<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1995.
/ / 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: 0-15253
KEMPER FINANCIAL COMPANIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 36-3451068
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
One Kemper Drive
Long Grove, Illinois 60049-0001
(Address of principal executive offices) (Zip Code)
708-320-4700
(Registrant's telephone number, including area code)
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 (or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes __X__ No ____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of October 1, 1995, 43,268,038 shares of Class A Common Stock (all held by
an affiliate, Kemper Corporation) and 5,103 shares of Class B Common Stock were
outstanding and not subject to mandatory redemption.
<PAGE> 2
KEMPER FINANCIAL COMPANIES, INC.
THIRD-QUARTER 1995
FORM 10-Q
PART I. FINANCIAL STATEMENTS Page
----
Consolidated Balance Sheet -
September 30, 1995 and December 31, 1994........................3
Consolidated Statement of Operations -
Three months and nine months ended September 30, 1995 and 1994..4
Consolidated Statement of Cash Flows -
Nine months ended September 30, 1995 and 1994...................5
Notes to Consolidated Financial Statements.........................6
Management's Discussion and Analysis -
Results of Operations...........................................9
Investments ...................................................22
Liquidity and Capital Resources................................33
PART II. OTHER INFORMATION
ITEM 5. Other Information.......................................36
ITEM 6. Exhibits and Reports on Form 8-K........................38
Signatures........................................................39
Exhibit 10........................................................40
Exhibit 27........................................................42
Exhibit 99........................................................43
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<PAGE> 3
KEMPER FINANCIAL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(in thousands, except share data)
(unaudited)
<TABLE>
<CAPTION>
September 30 December 31
1995 1994
------------ -----------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities available for sale, at market
(cost 1995, $3,563,761; 1994, $3,711,839) $3,594,381 $3,468,214
Short-term investments 341,115 204,164
Joint venture mortgage loans 408,300 407,540
Third-party mortgage loans 268,647 323,696
Other real estate-related investments 212,637 242,086
Policy loans 288,774 277,743
Other invested assets 59,240 55,363
---------- -----------
Total investments 5,173,094 4,978,806
Cash 219,127 199,917
Other accounts and notes receivable 499,585 321,494
Reinsurance recoverable 519,197 642,801
Deferred insurance acquisition costs 296,040 310,466
Deferred investment product sales costs 149,295 166,397
Fixed assets, at cost less accumulated depreciation 37,284 84,603
Other assets 54,421 63,393
Net assets of discontinued operations - 249,033
Assets of separate accounts 1,708,010 1,507,984
---------- ----------
Total assets $8,656,053 $8,524,894
========== ==========
LIABILITIES
Future policy benefits $4,607,610 $4,843,690
Other accounts payable and liabilities 945,459 910,593
Notes payable 1,048,935 1,095,128
Convertible debentures 10,783 33,113
Liabilities of separate accounts 1,708,010 1,507,984
---------- ----------
Total liabilities 8,320,797 8,390,508
---------- ----------
Commitments and contingent liabilities
STOCKHOLDERS' EQUITY
Class A common stock-$.10 par value
authorized 135,000,000 shares; outstanding 1995 and 1994, 43,268,038 shares 4,327 4,327
Additional paid-in capital 442,828 442,828
Unrealized loss on foreign currency translations (23,052) (22,512)
Unrealized gain (loss) on investments 12,856 (237,957)
Retained deficit (101,703) (52,300)
---------- ----------
Total stockholders' equity 335,256 134,386
---------- ----------
Total liabilities and stockholders' equity $8,656,053 $8,524,894
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE> 4
KEMPER FINANCIAL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Nine months ended Three months ended
September 30 September 30
------------------ ------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
REVENUE
Investment management and other fees $246,041 $274,143 $ 81,901 $ 87,258
Commissions 39,401 50,633 13,240 13,504
Investment income 273,971 249,920 87,322 96,543
Securities gain (loss), net 1,921 (657) 791 215
Realized investment gain (loss) 18,377 (21,794) 41,602 (12,016)
Other income 34,659 34,385 10,525 14,959
-------- -------- -------- --------
Total revenue 614,372 586,631 235,384 200,464
-------- -------- -------- --------
EXPENSES
Operating expenses 200,224 212,858 68,936 72,295
Benefits and interest credited to policyholders 183,592 186,231 60,395 61,718
Commissions 60,956 71,794 20,433 19,724
Deferral of mutual fund and insurance acquisition costs (52,799) (63,579) (17,960) (18,441)
Amortization of mutual fund and insurance acquisition costs 62,895 64,785 14,329 22,632
Interest expense 76,282 55,211 25,439 21,635
-------- -------- -------- --------
Total expenses 531,153 527,302 171,575 179,564
-------- -------- -------- --------
Earnings from continuing operations before tax 83,219 59,328 63,809 20,899
Income tax expense 45,290 22,104 22,608 7,469
-------- -------- -------- --------
Income from continuing operations 37,929 37,224 41,200 13,429
Loss from discontinued operations, net of tax (2,712) (3,000) - (3,116)
Loss on divestiture of discontinued operations, net of tax (84,619) - (18,082) -
-------- -------- -------- --------
Net income (loss) $(49,402) $ 34,223 $ 23,117 $ 10,313
======== ======== ======== ========
Income per share from continuing operations $ .88 $ .86 $ .95 $ .31
Loss per share from discontinued operations (2.02) (.07) (.42) (.07)
-------- -------- -------- --------
Net income (loss) per share $ (1.14) $ .79 $ .53 $ .24
======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE> 5
KEMPER FINANCIAL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine months ended
September 30
-----------------------
1995 1994
------ ------
<S> <C> <C>
Cash flows from operating activities
Net income (loss) $ (49,402) $ 34,223
Reconcilement of net income (loss) to net cash provided:
Realized investment gain (loss) (19,588) 21,794
Future policy benefits 177,290 181,547
Accounts payable and liabilities (51,066) (72,606)
Accounts and notes receivable 194,289 53,843
Deferred insurance acquisition costs (7,005) (10,772)
Deferred investment product sales costs (17,102) 11,977
Amortization of discount and premium on investments 3,281 (14,654)
Other (70,754) 69,134
--------- ---------
Net cash provided from operating activities 159,943 274,486
--------- ---------
Cash flows from investing activities
Cash from investments sold or matured:
Fixed maturities held to maturity 194,719 77,385
Fixed maturities sold prior to maturity 261,190 774,510
Mortgage loans, policy loans and other invested assets 162,660 300,070
Cost of investments purchased:
Fixed maturities (299,843) (1,421,655)
Mortgage loans, policy loans and other invested assets 47,300 (184,157)
Net change in receivable/payable for securities sold/purchased 94,842 171,874
Short-term investments, net (136,856) 177,754
Discontinued operations 46,400 13,000
Acquisition of Dreman Value Management, L.P. assets (17,086) -
Other (33,063) (24,268)
--------- ---------
Net cash provided from (used in) investing activities 320,263 (115,487)
--------- ---------
Cash flows from financing activities
Policyholder account balances:
Deposits 185,626 169,209
Withdrawals (598,996) (456,815)
Increase (decrease) in notes payable, net (16,123) 211,078
Redemption and maturities of convertible debentures (9,235) (28,580)
Other (22,268) (8,662)
--------- ---------
Net cash used in financing activities (460,996) (113,770)
--------- ---------
Net increase in cash 19,210 45,229
Cash, beginning of period 199,917 169,715
--------- ---------
Cash, end of period $ 219,127 214,944
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE> 6
KEMPER FINANCIAL COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. In the opinion of management, all necessary adjustments consisting of
normal recurring accruals have been made for a fair statement of operations
for the periods included in these financial statements. These financial
statements should be read in conjunction with the financial
statements and related notes in the 1994 Annual Report on Form 10-K.
Certain reclassifications have been made in these financial statements for
1994 to conform to the 1995 presentation.
2. Net income (loss) per share is based on the weighted average number of
common shares and common share equivalents outstanding during the periods.
The calculation of net income (loss) per share is as follows:
<TABLE>
<CAPTION>
Nine months ended Three months ended
September 30 September 30
----------------- ------------------
(in thousands, except per share data) 1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net income (loss) reported $(49,402) $34,223 $23,117 $10,313
Add back:
Interest and amortization expense on convertible
debentures, net of tax * * * *
-------- ------- ------- -------
Total $(49,402) $34,223 $23,117 $10,313
======== ======= ======= =======
Average common shares outstanding 43,273 43,278 43,273 43,280
Average common share equivalents outstanding * * * *
------- ------- ------- -------
Average common and equivalent shares outstanding 43,273 43,278 43,273 43,280
------- ------- ------- ------
Net income (loss) per share $ (1.14) $ .79 $ .53 $ .24
======= ======= ======= =======
</TABLE>
* The effect of employee interests in Kemper Financial Companies, Inc. (the
"Company") and the related costs are anti-dilutive for the period;
accordingly, the net income (loss) and common shares outstanding are not
adjusted.
3. Certain accounts receivable are stated less an allowance for doubtful
accounts of $1.0 million at September 30, 1995.
4. Restricted cash at September 30, 1995 totaled $0.0 million.
5. Federal income tax paid to Kemper Corporation under the tax allocation
arrangement for the nine months ended September 30, 1995 and 1994 amounted
to $73.2 million and $65.4 million, respectively. Interest payments for
the same periods totaled $75.9 million and $80.5 million, respectively.
6. Pursuant to Statement of Financial Accounting Standards ("SFAS") 109,
"Accounting for Income Taxes," deferred tax assets are recognized if future
realization of the tax benefit is more likely than not, with a valuation
allowance for the portion that is not likely to be realized. 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
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<PAGE> 7
reversals of the valuation allowance are contingent upon the
recognition of future capital gains in the consolidated federal income
tax return of Kemper Corporation or a change in circumstances which
causes the recognition of the benefits to become more likely than not.
During the first nine months of 1995, the valuation allowance was
decreased by $85.0 million. This decrease in the valuation allowance
solely relates to the decrease in the deferred federal tax asset from
unrealized losses on investments.
The tax effects of temporary differences that gave rise to significant
portions of the Company's net deferred federal tax liability from
continuing operations (included in "Other liabilities" in the
consolidated balance sheet) were as follows:
<TABLE>
<CAPTION>
September 30 December 31
(in thousands) 1995 1994
------------ -----------
<S> <C> <C>
Deferred federal tax assets:
Real estate-related $ 86,336 $ 112,667
Life policy reserves 45,077 51,519
Other investment-related 20,749 19,275
Net operating loss carry forward 16,199 -
Unrealized losses on investments 8,170 8,899
Accrued employee benefits 7,973 93,211
Accrued expenses 4,148 5,027
Other 10,598 9,625
-------- ---------
Total deferred federal tax assets 199,250 300,223
Valuation allowance (42,208) (127,249)
-------- ---------
Total deferred federal tax assets after valuation allowance 157,042 172,974
-------- ---------
Deferred federal tax liabilities:
Deferred insurance acquisition costs 103,614 108,663
Deferred investment product sales costs 52,253 58,239
Depreciation and amortization 21,125 20,055
Unrealized gains on investments 10,620 -
Other investment-related 808 4,346
Other 9,936 9,837
-------- ---------
Total deferred federal tax liabilities 198,356 201,140
-------- ---------
Net deferred federal tax liability $(41,314) $ (28,166)
======== =========
</TABLE>
The tax returns through the year 1986 have been examined by the Internal
Revenue Service ("IRS"). The tax returns for the years 1987 through 1990
are currently under examination by the IRS. Changes proposed are not
material to the Company's financial position.
7. During the nine months ended September 30, 1995, Kemper Financial
Services, Inc. sold its 50 percent interest in Investors Fiduciary Trust
Company and the business operations of a wholly owned subsidiary,
Supervised Service Company, Inc., and acquired the assets of Dreman Value
Management, L.P. See "RESULTS OF OPERATIONS - Asset management" in this
Form 10-Q.
8. The Company's divestiture of its securities brokerage segment was
completed on September 13, 1995. These operations have been classified as
discontinued operations at and for the periods ended September 30, 1995 and
1994. The following table sets forth selected financial information
regarding the discontinued securities brokerage operations:
- 7 -
<PAGE> 8
<TABLE>
<CAPTION>
Nine months ended Three months ended
September 30 September 30
---------------------- -------------------
1995 1994 1995 1994
------ ------ ------ ------
(in millions)
<S> <C> <C> <C> <C>
Revenue $357.9 $283.1 $ 97.3 $131.8
====== ====== ====== ======
Loss, net of tax $ (2.7) $ (3.0) $ - $ (3.1)
Loss on divestiture, net of tax (84.6) - (18.1) -
------ ------ ------ ------
Net loss $(87.3) $ (3.0) $(18.1) $ (3.1)
====== ====== ====== =======
<CAPTION>
December 31, 1994
-----------------
<S> <C>
Total assets $1,641.8
Total liabilities 1,392.8
--------
Net assets $ 249.0
========
</TABLE>
9. On May 15, 1995, Kemper Corporation entered into a definitive agreement to
be acquired in a merger transaction. See "Management's Discussion and
Analysis" on the following page.
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<PAGE> 9
MANAGEMENT'S DISCUSSION AND ANALYSIS
Kemper Corporation ("Kemper") signed a definitive merger agreement, dated May
15, 1995 and amended September 6, 1995, with Zurich Insurance Company
("Zurich"), Insurance Partners, L.P., Insurance Partners Offshore (Bermuda),
L.P., and ZIP Acquisition Corp. (the "Merger Agreement"). Incident to the
Merger Agreement, Kemper Financial Services, Inc. ("KFS") and its subsidiaries
are expected to be sold to Zurich in a related merger transaction for a total
consideration of approximately $930 million. Consummation of the Merger
Agreement and related transactions is subject to certain remaining conditions,
including certain approvals by state insurance regulators and the common
stockholders of Kemper. The transactions are expected to close in early
January 1996. (See Part II, ITEM 5 below.)
On a fully converted basis, Kemper Financial Companies, Inc. ("KFC") is
approximately 99 percent owned by Kemper, with the remaining interests held by
employees. In the fourth quarter of 1995, KFC announced its intent to redeem
or repurchase all remaining outstanding employee-owned convertible debentures
and common stock prior to year-end 1995. Upon successfull completion of these
transactions, KFC likely would be merged with and into Kemper in early January
1996, prior to Kemper's merger pursuant to the Merger Agreement. (See
"LIQUIDITY AND CAPITAL RESOURCES - Convertible debentures and redeemable
securities" below.) KFC and its subsidiaries are referred to herein as the
"Company."
