<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the fiscal year ended December 31, 1998.
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from N/A to N/A.
Commission file number 333-02491*.
KEMPER INVESTORS LIFE INSURANCE COMPANY
(Exact name of registrant as specified in charter)
ILLINOIS
(State of Incorporation)
ONE KEMPER DRIVE
LONG GROVE, ILLINOIS
(Address of Principal Executive Offices)
36-3050975
(I.R.S. Employer
Identification Number)
60049
(Zip Code)
Registrant's telephone number, including area code: (847) 550-5500
Securities registered pursuant to Section 12(b) of the Act: none
Securities registered pursuant to Section 12(g) of the Act: none
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes X No ___ .
As of March 1, 1999, 250,000 shares of Common Stock (all held by an affiliate,
Kemper Corporation) were outstanding. There is no market value for any such
shares. See ITEM 5 of this Form 10-K.
* Pursuant to Rule 429 under the Securities Act of 1933, this Form 10-K also
relates to Commission file numbers 33-33547, 33-43462 and 33-46881.
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<PAGE> 2
PART I
ITEM 1. BUSINESS
CORPORATE STRUCTURE
KEMPER INVESTORS LIFE INSURANCE COMPANY ("KILICO"), founded in 1947, is
incorporated under the insurance laws of the State of Illinois. KILICO is
licensed in the District of Columbia and all states except New York. KILICO is a
wholly-owned subsidiary of Kemper Corporation ("Kemper"), a nonoperating holding
company.
CORPORATE CONTROL EVENTS
Effective January 4, 1996, Zurich Insurance Company ("Zurich"), Insurance
Partners, L.P. ("IP") and Insurance Partners Offshore (Bermuda), L.P. (together
with IP, "Insurance Partners") owned 80 percent and 20 percent, respectively, of
Kemper and therefore KILICO. On February 27, 1998, Zurich acquired Insurance
Partner's remaining 20 percent interest for cash. As a result of this
transaction, Kemper and KILICO became wholly-owned subsidiaries of Zurich.
Effective September 7, 1998, the businesses of Zurich merged with the financial
services business of B.A.T. Industries forming Zurich Financial Services
("ZFS"). ZFS is owned by Zurich Allied AG and Allied Zurich p.l.c., fifty-seven
percent and forty-three percent, respectively. Zurich Allied AG, representing
the financial interest of the former Zurich Group, is listed on the Swiss Market
Index, replacing Zurich. Allied Zurich p.l.c., representing the financial
interest of B.A.T. Industries, is included in the FTSE-100 Share Index in
London.
The acquisition of KILICO on January 4, 1996, was accounted for using the
purchase method of accounting. KILICO's consolidated financial statements prior
to January 4, 1996, were prepared on a historical cost basis and have been
labeled as "preacquisition" where appropriate in this Annual Report on Form
10-K. The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles.
KILICO originally began to amortize goodwill resulting from the acquisition on a
straight-line basis over twenty-five years. However, in the fourth quarter of
1997, KILICO changed its amortization period to twenty years. The change in
amortization periods was made to conform to Zurich's accounting practices and
policies. The change resulted in an increase in goodwill amortization of $5.1
million in 1997.
STRATEGIC INITIATIVES
KILICO's management, operations and strategic directions are integrated with
those of another Kemper subsidiary, Federal Kemper Life Assurance Company
("FKLA"). The integration streamlined management, controlled costs, improved
profitability, increased operating efficiencies and productivity, and helped to
expand both companies' distribution capabilities. Headquartered in Long Grove,
Illinois, FKLA markets term and interest-sensitive life insurance, as well as
certain annuity products through brokerage general agents and other independent
distributors.
Over the last several years, KILICO increased the competitiveness of its
variable annuity products by adding multiple variable subaccount investment
options and investment managers to existing variable annuity products. In 1996,
KILICO introduced a registered flexible individual variable life insurance
product. In 1997, KILICO introduced a non-registered individual and group
variable bank-owned life insurance contract ("BOLI") and a series of individual
variable life insurance contracts. In 1998, KILICO introduced a new registered
individual variable annuity product with 29 variable subaccount investment
options and various investment managers.
NARRATIVE DESCRIPTION OF BUSINESS
KILICO offers both individual fixed-rate (general account) and individual and
group variable (separate account) annuity contracts, as well as individual term
life, universal life and individual and group variable life insurance products
through various distribution channels. KILICO offers investment-oriented
products, guaranteed returns or a combination of both, to help policyholders
meet multiple insurance and financial objectives. Financial institutions,
securities brokerage firms, insurance agents and financial planners are
important distribution channels for KILICO's products. KILICO's sales mainly
consist of deposits received on certain long duration annuity and variable life
insurance contracts as well as reinsurance premiums assumed from FKLA beginning
in 1996.
KILICO's fixed and variable annuities generally have surrender charges that are
a specified percentage of policy values and decline as the policy ages. General
account annuity and interest-sensitive life policies are guaranteed to
accumulate at specified interest rates but allow for periodic crediting rate
changes.
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Over the last several years, in part reflecting the current interest rate
environment, KILICO has increased its emphasis on marketing its existing and new
separate account products. Unlike the fixed-rate annuity business where KILICO
manages spread revenue, such variable products pose minimal investment risk for
KILICO, as policyholders direct their premium to one or more subaccounts that
invest in underlying investment funds. KILICO, in turn, receives administrative
fee revenue on such variable products which compensates KILICO for providing
death benefits potentially in excess of cash surrender values. In addition, on
variable life insurance contracts, cost of insurance charges compensate KILICO
for providing death benefit coverage substantially in excess of surrender
values.
As a result of this strategy, KILICO's separate account assets and related sales
of its variable annuity and life products have increased as follows (in
millions):
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Separate account assets..................................... $7,099.2 $5,122.0 $2,127.2
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Variable annuity sales...................................... $ 300.4 $ 259.8 $ 254.6
Variable life sales......................................... 1,523.0 2,708.6 .2
-------- -------- --------
Total separate account sales.............................. $1,823.4 $2,968.4 $ 254.8
======== ======== ========
</TABLE>
In 1996, KILICO added several new subaccounts and new investment managers as
investment portfolio choices for certain purchasers of the Kemper Advantage III
variable annuity product. During mid-1998, KILICO introduced DESTINATIONS, a
registered individual variable annuity product. DESTINATIONS offers 29 variable
subaccount investment options with various investment managers, ten guarantee
period accounts and a fixed account, dollar cost averaging and a guaranteed
retirement income benefit option.
During late 1996, KILICO introduced POWER V, a registered flexible premium
variable life insurance product. During mid-1997, KILICO also introduced
variable BOLI, a group variable life insurance contract that is primarily
marketed to banks and other large corporate entities. Also in 1997, KILICO
issued a series of non-registered variable individual universal life insurance
contracts that are marketed primarily to high net worth individuals. Significant
fluctuations in KILICO's sales of the variable life products are due mainly to
the nature of the BOLI product -- high dollar volume per sale, low frequency of
sales -- and the uncertainty surrounding BOLI's tax advantaged status since the
release of the Clinton Administration's Fiscal Year 1998 Budget, continuing with
the release of the 1999 Budget.
Investors Brokerage Services, Inc., ("IBS") a wholly-owned subsidiary of KILICO,
is the principal underwriter and distributor of the variable annuity and
variable life products. Another Zurich affiliate is the principal underwriter
and distributor for the BOLI and high net worth products.
Current crediting rates, a conservative investment strategy and the interest
rate environment have impacted KILICO's general account annuity sales over the
last several years. KILICO's general account fixed annuity sales were as follows
(in millions):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
General account fixed annuity sales......................... $179.9 $145.7 $140.6
====== ====== ======
</TABLE>
Strong stock and bond markets during 1996 and most of 1997, which influenced
potential buyers of fixed annuity products to purchase variable annuity
products, caused sales of general account annuities to increase only slightly in
1997, compared with 1996. Sales of general account annuities increased in 1998,
compared with 1997, as certain investors opted for fixed crediting rates rather
than other investment alternatives available during a period of market
uncertainty, primarily in the second half of 1998.
During 1998 and 1997, KILICO assumed $21.6 million and $21.1 million,
respectively, of term life insurance premiums from FKLA. Excluding the amounts
assumed from FKLA, KILICO's total term life sales, including new and renewal
premiums, net of reinsurance ceded, amounted to $846 thousand in 1998, compared
with $1.1 million in 1997 and $565 thousand in 1996.
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FEDERAL INCOME TAX DEVELOPMENTS
In early 1999, the Clinton Administration's Fiscal Year 1999 Budget ("Budget")
was released and contained certain proposals to change the taxation of BOLI. It
is currently unknown whether or not such proposals will be accepted, amended or
omitted in the final 1999 Budget approved by Congress. If the current Budget
proposals are accepted, BOLI contracts may no longer be tax advantaged products
and therefore less attractive to those customers who purchase them in
recognition of their favorable tax attributes. Additionally, sales of these
products during 1999 may also be negatively impacted until the likelihood of the
current proposals being enacted into law has been determined.
YEAR 2000 COMPLIANCE
Many existing computer programs were originally designed without considering the
impact of the year 2000 and currently use only two digits to identify the year
in the date field. This issue affects nearly all companies and organizations and
could cause computer applications and systems to fail or create erroneous
results for any transaction with a date of January 1, 2000, or later.
Many companies must undertake major projects to address the year 2000 issue.
Each company's costs and uncertainties will depend on a number of factors,
including its software and hardware, and the nature of the industry. Companies
must also coordinate with other entities with which they electronically
interact, including suppliers, customers, creditors and other financial services
institutions.
If a company does not successfully address its year 2000 issues, it could face
material adverse consequences in the form of lawsuits against the company, lost
business, erroneous results and substantial operating problems after January 1,
2000.
KILICO has taken substantial steps over the last several years to ensure that
its systems will be compliant for the year 2000. Such steps have included the
replacement of older systems with new systems which are already compliant. In
1996, KILICO replaced its investment accounting system, and, in 1997, KILICO
replaced its general ledger and accounts payable system. KILICO has also ensured
that new systems developed to support new product introductions in 1997, 1998
and beyond are already year 2000 compliant. Data processing expenses related
solely to bringing KILICO's systems in compliance with the year 2000 amounted to
$1.3 million in 1998. KILICO anticipates that it will cost an additional $662
thousand to bring all remaining systems into compliance.
KILICO's policy administration systems have been completely renovated to be year
2000 compliant and are currently running in a test environment. Approximately 75
percent of KILICO's ancillary systems confirmed to be Year 2000 compliant were
in production at December 31, 1998. It is anticipated that all such systems will
be in production at April 30, 1999 or sooner. Testing procedures have confirmed
the performance, functionality, and integration of converted or replaced
platforms, applications, databases, utilities, and interfaces in an operational
environment. KILICO's testing and verification for year 2000 compliance has
encompassed the following:
- mainframe computing systems
- mainframe hardware and systems software
- PC/LAN computing systems
- PC/LAN hardware and systems software
- end-user computing systems
- interfaces to and from third parties, and
- other miscellaneous electronic non-information systems
KILICO has also taken steps requiring all other entities with which KILICO
electronically interacts, including suppliers and other financial services
institutions, to attest in writing to KILICO that their systems are year 2000
compliant.
If KILICO does not successfully address its year 2000 issues, it could face
material adverse consequences from lawsuits, lost business, erroneous results
and substantial operating problems after January 1, 2000. Although KILICO fully
expects to be year 2000 compliant by the close of 1999, KILICO is currently
developing contingency plans to handle the most reasonably likely worst case
scenarios. These contingency plans are scheduled for completion in the third
quarter of 1999.
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<PAGE> 5
NAIC RATIOS
The National Association of Insurance Commissioners (the "NAIC") annually
calculates certain statutory financial ratios for most insurance companies in
the United States. These calculations are known as the Insurance Regulatory
Information System ("IRIS") ratios. Currently, twelve IRIS ratios are
calculated. The primary purpose of the ratios is to provide an "early warning"
of any negative developments. The NAIC reports a company's ratios to state
regulators who may then contact the company if three or more ratios fall outside
the NAIC's "usual ranges".
Based on statutory financial data as of December 31, 1998, KILICO had two ratios
outside the usual ranges, the change in reserving ratio and the change in
premium ratio. KILICO's change in reserving ratio reflected the level of
interest-sensitive life surrenders and withdrawals during 1998, as well as the
effects of a reinsurance agreement with FKLA. KILICO's change in premium ratio
reflected the $1.2 billion decrease in BOLI premiums received during 1998,
compared with 1997. Other than certain states requesting quarterly financial
reporting and/or explanations of the underlying causes for certain ratios, no
state regulators have taken any action due to KILICO's IRIS ratios for 1998 or
earlier years.
RISK-BASED CAPITAL, ASSET ADEQUACY AND CODIFICATION
Under Illinois' asset adequacy and risk-based capital rules, state regulators
may mandate remedial action for inadequately reserved or inadequately
capitalized companies. The asset adequacy rules are designed to assure that
assets supporting reserves are adequate to cover liabilities under a variety of
economic scenarios. The focus of risk-based capital rules is a risk-based
formula that applies prescribed factors to various risk elements in an insurer's
business and investments to develop a minimum capital requirement designed to be
proportional to the amount of risk assumed by the insurer. KILICO has capital
levels substantially exceeding any that would mandate action under the
risk-based capital rules and is in compliance with applicable asset adequacy
rules.
In March 1998, the NAIC approved the codification of statutory accounting
principles. Codification is effective January 1, 2001; however, KILICO's
domiciliary state of Illinois has yet to adopt codification. In any event,
KILICO has not quantified the impact that codification will have on its
statutory financial position or results of operations.
RESERVES AND REINSURANCE
The following table provides a breakdown of KILICO's reserves for future policy
benefits by product type (in millions):
<TABLE>
<CAPTION>
DECEMBER 31 DECEMBER 31
1998 1997
----------- -----------
<S> <C> <C>
General account annuities................................... $2,864 $3,137
Interest-sensitive life insurance and other................. 688 709
Term life reserves.......................................... 9 10
Ceded future policy benefits................................ 345 383
------ ------
Total............................................. $3,906 $4,239
====== ======
</TABLE>
Ceded future policy benefits shown above reflect coinsurance (indemnity
reinsurance) transactions where KILICO insured liabilities of approximately $516
million in 1992 and $416 million in 1991 with our affiliate Fidelity Life
Association, A Mutual Legal Reserve Company ("FLA"). FLA shares directors,
management, operations and employees with FKLA pursuant to an administrative and
management services agreement. FLA produces policies not produced by FKLA or
KILICO as well as other policies similar to certain FKLA policies. At December
31, 1998 and 1997, KILICO's reinsurance reserve credit from FLA related to these
coinsurance transactions totaled approximately $344.8 million and $382.6
million, respectively. Utilizing FKLA's employees, KILICO is the servicing
company for this coinsured business and is reimbursed by FLA for the related
servicing expenses.
During December 1997, KILICO entered into a funds withheld reinsurance agreement
with a Zurich affiliated company, ZC Life Reinsurance Limited ("ZC Life"),
formerly EPICENTRE Reinsurance (Bermuda) Limited. Under the terms of this
agreement, KILICO ceded, on a yearly renewable term basis, ninety percent of the
net amount at risk (death benefit payable to the insured less the insured's
separate account cash surrender value) related to variable BOLI, which is held
in KILICO's separate accounts. During 1998, KILICO modified the reinsurance
agreement to increase the reinsurance from ninety percent to one hundred
percent. During 1998 and 1997, KILICO issued $6.9 billion (face amount) and
$59.3 billion (face amount), respectively, of new BOLI business and ceded $11.1
billion (face amount) and $51.5 billion (face amount), respectively, to ZC Life
under the terms of the treaty. During 1998 and 1997, KILICO also ceded $175.5
million and $24.3 million, respectively, of separate account fees (cost of
insurance charges) to ZC Life. KILICO has also withheld approximately $170.9
million and $23.4 million of the funds due to ZC Life under the terms of
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<PAGE> 6
the reinsurance agreement as a component of benefits and funds payable in the
accompanying consolidated balance sheets in ITEM 8 of this Annual Report on 10-K
as of December 31, 1998 and 1997, respectively.
KILICO has a large and growing funds withheld account ("FWA") supporting reserve
credits on reinsurance ceded on the BOLI product. Amendments to the reinsurance
contracts during 1998 changed the methodology used to determine increases to the
FWA. A substantial portion of the FWA is now marked-to-market based upon the
Total Return of the Governmental Bond Division of the KILICO Variable Series I
Separate Account. During 1998, KILICO recorded a $2.5 million increase to the
FWA related to this mark-to-market. In November 1998, to properly match revenue
and expenses, KILICO placed assets supporting the FWA in a segmented portion of
its General Account. This portfolio is classified as "trading" under Statement
of Financial Accounting Standards No. 115 ("FAS 115"). FAS 115 mandates that
assets held in a trading account be valued at fair value, with changes in fair
value flowing through the income statement as realized capital gains and losses.
During 1998, KILICO recorded a realized capital gain of $2.8 million upon
transfer of these assets from "available for sale" to the trading portfolio as
required by FAS 115. In addition, KILICO recorded realized capital losses of
$151 thousand related to the changes in fair value of this portfolio during
1998. The fair value of this portfolio was $101.8 million at December 31, 1998,
and the amortized cost was $99.1 million. KILICO periodically purchases assets
into this segmented portfolio to support changes in the FWA.
During 1996, KILICO assumed on a yearly renewable term basis approximately $14.4
billion (face amount) of term life insurance from FKLA. As a result of this
transaction, KILICO also recorded reserves in 1998 and 1997 of approximately
$8.5 million and $7.9 million, respectively.
COMPETITION
KILICO is in a highly competitive business. KILICO competes with a large number
of other stock and mutual life insurance companies, many of which are larger
financially, although none is truly dominant in the industry. KILICO, with its
emphasis on annuity products, also competes for savings dollars with securities
brokerage and investment advisory firms as well as other institutions that
manage assets, produce financial products or market other types of investment
products.
KILICO's principal methods of competition continue to be innovative products,
often designed for selected distribution channels and economic conditions, as
well as appropriate product pricing, careful underwriting, expense control and
the quality of services provided to policyholders and agents.
To address its competition, KILICO has adopted certain business strategies.
These include:
- systematic review of investment risk and its capital position
- continued focus on existing and new variable annuity and variable life
insurance products
- distribution through diversified channels, and
- ongoing efforts to continue as a low-cost provider of insurance products
and high-quality services to agents and policyholders through the use of
technology
RANKINGS AND RATINGS
According to BEST'S AGENTS GUIDE TO LIFE INSURANCE COMPANIES, 1998, as of
December 31, 1997, KILICO ranked 62nd of 1,262 life insurers by admitted assets;
53rd of 1,015 by insurance in force; and 31st of 1,189 by net premiums written.
In October 1997, Zurich announced a planned merger with B.A.T. Industries plc.
In connection with that merger, Zurich's and KILICO's claims-paying ability
ratings were placed on ratings watch with negative implications by certain
rating agencies. However, during 1998 the current ratings were affirmed by each
rating agency, primarily due to the perceived long-term strategic benefit of the
merger and the increased financial strength of Zurich. KILICO's current ratings
and their current status are as follows:
<TABLE>
<CAPTION>
CURRENT RATING CURRENT STATUS
--------------- --------------
<S> <C> <C>
A.M. Best Company........................................... A (Excellent) Affirmed
Moody's Investors Service................................... Aa3 (Excellent) Affirmed
Duff & Phelps Credit Rating Co.............................. AA (Very High) Affirmed
Standard & Poor's........................................... AA- (Excellent) Affirmed
</TABLE>
5
<PAGE> 7
EMPLOYEES
At December 31, 1998, KILICO used the services of approximately 861 employees of
FKLA, which are also shared with FLA and Zurich Life Insurance Company of
America ("ZLICA"). On January 5, 1996, KILICO, FKLA, FLA and ZLICA began to
operate under the trade name Zurich Kemper Life. On July 1, 1996, Kemper
acquired 100 percent of the issued and outstanding common stock of ZLICA from
Zurich.
