Kemper’s subsidiaries together own and occupy eleven buildings located in seven states consisting of approximately 400,000 square feet in the aggregate. One of Kemper’s subsidiaries owns one building totaling approximately 4,000 square feet which
Selected financial information as of and for the years ended December 31, 2018, 2017, 2016, 2015 and 2014 is presented below. See Note 2, “Summary of Accounting Policies and Accounting Changes”, and Note 3, “Acquisition of Business,” to the Consolidated Financial Statements for items which may affect comparability of selected financial information across the periods presented.
of the segment’s results. In the Life & Health Insurance segment, segment net operating income decreased by $0.4 million due primarily to higher policyholders’ benefits and incurred losses and LAE and lower net investment income, almost entirely offset by lower income tax expense due to the lower corporate income tax rate in 2018. See MD&A, “Life & Health Insurance,” beginning on page 45 for additional discussion of the segment’s results. Additionally, the Company’s results were impacted in 2018, compared to 2017, by transaction and integration costs associated with Kemper’s acquisition of Infinity and a loss from the change in the fair value of the Company’s equity security portfolio, for which such changes are recorded through the Consolidated Statement of Income in 2018, compared to Accumulated Other Comprehensive Income, in 2017, partially offset by the positive effects of tax law changes and the partial satisfaction of a legal judgment. See MD&A, “Investment Results,” beginning on page 50 and MD&A, “Income Taxes,” beginning on page 57 and Note 23, “Contingencies.” to the Consolidated Financial Statements for additional discussion.
Net Investment Income increased by $13.7 million in 2018 due primarily to a higher level of investments in fixed income securities and short-term securities, partially offset by a lower rate of return from Alternative Investments, lower yields on fixed income securities and the impact of presenting Fair Value Option Investments within Loss from Change in Fair Value of Equity and Convertible Securities (outside of Net Investment Income) as of January 1, 2018. Net Investment Income from Alternative Investments, which consist of Equity Method Limited Liability Investments, Fair Value Option Investments and other limited liability investments included in Equity Securities at Fair Value or Equity Securities at Modified Cost, decreased by $17.3 million. Alternative investment income from Equity Method Limited Liability Investments decreased by $13.8 million. Alternative investment income from limited liability investments included in either Equity Securities at Fair Value or Equity Securities at Modified Cost decreased by $2.2 million for the year ended December 31, 2018, compared to the same period in 2017. No Net Investment Income was recorded on Fair Value Option Investments for the year ended December 31, 2018, compared to $1.3 million for the same period in 2017. See MD&A, “Investment Results,” under the sub-caption “Net Investment Income” beginning on page 50 for additional discussion.
Other Income increased by $38.2 million for the year ended December 31, 2018, compared to the same period in 2017, due primarily to the the partial satisfaction of a final judgment against Computer Sciences Corporation (“CSC”). See Note 23,
The Company adopted Accounting Standards Update (“ASU”) 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, in 2018. As a result of adoption, beginning in 2018, changes in the fair value of the Company’s investments in equity securities with readily determinable fair values are recognized in the Consolidated Statements of Income. Loss from Change in Fair Value of Equity and Convertible Securities recognized in the Consolidated Statements of Income was $64.3 million in 2018. Prior to 2018, changes in the fair value of equity securities were recognized in other comprehensive income. See MD&A, “Investment Results,” under the sub-caption “Loss from Change in Fair Value of Equity and Convertible Securities” beginning on page 51 for additional discussion
Net Investment Income increased by $28.9 million in 2017 due primarily to higher investment returns from Alternative Investments and higher levels of investments in fixed income securities, partially offset by lower yields on fixed income securities. Net Investment Income from Alternative Investments, which consist of Equity Method Limited Liability Investments, Fair Value Option Investments and other limited liability investments included in Equity Securities, increased by $27.1 million. Alternative investment income from Equity Method Limited Liability Investments, other limited liability investments included in Equity Securities, and Fair Value Option Investments increased by $17.3 million, $6.6 million and $3.2 million, respectively, in 2017, compared to 2016. See MD&A, “Investment Results,” under the sub-caption “Net Investment Income” beginning on page 50 for additional discussion.
Net Realized Gains on Sales of Investments were $56.5 million in 2017, compared to $33.1 million in 2016. See MD&A, “Investment Results,” under the sub-caption “Net Realized Gains on Sales of Investments” beginning on page 52 for additional discussion. Net Impairment Losses Recognized in Earnings in 2017 and 2016 were $14.3 million and $32.7 million, respectively. See MD&A, “Investment Results,” under the sub-caption “Net Impairment Losses Recognized in Earnings” beginning on page 52 for additional discussion. The Company cannot predict when or if similar investment gains or losses may occur in the future.
The number of ISO-classified catastrophic events and catastrophe losses and LAE, net of reinsurance recoveries, (excluding loss and LAE reserve development) by range of loss and business segment for the years ended December 31, 2018, 2017 and 2016 are presented below.
The Company primarily manages its exposure to catastrophes and other natural disasters through a combination of geographical diversification, restrictions on the amount and location of new business production in such regions, modifications of, and/or limitations to coverages and deductibles for certain perils in such regions and a catastrophe reinsurance program for the Company’s Preferred Property & Casualty Insurance and Specialty Property & Casualty Insurance segments. Coverage under the catastrophe reinsurance program is provided in various contracts and layers. The Company’s Preferred Property & Casualty Insurance and Specialty Property & Casualty Insurance segments also purchase reinsurance from the FHCF for hurricane losses in Florida at retentions lower than its catastrophe reinsurance program. The Life & Health Insurance segment also purchases reinsurance from the FHCF for hurricane losses in Florida. Except for the coverage provided by the FHCF, the Life & Health Insurance segment does not carry any other catastrophe reinsurance coverage.
In 2018 and 2017, the Company had catastrophe reinsurance recoveries of $31.8 million and $11.9 million under its catastrophe reinsurance programs, respectively. Catastrophe recoveries under the FHCF were not material in 2018 or 2017. In 2018 and 2017, the Company paid $0.4 million and $0.8 million in reinstatement premium, respectively. The Company did not pay any reinstatement premium in 2016.
Increases (decreases) in the Company’s property and casualty loss and LAE reserves for the years ended December 31, 2018, 2017 and 2016 to recognize adverse (favorable) loss and LAE reserve development from prior accident years in continuing operations, hereinafter also referred to as “reserve development” in the discussion of segment results, are presented below.
periods as a result of their incidence of occurrence and magnitude and can have a significant impact on incurred losses and LAE and the combined ratio. Prior-year reserve developments are caused by unexpected loss development on historical reserves. Because reserve development relates to the re-estimation of losses from earlier years, it has no bearing on the performance of the Company’s insurance products that were in force in the current period. The Company believes it is useful for investors to evaluate these components separately and in the aggregate when reviewing the Company’s underwriting performance.
The Company believes that Adjusted Consolidated Net Operating Income provides investors with a valuable measure of its ongoing performance because it reveals underlying operational performance trends that otherwise might be less apparent if the items were not excluded. Income (Loss) from Change in Fair Value of Equity and Convertible Securities, Net Realized Gains on Sales of Investments and Net Impairment Losses Recognized in Earnings related to investments included in the Company’s results may vary significantly between periods and are generally driven by business decisions and external economic developments such as capital market conditions that impact the values of the Company’s investments, the timing of which is unrelated to the insurance underwriting process. Acquisition Related Transaction, Integration and Other Costs may vary significantly between periods and are generally driven by the timing of acquisitions and business decisions which are unrelated to the insurance underwriting process. Loss from Early Extinguishment of Debt is driven by the Company’s financing and refinancing decisions and capital needs, as well as external economic developments such as debt market conditions, the timing of which is unrelated to the insurance underwriting process. Significant non-recurring items are excluded because, by their nature, they are not indicative of the Company’s business or economic trends.
The Preferred Property & Casualty Insurance segment reported Segment Net Operating Income of $25.7 million for the year ended December 31, 2018, compared to Segment Net Operating Loss of $45.4 million in 2017. Segment net operating results improved by $71.1 million due primarily to lower current year catastrophe losses and LAE (excluding loss and LAE reserve development) and the favorable impact of loss and LAE reserve development, partially offset by higher insurance expense as a percentage of earned premiums.
Earned Premiums in the Preferred Property & Casualty Insurance segment increased by $0.4 million in 2018, compared to 2017, as higher average earned premium accounted for an increase of $21.4 million, partially offset by a decrease in volume of $21.0 million. All product lines experienced an increase in average earned premium, although the overall impact on Earned Premiums was driven primarily by preferred personal automobile insurance, which had increases due to higher average earned premium of $19.5 million. The lower volume was driven by homeowners insurance and preferred personal automobile insurance which had volume decreases of $15.5 million and $2.1 million, respectively.
Underlying losses and LAE as a percentage of earned premiums were 62.9% in both 2018 and 2017. Underlying incurred losses and LAE exclude the impact of catastrophes and loss and LAE reserve development. Catastrophe losses and LAE (excluding reserve development) were $87.3 million in 2018, compared to $173.5 million in 2017, which is a decrease of $86.2 million due primarily to lower losses on California wildfires in 2018, compared 2017, due in part to reinsurance recoveries in 2018 under the aggregate property catastrophe reinsurance contract and fewer catastrophe losses and LAE (excluding reserve development) from events with greater than $20.0 million in losses and LAE. Favorable loss and LAE reserve development (including catastrophe reserve development) was $8.3 million in 2018, compared to adverse development of $15.7 million in 2017. Adverse development in 2017 was driven primarily by preferred personal automobile insurance.
