KEMPER Corp Q3 FY2022 Earnings Call

Good afternoon, ladies and gentlemen, and welcome to Kemper's Third Quarter 2022 Earnings Conference Call. My name is Drew, and I'll be your coordinating your call today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at the time. As a reminder, this conference call is being recorded for replay purposes. I would now like to introduce your host for today's conference call, Karen Guerra, Kemper's Vice President of Investor Relations. Ms. Guerra, you may begin.

Thank you, operator. Good afternoon everyone and welcome to Kemper's discussion of our third quarter 2022 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 the Property & Casualty Division President. We will make a few opening remarks to provide context around our third quarter results and then open the call for a Q&A session. During the interactive portion of our call, our presenters will be joined by John Boschelli, Kemper's Executive Vice President and Chief Investment Officer. After the markets closed today, we issued our earnings release and published our earnings presentation and financial supplement and Form 10-Q. You can find these documents on the Investors section of our website, kemper.com. Our discussion today may contain forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, the company's outlook and its future results of operations and financial conditions. Our actual future results and financial condition may differ materially from these statements. These statements may also be impacted by the COVID-19 pandemic. For information on additional risks that may impact these forward-looking statements, please refer to our 2021 Form 10-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. In our financial supplement, earnings presentation and earnings release, we have defined and reconciled all the non-GAAP financial measures to GAAP where required in accordance with the SEC rules. You can find each of these documents on the Investors section of our website, kemper.com. All comparative references will be to the corresponding 2021 period, unless otherwise stated. I will now turn the call over to Joe.

Thank you, Karen. Good afternoon everyone and welcome to our third quarter conference call. In addition to our financial results for the quarter, on today's call, we're also going to highlight a series of strategic initiatives that are underway. I'll start by providing some context for the two main areas of our strategic update. First, the sharpening of our business focus; and second, specific initiatives to enhance our operating model. On Page 3, we've profiled our strategic intent, the team and culture that fuel it, characteristics of our target markets and differentiating capabilities and our foundational businesses. As a reminder, we focus our energy and capital on markets that are underserved or require specialization where we have or can build systematic, sustainable competitive advantages, and our offerings improve customer lives through better customer understanding and favorable pricing. Kemper Auto and Kemper Life demonstrate how our tailored focus that builds off our differentiated capabilities is leveraged to meet our target customers' unique needs better and more completely than our competition. In both of these businesses, we have leading franchises that provide valuable protection services at attractive prices. As part of our annual planning process, we review our portfolio of businesses to determine if our businesses deliver a competitive advantage and if they are either made better by being part of our portfolio or make the rest of the portfolio better. As a result of this, we've initiated a strategic review of Kemper Personal Insurance, our preferred home and auto business. This includes restructuring to potential divestiture of a segment or components of the segment. We'll provide a further update when we have more information to share. In addition, the sale of Reserve National Insurance Company and its subsidiaries, otherwise known as Kemper Health, to Medical Mutual of Ohio remains on track to close in the fourth quarter. Moving to the second key component of our strategic update, we have initiated several operating model enhancements to enable additional productivity and growth within our core businesses. First, to ensure we have the ability to meet our customers' needs at the lowest possible price, we're always looking for ways to optimize capital usage. To that end, we've established an offshore captive that has unlocked a substantial amount of trapped capital. Additionally, we are in the process of creating a reciprocal exchange. This will enhance customer pricing, lower the cost of capital, reduce earnings volatility and improve returns on equity. Finally, to ensure our organization is best positioned to thrive in the post-pandemic era, we're announcing a restructuring program that will reduce costs across our business and accelerate capability advancements. The cumulative result of these initiatives will result in a franchise with rapidly improving profitability and a strengthened position to meet current and future customer needs. Jim will share more details on the anticipated benefits from these actions later in this presentation. Moving to Page 5 to review the quarter's highlights. Today, we reported results that showed ongoing progress toward restoring profitability. This quarter, we again exceeded our P&C rate-taking forecast. The cumulative benefit of the planned rate and non-rate actions taken over the past year continues to earn in at an accelerating pace. Although severity inflation remained elevated, incrementally, it was less severe than in previous quarters. We remain laser-focused on our work to both further accelerate underlying profitability improvement and ultimately grow our franchise. Our actions have more than offset the incremental loss cost pressure, particularly in specialty personal auto. They continue to have the anticipated impact. Their benefits are accelerating. Since July 2021, private passenger auto received 35 points of cumulative written rate on 45% of our total auto book. We saw progress displayed in financial results this quarter, with the cumulative impact of 4.5 points of rate earning into the book. I'm confident these actions combined with our non-rate actions will restore Kemper Auto to underwriting profitability next year. In addition, in the Life & Health segment, profitability improved from declining mortality and higher investment yields. I see things trending in the right direction. And certainly, enhancements in our operating model will only further advance profitability gains. I'll now turn the call over to Jim to discuss additional details on operating results.

