based compensation plan to replace Infinity restricted shares that were outstanding immediately prior to the closing. The aggregate fair value of such Kemper restricted units granted was $3.3 million at July 2, 2018, of which $1.6 million is attributed to service provided prior to the closing and included in consideration paid. The remaining amount of $1.7 million is attributed to future service and will be recognized in compensation expense primarily over a period of two years. The cash consideration was funded by cash on hand as of July 2, 2018, inclusive of $250.0 million in borrowings under the Company’s delayed draw term loan facility and $110.0 million of Kemper subsidiary borrowings from the FHLB of Dallas and FHLB of Chicago. On July 13, 2018, Kemper subsidiaries repaid in full the $110.0 million of FHLB borrowings, plus accrued interest. On December 28, 2018, Kemper repaid $215.0 million of the delayed draw term loan facility. See Note 7, “Debt,” to the Consolidated Financial Statements for additional information. Infinity is a national provider of auto insurance focused on serving the specialty automobile market. With approximately 10,600 independent agents and $1.4 billion in 2017 direct written premiums, Infinity is one of the largest specialty auto insurers in the United States.
Based on the Company’s preliminary allocation of the purchase price as of December 31, 2018, the fair values of the assets acquired and liabilities assumed were:
The following unaudited pro forma information presents the Company’s results of operations as if the acquisition of Infinity occurred on January 1, 2017. The adjustments to arrive at the pro forma information below included adjustments for the lost investment income on the cash used to fund the acquisition, amortization of the fair value adjustment on Infinity investments, amortization of the acquired intangible assets, interest expense on debt incurred to finance the acquisition and the exclusion of
The amortized cost and estimated fair values of the Company’s Investments in Fixed Maturities at December 31, 2017 were:
The amortized cost and estimated fair values of the Company’s Investments in Fixed Maturities at December 31, 2018 by contractual maturity were:
Unrealized losses on fixed maturities, which the Company has determined to be temporary at December 31, 2018, were $86.6 million, of which $22.0 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, 2018 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “Less Than 12 Months.” There were no unrealized losses at December 31, 2018 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “12 Months or Longer.” Investment-grade fixed maturity investments comprised $69.5 million and below-investment-grade fixed maturity investments comprised $17.1 million of the unrealized losses on investments in fixed maturities at December 31, 2018. For below-investment-grade fixed maturity investments in an unrealized loss position, the unrealized loss amount, on average, was less than 5% of the amortized cost basis of the investment. At December 31, 2018, 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, 2018 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.
On January 1, 2018, the Company adopted ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. See Note 2, “Summary of Accounting Policies and Accounting Changes,” to the Consolidated Financial Statements under the sub-caption “Change in Accounting and Adoption of New Accounting Standards” for additional discussion.
As a result of adopting ASU 2016-01, the Company revised its accounting policy as of January 1, 2018 and no longer classifies equity investments as available-for-sale or trading securities. Equity securities with readily-determinable fair values, including equity securities which the Company previously classified as Fair Value Option Investments, are classified as Equity Securities at Fair Value in the Consolidated Balance Sheet at December 31, 2018 with changes in fair value recorded as Income from Change in Fair Value of Equity and Convertible Securities in the Consolidated Statement of Income for the year ended December 31, 2018. Net unrealized losses arising during the year-ended December 31, 2018 and recognized in earnings, related to such investments still held as of December 31, 2018 were $48.9 million.
Gross unrealized gains and gross unrealized losses on the Company’s Investments in Equity Securities at Fair Value at December 31, 2017 is presented below.
For Investments in Equity Securities at Fair Value at December 31, 2017, the Company considered various factors when determining whether a decline in the fair value was other than temporary, including, but not limited to:
The Company tests goodwill for recoverability at the reporting unit level on an annual basis, or whenever events or circumstances indicate the fair value of a reporting unit may have declined below its carrying value. In 2018, the Company changed the date on which it performs the annual goodwill impairment test from January 1 to October 1, moving the test date closer to year-end. Accordingly, the Company performed two goodwill impairment tests in 2018, the first as of January 1, 2018 and the second as of October 1, 2018. The Company performed a qualitative goodwill impairment assessment as of both dates for all reporting units with goodwill. In prior years, the Company performed a quantitative goodwill impairment assessment. The qualitative assessment takes into consideration changes in macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, changes in management or key personnel, changes in strategy and changes in our stock price since the last quantitative assessment, which was performed on January 1, 2017. Both the qualitative and quantitative goodwill impairment assessments compare the estimated fair value of a reporting unit to its carrying value to determine if there is an impairment of goodwill. 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.
