The Company owns the 41-story office building at One East Wacker Drive, Chicago, Illinois, that houses the executive offices of Kemper and the home office of its Direct operations, which together occupy approximately 52,000 square feet of the 527,000 rentable square feet in the building. In addition, Kemper’s subsidiaries together own and occupy 13 buildings located in 7 states consisting of approximately 42,000 square feet in the aggregate. Kemper’s subsidiaries hold additional properties solely for investment purposes that are not utilized by Kemper or its subsidiaries.
Specialty leases facilities with an aggregate square footage of approximately 107,000 at 3 locations in 3 states. The latest expiration date of the existing leases is in September of 2018.
Direct leases facilities with an aggregate square footage of approximately 199,000 at 6 locations in 5 states. The latest expiration date of the existing leases is in October of 2016.
Preferred, Specialty and Direct share leased facilities with an aggregate square footage of approximately 138,000 at 15 locations in 8 states. The latest expiration date of the existing leases is in September of 2018.
Kemper’s Life and Health Insurance segment leases facilities with aggregate square footage of approximately 508,000 at 125 locations in 26 states. The latest expiration date of the existing leases is in October of 2019.
Net Income was $83.7 million ($1.38 per unrestricted common share) for the year ended December 31, 2011, compared to $184.6 million ($2.98 per unrestricted common share) for the year ended December 31, 2010. Income from Continuing Operations was $70.9 million ($1.17 per unrestricted common share) in 2011, compared to $169.1 million ($2.73 per unrestricted common share) in 2010.
Catastrophe losses and LAE from continuing operations (excluding loss and LAE reserve development from prior accident years) were $163.8 million before tax for the year ended December 31, 2011, compared to $79.3 million for 2010, an increase of $84.5 million. Preferred contributed $74.1 million to the increase in catastrophe losses and LAE before tax, with the Direct and Life Health Insurance segments contributing $4.9 million and $4.6 million, respectively, to the increase. The Company reported Income from Discontinued Operations of $12.8 million and $15.5 million for the years ended December 31, 2011 and 2010, respectively.
Catastrophe reinsurance premiums for the Company’s primary reinsurance programs, the Preferred NC Program and the FHCF reduced earned premiums for the years ended December 31, 2011, 2010 and 2009 by the following:
Catastrophe losses and LAE (excluding loss and LAE reserve development from prior accident years) from continuing operations were $163.8 million, $79.3 million and $61.6 million for the years ended December 31, 2011, 2010 and 2009, respectively. Catastrophe losses and LAE (excluding loss and LAE reserve development) by business segment for the years ended December 31, 2011, 2010 and 2009 are presented below:
In the second quarter of 2011, the United States experienced a high volume of spring storms, including a record level of tornadoes in April. These storms contributed significantly to the increase in the Company’s catastrophe losses and LAE in 2011, compared to 2010. In the third quarter of 2011, the Company also incurred claims related to Hurricane Irene. Catastrophe losses and LAE for the year ended December 31, 2011 includes $22.1 million related to Hurricane Irene, of which $21.2 million is included in the Preferred segment. No major hurricanes that significantly impacted the Company made landfall in the United States during 2010.
Consolidated Net Operating Income is an after-tax, non-GAAP measure and is computed by excluding from Income from Continuing Operations the after-tax impact of 1) Net Realized Gains on Sales of Investments, 2) Net Impairment Losses Recognized in Earnings related to investments and 3) other significant non-recurring or infrequent items that may not be indicative of ongoing operations. Significant non-recurring items are excluded when (a) the nature of the charge or gain is such that it is reasonably unlikely to recur within two years, and (b) there has been no similar charge or gain within the prior two years. The most directly comparable GAAP financial measure is Income from Continuing Operations.
A reconciliation of Consolidated Net Operating Income to Income from Continuing Operations for the years ended December 31, 2011, 2010 and 2009 is presented below:
Net Investment Income in the Preferred segment decreased by $3.2 million for the year ended December 31, 2011, compared to 2010, due primarily to lower net investment income from Equity Method Limited Liability Investments, partially offset by higher dividends on equity securities. The Preferred segment reported net investment income from Equity Method Limited Liability Investments of $8.0 million for the year ended December 31, 2011, compared to $15.5 million for 2010.
Catastrophe losses and LAE (excluding development) were $144.2 million for the year ended December 31, 2011, compared to $70.1 million for 2010, an increase of $74.1 million. Favorable loss and LAE reserve development (including catastrophe development) was $19.1 million for the year ended December 31, 2011, compared to $23.8 million for 2010. Underlying losses and LAE as a percentage of earned premiums were 67.9% for the year ended December 31, 2011, compared to 66.2% for 2010.
Automobile insurance incurred losses and LAE were $389.5 million for the year ended December 31, 2011, compared to $399.1 million for 2010. Automobile insurance incurred losses and LAE decreased by $9.6 million due primarily to lower claim volume resulting principally from fewer automobile insurance policies in force and lower underlying losses and LAE as a percentage of automobile insurance earned premiums, partially offset by higher incurred catastrophe losses and LAE (excluding development) and the impact of lower favorable loss and LAE reserve development (excluding catastrophe development). Underlying losses and LAE as a percentage of automobile insurance earned premiums were 73.8% for the year ended December 31, 2011, compared to 74.1% for the same period in 2010. Underlying losses and LAE as a percentage of automobile insurance earned premiums decreased due primarily to lower average frequency of losses. Catastrophe losses and LAE (excluding development) were $14.1 million for the year ended December 31, 2011, compared to $7.2 million in 2010. Favorable Loss and LAE reserve development (excluding catastrophe development) was $1.3 million for the year ended December 31, 2011, compared to favorable development of $11.6 million for the same period in 2010.
The Preferred segment reported Segment Net Operating Loss of $16.6 million for the year ended December 31, 2011, compared to Segment Net Operating Income of $50.6 million for the same period in 2010. The Preferred segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $25.0 million for the year ended December 31, 2011, compared to $24.7 million for the same period in 2010.
Operating Profit in the Preferred segment decreased by $22.3 million for the year ended December 31, 2010, compared to 2009, due primarily to the impact of lower favorable loss and LAE reserve development and higher incurred catastrophe losses and LAE (excluding development), partially offset by lower underlying losses and LAE as a percentage of earned premiums, higher net investment income and lower insurance expenses as a percentage of earned premiums. Favorable loss and LAE reserve development was $23.8 million for the year ended December 31, 2010, compared to $60.5 million for 2009. Catastrophe losses and LAE were $70.1 million (excluding favorable development of $4.9 million), compared to $47.6 million (excluding favorable development of $18.3 million) for 2009. Underlying losses and LAE as a percentage of earned premiums were 66.2% for the year ended December 31, 2010, compared to 68.8% for 2009.
Other personal insurance incurred losses and LAE were $24.5 million for the year ended December 31, 2010, compared to $29.4 million for 2009. Other personal insurance incurred losses and LAE decreased by $4.9 million due primarily to lower levels of underlying losses and LAE and the impact of higher favorable loss and LAE reserve development. Underlying losses and LAE decreased by $2.7 million due to lower average, estimated severity of umbrella liability insurance losses. Favorable loss and LAE reserve development was $3.7 million for the year ended December 31, 2010, compared to favorable development of $2.1 million for 2009.
Earned Premiums in the Specialty segment decreased by $29.7 million for the year ended December 31, 2011, compared to 2010, due to lower earned premiums for both personal and commercial automobile insurance. Personal automobile insurance earned premiums decreased by $26.1 million for the year ended December 31, 2011, compared to 2010, due primarily to lower volume and, to a lesser extent, lower average earned premium per policy. Throughout 2010 and 2011, Specialty’s personal automobile insurance policies in force decreased due to economic conditions, increased competition and higher premium rates, particularly in California. Personal automobile insurance policies in force were approximately 302,000 at December 31, 2011, compared to 329,000 at the beginning of 2011 and approximately 351,000 at the beginning of 2010. Specialty expects that personal automobile insurance policies in force will be marginally down in 2012. Commercial automobile insurance earned premiums decreased by $3.6 million for the year ended December 31, 2011, compared to 2010, due primarily to lower volume. Commercial automobile insurance volume has decreased due primarily to a smaller renewal book of business, partially offset by higher retention rates and increased new business production. In the fourth quarter of 2011, Specialty reorganized the product management and sales structure to better align management with the current product mix and improve focus for all sales initiatives.
