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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, 1997.
[ ] 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, 1998, 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.
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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 that change in
control, Zurich and Insurance Partners owned 80 percent and 20 percent,
respectively, of Kemper and therefore KILICO. On February 27, 1998, Zurich
acquired Insurance Partner's remaining 20 percent interest for cash. As a result
of this transaction, Kemper and KILICO became wholly-owned subsidiaries of
Zurich.
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 values as of the acquisition date. The difference between
the allocated cost of $745.6 million of acquiring KILICO and the net fair values
of KILICO's assets and liabilities as of the acquisition date resulted in $254.9
million of goodwill. KILICO originally began to amortize goodwill on a
straight-line basis over twenty-five years, however, in the fourth quarter of
1997, KILICO changed its amortization period to twenty years. The change in
amortization periods was made to conform to Zurich's accounting practices and
policies and resulted in an increase in goodwill amortization of $5.1 million in
1997. KILICO has presented January 4, 1996 (the acquisition date) as the opening
purchase accounting balance sheet for comparative purposes, where appropriate,
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 the early 1990's, 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 4.9 percent at
year-end 1997.
The management, operations and strategic directions of KILICO were also
integrated by the end of 1993 with those of another Kemper subsidiary, Federal
Kemper Life Assurance Company ("FKLA"). The integration streamlined management,
controlled costs, improved profitability, increased operating efficiencies and
productivity, and helped 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.
Beginning in 1995, KILICO also began to introduce and expand new and existing
product lines. In late 1995, KILICO began to sell term life insurance products
in order to balance its product mix and asset-liability structure. Over the last
three years, KILICO increased the competitiveness of its variable annuity
products by adding multiple variable subaccount investment options and
investment managers to existing variable annuity products. In 1996, KILICO
introduced a registered flexible individual variable life insurance product and
in 1997 KILICO introduced a non-registered individual and group variable
bank-owned life insurance contract ("BOLI") and a series of individual variable
life insurance contracts.
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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 individual and group 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. KILICO's sales mainly
consist of deposits received on certain long duration annuity and variable life
insurance contracts as well as reinsurance premiums assumed from FKLA beginning
in 1996. (See note captioned "Reinsurance" in the notes to the consolidated
financial statements and see the table captioned "Sales" on page 10.)
KILICO's fixed and variable 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 existing and new
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 as well as cost of
insurance charges which compensate KILICO for providing life insurance coverage
to the contractholder potentially in excess of their cash surrender values.
As a result of this strategy, KILICO's separate account assets and related sales
of its variable annuity and life products have increased as follows (in
millions):
DECEMBER 31 JANUARY 4
------------------- ----------
1997 1996 1996
-------- -------- ----------
Separate account assets..................................... $5,122.0 $2,127.2 $1,761.1
======== ======== ========
YEAR ENDED DECEMBER 31
----------------------------------
PREACQUISITION
--------------
1997 1996 1995
-------- ------ --------------
Variable annuity sales...................................... $ 259.8 $254.6 $ 151.1
Variable life sales......................................... 2,708.6 .2 --
-------- ------ --------
Total separate account sales.............................. $2,968.4 $254.8 $ 151.1
======== ====== ========
Rating improvements in 1996 (see "Rankings and ratings" on page 6) and the 1996
change in control also helped to increase KILICO's sales in 1997 and 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 introduced POWER V, a registered flexible premium variable
life insurance product. During mid-1997, KILICO also introduced variable BOLI
which is primarily marketed to banks and other large corporate entities and a
series of non-registered variable individual universal life insurance contracts
which are marketed primarily to high net worth individuals. These products are
being marketed and distributed by Investors Brokerage Services, Inc., ("IBS") a
wholly-owned subsidiary of KILICO. Excluding these contracts marketed and
distributed by IBS which accounted for $2,705.8 million of KILICO's first year
sales, INVEST Financial Corporation, ("INVEST") an affiliated company until June
28, 1996, and certain other unrelated companies of INVEST's new parent First
American National Bank, and EVEREN Securities, Inc., an affiliated company until
September 13, 1995, accounted for approximately 23.0 percent and 5.0 percent,
respectively, in 1997 of KILICO's first-year sales, compared with 24 percent and
12 percent, respectively, in 1996.
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Current crediting rates, a conservative investment strategy and the interest
rate environment have impacted general account annuity sales for KILICO over the
last several years. KILICO's general account fixed annuity sales were as follows
(in millions):
YEAR ENDED DECEMBER 31
--------------------------------
PREACQUISITION
--------------
1997 1996 1995
------ ------ --------------
General account fixed annuity sales......................... $145.7 $140.6 $247.6
====== ====== ======
Beginning 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. 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 and most of 1997, which influenced
potential buyers of fixed annuity products to purchase variable annuity
products, sales of general account annuities have increased only slightly in
1997, compared with 1996.
Beginning in 1995, KILICO began to sell term life insurance products in order to
balance its product mix and asset-liability structure. During 1997 and 1996,
KILICO also assumed $21.1 million and $7.3 million, respectively, of term life
insurance premiums from FKLA. Excluding the amounts assumed from FKLA, KILICO's
total term life sales, including new and renewal premiums, net of reinsurance
ceded, amounted to $1.1 million in 1997, compared with $565 thousand in 1996 and
$236 thousand in 1995.
FEDERAL INCOME TAX DEVELOPMENTS
In early 1998, the Clinton Administration's Fiscal Year 1998 Budget ("Budget")
was released and contained certain proposals to change the taxation of
non-qualified fixed and variable annuities and variable life insurance
contracts. It is currently unknown whether or not such proposals will be
accepted, amended or omitted in the final 1999 Budget approved by Congress. If
the current Budget proposals are accepted, certain of KILICO's non-qualified
fixed and variable annuities and certain of its variable life insurance
products, including BOLI and the nonregistered individual variable universal
life insurance contract introduced during 1997, may no longer be tax advantaged
products and therefore no longer attractive to those customers who purchase them
because of their favorable tax attributes. Additionally, sales of such products
during 1998 may also be negatively impacted until the likelihood of the current
proposals being enacted into law has be determined.
YEAR 2000 COMPLIANCE
Many existing computer programs were originally designed without considering the
impact of the year 2000 and currently use only two digits to identify the year
in the date field. This issue affects nearly all companies and organizations and
could cause computer applications and systems to fail or create erroneous
results to occur for any transaction with a date of January 1, 2000, or later.