REGULATION
KILICO is generally subject to regulation and supervision by the insurance
departments of Illinois and other jurisdictions where KILICO is licensed to do
business. These departments enforce laws and regulations designed to assure that
insurance companies maintain adequate capital and surplus, manage investments
according to prescribed character, standards and limitations and comply with a
variety of operational standards. The departments also make periodic
examinations of individual companies and review annual and other reports on the
financial condition of each company operating within their respective
jurisdictions. Regulations, which often vary from state to state, cover most
aspects of the life insurance business, including market practices, policy forms
and accounting and financial reporting procedures.
Insurance holding company laws enacted in many states grant additional powers to
state insurance commissioners to regulate acquisition of and by domestic
insurance companies, to require periodic disclosure of relevant information and
to regulate certain transactions with related companies. These laws also impose
prior approval requirements for certain transactions with affiliates and
generally regulate dividend distributions by an insurance subsidiary to its
holding company parent.
In addition, certain of KILICO's variable life insurance and annuity products,
and the related separate accounts, are subject to regulation by the Securities
and Exchange Commission (the "SEC").
KILICO believes it is in compliance in all material respects with all applicable
regulations. For information on regulatory and other dividend restrictions, see
ITEM 5(c).
INVESTMENTS
A changing marketplace has affected the life insurance industry. To accommodate
customers' increased preference for safety over higher yields, KILICO has
systematically reduced its investment risk and strengthened its capital
position.
KILICO's cash flow is carefully monitored and its investment program is
regularly and systematically planned to provide funds to meet all obligations
and to optimize investment return. For securities, portfolio management is
handled by an affiliated company, Scudder Kemper Investments, Inc. ("SKI") and
its subsidiaries and affiliates. KILICO's real estate-related investments are
handled by a majority-owned Kemper real estate subsidiary. Investment policy is
directed by KILICO's board of directors. KILICO's investment strategies take
into account the nature of each annuity and life insurance product, the
respective crediting rates and the estimated future policy benefit maturities.
FORWARD-LOOKING STATEMENTS
All statements, trend analyses and other information contained in this report
and elsewhere (such as in other filings by KILICO with the SEC, press releases,
presentations by KILICO or its management or oral statements) about markets for
KILICO's products and trends in KILICO's operations or financial results, as
well as other statements including words such as "anticipate," "believe,"
"plan," "estimate," "expect," "intend," and other similar expressions,
constitute forward-looking statements under the Private Securities Litigation
Reform Act of 1995. These forward-looking statements are subject to known and
unknown risks, uncertainties and other factors which may cause actual results to
be materially different from those contemplated by the forward-looking
statements. These factors include, among other things:
(i) general economic conditions and other factors, including prevailing
interest rate levels and stock market performance, which may affect the
ability of KILICO to sell its products, the market value of KILICO's
investments and the lapse rate and profitability of KILICO's contracts
(ii) KILICO's ability to achieve anticipated levels of operational efficiencies
through certain cost-saving initiatives
(iii) customer response to new products, distribution channels and marketing
initiatives
(iv) mortality, morbidity, and other factors which may affect the profitability
of KILICO's insurance products
(v) changes in the federal income tax laws and regulations which may affect the
relative tax advantages of some of KILICO's products
(vi) increasing competition which could affect the sale of KILICO's products
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<PAGE> 8
(vii) regulatory changes or actions, including those relating to regulation of
financial services affecting (among other things) bank sales and
underwriting of insurance products, regulations of the sale and
underwriting and pricing of insurance products, and
(viii) the risk factors or uncertainties listed from time to time in KILICO's
other filings with the SEC
ITEM 2. PROPERTIES
KILICO primarily shares 84,270 sq. ft. of office space leased by FKLA from
Lumbermens Mutual Casualty Company, a former affiliate, ("Lumbermens"), located
in Long Grove, Illinois. KILICO also shares 74,000 sq. ft. of office space
leased by FKLA and ZLICA from Zurich American Insurance Company, an affiliate,
located in Schaumburg, Illinois.
ITEM 3. LEGAL PROCEEDINGS
KILICO has been named as defendant in certain lawsuits incidental to its
insurance business. Based upon the advice of legal counsel, KILICO's management
believes that the resolution of these various lawsuits will not result in any
material adverse effect on KILICO's consolidated financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
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<PAGE> 9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
(a) There is no established public trading market for KILICO's common stock.
(b) Kemper owns all of the common stock of KILICO as of the date of this filing.
(c) KILICO declared no cash dividends on its common stock in 1996. Cash
dividends of $29.3 million were declared and paid to Kemper during 1997. Cash
dividends of $40.0 million and $55.0 million were declared and paid to Kemper on
October 31, 1998 and December 30, 1998, respectively. No additional dividends
have been declared or paid through the date of filing this Form 10-K.
RESTRICTIONS ON DIVIDENDS
Dividend distributions from KILICO to its stockholder are restricted by state
insurance laws. In Illinois, where KILICO is domiciled, if such dividend,
together with other distributions during the 12 preceding months would exceed
the greater of (a) ten percent of the insurer's statutory surplus as regards
policyholders as of the preceding December 31, or (b) the statutorily adjusted
net income for the preceding calendar year, then such proposed dividend must be
reported to the director of insurance at least 30 days prior to the proposed
payment date. The dividend then may be paid only if not disapproved. The
Illinois insurance laws also permit payment of dividends only out of earned
surplus, exclusive of most unrealized capital gains. The maximum amount of
dividends which can be paid by KILICO without prior approval in 1999 is $64.9
million.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial information for KILICO for the
five years ended December 31, 1998, and for the opening balance sheet as of the
acquisition date, January 4, 1996. Such information should be read in
conjunction with KILICO's consolidated financial statements and notes thereto
included in ITEM 8 of this Annual Report on Form 10-K. All amounts are shown in
millions.
<TABLE>
<CAPTION>
PREACQUISITION
----------------------
DECEMBER 31
DECEMBER 31 DECEMBER 31 DECEMBER 31 JANUARY 4 ----------------------
1998 1997 1996 1996(2) 1995 1994
----------- ----------- ----------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
TOTAL REVENUE................ $ 419.7 $ 425.5 $ 356.2 $ -- $ 68.1(1) $ 330.5
========= ========= ======== ======== ======== ========
NET INCOME EXCLUDING REALIZED
INVESTMENT RESULTS......... $ 31.4 $ 31.9 $ 25.6 $ -- $ 74.2 $ 61.9
========= ========= ======== ======== ======== ========
NET INCOME (LOSS)............ $ 65.1 $ 38.7 $ 34.4 $ -- $ (133.0)(1) $ 26.4
========= ========= ======== ======== ======== ========
FINANCIAL SUMMARY
Total separate account
assets..................... $ 7,099.2 $ 5,122.0 $2,127.2 $1,761.1 $1,761.1 $1,508.0
========= ========= ======== ======== ======== ========
Total assets................. $12,239.7 $10,589.7 $7,717.9 $7,682.7 $7,581.7 $7,537.1
========= ========= ======== ======== ======== ========
Future policy benefits....... $ 3,561.6 $ 3,856.9 $4,256.5 $4,585.1 $4,573.2 $4,843.7
========= ========= ======== ======== ======== ========
Stockholder's equity......... $ 853.9 $ 865.6 $ 751.0 $ 745.6 $ 605.9 $ 434.0
========= ========= ======== ======== ======== ========
</TABLE>
- ---------------
(1) Real estate-related investment losses adversely impacted total revenue and
net income (loss) for 1995. These losses reflect a change in KILICO's
strategy with respect to its real estate-related investments resulting from
the January 4, 1996 acquisition of Kemper by the Zurich-led investor group.
(2) The consolidated information presented as of the acquisition on January 4,
1996 is accounted for using the purchase method of accounting.
8
<PAGE> 10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As discussed in the note captioned "Summary of Significant Accounting Policies"
in the notes to the consolidated financial statements, Kemper, and therefore
KILICO, were acquired on January 4, 1996, by an investor group led by Zurich. In
connection with the acquisition, KILICO's assets and liabilities were marked to
their respective fair values as of the acquisition date in conformity with the
purchase accounting method required under generally accepted accounting
principles.
RESULTS OF OPERATIONS
KILICO recorded net income of $65.1 million in 1998, compared with net income of
$38.7 million in 1997 and $34.4 million in 1996. The increase in net income in
1998, compared with 1997, was due to a significant increase in net realized
capital gains and a decrease in goodwill amortization, offset by a slight
decline in operating earnings before amortization of goodwill.
The following table reflects the components of net income:
NET INCOME
(in millions)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Operating earnings before amortization of
goodwill................................... $ 44.1 $ 47.2 $ 35.8
Amortization of goodwill..................... (12.7) (15.3) (10.2)
Net realized investment gains................ 33.7 6.8 8.8
------ ------ ------
Net income......................... $ 65.1 $ 38.7 $ 34.4
====== ====== ======
</TABLE>
The following table reflects the major components of realized investment results
included in net income above.
REALIZED INVESTMENT RESULTS, AFTER TAX
(in millions)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Real estate-related gains.................... $ 26.9 $ 12.8 $ 11.4
Fixed maturity write-downs................... (2.0) (2.8) (.9)
Other gains (losses), net.................... 8.8 (3.2) (1.7)
------ ------ ------
Total.............................. $ 33.7 $ 6.8 $ 8.8
====== ====== ======
</TABLE>
The real estate-related gains over the last three years, reflect KILICO's
adoption of Zurich's strategy for disposition of real estate-related
investments. This strategy to reduce exposure to real estate-related
investments, as well as improving real estate market conditions in most areas of
the country, generated the increasing real estate-related gains during the last
three years. Fixed maturity write-downs in 1998 and 1997 primarily reflect
other-than-temporary declines in value of certain U.S. dollar denominated fixed
maturity investments which have significant exposure to countries in Southeast
Asia, as well as other U.S. dollar denominated securities that had
other-than-temporary declines in value in 1998. Other realized investment gains
and losses for 1998, 1997 and 1996 relate primarily to the sale of fixed
maturity investments, as well as gains from equity securities in 1998. The
losses generated in 1997 and 1996 arose primarily from the sale of fixed
maturity investments, consisting of lower yielding U.S. Treasury bonds,
collateralized mortgage obligations and corporate bonds, related to ongoing
repositionings of KILICO's fixed maturity investment portfolio. The proceeds
from the repositionings, together with cash and short-term investments, were
reinvested into higher yielding corporate bonds and asset-backed securities in
1997 and 1996.
Operating earnings before the amortization of goodwill decreased to $44.1
million in 1998, compared with $47.2 million in 1997. Operating earnings
decreased in 1998 before the amortization of goodwill, compared with 1997,
primarily due to:
- a decrease in separate account fees and charges
- an increase in commissions and operating expenses
- an increase in the amortization of insurance acquisition costs, offset by
9
<PAGE> 11
- a decrease in taxes, licenses and fees
- an increase in the deferral of insurance acquisition costs, and
- a decrease in the amortization of the value of business acquired
Operating earnings before the amortization of goodwill increased to $47.2
million in 1997, compared with $35.8 million in 1996, primarily due to:
- an increase in spread revenue (investment income earned less interest
credited)
- an increase in separate account fees and charges
- an increase in premium income
- an increase in the deferral of insurance acquisition costs, offset by
- an increase in claims incurred and other policyholder benefits
- an increase in taxes, licenses and fees, and
- an increase in commissions and operating expenses
Investment income and interest credited declined in 1998, compared with 1997 and
1996, as a result of a decrease in both total invested assets and liabilities
for future policy benefits to policyholders. Such decreases were the result of
surrender and withdrawal activity over the last three years. Investment income
also decreased in 1998, compared with 1997, due to reinvestment of 1998 fixed
maturity sales proceeds at lower yields than in 1997 and higher amortization of
bond premium. This amortization was due to an increase in certain collateralized
mortgage obligation prepayments due to the low interest rate environment in
1998.
Investment income was also reduced over the last three years reflecting purchase
accounting adjustments related to the amortization of premiums on fixed maturity
investments. Under purchase accounting, the fair value of KILICO's fixed
maturity investments as of January 4, 1996 became KILICO's new cost basis in the
investments. The difference between the new cost basis and original par is then
amortized against investment income over the remaining effective lives of the
fixed maturity investments. As a result of the interest rate environment as of
January 4, 1996, the market value of KILICO's fixed maturity investments was
approximately $133.9 million greater than original par. Premium amortization
decreased investment income by approximately $14.4 million in 1998, compared
with $15.3 million in 1997 and $22.7 million in 1996.
Investment income was also negatively impacted during 1996 by a higher level of
cash and short-term investments held in the first quarter of 1996. The increase
in cash and short-term investments in the first quarter of 1996 was caused in
part by the cash proceeds received from bulk sales of real estate-related
investments in late December 1995.
Investment income was negatively impacted by dividends paid to Kemper in 1998.
Investment income was positively impacted in 1997 and 1996 from the benefits of
capital contributions to KILICO and from the above-mentioned repositionings of
KILICO's investment portfolio.
The following table reflects KILICO's sales.
SALES
(in millions)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------
1998 1997 1996
-------- -------- ------
<S> <C> <C> <C>
Annuities:
General account..................................... $ 179.9 $ 145.7 $140.6
Separate account.................................... 300.4 259.8 254.6
-------- -------- ------
Total annuities.................................. 480.3 405.5 395.2
-------- -------- ------
Life Insurance:
Separate account bank-owned variable
universal life ("BOLI").......................... 1,501.0 2,700.0 --
Separate account variable universal life............ 22.0 8.6 .2
Term life........................................... 22.4 22.2 7.8
Interest-sensitive life............................. .2 -- .6
-------- -------- ------
Total life....................................... 1,545.6 2,730.8 8.6
-------- -------- ------
Total sales............................ $2,025.9 $3,136.3 $403.8
======== ======== ======
</TABLE>
10
<PAGE> 12
Sales of annuity products consist of total deposits received. General account
annuity sales increased in 1998, compared with 1997, as certain investors opted
for fixed crediting rates rather than other investment alternatives available
during a period of market uncertainty, primarily in the second half of 1998. The
slight increase in 1997 general account (fixed annuity) sales, compared with
1996, reflected the low interest rate environment and the strong equity market
during 1997.
The increase in separate account (variable sales) in 1998, compared with 1997
and 1996, was in part due to:
- the addition of new separate account investment fund options
- the addition of new investment fund managers
- a strong overall underlying stock and bond market, and
- a new variable annuity product introduced during 1998
Sales of variable annuities increase administrative fees earned. In addition,
they pose minimal investment risk for KILICO, as policyholders direct their
premium to one or more subaccounts that invest in underlying investment funds
which invest in stocks and bonds. KILICO believes that the increase in its
financial strength and performance ratings in January 1996, together with
KILICO's association with Zurich, will continue to assist in KILICO's future
sales efforts.
In 1997, KILICO introduced several non-registered variable universal life
insurance contracts, BOLI and a series of individual universal life insurance
contracts. Sales of these separate account variable products, like variable
annuities, pose minimal investment risk for KILICO as policyholders also direct
their premium to one or more subaccounts that invest in underlying investment
funds which invest in stocks and bonds. KILICO receives premium tax and DAC tax
expense loads from certain contract holders, as well as administrative fees and
cost of insurance charges. These fees and charges compensate KILICO for
providing life insurance coverage to the contractholders in excess of their cash
surrender values. Face amount of new variable universal life insurance business
issued amounted to $7.7 billion in 1998, compared with $59.6 billion in 1997.
The decrease in face amount issued in 1998, compared to 1997 is due to a
significant portion of renewal premiums in 1998 and higher funded policies
issued in 1998, compared to those issued in 1997.
In early 1999, the Clinton Administration's Fiscal Year 1999 Budget ("Budget")
was released and contained certain proposals to change the taxation of BOLI. It
is currently unknown whether or not such proposals will be accepted, amended or
omitted in the final 1999 Budget approved by Congress. If the current Budget
proposals are accepted, BOLI contracts may no longer be tax advantaged products
and therefore no longer attractive to those customers who purchase them because
of their favorable tax attributes. Sales of these products during 1999 may be
negatively impacted until the likelihood of the current proposals being enacted
into law has been determined.
In 1998 and 1997, KILICO assumed $21.6 million and $21.1 million, respectively,
of term life insurance premiums from FKLA. Excluding the amounts assumed from
FKLA, KILICO's total term life sales, including new and renewal premiums,
amounted to $846 thousand in 1998, compared with $1.1 million in 1997 and $565
thousand in 1996. The face amounts of new term business issued during 1998, 1997
and 1996 totaled approximately $276 million, $278 million and $187 million,
respectively.
Included in separate account fees and charges are administrative fees received
from KILICO's separate account products of $38.3 million in 1998, compared with
$31.0 million and $25.3 million in 1997 and 1996, respectively. Administrative
fee revenue increased in each of the last three years due to growth in average
separate account assets.
Also included in separate account fees and charges in 1998 and 1997 are cost of
insurance ("COI") charges related to variable universal life insurance,
primarily BOLI, of $167.6 million and $27.6 million, respectively. Of these COI
charges, $175.5 million and $24.3 million of such fees were ceded in 1998 and
1997, respectively, to a Zurich affiliated company, ZC Life Reinsurance Limited
("ZC Life"), formerly EPICENTER Reinsurance (Bermuda) Limited. In 1998, KILICO
ceded in excess of 100 percent of the COI charges received due to changes to the
reinsurance agreement with ZC Life. Separate account fees and charges in 1998
and 1997 also include BOLI-related premium tax expense loads of $29.1 million
and $51.1 million, respectively.
Other income includes surrender charge revenue of $4.0 million in 1998, compared
with $5.2 million and $5.4 million in 1997 and 1996, respectively. The decrease
in surrender charge revenue in 1998, compared with 1997, primarily reflects a
decrease in total general account and separate account policyholder surrenders
and withdrawals. The slight decrease in surrender charge revenue in 1997,
compared with 1996, reflects that 46 percent of KILICO's fixed and variable
annuity liabilities, excluding BOLI, at December 31, 1997 are subject to minimal
(5 percent or less) or no surrender charges,
11
<PAGE> 13
compared with 57 percent in 1996. This decrease in surrender charge revenue in
1997 was offset somewhat by an increase in total general account and separate
account policyholder surrenders and withdrawals.
POLICYHOLDER SURRENDERS, WITHDRAWALS AND DEATH BENEFITS
(in millions)
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
General account................................ $645.5 $703.1 $652.0
Separate account............................... 260.9 236.2 196.7
------ ------ ------
Total..................................... $906.4 $939.3 $848.7
====== ====== ======
</TABLE>
Reflecting the current interest rate environment and other competitive market
factors, KILICO adjusts its crediting rates on interest-sensitive products over
time in order to manage spread revenue and policyholder surrender and withdrawal
activity. KILICO can also improve spread revenue over time by increasing
investment income. The current interest rate environment during 1997 and 1998,
has mitigated at present, competitive pressures to increase existing renewal
crediting rates.
General account surrenders, withdrawals and death benefits decreased $57.6
million in 1998, compared with 1997. This decrease primarily reflects a decrease
in surrenders and withdrawals due to uncertainty with alternative investment
options because of market instability during the second half of 1998.
Taxes, licenses and fees decreased $22.3 million in 1998 to $30.3 million,
reflecting the decrease in premium taxes on BOLI. Excluding the taxes due on
BOLI, for which KILICO received a corresponding expense load in separate account
fees and other charges, taxes, licenses and fees amounted to $1.5 million,
compared with $1.5 million in 1997 and $2.2 million in 1996.