Personal automobile insurance operating profit decreased by $6.9 million for the year ended December 31, 2011, compared to 2010, due primarily to higher underlying incurred losses and LAE as a percentage of personal automobile insurance earned premiums, higher insurance expenses as a percentage of personal automobile insurance earned premiums and lower net investment income, partially offset by the favorable effects of loss and LAE reserve development. Underlying incurred losses and LAE exclude the impact of catastrophes and loss and LAE reserve development. Underlying incurred losses and LAE as a percentage of personal automobile insurance earned premiums increased due primarily to higher frequency of losses and, to a lesser extent, higher severity of losses for the year ended December 31, 2011, compared to 2010. Loss and LAE reserve development on personal automobile insurance had a favorable effect of $3.6 million for the year ended December 31, 2011, compared to an adverse effect of $3.7 million in 2010. Insurance expenses as a percentage of personal automobile insurance earned premiums increased due primarily to investment in policy and billing systems.
Commercial automobile insurance operating profit increased by $4.3 million for the year ended December 31, 2011, compared to 2010, due primarily to the favorable effects of loss and LAE reserve development and lower underlying incurred losses and LAE as a percentage of commercial automobile insurance earned premiums. Favorable Loss and LAE reserve development on commercial automobile insurance was $6.1 million for the year ended December 31, 2011, compared to $1.1 million in 2010. Underlying incurred losses and LAE as a percentage of commercial automobile insurance earned premiums decreased for the year ended December 31, 2011, compared to 2010, due primarily to lower severity, partially offset by higher frequency of losses.
Earned Premiums in the Specialty segment decreased by $52.6 million for the year ended December 31, 2010, compared to 2009, due to lower earned premiums for both personal and commercial automobile insurance. Personal automobile insurance earned premiums decreased by $40.2 million for the year ended December 31, 2010, compared to 2009, due to lower volume, slightly offset by higher average premium rates. Economic conditions, increased competition and higher premium rates, particularly in California, all contributed to a decline in the number of personal automobile insurance policies in force in the Specialty segment. There were approximately 360,000 personal automobile insurance policies in force at the beginning of 2009, rising to a peak of approximately 380,000 policies at the end of the first quarter of 2009. Policies in force declined to approximately 351,000 policies at December 31, 2009 and then further declined to approximately 329,000 policies at the end of 2010. Commercial automobile insurance earned premiums decreased by $12.4 million for the year ended December 31, 2010, compared to 2009, due to lower volume and, to a lesser extent, lower average earned premium per policy. Commercial automobile insurance volume declined due, in part, to increased competition and a contraction of the commercial automobile insurance market resulting from the continued effects of the economy. Average earned premium per policy on commercial automobile insurance declined due, in part, to the continued shift in the mix of Specialty’s commercial automobile insurance business towards light commercial vehicle insurance products, which carry a lower premium rate per policy than other classes of commercial vehicles.
Net Investment Income in the Specialty segment increased by $4.0 million for the year ended December 31, 2010, compared to 2009, due primarily to higher net investment income from Equity Method Limited Liability Investments. The Specialty segment reported net investment income of $7.3 million from Equity Method Limited Liability Investments for the year ended December 31, 2010, compared to $3.5 million for 2009.
Operating Profit in the Specialty segment decreased by $5.9 million for the year ended December 31, 2010, compared to 2009, due to lower operating profit in commercial automobile insurance and other insurance, partially offset by higher operating profit in personal automobile insurance.
Personal automobile insurance operating profit increased by $3.4 million for the year ended December 31, 2010, compared to 2009, due primarily to higher net investment income and lower underlying losses and LAE as a percentage of personal automobile insurance earned premiums, partially offset by the impact of adverse loss and LAE reserve development and higher insurance expenses as a percentage of personal automobile insurance earned premiums. Net investment income allocated to personal automobile insurance increased by $4.0 million for the year ended December 31, 2010, compared to 2009, due primarily to higher investment returns on Equity Method Limited Liability Investments. Underlying losses and LAE as a percentage of personal automobile earned premiums improved due primarily to lower frequency, partially offset by higher severity. Loss and LAE reserve development on personal automobile insurance had an adverse effect of $3.6 million for the year ended December 31, 2010, compared to a favorable effect of $2.3 million for 2009. Personal automobile insurance catastrophe losses and LAE were $3.0 million for the year ended December 31, 2010, compared to $4.2 million for 2009. Insurance expenses as a percentage of personal automobile insurance earned premiums increased due primarily to increased investment in technology and reduced economies of scale.
Segment Net Operating Income in the Specialty segment was $20.2 million for the year ended December 31, 2010, compared to $23.5 million for 2009. Specialty’s effective tax rate differs from the statutory tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $11.5 million for both the year ended December 31, 2010, and the year ended December 31, 2009.
Earned Premiums in the Direct segment decreased by $59.7 million for the year ended December 31, 2011, compared to 2010, due primarily to lower volume, partially offset by higher average premium rates.
Along with the above mentioned actions, Direct intends to withdraw its direct automobile insurance business in the state of Michigan and terminate broker relationships comprising approximately 20% of Direct Response’s business in the state of New York. Accordingly, the Direct segment expects that earned premiums will continue to decline in the next several quarters.
Net Investment Income in the Direct segment decreased by $3.5 million for the year ended December 31, 2011, compared to 2010, due primarily to lower net investment income from Equity Method Limited Liability Investments. Net investment income from Equity Method Limited Liability Investments was $3.0 million for the year ended December 31, 2011, compared to $6.3 million for 2010.
Insurance Expenses in the Direct segment were 34.3% of earned premiums for the year ended December 31, 2011, compared to 30.8% of earned premiums for 2010. Insurance Expenses as a percentage of earned premiums increased for the year ended December 31, 2011, compared to 2010, due primarily to higher amortization expense related to the acquisition of Direct Response, higher restructuring costs and higher consulting expenses.
While Direct has taken various rate actions on the Direct Response book of business over the past several years, the actions taken thus far have not improved the book of business at the rate that Direct had initially expected. Accordingly, as part of its strategic planning process, Direct has developed additional initiatives to improve the profitability of the Direct Response book of business including terminating certain unprofitable broker relationships in the state of New York and converting the book of business to Direct’s product, which has better pricing sophistication. As a result, Direct determined that the customer relationships intangible asset related to the Direct Response acquisition was impaired at December 31, 2011 and recognized a charge of $13.5 million in 2011 to write down the asset to its estimated fair value.
On February 13, 2009, the Company completed its acquisition of Direct Response in a cash transaction. Direct Response specializes in the sale of personal automobile insurance through direct mail and the internet through web insurance portals and its own websites, response.com and teachers.com. The results for Direct Response are included in the Direct segment from the date of acquisition. Direct Response products had earned premiums of $106.8 million for year ended December 31, 2010, compared to $115.2 million from the date of acquisition through December 31, 2009.
The Direct segment has implemented rate increases across its book of business. These actions have led to a decrease in the overall premium volume, with the number of policies in force at December 31, 2010 decreasing by 19% from the level at December 31, 2009. While premium rate increases have been implemented over much of the Direct segment’s book of business, average earned premiums per policy have remained relatively flat. In the third quarter of 2010, one of Direct’s web insurance portal partners was purchased and the acquiring company ceased marketing for the portal. The number of new policies written through this portal has declined substantially. The web insurance portal partner represented 8% and 9% of Direct’s policies in force at December 31, 2010 and December 31, 2009, respectively.
Incurred losses and LAE as a percentage of earned premiums were 79.3% for the year ended December 31, 2010, compared to 77.9% for 2009. Incurred losses and LAE as a percentage of earned premiums increased due primarily to higher underlying losses and LAE and the impact of lower favorable loss and LAE reserve development, partially offset by lower catastrophe losses and LAE (excluding development).
