Kemper’s corporate data processing operation leases a facility with aggregate square footage of approximately 30,000 square feet at one location in one state. The expiration date of the existing lease is in June 2021.
Selected financial information as of and for the years ended December 31, 2019, 2018, 2017, 2016 and 2015 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.
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2019, 2018 and 2017
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2019, 2018 and 2017
Investments in Fixed Maturities include bonds, notes and redeemable preferred stocks. Investments in Fixed Maturities are classified as available for sale and reported at fair value. Net Investment Income, including amortization of purchased premiums and accretion of market discounts, on Investments in Fixed Maturities is recognized as interest over the period that it is earned using the effective yield method. Unrealized appreciation or depreciation, net of applicable deferred income taxes, on fixed maturities classified as available for sale is reported in Accumulated Other Comprehensive Income (“AOCI”) included in Shareholders’ Equity.
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 Sheets. Changes in fair value of Convertible Securities are recorded in the Consolidated Statements of Income during the period such changes occur.
Equity investments include common stocks, non-redeemable preferred stocks, exchange traded funds, money market mutual funds and limited liability companies and investment partnerships in which the Company’s interests are deemed minor. Equity investments with readily determinable fair values are recorded as Equity Securities at Fair Value on the Consolidated Balance Sheets. Effective January 1, 2018, changes in the fair value of such equity securities are reported in the Consolidated Statements of Income. Prior to January 1, 2018, changes in the fair values of such equity securities were reported in AOCI. Dividend income on investments in common and non-redeemable preferred stocks is recognized on the ex-dividend date. 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 the identical or similar investment of the same issuer on the Consolidated Balance Sheets as Equity Securities at Modified Cost. Changes in the carrying value of Modified Cost investments due to observable price changes are recorded as Income (Loss) from Change in Fair Value of Equity and Convertible Securities.
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.
Short-term Investments include certificates of deposit and other fixed maturities that mature within one year from the date of purchase, U.S. Treasury bills, money market mutual funds and overnight interest bearing accounts. Short-term Investments are reported at cost, which approximates fair value.
For traditional life insurance products, the reserves for future policy benefits are estimated on the net level premium method using assumptions as of the issue date for mortality, interest, policy lapses and expenses, including provisions for adverse deviations. These assumptions vary by such characteristics as plan, age at issue and policy duration. Mortality assumptions are based on the Company’s historical experience and industry standards. Interest rate assumptions principally range from 3% to 7%. Lapse rate assumptions are based on actual and industry experience. Insurance Reserves for life insurance products are comprised of reserves for future policy benefits plus an estimate of the Company’s liability for unpaid life insurance claims and claims adjustment expenses, which includes an estimate for IBNR life insurance claims. Prior to 2016, except when required by applicable law, the Company did not utilize the database of reported deaths maintained by the Social Security Administration or any other comparable database (a “Death Master File” or “DMF”) in its operations, including to determine its IBNR liability for life insurance products. Instead of using such a database, the Company calculated its IBNR liability for life insurance products using Company-specific historical information, which included analyzing average paid claims and the average lag between date of death and the date reported to the Company for claims for which proof of death had been provided. In 2016, the Company initiated a voluntary enhancement of its claims handling procedures for its life insurance policies. The Company is now utilizing a DMF to identify potential situations where the Company has yet to be notified of an insured’s death and, as appropriate, initiating an outreach process to identify and contact beneficiaries and settle claims. Policyholders’ Benefits and Incurred Losses and Loss Adjustment Expenses for the year ended December 31, 2016 included a charge of $77.8 million to recognize the initial impact of using a DMF in the Company’s operations, including to determine its IBNR liability for unpaid claims and claims adjustment expenses for life insurance products. The Company reduced its estimate of the initial impact of using death verification databases by $21.0 million for the year ended December 31, 2019.
Other Assets primarily include property and equipment, internal use software, right-of-use assets, insurance licenses acquired in business combinations, the value of other intangible assets acquired, corporate-owned life insurance (“COLI”) and prepaid expenses. Property and equipment is depreciated over the useful lives of the assets, generally using the straight-line or double declining balance methods of depreciation depending on the asset involved. Internal use software is amortized over the useful life of the asset using the straight-line method of amortization and is evaluated for recoverability upon identification of
impairment indicators. Insurance licenses acquired in business combinations and other indefinite life intangibles are not amortized, but rather tested periodically for recoverability.
The Company accounts for the value of business acquired (“VOBA”) based on actuarial estimates of the present value of future cash flows embedded in insurance in force as of an acquisition date. VOBA was $24.1 million and $30.2 million at December 31, 2019 and 2018, respectively. VOBA is amortized over the expected profit emergence period of the policies in force as of the acquisition date. The Company evaluates VOBA assets for recoverability annually.
