Kemper - Q3 2023

Transcript

Operator (participant)

Good afternoon, ladies, ladies, and gentlemen, and welcome to Kemper's Third Quarter 2023 Earnings Conference Call. My name is Lester, and I will be your coordinator today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this conference is being recorded for replay purposes. I would now like to introduce your host for today's conference call, Karen Guerra, Kemper's Vice President for Investor Relations. Ms. Guerra, you may begin.

Karen Guerra (VP of Investor Relations)

Thank you, operator. Good afternoon, everyone, and welcome to Kemper's discussion of our Third Quarter 2023 Results. This afternoon, you'll hear from Joe Lacher, Kemper's President, Chief Executive Officer, and Chairman, Brad Camden, Kemper's Senior Vice President and Interim Chief Financial Officer, and Matt Hunton, Kemper's Executive Vice President and President of Kemper Auto. We'll make a few opening remarks to provide context around our third quarter results, followed by a Q&A session. During the interactive portion of our call, our presenters will be joined by Duane Sanders, Kemper's Executive Vice President and President of the P&C Division, John Boschelli, Kemper's Executive Vice President and Chief Investment Officer, and Chris Flint, Kemper's Executive Vice President and President of Kemper Life. After the markets closed today, we issued our earnings release and published our earnings presentation, financial supplement, and Form 10-Q.

You can find these documents in the investor section of our website, kemper.com. Our discussion today may contain forward-looking statements within the meaning of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, the Company's outlook and its future results of operations and financial conditions. Our actual future results and financial conditions may differ materially from these statements. For information on additional risks that may impact these forward-looking statements, please refer to our 2022 Form 10-K and our third quarter earnings release. This afternoon's discussion also includes non-GAAP financial measures we believe are meaningful to investors. In our financial supplement, earnings presentation, and earnings release, we've defined and reconciled all non-GAAP financial measures to GAAP, where required in accordance with the SEC rules.

You can find each of these documents in the investor section of our website, kemper.com. All comparative references will be to the corresponding 2022 period, unless otherwise stated. I will now turn the call over to Joe.

Joe Lacher (Chairman, President and CEO)

Thank you, Karen. Good afternoon, and thank you, everybody, for joining us today. We're going to communicate several key points today, perhaps best grouped into four buckets. First, is the favorable trend in our underlying results. Our underlying combined ratio improved sequentially and was inside the range of our prior guidance. Second, is what's happening outside the current near underlying results, including additional prior-year reserve development. Third, is the strong progress made on our strategic initiatives, which together reduce our long-term risk, improve our capital and liquidity, and enhance our ability to generate stable, long-term distributable cash flow and earnings. And lastly, we are reaffirming our full-year 2024 guidance. Let's move to page four. Looking at results, we're pleased with the 1.5-point sequential improvement in the Specialty P&C underlying combined ratio as the benefits from our profit improvement actions take further hold.

We have confidence in further improvements as we look forward. As expected, the 30-point California personal auto rate increase, effective in August, had only a marginal earned impact in the third quarter. Its earned impact will meaningfully increase in each of the next two quarters. This incremental earned rate, along with the additional benefits from all our other profit improvement actions, provides a significant tailwind for loss ratio improvement in the fourth quarter and more so for full year 2024. Moving to our second big topic, what's happening outside of the current year's underlying results? Prior year reserve development was largely driven by recent trends in Florida Personal Injury Protection, or PIP, which has been an industry issue in recent quarters, and to a lesser extent, the extension of the bodily injury and property damage development patterns from 2022.

We'll discuss the drivers further when we get to slide six. Reflecting on our third major topic, we continue to make strong progress on our strategic initiatives. All our programs are on track to be completed on time and produce or exceed their targeted financial and operational benefits. Let me comment on a few highlights. We're very pleased that our reciprocal exchange has received all necessary approvals and was actively writing business during the quarter, albeit at expectedly modest premium levels. The exit from the preferred home and auto business is moving as expected. This action will enhance our return on capital and support profitable growth in our core businesses. We expect to realize significant additional liquidity benefits in the fourth quarter from the Bermuda optimization. And finally, we're meeting or exceeding the expected expense savings with each of our cost structure initiatives.