Operating Profit in the Life and Health Insurance segment was $167.6 million for the year ended December 31, 2011, compared to $154.0 million for 2010. Operating Profit increased for the year ended December 31, 2011 due primarily to lower Policyholders’ Benefits and Incurred Losses and LAE and the impact of a charge to write off goodwill in 2010, partially offset by the lower net investment income and higher insurance expenses. Policyholders’ Benefits and Incurred Losses and LAE decreased by $21.2 million for the year ended December 31, 2011, compared to 2010, due primarily to lower policyholders’ benefits on life insurance, lower accident and health insurance losses as a percentage of accident and health earned premiums and the favorable impact of Loss and LAE reserve development on property insurance, partially offset by higher catastrophe losses and LAE (excluding development) on property insurance. Policyholders’ benefits on life insurance were $253.2 million for the year ended December 31, 2011, compared to $263.0 million in 2010, a decrease of $9.8 million. Policyholder benefits on life insurance decreased due primarily to reserve adjustments in 2011 associated with correcting expiry dates for certain extended term life insurance policies and better mortality experience, partially offset by higher reserve additions for persisting policies. Incurred accident and health insurance losses were $88.9 million, or 53.5% of accident and health insurance earned premiums, for the year ended December 31, 2011, compared to $95.7 million, or 59.1% of accident and health insurance earned premiums, in 2010. Incurred accident and health insurance losses as a percentage of accident and health insurance earned premiums decreased due primarily to lower frequency and severity of health claims. Incurred Losses and LAE on property insurance were $43.5 million for the year ended December 31, 2011, compared to $48.1 million in 2010. Favorable loss reserve development on property insurance was $2.6 million (including favorable development of $1.5 million on catastrophes) for the year ended December 31, 2011, compared to adverse development of $4.5 million (including adverse development of $3.4 million on catastrophes) in 2010. Catastrophe losses and LAE (excluding development) were $9.1 million for the year ended December 31, 2011, compared to $4.5 million in 2010. Insurance Expenses in the Life and Health Insurance segment increased by $11.7 million for the year ended December 31, 2011, compared to 2010, due primarily to higher commission and fringe benefit expenses, partially attributable to an increase in the number of career agents employed, and higher amortization of deferred policy acquisition costs. The Company wrote off $14.8 million of goodwill in 2010 related to Reserve National.
Earned Premiums in the Life and Health Insurance segment decreased by $6.5 million for the year ended December 31, 2010, compared to 2009. Earned premiums on life insurance decreased by $3.0 million for the year ended December 31, 2010, compared to 2009, due to lower volume, partially offset by higher average premium rates. Earned premiums on accident and health insurance increased by $2.7 million for the year ended December 31, 2010, compared to 2009, due to higher average premium rates, partially offset by lower volume. Earned premiums on property insurance decreased by $6.2 million for the year ended December 31, 2010, compared to 2009, due primarily to lower volume resulting from a strategy to reduce the segment’s catastrophe exposure through the non-renewal of dwelling policies in certain coastal areas and the continued run-off of dwelling policies in all other markets, slightly offset by lower catastrophe reinsurance premiums and higher average premium rates on dwelling coverage in Texas.
Operating Profit in the Life and Health Insurance segment was $154.0 million for the year ended December 31, 2010, compared to $168.5 million for 2009. The Life and Health Insurance segment wrote off $14.8 million of goodwill at the Company’s health insurance subsidiary, Reserve National, in the third quarter of 2010. Excluding the write-off of goodwill, Operating Profit in the Life and Health Insurance segment increased $0.3 million for the year ended December 31, 2010, compared to 2009.
Net Investment Income decreased by $27.7 million for the year ended December 31, 2011, compared to 2010. Investment income from Equity Method Limited Liability Investments decreased by $39.2 million for the year ended December 31, 2011, compared to 2010, due primarily to a lower total rate of return. Dividends on equity securities increased by $9.2 million for the year ended December 31, 2011, compared to 2010, due primarily to higher levels of income producing equity securities. Interest and dividends on fixed maturities and policyholder loans increased by $2.8 million and $1.2 million, respectively for the year ended December 31, 2011, compared to 2010.
The components of Net Realized Gains on Sales of Investments for the years ended December 31, 2011, 2010 and 2009 were:
The Company regularly reviews its investment portfolio for factors that may indicate that a decline in the fair value of an investment is other than temporary. Losses arising from other-than-temporary declines in fair value are reported in the Consolidated Statements of Income in the period that the declines are determined to be other than temporary. Net Impairment Losses recognized in the Consolidated Statement of Income for the years ended December 31, 2011, 2010 and 2009 include other-than-temporary impairment (“OTTI”) losses of $11.3 million, $16.5 million and $50.4 million, respectively. OTTI losses recognized in the Consolidated Statement of Income for the year ended December 31, 2011 included pre-tax losses of $7.2 million to write down real estate investments. OTTI losses recognized in the Consolidated Statement of Income for the year ended December 31, 2010 included pre-tax losses of $11.9 million due to the deterioration of the business prospects of a single issuer in the waste management business. OTTI losses recognized in the Consolidated Statement of Income for the year ended December 31, 2010 included pre-tax foreign currency losses of $2.1 million. OTTI losses from write-downs of fixed maturities for the year ended December 31, 2009 included a pretax loss of $24.4 million related to credit losses recognized for a single issuer in the manufacturing industry due to a continued deterioration in the issuer’s business prospects.
Company’s investment in Intermec common stock was included in Investments in Equity Securities and was reported at its fair value. See Note 4, “Investments,” to the Consolidated Financial Statements. Investment gains recognized in Other Comprehensive Income increased for the year ended December 31, 2011, compared to 2010, due primarily to lower overall interest rates resulting from lower risk-free interest rates, partially offset by an other comprehensive loss of $50.6 million from disposing of all of the Company’s holding of Intermec common stock and other comprehensive losses from declines in the fair values of equity securities. The gains on Equity Securities recognized in Other Comprehensive Income for the year ended December 31, 2010 include other comprehensive gains of $50.6 million related to the Company’s investment in the common stock of Intermec.
The Company’s fixed maturity investment portfolio is comprised primarily of high-grade municipal, corporate and agency bonds. At December 31, 2011, nearly 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 Company has not made significant investments in securities that are directly or indirectly related to sub-prime mortgage loans, including, but not limited to, collateralized debt obligations and structured investment vehicles.The following table summarizes the credit quality of the fixed maturity investment portfolio at December 31, 2011 and 2010:
Gross unrealized losses on the Company’s investments in below-investment-grade fixed maturities were $5.4 million and $4.1 million at December 31, 2011 and 2010, respectively.
At December 31, 2011, the Company had $275.2 million of bonds issued by states and political subdivisions 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. At December 31, 2011, the Company had $1,577.4 million of investments in bonds issued by states and political subdivisions, commonly referred to as “municipal bonds,” that had not been pre-refunded, of which $286.2 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 nearly 94% of the Company’s entire municipal bond portfolio that has not been pre-refunded is AA or higher, the majority of which are direct obligations of states.
The following table summarizes the fair value of the Company’s investments in governmental fixed maturities at December 31, 2011 and 2010:
The Company’s short-term investments at December 31, 2011 include $212.8 million invested in money market funds which primarily invest in U.S. Treasury securities. The Company does not have any investments in sovereign debt securities issued by foreign governments. The following table summarizes the fair value of the Company’s investments in non-governmental fixed maturities by industry at December 31, 2011 and 2010:
Sixty-four companies comprised over 75% of the Company’s fixed maturity exposure to the Manufacturing industry at December 31, 2011, with the largest single exposure, Caterpillar, Inc., comprising 2.5%, or $28.8 million, of the Company’s fixed maturity exposure to such industry. Thirty-two companies comprised over 75% of the Company’s exposure to the Finance, Insurance and Real Estate industry at December 31, 2011, with the largest single exposure, Massachusetts Mutual Life Insurance Company, comprising 5.8%, or $34.4 million, of the Company’s exposure to such industry.
The following table summarizes the fair value of the Company’s ten largest investment exposures, excluding investments in U.S. Government and Government Agencies and Authorities, at December 31, 2011:
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 $1.3 million at December 31, 2011 included in Other under the heading “Reported as Other Equity Interests and Reported at Fair Value” in the preceding table. Such investment consists solely of restricted assets that are being redeemed over several periods.
The Company’s effective income tax rate from discontinued operations differs from the Federal statutory income tax rate due primarily to the net effects of state income taxes. State income tax, net of federal taxes, from discontinued operations was $0.3 million of benefit, $1.1 million of expense, and $6.3 million of expense for the years ended December 31, 2011, 2010 and 2009, respectively. State income tax includes changes in the state deferred tax asset valuation allowance related to Fireside Bank and is net of a $2.3 million benefit, $0.5 million benefit, and $6.0 million expense for the years ended December 31, 2011, 2010 and 2009, respectively.
