Kemper Corporation (KMPR) Earnings Call Transcript & Summary

Good afternoon. I'd like to continue on with our afternoon schedule. I'm Greg Peters. I cover insurance, insurance brokerage, insurance technology stocks for Raymond James. It really is an honor to welcome back Kemper Corporation. It is an evolving story, but its specialty business and non-standard auto clearly has defined it as a unique opportunity within the personal line space. From management today, we have Joe Lacher, who's the CEO. We have Jim McKinney, who terms -- serves as the CFO. And then, of course, Christine Patrick, who serves as the Director of Investor Relations. So I think what we're going to do for the purposes of today's presentation is that management give some opening remarks, and then we'll probably just proceed right into a Q&A to keep the conversation rather robust. So let me turn it over to Joe.

Terrific, Greg. Thank you very much and thank you, everybody, who's with us live and on the webcast. As Greg said, Jim and I are going to walk through some overview comments overall and then try to take you through wherever you guys want to go from a Q&A perspective. Kemper, as an organization, is a broad, specialized insurer. I avoid using the term multi-line insurer because while we do have multiple lines, I think it's more important to think of us as a portfolio of specialized insurance operations and businesses around it. The company has over $13 billion in assets, over 30,000 agents and brokers and nearly 9,000 employees, and again, a portfolio of these specialty businesses, a specialty auto business, a personal insurance business and a Life & Health business. The important thing to think about when you think of the organization is that we look at each of these businesses and we endeavor to build a systematic, sustainable, competitive advantage where each of those businesses can generate an appropriate set of returns and then grow market share sustainably over time. With that portfolio of businesses, we try to be part of that portfolio. A company either has to or a business either has to be made better by being part of a portfolio or has to make the portfolio, some other parts of it better by being part of that ecosystem. And we can talk about some examples of that, but it provides a capital efficiency, a stability of earnings stream, an ability to have these businesses operate together and simultaneously derisk the organization and produce better ROEs even at the same margins, and we've been fairly successful with that. And again, we can talk about examples of that as we move forward. But ultimately, as a group, we think about our business strategy and our business tactics saying that really, we're cash oriented. How do we build these businesses in a way to generate an appropriate shareholder return and produce a stable, steady stream of cash and cash realization? Not every organization is focused on that. We sort of bring everything we do back to those first principles and watch the individual businesses and their interplay, and that becomes ultimately a good measure of success. The businesses we're in, in really all cases, are focused on specific niche markets or underserved markets, where we have some unique expertise or specialization, either it's our customer focus, our underwriting ability, a claim or distribution ability, a scale advantage, some component that lets us do that. And in most cases, weak or unfocused competition, where we're providing really an unmet need there, and we have an ability to sort of flex our strength inside of that marketplace. I'll flip through a couple of quick highlights, and for those of you online, you can pick up this presentation on our website. We've got this portfolio of businesses. We've got a strong group of seasoned and experienced managers that have come from insurance and financial services operations to what largely is a smaller company than their experience base would suggest, but they're building this franchise in a way that helps us continue to build shareholder value and provide for what we believe is a real upside and growth in the organization. If I jump into each of the businesses for a moment, our first and biggest business at this point is our Specialty Property & Casualty Insurance segment. It is largely driven around specialty auto, both on the consumer side and a smaller piece of small commercial. We are very strong in this space. The typical auto space in personal lines is characterized by large, what often are described as standard and preferred carriers. They deal, to a large degree, in mass customized risks. The competitive advantages there center around scale, claim effectiveness, product sophistication, pricing effectiveness, brand recognition, a series of things there. We focus in the specialty auto market. The same set of competitive advantages are important, but there's a series of specialty niches that sort of hang around the outer edges of that standard and preferred marketplace, where a unique set of skills are required to be effective. Most of the bigger players view those segments of the marketplace as exception processing. For them to work in that space, they have to do something different than they normally do, it adds to their cost, they are often less effective in it because they don't focus on it, and frequently, they stay away from those segments because they don't generate the returns they would otherwise because of their lack of focus and their lack of expertise. And because the market for the standard and preferred world is so much bigger, they can find they can get reasonable growth opportunities without having to be troubled with that specialization. We actually are really good at those specialties and excel at those. And because we're focused on and really good at them, we can generate an above-average return. The Specialty segment includes what would traditionally be described as a sort of a normal nonstandard market, habitual