Kemper Corporation (KMPR) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Greg Peters. I'm the analyst at Raymond James covering insurance stocks and all the fun stuff associated with that. So day 2 of live conference. And I'm pleased to welcome back the management team of Kemper. From earlier conversations with other companies and from what everyone's reported certainly last year and then early this year, the auto insurance market has been under a lot of duress due to inflationary pressures. And I think it's pretty timely to have Joe and Jim here to talk about the trends they're seeing in their business, because it feels like we could be nearing a cyclical trough in earnings. And as pricing recovers and changes to other underwriting guidelines, it's quite possible that results can eventually improve, not only for Kemper, but for the industry. So from management today, we have a number of people here, and it's worth highlighting that Karen Guerra, who's on the hallway, helps out with Investor Relations. And she is an important person for everyone here because she will respond really quickly to e-mail questions and phone calls. Brad Camden, who's the Treasurer, is always an e-mail away as well, and he's in the audience. From management, we have Jim McKinney, who is the CFO; and Joe Lacher, the CEO. So the next 28 minutes is structured as a fireside chat. Before I launch into some questions, I thought I would let Joe open up with some comments. So Joe?

Terrific. Thanks, Greg, for having us and organizing the conference, and for everybody here for being with us today. At Kemper, we're a portfolio of specialized businesses. Each one of those businesses targets some underserved or specialty market where we bring some unique skill set to bear that lets us, over time, develop a systematic, sustainable competitive advantage to meet, again, that unmet or underserved customer need. We've got a series of those businesses that I think have real great franchise value and have premier positions in the marketplace. Our Specialty Auto business and our life insurance business are 2 of those. And we think over time, they produce attractive returns and allow the organization to grow. So we feel pretty good about the strength of that underlying franchise despite facing what really, in almost any measurement, you might call a 1 in 200 year type event with the pandemic, either from a mortality perspective or what it's doing in the imbalance of inflation and rate in an auto marketplace. And we think those are issues that work themselves out as the normal insurance marketplace works itself out, but the underlying strength of the franchise is still there and provides great value to our customers and all our stakeholders.

Yes. Well, we can take the conversation in a couple of different ways, but I think probably the most important starting point would be around the inflationary pressures on the auto side. And it almost is 2 different conversations, same issues, but preferred versus specialty. But to start things off, let's focus on the specialty piece because that's the most important piece. Where are we right now? We see some mixed data coming out. Manheim, I think, is showing some stabilization in used car pricing. You were one of those guys -- you were one of the first companies out of the box to call this out before it hit. Where do you think we are right now and talk to us about the path of recovery.

No, great question. We continue to think higher for longer. What that means is that when we look back and we just think about what drives kind of that imbalance and what would need to happen in order to reduce some of the severity pressure or the inflationary trends that are out there. Either you got to have something that's going to materially change demand from where it is today. So consumers having an appetite or desire to own a new vehicle or a used vehicle from where it's at today. Or you need something to fundamentally change from a supply chain, our ability to produce new vehicles or change kind of parts inventory or other elements from there. When you think about where we were at in 2021, we had a fairly sizable gap between demand and supply that was out there in terms of the total demand. We still are not back at the 2019 expected production levels. And then on top of that, with folks moving away from the city and some of the change in behaviors that we've had since then, there was an additional increase in demand that actually occurred over that period of time. So when we look at that and some of those inflationary pressures that are out there, those are, at least from what I can see and what we could see kind of out there from a data perspective, they continue to kind of build off each other, even though you might have some slight reprieve at points in time or bottlenecks that kind of loosen up, in total that pressure is still building. And I don't think that the Ukraine-Russia scenario likely helps the matter. I think it further disjoints the supply chains and will further cause folks to kind of reroute. And so I think if you were to look at for the next 6 to 12 months, my general view is there's not going to be a tremendous reprieve at this point in time to the severity pressures that we're seeing. And we might not see it until kind of middle of 2023, and we'll see. But that would be kind of my base case in terms of when I look at it, when I'm seeing.