During the third quarter of 2011, Kemper borrowed $95.0 million under the 2012 Credit Agreement. The proceeds from the borrowing were used, in part, to make a voluntary contribution of $83.7 million to fund the Company’s defined benefit pension plan. The contribution consisted of cash of $32.2 million and 7,309,764 shares of Intermec common stock purchased from Kemper’s subsidiary, Trinity, with some of the proceeds (see Note 17, “Pension Benefits”). The Company does not expect that it will be required to contribute to its defined benefit pension plan in 2012, but could make a voluntary contribution pursuant to the maximum funding limits under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). Kemper’s subsidiary, United Insurance, paid a cash dividend of $25.0 million to Kemper in September 2011, which was used along with cash on hand to repay $30 million of the borrowings under the 2012 Credit Agreement during the third quarter of 2011. As described below, during October 2011, the borrowings under the 2012 Credit Agreement were repaid in full. The 2012 Credit Agreement was undrawn at both December 31, 2011 and 2010. Management estimates that it could borrow the full amount under the 2012 Credit Agreement and still meet the financial covenants therein.
In 2007, Kemper issued $360 million of its 6.00% senior notes due May 15, 2017 (the “2017 Senior Notes”). 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 used a portion of the proceeds from the sale of the 2017 Senior Notes to repay the $300 million aggregate principal amount of its 5.75% senior notes which matured on July 1, 2007. Interest expense under the 2017 Senior Notes was $22.0 million for each of the annual periods ended December 31, 2011, 2010 and 2009, respectively.
In 2003, Kemper issued $200 million of its 4.875% senior notes due November 1, 2010 (the “2010 Senior Notes”) for an effective yield of 5.04%. The 2010 Senior Notes were repaid and retired in 2010. Interest expense under the 2010 Senior Notes was $8.4 million and $10.1 million for the years ended December 31, 2010 and 2009, respectively.
consisting of $70.5 million in cash to Kemper during 2011. In 2012, Kemper estimates that its direct insurance subsidiaries would be able to pay $175.0 million in dividends to Kemper without prior regulatory approval.
On February 2, 2011, the Board of Directors approved a new repurchase program under which Kemper is authorized to repurchase up to $300 million worth of its common stock. 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 under the new repurchase program. During 2010, Kemper repurchased approximately 1.4 million shares of its common stock at an aggregate cost of $34.4 million in open market transactions.
Kemper directly held cash and investments totaling $217.0 million at December 31, 2011, compared to $60.5 million at December 31, 2010. Sources available for the repayment of indebtedness, repurchases of common stock, future shareholder dividend payments, and the payment of interest on Kemper’s senior notes include cash and investments directly held by Kemper, receipt of dividends from Kemper’s subsidiaries and borrowings under the 2012 Credit Agreement.The primary sources of funds for Kemper’s insurance subsidiaries are premiums, investment income and proceeds from the sales and maturity of investments. The primary uses of funds are the payment of policyholder benefits under life insurance contracts, claims under property and casualty insurance contracts and accident and health insurance contracts, the payment of commissions and general expenses and the purchase of investments. Generally, there is a time lag between when premiums are collected and when policyholder benefits and insurance claims are paid. Accordingly, during periods of growth, insurance companies typically experience positive operating cash flows and are able to invest a portion of their operating cash flows to fund future policyholder benefits and claims. During periods in which premium revenues decline, insurance companies may experience negative cash flows from operations and may need to sell investments to fund payments to policyholders and claimants. In addition, if the Company’s property and casualty insurance subsidiaries experience several significant catastrophic events over a relatively short period of time, investments may have to be sold in advance of their maturity dates to fund payments, which could either result in investment gains or losses. Management believes that its property and casualty insurance subsidiaries maintain adequate levels of liquidity in the event that they experience several future catastrophic events over a relatively short period of time. Prior to the sale of its active portfolio of automobile loan receivables, the primary sources of funds for Fireside Bank also included the repayments of automobile loans, interest on automobile loans, investment income and proceeds from the sales and maturity of investments. The primary uses of funds for Fireside Bank are general expenses and purchase of investments. Prior to the redemption of its Certificates of Deposits, the primary uses of funds for Fireside Bank also included the repayment of customer deposits and interest paid to depositors.
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 $245.3 million for the year ended December 31, 2011, compared to the same period of 2010. Purchases of Fixed Maturities exceeded Sales of Fixed Maturities by $13.1 million for the year ended December 31, 2011. Sales of Fixed Maturities exceeded Purchases of Fixed Maturities by $174.6 million in the same period of 2010. Sales of Equity Securities exceeded Purchases of Equity Securities by $49.1 million for the year ended December 31, 2011. Purchases of Equity Securities exceeded Sales of Equity Securities by $155.3 million for the year ended December 31, 2010. Net cash provided by dispositions of short-term investments was $155.5 million for the year ended December 31, 2011, compared to net cash of $7.3 million used by acquisitions of short-term investments in the same period of 2010. Net proceeds from the sale of Fireside Bank’s active portfolio of automobile loan receivables provided $220.7 million of cash for the year ended December 31, 2011. Receipts from Automobile Loan Receivables provided $166.5 million of cash for the year ended December 31, 2011, compared to $339.6 million of cash provided in the same period of 2010. Receipts from the sale of a business provided $4.1 million of cash for the year ended December 31, 2010.
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 $3.7 billion using the same assumptions used to estimate the cash outflows. The Company’s Life Insurance Reserves in the Company’s Consolidated Balance Sheet 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, 2011.
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.
The Company’s Property and Casualty Insurance Reserves are reported using the Company’s estimate of its ultimate liability for losses and LAE for claims that occurred prior to the end of any given accounting period but have not yet been paid. The Company had $1,029.1 million and $1,118.7 million of gross loss and LAE reserves at December 31, 2011 and 2010, respectively. Property and Casualty Insurance Reserves for the Company’s business segments at December 31, 2011 and 2010 were:
The Unallocated Reserves were acquired in connection with a business acquisition from SCOR in 2002 and are reinsured by an insurance subsidiary of SCOR (see Note 6, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements). The Company does not allocate these reserves to its business segments or Unitrin Business Insurance.
The Company’s actuaries generally review the results of at least four of these estimation methodologies, two based on paid data and two based on incurred data, to initially estimate the ultimate losses and LAE for the current accident quarter and re-estimate the ultimate losses and LAE for previous accident quarters to determine if changes in the previous estimates of the ultimate losses and LAE are indicated by the most recent data. In some cases, the methodologies produce a cluster of estimates with a tight band of indicated possible outcomes. In other cases, however, the methodologies produce conflicting results and wider bands of indicated possible outcomes, and the Company’s actuaries perform additional analyses before making their final selections. However, such bands do not necessarily constitute a range of outcomes, nor does the Company’s management or the Company’s actuaries calculate a range of outcomes.
In estimating reserves, the Company’s actuaries exercise professional judgment and must consider, and are influenced by, many variables that are difficult to quantify, such as:
Changes to claims practices, including, but not limited to, changes in the reporting and impact of large losses, timing of reported claims, adequacy of case reserves, implementation of new systems for handling claims, turnover of claims department staffs, timing and depth of the audit review of claims handling procedures;
The final step in the quarterly loss and LAE reserving process involves a comprehensive review of the actuarial indications by the Company’s senior actuary and senior management who apply their collective judgment and determine the appropriate estimated level of reserves to record. Numerous factors are considered in this determination process, including, but not limited to, the assessed reliability of key loss trends and assumptions that may be significantly influencing the current actuarial indications, changes in claim handling practices or other changes that affect the timing of payment or development patterns, changes in the mix of business, the maturity of the accident year, pertinent trends observed over the recent past, the level of volatility within a particular line of business, the improvement or deterioration of actuarial indications in the current period as compared to prior periods, and the amount of reserves related to third party pools for which the Company does not have access to the underlying data and, accordingly, relies on calculations provided by such pools. Total recorded reserves for property and casualty insurance losses and LAE were equal to the actuarial indication of reserves at December 31, 2011 and 0.5% and 0.9% higher than the actuarial indication of reserves at December 31, 2010 and 2009, respectively.