RESULTS OF OPERATIONS
The following table is a summary of the Company's results by category, for the
periods ended September 30, 1995 and 1994:
Summary of Income (Loss) by Category
(in millions)
<TABLE>
<CAPTION>
Nine months ended September 30, 1995 Nine months ended September 30, 1994
------------------------------------ ------------------------------------
Net Net
realized Net realized Net
Operating investment income Operating investment income
earnings(1) results(2) (loss) earnings(1) results(2) (loss)
----------- --------- ------ ----------- ---------- ------
<S> <C> <C> <C> <C> <C> <C>
Asset management $ 46.3 $ 24.1 $ 70.4 $ 57.4 $ - $ 57.4
Life insurance 52.4 (27.5) 24.9 44.4 (20.0) 24.4
Real estate (11.1) - (11.1) (18.8) 6.0 (12.8)
Other (46.3) - (46.3) (31.5) (.2) (31.7)
------ ------ ------ ------ ----- -----
Continuing operations 41.3 (3.4) 37.9 51.5 (14.2) 37.2
Discontinued operations (2.7) (84.6) (87.3) (3.0) - (3.0)
------ ------ ------ ------ ----- -----
Total $ 38.6 $(88.0) $(49.4) $ 48.5 $(14.2) $ 34.2
====== ====== ====== ====== ====== ======
</TABLE>
(1) Net income (loss) excluding realized investment results.
(2) See following table for realized investment results.
- 9 -
<PAGE> 10
Realized investment gain (loss)
(in millions)
<TABLE>
<CAPTION>
Nine months ended Three months ended
September 30 September 30
---------------------- ----------------------
1995 1994 1995 1994
----- ----- ----- -----
<S> <C> <C> <C> <C>
Real estate-related gains (losses) $(53.6) $ (6.3) $(0.2) $ 15.0
Gain on sale of IFTC, SSC & State Street 47.5 - (0.7) -
Orange County-related reserve adjustment 13.6 - 38.4 -
Other gains and losses, net 10.9 (15.5) 4.1 (27.0)
------ ------ ------ ------
Realized investment gain (loss)
from continuing operations 18.4 (21.8) 41.6 (12.0)
Income tax expense (benefit) 21.8 (7.6) 14.5 (4.2)
------ ------ ------ ------
Net realized investment gain (loss)
from continuing operations (3.4) (14.2) 27.1 (7.8)
Loss on divestiture of discontinued
operations, net of tax (84.6) - (18.1) -
------ ------ ------ ------
Total $(88.0) $(14.2) $ 9.0 $ (7.8)
====== ====== ====== ======
</TABLE>
Continuing operations
Operating earnings for continuing operations were $41.3 million for the first
nine months of 1995, compared with $51.5 million in the same 1994 period.
Operating earnings for the third quarter of 1995 totaled $14.1 million,
compared with $21.3 million for the same period of 1994. The 1995 nine-month
results reflect increased spreads on fixed rate annuities and expense control
in the life insurance segment. The real estate segment benefited from reduced
joint venture operating losses in the nine month 1995 period but had higher
operating expenses due to merger-related costs in both periods of 1995. Asset
management earnings declined in both the nine-month and third-quarter periods
of 1995 largely due to reduced management fees, distribution fees and
commission income.
Net income from continuing operations totaled $37.9 million in the first nine
months of 1995, compared with net income of $37.2 million in the first nine
months of 1994. The Company reported third-quarter 1995 net income of $41.2
million, compared with net income of $13.4 million in the third quarter of
1994. Increased net income for the nine-month and third-quarter periods of
1995 resulted from an Orange County-related reserve adjustment of $25.7 million
after tax in the asset management segment, which more than offset other net
realized investment losses.
The other operations and corporate category consists of the holding company
income and expenses of KFC. This category reported a net loss of $46.3 million
for the first nine months of 1995, compared with a net loss of $31.7 million
for the same period of 1994. The 1994 results reflect realized investment
losses of $0.2 million after tax. The net loss increased in 1995 primarily due
to an increase in interest expense over 1994 on increased borrowings from
Kemper.
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<PAGE> 11
Total operations
Including discontinued operations, the Company's net income totaled $49.4
million for the first nine months of 1995, compared with net income of $34.2
million for the first nine months of 1994. Net loss per share for the first
nine months of 1995 was $1.14, compared with net income per share of $0.79 in
the first nine months of 1994. The Company recorded net income of $23.1
million, or $0.53 per share, in the third quarter of 1995, compared with
$10.3 million, or $0.24 per share, in the same period of 1994.
Discontinued operations consist of the Company's former securities brokerage
segment which was divested on September 13, 1995. The divestiture is further
described in a current report on Form 8-K dated August 24, 1995 which the
Company filed September 28, 1995 and which is incorporated herein by reference.
In the first nine months of 1995, the net loss from discontinued operations
totaled $87.3 million, primarily due to an $84.6 million loss related to the
divestiture. In the first nine months of 1994, the net loss from discontinued
operations totaled $3.0 million, reflecting securities brokerage operating
losses.
Book value per share, on a fully converted basis, was $7.98 at September 30,
1995, compared with $3.85 at year-end 1994, as the change in unrealized gain on
investments of $250.8 million, or $5.73 per share, in the first nine months of
1995 more than offset the net loss per share. Taking into account results for
the trailing 24 months ended September 30, 1995, the formula purchase price per
share would be a positive $13.06 at September 30, 1995, compared with a
negative $3.29 at December 31, 1994.
Net income (loss) per share in the following segment discussions is on a
primary basis.
- 11 -
<PAGE> 12
Asset management
The asset management segment principally consists of KFS and its subsidiaries,
including Kemper Service Company ("KSvC") and INVEST Financial Corporation
("INVEST").
Selected Financial Highlights
(in millions, except per share data)
<TABLE>
<CAPTION>
Nine months ended September 30 Three months ended September 30
------------------------------ -------------------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
STATEMENT OF INCOME
Investment management fees $154.5 $164.8 $ 53.7 $ 52.7
Commission income 44.5 56.7 15.2 15.8
Distribution and redemption fees 43.5 52.4 14.1 16.1
Transfer agent revenue 48.1 56.5 14.1 18.2
Investment and other income 15.7 15.4 5.1 6.8
Realized investment gain 60.7 - 37.2 -
------ ------ ------ ------
Total revenue 367.0 345.8 139.4 109.6
------ ------ ------ ------
Operating expenses 167.8 186.4 56.2 59.1
Commission expense 47.6 58.2 16.2 16.1
Deferral of mutual fund commissions
and sales expense (22.3) (30.0) (7.6) (7.6)
Amortization of deferred mutual fund
commissions and sales expense 39.4 42.0 12.8 14.5
------ ------ ------ ------
Total expenses 232.5 256.6 77.6 82.1
------ ------ ------ ------
Earnings before income tax 134.5 89.2 61.8 27.5
Income tax expense 64.1 31.8 22.4 9.6
------ ------ ------ ------
Net income $ 70.4 $ 57.4 $ 39.4 $ 17.9
====== ====== ====== ======
Realized investment gain, net of tax $ 24.1 $ - $ 24.2 $ -
====== ====== ====== ======
Operating earnings $ 46.3 $ 57.4 $ 15.2 $ 17.9
====== ====== ====== ======
Per share:
Operating earnings $ 1.07 $ 1.33 $ .35 $ .41
====== ====== ====== ======
Net income $ 1.63 $ 1.33 $ .91 $ .41
====== ====== ====== ======
</TABLE>
The asset management segment's net income for the first nine months of 1995
increased $13.0 million from the first nine months of 1994. This increase was
primarily due to net realized investment gains of $11.6 million in the first
quarter of 1995 from the sale of KFS' 50 percent interest in Investors
Fiduciary Trust Company ("IFTC"), $4.4 million in the second quarter of 1995
from the sale of shares of State Street Boston Corporation ("State Street")
common stock, and an $8.8 million increase in the value of certain Orange
County securities. These gains were offset by an $11.1 million decrease in
operating earnings.
On January 31, 1995, KFS sold its 50 percent interest in IFTC to State Street
in exchange for 2,986,111 shares of State Street common stock with a market
value of $98.2 million at that date. On June 21, 1995, KFS sold all of its
shares of State Street stock and received approximately $105.0 million. IFTC
contributed $0.6 million and $4.5 million of the segment's operating earnings
recorded in the first nine months of 1995 and 1994, respectively.
Increasing the segment's nine-month 1995 realized investment gain was an
- 12 -
<PAGE> 13
Orange County-related reserve adjustment of $8.8 million after tax. The
Company bears the risk of loss associated with $198.0 million face amount of
notes issued by Orange County, California held by five non-government taxable
money market mutual funds managed by KFS. The reserve adjustment reflected an
increase in the estimated value of the notes at September 30, 1995. Orange
County, which filed for bankruptcy protection in December 1994, has made the
monthly interest payments on the notes to date. The five affected Kemper money
market funds have consented to extend the maturity date of the notes to June
30, 1996. The original maturity date was July 10, 1995. Kemper's bank letter
of credit arrangements with respect to the Orange County notes were also
extended through the new maturity date.
Reduced management fees, distribution and redemption fees, transfer agent fees
and commission income all contributed to the segment's decrease in operating
earnings. These revenue reductions were partially offset by reduced operating
and commission expenses (see discussion below).
The decrease of $10.3 million in investment management fees in the first nine
months of 1995, compared with the first three quarters of 1994, was primarily
due to a $2.3 billion reduction in mutual fund average assets under management.
Bond funds accounted for a $2.5 billion decrease, while stock funds were
virtually flat and money market funds represented an increase of $0.2 billion.
Commission income was $44.5 million in the first nine months of 1995, compared
with $56.7 million for the same period last year, due to lower sales of most
products. At INVEST, the segment's principal producer of commission revenue,
commissions on the sale of mutual fund products declined $5.7 million in the
first nine months of 1995, compared with the same period in 1994. Decreased
sales of annuity products also adversely affected INVEST's revenue, as
commissions declined $6.5 million for the first three quarters of 1995,
compared with the same period in 1994. INVEST's year-to-date 1995 sales were
down in large part because of favorable interest rates available from competing
products in the bank distribution system.
Distribution and redemption fee revenue decreased $8.9 million in the first
nine months of 1995 compared with the first nine months of 1994. Distribution
fees, based on assets managed in KFS' spread load mutual funds, were
approximately $6.4 million lower as average spread load assets were lower in
1995 than in 1994 primarily due to redemptions of shares and routine
conversions of spread load assets to front-end load shares which are exempt
from distribution fees. Receipt of contingent deferred sales charges from
redemption activity also declined as redemptions from spread load funds were
lower during the 1995 period.
Transfer agent revenue decreased to $48.1 million in the first nine months of
1995 from $56.5 million in the same period last year. This $8.4 million
decrease was primarily due to reductions in the number of transactions and new
account activity, fee caps on spread load and level load assets, and cessation
of unit investment trust processing in 1995. In addition, Supervised Service
Company, Inc. ("SSC") transfer agent fees decreased approximately $2.7 million
during the period due to the sale of its business operations described below.
KSvC accounted for transfer agent revenue of $44.8 million and $50.5 million in
the first nine months
- 13 -
<PAGE> 14
of 1995 and 1994, respectively. SSC accounted for transfer agent revenue of
$3.3 million and $6.0 million in the first nine months of 1995 and 1994,
respectively.
In April and July 1995, KFS sold 5,034 and 3,844, respectively, of its original
12,500 shares of Dimensional Fund Advisors, Inc. ("DFA") for approximately $2.2
million and $1.7 million, respectively. In July, KFS also entered into an
agreement to sell its remaining 3,622 shares of DFA for approximately $1.5
million. Realized investment gains of approximately $280,000 and $214,000 were
attributable to the April and July sales, respectively, and an additional gain
of approximately $201,000 is expected to be realized in December 1995.
Operating expenses declined by $18.6 million in the first nine months of 1995,
compared with the first nine months of 1994. Personnel expenses decreased
approximately $12.0 million due to staff reductions and reductions in
production-related compensation due to lower sales. Expense reductions in
advertising, literature and sales promotion of mutual fund products
approximated $1.4 million. Transfer agent technology costs were $6.0 million
lower during the period due to the SSC transaction with DST Systems, Inc.
("DST") described below. Professional services expenses increased by
approximately $2.0 million primarily due to litigation-related expenses.
Commission expense decreased to $47.6 million in the first nine months of 1995,
compared with $58.2 million in the first nine months of 1994, due to lower
sales. With the reduction of sales there was a related decrease in the
deferral of mutual fund commissions and sales expense. Amortization of
deferred mutual fund commissions and sales expense also decreased during 1995.
The decrease was due to greater than planned investment performance in the
spread load funds in 1995, and was partially offset by a shortening of the
amortization period in 1995 for expenses related to sales of front-end load
mutual funds at net asset value.
In April 1995, KSvC sold to DST certain of its assets as well as the business
operations of SSC, including certain internally-developed transfer agent
recordkeeping software. The Company also entered into a long-term remote
processing agreement with DST. In conjunction with the sale, KSvC took a
write-down on the carrying value of its data center equipment assets as the
area is being downsized. The net impact of the sale to DST and KSvC's
write-down was immaterial to the segment's financial results.
On August 24, 1995, KFS completed the acquisition of substantially all the
assets of Dreman Value Management, L.P. ("Dreman"). The acquisition broadens
KFS' retail and institutional product offerings to include the value style of
equity investing and complements KFS' current growth style. Dreman had
approximately $1.5 billion in institutional assets under management and $77.0
million in mutual fund assets now managed by a KFS subsidiary.
- 14 -
<PAGE> 15
Assets under management
(in billions)
<TABLE>
<CAPTION>
9/30/95 6/30/95 3/31/95 12/31/94 9/30/94
------- ------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
Mutual funds:
Bond $21.0 $21.1 $21.0 $20.6 $21.9
Stock 10.1 9.4 8.9 8.7 9.0
Money market 13.1 12.6 12.1 12.2 12.3
Investment advisory 5.2 4.6 4.5 5.0 5.6
Kemper Corporation
affiliates 8.8 9.0 9.1 9.3 9.6
The Kemper National
Insurance Companies 6.7 6.6 6.6 6.9 7.0
----- ----- ----- ----- -----
Total $64.9 $63.3 $62.2 $62.7 $65.4
===== ===== ===== ===== =====
</TABLE>
Bond and stock mutual fund assets under management increased $1.8 billion from
December 31, 1994 primarily due to market value appreciation. Bond and stock
funds had asset appreciation of $4.6 billion in the first nine months of 1995,
compared with asset depreciation of approximately $1.2 billion in the first
nine months of 1994. Redemptions of stock and bond funds totaled $3.9 billion
in the first nine months of 1995, while sales totaled $1.6 billion. Comparable
nine-month 1994 redemptions and sales totals were $4.6 billion and $2.2
billion, respectively. Bond funds made up 64 percent of the redemption volume
in the first nine months of 1995, down from 77 percent in the same period last
year. Sales of stock mutual funds represented 45 percent of total stock and
bond fund sales in the first nine months of 1995, up slightly from 43 percent
in the first nine months of 1994.
