Disquieting Developments at Kemper/Lumbermens Mutual

Even being in business for over 90 years doesn’t seem to assure financial stability these days. 2002 was not a good year for the Chicago-based Kemper Group, headed by Lumbermen’s Mutual Casualty Company, a leading writer of workers’ compensation coverage, with an approximately nine percent current national market share.

James S. Kemper founded Lumbermens in 1912 to cover the Midwest’s sawmills and their workers. Now the group has become the latest victim of a series of events that create a “snowball effect.” Once one of the more strongly capitalized mutual insurers – as recently as April 2000 it bailed out California workers’ comp insurer Superior National with a cut through agreement when it was heading for insolvency – Kemper has itself fallen victim to rising losses that have become more or less endemic to the entire industry.

Once losses begin to pile up, reserves have to be tapped in order to meet claims, and then have to be strengthened. This frequently weakens the capital structure of the company. The rating agencies, whose job is to let people know how strong – or how weak – any given enterprise is at any given time, begin reviewing its financial strength. What they found at Kemper wasn’t good news.

On Dec. 20 both Moody’s Investors Service and Standard & Poor’s announced ratings downgrades on the members of Kemper’s Intercompany Insurance Pool – Lumbermen’s (77 percent), American Motorists Insurance Co. (15 percent) and American Manufacturers Mutual insurance Co. (8 percent). S&P’s lowered the ratings to ‘BBB’ from ‘A’ and Moody’s from Baa1 to Ba1. A.M. Best followed a few days later, downgrading the pool to ‘B+’ from ‘A-‘. In addition the agencies also lowered their ratings on Lumbermens $700 million in surplus notes – S&P’s to ‘BB’ from ‘BBB’ and Moody’s from Ba1 to B2.

S&P’s then noted that it had removed the pool members from its CreditWatch and said their out look was “stable.” Moody’s indicated it had concluded a review begun on Nov. 26, “following the group’s reporting of its third quarter statutory results.” But it kept the ratings outlook in the negative category, and stated that, “the downgrade reflects the company’s strained capital position and its limited financial flexibility.”

If things had ended there, the situation might have been resolved, as the company continued its restructuring, exiting unprofitable lines, cutting costs and most importantly negotiated a cut through agreement with Berkshire Hathaway’s ‘A++, ‘AAA’, rated National Indemnity Co. Things didn’t end there, however.

On Dec. 30 Kemper made the surprise announcement that its president and chief operating officer, William D. Smith, had “decided to retire effective year-end.” While senior management figures do retire now and then, Smith, who had been instrumental in restructuring Kemper over the last five years, was scheduled to take over as head of the company from long-time CEO David B. Mathis in two days. “We certainly didn’t see that on the horizon,” said S&P’s credit analyst Fred Sklow. Neither did anybody else and the news increased the size of the snowball considerably.

Kemper announced that an “Office of the Chairman” had been created under Mathis, who has agreed to continue in his position as CEO for the next 18 months, “to help lead the company.” The Board consists of Dennis R. Brand, Sr. VP and chief risk officer, Patricia A. Drago, executive VP and leader of Kemper’s Client Services Group, William A. Hickey, executive VP and CFO, Robert A. Lindemann Sr. VP and president of American Manufacturers’ Mutual Insurance Company and Gary J. Tully, Sr. VP and president of Kemper Financial Protection and Kemper International.

Smith’s departure “for personal reasons” remains largely unexplained, but Sklow indicated that as he had been closely involved in making a number of management decisions, including exiting personal lines, “maybe things didn’t progress fast enough, or in the right direction, and he might have been held responsible.” Whatever the reasons were, they’re likely to remain largely unknown, but analysts view the current setup as temporary, and think it’s unlikely to assert the firm control the group needs.

“They’re more or less looking for someone [as the new CEO] from within the company,” said Sklow. “There’s less of a learning curve involved, and someone [from Kemper] could be expected to continue in the same direction. An outsider might make changes.” He indicated that one of the five members of the Office of the Chairman would probably be selected.

By now the snowball was becoming an avalanche, as the rating agencies refocused their attention on Kemper, and, with the onset of the renewal season, brokers and Kemper’s large commercial accounts began to take an earnest look at the group’s financial stability.

Editor’s Note: To see the full story, please see the Jan. 27 issue of Insurance Journal.