Commission expense was higher in 1998, compared with both 1997 and 1996, due to
an increase in total sales, excluding BOLI.
Operating expenses increased in 1998 and 1997, compared with 1996, as a result
of:
- restaffing after the completion of the acquisition and for new business
initiatives
- an increase in various outside consulting fees
- an increase in printing and stationary expenses for sales materials, and
- an increase in data processing expenses
Data processing expenses increased to $12.9 million in 1998, compared with $10.8
million in 1997 and $4.1 million in 1996, primarily due to:
- infrastructure improvements related to new product development
- new systems implemented and put into production
- system conversion projects
- development of a data warehouse, and
- costs related to bringing KILICO's systems in compliance with the year
2000
Data processing expenses related to bringing KILICO's systems in compliance with
the year 2000 amounted to $1.3 million in 1998. KILICO currently anticipates
that it will cost an additional $662 thousand to bring all remaining systems in
compliance.
Operating earnings were positively impacted by the deferral of insurance
acquisition costs in 1998, compared with 1997 and 1996. The deferral of
insurance acquisition costs increased in 1998, compared with both 1997 and 1996.
This reflects an increase in commissions expense and operating expenses related
directly to the increase in production of new business.
Operating earnings were negatively impacted by the amortization of insurance
acquisition costs in 1998 and 1997, compared with 1996, with the most dramatic
increase occurring in 1998. The increase in amortization of insurance
acquisition costs in 1998, compared with 1997, was primarily due to the increase
in production of new business in 1998, as well as increased profits in 1998.
These increases tend to accelerate amortization. Deferred insurance acquisition
costs, and their related amortization, for policies sold prior to January 4,
1996 have been replaced under purchase accounting by the value of business
acquired. The value of business acquired reflects the present value of the right
to
12
<PAGE> 14
receive future cash flows from insurance contracts existing at the date of
acquisition. The amortization of the value of business acquired is calculated
assuming an interest rate equal to the liability or contract rate on the value
of the business acquired. Deferred insurance acquisition costs are established
on all new policies sold after January 4, 1996.
The amortization of the value of business acquired decreased in 1998, compared
with 1997, as a result of:
- a significant increase in separate account assets, which increases
estimated future gross profits and shifts amortization to later years
- a decreasing block of business previously acquired, resulting in less
amortization as gross profits on this business decrease, offset by
- a significant increase in realized capital gains which tend to accelerate
the amortization of the value of business acquired as the gains tend to
decrease KILICO's projected future estimated gross profits
The difference between the cost of acquiring KILICO and the net fair value of
KILICO's assets and liabilities as of January 4, 1996 was recorded as goodwill.
During 1996, KILICO began to amortize goodwill on a straight-line basis over
twenty-five years. In December of 1997, KILICO changed its amortization period
to twenty years in order to conform to Zurich's accounting practices and
policies. As a result of the change in amortization periods, KILICO recorded an
increase in amortization expense of $5.1 million during 1997.
INVESTMENTS
KILICO's principal investment strategy is to maintain a balanced,
well-diversified portfolio supporting the insurance contracts written. KILICO
makes shifts in its investment portfolio depending on, among other factors:
- its evaluation of risk and return in various markets
- consistency with KILICO's business strategy and investment guidelines
approved by the board of directors
- the interest rate environment
- liability durations, and
- changes in market and business conditions
INVESTED ASSETS AND CASH
(in millions)
<TABLE>
<CAPTION>
DECEMBER 31 DECEMBER 31
1998 1997
--------------- ---------------
<S> <C> <C> <C> <C>
Cash and short-term investments............................. $ 72 1.7% $ 260 5.8%
Fixed maturities:
Investment-grade:
NAIC(1) Class 1........................................ 2,663 63.7 3,004 67.1
NAIC(1) Class 2........................................ 724 17.3 651 14.5
Below investment grade:
Performing............................................. 96 2.3 14 .3
Nonperforming.......................................... -- -- -- --
Trading account securities.................................. 102 2.4 -- --
Joint venture mortgage loans................................ 66 1.6 73 1.6
Third-party mortgage loans.................................. 76 1.8 103 2.3
Other real estate-related investments....................... 22 .5 44 1.0
Policy loans................................................ 271 6.5 282 6.3
Equity securities........................................... 67 1.6 25 .6
Other....................................................... 24 .6 21 .5
------ ----- ------ -----
Total(2).......................................... $4,183 100.0% $4,477 100.0%
====== ===== ====== =====
</TABLE>
- ---------------
(1) National Association of Insurance Commissioners ("NAIC").
-- Class 1 = A- and above
-- Class 2 = BBB- through BBB+
(2) See the note captioned "Financial Instruments--Off-Balance-Sheet Risk" in
the notes to the consolidated financial statements.
13
<PAGE> 15
FIXED MATURITIES
KILICO is carrying its fixed maturity investment portfolio, which it considers
available for sale, at estimated fair value. The aggregate unrealized
appreciation or depreciation is recorded as a component of accumulated other
comprehensive income, net of any applicable income tax expense. The aggregate
unrealized appreciation (depreciation) on fixed maturities at December 31, 1998
and 1997 was $61.3 million and $24.6 million, respectively. Fair values are
sensitive to movements in interest rates and other economic developments and can
be expected to fluctuate, at times significantly, from period to period.
At December 31, 1998, investment-grade fixed maturities and cash and short-term
investments accounted for 82.7 percent of KILICO's invested assets and cash,
compared with 87.4 percent at December 31, 1997. Approximately 53.4 percent of
KILICO's NAIC Class 1 bonds were rated AAA or equivalent at year-end 1998,
compared with 54.0 percent at December 31, 1997.
Approximately 28.0 percent of KILICO's investment-grade fixed maturities at
December 31, 1998 were mortgage-backed securities, down from 35.1 percent at
December 31, 1997, due to sales and paydowns during 1998. These investments
consist primarily of marketable mortgage pass-through securities issued by the
Government National Mortgage Association, the Federal National Mortgage
Association or the Federal Home Loan Mortgage Corporation and other
investment-grade securities collateralized by mortgage pass-through securities
issued by these entities. KILICO has not made any investments in interest-only
or other similarly volatile tranches of mortgage-backed securities. KILICO's
mortgage-backed investments are generally of AAA credit quality, and the markets
for these investments have been and are expected to remain liquid. KILICO plans
to continue to reduce its holding of such investments over time.
As a result of the previously discussed repositionings of KILICO's fixed
maturity portfolio, approximately 15.4 percent and 10.8 percent of KILICO's
investment-grade fixed maturities at December 31, 1998 and 1997, respectively,
consisted of corporate asset-backed securities. The majority of KILICO's
investments in asset-backed securities were backed by home equity loans (21.9%),
auto loans (8.2%), manufactured housing loans (14.8%), equipment loans (5.2%),
and commercial mortgage backed securities ("CMBs") (22.1%).
Future investment income from mortgage-backed securities and other asset-backed
securities may be affected by the timing of principal payments and the yields on
reinvestment alternatives available at the time of such payments. As a result of
purchase accounting adjustments to fixed maturities, most of KILICO's
mortgage-backed securities are carried at a premium over par. Prepayment
activity resulting from a decline in interest rates on such securities purchased
at a premium would accelerate the amortization of the premiums. Accelerated
amortization would result in reductions of investment income related to such
securities.
At December 31, 1998 and 1997 KILICO had unamortized premiums and discounts
related to mortgage-backed and asset-backed securities as follows (in millions):
<TABLE>
<CAPTION>
DECEMBER 31
-------------
1998 1997
----- -----
<S> <C> <C>
Unamortized premiums........................................ $15.8 $19.6
===== =====
Unamortized discounts....................................... $ 4.6 $ 5.2
===== =====
</TABLE>
Amortization of the discount or premium from mortgage-backed and asset-backed
securities is recognized using a level effective yield method. This method
considers the estimated timing and amount of prepayments of the underlying loans
and is adjusted to reflect differences between the prepayments originally
anticipated and the actual prepayments received and currently anticipated. To
the extent that the estimated lives of these securities change as a result of
changes in prepayment rates, the adjustment is also included in net investment
income.
14
<PAGE> 16
The table below provides information about KILICO's mortgage-backed and
asset-backed securities that are sensitive to changes in interest rates. The
expected maturity dates have been calculated on a security by security basis
using prepayment assumptions obtained from a survey conducted by a securities
information service. These assumptions are consistent with the current interest
rate and economic environment.
<TABLE>
<CAPTION>
CARRYING FAIR VALUE
VALUE AT EXPECTED MATURITY DATE AT
DECEMBER 31, ------------------------------------------------------ DECEMBER 31,
(IN MILLIONS) 1998 1999 2000 2001 2002 2003 THEREAFTER TOTAL 1998
------------- ------------ ---- ---- ---- ---- ---- ---------- ----- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed Maturities:
Mortgage-backed
bonds............. $ 946.7 $137.2 $ 85.7 $ 48.3 $47.7 $149.6 $478.2 $ 946.7 $ 946.7
Average yield..... 6.45% 6.46% 6.42% 6.43% 6.42% 6.42% 6.42% 6.45% 6.45%
Asset-backed bonds... $ 407.4 $ 17.9 $ 36.1 $ 49.8 $36.1 $ 31.9 $235.6 $ 407.4 $ 407.4
Average yield..... 6.67% 6.73% 6.75% 6.82% 6.90% 6.90% 6.95% 6.67% 6.67%
CMBs................. $ 115.5 $ 1.3 $ 1.2 $ 1.4 $ 1.5 $ 12.3 $ 97.8 $ 115.5 $ 115.5
Average yield..... 6.25% 6.28% 6.28% 6.28% 6.28% 6.28% 6.28% 6.25% 6.25%
-------- -------- --------
$1,469.6 $1,469.6 $1,469.6
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
CARRYING FAIR VALUE
VALUE AT EXPECTED MATURITY DATE AT
DECEMBER 31, ----------------------------------------------------- DECEMBER 31,
(IN MILLIONS) 1997 1998 1999 2000 2001 2002 THEREAFTER TOTAL 1997
------------- ------------ ---- ---- ---- ---- ---- ---------- ----- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed Maturities:
Mortgage-backed
bonds.............. $1,283.6 $219.1 $232.5 $145.1 $92.2 $64.5 $530.2 $1,283.6 $1,283.6
Average yield...... 6.58% 6.60% 6.61% 6.64% 6.64% 6.63% 6.67% 6.58% 6.58%
Asset-backed bonds.... $ 353.0 $ 18.9 $ 16.9 $ 30.8 $35.5 $47.2 $203.7 $ 353.0 $ 353.0
Average yield...... 6.81% 6.85% 7.04% 7.05% 7.15% 7.13% 7.20% 6.81% 6.81%
CMBs.................. $ 42.2 $ 0.3 $ 0.4 $ 0.4 $ 0.4 $ 8.0 $ 32.7 $ 42.2 $ 42.2
Average yield...... 6.64% 6.64% 6.64% 6.64% 6.64% 6.63% 6.63% 6.64% 6.64%
-------- -------- --------
$1,678.8 $1,678.8 $1,678.8
======== ======== ========
</TABLE>
The current weighted average maturity of the mortgage-backed and asset-backed
securities at December 31, 1998, is 4.0 years. A 200 basis point increase in
interest rates would extend the weighted average maturity by approximately .65
of a year, while a 200 basis point decrease in interest rates would decrease the
weighted average maturity by approximately 1.45 years.
The weighted average maturity of the mortgage-backed and asset-backed securities
at December 31, 1997, was 3.8 years. A 200 basis point increase in interest
rates would have extended the weighted average maturity by approximately 1.0
year, while a 200 basis point decrease in interest rates would have decreased
the weighted average maturity by approximately 1.3 years.
As of December 31, 1998, KILICO had $29.9 million of U.S. dollar denominated
fixed maturity investments, after write-downs for other-than-temporary declines
in value, which have significant exposure to countries in Southeast Asia.
Approximately $3.5 million of these securities were from Korea, $17.6 million
were from Hong Kong, China, $2.9 million were from South Korea and the remainder
were from a United Kingdom bank with most of its loans issued to countries in
Southeast Asia. Write-downs on these securities, which were considered to be
other-than-temporary, as of December 31, 1998 and 1997 amounted to $1.1 million
and $3.1 million, respectively. There can be no assurance that the current
estimate for other-than-temporary declines in value for such securities will
prove accurate over time due to changing economic conditions in Southeast Asia.
Below investment-grade securities holdings (NAIC classes 3 through 6),
representing securities of 40 issuers at December 31, 1998, totaled 2.3 percent
of cash and invested assets at December 31, 1998 and .3 percent at December 31,
1997. Below investment-grade securities are generally unsecured and often
subordinated to other creditors of the issuers. These issuers may have
relatively higher levels of indebtedness and be more sensitive to adverse
economic conditions than investment-grade issuers. KILICO's strategy of limiting
exposure to below investment-grade securities takes into account the more
conservative nature of today's consumer and the resulting demand for higher-
quality investments in the life insurance and annuity marketplace.
15
<PAGE> 17
REAL ESTATE-RELATED INVESTMENTS
The $164.4 million real estate-related portfolio held by KILICO, consists of
joint venture and third-party mortgage loans and other real estate-related
investments. The real estate-related portfolio constituted 3.9 percent of cash
and invested assets at December 31, 1998, compared with $220.0 million, or 4.9
percent, at December 31, 1997. The decrease in real estate-related investments
during 1998 was primarily due to asset sales and a net increase of $16.1 million
in real estate-related reserves during 1998.
As reflected in the "Real estate portfolio" table below, KILICO has continued to
fund both existing projects and legal commitments. The future legal commitments
were $64.4 million at December 31, 1998. This amount represented a net decrease
of $10.9 million since December 31, 1997, primarily due to sales in 1998. As of
December 31, 1998, KILICO expects to fund approximately $.2 million of these
legal commitments, along with providing capital to existing projects. The
disparity between total legal commitments and the amount expected to be funded
relates principally to standby financing arrangements that provide credit
enhancements to certain tax-exempt bonds. KILICO does not currently expect to
fund these commitments. The total legal commitments, along with estimated
working capital requirements, are considered in KILICO's evaluation of reserves
and write-downs.
Excluding the $1.2 million of net equity investments in joint ventures, KILICO's
real estate loans totaled $163.2 million at December 31, 1998, after reserves
and write-downs. Of this amount, $131.3 million are on accrual status with a
weighted average interest rate of approximately 8.79 percent. Of these accrual
loans:
- 17.0 percent have terms requiring current periodic payments of their full
contractual interest
- 46.1 percent require only partial payments or payments to the extent of
borrowers' cash flow, and
- 36.9 percent defer all interest to maturity
The equity investments in real estate at December 31, 1998 consisted of KILICO's
other equity investments in joint ventures. These equity investments include
KILICO's share of periodic operating results. KILICO, as an equity owner or
affiliate of an equity owner, has the ability to fund, and historically has
elected to fund, operating requirements of certain joint ventures.
REAL ESTATE PORTFOLIO
(in millions)
<TABLE>
<CAPTION>
OTHER REAL ESTATE-RELATED
MORTGAGE LOANS INVESTMENTS
---------------- ------------------------------------
JOINT THIRD- OTHER REAL ESTATE EQUITY
VENTURE PARTY LOANS(2) OWNED INVESTMENTS TOTAL
------- ------ -------- ----------- ----------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1997............................ $ 72.7 $103.0 $ 21.1 $ 4.0 $ 19.2 $220.0(1)
Additions (deductions):
Fundings................................................ 13.1 -- -- .2 -- 13.3
Interest added to principal............................. 6.3 2.8 -- -- -- 9.1
Sales/paydowns/distributions............................ (11.8) (30.1) (.3) (6.6) (27.0) (75.8)
Operating gain.......................................... -- -- -- -- .2 .2
Transfers............................................... -- -- -- (.7) -- (.7)
Net realized investments gains (losses)................. (3.0) 32.4 .4 3.1 8.5 41.4(4)
Other transactions, net................................. (11.5) (31.6) (.3) -- .3 (43.1)(4)
------ ------ ------ ----- ------ ------
Balance at December 31, 1998............................ $ 65.8 $ 76.5 $ 20.9 $ 0 $ 1.2 $164.4(3)
====== ====== ====== ===== ====== ======
</TABLE>
- ---------------
(1) Net of $9.2 million reserve and write-downs. Excludes $9.5 million of real
estate-related accrued interest.
(2) The other real estate loans were notes receivable evidencing financing,
primarily to joint ventures. These loans were issued by KILICO generally to
provide financing for Kemper's or KILICO's joint ventures for various
purposes.
(3) Net of $25.3 million reserve and write-downs. Excludes $8.7 million of real
estate-related accrued interest.
(4) Included in this amount is $37.0 million of contingent interest payments
related to a 1995 real estate sale. These payments were recorded as
realized investment gains and then deducted from other transactions because
they did not affect the carrying value.
REAL ESTATE CONCENTRATIONS AND OUTLOOK
KILICO's real estate portfolio is distributed by geographic location and
property type. However, KILICO has concentration exposures in certain states and
in certain types of properties. In addition to these exposures, KILICO also has
exposures to certain real estate developers and partnerships.
16
<PAGE> 18
As a result of KILICO's ongoing strategy to reduce its exposure to real
estate-related investments, as of December 31, 1998, KILICO had three remaining
properties which account for approximately 87.2 percent of KILICO's $164.4
million real estate-related portfolio.
The largest of these investments at December 31, 1998 amounted to $64.5 million
and consisted of second mortgages on nine hotel properties and two office
buildings. Patrick M. Nesbitt or his affiliates, a third-party real estate
developer, have ownership interests in these properties. These hotels and office
buildings are geographically dispersed and the current market values of the
underlying properties substantially exceed the balances due on KILICO's
mortgages. These loans are on accrual status.
KILICO's loans to a master limited partnership (the "MLP") between subsidiaries
of Kemper and subsidiaries of Lumbermens, amounted to $51.6 million at December
31, 1998. The MLP's underlying investment primarily consists of a water
development project located in California's Sacramento River Valley. This
project is currently in the final stages of a permit process with various
Federal and California State agencies which will determine the long-term
economic viability of the project. Loans to the MLP are on accrual status.
The remaining significant real estate-related investment amounted to $27.3
million at December 31, 1998 and consisted of various zoned and unzoned
residential and commercial lots located in Hawaii. Due to certain negative
zoning restriction developments in January 1997 and a continuing economic slump
in Hawaii, KILICO has placed these real estate-related investments on nonaccrual
status as of December 31, 1996. KILICO is currently pursuing the zoning of all
remaining unzoned properties, as well as pursuing steps to sell all remaining
zoned properties. However, due to the state of Hawaii's economy, which has
lagged behind the economic expansion of most of the rest of the United States,
KILICO anticipates that it could be several additional years until it completely
disposes of all investments in Hawaii.
KILICO evaluates its real estate-related investments (including accrued
interest) using an estimate of the investments observable market price, net of
estimated selling costs. Because KILICO's real estate review process includes
estimates involving changing economic conditions and other factors, there can be
no assurance that current estimates will prove accurate over time. KILICO's real
estate-related investments are expected to continue to decline further through
future sales. KILICO's net income could be materially reduced in future periods
if:
- real estate market conditions worsen in areas where KILICO's portfolio is
located
- Kemper's and KILICO's plans with respect to certain projects change, or
- necessary construction or zoning permits are not obtained
The following table is a summary of KILICO's troubled real estate-related
investments:
TROUBLED REAL ESTATE-RELATED INVESTMENTS
(BEFORE RESERVES AND WRITE-DOWNS, EXCEPT FOR REAL ESTATE OWNED)
(in millions)
<TABLE>
<CAPTION>
DECEMBER 31 DECEMBER 31
1998 1997
----------- -----------
<S> <C> <C>
Potential problem loans(1)........................... $-- $--
Past due loans(2).................................... -- --
Nonaccrual loans (primarily Hawaiian
properties)(3)..................................... 37.4 47.4
Real estate owned.................................... -- 4.0
----- -----
Total...................................... $37.4 $51.4
===== =====
</TABLE>
- ---------------
(1) These are real estate-related investments where KILICO, based on known
information, has serious doubts about the borrowers' abilities to comply
with present repayment terms and which KILICO anticipates may go into
nonaccrual, past due or restructured status.
