ITEM 1. BUSINESS
CORPORATE STRUCTURE
KEMPER INVESTORS LIFE INSURANCE COMPANY ("KILICO"), founded in 1947, is incorporated under the insurance laws of Illinois. KILICO is licensed in the District of Columbia and all states except New York. KILICO is a wholly owned subsidiary of Kemper Corporation ("Kemper"), a nonoperating holding company.
CORPORATE CONTROL EVENTS
On January 4, 1996, an investor group comprised of Zurich Insurance Company ("Zurich"), Insurance Partners, L.P. ("IP") and Insurance Partners Offshore (Bermuda), L.P. (together with IP, "Insurance Partners") acquired all of the issued and outstanding common stock of Kemper. As a result of the change in control, Zurich and Insurance Partners indirectly and directly own 80 percent and 20 percent, respectively, of Kemper and therefore KILICO.
STRATEGIC INITIATIVES
During 1992 and 1993, in order to streamline management, control costs and improve profitability, the management, operations and strategic directions of KILICO were integrated with those of another Kemper subsidiary, Federal Kemper Life Assurance Company ("FKLA"). 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. The integration encompassed virtually all aspects of operations, distribution channels and product development and was designed to promote increased efficiencies and productivity and to expand both companies' distribution capabilities. As described below, KILICO has emphasized different products and distribution methods.
Since late 1991, KILICO intensified its management of 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, cash sales of real estate-related investments amounting to $646.0 million since 1991 to affiliated non-life realty companies, 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 6.3 percent at year-end 1995.
Further addressing the quality of its investment portfolio, KILICO reduced its holdings of below investment-grade securities (excluding real estate-related investments) from 20.0 percent of its total invested assets and cash at year-end 1990 to 1.8 percent at year-end 1995.
Since 1991, KILICO has also received $342.5 million in capital contributions from Kemper. KILICO also ceded approximately $932 million of fixed-rate annuity liabilities in reinsurance transactions in 1991 and 1992.
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 universal life and variable life insurance products through various distribution channels. KILICO's broad product selection is designed for diverse economic environments. KILICO structures its products to offer investment-oriented products, guaranteed returns or a combination of both to help policyholders meet multiple insurance and financial objectives. Financial institutions, securities brokerage firms, insurance agents and financial planners are important distribution channels for KILICO's products. In 1995, INVEST Financial Corporation, an affiliated company, and EVEREN Securities, Inc., ("EVEREN"), an affiliated company until September 13, 1995, accounted for approximately 37 percent and 21 percent, respectively, of KILICO's first-year sales, compared with 36 percent and 20 percent, respectively, in 1994. KILICO's sales mainly consist of deposits received on certain long duration annuity contracts. (See the table captioned "Sales" on page 8.)
Annuities accounted for approximately 99 percent of KILICO's sales in recent years. KILICO's annuities generally have surrender charges that are a specified percentage of policy values and decline as the policy ages. General account annuity and interest-sensitive life policies are guaranteed to accumulate at specified interest rates but allow for periodic crediting rate changes.
Over the last several years, in part reflecting the current interest rate environment, and to reduce its exposure to investment risk, KILICO's strategy has been to place more emphasis on marketing its separate account products. Unlike the fixed-rate annuity business where KILICO manages spread revenue, variable annuities pose minimal investment risk for KILICO, as policyholders invest in one or more of several underlying investment funds. KILICO in turn receives administrative fee revenue. KILICO's separate account assets totaled $1.76 billion at December 31, 1995 and $1.50 billion at December 31, 1994 and 1993. KILICO's sales of its separate account annuities were $151.3 million in 1995, $250.7 million in 1994 and $263.7 million in 1993. Despite KILICO's strategy to emphasize the sale of variable annuities, such sales have declined in each of the last two years due to competitive conditions in certain distribution channels, in part reflecting KILICO's financial strength and performance ratings and uncertainty concerning KILICO's ownership. Rating improvements in 1996 (see "Rankings and ratings" on page 4) and the 1996 change in control are expected to increase KILICO's future sales.
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, KILICO also added seven new subaccounts as investment portfolio choices for certain purchasers of the Kemper Advantage III variable annuity product.
Reductions in crediting rates and investment portfolio issues have also lowered general account annuity sales for KILICO over the last several years. Beginning in the second half of 1994 and in early 1995, KILICO began raising crediting rates on certain of its existing and new general account products, reflecting both competitive conditions and a rising interest rate environment during 1994 and early 1995. As a result of these actions, sales of general account annuities increased and represented 62.0 percent of KILICO's total sales in 1995, compared with 46.0 percent in 1994, and 47.9 percent in 1993.
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, 1995, KILICO had three ratios outside the usual ranges. KILICO's net income to total income was adversely affected by realized investment losses, primarily from dispositions of real estate-related investments. (See the discussion captioned "INVESTMENTS" beginning on page 9.) KILICO's change in premium and change in reserving ratios reflected declines in variable annuity sales and interest-sensitive life sales, respectively. 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 1995 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 1995, 1994 and 1993 amounted to $5.8 million, $0.0 million and $5.8 million, respectively. Such amounts relate to accrued guaranty fund assessments of $5.0 million, $4.0 million and $8.9 million at December 31, 1995, 1994 and 1993, respectively. No assessments were charged to expense during 1994 as KILICO had established adequate accruals for all known insolvencies where an estimate of the cost to cover losses to policyholders was available as of December 31, 1994. Additional assessments
charged to expense in 1995 reflect accruals for the life insurance industry's revised loss estimates for certain insolvent insurance companies.
RISK-BASED CAPITAL
Since the early 1990s, reflecting a recessionary environment and the insolvencies of a few large life insurance companies, both state and federal legislators have increased scrutiny of the existing insurance regulatory framework. While various initiatives, such as a new model investment law, 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 adopted in 1993 in Illinois (the domiciliary state of KILICO), state regulators may mandate remedial action for inadequately reserved or inadequately capitalized companies. The new asset adequacy rules are designed to assure that reserves and assets are adequate to cover liabilities under a variety of economic scenarios. The focus of the new capital rules is a risk-based formula that applies prescribed factors to various risk elements in an insurer's business and investments to develop a minimum capital requirement designed to be proportional to the amount of risk assumed by the insurer. KILICO has capital levels substantially exceeding any which would mandate action under the risk-based capital rules and is in compliance with applicable asset adequacy rules.
RESERVES AND REINSURANCE
The following table provides a breakdown of KILICO's reserves for future policy benefits by product type at December 31, 1995, 1994 and 1993 (in millions):
Ceded future policy benefits shown above reflect coinsurance (indemnity reinsurance) transactions in which KILICO reinsured liabilities of approximately $516 million in 1992 and $416 million in 1991 with Fidelity Life Association ("FLA"), an affiliated mutual insurance company. FLA shares management, operations and employees with FKLA and KILICO pursuant to an administrative and management services agreement. FLA produces whole life policies not produced by FKLA or KILICO as well as other policies similar to certain FKLA policies. At December 31, 1995, KILICO's reinsurance recoverable from FLA related to these coinsurance transactions totaled approximately $502.8 million. KILICO remains primarily liable to its policyholders for this amount. Utilizing FKLA's employees, KILICO is the servicing company for this coinsured business and is reimbursed by FLA for the related servicing expenses. Excluding this coinsurance, KILICO, because it is primarily an annuity company, reinsures only a very limited portion of its business. KILICO has immaterial exposure to mortality losses. (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 1993, 1994 and 1995 than in earlier years, and they were under review in 1994 and 1995 due to uncertainty with respect to Kemper's and KILICO's ownership. These ratings impacted sales efforts in certain markets; however, increases in KILICO's financial strength ratings and claims-paying/performance ratings in January 1996 should 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 products; distribution through diversified channels; and ongoing efforts to continue as a low-cost provider of insurance products and high-quality services to agents and policyholders through the use of technology.
RANKINGS AND RATINGS
According to BEST'S AGENTS GUIDE TO LIFE INSURANCE COMPANIES, 1995, as of December 31, 1994, KILICO ranked 61 of 1,315 life insurers by admitted assets; 440 of 1,137 by insurance in force; and 143 of 1,219 by net premiums written.
Following the January 1996 change in control, certain of KILICO's financial strength ratings and claims-paying ability ratings were upgraded. KILICO's ratings are as follows:
EMPLOYEES
At December 31, 1995, KILICO utilized the services of approximately 380 employees of FKLA which are also shared with FLA. On January 1, 1996, approximately 160 employees of Zurich Life Insurance Company of America ("Zurich Life"), an affiliated company, became employees of FKLA in connection with the integration of Zurich Life's operations with those of FKLA's. Beginning on January 5, 1996, KILICO, FKLA, FLA and Zurich Life operate under the trade name the Zurich Kemper Life Insurance Companies.
