Good afternoon, everyone. Joining us for this fireside chat is the Senior Management team from Kemper. Immediately to my right, we have President and CEO, Joe Lacher, and to his right, we have CFO, Jim McKinney. Thank you for joining us this afternoon, gentlemen. We appreciate it.
Thanks for having us.
Thank you.
All right. Great. I guess let's just get started. Since I'm a P&C analyst, I'll start with life and health.
Right.
Just to get out of my comfort zone. That was obviously a big topic last earnings. A lot of noise in the results. To me, it just seems like a bunch of minor things that impacted earnings. Nothing comprehensive or major. I guess just how should we be thinking about last quarter's results and then life and health results going forward?
It's a great question and maybe Jim and I will tag-team the approach. First, it's generally a reminder. Our life business is very much a core business for the organization. A lot of times we'll find folks who, and I'll tease you a little bit, will describe themselves as a P&C analyst or think of it as a P&C only story. Our life business provides a huge strategic benefit to us because of the capital diversification benefits, and the ability to really unlock value inside our overall organization. The combination of the P&C and the life business together, if we were to separate them, the organization would require somewhere between $350 million and $500 million of additional capital. There's a huge plus that having these things together is really inside of our strategy, and people miss sometimes.
The second piece hops into the earnings issue. A number of things that I would largely describe as non-recurring or one time in nature occurred in the quarter. It's unfortunate from a timing perspective that they all seem to occur there. We try to describe to folks that really, if you exclude last quarter and look at the prior four quarters, and average those, that gives you a pretty good run rate for what's going on in the business. We can talk a little bit about what the underlying issues were to give you some color on it. Again, they're largely non-recurring in nature. We very consciously decided to outsource some actuarial functions that we wanted to deal with. We've got a fairly vanilla book of business. We thought we could get some additional talent and some additional capabilities by bringing in an outside firm.
That work was going on in the quarter. Their processes that they were using to come up with an estimate were modestly different that caused them to look at the reserves a little differently. We went through some traditional experience studies that you would go through on a regular basis. They were doing experience studies. They were helping with some of the components that are inputs that our pricing team uses. A lot of this work was sort of ongoing in the quarter. You had some expense components. You had a very minor change in the reserve balance, which I would describe as not a recurring or ongoing change in mortality. It was a process difference that generated that. These were items that I don't think fundamentally changed the long-term run rate of that business.
The prior four quarters, sort of a rolling average gives you a good number. We had a couple of one-time items that were related to growth, which are positive items. This has been a business that had been shrinking two or three percent for a year for 20 or 30 years. We've turned it around to growing a couple of percent, which is a real positive. It adds to the long-term economic value of the organization. You get two issues when that happens. When you start growing the life business in that first year when you put the business on the books, there's a little bit of a charge that runs through in that, and you get the earnings over the longer-term piece of the contract. Going from shrinking to growing causes there to be sort of a one-time adjustment inside of that.
We have compensation programs that run through for our field teams. Some of those are based on a per policy commission. Some of those are the result of if you hit certain growth targets in aggregate, those trigger a payment. For life accounting, if you can charge the expense to a policy, you can DAC it. If you can't charge it to a policy, if it's spread across, you can't DAC it. The fact that we hit bigger growth numbers caused the growth bonus to be paid, which triggers a one-time payment. If you're thinking about it from a pure cigar box accounting, it doesn't change the cash of what works through the entire economics. It came through from an accounting perspective in the quarter.
These are things that I think when you peel through them, aren't things that would cause us at all to have any negative view of where that long-term earnings view of the business is.
I think I would add on. The items that we mentioned, again, kind of hygiene or change in a methodology from an estimate approach and further enhancements, they're not run rate. The real takeaway, as opposed to getting kind of lost in unfortunately that one-time noise, is the fact that we are growing that business, that we are having success at doing that, and the initiatives that we've had, while maybe marginal or modest relative to total dollars that we put in, has actually fundamentally changed the trajectory of that business. Now we're actually growing inside there at a rate that's above kind of a market average inside our segment. A component that was really something that was out there, and we had talked about, and we had been making marginal progress, you really got a good proof point of that.
You got a good proof point with that with sales far in excess of what we had really anticipated, not like what you would have in our specialty auto book of business. When you're starting to get up in that 3%, 4%, 4.5% growth for a life business, that's a really good momentum and a great place for us to be. Those are dollars that aren't requiring additional capital to come into our system. That's additional margin that will flow through over time without necessarily having more capital because of the overall diversification that it provides for our overall model. We think that's just a big win, and unfortunately, in my mind, that point was obscured or lost in terms of what actually happened in the quarter.
