Kemper Corp (KMPR) 2012 Q2 法說會逐字稿

Good morning, ladies and gentlemen and welcome to Kemper's second quarter 2012 earnings conference call. My name is Karen and I will be your coordinator today. (Operator Instructions).

I would now like to introduce your host for today's conference, Ms. Diana Hickert-Hills, Vice-President Investor Relations and corporate identity. You may begin.

Thank you, Karen. Good morning, everyone. And thank you for joining us. After the market's close yesterday we filed our Form 10-Q with the SEC and issued our press release and financial supplement. You can find these documents on the investor section of our website Kemper.com.

We would also like to mention that in our financial supplement this quarter we added an additional page of disclosures related to our catastrophe frequency and loss and severity performance. You can find this information on page 11. This morning you will hear from three of our business executives starting with Don Southwell, Kemper's Chairman, President and Chief Executive Officer. Jim Schulte, 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 second quarter results. We will then open up the call for a question and answer session.

Please note that our discussion today may contain forward-looking statements. Our actual results may differ materially from these statements. Please refer to our Form 10-K filed with the SEC on February 17, 2012, as well as our second quarter 2012 Form 10-Q and earnings release for financial information on potential risks associated with relying on forward-looking statements.

This morning's discussion also includes non-GAAP financial measures that we believe may be meaningful to investors. In our 10-Q supplement and 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.

Thank you, Diana. As you heard in the introductions, I have asked Jim Schulte to join the call to provide details on our Property and Casualty business. I will confine my remarks to the following three topics. First, our recent decision about the direct business. Second, our Life Health and Investment performance and third our progress on our capital.

Starting with Kemper Direct. We recently announced that we are reviewing strategic options for the direct business in that we have ceased the direct marketing activities. Over time we had undertaken several significant actions to improve profitability in this segment.

We were intentionally shrinking the business until loss ratios and acquisition fundamentals improved. But we were not satisfied with the rate of progress. Given the reality that we were not getting an appropriate return on capital we decided it was time to take more significant action.

We have stopped direct marketing activities. We are evaluating all of our options for Kemper Direct. Since our announcement, we have received a number of inquiries which we are actively exploring. Turning now to our business performance. Overall we are benefiting from the diversity of our portfolio of companies. The Life and Health businesses once again delivered steady top lines and good profits. This along with our strong portfolio yield has helped to offset losses in P&C.

In the life and health segment the top line held steady despite the discontinuation of sales of our dwelling and hospitalization products. We also delivered strong bottom line performance and have taken price increases on life insurance to help offset the difficult interest rate environment. Our Kemper Home Service Company flagship entity, United Insurance Company of America, was recognized as one of the top 50 performing life insurance companies by The Word Group, a leading provider of benchmarking and best practice services for the insurance industry.

This was the second consecutive year that our life business was recognized. In the supplemental health side I'm pleased with our reserve national team's performance as it continues its mix shift to products less affected by national healthcare reform. The investment portfolio delivered a solid performance as we navigate this low interest rate environment.

While returns on our equity method investments were lower than last year's superior results they were within our range of expectations. Despite the inherent volatility we like the expected lifetime performance of these assets. As to capital, we are in a strong position. We continue to be disciplined as we allocate capital across our four priorities which include funding profitable organic growth, considering acquisitions that have a clear fit and make our existing businesses stronger, maintaining our competitive dividend and repurchasing shares.

On this fourth point, we have repurchased just over $50 million of stock year-to-date through July which is good progress on our plan to repurchase up to $100 million in 2012. I want to be very clear about my views on the quarter. In life and health, investments and capital management we delivered solid results.

On the P&C side results were disappointing. Our priorities for P&C are the following; improve margins before growth. Increase homeowners' profitability. Achieve overall rate adequacy and continue to leverage our shared services to maximize operational effectiveness.

Now, I will turn the call over to Jim to provide color on the quarter's results and explain how his team is addressing these priorities.

Thank you, Don. Kemper's second quarter P&C results fell very short of the expectations in two primary areas. First, although CAP losses declined significantly over last year, losses in the quarter and year-to-date are well above historical averages. On a reported basis, the homeowners combined ratio was 135% and 119% for the current quarter and year-to-date respectively. Second, the P&C group's underlying combined ratio for private passenger auto deteriorated 3 percentage points over last year resulting in an overall of 106% for the quarter.