The Preferred Property & Casualty Insurance segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $8.5 million in 2018, compared to $13.9 million in 2017.
Net Investment Income in the Preferred Property & Casualty Insurance segment increased by $10.3 million in 2017, compared to 2016, due primarily to higher investment income from Alternative Investments, and to a lesser extent, higher levels of non-alternative investments. The Preferred Property & Casualty Insurance segment reported Net Investment Income from Alternative Investments of $22.5 million in 2017, compared to $12.6 million in 2016.
Underlying losses and LAE as a percentage of earned premiums were 62.9% in 2017, an increase of 0.1% percentage points, compared to 2016, driven primarily by increases in preferred automobile insurance, partially offset by decreases in homeowners insurance. Catastrophe losses and LAE (excluding reserve development) were $173.5 million in 2017, compared to $103.1 million in 2016, which is an increase of $70.4 million due primarily to California wildfires and higher average severity on catastrophic events with losses and LAE (excluding reserve development) of less than $15.0 million in 2017, compared to 2016. This increase was partially offset by two large catastrophes, both Texas hailstorms, occurring in 2016, with aggregated estimated losses and LAE of $61.9 million, compared to one such Texas hailstorm, occurring in 2017, with estimated losses and LAE of $43.9 million. Adverse loss and LAE reserve development (including catastrophe reserve development) was $15.7 million in 2017, compared to favorable development of $23.4 million in 2016. Adverse development in 2017 was driven primarily by preferred automobile insurance.
Insurance expenses were $217.8 million, or 29.8% of earned premiums, in 2017, an improvement of 1.1 percentage points compared to 2016, driven primarily by cost reduction initiatives and an increase in the percentage of software development costs eligible for capitalization.
The Preferred Property & Casualty Insurance segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income and dividends received deductions. Tax-exempt investment income and dividends received deductions were $13.9 million in 2017, compared to $13.7 million in 2016.
Earned premiums in preferred personal automobile insurance increased by $17.4 million in 2018, compared to 2017, as higher average earned premium accounted for an increase of $19.5, while lower volume accounted for a decrease of $2.1 million. The decrease in earned premium attributed to lower volume was primarily due to the run-off of the direct-to-consumer business. Incurred losses and LAE were $310.2 million, or 70.5% of earned premiums, in 2018, compared to $339.6 million, or 80.3% of earned premiums, in 2017. Incurred losses and LAE as a percentage of earned premiums decreased due primarily to a favorable change in loss and LAE reserve development, lower underlying losses and LAE as a percentage of related earned premiums and lower catastrophe losses and LAE (excluding reserve development). Underlying losses and LAE as a percentage of related earned premiums were 70.2% in 2018, compared to 73.0% in 2017, which was an improvement of 2.8 percentage points due primarily to lower frequency of claims and higher average earned premiums, partially offset by higher severity of losses, particularly on bodily injury coverages. Catastrophe losses and LAE (excluding reserve development) were $7.2 million in 2018, compared to $11.3 million in 2017. Favorable loss and LAE reserve development was $5.8 million in 2018, compared to adverse development of $19.3 million in 2017.
Earned premiums in preferred personal automobile insurance decreased by $1.8 million in 2017, compared to 2016, as lower volume accounted for a decrease of $16.6 million, while higher average earned premium accounted for an increase of $14.8 million. The run-off of the direct-to-consumer business accounted for approximately 60% of the decrease in earned premiums attributed to lower volume. Incurred losses and LAE were $339.6 million, or 80.3% of earned premiums, in 2017, compared to $324.2 million, or 76.4% of earned premiums, in 2016. Incurred losses and LAE as a percentage of earned premiums increased due primarily to a higher level of adverse loss and LAE reserve development and higher underlying losses and LAE as a percentage of related earned premiums. Underlying losses and LAE as a percentage of related earned premiums were 73.0% in 2017, compared to 72.6% in 2016, which was a deterioration of 0.4 percentage points due primarily to higher severity of losses, particularly on bodily injury coverages, partially offset by lower frequency of claims on most coverages, particularly bodily injury. Catastrophe losses and LAE (excluding reserve development) were $11.3 million in 2017, compared to $11.6 million in 2016, both periods experiencing higher losses than average due primarily to Hurricane Harvey in 2017, and hailstorms in Texas in 2017 and 2016. Adverse loss and LAE reserve development was $19.3 million in 2017, compared to $4.6 million in 2016.
See MD&A, “Critical Accounting Estimates,” under the caption “Property and Casualty Insurance Reserves for Losses and Loss Adjustment Expenses” beginning on page 64 for additional information pertaining to the Company’s process of estimating property and casualty insurance reserves for losses and LAE, development of property and casualty insurance losses and LAE from prior accident years, also referred to as “reserve development” in the discussion of segment results, estimated variability of property and casualty insurance reserves for losses and LAE, and a discussion of some of the variables that may impact development of property and casualty insurance losses and LAE and the estimated variability of property and casualty insurance reserves for losses and LAE.
Earned Premiums in the Specialty Property & Casualty Insurance segment increased by $1,021.7 million in 2018, compared to 2017. Infinity accounted for $758.1 million of the increase while higher volume and higher average earned premium on Kemper’s legacy business accounted for increases of $198.9 million and $64.7 million, respectively. Both of Kemper’s legacy product lines experienced an increase in average earned premium, although the overall impact on Earned Premiums was driven primarily by specialty personal automobile insurance which had increases due to higher average earned premium of $61.9 million. Kemper’s legacy’s higher volume was driven by specialty personal automobile insurance, which had a volume increase of $202.9 million, partially offset primarily by a volume decrease in commercial automobile insurance of $4.0 million.
Insurance expenses were $421.7 million, or 20.8% of earned premiums, in 2018, an increase of 4.4 percentage points, compared to 2017, driven primarily by the amortization of Infinity purchase accounting adjustments.
The Specialty Property & Casualty Insurance segment reported Segment Net Operating Income of $56.3 million for the year ended December 31, 2017, compared to Segment Net Operating Loss of $14.5 million in 2016. Segment net operating results improved by $70.8 million due primarily to lower underlying losses and LAE as a percentage of earned premiums, in both the specialty automobile and commercial automobile product lines, lower insurance expenses as a percentage of earned premiums, higher net investment income from Alternative Investments and lower levels of adverse loss and LAE reserve development.
Earned Premiums in the Specialty Property & Casualty Insurance segment increased by $132.4 million in 2017, compared to 2016, as higher average earned premium and higher volume accounted for increases of $81.9 million and $50.5 million, respectively. The increase in average earned premium was driven by both the specialty automobile and commercial automobile product lines, with increases in average earned premium of $77.7 million and $4.2 million, respectively. The higher volume was driven by specialty automobile insurance, which had a volume increase of $56.6 million, partially offset by a volume decrease in commercial automobile insurance of $6.1 million.
Underlying losses and LAE as a percentage of earned premiums were 78.7% in 2017, a decrease of 8.1% percentage points, compared to 2016, driven primarily by improvements in specialty automobile insurance. Catastrophe losses and LAE (excluding reserve development) were $5.5 million in 2017, compared to $6.5 million in 2016. Adverse loss and LAE reserve development (including catastrophe reserve development) was $3.8 million in 2017, compared to $9.1 million in 2016.
Earned Premiums on specialty personal automobile insurance increased by $134.3 million in 2017, compared to 2016, as higher average earned premium and higher volume accounted for increases of $77.7 million and $56.6 million, respectively. Incurred losses and LAE were $758.1 million, or 79.4% of earned premiums, in 2017, compared to $726.7 million, or 88.6% of earned premiums, in 2016. Incurred losses and LAE as a percentage of earned premiums decreased due to lower underlying losses and LAE as a percentage of earned premiums, and to a lesser extent, a lower level of adverse loss and LAE reserve development. Underlying losses and LAE as a percentage of related earned premiums were 78.6% in 2017, compared to 87.1% in 2016, which was an improvement of 8.5 percentage points. Catastrophe losses and LAE (excluding reserve development) were $4.8 million in 2017, compared to $5.7 million in 2016. Adverse loss and LAE reserve development was $2.9 million in 2017, compared to $6.7 million in 2016.
Net Investment Income decreased by $12.3 million in 2018, compared to 2017, due primarily to lower investment returns from alternative investments and lower income from fixed maturities, partially offset by higher levels of fixed maturities. The weighted-average book yield on the Company’s life and health insurance subsidiaries’ investments in fixed maturities was approximately 5.3% and 5.4% at December 31, 2018 and 2017, respectively.
