Kemper Corporation (KMPR) Earnings Call Transcript & Summary

Good afternoon, everybody, and welcome to the UBS Financial Services Conference. My name is Brian Meredith, and I am the insurance analyst here at UBS. It gives me great pleasure in presenting our next fireside chat here in the insurance area. We've got Kemper Corporation with us. And from Kemper, we've got the Chairman, President and CEO, Joe Lacher; and we've got Jim McKinney, who is the EVP and Chief Financial Officer. I'm going to go through and ask a number of questions. In addition to that, you have the ability to ask questions yourself via the website. [Operator Instructions]

And with that, let's get started here. Let me start off with our first question here. Let's start off with the topic of the day, topic of the quarter and what happened in the specialty personal auto business with the second quarter. If you looked at your adjusted underlying combined ratio, 107.8% in the second quarter, but that did include some current year development. So as we think about it, what's kind of the right baseline that we should be thinking of to improve upon?

Yes. I think you hit the question the right way, Brian. We would point to the 6-month underlying combined ratio. That takes the intra-year development out. Without looking at that, you'd be off. I do think the numbers you were referencing were private passenger auto, not the whole bucket. So we'd start and point to the specialty.

Yes. [indiscernible] personal, yes.

We'd point you to the Specialty P&C and say, look at the 12-month -- I'm sorry, the 6-month number, and that's the right one to start as a jumping off point without the prior year impacts.

Got you. So kind of going on from that, claims frequency up 45% to 50%. So how much is claims frequency up from the same period in 2019? And what do you see as kind of the long-term trend right now?

Claim -- and again, you're asking the right question, measuring it off of 2020, there's a wonky base effect going on there. It's probably up in the neighborhood of 3% from 2019. What I would tell you is that's sort of a good way to look at it. There's a couple of things going on underneath that. We think that there's typically 1%, 1.5% frequency uptick in a given year that's largely driven by the population. So '19 to '21, you get 2 years of that. That gets you in that zone. I think it's a reasonable pick to see. We're seeing that the losses -- the loss frequency or the types of losses are a little different. This shouldn't shock anybody. There's almost no part of our economy that when you look at the pre-pandemic to the post pandemic, that's running exactly the same. Just because we're not in lockdowns anymore and people are back out and about, you're not seeing a mirror reflection of the down and the up. The miles driven are up a little bit per trip. The time of day has shifted a little bit. The average speed has shifted a little bit. And the simplest way I can describe it is in an old traditional environment where you had a big chunk of people that went to work every day, they left in the morning, they drove in rush-hour traffic. They got to the office and they didn't leave till the end of the day where they drove home in rush hour traffic. Those trips made have been shorter they were at slower speeds because you were in rush hour, there wasn't something going on in the middle. Now with those same people, many of them working from home, they might run a couple of errands in the middle of the day. So they might be on the road at different hours of the day. Because there's not rush hour traffic, they're driving a bit faster. They might take a slightly longer trip because they ran that errand. And if you're driving at 10 miles an hour versus 35 miles an hour, you're going to wind up with a different severity of the accident. So the frequency number is a good one to match. It's generally in line with what we'd look at from a population and a regular sort of frequency uptick when you take 2 years combined, but they're a little different.

I think what I would add on, Brian, is for folks who are trying to kind of reconcile our frequency trends to maybe what would be the broader national averages, you're going to see some differences because the population growth rates across the country is just not commensurate with what the population growth rates are, quite frankly, in the territories that are our largest, so that being California, Florida and Texas. You continue to see significant population growth rates there versus kind of what the national average. So while you might be down from a national perspective, those areas actually have a little bit of a different trend, and we remain in line with the trend that you would see in those markets.

Do you think the trend there is maybe a little elevated? Because it seems like -- I mean, I know where I am, it seems like everybody has been spending COVID in Florida -- you know, [indiscernible] the Northeast.

I think there's an uptick in those geographies for a couple of reasons. One, the population is growing faster than the rest of the U.S. So that's just -- there's just more bodies there. And two, you're finding a lot of people who were spending 2 months there or 3 months there or they're renting the house there. One of the things that typically you'll see and -- when you look at usage-based or attribution of risks or accidents, you're likely to have a higher number of auto accidents right after you've moved. That's not because you became a crummy driver, but it's because you're learning a new geography. You're learning which intersections are tough intersections, where is the store. You might be checking a map more often. You might be checking your Google Maps or Waze or something more often, where once you've lived in a place for a certain while, you just know where these things are and you work around it. You've introduced a learning process, which results in some minor uptick in accidents. So to the extent that we've been concentrated in geographies, even if our insureds aren't the ones who had that experience, the tourists, if you will, even if they were 2- or 3- or 4-month tourists or the newcomers, are experiencing that, and they hit whoever is on the road. So there's some element of that, that's increasing as a result. And that, I think, normalizes itself over time.

