Kemper’s subsidiaries together own and occupy six buildings located in six states consisting of approximately 21,000 square feet in the aggregate. One of Kemper’s subsidiaries owns two buildings totaling approximately 6,000 square feet which were vacant at December 31, 2017. Kemper’s subsidiaries hold, solely for investment purposes, additional properties that are not occupied by Kemper or its subsidiaries.
Net Income was $120.9 million ($2.34 per unrestricted common share) for the year ended December 31, 2017, compared to $16.8 million ($0.33 per unrestricted common share) for the year ended December 31, 2016. Income from Continuing Operations was $119.9 million ($2.32 per unrestricted common share) in 2017, compared to $12.7 million ($0.25 per unrestricted common share) in 2016.
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, 2017, 2016 and 2015 is presented below.
The Company’s net income increased by $104.1 million in 2017, compared to 2016. In the Property & Casualty Insurance segment, segment net operating results increased by $10.7 million due primarily to lower underlying losses and LAE as a percentage of earned premiums and, to a lesser extent, lower insurance expenses as a percentage of earned premiums and higher net investment income from Alternative Investments, partially offset by higher incurred catastrophe losses and LAE (excluding reserve development). See MD&A, “Property & Casualty Insurance,” beginning on page 36 for additional discussion of the segment’s results. In the Life & Health Insurance segment, segment net operating income increased by $60.5 million due primarily to a $50.5 million after-tax charge in 2016 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. See MD&A, “Life & Health Insurance,” beginning on page 46 for additional discussion of the segment’s results. The Company’s results were also positively impacted in 2017, compared to 2016, by higher net realized gains on sales of investments, lower impairment losses recognized in earnings and a lower unallocated net operating loss, due primarily to an income tax benefit of $7.4 million to recognize the effects of changes in the federal income tax law. See MD&A, “Investment Results,” beginning on page 51 and MD&A, “Income Taxes,” beginning on page 58 for additional discussion.
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 36 for additional discussion of the segment’s
Earned Premiums were $2,350.0 million in 2017, compared to $2,220.0 million in 2016, an increase of $130.0 million. Earned Premiums increased by $121.2 million and $8.8 million in the Property & Casualty Insurance segment and Life & Health Insurance segment, respectively. See MD&A, “Property & Casualty Insurance,” beginning on page 36 and MD&A, “Life & Health Insurance,” beginning on page 46 for discussion of the changes in each segment’s earned premiums.
Net Investment Income increased by $28.9 million in 2017 due primarily to higher investment returns from Alternative Investments and higher level of investments in fixed income securities, partially offset by lower yields on fixed income securities. Net Investment Income from Alternative Investments, which consist of Equity Method Limited Liability Investments, Fair Value Option Investments and other limited liability investments included in Equity Securities, increased by $27.1 million. Alternative investment income from Equity Method Limited Liability Investments, other limited liability investments included in Equity Securities, and Fair Value Option Investments increased by $17.3 million, $6.6 million and $3.2 million, respectively, in 2017, compared to 2016. See MD&A, “Investment Results,” under the sub-caption “Net Investment Income” beginning on page 51 for additional discussion.
Net Realized Gains on Sales of Investments were $56.5 million in 2017, compared to $33.1 million in 2016. See MD&A, “Investment Results,” under the sub-caption “Net Realized Gains on Sales of Investments” beginning on page 52 for additional discussion. Net Impairment Losses Recognized in Earnings in 2017 and 2016 were $14.3 million and $32.7 million, respectively. See MD&A, “Investment Results,” under the sub-caption “Net Impairment Losses Recognized in Earnings” beginning on page 53 for additional discussion. The Company cannot predict when or if similar investment gains or losses may occur in the future.
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 36 and MD&A, “Life & Health Insurance,” beginning on page 46 for discussion of the changes in each segment’s earned premiums.
Net Realized Gains on Sales of Investments were $33.1 million in 2016, compared to $52.1 million in 2015. See MD&A, “Investment Results,” under the sub-caption “Net Realized Gains on Sales of Investments” beginning on page 52 for additional discussion. Net Impairment Losses Recognized in Earnings in 2016 and 2015 were $32.7 million and $27.2 million, respectively. See MD&A, “Investment Results,” under the sub-caption “Net Impairment Losses Recognized in Earnings” beginning on page 53 for additional discussion. The Company cannot predict when or if similar investment gains or losses may occur in the future.
As shown in the preceding table, catastrophe losses and LAE increased for the year ended December 31, 2017, compared to 2016, due primarily to an increase in the severity of losses on ISO-classified catastrophe events with losses and LAE of less than $15.0 million and estimated losses and LAE associated with two California wildfires in the fourth quarter of 2017 and a Texas hailstorm in March of 2017 (aggregate estimated losses and LAE of $96.4 million, net of reinsurance recoveries), compared to estimated losses and LAE of two significant catastrophe events in 2016 (a Texas hailstorm in March of 2016 and another Texas hailstorm in April of 2016 with aggregate estimated losses and LAE of $64.0 million). In accordance with the terms of the Company’s catastrophe reinsurance program, the Company estimates reinsurance recoveries for losses and LAE incurred related to the two California wildfires, which are classified as separate events by ISO, but a single event under the
Company’s catastrophe reinsurance agreement, to be $11.9 million in 2017. The Company did not have any reinsurance recoveries on catastrophe losses and LAE in 2016 or 2015.
As shown in the preceding table, catastrophe losses and LAE increased for the year ended December 31, 2016, compared to 2015, due primarily to two significant catastrophe events in 2016 exceeding $25 million of losses (a hailstorm in Texas in March with losses and LAE of $36.0 million and another hailstorm in Texas in April with losses and LAE of $28.0 million), compared to no such events in 2015, partially offset by lower severity of events below $10 million of losses in 2016, compared to 2015.
The Company primarily manages its exposure to catastrophes and other natural disasters through a combination of geographical diversification, restrictions on the amount and location of new business production in such regions, modifications of, and/or limitations to coverages and deductibles for certain perils in such regions and a catastrophe reinsurance program for the Property & Casualty Insurance segment. Coverage for this segment’s catastrophe reinsurance program is provided in various contracts and layers. The Property & Casualty Insurance segment also purchases reinsurance from the FHCF for hurricane losses in Florida at retentions lower than its catastrophe reinsurance program. The Life & Health Insurance segment also purchases reinsurance from the FHCF for hurricane losses in Florida. Except for the coverage provided by the FHCF, the Life & Health Insurance segment does not carry any other catastrophe reinsurance coverage.
In 2017, the Property & Casualty Insurance segment had catastrophe reinsurance recoveries of $11.9 million under the catastrophe reinsurance program. Catastrophe recoveries under the FHCF were not material in 2017. Neither segment had catastrophe reinsurance recoveries in 2016 or 2015.
In 2017, the Company paid $0.8 million in reinstatement premium to reinstate the first layer of coverage under the Property & Casualty Insurance segment’s catastrophe reinsurance program. The Company did not pay any reinstatement premium in 2016 or 2015.
Increases (decreases) in the Company’s property and casualty loss and LAE reserves for the years ended December 31, 2017, 2016 and 2015 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.
Consolidated Net Operating Income is an after-tax, non-GAAP financial measure and is computed by excluding from Income from Continuing Operations the after-tax impact of:
Significant non-recurring items are excluded when (a) the nature of the charge or gain is such that it is reasonably unlikely to recur within two years, and (b) there has been no similar charge or gain within the prior two years. The most directly comparable GAAP financial measure is Income from Continuing Operations. There were no applicable significant non-recurring items that the Company excluded from the calculation of Consolidated Net Operating Income for the years ended December 31, 2017, 2016 or 2015.