Thank you, Joe. I'll begin on Page 6 with our consolidated financial results. The ongoing environmental challenges facing the P&C and Life insurance industries continue to impact Kemper's results. Notable factors include severity trend inflation, elevated mortality and Hurricane Ian. For the quarter, we generated a net loss of $1.19 per diluted share and an adjusted consolidated net operating loss of $0.48 per diluted share. This included capacity losses of $27 million, of which approximately $16 million was related to Hurricane Ian. Against this backdrop, we continue to make progress in restoring the business to profitability. Highlights include the approximately 3-point sequential quarter improvement in Kemper Auto private passenger auto underlying combined ratio, continued strong profitable growth in commercial vehicle, and a $5.5 million decrease in life policyholder benefits due to lower mortality. Next, I would note that the ongoing profit restoration items continue to accelerate. In our P&C segments, the spread between earned rate and ongoing severity trends is widening. This will lead to continued underwriting profit margin improvements. Within Life & Health, mortality trends continue to moderate and move through our pre-pandemic levels. Together, these items provide a tailwind to continued profitability improvements. Finally, in the quarter, we had roughly $7 million of favorable prior year development. For the year, we have approximately $22 million of favorable prior year development. In this challenging and dynamic environment, these outcomes demonstrate the quality of our information, analytics and commitment to operating transparency. Moving to Slide 7. We highlight a few key updates. First, this quarter we ceded 80% of our Life business to our wholly-owned, newly established offshore captive. This initiative unlocks substantial capital and enabled a $300 million extraordinary dividend to the holding company, resulting in additional liquidity and capital availability. Second, we remain committed to our long-term debt to capital target of 17% to 22%, excluding unrealized fixed income gains and losses. Correspondingly, we have earmarked $150 million to reduce the principal we will eventually refinance in connection with the February 2025 debt maturity. Third, Kemper is adopting the new LDTI accounting guidance effective January 1, 2023 using the modified retrospective method. Discount rates as of September 30, 2022 result in an increase to shareholders' equity of between $175 million and $275 million. As a reminder, our asset liability management philosophy aims to closely align our Life assets and liabilities. We evaluate Life liability customers using both economic and accounting views to mitigate economic and short-term valuation volatility. Potential asset liability rate risk is managed to less than $50 million annually. Short-term fixed income valuation volatility relative to the A rated eval is limited to $100 million. During the quarter, our asset liability management philosophy resulted in an equity gain of approximately $20 million. Moving to Page 8. We maintained significant capital and liquidity positions. At the end of the third quarter, we held a healthy liquidity balance of nearly $1.4 billion. The increase in liquidity relative to the second quarter was driven by the aforementioned $300 million Life dividend. The Bermuda reinsurance initiative also impacted our Life & Health RBC ratio and improved to 535% from 405%. The debt to capital ratio, excluding fixed income gains and losses, is above our long-term target. The previously mentioned debt reduction initiative and the net transition impact from LDTI are expected to reduce the debt to capital ratio by approximately 4.5 points. Further targeted debt repayments using cash on hand and improved operating cash flows will enable us to return to our long-term target debt to capital range of 17% to 22% over the next couple of years. Turning to Page 9. Net investment income for the quarter was $98 million. New investment yields are up 250 to 275 basis points over the prior year, leading to a pre-tax equivalent annualized book yield of 4.2%. We estimate $275 million to $325 million of our fixed income portfolio will be subject to reinvestment in 2023. New money yields are expected to yield 140 basis points higher relative to the investments maturing over the next year. This will provide incremental improvements to future core portfolio net investment income. I'll now turn the call over to Duane to provide details on our P&C segments.

