Back to GetFilings.com
1
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the fiscal year ended December 31, 1996.
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from N/A to N/A.
Commission file number 333-02491*.
KEMPER INVESTORS LIFE INSURANCE COMPANY
(Exact name of registrant as specified in charter)
ILLINOIS
(State of Incorporation)
ONE KEMPER DRIVE
LONG GROVE, ILLINOIS
(Address of Principal Executive Offices)
36-3050975
(I.R.S. Employer
Identification Number)
60049
(Zip Code)
Registrant's telephone number, including area code: (847) 550-5500
Securities registered pursuant to Section 12(b) of the Act: none
Securities registered pursuant to Section 12(g) of the Act: none
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes X No ___ .
As of March 1, 1997, 250,000 shares of Common Stock (all held by an affiliate,
Kemper Corporation) were outstanding. There is no market value for any such
shares. See ITEM 5 of this Form 10-K.
* Pursuant to Rule 429 under the Securities Act of 1933, this Form 10-K also
relates to Commission file numbers 33-33547, 33-43462 and 33-46881.
- --------------------------------------------------------------------------------
2
PART I
ITEM 1. BUSINESS
CORPORATE STRUCTURE
KEMPER INVESTORS LIFE INSURANCE COMPANY ("KILICO"), founded in 1947, is
incorporated under the insurance laws of the State of Illinois. KILICO is
licensed in the District of Columbia and all states except New York. KILICO is a
wholly-owned subsidiary of Kemper Corporation ("Kemper"), a nonoperating holding
company.
CORPORATE CONTROL EVENTS
On January 4, 1996, an investor group comprised of Zurich Insurance Company
("Zurich"), Insurance Partners, L.P. ("IP") and Insurance Partners Offshore
(Bermuda), L.P. (together with IP, "Insurance Partners") acquired all of the
issued and outstanding common stock of Kemper. As a result of the change in
control, Zurich and Insurance Partners own 80 percent and 20 percent,
respectively, of Kemper and therefore KILICO.
The acquisition of KILICO was accounted for using the purchase method of
accounting. The consolidated financial statements of KILICO prior to January 4,
1996, were prepared on a historical cost basis and have been labeled as
"preacquisition" throughout this Annual Report on Form 10-K.
Under purchase accounting, KILICO's assets and liabilities have been marked to
their relative fair market values as of the acquisition date. The difference
between the allocated cost of $745.6 million of acquiring KILICO and the net
fair market values of KILICO's assets and liabilities as of the acquisition date
resulted in $254.9 million of goodwill. KILICO is amortizing goodwill on a
straight-line basis over twenty-five years. KILICO has presented January 4, 1996
(the acquisition date) as the opening purchase accounting balance sheet for
comparative purposes throughout the Annual Report on Form 10-K.
Purchase accounting adjustments primarily affected the recorded historical
values of fixed maturities, mortgage loans, other invested assets, deferred
insurance acquisition costs, future policy benefits and deferred income taxes.
(See note captioned "Summary of Significant Accounting Policies" in the notes to
the consolidated financial statements.)
STRATEGIC INITIATIVES
Since late 1991, KILICO has intensified the management of its real
estate-related investments due to adverse market conditions. KILICO also
successfully implemented strategies over the last several years to reduce both
its joint venture operating losses and the level of its real estate-related
investments. These strategies included individual property sales, refinancings
and restructurings, as well as bulk sale transactions completed in December 1995
in anticipation of the 1996 change in control. As a result of these strategies,
KILICO reduced its holdings of real estate-related investments from 36.2 percent
of its total invested assets and cash at year-end 1991 to 5.9 percent at
year-end 1996.
Further addressing the quality of its investment portfolio, KILICO has reduced
its holdings of below investment-grade securities to 0.3 percent of its total
invested assets and cash at year-end 1996.
The management, operations and strategic directions of KILICO were integrated
during 1992 and 1993 with those of another Kemper subsidiary, Federal Kemper
Life Assurance Company ("FKLA"). The integration was designed to streamline
management, control costs, improve profitability, increase operating
efficiencies and productivity, and to expand both companies' distribution
capabilities. Headquartered in Long Grove, Illinois, FKLA markets term and
interest-sensitive life insurance, as well as certain annuity products through
brokerage general agents and other independent distributors. As described below,
KILICO has emphasized different products and distribution methods.
NARRATIVE DESCRIPTION OF BUSINESS
KILICO offers both individual fixed-rate (general account) and individual and
group variable (separate account) annuity contracts, as well as individual term
life, universal life and variable life insurance products through various
distribution channels. KILICO offers investment-oriented products, guaranteed
returns or a combination of both, to help policyholders meet multiple insurance
and financial objectives. Financial institutions, securities brokerage firms,
insurance agents and financial planners are important distribution channels for
KILICO's products. In 1996, INVEST Financial Corporation, an affiliated company
until June 28, 1996 and EVEREN Securities, Inc., an affiliated company until
September 13, 1995, accounted for approximately 24 percent and 12 percent,
respectively, of KILICO's first-year sales, compared with 37 percent and 21
percent, respectively, in 1995. KILICO's sales mainly consist of deposits
received on certain long duration
1
3
annuity contracts as well as reinsurance assumed from FKLA during 1996. (See
note captioned "Reinsurance" in the notes to the consolidated financial
statements and see the table captioned "Sales" on page 8.)
Annuities have accounted for approximately 98 percent of KILICO's sales in
recent years. KILICO's annuities generally have surrender charges that are a
specified percentage of policy values and decline as the policy ages. General
account annuity and interest-sensitive life policies are guaranteed to
accumulate at specified interest rates but allow for periodic crediting rate
changes.
Over the last several years, in part reflecting the current interest rate
environment, KILICO has increased its emphasis on marketing its separate account
products. Unlike the fixed-rate annuity business where KILICO manages spread
revenue, variable annuities pose minimal investment risk for KILICO, as
policyholders invest in one or more of several underlying investment funds.
KILICO, in turn, receives administrative fee revenue. KILICO's separate account
assets totaled $2.1 billion at December 31, 1996, compared with $1.8 billion and
$1.5 billion at December 31, 1995 and 1994, respectively. KILICO's sales of its
separate account annuities were $254.8 million in 1996, $151.1 million in 1995
and $250.8 million in 1994. Despite KILICO's strategy to emphasize the sale of
variable annuities, such sales declined in 1995, compared with 1994, due to
competitive conditions in certain distribution channels, in part reflecting
KILICO's financial strength and performance ratings and uncertainty concerning
KILICO's ownership during this period. Rating improvements in 1996 (see
"Rankings and ratings" on page 4) and the 1996 change in control helped to
increase KILICO's sales in 1996, compared with 1995.
In order to increase variable annuity sales, KILICO introduced Kemper PASSPORT
in 1992. Kemper PASSPORT is a variable and market value adjusted annuity
featuring a choice of investment portfolios, an increasing estate benefit, tax-
free transfers and guaranteed rates for a variety of terms. In 1994, KILICO
changed Kemper PASSPORT from a single premium annuity to one with a flexible
premium structure and also added a small capitalization equity subaccount as
another investment portfolio option. In 1995 and 1996, KILICO also added several
new subaccounts and new investment managers as investment portfolio choices for
certain purchasers of the Kemper Advantage III variable annuity product. During
late 1996, KILICO also introduced POWER V, a flexible premium variable life
insurance product.
Current crediting rates, a conservative investment strategy and the interest
rate environment have impacted general account annuity sales for KILICO during
1996. Beginning in the second half of 1994 and in early 1995, KILICO began
raising crediting rates on certain of its existing and new general account
products, reflecting both competitive conditions and a rising interest rate
environment. As a result of these actions, sales of general account annuities
increased and represented 62.0 percent of KILICO's total sales in 1995, compared
with 46.0 percent in 1994. During late 1995, as interest rates fell, KILICO
began reducing crediting rates on certain of its existing and new general
account products reflecting both competitive conditions and the falling interest
rate environment. As a result of these events, as well as a strong stock and
bond market during 1996, which influenced potential buyers of fixed annuity
products to purchase variable annuity products, sales of general account
annuities decreased to 34.8 percent of KILICO's total sales in 1996.
Beginning in 1995, KILICO began to sell term life insurance products in order to
balance its product mix and asset-liability structure. In December 1996, KILICO
also assumed $7.3 million of term life insurance premiums from FKLA. Excluding
the amounts assumed from FKLA, KILICO's total term life sales, including new and
renewal premiums, amounted to $565 thousand in 1996, compared with $236 thousand
in 1995.
NAIC RATIOS
The National Association of Insurance Commissioners (the "NAIC") annually
calculates certain statutory financial ratios for most insurance companies in
the United States. These calculations are known as the Insurance Regulatory
Information System ("IRIS") ratios. There presently are twelve IRIS ratios. The
primary purpose of the ratios is to provide an "early warning" of any negative
developments. The NAIC reports the ratios to state regulators who may then
contact the companies if three or more ratios fall outside the NAIC's "usual
ranges".
Based on statutory financial data as of December 31, 1996, KILICO had only one
ratio outside the usual ranges. KILICO's change in reserving ratio reflected the
level of interest-sensitive life surrenders and withdrawals during 1996 as well
as the 1996 reinsurance agreement with FKLA. Other than certain states
requesting quarterly financial reporting and/or explanations of the underlying
causes for certain ratios, no state regulators have taken any action due to
KILICO's IRIS ratios for 1996 or earlier years.
GUARANTY ASSOCIATION ASSESSMENTS
From time to time, mandatory assessments are levied on KILICO by life and health
guaranty associations of most states in which KILICO is licensed, to cover
losses to policyholders of insolvent or rehabilitated insurance companies. These
associations levy assessments (up to prescribed limits) on all member insurers
in a particular state, in order to pay claims
2
4
on the basis of the proportionate share of premiums written by member insurers
in the lines of business in which the insolvent or rehabilitated insurer
engaged. These assessments may be deferred or forgiven in certain states if they
would threaten an insurer's financial strength, and, in some states, these
assessments can be partially recovered through a reduction in future premium
taxes.