The Property & Casualty Insurance segment reported Segment Net Operating Income of $7.8 million for the year ended December 31, 2017, compared to Segment Net Operating Loss of $2.9 million in 2016. Segment net operating results improved by $10.7 million due primarily to lower underlying losses and LAE as a percentage of earned premiums, particularly in the Company’s nonstandard automobile insurance business, lower insurance expenses as a percentage of earned premiums and higher net investment income from Alternative Investments, partially offset by higher incurred catastrophe losses and LAE (excluding reserve development) and an unfavorable change in loss and LAE reserve development.
Earned Premiums in the Property & Casualty Insurance segment increased by $121.2 million in 2017, compared to 2016, as higher average earned premium and higher volume accounted for increases of $103.3 million and $17.9 million, respectively. All product lines experienced an increase in average earned premium, although the overall impact on Earned Premiums was driven primarily by nonstandard personal automobile insurance and preferred personal automobile insurance, which had increases due to higher average earned premium of $77.7 million and $14.8 million, respectively. The higher volume was driven by nonstandard personal automobile insurance, which had a volume increase of $56.6 million, partially offset primarily by volume decreases in preferred personal automobile insurance, homeowners insurance and commercial automobile insurance of $16.6 million, $13.2 million, and $6.1 million, respectively.
Underlying losses and LAE as a percentage of earned premiums were 72.1% in 2017, a decrease of 3.7 percentage points, compared to 2016, driven primarily by improvements in nonstandard personal automobile insurance, particularly in the Alliance United business. Underlying incurred losses and LAE exclude the impact of catastrophes and loss and LAE reserve development. Catastrophe losses and LAE (excluding reserve development) were $179.0 million in 2017, compared to $109.6 million in 2016, which is an increase of $69.4 million due primarily to California wildfires and higher average severity on catastrophic events with losses and LAE (excluding reserve development) of less than $15 million in 2017, compared to 2016. This increase was partially offset by two large catastrophes, both Texas hailstorms, occurring in 2016, with aggregate estimated losses and LAE of $63.4 million, compared to one such Texas hailstorm, occurring in 2017, with estimated losses and LAE of $42.6 million. Adverse loss and LAE reserve development (including catastrophe reserve development) was $19.5 million in 2017, compared to favorable development of $14.3 million in 2016. Adverse development in 2017 was driven primarily by preferred personal automobile insurance.
The Property & Casualty Insurance segment reported Segment Net Operating Loss of $2.9 million for the year ended December 31, 2016, compared to Segment Net Operating Income of $26.7 million in 2015. Segment net operating results deteriorated by $29.6 million due primarily to higher incurred catastrophe losses and LAE (excluding reserve development) and higher net operating losses from Alliance United, largely due to it being included in 2016 results for the full year. The deterioration was partially offset by lower underlying losses and LAE as a percentage of earned premiums in the legacy business and the write-off of internal-use software in 2015.
Insurance expenses were $385.7 million, or 23.9% of earned premiums, in 2016. Excluding a write-off of a long-lived asset, insurance expenses were $368.1 million, or 26.0% of earned premiums, in 2015. The improvement in the ratio of 2.1 percentage points from 2015 to 2016 was due primarily to the inclusion of Alliance United, which runs at a lower insurance expense ratio, for a full year in 2016. Excluding the impact of the write-off and Alliance United, insurance expenses decreased by $12.7 million in 2016, compared to 2015, and decreased as a percentage of earned premiums from 28.8% in 2015 to 28.4% in 2016.
Catastrophe losses and LAE (excluding reserve development) were $11.6 million in 2016, compared to $3.0 million in 2015. This increase was driven primarily by the two aforementioned hailstorms in Texas in 2016. Loss and LAE reserve development was adverse by $4.6 million in 2016, compared to favorable development of $15.2 million in 2015.
Selected financial information for the nonstandard personal automobile insurance product line for the years ended December 31, 2017, 2016 and 2015 is presented in the following table. The results for the year ended December 31, 2015 for Alliance United include only the last eight months of the period, which is the period since the date of acquisition.
Earned Premiums on nonstandard personal automobile insurance increased by $134.3 million in 2017, compared to 2016, as higher average earned premium and higher volume accounted for increases of $77.7 million and $56.6 million, respectively. Incurred losses and LAE were $758.1 million, or 79.4% of earned premiums, in 2017, compared to $726.7 million, or 88.6% of earned premiums, in 2016. Incurred losses and LAE as a percentage of earned premiums decreased due primarily to lower underlying losses and LAE as a percentage of earned premiums, and to a lesser extent, a lower level of adverse loss and LAE reserve development. Underlying losses and LAE as a percentage of related earned premiums were 78.6% in 2017, compared to 87.1% in 2016, which was an improvement of 8.5 percentage points due primarily to improvement in both the Alliance United and legacy books of business. For Alliance United, underlying losses and LAE as a percentage of related earned premiums improved 11.5 percentage points due primarily to higher average earned premium and, to a lesser extent, lower frequency of liability claims. For the legacy book, underlying losses and LAE as a percentage of related earned premiums improved 3.9 percentage points due primarily to lower frequency of claims, particularly on liability coverages, and higher average earned premium, partially offset by higher severity of losses on most coverages. Catastrophe losses and LAE (excluding reserve development) were $4.8 million in 2017, compared to $5.7 million in 2016. Adverse loss and LAE reserve development was $2.9 million in 2017, compared to $6.7 million in 2016.
Earned premiums in homeowners insurance decreased by $14.4 million in 2016, compared to 2015, as lower volume accounted for a decrease of $11.9 million and lower average earned premium accounted for a decrease of $2.5 million. Incurred losses and LAE were $204.5 million, or 75.2% of earned premiums, in 2016, compared to $189.7 million, or 66.3% of earned premiums, in 2015. Incurred losses and LAE as a percentage of earned premiums increased due to higher incurred catastrophe losses and LAE (excluding reserve development), partially offset by a higher level of favorable loss and LAE reserve development and lower underlying losses and LAE as a percentage of earned premiums. Underlying losses and LAE as a percentage of earned premiums were 49.9% in 2016, compared to 50.7% in 2015, which was an improvement of 0.8 percentage points due primarily to lower frequency of claims, partially offset by higher severity of losses. Catastrophe losses and LAE (excluding reserve development) were $89.0 million in 2016, compared to $55.4 million in 2015. This increase was driven primarily by the two aforementioned hailstorms in Texas in 2016. Favorable loss and LAE reserve development was $20.0 million in 2016, compared to $10.8 million in 2015.
Earned premiums in other personal insurance decreased by $2.3 million in 2017, compared to 2016, as lower volume accounted for a decrease of $2.8 million, while higher average earned premium accounted for an increase of $0.5 million. Incurred losses and LAE were $22.1 million, or 51.8% of earned premiums, in 2017, compared to $16.6 million, or 36.9% of earned premiums, in 2016. Incurred losses and LAE as a percentage of earned premiums increased due to a lower level of favorable loss and LAE reserve development, higher catastrophe losses and LAE (excluding reserve development) and, to a lesser extent, higher underlying losses and LAE as a percentage of earned premiums. Underlying losses and LAE as a percentage of earned premiums were 51.1% in 2017, compared to 49.1% in 2016, which was a deterioration of 2.0 percentage points due primarily to higher frequency of umbrella claims, partially offset by lower severity of losses on umbrella claims. Catastrophe losses and LAE (excluding reserve development) were $4.9 million in 2017, compared to $2.5 million in 2016. Favorable loss and LAE reserve development was $4.6 million in 2017, compared to $8.0 million in 2016.
