Ready? Excellent. Good afternoon, everyone. Continuing on with day two of the Raymond James 45th Annual Institutional Investors Conference. Appreciate everyone coming today to kick off the afternoon session here. In this room, we have the management team of Kemper. They've been a participant of the Raymond James conference for many years now, so we certainly appreciate your continuing involvement and support.
For those of you that have been paying attention to the auto insurance market in particular, it's been an incredible journey, not only for Kemper, but for the broader industry over the last 24- months. I firmly believe that from an outsider looking in, probably the most challenging environment of our lifetimes, and the companies, Kemper included, are still standing and with an outlook that I think is quite positive. So, this conversation is structured as a fireside chat, minus the fire. If anyone has questions, feel free to raise your hands, but I thought I'd start off with some, just some introductory comments from Joe, and maybe provide your perspective on how the market's evolved over the last 24 months, and how Kemper has performed inside that.
Sure. Thank you, Greg, again, for hosting the conference.
Yeah.
Always a great event to touch a lot of different folks. I echo your comments about the last 24 months. The auto insurance business, in particular, if you look back probably over the last 40 years, ran an environment where loss inflation was roughly 3% or 4%. Sometimes it was a couple points higher, sometimes lower, but basically 3% or 4%. It's a business with a probably 4% underwriting profit margin underneath it. And when you've got that environment in a regulatory process, they look at historical losses to help you set future prices. You set your price at the beginning of the policy period, and then basically keep it flat for the entire policy term. Those rates and loss trends were roughly in balance.
What we saw was in the COVID lockdown, you saw people stop driving, so you had a massive negative loss trend from frequency, minus 10%, 15%, 20%, and then when people started driving again, you had a supply chain problem where loss inflation was north of 20%. The combination of those two things, the regulatory system wasn't designed to handle it. There was basically a lag in rate increases, so you had a big surge in inflation, a lag in price increases, and a massive compression of profit margins. And it just takes a while for the rate to catch up, and let the equation rebalance. There's things carriers can do to combat that that aren't the result of rate, but there's only so much you can do, and adjust.
Where we are at this point, at least for Kemper, and I think chunks of the industry, we're on the backside of that. We've seen cumulative rate increases exceed the cumulative loss trend. The earned rate increase is coming back in, and profit margins are restoring, and we're starting to take off those non-rate actions, and get back into a more normalized environment. It's certainly one of those time periods that I would have never expected, having been in this industry north of 35 years, that would have occurred. I don't anticipate seeing it happen again, but we've learned a lot from it.
As a company, we've had the ability to use that time period to strengthen some underlying capabilities, to de-risk the organization, to again improve the capabilities. So as we come out on the backside of this, there is an opportunity to capitalize on a disrupted environment where smaller players or players with less competitive advantages will be disadvantaged in that environment. So we look forward to what should be a fun couple of years after what was an exceptionally painful couple of years.
Pain is an understatement for all of us, for shareholders, for management, and for analysts recommending your stock. You know, if I reflect back on some comments you made at the end of, with your fourth quarter earnings call, one of the points that you highlighted that it struck with me was, like: If we were a private company, we'd be growing faster than we are right now. So maybe you can, you know, back up and tell us the genesis behind that comment, because growth is, policy counts are an issue right now, and then tell us what you mean by that.
Sure. We're in a non-standard auto business. That business tends to run 50%, 60%, sometimes a little higher, retentions. That's normal. A typical standard and preferred carrier might run 85%-90% retentions. That doesn't mean we're disadvantaged, doesn't mean it's a problem. It's a normal, ordinary course part of the business, and we expect it. One of the things we did, when profit margins were pressured is we reduced new business writing. That's a way to sort of boost earnings relatively quickly. There's normally a new business penalty, when you write policies. The result of curtailing new business while having a more modest retention is allowing policies in force to shrink.
Earned premium isn't really shrinking because the rate increases are so high, so the revenue of the organization has stayed relatively flat, but customer count declined. We were in a spot where we had a couple of years where profit margins were pressured from that environment I described. We had taken enough rate. We filed for the rates, we got regulators to approve them, they had approved them. Those were going to be written and earned in the policies, but for the passage of time. The only way they weren't gonna be is if for some reason we weren't following the law and executing the approved rates. So that was going to happen. Those rates were far in excess of loss trend. It's an algebraic certainty that the profit margins were gonna improve.