In the early 1990s, there were a number of failures of life insurance companies.
KILICO's financial statements include provisions for all known assessments that
will be levied against KILICO by various state guaranty associations as well as
an estimate of amounts (net of estimated future premium tax recoveries) that
KILICO believes will be assessed in the future for failures which have occurred
to date and for which the life insurance industry has estimated the cost to
cover losses to policyholders. Assessments levied against KILICO and charged to
expense in 1996, 1995 and 1994 amounted to $601 thousand, $5.8 million and $0.0
million, respectively. Such amounts relate to accrued guaranty fund assessments
of $5.8 million, $5.0 million and $4.0 million at December 31, 1996, 1995 and
1994, respectively. No assessments were charged to expense during 1994 as KILICO
had established adequate accruals for all known insolvencies where an estimate
of the cost to cover losses to policyholders was available as of December 31,
1994. Additional assessments charged to expense in 1996 and 1995 reflect
accruals for the life insurance industry's new or revised loss estimates for
certain insolvent insurance companies.
RISK-BASED CAPITAL
Since the early 1990s, reflecting a recessionary environment and the
insolvencies of a few large life insurance companies, both state and federal
legislators have increased scrutiny of the existing insurance regulatory
framework. While various initiatives, such as a new model investment law and the
codification of statutory accounting principles, are being considered for future
implementation by the NAIC, it is not presently possible to predict the future
impact of potential regulatory changes on KILICO.
Under asset adequacy and risk-based capital rules in Illinois, state regulators
may mandate remedial action for inadequately reserved or inadequately
capitalized companies. The new asset adequacy rules are designed to assure that
reserves and assets are adequate to cover liabilities under a variety of
economic scenarios. The focus of the new capital rules is a risk-based formula
that applies prescribed factors to various risk elements in an insurer's
business and investments to develop a minimum capital requirement designed to be
proportional to the amount of risk assumed by the insurer. KILICO has capital
levels substantially exceeding any which would mandate action under the
risk-based capital rules and is in compliance with applicable asset adequacy
rules.
RESERVES AND REINSURANCE
The following table provides a breakdown of KILICO's reserves for future policy
benefits by product type (in millions):
PREACQUISITION
---------------------------
DECEMBER 31 JANUARY 4 DECEMBER 31 DECEMBER 31
1996 1996 1995 1994
----------- --------- ----------- -----------
General account annuities..................... $3,507 $3,805 $3,794 $4,010
Interest-sensitive life insurance............. 743 780 779 833
Term life reserves............................ 7 -- -- --
Ceded future policy benefits.................. 427 503 503 643
------ ------ ------ ------
Total............................... $4,684 $5,088 $5,076 $5,486
====== ====== ====== ======
Ceded future policy benefits shown above reflect coinsurance (indemnity
reinsurance) transactions in which KILICO insured liabilities of approximately
$516 million in 1992 and $416 million in 1991 with Fidelity Life Association
("FLA"), an affiliated mutual insurance company. FLA shares directors,
management, operations and employees with FKLA pursuant to an administrative and
management services agreement. FLA produces whole life policies not produced by
FKLA or KILICO as well as other policies similar to certain FKLA policies. At
December 31, 1996, KILICO's reinsurance recoverable from FLA related to these
coinsurance transactions totaled approximately $427.0 million. KILICO remains
primarily liable to its policyholders for this amount. Utilizing FKLA's
employees, KILICO is the servicing company for this coinsured business and is
reimbursed by FLA for the related servicing expenses. Excluding this
coinsurance, KILICO, because it is primarily an annuity company, reinsures only
a very limited portion of its business. During December 1996, KILICO assumed on
a yearly renewable term basis approximately $14.4 billion (face amount) of term
life insurance from FKLA. As a result of this transaction, KILICO recorded
premiums and reserves of approximately $7.3 million. (See the note captioned
"Reinsurance" in the notes to the consolidated financial statements.)
3
5
COMPETITION
KILICO is in a highly competitive business and competes with a large number of
other stock and mutual life insurance companies, many of which are larger
financially, although none is truly dominant in the industry. KILICO, with its
emphasis on annuity products, also competes for savings dollars with securities
brokerage and investment advisory firms as well as other institutions that
manage assets, produce financial products or market other types of investment
products.
KILICO's principal methods of competition continue to be innovative products,
often designed for selected distribution channels and economic conditions, as
well as appropriate product pricing, careful underwriting, expense control and
the quality of services provided to policyholders and agents. Certain of
KILICO's financial strength ratings and claims-paying/ performance ratings,
however, were lower in 1994 and 1995 than in earlier years, and were under
review in 1994 and 1995, due to uncertainty with respect to Kemper's and
KILICO's ownership. These ratings impacted sales efforts in certain markets;
however, increases in KILICO's financial strength ratings and
claims-paying/performance ratings in January 1996 favorably impacted variable
annuity sales during 1996 and should continue to favorably impact future sales.
To address its competition, KILICO has adopted certain business strategies.
These include systematic reductions of investment risk and strengthening of its
capital position; continued focus on existing and new variable annuity and
variable life insurance products; distribution through diversified channels; and
ongoing efforts to continue as a low-cost provider of insurance products and
high-quality services to agents and policyholders through the use of technology.
RANKINGS AND RATINGS
According to BEST'S AGENTS GUIDE TO LIFE INSURANCE COMPANIES, 1996, as of
December 31, 1995, KILICO ranked 70th of 1,273 life insurers by admitted assets;
443rd of 1,089 by insurance in force; and 167th of 1,179 by net premiums
written.
Following the January 1996 change in control, certain of KILICO's financial
strength ratings and claims-paying ability ratings were upgraded. KILICO's
ratings are as follows:
CURRENT RATING PRIOR RATING
--------------- ---------------
A.M. Best Company........................................... A (Excellent) A- (Excellent)
Moody's Investors Service................................... Aa3 (Excellent) Baa1 (Adequate)
Duff & Phelps Credit Rating Co.............................. AA (Very High) A+ (High)
Standard & Poor's........................................... AA- (Excellent) Aq (Good)
EMPLOYEES
At December 31, 1996, KILICO utilized the services of approximately 514
employees of FKLA, which are also shared with FLA. On January 1, 1996,
approximately 160 employees of Zurich Life Insurance Company of America
("ZLICA"), an affiliated company, became employees of FKLA in connection with
the integration of ZLICA's operations with those of FKLA's. On January 5, 1996,
KILICO, FKLA, FLA and ZLICA began to operate under the trade name Zurich Kemper
Life. On July 1, 1996, Kemper acquired 100 percent of the issued and outstanding
common stock of ZLICA from Zurich.
REGULATION
KILICO is generally subject to regulation and supervision by the insurance
departments of Illinois and other jurisdictions in which KILICO is licensed to
do business. These departments enforce laws and regulations designed to assure
that insurance companies maintain adequate capital and surplus, manage
investments according to prescribed character, standards and limitations and
comply with a variety of operational standards. The departments also make
periodic examinations of individual companies and review annual and other
reports on the financial condition of each company operating within their
respective jurisdictions. Regulations, which often vary from state to state,
cover most aspects of the life insurance business, including market practices,
forms of policies and accounting and financial reporting procedures.
Insurance holding company laws enacted in many states grant additional powers to
state insurance commissioners to regulate acquisition of and by domestic
insurance companies, to require periodic disclosure of relevant information and
to regulate certain transactions with related companies. These laws also impose
prior approval requirements for certain transactions with affiliates and
generally regulate dividend distributions by an insurance subsidiary to its
holding company parent.
In addition, variable life insurance and annuities offered by KILICO, and the
related separate accounts, are subject to regulation by the Securities and
Exchange Commission (the "SEC").
KILICO believes it is in compliance in all material respects with all applicable
regulations. For information on regulatory and other dividend restrictions, see
ITEM 5(c).
4
6
INVESTMENTS
A changing marketplace has affected the life insurance industry and to
accommodate customers' increased preference for safety over higher yields,
KILICO has systematically reduced its investment risk and strengthened its
capital position.
KILICO's cash flow is carefully monitored and its investment program is
regularly and systematically planned to provide funds to meet all obligations
and to optimize investment return. For securities, portfolio management is
handled by an affiliated company, Zurich Kemper Investments, Inc. ("ZKI"), and
its subsidiaries and affiliates, with KILICO's real estate-related investments
being handled by a Kemper real estate subsidiary. Investment policy is directed
by KILICO's board of directors. KILICO's investment strategies take into account
the nature of each annuity and life insurance product, the respective crediting
rates and the estimated future policy benefit maturities. See "INVESTMENTS" in
ITEM 7.
ITEM 2. PROPERTIES
KILICO shares 99,000 sq. ft. of office space leased by FKLA from Lumbermens
Mutual Casualty Company, a former affiliate, ("Lumbermens"), located in Long
Grove, Illinois.
ITEM 3. LEGAL PROCEEDINGS
KILICO has been named as defendant in certain lawsuits incidental to its
insurance business. Based upon the advice of legal counsel, KILICO's management
believes that the resolution of these various lawsuits will not result in any
material adverse effect on KILICO's consolidated financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Effective January 4, 1996, KILICO's board of directors changed reflecting the
acquisition of Kemper, and therefore KILICO, by Zurich and Insurance Partners.
See ITEM 10 below.
5
7
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
(a) There is no established public trading market for KILICO's common stock.
(b) Kemper owns all of the common stock of KILICO as of the date of this filing.
(c) KILICO has declared no cash dividends on its common stock in 1995 or 1996. A
cash dividend of $26.9 million has been declared and is expected to be paid to
Kemper on March 31, 1997.