Mm-hmm. Great. Then within life and health, you have three businesses, life insurance, accident and health, and property insurance. Are any more core than any others?
The life business itself drives the biggest bulk of the capital diversification benefit. Inside of that life business, the property that's in there is really an ancillary product that goes along with that sale. I wouldn't think of it as a separate business. It's a product line that we sell to those households while we're already in selling the life component. We have a modest supplemental health business, which has similar capital diversification benefits, similar positive views, has attractive margins, and is just more modest in size.
Mm-hmm. Okay. All right. Do we have any questions from the audience? Yeah, just please wait for the microphone. Thank you.
Joe, you spoke of the required additional capital if you split up the company $350 million-$500 million. Can you explain what that is? What would cause that need for additional capital if you were to split the two businesses?
Can I explain it maybe in a reverse answer? There's a diversification benefit we get from having the businesses combined. You'd lose that diversification benefit.
That's from rating agencies or?
It's rating agencies in terms of what would come in. It's liquidity elements. We, again, look at things from a probability of ruin and having about a half % chance. That creates a certain amount of economic capital charge that's inside your business to ensure that. Everything that we have inside that life business both brings it down in terms of the total earnings or the cash flow that it generates, so that $100 million plus a year that's coming in from that perspective, as well as effectively the other elements that come in from a liquidity perspective. Your ability, if you've got a change in your investment environment or others that provides liquidity for investments that wouldn't otherwise sit there in that time period because the cash flow is going to be very different.
As well as borrowing capacity and other that sits there and is able to create committed contingent capital facilities that wouldn't be there. That leads you to a $300 million-$500 million type capital synergy in terms of where we solve for, again, kind of a target A rating, if you will, from that perspective. The additional capital that comes out because of the diversification benefits are in there. A proof point of that, and it's really easy to see, is Infinity. On day one, we had $150 million that basically came out. Since then you've seen us actually take out another $100 million-$150 million, depending on how you're estimating it, and actually pay down the debt and the other elements that were associated with that transaction.
Just the overall diversification that we have because of that life book effectively gives us a lower total amount of capital needed for the risk level which we consider that one in 200 pretty low and pretty thoughtful relative to where we're at. There are additional benefits that come in as well. When you think about an investment horizon, we're matching to the expected life of the liability as opposed to having to match our investment. If you took the same A investment and you thought you had a three-year or a five-year liability for maybe bodily injury or other things that come out, if you had to book in three years, you're giving up incremental yield in a normal yield environment that you otherwise would not be able to achieve because of that sacrifice that you're needing to make for liquidity inside that time period.
In addition to that, from a rating agency perspective, that because of the diversification, as you saw with our model, instead of being at a AAA level of capital to reach our target rating, we can be at a AA rating which is further muting the expectations for natural volatility that happens over time. Those levels have come down. All of those other elements that are additive in that are in addition to the benefits that we get by having $300 million-$500 million less of just total capital in the business for the same risk level that effectively just reduces cost and allows us to provide more earnings to our shareholders and others, and a better product at a lower price to our consumers.
Okay, great. Do we have any more questions from the audience? Okay. All right, great. Moving on to P&C and specialty auto in particular. Can you just describe the non-standard competitive landscape? How has this changed since you acquired Infinity? What's the rate environment look like in that line of business?
Sure. Couple of points underneath that. First, we've been hearing some conversations or people asking different questions, so I'll expand your question a little bit. The standard and preferred market and then the specialty auto market really operate very much differently and disconnected.
Just because you hear that the standard and preferred market's getting more competitive doesn't mean that that's happening in the specialty auto market. They operate, again, in that disconnected fashion in terms of the relative competitive pressures. They'll often experience similar loss trend dynamics where if frequency's going up or frequency's going down, obviously the cars are on the same roads, they're getting in the same accidents. You get a different competitor set, so the responses are different. If you back up two and a half years ago, the specialty auto and the whole auto industry had seen rises in frequency as unemployment dropped. You saw many competitors responding to that increase in frequency with increasing rate actions, tightening underwriting, generally disrupting the marketplace and pushing more consumers into the marketplace to shop. At that time, we were well-positioned from a profitability perspective.
We were capitalizing on that. We were growing fairly significantly. What we've seen since that time period is the frequency environment has stabilized. Most competitors have gotten themselves to a more reasonable level of profitability, so they're not generally being as disruptive in terms of as significant a rate increases or as significant an underwriting tightening, and they're not pushing as many customers into a shopping component. It's sort of a more normalized level. It's not what I would describe as a significantly soft market where people are rushing out and dropping rates and doing crazy things to grow. It's just one that's not particularly hard where people are jacking up prices. That reduces the number of consumers shopping. It doesn't cause the supply, if you will, the company's writing business to be dramatically doing anything silly. We're not seeing great aggressiveness as a result.