The Company accounts for the present value of the future profits embedded in broker or agent relationships acquired (“Agent Relationships”) based on the present value of estimated future cash flows from such acquired relationships or, using the cost recovery method, which estimates the ultimate cost to build a comparable distribution network. Agent Relationships was $62.5 million and $68.0 million at December 31, 2019 and 2018, respectively, and are amortized on a straight-line basis over the estimated useful life of the relationship. Agent Relationships are tested for recoverability using undiscounted projections of future cash flows and written down to estimated fair value if the carrying value exceeds the sum of such projections of undiscounted cash flows.
In 2008, the Company sold its Unitrin Business Insurance operations and retained certain liabilities for unpaid insured losses that occurred prior to the date of the sale. Changes in the Company’s estimate of such retained liabilities after the sale are reported in Income from Discontinued Operations.
Effective January 1, 2019, the Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2016-02, Leases-(Topic 842). ASU 2016-02 introduced a lessee model that requires the recognition of a right-of-use (“ROU”) asset and a lease liability for all leases with terms greater than twelve months. The Company adopted ASU 2016-02 using the modified retrospective method at the beginning of the period of the adoption and elected the permitted practical expedients to not reassess whether any expired or existing contracts contain leases, the lease classification for any expired or existing leases and initial direct costs for any existing leases. The adoption of ASU 2016-02 had no impact on the Company’s Shareholders’ Equity as of January 1, 2019, but resulted in the establishment of a ROU asset of $66.5 million, a lease liability of $82.5 million and an adjustment to deferred rent liability of $16.0 million. The ROU asset and related liabilities were included in Other Assets and Accrued Expenses and Other Liabilities, respectively, on the Consolidated Balance Sheet at December 31, 2019.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 replaces the existing incurred loss impairment model with an expected credit loss impairment model. The expected credit loss impairment model requires the entity to recognize its estimate of expected credit losses for affected financial assets using an allowance for credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments in this ASU require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected. The income statement includes the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have occurred during the period. Credit losses on available-for-sale debt securities are measured in a manner similar to current GAAP, although ASU 2016-13 requires that they be presented as an allowance rather than as a write-down of the amortized cost. In situations where the estimate of credit loss on an available-for-sale debt security declines, entities will be able to record a reversal of the allowance to income in the current period, which was prohibited prior to the adoption of ASU 2016-13. ASU 2016-13 is effective for annual periods beginning after December 15, 2019 and interim periods within those annual periods. The impact of the initial adoption of ASU 2016-13 is not expected to be material.
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 January 1, 2022. 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.
In May 2019, the FASB issued ASU 2019-05, Financial Instruments-Credit Losses (Topic 326): Targeted Transition Relief. ASU 2019-05 provides transition relief for entities adopting the credit loss standard, ASU 2016-13. Specifically ASU 2019-05 amends ASU 2016-13 to allow companies to irrevocably elect, upon adoption of ASU 2016-13, the fair value option for financial instruments that are: (i) within the scope of the credit loss guidance in Accounting Standards Codification (“ASC”) Topic 326, Financial Instruments-Credit Losses; (ii) were previously recorded at amortized cost; (iii) are eligible for the fair value option under ASC Topic 825, Financial Instruments; and (iv) are not held to maturity debt. ASU 2019-05 is effective for annual periods beginning after December 15, 2019 and interim periods within those annual periods. The Company does not intend to elect the fair value option upon adoption of ASU 2016-13 for financial instruments outlined above.
On July 2, 2018, Kemper acquired 100% of the outstanding common stock of Infinity Property and Casualty Corporation (“Infinity”), pursuant to the terms of the merger agreement dated February 13, 2018, with total cash, stock and equity-based compensation consideration paid to Infinity shareholders of approximately $1.5 billion. In conjunction with closing the acquisition, Kemper issued 13,184,107 shares, with an aggregate fair value of $982.5 million based on Kemper’s July 2, 2018 stock price of $74.53 per share, and paid $564.6 million in cash consideration to Infinity’s shareholders. In addition, Kemper issued 44,010 restricted stock units under Kemper’s equity-based compensation plan to replace Infinity restricted shares that were outstanding immediately prior to the closing. The aggregate fair value of such Kemper restricted stock units granted was $3.3 million at July 2, 2018, of which $1.6 million is attributed to service provided prior to the closing and included in consideration paid. The remaining amount of $1.7 million is attributed to future service and will be recognized in compensation expense primarily over a period of two years. The cash consideration was funded by cash on hand as of July 2, 2018, inclusive of $250.0 million in borrowings under the Company’s delayed draw term loan facility and $110.0 million of Kemper subsidiary borrowings from the FHLB of Dallas and FHLB of Chicago. On July 13, 2018, Kemper subsidiaries repaid in full the $110.0 million of FHLB borrowings, plus accrued interest. On December 28, 2018, Kemper repaid $215.0 million of the delayed draw term loan facility. See Note 8, “Debt,” to the Consolidated Financial Statements for additional information. Infinity is a national provider of auto insurance focused on serving the specialty automobile market.