But we got very clear feedback from investors, and particularly some of our biggest, that said: "Look, this, this profit margin, pressure has been there for a while. We want you to print an underwriting profit. We want to see a combined ratio below 100, before you start, the increasing that new business and returning towards a policy growth basis." We recognized that, understood it. Again, I say as if Brad and I owned the company, we would have started that, that process sooner because we believed the medicine had been applied, that it was clear, that profit margin was going to improve.
Right.
But it’s not our money. We don’t own the place. We listened to the folks who do and said they wanted not just the certainty, but they wanted to see it. We hit the fourth quarter. We produced a 98 combined ratio. We’ve still got earned rate well in excess of loss trend, so it’s clear that at this point we ought to be expanding that new business, so we are.
Yeah. So one of the perspectives on new business, and you've used this analogy where you do the index value of one, and step back and talk to us about index value at nine in 2019, where it went in 2020, 2021, 2022. Can you and where it is today, can you, for the, the audience and for those listening in, can you walk us through that analogy?
For new business?
Yeah, for new business.
Yeah, from a new business perspective, if you assume that, you know, the 2019 period was sort of a 100%, you know, a spot, and that doesn't mean we wrote everything in the market, but what of our new business levels, we were there. By the time we got into 2023, we'd curtailed new business, and at the beginning of 2023, we were probably at about 50% of that level. By the time we got into the middle of the year, we were again seeing it take longer to get rate in California, longer to see the profitability improve, and we actually slowed that down probably to closer to 10% of that 2019 level, which is why the policies in force are contracting the way they are.
We will expand that back and see every likelihood that we can expand that back to roughly that 100% level. But we'll do it in a couple of steps over the course of the year. From a prudence perspective, it's not like flipping a light switch and turning it back on to a 100%. The environment when we were writing at that 100% level was what I might describe as a more soft market, a more stable market, a more consistent environment. We're in a different environment right now, and so we will turn on that flow and increase it, validate how the business is performing from a loss perspective, and when it hits our targets and we're comfortable with how it's performing, continue to expand.
The first notch or two will likely go faster because as you can imagine, when we were slowing down new business, we took the stuff that was the least profitable and slowed it down first, then the next tranche, and then, you know, the last stuff we had done was what had historically been the most profitable. We'll expand in reverse. So we'll have the most confidence about the first tranche and the least confidence about the last. By the way, I think it's a high confidence about the last, but it will by nature be less. So we'll start the expansion more rapidly, and then it will, the pace of expansion, will slow a touch.
Right. And so very much this is a state-by-state business for you. And so, maybe you can provide some broad commentary on which states look like they're, you know, price adequate at this point versus the other states are still work in progress. I know you got, one of the first companies to receive a substantial rate increase in California last year.
Yeah, I'm happy to. We're very pleased about the rate increase in California. The insurance commissioner, I think, recognized the challenges in the marketplace, and very thoughtfully adopted a different approach than perhaps the insurance department had had in the past and said: "Look, you guys should and need to file for all the rate you think you need to, to be rate adequate in the market and in such a way that you won't need to come back for at least another year." So it's got a forward-looking view of rate adequacy. We worked very thoughtfully with the department. They approved our request. So again, based on the commissioner's, you know, recommendation, we filed for what we thought we needed and in a way that we wouldn't have to come back within a year.
So, we feel good about where our position is there. As a general comment on rate adequacy, we feel overall the book is rate adequate. Now, let me add a comment about that. At any given point in time, through the history of time, any insurance company might say we're rate adequate, and that's an aggregate statement, but there's always some place where we think we need to be moving. And inherently, we set a price based on a regulatory approval that we know will be in place for the policy term. So we've got a forward-looking view of inflation out 12, 18, or 24 months when we're talking about that. So we know that there'll be inflation. We know over that policy term, we'll make another rate change.
We know things are going to go up or down a few points one way or another. What I would say is we believe we're broadly rate adequate. We believe over the course of the next 12 and 24 months, we're gonna take what I might describe as maintenance rate changes, which include normal, ordinary course inflation, and it includes some rebalancing, when you go by line of insurance, whether it's liability insurance or property damage or physical damage, you know, metal coverages versus liability coverages, those may go up or down. It may adjust a little, state by state. And we recognize that in states like California, that are a little slower to move on rate activity, we try to get a little more certainty of where we are.