From a rate perspective, it very much varies by geography. That's actually one of the things that we find to be an advantage in the specialty auto market. There are a lot of small regional carriers in this marketplace. You'll periodically find one that does something a little aggressive, but just because somebody does something aggressive in South Florida, where that's the only place they're doing business, it has no impact on us in California or Texas or Georgia or the other geographies. We see a muted response when you're seeing somebody deal with that in terms of what it does to the overall book of business. Where we are is we've got very attractive combined ratios right now. We're growing significantly faster than the overall marketplace.
We're in a time period where while now Infinity is part of the organization and has been part of the organization for a little over a year, the benefits of being part of the organization are starting to materialize. We've been able to make different rate filings, deploy different capabilities, operate with a wider set of error bars in terms of how the product managers are operating. The results of that are starting to bear fruit. As an example, when we closed the transaction in July of 2018, the Kemper business was growing in the low teens%. The Infinity business was basically flat. When you just average that, you get something in the mid-single digit range, which is about what we generated this past quarter.
What we're starting to see in the results that are coming out and will be more clearly visible to all of you as we report next quarter, is that Infinity business is now starting to see a higher growth rate as we're deploying those capabilities. You're going to see that growth overall go up inside of the organization. Not back into the teens range, but up from the 6% on a unit count basis. That's really demonstrating the strength that the organization has in the marketplace. A reasonable and thoughtful competitive environment, a stronger organization, and a stronger set of capabilities that we have, we're starting to see those come to the marketplace and bear fruit.
Do we have any questions from the audience on non-standard auto? Okay. Well, I'll dig a little bit more into specialty auto. Obviously you did get a benefit from Access going bankrupt. Have you started to see that tailwind moderate in terms of the growth that you've gotten from that? Then what pockets of, in terms of how you segment non-standard, are the most attractive for you to grow?
Two pieces of that. The Access issue was a 60-day phenomenon in early 2018.
Okay.
That moderated long before we closed the Infinity transaction. That was a liquidation. All the business came into the market. We saw it jump in. We wrote the business, then it took a little while to digest it. The claims activity and other items worked their way through. That's got no impact on our growth and hasn't for more than 12 months. When we think about growth opportunities, in any particular geography, there's always different cells or different types in the marketplace that are more attractive than others. It's almost impossible for me to describe it overall. I can generally describe maybe geographies. We had been growing in 2018 in California far greater than we were growing in the rest of the country.
We now, and we talked about it in our last quarterly earnings release, are growing outside of California more than we're growing in California. That is not because we've started to shrink California or we put the brakes on California. We're still at reasonable returns there, and we're still growing California, but we've increased the growth in other geographies. We think is an attractive opportunity for us. We're at reasonable returns. We think it actually becomes a very attractive investor opportunity because we have a size in California and a required capital to be that size. If we grew $200 million as an example, outside of California, we wouldn't need incremental capital in order to be able to generate that growth. It's actually a case where we could write the business at a combined ratio that's worse than we're writing our aggregate book today.
Because it didn't require excess capital or extra capital, any incremental return there adds to return but doesn't add to the E. The ROE goes up, the EPS goes up, and the combined ratio actually deteriorates. It's a spot where we're very thoughtfully recognizing that the best shareholder value answer there is to recognize that all growth dollars are not created equal in terms of the capital required, in terms of the impact on ROE and the impact on an EPS and growth in tangible book value. We're generating that growth in places that have a greater value to us because of our geographic diversification.
Mm-hmm. Okay, great. I'm sorry, are there any questions?
Just going to ask about just with regard to the non-standard auto business. Do you have a combined ratio target for that business? Have you in the past?
No, the way that we have described that and where we try to come at that, because we have several different businesses that we come at it from, is to think about it from a low double-digit perspective, which we've defined-
Low double-digit ROE.
ROE, yeah, perspective, which we've defined in that 10%-12% range. That's specific. You can kind of back into what you might expect then from a combined ratio, potentially from an industry average, you might think about it similar to Progressive, where you might see where they have a 96% or a 96%-98% would kind of get you to that same point. It's not one where you incrementally target and try to just drive at that. What you're trying to do is make sure that you've got a very compelling proposition for consumers that that makes a lot of sense, and that you've got the right capabilities and other things behind that to support it. In every one of those cases, then it becomes grow as fast as you can inside there where those opportunities exist.
