Welcome to Kemper's Investor Day. We have a great agenda for today. However, before we dive into the presentations, I have a couple of legal items to cover. Today's presentation commentary includes forward-looking statements with respect to Kemper's future financial and business performance, strategies, and expectations. The forward-looking statements in today's presentation may involve known or unknown risks, uncertainties, and other factors which may cause Kemper's actual results, performance, achievements, plans, and objectives to be materially different from current expectations. For information on additional risks that may impact these forward-looking statements, please refer to our 10-K and other reports filed with the SEC. Today's discussion also includes non-GAAP financial measures we believe are meaningful for investors. For reconciliations to all non-GAAP financial measures to GAAP, please refer to tables at the end of this presentation. Today's presenters include Joe Lacher, Kemper's President, Chief Executive Officer, and Chairman.
Jim McKinney, Kemper's Executive Vice President and Chief Financial Officer. Matt Hunton, Executive Vice President and President of our Kemper Auto business, and Tim Stonehocker, Executive Vice President and President of our Kemper Life business. Today, you'll hear about why Kemper is a compelling investment opportunity. We'll cover details around our business, competitive position, short and long-term priorities, and other key initiatives. We have two opportunities for audience Q&A. Following the first two presentations, we will pause for Q&A and then again at the end of all presentations. With time permitting, we will also take questions from our virtual audience. To submit a virtual question, please click on the Ask a Question tab in the upper right-hand corner of your video player. I hope you all enjoy today's presentation. Please welcome Joe Lacher, Kemper's President, Chief Executive Officer, and Chairman to the stage.
Thank you, Karen, and thank you, everybody, for being with us today. We're looking forward to having a terrific conversation with you all, and want to spend some time focusing around really where we are today, how we're accelerating our path to target profitability, and then really do some double clicks into the underlying capabilities inside of the organization. What we're gonna do and spend time today is talking around about, again, that path to achieving target profitability and delivering really long-term value creation. We've announced a core set of initiatives, and we're gonna spend time on each of those. Again, sharpening our business focus around the core purpose and core principles of the organization. You've seen us in the last couple of quarters divest our health insurance business.
I'll talk a little bit about why. We've got a strategic review underway for our personal insurance business. We're spending time, and have, and continue to spend time on what we described early in the pandemic was home improvement projects. They're things that sort of go on under the surface inside our organization all the time, but are getting a higher profile. Initiatives that enhance our operating model, improve our underlying capabilities, drive the enablers that ultimately let us deliver systematic, sustainable competitive advantages into the marketplace. Over the course of the day, you're not gonna hear any updates to our fourth quarter guidance. We're reaffirming that.
Very enthusiastic about it, and believe we're going to see an operating profit during the first half of 2023, and underwriting profits during the second half of the year, and back to target returns being realized in 2024. That's really a punchline, and we'll hit that one several times as we go through the day. As we think about the overall direction, I'm gonna spend some time talking about our purpose and our strategic intent, as we call it, and the broad process that we use to build enablers and capabilities, and talk about how we're investing in those. We're gonna follow with Jim giving us a little deeper dive on some of those capabilities, and an update on that path to achieving profitability.
We're gonna take a little break there and understand and digest those. The balance of what we're gonna do is really double-clicking with Matt and Tim, very specifically getting into our life and auto businesses and teasing out a little bit more about what those capabilities are, what those markets are, how we bring it to life, and why we have a very focused and systematic, sustainable competitive advantage in those business. We're gonna dig into a number of the other initiatives that sort of work across the franchise that I know have a high degree of interest from folks overall, our Bermuda captive, the reciprocal structure that we're working through and help understand a little bit how those are gonna unlock what I believe is a real significant value upside for the organization.
For us, we go through almost everything we do, coming back to first principles, and then we sort of work our way through, you know, any problem that way. We start as a purpose-driven organization. A lot of folks will talk about a mission statement or a vision statement. Our experience is a lot of times those get a little flowery, and they don't necessarily tell you what to do. For us, we talk about a strategic intent. It both encapsulates that purpose, but it drives towards action. As an organization, we look to be a leading insurer, empowering specialty in underserved markets. Empowering those customers to have their needs met in a way that the bulk of the rest of the industry isn't doing.
Either they're overlooking these customers, or they're saying, "Eh, there's not enough money to be made here by focusing on them, or we could make plenty of money somewhere else, or these needs are too hard to meet," or whatever it is, it leaves customers with an unmet need. We bring a dynamic and diverse and innovative workforce to tackle those problems. A real strong purpose orientation and bias towards what we're doing, being impactful for those customers, but actually recognizing, as I talk a lot of times, internally about, there's three legs of a stool. You've got customers, you've got shareholders, and you've got employees. Think about all those stakeholders. If you balance that stool appropriately, everybody wins. If you get it imbalanced, you wind up tilting in a way that breaks.
Sometimes as a shareholder, you might say, "Boy, I'd love it if you'd expand returns." Well, if we get them beyond a fair return, customers don't wanna buy. If we, if we get them beyond, you know, a target return because we're underpaying and undercompensating our employees, then the system doesn't work, and they don't wanna be employees. If we make a fair return for those customers, if we're focused on what they need and why they need it, we do it better than our competition, that should enable us to win in the marketplace, grow market share over time, and produce a steady stream of fair returns and long-term sustainable cash flows, long-term target returns in a growing environment. That creates a great opportunity for employees because they see a growing organization, they see an opportunity to develop, to learn, to add value.
They get energized about helping those customers. Everybody in that cycle wins. When we look at delivering those appropriate and affordable insurance solutions, we go through a set of processes to make sure the markets we're in, the capabilities we have a consistency across the organization and leverage our talents so that we have a high degree of predictable and sustainable success. Our core businesses right now, or foundational businesses, if you will, are our Kemper Auto and Kemper Life businesses. We'll go back and forth between talking about them with the brand we use in the marketplace and with the product names underneath it. Our specialty auto business that has a focus on non-standard auto, Hispanic customers, urban customers, and our low face amount life insurance business that targets low to moderate income marketplace individuals.
We'll sometimes slip back and forth and call it an LMI market. What's common between each of these foundational businesses is a set of market characteristics, a large and growing market. There's real upside for us to expand and grow. Some place that requires a unique expertise. It's not just, you know, an accident that you can grow and make money and serve those customer needs. That expertise becomes a real differentiator. We love markets where there's limited or unfocused competition. You know, in some ways, it's a little bit like when you were thinking about the playground as a kid, don't go over where the big bullies are, go where somebody else is. You know, that you got a better chance of winning. We like those spots.
We look at every one of those market characteristics and say, "Is there some place there that we can build a systematic, sustainable competitive advantage?" We talk about those words a lot internally, and each one of them matters. Is there an ability to have a competitive advantage meeting those customer needs? It should be systematic and sustainable. We need to understand why we're winning, understand how that formula works together, and it needs to be defensible and a place where we can accelerate our lead and maintain that lead over time. Each one of those capabilities requires a core set of enablers and a core set of differentiated capabilities. There's a common theme around our foundational businesses. Most cases, these customers, are very price sensitive. We look to build a capability that has a low-cost management.
We don't just mean expenses there. We mean total cost. That might mean base expenses. It might mean loss cost, and what we pay out from a claim perspective. It also means the cost of capital, and the capital required because that ultimately is a cost of delivering that business model. Everything focuses around that. Then inside of those businesses, there's some combination of product sophistication, ease of use, and distribution that become a solution to that customer need. There, that product sophistication might be the product form, the actual policy coverage. It might be how we package the product and the service model to solve that customer's need. In almost all cases, ease of use is critical. Very few people wake up in the morning, tell some friends, "I've got a great weekend planned.
I wanna go buy insurance." It, it doesn't generally excite the customer, but it's important to 'em. They need it. They value it. They're looking for that solution, but they want it to be, you know, easy and effective, and that's a differentiator. Our distribution system enables the execution of those. We're gonna talk a lot about that. Our belief is that if we start with that strategic intent, we understand at core levels, you know, at core principles, when you click through that, what are the market characteristics that'll allow us to achieve that? What are the enablers and the capabilities?
That allows us to create a top quartile, even top decile value creation for each of the legs of the stool, our customers, our employees, and our shareholders. If I click in a little bit more on our particular businesses, we'll talk about foundational businesses. Sometimes I'll even describe almost a pyramid. We'll have foundational businesses. We'll have emerging opportunities. We might even go into a world of R&D at the top of that pyramid. Foundational businesses are ones that meet and match each one of those market characteristics, selection criteria, that we're looking for. An emerging opportunity might be one where we see some potential to get there, and believe we can get there, but we've got some work to do. Our specialty auto business and life business clearly are foundational for us.
Inside of specialty auto, Matt will spend a lot of time talking about this, both in our private passenger auto and our commercial vehicle business, that we have targeted, underrepresented, unfocused, or carriers, places where customers have unmet needs. We'll target Hispanic customers where Spanish is their first language, urban areas, difficult regulatory environments, non-standard auto, high-risk drivers. These are all segments that the bulk of the auto carriers out there say, "You know what? This is hard. Maybe we don't wanna go there" or "This is different than we do. It's not our standard process. We have to deal with exception processing." They might write the business, but they do it grudgingly, or they charge a higher rate, or they don't do it quite as effectively, as that customer has or wants.
That allows us an opportunity to both differentiate and match those customer needs and bring in expertise that can allow us to outperform financially the, that structure because it's not an exception for us, it's a focus. We've got a broad independent agent broker network that extends again, very wide. You could look at that number, and if you thought about it nationally, it'd be a big number. If you think about it in the tailored focused markets that we're in, it gives us a really deep penetration inside of those markets. Our life business targets low to moderate income individuals. I love this business. Very purpose-oriented. We're finding customers who have a very small amount of disposable income, but largely for religious or social or cultural reasons, want a proper end of life.
They're looking for a dignity, an emotional dignity of being able to know that they have that proper end of life, that can deal with the final expense of funeral, et cetera. They struggle finding ways to save for that themselves or have the financial wherewithal to deal with it themselves. They're looking for us to help them achieve that. The bulk of the industry says, "Eh, we want somebody who's dealing with wealth management or estate planning or tax planning or some complicated piece like that where we can make a lot more dollars per person." What that does is it provides a perfect nexus for us, a real driven purpose item, a real growing segment of the marketplace where customers have a need and the rest of the industry is not there.
We bring a long-term knowledge there, a distribution plant that Tim will spend a lot of time talking about that intimately knows those customers, their needs, their mortality, their lapse potential, all of the things that allow that economic model to work and lets us deliver a real value in a systematic and sustainable way. Our preferred auto and home business, we've talked about the fact that business is under strategic review. I'm gonna talk about it a little bit down the road, it would be what we'd put in that emerging opportunity bucket. It misses a number of those key criteria in terms of having a clear answer of how we can have that differentiated market position.
We're working through saying, can we find a path, and what do we need to do differently to make it a foundational business? Or does it become better served for the customer, and employees and owners potentially by being somewhere else? We'll talk a little bit about more of that later. Clicking down a little bit on that framework and that process, I don't mean this to be repetitive, but I mean it a little bit to show you how we march our way through this. We start, again, a lot of frameworks inside of the place, a lot of disciplined thought process, almost the boring nature of a set of engineers or doctors sort of working their way through a step.
Each business each of our franchises, each place we look to deploy capital, we're saying, does it meet those market characteristics, unique expertise, size, unfocused competition? Is there an ability for each of our franchises? It needs to be, say, an auto business or a life business. It needs to be functional and effective on a standalone basis. We need to be able to develop that systematic, sustainable competitive advantage in that on a standalone basis. To be part of the portfolio, to be part of the organization, each of those franchises either needs to make Kemper as a whole better or needs to be made better by being part of Kemper. That should be inherently logical.
We believe these businesses are better together than they are apart because the overall ecosystem adds to them or they add to the rest of the ecosystem in a way that enhances long-term shareholder value creation. The combination of that is really what drives our selection and participation criteria for the franchises inside the organization. Each one of those steps back into a set of employees that are targeting everything we do, saying, "Is this targeting a customer need? Is it matching what they need to do? Does it drive an ease of use? Is it a specialized delivery?" Each one of those becomes an inherent component of a systematic, sustainable competitive advantage.
Greater customer knowledge, greater intimacy, greater tailoring, in a way that inherently meets target returns, has a low-cost process, has a systematic and sustainable delivery mechanism. It creates barriers to entry. It creates defensible positions. It creates reliable long-term value creation. That proven repeatable process, that approach, is what drives our ability to consistently execute, and deliver that long-term value. Now, we take, inside of that, you know, the entire ecosystem of you that says we've gotta have really strong talent. This is inherently a people-related businesses. We manufacture promises. We take our analytics, and we're effectively predicting the future, trying to figure out who's gonna have a loss and where and how much. That inherently is driven by having the right team of folks and a relentless analytic superiority.
We've gotta constantly be asking questions, figuring out how to convert data information, how to accelerate the pace of that, how to get it quicker, faster, and more actionable, to deliver on those promises and again to predict that future. Again, as an insurance company, one that's driven by making promises, it's gotta have a rock-solid financial strength, to enable that. Each of those enablers supports a set of capabilities. Some of those are enterprise capabilities, holding company capabilities, things that run across the joint, and some of those become a little more idiosyncratic or tailored inside of the business franchises we've got. Conceptually they're the same, they're targeted a little more focused in the business.
Our, our capital allocation, our ability to be efficient users of capital, to drive cost in the organization down by doing that is a critical holding company benefit. Our, our thought process of how we deal with organizational development, whether that's talent development, whether that's building a core set of analytic capabilities or underlying technology capabilities or systems of financial controls, each one of those is part of our organizational development. Then how we think through strategic management. You know, how are we going through the frameworks I just described and making sure that we're living into them? You're gonna hear Matt and Tim talk a lot about key pieces of this business capability, that ease of use, distribution, and product sophistication.
Sometimes those words will seem to blend together because that product isn't just a form, but it's what is the customer actual need? In life, we might actually be selling them the financial discipline to buy, procure, and maintain a life insurance policy over their entire life. It's more than just the product form. It's that entire view of how those weave together. Each of these combined is what leads us to those SSCAs, those systematic, sustainable, competitive advantages, and ultimately what we believe provides that long-term value creation for stakeholders. When I go back to that framework, I said I would come back to this again. When we look at our foundational businesses, those market characteristics, those differentiated capabilities, our Auto business and our Life business really hit a check on every single one of them.
That's why we describe them as core or foundational businesses inside of the organization. They meet those needs, they have those capabilities, they have those items. We believe in each of these cases, we can accelerate them. They have a strength that can be built upon, that can run up the score, that can enhance the lead. This is what gives us a comfort that over the long term, through the cycle, we can hit the appropriate return hurdles and grow these businesses at a minimum of what the market growth rate is, but more likely meaningfully above that market growth rate. That provides a real advantage to us. Our health business, I mentioned before, we already have sold.
You could see, in the check and X box here, there were a number of places that we think that was a very attractive business. We thought it had the ability to deliver a niche. It wasn't in the right spot with us. We weren't gonna be able to answer those questions in a way that produced an optimal value there. Focusing our organization was the right answer, making sure we were uniquely focused on places where we could win, added value. We're in the middle of a strategic review of personal insurance. A number of you are probably gonna or are planning on asking what's the answer. We're not gonna tell you today. We're not done. There's an array of options that we're looking at there.
It's the full thing, set of things you'd expect, in a strategic review. We could decide that what we're doing is the right answer, and we could continue it. We could decide that we're gonna move down to a much smaller, much more focused, narrower view inside that business, or we could decide that it might be better off, with someone else, either because we sell it or shut it down or do something else, that exit that process. We'll have some update for you, likely inside of the next quarter. That is in process.
I'm not intending to give you an answer on one of those, but to tell you the full array of thought processes there and then give you some view of sort of how we think about our positioning right now of what's working and where we need a little bit of oomph. Again, I'm gonna come back to where I started. Highlights for today's meeting. You're gonna see us consistently start with a purpose-driven organization, a set of framework and principles by which we work through each of our franchise, each of our capabilities, each of our enablers, and it clicks down to build ultimately systematic, sustainable competitive advantages that we think unlock real, meaningful long-term value. We're gonna click in on various parts of those.
It's not intended to be a holistic view of everything that's inside of the organization, but a real ability, whether it's with Matt and Tim, to understand at a deeper level how this comes to life, at a customer level or in some of the material that Jim and I will cover, in different spots, a clearer understanding of the path to achieving target returns or the path to unlocking some of the value on those more interesting initiatives, around, say, the reciprocal and Bermuda. What you should clearly walk away from is a couple of thoughts. One, we're a purpose-driven organization. We've got a clear set of frameworks that drive to those systematics sustainable competitive advantages. From a priority perspective, our first and foremost priority as an organization is achieving target returns, no question about anything else.
Number two, it's achieving and enabling some of the key capital unlocks that we've talked about, the reciprocal probably being at the top of the list and the shift towards that model. Number three is focusing on the capabilities, the detailed capabilities that accelerate and enable that systematic, sustainable competitive advantage to drive that long-term value creation and growth. A unique focus on those three, it should come through in everything we talk about. Thank you. With that, I'm gonna hand it over to Jim to dig into our model a little bit more.
Thank you, Joe. Thank you everyone for spending a few moments of your time with us this morning. Honored to be here. Honored to be able to spend a few moments talking about our model and what enables us to achieve success over the long term. With that, I'm gonna jump in to a couple of items. I'm gonna build on what Joe mentioned before, and specifically, give some details around the operating principles that really drive our day-to-day decision-making, that also serve as the backbone in terms of how do we ensure that we're living into kind of our broader strategic intent, but doing so in a reasonably efficient and optimal way as we get into this.
The second element that's inside here is a topic that I know that us and you have a lot of interest in, and that's the path to achieving, you know, our target profitability, both for this year and then as we go forward. I'll spend a few moments obviously deep diving into some of the assumptions. We're gonna give you a lot of details or more details in terms of what those curves look like, and the various things that would be the biggest influencers in terms of achieving the targets that we set out both in our third and our fourth quarter calls. With that, we have four core points that are foundational to our operating principles. The first one is that we're customer centric.