What I might add to it, and I agree with everything you said, in an overly simplified fashion, if you think about loss cost, a 1/3 of it may be driven by medical inflation, 1/3 of it may be driven by total losses, and 1/3 of it may be driven by physical damage type cost to repair a vehicle. Over time, those total losses and the cost of used cars at a relatively stable and not sort of changing picture. Medical inflation had a steady rise. That's still going on. The cost to repair a vehicle had a sort of a steady rise, that's still going on. The reason we're all talking about used cars is that, that went from sort of being flat to having a big spike relative to the supply-demand imbalance that Jim is talking about. We would expect that's going to continue for a while, that may abate. There's a question of whether the other the 2 sides of the equation, the just general underlying cost of parts and medical inflation. We don't see those moving off historical levels of rising and they may be a bit elevated from historical levels.

That makes sense. So against the backdrop of at least some part of the equation, the rising loss cost equation, the obvious solution is rate; the less obvious solution, but still equally powerful is underwriting changes. So tackle both those pieces in whichever order do you think is appropriate?

So ultimately, this is just a system that we need to be in balance. If loss costs are going up, prices have to go up to match them or something else has to come down. The rate of increase in loss cost is so high that it's going to have to be on risk collection or pricing, as you described it. At some point, we can live with higher inflation for longer once the rate and price changes catch up. It finds equilibrium at a different level. So we've got to catch up and then reestablishing that point. We've described before, in our last earnings call, that we thought somewhere between maybe 1/3, maybe up to 1/2 of the gap between our current profit levels and sort of a target would be covered with what we might describe as non-rate actions. We're going to look for price increases. We're going to move those through insurance departments. We'll work that through. That will hit policies every renewal we make the filing. The filing is approved, its policies at renewal, it starts forward our new business. The other component is these nonrate actions, which might be underwriting activity that might stop a risk from coming into us at all. It might be an underwriting action that changes the tiering that might take somebody from a lower price tier to a higher price tier on the same rate card. It might be things like adjusting commissions to agents. If you took a 10% commission down to an 8% commission, that's the equivalent of 2 points of rate running through. It has a similar impact. So there's a variety of things we can do and tools we have that can trigger that underwriting effect. Sometimes it's a nonrenewal. Sometimes states don't allow a nonrenewal, but we can do things like changing billing plans or we can terminate relationships with agents, which then the agent typically will move their entire book. So there's a variety of things we can do tactically that drive that non-rate activity.

Right. So against that backdrop, when did you initiate the process of applying some of these changes to your business in the specialty business. And it feels like it's accelerating. So give us...

Yes. Some of the nonrate actions, the earlier and easier ones we started in the second half of last year. The rate activity started in earnest late last year and continues. We've displayed in our quarterly earnings presentation, and I think the specialty business was on Page 12 for the last 2 quarters, if I got that right, in the top right corner of that slide, rate activity and what we've been doing there. And so that was moving at a fairly brisk pace from a file and an effective perspective. It's got to work its way on to policies at renewal. Ideally, we would have started that quicker, but it wasn't possible. The way the rate filing processes work, you take your historical experience, put that together with a projection of forward inflation and bring that to a regulator. Well, the 2020 year and the early part of 2021 were very low frequency years, so they were very attractive from a loss content perspective that didn't support rate activity. So we had to let a little bit of the experience of '21 get onto the books, so it will become more apparent.

Right.

Large chunks of states across the country right now are recognizing the rate challenge, the rate need, the need from a carrier perspective to see rates move up and have been responsive. And there's a number of states, big ones for us, like Florida and Texas, where we've already filed for and received approval for multiple rate increases.

And the state which is more problematic, which is still a large piece, is California. Talk to us about that state.