The Company records intangible assets acquired in business combinations and certain costs incurred developing and customizing internal-use software within Other Assets on the Consolidated Balance Sheet. Definite lived intangible assets are amortized over the estimated profit emergence period or estimated useful life of the asset. Indefinite lived intangible assets are not amortized, but rather tested annually for impairment. In 2018 and 2017, the Company recognized amortization expense on definite lived intangible assets of $166.4 million and $11.3 million, respectively.
The determination of individual case reserves differs by line of business. For preferred personal automobile insurance, homeowners insurance and other personal insurance, case reserves are set by adjusters and are based on the adjusters’ estimates of the amount for which the claims will ultimately be paid. For specialty personal automobile insurance and commercial automobile insurance, case reserves are set primarily using statistical reserves that are based on studies of historical average paid amounts by state, coverage and product. However, when such reserves exceed certain thresholds they are set manually by adjusters.
The following tables contain information about incurred and paid claims development as of and for the year ended December 31, 2018, net of reinsurance and indemnification, as well as cumulative claim frequency and the total of IBNR liabilities, including expected development on reported claims included within the net incurred losses and allocated LAE amounts. The tables are grouped by major product line and, if relevant, coverage. The information about incurred and paid claims development for the years ended December 31, 2014 through 2017 is presented as supplementary information and is unaudited.
The claim counts in the preceding tables are cumulative reported claim counts as of December 31, 2018 and are equal to the sum of cumulative open and cumulative closed claims, including claims closed without payment. Certain product lines, particularly the Company’s specialty personal automobile insurance, tend to have a higher percentage of claims closed without payment.
Property and Casualty Insurance Reserve activity for the years ended December 31, 2018, 2017 and 2016 was:
adversely by $19.5 million, and commercial lines insurance loss and LAE reserves developed favorably by $0.6 million. Personal automobile insurance loss and LAE reserves developed adversely by $22.2 million due primarily to the emergence of loss patterns that were worse than expected for both physical damage and liability insurance for the 2016 accident year and, to a lesser extent, for liability insurance for the 2015 and 2014 accident years, partially offset by the emergence of more favorable loss patterns than expected for the 2013 and prior accident years. Homeowners insurance loss and LAE reserves developed adversely by $1.0 million due primarily to the emergence of non-catastrophe loss patterns that were worse than expected for the 2016 accident year, and to a lesser extent, the 2013 and prior accident years, partially offset by $3.7 million of favorable development on catastrophes primarily for the 2016 accident year and, to a lesser extent, the 2015 accident year. Other personal lines loss and LAE reserves developed favorably by $3.7 million due primarily to the emergence of more favorable loss patterns than expected for the 2015, 2014, 2013 and prior accident years, partially offset by the emergence of loss patterns that were worse than expected for the 2016 accident year. Commercial lines insurance loss and LAE reserves included adverse development of $0.9 million from continuing operations and favorable development of $1.5 million from discontinued operations.
The Company designates debt obligations as either short-term or long-term based on maturity date at issuance, or in the case of the 2022 Senior Notes, based on the date of assumption. Total amortized cost of Long-term Debt outstanding at December 31, 2018 and 2017 was:
The Company has $450.0 million of 4.35% senior notes due February 15, 2025 (the “2025 Senior Notes”) outstanding as of December 31, 2018. The Company initially issued $250.0 million of the 2025 Senior Notes in February of 2015, with proceeds from the issuance of $247.3 million, net of discount and transaction costs, for an effective yield of 4.49%. Kemper used the net proceeds from the sale, together with available cash, to redeem in full the $250.0 million outstanding principal amount of its 6.00% senior notes due November 30, 2015.
Future minimum lease payments under capital and operating leases at December 31, 2018 were:
The total of minimum rentals to be received in the future under non-cancelable subleases was $0.0 million and $0.4 million at December 31, 2018 and 2017, respectively.
Kemper did not repurchase any of its common stock in open market transactions in 2018 or 2017. Kemper repurchased and retired 0.1 million shares of its common stock in open market transactions at an aggregate cost of $3.8 million in 2016.
