Kemper’s subsidiaries together own and occupy seven buildings located in six states consisting of approximately 25,000 square feet in the aggregate. One of Kemper’s subsidiaries owns one building totaling approximately 2,000 square feet which was vacant at December 31, 2016. Kemper’s subsidiaries hold, solely for investment purposes, additional properties that are not occupied by Kemper or its subsidiaries.
The properties described above are in good condition. The properties utilized in the Company’s operations consist of facilities suitable for general office space, call centers and data processing operations.
A reconciliation of Segment Net Operating Income to Consolidated Net Operating Income (a non-GAAP financial measure) and to Net Income for the years ended December 31, 2016, 2015 and 2014 is presented below.
The Company’s net income decreased by $68.9 million in 2016, compared to 2015. In the Property & Casualty Insurance segment, segment net operating results deteriorated by $29.6 million due primarily to higher incurred catastrophe losses and LAE (excluding reserve development) and higher underlying losses and LAE as a percentage of earned premiums, partially offset by lower insurance expenses as a percentage of earned premiums and the impact of the write-off of internal use software in 2015. See MD&A, “Property & Casualty Insurance,” beginning on page 30 for additional discussion of the segment’s results. See MD&A, “Write-offs of Long-lived Assets,” beginning on page 51 for additional information related to the internal use software write-off. In the Life & Health Insurance segment, segment net operating income decreased by $41.4 million due primarily to a $50.5 million after-tax charge to recognize the impact of using death verification databases in the Company’s operations, including to determine its IBNR liability for unpaid claims and claims adjustment expenses for life insurance products, partially offset by the impact of an adjustment recorded in 2015 to correct deferred premium reserves on certain limited pay life insurance policies and lower Insurance Expenses. See MD&A, “Life & Health Insurance,” beginning on page 40 for additional discussion of the segment’s results. The Company’s results were also significantly and negatively impacted in 2016, compared to 2015, by lower net realized gains on sales of investments and positively impacted in 2016, compared to 2015, from a loss from early extinguishment of debt in 2015. See MD&A, “Investment Results,” beginning on page 45 and MD&A, “Liquidity and Capital Resources,” beginning on page 52 for additional discussion.
net operating income decreased by $20.1 million due primarily to a $13.9 million after-tax dividend in 2014 from an investment that had sold substantially all of its operations, an after-tax adjustment to earned premiums of $4.9 million recorded in the first quarter of 2015 to correct deferred premium reserves on certain limited pay life insurance policies, and higher policyholders’ benefits on life insurance. See MD&A, “Life & Health Insurance,” beginning on page 40 for additional discussion of the segment’s results. The Company’s results were also significantly and negatively impacted in 2015, compared to 2014, by higher net impairment losses recognized in earnings and a loss from early extinguishment of debt in 2015, partially offset by higher net realized gains on sales of investments. See MD&A, “Investment Results,” beginning on page 45 and MD&A, “Liquidity and Capital Resources,” beginning on page 52 for additional discussion.
Earned Premiums were $2,220.0 million in 2016, compared to $2,009.6 million in 2015, an increase of $210.4 million. Earned Premiums increased by $199.6 million and $10.8 million in the Property & Casualty Insurance segment and Life & Health Insurance segment, respectively. See MD&A, “Property & Casualty Insurance,” beginning on page 30 and MD&A, “Life & Health Insurance,” beginning on page 40 for discussion the changes in each segment’s earned premiums.
$11.5 million and $2.1 million, respectively, for the year ended December 31, 2016, compared to the same period in 2015, while alternative investment income from other limited liability investments included in Equity Securities increased by $4.4 million. See MD&A, “Investment Results,” under the sub-caption “Net Investment Income” beginning on page 45 for additional discussion.
Net Investment Income decreased by $6.5 million in 2015, compared to 2014, due primarily to lower investment income from Alternative Investments, partially offset by higher investment income from investments in fixed income securities. Net Investment Income from Alternative Investments decreased by $12.2 million due primarily to a $21.8 million dividend in 2014 from an investment that had sold substantially all of its operations, partially offset by higher investment income from Equity Method Limited Liability Investments.See MD&A, “Investment Results,” under the sub-caption “Net Investment Income” beginning on page 45 for additional discussion.
Increases (decreases) in the Company’s property and casualty loss and LAE reserves for the years ended December 31, 2016, 2015 and 2014 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.
The following discussions of segment results use the non-GAAP financial measures of (i) Underlying Losses and LAE and (ii) Underlying Combined Ratio. Underlying Losses and LAE (also referred to in the discussion as “Current Year Non-catastrophe Losses and LAE”) exclude the impact of catastrophe losses and loss and LAE reserve development from prior years from the Company’s Incurred Losses and LAE, which is the most directly comparable GAAP financial measure. The Underlying Combined Ratio is computed by adding the Current Year Non-catastrophe Losses and LAE Ratio with the Insurance Expense (including write-offs of long-lived assets) Ratio. The most directly comparable GAAP financial measure is the Combined Ratio, which is computed by adding total incurred losses and LAE, including the impact of catastrophe losses and loss and LAE reserve development from prior years, with the Insurance Expense (including write-offs of long-lived assets) Ratio. The Company believes Underlying Losses and LAE and the Underlying Combined Ratio are useful to investors and are used by management to reveal the trends in the Company’s Property & Casualty Insurance business that may be obscured by catastrophe losses and prior year reserve development. These catastrophe losses may cause the Company’s loss trends to vary significantly between periods as a result of their incidence of occurrence and magnitude, and can have a significant impact on incurred losses and LAE and the combined ratio. Prior-year reserve developments are caused by unexpected loss development on historical reserves. Because reserve development relates to the re-estimation of losses from earlier 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.
As discussed in Note 3, “Acquisition of Business,” to the Consolidated Financial Statements, the Company completed its acquisition of Alliance United on April 30, 2015. Alliance United is a provider of nonstandard personal automobile insurance in California and has added significant scale to the Property & Casualty Insurance segment’s premium base. The results of Alliance United’s operations have been included in the Company’s consolidated results since the date of its acquisition, which can obscure certain comparisons of year-over-year results, particularly when analyzing overall segment results as well as the nonstandard personal automobile insurance line of business. To focus on the performance of the segment’s legacy business, certain comparisons exclude Alliance United’s impact on the segment’s results.
Net Investment Income in the Property & Casualty Insurance segment decreased by $0.9 million in 2016,, compared to 2015, due primarily to lower investment income from Alternative Investments and a lower level of non-alternative investments, partially offset by investment income from the investments acquired from the acquisition of, and the capital contributed to, Alliance United and higher yields on non-alternative investments. The Property & Casualty Insurance segment reported Net Investment Income from Alternative Investments of $20.2 million in 2016, compared to $25.3 million in 2015.