In 2019, the Company completed the process of estimating the fair value of assets acquired and liabilities assumed. In accordance with ASC Topic 805, Business Combinations, changes to the preliminary estimates and allocation as a result of events or conditions as of the acquisition date, are reported in the Company’s financial statements as an adjustment to the assets acquired and liabilities assumed. The Company finalized its estimate of certain legal and tax accruals, increasing liabilities assumed by $1.8 million, increasing current income tax assets by $0.2 million and increasing goodwill by $1.6 million compared with balances as of December 31, 2018. 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.
Other Receivables included $1.0 million and $0.5 million of unsettled sales of Investments in Fixed Maturities at December 31, 2019 and December 31, 2018, respectively.Accrued Expenses and Other Liabilities included unsettled purchases of Investments in Fixed Maturities of $19.5 million and $10.5 million at December 31, 2019 and 2018, respectively.
Equity securities with readily-determinable fair values, including equity securities which the Company previously classified as Fair Value Option Investments, are classified as Equity Securities at Fair Value in the Consolidated Balance Sheets with changes in fair value recorded as Income from Change in Fair Value of Equity and Convertible Securities in the Consolidated Statements of Income. Net unrealized losses arising during the year-ended December 31, 2019 and recognized in earnings, related to such investments still held as of December 31, 2019 were $126.0 million.
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 2019 and 2018, 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 $2,368.1 million, $2,805.3 million and $2,393.7 million, as of December 31, 2019, 2018 and 2017, respectively. Aggregate total liabilities of the Equity Method Limited Liability Investments in which the Company invested totaled $817.2 million, $1,030.7 million and $899.7 million, as of December 31, 2019, 2018 and 2017, respectively. Aggregate net income of the Equity Method Limited Liability Investments in which the Company invested totaled $78.0 million, $130.4 million and $209.3 million for the years ended December 31, 2019, 2018 and 2017, 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, 2019 is limited to the total carrying value of $220.4 million. In addition, the Company had outstanding commitments totaling approximately $97.2 million to fund Equity Method Limited Liability Investments at December 31, 2019.
The carrying values of the Company’s Other Investments at December 31, 2019 and 2018 were:
Goodwill balances by business segment at December 31, 2019 and 2018 were:
The Company tests goodwill for recoverability at the reporting unit level on an annual basis, or whenever events or circumstances indicate the fair value of a reporting unit may have declined below its carrying value. The Company performed a qualitative goodwill impairment assessment for all reporting units with goodwill as of October 1, 2019. The qualitative assessment takes into consideration changes in macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, changes in management or key personnel, changes in strategy and changes in Kemper’s stock price since the last quantitative assessment, which was performed on January 1, 2017. Based on its qualitative assessment, the Company concluded that the associated goodwill was recoverable for each reporting unit tested.
Definite and indefinite life intangible assets at December 31, 2019 and 2018 were:
The determination of individual case reserves differs by line of business. For specialty personal automobile insurance and commercial automobile insurance, case reserves are set primarily using statistical reserves that are based on studies of historical average paid amounts by state, coverage and product. However, when such reserves exceed certain thresholds they are set manually by adjusters. For preferred personal automobile insurance, homeowners insurance and other personal insurance, case reserves are set by adjusters and are based on the adjusters’ estimates of the amount for which the claims will ultimately be paid.
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 generally results in the historical development factors becoming less reliable over time in predicting how losses and LAE will ultimately develop. The Company’s actuaries use professional judgment in determining 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. In some cases, the Company’s actuaries make adjustments to the loss reserving estimation methodologies to estimate ultimate losses and LAE.
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, 2019.
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. Specialty Personal automobile insurance loss and LAE reserves developed adversely by $2.9 million. Commercial lines insurance loss and LAE reserves included favorable development of $0.6 million. Preferred Personal automobile insurance loss and LAE reserves developed adversely by $19.3 million due primarily to the emergence of loss patterns that were worse than expected for both physical damage and liability insurance for the 2016 accident year and, to a lesser extent, for liability insurance for the 2015 and 2014 accident years, partially offset by the emergence of more favorable loss patterns than expected for the 2013 and prior accident years. Homeowners insurance loss and LAE reserves developed adversely by $1.0 million due primarily to the emergence of non-catastrophe loss patterns that were worse than expected for the 2016 accident year, and to a lesser extent, the 2013 and prior accident years, partially offset by $3.7 million of favorable development on catastrophes primarily for the 2016 accident year and, to a lesser extent, the 2015 accident year. Other personal lines loss and LAE reserves developed favorably by $3.7 million due primarily to the emergence of more favorable loss patterns than expected for the 2015, 2014, 2013 and prior accident years partially offset by the emergence of loss patterns that were worse than expected for the 2016 accident year.