Policyholders’ Benefits and Incurred Losses and LAE increased by $16.8 million in 2018, compared to 2017, due primarily to higher policyholders’ benefits and incurred losses and LAE on life and accident and health business and overall growth in the accident and health business. Insurance Expenses in the Life & Health Insurance segment increased by $8.9 million due primarily to growth in the accident and health business for Reserve National and higher general expenses, incentive commissions and fringe benefits for KHSC, partially offset by lower expenses related to lower volume of life insurance sold by Reserve National. Segment Net Operating Income in the Life & Health Insurance segment was $91.5 million for the year ended December 31, 2018, compared to $91.9 million in 2017.
Earned Premiums in the Life & Health Insurance segment increased by $8.8 million for the year ended December 31, 2017, compared to 2016, due primarily to higher volume from accident and health insurance products offered by Reserve National, partially offset by lower earned premiums on property insurance products offered by KHSC.
Net Investment Income increased by $9.0 million in 2017, compared to 2016, due primarily to higher levels of non-alternative investments and higher returns from Alternative Investments, partially offset by lower yields on non-alternative investments. The weighted-average book yield on the Company’s life and health insurance subsidiaries’ investment in fixed maturities was approximately 5.4% and 5.5% at December 31, 2017 and 2016, respectively.
Policyholders’ Benefits and Incurred Losses and LAE decreased by $74.2 million in 2017, compared to 2016. Excluding the impact of using death verification databases described above, Policyholders’ Benefits and Incurred Losses and LAE increased by $3.6 million due primarily to growth in the Company’s accident and health insurance businesses, partially offset by lower policyholders’ benefits on life insurance. Insurance Expenses in the Life & Health Insurance segment decreased by $1.7 million due primarily to a higher portion of agent compensation for KHSC being deferrable as well as lower legal and agent incentive conference expenses, partially offset by higher commission and amortization expense for Reserve National. Segment Net Operating Income in the Life & Health Insurance segment was $91.9 million for the year ended December 31, 2017, compared to $31.0 million in 2016.
Selected financial information for the life insurance product line is presented below.
Earned premiums on life insurance decreased by $1.9 million in 2017, compared to 2016, due primarily to the termination of the relationship between Reserve National and one of its brokers. Policyholders’ benefits and incurred losses and LAE on life insurance were $274.1 million in 2017, compared to $356.3 million in 2016, a decrease of $82.2 million. Excluding the initial impact of using death verification databases described above, Policyholders’ benefits and incurred Losses and LAE decreased by $4.4 million due primarily to lower policyholder benefits on Reserve National’s life insurance products. Insurance expenses decreased by $3.4 million in 2017, compared to 2016, due primarily to a higher portion of agent compensation for KHSC being deferrable as well as lower legal and agent incentive conference expenses for KHSC, partially offset by higher commission and other general expenses for Reserve National.
Earned premiums on accident and health insurance increased by $15.8 million in 2018, compared to 2017, due primarily to higher volume on accident and health insurance products offered by Reserve National. Incurred accident and health insurance losses and LAE were $98.9 million, or 55.7% of accident and health insurance earned premiums, in 2018, compared to $88.7 million, or 54.9% of accident and health insurance earned premiums, in 2017, an increase of 0.8 percentage points due primarily to higher incurred claims on certain health products offered by Reserve National. Insurance expenses increased by $10.5 million in 2018, compared to 2017, due primarily to growth in Reserve National’s accident and health business.
Selected financial information for the property insurance product line is presented below.
Earned premiums on property insurance decreased by $2.2 million in 2018, compared to 2017, due primarily to a lower volume of insurance sold. Incurred losses and LAE on property insurance were $25.9 million, or 36.8% of property insurance earned premiums, in 2018, compared to $24.6 million, or 33.9% of property insurance earned premiums, in 2017. Current year non-catastrophe losses and LAE on property insurance were $20.5 million, or 29.2% of property insurance earned premiums, in 2018, compared to $17.8 million, or 24.5% of property insurance earned premiums, in 2017, an increase of 4.7 percentage points due to a higher frequency of claims. Catastrophe losses and LAE (excluding development) were $4.0 million in 2018, compared to $5.9 million in 2017, due primarily to a higher frequency of claims and severity of losses in connection with catastrophic events in the prior year. Adverse loss and LAE reserve development was $1.4 million in 2018, compared to $0.9 million in 2017. Insurance expenses decreased $1.4 million in 2018, compared to 2017, due primarily to lower commission expense due in part to a lower volume of earned premium.
Net Investment Income for the years ended December 31, 2018, 2017 and 2016 is presented below.
During the fourth quarter of 2018, the Company began repositioning the fixed maturity investment portfolio in in its Life and Health Insurance segment and recognized Realized Gains on Sales of Fixed Maturities of $13.3 million and Realized Losses on Sales of Fixed Maturities of $4.4 million in connection with the repositioning.
Net Realized Gains on Sales of Equity Securities for the year ended December 31, 2016 includes a net realized gain of $8.1 million from a transaction in which the Company’s investment in the common stock of a company was acquired by another company for cash and shares of such acquiring company.
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.
The Company’s fixed maturity investment portfolio is comprised primarily of high-grade municipal, corporate and agency bonds. At December 31, 2018, 92% of the Company’s fixed maturity investment portfolio was rated investment-grade, which the Company defines as a security issued by a high quality obligor with at least a relatively stable credit profile and where it is highly likely that all contractual payments of principal and interest will timely occur and carry a rating from the National Association of Insurance Commissioners (“NAIC”) of 1 or 2. Securities with a rating of 1 or 2 from the NAIC typically are rated by one or more Nationally Recognized Statistical Rating Organizations and either have a rating of AAA, AA, A or BBB from S&P; a rating of Aaa, Aa, A or Baa from Moody’s; or a rating of AAA, AA, A or BBB from Fitch.
The following table summarizes the fair value of the Company’s investments in governmental fixed maturities at December 31, 2018 and 2017.
The Company’s short-term investments primarily consist of money market funds, U.S. Treasury securities with maturities of less than one year at the date of purchase, commercial paper and overnight interest bearing accounts. At December 31, 2018, the Company had $189.9 million invested in U.S. Treasury securities with maturities of less than one year at the date of purchase, $74.6 million invested in money market funds which primarily invest in U.S. Treasury securities and $21.7 million invested in overnight interest bearing bank accounts with one of the Company’s custodial banks.
The following table summarizes the fair value of the Company’s ten largest exposures, excluding investments in U.S. Government and Government Agencies and Authorities and Short-term Investments, at December 31, 2018.
The Company expects that it will be required to fund its commitments over the next several years. The Company expects that the proceeds from distributions from these investments will be the primary source of funding of such commitments.
Expenses for the years ended December 31, 2018, 2017 and 2016 were:
Interest expense increased by $8.5 million for the year ended December 31, 2018, compared to 2017, due primarily to higher levels of debt outstanding to facilitate the funding of the acquisition of Infinity. Interest expense decreased by $9.5 million for the year ended December 31, 2017, compared to 2016, due primarily to lower levels of debt outstanding and a lower average effective interest rate thereon. See MD&A, “Liquidity and Capital Resources,” and Note 7, “Debt,” to the Consolidated Financial Statements for additional discussion of debt activity.
Other Expenses increased by $69.9 million for the year ended December 31, 2018, compared to 2017, due primarily to the acquisition of Infinity, the inclusion of acquisition related transaction, integration and other costs and higher employee compensation. Other Expenses decreased by $0.2 million for the year ended December 31, 2017, compared to 2016, due primarily to lower pension expense in 2017 resulting from the full-year effect of freezing benefit accruals under the Company’s defined benefit pension plans and a longer amortization period to amortize actuarial losses, as discussed in Note 16 “Pension Benefits” to the Consolidated Financial Statements, partially offset by net curtailment gains recognized in 2016, higher employee compensation and a charge to earnings in 2017 to record the ineffective portion of a hedging relationship related to the Company’s debt issuance.
On December 22, 2017, Public Law 115-97, more commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”), was enacted. The Tax Act includes numerous changes to existing federal income tax law, including a permanent reduction in the federal corporate income tax rate from 35% to 21%, effective January 1, 2018. In 2017, pursuant to Staff Accounting Bulletin
The Company’s effective income tax rate from continuing operations differs from the Federal statutory income tax rate due primarily to (1) the Tax Act, (2) the effects of tax-exempt investment income and dividends received deductions, (3) certain indemnification recoveries recognized in earnings that result in an adjustment in the tax purchase price and are excluded from the determination of taxable income, and (4) the net effects of state income taxes.
The tax benefit recorded pursuant to the Tax Act was $26.4 million and $7.4 million for the years ended December 31, 2018 and 2017, respectively. Tax-exempt investment income and dividends received deductions were $22.4 million, $28.0 million and $28.0 million for the years ended December 31, 2018, 2017 and 2016, respectively. Estimated indemnification recoveries recognized in earnings result in an adjustment in the tax purchase price and are excluded from the determination of taxable income and income tax expense. Such recoveries were $0.7 million for the year ended December 31, 2016. State income tax expense, net of federal benefit, from continuing operations was $0.1 million and $0.6 million in 2018 and 2016, respectively. State income tax benefit, net of federal expense, from continuing operations was $0.1 million in 2017. See Note 15, “Income Taxes,” to the Consolidated Financial Statements for additional discussion of income taxes.