Thank you, Jim, and good afternoon, everyone. Moving to Page 10, we'll begin with our Specialty P&C business details. Specialty auto experienced sequential underlying combined ratio improvement of 2 points. We more than offset the incremental severity we experienced in the quarter through rate and non-rate actions. For the segment, policies in-force declined about 14% year-over-year and earned premium down 2.7% for the same period. This quarter, for private passenger auto, we exceeded our expectations for filed rates, filing an additional 16% on 7% of the book. We plan to file for an additional 5% on 14% of the book in the fourth quarter. At this stage, we have 4.7 points of earned rate, an increase from 2.4 points last quarter. In the fourth quarter, we expect 3.1 points of additional earned rate. The incremental benefits of earned rate and underwriting actions are expected to more than offset fourth quarter normal seasonality with incremental net trend leading to at least 1 point of sequential improvement in PPA's underlying combined ratio. Our commercial vehicle business continues to build momentum with strong results in the quarter. The year-to-date underlying combined ratio, including third quarter seasonality, is 92.7%. Year-over-year, net premium grew 34% and policies in-force grew 16%. The strength of the underlying business model and our ability to continue to achieve rate will enable us to continue to profitably grow this business. Now let's turn to Page 11. Preferred auto experienced a sequential underlying combined ratio increase of 2.4 points, driven by slight seasonal increase in BI claim activity and metal severity. We continue to make progress towards offsetting severity through rate and non-rate actions. Looking at the chart on the upper right, we filed for an additional 18% of rate on 40% of our preferred auto book during the third quarter and have 2.5 points of earned rate. We're planning to file an additional 15% of rate on 9% of the book in the fourth quarter. We also expect 1.5 points of additional earned rate in the fourth quarter. Although actions will take time to run into the book, the pace will accelerate in the fourth quarter and throughout 2023. I'll now turn the call back to Joe.

Thank you, Duane. Turning to our Life & Health segment on Page 12. Profitability improved due to two primary items. First, COVID-related mortality declined. We've now experienced two quarters of sequential decline. Consistent with national trends, mortality is above pre-pandemic levels but trending back towards pre-pandemic levels. Second, we had solid investment performance driven by a high-quality portfolio and new money yields increasing long-term spread margin. New rates are exceeding yield maturities by approximately 100 points. Additionally, Life new business sales continue to be at pre-pandemic levels. These items provide a favorable tailwind to restore the business to its pre-pandemic levels of profitability. From a run rate perspective, we anticipate this will occur in the back half of 2023. I'll now turn the call back to Jim so he can share additional details on the strategic initiatives.

Moving to Page 13. Here we outline initiatives that will strengthen our competitive advantages and accelerate our path to target profitability. These include programs to enhance and optimize spending within LAE, enterprise expense and real estate. In total, we expect to achieve annualized expense savings in excess of $150 million. The cost to bring these savings to fruition is between $150 million to $200 million in pre-tax charges that will be incurred over the next three years. A portion of this expense is non-cash. To enable tracking, the table on this page will be provided quarterly with our earnings updates. The actions displayed here are underway. We expect to start to earn some of these benefits in the fourth quarter. The majority of benefits will be realized by the end of 2023 with additional savings in 2024 and then 2025. Turning to Page 14. As we previously discussed the offshore captive, I'm going to start with the transformation of our P&C performed businesses to fee-based models through the incorporation of a reciprocal exchange. An example of this model is Erie. If you're not familiar with this model, it's an alternative way to structure an insurance company. In this configuration, Kemper will be responsible for the day-to-day management of a carrier owned by policyholders. We'll be paid a fee for our services and we will be removed from underwriting risks. Over a five to seven-year period, we expect this will free up over 50% of the capital we currently have deployed to support these underwriting activities. In addition, it will provide meaningful tax advantages that we'll use to optimize pricing. The aforementioned capital release will largely be back ended due to the time it will take for the carrier to become self-sufficient and for us to subsequently be consolidated. From a timing perspective, we're at an advanced stage of the planning process, and we intend to submit our plan to regulators before year-end. We anticipate beginning to write business starting in the third quarter of 2023. We're excited about the long-term prospects of this insurance model, and we'll continue to provide updates on further investor calls. I'll now turn the call over to Joe for closing remarks.

