Kemper Corporation — Q2 2015 Form 10-Q
Business and period: Kemper is an insurance holding company operating Property & Casualty (P&C) and Life & Health businesses. This unaudited report covers the three and six months ended June 30, 2015; comparisons are to the same periods in 2014 unless noted.
Financial results and liquidity
| Metric ($ millions, except per-share amounts and ratios) | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenues | 609.2 | 542.5 | 1,108.4 | 1,097.1 |
| Income from continuing operations | 27.4 | 9.3 | 40.9 | 44.5 |
| Net income | 29.7 | 9.3 | 43.2 | 44.4 |
| Diluted net income per unrestricted share | $0.57 | $0.17 | $0.83 | $0.80 |
| Net investment income | 76.7 | 72.6 | 147.3 | 143.7 |
| Net realized investment gains | 34.0 | 3.5 | 37.4 | 10.1 |
- Cash flow: Six-month operating cash flow was $80.7 million, up from $72.6 million. Investing activities used $4.1 million versus $125.7 million in 2014; financing activities used $58.9 million versus $48.4 million provided. Cash ended the period at $93.8 million, compared with $76.1 million at year-end.
- Balance sheet and debt: Total assets were $8.06 billion and shareholders’ equity $2.01 billion at June 30, versus $7.83 billion and $2.09 billion at December 31, 2014. Debt at amortized cost was $750.2 million; its reported fair value was $789.5 million. Total investments were $6.45 billion.
- Liquidity: Kemper directly held $378.8 million in cash and investments at June 30. It had no borrowings under its $225 million revolving credit facility, whose maturity was extended to June 2020. Insurance subsidiary dividends are subject to regulatory restrictions.
- P&C underwriting: Six-month combined ratio was 103.7% (103.5% in 2014); underlying combined ratio was 98.2% (96.8%). Q2 combined ratio was 107.8% (107.6%) and underlying combined ratio 98.8% (94.3%). Ratios include an $11.1 million software write-off.
Material changes and management commentary
- Six-month earned premiums declined to $931.4 million from $947.9 million, while Q2 premiums rose to $500.1 million from $470.3 million. P&C Q2 growth included Alliance United; excluding that acquisition, P&C earned premiums declined year over year as legacy business volume remained lower.
- On April 30, Kemper acquired Alliance United, a California nonstandard auto insurer, for $71 million and contributed a further $75 million to support the business. Since acquisition, it contributed $62.1 million of earned premiums and had a 97.4% combined ratio. Purchase-price allocation remained preliminary.
- Six-month consolidated net operating income, a non-GAAP measure, declined to $28.5 million from $41.1 million. Segment net operating income fell in both P&C ($10.8 million versus $13.2 million) and Life & Health ($30.4 million versus $38.0 million). Management cited lower favorable prior-year reserve development, higher underlying P&C losses, lower P&C investment income, higher life benefits and expenses, and pension-related costs.
- Lower catastrophe losses benefited P&C results: $45.7 million for the first half versus $77.9 million in 2014. Favorable prior-year P&C reserve development was $13.9 million, versus $34.3 million in 2014.
- Investment gains supported reported earnings: Q2 equity-security sales generated $31.4 million of gains, part of $34.0 million in quarterly realized gains. Conversely, six-month other comprehensive income was a $77.4 million loss, largely reflecting unrealized investment losses; total comprehensive income was a $34.2 million loss.
- Kemper wrote off $11.1 million of P&C software after abandoning a development project. It also recorded a $9.1 million pretax loss on early debt extinguishment after refinancing $250 million of 6.00% notes due 2015 with 4.35% senior notes due 2025. The quarterly dividend was $0.24 per share; the company repurchased $23.7 million of shares in the first half.
- No specific earnings or financial guidance was provided. Management said legacy P&C retention and new-business growth had improved, but further improvement was needed to stabilize and grow premiums.
Risks, contingencies, and other matters
- Unclaimed property litigation and regulation: State initiatives seek to require insurers to search death databases and potentially apply new requirements to existing life policies. Kemper is litigating or participating in related proceedings in several states; certain cases and examinations remain ongoing. The company said outcomes and any loss cannot reasonably be estimated. Retroactive changes could accelerate benefit payments or escheatment, increase claims-handling costs, and materially affect profitability, financial position, and cash flows.
- Insurance and investment risks: Catastrophe frequency and severity, reserve estimate changes, claims inflation, reinsurance availability, investment markets and interest rates may affect results. The filing’s modeled adverse market scenarios estimated a $306.1 million decline in fixed-maturity fair value for a 100-basis-point rate increase and a $138.5 million decline in equity securities for a 30% equity-market fall; these are sensitivities, not forecasts.
- Other exposures: Kemper had $105.3 million of unfunded commitments to certain investment funds and $47.4 million of commitments to equity-method investments. The company is assessing Alliance United’s internal controls following the acquisition. Management reported disclosure controls were effective and no other material internal-control changes during the quarter.
Important facts for investors to verify
- Whether legacy P&C premium trends, retention, new business and underlying loss ratios improve, and how Alliance United performs as it scales.
- How much of reported earnings depends on realized investment gains, reserve development, tax benefits and other nonrecurring items; compare GAAP results with the company’s non-GAAP operating income.
- Developments in unclaimed-property laws, audits and litigation, including potential retroactive application and effects on cash flows and claim liabilities.
- Insurance subsidiary capital, dividend capacity, catastrophe exposure, and the adequacy of loss reserves.
- Final Alliance United purchase-price allocation, future capital needs, and the carrying value and performance of Level 3 and other less-liquid investments.