Statements when the Company increases its previous estimate of ultimate losses and LAE and results in a decrease in net income. The Company reported total favorable development of $33.1 million, $24.9 million and $80.9 million before tax for the years ended December 31, 2011, 2010 and 2009, respectively. Development for each of the Company’s continuing business segments and Unitrin Business Insurance for the years ended December 31, 2011, 2010 and 2009, was:
Development in the Preferred segment comprised the largest portion of the Company’s development reported in continuing operations in 2011, 2010 and 2009. Additional information regarding the Preferred development is discussed below. Development in the Life and Health Insurance segment in 2011 and 2010 is due primarily to development on certain hurricanes. See MD&A, “Life and Health Insurance.”
The Company’s actuaries typically use a variety of five generally accepted actuarial loss reserving estimation methodologies-the incurred loss development methodology, the paid loss development methodology, the Bornhuetter-Ferguson incurred loss development methodology, Bornhuetter-Ferguson paid loss development methodology and the frequency and severity methodology. Preferred continues to experience various changes which impact numerous variables that are difficult to quantify and/or impact the predictive value of prior development patterns. Accordingly, in some cases, the Company’s actuaries must make adjustments to these loss reserving estimation methodologies or use additional generally accepted actuarial loss reserving
estimation methodologies until the development patterns fully emerge and the Company’s actuaries can fully rely on the unadjusted methodologies. These changes have occurred over several years and the impact of some changes is more fully developed than it is for other changes. Accordingly, the Company’s actuaries in some cases have continued to place greater weight on certain emerging loss development trends, while in other cases have placed greater weight on the adjusted loss reserving estimation methodologies or additional generally accepted actuarial loss reserving estimation methodologies in their actuarial indications. Beginning in 2007, the Company’s senior actuary and senior management began placing greater reliance on the actuarial indications in determining the appropriate estimated level of reserves.
In 2005, the personal lines claims function of Unitrin’s Multi Lines Insurance (“MLI”) unit was combined into the Preferred segment’s claims function. In September 2005, Kemper converted all open MLI personal lines claims to its claims system and began including new claims from the MLI business in its claim system.
All of these changes have impacted the development patterns for Kemper’s loss reserving data. Although the Company’s actuaries were aware of, and gave consideration to, the changes in the Company’s claims handling processes, including the merging of the Preferred and MLI claims functions, it takes several years to ascertain whether such changes in claims handling procedures will ultimately result in lower ultimate paid losses and LAE. Accordingly, the effects of the improvements and the changes in the claims handling processes have emerged and have been recognized over several years as the Company’s actuaries have become more convinced that lower losses and LAE have in fact been realized. However, the Company cannot make any assurances that all such improvements and effects have fully emerged or will continue to emerge.
While the Company believes that none of its reporting units with material goodwill are at risk of failing step one of the goodwill impairment test, the process of determining whether or not an asset, such as Goodwill, is impaired or recoverable relies on projections of future cash flows, operating results and market conditions. Such projections are inherently uncertain and, accordingly, actual future cash flows may differ materially from projected cash flows. In evaluating the recoverability of Goodwill, the Company performs a discounted cash flow analysis for each of the Company’s reporting units. The discounted cash value may be different from the fair value that would result from an actual transaction between a willing buyer and a willing seller. Such analyses are particularly sensitive to changes in discount rates and investment rates. Changes to these rates might result in material changes in the valuation and determination of the recoverability of Goodwill. For example, an increase in the rate used to discount cash flows will decrease the discounted cash value. There is likely to be a similar, but not necessarily as large as, increase in the investment rate used to project the cash flows resulting from investment income earned on the Company’s investments. Accordingly, an increase in the investment rate would increase the discounted cash value.
A change in any one or more of these assumptions is likely to result in an ultimate liability different from the original actuarial estimate. 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, 2011 by $75.1 million, while a one-percentage point increase in the rate would decrease the pension benefit obligation at December 31, 2011 by $60.5 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, 2011 by $3.5 million, while a one-percentage point increase in the rate would decrease pension expense by $3.5 million for the same period.
ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements; and
Consolidated Statements of Cash Flows for the Years Ended December 31, 2011, 2010 and 2009
Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the Years Ended December 31, 2011, 2010 and 2009
During the third quarter of 2011, Kemper’s subsidiary, Fireside Bank, sold its active portfolio of automobile loan receivables. Accordingly, the Company has accounted for Fireside Bank as a discontinued operation and has reclassified the results of Fireside Bank and the related disclosures for the years ended December 31, 2010 and 2009 to conform to the current presentation. The Company also accounts for its former Unitrin Business Insurance operations as discontinued operations. See Note 3, “Discontinued Operations,” to the Consolidated Financial Statements.
The fair values of the Company’s Investments in Fixed Maturities, Investments in Equity Securities and Senior Notes Payable are estimated using a hierarchal framework which prioritizes and ranks market price observability. The fair value of Automobile Loan Receivables at December 31, 2010 has been estimated by discounting the estimated future cash flows using the rates at which loans would be made to borrowers with similar credit ratings and the same remaining maturities. The fair value of Certificates of Deposits at December 31, 2010 has been estimated by discounting the future cash flows using the rate of discount required to liquidate existing deposits. The carrying amounts reported in the Consolidated Balance Sheets approximate fair value for Cash, Short-term Investments and certain other assets and other liabilities because of their short-term nature. The actual value at which financial instruments could actually be sold or settled with a willing buyer or seller may differ from estimated fair values depending on a number of factors, including, but not limited to, current and future economic conditions, the quantity sold or settled, the presence of an active market and the availability of a willing buyer or seller.
Investments in Fixed Maturities include bonds, notes and redeemable preferred stocks. Investments in Fixed Maturities are classified as available for sale and reported at fair value. Net Investment Income, including amortization of purchased premiums and accretion of market discounts, on Investments in Fixed Maturities is recognized as interest earned using the effective yield method.
Unrealized appreciation or depreciation, net of applicable deferred income taxes, on fixed maturities and equity securities is reported in Accumulated Other Comprehensive Income 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 of the real estate may not be recoverable. An impairment on real estate is recognized when carrying value exceeds the sum of undiscounted cash flows.
Gains and losses on sales of investments are computed on the specific identification method and are reported in the Consolidated Statements of Income in the period in which the sales occur. 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. Losses are computed on the specific identification method and reported in the Consolidated Statements of Income in the period that the decline is determined to be other than temporary. In the second quarter of 2009, the Company adopted a required change in accounting which impacts the determination of the amount of OTTI losses on Investments in Fixed Maturities that are recognized in earnings subsequent to April 1, 2009. Effective April 1, 2009, the portion of an impairment of an investment in a fixed maturity attributed to a credit loss is reported in Net Impairment Losses Recognized in Earnings in the Consolidated Statement of Income, with the balance of such impairment reported in Accumulated Other Comprehensive Income.
Costs directly associated with the acquisition of business, principally commissions and certain premium taxes and policy issuance costs, are deferred. Costs deferred on property and casualty insurance products and health insurance products are amortized over the period in which premiums are earned. Costs deferred on traditional life insurance products are primarily amortized over the anticipated premium-paying period of the related policies in proportion to the ratio of the annual premiums to the total premiums anticipated, which is estimated using the same assumptions used in calculating policy reserves.
Reserves for losses and LAE on property and casualty coverage and health insurance coverage represent the estimated claim cost and loss adjustment expense necessary to cover the ultimate net cost of investigating and settling all losses incurred and unpaid. Such estimates are based on individual case estimates for reported claims and estimates for incurred but not reported losses. These estimates are adjusted in the aggregate for ultimate loss expectations based on historical experience patterns and current economic trends, with any change in the estimated ultimate liabilities being reported in the Consolidated Statements of Income in the period of change. Changes in such estimates may be material.
Other Receivables primarily include automobile loan receivables, reinsurance recoverables and accrued investment income.
Property and casualty insurance and 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.
Deferred income tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. A valuation allowance is maintained for the portion of deferred income tax assets that the Company does not expect to recover. Increases in the valuation allowance for deferred income tax assets are recognized as
Except for rules and interpretive releases of the SEC under authority of federal securities laws and a limited number of grandfathered standards, the FASB Accounting Standards Codification (“ASC”) is the sole source of authoritative GAAP literature recognized by the FASB and applicable to the Company. The Company did not adopt any new accounting standards in 2011.
