Kemper Corporation — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Kemper operates property-and-casualty and life-and-health insurance businesses through Kemper Preferred, Kemper Specialty, Kemper Direct, and Life and Health Insurance. Amounts below are in millions except per-share data and ratios.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenues | $645.6 | $592.8 | $1,865.7 | $1,881.7 |
| Earned premiums | $527.3 | $543.0 | $1,586.3 | $1,637.1 |
| Net investment income | $70.4 | $58.6 | $223.0 | $222.7 |
| Income from continuing operations | $55.6 | $1.1 | $93.5 | $36.7 |
| Net income | $55.6 | $2.0 | $101.5 | $50.2 |
| Diluted EPS from continuing operations | $0.95 | $0.01 | $1.56 | $0.61 |
| Diluted net income per share | $0.95 | $0.03 | $1.70 | $0.83 |
Nine-month total expenses were $1,737.3 versus $1,844.5; pretax continuing income was $128.4 versus $37.2. The improvement in earnings reflected lower catastrophe losses and higher realized investment gains, among other factors. Net realized investment gains were $59.9 for the nine months, including a $44.9 gain on Q3 municipal-bond sales; Q3 gains were $50.9, compared with a $4.2 loss a year earlier. These gains are volatile and management cautioned they may not recur. Discontinued operations contributed $8.0 to nine-month 2012 net income, including a $12.9 gain from selling Fireside’s inactive loan portfolio.
- Underwriting and segments: Nine-month catastrophe losses and LAE were $79.5, down from $156.7; prior-year P&C reserve development was favorable by $23.2, versus $30.1 favorable in 2011. Kemper Preferred improved to $8.5 segment net operating income from a $30.3 loss, benefiting chiefly from lower catastrophe losses. Specialty income fell to $4.0 from $15.4; its combined ratio worsened to 103.8% from 99.7%. Direct narrowed its nine-month loss to $2.7 from $10.4, but its combined ratio remained above 100% at 113.4%. Life and Health income was $66.5 versus $67.7.
- Cash flow and liquidity: Operating cash flow was $99.6, compared with cash used of $10.1 in the first nine months of 2011. Investing cash flow was $66.9, down from $684.6; financing cash used was $99.0, versus $320.7. Cash ended at $318.7, up from $251.2 at year-end 2011. Kemper directly held $214.7 of cash and investments. Its new $325.0 four-year revolving credit facility had no borrowings outstanding, leaving the full amount available.
- Balance sheet and debt: Total assets were $8,120.8 versus $7,934.7 at December 31, 2011; shareholders’ equity was $2,204.5 versus $2,116.6. Notes payable were $611.2, broadly unchanged from $610.6; reported fair value was $678.5. Insurance reserves totaled $4,131.6. Fixed-maturity investments were $4,725.6, of which 93% were investment grade.
Material changes and management commentary
- Earned premiums fell 3.1% year to date, with declines in Direct, Specialty, and Life and Health partly offset by growth in Preferred. Direct premiums declined $40.6, primarily from lower volume; Specialty declined $19.4. Preferred premiums rose $13.1.
- Management announced in July that Kemper Direct would cease direct marketing activities while it evaluates strategic options. The segment expects policies in force to decline 25%–35% over the next 12 months; renewals and web, affinity, and worksite fulfillment continue during the review.
- In late October, Superstorm Sandy generated a substantial number of claims, largely in New York. Kemper said it was still assessing damage but expected Sandy losses to be material to Q4 2012 operating results.
- Kemper repurchased 2.0 million shares for an aggregate $60.7 in the first nine months. It paid dividends of $0.24 per share each quarter, or $42.9 in total. Shares outstanding were 58.35 million at October 31, 2012.
- Adoption of ASU 2010-26, applied retrospectively, reduced opening 2012 shareholders’ equity by $99.5 and reduced 2012 continuing and net income by $7.5 for the first nine months ($2.5 in Q3). Prior-period figures were adjusted.
Risks, contingencies, and outlook
No specific earnings or revenue guidance was provided. The filing highlights catastrophe frequency and severity, reserve-estimate uncertainty, investment-market and interest-rate exposure, competition, regulatory changes, and litigation as risks. Most notably, state initiatives seek to require life insurers to search death records proactively and may be applied to existing policies, potentially accelerating benefit or escheatment payments and increasing claims costs. Kemper’s life insurers were subject to a 35-state unclaimed-property examination and a state market-conduct examination. The company filed a Kentucky declaratory-judgment action on November 8, 2012; it said potential losses could not be reasonably estimated.
Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter. The company also noted that insurer-subsidiary dividends are subject to regulatory limits and that insurance reserves and investment valuations depend on estimates.
Most important facts for investors to verify
- How much of reported earnings growth reflects recurring underwriting and investment income versus the $44.9 municipal-sale gain and other realized gains.
- Sandy’s ultimate insured losses, reinsurance recoveries, and effect on Q4 results and capital.
- Whether P&C reserve development remains favorable and whether rising underlying loss ratios in Specialty and auto lines persist.
- The outcome and potential financial impact of state unclaimed-property initiatives, examinations, and the Kentucky lawsuit.
- Execution and financial consequences of the Kemper Direct strategic review and projected policy attrition.