Selected financial information as of and for the years ended December 31, 2013, 2012, 2011, 2010 and 2009 is presented below.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Net Income was $217.7 million ($3.81 per unrestricted common share) for the year ended December 31, 2013, compared to $103.4 million ($1.75 per unrestricted common share) for the year ended December 31, 2012. Income from Continuing Operations was $214.5 million ($3.75 per unrestricted common share) in 2013, compared to $91.8 million ($1.55 per unrestricted common share) in 2012.
A reconciliation of Total Segment Net Operating Income to Net Income for the years ended December 31, 2013, 2012 and 2011 is presented below:
The Company manages its exposure to catastrophes and other natural disasters through a combination of geographical diversification, management of the amount and location of new business production in certain regions and primary catastrophe reinsurance programs for its property and casualty insurance businesses. Coverage for each primary catastrophe reinsurance program is provided in various layers (see Note 20, “Catastrophe Reinsurance,” to the Consolidated Financial Statements for further discussion of these programs). In addition to these programs, the Kemper Preferred segment had a reinsurance treaty covering the three-year period that ended June 1, 2013 for catastrophe losses in North Carolina at retentions lower than the Company’s primary catastrophe reinsurance programs (“the Kemper Preferred NC Program”). The Company purchases reinsurance from the FHCF for hurricane losses in Florida at retentions lower than the Company’s primary catastrophe reinsurance programs.
Catastrophe reinsurance premiums for the Company’s primary reinsurance programs, the Kemper Preferred NC Program and the FHCF reduced earned premiums for the years ended December 31, 2013, 2012 and 2011 by the following:
Catastrophe losses and LAE (excluding loss and LAE reserve development) by business segment for the years ended December 31, 2013, 2012 and 2011 are presented below:
The number of catastrophic events and catastrophe losses and LAE (excluding loss and LAE reserve development) by range of loss for the years ended December 31, 2013, 2012 and 2011 are presented below:
As shown in the preceding table, catastrophe losses and LAE decreased for the year ended December 31, 2013, compared to 2012, due primarily to no occurrences of events with losses in excess of $25 million in 2013, compared with one event in 2012; no occurences of losses in the $10 million to $15 million range in 2013, compared with one event in 2012; and lower frequency and severity of losses ranging from $5 million to $10 million per event in 2013, compared to 2012, partially offset by higher frequency and severity of losses below $5 million per event in 2013, compared to 2012.
As shown in the preceding table, catastrophe losses and LAE decreased for the year ended December 31, 2012, compared to 2011, due primarily to lower severity of losses below $5 million per event in 2012, compared to 2011, and lower frequency of losses in excess of $15 million per event in 2012, compared to 2011, partially offset by higher frequency of losses ranging from $5 million to $10 million per event in 2012, compared to 2011.
The five events in the $5 million to $10 million range and one event in the $10 million to $15 million range for the year ended December 31, 2012 were related to hail or wind events in either Texas, Colorado or the Midwest and mid-Atlantic states. In the fourth quarter of 2012, the Company incurred claims related to one event in the greater than $25 million range which was Superstorm Sandy. In late October 2012, Superstorm Sandy, a named catastrophe and at one point a level two hurricane while over the Atlantic ocean, caused a significant amount of damage in several northeastern states. Catastrophe losses and LAE for the year ended December 31, 2012 includes $48.5 million related to Superstorm Sandy, of which $44.0 million is included in the Kemper Preferred segment.
Total catastrophe loss and LAE reserves, net of reinsurance recoverables, developed favorably by $14.5 million, $6.3 million and $6.4 million in 2013, 2012 and 2011, respectively. Favorable catastrophe loss and LAE reserve development in 2013 included favorable development of $1.5 million from Superstorm Sandy and favorable development, net of reinsurance, of $2.0 million resulting from a final assessment issued by the Mississippi Windstorm Underwriting Association (“MWUA”) that reduced the Company’s share of MWUA’s losses for the 2004 through 2006 policy periods. See MD&A, “Loss and LAE Reserve Development,” of this 2013 Annual Report for catastrophe loss and LAE reserve development by business segment.
Increases (decreases) in the Company’s property and casualty loss and LAE reserves for the years ended December 31, 2013, 2012 and 2011 to recognize adverse (favorable) loss and LAE reserve development from prior accident years in continuing operations, hereinafter also referred to as “reserve development” in the discussion of segment results, is presented below:
The following discussions for the Kemper Preferred, Kemper Specialty and Kemper Direct segments use the non-GAAP financial measures of (i) Underlying Losses and LAE and (ii) Underlying Combined Ratio. Underlying Losses and LAE (also referred to in the discussion as “Current Year Non-catastrophe Losses and LAE”) exclude the impact of catastrophe losses, and loss and LAE reserve development from the Company’s Incurred Losses and LAE, which is the most directly comparable GAAP financial measure. The Underlying Combined Ratio is computed by adding the Current Year Non-catastrophe Losses and LAE Ratio with the Incurred Expense Ratio. The most directly comparable GAAP financial measure is the combined ratio, which uses total incurred losses and LAE, including the impact of catastrophe losses, and loss and LAE reserve development.
The Company believes Underlying Losses and LAE and the Underlying Combined Ratio are useful to investors and are used by management to reveal the trends in the Company’s Property and Casualty insurance businesses that may be obscured by catastrophe losses and prior year reserve development. These catastrophe losses may cause the Company’s loss trends to vary significantly between periods as a result of their incidence of occurrence and magnitude, and can have a significant impact on incurred losses and LAE and the combined ratio. Prior year reserve developments are caused by unexpected loss development on historical reserves. Because reserve development relates to the re-estimation of losses from earlier periods, it has no bearing on the performance of the Company’s insurance products in the current period. The Company believes it is useful for investors to evaluate these components separately and in the aggregate when reviewing the Company’s underwriting performance.
Net Investment Income in the Kemper Preferred segment increased by $10.7 million for the year ended December 31, 2013, compared to 2012, due primarily to higher net investment income from Equity Method Limited Liability Investments, higher dividends on equity securities and higher levels of investments allocated to the Kemper Preferred segment, partially offset by lower yields on fixed maturities. The Kemper Preferred segment reported net investment income from Equity Method Limited Liability Investments of $10.1 million in 2013, compared to $4.0 million in 2012.
Operating Profit in the Kemper Preferred segment was $87.7 million for the year ended December 31, 2013, compared to an Operating Loss of $28.0 million in 2012. Operating results improved due primarily to lower catastrophe losses and LAE (excluding reserve development), lower underlying losses and LAE as a percentage of earned premiums, higher favorable loss and LAE reserve development and higher net investment income, partially offset by higher insurance expenses as a percentage of earned premiums. Underlying losses and LAE exclude the impact of catastrophes and loss and LAE reserve development. Catastrophe losses and LAE (excluding reserve development) were $41.1 million in 2013, compared to $105.4 million in 2012. Underlying losses and LAE as a percentage of earned premiums improved due to lower underlying losses as a percentage of earned premiums in homeowners insurance and other personal insurance. Favorable loss and LAE reserve development (including catastrophe development) was $27.5 million in 2013, compared to $4.8 million in 2012. Kemper Preferred continues to take actions intended to improve profitability, including additional rate increases, enhanced pricing segmentation, higher deductibles, in particular for wind or hail events, and other underwriting actions.
Automobile insurance incurred losses and LAE were $388.5 million, or 77.1% of automobile insurance earned premiums, for the year ended December 31, 2013, compared to $413.7 million, or 80.3% of automobile insurance earned premiums, in 2012. Automobile insurance incurred losses as a percentage of automobile earned premiums decreased by 3.2% due primarily to a favorable impact from a change in loss and LAE reserve development and lower catastrophe losses and LAE (excluding reserve development), partially offset by higher underlying losses and LAE as a percentage of automobile insurance earned premiums. Favorable loss and LAE reserve development was $3.2 million in 2013, compared to adverse loss and LAE reserve development of $7.3 million in 2012. Catastrophe losses and LAE (excluding reserve development) were $3.5 million in 2013,
compared to $12.7 million in 2012. Underlying losses and LAE as a percentage of automobile insurance earned premiums were 77.1% in 2013, compared to 76.4% in 2012. Underlying losses and LAE as a percentage of automobile insurance earned premiums increased due primarily to higher severity of bodily injury and collision losses, partially offset by higher average premium and lower frequency of bodily injury and comprehensive claims.
