<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 June 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)
<TABLE>
<S> <C>
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)
</TABLE>
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 July 1, 1995, 43,268,038 shares of Class A Common Stock (all held by an
affiliate, Kemper Corporation) and 5,831 shares of Class B Common Stock were
outstanding.
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KEMPER FINANCIAL COMPANIES, INC.
SECOND-QUARTER 1995
FORM 10-Q
<TABLE>
<CAPTION>
PART I. FINANCIAL STATEMENTS Page
----
<S> <C>
Consolidated Balance Sheet -
June 30, 1995 and December 31, 1994.............................3
Consolidated Statement of Operations -
Three months and six months ended June 30, 1995 and 1994........4
Consolidated Statement of Cash Flows -
Six months ended June 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 1. Legal Proceedings.......................................37
ITEM 5. Other Information.......................................37
ITEM 6. Exhibits and Reports on Form 8-K........................39
Signatures........................................................41
</TABLE>
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<PAGE> 3
KEMPER FINANCIAL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(in thousands, except share data)
(unaudited)
<TABLE>
<CAPTION>
June 30 December 31
1995 1994
-------- -----------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities available for sale, at market
(cost 1995, $3,583,537; 1994, $3,711,839) $3,614,993 $3,468,214
Short-term investments 191,800 204,164
Joint venture mortgage loans 413,197 407,540
Third-party mortgage loans 302,407 323,696
Other real estate-related investments 236,157 242,086
Policy loans 281,691 277,743
Other invested assets 45,045 55,363
---------- -----------
Total investments 5,085,290 4,978,806
Cash 283,177 199,917
Other accounts and notes receivable 457,021 321,494
Reinsurance recoverable 550,607 642,801
Deferred insurance acquisition costs 286,956 310,466
Deferred investment product sales costs 154,466 166,397
Fixed assets, at cost less accumulated depreciation 39,505 84,603
Other assets 13,088 63,393
Net assets of discontinued operations 132,686 249,033
Assets of separate accounts 1,641,106 1,507,984
---------- ----------
Total assets $8,643,902 $8,524,894
========== ==========
LIABILITIES
Future policy benefits $4,645,628 $4,843,690
Other accounts payable and liabilities 901,049 910,593
Notes payable 1,112,096 1,095,128
Convertible debentures 26,676 33,113
Liabilities of separate accounts 1,641,106 1,507,984
---------- ----------
Total liabilities 8,326,555 8,390,508
---------- ----------
Commitments and contingent liabilities
STOCKHOLDERS' EQUITY
Class A common stock-$.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 (21,938) (22,512)
Unrealized gain (loss) on investments 13,308 (237,957)
Retained deficit (121,178) (52,300)
---------- ----------
Total stockholders' equity 317,347 134,386
---------- ----------
Total liabilities and stockholders' equity $8,643,902 $8,524,894
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
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KEMPER FINANCIAL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Six months ended Three months ended
June 30 June 30
----------------- ------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
REVENUE
Investment management and other fees $164,139 $186,885 $ 80,508 $ 92,298
Commissions 26,160 37,129 13,221 17,427
Investment income 186,648 153,377 72,962 78,135
Securities gain (loss), net 1,130 (873) 22,414 (146)
Realized investment loss (23,225) (9,777) (62,068) (15,356)
Other income 24,133 19,426 11,735 7,332
-------- -------- -------- --------
Total revenue 378,985 386,167 138,772 179,690
-------- -------- -------- --------
EXPENSES
Operating expenses 131,286 140,563 63,036 67,912
Benefits and interest credited to policyholders 123,197 124,513 61,773 61,906
Commissions 40,523 52,069 21,104 24,513
Deferral of mutual fund and insurance acquisition costs (34,839) (45,137) (18,285) (21,233)
Amortization of mutual fund and insurance acquisition costs 48,566 42,153 22,005 23,260
Interest expense 50,843 33,575 25,830 18,540
-------- -------- -------- --------
Total expenses 359,576 347,736 175,463 174,898
-------- -------- -------- --------
Earnings (loss) from continuing operations before tax 19,409 38,431 (36,691) 4,792
Income tax expense (benefit) 22,681 14,634 (12,176) 2,443
-------- -------- -------- --------
Income (loss) from continuing operations (3,272) 23,797 (24,515) 2,349
Income (loss) from discontinued operations, net of tax (2,712) 113 502 (2,563)
Loss on divestiture of discontinued operation, net of tax (66,536) - (502) -
-------- -------- -------- --------
Net income (loss) $(72,520) $ 23,910 $(24,515) $ (214)
======== ======== ======== ========
Income (loss) per share from continuing operations $ (.08) $ .55 $ (.57) $ .05
Loss per share from discontinued operations (1.60) - - (.05)
-------- -------- -------- --------
Net income (loss) per share $ (1.68) $ .55 $ (.57) $ -
======== ======== ======== ========
</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>
Six months ended
June 30
-----------------------
1995 1994
------ ------
<S> <C> <C>
Cash flows from operating activities
Net income (loss) $ (72,520) $ 23,910
Reconcilement of net income (loss) to net cash provided:
Realized investment gain 23,142 9,777
Future policy benefits 118,437 121,337
Accounts payable and liabilities 9,544 (40,045)
Accounts and notes receivable 135,527 25,514
Deferred insurance acquisition costs 1,797 (8,110)
Deferred investment product sales costs (14,629) 5,126
Amortization of discount and premium on investments 2,086 1,598
Other (92,111) (6,916)
--------- ---------
Net cash provided from operating activities 111,273 132,191
--------- ---------
Cash flows from investing activities
Cash from investments sold or matured:
Fixed maturities held to maturity 71,888 21,752
Fixed maturities sold prior to maturity 161,453 432,677
Mortgage loans, policy loans and other invested assets 106,712 235,702
Cost of investments purchased:
Fixed maturities (99,918) (712,864)
Mortgage loans, policy loans and other invested assets 47,300 (131,425)
Net change in receivable/payable for securities sold/purchased (548) (13,490)
Short-term investments, net 12,383 80,065
Discontinued operations 2,750 13,000
Other (4,244) (21,324)
--------- ---------
Net cash provided from (used in) investing activities 297,776 (95,907)
--------- ---------
Cash flows from financing activities
Policyholder account balances:
Deposits 125,131 115,472
Withdrawals (441,630) (302,360)
Increase in notes payable, net 16,968 200,019
Redemption and maturities of convertible debentures (9,235) (28,580)
Other (17,023) (9,469)
--------- ---------
Net cash used in financing activities (325,789) (24,918)
--------- ---------
Net increase in cash 83,260 11,366
Cash, beginning of period 199,917 169,715
--------- ---------
Cash, end of period $ 283,177 $ 181,081
========= =========
</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>
Six months ended Three months ended
June 30 June 30
---------------- ------------------
(in thousands, except per share data) 1995 1994 1995 1994
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) reported $(72,520) $23,910 $(24,515) $ (214)
Add back:
Interest and amortization expense on convertible
debentures, net of tax * * * *
-------- ------- -------- ------
Total $(72,520) $23,910 $(24,515) $ (214)
======== ======= ======== ======
Average common shares outstanding 43,274 43,278 43,274 43,279
Average common share equivalents outstanding * * * *
-------- ------- -------- -------
Average common and equivalent shares outstanding 43,274 43,278 43,274 43,279
======== ======= ======== ======
Net income (loss) per share $ (1.68) $ 0.55 $ (0.57) $ 0.00
======== ======= ======== ======
</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 June 30, 1995.