Policyholder Contract Liabilities at December 31, 2019 and 2018 were as follows:
United Insurance has entered into funding agreements with the FHLB of Chicago in exchange for cash, which it uses for spread lending purposes. United Insurance received advances of $614.5 million from the FHLB of Chicago and made repayments of $381.1 million under the spread lending program in 2019. United Insurance received advances of $10.0 million from the FHLB of Chicago in 2018 under the spread lending program.
United Insurance’s liability under the funding agreements with the FHLB of Chicago, the amount of collateral pledged under such agreements and FHLB of Chicago common stock owned by United Insurance at December 31, 2019 and 2018 is presented below.
On June 8, 2018, the Company entered into an amended and extended credit agreement and term loan facility. The amended and extended credit agreement increased the borrowing capacity of the existing unsecured credit agreement to $300.0 million and extended the maturity date to June 8, 2023. The term loan facility included a delayed-draw feature with borrowing capacity of $250.0 million and a maturity date two years from the borrowing date (see discussion below under heading, “Term Loan Due 2020,” for additional information). On June 4, 2019, the Company utilized the accordion feature under the credit agreement to increase its credit borrowing capacity by $100.0 million, resulting in the available credit commitments increasing from $300.0 million to $400.0 million. The Company incurred $0.1 million in additional debt issuance costs in connection with the utilization of the accordion feature which, in addition to the $1.1 million of remaining unamortized costs under the credit agreement, will be amortized under the remaining term of the credit agreement. There were no outstanding borrowings under the credit agreement at either December 31, 2019 or December 31, 2018.
The Company designates debt obligations as either short-term or long-term based on maturity date at issuance, or in the case of the 2022 Senior Notes, based on the date of assumption. Total amortized cost of Long-term Debt outstanding at December 31, 2019 and 2018 was:
On June 29, 2018, the Company borrowed $250.0 million under its delayed-draw term loan facility dated June 8, 2018, to facilitate the funding of the acquisition of Infinity. The proceeds from the term loan facility, net of debt issuance costs, were $249.4 million. On December 28, 2018, the Company repaid $215.0 million of the outstanding term loan. On May 31, 2019, remaining outstanding balance of $35.0 million was repaid.
On June 4, 2019, the Company entered into a delayed-draw term loan facility with a borrowing capacity of $50.0 million and a maturity date four years from the borrowing date (the “2023 Term Loan”). On July 5, 2019, the Company borrowed $49.9 million, net of debt issuance costs, under the 2023 Term Loan, with a final maturity date of July 5, 2023. The agreement includes a mutual option to extend the maturity date by one year.
Infinity’s liabilities at the acquisition date included $275.0 million principal amount, 5.0% Senior Notes due September 19, 2022 (“2022 Senior Notes”). The 2022 Senior Notes were recorded at fair value as of the acquisition date, $282.1 million, 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.
The Company used the proceeds received from Kemper’s common stock offering on June 7, 2019, as well as a portion of the proceeds from its July 5, 2019 borrowing under the 2023 Term Loan, to repay the 7.375% Subordinated Debentures. See Note 10, “Shareholders’ Equity,” for additional information regarding the common stock offering.
Interest Expense, including facility fees, accretion of discount, amortization of premium and amortization of issuance costs, was $42.5 million, $43.3 million and $34.9 million for the years ended December 31, 2019, 2018 and 2017, respectively. Interest paid, including facility fees, was $44.0 million, $37.9 million and $34.7 million for the years ended December 31, 2019, 2018 and 2017, respectively.
Supplemental cash flow information related to the Company’s operating leases for the year-ended December 31, 2019 is as follows:
Future minimum lease payments under finance and operating leases at December 31, 2019 were:
Future minimum lease payments under finance and operating leases at December 31, 2018 were:
The total of minimum rentals to be received in the future under non-cancelable subleases was $0.8 million and $0.0 million at December 31, 2019 and 2018, respectively.
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, 2019 and 2018. There were 66,665,888 shares and 64,756,833 shares of common stock outstanding at December 31, 2019 and 2018, respectively.
On June 7, 2019, the Company completed a public offering of its common stock and issued 1,552,500 shares of common stock, at $83.00 per share. Gross proceeds from the offering were $128.9 million. Transaction costs, including the underwriting discount, were $1.7 million, of which $0.1 million was accrued for and included in Accrued Expenses and Other Liabilities on the Company’s Consolidated Balance Sheet at December 31, 2019. In July 2019, the Company used the net proceeds of $127.2 million from the offering, together with a portion of the proceeds from the 2023 Term Loan (see Note 8, “Debt”) to redeem all $150.0 million in aggregate outstanding principal of its 7.375% Subordinated Debentures due 2054.
In conjunction with the closing of the Infinity acquisition, Kemper issued 13,184,107 shares of common stock on July 2, 2018, at $74.53 per share. See Note 3, “Acquisition of Business,” to the Consolidated Financial Statements for additional information.