Money market fund assets under management increased $0.9 billion in the first
nine months of 1995, as net sales in wholesale-distributed money funds were
positive for the period.
The increase in investment advisory assets in the first nine months of 1995 was
primarily due to the acquisition of Dreman discussed above. This increase was
tempered by a loss of advisory client assets in the first nine months of 1995
due to uncertainties with respect to KFS' ownership, portfolio management
turnover, and investment performance-related factors. The Company believes
organizational stability affects the relationships with institutional clients
and the retention of their assets.
The Kemper National Retirement Plan, representing approximately $0.3 billion in
assets under management, was transferred from Kemper Corporation affiliates to
the investment advisory category in the first nine months of 1995. Prior
periods in the table above have been restated.
The declines in assets managed for Lumbermens Mutual Casualty Company
("Lumbermens") and its affiliates (together with Lumbermens, the "Kemper
National Insurance Companies") and Kemper Corporation affiliates were primarily
due to reductions in real estate-related assets. These declines do not affect
the asset management segment's revenue or net income. (See "Real Estate"
below.)
- 15 -
<PAGE> 16
Life insurance
The life insurance segment consists of Kemper Investors Life Insurance Company
("KILICO") and its subsidiaries.
Selected financial highlights
(in millions, except per share data)
<TABLE>
<CAPTION>
Nine months ended Three months ended
September 30 September 30
------------------- -------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
STATEMENT OF INCOME
Investment income $ 266.7 $ 260.5 $ 87.5 $ 94.7
Other income 25.4 23.6 8.0 7.8
Realized investment gain (loss) (42.3) (30.8) 4.4 (25.8)
------- ------- ------- ------
Total revenue 249.8 253.3 99.9 76.7
------- ------- ------- ------
Benefits to policyholders 183.6 186.2 60.4 61.7
Commissions, taxes, licenses and fees 21.0 20.0 6.9 6.4
Operating expenses 15.4 19.4 5.7 6.5
Deferral of policy acquisition costs (30.5) (33.5) (10.3) (10.8)
Amortization of deferred policy
acquisition costs 23.5 22.8 1.5 8.1
------- ------- ------- ------
Total benefits and expenses 213.0 214.8 64.2 71.9
------- ------- ------- ------
Earnings before income tax 36.8 38.4 35.6 4.8
Income tax expense 11.9 14.0 11.9 1.8
------- ------- ------ ------
Net income $ 24.9 $ 24.4 $ 23.7 $ 3.0
======= ======= ======= ======
Realized investment gain (loss),
net of tax $ (27.5) $ (20.0) $ 2.8 $(16.7)
======= ======= ======= ======
Operating earnings $ 52.4 $ 44.4 $ 20.9 $ 19.7
======= ======= ======= ======
Per share:
Operating earnings $ 1.21 $ 1.03 $ .48 $ .46
======= ======= ======= ======
Net income $ .58 $ .56 $ .55 $ .07
======= ======= ======= ======
</TABLE>
The life insurance segment reported net income in the first nine months of 1995
of $24.9 million, compared with net income of $24.4 million in the first nine
months of 1994. Net income increased despite higher realized investment losses
in the first nine months of 1995, compared with the same period in 1994. See
the discussion captioned "Real Estate Asset Sales" in ITEM 5 below.
The following table reflects the major components of realized
investment gains (losses) included in net income:
Realized investment gains (losses):
<TABLE>
<CAPTION>
(in millions) Nine months ended Three months ended
September 30 September 30
------------------ ------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
Real estate-related losses $(53.6) $(18.1) $ (0.2) $ -
Fixed maturity write-downs (1.8) (0.1) (1.8) -
Other gains (losses), net 13.1 12.6 6.4 (25.8)
------ ------ ------ ------
Realized investment gains (losses) (42.3) (30.8) 4.4 (25.8)
Income tax expense (benefit) (14.8) (10.8) 1.6 (9.1)
------ ------ ------ ------
Net realized investment gains (losses) $(27.5) $(20.0) $ 2.8 $(16.7)
====== ====== ====== ======
</TABLE>
- 16 -
<PAGE> 17
Operating earnings improved to $52.5 million in the first nine months of 1995,
compared with $44.4 million in the first nine months of 1994, primarily due to
improvements in spread income and reductions in operating expenses.
KILICO improved spread income by increasing investment income and by also
reducing crediting rates on certain existing blocks of fixed annuity and
interest-sensitive life insurance products through most of 1994. Such
reductions in crediting rates occurred as overall interest rates also declined.
Operating earnings then began to improve as crediting rates declined at a
faster rate than KILICO's investment income. Beginning in late 1994,
however, as a result of rising interest rates and other competitive
market factors, KILICO began to increase crediting rates on such
interest-sensitive products, which actions adversely impacted spread income.
The recent declines in interest rates during the second and third quarters of
1995, however, have mitigated at present competitive pressures to increase
renewal crediting rates further.
Investment income was positively impacted in the first nine months of 1995,
compared with the first nine months of 1994, from reductions in the level of
non-performing real estate-related investments, primarily from sales of certain
real estate-related investments to affiliated non-life realty companies. These
sales totaled $3.5 million in the first nine months of 1995 and $133.8 million
in the first nine months of 1994 and resulted in no realized gain or loss to
KILICO.
Investment income in 1995 also benefited from a repositioning of KILICO's fixed
maturity investment portfolio in September 1994. The repositioning of KILICO's
investment portfolio involved the sale of $330.7 million of fixed maturity
investments, which consisted of lower yielding investment-grade corporate
securities and collateralized mortgage obligations. The $306.9 million of
proceeds from the repositioning, together with $275.0 million of other cash and
short-term investments, were reinvested into higher yielding U.S. government
and agency guaranteed mortgage pass-through securities issued by the Government
National Mortgage Association and the Federal National Mortgage Association.
See "INVESTMENTS" below.
Life insurance sales
(in millions)
<TABLE>
<CAPTION>
Nine months ended Three months ended
September 30 September 30
----------------- ------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
Annuities:
General account $ 185.3 $ 168.5 $ 60.2 $ 53.7
Separate account 114.7 202.4 28.0 55.7
------- ------- ------- -------
Total annuities 300.0 370.9 88.2 109.4
Interest-sensitive life insurance .3 .7 .3 -
------- ------- ------- -------
Total sales $ 300.3 $ 371.6 $ 88.5 $ 109.4
======= ======= ======= =======
</TABLE>
Sales of annuity products consist of total deposits received. The increase in
general account (fixed annuity) sales reflected KILICO's current strategy to
increase sales of fixed annuities in the current interest rate environment.
KILICO's longer-term strategy is to direct its sales efforts toward separate
account (variable annuity) products, which
- 17 -
<PAGE> 18
increase administrative fees earned and pose minimal investment risk for KILICO
as policyholders invest in one or more of several underlying investment funds.
Despite this strategy, separate account sales declined in the first nine months
of 1995, compared with the first nine months of 1994. This decline was due to
competitive conditions in certain distribution channels, in part reflecting
KILICO's financial strength and performance ratings and uncertainty concerning
KILICO's ownership.
Included in fees and other income are administrative fees received from
KILICO's separate account products of $16.1 million in the first nine months of
1995, compared with $15.6 million in the first nine months of 1994. Other
income also included surrender charge revenue of $6.3 million in the first nine
months of 1995, compared with $5.2 million in the first nine months of 1994, as
total general account and separate account policyholder surrenders and
withdrawals increased to $778.4 million in the first nine months of 1995,
compared with $541.0 million in the first nine months of 1994.
Policyholder surrenders and withdrawals
(in millions)
<TABLE>
<CAPTION>
Nine months ended Three months ended
September 30 September 30
----------------- ------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
General account $ 622.4 $ 435.4 $ 159.4 $ 159.8
Separate account 156.0 105.6 45.6 34.6
------- ------- ------- -------
Total $ 778.4 $ 541.0 $ 205.0 $ 194.4
======= ======= ======= =======
</TABLE>
Policyholder withdrawals increased during the first nine months of 1995. See
"LIQUIDITY AND CAPITAL RESOURCES - Consolidated" below. KILICO's crediting
rate increases in late 1994 and in early 1995 were designed to reduce the level
of future withdrawals. As a result of increases in renewal crediting rates and
declining interest rates in the second and third quarters of 1995, together
with the benefits of the planned association with Zurich, policyholder
surrenders and withdrawals for the quarter ended September 30, 1995 declined
from the level of surrenders and withdrawals in the first two quarters of 1995.
KILICO expects that the level of its surrender and withdrawal activity should
remain relatively stable for the remainder of 1995.
The deferral of insurance acquisition costs was lower in the first nine months
of 1995, compared with the first nine months of 1994, primarily reflecting
lower overall annuity sales. The amortization of insurance acquisition costs
increased in the first nine months of 1995, compared with the first nine months
of 1994, primarily as a result of an increase in policyholder withdrawals and
increasing renewal crediting rates. Policyholder withdrawals and increasing
renewal crediting rates adversely impact the amortization of insurance
acquisition costs as both would be expected to decrease KILICO's projected
future estimated gross profits.
Commissions, taxes, licenses and fees increased $1.0 million during the first
nine months of 1995, compared with the first nine months of 1994, primarily due
to an increase in guaranty fund assessments for insolvent life insurance
companies.
Operating expenses decreased by $4.0 million, or 20.5 percent, in
- 18 -
<PAGE> 19
the first nine months of 1995, compared with the first nine months of 1994,
primarily as a result of expense control efforts.
Since year-end 1990, KILICO has taken many steps to improve its earnings,
financial strength and competitive marketing position. These steps included
adjustments in crediting rates, reductions of operating expenses, reductions of
below investment-grade securities, a strategy not to embark on new real estate
projects, additional provisions for real estate-related losses, sales of $646.0
million of certain real estate-related investments to affiliated non-life
realty companies through September 30, 1995, third-party sales and refinancings
of certain mortgage and other real estate loans, approximately $900 million in
annuity reinsurance transactions with an affiliated mutual life insurance
company, a parental guarantee of any indebtedness, and capital contributions of
$342.5 million through September 30, 1995. KILICO's statutory surplus ratio
improved to 12.3 percent at September 30, 1995 from 10.2 percent at December
31, 1994, 8.2 percent at December 31, 1993, 6.6 percent at December 31, 1992,
6.5 percent at December 31, 1991, and 4.0 percent at year-end 1990.
The following tables reflect selected balance sheet data of the life insurance
segment:
Invested assets and cash
<TABLE>
<CAPTION>
(in millions) September 30 December 31
1995 1994
------------ -----------
<S> <C> <C>
Cash and short-term investments $ 336 6.6% $ 227 4.6%
Fixed maturities:
Investment-grade:
NAIC(1) Class 1 2,894 57.0 2,569 52.2
NAIC(1) Class 2 624 12.3 760 15.5
Below investment-grade:(2)
Performing 67 1.3 135 2.8
Non-performing 4 .1 - -
Equity securities 4 .1 15 0.3
Joint venture mortgage loans(3)(4) 343 6.8 351 7.1
Third-party mortgage loans(3)(4) 262 5.2 319 6.5
Other real estate-related investments(4) 226 4.5 237 4.8
Other 314 6.1 304 6.2
------ ----- ------ -----
Total(5) $5,074 100.0% $4,917 100.0%
====== ===== ====== =====
</TABLE>
(1) National Association of Insurance Commissioners ("NAIC").
- Class 1 = A- and above
- Class 2 = BBB- through BBB+
(2) Excludes $27.6 million, or 0.5 percent, and $49.9 million, or 1.0 percent,
at September 30, 1995 and December 31, 1994, respectively, of bonds
carried in other real estate-related investments.
(3) A joint venture mortgage loan is recharacterized in the current period as
a third-party mortgage loan when the Company and its affiliates have
disposed of their related equity interest in that venture.
(4) See table captioned "Summary of gross and net real estate investments"
below.
(5) See "INVESTMENTS" below.
Other selected balance sheet data
(in millions)
<TABLE>
<CAPTION>
September 30 December 31
1995 1994
------------ -----------
<S> <C> <C>
Deferred insurance acquisition costs $ 296 $ 310
Assets of separate accounts 1,708 1,508
Total assets 7,765 7,537
Life policy benefits, net of ceded reinsurance 4,607 4,844
Net unrealized gain (loss) on investments 13 (236)
Stockholder's equity 708 434
</TABLE>
- 19 -
<PAGE> 20
Real estate
This segment consists of the Company's real estate subsidiaries. These
subsidiaries include companies which act as general or limited partners in and
lenders to various joint ventures. Loans held by these subsidiaries are
subordinate to loans held by the Company's life insurance subsidiary.
Selected financial highlights
(in millions, except per share data)
<TABLE>
<CAPTION>
Nine months ended September 30 Three months ended September 30
------------------------------ -------------------------------
1995 1994 1995 1994
STATEMENT OF INCOME ------- ------- ------- -------
<S> <C> <C> <C> <C>
Joint venture operating losses $ (10.4) $ (27.5) $ (6.6) $ (6.2)
Investment income and other 8.5 10.8 3.2 4.1
Realized investment gain - 9.3 - 13.8
------- ------- ------- -------
Total revenue (1.9) (7.4) (3.4) 11.7
------- ------- ------- -------
Operating expenses 14.1 10.5 6.1 3.5
Interest expense .9 1.8 .3 .4
------- ------- ------- -------
Total expenses 15.0 12.3 6.4 3.9
------- ------- ------- -------
Income (loss) before income tax (16.9) (19.7) (9.8) 7.8
Income tax expense (benefit) (5.8) (6.9) (3.4) 2.7
------- ------- ------- -------
Net income (loss) $ (11.1) $ (12.8) $ (6.4) $ 5.1
======= ======= ======= =======
Realized investment gain,
net of tax $ - $ 6.0 $ - $ 9.0
======= ======= ======= =======
Operating loss $ (11.1) $ (18.8) $ (6.4) $ (3.9)
======= ======= ======= =======
Per share:
Operating loss $ (.26) $ (.44) $ (.15) $ (.09)
======= ======= ======= =======
Net income (loss) $ (.26) $ (.30) $ (.15) $ .12
======= ======= ======= =======
</TABLE>
The $17.1 million joint venture operating loss decline in the first nine months
of 1995, compared with the year ago period, was primarily due to certain joint
venture audit adjustments in the first nine months of 1995. The decline also
reflected sales and restructurings in both 1994 and 1995 with respect to
certain joint ventures, which reduced the level of operating losses the Company
was required to record. Audit adjustments to certain ventures' 1994 operating
losses reported to the Company in 1995 included $3.0 million relating to
recognizing gains in certain property sales which previously were deferred and
$3.9 million relating to interest on third-party debt previously expensed in
1994 which was capitalized in the first nine months of 1995.