Kemper’s insurance subsidiaries are required to file financial statements prepared on the basis of statutory insurance accounting practices, a comprehensive basis of accounting other than GAAP. Statutory capital and surplus for the Company’s life and health insurance subsidiaries was $454.7 million and $414.3 million at December 31, 2018 and 2017, respectively. Statutory net income for the Company’s life and health insurance subsidiaries was $143.9 million, $84.1 million and $29.7 million for the years ended December 31, 2018, 2017 and 2016, respectively. Statutory capital and surplus for the Company’s property and casualty insurance subsidiaries was $1.4 billion and $855.3 million at December 31, 2018 and 2017, respectively. Statutory net income for the Company’s property and casualty insurance subsidiaries was $236.4 million, $56.9 million and $1.4 million for the years ended December 31, 2018, 2017 and 2016, respectively. Statutory capital and surplus and statutory net income exclude parent company operations.
Outstanding equity-based compensation awards at December 31, 2018 consisted of tandem stock option and stock appreciation rights (“Tandem Awards”), RSUs, PSUs and DSUs. RSUs, PSUs and DSUs give the recipient the right to receive one share of Kemper common stock for each RSU, PSU or DSU issued. Recipients of RSUs, PSUs and DSUs receive full dividend equivalents on the same basis as all other outstanding shares of Kemper common stock, but do not receive voting rights until such shares are issued. Except as described below for equity-based compensation awards granted to each member of the Board of Directors who is not employed by the Company (“Non-employee Directors”), all outstanding awards are subject to forfeiture until certain restrictions have lapsed.
Tandem Award activity for the year ended December 31, 2018 is presented below.
The weighted-average grant-date fair values of Tandem Awards granted during 2018, 2017 and 2016 were $15.14, $8.89 and $5.17, respectively. Total intrinsic value of Tandem Awards exercised was $3.9 million, $4.9 million and $2.0 million for the years ended December 31, 2018, 2017 and 2016, respectively. Cash received from exercises of Tandem Awards was $0.9 million, $4.0 million and $3.5 million for the years ended December 31, 2018, 2017 and 2016, respectively. Total tax benefit realized for tax deductions from exercises of Tandem Awards was $0.8 million, $1.7 million and $0.7 million for the years ended December 31, 2018, 2017 and 2016, respectively.
exceeds the “target” performance level, all of the PSUs will vest and additional shares of stock will be issued to the award recipient;
Fifty percent of the PSU awards granted to employees and officers in 2018, 2017 and 2016 are measured solely using a Company-specific metric. Final payout for these awards, and any forfeitures of shares for performance below the “target” performance level, will be determined based on Kemper’s adjusted return on equity over a three-year performance period. The three-year performance periods for the 2018, 2017 and 2016 awards end on December 31, 2020, December 31, 2019 and December 31, 2018, respectively. Fair value for these awards was determined using the closing price of Kemper common stock on the date of grant. Accruals of compensation cost for these awards are estimated based on the probable outcome of the performance condition.
The number of shares of Kemper common stock that were excluded from the calculations of Equity-based Compensation Equivalent Shares and Weighted-average Unrestricted Shares and Equivalent Shares Outstanding Assuming Dilution for the years ended December 31, 2018, 2017 and 2016 because the exercise prices for the options exceeded the average market price is presented below.
The components of Other Comprehensive Income (Loss) Before Income Taxes for the years ended December 31, 2018, 2017 and 2016 were:
NOTE 12. OTHER COMPREHENSIVE INCOME (LOSS) AND ACCUMULATED OTHER COMPREHENSIVE INCOME (Continued)
Net Investment Income for the years ended December 31, 2018, 2017 and 2016 was:
Other Receivables includes accrued investment income of $77.9 million and $72.8 million at December 31, 2018 and 2017, respectively.
The tax effects of temporary differences that give rise to significant portions of the Company’s Net Deferred Income Tax Assets and Deferred Income Tax Liabilities at December 31, 2018 and 2017 were:
The expiration of federal net operating loss (“NOL”) carryforwards and their related deferred income tax assets at December 31, 2018 is presented below by year of expiration.
A reconciliation of the beginning and ending amount of Unrecognized Tax Benefits for the years ended December 31, 2018, 2017 and 2016 is presented below.