In states where they're more flexible or responsive in their rate change activity, we need to have a little less certainty, or we might do recognize that we're gonna take rates a little more often because it's a little more easier to tune that. As Greg mentioned, we'll continue to see over the course of the year as we sort of get back to that new business, normal new business level expansion, and it will vary by state. I'd love to tell you exactly how it's gonna be one state at a time and which state goes where. That's a function of where we think the state's rate adequacy is, and that could be more than rate adequate in some spots. How are things going by line? What's the competition doing?
It will. I can probably say with a high degree of confidence, we'll be back at that traditional new business level by the first quarter of next year. But I know it's not gonna be linear, and I don't know exactly the slope of the line from here to there. And with as much of a unprecedented market time as we've had in the last two years, predicting the slope of that rebalancing is virtually impossible.
So, thanks for those color, the color on that. And then, to wrap up just in the specialty auto business, where are your target combined ratios for that business? And you mentioned where the underlying was in the fourth quarter, and have you put a timestamp on when you expect to get to that level? I know you've set up some other financial objectives for this year, so.
Yeah. We'll sort of tag team this a little bit, probably between Brad and I. We don't give a target Combined Ratio. We give a target long-term ROE through the cycle, because we've got more than one business, and so the Combined Ratio in auto, it becomes a function of, you know-
Right
... all these different things, and it becomes a little bit of a, a nuisance when you're trying to combine all those businesses together. That said, if you were to do a little bit basic math, and you took that target from ROE and did a leverage ratio, a typical premium to surplus ratio on the auto, you'd probably do math that got you somewhere in that 95-97 range. You know, call it a 96. That would be order of magnitude.
Right.
We had a 98 combined in our specialty auto business in the fourth quarter. We've got a little north of 20 points of unearned rate, which we'll earn in over the course of 2024. If you assume there's 20... and I'll do rough math, so we can all do it in our head. If you assume 20 points of rate, you take what people have described as inflation, us included, of mid to high single digit, call it seven or eight points. Let's be conservative and call it eight points of inflation. 20- 8 is 12 points that should improve profit margins. If we're at a 98, you're trying to get a 96, you only need 2 points.
So there is ample room to get to that target in relatively short order and room to perhaps surpass it, or perhaps more importantly, what we clearly described was gonna happen back in 2022. We said at some point as we approach that target, we will have taken more rate than it appears we need because we will turn off or take off some of those non-rate actions. We took a series of non-rate actions to improve profitability before rates could be taken.
Those included tightening underwriting standards and reducing new business. As we loosen the underwriting standards and get them back to normal, it will expand new business, and there's a cost to that. So we have a high degree of confidence that those target margins will be met relatively briskly, and that there's ample room in the unearned rate to facilitate allowing us to re-expand new business to more traditional levels.
I think you hit everything, there, Joe. One thing I will highlight, though, that will come up likely in the first or second quarter, one of the, the offsets that earned rate coming in, besides the unwinding the non-rate actions, will be the expense ratio. As earned premium's coming down, we've cut a lot of expenses, but, you know, we don't wanna cut to the bone. So the fixed cost will be there. Expect maybe one point or 1.5 points over the year of an expense ratio pressure. So you got that 20 points of rate coming through. You've got, severity, inflation, seven to eight points. You got a little bit of, non-rate actions being unwound, but we will have a little bit of expense pressure. I don't want that to be a surprise to those who, like to model.
Brad, is that an expense pressure that you'd expect stays forever, or is it a one or two quarter?
It's a few quarters as we get to writing the business. You know, expect the way we're looking at things right now, on a written basis, somewhere midyear, on a year-over-year basis, you'll see a written premium growth. A quarter after that, or maybe a quarter or two after that, you'll see an earned premium growth on a year-over-year basis, and then shortly after that, you'll see a PIF growth. So in line with that growth, you'll see the expense ratio trough out or peak and then start to decline from there.
So to be clear, we think we still have an ongoing expense advantage. That pressure you'll see relatively short term, won't pressure the combined ratio, we'll hit the targets, and it really is a timing issue that works itself out over the course of 12 months.
Excellent. So, there's a lot of other moving pieces inside Kemper that have been going on, so it's probably worth touching on a couple of the other initiatives, no particular order, there's the preferred business, and you announced that you were getting out of the preferred market. So maybe you could provide an update on the process, the progress being made with that piece of business?