For a description of certain real estate sales in 1995, see "Real Estate Asset
Sales" in ITEM 5 below.
In the first nine months of 1994, such sales included real estate investment
trust ("REIT") transactions, and such restructurings included a transaction in
which the interest payment terms of certain loans held by the Company, Fidelity
Life Association and the Kemper National Insurance Companies were amended,
effective January 1, 1994, to make interest payments contingent on cash being
available. This restructuring transaction reduced joint venture operating
losses in 1994 by $6.5 million and was recorded in the second half of 1994.
Investment and other income declined $2.3 million in the first nine
- 20 -
<PAGE> 21
months of 1995 primarily due to a reduction in real estate management fee
income as a result of a lower level of real estate assets under management.
While mostly attributable to a decline in real estate assets managed, this
decrease was also in part due to the Kemper National Insurance Companies
engaging a third-party real estate asset manager effective January 1, 1995. In
the first nine months of 1994, this segment recorded $0.6 million of real
estate management fee revenue from managing real estate assets of the Kemper
National Insurance Companies.
In the first nine months of 1995, the segment generated realized gains at a
level equal to additions to reserves and write-downs. In the first nine months
of 1994, sales and other transfers to third parties of certain equity
investments in real estate, which had negative carrying values, generated
realized gains in excess of the real estate segment's additions to reserves and
write-downs.
The following table reflects selected balance sheet data of the real estate
segment:
Selected balance sheet data
(in millions)
<TABLE>
<CAPTION>
September 30 December 31
1995 1994
------------ -----------
<S> <C> <C>
Cash and short-term investments $ 10 $ 9
Joint venture mortgage loans (1) 66 61
Third-party mortgage loans (1) 6 5
Other real estate-related investments (1) (13) 5
Other 5 4
---- ----
Total invested assets and cash (2) $ 74 $ 84
==== ====
Net deferred federal tax asset $ 29 $ 52
Total assets 208 234
Long-term debt 13 13
Stockholder's equity 169 181
</TABLE>
(1) See the table captioned "Summary of gross and net real estate investments"
below.
(2) See "INVESTMENTS" below.
- 21 -
<PAGE> 22
INVESTMENTS
The Company's invested assets predominately reflect investments of its life
insurance and real estate subsidiaries. The Company's principal investment
strategy is to maintain a balanced, well-diversified portfolio supporting
insurance contracts written by its life insurance subsidiary. The Company's
subsidiaries make shifts in their investment portfolios depending on, among
other factors, the interest rate environment, liability durations and changes
in market and business conditions.
Invested assets and cash
<TABLE>
<CAPTION>
(in millions) September 30 December 31
1995 1994
------------- -----------
<S> <C> <C>
Cash and short-term investments $ 560 10.4% $ 404 7.8%
Fixed maturities
Investment-grade:
NAIC(1) Class 1 2,894 53.7 2,569 49.6
NAIC(1) Class 2 624 11.6 760 14.7
Below investment-grade:(2)
Performing 72 1.3 139 2.7
Nonperforming 4 0.1 - -
Joint venture mortgage loans(3)(4) 408 7.5 407 7.9
Third-party mortgage loans(3)(4) 269 5.0 324 6.2
Other real estate-related investments(4) 213 4.0 242 4.7
Policy loans 289 5.3 278 5.4
Other 59 1.1 55 1.1
------ ----- ------ -----
Total $5,392 100.0% $5,179 100.0%
====== ===== ====== =====
</TABLE>
(1) National Association of Insurance Commissioners ("NAIC").
- Class 1 = A- and above
- Class 2 = BBB- through BBB+
(2) Excludes $52.5 million, or 1.0 percent, and $80.0 million, or 1.5 percent,
at September 30, 1995 and December 31, 1994, respectively, of bonds
carried in other real estate-related investments.
(3) A joint venture mortgage loan is recharacterized in the current period as
a third-party mortgage loan when the Company and its affiliates have
disposed of their related equity interests in that venture.
(4) See table captioned "Summary of gross and net real estate investments"
below.
Fixed maturities
The Company is carrying its fixed maturity investment portfolio, which it
considers available for sale, at estimated market value, with the aggregate
unrealized appreciation or depreciation being recorded as a separate component
of stockholders' equity, net of any applicable income tax effect. The
aggregate unrealized appreciation, net of tax, on fixed maturities at September
30, 1995 was $19.9 million, or $0.45 per share, compared with unrealized
depreciation of $243.6 million, or $5.45 per share, at December 31, 1994. The
Company does not record a net deferred tax benefit for aggregate depreciation
on investments. Market 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 September 30, 1995, investment-grade fixed maturities and cash and
short-term investments accounted for 75.7 percent of the Company's invested
assets and cash, compared with 72.1 percent at December 31, 1994.
Approximately 67.2 percent of the Company's NAIC Class 1 bonds were rated AAA
or equivalent at September 30, 1995.
Approximately 48.0 percent of the Company's investment-grade fixed maturities
at September 30, 1995 were mortgage-backed securities. These investments
consist primarily of marketable mortgage pass-through securities issued by the
Government National Mortgage Association, the
- 22 -
<PAGE> 23
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 of AAA credit quality, and the markets for these investments have
been and are expected to remain liquid.
Future investment income from mortgage-backed securities may be affected by the
timing of principal payments and the yields on reinvestment alternatives
available at the time of such payments. Due to the fact that the Company's
investments in mortgage-backed securities were predominately made since 1992,
the current interest rate environment is not expected to cause any material
extension of the average maturities of these investments. With the exception
of many of the life insurance segment's September 1994 purchases of such
investments, most of these investments were purchased by the Company at
discounts. Prepayment activity on such securities purchased at a discount is
not expected to result in any material losses to the Company because
prepayments would generally accelerate the reporting of the discounts as
investment income. Prepayment activity resulting from a decline in interest
rates on such securities purchased at a premium would accelerate the
amortization of premiums which would result in reductions of investment income
related to such securities. At September 30, 1995, the Company had unamortized
discounts and premiums of $12.1 million and $17.9 million, respectively,
related to mortgage-backed securities. Given the credit quality, liquidity and
anticipated payment characteristics of the Company's investments in
mortgage-backed securities, the Company believes that the associated risk can
be managed without material adverse consequences on its consolidated financial
statements.
Below investment-grade securities holdings (NAIC classes 3 through 6),
representing securities of 8 issuers at September 30, 1995, totaled less than
three percent of cash and invested assets at September 30, 1995 and December
31, 1994. 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. Over the last four years,
the Company significantly reduced its exposure to below investment-grade
securities. This strategy 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.
Real estate-related investments
The $889.5 million real estate portfolio constituted 16.5 percent of the
Company's cash and invested assets at September 30, 1995, compared with $973.3
million, or 18.8 percent, at December 31, 1994. The real estate portfolio
consists of joint venture and third-party mortgage loans and other real
estate-related investments. The majority of the Company's real estate loans
are on properties or projects where the Company or its affiliates have taken
ownership positions in joint ventures with a small number of partners.
- 23 -
<PAGE> 24
Summary of gross and net real estate investments
(in millions)
<TABLE>
<CAPTION>
September 30, 1995 December 31, 1994
-------------------------------- ------------------------------
Life Real Life Real
insurance estate insurance estate
Total segment segment Total segment segment
----- --------- -------- ----- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Investments before reserves,
write-downs, foreign
currency translation
adjustments and net joint
venture operating losses:
Joint venture mortgage loans $ 424 $ 355 $ 69 $ 454 $ 353 $ 101
Third-party mortgage loans 280 274 6 358 353 5
Other real estate-related
investments 713 314 399 828 351 477
------ ------ ----- ------ ------ -----
Subtotal 1,417 943 474 1,640 1,057 583
Reserves (77) (49) (28) (134) (43) (91)
Write-downs (288) (49) (239) (362) (97) (265)
Foreign currency translation
adjustments (23) - (23) (23) - (23)
Cumulative net operating losses
of joint ventures owned (139) (14) (125) (148) (15) (133)
------ ------ ----- ------ ------ -----
Net real estate investments $ 890 $ 831 $ 59 $ 973 $ 902 $ 71
====== ====== ===== ====== ====== =====
</TABLE>
As reflected in the real estate portfolio table below, the Company has
continued to fund both existing projects and legal commitments. The future
legal commitments were $268.7 million at September 30, 1995. This amount
represented a net decrease of $114.0 million since December 31, 1994, in part
due to fundings in the first nine months of 1995. As of September 30, 1995,
the Company expects to fund approximately $61.6 million of these 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, which the Company does not presently expect to fund. The
total legal commitments, along with estimated working capital requirements, are
considered in the Company's evaluation of reserves and write-downs.
Generally, at the inception of a real estate loan, the Company anticipated that
it would roll over the loan and reset the interest rate at least one time in
the future, although the Company is not legally committed to do so. As a
result of the continued weakness in real estate markets and fairly restrictive
lending practices by other lenders in this environment, the Company expects
that all or most loans maturing in 1995 will be rolled over, restructured or
foreclosed.
Excluding $55.6 million of real estate owned and a $32.7 million deficit in the
Company's net equity investments in joint ventures, the Company's real estate
loans (including real estate-related bonds) totaled $866.6 million at September
30, 1995, after reserves and write-downs. Of this amount, $502.0 million are
on accrual status with a weighted average interest rate of 7.8 percent. Of
these accrual loans, 58.8 percent have terms requiring current periodic
payments of their full contractual interest, 26.8 percent require only partial
payments or payments to the extent of cash flow of the borrowers, and 14.4
percent defer all interest to maturity.
The deficit in equity investments in real estate at September 30, 1995
- 24 -
<PAGE> 25
consisted of $97.9 million of loans to Spanish projects (described below),
$40.2 million of unsecured loans to joint ventures treated as equity
investments, a $148.6 million deficit in the Company's other equity investments
in joint ventures and $22.2 million of reserves. The deficit includes the
Company's share of periodic operating results. The Company, as an equity
owner, has the ability to fund, and historically has elected to fund, operating
requirements of certain joint ventures.
The Company's real estate owned included $16.2 million of foreclosures, $38.1
million of deeds in lieu of foreclosure and $1.3 million of certain purchased
properties at September 30, 1995. Real estate owned was net of $58.0 million
of write-downs at September 30, 1995.
Real estate portfolio
<TABLE>
<CAPTION>
(in millions) Mortgage loans Other real estate-related investments
--------------- ------------------------------------------
Real
Joint Third Other estate Equity
venture party Bonds(2) loans(3) owned investments Total
------- ------ -------- ------- ------ ----------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $407.5 $323.7 $80.0 $149.2 $72.8 $(59.9) $973.3(1)
Additions (deductions):
Fundings 22.4 3.0 - 1.0 3.7 23.5 53.6
Interest added to principal 12.1 5.9 0.1 2.3 - - 20.4
Sales/paydowns/distributions (26.1) (24.3) (0.1) (13.4) (41.7) (7.1) (112.7)
Maturities - - - (0.4) - - (0.4)
Rollovers at maturity:
Principal - - - 0.4 - - 0.4
Operating loss - - - - - (10.5) (10.5)
Transfers to real estate owned (3.6) (16.2) - - 19.8 - -
Realized investment gain (loss) (12.3) (14.2) (4.0) (61.3) 7.3 30.9 (53.6)
Net transfers 18.3 (25.4) (22.2) 37.4 - (8.1) -
Other transactions, net (10.0) 16.1 (0.2) 20.9 (6.3) (1.5) 19.0
------ ------ ----- ------ ----- ------ ------
Balance at September 30, 1995 $408.3 $268.6 $53.6 $136.1 $55.6 $(32.7) $889.5(4)
====== ====== ===== ====== ===== ====== ======
</TABLE>
(1) Net of $496.5 million reserve and write-downs. Excludes $39.0 million of
real estate-related accrued interest.
(2) The Company's real estate-related bonds, all of which are presently rated
below investment-grade, were issued to the Company by real estate finance
or development companies generally to provide financing for the Company's
joint ventures for such purposes as land acquisition,
construction/development, refinancing debt, interest and other operating
expenses.
(3) The other real estate loans are notes receivable evidencing financing,
primarily to joint ventures, for purposes similar to those funded by real
estate-related bonds.
(4) Net of $365.9 million reserve and write-downs. Excludes $27.9 million of
real estate-related accrued interest.
As reflected in the preceding table, cash received by the Company from
sales/paydowns/distributions during the first nine months of 1995 exceeded the
Company's cash fundings during the same period by $59.1 million.
Real estate concentrations
Real estate markets have been depressed in recent years in areas where most of
the Company's real estate portfolio is located. Approximately one-half of the
Company's real estate holdings are in California and Illinois. California real
estate market conditions have continued to be worse than in many other areas of
the country. Real estate markets in northern California and Illinois have
shown some stabilization and improvement recently.
At September 30, 1995, the Company's real estate portfolio also included $97.9
million of loans carried as equity investments in real estate (net
- 25 -
<PAGE> 26
of $119.4 million of cumulative write-downs, $23.0 million of cumulative
foreign currency translation losses and $23.4 million of cumulative operating
losses) related to land for office and retail development and residential
projects located in Barcelona, Spain. Such equity investments in Spain totaled
$79.2 million at December 31, 1994, after accounting for net fundings by
Company subsidiaries of $27.0 million during 1994. The Spanish projects
accounted for $20.0 million of net fundings, $2.1 million of foreign currency
translation losses and operating income of $0.8 million during the first nine
months of 1995 and represented approximately 10.9 percent of the Company's real
estate portfolio at September 30, 1995. These investments, which began in the
late 1980s, accounted for $13.0 million of the September 30, 1995 off-
balance-sheet legal commitments, of which the Company expects to fund up to
approximately $3.8 million.
Undeveloped land, including the Spanish projects, represented approximately
28.3 percent of the Company's real estate portfolio at September 30, 1995. To
maximize the value of certain land and other projects, additional development
has been proceeding or has been planned, but in any event further development
is subject to certain consents from the parties to the Merger Agreement. Such
development of existing projects would continue to require substantial 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 the
Company's plans with respect thereto, obtaining necessary 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 the Company's plans with respect to such
projects may not change substantially. (See "Real Estate Asset Sales" in ITEM
5 below.)