FASB issues Accounting Standards Updates (“ASUs”) to amend the authoritative literature in ASC. There were twelve ASUs issued in 2011 that amend the original text of ASC. Except for ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements and ASU 2011-08, Testing Goodwill for Impairment, described below, none of the ASUs issued in 2011 are expected to have an impact on the Company. ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, which was issued in 2010 and also described below, is expected to have an impact on the Company.
In October 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. The standard is effective for interim and annual reporting periods beginning after December 15, 2011, with earlier adoption permitted. The provisions of the new standard can be applied either prospectively or retrospectively. The standard amends ASC Topic 944, Financial Services-Insurance, and modifies the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts. The Company intends to adopt the standard on January 1, 2012 and apply its provisions retrospectively. The Company anticipates that the adoption of the standard will reduce consolidated shareholders’ equity by $100.4 million on January 1, 2012. The retrospective application of the standard will decrease reported net income for the years ended December 31, 2011, 2010 and 2009 by $9.3 million, $6.8 million and $5.7 million, respectively.
In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment. The standard is effective for the first interim or annual period beginning on or after December 15, 2011 with early adoption permitted. The standard amends ASC Topic 350, Intangibles-Goodwill and Other, and gives companies the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Except for the requirement to perform the qualitative assessment, the Company does not anticipate that the adoption of the new standard will have a material impact on the Company.
The Company accounts for Kemper’s subsidiary, Fireside Bank, and the Company’s former Unitrin Business Insurance operations as discontinued operations. Fireside Bank, which began to exit the automobile finance business in 2009, was reported as a continuing operation in the 2010 and 2009 Consolidated Financial Statements. Accordingly, results of Fireside Bank and the related disclosures for the years ended December 31, 2010 and 2009 have been reclassified to conform to the current presentation in these consolidated financial statements.
Summary financial information included in Income (Loss) from Discontinued Operations for the years ended December 31, 2011, 2010 and 2009 is presented below:
During the first four months of 2011, all of the Certificates of Deposits that were outstanding at December 31, 2010 either matured or were redeemed by Fireside Bank in advance of their respective maturity dates. On October 20, 2011, Fireside Bank requested that the FDIC terminate Fireside Bank’s FDIC insurance, which request was granted on December 8, 2011, effective March 31, 2012.
Other Receivables at December 31, 2010 included automobile loan receivables, net of allowance for loan losses, with a carrying value of $337.6 million and an estimated fair value of $340.0 million. During the third quarter of 2011, Fireside Bank sold its active portfolio of automobile loan receivables with a carrying value of $214.2 million, net of Reserve for Loan Losses of $22.9 million, at a gain of $4.5 million before tax. Fireside Bank retained its portfolio of loans that had been previously charged off. Such portfolio is not carried on the Company’s Consolidated Balance Sheet. Accordingly, no automobile loans receivables were carried on the Company’s Consolidated Balance Sheet following the sale of the active loan portfolio.
Following approval from its regulators, Fireside Bank distributed $250.0 million of its capital to its parent company, Fireside Securities, in October 2011. Fireside Securities, then in turn, distributed the same amount to its parent company, Kemper Corporation. Fireside Bank had total capital of $16.1 million at December 31, 2011.
The amortized cost and estimated fair values of the Company’s Investments in Fixed Maturities at December 31, 2011 were:
There were no unsettled purchases of Investments in Fixed Maturities at December 31, 2011 or December 31, 2010.
Gross unrealized gains and gross unrealized losses on the Company’s Investments in Equity Securities at December 31, 2011 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 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, 2011, were $11.1 million, of which $5.9 million was related to fixed maturities that were in an unrealized loss position for 12 months or longer. Unrealized losses at December 31, 2011 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “Less Than 12 Months” were insignificant. There were no unrealized losses at December 31, 2011 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “12 Months or Longer.” Included in the preceding table under the heading “12 Months or Longer” are unrealized losses of $0.2 million at December 31, 2011 related to securities for which the Company has previously recognized foreign currency losses in earnings. Investment-grade fixed maturity investments comprised $5.7 million and below-investment-grade fixed maturity investments comprised $5.4 million of the unrealized losses on investments in fixed maturities at December 31, 2011. Unrealized losses for below-investment-grade fixed maturities included unrealized losses totaling $0.2 million for one issuer that the Company previously recognized foreign currency impairment losses in earnings. For the other remaining below-investment-grade fixed maturity investments in an unrealized loss position, the unrealized loss amount, on average, was less than 4% of the amortized cost basis of the investment. At December 31, 2011, 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, 2011 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 vast majority of the Company’s preferred stocks in an unrealized loss position at December 31, 2011 were perpetual preferred stocks of financial institutions. The Company considers the debt-like characteristics of perpetual preferred stocks along with issuer ratings when evaluating impairment. All such preferred stocks paid dividends at the stated dividend rate during the twelve-month period preceding the evaluation date. The Company concluded that the declines in the fair values of these perpetual preferred stocks were temporary in nature, largely driven by market conditions, and since the Company intends to hold the securities until recovery, these investments were not considered to be other-than-temporarily impaired at December 31, 2011. The Company concluded that the unrealized losses on its investments in common stocks at December 31, 2011 were temporary based on 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 partnerships that primarily invest in distressed debt, mezzanine debt and secondary transactions. By the nature of their underlying investments, the Company believes that its investments in the limited liability partnerships also exhibit debt-like characteristics which, among other factors, the Company considers when evaluating these investments for impairment. Based on evaluations of the factors in the preceding paragraph, the Company concluded that the declines in the fair values of the Company’s investments in equity securities were temporary at December 31, 2011.
The vast majority of the Company’s preferred stocks in an unrealized loss position at December 31, 2010 are perpetual preferred stocks of financial institutions and public utilities. The Company considers the debt-like characteristics of perpetual preferred stocks along with issuer ratings when evaluating impairment. All such preferred stocks paid dividends at the stated
sell Reserve National. Based on a projection of discounted future cash flows, updated to take into consideration the impact of the Health Care Acts, discussions with a potential buyer for Reserve National during the first quarter of 2010 and preliminary discussions with an adviser retained in April 2010, the Company concluded that the estimated fair value of Reserve National exceeded its carrying value at March 31, 2010, and the Company concluded that such goodwill was recoverable. In the second quarter of 2010, based on the Company’s analysis at March 31, 2010 and preliminary, non-binding price indications from potential buyers for Reserve National, the Company concluded that the goodwill associated with Reserve National was also recoverable at June 30, 2010.
In 2011, the Company reduced its property and casualty insurance reserves by $33.1 million to recognize favorable development of losses and LAE from prior accident years. Personal lines insurance losses and LAE reserves developed favorably by $29.3 million and commercial lines insurance losses and LAE reserves developed favorably by $3.8 million. The personal lines insurance losses and LAE reserves developed favorably due primarily to the emergence of more favorable loss trends than expected for the 2010, 2009 and 2008 accident years and favorable development on certain catastrophes.
In 2009, the Company reduced its property and casualty insurance reserves by $80.9 million to recognize favorable development of losses and LAE from prior accident years. Personal lines insurance losses and LAE reserves developed favorably by $72.3 million and commercial lines insurance losses and LAE reserves developed favorably by $8.6 million. The personal lines insurance losses and LAE reserves developed favorably due primarily to the emergence of more favorable loss trends than expected for the 2007, 2006 and 2005 accident years due to the improvements in the Company’s claims handling procedures and due to favorable development on catastrophes.
The Company cannot predict whether loss and LAE will develop favorably or unfavorably from the amounts reported in the Company’s consolidated financial statements. The Company believes that any such development will not have a material effect on the Company’s consolidated financial position, but could have a material effect on the Company’s consolidated financial results for a given period.
