Kemper Corp (KMPR) 2013 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Kemper's fourth-quarter 2013 earnings conference call. My name is Jonathan, and I will be your coordinator today. (Operator Instructions). 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.

Thank you, operator. Good morning, everyone, and thank you for joining us. This morning you will hear from two of our business executives starting with Don Southwell, Kemper's Chairman, President, and Chief Executive Officer; followed by Frank Sodaro, 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 presenters will be joined by John Boschelli, Kemper's Vice President and Chief Investment Officer; and Ed Konar, Kemper's Life and Health Group Executive.

After the markets closed yesterday, we issued our press release and financial supplement. You can find these documents on the investor section of our website, Kemper.com.

Please note that our discussion today may contain forward-looking statements. Our actual results may differ materially from these statements. For information on potential risks associated with relying on forward-looking statements, please refer to our Form 10-K and 10-Q reports filed with the SEC as well as our fourth-quarter 2013 earnings release. We plan to file our 2013 Form 10-K on or about February 14, 2014.

This morning's discussion includes non-GAAP financial measures that we believe may be meaningful to investors. In our supplement and earnings release, we have defined and reconciled non-GAAP financial measures to GAAP where required in accordance with SEC rules. And finally, all comparative references will be to fourth-quarter 2012 unless we state otherwise. Now I will turn the call over to Don.

Thank you, Diana. Good morning, everyone, and thanks for your interest in Kemper. Today I will discuss our overall results for the quarter and the year, and Frank will review details on our financial results, capital, and liquidity. Then I will wrap up.

Before we start on the commentary, I want to mention that Denise Lynch, our Property and Casualty Group Executive has a schedule conflict so I will be covering P&C results in addition to the Life and Health Group results. Fortunately, those of you who will be participating in the 2014 Association of Insurance and Financial Analysts, or AIFA conference, in three weeks will have an opportunity to see Denise in person as she will be a member of the P&C personal lines panel. Denise and Frank will also be participating in Kemper's one-on-one meetings at that conference.

Now let's turn to our results. In total, we're very pleased with our progress in the fourth quarter as well as for the full year. We earned $55 million in net income in the quarter and $218 million in net income for the year. We finished the year with an ROE of more than 10%. Like others in the P&C industry, we benefited from low catastrophe levels and favorable development, but we also made significant tangible progress in our run rate. We had a very good year. I feel great about our team's results, and we are well positioned for continued improvement and profitability.

Our Property and Casualty Group delivered another quarter of substantial improvements. We achieved our goal to reduce the Group's underlying combined ratio by 3 to 5 points in the year, delivering a 4 point reduction in total.

As Denise mentioned in past calls, we focus intently on long-term profitability even at the expense of the top line in the short term. While our underlying performance significantly improved, we still have work to do. We continue to focus on aggressive action such as rate increases, improved underwriting discipline, and product line management.

Four key P&C highlights this quarter includes: first, the total Group's combined ratio improved 20 points to 95. The underlying combined ratio also improved by nearly 5 points to 98 with each of our segments contributing to this improvement.

Second, weather remained less active in the quarter with catastrophe losses significantly below the levels we saw in 2012.

Third, we're making progress with the actions to improve pricing, product management, and analytic capabilities, and we will continue to focus on these areas. Accordingly, the Property and Casualty Group continued its strategic reduction of the earned premium, shrinking 5% overall in the year.

And fourth, the direct runoff continues to go very well.

Now, I will walk through a few more detailed comments on our product lines.

We continue to optimize our business mix to drive improved performance. For example, our Package Plus product, the premier offering for the Kemper Preferred segment, paid up 67% of all new preferred sales in the quarter and 61% for the year.

The homeowners' line continued to show improvement. We achieved a 14% filed rate increase in 2013, up from our original 10% plan. We have another year or two of increases to achieve full-rate adequacy, and we think the market will support this. This remains a priority as we continued to implement appropriate actions to improve and sustain the performance of the homeowners' book of business.

Auto progressed as well, but more slowly than did homeowners. We continue to take aggressive actions to improve auto profitability in the both Preferred and Specialty.

