KEMPER Corp annual report, FY2011

Kemper Corporation — FY 2011 Form 10-K

Reporting period: Fiscal year ended December 31, 2011; year-over-year comparisons are primarily with FY 2010. The filing also reports fourth-quarter results. Kemper, formerly Unitrin, changed its name and NYSE ticker to KMPR in August 2011. Its continuing U.S. insurance operations comprise Preferred, Specialty, Direct, and Life and Health Insurance.

Financial performance and condition

Metric	FY 2011	FY 2010
Total revenue	$2,495.0 million	$2,642.5 million
Earned premiums	$2,173.6 million	$2,289.4 million
Net investment income	$298.0 million	$325.7 million
Income from continuing operations	$70.9 million; $1.17 per diluted share	$169.1 million; $2.73 per diluted share
Net income	$83.7 million; $1.38 per diluted share	$184.6 million; $2.98 per diluted share
Net cash from operating activities	$(25.0) million	$58.5 million

Total revenue fell 5.6% and earned premiums fell 5.1%. Net income declined 54.6%; continuing-operations income declined 58.1%.
Property and casualty catastrophe losses and LAE from continuing operations, excluding prior-year reserve development, rose to $163.8 million from $79.3 million. Severe spring storms and tornadoes and Hurricane Irene were key factors; Irene accounted for $22.1 million of catastrophe losses and LAE.
Prior-year reserves developed favorably by $33.1 million before tax, versus $24.9 million in 2010. This favorable effect partially offset current-year losses.
Segment net operating income: Preferred $(16.6) million (2010: $50.6 million); Specialty $18.3 million ($20.2 million); Direct $(27.1) million ($(1.1) million); Life and Health $108.5 million ($94.9 million). Preferred’s combined ratio was 110.3%; Specialty’s 99.8%; Direct’s 129.0%. Life and Health reported operating profit of $167.6 million.
At year-end, total assets were $8.086 billion, shareholders’ equity $2.216 billion, and total liabilities $5.870 billion. Insurance reserves were $4.132 billion, including $1.029 billion of property and casualty reserves.
Notes payable were $610.6 million, primarily senior notes due 2015 and 2017. The $245 million revolving credit facility was undrawn at year-end. Kemper directly held $217.0 million in cash and investments; consolidated cash was $251.2 million and total investments were $6.223 billion.
Common dividends were $0.96 per share for the year. Kemper repurchased 0.9 million shares for $27.4 million. Book value was $36.78 per share.

Material changes and unusual items

Revenue and premiums contracted across the P&C segments, most notably Direct and Specialty. Life and Health earned premiums were broadly stable.
Preferred moved to an underwriting loss as catastrophe costs more than doubled, underlying homeowners losses increased, and favorable reserve development was lower. Its underlying combined ratio rose to 95.7% from 93.6%.
Direct’s operating loss widened. It recorded a $13.5 million impairment of customer-relationship intangibles acquired with Direct Response; its combined ratio increased to 129.0% from 110.1%.
Net investment income declined $27.7 million, principally because income from equity-method limited-liability investments fell $39.2 million. Net realized investment gains were $33.7 million, while impairment losses recognized in earnings were $11.3 million.
Fireside Bank sold its active auto-loan portfolio, recognizing a $4.5 million pretax gain, and distributed $250 million of capital to Kemper. The bank and the former Unitrin Business Insurance operations are presented as discontinued operations. Fireside’s remaining charged-off loans are in runoff.
Kemper made an $83.7 million voluntary pension contribution, consisting of $32.2 million cash and Intermec shares valued at $51.5 million; the share contribution generated a $7.0 million realized loss. Pension assets were $441.3 million against a $499.2 million benefit obligation.
Other comprehensive income included $201.6 million of investment gains, largely reflecting lower interest rates; this is distinct from income recognized in net income.
Cash from operations turned negative despite positive net income. Cash from investing activities was $564.6 million, including proceeds from the Fireside portfolio sale; financing used $405.6 million, including deposit repayments, dividends, and repurchases.

Outlook, risks, and contingencies

The filing gives no consolidated earnings or revenue guidance. Management expected Direct premiums to continue declining over the next several quarters as it repriced and exited selected business; profitability remained uncertain. Specialty expected personal auto policies in force to be marginally lower in 2012.
Reserve National suspended sales of certain health products subject to health-care reform provisions. Management expected premiums from those affected products to decline approximately 15% in 2012 and cautioned that replacement supplemental products might not fully offset the decline.
Management did not expect a required pension contribution in 2012, though it could make a voluntary contribution. Insurance subsidiaries were estimated to have capacity to pay $175 million in dividends to the parent in 2012 without prior regulatory approval; actual distributions remain subject to regulatory constraints.
Key risks include unpredictable catastrophe severity and geographic concentration; reserve-estimation uncertainty, including long-tail asbestos, environmental, and construction-defect claims; reinsurance availability and collectability; rate regulation and competitive pricing; investment interest-rate, credit, and equity risk; and execution of Direct’s turnaround and Reserve National’s product transition.
At year-end, 93% of fixed-maturity investments were investment grade. Equity-method and partnership investments included $306.3 million invested and $132.2 million of unfunded commitments, with exposure to distressed and mezzanine debt and secondary transactions.
Kemper said pending legal proceedings were not reasonably expected, based on available information, to have a material effect on the financial statements. The auditor issued an unqualified opinion and reported effective internal control over financial reporting.

Important facts for investors to verify

Whether Direct’s rate, underwriting, marketing, and market-exit actions improve its loss ratio and reduce its operating losses without excessive premium attrition.
Whether the elevated 2011 catastrophe burden and the favorable reserve development recorded in 2011 are sustainable or repeatable; review subsequent catastrophe experience and reserve triangles.
Whether Reserve National’s replacement products compensate for the expected decline in affected health premiums and satisfy applicable loss-ratio requirements.
How negative operating cash flow, parent-company liquidity, subsidiary dividend restrictions, and the 2015/2017 debt maturities affect capital returns and financial flexibility.
Whether investment income, private-fund valuations and commitments, and pension assumptions remain appropriate as market conditions change.