Good afternoon ladies and gentlemen and welcome to Kemper's Third Quarter twenty twenty one Earnings Conference Call. My name is Charlie, and I will be coordinating your call today. At this time, all participants are in listen-only mode. As a reminder, this conference is being recorded for replay purposes. I would now like to introduce your host for today's conference call, Michael Marinaccio, Kemper's Vice President of Corporate Development and Investor Relations. Mr. Marinaccio, you may begin.

Thank you, Charlie. Good afternoon, everyone, and welcome to Kemper's discussion of our third quarter twenty twenty one results. This afternoon, you'll hear from Joe Lacher, Kemper's President, Chief Executive Officer and Chairman; Jim McKinney, Kemper's Executive Vice President and Chief Financial Officer; and Duane Sanders, Kemper's Executive Vice President and Property and Casualty Division President. We'll make a few opening remarks to provide context around our third quarter results and then open the call for a question-and-answer session. During the interactive portion of the call, our presenters will be joined by John Boschelli, Kemper's Executive Vice President and Chief Investment Officer; and Erich Sternberg, Kemper's Executive Vice President and Life and Health Division President. After the markets closed this afternoon, we issued our earnings release and published our third quarter earnings presentation, financial supplement, and Form ten Q. You can find these documents on the Investors section of our website, kemper.com. Our discussions today may contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of nineteen ninety five. These statements include, but are not limited to, the company's outlook and its future results of operation and financial condition. These statements may also include impacts related to the COVID-nineteen pandemic. Our actual future results and financial condition may differ materially from these statements. For information on potential risks associated with relying on forward-looking statements, please refer to our twenty twenty Form ten K, as well as our third quarter earnings release. This afternoon's discussion also includes non-GAAP financial measures we believe are meaningful to investors. One such measure is as adjusted for acquisition.

Thank you, Mike. Good afternoon, everyone, thanks for joining us today. Earlier today, we reported results that continue to be impacted by the pandemic reopening. The earnings were below our long-term expectations and as a result disappointing. We previously discussed the anticipated challenges of the current environment, which is dynamic and changing rapidly. Against this backdrop, we're focusing on minimizing these impacts and optimizing the business. There are two groupings of items impacting our results this quarter. One, the pandemic and the integrated impact of restarting an economy post-lockdown; and two, a group of items, which are expected through cycles, but unpredictable on a quarterly basis. I'll make a few broad comments on the first grouping before we dive into details. We'll cover the second grouping throughout the call. When we look at the impact of the pandemic, these are unprecedented times for the industry. Historically, in P and C, there's been a rough balance between loss cost inflation and rate inflation. The dramatic frequency reductions at the start of the pandemic led to an extended period with effectively no rate increases. While accident volume was historically low, Kemper, along with most major companies, delivered premium rebates to auto customers. The reopening led to rapid increases in auto frequency. They also saw global disruptions in the supply chain, together leading to severity and combined loss cost inflation at levels we haven't seen in the industry for over thirty years. Across the industry, there's currently no significant rate in the system to offset this loss inflation. The system is out of equilibrium. In some ways, it's like turning off a water supply to your house during a remodeling project. It's fine while you're working, but when you turn the water supply back on, water doesn't immediately flow from each tap. You hear some clanking, you get some air, some spray, some gurgling, and a few surges of water before normal flow is reestablished. And you have to turn on all the taps in the house to clear the pipes running to each faucet. It requires some work, some time, and a little spray to restore the equilibrium. That's where we are right now. We’re all asking a few big questions. What's the overall level of loss cost inflation or severity increase? When will it stabilize to a new normal, and how quickly will rate increases be approved and be earned into results? I know that last quarter there was a broad view that inflation was hopefully transitory. Like most, we revised our view in the last ninety days and see it as something we will be dealing with for a more extended period. In our Life business, the Delta variant increased mortality to levels last seen near the height of the pandemic. Our results remain in line with national experience, and with increased vaccination rates, advancements in medical care, and strength in natural immunity, we anticipate moving from a pandemic to an endemic, resulting in a return to more normalized mortality rates. We'll offer some additional thoughts on these macro issues later in the call. Moving to a few specifics on the quarter, we generated a net loss of seventy-five million dollars or one point one eight dollars per share as reported and sixty-nine million or one point zero eight dollars per share as adjusted. We also produced an adjusted consolidating net operating loss of seventy-six million dollars, or one point one nine dollars per diluted share as reported and sixty-nine million or one point zero eight dollars per share as adjusted. Return on tangible equity, excluding unrealized gains, was three percent. This is below our target return. As highlighted earlier, the impact of the reopening and other environmental challenges continue to negatively impact these. We are actively deploying corrective actions to restore target margins and returns. Our balance sheet and business model remain well positioned to navigate through these challenges. Turning to segment results, given the environmental headwinds impacting our P and C segments, our focus is on restoring them to target profitability. In our Life and Health segment, we are seeing higher demand for our products and strong policy retention. Overall, the business remains positioned for long-term profitable growth. In summary, we are taking the actions necessary to combat environmental challenges in the P and C industry. We, along with the rest of the industry, are repriming the pipes and restoring equilibrium in the system. The benefits of these actions will take time to fully work their way into our book. And on the Life side, the Delta variant has caused another spike in COVID-related mortality. Our strong balance sheet and business model enable us to continue to navigate the current environment, and position the business for growth in twenty twenty-three.