Kemper’s subsidiaries, United Insurance and Trinity Universal Insurance Company (“Trinity”), are members of the Federal Home Loan Bank (“FHLB”) of Chicago and Dallas, respectively. As a requirement of membership in the FHLB, United Insurance and Trinity maintain a certain level of investment in FHLB stock. Total holdings of FHLB of Chicago stock were $0.8 million and $0.4 million at December 31, 2018 and December 31, 2017, respectively. Total holdings of FHLB of Dallas stock were $3.3 million at both December 31, 2018 and December 31, 2017, respectively.
Various state insurance laws restrict the ability of Kemper’s insurance subsidiaries to pay dividends without regulatory approval. Such insurance laws generally restrict the amount of dividends paid in an annual period to the greater of statutory net income from the previous year or 10% of statutory capital and surplus. Kemper’s direct insurance subsidiaries paid dividends of $130.4 million, $108.1 million and $104.5 million to Kemper in 2018, 2017 and 2016, respectively. In 2019, Kemper estimates that its direct insurance subsidiaries would be able to pay $351 million in dividends to Kemper without prior regulatory approval.
In 2018, to fund growth initiatives and meet capital requirements, Kemper made a capital contribution of $20.0 million to its subsidiary, Alliance United Insurance Company.
On August 6, 2014, the Board of Directors approved the 2014 Repurchase Program under which Kemper is authorized to repurchase up to $300 million of its common stock and terminated Kemper’s remaining authorization under the 2011 Repurchase Program.
During 2018 and 2017, Kemper did not repurchase any shares of its common stock. During 2016, Kemper repurchased approximately 0.1 million shares of its common stock at an aggregate cost of $3.8 million in open market transactions under the 2014 Repurchase Program. The Company had $243.7 million of remaining capacity under the 2014 Repurchase Program at December 31, 2018.
The primary sources of funds for Kemper’s insurance subsidiaries are premiums, investment income and proceeds from the sales and maturity of investments, advances from the FHLBs of Dallas and Chicago, and capital contributions from Kemper. The primary uses of funds are the payment of policyholder benefits under life insurance contracts, claims and claims-related expenses under property and casualty insurance contracts and accident and health insurance contracts, the payment of commissions and general expenses, the purchase of investments, repayments of advances from the FHLBs of Dallas and Chicago and payment of dividends to Kemper. Generally, there is a time lag between when premiums are collected and when policyholder benefits and insurance claims are paid.
In the third quarter of 2016, the Company’s Life & Health segment voluntarily began implementing a comprehensive process under which it cross-references its life insurance policies against the DMF and other death verification databases to identify potential instances where the beneficiaries may not have filed a claim following the death of an insured and initiate an outreach process to identify and contact beneficiaries and settle claims.
Net Cash Used by Financing Activities was $12.2 million for the year ended December 31, 2018, compared to $205.2 million for the same period in 2017. Net proceeds from the issuance of long-term debt, which was used to fund the acquisition of Infinity, provided $249.4 million of cash for the year ended December 31, 2018. Kemper used $215.0 million of cash to repay long-term debt for the year ended December 31, 2018. Kemper did not use any cash during 2018 or 2017 to repurchase shares of its common stock. Kemper used $56.4 million of cash to pay dividends for the year ended December 31, 2018, compared to $49.5 million of cash used to pay dividends in the same period of 2017. The quarterly dividend rate was $0.24 per common share for each quarter of 2018 and 2017.
Estimated cash disbursements pertaining to the Company’s contractual obligations at December 31, 2018 are presented below.
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 $3.8 billion using the same assumptions used to estimate the cash outflows. The Company’s Life Insurance Reserves in the Company’s Consolidated Balance Sheets are generally based on the historical assumptions for mortality and policy lapse rates and are on a discounted basis. Accordingly, the sum of the amounts presented above for Life and Health Insurance Policy Benefits significantly exceeds the amount of Life and Health Insurance Reserves reported on the Company’s Consolidated Balance Sheet at December 31, 2018.
prices that the Company might realize from actual sales of investments are likely to vary from their respective estimated fair values at December 31, 2018 due to changing market conditions and limitations inherent in the estimation process.
The classification of a company’s investment in a financial instrument may affect its reported results. Under GAAP, a company may elect to use the fair value option method of accounting for some or all of its investments in financial instruments. Under the fair value option method of accounting, a company is required to recognize changes in fair values into income for the period reported. The Company has elected the fair value option for investments in fixed maturities with equity conversion features which are recorded on the Consolidated Balance Sheets as Convertible Securities. Accordingly, both the reported and fair values of the Company’s investments in Convertible Securities accounted for under the fair value option method of accounting were $31.5 million at December 31, 2018. For investments in fixed maturities classified as held to maturity, a company is required to carry the investment at amortized cost, with only amortization occurring during the period recognized into income. None of the Company’s investments in fixed maturities were classified as held to maturity at December 31, 2018. Changes in the fair value of investments in fixed maturities classified as available for sale are not recognized in income during the period, but rather are recognized as a separate component of AOCI until realized. Both the reported and fair values of the Company’s investments in fixed maturities classified as available for sale were $6,424.2 million at December 31, 2018.
Equity securities with readily determinable fair values are recorded as Equity Securities at Fair Value with changes in fair values recognized into income for the period reported. Accordingly, both the reported and fair values of the Company’s investments in Equity Securities at Fair Value were $684.4 million at December 31, 2018. The Company holds certain equity investments without readily determinable fair values at cost, less impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments from the same issuer. Changes in the carrying value of Equity Securities at Modified Cost due to observable price changes are recorded into income for the period reported.
Had the Company elected the fair value option for all of its investments in financial instruments, the Company’s reported net income for the year ended December 31, 2018, would have decreased by $174.9 million.
Changes in these factors from their December 31, 2018 evaluation date could result in the Company determining that a temporary decline in the fair value of an investment held and evaluated at December 31, 2018 is no longer temporary at a subsequent evaluation date. Such determination would result in an impairment loss recognized in earnings in the period such determination is made.
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 $1,874.9 million and $1,016.8 million of gross loss and LAE reserves at December 31, 2018 and 2017, respectively.
Property and Casualty Insurance Reserves for the Company’s business segments at December 31, 2018 and 2017 were:
The key assumption in these estimation methodologies is that patterns observed in prior periods are indicative of how losses and LAE are expected to develop in the future and that such historical data can be used to predict and estimate ultimate losses and LAE. However, changes in the Company’s business processes, by their very nature, are likely to affect the development patterns, which means the Company’s actuaries must routinely evaluate the applicability of historical data in future projections. The ultimate impact of a single change in a business process is difficult to quantify and detect, and even more difficult if several changes to business processes occur over several years. Initially after a change is implemented, there are fewer data points, as compared to the historical data, for the Company’s actuaries to analyze. With fewer data points to analyze, the Company’s actuaries cannot be certain that observed differences from the historical data trends are a result of the change in business process or merely a random fluctuation in the data. As the Company’s actuaries observe more data points following the change in business process, the Company’s actuaries can gain more confidence in whether the change in business process is affecting the development pattern. The challenge for the Company’s actuaries is how much weight to place on the development patterns based on the older historical data and how much weight to place on the development patterns based on more recent data.
Although development will emerge in all of the Company’s product lines, development in the Company’s specialty personal automobile insurance product line could have the most significant impact due to the relative size of its loss and LAE reserves. To further illustrate the sensitivity of the Company’s reserves for specialty personal automobile insurance losses and LAE, the Company measures the standard deviation of the mean reserve estimate using a bootstrapping methodology. The Company believes that one standard deviation of variability is a reasonably likely scenario to measure variability for its loss and LAE reserves for specialty personal automobile insurance. The Company estimates that the Company’s specialty personal automobile insurance loss and LAE reserves could have varied by $59.1 million in either direction at December 31, 2018 for all accident years combined under this scenario. In addition to the factors described above, other factors may also impact loss reserve development in future periods. These factors include governmental actions, including court decisions interpreting existing laws, regulations or policy provisions, developments related to insurance policy claims and coverage issues, adverse or favorable outcomes in pending claims litigation, the number and severity of insurance claims, the impact of inflation on insurance claims and the impact of required participation in windpools and joint underwriting associations and residual market assessments. Although the Company’s actuaries do not make specific numerical assumptions about these factors, changes in these factors from past patterns will impact historical loss development factors and, in turn, future loss reserve development. Significant favorable changes in one or more factors will lead to favorable future loss reserve development, which could result in the actual loss developing closer to, or even below, the lower end of the Company’s estimated reserve variability. Significant unfavorable changes in one or more factors will lead to unfavorable loss reserve development, which could result in the actual loss developing closer to, or even above, the higher end of the Company’s estimated reserve variability. Accordingly, due to these factors and the other factors enumerated throughout the MD&A and the inherent limitations of the loss reserving estimation methodologies, the estimated and illustrated reserve variability may not necessarily be indicative of the Company’s future reserve variability, which could ultimately be greater than the estimated and illustrated variability. In addition, as previously noted, development will emerge in all of the Company’s product lines over time. Accordingly, the Company’s future reserve variability could ultimately be greater than the illustrated variability. Additional information pertaining to the estimation of, and development of, the Company’s Property and Casualty Insurance Reserves is contained in Item 1 of Part I of this 2018 Annual Report under the heading “Property and Casualty Loss and Loss Adjustment Expense Reserves.”