Thanks, Jim. As a reminder, we recently published our 2022 ESG report. Updates include enhancement to our ESG transparency with new disclosures aligned to the Sustainability Accounting Standards Board. You can read more about these topics in the report available on temper.com. In closing, I'd like to reiterate that the strategic initiatives we announced today are aimed at improving our company and strengthening our strategy over the long term that will enable us to continue to expand our market share in our core businesses and improve margins. We're continuously enhancing and advancing platforms and capabilities that help us better serve the affordability and ease-of-use needs of our specialty and underserved markets. We aim to decrease capital requirements, lower costs, enhance customer product offerings, and reduce our risk profile. This will better position us to serve the needs of our customers and employees and provide significant long-term shareholder value. Finally, I'm confident our actions will generate the necessary results to restore underwriting profitability, and make us a stronger organization. Today, we have 4.5 points of earned rate running through our personal line auto books. Don't miss the fact that based on actions already effective by this time next year, we'll have at least 19 points of earned rate running through these books. Further, our operating model enhancements will advance capabilities and our expense initiatives will drive further cost advantages. As always, I want to thank our employees for continuing to strengthen our company, serve our customers and ensure a bright future. I'll now turn the call over to the operator for questions.

Thank you. We will now begin the Q&A session. Our first question today comes from Greg Peters from Raymond James. Your line is now open.

Hi. Good afternoon, everyone. So a lot of information, and I appreciate the slide deck. I guess my first question would just start off in the specialty P&C insurance segment. Some of your peers have reported some continuing adverse development and some reserve charges. It seemed like you avoided that this quarter. So maybe you could comment on the state of your reserves? And then secondly on rate, looking at the table that you put on Page 10, it still seems like there's some rate opportunities. So maybe you can give us some color on what's going on state by state?

Okay. Greg, this is Jim. I'll start with the reserve question. We'll tag team, or Duane and Joe will jump in on the rate. I can follow up if there's something missed there. Big picture from a reserving perspective, we feel pretty good in terms of where we're at. Obviously, as we've indicated previously, we try to have a forward view of where these things are going. We try to make sure that we understand each of the underlying pieces and what has to be true for those things to come to fruition. And those things are included in our viewpoints. We get a lot of data on a day-in and day-out basis and on a quarterly basis that enables us to kind of have a very thoughtful quarterly pick and to watch that through. And secondarily, I'll remind folks, when you think about a 50/50 pick, from a confidence perspective that comes into that, we look to have a 60% plus generally confidence, especially in an environment like this with that pick. So there's a, I don't want to say, conservatism because it's the consistency with which we apply to that. But I think those elements kind of come together to highlight both our reserving philosophy and why you can have good confidence in the quality of our loss ratio picks and the quality of our balance sheet.

I'll take a start, Greg, on the rate piece and see if there's additional comments after. Look, we've been taking a lot of rate and will continue to take a lot of rate. This only shows three quarters on Slide 10. So don't forget, there's rate we took in the ones that have sort of rolled off that page that's there for historical information. We didn't try here to present the totality. But that is why I gave you sort of that cumulative over the last year and a half what's been running through. We are in states outside of California basically taking our full rate indications and whenever they're available, taking more. For the large part, we've done that at this point. When the rate indication shows that there's an ability to file for more rate, we will. The story in California, there's no particular news to update. I think you've probably seen they've approved a couple of individual companies' rate programs. They've got an election on Tuesday. We continue to watch the environment. And we'll continue to appropriately file for rate there and move forward once the ones we have are approved.

That's helpful. I guess my second question, strategically you've announced a bunch of moves and I'm particularly interested in the potential divestiture of the preferred business and, of course, the establishment of reciprocal. So obviously, you're not going to share with us everything that's going on, but maybe you could establish some guideposts on how the Board and management's thinking about these important moves that you're making and how we as investors should be looking at them on a quarterly and annual basis as you deploy whatever strategies you've announced?