Under the ESPP, eligible employees may purchase shares of Company common stock through payroll deductions of between 1% and 10% of after-tax compensation each pay period, with a maximum participation of $25,000 annually. The shares are purchased at the end of each three-month offering period at a 15% discount from the closing market price as reported on the New York Stock Exchange on the last trading day of the offering period. The Company issued 24,080 shares under the plan in 2019 at an average discounted price of $66.08 per share. Compensation costs charged against income were $0.3 million for the year ended December 31, 2019.
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 $239.0 million to Kemper in 2019. In 2020, Kemper’s
insurance subsidiaries would be able to pay $435.4 million in dividends to Kemper without prior regulatory approval. Kemper’s insurance subsidiaries had net assets of $3.9 billion, determined in accordance with GAAP, that were restricted from payment to Kemper without prior regulatory approval at December 31, 2019.
On May 4, 2011, Kemper’s shareholders approved the 2011 Omnibus Equity Plan (“2011 Omnibus Plan”). The 2011 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, but no new equity-based compensation awards can be granted under the Prior Plans. A maximum number of 10,000,000 shares of Kemper common stock may be issued under the 2011 Omnibus Plan (the “Share Authorization”). As of December 31, 2019, there were 3,254,822 common shares available for future grants under the 2011 Omnibus Plan, of which 1,082,460 shares were reserved for future grants based on the performance results under the terms of outstanding performance share units (“PSUs”).
For grants prior to November 2017, recipients of RSUs and PSUs receive full dividend equivalents on the same basis as all other outstanding shares of Kemper common stock, but do not receive voting rights until such shares are issued. Except as described below for certain equity-based compensation awards granted to each member of the Board of Directors who is not employed by the Company (“Non-employee Directors”), all outstanding awards are subject to forfeiture until certain restrictions have lapsed.
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 $25.3 million, $18.6 million and $9.4 million for the years ended December 31, 2019, 2018 and 2017, respectively. Total unamortized compensation expense related to unvested awards at December 31, 2019 was $20.4 million, which is expected to be recognized over the next three years ending December 31, 2020, 2021 and 2022.
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 2011 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 program in effect for 2019, each non-employee director received an annual RSU award with an aggregate grant date fair value of $130,000 (“Director RSUs”) at the conclusion of the 2019 annual shareholder meeting. The Director RSUs vest over a period of one year, enable the award holder to make an election to defer the conversion to shares of common stock in accordance with applicable deferral rules, and include the right to receive dividend equivalents on the same basis as all other outstanding shares of Kemper common stock only if, to the extent, and at the time that they vest and on subsequent dividend payment dates after they vest until the awards are settled. Under the Non-employee Director compensation program in effect for 2018 and 2017, each non-employee director received an annual DSU award with an aggregate grant date fair value of $110,000 at the conclusion of each annual shareholder meeting. The DSUs granted to Non-employee Directors are fully vested on the date of grant and include the right to receive full dividend equivalents on the same basis as all other outstanding shares of Kemper common stock. Conversion of the DSUs into shares of Kemper’s common stock is deferred until the date a director’s board service terminates.
The Company uses the Black-Scholes option pricing model to estimate the fair value of each Tandem Award on the date of grant. The expected terms of Tandem Awards are developed by considering the Company’s historical Tandem Award exercise experience, demographic profiles, historical share retention practices of employees and assumptions about their propensity for early exercise in the future. Expected volatility is estimated using weekly historical volatility. The Company believes that historical volatility is currently the best estimate of expected volatility. The dividend yield in 2019, 2018 and 2017 was calculated by taking the natural logarithm of the annualized yield divided by the Kemper common stock price on the date of grant. The risk-free interest rate was the yield on the grant date of U.S. Treasury zero coupon issues with a maturity comparable to the expected term of the option.
The assumptions used in the Black-Scholes pricing model for Tandem Awards granted during the years ended December 31, 2019, 2018 and 2017 are presented below.
Tandem Award activity for the year ended December 31, 2019 is presented below.
Activity related to nonvested PSU awards for the year ended December 31, 2019 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 2019, 2018 and 2017 three-year performance periods was 146,134 common shares, 137,343 common shares and 77,343 common shares, respectively, (as “full value awards,” the equivalent of 438,402 shares, 412,029 shares, and 232,029 shares, respectively, under the Share Authorization) at December 31, 2019.
The grant date fair values of the PSU awards with a market performance condition are determined using the Monte Carlo simulation method. The Monte Carlo simulation model produces a risk-neutral simulation of the daily returns on the common stock of Kemper and each of the other companies included in the peer group. Returns generated by the simulation depend on the risk-free interest rate used and the volatilities of, and the correlation between, these stocks. The model simulates stock prices and dividend payouts to the end of the three-year performance period. Total shareholder returns are generated for each of these stocks based on the simulated prices and dividend payouts. The total shareholder returns are then ranked, and Kemper’s simulated ranking is converted to a payout percentage based on the terms of the PSU awards. The payout percentage is applied to the simulated stock price at the end of the performance period, reinvested dividends are added back, and the total is
discounted to the valuation date at the risk-free rate. This process is repeated approximately ten thousand times, and the grant date fair value is equal to the average of the results from these trials.