RESTRICTIONS ON DIVIDENDS
Dividend distributions from KILICO to its stockholder are restricted by state
insurance laws. In Illinois, where KILICO is domiciled, if such dividend,
together with other distributions during the 12 preceding months would exceed
the greater of (a) ten percent of the insurer's statutory surplus as regards
policyholders as of the preceding December 31, or (b) the statutorily adjusted
net income for the preceding calendar year, then such proposed dividend must be
reported to the director of insurance at least 30 days prior to the proposed
payment date and may be paid only if not disapproved. The Illinois insurance
laws also permit payment of dividends only out of earned surplus, exclusive of
most unrealized capital gains.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial information for KILICO for the
five years ended December 31, 1996 and for the opening balance sheet as of the
acquisition date, January 4, 1996. Such information should be read in
conjunction with KILICO's consolidated financial statements and notes thereto
included in ITEM 8 of this Annual Report on Form 10-K. All amounts are shown in
millions.
PREACQUISITION
----------------------------------------------
DECEMBER 31
DECEMBER 31 JANUARY 4 ----------------------------------------------
1996 1996 1995 1994 1993 1992
----------- --------- -------- -------- -------- --------
TOTAL REVENUE......................... $ 356.2 $ -- $ 68.1(1) $ 330.5 $ 337.4 $ 353.6
======== ======== ======== ======== ======== ========
NET INCOME EXCLUDING REALIZED
INVESTMENT RESULTS.................. $ 25.6 $ -- $ 74.2 $ 61.9 $ 33.7 $ 10.3
======== ======== ======== ======== ======== ========
NET INCOME (LOSS)..................... $ 34.4 $ -- $ (133.0)(1) $ 26.4 $ 14.0 $ (51.9)
======== ======== ======== ======== ======== ========
FINANCIAL SUMMARY
Total separate account assets......... $2,127.2 $1,761.1 $1,761.1 $1,508.0 $1,499.5 $1,140.3
======== ======== ======== ======== ======== ========
Total assets.......................... $7,717.9 $7,682.7 $7,581.7 $7,537.1 $8,113.7 $6,845.9
======== ======== ======== ======== ======== ========
Future policy benefits................ $4,256.5 $4,585.1 $4,573.2 $4,843.7 $5,040.0 $5,040.7
======== ======== ======== ======== ======== ========
Stockholder's equity.................. $ 751.0 $ 745.6 $ 605.9 $ 434.0 $ 654.6 $ 488.7
======== ======== ======== ======== ======== ========
- ---------------
(1) Total revenue and net income (loss) for 1995 were adversely impacted by real
estate-related investment losses. Such losses reflect a change in KILICO's
strategy with respect to its real estate-related investments in connection
with the January 4, 1996 acquisition of Kemper by the Zurich-led investor
group. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in ITEM 7.
6
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As discussed in the note captioned "Summary of Significant Accounting Policies"
in the notes to the consolidated financial statements, Kemper, and therefore
KILICO, were acquired on January 4, 1996, by an investor group led by Zurich. In
connection with the acquisition, KILICO's assets and liabilities were marked to
their respective fair market values as of the acquisition date in conformity
with the purchase accounting method required under generally accepted accounting
principles.
KILICO's financial statements as of January 4, 1996, and as of and for the year
ended December 31, 1996, have been adjusted to reflect the effects of such
purchase accounting adjustments. KILICO's financial statements for the years
ended December 31, 1995 and 1994 have been prepared on a historical cost basis
and do not reflect such purchase accounting adjustments.
RESULTS OF OPERATIONS
KILICO recorded net income of $34.4 million in 1996, compared with net loss of
$133.0 million in 1995 and net income of $26.4 million in 1994. The increase in
net income in 1996, compared with 1995 and 1994, was primarily due to a decrease
in the level of real estate-related realized investment losses. KILICO's
strategy with respect to its real estate-related investments changed
dramatically as of year-end 1995 in connection with the Zurich-led investor
group's acquisition of Kemper. This change, as further discussed below, resulted
in significant reductions in real estate-related investments and significant
realized capital losses in the second half of 1995.
The following table reflects the components of net income (loss):
NET INCOME (LOSS)
(in millions)
YEAR ENDED DECEMBER 31
--------------------------
PREACQUISITION
-----------------
1996 1995 1994
----- ------- ------
Operating earnings.......................... $25.6 $ 74.2 $ 61.9
Net realized investment gains (losses)...... 8.8 (207.2) (35.5)
----- ------- ------
Net income (loss)................. $34.4 $(133.0) $ 26.4
===== ======= ======
The following table reflects the major components of realized investment results
included in net income (loss) above. (See "INVESTMENTS" beginning on page 10,
and the note captioned "Invested Assets and Related Income" in the notes to the
consolidated financial statements.)
REALIZED INVESTMENT RESULTS, AFTER TAX
(in millions)
YEAR ENDED DECEMBER 31
--------------------------
PREACQUISITION
-----------------
1996 1995 1994
----- ------- ------
Real estate-related gains (losses).......... $11.4 $(211.6) $(27.1)
Fixed maturity write-downs.................. (.9) (4.7) --
Other gains (losses), net................... (1.7) 9.1 (8.4)
----- ------- ------
Total............................. $ 8.8 $(207.2) $(35.5)
===== ======= ======
The higher level of real estate-related losses in 1995, compared with both 1996
and 1994, reflected realized capital losses predominately from real
estate-related bulk sale transactions in December 1995, as well as a higher
level of write-downs on real estate-related investments. These sales and
write-downs in 1995, reflect Zurich's and Insurance Partners' strategies,
adopted by KILICO, with respect to the disposition of real estate-related
investments. Other realized investment gains and losses for 1996, 1995 and 1994
relate primarily to the sale of fixed maturity investments. The fixed maturity
losses generated in 1996 and 1994 arose primarily from the sale of fixed
maturity investments, consisting of lower yielding U.S. Treasury bonds and
collateralized mortgage obligations in 1996 and investment-grade corporate
securities and collateralized mortgage obligations in 1994, related to
repositionings of KILICO's fixed maturity investment portfolio. The proceeds
from the repositionings, together with cash and short-term investments, were
reinvested into higher yielding corporate bonds and asset-backed securities in
1996 and U.S. government and agency guaranteed mortgage pass-through securities
issued by the Government National Mortgage Association and the Federal National
Mortgage Association in 1994. (See "INVESTMENTS" beginning on page 10.)
7
9
Operating earnings decreased to $25.6 million in 1996, compared with $74.2
million and $61.9 million in 1995 and 1994, respectively, primarily due to
purchase accounting adjustments which reduced investment income and increased
expenses. Operating income increased in 1995, compared with 1994, primarily due
to an increase in fees and other income, reductions in operating expenses and an
increase in the net deferral of insurance acquisition costs, partially offset by
an increase in commissions, taxes, licenses and fees.
Investment income was lower in 1996, compared with both 1995 and 1994, primarily
reflecting purchase accounting adjustments related to the amortization of
premiums on fixed maturity investments. Under purchase accounting, the market
value of KILICO's fixed maturity investments as of January 4, 1996 became
KILICO's new cost basis in such investments. The difference between the new cost
basis and original par is then amortized against investment income over the
remaining effective lives of the fixed maturity investments. As a result of the
interest rate environment as of January 4, 1996, the market value of KILICO's
fixed maturity investments was approximately $133.9 million greater than
original par. The amortization of such premiums reduced investment income by
approximately $22.7 million in 1996, compared with 1995 and 1994.
Investment income and interest credited also declined in 1996, compared with
1995 and 1994, as a result of a decrease in total invested assets and future
policy benefits. Such decreases were the result of surrender and withdrawal
activity over the last three years.
Investment income was also negatively impacted during 1996, compared with 1995
and 1994, by a higher level of cash and short-term investments held in the first
quarter of 1996. The increase in cash and short-term investments in the first
quarter of 1996 was caused in part by the cash proceeds received from bulk sales
of real estate-related investments in late December 1995. The reduction in real
estate-related investments reflects KILICO's current strategy to continue to
reduce its investments in, and overall exposure to, real estate-related
investments.
Investment income was positively impacted in 1996, 1995 and 1994 from the
benefits of capital contributions to KILICO and from reductions in the level of
nonperforming real estate-related investments, primarily from the sales of
certain real estate-related investments to affiliated non-life realty companies.
These sales totaled $3.5 million in 1995 and $154.0 million in 1994 and resulted
in no realized gain or loss to KILICO. Investment income in 1996 and 1995 also
benefitted from the above-mentioned repositionings of KILICO's investment
portfolio, however, the full benefits of KILICO's 1996 repositioning will not
occur until 1997.
The following table reflects KILICO's sales.
SALES
(in millions)
YEAR ENDED DECEMBER 31
------------------------------
PREACQUISITION
------------------
1996 1995 1994
------ ------ ------
Annuities:
General account................................. $140.6 $247.6 $214.2
Separate account................................ 254.8 151.1 250.8
------ ------ ------
Total annuities.............................. 395.4 398.7 465.0
------ ------ ------
Life Insurance:
Term life....................................... 7.8 .2 --
Interest-sensitive life......................... .6 .2 .8
------ ------ ------
Total life................................... 8.4 .4 .8
------ ------ ------
Total sales........................ $403.8 $399.1 $465.8
====== ====== ======
Sales of annuity products consist of total deposits received. The decrease in
1996 general account (fixed annuity) sales, compared with 1995, and the increase
in general account annuity sales in 1995, compared with 1994, is reflective of
the fluctuating interest rate environments and the stock and bond markets during
1996 and 1995, respectively, which made variable annuities more attractive to
consumers in 1996, and fixed annuities more attractive to consumers during 1995.
The increase in separate account (variable sales) in 1996, compared with 1995
and 1994, was in part due to improvements in KILICO's financial strength and
performance ratings in January 1996, the addition of new separate account
investment fund options, new investment fund managers and a strong underlying
stock and bond market. Sales of variable annuities not only increase
administrative fees earned but they also pose minimal investment risk for
KILICO, as policyholders invest in one or more of several underlying investment
funds which invest in stocks and bonds. Separate account sales declined in 1995,
compared with 1994, due to competitive conditions in certain distribution
channels, in part reflecting KILICO's financial strength and performance ratings
which were lower in 1995 and 1994, compared with
8
10
1996, and uncertainty concerning KILICO's ownership. KILICO believes that the
increase in its financial strength and performance ratings in January 1996
together with KILICO's association with Zurich, will continue to assist in
KILICO's future sales efforts.