As Joe mentioned, the customer is at the heart of everything that we do. This is important because as we get into it, one, ensures that we have a deep customer intimacy that's inside there. That means that we both know and understand the needs and the lifestyle choices of our customers better than anyone, quite frankly. That's what we strive for. That's what we try to achieve. The second thing that's inside there, which is equally important, is it's to understand and to be able to anticipate how those things are going to evolve. The key point here is you wanna be in the front part, right, looking forward and helping to be there for your customers with the anticipated need, not reacting to it later. That allows for us to have a superior customer experience.
It allows for us to meet their needs better than others. It allows us to do so with an efficiency and a cost advantage, as we'll see here, that you just can't achieve without this kind of mindset. The second thing is really a disciplined risk management component. Some folks look at risk management as a compliance type activity. You'll see where this is strategic to us. Not only do we meet and efficiently go through the various practices that allow us to be a source of strength for our customers through good times and bad, it's a strategic advantage for us in terms of the way that we think through and leverage effectively the frameworks in that to drive an optimal cost outcome. We know the risks we can take and that we can't take, and then we also know those risks that we can take.
Where is it optimal for us to take those risks from a pricing perspective versus where is it optimal to put those things? That enables us, again, to be very efficient, when you think about pricing to an outcome for customers, that we'll get into. The third element is our dynamic financial management. This is really empowered by superior analytical thought processes that come into this. This is foundational to the way we have success, and we'll talk a little or I'll provide some additional details in terms of how this will further evolve our model when you think about the two-three years to come and essentially what that means. The final one is the sustainable business practices.
There's obviously a lot of headlines around ESG and others, but you'll see for us where this is really something that we take to heart, not because it's a great topic in the market today or gets a lot of focus, but it's just in our core DNA and how we think about things because it's important for us to have it in order to achieve a 360-degree view, right, of the customer, of what's happening from an environmental operational perspective in order to achieve superior results.
The second thing is, when you try to think about, like, sustainability, trust, again, cost outcomes, things of that nature, you really need strong governance and the right models in place and the right communication mechanisms to ensure that that information transfers across your organization is reviewed, is pressure tested at the right point and at the right levels. One way to think about this is kind of in one-way doors and two-way door frameworks. One-way doors, you go through, you really can't come back. You wanna make sure that at the right levels of your organization, that you've really pressure tested and thought about those things at the highest level in judgment. At that same point in time, on the two-way door items, you wanna make sure that those are being made lower in the organization with the right frameworks to help empower them to make that.
At that same point in time, those items then are the investments that help prepare people to essentially be there, right, in the future for those one-way doors so that they've developed the judgment in others, and we effectively have created very sustainable, leverageable, practices across organs that allow us to scale over the long term. We'll get into that a little bit as we continue to go further. I mentioned the first core pillar here, being value creation driven by customer centric franchises. As I said, the customer is at the heart of everything that we do. When you think about this and you start with that superior customer intimacy, it enables you to be very efficient with what you do with your actions, right?
It's important to understand that so that you can achieve essentially a top decile expense ratio, right? It's important for an organization to achieve that you can predict and understand what technology solutions you're really gonna need. If you try to implement everything, you're just gonna end up with a significant amount of cost. So you've got to be able to predict what that customer really wants, you've got to be able to deliver on that experience, and you've got to be able to do so with great efficiency. When you look at our organization and you think about the backbone, whether it's six or seven years ago, when you heard the first strategic presentation that we made, or if you think about where we made adjustments or enhancements in our third quarter call, tremendous.
We originally were moving towards the cloud very expeditiously as an organization, much faster than just about any of our peers, quite frankly, unless it's a tech start-up. We had started there, you had seen that we, our GL, our enterprise resource systems were inside the cloud, native to it, SaaS oriented. You saw us with our major policy applications there. What you saw and what we learned and what happened in terms of the environment, that occurred with the pandemic, was a substantial, significant, even further upgrade in the technologies that were available from a cloud perspective. You saw us look around the corner, and while some of this is still in process today, we're not waiting for the five or six years to make adjustments.
We refined, and instead of it just being our major core systems that were there, we understand and can see now with the technologies that the cost for that refactorization and that for other apps, it's come down to a level that it makes sense to move. What are we doing? We revised our plans, incorporated all that, and now we're accelerating to be there. That means to you, every one of our applications, right, we will be effectively off, basically our servers, and we will be in the cloud from that standpoint. There'll be a couple of things co-load, but we will be out of this, the on-prem business. We'll basically be almost 100% cloud native. That matters because when you think about productivity or cost, how does that change?
First of all, on a first line metric, you think about why did we make this change right now or announce that? How do you think about, like, the expenses and that were associated with the integration and other elements that we announced? That's gonna lower our five-year spend on technology by about 20% as a first and foremost. That's a pretty material number, when you come across. It's gonna increase productivity, more importantly, about 35%-40% across the organization. There are many things that the cloud provides. One of them is its reliability, its ability to stand up, right, and to kind of be there through all times.
Also more importantly, if you think about some of the experiences in that that you've seen, whether it's with Amazon or others, you have this ability to do incremental rollouts where you can effectively target a very small area, test that enhancement, and then expand it to the rest of your group. You can do it without needing to have kind of a waterfall approach. That will enable us to interact with our agents, right, and that interface in a much enhanced way. It'll also enable us to move with our clients in a much faster way than we are today. Some of the things that might take us six or 12 months to roll out today will take one month or two months to roll out relative to this new infrastructure.
You've heard a little bit about Progressive talking about a year or better to kind of bring in product and other elements. This is an area that when we get all of our ecosystem here through there, that it will accelerate and bring us to that path or faster so that we're adjusting it on the balls of our feet. As we can all see in this moment in time, like through the pandemic, a lot has changed really quickly. We have to have the ability and the agility to change just as fast as that, and effectively having this mindset and understanding that, and starting with that customer and what they're gonna need and how fast their behaviors are gonna change, it enables us to make that investment such that we're driving forward.
That's an example of where this comes into play, that if you didn't have this mindset, you might think differently. If you started with, "How do I reduce expenses?" or "How do I do this?" as opposed to, "What do you need in order to deliver into the side of that customer market?" you get to potentially a different answer as you go through. The other thing that this does is it enables us to understand and optimize around investments across the organization, not just in IT organization, but in two more additional dimensions. One dimension is obviously our investment portfolio. We're able to very quickly enhance and make changes really quickly to what the right long-term market strategies for us are.
When you think about that, if you think about this period, if you would have taken your long-term, expectations for market returns in 2019, you would have a certain path to that. Today, you have another path, and you have another path even from yesterday's, conversations and the day before from Powell's. We're able to update our models for that and adjust. We've moved over and redeployed over $500 million that was on a certain path.
We are able to look forward, understand what that path was for interest rates, change that, optimize both either take gains or basically sell at a par value, extend the duration of our curve and our investments, and that to capture an additional roughly 1.5%-2% of NII net margin that would not be possible without these types of capabilities and that forward view and the way that we invest and think about things. Secondarily, when you think about the investments that we make from business process, we talked a little bit about the technology component. The next piece is really on people and process, right? Knowing what is at the customer, what needs to be delivered, having clarity on that and what's coming, enables us to limit the number of iterations that we need to achieve that outcome.
That is what enables us to achieve and continue to have a top decile expense ratio while we're providing a superior service, right? That's important to understand. We have a superior outcome. Whether it's in the Hispanic area, and it's the language capabilities that we bring, or it's the form capabilities or the other elements, we're doing that at a cost that is lower than our competitors, and they don't have that capability. That's because we're more thoughtful about where things are going, where they're going to be, which essentially enables us to create a value creation engine that others are gonna have a difficult time or have a hard time matching or catching up to. That creates outsized value, right, through time. Moving into strong risk and control management. These are non-negotiables for us, as you would expect.
Some folks look at this, as I highlighted, as a compliance type activity. This is really a strategic advantage for us. The first area that you can see this come out is in essentially the way that we set our risk appetite statement. As I said before, we have two dimensions that we look at from this. The first dimension is on a one-year to an 18-month time period and having about a 0.5% probability to ruin associated with those events. What does ruin mean for us? This is an important attribute. That means essentially a downgrade in our ratings. We insert capital and liquidity such, right, that we have less than a 0.5% chance of that happening in a particular year.
The second one is we look over the life of our liabilities, so that's roughly a 20-year type timeframe. We look at the aggregated risk. What we know is if we target a 2% or better outcome on that front. That number is set essentially by one year's worth roughly of income that comes into the organization, right, when we get out. Why are these metrics important? They size where and how much risk we should take in the areas, right? Once we've said, "Hey, where's the outcome?" Where does that enable us to achieve optimal pricing associated with that, right? We can tell you where is it that we lower what the volatility capital is across the network for the various decisions. We can also tell you where volatility capital won't cover the issue.
As a result, we don't enable ourselves to take that risk, period, right. You can either do that by pure put or by just not engaging in that business activity. It provides very clear walls for that. That translates into an attractive cost of funds for us across our business, right, that essentially enables us to achieve the same or better outcomes at a lower price for our customer. That comes into play. If we didn't have this system, we wouldn't have those capabilities. The second thing is that as you saw us work through the pandemic, work through these challenging times, you haven't seen us need to adjust our behaviors materially in terms of making sure that we are quarter-to-quarter focused. We can stay forward-focused and leaning in terms of the capabilities in that we're building and the way that we approach the market.
This allows us to have a consistent offering, but also ensures that we're not starting and stopping initiatives, and that we're constantly building to what that outcome is over the long term. That's enabled by that superior capital and liquidity that enables us to navigate environments like this and not to do so on our heels or not to needing to come to the market or do other things that are just not attractive to the business over the longer term. Moving forward into our essentially some of the foundational elements that allow us to achieve a superior analytical capability. These things start with the infrastructure that's been built here, and that we continue to build out and move forward here into the future. The piece that when I reference kind of the building out is gonna be moving those additional 400 apps and that were there.
When you think about that, you say, "Jim, how much should I risk adjust that?" I would keep that low. We've already moved 230 that are there, right? This is just time and distance management execution. We're good at this. We're moving. We're gonna take advantage of that. Secondarily, though, you should understand that we have an event-based data architecture. That's really important, okay, in terms of how we're building and scaling and going into the future. When you think about, like, the traditional models in terms of how people built their data infrastructures and things of that nature, one of the things that you see is that you've got this traditional, "Hey, I have this requirement. I want this. I'm gonna literally export it. I'm gonna translate it.
I'm gonna load it into my database so that other people, right, or my data warehouse can, like, harvest it, take a look at it, and, you know, the next time I have a new requirement, I'll send you back out to that same area and effectively grab the additional data for that, and then I'll adjust. Well, with AI machine learning and then with our ability to use other digital tools, whether it's a MicroStrategy or a Power BI or all the other elements, you can essentially sift through and sort through data and aggregate it and understand it, right, in ways that you never could before. In addition to that, right, you have this learning system that's applying in the background that brings insights to you that you didn't know you had before. Well, what does that do? That leads to more questions, right?
If every time I have more questions, I have to go back out to ask for an additional piece of information at an event that I didn't have before, I gotta start that whole loop. It's very long and time-consuming. An event-based data architecture essentially provides you with the foundation such that I'll take an event, an onboarding experience, a price change, whatever. I gain all of the access to those data elements, right? I can choose the two or three. The ETL process that I expected before that takes it essentially into that database that can be mined, I just tell it what data I want, and it automatically happens. I don't have months of iteration or going through. How does that impact us? Where does that mean things then go in the future?
As Matt will go into with some of our next gen products and other things that we're going through there, that enables us to transform similar to what you might have seen that happened in the trading world, right? From investments. You move to, you know, traders with deep knowledge or other elements associated with what they're doing, to where essentially they become more like risk managers, optimizing systems that can identify trends, patterns, and adjustments going through, and can respond in the moment to changes.
This architecture allows us to transform that product management position into that dynamic type of risk manager, so that as you go forward here into the future, right, the next two or three years, we can make real-time changes to the outcomes that we're segmenting during a day and sift through infinite amounts of data, not where we're coming back and see those things pop, so that our product managers are just affecting an agent or multiple agents with their underwriting actions. They can influence thousands, right? There's DNA and a culture and we're building, that's what this infrastructure enables us. You're not hearing us talk about this five years from now. We're talking about being there, right, in two-three years, and we already have this, right? One of the areas that you saw this come up is inside our reserving practices.
People ask very early on. I was in a number of conferences where folks said, "Jim, you've built a ton of reserves. Like, is that just gonna be excess capital that flows through?" We were like, "Well, it could be if your thesis is right, but we think this is gonna be the likely outcome," right? We had $17 million in favorable development last year. We are pretty close in what is an incredibly dynamic environment, right, for where this stuff goes. Well, how is that? We've got high frequency data that we pair with all the normal pricing and reserving methodologies that you see that enable us to empower at what is an incremental method.
First of all, not many folks use it, but we're able to populate that both on the historical and in the forward views with simulations in that in terms of what needs to be true for those outcomes to happen. That enables us to track and look forward. We're not sitting here saying, "Well, hey, the inflation curve is gonna be 2% or 8% or 4%," right? We have a pretty good idea, and we can match that up with what's happening daily. I talked in the fourth quarter about trends that had happened, and we started booking for, that were only a week or two old inside that moving forward. In a traditional model, right, that means you would have recognized that nine, 12, 18 or two years from now coming back through.
That same element can be moved into the more of the pricing stuff in real-time days, you have more process in that, right, to influence. That's where we're headed. We're already doing this essentially on the reserving and other sides, the capital management sides inside our business. If you want a model of where this has happened before to think, can it happen? You can literally look to the trading world and you've seen that it happens. This is just a matter of time and distance and who is gonna have that first-mover advantage doing that. Our architecture enables that and enables those cost-effective outcomes. Moving forward, I mentioned ESG before. Big picture for us, this is not new.
It might be new in terms of how we describe it and interact with the market, but this is just core to how we think about things. We're a purpose-driven organization, first and foremost, right? We've always had a purpose. It was never just to purely make a profit. We understand that that is necessary, and we target returns that enable us to have an optimal return that comes in that essentially enables us to achieve the lowest possible pricing and outcomes for our customers to meet their needs and lifestyle choices. We've always had a 360 degree view of the customer and the landscape and where it's going to achieve those outcomes, right? We're building on those things, right? You'll see more and more information. This is not new for us. This is just core in our DNA.
It's how we view things. It's the way that we approach things. Not only that, it's always been good, right? When you think about our community investments or other outcomes that are there, those elements essentially provide us to have a strategic pipeline and to achieve the attraction of talent. One of the ways that we're able to get to the outcomes that we have, as Dwayne says and does really well, and I've stolen his words, right, through this, is that everything happens by and through talent. These investments in that both set up the foundation for where it's going, but enable us to be one of those attractive candidates in the market such that they know that they can have an impact that's greater than what they could achieve on an individual basis for them. That enables us to win, right, in that market.
It enables us to essentially create retention and other outcomes that enable us to continue to accelerate through these cycles that you couldn't have. That's not an ESG, that's just smart business, right? It falls into this category, but that's essentially how we've always approached it. We continue to put these dynamics around it, and you'll see more and more of that to come out. This isn't new. This is just who we are. Second thing, I talked about, you know, a whole bunch of things that were out there. I talked about our risk management and all those other things, right, that lead to a continuous investment cycle for us that comes through. It's necessary for all the reasons that you see here.
Second of all, the right outcome and where we do that really thoughtfully and expeditiously, this enables us to really sustain and advance those competitive advantages that we have. We're not standing still. That's important 'cause you don't need to wake up three years from now or five years from now asking the question whether or not we're gonna still be in the leadership position we are from a price perspective, from a capability perspective and other. We're advancing the ball on those things every day, right? Whether it's this environment or another environment. That doesn't change.
We understand that every day that we've got to come in and do something that enables us to disrupt our own business model so that we stay ahead of the curve, right, over the long term and are always essentially providing that best value to the customer, right, and to our stakeholders as a whole. That's core to our DNA. You're going to see that. That's not changing. You also see a discipline with those investments, right? You don't see a lot of extra or excess things that don't go to market. You don't see a lot of mistakes or that comes through because we really pressure test those things, and you've generally seen those things. If you look at the cash orientation of the business, you've generally seen the cash orientation grow, become more efficient. We achieve marginal economics with each additional dollar that we invest.
That's one of the ways we can tell, hey, are we still on this same curve? We're able to look at that and carry that through. If you literally add up both the Infinity investments, if you saw what they had going through plus our own, you'll see that we've enhanced what we're doing there even throughout this time period, over the three- to-four -year period, by more than 15%. We're gonna continue that. That's gonna continue to cycle through. We're gonna continue to get that leverage as we go through. I wouldn't be a CFO if I didn't have a scorecard, as we all have, right? CFOs have memories. We have scorecards. That's what we do. Good or bad. Big picture-wise, when you think about the metrics and that we set, there are two things that Joe said, first and foremost.
Like, to have a business, you need to be able to achieve your cost of capital or higher, right? First and foremost, and two, you need to be able to grow at market or better. Those metrics really guide, right? Whether or not we have a business, whether that's sustainable and where it's going. We look at that through the cycle when we go through. There are going to be times where we want to pull back, and there's gonna be times where we wanna press forward.
When you think about a five-year time period, generally, you should always be able to come back and say, "Hey, did you achieve your cost of capital, and did you grow at the market or greater?" You should be able to do that in the sum total for Kemper, and you should be able to do that essentially at an individual business unit if you wanna see where our perspectives are or others. As you're building your models, maybe we get right or wrong, you know, 1 quarter or one year in terms of where those outcomes are, or maybe that's just the dynamics of the market. The goal is to be smarter, right, and to optimally navigate those markets going through here, right? You'll see differences. When you get to that five-year period, you should see very consistent and stable results that come through there.