REGULATION
KILICO is generally subject to regulation and supervision by the insurance departments of Illinois and other jurisdictions in which KILICO is licensed to do business. These departments enforce laws and regulations designed to assure that insurance companies maintain adequate capital and surplus, manage investments according to prescribed character, standards and limitations and comply with a variety of operational standards. The departments also make periodic examinations of individual companies and review annual and other reports on the financial condition of each company operating within their respective jurisdictions. Regulations, which often vary from state to state, cover most aspects of the life insurance business, including market practices, forms of policies and accounting and financial reporting procedures.
Insurance holding company laws enacted in many states grant additional powers to state insurance commissioners to regulate acquisition of and by domestic insurance companies, to require periodic disclosure of relevant information and to regulate certain transactions with related companies. These laws also impose prior approval requirements for certain transactions with affiliates and generally regulate dividend distributions by an insurance subsidiary to its holding company parent.
In addition, variable life insurance and annuities offered by KILICO, and the related separate accounts, are subject to regulation by the Securities and Exchange Commission (the "SEC").
KILICO believes it is in compliance in all material respects with all applicable regulations. For information on regulatory and other dividend restrictions, see ITEM 5(c).
INVESTMENTS
Changing marketplace dynamics have affected the life insurance industry in recent years. To accommodate customers' increased preference for safety over higher yields, KILICO has systematically reduced its investment risk, as investments are an integral part of KILICO's business, 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. Portfolio management is handled by an affiliated company, Zurich Kemper Investments, Inc. ("ZKI"), and its subsidiaries and affiliates, with KILICO's real estate-related investments being handled by a Kemper subsidiary. Investment policy is directed by KILICO's board of directors. KILICO's investment strategies take into account the nature of each annuity and life insurance product, the respective crediting rates and the estimated future policy benefit maturities. See "INVESTMENTS" in ITEM 7.
ITEM 2.
ITEM 2. PROPERTIES
KILICO primarily shares the office space leased by FKLA from Lumbermens Mutual Casualty Company, a former affiliate, ("Lumbermens"), 78,000 sq. ft. in Long Grove, Illinois. FKLA anticipates increasing its Long Grove office space by up to 43,000 sq. ft. in 1996. KILICO also has utilized 12,000 sq. ft. of office space presently leased by ZKI in Chicago, although virtually all of this space is expected to be eliminated by the end of 1996.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
KILICO has been named as defendant in certain lawsuits incidental to its insurance business. KILICO's management, based on the advice of legal counsel, believes that the resolution of these various lawsuits will not result in any material adverse effect on KILICO's consolidated financial position.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1995, pursuant to a written consent of the sole shareholder of KILICO effective October 1, 1995, Jerome J. Cwiok was elected to serve as a member of the board of directors. The remaining directors whose terms continued after October 1, 1995 were John H. Fitzpatrick, David B. Mathis, John B. Scott and Stephen B. Timbers. Effective January 4, 1996, KILICO's board of directors changed reflecting the acquisition of Kemper and therefore KILICO by Zurich and Insurance Partners. See ITEM 10 below.
PART II
ITEM 5.
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 1994, 1995 or 1996 through the date of filing of 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.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial information for KILICO for the five years ended December 31, 1995. 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.
- --------------- (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.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
KILICO recorded a net loss of $133.0 million in 1995, compared with net income of $26.4 million in 1994 and $14.0 million in 1993. The net loss in 1995 was primarily due to an increase in the level of real estate-related realized investment losses. In connection with the Zurich-led investor group's acquisition of Kemper in early January 1996, KILICO's strategy with respect to its real estate-related investments changed dramatically as of year-end 1995. 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 improvement in 1994 net income, compared with 1993, was primarily the result of increases in spread income, an increase in fees and other income and a decrease in commissions, taxes, licenses and fees. These improvements in 1994 were partially offset by higher realized investment losses in 1994, compared with 1993.
The following table reflects the major components of realized investment results included in net income (loss). (See "INVESTMENTS" beginning on page 9, and the note captioned "Invested Assets and Related Income" in the notes to the consolidated financial statements.)
REALIZED INVESTMENT RESULTS, AFTER TAX (in millions)
Real estate-related losses increased in 1995, compared with 1994 and 1993, reflecting realized capital losses predominately from real estate-related bulk sale transactions in December 1995 and a higher level of write-downs on real estate-related investments. These sales and write-downs reflect Zurich's and Insurance Partners' strategies, now adopted by KILICO, with respect to the disposition of real estate-related investments. Other realized investment gains and losses for 1995, 1994 and 1993 relate primarily to the sale of fixed maturity investments. The fixed maturity losses generated in 1994 arose primarily from the sale of $330.7 million of fixed maturity investments, consisting of lower yielding investment-grade corporate securities and collateralized mortgage obligations, related to a repositioning of KILICO's fixed maturity investment portfolio in September 1994. The $306.9 million of proceeds from the repositioning, together with $275.0 million of cash and short-term investments, were reinvested into higher yielding U.S. government and agency guaranteed mortgage pass-through securities issued by the Government National Mortgage Association and the Federal National Mortgage Association. (See "INVESTMENTS" beginning on page 9.)
Operating earnings (net income excluding realized investment results) improved to $74.2 million in 1995, compared with $61.9 million and $33.7 million in 1994 and 1993, respectively, primarily due to an increase in fees and other income, reductions in operating expenses and an increase in the net deferral of insurance acquisition costs, offset by an increase in commissions, taxes, licenses and fees. Operating earnings also improved in 1994, compared with 1993, as a result of improvements in spread income.
KILICO improved spread income by increasing investment income in 1993 and 1994 and by also reducing crediting rates on certain existing blocks of fixed annuity and interest-sensitive life insurance products in 1993 and through most of 1994. Such reductions in crediting rates occurred as overall interest rates also declined. Operating earnings then began to improve as crediting rates declined at a faster rate than KILICO's investment income. Beginning in late 1994, however, as a result of rising interest rates and other competitive market factors, KILICO began to increase crediting rates on such interest-sensitive products which actions adversely impacted spread income. The recent declines in interest rates during the last three quarters of 1995, however, have mitigated at present competitive pressures to increase existing renewal crediting rates further.
Investment income was positively impacted in 1995, 1994 and 1993 from the benefits of capital contributions to KILICO and from reductions in the level of nonperforming real estate-related investments, primarily from the sales of certain real estate-related investments to affiliated non-life realty companies. These sales totaled $3.5 million in 1995, $154.0 million in 1994, $343.7 million in 1993 and $144.8 million in 1992 and resulted in no realized gain or loss to KILICO. Investment income in 1995 and 1994 also benefitted from the above-mentioned repositioning of KILICO's investment portfolio and
a $5.0 million pre-tax adjustment in 1994 related to the amortization of the discount or premium on mortgage-backed securities. Investment income for 1995, 1994 and 1993 has also been impacted by a shift over the last few years to higher-quality, lower yielding investments and foregone income on nonperforming investments.
SALES (in millions)
Sales of annuity products consist of total deposits received. The increase in 1995 general account (fixed annuity) sales reflected KILICO's strategy to increase sales of fixed annuities. KILICO's longer-term strategy is to direct its sales efforts toward separate account (variable annuity) products, which increase administrative fees earned and pose minimal investment risk for KILICO as policyholders invest in one or more of several underlying investment funds. Despite this strategy, separate account sales declined in 1995 and 1994, compared with 1993, due to competitive conditions in certain distribution channels, in part reflecting KILICO's financial strength and performance ratings and uncertainty concerning KILICO's ownership. KILICO believes that the increase in its financial strength and performance ratings in January 1996 together with KILICO's association with Zurich, will assist in KILICO's future sales efforts.
Included in fees and other income are administrative fees received from KILICO's separate account products of $21.9 million in 1995, compared with $20.8 million and $18.1 million in 1994 and 1993, respectively. Administrative fee revenue increased in each of the last three years due to growth in average separate account assets. Also included in other income in 1995 is a ceding commission experience adjustment which resulted in income of $4.4 million related to certain reinsurance transactions entered into by the Company during 1992. (See the note captioned "Reinsurance" in the notes to the consolidated financial statements.) Other income also included surrender charge revenue of $7.7 million in 1995, compared with $7.4 million and $6.3 million in 1994 and 1993, respectively, as total general account and separate account policyholder surrenders and withdrawals increased in each of the last three years.
POLICYHOLDER SURRENDERS AND WITHDRAWALS (in millions)
Policyholder withdrawals increased during each of the last three years due to planned reductions in fixed annuity crediting rates, a rising interest rate environment during the last half of 1994 and early 1995, uncertainty regarding KILICO's ownership until 1996 and KILICO's financial strength ratings and claims-paying/performance ratings which were lower in 1993, 1994, and 1995 than in earlier years and in 1996. KILICO's crediting rate increases in late 1994 and in early 1995 were designed to reduce the level of future withdrawals. As a result of increases in renewal crediting rates and declining interest rates in the last three quarters of 1995, together with the benefits of the planned association with Zurich, policyholder surrenders and withdrawals for the last half of 1995 declined substantially from the level of surrenders and withdrawals in the first half of 1995. KILICO expects that the level of surrender and withdrawal activity experienced should remain relatively stable for 1996 as a result of projected stable interest rates, the majority ownership of KILICO by Zurich and the upgrades in KILICO's ratings in January 1996.