bad actors, folks who have poor driving records or have accidents, DUIs, speeding tickets or folks who might be described as credit nonstandard, folks who lapse their policy several times a year. That creates a challenge because if they will have a gap in coverage, you have to have a fairly significant investigatory and detailed view to watch when accidents happen to make sure that the loss occurred during a covered time period, not a lapse time period. You also have to be very good about your cash management to make sure you're not giving insurance away for free. So it requires a clear specialization. There's also a series or set of parts of the market that are not necessarily nonstandard, but they are specialties, geographic specialization. There's a series of geographies that for a variety of reasons are more complicated and different than the rest, they preferred auto at home. It might be a regulatory complexity, like California. That is a place where there are unique set of laws, a unique set of underwriting criteria, rating logic that behaves very differently than the entire rest of the country. Most companies will have 49 states, a product management group and a 1 state for California only, a clear specialist opportunity. You have geographic areas where you have high degrees of fraud and abuse and other challenges, like a South Florida, a Miami, Broward environment. Many big players will avoid that environment because it's much more difficult to do business there. We actually are really good at that. We excel at that. We're okay with that. And again, you get an environment where you get weaker or less focused or less sophisticated competition. It gives us an opportunity to excel. Urban areas is another example. Many big carriers will stay out of the deepest part of an urban area because it just functions differently. There's more accidents, you garage vehicles differently, they just avoid it. These are all examples of there being a specialist provides a distinct advantage. There's no clear, exact measurement that you can pick up somewhere else of the specialty size of the specialty market, but if you take each of those components together, the overall auto market is somewhere between $250 billion and $300 billion. In premium, these specialty segments are close to between $75 billion and $100 billion. So fairly significant marketplace opportunity. We've been very effective inside of that space. We've had very attractive combined ratios over the last number of years and have been doing so, again, consistently, and we've had outsized growth in the marketplace. That growth is a clear demonstration of our competitive advantage inside of that space. You'll often hear people talk about an increase in a competitive environment or soft market in the standard and preferred environment. Because these markets operate to some degree differently and have different competitors in them, frequently, the fact that there's a soft market in a preferred environment doesn't make it so in a specialty environment. They're more fragmented and local and geographically sensitive, so we can accelerate even when you're seeing the big guys in the standard and preferred do something different. What you see in the bottom right corner of this slide is an ability to sort of understand some of the additional competitive advantages or tailwinds we have as an organization. California is by far our biggest state, Florida and Texas are our next 2 biggest. What you can see in the chart is the U.S. population is growing about 0.5% a year. We have very big focuses on the Hispanic market, a specialization that I didn't mention on the Hispanic marketplace, customers where Spanish is their first and primary language. And we have the majority of our customer, service reps and claim reps who are bilingual. It provides a differentiated set of service to that group of customers. That customer segment is growing faster than the U.S. population. Our geographic focuses on states are growing faster than the U.S. population. We have a concentration in California and Florida and Texas, but we are expanding outside of those states. So while we are growing very rapidly in, if you will, our same-store sales, our new-store sales opportunity gives us another tailwind of growth. So we're getting very attractive returns, well above-market growth rates, and we're doing it in geographies that have and make it easier to grow, in customer segments that make it easier to grow. And as we expand in different states, it's easier to grow. So this is really an advantage that should operate for the foreseeable future. We have a preferred auto and home business, second key business. This is one that has a bit more of a strategic challenge. It sort of hit part of those potential competitive advantages, but it is not as strategically well positioned as the other 2 businesses. We have shrunk that business in terms of its total size of the portfolio largely because we've grown the other businesses. We've had modest profitability improvement in that business over the last several years. We have used much of that profitability improvement to derisk the portfolio. We have purchased additional reinsurance to cover catastrophes, the cat agg treaty, an aggregate-of-loss treaty, which protects against high-frequency, lower-severity catastrophes, tornadoes, hailstorms and the like. So we've effectively reduced the risk volatility of the business to make a better risk/reward trade-off and reduced its percentage of the overall portfolio. That helps us and it allows us to be a lower-risk option on exploring another strategic, sustainable, systematic, sustainable competitive advantage, and we're focusing on enhancing and building out that capability inside of that business. While we're doing it, we're enhancing its underlying profitability, largely with many of the efforts that we're dealing with in our specialty auto business. They will help that preferred auto