Beginning in 1995, KILICO began to sell low-cost term life insurance products
offering initial level premiums for 5, 10, 15 and 20 years in order to balance
its product mix and asset-liability structure. In December 1996, KILICO also
assumed $7.3 million of term life insurance premiums from FKLA. (See the note
captioned "Reinsurance" in the notes to the consolidated financial statements.)
Excluding the amounts assumed from FKLA, KILICO's total term life sales,
including new and renewal premiums, amounted to $565 thousand in 1996, compared
with $236 thousand in 1995. Face amount of new business issued during 1996 and
1995 amounted to approximately $319 million and $120 million, respectively.
Included in fees and other income are administrative fees received from KILICO's
separate account products of $25.3 million in 1996, compared with $21.9 million
and $20.8 million in 1995 and 1994, respectively. Administrative fee revenue
increased in each of the last three years due to growth in average separate
account assets. Other income also included surrender charge revenue of $5.4
million in 1996, compared with $7.7 million and $7.4 million in 1995 and 1994,
respectively, as total general account and separate account policyholder
surrenders and withdrawals decreased in 1996, compared with 1995. The decrease
in surrender charge revenue also reflects that 57 percent of KILICO's fixed and
variable annuity liabilities are subject to minimal (5 percent or less) or no
surrender charges, compared with 56 percent in 1995 and 43 percent in 1994. Also
included in other income in 1995 is a ceding commission experience adjustment
which resulted in income of $4.4 million related to certain reinsurance
transactions entered into by KILICO during 1992. (See the note captioned
"Reinsurance" in the notes to the consolidated financial statements.)
POLICYHOLDER SURRENDERS AND WITHDRAWALS
(in millions)
PREACQUISITION
---------------------
1996 1995 1994
------ ------ ------
General account................................ $652.0 $755.9 $652.5
Separate account............................... 196.7 205.6 150.3
------ ------ ------
Total..................................... $848.7 $961.5 $802.8
====== ====== ======
Reflecting the current interest rate environment and other competitive market
factors, KILICO adjusts its crediting rates on interest-sensitive products over
time in order to manage spread revenue and policyholder surrender and withdrawal
activity. KILICO can also improve spread revenue over time by increasing
investment income. Beginning in late 1994, as a result of rising interest rates
and other competitive market factors, KILICO began to increase crediting rates
on certain interest-sensitive products which adversely impacted spread income.
The declines in interest rates during the last three quarters of 1995, however,
and the current interest rate environment during 1996, have mitigated at
present, competitive pressures to increase existing renewal crediting rates
further.
Policyholder withdrawals increased during 1995, compared with 1994, due to
planned reductions in fixed annuity crediting rates, a rising interest rate
environment during the last half of 1994 and early 1995, uncertainty regarding
KILICO's ownership and KILICO's financial strength ratings and
claims-paying/performance ratings. 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 last three quarters of 1995, policyholder surrenders and withdrawals in
1996 declined from the level of surrenders and withdrawals in 1995. KILICO
expects that the level of surrender and withdrawal activity experienced should
remain at a similar level in 1997 given current projections for relatively
stable interest rates.
Commissions, taxes, licenses and fees were lower in 1996, compared with 1995,
but were higher in 1995, compared with 1994, primarily reflecting the level of
guaranty fund assessments in each of those years. Expenses for such assessments
totaled $601 thousand, $5.8 million, and $0.0 million in 1996, 1995 and 1994,
respectively. (See "Guaranty association assessments" in ITEM 1 beginning on
page 2.)
Operating expenses declined in 1995, compared with 1994, primarily as a result
of a decrease in headcount. Headcount declined during 1995 as a result of
uncertainty concerning KILICO's ownership. Operating expenses increased in 1996,
compared with 1995, as a result of restaffing after the completion of the
merger.
Operating earnings were negatively impacted by the net deferral of insurance
acquisition costs and the amortization of the value of business acquired in
1996, compared with the net deferral of insurance acquisition costs in 1995 and
1994. Deferred insurance acquisition costs, and the related amortization
thereof, for policies sold prior to January 4, 1996 have been replaced under
purchase accounting by the value of business acquired. The value of business
acquired reflects the
9
11
present value of the right to receive future cash flows from insurance contracts
existing at the date of acquisition. The amortization of the value of business
acquired is calculated assuming an interest rate equal to the liability or
contract rate on the value of the business acquired. (See note captioned
"Summary of Significant Accounting Policies" in the notes to the consolidated
financial statements.) Deferred insurance acquisition costs are established on
all new policies sold after January 4, 1996.
The net amortization of the value of business acquired in 1996 was adversely
affected by net realized capital gains in 1996, while the net deferral of
insurance acquisition costs in 1995 and 1994, was positively affected by
realized capital losses, partially offset by the level of policyholder
surrenders and withdrawals in 1995 and 1994. Net realized capital gains and
policyholder surrenders tend to accelerate the amortization of both the value of
business acquired and deferred insurance acquisition costs as they tend to
decrease KILICO's projected future estimated gross profits. Net realized capital
losses tend to defer such amortization into future periods as they tend to
increase KILICO's projected future estimated gross profits.
The higher level of deferral of policy acquisition costs in 1995, compared with
1994, reflected an increase in the amount of imputed interest capitalized due to
improvements in projected future revenue streams primarily as a result of the
decline in the level of nonperforming real estate-related investments. The
amortization of policy acquisition costs was favorably impacted during 1995 due
to real estate-related capital losses. Excluding the effects of the real
estate-related capital losses, the amortization of policy acquisition costs
increased in 1995, compared with 1994, primarily as a result of improved net
operating earnings during 1995.
The difference between the cost of acquiring KILICO and the net fair market
value of KILICO's assets and liabilities as of January 4, 1996 was recorded as
goodwill. The amortization of goodwill increased expenses by $10.2 million in
1996, compared with 1995 and 1994. KILICO is amortizing goodwill on a
straight-line basis over twenty-five years.
INVESTMENTS
KILICO's principal investment strategy is to maintain a balanced,
well-diversified portfolio supporting the insurance contracts written. KILICO
makes shifts in its investment portfolio depending on, among other factors, its
evaluation of risk and return in various markets, consistency with KILICO's
business strategy and investment guidelines approved by the board of directors,
the interest rate environment, liability durations and changes in market and
business conditions. In addition, as previously discussed, KILICO's strategy
with respect to its real estate-related investments changed dramatically by
year-end 1995.
INVESTED ASSETS AND CASH
(in millions)
DECEMBER 31 JANUARY 4
1996 1996
--------------- ---------------
Cash and short-term investments............................. $ 74 1.6% $ 398 8.4%
Fixed maturities:
Investment-grade:
NAIC(1) Class 1........................................ 3,231 71.5 3,096 65.2
NAIC(1) Class 2........................................ 621 13.7 570 12.0
Below investment grade:
Performing............................................. 13 .3 78 1.6
Nonperforming.......................................... 1 -- 5 .1
Joint venture mortgage loans................................ 111 2.4 110 2.3
Third-party mortgage loans.................................. 107 2.4 145 3.1
Other real estate-related investments....................... 50 1.1 34 .7
Policy loans................................................ 288 6.4 289 6.1
Other....................................................... 24 .6 20 .5
------ ----- ------ -----
Total(2).......................................... $4,520 100.0% $4,745 100.0%
====== ===== ====== =====
- ---------------
(1) National Association of Insurance Commissioners ("NAIC").
-- Class 1 = A- and above
-- Class 2 = BBB- through BBB+
(2) See the note captioned "Financial Instruments--Off-Balance-Sheet Risk" in
the notes to the consolidated financial statements.
FIXED MATURITIES
KILICO is carrying its fixed maturity investment portfolio, which it considers
available for sale, at estimated fair value, with the aggregate unrealized
appreciation or depreciation being recorded as a separate component of
stockholder's
10
12
equity, net of any applicable income tax expense. The aggregate unrealized
depreciation on fixed maturities at December 31, 1996 was $63.2 million,
compared with no unrealized appreciation or depreciation, at January 4, 1996 as
a result of purchase accounting adjustments. KILICO does not record a net
deferred tax benefit for the aggregate unrealized depreciation on investments.
Fair values are sensitive to movements in interest rates and other economic
developments and can be expected to fluctuate, at times significantly, from
period to period.
At December 31, 1996, investment-grade fixed maturities and cash and short-term
investments accounted for 86.8 percent of KILICO's invested assets and cash,
compared with 85.6 percent at January 4, 1996. Approximately 58.4 percent of
KILICO's NAIC Class 1 bonds were rated AAA or equivalent at year-end 1996,
compared with 66.0 percent at January 4, 1996.
Approximately 36.4 percent of KILICO's investment-grade fixed maturities at
December 31, 1996 were mortgage-backed securities, down from 45.7 percent at
January 4, 1996, due to sales and paydowns during 1996. These investments
consist primarily of marketable mortgage pass-through securities issued by the
Government National Mortgage Association, the Federal National Mortgage
Association or the Federal Home Loan Mortgage Corporation and other
investment-grade securities collateralized by mortgage pass-through securities
issued by these entities. KILICO has not made any investments in interest-only
or other similarly volatile tranches of mortgage-backed securities. KILICO's
mortgage-backed investments are generally of AAA credit quality, and the markets
for these investments have been and are expected to remain liquid. KILICO plans
to continue to reduce its holding of such investments over time.
As a result of the previously discussed 1996 repositioning of KILICO's fixed
maturity portfolio, approximately 8.8 percent of KILICO's investment-grade fixed
maturities at December 31, 1996 consisted of corporate asset-backed securities.
The majority of the Company's investments in asset-backed securities were backed
by manufactured housing loans, auto loans and home equity loans.