Commissions, taxes, licenses and fees were higher in 1995, compared with 1994, primarily reflecting an increased level of guaranty fund assessments. Expenses for such assessments totaled $5.8 million, $0.0, and $5.8 million in 1995, 1994 and 1993, respectively. (See "Guaranty association assessments" in ITEM 1 on page 2.) Commissions, taxes, licenses and fees were lower in 1994, compared with 1993, primarily reflecting lower annuity sales and reduced guaranty fund assessments.
The higher level of deferral of policy acquisition costs in 1995, compared with 1994, reflected an increase in the amount of imputed interest capitalized due to improvements in projected future revenue streams primarily as a result of the decline in the level of nonperforming real estate-related investments. The amortization of policy acquisition costs was favorably impacted during 1995 due to real estate-related capital losses and in 1994 due to the repositioning of KILICO's investment portfolio. These repositionings in 1995 and 1994 favorably impacted the amortization of policy acquisition costs because they resulted in current realized investment losses as well as an increase in projected future net investment income, which together are expected to increase KILICO's projected future estimated gross profits in later years. Excluding the effects of the repositionings, the amortization of policy acquisition costs increased in both 1995 and 1994, compared with 1993, primarily as a result of improved net operating earnings during 1995 and 1994.
Operating expenses in 1995, compared with 1994 and 1993, declined as a result of expense control efforts and the integration of the two life insurance subsidiaries' operations and management beginning in 1992. Operating expenses in 1995 declined by approximately 18 percent, compared with the 1994 level.
Since year-end 1990, KILICO has taken many steps to improve its earnings, financial strength and competitive marketing position. These steps included adjustments in crediting rates, reductions of operating expenses, reductions of below investment-grade securities, a strategy not to embark on new real estate projects, additional provisions for real estate-related losses, sales of $646.0 million of certain real estate-related investments to affiliated non-life realty companies through December 31, 1995, third-party sales and refinancings of certain mortgage and other real estate loans, approximately $932 million in annuity reinsurance transactions with an affiliated mutual life insurance company, and capital contributions of $342.5 million through December 31, 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, the interest rate environment, liability durations and changes in market and business conditions. In addition, as previously discussed, KILICO's strategy with respect to its real estate-related investments changed dramatically by year-end 1995.
INVESTED ASSETS AND CASH (in millions)
- ---------------
(1) National Association of Insurance Commissioners ("NAIC"). -- Class 1 = A- and above -- Class 2 = BBB- through BBB+ (2) Excludes $49.9 million, or 1.0 percent, at December 31, 1994 of bonds carried in other real estate-related investments. All such bonds were sold during 1995. (3) A joint venture mortgage loan is recharacterized in the current period as a third-party mortgage loan when KILICO and its affiliates have disposed of their related equity interest in that venture. (4) 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, net of tax, on fixed maturities at December 31, 1995 was $70.4 million, compared with unrealized depreciation of $243.6 million, at December 31, 1994. KILICO does not record a net deferred tax benefit for the aggregate unrealized depreciation on investments. Fair values are sensitive to movements in interest rates and other economic developments and can be expected to fluctuate, at times significantly, from period to period.
At December 31, 1995, investment-grade fixed maturities and cash and short-term investments accounted for 85.2 percent of KILICO's invested assets and cash, compared with 72.3 percent at December 31, 1994. Approximately 66 percent of KILICO's NAIC Class 1 bonds were rated AAA or equivalent at year-end 1995, compared with 70 percent at December 31, 1994.
Approximately 45.7 percent of KILICO's investment-grade fixed maturities at December 31, 1995 were mortgage-backed securities, down from 49.2 percent at December 31, 1994. 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.
Future investment income from mortgage-backed securities may be affected by the timing of principal payments and the yields on reinvestment alternatives available at the time of such payments. Due to the fact that KILICO's investments in mortgage-backed securities were predominately made since 1992, the current interest rate environment is not expected to cause any material extension of the average maturities of these investments. With the exception of many of KILICO's September 1994 purchases of such investments, most of these investments were purchased by KILICO at discounts. Prepayment activity on securities purchased at a discount is not expected to result in any material losses to KILICO because prepayments would generally accelerate the reporting of the discounts as investment income. Prepayment activity resulting from a decline in interest rates on such securities purchased at a premium would accelerate the amortization of the premiums which would result in reductions of investment income related to such securities. At December 31, 1995, KILICO had unamortized discounts and premiums of $17.0 million and $11.0 million, respectively, related to mortgage-backed securities. Given the credit quality, liquidity and anticipated payment characteristics of KILICO's investments in mortgage-backed securities, KILICO believes that the associated risk can be managed without material adverse consequences on its consolidated financial statements.
Below investment-grade securities holdings (NAIC classes 3 through 6), representing securities of 11 issuers at December 31, 1995, totaled 1.8 percent of cash and invested assets at December 31, 1995, compared with 2.8 percent at December 31, 1994. See the 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 1990. This strategy takes into account the more conservative nature of today's consumer and the resulting demand for higher-quality investments in the life insurance and annuity marketplace.
REAL ESTATE-RELATED INVESTMENTS
The $300 million real estate portfolio held by KILICO, consisting of joint venture and third-party mortgage loans and other real estate-related investments, constituted 6.3 percent of cash and invested assets at December 31, 1995, compared with $907 million, or 18.4 percent, at December 31, 1994. The decrease in real estate-related investments was primarily due to bulk sale transactions in December 1995, write-downs reflecting Kemper's and therefore KILICO's new owners' future plans for real estate-related investments and other sales during 1995.
SUMMARY OF GROSS AND NET REAL ESTATE INVESTMENTS (in millions)
As reflected in the "Real estate portfolio" table on the following page, KILICO has continued to fund both existing projects and legal commitments. The future legal commitments were $248.2 million at December 31, 1995. This amount represented a net decrease of $127.9 million since December 31, 1994, primarily due to sales and fundings in 1995. As of December 31, 1995, KILICO expects to fund approximately $56.4 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 the note captioned "Financial Instruments--Off-Balance-Sheet Risk" in the notes to the consolidated financial statements.)
Generally, at the inception of a real estate loan, KILICO anticipated that it would roll over the loan and reset the interest rate at least one time in the future, although KILICO is not legally committed to do so. As a result of the continued weakness in real estate markets and fairly restrictive lending practices by other lenders in this environment, KILICO expects that all or most loans maturing in 1996 will be rolled over, restructured or foreclosed if not earlier disposed of.
Excluding the $0.5 million of real estate owned and $17.1 million of net equity investments in joint ventures, KILICO's real estate loans totaled $282.0 million at December 31, 1995, after reserves and write-downs. Of this amount, $278.5 million are on accrual status with a weighted average interest rate of approximately 8.2 percent. Of these accrual loans, 33.0 percent have terms requiring current periodic payments of their full contractual interest, 46.0 percent require only partial payments or payments to the extent of cash flow of the borrowers, and 21.0 percent defer all interest to maturity.
The equity investments in real estate at December 31, 1995 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)
- --------------- (1) Net of $139.6 million reserve and write-downs. Excludes $29.8 million of real estate-related accrued interest.
(2) KILICO's real estate-related bonds, all of which were rated below investment-grade, were generally unsecured and were issued to KILICO by real estate finance or development companies generally to provide financing for Kemper's or KILICO's joint ventures for various purposes. All such bonds were disposed of during 1995.
(3) The other real estate loans were notes receivable evidencing financing, primarily to joint ventures, for purposes similar to those funded by real estate-related bonds.
(4) Net of $33.2 million reserve and write-downs. Excludes $5.6 million of real estate-related accrued interest.
REAL ESTATE CONCENTRATIONS
KILICO's real estate portfolio is distributed by geographic location and property type. However, KILICO has concentration exposures in certain states and in certain types of properties. In addition to these exposures, KILICO also has exposures to certain real estate developers and partnerships. (See the notes captioned "Unconsolidated Investors" and "Concentration of Credit Risk" in the notes to the consolidated financial statements.)
PROVISIONS FOR REAL ESTATE-RELATED LOSSES
KILICO evaluates its real estate-related investments (including accrued interest) by estimating the probabilities of loss. (See the discussion of SFAS 114, "Accounting by Creditors for Impairment of a Loan" in the 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 reserve was allocated as follows:
REAL ESTATE RESERVE (in millions)
The substantial reductions in reserves and write-downs by year-end 1995 reflect the sales of real estate-related investments primarily in the fourth quarter of 1995.
REAL ESTATE OUTLOOK
KILICO's $300 million investment in real estate-related investments is expected 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 or if Kemper's and KILICO's plans with respect to certain projects change.