Net Investment Income increased by $8.3 million in 2017, compared to 2016, due primarily to higher levels of non-alternative investments and higher returns from Alternative Investments, partially offset by lower yields on non-alternative investments. The weighted-average book yield on the Company’s life and health insurance subsidiaries’ investments in fixed maturities was approximately 5.4% and 5.5% at December 31, 2017 and 2016, respectively. A protracted low interest rate environment,
Earned Premiums in the Life & Health Insurance segment increased by $10.8 million for the year ended December 31, 2016, compared to 2015 due primarily to the impact of an adjustment of $7.6 million recorded in 2015 to correct deferred premium reserves on certain limited pay life insurance policies.
Net Investment Income decreased by $1.0 million in 2016, compared to 2015, due primarily to lower yields on investments in fixed income securities and lower levels of Alternative Investments, partially offset by higher levels of investments in non-alternative investments.
Earned premiums on life insurance increased by $7.5 million in 2016, compared to 2015, due primarily to an adjustment of $7.6 million recorded in the first quarter of 2015 to correct deferred premium reserves on certain limited pay life insurance policies. Excluding the adjustment, earned premiums on life insurance decreased by $0.1 million as a decrease of $3.4 million from life insurance products offered by KHSC was offset by an increase of $3.3 million from life insurance products offered by Reserve National. Policyholders’ benefits on life insurance were $356.3 million in 2016, compared to $274.9 million in 2015, an increase of $81.4 million. Excluding the impact of using death verification databases described above, Policyholders’ Benefits and Incurred Losses and LAE increased by $3.6 million. Insurance Expenses decreased by $10.4 million in 2016, compared to 2015, due primarily to lower legal costs, partially offset by higher agent and field management compensation costs for KHSC.
Earned premiums on accident and health insurance increased by $12.3 million in 2017, compared to 2016, due primarily to higher volume on accident and health insurance products offered by Reserve National and, to a lesser extent, lower accrued medical loss ratio (“MLR”) premium rebates. Incurred accident and health insurance losses were $88.7 million, or 54.9% of accident and health insurance earned premiums, in 2017, compared to $80.3 million, or 53.7% of accident and health insurance earned premiums, in 2016. Incurred accident and health insurance losses increased as a percentage of earned premiums due primarily to deterioration in the ratios on critical illness and hospital indemnity products. Insurance Expenses increased by $4.1 million in 2017, compared to 2016, due primarily to higher commission expense for Reserve National due in part to a higher volume of earned premium.
Earned premiums on accident and health insurance increased by $4.5 million in 2016, compared to 2015, due primarily to higher volume. Incurred accident and health insurance losses were $80.3 million, or 53.7% of accident and health insurance earned premiums, in 2016, compared to $80.8 million, or 55.8% of accident and health insurance earned premiums, in 2015. Incurred accident and health insurance losses decreased as a percentage of earned premiums due primarily to lower average claim costs in other supplemental products and a lower level of hospitalization exposure, partially offset by higher frequency and higher average claim costs in Medicare Supplement. Insurance Expenses increased by $3.8 million in 2016, compared to 2015, due primarily to the impact of an adjustment made in 2015 to Reserve National’s deferred policy acquisition costs and the higher level of earned premiums
Earned premiums on property insurance decreased by $1.2 million in 2016, compared to 2015, due primarily to a 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.
Net Investment Income decreased by $4.3 million for the year ended December 31, 2016, compared to 2015, due primarily to lower investment returns from Alternative Investments, lower levels and lower returns on investments in equity securities excluding alternative investments and lower yields on fixed income securities, partially offset by higher level of investments in fixed income securities.
The components of Total Comprehensive Investment Gains (Losses) for the years ended December 31, 2017, 2016 and 2015 is presented below.
Information pertaining to Net Impairment Losses Recognized in Earnings reported in the Consolidated Statements of Income for the years ended December 31, 2017, 2016 and 2015 is presented below.
The Company’s fixed maturity investment portfolio is comprised primarily of high-grade municipal, corporate and agency bonds. At December 31, 2017, 89% of the Company’s fixed maturity investment portfolio was rated investment-grade, which the Company defines as a security issued by a high quality obligor with at least a relatively stable credit profile and where it is highly likely that all contractual payments of principal and interest will timely occur and carry a rating from the National Association of Insurance Commissioners (“NAIC”) of 1 or 2. Securities with a rating of 1 or 2 from the NAIC typically are rated by one or more Nationally Recognized Statistical Rating Organizations and either have a rating of AAA, AA, A or BBB from Standard & Poor’s (“S&P”); a rating of Aaa, Aa, A or Baa from Moody’s Investors Service (“Moody’s”); or a rating of AAA, AA, A or BBB from Fitch Ratings.
Gross unrealized losses on the Company’s investments in below-investment-grade fixed maturities were $6.9 million and $12.7 million at December 31, 2017 and 2016, respectively.
The following table summarizes the fair value of the Company’s investments in governmental fixed maturities at December 31, 2017 and 2016:
The following table summarizes the fair value of the Company’s investments in non-governmental fixed maturities by industry at December 31, 2017 and 2016:
The following table summarizes the fair value of the Company’s investments in non-governmental fixed maturities by range of amount invested at December 31, 2017.
The Company’s short-term investments primarily consist of money market funds, U.S. Treasury securities with maturities of less than one year at the date of purchase, commercial paper and overnight interest bearing accounts. At December 31, 2017, the Company had $116.1 million invested in money market funds which primarily invest in U.S. Treasury securities, $81.2 million invested in U.S. Treasury securities with maturities of less than one year at the date of purchase, $23.0 million invested in commercial paper and $15.2 million invested in overnight interest bearing bank accounts with one of the Company’s custodial banks.
The Company owns investments in various limited liability investment companies and limited partnerships that primarily invest in mezzanine debt, hedge funds and distressed debt. The Company’s investments in these limited liability investment companies and limited partnerships are reported either as Equity Method Limited Liability Investments, Other Equity Interests and included in Equity Securities, or Fair Value Option Investments depending on the accounting method used to report the investment. See Note 2, “Summary of Accounting Policies and Accounting Changes,” to the Consolidated Financial Statements. Additional information pertaining to these investments at December 31, 2017 and 2016 is presented below.
Prior to their scheduled maturity, Kemper redeemed in full the $250.0 million outstanding principal amount of its 6.00% senior notes due November 30, 2015. Kemper recognized a loss of $9.1 million before income taxes in 2015 from the early redemption of these senior notes.
Interest expense decreased by $9.5 million for the year ended December 31, 2017, compared to 2016, due primarily to lower levels of debt outstanding and a lower average effective interest rate thereon. See MD&A, “Liquidity and Capital Resources,” and Note 7, “Debt” to the Consolidated Financial Statements for additional discussion of debt activity. Other Expenses decreased by $0.2 million for the year ended December 31, 2017, compared to 2016, due primarily to lower pension expense in
In 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. The Company has accounted for this change as a change in accounting estimate that is inseparable from a change in accounting principle and, accordingly, recognized the effect prospectively in 2016. The change in method for estimating the interest and service cost components decreased pension expense by $2.7 million in 2016, compared to 2015, but had no impact on the measurement of benefit obligations. See Note 2 , “Summary of Accounting Policies and Accounting Changes” to the Consolidated Financial Statements.