Many companies must undertake major projects to address the year 2000 issue and
each companies costs and uncertainties will depend on a number of factors,
including its software and hardware, and the nature of the industry. Companies
must also coordinate with other entities with which they electronically
interact, including suppliers, customers, creditors and other financial services
institutions.
If a company does not successfully address its year 2000 issues it could face
material adverse consequences in the form of lawsuits against the company, lost
business, erroneous results and substantial operating problems after January 1,
2000.
KILICO has taken substantial steps over the last several years to ensure that
its systems will be compliant for the year 2000. Such steps have included the
replacement of older systems with new systems which are already compliant. In
1996, KILICO replaced its investment accounting system and in 1997 KILICO
replaced its general ledger and accounts payable system. KILICO has also ensured
that new systems developed to support new product introductions in 1996 and 1997
are already year 2000 compliant. Data processing expenses related solely to
bringing KILICO's systems in compliance with the year 2000 amounted to $88
thousand in 1997 and KILICO anticipates that it will cost an additional $895
thousand to bring all remaining systems into compliance.
KILICO has also undertaken steps which require that all other entities with
which KILICO electronically interacts, including suppliers and other financial
services institutions, attest in writing to KILICO that their systems are year
2000 compliant.
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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, 1997, KILICO had three
ratios outside the usual ranges, the change in reserving ratio, the change in
premium ratio and the change in product mix ratio. KILICO's change in reserving
ratio reflected the level of interest-sensitive life surrenders and withdrawals
during 1997, as well as the 1997 reinsurance agreement with FKLA. KILICO's
change in premium ratio and change in product mix ratio reflected the $2.7
billion increase in BOLI premiums received during 1997. 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 1997 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 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 1997, 1996 and 1995 amounted to $1.2 million, $601 thousand and $5.8
million, respectively. Such amounts relate to accrued guaranty fund assessments
of $4.8 million, $5.8 million and $5.0 million at December 31, 1997, 1996 and
1995, respectively. Additional assessments charged to expense 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 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 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 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.
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RESERVES AND REINSURANCE
The following table provides a breakdown of KILICO's reserves for future policy
benefits by product type (in millions):
DECEMBER 31 DECEMBER 31
1997 1996
----------- -----------
General account annuities................................... $3,137 $3,507
Interest-sensitive life insurance and other................. 709 743
Term life reserves.......................................... 10 7
Ceded future policy benefits................................ 383 427
------ ------
Total............................................. $4,239 $4,684
====== ======
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, A
Mutual Legal Reserve Company ("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 policies not
produced by FKLA or KILICO as well as other policies similar to certain FKLA
policies. At December 31, 1997 and 1996, KILICO's reinsurance recoverable from
FLA related to these coinsurance transactions totaled approximately $382.6
million and $427.2 million, respectively. Utilizing FKLA's employees, KILICO is
the servicing company for this coinsured business and is reimbursed by FLA for
the related servicing expenses.
During December 1997, KILICO entered into a funds held reinsurance agreement
with another Zurich affiliated company, EPICENTRE Reinsurance (Bermuda) Limited
("EPICENTRE"). Under the terms of this agreement, KILICO ceded, on a yearly
renewable term basis, ninety percent of the net amount at risk (death benefit
payable to the insured less the insured's separate account cash surrender value)
related to variable BOLI, which is held in KILICO's separate accounts. During
1997, KILICO ceded to EPICENTRE approximately $24.3 million of separate account
fees (cost of insurance charges) paid to KILICO by these policyholders for the
life insurance coverage provided under the terms of each separate account
contract. KILICO has also withheld approximately $23.4 million of such funds due
to EPICENTRE under the terms of the reinsurance agreement as a component of
benefits and funds payable in the accompanying consolidated balance sheet in
ITEM 8 of this Annual Report on Form 10-K as of December 31, 1997. KILICO
remains primarily liable to its policyholders for these amounts.
During 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 also recorded reserves in 1997 and 1996 of approximately
$7.9 million and $7.3 million, respectively. (See the note captioned
"Reinsurance" in the notes to the consolidated financial statements.)
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 1995 than in earlier years, and were under review in
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 1997 and 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.
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RANKINGS AND RATINGS
According to BEST'S AGENTS GUIDE TO LIFE INSURANCE COMPANIES, 1997, as of
December 31, 1996, KILICO ranked 74th of 1,249 life insurers by admitted assets;
156th of 1,034 by insurance in force; and 171st of 1,183 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. In October
1997, Zurich announced a planned merger with B.A.T. Industries plc. In
connection with that merger, Zurich's and KILICO's claims-paying ability ratings
were placed on ratings watch with negative implications by certain rating
agencies. KILICO's current ratings and their current status are as follows:
CURRENT RATING CURRENT STATUS
--------------- ----------------------------------
A.M. Best Company........................ A (Excellent) Affirmed
Moody's Investors Service................ Aa3 (Excellent) Under review -- possible downgrade
Duff & Phelps Credit Rating Co........... AA (Very High) Rating watch -- developing
Standard & Poor's........................ AA- (Excellent) Affirmed
EMPLOYEES
At December 31, 1997, KILICO utilized the services of approximately 620
employees of FKLA, which are also shared with FLA and Zurich Life Insurance
Company of America ("ZLICA"). 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, certain of KILICO's variable life insurance and annuity products,
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).
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, Scudder Kemper Investments, Inc. ("SKI"),
formerly Zurich Kemper Investments, Inc. ("ZKI"), and its subsidiaries and
affiliates, with KILICO's real estate-related investments being handled by a
majority-owned 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.
FORWARD-LOOKING STATEMENTS
All statements, trend analyses and other information contained in this report
and elsewhere (such as in other filings by KILICO with the Securities and
Exchange Commission, press releases, presentations by KILICO or its management
or oral statements) relative to markets for KILICO's products and trends in
KILICO's operations or financial results, as well as
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other statements including words such as "anticipate," "believe," "plan,"
"estimate," "expect," "intend," and other similar expressions, constitute
forward-looking statements under the Private Securities Litigation Reform Act of
1995. These forward-looking statements are subject to known and unknown risks,
uncertainties and other factors which may cause actual results to be materially
different from those contemplated by the forward-looking statements. Such
factors include, among other things: (i) general economic conditions and other
factors, including prevailing interest rate levels and stock market performance,
which may affect the ability of KILICO to sell its products, the market value of
KILICO's investments and the lapse rate and profitability of KILICO's contracts;
(ii) KILICO's ability to achieve anticipated levels of operational efficiencies
through certain cost-saving initiatives; (iii) customer response to new
products, distribution channels and marketing initiatives; (iv) mortality,
morbidity, and other factors which may affect the profitability of KILICO's
insurance products; (v) changes in the Federal income tax laws and regulations
which may affect the relative tax advantages of some of KILICO's products; (vi)
increasing competition which could affect the sale of KILICO's products; (vii)
regulatory changes or actions, including those relating to regulation of
financial services affecting (among other things) bank sales and underwriting of
insurance products, regulations of the sale and underwriting and pricing of
insurance products; and (viii) the risk factors or uncertainties listed from
time to time in KILICO's other filings with the Securities and Exchange
Commission.