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)
- --------------- (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. (4) KILICO defines a "restructuring" of debt as an event whereby KILICO, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor it would not otherwise consider. Such concessions either stem from an agreement between KILICO and the debtor or are imposed by law or a court. By this definition, restructured loans do not include any loan that, upon the expiration of its term, both repays its principal and pays interest then due from the proceeds of a new loan that KILICO, at its option, may extend (roll over).
KILICO continues to devote significant attention to its real estate portfolio, enhancing monitoring of the portfolio and formulating specific action plans addressing nonperforming and potential problem loans. KILICO is continuing to analyze various potential transactions designed to further reduce both its joint venture operating losses and the amount of its real estate-related investments. Specific types of transactions under consideration (and previously utilized) include loan sales, property sales, mortgage refinancings and real estate investment trusts. However, there can be no assurance that such efforts will result in continued improvements in the performance of KILICO's real estate portfolio.
NET INVESTMENT INCOME
KILICO's pre-tax net investment income totaled $348.4 million in 1995, compared with $353.1 million in 1994 and $339.3 million in 1993. 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.
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)
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, 1995, KILICO estimates foregone investment income in 1996 will decrease compared with the 1995 level. Any increase in nonperforming securities, and either worsening or stagnant real estate conditions, would increase the expected adverse effect on KILICO's future investment income and realized investment results.
Future net investment income, results of operations and cash flow will reflect KILICO's current levels of investments in investment-grade securities, real estate fundings treated as equity investments, nonaccrual real estate loans and joint venture operating losses. KILICO expects, however, that any adverse effects should be offset to some extent by certain advantages that it expects to realize over time from its other investment strategies, its product mix and its continuing cost-control measures. Other mitigating factors include marketing advantages that could result from KILICO having lower levels of investment risk, higher financial strength and claims-paying ability ratings and earnings improvements from KILICO's ability to adjust crediting rates on annuities and interest-sensitive life products over time.
REALIZED INVESTMENT RESULTS
Reflected in net income are after-tax realized investment losses of $207.2 million, $35.5 million and $19.7 million for 1995, 1994 and 1993, respectively. (See the 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. 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 was established upon adoption of SFAS 109 "Accounting for Income Taxes" at January 1, 1993 (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 the 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.
When maturing or sold investments are reinvested at lower yields in a low interest rate environment, KILICO can adjust its crediting rates on fixed annuities and other interest-bearing liabilities. However, competitive conditions and contractual commitments do not always permit the reduction in crediting rates to fully or immediately reflect reductions in investment yield, which can result in narrower spreads.
The rising interest rate environment in 1994 contributed to an increase in net investment income as well as to both realized and unrealized fixed maturity investment losses in 1994. Also, lower renewal crediting rates on annuities, compared with competitors' higher new money crediting rates 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 one-half of KILICO's fixed annuity liabilities as of December 31, 1995, however, were no longer subject to significant surrender fees.
As interest rates rose during 1994 and early 1995, KILICO's capital resources were adversely impacted by unrealized loss positions from its fixed maturity investments. As interest rates declined during the remainder of 1995, KILICO's capital resources were positively impacted by the elimination of the 1994 year-end unrealized loss position on its fixed maturity investments.
LIQUIDITY AND CAPITAL RESOURCES
KILICO carefully monitors cash and short-term investments to maintain adequate balances for timely payment of policyholder benefits, expenses, taxes and policyholder's account balances. In addition, regulatory authorities establish minimum liquidity and capital standards. The major ongoing sources of KILICO's liquidity are deposits for fixed annuities, investment income, other operating revenue and cash provided from maturing or sold investments. (See the Policyholder surrenders and withdrawals table and related discussion on page 8 and "INVESTMENTS" beginning on page 9.)
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 4.)
STOCKHOLDER'S EQUITY
Stockholder's equity totaled $605.9 million at December 31, 1995, compared with $434.0 million and $654.6 million at December 31, 1994 and 1993, respectively. The 1995 increase in stockholder's equity was primarily due to a $304.9 million benefit related to the change in the unrealized gain position of KILICO's fixed maturity investment portfolio due to declining interest rates, offset by a net loss of $133.0 million. The 1994 decrease in stockholder's equity was primarily due to a $329.5 million unrealized loss related to the change in the unrealized loss position of KILICO's fixed maturity investment portfolio due to rising interest rates, offset by a capital contribution of $82.5 million and net income of $26.4 million.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors Kemper Investors Life Insurance Company:
We have audited the consolidated balance sheet of Kemper Investors Life Insurance Company and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholder's equity and cash flows for each of the years in the three-year period ended December 31, 1995. In connection with our audits of the consolidated financial statements, we also have audited the supplementary schedule as listed in the accompanying index. These consolidated financial statements and the supplementary schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the supplementary schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kemper Investors Life Insurance Company and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles. Also in our opinion, the related supplementary schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in the notes to the consolidated financial statements, effective January 1, 1994, the Company changed its method of accounting for investment securities to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards ("SFAS") 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. Also, as discussed in the notes, effective January 1, 1993, the Company changed its method of accounting for impairment of loans receivable to adopt the provisions of SFAS 114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN, and changed its method of accounting for income taxes to adopt the provisions of SFAS 109, ACCOUNTING FOR INCOME TAXES.
KPMG PEAT MARWICK LLP Chicago, Illinois March 15, 1996
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (in thousands, except share data)
See accompanying notes to consolidated financial statements.
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS (in thousands)
See accompanying notes to consolidated financial statements.
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (in thousands)
See accompanying notes to consolidated financial statements.
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)
See accompanying notes to consolidated financial statements.
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 and interest-sensitive life insurance products marketed primarily through a network of financial institutions, nonaffiliated and affiliated 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 investors group comprised of Zurich Insurance Company ("Zurich"), Insurance Partners, L.P. ("IP") and Insurance Partners Offshore (Bermuda), L.P. (together with IP, "Insurance Partners") acquired all of the issued and outstanding common stock of Kemper. As a result of the change in control, Zurich and Insurance Partners indirectly and directly own 80 percent and 20 percent, respectively, of Kemper and therefore the Company. The consolidated financial statements of the Company as of December 31, 1995 have been prepared on a historical cost basis and have not been adjusted to reflect the fair values of the Company's assets and liabilities as of the date of the acquisition by Zurich and Insurance Partners.
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles. The statements include the accounts of the Company on a consolidated basis. All significant intercompany balances and transactions have been eliminated.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that could affect the reported amounts of assets and liabilities as well as the disclosure of contingent assets or liabilities at the date of the financial statements. As a result, actual results reported as revenue and expenses could differ from the estimates reported in the accompanying financial statements. As further discussed in the accompanying notes to the consolidated financial statements, significant estimates and assumptions affect deferred insurance acquisition costs, provisions for real estate-related losses and reserves, other than temporary declines in values for fixed maturities, the valuation allowance for deferred income taxes and the calculation of fair value disclosures for certain financial instruments.
LIFE INSURANCE REVENUE AND EXPENSES
Revenue for annuities and interest-sensitive life insurance products consists of investment income, and policy charges such as mortality, expense and surrender charges. Expenses consist of benefits and interest credited to contracts, policy maintenance costs and amortization of deferred insurance acquisition costs. Also reflected in fees and other income is a ceding commission experience adjustment received in 1995 as a result of certain reinsurance transactions entered into by the Company during 1992. (See the note captioned "Reinsurance".)
DEFERRED INSURANCE ACQUISITION COSTS
The costs of acquiring new business, principally commission expense and certain policy issuance and underwriting expenses, have been deferred to the extent they are recoverable from estimated future gross profits on the related contracts and policies. The deferred insurance acquisition costs for annuities, separate account business and interest-sensitive life insurance products are being amortized over the estimated contract life in relation to the present value of estimated gross profits. Beginning in 1994, deferred insurance acquisition costs reflect the estimated impact of unrealized gains or losses on fixed maturities held as available for sale in the investment portfolio, through a credit or charge to stockholder's equity, net of income tax.
FUTURE POLICY BENEFITS
Liabilities for future policy benefits related to annuities and interest-sensitive life contracts reflect net premiums received plus interest credited during the contract accumulation period and the present value of future payments for contracts that have annuitized. Current interest rates credited during the contract accumulation period range from 4 percent to 8.35 percent. Future minimum guaranteed interest rates vary from 4 percent to 8.35 percent for periods ranging from a portion of 1996 up to a portion of 1998 and are generally 3 percent to 4.5 percent thereafter. For contracts that have annuitized, interest rates used in determining the present value of future payments range principally from 3 percent to 11.25 percent.
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVESTED ASSETS AND RELATED INCOME
Investments in fixed maturities are carried at fair value. Short-term investments are carried at cost, which approximates fair value. (See the note captioned "Fair Value of Financial Instruments".)
Mortgage loans are carried at their unpaid balance net of unamortized discount and any applicable reserves or write-downs. Other real estate-related investments net of any applicable reserve and write-downs include certain bonds issued by real estate finance or development companies; notes receivable from real estate ventures; investments in real estate ventures carried at cost, adjusted for the equity in the operating income or loss of such ventures; and real estate owned carried primarily at fair value.
