Kemper Corp (KMPR) 2014 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Kemper's third-quarter 2014 earnings conference call. My name is Danielle and I will be your coordinator for today. (Operator Instructions) As a reminder, the 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 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 Frank Sodaro, Kemper's Senior Vice President and Chief Financial Officer.

We will make a few opening remarks to provide context around our third-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 Conar, Kemper's Life and Health Group Executive.

After the markets closed yesterday, we issued our press release and financial supplement. In addition, we filed our Form 10-Q with the SEC and 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, filed with the SEC on February 14, 2014, as well as our third-quarter 2014 Form 10-Q and earnings release.

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 the third quarter of 2013 unless we state otherwise.

Now I will turn the call over to Don Southwell.

Thank you, Diana. Good morning, everyone, and thanks for joining us on our call this morning. I will provide a few opening comments, including an update on our life and health segment and our investment performance.

Denise will update you on the property and casualty segment performance. Frank will cover financials, capital, and liquidity. I will then close with a few remarks on our capital deployment before we go into the question-and-answer session.

Let's start with the total view. At the end of the quarter, we announced a $35 million after-tax write-off of software for the property and casualty group. We included this non-cash charge in net operating income, but it is also instructive to consider our performance without the charge to better see trends, which included underlying improvement in many areas.

So in total, our net operating income decreased $37 million to $2 million. Excluding the software write-off, net operating income for the quarter was almost flat with prior year, as improvement in the property and casualty underlying loss ratio nearly offset lower net investment income.

Turning to our life and health segment, we had a good quarter, but not as good as last year. We reported $20 million in net income, down $3 million. Net investment income and lower premium revenue drove the decline. These were partially offset by lower benefit payments and insurance expenses.

Premium revenue for the quarter was down 4%, although flat sequentially, primarily from a lower level of accident and health insurance premiums. Most of this premium decline is due to the nonrenewal of a portion of Reserve National's hospitalization policies. These were required to be nonrenewed in 2014 in accordance with the new national health care law.

In addition, many of these hospitalization policyholders also owned other Reserve National supplemental policies, which they allowed to lapse when the mandatory hospitalization nonrenewal occurred. Partially offsetting this decline was an increase in premium revenue from new supplemental products, which totaled about $2 million in the quarter.

Life insurance premiums decreased 2% in the quarter, with a decrease in Kemper's home service life premiums being partially offset by an increase in life premiums from Kemper Senior Solutions.

Net investment income supporting the life and health segment decreased $7 million, so with about $4 million coming from equity method investments, where we do expect some volatility, and the remainder coming from lower income from other equity interests and lower yields in this low interest rate environment.

In total, insurance expenses declined in line with the decrease in earned premiums. We continue our investment to grow the Kemper Senior Solutions and Kemper Benefit businesses, but some of this spend was offset by lower operating expenses at Kemper Home Service.

Kemper Senior Solutions and Kemper Benefits generated $5 million in earned premium in the quarter. Now I will remind you that these businesses are still in the early stages, so while market reception is favorable, expenses are still high relative to premiums, producing some drag on current earnings.

Now I will turn to our overall investment portfolio performance. We continue to see solid results, given the challenging investment environment. Our total return was positive for both the quarter and year to date, coming in about 1.3% and 7.4%, respectively. This was driven by increased bond values from declining interest rates and equity appreciation.

For the year, we have purchased $400 million of fixed maturities. This included purchasing more than $280 million of investment grade bonds with a pre-tax equivalent yield of 4.5% and more than $120 million of noninvestment grade bonds to replace most of the noninvestment grade redemptions to date.

So our diversified fixed income portfolio remains 93% investment grade. We do not expect a material change in our overall noninvestment grade fixed income allocation.

Now I will turn the call over to Denise to discuss our property and casualty segment results.

Thanks, Don. Property and casualty insurance segment reported a net operating loss of $14 million, down from net operating income of $23 million. Excluding the software write-off, property and casualty net operating income was $22 million, with solid improvement in the underlying book of business.