(2) Interest more than 90 days past due but not on nonaccrual status.
(3) KILICO does not accrue interest on real estate-related investments when it
judges that the likelihood of interest collection is doubtful. Loans on
nonaccrual status after reserves and write-downs amounted to $31.8 million
and $41.8 million at December 31, 1998 and December 31, 1997, respectively.
NET INVESTMENT INCOME
KILICO's pre-tax net investment income totaled $273.5 million in 1998, compared
with $296.2 million in 1997 and $299.7 million in 1996. This includes KILICO's
share of the operating losses from equity investments in real estate consisting
of other income less depreciation, interest and other expenses. Such operating
results exclude interest
17
<PAGE> 19
expense on loans which are on nonaccrual status. As previously discussed,
KILICO's net investment income in 1998 and 1997, compared with 1996, has been
negatively impacted by purchase accounting adjustments.
KILICO's total foregone investment income before tax on both nonperforming fixed
maturity investments and nonaccrual real estate-related investments was as
follows:
FOREGONE INVESTMENT INCOME
(dollars in millions)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Fixed maturities...................................... $.3 $.5 $ .7
Real estate-related investments....................... 3.2 3.9 .5
---- ---- ----
Total.......................................... $3.5 $4.4 $1.2
==== ==== ====
Basis points.......................................... 8 10 3
==== ==== ====
</TABLE>
Foregone investment income from the nonaccrual of real estate-related
investments is net of KILICO's share of interest expense on these loans excluded
from KILICO's share of joint venture operating results. Any increase in
nonperforming securities, and either worsening or stagnant real estate
conditions, would increase the expected adverse effect on KILICO's future
investment income and realized investment results.
REALIZED INVESTMENT RESULTS
Net income reflects after-tax realized investment gains of $33.7 million, $6.8
million and $8.8 million in 1998, 1997 and 1996, respectively. Included in the
after-tax realized investment gains are trading account security gains of $1.7
million in 1998. As previously discussed, KILICO segregated a portion of its
General Account investment portfolio in 1998 into a "trading" account under
Statement of Financial Accounting Standards No. 115 ("FAS 115"). FAS 115
mandates that assets held in a trading account be valued at fair value, with
changes in fair value flowing through the income statement as realized capital
gains and losses.
Unrealized gains and losses on fixed maturity investments which are available
for sale are not reflected in KILICO's net income. These changes in unrealized
value are recorded as a component of accumulated other comprehensive income, net
of any applicable income taxes. If and to the extent a fixed maturity investment
suffers an other-than-temporary decline in value, however, the security is
written down to net realizable value, and the write-down adversely impacts net
income.
KILICO regularly monitors its investment portfolio and as part of this process
reviews its assets for possible impairments of carrying value. Because the
review process includes estimates involving changing economic conditions and
other factors, there can be no assurance that current estimates will prove
accurate over time.
A valuation allowance has been established to reduce the deferred tax asset for
investment losses to the amount that, based upon available evidence, is in
management's judgment more likely than not to be realized. The valuation
allowance is evaluated as of each balance sheet date.
INTEREST RATES
Interest rates remained relatively stable during 1996 and 1997, before declining
in 1998. The Federal Reserve Board lowered rates 3 times during the second half
of 1998, resulting in a steeper yield curve due to the lower short-term interest
rates.
When maturing or sold investments are reinvested at lower yields in a low
interest rate environment, KILICO can adjust its crediting rates on fixed
annuities and other interest-bearing liabilities. However, competitive
conditions and contractual commitments do not always permit the reduction in
crediting rates to fully or immediately reflect reductions in investment yield.
This can result in narrower spreads.
A rising interest rate environment can increase net investment income as well as
contribute to both realized and unrealized fixed maturity investment losses. A
declining interest rate environment can decrease net investment income as well
as contribute to both realized and unrealized fixed maturity investment gains.
Also, lower renewal crediting rates on annuities, compared with competitors'
higher new money crediting rates, have influenced certain annuity holders to
seek alternative products. KILICO mitigates this risk somewhat by charging
surrender fees, which decrease over time, when annuity holders withdraw funds
prior to maturity on certain annuity products. Approximately 46 percent of
KILICO's fixed and variable annuity liabilities as of December 31, 1998,
however, were no longer subject to significant surrender fees.
18
<PAGE> 20
LIQUIDITY AND CAPITAL RESOURCES
KILICO carefully monitors cash and short-term investments to maintain adequate
balances for timely payment of policyholder benefits, expenses, taxes and
policyholder's account balances. In addition, regulatory authorities establish
minimum liquidity and capital standards. The major ongoing sources of KILICO's
liquidity are deposits for fixed annuities, premium income, investment income,
separate account fees, other operating revenue and cash provided from maturing
or sold investments.
RATINGS
Ratings are an important factor in establishing the competitive position of life
insurance companies. Rating organizations continue to review the financial
performance and condition of life insurers and their investment portfolios,
including those of KILICO. Any reductions in KILICO's claims-paying ability or
financial strength ratings could result in its products being less attractive to
consumers. Any reductions in KILICO's parent's ratings could also adversely
impact KILICO's financial flexibility.
Ratings reductions for Kemper or its subsidiaries and other financial events can
also trigger obligations to fund certain real estate-related commitments to take
out other lenders. In such events, those lenders can be expected to renegotiate
their loan terms, although they are not contractually obligated to do so.
Each rating is subject to revision or withdrawal at any time by the assigning
organization and should be evaluated independently of any other rating.
STOCKHOLDER'S EQUITY
Stockholder's equity totaled $853.9 million at December 31, 1998, compared with
$865.6 million at December 31, 1997, and $751.0 million at December 31, 1996.
The 1998 decrease in stockholder's equity was primarily due to dividends of
$95.0 million paid to Kemper during 1998. This decrease was offset by 1998 net
income of $65.1 million and an increase of $20.3 million in accumulated other
comprehensive income. The increase in accumulated other comprehensive income was
primarily related to the change in unrealized appreciation related to KILICO's
fixed maturity investment portfolio due to falling interest rates during 1998.
The 1997 increase in stockholder's equity was primarily due to net income of
$38.7 million, a $45.0 million capital contribution and an increase in
accumulated other comprehensive income related to the change in unrealized
appreciation of $60.1 million related to KILICO's fixed maturity investment
portfolio. These increases were offset by a dividend of $29.2 million to Kemper.
EMERGING ISSUE
In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES. This statement is effective for fiscal years
beginning after June 15, 1999. Full implementation of SFAS No. 133 is expected
in December 1999. The impact of implementation is not expected to be material to
KILICO.
19
<PAGE> 21
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
PAGE(S)
-------
<S> <C>
Reports of Independent Public Accountants................... 20-21
Consolidated Balance Sheets, December 31, 1998 and 1997..... 22
Consolidated Statements of Operations, three years ended
December 31, 1998......................................... 23
Consolidated Statements of Comprehensive Income, three years
ended December 31, 1998................................... 24
Consolidated Statements of Stockholder's Equity, three years
ended December 31, 1998................................... 25
Consolidated Statements of Cash Flows, three years ended
December 31, 1998......................................... 26
Notes to Consolidated Financial Statements.................. 27-43
Financial Statement Schedules:
Reinsurance............................................... 51
Valuation and Qualifying Accounts......................... 52
</TABLE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholder of
Kemper Investors Life Insurance Company:
In our opinion, the accompanying consolidated balance sheets as of December 31,
1998 and 1997 and the related consolidated statements of operations,
comprehensive income, stockholder's equity and cash flows present fairly, in all
material respects, the financial position of Kemper Investors Life Insurance
Company and subsidiaries (the "Company") at December 31, 1998 and 1997, and the
results of their operations and their cash flows for the years then ended, in
conformity with generally accepted accounting principles. In addition, in our
opinion, the financial statement schedules listed in the accompanying index
present fairly, in all material respects, the information set forth therein when
read in conjunction with the related consolidated financial statements. These
financial statements and financial statement schedules are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedules based on our audits. We
conducted our audits of these statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above. The financial
statements of the Company for the period from January 4, 1996 to December 31,
1996 were audited by other independent accountants whose report, dated March 21,
1997, expressed an unqualified opinion on those statements.
PricewaterhouseCoopers LLP
Chicago, Illinois
March 12, 1999
20
<PAGE> 22
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholder
Kemper Investors Life Insurance Company:
We have audited the accompanying consolidated statements of operations,
comprehensive income, stockholder's equity, and cash flows of Kemper Investors
Life Insurance Company and subsidiaries for the period from January 4, 1996 to
December 31, 1996. In connection with our audit of the consolidated financial
statements, we also have audited the financial statement schedules as of
December 31, 1996 as listed in the accompanying index. These financial statement
schedules are incorporated by reference to a previously filed Form 10-K. These
consolidated financial statements and the financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and schedules based on our
audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the aforementioned consolidated financial statements present
fairly, in all material respects, the results of operations and the cash flows
of Kemper Investors Life Insurance Company and subsidiaries for the period from
January 4, 1996 to December 31, 1996, in conformity with generally accepted
accounting principles. Also, in our opinion, the aforementioned supplementary
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
KPMG LLP
Chicago, Illinois
March 21, 1997
21
<PAGE> 23
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31 DECEMBER 31
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Fixed maturities, available for sale, at fair value
(amortized cost: December 31, 1998, $3,421,535;
December 31, 1997, $3,644,075).............................. $3,482,820 $ 3,668,643
Trading account securities at fair value (amortized cost:
December 31, 1998, $99,095)............................... 101,781 --
Short-term investments...................................... 58,334 236,057
Joint venture mortgage loans................................ 65,806 72,663
Third-party mortgage loans.................................. 76,520 102,974
Other real estate-related investments....................... 22,049 44,409
Policy loans................................................ 271,540 282,439
Equity securities........................................... 66,854 24,839
Other invested assets....................................... 23,645 20,820
----------- -----------
Total investments................................. 4,169,349 4,452,844
Cash........................................................ 13,486 23,868
Accrued investment income................................... 124,213 117,789
Goodwill.................................................... 216,651 229,393
Value of business acquired.................................. 118,850 138,482
Deferred insurance acquisition costs........................ 91,543 59,459
Deferred income taxes....................................... 35,059 39,993
Reinsurance recoverable..................................... 344,837 382,609
Receivable on sales of securities........................... 3,500 20,076
Other assets and receivables................................ 23,029 3,187
Assets held in separate accounts............................ 7,099,204 5,121,950
----------- -----------
Total assets...................................... $12,239,721 $10,589,650
=========== ===========
LIABILITIES
Future policy benefits...................................... $3,906,391 $ 4,239,480
Benefits and funds payable.................................. 318,369 150,524
Other accounts payable and liabilities...................... 61,898 212,133
Liabilities related to separate accounts.................... 7,099,204 5,121,950
----------- -----------
Total liabilities................................. 11,385,862 9,724,087
----------- -----------
Commitments and contingent liabilities
STOCKHOLDER'S EQUITY
Capital stock--$10 par value,
authorized 300,000 shares; outstanding 250,000 shares..... 2,500 2,500
Additional paid-in capital.................................. 804,347 806,538
Accumulated other comprehensive income...................... 32,975 12,637
Retained earnings........................................... 14,037 43,888
----------- -----------
Total stockholder's equity........................ 853,859 865,563
----------- -----------
Total liabilities and stockholder's equity........ $12,239,721 $10,589,650
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE> 24
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------
1998 1997 1996
-------- -------- --------------
<S> <C> <C> <C>
REVENUE
Net investment income....................................... $273,512 $296,195 $299,688
Realized investment gains................................... 51,868 10,546 13,602
Premium income.............................................. 22,346 22,239 7,822
Separate account fees and charges........................... 61,982 85,413 25,309
Other income................................................ 10,031 11,087 9,786
-------- -------- --------
Total revenue..................................... 419,739 425,480 356,207
-------- -------- --------
BENEFITS AND EXPENSES
Interest credited to policyholders.......................... 176,906 199,782 223,094
Claims incurred and other policyholder benefits............. 28,029 28,372 14,255
Taxes, licenses and fees.................................... 30,292 52,608 2,173
Commissions................................................. 39,046 32,602 25,962
Operating expenses.......................................... 44,575 36,837 24,678
Deferral of insurance acquisition costs..................... (46,565) (38,177) (27,820)
Amortization of insurance acquisition costs................. 12,082 3,204 2,316
Amortization of value of business acquired.................. 17,677 24,948 21,530
Amortization of goodwill.................................... 12,744 15,295 10,195
-------- -------- --------
Total benefits and expenses....................... 314,786 355,471 296,383
-------- -------- --------
Income before income tax expense............................ 104,953 70,009 59,824
Income tax expense.......................................... 39,804 31,292 25,403
-------- -------- --------
Net income........................................ $ 65,149 $ 38,717 $ 34,421
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE> 25
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
NET INCOME.................................................. $ 65,149 $ 38,717 $ 34,421
-------- -------- --------
OTHER COMPREHENSIVE INCOME (LOSS), BEFORE TAX:
Unrealized holding gains (losses) on investments arising
during period:
Unrealized holdings gains (losses) on investments...... 25,372 60,802 (84,036)
Adjustment to value of business acquired............... (9,332) (28,562) 16,735
Adjustment to deferred insurance acquisition costs..... (2,862) (2,680) 1,307
-------- -------- --------
Total unrealized holding gains (losses) on
investments arising during period............... 13,178 29,560 (65,994)
-------- -------- --------
Less reclassification adjustments for items included in
net income:
Adjustment for (gains) losses included in realized
investment gains...................................... 6,794 (9,016) 3,963
Adjustment for amortization of premium on fixed
maturities included in net investment income.......... (17,064) (17,866) (26,036)
Adjustment for (gains) losses included in amortization
of value of business acquired......................... (7,378) (2,353) (4,212)
Adjustment for (gains) losses included in amortization
of insurance acquisition costs........................ (463) (355) --
-------- -------- --------
Total reclassification adjustments for items
included in net income.......................... (18,111) (29,590) (26,285)
-------- -------- --------
Other comprehensive income (loss), before related income tax
expense (benefit) 31,289 59,150 (39,709)
Related income tax expense (benefit)........................ 10,952 (985) 7,789
-------- -------- --------
Other comprehensive income (loss), net of tax..... 20,337 60,135 (47,498)
-------- -------- --------
Comprehensive income (loss)....................... $ 85,486 $ 98,852 $(13,077)
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE> 26
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(in thousands)
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
CAPITAL STOCK, beginning and end of period.................. $ 2,500 $ 2,500 $ 2,500
-------- -------- --------
ADDITIONAL PAID-IN CAPITAL, beginning of period............. 806,538 761,538 743,104
Capital contributions from parent........................... 4,261 45,000 18,434
Adjustment to prior period capital contribution from
parent.................................................... (6,452) -- --
-------- -------- --------
End of period..................................... 804,347 806,538 761,538
-------- -------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), beginning of
period.................................................... 12,637 (47,498) --
Other comprehensive income (loss), net of tax............... 20,338 60,135 (47,498)
-------- -------- --------
End of period..................................... 32,975 12,637 (47,498)
-------- -------- --------
RETAINED EARNINGS, beginning of period...................... 43,888 34,421 --
Net income.................................................. 65,149 38,717 34,421
Dividends to parent......................................... (95,000) (29,250) --
-------- -------- --------
End of period..................................... 14,037 43,888 34,421
-------- -------- --------
Total stockholder's equity........................ $853,859 $865,563 $750,961
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE> 27
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------------------
1998 1997 1996
----------- --------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................................ $ 65,149 $ 38,717 $ 34,421
Reconcilement of net income to net cash provided:
Realized investment gains.............................. (51,868) (10,546) (13,602)
Net change in trading account securities............... (6,727) -- --
Interest credited and other charges.................... 173,958 198,206 230,298
Deferred insurance acquisition costs................... (34,483) (34,973) (25,504)
Amortization of value of business acquired............. 17,677 24,948 21,530
Amortization of goodwill............................... 12,744 15,295 10,195
Amortization of discount and premium on investments.... 17,353 17,866 25,743
Deferred income taxes.................................. (12,469) (99,370) (897)
Net change in current federal income taxes............. (73,162) 97,386 108,806
Benefits and premium taxes due related to separate
account bank-owned life insurance.................... 123,884 180,546 --
Other, net............................................. (41,477) 17,168 (22,283)
----------- --------- -----------
Net cash provided from operating activities....... 190,579 445,243 368,707
----------- --------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash from investments sold or matured:
Fixed maturities held to maturity...................... 491,699 229,208 264,383
Fixed maturities sold prior to maturity................ 882,596 633,872 891,995
Equity securities...................................... 107,598 -- --
Mortgage loans, policy loans and other invested
assets............................................... 180,316 131,866 168,727
Cost of investments purchased or loans originated:
Fixed maturities....................................... (1,319,119) (606,028) (1,369,091)
Equity securities...................................... (83,303) -- --
Mortgage loans, policy loans and other invested
assets............................................... (66,331) (76,350) (119,044)
Short-term investments, net............................... 177,723 (164,361) 300,819
Net change in receivable and payable for securities
transactions........................................... (677) 29,746 (31,667)
Net change in other assets................................ -- 244 115
----------- --------- -----------
Net cash provided by investing activities......... 370,502 178,197 106,237
----------- --------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Policyholder account balances:
Deposits............................................... 180,124 145,687 141,159
Withdrawals............................................ (649,400) (745,510) (700,084)
Capital contributions from parent......................... 4,261 45,000 18,434
Dividends to parent....................................... (95,000) (29,250) --
Other..................................................... (11,448) (18,275) 42,512
----------- --------- -----------
Net cash used in financing activities............. (571,463) (602,348) (497,979)
----------- --------- -----------
Net increase (decrease) in cash.............. (10,382) 21,092 (23,035)
CASH, beginning of period................................... 23,868 2,776 25,811
----------- --------- -----------
CASH, end of period......................................... $ 13,486 $ 23,868 $ 2,776
=========== ========= ===========
</TABLE>
See accompanying notes to consolidated financial statements.
26
<PAGE> 28
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Kemper Investors Life Insurance Company and subsidiaries (the "Company") issues
fixed and variable annuity products, variable life, term life and
interest-sensitive life insurance products marketed primarily through a network
of financial institutions, securities brokerage firms, insurance agents and
financial planners. The Company is licensed in the District of Columbia and all
states except New York. The Company is a wholly-owned subsidiary of Kemper
Corporation ("Kemper"). Effective January 4, 1996, Zurich Insurance Company
("Zurich"), Insurance Partners, L.P. ("IP") and Insurance Partners Offshore
(Bermuda), L.P. (together with IP, "Insurance Partners") owned 80 percent and 20
percent, respectively, of Kemper and therefore the Company. On February 27,
1998, Zurich acquired Insurance Partner's remaining 20 percent interest for
cash. As a result of this transaction, Kemper and the Company became
wholly-owned subsidiaries of Zurich.
Effective September 7, 1998, the businesses of Zurich merged with the financial
services business of B.A.T. Industries forming Zurich Financial Services
("ZFS"). ZFS is owned by Zurich Allied AG and Allied Zurich p.l.c., fifty-seven
percent and forty-three percent, respectively. Zurich Allied AG, representing
the financial interest of the former Zurich Group, is listed on the Swiss Market
Index, replacing Zurich. Allied Zurich p.l.c., representing the financial
interest of B.A.T. Industries, is included in the FTSE-100 Share Index in
London.