4. Restricted cash at June 30, 1995 totaled $0.0 million.
5. Federal income tax paid to Kemper Corporation under the tax allocation
arrangement for the six months ended June 30, 1995 and 1994 amounted
to $30.3 million and $31.6 million, respectively. Interest payments
for the same periods totaled $49.9 million and $50.0 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
reversals of the valuation allowance are contingent upon the
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<PAGE> 7
recognition of future capital gains in Kemper Corporation's
consolidated federal income tax return or a change in circumstances
which causes the recognition of the benefits to become more likely
than not. During the first six months of 1995, the valuation
allowance was decreased by $85.4 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 give 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>
June 30 December 31
(in thousands) 1995 1994
------- -----------
<S> <C> <C>
Deferred federal tax assets:
Real estate-related $ 86,290 $ 112,667
Life policy reserves 46,246 51,519
Other investment-related 34,074 19,275
Accrued employee benefits 7,673 8,899
Unrealized losses on investments 7,780 93,211
Accrued expenses 3,283 5,027
Other 9,683 9,625
-------- ---------
Total deferred federal tax assets 195,029 300,223
Valuation allowance (41,818) (127,249)
-------- ---------
Total deferred federal tax assets after valuation allowance 153,211 172,974
-------- ---------
Deferred federal tax liabilities:
Deferred insurance acquisition costs 100,435 108,663
Deferred investment product sales costs 54,063 58,239
Depreciation and amortization 20,939 20,055
Unrealized gains on investments 10,963 -
Other investment-related 837 4,346
Other 9,936 9,837
-------- ---------
Total deferred federal tax liabilities 197,173 201,140
-------- ---------
Net deferred federal tax liability $(43,962) $ (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 six months ended June 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 entered into a definitive agreement to
acquire the assets of Dreman Value Management, L.P. See "RESULTS OF
OPERATIONS - Asset Management" in this Form 10-Q.
8. On April 3, 1995, a plan to divest the Company's securities brokerage
segment was announced. As a result, these operations have been
classified as discontinued operations at and for the periods ended
June 30, 1995 and 1994. The following table sets forth selected
financial information regarding the discontinued securities brokerage
operations:
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<PAGE> 8
<TABLE>
<CAPTION>
Six months ended June 30 Three months ended June 30
------------------------ --------------------------
1995 1994 1995 1994
------ ------ ------ ------
(in millions)
<S> <C> <C> <C> <C>
Revenue $260.6 $283.1 $134.8 $131.8
====== ====== ====== ======
Income (loss), net of tax $ (2.7) $ 0.1 $ 0.5 $ (2.6)
Loss on divestiture, net of tax (66.5) - (0.5) -
------ ------ ------ ------
Net income (loss) $(69.2) $ 0.1 $ - $ (2.6)
====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
June 30, 1995 December 31, 1994
-------------- -----------------
<S> <C> <C>
Total assets $1,792.4 $1,641.8
Total liabilities 1,659.7 1,392.8
-------- --------
Net assets $ 132.7 $ 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
On April 3, 1995, Kemper Corporation ("Kemper") and Kemper Financial Companies,
Inc. ("KFC") approved a plan to divest the securities brokerage segment. The
plan has resulted in the segment being reclassified as a component of
discontinued operations. KFC's planned divestiture of the securities brokerage
operations involves a sale to an employee stock ownership plan and a payment to
Kemper (with the proceeds from both to reduce KFC's debt to Kemper) comprised of
shares of stock in the newly formed company which will hold the securities
brokerage operations (which shares Kemper plans to distribute to its common
stockholders in a property dividend). The transaction is proceeding.
Completion of the transaction is subject to certain conditions, including the
Securities and Exchange Commission declaring effective a related registration
statement.
On May 15, 1995, Kemper signed a definitive merger agreement 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 not less than $900 million.
Consummation of the Merger Agreement and related transactions are subject to
certain conditions, including divestiture of the securities brokerage
operations and certain approvals by state insurance regulators, mutual fund
shareholders and the common stockholders of Kemper. The transactions are
expected to close in the fourth quarter of 1995 or, at the option of the
investor group, in January 1996. (See Part II, ITEM 5 of this Form 10-Q.)
On a fully converted basis, KFC is approximately 97 percent owned by Kemper,
with the remaining interests held by employees. Virtually all of the Company's
outstanding employee-owned interests will become subject to mandatory
redemption as a result of closing the planned securities brokerage divestiture
and the planned sale of KFS to Zurich. 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 June 30, 1995 and 1994:
Summary of Income (Loss) by Category
(in millions)
<TABLE>
<CAPTION>
Six months ended June 30, 1995 Six months ended June 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 $31.1 $ (.1) $ 31.0 $39.5 $ - $39.5
Life insurance 31.6 (30.4) 1.2 24.7 (3.3) 21.4
Real estate (4.7) - (4.7) (15.0) (2.9 (17.9)
Other (30.8) - (30.8) (19.0) (.2) (19.2)
----- ------ ------ ------ ----- -----
Continuing operations 27.2 (30.5) (3.3) 30.2 (6.4) 23.8
Discontinued operations (2.7) (66.5) (69.2) .1 - .1
----- ------ ------ ------ ----- -----
Total $24.5 $(97.0) $(72.5) $30.3 $(6.4) $23.9
===== ====== ====== ====== ===== =====
</TABLE>
(1) Net income (loss) excluding realized investment results.
(2) See following table for realized investment results.
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<PAGE> 10
Realized investment gain (loss)
(in millions)
<TABLE>
<CAPTION>
Six months ended June 30 Three months ended June 30
------------------------ --------------------------
1995 1994 1995 1994
----- ----- ----- -----
<S> <C> <C> <C> <C>
Real estate-related losses $(53.4) $(21.3) $(53.4) $ (8.8)
Gain on sale of IFTC, SSC & State Street 48.2 - 6.0 -
Orange County write-down (24.8) - (22.8) -
Other gains and losses, net 6.7 11.5 8.1 (6.6)
------ ----- ------ ------
Realized investment loss from
continuing operations (23.3) (9.8) (62.1) (15.4)
Income tax expense (benefit) 7.2 (3.4) (21.6) (5.4)
------ ----- ------ ------
Net realized investment loss
from continuing operations (30.5) (6.4) (40.5) (10.0)
Loss on divestiture of discontinued
operations, net of tax (66.5) - (0.5) -
------ ----- ------ ------
Total $(97.0) $(6.4) $(41.0) $(10.0)
====== ===== ====== ======
</TABLE>
Continuing operations
Operating earnings for continuing operations were $27.2 million for the first
six months of 1995, compared with $30.2 million in the same 1994 period.
Operating earnings for the second quarter of 1995 totaled $16.0 million,
compared with $12.3 million for the same period of 1994. These improvements in
second-quarter results reflect increased spreads on fixed rate annuities and
effective expense control in the life insurance segment and reduced joint
venture operating losses in the real estate segment. Asset management earnings
declined in both the six-month and second-quarter periods largely due to
reduced management fees, distribution fees and commission income.
