Kemper Corporation — Q2 2018 Form 10-Q
Business context and period. Kemper is an insurer operating through Property & Casualty Insurance and Life & Health Insurance segments. This unaudited report covers the three and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods. All dollar amounts below are in millions unless noted.
Financial results and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenues | $741.9 | $684.4 | $1,434.9 | $1,335.8 |
| Earned premiums | $658.1 | $582.5 | $1,267.9 | $1,145.9 |
| Net investment income | $78.4 | $77.1 | $157.6 | $158.7 |
| Income from continuing operations | $37.5 | $36.6 | $91.1 | $36.2 |
| Net income | $37.6 | $36.6 | $91.4 | $36.3 |
| Diluted net income per unrestricted share | $0.73 | $0.71 | $1.76 | $0.70 |
- Operating measure: Adjusted Consolidated Net Operating Income, a non-GAAP measure, was $36.5 for Q2 and $94.0 for the first half, compared with $21.0 and $17.1, respectively. The measure excludes investment gains/losses and acquisition-related costs, among other specified items.
- Cash flow: First-half operating cash flow was $191.4, versus $104.0 in 2017. Financing cash flow was $344.6, compared with cash used of $183.4, including $249.4 net term-loan proceeds and $120.0 of FHLB advances. The cash flow statement reports investing cash flow of $68.2 provided; MD&A describes $68.2 as used, so the filing is inconsistent on this sign.
- Balance sheet at June 30: Cash was $649.9; investments totaled $6,580.9; total assets were $8,840.5; shareholders’ equity was $2,045.7. Debt at amortized cost was $951.8, versus $592.3 at year-end 2017. The debt balance included $110.0 of FHLB advances related to the acquisition, repaid July 13. Parent-held cash and investments were $708.6, compared with $197.3 at year-end.
- Margins/underwriting: P&C’s six-month combined ratio improved to 98.3% from 109.3%; its underlying combined ratio improved to 93.0% from 95.5%. For Q2, the combined ratio was 101.0% versus 103.9%, and the underlying ratio was 92.0% versus 94.2%. Ratios below 100% indicate underwriting profit before other items.
- Comprehensive income: First-half other comprehensive loss was $143.0, resulting in total comprehensive loss of $51.6 despite net income of $91.4. Unrealized investment holding losses were the principal driver; AOCI fell to $69.6 from $194.4 at year-end.
Material changes versus prior period
- First-half net income increased $55.1, led by a $68.4 improvement in P&C segment net operating results. Management attributed this primarily to lower catastrophe losses, improved reserve development, lower underlying loss ratios and lower expense ratios. Q2 net income increased only $1.0 year over year.
- Earned premiums grew $122.0 in the first half, driven mainly by P&C personal auto, particularly nonstandard auto. P&C earned premiums increased $116.7; Life & Health premiums increased $5.3.
- First-half catastrophe losses and LAE in P&C were $49.9, down from $98.4 in 2017. Prior-year P&C reserve development was adverse by $1.6, substantially below the $18.9 adverse development in 2017. Personal auto liability reserve emergence remained a concern; homeowners had adverse development, partly offset by favorable catastrophe reserve development.
- Net realized investment gains fell to $6.4 from $36.9 for the first half, while net impairment losses improved to $0.5 from $7.6. The company adopted accounting guidance requiring fair-value changes in many equity securities to flow through earnings, which management said may increase earnings volatility.
- The federal corporate tax rate fell to 21% from 35%. Management cited lower tax rates as a key contributor to higher Life & Health segment net operating income.
Outlook, transactions, risks and contingencies
- Infinity acquisition: After quarter-end, Kemper completed its acquisition of Infinity on July 2, 2018 for approximately $1.6 billion in cash and stock. Kemper issued 13,184,107 shares valued at $982.6 and paid $564.6 in cash. Funding included the $250.0 delayed-draw term loan and $110.0 in temporary FHLB advances. Infinity is a specialty nonstandard auto insurer with 2017 direct written premiums of $1.4 billion. No quantified synergy or earnings guidance is provided in the supplied filing text.
- Debt facilities: The June credit agreement increased revolving capacity to $300.0, extended maturity to June 2023, and provided a $250.0 delayed-draw term loan; an accordion feature permits an additional $100.0 of capacity. The term loan matures two years after borrowing.
- Legal award: A 2017 arbitration award against CSC/DXC granted Kemper’s subsidiary $84.3 in damages, 9% annual prejudgment interest, and $7.2 in costs and expenses. Confirmation and vacatur proceedings remained pending. The company treats the award as a gain contingency and has not recognized it; final amount and timing of collection are uncertain.
- Key risks: Insurance results depend on catastrophe frequency and severity, claims inflation, reserve-estimate changes, reinsurance availability, regulatory actions and competition. Management also cites investment-market and interest-rate risks, acquisition integration and synergy uncertainty, technology/cybersecurity risks, and possible adverse litigation outcomes. The filing provides no specific earnings or revenue guidance.
Important facts for investors to verify
- Integration progress, financing costs, dilution and realized benefits from the July 2018 Infinity acquisition.
- Whether improved auto underwriting and reserve trends persist, particularly given adverse personal-auto liability development and Q2 homeowners catastrophe losses.
- The effect of equity fair-value accounting and market movements on reported earnings and the large first-half OCI loss.
- Debt and liquidity after repayment of the temporary FHLB advances, including capital needs and subsidiary dividend restrictions.
- Outcome, collectible value and timing of the CSC/DXC arbitration award, which is not recorded as an asset or gain.
- The investing-cash-flow sign discrepancy between the cash flow statement and MD&A.