business improve going forward. Our third biggest business is our Life & Health segment. This is another business. Our life business is a key foundational business of ours. It has a strategic -- a systematic, sustainable competitive advantage. It targets low-face amount life insurance business, whole life business for low- to moderate-income individuals who are largely looking for final expense or burial-type end-of-life insurance. For social or cultural or religious reasons, it's very important to them that they have sort of that proper end-of-life treatment. So they're looking for a policy that will help them fund that. They recognize that they largely don't have the financial discipline to do that on their own. So they're very much looking for a high-touch, high-service product that will help them achieve that social and religious goal by providing that financial discipline. This is a very stable source of earnings and cash flow for us. The average in-sourced face amount policy is about $5,000. The average new business policy has a face amount of life benefit of about $13,000. This is spread across north of 4 million policyholders. Very diversified, very stable source of earnings. This is largely a growing customer segment. The customers value our product. We make a reasonable return on it, and we have virtually no significant competition inside the space. We distribute this product through an employee captive sales force. It's a fairly expensive set of infrastructure to build and develop a set of relationships in the community. So there's a fairly significant barrier to entry for someone else to enter. It's sort of got all of the key measurements of what you would describe as a competitive advantage. When you put that life insurance business with our specialty auto business, the fact that those 2 businesses coexist actually provides a huge capital diversification benefit to us overall. It actually, while both have their own sustainable competitive advantage, when they're inside of the same ecosystem, they enhance each other's competitive advantage and add to our strength overall. With that, I'll take a breath and maybe ask Jim to climb through some of those advantages and the capital around that.

Yes. Thank you, Joe. So big picture, a couple of things that we've seen over time and what you specifically saw when we bring kind of our ecosystem and business model together were shown through our acquisition of Infinity. When we acquired the business, at that point in time, you had a business that was largely making 6% to 7% type ROE with kind of flat to declining growth over an extended period of time. When we came in, we were able -- because of the life portfolio benefits and the diversification that comes in, we were able to take out roughly $400 million in total capital, but at that same point in time actually reduced its risk profile, which is evidenced partly by, if you look at our recent ratings upgrades and some other elements that came through there. And it wasn't about kind of the base capital that you might have for your base premium or surplus, it's about what happened, right, from a volatility perspective over time. Our model effectively enables that to be internally funded as well as having good, committed, contingent liquidity sources that enable us to have that access but without incurring the significant cost of maintaining that in a treasury-like fashion, if you will, on an abundance. That has enabled us to hit growth profiles and other elements within our communities and our customers that are industry-leading from that -- from just about any perspective, quite frankly, top quartile, other, at a rate and a price that is very attractive for our customers on that end. And you see that through, again, top quartile growth, which Joe highlighted in our specialty business, and we're going to talk on -- and I'll touch on it in a moment, kind of what those returns are because in order to really be creating economic value, as we've talked to -- indicated, you've got to be both growing or taking market share, but doing so at a rate where you're earning an amount that's greater than your cost of capital. So there's a couple of things. In terms of other elements that you might say from an acquisition or capabilities kind of internally how we bring this together, at the time when we announced the transaction, we had talked about a 2-year payback period. That payback period in terms of the actual realization and what we're able to achieve occurred within the first 3 quarters of the year. Again, largely because of the overall benefits associated with the model. We also announced synergy benefits. At the time, you might remember, we announced about a $300 million premium for the business and about, I don't know, $900 million to $1.1 billion, depending on what kind of multiple you're going to put on it from a synergy value. And there were questions about, hey, could you achieve that level of synergy, you're looking at kind of that $60 million, $65 million. We had yield benefits of $5 million to $10 million. What you saw within the first year, we actually had announced an increase to our overall synergy target. And before we got through 1.5 years of the ownership of the business, we had actually achieved those levels. And so that gives you an idea of the power of essentially kind of our ecosystem, how it comes together to enable us to create outsized value both for our customers and then for our shareholders. In terms of moving forward, I mentioned that I would highlight and talk through, again, some of those returns. If folks remember and look back to kind of the 2016 time period, when Joe and most of the new management kind of came in through that period of time, you had a business that was generally returning low single digits, 1%, 2%, 3% type return. If you fast forward in terms of where we're at today, you're looking at ROEs that are in the 16.3% range in terms of [ where we left ], and you're looking at a return on average tangible common equity of 25%. Those again are both top quartile, industry-leading with that industry-leading growth, highlighting the success that the overall ecosystem in our model really brings to bear to enable us to both unlock value for customers and for shareholders. All of this is great, but you also then have to add on: What's the level of risk inside your business? And are you able to achieve those results because you're taking risk that others would not? We've actually decreased the overall risk profile of the company and actually have an incredibly stable and strong company as a whole. We'll talk about some of our capital and liquidity metrics here in a moment. But big picture, the way we actually size our capital and our liquidity needs is on a probability of ruin basis. We have a 1-year target, where our risk level will not exceed 0.5% probability of ruin, and we have a over the life of the liability. So think about that as a 20-year type metric of 2%. That probability of ruin is actually to a ratings downgrade. It is not from a solvency perspective. So when you think about the level of capital and the level of liquidity that we maintain around our business decisions and the other elements, these are very robust levels. And so you're looking at elements where we've got outsized growth, you've got outsized returns because of the ecosystem, and we're actually doing it with a capital and a liquidity position and a balance sheet that is better and stronger and of a higher quality, quite frankly, than what our competition and others would have inside the market. That, by definition, right, is essentially where you can see we're creating economic value and achieving strong, long-term returns for everyone inside the ecosystem. Thinking about that, one of the areas that folks constantly and appropriately ask about in an insurance company is the investment portfolio. This is another case where, because of our size, our capabilities, our ecosystem, then we've been able to achieve outsized results over time from an investment perspective and on a risk-adjusted basis. Our size in the ecosystem by coupling both our life business with essentially our P&C capabilities has allowed us to make investments on the investment side, if you will, in terms of capabilities, people, where we can essentially achieve our results, but do it for -- on a more cost-advantaged point of view. The companies of similar size or scale on our individual businesses would likely have to move to and essentially outsource these capabilities, and there'd be a cost associated with that. In addition to that, we're able to leverage our size. And because it's an internal capability, we're able to be more selective than what we would be if we had to hire a manager to kind of run our portfolio for ourselves. What that means is, at our size, we are large enough to be selective and meaningful to folks to play in when there's new offerings or other elements that are out there, we can choose to do that, and we have a seat at the table. But at that same point in size, we're not the same size as some of the bigger players that are out there that really kind of have to be in every deal. And at that same point in time, if you had more of a management-type arrangement, you would likely have more of a spread and you would have less flexibility in terms of your ability to have that specialization or that selective as to where we can truly kind of pick where it's appropriate, where we're getting an appropriate return relative to the investment of our dollars from an investment standpoint for the flow. So we think that's another area where, when you're thinking about what do you need to charge for policyholders and others to achieve that appropriate return for shareholders, right, in order to be empowered to run your business were because of what we're able to do on the investment side that further lowers the cost that we need to charge from a policy perspective, which enables growth and a whole bunch of other elements and outsized value to customers. Moving forward, I said I would highlight some of our capital and liquidity perspectives. You can see from our risk-based capital levels that we run at a very strong level in terms of what's inside our business. With that perspective, you can see that we run significantly above kind of our targets or other elements that are inside of there. Again, our overall framework for risk management comes back to the probability of ruin concept that I highlighted before, which largely drives what's kind of inside our entities or [indiscernible] and what type of capital levels we maintain at the HoldCo and other to ensure that we live into that risk appetite statement. With that in mind, we have almost $900 million of liquidity. So when you think about events or challenges or hiccups in the market, when you think about our total capital stack or other, we basically have 25% from a liquidity perspective that we can draw on at any one of those points in time. From a debt-to-capital perspective, if you -- again, you think back to that 2015, 2016 time period, where Joe and the management team came in, at that point in time, we had a 27%, 28% type debt-to-capital ratio. Today, we're at a 16.4% debt-to-cap ratio. It's about 1.5 points better than kind of our longer-term targets, which are 18% to 22%. Some of that's just kind of timing and how these things come together. There's not a lot to read in there. But big picture, what you can see is a very prudent approach to risk management and again, that strength of the balance sheet and the financial flexibility that we have. And then you also see us highlighting our cash flow from operating activities. One of the big misnomers that are out there is: What's the percentage of net income that actually turns into cash, right, at the end of the day versus other assets that get strung up on the balance sheet? We highlight