Homeowners insurance incurred losses and LAE were $183.6 million, or 57.8% of homeowners insurance earned premiums, for the year ended December 31, 2013, compared to $264.5 million, or 85.7% of homeowners insurance earned premiums, in 2012. Homeowners insurance incurred losses and LAE as a percentage of homeowners insurance earned premiums decreased due primarily to lower catastrophe losses and LAE (excluding reserve development), lower underlying losses and LAE as a percentage of homeowners insurance earned premiums and higher levels of favorable loss and LAE reserve development. Catastrophe losses and LAE (excluding reserve development) on homeowners insurance were $36.4 million in 2013, compared to $87.8 million in 2012. Catastrophe losses and LAE (excluding reserve development) incurred in 2012 were due in part to $44.0 million of catastrophe losses and LAE from Superstorm Sandy and several hail and wind events throughout the United States. Underlying losses and LAE as a percentage of homeowners insurance earned premiums were 52.4% in 2013, compared to 60.3% in 2012. Underlying losses and LAE as a percentage of homeowners insurance earned premiums decreased by 7.9% due primarily to lower severity of losses and higher average premium. Favorable loss and LAE reserve development was $19.2 million in 2013, compared to $9.4 million in 2012.
Other personal insurance incurred losses and LAE were $20.3 million, or 36.8% of other personal insurance earned premiums, for the year ended December 31, 2013, compared to $30.8 million, or 55.6% of other personal insurance earned premiums, in 2012. Other personal insurance incurred losses and LAE decreased by $10.5 million due primarily to lower underlying losses and LAE as a percentage of other personal insurance earned premiums, lower catastrophe losses and LAE (excluding reserve development) and higher levels of favorable loss and LAE reserve development. Underlying losses and LAE as a percentage of other personal insurance earned premiums were 43.8% in 2013, compared to 51.6% in 2012. Underlying losses and LAE as a percentage of other personal insurance earned premiums decreased by 7.8% due primarily to lower frequency of umbrella liability insurance claims, lower severity of losses in other insurance lines (excluding umbrella liability) and higher average premium, partially offset by higher severity of umbrella liability insurance losses. Catastrophe losses and LAE (excluding reserve development) were $1.2 million in 2013, compared to $4.9 million in 2012. Favorable loss and LAE reserve development was $5.1 million in 2013, compared to $2.7 million in 2012.
The Kemper Preferred segment reported Segment Net Operating Income of $63.1 million for the year ended December 31, 2013, compared to Segment Net Operating Loss of $11.2 million in 2012. The Kemper Preferred segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $16.7 million in 2013, compared to $20.2 million in 2012.
Net Investment Income in the Kemper Preferred segment decreased by $3.8 million for the year ended December 31, 2012, compared to 2011, due primarily to lower net investment income from Equity Method Limited Liability Investments. The Kemper Preferred segment reported net investment income from equity method limited liability investments of $4.0 million in 2012, compared to $8.0 million in 2011.
Insurance Expenses increased by $4.0 million for the year ended December 31, 2012, compared to 2011, due primarily to increased new business and renewal production.
Earned Premiums in the Kemper Specialty segment decreased by $27.0 million for the year ended December 31, 2013, compared to 2012, due to lower earned premiums on personal automobile insurance, partially offset by higher earned premiums on commercial automobile insurance. Personal automobile insurance earned premiums decreased by $35.8 million in 2013, compared to 2012, as lower volume of personal automobile insurance decreased personal automobile insurance earned premiums by $63.4 million, while higher average premium accounted for a $27.6 million increase in earned premiums. Personal automobile insurance policies in force were approximately 208,000 at December 31, 2013, compared to 260,000 at the beginning of 2013 and 302,000 at the beginning of 2012. Commercial automobile insurance earned premiums increased by $8.8 million in 2013, compared to 2012, due primarily to higher volume from an increase in new business production.
Operating Profit in the Kemper Specialty segment was $12.3 million for the year ended December 31, 2013, compared to Operating Loss of $2.8 million in 2012. Operating results improved due primarily to lower underlying losses and LAE as a percentage of earned premiums, higher net investment income and a higher level of favorable reserve development, partially offset by higher underwriting expenses as a percentage of earned premiums.
Personal automobile insurance operating results increased by $27.8 million for the year ended December 31, 2013, compared to 2012, due primarily to a favorable impact from a change in loss and LAE reserve development and lower underlying losses and LAE as a percentage of personal automobile insurance earned premiums. Underlying losses and LAE exclude the impact of catastrophes and loss and LAE reserve development. Loss and LAE reserve development on personal automobile insurance had a favorable effect of $1.9 million in 2013, compared to an adverse effect of $10.3 million in 2012. Underlying losses and LAE were $271.9 million, or 79.9% of personal automobile insurance earned premiums in 2013, compared to $312.5 million, or 83.1% of personal automobile insurance earned premiums in 2012. Personal automobile insurance underlying losses and LAE as a percentage of personal automobile insurance earned premiums decreased due primarily to higher average premium and lower frequency of bodily injury and comprehensive claims, partially offset by higher severity of losses in all coverages.
Earned Premiums in the Kemper Specialty segment decreased by $25.4 million for the year ended December 31, 2012, compared to 2011, due primarily to lower earned premiums for personal automobile insurance, partially offset by higher earned premiums on commercial automobile insurance. Personal automobile insurance earned premiums decreased by $28.9 million in 2012, compared to 2011, due primarily to lower volume, partially offset by higher average premium. Personal automobile insurance policies in force were approximately 260,000 at December 31, 2012, compared to 302,000 at the beginning of 2012 and 329,000 at the beginning of 2011. Commercial automobile insurance earned premiums increased by $3.5 million in 2012, compared to 2011, due primarily to higher volume from an increase in new business production.
Net Investment Income in the Kemper Specialty segment decreased by $3.8 million for the year ended December 31, 2012, compared to 2011, due primarily to lower net investment income from equity method limited liability investments and lower levels of investments allocated to Kemper Specialty. The Kemper Specialty segment reported net investment income of $1.7 million from equity method limited liability investments in 2012, compared to $3.7 million for 2011.
Operating Loss in the Kemper Specialty segment was $2.8 million for the year ended December 31, 2012, compared to Operating Profit of $24.2 million in 2011. Operating results deteriorated due primarily to higher underlying losses and LAE as a percentage of earned premiums, lower favorable reserve development, lower net investment income and higher underwriting expenses as a percentage of earned premiums.
Personal automobile insurance operating results decreased by $30.5 million for the year ended December 31, 2012, compared to 2011, due primarily to higher underlying losses and LAE as a percentage of personal automobile insurance earned premiums, unfavorable loss and LAE reserve development, higher insurance expenses as a percentage of personal automobile insurance earned premiums and lower net investment income. Underlying losses and LAE were $312.5 million, or 83.0% of personal automobile insurance earned premiums in 2012 compared to $328.5 million, or 81.1% of personal automobile insurance earned premiums in 2011. Personal automobile insurance underlying losses and LAE as a percentage of personal automobile insurance earned premiums increased due primarily to higher claims handling costs in 2012, compared to 2011. Loss and LAE reserve development on personal automobile insurance had an adverse effect of $10.3 million in 2012, compared to a favorable effect of $3.6 million in 2011, and was related primarily to the 2011 and 2010 accident years.
Commercial automobile insurance operating profit increased by $3.3 million for the year ended December 31, 2012, compared to 2011, due primarily to the favorable effects of loss and LAE reserve development, partially offset by higher underlying losses and LAE as a percentage of commercial automobile insurance earned premiums. Favorable loss and LAE reserve development on commercial automobile insurance was $12.6 million in 2012, of which $5.9 million related to 2011 and 2010 accident years, with the balance of $6.7 million dispersed over several older accident years. Favorable loss and LAE reserve development was $6.1 million in 2011. Underlying losses and LAE as a percentage of commercial automobile insurance earned premiums were 81.5% in 2012, compared to 74.3% in 2011, and increased due primarily to higher frequency of losses.
Management’s Discussion and Analysis of Financial Condition and Results of Operations-(Continued)
Insurance Expenses were $34.7 million, or 28.1% of earned premiums, for the year ended December 31, 2013, compared to $57.2 million, or 34.0% of earned premiums, in 2012. Insurance Expenses as a percentage of earned premiums decreased due primarily to reduced salaries and marketing related expenses.
Kemper Direct reported Segment Net Operating Income of $27.1 million for the year ended December 31, 2013, compared to a Segment Net Operating Loss of $0.9 million in 2012. The Kemper Direct 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 $4.0 million in 2013, compared to $6.2 million in 2012.
The Kemper Direct segment reported an Operating Loss of $4.8 million for the year ended December 31, 2012, compared to an Operating Loss of $47.2 million in 2011. Operating results improved in the Kemper Direct segment in 2012, compared to 2011, due primarily to lower levels of unprofitable business, higher levels of favorable reserve development, the impact of the partial write-off in 2011 of an intangible asset from the acquisition of Direct Response Corporation (“Direct Response”) that did not recur in 2012 and lower underlying losses and LAE, partially offset by lower net investment income.