Net loss from continuing operations totaled $3.3 million in the first six
months of 1995, compared with net income of $23.8 million in the first six
months of 1994. The Company reported a second-quarter 1995 net loss of $24.5
million, compared with net income of $2.4 million in the second quarter of
1994. Decreased net income for the six-month and second-quarter periods of 1995
resulted from $34.7 million of after-tax real estate-related realized
investment losses in the life insurance segment.
The other operations and corporate category consists of the holding company
income and expenses of KFC. This category reported a net loss of $30.8 million
for the first half of 1995, compared with a net loss of $19.2 million for the
same period of 1994. The 1994 results reflect realized investment losses of
$0.2 million (after-tax). The loss increased in 1995 primarily due to an
increase in interest expense over 1994 on increased borrowings from Kemper.
Total operations
Including discontinued operations, the Company's net loss totaled $72.5 million
for the first six months of 1995, compared with net income of $23.9 million for
the first six months of 1994. Net loss per share for the first six months of
1995 was $1.68, compared with net income per share of $.55 in the first six
months of 1994. The Company recorded a net loss of $24.5 million, or $.57 per
share, in the second quarter of
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<PAGE> 11
1995, compared with a net loss of $0.2 million, or $.00 per share, in the same
period of 1994.
Discontinued operations consist of the Company's securities brokerage
subsidiaries, for which a plan for divestiture was announced in April 1995. In
the first six months of 1995, the net loss from discontinued operations totaled
$69.2 million, primarily due to a $66.1 million loss relating to the proposed
divestiture. In the first six months of 1994, the net gain from discontinued
operations totaled $0.1 million, reflecting securities brokerage operating
earnings.
Book value per share, on a fully converted basis, was $7.83 at June 30, 1995,
compared with $3.85 at year-end 1994, as the change in unrealized gain on
investments of $251.3 million, or $5.66 per share, in the first six months of
1995 more than offset the net loss per share. Taking into account results for
the trailing 24 months ended June 30, 1995, the formula purchase price per
share was a positive $2.45 at June 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.
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<PAGE> 12
Asset management
The asset management segment principally consists of Kemper Financial Services,
Inc. ("KFS") and its subsidiaries, including Kemper Service Company ("KSvC")
and INVEST Financial Corporation ("INVEST").
Selected Financial Highlights
(in millions)
<TABLE>
<CAPTION>
Six months ended June 30 Three months ended June 30
------------------------ --------------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
STATEMENT OF INCOME
Investment management fees $100.8 $112.1 $ 50.8 $ 54.9
Commission income 29.4 40.9 15.2 19.0
Distribution and redemption fees 29.4 36.3 14.5 17.2
Transfer agent revenue 33.9 38.3 15.2 20.1
Investment and other income 10.5 8.6 5.2 4.6
Realized investment gain (loss) 23.5 - (16.8) -
------ ------ ------ ------
Total revenue 227.5 236.2 84.1 115.8
------ ------ ------ ------
Operating expenses 111.6 127.2 51.9 63.0
Commission expense 31.4 42.2 16.0 19.9
Deferral of mutual fund commissions
and sales expense (14.6) (22.4) (7.6) (10.3)
Amortization of deferred mutual fund
commissions and sales expense 26.5 27.5 12.8 14.6
------ ------ ------ ------
Total expenses 154.9 174.5 73.1 87.2
------ ------ ------ ------
Earnings before income tax 72.6 61.7 11.0 28.6
Income tax expense 41.6 22.2 4.5 10.1
------ ------ ------ ------
Net income $ 31.0 $ 39.5 $ 6.5 $ 18.5
====== ====== ====== ======
Realized investment loss, net of tax $ (0.1) $ - $(11.0) $ -
====== ====== ====== ======
Operating earnings $ 31.1 $ 39.5 $ 17.5 $ 18.5
====== ====== ====== ======
Per share:
Operating earnings $ .72 $ .91 $ .40 $ .43
====== ====== ====== ======
Net income .72 $ .91 $ .15 $ .43
====== ====== ====== ======
</TABLE>
The asset management segment's net income for the first six months of 1995
decreased $8.5 million when compared with the first six months of 1994. This
decrease was primarily due to lower operating earnings, which were $31.1
million in the first half of 1995, compared with $39.5 million in the first
half of 1994. Reduced management fees, distribution and redemption fees,
transfer agent fees and commission income all contributed to the decline in
operating earnings. These revenue reductions were partially offset by reduced
operating and commission expenses (see discussion below).
Also reducing the segment's net income was an after-tax Orange County-related
charge totaling $16.1 million in the first six months of 1995. This charge
primarily reflected the difference between the December 31, 1994 estimated value
of $198.0 million face amount of Orange County, California notes and their June
30, 1995 estimated value. Kemper renewed credit-enhancing arrangements in the
period that were established in the fourth quarter of 1994 pursuant to which
the Company bears the risk of loss associated with the Orange County notes held
by
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<PAGE> 13
five non-government taxable money market mutual funds managed by KFS. 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 to the new maturity date.
The segment's net income in 1995 benefited from a net realized investment gain
of $11.6 million in the first quarter from the sale of KFS' 50 percent interest
in Investors Fiduciary Trust Company ("IFTC") and by a net realized investment
gain of $4.4 million in the second quarter from the sale of shares of State
Street Boston Corporation ("State Street") common stock. 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 $2.8 million of the segment's operating earnings recorded in
the first half of 1995 and 1994, respectively.
In April 1995, KSvC sold to DST Systems, Inc. ("DST") the business operations
of Supervised Service Company, Inc. ("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.
Also, in April 1995, KFS sold 5,034 shares of its 12,500 shares of Dimensional
Fund Advisors, Inc. ("DFA") to DFA for approximately $2.2 million. In July, KFS
entered into an agreement to sell its remaining 7,466 shares of DFA for
approximately $3.2 million. A realized investment gain of approximately
$280,000 was attributable to the April sale and an additional gain of
approximately $415,000 is expected to be realized in the second half of 1995.
On May 2, 1995, KFS announced the signing of a definitive agreement to acquire
substantially all the assets of Dreman Value Management, L.P. ("DVM"). The
planned acquisition would broaden KFS' retail and institutional product
offerings to include the value style of equity investing and complement KFS'
current growth style. DVM currently has approximately $1.5 billion in
institutional assets under management and $60.0 million in assets managed for
three value style equity mutual funds and one fixed income fund. Consummation
of the transaction is subject to, among other conditions, certain third-party
approvals. The transaction is expected to close later in the third quarter of
1995.
The decrease of $11.3 million in investment management fees in the first half
of 1995 when compared with the first half of 1994 was primarily due to a
$4.0 billion reduction in mutual fund average assets under management. Bond
funds accounted for $3.4 billion of this decrease, while stock funds and money
market funds represented declines of $0.4 billion and $0.2 billion,
respectively.
- 13 -
<PAGE> 14
Commission income was $29.4 million in the first six months of 1995,
compared with $40.9 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 $7.0 million
in the first six months of 1995 when compared with the same period in 1994.
Also adversely affecting INVEST's revenue were decreased sales of annuity
products, where commissions declined $4.5 million in the first half of 1995
compared with the first half of 1994. INVEST's first-half 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 $6.9 million in the
first six months of 1995 compared with the first six months of 1994.