At September 30, 1995, the Company's loans to and investments in projects with
the Prime Group, Inc. or its affiliates, based in Chicago, represented
approximately $265.0 million, or 29.8 percent, of the Company's real estate
portfolio (including the previously mentioned Spanish projects, which are Prime
Group-related). This amount reflected $23.4 million in fundings during the
first nine months of 1995 and $96.3 million during the same period of 1994.
The Company also received cash from Prime Group-related
sales/paydowns/distributions totaling $5.5 million in the first nine months of
1995. Prime Group-related commitments accounted for $196.1 million of the
off-balance-sheet commitments at September 30, 1995, of which the Company
expects to fund up to $25.8 million.
Effective January 1, 1993, Kemper and its subsidiaries, including the Company,
formed a master limited partnership (the "MLP") with Lumbermens and its
subsidiaries. The assets of the MLP consist of the equity interests each
partner or its subsidiaries previously owned in projects with Peter B. Bedford
or his affiliates ("Bedford"), a California-based real estate developer.
Pursuant to agreements entered into in January 1994, Bedford transferred to the
MLP and a Kemper affiliate all of Bedford's ownership interest in ventures in
which Bedford, the Company, Kemper, Lumbermens and their respective
subsidiaries previously shared ownership interests. As MLP partners, Kemper
and Lumbermens have
- 26 -
<PAGE> 27
participated in funding certain cash needs of the MLP projects. During the
first nine months of 1995, the Company provided $21.8 million of fundings to
the MLP projects, compared with fundings of $20.5 million in the same period of
1994. The Company also received cash from MLP- related
sales/paydowns/distributions and refinancings of $49.6 million in the first
nine months of 1995. At September 30, 1995, projects in the MLP accounted for
$31.8 million of the Company's off-balance-sheet legal commitments, of which
the Company expects to fund up to $25.0 million. The Company's equity
interests in real estate that were affected by formation of the MLP are held
almost entirely in the Company's real estate segment. Of the Company's real
estate portfolio at September 30, 1995, approximately $248.4 million, or 27.9
percent, represented loans to and investments in MLP-owned ventures. (See ITEM
5 below.)
Provisions for real estate-related losses
The Company monitors its real estate portfolio and identifies changes in the
relevant real estate marketplaces, the economy and each borrower's
circumstances. The Company establishes its provisions for real estate-related
losses (both reserves and write-downs) on the basis of its valuations of the
related real estate, estimated in light of current economic conditions and
calculated in conformity with Statement of Financial Accounting Standards
("SFAS") 114, "Accounting by Creditors for Impairment of a Loan." The Company
evaluates its real estate-related assets (including accrued interest) by
estimating the probabilities of loss utilizing various projections that include
several factors relating to the borrower, property, term of the loan, tenant
composition, rental rates, other supply and demand factors and overall economic
conditions. Because the Company's real estate review process includes
estimates, there can be no assurance that current estimates will prove accurate
over time due to changing economic conditions and other factors.
The deficit in (i.e., the negative carrying value of) the Company's equity
investments in real estate is considered in the Company's periodic evaluations
of, and serves to reduce the level of, its provisions for real estate-related
losses. In 1994 and the first nine months of 1995, because certain negative
carrying values were eliminated due to sales or transfers of the Company's
interests in the corresponding joint ventures, the Company generally added to
its provisions for real estate-related losses an amount equal to the gains from
such sales and transfers.
The Company decreased the net amount of its real estate reserves and
write-downs in the first nine months of 1995 and throughout 1994, primarily
reflecting sales and transfers to third parties. While the real estate
subsidiaries, as equity owners, recognized gains on sales and other
transactions during 1995 and 1994, additions to reserves and increases in
write-downs have affected both the life insurance segment (where most of the
Company's loans are held) and the real estate segment. The Company's real
estate reserve was allocated as follows:
- 27 -
<PAGE> 28
Real estate reserve
(in millions)
<TABLE>
<CAPTION>
Joint venture Other real
and third-party estate-related
mortgage loans investments Total
------------------ ------------------ ------------------
Life Real Life Real Life Real
insurance estate insurance estate insurance estate
segment segment segment segment segment segment
--------- ------- --------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Balance at 12/31/94 $17.1 $ 39.8 $25.5 $ 51.8 $42.6 $ 91.6
Change in reserve (3.7) (36.8) 10.1 (26.3) 6.4 (63.1)
----- ------ ----- ------ ----- ------
Balance at 9/30/95 $13.4 $ 3.0 $35.6 $ 25.5 $49.0 $ 28.5
===== ====== ===== ====== ===== ======
</TABLE>
In addition to the reserve, the Company's provisions for real estate-related
losses (on assets held at the respective period end) included cumulative
write-downs totaling $288.4 million (life insurance segment, $48.6 million;
real estate segment, $239.8 million) at September 30, 1995, and $362.3 million
(life insurance segment, $96.6 million; real estate segment, $265.7 million) at
December 31, 1994. Reserves decreased in the first nine months of 1995
primarily due to sales of real estate-related assets which carried reserves at
the time of sale, as well as write-offs of fully reserved loans.
Real estate outlook
The Company's real estate experience could continue to be adversely affected by
overbuilding and weak economic conditions in certain real estate markets and by
tight lending practices by banks and other lenders. Stagnant or worsening
economic conditions in the areas in which the Company has made loans, or
additional adverse information becoming known to the Company through its
regular reviews or otherwise, could result in higher levels of problem loans or
potential problem loans, reductions in the value of real estate collateral and
adjustments to the real estate reserve. The Company's net income and
stockholders' equity could be materially reduced in future periods if real
estate market conditions remain stagnant or worsen in areas where the Company's
portfolio is located or if the Company's plans with respect to certain projects
change. (See ITEM 5 below.)
Current conditions in the real estate markets have been adversely affecting the
financial resources of certain of the Company's joint venture partners. Every
partner, however, remains active in the control of its respective joint
ventures. In evaluating a partner's ability to meet its financial commitments,
the Company considers the amount of all applicable debt and the value of all
properties within that portion of the Company's portfolio consisting of loans
to and investments in joint ventures with such partner.
The following table is a summary of the Company's troubled real estate-related
investments:
- 28 -
<PAGE> 29
Troubled real estate-related investments
(before reserves and write-downs, except for real estate owned)
(in millions)
<TABLE>
<CAPTION>
September 30, 1995 December 31, 1994
----------------------------- ----------------------------
Life Real Life Real
insurance estate insurance estate
segment segment Total segment segment Total
--------- ------- ----- --------- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Potential problem loans(1) $ 13.1 $ - $ 13.1 $ 57.9 $ 0.2 $ 58.1
Past due loans (2) 4.7 - 4.7 - - -
Nonaccrual loans(3) 304.7 139.5 444.2 274.6 199.3 473.9
Restructured loans(4)
(currently performing) 45.4 .7 46.1 50.5 0.8 51.3
Real estate owned(5) 50.6 5.0 55.6 57.3 15.4 72.7
------ ------ ------ ------ ------ ------
Total(6)(7) $418.5 $145.2 $563.7 $440.3 $215.7 $656.0
====== ====== ====== ====== ====== ======
</TABLE>
(1) These are real estate-related investments where the Company, based on
known information, has serious doubts about the borrowers' abilities to
comply with present repayment terms and which the Company anticipates may
go into nonaccrual, past due or restructured status.
(2) Interest more than 90 days past due but not on nonaccrual status.
(3) The Company does not accrue interest on real estate-related investments
when it judges that the likelihood of collection of interest is doubtful.
The 1995 decrease in nonaccrual loans primarily reflected sales and
foreclosures as well as write-offs of certain fully reserved loans.
(4) The Company defines a "restructuring" of debt as an event whereby the
Company, for economic or legal reasons related to the debtor's financial
difficulties, grants a concession to the debtor it would not otherwise
consider. Such concessions either stem from an agreement between the
Company and debtor or are imposed by law or a court. By this definition,
restructured loans do not include any loan that, upon the expiration of
its term, both repays its principal and pays interest then due from the
proceeds of a new loan that the Company, at its option, may extend (roll
over).
(5) Real estate owned is carried at fair value and includes foreclosures,
deeds in lieu of foreclosure and certain purchased property. Cumulative
write-downs to fair value were $58.0 million and $115.8 million at
September 30, 1995 and December 31, 1994, respectively, on real estate
owned at those dates.
(6) Total reserves and cumulative write-downs on properties owned at September
30, 1995 (excluding fair value adjustments to real estate owned) were 54.6
percent of total troubled real estate-related investments and 25.7 percent
of the Company's total real estate portfolio before reserves and
write-downs.
(7) Equity investments in real estate are not defined as part of, and
therefore are not taken into account in calculating, total troubled real
estate because the negative carrying value of equity investments would
reduce the total. The Company's equity investments also involve real
estate risks. See "Real estate concentrations" above.
Based on the level of troubled real estate-related investments the Company has
experienced, the Company anticipates additional foreclosures and deeds in lieu
of foreclosure in 1995 and beyond. Any consolidation accounting resulting from
foreclosures would add the related ventures' assets and senior third-party
liabilities to the Company's balance sheet and eliminate the Company's loans to
such ventures.
Due to the adverse real estate environment affecting the Company's portfolio in
recent years, the Company has continued to devote significant attention to its
real estate portfolio, enhancing monitoring of the portfolio and formulating
specific action plans addressing nonperforming and potential problem credits.
Since 1991, the Company has intensified its attention to evaluating the asset
quality, cash flow and prospects associated with each of its projects. The
Company continues to analyze various potential transactions designed to reduce
both its joint venture operating losses and the amount of its real
estate-related investments. Specific types of transactions under consideration
(and previously utilized) include loan sales, property sales, mortgage
- 29 -
<PAGE> 30
refinancings and real estate investment trusts. However, there can be no
assurance that such efforts will result in continued improvements in the
performance of the Company's real estate portfolio.
Investment income from invested assets
The following table shows each segment's contribution to the Company's net
investment income:
Net investment income before taxes
(dollars in millions)
<TABLE>
<CAPTION>
Nine months ended September 30 Three months ended September 30
------------------------------ -------------------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
Life insurance $266.8 $260.5 $87.6 $94.7
Real estate (7.5) (22.9) (5.3) (4.0)
Other and eliminations 4.6 4.9 1.3 2.0
------ ------ ----- -----
Total from invested assets 263.9 242.4 83.6 92.6
Asset management 10.2 7.5 3.8 3.9
------ ------ ----- -----
Consolidated $274.0 $249.9 $87.3 $96.5
====== ====== ===== =====
Investment yields:
Life insurance 7.12% 6.56% 6.96% 7.38%
====== ====== ===== =====
Consolidated 6.91% 6.08% 6.49% 7.20%
====== ====== ===== =====
</TABLE>
Included in pre-tax net investment income is the Company's share of operating
losses from equity investments in real estate. The Company's share of real
estate operating losses (excluding write-downs) totaled $10.5 million and $28.6
million for the nine months ended September 30, 1995 and 1994, respectively.
These pre-tax operating results consist of rental and other income less
depreciation, interest and other expenses. Such operating results exclude
interest expense on loans by the Company which are on nonaccrual status.
The Company's total foregone investment income before tax was as follows:
Foregone investment income
(dollars in millions)
<TABLE>
<CAPTION>
Nine months ended September 30 Three months ended September 30
------------------------------ -------------------------------
1995 1994 1995 1994
----- ----- ----- -----
<S> <C> <C> <C> <C>
Real estate-related investments:
Life insurance segment $14.7 $23.9 $4.8 $5.9
Real estate segment 1.0 1.3 (.5) 1.8
----- ----- ---- ----
Total $15.7 $25.2 $4.3 $7.7
===== ===== ==== ====
Basis points:
Life insurance segment 39 60 38 46
==== ==== ==== ====
Consolidated 41 64 34 70
==== ==== ==== ====
</TABLE>
Foregone investment income from the nonaccrual of real estate-related
investments is net of the Company's share of interest expense on these loans
excluded from the Company's share of joint venture operating results. Based on
the level of nonaccrual real estate-related investments at September 30, 1995,
the Company estimates foregone investment income in 1995 will decrease slightly
compared with the 1994 level. Any increase in nonperforming securities, and
either worsening or
- 30 -
<PAGE> 31
stagnant real estate conditions, would increase the expected adverse effect on
the Company's future investment income and realized investment results.
Future net investment income, results of operations and cash flow will reflect
the Company's current levels of investments in investment-grade securities,
real estate fundings treated as equity investments, nonaccrual real estate
loans and joint venture operating losses. The Company expects, however, that
any adverse effects should be offset to some extent by certain advantages that
it expects to realize over time from its other investment strategies, its life
insurance product mix and its continuing cost control measures. Other
mitigating factors include marketing advantages that could result from the
Company having lower levels of investment risk and earnings improvements from
its life insurance operations' ability to adjust crediting rates on annuities
and interest-sensitive life products over time.
Realized investment results
Reflected in the Company's results from continuing operations are after-tax
realized investment gains of $3.4 million for the first nine months of 1995,
compared with losses of $14.2 million for the first nine months of 1994. The
life insurance segment reported real estate-related losses of $34.8 million
(see the discussion captioned "Real Estate Asset Sales" in ITEM 5 below) and
$11.8 million for the nine months ended September 30, 1995 and 1994,
respectively, in addition to other realized investment gains of $7.3 million
and other losses of $8.1 million for the respective nine-month periods,
primarily from the life insurance segment's sales of fixed maturity investments
in both 1995 and 1994. In the first nine months of 1995, the asset management
segment reported net realized investment gains of $24.1 million. (See "RESULTS
OF OPERATIONS - Asset management" above.)
Unrealized gains and losses on fixed maturity investments are not reflected in
the Company's results of operations. These changes in unrealized value are
included as a separate component of stockholders' equity, net of any applicable
income taxes. If and to the extent a fixed maturity investment suffers an
other-than-temporary decline in value, however, such security is written down
to net realizable value, and the write-down adversely impacts net income.
The Company 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, there can be no assurance that current
estimates will prove accurate over time due to changing economic conditions and
other factors.
A valuation allowance was established under SFAS 109 (and is evaluated as of
each reported period end) 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.
-31-
<PAGE> 32
Interest rates
Interest rate fluctuations affect KILICO. In 1994, rapidly rising short-term
interest rates resulted in a much flatter yield curve as the Federal Reserve
Board raised rates five times during 1994 and once during the first quarter of
1995. Interest rates have subsequently declined through the second and third
quarters of 1995.