Future investment income from mortgage-backed securities and other asset-backed
securities may be affected by the timing of principal payments and the yields on
reinvestment alternatives available at the time of such payments. As a result of
purchase accounting adjustments to fixed maturities, most of KILICO's
mortgage-backed securities are carried at a premium over par. Prepayment
activity resulting from a decline in interest rates on such securities purchased
at a premium would accelerate the amortization of the premiums which would
result in reductions of investment income related to such securities. At
December 31, 1996, KILICO had unamortized premiums and discounts of $24.7
million and $5.7 million, respectively, related to mortgage-backed and
asset-backed securities. KILICO believes that as a result of the purchase
accounting adjustments and the current interest rate environment, anticipated
prepayment activity is expected to result in reductions to future investment
income similar to those reductions experienced by KILICO in 1996.
Amortization of the discount or premium from mortgage-backed and asset-backed
securities is recognized using a level effective yield method which considers
the estimated timing and amount of prepayments of the underlying loans and is
adjusted to reflect differences which arise between the prepayments originally
anticipated and the actual prepayments received and currently anticipated. To
the extent that the estimated lives of such securities change as a result of
changes in prepayment rates, the adjustment is also included in net investment
income.
The table below provides information about KILICO's mortgage-backed and
asset-backed securities that are sensitive to changes in interest rates. The
expected maturity dates have been calculated on a security by security basis
using prepayment assumptions obtained from a survey conducted by a securities
information service. These assumptions are consistent with the current interest
rate and economic environment.
CARRYING FAIR VALUE
VALUE AT EXPECTED MATURITY DATE AT
DECEMBER 31, ------------------------------------------------------- DECEMBER 31,
(IN MILLIONS) 1996 1997 1998 1999 2000 2001 THEREAFTER TOTAL 1996
------------- ------------ ---- ---- ---- ---- ---- ---------- ----- ------------
Fixed Maturities:...........
Mortgage-backed bonds..... $1,402.0 $161.4 $239.0 $261.4 $166.1 $ 61.8 $512.3 $1,402.0 $1,402.0
Average yield.......... 6.83% 6.83% 6.83% 6.83% 6.83% 6.83% 6.83% 6.83% 6.83%
Asset-backed bonds........ $ 339.3 $ 31.4 $ 38.1 $ 36.6 $ 44.4 $ 51.0 $137.8 $ 339.3 $ 339.3
Average yield.......... 6.82% 6.82% 6.82% 6.82% 6.82% 6.82% 6.82% 6.82% 6.82%
-------- -------- --------
$1,741.3 $1,741.3 $1,741.3
======== ======== ========
The current weighted average maturity of the mortgage-backed and asset-backed
securities at December 31, 1996, is 4.6 years. A 200 basis point increase in
interest rates would extend the weighted average maturity by approximately 1.7
years, while a 200 basis point decrease in interest rates would decrease the
weighted average maturity by approximately 1.3 years.
11
13
Below investment-grade securities holdings (NAIC classes 3 through 6),
representing securities of 8 issuers at December 31, 1996, totaled 0.3 percent
of cash and invested assets at December 31, 1996, compared with 1.7 percent at
January 4, 1996. (See note captioned "Invested Assets and Related Income" in the
notes to the consolidated financial statements.) Below investment-grade
securities are generally unsecured and often subordinated to other creditors of
the issuers. These issuers may have relatively higher levels of indebtedness and
be more sensitive to adverse economic conditions than investment-grade issuers.
KILICO has significantly reduced its exposure to below investment-grade
securities since 1991. 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 $267.7 million real estate-related portfolio held by KILICO, consisting of
joint venture and third-party mortgage loans and other real estate-related
investments, constituted 5.9 percent of cash and invested assets at December 31,
1996, compared with $288.9 million, or 6.1 percent, at January 4, 1996. The
decrease in real estate-related investments during 1996 was primarily due to
asset sales.
As reflected in the "Real estate portfolio" table below, KILICO has continued to
fund both existing projects and legal commitments. The future legal commitments
were $197.4 million at December 31, 1996. This amount represented a net decrease
of $50.8 million since January 4, 1996, primarily due to sales and fundings in
1996. As of December 31, 1996, KILICO expects to fund approximately $39.6
million of these legal commitments, along with providing capital to existing
projects. The disparity between total legal commitments and the amount expected
to be funded relates principally to standby financing arrangements that provide
credit enhancements to certain tax-exempt bonds, which KILICO does not presently
expect to fund. The total legal commitments, along with estimated working
capital requirements, are considered in KILICO's evaluation of reserves and
write-downs. (See note captioned "Financial Instruments--Off-Balance-Sheet Risk"
in the notes to the consolidated financial statements.)
Generally, at the inception of a real estate loan, KILICO anticipated that it
would roll over the loan and reset the interest rate at least one time in the
future, although KILICO is not legally committed to do so. KILICO anticipates
that as certain mortgages mature they could be rolled over, restructured or
foreclosed if not earlier disposed of.
Excluding the $7.5 million of real estate owned and $11.7 million of net equity
investments in joint ventures, KILICO's real estate loans totaled $248.5 million
at December 31, 1996, after reserves and write-downs. Of this amount, $210.3
million are on accrual status with a weighted average interest rate of
approximately 8.6 percent. Of these accrual loans, 17.0 percent have terms
requiring current periodic payments of their full contractual interest, 58.2
percent require only partial payments or payments to the extent of cash flow of
the borrowers, and 24.8 percent defer all interest to maturity.
12
14
The equity investments in real estate at December 31, 1996 consisted of KILICO's
other equity investments in joint ventures. These equity investments include
KILICO's share of periodic operating results. KILICO, as an equity owner or
affiliate thereof, has the ability to fund, and historically has elected to
fund, operating requirements of certain joint ventures.
REAL ESTATE PORTFOLIO
(in millions)
MORTGAGE LOANS OTHER REAL ESTATE-RELATED INVESTMENTS
---------------- ---------------------------------------
JOINT THIRD- OTHER REAL ESTATE EQUITY
VENTURE PARTY LOANS(2) OWNED INVESTMENTS TOTAL
------- ------ --------- ------------ ------------ ------
Balance at January 4, 1996.......................... $110.2 $144.5 $ 22.3 $ .5 $11.4 $288.9(1)
Additions (deductions):
Fundings............................................ 9.6 2.5 -- 15.0 -- 27.1
Interest added to principal......................... 4.5 3.1 -- -- -- 7.6
Sales/paydowns/distributions........................ (13.1) (36.8) (10.1) (16.1) (2.6) (78.7)
Purchases from affiliated realty companies.......... 4.8 1.3 16.5 -- -- 22.6
Operating gain...................................... -- -- -- -- .3 .3
Transfers to real estate owned...................... -- -- -- 1.5 (1.5) --
Realized investments gains (losses)................. (2.9) 2.9 6.3 7.1 4.1 17.5
Other transactions, net............................. (2.1) (10.9) (4.1) (.5) -- (17.6)
------ ------ ------ ------ ----- ------
Balance at December 31, 1996........................ $111.0 $106.6 $ 30.9 $ 7.5 $11.7 $267.7(3)
====== ====== ====== ====== ===== ======
- ---------------
(1) Net of $15.5 million reserve and write-downs. Excludes $5.6 million of real
estate-related accrued interest.
(2) The other real estate loans were notes receivable evidencing financing,
primarily to joint ventures. These loans were issued by KILICO generally to
provide financing for Kemper's or KILICO's joint ventures for various
purposes.
(3) Net of $11.8 million reserve and write-downs. Excludes $9.7 million of real
estate-related accrued interest.
REAL ESTATE CONCENTRATIONS
KILICO's real estate portfolio is distributed by geographic location and
property type. However, KILICO has concentration exposures in certain states and
in certain types of properties. In addition to these exposures, KILICO also has
exposures to certain real estate developers and partnerships. (See notes
captioned "Unconsolidated Investors" and "Concentration of Credit Risk" in the
notes to the consolidated financial statements.)
REAL ESTATE OUTLOOK
The following table is a summary of KILICO's troubled real estate-related
investments:
TROUBLED REAL ESTATE-RELATED INVESTMENTS
(BEFORE RESERVES AND WRITE-DOWNS, EXCEPT FOR REAL ESTATE OWNED)
(in millions)
DECEMBER 31 JANUARY 4
1996 1996
----------- ---------
Potential problem loans(1)......................... $ 3.2 $17.9
Past due loans(2).................................. -- --
Nonaccrual loans(3)................................ 43.5 3.5
Restructured loans (currently performing)(4)....... -- .2
Real estate owned.................................. 7.5 .5
----- -----
Total.................................... $54.2 $22.1
===== =====
- ---------------
(1) These are real estate-related investments where KILICO, based on known
information, has serious doubts about the borrowers' abilities to comply
with present repayment terms and which KILICO anticipates may go into
nonaccrual, past due or restructured status.
(2) Interest more than 90 days past due but not on nonaccrual status.
(3) KILICO does not accrue interest on real estate-related investments when it
judges that the likelihood of collection of interest is doubtful. Loans on
nonaccrual status after reserves and write-downs amounted to $38.2 million
and $3.5 million at December 31, 1996 and January 4, 1996, respectively.
(4) KILICO defines a "restructuring" of debt as an event whereby KILICO, 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 KILICO and the 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
KILICO, at its option, may extend (roll over).
13
15
KILICO evaluates its real estate-related investments (including accrued
interest) using an estimate of the investments observable market price, net of
estimated costs to sell. (See note captioned "Summary of Significant Accounting
Policies" in the notes to the consolidated financial statements.) Real
estate-related reserves amounted to $9.5 million and $15.4 million at December
31, 1996 and January 4, 1996, respectively. Because KILICO'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.
KILICO's real estate-related investments are expected to continue to decline
further through future sales. Although the real estate-related investments have
been valued using an estimate of the investment's observable market price, net
of estimated costs to sell, KILICO's net income could be materially reduced in
future periods if real estate market conditions worsen in areas where KILICO's
portfolio is located or if Kemper's and KILICO's plans with respect to certain
projects change.
The increase in nonaccrual loans at December 31, 1996, compared with January 4,
1996, reflects certain negative developments in January 1997 related to the
zoning of undeveloped land in Hawaii. As a result of the uncertainty related to
the zoning process, KILICO placed the related real estate-related investments on
nonaccrual status at December 31, 1996 and increased its real estate-related
reserves by $5.3 million.