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
None
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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.
Cash dividends of $26.9 million and $2.4 million were declared and paid to
Kemper on March 31, 1997 and May 1, 1997, respectively. No additional dividends
have been declared or paid through the date of filing this Form 10-K.
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. The maximum amount of dividends which can be paid
by KILICO without prior approval in 1998 is $58.4 million.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial information for KILICO for the
five years ended December 31, 1997 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 DECEMBER 31 JANUARY 4 ----------------------------------
1997 1996 1996 1995 1994 1993
----------- ----------- --------- -------- -------- --------
TOTAL REVENUE..................... $ 425.5 $ 356.2 $ -- $ 68.1 (1) $ 330.5 $ 337.4
========= ======== ======== ======== ======== ========
NET INCOME EXCLUDING REALIZED
INVESTMENT RESULTS.............. $ 31.9 $ 25.6 $ -- $ 74.2 $ 61.9 $ 33.7
========= ======== ======== ======== ======== ========
NET INCOME (LOSS)................. $ 38.7 $ 34.4 $ -- $ (133.0)(1) $ 26.4 $ 14.0
========= ======== ======== ======== ======== ========
FINANCIAL SUMMARY
Total separate account assets..... $ 5,122.0 $2,127.2 $1,761.1 $1,761.1 $1,508.0 $1,499.5
========= ======== ======== ======== ======== ========
Total assets...................... $10,589.7 $7,717.9 $7,682.7 $7,581.7 $7,537.1 $8,113.7
========= ======== ======== ======== ======== ========
Future policy benefits............ $ 3,856.9 $4,256.5 $4,585.1 $4,573.2 $4,843.7 $5,040.0
========= ======== ======== ======== ======== ========
Stockholder's equity.............. $ 865.6 $ 751.0 $ 745.6 $ 605.9 $ 434.0 $ 654.6
========= ======== ======== ======== ======== ========
- ---------------
(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.
8
10
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 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 year
ended December 31, 1995 has been prepared on an historical cost basis and do not
reflect such purchase accounting adjustments.
RESULTS OF OPERATIONS
KILICO recorded net income of $38.7 million in 1997, compared with net income of
$34.4 million in 1996 and with a net loss of $133.0 million in 1995. The
increase in net income in 1997, compared with 1996, was due to a significant
increase in operating earnings before the amortization of goodwill, offset by an
increase in goodwill amortization and a slight decline in net realized capital
gains. The increase in net income in 1996, compared with 1995, 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
--------------
1997 1996 1995
------ ------ --------------
Operating earnings before amortization
of goodwill......................... $ 47.2 $ 35.8 $ 74.2
Amortization of goodwill.............. (15.3) (10.2) --
Net realized investment gains
(losses)............................ 6.8 8.8 (207.2)
------ ------ -------
Net income (loss)........... $ 38.7 $ 34.4 $(133.0)
====== ====== =======
The following table reflects the major components of realized investment results
included in net income (loss) above. (See "INVESTMENTS" beginning on page 13,
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
--------------
1997 1996 1995
------ ------ --------------
Real estate-related gains (losses).... $ 12.8 $ 11.4 $(211.6)
Fixed maturity write-downs............ (2.8) (.9) (4.7)
Other gains (losses), net............. (3.2) (1.7) 9.1
------ ------ -------
Total....................... $ 6.8 $ 8.8 $(207.2)
====== ====== =======
The higher level of real estate-related losses in 1995, compared with both 1997
and 1996, 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 1997, 1996 and 1995
relate primarily to the sale of fixed maturity investments. The fixed maturity
losses generated in 1997 and 1996 arose primarily from the sale of fixed
maturity investments, consisting of lower yielding U.S. Treasury bonds,
collateralized mortgage obligations and corporate bonds, related to ongoing
9
11
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
1997 and 1996. Real estate-related gains in both 1997 and 1996, continue to
reflect KILICO's strategy to reduce its exposure to real estate-related
investments, as well as improving real estate market conditions in most areas of
the country. Fixed maturity write-downs in 1997 primarily reflect
other-than-temporary declines in value of certain U.S. dollar denominated fixed
maturity investments which have significant exposure to countries in Southeast
Asia. (See "INVESTMENTS" beginning on page 13.)
Operating earnings before the amortization of goodwill increased to $47.2
million in 1997, compared with $35.8 million in 1996. Operating earnings
increased in 1997 before the amortization of goodwill, compared with 1996,
primarily due to an increase in spread revenue (investment income earned less
interest credited), an increase in separate account fees and charges, an
increase in premium income and an increase in the deferral of insurance
acquisition costs, offset by an increase in claims incurred and other
policyholder benefits, taxes, licenses and fees, commissions, operating expenses
and an increase in the amortization of the value of business acquired.
Operating earnings before the amortization of goodwill decreased to $35.8
million in 1996, compared with $74.2 million in 1995, primarily due to purchase
accounting adjustments which reduced investment income and increased expenses.
Investment income was lower in 1996, compared with 1995, primarily reflecting
purchase accounting adjustments related to the amortization of premiums on fixed
maturity investments. Under purchase accounting, the fair 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 $14.1 million in 1997
and $22.7 million in 1996, compared with 1995.
Investment income and interest credited also declined in 1997, compared with
1996 and 1995, as a result of a decrease in both total invested assets and
liabilities for future policy benefits to policyholders. 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,
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.
Investment income was positively impacted in 1997 and 1996 from the benefits of
capital contributions to KILICO and from the above-mentioned repositionings of
KILICO's investment portfolio.
The following table reflects KILICO's sales.
