Kemper Corporation
Q4 2012 Earnings Call Transcript

Published: 8 Feb 2013

[Operator:]

Good morning, ladies and gentlemen, and welcome to Kemper’s Fourth Quarter 2012 Earnings Conference Call. My name is Shawn and I will be your coordinator today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference is being recorded for replay purposes. I would now like to introduce your host for today’s conference, Ms. Diana Hickert-Hill, Vice President, Investor Relations and Corporate Identity. Ms. Hickert-Hill, you may begin.

[Diana Hickert-Hill:]

Thank you, operator. Good morning, everyone, and thank you for joining us. After the market’s close yesterday, we issued our earnings release and filed it along with our financial supplement. You can find these documents on the Investors section of our website, kemper.com. This morning you will hear from three of our business executives, starting with Don Southwell, Kemper’s Chairman, President and Chief Executive Officer, followed by Denise Lynch, Kemper’s Property and Casualty Group Executive; and finally, Dennis Vigneau, Kemper’s Senior Vice President and Chief Financial Officer. We will make a few opening remarks to provide context around our fourth quarter results. We will then open up the call for a question-and-answer session. During this interactive portion of the call, our three presenters will be joined by John Boschelli, Kemper’s Vice President and Chief Investment Officer; and Ed Konar, Kemper’s Life & Health Group Executive. Please note that our discussion today may contain forward-looking statements. Our actual results may differ materially from these statements. Please refer to the risk factors and cautionary disclosures on potential risks associated with relying on forward-looking statements included in our periodic filings with the SEC as well as in our earnings release. We plan to file our 2012 Form 10-K with the SEC on or about Friday, February 15, 2013. This morning’s discussion also includes non-GAAP financial measures that we believe may be meaningful to investors. In our supplement and our earnings release, non-GAAP financial measures have been reconciled to GAAP, where required in accordance with SEC rules. Now, I will turn the call over to Don Southwell.

[Don Southwell:]

Thank you, Diana, and good morning, everyone. As we look back over the fourth quarter in the past year, we see significant progress on many fronts, but challenges on others. Overall, I would characterize the year as mixed. Year-over-year, we did see improvement in earnings. However, in the fourth quarter, earnings were lower, primarily from Superstorm Sandy. We took several actions to improve profitability, including accelerating our rate increases and tightening underwriting and while a continued low interest rate environment persists, we delivered stable earnings in the Life and Health segment. In the year-end, we wrapped up our strategic evaluation of the Direct segment. Let me take a moment to comment on our performance in Superstorm Sandy. This storm affected many of our policyholders. It is at times like these when our agents and our claims teams show the value of Kemper fulfilling our promises and helping our customers restore their lives. I’m proud of the professional and caring support our team provides to our policyholders. As you heard in the introductions, I’ve asked Denise Lynch to provide an update on our Property and Casualty businesses. While Denise continues to lead the Kemper Preferred business, we promoted her in the fourth quarter to be the Group Executive for all of our Property and Casualty businesses. I’m delighted to have Denise as a key member of Kemper’s senior leadership team. Today, I’ll focus my remarks on two topics

[Denise Lynch:]