Yes, California remains, in general, the most challenging environment. Historically, they've got a unique rate filing process, a unique rating process. And their approval processes generally take, on a normal standpoint, a little longer than other places. And that is bearing truth or coming forth as we might expect. We have 4 programs in our specialty business there. All 4, we filed for rate increases. A couple of them in late December, a couple of them in early January. The state has accepted the rate filing, moved it on to their analysts. They're working their way through their normal ordinary course process. We have taken more non-rate actions in California than we have in some other spots because other geographies have been more forthcoming with rate actions. So the ability to solve it has been easier with a rate tool in other geographies. So we've taken more actions on new business and more tightening of underwriting and more restrictive items there. We haven't pulled every lever we've got, but we're increasingly pulling those levers and pushing them. And the issue will become how fast does the insurance department recognize the issue. Hopefully, it's soon, and appropriately aggressively, meaning bearing fruit on the rates. If not, it puts us and probably most carriers in a position where they're just going to stop writing rating business in California. This doesn't work. And that's a terrible answer from a stakeholder perspective, from a customer perspective, from a shareholder perspective from all involved. So we're very hopeful the insurance department doesn't sort of push the market into that position.

Well, they have been certainly more generous with rate in the property side. So maybe that will be a lesson that they'll extend into the auto piece. One of the other variables in -- and I know there's different nuances between the preferred and specialty and I've been focused on the specialty piece for the time being. But there's also a policy link between 6-month policies and year policies. Can you talk to me about how the profile between specialty and preferred on that metric looks for Kemper?

Why don't you take that? I'll probably do a little bit on specialty, too, because I think there's a little nuance under that.

Yes. So there were a couple of things underneath specialty. First, if you're looking at that, I think there's a couple of groups that you have to segment in between there. One group is obviously the commercial vehicle business, which is roughly a $500 million business. Generally, it's about 90-plus percent would be 12-month policies that are going through there. It runs at a high 80s, low 90s combined ratio and continues to be just a great testament to some of the franchise and the capabilities that we can build. Inside of that, then you have the rest is kind of the PPA market. That market segments into a couple of different components that we have. Some of those subsegments are going to be what I might -- one of them in particular, I might call out is what you really referenced is a specialty group, which is somewhere between your profiles of your standard preferred and your nonstandard, or what people might traditionally reference by nonstandard. There might be some credit challenges or poor driving or other things that are leading to a rating or some outcome that brings folks in there. That specialty [indiscernible] the book, call it, 65, 70, 75 where, again, they're going to be kind of in between good credit scores, good drivers, good behavior that are coming in. And that might have more of a component that might have more of a 12-month mix or profile to it. Whereas some of the other elements where you might have other driving challenges or other things that you're reflecting from a billing perspective, might be more 6 months. The way that, that group splits and there's 2 elements that I think become key there is your policy split. You've probably 50% effectively 6-month policies, 50% 12-month inside of there. But from an effective premium basis, it's going to be more like 60% in that 12 and it's going to be much more reflective of that specialty segment that I'm referencing that's kind of in between. That's going to be closer in approximation to what you're going to see actually within our personal insurance space, which is going to be more, I think, representative of the broad kind of standard preferred market, which is going to have much more policies in that 12-month base in terms of where that's at.

And so that's the answer for -- as you apply the rate, the 12-month policy is going to take a longer time for that to manifest itself in terms of improvement in your results versus the short term. But like you pointed out, the commercial piece has its own rhythm to it and looks better.

Yes. And you're going to -- even under those subsegments, you're going to have different rate adequacy levels. And what I would suggest is some of that 12-month group is going to be closer to rate adequate due to different amount of rate than some of the 6-month components. You have different frequencies rather than there that are just going to impact you more on that severity side. So it's not as black and white is what you see, and it would not be the right answer to paint that with like a broad spread. But to your point, it will take a little bit longer to kind of move those things. Clearly, a market that has 50-plus percent used car price increases into your policies are not -- we don't go in with those expectations, at least historically speaking here. So there are some adjustments that need to be made. It will take a little longer. But as a whole, definitely moving the book.