The total fair value of RSUs and PSUs that vested during the year ended December 31, 2019 was $24.8 million. The tax benefits for tax deductions realized from such awards was $5.2 million. 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 Company’s awards of deferred stock units contain rights to receive non-forfeitable dividend equivalents and participate in the undistributed earnings with common shareholders, as did the Company’s awards of restricted stock units and performance share units prior to 2018. Accordingly, the Company is required to apply the two-class method of computing basic and diluted earnings per share. A reconciliation of the numerator and denominator used in the calculation of Basic Income from Continuing Operations Per Unrestricted Share and Diluted Income from Continuing Operations Per Unrestricted Share for the years ended December 31, 2019, 2018 and 2017 is presented below.
The number of shares of Kemper common stock that were excluded from the calculations of Equity-based Compensation Equivalent Shares and Weighted-average Unrestricted Shares and Equivalent Shares Outstanding Assuming Dilution for the years ended December 31, 2019, 2018 and 2017, because the effect of inclusion would be anti-dilutive, is presented below.
NOTE 13. OTHER COMPREHENSIVE INCOME (LOSS) AND ACCUMULATED OTHER COMPREHENSIVE INCOME
The components of AOCI at December 31, 2019 and 2018 were:
Components of AOCI were reclassified to the following lines of the Consolidated Statements of Income for the years ended December 31, 2019, 2018 and 2017:
Other Receivables includes accrued investment income of $78.7 million and $77.9 million at December 31, 2019 and 2018, respectively.
The components of Net Impairment Losses Recognized in Earnings reported in the Consolidated Statements of Income for the years ended December 31, 2019, 2018 and 2017 were:
Insurance Expenses for the years ended December 31, 2019, 2018 and 2017 were:
A reconciliation of the beginning and ending amount of Unrecognized Tax Benefits for the years ended December 31, 2019, 2018 and 2017 is presented below.
The statute of limitations related to Kemper and its eligible subsidiaries’ consolidated Federal income tax returns is closed for all tax years up to and including 2011. As a result of the Company filing amended federal income tax returns resulting from an election to update interest rates used to compute the tax basis of reserves on life insurance contracts issued prior to 2018, tax years 2012 and 2013 are under limited examination with respect to carryback adjustments associated with the amended returns. The statute of limitations related to tax years 2014 and 2015 has been extended to June 30, 2020.
There were no Unrecognized Tax Benefits at December 31, 2019. Unrecognized Tax Benefits at December 31, 2018 and 2017 include $3.7 million and $7.6 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.
The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense. The liability for Unrecognized Tax Benefits included accrued interest of $0.7 million and $0.5 million at December 31, 2018 and 2017, respectively. Net interest related to unrecognized tax benefits for the years ended December 31, 2018 and 2017 were insignificant.
The components of Income Tax Expense from Continuing Operations for the years ended December 31, 2019, 2018 and 2017 were:
Income taxes paid, net of income tax refunds received, were $68.1 million, $0.2 million, and $13.0 million in 2019, 2018, and 2017, respectively.
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, 2019, 2018 and 2017 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, 2019 and 2018 is presented below.
The measurement dates of the assets and liabilities at end of year presented in the preceding table under the headings, “2019” and “2018” were December 31, 2019 and December 31, 2018, respectively.
The investment objective of the Pension Plan is to produce current income and long-term capital growth through a combination of equity and fixed income investments which, together with appropriate employer contributions and any required employee contributions, is adequate to provide for the payment of the benefit obligations of the Pension Plan. The assets of the Pension Plan may be invested in fixed income and equity investments or any other investment vehicle or financial instrument deemed
The fair values of pension plan assets are estimated using the same methodologies and inputs as those used to determine the fair values for the respective asset category of the Company. These methodologies and inputs are disclosed in Note 22, “Fair Value Measurements,” to the Consolidated Financial Statements. Fair value measurements for the Pension Plan’s assets at December 31, 2019 are summarized below.
Fair value measurements for the Pension Plan’s assets at December 31, 2018 are summarized below.
The components of Comprehensive Pension Expense (Income) for the Pension Plan for the years ended December 31, 2019, 2018 and 2017 were:
On August 22, 2019, the Company made a voluntary cash contribution of $55.3 million to the Pension Plan. On July 13, 2018, the Company made a voluntary cash contribution of $5.1 million to the Pension Plan. The Company did not contribute to the Pension Plan in 2017. The Company does not expect that it will be required to contribute to the Pension Plan in 2020, but could make a voluntary contribution pursuant to the maximum funding limits under ERISA.