Thank you, Don. Fourth quarter overall Property and Casualty results deteriorated when compared to the same period last year as well as sequentially. The largest single driver was Superstorm Sandy, which is estimated to be approximately $32 million in after-tax losses and loss adjusting expenses for our Property and Casualty businesses. In addition to this significant storm, the adverse loss trend continued to affect the auto line. For the full year, the combined ratio improved about 2 points and the underlying combined ratio was down about 1 point from prior year at 101%, which was a modest improvement and remains an area of our continued focus. While we are seeing progress, much work remains to be done. We continued to file rate increases and average premium is rising. We are well into implementing underwriting changes, including increased deductibles in 25 states and selectively reducing hurricane and earthquake home owner exposures. I will walk through each of our P&C businesses starting with Kemper Direct. We stopped the direct marketing spend early in the third quarter and initiated additional expense reductions consistent with a change in strategy. We’ve reduced staff levels in line with top line projections. Going forward, we will continue to reduce expenses consistent with premium projections and will eliminate infrastructure costs by consolidating programs and systems platforms. We will continue to grow the affinity, worksite and renters business, which is separate from the direct-to-consumer business. Profitability improved in the Kemper Direct segments for the second half of 2012 with two consecutive quarters of positive net operating income. The combined ratio and underlying combined ratio both improved in the quarter and on a year-to-date basis. We continue to focus on improving the bottom line results by first, taking great actions in line with full indications as well as taking other underwriting actions. On average in 2012, we filed for high single-digit rate increases across the book. These rate changes will earn in over the next six to 12 months. Second, continuing our previously announced actions to limit business in Michigan, Florida and New York. About 90% of the Direct Auto Michigan business has run off the books since the beginning of 2012. And finally, reducing expenses commensurate with the premium decline through the direct-to-consumer run-off. Moving to our largest business, Kemper Preferred, our focus remains on the bottom line and attracting new and renewal business in our target market. We are optimizing our mix and emphasizing our auto and home package products with those target customers. Year-over-year, our target market premium was up double digits. The deterioration in Kemper Preferred’s performance in the quarter relates to Superstorm Sandy as well as higher auto severity and adverse loss reserve development in auto. With respect to Superstorm Sandy, I would like to extend my personal appreciation to our colleagues in the claim department, who have worked so hard and continue to work diligently to serve our agents and policyholders throughout this event. On a full-year basis, Kemper Preferred’s combined ratio improved, largely due to lower catastrophe losses, offset by an increase in auto severity and adverse auto loss reserve development. The underlying loss ratio deteriorated largely because of increased auto severity. In the homeowners line, catastrophe losses for the year while less than 2011, remained well above our historical averages. We remain steadfast in taking actions to reduce exposures in the highest catastrophe prone areas and ensuring we are pricing for the risk we are accepting. Specifically, we filed and received approval for an overall rate increase of 11% in 2012 for home. This was a full 3 points above our original expectations for the year. Much of that increased rate is focused on states with cat exposure. We increased homeowners’ deductibles especially in states with tornado and hail exposures. We enhanced pricing segmentation and we selectively reduced homeowners’ exposures in certain states with further reductions to come in 2013. Moving to auto, we continued to address profitability with filed rate increases, averaging nearly 8% in 2012. This is more than 2 points above our original expectations for 2012. We also implemented other pricing and other underwriting actions and initiatives throughout the year and expect them along with filed rate increases to produce improved loss ratios in 2013. Now turning to Kemper Specialty. Our quarterly and annual results were certainly disappointing, as significant unfavorable severity trends related to bodily injury coverage drove unfavorable development in Kemper Specialty’s book. Fortunately, Specialty’s business model allows us to react quickly to changing external conditions. With improved pricing analytics and segmentations put in place recently and a high proportion of six-month policies, we are moving rate into the book quickly and efficiently. The business team filed rate-related actions during 2012 of approximately 10% on private passenger auto. We expect to continue these actions into the next quarters. While commercial auto has remained profitable for the year, we have tightened underwriting guidelines related to certain classes of vehicles in order to maintain net profit margins historically and at book. In total for Kemper Specialty, given the significant pricing actions we’ve taken on the book in 2012 along with other underwriting initiatives, we are targeting a reduction in the combined ratio of 4 to 5 percentage points in 2013. So, to summarize the Property Casualty Group, while we have challenges to address, we have sharp focus on executing to improve profitability. With that, I’ll turn it over to Dennis to discuss the financials.

