Kemper Corporation — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013; filed August 1, 2013. Kemper operates property and casualty and life and health insurance businesses through Kemper Preferred, Kemper Specialty, Kemper Direct, and Life and Health Insurance.
Financial results
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Total revenue | $588.9 million, versus $608.9 million in 2012 | $1,204.8 million, versus $1,220.1 million |
| Earned premiums | $512.8 million, versus $529.8 million | $1,022.7 million, versus $1,059.0 million |
| Income from continuing operations | $32.5 million, versus $1.6 million | $91.1 million, versus $37.9 million |
| Net income | $34.0 million; diluted EPS $0.59, versus $2.3 million and $0.04 | $92.4 million; diluted EPS $1.59, versus $45.9 million and $0.77 |
| Net investment income | $74.6 million, versus $75.2 million | $155.4 million, versus $152.6 million |
| Cash from operating activities | Not separately reported for the quarter | $76.6 million, versus $56.7 million |
Six-month total expenses declined to $1,073.8 million from $1,173.2 million, mainly reflecting lower policyholder benefits and incurred losses. Pre-tax continuing income was $131.0 million for the first half and $46.4 million for Q2. The filing reports segment combined ratios, rather than a consolidated margin: first-half ratios were 97.3% for Preferred, 103.6% for Specialty, and 78.4% for Direct; Q2 ratios were 99.7%, 104.9%, and 73.6%, respectively.
Balance sheet, cash flow, debt, and capital
- At June 30, total assets were $7,820.8 million and shareholders’ equity was $2,005.0 million, compared with $8,009.1 million and $2,161.7 million at year-end. AOCI fell to $138.5 million from $312.7 million, primarily reflecting a sharp decline in unrealized investment gains.
- Cash was $69.5 million, down from $96.3 million at December 31. First-half investing activities used $31.5 million; financing activities used $71.9 million, including repurchases and dividends.
- Notes payable were $611.9 million at amortized cost; fair value was $670.7 million. The $325 million revolving credit facility had no borrowings and was fully available. Cash and investments directly held by Kemper totaled $124.3 million.
- Kemper repurchased 1.5 million shares for an aggregate $48.9 million during the first half and paid $0.24 per share in each quarter. It planned a voluntary $55 million pension contribution in Q3.
Material changes and management commentary
- First-half earnings improved substantially year over year, while earned premiums declined 3.4%. Lower catastrophe losses and favorable prior-year reserve development were significant contributors: catastrophe losses and LAE were $38.1 million versus $67.2 million, and continuing-operations prior-year reserve development was favorable by $31.1 million versus $12.3 million.
- Preferred’s first-half segment net operating income rose to $29.3 million from $0.1 million, supported by lower catastrophe losses, favorable reserve development, and improved underlying results. Management said it continued rate increases, pricing segmentation, higher wind/hail deductibles, and other underwriting actions. Auto underlying loss performance remained a concern.
- Specialty earned premiums fell, reflecting lower personal auto volume; policies in force declined to about 237,000 from 260,000 at the start of 2013. Personal auto results improved, but commercial auto results weakened, including higher bodily-injury loss severity.
- Direct remained in run-off for direct-to-consumer business while continuing worksite and affinity programs. Management expected 2013 policies in force to decline 25%–35% and expected positive run-off earnings. First-half segment net operating income was $14.6 million versus a $4.2 million loss, with favorable reserve development of $14.0 million.
- Life and Health first-half segment net operating income declined to $41.5 million from $47.3 million. Higher legal and distribution start-up costs and weaker investment yields weighed on results; accident and health loss ratios increased.
Outlook, unusual items, and risks
- Investment sales generated $29.2 million of first-half realized gains, including $24.8 million from sales of corporate bonds following a portfolio review. Investment impairment losses recognized in earnings were $2.9 million. Management cautioned that similar gains or losses are not predictable.
- Unrealized investment losses drove $174.2 million of after-tax other comprehensive loss for the first half; total comprehensive loss was $81.8 million, despite positive net income. Management attributed much of the portfolio valuation movement to market conditions and classified relevant unrealized declines as temporary at June 30.
- Subsequent event: on July 25, Kemper sold its corporate headquarters building, recognizing an approximately $45 million pre-tax gain. It entered a long-term operating lease for five floors. Net proceeds before tax, after specified repayments, advances, costs, and liabilities, were approximately $50 million. This transaction was after the reporting date.
- Material contingency: state initiatives and audits concerning unclaimed life-insurance benefits may require death-record searches and could accelerate benefit payments or escheatment and increase claims-handling costs. Kemper challenged retroactive application in Kentucky; enforcement was stayed pending appeal. It also filed a Maryland action, faces a multi-state compliance audit, and reported a California Controller lawsuit. The potential loss, if any, could not be reasonably estimated.
- Other key exposures include catastrophe frequency and severity, reserve-estimation uncertainty, investment interest-rate and equity-price risk, and regulatory or legal developments. A 100-basis-point rate increase was estimated to reduce fixed-maturity fair value by $322 million; a 30% equity-market decline was estimated to reduce equity-security value by $87.9 million. The filing provided no earnings guidance.
Important facts for investors to verify
- How much of the earnings improvement is sustainable after separating lower catastrophe losses, favorable reserve development, and realized investment gains?
- Whether auto claim trends improve, particularly Preferred personal auto bodily-injury and Specialty commercial auto severity.
- Progress and financial effects of the unclaimed-property disputes, audits, and related regulatory requirements.
- Cash, capital, and investment-portfolio sensitivity to interest rates and equity markets, including the effect of the headquarters sale, lease, and planned pension contribution.
- Whether Direct run-off earnings and the projected 25%–35% policy decline track management’s expectations.