Real estate reserves are established when declines in collateral values, estimated in light of current economic conditions and calculated in conformity with Statement of Financial Accounting Standards ("SFAS") 114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN, indicate a likelihood of loss. Prior to year-end 1995, the Company evaluated its real estate-related assets (including accrued interest) by estimating the probabilities of loss utilizing various projections that included several factors relating to the borrower, property, term of the loan, tenant composition, rental rates, other supply and demand factors and overall economic conditions. Generally, at that time, the reserve was based upon the excess of the loan amount over the estimated future cash flows from the loan discounted at the loan's contractual rate of interest taking into consideration the effects of recourse to, and subordination of loans held by, affiliated non-life realty companies. At year-end 1995, reflecting the Company's change in strategy with respect to its real estate portfolio, and the disposition thereof, real estate-related investments were valued using an estimate of the investments observable market price, net of estimated costs to sell.
SFAS 114 defines "impaired loans" as loans in which it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. In the fourth quarter of 1994, the Company adopted SFAS 118, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN--INCOME RECOGNITION AND DISCLOSURES. SFAS 118 amends SFAS 114, providing clarification of income recognition issues and requiring additional disclosures relating to impaired loans. The adoption of SFAS 118 had no effect on the Company's financial position or results of operations at or for the year ended December 31, 1994.
Realized gains or losses on sales of investments, determined on the basis of identifiable cost on the disposition of the respective investment, recognition of other-than-temporary declines in value and changes in real estate-related reserves and write-downs are included in revenue. Unrealized gains or losses on revaluation of investments are credited or charged to stockholder's equity. Such unrealized gains are recorded net of deferred income tax expense, while unrealized losses are not tax benefitted.
The amortized cost of fixed maturities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization is included in net interest income. Amortization of the discount or premium from mortgage-backed securities is recognized using a level effective yield method which considers the estimated timing and amount of prepayments of the underlying mortgage 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 mortgage-backed securities change as a result of changes in prepayment rates, the adjustment is also included in net investment income. The Company does not accrue interest income on fixed maturities deemed to be impaired on an other-than-temporary basis, or on mortgage loans, real estate-related bonds and other real estate loans where the likelihood of collection of interest is doubtful.
Policy loans are carried at their unpaid balance. Other invested assets consist primarily of venture capital investments and a leveraged lease and are carried at cost. Other invested assets also included equity securities which are carried at fair value.
SEPARATE ACCOUNT BUSINESS
The assets and liabilities of the separate accounts represent segregated funds administered and invested by the Company for purposes of funding variable annuity and variable life insurance contracts for the exclusive benefit of variable annuity and variable life insurance contract holders. The Company receives administrative fees from the separate account and
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) retains varying amounts of withdrawal charges to cover expenses in the event of early withdrawals by contract holders. The assets and liabilities of the separate accounts are carried at fair value.
INCOME TAX
The operations of the Company have been included in the consolidated Federal income tax return of Kemper. Income taxes receivable or payable have been determined on a separate return basis, and payments have been received from or remitted to Kemper pursuant to a tax allocation arrangement between Kemper and its subsidiaries, including the Company. The Company generally had received a tax benefit for losses to the extent such losses can be utilized in Kemper's Federal consolidated tax return.
Under SFAS 109, ACCOUNTING FOR INCOME TAXES, deferred taxes are provided on the temporary differences between the tax and financial statement basis of assets and liabilities.
(2) CASH FLOW INFORMATION
The Company defines cash as cash in banks and money market accounts. Federal income tax paid to (refunded by) Kemper under the tax allocation arrangement for the years ended December 31, 1995, 1994 and 1993 amounted to $(25.2 million), $(10.7 million) and $4.2 million, respectively.
Not reflected in the statement of cash flows are rollovers of mortgage loans, other loans and investments totaling approximately $57.0 million and $146.0 million in 1994 and 1993, respectively.
The Company also transferred its equity ownership interests in two limited partnerships during 1994 and 1993. (See the note captioned "Related-Party Transactions".)
(3) INVESTED ASSETS AND RELATED INCOME
The Company is carrying its fixed maturity investment portfolio at estimated fair value as fixed maturities are considered available for sale, depending upon certain economic and business conditions. The carrying value (estimated fair value) of fixed maturities compared with amortized cost, adjusted for other-than-temporary declines in value, at December 31, 1995 and 1994, were as follows:
Upon default or indication of potential default by an issuer of fixed maturity securities, the Company-owned issue(s) of such issuer would be placed on nonaccrual status and, since declines in fair value would no longer be considered by the
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED) Company to be temporary, would be analyzed for possible write-down. Any such issue would be written down to its net realizable value during the fiscal quarter in which the impairment was determined to have become other than temporary. Thereafter, each issue on nonaccrual status is regularly reviewed, and additional write-downs may be taken in light of later developments.
The Company's computation of net realizable value involves judgments and estimates, so such value should be used with care. Such value determination considers such factors as the existence and value of any collateral security; the capital structure of the issuer; the level of actual and expected market interest rates; where the issue ranks in comparison with other debt of the issuer; the economic and competitive environment of the issuer and its business; the Company's view on the likelihood of success of any proposed issuer restructuring plan; and the timing, type and amount of any restructured securities that the Company anticipates it will receive.
The Company's $300 million real estate portfolio consists of joint venture and third-party mortgage loans and other real estate-related investments.
At December 31, 1995 and 1994, total impaired loans amounted to $21.9 million and $75.9 million, respectively. Impaired loans with reserves were $21.9 million and $67.6 million with corresponding reserves of $6.5 million and $18.8 million at December 31, 1995 and 1994, respectively. The Company had an average balance of $124.2 million and $93.9 million in impaired loans for 1995 and 1994, respectively. Cash payments received on impaired loans are generally applied to reduce the outstanding loan balance. At December 31, 1995 and 1994, loans on nonaccrual status amounted to $3.5 million and $274.6 million, respectively. Impaired loans are generally included in the Company's nonaccrual loans.
At December 31, 1995, securities carried at approximately $5.9 million were on deposit with governmental agencies as required by law.
Proceeds from sales of investments in fixed maturities prior to maturity were $297.6 million, $910.9 billion and $1.7 billion during 1995, 1994 and 1993, respectively. Gross gains of $21.2 million, $6.0 million and $80.4 million and gross losses of $4.7 million, $55.9 million and $37.8 million were realized on sales of fixed maturities in 1995, 1994 and 1993, respectively.
The following table sets forth the maturity aging schedule of fixed maturity investments at December 31, 1995:
- --------------- (1) Weighted average maturity of 5.4 years.
The sources of net investment income were as follows:
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED) Realized gains (losses) for the years ended December 31, 1995, 1994 and 1993, were as follows:
Unrealized gains (losses) are computed below as follows: fixed maturities--the difference between fair value and amortized cost, adjusted for other-than-temporary declines in value; equity securities and other--the difference between fair value and cost. The change in unrealized investment gains (losses) by class of investment for the years ended December 31, 1995, 1994 and 1993 were as follows:
(4) UNCONSOLIDATED INVESTEES
At December 31, 1995, the Company, along with other Kemper subsidiaries, directly held partnership interests or options to acquire equity interests (or has made loans with additional interest features) in a number of real estate joint ventures. The Company's direct and indirect real estate joint venture investments are accounted for utilizing the equity method, with the Company recording its share of the operating results of the respective partnerships. The Company, as an equity owner, has the ability to fund, and historically has elected to fund, operating requirements of certain of the joint ventures. Consolidation accounting methods are not utilized as the Company, in most instances, does not own more than 50 percent in the aggregate, and in any event, major decisions of the partnership must be made jointly by all partners.
As of December 31, 1995 and 1994, the Company's net equity investment in unconsolidated investees amounted to $17.1 million and $45.4 million, respectively. The Company's share of net losses related to such unconsolidated investees amounted to $453 thousand and $6.3 million for the years ended December 31, 1995 and 1994, respectively.
Also at December 31, 1995, the Company had joint venture-related loans totaling $21.8 million before reserves to partnerships in which Lumbermens Mutual Casualty Company, an affiliate until August 1993 ("Lumbermens"), and Fidelity Life Association ("FLA"), an affiliated mutual insurance company, had equity interests. These joint venture-related loans totaled $37.5 million before reserves at December 31, 1994. (See the note captioned "Financial Instruments--Off-Balance-Sheet Risk".)
(5) CONCENTRATION OF CREDIT RISK
The Company generally strives to maintain a diversified invested asset portfolio; however, certain concentrations of credit risk exist in mortgage-backed securities (see "INVESTMENTS" beginning on page 9) and real estate.
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) CONCENTRATION OF CREDIT RISK (CONTINUED) The Company's real estate portfolio is distributed by geographic location and property type, as shown in the following two tables:
GEOGRAPHIC DISTRIBUTION AS OF DECEMBER 31, 1995
- --------------- (1) No other single location exceeded 2.0 percent.