[Dennis Vigneau:]

Thanks, Denise, and good morning, everyone. This morning, I’ll share further insights in the following areas

[Don Southwell:]

Thank you, Dennis. Thank you, Denise. As you just heard, we’re making progress in key areas and have plans in place to continue improvements and address our challenges. At this time, I’ll turn the call back over to the operator, so we may take your questions. Operator?

[Operator:]

Thank you. (Operator Instructions) Our first question comes from Paul Newsome with Sandler O’Neill. Please go ahead with your question.

[Paul Newsome:]

Good morning and thank you for the call. I want to ask about how the – sort of the mechanics of the timing of returning capital from the Direct business, exactly how would that work?

[Don Southwell:]

Well, Paul, I’m going to ask Dennis to answer that question, but the basic answer is as the business runs up, the capital needed to support it frees up.

[Dennis Vigneau:]

Hey, Paul. Good morning. We’d expect that capital based on our current run-off projections to – a majority of that would come out over the next two to three years and that’s comprised of, as you can imagine, a few different pieces. There’s what you’d expect in terms of allocated, required capital surplus for the book of business that’s there that aligned down. And then, in addition to that, there are other intangible assets, licenses, et cetera that also have value and as those – the book runs off those companies, we would expect to monetize those that we don’t intend to use going forward.

[Paul Newsome:]

So, you’d have to sell the piece that you – that those intangibles you’re talking about selling them to...

[Dennis Vigneau:]

Yes, those are the legal entity shells and licenses that, to the extent we don’t use them, in the ongoing businesses elsewhere, we would monetize those. That’s right. And we’ve done that in the past on a number of occasions.

[Paul Newsome:]

No question. But so, is it kind of the business runs off, as we look at it as premium and then the following year, we’re able to dividend the cash out. Is that kind of how it works?

[Dennis Vigneau:]

When you think about the capital that’s behind the business, it’s in the ballpark of $160 million at this point. That’s our internal allocated capital. And everything else that’s not allocated to support the business just automatically is freed up and available either for redeployment behind the other P&C business lines or to the extent we want to take a dividend out of the P&C businesses and bring it up to the holding company, we could choose to do that.

[Paul Newsome:]

Okay, great. Thank you very much.

[Dennis Vigneau:]

You bet.

[Operator:]

Our next question comes from Ray Iardella with Macquarie. Please go ahead with your question.

[Ray Iardella:]

Thanks and good morning, everyone. Maybe just going to sort of sticking on the capital question and you kind of talked about the three priorities, but I guess sort of just breaking them down a little bit further, organic growth, I’m just kind of wondering, I mean what type of return do you think you can get on that? And it just feels to me just given more valuation is maybe the better return would be to increase your share repurchases, any thoughts on that?

[Don Southwell:]

Sure, Ray, organic growth is always on our list because that’s profitable organic growth is the best use of capital. As we look into 2013, we’re not anticipating that we’ll be in growth mode. In fact, we may well continue to be in shrinkage mode with the run-off of Direct and with the intense emphasis on margin improvement. So while it’s our first priority that doesn’t mean we anticipate we’re going to deploy capital there this year. So, we certainly do have capital available to return to shareholders and our dividend is important to our shareholders and is competitive and we want to certainly maintain that and be opportunistic on our capital return through this year buyback.

[Ray Iardella:]

Okay, that’s helpful. And I guess going back to the Direct business, I mean how should we think about premiums going to 2013. I mean so is it – there’s just going to be zero going through written and then whatever earned gets earned out and then you guys are just paid stuck, paying the losses as they pay out over time? Is that sort of the right way to think about that?

[Don Southwell:]

Of course, I’m going to ask Denise to elaborate.

[Denise Lynch:]

Okay. I’ll add a little bit more information to that. We have discontinued our marketing efforts to solicit new business. Having said that, new business will continue to come in to us and we’ll accept that where it is appropriate. So, there will be some new business coming in although just a small percent of what we’ve seen historically. And we will continue to renew business as appropriate. But over time, this book of business will continue in its run-off, the direct to consumer business that is.