Interest Paid on Notes Payable, including facility fees, for the years ended December 31, 2011, 2010 and 2009 was:
On October 30, 2009, Kemper entered into the 2012 Credit Agreement, a three-year, $245 million, unsecured, revolving credit agreement, expiring October 30, 2012, with a group of financial institutions. The 2012 Credit Agreement replaced the 2010 Credit Agreement, which was a $325 million, unsecured, revolving credit agreement scheduled to expire on June 30, 2010 and was terminated on October 30, 2009. There were no borrowings under the 2010 Credit Agreement at its termination. The 2012 Credit Agreement provides for fixed and floating rate advances for periods up to six months at various interest rates. The 2012 Credit Agreement contains various financial covenants, including limits on total debt to total capitalization, consolidated net worth and minimum risk-based capital ratios for Kemper’s largest insurance subsidiaries, United Insurance and Trinity. Proceeds from advances under the 2012 Credit Agreement may be used for general corporate purposes, including repayment of existing indebtedness.
During the third quarter of 2011, Kemper borrowed $95.0 million under the 2012 Credit Agreement. The proceeds from the borrowing were used, in part, to make a voluntary contribution of $83.7 million to fully fund the Company’s defined benefit pension plan under the funding requirements of ERISA. The contribution consisted of cash of $32.2 million and 7,309,764 shares of Intermec common stock purchased from Kemper’s subsidiary, Trinity, with some of the proceeds (see Note 17, “Pension Benefits,” to the Consolidated Financial Statements). Kemper repaid $30.0 million and $65.0 million of the borrowing in September and October of 2011, respectively.
Kemper had no outstanding advances under the 2012 Credit Agreement at either December 31, 2011 or 2010. The amount available for borrowing under the 2012 Credit Agreement was $245 million at both December 31, 2011 and 2010.
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 used a portion of the proceeds from the sale of the 2017 Senior Notes to repay the $300 million aggregate principal amount of its 5.75% Senior Notes which matured on July 1, 2007.
Net rental expense for operating leases for the years ended December 31, 2011, 2010 and 2009 was:
Various state insurance laws restrict the amount that an insurance subsidiary may pay in the form of dividends, loans or advances without the prior approval of regulatory authorities. Also, that portion of an insurance subsidiary’s net equity which results from differences between statutory insurance accounting practices and GAAP would not be available for cash dividends,
For equity-based compensation awards with a graded vesting schedule, the Company recognizes compensation expense on a straight-line basis over the requisite service period for each separately vesting portion of the awards as if each award were, in substance, multiple awards. Compensation expense is recognized only for those awards expected to vest, with forfeitures estimated at the date of grant based on the Company’s historical experience and future expectations. Equity-based compensation expense for all of the Company’s long-term equity-based compensation plans was $5.3 million, $4.2 million and $3.1 million for the years ended December 31, 2011, 2010 and 2009, respectively. Total unamortized compensation expense related to nonvested awards of such plans at December 31, 2011 was $5.2 million, which is expected to be recognized over a weighted-average period of 1.5 years.
(“Non-Employee Director”) receives an initial option to purchase 4,000 shares of Kemper common stock immediately upon becoming a director. Thereafter, on the date of each of Kemper’s annual meetings of shareholders, eligible Non-Employee Directors automatically receive annual grants of options to purchase 4,000 shares of common stock for so long as they remain eligible directors. Such options granted to Non-Employee Directors are exercisable one year from the date of grant at an exercise price equal to the fair market value of Kemper’s common stock on the date of grant and expire 10 years from the date of grant.
The assumptions used in the Black-Scholes pricing model for options granted during the years ended December 31, 2011, 2010 and 2009, were as follows:
Information pertaining to options outstanding at December 31, 2011 is presented below:
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 2011 and 2010 three-year performance periods was 63,950 common shares and 56,900 common shares, respectively, at December 31, 2011. For the 2009 three-year performance period, the Company exceeded target performance levels with a payout percentage of 183%. Accordingly, an additional 39,748 shares of stock were issued to award recipients on January 31, 2012.
Activity related to nonvested restricted stock for the year ended December 31, 2011 is presented below:
Restricted stock granted during the year ended December 31, 2011 includes 72,450 shares of time-vested restricted stock and 65,475 shares of performance-based restricted stock. The nonvested balance of restricted stock at December 31, 2011 was comprised of 116,784 shares of time-vested restricted stock and 172,875 shares of performance-based restricted stock. The total fair value of restricted stock that vested, all of which were time-based restricted stock awards, during the years ended December 31, 2011, 2010 and 2009 was $1.4 million, $2.2 million and $0.8 million, respectively. Tax benefits for tax deductions realized from the vesting of restricted stock were $0.5 million, $0.8 million and $0.3 million for the years ended December 31, 2011, 2010 and 2009, respectively.
The Company’s awards of restricted common stock contain a right to receive non-forfeitable dividends and participate in the undistributed earnings with common shareholders. Accordingly, the Company is required to apply the two-class method of computing basic and diluted earnings per share. A reconciliation of the numerator and denominator used in the calculation of Basic Income from Continuing Operations Per Unrestricted Share and Diluted Income from Continuing Operations Per Unrestricted Share for the years ended December 31, 2011, 2010 and 2009 is as follows:
Options outstanding to purchase 3.3 million, 4.1 million and 4.7 million shares of Kemper common stock were excluded from the computation of Kemper Equity-based Compensation Equivalent Shares and Weighted-Average Common Shares and Equivalent Shares Outstanding Assuming Dilution for the years ended December 31, 2011, 2010 and 2009, respectively, because the exercise price exceeded the average market price.
Insurance Expenses for the years ended December 31, 2011, 2010 and 2009 were:
Except for the net operating losses scheduled to expire in 2031, all of the federal net operating loss 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 net operating loss carryforwards. The state net operating loss carryforwards relate to Fireside Bank, the majority of which are scheduled to expire in 2029. Deferred tax asset valuation allowances of $6.8 million and $9.1 million were required at December 31, 2011 and 2010, respectively, and relate to state income taxes for Fireside Bank.
Income taxes refunded, net of income tax paid of $57.1 million, were $4.1 million in 2011. Income taxes paid were $65.1 million and $72.3 million in 2010 and 2009, respectively.
A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2011, 2010 and 2009 is as follows:
Included in the balance of unrecognized tax benefits at December 31, 2011, December 31, 2010 and December 31, 2009 are tax positions of $3.7 million, $5.7 million and $7.2 million, respectively, for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred income tax accounting, other than for interest and penalties, the disallowance of the shorter deductibility period would not affect the effective income tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.
A reconciliation of the Statutory Federal Income Tax Expense and Rate to the Company’s Effective Income Tax Expense and Rate from Continuing Operations for the years ended December 31, 2011, 2010 and 2009 was:
Comprehensive Income Tax Benefit (Expense) included in the Consolidated Financial Statements for the years ended December 31, 2011, 2010 and 2009 was:
The Accumulated Benefit Obligation was $480.5 million and $417.5 million at December 31, 2011 and 2010, respectively. For the Company’s pension plan with an accumulated benefit obligation in excess of plan assets at December 31, 2011, the Projected Benefit Obligation was $496.8 million, the Accumulated Benefit Obligation was $478.1 million and the Fair Value of Plan Assets was $438.7 million. For the Company’s pension plan with an accumulated benefit obligation in excess of plan assets at December 31, 2010, the Projected Benefit Obligation was $430.6 million, the Accumulated Benefit Obligation was $415.0 million and the Fair Value of Plan Assets was $349.8 million.The actuarial assumptions used to develop the components of the Pension Projected Benefit Obligation at December 31, 2011 and 2010 were:
Weighted-average asset allocations for the Pension Plans at December 31, 2011 and 2010 by asset category were:
The investment objective of the Pension Plans is to produce current income and long-term capital growth through a combination of equity and fixed income investments which, together with appropriate employer contributions and any required employee contributions, is adequate to provide for the payment of the benefit obligations of the Pension Plans. The assets of the Pension Plans may be invested in both fixed income and equity investments. Fixed income investments may include cash and short-term instruments, U.S. Government securities, corporate bonds, mortgages and other fixed income investments. Equity investments may include various types of stock, such as large-cap, mid-cap and small-cap stocks, and may also include investments in investment companies and Kemper common stock (subject to Section 407 and other requirements of ERISA). The Pension Plans have not invested in Kemper common stock.