The financial statements include the accounts of the Company on a consolidated
basis. All significant intercompany balances and transactions have been
eliminated. Certain reclassifications have been made to the 1997 and 1996
consolidated financial statements in order for them to conform to the 1998
presentation.
BASIS OF ACCOUNTING
The acquisition of the Company on January 4, 1996, was accounted for using the
purchase method of accounting. The consolidated financial statements of the
Company prior to January 4, 1996, were prepared on a historical cost basis in
accordance with generally accepted accounting principles. The accompanying
consolidated financial statements of the Company as of and for the years ended
December 31, 1996, 1997 and 1998, have been prepared in conformity with
generally accepted accounting principles.
ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
could affect the reported amounts of assets and liabilities as well as the
disclosure of contingent assets or liabilities at the date of the financial
statements. As a result, actual results reported as revenue and expenses could
differ from the estimates reported in the accompanying financial statements. As
further discussed in the accompanying notes to the consolidated financial
statements, significant estimates and assumptions affect deferred insurance
acquisition costs, the value of business acquired, provisions for real
estate-related losses and reserves, other-than-temporary declines in values for
fixed maturities, the valuation allowance for deferred income taxes and the
calculation of fair value disclosures for certain financial instruments.
GOODWILL
The Company reviews goodwill to determine if events or changes in circumstances
may have affected the recoverability of the outstanding goodwill as of each
reporting period. In the event that the Company determines that goodwill is not
recoverable, it would amortize such amounts as additional goodwill expense in
the accompanying financial statements. As of December 31, 1998, the Company
believes that no such adjustment is necessary.
The Company began to amortize goodwill during 1996 on a straight-line basis over
twenty-five years. In December of 1997, the Company changed its amortization
period to twenty years in order to conform to Zurich's accounting practices and
policies. As a result of the change in amortization periods, the Company
recorded an increase in goodwill amortization expense of $5.1 million during
1997.
VALUE OF BUSINESS ACQUIRED
The value of business acquired reflects the estimated fair value of the
Company's life insurance business in force and represents the portion of the
cost to acquire the Company that is allocated to the value of the right to
receive future cash
27
<PAGE> 29
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
flows from insurance contracts existing at the date of acquisition. Such value
is the present value of the actuarially determined projected cash flows for the
acquired policies.
The value of the business acquired is amortized over the estimated contract life
of the business acquired in relation to the present value of estimated gross
profits using current assumptions based on an interest rate equal to the
liability or contract rate on the value of business acquired. The estimated
amortization and accretion of interest for the value of business acquired for
each of the years through December 31, 2003 are as follows:
<TABLE>
<CAPTION>
PROJECTED
(IN THOUSANDS) BEGINNING ACCRETION OF ENDING
YEAR ENDED DECEMBER 31 BALANCE AMORTIZATION INTEREST BALANCE
- -------------------------------------------------------- --------- ------------ ------------ ---------
<S> <C> <C> <C> <C>
1996 (actual)........................................... $190,222 $(31,427) $9,897 $168,692
1997 (actual)........................................... 168,692 (34,906) 9,958 143,744
1998 (actual)........................................... 143,744 (26,807) 9,129 126,066
1999.................................................... 126,066 (24,926) 7,741 108,881
2000.................................................... 108,881 (22,649) 6,619 92,851
2001.................................................... 92,851 (20,736) 5,577 77,692
2002.................................................... 77,692 (17,096) 4,695 65,291
2003.................................................... 65,291 (15,504) 3,948 53,735
</TABLE>
The projected ending balance of the value of business acquired will be further
adjusted to reflect the impact of unrealized gains or losses on fixed maturities
held as available for sale in the investment portfolio. Such adjustments are not
recorded in the Company's net income but rather are recorded as a credit or
charge to accumulated other comprehensive income, net of income tax. As of
December 31, 1998 and 1997, this adjustment decreased the value of business
acquired by $7.2 million and $5.3 million, respectively, and accumulated other
comprehensive income by approximately $4.7 million and $3.4 million,
respectively.
LIFE INSURANCE REVENUE AND EXPENSES
Revenue for annuities, variable life insurance and interest-sensitive life
insurance products consists of investment income, and policy charges such as
mortality, expense and surrender charges and expense loads for premium taxes on
certain contracts. Expenses consist of benefits and interest credited to
contracts, policy maintenance costs and amortization of deferred insurance
acquisition costs.
Premiums for term life policies are reported as earned when due. Profits for
such policies are recognized over the duration of the insurance policies by
matching benefits and expenses to premium income.
DEFERRED INSURANCE ACQUISITION COSTS
The costs of acquiring new business, principally commission expense and certain
policy issuance and underwriting expenses, have been deferred to the extent they
are recoverable from estimated future gross profits on the related contracts and
policies. The deferred insurance acquisition costs for annuities, separate
account business and interest-sensitive life insurance products are being
amortized over the estimated contract life in relation to the present value of
estimated gross profits. Deferred insurance acquisition costs related to such
interest-sensitive products also reflect the estimated impact of unrealized
gains or losses on fixed maturities held as available for sale in the investment
portfolio, through a credit or charge to accumulated other comprehensive income,
net of income tax. The deferred insurance acquisition costs for term-life
insurance products are being amortized over the premium paying period of the
policies.
FUTURE POLICY BENEFITS
Liabilities for future policy benefits related to annuities and
interest-sensitive life contracts reflect net premiums received plus interest
credited during the contract accumulation period and the present value of future
payments for contracts that have annuitized. Current interest rates credited
during the contract accumulation period range from 3.0 percent to 7.5 percent.
Future minimum guaranteed interest rates vary from 3.0 percent to 4.0 percent.
For contracts that have
28
<PAGE> 30
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
annuitized, interest rates used in determining the present value of future
payments range principally from 2.5 percent to 12.0 percent.
Liabilities for future term life policy benefits have been computed principally
by a net level premium method. Anticipated rates of mortality are based on the
1975-1980 Select and Ultimate Table modified by Company experience, including
withdrawals. Estimated future investment yields are a level 6.8 percent.
GUARANTY FUND ASSESSMENTS
The Company is liable for guaranty fund assessments related to certain
unaffiliated insurance companies that have become insolvent during the years
1998 and prior. The Company's financial statements include provisions for all
known assessments that are expected to be levied against the Company as well as
an estimate of amounts (net of estimated future premium tax recoveries) that the
Company believes it will be assessed in the future for which the life insurance
industry has estimated the cost to cover losses to policyholders.
INVESTED ASSETS AND RELATED INCOME
Investments in fixed maturities and equity securities are carried at fair value.
Short-term investments are carried at cost, which approximates fair value.
The amortized cost of fixed maturities is adjusted for amortization of premiums
and accretion of discounts to maturity, or in the case of mortgage-backed and
asset-backed securities, over the estimated life of the security. Such
amortization is included in net investment income. Amortization of the discount
or premium from mortgage-backed and asset-backed securities is recognized using
a level effective yield method which considers the estimated timing and amount
of prepayments of the underlying loans and is adjusted to reflect differences
which arise between the prepayments originally anticipated and the actual
prepayments received and currently anticipated. To the extent that the estimated
lives of such securities change as a result of changes in prepayment rates, the
adjustment is also included in net investment income. The Company does not
accrue interest income on fixed maturities deemed to be impaired on an
other-than-temporary basis, or on mortgage loans and other real estate loans
where the likelihood of collection of interest is doubtful.
Mortgage loans are carried at their unpaid balance, net of unamortized discount
and any applicable reserves or write-downs. Other real estate-related
investments, net of any applicable reserves and write-downs, include: (1) notes
receivable from real estate ventures; (2) investments in real estate ventures,
adjusted for the equity in the operating income or loss of such ventures, and
(3) real estate owned at December 31, 1997, carried at fair value. Real estate
reserves are established when declines in collateral values, estimated in light
of current economic conditions, indicate a likelihood of loss.
Investments in policy loans and other invested assets, consisting primarily of
venture capital investments and a leveraged lease, are carried primarily at
cost.
Realized gains or losses on sales of investments, determined on the basis of
identifiable cost on the disposition of the respective investment, recognition
of other-than-temporary declines in value and changes in real estate-related
reserves and write-downs are included in revenue. Net unrealized gains or losses
on revaluation of investments are credited or charged to accumulated other
comprehensive income. Such unrealized gains are recorded net of deferred income
tax expense, while unrealized losses are not tax benefitted.
SEPARATE ACCOUNT BUSINESS
The assets and liabilities of the separate accounts represent segregated funds
administered and invested by the Company for purposes of funding variable
annuity and variable life insurance contracts for the exclusive benefit of
variable annuity and variable life insurance contract holders. The Company
receives administrative fees from the separate account and retains varying
amounts of withdrawal charges to cover expenses in the event of early
withdrawals by contract holders. The assets and liabilities of the separate
accounts are carried at fair value.
29
<PAGE> 31
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAX
For the period January 1 through January 4, 1996, the Company's federal income
tax return was consolidated with Kemper and Kemper's other wholly-owned life
insurance subsidiary, Federal Kemper Life Assurance Company ("FKLA"). The Boards
of Directors of Kemper, KILICO and FKLA, adopted a written plan that provided
that federal income taxes would be paid to or recovered from Kemper on the basis
of each company's taxable income or loss as shown on its respective federal
income tax return. In the event of a federal income tax credit which is greater
than the amount recoverable from the other life insurance company or from the
Internal Revenue Service, the funds available would be apportioned among the
life companies entitled to a recovery on the basis of the relationship of each
company's tax credit to the total of all of the life insurance companies in a
deficit position. For the period January 5 through December 31, 1996, and
subsequent years, the Company has filed a separate federal income tax return.
Deferred taxes are provided on the temporary differences between the tax and
financial statement basis of assets and liabilities.
(2) CASH FLOW INFORMATION
The Company defines cash as cash in banks and money market accounts. The Company
paid federal income taxes of $126.0 million, $29.0 million and $28.1 million
directly to the United States Treasury Department during 1998, 1997 and 1996
respectively.
(3) INVESTED ASSETS AND RELATED INCOME
The Company is carrying its fixed maturity investment portfolio at estimated
fair value as fixed maturities are considered available for sale. The carrying
value of fixed maturities compared with amortized cost, adjusted for other-than-
temporary declines in value, were as follows:
<TABLE>
<CAPTION>
ESTIMATED UNREALIZED
CARRYING AMORTIZED --------------------
VALUE COST GAINS LOSSES
(in thousands) -------- --------- ----- ------
<S> <C> <C> <C> <C>
DECEMBER 31, 1998
U.S. treasury securities and obligations of U.S. government
agencies and authorities.................................. $ 7,951 $ 7,879 $ 81 $ (9)
Obligations of states and political subdivisions, special
revenue and nonguaranteed................................. 27,039 26,768 362 (91)
Debt securities issued by foreign governments............... 69,357 67,239 2,266 (148)
Corporate securities........................................ 1,908,850 1,866,372 46,664 (4,186)
Mortgage and asset-backed securities........................ 1,469,623 1,453,277 19,063 (2,717)
---------- ---------- ------- --------
Total fixed maturities............................... $3,482,820 $3,421,535 $68,436 $ (7,151)
========== ========== ======= ========
DECEMBER 31, 1997
U.S. treasury securities and obligations of U.S. government
agencies and authorities.................................. $ 6,258 $ 6,298 $ 4 $ (44)
Obligations of states and political subdivisions, special
revenue and nonguaranteed................................. 29,330 29,308 160 (138)
Debt securities issued by foreign governments............... 92,563 92,722 188 (347)
Corporate securities........................................ 1,861,655 1,846,588 24,733 (9,666)
Mortgage and asset-backed securities........................ 1,678,837 1,669,159 10,035 (357)
---------- ---------- ------- --------
Total fixed maturities............................... $3,668,643 $3,644,075 $35,120 $(10,552)
========== ========== ======= ========
</TABLE>
The carrying value and amortized cost of fixed maturity investments, by
contractual maturity at December 31, 1998, are shown below. Actual maturities
will differ from contractual maturities because borrowers may have the right to
call or
30
<PAGE> 32
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED)
prepay obligations with or without call or prepayment penalties and because
mortgage-backed and asset-backed securities provide for periodic payments
throughout their life.
<TABLE>
<CAPTION>
CARRYING AMORTIZED
VALUE COST
(in thousands) -------- ---------
<S> <C> <C>
One year or less............................................ $ 44,816 $ 44,745
Over one year through five years............................ 814,646 802,147
Over five years through ten years........................... 891,767 866,613
Over ten years.............................................. 261,968 254,753
Securities not due at a single maturity date, primarily
mortgage and asset-backed securities(1)................... 1,469,623 1,453,277
---------- ----------
Total fixed maturities............................... $3,482,820 $3,421,535
========== ==========
</TABLE>
- ---------------
(1) Weighted average maturity of 4.0 years.
Proceeds from sales of investments in fixed maturities prior to maturity were
$882.6 million, $633.9 million and $892.0 million during 1998, 1997 and 1996,
respectively. Gross gains of $10.1 million, $3.1 million and $9.9 million and
gross losses of $8.0 million, $13.7 million and $16.2 million were realized on
sales and write-downs of fixed maturities in 1998, 1997 and 1996, respectively.
At December 31, 1998, the Company had 12 separate asset-backed securities
included in fixed maturity investments from trusts formed to collateralize
assets underwritten by Green Tree Financial Corporation, which in aggregate
amounted to $97.7 million. No other individual investments exceeded ten percent
of stockholder's equity at December 31, 1998.
At December 31, 1998, securities carried at approximately $6.4 million were on
deposit with governmental agencies as required by law.
Upon default or indication of potential default by an issuer of fixed maturity
securities, the issue(s) of such issuer would be placed on nonaccrual status
and, since declines in fair value would no longer be considered by the Company
to be temporary, would be analyzed for possible write-down. Any such issue would
be written down to its net realizable value during the fiscal quarter in which
the impairment was determined to have become other than temporary. Thereafter,
each issue on nonaccrual status is regularly reviewed, and additional
write-downs may be taken in light of later developments.
The Company's computation of net realizable value involves judgments and
estimates, so such value should be used with care. Such value determination
considers such factors as the existence and value of any collateral security;
the capital structure of the issuer; the level of actual and expected market
interest rates; where the issue ranks in comparison with other debt of the
issuer; the economic and competitive environment of the issuer and its business;
the Company's view on the likelihood of success of any proposed issuer
restructuring plan; and the timing, type and amount of any restructured
securities that the Company anticipates it will receive.
The Company's $164.4 million real estate portfolio at December 31, 1998 consists
of joint venture and third-party mortgage loans and other real estate-related
investments. At December 31, 1998 and 1997, total impaired real estate-related
loans were as follows:
<TABLE>
<CAPTION>
DECEMBER 31 DECEMBER 31
1998 1997
(in millions) ----------- -----------
<S> <C> <C>
Impaired loans without reserves--gross...................... $83.9 $39.3
Impaired loans with reserves--gross......................... 21.5 2.2
----- -----
Total gross impaired loans........................... 105.4 41.5
Reserves related to impaired loans.......................... (18.5) (2.1)
----- -----
Net impaired loans................................... $86.9 $39.4
===== =====
</TABLE>
Impaired loans without reserves include loans in which the deficit in equity
investments in real estate-related investments is considered in determining
reserves and write-downs. The Company had an average balance of
31
<PAGE> 33
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED)
$54.6 million and $45.2 million in impaired loans for 1998 and 1997,
respectively. Cash payments received on impaired loans are generally applied to
reduce the outstanding loan balance.
At December 31, 1998 and 1997, loans on nonaccrual status, before reserves and
write-downs, amounted to $37.4 million and $47.4 million, respectively. The
Company's nonaccrual loans are generally included in impaired loans.
The sources of net investment income were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
(in thousands) -------- -------- --------
<S> <C> <C> <C>
Interest and dividends on fixed maturities.................. $232,707 $250,170 $250,683
Dividends on equity securities.............................. 2,143 2,123 646
Income from short-term investments.......................... 5,391 4,128 9,130
Income from mortgage loans.................................. 14,964 16,283 20,257
Income from policy loans.................................... 21,096 20,549 20,700
Income from other real estate-related investments........... 352 6,631 4,917
Income from other loans and investments..................... 2,223 2,045 2,480
-------- -------- --------
Total investment income.............................. 278,876 301,929 308,813
Investment expense.......................................... (5,364) (5,734) (9,125)
-------- -------- --------
Net investment income................................ $273,512 $296,195 $299,688
======== ======== ========
</TABLE>
Net realized investment gains (losses) for the years ended December 31, 1998,
1997 and 1996, were as follows:
<TABLE>
<CAPTION>
REALIZED GAINS (LOSSES)
-------------------------------------
1998 1997 1996
(in thousands) -------- -------- -------
<S> <C> <C> <C>
Real estate-related......................................... $ 41,362 $ 19,758 $17,462
Fixed maturities............................................ 2,158 (10,656) (6,344)
Trading account securities--gross gains on transfer......... 3,254 -- --
Trading account securities--gross losses on transfer........ (417) -- --
Trading account securities--holding losses.................. (151) -- --
Equity securities........................................... 5,496 914 --
Other....................................................... 166 530 2,484
-------- -------- -------
Realized investment gains before income tax expense....... 51,868 10,546 13,602
Income tax expense.......................................... (18,154) (3,691) (4,761)
-------- -------- -------
Net realized investment gains............................. $ 33,714 $ 6,855 $ 8,841
======== ======== =======
</TABLE>
Unrealized gains (losses) are computed below as follows: fixed maturities--the
difference between fair value and amortized cost, adjusted for
other-than-temporary declines in value; equity and other securities--the
difference between fair value and cost. The change in net unrealized investment
gains (losses) by class of investment for the years ended December 31, 1998,
1997 and 1996 were as follows:
<TABLE>
<CAPTION>
CHANGE IN UNREALIZED GAINS (LOSSES)
-----------------------------------------
DECEMBER 31 DECEMBER 31 DECEMBER 31
1998 1997 1996
(in thousands) ------------ ------------ -----------
<S> <C> <C> <C>
Fixed maturities............................................ $ 36,717 $ 87,787 $(63,219)
Equity and other securities................................. (1,074) (103) 1,256
Adjustment to deferred insurance acquisition costs.......... (2,399) (2,325) 1,307
Adjustment to value of business acquired.................... (1,954) (26,209) 20,947
-------- -------- --------
Unrealized gain (loss) before income tax expense
(benefit).............................................. 31,290 59,150 (39,709)
Income tax expense (benefit)................................ 10,952 (985) 7,789
-------- -------- --------
Net unrealized gain (loss) on investments............ $ 20,338 $ 60,135 $(47,498)
======== ======== ========
</TABLE>
32
<PAGE> 34
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) UNCONSOLIDATED INVESTEES
At December 31, 1998 and 1997 the Company, along with other Kemper subsidiaries,
directly held partnership interests in a number of real estate joint ventures.
The Company's direct and indirect real estate joint venture investments are
accounted for utilizing the equity method, with the Company recording its share
of the operating results of the respective partnerships. The Company, as an
equity owner, has the ability to fund, and historically has elected to fund,
operating requirements of certain of the joint ventures. Consolidation
accounting methods are not utilized as the Company, in most instances, does not
own more than 50 percent in the aggregate, and in any event, major decisions of
the partnership must be made jointly by all partners.
As of December 31, 1998 and 1997, the Company's net equity investment in
unconsolidated investees amounted to $1.2 million and $19.3 million,
respectively. The Company's share of net income related to such unconsolidated
investees amounted to $241 thousand, $835 thousand and $223 thousand in 1998,
1997 and 1996, respectively.
(5) CONCENTRATION OF CREDIT RISK
The Company generally strives to maintain a diversified invested asset
portfolio; however, certain concentrations of credit risk exist in mortgage and
asset-backed securities and real estate.