Severity is up in both liability lines and to a lesser degree in physical damage. As well some business units experienced higher claims frequency and physical damage coverages. I will provide some perspectives on what we are doing to improve the profits across the group. I will start with an overview of the entire P&C area. Second quarter CAT losses is were significant for the industry as a whole and we were not immune to that.

Our CAT losses were less than last year's record levels but are still above our expectations. So we are continuing to take actions to improve profits.

Overall while we are not ready call it a hard market, we continue to see signs of improving market environmental conditions in some states in both personal and commercial lines. Turning to direct.

I want to reiterate that we have ceased direct marketing activities. We continued to take actions at the same time to improve underlying performance. I will give you an overview of where we stand in Michigan, New York and Florida. We have exited direct auto sales in Michigan and are in the process of non renewing the book of business.

We are migrating the New York book to a new platform and we expect to achieve significant rate increases over the next two to three years. And finally, we decreased the Florida book 37% to $19 million in force over the last 12 months. And the remaining states we continue to take rate actions in line with our indications. Overall our current plans project the entire direct business to make a profit in 2013.

I will turn now to our largest P&C segment Kemper Preferred. Like others in the industry we experienced a high level of CAT losses in the second quarter. While the losses were below record levels from last year they are still way above our expectations for the quarter.

We are taking a number of steps to improve our results. On home, we are taking significant rate action in most states, increasing deductibles, especially in states with tornado and hail exposure and improving the overall accuracy of our pricing. On auto, we have accelerated our current increases and are zeroing in on any problem business.

Preferred business has several ongoing initiatives and ended in increasing agency engagement and recent customer retention ratios and continuing to increase mix of both new and renewal target market customers. As of the second quarter the target market now represents over half of our in force book.

Over the near term we are addressing the uptick in the underlying loss ratio to achieve pricing targets. In order to improve returns we are taking many actions including addressing distribution relationships having sub par loss performance trends to develop improvement plans or take other corrective actions. Continuing efforts, we are also continuing efforts to reduce the amount in mix of auto line, auto business particularly in non target market customers.

The target market business tends to be more upscale business which has better loss ratios and retention levels. And finally we are reviewing performance metrics and capital allocation plans particularly in homeowners.

I will note that some of these may result in fluctuations, some of the actions may result in fluctuations in customer retention ratios or in premium but ultimately deliver higher profit margins and return for shareholders. We expect returns in the auto line to improve faster than in the homeowner.

Lastly on preferred, let me provide an update on the comprehensive rate actions we have in the pipeline to improve profit. On the homeowners book we continue to file for double digit rate increases in many of the states that already approve them.

By the end of 2012 we now expect to achieve a countrywide rate average increase of 10% to 11%. The majority of which will earn during 2013. This 2.5 points above the original plan and we will continue to take needed rate actions.

And if those actions don't give us adequate returns we will reduce our overall exposures where targeted returns can not be achieved. On the auto book we are targeting 7 to 8 points of higher grade on a countrywide basis by the end of 2012, the bulk of which we will earn in next year.

This is also two points above our original plan for the year and is largely targeted at the severity trend we see in liability. While these actions will take some time to yield the full benefits, they are important steps for our long-term business model.

As we shift our business mix we are seeing better underlying performance of target market policies. Stepping back although we are pleased to see the positive results in the target market mix new business and policy retention metrics over the last few quarters, I want to reiterate Don's earlier comment.

Our primary focus is to improve margins across the product line and secondarily to grow the business. Turning now to Kemper's specialty. Our nonstandard segment also saw challenges in the quarter particularly in the private passenger auto line. We saw the underlying combined ratio increase by over 5 points. Primary drivers include physical damage, frequency and higher expenses.

The team is responding on multiple fronts to get ahead of those trends and restore profit including the following. The 2012 countrywide rate action target has increased from 6% to 10% and we are counting on these rate actions have been accelerated. Where possible we are restricting new business growth in lower volume states and customer segments having higher frequency until adequate pricing is achieved or other corrective actions are in place to achieve targeted returns.

In California, the businesses largest state we had our latest rate increase approved and a new personal auto classifying slated to be filed later in the third quarter with the targeted implementation date early in 2013. And finally, we have several ongoing agency engagement and customer segmentation initiatives.

We are also taking underwriting and marketing actions to improve the results over the coming quarters the commercial side and had another solid quarter and continues to grow premium. Turning now to Kemper Services Group, this group supports our P&C businesses for such areas as information technology, HR, Claims and Legal, the initiative allows us to take advantage of scale that we have across the business.