SALES
(in millions)
YEAR ENDED DECEMBER 31
----------------------------------------
PREACQUISITION
--------------
1997 1996 1995
-------- ------ --------------
Annuities:
General account........................ $ 145.7 $140.6 $247.6
Separate account....................... 259.8 254.6 151.1
-------- ------ ------
Total annuities..................... 405.5 395.2 398.7
-------- ------ ------
Life Insurance:
Separate account bank-owned variable
universal life ("BOLI")............. 2,700.0 -- --
Separate account variable universal
life................................ 8.6 .2 --
Term life.............................. 22.2 7.8 .2
Interest-sensitive life................ -- .6 .2
-------- ------ ------
Total life.......................... 2,730.8 8.6 .4
-------- ------ ------
Total sales............... $3,136.3 $403.8 $399.1
======== ====== ======
Sales of annuity products consist of total deposits received. General account
annuity sales increased only slightly in 1997, compared with 1996, due to the
current low interest rate environment. The decrease in 1996 general account
(fixed annuity) sales, compared with 1995, is reflective of the declining
interest rate environments and the stock and bond
10
12
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 1997, compared with 1996
and 1995, 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, the addition of new investment fund managers and a
strong overall 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. 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 late 1995, KILICO introduced a registered flexible individual
variable life insurance product and in 1997 KILICO introduced several
non-registered variable universal life insurance contracts, BOLI and a series of
individual universal life insurance contracts. Sales of these separate account
variable products, like variable annuities, pose minimal investment risk for
KILICO as policyholders also invest in one or more underlying investment funds
which invest in stocks and bonds. KILICO receives premium tax and DAC tax
expense loads from certain contract holders, as well as administrative fees and
cost of insurance charges which compensate KILICO for providing life insurance
coverage to the contractholders in excess of their cash surrender values. Face
amount of new variable universal life insurance business issued amounted to
$59.6 billion in 1997, compared with $4.0 million in 1996.
In early 1998, the Clinton Administration's Fiscal Year 1998 Budget ("Budget")
was released and contained certain proposals to change the taxation of
non-qualified fixed and variable annuities and variable life insurance
contracts. It is currently unknown whether or not such proposals will be
accepted, amended or omitted in the final 1999 Budget approved by Congress. If
the current Budget proposals are accepted, certain of KILICO's non-qualified
fixed and variable annuities and certain of its variable life insurance
products, including BOLI and the non-registered individual variable universal
life insurance contract introduced during 1997, may no longer be tax advantaged
products and therefore no longer attractive to those customers who purchase them
because of their favorable tax attributes. Additionally, sales of such products
during 1998 may also be negatively impacted until the likelihood of the current
proposals being enacted into law has been determined.
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 1997 and 1996, KILICO also
assumed $21.1 million and $7.3 million, respectively, 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
$1.1 million in 1997, compared with $565 thousand in 1996 and $236 thousand in
1995. Face amount of new term business issued during 1997, 1996 and 1995
amounted to approximately $278 million, $187 million and $120 million,
respectively.
Included in separate account fees and charges are administrative fees received
from KILICO's separate account products of $31.0 million in 1997, compared with
$25.3 million and $21.9 million in 1996 and 1995, respectively. Administrative
fee revenue increased in each of the last three years due to growth in average
separate account assets.
Also included in separate account fees and charges in 1997 are cost of insurance
charges related to variable universal life insurance, primarily BOLI, of $27.6
million, of which $24.3 million of such fees were ceded to EPICENTRE. (See the
note captioned "Reinsurance" in the notes to the consolidated financial
statements.) Separate account fees and charges in 1997 also include premium tax
expense loads of $51.1 million related to BOLI.
Other income includes surrender charge revenue of $5.2 million in 1997, compared
with $5.4 million and $7.7 million in 1996 and 1995, respectively, as total
general account and separate account policyholder surrenders and withdrawals
decreased in 1997 and 1996, compared with 1995. The decrease in surrender charge
revenue in 1997, compared with 1996 and 1995 also reflects that 49 percent of
KILICO's fixed and variable annuity liabilities, excluding BOLI, at December 31,
1997 are subject to minimal (5 percent or less) or no surrender charges,
compared with 57 percent in 1996 and 56 percent in 1995. Also included in other
income in 1995 is a ceding commission experience adjustment
11
13
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, WITHDRAWALS AND DEATH BENEFITS
(in millions)
PREACQUISITION
--------------
1997 1996 1995
------ ------ --------------
General account......................... $703.1 $652.0 $755.9
Separate account........................ 236.2 196.7 205.6
------ ------ ------
Total.............................. $939.3 $848.7 $961.5
====== ====== ======
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 and 1997, have mitigated
at present, competitive pressures to increase existing renewal crediting rates
further.
General account surrenders, withdrawals and death benefits increased $51.1
million in 1997, compared with 1996, reflecting an increase of $18.2 million in
claims incurred as a result of the aforementioned term life insurance business
assumed from FKLA as well as an increase in overall surrenders and withdrawals
in 1997, compared with 1996. KILICO expects that the level of surrender and
withdrawal activity experienced in 1997 should remain at a similar level in 1998
given current projections for relatively stable interest rates.
Taxes licenses and fees increased in 1997 to $52.6 million of which $51.1
million of this increase was related to premium taxes on BOLI. Excluding the
taxes due on BOLI, of which KILICO received a corresponding expense load in
separate account fees and other charges, taxes licenses and fees amounted to
$1.5 million, compared with $2.2 million in 1996 and $6.9 million in 1995.
Taxes, licenses and fees were lower in 1997 and 1996, compared with 1995,
primarily reflecting the level of guaranty fund assessments in each of those
years. Expenses for such assessments totaled $1.2 million, $601 thousand, and
$5.8 million in 1997, 1996 and 1995, respectively. (See "Guaranty association
assessments" in ITEM 1 beginning on page 4.)
Commissions expense was higher in 1997, compared with both 1996 and 1995, due to
an increase in total sales, excluding BOLI.
Operating expenses declined in 1995, primarily as a result of a decrease in
headcount resulting from the uncertainty concerning KILICO's ownership.
Operating expenses increased in 1997 and 1996, compared with 1995, as a result
of restaffing after the completion of the merger, an increase in evidence costs
related to new term life sales and an increase in data processing expenses. Data
processing expenses increased to $10.8 million in 1997, compared with $4.1
million in 1996 and $3.7 million in 1995, primarily due to infrastructure
improvements related to new product development, a new general ledger and
accounts payable system, development of a data warehouse and costs related to
bringing KILICO's systems in compliance with the year 2000. Data processing
expenses related to bringing KILICO's systems in compliance with the year 2000
amounted to $88 thousand in 1997. KILICO currently anticipates that it will cost
an additional $895 thousand to bring all remaining systems in compliance. (See
"Year 2000 compliance" in ITEM 1 beginning on page 3.)