Advancing these initiatives further enhances Kemper's operating capabilities and financial profile. We remain highly focused on returning the business to profitability and maximizing long-term shareholder value. This leads me to our last topic. We are reaffirming our 2024 financial guidance. We continue to expect a 2024 ROE equal to or greater than 10%. I've spoken frequently about this environment being the most dynamic and volatile the personal auto insurance industry has ever seen. I still believe that. While we believe this will persist for at least a year or two, we continue to be optimistic about what's ahead for Kemper. Now I'll turn the call over to Brad.

Brad Camden (SVP and Interim CFO)

Thank you, Joe. I'll begin on page five. As Joe highlighted, we had another quarter of improved underlying results, positioning us for return to profitability. Offsetting this progress is prior development, pension settlement, and catastrophes. For the quarter, we had a net loss of $2.28 per diluted share, an adjusted consolidated net operating loss of $0.44. The net loss included a non-cash charge of $56 million related to the termination of our remaining pension obligations, which was previously recognized in accumulated other comprehensive income, or AOCI. The net loss and adjusted consolidated net operating loss included specialty auto adverse development of $78 million and catastrophes of $7 million. Last quarter, we announced that we were exiting the preferred P&C business, and as a result, the business is now reported below the line in non-core operations.

The business generated a net loss of $7 million, including approximately $14 million in pre-tax catastrophe losses. Turning to the prior year reserve development details on page six. Florida PIP, bodily injury, and property damage coverages drove reserve strengthening. PIP reserve changes resulted from increased frequency and severity of litigated claim activity, mainly from policy periods 2020 through 2022. Today, roughly three-quarters of PIP claims have attorney representation, up from two-thirds a few years ago. We anticipate attorney representation for these policy periods will remain elevated and have reflected this in our reserving. On bodily injury and property damage-related claims, we continue to see extended claim reporting timelines and more claims closing with payment. This was mainly related to activity during the second half of 2022. As Joe noted, the environment continues to be volatile.

However, given the short tail nature of our business, we are confident we have appropriately recognized these emerging trends in prior and current year reserves. Pages seven, eight, and nine provide an update on our strategic initiatives. These are on track to be completed on time, producing or exceeding their targeted financial and operational benefits. As you know, we launched the Bermuda project in 2022, and we continue to optimize the initiative. We expect $250 million in life dividends to be paid to the parent in the fourth quarter, up from $200 million as previously indicated. This continues to create value and financial flexibility for the company. This quarter, we also concluded our multi-year pension termination project, which reduced our tail risk and related expenses.

We recognized a $56 million non-cash charge to finalize the termination, which was previously recognized in AOCI and is therefore neutral to shareholders' equity. Last quarter, we announced our exit from the preferred P&C business. The wind-down process is underway and is expected to release approximately $175 million of capital by the end of 2024 and another $100 million in 2025. Next, our cost reduction initiatives are on track to produce their intended benefit. Since the onset of this effort, we have already achieved over $135 million of run-rate savings, which is roughly 90% of our goal previously projected to be realized by 2025. And finally, on page nine, the Kemper Reciprocal Exchange was established and began writing policies in Illinois in the third quarter.

Over the next year, we plan to populate the exchange by reinsuring select new business from Kemper legal entities and directly writing premium in the exchange. Growth is expected to ramp up as we receive approval to expand into new states. We plan to host a special topic call during the first quarter of 2024 to disclose the reciprocal structural and financial reporting. Moving to page 10. Our insurance companies are well capitalized and have significant resources of liquidity. At the end of the quarter, we had $820 million of liquidity, consisting of revolver capacity, intercompany lending capacity, and holding company cash and investments. We expect parent liquidity to be bolstered by at least $250 million in the fourth quarter from our Bermuda optimization.

Our healthy liquidity balance enables us to support our operating subsidiaries and pay holding company dividends and interest payments. We continue to have the capital and liquidity needed to navigate this ongoing dynamic operating environment. Moving to page 11, net investment income for the quarter was $107 million, and our pre-tax equivalent annualized book yield is 4.6%. Lastly, our approach to asset liability management continues to produce the intended results in a rising interest rate environment. I will now turn the call over to Matt to discuss the specialty P&C business.