Pursuant to Staff Accounting Bulletin No. 118 (“SAB 118”), the Company recorded certain provisional amounts for the estimated income tax effects of the Tax Act on deferred income taxes. The Company estimates that the reduction in the corporate income tax rate decreased its net deferred income tax liability as of December 22, 2017 by $10.5 million. The effect of the rate change was recorded as a decrease to income tax expense in the Company’s Consolidated Statement of Income for the year ended December 31, 2017. Final determination of the effects of the Tax Act on deferred income taxes requires additional information, including data from third parties, actuarial computations and other items. The Company expects to complete its determination of the effect of the Tax Act on its deferred income tax assets and liabilities pursuant to its annual income tax return filing process which is expected to be completed during the fourth quarter of 2018.
The Company had not previously provide for Federal income taxes on $14.7 million of Mutual Savings Life’s income earned prior to 1984, which was not subject to income taxes under certain conditions prior to the Tax Act. Under the Tax Act, such income is now subject to taxation. Accordingly, the Company recognized current income tax expense of $3.1 million in the Company’s Consolidated Statement of Income for the year ended December 31, 2017.
Tax-exempt investment income and dividends received deductions were $28.0 million, $28.0 million and $27.9 million in 2017, 2016 and 2015, respectively. The tax benefit recorded pursuant to the Tax Act was $7.4 million for the year ended December 31, 2017. 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. The amount of expense recognized for long-term equity-based compensation expense under GAAP was $1.1 million lower than the amount that would be deductible under the Internal Revenue Code for the year ended December 31, 2017. State income tax expense, net of federal benefit, from continuing operations was $0.1 million, $0.6 million and $0.6 million in 2017, 2016 and 2015, respectively. See Note 15, “Income Taxes,” to the Consolidated Financial Statements for additional discussion of income taxes.
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, United Insurance and Trinity Universal Insurance Company (“Trinity”). Proceeds from advances under the credit agreement may be used for general corporate purposes, including repayment of existing indebtedness. The Company’s borrowings under the credit agreement were insignificant in 2017. The Company did not borrow under the credit agreement during 2016 or 2015. There were no outstanding borrowings under the credit agreement at December 31, 2017, and accordingly, $225.0 million was available for future borrowings.
The Company has $450.0 million of 4.35% senior notes due February 15, 2025 (the “2025 Senior Notes”) outstanding as of December 31, 2017. The Company initially issued $250 million of the 2025 Senior Notes in February of 2015, with proceeds from the issuance of $247.3 million, net of discount and transaction costs, for an effective yield of 4.49%. Kemper used the net proceeds from the sale, together with available cash, to redeem in full the $250.0 million outstanding principal amount of its 6.00% senior notes due November 30, 2015. Kemper recognized a loss of $9.1 million before income taxes in 2015 from the early redemption of these senior notes.
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. Trinity’s outstanding advances from the FHLB of Dallas did not exceed $60 million during 2017. United Insurance’s outstanding advances from the FHLB of Chicago did not exceed $80 million during 2017. During 2016, Trinity borrowed and repaid one advance of $10 million under its agreement with the FHLB of Dallas. United Insurance did not borrow under its agreement with the FHLB of Chicago in 2016. There were no advances from the FHLB of Dallas or Chicago outstanding at either December 31, 2017 or December 31, 2016.
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 $108.1 million, $104.5 million and $285.0 million to Kemper in 2017, 2016 and 2015, respectively. In 2018, Kemper estimates that its direct insurance subsidiaries would be able to pay $201 million in dividends to Kemper without prior regulatory approval.
On February 13, 2018, Kemper and Infinity announced that they have entered into the Infinity Merger Agreement under which Kemper will acquire Infinity in a cash and stock transaction. The Infinity Merger is expected to close in the third quarter of 2018, subject to the satisfaction or waiver of applicable closing conditions, including the approval of shareholders of both companies and receipt of required regulatory clearances and approvals. If approved and consummated, Kemper expects to fund the cash portion of the consideration with a combination of cash on hand and other internal resources. While no additional
financing resources are needed to consummate the Infinity Merger, Kemper may explore issuing an institutional term loan prior to the closing of the Infinity Merger in order to optimize its liquidity position. See Item 1A., “Risk Factors” and Note 26, “Subsequent Events,” to the Consolidated Financial Statements and our current report on Form 8-K filed with the SEC on the date hereof and subsequent filings with the SEC for additional information.
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 made no capital contributions to Alliance United in 2017.
In the third quarter of 2016, the Company’s Life & Health segment voluntarily began implementing a comprehensive process under which it cross-references its life insurance policies against the DMF and other death verification databases to identify potential instances where the beneficiaries may not have filed a claim following the death of an insured and initiate an outreach process to identify and contact beneficiaries and settle claims. The Company expects to pay approximately $80 million in claims over the next several years to complete the initial outreach process.
Net Cash Used by Financing Activities was $205.2 million for the year ended December 31, 2017, compared to $48.4 million for the same period in 2016. Kemper used $360.0 million of cash to repay long-term debt for the year ended December 31, 2017. Net proceeds from the issuance of long-term debt provided $200.2 million of cash for the year ended December 31, 2017. Kemper did not use any cash during 2017 to repurchase shares of its common stock, compared to $3.8 million in 2016. Kemper used $49.5 million of cash to pay dividends for the year ended December 31, 2017, compared to $49.2 million of cash used to pay dividends in the same period of 2016. The quarterly dividend rate was $0.24 per common share for each quarter of 2017 and 2016.
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 $258.8 million of cash to redeem the 2015 Senior Notes for the year ended December 31, 2015. Net proceeds from the issuance of the 2025 Senior Notes provided $247.3 million of cash for the year ended December 31, 2015. Kemper used $3.8 million of cash during 2016 to repurchase shares of its common stock, compared to $45.0 million of cash to repurchase shares of its common stock 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 in 2015. The quarterly dividend rate was $0.24 per common share for each quarter of 2016 and 2015.
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 $5.2 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, 2017.
The reported value of the Company’s investments was $6,804.9 million at December 31, 2017, of which $5,992.9 million, or 88%, was reported at fair value, $161.0 million, or 2%, was reported under the equity method of accounting, $298.6 million, or 4%, was reported at unpaid principal balance and $352.4 million, or 5%, was reported at cost or depreciated cost. Investments, in general, are exposed to various risks, such as interest rate risk, credit risk and overall market volatility risk. Accordingly, it is
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 $6.7 million at December 31, 2017. Both the reported and fair values of the Company’s investments accounted for under the fair value option method of accounting were $77.5 million at December 31, 2017. 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, 2017. 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, 2017. 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, 2017 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.
Property and Casualty Insurance Reserves for the Company’s business segments at December 31, 2017 and 2016 were:
result of the change in business process or merely a random fluctuation in the data. As the Company’s actuaries observe more data points following the change in business process, the Company’s actuaries can gain more confidence in whether the change in business process is affecting the development pattern. The challenge for the Company’s actuaries is how much weight to place on the development patterns based on the older historical data and how much weight to place on the development patterns based on more recent data.
At a minimum, the Company’s actuaries analyze 45 product and/or coverage levels for over 40 separate current and prior accident quarters for both losses and LAE using many of the loss reserving estimation methodologies identified above as well as other generally accepted actuarial estimation methodologies. In all, there are more than 10,000 combinations of accident quarters, coverage levels, and generally accepted actuarial estimation methodologies used to estimate the Company’s unpaid losses and LAE. In some cases, the Company’s actuaries make adjustments to the loss reserving estimation methodologies identified above or use additional generally accepted actuarial estimation methodologies to estimate ultimate losses and LAE.