Everything we announced is on track. As we mentioned a short time ago, over the next two years, two and a half years, we expect to release about $300 million of capital. The premium wind down is going as expected. We released in the back half of 2023, about $45 million of capital. We expect about $130 million of capital freed up this year, in 2024 and in 2025, another $100 million.
We're getting the approvals we need, you know, in the various states that we operate in to exit. One of the most important states, that being California, for both property and home, will start to non-renew this month, later in March. Everything is moving as planned. That capital that's freed up will be used for the, the new business expansion that we've been talking about, and specialty auto business.
So embedded in that, one of the challenges that, you know, analysts have faced for your company is that it, it's been a small component, but still, there's been some volatility among cat losses. The expectation is, as you wind that business down, your exposure to cat volatility will be greatly diminished, too. Correct?
Absolutely. Absolutely, and you can see that-- Give an example of what we expect this year. You know, we reduced, you know, by $50 million, roughly, our reinsurance towers-
Yeah.
excess of loss program from 2022- 2023 or 2023- 2024. I'd expect the cat loss or cat expectations to come down significantly as we exit the property business throughout this year and next.
Okay. One of the other initiatives that you guys have executed on is the re-domicile of the life business and repositioning the capital inside that. So step back, provide a perspective on what that business is, and then tell us what you did and how it benefited the balance sheet.
So let's tag team a little bit. Our life business overall is a low face amount, whole life business that sells policies to low to moderate income individuals who want a proper end of life, a final expense type policy. It is very vanilla whole life policies. Customers pay a monthly, often in cash, for these policies, and then hold them for the duration of their life. They're looking to make sure they, again, have that proper end of life. For us, it's a very steady stream of earnings and distributable cash flow. It's a growing customer segment. The customers want the product. They value it highly, and there's a limited sphere of competitors that target this segment of customers. So we have a real strong competitive advantage there.
Again, it provides that steady stream of earnings, and distributable cash flow. It also has a great capital diversification benefit, that works with our auto business. And I use this analogy all the time. If you think about the auto business as an ice cream stand, the life business functions like a Christmas tree farm. It's stable, it's consistent, it's not weather dependent, it operates, and its existence provides a capital diversification benefit that actually allows us to be more price efficient on the auto side of the house.
If we were to exit the business, leave it, sell it, do something else, the required capital from a rating agency perspective would significantly increase in the auto business, equal to roughly the capital we deploy in the life business. We wouldn't have its earnings. We'd have to increase the earnings in the P&C business, which would result in prices going up, which would result in growth going down. So it's probably a four or five point advantage in pricing power inside of our auto business. So it's got a real strategic value to us. And we didn't technically re-domicile-
Right. Right.
...the book, but we deployed, you know, a Bermuda capability.
Yeah. In 2022, we established Kemper Bermuda. Late in the third quarter, we reinsured 80% of the life business into Kemper Bermuda Limited. Doing so moves from, you know, a statutory regime to a more contemporary regulatory regime in Bermuda. This enabled the free up of roughly $300 million of regulatory capital, really liquidity, and that we sent that up to the parent. We continued on with that, and we did what's called a systematic reserve review. So as, you know, when you look at the liabilities on our balance sheet, are you appropriately reserved? We have been very conservative with our reserving over many, many years.
Through that review process, you know, working with our actuaries, working with the regulator in Illinois, we were able to reduce our reserve requirements and free up an additional roughly $300 million of regulatory capital or liquidity, and send that to the parent in the fourth quarter of this year. So this, we call it the Bermuda Optimization Program. In the last two years, it's freed up roughly $600 million of liquidity. We've used that liquidity to support all of our operating subsidiaries and it's been a great project through this dynamic operating environment in the P&C space.
Yeah. We're gonna get to capital, you know, as we wrap up. Before we do, I think it's important to spend a couple minutes talking about one of the last major initiatives that's ongoing, which is the reciprocal initiative. Maybe you can frame it for everyone. What's the objective of pivoting to a reciprocal format and, you know, what's the outlook? What's the runway? How long does it take to get there, etc ?
Sure. There's a couple objectives. We think that ultimate structure. There's a couple of things. We think it produces significant shareholder value once the transition occurs. And we believe it allows the business ultimately to be more price competitive for consumers. The combination of those should allow us, again, to create more shareholder value, grow the business more rapidly, improve the ecosystem for all the stakeholders involved. The crux to the issue is the structure involved. If you think about insurance generally having two big functions. There's a risk transfer function, which requires a lot of capital, and there's a service function, which requires a little capital. When a stock company has both, you require a certain ROE on both of those pieces.
