Rating Agencies Downgrade Kemper

These earlier rating downgrades came just days after Kemper's announcement on Dec. 23, 2002, that the company was repurchasing a $125-million investment by Omaha, Neb.-based Berkshire Hathaway Inc. in a subsidiary that was set up last May to attract outside investments.

Kemper also announced that it had negotiated an agreement-in-principle with Berkshire's subsidiary National Indemnity Company, which would guarantee payment of claims on certain Kemper policies issued after Jan. 1, 2003.

With National Indemnity's top financial ratings, the arrangement could shore up the confidence of Kemper clients.

"The cut-through agreement basically protects these policyholders in the event that Kemper is unable to pay claims. These policyholders can go to National Indemnity to collect those claims," said David Havens, executive director of fixed income at UBS Warburg.

Kemper declined a request for an interview on recent rating downgrades, but Mr. Havens said these downgrades are simply going to make the situation even more difficult for Kemper. "I think there certainly were questions about the company's financial stability even before downgrades," he said.

Mr. Havens told National Underwriter that what prompted these recent downgrades was Kemper's decision to repurchase Berkshire's $125-million minority equity investment.

"This was not anticipated. This came as quite a surprise. However, the overall market had been taking a cautious approach to Kemper before the news broke," he said.

Mr. Havens predicted that these downgrades are going to make it difficult for Kemper to generate high-quality business going forward.

"Insurance buyers are increasingly risk-averse. Ever since 9/11, they have been attuned to financial strengths of insurance companies, and there is no question in my mind now that these ratings will make it ever more difficult for Kemper to compete for quality business," Mr. Havens said.

Furthermore, the "unexpected" retirement of William Smith, president and chief operating officer of Kemper, at the end of 2002 has done little to bolster confidence in the company, Mr. Havens added.

In light of Mr. Smith's departure, Kemper Chairman and Chief Executive Officer David Mathis will postpone his planned retirement and continue in his current role for the foreseeable future, according to Kemper. (In May of last year, Kemper had announced that Mr. Smith would rise to the CEO position on Jan. 1, 2003, and assume the role of chairman in April, when Mr. Mathis had planned to retire.)

"Such unexpected departure of a COO rarely presages positive developments. And looking from outside, it doesn't look like an orderly departure," he said.

Peter Patrino, senior director at Fitch Ratings in New York, told National Underwriter that the downgrade reflects the general concerns Fitch has regarding the company.

"There is a strategic partnership with Berkshire which is in the process of getting adjusted. In our opinion, this change appears to be signaling some challenges, including reductions in capital and liquidity, which is very important to the company," Mr. Patrino said.

These changes, plus the recent departure of Mr. Smith, continue to raise concerns, he added.

"I think the company is really close to encountering some very stressful times. At the year-end 2001, Kemper's largest operating insurance subsidiary was slightly above the minimum capital requirement, and that was partially achieved through a reinsurance agreement and some reserve discounting. The company was barely above the minimum before, so recent developments are not encouraging signs," Mr. Patrino said.

Regarding Kemper's possible plan for demutualization, Mr. Patrino noted that if the company can accomplish it and start an initial public offering of its stock, "that would be terrific. It will add much-need capital to the company. Successful demutualizaion and an IPO would be helpful. It's just the question of whether the company can do it well, and we have some reservations on whether Kemper can do it successfully."

Matthew Mosher, group vice president, property-casualty division of A.M. Best Company, who plans to meet with Kemper officials soon, said the basic reason for the rating downgrade was the decline in Kemper's capitalization. He also argued that Mr. Smiths departure shouldn't have been a surprise to anyone given the difficulty the company faced last year.

"Following the company's announcement of the repurchase of Berkshire stake, we also have concerns for the potential for additional charges. Kemper took a significant reserve charge at year-end 2001," Mosher said, adding that he has recently seen a number of companies taking charges for pension liabilities.

"The company had announced the Berkshire investment early last year, and it announced the repurchase in December. All these noises create concerns about the level of capitalization it has," he said.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, January 13, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.