The statute of limitations related to Kemper and its eligible subsidiaries’ consolidated Federal income tax returns is closed for all tax years up to and including 2011. As a result of the Company filing amended federal income tax returns resulting from an election to update interest rates used to compute the tax basis of reserves on life insurance contracts issued prior to 2018, tax years 2012 and 2013 are under limited examination with respect to carryback adjustments associated with the amended returns. The statute of limitations related to tax years 2014 and 2015 has been extended to December 31, 2019.
The expiration of the statute of limitations related to the various state income tax returns that Kemper and its subsidiaries file varies by state.
The components of Income Tax Expense from Continuing Operations for the years ended December 31, 2018, 2017 and 2016 were:
Kemper sponsors a qualified defined benefit pension plan (the “Pension Plan”). The Pension Plan covers approximately 8,800 participants and beneficiaries, of which 1,400 are active employees. Effective June 30, 2016, benefit accruals were frozen for substantially all of the participants under the Pension Plan, and, effective January 1, 2006 the Pension Plan was closed to new hires. The Pension Plan is generally non-contributory, but participation requires or required some employees to contribute 3% of pay, as defined, per year. Benefits for participants who are or were required to contribute to the Pension Plan are based on compensation during plan participation and the number of years of participation. Benefits for the vast majority of participants who are not required to contribute to the Pension Plan are based on years of service and final average pay, as defined. The Company funds the Pension Plan in accordance with the requirements of ERISA.
The weighted-average discount rate and rate of increase in future compensation levels used to estimate the components of the Projected Benefit Obligation for the Pension Plan at December 31, 2018 and 2017 were:
The trust investment committee for the Pension Plan, along with its third party fiduciary advisor, periodically reviews the performance of the Pension Plan’s investments and asset allocation. Several external investment managers, one of which is Fayez Sarofim & Co. (see Note 24, “Related Parties,” to the Consolidated Financial Statements), manage the equity investments of the trust for the Pension Plan. Each manager is allowed to exercise investment discretion, subject to limitations, if any, established by the trust investment committee for the Pension Plan. All other investment decisions are made by the Company, subject to general guidelines as set by the trust investment committee for the Pension Plan.
The fair values of pension plan assets are estimated using the same methodologies and inputs as those used to determine the fair values for the respective asset category of the Company. These methodologies and inputs are disclosed in Note 22, “Fair Value Measurements,” to the Consolidated Financial Statements. Fair value measurements for the Pension Plan’s assets at December 31, 2018 are summarized below.
The components of Comprehensive Pension Expense (Income) for the Pension Plan for the years ended December 31, 2018, 2017 and 2016 were:
The actuarial loss included in AOCI at December 31, 2018 is being amortized over approximately 23 years, the remaining average estimated life expectancy of participants. The Company estimates that Pension Income for the Pension Plan for the year ended December 31, 2019 will include expense of $2.6 million resulting from the amortization of the related accumulated actuarial loss included in AOCI at December 31, 2018.
The Company also sponsors several defined contribution benefit plans covering most of its employees. The Company made contributions to those plans of $15.1 million, $10.6 million and $8.4 million in 2018, 2017 and 2016, respectively.
The weighted-average discount rate and rate of increase in future compensation levels used to develop the components of the Accumulated Postretirement Benefit Obligation at December 31, 2018 and 2017 were:
The assumed health care cost trend rate used in measuring the Accumulated Postretirement Benefit Obligation at December 31, 2018 was 7.50% for 2019, gradually declining to 4.8% in the year 2025 and remaining at that level thereafter for medical benefits and 10.00% for 2019, gradually declining to 4.8% in the year 2026 and remaining at that level thereafter for prescription drug benefits. The assumed health care cost trend rate used in measuring the Accumulated Postretirement Benefit Obligation at December 31, 2017 was 7.5% for 2018, gradually declining to 4.8% in the year 2025 and remaining at that level thereafter for medical benefits and 10.0% for 2018, gradually declining to 4.8% in the year 2026 and remaining at that level thereafter for prescription drug benefits.
The components of Comprehensive OPEB Expense (Income) for the years ended December 31, 2018, 2017 and 2016 were:
Segment Revenues, including a reconciliation to Total Revenues, for the years ended December 31, 2018, 2017 and 2016 were:
Segment Operating Profit, including a reconciliation to Income from Continuing Operations before Income Taxes, for the years ended December 31, 2018, 2017 and 2016 was:
Summary financial information included in Income from Discontinued Operations for the years ended December 31, 2018, 2017 and 2016 is presented below.