Sure. And Jim and I will tag team this a little bit. Maybe I'll start with the PI and then on the other pieces of the enhancements. Jim I think has outlined a couple of those guidelines, but we'll add a couple more on top of that. We're in a strategic review process with personal insurance. We understand that this is a challenging environment for most of the P&C personal lines industry at this point. We've seen our combined ratios start to drop, but I think you're still seeing a lot of folks seeing this climb that will make this a challenging environment to go through that thought process. We are looking at every option we have in terms of how to think through that business and what we can do on our own or what might make sense with another partner. We're going to need a little time to work through that. I don't imagine that will take us more than a couple of quarters to have a point of view on how to resolve that. It will likely take longer than that to complete whatever we're doing. But we'll have a point of view there. I'd just highlight for you that it's a challenging environment for everybody in this space now, and that's going to impact the optionality.

Greg, from a reciprocal standpoint, I'd highlight kind of where we start from a principal-based perspective. We're always looking for ways to enable ourselves to be able to provide customers with the lowest potential pricing that we can for the quality products that we provide. The reciprocal structure has several benefits of it, but one or two of them that are really notable are the positive impacts that's there from a capital perspective in terms of lower charges, things of that nature for the policyholder, as well as some tax benefits and things like that that are inside there. When we look at that model, you start with that customer standpoint, it's something that can help us advance the ball, further elongate some of the pricing advantages in that that we have, and it's also very positive for the remainder of our stakeholders, that being effectively the stockholders of the company as well as employees. That pricing advantage, that gives us further competitive advantages inside the markets, makes us stronger, more stable, enables us to grow over the longer term in an accelerated way, making us a further stronger company from that perspective. And then again, removing some of the volatility or the elements that you would see from a day-in, day-out model perspective that would be in today's model, I think is good for essentially our stockholders. And so this is our move in that direction. We've been working on this for a while, and we're excited to continue on that path and to unlock these benefits both for our customers and for our stockholders.

The last copy of the reciprocal strategy sounds really interesting. Just from a capital perspective, Jim, it sounds like you're going to have to have capital to establish the reciprocal exchange at the same time. Are you going to get the capital from your existing subsidiaries as they move it over to the entities? I'm just trying to understand the sequencing of capital movements between the entities.

Yes. So we'll start with a surplus note and other from a capital perspective. It will then obviously create over time. This is one of the reasons it takes five to seven years to fully appreciate those benefits. But then that surplus note, right, will become repayable as you go forward in the future as the reciprocal in and of itself becomes self-sufficient. Again, that will take about five to seven years to fully come to fruition. But that capital benefit is very meaningful that comes there for our customers. And it will obviously provide meaningful capital to the organization as a whole in terms of our ongoing endeavors to continue to grow the business. Or if the right option there is to return the capital, we'll return the capital. So both of those things, I think, are big positives. And effectively, that's how we're going to start.

Good evening. Thank you for the call. I have a follow-up question regarding the reciprocal idea. Is the intent for the reciprocal to begin with its own new policies, licenses, and filings, making it independent from your current setup? Is there a theoretical transfer process involved, and how would that work mechanically? Would you be transferring the existing book, or is it simply a matter of starting a new reciprocal business and letting that develop?

Good question. I'm sorry. I didn't mean to interrupt you. I thought you were done. What we'll do is we will start and create a fresh entity with fresh licenses and fresh filings. It will be in many cases mirrors the products we're using already. And we will write new business into that entity. If we took state X and we started doing it, we would stop writing new business in our old entities and write all the new business in the new entity. As Jim mentioned, you started with a surplus note to get it capitalized. And then as it takes the surplus contributions that are part of the policy or the premium and the underwriting profit it makes, then it's generating its own capital over time. And we'll fill it up. So what will happen as the new business gets written here and we stop new business in other entities, it would gradually naturally shift over. Very similar to how sometimes you'll see a company do an open book, close book strategy where they change products, nominees, a different legal entity inside the organization, the old program winds down and the new one grows, this will do the same thing in that process. And that's again part of why it takes a little bit of time. It's because it transfers on new and because it has to build up its own capital.

