Net Realized Gains on Sales of Investments, reported in the Consolidated Statement of Income, were $33.7 million in 2011, compared to $42.6 million in 2010. Net Impairment Losses Recognized in Earnings for the years ended December 31, 2011 and 2010 were $11.3 million and $16.5 million, respectively. The Company cannot predict when or if similar investment gains or losses may occur in the future. Other Comprehensive Investment Gains, which are not reported in the Consolidated Statement of Income, but rather are reported in the Consolidated Statement of Comprehensive Income, were $201.6 million in 2011, compared to $179.4 million in 2010. The net comprehensive investment gain for the year ended December 31, 2011 was largely due to lower overall interest rates, partially offset by a decrease in the fair value of equity securities. The net comprehensive investment gain for the year ended December 31, 2010 was largely due to lower overall interest rates and an appreciation in the fair value of equity securities.
The Company manages its exposure to catastrophes and other natural disasters through a combination of geographical diversification, restrictions on the amount and location of new business production in certain regions and reinsurance. To limit its exposures to catastrophic events, the Company maintains various primary catastrophe reinsurance programs for its property
Ceded Catastrophe Reinsurance Premiums for the Life and Health Insurance segment for the year ended December 31, 2011 in the preceding table includes a reduction of $0.2 million in the Company’s estimate for reinsurance reinstatement premiums for certain hurricanes that occurred in prior years. Ceded Catastrophe Reinsurance Premiums for the Life and Health Insurance segment in the preceding table includes reinsurance reinstatement premiums of $0.6 million and $0.7 million for the years ended December 31, 2010 and 2009 to reinstate coverage following certain hurricanes.
Insurance Expenses decreased by $4.3 million for the year ended December 31, 2011, compared to 2010, due primarily to lower acquisition expenses, partially offset by higher underwriting expenses, largely due to information technology expenses related to several new systems initiatives.
Other insurance consists of certain reinsurance pools in run-off and other personal insurance in run-off. Other insurance operating loss was $0.1 million for the year ended December 31, 2011, compared to $0.6 million for 2010. Adverse loss and LAE reserve development on certain reinsurance pools in run-off was $0.4 million for the year ended December 31, 2011, compared to $0.7 million in 2010. Excluding development from these reinsurance pools, loss and LAE reserve development on other personal insurance had an adverse effect of $0.9 million for the year ended December 31, 2010 and was almost entirely related to two liability claims, one from 2003 and the other from 2005. Insurance expenses for the year ended December 31, 2010 included a reduction of expense of $0.8 million related to a change in estimate for uncollectible reinsurance.
Commercial automobile insurance operating profit decreased by $7.6 million for the year ended December 31, 2010, compared to 2009, due primarily to lower favorable reserve development and higher underlying losses and LAE as a percentage of commercial automobile insurance earned premiums and higher insurance expenses as a percentage of commercial automobile insurance earned premiums. Favorable loss and LAE reserve development on commercial automobile insurance was $1.1 million for the year ended December 31, 2010, compared to $5.4 million for 2009. Underlying losses and LAE as a percentage of commercial automobile insurance earned premiums increased for the year ended December 31, 2010, compared to 2009, due primarily to higher frequency, partially offset by lower severity of losses. Net investment income allocated to commercial automobile insurance was flat for the year ended December 31, 2010, compared to 2009, as lower levels of investments allocated to commercial automobile insurance were offset by higher investment returns on Equity Method Limited Liability Investments. Insurance expenses as a percentage of commercial automobile insurance earned premiums increased due primarily to increased investment in technology and reduced economies of scale.
Kemper believes that some of the health insurance products sold by its subsidiary, Reserve National, could be adversely impacted by some provisions of the Health Care Acts that were signed into law in the first quarter of 2010. In particular, a provision which sets minimum loss ratios for health insurance policies could adversely impact Reserve National’s business prospects. Such affected health insurance products accounted for $72.1 million, or 43%, of the Life and Health Insurance segment’s accident and health insurance earned premiums for the year ended December 31, 2011. Reserve National has been adapting its business model in response and in 2011 began transitioning its sales to other health insurance products that are not expected to be as severely impacted by the Health Care Acts. In connection with the transition, Reserve National suspended sales of such affected health insurance products at the end of 2011. The Life and Health Insurance segment expects earned premiums from these affected health insurance products to decrease by approximately 15% in 2012 due to such suspension of sales. There can be no assurance that the transition will fully offset the impact from suspending sales of the affected health insurance products.
