Kemper Corporation

Good afternoon ladies and gentlemen and welcome to Kemper's third quarter 2021 earnings conference call. My name is Charlie and I will be coordinating your call today. At this time all participants are in 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 call, Michael Macinario, Kemper's Vice President and Corporate Development and Investor Relations. Mr. Marinaccio, you may begin.

Thank you, Charlie. Good afternoon, everyone, and welcome to Kemper's discussion of our third quarter 2021 results. This afternoon, you'll hear from Joe Locker, Kemper's President, Chief Executive Officer and Chairman, Jim McKinney, Kemper's Executive Vice President and Chief Financial Officer, and Dwayne Sanders, Kemper Executive Vice President and the Property and Casualty Division President. We'll make a few opening remarks to provide context around our third quarter results and then open the call for a question and answer session. During the interactive portion of the call, our presenters will be joined by John Buscelli, Kemper's Executive Vice President and Chief Investment Officer, and Eric Sternberg, Kemper's Executive Vice President and Life and Health Division President. After the markets closed this afternoon, we issued our earnings release and published our third quarter earnings presentation, financial supplement, and form 10Q. You can find these documents on the investors section of our website, Kemper.com. Our discussions today may contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, the company's outlook and its future results of operation, and financial condition. These statements may also include impacts related to the COVID-19 pandemic. Our actual future results and financial condition may differ materially from these statements. For information on potential risks associated with relying on forward-looking statements, please refer to our 2020 Form 10-K, as well as our third quarter earnings release. This afternoon's discussion also includes non-GAAP financial measures we believe are meaningful to investors. One such measure is as-adjusted for acquisition. It is important to understand our reported results, including the impact the American Access acquisition has to Kemper overall. However, investors have also expressed an interest in understanding the underlying organic performance of the combined businesses. Since our as-reported financials don't include American Access's historical information prior to closing, of the acquisition, and current results include the impact of purchase accounting, the underlying trends are not easily discernible. In an effort to provide insight into the underlying performance of the combined businesses, we also display our financials as adjusted for acquisition. This view removes the impact of purchase accounting and includes historical American access information for periods prior to the acquisition to more readily provide a meaningful year-over-year comparison. In our financial supplement presentation and earnings release, we have defined and reconciled all the non-GAAP financial measures to GAAP, where required in accordance with SEC rules. You can find each of these documents on the investor section of our website, Kemper.com. All comparative references will be to the corresponding 2020 period unless otherwise stated. I will now turn the call over to Joe.

Thank you, Mike. Good afternoon, everyone. Thanks for joining us today. Earlier today, we reported results that continue to be impacted by the pandemic reopening. The earnings were below our long-term expectations and, as a result, disappointing. We previously discussed the anticipated challenges of the current environment, which is dynamic and changing rapidly. Against this backdrop, we're focusing on minimizing these impacts and optimizing the business There are two groupings of items impacting our results this quarter. One, the pandemic and the integrated impact of restarting an economy post-lockdown. And two, a group of items which are expected through cycles, but unpredictable on a quarterly basis. I'll make a few broad comments on the first grouping before we dive into details. We'll cover the second grouping throughout the call. When we look at the impact of the pandemic, these are unprecedented times for the industry. Historically in PNC, there's been a rough balance between lost cost inflation and rate inflation. The dramatic frequency reductions at the start of the pandemic led to an extended period with effectively no rate increases. While accident volume was historically low, Kemper, along with most major companies, delivered premium rebates to auto customers. The reopening led to rapid increases in auto frequency. It also saw global disruptions in supply chains. together leading to severity and combined loss cost inflation at levels we haven't seen in the industry for over 30 years. Across the industry, there's currently no significant rate in the system to offset this loss inflation. The system is out of equilibrium. In some ways, it's like turning off the water supply to your house during a remodeling project. It's fine while you're working, but when you turn the water supply back on, water doesn't immediately flow from each tap. You hear some clanking, you get some air, some spray, some gurgling, and a few surges of water before normal flow is reestablished. And you have to turn on all the taps in the house to clear the pipes running to each faucet. It requires some work, some time, and a little spray to restore the equilibrium. That's where we are right now. We're all asking a few big questions. What's the overall level of loss, cost, inflation, or severity