Incurred losses and LAE were $129.5 million, or 77.1% as a percentage of earned premiums, for the year ended December 31, 2012, compared to $197.6 million, or 88.7% as a percentage of earned premiums, in 2011. Incurred losses and LAE decreased in 2012, due primarily to the impact of lower earned premiums, higher levels of favorable loss and LAE reserve development and lower underlying losses and LAE as a percentage of earned premiums, partially offset by higher incurred catastrophe losses and LAE (excluding reserve development). Favorable loss and LAE reserve development was $17.8 million in 2012, compared to $3.9 million in 2011. Underlying losses and LAE as a percentage of earned premiums were 82.8% in 2012, compared to 87.5% in 2011. Underlying losses and LAE as a percentage of earned premiums decreased in both automobile and homeowners insurance. Catastrophe losses and LAE (excluding reserve development) were $8.3 million in 2012, compared to $6.7 million in 2011.
Earned Premiums in the Life and Health Insurance segment decreased by $7.0 million for the year ended December 31, 2013, compared to 2012. Earned premiums on life insurance decreased by $0.7 million in 2013, compared to 2012, due primarily to a lower volume of insurance, as a decrease of $6.4 million from life insurance products offered by the Kemper Home Service Companies (“KHSC”) was partially offset by an increase of $5.7 million from life insurance products offered by Reserve National. In late 2012, Reserve National began offering its life insurance products through an expanded network of brokers and non-exclusive independent agents (See Item 1A., “Risk Factors” entitled “Reserve National’s operating history with its expanded distribution channels and new products is limited”). Earned premiums on accident and health insurance decreased by $3.8 million in 2013, compared to 2012, due primarily to lower volume of insurance resulting primarily from the run-off of certain health insurance products, partially offset by higher volume of supplemental health insurance products and higher average premium. The Company believes that some of the health insurance products previously sold by Reserve National could be adversely impacted by some provisions of the Health Care Acts. In particular, a provision which sets minimum loss ratios for health insurance policies; a provision, beginning in 2014, establishing health insurance exchanges; and a provision, beginning in 2014, prohibiting the renewal of certain policies issued by Reserve National after the issuance of the Health Care Acts could adversely impact Reserve National’s business. Such affected health insurance products (the “Affected Products”) accounted for $49.6 million, or 31%, of the Life and Health Insurance segment’s accident and health insurance earned premiums in 2013 and $62.5 million, or 38%, of the Life and Health Insurance segment’s accident and health insurance earned premiums in 2012. Reserve National has been adapting its business model in response to the Health Care Acts and ceased selling the Affected Products at the end of 2011 and began transitioning its sales to supplemental health insurance products that are not expected to be as severely impacted by the Health Care Acts. Reserve National expects earned premiums from the Affected Products to decrease by approximately 37% in 2014 and expects an increase in earned premiums from sales of supplemental insurance
Operating Profit in the Life and Health Insurance segment was $136.9 million before taxes for the year ended December 31, 2013, compared to $140.4 million in 2012. Policyholders’ Benefits and Incurred Losses and LAE decreased by $5.2 million in 2013 due primarily to lower underlying losses on property insurance, lower catastrophe losses and LAE and higher favorable loss and LAE reserve development, partially offset by higher policyholders’ benefits on life insurance and higher incurred accident and health insurance losses. Policyholders’ benefits on life insurance were $269.6 million in 2013, compared to $265.3 million in 2012, an increase of $4.3 million. Policyholders’ benefits on life insurance increased due primarily to higher volume of insurance from policies issued by Reserve National and slightly higher mortality rates related to insurance policies issued by KHSC, partially offset by the impact of a higher lapse rate for KHSC’s in-force book of business. Incurred accident and health insurance losses were $90.9 million, or 56.3% of accident and health insurance earned premiums, in 2013, compared to $88.9 million, or 53.8% of accident and health insurance earned premiums, in 2012. Incurred accident and health insurance losses as a percentage of accident and health insurance earned premiums increased due primarily to higher severity of accident and health insurance losses, partially offset by lower frequency of claims.
Incurred losses and LAE on property insurance were $27.4 million, or 34.8% of property insurance earned premiums, in 2013, compared to $38.9 million, or 47.8% of property insurance earned premiums, in 2012. Underlying losses and LAE on property insurance were $25.6 million, or 32.5% of property insurance earned premiums, in 2013, compared to $33.2 million, or 40.8% of property insurance earned premiums, in 2012 and decreased due primarily to lower severity of insurance losses. Catastrophe losses and LAE (excluding reserve development) were $3.6 million in 2013, compared to $6.0 million in 2012. Favorable loss and LAE reserve development was $1.8 million in 2013, compared to $0.3 million in 2012. Favorable loss and LAE reserve development in 2013 resulted primarily from a final assessment issued by the MWUA that reduced KHSC’s share of MWUA’s losses for the 2004 through 2006 policy periods by $2.0 million.
Certain state insurance regulators, legislators and treasurers/controllers are involved in an array of initiatives that could result in significant changes to the application of unclaimed property laws and related claims handling practices with respect to life insurance policies. These initiatives seek, in various ways, to impose a new duty on the part of life insurers to proactively search for deaths of their insureds. It is the Company’s position that state officials lack the legal authority to impose new requirements that have the effect of changing the terms of existing life insurance contracts. See Item 1A., “Risk Factors,” under the caption “Unclaimed Property Risk Factor” MD&A, “Liquidity and Capital Resources,” and Note 23, “Contingencies,” to the Consolidated Financial Statements for additional information about these matters.
Earned Premiums in the Life and Health Insurance segment decreased by $6.0 million for the year ended December 31, 2012, compared to 2011. Earned premiums on life insurance decreased by $1.7 million in 2012, compared to 2011, due primarily to lower volume of insurance. Earned premiums on accident and health insurance decreased by $1.1 million in 2012, compared to 2011, due primarily to lower volume of insurance resulting from the suspension of sales of the Affected Policies described above and, to a lesser extent, lower volume of Medicare supplement insurance, partially offset by higher volume of supplemental health insurance products and higher average premium. Earned premiums on property insurance decreased by $3.2 million in 2012, compared to 2011, due primarily to lower volume of insurance from the run-off and, in certain geographical areas, the non-renewal of Dwelling Policies.
Segment Net Operating Income in the Life and Health Insurance segment was $90.8 million for the year ended December 31, 2012, compared to $98.9 million in 2011.
Net Investment Income for the years ended December 31, 2013, 2012 and 2011 was:
Net Investment Income increased by $18.8 million for the year ended December 31, 2013, compared to 2012, due primarily to higher income on Equity Method Limited Liability Investments, higher dividends on Equity Securities, higher levels of Fixed Maturities, partially offset by lower yields on Fixed Maturities. Interest income from loans to policyholders increased by $0.9 million in 2013, compared to 2012, due to a higher level of loans outstanding. Net investment income from real estate increased by $1.2 million in 2013, compared to 2012, due primarily to income from the early termination of one tenant’s lease.
In the first quarter of 2013, the Company sold $138.5 million of Corporate Bonds and Notes in conjunction with a comprehensive review of the prospects of each issuer in the Company’s publicly-traded corporate bond portfolio. Realized Gains on Sales of Fixed Maturities for the year ended December 31, 2013 include realized gains of $24.8 million from such sales. In the third quarter of 2012, the Company sold $320.1 million of municipal securities to take advantage of attractive pricing for such securities and for tax planning and other portfolio management purposes. Realized Gains on Sales of Fixed Maturities for the year ended December 31, 2012 include realized gains of $44.9 million from such sales.
In the third quarter of 2013, the Company sold the building where Kemper’s corporate offices are headquartered and recognized a realized gain of $43.6 million.
Net Impairment Losses recognized in the Consolidated Statements of Income for the year ended December 31, 2011 include credit losses of $2.2 million from other-than-temporary declines in the fair values of investments in fixed maturities of one issuer and losses of $0.7 million from other-than-temporary declines in the fair values of investments in equity securities of five issuers and $1.2 million to write down the value of one exchange traded fund that the Company intended to sell in the near term. In connection with the Company’s periodic review of the recoverability of its investments in real estate, the Company wrote down four properties to their respective fair values and recognized impairment losses of $7.2 million in 2011.