Underlying losses and LAE as a percentage of earned premiums were 75.8% in 2016, an increase of 2.6 percentage points, compared to 2015. Alliance United, which runs at a higher underlying losses and LAE ratio but lower insurance expense ratio, added 8.4 percentage points to the overall underlying losses and LAE ratio in 2016, compared to adding 4.8 percentage points in 2015. Excluding the impact of Alliance United, underlying losses and LAE as a percentage of earned premiums were 67.4% in 2016, compared to 68.4% in 2015, or a decrease of 1.0 percentage points, as all product lines improved with the exception of preferred personal automobile insurance, which deteriorated. Underlying incurred losses and LAE exclude the impact of catastrophes and loss and LAE reserve development. Catastrophe losses and LAE (excluding reserve development) were $109.6 million in 2016, compared to $64.5 million in 2015, which is an increase of $45.1 million due primarily to two separate hailstorms in Texas-one in March 2016 with estimated losses and LAE of $36.0 million and another in April 2016 with estimated losses and LAE of $27.4 million. The increase was partially offset by reduced severity of catastrophic events with losses and LAE (excluding reserve development) of less than $10 million in 2016, compared to 2015. Excluding the impact of Alliance United, favorable loss and LAE reserve development (including favorable catastrophe reserve development of $19.2 million in 2016 and $7.9 million in 2015) was $19.4 million in 2016, compared to $20.6 million in 2015.
The Property & Casualty Insurance segment’s effective income tax rate differs from the federal statutory income tax rate due primarily to tax-exempt investment income, dividends received deductions and estimated indemnification recoveries recognized in earnings pursuant to the Alliance United purchase agreement. Tax-exempt investment income and dividends received deductions were $23.7 million in 2016, compared to $22.6 million in 2015. Indemnification recoveries result in an adjustment to the tax purchase price and are excluded from the determination of taxable income and income tax expense. Estimated indemnification recoveries recognized in earnings were $0.7 million in 2016, all of which has been reported as a reduction of Insurance Expenses. Estimated indemnification recoveries recognized in earnings were $10.4 million in 2015, of which $5.9 million has been reported as a reduction of Incurred Losses and LAE and $4.5 million has been recorded as a reduction of Insurance Expenses.
Net Investment Income in the Property & Casualty Insurance segment increased by $0.6 million for the year ended December 31, 2015, compared to the same period in 2014, due primarily to higher investment income from Alternative Investments, higher yields on fixed income securities and investment income from the investments acquired from the acquisition of and, the capital contributed to, Alliance United, partially offset by lower dividends on equity securities and lower levels of allocated investments resulting from a decline in the level of capital needed to support the legacy business. The Property & Casualty Insurance segment reported Net Investment Income from Alternative Investments of $25.3 million in 2015, compared to $ 22.2 million in 2014.
to the tax purchase price and are excluded from the determination of taxable income and income tax expense. Estimated indemnification recoveries recognized in earnings were $10.4 million in 2015, of which $5.9 million has been reported as a reduction of Incurred Losses and LAE and $4.5 million has been recorded as a reduction of Insurance Expenses.
injury, uninsured/underinsured motorists, property damage and comprehensive coverages, partially offset by higher severity of losses on most coverages. Catastrophe losses and LAE (excluding reserve development) were $3.0 million in 2015, compared to $8.9 million in 2014. Favorable loss and LAE reserve development was $15.2 million in 2015, compared to $31.8 million in 2014.
For Alliance United, underlying losses and LAE as a percentage of related earned premiums were 94.0% in 2016, compared to 92.8% in 2015, which was a deterioration of 1.2 percentage points. Alliance United’s underlying loss and LAE ratio continues to be significantly higher than what had been reported by Alliance United prior to the acquisition date. Alliance United has experienced significantly higher frequency of claims on all coverages and, to a lesser extent, higher severity of losses on most coverages than the trend that Kemper had anticipated prior to the acquisition. Alliance United’s premium rates have become inadequate due in part to the significant adverse changes in underlying frequency and severity trends. The Company continues to analyze its experience against industry information as it becomes available and believes that Alliance United’s frequency trend may be worse than industry due in part to anti-selection resulting from inadequate rates and higher growth rates for new business, which tends to run at a higher underlying loss and LAE ratio than renewal business. In addition, Alliance United’s results for the year ended December 31, 2016 include adverse loss and LAE reserve development of $5.1 million. Since the acquisition, several events have resulted in the historical development factors becoming less reliable in predicting how losses will ultimately emerge. For 2016, the primary driver of adverse development was a decrease in the ratio of claims closed without payment, which has driven the Company’s selection of ultimate losses higher. In addition, payment development patterns, as well as claim severity patterns, may have been influenced by an inadequate level of claims adjusters, as staffing levels for Alliance United’s claims adjusters were not able to keep pace with Alliance United’s growth rate prior to and after the acquisition date and the recent spike in frequency. The Company has taken and continues to take various actions to address Alliance United’s performance, including increasing the staffing levels for claims adjusters, slowing growth rates for new business, various agency management actions and filing and implementing rate increases. The Company anticipates it will take several more pricing cycles to become rate adequate.
Earned premiums in commercial automobile insurance decreased by $0.3 million in 2015, compared to 2014, due primarily to a slight decrease in volume, nearly offset by an increase in average earned premium. Incurred losses and LAE were $47.7 million, or 87.5% of earned premiums, in 2015, compared to $42.2 million, or 77.0% of earned premiums, in 2014. Incurred losses and LAE as a percentage of earned premiums increased due primarily to adverse loss and LAE reserve development in 2015, compared to favorable development in 2014, and higher underlying losses and LAE as a percentage of earned premiums. Underlying losses and LAE as a percentage of earned premiums were 83.8% in 2015, compared to 81.3% in 2014, which was a deterioration of 2.5 percentage points due primarily to higher frequency of claims across all coverages, particularly bodily injury, partially offset by lower severity of losses across most coverages, particularly bodily injury and comprehensive. Adverse loss and LAE reserve development was $1.8 million in 2015, compared to favorable development of $2.6 million in 2014.