DISTRIBUTION BY PROPERTY TYPE AS OF DECEMBER 31, 1995
Real estate markets have been depressed in recent periods in areas where most of the Company's real estate portfolio is located. California real estate market conditions have continued to be worse than in many other areas of the country. Real estate markets in northern California and Illinois show some stabilization and improvement.
Undeveloped land represented approximately 17.2 percent of the Company's real estate portfolio at December 31, 1995. To maximize the value of certain land and other projects, additional development has been proceeding or has been planned. Such development of existing projects would continue to require funding, either from the Company or third parties. In the present real estate markets, third-party financing can require credit enhancing arrangements (e.g., standby financing arrangements and loan commitments) from the Company. The values of development projects are dependent on a number of factors, including Kemper's and the Company's plans with respect thereto, obtaining necessary permits and market demand for the permitted use of the property. The values of certain development projects have been written down as of December 31, 1995, reflecting changes in plans in connection with the Zurich-led acquisition of Kemper. There can be no assurance that such permits will be obtained as planned or at all, nor that such expenditures will occur as scheduled, nor that Kemper's and the Company's plans with respect to such projects may not change substantially.
The majority of the Company's real estate loans are on properties or projects where the Company, Kemper, or their affiliates have taken ownership positions in joint ventures with a small number of partners. (See the note captioned "Unconsolidated Investees".)
At December 31, 1995, loans to and investments in joint ventures in which Patrick M. Nesbitt or his affiliates ("Nesbitt") have interests constituted approximately $99.7 million, or 33.3 percent, of the Company's real estate portfolio. The Nesbitt ventures primarily consist of eleven hotel properties. At December 31, 1995, the Company did not have any Nesbitt-related off-balance-sheet legal funding commitments outstanding.
At December 31, 1995, loans to and investments in a master limited partnership (the "MLP") between subsidiaries of Kemper and subsidiaries of Lumbermens, constituted approximately $66.0 million, or 22.0 percent, of the Company's real estate portfolio. The Company's interest in the MLP is a less than one percent limited partnership interest, and Kemper's interest is 75 percent at December 31, 1995. Prior to 1995, Kemper's interest was 50 percent. At December 31, 1995, MLP-related commitments accounted for approximately $29.8 million of the Company's off-balance-sheet legal commitments, of which the Company expects to fund $17.0 million.
At December 31, 1995, the Company's loans to and investments in projects with the Prime Group, Inc. or its affiliates totaled approximately $24.8 million, or 8.3 percent, of the Company's real estate portfolio. Prime Group-related commitments accounted for $165.6 million of the off-balance-sheet legal commitments at December 31, 1995, of which the Company expects to fund $15.0 million.
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) INCOME TAXES
Income tax expense (benefit) was as follows for the years ended December 31, 1995, 1994 and 1993:
Included in the current tax benefit is the recognition of a net operating loss carryover at December 31, 1995 which will be utilized against taxable income on Kemper's consolidated short period Federal income tax return for the January 1 through January 4, 1996 tax year. Beginning January 5, 1996, the Company will file a stand alone Federal income tax return. Previously, the Company had filed a consolidated Federal income tax return with Kemper. In the first quarter of 1996, the Company and Kemper settled the outstanding balances for the short period under the tax allocation agreement with Kemper making a payment to the Company of approximately $30 million. The Company's receivable from Kemper for all remaining balances under the tax allocation agreement, after adjusting for the $30 million payment, totaled approximately $82.6 million at December 31, 1995. Such remaining amounts are expected to be settled in the fourth quarter of 1996.
The actual income tax expense (benefit) for 1995, 1994 and 1993 differed from the "expected" tax expense (benefit) for those years as displayed below. "Expected" tax expense (benefit) was computed by applying the U.S. Federal corporate tax rate of 35 percent in 1995, 1994, and 1993 to income (loss) before income tax expense (benefit) and cumulative effect of change in accounting principle.
Under SFAS 109 ACCOUNTING FOR INCOME TAXES, deferred tax assets and liabilities are generally determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. SFAS 109 allows recognition of deferred tax assets if future realization of the tax benefit is more likely than not, with a valuation allowance for the portion that is not likely to be realized.
The implementation of SFAS 109 in 1993 resulted in a one-time increase to earnings of $2.4 million.
Under SFAS 109, a valuation allowance is established to reduce the deferred Federal tax asset related to real estate and other investments to the amount that, based upon available evidence, is, in management's judgment, more likely than not to be realized. Any reversals of the valuation allowance are contingent upon the recognition of future capital gains in Kemper's Federal income tax return or a change in circumstances which causes the recognition of the benefits to become more likely than not. During 1995 and 1994, the change in the valuation allowance related solely to the change in the net deferred Federal tax asset or liability from unrealized gains or losses on investments.
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) INCOME TAXES (CONTINUED) The tax effects of temporary differences that give rise to significant portions of the Company's net deferred Federal tax liability were as follows:
The valuation allowance is subject to future adjustments based on, among other items, Kemper's estimates of future operating earnings and capital gains.
The tax returns through the year 1986 have been examined by the Internal Revenue Service ("IRS"). Changes proposed are not material to the Company's financial position. The tax returns for the years 1987 through 1990 are currently under examination by the IRS.
(7) RELATED-PARTY TRANSACTIONS
The Company received cash capital contributions of $82.5 million and $90.0 million during 1994 and 1993, respectively.
In 1994 and 1993, the Company transferred the majority of its deficit equity ownership interest in two limited partnerships to another Kemper subsidiary resulting in an increase of the Company's additional paid-in capital of $71 thousand and $9.2 million, respectively. The Company also paid a non-cash dividend of $530 thousand in December 1993, which represented the positive equity ownership interests of the majority of one of its limited partnerships. Net losses associated with the Company's ownership interests in these limited partnerships amounted to $0.4 million, $1.4 million and $5.4 million in 1995, 1994 and 1993, respectively, and are included in the Company's consolidated statement of operations.
The Company has loans to joint ventures, consisting primarily of mortgage loans on real estate, in which the Company and/or one of its affiliates has an ownership interest. At December 31, 1995 and 1994, joint venture mortgage loans totaled $120 million and $351 million, respectively, and during 1995, 1994 and 1993, the Company earned interest income on these joint venture loans of $19.6 million, $22.0 million and $63.1 million, respectively.
All of the Company's personnel are employees of Federal Kemper Life Assurance Company ("FKLA"), an affiliated company. The Company is allocated expenses for the utilization of FKLA employees and facilities, the investment management services of Zurich Kemper Investments, Inc. ("ZKI"), an affiliated company, and the information systems of Kemper Service Company ("KSvC"), a ZKI subsidiary, based on the Company's share of administrative, legal, marketing, investment management, information systems and operation and support services. During 1995, 1994 and 1993, expenses allocated to the Company from ZKI and KSvC amounted to $4.4 million, $6.5 million and $3.1 million, respectively. The Company also paid to ZKI investment management fees of $3.4 million, $6.0 million and $6.7 million
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) RELATED-PARTY TRANSACTIONS (CONTINUED)
during 1995, 1994 and 1993, respectively. In addition, expenses allocated to the Company from FKLA during 1995, 1994 and 1993 amounted to $14.3 million, $11.1 million and $13.1 million, respectively.
During 1995, 1994 and 1993, the Company sold certain mortgages and real estate-related investments, net of reserves, amounting to approximately $3.5 million, $154.0 million and $343.7 million respectively, to KFC Portfolio Corp., an affiliated non-life realty company, in exchange for cash. No gain or loss was recognized on these sales. The Company also paid KFC Portfolio Corp. $1.8 million in 1995 related to the management of the Company's real estate portfolio.
(8) REINSURANCE
In the ordinary course of business, the Company enters into reinsurance agreements to diversify risk and limit its overall financial exposure to certain blocks of fixed-rate annuities. The Company generally cedes 100 percent of the related annuity liabilities under the terms of the reinsurance agreements. Although these reinsurance agreements contractually obligate the reinsurers to reimburse the Company, they do not discharge the Company from its primary liabilities and obligations to policyholders. As such, these amounts paid or deemed to have been paid are recorded on the Company's consolidated balance sheet as reinsurance recoverables and ceded future policy benefits.
In 1992 and 1991, the Company entered into 100 percent indemnity reinsurance agreements ceding $515.7 million and $416.3 million, respectively, of its fixed-rate annuity liabilities to FLA. FLA is a mutual insurance company that shares common management with the Company and FKLA and common board members with the Company, FKLA and Kemper. As of December 31, 1995, the reinsurance recoverable related to the fixed-rate annuity liabilities ceded to FLA amounted to approximately $503 million. During 1995 the Company recorded income of $4.4 million related to a ceding commission experience adjustment from the 1992 reinsurance agreement.