Overall, our underlying loss and LAE ratio results continue to improve. In the quarter, underlying loss and LAE ratio improved 3.5 points, with 6 of the last 7 quarters showing quarter-over-quarter improvement. We feel good about the profitability momentum and look forward to continued progress.

Overall, catastrophe losses were below our expectations, but not as low as third quarter of 2013, which was an unusually light catastrophe quarter.

While we remain focused on improving profitability, we are also addressing topline challenges. Overall, net written premium was down 11%, primarily as a result of our deliberate actions to improve the overall quality and price adequacy of our book of business and to reduce catastrophe exposures. We are encouraged by agent engagement trends on new business and look forward to continued progress.

As we implemented profit improvement strategies, we have also seen pressure on the retention front. While our premium retention is lower than expected, we feel good about the risk quality and improving price adequacy of the book of business.

Turning to expenses, excluding the software write-off, our total expenses were down over $7 million, as we are benefiting from lower acquisition costs as well as from lower expense levels following the organization realignment we implemented earlier this year. That said, we are seeing pressure on our expense ratio because of the lower premium level.

Earlier in the year, we indicated we are targeting a 2 to 4 point improvement in our underlying combined ratio in 2014. While we are achieving progress on the underlying loss ratio, the expense ratio deteriorated with a decline in earned premium. We expect the pressure on the expense ratio to persist.

Now I will provide some color on each of our lines of business. I will start with auto. Private passenger auto experienced the biggest revenue pressure, with net written premium declining 13%, with roughly 20% of that decline related to the runoff of our direct-to-consumer business.

New business levels are starting to improve, but written premium is down. Blended premium retention, which includes both standard preferred and nonstandard books, was down 4% to 74.2%.

The loss in LAE ratio improved one point, as a three point improvement in the underlying loss and LAE ratio was offset by higher catastrophes and a lower level of favorable reserve development.

Average earned premium increased more than 3% and exceeded loss cost trends. Our low single-digit loss cost trends are mostly consistent with the industry. In the last year, bodily injury frequency has declined, while bodily injury severity has increased by low single-digits, both consistent with the industry. Property damage and collision loss costs have escalated by mid-single digits, also consistent with industry trends.

In commercial auto, net written premium increased 8%. The loss and LAE ratio was 78%, with the underlying loss and LAE ratio up a point to 82%. This remains an area of focus as we continue to shift the book to lower weight vehicles and lower limit policies.

In homeowners, net written premium was down 8% from both lower new sales volume and lower premium retention. Premium retention was down 7 points to 84.7%. Home loss and LAE ratio improved 7.3 points to 58.9%. While catastrophe levels improved sequentially, they are still higher than what we saw in the third quarter of last year, which was a light catastrophe quarter.

Homeowners underlying loss and LAE ratio improved 9 points to 49%, reflecting an increase of 11% in average earned premium and flat pure premium trends. We are pleased with the continued progress we are making on homeowners as a result of our focused profit improvement actions.

So looking at the property and casualty segment in total, performance and outlook improved in the following key areas. Our underlying loss and LAE in auto and homeowners improved quarter over quarter in 6 of the last 7 quarters. Underwriting expenses were down $7 million year over year and we continue to have a sharp focus on expense management. New business writings improved each quarter of 2014 and the direct-to-consumer runoff continued to proceed well.

We remain focused on driving initiatives to improve profitability while gradually improving premium retention and new business.

Now I will turn the call over to Frank.

Thanks, Denise, and good morning, everyone. Today I will cover Kemper's overall third-quarter 2014 performance, capital, and parent company liquidity.

We reported net income of $5 million, or $0.09 per share, compared to $70 million, or $1.23 per share, last year. Our net operating income was $2 million, or $0.04 per share, for the quarter compared to $39 million, or $0.69 per share, last year.

Both net income and net operating income included the previously announced software write-off of $35 million after-tax or $0.67 per share. Total revenues were $540 million for the quarter, a decrease of $96 million, resulting from a $45 million decline in earned premiums, $41 million lower net realized gains, and $10 million lower net investment income.