here and other places, again, that we tend to generate more cash than effectively what is our net income profile. You might say, well, why would that be? Well, you have some gains or other elements where you could have some disconnect relative to the fair market valuation gains for subsidy you haven't sold. But absent that, you'll see that we generate more cash coming into our model than effectively what the net income is on the other side, which is a great phenomenon. It's a strong point of our company, and it really brings us back to what Joe highlighted is a company where we start with a fundamental basis of thinking about cash and the cash box, what puts cash into there, what takes cash out and bringing everything back to that thoughtfulness and that specific focus just really on cash and not diluting ourselves relative to what some accounting metrics or others might say. This is really about kind of time value of money and cash inside that cash box and the risk associated with that. Okay. When we go forward from there, then it comes to our capital deployment opportunities. Clearly, we're in a position when you look at a 25% return on average tangible common equity, and even though we've got double-digit growth and things like that, that you're seeing, that we are producing excess capital. You saw the first point from where we're at relative to the transaction with Infinity. We said priority 1 would be to reduce ourselves and to deleverage and get back to what is a normal rate for us from a debt-to-cap perspective. We've obviously achieved that much earlier than we're initially anticipating. The secondary element of what we've said is that we will deploy cash then for organic growth opportunities where we can achieve essentially with those dollars coming in at 10% to 12% type over the cycle ROE, or if you're looking at [indiscernible] others, a 14% return on average tangible common equity at that stage. So those are the types of opportunities where we look to deploy cash for our capital on that front. The secondary element in terms of where we've indicated we would deploy cash is on acquisitions or other elements that are similar to like Infinity -- similar to the Infinity transaction where they make us better, they may also make us bigger. But the goal is not to be bigger, the goal is to be better. And better may at times be bigger. But at the end of the day, what we're shooting for and what needs to happen is for us to be bigger or any better in anything that we would kind of look at. It also has to have a very attractive financial profile. As one can guess, you can see the math and the rigor that we put in from a financial analysis and how we kind of build our models and the way that we think about things. Anything that we would do similar to an Infinity-type transaction would have that same type of rigor around it. And so we look for opportunities where that is a situation where we can continue to build out additional and broaden and strengthen the competitive advantages that we have and where we can effectively create even more value for our customers and for our shareholders as we go through. A couple of other metrics that you should kind of think about that and where we've highlighted is, generally speaking, from a crossover rate or other, we've generally looked at that as being kind of a 3- to 5-year component, if we were to head down that page with relatively 3 or less years, generally, in terms of kind of payback periods or other elements. Again, that gives you in a mindset for what our risk profile is and the type of accretion that you would generally expect with us in terms of how we would look at something from a strategic financial lens. That's not to suggest that there's anything coming in. I don't want anyone to misconstrue. We've just been very clear on what are some of the metrics that we look at when considering opportunities or other things that are out there. My comments here are purely to help make sure that we bring that framework together and you understand how we look at it as opposed to having different bite-sized pieces in different places. The third opportunity and what we've said is if we are unlikely to deploy that capital over an 18-month period, either into the organic or the inorganic component that would make us better, we would look then to return that capital to shareholders. When we look at the model after an 18-month period, the math would suggest that it's very -- it's dilutive to hold that. And if there's an opportunity that came along 3 years out or 5 years out, it would be better to, if you needed to raise or to do something in that moment, to think about it at that time versus to hold that capital through the cycle. So when we look at it, we've got about an 18-month period for which we look at and manage essentially our capital or hold for those organic [indiscernible]. After that, we look to return it to shareholders. You've seen to date about a 20-plus percent increase over the last year in our dividends as we've gone through the cycle. You'll also look at us, and we'll make the right decisions if that was -- the return element was the right option. We would look at share buybacks with the lens of saying, "Hey, we have that same type of crossover period where the earnings per share, if we were to go down that path, would effectively essentially create on a tangible net book value in that kind of 5 to 7-year period in terms of where they're at." And then if that wasn't the right answer relative to where we're looking, you would see the additional dividends or a one-off dividend, whatever it is at that point in time that creates the most value for our shareholders. So that concludes our initial remarks, and we look forward to taking your questions.

We actually ran out of time. So we're going to have the breakout session at quarter past 6. And thank you, guys, for the presentation. Thanks for coming to the conference.

Thank you.

Thank you.