KILICO continues to devote significant attention to its real estate portfolio,
enhancing monitoring of the portfolio and formulating specific action plans
addressing nonperforming and potential problem loans. KILICO is continuing to
analyze various potential transactions designed to further reduce both its joint
venture operating losses and the amount of its real estate-related investments.
Specific types of transactions under consideration (and previously utilized)
include loan sales, property sales and mortgage refinancings. However, there can
be no assurance that such efforts will result in continued improvements in the
performance of KILICO's real estate portfolio.
NET INVESTMENT INCOME
KILICO's pre-tax net investment income totaled $299.7 million in 1996, compared
with $348.4 million in 1995 and $353.1 million in 1994. Included in pre-tax net
investment income is KILICO's share of the operating losses from equity
investments in real estate consisting of other income less depreciation,
interest and other expenses. Such operating results exclude interest expense on
loans by KILICO which are on nonaccrual status. As previously discussed,
KILICO's net investment income in 1996, compared with 1995 and 1994 has been
negatively impacted by purchase accounting adjustments.
KILICO's total foregone investment income before tax on both nonperforming fixed
maturity investments and nonaccrual real estate-related investments was as
follows:
FOREGONE INVESTMENT INCOME
(dollars in millions)
YEAR ENDED DECEMBER 31
----------------------------
PREACQUISITION
-----------------
1996 1995 1994
---- ----- -----
Fixed maturities........................................ $ .7 $ .4 $--
Real estate-related investments......................... .5 20.5 28.4
---- ----- -----
Total............................................ $1.2 $20.9 $28.4
==== ===== =====
Basis points............................................ 3 43 55
==== ===== =====
Foregone investment income from the nonaccrual of real estate-related
investments is net of KILICO's share of interest expense on these loans excluded
from KILICO's share of joint venture operating results. Based on the level of
nonaccrual real estate-related investments at December 31, 1996, KILICO
estimates foregone investment income in 1997 will increase compared with the
1996 level. Any increase in nonperforming securities, and either worsening or
stagnant real estate conditions, would increase the expected adverse effect on
KILICO's future investment income and realized investment results.
Future net investment income, results of operations and cash flow will reflect
KILICO'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. KILICO 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 product mix and
its continuing cost-control measures. Other mitigating factors include marketing
advantages that could result from KILICO having lower
14
16
levels of investment risk, higher financial strength and claims-paying ability
ratings and earnings improvements from KILICO's ability to adjust crediting
rates on annuities and interest-sensitive life products over time.
REALIZED INVESTMENT RESULTS
Reflected in net income (loss) are after-tax realized investment gains of $8.8
million in 1996, compared with after-tax realized investment losses of $207.2
million and $35.5 million in 1995 and 1994, respectively. (See note captioned
"Invested Assets and Related Income" in the notes to the consolidated financial
statements.)
Unrealized gains and losses on fixed maturity investments are not reflected in
KILICO's net income (loss). These changes in unrealized value are included
within a separate component of stockholder's 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.
KILICO regularly monitors its investment portfolio and as part of this process
reviews its assets for possible impairments of carrying value. Because the
review process includes estimates, there can be no assurance that current
estimates will prove accurate over time due to changing economic conditions and
other factors.
A valuation allowance has been established, 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. (See note captioned "Income Taxes" in the notes to the
consolidated financial statements.)
INTEREST RATES
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 the year
and once during first-quarter 1995. Interest rates subsequently declined through
the remainder of 1995. In 1996, however, interest rates again began to rise.
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 1996 contributed to an increase in net
investment income as well as to both realized and unrealized fixed maturity
investment losses. Also, lower renewal crediting rates on annuities, compared
with competitors' higher new money crediting rates, influenced certain annuity
holders to seek alternative products. KILICO mitigates this risk somewhat by
charging surrender fees which decrease over time when annuity holders withdraw
funds prior to maturity on certain annuity products. Approximately 57 percent of
KILICO's fixed and variable annuity liabilities as of December 31, 1996,
however, were no longer subject to significant surrender fees.
As interest rates rose during 1996, KILICO's capital resources were adversely
impacted by unrealized loss positions from its fixed maturity investments.
LIQUIDITY AND CAPITAL RESOURCES
KILICO carefully monitors cash and short-term investments to maintain adequate
balances for timely payment of policyholder benefits, expenses, taxes and
policyholder's account balances. In addition, regulatory authorities establish
minimum liquidity and capital standards. The major ongoing sources of KILICO's
liquidity are deposits for fixed annuities, investment income, other operating
revenue and cash provided from maturing or sold investments. (See the
Policyholder surrenders and withdrawals table and related discussion on page 9
and "INVESTMENTS" beginning on page 10.)
RATINGS
Ratings are an important factor in establishing the competitive position of life
insurance companies. Rating organizations continue to review the financial
performance and condition of life insurers and their investment portfolios,
including those of KILICO. Any reductions in KILICO's claims-paying ability or
financial strength ratings could result in its products being less attractive to
consumers. Any reductions in KILICO's parent's ratings could also adversely
impact KILICO's financial flexibility.
15
17
Ratings reductions for Kemper or its subsidiaries and other financial events can
also trigger obligations to fund certain real estate-related commitments to take
out other lenders. In such events, those lenders can be expected to renegotiate
their loan terms, although they are not contractually obligated to do so.
Each rating is subject to revision or withdrawal at any time by the assigning
organization and should be evaluated independently of any other rating. (See
"Ranking and ratings" on page 4.)
STOCKHOLDER'S EQUITY
Stockholder's equity totaled $751.0 million at December 31, 1996, compared with
$745.6 million at January 4, 1996. The 1996 increase in stockholder's equity was
primarily due to net income of $34.4 million and an $18.4 million capital
contribution, offset by a $47.4 million decrease in stockholder's equity related
to the change in the unrealized loss position of KILICO's fixed maturity
investment portfolio due to rising interest rates during 1996.
16
18
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE(S)
-------
Report of Independent Public Accountants.................... 17
Consolidated Balance Sheets, December 31, 1996 and January
4, 1996................................................... 18
Consolidated Statements of Operations, three years ended
December 31, 1996......................................... 19
Consolidated Statements of Stockholder's Equity, three years
ended December 31, 1996................................... 20
Consolidated Statements of Cash Flows, three years ended
December 31, 1996......................................... 21
Notes to Consolidated Financial Statements.................. 22-35
Financial Statement Schedules:
Reinsurance............................................... 44
Valuation and Qualifying Accounts......................... 45
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholder's
Kemper Investors Life Insurance Company:
We have audited the accompanying consolidated balance sheets of Kemper Investors
Life Insurance Company and subsidiaries as of December 31, 1996 and as of
January 4, 1996, and the related consolidated statements of operations,
stockholder's equity, and cash flows for the periods from January 4, 1996 to
December 31, 1996 (post-acquisition), and for each of the years in the two-year
period ended December 31, 1995 (pre-acquisition). In connection with our audits
of the consolidated financial statements, we also have audited the financial
statement schedules as listed in the accompanying index. These consolidated
financial statements and the financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the aforementioned post-acquisition consolidated financial
statements and financial statement schedules present fairly, in all material
respects, the financial position of Kemper Investors Life Insurance Company and
subsidiaries as of December 31, 1996 and as of January 4, 1996, and the results
of their operations and their cash flows for the post-acquisition period, in
conformity with generally accepted accounting principles. Further, in our
opinion, the aforementioned pre-acquisition consolidated financial statements
present fairly, in all material respects, the financial position of Kemper
Investors Life Insurance Company and subsidiaries and the results of their
operations and their cash flows for the pre-acquisition periods, in conformity
with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, effective
January 4, 1996, an investor group as described in Note 1, acquired all of the
outstanding stock of Kemper Investors Life Insurance Company in a business
combination accounted for as a purchase. As a result of the acquisition, the
consolidated financial information for the periods after the acquisition is
presented on a different cost basis than that for the periods before the
acquisition and, therefore, is not comparable.
KPMG PEAT MARWICK LLP
Chicago, Illinois
March 21, 1997
17
19
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
DECEMBER 31 JANUARY 4
1996 1996
----------- ----------
ASSETS
Fixed maturities, available for sale, at fair value (cost:
December 31, 1996, $3,929,650; January 4, 1996,
$3,749,323)............................................... $3,866,431 $3,749,323
Short-term investments...................................... 71,696 372,515
Joint venture mortgage loans................................ 110,971 110,194
Third-party mortgage loans.................................. 106,585 144,450
Other real estate-related investments....................... 50,157 34,296
Policy loans................................................ 288,302 289,390
Other invested assets....................................... 23,507 19,215
---------- ----------
Total investments................................. 4,517,649 4,719,383
Cash........................................................ 2,776 25,811
Accrued investment income................................... 115,199 104,402
Goodwill.................................................... 244,688 254,883
Value of business acquired.................................. 189,639 190,222
Deferred insurance acquisition costs........................ 26,811 --
Federal income tax receivable............................... 3,840 112,646
Reinsurance recoverable..................................... 427,165 502,836
Receivable on sales of securities........................... 32,569 902
Other assets and receivables................................ 30,277 10,540
Assets held in separate accounts............................ 2,127,247 1,761,110
---------- ----------
Total assets...................................... $7,717,860 $7,682,735
========== ==========
LIABILITIES
Future policy benefits...................................... $4,256,521 $4,585,148
Ceded future policy benefits................................ 427,165 502,836
Benefits and claims payable to policyholders................ 36,142 4,535
Other accounts payable and liabilities...................... 59,462 30,030
Deferred income taxes....................................... 60,362 53,472
Liabilities related to separate accounts.................... 2,127,247 1,761,110
---------- ----------
Total liabilities................................. 6,966,899 6,937,131
---------- ----------
Commitments and contingent liabilities
STOCKHOLDER'S EQUITY
Capital stock--$10 par value,
authorized 300,000 shares; outstanding 250,000 shares..... 2,500 2,500
Additional paid-in capital.................................. 761,538 743,104
Unrealized loss on investments.............................. (47,498) --
Retained earnings........................................... 34,421 --
---------- ----------
Total stockholder's equity........................ 750,961 745,604
---------- ----------
Total liabilities and stockholder's equity........ $7,717,860 $7,682,735
========== ==========
See accompanying notes to consolidated financial statements.