$39 million of the decline in earned premium was from property and casualty, of which $7 million was from the continued runoff of our direct-to-consumer business. And $6 million was from lower life and health earned premiums.

The net investment income decrease of $10 million was driven by lower income on our equity securities, fixed maturities, and equity method investments. The third-quarter annualized pre-tax equivalent book yield on average invested assets was 5.1%, down about 80 basis points from last year. Now I will discuss the financial results of each of our businesses.

The property and casualty insurance segment reported a net operating loss of $14 million for the quarter compared to net operating income of $23 million last year. The current quarter results included the $35 million software write-off.

Excluding this impairment, the property and casualty segments combined ratio improved 0.8 points 96.1% for the quarter, driven by improved underlying loss and LAE results, partially offset by higher calendar quarter catastrophes and higher expenses as a percentage of earned premiums.

The underlying loss and LAE ratio improved 3.5 percentage points to 66.8%, primarily from higher average earned premium rates in personal auto and homeowners. Catastrophe losses and LAE were $14 million in the third quarter compared to $10 million last year.

Insurance expenses, excluding the write-off, dropped $7 million, but the expense ratio increased 1.4 percentage points to 28.1% in the third quarter, driven by the lower premium base.

Now shifting to the life and health insurance segment. Net operating income was $20 million for the quarter compared to $23 million last year. In the third quarter, net investment income decreased $7 million compared to last year.

Insurance expenses decreased $4 million as lower home service agent commissions and lower legal expenses were partially offset by higher start up costs related to our Reserve National growth initiatives. I'll now cover book value capital and parent company liquidity.

Book value per share was $39.96 at the end of the quarter, up more than 8% from year end, largely from the impact of lower market yields on our fixed maturity portfolio. Book value per share, excluding unrealized gains on fixed maturities, was $35.31, up 2% from year end due primarily to the impact of net income.

Statutory surplus levels in our insurance companies remain strong and we estimate that we will end the year with risk-based capital ratios of approximately 430% for our life and health group and 330% for our property and casualty group.

Overall, we estimate that we ended the quarter with more than $250 million of excess capital. The software write-off did not impact our calculations of excess capital or statutory surplus, because the asset was not admitted for statutory accounting.

During the quarter, the life and health group paid a dividend of $54 million to the holding company and we're planning for our insurance subsidiaries to pay additional ordinary dividends of at least $25 million during the fourth quarter.

Turning to liquidity. At the end of the quarter, the parent company held cash and investments of about $300 million and our $225 million revolver remained undrawn.

Now I'll turn the call back over to Don.

Thanks, Frank. As you just heard, we are in a strong capital position. Our long-term capital deployment priorities remain unchanged.

First, funding profitable organic growth. Second, strategic acquisitions. And third, returning capital to shareholders, both through share repurchases and dividends. We make our near-term decisions within this framework as we evaluate options.

Beginning with our first priority, we are selectively funding organic growth in certain areas, yet in total, premium revenues are declining in 2014, as we shared with you earlier. As a result, organic growth will not use capital this year.

As for our second priority, we routinely evaluate opportunities for strategic acquisitions and are keeping some powder dry.

Turning to our third priority, returning capital to shareholders, we repurchased more than 800,000 shares in the third quarter. In addition, we maintained our competitive dividend. In total, we've returned $43 million to shareholders in the quarter and $146 million year to date.

When we look at our progress overall, we are pleased in some areas and remain committed to continuing our turnaround in others. We are optimistic about our prospects.

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

(Operator Instructions) Carl Dorian, Raymond James.

So I had a couple of questions. First of all, I was curious about what your latest thoughts are on telematics?

Denise, you want to grab that one?

Sure, I would be glad to grab that. Good morning. We've been looking into telematics and the various applications of telematics, both from a rate perspective and a customer experience perspective.

And what I would say is we continue to look at that and continue to examine exactly when and how we want to apply telematics in our business model.

