Kemper Corporation — Q3 2013 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2013, compared with the corresponding 2012 periods. Kemper operates in property and casualty and life and health insurance through Kemper Preferred, Kemper Specialty, Kemper Direct, and Life and Health Insurance. Unless noted otherwise, amounts below are in millions of dollars.
Financial results and position
- Revenue: Third-quarter total revenue was $635.7, down 1.5% from $645.6. Nine-month revenue was $1,840.5, down 1.4% from $1,865.7. Nine-month earned premiums declined $56.1 to $1,530.2; net investment income rose $14.8 to $237.8.
- Profit: Third-quarter net income was $70.1, or $1.24 per diluted unrestricted share, versus $55.6, or $0.95. Nine-month net income was $162.5, or $2.81 per diluted share, versus $101.5, or $1.70. Continuing-operations income was $68.6 for the quarter and $159.7 year to date. Consolidated net operating income, a non-GAAP measure, was $38.9 for the quarter and $112.9 for nine months, versus $24.6 and $57.2, respectively.
- Investment gains and unusual items: Nine-month realized investment gains were $78.3, including a $43.6 pretax gain on the sale of Kemper’s headquarters building; 2012 gains were $59.9. Nine-month impairment losses recognized in earnings were $6.3, versus $4.1.
- Insurance performance: Nine-month catastrophe losses and LAE, excluding prior-year reserve development, were $48.4 versus $79.5. Prior-year P&C reserves developed favorably by $43.2 in continuing operations ($47.7 including discontinued operations), compared with $23.2 favorable development in continuing operations in 2012. Nine-month reported combined ratios were 97.9% for Preferred, 101.6% for Specialty, and 77.8% for Direct. Direct’s result included substantial favorable reserve development; the filing does not provide a consolidated combined ratio.
- Cash flow: Nine-month operating cash flow was $92.9, versus $99.6. Investing activities provided $14.2, versus $66.9; financing activities used $127.3, versus $99.0. Cash fell to $76.1 from $96.3 at year-end 2012.
- Balance sheet and liquidity: At September 30, total assets were $7,745.9, total liabilities $5,736.8, and shareholders’ equity $2,009.1. Notes payable were $606.7. No borrowings were outstanding under the $325.0 revolving credit facility, which expires in March 2016. Fixed-maturity investments totaled $4,645.0 at fair value; insurance reserves totaled $4,086.1.
- Capital returns and pension: Kemper reported repurchasing 2.5 million shares for an aggregate $85.2 during the first nine months; cash flow statements report $82.9 of repurchase cash outflow. Dividends were $0.24 per share each quarter, or $41.5 paid year to date. The company contributed $55.0 to its defined-benefit pension plan.
- Comprehensive income: Nine-month other comprehensive loss was $191.6, primarily reflecting investment valuation changes; total comprehensive loss was $29.1 despite positive net income. Accumulated other comprehensive income declined to $121.1 from $312.7 at year-end 2012.
Material changes versus the prior period
- Nine-month net income increased $61.0, and continuing-operations income increased $66.2. Better P&C underwriting results, lower catastrophe losses, favorable reserve development, and higher investment income contributed; realized investment gains also increased.
- Earned premiums fell, particularly in Kemper Direct and Kemper Specialty. Kemper Direct’s direct-to-consumer business was placed in run-off; its premiums and expenses declined while reported operating results improved. Management expected Direct policies in force to decline 25%–35% in 2013.
- Preferred’s nine-month operating profit improved markedly, supported by lower catastrophe losses and more favorable reserve development. Specialty’s personal auto results improved, while commercial auto results weakened amid higher underlying losses and less favorable reserve development. Life and Health nine-month operating profit declined, including higher legal and distribution start-up expenses.
- The headquarters building sale generated a substantial one-time gain. The company entered into a long-term operating lease for five floors of the building.
Outlook, risks, and contingencies
- The filing provides no quantitative consolidated earnings guidance. Management described the Direct segment run-off and its expected 2013 policy decline; the company also cited ongoing Preferred-segment rate, pricing, deductible, and underwriting actions to improve profitability.
- Life-insurance unclaimed property matters: State initiatives and audits seek death-record database comparisons and could change claims handling and accelerate benefit payments or escheatment. Kemper and certain subsidiaries challenged retroactive application and regulators’ authority in several states. A Kentucky trial court ruled against the subsidiaries on retroactivity; enforcement was stayed pending appeal. The company could not estimate a potential loss, which it said could materially affect profitability and financial position.
- Other key exposures include catastrophe frequency and severity, uncertainty in loss reserves, reinsurance availability and recoverability, interest rates and investment valuations, regulation, litigation, and economic conditions. A modeled instantaneous 100-basis-point rate increase implied a $311.7 adverse fair-value effect on fixed maturities; this is a sensitivity scenario, not a forecast.
- Management said disclosure controls and procedures were effective and reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- How much of the earnings improvement is sustainable underwriting and investment income versus favorable reserve development and realized gains, including the headquarters sale gain.
- Whether P&C reserve development remains favorable as newer accident-year loss trends emerge, particularly in personal auto and commercial auto.
- Progress and potential financial impact of the death-record database litigation, audits, and state regulatory initiatives; the filing says the loss cannot currently be estimated.
- Investment portfolio sensitivity to interest rates and equity markets, including the sizable decline in accumulated other comprehensive income.
- Cash generation, capital returns, pension funding, and the continued premium and policy decline associated with Kemper Direct’s run-off.