Earned premiums in other personal insurance decreased by $4.2 million in 2015, compared to 2014, as lower volume accounted for a decrease of $5.5 million, while higher average earned premium accounted for an increase of $1.3 million. Incurred losses and LAE were $23.5 million, or 50.3% of earned premiums, in 2015, compared to $25.5 million, or 50.1% of earned premiums, in 2014. Incurred losses and LAE as a percentage of earned premiums increased due to a lower level of favorable loss and LAE reserve development, partially offset by lower underlying losses and LAE as a percentage of earned premiums and lower catastrophe losses and LAE (excluding reserve development). Underlying losses and LAE as a percentage of earned premiums were 50.1% in 2015, compared to 55.2% in 2014, which was an improvement of 5.1 percentage points due primarily to lower frequency of umbrella claims, partially offset by higher severity of losses across all coverages. Catastrophe losses and LAE (excluding reserve development) were $2.2 million in 2015, compared to $2.8 million in 2014. Favorable loss and LAE reserve development was $2.1 million in 2015, compared to $5.4 million in 2014.
In the third quarter of 2016, the Company’s Life & Health segment voluntarily began implementing a comprehensive process under which it will cross-reference its life insurance policies against the DMF and other death verification databases to identify potential situations 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. Policyholders’ Benefits and Incurred Losses and Loss Adjustment Expenses for the year ended December 31, 2016 include a pre-tax charge of $77.8 million to recognize the initial impact of using death verification databases in the Company’s operations, including to determine its IBNR liability for unpaid claims and claims adjustment expenses for life insurance products. See Note 2, “Summary of Accounting Policies and Accounting Changes.” to the Consolidated Financial Statements under the sub-caption “Insurance Reserves” for additional discussion.
Policyholders’ Benefits and Incurred Losses and LAE increased by $6.9 million in 2015, compared to 2014, due primarily to higher policyholders’ benefits on life insurance and higher incurred losses and LAE on property insurance. Insurance Expenses in the Life & Health Insurance segment increased by $4.0 million due primarily to higher legal costs and costs incurred in connection with a project to digitize historical records, partially offset by lower salary expenses from a lower level of field staff managers and district managers resulting from a consolidation of KHSC field operations substantially completed in the first quarter of 2015 and lower agent incentive conference expense. Segment Net Operating Income in the Life & Health Insurance segment was $71.7 million in 2015, compared to $91.8 million in 2014.
Earned premiums on property insurance decreased by $1.2 million in 2016, compared to 2015, due primarily to lower volume of insurance. Incurred losses and LAE on property insurance were $25.0 million, or 33.7% of property insurance earned premiums, in 2016, compared to $25.6 million, or 34.0% of property insurance earned premiums, in 2015. Underlying losses and LAE on property insurance were $19.6 million, or 26.4% of property insurance earned premiums, in 2016, compared to $20.4 million, or 27.1% of property insurance earned premiums, in 2015. Catastrophe losses and LAE (excluding development) were $5.5 million in 2016, compared to $3.8 million in 2015. Favorable loss and LAE reserve development was $0.1 million in 2016, compared to unfavorable loss and LAE reserve development of $1.4 million in 2015.
The components of Total Comprehensive Investment Gains (Losses) for the years ended December 31, 2016, 2015 and 2014 is presented below.
In 2015, the Company sold $149.9 million of equity securities due to portfolio allocation adjustments and tax planning initiatives. The Company recognized Gains on Sales of Equity Securities of $31.4 million and Losses on Sales of Equity Securities of $0.7 million resulting from such sales.
In 2014, the Company sold certain common stocks and other equity interests to reduce a concentration with an external investment manager and to accelerate utilization of net operating loss carryforwards. Net Realized Gains on Sales of Equity Securities for the year ended December 31, 2014 include net realized gains of $21.6 million from such sales.
In 2014, the Company determined that the book value of one property was not recoverable based on the Company’s estimate of the weighted-average, undiscounted cash flows from such property. Accordingly, the Company wrote down the property to its estimated fair value and recognized an impairment loss of $2.4 million in 2014.
The following table summarizes the fair value of the Company’s investments in non-governmental fixed maturities by industry at December 31, 2016 and 2015:
The Company’s short-term investments primarily consist of overnight repurchase agreements, overnight interest bearing accounts, certificates of deposits, U.S. Treasury securities with maturities of less than one year at the date of purchase and money market funds. At December 31, 2016, the Company had $67.6 million invested in overnight repurchase agreements primarily collateralized by securities issued by the U.S. government and government agencies and authorities, $79.1 million invested in overnight interest bearing accounts with one of the Company’s custodial banks, $60.0 million invested in certificates of deposits issued by a single bank, $46.1 million invested in U.S. Treasury securities with maturities of less than one year at the date of purchase and $20.9 million invested in money market funds which primarily invest in U.S. Treasury securities.
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, 2016.
The Company does not directly participate, as either a lender or borrower of securities, in any securities lending program. The Company does not participate directly in credit default swaps. Except for a cash flow hedge entered into by the Company in 2016 in anticipation of a debt offering in 2017, the Company does not engage directly in hedging activities, including, but not limited to, activities involving interest rate swaps, forward foreign currency contracts, commodities contracts, exchange traded and over-the-counter options or warrants. The Company has limited exposure to such programs and activities by virtue of its investments in the limited liability investment companies and limited partnerships noted above. See Note 7 “Debt,” to the Consolidated Financial Statements for additional discussion of the cash flow hedge entered into by the Company in 2016 in anticipation of a debt offering in 2017.
As discussed in Note 16, “Pension Benefits,” the Company had an Accumulated Actuarial Loss included in Accumulated Other Comprehensive Income (“AOCI”) of $152.2 million at December 31, 2015, which was being amortized over five years-the remaining average service life of participants at December 31, 2015. As a result of freezing benefit accruals under the Company’s defined benefit pension plan, the Accumulated Actuarial Loss of $144.7 million included in AOCI at December 31, 2016 is being amortized over 25 years-the remaining average estimated life expectancy of participants. Amortization of accumulated actuarial losses included as a component of pension expense is anticipated to decrease by $4.2 million in 2017, compared to 2016, due primarily to the change in amortization period resulting from the pension freeze.
The Company’s effective income tax rate from continuing operations differs from the Federal statutory income tax rate due primarily to the effects of tax-exempt investment income and dividends received deductions, interest related to unrecognized tax benefits, estimated indemnification recoveries recognized in earnings pursuant to the Alliance United purchase agreement and the net effects of state income taxes. Tax-exempt investment income and dividends received deductions were $28.0 million, $27.9 million and $25.6 million in 2016, 2015 and 2014, 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 and $10.4 million for the years ended December 31, 2016 and December 31, 2015, respectively. Tax expense for the year ended December 31, 2015 includes an interest benefit on unrecognized tax benefits of $2.3 million from the settlement of certain tax years. State income tax expense, net of federal benefit, from continuing operations was $0.6 million, $0.6 million and $0.6 million in 2016, 2015 and 2014, respectively. See Note 15, “Income Taxes,” to the Consolidated Financial Statements for additional discussion of income taxes.