Thank you, Joe. Turning to page five, environmental headwinds led to challenged financial results. We reported a net loss of seventy-five million and an adjusted loss of sixty-nine million. We reported consolidated net operating loss of seventy-six million and an adjusted net loss of sixty-nine million. The corrective actions we have taken in response to higher frequency and severity will over time, return our auto business to target profitability. In addition, as the health impacts of COVID subside, life mortality and benefit costs will revert to normalized levels. Turning now to tangible book value per share, excluding unrealized gains, tangible book value per share declined three point two seven dollars compared to last September. We continue to believe this transaction is accretive to franchise value. On page six, we highlight our view of operating income, which continued to be negatively impacted by environmental challenges. This quarter experienced higher frequency and severity, leading our specialty P and C segment to report an as adjusted underlying combined ratio of one hundred and eight percent and further strengthening of reserves due to an atypical second surge in Florida PIP related litigation and elevated life costs due to excess Delta variant related mortality, higher new business sales and persistency gains. Over the past twelve months, return on tangible equity, excluding unrealized gains was two percent. This was a direct result of the environmental challenges impacting the industry. While this is disappointing and below our target, we are instituting corrective measures to return the business to target profitability. Continuing on page eight, we highlight the strength of our balance sheet. We continue to produce strong cash flow, generating over five hundred million over the past twelve months. Our insurance entities are well capitalized, and liquidity remains strong. Our debt to capital ratio of twenty-one point three percent remains within our stated target range of seventeen percent to twenty-two percent. This business profile provides us with financial flexibility to navigate this environment.

Thank you, Jim, and good afternoon, everyone. To start, I will make a few comments about the current environmental challenges impacting our businesses, as well as the relationship between earned rate and loss trends. Let's turn to page ten. There continue to be several environmental challenges impacting auto loss costs. On the frequency side, miles driven continue with an eighteen percent to twenty percent increase in claim activity. At the same time severity increased eight percent to ten percent due to supply chain challenges, labor shortages, and social inflation. We are taking actions to address these challenges. Last quarter, we discussed the impact of some recent Florida PIP related court rulings and the related increase to our prior year reserves, typically significant Florida PIP related court decisions result in a single surge of litigation. This time, we witnessed an atypical second surge; therefore, we are further strengthening reserves by twenty-five million. Based on some questions we've received over the quarter and discussions taken place within the industry, we thought we'd take a moment to review the interaction between earned rate and loss trends for various periods in and around the pandemic. This is an illustrative display intended to bring context to those discussions. Pre-pandemic, the relationship between loss costs and earned rates had maintained a long steady equilibrium. There have been times of modest divergence creating either increased profitability or margin compression, but over the long term, they were largely balanced. During the pandemic-related lockdowns, there was a dramatic drop in frequency, resulting in a significant reduction in loss trends and noticeable improvement in profitability. This eliminated the need and ability to raise rates. When the economy reopened, frequency increased, miles driven surged. In addition, challenges to an already stressed supply chain were exacerbated, increasing severity. Together, these items drove a surge in loss trends that escalated at unprecedented levels. Given that little to no rate is running through the system, margins were immediately and adversely impacted. Rate changes are subject to our regulatory approval process, and it will take at least several quarters for their earned impact to be seen in results. Moving to page twelve, the segment experienced an underlying combined ratio year over year increase of twenty-two points, a sequential quarter increase of two points, and an underwriting loss of approximately eighty million dollars. Despite this recent performance, we remain comfortable with the business profile. Overall, we anticipate a favorable outcome from our ability to address recent challenges through pricing and other profit improvement actions. Given the environment, we are prioritizing profit restoration over growth.