(9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company and FKLA sponsor a welfare plan that provides medical and life insurance benefits to their retired and active employees and the Company is allocated a portion of the costs of providing such benefits. The Company is self insured with respect to medical benefits, and the plan is not funded except with respect to certain disability-related medical claims. The medical plan provides for medical insurance benefits at retirement, with eligibility based upon age and the participant's number of years of participation attained at retirement. The plan is contributory for pre-Medicare retirees, and will be contributory for all retiree coverage for most current employees, with contributions generally adjusted annually. Postretirement life insurance benefits are noncontributory and are limited to $10,000 per participant.
The discount rate used in determining the allocated postretirement benefit obligation was 7.25 percent and 8 percent for 1995 and 1994, respectively. The assumed health care trend rate used was based on projected experience for 1995 and 1996, 10 percent in 1997, gradually declining to 6 percent by the year 2000 and remaining at that level thereafter.
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (CONTINUED) The status of the plan as of December 31, 1995 and 1994, was as follows:
Accumulated postretirement benefit obligation:
A one percentage point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as of December 31, 1995 and 1994 by $146 thousand and $48 thousand, respectively, and the net postretirement health care interest and service costs for the years ended December 31, 1995 and 1994 by $24 thousand and $14 thousand, respectively.
During 1994, the Company adopted certain severance-related policies to provide benefits, generally limited in time, to former or inactive employees after employment but before retirement. The effect of adopting these policies was immaterial.
(10) COMMITMENTS AND CONTINGENT LIABILITIES
The Company is involved in various legal actions for which it establishes liabilities where appropriate. In the opinion of the Company's management, based upon the advice of legal counsel, the resolution of such litigation is not expected to have a material adverse effect on the consolidated financial statements.
Although none of the Company or its joint venture projects have been identified as a "potentially responsible party" under Federal environmental guidelines, inherent in the ownership of or lending to real estate projects is the possibility that environmental pollution conditions may exist on or near or relate to properties owned or previously owned on properties securing loans. Where the Company has presently identified remediation costs, they have been taken into account in determining the cash flows and resulting valuations of the related real estate assets. Based on the Company's receipt and review of environmental reports on most of the projects in which it is involved, the Company believes its environmental exposure would be immaterial to its consolidated results of operations. However, the Company may be required in the future to take actions to remedy environmental exposures, and there can be no assurance that material environmental exposures will not develop or be identified in the future. The amount of future environmental costs is impossible to estimate due to, among other factors, the unknown magnitude of possible exposures, the unknown timing and extent of corrective actions that may be required, the determination of the Company's liability in proportion to others and the extent such costs may be covered by insurance or various environmental indemnification agreements.
See the note captioned "Financial Instruments--Off-Balance-Sheet Risk" below for the discussion regarding the Company's loan commitments and standby financing agreements.
The Company is liable for guaranty fund assessments related to certain unaffiliated insurance companies that have become insolvent during the years 1995 and prior. The Company's financial statements include provisions for all known assessments that are expected to be levied against the Company as well as an estimate of amounts (net of estimated future premium tax recoveries) that the Company believes it will be assessed in the future for which the life insurance industry has estimated the cost to cover losses to policyholders. The Company is also contingently liable for any future guaranty fund assessments related to insolvencies of unaffiliated insurance companies, for which the life insurance
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10) COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) industry has been unable to estimate the cost to cover losses to policyholders. No specific amount can be reasonably estimated for such insolvencies as of December 31, 1995.
(11) FINANCIAL INSTRUMENTS--OFF-BALANCE-SHEET RISK
At December 31, 1995, the Company had loan commitments and stand-by financing agreements totaling $248.2 million to support the financing needs of various real estate investments. To the extent these arrangements are called upon, amounts loaned would be secured by assets of the joint ventures, including first mortgage liens on the real estate. The Company's criteria in making these arrangements are the same as for its mortgage loans and other real estate investments. The Company presently expects to fund approximately $56.4 million of these arrangements. These commitments are included in the Company's analysis of real estate-related reserves and write-downs. The fair values of loan commitments and standby financing agreements are estimated in conjunction with and using the same methodology as the fair value estimates of mortgage loans and other real estate-related investments.
(12) DERIVATIVE FINANCIAL INSTRUMENTS
The Company is party to derivative financial instruments in the normal course of business for other than trading purposes to hedge exposures in foreign currency fluctuations related to certain foreign fixed maturity securities held by the Company. The following table summarizes various information regarding these derivative financial instruments as of December 31, 1995 and 1994:
The Company's hedges relating to foreign currency exposure are implemented using forward contracts on foreign currencies. These are generally short duration contracts with U.S. money-center banks. The Company records realized and unrealized gains and losses on such investments in net income on a current basis. The amounts of gain (loss) included in net income during 1995, 1994 and 1993 totaled $(1.0 million), $6.4 million and $(2.8 million), respectively.
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates are made at specific points in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. A significant portion of the Company's financial instruments are carried at fair value. (See the note captioned "Invested Assets and Related Income".) Fair value estimates for financial instruments not carried at fair value are generally determined using discounted cash flow models and assumptions that are based on judgments regarding current and future economic conditions and the risk characteristics of the investments. Although fair value estimates are calculated using assumptions that management believes are appropriate, changes in assumptions could significantly affect the estimates and such estimates should be used with care.
Fair value estimates are determined for existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and certain liabilities that are not considered financial instruments. Accordingly, the aggregate fair value estimates presented do not represent the underlying value of the Company. For example, the Company's subsidiaries are not considered financial instruments, and their value has not been incorporated into the fair value estimates. In addition, tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Fixed maturities and equity securities: Fair values for fixed maturity securities and for equity securities were determined by using market quotations, or independent pricing services that use prices provided by market makers or estimates of
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
fair values obtained from yield data relating to instruments or securities with similar characteristics, or fair value as determined in good faith by the Company's portfolio manager, ZKI.
Cash and short-term investments: The carrying amounts reported in the consolidated balance sheet for these instruments approximate fair values.
Mortgage loans and other real estate-related investments: Fair values for mortgage loans and other real estate-related investments for year-end 1994 were estimated on a project-by-project basis. Generally, the projected cash flows of the collateral were discounted using a discount rate of 10 to 12 percent. The resulting collateral estimates were then used to determine the value of the Company's real estate-related investments. Fair values for mortgage loans and other real estate-related investments for year-end 1995 were estimated based upon the investments observable market price, net of estimated costs to sell. The estimates of fair value should be used with care given the inherent difficulty of estimating the fair value of real estate due to the lack of a liquid quotable market.
Other loans and investments: The carrying amounts reported in the consolidated balance sheet for these instruments approximate fair values. The fair values of policy loans were estimated by discounting the expected future cash flows using an interest rate charged on policy loans for similar policies currently being issued.
Life policy benefits: Fair values of the life policy benefits regarding investment contracts (primarily deferred annuities) and universal life contracts were estimated by discounting gross benefit payments, net of contractual premiums, using the average crediting rate currently being offered in the marketplace for similar contracts with maturities consistent with those remaining for the contracts being valued. The Company had projected its future average crediting rate in 1995 and 1994 to be 4.5 percent and 5.5 percent, respectively, while the assumed average market crediting rate was 5.5 percent in 1995 and 6.5 percent in 1994.
The carrying values and estimated fair values of the Company's financial instruments at December 31, 1995 and 1994 were as follows:
- --------------- (1) Includes $112 and $18 carrying value and fair value for 1995 and 1994, respectively, of derivative securities used to hedge the foreign currency exposure on certain specific foreign fixed maturity investments.
(14) STOCKHOLDER'S EQUITY--RETAINED EARNINGS
The maximum amount of dividends which can be paid by insurance companies domiciled in the State of Illinois to shareholders without prior approval of regulatory authorities is restricted. (See "Restrictions on dividends" on page 6.) The maximum amount of dividends which can be paid by the Company without prior approval in 1996, assuming that there is sufficient statutory earned surplus, is $38.3 million. The Company paid no cash dividends in 1995, 1994 or 1993.
The Company's net income (loss) and stockholder's equity as determined in accordance with statutory accounting principles were as follows:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
TABLE I SUMMARY COMPENSATION TABLE
- --------------- (1) Also served in same positions for FKLA and FLA. An allocation of the time devoted to duties as executive officer of KILICO has been made. All compensation items reported in the Summary Compensation Table reflect this allocation.
(2) The amounts disclosed in this column include:
(a) Amounts paid as non-preferential dividend equivalents on shares of restricted stock and phantom stock units.
(b) The cash value of shares of Kemper common stock when awarded under the Kemper Anniversary Award Plan. Employees were awarded shares on an increasing scale beginning with their 10th year of employment and every 5 years thereafter, with a pro rata award at retirement.
(c) The taxable benefit from personal use of an employer-provided automobile and certain estate planning services facilitated for executives.
(d) Relocation expense reimbursements of $109,760 in 1994 and $15,474 in 1995 for Mr. Cwiok.