[Ray Iardella:]

Okay. Thank you. That’s very helpful. And then maybe just talking about the Specialty business and I think there were some severity trends that drove the action, your hire, I mean. Is there anything in particular you guys are noticing in that book of business? And then, I guess, is the way to combat it sort of just continued push of rate or is there anything else you guys can do?

[Don Southwell:]

Denise, you want to take that one too?

[Denise Lynch:]

Yes, I’ll be happy to take that one. Our Kemper severity – our Kemper Specialty book of business, you’re right, we’re watching those loss trends pretty carefully. Over time, we’ve experienced about a 3% to 4% loss trend. In the last year, we saw increased frequency and increased severity in that book of business. And I’m talking specifically about the private passenger book because that is majority of our book. Where we’re seeing the increased frequencies on the comp and collision and where we’re seeing the severity trend is on the BI and also on the comprehensive coverage. We’re addressing it aggressively. We’re addressing it with rate. As we said before, we’ve filed rate essentials of about 10% last year. And we’ll continue to file additional rate in the coming year. But in addition to rate, we’re addressing it with continued underwriting efforts and improving our segmentation and the pricing of the product. So, there’s a lot of ways we’re going at it with rate, with underwriting and improving our product.

[Ray Iardella:]

Okay. Thank you very much.

[Operator:]

(Operator Instructions) Our next question comes from Steven Schwartz of Raymond James. Please go ahead with your question.

[Steve Schwartz:]

Thank you. Good morning, everybody. Talking about Preferred, there was adverse development there. I was wondering if we could possibly talk about what lines, what years and maybe what geographies led to that for the quarter?

[Denise Lynch:]

I will take that one also then. For Preferred, we did see adverse development on our auto line of business. It was primarily in 2011 and it was primarily on the liability coverages is where we saw that. We are addressing again that book of business also with rate and also with underwriting in pricing, product improvements.

[Steve Schwartz:]

Denise, was this in the – was this widespread or was this concentrated in the three states we’ve been talking about for the other lines?

[Denise Lynch:]

No. That development was spread – or said differently, it wasn’t heavily concentrated in any particular geography. That was spread.

[Steve Schwartz:]

Okay. And then going back to Direct, the programs that you are going to keep, the affinity group, the worksite, how much in premium is that?

[Denise Lynch:]

We’re looking at about $30 million in premium for our affinity and worksite business. It’s been good business for us. It’s a good product. It’s distributed through primarily agents and brokers and we intend to keep that and to grow it.

[Steve Schwartz:]

Okay. And then, Dennis, of the $90 million, $95 million that you talked about dividending up to the holding company, how much of that would come from the life cos?

[Dennis Vigneau:]

At this point, the majority of it will come from the life. We may, as we move through the year, shift a little bit of that over to the P&C business. We’ll see how weather performs. I’d say, if we take any from P&C, it’d be in the second half of this year.

[Steve Schwartz:]

Okay. And then the life cos dividend, is that – first off, is that greater or less than, and is that restricted to statutory operating or net income?

[Dennis Vigneau:]

The life co dividend is based on earnings.

[Steve Schwartz:]

Oh, based on the net, so realized losses go through that. Okay. And then do you have an estimate for that for 2012?

[Dennis Vigneau:]

Yes, it’s been pretty stable. It’s in the roughly $90 million on a statutory basis.

[Steve Schwartz:]

Okay, so you’ve just taken all of it. Okay. Thank you. That’s what I had.

[Dennis Vigneau:]

Yes, thanks.

[Operator:]

I’m not showing any other questions in the queue. I’d like to turn it back over to Diana Hickert-Hill for closing comments.

[Diana Hickert-Hill:]

Thank you, operator. If anybody has any final questions or comments, they can contact me directly and we’d be happy to address them. This concludes our call.

[Operator:]

Thank you. Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the conference. You may now disconnect. Good day.