Thanks, Duane. Turning to our Life and Health Segment on Page fourteen. Overall, this business was negatively impacted by increased mortality related to the Delta variant and Hurricane Ida. For the quarter, segment net income was three million dollars. Our mortality results continue to remain in line with country-wide trends. We continue to see and are encouraged by strong consumer demand for our products. This is evidenced through high new issuance rates and policy retention remain above pre-pandemic levels. Overall, the outlook for the Life and Health Segment remains positive. In summary, this quarter's financial results were disappointing. As we stated earlier, it is going to take time for corrective actions to earn into our book and return us to target profitability. We believe our actions will position us for growth in twenty twenty-three. Our balance sheet provides appropriate financial stability for these types of challenges. Our strong capital and liquidity positions enable us to navigate and optimize the current environment. Despite the continued challenges, we remain financially strong.

Our first question comes from Greg Peters of Raymond James. Your line is open. Please go ahead.

Hi. This is Alex Bolton calling in on behalf of Greg. Could you take some time and give us an idea of how labor shortages, materials, and time of repair are affecting severity?

Sure, Alex. Happy to. What happens when you're repairing a vehicle is that if you have an accident resulting in two thousand dollars’ worth of damage to a bumper, that's the minimum that's going to get paid. From that point, effectively, leakage starts. We've got to repair that vehicle. If you've got a labor shortage and it takes longer at the body shop, that might cause another day or two of rental car expense. If the rental car companies don't have all the inventory they had pre-pandemic, they might have their rates up. So now, in addition to the day or two you have, it is actually at a higher cost. If you're finding out there's labor shortages, and supply chain so trucks aren’t moving from ports in California, you might find that the headlight you needed that was manufactured overseas isn't there, and it's taking a little extra time in that car sitting in the body shop; there might be storage charges because it's waiting for the parts to come in. All these things add up to incremental increased costs in the process. It might be that those parts cost more because they had to pay the truck driver higher wages to get him there or they're running twenty-four seven, so there's overtime involved. We are seeing impacts across all these facets.

Yeah. I guess I was just asking from a portion standpoint. Is it more labor cost, or is it more material cost?

It really is across the board. At this point, we don't have sufficient sensitivity to really pinpoint each of the different components. There's something in all of them that's impacting costs. My sense is that these issues are leading to high single-digit to low double-digit increases overall. It may vary a little by local geography. I'd probably point you back to page eleven, the illustrative example Duane was using, where what you see is changes in loss trend, whether it’s labor or supply chain or social inflation. Those changes in loss inflation occur immediately and are reflected across the entire book. Rate changes, whether loss inflation goes down or up, have to be filed, approved and earned into our results. Rate will always lag inflationary trends.

Okay. I appreciate that. And maybe can you touch on the regulatory environment? It seems like you're getting some rate. What's your expectation of regulators as we look into twenty twenty?

Yes, it's a great question. There's, sort of two things underneath it. One is the regulatory environment, and the second is our activity. Regulators go through a normal process. They look at your historical results and then observe the current loss trend. Their responsibility is to ensure fair and appropriate rates for consumers and to ensure companies are making a reasonable return to maintain solvency. It’s a bit confusing for them when they look back and consider how to account for twenty twenty. I think every month we release a new set of results as an industry, making it increasingly apparent to regulatory bodies that twenty twenty was an anomaly and needs to be discounted. You can see that reflected in our activity; we had rate activity on roughly a third of our book in the second quarter. In the fourth quarter, we're anticipating rate activity on nearly forty percent of our book. I suspect we may be able to get closer to one hundred percent. The critical issue for us is California, which has a unique set of rules and rating templates that we have to navigate. If those templates indicate the need for a rate increase, we will file for it. My expectation is that we will pursue that in the fourth quarter, if the data supports it. The key takeaway is that we recognized this issue early and responded appropriately, and we're optimistic about the outcome of our efforts.

Okay. I appreciate that. And then maybe in Life and Health, I noticed the expense ratio jumped up a little bit. Can you touch on what's happening there?

No, happy to. Actually, I think it's displayed on pages thirty-eight and thirty-nine of the supplement. What you'll see there that's driving this is the amortization of the VOBA asset from the acquisition of AAC. If you remove that, which accounts for about a point for the quarter, you'll see that it’s down a little bit on a quarter-over-quarter and year-over-year basis. So, not much to report. I'm happy to provide more detail if you want, but that's effectively what you're seeing in the numbers.

And to clarify, Erich, if you examine the numbers post-acquisition, a similar pattern emerged as the VOBA runs through our results after the Infinity acquisition and works its way out over time as an expense. So, you observed that same pattern in the first couple of quarters following the Infinity acquisition.

Yes, that's correct Joe.