That makes sense. The reciprocal, if this is just for the specialty business, it wouldn't be for the preferred, it wouldn't be for the commercial business as well, or is that separate?

Paul, good question. At this time, it's intended to be for the P&C personal lines underwritings as we go forward. So we've got to go through a complete essentially our strategic review of PI, but depending on what direction. It would also be included in this, depending on what the outcome is of that review. Or it will be, the K, PPA underwritings. The commercial business has the potential to go through here. But our intent at this stage is for it to continue to write in the entities that it's currently in. This is the current benefits and where we think about it at this point in time, there's a very clear benefit for the PPA side. It's a little bit more cloudy, if you will, on whether or not there's that benefit. But if it were to produce that benefit, then we would head in that direction again, so we can provide that. But right now, it's the intent for the PPA writings to go through that.

And to be clear, Paul, we're going to start with the specialty PPA and be working there. I agree 100% with Jim, but we'll complete a strategic review of PI before we conducted any opportunity to move in that direction.

Okay, that's great. And then I guess I'll ask one question. I want to know what kind of cash flow process of the Life captive? Did that tie to the operating cash flow negativity, year-to-date? And I guess relatedly, trapped captive, was that purely a statutory capital? So you're essentially holding a little less or able to hold less capital in the captive, or is it something that you were able to do with the Life reserves as part of the transfer?

Paul, if I understand correctly, I'm going to answer. And if I don't get to what you're looking for, please ask a follow up on this. Big picture, it's 100% consolidated first of all. Second of all, when we went through with the transferring of that, we then received an extraordinary dividend that effectively went to the Holdco from essentially United, or the entity that was essentially holding the reserves today. In terms of what you're going to see on an ongoing basis, it's going to act in the same way that the rest of our business does. This is a statutory capital release and trapped capital versus essentially, I guess, a GAAP capital in terms of where you're at. But in terms of our ability for uses and other elements, we obviously have the same freedom. And then if you're thinking about kind of what that reinsurance structure looks like, it's done on a funds withheld basis. So happy to talk through any questions if you've got them further inside there, but hopefully I hit on the points that you were hoping I would touch on.

No, I think I get it. It's just the question is like how much capital is actually in the captive versus what got pulled out of the insurance subsidiary, if there's a difference there?

There is still approximately $400 million in capital within the entity. As we continue to progress, we anticipate an additional $100 million or so to be released over the next year to the Holdco. The Life entities maintain similar ratios to what we've experienced in the past. Currently, we are significantly above those ratios, which underscores the strength of our overall position.

Hi. Good evening. A couple of them here for you. First, just on the operating model enhancements here. So I just want to make sure I understand this correctly. So in theory over the next couple of years, we're going to see your LAE ratio decline by 2.5 to 3 points. And also your expense ratio, I think if I looked at $60 million to $70 million run rate, that's about 1 point to 1.5 point on your expense rate. Is that the way to kind of think about it than a real estate optimization a little bit more?

Brian, I think you're thinking about it the right way. Now again different sizes of what would be there, but yes, if you just extrapolated to where we're at today, that is the right directional answer.

Excellent. And then second question, just curious, obviously, you've put through a lot of rate increases so far. Where are you with respect to rate adequacy right now you think on your book of business as far as what you've filed as of today? And the reason I'm asking is, is there a point at which we could maybe start to see some sequential improvements, obviously excluding California, because that's a different animal?

Hi. This is Duane. Yes, good question. Outside of California, we're in a good position. We're generally rate adequate, and as Joe mentioned, we are regularly reviewing indicators and will take action if we need to adjust rates.

Got you. So are you in a position to perhaps start to grow again outside of California?

We're trying to be careful with our words here. So I'm going to be really blunt about it. We believe it was adequate. We believe that there's still a significant inflationary environment around. So we'll remain for the moment modestly cautious outside of those geographies. We want to see that rate earn in. I want to see a little bit more on what inflation does and make sure that we're following up with the rate behind it, because we don't want to be behind again. We want to get back out in front of it. So we'll be a little tempered when we step on the gas.

And the only other piece that I would add is that it's your position in the marketplace relative to others. So sometimes are we moving in tandem, or we move differently? And so depending on how you find that in the marketplace will also dictate our ability to grow.