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 assumed health care cost trend rate used in measuring the Accumulated Postretirement Benefit Obligation at December 31, 2019 was 7.50% for 2020, gradually declining to 4.8% in the year 2025 and remaining at that level thereafter for medical benefits and 10.00% for 2020, gradually declining to 4.8% in the year 2026 and remaining at that level thereafter for prescription drug benefits. The assumed health care cost trend rate used in measuring the Accumulated Postretirement Benefit Obligation at December 31, 2018 was 7.5% for 2019, gradually declining to 4.8% in the year 2025 and remaining at that level thereafter for medical benefits and 10.0% for 2019, gradually declining to 4.8% in the year 2026 and remaining at that level thereafter for prescription drug benefits.
The components of Comprehensive OPEB Expense (Income) for the years ended December 31, 2019, 2018 and 2017 were:
The Company estimates that OPEB Expense for the year ended December 31, 2020 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, 2019.
The weighted-average discount rate and rate of increase in future compensation levels used to develop OPEB Expense for the years ended December 31, 2019, 2018 and 2017 were:
The Company expects to contribute $1.3 million, net of the expected Medicare Part D subsidy, to its OPEB Plan to fund benefit payments in 2020.
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: Specialty Property & Casualty Insurance, Preferred Property & Casualty Insurance and Life & Health Insurance.
It is the Company’s management practice to allocate certain corporate expenses, primarily compensation costs for corporate employees and related facility costs, included in Interest and Other Expenses in the Consolidated Statements of Income to its insurance operations. The amount of such allocated corporate expenses was $103.9 million, $68.0 million and $50.8 million for the years ended December 31, 2019, 2018 and 2017, 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, Acquisition Related Transaction, Integration and Other Costs, Loss from Early Extinguishment of Debt, interest expense on debt or postretirement benefit plans, and actuarial gains and losses on its postretirement benefit plans to its operating segments. Additionally, the Company did not allocate the 2018 and 2017 impacts of the Tax Act or the gains recognized in 2019 and 2018 on the partial satisfaction of a final judgment against Computer Sciences Corporation (“CSC”) to its operating segments.
Segment Net Operating Income, including a reconciliation to Income from Continuing Operations, for the years ended December 31, 2019, 2018 and 2017 was:
Coverage on individual catastrophes provided under the excess of loss reinsurance contracts effective January 1, 2019 to December 31, 2019 is provided in various layers as presented below.
Coverage on individual catastrophes provided under the excess of loss reinsurance contracts effective January 1, 2018 to December 31, 2018 is provided in various layers as presented below.
Coverage on individual catastrophes provided under the excess of loss reinsurance contracts effective January 1, 2017 to December 31, 2017 is provided in various layers as presented below.
The catastrophe reinsurance in 2019, 2018 and 2017 for the property and casualty insurance companies also included reinsurance coverage from the Florida Hurricane Catastrophe Fund (the “FHCF”) for hurricane losses in Florida at retentions lower than those described above. The Life & Health Insurance segment also purchases reinsurance from the FHCF for hurricane losses in Florida. Except for the coverage provided by the FHCF, the Life & Health Insurance segment does not carry any other catastrophe reinsurance coverage in 2019, 2018 and 2017.
Reinsurance premiums for the Company’s catastrophe reinsurance programs and the FHCF Program reduced earned premiums for the years ended December 31, 2019, 2018 and 2017 by the following:
In 2019, 2018 and 2017 the Company paid $0.0 million, $0.4 million and $0.8 million respectively, in reinstatement premium. In 2019, the Company received a $0.9 million refund of reinstatement premiums related to the 2017 and 2018 wildfires.
Catastrophe losses and LAE (including reserve development), net of reinsurance recoveries, for the years ended December 31, 2019, 2018 and 2017 by business segment are presented below.
The process of estimating and establishing reserves for catastrophe losses is inherently uncertain and the actual ultimate cost of a claim, net of actual reinsurance recoveries, may vary materially from the estimated amount reserved. The Company’s estimates of direct catastrophe losses are generally based on inspections by claims adjusters and historical loss development experience for areas that have not been inspected or for claims that have not yet been reported. The Company’s estimates of direct catastrophe losses are based on the coverages provided by its insurance policies. The Company’s homeowners and dwelling insurance policies do not provide coverage for losses caused by floods, but generally provide coverage for physical damage caused by wind or wind-driven rain. Accordingly, the Company’s estimates of direct losses for homeowners and dwelling insurance do not include losses caused by flood. Depending on the policy, automobile insurance may provide coverage for losses caused by flood. Estimates of the number and severity of claims ultimately reported are influenced by many variables, including, but not limited to, repair or reconstruction costs and determination of cause of loss that are difficult to quantify and will influence the final amount of claim settlements. All these factors, coupled with the impact of the availability of labor and material on costs, require significant judgment in the reserve setting process. A change in any one or more of these factors is likely to result in an ultimate net claim cost different from the estimated reserve. The Company’s estimates of indirect
Earned Premiums ceded on long-duration and short-duration policies were $27.4 million, $31.6 million and $18.2 million for the years ended December 31, 2019, 2018 and 2017, respectively, of which $20.5 million, $20.5 million and $11.0 million, respectively, was related to catastrophe reinsurance. See Note 20, “Catastrophe Reinsurance,” to the Consolidated Financial Statements for additional information regarding the Company’s catastrophe reinsurance programs. Certain insurance subsidiaries assume business from other insurance companies and involuntary pools. Earned Premiums assumed on long-duration and short-duration policies were $92.3 million, $85.2 million and $72.9 million for the years ended December 31, 2019, 2018 and 2017, respectively.