Approximately 28.0 percent of the Company's investment-grade fixed maturities at
December 31, 1998 were mortgage-backed securities, down from 35.1 percent at
December 31, 1997, due to sales and paydowns during 1998. These investments
consist primarily of marketable mortgage pass-through securities issued by the
Government National Mortgage Association, the Federal National Mortgage
Association or the Federal Home Loan Mortgage Corporation and other
investment-grade securities collateralized by mortgage pass-through securities
issued by these entities. The Company has not made any investments in
interest-only or other similarly volatile tranches of mortgage-backed
securities. The Company's mortgage-backed investments are generally AAA credit
quality.
Approximately 15.4 percent and 10.8 percent of the Company's investment-grade
fixed maturities at December 31, 1998 and 1997, respectively, consisted of
corporate asset-backed securities. The majority of the Company's investments in
asset-backed securities were backed by home equity loans (21.9%), auto loans
(8.2%), manufactured housing loans (14.8%), equipment loans (5.2%), and
commercial mortgage backed securities (22.1%).
The Company's real estate portfolio is distributed by geographic location and
property type. The geographic distribution of a majority of the real estate
portfolio as of December 31, 1998 was as follows: California (31.5%), Hawaii
(16.2%), Washington (9.9%) and Colorado (9.4%). The property type distribution
of a majority of the real estate portfolio as of December 31, 1998 was as
follows: hotels (39.9%), land (30.9%) and residential (15.5%).
Undeveloped land represented approximately 30.9 percent of the Company's real
estate portfolio at December 31, 1998. To maximize the value of certain land and
other projects, additional development has been proceeding or has been planned.
Such development of existing projects would continue to require funding, either
from the Company or third parties. In the present real estate markets,
third-party financing can require credit enhancing arrangements (e.g., standby
financing arrangements and loan commitments) from the Company. The values of
development projects are dependent on a number of factors, including Kemper's
and the Company's plans with respect thereto, obtaining necessary construction
and zoning permits and market demand for the permitted use of the property.
There can be no assurance that such permits will be obtained as planned or at
all, nor that such expenditures will occur as scheduled, nor that Kemper's and
the Company's plans with respect to such projects may not change substantially.
Approximately half of the Company's real estate mortgage loans are on properties
or projects where the Company, Kemper, or their affiliates have taken ownership
positions in joint ventures with a small number of partners.
At December 31, 1998, loans to and investments in joint ventures in which
Patrick M. Nesbitt or his affiliates ("Nesbitt"), a third-party real estate
developer, have ownership interests constituted approximately $64.5 million, or
39.3 percent, of the Company's real estate portfolio. The Nesbitt ventures
consist of nine hotel properties and two office buildings. At December 31, 1998,
the Company did not have any Nesbitt-related off-balance-sheet legal funding
commitments outstanding.
At December 31, 1998, loans to a master limited partnership (the "MLP") between
subsidiaries of Kemper and subsidiaries of Lumbermens Mutual Casualty Company
("Lumbermens"), a former affiliate, constituted approximately $51.6 million, or
31.4 percent, of the Company's real estate portfolio. Kemper's interest is 75
percent at December 31,
33
<PAGE> 35
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) CONCENTRATION OF CREDIT RISK (CONTINUED)
1998. At December 31, 1998, MLP-related commitments accounted for approximately
$6.1 million of the Company's off-balance-sheet legal commitments.
The remaining significant real estate-related investments amounted to $27.3
million at December 31, 1998 and consisted of various zoned and unzoned
residential and commercial lots located in Hawaii. Due to certain negative
zoning restriction developments in January 1997 and a continuing economic slump
in Hawaii, the Company has placed these real estate-related investments on
nonaccrual status as of December 31, 1996. The Company is currently pursuing the
zoning of all remaining unzoned properties, as well as pursuing steps to sell
all remaining zoned properties. However, due to the state of Hawaii's economy,
which has lagged behind the economic expansion of most of the rest of the United
States, the Company anticipates that it could be several additional years until
the Company completely disposes of all of its investments in Hawaii.
At December 31, 1998, the Company no longer had any outstanding loans or
investments in projects with the Prime Group, Inc. or its affiliates, as all
such investments have been sold. However, the Company continues to have Prime
Group-related commitments, which accounted for $25.7 million of the Company's
off-balance-sheet legal commitments at December 31, 1998.
(6) INCOME TAXES
Income tax expense (benefit) was as follows for the years ended December 31,
1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
(in thousands) -------- -------- --------
<S> <C> <C> <C>
Current..................................................... $ 52,274 $130,662 $ 26,300
Deferred.................................................... (12,470) (99,370) (897)
-------- -------- --------
Total............................................. $ 39,804 $ 31,292 $ 25,403
======== ======== ========
</TABLE>
Additionally, the deferred income tax expense (benefit) related to items
included in other comprehensive income was as follows for the years ended
December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
(in thousands) ------- ------- ------
<S> <C> <C> <C>
Unrealized gains and losses on investments.................. $12,475 $ 9,002 $ --
Value of business acquired.................................. (684) (9,173) 7,331
Deferred insurance acquisition costs........................ (840) (814) 457
------- ------- ------
Total............................................. $10,952 $ (985) $7,789
======= ======= ======
</TABLE>
The actual income tax expense for 1998, 1997 and 1996 differed from the
"expected" tax expense for those years as displayed below. "Expected" tax
expense was computed by applying the U.S. federal corporate tax rate of 35
percent in 1998, 1997, and 1996 to income before income tax expense.
<TABLE>
<CAPTION>
1998 1997 1996
(in thousands) ------- ------- -------
<S> <C> <C> <C>
Computed expected tax expense............................... $36,734 $24,503 $20,938
Difference between "expected" and actual tax expense:
State taxes............................................... (434) 1,801 913
Amortization of goodwill.................................. 4,460 5,353 3,568
Dividend received deduction............................... (540) -- --
Foreign tax credit........................................ (250) (278) --
Other, net................................................ (166) (87) (16)
------- ------- -------
Total actual tax expense.......................... $39,804 $31,292 $25,403
======= ======= =======
</TABLE>
Deferred tax assets and liabilities are generally determined based on the
difference between the financial statement and tax basis of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. The Company only records deferred tax
assets if future realization of the tax benefit is more likely than not, with a
valuation allowance recorded for the portion that is not likely to be realized.
The valuation allowance is subject to
34
<PAGE> 36
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) INCOME TAXES (CONTINUED)
future adjustments based upon, among other items, the Company's estimates of
future operating earnings and capital gains.
The Company has established a valuation allowance to reduce the deferred federal
tax asset related to real estate and other investments to the amount that, based
upon available evidence, is, in management's judgment, more likely than not, to
be realized. Any reversals of the valuation allowance are contingent upon the
recognition of future capital gains in the Company's federal income tax return
or a change in circumstances which causes the recognition of the benefits to
become more likely than not. The change in the valuation allowance is related
solely to the change in the net deferred federal tax asset or liability from
unrealized gains or losses on investments.
The tax effects of temporary differences that give rise to significant portions
of the Company's net deferred federal tax assets or liabilities were as follows:
<TABLE>
<CAPTION>
DECEMBER 31 DECEMBER 31 DECEMBER 31
1998 1997 1996
(in thousands) ----------- ------------ ------------
<S> <C> <C> <C>
Deferred federal tax assets:
Deferred insurance acquisition costs...................... $ 86,332 $ 75,522 $ 4,520
Unrealized losses on investments.......................... -- -- 16,624
Life policy reserves...................................... 27,240 43,337 46,452
Unearned revenue.......................................... 42,598 37,243 --
Real estate-related....................................... 13,944 13,400 20,642
Other investment-related.................................. 5,770 3,298 5,409
Other..................................................... 4,923 4,371 3,639
-------- -------- --------
Total deferred federal tax assets...................... 180,807 177,171 97,286
Valuation allowance....................................... (15,201) (15,201) (31,825)
-------- -------- --------
Total deferred federal tax assets after valuation
allowance............................................ 165,606 161,970 65,461
-------- -------- --------
Deferred federal tax liabilities:
Value of business acquired................................ 41,598 48,469 66,373
Deferred insurance acquisition costs...................... 32,040 20,811 9,384
Depreciation and amortization............................. 19,111 20,201 15,473
Other investment-related.................................. 14,337 18,774 28,855
Unrealized gains on investments........................... 21,477 9,002 --
Other..................................................... 1,984 4,720 5,738
-------- -------- --------
Total deferred federal tax liabilities................. 130,547 121,977 125,823
-------- -------- --------
Net deferred federal tax assets (liabilities)............... $ 35,059 $ 39,993 $(60,362)
======== ======== ========
</TABLE>
The net deferred tax assets relate primarily to unearned revenue and the tax on
deferred insurance acquisition costs ("DAC Tax") associated with $1.5 billion
and $2.7 billion of new and renewal sales in 1998 and 1997, respectively from a
non-registered individual and group variable bank-owned life insurance contract
("BOLI"). Management believes that it is more likely than not that the results
of future operations will generate sufficient taxable income over the ten year
amortization period of the unearned revenue and DAC Tax to realize such deferred
tax assets.
The tax returns through the year 1993 have been examined by the Internal Revenue
Service ("IRS"). Changes proposed are not material to the Company's financial
position. The tax returns for the years 1994 through 1996 are currently under
examination by the IRS.
(7) RELATED-PARTY TRANSACTIONS
The Company received capital contributions from Kemper of $4.3 million, $45.0
million and $18.4 million during 1998, 1997 and 1996, respectively. The Company
paid cash dividends of $95.0 million and $29.3 million to Kemper during 1998 and
1997, respectively. The Company did not pay any cash dividends to Kemper during
1996.
The Company has loans to joint ventures, consisting primarily of mortgage loans
on real estate, in which the Company and/or one of its affiliates has an
ownership interest. At December 31, 1998 and 1997, joint venture
35
<PAGE> 37
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) RELATED-PARTY TRANSACTIONS (CONTINUED)
mortgage loans totaled $65.8 million and $72.7 million, respectively, and during
1998, 1997 and 1996, the Company earned interest income on these joint venture
loans of $6.8 million, $7.5 million and $9.5 million, respectively.
All of the Company's personnel are employees of Federal Kemper Life Assurance
Company ("FKLA"), an affiliated company. The Company is allocated expenses for
the utilization of FKLA employees and facilities, the investment management
services of Scudder Kemper Investments, Inc. ("SKI") an affiliated company, and
the information systems of Kemper Service Company ("KSvC"), an SKI subsidiary,
based on the Company's share of administrative, legal, marketing, investment
management, information systems and operation and support services. During 1998,
1997 and 1996, expenses allocated to the Company from SKI and KSvC amounted to
$43 thousand, $114 thousand and $1.7 million, respectively. The Company also
paid to SKI investment management fees of $3.1 million, $3.5 million and $3.6
million during 1998, 1997 and 1996, respectively. In addition, expenses
allocated to the Company from FKLA during 1998, 1997 and 1996 amounted to $35.5
million, $30.0 million and $10.5 million, respectively. The Company also paid to
Kemper real estate subsidiaries $1.5 million, $2.2 million and $1.8 million in
1998, 1997 and 1996, respectively, related to the management of the Company's
real estate portfolio.
(8) REINSURANCE
In the ordinary course of business, the Company enters into reinsurance
agreements to diversify risk and limit its overall financial exposure to certain
blocks of fixed-rate annuities and to individual death claims. The Company
generally cedes 100 percent of the related annuity liabilities under the terms
of the reinsurance agreements. Although these reinsurance agreements
contractually obligate the reinsurers to reimburse the Company, they do not
discharge the Company from its primary liabilities and obligations to
policyholders. As such, these amounts paid or deemed to have been paid are
recorded on the Company's consolidated balance sheet as reinsurance recoverables
and ceded future policy benefits.
As of December 31, 1998 and 1997, the reinsurance recoverable related to
fixed-rate annuity liabilities ceded to an affiliate amounted to $344.8 million
and $382.6 million, respectively.
In December 1996, the Company assumed on a yearly renewable term basis
approximately $14.4 billion (face amount) of term life insurance from FKLA. As a
result of this transaction, the Company recorded premiums and reserves of
approximately $7.3 million. The difference between the cash transferred, which
represents the statutory reserves of the business assumed, and the reserves
recorded under generally accepted accounting principles ("GAAP"), of
approximately $18.4 million, was deemed to be a capital contribution from Kemper
and was recorded as additional paid-in-capital during 1996. As of the date of
this transaction, no deferred tax impact was recorded on the difference between
the statutory and GAAP reserves. This deferred tax impact of $6.5 million was
recorded in 1998 as a reduction to the original capital contribution. Premiums
assumed during 1998 under the terms of the treaty amounted to $21.6 million and
the face amount which remained outstanding at December 31, 1998 amounted to
$11.7 billion.
Effective January 1, 1997, the Company ceded 90 percent of all new term life
insurance premiums to outside reinsurers. Term life reserves ceded to outside
reinsurers on the Company's direct business amounted to approximately $293
thousand and $139 thousand as of December 31, 1998 and 1997, respectively.
During December 1997, the Company entered into a funds withheld reinsurance
agreement with a Zurich affiliated company, ZC Life Reinsurance Limited ("ZC
Life"), formerly EPICENTRE Reinsurance (Bermuda) Limited. Under the terms of
this agreement, the Company ceded, on a yearly renewable term basis, ninety
percent of the net amount at risk (death benefit payable to the insured less the
insured's separate account cash surrender value) related to the new BOLI product
developed in 1997, which is held in the Company's separate accounts. During
1997, the Company issued $59.3 billion (face amount) of new BOLI business and
ceded $51.1 billion (face amount) to ZC Life under the terms of the treaty.
During 1997, the Company also ceded $24.3 million of separate account fees (cost
of insurance charges) to ZC Life. The Company has also withheld approximately
$23.4 million of such funds due to ZC Life under the terms of the reinsurance
agreement as a component of benefits and funds payable in the accompanying
consolidated balance sheet as of December 31, 1997.
During 1998, the Company modified the reinsurance agreement to increase the
reinsurance from ninety percent to one hundred percent. During 1998, the Company
issued $6.9 billion (face amount) of new BOLI business and ceded $11.1 billion
(face amount) to ZC Life under the terms of the modified treaty. During 1998,
the Company also ceded $175.5 million of separate account fees (cost of
insurance charges) to ZC Life. The Company has also withheld
36
<PAGE> 38
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) REINSURANCE (CONTINUED)
approximately $170.9 million of such funds due to ZC Life under the terms of the
reinsurance agreement as a component of benefits and funds payable in the
accompanying consolidated balance sheet as of December 31, 1998.
KILICO has a large and growing funds withheld account ("FWA") supporting reserve
credits on reinsurance ceded on the BOLI product. Amendments to the reinsurance
contracts during 1998 changed the methodology used to determine increases to the
FWA. A substantial portion of the FWA is now marked-to-market based upon the
Total Return of the Governmental Bond Division of the KILICO Variable Series I
Separate Account. During 1998, the Company recorded a $2.5 million increase to
the FWA related to this mark-to-market. To properly match revenue and expenses,
the Company has placed assets supporting the FWA in a segmented portion of its
General Account. This portfolio is classified as "trading" under Statement of
Financial Accounting Standards No. 115 ("FAS 115"). FAS 115 mandates that assets
held in a trading account be valued at fair value, with changes in fair value
flowing through the income statement as realized capital gains and losses.
During 1998, the Company recorded a realized capital gain of $2.8 million upon
transfer of these assets from "available for sale" to the trading portfolio as
required by FAS 115. In addition, the Company recorded realized capital losses
of $151 thousand related to the changes in fair value of this portfolio during
1998. The fair value of this portfolio was $101.8 million at December 31, 1998,
and the amortized cost was $99.1 million. The Company periodically purchases
assets into this segmented portfolio to support changes in the FWA.
(9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
FKLA sponsors a welfare plan that provides medical and life insurance benefits
to its retired and active employees and the Company is allocated a portion of
the costs of providing such benefits. The Company is self insured with respect
to medical benefits, and the plan is not funded except with respect to certain
disability-related medical claims. The medical plan provides for medical
insurance benefits at retirement, with eligibility based upon age and the
participant's number of years of participation attained at retirement. The plan
is contributory for pre-Medicare retirees, and will be contributory for all
retiree coverage for most current employees, with contributions generally
adjusted annually. Postretirement life insurance benefits are noncontributory
and are limited to $10,000 per participant.
The allocated accumulated postretirement benefit obligation accrued by the
Company amounted to $2.0 million and $1.9 million at December 31, 1998 and 1997,
respectively.
The discount rate used in determining the allocated postretirement benefit
obligation was 7.0 percent and 7.25 percent for 1998 and 1997, respectively. The
assumed health care trend rate used was based on projected experience for 1998,
8.0 percent for 1999, gradually declining to 6.4 percent by the year 2003 and
gradually declining thereafter.
A one percentage point increase in the assumed health care cost trend rate for
each year would increase the accumulated postretirement benefit obligation as of
December 31, 1998 and 1997 by $312 thousand and $242 thousand, respectively.
(10) COMMITMENTS AND CONTINGENT LIABILITIES
The Company is involved in various legal actions for which it establishes
liabilities where appropriate. In the opinion of the Company's management, based
upon the advice of legal counsel, the resolution of such litigation is not
expected to have a material adverse effect on the consolidated financial
statements.
Although neither the Company nor its joint venture projects have been identified
as a "potentially responsible party" under Federal environmental guidelines,
inherent in the ownership of, or lending to, real estate projects is the
possibility that environmental pollution conditions may exist on or near or
relate to properties owned or previously owned on properties securing loans.
Where the Company has presently identified remediation costs, they have been
taken into account in determining the cash flows and resulting valuations of the
related real estate assets. Based on the Company's receipt and review of
environmental reports on most of the projects in which it is involved, the
Company believes its environmental exposure would be immaterial to its
consolidated results of operations. However, the Company may be required in the
future to take actions to remedy environmental exposures, and there can be no
assurance that material environmental exposures will not develop or be
identified in the future. The amount of future environmental costs is impossible
to estimate due to, among other factors, the unknown magnitude of possible
exposures, the unknown timing and extent of corrective actions that may be
required, the determination of the Company's liability in proportion to others
and the extent such costs may be covered by insurance or various environmental
indemnification agreements.
37
<PAGE> 39
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(11) FINANCIAL INSTRUMENTS--OFF-BALANCE-SHEET RISK
At December 31, 1998, the Company had future legal loan commitments and stand-by
financing agreements totaling $64.4 million to support the financing needs of
various real estate investments. To the extent these arrangements are called
upon, amounts loaned would be collateralized by assets of the joint ventures,
including first mortgage liens on the real estate. The Company's criteria in
making these arrangements are the same as for its mortgage loans and other real
estate investments. These commitments are included in the Company's analysis of
real estate-related reserves and write-downs. The fair values of loan
commitments and standby financing agreements are estimated in conjunction with
and using the same methodology as the fair value estimates of mortgage loans and
other real estate-related investments.
(12) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates are made at specific points in time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from offering
for sale at one time the Company's entire holdings of a particular financial
instrument. A significant portion of the Company's financial instruments are
carried at fair value. Fair value estimates for financial instruments not
carried at fair value are generally determined using discounted cash flow models
and assumptions that are based on judgments regarding current and future
economic conditions and the risk characteristics of the investments. Although
fair value estimates are calculated using assumptions that management believes
are appropriate, changes in assumptions could significantly affect the estimates
and such estimates should be used with care.
Fair value estimates are determined for existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and certain liabilities that are not
considered financial instruments. Accordingly, the aggregate fair value
estimates presented do not represent the underlying value of the Company. For
example, the Company's subsidiaries are not considered financial instruments,
and their value has not been incorporated into the fair value estimates. In
addition, tax ramifications related to the realization of unrealized gains and
losses can have a significant effect on fair value estimates and have not been
considered in any of the estimates.