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,
which can result in narrower spreads.
The rising interest rate environment in 1994 contributed to an increase in net
investment income as well as to both realized and unrealized fixed maturity
investment losses in 1994. Also, lower renewal crediting rates on annuities
compared with higher new money crediting rates have influenced certain clients
to seek alternative products. The Company mitigates this risk somewhat within
KILICO by charging decreasing surrender fees when annuity holders withdraw
funds prior to maturity on certain annuity products. Approximately one-half of
the Company's fixed annuity liabilities as of September 30, 1995, however, are
no longer subject to significant surrender fees.
As interest rates rose during 1994, KILICO's capital resources were adversely
impacted by unrealized loss positions from its fixed maturity investments. As
interest rates declined in the second two quarters of 1995, KILICO's capital
resources were positively impacted from elimination of its year-end 1994
unrealized loss positions on its fixed maturity investments.
-32-
<PAGE> 33
LIQUIDITY AND CAPITAL RESOURCES
Holding company
As a parent holding company, KFC regularly reviews the strategic fit of all its
businesses and may consider the acquisition or disposition of its and its
subsidiaries' assets, and the Company may consider entering into joint venture,
reinsurance and other transactions, subject in any event to the terms of the
Merger Agreement. Since KFC is a holding company, its rights and the rights of
its creditors to participate in the assets of any subsidiary upon the latter's
liquidation or recapitalization will be subject to prior claims of the
subsidiaries' creditors, including customers of asset management subsidiaries,
policyholders of insurance company subsidiaries and lenders with respect to
real estate subsidiaries (except to the extent the Company itself may be a
creditor with recognized or secured claims against the subsidiary).
KFC receives from its subsidiaries dividends and interest on loans.
Distributions to KFC from its subsidiaries are restricted by various regulatory
limitations. KFC has previously used these resources and its line of credit
from Kemper for dividends to stockholders, corporate interest and other holding
company expenses, additional investments in subsidiaries and purchases of real
estate-related assets from KILICO. In 1995, the Company purchased $3.6 million
of certain real estate-related investments from KILICO. In 1994, the Company
purchased $154.0 million of certain real estate-related investments from KILICO
and contributed $82.5 million to KILICO's capital. The Company's purchases of
such investments from KILICO were consummated at KILICO's carrying values of
such investments at the dates of the purchases.
Consolidated
KFC and each of its subsidiaries carefully monitor cash and short-term money
market investments to maintain adequate balances for timely payment of
policyholder benefits, expenses, taxes and customer account balances. In
addition, regulatory authorities establish minimum liquidity and capital
standards for the asset management and life insurance companies. The major
ongoing sources of liquidity with respect to the Company's continuing
operations are asset management fees, borrowings from Kemper, deposits for
fixed annuities and interest-sensitive life contracts, investment income, other
operating revenue and cash provided from maturing or sold investments. (See
"INVESTMENTS" above.)
On August 24, 1995, the Company's asset management segment acquired
substantially all the assets of Dreman. (See "RESULTS OF OPERATIONS - Asset
management" above.) The acquisition required an initial cash payment of
approximately $17 million and a cash payment of $8.5 million in October 1995
and calls for contingent cash payments in future periods dependent on the
levels of Dreman assets retained through such periods.
In the life insurance segment, policyholder deposits increased to $185.6
million during the first nine months of 1995 from $169.2 million for the first
nine months of 1994. Policyholder withdrawals increased to $599.0 million
during the first nine months of 1995 from $456.8 million for the first nine
months of 1994, primarily due to rising interest rates which caused the life
insurance segment's renewal crediting rates to be lower
-33-
<PAGE> 34
than competitors' new money crediting rates, increased competition and
uncertainty regarding the Company's ownership. KILICO's late 1994 increases in
crediting rates are designed to maintain or increase policyholder deposits and
reduce withdrawals.
Insurance company ratings
Ratings have become an increasingly important factor in establishing KILICO's
competitive position. Rating organizations continue to review the financial
performance and condition of all 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 becoming less
attractive to consumers. Any reductions in Kemper's senior debt ratings could
adversely impact Kemper's financial flexibility by limiting Kemper's access to
capital or increasing its cost of borrowings which would similarly impact KFC's
barrowings under its Kemper line of credit.
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. Subject to certain limitations under the Merger Agreement, such
circumstances could accelerate or increase the real estate subsidiaries'
purchases of real estate-related assets from KILICO to further support its
statutory capital position.
A credit rating is not a recommendation to buy, sell or hold securities. Each
rating is subject to revision or withdrawal at any time by the assigning
organization and should be evaluated independently of any other rating. On
April 11, 1995, following the announcement of an agreement in principle to sell
Kemper, Standard & Poor's Corporation ("S&P") announced that it revised its BBB
senior debt and BB+ preferred stock ratings of Kemper, which S&P had placed
under "Credit Watch with 'negative' implications" in 1994, to BB+ and BB-,
respectively, and placed these ratings on "Credit Watch with 'developing'
implications"; Duff & Phelps Credit Rating Co. advised Kemper that it did not
revise its A- senior debt rating of Kemper, AA- claims paying ability rating of
Federal Kemper Life Assurance Company (Kemper's other life insurance
subsidiary) ("FKLA") and A+ claims paying ability rating of KILICO from "Rating
Watch - Uncertain"; and A. M. Best Company announced that its A- ratings of
Kemper's life insurance subsidiaries, including KILICO, remain "under review
with developing implications." On August 31, 1995, Moody's Investors Service
announced that it changed the direction of its review of its Baa2 senior debt
and Baa3 preferred stock ratings of Kemper and Baa1 insurance financial
strength ratings of Kemper's life insurance subsidiaries, including KILICO,
from under review with "direction uncertain" to "possible upgrade."
On July 26, 1995, KILICO and FKLA were notified by S&P that they have been
assigned a claims-paying ability rating of Aq "Good."
Notes payable
All of the Company's $1,048.9 million of notes payable at September 30,
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<PAGE> 35
1995 consisted of KFC's borrowings from Kemper, compared with $1,091.0 million
of such borrowings at December 31, 1994, when notes payable totaled $1,095.1
million. These borrowings are drawn against a line of credit totaling $1.2
billion at September 30, 1995, extended to KFC by Kemper. The interest rate on
the Kemper line of credit is equal to the corporate base rate announced from
time to time by The First National Bank of Chicago (the "Bank").
Convertible debentures and redeemable securities
Obligations under the convertible debentures of KFC decreased to $10.8 million
at September 30, 1995 from $33.1 million at December 31, 1994 primarily as a
result of debentures becoming subject to mandatory redemption due to
terminations of employment, including terminations due to the securities
brokerage divestiture. "Other accounts payable and liabilities" on the
Company's September 30, 1995 consolidated balance sheet included KFC's
obligation of $13.1 million to holders of debentures whose employment with the
Company terminated during the first nine months of 1995. Approximately $3.6
million of additional debentures are scheduled to mature on November 30, 1995.
Interest on the convertible debentures is payable quarterly at a fluctuating
rate per annum equal to (i) 1/8 percent over the corporate base rate announced
from time to time by the Bank for Series D-E, I-J, N-O and R-T, (ii) the
corporate base rate for Series V-Y, and (iii) 0.7 percent over the Eurodollar
base rate announced from time to time by the Bank for Series AA-EE. This
interest totaled $2.1 million in the first nine months of 1995, compared with
$2.5 million for the same period of 1994.
By notice dated October 26, 1995, KFC announced that it will redeem all of the
convertible debentures on December 28, 1995 (other than the $3.6 million of
debentures which mature November 30, 1995) at a redemption price equal to 100
percent of the principal amount plus accrued interest. A copy of said notice
is filed as exhibit 99 to this Form 10-Q and is incorporated herein by
reference. As stated in said notice, KFC also intends to seek to acquire all
the outstanding shares of its Class B common stock (5,103 shares as of
September 30, 1995) prior to January 2, 1996 when, it is currently
contemplated, KFC will be merged with and into Kemper, with Kemper being the
surviving corporation.
Common stock dividends
No common stock dividends were declared in the first nine months of 1995 or in
1994. No future dividend declarations are planned.
Stockholders' equity
Stockholders' equity totaled $335.3 million at September 30, 1995, compared
with $134.4 million at December 31, 1994. The nine-month 1995 increase
reflected a $250.8 million benefit in the unrealized position of the Company's
investments, primarily fixed maturities of KILICO, due to declining interest
rates. Stockholders' equity at September 30, 1995 also reflected a net loss of
$49.4 million during the first nine months.
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<PAGE> 36
PART II. OTHER INFORMATION
ITEM 5. Other Information
Real Estate Asset Sales
In compliance with the Merger Agreement, Kemper has been using diligent efforts
to enter into agreements to sell, and to cause its subsidiaries to enter into
agreements to sell, various real estate assets, including certain mortgage and
other loans, real estate owned and equity interests in real estate. Pursuant
to Section 4.6(a) of the Merger Agreement, Kemper has the right to require that
any binding sale agreement with a third party include a condition that Kemper
shall not be obligated to consummate such real estate asset sale unless either
the Merger (as defined in the Merger Agreement) is consummated or the
Preliminary Closing Conditions (as defined in the Merger Agreement) are
satisfied or waived.
Since May 15, 1995, however, with respect to certain selected real estate
assets, Kemper and the Company have entered into sale agreements without the
above-described condition, or Kemper and the Company have otherwise determined
that they are willing to enter into such sales contracts. A major consequence
of Kemper's and the Company's unconditional intent to sell such assets under
current real estate market conditions is the Company's recording of additions
to its provisions for real estate-related losses (reserves and write-downs) to
mark the subject assets down to the estimated or actual sales contract prices
(less estimated sales expenses). Such prices in several instances differed
significantly from the Company's carrying values as determined pursuant to
Statement of Financial Accounting Standards No. 114, "Accounting by Creditors
for Impairment of a Loan." Primarily due to these differences, the Company's
additions to reserves and write-downs in the second quarter of 1995 resulted in
after-tax, real estate-related, realized investment losses of approximately
$34.7 million, all recorded in the life insurance segment.
Although Kemper and the Company would not have intended to sell all of such
real estate assets at such prices in the absence of the Merger Agreement,
Kemper and the Company determined to proceed with the sales with respect to
selected assets without the above-described condition in order to facilitate
their sales and the Merger.
If Kemper and the Company determine to enter into other real estate sales
contracts without including therein the above-described condition, then further
additions to the Company's provisions for real estate-related losses may be
necessary prior to the Merger or the satisfaction or waiver of the Preliminary
Closing Conditions.
Kemper has entered into certain real estate sales and other contracts that
include the above-described condition. These contracts include a Purchase and
Sale Agreement dated July 28, 1995, pursuant to which certain real estate
assets held by the Company would be sold at a price substantially less than
their September 30, 1995 carrying value of approximately $400 million, and a
letter agreement with Lumbermens dated May 15, 1995 (the "Lumbermens
Agreement"), pursuant to which, among other things, the MLP would be
substantially restructured.
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<PAGE> 37
Although KFC is not a party to each of the above-described real estate/sales
agreements, the Company supports these transactions due to the business
advantages for KILICO expected to result from a markedly reduced level of real
estate-related investments.
Also in the Merger Agreement, Kemper agreed to various covenants relating to
the conduct of its and its subsidiaries' businesses prior to the Merger. Such
covenants include real estate-related restrictions with respect to operating,
funding or entering into contracts with respect to real estate projects,
including in particular the Spanish development projects. See "Management's
Discussion and Analysis - INVESTMENTS - Real estate concentrations" above.
Because the values of development projects depend in part on Kemper's and the
Company's plans with respect thereto, and because the consent of the other
parties to the Merger Agreement is necessary at the present time for
implementing such plans, there can be no assurance that Kemper's and the
Company's plans, and therefore estimated values, may not change substantially
before either the Merger or the satisfaction or waiver of the Preliminary
Closing Conditions. In such event, the Company would record further additions
to its provisions for real estate-related losses.
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<PAGE> 38
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit Number
- --------------
10 Indemnification Agreement made and entered into as of September 13,
1995 by and between Kemper Financial Companies, Inc. and Kemper
Corporation.
27 Financial data schedule.
99 Notice of Optional Redemption of Aggregate Principal Amount of All
Floating Rate Convertible Subordinated Debentures, dated October 26,
1995.
(b) REPORTS ON FORM 8-K.
During the three months ended September 30, 1995, the Company filed
two current reports on Form 8-K.
Filed on July 17, 1995 and dated June 6, 1995, one Form 8-K reported,
under ITEM 5 thereof, (A) certain legal proceedings, (B) the Company's
sale of 2,986,111 shares of common stock of State Street Boston
Corporation, (C) an update on the Company's Orange County-related letter
of credit arrangements, and (D) certain real estate asset sales. The
other Form 8-K, filed on September 28, 1995 and dated August 24, 1995,
reported, under ITEMS 2 and 7 thereof, the divestiture of the Company's
securities brokerage segment (including certain proforma financial
statements) and, under ITEM 5 thereof, (A) the completion of KFS'
acquisition of Dreman assets and (B) a merger transaction update.
-38-
<PAGE> 39
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEMPER FINANCIAL COMPANIES, INC.
(Registrant)
Date: November 14, 1995 /s/JOHN H. FITZPATRICK
John H. Fitzpatrick
Executive Vice President and
Chief Financial Officer
Date: November 14, 1995 /s/JOSEPH R. SITAR
Joseph R. Sitar
Senior Vice President and
Chief Accounting Officer
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<PAGE> 1
EXHIBIT 10
INDEMNIFICATION AGREEMENT - KFC to Kemper
INDEMNIFICATION AGREEMENT made and entered into as of September 13, 1995
by and between KEMPER FINANCIAL COMPANIES, INC., a Delaware corporation
("KFC"), and KEMPER CORPORATION, a Delaware corporation ("Kemper").
WHEREAS, concurrently herewith, Kemper Securities, Inc. (name changing to
EVEREN Securities, Inc., effective 11:59 p.m. (EDT) on the date hereof), a
Delaware corporation (KSI) and an indirect wholly owned subsidiary of KFC, and
Kemper will enter into an Assumption Agreement relating to certain litigation
matters (the "Assumption Agreement"); and
WHEREAS, Kemper owns over 99% of the outstanding voting stock of KFC; and
WHEREAS, KFS deems it advantageous to KFC that Kemper execute the
Assumption Agreement; and
WHEREAS, Kemper has stated that a condition of its entering into or
executing the Assumption Agreement (but not a condition to its performance
thereafter of its respective obligations thereunder) is that Kemper and KFC
enter into this Indemnification Agreement pursuant to which KFC will indemnify
and hold harmless Kemper with respect to any liability, loss, cost, damage,
expense or amounts paid by Kemper pursuant to or in connection with the
Assumption Agreement or Kemper's performance thereunder;
NOW, THEREFORE, in consideration of the mutual terms, conditions and other
agreements set forth herein, KFC and Kemper hereby agree as follows:
1. Incorporation of Recitals.
Each of the recitals set forth above is hereby incorporated in
its entirety.