Now, does your demographic mix of business have any effect relative to the rest of the industry, at least in the near-term, short-term time frame?

It does a little bit. Just because you're a specialty auto customer doesn't mean you're blue collar versus white collar. It doesn't mean -- it's not an automatic requirement. But as a general rule, our customer base tends to be a little more working class. Their jobs were less likely to be remote working. So in the early days of the pandemic, Specialty Auto saw less frequency decline than, say, a preferred auto space because many of those folks were still -- whatever the job was, maybe they were landscapers, maybe they were working in a grocery store, maybe they were they were doing things that had them out and about more so they didn't get all the frequency benefit. When people started coming back to work and coming back out, they were already out. So when you might see a really big pop in a preferred because they weren't doing anything and now they're doing something, but we also saw an uptick in that frequency because the roads are more congested. And the ability of our group as -- on average, is a little less to be able to be hybrid and remote.

Got you, which makes some sense because if you look at some of the other preferred writers that have reported this quarter, they're still talking about claims frequency 20% below 2019 levels. And you guys are saying, we're basically there, right, and back.

And again, that doesn't shock me because if there's a certain percentage of the population that's still working hybrid, and they had a greater percentage of that population and we have it disproportionately less, you're going to see that. And many of them have their books in places where the population is actually declining. So fewer people -- and even if the population wasn't declining, you've got perhaps folks who were living in the New York metropolitan area who rented a house in Florida for 4 months. Well, not -- even if they're out a little more, they're not out in New York. So you're getting -- if they had an accident, that would go towards that preferred carrier, but everybody else in the New York area saw an effective population decline even if the resident didn't leave. So they didn't see the same uptick. And when those folks go back from Florida to their house, you'll see that ripple through.

Got you. Got you. Interesting. So let's flip over to the severity side of things. You talked about 8% to 10% severity. What is driving the severity? And kind of what are your assumptions on how long this is going to last for the inflationary trends and stuff?

Yes. Great question. I'm going to expand it slightly because what we've seen is some folks misunderstand a little bit. They heard most carriers at the beginning of the pandemic describe a frequency decline and then said severity went up because people were driving maybe a little COVID-crazy. They were a little faster, a little more reckless because people weren't on the road. And because the largest -- on a weighted average basis, most of the claims that dropped out were small claims. So the weighted average severity went up. Many people instinctively say, "Why doesn't the reverse happen?" Okay. Maybe the COVID-crazy driving went back to normal. You've added some more of the smaller losses that came back in. So that might reverse itself. But what happened after that is, I already talked about this, the time of day change from people drove, the average length of trip changed, the average speed changed because there are people who are now working hybrid are doing things in the middle of the day. That meant those tiny fender benders, some of them were replaced with slightly larger accidents. So when you re-mixed, you didn't mix with the smallest. You mix with 1 or 2 steps up. That pushes the average severity up. Then the last piece is the world didn't go back to the pre-pandemic supply chain. There were a certain number of rental cars pre-pandemic. All the rental car companies have smaller fleets. As a result, the cost per day is up in rental cars. The body shops may have fewer employees, and it's harder to get employees back. So it takes another day or 2 to repair a car. Well, maybe there's a storage fee at the body shop. Maybe it's 2 more days of rental car expense at that higher cost. There's chip shortages. There may be a problem getting containers on ships. And as a result, the headlight for this particular vehicle is late getting back into the country. All of those labor costs, supply chain issues, all of those things are driving some piece of severity up. We also saw -- I think much of the industry has been talking about social inflation. We have generally described that, with our lower-limit policies, most of the time, the attorneys were looking at that and saying, "You know what, that's not worth working those policies over because there's not a lot of ROI for me." A lot of them said, seem to behaviorally, it appears, that with fewer auto accidents to work from, they still had a certain staff and they were looking for things to do. The ROI made more sense for them to go to smaller limit policies. So we started to see an uptick in that social inflation that others had experienced that hadn't sort of worked its way into Specialty Auto. We're seeing it work more into those lower-limit policies.

Got you. Do you think that's temporary?