18
20
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
YEAR ENDED DECEMBER 31
-----------------------------------
PREACQUISITION
----------------------
1996 1995 1994
-------- --------- --------
REVENUE
Net investment income....................................... $299,688 $ 348,448 $353,084
Realized investment gains (losses).......................... 13,602 (318,700) (54,557)
Premium income.............................................. 7,822 236 --
Fees and other income....................................... 35,095 38,101 31,950
-------- --------- --------
Total revenue..................................... 356,207 68,085 330,477
-------- --------- --------
BENEFITS AND EXPENSES
Benefits and interest credited to policyholders............. 237,349 245,615 248,494
Commissions, taxes, licenses and fees....................... 28,135 31,793 26,910
Operating expenses.......................................... 24,678 20,837 25,324
Deferral of insurance acquisition costs..................... (27,820) (36,870) (31,852)
Amortization of insurance acquisition costs................. 2,316 14,423 20,809
Amortization of value of business acquired.................. 21,530 -- --
Amortization of goodwill.................................... 10,195 -- --
-------- --------- --------
Total benefits and expenses....................... 296,383 275,798 289,685
-------- --------- --------
Income (loss) before income tax expense (benefit)........... 59,824 (207,713) 40,792
Income tax expense (benefit)................................ 25,403 (74,664) 14,431
-------- --------- --------
Net income (loss)................................. $ 34,421 $(133,049) $ 26,361
======== ========= ========
See accompanying notes to consolidated financial statements.
19
21
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(in thousands)
PREACQUISITION
-------------------------
DECEMBER 31 JANUARY 4 DECEMBER 31 DECEMBER 31
1996 1996 1995 1994
----------- --------- ----------- -----------
CAPITAL STOCK, beginning and end of period............. $ 2,500 $ 2,500 $ 2,500 $ 2,500
-------- -------- --------- ---------
ADDITIONAL PAID-IN CAPITAL, beginning of period........ 743,104 491,994 491,994 409,423
Capital contributions from parent...................... 18,434 -- -- 82,500
Adjustment to reflect purchase accounting method....... -- 251,110 -- --
Transfer of limited partnership interest to parent..... -- -- -- 71
-------- -------- --------- ---------
End of period................................ 761,538 743,104 491,994 491,994
-------- -------- --------- ---------
UNREALIZED GAIN (LOSS) ON INVESTMENTS, beginning of
period............................................... -- 68,502 (236,443) 93,096
Unrealized gain (loss) on revaluation of investments,
net.................................................. (47,498) -- 304,945 (329,539)
Adjustment to reflect purchase accounting method....... -- (68,502) -- --
-------- -------- --------- ---------
End of period................................ (47,498) -- 68,502 (236,443)
-------- -------- --------- ---------
RETAINED EARNINGS, beginning of period................. -- 42,880 175,929 149,568
Net income (loss)...................................... 34,421 -- (133,049) 26,361
Adjustment to reflect purchase accounting method....... -- (42,880) -- --
-------- -------- --------- ---------
End of period................................ 34,421 -- 42,880 175,929
-------- -------- --------- ---------
Total stockholder's equity................... $750,961 $745,604 $ 605,876 $ 433,980
======== ======== ========= =========
See accompanying notes to consolidated financial statements.
20
22
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEAR ENDED DECEMBER 31
-----------------------------------------
PREACQUISITION
-------------------------
1996 1995 1994
----------- --------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)......................................... $ 34,421 $(133,049) $ 26,361
Reconcilement of net income (loss) to net cash provided:
Realized investment losses (gains)..................... (13,602) 318,700 54,557
Interest credited and other charges.................... 230,298 237,984 242,591
Deferred insurance acquisition costs................... (25,504) (22,447) (11,043)
Amortization of value of business acquired............. 21,530 -- --
Amortization of goodwill............................... 10,195 -- --
Amortization of discount and premium on investments.... 25,743 4,586 (1,383)
Deferred income taxes.................................. (897) 38,423 20,809
Net change in Federal income tax receivable............ 108,806 (86,990) 809
Other, net............................................. (22,283) (29,905) (14,161)
----------- --------- -----------
Net cash provided from operating activities....... 368,707 327,302 318,540
----------- --------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash from investments sold or matured:
Fixed maturities held to maturity...................... 264,383 320,143 144,717
Fixed maturities sold prior to maturity................ 891,995 297,637 910,913
Mortgage loans, policy loans and other invested
assets............................................... 168,727 450,573 536,668
Cost of investments purchased or loans originated:
Fixed maturities....................................... (1,369,091) (549,867) (1,447,393)
Mortgage loans, policy loans and other invested
assets............................................... (119,044) (131,966) (281,059)
Short-term investments, net............................... 300,819 (168,351) 198,299
Net change in receivable and payable for securities
transactions........................................... (31,667) (1,397) (16,553)
Net reductions in other assets............................ 105 1,996 2,678
----------- --------- -----------
Net cash provided by investing activities......... 106,237 218,768 48,270
----------- --------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Policyholder account balances:
Deposits............................................... 141,159 247,778 215,034
Withdrawals............................................ (700,084) (755,917) (652,513)
Capital contributions from parent......................... 18,434 -- 82,500
Other..................................................... 42,512 (35,309) 3,871
----------- --------- -----------
Net cash used in financing activities............. (497,979) (543,448) (351,108)
----------- --------- -----------
Net increase (decrease) in cash.............. (23,035) 2,622 15,702
CASH, beginning of period................................... 25,811 23,189 7,487
----------- --------- -----------
CASH, end of period......................................... $ 2,776 $ 25,811 $ 23,189
=========== ========= ===========
See accompanying notes to consolidated financial statements.
21
23
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Kemper Investors Life Insurance Company and subsidiaries (the "Company") issues
fixed and variable annuity products, variable life, term life and
interest-sensitive life insurance products marketed primarily through a network
of financial institutions, securities brokerage firms, insurance agents and
financial planners. The Company is licensed in the District of Columbia and all
states except New York. The Company is a wholly-owned subsidiary of Kemper
Corporation ("Kemper"). On January 4, 1996, an investor group comprised of
Zurich Insurance Company ("Zurich"), Insurance Partners, L.P. ("IP") and
Insurance Partners Offshore (Bermuda), L.P. (together with IP, "Insurance
Partners") acquired all of the issued and outstanding common stock of Kemper. As
a result of the change in control, Zurich and Insurance Partners own 80 percent
and 20 percent, respectively, of Kemper and therefore the Company.
The financial statements include the accounts of the Company on a consolidated
basis. All significant intercompany balances and transactions have been
eliminated.
PURCHASE ACCOUNTING METHOD
The acquisition of the Company on January 4, 1996, was accounted for using the
purchase method of accounting. The consolidated financial statements of the
Company prior to January 4, 1996, were prepared on a historical cost basis in
accordance with generally accepted accounting principles. The accompanying
financial statements and notes thereto prepared prior to January 4, 1996 have
been labeled "preacquisition". The accompanying consolidated financial
statements of KILICO as of January 4, 1996 (the acquisition date) and as of and
for the year ended December 31, 1996, have been prepared in conformity with the
purchase method of accounting. The Company has presented January 4, 1996 (the
acquisition date), as the opening purchase accounting balance sheet for
comparative purposes throughout the accompanying financial statements and notes
thereto.
Under purchase accounting, the Company's assets and liabilities have been marked
to their relative fair market values as of the acquisition date. The difference
between the cost of acquiring the Company and the net fair market values of the
Company's assets and liabilities as of the acquisition date has been recorded as
goodwill. KILICO is amortizing goodwill on a straight-line basis over
twenty-five years. The allocated cost of acquiring the Company was $745.6
million and the acquisition resulted in goodwill of $254.9 million as of January
4, 1996.
The Company reviews goodwill to determine if events or changes in circumstances
may have affected the recoverability of the outstanding goodwill as of each
reporting period. In the event that the Company determines that goodwill is not
recoverable, it would amortize such amounts as additional goodwill expense in
the accompanying financial statements. As of December 31, 1996, the Company
believes that no such adjustment is necessary.
Purchase accounting adjustments primarily affected the recorded historical
values of fixed maturities, mortgage loans, other invested assets, deferred
insurance acquisition costs, future policy benefits and deferred income taxes.
Deferred insurance acquisition costs, and the related amortization thereof, for
policies sold prior to January 4, 1996, have been replaced by the value of
business acquired.
The value of business acquired reflects the estimated fair value of the
Company's life insurance business in force and represents the portion of the
cost to acquire the Company that is allocated to the value of the right to
receive future cash flows from insurance contracts existing at the date of
acquisition. Such value is the present value of the actuarially determined
projected cash flows for the acquired policies.
A 15 percent discount rate was used to determine such value and represents the
rate of return required by Zurich and Insurance Partners to invest in the
business being acquired. In selecting the rate of return used to value the
policies purchased, the Company considered the magnitude of the risks associated
with each of the actuarial assumptions used in determining expected future cash
flows, the cost of capital available to fund the acquisition, the perceived
likelihood of changes in insurance regulations and tax laws, the complexity of
the Company's business, and the prices paid (i.e., discount rates used in
determining other life insurance company valuations) on similar blocks of
business sold in recent periods.