The second thing is, and we don't miss sight of this, we obviously have the return profiles that we talked about, kind of the market growth. Another way that we measure success, even independent of that, is based on the number of customers that we're able to serve and empower with our solutions. We bring that back, right? We think about, hey, how have we advanced the ball in those particular areas? And that's something we do monthly, quarterly, really yearly, but we're doing it with a view of, okay, where is that right price point? If we move today, will we serve more people? Is holding back going to allow us to serve more people over that five-year view? Because sometimes it just doesn't make sense, right?
We saw this with some of the things that we did to move kind of our books and that on the KA side. Others picked that up. Now they're working through. They've rented those customers for a period of time at a loss position. We'll continue to move through, and, you know, when you see us, say, two years from now, three years from now, you're gonna see a very attractive outcome there. We have three things right now we're using as levers to accelerate our path, obviously back to our target returns. The first one that we mentioned is obviously we've taken 42 points of rate, right? That's effectively through the end of the fourth quarter. We continue to move forward with those outcomes. We've got 23 points that are approved and effective that are coming into the market.
We've had eight that are earned. There's another 13+ points that will come if nothing else happens post, well, post the end of the year, which obviously other items have already continued to evolve. Second outcome that you'll see and as we go through was our cost optimization program. Cost optimization is the right words. It was not a cost program simply to reduce cost. It was relative to the operating environment that when you look forward, what is the optimal place to be, kind of given the new capabilities and the other outcomes that are essentially here and the learnings that we had as part of the pandemic. The third is the macro tailwinds. When you think about some of the key assumptions that are here, right, as we go forward, one outcome I wanna call out is the net loss trend.
That has the traditional frequency severity elements that you're seeing in there, right? When you think about that, a one to four points, not 1% to 4%, one to four points above essentially what we're able to do from an underwriting action perspective and essentially the loss in LAE initiatives that we have going through here. What does that mean? That means effectively, whether you're looking at our rate filings, whether you're looking forward, we're still progressing and still have at the back of our assumptions, severity and in trend indications that are mid to high single digits. I know that's a question that's coming, so I'm gonna get there.
I'm gonna also highlight again, we can go into some of the very specific attributes that are underneath that, but the important thing is how those things are a recipe and a stew that kind of come together interconnected. While you might see loss costs going up with used cars or coming down, it's really that all of the components play together, right, for that trend. When we look at that trend, that's essentially what we see coming, and we've accounted for it. When we jump into the slide here with where we expect to be and what those curves are for our path to achieving target profitability, this is what's baked in there. This is not a 1% environment or a negative environment that gets us back.
The second thing is that you'll see some real positive outcomes and that starting to occur in a much more conductive or productive regulatory environment. You see that with both the rate approval that occurred with California and some of the ongoing dialogue and filings that we have there. Those are upside scenarios from here in terms of this year's profitability. It's also an upside scenario in terms of the amount of the market that we can serve and provide people with solutions. If those things come forward, you'll see that we have an upside scenario on how that bakes in. It has more impact, to avoid confusion, on 2024 than it has on 2023, but there's still an impact that it has on 2023. With that, just jumping into it.
What you take away here and that I've already previously highlighted, we talked about and Joe did a nice job talking about it. You know, we're on track, right, for all of the guidance that we've provided to date. Profitability to occur with inside the first half, underwriting profits in the second half. More importantly, when you take a look at this, that 97-100, that puts us on a trajectory. That is the expected reported numbers. When we get to 4Q, that's the range of outcomes based on what we know today. Now guys, if there's a 10 or 15 point increase in the severity curve or inflation, we'll come back and obviously update. That's not inside here. We would respond.
Under the normal like scenarios with a wide, reasonably wide, much wider than it was pre-pandemic kind of range of things to occur, we anticipate being here. We're committed to that. We're able to adjust our model, and we can do that, okay? That means that we're achieving our target returns both from an ROE perspective in 2024, but we're also growing, okay? The question has been when does that start again? That's where we're looking at that growth to begin to occur and for us to be back kind of inside that market. We feel highly confident right now with inside those outcomes. Okay. Our cost structure initiatives continue to be on path. I'm not gonna overly deep dive this from the others in the sense that you can see what we've said previously.
These initiatives, based on all the comments I said before, were not just to essentially achieve or enhance or accelerate the path to target profitability, but are really designed to provide the optimal model as we go forward. You heard that with our technology. We added, obviously, the entirety of the move to the cloud. You saw that with our real estate initiatives, essentially moving and recognizing a hybrid model. We adjusted that and we came into those, right? We've done the other things that we needed to and taking advantage of digital and other things from workflow or other perspective to further optimize our claim experiences and that we can achieve, okay? Those things are all moving on. They provide really material savings.
You'll see that the cash savings on a per year basis, right, are more effectively than the cost of the whole program. In one year, the savings from that essentially are more and pay for what the program is. The other thing that I would highlight to you, a bunch of those things that I mentioned originally with moving apps that were on a five-year or three-year whatever cycle, right, you're going through from a depreciation or amortization perspective, and then you think about real estate and all those things. Those were non-cash charges that are going through here. When you look at that number that we have from an expense perspective, a substantial component of that is non-cash, right? You're gonna continue. You should not think about that as requiring additional. You should think about us continue to accelerate in enhancing kind of our end outcomes.
It's the recognition component of that additional speed up that we had that came through. The last thing that I'll highlight is obviously an improving regulatory environment. We saw some of the things in California. You're also seeing some of the benefits or some of the conversations occurring right now in a very productive way inside Florida around the assignment of benefits, the way that Florida PIP would potentially navigate. None of those things, by the way, are in any of our assumptions that are inside here that we went through. Those are really positive, productive conversations from market. Those are substantially ahead of where we thought they might be, as we walk through with things. The other thing that I would tell you is the investment environment continues to be very attractive from an insurance perspective in terms of where we feel.
It's not gonna solve the complete challenges or the other outcomes that are there, but this is a tailwind. We continue to be above the assumptions that we've had there. We are seeing an increasing margin as it relates to our crediting rates on the life side as well as what our assumptions are from a P&C pricing perspective. When you think about that, even from our last turn, there's about another 25-50 basis points that when you think about that reinvestment component that is coming in and come through here just even over the last 45 days, roughly. That tailwind continues. Obviously, all these things lead together to create that outcome. When you're thinking about 2024, you see a 10%-12%. We're back at that from an ROE perspective, and we're growing.
Hopefully with that, I've left you with three potential outcomes. We have a strong ongoing operating model. The second one, we had a high level of confidence in achieving our profitability targets and the guidance that we provided for 2023. On top of that, we're back to our normalized results starting in 2024 and building off of that and continuing to move forward. With that, we'll wait for Joe. Give him a moment, and we'll take some questions. I don't know if someone's walking around with him. Mic. Perfect. Mics on the two sides. Greg.
Good morning, everyone. Can Jim, can you go back to slide 25?
Can I or will I?
Can you walk us through, I, when I see net loss trend of one to four points and I see additional California action zero to one points, walk us through what you, I mean, I know you tried to explain it in your commentary?
Yep.
That doesn't
That's a sort of foot with what I'm thinking about, so maybe help me.
Okay. First and foremost, when we think about net loss trend, right? You've obviously got your traditional frequency, severity components that are coming through there. The biggest one that you see, for us in our fourth quarter call, we talked about some of the underwriting actions in that we've taken, right? We talked about essentially from a frequency perspective, if you go back to 2019, we're about 11% better, right, than we were at that period of time. One of the things that we're talking about is when we talk about that net, is so we're obviously maintaining and keeping and building upon those underwriting actions. They are less than what they were obviously a year ago in terms of what we can do, but they're still there, and they offset essentially that net trend.
The second thing that's inside of there is when you think about that A&O, we have the one-three points that are coming through there. That's also baked in here. What I'm trying to do is make the math simple for all of us. If you think about the incremental earned rate that's coming in, obviously, we have the chart that's a part of every one of our earnings presentations. If you look at that, you got 4.5 points that's kind of coming in on a very simple basis over here the next quarter, right? If you've got that, and essentially on the other end, you've got kind of this net trend of one-four points kind of sitting in there, right, above kind of those underwriting actions.
You're taking that from a glide path perspective and saying, okay, like, again, if I start with that incremental improvement is the four points, then I subtract out two points of effectively trying to pick whatever, you know, you guys will figure out whether I provided some thoughts on that during kind of the fourth quarter call as a starting point, and then you can look at the rest. You would say, okay, I should expect that combined ratio to incrementally improve by two points. That would then tell you then from a severity perspective or that inside the market, that we think that's more like an eight or a nine-point severity trend inflation that is continuing to come through there. Right. Over there.
Two questions maybe that are there.
Yeah.
Are those each annualized or do you add them together and you get annualized?
You add those together, both sides. That's if you think about the six-seven, five-six I referenced just on the earned rate, we have 13 more points to go. I'm giving you, here's how much is gonna hit in the first half, here's how much is gonna hit in the second half.
two-eight points a trend.
That's right.
That's net of the underwriting actions and net of the other items. It's not gross external loss trend. It's mushing them together because we'll get questions all the time. Oh, the Manheim Used Car Index, explain this. What's your earnings gonna be next month? Like, it didn't work that way. There's a bunch of other things that are going in there, and we're trying to give the net answer. When we get too specific on it, what ends up happening is people will grab one item and they'll miss the others. We're trying to say, you got to put all of the items and the ingredients in the stew and look at the stew, and we're trying to do that with that view.
Joe, you went exactly where I was heading, I appreciate that. I guess my second question would be just on the ROE target for fiscal year 2024. You know, with interest rates having moved up, cost of capital moved up, is really 10%-12% return to equity the right hurdle now in this environment? I mean, how has the current interest rate environment, cost of capital environment affected your perspective on that?
Before. That's a great question, and I'll let you answer that 100%. Greg, you asked about the additional California actions.
Yes.
I don't know if we answered that, but I wanna come back to it 'cause I'm sure somebody else hasn't. What we're saying there is we've got a two big California books. When you net them together, it's about 30 points of incremental rate that we filed. What that's saying there is we've included none of that being filed and approved. That's not because we're in our forecast. That's not because we don't think that it will effectively happen. It's just not in our forecast. What this is highlighting is that if it did get approved, it will have to be then written and then earned, and it's trying to give some sense of what that could be, because it won't be like 30 points 'cause blowing through in the current year. It'll go into the next year.
It's not trying to forecast the date. You should feel really good about it if it gets approved, but most of the benefit will be in 2024 just because that's how long it takes to earn in.
So rry.
No,.
That's great. We've tried to provide the curve such that you can adjust for those things, right? If it's later getting approved versus sooner, again, you have that curve to both move forward and move back, that should begin to help you understand what that glide path is, for how that stuff will earn in.
It was capital and ROE.
From a capital and ROE perspective, in terms of what you've seen in terms of our weighted average cost of capital and certain components, and it depends with materiality and what you're doing. I'll give it, there's a range around these outcomes. That's moved roughly, you know, one point to two points through this period. One of the reasons that we provide kind of a 10%-12% type range, one, it's above our cost of capital already by a significant amount so that we're not constantly coming in and out of the market and adjusting kind of those elements, based on things that might be one- or two-year trends, but it's matching up more with five-, 10-, and 15-year trends. Essentially when you're making investments on certain or if you're bringing on clients to that.
On the light side, you're talking about a 20-year type timeframe in terms of what you're looking at, and you're setting that at the start. You're selling similar things on the P&C side, where it's a 5- 10-year type relationship. Those targets, we wanna make sure that we're at the right level for that through the cycle, the average, right? Weighted average cost of capital that's and that we're successful relative to that. That's kind of the first thing from a principal perspective. When we're looking out, we wanna When we set those targets, we wanna make sure that those are good targets throughout the cycle, plus or not. Obviously, if interest rates go up another 5 points or something like that.
That could create a situation where we revisit. That's not inside our baseline assumptions today. We, we don't have a 10% Treasury or Fed funds rate rolling through. If that is, then I might come back to you. Secondarily, when we think about these things, from a target return perspective, one of the things that you're gonna see, is essentially the way that these things continue to kind of build on themselves. One of the reasons that we put the ROATCE metric in there, right, is relative to where you're going, is that effectively adjusts up. If we have a year like this year and last year, that means that we're adjusting up so that through the cycle return is 10%-12%.
That means we're gonna be more like 14 or 16 or 20 on a capital deployment perspective, right? Essentially we have less tangible capital today than we did yesterday. There's got to be a return, right, for investors over that through the cycle. While you might say, "Hey Jim, your 10 to 12 isn't there," the secondary component is that ROATCE number that is going to drive or bring that back up so that our pricing targets in that bring us in, and that could lead to a short-term or other outcome as you've seen in the past, where we have obviously overachieved that 10% to 12% type of ROE number. That's there as well to assume that we've essentially captured kind of that risk component in terms of what we're doing. Hopefully, that's helpful.
I will say, not to get too far out, cause the Reciprocal Deca talk we're gonna talk about the afternoon, that will change things over time. You should think about that being three-five years out, not here because the consolidated nature of our results, which again, not the goal to deep dive that here. We'll just enhance some of these metrics. You'll see more of moving to free cash flow or other elements that will effectively be more reflective of that model as we kinda get there. That isn't for at least a three-five-year period before you're gonna begin to wanna focus on those things. This is your three year as you look forward based on what we know about the market today. Paul? Oh, sorry. Greg .
Thanks, Jim. Jim, you did a good job kinda walking through kind of your risk management, right, and operational risks, et cetera. The one I'm really curious about that's clearly been a problem for you the last couple years is regulatory risk.
Mm-hmm.
How do you deal with regulatory risk? clearly, there's some geographic-
Yep.
Concentration issues that cause some of that. How do you think about that and how do you think about managing that going forward?
There's a couple of pieces to it. Part goes into sort of how we think about returns and like, part of it is strategic thought process. You're gonna see in Matt's presentation some view how we think about geographic issues. As an organization, we've recognized that we were very concentrated, you know, in our specialty auto business in California. If you actually go back before the Infinity transaction, we were north of 80% bureau premium was in California. The Infinity transaction diversified the organization. If you think in that spot Jim just described a slide, I'm pointing sort of the top right corner of our specialty auto page that we've had in every one of our earnings presentations. Right now it's showing rate.
Prior to the pandemic, it was showing growth in California, growth in Florida and Texas, growth in other. Specifically because we had strategically recognized we needed to grow in other geographies, so we were actually spreading out that risk. It's very much been in the forefront of our mind for six years. Everything we've been doing has been marching that way and is continuing to march that way. You'll see in some of the slides that Matt's gonna present that a forecast that continues to watch that diversification occur. It's, it's in the front of our mind in that in that process. We factor that into our pricing thought processes. As an example, in Florida, every four, five, six years, something changes in Florida where PIP rules change or something, and it has some retroactive thought process to it.
We actually think through that from a pricing perspective and anticipate some of that is gonna happen, and factor that into our process. It's the expected unexpected in there. We were thoughtful about that from a California perspective. We didn't anticipate what was going on in the pandemic, but we were actually running California pre-pandemic a bit more conservatively from a growth perspective and everything else underneath it because we knew it was a more challenging regulatory environment. We could actually run a little more aggressively in a Florida and a Texas because we knew that the ability from a regulatory perspective to adjust rates and adjust underwriting was simpler. You can have a wider degree of freedom.
You know, if you think about, driving, you know, in a New York City street, the lanes are narrower, there's more traffic, you wouldn't drive at highway speeds. On the highway, the lanes are wider, there's a little more you'll drive faster because you know you can, you know, move a little bit back and forth in the lane and still be safe. We factor our behavior and geographies around whatever the nature of the challenge is in that regulatory environment. Does that make sense? Does that get what you were looking for?
Yeah.
Maybe baking in, what does that then essentially mean from a modeling perspective or other? You know, there are two things that kinda go in. One, obviously the target returns. The target returns effectively get adjusted by that incremental economic capital, right, and liquidity that we hold essentially for those territories. If you're gonna look at regulatory and other outcomes, it's increased our economic capital by more than $100 million.
Over the last several years. That said, just to give you guys an idea, we generally have committed in contingent capital and have been from a volatility perspective, not because we think these are likely outcomes, but if you think about the 0.5% probably ruined some of these other outcomes. We've traditionally had in excess of $500 million, on those fronts to cover the expected unexpected, to be able to navigate environments like this where we have multiple years of potential challenges so that we're on the balls of feet. You've seen us be able to maintain those levels through this, right? You're not talking about, hey, we need to go back out to the market and raise additional capital for that. Those things are baked into how we kind of think about it.
The second thing is it has increased that by over $100. If you think about $100 million that's inside of there relative to the numbers that we just talked about, that means, effectively there's an additional $10+ million from a baseline that goes into the pricing and the other outcomes, right, on a basis to essentially recover and to pay for that. That, you know, effectively represents kind of the environment. We work with regulators and others to try to make sure that everybody has an understanding of those things, such that over the medium and long term, we can do everything we can to optimize that pricing for that customer.
That is not something that essentially we look at and say, "Hey, we would charge that additional amount if it wasn't." It is literally with the focus, how do we achieve our outcomes, right, at the best possible way. We do that in a responsible way so that we're empowered to do that over the long term. If we can enhance that, if with our regulatory and the other specialties that we create, we can bring those things down over time, of course we will, and that leads to pricing. To the extent you can't, it goes back into that pricing outcome that's there.
Thanks. Just one more question. On the ROE targets, obviously there's one company out there, Progressive, that is kind of the pinnacle of where they are from a return perspective. My question is can Kemper get to that type of a return on equity, the, you know, that a Progressive achieves? I mean, looking at your business model and everything, is that aspirational? Is that something that you guys would like to achieve at some point?
Yes. What I'd remind you of is, you know, I've watched them for a long time in the business. They've done, you know, an exceptional job of building their business and their franchise. You know, roll back to when they had $3 billion or $4 billion in non-standard auto. They were smart and effective, but they weren't in the same tier you're at. Give us a couple years to, you know, catch up to some of that and the flywheel moves, and that's part of what we're trying to describe to you in everything we're doing, is a systematic way to get the flywheel accelerating that produces that.