I don't know whether that stays. I don't know. It may be temporary. My instinct tells me that somebody is still going to do the ROI and going to conclude that they're working really hard for not a lot of dollars. But I'm not in that spot. I don't know exactly how the math works on the trial attorney side of the house. I know it doesn't do a lot for consumers. What it does is it adds cost to the system that doesn't usually end up in insured's pockets. It ends up in a trial lawyer's pocket and then ultimately drives cost up in premium. So it's not a social good in the process. I don't know where it ends up. To your -- your full question was how long does this occur? I think the mix change of people driving midday or driving maybe longer trips, more speed, my guess is that's going to be a little more like a permanent change. I think we're going to wind up with more hybrid work environment. I think we're going to wind up with a lot of those changes that will be here for a while. They may not -- I don't think we're ever going to go exactly back to normal "pre-pandemic normal." And if we do, it's going to be over a gradual pace. So I think the mix of types of losses will stay. I don't know what's going to happen on social inflation. We're going to assume that it stays there. And the supply chain issues, I think, are going to be here for a while. I think it's -- I haven't read anywhere where anybody thinks that the sort of the global pandemic vaccination rate and the global problems with shipping are going to be back to normal in under 9 or 12 months. I don't think -- importantly for us, if it's in that 8% to 10% range, what causes us angst is when it changes quickly and it changes by a large order of magnitude. Going from 0% to 10% in 2 months, big challenge. Going from 10% to 20% in 2 months, a big challenge. Staying at 8% to 10% for 12 months and being relatively consistent, not ideal, but we actually -- if we can somewhat forecast it, we can manage that. We can work it into pricing issues. We can work it into how we run and operate the business. It becomes a relatively consistent and stable environment. It takes us a number of quarters to work it in, but it's manageable.

Got you. And on that, I'm just -- how are you booking this stuff? Are you assuming that this inflationary environment stays with us for a while when you kind of book your loss picks?

We have to date in terms of our assumptions, and that's one of the elements that led to a little bit of that Q1 intra-year development, if you will. We had an initial kind of expectation, if you listened to the Q1 call, closer to kind of a 6- to 8-point type severity trend range. We could see the severity or the pressures occurring in the supply chain at that point in time. It was an area that we spent some time on the call talking about trying to highlight this to folks' attention. What we learned in the quarter, though, that brought that forward and further kind of moved us to that 8 to 10 range was less about lockdowns in terms of people's behaviors, driving patterns, more about incremental per capita mortality impact. And once you saw the impact that vaccines had, ability to treat, other elements, and you saw those rates plummet in terms of the impact that it was happening on per capita of rates, you saw people come back and their behaviors migrate more to norms or whatever the new norm is going to be very, very quickly. So once people had a certain level of comfort, and they thought they were maybe dealing with something that would have more of an impact like a flu and that they would work through it, I'm not saying that's what this is, I'm just highlighting a trend, you saw a much quicker return to a normal behavior pattern. And that's despite what's happening either for lockdowns or other elements. It's -- from what I've seen so far, it's really about that incremental mortality rate and how that's changing that drives human behaviors around it.

Got you. Got you. So you're booking it, though, that you're assuming it's going to be around for a little bit longer, the inflationary environment.

Yes, we're booking with an assumption at this stage that it's basically here for the year.

Good. Okay.

And that's appropriate. That's part of the reason we had the prior entry year development. If there's an open claim, we're looking at what we think the ultimate severity will be on those claims and what will happen. And many times, we know the claim's here but we're going to settle it somewhere out in the future. So we need to be putting up the number for the ultimate. Our sense is, Brian, that we've been out in front of the issue and we've been spotting the trend early and then responding to it. We talked about it in the -- in our first quarter call that we saw it coming. To Jim's point, it came more rapidly than we thought it was going to come because people got out and about more quickly. And because they were out and about more quickly and the accidents happen more quickly, that put more stress on the supply chain, which then pushed the inflation up faster as you depleted the shelves, so to speak. And we were describing it as a third and fourth quarter issue. It came in quicker. And so we're going to respond accordingly with every lever, whether it's booking our losses or what we do with underwriting or what we do on pricing or what we do with any other lever we have to manage through the issue.

Yes. Let's follow up on that a little bit here. So you talked about 2 to 4 quarters for this to kind of get back to your mid-90s combined ratios. Typically 1 to 2 quarters, you can reprice pretty quickly. One, how receptive are regulators right now to kind of letting you take that rate? And is that the reason? And also, as you kind of said, what are the levers can you pull here to improve margins on your business without necessarily getting that rate?