That's kind of the framework, we think about that in terms of the totality of the business model that we have in terms of how we bring those things together to optimize around that.
What's important to remember when we're actually using it or dealing with it, I'd love to tell you that this is just plain and simple, but you said if we're running at a 93 combined now and we lower rates to get to a 96, that immediately translates to X amount of growth. In reality, what happens here is we've got product managers, they're in every geography, and they're looking at what's going on. We're taking comparative rater data. We're taking data and information we're picking up from our agency managers and their contact with agents to see where folks are in the market. If we're already in a leading position on a comparative rater, we don't actually need to lower the rate to generate more growth. If we're behind somebody else and we're out of position, then pricing action might be appropriate.
We've got other levers other than pure price that we can use to generate growth. We're using all of the tools of the appropriate items in a customer value proposition and how we're working billing plans and fee arrangements and pricing to optimize that growth and optimize the overall economic answer. We might say, if you did the math that Jim was suggesting and suggested or inferred that there was a target like a 96, what that is it doesn't mean we're trying to always drive to that. It means we're trying to hit or beat that and generate an optimal amount of growth in that spot, and we're looking at the trade. If we don't need to spend any more powder to generate the growth, we won't. If we would and it generates a better shareholder answer, we will.
I think we have a question back there.
Yeah. You mentioned there's a lot of small competitors in non-standard, I think my understanding is that Progressive's been in there in a big way for a long time. I'm not familiar with their kind of gets lost with all their other growth. Are they still kind of a majority market share and is that who you're often bumping into or how's that kind of changed over the last 10 or 15 years?
I can tell you my observations on them from an outside perspective. They grew up in non-standard auto. Did a great job at it. Were clearly far and away the market leader. Got to a certain size in that segment that they were not going to be able to generate the same growth in that space that they had long term. What it appears they did is they said, "Gosh, to continue to generate that growth, we've got to expand beyond non-standard into standard and preferred." They built a direct business. When you build a direct business and you're having all the acquisition cost up front, you try to drive your retention up so that you get the right return on that investment. To drive your retention up, you usually move out of non-standard into standard and preferred, and you move up market.
They've been spending time trying to build a homeowners product to increase the stickiness of those programs. They've got a great commercial auto business. They're trying to figure out how to get into small commercial. They're finding other markets that are very attractive to them, that do a great job of building shareholder value to them. When you move into those environments You've got one claim department, and most of us do. You can't, in a claim department, say, "Hey, before I give you service, can you tell me, were you a non-standard or a preferred customer? Because I'm going to treat you differently." Not a good market conduct item.
As you move into a different market segment where the customer value proposition is different and you're providing a different level of service and you might have less fraud and you might have an ability to move a different way. They're doing things that help them grow that standard and preferred environment. They make them less effective in the non-standard space. They're still smart. They could be effective if they wanted to. I think what it would do is it would start confusing their organization, and they'd move that direction, and they'd give up a lot of shareholder value creation somewhere else. They might see their retention drop, or they might see something else that hurts the direct business. They're in the space. They're just not as formidable as they once were. We're finding that we have an ability to be very price competitive with them.
We've got enough scale to be effective in our claims process in the geographies we're in. We're not spreading our specialty auto business, $3 billion spread across the entire U.S. We're in a smaller number of states, and we're in urban areas, and we're in a segment of the market. We play above our weight class in those geographies and bring enough scale and enough pricing advantage that we can be every bit as competitive. We're bringing the non-standard expertise in that. We're in that segment. We can be sharper and more effective and a very formidable competitor.
Great. Are there any other questions right now? All right, great. Kind of moving on to the preferred P&C segment. Kind of got lost in all the noise of last quarter, but pretty decent results in terms of the progress that you guys have in that turnaround. I guess just can you give us an update on where you're at with preferred P&C?
It continues to be a work in progress. Our primary focus there is enhancing the profitability of that business. It changes and improves at a slower pace than you can deal with within a specialty auto business. Partly because there's many more six-month policies in specialty auto. It's pretty much all 12-month policies in a preferred space. It's just slower to make the rate changes. It's slower for them to then move on to the entire book because you have to wait for the entire 12-month cycle for the policies to renew. It just takes a little bit longer to make improvement there. We've continued to focus on that. I think inside of our homeowners business, in the last couple of years, we've done a very nice job of reducing the earnings volatility that was there.