Over the course of the last 30 years, some number of you in the room have written reports that the bloom was coming off of that rose because of something that happened, you know, in the journey from $4 billion to $40 billion up. There are pieces in that. You don't get to that point without learning and effectiveness. We're enhancing what we're doing every day and accelerating and showing what I believe are a lot of the core disciplines that produce that over time, but at a younger stage.
The other thing that I think you'll find we're much closer to Progressive, I highlight and build off all the things Joe just said. When you look at the ROATCE number, that is a much more closely comparable number from where we're at from a cycle perspective. You know, hopefully when we're $40 billion one day, you'll obviously see, you know, tangible capital as a % of your total capital will be a higher number. If that's the assumption of the case, right, because of the goodwill, which will be a much smaller component, you're gonna see those returns really line up on those two outcomes very similarly. It's really about the deployment of that tangible capital 'cause you can't deploy non-tangible capital, right? Like, that doesn't support premium or liabilities.
Really what you're talking about is, okay, there's Infinity and there's AAC that provide really some competitive advantages for that. You're just seeing the delta between the tangible capital, what we're earning there, and what then essentially goes in for the cost of the building of those capabilities and the extension. There's still a couple of points that would be reconciliation elements, Greg, to your points that are in between there, but we're fairly close today. As we continue to grow and scale, I think you'll see those things naturally wind up, and that'll align with essentially the speed of growth and other outcomes that we have.
A quick clarifying question on the ROE targets. Should we think about the denominators as being reported equity or xAOCI equity?
It should be xAOCI equity, which in this point in time will actually increase effectively the target that you're thinking about other time periods just for a reduction. We intend to hold our bonds to maturity. Effectively, the right outcome there is it's about that tangible deployment of capital and where we're at. The second thing that I will point to you, those numbers are gonna line up with LDTI, the new accounting standard framework, much closer. We've mentioned that previously that there's an additional $300+ million when you look at right range, and we gave a range $50+, 50 above, right? This forthcoming, obviously you'll have much more details about that within the next kind of 45 days, nothing's changed relative to those estimates.
You've essentially in the past fair valued the assets, right, coming through on the balance sheet, but you haven't fair valued that liability, right, for where it's at. You're gonna now see those things match up. You're gonna see that matching balance essentially that we've got. This all obviously takes into account those additional outcomes as well.
Here and then here. Yeah.
I've got a couple, I think, related questions. One is, when we're looking at the improvements expected in the specialty business, do they include anything that needs to be happening as part of the strategic review for the preferred business? I think historically there were some shared services and claims folks, but obviously there's been an enormous amount of change in between then and now.
From a hypothetical perspective, 'cause I think that's what you're asking me, is essentially if you wound up with the answer being, hey, the business was better with someone else or some other component, right? In that scenario, we're not anticipating, and when we go through this, if we were to go through this, we don't believe that there's any trapped costs that would be residual, and that would effectively create a difference in terms of the outcome to either one of our business and the price position that they are in. We would be looking at those things being unchanged. Unchanged from a path to profitability, and essentially the target outcomes.
That would be something that we would be navigating, would be baked into, you know, our assumptions, and you should assume that if we were there'd be no net cost absorbed by the organization.
Okay. Relatedly, as we think of your thoughts about ROE targets over the cycle, how much either has to do with the preferred business or, you know, fairly significant capital efforts and efficiencies that you're doing on the life side to achieve those ROEs targets as well?
Life is an incredibly good business. Paul, as you know, that's a business even during what I might reference as like a one in 200 year cat event from pandemic that still earn much more than its cost of capital. If you look at it, there's roughly $400 million of surplus that's inside those entities. When you think about that, you know, if you looked at just without any further improvement to earnings, which would not align with what I think the, what we indicated inside our fourth quarter call, that was a business that was at $20-plus million, right, inside the fourth quarter.
That doesn't mean you couldn't have a flu season or other outcomes instantly change, but that business is well on its path back to its historical, anywhere from, you know, $85 million-$115 million, you know, net after-tax profitability, that's going on. That would lead, obviously, if you're, just to keep the math simple, that's a 20%-25% type, right, up to a 30%, return on surplus, that would be working its way through there. Pretty good. That's not-- We anticipate that staying where it is. In terms of the PI business, that is basically a flat to, you know, a little negative, obviously, in terms of where those outcomes are.
Depending on the way that you would execute a solution or its path to profitability, those things would incrementally lift the ROE of the organization. That said, you know, right now we're starting with an assumption for these purposes and these conversations that it's the steady state. I'm not saying that's the outcome, but we're starting there when you think about it. That means we are absorbing that, and that is included inside our current expectations with the 10-12. Any costs associated with that, obviously, we thought about how these businesses kinda come together to achieve that outcome.
I agree with everything Jim said. Paul, I thought I heard you and understood the question a little differently in the sense that if we're unlocking capital that might be used in a highly capital-intensive home business, or we're unlocking capital with some of what we're doing in life, does that change the target? Is that part of what you were getting at? We don't think it changes the target because we're setting the target in terms of what is a high, you know, top quartile industry return. What we're recognizing is that we can either increase the earnings or get the earnings to achieve it, or we can decrease the required capital. Either one is a value add for a shareholder because it achieves the targeted outcome. We don't only have to work the numerator.
We can work the numerator or the denominator. I'd actually argue that working the required capital is actually a better way to do it because then it releases the capital to turn it back to be used somewhere else. What the net effect it does from a consumer perspective is if you have a more efficient capital base at the same return, you actually can be more price competitive and grow the business faster, which produces a better long-term flow of distributable cash flow. We think about it on both sides of that and would think about it that way. That's why we would look to those and we get excited about them. It doesn't move the return up, but it should move the growth up and the long-term stream of cash up.
Andrea?
Thank you. You know, compared to the standard other carriers, like non-standard nature of your book in the current inflationary environment, does it kind of make it easier for you or more difficult to deal with, you know, higher loss cost trends? For instance, does the fact that you have lower limits help or any other things I'm not kind of thinking about? Kind of compare the behavior of a more standard preferred book versus non-standard in the current environment. The second question, you're making a lot of changes in your organization, structural changes. It's captive for your life business. You're moving to reciprocal. You are thinking about potentially disposing your preferred business. I assume that you talk about the rating agencies along the way, specifically with AM Best in your case.
What are their take, kind of? What are your communications with the rating agencies on this?
Sure. let's go through it in a couple ways, and we'll tag team this. First, the non-standard versus preferred kind of view, from an environment perspective. At its simplest level, whether you're preferred or non-standard, let's make something up. You had two businesses. They were both operating at a 70% loss ratio. Okay. You're gonna have a different composition, perhaps of the amount of frequency per customer that would be higher in non-standard. If it's producing, in both cases, a 70% loss ratio, you're gonna be impacted by the general inflationary environment in some ways comparably, okay? 'Cause it's gonna hit the severity all over. The non-standard customer tends to have lower limits.
That probably is a help for us because if you had a policy that had a $20,000 limit and there was $30,000 worth of damage done, you stop at the $20,000 point, you don't go above that. There's a buffer there, where if you'd had a $300,000 limit and there was $30,000 of damage, you're going all the way up. With another 10% inflation, now you're at $33,000, we stop at $20,000. There clearly is a plus on that.
Given the increase in frequency and given that in this environment, in a post-pandemic environment, our customers were less likely to have been working from home, we may have, in those two examples, disproportionately felt it sooner in the environment because we had folks that were more on the street consistently. That might be idiosyncratic to this environmental piece. Where we are right now in the process is we should sort of all be at the same water temperature of what's going on in inflation. We should generally be helped from a limits profile perspective. There are behaviors that sometimes people will attribute to a, and I'll say non-standard versus specialty auto, 'cause I'm meaning the more traditional non-standard when I describe this, not perhaps the Hispanic customer group.
I'm very specifically going into the subset, that will remind you of our subsets in a couple minutes. That traditional non-standard customer might have a little bit higher fraud, a little bit higher, you know, other characteristics. We're tuned to that already. we-- that's one of the specialties we have of spotting that, finding that, managing that from a claims perspective. We anticipate it. It's not, it's not unexpected. It's in our claim operating models. It's in our pricing models. We're expecting it, watching it. I know that difference is there, I'm not sure if we took one specific line item or one specific row in a financial statement or an operating, we might see a temperature around it.
We have compensating spots that are intentionally watching it, so I don't think we're gonna get a fundamental temperature difference as a result. Your second question on the changes, you rattled off a couple of them. We're not changing our captive life agent model. They were captive agents before. They have been for 100 years. We're enhancing their abilities. We're improving capabilities. We're going to wind up growing the number of them. It's not like we're gonna grow them by doubling them. We're growing them very thoughtfully and in geographies and around a radius that we're in. It's not a high risk item. It's a low risk, very consistent, very understandable, high probability of success process.
You should interpret it that way, and a rating agency would interpret it that way. Changes around the reciprocal, we're certainly talking to them about that, helping them understand it. That's not something that's gonna happen today. It's creating a new legal entity. It's gonna do an open books, closed book strategy. It's gonna have a set of processes that they're used to watching and seeing, and we're not gonna move towards a deconsolidation, again, till that five-seven year time period. It's not, it's not a process that somebody says, "Boy, you know, you're jumping into ice-cold water, and it's gonna shock the system." And I'm sure you can have some thoughts to add in the rating agency.
Yeah, no, I think, obviously, we aligned with your expectations. We are out in front and center with ratings giving kind of our thoughts and plans. We obviously do a lot of pro forma analysis with them around so that they can understand that. Those conversations are very productive. I think in all scenarios, we're looking at things that are gonna make and enhance the organization, and increase the predictability of cash flow, increase our competitive advantages, from an outcome perspective. You know, a lot of these things obviously are within core competencies, or they're all within core competencies that the management team has demonstrated time and again in terms of the enhancements. You might think about reciprocal being something new or different, but it's not really that much different.
It's a different structure, a couple of different things, but it's not all that different from creating a new legal entity, having new product essentially in that entity. This is a very similar process to that, and we do that all the time. That's something you've seen us demonstrate every year for the last seven years. We've had outcomes there. From that perspective, I think people have really high confidence, and you know, are continuing to be, you know, constructive in how they think about us and look at us, both now and into the future.
Building on that. If we told you we had a new rating and product sophistication model, and what we were gonna do is we were gonna roll it out in new legal entities and do an open book there and a closed book on something else, you guys would say, "Okay. Great. I've heard that story from 100 companies over the last 20 years in terms of how they're doing with product sophistication and a product rollout. I'm gonna view that as highly predictable. I'm gonna wanna know how your pricing model is set. I'm gonna wanna see how it's effective in the marketplace. Your questions would go there. This is another insurance legal entity that's gonna have an open and closed book strategy. From our employees' perspective, they're taking a product, they're selling it to a customer.
There's one or two more forms that an agent will have to sign. For 9,500 employees, you know, 9,400 of them, you know, 9,450 of them aren't gonna see anything different from what they're doing every day. A small group of them are gonna do some legal and, you know, financial paperwork a little differently. It's not all of a sudden, you know, asking us to do, you know, go from running a restaurant to running a farm. You know, it's much closer.
We have time for one more question. Okay. It looks like this concludes our Q&A. We have checked the virtual queue. There's no questions through the virtual queue. We will now break for 15 minutes and resume.
Thank you.
Thanks, everybody.
You have smaller regional carriers that have very sharp specialization, but they don't necessarily have the scale economies or the sophistication to grow that specialization into something more meaningful. Demand, it's a growing marketplace. It's a large marketplace. I mentioned we're a $4 billion business today, you think we have a $90 billion-$100 billion upside in this market. I'll peel back as I talk a little bit further. Market share and how we think about market share. The 4% doesn't necessarily represent exactly how we operate in the market, significant upside here and unmet from a supply point of view. The proverbial Diversified footprint.
From a line perspective, diversification from commercial lines point of view, the reason we like that is personal lines risk and commercial lines risk are oftentimes not necessarily correlated, so it creates that element there. From a geography perspective, which was mentioned earlier, diversifying away from our high concentration environments, which carry its, you know, if overly focused in one area, carries its share of risk, certainly regulatory when it comes to California, that was highlighted earlier. We're not done, right? As we continue to extend our model, it's a deliberate growth model around building that franchise into these new markets. We're not intending to shrink California so that we right-size our balance sheet. We're actually growing California, but we're growing these other markets more rapidly in a thoughtful way.
That for us creates that sustainability, that engine where we can generate those outsized returns over time. It also, for us, it allows us and forces us to focus on what are those innate core capabilities that create those sustainable, systematic competitive advantages that produces those outsized returns. Make sense? All right. Leveraging the framework slide that was presented earlier, our enterprise framework slide, there was a series of enabling capabilities and core capabilities. I'm gonna highlight a few core capabilities that from a business model perspective are embedded in everything we do, starting first with analytical superiority. Again, Jim highlighted extensively our investments in analytics and enabling infrastructure to really get that flywheel spinning more rapidly. Ultimately, at the end of the day, we need to transform data in the real-time into management insights into action.
In the marketplace that we play in, that's a requirement. From there, we take those data and we're able to sort of predict more effectively econometric trends, loss trends from an internal point of view and loss cost from an external point of view in terms of elasticity in the marketplace, where things are going, We could best optimize how we navigate through very dynamic cycles. We'll talk about that a little bit as we get into product and distribution. Product sophistication, I think most companies talk about this in terms of pricing segmentation. Pricing segmentation is no doubt a core component of our product sophistication, but it starts first with the contract that's informed by our real-time claim feedback to our product engine, right?
As our customers are changing in the marketplace and dynamics are happening, we're observing those patterns in the claim organization that's in the real-time, you know, of flowing through our contracts, how we're then putting those contracts in the market, putting the right price around them, and wrapping that all within a process that works well. I mentioned earlier a billing dynamic, right? How do you bill customers? How do you appropriately put a product price in the marketplace and not extend credit to non-credit worthy customers? There's a unique capability set in there. How do we leverage real-time underwriting capabilities around our internal best view of cost relative to the price we're able to present in the market?
There's a lot of exciting stuff underneath there that I'll try to unpack a little bit as we step through. Then the specialized distribution. I'm not gonna highlight anything here because we have a couple slides on this that we'll talk through, but again, a unique capability for us in terms of how we navigate and access these target customers. At the core of our investment thesis, again, it's agility, that speed to market, the ability to translate data and analysis into insights, into management action, and how do we move that flywheel more rapidly.
I can't emphasize enough the items that Jim was pointing out earlier in terms of that event-based data architecture, so that our teams in the real-time are seeing this insight and we're building upon cloud-based microservice applications, contemporary applications that's allowing us to sort of advance capability in market, again, you know, in much nearer to real-time than maybe legacy would expect to. A couple areas I'll highlight here. We'll do product, we'll do distribution, and then we'll get into commercial lines. Product. As I mentioned earlier, product sophistication, we have a continuous improvement mindset to how we approach our product sophistication. It starts first with the offering and the contract in the market that we're putting the appropriate contract and limit profile in front of the customer based off of what we know about that customer.
Having the right price, advancing that segmentation, as we see cost move across a series of dimensions, we're putting that right price in the marketplace, and we're underwriting that effectively. The ability for our product managers who are consistently evolving in terms of their skill set. Mentioned earlier, they're evolving to more risk managers. We love that term because it's more data-driven, it's more predictive in nature, less subjective. But having the ability to real-time manage these products in the marketplace, and then ultimately, you talk about the expense efficiency that sits underneath our product. It's the whole offering. It's not just the pricing segmentation component. We want to be low cost, total low cost. This was mentioned earlier as a key point.
Total low cost is not just the expense element, it's the indemnity that goes out the back, and it's the TCO component that sits under our loss ratio, right? What is the cost of goods sold to an optimal level in, you know, with the indemnity element and the expense sitting on top. A key component of that expense is agency compensation and how we optimize outcomes associated with that partnership model with agents. As we've bolted on capabilities over the last four or five years, these have been additive capabilities. We've generated insights from our products that we've brought into the ecosystem.
The goal of ours, which I think oftentimes is a challenge for most insurance companies, is how do you maintain the specialization that you have in your go-to-market strategy, but at the same time find economies of scale as you grow? What happens, more often than not, is as you're looking for scale economies, you lose the edge on the specialization. You lose that component. For us, as we're building out our and modernizing our product, we're building on a common chassis. Again, a contemporary platform that's a cloud-based platform that enables us to then through almost through that microservice architecture, almost like LEGO blocks, pull together products that are bespoke to the customer segments that we are targeting. We don't have separate stacks for products that creates a high expense for it. We're driving those economies of scale.
The equation of a line y = mx + b, we're enhancing the M, the segmentation, but at the same time, we're decreasing the B as we move forward. This is unique. We may have a product offering in the marketplace that has three underwriting companies with three separate contracts that sit underneath that within each one of those products could present an array of options on a comparative rater platform that is bespoke to the risk that we're seeing come through that rating engine. This is a constant improvement area for us. It's an opportunity area for us. The analytics advancements that we're making will only accelerate this capability that we have in the marketplace that we believe is differentiating. All right. Distribution. Again, it's mentioned earlier that at the center of everything we do is understanding where our customer is.
Our customers have unique sets of purchasing requirements. They go through certain agents that are trusted partners for them. We have, over the past 20, 30, 40 years, developed partnerships with our distribution, you know, network, that's deeper and more purpose-driven than I think you might expect. When you think about independent agent market, the barrier to enter into an independent agent marketplace is very low, right? Anyone can appoint an independent agent or broker and pay an X% commission and get their product placed on the shelf. What we do is we identify through a unique set, again, of characteristics from the customer, we're able to locate which agents are in those domains. We're able to identify behaviors of those agents from an input and output perspective quantitatively, that then we can find partnership, deep-rooted partnership opportunities.