A change in any one or more of these assumptions is likely to result in a projected benefit obligation or pension cost that differs from the actuarial estimates at December 31, 2018. 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, 2018 by $75.9 million, while a one-percentage point increase in the rate would decrease the pension benefit obligation at December 31, 2018 by $62.8 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, 2018 by $5.4 million, while a one-percentage point increase in the rate would decrease pension expense by $5.4 million for the same period.
Consolidated Statements of Income for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2018, 2017 and 2016
Investments in Convertible Securities include fixed maturities with equity conversion features. The Company has elected the fair value option method of accounting for investments in Convertible Securities and records Convertible Securities at fair value on the Consolidated Balance Sheet. Changes in fair value of Convertible Securities are recorded in the Consolidated Statements of Income during the period such changes occur.
Other Investments primarily include loans to policyholders and real estate. Loans to policyholders are carried at unpaid principal balance. Real estate is carried at cost, net of accumulated depreciation. Real estate is depreciated over the estimated useful life of the asset using the straight-line method of depreciation. Real estate is evaluated for impairment when events or circumstances indicate the carrying value may not be recoverable. An impairment loss on real estate is recognized when the carrying value exceeds the sum of undiscounted projected future cash flows as well as the fair value, or, in the case of a property classified as held for sale, when the carrying value exceeds the fair value, net of costs to sell.
Observable inputs are based on market data obtained from independent sources, while unobservable inputs are based on the Company’s market assumptions. Unobservable inputs require significant management judgment or estimation. In some cases, the inputs used to measure an asset or liability may fall into different levels of the fair value hierarchy. In those cases, the fair
Other Receivables primarily include reinsurance recoverables and accrued investment income. Reinsurance Recoverables were $158.3 million and $111.6 million at December 31, 2018 and 2017, respectively. Accrued Investment Income was $77.9 million and $72.8 million at December 31, 2018 and 2017, respectively.
Accrued Expenses and Other Liabilities primarily include accrued salaries and commissions, pension benefits, postretirement medical benefits and accrued taxes, licenses and fees.
Property and casualty insurance and short duration health insurance premiums are deferred when written and recognized and earned ratably over the periods to which the premiums relate. Unearned Premiums represent the portion of the premiums written related to the unexpired portion of policies in force which has been deferred and is reported as a liability. The Company performs a premium deficiency analysis typically at a product line level, namely automobile insurance, homeowners insurance and other insurance, which is consistent with the manner in which the Company acquires and services policies and measures profitability. Anticipated investment income is excluded from such analysis. A premium deficiency is recognized when the sum of expected claim costs, claim adjustment expenses, unamortized deferred policy acquisition costs and maintenance costs exceeds the related unearned premiums by first reducing related deferred policy acquisition costs to an amount, but not below zero, at which the premium deficiency would not exist. If a premium deficiency remains after first reducing deferred policy acquisition costs, a premium deficiency reserve is established and reported as a liability in the Company’s financial statements.
Fair Value of Equity and Convertible Securities in the Consolidated Statement of Income for the year ended December 31, 2018. The Company anticipates ASU 2016-01 will result in increased volatility within the Consolidated Statements of Income in future periods.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), by amending the Accounting Standards Codification (“ASC”) and creating a new topic on accounting for leases. ASU 2016-02 introduces a lessee model that requires most leases to be reported on the balance sheet of a lessee. ASU 2016-02 also aligns many of the underlying principles of the new lessor model with those in ASC Topic 606, Revenue from Contracts with Customers, the FASB’s new revenue recognition standard (e.g., those related to evaluating when profit can be recognized). Furthermore, ASU 2016-02 addresses other concerns related to the current leases model. For example, ASU 2016-02 eliminates the requirement in current GAAP for an entity to use bright-line tests in determining lease classification. ASU 2016-02 also requires lessors to increase the transparency of their exposure to changes in value of their residual assets and how they manage that exposure. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 and interim periods within those years. The adoption of ASU 2016-02 will have no impact on the Company’s total Shareholders’ Equity as of January 1, 2019, but will result in the establishment of a right of use asset and an offsetting, corresponding lease liability, of approximately $85.0 million.
In August 2018, the FASB issued ASU 2018-12, Financial Services-Insurance (Topic 944): Targeted Improvements to Accounting for Long-Duration Contracts. ASU 2018-12 amends the accounting model for certain long-duration insurance contracts and requires the insurer to provide additional disclosures in annual and interim reporting periods. ASU 2018-12 is effective for fiscal years beginning after December 15, 2020, including interim periods therein. The amendments in ASU 2018-12 are intended to improve measurement of the liability for future policy benefits related to nonparticipating traditional and limited-payment contracts, measurement and presentation of market risk benefits, amortization of deferred acquisition costs, and enhance presentation and disclosures. The Company is currently evaluating the impact of this guidance on its financial statements.
The Company has not yet completed the process of estimating the fair value of assets acquired and liabilities assumed, including, but not limited to, receivables, intangible assets, unearned premium reserves, certain tax-related balances and certain other asset and liabilities. Accordingly, the Company’s preliminary estimates and the allocation of the purchase price to the assets acquired and liabilities assumed may change as the Company completes the process, which would also likely impact the Company’s allocation of the purchase price to Goodwill. In accordance with ASC 805, Business Combinations, changes, if any, to the preliminary estimates and allocation, as a result of events or conditions as of the acquisition date, will be reported in the Company’s financial statements as an adjustment to the assets acquired and liabilities assumed. During the fourth quarter, the Company further refined its estimate of certain legal accruals, other liabilities and tax-related balances, increasing liabilities assumed by $22.9 million, increasing assets acquired by $1.7 million and increasing goodwill by $21.2 million. The Company has allocated all of the goodwill associated with the Infinity acquisition to the Specialty Property & Casualty Insurance segment. The factors that contributed to the recognition of goodwill include synergies from economies of scale within the underwriting and claims operations, acquiring a talented workforce and cost savings opportunities.
Accrued Expenses and Other Liabilities included unsettled purchases of Investments in Fixed Maturities of $10.5 million and $5.4 million at December 31, 2018 and 2017, respectively. There were $0.5 million of unsettled sales of Investments in Fixed Maturities at December 31, 2018. There were no unsettled sales of Investments in Fixed Maturities at December 31, 2017.
Investments in Mortgage- and Asset-backed Securities Not Due at a Single Maturity Date at December 31, 2018 consisted of securities issued by the Government National Mortgage Association with a fair value of $618.5 million, securities issued by the Federal National Mortgage Association with a fair value of $8.4 million, securities issued by the Federal Home Loan Mortgage Corporation with a fair value of $7.6 million and securities of other non-governmental issuers with a fair value of $539.6 million.
Unrealized losses on fixed maturities, which the Company determined to be temporary at December 31, 2017, were $19.5 million, of which $13.9 million was related to fixed maturities that were in an unrealized loss position for 12 months or longer. There were no unrealized losses at December 31, 2017 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “Less Than 12 Months.” There were no unrealized losses at December 31, 2017 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “12 Months or Longer.” Investment-grade fixed maturities comprised $12.6 million and below-investment-grade fixed maturities comprised $6.9 million of the unrealized losses on investments in fixed maturities at December 31, 2017. For below-investment-grade fixed maturities 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, 2017, 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, 2017 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 following table sets forth the pre-tax amount of Other Than Temporary Impairments (“OTTI”) credit losses, recognized in Retained Earnings for Investments in Fixed Maturities held by the Company as of December 31, 2018, 2017 and 2016, for which a portion of the OTTI loss related to factors other than credit has been recognized in AOCI, and the corresponding changes in such amounts.
An aging of unrealized losses on the Company’s Investments in Equity Securities at Fair Value at December 31, 2017 is presented below.
With respect to Investments in Equity Securities at Fair Value, the Company concluded that the unrealized losses on its investments in preferred and common stocks at December 31, 2017 were temporary based on various factors, including the relative short length and magnitude of the losses and overall market volatility. The Company’s investments in other equity interests include investments in limited liability companies and limited partnerships that primarily invest in mezzanine debt and
There were no unsettled sales of Investments in Equity Securities at Fair Value at either December 31, 2018 or December 31, 2017. There were no unsettled purchases of Investments in Equity Securities at Fair Value at either December 31, 2018 or December 31, 2017.
Effective January 1, 2018 with the adoption of ASU 2016-01, for Equity Securities at Modified Cost, the Company performs a qualitative impairment analysis on a quarterly basis consisting of various factors such as earnings performance, current market conditions, changes in credit ratings, changes in the regulatory environment and other factors. If the qualitative analysis identifies the presence of impairment indicators, the Company estimates the fair value of the investment. If the estimated fair value is below the carrying value, the Company records an other-than-temporary impairment in the Consolidated Statements of Income to reduce the carrying value to the estimated fair value. When the Company identifies observable transactions of the same or similar securities to those held by the Company, the Company increases or decreases the carrying value to the observable transaction price. The Company did not recognize any increases or decreases in the carrying value due to observable transactions. The Company recognized an impairment of $2.5 million on Equity Securities at Modified Cost for the year ended December 31, 2018 as a result of the Company’s qualitative impairment analysis. The Company has recognized no cumulative increases in the carrying value due to observable transactions, no cumulative decreases in the carrying value due to observable transactions and $4.8 million of cumulative impairments on Equity Securities at Modified Cost held as of December 31, 2018.