The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments:
FIXED MATURITIES AND EQUITY SECURITIES: Fair values were determined by using
market quotations, or independent pricing services that use prices provided by
market makers or estimates of fair values obtained from yield data relating to
instruments or securities with similar characteristics, or fair value as
determined in good faith by the Company's portfolio manager, SKI.
CASH AND SHORT-TERM INVESTMENTS: The carrying amounts reported in the
consolidated balance sheets for these instruments approximate fair values.
MORTGAGE LOANS AND OTHER REAL ESTATE-RELATED INVESTMENTS: Fair values were
estimated based upon the investments observable market price, net of estimated
costs to sell. The estimates of fair value should be used with care given the
inherent difficulty in estimating the fair value of real estate due to the lack
of a liquid quotable market.
OTHER LOANS AND INVESTMENTS: The carrying amounts reported in the consolidated
balance sheets for these instruments approximate fair values. The fair values of
policy loans were estimated by discounting the expected future cash flows using
an interest rate charged on policy loans for similar policies currently being
issued.
LIFE POLICY BENEFITS: Fair values of the life policy benefits regarding
investment contracts (primarily deferred annuities) and universal life contracts
were estimated by discounting gross benefit payments, net of contractual
premiums, using the average crediting rate currently being offered in the
marketplace for similar contracts with maturities consistent with those
remaining for the contracts being valued. The Company had projected its future
average crediting rate in 1998 and 1997 to be 4.75 percent and 5.25 percent,
respectively, while the assumed average market crediting rate was 5.0 percent
and 6.0 percent in 1998 and 1997, respectively.
38
<PAGE> 40
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(12) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The carrying values and estimated fair values of the Company's financial
instruments at December 31, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------------ ------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
(in thousands) ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Financial instruments recorded as assets:
Fixed maturities....................................... $3,482,820 $3,482,820 $3,668,643 $3,668,643
Trading account securities............................. 101,781 101,781 -- --
Cash and short-term investments........................ 71,820 71,820 259,925 259,925
Mortgage loans and other real estate-related assets.... 164,375 164,375 220,046 220,046
Policy loans........................................... 271,540 271,540 282,439 282,439
Equity securities...................................... 66,854 66,854 24,839 24,839
Other invested assets.................................. 23,645 27,620 20,820 24,404
Financial instruments recorded as liabilities:
Life policy benefits, excluding term life reserves..... 3,551,050 3,657,510 3,846,023 4,050,852
Funds withheld account................................. 170,920 170,920 23,420 23,420
</TABLE>
(13) STOCKHOLDER'S EQUITY--RETAINED EARNINGS
The maximum amount of dividends which can be paid by insurance companies
domiciled in the State of Illinois to shareholders without prior approval of
regulatory authorities is restricted. The maximum amount of dividends which can
be paid by the Company without prior approval in 1999 is $64.9 million. The
Company paid cash dividends of $95.0 million and $29.3 million to Kemper during
1998 and 1997, respectively. The Company paid no cash dividends in 1996.
The Company's net income and capital and surplus as determined in accordance
with statutory accounting principles were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
(in thousands) -------- -------- --------
<S> <C> <C> <C>
Net income.................................................. $ 64,871 $ 58,372 $ 37,287
======== ======== ========
Statutory capital and surplus............................... $455,213 $476,924 $411,837
======== ======== ========
</TABLE>
39
<PAGE> 41
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(14) UNAUDITED INTERIM FINANCIAL INFORMATION
The following table sets forth the Company's unaudited quarterly financial
information:
(in thousands)
<TABLE>
<CAPTION>
QUARTER ENDED MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------- -------- ------- ------------ -----------
<S> <C> <C> <C> <C>
1998 OPERATING SUMMARY
Net investment income..................................... $70,551 $68,467 $ 66,892 $ 67,602
Realized investment gains................................. 1,854 15,673 8,951 25,390
Premium income............................................ 5,203 5,941 5,278 5,924
Separate account fees and other income.................... 20,418 19,922 17,631 14,042
------- ------- -------- --------
Total revenue..................................... 98,026 110,003 98,752 112,958
------- ------- -------- --------
Interest credited and benefits to policyholders........... 57,930 57,939 54,251 34,815
Commissions, taxes, licenses and fees..................... 13,885 13,922 12,282 29,251
Operating expenses........................................ 10,094 12,157 10,528 11,794
Net deferral of insurance acquisition costs............... (7,973) (11,983) (9,669) (4,858)
Amortization of value of business acquired................ 4,427 7,121 6,359 (230)
Amortization of goodwill.................................. 3,186 3,186 3,186 3,186
------- ------- -------- --------
Total benefits and expenses....................... 81,549 82,342 76,937 73,958
------- ------- -------- --------
Income before income tax expense.......................... 16,477 27,661 21,815 39,000
Income tax expense........................................ 7,247 11,774 8,828 11,955
------- ------- -------- --------
Net income........................................ $ 9,230 $15,887 $ 12,987 $ 27,045
======= ======= ======== ========
1997 OPERATING SUMMARY
Net investment income..................................... $74,249 $74,050 $ 72,950 $ 74,946
Realized investment gains (losses)........................ 889 8,161 (3,032) 4,528
Premium income............................................ 5,008 4,121 3,938 9,172
Separate account fees and other income.................... 8,909 12,961 12,215 62,415(1)
------- ------- -------- --------
Total revenue..................................... 89,055 99,293 86,071 151,061
------- ------- -------- --------
Interest credited and benefits to policyholders........... 57,859 56,643 57,965 55,687
Commissions, taxes, licenses and fees..................... 8,023 9,475 8,389 59,323(1)
Operating expenses........................................ 7,175 8,780 10,014 10,868
Net deferral of insurance acquisition costs............... (7,216) (6,877) (7,471) (13,409)
Amortization of value of business acquired................ 4,821 6,991 6,743 6,393
Amortization of goodwill.................................. 2,547 2,552 2,549 7,647(2)
------- ------- -------- --------
Total benefits and expenses....................... 73,209 77,564 78,189 126,509
------- ------- -------- --------
Income before income tax expense.......................... 15,846 21,729 7,882 24,552
Income tax expense........................................ 5,678 8,723 3,778 13,113
------- ------- -------- --------
Net income........................................ $10,168 $13,006 $ 4,104 $ 11,439
======= ======= ======== ========
</TABLE>
- ---------------
Notes:
(1) Reflects premium tax expense loads received and premium taxes incurred of
$49.1 million related to new BOLI sales of $2.6 billion in the fourth
quarter of 1997.
(2) Reflects the effect of the change in amortization of goodwill from 25 to 20
years.
(15) OPERATING SEGMENTS AND RELATED INFORMATION
In June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 establishes standards for how
to report information about operating segments. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. The Company adopted SFAS No. 131 as of December 31, 1998 and the
impact of implementation did not affect the Company's consolidated financial
position, results of operations or cash flows. In the initial year of adoption,
SFAS No. 131 requires comparative information for earlier years to be restated,
unless impracticable to do so.
40
<PAGE> 42
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In connection with the acquisition by Zurich, the Company, FKLA, ZLICA, and
Fidelity Life Association ("FLA"), a Mutual Legal Reserve Company, owned by its
policyholders, began to operate under the trade name Zurich Kemper Life. For
purposes of this operating segment disclosure, Zurich Kemper Life will also
include the operations of Zurich Direct, Inc., an affiliated direct marketing
life insurance agency and excludes FLA, as it is owned by its policyholders.
Zurich Kemper Life is segregated by Strategic Business Unit ("SBU"). The SBU
concept employed by ZFS has each SBU concentrate on a specific customer market.
The SBU is the focal point of Zurich Kemper Life, because it is at the SBU level
that Zurich Kemper Life can clearly identify customer segments and then work to
understand and satisfy the needs of each customer. The contributions of Zurich
Kemper Life's SBU's to consolidated revenues, operating results and certain
balance sheet data pertaining thereto, are shown in the following tables on the
basis of generally accepted accounting principles. Zurich Kemper Life's SBU's
were formed in 1996, subsequent to the acquisition by Zurich, however, financial
information was not produced by SBU until 1997. Therefore, Zurich Kemper Life
has not provided segment information for 1996, as it would be impracticable to
do so.
Zurich Kemper Life is segregated into the Agency, Financial, Group Retirement
and Direct SBU's. The SBU's are not managed at the legal entity level, but
rather at the Zurich Kemper Life level. Zurich Kemper Life's SBU's cross legal
entity lines, as certain similar products are sold by more than one legal
entity. The vast majority of the Company's business is derived from the
Financial and Group Retirement SBU's.
Each SBU's revenue is derived from geographically dispersed areas as Zurich
Kemper Life is licensed in the District of Columbia and all states except New
York. During 1998 and 1997, Zurich Kemper Life did not derive net revenue from
one customer that exceeded 10 percent of the total revenue of Zurich Kemper
Life.
The principal products and markets of Zurich Kemper Life's SBU's are as follows:
AGENCY: The Agency SBU develops low cost term and universal life insurance, as
well as fixed annuities, to market through independent agencies and national
marketing organizations.
FINANCIAL: The Financial SBU focuses on a wide range of products that provide
for the accumulation, distribution and transfer of wealth and primarily includes
variable and fixed annuities, variable universal life and bank-owned life
insurance. These products are distributed to consumers through financial
intermediaries such as banks, brokerage firms and independent financial
planners.
GROUP RETIREMENT: The Group Retirement SBU has a sharp focus on its target
customer. This SBU markets variable annuities to K-12 schoolteachers,
administrators, and healthcare workers, along with college professors and
certain employees of selected non-profit organizations. This target market is
eligible for what the IRS designates as retirement-oriented savings or
investment plans that qualify for special tax treatment.
DIRECT: The Direct SBU is a direct marketer of basic, low-cost term life
insurance through various marketing media.
41
<PAGE> 43
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summarized financial information for ZKL's SBU's are as follows:
As of and for the period ending December 31, 1998:
(in thousands)
<TABLE>
<CAPTION>
GROUP
AGENCY FINANCIAL RETIREMENT DIRECT TOTAL
INCOME STATEMENT ---------- ---------- ---------- -------- -----------
<S> <C> <C> <C> <C> <C>
REVENUE
Premium income................................. $ 160,067 $ 56 $ -- $ 5,583 $ 165,706
Net investment income.......................... 141,171 180,721 100,695 271 422,858
Realized investment gains...................... 20,335 33,691 15,659 30 69,715
Fees and other income.......................... 80,831 40,421 31,074 23,581 175,907
---------- ---------- ---------- -------- -----------
Total revenue............................. 402,404 254,889 147,428 29,465 834,186
---------- ---------- ---------- -------- -----------
BENEFITS AND EXPENSES
Policyholder benefits.......................... 243,793 117,742 73,844 2,110 437,489
Intangible asset amortization.................. 58,390 15,669 15,703 -- 89,762
Net deferral of insurance acquisition costs.... (55,569) (9,444) (22,964) (22,765) (110,742)
Commissions and taxes, licenses and fees....... 29,539 43,919 22,227 11,707 107,392
Operating expenses............................. 61,659 24,924 20,279 35,593 142,455
---------- ---------- ---------- -------- -----------
Total benefits and expenses............... 337,812 192,810 109,089 26,645 666,356
---------- ---------- ---------- -------- -----------
Income before income tax expense................. 64,592 62,079 38,339 2,820 167,830
Income tax expense............................... 26,774 24,340 14,794 1,001 66,909
---------- ---------- ---------- -------- -----------
Net income................................ $ 37,818 $ 37,739 $ 23,545 $ 1,819 $ 100,921
========== ========== ========== ======== ===========
BALANCE SHEET
Total assets................................... $3,194,530 $8,232,927 $4,172,828 $ 46,254 $15,646,539
========== ========== ========== ======== ===========
</TABLE>
<TABLE>
<CAPTION>
NET
REVENUE INCOME ASSETS
----------- -------- -----------
<S> <C> <C> <C>
Total revenue, net income and assets, respectively, from above:..... $ 834,186 $100,921 $15,646,539
----------- -------- -----------
Less:
Revenue, net income and assets of FKLA............................ 336,841 35,953 2,986,381
Revenue, net loss and assets of ZLICA............................. 54,058 (1,066) 416,115
Revenue, net income and assets Zurich Direct...................... 23,548 885 4,322
----------- -------- -----------
Totals per the Company's consolidated financial statements........ $ 419,739 $ 65,149 $12,239,721
=========== ======== ===========
</TABLE>
42
<PAGE> 44
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the period ending December 31, 1997:
(in thousands)
<TABLE>
<CAPTION>
GROUP
AGENCY FINANCIAL RETIREMENT DIRECT TOTAL
INCOME STATEMENT ---------- ---------- ---------- -------- -----------
<S> <C> <C> <C> <C> <C>
REVENUE
Premium income............................ $ 167,439 $ -- $ -- $ 4,249 $ 171,688
Net investment income..................... 155,885 212,767 91,664 455 460,771
Realized investment gains................. 2,503 7,744 2,692 50 12,989
Fees and other income..................... 78,668 73,823 23,663 8,007 184,161
---------- ---------- ---------- -------- -----------
Total revenue........................ 404,495 294,334 118,019 12,761 829,609
---------- ---------- ---------- -------- -----------
BENEFITS AND EXPENSES
Policyholder benefits..................... 247,878 153,327 60,061 2,234 463,500
Intangible asset amortization............. 58,534 25,593 15,589 -- 99,716
Net deferral of insurance acquisition
costs.................................. (50,328) (18,222) (13,033) (5,242) (86,825)
Commissions and taxes, licenses and
fees................................... 39,477 66,552 16,668 3,518 126,215
Operating expenses........................ 55,859 20,282 14,320 19,472 109,933
---------- ---------- ---------- -------- -----------
Total benefits and expenses.......... 361,420 247,532 93,605 19,982 712,539
---------- ---------- ---------- -------- -----------
Income (loss) before income tax expense
(benefit)................................. 53,075 46,802 24,414 (7,221) 117,070
Income tax expense (benefit)................ 25,554 21,144 10,545 (2,528) 54,715
---------- ---------- ---------- -------- -----------
Net income (loss).................... $ 27,521 $ 25,658 $ 13,869 $ (4,693) $ 62,355
========== ========== ========== ======== ===========
BALANCE SHEET
Total assets.............................. $2,877,854 $7,416,791 $3,759,173 $ 41,669 $14,095,487
========== ========== ========== ======== ===========
</TABLE>
<TABLE>
<CAPTION>
NET
REVENUE INCOME ASSETS
----------- -------- -----------
<S> <C> <C> <C>
Total revenue, net income and assets, respectively, from above:..... $ 829,609 $ 62,355 $14,095,487
Less:
Revenue, net income and assets of FKLA............................ 338,854 24,740 3,105,396
Revenue, net income and assets of ZLICA........................... 57,233 2,193 398,786
Revenue, net loss and assets of Zurich Direct..................... 8,042 (3,295) 1,655
----------- -------- -----------
Totals per the Company's consolidated financial statements... $ 425,480 $ 38,717 $10,589,650
=========== ======== ===========
</TABLE>
43
<PAGE> 45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
On September 12, 1997, Kemper Investors Life Insurance Company ("KILICO")
appointed the accounting firm of PricewaterhouseCoopers LLP
("PricewaterhouseCoopers"), formerly Coopers & Lybrand, L.L.P., as independent
accountants for the year ended December 31, 1997 to replace KPMG LLP effective
with such appointment. KILICO's Board of Directors approved the selection of
PricewaterhouseCoopers as the new independent accountants. Management had not
consulted with PricewaterhouseCoopers on any accounting, auditing or reporting
matter, prior to that time.
During the fiscal year ended December 31, 1996, there were no disagreements with
KPMG LLP on any matter of accounting principles or practices, financial
statement disclosure or auditing scope or procedure or any reportable events.
KPMG LLP's report on the financial statements for 1996 contained no adverse
opinion or disclaimer of opinion and was not qualified or modified as to
uncertainty, audit scope or accounting principles.
There were no disagreements with PricewaterhouseCoopers on accounting or
financial disclosures for the years ended December 31, 1998 or 1997.
44
<PAGE> 46
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
NAME AND AGE
POSITION WITH KILICO
YEAR OF ELECTION OTHER BUSINESS EXPERIENCE DURING PAST 5 YEARS OR MORE
-------------------- -----------------------------------------------------
<S> <C>
John B. Scott (54) Chief Executive Officer, President and Director of Federal
Chief Executive Officer since Kemper Life Assurance Company (FKLA) and Fidelity Life
February 1992. President since Association (FLA) since 1988. Chief Executive Officer,
November 1993. Director since 1992. President and Director of Zurich Life Insurance Company of
America (ZLICA) and Zurich Direct, Inc. (ZD) since March
1996. Chairman of the Board and Director of Investors
Brokerage Services, Inc. (IBS) and Investors Brokerage
Services Insurance Agency, Inc. (IBSIA) since 1993. Chairman
of the Board of FKLA and FLA from April 1988 to January
1996. Chairman of the Board of KILICO from February 1992 to
January 1996. Executive Vice President and Director of
Kemper Corporation (Kemper) from January 1994 and March
1996, respectively. Executive Vice President of Kemper
Financial Companies, Inc. from January 1994 to January 1996
and Director from 1992 to January 1996.
Eliane C. Frye (51) Executive Vice President of FKLA and FLA since 1995.
Executive Vice President since 1995. Executive Vice President of ZLICA and ZD since March 1996.
Director since May 1998. Director of FLA since December 1997. Director of FKLA and
ZLICA since May 1998. Director of ZD from March 1996 to
March 1997. Director of IBS and IBSIA since 1995. Senior
Vice President of KILICO, FKLA and FLA from 1993 to 1995.
Vice President of FKLA and FLA from 1988 to 1993.
Frederick L. Blackmon (47) Senior Vice President and Chief Financial Officer of FKLA
Senior Vice President and Chief since December 1995. Senior Vice President and Chief
Financial Officer since December Financial Officer of FLA since January 1996. Senior Vice
1995. President and Chief Financial Officer of ZLICA since March
1996. Senior Vice President and Chief Financial Officer of
ZD since March 1996. Director of FLA since May 1998.
Director of ZD from March 1996 to March 1997. Treasurer and
Chief Financial Officer of Kemper since January 1996. Chief
Financial Officer of Alexander Hamilton Life Insurance
Company from April 1989 to November 1995.
James C. Harkensee (40) Senior Vice President of FKLA and FLA since January 1996.
Senior Vice President since January Senior Vice President of ZLICA since 1995. Senior Vice
1996. President of ZD since 1995. Director of ZD from April 1993
to March 1997 and since March 1998. Vice President of ZLICA
from 1992 to 1995. Chief Actuary of ZLICA from 1991 to 1994.
Assistant Vice President of ZLICA from 1990 to 1992. Vice
President of ZD from 1994 to 1995.
James E. Hohmann (43) Senior Vice President of FKLA since December 1995. Chief
Senior Vice President since December Actuary of FKLA and KILICO from December 1995 to January
1995. Director since May 1998. 1999. Senior Vice President of FLA since January 1996. Chief
Actuary of FLA from January 1996 to January 1999. Senior
Vice President of ZLICA and ZD since March 1996. Chief
Actuary of ZLICA and ZD from March 1996 to January 1999.
Director of FLA since June 1997. Director of FKLA and ZLICA
since May 1998. Director of ZD from March 1996 to March
1997. Managing Principal (Partner) of Tillinghast-Towers
Perrin from January 1991 to December 1995.
Consultant/Principal (Partner) of Tillinghast-Towers Perrin
from November 1986 to January 1991.
Edward K. Loughridge (44) Senior Vice President and Corporate Development Officer of
Senior Vice President and Corporate FKLA and FLA since January 1996. Senior Vice President and
Development Officer since January Corporate Development Officer for ZLICA and ZD since March
1996. 1996. Senior Vice President of Human Resources of Zurich-
American Insurance Group from February 1992 to March 1996.