2. KFC Indemnification of Kemper.
KFC, in order to induce Kemper to enter into and execute the
Assumption Agreement, hereby agrees unconditionally to indemnify and
hold harmless Kemper with respect to any liability, loss, cost,
damage, expense or amounts paid by Kemper pursuant to or in connection
with the Assumption Agreement or Kemper's performance thereunder.
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<PAGE> 2
3. Kemper Execution of Assumption Agreement.
In consideration of KFC's indemnification hereunder, Kemper
agrees unconditionally to enter into and execute the Assumption
Agreement and to fully perform its respective obligations
thereunder.
4. No Waiver.
No delay or omission of any party to this Indemnification
Agreement to exercise any right or power to enforce any provision
hereof shall impair such right or power or be a waiver of any
default or an acquiescence therein, and any single or partial
exercise of any such right or power shall not preclude other or
further exercise thereof or the exercise of any other right.
5. Governing Law.
This Indemnification Agreement has been entered into in, and
shall be governed by and construed in accordance with the
internal laws of, the State of Illinois.
IN WITNESS WHEREOF, the parties have executed, delivered and entered into
this Indemnification Agreement as of the date first above written.
KEMPER CORPORATION
By: /s/ ARTHUR J. McGIVERN
Name: Arthur J. McGivern
Title: Senior Vice President
KEMPER FINANCIAL COMPANIES, INC.
By: /s/ WILLIAM A. HICKEY
Name: William A. Hickey
Title: Authorized Agent
-41-
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE THIRD
QUARTER FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> SEP-30-1995
<DEBT-HELD-FOR-SALE> 3,594,381
<DEBT-CARRYING-VALUE> 3,594,381
<DEBT-MARKET-VALUE> 3,594,381
<EQUITIES> 0
<MORTGAGE> 676,947
<REAL-ESTATE> 212,637
<TOTAL-INVEST> 5,173,094
<CASH> 219,127
<RECOVER-REINSURE> 519,197
<DEFERRED-ACQUISITION> 296,040
<TOTAL-ASSETS> 8,656,053
<POLICY-LOSSES> 4,607,610
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 1,048,935
<COMMON> 4,327
0
0
<OTHER-SE> 330,929
<TOTAL-LIABILITY-AND-EQUITY> 8,656,053
0
<INVESTMENT-INCOME> 273,971
<INVESTMENT-GAINS> 18,377
<OTHER-INCOME> 34,659
<BENEFITS> 183,592
<UNDERWRITING-AMORTIZATION> 23,489
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 83,219
<INCOME-TAX> 45,290
<INCOME-CONTINUING> 37,929
<DISCONTINUED> (87,331)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (49,402)
<EPS-PRIMARY> (1.14)
<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>
<PAGE> 1
EXHIBIT 99
KEMPER FINANCIAL COMPANIES, INC.
NOTICE OF OPTIONAL REDEMPTION
of
Aggregate Principal Amount of All
Floating Rate Convertible Subordinated Debentures
Series E, I, J, N, O, R, S, T, V, W, X, Y, AA, BB, CC, DD and EE
Optional Redemption Date: December 28, 1995
Pursuant to ARTICLE ELEVEN of that certain Indenture between Kemper Financial
Companies, Inc. (the "Company") and Bank of America Illinois (formerly known as
Continental Illinois National Bank and Trust Company of Chicago) (the
"Trustee") dated as of September 1, 1986, and all supplements thereto (the
"Indenture"), the Company hereby gives notice that on December 28, 1995 (the
"Optional Redemption Date"), it will redeem (the "Optional Redemption") all
Floating Rate Convertible Subordinated Debentures, Series E, I, J, N, O, R, S,
T, V, W, X, Y, AA, BB, CC, DD and EE (the "Debentures"), of the Company then
outstanding at a redemption price equal to 100% of the principal amount of each
such Debenture plus accrued interest to the Optional Redemption Date (the
"Redemption Price").
The Redemption Price will become due and payable by the Company on the Optional
Redemption Date. The Redemption Price payable to each holder surrendering
Debentures for redemption will be rounded up to the nearest penny. From and
after the Optional Redemption Date, (i) interest will cease to accrue on the
Debentures, (ii) the Debentures will no longer be deemed to be outstanding and
will not have the status of Debentures, and (iii) your rights as a holder of
Debentures under the Indenture (except the right to receive the Redemption
Price) will cease.
THE OPTIONAL REDEMPTION WILL ELIMINATE ANY FURTHER INTERESTS IN THE DEBENTURES
REDEEMED AS WELL AS IN THE CLASS B COMMON STOCK OF THE COMPANY INTO WHICH THE
DEBENTURES ARE CONVERTIBLE.
A. Intervening Maturity of Series D Debentures.
The Series D Debentures issued by the Company in 1986 will mature in accordance
with their terms on November 30, 1995. This maturity will take place as
scheduled (irrespective of and apart from the Optional Redemption). Holders of
the Series D Debentures will receive a separate communication package
describing the effects of, and such holders' rights in connection with, such
maturity.
B. Inclusion of Debentures Subject to Mandatory Redemption.
The Optional Redemption includes those Debentures of all series held by former
employees whose Debentures became subject to mandatory redemption
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<PAGE> 2
due to employment termination events occurring since January 1, 1995, including
those holders employed by EVEREN Capital Corporation ("EVEREN") or its
subsidiaries on September 13, 1995. In the Optional Redemption, such holders'
Debentures will be redeemed for the Redemption Price on the Optional Redemption
Date, rather than settled in April of 1996 as otherwise would have been the
case under the mandatory redemption provisions of the Indenture.
REASONS FOR THE OPTIONAL REDEMPTION
A. The Kemper Merger.
The Optional Redemption is being effected by the Company in contemplation of
the acquisition of Kemper Corporation ("Kemper") by an investor group led by
Zurich Insurance Company (the "Investor Group") pursuant to that certain
agreement and plan of merger, dated as of May 15, 1995 and amended as of
September 6, 1995 (the "Merger Agreement"), among Kemper, Zurich, Insurance
Partners, L.P., Insurance Partners Offshore (Bermuda), L.P. and ZIP Acquisition
Corp. (the "Kemper Merger"). In connection with the Kemper Merger, it is
currently contemplated that the Company will be merged with and into Kemper
(the "KFC Merger") on or about January 2, 1996, prior to the Kemper Merger and
with Kemper being the surviving corporation in the KFC Merger.
B. Mandatory Redemption through Securities Brokerage Divestiture.
A condition precedent to the Kemper Merger was the divestiture of the
securities brokerage segment of Kemper and the Company, effected on September
13, 1995 with the Company's sale of its common stock interest in EVEREN to an
employee stock ownership plan. This transaction (the "Securities Brokerage
Divestiture") subjected all Company securities, including any Debentures, held
by employees of the Company's former securities brokerage segment to mandatory
redemption in April of 1996, in accordance with the terms of the Indenture. It
is expected that, absent the earlier Optional Redemption, an amount equal to
only the principal amount (plus accrued interest) would be payable on the
mandatory redemption of such Debentures, based on current estimates of the
Formula Purchase Price Per Share of Company Class B Common Stock as of December
31, 1995 (the "1995 Formula Price").
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<PAGE> 3
C. Mandatory Redemption Potential of Planned KFS Sale.
Also in connection with the Kemper Merger and, at the election of the Investor
Group, as a condition precedent to the consummation of the Kemper Merger, the
Company's asset management operations, consisting of Kemper Financial Services,
Inc. ("KFS") and KFS' various subsidiaries, are to be acquired by a
wholly-owned subsidiary of Zurich Insurance Company in a merger transaction
(the "KFS Sale").
It is currently contemplated that the Kemper Merger will be consummated on
January 4, 1996 in accordance with the terms of the Merger Agreement and that
the KFS Sale will be effected on the same date, immediately prior to the Kemper
Merger. As such, if either the Optional Redemption or the KFC Merger is not
consummated for any reason, it is expected that all Company securities,
including any Debentures, held by then-active employees of KFS and its
subsidiaries would become subject, on January 4, 1996, to mandatory redemption
in April of 1997, in accordance with the terms of the Indenture. It is
expected that, absent the earlier Optional Redemption, an amount equal to only
the principal amount (plus accrued interest) would be payable on such mandatory
redemption of Debentures, based on current estimates of the Formula Purchase
Price Per Share of Company Class B Common Stock as of December 31, 1996 (the
"1996 Formula Price").
D. Advantages of Earlier Optional Redemption.
Inasmuch as the Securities Brokerage Divestiture, coupled with the KFS Sale,
will otherwise ultimately redeem all of the Company's outstanding securities,
including the Debentures (at amounts not expected to exceed principal plus
accrued interest), the Company has agreed that it is appropriate to effect the
Optional Redemption at this time, to accelerate the redemption of the
Debentures and earlier eliminate any ongoing tax expenses to employee holders
arising through Debenture ownership and the corporate expenses associated with
maintaining the Company's employee securities ownership program as well as to
facilitate certain tax objectives of the Investor Group.
It is also important to recall that, since 1993, Kemper and the Company have
advised that they were seriously considering calling all outstanding Debentures
for redemption by year-end 1995 or in early 1996 in accordance with the terms
of the Indenture, independent of, and, in fact, long before, any change of
control transaction affecting Kemper materialized. Consequently, effecting the
Optional Redemption at this time is not inconsistent with these earlier
intentions respecting the eventual elimination of ongoing employee interests in
the Company.
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<PAGE> 4
E. Plans Respecting Class B Shares.
To facilitate consummation of any KFC Merger, the Company intends to earlier
seek to acquire the outstanding shares of Class B Common Stock of the Company
from the seven active employee holders thereof, in consideration of the
Company's repayment of the amounts such holders invested to acquire such shares
(the "Stock Repurchase Transactions"). All of such shares were acquired upon
conversion of Debentures otherwise approaching maturity at the applicable
conversion prices of the maturing Debentures.
If any shares of Class B Common Stock remain outstanding following the Optional
Redemption Date, as a result of conversions of Debentures into Class B Common
Stock from the date hereof until the Optional Redemption Date or the failure of
the Company to repurchase all of the currently outstanding shares of Class B
Common Stock pursuant to the Stock Repurchase Transactions, the Company may
determine to make an offer to purchase such outstanding shares of Class B
Common Stock at a price per share of not more than $20.00 (the "Offer Price").
Pursuant to Section 8 of Article EIGHTH of the Company's Fourth Restated
Certificate of Incorporation (the "Company's Certificate"), if the Company were
to acquire as a result of such an offer more than 50% of the shares of Class B
Common Stock then outstanding, then, on and as of the date such number of
shares were acquired, the Company would be deemed to have acquired all
remaining shares of Class B Common Stock if, within ten days thereafter, the
Company shall have tendered to each registered holder of Class B Common Stock
the Offer Price multiplied by the number of shares of Class B Common Stock held
by such holder (the "Mandatory Purchase").
If the Company does not make such an offer, or if such an offer is made but not
accepted by the holders of more than 50% of the shares of Class B Common Stock
then outstanding, the Company may still seek to effect the KFC Merger. If any
shares of Class B Common Stock remain outstanding at the effective time of the
KFC Merger, it is currently contemplated that each such share would be
converted into the right to receive an amount in cash equal to not more than
$20.00 per share in the KFC Merger.
Former employees who held shares of Class B Common Stock now subject to
mandatory purchase by the Company in accordance with the terms of the Company's
Certificate due to employment termination events occurring since January 1,
1995 (including those now employed by EVEREN or its subsidiaries), are entitled
to receive the 1995 Formula Price for such Class B Common Stock interests. The
1995 Formula Price will be calculated, as required by the terms of the
Company's Certificate, as soon as practicable after preparation of the
Company's audited consolidated financial statements for the year ending
December 31, 1995 and, if the 1995 Formula Price is a positive dollar amount,
such amount will be paid by the Company in respect of such Class B Common Stock
interests to such former holders in late March or early April, 1996.
F. Kemper Vote on any KFC Merger.
At September 30, 1995, Kemper owned over 99.9% of the Company's outstanding
common stock and approximately 98.8% of the Company's common stock on a fully
converted basis, assuming all outstanding Company securities were converted or
exercised in full in accordance with their
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<PAGE> 5
terms. Kemper has sufficient voting power to effect the KFC Merger in
accordance with the pertinent provisions of the Company's Certificate and the
General Corporation Law of the State of Delaware (the "Delaware Law"),
regardless of the level of votes in favor thereof cast by employee holders of
the Company's Class B Common Stock. Holders of any outstanding shares of Class
B Common Stock would have appraisal rights under Section 262 of the Delaware
Law in connection with any KFC Merger, subject to perfection of such rights in
accordance with the provisions of Section 262.
If (i) the Company is unable to acquire the currently outstanding shares of
Class B Common Stock through the Stock Repurchase Transactions or through a
Mandatory Purchase, (ii) substantial amounts of Debentures are converted into
additional shares of Class B Common Stock prior to the Optional Redemption
Date, or (iii) holders of any substantial number of shares of Class B Common
Stock seek to exercise appraisal rights under Section 262 of the Delaware Law,
consummation of any KFC Merger is likely to be abandoned or deferred pending
consummation of the KFS Sale and the mandatory purchase at the 1996 Formula
Price it would trigger.
REDEMPTION PROCEDURES
Payment of the Redemption Price for Debentures to be redeemed will be made on
or after the Optional Redemption Date only after any such Debentures have been
surrendered to the Company, in care of the Trustee, at:
First Trust National Association
Corporate Trust Department - Third Floor
180 East Fifth Street
St. Paul, Minnesota 55101
A. Owned Debenture.
If you own any of your Debentures outright, the Redemption Price payable by the
Company will be paid directly to you by the Trustee with respect to the
Debentures provided you have delivered your owned Debentures to the Trustee on
or before the Optional Redemption Date at the address set forth above.
It is currently expected that checks representing the Redemption Price payable
in respect of owned Debentures will be deposited in the mail not later than one
day after the Optional Redemption Date.
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<PAGE> 6
B. Financed Debenture.
If, like most holders of the Debentures, you fully financed the purchases of
your Debentures through The First National Bank of Chicago ("First National"),
your promissory note(s) to First National obligate you to repay the bank the
principal amount of your Debentures, together with accrued but unpaid interest.