Distribution fees, based on assets managed in KFS' spread load mutual funds,
were approximately $5.5 million lower as spread load assets declined due to
market depreciation, redemptions of fund 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 $33.9 million in the first six months of
1995 from $38.3 million in the same period last year. This $4.4 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, SSC's transfer agent
fees decreased approximately $0.5 million during the 1995 period due to the
above-described sale of its business operations. KSvC accounted for transfer
agent revenue of $30.7 million and $34.6 million in the first six months of
1995 and 1994, respectively. SSC accounted for transfer agent revenue of $3.2
million and $3.7 million in the first six months of 1995 and 1994,
respectively.
Investment and other income increased by $1.9 million in the first half of
1995 compared with the first half of 1994. This increase was primarily due to
additional interest and dividend income of approximately $2.8 million in 1995
and the above-described sale of KFS' DFA shares.
Operating expenses declined by $15.6 million in the first six months of
1995 when compared with the first six months of 1994. Expense reductions
in advertising, literature and sales promotion of mutual fund products
approximated $1.2 million. Personnel expenses decreased approximately $10.6
million due to staff reductions and reductions in production-related
compensation due to lower sales. Transfer agent remote processing fees and
software application depreciation costs were $3.5 million lower during the
period based on the above-mentioned agreement with DST. Professional services
expenses increased by approximately $1.2 million primarily due to
litigation-related expenses.
Commission expense decreased to $31.4 million in the first half of 1995,
compared with $42.2 million in the first half of 1994, due to lower sales.
With the reduction of sales there was a related decrease in the
- 14 -
<PAGE> 15
deferral of mutual fund commissions and sales expense. Amortization of
deferred mutual fund commission and sales expense 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.
Assets under management
(in billions)
<TABLE>
<CAPTION>
6/30/95 3/31/95 12/31/94 9/30/94 6/30/94
------- ------- -------- ------- -------
<S> <C> <C> <C> <C> <C>
Mutual funds:
Bond $21.1 $21.0 $20.6 $21.9 $22.9
Stock 9.4 8.9 8.7 9.0 8.7
Money market 12.6 12.1 12.2 12.3 12.2
Investment advisory 4.6 4.5 5.0 5.6 4.8
Kemper Corporation
affiliates 9.0 9.1 9.3 9.6 9.6
The Kemper National
Insurance Companies 6.6 6.6 6.9 7.0 6.9
----- ----- ----- ----- -----
Total $63.3 $62.2 $62.7 $65.4 $65.1
===== ===== ===== ===== =====
</TABLE>
Bond and stock mutual fund assets under management increased $1.2 billion from
December 31, 1994 primarily due to market value appreciation. Bond and stock
funds had asset appreciation of $3.4 billion in the first six months of 1995,
compared with asset depreciation of approximately $1.7 billion in the first
half of 1994. Redemptions of stock and bond funds totaled $2.8 billion in the
first half of 1995, while sales totaled $1.0 billion. Comparable six-month
1994 redemptions and sales totals were $3.1 billion and $1.6 billion,
respectively. Bond funds made up 63 percent of the redemption volume in the
first half of 1995, down from 78 percent in the same period last year. Sales
of stock mutual funds represented 44 percent of total stock and bond fund sales
in the first six months of 1995, up from 42 percent in the first half of 1994.
Money market fund assets under management increased $0.4 billion in the first
half of 1995, as net sales in wholesale-distributed money funds were positive
for the period.
The decline in investment advisory assets in the first half of 1995 was
primarily due to the loss of clients because of uncertainties with respect to
the Company's ownership, portfolio management turnover and performance.
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 area in the first half of 1995. Prior periods in the
table above have been restated.
The first-half declines in assets managed for the Kemper National Insurance
Companies and Kemper Corporation affiliates were primarily due to decreases in
real estate-related assets. These decreases 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>
Six months ended Three months ended
June 30 June 30
------------------ -------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
STATEMENT OF INCOME
Investment income $ 179.1 $ 165.7 $ 89.0 $ 83.5
Other income 17.5 15.8 8.5 7.8
Realized investment loss (46.7) (5.0) (45.3) (11.1)
------- ------- ------- ------
Total revenue 149.9 176.5 52.2 80.2
------- ------- ------- ------
Benefits to policyholders 123.2 124.5 61.8 61.9
Commissions, taxes, licenses and fees 14.0 13.6 8.2 5.9
Operating expenses 9.7 12.9 4.8 6.7
Deferral of policy acquisition costs (20.2) (22.8) (10.7) (10.9)
Amortization of deferred policy
acquisition costs 22.0 14.7 9.2 8.7
------- ------- ------- ------
Total benefits and expenses 148.7 142.9 73.3 72.3
------- ------- ------- ------
Earnings (loss) before income tax 1.2 33.6 (21.1) 7.9
Income tax expense (benefit) - 12.2 (7.4) 3.3
------- ------- ------ ------
Net income (loss) $ 1.2 $ 21.4 $ (13.7) $ 4.6
======= ======= ======= ======
Realized investment loss,
net of tax $ (30.3) $ (3.3) $ (29.4) $ (7.2)
======= ======= ======= ======
Operating earnings $ 31.5 $ 24.7 $ 15.7 $ 11.8
======= ======= ======= ======
Per share:
Operating earnings $ .73 $ .57 $ .36 $ .27
======= ======= ======= ======
Net income (loss) $ .03 $ .49 $ (.32) $ .11
======= ======= ======= ======
</TABLE>
The life insurance segment reported net income in the first six months of 1995
of $1.2 million, compared with net income of $21.4 million in the first six
months of 1994. The decline was primarily due to realized investment losses in
1995, compared with realized investment gains in 1994. See the discussion
captioned "Real Estate Asset Sales" in ITEM 5 of this Form 10-Q below.
The following table reflects the major components of realized
investment gains (losses) included in net income:
Realized investment gains (losses):
(in millions)
<TABLE>
<CAPTION>
Six months ended Three months ended
June 30 June 30
------------------ ------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
Real estate-related losses $(53.4) $(18.1) $(53.4) $ (4.3)
Fixed maturity write-downs - (0.1) - -
Other gains (losses), net 6.7 13.2 8.1 (6.7)
------ ------ ------ ------
Realized investment losses (46.7) (5.0) (45.3) (11.0)
Income tax benefit (16.4) (1.7) (15.9) (3.8)
------ ------ ------ ------
Net realized investment losses $(30.3) $ (3.3) $(29.4) $ (7.2)
====== ====== ====== ======
</TABLE>
- 16 -
<PAGE> 17
Operating earnings improved to $31.6 million in the first half of 1995,
compared with $24.7 million in the first half of 1994, primarily due to
increased spread income, lower operating expenses and an increase in fees and
other income. These improvements were partially offset by an increase in the
amortization of deferred insurance acquisition costs.
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 adversely impacts spread income. The recent decline in interest rates
during the second quarter of 1995, however, has created an interest rate
environment mitigating at present competitive pressures to increase renewal
crediting rates further.