A change in any one or more of the foregoing factors is likely to result in a projected ultimate net loss and LAE that is different from the previously estimated reserve and/or previous frequency and severity trends. Such changes in estimates may be material.
The final step in the quarterly loss and LAE reserving process involves a comprehensive review of the actuarial indications by the Company’s corporate actuary and corporate management who apply their collective judgment and determine the appropriate estimated level of reserves to record. Numerous factors are considered in this determination process, including, but not limited to, the assessed reliability of key loss trends and assumptions that may be significantly influencing the current actuarial indications, changes in claim handling practices or other changes that affect the timing of payment or development patterns,
changes in the mix of business, the maturity of the accident year, pertinent trends observed over the recent past, the level of volatility within a particular line of business, the improvement or deterioration of actuarial indications in the current period as compared to prior periods, and the amount of reserves related to third party pools for which the Company does not have access to the underlying data and, accordingly, relies on calculations provided by such pools.
Although development will emerge in all of the Company’s product lines, development in the Company’s personal automobile insurance product line could have the most significant impact due to the relative size of its loss and LAE reserves. To further illustrate the sensitivity of the Company’s reserves for personal automobile insurance losses and LAE to changes in the cumulative development factors, for each quarterly evaluation point the Company’s actuaries calculated the variability of cumulative development factors observed in the incurred loss development methodology using one standard deviation. The Company believes that one standard deviation of variability is a reasonably likely scenario to measure variability for its loss and LAE reserves under the incurred development method for personal automobile insurance. Assuming that the Company’s personal automobile insurance loss and LAE reserves were based solely on the incurred loss development methodology and the variability in the cumulative development factors occurred within one standard deviation, the Company estimates that the Company’s personal automobile insurance loss and LAE reserves could have varied by $79.5 million in either direction at December 31, 2017 for all accident years combined under this scenario. In addition to the factors described above, other factors may also impact loss reserve development in future periods. These factors include governmental actions, including court decisions interpreting existing laws, regulations or policy provisions, developments related to insurance policy claims and coverage issues, adverse or favorable outcomes in pending claims litigation, the number and severity of insurance claims, the impact of inflation on insurance claims and the impact of required participation in windpools and joint underwriting associations and residual market assessments. Although the Company’s actuaries do not make specific numerical assumptions about these factors, changes in these factors from past patterns will impact historical loss development factors and, in turn, future loss reserve development. Significant favorable changes in one or more factors will lead to favorable future loss reserve
The Company tests goodwill for impairment annually on January 1, or whenever events or circumstances indicate the carrying amount of goodwill may not be recoverable. Goodwill is tested for impairment at the reporting unit level. As of January 1, 2017, the Company performed a quantitative goodwill impairment assessment for all reporting units with goodwill. The quantitative assessment compares the estimated fair value of a reporting unit to its carrying value to determine if there is an impairment of goodwill. Estimating the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions by the Company. The estimates and assumptions included, but were not limited to, projections of future cash flows, operating results, discount rates, investment yields and market conditions. Such projections are inherently uncertain and, accordingly, actual future results may differ materially from the Company’s projections. For each reporting unit tested, the estimated fair value exceeded the carrying value of the reporting unit, and the Company concluded that the associated goodwill was recoverable.
Except for rules and interpretive releases of the SEC under authority of federal securities laws and a limited number of grandfathered standards, the FASB Accounting Standards Codification (“ASC”) is the sole source of authoritative GAAP recognized by the Financial Accounting Standards Board (“FASB”) that is applicable to the Company. The FASB issues Accounting Standards Updates (“ASUs”) to amend the authoritative literature in ASC.
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2017, 2016 and 2015
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2017, 2016 and 2015
The fair values of the Company’s Investments in Fixed Maturities, Investments in Equity Securities, Fair Value Option Investments, Trading Securities, Debt, and derivative instruments included in either Other Assets or Other Liabilities are estimated using a hierarchical framework which prioritizes and ranks market price observability. The carrying amounts reported in the Consolidated Balance Sheets approximate fair value for Cash, Short-term Investments and certain other assets and other liabilities because of their short-term nature. The actual value at which financial instruments could be sold or settled with a willing buyer or seller may differ from estimated fair values depending on a number of factors, including, but not limited to, current and future economic conditions, the quantity sold or settled, the presence of an active market and the availability of a willing buyer or seller.
The process of determining whether an asset is impaired or recoverable relies on projections of future cash flows, operating results and market conditions. Projections are inherently uncertain, and, accordingly, actual future cash flows may differ materially from projected cash flows. As a result, the Company’s assessment of the impairment of long-lived assets is susceptible to the risk inherent in making such projections.
Other Receivables primarily include reinsurance recoverables and accrued investment income. Reinsurance Recoverables were $111.6 million and $106.4 million at December 31, 2017 and 2016, respectively. Accrued Investment Income was $72.8 million and $70.8 million at December 31, 2017 and 2016, respectively.
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. Write-offs of Long-lived Assets for the year ended December 31, 2015 were $11.1 million to write off the costs of a computer software development project that was abandoned by the Company’s Property & Casualty Insurance segment.
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 as of December 31, 2017 and 2016 include reductions of $1.2 million and $9.7 million, respectively, due to premium deficiencies with respect to Alliance United’s personal automobile book of business.
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 particularly on the liability for unpaid claims and claim adjustment expenses. Insurers are required to disclose tables showing incurred and paid claims development information by accident year for the number of years that claims typically remain outstanding, although not to exceed ten years, as well as a reconciliation of this information to the balance sheet. Additional disclosures are also required on the total of IBNR liabilities, including expected development on reported claims, reserving methodologies, quantitative information about claim frequency, qualitative description of the methodologies used for determining claim frequency and average annual percentage payout of incurred claims by age. The Company adopted ASU 2015-09 in its 2016 year-end financial statements. Except for the additional disclosure requirements, adoption of ASU 2015-09 did not impact the Company’s financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which the Company adopted in the first quarter of 2017. ASU 2016-09 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 impacts the timing of when excess tax benefits are recognized by eliminating the delay in the recognition of a tax benefit until the tax benefit is realized through a reduction to income taxes payable. The Company applied the modified retrospective transition method and recognized an increase to retained earnings of $0.5 million as of January 1, 2017 to recognize excess tax benefits that had been previously delayed. On a prospective basis, all excess tax benefits and tax deficiencies are recognized as income tax expense or benefit in the Company’s Consolidated Statements of Income. Further, the Company will continue to estimate the number of awards that are expect to vest.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which revises the criteria for recognizing revenue. ASU 2014-09 requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those services. The guidance is effective for reporting periods beginning after December 15, 2017 and is to be applied using either the full retrospective or modified retrospective transition method. The guidance specifically excludes insurance contracts, lease contracts and investments from its scope. Accordingly, the Company does not expect adoption to have a material impact on net income or its financial position.
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 an 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. Adopting ASU 2016-01 will have no impact on the Company’s total Shareholders’ Equity as of January 1, 2018, but will result in an increase to Retained Earnings of $17.7 million, with a corresponding reduction to AOCI. Subsequent to adoption, ASU 2016-01 is expected to cause increased volatility in the Company’s Consolidated Statements of Income.