If you back up four years ago, the company was making about $100 million a year, and it seen a lot of cat volatility inside of that business. We as a profile, and pick whatever number you want now for our earnings number, I'm not trying to give you one, but it's more in line with a 400 than a 100. We've decreased the premium volume in that homeowners business. We've added a catastrophe aggregate policy. We've mitigated the real volatility of what you could see from an earnings perspective while improving its earnings and improving the earnings of the overall preferred business. I think it's making progress. It's still a work in progress, and we'll continue to get after it, but we're generally pleased with the direction it's headed.
Got it. When you're thinking about preferred auto and then the rate declines we're seeing at an aggregate level in California, Texas, Florida, how is that impacting the timing of the P&C turnaround from your perspective?
We're not chasing growth in that business. We're pushing to get to an appropriate set of returns there. If somebody else wants to be more aggressive, that'll put a little growth pressure on us in that business. I think that's the right trade for us. It's not causing us a problem in terms of our overall corporate growth and our ability to grow our top line for our overall business. It doesn't really concern us, and it's not going to distract us from the mission of strengthening the profit profile of that business.
Okay. Got it. If you're just thinking about the scale of that business, I mean, you obviously have scale in non-standard. Where do you look at yourselves in terms of the size of the personal auto and homeowners book and just the scale you have there versus non-standard?
It's a business that doesn't have the scale we need to have long term. One of the things we're going to do very consciously in it is focus on enhancing our homeowners capability and the sophistication in that marketplace, and the ability to be a real leader in that space. That will take us a little time to get there, and we're doing that sort of as a secondary effort underneath the profit enhancements that are going on, and believe that we can get there. At the same time, all the work we're doing in our specialty auto business of improving claim capability, pricing sophistication, other items, have a ripple effect that move into and help our preferred auto business. We operate one claim department. We recognize that we've got different limit profiles in these different groups.
We'll run similar processes and leverage those scale advantages, and we'll have specialized groups that might deal with higher BI limits or higher items. There's a similar process. We get some of the scale advantage we get in specialty auto to ripple over. It's not everything we need in that space, and will continue to be an issue we'll wrestle with over the next couple of years.
Got it. Would that be one you could potentially consider inorganic growth to add scale within that segment?
I think our issue on inorganic growth, Chris, is always a similar thought process. We start with the view that we should, in each of our businesses, build businesses that match our strategic thought process, finding an opportunity to serve customers in growing niche specialty opportunities. We should be building systematic, sustainable competitive advantages, where we can organically grow the business. We should be looking at inorganic opportunities that make us better, not just bigger. If an inorganic opportunity accelerates our ability to build an advantage, if it adds a capability we don't have, if it brings us into a business that fits in the portfolio of what we're doing, those are great things to consider. If it just adds volume or is just a financial trade, it probably isn't something we're going to think about.
We'll, in this business or any other business, we'll put that lens on what we're doing.
Okay. That applies like a non-standard too.
That applies in every business we're in.
I think what I would highlight there, Chris, is clearly when we look at that preferred auto and home, we're saying that the way that we think we can make a difference from a market perspective and win long-term in a systematic, sustainable way is by starting with the home, right? Being very thoughtful about what we're doing there. We have to have a certain amount of scale or other things over time in terms of where we would go, we're not saying that our game inside that business is to have a low-cost model that effectively creates more value. We'd rather have lower cost there than not, there are some pretty sizable competitors with the same. If you're doing things the same way out there, it's going to be harder to kind of catch up on that basis.
Not if we're different from a home or a product perspective, where we're bringing a unique element to the market that is underserved and that is maybe not as desired by others in terms of how we would approach it. When you're thinking about that from a non-standard or specialty auto perspective, we have both a product advantage there and we have a cost advantage on that front. Similar to where you think about our life, we've got a product and distribution capabilities as well as a cost advantage on those markets that, again, continue to make the potential success that we have systematic, sustainable, and where we can create outsized value for both consumers as well as our other stakeholders, our shareholders of the company.
Okay. Great. Now, we probably have a chance for one more question from the audience, if anyone would like to ask one more question.
Anything on buyback given what the market pulled strong in the last few months?
Yeah. Our view when we think about capital management in general, the question for folks on the webcast was views on buyback. We start with a view that we ought to be growing our business organically, and putting capital to work there. We then look to see is there an inorganic opportunity, and where it's not, we look to return capital to shareholders. We start with that framework. Anytime we think about a buyback, we're looking at what's the return on that transaction, and does it generate an appropriate return on capital. Given where the shares have traded in the last month, it does have us thinking about it differently, and the economics of that in our mind are different than they were 60 days ago.
Any other questions? Okay, great. Thank you all for joining us, and thank you, Joe and Jim for-
Thank you, Jim. Appreciate it.