Investment income was positively impacted in the first half of 1995, compared
with the first half 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 in recent
periods. These sales totaled $3.5 million in the first half of 1995 and
$107.3 million in the first half 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 resulted in 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 cash and
short-term investments, was 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>
Six Months Ended Three Months Ended
June 30 June 30
----------------- ------------------
1995 1994 1995 1994
----- ------ ----- -----
<S> <C> <C> <C> <C>
Annuities:
General account $ 125.1 $ 114.8 $ 74.3 $ 53.7
Separate account 86.7 146.7 38.3 69.3
------- ------- ------- -------
Total annuities 211.8 261.5 112.6 123.0
Interest-sensitive life insurance - .7 - .2
------- ------- ------- -------
Total sales $ 211.8 $ 262.2 $ 112.6 $ 123.2
======= ======= ======= =======
</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 as a result of the
- 17 -
<PAGE> 18
current interest rate environment. KILICO's longer term strategy is to direct
its sales efforts toward separate account (variable annuity) products, which
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 half of
1995, compared with the first half 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 $10.5 million in the first half of 1995,
compared with $10.3 million in the first half of 1994. Other income also
included surrender charge revenue of $4.8 million in the first half of 1995,
compared with $3.5 million in the first half of 1994, as total general account
and separate account policyholder surrenders and withdrawals increased to
$573.4 million in the first half of 1995, compared with $346.5 million in the
first half of 1994. Policyholder withdrawals increased during the first half
of 1995 reflecting uncertainty regarding KILICO's ownership and rising interest
rates late in 1994 and early in 1995. 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 quarter of 1995, together with the
benefits of KILICO'S planned association with Zurich, KILICO expects that the
level of surrender and withdrawal activity experienced in the first half of
1995 should decrease for the remainder of 1995.
The deferral of insurance acquisition costs was lower in the first half of
1995, compared with the first half of 1994, primarily reflecting lower overall
annuity sales. The amortization of insurance acquisition costs increased in
the first six months of 1995, compared with the first six 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 $0.4 million during the first
half of 1995, compared with the first half of 1994, primarily due to an
increase in guaranty fund assessments for insolvent life insurance companies.
Operating expenses decreased by $3.2 million, or 24.6 percent, in the first
half of 1995, compared with the first half 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-
- 18 -
<PAGE> 19
related investments to affiliated non-life realty companies through June 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
indebtedness, and capital contributions of $342.5 million through June 30,
1995. KILICO's statutory surplus ratio improved to 11.9 percent at June 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
(in millions)
<TABLE>
<CAPTION>
June 30 December 31
1995 1994
-------------- --------------
<S> <C> <C> <C> <C>
Cash and short-term investments $ 188 3.8% $ 227 4.6%
Fixed maturities:
Investment-grade:
NAIC(1) Class 1 2,732 54.8 2,569 52.2
NAIC(1) Class 2 736 14.8 760 15.5
Performing below investment-grade(2) 142 2.8 135 2.8
Equity securities 4 0.1 15 0.3
Joint venture mortgage loans(3)(4) 353 7.1 351 7.1
Third-party mortgage loans(3)(4) 296 5.9 319 6.5
Other real estate-related investments(4) 227 4.5 237 4.8
Other 307 6.2 304 6.2
------ ----- ------ -----
Total(3) $4,985 100.0% $4,917 100.0%
====== ===== ====== =====
</TABLE>
(1) National Association of Insurance Commissioners ("NAIC").
- Class 1 = A- and above
- Class 2 = BBB- through BBB+
(2) Excludes $26.5 million, or 0.5 percent, and $49.9 million, or 1.0 percent,
at June 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>
June 30 December 31
1995 1994
------- -----------
<S> <C> <C>
Deferred insurance acquisitions costs $ 287 $ 310
Assets of separate accounts 1,641 1,508
Total assets 7,636 7,537
Life policy benefits, net of ceded reinsurance 4,646 4,844
Net unrealized gain (loss) on investments 13 (236)
Stockholder's equity 685 434
</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>
Six months ended June 30 Three months ended June 30
------------------------ --------------------------
1995 1994 1995 1994
<S> <C> <C> <C> <C>
STATEMENT OF INCOME ------- ------- ------- -------
Joint venture operating losses $ (3.8) $ (21.4) $ (.1) $ (10.0)
Investment income and other 5.3 6.8 2.9 3.1
Realized investment loss - (4.5) - (4.3)
------- ------- ------- -------
Total revenue 1.5 (19.1) 2.8 (11.2)
------- ------- ------- -------
Operating expenses 8.0 7.1 4.7 3.7
Interest expense .6 1.4 .2 .7
------- ------- ------- -------
Total expenses 8.6 8.5 4.9 4.4
------- ------- ------- -------
Loss before income tax benefit (7.1) (27.6) (2.1) (15.6)
Income tax benefit (2.4) (9.7) (.7) (5.5)
------- ------- ------- -------
Net loss $ (4.7) $ (17.9) $ (1.4) $ (10.1)
======= ======= ======= =======
Realized investment loss,
net of tax benefit $ - $ (2.9) $ - $ (2.8)
======= ======= ======= =======
Operating loss $ (4.7) $ (15.0) $ (1.4) $ (7.3)
======= ======= ======= =======
Per share:
Operating loss $ (.11) $ (.35) $ (.03) $ (.17)
======= ======= ======= =======
Net loss $ (.11) $ (.41) $ (.03) $ (.23)
======= ======= ======= =======
</TABLE>
The $17.6 million joint venture operating loss decline in the first six months
of 1995 from the level in the year-ago period was primarily due to certain
joint venture audit adjustments and also reflected sales and restructurings
that were completed with respect to certain joint ventures, reducing 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 six months of 1995.
In the first half 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 decreased $1.5 million in the first half 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,
- 20 -
<PAGE> 21
1995. In the first half of 1994, this segment recorded $0.5 million of real
estate management fee revenue from managing real estate assets of the Kemper
National Insurance Companies.
In the first half of 1995, the segment generated realized gains at a level
equal to additions to reserves and write-downs. In the first six 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.
See "INVESTMENTS-Provisions for real estate-related losses" below.
The following table reflects selected balance sheet data of the real estate
segment:
Selected balance sheet data
(in millions)
<TABLE>
<CAPTION>
June 30 December 31
1995 1994
------- -----------
<S> <C> <C>
Cash and short-term investments $ 8 $ 9
Joint venture mortgage loans (1) 65 61
Third-party mortgage loans (1) 6 5
Other real estate-related investments (1) 9 5
Other 6 4
---- ----
Total invested assets and cash (2) $ 94 $ 84
==== ====
Net deferred federal tax asset $ 29 $ 52
Total assets 224 234
Long-term debt 13 13
Stockholder's equity 176 181
</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
(in millions)
<TABLE>
<CAPTION>
June 30 December 31
1995 1994
------------- -------------
<S> <C> <C> <C> <C>
Cash and short-term investments $ 475 8.9% $ 404 7.8%
Fixed maturities:
Investment-grade:
NAIC(1) Class 1 2,732 50.9 2,569 49.6
NAIC(1) Class 2 736 13.7 760 14.7
Performing below investment-grade(2) 147 2.7 139 2.7
Joint venture mortgage loans 413 7.7 407 7.9
Third-party mortgage loans 302 5.6 324 6.2
Other real estate-related investments(3) 236 4.4 242 4.7
Policy loans 282 5.3 278 5.4
Other 45 0.8 56 1.0
------ ----- ------ -----
Total $5,368 100.0% $5,179 100.0%
====== ===== ====== =====
</TABLE>
(1) National Association of Insurance Commissioners ("NAIC").