Debra P. Rezabek (43) Senior Vice President of FKLA and FLA since March 1996.
Senior Vice President since 1996. Corporate Secretary of FKLA and FLA since January 1996.
General Counsel since 1992. Corporate Director of FLA since May 1998. Vice President of KILICO,
Secretary since January 1996. FKLA and FLA since 1995. General Counsel and Director of
Government Affairs of FKLA and FLA since 1992 and of KILICO
since 1993. Senior Vice President, General Counsel and
Corporate Secretary of ZLICA since March 1996. Senior Vice
President, General Counsel and Corporate Secretary of ZD
since March 1996. Director of ZD from March 1996 to March
1997. Secretary of IBS and IBSIA since 1993. Director of IBS
and IBSIA from 1993 to 1996. Assistant General Counsel of
FKLA and FLA from 1988 to 1992. General Counsel and
Assistant Secretary of KILICO, FKLA and FLA from 1992 to
1996. Assistant Secretary of Kemper since January 1996.
</TABLE>
45
<PAGE> 47
<TABLE>
<CAPTION>
NAME AND AGE
POSITION WITH KILICO
YEAR OF ELECTION OTHER BUSINESS EXPERIENCE DURING PAST 5 YEARS OR MORE
-------------------- -----------------------------------------------------
<S> <C>
Kenneth M. Sapp (53) Senior Vice President of FKLA, FLA and ZLICA since January
Senior Vice President since January 1998. Director of IBS since May 1998. Director of IBSIA
1998. since September 1998. Vice President--Aetna Life Brokerage
of Aetna Life & Annuity Company from February 1992 to
January 1998.
George Vlaisavljevich (56) Senior Vice President of FKLA, FLA and ZLICA since October
Senior Vice President since October 1996. Senior Vice President of ZD since March 1997. Director
1996. of IBS and IBSIA since October 1996. Executive Vice
President of The Copeland Companies from April 1983 to
September 1996.
Loren J. Alter (60) Director of FKLA, FLA and Scudder Kemper Investments, Inc.
Director since January 1996. (SKI) since January 1996. Director of ZLICA since May 1979.
Executive Vice President and Chief Financial Officer of
Zurich U.S. since 1979. President, Chief Executive Officer
and Director of Kemper since January 1996.
William H. Bolinder (55) Chairman of the Board and Director of FKLA and FLA since
Chairman of the Board and Director January 1996. Chairman of the Board of ZLICA and ZD since
since January 1996. March 1995. Chairman of the Board and Director of Kemper
since January 1996. Director of SKI since January 1996. Vice
Chairman of SKI from January 1996 to 1998. Member of the
Group Executive Board of Zurich Financial Services Group
since 1998. Member of the Corporate Executive Board of
Zurich Insurance Group from October 1994 to 1998. Chairman
of Zurich American Insurance Company since 1998. Chairman of
the Board of American Guarantee and Liability Insurance
Company, Zurich American Insurance Company of Illinois,
American Zurich Insurance Company and Steadfast Insurance
Company since 1995. Chief Executive Officer of American
Guarantee and Liability Insurance Company, Zurich American
Insurance Company of Illinois and American Zurich Insurance
Company from 1986 to June 1995. President of Zurich Holding
Company of America since 1986. Manager of Zurich Insurance
Company, U.S. Branch from 1986 to 1988. Underwriter for
Zurich American Lloyds since 1986.
David A. Bowers (52) Director of FKLA and ZLICA since May 1997. Director of FLA
Director since May 1997. since June 1997. Executive Vice President, Corporate
Secretary and General Counsel of Zurich U.S. since August
1985. Vice President, General Counsel and Secretary of
Kemper since January 1996.
Gunther Gose (54) Director of FKLA, FLA and ZLICA since November 1998. Chief
Director since November 1998. Financial Officer and Member of the Group Executive Board of
Zurich Financial Services since October 1998. Member of the
Corporate Executive Board of Zurich Insurance Group from
April 1990 to October 1998.
</TABLE>
46
<PAGE> 48
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
LONG TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
-------------------------------------------------------------
LONG TERM
OTHER INCENTIVE
ANNUAL PLAN ALL OTHER
NAME AND BONUS COMPENSATION PAYOUTS COMPENSATION
PRINCIPAL POSITION YEAR SALARY ($) ($)(2) ($)(3) ($)(2) ($)(4)(5)(6)
- -----------------------------------------------------------------------------------------------------------------------------------
John B. Scott.............................. 1998 $171,000 $ -- $-- $ -- $ 38,326
Chief Executive Officer(1) 1997 171,000 112,100 -- 239,400 64,089
1996 212,500 94,000 -- 212,500 142,498
Eliane C. Frye............................. 1998 107,160 -- -- -- 18,024
Executive Vice President(1) 1997 98,040 47,515 -- 91,590 30,311
1996 105,000 41,750 -- 69,750 58,520
Frederick L. Blackmon...................... 1998 94,160 -- -- -- 8,977
Senior Vice President and Chief Financial 1997 96,300 54,225 -- 112,500 19,543
Officer(1) 1996 100,583 47,000 27,924 71,250 11,226
George Vlaisavljevich...................... 1998 260,000 -- -- -- 23,236
Senior Vice President(1)................... 1997 252,500 146,000 39,922 243,000 9,165
James E. Hohmann........................... 1998 88,400 -- -- -- 7,823
Senior Vice President and 1997 79,333 45,500 -- 80,150 1,063
Chief Actuary(1) 1996 113,333 -- -- -- 11,333
</TABLE>
- ---------------
(1) Also served in same positions for FKLA, ZLICA and FLA. An allocation of the
time devoted to duties as executive officer of KILICO has been made. All
compensation items reported in the Summary Compensation Table reflect this
allocation.
(2) Annual bonuses are paid pursuant to annual incentive plans. The amounts of
the bonuses earned in 1998 were not available as of the date of this filing.
(3) The amounts disclosed in this column include:
(a) Amounts paid as non-preferential dividend equivalents on shares of
restricted stock and phantom stock units.
(b) The cash value of shares of Kemper common stock when awarded under the
Kemper Anniversary Award Plan. Employees were awarded shares on an
increasing scale beginning with their 10th year of employment and every 5
years thereafter, with a pro rata award at retirement.
(c) The taxable benefit from personal use of an employer-provided automobile
and certain estate planning services facilitated for executives.
(d) Relocation expense reimbursements of $21,437 in 1996 for Mr. Blackmon
and $24,498 for Mr. Vlaisavljevich in 1997.
(4) The amounts in this column include:
(a) The amounts of employer contributions allocated to the accounts of the
named persons under profit sharing plans or under supplemental plans
maintained to provide benefits in excess of applicable ERISA limitations.
(b) Distributions from the Kemper and FKLA supplemental plans.
(5) Pursuant to the Conseco Merger Agreement, which was an agreement that was
subsequently terminated as the result of a failed merger attempt by Conseco,
the restricted stock awards for 1993 and 1994 were cancelled. To replace
these awards, on June 30, 1994, the Committee, under the Kemper Bonus
Restoration Plan and in its sole discretion, granted cash awards to the
named executive officers and other affected executives entitling each of
them to receive an amount in cash immediately prior to the effective time of
the then-planned Conseco merger equal to the product of the number of shares
of restricted stock previously granted to such individual under the 1993
Senior Executive Long-Term Incentive Plan multiplied by the consideration
payable in the merger. As a result of the termination of the Conseco Merger
Agreement, no cash awards were paid pursuant to the Kemper Bonus Restoration
Plan.
In January 1995, the board of directors, upon the advice of the Committee,
approved the adoption of the Kemper 1995 Executive Incentive Plan under
which active employee holders of the previously cancelled shares of
restricted
47
<PAGE> 49
stock were granted phantom stock units by the Committee equal to the number of
shares cancelled plus an added amount representing 20 percent of the Aggregate
cancelled shares. The 20 percent supplement was awarded in recognition of the
imposition of new vesting periods on the phantom awards (to the extent the
restricted stock held prior to cancellation would otherwise have vested in
June 1994 had stockholder approval of the affected restricted stock plan been
obtained as earlier anticipated).
By their terms, the phantom stock units associated with cancelled shares of
restricted stock originally awarded in 1993, as supplemented, would have vested
on December 31, 1995 and entitled the holders to a cash payment (net of any
required tax withholding) determined by the value of Kemper's common stock
based on an average trading range to December 31, 1995, and those phantom
stock units associated with the cancelled restricted stock originally awarded
in 1994 could similarly have vested and been paid on December 31, 1996,
subject to ongoing employment to the respective vesting dates.
Notwithstanding these vesting provisions, the phantom stock units earlier
vested and entitled payment upon the consummation of a "change of control" of
Kemper. Dividend equivalents were payable to holders of the phantom stock
units as compensation income when and as dividends were paid on Kemper's
outstanding common stock, and the Executive Incentive Plan provided for
standard anti-dilution adjustments.
Phantom stock units awarded to the named executive officers subject to vesting
on December 31, 1996, were Mr. Scott 12,600 phantom units and Ms. Frye 1,680
phantom units. All phantom stock units vested and were paid immediately prior
to the effectiveness of the January 4, 1996 acquisition of Kemper by Zurich
and Insurance Partners. Mr. Scott and Ms. Frye received allocated cash out
payments of $430,272, and $80,317, respectively, in 1996.
(6) Pursuant to the terms of a Termination Protection Agreement with Kemper
dated March 17, 1994, Mr. Scott received payments in 1995 and 1996. These
payments were made by Kemper and no portion of the payments were allocated
to KILICO.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(A) AS OF MARCH 1, 1999, 100% OF THE OUTSTANDING SHARES OF KILICO WERE OWNED BY
KEMPER CORPORATION, 1 KEMPER DRIVE, LONG GROVE, ILLINOIS 60049.
(B) NOT APPLICABLE.
(C) CHANGES IN CONTROL.
As previously discussed in PART 1, ITEM 1, on February 27, 1998, Zurich acquired
Insurance Partner's remaining 20 percent interest for cash. As a result of this
transaction, Kemper Corporation and KILICO became wholly-owned subsidiaries of
Zurich.
Effective September 7, 1998, the businesses of Zurich merged with the financial
services business of B.A.T. Industries forming Zurich Financial Services
("ZFS"). ZFS is owned by Zurich Allied AG and Allied Zurich p.l.c., fifty-seven
percent and forty-three percent, respectively. Zurich Allied AG, representing
the financial interest of the former Zurich Group, is listed on the Swiss Market
Index, replacing Zurich. Allied Zurich, p.l.c., representing the financial
interest of B.A.T. Industries, is included in the FTSE-100 Share Index in
London.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
(A) TRANSACTIONS WITH MANAGEMENT AND OTHERS--none.
(B) CERTAIN BUSINESS RELATIONSHIPS--not applicable.
(C) INDEBTEDNESS OF MANAGEMENT--not applicable.
(D) TRANSACTIONS WITH PROMOTERS--not applicable.
48
<PAGE> 50
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS.
A listing of all financial statements filed as part of this Annual Report on
Form 10-K is included on page 22 in ITEM 8.
(A)(2) SCHEDULES.
The following schedules are supplemental to the financial statements of KILICO
and its subsidiaries for 1998 and are included in this Form 10-K on the pages
indicated below. All other schedules are omitted because the information
required to be stated therein is included in the financial statements or notes
thereto or because they are inapplicable.
<TABLE>
<CAPTION>
SCHEDULE TITLE PAGE
- -------- ----- ----
<C> <S> <C>
IV Reinsurance, for the year ended December 31, 1998*.......... 51
V Valuation and qualifying accounts, for the year ended
December 31, 1998*.......................................... 52
</TABLE>
- ---------------
* This schedule for the years ended December 31, 1997 and 1996 is incorporated
by reference to KILICO's Form 10-K filed on March 25, 1998 and on March 25,
1997, respectively.
(A)(3) EXHIBITS.
The exhibits listed on the accompanying Index to Exhibits on page 55 are filed
as part of this Annual Report on Form 10-K.
(B) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the fourth quarter of 1998.
49
<PAGE> 51
POWER OF ATTORNEY
Each person whose signature appears below hereby appoints Frederick L. Blackmon,
Senior Vice President and Chief Financial Officer, and David S. Jorgensen,
Corporate Controller, his true and lawful attorney-in-fact with authority
together or individually to execute in the name of each such signatory, and with
authority to file with the Securities and Exchange Commission, any and all
amendments to this Annual Report on Form 10-K, together with any exhibits
thereto and other documents therewith, necessary or advisable to enable Kemper
Investors Life Insurance Company to comply with the Securities Exchange Act of
1934, as amended, and any rules, regulations and requirements of the Securities
and Exchange Commission in respect thereof, which amendments may make such other
changes in the Annual Report on Form 10-K as the aforesaid attorney-in-fact
executing the same deems appropriate.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, Kemper Investors Life Insurance Company has duly caused this Annual Report
on Form 10-K for the fiscal year ended December 31, 1998 to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Long Grove,
State of Illinois, on the 26th day of March, 1999.
KEMPER INVESTORS LIFE INSURANCE COMPANY
By: /s/ JOHN B. SCOTT*
John B. Scott
President and Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES AND EXCHANGE ACT OF 1934, THIS
ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 HAS BEEN
SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF KEMPER INVESTORS LIFE
INSURANCE COMPANY IN THE CAPACITIES INDICATED ON THE 26TH DAY OF MARCH, 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ WILLIAM H. BOLINDER* Chairman of the Board
- -----------------------------------------------------------
William H. Bolinder
/s/ JOHN B. SCOTT* President, Chief Executive Officer and Director
- -----------------------------------------------------------
John B. Scott
/s/ FREDERICK L. BLACKMON* Senior Vice President and Chief Financial Officer
- -----------------------------------------------------------
Frederick L. Blackmon
/s/ LOREN J. ALTER* Director
- -----------------------------------------------------------
Loren J. Alter
* By: /s/ DAVID S. JORGENSEN Corporate Controller
- -----------------------------------------------------------
David S. Jorgensen,
Pursuant to a Power of Attorney
</TABLE>
50
<PAGE> 52
SCHEDULE IV
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
REINSURANCE
YEAR ENDED DECEMBER 31, 1998
(in thousands)
<TABLE>
<CAPTION>
CEDED TO ASSUMED PERCENTAGE OF
GROSS OTHER FROM OTHER NET AMOUNT
DESCRIPTION AMOUNT(1) COMPANIES(2) COMPANIES(3) AMOUNT ASSUMED TO NET
----------- --------- ------------ ------------ ------ --------------
<S> <C> <C> <C> <C> <C>
Life insurance in force........... $68,990,708 $(62,879,610) $11,682,256 $17,793,354 65.7%
=========== ============ =========== =========== =====
Life insurance premiums........... $ 810 $ (32) $ 21,569 $ 22,347 96.5%
=========== ============ =========== =========== =====
</TABLE>
- ---------------
(1) The significant increase in life insurance in force reflects $6.9 billion of
face amount issued related to individual and group variable bank-owned life
insurance contracts sold in 1998.
(2) Life insurance in force ceded to other companies was primarily ceded to an
affiliated company, ZC Life Reinsurance Limited.
(3) Premiums assumed during 1998 were from an affiliated company, Federal Kemper
Life Assurance Company.
51
<PAGE> 53
SCHEDULE V
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
YEAR ENDED DECEMBER 31, 1998
(in thousands)
<TABLE>
<CAPTION>
ADDITIONS
--------------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER ACCOUNTS-- DEDUCTIONS-- END OF
DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD
----------- ---------- ---------- ---------------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Asset valuation reserves:
Joint venture mortgage loans............... $-- $16,433 $-- $-- $16,433
Third-party mortgage loans................. -- -- -- -- --
Other real estate-related investments...... 6,779 -- -- 365 6,414
------ ------- --- ------- -------
Total $6,779 $16,433 $-- $ 365(1) $22,847
====== ======= === ======= =======
</TABLE>
- ---------------
(1) These deductions represent the net effect on the valuation reserve of
write-downs, sales, foreclosures and restructurings.
52
<PAGE> 54
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO.
<S> <C>
3(a) Articles of Incorporation are incorporated herein by
reference to Exhibits filed with Registration Statement on
Form S-1 (File No. 333-02491) filed on or about April 12,
1996.
3(b) Bylaws are incorporated herein by reference to Exhibits
filed with Registration Statement on Form S-1 (File No.
333-02491) filed on or about April 12, 1996.
4(a) Form of Variable and Market Value Adjusted Deferred Annuity
Contract is incorporated herein by reference to Exhibits
filed with Registration Statement on Form S-1 (File No.
33-43462) filed October 23, 1991.
4(b) Form of Certificate to Variable and Market Value Adjusted
Deferred Annuity Contract and Enrollment Application is
incorporated herein by reference to Exhibits filed with
Registration Statement on Form S-1 (File No. 33-43462) filed
October 23, 1991.
4(c) Form of Individual Variable and Market Value Adjusted
Annuity Contract and Enrollment Application is incorporated
herein by reference to Exhibits filed with Post-Effective
Amendment No. 4 to the Registration Statement on Form N-4
for KILICO Variable Annuity Separate Account (File No.
33-43501) filed November 19, 1993.
4(d) Form of Endorsement to Variable and Market Value Adjusted
Deferred Annuity Contract is incorporated herein by
reference to Exhibits filed with Post-Effective Amendment
No. 4 to the Registration Statement on Form N-4 for KILICO
Variable Annuity Separate Account (File No. 33-43501) filed
November 19, 1993.
4(e) Form of Endorsement to Certificate to Variable and Market
Value Adjusted Deferred Annuity Contract is incorporated
herein by reference to Exhibits filed with Post-Effective
Amendment No. 4 to the Registration Statement on Form N-4
for KILICO Variable Annuity Separate Account (File No.
33-43501) filed November 19, 1993.
4(f) Form of Revised Variable and Market Value Adjusted Deferred
Annuity Contract is incorporated herein by reference to
Exhibits filed with Post-Effective Amendment No. 4 to the
Registration Statement on Form N-4 for KILICO Variable
Annuity Separate Account (File No. 33-43501) filed November
19, 1993.
4(g) Form of Revised Certificate to Variable and Market Value
Adjusted Deferred Annuity Contract is incorporated herein by
reference to Exhibits filed with Post-Effective Amendment
No. 4 to the Registration Statement on Form N-4 for KILICO
Variable Annuity Separate Account (File No. 33-43501) filed
November 19, 1993.
10(a) Distribution Agreement between Kemper Investors Life
Insurance Company and Investors Brokerage Services, Inc. is
incorporated herein by reference to Exhibits filed with
Amendment No. 4 to Registration Statement on Form S-1 (File
No. 33-43462) filed on April 14, 1995.
</TABLE>
53
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE YEAR-END
FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 3,482,820
<DEBT-CARRYING-VALUE> 3,482,820
<DEBT-MARKET-VALUE> 3,482,820
<EQUITIES> 66,854
<MORTGAGE> 142,326
<REAL-ESTATE> 22,049
<TOTAL-INVEST> 4,169,349
<CASH> 13,486
<RECOVER-REINSURE> 344,837
<DEFERRED-ACQUISITION> 91,543
<TOTAL-ASSETS> 12,239,721
<POLICY-LOSSES> 3,561,554
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 318,369
<NOTES-PAYABLE> 0
0
0
<COMMON> 2,500
<OTHER-SE> 851,359
<TOTAL-LIABILITY-AND-EQUITY> 12,239,721
22,346
<INVESTMENT-INCOME> 273,512
<INVESTMENT-GAINS> 51,868
<OTHER-INCOME> 72,013
<BENEFITS> 204,935
<UNDERWRITING-AMORTIZATION> 12,082
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 104,953
<INCOME-TAX> 39,804
<INCOME-CONTINUING> 65,149
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 65,149
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