Accomplishments is to date include the integration of most aspects of the claims processes and IT effort on a fully consolidated accounted reserving and HR. In sum, we are facing our challenges head on and taking divisive actions in direct and we are addressing our issues in preferred and specialty. We are committed to improving profit of these lines and I feel good about the plans we have in place. With that I will turn it over to Dennis about the financials.

Thanks, Jim. And good morning, everyone. As you have heard, the second quarter results were below our expectations in two areas. Catastrophe losses in the homeowners book were well above historical averages and elevated underlying combined ratios were experienced in the P&C group. I will get into details by business on both of these topics as well as other performance drivers in just a few minutes. But first, let's walk through you Kemper's consolidated revenues and earnings. Reported revenues for Kemper were $609 million in the second quarter. Flat with last quarter and 6% lower than the prior year.

Earned premiums were $529 million in the quarter, down slightly from last year largely from actions taken in direct. Consolidated net investment income for the company was $75 million this quarter and included $1 million from equity method investments. Last year's net investment income was $83 million and included $11 million from equity method investments. An exceptionally strong quarter. As a reminder, this asset class inherently has a less predictable earnings pattern, but they also have historically delivered lifetime returns well above other asset classes and provide important diversification benefits for the overall portfolio.

Aside from the $10 million change year-over-year, I mentioned net investment income grew $2 million or 3% drew to higher average invested assets. The pretax equivalent annualized book yield on the portfolio was 5.6% for the period, down 50 basis points from last year. And finally, net realized gains in the quarter were $4 million pretax, lower by $14 million over last year. On a consolidated net operating basis, Kemper's second quarter net loss was just under $1 million or $0.01 per share compared to a net loss of $20 million or $0.33 per share reported in the second quarter of 2011.

This year-over-year improvement of $19 million was comprised of the following three items. First, $31 million or $0.51 per share from lower CATs, partially offset by lower after tax earnings from equity method investments of $6 million or $0.11 per share. And $5 million or $0.08 per share unfavorable impact from the increase in the underlying personal auto loss ratio across the P&C group.

Shifting to the details of each of the operating unit's performance, I will start with Kemper Preferred. Where the net operating loss for the period was $10.3 million, an improvement of $23 million over the second quarter of 2011. This improvement was primarily from $30 million lower weather-related losses which was partially offset by $4 million higher frequency and severity of non cap fire losses. $2 million of higher severity in auto liability, and $2 million lower net investment income. On the revenue front, net written premiums increased about 4% to $233 million and earned premiums grew 2% compared to the prior year.

Overall, premium retention in the first half was 88%, up two points compared to last year. Shifting to Kemper Specialty. The net operating loss in the period was $2.8 million compared to a net operating gain of $5.3 million a year ago. This result was comprised of an $11 million decline in personal auto, partially offset by $2.8 million higher earnings in commercial auto.

Let me add some further color here beginning with the drivers of the $11 million variance for nonstandard personal auto. First, the business had a $5 million shift in development. $4 million unfavorable in the current period from higher BI severity, mostly in the 2010 and 2011 accident years compared to $1 million favorable development in the second quarter of last year. Secondly, $3 million mostly due to higher claims frequency and physical damage resulting in an increase in the underlying loss ratio of 4 points. Lastly, $2 million of lower investment income coupled with $2 million of higher expenses, the majority of which was related to technology enhancements. Shifting to the commercial book.

That performed well during the quarter earning $4.8 million after tax, an increase of $2.8 million over last year. The main driver here was $2.3 million higher favorable prior year development across all accident years related to the mix shift in this product line. Kemper Specialty net written premiums were $99 million in the quarter reflecting lower volume on the personal auto side and higher volume in commercial auto. Current premiums were $107 million in the second quarter, lower by approximately $7 million compared to 2011.

Policies in force were roughly $306,000 at the end of June, down 10% over the same period last year. Let's shift to direct. The team continues to execute its plans to improve overall profitability and for the second quarter the business reported a net operating loss of $2.9 million, an improvement over last year of $1.9 million. The drivers of that variance included $2 million improvement from actions taken to reduce premium volume, $2 million improvement from lower CAT losses and higher favorable development. These favorable items were partially offset by $1 million lower income on equity method investments and $1 million unfavorable impact of increasing severity and liability lines. Let's shift to life and health.