- Class 1 = A- and above
- Class 2 = BBB- through BBB+
(2) Excludes $50.4 million, or 0.9 percent, and $80.0 million, or 1.5 percent,
at June 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 June 30,
1995 was $20.4 million, or $0.46 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 June 30, 1995, investment-grade fixed maturities and cash and short-term
investments accounted for 73.5 percent of the Company's invested assets and
cash, compared with 72.1 percent at December 31, 1994. Approximately 69.5
percent of the Company's NAIC Class 1 bonds were rated AAA or equivalent at
June 30, 1995.
Approximately 50 percent of the Company's investment-grade fixed maturities at
June 30, 1995 were mortgage-backed securities. These investments consist
primarily of marketable mortgage pass-through
- 22 -
<PAGE> 23
securities issued by the Government National Mortgage Association, the Federal
National Mortgage Association or the Federal Home Loan Mortgage Corporation and
other investment-grade securities collateralized by mortgage pass-through
securities issued by these entities. The Company has not made any investments
in interest-only or other similarly volatile tranches of mortgage-backed
securities. The Company's mortgage-backed investments are generally of AAA
credit quality, and the markets for these investments have been and are
expected to remain liquid.
Future investment income for 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 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 the premiums which would result in reductions of investment
income related to such securities. At June 30, 1995, the Company has
unamortized discounts and premiums of $18.8 million and $13.2 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
financial statements.
Below investment-grade securities holdings (NAIC classes 3 through 6),
representing securities of 11 issuers at June 30, 1995, totaled less than three
percent of cash and invested assets at June 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 $951.8 million real estate portfolio constituted 17.7 percent of the
Company's cash and invested assets at June 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>
June 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 $ 356 $ 68 $ 454 $ 353 $ 101
Third-party mortgage loans 321 314 7 358 353 5
Other real estate-related
investments 761 320 441 828 351 477
------ ------ ----- ------ ------ -----
Subtotal 1,506 990 516 1,640 1,057 583
Reserves (64) (44) (20) (134) (43) (91)
Write-downs (331) (60) (271) (362) (97) (265)
Foreign currency translation
adjustments (22) - (22) (23) - (23)
Cumulative net operating losses
of joint ventures owned (137) (15) (122) (148) (15) (133)
------ ------ ----- ------ ------ -----
Net real estate investments $ 952 $ 871 $ 81 $ 973 $ 902 $ 71
====== ====== ===== ====== ====== =====
</TABLE>
As reflected in the real estate portfolio table on the following page, the
Company has continued to fund both existing projects and legal commitments.
The future legal commitments were $341.6 million at June 30, 1995. This amount
represented a net decrease of $41.1 million since December 31, 1994, largely
due to fundings in the first six months of 1995. As of June 30, 1995, the
Company expects to fund approximately $63.9 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 $63.0 million of real estate owned and a $36.1 million deficit in
the Company's net equity investments in joint ventures, the Company's real
estate loans (including real estate-related bonds) totaled $924.9 million at
June 30, 1995, after reserves and write-downs. Of this amount, $583.7 million
are on accrual status with a weighted average interest rate of 8.0 percent. Of
these accrual loans, 56.1 percent have terms requiring current periodic
payments of their full contractual interest, 27.2 percent require only partial
payments or payments to the extent of cash flow of the borrowers, and 16.7
percent defer all interest to maturity.
- 24 -
<PAGE> 25
The deficit in equity investments in real estate, at June 30, 1995, consisted
of $98.4 million of loans to Spanish projects (described below), $44.2 million
of unsecured loans to joint ventures treated as equity investments, a $156.7
million deficit in the Company's other equity investments in joint ventures and
$22.0 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 $3.8 million of foreclosures, $55.4
million of deeds in lieu of foreclosure and $3.8 million of certain purchased
properties at June 30, 1995. Real estate owned was net of $84.8 million of
write-downs at June 30, 1995.
Real estate portfolio
(in millions)
<TABLE>
<CAPTION>
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 20.8 2.4 - 1.0 3.0 20.1 47.3
Interest added to principal 9.8 5.9 0.1 2.3 - - 18.1
Sales/paydowns/distributions (22.0) (6.1) (0.1) (5.4) (12.3) (2.0) (47.9)
Maturities - - - (0.4) - - (0.4)
Rollovers at maturity:
Principal - - - 0.4 - - 0.4
Operating loss - - - - - (4.2) (4.2)
Transfers to real estate owned (3.6) - - - 3.6 - -
Realized investment gain (loss) (7.0) (14.2) (6.1) (47.3) 2.8 18.4 (53.4)
Net transfers 18.3 (25.4) (22.2) 37.4 - (8.1) -
Other transactions, net (10.6) 16.1 (0.1) 20.5 (6.9) (0.4) 18.6
------ ------ ----- ------ ----- ------ ------
Balance at June 30, 1995 $413.2 $302.4 $51.6 $157.7 $63.0 $(36.1) $951.8(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 $395.9 million reserve and write-downs. Excludes $26.3 million of
real estate-related accrued interest.
As reflected in the preceding table, cash received from
sales/paydowns/distributions approximated the Company's cash fundings during
the first six months of 1995.
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 show some
stabilization and improvement.
At June 30, 1995, the Company's real estate portfolio also included $98.4
million of loans carried as equity investments in real estate (net of
- 25 -
<PAGE> 26
$119.4 million of cumulative write-downs, $21.8 million of foreign currency
translation losses and $22.4 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 $18.4 million of
net fundings, $1.0 million of foreign currency translation losses and operating
income of $1.8 million during the first six months of 1995 and represented
approximately 10.4 percent of the Company's real estate portfolio at June 30,
1995. These investments, which began in the late 1980s, accounted for $13.3
million of the June 30, 1995 off-balance-sheet legal commitments, of which the
Company expects to fund approximately $3.8 million.
Undeveloped land, including the Spanish projects, represented approximately
26.1 percent of the Company's real estate portfolio at June 30, 1995. To
maximize the value of certain land and other projects, additional development
is proceeding or is planned. Such development of existing projects may
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.
At June 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 27.8 percent, of the Company's real estate
portfolio (including the previously mentioned Spanish projects, which are Prime
Group-related). This amount reflected $19.7 million in fundings during the
first half of 1995 and $65.6 million during the same period of 1994. The
Company also received cash from Prime Group-related
sales/paydowns/distributions totaling $26.3 million in the first six months of
1995. Prime Group-related commitments accounted for $196.4 million of the
off-balance-sheet commitments at June 30, 1995, of which the Company expects to
fund $24.1 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 participated in funding certain cash needs of the MLP
projects. During the first six months of 1995, the Company provided $21.3
million of fundings to the MLP projects, compared with fundings of $16.4
million in
- 26 -
<PAGE> 27
the same period of 1994. The Company also received cash from MLP-related
sales/paydowns/distributions and refinancings of $23.6 million in the first
half of 1995. At June 30, 1995, projects in the MLP accounted for $34.2
million of the Company's off-balance-sheet legal commitments, of which the
Company expects to fund $27.4 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
June 30, 1995, approximately $263.9 million, or 27.7 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 half 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 six 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 (8.9) (36.2) 10.9 (35.1) 2.0 (71.3)
----- ------ ----- ------ ----- ------
Balance at 6/30/95 $ 8.2 $ 3.6 $36.4 $ 16.7 $44.6 $ 20.3
===== ====== ===== ====== ===== ======
</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 $330.9 million (life insurance segment, $59.6 million;
real estate segment, $271.3 million) at June 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 six 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.