That's part of the reason that when we talk about nonrate actions, I think perhaps 1/3 to 50% of the impact on the loss ratio improvement we need to have. Sometimes what those are is they are a mix adjustment. So we're taking different cohorts and we're bringing them out of the book. We didn't necessarily make that cohort profitable. We eliminated it from the book, because over the short term it needs too much rate. So you get the same P&L impact, but it wasn't because we cut an expense or cut a commission or raised a price. It's because we eliminated it from the book.

Right. I know Mercury is -- they're also for the California piece, which is much larger for them. There is a totally different profile. But I know they spoke about being or adding odometer verification, because it's 1 of the main 3 variables in California. They're actually going through and demanding their policyholders prove to them that they're in the bandwidth that they've described themselves in terms of mile usage. California is its own state and you didn't mention the other states. My sense is that the operating environment for getting the rate you want in your other states is much more favorable and it's, I don't know, not all of them are fairly easy, but most of them are for you, the other states?

From a practical perspective, Greg, the easiest way for folks to think about it is they're moving at a normal reasonable commercial speed. And regardless of the specifics of the regulatory environment, from a practical perspective, they're taking the filings, they're moving them through. They're not saying you can only do 1 a year or 1 every 6 months. And in many cases, we've done multiple filings inside of 6 months, and they've moved through with a what I would describe as a normal course or accelerated course. They're moving through a reasonable speed that would apply the penicillin to the infection at a reasonable pace.

Yes. I forgot to highlight everything that this is supposed to be an open chat. If you guys have questions, you're welcome to participate, but I can keep going. So -- doing this for 20 years, I can talk for hours about insurance. So we covered the non-California states. We covered the California state. We covered rate. We covered policy terms. There's another variable that's emerging right now that I think hasn't really come into the full equation. And maybe you can help us think about this and the fact that gas prices are going up substantially. And traditionally, when we've seen spikes in gas prices, we've seen drop off in frequency. How do you think we are with that variable coming into play now quite prominently.

There's a couple of thoughts. One, we'd expect it to be a little more muted in impact than we've seen in the past, partly because consumers are generally flush from a balance sheet perspective in ways they weren't before. They're also seeing rising wages in ways they weren't before. So that will mute somethings a bit. The other issue we've got is in historic times when we've seen that, there was a reasonable balance between loss trend and rate already. We've got a significant imbalance right now where there's a significant rate need. Some drop in driving would reduce that rate need, but it's not going to solve it. We have a marginally favorable impact, but it doesn't cross and rebalance. So from our perspective, be nice if it happens. We're not counting on it being so much that it solves the problem. We're driving full force ahead on all of our other activities.

It's not going to affect severity.

It shouldn't affect severity. It won't impact any worse than because the shipping costs are going to increase. You're going to -- petroleum products are used in a lot of other things. It's going to have other impacts on other parts of the supply chain. It may have a frequency impact, but we're not counting on it being a solution.

Right. So we have just over 5 minutes left. And I feel like we got a -- there's 2 other pieces of your business that we should cover. One would be a brief -- the property piece is probably worth spending a couple of minutes on and then certainly pivoting to the life component, which has also had some headwinds. So let's first go to the property piece. Give us an update on what's going on in the property book. And how you're addressing rising placement costs, et cetera, within that book and what you expect that -- how that business to trend over the next 24 months?

Sure. And maybe we sort of tag in this. I make a couple of comments on property and then you drive life. Property is a couple of hundred million dollars of business for us. It, historically, if you back up 5 years ago, had a great volatility around catastrophe losses. We've re-underwritten the book. We've put in a catastrophe aggregate treaty. It really has narrowed the earnings volatility on that to a relatively tight range. So it doesn't have the same piece of the overall pie for the organization. It doesn't have the same earnings volatility it did. We've largely boxed that risk. So it's going to have supply chain and inflationary pressures that are going to have the same rate and underwriting issues that we're going to apply across the rest of the book, and we're diligently working on those. We don't have a Florida exposure, which has been in the press a lot from a property perspective as having a series of issues, so it's a smaller issue. And I think the biggest challenge we've had before, we sort of boxed tiling.

And before we pivot to the life piece, you mentioned reinsurance. Talk about how your reinsurance costs compare for '22 relative to '21. Is it higher, lower?