Equity Method Limited Liability Investments include investments in limited liability investment companies and limited partnerships in which the Company’s interests are not deemed minor and are accounted for under the equity method of accounting. The Company’s investments in Equity Method Limited Liability Investments are generally of a passive nature in that the Company does not take an active role in the management of the investment entity. In 2017 and 2016, aggregate investment income (losses) from Equity Method Limited Liability Investments exceeded 10% of the Company’s pretax consolidated net income. Accordingly, the Company is disclosing aggregated summarized financial data for its Equity Method Limited Liability Investments for all periods presented in the Consolidated Financial Statements. Such aggregated summarized financial data does not represent the Company’s proportionate share of the Equity Method Limited Liability Investment assets or earnings. Aggregate total assets of the Equity Method Limited Liability Investments in which the Company invested totaled $2,805.3 million, $2,393.7 million and $2,618.1 million, as of December 31, 2018, 2017 and 2016, respectively. Aggregate total liabilities of the Equity Method Limited Liability Investments in which the Company invested totaled $1,030.7 million, $899.7 million and $828.0 million, as of December 31, 2018, 2017 and 2016, respectively. Aggregate net income of the Equity Method Limited Liability Investments in which the Company invested totaled $130.4 million, $209.3 million and $85.0 million for the years ended December 31, 2018, 2017 and 2016, respectively. The aggregate summarized financial data is based on the most recent and sufficiently-timely financial information available to the Company as of the respective reporting dates and periods. The Company’s maximum exposure to loss at December 31, 2018 is limited to the total carrying value of $187.0 million. In addition, the Company had outstanding commitments totaling approximately $112.4 million to fund Equity Method Limited Liability Investments at December 31, 2018.
The carrying values of the Company’s Other Investments at December 31, 2018 and 2017 were:
Definite and indefinite lived intangible assets at December 31, 2018 and 2017 were:
The Company’s goal is to ensure that its total reserves for property and casualty insurance losses and LAE are adequate to cover all costs, while sustaining minimal variation from the time reserves for losses and LAE are initially estimated until losses and LAE are fully developed. Changes in the Company’s estimates of these losses and LAE over time, also referred to as “development,” will occur and may be material.
The following table reconciles the net incurred and paid claims development tables presented above to the Company's liability for Property and Casualty Insurance Reserves included in the Consolidated Balance Sheet at December 31, 2018.
In 2017, the Company increased its property and casualty insurance reserves by $18.9 million to recognize adverse development of loss and LAE reserves from prior accident years. Personal lines insurance loss and LAE reserves developed
In 2016, the Company reduced its property and casualty insurance reserves by $20.7 million to recognize favorable development of losses and LAE from prior accident years. Personal lines insurance loss and LAE reserves developed favorably by $16.8 million and commercial lines insurance loss and LAE reserves developed favorably by $3.9 million. Personal automobile insurance loss and LAE reserves developed adversely by $11.3 million due primarily to the emergence of loss patterns that were worse than expected for liability insurance for the 2015 and 2014 accident years and, to a lesser extent, the 2013 and 2012 accident years. Homeowners insurance loss and LAE reserves developed favorably by $20.0 million due primarily to $16.8 million of favorable development on catastrophes primarily for the 2015 accident year and, to a lesser extent, the 2014 accident year. Other personal lines loss and LAE reserves developed favorably by $8.1 million due primarily to the emergence of more favorable loss patterns than expected for the 2015, 2014, 2013 and 2012 accident years. Commercial lines insurance loss and LAE reserves included adverse development of $2.4 million from continuing operations and favorable development of $6.3 million from discontinued operations.
The Company cannot predict whether loss and LAE reserves will develop favorably or unfavorably from the amounts reported in the 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.
Infinity’s liabilities at the acquisition date included $275.0 million principal amount, 5.0% Senior Notes due September 19, 2022 (the “2022 Infinity Senior Notes”). The 2022 Infinity Senior Notes were recorded at a fair value of $282.1 million as of the acquisition date, with the $7.1 million premium being amortized as a reduction to interest expense over the remaining term,
resulting in an effective interest rate of 4.36%. On November 30, 2018 Kemper executed a guarantee to fully and unconditionally guarantee the payment and performance obligations of the 2022 Senior Notes.
In June of 2017, Kemper issued an additional $200 million of the 2025 Senior Notes. The proceeds of the additional issuance were $200.2 million, net of discount and transaction costs, for an effective yield of 4.16%. The additional notes are fungible with the initial notes issued in 2015, and together are treated as part of a single series for all purposes under the indenture governing the 2025 Senior Notes. Kemper used the net proceeds from the additional issuance for general corporate purposes. The 2025 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.
During the fourth quarter of 2016, in anticipation of a debt issuance in 2017 and for risk management purposes, the Company entered into a derivative transaction to hedge the risk of changes in the debt cash flows attributable to changes in the benchmark U.S. Treasury interest rate during the period leading up to the probable debt issuance (“Treasury Lock”). The Treasury Lock was formally designated as a cash flow hedge at inception and qualified for hedge accounting treatment. In the second quarter of 2017, the Company de-designated a portion of the cash flow hedge because the anticipated principal issuance was less than the notional amount of the Treasury Lock and recorded a pre-tax charge of $1.1 million in Other Expenses. The effective portion of the loss on the derivative instrument upon discontinuance was $4.5 million before taxes, and is reported as a component of Accumulated Other Comprehensive Income. Beginning with the additional issuance of the 2025 Senior Notes described in the preceding paragraph, such loss is being amortized into earnings and reported in Interest Expense in the same periods that the hedged items affect earnings. Amortization, reported in Interest Expense, was $0.3 million for the year ended December 31, 2018. The Company expects to reclassify $0.3 million of net losses on derivative instruments from AOCI to earnings for the twelve months ended December 31, 2019 as interest expense on the debt is recognized.
Kemper’s subsidiaries, United Insurance Company of America (“United Insurance”) and Trinity Universal Insurance Company (“Trinity”), are members of the Federal Home Loan Bank (“FHLB”) of Chicago and Dallas, respectively. As a requirement of membership in the FHLB, United Insurance and Trinity maintain a certain level of investment in FHLB stock. Total holdings of FHLB of Chicago stock were $0.8 million and $0.4 million at December 31, 2018 and December 31, 2017, respectively. Total holdings of FHLB of Dallas stock were $3.3 million and $3.3 million at December 31, 2018 and December 31, 2017, respectively.
In March of 2018, United Insurance received advances of $10.0 million from the FHLB of Chicago. The advances, which mature in one year or less, were made in connection with the start-up of the Company’s collateralized investment borrowing program. In connection with the advances, United Insurance pledged U.S. Government Agency securities with a fair value of $15.7 million at December 31, 2018. The fair value of the collateral pledged must be maintained at certain specified levels above the borrowed amount, which can vary depending on the assets pledged. If the fair value of the collateral declines below these specified levels of the amount borrowed, United Insurance would be required to pledge additional collateral or repay outstanding borrowings. Accrued Expenses and Other Liabilities in the Consolidated Balance Sheet at December 31, 2018 includes $10.0 million related to these advances. There were no advances from the FHLB of Dallas outstanding as of December 31, 2018.
Interest Expense, including facility fees, accretion of discount and amortization of issuance costs, was $43.3 million, $34.9 million and $44.4 million for the years ended December 31, 2018, 2017 and 2016, respectively. Interest paid, including facility fees, was $37.9 million, $34.7 million and $44.2 million for the years ended December 31, 2018, 2017 and 2016, respectively.
Net rental expense for operating leases for the years ended December 31, 2018, 2017 and 2016 was:
Kemper is authorized to issue 20 million shares of $0.10 par value preferred stock and 100 million shares of $0.10 par value common stock. No preferred shares were issued or outstanding at December 31, 2018 and 2017. There were 64,756,833 shares and 51,462,405 shares of common stock outstanding at December 31, 2018 and 2017, respectively.
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, loans or advances. Kemper’s insurance subsidiaries paid dividends of $130.4 million to Kemper in 2018. In 2019, Kemper’s insurance subsidiaries would be able to pay $350.9 million in dividends to Kemper without prior regulatory approval. Kemper’s insurance subsidiaries had net assets of $3.4 billion, determined in accordance with GAAP, that were restricted from payment to Kemper without prior regulatory approval at December 31, 2018.
In 2018, Kemper paid dividends of $56.4 million to its shareholders. Except for certain financial covenants under Kemper’s credit agreement or during any period in which Kemper elects to defer interest payments, there are no restrictions on Kemper’s ability to pay dividends to its shareholders. Certain financial covenants, namely minimum net worth and a maximum debt to total capitalization ratio, under Kemper’s credit agreement could limit the amount of dividends that Kemper may pay to shareholders at December 31, 2018. Kemper had the ability to pay without restrictions $910.5 million in dividends to its shareholders and still be in compliance with all financial covenants under its credit agreement at December 31, 2018.