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>
June 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) $ 59.4 $ 0.4 $ 59.8 $ 57.9 $ 0.2 $ 58.1
Past due loans(2) 4.7 - 4.7 - - -
Nonaccrual loans(3) 259.0 148.0 407.0 274.6 199.3 473.9
Restructured loans(4)
(currently performing) 45.4 0.7 46.1 50.5 0.8 51.3
Real estate owned(5) 49.8 13.2 63.0 57.3 15.4 72.7
------ ------ ------ ------ ------ ------
Total(6)(7) $418.3 $162.3 $580.6 $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 $84.8 million and $115.8 million at June
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 June 30,
1995 (excluding fair value adjustments to real estate owned) were 53.6
percent of total troubled real estate-related investments and 24.6 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
- 29 -
<PAGE> 30
previously utilized) include loan sales, property sales, mortgage 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 (respecting the Company's entire investment portfolio)
shows each segment's contribution to the Company's net investment income:
Net investment income before taxes
(dollars in millions)
<TABLE>
<CAPTION>
Six months ended June 30 Three months ended June 30
------------------------ --------------------------
1995 1994 1995 1994
------ ------ ------ ------
<S> <C> <C> <C> <C>
Life insurance $179.2 $165.8 $89.0 $83.5
Real estate (2.2) (18.9) 0.8 (8.8)
Other and eliminations 3.3 2.9 1.7 1.5
------ ------ ----- -----
Total from invested assets 180.3 149.8 91.5 76.2
Asset management 6.4 3.6 2.8 1.9
------ ------ ----- -----
$186.7 $153.4 $94.3 $78.1
====== ====== ===== =====
Investment yields:
Life insurance 7.24% 6.35% 7.19% 6.54%
====== ====== ===== =====
Consolidated 7.08% 5.70% 7.11% 5.91%
====== ====== ===== =====
</TABLE>
Included in pre-tax net investment income is the Company's share of the
operating losses from equity investments in real estate. The Company's share
of real estate operating losses (excluding write-downs) totaled $4.2 million
and $22.0 million for the six months ended June 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 on nonaccrual real
estate-related investments was as follows:
Foregone investment income
(dollars in millions)
<TABLE>
<CAPTION>
Six months ended June 30 Three months ended June 30
------------------------ ---------------------------
1995 1994 1995 1994
----- ----- ----- -----
<S> <C> <C> <C> <C>
Real estate-related investments:
Life insurance segment $ 9.9 $18.0 $4.7 $8.9
Real estate segment 1.5 (0.5) 1.0 0.5
----- ----- ---- ----
Total $11.4 $17.5 $5.7 $9.4
===== ===== ==== ====
Basis points:
Life insurance segment 40 69 38 70
===== ===== ==== ====
Consolidated 45 67 45 74
===== ===== ==== ====
</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
- 30 -
<PAGE> 31
investments at June 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 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 losses of $30.5 million for the first six months of 1995,
compared with $6.4 million for the first six months of 1994. The life
insurance segment reported real estate-related losses of $34.7 million (see the
discussion captioned "Real Estate Asset Sales" in ITEM 5 of this Form 10-Q
below) and $11.8 million for the first six months ended June 30, 1995 and 1994,
respectively, offset by other realized investment gains of $4.4 million and
$8.5 million for the six months ended June 30, 1995 and 1994, respectively,
primarily from the sales of fixed maturity investments in 1995 and common
stocks in 1994. In the first six months of 1995, the asset management segment
reported net realized investment gains of $0.1 million.
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 remainder of the
first six month 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 competitors' 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 June
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 first six months of 1995, KILICO's capital
resources were positively impacted from elimination of its unrealized loss
position 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 or
securities brokerage 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 used its cash resources and its line of credit from
Kemper for dividends to stockholders, corporate interest and other holding
company expenses, additional investments in subsidiaries and, in earlier
periods, purchases of real estate-related assets from KILICO. In the first
quarter of 1995, the Company purchased $3.6 million of certain real
estate-related investments from KILICO. In 1994, the Company purchased $154.0
million of such 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 the 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 customers' account balances. In
addition, regulatory authorities establish minimum liquidity and capital
standards for the asset management, life insurance and securities brokerage
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.)
In the life insurance segment, policyholder deposits increased to $125.1
million during the first six months of 1995 from $115.5 million for the first
six months of 1994. Policyholder withdrawals increased to $441.6 million
during the first six months of 1995 from $302.4 million for the first six
months of 1994, primarily due to increased competition, uncertainty with
respect to the Company's ownership and rising interest rates which caused the
life insurance segment's renewal crediting rates to be lower than competitors'
new money crediting rates. KILICO's late 1994 increases in crediting rates are
designed to maintain or increase policyholder deposits and reduce withdrawals.
- 33 -
<PAGE> 34
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.
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 "CreditWatch with 'negative' implications" in 1994, to BB+ and BB-,
respectively, and placed these ratings on "CreditWatch with 'developing'
implications"; 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, to under review "with direction
uncertain" from "for possible downgrade"; 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 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 $1,112.1 million of notes payable at June 30, 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
- 34 -
<PAGE> 35
$1,095.1 million. These borrowings are drawn against a line of credit totaling
$1.2 billion at June 30, 1995, extended to KFC by Kemper. KFC intends to repay
much of the outstanding balance under the Kemper line of credit with the
proceeds from the planned sale of KFS to Zurich and the planned divestiture of
the securities brokerage operations. 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").
The other portion of notes payable consisted of short-term notes payable
totaling $4.2 million at December 31, 1994.
Convertible debentures
Obligations under the convertible debentures of KFC decreased to $26.7 million
at June 30, 1995 from $33.1 million at December 31, 1994 as a result of
maturities and of debentures becoming subject to mandatory redemption due to
terminations of employment. "Other accounts payable and liabilities" on the
Company's consolidated balance sheet included KFC's obligation of $2.5 million
to holders of debentures whose employment with the Company terminated during
the first half of 1995. Approximately $3.6 million of additional debentures
are scheduled to mature later in 1995. The Company anticipates that as each
additional series of debentures matures, its cash needs would increase, and
that internal and external sources of capital will be used to fund the
maturities.
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 $1.5 million in the first six months of 1995, compared with
$1.7 million for the same period of 1994.
At its option, KFC may call the debentures in connection with a public offering
of its common stock or at any time on or after the fifth anniversary of the
date the debentures are issued. If employment with KFC and its subsidiaries of
an employee to whom debentures initially are issued terminates or an employee
holder becomes subject to certain insolvency or bankruptcy events, his or her
then-outstanding debentures become subject to mandatory redemption. All of the
debentures are presently subject to KFC's right to call. All of the
outstanding debentures will become subject to mandatory redemption as a result
of closing the planned divestiture of the Company's securities brokerage
operations and the planned sale of KFS and its subsidiaries to Zurich.
