Kemper Corporation — Q2 2012 Form 10-Q
Business context and reporting period. Unaudited results cover the three and six months ended June 30, 2012, compared with the same periods in 2011. Kemper operates property and casualty and life and health insurance businesses through Kemper Preferred, Kemper Specialty, Kemper Direct, and Life and Health Insurance. Fireside and former Unitrin Business Insurance operations are reported as discontinued operations. Dollars below are in millions unless stated otherwise.
Financial performance and position
| Metric | Six months 2012 | Six months 2011 | Q2 2012 | Q2 2011 |
|---|---|---|---|---|
| Total revenue | $1,220.1 | $1,288.9 | $608.9 | $647.7 |
| Earned premiums | $1,059.0 | $1,094.1 | $529.8 | $548.1 |
| Net investment income | $152.6 | $164.1 | $75.2 | $82.9 |
| Income (loss) from continuing operations | $37.9 | $35.6 | $1.6 | $(9.4) |
| Net income (loss), including discontinued operations | $45.9 | $48.2 | $2.3 | $(3.3) |
| Diluted continuing-operations EPS | $0.63 | $0.58 | $0.03 | $(0.16) |
| Diluted net EPS | $0.77 | $0.79 | $0.04 | $(0.06) |
- First-half operating cash flow was $56.7, versus $21.2 in 2011. Investing activities provided $8.2, compared with $357.1; financing used $66.6, compared with $371.7. Cash ended June at $249.5, versus $251.2 at year-end 2011.
- At June 30, total assets were $8,006.8 and shareholders’ equity was $2,148.7. Total liabilities were $5,858.1, including $4,140.8 of insurance reserves and $611.0 of notes payable at amortized cost. Notes payable fair value was $665.1.
- Investments totaled $6,293.8, including $4,766.7 of fixed maturities. Management reported 93% of fixed maturities as investment grade. Fixed maturity fair value includes substantial unrealized gains; accumulated other comprehensive income was $311.5, up from $258.0 at year-end.
- First-half dividends were $28.8, or $0.48 per share. Kemper repurchased 1.4 million shares for an aggregate $40.7; the cash-flow statement reports $39.3 of repurchase cash payments.
Material changes versus comparable periods
- First-half revenue declined $68.8, reflecting lower premiums, lower investment income, and net realized investment gains of $9.0 versus $32.0 in 2011. Lower catastrophe losses and higher operating income partly offset these effects.
- First-half continuing-operations income improved $2.3, but net income declined $2.3 because discontinued-operations income fell to $8.0 from $12.6. Q2 continuing operations returned to a small profit from a loss a year earlier.
- Catastrophe losses and LAE, excluding prior-year reserve development, were $67.2 for the first half versus $114.0 in 2011, primarily reflecting lower severity. Favorable prior-year P&C reserve development was $12.3, compared with $11.9 in 2011.
- Segment results were mixed. First-half segment net operating income improved at Preferred to $0.1 from a $22.0 loss and at Direct to a $4.2 loss from an $8.7 loss. Specialty declined to $1.3 from $9.7; Life and Health was $47.3 versus $48.0. Specialty and Direct reported first-half combined ratios of 105.0% and 117.4%, respectively; Preferred’s was 106.7%. Preferred’s underlying combined ratio was 95.9%.
- Net investment income fell $11.5 for the first half, mainly from lower returns on equity-method limited liability investments, higher investment expenses, and lower equity dividends; fixed-maturity interest and dividends increased.
Outlook, management commentary, risks and unusual items
- Kemper Direct: On July 19, 2012, the company announced a review of strategic options and that it would cease direct marketing. Management expected policies in force to decline 30% to 40% over the next 12 months; web, affinity, and worksite fulfillment would continue while options were evaluated.
- Other outlook: Specialty expected personal auto policies in force to be marginally down for the rest of 2012. Preferred said it was pursuing rate increases, pricing segmentation, and underwriting actions to improve profitability. The filing provides no consolidated earnings or revenue guidance.
- Reserves and catastrophe exposure: Loss reserves depend on estimates and emerging trends; future development may be favorable or adverse and could materially affect a period’s results. Management said future reserve development was not expected to materially affect consolidated equity, but could materially affect financial results in a given period. Catastrophes, claim severity and frequency, inflation, and reinsurance availability remain key exposures.
- Insurance regulation and product exposure: State enforcement of abandoned-property laws and life-insurance claims practices could accelerate benefit payments or escheatment. Kemper life companies were subject to a multi-state compliance audit and a state market-conduct examination; outcomes were not yet known. The company warned that broad regulatory changes could materially adversely affect profitability and financial position. PPACA may affect certain health products; Reserve National had suspended sales of affected products and was transitioning to alternatives, with no assurance the transition would offset the impact.
- Accounting change: Retrospective adoption of ASU 2010-26 reduced shareholders’ equity by $99.5 as of January 1, 2012, and reduced 2012 first-half continuing income and net income by $5.0, or $0.08 per share.
- Liquidity and debt: A new unsecured $325.0 million revolving facility runs to March 2016; none was drawn at June 30. Kemper estimated insurance subsidiaries could pay $177.0 in dividends to the parent during the remainder of 2012 without prior regulatory approval. The company reported no pending legal proceedings reasonably likely to have a material financial-statement effect.
- Market risk: Under the filing’s instantaneous stress assumptions, a 100-basis-point rate increase and a 30% equity-market decline would reduce asset fair values; the estimated impacts were $(329.3) on fixed maturities and $(89.8) on equity securities, partly offset by a $25.5 increase in notes-payable fair value. These are illustrative sensitivities, not forecasts.
Important facts for investors to verify
- Whether the Direct strategic review and cessation of direct marketing result in the forecast 30%–40% policy decline, and what costs or proceeds follow from any strategic action.
- Whether Specialty’s adverse auto reserve development and underwriting results persist, and whether Preferred’s underlying loss trends improve after pricing actions.
- The development of P&C reserves, especially given reliance on estimates and the possibility that future development materially affects quarterly earnings.
- The outcome and potential financial effect of the abandoned-property audit and market-conduct examination, as well as changes to life-benefit claims requirements.
- The sustainability of investment income and reported earnings, including exposure to equity-method fund returns, investment valuation assumptions, and realized gains that varied substantially year over year.
- Any effect of the IRS audit and Joint Committee on Taxation review of prior-year tax refunds; management did not anticipate a material modification.