Very comparable.

Very comparable. So you're seeing the type of structure that some of the Florida carriers are, for example?

Correct.

Yes. Okay. And so then the other area that's had varying levels of duress over the last 2 years is the life business. So for the benefit of everyone, remind us about what the profile of that business looks like. And then talk to us about some of the issues that it's faced. And presumably, at some point, some of those issues should become tailwinds, but I don't want to get in front of you on that.

Yes. Thank you. It's a business that is really focused around serving a low to moderate income space and providing end-of-life solutions that in the absence of kind of us, and maybe a couple of others who are much smaller at this point in time, just those options would no longer exist in the market today. So we meet a growing need in the market, we do so at a very affordable price point and with a high quality, strong balance sheet, strong investment capabilities that allow us to do that. The policy profiles that we have are, Joe says this well and we'll steal it from him, they're straight kind of black coffee, not the mill of bean coffee or anything else like, it is just plain vanilla, the stuff that it's exactly kind of the top. So our average in force cloud is about $6,000. We have more than 3.4 million to 3.3 million policies out there. It's an incredibly well-diversified book that's inside of there. And it is straight either whole life or term that has converted out of that. In terms of some of the pressures that we faced, similar others, and just really sadly, obviously, COVID had an impact on mortality, both for the country, and more specifically on some of the more older demographics or others that had some preconditions or other. We have had -- and our policy holders had the great fortune of dramatically exceeding kind of the life expectancy and the elements that have been based inside there, but there has been some increased levels of mortality that were driven associated with COVID. Our results are largely aligned or are aligned with the national averages. So as they've kind of come up, you've seen ours roughly come up at the same amount. And as they go back, likely have it go back the same amount. Positive negatives, we had a business that was growing about 2x or 3x kind of maybe what the average market was growing. So we had good demand growth inside of there. We've seen that growth further accelerate in terms of demand policies. We'll see if that's a new permanent probably over a couple of years, but a tremendous amount of additional value we've created in a number of additional customers now that we've been able to provide solution for, and this has been a product that folks are viewing with increasing demand. And so we feel really good about what the future holds from that perspective. And there's no indication of some longer tail. As COVID -- we move through this period, we should return to kind of our pre-pandemic levels of results, which were very favorable. I might add, though, that even during the pandemic, well, look, it has had strong profit or reasonable profit levels. So down from the historical last year, '21, probably 50% or 60%, maybe less than what it was, but still more than earned its cost of capital inside of there. And had strong results, obviously, in 2020 that came in. So great business, we do a lot of good and should be a bright future, but we are still kind of traversing what is a little bit of a model and a challenging time.

So we have 1 minute left and probably a very important piece to every insurance discussion is capital. You recently raised some capital in the markets and debt capital. Just give me the 1-minute boiler plate on your view of capital, what's going on there and how the company looks.

So we're, I think, in a really strong and fortuitous position from a capital standpoint. Our recent activities were twofold, and we have talked about these. The first one was related to the upcoming Infinity note that comes due in September. We've talked about both from an interest rate perspective as well as some of the craziness in the world today that we wanted to be more forward-leaning in terms of essentially creating or raising the funds essentially for the refinance of that. The secondary element what we've talked about is, we think while the environment is challenging at this stage from a rate adequacy on the P&C side, we do think that we'll be quicker to work through this environment and similar to other environments that are really challenging for P&C companies, that is going to enable a fairly sizable growth and market share gain coming again. And so our recent activities on the hybrid market were to essentially bring in that capital. It's a little sooner than we would anticipate deploying it, but we believe that we have that capital then in order to be in a [indiscernible] perspective when the time is right and when we're back to kind of a rate adequacy.

That makes sense, strategic positioning. We've got to our 30-minute mark. And so I want to thank you for your presentation. For everyone here, there's going to be a breakout session downstairs, where you get to ask questions of management for the next 30 minutes. So Joe, thank you very much for your time and participation.

Thank you. Appreciate it.