The Company has adopted all recently issued accounting pronouncements with effective dates prior to January 1, 2018. There were no adoptions of such accounting pronouncements in 2017 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, 2017 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”). 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.
Under the purchase agreement, the Company was indemnified up to $12.5 million on an after-tax basis for, among other things, breaches of customary representations and warranties, loss and LAE reserve development and pre-closing income taxes. In addition, the Company was indemnified up to $5.0 million on an after-tax basis, for certain employment related matters. Other Receivables in the preceding table include an indemnification receivable of $5.4 million. Other Receivables in the Consolidated Balance Sheets at December 31, 2016 include an indemnification receivable of $16.0 million. There are no indemnification receivables included in the Consolidated Balance Sheets at December 31, 2017.
Included in the fair value of Other Mortgage- and Asset-backed investments at December 31, 2017 are $1.1 million of non-governmental residential mortgage-backed securities.
Accrued Expenses and Other Liabilities included unsettled purchases of Investments in Fixed Maturities of $5.4 million and $0.1 million at December 31, 2017 and 2016, respectively. There were no unsettled sales of Investments in Fixed Maturities at December 31, 2017, compared to $2.7 million of unsettled sales of Investments in Fixed Maturities included in Other Receivables at December 31, 2016.
Gross unrealized gains and gross unrealized losses on the Company’s Investments in Equity Securities at December 31, 2017 were:
Gross unrealized gains and gross unrealized losses on the Company’s Investments in Equity Securities at December 31, 2016 were:
The Company regularly reviews its investment portfolio for factors that may indicate that a decline in fair value of an investment is other than temporary. The portions of the declines in the fair values of investments that are determined to be other than temporary are reported as losses in the Consolidated Statements of Income in the periods when such determinations are made.
With respect to Investments in Equity Securities, the Company concluded that the unrealized losses on its investments in preferred and common stocks at December 31, 2017 were temporary based on various factors, including the relative short length and magnitude of the losses and overall market volatility. The Company’s investments in other equity interests include investments in limited liability companies and limited partnerships that primarily invest in mezzanine debt and senior debt. By the nature of their underlying investments, the Company believes that some of its investments in the limited liability companies and limited partnerships exhibit debt-like characteristics which, among other factors, the Company also considers when evaluating these investments for impairment. Based on evaluations of the factors in the preceding paragraph, the Company concluded that the declines in the fair values of the Company’s investments in equity securities presented in the preceding table were temporary at December 31, 2017.
Unrealized losses on fixed maturities, which the Company 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 maturities comprised $33.8 million and below-investment-grade fixed maturities comprised $12.7 million of the unrealized losses on investments in fixed maturities at December 31, 2016. For below-investment-grade fixed maturities 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.
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, 2017, 2016 and 2015, 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, 2017 and 2016 were:
Goodwill balances by business segment at December 31, 2017 and 2016 were:
The Company’s Property and Casualty Insurance Reserves are reported using the Company’s estimate of its ultimate liability for losses and LAE for claims that occurred prior to the end of any given accounting period but have not yet been paid. Such estimates are based on individual case estimates for reported claims and estimates for IBNR losses, including expected development on reported claims.
The Company’s actuaries generally estimate ultimate losses and LAE and, therefore, reserves at least quarterly for most product lines and/or coverage levels using accident quarters spanning 10 or more years, depending on the size of the product line and/or coverage level or emerging issues relating to them. The Company’s actuaries use a variety of generally accepted actuarial loss reserving estimation methodologies to estimate the ultimate losses and LAE for the current accident quarter and re-estimate the ultimate losses and LAE for previous accident quarters to determine if changes in the previous estimates of the ultimate losses and LAE are indicated by the most recent data.
The claim counts in the preceding tables are cumulative incurred claim counts as of December 31, 2017 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.
The Company's claims are counted at the feature level. As such, each claimant and each coverage is counted separately. For example, if for one occurrence, the Company's policyholder is at fault for damage to his/her own vehicle, another party's vehicle and three injured parties, there may be five features-three for bodily injury liability, one for property damage liability and one for first-party collision coverage. There may also be another feature for first-party medical payments.
Property and Casualty Insurance Reserve activity for the years ended December 31, 2017, 2016 and 2015 was:
In 2017, the Company increased its property and casualty insurance reserves by $18.9 million to recognize adverse development of loss and LAE reserves from prior accident years. Personal lines insurance loss and LAE reserves developed adversely by $19.5 million, and commercial lines insurance loss and LAE reserves developed favorably by $0.6 million. Personal automobile insurance loss and LAE reserves developed adversely by $22.2 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. Commercial lines insurance loss and LAE reserves included adverse
In 2016, the Company reduced its property and casualty insurance reserves by $20.7 million to recognize favorable development of losses and LAE from prior accident years. Personal lines insurance loss and LAE reserves developed favorably by $16.8 million, and commercial lines insurance loss and LAE reserves developed favorably by $3.9 million. Personal automobile insurance loss and LAE reserves developed adversely by $11.3 million due primarily to the emergence of loss patterns that were worse than expected for liability insurance for the 2015 and 2014 accident years and, to a lesser extent, the 2013 and 2012 accident years. Homeowners insurance loss and LAE reserves developed favorably by $20.0 million due primarily to $16.8 million of favorable development on catastrophes primarily for the 2015 accident year and, to a lesser extent, the 2014 accident year. Other personal lines loss and LAE reserves developed favorably by $8.1 million due primarily to the emergence of more favorable loss patterns than expected for the 2015, 2014, 2013 and 2012 accident years. Commercial lines insurance loss and LAE reserves included adverse development of $2.4 million from continuing operations and favorable development of $6.3 million from discontinued operations.
Kemper’s subsidiaries, Trinity Universal Insurance Company (“Trinity”) and United Insurance Company of America (“United Insurance”), are members of the Federal Home Loan Bank (“FHLB”) of Dallas and Chicago, respectively. There were no advances from the FHLB of Dallas or Chicago outstanding at either December 31, 2017 or December 31, 2016.
Net rental expense for operating leases for the years ended December 31, 2017, 2016 and 2015 was:
Kemper is authorized to issue 20 million shares of $0.10 par value preferred stock and 100 million shares of $0.10 par value common stock. No preferred shares were issued or outstanding at December 31, 2017 and 2016. There were 51,462,405 shares and 51,270,940 shares of common stock outstanding at December 31, 2017 and 2016, respectively. There were no shares of outstanding common stock at December 31, 2017, that had been issued subject to vesting or other requirements, in connection with the Company’s long-term equity compensation plans, compared to 16,000 shares at December 31, 2016. See Note 10, “Long-Term Equity-based Compensation,” to the Consolidated Financial Statements for a discussion of the restrictions and vesting provisions.
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 $108.1 million to Kemper in 2017. In 2018, Kemper’s insurance subsidiaries would be able to pay $201 million in dividends to Kemper without prior regulatory approval. Kemper’s insurance subsidiaries had net assets of $2.4 billion, determined in accordance with GAAP, that were restricted from payment to Kemper without prior regulatory approval at December 31, 2017.
In 2017, Kemper paid dividends of $49.5 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, 2017. Kemper had the ability to pay without restrictions $326 million in dividends to its shareholders and still be in compliance with all financial covenants under its credit agreement at December 31, 2017.