Again, for clarity, what's being observed here is due to an unusual item regarding the amortization of an intangible asset. The revenue hits the top line while the offsetting expense translates it into a tangible asset. This is not necessarily an ongoing expense; rather, it's the mechanics of how an asset on the balance sheet transitions from intangible to tangible.

Okay. I appreciate you pointing that out. Thank you for the comprehensive answers.

Thanks. Good evening. A couple of questions here. First, is there any way to break down what loss trend looks like in your specialty auto versus twenty nineteen? I think that would be a better comparison than looking at some of the frequency and severity statistics you have up there right now?

Not sure, Brian. Let's address this later.

To provide a big picture overview, looking back to twenty nineteen, we're currently within about one percentage point of where we stood in specialty auto at that stage. That said, from an ultimate perspective, some assumptions should be kept in mind here regarding how these figures evolve. You may notice a slight divergence in driving patterns compared to twenty nineteen, but overall, there shouldn’t be significant movement at this stage. This suggests that our business profile remains similar, and perhaps even improves as we factor in the higher feature counts than what was historically present. When you consider severity, we have observed a double-digit range of inflation, approximately in the ten percent to twelve percent category. Some claims with a longer tail, such as bodily injury claims, are affected by the inflation discussed previously, which is important as we navigate our numbers.

Great. That's helpful. I understand you were comfortable continuing to grow the business amid this loss cost scenario. Has that changed? Is it simply because inflation is not transitory any longer, or is there more happening? Does it also indicate we won't see normalized profitability until twenty twenty-three?

Yes, there are several factors at play here. Last quarter, we were experiencing growth and believed that inflationary trends would stabilize more quickly. This was suggesting profit challenges, but with more rapid corrections. However, since that time, our perspective has shifted. I think we can all agree that the overall environment has changed. Every time I read a Wall Street Journal or tune into CNBC, it's evident that the mood regarding inflation severity and duration has evolved significantly from merely ninety days ago. This is placing additional pressure on profitability and will take longer to normalize alongside pricing adjustments. Essentially, it’s the uncertainty regarding the duration of the inflationary trend and its impacts on pricing that necessitate a more cautious approach to growth initiatives. We haven’t altered our perspective regarding long-term prospects or underwriting; rather, we're adjusting to the unpredictable inflationary conditions we face. We have observed that inflationary pressures have outpaced rate changes, and we're scrutinizing our reserving and bookings with great diligence.

Got it. That makes sense. You're obviously likely taking other initiatives to improve profitability aside from just rate changes?

Absolutely. We are examining every lever available to pull, whether it's rate or non-rate actions. We aim to be responsible in our approach. While growing during colder periods, we're cautious not to undermine long-term performance. Investments that can enhance expense structures and position us favorably for the future continue to be pursued, but we're not looking to expand into new markets at this time. We're exercising caution and handling matters judiciously as we weather this storm.

Great, great. One last question. Regarding the Florida PIP charge, I had gotten the impression after last quarter that we were through that. Has the situation evolved further?

Great question. I think it’s essential to understand the complexities involved with this environment. We have increased confidence compared to where we stood previously. We're witnessing a positive trend and feeling more secure about what's coming in. Additionally, we're actively working on mitigation processes around any outstanding bills to prevent potential problems in the future.

To clarify, Duane, we were confident in our previous assessment, based on normal patterns of surges in litigation following significant court rulings. However, we experienced an atypical second surge. Could you explain what led us to reassess our understanding after the second surge, and how we are handling it now?

There are various dynamics at play. There are established patterns that typically manifest as one-time surges in litigation. This time around, we observed an unusual delay in some bulk billings that later resurfaced unexpectedly. Additionally, there may have been heightened activity due to impending PIP reforms in the marketplace, compelling individuals to file claims sooner than they normally would. Staffing shortages have affected all facets of this process, including claims handling, which has also contributed to this unprecedented pattern. However, we’re proactive in addressing these matters to mitigate future litigation.

In addition to the concerns Duane noted, it's important to emphasize that this situation is new terrain, characterized by unforeseen outcomes. We can't definitively ascertain if it was related to increased scrutiny from our recent calls or industry-wide discussions or other pressures affecting trends. Nevertheless, we move forward in our assessments and remain confident in the reserves we've established in response to recent fluctuations.

Great. Thanks for the insight.

Thank you, operator and thank you everybody for joining the call today. We appreciate your interest. We're going to continue to work hard to reestablish and reignite profitability and deliver results for our customers and our shareholders. Thanks for being with us.

This concludes today's call. Thank you for joining. You may now disconnect your lines.