Operating earnings were positively impacted by the deferral of insurance
acquisition costs in 1997, compared with 1996 and 1995. The deferral of
insurance acquisition costs increased in 1997, compared with both 1996 and 1995
reflecting an increase in commissions expense and operating expenses related
directly to the increase in production of new business.
Operating earnings were negatively impacted by the amortization of insurance
acquisition costs and the amortization of the value of business acquired in 1997
and 1996, compared with the amortization of insurance acquisition costs in 1995.
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 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.
12
14
The amortization of the value of business acquired increased in 1997, compared
with 1996, as a result of an increase in net operating earnings related to the
business previously acquired. The amortization of the value of business acquired
in 1997 and 1996 was also adversely affected by net realized capital gains in
1997 and 1996, while the net amortization of insurance acquisition costs in
1995, was positively affected by realized capital losses. Net realized capital
gains 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 difference between the cost of acquiring KILICO and the net fair value of
KILICO's assets and liabilities as of January 4, 1996 was recorded as goodwill.
During 1996, KILICO began to amortize goodwill on a straight-line basis over
twenty-five years. In December of 1997, KILICO changed its amortization period
to twenty years in order to conform to Zurich's accounting practices and
policies. As a result of the change in amortization periods, KILICO recorded an
increase in amortization expense of $5.1 million during 1997. The amortization
of goodwill increased expenses by $10.2 million in 1996, compared with 1995.
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.
INVESTED ASSETS AND CASH
(in millions)
DECEMBER 31 DECEMBER 31
1997 1996
--------------- ---------------
Cash and short-term investments............................. $ 260 5.8% $ 74 1.6%
Fixed maturities:
Investment-grade:
NAIC(1) Class 1........................................ 3,004 67.1 3,231 71.5
NAIC(1) Class 2........................................ 651 14.5 621 13.7
Below investment grade:
Performing............................................. 14 .3 13 .3
Nonperforming.......................................... -- -- 1 --
Joint venture mortgage loans................................ 73 1.6 111 2.4
Third-party mortgage loans.................................. 103 2.3 107 2.4
Other real estate-related investments....................... 44 1.0 50 1.1
Policy loans................................................ 282 6.3 288 6.4
Equity securities........................................... 25 .6 10 .2
Other....................................................... 21 .5 14 .4
------ ----- ------ -----
Total(2).......................................... $4,477 100.0% $4,520 100.0%
====== ===== ====== =====
- ---------------
(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 equity, net of any applicable income tax expense. The aggregate
unrealized appreciation (depreciation) on fixed maturities at December 31, 1997
and 1996 was $24.6 million and $(63.2) million, respectively, 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.
13
15
At December 31, 1997, investment-grade fixed maturities and cash and short-term
investments accounted for 87.4 percent of KILICO's invested assets and cash,
compared with 86.8 percent at December 31, 1996. Approximately 54.0 percent of
KILICO's NAIC Class 1 bonds were rated AAA or equivalent at year-end 1997,
compared with 58.4 percent at December 31, 1996.
Approximately 35.1 percent of KILICO's investment-grade fixed maturities at
December 31, 1997 were mortgage-backed securities, down from 36.4 percent at
December 31, 1996, due to sales and paydowns during 1997. 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 repositionings of KILICO's fixed
maturity portfolio, approximately 10.8 percent and 8.8 percent of KILICO's
investment-grade fixed maturities at December 31, 1997 and 1996, respectively,
consisted of corporate asset-backed securities. The majority of KILICO's
investments in asset-backed securities were backed by home equity loans (27.7%),
auto loans (22.3%), manufactured housing loans (17.2%), equipment loans (13.7%),
and commercial mortgage backed securities ("CMBs") (10.7%).
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, 1997 and 1996 KILICO had unamortized premiums and discounts
related to mortgage-backed and asset-backed securities as follows (in millions):
DECEMBER 31
-------------
1997 1996
----- -----
Unamortized premiums........................................ $19.6 $24.7
===== =====
Unamortized discounts....................................... $ 5.2 $ 5.7
===== =====
KILICO believes that as a result of the purchase accounting adjustments and the
current interest rate environment, anticipated prepayment activity in 1998 is
expected to result in reductions to future investment income similar to or
greater than those reductions experienced by KILICO in 1997.
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.
14
16
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) 1997 1998 1999 2000 2001 2002 THEREAFTER TOTAL 1997
------------- ------------ ---- ---- ---- ---- ---- ---------- ----- ------------
Fixed Maturities:
Mortgage-backed
bonds............. $1,283.6 $219.1 $232.5 $145.1 $92.2 $64.5 $530.2 $1,283.6 $1,283.6
Average yield..... 6.58% 6.60% 6.61% 6.64% 6.64% 6.63% 6.67% 6.58% 6.58%
Asset-backed bonds... $ 353.0 $ 18.9 $ 16.9 $ 30.8 $35.5 $47.2 $203.7 $ 353.0 $ 353.0
Average yield..... 6.81% 6.85% 7.04% 7.05% 7.15% 7.13% 7.20% 6.81% 6.81%
CMBs................. $ 42.2 $ 0.3 $ 0.4 $ 0.4 $ 0.4 $ 8.0 $ 32.7 $ 42.2 $ 42.2
Average yield..... 6.64% 6.64% 6.64% 6.64% 6.64% 6.63% 6.63% 6.64% 6.64%
-------- -------- --------
$1,678.8 $1,678.8 $1,678.8
======== ======== ========
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, 1997, is 3.8 years. A 200 basis point increase in
interest rates would extend the weighted average maturity by approximately 1.0
year, while a 200 basis point decrease in interest rates would decrease the
weighted average maturity by approximately 1.3 years.
The weighted average maturity of the mortgage-backed and asset-backed securities
at December 31, 1996, was 4.6 years. A 200 basis point increase in interest
rates would have extended the weighted average maturity by approximately 1.7
years, while a 200 basis point decrease in interest rates would have decreased
the weighted average maturity by approximately 1.3 years.
As of December 31, 1997, KILICO had $54.7 million of U.S. dollar denominated
fixed maturity investments, after write-downs for other-than-temporary declines
in value, which have significant exposure to countries in Southeast Asia.