Kemper Direct outperformed once again as we continue to wind down the direct-to-consumer business. Direct benefited from low cat losses, the elimination of marketing expenses, and continued favorable development. The tendency of season business to perform better coupled with significant rate increases led to the underlying combined ratio improving 19 points year to date. We are very pleased with the results this team has delivered, and I believe they will continue to manage Kemper Direct's underlying loss ratio at about these levels. But fixed expenses will put some upward pressure on the expense ratio.

So to summarize the Property and Casualty Group, we're pleased with our progress in many areas, and we are focused on delivering further improvement. We are targeting a 2 to 4 point improvement in the P&C Group's underlying combined ratio in 2014. We expect this improvement to have some impact on our top line although premium reduction should moderate as the year progresses.

Written premium increases in Preferred and Specialty should mostly offset the runoff in Direct. Earned premiums will, of course, lag written premiums.

Turning now to Life and Health, earnings were up 2% in the quarter. Last quarter, we told you we expected the Life and Health segment earnings in the second half of 2013 to be at about the same level as the second half of 2012. We exceeded that forecast by $4 million and delivered $89 million of earnings in total four 2013. Overall, our total life insurance premiums grew with the Reserve National business fueling the growth. Life insurance premiums in the Kemper home service companies were fairly stable.

Our Reserve National business continues its expansion strategy in supplemental products with both new and existing distribution channels. As we have seen in recent quarters, expenses are up somewhat with more people and more commissions supporting our diversified model, but we're pleased with the market interest. The team remains agile as national healthcare evolves. It is still early. And we are keeping a close eye on the team's plans and progress, but we like what we see so far.

Turning now to investments, the portfolio delivered another quarter of solid results mainly from higher returns on equity method investments. Our LPs and LLCs tend to do well over time, but are subject to some volatility. The performance of these assets drove the overall portfolio performance.

We continue to anticipate a rising interest rate environment in the year despite January's decline.

Now, I will turn the call over to Frank.

Thanks, Don, and good morning, everyone. Today I will cover Kemper's fourth-quarter 2013 performance and parent company capital and liquidity.

As Don mentioned, overall we capped off another very strong year with another solid quarter. We delivered net income of $55 million, or $0.99 per diluted share, up from $2 million, or $0.03 per diluted share. Results included $9 million of after-tax net investment gains in the current quarter compared to $2 million last year. For the full year, net income was $218 million, or $3.80 per diluted share, more than double the $103 million, or $1.74 per share we earned last year.

Our net operating income was $46 million for the quarter compared to net operating loss of $3 million last year.

For the year, net operating income was $159 million, up from $54 million last year.

Total revenues were $586 million for the quarter, a decrease of $11 million due to lower earned premiums offset by higher net investment gains and higher net investment income. On a full-year basis, revenues were just over $2.425 billion, down $36 million from 2012 driven by lower earned premiums, offset by higher net investment gains and higher net investment income. The earned premium decline were in line with our expectations and mainly the result of profitability improvement actions we took across our P&C businesses.

Consolidated net investment income was $77 million in the quarter, an increase of $4 million driven by higher equity method investment income. These investments earned $7 million in the quarter compared to $2 million last year. Excluding these equity-method investments, net investment income decreased slightly due to lower yields offset by higher average investment pace.

Fourth-quarter annualized pretax equivalent book yield on average invested assets was 5.5%, up about 10 basis points. Our average investment grade fixed-maturity reinvestment rate increase about 90 basis points sequentially to just over 4%, although the amount reinvested was lower.

Net investment income for the year was $315 million, up from $296 million in 2012 and largely the result of higher returns on our equity method limited liability investments.

The year-to-date pretax equivalent book yield on average invested assets was 5.7%, up about 15 basis points from 2012. We are pleased that the reinvestment rates have increase, but they still remain below the book yield on our existing portfolio.

Now, I will discuss the financial results of each of our businesses starting with P&C. Kemper Preferred reported net operating income of $23 million for the quarter, up from a net operating loss of $20 million last year. Overall, Preferred's combined ratio improved 28 points, 91.5% for the quarter, due to lower catastrophe losses, improved underlying loss results, and the impact of net favorable reserve development partially offset by higher expenses.

The underlying loss ratio improved almost 8 points, primarily as a result of the higher average earned premiums outpacing loss costs for homeowners and auto.