increase? When will it stabilize to a new normal? And how quickly will rate increases be approved and be earned into results? I know that last quarter there was a broad view that inflation was hopefully transitory. Like most, we revised our view in the last 90 days and see it as something we will be dealing with for a more extended period of time. In our life business, the Delta variant increased mortality to levels last seen near the height of the pandemic. Our results remain in line with national experience. With increased vaccination rates, advancements in medical care, and strengthened natural immunity, we anticipate moving from a pandemic to an endemic, resulting in a return to more normalized mortality rates. We'll offer some additional thoughts on these macro issues later in the call. Moving to a few specifics on the quarter, please turn to page four. We generated a net loss of $75 million, or $1.18 per share, as reported, and $69 million, or $1.08 per share, as adjusted. We also produced an adjusted consolidated net operating loss of $76 million or $1.19 per diluted share as reported and $69 million or $1.08 per share as adjusted. Return on tangible equity excluding unrealized gains was 3%. This is below our target return. As highlighted earlier, the impact of the reopening and other environmental challenges continue to negatively impact these. We are actively deploying corrective actions to restore target margins and returns. Our balance sheet and business model remain well positioned to navigate through these challenges. Turning to segment results. As discussed, given the environmental headwinds impacting our PNC segments, our focus is on restoring them to target profitability. Our life and health segment, we are seeing higher demand for our products and strong policy retention. Although we experienced a reduction in COVID-related mortality last quarter, we saw a spike this quarter as a result of the Delta variant. overall the business remains positioned for long-term profitable growth in summary we are taking the actions necessary to combat the environmental challenges the pnc industry and our businesses we along with the rest of the industry are repriming the pipes and restoring equilibrium in the system the benefits benefits of these actions will take time to fully work their way into our book and on the life side the delta variant has caused another spike in covert related mortality Our strong balance sheet and business model enable us to continue to navigate the current environment and position the business for growth in 2023. I'll now turn the call over to Jim to discuss our third quarter operating results in more detail. Thank you, Joe. Turning to page five, environmental headwinds led to challenged financial results. We reported a net loss of $75 million and an adjusted loss of $69 million. We reported consolidated net operating loss of $76 million and an adjusted adjusted net loss of $69 million. The corrective actions we have taken and are taking in response to higher frequency and severity will, over time, return our auto business to target profitability. In addition, as the health impacts of COVID subside, life mortality and benefit costs will revert to normalized levels. Turning now to tangible book value per share. Excluding unrealized gains, tangible book value per share declined $3.27, compared to last September. $3.11 of the change is related to AAC and the corresponding goodwill the transaction created. We continue to believe this transaction is accretive to franchise value. On page six, we highlight our view of operating income, which continued to be negatively impacted by environmental challenges. As mentioned earlier, this quarter experienced higher frequency and severity, leading to our specialty P&C segment reporting an as-adjusted underlying combined ratio of 108%, a further strengthening of reserves due to an atypical second surge in Florida PIP-related litigation, and elevated life costs due to excess Delta variant-related mortality, higher new business sales, and persistency gains. On the bottom half of the table, we indicate sources of volatility. Except for prior year reserve development, the remaining items are relatively consistent with past periods. On page seven, we review some of the key capital metrics we use to track our performance, including growth in tangible book value per share and tangible return on equity. Over the past 12 months, return on tangible equity, excluding unrealized gains, was 2%. This was a direct result of the environmental challenges impacting the industry. While this is disappointing and below our target, we've instituted and will continue to institute corrective measures to return the business to target profitability. Continuing on page 8, we highlight the strength of our balance sheet. We continue to produce strong cash flow, generating over $500 million over the past 12 months. Our insurance entities are well capitalized. Liquidity remains strong, and our debt-to-capital ratio of 21.3% remains within our stated target range of 17% to 22%. This business profile provides us with financial flexibility to navigate this environment. Turning to page 9. Net investment income for the quarter was $102 million. Our portfolio construction is designed to match liabilities and provide stable income through various cycles. This quarter, we generated a pre-tax equivalent yield of 4.4%. In closing, the company's quarterly financial performance continues to be pressured by various environmental factors. We are confident that the corrective actions we have taken and are taking will, over time, return us to our financial targets. I'd now like to