The goal for us is not to place product on the agent shelf, it's to actually sit with that agent and broker, understand their intentions, business model, and identify the synergistic opportunities, so we don't just grow the share of the pie, we actually grow their pie and our share at the same time. An example of this is we have an agent in Miami, a few years ago, he was building affinity relationships with local universities targeting Hispanic young professionals. He was getting more inflow than he had the ability to work. He didn't know how to build a call center, a telephony center. We identified the opportunity. We worked with him. We invested in that.
We leveraged our infrastructure, some of our recruiting capabilities and tools that we had to have him build out. We saw outsized return from that investment, from that partnership point of view. We have a lot of stories underneath there that we can bring to life in here. Again, it's a unique competitive advantage here in terms of how we approach this market. The other thing I'll mention is our gang that's out there from a relationship management and sales perspective, they're not just doing the milk route, right? They're not just going out there dropping off papers and, you know, shaking hands and kissing babies. They're in there actually having the hard development conversations to really identify those opportunities and see those opportunities come to fruition from a return point of view.
I'd love to bring this capability to life in a bunch of different ways. This is meant to be a little bit of an eye chart slide to demonstrate the wheel by which sort of we work this process. It starts first with identified earlier. It starts first with people. Do you have the right cultural mindset? Are you bringing the right level of drive and humility from a sales perspective? Are you building a model in place, almost like the Bill Belichick model, where it's a repeatable practice, right? We're able to target the talent we need, and we're putting through a series of processes and trainings that we have a targeted and intended outcome. We're not just sort of casting a wide net for talent and letting them do their thing in the marketplace.
It's very deliberate in terms of how we're getting our sales folks up to speed and attacking this marketplace. Again, driven around data, right? In terms of opportunity, understanding the dynamics within those agents. More oftentimes than not, we have more information and insights on the agent and broker themselves than the broker does. Having those real-time conversations and having those partnership conversations where they see us as an indispensable partner, but we're there driving the outcome of that relationship. We have reports in the real-time. There's an exhibit up here in the upper right. This we call the heartbeat report.
This is coming in intraday by the hour of, you know, here are the input metrics we're tracking relative to the conversations we've had, the output metrics, and we're able to see how the pulse of the business is evolving relative to the investment we're making. There's really identifying the upside. What is the upside, right? A lot of folks, a lot of carriers, I should say, have data on how their product is performing in that agency. The subjective, the qualitative evaluation of what that headroom opportunity is, the performance by the potential allows us to really build our sequencing of where we're spending time and how we're making these investments. Ultimately, you know, you can see there in the lower right, we have, you know, conversations with agents where we're doing real-time training and onboarding and partnership conversations in terms of business development.
It's a very deliberate, very focused exercise, almost a franchise-type model, where it's analytically based, evidence-based, repeatable process. This drives, you know, measured outcomes, consistent and measured outcomes for us, in a differentiated way in terms of how we go after this target segment in the marketplace. Hit product, hit distribution, both of those are good areas to highlight. We'll spend a little bit of time on commercial lines. The commercial business for us is almost the pinnacle of specialization in terms of how we focus in this marketplace. The commercial auto market is about a $50 billion market, ±. I think most carriers approach this line as an accommodation line. It's not necessarily primary.
You may have a liability property or comp or workers' comp element that's underwritten, and this becomes a pricing element behind the scenes in a very blanketed perspective. Our approach to this market is, this is our lead line. Our strategy here in terms of how we go after this segment is very much so a draft strategy around our non-standard specialty business. These are the same customers, but this is now their business, their livelihood. You're an artisan contractor, you're a landscape designer or worker. You have its last mile delivery, and it's ensuring their livelihood as we move. We're very deliberate also in terms of the types of risks that we focus on. We stay away from the large liability elements in terms of long-haul trucking and dirt, sand, gravel, and some of that.
That represents a significant market opportunity, as a percentage of the 50. We're going after 25% of the $50 billion because it's aligned deliberately to our target customer segment. When we go to market, knowing who our target segment is, knowing what that risk profile is from an exposure vehicle perspective, the underwriting tools and the capabilities, the offering we bring to the market is entirely bespoke. We don't use any ISO forms. They're very deliberate homegrown forms, proprietary forms. In terms of our underwriting that we wrap around this is a market-leading capability for us. Identifying the opportunity and the secret sauce, frankly, in the commercial lines business, the commercial auto business, is knowing what that risk is when you write it and knowing what it is tomorrow.
'Cause these are small businesses that are constantly evolving their exposure. How we leverage underwriting, not just at the point of sale, but we leverage underwriting capabilities through the life cycle of the product, that is a differentiating capabilities. We have PPA-type rating on the driver and exposure on the vehicle level that again, is a differentiator for us in terms of our pricing segmentation. We have high-tenured staff that's constantly doing that evaluation. Our average underwriting staff is, the tenure is 18 years. We've been in the business for a while, again, highly focused on it. It is, it's seeing outsized results, right. Outsized production in terms of 28% relative to what the industry is seeing.
The more impressive statistic for us is the margin by which we're able to operate as we maintain that deliberate focus in the marketplace. You see a sub-90 combined ratio consistently over time. Again, it's because we're going to market articulating what our appetite is, what we're comfortable with from an underwriting and pricing point of view. How do we do that? I'll highlight quickly some of the underwriting capabilities. We know, as I mentioned, and we're deliberate in terms of our vehicle types and our occupations and our customer segments we go for. What we try to do with our agent partners is communicate that very deliberately.
Appetite articulation is oftentimes overlooked, but in our market segment, we're very deliberate in saying, "Here's what we want, here's what we need, here's the price point." We're willing to walk away from risks if they're not in that segment or if they're not at the price point we're comfortable with. I'll give you an example, right? This is an interesting one. It actually bleeds over into the telematics perspective. Delivery services. Wholesale delivery service or package delivery service. A wholesale delivery service has a significantly lower price than a package delivery. Wholesale, you're doing two, three stops a day, you're picking up a bunch of stuff, you're dropping off a bunch of stuff. Package delivery, you're doing 50- 70 stops a day, doing a lot of left turns and so forth.
If we don't identify what that occupation is up front accurately, we're underpriced by 40%, and you're gonna get burnt in that market. Now, someone today who registers as a package delivery or a wholesale delivery could flip to package because the nature of small businesses as they're looking for opportunity and revenue opportunity. What we require, and this is just one example, we plug in telematics on the driver and the vehicle. We're matching the driver to the vehicle, and we're seeing how they're actually using that vehicle, that exposure through the life of the policy. You know, if we see something that's out of pattern, you know, in the real-time, we'll re-underwrite it, and we'll move it to the right price.
We have about $100 million-$150 million of business on a telematics program. That's just one example of trying to maintain that edge in the marketplace and an understanding of what the exposure is when we see it and how it maintains over time. Again, this is an opportunity. If you don't have these razor-sharp capabilities, you can really write some stuff that you don't know you're writing. This has produced outsized profitable growth for us, these capabilities, occupation accuracy, telematics and other capabilities in the marketplace. The last piece I'll mention on commercial. As many of you know, Commercial Lines is not a comparative rated business.
It's on proprietary system, so ease of doing business, ease of use, simple screen flow, that's paramount in order to gain mind share of that agent. If you're not easy to do business with, they're not gonna use you because it's not worth learning your clunky system, and you're not gonna generate the business you wanna see. We have a market-leading quoting experience and issue experience in the marketplace. We consistently come out top decile, if not number one. That's what you see over on the left. We continue to invest in these capabilities to create that advantage in the market.
It's not just the underwriting element, it's the ease of use which gives us access, and favorable access, priority in the agencies that we want to see to the target segment that we want to write. Ease of use is a key component here because it gives us access and it allows us to become known as the preferred solution in these agents, and we're seeing that accelerate our need, our demand in the market. Additionally, the easier the experience, the higher the integrity of the data that's put in. Again, it's the flywheel. If you get better data put in and the ability to validate that data at new business, your ability to underwrite and price accurately is also enhanced. Again, this is a bit of the flywheel here that works.
Just like on the specialty auto side, on the PPA side, a very deliberate model focused highly around that customer, leveraging that proprietary customer understanding in terms of how we target customer segments, how we bring offerings and product to the marketplace, and continuously investing in those differentiating capabilities will allow for us to sustain, you know, those returns, enhance and sustain those returns over time. With that, couple key takeaways. Again, I highlighted this earlier. Hope you appreciate the specialty auto market. It's a growing marketplace. There's significant headroom for us in that market. It's dynamic. Customer sets are heterogeneous, they're complex, they're unique. You have to have a unique set of capabilities that are grown to meet that customer segment. We believe we do from a distribution, from a product offering, from an analytics perspective.
We're intensely focused on achieving our target returns. With that, I'm gonna wrap. I'll hand the baton over to Tim Stonehocker to talk about our life business. Thank you.
All right. Thanks, Matt. Thanks, Matt. Good morning. Excited to be here to talk about our life business. Few things we're gonna cover today. Market, our capabilities, our distribution, and how it's gonna drive growth. Some of the key takeaways is the opportunity here, right? It's, we basically have a 2%-3% market share, but have a really large opportunity to grow our business. There is limited competition and high barriers of entry, so we'll cover those as we go through this. Quick overview of our business. We're in the LMI market. It's a big market, about $57 million, of which, when we whittle it down, it gets a little smaller, and I'll go through slices of that and how we break it up. We serve about 700,000 households today.
The LMI market really is made up of customers who have a deep desire to have a proper end of life for various cultural, social reasons. We focus on the market with life products. We do have some other products we'll talk about. Our life product is the market. Excuse me, our life products are the products of choice. We do it through a high-touch employee-based distribution organization. Couple key highlights that I'd like you to take away. We are 25%-30% of the normalized earnings for Kemper as an organization on any given year. The other part is we, it is a large, mature book of business with long-term steady cash flows. Good solid outlook for the organization, great opportunity for growing our business, and good, steady cash flows.
If we take a slice and really start looking at the market that we serve, we start with the 5 primary market segments. We're clearly focused on the low to moderate income market. Again, I'll refer to it as the LMI market. We're focused on that because it requires a real specialization. I'll talk a little bit about that specialization, how it differentiates between the other markets. It is a large market and a growing market, $15,000-$75,000 income, focusing on a proper end of life. Again, limited competition for the way we serve that market, the way we take our products to that marketplace and how we serve our customers. If we take the next slice of that market and look at it, we start at the 57 million households, start dialing it down.
We get to 44 million that have that cultural or social desire to have a proper end of life. We look at where is our footprint today, Kemper Life, what states are we in? We're in about 25 states, that represents about 30 million of those households. Big opportunity within the states, we take the next slice down and really there are about 10 million households within what you'll see our next, my next slide will show what we call our existing footprint. There are 10 million households of which we currently serve 700,000 within our existing footprint. As we take a look at that, at our existing footprint, we're gonna look at the 25 states we're in. We basically have around, let's call it 80 offices, 83 district offices.
Within around 25 miles of that, we have 10 million households that have that deep desire for a proper end of life. Ideal customer base for us. With those 83 districts, we have about 370 sales managers that serve and lead 2,300 agents that are serving those 700,000 households today. A great footprint that allows us an opportunity to leverage and grow from there. As I mentioned, to penetrate this market, we need to think about it as a specialization, and there is a specialization that comes along with this marketplace. We start with the customers. As Jim and Joe both talked about, you know, start with the customer. Customer is first, right? What does the customer have now?
Where is the customer at today? Again, when we look at it and break that down and slice that market apart, we think about that customer and their desire for that proper end of life because of their cultural, social, or ethnic background, ethnic beliefs. They have a real challenge with their budget, with their income, with disposable income. It's how do you help them, right? That disposable income, and there's co-competition for that disposable income. It's not just other insurance companies, right? We're not competing when we look at this market, we're not competing against our life companies. We're competing against the telephone bill, the cell bill. We're competing against the cable bill.
We're competing against things that are really going after that disposable income, how do we get in front of those? That's really the solution to, you know, to provide those products and to keep the products in force, is how do you get in front of those other bills as it relates to disposable income. That's where they are today. What is it that customer really wants or needs? Well, what they want or need is first is somebody to help them plan for that event, where they have the proper end of life. They need somebody to help them with their financial discipline. That's not just about acquiring or selling them a product, it's really about the whole phase of it.
It's about taking them from buying the right product to premium collection, to servicing that along the way, and more-- and most important, keeping that product in force. They also need, they need a product that's easy to understand. They need a product that is, if I pay my premiums, it's gonna be there, right? It's gonna pay the death benefit at the time I need it the most, which is when I die. They want a relationship, a relationship with somebody that they can trust. Typically somebody in the community or around the community. They want an opportunity to have a relationship with an agent and/or a company or a district office. We see those relationships run deep.
That's really what Kemper brings to this market, is that high touch service model that allows that customer to have a strong relationship with either agent, the district office or the company, or all three combined. We bring a high touch service model that touches that customer on a regular basis. Not only helps them acquire the right product, but also helps them keep that product in force by collecting premiums. They also want an affordable priced product and we do deliver those products in an affordable way and are fit the customer's needs.
In order to hit this specialization, there are some capabilities that we think about that, you know, aren't normally, you wouldn't normally look at and say, "Well, there's a difference in our administrative processes." Realistically, there aren't. There are some really tailored capabilities that are required to target this market and have success in this market. I'd start with the one I was just referencing. It's, you know, the four of them we talked about. High touch service, sales and service distribution organization. Really difficult to replicate. If you don't already have that distribution organization in place to go out and build it, create it and tap into this market is really gonna be difficult. Important not only to have it, but how do we build it.
An ecosystem that is, creates an ease of use for the customer. The ecosystem isn't just about buying the product, but it's also about how do I pay my premiums, how do I get service on my products, right? It's an ecosystem with an ease of use. Underwriting, specialized underwriting. Underwriting is gonna be different depending on which one of those five market segments I lie in. We have a simple underwriting process, but it still achieves our risk selection at pricing, right? Simple underwriting, ease of use. Underwriting works, makes sense, easy for our customers to understand how that works, but still gets to our risk selection and pricing. The low-cost model.
The low-cost model is about providing those services that the customer wants and needs with an affordable product. As we look at these tailored capabilities, I'll go a little deeper in the low-cost model in a few minutes, but through that, we're gonna deliver certain products. It's again, it's the simple and ease of products that we wanna deliver to this market. It's important for this customer to understand the products and have confidence that when they pay that premium, their policy is gonna stay in force. When they die or the event of death, they're gonna be somebody's gonna be paid a death benefit, and we're gonna have a proper end of life. There's a lot of our policies in our industry today that, you know, can't necessarily step up and say that.
We deliver really four basic concepts of products, very simple. Our focus is life insurance, we start with whole life. It's a permanent death benefit. As long as they pay the premiums, it's gonna be in force. The great value here is it also builds cash value. In the event of an emergency or event I can't pay my premiums this month because something came up, I have the ability to borrow money from my cash value and keep that policy in force. We've seen a lot of that throughout the history of this business and a lot, quite frankly, recently. What we also see is our customers not only borrow the money to pay premiums, but they also will repay those loans.
Our agents are there, our distribution organizations, they're not only to help them make sure that policy stays in force, but that they repay those loans. Not only do they have the ability to borrow dollars to pay the premiums, but also in the event of emergency. It is a vehicle that allows them the opportunity to have some sort of a savings vehicle, where there's accessible dollars that a lot of people in this market just really don't have anywhere else. Next product, a guaranteed issue product. If you can't qualify for the whole life, you go to a guaranteed issue product. There's basically about two questions on a guaranteed issue product, and it says you're essentially unhealthy.
I want, I still want that proper end of life, and I still wanna make sure there's a death benefit available or dollars available to provide that. We'll move to a guaranteed issue product. Again, pay the premiums, it's permanent, it stays in force. Term life. When we think about our market, our LMI market, we do have three segments we break it down into. We have children, we have the family market, and then we have the senior market. When I think about term life, I'd talk about the family market. It, it really is about providing in that family market a big enough death benefit to protect against whether it's kids still at home or some other event that has a timeframe on it. We see that term life.
We do have the ability to convert that term into a permanent plan like most companies do, we do the same. More often than not, it truly is a targeted need or want that has a term to it that says, "I need a little more life insurance while my kids are still at home." Contents and A&H. Contents and A&H, contents being basically a P&C product and A&H being a simple product. These products are what I call to or refer to as client acquisition products or door knocker products. These products are about having our giving our agents an opportunity when they're out collecting a premium at somebody's house, they might go four or five doors down and not have a referred lead they can knock on the door.
That person when they knock on the door is significantly more likely to talk to them about a contents product or an A&H product than they are a life insurance product. These products are fairly inexpensive and fairly simple products. Therefore, again, it's a client acquisition product, someone we can talk to them. They buy that product, and as I collect those premiums or service that policy, I build that relationship. I have the opportunity to, what? Sell life insurance or help them plan for their financial future and when they die or that proper end of life. It is a key product for us. They, you know, it's part of our portfolio.
Again, when you look at it, if you look at it overall, those products are profitable products for us as well, not only from an earnings standpoint, but more importantly from a client acquisition standpoint and really building our opportunity to acquire new clients. As we think about delivering these products, we think about what it takes, the capabilities and the ecosystem that benefits not only our customer, but quite frankly, our shareholders. As we look at this and we think about the service and sales and service model, it's that distribution organization. I'll share a little bit more about that in a minute, but it's the distribution organization that's designed not only to serve, sell that business, but service it. We collect about 85% of our premiums are still collected, you know, door to door or cash.
We're still heavily in the service business, and that service business keeps that client in force or helps them maintain that policy, helps create that financial discipline. In that capability of sales and service, and that strategic component, we also have policies, as I just described, that are really straightforward, easy to buy. What's important is our distribution organization is there from beginning to end, right? Our agent is there when they enroll the policy. Our agent is there to collect the premiums on a regular basis or service that client on a regular basis. They're, a lot of times they're at the end of the period when we pay a death claim. We have a large number of agents that have been with us 20, 25, 35, 40 years.
large number that are there from beginning to end. The two enablers I think that really support the sales and service are the two of the strategic components is the low cost operating model. You know, and it's really about, it's about the whole model. It's from beginning to end. It's business processes and systems that are optimized to drive, right, efficiencies through our organization that meet our customer needs. When I look at that segment, the five segments of our life insurance and look at, say, you know, we're focused on that LMI market. If we tried to combine those LMI services with the middle market services to serve that middle market or that higher end market, they don't work, they don't overlap, they don't combine.