Yes. So there's 3 or 4 things under there. One, let me start with sort of a bogey. I think we're talking about not necessarily mid-90s, but we should be thinking in that 97%, 98% range. That's probably the math you do if you got back to a 10% to 12% ROE. So I start with that view. The second piece is what are the levers that we have? One lever is pure base rate. We can change the rate filings. In many of our companies, we have multiple pricing tiers that you move between the pricing tiers for underwriting reasons. We have the ability to change the underwriting rules in those, which, when you move to a different tier, it moves you to a different rate level. So there's the 1.0 rate. There's the 1.05, the 0.95. And there's different underwriting criteria that move you back and forth. We have the ability to adjust those relatively quickly. We have billing plan options that we have at a very granular level. If we decided that males under the age of 35 with an accident, if our data showed that they were running a very hot combined ratio, we could change the billing plan to make it 100% down rather than a 1 month down. That's likely to cause certain of those customers to say, "You know what? I might be willing to pay a higher premium somewhere else to get a better cash flow dynamic." That has an impact on sort of the mix of customers that we wind up with. All of those things -- we can do all of those very quickly and very locally, we are doing those, and we'd expect that. The last piece is regulators -- or the second to last piece, excuse me, is regulators' receptivity. Regulators are very thoughtful, but they have a set of competing priorities. On one hand, they're worried about carrier solvency. They want to make sure you have enough dollars that you're there to pay all the claims to the policyholders. On the other hand, they're worried about affordability and don't want insurance companies to be making sort of a user reset of returns. They want a fair return for the customers and a fair return for the companies, and they're trying to find a balance between the [ 2 ]. Also, the biggest problem they sometimes have is an availability problem. If they get too out of balance on affordability and solvency or making sure the rates are high enough, the -- what a company will do is if they're running a 110% combined ratio, they just stop writing. And if you get enough of them, now we have an availability problem. When regulators are looking at -- and they're looking at filing, all of us file our rates and we use our historical experience and our projections of forward loss trend. 3 months ago, we were all dealing with a big period of COVID, low frequency, lower severity period of what some might describe as increased profitability. And we thought there was frequency and severity coming but it hadn't been seen yet. That's difficult from a regulator's perspective to be certain that's coming. What's happening now is that frequency and severity is here. It's impacting open losses. It's moving very rapidly. It's very visible. Most regulators will look at the last 12 months and say, "That was an anomaly." We shouldn't wait that heavily. And they're going to look at the speed of the rising loss trend and say, "We don't want to have an availability problem or a solvency problem." I'm not suggesting we have a solvency issue, but that's the way -- those are the words a regulator would use. They want to avoid those 2 issues. So my sense is they're going to be more amenable to the fact of needing to respond around it because the data shows that it's there. Now we haven't been through all of the different geographies and all of the different regulatory environments. And -- but my sense is you're going to have most of us in the industry with a similar point of view. Some will be at the front of the line because we see it quicker. Some will be in the middle or the back of the line because we've seen it later but it's not going to be 3 or 4 months before everybody is seeing the same stuff. They're just going to recognize it a little later.

Got you. Got you.

Can I give you one more? The fourth piece is the last piece, which I think is actually probably the most important for people to digest and understand. There is a pace with which, in a stable environment, you can move and fix the profitability. Who here right now is certain how fast the global supply chain is going to open up and whether or not there's going to be any more push from a severity perspective? Who here can tell me right now if we're going to see lockdowns further imposed as the Delta variant runs or if we're going to see people when the FDA puts emergency use, takes that off the label, if companies are going to mandate vaccines, then they're going to push people back into the office. If you see people pushed back into the office faster, and we might even see a little bit more pop in frequency and you see a push in the supply chain problems, we could see combined ratios still go up a little bit. If you see people go back into a little bit of a lockdown mode and you see the supply chain catch up, we're going to see a little bit of help. None of those have anything to do with what any company does on underwriting or pricing. There's probably at least a 3- or 4-point margin of -- combined ratio point margin of motion that we could see over the next couple of quarters that are purely environmental. And depending on where you project the number to be, you may get too much rate and too much underwriting help or you may get too little. And there's only so much a regulator is going to let you get right now, so if you go to the point where you're pushing sort of where the edge of the regulators will let you get and you get a little bit more environmental deterioration, things could actually get a little worse before they get better. I'm not telling you which way it's going to go. What I'm actually telling you is if you sat down with almost any economist, anybody who looks environmentally, you're going to find a range around that, and people should be doing the math. This is us putting the -- like the surgeon general's warning label on the cigarettes, exactly what we did at the first quarter when we said we expect a supply chain issue working. There's some range around that, that's environmental in nature that it's going to take a couple of quarters to know how it's playing out.