Approximately $5.6 million of such securities were from Korea, $21.9 million
were from Hong Kong, China, $20.4 million were from Malaysia and the remainder
of such bonds were from a United Kingdom bank with most of its loans issued to
countries in Southeast Asia. Write-downs on such securities, which were
considered to be other-than-temporary, as of December 31, 1997 amounted to $3.1
million. There can be no assurance that the current estimate for other-than-
temporary declines in value for such securities will prove accurate over time
due to changing economic conditions in Southeast Asia.
Below investment-grade securities holdings (NAIC classes 3 through 6),
representing securities of 9 issuers at December 31, 1997, totaled 0.3 percent
of cash and invested assets at both December 31, 1997 and December 31, 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. KILICO expects to increase its holdings
in this category selectively during 1998.
15
17
REAL ESTATE-RELATED INVESTMENTS
The $220.0 million real estate-related portfolio held by KILICO, consisting of
joint venture and third-party mortgage loans and other real estate-related
investments, constituted 4.9 percent of cash and invested assets at December 31,
1997, compared with $267.7 million, or 5.9 percent, at December 31, 1996. The
decrease in real estate-related investments during 1997 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 $75.3 million at December 31, 1997. This amount represented a net decrease
of $122.1 million since December 31, 1996, primarily due to sales in 1997. As of
December 31, 1997, KILICO expects to fund approximately $21.2 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.)
Excluding the $4.0 million of real estate owned and $19.2 million of net equity
investments in joint ventures, KILICO's real estate loans totaled $196.8 million
at December 31, 1997, after reserves and write-downs. Of this amount, $155.0
million are on accrual status with a weighted average interest rate of
approximately 8.82 percent. Of these accrual loans, 9.7 percent have terms
requiring current periodic payments of their full contractual interest, 53.4
percent require only partial payments or payments to the extent of cash flow of
the borrowers, and 36.9 percent defer all interest to maturity.
The equity investments in real estate at December 31, 1997 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 December 31, 1996........................ $111.0 $106.6 $ 30.9 $ 7.5 $11.7 $267.7(1)
Additions (deductions):
Fundings............................................ 11.8 -- -- -- -- 11.8
Interest added to principal......................... 5.6 .7 -- -- -- 6.3
Sales/paydowns/distributions........................ (47.9) (13.8) (10.4) (4.1) (3.0) (79.2)
Operating gain...................................... -- -- -- -- .8 .8
Transfers........................................... (9.1) 9.1 -- -- -- --
Realized investments gains.......................... 7.6 .4 2.2 .7 8.8 19.7
Other transactions, net............................. (6.3) -- (1.6) (.1) .9 (7.1)
------ ------ ------ ----- ----- ------
Balance at December 31, 1997........................ $ 72.7 $103.0 $ 21.1 $ 4.0 $19.2 $220.0(3)
====== ====== ====== ===== ===== ======
- ---------------
(1) Net of $11.8 million reserve and write-downs. Excludes $9.7 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 $9.2 million reserve and write-downs. Excludes $9.5 million of real
estate-related accrued interest.
REAL ESTATE CONCENTRATIONS AND OUTLOOK
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 Investees" and "Concentration of Credit Risk" in the
notes to the consolidated financial statements.)
As a result of KILICO's ongoing strategy to reduce its exposure to real
estate-related investments, as of December 31, 1997, KILICO had three remaining
properties which account for approximately 83.2 percent of KILICO's $220.0
million real estate-related portfolio.
16
18
The largest of these investments at December 31, 1997 amounted to $88.2 million
and consisted of second mortgages on nine hotel properties and two office
buildings in which Patrick M. Nesbitt or his affiliates, a third-party real
estate developer, have ownership interests. These hotels and office buildings
are geographically dispersed and the current market values of the underlying
properties substantially exceed the balances due on KILICO's mortgages. These
loans are on accrual status.
KILICO's loans to a master limited partnership (the "MLP") between subsidiaries
of Kemper and subsidiaries of Lumbermens, amounted to $60.5 million at December
31, 1997. The MLP's underlying investment primarily consists of a water
development project located in California's Sacramento River Valley. This
project is currently in the final stages of a permit process with various
Federal and California State agencies which will determine the long-term
economic viability of the project. KILICO currently anticipates that the permit
process will be successfully completed in 1998. Loans to the MLP are on accrual
status.
The remaining significant real estate-related investment amounted to $34.4
million at December 31, 1997 and consisted of various zoned and unzoned
residential commercial lots located in Hawaii, as well as a sewer treatment
plant which is located in the same geographical area as the residential lots.
The sewer treatment plant is currently under a sales contract and is expected to
close in early 1998. Due to certain negative zoning restriction developments in
January 1997 and a continuing economic slump in Hawaii, KILICO has placed these
real estate-related investments on nonaccrual status as of December 31, 1996.
KILICO is currently pursuing the zoning of all remaining unzoned properties, as
well as pursuing steps to sell all remaining zoned properties. However, due to
the state of Hawaii's economy, which has lagged behind the economic expansion of
most of the rest of the United States, KILICO anticipates that it could be
several additional years until all of KILICO's investments in Hawaii are
completely disposed of.
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.) 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. 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, if Kemper's and
KILICO's plans with respect to certain projects change or if necessary
construction or zoning permits are not obtained.
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 DECEMBER 31
1997 1996
----------- -----------
Potential problem loans(1)........................... $ -- $ 3.2
Past due loans(2).................................... -- --
Nonaccrual loans (primarily Hawaiian
properties)(3)..................................... 47.4 43.5
Real estate owned.................................... 4.0 7.5
----- -----
Total...................................... $51.4 $54.2
===== =====
- ---------------
(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 $41.8 million
and $38.2 million at December 31, 1997 and December 31, 1996, respectively.
NET INVESTMENT INCOME
KILICO's pre-tax net investment income totaled $296.2 million in 1997, compared
with $299.7 million in 1996 and $348.4 million in 1995. 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
17
19
net investment income in 1997 and 1996, compared with 1995, 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
--------------
1997 1996 1995
---- ---- --------------
Fixed maturities................................ $ .5 $ .7 $ .4
Real estate-related investments................. 3.9 .5 20.5
---- ---- -----
Total.................................... $4.4 $1.2 $20.9
==== ==== =====
Basis points.................................... 10 3 43
==== ==== =====
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, 1997, KILICO
estimates foregone investment income in 1998 will be similar to the 1997 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.