Total Comprehensive Investment Gains (Losses) are comprised of Net Realized Gains on Sales of Investments and Net Impairment Losses Recognized in Earnings reported in the Consolidated Statements of Income and unrealized investment gains and losses that are not reported in the Consolidated Statements of Income, but rather are reported in the Consolidated Statements of Comprehensive Income. The components of Total Comprehensive Investment Gains (Losses) for the years ended December 31, 2013, 2012 and 2011 were:
The Company’s fixed maturity investment portfolio is comprised primarily of high-grade municipal, corporate and agency bonds. At December 31, 2013, 93% of the Company’s fixed maturity investment portfolio was rated investment grade, which is defined as a security having a rating of AAA, AA, A or BBB from S&P; a rating of Aaa, Aa, A or Baa from Moody’s; a rating of AAA, AA, A or BBB from Fitch; or a rating from the NAIC of 1 or 2. The following table summarizes the credit quality of the fixed maturity investment portfolio at December 31, 2013 and 2012:
At December 31, 2013, the Company had $162.6 million of bonds issued by states and political subdivisions, commonly referred to as “municipal bonds,” that had been pre-refunded with U.S. Government and Government Agencies and Authorities obligations held in trust for the full payment of principal and interest (“Pre-refunded Municipal Bonds”). At December 31, 2013, the Company had $1,198.4 million of investments in municipal bonds that had not been pre-refunded, of which $84.0 million were enhanced with insurance from monoline bond insurers. The Company’s municipal bond investment credit-risk strategy is to focus on the underlying credit rating of the issuer and not to rely on the credit enhancement provided by the monoline bond insurer when making investment decisions. To that end, the underlying rating of over 96% of the Company’s entire municipal bond portfolio that has not been pre-refunded is AA or higher, half of which are direct obligations of states.
The Company’s short-term investments primarily consist of overnight repurchase agreements, money market funds and U.S. Treasury bills. At December 31, 2013, the Company had $144.0 million invested in overnight repurchase agreements primarily collateralized by securities issued by the U.S. government, $64.1 million invested in money market funds which primarily invest in U.S. Treasury securities and $48.7 million of U.S. Treasury bills. At the time of borrowing, the repurchase agreements generally require the borrower to provide collateral to the Company at least equal to the amount borrowed from the Company. The Company bears some investment risk in the event that a borrower defaults and the value of collateral falls below the amount borrowed. The Company does not have any investments in sovereign debt securities issued by foreign governments.
The following table summarizes the fair value of the Company’s ten largest exposures, excluding exposures to short term investments and investments in U.S. Government and Government Agencies and Authorities and Pre-refunded Municipal Bonds, at December 31, 2013:
The Company owns investments in various limited liability companies and limited partnerships that primarily invest in distressed debt, mezzanine debt and secondary transactions. The Company’s investments in these limited liability companies and limited partnerships are reported either as Equity Method Limited Liability Investments, or Other Equity Interests and included in Equity Securities 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, 2013 and 2012 is presented below:
The Company does not directly participate, as either a lender or borrower of securities, in any securities lending program. The Company does not participate directly in credit default swaps. The Company does not engage directly in hedging activities, including, but not limited to, activities involving interest rate swaps, forward foreign currency contracts, commodities contracts, exchange traded and over-the-counter options or warrants. The Company has limited exposure to such programs and activities by virtue of an investment of $0.6 million at December 31, 2013 included in Other under the heading “Reported as Other Equity Interests at Fair Value” in the preceding table. Such investment consists solely of restricted assets that are being redeemed over several periods.
On March 7, 2012, Kemper entered into the 2016 Credit Agreement, a new four-year, $325.0 million, unsecured, revolving credit agreement, expiring March 7, 2016, with a group of financial institutions. Effective December 31, 2013, Kemper amended the 2016 Credit Agreement to, among other things, reduce the amount of the aggregate commitments under the 2016 Credit Agreement by $100 million, bringing the aggregate commitments to $225 million, and to increase the amount of indebtedness that may be incurred and outstanding in the aggregate at any time in connection with borrowings from the FHLB or issuances of surplus notes by $150 million, to $250 million, provided that the aggregate indebtedness incurred and outstanding in connection with issuances of surplus notes may not exceed $100 million at any one time. The action resulted from the completion in December 2013 of the process initiated by Kemper’s subsidiaries, United Insurance and Trinity, to become members of the FHLBs of Chicago and Dallas, respectively. The FHLB memberships provide United and Trinity with access to additional sources of liquidity and consequently reduce the need for such liquidity at the parent company level.
Under various state insurance laws, Kemper’s insurance subsidiaries may pay dividends without obtaining prior regulatory approval based upon levels of statutory capital and surplus and/or net income, as defined by the applicable state law. Kemper’s direct insurance subsidiaries paid dividends of $95.0 million, $95.0 million and $70.5 million in cash to Kemper in 2013, 2012 and 2011, respectively. In 2014, Kemper estimates that its direct insurance subsidiaries would be able to pay $217.0 million in dividends to Kemper without prior regulatory approval.
On February 2, 2011, the Board of Directors approved a new share repurchase program under which Kemper is authorized to repurchase up to $300 million of its common stock. During 2013, Kemper repurchased approximately 3.0 million shares of its common stock at an aggregate cost of $100.4 million in open market transactions under the repurchase program. During 2012, Kemper repurchased approximately 2.0 million shares of its common stock at an aggregate cost of $60.7 million in open market transactions under the new repurchase program. During 2011, Kemper repurchased approximately 0.9 million shares of its common stock at an aggregate cost of $27.4 million in open market transactions.
Kemper paid a quarterly dividend to shareholders of $0.24 per common share in each quarter of 2013. Dividends paid were $54.9 million for the year ended December 31, 2013.
Net Cash Used by Financing Activities increased by $42.3 million for the year ended December 31, 2013, compared to 2012. Kemper used $100.4 million of cash during 2013 to repurchase shares of its common stock, compared to $60.7 million of cash used to repurchase shares of its common stock in 2012. Kemper used $54.9 million of cash to pay dividends for the year ended December 31, 2013, compared to $56.9 million of cash used to pay dividends in 2012. The quarterly dividend rate was $0.24 per common share for each quarter of 2013 and 2012.
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 Provided by Investing Activities increased by $111.0 million for the year ended December 31, 2013, compared to 2012. Purchases of Fixed Maturities exceeded Sales of Fixed Maturities by $80.1 million for the year ended December 31, 2013. Sales of Fixed Maturities exceeded Purchases of Fixed Maturities by $41.8 million in 2012. Purchases of Equity Securities exceeded Sales of Equity Securities by $31.3 million for the year ended December 31, 2013. Purchases of Equity Securities exceeded Sales of Equity Securities by $66.9 million for the year ended December 31, 2012. Cash provided by the sale of investment real estate was $102.7 million for the year ended December 31, 2013 compared to $6.0 million for the year ended December 31, 2012. Net cash provided by dispositions of short-term investments was $41.8 million for the year ended December 31, 2013, compared to net cash of $80.0 million used by acquisitions of short-term investments in 2012. Net proceeds from the sale of FAF’s inactive loan portfolio provided $16.7 million of cash for the year ended December 31, 2012. Receipts from Automobile Loan Receivables provided $2.0 million of cash for the year ended December 31, 2012.
Amounts included in Life and Health Insurance Policy Benefits within the contractual obligations table above represent the estimated cash payments to be made to policyholders and beneficiaries. Such cash outflows are based on the Company’s current assumptions for mortality, morbidity and policy lapse, but are undiscounted with respect to interest. Policies must remain in force for the policyholder or beneficiary to receive the benefit under the policy. Depending on the terms of a particular policy, future premiums from the policyholder may be required for the policy to remain in force. The Company estimates that future cash inflows would total $4.1 billion using the same assumptions used to estimate the cash outflows. The Company’s Life Insurance Reserves in the Company’s Consolidated Balance Sheets are generally based on the historical assumptions for mortality and policy lapse rates and are on a discounted basis. Accordingly, the sum of the amounts presented above for Life and Health Insurance Policy Benefits significantly exceeds the amount of Life and Health Insurance Reserves reported on the Company’s Consolidated Balance Sheet at December 31, 2013.
In addition to the purchase obligations included above, the Company had certain investment commitments totaling $192.7 million at December 31, 2013. The funding of such investment commitments is dependent on a number of factors, the timing of which is indeterminate. The contractual obligations reported above also exclude the Company’s liability of $6.8 million for unrecognized tax benefits. The Company cannot make a reasonably reliable estimate of the amount and period of related future payments for such liability. Other Contractual Obligations Reflected in Long Term Liabilities on the Consolidated Balance Sheet under GAAP primarily consist of interest obligations related to Long Term Debt Obligations.