On May 4, 2011, Kemper’s shareholders approved the 2011 Omnibus Equity Plan (“Omnibus Plan”). The Omnibus Plan replaced the Company’s previous employee stock option plans, director stock option plan and restricted stock plan (collectively, the “Prior Plans”). Awards previously granted under the Prior Plans remain outstanding in accordance with their original terms. Beginning May 4, 2011, equity-based compensation awards may only be granted under the Omnibus Plan. A maximum number of 10,000,000 shares of Kemper common stock may be issued under the Omnibus Plan (the “Share Authorization”). As of December 31, 2018, there were 4,510,504 common shares available for future grants under the Omnibus Plan, of which 981,900 shares were reserved for future grants based on the performance results under the terms of outstanding performance-based stock unit awards.
The design of the Omnibus Plan provides for fungible use of shares to determine the number of shares available for future grants, with a fungible conversion factor of three to one, such that the Share Authorization will be reduced at two different rates, depending on the type of award granted. Each share of Kemper common stock issuable upon the exercise of stock options or stock appreciation rights will reduce the number of shares available for future grant under the Share Authorization by one share, while each share of Kemper common stock issued pursuant to “full value awards” will reduce the number of shares available for future grant under the Share Authorization by three shares. “Full value awards” are awards, other than stock options or stock appreciation rights, that are settled by the issuance of shares of Kemper common stock and include time-based restricted stock units (collectively “RSUs”), performance-based restricted stock units (“PSUs”) and deferred stock units (“DSUs”).
For awards subject to a performance condition, the Company recognizes compensation expense based upon the probable outcome of the performance condition, which on the grant date reflects an estimate of attaining 100% of the performance units granted. The estimate is revised if the actual number of PSUs expected to vest is likely to differ from the previous estimate. Compensation expense for awards is recognized on a straight-line basis over the requisite service period. 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 was $18.6 million, $9.4 million and $4.7 million for the years ended December 31, 2018, 2017 and 2016, respectively. Total unamortized compensation expense related to unvested awards at December 31, 2018 was $23.0 million, which is expected to be recognized over a weighted-average period of 1.2 years.
The Compensation Committee of the Board of Directors, or the Board’s authorized designee, has sole discretion to determine the persons to whom awards under the Omnibus Plan are granted, and the material terms of the awards. For Tandem Awards, material terms include the number of shares covered by such awards and the exercise price, vesting and expiration dates of such awards. Tandem Awards are non-transferable. The exercise price of Tandem Awards is the fair value of Kemper’s common stock on the date of grant. Tandem Awards and RSU awards granted to employees generally vest in three equal annual installments over a period of three years, with the Tandem Awards expiring ten years from the date of grant. Employee PSU awards generally vest over a period of three years, subject to performance results and other restrictions.
Under the Non-employee Director compensation programs in effect for 2018, 2017 and 2016, each non-employee director received an annual DSU award covering shares of Kemper common stock with an aggregate grant date fair value of $110,000, $110,000 and $75,000, respectively, at the conclusion of each annual shareholder meeting. The DSUs granted to Non-employee Directors are fully vested on the date of grant. Conversion of the DSUs into shares of Kemper’s common stock is deferred until the date a director’s board service terminates.
The assumptions used in the Black-Scholes pricing model for Tandem Awards granted during the years ended December 31, 2018, 2017 and 2016 are presented below.
Information pertaining to Tandem Awards outstanding at December 31, 2018 is presented below.
The grant-date fair values of RSUs are determined using the closing price of Kemper common stock on the date of grant. Activity related to nonvested RSUs for the year ended December 31, 2018 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 PSU awards for the 2018, 2017 and 2016 three-year performance periods was 142,413 common shares, 80,999 common shares and 103,888 common shares, respectively, (as “full value awards,” the equivalent of 427,239 shares, 242,997 shares, and 311,664 shares, respectively, under the Share Authorization) at December 31, 2018.
Fifty percent of the PSU awards granted to employees and officers in 2018, 2017 and 2016 are measured using a market performance condition. Fair value for these awards was estimated using the Monte Carlo simulation method described above. Final payout for these awards, and any forfeitures of units for performance below the “target” performance level, will be based on Kemper’s total shareholder return, relative to a peer group comprised of all the companies in the S&P Supercomposite Insurance Index, over a three-year performance period. The three-year performance periods for the 2018, 2017 and 2016 awards end on January 31, 2021, January 31, 2020 and February 28, 2019, respectively. Compensation cost for these awards is recognized ratably over the requisite service period. In the event that the market performance condition is not satisfied, previously recognized compensation cost would not reverse, but it would reverse if the requisite service period is not met.
The total fair value of RSUs and PSUs that vested during the year ended December 31, 2018 was $8.7 million. The tax benefits for tax deductions realized from such awards was $1.8 million. The total fair value of RSUs and PSUs that vested during the year ended December 31, 2017 was $3.2 million. The tax benefits for tax deductions realized from such awards was $1.1 million. The total fair value of RSUs and PSUs that vested during the year ended December 31, 2016 was $1.3 million. The tax benefits for tax deductions realized from such awards was $0.5 million.
The grant-date fair values of DSU awards granted to Non-employee Directors are determined using the closing price of Kemper common stock on the date of grant. The total fair value of DSUs that vested during the years ended December 31, 2018, 2017 and 2016 was $1.0 million, $0.9 million and $0.5 million, respectively.
Activity related to DSU awards for the year ended December 31, 2018 is presented below.
The Company’s awards of DSUs contain rights to receive non-forfeitable dividend equivalents and participate in the undistributed earnings with common shareholders, as did the Company’s awards of RSUs and PSUs prior to 2018. Accordingly, the Company applies 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, 2018, 2017 and 2016 is presented below.
The components of Other Comprehensive Income Tax Benefit (Expense) for the years ended December 31, 2018, 2017 and 2016 were:
The components of AOCI at December 31, 2018 and 2017 were:
Components of AOCI were reclassified to the following lines of the Consolidated Statements of Income for the years ended December 31, 2018, 2017 and 2016:
The components of Net Realized Gains on Sales of Investments for the years ended December 31, 2018, 2017 and 2016 were:
The components of Net Impairment Losses Recognized in Earnings reported in the Consolidated Statements of Income for the years ended December 31, 2018, 2017 and 2016 were:
Insurance Expenses for the years ended December 31, 2018, 2017 and 2016 were:
In 2018, the Company finalized its determination of the effects of the Tax Act on deferred income taxes based on information received from third parties, completion of actuarial tax computations that impact the amount of deductions related to reserves reportable for federal income tax purposes for tax years prior to 2018, and other items. As a result, the Company recorded a benefit of $26.4 million during the year ended December 31, 2018, which was primarily attributable to the effect of updated actuarial tax computations.
The Company’s consolidated federal income tax returns from 2012-2017 are subject to examination by the Internal Revenue Service.
Unrecognized Tax Benefits at December 31, 2018, 2017 and 2016 include $3.7 million, $7.6 million and $4.6 million, respectively, for tax positions 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.
Income taxes paid, net of income tax refunds received, were $0.2 million in 2018. Income tax paid, net of refunds received, were $13.0 million in 2017. Income tax refunds received, net of income tax paid, were $0.5 million 2016.
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, 2018, 2017 and 2016 is presented below.
Changes in Fair Value of Plan Assets and Changes in Projected Benefit Obligation for the Pension Plan for the years ended December 31, 2018 and 2017 is presented below.
The measurement dates of the assets and liabilities at end of year presented in the preceding table under the headings, “2018” and “2017” were December 31, 2018 and December 31, 2017, respectively.
Weighted-average asset allocations for the Pension Plan at December 31, 2018 and 2017 by asset category were:
Additional information pertaining to the changes in the fair value of the Pension Plan’s assets classified as Level 3 in the two preceding tables for the years ended December 31, 2018 and 2017 is presented below.
The weighted-average discount rate, service cost discount rate, interest cost discount rate, rate of increase in future compensation levels and expected long-term rate of return on plan assets used to develop the components of Pension Expense for the Pension Plan for the periods presented below were:
The Company also sponsors a non-qualified supplemental defined benefit pension plan (the “Supplemental Plan”). Benefit accruals for all participants in the Supplemental Plan were frozen effective June 30, 2016. The unfunded liability related to the Supplemental Plan was $24.2 million and $26.3 million at December 31, 2018 and 2017, respectively. Pension expense for the Supplemental Plan was $0.8 million and $0.8 million for the years ended December 31, 2018, and 2017, respectively. Pension income for the Supplemental Plan was $1.0 million for the year ended December 31, 2016. An actuarial gain of $1.3 million before taxes, an actuarial loss of $1.6 million before taxes and an actuarial gain of $4.8 million before taxes are included in Other Comprehensive Income (Loss) for the years ended December 31, 2018, 2017 and 2016, respectively.
Kemper and Infinity sponsor other than pension postretirement employee benefit plans (“OPEB”) that together provide medical, dental and/or life insurance benefits to approximately 700 retired and 600 active employees.