The way we underwrite, the way we collect premiums, the way we service the customers, the KPIs, the time to answer the phone, the time to get back, all of those are different. It's the Macy's versus the Walmart, right? Where really the LMI market's Walmart. Our customers are willing to have a different service model and allows us to provide good products at a competitive price for this market and this level of service that we provide. Low cost operating model is a key element for us as we think about how do we grow this business, and we stay clearly focused on that LMI market. The other element of it is how do we grow the business? It's really through systematic, transferable, duplicatable systems. Systems that allow us to remove some costs or create some efficiency.
It allows us the opportunity to not reinvent the wheel in order to grow, whether it's distribution or other processes and systems. We focus on that, and I'll talk to that in a minute. The third key element that really brings together our systemic sustainable competitive advantage is our data and analytics. Our data, there's a ton of proprietary data. For as long as we've been in the business and the length of our policy holder base, the longevity or tenure of our top policy holder base, it's amazing the amount of data we have. That proprietary data allows us to create better solutions, better price solutions, right? Not only price for the customer, but price to make sure that we're hitting our returns. It allows us to understand our risk selection better because there is some risk selection in this.
If you don't understand the market and don't have the data, you could be underwriting, some risks that we probably shouldn't be underwriting. As we look at that and look through that data and source it and run it back in the back test models, we see there's certain risks that we don't want. Other companies might jump into those risks if they didn't have the data we have available. There's a lot of opportunity in data and analytics, not only to be better risk selection, but also to target where we should be, where we should be growing. Where's our business growth? Where's our greatest opportunity? Of those 10 million households within 25 miles of our district footprint, what's the best areas we should be targeting to grow? What's that customer look like?
Great opportunities here. These three strategic key components really drive that systematic, sustainable competitive advantage. As I referenced at the beginning, our distribution ecosystem drives that competitive advantage. Without the distribution organization, it really doesn't happen. It starts with that district manager. 83 offices or 83 district managers, around 83, with 370 sales managers serving and leading 2,300 agents that are touching, you know, our 3.5 million policyholders or 700,000 households we have. That is that, touching them on a regular basis, right? It's the high-touch service model. It's, it's making sure, it's a little bit of what Matt referenced.
It's that system that we put in place that allows the opportunity for that district manager, that sales manager to run a model, run a business that puts agents in the business to touch those customers on a regular basis and to continue to acquire new customers. We do that through enabling processes. We're gonna talk a little bit about our how we accelerate growth, and it really is around these enabling processes. We wanna optimize our ecosystem to accelerate our growth, and it comes back to our target operating model. We have a target operating model for our distribution organization, for that ecosystem that has breakdowns for how does a district manager operate, how does a sales manager operate, and then how does an agent operate?
How do we maximize what they're doing on a daily basis in order to not only service, but grow our business? We have systematized training, recruiting training, education, and development plans that allow folks to focus on executing on their business versus deciding what they need to do to help grow to help an agent grow their business or serve those customers. We really think of it and look at it as a franchise model. We all know and we've seen the numbers, right? If I look at a franchise business versus an independent mom-and-pop shop, my chances of success are significantly greater in that franchise model.
As we think about how do we implement and grow faster, we're optimizing that target model by really franchising the operating system, which is transferable and duplicatable systems that people can plug into and creates the greatest amount of success. It's a system-driven success versus the personality-driven success. We can enhance the opportunity for not only the company to have great success and grow this business, but for each one of those, the agent, the sales manager, district manager to have great success in servicing that existing customer as well as growing additional customers. As we accelerate growth, we really look at you know, where and where and when. We have a great opportunity, 10 million households within 25 miles or around 25 miles of our existing footprint. That's what we have today.
We have $10 million opportunity. As we look at that and think about how do we really attack those $10 million, it's really adding more what I typically refer to as feet on the street, right? Adding more agents and helping them be more successful. We can do that, and we can add those agents, and our growth is 5%-10% a year. We can add those agents without significant investment in infrastructure 'cause we're within 25 miles of our office. We can add those agents without significant investment in additional management or leadership because we can increase span of control, more agents served by fewer sales managers or the same number of sales managers by optimizing our systems and our target operating model.
Great opportunities for growth in this business by optimizing what we've already been working on, what we've already been executing on, and it's just continuing to leverage those points up, target operating model in the district offices we run today. Those that 5%-10% agent growth will get a 7%-12% collected premium growth over the next year, over the next five years. We've seen the growth. We know how to grow. It's a great market. It's a big market. It's an underserved market. A market that when you look at it, 10 million households within 25 miles of where we exist today, where we sit today. Even bigger beyond that as we think about further out or adjacent markets and how we potentially penetrate those.
Great market, great opportunity, a target model that works and is built to be a franchise model, so it allows us the opportunity to increase the chances of success for anybody that joins our organization. A couple things I'll leave you with as I draw a conclusion. Again, high barrier of entry, so limited competition. There's not a lot of people that really want to be in this business because it's a hard business to understand, and it takes a real focus and discipline to serve it. There's a significant growth opportunity. I've talked about that several times. 2%-3% market share today, significantly better chances, better opportunities in the future, bigger market share.
A distribution organization that's in place today that as we optimize our target model, has a real, a great chance or has the ability to accelerate our growth with clear focus on that LMI market. Appreciate your time. Thank you.
Thanks, Tim. I'm gonna transition us here.
Forgot.
Oh, there we go. I think that's better.
Transition us to the how are we evolving for the future, in terms of what we're doing and how do we plan to have the operating model that's not just right for today, but for the future. There are two initiatives that I want to point to here that have outsized impact, that are really transformational like opportunities that would be more normalized seeing with something like a startup, but without necessarily the risk associated with that, right? Strong balance sheet, proven operating model, proven businesses, but an opportunity to fundamentally change and transform the risk profile of the company in a way that just really hasn't happened in our industry, quite frankly, to date, associated with the business lines that we're talking about.
The first item that's inside of there is our continued evolution around capital efficiency. That item would be Bermuda. We talked about and released last year about an additional $300 million in capital and liquidity through our efforts, where we created obviously a Bermuda-based entity and essentially reinsured about 80% of the business over there. I won't re-go through kind of all the things that we did in specifically to bring that to fruition, but I would highlight then that we indicated that there's an additional $100 million to come. We're well on our way for those initiatives and what's gonna unlock that this year, and we anticipate we'll achieve that, and you'll see that more in the third or fourth quarter this year as we continue to progress throughout the year.
This is important because I think you've seen a consistent theme come through here from the start to the end of our presentations, right? We wanna position ourselves such that when we think about the total cost of providing a solution, we have the ability to be in the position of the low-cost provider. Part of that is essentially what we pay for capital and liquidity. If we need less capital and liquidity to see the same outcomes with the same risk profile or a better profile, right? That effectively reduces pricing. We think about it all encompassing on in terms of where we're at. Doesn't mean that every moment in time that that's where we'll set our pricing, but we definitely want the flexibility to be able to do that.
The second thing that I would note here, we've had questions in that whether this is tax arbitrage or other. It's not either one of those two things. This is us really moving the business to a more or an advanced risk rating framework that matches essentially our business model. We're a spread-based liability company essentially with our life company. There are different companies who have different strategies. We look to earn a consistent margin on the business over our spread, right, of essentially those liabilities. The way to think about that in an overly simplified way, think about savings accounts, right? We wanna earn basically a point and a half, 2 points, depending on which tranche it is, which underwriting, which product, right?
Above essentially our cost of funds or the interest rate basically that we provide or credit to our policyholders. This model enables us to do that even more efficiently, right, as we go through. Bermuda essentially matches or reflects the ALM characteristics or the asset liability characteristics associated with your business, okay? The Advanced Solvency II framework says that basically if you are unmatched, right? If I had a 20-year liability, and I effectively had a 10-year asset against that, I have risk associated with that reinvestment. You have to hold a tremendously amount of additional capital in Bermuda if that's the case. If you look at other frameworks for where you're at, there's an assumed amount of mismatching or matching this corporate. It doesn't really segment to the same level of the risk-taking that you have.
The net outcome is that you could have a mismatch in our current risk, right, and not have additional capital required in order to match up to that risk-taking component. What this means is that we've moved to a jurisdiction that if we were to mismatch our liabilities, not have that consistent, right, margin that I'm talking about, you're gonna see capital requirements go up pretty substantially. At the same point in time, because we are matched and that is the risk profile of our business, we have tremendously less capital associated with that, right? Because it represents what is the net risk position that we're taking, right, associated with that. That's essentially what we're doing. It's not tax arbitrage, not anything else. It's just a reflection of our business and matching how we run the business, right, to essentially the capital and the outcomes that are associated with it.
That enables us to have that capital and liquidity at the top of the house. That enables us to reduce outstanding leverage and effectively reduce risk across the organization. In addition to that, it enables us to have less essential volatility capital to achieve the same outcomes. When you think about whether it's in one entity or another, you don't have the free movement of that e-capital from one entity to the other, so you need to hold higher because you got an expectation that you might have challenges moving it. This creates that flexibility where it creates additional efficiency for us. The way to think about that in two ways.
One, we either reduce pricing in totality associated with that, so we grow more, so we get more cash flow that comes into the organization, and the NPV of the organization goes up, and we consistently grow with a higher, faster multiple, or we earn a higher ROE or, you know, effectively the same margin with less capital equity in the business to achieve the same outcomes and just higher returns. Right. A net-net positive. The way to think about that in total, you've got this outcome, but you also have essentially then what does this say about the management team and the way that Kemper orders business? We turn over every rock to look for how we can create efficiencies and to improve our model to make sure that we're always doing the optimal outcomes then for the customers and for our shareholders and our employees.
All of these things come together that we can invest the right levels in our employees, the right levels in the customer from pricing, and provide attractive returns, right, through time, so that we're constantly creating that engine that creates growth and outsized growth and basically both from shareholder value perspective and from a customer value perspective and an employee value perspective, right, across each of those dimensions, as Joe mentioned, the three-legged stool, through time and in the moment. Okay? Second outcome that I'm going to jump into is reciprocal. Obviously, we announced this is a big change in some lines. It's a little bit more akin to kind of an open closed book strategy in how we're going through there.
Because it represents a difference in terms of the change in the model from a five-seven , we're obviously out and talking about it because you're gonna see this, you're gonna have questions. In the absence of information, sometimes people go to dark places. This is obviously not something to do. This is a very exciting thing. This is something that will fundamentally change, right, our business model, our ability to do it efficiently and essentially the volatility that you see with outcomes. We're gonna go through that here in a moment as we go through in terms of what this is, how it works, and essentially why is this a very opportunistic thing for us. Then we'll talk about how does this stuff kind of come together from, you know, a net outcome perspective in terms of cash flow volatility, earnings volatility, right.
Those types of things that will help, I think, transfer in in terms of how does this kind of size up from an opportunity, what does it mean to you if you're thinking about this from a five-seven year, how do you look forward and think about, well, what is that income statement gonna kinda look like or the volatility of that? What's gonna be cash flow? How does it change? What should I be kind of thinking about as we go along this journey? First and foremost, you know, obviously, this may seem a little rudimentary, but I think it's important to establish what the base is that we're starting with to really limit any potential here for confusion. You got two traditional kind of structures that are out there, right?
You got stock companies, effectively you've got your traditional mutual companies. In both case, there's a policy serving component and there's an underwriting risk component, right? In one case, you have stockholders that own the total risk for those activities, you got policyholders that own the risk for those activities. In a reciprocal model, right, you effectively split these things. You move from a stock-based company owning both to a stock company that effectively owns or right, is on the hook for the risk associated with the policy servicing component. The stockholders own that, the underwriting risk remains and stays with essentially the policyholders from that. Okay? Not different from mutual. It's just saying, "Hey, you got two structures out there. You got a mutual structure, you got stock structure." Sorry.
How do we split those and get the advantages of both of those things for the best of those capabilities that come together? By doing this, right, we create those outcomes, and we're incentivized to essentially, you know, provide all the same services, high-quality outcomes that we do, and be very, very thoughtful about the underwriting risk, right? There's a symbiotic relationship between us as you work through these things, right? The more and the better job that we do managing that reciprocal, right, as an exchange, the more it can grow, the more people it can serve, and essentially the more services we can provide. Effectively, you know, we are not really tied together, but we both benefit from, you know, high-quality outcome services and things of that nature.
The difference being, right, that this structure, not only does it essentially allocate these or separate these things, but it creates additional benefits that are not available in either one of the mutual or essentially the stock company models. You might ask, "Well, what is that?" The first one is tax efficiencies that are essentially created through this. This model creates an additional two-three points net of tax efficiencies that just aren't there inside like a traditional stock or mutual model. Why is that important? Well, if you think about the traditional margin that you might target, right? Whether it's 95-97 or 94-96 or wherever you wanna come out with from an auto perspective, right? two-three points is 50%-60% of that potential margin. That's a lot, right, when you talk about that.
That essentially helps create the funding vehicle that changes, right? It creates additional two, three events to fund the capital creation in, through this structure that enables the reciprocal to attain the same financial profile that we can achieve on as a stock company, but it enables effectively you to have a consistent cash margin from a stock company perspective, right? Without effectively necessarily having to take on the underwriting risk and the volatility that comes through there. Those additional benefits can fund and essentially fuel the growth of that entity to where it achieves the same type of financial profile, the same strength, but enables now a changing of the relationship such that we can really bifurcate the revenue streams such that this one doesn't have a lot of volatility, right?
This one may have volatility, but it's measured and its impact is over like a 10-year time period, and it has additional benefits, tax benefits, that funds that volatility in a way that I can't do or anyone else can do from a stock company perspective. That's first and foremost that comes in there. The second thing that it allows is with that volatility, if you guys think about when you buy insurance and other outcomes, I don't know that any of you are thinking about, "Hey, I want a 10 or a 12% return on capital associated with the capital that's on my policy from an insurance perspective." Now, if you do, great, like fantastic, go hard.
Most people tell me they would rather pay less and have like a 3% or 3.5% return or a 4% return on that capital, right, that's going through. Not only do we get the tax benefits, but effectively we align for our policyholders that benefit from a cost of capital perspective. Instead of them needing to pay 10% or 12%, right, that's coming in first, they can pay that 3.5%, 4%. Both the tax and the capital benefits come in to self-fund this entity. We go through with the essentially the auto premium. If you think about our private passenger auto premium that we're looking at, this goes into self-fund now. Why does that matter to you?
Lots of questions essentially about like the earnings capacity entity and does this model change the earnings capacity of the entity? The answer to that is no. If anything, over the longer term, it accelerates it. Okay? When we get out five or seven years, right, relative to what you're thinking, and I'm just gonna play off of the numbers that we have for 2024 to make this much more simple in terms of the Wall Street estimates. Today, we're forecasting a $5.02 of earnings. If I was 100% inside of reciprocal today, right, for where we're at, and it was deconsolidated, and the end result, we'd have $5.02 of earnings.
The reciprocal would have the same outcome, right, on their side for their component, net of the fees, and they would have an additional three points of earnings or two that we wouldn't have to help fund growth. That's the way overly simplified version, but that's the easiest way to kind of think about it. What would happen inside that model is we would have created two-three points of additional benefits, right? That are gonna be essentially in like a 401(k) account that aren't taxed, right, until the money comes out for the shareholders, but the capital doesn't amount. It's a contribution for there that stays with those policies, right, for life. That thing grows and provides that capital support for those anticipated but unanticipated events. It grows to support that.
That enables an additional level of growth that we could not achieve outside, right? Because we now have two-three points more. If you think about a premium to surplus ratio, whether it's three-one or four-one or 3.5- one, right, on your auto, take whatever you want from an industry perspective. If I had $10, right, of additional premium, I need effectively additional $3 more. This model enables us to write on the same outcomes, right, that additional $10 of capital without effective or $10 of premium without effectively needing to increase, right, the capital by a third for that amount. It's way more efficient on that front, and that's what enables it to essentially self-fund.
The first component when we go through here is to enable this entity to create, and it will harvest those additional benefits, right, for consumers. We won't be reducing pricing through this on day one, right, for customers. Those outcomes will essentially go at additional 3%- 4%, and then the returns on the capital that would be inside there to fund, right, the growth of the capital to make it an independent, economically viable entity on its own. They will accumulate, which is part of the reason why deconsolidation doesn't necessarily start on day one. There are a couple of things that need to happen. One, the entity has to become economically viable. Well, 1 component of that is the capital. Could I go out and get third-party capital and do other things that would potentially accelerate that?
The answer to that question is yes, and yes, that could be done very efficiently. We can do that at any point in time, right? Great examples of that would be Farmers, right, inside Zurich. Most, if not all, of that capital today is either the policyholders or external, right? It didn't start that way. You can see where Erie's at today, right? That's all basically policyholder capital. You can leverage and use third-party capital in a very efficient way to do that. We can also create it, though, very efficiently inside the model. The second part about that economically viable component is demonstrating that track record for success, right, of the underwriting actions in that. That's not a long time period, right? That's a three- five year time period that basically comes into period.
It's the same model that we have today, moving it over, demonstrating that, hey, we're gonna manage it the same way, right? We're gonna have that same discipline, whatnot, that goes in. Your first couple of years that you're going through, you say, "Well, why doesn't it take five years instead of three years?" Whatever. You have a new cost of new business, right, that comes with the new. You're gonna have an open closed book strategy here. You're gonna have a significant weighting of the new coming in. The net result that you'll see for us won't be any different, but you'll effectively have a little bit of difference in terms of those financials and how fast, right, that capital accumulates from that because it's gonna have more new coming in there.
