Kemper Corporation — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; unaudited consolidated results. Unless otherwise noted, dollar amounts are in millions. Comparisons are with Q1 2011, adjusted for the insurance acquisition-cost accounting change described below.
Business context
Kemper operates property and casualty and life and health insurance businesses through Kemper Preferred, Kemper Specialty, Kemper Direct, and Life and Health Insurance. Fireside Auto Finance and former Unitrin Business Insurance operations are reported as discontinued operations.
Financial performance and position
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Total revenue | $611.2 | $641.2 |
| Earned premiums | $529.2 | $546.0 |
| Net investment income | $77.4 | $81.2 |
| Income from continuing operations | $36.3 | $45.0 |
| Net income | $43.6 | $51.5 |
| Diluted EPS, continuing operations / net income | $0.60 / $0.72 | $0.73 / $0.84 |
| Operating cash flow | $55.6 | $73.2 |
- Total revenue declined 4.7%, while net income fell 15.3%. Continuing income fell $8.7; the $7.9 net-income decline was partly offset by higher discontinued-operations income.
- Investment gains on sales were $4.9, versus $14.2; investment impairment losses recognized in earnings were $0.5, versus $0.4. Net investment income decreased mainly because of lower returns from equity-method investments and lower equity dividends.
- Q1 2012 total comprehensive income was $47.7, compared with $35.7 in Q1 2011, reflecting a year-over-year improvement in other comprehensive income.
- Property and casualty catastrophe losses and LAE were $11.4, compared with $9.7. Prior-year P&C reserve development was favorable by $5.7, versus $3.9 favorable in Q1 2011.
- Segment net operating income: Preferred $10.4 (prior $11.3); Specialty $4.1 (prior $4.4); Direct loss $1.3 (prior loss $3.9); Life and Health $27.8 (prior $30.0). Direct improved, but remained loss-making.
- Combined ratios: Preferred 99.0% (prior 100.1%); Specialty 100.3% (prior 101.1%); Direct 114.1% (prior 121.4%). Underlying combined ratios were 95.4%, 101.0%, and 117.9%, respectively. Lower than 100% generally indicates underwriting profit.
- At March 31, total assets were $7,970.4, total liabilities $5,838.6, and shareholders’ equity $2,131.8. Total investments were $6,392.2 and cash was $128.7, down from $251.2 at year-end 2011.
- Debt carrying value was $610.8; disclosed fair value was $657.1. A new $325.0 unsecured revolving credit facility was undrawn, leaving $325.0 available. The quarterly dividend was $0.24 per share.
- Operating cash flow was positive, but investing activities used $146.7, chiefly reflecting $116.7 invested in short-term investments; financing activities used $31.4. Cash decreased $122.5 during the quarter.
Material changes and unusual items
- Kemper retrospectively adopted ASU 2010-26 on insurance acquisition costs. Adoption reduced equity by $99.5 million at January 1, 2012; at March 31, 2012 it reduced deferred acquisition costs by $157.9 million and equity by $101.7 million relative to the prior accounting. Comparative income statements were adjusted: the change reduced reported Q1 2012 net income by $2.2 million and adjusted Q1 2011 net income by $2.6 million.
- Discontinued operations contributed $7.3 of Q1 2012 income, including an $11.3 net gain from the sale of $283 million of Fireside’s inactive charged-off loan portfolio. The gain was net of $14.9 in transaction, shutdown, and other costs; $8.7 of those costs remained unpaid at quarter-end.
- Kemper repurchased approximately 0.6 million shares in Q1 for an aggregate cost of $19.2 million, and paid $14.5 in shareholder dividends.
- Fireside converted from an industrial bank to a general business corporation on March 31. On April 5, it distributed $20 million of capital, ultimately to Kemper.
Outlook, risks, and contingencies
- No consolidated earnings guidance was provided. Management expected Kemper Direct earned premiums to continue declining in the next several quarters and Specialty personal-auto policies in force to be marginally down through the remainder of 2012.
- Reserve estimates are uncertain and may change as claims experience develops. Management said reserve development could materially affect results in a given period, though it did not expect it to materially affect consolidated equity.
- Management identified catastrophe frequency and severity, reserve adequacy, inflation in claim costs, reinsurance availability and creditworthiness, investment-market and interest-rate changes, regulation, competition, and execution of technology and consolidation initiatives among factors that could make actual results differ from expectations.
- About 41% of Life and Health accident and health premiums came from products potentially affected by the Affordable Care Act. Reserve National had suspended sales of affected products; management cautioned that replacement products might not fully offset the impact.
- The fixed-maturity portfolio was nearly 93% investment grade. The company reported no significant derivative holdings. Its modeled adverse market-risk scenario included a 100-basis-point rate change and a 30% S&P 500 decline; management cautioned that these scenarios are illustrative, not forecasts.
- The IRS began auditing the 2009 and 2010 federal returns, including years with loss carrybacks and refunds already received. Management did not anticipate a material modification to the returns or refunds. The company said pending legal proceedings were not reasonably likely to materially affect its financial statements.
- The new credit agreement contains financial covenants, including leverage, net-worth, and insurance-subsidiary risk-based-capital requirements. State insurance laws restrict subsidiary dividends; Kemper estimated $177.0 of dividends could be paid to the parent during the rest of 2012 without prior regulatory approval.
Most important facts for investors to verify
- Whether premium trends, particularly in Direct and Specialty personal auto, and segment underwriting ratios improve or deteriorate in subsequent quarters.
- Whether favorable reserve development persists and how catastrophe losses and claim-cost inflation affect reserve adequacy.
- How much recurring earnings depend on investment income and realized investment gains, and how the portfolio responds to rates and equity-market movements.
- The realized impact of the acquisition-cost accounting change on reported results and equity, and whether the IRS audit or Affordable Care Act-related product transition changes expectations.
- Cash needs, insurance-subsidiary dividend capacity, credit-facility covenant headroom, and continued share repurchases and dividends.