Say that again? And I also had a -- I guess a couple more -- I was really interested also in any thoughts you guys might have on the pricing cycle in homeowners. Are we the near the top? Or is there [someone left]?

I will take that one as well. Our point of view from our book of business is that we will continue to evaluate how our book is performing relative to expectations. We will continue to look at what indications tell us about the book of business and loss trends and then we will continue to take an appropriate amount of rate or other underwriting actions to achieve the outcome that we want.

Looking more broadly in the marketplace, we do continue to see, I would say, disciplined underwriting and disciplined rate taking in the homeowners marketplace.

You guys haven't made up your mind or have any thoughts on where exactly the industry is as far as the market as a whole?

Homeowners, it's a volatile marketplace, particularly when I think about catastrophes. This year, maybe for the industry, is turning out perhaps to be a lighter year, but -- and last year was a lighter year, but there's still volatility that can affect carriers in very different ways.

I guess I think about it and I think that carriers are in different places. And so I guess I believe that there is still some need to continue to address profitability and to get appropriate returns over the long term and not just in a single year. So I would say that there are still some need for rate in the industry and we will continue to see that.

And if I can sneak in one last one. How much of -- related to the Reserve Nationals, how much of the non-Obamacare policies have you guys sold in the fourth quarter of last year? If you have that number?

I'm sorry, could you repeat the question?

The non-Obamacare hospitalization policies for Reserve National sold in the fourth quarter of last year?

We don't sell any policies that are part of the Obamacare exchanges. All of the policies that we sell are various kind of supplemental products that are not subject to those rules. That answer your question?

Paul Newsome, Sandler O'Neill.

I would like to maybe talk a little bit more about the old goal of reaching a 10% ROE, in light of the shrinkage in the size of the business on both the property-casualty and life side of the business.

Are we getting to a point, given the decline in the business, where the scale is such that both sides of the business really can't give us a double-digit ROE? And if that's the case, then is the next thing for us to follow rebuilding that scale?

Paul, scale is certainly an issue and more scale makes things easier. I would say that given topline trends that we've seen, we've got some temporary expense ratio pressures, but that we're not materially in a different place as far as our ability to achieve.

It does push out our timeline and we have constantly talked about also looking for opportunities to grow through acquisition. So we see the same thing you see, that it's easier with more scale and we would like to have more scale, but we want to do it in a smart way. And we'll look for smart ways to build our scale.

I guess one of the things I'm struggling with -- and I don't know if you can respond as detailed as I would like -- is that I am having trouble coming up with how to come up with more than an ROE that is in the mid-single digits in general, especially given -- it looks like your portfolio yield may be falling, given where interest rates are at.

The life side, you've got the A&H business that's going away, in part because of the Obamacare. And then obviously, the P&C side has shrunk a lot this year as well. And so I'm having trouble -- and given where your capital position is and desire to hold excess capital, I am having trouble coming up with those pieces.

Is there any way you could kind of walk us through how those pieces -- not necessarily next year, but over the next couple of years could move in a way that would give you a higher ROE?

Yes, there's really -- there's four elements we've talked about that are necessary to get us to a double-digit ROE. And one of those is just simply that cats are normal, so in any given year, you're going to have some volatility due to cats.

But normal cats is one element of that. And continued improvement in the P&C profit margins -- we've talked about getting our combined ratio down in the 95% range and that's an important element.

A third important element is increasing interest rates, because we believe that they will happen. Timing is difficult, but particularly given our life business, interest rates staying where they are, are not conducive.

So we've planned on interest rates to move pretty much as the Federal Reserve base case scenario projects. And that is a slower projection -- a slower growth this year than they projected last year, but increasing interest rates is certainly part of -- for what will be required.

And most importantly, it's full deployment of capital. And we would like some of that deployment to come in terms of growth and not entirely in terms of returning to shareholders. Is that helpful, Paul?

Absolutely. Thank you very much.

Matt Carletti, JMP Securities.