Insurance expenses increased primarily from higher employee costs.

For the year, Preferred's underlying combined ratio was 95%, improving from 97% in 2012 as improvements in homeowners and other personal insurance lines offset a slight deterioration in our auto underlying loss ratio.

As Don mentioned, we continue to take aggressive actions to improve the performance of the auto line. While the average earned rate increase was 4.5%, this was the fourth quarter in which the pure premium has increased mid-single digits, largely driven by higher severity and bodily injury. We continue to work on price adequacy with improved price segmentation and filed rate increases, which were about 9% for 2013.

Preferred's net written premiums were $193 million in the quarter, which is about $20 million lower than last year, and net earned premiums were $216 million in the quarter, down $8 million. The drops in written and earned premium were driven by a lower level of auto policies, partially offset by higher overall premium rates. In total, premium retention was 85%. On a full-year basis, net written premiums decreased 5%, and full-year net earned premiums were about flat with 2012.

Now turning to Kemper Specialty, we reported net operating income of $1 million for the fourth quarter, up from a net operating loss of $3 million last year. Combined ratio in Kemper Specialty improved almost 5 points to 105%. The underlying combined ratio improved 1 point this quarter due to the favorable impact of our rate and underwriting actions even with the headwinds of 5 points of adverse development from the first three quarters of the current year. Full-year 2013 underlying combined ratio improved 2 points to 103%.

Specialty's net written premiums were $85 million in the quarter compared to $95 million last year, and net earned premiums were $95 million compared to $103 million last year. Overall, premium retention was 66%. These results are driven by rate actions we implemented which contributed to a decline of 17% in total segment policies in force. For the year, net written premiums decreased 8% to $383 million, and net earned premiums decreased 6% to $393 million.

Now, I will turn to Kemper Direct. In the quarter, we reported net operating income of $6 million, up from $2 million last year with an 82% combined ratio this year compared to a 103% last year. The underlying combined ratio improved almost 8 points to 103% driven by lower expenses and 2 points of improvement in the underlying loss ratio. The expense ratio improvement was primarily from lower employee compensation and lower restructuring charges. Kemper Direct's net earned premiums were $28 million for the quarter, down from $37 million and in line with our expectations.

Auto and home average earned premium rates increase in the quarter by 6% and 11%, respectively, but were more than offset by lower volume. Going forward, we expect the direct-to-consumer portion of this business to continue to decline at roughly the same pace as 2013. In line with the reduction in premium and the runoff reserves, we currently allocate roughly $135 million of capital to Kemper Direct.

Shifting to the Life and Health segment, net operating income overall was $25 million and $89 million for the quarter and year, respectively, compared to $24 million and $91 million in 2012. Earned premiums decreased slightly to $157 million in the quarter and $633 million for the year. Net investment income was flat for the quarter, but increased $4 million after tax for the year, largely from higher return on equity method investments.

For the quarter, the life business incurred higher start-up costs related to Reserve National's new distribution initiatives, but these expenses were offset by lower home-service agent commissions.

Finally, I will discuss book value, capital, and parent company liquidity.

Book value per share was $36.86 at the end of the quarter, up $1 from the third quarter, but down slightly from prior year end. The impact of higher interest rates on our fixed maturity portfolio was a drag for both the quarter and the year. Book value per share excluding unrealized gains on fixed maturities was $34.49, up more than $1.50 from the third quarter and up close to $4.00 from prior year end.

Statutory surplus levels in the insurance company remains strong, and we estimate that we will end the year with risk-based capital ratios of approximately 440% for our Life and Health Group and 360% for our Property and Casualty Group. We estimate that our insurance companies will have a maximum ordinary dividend capacity of about $215 million in 2014 comprised of $80 million from life and health and $135 million from P&C. We expect both Groups to pay dividends to the parent company in 2014, but we have not determined the levels at this point.

Turning to liquidity, in the fourth quarter, Kemper subsidiaries, United and Trinity, became members of the Federal Home Loan Bank of Chicago and Dallas, respectively. In connection with this, we reduced our revolving line of credit $225 million from $325 million. These memberships give United and Trinity access to cost-efficient sources of liquidity and, consequently, reduce the need for as large of a credit line at the parent company level.