The Company’s present intention is to issue at least $250 million of 10 year senior notes to refinance its $360 million 6.00% Senior Notes maturing in the second quarter of 2017. For risk management purposes, during the fourth quarter of 2016, 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 during the period leading up to the probable debt issuance. See Note 7, “Debt,” to the Consolidated Financial Statements for additional information regarding such hedge.
Trinity and United Insurance are members of the Federal Home Loan Bank (“FHLB”) of Dallas and the FHLB of Chicago, respectively. As members, Trinity and United Insurance may obtain advances from the FHLB of Dallas and Chicago, respectively. Advances from the FHLB of Dallas and Chicago are subject to collateral requirements as specified in the respective agreements with Trinity and United Insurance. From time to time, Trinity and United Insurance obtain advances from the FHLB of Dallas and Chicago, respectively, for short-term liquidity needs. During 2016 and 2015, Trinity borrowed and repaid $10.0 million and $77.5 million, respectively under its agreement with the FHLB of Dallas. During 2015, United Insurance borrowed and repaid $21.0 million under its agreement with the FHLB of Chicago. There were no advances from the FHLB of Dallas or Chicago outstanding at either December 31, 2016 or December 31, 2015.
Under various state insurance laws, Kemper’s insurance subsidiaries may pay dividends without obtaining prior regulatory approval based upon levels of statutory capital and surplus and/or net income, as defined by the applicable state law. Kemper’s direct insurance subsidiaries paid dividends of $104.5 million, $285.0 million and $217.5 million to Kemper in 2016, 2015 and 2014, respectively. In 2017, Kemper estimates that its direct insurance subsidiaries would be able to pay $133 million in dividends to Kemper without prior regulatory approval.
On April 30, 2015, Kemper completed its acquisition of Alliance United in a cash transaction for a total purchase price of $71.0 million, subject to certain post-closing indemnifications. After completing the transaction, Kemper contributed $75.0 million to support the book of business acquired. Kemper contributed $30 million of additional capital in the fourth quarter of 2015 due primarily to support Alliance United’s growing book of business and reductions in statutory capital resulting from the impacts of development of pre-acquisition losses and LAE and non-admission of indemnification receivables. In 2016, Kemper contributed $55 million of additional capital to Alliance United.
Kemper paid a quarterly dividend to shareholders of $0.24 per common share in each quarter of 2016. Dividends paid were $49.2 million for the year ended December 31, 2016.
Kemper directly held cash and investments totaling $298.7 million at December 31, 2016, compared to $341.2 million at December 31, 2015. Sources available for the repayment of indebtedness, repurchases of common stock, future shareholder dividend payments, additional capitalization of its direct insurance subsidiaries, and the payment of interest on Kemper’s senior notes and subordinated debentures include cash and investments directly held by Kemper, receipt of dividends from Kemper’s subsidiaries and borrowings under the credit agreement.
Net Cash Used by Financing Activities was $48.4 million for the year ended December 31, 2016, compared to $100.8 million for the same period in 2015. Net proceeds from advances from FHLB provided $10.0 million for the year ended December 31, 2016. Kemper used $10.0 million of cash to repay the FHLB advances for the year ended December 31, 2016. Kemper used $357.3 million of cash to repay debt for the year ended December 31, 2015, of which $258.8 million was used to redeem the 2015 Senior Notes and $98.5 million to repay the FHLB advances. Net proceeds from the issuance of debt provided $345.8 million of cash for the year ended December 31, 2015, of which $247.3 million was related to the issuance of the 2025 Senior Notes and $98.5 million from FHLB advances. Kemper used $3.8 million of cash during 2016 to repurchase shares of its common stock, compared to $45.0 million in 2015, including $1.5 million of cash to settle repurchases made at the end of 2014. Kemper used $49.2 million of cash to pay dividends for the year ended December 31, 2016, compared to $49.7 million of cash
used to pay dividends in the same period of 2015. The quarterly dividend rate was $0.24 per common share for each quarter of 2016 and 2015.
Net Cash Used by Investing Activities was $28.6 million for the year ended December 31, 2015, compared to $104.3 million in 2014. Net cash provided by dispositions of short-term investments was $104.9 million for the year ended December 31, 2015, compared to net cash of $63.9 million used by acquisitions of short-term investments in 2014. Fixed Maturities investing activities used net cash of $53.5 million for the year ended December 31, 2015, compared to providing net cash of $20.7 million in 2014. Equity Securities investing activities provided net cash of $104.4 million for the year ended December 31, 2015, compared to $10.1 million in 2014. Equity Method Limited Liability Investments investing activities provided net cash of $0.5 million for the year ended December 31, 2015, compared to $33.8 million in 2014. Fair Value Option Investments investing activities used net cash of $111.0 million for the year ended December 31, 2015, compared to $54.0 million in 2014. Net cash used to acquire Alliance United was $57.6 million for the year ended December 31, 2015 compared to net cash of $8.9 million provided by the disposition of a subsidiary in 2014. Purchases of Corporate-owned Life Insurance were $7.5 million for the year ended December 31, 2015, compared to $33.5 million in 2014.
Estimated cash disbursements pertaining to the Company’s contractual obligations at December 31, 2016 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 $4.0 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, 2016.
The fair value of the Company’s investments measured and reported at fair value was $5,723.3 million at December 31, 2016, of which $4,861.5 million, or 85%, were investments that were based on quoted market prices or significant value drivers that are observable, $581.7 million, or 10%, were investments where at least one significant value driver was unobservable and $280.1 million or 5% were investments for which fair value is measured using the net asset value per share practical expedient. Fair value measurements based on readily available, active, quoted market prices or for which fair value can be measured from actively quoted prices generally are deemed to have a higher degree of market price observability and a lesser degree of judgment, compared to fair value measurements based on significant unobservable inputs used in measuring fair value. The prices that the Company might realize from actual sales of investments are likely to vary from their respective estimated fair values at December 31, 2016 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. For investments classified as trading or for financial instruments for which a company has elected the fair value option method of accounting, a company is required to recognize changes in the fair values into income for the period reported. Accordingly, both the reported and fair values of the Company’s investments classified as trading were $5.3 million at December 31, 2016. Both the reported and fair values of the Company’s investments accounted for under the fair value option method of accounting were $111.4 million at December 31, 2016. 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, 2016. Changes in the fair value of investments in fixed maturities classified as available for sale, investments in equity securities classified as available for sale and an insurance entity’s investments in equity securities without readily determinable fair values are not recognized in income during the period, but rather are recognized as a separate component of AOCI until realized. All of the Company’s investments in fixed maturities were classified as available for sale at December 31, 2016. Except for investments accounted for under the equity method of accounting or classified as trading, all of the Company’s investments in equity securities at December 31, 2016 are reported at fair value with changes in fair value reported in AOCI until realized. The Company’s investments accounted for under the equity method of accounting consist of the Company’s investments in Equity Method Limited Liability Investments and are valued at cost plus cumulative undistributed comprehensive earnings or losses, and not at fair value.
