KEMPER Corp annual report, FY2013

Kemper Corporation — FY2013 Form 10-K

Business context and reporting period. Kemper is a U.S. insurance holding company offering property and casualty, life, health and related products. This filing covers the fiscal year ended December 31, 2013, with comparisons to FY2012; it is an annual report, not a standalone fourth-quarter filing. Unless noted otherwise, financial amounts are in millions of dollars.

Financial performance and position

Revenue: Total revenue was $2,426.5, down from $2,462.3. Earned premiums declined $81.3 to $2,025.8; net investment income rose $18.8 to $314.7.
Profit: Net income was $217.7 ($3.80 diluted per share), versus $103.4 ($1.74) in 2012. Income from continuing operations was $214.5, versus $91.8. Non-GAAP consolidated net operating income was $159.2, versus $53.8.
Key earnings drivers: Net realized investment gains increased to $99.1 from $65.4, including a $43.6 pretax gain on the sale of the corporate office building. Catastrophe losses from continuing operations, excluding prior-year reserve development, fell to $50.7 from $124.5. Favorable prior-year reserve development was $59.8 in continuing operations, compared with $25.2.
Segment results: Segment net operating income was $63.1 for Kemper Preferred (2012 loss of $11.2), $10.4 for Kemper Specialty ($1.2 income), $27.1 for Kemper Direct ($0.9 loss), and $89.3 for Life and Health ($90.8 income). Kemper Specialty remained underwriting-unprofitable, with a 102.5% combined ratio; Preferred’s was 96.4% and Direct’s was 78.7%. Direct’s reported ratio reflects favorable prior-year reserve development.
Cash flow: Operating cash flow was $122.1, compared with $65.7 in 2012. Investing activities provided $4.8; financing activities used $156.7, including $100.4 of share repurchases and $54.9 of dividends. Cash ended the year at $66.5, down from $96.3.
Balance sheet and debt: Total assets were $7,656.4, down from $8,009.1; shareholders’ equity was $2,051.5, down from $2,161.7. Notes payable were $606.9, including $250 of 6.00% senior notes due 2015 and $360 of 6.00% senior notes due 2017 (principal amounts). The $225 revolving credit facility was undrawn at year-end; no FHLB advances were outstanding.
Liquidity and capital: Kemper directly held $156.7 of cash and investments at year-end. Insurance subsidiaries paid $95.0 in dividends to the parent in 2013; management estimated they could pay $217.0 in 2014 without prior regulatory approval. All insurance subsidiaries exceeded applicable minimum risk-based capital levels.
Investment portfolio: Total investments were $6,151.3. Of $4,575.0 in fixed maturities, 93% were investment grade. Other comprehensive income was a loss of $177.4, primarily reflecting lower unrealized investment gains; book value per share was $36.86 versus $36.98.

Material changes versus FY2012

Net income more than doubled as property-and-casualty underwriting improved and catastrophe losses declined, while investment gains also increased. The office-building sale was a significant, non-recurring contributor.
Earned premiums contracted, particularly in Kemper Direct and Kemper Specialty. Direct continued running off its direct-to-consumer business; its policies in force fell 25% in 2013. Specialty personal-auto policies in force fell to approximately 208,000 from 260,000 at the start of 2013.
Total favorable property-and-casualty reserve development rose to $64.6 from $31.5, including discontinued operations. Reserve estimates remain subject to material uncertainty.
Year-end property-and-casualty reserves declined to $843.5 from $970.6. Life-and-health reserves increased to $3,217.5 from $3,161.6.
The company amended its credit agreement effective December 31, 2013: revolving commitments fell from $325 to $225, while permitted FHLB and surplus-note indebtedness increased by $150 to $250, subject to a $100 cap on surplus notes. Subsidiaries’ new FHLB memberships provide additional potential liquidity.

Outlook, commentary and risks

Management expected Kemper Direct policies in force to decline a further 25%–35% in 2014, with fixed expenses potentially weighing more heavily on a shrinking premium base. The filing does not provide consolidated earnings guidance.
Reserve National was expanding distribution through new senior, employer-benefits and dental channels, appointing 12,900 independent agents in 2013. Management cautioned that experience with these channels and products was limited and returns could differ materially from assumptions.
Reserve National expected premiums from health products affected by the Health Care Acts to decline approximately 37% in 2014, with supplemental-product growth expected to offset much, but not necessarily all, of the decline.
On February 11, 2014, Kemper announced a property-and-casualty business realignment; one P&C reporting segment was planned beginning in Q1 2014.
Unclaimed-property dispute: State initiatives and litigation seek to require proactive searches of life-policy records against death databases, potentially including existing policies. Kemper challenged retroactive application and related information requests. Outcomes and potential losses could not be reasonably estimated; adverse results could accelerate benefit payments and increase claims-handling costs.
Other principal risks: Catastrophes and reinsurance availability or collectability; reserve adequacy and pricing; regulatory and legal changes; investment-market and low-interest-rate exposure; ratings; competition; data security and system continuity; and restrictions on dividends from insurance subsidiaries.
The filing reports no material off-balance-sheet arrangements. Deloitte issued an unqualified audit opinion, and management and the auditor concluded internal control over financial reporting was effective at December 31, 2013.

Important facts for investors to verify

How much of the earnings increase reflects recurring underwriting and investment income versus the $43.6 building-sale gain and favorable reserve development?
Whether favorable reserve development—particularly in Kemper Direct—continues as newer accident years mature, and how actual claims compare with recorded reserves.
Progress in stabilizing or managing the runoff of Direct and Specialty premiums, and the 2014 expense impact of a smaller Direct book.
Developments in the unclaimed-property audits, examinations and litigation, including any changes to expected benefit-payment timing, costs or exposure.
Whether new Reserve National products and distribution channels produce adequate results, and whether supplemental premiums offset expected declines in affected health products.
Liquidity and parent-company dividend capacity, including the 2015 senior-note maturity, regulatory limits on subsidiary dividends and the terms and collateral requirements of FHLB funding.
Investment portfolio valuation and interest-rate sensitivity, including the impact of market movements on accumulated other comprehensive income and capital.