The trust investment committee for the Pension Plans periodically reviews the performance of the Pension Plans’ investments and asset allocation. Several external investment managers, one of which is Fayez Sarofim & Co. (“FS&C”), manage the equity investments of the trust for the Pension Plans. One of Kemper’s directors, Mr. Fayez Sarofim, is Chairman of the Board, President and the majority shareholder of FS&C, a registered investment advisory firm (see Note 24, “Related Parties,” to the Consolidated Financial Statements). Each manager is allowed to exercise investment discretion, subject to limitations, if any, established by the trust investment committee for the Pension Plans. An independent fiduciary has sole investment discretion with respect to shares of Intermec common stock contributed by the Company to one of the pension plans in 2011. All other investment decisions are made by the Company, subject to general guidelines as set by the trust investment committee for the Pension Plans.
Fair value measurements for the Pension Plans’ assets at December 31, 2011 is summarized below:
The actuarial assumptions used to develop the components of the Pension Expense for the years ended December 31, 2011, 2010 and 2009 were:
The Company does not expect that it will be required to contribute to its Pension Plans in 2012, 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 $21.7 million and $22.0 million at December 31, 2011 and 2010, respectively. Pension expense for the Supplemental Plan was $3.3 million, $3.1 million and $0.9 million in 2011, 2010 and 2009, respectively. An actuarial gain of $2.9 million before tax is included Other Comprehensive Income for the year ended December 31, 2011.
The Company sponsors an other than pension postretirement employee benefit plan (“OPEB”) that provides medical, dental and/or life insurance benefits to approximately 700 retired and 400 active employees (the “OPEB Plan”). The Company generally is self-insured for the benefits under the OPEB Plan. The medical plan generally provides for a limited number of years of medical insurance benefits at retirement based on the participant’s attained age at retirement and number of years of service until specified dates and generally requires participant contributions, with most contributions adjusted annually.
The measurement dates of the assets and liabilities at end of year in the preceding table under the headings “2011” and “2010” were December 31, 2011 and December 31, 2010, respectively.
The actuarial assumptions used to develop the components of the Accumulated Benefit Obligation at December 31, 2011 and 2010 were:
The assumed health care cost trend rate used in measuring the Accumulated Benefit Obligation at December 31, 2011 was 7.5% for 2012, gradually declining to 5.0% in the year 2017 and remaining at that level thereafter for medical benefits and 9.0% for 2012, gradually declining to 5.0% in the year 2020 and remaining at that level thereafter for prescription drug benefits. The assumed health care cost trend rate used in measuring the Accumulated Benefit Obligation at December 31, 2010 was 6.5% for 2011, gradually declining to 5.0% in the year 2014 and remaining at that level thereafter for medical benefits and 7.0% for 2011, gradually declining to 5.0% in the year 2013 and remaining at that level thereafter for prescription drug benefits.
A one-percentage point increase in the assumed health care cost trend rate for each year would increase the Accumulated Benefit Obligation at December 31, 2011 by $2.8 million and 2011 OPEB expense by $0.1 million. A one-percentage point increase in the assumed health care cost trend rate for each year would increase the Accumulated Benefit Obligation at December 31, 2010 by $2.5 million and 2010 OPEB expense by $0.1 million.
The components of Comprehensive OPEB Expense for the years ended December 31, 2011, 2010 and 2009 were:
The Company is engaged, through its subsidiaries, in the property and casualty insurance and life and health insurance businesses. The Company conducts its continuing operations through four operating segments: Preferred, Specialty, Direct and Life and Health Insurance.
The Company does not allocate insurance reserves from its 2002 acquisition of certain insurance companies from SCOR (see Note 6, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements). It is also 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 $33.0 million, $30.9 million and $30.9 million for the years ended December 31, 2011, 2010 and 2009, respectively. The Company does not allocate Net Realized Gains on Sales of Investments, Net Impairment Losses Recognized in Earnings, interest expense on debt or retirement plans, and actuarial gains and losses on its retirement plans to its operating segments.
Segment Net Operating Income for the years ended December 31, 2011, 2010 and 2009 was:
Catastrophe losses and LAE (including development), net of reinsurance recoveries, for the years ended December 31, 2011, 2010 and 2009 by business segment are presented below.
Total Catastrophe loss and LAE reserves, net of reinsurance recoverables, developed favorably by $6.4 million, $1.2 million and $18.1 million for the years ended December 31, 2011, 2010 and 2009, respectively. The Preferred segment reported favorable catastrophe reserve development of $5.5 million, $4.9 million and $18.3 million for the years ended December 31, 2011, 2010 and 2009, respectively. The Life and Health Insurance segment reported adverse catastrophe reserve development of $3.4 million for the year ended December 31, 2010, and favorable catastrophe reserve development of $1.5 million and $0.1 million for the years ended December 31, 2011 and 2009, respectively.
For the year ended December 31, 2010, compared to 2009, the Preferred segment experienced a higher severity of catastrophe losses, due in part to a catastrophe loss of $12.9 million resulting from damage caused by hail in the state of Arizona in the fourth quarter of 2010. No major hurricanes that significantly impacted the Company made landfall in the United States during 2010 or 2009.
Insurance Expenses for the year ended December 31, 2009 includes a reduction of expense of $2.8 million due to a decrease in the Company’s estimate of its share of assessments from TWIA.
Earned Premiums ceded on long-duration and short-duration policies were not material for the years ended December 31, 2011, 2010 and 2009. Certain insurance subsidiaries assume business from other insurance companies and involuntary pools. Earned Premiums assumed on long-duration and short-duration policies for the years ended December 31, 2011, 2010 and 2009 were:
Trinity and Capitol are parties to a quota share reinsurance agreement whereby Trinity assumes 100% of the business written by Capitol. Capitol is a mutual insurance company and, accordingly, is owned by its policyholders. five employees of the Company serve as directors of Capitol’s five member board of directors. nine employees of the Company also serve as directors of Capitol’s wholly owned subsidiary’s, ORCC’s, nine member board of directors. Trinity and ORCC are parties to a quota share reinsurance agreement whereby Trinity assumes 100% of the business written by ORCC. Kemper’s subsidiary, United Insurance, provides claims and administrative services to Capitol and ORCC. In addition, agents appointed by Kemper’s subsidiary, Reliable, and employed by United Insurance, are also appointed by Capitol and ORCC to sell property insurance products. The Company also provides certain investment services to Capitol and ORCC.
The Company classifies its Investments in Fixed Maturities and Equity Securities as available for sale and reports these investments at fair value. The Company classifies certain investments in mutual funds included in Other Investments as trading securities and reports these investments at fair value. The Company has no material liabilities that are measured and reported at fair value.
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, state and municipal bonds, 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.
Information by security type pertaining to the changes in the fair value of the Company’s investments classified as Level 3 for the year ended December 31, 2011 is presented below:
The Company’s policy is to recognize transfers between levels as of the end of the reporting period. Transfers between levels 1 and 2 were not significant for the year ended December 31, 2011. Included in Other Equity Interests at December 31, 2011 in the preceding table is $84.1 million of private equity funds and mezzanine debt funds which the Company has unfunded commitments of $77.1 million. These funds cannot be redeemed, instead distributions are received through the liquidation of the underlying investments of the fund. It is estimated that the assets of these funds will be liquidated and distributed to the Company between 2012 and 2021.
In the ordinary course of its businesses, the Company is involved in legal proceedings, including lawsuits, regulatory examinations and inquiries. Based on currently available information, the Company does not believe that it is reasonably possible that any of its pending legal proceedings will have a material effect on the Company’s financial statements.
One of Kemper’s directors, Mr. Fayez Sarofim, is the Chairman of the Board, President and the majority shareholder of FS&C, a registered investment advisory firm. In the second quarter of 2010, Kemper’s subsidiary, Trinity, entered into an agreement with FS&C whereby FS&C provides investment management services with respect to certain assets of Trinity for a fee based on the fair market value of the assets under management. Such agreement is terminable by either party at any time upon 30 days advance written notice. At December 31, 2011, Trinity had $115.2 million in assets managed by FS&C. Investment Expenses incurred in connection with such agreement were $0.3 million and $0.1 million for the years ended December 31, 2011 and 2010, respectively. FS&C did not provide investment management services to Trinity in 2009.
FS&C also provides investment management services with respect to certain funds of the Company’s defined benefit pension plans. The Company’s defined benefit pension plans had $107.1 million, $98.3 million and $84.3 million, in assets managed by FS&C at December 31, 2011, 2010 and 2009, respectively. The Company’s defined benefit pension plans 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, 2011, 2010 and 2009, respectively.
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, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, 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, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.