Net operating income increased over 8% to $19.5 million from lower catastrophe losses of $3 million, which was partially offset by $1.5 million of lower net investment income. Overall earned premiums remain relatively stable at $161 million. The teams is in life and health continue to respond proactively to a challenging environment with price increases on new business, expanded supplemental product offerings and by maintaining a disciplined approach to expense management.

I will wrap up on book value and capital. Book value per share increased in the quarter to $36.42, up from $35.69 at the end of the first quarter.

Statutory solvency and surplus levels of the insurance companies remain strong. Risk based capital ratios were 480% in life and 290% for the property and casualty business. On a combined basis the insurance operating units have a max ordinary dividend capacity of roughly $175 million for 2012. Currently we anticipate that between $70 million and $90 million will be paid as dividends to the holding company during the second half of the year with all of that slated to come from the life business. In terms of liquidity the holding Company ended the quarter with cash and investments of $163 million, and a $325 million revolving line of credit remains undrawn you. I will now turn the call back over to Don.

Thank you, Dennis and Jim. As you just heard, we did have a challenging quarter yet we have solid plans in place to address the issues. At this time I would like to turn the call back over to the Operator so that Jim, Dennis and I may take your questions. Operator?

Thank you, sir.(Operator Instructions). Our first question comes from the line of Paul Newsome from Sandler O'Neill. Sir, your line is open.

Good morning. I was hoping you could -- actually, I have two topics. Let's start with the claims trend issue. I think we last discussed it seemed to be more of a PIP issue and fairly focused in a fairly small number of states, for obvious reasons. This sounds much more broad based across all of your businesses and across all of your states. Is that true and can you offer any theories as to why it may be happening?

I'm going to ask Jim Schulte to take first crack at that.

Yes. Thank you. It is definitely true that we were seeing significant issues on PIP, especially in the states of Florida and Michigan and New York on a direct basis. Late last year we began to recognize other trends beginning to develop, especially on BI and liability lines in general and to some degree on physical damage. Those trends accelerated as the year progressed and we are taking right action to address that.

So the issue that you just missed that acceleration?

I would say we saw it and it came faster than we expected.

Okay. I would like to switch very quickly to the life side of the business. Obviously on a year-over-year basis the life business is fine but sort of quarter by quarter and I think of the life insurance business not like the P&C business as being sort of more of a continuous business. The earnings were a lot less than the quarterly run rate we have seen in the past. Perhaps you could talk to that. Is this a $90 million business which is what we should think of in the quarter or is it more like a $100 plus million dollars business?

Hi, Paul. There are definitely some things going on in the the life business that over the long haul will provide challenge. The most obvious is low interest rates and our portfolio yield is holding up quite well and yet it still is down I think 50 basis points from the same quarter last year. And with roughly $3 billion of assets it has an impact. Interest rates in the future if they stay low that will continue to have some impact on this business.

Short of giving guidance, I would just say that we have been taking actions that help to offset the low interest rates. Certainly we have been trying to keep the top line steady and controlling our expenses. And in addition to that we recently took a price increase on our basic life insurance product and recognized the fact that interest rates aren't what they used to be.

I'll requeue. Thank you.

Thank you. Our next question comes from the line of Adam Klauber from William Blair.

Thanks. Good morning. Just a follow-up on Paul's question. So what is the preferred auto book, what is the rate that severity is running now versus, say, six months ago? And what type of rate increases are you putting in now in that auto book across the board compared to six months ago?

Do you want to take that one, too?

Sure, I would be happy to. At the end of the year, we had taken approximately 2 to 3 points of rate on both home and automobile. Right now, our plans on home call for about a 10% to 11% rate increase across the country during 2012 and on auto we are going to run at about 7% to 8%.

The 7% to 8% what does that compare to six months ago? Is that in that 2 to 3 range?

That would be correct.

Okay. And how about what has been the jump in severities compared to six months ago, severity trend?

It is up approximately 2% on the liability line.

Okay. And then as -- in homeowners as you have begun to put in some of the higher rate increases how have retentions been running?

Retention has remained pretty strong on homeowners. We really target packaged business, which combines auto and home together and retention has stayed up pretty well on home.

Okay. That's good to hear. And then nonstandard specialty book, what type of rate increases are you putting in that book of business for the higher PD?

We are taking approximately 8% to 9% year-over-year. We intend to have that by year end. And that would be up significantly from last year.

Okay, great. As far as the direct business, you mentioned you have already received several inquiries. Are you running a process through a banker, going out to people or is it more parties calling interested in the division?