Under GAAP, a company may elect to use the fair value option for some or all of its investments in financial instruments. Under the fair value option, a company is required to recognize changes in the fair values into income for the period reported. 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, 2016, would have decreased by $1.5 million.
Changes in these factors from their December 31, 2016 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, 2016 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 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. Favorable development is recognized and reported in the Consolidated Financial Statements when the Company decreases its previous estimate of ultimate losses and LAE and results in an increase
See MD&A, “Loss and LAE Reserve Development,” “Property & Casualty Insurance,” and “Life & Health Insurance,” for further information on development reported in the Consolidated Financial Statements.
Estimated rate used to discount the expected benefit payment to a present value.
The Company has adopted all recently issued accounting pronouncements with effective dates prior to January 1, 2017. See Note 2, “Summary of Accounting Policies and Accounting Changes” for discussion on adoption of these ASUs and impacts to the Company’s financial statements, which were not material. With the possible exceptions of ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, ASU 2016-02, Leases (Topic 842) and ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, the Company does not expect the adoption of all other recently issued accounting pronouncements with effective dates after December 31, 2016 to have a material impact on the Company’s financial statements. All other recently issued accounting pronouncements with effective dates after December 31, 2016 are not expected to have a material impact on the Company.
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2016, 2015 and 2014
The process of estimating and establishing reserves for losses and loss adjustment expenses ("LAE") for property and casualty insurance is inherently uncertain, and the actual ultimate net cost of known and unknown claims may vary materially from the estimated amounts reserved. The reserving process is particularly imprecise for claims involving long-tailed exposures, which may not be discovered or reported until years after the insurance policy period has ended. Management considers a variety of factors, including, but not limited to, past claims experience, current claim trends and relevant legal, economic and social conditions, in estimating reserves. A change in any one or more factors is likely to result in the ultimate net claim costs to differ from the estimated reserve. Changes in such estimates may be material and would be recognized in the Consolidated Financial Statements when such estimates change.
Short-term Investments include certificates of deposits and other fixed maturities that mature within one year from the date of purchase, U.S. Treasury bills, money market mutual funds, overnight interest bearing accounts, and repurchase agreements. Short-term Investments are reported at cost, which approximates fair value.
Other Receivables primarily include reinsurance recoverables and accrued investment income. Reinsurance Recoverables were $106.4 million and $108.3 million at December 31, 2016 and 2015, respectively. Accrued Investment Income was $70.8 million and $68.5 million at December 31, 2016 and 2015, respectively.
Corporate-owned life insurance is reported at cash surrender value with changes due to cost of insurance and investment experience reported in Other Income in the Consolidated Statements of Income.
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. The Company’s deferred policy acquisition costs in the Consolidated Balance Sheets at December 31, 2016 and 2015 include reductions of $9.7 million and $9.0 million, respectively, due to premium deficiencies with respect to Alliance United’s personal automobile book of business.
Policyholders’ Benefits and Incurred Losses and Loss Adjustment Expenses include provisions for future policy benefits under life and certain accident and health insurance contracts and provisions for reported claims, estimates for IBNR claims and loss adjustment expenses. Benefit payments in excess of policy account balances are expensed.
In May 2015, the FASB issued ASU 2015-07 Fair Value Measurement (Topic 820), Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). ASU 2015-07 removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments also remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient. The Company adopted ASU 2015-07 in the first quarter of 2016 and applied its provisions on a retrospective basis. Except for the change in disclosure requirements, adoption of ASU 2015-07 did not impact the Company’s financial statements. The presentation of certain prior year amounts and disclosures have been reclassified to conform to the presentation for the current year.
In May 2015, the FASB issued ASU 2015-09, Financial Services-Insurance (Topic 944): Disclosures about Short-Duration Contracts. ASU 2015-09 requires insurers to provide additional disclosures about short-duration insurance contracts, focusing
changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. ASU 2016-01 also simplifies the impairment assessment of equity investments without readily-determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value.
ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company currently records its Investments in Equity Securities at fair value with net unrealized appreciation or depreciation reported in AOCI in Shareholders’ Equity. The Company’s Investments in Equity Securities include securities with readily-determinable fair values and securities without readily-determinable fair values. Until the Company adopts ASU 2016-01 and makes its elections for Investments in Equity Securities that do not have readily-determinable fair values, it cannot determine the impact of the adoption on its consolidated balance sheet. Subsequent to adoption, ASU 2016-01 is expected to cause increased volatility in the Company’s Consolidated Statements of Operations.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), by amending the Accounting Standards
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718), which simplifies several aspects of the accounting for share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods with early adoption permitted. The Company does not anticipate adoption to have a material impact on its financial statements.
debt security declines, entities will be able to record the reversal to income in the current period, which GAAP currently prohibits. ASU 2016-13 is effective for annual periods beginning after December 15, 2019 and interim periods within those annual periods with early adoption permitted for fiscal years beginning after December 31, 2018 and interim periods within such year. The Company is currently evaluating the impact of this guidance on its financial statements.
The Company has adopted all recently issued accounting pronouncements with effective dates prior to January 1, 2017. There were no adoptions of such accounting pronouncements in 2016 that had a material impact on the Company’s Consolidated Financial Statements. With the possible exceptions of ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, ASU 2016-02, Leases (Topic 842) and ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, the Company does not expect the adoption of all other recently issued accounting pronouncements with effective dates after December 31, 2016 to have a material impact on the Company’s financial statements.
On April 30, 2015, Kemper acquired 100% of the outstanding common stock of Alliance United Group and its wholly-owned subsidiaries, Alliance United Insurance Company and Alliance United Insurance Services, (individually and collectively referred to herein as “Alliance United”) in a cash transaction for a total purchase price of $71.0 million, of which $17.5 million was placed in escrow to secure the sellers’ potential indemnification obligations under the purchase agreement. After completing the transaction, Kemper contributed $75.0 million to support the book of business acquired and commuted a quota share reinsurance agreement whereby Alliance United ceded a portion of its business to an unaffiliated reinsurer. The results of Alliance United are included in the Consolidated Financial Statements from the date of acquisition and are reported in the Company’s Property & Casualty Insurance segment. Alliance United is a provider of nonstandard personal automobile insurance in California. As a result of the acquisition, the Company increased its presence in the California nonstandard automobile insurance market by gaining access to additional brokers and gained expertise in serving the Hispanic market.