Kemper has historically self-insured the benefits under the Kemper OPEB Plan. The Kemper 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 has required participant contributions, with most contributions adjusted annually. On December 30, 2016, Kemper amended the Kemper OPEB Plan and, effective December 31, 2016, will no longer offer coverage to post-65 Medicare-eligible retirees and Medicare-eligible spouses under the self-insured portion of its coverage. Rather, beginning on January 1, 2017, the Kemper OPEB Plan offers access to a private, third-party Medicare exchange and provides varying levels of a Company-determined subsidy via health reimbursement accounts to certain Medicare-eligible retirees and spouses in order to help fund a portion of the participants’ cost. Further, the amendment eliminates the requirement for such participants to contribute to the Kemper OPEB Plan. In conjunction with the amendment, the Company recorded a pre-tax reduction to its Accumulated Postretirement Benefit Obligation of $11.0 million through Other Comprehensive Income. This prior service credit is being amortized into income over the remaining average life of the Kemper OPEB Plan’s participants.
Changes in Fair Value of Plans’ Assets and Changes in Accumulated Postretirement Benefit Obligation for the years ended December 31, 2018 and 2017 were:
A one-percentage point increase in the assumed health care cost trend rate for each year would have increased the Accumulated Postretirement Benefit Obligation at December 31, 2018 by $0.8 million and 2018 OPEB expense by an insignificant amount. A one-percentage point increase in the assumed health care cost trend rate for each year would have increased the Accumulated Postretirement Benefit Obligation at December 31, 2017 by $0.6 million and 2017 OPEB expense by an insignificant amount.
The Company estimates that OPEB Expense for the year ended December 31, 2019 will include income of $3.3 million resulting from the amortization of the related accumulated actuarial gain and prior service credit included in AOCI at December 31, 2018.
Effective January 1, 2016, the Company changed its method for estimating the interest and service cost components of expense recognized for its pension and other postretirement employee benefit plans. As a result, the Company elected to use a full yield curve approach to estimate these components of benefit cost by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. See Note 2, “Summary of Accounting Policies and Accounting Changes,” to the Consolidated Financial Statements for further discussion of the change. The weighted-average discount rate and rate of increase in future compensation levels used to develop OPEB Expense for the years ended December 31, 2018, 2017 and 2016 were:
The Company expects to contribute $1.7 million, net of the expected Medicare Part D subsidy, to its OPEB Plan to fund benefit payments in 2019.
The Company is engaged, through its subsidiaries, in the property and casualty insurance and life and health insurance businesses. The Company conducts its operations through three operating segments: Preferred Property & Casualty Insurance, Specialty Property & Casualty Insurance and Life & Health Insurance.
The Preferred Property & Casualty Insurance segment’s principal products are preferred automobile insurance, homeowners insurance, and other personal insurance. The Specialty Property & Casualty Insurance segment’s principal products are specialty automobile insurance and commercial automobile insurance. These products are distributed primarily through independent agents and brokers. The Life & Health Insurance segment’s principal products are individual life, accident, health and property insurance. These products are distributed by career agents employed by the Company and independent agents and brokers.
It is the Company’s management practice to allocate certain corporate expenses, primarily compensation costs for corporate employees and related facility costs, included in Interest and Other Expenses in the Consolidated Statements of Income to its insurance operations. The amount of such allocated corporate expenses was $68.0 million, $50.8 million and $52.9 million for the years ended December 31, 2018, 2017 and 2016, respectively. The Company does not allocate Income from Change in Fair Value of Equity and Convertible Securities, Net Realized Gains on Sales of Investments, Net Impairment Losses Recognized in Earnings, interest expense on debt or postretirement benefit plans, and actuarial gains and losses on its postretirement benefit plans to its operating segments. Additionally, in 2018 the Company did not allocate the impact of the Tax Act or the gain recognized on the partial satisfaction of a final judgment against CSC to its operating segments.
Earned Premiums by product line for the years ended December 31, 2018, 2017 and 2016 were:
Amortization of Deferred Policy Acquisition Costs by Operating Segment for the years ended December 31, 2018, 2017 and 2016 was:
The Company manages its exposure to catastrophes and other natural disasters through a combination of geographical diversification, restrictions on the amount and location of new business production in certain regions, and reinsurance. To limit its exposures to catastrophic events, the Company maintains a catastrophe reinsurance program for the property and casualty insurance companies. Coverage for the catastrophe reinsurance program is provided in various layers through multiple excess of loss reinsurance contracts and in 2018 an annual aggregate excess property catastrophe reinsurance contract.
Coverage on individual catastrophes provided under the excess of loss reinsurance contracts effective January 1, 2016 to December 31, 2016 is provided in various layers as presented below.
Reinsurance premiums for the Company’s catastrophe reinsurance programs and the FHCF Program reduced earned premiums for the years ended December 31, 2018, 2017 and 2016 by the following:
The Company classifies its investments in Fixed Maturities as available for sale and reports these investments at fair value. The Company reports equity investments with readily determinable fair values as Equity Securities at Fair Value. Certain investments that are measured at fair value using the net asset value practical expedient are not required to be classified using the fair value hierarchy, but are presented in the following tables to permit reconciliation of the fair value hierarchy to the amounts presented in the Consolidated Balance Sheets.
The valuation of assets measured at fair value in the Company’s Consolidated Balance Sheet at December 31, 2018 is summarized below. The Company has no material liabilities that are measured and reported at fair value.
At December 31, 2018, the Company had unfunded commitments to invest an additional $148.2 million in certain limited liability investment companies and limited partnerships that will be included in Other Equity Interests when funded.
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 at Fair Value that are classified as Level 1 in the two preceding tables consist either of 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, obligations of states and political subdivisions, and bonds and mortgage-backed securities of U.S. government agencies. The Company’s investments in Equity Securities at Fair Value that are classified as Level 2 in the two preceding tables primarily consist of investments in preferred stocks. The Company uses a leading, nationally recognized provider of market data and analytics to price the vast majority of the Company’s Level 2 measurements. The provider utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information. Because many fixed maturity securities do not trade on a daily basis, the provider’s evaluated pricing applications apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing to prepare evaluations. In addition, the provider uses model processes to develop prepayment and interest rate scenarios. The pricing provider’s models and processes also take into account market convention. For each asset class, teams of its evaluators gather information from market sources and integrate relevant credit information, perceived market movements and sector news into the evaluated pricing applications and models. The Company generally validates the measurements obtained from its primary pricing provider by comparing them with measurements obtained from one additional pricing provider that provides either prices from recent market transactions or quotes in inactive markets or evaluations based on its own proprietary models.
The Company’s policy is to recognize transfers between levels as of the end of the reporting period. There were no transfers between Levels 1 and 2 for the year ended December 31, 2018. Transfers into Level 3 for the year ended December 31, 2018 relate to transfers from Level 2 due to to changes in the availability of market observable inputs. Transfers out of Level 3 were $71.3 million for the year ended December 31, 2018, of which $61.8 million was transferred into Equity Securities at Modified Cost due to the adoption of ASU 2016-01 and $9.5 million was transferred into Level 2 due to changes in the availability of market observable inputs.
The fair value measurement for loans to policyholders are categorized as Level 3 within the fair value hierarchy. The fair value measurement of Short-term Investments is estimated using inputs that are considered either Level 1 or Level 2 measurements. The fair value of Debt is estimated using quoted prices for similar liabilities in markets that are not active. The inputs used in the valuation are considered Level 2 measurements. Collateralized Borrowings consist of short-term advances from the FHLB of Chicago, and the inputs used in the valuation are considered Level 2 measurements.
Over the last decade, there have been an array of initiatives that seek, in various ways, to impose new duties on life insurance companies to proactively search for information related to the deaths of their insureds. These initiatives, which can include legislation, unclaimed property audits, market conduct examinations and related litigation, could alter the terms of Kemper’s life insurance subsidiaries’ existing life insurance contracts by imposing requirements that did not exist and were not contemplated at the time those companies entered into such contracts. In 2016, the Company voluntarily began implementing a comprehensive process to compare its life insurance records against one or more death verification databases to determine if any of its insureds may be deceased. See Note 2, “Summary of Accounting Policies and Accounting Changes,” to the Consolidated Financial Statements for discussion of the estimated financial impact of such voluntary action recognized in the Company’s Consolidated Financial Statements. Any attempt to estimate the ultimate outcomes of the aforementioned initiatives entails uncertainties including, but not limited to (i) the scope and interpretation of DMF statutes, including the matching criteria and methodologies to be used in comparing policy records against a DMF, (ii) the universe of policies affected, (iii) the results of audits, examinations and other actions by regulators and (iv) related litigation.
The Company cannot make any assurance as to the additional amounts of the final judgment that will actually be collected or when they may be received. The unpaid balance of the final judgment is treated as a gain contingency for accounting purposes and accordingly, is not recognized in these Consolidated Financial Statements.
Mr. Christopher B. Sarofim, a director of Kemper, is Vice Chairman and a member of the board of directors of Fayez Sarofim & Co. (“FS&C”), a registered investment advisory firm. The Company’s Pension Plan had $124.5 million, $171.8 million and $148.4 million in assets managed by FS&C at December 31, 2018, 2017 and 2016, respectively, under an agreement with
We have audited the accompanying consolidated balance sheets of Kemper Corporation and subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income (loss), shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control- Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
As discussed in Note 2 to the financial statements, the Company has changed its method of accounting for recognition and measurement of equity securities in 2018.