Every time we open up a new entity, right, new states, each one will transit. It's gonna be an open like closed book strategy. New will go in. We'll continue to maintain in the stock company, right, those renewals and those other components over here. It would make sense, but there's a general benefit to having them over here and not disrupting those customers, right, from that perspective. You'll have, you know, the results will become a little lopsided for the net results to us won't be there, but it'll take that period of time. You'll hit essentially that period where that crosses, and you'll see that renewal book coming in. It'll accrete capital even faster. You'll have the net outcomes that are the same that you would have achieved over here. You show the discipline associated with that.
Now you've essentially met the second component of the test. An overly simplified way. I can go into any of the nuances with anyone they want, post this or on the phone or wherever, if they want to get into real nitty-gritty. I will enjoy that conversation. You may not. I'll hold some of that. The net outcome effectively is, right, effectively that capital accretion where you've shown both an independent financial profile and the discipline for how it's going to be managed and the ability to manage those things, and then it becomes deconsolidated. That's important when we think about the outcomes of these things, because on day one we'll probably support that difference with a reciprocal note or a surplus note. That's just a loan to the policy holders, right, that we're making that will be repaid associated with that, right?
We'll do that either from the life or the P&C companies or the wholesale. We can do it from any one of them, right? Just a question of where it's most efficient, best place for that to happen. If we think about that from a life perspective on day one, I'm gonna make a very simple, like, example here, and why consolidation matters or deconsolidation matters. On day one, let's say we put $100 in a surplus note into the entity, right? From a rating agency and from a capital perspective and from a state perspective, you basically look at that $100 as nothing new, right? Like, okay, I got a surplus note there. I gave a 100% capital charge against it, right, into the entity.
If the entity at the top of the house had $100 before, we didn't get $200 because we put it down there. We still only have $100. It's looked at. It's 100% funded, but it's capital, right? $10 float. It's 100%. When deconsoliation occurs, let's say that we made that, right, $100 investment or loan, right, from our life company into this entity. We essentially put the $100. The life company holds $5 or $10, which would be like the capital in a normal scenario against it. We put more down as the company, the holding company, right, to support that, 'cause on day one it requires $100 for that note, right, to go down.
On day two, a deconsolidation, that now looks like any of the other notes that we have. Instead of effectively having $100 of capital in there, we have $5 or $10 of capital, and we have $90 of float or we're basically reserves or liabilities that are funding that $100. That's what happens essentially on that day two. That capital is then released, right, at that moment in time. Once you hit the deconsolidation, the capital then gets released, and now I have $90 more, right, in that scenario or $95 more that wasn't available before. I have an investment grade-rated risk, right, at the outside. The policyholders have the same strength that they had before. I've got two-three points of additional benefits, right, that are being created from the tax, plus a lower cost of capital.
That entity now can grow faster than it can in any one of these other two forms, right? I now essentially have a stock company that's become a servicing fee or a franchise business that has a very steady stream of cash flow that comes into it. Let's say that, you know, and here is a great example of this. Let's say that I had the $5.02 that's being forecasted for, you know, 2024. If I were to think about that from a net risk position, you say, "Well, gee, 2021 and 2022 hit, what happens to my $5? How much does it go down?" Think about that as like $4.50, $4.45. How much we have a great investment environment. We're working. Everything's hitting on all cylinders.
We're at 92s in the normal right? That we had on some of our KA business or commercial. What happens then? Well, then we move up to maybe 550. Okay? It just continues along that path, right? That glide path. it's more about what's the growth and what's the net services that we're providing, right, that are coming across. This is very different than if you had a property business that you were putting in or other. You have to come back into what are the premium to surplus ratios and how does cash fundamentally change in each of those things. Those businesses, highly unlikely that they would essentially create, right, the float or the capital to support themselves. Think about a traditional home property, and they're all gonna be different.
That might have a 0.8 after you load in economic capital, 0.8 to one premium to surplus. If that business is growing 10% per year, effectively it needs about 30% more capital, and it's generating 10%. It never self-funds. Auto, very different than that, right, on the outcome in terms of what we're achieving with that. Doesn't mean that it wouldn't be great for home, doesn't mean it wouldn't be over all these other things. I'm just giving you, there's a different way in terms of how the funding, right, comes about to essentially create these outcomes. Auto is a product that as you go through here and that self-funds if you're running it on the right way.
That's the big outcome for us, is then once we've got it self-funded, now we have that ability to split those benefits where essentially the entity is taking, say, that two or three points, let's call it three just to keep the math simple or two. 1.5 to one point goes to building that capital, continuing to strengthen it, broaden it, entity. Another point goes into reduced pricing than from the customer perspective. If you think about the way that this works in a normal world, and we'll see what price elasticities are post this, but traditionally about every point of price reduction has led to an additional one point of growth to two points of growth on a net basis.
If you think about your target margins, an additional two-three points of growth, you think about the 60% type retention associated with that and the way that that accumulates over that five, six, seven-year period, you've effectively tremendously, you've grown your cash flow stream that's associated with that, right, by about 20%- 25%, is where it comes in on that net basis when it comes to the outcome. You're both freeing up the capital that you would originally pledged, and on top of that, you're creating those additional tax rates, and you're growing more. All of those outcomes essentially create a flywheel that accelerates what the outcome is. Okay.
We're very excited about that and this initiative in particular. Great examples, if you want to see, GAAP audited financial statements that have these outcomes, I'd point you to the historical NatGen financial statements where they had the reciprocal for the period of time while they were working to a deconsolidation standpoint. You'll see that there's no change to the front of the income statement today, right? You'll see what information obviously is provided. That is the form template that is effectively out there. That's gonna be the same for all of us. I just point you to see, hey, what does it look like for a journey on the path there versus effectively it being the end outcome.
The end outcome of the financial statement, what you should expect is the Erie financial statements in terms of how those things work their way through. Okay? What does this then mean for financial outcomes? I talked a little bit about there. First and foremost, if you think about how folks made it through this period, right? You take the pandemic and some of the outcomes, you saw the net income volatility, right? Was a fraction, almost a third, right? For the reciprocal entity as it was for effectively stock companies through this period of time. The return on average equity volatility, similarly, way down, right? Essentially the same types of average returns, you see ROE go up. Why do we see ROE go up?
We need less capital inside the stock company to effectively fund and manage the outcomes to be that source of strength for the same outcomes. Because it's now sitting over here in the reciprocal, and the reciprocal created the extra capital on its own and actually built a financial profile and accretion that wasn't available outside of this model. The big wow number that then comes into there, and as we highlighted essentially as part of our third quarter call, that capital now becomes available either to grow the business in a thoughtful way, in an accretive way, Cheryl, or dividends, stock buyback. Those are material numbers. When you think about the long term and the five-seven year, you're talking about, you know, the potential to free up $1 billion+ in capital there and even more as you go forward from that point.
When you think about the growth of the capital and what's coming, you've got this earning engine that's gonna accelerate here. Go back to a much more traditional. On top of that, you essentially have a building cash flow fund profile that while every time we build the 3% on the way, that will release from our stock portfolio component, by the way. You have the incremental, and then you'll get this big bang of capital that's released associated with the surplus notes or the other outcomes, right, with the consolidation. You've got a much improved financial profile here, in terms of where we're headed that will lead to an even better profile customer than for our customer.
On top of that, there's a tremendous upside here in terms of the cash that is going to be released and available, right, in accretive ways for this business that would not be available in any other way within this five to seven-year period. Substantial dollars. Again, when we think about that's very much like almost like a startup opportunity type growth or outcome, but it's with an established company, a disciplined company, a strong risk profile, a strong balance sheet. Right? Are we doing something that others haven't done in this space? Yes. Is it any more really complicated than essentially creating new legal entities in the way they are? Not really. There's a lot of work and thought that goes in between, so I don't want to suggest everyone can just replicate it.
They can replicate it, but it's gonna take some time, right, in terms of working through that stuff and making sure you got all the things underneath the hood. We can achieve these outcomes without effectively changing that risk profile or the additional elements that are underneath this without really any substantial amount of execution risk that's different. Sometimes it'll be a little waiting on, right, state agencies or others. Very attractive, but these are things we control. That's no different than if we were opening up a new legal entity, introducing a new product. It's the exact same outcome that would be there. It's just we're doing it with a different structure than we were before. The reason that we're talking about it is 'cause you can see it.
If I wouldn't do that, I'm gonna go right back to the first part that I said. In the absence of information, we're gonna go to dark places. We don't want that when it's essentially. This will likely become a proof point. You'll probably see industry participants and others follow. I don't think we'll be the last company that does this. I do think we're the trailblazer as it relates to this. You guys can monitor and, you know, you'll see how fast and others kinda come along. We think we'll have a first-mover advantage in this relation, and we think it's gonna be a really attractive opportunity for you. Now if we think about this from a valuation perspective, what does this mean? If you look forward to today, there's two outcomes.
There's our path to profitability, right, in terms of what does that look like. We think about valuation, we start with wherever the stock price of the company is today, and we essentially subtract out what is the hypothetical liquidation value of that company today. We use tangible net book value, right, with basically bonds at par for where they're gonna come, all right? Ex AOCI for that piece. Notice we would adjust for things like pension. If someone's got a liability or they had an an asset, all right, that we should adjust for that. Effectively, it's the tangible net book value. We think about, okay, well, what's the multiple then remaining if you got a street estimate, right, for earnings of that?
What's the multiple that people are giving for how many years that they think they're gonna be able to create that and then use that to free up cash associated with the business? Right now, we have an attractive risk profile and a growth profile of business. We have two core businesses.
That would be really difficult to mimic and that we have substantial competitive advantages over our peers. We're moving, and you're gonna see those things come back. We gave you kind of our path to achieving our target profitability. Right now, we're at about a 6.7x multiple in terms of that future income. The industry as a whole, depending on which ones you're gonna look at it, is trading on these same metrics at close to 12 to 14 x. I say 12 to 14 because Erie is inside of that personal specialty P&C that drags it up. When you think about what's the potential over the five-seven -year- period associated with this, the enhancement from the tax efficiency and then essentially that capital or the consistency of cash flow.
If you look at Erie, right, that's about a 27- 28 multiple, right, in terms of credit. You might ask, "Well, why is that?" All really Erie is at the end side, if we're gonna overly simplify this, is an inflation index bond. We're trading and moving our PPA business to an inflation index bond structure. If you think about that, right, you got A, AA level rated capital entity. You can see exactly what's moving along then with those outcomes, same that Erie has today, right? You get hit with essentially an inflationary environment or something like we have today, or regulatory challenges, whether it's in California or other states, right, they come across. They got a 20% kinda in a normal bond. If you got a 2%, 3%, 4% into them, you're making a 30-year outcome.
You had a certain assumption right in for the earnings of that company. If it was 2%, you got basically 50 x earnings that you're looking into today. You don't have an inflation guard. This provides, oh, there's that inflation earnings hit, 20% rate increase, right? What happens to the fees that come across to the servicing company there? They increase by 20%. So in an overly simplified way, it's transforming this business, right, in terms of the outcomes that come to you into that inflation index bond and effectively having that 10-year constantly revolving, right, cash flow cycle on that is generative and provides that capital, supports that business, and then enables us to have a very efficient, right, capital structure and creation of cash engine for all of us. What does that do at the end of the day?
That creates an optimal pricing outcome for our customers that we can then use to accelerate more growth and empower more customers across the group and essentially create what we think is a very meaningful upside opportunity for you. With that, I think we're going to wrap, and we'll move to the question section of the afternoon. I think we're gonna bring up some chairs and some others will join us as well. Oh, sorry. I probably should have fast-forwarded. I'll put it this way.
For those in the room, we can start taking questions if you wanna raise your hand.
Okay. Good morning, again. To borrow Jim's phrase, I'm gonna start from a very dark place.
Is that different than normal, Greg?
Probably not. You know, Matt, you gave a pretty spirited conversation, you know, presentation around relationships with your independent agency distribution force, and in the back of my mind, all I'm thinking about is what's transpired in California over the last 24 months. In that dark place, you're not able to get rate. You know, profitability is under pressure. Walk us through how the relationship with your agents evolved during this time period.
Yes, I think it's a great question. Something we've worked on pretty hard over the past couple years. What I'll say is, let me start with the series of levers that we think about, you know, pulling in a state like California. Clearly, you have rate levers. You have a series of non-rate levers in terms of agency management, underwriting, other sort of components where you can throttle production in the marketplace. What I'll tell you is, in probably the second quarter of 2021, we started messaging to our agents that we have an adequacy challenge that's forthcoming as an industry. The reaction we got was, "You guys are nuts," and no one else is saying that.
If you think about the California marketplace, you get a lot of regional players out there that serve that market, a lot of smaller carriers that have me too filings around sort of big companies and so forth. We were out there early on saying, "This is gonna be an issue for us." We took corrective action from a agency compensation perspective, whether it's profit-sharing agreements or additional commissions or other things, to try to share in that economy that we were starting to see manifest. The first two or three months were hard, but Us, it's been actually a credibility enhancement exercise for us that we've developed with our, with our brokers in California. Now, it hasn't been easy, right? They've been hard conversations. Certainly, our production is down meaningfully in that marketplace.
The hard conversations frankly continue with our agency plan. You know, as we continue to take rate increases and see rate increases manifest in that market, when you're taking 20%, 30% price points up, you know, an agency will see a 20%- 30% raise in terms of their compensation for an effort that none really changed. We're having those conversations now where we re-baseline expectations in terms of percentage-based acquisition costs. For us, it's been an evolving characteristic. The one thing we didn't wanna do was be late to the game.
You know, observe a pattern, see how it played out, be late to the game, and have a wholesale sort of left blinker experience where we're saying, "Look, we're gonna turn." We saw that with a lot of regional carriers, maybe nine to 12 months after we took action. Agents are struggling with availability now. Where we would have seen 13-15 companies return a premium on a quote, we're seeing something closer to four-five at this point. A lot of the relationships in that marketplace have been hurt, which will limit, for a period of time, their ability to reenter that marketplace.
Now as rates start to you know, get approved, and we're seeing that come through on the six nines and others, and, you know, we have obviously our outstanding filing with the department that Joe talked about earlier, I think we'll see a reopening there that will be lumpy in nature just by the, the fact that, you know, how the CDI itself is working rate approvals through.
The important thing to remember is this, these aren't relationships that are like you have with your spouse or your kids. These are commercial relationships. What brings the strength is the fact that we have candid conversations, we have a stable, consistent view of how we approach the marketplace and how we deal with pricing and how we deal with communication. You know, we engage appropriately with the agents that way. Now, we may have appeared to be early, we may have looked like we were a little out of pattern, everybody else caught up. These are commercial relationships.
If you're a business partner on the other end of that, your ability to plan, your ability to understand how to work your business, your ability to understand how to operate, is much better than with somebody who's late to the game and one day just turns off new business or something. That's a problem, and that reduces the reliability and sustainability of that relationship. Matt and his team have done a really nice job of thinking through that over time. It doesn't mean you don't have to confront a problem, but how you do it has a ripple effect, and I think we've done a nice job at that.
Thanks for the answer. I guess, thematically staying in the dark place, but pivoting to Jim's presentation. Conceptually, what you're mapping out, the details you've put forward make sense. Let's go back to California, where the regulatory overlay is, can be difficult at times. It's just not California, there are other states too. Walk us through how you think you're gonna navigate the regulatory challenges of this process that you're embarking on.
Are you specifically, Greg, asking the return to profitability or the reciprocal?
The reciprocal. I'm sorry.
I'm just confirming to make sure.
Yeah.
Look, there are a variety of entities that operate in an insurance space and issue insurance policies. There are stock entities, there's reciprocals, there's mutual companies. State insurance departments deal with those all the time. We've got scores of entities inside our existing operation today that operate in an insurance space. We're gonna take an entity, we're going to have it, you know, licensed in certain spots, and we're gonna file products, and we're gonna write premium in it. That happens all the time, in that process. It's not gonna be radically different than filing a new product anywhere in terms of what's going on. It doesn't add incremental risk to a customer. It doesn't add incremental solvency risk. This is not news.
There's, you know, one, you know, small, not really well-known reciprocal, I think it's called Farmers, that's headquartered in California. The California Insurance Department is not lost on them how these work, and they operate effectively today. You know, there's always some regulatory complexity with rate filings and the like, but that's sort of ordinary course business operation. This is not some radical new concept that we're introducing.
Greg, I think, you know, building on what Joe said, I think there are, some tactics, obviously, given some of the outlooks or, you know, some of the grandfathering versus non-grandfathering for how California looks at reciprocals that still enable us to get to a quality outcome. One option would be very simply to have essentially the stock company or to have the reciprocal own a stock company. You wouldn't see a change in the delivery, but you'd see it go through the same model. The second outcome that you could potentially have that's inside there, and there's a bunch of different ones, so I'm just gonna kinda give an example versus trying to create the whole playbook. Can definitely kind of walk through that, in greater detail with you or others, at the appropriate time.
You could look at things like, for folks when you think about if you went and got a fund from Fidelity, right? It might have a load charge or something like that in that goes in, right, for the three or the five years. Potentially when you're thinking about, like, your outcome, if what you're saying is you can't have a cost differential on one end, you could have a differential for an investment outcome that gets you to the same fundamental outcome, right, that comes through there, while still achieving those tax benefits or other in terms of the way that that entity is funded, then ensures that essentially the servicing company, right, receives appropriate compensation, for its efforts, right, in terms of maximizing the outcome then for the policyholders. Those outcomes will be available.
We can go into some of more of those nuances but understand there's a whole menu of things we can do so that the end outcome isn't changed. Maybe some of the tactics inside.
You know, a California that are the right way or a little bit different in terms of there versus other states, but there's gonna be some of that nuance that, to Joe's points, that rolls through all of the states. What I would take away is that we've studied those outcomes, we've got a plan and have had conversations in advance on those things, and that we're really in the execution phase about bringing those things to bear at this stage. Again, I think the execution elements that are there are gonna be much more standard course where we're applying these different levers to kinda get there versus really even needing to look at or to have completely different levers in terms of what we would do.
just to comment on this.