Outstanding equity-based compensation awards at December 31, 2017 consisted of tandem stock option and stock appreciation rights (“Tandem Awards”), RSUs, PSUs and DSUs. RSUs, PSUs and DSUs give the recipient the right to receive one share of Kemper common stock for each RSU, PSU or DSU issued. Recipients of RSUs, PSUs and DSUs 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 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 $9.4 million, $4.7 million and $6.5 million for the years ended December 31, 2017, 2016 and 2015, respectively. Total unamortized compensation expense related to nonvested awards at December 31, 2017 was $9.4 million, which is expected to be recognized over a weighted-average period of 1.4 years.
The Compensation Committee of the Board of Directors, or the Board’s authorized designee, has sole discretion to determine the persons to whom awards under the Omnibus Plan are granted, and the material terms of the awards. For Tandem Awards, material terms include the number of shares covered by such awards and the exercise price, vesting and expiration dates of such awards. Tandem Awards are non-transferable. The exercise price of Tandem Awards is the fair value of Kemper’s common stock on the date of grant. Tandem Awards and RSU awards granted to employees generally vest in four equal annual installments over a period of 3.5 years, with the Tandem Awards expiring ten years from the date of grant. Employee PSU awards generally vest over a period of three years, subject to performance results and other restrictions.
Under the Non-employee Director compensation programs in effect for 2017 and 2016, each non-employee director received an annual DSU award covering shares of Kemper common stock with an aggregate grant date fair value of $110,000 and $75,000, respectively, at the conclusion of each annual shareholder meeting. Under the Non-employee Director compensation programs in effect for 2015, 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.
In addition to the annual DSU awards under the Non-employee Director compensation programs in effect for 2015, each Non-employee Director received an initial option award to purchase 4,000 shares of Kemper common stock immediately upon becoming a director, and in addition, received an annual option award to purchase 4,000 shares of common stock on the date of each annual meeting of Kemper’s shareholders. Grants of such option awards were fully vested and exercisable on the date of grant at an exercise price equal to the fair value of Kemper’s common stock on the date of grant and expire ten years from the date of grant.
is below a “minimum” performance level, none of the PSUs originally issued to the award recipient will vest.
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 2017, 2016 and 2015 three-year performance periods was 84,383 common shares, 107,638 common shares and 33,962 common shares, respectively, (as “full value awards,” the equivalent of 253,149 shares, 322,914 shares, and 101,886 shares, respectively, under the Share Authorization) at December 31, 2017. For the 2014 and 2013 three-year performance periods, the Company’s performance level was below the minimum performance level, and all of the related 43,207 shares and 51,400 shares, respectively, of PSUs were forfeited on February 4, 2017 and February 4, 2016, the three-year anniversary of their grant date.
Fifty percent of the PSU awards granted to employees and officers in 2017 and 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. The three-year performance periods for the 2017 and 2016 awards end on December 31, 2019 and December 31, 2018, respectively. 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 total fair value of RSUs and PSUs that vested during the year ended December 31, 2017 was $3.2 million. The tax benefits for tax deductions realized from such awards was $1.1 million. The total fair value of RSUs and PSUs that vested during the year ended December 31, 2016 was $1.3 million. The tax benefits for tax deductions realized from such awards was $0.5 million. The total fair value of RSUs and PSUs that vested during the year ended December 31, 2015 was $1.4 million. The tax benefits for tax deductions realized from such awards was $0.5 million.
The grant-date fair values of DSU awards granted to Non-employee Directors are determined using the closing price of Kemper common stock on the date of grant. The total fair value of DSUs that vested during the years ended December 31, 2017, 2016 and 2015 was $0.9 million, $0.5 million and $0.1 million, respectively.
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, 2017, 2016 and 2015 because the exercise prices for the options exceeded the average market price is presented below.
The components of Other Comprehensive Income Tax Benefit (Expense) for the years ended December 31, 2017, 2016 and 2015 were:
Other Receivables includes accrued investment income of $72.8 million and $70.8 million at December 31, 2017 and 2016, respectively.
The components of Net Impairment Losses Recognized in Earnings reported in the Consolidated Statements of Income for the years ended December 31, 2017, 2016 and 2015 were:
On December 22, 2017, Public Law 115-97, more commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”), was enacted. The Tax Act includes numerous changes to existing federal income tax law, including a permanent reduction in the federal corporate income tax rate from 35% to 21%, effective January 1, 2018.
Pursuant to SAB 118, the Company recorded certain provisional amounts for the estimated income tax effects of the Tax Act on deferred income taxes. The Company estimates that the reduction in the corporate income tax rate decreased its net deferred income tax liability as of December 22, 2017 by $10.5 million. The effect of the rate change was recorded as a decrease to income tax expense in the Company’s Consolidated Statement of Income for the year ended December 31, 2017. Final determination of the effects of the Tax Act on deferred income taxes requires additional information, including data from third parties, actuarial computations and other items. The Company expects to complete its determination of the effect of the Tax Act on its deferred income tax assets and liabilities pursuant to its annual income tax return filing process which is expected to be completed during the fourth quarter of 2018.
The tax effects of temporary differences that give rise to significant portions of the Company’s Net Deferred Income Tax Assets and Deferred Income Tax Liabilities at December 31, 2017 and 2016 were:
Except for the NOL carryforwards scheduled to expire in 2031 through 2037, all of the NOL carryforwards were acquired in connection with business acquisitions made in prior years and are subject to annual usage limitations under the Internal Revenue Code. The Company expects to fully utilize these federal NOL carryforwards.
The components of Income Tax Expense from Continuing Operations for the years ended December 31, 2017, 2016 and 2015 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, 2017, 2016 and 2015 is presented below.
Comprehensive Income Tax Benefit (Expense) included in the Consolidated Financial Statements for the years ended December 31, 2017, 2016 and 2015 was:
The measurement dates of the assets and liabilities at end of year presented in the preceding table under the headings, “2017” and “2016” were December 31, 2017 and December 31, 2016, respectively.
The weighted-average discount rate and rate of increase in future compensation levels used to estimate the components of the Projected Benefit Obligation for the Pension Plan at December 31, 2017 and 2016 were:
Weighted-average asset allocations for the Pension Plan at December 31, 2017 and 2016 by asset category were:
Fair value measurements for the Pension Plan’s assets at December 31, 2017 are summarized below.
Fair value measurements for the Pension Plan’s assets at December 31, 2016 are summarized below.
The components of Comprehensive Pension Expense (Income) for the Pension Plan for the years ended December 31, 2017, 2016 and 2015 were:
The actuarial loss included in AOCI at December 31, 2017 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, 2018 will include expense of $4.2 million resulting from the amortization of the related accumulated actuarial loss included in AOCI at December 31, 2017.
The Company did not contribute to the Pension Plan in 2017. 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. The Company does not expect that it will be required to contribute to the Pension Plan in 2018, but could make a voluntary contribution pursuant to the maximum funding limits under ERISA.
The Company also sponsors several defined contribution benefit plans covering most of its employees. The Company made contributions to those plans of $10.6 million, $8.4 million and $7.8 million in 2017, 2016 and 2015, respectively.
The Company sponsors an other than pension postretirement employee benefit plan (“OPEB”) that provides medical, dental and/or life insurance benefits to approximately 475 retired and 200 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 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 OPEB Plan. In conjunction with the amendment, the Company recorded a pre-tax reduction to its Accumulated Postretirement Benefit Obligation of $11.0 million through Other Comprehensive Income. This prior service credit is being amortized into income over the remaining average life of the OPEB Plan’s participants.