The reported value of the Company’s investments was $6,151.3 million at December 31, 2013, of which $5,178.5 million, or 84%, was reported at fair value, $245.1 million, or 4%, was reported under the equity method of accounting, $275.4 million, or 5%, was reported at unpaid principal balance and $452.3 million, or 7%, was reported at cost or depreciated cost. Investments, in general, are exposed to various risks, such as interest rate risk, credit risk, and overall market volatility risk. Accordingly, it is reasonably possible that changes in the fair values of the Company’s investments reported at fair value will occur in the near term and such changes could materially affect the amounts reported in the financial statements. Also, it is reasonably possible that changes in the carrying values of the Company’s Equity Method Limited Liability Investments will occur in the near term and such changes could materially affect the amounts reported in the financial statements because these issuers follow specialized industry accounting rules which require that they report all of their investments at fair value (See Item 1A., “Risk Factors” entitled “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”).
Under GAAP, a company may elect to use the fair value option for some or all of its investments in financial instruments. Under the fair value option, a company is required to recognize changes in the fair values into income for the period reported. The Company has not elected the fair value option for any of its investments in financial instruments. Had the Company elected
Property and Casualty Insurance Reserves for Losses and Loss Adjustment Expenses
In estimating the Company’s Property and Casualty Insurance Reserves, the Company’s actuaries exercise professional judgment and must consider, and are influenced by, many variables that are difficult to quantify. Accordingly, the process of estimating and establishing the Company’s Property and Casualty Insurance Reserves is inherently uncertain and the actual ultimate net cost of known and unknown claims may vary materially from the estimated amounts reserved. The reserving process is particularly imprecise for claims involving asbestos, environmental matters, construction defect and other emerging and/or long-tailed exposures which may not be discovered or reported until years after the insurance policy period has ended. Property and Casualty Insurance Reserves related to the Company’s discontinued operations are predominantly long-tailed exposures, $35.2 million of which was related to asbestos, environmental matters and construction defect exposures at December 31, 2013.
incurred loss development methodology for that particular accident quarter. As an accident quarter 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 towards 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, 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.
Repair costs, including, but not limited to, the impact of inflation and the availability of labor and materials;
In 2008, the Company sold its Unitrin Business Insurance operations. The Company retained Property and Casualty Insurance Reserves for unpaid insured losses that occurred prior to June 1, 2008, the effective date of the sale. Development in Unitrin Business Insurance comprised all of the Company’s development reported in discontinued operations.
Additional information pertaining to the estimation of, and development of, the Company’s Property and Casualty Insurance Reserves is contained in Item 1 of Part I of this 2013 Annual Report under the heading “Property and Casualty Loss and Loss Adjustment Expense Reserves.”
A change in any one or more of these assumptions is likely to result in present value of expected benefit payments to differ from the actuarial estimate at December 31, 2013. Such changes in estimates may be material. For example, a one-percentage point decrease in the Company’s estimated discount rate would increase the pension benefit obligation at December 31, 2013 by $72.7 million, while a one-percentage point increase in the rate would decrease the pension benefit obligation at December 31, 2013 by $59.1 million. A one-percentage point decrease in the Company’s estimated long-term rate of return on plan assets would increase the pension expense for the year ended December 31, 2013 by $4.2 million, while a one-percentage point increase in the rate would decrease pension expense by $4.2 million for the same period.
ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2013, 2012 and 2011
The process of estimating and establishing reserves for losses and LAE for property and casualty insurance is inherently uncertain and the actual ultimate net cost of known and unknown claims may vary materially from the estimated amounts reserved. The reserving process is particularly imprecise for claims involving long-tailed exposures, which may not be discovered or reported until years after the insurance policy period has ended. Management considers a variety of factors, including, but not limited to, past claims experience, current claim trends and relevant legal, economic and social conditions, in estimating reserves. A change in any one or more factors is likely to result in the ultimate net claim costs to differ from the estimated reserve. Changes in such estimates may be material and would be recognized in the Consolidated Financial Statements when such estimates change.
Unrealized appreciation or depreciation, net of applicable deferred income taxes, on fixed maturities and equity securities is reported in AOCI included in Shareholders’ Equity.
Other Investments primarily include loans to policyholders and real estate. Loans to policyholders are carried at unpaid principal balance. Real estate is carried at cost, net of accumulated depreciation. Real estate is depreciated over the estimated useful life of the asset using the straight-line method of depreciation. Real estate is evaluated for impairment when events or circumstances indicate the carrying value may not be recoverable. An impairment on real estate is recognized when the carrying value exceeds the sum of undiscounted projected future cash flows.
For traditional life insurance products, the reserves for future policy benefits are estimated on the net level premium method based on rates for expected mortality, lapse rates and interest rates, 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.
The Company accounts for the present value of the future profits embedded in life insurance in force acquired (“Life VIF”) based on actuarial estimates of the present value of estimated net cash flows. Life VIF was $41.2 million and $46.4 million at December 31, 2013 and 2012, respectively. Life VIF is amortized using the effective interest method using interest rates consistent with the rates in the underlying insurance contracts. The Company estimates that it will record Life VIF amortization, net of interest, of $4.6 million in 2014, $4.2 million in 2015, $3.7 million in 2016, $3.2 million in 2017 and $2.9 million in 2018. The Company evaluates the Life VIF for recoverability annually.
The Company accounts for the present value of the future profits embedded in Property and Casualty Insurance Customer Relationships Acquired (“P&C Customer Relationships”) based on the present value of estimated future cash flows from the customer relationships acquired. P&C Customer Relationships was $15.8 million and $18.7 million at December 31, 2013 and 2012, respectively. P&C Customer Relationships is amortized using the effective interest method. P&C Customer Relationships is tested for recoverability using undiscounted projections of future cash flows and written down to estimated fair value if the carrying value exceeds the sum of such projections of undiscounted cash flows. The Company recorded a loss of $13.5 million before tax for the year ended December 31, 2011 to write down the carrying value of P&C Customer Relationships related to the acquisition of Direct Response to its estimated fair value.
Property and casualty insurance and short duration health insurance premiums are deferred when written and recognized and earned ratably over the periods to which the premiums relate. Unearned Premiums represent the portion of the premiums written related to the unexpired portion of policies in force which has been deferred and is reported as a liability. A premium deficiency reserve is established if the sum of expected claim costs, claim adjustment expenses, unamortized deferred policy acquisition costs and
maintenance costs exceeds the related unearned premiums. For each business segment, the analysis is performed at a product line level, namely automobile insurance, homeowners insurance and other insurance, which is consistent with the manner in which the Company acquires, services and measures profitability. Anticipated investment income is excluded from such analysis.
Gains related to long-duration reinsurance contracts are deferred and amortized over the life of the underlying reinsured policies. Losses related to long-duration reinsurance contracts are recognized immediately. Any gain or loss associated with reinsurance agreements for which Kemper’s insurance subsidiaries have been legally relieved of their obligations to the policyholder is recognized in the period of relief.
In February 2013, the FASB issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The new standard amends and enhances disclosure requirements by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in a statement of income. The Company adopted the standard in the first quarter of 2013. Except for the additional disclosure requirements, the initial application of the standard did not have an impact on the Company.
In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. The standard is effective for the first interim or annual period beginning on or after December 15, 2013 with early adoption permitted. The standard amends ASC Topic 740, Income Taxes, to provide guidance and reduce diversity in practice on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. Except for the changes, if any, in the Company’s presentation, the initial application of the standard will not impact the Company.
The amortized cost and estimated fair values of the Company’s Investments in Fixed Maturities at December 31, 2012 were:
The amortized cost and estimated fair values of the Company’s Investments in Fixed Maturities at December 31, 2013 by contractual maturity were:
Other Receivables at December 31, 2013 includes a receivable of $2.5 million primarily from sales of Investments in Fixed Maturities that settled in January 2014. There were no unsettled purchases of Investments in Fixed Maturities at December 31, 2013. Accrued Expenses and Other Liabilities at December 31, 2012 includes a payable of $1.5 million for purchases of Investments in Fixed Maturities that settled in January 2013. There were no unsettled sales of Investments in Fixed Maturities at December 31, 2012.
Gross unrealized gains and gross unrealized losses on the Company’s Investments in Equity Securities at December 31, 2012 were:
The Company regularly reviews its investment portfolio for factors that may indicate that a decline in fair value of an investment is other than temporary. The credit loss portions of the declines in the fair values of investments that are determined to be other than temporary are reported as losses in the Consolidated Statements of Income in the periods when such determinations are made.