Trinity and Capitol County Mutual Fire Insurance Company (“Capitol”) are parties to a quota share reinsurance agreement whereby Trinity assumes 100% of the business written by Capitol, subject to a cap, for ceded losses for dwelling coverage. Earned Premiums assumed by Trinity from Capitol were $19.4 million, $20.0 million and $20.7 million for the years ended December 31, 2019, 2018 and 2017, respectively. Capitol is a mutual insurance company and, accordingly, is owned by its policyholders. Trinity and Old Reliable Casualty Company (“ORCC”), a subsidiary of Capitol, are parties to a quota share reinsurance agreement whereby Trinity assumes 100% of the business written by ORCC, subject to a cap, for ceded losses for dwelling coverage. Earned Premiums assumed by Trinity from ORCC were $5.2 million, $5.6 million and $5.9 million for the years ended December 31, 2019, 2018 and 2017, respectively.
At December 31, 2019, the Company had unfunded commitments to invest an additional $248.1 million in certain limited liability investment companies and limited partnerships that will be included in Other Equity Interests when funded.
The valuation of assets measured at fair value in the Company’s Consolidated Balance Sheet at December 31, 2018 is summarized below.
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, 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, 2019. Transfers into Level 3 of $19.1 million for the year ended December 31, 2019 were due to changes in the availability of market observable inputs. There were no transfers out of Level 3 for the year ended December 31, 2019.
Information by security type pertaining to the changes in the fair value of the Company’s investments classified as Level 3 for the year ended December 31, 2018 is presented below.
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 measurement of Mortgage Loans is estimated using inputs that are considered 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. Policyholder Contract Liabilities consist of advances from the FHLB of Chicago, and the inputs used in the valuation are considered Level 2 measurements.
In the ordinary course of its businesses, the Company is involved in legal proceedings, including lawsuits, arbitrations, regulatory examinations, audits and inquiries. Except with regard to the matters discussed below, based on currently available information, the Company does not believe that it is reasonably possible that any of its pending legal proceedings will have a material effect on the Company’s consolidated financial statements.
Over the last decade there have been an array of initiatives that intend, 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, audits, regulatory examinations and related litigation, seek to alter the terms of life insurance contracts by imposing requirements that did not exist and were not contemplated at the time the issuing companies entered into such contracts.
In April 2017, the parties participated in an evidentiary hearing in Texas before a AAA-appointed arbitrator. Subsequently, in October 2017, the arbitrator issued a Partial Final Award finding that CSC had breached the Agreements and awarded KCSI direct damages plus pre-judgment interest. KCSI then submitted to the arbitrator a supplemental petition providing pre-judgment interest calculations and seeking an award for certain costs and expenses. In November 2017, the arbitrator issued a Final Award awarding KCSI direct damages against CSC of $84.3 million, prejudgment interest at the annual rate of 9% and costs and expenses in the amount of $7.2 million.
CSC appealed the district court’s ruling to the U.S. Court of Appeals for the Fifth Circuit, but in the meantime paid Kemper $35.7 million in September 2018 and an additional $20.1 million in April 2019 in partial satisfaction of the final judgment. The Company recognized such payments in Other Income in its Consolidated Statement of Income for the years ended December 31, 2018 and December 31, 2019, respectively. On January 10, 2020, the Court of Appeals for the Fifth Circuit issued a unanimous opinion affirming the ruling of the district court. On January 24, 2020, CSC filed a petition with the Fifth Circuit requesting a rehearing en banc.
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We developed a range of independent estimates of the property and casualty insurance reserves and compared our estimates to the recorded reserves.
We compared our prior year estimates of expected incurred losses to actual experience during the most recent year to identify potential bias in the Company’s determination of property and casualty insurance reserves.
Fixed Maturities at Fair Value - Refer to Notes 2, 4 and 22 to the consolidated financial statements
We tested the effectiveness of controls related to fixed maturity securities, including those controls related to the determination of fair value.
With the assistance of our fair value specialists, we compared management’s unobservable inputs to external sources, and for a sample of the investments, developed independent estimates of the fair value and compared our estimates to the Company’s estimates.