Accrued Expenses and Other Liabilities included unsettled purchases of Investments in Fixed Maturities of $0.1 million and $5.6 million at December 31, 2016 and 2015, respectively. Other Receivables included unsettled sales of Investments in Fixed
The amortized cost and estimated fair values of the Company’s Investments in Fixed Maturities at December 31, 2016 by contractual maturity were:
The expected maturities of the Company’s Investments in Fixed Maturities may differ from the contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Investments in Mortgage- and Asset-backed Securities Not Due at a Single Maturity Date at December 31, 2016 consisted of securities issued by the Government National Mortgage Association with a fair value of $126.2 million, securities issued by the Federal National Mortgage Association with a fair value of $13.9 million, securities issued by the Federal Home Loan Mortgage Corporation with a fair value of $4.8 million and securities of other non-governmental issuers with a fair value of $124.8 million.
Other Receivables included unsettled sales of Investments in Equity Securities of $0.2 million at December 31, 2016. There were no unsettled sales of Investments in Equity Securities at December 31, 2015. There were no unsettled purchases of Investments in Equity Securities at either December 31, 2016 or December 31, 2015.
Unrealized losses on fixed maturities, which the Company has determined to be temporary at December 31, 2016, were $46.5 million, of which $7.8 million was related to fixed maturities that were in an unrealized loss position for 12 months or longer. There were unrealized losses of $0.1 million at December 31, 2016 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, 2016 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “12 Months or Longer.” Investment-grade fixed maturity investments comprised $33.8 million and below-investment-grade fixed maturity investments comprised $12.7 million of the unrealized losses on investments in fixed maturities at December 31, 2016. For below-investment-grade fixed maturity investments in an unrealized loss position, the unrealized loss amount, on average, was approximately 5% of the amortized cost basis of the investment. At December 31, 2016, 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, 2016 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.
Unrealized losses on fixed maturities, which the Company determined to be temporary at December 31, 2015, were $50.0 million, of which $16.9 million was related to fixed maturities that were in an unrealized loss position for 12 months or longer. There were unrealized losses of $0.2 million at December 31, 2015 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, 2015 related to securities for which the Company has recognized credit losses in earnings in the preceding table under the heading “12 Months or Longer.” Investment-grade fixed maturity investments comprised $33.5 million and below-investment-grade fixed maturity investments comprised $16.5 million of the unrealized losses on investments in fixed maturities at December 31, 2015. For below-investment-grade fixed maturity investments in an unrealized loss position, the unrealized loss amount, on average, was less than 8% of the amortized cost basis of the investment. At December 31, 2015, 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, 2015 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, 2016, 2015 and 2014, 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.
The carrying values of the Company’s Other Investments at December 31, 2016 and 2015 were:
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 tables contain information about incurred and paid claims development as of and for the year December 31, 2016, net of reinsurance and indemnification, as well as cumulative claim frequency and the total of IBNR liabilities, including expected development on reported claims included within the net incurred losses and allocated LAE amounts. The tables are grouped by major product line and, if relevant, coverage. The information about incurred and paid claims development for the years ended December 31, 2012 through 2015 is presented as supplementary information and is unaudited.
The claim counts in the preceding tables are cumulative incurred claim counts as of December 31, 2016 and are equal to both (i) reported claims minus claims closed without payment as well as (ii) open claims plus claims closed with payment. As such, the difference between these claim counts and final claim counts once all claims have been identified and settled will tend to be higher in recent accident years, particularly the most recent accident year, due to claims closed without payment. Certain product lines, particularly the Company’s non-standard personal automobile insurance, tend to have a higher percentage of claims closed without payment.
In 2015, the Company reduced its property and casualty insurance reserves by $20.1 million to recognize favorable development of losses and LAE from prior accident years, including the impact of adverse development of $7.7 million, net of estimated indemnification recoveries, related to Alliance United for periods prior to the date of its acquisition. Personal lines
Reinsurance and indemnification recoverables on property and casualty insurance reserves were $50.2 million and $52.0 million at December 31, 2016 and 2015, respectively. These recoverables are concentrated with several reinsurers, the vast majority of which are highly rated by one or more of the principal investor and/or insurance company rating agencies. While most of these recoverables were unsecured at December 31, 2016 and 2015, the agreements with the reinsurers generally provide for some form of collateralization upon the occurrence of certain events.
The Company designates debt obligations as either short-term or long-term based on maturity date at issuance. Total amortized cost of Long-term Debt, Current and Non-current, outstanding at December 31, 2016 and 2015 was:
Interest Expense, including facility fees, accretion of discount and amortization of issuance costs, for the years ended December 31, 2016, 2015 and 2014 was:
Interest Paid, including facility fees, for the years ended December 31, 2016, 2015 and 2014 was:
Kemper has a $225.0 million, unsecured, revolving credit agreement expiring June 2, 2020. The credit agreement provides for fixed and floating rate advances for periods up to six months at various interest rates. The credit agreement contains various financial covenants, including limits on total debt to total capitalization, consolidated net worth and minimum risk-based capital ratios for Kemper’s largest insurance subsidiaries, Trinity and United Insurance. Proceeds from advances under the credit agreement may be used for general corporate purposes, including repayment of existing indebtedness. There were no outstanding borrowings under the credit agreement at either December 31, 2016 or December 31, 2015.
The Company leases certain office space under non-cancelable operating leases, with initial terms typically ranging from one to ten years, along with options that permit renewals for additional periods. The Company also leases certain equipment under non-cancellable operating leases, with initial terms typically ranging from one to five years. Minimum rent is expensed on a straight-line basis over the term of the lease.
The total of minimum rentals to be received in the future under non-cancellable subleases was $2.1 million at December 31, 2016.
Kemper’s insurance subsidiaries are required to file financial statements prepared on the basis of statutory insurance accounting practices, a comprehensive basis of accounting other than GAAP. Statutory capital and surplus for the Company’s life and health insurance subsidiaries was $403.7 million and $394.6 million at December 31, 2016 and 2015, respectively. Statutory net income for the Company’s life and health insurance subsidiaries was $29.7 million, $62.8 million and $100.7 million for the years ended December 31, 2016, 2015 and 2014, respectively. Statutory capital and surplus for the Company’s property and casualty insurance subsidiaries was $928.9 million and $957.7 million at December 31, 2016 and 2015, respectively. Statutory net income for the Company’s property and casualty insurance subsidiaries was $1.4 million, $58.9 million and $85.7 million for the years ended December 31, 2016, 2015 and 2014, respectively. Statutory capital and surplus and statutory net income exclude parent company operations.