(e) Compensation income reported in 1994 of $384,822 for Mr. Scott and $55,974 for Ms. Frye, based on the market value on the vesting date of restricted stock awarded under Kemper's long-term incentive plans.
(3) Due to the June 1994 vesting of all outstanding shares of restricted stock granted in 1992 or earlier and the cancellation of shares awarded in 1993 and 1994, no shares of restricted stock were held by any of the named executive officers at December 31, 1995.
(4) Options were granted under Kemper stock option plans maintained for selected officers and employees of Kemper and its subsidiaries.
(5) The amounts in this column include:
(a) The amounts of employer contributions allocated to the accounts of the named persons under profit sharing plans or under supplemental plans maintained to provide benefits in excess of applicable ERISA limitations.
(b) Distributions from the Kemper and FKLA supplemental plans.
(c) Amounts representing a portion of the executives' income tax payments arising from the June 1994 vesting of shares of restricted stock due to the approval of a merger agreement among Kemper, Conseco, Inc. ("Conseco") and a wholly owned subsidiary of Conseco (the "Conseco Merger Agreement.") The Committee on Compensation and Organization of the Kemper board of directors (the "Committee") authorized such payments to 16 senior executives who were either precluded under pertinent securities law limitations or discouraged as a matter of appearance from subsequently selling their vested shares of restricted stock prior to the closing of the then-planned Conseco merger transaction. The executives' tax liabilities were based on the $61.375 fair market value of the restricted stock on the vesting date. Kemper's payments to the executives were derived from a formula based on certain relative stock values but approximated one-third of the executives' total income tax liabilities from the imputed income on vesting. Mr. Scott and Ms. Frye received $96,318 and $17,103, respectively, reported for 1994, under this tax liability payment arrangement.
(d) Income related to the distribution of shares of the preferred stock of EVEREN to holders of Kemper employee stock options and/or phantom stock units as a result of the spin-off of EVEREN by Kemper.
(6) Pursuant to the Conseco Merger Agreement, the restricted stock awards for 1993 and 1994 were cancelled. To replace these awards, on June 30, 1994, the Committee, under the Kemper Bonus Restoration Plan and in its sole discretion, granted cash awards to the named executive officers and other affected executives entitling each of them to receive an amount in cash immediately prior to the effective time of the then-planned Conseco merger equal to the product of the number of shares of restricted stock previously granted to such individual under the 1993 Senior Executive Long-Term Incentive Plan multiplied by the consideration payable in the merger. As a result of the termination of the Conseco Merger Agreement, no cash awards were paid pursuant to the Kemper Bonus Restoration Plan.
In January 1995, the board of directors, upon the advice of the Committee, approved the adoption of the Kemper 1995 Executive Incentive Plan under which active employee holders of the previously cancelled shares of restricted stock were granted phantom stock units by the Committee equal to the number of shares cancelled plus an added amount representing 20 percent of the aggregate cancelled shares. The 20 percent supplement was awarded in recognition of the imposition of new vesting periods on the phantom awards (to the extent the restricted stock held prior to cancellation would otherwise have vested in June 1994 had stockholder approval of the affected restricted stock plan been obtained as earlier anticipated).
By their terms, the phantom stock units associated with cancelled shares of restricted stock originally awarded in 1993, as supplemented, would have vested on December 31, 1995 and entitle the holders to a cash payment (net of any required tax withholding) determined by the value of Kemper's common stock based on an average trading range to December 31, 1995, and those phantom stock units associated with the cancelled restricted stock originally awarded in 1994 could similarly have vested and been paid on December 31, 1996, subject to ongoing employment to the respective vesting dates. Notwithstanding these vesting provisions, the phantom stock units earlier vested and entitled payment upon the consummation of a "change of control" of Kemper. Dividend equivalents were payable to holders of the phantom stock units as compensation income when and as dividends were paid on Kemper's outstanding common stock, and the Executive Incentive Plan provided for standard anti-dilution adjustments.
Phantom units awarded to the named executive officers subject to vesting on December 31, 1995 and December 31, 1996, were Mr. Scott 5,400 and 12,600 phantom units, respectively, Ms. Frye 1,680 and 1,680 phantom units, respectively, and Mr. Cwiok 0 and 1,680 phantom units, respectively. All phantom stock units vested and were paid immediately prior to the effectiveness of the January 4, 1996 acquisition of Kemper by Zurich and Insurance Partners. Messrs. Scott and Cwiok and Ms. Frye received allocated cash out payments of $430,272, $41,832 and $80,317, respectively, in 1996.
(7) Pursuant to the terms of a Termination Protection Agreement with Kemper dated March 17, 1994, Mr. Scott received payments in 1995 and 1996. These payments were made by Kemper and no portion of the payments were allocated to KILICO.
TABLE II OPTION/SAR GRANTS IN LAST FISCAL YEAR
- --------------- (1) Each of the options reflected in the table, when granted, were subject to installment vesting provisions whereby only a portion of the underlying stock would become eligible for exercise on successive anniversaries of the date of grant. Such options became exercisable in full, however, in connection with the approval of the merger agreement with Zurich and Insurance Partners in May, 1995.
(2) Based on 654,750 shares, the total number of shares under options granted in 1995 for all eligible employees of KILICO, Kemper and eligible affiliates.
(3) The option exercise price assigned was the last sale price for Kemper common stock on the date of the respective grants.
(4) All unexercised Kemper stock options were cancelled immediately prior to the January 4, 1996 effectiveness of the acquisition of Kemper by Zurich and Insurance Partners. Optionees were paid the spread between their option exercise price and $49.80 per share. Mr. Cwiok and Ms. Frye received $84,150 and $112,370, respectively, in 1996 as a result of such payments. Mr. Scott exercised 133,325 options in 1996 prior to the acquisition for a total realized income of $1,525,185.
TABLE III AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
- ---------------
(1) See footnote (4) under Table II above.
(2) Includes options granted related to service for FKLA.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(A) AS OF MARCH 1, 1996, 100% OF THE OUTSTANDING SHARES OF KILICO WERE OWNED BY KEMPER CORPORATION, 1 KEMPER DRIVE, LONG GROVE, ILLINOIS 60049.
(B) NOT APPLICABLE.
(C) CHANGES IN CONTROL.
There are no arrangements known to KILICO, which may at a subsequent date result in a change in control of KILICO.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
(A) TRANSACTIONS WITH MANAGEMENT AND OTHERS--none.
(B) CERTAIN BUSINESS RELATIONSHIPS--not applicable.
(C) INDEBTEDNESS OF MANAGEMENT--not applicable.
(D) TRANSACTIONS WITH PROMOTERS--not applicable.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS.
A listing of all financial statements filed as part of this Annual Report on Form 10-K is included on page 16 in ITEM 8.
(A)(2) SCHEDULES.
The following schedule is supplemental to the financial statements of KILICO and its subsidiaries for 1995 and is included in this Form 10-K at the page indicated below. All other schedules are omitted because the information required to be stated therein is included in the financial statements or notes thereto or because they are inapplicable.
- --------------- * This schedule for the years ended December 31, 1994 and 1993 is incorporated by reference to KILICO's Form 10-K filed on March 28, 1995 and Form S-1 filed on March 29, 1994, respectively.
(A)(3) EXHIBITS.
The exhibits listed on the accompanying Index to Exhibits on page 42 are filed as part of this Annual Report on Form 10-K.
(B) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the fourth quarter of 1995.
POWER OF ATTORNEY
Each person whose signature appears below hereby appoints Frederick L. Blackmon, Senior Vice President and Chief Financial Officer, and Robert A. Daniel, Vice President, Treasurer and Controller, his true and lawful attorney-in-fact with authority together or individually to execute in the name of each such signatory, and with authority to file with the Securities and Exchange Commission, any and all amendments to this Annual Report on Form 10-K, together with any exhibits thereto and other documents therewith, necessary or advisable to enable Kemper Investors Life Insurance Company to comply with the Securities Exchange Act of 1934, as amended, and any rules, regulations and requirements of the Securities and Exchange Commission in respect thereof, which amendments may make such other changes in the Annual Report on Form 10-K as the aforesaid attorney-in-fact executing the same deems appropriate.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, Kemper Investors Life Insurance Company has duly caused this Annual Report on Form 10-K for the fiscal year ended December 31, 1995 to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Long Grove, State of Illinois, on the 25th day of March, 1996.
KEMPER INVESTORS LIFE INSURANCE COMPANY
By: /s/ JOHN B. SCOTT ----------------------------------- John B. Scott President and Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES AND EXCHANGE ACT OF 1934, THIS ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995 HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF KEMPER INVESTORS LIFE INSURANCE COMPANY IN THE CAPACITIES INDICATED ON THE 25TH DAY OF MARCH, 1996.
SCHEDULE V KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
YEAR ENDED DECEMBER 31, 1995 (in thousands)
- --------------- (1) These deductions represent the net effect on the valuation reserve of write-downs, sales, foreclosures and restructurings.
INDEX TO EXHIBITS