Unrealized losses on fixed maturities, which the Company has determined to be temporary at December 31, 2013, were $79.7 million, of which $9.2 million was related to fixed maturities that were in an unrealized loss position for 12 months or longer. There were no unrealized losses at December 31, 2013 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “Less Than 12 Months.” Included in the preceding table under the heading “12 Months or Longer” there were unrealized losses of $0.3 million at December 31, 2013 related to securities for which the Company has recognized credit losses in earnings. Investment-grade fixed maturity investments comprised $74.2 million and below-investment-grade fixed maturity investments comprised $5.5 million of the unrealized losses on investments in fixed maturities at December 31, 2013. 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, 2013, 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, 2013 of the prospects of the issuers, including, but not limited to, the credit ratings of the issuers of the investments in the fixed maturities, and the Company’s intention to not sell and its determination that it would not be required to sell before recovery of the amortized cost of such investments, the Company concluded that the declines in the fair values of the Company’s investments in fixed maturities presented in the preceding table were temporary at the evaluation date.
The Company concluded that the unrealized losses on its investments in preferred and common stocks at December 31, 2013 were temporary based on various factors, including the relative short length and magnitude of the losses and overall market volatility. The Company’s investments in other equity interests include investments in limited liability companies and limited liability partnerships that primarily invest in distressed debt, mezzanine debt and secondary transactions. By the nature of their underlying investments, the Company believes that its investments in the limited liability companies and limited liability partnerships also exhibit debt-like characteristics which, among other factors, the Company considers when evaluating these investments for impairment. Based on Company’s evaluations of the factors in the preceding paragraph, the Company concluded that the declines in the fair values of the Company’s investments in equity securities presented in the preceding table were temporary at December 31, 2013.
Equity Method Limited Liability Investments include investments in limited liability investment companies and limited partnerships in which the Company’s interests are not deemed minor and are accounted for under the equity method of accounting. The Company’s investments in Equity Method Limited Liability Investments are generally of a passive nature in that the Company does not take an active role in the management of the investment entity. In 2012, aggregate investment income (losses) from Equity Method Limited Liability Investments exceeded 10% of the Company’s pretax consolidated net income. Accordingly, the Company is disclosing aggregated summarized financial data for its Equity Method Limited Liability Investments. Such aggregated summarized financial data does not represent the Company’s proportionate share of the Equity Method Limited Liability Investment assets or earnings. Aggregate total assets of the Equity Method Limited Liability Investments in which the Company invested totaled $3,392.1 million and $3,643.6 million as of December 31, 2013 and 2012, respectively. Aggregate total liabilities of the Equity Method Limited Liability Investments in which the Company invested totaled $576.3 million and $421.0 million as of December 31, 2013 and 2012, respectively. Aggregate net income of the Equity Method Limited Liability Investments in which the Company invested totaled $181.1 million and $134.6 million for the years ended December 31, 2013 and 2012, respectively. Aggregate net loss of the Equity Method Limited Liability Investments in which the Company invested totaled $13.8 million for the year ended December 31, 2011. The aggregate summarized financial data is based on the most recent and sufficiently-timely financial information available to the Company as of the respective reporting dates and periods. The Company’s maximum exposure to loss at December 31, 2013 is limited to the total carrying value of $245.1 million. In addition, the Company had outstanding commitments totaling approximately $50.4 million to fund Equity Method Limited Liability Investments at December 31, 2013.
In the third quarter of 2013, the Company sold the 41-story office building where Kemper’s corporate offices are headquartered for a gain of $43.6 million before income taxes. Proceeds from the sale, net of transaction costs, were $101.5 million.
Reinsurance and indemnification recoverables on property and casualty insurance reserves were $63.4 million and $66.2 million at December 31, 2013 and 2012, respectively. These recoverables are concentrated with several reinsurers, the vast majority of which are highly rated by one or more of the principal investor and/or insurance company rating agencies. While most of these recoverables were unsecured at December 31, 2013 and 2012, the agreements with the reinsurers generally provide for some form of collateralization upon the occurrence of certain events.
The 2016 Credit Agreement replaced Kemper’s Former Credit Agreement, a $245.0 million, unsecured, revolving credit agreement which was scheduled to expire on October 30, 2012 and was terminated on March 7, 2012. There were no borrowings under the Former Credit Agreement at either December 31, 2011 or at its termination. The 2016 Credit Agreement provides for fixed and floating rate advances for periods up to six months at various interest rates. The 2016 Credit Agreement contains various financial covenants, including limits on total debt to total capitalization, consolidated net worth and minimum risk-based capital ratios for Kemper’s largest insurance subsidiaries, United Insurance and Trinity. Proceeds from advances under the 2016 Credit Agreement may be used for general corporate purposes, including repayment of existing indebtedness. There were no outstanding borrowings under the 2016 Credit Agreement at December 31, 2013, and accordingly, $225.0 million was available for future borrowings.
In 2010, Kemper issued $250 million of its 6.00% senior notes due November 30, 2015. The 2015 Senior Notes are unsecured and may be redeemed in whole at any time or in part from time to time at Kemper’s option at specified redemption prices. Kemper issued the 2015 Senior Notes for proceeds of $247.8 million, net of transaction costs, for an effective yield of 6.21%.
In 2007, Kemper issued $360 million of its 6.00% senior notes due May 15, 2017. The 2017 Senior Notes are unsecured and may be redeemed in whole at any time or in part from time to time at Kemper’s option at specified redemption prices. Kemper issued the 2017 Senior Notes for proceeds of $354.8 million, net of transaction costs, for an effective yield of 6.19%.
Kemper is authorized to issue 20 million shares of $0.10 par value preferred stock and 100 million shares of $0.10 par value common stock. No preferred shares were issued or outstanding at December 31, 2013 and 2012. There were 55,653,437 shares and 58,454,390 shares of common stock outstanding at December 31, 2013 and 2012, respectively. Common stock outstanding included 278,427 shares and 313,424 shares at December 31, 2013 and 2012, respectively, that have been issued, subject to certain vesting and other requirements, in connection with the Company’s long-term equity compensation plans. See Note 9, “Long-Term Equity-based Compensation,” to the Consolidated Financial Statements for a discussion of the restrictions and vesting provisions.
Kemper repurchased and retired 3.0 million shares of its common stock in open market transactions at an aggregate cost of $100.4 million in 2013. Kemper repurchased and retired 2.0 million shares of its common stock in open market transactions at an aggregate cost of $60.7 million in 2012. Kemper repurchased and retired 0.9 million shares of its common stock in open market transactions at an aggregate cost of $27.4 million in 2011.
Kemper’s insurance subsidiaries are also required to hold minimum levels of statutory capital and surplus to satisfy regulatory requirements. The minimum statutory capital and surplus, or company action level RBC, necessary to satisfy regulatory requirements for the Company’s life and health insurance subsidiaries collectively was $123.7 million at December 31, 2013. The minimum statutory capital and surplus necessary to satisfy regulatory requirements for the Company’s property and casualty insurance subsidiaries collectively was $286.4 million at December 31, 2013. Company action level RBC is the level at which a company is required to file a corrective action plan with its regulators and is equal to 200% of the authorized control level RBC.
In 2013, Kemper paid dividends of $54.9 million to its shareholders. Except for certain financial covenants under the 2016 Credit Agreement, there are no restrictions on Kemper’s ability to pay dividends to its shareholders. Certain financial covenants, namely minimum net worth and a maximum debt to total capitalization ratio, under the 2016 Credit Agreement could limit the amount of dividends that Kemper may pay to shareholders at December 31, 2013. Kemper had the ability to pay without restrictions $407 million in dividends to its shareholders and still be in compliance with all financial covenants under the 2016 Credit Agreement at December 31, 2013.
The Compensation Committee of the Board of Directors, or the Board’s authorized designee, has sole discretion to determine the persons to whom awards under the Omnibus Plan are granted, and the material terms of the awards. For Tandem Awards, material terms include the number of shares covered by such awards and the exercise price, vesting and expiration dates of such awards. Tandem Awards are non-transferable. The exercise price is the fair value of Kemper’s common stock on the date of grant. Employee Tandem Awards generally vest, beginning six months after date of grant, in four equal annual installments over a period of three and one-half years and expire ten years from the date of grant.
The Company uses the Black-Scholes option pricing model to estimate the fair value of each option on the date of grant. The expected terms of options are developed by considering the Company’s historical share option exercise experience, demographic profiles, historical share retention practices of employees and assumptions about their propensity for early exercise in the future. Further, the Company aggregates individual awards into relatively homogenous groups that exhibit similar exercise behavior to obtain a more refined estimate of the expected term of options. Expected volatility is estimated using weekly historical volatility. The Company believes that historical volatility is currently the best estimate of expected volatility. The dividend yield in 2013, 2012 and 2011 was calculated by taking the natural logarithm of the annualized yield divided by the Kemper common stock price on the date of grant. The risk free interest rate was the yield on the grant date of U.S. Treasury zero coupon issues with a maturity comparable to the expected term of the option.
