Kemper Corporation — Q2 2016 Form 10-Q
Business context and period: Kemper is an insurer operating Property & Casualty (P&C) and Life & Health segments. This unaudited report covers the three and six months ended June 30, 2016; comparisons are with the same periods in 2015. The P&C results include Alliance United, acquired April 30, 2015, so year-over-year comparisons are affected by the additional months of its operations.
Financial performance and position
| Metric | Six months ended June 30, 2016 | Comparable 2015 period |
|---|---|---|
| Earned premiums | $1,099.7 million | $931.4 million |
| Total revenues | $1,238.5 million | $1,108.4 million |
| Income from continuing operations | $1.9 million; $0.04 per share | $40.9 million; $0.79 per share |
| Net income | $1.9 million; $0.04 per share | $43.2 million; $0.83 per share |
| Operating cash flow | $116.9 million | $80.7 million |
- For Q2 alone, revenues were $627.2 million versus $609.2 million; net income was $4.0 million ($0.08 per share) versus $29.7 million ($0.57 per share).
- Six-month expenses rose to $1,242.4 million from $1,056.3 million. The company reported a pre-tax continuing-operations loss of $3.9 million, offset by a $5.8 million income tax benefit.
- Net investment income fell to $140.7 million from $147.3 million, and realized investment gains declined to $12.4 million from $37.4 million. Net impairment losses recognized in earnings increased to $15.7 million from $9.2 million.
- P&C segment net operating loss was $22.0 million, compared with income of $10.8 million; its reported combined ratio rose to 109.0% from 103.7%. The underlying combined ratio was 100.3%, versus 98.2%.
- Life & Health segment net operating income improved to $36.7 million from $30.4 million. Consolidated net operating income, a non-GAAP measure, was $4.0 million versus $28.5 million.
- At June 30, total assets were $8.306 billion, investments $6.717 billion, cash $159.8 million, total shareholders’ equity $2.105 billion, and debt $751.1 million. Debt was broadly unchanged from year-end 2015; no borrowings were outstanding under the $225 million revolving facility.
- Cash and investments held directly by Kemper were $344.2 million. Six-month investing cash use was $91.2 million and financing cash use was $27.6 million. The company paid $24.5 million in dividends, or $0.48 per share for the half-year.
- Other comprehensive income was $136.8 million for the six months, principally reflecting investment valuation gains; accumulated other comprehensive income rose to $261.1 million from $124.3 million at year-end.
Material changes versus 2015
- Earned premiums increased $168.3 million, led by a $161.8 million increase in P&C. Alliance United drove much of the growth; excluding it, P&C earned premiums declined $22.9 million.
- P&C catastrophe losses and LAE, excluding reserve development, increased to $86.6 million from $45.7 million, largely due to two Texas hailstorms. Prior-year P&C reserves developed favorably by $16.6 million, versus $13.9 million a year earlier.
- Alliance United’s nonstandard auto underlying loss ratio was 97.1% for the half-year, compared with 84.5% in its partial-period 2015 comparison. Kemper cited higher claim frequency and severity, adverse development, and claims-adjuster capacity constraints.
- Investment results were less favorable than in 2015, which included substantial equity-security sale gains. Impairment losses also increased, while lower pension-related expense helped reduce other expenses.
- Kemper froze benefit accruals under substantially all qualified pension-plan participants, effective June 30, 2016, and froze supplemental-plan accruals as well. The change reduced ongoing pension costs; the filing reports a $0.3 million pre-tax curtailment gain for the qualified plan and a $3.6 million pre-tax gain for the supplemental plan, alongside a $1.3 million expense for recognition of its remaining prior service costs.
Outlook, risks, and contingencies
- The filing provides no specific earnings, premium, or combined-ratio guidance. Management said Alliance United may require several more pricing cycles to achieve adequate rates; actions include rate increases, slowing new-business growth, agency management, and increasing claims staffing.
- The P&C business remains exposed to catastrophe frequency and severity, claims inflation, reserve-estimation uncertainty, competition, and rate-approval constraints. The company cannot predict future reserve development.
- Life-insurance subsidiaries face disputes and regulatory initiatives concerning unclaimed property and use of the Social Security Administration’s Death Master File. Litigation includes California and Illinois matters, a pending Maryland appeal, and a Florida case in which enforcement was stayed. The California matter was set for trial in early 2017. Kemper said the potential economic effect of retroactive requirements cannot currently be reasonably estimated; possible effects include accelerated benefit payments or escheatment, higher handling costs, and reputational harm.
- Liquidity depends partly on insurance-subsidiary dividends, which are subject to regulatory limits. Kemper estimated subsidiaries could pay approximately $79.7 million more during the remainder of 2016 without prior regulatory approval. The company also contributed $30 million to Alliance United in the first half.
- Market risk includes interest-rate and equity-price exposure. The filing’s illustrative shocks estimated a $312.6 million decline in fixed-maturity fair value from a 100-basis-point rate increase and a $130.5 million decline in equity securities from specified rate and equity-price shocks; these are sensitivities, not forecasts.
Important facts for investors to verify
- Whether Alliance United’s claim trends, rate adequacy, staffing, and underwriting results improve, and how much they continue to affect consolidated P&C results.
- Whether catastrophe losses and P&C combined ratios normalize, and whether favorable reserve development persists.
- The drivers and sustainability of the sharp decline in reported earnings, including investment gains and impairments, taxes, and pension-related expense changes.
- Developments in Death Master File and unclaimed-property litigation or regulation, including any potential financial, liquidity, or reputational consequences.
- Debt refinancing or repayment plans for the $359.4 million of 6.00% senior notes due May 2017, and the availability of subsidiary dividends and parent-level liquidity.