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 $27.5 million and $32.8 million at December 31, 2018 and 2017, respectively, for the retained liabilities. In accordance with GAAP, changes in the Company’s estimate of such retained liabilities after the sale are reported as a separate component of the results of discontinued operations. See Note 6, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements for information pertaining cash used by operating activities to pay losses and LAE related to discontinued operations.
The catastrophe reinsurance in 2018, 2017 and 2016 for the property and casualty insurance companies also included reinsurance coverage from the Florida Hurricane Catastrophe Fund (the “FHCF”) for hurricane losses in Florida at retentions lower than those described above. The Life & Health Insurance segment also purchases reinsurance from the FHCF for hurricane losses in Florida. Except for the coverage provided by the FHCF, the Life & Health Insurance segment does not carry any other catastrophe reinsurance coverage.
In 2018 and 2017, the Company paid $0.4 million and $0.8 million, respectively, in reinstatement premium. The Company did not pay any reinstatement premium in 2016.
In 2018 and 2017, Kemper’s property and casualty subsidiaries had catastrophe reinsurance recoveries of $31.8 million and $11.9 million under the catastrophe reinsurance program. The property and casualty insurance companies did not have any recoveries from the FHCF. The Life & Health Insurance segment had reinsurance recoveries of $1.6 million and $0.2 million from the FHCF in 2018 and 2017. Neither segment had catastrophe reinsurance recoveries from the FHCF in 2016.
Total catastrophe loss and LAE reserves, net of reinsurance recoverables, developed favorably by $8.4 million, $4.5 million and $19.3 million in 2018, 2017 and 2016, respectively. The Preferred Property & Casualty Insurance segment reported favorable catastrophe reserve development of $8.2 million, $4.7 million and $19.0 million in 2018, 2017 and 2016, respectively. The Specialty Property & Casualty Insurance segment reported favorable catastrophe reserve development of $0.3 million, $0.3 million, and $0.2 million in 2018, 2017 and 2016, respectively. The Life & Health Insurance segment reported adverse catastrophe reserve development of $0.1 million in 2018, favorable catastrophe reserve development of $0.5 million in 2017, and adverse catastrophe reserve development of $0.1 million in 2016.
Earned Premiums ceded on long-duration and short-duration policies were $31.6 million, $18.2 million and $19.0 million for the years ended December 31, 2018, 2017 and 2016, respectively, of which $20.5 million, $11.0 million and $12.0 million, respectively, was related to catastrophe reinsurance. See Note 20, “Catastrophe Reinsurance,” to the Consolidated Financial Statements for additional information regarding the Company’s catastrophe reinsurance programs. Certain insurance subsidiaries assume business from other insurance companies and involuntary pools. Earned Premiums assumed on long-duration and short-duration policies were $85.2 million, $72.9 million and $67.3 million for the years ended December 31, 2018, 2017 and 2016, respectively.
Trinity and Capitol County Mutual Fire Insurance Company (“Capitol”) are parties to a quota share reinsurance agreement whereby Trinity assumes 100% of the business written by Capitol, subject to a cap, for ceded losses for dwelling coverage. Earned Premiums assumed by Trinity from Capitol were $20.0 million, $20.7 million and $21.3 million for the years ended December 31, 2018, 2017 and 2016, respectively. Capitol is a mutual insurance company and, accordingly, is owned by its policyholders. Trinity and Old Reliable Casualty Company (“ORCC”), a subsidiary of Capitol, are parties to a quota share reinsurance agreement whereby Trinity assumes 100% of the business written by ORCC, subject to a cap for ceded losses for dwelling coverage. Earned Premiums assumed by Trinity from ORCC were $5.6 million, $5.9 million and $6.2 million for the years ended December 31, 2018, 2017 and 2016, respectively.
The valuation of assets measured at fair value in the Company’s Consolidated Balance Sheet at December 31, 2017 is summarized below.
The Company’s investments in Fixed Maturities that are classified as Level 3 in the two preceding tables primarily consist of privately placed securities not rated by a Nationally Recognized Statistical Rating Organization and are priced primarily using a market yield approach. A market yield approach uses a risk-free rate plus a credit spread depending on the underlying credit profile of the security. For floating rate securities, the risk-free rate used in the market yield is the contractual floating rate of the security. For each individual security, the Company or the Company’s third party appraiser gathers information from market sources, relevant credit information, perceived market movements and sector news and determines an appropriate market yield for each security. The market yield selected is then used to discount the estimated future cash flows of the security to determine the fair value. The Company separately evaluates market yields based upon asset class to assess the reasonableness of the recorded fair value. For non-investment-grade investments in Fixed Maturities that are classified as Level 3, the two primary asset classes are senior debt and junior debt. Senior debt includes those securities that receive first priority in a liquidation and junior debt includes any fixed maturity security with other than first priority in a liquidation.