Adam, we did note that we had several inquiries and let me just expand a little bit on this topic. As Jim indicated, we expect to be profitable in 2013 with the succession of the marketing spend and actions taken in some of the problems states and with a significant seasoned book our internal options include profitability. So any external option will have to be better than our internal option.

We are are trying to do this on a relatively fast but careful and cautious basis, a thoughtful basis rather. So we are unlikely to have -- we are not going to have a standard auction where we spend a long time trying to round up people, but likely suspects have come to us and will be identified quickly and we should reach a conclusion for what is best for shareholders in the not too distant future.

Great. How much capital supports that business?

Dennis do you want to take that one?

Sure, we've got roughly $175 million supporting that business line.

Okay. Okay. Thank you very much.

Thank you. And, our next question comes from the line of Steven Schwartz from Raymond James & Associates.

Hey, good morning, everybody. Just to follow up on the last question. Don, you are renewing, right, on the direct marketing side of the business? It is just that there is no new sales outside of the three states?

Outside of the three states we are stopping marketing spend but we are fulfilling sales. Some sales come to us -- continue to come to us through the website so, on affinity cases that are in place, so we are fulfilling sales. We haven't discontinued new sales, we have discontinued marketing spend.

Okay, I guess I don't understand, maybe, if I'm a client of Kemper Direct and I want to renew six months from now can I or not?

Yes.

Yes, okay good. Just making sure. If I can, on the life side. I have been well aware for a long time there has been -- there is seasonality on the loss ratio although it didn't seem to show up in this quarter. What I'm wondering about is on the expense side. Is there seasonality on the expense side because the expense ratio is much higher than the last quarter. I actually see that has been a pattern for the last couple of years?

Dennis, do you want to help out on that?

I would say there is not really any identifiable seasonality to that business. There are fluctuations quarter to quarter but no -- nothing that I would point to that would drive any sort of meaningful expense fluctuation.

Okay. And then one more, if I may, on life and then I will go back to auto. There has been a -- there is a lot of talk about ACA coming in 2014 and the potential to maybe arbitrage the costs, arbitrage the penalties, arbitrage the fact that it is guaranteed issue with accident and health and other types of policies. I'm kind of wondering if Reserve National is looking at that?

When you step back at a high level, here is how we are thinking about Reserve National, they have been as you know and we talked about previously since late 2009 they have been repositioning their business, their product suite, as well as repositioning the distribution force and away from those products that have been most affected by national healthcare reform and towards a much broader array of supplemental product offerings that should be far less likely to have any negative impact as that comes into full implementation which, quite frankly, is still in many ways just uncertain at this point.

So they have been thinking about the issue that you raise but forging ahead and just really doing all the necessary blocking and tackling on the distribution and product side to continue to move the business forward so that whatever may develop they are as well positioned as they can be for those changes.

I just add that we have continued sales of the hospitalization product which are subject to the medical loss ratio requirements and the field force is making the transition very nicely.

Okay. And then finally for Jim, with the price increases that you are talking about, I think it was Don that said he thought maybe not ready to call hard market but things are changing. Are you -- looking at this, are you going be in line when you are done competitively do you think, Jim?

Yes.

Okay. Alright. Thank you guys, very much.

Thank you. Our next question is a follow-up from the line of Paul Newsome from Sandler O'Neill.

I just wanted to make sure, the area of price increases for the auto and home business with personal lines, is that enough at this point to get you to a level of profitability that you think you should have? Or are we sort of implying more than one round of price increases above the underlying claim costs.

Because I'm thinking simple math, you are still in the 110 combined, and with in price increases are probably, you know, 8 or 9. And you have underlying loss cost trend of maybe three or maybe even four. So that takes you from a 110 to something still probably not break even. Am I too simple on the math or do we need more price increases?

I will answer it in two ways. One, on homeowners, I believe homeowners will take a series of rate increases over the coming years to bring that line back to profit. As you know, homeowners is heavily driven by weather and weather can change overnight and that picture could clear up very quickly. Auto actions there will show up much quicker but even there it will take a series of rate increases to bring us back in line.

And I would just add Paul that 110 is probably not the right starting point for your simple approach because it does include some abnormally high weather.

From his lips to God's ears, I hope that's right. The weather's been bad.

Thank you. And I see no additional questions in the queue at this time.

Thank you, operator. This is Diana. If anybody has any follow-up calls you can contact me directly.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone, have a good day.