Redeemable securities
KFC's redeemable securities consist of Class B common stock and are included in
the consolidated balance sheet line item "Other accounts payable and
liabilities." All of the Class B common stock will become subject to mandatory
redemption as a result of closing the planned divestiture of the Company's
securities brokerage operations and the planned sale of KFS and its
subsidiaries to Zurich.
At June 30, 1995, there were 5,831 shares of Class B common stock outstanding,
and no elections to sell shares to KFC were made in 1995. Shares of Class B
common stock which are outstanding and not subject to mandatory redemption
receive dividends equally with those declared and paid on KFC's Class A common
stock, all presently held by Kemper.
- 35 -
<PAGE> 36
Common stock dividends
No common stock dividends were declared in the first half of 1995 or in
1994. While KFC's board of directors does not presently intend to declare
quarterly cash dividends on the common stock in 1995 (subject to the provisions
of the Merger Agreement), future declarations, if any, of such dividends will
depend upon, among other factors, the earnings of the Company, its financial
condition, its capital requirements and general business conditions.
Stockholders' equity
Stockholders' equity totaled $317.3 million at June 30, 1995, compared with
$134.4 million at December 31, 1994. The first-half 1995 increase reflected a
$251.3 million benefit in the unrealized position of the Company's investments,
primarily fixed maturities of KILICO, due to declining interest rates.
Stockholders' equity at June 30, 1995 also reflected a net loss of $72.5
million during the first six months.
- 36 -
<PAGE> 37
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
During the second quarter of 1995, the previously reported investigation by the
Securities and Exchange Commission into Kemper's real estate-related accounting
practices and related disclosures was resolved with an administrative
proceeding in which Kemper consented to the issuance of an order. See the
section captioned "Legal Proceedings" in the Company's current report on Form
8-K dated June 6, 1995, filed July 17, 1995 (the "June 6 Form 8-K") which
is incorporated herein by reference.
ITEM 5. Other Information
On May 15, 1995, Kemper, Zurich, Insurance Partners, L.P., Insurance
Partners Offshore (Bermuda), L.P. (collectively, "Insurance Partners," and
together with Zurich, the "Investor Group") and ZIP Acquisition Corp. entered
into the Merger Agreement pursuant to which Kemper would be acquired in a
merger transaction. The Merger Agreement, the related merger agreement
pursuant to which Zurich would acquire KFS, and the Lumbermens Agreement
(defined in ITEM 5 below) were filed as exhibits nos. 2.1, 2.2 and 2.3,
respectively, to the Company's Current Report on Form 8-K dated May 15, 1995,
filed May 23, 1995 (the "May 15 Form 8-K"), and are incorporated herein by
reference.
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.
- 37 -
<PAGE> 38
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.
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 June 30, 1995 carrying value of approximately $407.2 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. The Lumbermens Agreement was filed as exhibit no.
2.3 to the May 15 Form 8-K and is incorporated herein by reference.
Also in the Merger Agreement, Kemper agreed to various covenants relating to
conduct of business 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 developments. 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 Investors Group's consent 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.
- 38 -
<PAGE> 39
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit Number
2.1 Agreement and Plan of Merger dated May 15, 1995 between Zurich
Insurance Company, Insurance Partners, L.P., Insurance Partners
Offshore (Bermuda), L.P., ZIP Acquisition Corp. and Kemper
Corporation. Incorporated herein by reference to the identically
numbered exhibit to the May 15 Form 8-K.
2.2 Agreement and Plan of Merger dated May 15, 1995 between Zurich
Insurance Company, KFS Acquisition Corp., Kemper Financial
Services, Inc., Kemper Financial Companies, Inc. and Kemper
Corporation. Incorporated herein by reference to the identically
numbered exhibit to the May 15 Form 8-K.
2.3 Letter Agreement dated May 15, 1995 between Zurich Insurance
Company, Insurance Partners, L.P., Insurance Partners Offshore
(Bermuda), L.P., Lumbermens Mutual Casualty Company, Kemper
Corporation and Kemper Financial Services, Inc. Incorporated
herein by reference to the identically numbered exhibit to the
May 15 Form 8-K.
10.1 Amendment No. 2, dated as of July 7, 1995, to the Letter of Credit
Agreement, dated as of January 26, 1995, among Kemper Asset
Holdings, Inc., the banks party thereto and The Bank of New York as
administrative agent and issuing bank. Incorporated herein by
reference to the identically numbered exhibit to the June 6 Form
8-K.
10.2 Amended Restated Note Proceeds Transfer Agreement dated as of
July 7, 1995 among Kemper Asset Holdings, Inc., certain
Massachusetts business trusts and Kemper Corporation as guarantor.
Incorporated herein by reference to the identically numbered exhibit
to the June 6 Form 8-K.
27 Financial data schedule is filed electronically herewith.
(b) REPORTS ON FORM 8-K.
During the three months ended June 30, 1995, the Company filed two
current reports on Form 8-K. Filed on April 12, 1995 and dated
April 3, 1995, this Form 8-K reported, under Item 5 thereof, the
Company's announcement of its plan to divest its securities
brokerage operations and an agreement in principle pursuant to which
Kemper would be acquired in a merger transaction, as well as certain
changes in the credit ratings of Kemper and its life insurance
subsidiaries, including KILICO. During the second quarter of 1995,
the Company also filed the May 15 Form 8-K which reported, under Item 5
thereof, the execution of the Merger Agreement.
In the third quarter of 1995 through the date of the filing of this
- 39 -
<PAGE> 40
Form 10-Q, the Company filed one current report on Form 8-K. The June 6
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.
- 40 -
<PAGE> 41
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: August 14, 1995
/s/ J. H. FITZPATRICK
---------------------------------
J. H. Fitzpatrick
Executive Vice President and
Chief Financial Officer
Date: August 14, 1995
/s/ J. R. SITAR
---------------------------------
J. R. Sitar
Senior Vice President and
Chief Accounting Officer
- 41 -
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE SECOND
QUARTER FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> JUN-30-1995
<DEBT-HELD-FOR-SALE> 3,614,993
<DEBT-CARRYING-VALUE> 3,614,993
<DEBT-MARKET-VALUE> 3,614,993
<EQUITIES> 0
<MORTGAGE> 715,604
<REAL-ESTATE> 236,157
<TOTAL-INVEST> 5,085,290
<CASH> 283,177
<RECOVER-REINSURE> 550,607
<DEFERRED-ACQUISITION> 286,956
<TOTAL-ASSETS> 8,643,902
<POLICY-LOSSES> 4,645,628
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 1,112,096
<COMMON> 4,327
0
0
<OTHER-SE> 313,020
<TOTAL-LIABILITY-AND-EQUITY> 8,643,902
0
<INVESTMENT-INCOME> 186,648
<INVESTMENT-GAINS> (23,225)
<OTHER-INCOME> 24,133
<BENEFITS> 123,197
<UNDERWRITING-AMORTIZATION> 22,007
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 19,409
<INCOME-TAX> 22,681
<INCOME-CONTINUING> (3,272)
<DISCONTINUED> (69,248)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (72,520)
<EPS-PRIMARY> (1.68)
<EPS-DILUTED> 0
<RESERVE-OPEN> 0
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