The table below presents quantitative information about the significant unobservable inputs utilized by the Company in determining fair values for fixed maturity investments in corporate securities classified as Level 3 at December 31, 2018.
The Company’s policy is to recognize transfers between levels as of the end of the reporting period. There were no transfers between Levels 1 and 2 for the year ended December 31, 2017. Transfers into Level 3 for the year ended December 31, 2017 relate to transfers from Level 2 due to to changes in the availability of market observable inputs. Transfers out of Level 3 were $45.4 million for the year ended December 31, 2017, of which $3.5 million was transferred into Level 1 due to an issuer’s initial public offering of the security and $41.9 million was transferred into Level 2 due to changes in the availability of market observable inputs.
In the ordinary course of its businesses, the Company is involved in legal proceedings, including lawsuits, regulatory examinations, audits and inquiries. Except with regard to the matters discussed below, based on currently available information, the Company does not believe that it is reasonably possible that any of its pending legal proceedings will have a material effect on the Company’s consolidated financial statements.
In October 2015, Kemper’s subsidiary, Kemper Corporate Services, Inc. (“KCSI”), filed a demand for arbitration with the American Arbitration Association (“AAA”), claiming that Computer Services Corporation (“CSC”) had breached the terms of a master software license and services agreement and related agreements (collectively, the “Agreements”) by failing, among other things, to timely produce and deliver certain software to KCSI. CSC denied KCSI’s claims and filed a counterclaim. On April 1, 2017, CSC merged with a spin-off of the Enterprise Services business of Hewlett Packard Enterprise Company and is now known as DXC Technology Company (“DXC”). Currently, DXC’s stock is publicly traded on the New York Stock Exchange.
In April 2017, the parties participated in an evidentiary hearing in Texas before a AAA-appointed arbitrator. Subsequently, in October 2017, the arbitrator issued a Partial Final Award finding that CSC had breached the Agreements and awarding KCSI direct damages plus pre-judgment interest. KCSI then submitted to the arbitrator a supplemental petition providing pre-judgment interest calculations and seeking an award for certain costs and expenses. In November 2017, the arbitrator issued a Final Award awarding KCSI direct damages against CSC of $84.3 million, prejudgment interest at the annual rate of 9% and costs and expenses in the amount of $7.2 million.
KCSI pursued confirmation and enforcement of the Final Award in U.S. District Court in Texas. In December 2017, CSC filed
a Petition to Vacate an Arbitration Award in the U.S. District Court in New York and a motion to stay the proceedings in Texas. Following briefing and a hearing, the New York district court denied CSC’s motion to stay the Texas action and instead stayed the New York action. In March 2018, the Texas district court denied CSC’s motion to transfer venue and the New York district court subsequently transferred the vacatur proceeding to Texas. In April 2018, the Texas district court consolidated the two actions and the parties briefed KCSI’s Amended Motion to Confirm Arbitration Award and CSC’s motion to vacate the arbitration award.
On September 26, 2018, the Texas district court issued an Amended Final Judgment that (i) confirmed the Arbitration Award in favor of KCSI, (ii) denied CSC’s motion to vacate, and (iii) entered judgment against CSC in the total amount of $141.7 million. CSC has appealed the district court’s ruling to the U.S. Court of Appeals for the Fifth Circuit, but in the meantime has paid Kemper $35.7 million in partial satisfaction of the final judgment, with approximately $28.5 million of the payment attributable to the direct damages that are not contested by CSC and $7.2 million to the costs and expenses noted above. Kemper recognized the payment as a gain for year ended December 31, 2018 in these Consolidated Financial Statements.
FS&C whereby FS&C provides investment management services with respect to certain funds of the plan. Investment Expenses incurred in connection with such agreement were $0.9 million, $0.9 million and $0.8 million for the years ended December 31, 2018, 2017 and 2016, respectively.
The sum of quarterly per share amounts may not equal per share amounts for the year due to differences in weighted-average shares and/or equivalent shares outstanding for each of the periods presented.