At the end of 2013, the parent company held cash and investments of about $160 million and our $225 million revolving credit line remains undrawn.

And now, I will turn the call back over to Don.

Thank you, Frank. As you have just heard, our capital position remains strong. Our long-term capital deployment priorities continue to include: first, funding profitable organic growth; second, strategic acquisitions; and third, returning capital to shareholders, both through share repurchases and dividends.

We are achieving profitability and remain committed to further improvement. But we are selectively funding organic growth in some areas. In total, premium revenues are expected to remain flat to declining in 2014 so organic growth will not use capital this year.

As results improve, we are more open to acquisitions, and we intend to keep powder dry for opportunities. We have maintained our competitive dividend and continue to buy back shares opportunistically. In the fourth quarter, we repurchased $15 million with the common stock bringing our 2013 total to 3 million shares repurchased for just over $100 million.

In 2013, we communicated our goal to achieve a double-digit ROE by the end of 2015 on a run rate basis. And we outlined a path that had four main elements: one, continued improvement in our P&C combined ratio; two, full deployment of available capital; three, increases in interest rates consistent with the Federal Reserve baseline scenario; and four, normalized catastrophe losses.

While we hit a double-digit ROE in 2013, some of the profits were of a nonrecurring nature, so we do not consider our goal to be achieved. Nonetheless, our actions and results to date are consistent with our plans to achieve double digits by the end of 2015. We do expect some volatility along the way. External factors such as cats and interest rates affect ROE, and importantly, we will need opportunities to fully deploy our capital. Regardless, we like our business model and our team's commitment to delivering results.

So in closing, we had another very good quarter and a very good year. Our underlying performance continues to improve. Our actions are aligned to drive further progress, and we outlined a few milestones for you on this call. We are committed to delivering, and we are optimistic about our prospects.

With that, I will turn the call back over to the operator so we may take your questions. Operator.

(Operator Instructions). Miranda Davidson, Raymond James.

Everything looks pretty good this quarter and pretty straightforward. So I thought I would just revisit the Direct runoff. Is there any more color you would like to add on the running off of the direct-to-consumer part or the investing back in the affinity book? And as things continue to improve, does that make selling the unit anymore attractive?

Miranda, thanks for your comments. There isn't a lot more color to add around Direct. It is not something that we have seen that we would put on a block. It is performing well. The only color I would add is that the amount of development we had this year was pretty significant. And certainly wouldn't want you to build that in your models going forward.

Okay, thank you, Don.

Adam Klauber, William Blair.

In the Preferred segment, how is the standard loss ratio accident, your ex-cats this quarter versus last couple of quarters?

You want to repeat that question, Adam? I didn't --

Sure. I am looking for the auto, the core auto loss ratio in the Preferred business for the quarter versus what it was in the first nine months.

Frank, do you have that available?

I could take a shot at this. So auto and preferred we have an underlying loss ratio improvement of about 2.5 points. And that is on lower frequency offset a little bit by higher severity.

As far as compared to prior quarters, I don't have that handy.

Okay. 2.5 is good. Do you know if it was running lower than it was earlier in the year?

We will have to get back to you on that, Adam. But we can give you call and get you that info.

That would be helpful.

Also, could you talk about competitive trends in the standard auto market? What has gone on in the last six months? Have they heated up or is it status quo where we were at before?

I would say it is probably up a little bit. Certainly what is going on with Travelers and Quantum is -- the jury is still out on where that is going to head. But people are starting to make noises about growth and adequacy.

I guess we haven't seen it quite so much in a marketplace as we have heard the noise about it though.

Okay, that is good. And then the last question, it looked like for the quarter the loss ratio in Specialty moved up. What drove that increase?

Frank, do you want to take a crack at that?

Sure. So for the quarter the loss ratio for special -- I will break it down into two pieces. The underlying loss on personal lines under personal -- private passenger auto was really about flat on the underlying basis. Commercial had actually a better underlying loss ratio than prior fourth quarter, going from a 92.4 down to a 78.

So I know there was some noise on Specialty lines because we had some inter-year development.

Okay.