By transferring the risk transfer process to a reciprocal, which is owned by the policyholders, that ROE requirement is much lower. Policyholder's not looking to make 15% ROE. They're happy to make 2% or 3%. That provides either increased earnings at the same aggregate price or pricing power that can be applied back into the program. So once the structure is changed, the Kemper legal entity, the Kemper company, the one that you as investors own, will be providing the service to the reciprocal, having a very capital-thin model, and seeing profitability come across from a service component.
And the capital required to support those underwriting risk transfer items will be freed up to be reused or redeployed or returned to shareholders while capital is generated inside the reciprocal from its own retained earnings or from surplus notes or something else. So the swap, when you're done, should result in a higher multiple model inside the Kemper entity and freed up capital, and it should result in the ability to have a more, more price competitive program inside the reciprocal. Now, that takes a number of years, probably at least five years before this is deconsolidated and gets that benefit.
This is a program, and I mean this appropriately, respectfully, but we wouldn't have talked to any of you about it, just the way many companies have R&D and do different things, and they don't talk about them until they're ready to be used and for prime time. The minute we filed to create the entity, it was visible in public insurance company filings, so you guys could have all seen it, and you would've said, "What you're doing?"
So it's one of these things that we know it's gonna take a little while. We're not promising it's an immediate benefit. It's got a longer-term benefit, but it became visible. So this isn't one of those things that there's a big update every two, three, four months. It's gonna take a little while for it to grow to a size where it provides that benefit. We'll provide an update later in the year. You can try to see the accounting, and we'll help sort of people figure out where that goes in a more detailed view of it to help people think about how it grows and expands.
Excellent. So, just, two minutes left, so let's close out with a discussion on capital. That's certainly been, you know, for you, your company and for a couple other companies, an area of focus of investors. So especially considering the challenging results you posted, you know, in 2023, to a lesser degree in 2022. So maybe you can provide an update of where the capital position is relative to expectations at year-end 2023 and how you, how you're thinking that's gonna look as we move through 2024?
Yeah, definitely. Good to see us having a different conversation around growth versus the ongoing capital and liquidity discussion or questions we were getting at the end of Q3. Just a reminder, when we had a lot of conversations, a lot of questions around the capital and liquidity position at the end of Q3, we told you we were solid and sound, and we're not worried about capital. Since then, and throughout Q4 of 2023, you know, we completed a Bermuda optimization effort. We completed our expense initiative. The KPI or Kemper Preferred Insurance wind down has continued. We've done a lot of different things, and we made money. We printed a 98 Combined Ratio, underlying Combined Ratio. We made roughly $50 million of that income in operating profit.
And so I'm very pleased and comfortable with our capital levels at the end of the year. The RBC ratio for the P&C entity in our earnings deck was roughly 275%, north of 500 in the life business, so very strong from those metrics. Additionally, as we make money, that will continue to only get better. So, you know, think about what's going on. We're making money. We've got significant tailwinds from rate well in excess of loss costs. We've got the Kemper Preferred Insurance wind down. Those two things, plus the expense initiatives that we continue to earn through, will be helpful for earnings and capital generation, so very comfortable from that perspective. Additionally, there's lots of question around in the third quarter with respect to just kinda changes in liquidity quarter-over-quarter.
We typically have somewhere between $800 million and $1.2 billion of liquidity on hand or available liquidity. At the end of the year, we ended at $1.15 billion, so plenty of liquidity to do a variety of different things. And we'll use our both our capital and liquidity to reinvest in our business as we grow and expand, the specialty auto business with new business writings. Additionally, we have a debt maturity in February of 2025 of $450 million.
We told you back in November of 2022, we'll look to address a part of that and take some of that out. As our goal over the next year and a half, two years, is to continue to delever in our debt-to-cap ratio, you know, 35% approximately. We wanna bring that back down as quickly as prudently possible. Didn't get up there overnight. We don't expect it to come down overnight, but by the end of 2025, expect that to be in the mid-20, 20%.
Excellent. Well, we've hit the 30-minute mark for your presentation, so we're gonna go proceed downstairs to breakout. But before we do, I wanna just thank you for your participation and presence here. We thank you for your time.
Thank you.
Thank you.