The assumed health care cost trend rate used in measuring the Accumulated Postretirement Benefit Obligation at December 31, 2017 was 7.50% for 2018, gradually declining to 4.8% in the year 2025 and remaining at that level thereafter for medical benefits and 10.00% for 2018, 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, 2016 was 6.8% for 2017, gradually declining to 5.0% in the year 2024 and remaining at that level thereafter for medical benefits and 10.3% for 2017, gradually declining to 5.0% in the year 2024 and remaining at that level thereafter for prescription drug benefits.
A one-percentage point increase in the assumed health care cost trend rate for each year would have increased the Accumulated Postretirement Benefit Obligation at December 31, 2017 by $0.6 million and 2017 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, 2016 by $0.6 million and 2016 OPEB expense by an insignificant amount.
The components of Comprehensive OPEB Expense (Income) for the years ended December 31, 2017, 2016 and 2015 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, 2017, 2016 and 2015 were:
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 $50.8 million, $52.9 million and $43.4 million for the years ended December 31, 2017, 2016 and 2015, 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. Additionally, in 2017 the Company did not allocate the impact of the Tax Act to its operating segments.
Earned Premiums by product line for the years ended December 31, 2017, 2016 and 2015 were:
Segment Net Operating Income, including a reconciliation to Income from Continuing Operations, for the years ended December 31, 2017, 2016 and 2015 was:
Amortization of Deferred Policy Acquisition Costs by Operating Segment for the years ended December 31, 2017, 2016 and 2015 was:
In 2008, the Company sold its Unitrin Business Insurance operations. The Company retained Property and Casualty Insurance Reserves for unpaid insured losses that occurred prior to the date of the sale. Property and Casualty Insurance Reserves reported in the Company’s Consolidated Balance Sheets include $32.8 million and $38.3 million at December 31, 2017 and 2016, respectively, for the retained liabilities. In accordance with GAAP, changes in the Company’s estimate of such retained liabilities after the sale are reported as a separate component of the results of discontinued operations. See Note 6, “Property and Casualty Insurance Reserves,” to the Consolidated Financial Statements for information pertaining cash used by operating activities to pay losses and LAE related to discontinued operations.
Catastrophes and natural disasters are inherent risks of the property and casualty insurance business. These catastrophic events and natural disasters include, without limitation, hurricanes, tornadoes, earthquakes, hailstorms, wildfires, high winds and winter storms. Such events result in insured losses that are, and will continue to be, a material factor in the results of operations and financial position of the Company’s property and casualty insurance companies. Further, because the level of these insured losses occurring in any one year cannot be accurately predicted, these losses may contribute to material year-to-year fluctuations in the results of operations and financial position of these companies. Specific types of catastrophic events are more likely to occur at certain times within the year than others. This factor adds an element of seasonality to property and casualty insurance claims. The Company has adopted the industry-wide catastrophe classifications of storms and other events promulgated by ISO to track and report losses related to catastrophes. ISO classifies a disaster as a catastrophe when the event causes $25.0 million or more in direct insured losses to property and affects a significant number of policyholders and insurers. ISO-classified catastrophes are assigned a unique serial number recognized throughout the insurance industry. The discussions that follow utilize ISO’s definition of catastrophes.
Coverage for the Property & Casualty Insurance segment’s catastrophe reinsurance program effective January 1, 2017 to December 31, 2017 is provided in various layers as presented below.
Coverage for the Property & Casualty Insurance segment’s catastrophe reinsurance program effective January 1, 2016 to December 31, 2016 is provided in various layers as presented below.
Reinsurance premiums for the Company’s catastrophe reinsurance programs and the FHCF Program reduced earned premiums for the years ended December 31, 2017, 2016 and 2015 by the following:
Catastrophe losses and LAE (including reserve development), net of reinsurance recoveries, for the years ended December 31, 2017, 2016 and 2015 by business segment are presented below.
In 2017, the Property & Casualty Insurance segment had catastrophe reinsurance recoveries of $11.9 million under the catastrophe reinsurance program. The Property & Casualty Insurance segment did not have any recoveries from the FHCF. The Life & Health Insurance segment had reinsurance recoveries of $0.2 million under the FHCF in 2017. Neither segment had catastrophe reinsurance recoveries in 2016 or 2015.
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.
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 Liabilities at fair value at December 31, 2017. The Company had a separate derivative instrument that was 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 table below presents quantitative information about the significant unobservable inputs utilized by the Company in determining fair values for fixed maturity investments in corporate securities classified as Level 3 at December 31, 2017.
The table below presents quantitative information about the significant unobservable inputs utilized by the Company in determining fair values for fixed maturity investments in corporate securities classified as Level 3 at December 31, 2016.
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, 2017 is presented below.
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. The transfers out of Level 3 for the year ended December 31, 2016 were due to changes in the availability of market observable inputs.
Over the last several years there have been an array of initiatives that seek, in various ways, to impose new duties on life insurance companies to proactively search for information related to the deaths of their insureds. These initiatives, which can include legislation, unclaimed property audits, market conduct examinations and related litigation, could have the effect of altering the terms of Kemper’s life insurance subsidiaries’ existing life insurance contracts by imposing requirements that did not exist and were not contemplated at the time those companies entered into such contracts.
In December 2017, CSC filed a Petition to Vacate an Arbitration Award in the U.S. District Court for the Southern District of New York and a motion to stay the proceedings in Texas. Following briefing and a hearing, the New York district court denied CSC’s motion to stay the Texas action and instead stayed the New York action. The Texas district court then set a briefing schedule with regard to CSC’s motion to transfer venue to the Southern District of New York. Once venue is resolved, the parties will proceed with the confirmation and vacatur litigation.
Mr. Christopher B. Sarofim, a director of Kemper, is Vice Chairman and a member of the board of directors of Fayez Sarofim & Co. (“FS&C”), a registered investment advisory firm. In 2015, FS&C provided investment management services with respect to certain assets of Kemper’s subsidiary, Trinity, under an agreement between the parties. Trinity began reducing the amount of assets managed by FS&C in 2014, and completed the disposal of all the assets managed by FS&C in 2015. Investment Expenses incurred in connection with such agreement were $0.1 million for the year ended December 31, 2015.
The Company believes that the transactions described above have been provided on terms no less favorable to the Company than could have been negotiated with non-affiliated third parties.
As described in Note 21, “Other Reinsurance,” to the Consolidated Financial Statements, the Company also has certain relationships with Capitol, a mutual insurance company that is owned by its policyholders, and its subsidiary, ORCC.
Under the terms of the Infinity Merger Agreement, as of the effective time of the Infinity Merger (the “Effective Time”), each share of Infinity common stock issued and outstanding as of immediately prior to the Effective Time (other than as set forth in the Infinity Merger Agreement) will be canceled and converted into, at the election of the holder of such share, the right to, receive(i) $51.60 in cash and 1.2019 Kemper common shares for each share of Infinity common stock, without interest (the “Mixed Consideration”), (ii) an amount of cash for each share of Infinity common stock, without interest, equal to $129.00 (the “Cash Consideration”) or (iii) a number of shares of Kemper common stock equal to 2.0031 (the “Stock Consideration”). Holders of Infinity common stock who do not make an election will receive the Mixed Consideration. The consideration to be paid to holders of Infinity common stock electing to receive the Cash Consideration or the Stock Consideration in connection with the Infinity Merger is subject to automatic adjustment, as applicable, to ensure that the total amount of cash paid and the total number of shares of Kemper common stock issued in the Infinity Merger is the same as what would be paid and issued if all holders of Infinity common stock were to receive the Mixed Consideration. Following the close of the Infinity Merger, Infinity shareholders are expected to own approximately 20% of the combined company on a pro-forma basis.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.