In 2016, Kemper paid dividends of $49.2 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, 2016. Kemper had the ability to pay without restrictions $269 million in dividends to its shareholders and still be in compliance with all financial covenants under its credit agreement at December 31, 2016.
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, 2016, there were 6,762,714 common shares available for future grants under the Omnibus Plan, of which 682,752 shares were reserved for future grants based on the achievement of performance goals under the terms of outstanding performance-based restricted stock unit (“RSU”) awards.
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 $4.7 million, $6.5 million and $6.4 million for the years ended December 31, 2016, 2015 and 2014, respectively. Total unamortized compensation expense related to nonvested awards at December 31, 2016 was $8.1 million, which is expected to be recognized over a weighted-average period of 1.8 years.
Under the Non-employee Director compensation programs in effect for 2016, each non-employee director receives an annual DSU award covering shares of Kemper common with an aggregate grant date fair value of $75,000 at the conclusion of each annual shareholder meeting. Under the Non-employee Director compensation programs in effect for 2015 and 2014, annual awards to each Non-employee Director included 500 DSUs and stock options, as described below. 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.
connection with such exercise, there were no options outstanding at December 31, 2016 that were eligible to receive a grant of a Restorative Option. Restorative Options are subject to the same terms and conditions as the original options, including the expiration date, except that the exercise price is equal to the fair value of Kemper common stock on the date of grant of a Restorative Option and cannot be exercised until six months after the date of grant. The grant of a Restorative Option does not result in an increase in the total number of shares and options held by an employee, but changes the mix of the two.
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 2016, 2015 and 2014 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.
exceeds the “target” performance level, additional shares of stock will be issued to the award recipient;
Activity related to nonvested performance-based restricted stock and nonvested performance-based RSU awards for the year ended December 31, 2016 is presented below.
The number of additional shares that would be granted if the Company were to meet or exceed the maximum performance levels related to the outstanding performance-based awards for the 2016 and 2015 three-year performance periods was 137,615 common shares and 46,762 common shares, respectively, (as “full value awards,” the equivalent of 412,845 shares and 140,286 shares, respectively, under the Share Authorization) at December 31, 2016. For the 2014 three-year performance period, the Company’s performance level was below the minimum performance level, and all of the related 43,207 shares of performance-based RSUs were forfeited on February 4, 2017, the three-year anniversary of their grant date. For the 2013 three-year performance period, the Company’s performance level was below the minimum performance level, and all of the related 51,400 shares of performance-based restricted shares were forfeited on February 4, 2016, the three-year anniversary of their grant date.
Half of the performance-based RSUs granted in 2016 are measured solely using a Company-specific metric. Final payout for these awards, and any forfeitures of shares for performance below the “target” performance level, will be determined based on Kemper’s adjusted return on equity over a three-year performance period ending on December 31, 2018. Fair value for these awards was determined using the closing price of Kemper common stock on the date of grant. Accruals of compensation cost for these awards are estimated based on the probable outcome of the performance condition.
The 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, 2016, 2015 and 2014 was $0.5 million, $0.1 million and $0.2 million, respectively.
Activity related to DSU awards for the year ended December 31, 2016 is presented below.
The Company’s awards of restricted stock contain rights to receive non-forfeitable dividends and participate in the undistributed earnings with common shareholders. The Company’s awards of RSUs and DSUs contain rights to receive non-forfeitable dividend equivalents and participate in the undistributed earnings with common shareholders. Accordingly, the Company is required to apply the two-class method of computing basic and diluted earnings per share. A reconciliation of the numerator and denominator used in the calculation of Basic Income from Continuing Operations Per Unrestricted Share and Diluted Income from Continuing Operations Per Unrestricted Share for the years ended December 31, 2016, 2015 and 2014 is presented below.
The components of AOCI at December 31, 2016 and 2015 were:
Other Receivables includes accrued investment income of $70.8 million and $68.5 million at December 31, 2016 and 2015, respectively.
Insurance Expenses for the years ended December 31, 2016, 2015 and 2014 were:
The Company has not provided for Federal income taxes on $14.7 million of Mutual Savings Life’s income earned prior to 1984 which is not subject to income taxes under certain circumstances. Federal income taxes of $5.1 million would be paid on such income if it is distributed to shareholders in the future or if it does not continue to meet certain limitations.
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 2012. The expiration of the statute of limitations related to the various state income tax returns that Kemper and its subsidiaries file varies by state.
Unrecognized Tax Benefits at December 31, 2016, 2015 and 2014 include $4.6 million, $3.3 million and $3.4 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 $0.5 million, $0.5 million and $3.8 million at December 31, 2016, 2015 and 2014, respectively. Net interest related to unrecognized tax benefits for the year ended December 31, 2016 was insignificant. Tax expense includes interest benefit of $3.3 million and interest expense of $0.4 million related to unrecognized tax benefits for the years ended December 31, 2015 and 2014, respectively.
The components of Income Tax Expense from Continuing Operations for the years ended December 31, 2016, 2015 and 2014 were:
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, 2016, 2015 and 2014 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, 2016 and 2015 is presented below.
The measurement dates of the assets and liabilities at end of year presented in the preceding table under the headings, “2016” and “2015” were December 31, 2016 and December 31, 2015, respectively.
Weighted-average asset allocations for the Pension Plan at December 31, 2016 and 2015 by asset category were:
The components of Comprehensive Pension Expense (Income) for the Pension Plan for the years ended December 31, 2016, 2015 and 2014 were:
The actuarial loss included in AOCI at December 31, 2016 is being amortized over approximately 24 years, the remaining average estimated life expectancy of participants. The Company estimates that Pension Expense for the Pension Plan for the year ended December 31, 2017 will include expense of $2.5 million resulting from the amortization of the related accumulated actuarial loss included in AOCI at December 31, 2016.
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, 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:
On August 12, 2016, the Company made a voluntary cash contribution of $9.0 million to the Pension Plan. The Company did not contribute to the Pension Plan in 2015 or 2014. The Company does not expect that it will be required to contribute to the Pension Plan in 2017, but could make a voluntary contribution pursuant to the maximum funding limits under ERISA.
The Company also sponsors a non-qualified supplemental defined benefit pension plan (the “Supplemental Plan”). As a result of the amendment to the Pension Plan, benefit accruals for all participants in the Supplemental Plan were also frozen effective June 30, 2016. Accordingly, plan liabilities for the Supplemental Plan were also re-measured in the second quarter of 2016, resulting in balances in accumulated unrecognized pension loss and unamortized prior service costs prior to the freeze of $1.6 million and $1.3 million, respectively. The Company recorded expense of $1.3 million in the second quarter of 2016 to immediately recognize the remaining net unamortized prior service costs in the Supplemental Plan. The curtailment reduced the Projected Benefit Obligation by $5.2 million at the re-measurement date. Accordingly, a curtailment gain of $3.6 million before tax was recorded to recognize the reduction in the Projected Benefit Obligation that exceeded the accumulated unrecognized pension loss prior to the freeze.