The value of the business acquired is amortized over the estimated contract life
of the business acquired in relation to the present value of estimated gross
profits using current assumptions based on an interest rate equal to the
liability or
22
24
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
contract rate on the value of business acquired. The estimated amortization and
accretion of interest for the value of business acquired for each of the years
through December 31, 2001 are as follows:
PROJECTED
(IN THOUSANDS) BEGINNING ACCRETION OF ENDING
YEAR ENDED DECEMBER 31 BALANCE AMORTIZATION INTEREST BALANCE
- -------------------------------------------------------- --------- ------------ ------------ ---------
1996.................................................... $190,222 $(31,427) $ 9,897 $168,692
1997.................................................... 168,692 (26,330) 10,152 152,514
1998.................................................... 152,514 (26,769) 9,085 134,830
1999.................................................... 134,830 (26,045) 8,000 116,785
2000.................................................... 116,785 (24,288) 6,834 99,331
2001.................................................... 99,331 (21,538) 5,867 83,660
The projected ending balance of the value of business acquired will be further
adjusted to reflect the impact of unrealized gains or losses on fixed maturities
held as available for sale in the investment portfolio. Such adjustments are not
recorded in the Company's net income but rather are recorded as a credit or
charge to stockholder's equity, net of income tax. As of December 31, 1996, this
adjustment increased the value of business acquired and stockholder's equity by
approximately $20.9 million and $13.6 million, respectively.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
could affect the reported amounts of assets and liabilities as well as the
disclosure of contingent assets or liabilities at the date of the financial
statements. As a result, actual results reported as revenue and expenses could
differ from the estimates reported in the accompanying financial statements. As
further discussed in the accompanying notes to the consolidated financial
statements, significant estimates and assumptions affect deferred insurance
acquisition costs, the value of business acquired, provisions for real
estate-related losses and reserves, other-than-temporary declines in values for
fixed maturities, the valuation allowance for deferred income taxes and the
calculation of fair value disclosures for certain financial instruments.
LIFE INSURANCE REVENUE AND EXPENSES
Revenue for annuities and interest-sensitive life insurance products consists of
investment income, and policy charges such as mortality, expense and surrender
charges. Expenses consist of benefits and interest credited to contracts, policy
maintenance costs and amortization of deferred insurance acquisition costs. Also
reflected in fees and other income is a ceding commission experience adjustment
received in 1995 as a result of certain reinsurance transactions entered into by
the Company during 1992. (See note captioned "Reinsurance".)
Premiums for term life policies are reported as earned when due. Profits for
such policies are recognized over the duration of the insurance policies by
matching benefits and expenses to premium income.
DEFERRED INSURANCE ACQUISITION COSTS
The costs of acquiring new business after January 4, 1996, principally
commission expense and certain policy issuance and underwriting expenses, have
been deferred to the extent they are recoverable from estimated future gross
profits on the related contracts and policies. The deferred insurance
acquisition costs for annuities, separate account business and
interest-sensitive life insurance products are being amortized over the
estimated contract life in relation to the present value of estimated gross
profits. Deferred insurance acquisition costs related to such interest-sensitive
products also reflect the estimated impact of unrealized gains or losses on
fixed maturities held as available for sale in the investment portfolio, through
a credit or charge to stockholder's equity, net of income tax. The deferred
insurance acquisition costs for term-life insurance products are being amortized
over the premium paying period of the policies.
FUTURE POLICY BENEFITS
Liabilities for future policy benefits related to annuities and
interest-sensitive life contracts reflect net premiums received plus interest
credited during the contract accumulation period and the present value of future
payments for contracts that have annuitized. Current interest rates credited
during the contract accumulation period range from 4.0 percent to
23
25
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
7.5 percent. Future minimum guaranteed interest rates vary from 3.0 percent to
4.5 percent. For contracts that have annuitized, interest rates used in
determining the present value of future payments range principally from 3.0
percent to 12.0 percent.
Liabilities for future term life policy benefits have been computed principally
by a net level premium method. Anticipated rates of mortality are based on the
1975-1980 Select and Ultimate Table modified by Company experience, including
withdrawals. Estimated future investment yields are a level 7 percent for
reinsurance assumed and for direct business, 8 percent for three years; 7
percent for year four; and 6 percent thereafter.
INVESTED ASSETS AND RELATED INCOME
Investments in fixed maturities are carried at fair value. Short-term
investments are carried at cost, which approximates fair value. (See note
captioned "Fair Value of Financial Instruments".)
The amortized cost of fixed maturities is adjusted for amortization of premiums
and accretion of discounts to maturity, or in the case of mortgage-backed and
asset-backed securities, over the estimated life of the security. Such
amortization is included in net investment income. Amortization of the discount
or premium from mortgage-backed and asset-backed securities is recognized using
a level effective yield method which considers the estimated timing and amount
of prepayments of the underlying loans and is adjusted to reflect differences
which arise between the prepayments originally anticipated and the actual
prepayments received and currently anticipated. To the extent that the estimated
lives of such securities change as a result of changes in prepayment rates, the
adjustment is also included in net investment income. The Company does not
accrue interest income on fixed maturities deemed to be impaired on an
other-than-temporary basis, or on mortgage loans, real estate-related bonds and
other real estate loans where the likelihood of collection of interest is
doubtful.
Mortgage loans are carried at their unpaid balance, net of unamortized discount
and any applicable reserves or write-downs. Other real estate-related
investments net of any applicable reserve and write-downs include notes
receivable from real estate ventures; investments in real estate ventures,
adjusted for the equity in the operating income or loss of such ventures; common
stock carried at fair value and real estate owned carried at fair value.
Real estate reserves are established when declines in collateral values,
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, indicate a likelihood of loss. At year-end
1995, reflecting the Company's change in strategy with respect to its real
estate portfolio, and the disposition thereof, and on January 4, 1996,
reflecting the acquisition of the Company, real estate-related investments were
valued using an estimate of the investments observable market price, net of
estimated costs to sell. Prior to year-end 1995, the Company evaluated its real
estate-related assets (including accrued interest) by estimating the
probabilities of loss utilizing various projections that included several
factors relating to the borrower, property, term of the loan, tenant
composition, rental rates, other supply and demand factors and overall economic
conditions. Generally, at that time, the reserve was based upon the excess of
the loan amount over the estimated future cash flows from the loan, discounted
at the loan's contractual rate of interest taking into consideration the effects
of recourse to, and subordination of loans held by, affiliated non-life realty
companies.
Under purchase accounting, the market value of the Company's policy loans and
other invested assets consisting primarily of venture capital investments and a
leveraged lease, became the Company's new cost basis in such investments.
Investments in policy loans and other invested assets after January 4, 1996 are
carried at cost. Other invested assets also include equity securities, not
related to real estate-related investments, which are carried at fair value.
Realized gains or losses on sales of investments, determined on the basis of
identifiable cost on the disposition of the respective investment, recognition
of other-than-temporary declines in value and changes in real estate-related
reserves and write-downs are included in revenue. Net unrealized gains or losses
on revaluation of investments are credited or charged to stockholder's equity.
Such unrealized gains are recorded net of deferred income tax expense, while
unrealized losses are not tax benefitted.
24
26
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SEPARATE ACCOUNT BUSINESS
The assets and liabilities of the separate accounts represent segregated funds
administered and invested by the Company for purposes of funding variable
annuity and variable life insurance contracts for the exclusive benefit of
variable annuity and variable life insurance contract holders. The Company
receives administrative fees from the separate account and retains varying
amounts of withdrawal charges to cover expenses in the event of early
withdrawals by contract holders. The assets and liabilities of the separate
accounts are carried at fair value.
INCOME TAX
The operations of the Company prior to January 4, 1996 have been included in the
consolidated Federal income tax return of Kemper. Income taxes receivable or
payable have been determined on a separate return basis, and payments have been
received from or remitted to Kemper pursuant to a tax allocation arrangement
between Kemper and its subsidiaries, including the Company. The Company
generally had received a tax benefit for losses to the extent such losses can be
utilized in Kemper's consolidated Federal tax return. Subsequent to January 4,
1996, the Company and its subsidiaries will file separate Federal income tax
returns.
Deferred taxes are provided on the temporary differences between the tax and
financial statement basis of assets and liabilities.
(2) CASH FLOW INFORMATION
The Company defines cash as cash in banks and money market accounts. Federal
income tax refunded by Kemper under the tax allocation arrangement for the
period from January 1, 1996 to January 4, 1996 and for the years ended December
31, 1995 and 1994 amounted to $108.8 million, $25.2 million and $10.7 million,
respectively. The Company paid $28.1 million of Federal income taxes directly to
the United States Treasury Department during 1996.
Not reflected in the statement of cash flows are rollovers of mortgage loans,
other loans and investments totaling approximately $57.0 million in 1994.
25
27
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME
The Company is carrying its fixed maturity investment portfolio at estimated
fair value as fixed maturities are considered available for sale. The carrying
value (estimated fair value) of fixed maturities compared with amortized cost,
adjusted for other-than-temporary declines in value, were as follows:
ESTIMATED UNREALIZED
CARRYING AMORTIZED ---------------------
VALUE COST GAINS LOSSES
(in thousands) -------- --------- ----- ------
DECEMBER 31, 1996
U.S. treasury securities and obligations of U.S. government
agencies and authorities.................................. $ 92,238 $ 93,202 $ -- $ (964)
Obligations of states and political subdivisions, special
revenue and nonguaranteed................................. 30,853 31,519 -- (666)
Debt securities issued by foreign governments............... 105,394 108,456 504 (3,566)
Corporate securities........................................ 1,896,615 1,935,511 5,918 (44,814)
Mortgage and asset-backed securities........................ 1,741,331 1,760,962 1,990 (21,621)
---------- ---------- ------ --------
Total fixed maturities............................... $3,866,431 $3,929,650 $8,412 $(71,631)
========== ========== ====== ========
JANUARY 4, 1996
U.S. treasury securities and obligations of U.S. government
agencies and authorities.................................. $ 215,637 $ 215,637 $ -- $ --
Obligations of states and political subdivisions, special
revenue and nonguaranteed................................. 24,241 24,241 -- --
Debt securities issued by foreign governments............... 139,361 139,361 -- --
Corporate securities........................................ 1,695,268 1,695,268 -- --
Mortgage and asset-backed securities........................ 1,674,816 1,674,816 -- --
---------- ---------- ------ --------
Total fixed maturities............................... $3,749,323 $3,749,323 $ -- $ --
========== ========== ====