In this circumstance, the Company will simply pay the Redemption Price directly
to First National on your behalf to satisfy your repayment obligation.
If your Debentures are fully financed through First National, they are held in
custody by First National as collateral for your loan(s). Therefore, First
National will arrange the delivery of such Debentures to the Trustee on or
before the Optional Redemption Date to facilitate prompt payment with respect
thereto. First National will also be required to deliver a Pledgee Release
contemplated by Section 1105 of the Indenture to the Company to confirm
settlement of all obligations to First National upon payment of the Redemption
Price and releasing any further liabilities or obligations to the bank.
C. Partial Financing.
If any Debentures you hold are partially financed through First National,
perhaps through the repayment of a portion of any of your loans, the Redemption
Price would be allocated ratably to repay that amount still owing to First
National which is associated with the financing of your Debenture purchase(s),
with the balance to be paid directly to you by the Trustee.
If any Debenture called for Optional Redemption shall not be paid upon
surrender thereof for redemption in accordance with the redemption procedures
described above, the principal shall, until paid, bear interest from the
Optional Redemption Date at the rate borne by the Debenture.
CONVERSION OF DEBENTURES ON OR BEFORE OPTIONAL REDEMPTION DATE
If you are an active employee holder of any series of Debentures, your
Debentures represent a present right to convert the Debentures into all or any
portion of the underlying shares of Class B Common Stock of the Company.
Holders of Debentures presently subject to mandatory redemption because their
employment with a Company subsidiary has terminated (including those holders
employed by EVEREN or its subsidiaries on September 13, 1995) CANNOT, from and
after their respective termination date, convert any of their Debentures per
Section 1201 of the Indenture.
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<PAGE> 7
Holders of Debentures considering whether to convert their Debentures into
shares of Class B Common Stock prior to the Optional Redemption Date must
carefully consider the effects on the Class B Common Stock of any Mandatory
Purchase, any KFC Merger and the KFS Sale, described above under "Reasons for
the Optional Redemption." The Company currently anticipates that employees
converting their Debentures into shares of Class B Common Stock may ultimately
receive less consideration, and are not in any event likely to receive more
consideration, in the aggregate, for such shares than employees surrendering
unconverted Debentures for the Redemption Price in the Optional Redemption.
If any of your Debentures is presented for conversion, depending on the series
of Debentures converted, each $100 principal amount of Debentures would
represent the right to receive the applicable number of shares of Class B
Common Stock set forth below, based on the conversion price applying to such
series of Debentures:
<TABLE>
<CAPTION>
NO. OF SHARES
SERIES CONVERSION PRICE ISSUABLE PER $100
<S> <C> <C>
E $ 20.00 5.0
I 20.00 5.0
J 20.00 5.0
N $ 26.16 3.8226
O 26.16 3.8226
R $ 29.29 3.4141
S 29.29 3.4141
T 29.29 3.4141
V $ 29.40 3.4014
W 29.40 3.4014
X 29.40 3.4014
Y 29.40 3.4014
AA $ 32.64 3.0637
BB 32.64 3.0637
CC 32.64 3.0637
DD 32.64 3.0637
EE 32.64 3.0637
</TABLE>
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<PAGE> 8
Conversion of Owned Debenture
If you own any of your Debentures outright and wish to present such Debenture
for conversion, you can present it to the Corporate Secretary of the Company
for conversion into all or any portion of the Class B Common Stock underlying
the Debenture on or before the Optional Redemption Date. Owned Debentures may
be transmitted for conversion to the following address:
Kathleen A. Gallichio
Corporate Secretary
Kemper Financial Companies, Inc.
1 Kemper Drive, Legal C-3
Long Grove, Illinois 60049
Conversion of any Financed Debenture
Assuming each of your Debentures is fully financed, and you wish to present any
of such Debentures for conversion, you can elect to repay First National the
principal amount of such Debenture to be converted which you borrowed from
First National to acquire the Debenture. This repayment will enable First
National to release your Debenture, which has been previously held as
collateral for your loan, so that your Debenture can be converted into all or
any portion of the shares of Class B Common Stock underlying the Debenture as
you elect.
Conversion of Partially Financed Debenture
If any of your Debentures are partially financed through First National and you
desire to convert all or a portion of any such Debenture into the underlying
shares of Class B Common Stock, you will similarly have to repay First National
the amount of outstanding indebtedness owed to First National on such Debenture
if you desire to convert the entire principal amount of that Debenture into
Class B Common Stock. Alternatively, you could choose to allow that portion of
your Debentures which remains subject to outstanding indebtedness to First
National to simply be redeemed on the Optional Redemption Date and convert the
non-financed portion of any such Debenture you own into Class B Common Stock
(or allow the entire Debenture to be redeemed or elect any variation of the
foregoing).
Note that if any of your Debentures has been fully or partially financed and
you repay First National the associated indebtedness prior to the Optional
Redemption Date to allow any conversion of your Debenture into Class B Common
Stock at the same date, First National will tender your Debenture directly to
the Company on your behalf to effect the stock issuance.
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Partial Conversion
Whether owned outright or financed, if you choose to convert only a portion of
any of your Debentures into Class B Common Stock, the unconverted portion of
your Debentures will be redeemed on the Optional Redemption Date and the
principal amount represented by such unconverted portion will be paid to you or
First National, as the case may be.
RISKS OF CONVERSION
ANY DECISION TO INVEST IN THE CLASS B COMMON STOCK THROUGH CONVERSION OF ANY
DEBENTURES SHOULD BE CAREFULLY EVALUATED AND INVOLVES SIGNIFICANT RISKS. SEE
"FORMULA PRICE RISKS" AND "OTHER RISKS OF CONVERSION" BELOW.
FORMULA PRICE RISKS
The Company's current projections indicate that both the 1995 Formula Price and
the 1996 Formula Price will be significantly less than $20.00 per share, the
minimum conversion price applicable for the Debentures. AS SUCH, THERE IS A
SUBSTANTIAL LIKELIHOOD THAT INVESTORS IN THE CLASS B COMMON STOCK THROUGH ANY
CONVERSION OF THEIR DEBENTURES WILL ULTIMATELY REALIZE LESS THAN THE CONVERSION
PRICE INVESTED.
The precise components underlying the calculation of the formula price are
described under "Formula Purchase Price To Be Paid For Shares" in the
DESCRIPTION OF THE COMMON STOCK OF KFC which is attached to this Notice of
Optional Redemption. As you know, the formula price has suffered significant
reductions in recent years due to a variety of factors, including real
estate-related issues and litigation charges. The formula price is calculated,
simply stated, on a combination of so-called "hard book value" plus 6 times the
average annual pre-tax earnings (or loss) during the trailing two-year period.
The Company suffered a pre-tax loss for the 1994 year which will continue to be
considered in the 1995 Formula Price, due to the trailing two-year feature.
Aside from attempting to assess the likely influence of the Company's 1995
earnings and/or losses by segment on the 1995 Formula Price as well as 1996
Formula Price, present estimates of the 1995 Formula Price and 1996 Formula
Price must also consider the effects of the various transactions earlier
described above together with the sizable level of real estate-related loss
projected for 1995 and 1996.
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<PAGE> 10
Please refer to the section entitled "Formula Purchase Price to Be Paid for
Shares" in the enclosed DESCRIPTION OF THE COMMON STOCK OF KFC. As described
in that section, gains or losses from the Company's disposition of any of its
subsidiaries are not included in pre-tax earnings (or loss) calculations for
purposes of computing the formula price, but such gains or losses would affect
the "base value" component of the formula. The Securities Brokerage
Divestiture produced a loss and a resultant reduction in the Company's
stockholders' equity, thus decreasing the "base value" component of the
formula, while the planned KFS Sale would result in a gain and corresponding
increase in base value for formula price calculation purposes.
Despite this projected gain on the KFS Sale as well as the benefits to the
formula price calculation of a further reduced level of Company debt to Kemper
expected after the KFS Sale (like the proceeds paid to the Company in the
Securities Brokerage Divestiture, it is expected that, absent a KFC Merger, the
proceeds from the KFS Sale would be applied to reduce indebtedness to Kemper
under the Company's line of credit), the 1995 Formula Price and 1996 Formula
Price are both presently estimated ultimately to be well below $20.00 per
share. These estimates consider the transactions outlined above, annualized
nine-month earnings for 1995, budgeted earnings estimates for 1996 under the
Kemper corporate plan together with the influence of the sizable levels of loss
projected from the accelerated level of real estate sales already contracted,
or projected to be sold or written down during the two-year period, by the
Company's subsidiaries with real estate interests.
The Company does not, as a matter of course, regularly publish or discuss its
formula price projections. While the Company's formula price projections have
been prepared in good faith, no assurance can be made regarding future events.
Projections of this type are based on estimates and assumptions that are
inherently subject to significant uncertainties and contingencies, all of which
are difficult to predict and many of which are beyond the Company's control.
Accordingly, there can be no assurance that the formula price projections will
be attained or that the actual 1995 Formula Price or 1996 Formula Price would
not be significantly higher or lower than projected. The Company does not
intend to publicly update or otherwise revise its formula price projections to
reflect circumstances existing after the date hereof, nor to reflect the
occurrence of unanticipated events, even if experience or future changes in
assumed conditions make or have made it clear that the formula price
projections have become or are inaccurate.
OTHER RISKS OF CONVERSION
ANY INVESTMENT IN THE CLASS B COMMON STOCK OF THE COMPANY INVOLVES SIGNIFICANT
RISKS AND SHOULD BE CAREFULLY EVALUATED BY EACH POTENTIAL INVESTOR. IN
ADDITION TO THE OTHER FACTORS DESCRIBED ABOVE, YOU SHOULD ALSO CONSIDER THE
APPROPRIATENESS OF THIS INVESTMENT IN LIGHT OF THE FOLLOWING CONSIDERATIONS.
A. Limited Holding Period.
Any active employee considering converting all or any portion of his or her
Debentures into Class B Common Stock must recognize that there are no plans to
pay more than $20.00 per share (the minimum conversion price applicable for the
Debentures) in any KFC Merger. In addition, if the
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<PAGE> 11
plans to effect the KFC Merger are abandoned for any reason, all
then-outstanding shares of Class B Common Stock would in any event become
subject to mandatory purchase, pursuant to the Company's Certificate, as a
result of the KFS Sale at the 1996 Formula Price. As such, there will be no
opportunity to hold such shares for any longer-term appreciation in value and,
given the current estimates of the 1996 Formula Price, there is a substantial
risk of loss of any conversion price invested.
B. Illiquidity of Investment.
There is no public trading market for KFC's securities, and there is no present
intention to publicly offer such securities. As such, the only present source
of liquidity for any investment in the Class B Common Stock is the Company.
C. Risk of Equity Investment/Risk of Mandatory Redemption at Lower
Price.
Anyone considering conversion of any of his or her Debentures into Class B
Common Stock must bear in mind that the Debentures represented funds borrowed
by the Company from you (even if you financed your purchase through First
National and thereby loaned the Company the proceeds you borrowed from the
bank). As debt securities, the Debentures constitute an obligation of the
Company and are to be repaid at not less than the aggregate principal amount of
the Debentures. Therefore, a holder of the Debentures has had relatively
little risk of loss on this investment.
BUT THE CLASS B COMMON STOCK CONSTITUTES AN EQUITY INVESTMENT IN THE COMPANY
SUBJECT TO VARIATIONS IN VALUE AND THE CONSEQUENT RISKS TYPICAL OF EQUITY
HOLDINGS. GIVEN THE LIKELIHOOD THAT ANY COMMON STOCK ISSUED ON CONVERSION
WILL, IN ANY EVENT, BECOME SUBJECT TO MANDATORY REDEMPTION AT THE 1996 FORMULA
PRICE NOT LATER THAN THE TIME OF THE KFS SALE, A HOLDER OF THE CLASS B COMMON
STOCK IS LIKELY TO RECEIVE LESS, AND IS NOT LIKELY TO RECEIVE MORE, THAN THE
CONVERSION PRICE PAID FOR SUCH STOCK.
D. Dividend-Related Issues.
Since the first quarter of 1993, the Company has not paid a quarterly cash
dividend on its Class A Common Stock owned by Kemper or on its outstanding
shares of Class B Common Stock. No future dividend declarations are planned.
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<PAGE> 12
E. Restrictions on Transfer.
The Class B Common Stock is subject to substantial restrictions on transfer
which are more fully described under "Restrictions on Transfer" in the
DESCRIPTION OF THE COMMON STOCK OF KFC attached to this Notice of Optional
Redemption. Basically, such shares may be held only while one remains an
active employee of the Company and its subsidiaries and cannot be sold or
transferred except to the Company. Further, such shares cannot be pledged as
collateral other than in connection with their initial purchase.
TAX EFFECTS
A. Optional Redemption.
The Company's redemption of your Debentures in the Optional Redemption should
not result in any taxable gain or loss since the redemption proceeds should in
most instances equal your cost basis in the Debentures. Any accrued interest
paid by the Company with respect to your Debentures will constitute taxable
ordinary income to you even though such payment may be made directly to First
National. Subject to certain limitations which are dependent on the extent of
one's taxable income, you will be entitled to a deduction for federal income
tax purposes (assuming you itemize deductions on your federal income tax
return) for the amount of interest paid to First National.
B. Conversion.
No gain or loss will be recognized for federal income tax purposes on
conversion of any Debenture into shares of Class B Common Stock. The tax basis
for the shares of the Class B Common Stock received upon conversion will be
equal to the tax basis of the Debenture converted. Provided that the Debenture
converted was held as a capital asset, the holding period of the shares of the
Class B Common Stock will include the holding period of the Debenture
converted.
THE FEDERAL INCOME TAX DISCUSSION SET FORTH ABOVE IS INCLUDED FOR GENERAL
INFORMATION ONLY. EACH SECURITYHOLDER IS URGED TO CONSULT HIS OR HER OWN TAX
ADVISOR AS TO THE SPECIFIC TAX CONSEQUENCES OF THE ABOVE-DESCRIBED EVENTS AND
THE APPLICABILITY AND EFFECT OF STATE, LOCAL AND OTHER TAX LAWS.
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<PAGE> 13
ADDITIONAL INFORMATION
Please contact Michael P. Malak at (708) 320-4611 or Kathleen A. Gallichio at
(708) 320-2468 if you have any questions regarding the procedures for
redemption or conversion or the transactions referenced in this Notice of
Optional Redemption. If you need to discuss any arrangements with First
National, please contact Lillian Arroyo at (312) 732-2279.
October 26, 1995 KEMPER FINANCIAL COMPANIES, INC.
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