Hi, it's actually Christine Worley standing in for Matt. Just had a couple of questions on your exposure management, looking at the topline. Given previous guidance, we would have thought that we would have -- the pressures that we are seeing there would have started to ease by now.

Could you sort of give us an update on where we are with that? Are we starting to turn a corner or should we expect these double-digit topline declines to continue for at least the next couple of quarters?

I think for us in property and casualty, we are starting to see some trends improve on new business. I think I have shared that we're focusing very much on the agent experience and our sales rep deployment, making it easier to do business with. And we are seeing that translate into improved new business, certainly on a sequential basis. So we like that.

The pressure really has been on the retention and that really reflects a lot of the hard work we've been doing in our pricing and improving our price segmentation as well as our catastrophe management work. So that's where we've seen the biggest impact, certainly, to the book of business and it's the right thing for us to do.

We like the outcome on the underlying loss improvement. We like the outcome in reducing some of the catastrophe exposures, so those are the right things to do, but we do expect some pressure there.

Okay, so it sounds like continued pressure on the retention side, but some improvement on the new business side?

Right.

Okay, perfect. And then, yes, you touched on it in your previous answer, but the accident year loss ratio improvement that we've seen throughout the year, is that reflective of the exposure management actions that you've taken or is it more looking at where the book is running for the year and trying to true up where you think it will eventually fall out or where it should fall out?

We really have been working for a good period of time of improving our underlying accident year improvement and it's been more deliberate than catastrophe management -- exposure management. It's included risk selection and price adequacy and, really, all through our operation.

So we've actually been at this for a good period of time. And so when I look at our underlying results, I really attribute it to a lot of that hard work between underwriting and exposure management and price adequacy.

Now naturally, there's always loss trend that goes into that that's environmental in nature that may influence, but when I think about our progress, our progress absolutely reflects the hard work of improving profitability.

Okay, perfect. Thank you very much.

Adam Klauber, William Blair.

Thanks. Morning, everyone. A couple questions. Can we go over the cash available for dividends and buybacks? Frank, I think you said maybe you have $300 million at the holding company. How much of that is -- how much cushion do you usually keep in?

You're correct. We have about $300 million of cash and short-term investments. At holding company, we target somewhere between $40 million and $60 million for cushion.

Okay. And then I think you mentioned dividends, I missed it. What's your statutory dividends this year?

We took $54 million up from the life group this quarter. We took $100 million up from P&C earlier in the year. We have remaining capacity at the life group of $25 million and at P&C group of about $38 million.

Okay. And aside from profitability getting better or worse, is there any reason we should think next year, your dividend capacity should be any better or worse than this year from the subs?

There should not be a material change to the dividend capacity from the subs.

Okay. Okay, that's helpful. On the technology write-off, you wrote off the software. I guess what direction are you taking now with your technology efforts?

Okay, I think I'll take that one, Adam. The -- we -- it's important to us to continue to build platforms that serve across our property and casualty business. So we do intend to continue that pursuit and we're in the process, then, of evaluating alternatives to continue that process.

Okay, so it sounds like we will hear more about that later. Was that good way of thinking about it?

Sure. The only thing I would add is that we've got some systems initiatives that are ongoing that are taking -- will allow us to improve things in the short term as well. And we will continue those.

Okay, okay. And then finally, again, a lot of discussion on the improvement in underwriting. That's a great sign. I think nine months, I calculated the improvement in the underlying accident year for P&C was well over 200 basis points, if you exclude cats and development.

Could you -- was the -- how material is -- I'm trying to phrase this correctly. How material is getting rid of the direct business to that improvement?

It's an interesting question. I think the direct business was important in the sense that it was a big expense item for us and we weren't approaching our profitability targets with the speed that we wanted to, so that certainly has been a part of it.

But aside from the direct, the ongoing business has demonstrated really a substantial amount of improvement across all of our lines. All of our lines with the exception of commercial vehicle, which is the one that we're still working on.