The assumptions used in the Black-Scholes pricing model for options granted during the years ended December 31, 2013, 2012 and 2011, were as follows:
Option and SAR activity for the year ended December 31, 2013 is presented below:
The weighted-average grant-date fair values of options granted during 2013, 2012 and 2011 were $10.20, $9.40 and $9.11, respectively. Total intrinsic value of stock options exercised was $4.1 million, $3.0 million and $0.3 million for the years ended December 31, 2013, 2012 and 2011, respectively. Cash received from option exercises was $1.7 million, $1.3 million and $0.2 million for the years ended December 31, 2013, 2012 and 2011, respectively. Total tax benefits realized for tax deductions from option exercises were $1.4 million, $1.0 million and $0.1 million for the years ended December 31, 2013, 2012 and 2011, respectively.
Prior to February 3, 2009, only awards of time-vested restricted stock had been granted. Beginning on February 3, 2009, in addition to time-vested restricted stock granted to certain employees and officers, the Company began awarding performance-based restricted stock to certain officers and employees. The initial number of shares awarded to each participant of a performance-based restricted stock award represents the shares that would vest if the performance goals were achieved at the “target” performance level. The final payout of these awards will be determined based on Kemper’s total shareholder return over a three-year performance period relative to a peer group comprised of all the companies in the S&P Supercomposite Insurance Index.
Activity related to nonvested performance-based restricted stock for the year ended December 31, 2013 was as follows:
The number of additional shares that would be granted if the Company were to meet or exceed the maximum performance levels related to the outstanding performance-based shares for the 2013 and 2012 three-year performance periods was 60,150 common shares and 59,775 common shares, respectively, (as “full value awards,” the equivalent of 180,450 shares and 179,325 shares, respectively, under the Share Authorization) at December 31, 2013. For the 2011 three-year performance period, the Company exceeded target performance levels with a payout percentage of 118%. Accordingly, an additional 9,014 shares of stock were issued to award recipients on February 1, 2014. For the 2010 three-year performance period, the Company exceeded target performance levels with a payout percentage of 114%. Accordingly, an additional 6,996 shares of stock were issued to award recipients on February 2, 2013 (the “2010 Additional Shares”). For the 2009 three-year performance period, the Company exceeded target performance levels with a payout percentage of 183%. Accordingly, an additional 40,727 shares of stock were issued to award recipients on January 31, 2012 (the “2009 Additional Shares”).
The components of Other Comprehensive Income (Loss) Before Income Taxes for the years ended December 31, 2013, 2012 and 2011 were:
Components of AOCI were reclassified to the following lines of the Consolidated Statements of Income for the years ended December 31, 2013, 2012 and 2011:
Current and Deferred Income Tax Assets at December 31, 2013 and 2012 were:
The tax effects of temporary differences that give rise to significant portions of the Company’s Net Deferred Income Tax Assets and Deferred Income Tax Liabilities at December 31, 2013 and 2012 were:
The expiration of the federal net operating loss carryforwards and the related deferred income tax assets is presented below by year of expiration.
Except for the federal NOL carryforwards scheduled to expire in 2031 through 2032, all of the federal NOL carryforwards were acquired in connection with business acquisitions made in prior years and are subject to annual usage limitations under the Internal Revenue Code. The Company expects to fully utilize these federal NOL carryforwards.
A reconciliation of the beginning and ending amount of Unrecognized Tax Benefits for the years ended December 31, 2013, 2012 and 2011 is as follows:
The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense. The liability for Unrecognized Tax Benefits included accrued interest of $3.4 million, $2.9 million and $2.5 million at December 31, 2013, 2012 and 2011, respectively. Tax expense includes interest expense of $0.4 million related to unrecognized tax benefits for each of the years ended December 31, 2013, 2012 and 2011.
The components of Income Tax Expense from Continuing Operations for the years ended December 31, 2013, 2012 and 2011 were:
Net income taxes paid were $42.4 million and $52.2 million in 2013 and 2012, respectively. Income taxes refunded, net of income tax paid of $57.1 million, were $4.1 million in 2011.
Comprehensive Income Tax Expense included in the Consolidated Financial Statements for the years ended December 31, 2013, 2012 and 2011 was:
The Company sponsors a qualified defined benefit pension plan (the “Pension Plan”). The Pension Plan covers approximately 9,000 participants and beneficiaries, of which 2,400 are active employees. The Pension Plan is generally non-contributory, but participation requires or required some employees to contribute 3% of pay, as defined, per year. Benefits for participants who are or were required to contribute to the Pension Plan are based on compensation during plan participation and the number of years of participation. Benefits for the vast majority of participants who are not required to contribute to the Pension Plan are based on years of service and final average pay, as defined. The Company funds the Pension Plan in accordance with the requirements of ERISA.
Changes in Fair Value of Plan Assets and Changes in Projected Benefit Obligation for the years ended December 31, 2013 and 2012 were:
The measurement dates of the assets and liabilities at end of year presented in the preceding table under the headings, “2013” and “2012” were December 31, 2013 and December 31, 2012, respectively.
The weighted-average discount rate and rate of increase in future compensation levels used to estimate the components of the Projected Benefit Obligation at December 31, 2013 and 2012 were:
Additional information pertaining to the changes in the fair value of the Pension Plan’s assets classified as Level 3 for the year ended December 31, 2013 is presented below:
Fair value measurements for the Pension Plan’s assets at December 31, 2012 are summarized below:
The components of Comprehensive Pension (Income) Expense for the years ended December 31, 2013, 2012 and 2011 were:
The Company does not expect that it will be required to contribute to its Pension Plan in 2014, but could make a voluntary contribution pursuant to the maximum funding limits under ERISA.
The Company also sponsors a non-qualified supplemental defined benefit pension plan (the “Supplemental Plan”). The unfunded liability related to the Supplemental Plan was $23.3 million and $24.0 million at December 31, 2013 and 2012, respectively. Pension expense for the Supplemental Plan was $1.8 million, $1.8 million and $3.3 million for the years ended December 31, 2013, 2012 and 2011, respectively. An actuarial gain of $1.5 million before tax, an actuarial loss of $1.3 million before tax and an actuarial gain of $2.9 million before tax is included Other Comprehensive Income for the years ended December 31, 2013, 2012 and 2011, respectively.
The measurement dates of the assets and liabilities at end of year in the preceding table under the headings “2013” and “2012” were December 31, 2013 and December 31, 2012, 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, 2013 and 2012 were:
The assumed health care cost trend rate used in measuring the Accumulated Postretirement Benefit Obligation at December 31, 2013 was 8.5% for 2014, gradually declining to 5.0% in the year 2021 and remaining at that level thereafter for medical benefits and 8.0% for 2014, gradually declining to 5.0% in the year 2022 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, 2012 was 7.0% for 2013, gradually declining to 5.0% in the year 2017 and remaining at that level thereafter for medical benefits and 8.5% for 2013, gradually declining to 5.0% in the year 2020 and remaining at that level thereafter for prescription drug benefits.
The components of Comprehensive OPEB (Income) Expense for the years ended December 31, 2013, 2012 and 2011 were:
The Company estimates that OPEB Expense for the year ended December 31, 2014 will include income of $1.5 million resulting from the amortization of the related accumulated actuarial gain included in Accumulated Other Comprehensive Income at December 31, 2013.
The weighted-average discount rate and rate of increase in future compensation levels used to develop OPEB Expense for the years ended December 31, 2013, 2012 and 2011 were:
The Company expects to contribute $3.7 million, net of the expected Medicare Part D subsidy, to its OPEB Plan to fund benefit payments in 2014.
The Kemper Preferred segment provides preferred and standard risk personal automobile insurance, homeowners insurance and other personal insurance through independent agents. The Kemper Specialty segment provides automobile insurance to individuals and businesses in the non-standard market through independent agents. The non-standard automobile insurance market consists of individuals and companies that have difficulty obtaining standard or preferred risk insurance, usually because of their adverse driving records or claim or credit histories. The Kemper Direct segment currently distributes personal automobile, homeowners and renters insurance products through employer-sponsored voluntary benefit programs and other affinity relationships. Prior to ceasing direct-to-consumer marketing activities in the third quarter of 2012, Kemper Direct also distributed its products directly to consumers through a variety of direct-to-consumer websites, including its own websites. The Life and Health Insurance segment provides individual life, accident, health and property insurance.