REALIZED INVESTMENT RESULTS
Reflected in net income (loss) are after-tax realized investment gains of $6.8
million and $8.8 million in 1997 and 1996, respectively, compared with after-tax
realized investment losses of $207.2 million in 1995. (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,
before declining again in 1997.
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.
A rising interest rate environment can increase net investment income as well as
contribute to both realized and unrealized fixed maturity investment losses,
while a declining interest rate environment can decrease net investment income
as well as contribute to both realized and unrealized fixed maturity investment
gains. Also, lower renewal crediting rates on annuities, compared with
competitors' higher new money crediting rates, have 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
18
20
49 percent of KILICO's fixed and variable annuity liabilities as of December 31,
1997, however, were no longer subject to significant surrender fees.
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, premium income, investment income,
separate account fees, other operating revenue and cash provided from maturing
or sold investments. (See the Policyholder surrenders and withdrawals table and
related discussion on page 12 and "INVESTMENTS" beginning on page 13.)
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.
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 6.)
STOCKHOLDER'S EQUITY
Stockholder's equity totaled $865.6 million at December 31, 1997, compared with
$751.0 million at December 31, 1996, and $745.6 million at January 4, 1996. The
1997 increase in stockholder's equity was primarily due to net income of $38.7
million, a $45.0 million capital contribution and an increase in stockholder's
equity related to the change in unrealized appreciation of $60.1 million related
to KILICO's fixed maturity investment portfolio due to falling interest rates
during 1997, offset by a dividend of $29.2 million to Kemper. 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.
EMERGING ISSUES
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 130, REPORTING COMPREHENSIVE
INCOME. SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses).
This statement requires that all items required to be reported be displayed with
the same prominence as other financial statements. This statement is effective
for fiscal years beginning after December 31, 1997. The impact of implementation
is not expected to be material to KILICO's reported net income before reporting
comprehensive income. Comprehensive income, however, by design, could be
materially different from reported net income, as changes in unrealized
appreciation and depreciation of investments for example will now be included as
a component of reported comprehensive income. Full implementation of SFAS No.
130 is expected in the first quarter of 1998.
In June 1997, the FASB also issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF
AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 establishes standards for
how to report information about operating segments. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. This statement is effective for fiscal years beginning
after December 31, 1997. Full implementation of SFAS No. 131 is expected in
December 1998 and the impact of implementation is not expected to be material to
KILICO.
In February 1998, the FASB issued SFAS No. 132, EMPLOYERS' DISCLOSURES ABOUT
PENSIONS AND OTHER POSTRETIREMENT BENEFITS. SFAS No. 132 revises standards for
disclosures related to pension and other postretirement benefit plans. This
statement is effective for fiscal years beginning after December 31, 1997. Full
implementation of SFAS No. 132 is expected in December 1998 and the impact of
implementation is not expected to be material to KILICO.
19
21
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE(S)
-------
Report of Independent Public Accountants.................... 20
Consolidated Balance Sheets, December 31, 1997 and December
31, 1996.................................................. 21
Consolidated Statements of Operations, three years ended
December 31, 1997......................................... 22
Consolidated Statements of Stockholder's Equity, three years
ended December 31, 1997................................... 23
Consolidated Statements of Cash Flows, three years ended
December 31, 1997......................................... 24
Notes to Consolidated Financial Statements.................. 25-39
Financial Statement Schedules:
Reinsurance............................................... 47
Valuation and Qualifying Accounts......................... 48
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholder's
Kemper Investors Life Insurance Company:
We have audited the accompanying consolidated balance sheet of Kemper Investors
Life Insurance Company and subsidiaries as of December 31, 1997, and the related
consolidated statements of operations, stockholder's equity, and cash flows for
the year then ended. In connection with our audit 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 and financial statement schedules based on our audit. The
financial statements of Kemper Investors Life Insurance Company and subsidiaries
for the period from January 4, 1996 to December 31, 1996 (post-acquisition
basis) and for the year ended December 31, 1995 (pre-acquisition basis), were
audited by other auditors, whose unqualified report, dated March 21, 1997,
included an explanatory paragraph that described the acquisition of Kemper
Investors Life Insurance Company as discussed in Note 1 to the financial
statements.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Kemper
Investors Life Insurance Company and subsidiaries as of December 31, 1997, and
the results of their operations and their cash flows for the year then ended in
conformity with generally accepted accounting principles. In addition, in our
opinion, the financial statement schedules referred to above, when considered in
relation to the basic financial statements taken as a whole, present fairly, in
all material respects, the information required to be included therein.
Coopers & Lybrand L.L.P.
Chicago, Illinois
March 18, 1998
20
22
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
DECEMBER 31 DECEMBER 31
1997 1996
----------- -----------
ASSETS
Fixed maturities, available for sale, at fair value
(amortized cost: December 31, 1997, $3,644,075; December
31, 1996, $3,929,650)..................................... $ 3,668,643 $3,866,431
Short-term investments...................................... 236,057 71,696
Joint venture mortgage loans................................ 72,663 110,971
Third-party mortgage loans.................................. 102,974 106,585
Other real estate-related investments....................... 44,409 50,157
Policy loans................................................ 282,439 288,302
Equity securities........................................... 24,839 9,910
Other invested assets....................................... 20,820 13,597
----------- ----------
Total investments................................. 4,452,844 4,517,649
Cash........................................................ 23,868 2,776
Accrued investment income................................... 117,789 115,199
Goodwill.................................................... 229,393 244,688
Value of business acquired.................................. 138,482 189,639
Deferred insurance acquisition costs........................ 59,459 26,811
Deferred income taxes....................................... 39,993 --
Reinsurance recoverable..................................... 382,609 427,165
Receivable on sales of securities........................... 20,076 32,569
Other assets and receivables................................ 3,187 34,117
Assets held in separate accounts............................ ,121,950 2,127,247
----------- ----------
Total assets...................................... $10,589,650 $7,717,860
=========== ==========
LIABILITIES
Future policy benefits...................................... $ 3,856,871 $4,256,521
Ceded future policy benefits................................ 382,609 427,165
Benefits and funds payable.................................. 150,524 36,142
Other accounts payable and liabilities...................... 212,133 59,462
Deferred income taxes....................................... -- 60,362
Liabilities related to separate accounts.................... 5,121,950 2,127,247
----------- ----------
Total liabilities................................. 9,724,087 6,966,899
----------- ----------
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.................................. 806,538 761,538
Unrealized gain (loss) on investments....................... 12,637 (47,498)
Retained earnings........................................... 43,888 34,421
----------- ----------
Total stockholder's equity........................ 865,563 750,961
----------- ----------
Total liabilities and stockholder's equity........ $10,589,650 $7,717,860
=========== ==========
See accompanying notes to consolidated financial statements.