Right. If our prices are higher than everybody else because we moved earlier, we might not be growing because we're not competitive. It's not just an underwriting filter as we might be. Customers can choose the cheaper person who's still inadequate.

Got you. Makes sense. And then last just quick question, I'm just curious post Hurricane Ian, I know some things happened in Florida from a regulatory perspective. One of them I believe is that they've suspended use and file. Does that change at all your kind of outlook of Florida right now as far as where you are with respect to growing in that state or doing stuff in that state?

Not at this time. Florida has been a state where we've been actively working to position ourselves well in terms of rates. As regulations change, we will adapt accordingly. If an approval process is needed upfront as in other states, we will follow that process. Often, states have an official regulatory category they use to classify their files, but how they operate can differ significantly. Some rule changes may not be immediately apparent. To clarify my previous comment, I don't want to suggest that we believe we're uncompetitive on price. We have adjusted our rates and feel they are adequate. However, we must be responsive to market dynamics, which are currently different with less shopping and moving activity. Despite these challenges, I believe we maintain a strong competitive advantage, a favorable expense structure, and the ability to meet customer needs. When the time is right to grow, we have the capacity to do so.

Looks like the question dropped there. So our next question is from Gary Ransom from Dowling & Partners. Please go ahead.

Yes. Good evening. A lot of my questions on the reciprocal have been answered. But I have a couple more. The way you seem to be describing it, it sounds like you put in a surplus note. You write some new business. If things go well, you put in another surplus note. You write some more business. That process continues over this five to seven years. I'm trying to understand exactly what you mean by the transition at that point? Are you saying that that's when it's self-sufficient and you don't have to put any more funding into it, or are you self-sufficient at that point because you've already gotten all the surplus notes back and you can be consolidated at that point?

Yes, that's a good question. You may not have all of the surplus notes returned, but you would be self-sufficient. You wouldn't necessarily need to inject more capital from that perspective, including reinsurance or other factors. You're also generating earnings along the way, and those earnings are accumulating. At that time, it’s self-sufficient for writing new business or any other elements that would come into the entity. The note itself is likely an extended term note, similar to a 30-year mortgage or something of that nature.

Right. Okay. I understand. And then when I think about the other reciprocals out there, whether Erie, USAA, Farmers, there's more of a preferred writing bent to it, yours being a little bit more shorter duration or shorter lifetime customers. And I was just wondering if that in any way affects how you are thinking about the buildup of that transition, if you have to calculate some churning with these customers a little more than other reciprocals?

So I think the Erie model is a good model to reference. I think what I would actually highlight and why I think this becomes more of a challenge necessarily for maybe preferred or standard companies versus maybe specialty or non-standard is it just takes longer to move the entire business and to recover those benefits. Because our policy life isn't quite as long as what you would see, right, on that tempo, it actually happens faster. And so we actually think there's more benefits for someone like us, or at least that's what our modeling and other elements would suggest that it's actually better and more favorable for us. And the difference that you might be is if I was 100% standard preferred and I didn't have it, it might be more like a 10 to 15-year period before you got to that consolidation versus kind of our five to seven.

Great. And one other little detail. When you're talking about tax benefits, are you imagining that the premium the customer pays might be partly attributed to a capital contribution?

That is correct, yes. And so that component of it, it obviously creates that tax benefit come through. If you think about that being maybe 50% of the margin that you might have, you might think of it as small, but you might think of it as large. It just depends on how you're thinking about it.

Right. And then what domicile are you setting up the reciprocal in?

So we haven't announced that. There's a couple though that I would say two or three that we're fairly deep and we're working on as the final details there and where it's going to be kind of the optimal location for us. And so there'll be more details shortly.

It's not actually finalized yet. Thank you, everybody, for joining us on our call today, for your interest and your questions. We're excited about where we're headed and to making good progress on restoring the underlying profitability of the organization. And I think as we mentioned a couple of quarters ago, we're going to spend some time on what we refer to as home improvement projects and you start to see the fruits of those labors being brought online. Look forward to speaking to you again next quarter. Take care.

This concludes Kemper's third quarter earnings conference call. You may now disconnect.