So our direct business was (technical difficulty) and the right decision for -- and has contributed to our improvement, but it's really been across lines, with the exception of commercial vehicle.

Okay. Thanks. So sorry if you mentioned this before, what type or what level of rate increases are you putting into the commercial vehicle line now?

It's, I think, about 5% to 6% on our commercial vehicle book of business.

Okay. Thanks a lot.

(Operator Instructions) Jason Busell, Millennium.

Hi, good morning. I'm sorry if I missed this earlier. I think in the release, the book yield on the investment portfolio was 5.1%?

John, is that the exact number?

Yes, that's -- for the quarter, yes.

And what is the new money rate?

That's a loaded question kind of, but we are investing across the platform of different types of investments. But what we put to work for the quarter in the investment grade area was about a $450 million pre-tax equivalent yield.

$450 million pre-tax, okay. And the -- I think to expand on Adam's question, the holdco cash, I know that you have a debt maturity coming up next year. Is the intention to use some of that to retire, given that -- I guess I'm trying to understand the -- what debt to capital level the Company expects to be running at and if that -- if you currently expect to retire that maturity.

So the way we're looking at it right now is we're preparing to retire that maturing. We have -- when we issued our hybrid, we committed to bring our debt to capital ratio down in line with where it had been historically.

So what we really are doing now is monitoring our options with the long-term intent to bring that ratio down more in line with where it has been. We have a 2017 maturity also out there, so we're looking at our options and we are monitoring it.

And down to where it's been -- you mean in the low 20%s?

That's where it's been historically.

Okay, okay, thank you. And then one follow-up for Denise. I know that you talked about retention falling. Were you referring to just home or auto, too?

I was referring to both lines.

And what is the retention now versus a year ago, outside of direct and auto -- and personal auto?

We don't break that out, because we report now by segment. So -- but the direct business continues to decline at about the same rate that it had been. So -- but we report today on an all-line basis.

Okay. And the -- I'm wondering, given the fact that you are facing challenges with retention, presumably some of the business you would like to keep -- what's the [upright] in the auto business that's -- is it a rate issue?

I guess I'm trying to understand why the non-direct to personal auto is -- retention is facing challenges, because that's not as cat exposed for you, obviously.

You know, that's true. We been addressing the underlying performance of the auto book of business. We were dissatisfied with where it was performing and set out to improve that line several quarters ago as well.

So it's really talking about improving the underlying book of business there in the auto. And as a result of that, we -- for several quarters now have been addressing that profitability with rate and underwriting risk selection actions, primarily. And so it's from that work that we are experiencing the pressure on retention.

Were there any regions in auto that you wanted to address with rate and underwriting actions or was it certain -- was it -- is it more on the nonstandard side or on the preferred side?

We -- it's really -- it's state specific. We look at -- and product line specific -- as we do our indications and evaluate the book of business and then make choices about applying rate, so it is by state and by line.

So therefore, it will vary, depending on what we see the trends being and where we see the line by state performing relative to our expectations. So it is variable.

Okay. And it sounded like from your comments regarding new business that the agent experience is improving -- that you sound like you've got a good handle on these issues and they will probably turn around.

Yes. The new business -- we are seeing a sequential basis improvement in our new business. And again, we've been addressing that as well. So we expect that to continue to make progress.

Thank you. That's all my questions I appreciate it.

Thank you and I'm not showing any further questions at this time. I would now like to turn the call back to Don Southwell for any further remarks.

Thank you, operator. Before we wrap up, I do have just a few comments on our results in the quarter in really four areas. In property and casualty, we continue to improve our underlying performance, but the software write-off in the topline did pressure overall results.

Our life and health segment profits were good, but slightly lower due to reduced investment income and the expenses associated with funding our strategic growth initiatives. Our investment portfolio continued to deliver in a tougher investment environment, and finally, our capital and liquidity positions remain strong, which afford us great flexibility.

We continue to focus to deliver to the shareholder returns that we all seek and we do appreciate your time. Look forward to updating you next quarter.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.