21
23
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
YEAR ENDED DECEMBER 31
--------------------------------------
PREACQUISITION
--------------
1997 1996 1995
-------- -------- --------------
REVENUE
Net investment income....................................... $296,195 $299,688 $ 348,448
Realized investment gains (losses).......................... 10,546 13,602 (318,700)
Premium income.............................................. 22,239 7,822 236
Separate account fees and charges........................... 85,413 25,309 21,909
Other income................................................ 11,087 9,786 16,192
-------- -------- ---------
Total revenue..................................... 425,480 356,207 68,085
-------- -------- ---------
BENEFITS AND EXPENSES
Interest credited to policyholders.......................... 199,782 223,094 237,984
Claims incurred and other policyholder benefits............. 28,372 14,255 7,631
Taxes, licenses and fees.................................... 52,608 2,173 6,912
Commissions................................................. 32,602 25,962 24,881
Operating expenses.......................................... 36,837 24,678 20,837
Deferral of insurance acquisition costs..................... (38,177) (27,820) (36,870)
Amortization of insurance acquisition costs................. 3,204 2,316 14,423
Amortization of value of business acquired.................. 24,948 21,530 --
Amortization of goodwill.................................... 15,295 10,195 --
-------- -------- ---------
Total benefits and expenses....................... 355,471 296,383 275,798
-------- -------- ---------
Income (loss) before income tax expense (benefit)........... 70,009 59,824 (207,713)
Income tax expense (benefit)................................ 31,292 25,403 (74,664)
-------- -------- ---------
Net income (loss)................................. $ 38,717 $ 34,421 $(133,049)
======== ======== =========
See accompanying notes to consolidated financial statements.
22
24
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(in thousands)
PREACQUISITION
--------------
DECEMBER 31 DECEMBER 31 JANUARY 4 DECEMBER 31
1997 1996 1996 1995
----------- ----------- --------- -----------
CAPITAL STOCK, beginning and end of period............ $ 2,500 $ 2,500 $ 2,500 $ 2,500
-------- -------- -------- ---------
ADDITIONAL PAID-IN CAPITAL, beginning of period....... 761,538 743,104 491,994 491,994
Capital contributions from parent..................... 45,000 18,434 -- --
Adjustment to reflect purchase accounting method...... -- -- 251,110 --
-------- -------- -------- ---------
End of period............................... 806,538 761,538 743,104 491,994
-------- -------- -------- ---------
UNREALIZED GAIN (LOSS) ON INVESTMENTS, beginning of
period.............................................. (47,498) -- 68,502 (236,443)
Unrealized gain (loss) on revaluation of investments,
net................................................. 60,135 (47,498) -- 304,945
Adjustment to reflect purchase accounting method...... -- -- (68,502) --
-------- -------- -------- ---------
End of period............................... 12,637 (47,498) -- 68,502
-------- -------- -------- ---------
RETAINED EARNINGS, beginning of period................ 34,421 -- 42,880 175,929
Net income (loss)..................................... 38,717 34,421 -- (133,049)
Dividends to parent................................... (29,250) -- -- --
Adjustment to reflect purchase accounting method...... -- -- (42,880) --
-------- -------- -------- ---------
End of period............................... 43,888 34,421 -- 42,880
-------- -------- -------- ---------
Total stockholder's equity.................. $865,563 $750,961 $745,604 $ 605,876
======== ======== ======== =========
See accompanying notes to consolidated financial statements.
23
25
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEAR ENDED DECEMBER 31
--------------------------------------------
PREACQUISITION
--------------
1997 1996 1995
--------- ----------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)......................................... $ 38,717 $ 34,421 $(133,049)
Reconcilement of net income (loss) to net cash provided:
Realized investment losses (gains)..................... (10,546) (13,602) 318,700
Interest credited and other charges.................... 198,206 230,298 237,984
Deferred insurance acquisition costs................... (34,973) (25,504) (22,447)
Amortization of value of business acquired............. 24,948 21,530 --
Amortization of goodwill............................... 15,295 10,195 --
Amortization of discount and premium on investments.... 17,866 25,743 4,586
Deferred income taxes.................................. (99,370) (897) 38,423
Net change in current Federal income taxes............. 97,386 108,806 (86,990)
Benefits and premium taxes due related to separate
account bank-owned life insurance.................... 180,546 -- --
Other, net............................................. 17,168 (22,283) (29,905)
--------- ----------- ---------
Net cash provided from operating activities....... 445,243 368,707 327,302
--------- ----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash from investments sold or matured:
Fixed maturities held to maturity...................... 229,208 264,383 320,143
Fixed maturities sold prior to maturity................ 633,872 891,995 297,637
Mortgage loans, policy loans and other invested
assets............................................... 131,866 168,727 450,573
Cost of investments purchased or loans originated:
Fixed maturities....................................... (606,028) (1,369,091) (549,867)
Mortgage loans, policy loans and other invested
assets............................................... (76,350) (119,044) (131,966)
Short-term investments, net............................... (164,361) 300,819 (168,351)
Net change in receivable and payable for securities
transactions........................................... 29,746 (31,667) (1,397)
Net reductions in other assets............................ 244 115 1,996
--------- ----------- ---------
Net cash provided by investing activities......... 178,197 106,237 218,768
--------- ----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Policyholder account balances:
Deposits............................................... 145,687 141,159 247,778
Withdrawals............................................ (745,510) (700,084) (755,917)
Capital contributions from parent......................... 45,000 18,434 --
Dividends to parent....................................... (29,250) -- --
Other..................................................... (18,275) 42,512 (35,309)
--------- ----------- ---------
Net cash used in financing activities............. (602,348) (497,979) (543,448)
--------- ----------- ---------
Net increase (decrease) in cash.............. 21,092 (23,035) 2,622
CASH, beginning of period................................... 2,776 25,811 23,189
--------- ----------- ---------
CASH, end of period......................................... $ 23,868 $ 2,776 $ 25,811
========= =========== =========
See accompanying notes to consolidated financial statements.
24
26
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 that change in control, Zurich and Insurance Partners owned 80
percent and 20 percent, respectively, of Kemper and therefore the Company. On
February 27, 1998, Zurich acqui