turn the call over to Duane to discuss the results of our P&C segments. Thank you, Jim, and good afternoon, everyone. To start, I will make a few comments about the current environmental challenges impacting our businesses, as well as the relationship between earned rate and loss trend. Let's turn to page 10. There continues to be several environmental challenges impacting auto loss costs. On the frequency side, miles driven continue to increase leading to an 18 to 20% increase in claim activity. At the same time, severity increased 8 to 10% due to supply chain challenges, labor shortages, and social inflation. We are taking actions to address these challenges. Last quarter, we discussed the impact of some recent Florida PIP-related court rulings and the related increase to our prior year reserves. Typically significant Florida PIP-related court decisions result in a single surge of litigation. This time we witnessed an atypical second surge. Therefore, we are further strengthening reserves by $25 million. Let's turn to page 11. Based on some questions we received over the quarter and discussions taking place within the industry, we thought we'd take a moment to review the interaction between earned rate and lost trend for various periods in and around the pandemic. This is an illustrative display intended to bring context to those discussions. Pre-pandemic, the relationship between lost costs and earned rate had maintained a long, steady equilibrium. There have been times of modest divergence, creating either increased profitability or margin compression. But over the long term, they were largely balanced. During the pandemic-related lockdowns, there was a dramatic drop in frequency, resulting in a significant reduction in lost trends and noticeably improvement in profitability. This eliminated the need and ability to raise rates. When the economy reopened, frequency increased as miles driven surged. In addition, challenges to an already stressed supply chain were exacerbated, increasing severity. Together these items drove a surge in loss trends that escalated at unprecedented levels. Since there is little to no rate running through the system, margins were immediately and adversely impacted. Given that rate changes are subject to a regulatory approval process, it will take at least several quarters for their earned impact to be seen in results. Moving to page 12, I'll start with specialty P&C. Against this backdrop, the segment experienced an underlying combined ratio year-over-year increase of 22 points, a sequential quarter increase of 2 points, and an underwriting loss of approximately $80 million. Despite this recent performance, we remain comfortable with the profile of the business. The frequency change versus 2019 is about 1%. This quarter's loss and temporary rate loss cost imbalance doesn't impact our view of the long-term profitability of the business. Over time, we anticipate a favorable outcome from our ability to address recent challenges through pricing and other profit improvement actions. Given the environment, we are prioritizing profit restoration over growth. The chart on the upper right should help you see how rate actions will migrate through our book of business. As an example, during the third quarter, we filed an approximately 3% rate increase on roughly 34% of our business, and it is already effective. We're in the process of filing for an additional 6% of rate on 38% of our business in the fourth quarter. Understandably, it takes time for filed and effective rate to be written and earned into our results. Over multiple quarters, rate and non-rate actions will return the business to target profitability. Turning to the preferred segment on page 13. The preferred P&C segment continues to face similar environmental challenges and was further impacted by Hurricane Ida. Similar to specialty, we are prioritizing profit restoration over growth. Looking at the chart on the upper right, during the third quarter, we filed for an approximately 4% rate increase on roughly 39% of our business, and 31% is already effective. We are in the process of filing for an additional 13 points of rate on 57% of our business in the fourth quarter. Overall, for the preferred segment, we continue to expect ongoing profit improvement actions to bring us closer to our desired level of performance. I'll now turn the call back to Joe. Thanks, Dwayne. Turning to our life and health segment on page 14. Overall, this business was negatively impacted by increased mortality related to the Delta variant and Hurricane Ida. For the quarter segment, that income was $3 million. Our mortality results continue to remain in line with countrywide trends. We continue to see and are encouraged by strong consumer demand for our products. This is evidenced through high new issuance rates, and policy retention that remain above pre-pandemic levels. Overall, the outlook for the life and health segment remains positive. In summary, this quarter's financial results were disappointing. As we stated earlier, it's going to take time for corrective actions to earn into our book and return us to target profitability. We believe our actions will position us for growth in 2023. Our balance sheet provides appropriate financial stability for these types of challenges. Our strong capital and liquidity positions enable us to navigate and optimize the current environment. Despite the continued challenges, we remain financially strong. Our team will continue to deliver on our promises to our customers and provide attractive, long-term results and value for our shareholders. I'll now turn the call over to the operator for questions.