Net Investment Income for the years ended December 31, 2011, 2010 and 2009 was:
The Company owns investments in various limited liability investment companies and limited partnerships that primarily invest in distressed debt, mezzanine debt and secondary transactions. The Company’s investments in these limited liability investment companies and limited partnerships are reported either as Equity Method Limited Liability Investments, or Other Equity Interests and included in Equity Securities 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, 2011 and 2010 is presented below:
The classification of a company’s investment in a financial instrument may affect its reported results. For investments classified as trading, a company is required to recognize changes in the fair values into income for the period reported. Both the reported and fair value of the Company’s investments classified as trading were $4.4 million at December 31, 2011. 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, 2011. 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 to income during the period, but rather are recognized as a separate component of Accumulated Other Comprehensive Income until realized. All of the Company’s investments in fixed maturities were classified as available for sale at December 31, 2011. 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, 2011 were required to be reported at fair value with changes in fair value reported in Accumulated Other Comprehensive Income 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.
Changes in the level of minimum case reserves, and the automatic aging of those minimum case reserves;
Observable inputs are based on market data obtained from independent sources, while unobservable inputs are based on the Company’s market assumptions. Unobservable inputs require significant management judgment or estimation. In some cases, the inputs used to measure an asset or liability may fall into different levels of the fair value hierarchy. In those instances, the Company classifies the fair value measurement using the lowest level of input that is significant to the fair value measurement. Such determination requires significant management judgment. In accordance with GAAP, the Company is not permitted to adjust quoted market prices in an active market, even if the Company owns a large investment, the sale of which could reasonably impact the quoted price.
Other Assets primarily include property and equipment, internal use software, insurance licenses acquired in business combinations, the value of other intangible assets acquired and prepaid expenses. Property and equipment is depreciated over the useful life of the assets, generally using the straight-line or double declining balance methods of depreciation depending on the asset involved. Internal use software is primarily amortized over the useful life of the asset using the straight-line method of amortization. Insurance licenses acquired in business combinations and other indefinite life intangibles are not amortized, but rather tested periodically for recoverability.
In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements. The standard is effective for the first interim or annual period beginning on or after December 15, 2011. The new standard amends the existing fair value definition and enhances disclosure requirements. Other than the enhanced disclosure requirements, the Company does not anticipate that the adoption of the new standard will have a material impact on the Company.
Kemper’s insurance subsidiaries are required to file financial statements prepared on the basis of statutory insurance accounting practices which is a comprehensive basis of accounting other than GAAP. Statutory capital and surplus for the Company’s life and health insurance subsidiaries was approximately $475 million and was $400.1 million at December 31, 2011 and 2010, respectively. Statutory net income for the Company’s life and health insurance subsidiaries was income of approximately $115 million, was income of $80.4 million and was income of $79.9 million for the years ended December 31, 2011, 2010 and 2009, respectively. Statutory capital and surplus for the Company’s property and casualty insurance subsidiaries was approximately $815 million and was $905.0 million at December 31, 2011 and 2010, respectively. Statutory net income for the Company’s property and casualty insurance subsidiaries was income of approximately $33 million, was income of $117.3 million and was income of $75.0 million for the years ended December 31, 2011, 2010 and 2009, respectively. Statutory capital and surplus and statutory net income exclude Fireside Bank and parent company operations.
On May 4, 2011, Kemper’s shareholders approved the 2011 Omnibus Equity Plan (the “Omnibus Plan”). The Omnibus Plan is a long-term equity-based compensation plan designed to attract, motivate and retain key employees and/or directors of the Company. The Omnibus Plan replaced the Company’s previous employee stock option plans, director stock option plan and restricted stock plan (collectively, the “Prior Plans”). Awards previously granted under the Prior Plans remain outstanding in accordance with their original terms. Beginning May 4, 2011, equity-based compensation awards may only be granted under the Omnibus Plan. A maximum number of 10,000,000 shares of Kemper common stock may be issued under the Omnibus Plan (the “Share Authorization”). As of December 31, 2011, there were 9,900,450 common shares available for future grants under the Omnibus Plan, of which 518,625 shares related to performance-based restricted stock awards outstanding under the Prior Plans were reserved for future grants.
In the second quarter of 2011, the United States experienced a high volume of spring storms, including a record level of tornadoes in April. In the third quarter of 2011, the Company incurred claims related to Hurricane Irene. Catastrophe losses and LAE for the year ended December 31, 2011 include $22.1 million related to Hurricane Irene, of which $21.2 million is included in the Preferred segment.
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 dwellings 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 dwellings 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 residual market assessments are based on a variety of factors, including, but not limited to, actual or estimated assessments provided by or received from the assessing entity, 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.
With respect to the Company’s defined contribution plans, one of the alternative investment choices afforded to participating employees is the Dreyfus Appreciation Fund, an open-end, diversified managed investment fund. FS&C provides investment management services to the Dreyfus Appreciation Fund as a sub-investment advisor. According to published reports filed by FS&C with the SEC, the Dreyfus Appreciation Fund pays monthly fees to FS&C according to a graduated schedule computed at an annual rate based on the value of the Dreyfus Appreciation Fund’s average daily net assets. The Company does not compensate FS&C for services provided to the Dreyfus Appreciation Fund. Participants in the Company’s defined contribution plans had allocated $19.3 million, $18.2 million and $16.9 million for investment in the Dreyfus Appreciation Fund at