Yep.
There's a lot of complexity in your answer and the thought and the process. For the investment community, you know, putting out benchmarks that we can that you know, you achieve this by year one, you achieve this by year two, having some benchmarks where we could gauge the process and how it's evolving would be helpful.
Yep.
Just a, you know, a side note.
That's good feedback, and we'll come back with something.
Yeah. We plan to provide incremental benchmarks, as we go. First phase here, we're, you know, finalizing kind of our conversations, obviously, with Illinois, you know, that were filed. You can see that. There'll be another phase, right? That comes after that. You should expect regular updates, to your point, that we'll provide here for guidance, so you can see that along the way. The big outcome that is much more, fundamentally determinable is we know where that five-seven-year outcome is, right? We kinda know the path in between, but are there quarters of difference here in terms of our rollout strategy this way or that way? Yeah.
As these things continue to aggregate in this, right, Illinois, whether we should be two quarters or three quarters this way versus one more quarter in this way, those things fall away. The five-seven years, that's not gonna move 'cause that has high predictability of this, of where things can go. We'll provide those incremental outcomes so that you can see that and see, oh, here's what I should expect at year three, here's what I should be expecting at year four. A lot of that's gonna come in a much more accelerated way once we have kind of some of these first pieces off the table, and then they just do the natural laddering for how other states and that come to bear with that.
Good morning. Two questions, if I may. The first one may be to Tim. Given the unique characteristics of your customer and the policyholder, maybe can you talk to us about the lapse trends, mortality, morbidity trends in respect to that specific group versus, I guess, the life industry? Maybe you could talk about your actual versus expected based on your assumptions that you had in the past. My second question to Jim is regarding the reciprocal. Of course, you're probably gonna be hearing a lot of questions about this today.
In a situation, and maybe this is an elementary question, but in a situation of a deconsolidation, and you were highlighting that $5.02, where does the investment income? There's a lot of earnings that are generated from P&C companies from that. How is that being flown through to the stock company? Maybe you could elaborate on that.
Yeah.
I appreciate it.
Happy to. I'll start with the lapse assumptions. What we saw during the pandemic is, you know, policies, we had significantly improved lapses, so significantly lower lapses. As the pandemic has and the fear of death has worn off a little bit, we've saw our lapses move back toward pre-pandemic. I would say on a, if we look at a trend line, we're still lower than pre-pandemic, so fewer lapses than pre-pandemic. As it relates to lapses versus the industry, we typically run a, what I would suggest, a little higher than the overall industry, 'cause you have to throw middle market or high net worth in there.
When you look at our segment and look at us comparative to other companies or books that have a similar face amount, similar profile, but don't necessarily come to market the same way, we run a really good, I would say it's after three years, it's a better than expected industry average on our lapse rate. So we're comfortable. We price for our lapse. We're properly priced for our lapse. We're better, we're running better than our pricing for our, both our first-year persistency as well as our overall lapse on the business.
We see that ultimate lapse rate in our book usually hit about year three, which is when we've really seen positive gains in our lapses versus our pricing, so better than pricing after year three in our overall book of business. From a mortality standpoint, as you'd expect, we had increased mortality during the pandemic, but essentially ran with what you'd consider the national trends and what you'd consider industry trends. We weren't an outlier necessarily from a mortality standpoint from the pandemic point of view. As again, as the pandemic has decreased, we've seen our mortality, the number of deaths decrease significantly, actually running at or below our pre-pandemic levels.
What we'd see and what we think about that as we think about that, the industry looks at it and would suggest we pulled those deaths forward two-three years. We're seeing about the same thing. We're seeing fewer deaths and we'll see how that trend continues, but we're certainly seeing it at the beginning of this year, and we'll see how it continues throughout the rest of the year. As I think of our actual expected as it relates to mortality and persistency or lapses, we're running at or better than what we'd expect or from a pricing standpoint, on the overall book of business outside of that pandemic. Mortality hit us hard, just like it did everybody from an expected standpoint.
When we ran our experience study, our new experience study, our new product, our pricing is based on that new experience study.
It basically, aligns well with what we've seen in the past and what we expect on a go-forward basis. Not sure I answered your question clearly.
maybe I could add,
Yeah.
A couple of points, I think we'll bring here. One component is inside of there, Mark, is I just wanna make sure there's an understanding of our product versus others. One, because the face amount of ours is much lower, right, in terms of what would be kind of the average industry face amount that you'd be expecting, much more of our revenue stream comes from the policy charges than it does the investment income. A normal policy, and I'm gonna, again, overly simplify here, swinging into it, but might be 2/3 investment income, 1/3 kind of policy and servicing, you know, premium collection elements, et cetera. Ours is actually about 2/3, 1/3. We're 2/3 effectively from a charge perspective or other bit. That's, again, that lower amount, so we don't establish really large savings accounts that have to grow.
That matters to you because it reduces that dependency, right, on extensions of lapsed lapse and mortality. The second thing that I would say is, if you just go back from a study in historical from a timing perspective, and Bermuda really pulls this out, and you can kind of see some of the things that we have there, and you're gonna have a whole lot more information on this from an LDTI perspective, so way better from an accounting perspective, and I think you guys will like that. We have tremendously outperformed through time, the mortality assumptions in that we face. We've been very, very conservative.
If you go back to kind of the company's opening practices and industrial life, it almost modeled every policyholder who's come in before we essentially got all of the additional data and proprietary data now that we have on the segment and how it performs and how has it changed through time periods. All males, all smokers, right, and just assume that across the board, whether you're writing females, males, whether someone smoked or not smoked, that was kind of the base foundational element that served underneath this from a block perspective. Again, we're way more sophisticated with pricing today, but you should assume that we're still very conservative with those tables that are going through in terms of where you're at. Again, you'll see that this isn't something you need to take my word on.
You're gonna have kind of that yearly update now with LDTI. You'll see essentially is the life expectancy that's associated with that, is it extending? Is it contracting? Is it going through, right? Everything's on pace for extensions of those things, right, and maintaining kind of where we're at relative to what Tim was indicating there. It has been throughout kind of our time period. If you think about the pandemic as a whole, it increased essentially, our mortality annually somewhere between 55 and almost $70 million, depending on which particular element and how you're run rating it, per year or which 12 months you wanna select. We're seeing now that we're basically back to kind of that, or pretty close to kind of pre-pandemic, but you pulled forward, right?
Unfortunately, sadly, I'm not in any way trying to diminish this, but you pulled forward a, you know, that's of maybe some of those deaths that would have been likely to occur over kind of a two-three- year period. That means over this next period, it won't be a 100% because there's an NPV, as you know, like on those guys, 'cause if I paid it out today, it's the same amount that would pay today or three years or five years, doesn't change. It's not a universal life policy. It's not offloading. It's just a straight amount. Effectively, though, we'll probably recover, you know, 60%, 70%, 80%. You'll see lower mortality effectively over the next three-ten years.
A lot of that will end up being front loaded from the three, but you'll see some of that play out over a five and into the 10 year, a much smaller component of that, as we go forward. You'll see, I think, increased profitability there, even from the traditional run rates, from the next few years, assuming that we've kinda exited this, that we continue in this post-pandemic in a more normalized environment.
Your second question was reciprocal investment income.
Stepping into that one real quick. Let's just take, if you got, let's just assume a 97 and a 96 combined ratio or 95, right? If I had a 97, that's three points of underwriting and assume three-four points of essentially, income that you're looking at, right, from an investment side, but it's kinda 60%, right, flow. It's not 100%. You gotta take that and multiply by that. We're targeting and where the end outcome for us will be is a six-eight point margin, effectively associated, right, at the net after expenses and outcomes for that will be. That essentially assumes either assume a four-point underwriting margin and a four-point, you know, investment income or a five- point and a three- point, however you wanna do it, right?
Assume that that's kind of six-eight that comes through there. If you take $4 billion premium, take $4 billion times it by 6%, that'll be the net fee income or times it by 8% or whatever, you know, premium amount, that will be essentially the net outcome from a pre-tax basis that is achieved from a profitability perspective there. The benefit that that has is you won't see the 92 days that we have, right? But you're not gonna have the 108 days. Those two things will blend its way out so that we have that long-term, 10-year type average profitability that's rolling through, and it's just gonna roll through consistently on a year-by-year basis. You won't see that net margin then change with that.
From an earnings perspective, on a normalized earnings perspective, if you thought normalized earnings was 502, you're gonna see 502 effectively, tomorrow, right, with those margin targets. Those are something we've already started to go. Like, those are in a good place. That is what we're doing. Hopefully that's helpful.
A series of a row here.
Thank you. onto the reciprocal still. My understanding is that Kemper benefits quite a bit from having, from a capital perspective as well as an investment perspective, by having both the life and the P&C businesses.
Mm-hmm.
You know, the vision years from now would be a reciprocal plus a life company, as I understand it. What, if anything, happens to the capital benefits that you had because of the diversification related to the life and the P&C?
Yep. From the extent that it sits on the outside, if you think about the volatility perspective, the surplus, the ability for us to have, again, not a, not 50% of capital, but say 10% or 15%. We have that ability then to issue essentially from the life company or other surplus notes that will maintain kind of that, effectively that capital benefit or other that would be there. Other outcomes, though, if you think about this, and we're not here, right? It takes a while for capital and that to maintain. You might ask yourself the question, well, what did Erie has a life company, what did they do with their life company? I think if you'll pull through and you look at things, right, you might find that it sits in the investment company of the organization.
That potentially becomes an option, right? In terms of where's the right place for it to sit or other, right? Does it become a fee-based business in the future or does it stay where? We'll figure out what the optimal answer is closer to the five to seven-year period. Like, let's get there, right? You should assume that those capital benefits and all the things that we're talking about today are maintained. You should also assume that, like, since life is infinitely more, the product that we have is the most attractive capital. Like, if you think about requiring 10% or eight percent basically, right, surplus to liability, right? That is a strong position.
As folks know, like, and you know this, Paul, for us, you've highlighted, like, "Jim, why do you keep so much capital there?" We think that's the right economic risk or whatever. That enables. every time they make $100, $90-$95 of that supports kind of the overall growth of the organization, right? those benefits don't trade and will enable us to ascend or change. That will enable us to continue to self-fund these elements in a very accretive, very attractive way, whether in or outside, in terms of where we, where we're going here into the future.
I might bring it back. I agree with everything Jim said, but I might bring it back to a basic set of simple principles. Right now, there's a benefit today. Prior to deconsolidation, that benefit remains there. As a core principle, what we look to be is efficient users of capital and a view that we should be getting the lowest overall cost. That's gonna apply going forward. You'll get it. We won't all of a sudden create something that now creates an inefficiency. That's completely opposite of everything we just described from a principles perspective. This will be an issue that becomes a potentially an issue of six, eight, 10, 12 years out, and we'll be optimizing that.
I love the high degree of confidence of how wildly successful we're gonna be, but that'll be an issue there. I'm glad you got the, the plus out of that.
Simple helps. I'm simple. This is almost a curiosity question. The commercial business, the plans are to put it in the reciprocal, like, as well. That business has been an excellent business for a long time.
We have no plans, Paul, today to move the commercial business. The reciprocal is intended today, and we'll always constantly be reviewing for what's the most efficient and the right way to do this. It's intended to be our private passenger auto component, essentially.
Just that.
Just that.
The future vision is a life company, a commercial auto business, whatever cool thing you make in between in the reciprocal.
I might say it differently. Right now, we're putting the private passenger auto business in because it has a clear benefit that produces a better answer for customers and shareholders. We will continue to evaluate all other things going forward. There's a difference between saying what's not going in and what is. This is what is, and that's all we're telling you right now, and we'll continue to evaluate everything else on a going forward basis to see what becomes optimal. We're certain this is optimal.
Yeah, a couple questions here. The first one, obviously, you're gonna be freeing up a lot of capital over the next five-seven years as you transfer business over to the reciprocal. What are your kind of plans, intentions for that capital? Also post this happening, do you anticipate kind of payoffs to be much higher? I think Erie's at a fairly high payout ratio right now 'cause it doesn't have the volatility to it.
You can take a shot.
Yeah. I think first and foremost, what we've said is we're returning and we're in active. You've seen that with Bermuda and others. We're gonna return our debt profile to our longer-term average. That's number one. You're gonna see that we would do that today as an example, very quickly. It's not that we don't have cash and liquidity and not to be able to do that. We do, but there's a cost essentially associated with the early call. We've set that stuff aside, right, to do that. Today with a 5% margin or income or 6% and a cost of funds that's 4% and change, 4.40% over here.
There's just a net margin, and there's no reason for us to essentially pay, right, to call in those notes sooner. You know, effectively play an additional cost and give up the additional spreading cost. We're doing that. We've set that aside. That's gonna be first and foremost, that will be there. The secondary element is that we'll look at, again, making sure that we've got all the things that are the right and the optimal and accretive outcomes, right, from a business perspective on an organic basis. I think that's gonna be the case, and I think there'll still be, you know, access, but we gotta get through that march. From there, we're gonna look at an optimization. What's the best thing for the shareholder? Is it then dividends, or is it stock buyback or some then combination thereof that will come in?
Obviously, on a go-forward basis, we'll have the same type of assessment model that could lead us to a higher dividend ratio or other, right? Similar to what you're saying. I think that's five-seven years out. I think it's probably premature to say, "Here's exactly how we will handle that at that stage." We will definitely be viewing and visiting and all the comments that you're making at this stage hold true. Let's get there, and then we'll figure out what the optimal path is kinda based on that framework that you just indicated will be the path that I think we take in terms of determining what's optimal.
It's not probably premature, it's certainly premature. The principles we're using all the time are gonna continue to apply. You know, first and foremost, we'll work the debt down, then we're gonna look at that organic growth and then returning capital, you know, if we don't have a deployable use in the most efficient way possible.
Great. That makes sense. The second question, I'm just curious. It seems like the tax benefit reciprocal, you know, gives you is a big reason for the strategy as well, right? It's the capital accumulations that are... How do you get comfort that that stick stays around, you know, permanently? Do you know, have some type of a letter agreement or something?
Brian, it's not a, it's not a complicated component. What ends up happening, let's do an overly simple example, and I feel like this is the 19th overly simple example we've used. If you're paying a premium to us today as a stock company, you're paying a $1,000 in premium. If you work into a reciprocal structure, you're gonna pay $950 in premium and a $50 capital contribution. As a customer, you wrote a $1,000 check. That $50 of capital contribution is like any other business process in the country. If you contributed capital to a business, it's not taxed as income to that business coming in. It's a capital contribution by an owner. That's the policyholder owns the business.
Yeah.
If you started a lemonade stand, you don't have to tax the capital contribution to the lemonade stand. It's not some crazy, you know, tax fit around. This is an owner who's starting the exchange, and the owners are contributing the capital needed to deal with the business and to create the business. It's just the nature of that entity, and that's how it gets its capital.
That has premium tax and income tax and state implications as you work through that. There are more nuances of that. I think we said it right. We're trying to give the directional, the simplified answer to get there. The big outcome is it's meaningful, it's there, it's permanent. Unless you're gonna fundamentally change the entirety of the tax code, both federal, state, and premium in each of those jurisdictions, that benefits us, and that would be a lot of coordination. I'm not saying it can never happen, but it's not just this business that would do. That would be almost all businesses. Oh, by the way, by the time that happens, it will have accreted its capital at the same point. This isn't an outcome that needs to be true for forever.
It's there right at the start where it creates that additional benefit to become self-funding. Once you're there's a whole bunch of options that it has, right? Whether it's taxed or not taxed as you go into the future to create additional surplus in the future so that it remains an independent, viable entity.
It is not a process where we're looking for some sort of, you know, quirky tax arbitrage that makes a bad headline somewhere. What we're actually doing is creating a more efficient structure which produces a more price competitive answer for customers because of how the pooling process works. It's producing a good outcome for the ultimate end users with an efficiency process. Other thoughts and questions?
We did receive a couple of questions via the virtual queue, but they've been largely answered through the in-person Q&A. That concludes our Q&A session. Joe, would you like to give us some closing remarks?
Sure. Thank you. And I'll really just give you know, one or two, and come back to where we started this. We're a company that starts with a real solid focus and purpose, a solid strategic intent, looking at how we serve an underserved group of customers. Doing that in a way that targets markets where we can build systematic, sustainable competitive advantages because there's either weak or unfocused competition, or some unmet customer need, but some ability to meet and match those needs in a way, again, that is systematic, that is sustainable, that allows us to outperform competition, to grow market share over the long term because we're winning in the marketplace in a way that's defensible and sustainable.
We take a set of principles and frameworks and processes that we do go through everything we're doing, to make sure we're building the right set of capabilities, the right set of enablers. We're focused on those core outcomes, and we're driving the capabilities and the efficiencies through everything we do, to accelerate that flywheel. I think you should have seen it, and hopefully you did over the course of all of our presentations, a common set of language, a common thought process, a common way to drive and turn over every different stone in the organization to advance the ball on each one of those outcomes. Our strong sense is when you look at that integrated approach and you watch it, we've got very attractive growing customer segments in our foundational businesses.
We've got an intense focus on those businesses. We've got sustainable competitive advantages and capabilities that are growing and accelerating. We've got some, what I think are unique and thoughtful ideas on how to understand the rules, understand the process, understand value creation that will allow us to accelerate that. That allows over time the ability to really unlock some significant value upside, to create some real value for every one of our stakeholders, our customers, our shareholders, and our employee. If we keep that three-legged stool balanced, and we continue to invest and accelerate in the flywheel, that process grows, it runs quicker. Everybody wins in that process, and that value gets unlocked. We're very excited about the opportunities.
We think when you look at them, while there may sometimes feel like there's a lot going on, we think they're actually very focused, very tightly, you know, centered around core existing capabilities or core existing markets or things that our franchise is really good at. It actually de-risks the issues around it. It increases the likelihood of success, and there's real significant growth upside in what we're doing. We're very much excited and thank you for spending your time with us today, and look forward to talking to you about our continued success going forward. Thanks again.