It is the Company’s management practice to allocate certain corporate expenses, primarily compensation costs for corporate employees and related facility costs, included in Interest and Other Expenses in the Consolidated Statements of Income to its insurance operations. The amount of such allocated corporate expenses was $39.7 million, $31.7 million and $33.0 million for the years ended December 31, 2013, 2012 and 2011, respectively. The Company does not allocate Net Realized Gains on Sales of Investments, Net Impairment Losses Recognized in Earnings, interest expense on debt or postretirement benefit plans, and actuarial gains and losses on its postretirement benefit plans to its operating segments.
Segment Revenues for the years ended December 31, 2013, 2012 and 2011 were:
Segment Net Operating Income for the years ended December 31, 2013, 2012 and 2011 was:
The Company accounts for Kemper’s subsidiary, FAF, and the Company’s former Unitrin Business Insurance operations as discontinued operations.
During 2011, FAF sold its active portfolio of automobile loan receivables at a gain of $4.5 million, net of transaction and other costs, while retaining its inactive portfolio of loans that had been previously charged-off (the “Inactive Portfolio”). The Inactive Portfolio was not carried on the Company’s Consolidated Balance Sheet. During 2012, FAF sold $283 million of loans in the Inactive Portfolio at a gain of $12.9 million, net of transaction, shutdown and other costs of $13.3 million, of which $1.0 million was unpaid at December 31, 2013.
Coverage for each catastrophe reinsurance program effective January 1, 2013 to December 31, 2013 is provided in various layers as presented below:
The catastrophe reinsurance program for the Kemper Preferred segment in 2012 also included reinsurance coverage for catastrophe losses in North Carolina at retentions lower than those presented in the preceding table. The catastrophe reinsurance program for the Life and Health Insurance and Kemper Direct segments in 2012 also included reinsurance coverage from the FHCF for hurricane losses in Florida at retentions lower than those described above.
The catastrophe reinsurance program for the Kemper Preferred segment in 2011 also included reinsurance coverage for catastrophe losses in North Carolina at retentions lower than those presented in the preceding table. The catastrophe reinsurance program for the Life and Health Insurance and Kemper Direct segments in 2011 also included reinsurance coverage from the FHCF for hurricane losses in Florida at retentions lower than those described above.
Reinsurance premiums for the Company’s primary catastrophe reinsurance programs, the Kemper Preferred NC Program and the FHCF Program reduced earned premiums for the years ended December 31, 2013, 2012 and 2011 by the following:
Total Catastrophe loss and LAE reserves, net of reinsurance recoverables, developed favorably by $14.5 million, $6.3 million and $6.4 million in 2013, 2012 and 2011, respectively. The Kemper Preferred segment reported favorable catastrophe reserve development of $11.9 million, $6.2 million and $5.5 million in 2013, 2012 and 2011, respectively. The Life and Health Insurance segment reported favorable catastrophe reserve development of $2.0 million and $1.5 million in 2013 and 2011, respectively, and adverse catastrophe reserve development of $0.1 million in 2012.
In the second quarter of 2011, the United States experienced a high volume of spring storms, including a record level of tornadoes in April. In the third quarter of 2011, the Company incurred claims related to Hurricane Irene. Catastrophe losses and LAE for the year ended December 31, 2011 include $23.0 million related to Hurricane Irene, of which $22.1 million is included in the Kemper Preferred segment.
Earned Premiums ceded on long-duration and short-duration policies were $33.9 million, $42.5 million and $40.7 million for the years ended December 31, 2013, 2012 and 2011, respectively. Certain insurance subsidiaries assume business from other insurance companies and involuntary pools. Earned Premiums assumed on long-duration and short-duration policies were $52.7 million, $44.0 million and $43.7 million for the years ended December 31, 2013, 2012 and 2011, respectively.
The Company’s investments in Fixed Maturities that are classified as Level 1 in the two preceding tables primarily consist of U.S. Treasury Bonds and Notes. The Company’s investments in Equity Securities that are classified as Level 1 in the two preceding tables consist of either investments in publicly-traded common stocks or exchange traded funds. The Company’s investments in Fixed Maturities that are classified as Level 2 in the two preceding tables primarily consist of investments in corporate bonds and redeemable preferred stocks, states and political subdivisions, and bonds and mortgage-backed securities of U.S. government agencies. The Company’s investments in Equity Securities that are classified as Level 2 in the two preceding tables primarily consist of investments in preferred stocks. The Company uses a leading, nationally recognized provider of market data and analytics to price the vast majority of the Company’s Level 2 measurements. The provider utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information. Because many fixed maturity securities do not trade on a daily basis, the provider’s evaluated pricing applications apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing to prepare evaluations. In addition, the provider uses model processes to develop prepayment and interest rate scenarios. The pricing provider’s models and processes also take into account market convention. For each asset class, teams of its evaluators gather information from market sources and integrate relevant credit information, perceived market movements and sector news into the evaluated pricing applications and models. The Company generally validates the measurements obtained from its primary pricing provider by comparing them with measurements obtained from one additional pricing provider that provides either prices from recent market transactions or quotes in inactive markets or evaluations based on its own proprietary models.
The majority of Investments in Fixed Maturities that are classified as Level 3 are priced 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 Investments in Fixed Maturities, corporate bonds and notes makes up the majority of the Company’s investments classified as Level 3. For corporate bonds and notes, the primary asset classes are investment grade private placements, non-investment grade senior debt, non-investment grade junior debt and other debt. Non-investment grade senior debt includes those securities that receive first priority in a liquidation and non-investment grade 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 investments in corporate bonds and notes classified as Level 3 at December 31, 2013.
In July 2013, certain of the Life Companies filed a declaratory judgment action in state court in Maryland, asking the court to construe the Maryland DMF Statute to apply only to policies issued in Maryland after the effective date of the statute for essentially the same reasons asserted in the Kentucky proceeding. The State of Maryland defendants filed a motion to dismiss the action, contending that the subject Life Companies did not exhaust their administrative remedies before filing their action in the trial court. A hearing on the state’s motion to dismiss is scheduled in March 2014.
The Life Companies are the subject of a multi-state market conduct examination by six state insurance regulators that is focused on the Life Companies’ claim settlement and policy administration practices, and specifically their compliance with state unclaimed property statutes (the “Multi-State Exam”). The Multi-State Exam was originated in June 2012 as a single-state examination by the Illinois Insurance Director. Insurance regulators from five additional states - California, Florida, Pennsylvania, New Hampshire and
In September 2013, certain of the Life Companies filed declaratory judgment actions against the insurance regulators in the states of California, Florida, Illinois and Pennsylvania, asking the courts in those states to declare that applicable law does not require life insurers to search a Death Master File to ascertain whether insureds are deceased. The subject Life Companies are also asking the courts to declare that regulators in those states do not have the legal authority to (i) obtain life insurers’ policy records for the purpose of comparing those records against a Death Master File, and (ii) impose payment obligations on life insurers before a claim and due proof of death have been submitted. The declaratory judgment action in California was filed as a counterclaim to the CA Controller’s complaint, joining the California Insurance Commissioner and the Audit Firm as parties to the counterclaim. These cases are in various stages procedurally and a decision in any of them is unlikely before the second quarter of 2014.
The results of the Treasurers’ Audit, Multi-State Exam and the various litigation described above cannot currently be predicted. The Life Companies continue to maintain that states lack the legal authority to establish new requirements that have the effect of changing the terms of existing life insurance contracts with regard to basic claims handling obligations and processes. If these state officials are able to apply such new requirements retroactively to the Life Companies’ existing life insurance policies, it will fundamentally alter the nature and timing of their responsibilities under such policies by effectively eliminating contractual terms that condition claim settlement and payment on the receipt of a claim, including “due proof of death” of an insured. The outcome of the various state initiatives and related litigation could have a significant effect on, including acceleration of, the Life Companies’ payment and/or escheatment of policy benefits, and significantly increase their claims handling costs. Kemper cannot reasonably estimate the amount of loss that it would recognize if the Life Companies were subjected to such requirements on a retroactive basis.
FS&C also provides investment management services with respect to certain funds of the Company’s Pension Plan. The Company’s Pension Plan had $148.6 million, $120.7 million and $107.1 million in assets managed by FS&C at December 31, 2013, 2012 and 2011, respectively. The Company’s Pension Plan incurred, in the aggregate, expenses of $0.3 million, $0.3 million and $0.3 million to FS&C for the years ended December 31, 2013, 2012 and 2011, respectively.
We have audited the accompanying consolidated balance sheets of Kemper Corporation and subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedules listed in Item 15. We also have audited the Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and financial statement schedules and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.
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, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth herein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.