The Company also sponsors several defined contribution benefit plans covering most of its employees. The Company made contributions to those plans of $8.4 million, $7.8 million and $7.3 million in 2016, 2015 and 2014, respectively.
The Company sponsors an other than pension postretirement employee benefit plan (“OPEB”) that provides medical, dental and/or life insurance benefits to approximately 500 retired and 225 active employees (the “OPEB Plan”). The Company has historically self-insured the benefits under the OPEB Plan. The medical plan generally provides for a limited number of years of medical insurance benefits at retirement based on the participant’s attained age at retirement and number of years of service until specified dates and generally has required participant contributions, with most contributions adjusted annually. On December 30, 2016, the Company amended the 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 OPEB Plan will offer access to a private, third-party Medicare exchange and will provide 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 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 will be amortized into income over the remaining average life of the OPEB Plan’s participants.
Changes in Fair Value of Plan Assets and Changes in Accumulated Postretirement Benefit Obligation for the years ended December 31, 2016 and 2015 were:
The measurement dates of the assets and liabilities at end of year in the preceding table under the headings “2016” and “2015” were December 31, 2016 and December 31, 2015, respectively.
The assumed health care cost trend rate used in measuring the Accumulated Postretirement Benefit Obligation at December 31, 2016 was 6.75% for 2017, gradually declining to 5.0% in the year 2024 and remaining at that level thereafter for medical benefits and 10.25% for 2017, gradually declining to 5.0% in the year 2024 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, 2015 was 7.0% for 2016, gradually declining to 5.0% in the year 2024 and remaining at that level
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, 2016 by $0.6 million and 2016 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, 2015 by $1.5 million and 2015 OPEB expense by $0.1 million.
The components of Comprehensive OPEB Expense (Income) for the years ended December 31, 2016, 2015 and 2014 were:
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, 2016, 2015 and 2014 were:
The Property & Casualty Insurance segment’s principal products are personal automobile insurance, both preferred and nonstandard, homeowners insurance, other personal 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 $52.9 million, $43.4 million and $42.1 million for the years ended December 31, 2016, 2015 and 2014, respectively. The Company does not allocate Net Realized Gains on Sales of Investments, Net Impairment Losses Recognized in Earnings, interest expense on debt or postretirement benefit plans, and actuarial gains and losses on its postretirement benefit plans to its operating segments.
Segment Operating Profit, including a reconciliation to Income from Continuing Operations before Income Taxes, for the years ended December 31, 2016, 2015 and 2014 was:
Amortization of Deferred Policy Acquisition Costs by Operating Segment for the years ended December 31, 2016, 2015 and 2014 was:
The Company accounts for its former Unitrin Business Insurance operations as discontinued operations.
Coverage for the Property & Casualty Insurance segment’s primary catastrophe reinsurance program effective January 1, 2016 to December 31, 2016 is provided in various layers as presented below.
Total catastrophe loss and LAE reserves, net of reinsurance recoverables, developed favorably by $19.3 million, $7.8 million and $14.7 million in 2016, 2015 and 2014, respectively. The Property & Casualty Insurance segment reported favorable catastrophe reserve development of $19.2 million, $7.9 million and $15.8 million in 2016, 2015 and 2014, respectively. The Life & Health Insurance segment reported favorable catastrophe reserve development of $0.1 million in 2016, adverse catastrophe reserve development of $0.1 million in 2015 and adverse catastrophe reserve development of $1.1 million in 2014.
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 losses from wind pools and joint underwriting associations are based on a variety of factors, including, but not limited to, actual or estimated assessments provided by or received from such entities, insurance industry estimates of losses, and estimates of the Company’s market share in the assessable states. Actual assessments may differ materially from these estimated amounts.
Earned Premiums ceded on long-duration and short-duration policies were $19.0 million, $20.6 million and $26.0 million for the years ended December 31, 2016, 2015 and 2014, respectively, of which $12.0 million, $12.9 million and $17.7 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 $67.3 million, $60.0 million and $57.1 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Five employees of the Company serve as directors of Capitol’s five member board of directors. Nine employees of the Company also serve as directors of ORCC’s nine member board of directors. Kemper’s subsidiary, United Insurance, provides claims and administrative services to Capitol and ORCC. In addition, agents appointed by Kemper’s subsidiary, The Reliable Life Insurance Company, and who are employed by United Insurance, are also appointed by Capitol and ORCC to sell property insurance products for the Company’s Life & Health Insurance segment. The Company also provides certain investment services to Capitol and ORCC.
The Company classifies its Investments in Fixed Maturities and Equity Securities as available for sale and reports these investments at fair value. The Company has elected the fair value option method of accounting for investments in certain hedge funds and, accordingly, reports these investments at fair value. The Company classifies certain investments in mutual funds included in Other Investments as trading securities and reports these investments at fair value. The Company has a derivative instrument that is classified as a cash flow hedge and reported in Other Assets at fair value at December 31, 2016. The Company has no material liabilities that are measured and reported at fair value.
The Company’s investments in Fixed Maturities that are classified as Level 1 in the two preceding tables primarily consist of U.S. Treasury Bonds and Notes. The Company’s investments in Equity Securities that are classified as Level 1 in the two preceding tables consist 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 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
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 or Levels 1 and 3 for the year ended December 31, 2016. All transfers into or out of Level 3 for the year ended December 31, 2016 were due to changes in the availability of market observable inputs.
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 or Levels 1 and 3 for the year ended December 31, 2015. The transfers out of Level 3 for the year ended December 31, 2015 were due to changes in the availability of market observable inputs.
The Company’s Pension Plan had $148.4 million, $137.2 million and $159.2 million in assets managed by FS&C at December 31, 2016, 2015 and 2014, respectively, under an agreement with FS&C whereby FS&C provides investment management services with respect to certain funds of the plan. Investment Expenses incurred in connection with such agreement were $0.8 million, $0.4 million and $0.4 million for the years ended December 31, 2016, 2015 and 2014, respectively.
We have audited the accompanying consolidated balance sheets of Kemper Corporation and subsidiaries (the “Company”) as of December 31, 2016 and 2015, 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, 2016. Our audits also included the financial statement schedules listed in the index at Item 15. We also have audited the Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and financial statement schedules and an opinion on the Company’s internal control over financial reporting based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kemper Corporation and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.