This is kind of a hard thing to walk through. But if you want me two a quick shot at this, I can. And I will walk from some of the numbers we have given. Starting with an underlying combined ratio, Specialty overall had an improvement of about 1 point. In the current year, there was some adverse development from the first three quarters of about 5 points. And if you were to look at last year, there was a similar phenomenon last year where the first three quarters had 3.5 points of adverse development. So on a modified basis, the underlying combined ratio actually improved about 2.5 points.

So including that then to get to a loss perspective, the expenses were up about 1 point.

So all said and done, there was about a 3.5 point improvement on a modified basis for the underlying loss ratio.

Okay.

You might have to look at the transcripts to follow that, but --.

No, that all make sense. That makes sense. Okay. Thank you very much.

Paul Newsome, Sandler O'Neill.

I was hoping to maybe move away from the property and casualty business and maybe revisit on the scenario -- well, I actually have two questions both focused on life.

The first question is, if we take out the changes in interest rates in look at measurements like policy-in-force growth and total insurance value, is the life insurance business growing or not?

And then the second question is [relatedly], under what scenarios do we see higher earnings in the life insurance business?

Well, I'm going to ask add to follow up my initial commentary, but in terms of growth, this quarter we did see some growth in the life insurance segments, but it was driven by growth in some of the new distribution efforts at Reserve National.

So typically, we have had a very modest decline in premiums in this business as it is a relatively mature business.

Ed, do you want to take a crack at rounding out that answer?

I think you got the main points. And our traditional home service business is in a modest shrink mode but actually pretty stable the last few years. Over on the Reserve National side we have got some different distribution initiatives underway. And the first of those sells primarily a final expense life insurance to senior citizens. That is what is fueling most of life insurance growth this year and probably into the near-term future.

Were there other elements to that question we missed?

Is there a scenario where the business -- where the earnings go up?

Sure, earnings have been growing in that business over recent years. And then there is a headwind with declining interest rates. So as interest rates climb back up, our reinvestment rate even at today's rates is lower than our portfolio rate. So they have to go up more before we start adding investment income. But we could potentially grow the profits in other ways. And Ed wants to tell you about that.

What I would add to that is over the last two years we have taken two rate increases. We took one in the spring of 2012, and we took another one the first of this year. And we took rate increases of roughly 5%, which when we calculate that back to what an equivalent is in terms of investment income, a 5% rate increase on the premium we charge our policyholders is worth about 100 basis points -- lower investment income over the life of the policy. So over the last two years we have built in a lower expectation from investment income.

And the only thing I will add to that is that unlike property and casualty, new business pricing is on new policies sold only, and in-force products aren't affected by those rate increases that Ed talked about, so it is comes in a little more slowly.

Great. Thank you.

Matt Carletti, JMP Securities.

Just a couple of questions. The first one on the reiterating the guidance and saying a double-digit ROE on a run-grade basis by the end of 2015. I was hoping you could clarify that a little.

When you say on a run-rate basis, is that ex one-timers full year 2015 you expect to be in the double-digit range? Or is it that by the time we get to the end of 2015, say, the latter part of the year if you annualized the quarterly results, we should be on pace for a double-digit ROE?

It is the latter.

And then the only other question I had is, some companies have given some color around January non-cat weather, the winter storms, particularly in the South. Are you able to give us any guidance in terms of what you have seen so far in your book? That would be helpful. Thanks.

Sure. We have got some preliminary reserve set up for those winter storms. And it is not material or we would have put something out on it. But most of our losses are freeze related and homeowners related. But it is certainly a noticeable uptick because of that, but it is nothing unusual for us.

All right. Great. Thanks for the answers and congrats on a nice year.

Thank you.

(Operator Instructions). And this does conclude the question-and-answer session of today's program. I would like to hand the program over to Don Southwell for closing comments.

Thank you, operator. I do have just a few closing comments.

2013 was a very good year -- a banner year. I am proud of the progress that our teams are making. And while we know we have more to do, this was another strong quarter and a great year for Kemper. So I want to say thank you to them Kemper team including our agents who helped deliver these terrific results.

We remain committed to fulfilling our promises to our customers and to delivering shareholder returns, the kind of returns we all seek. So thank you for your time this morning. We look forward to updating you on our progress again at our next call.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.