Matt Hunton (EVP and President of Kemper Auto)

Thank you, Brad, and good afternoon, everyone. Moving to page 12 in our specialty P&C business. We closed the third quarter with an underlying combined ratio improvement of 1.5 points sequentially and 6.3 points year-over-year. This was a result of incremental earned rate and ongoing underwriting actions, including new business restrictions, which was partially offset by severity and seasonality. And while loss trends remain elevated, they have stabilized. Earned rate increases forecast, and we expect it to accelerate in the fourth quarter and in 2024, due in part to the 30 points of California rate effective in August of this year. We anticipate the cumulative benefit of our profit actions to continue to exceed loss trends. We are observing hard market conditions, especially in California. As we renewed policies at higher rates, persistency remained in line with prior periods, creating favorable premium retention.

This quarter, we filed an additional 6 points of rate on 13% of the book. Going forward, we will make rate and segmentation filings across the business as needed. This quarter, specialty P&C observed a moderate level of catastrophe losses driven by tropical storms and wind/hail events. Our commercial vehicle underwriting and rate actions are continuing to positively impact loss performance. In the third quarter, the underlying combined ratio was 93.6%, and we project continued profitability as pricing remains strong. As mentioned on the second quarter call, we are planning to selectively write a modest amount of incremental new business to test new customer cohort buying and claim behavior. Moving to page 13, we remain hyper-focused on achieving target returns as cumulative actions will continue to outpace loss trends.

In addition, enhanced tools and analytics will enable a thoughtful balancing of underwriting profitability and new business writings. Finally, despite the ongoing dynamic environment, we anticipate achieving target profitability in 2024. I will now turn the call over to Joe to cover the life business.

Joe Lacher (Chairman, President and CEO)

Thank you, Matt. Turning to page 14, net operating income for our life business was $15 million for the third quarter. Profitability improved over the prior-year quarter and sequential quarter. Consumer demand for our products is strong, with life issued policies were up slightly and persistency remains stable. The life business continues to generate strong returns on capital and distributable cash flow. Turning to page 15, to reiterate our highlights for the quarter. One, we made solid progress on improving underlying combined and loss ratios. The California rate change for specialty auto will have an increasing impact over the next two quarters, reinforcing our confidence in returning to target margins. Two, our strategic initiatives are on schedule and expected to meet or exceed all financial targets. And three, we are reaffirming our 2024 financial guidance of delivering an ROE of 10% or greater.

In closing, I'd like to thank our entire Kemper team for their ongoing dedication and commitment to executing on our strategic priorities to generate consistent long-term shareholder value. Operator, I'm going to turn it over to you for questions.

Operator (participant)

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have any questions, please press star followed by the number 1 on your phone. Should you wish to cancel your request, please press star followed by the number 2. If you are using a speakerphone, please lift the handset before pressing any keys. One moment for your first question. Your first question comes from Greg Peters from Raymond James. Your line is now open.

Gregory Peters (Managing Director - Insurance)

Good afternoon, everyone. I guess, I'll start. I have a couple of questions, and I'll start first with the top line and the policy count in your specialty book. It's declining substantially on a year-over-year basis and sequentially. Can you talk about how, as you deploy the rate increases, how your rate might be competitively disadvantaged or, or other factors that might be contributing to the drop-off in policy count and written premium?

Joe Lacher (Chairman, President and CEO)

Sure, Greg. This is Joe. I'll take a start at it, and Matt, you can jump in with more thoughts. This is largely driven, Greg, by our reduction in new business or our constraint on new business policies. Our retention rates are consistent and/or even up slightly from where they were pre-pandemic levels. So this is driven by the new business curtailment. We will likely restart and start to reintegrate some of that new business, as Matt mentioned, in the fourth quarter and into the first. We'll start slowly, and you know, test the system, if you will, and let another quarter of rate earn in and watch the underlying loss ratios improve.

But this is largely driven with what we're seeing on our new business underwriting criteria, constraining business, rather than what we're seeing as a competitive problem that's driving lapse rates up.

Matt Hunton (EVP and President of Kemper Auto)

Just a quick add-on to that. So as you know, you know, non-standard specialty customers churn at a bit of a higher rate. So naturally, as you know, you don't put on new business, you're going to see policies in force leak a little bit more. Just a quick comment on the rate and its stickiness. We are seeing, you know, policy persistency actually slightly elevated versus prior periods. So our renewal book, as it's converting at higher written and earned rate levels, is sticking at a higher rate. But as Joe mentioned, the drawdown in policies in force is really a function of, you know, the lack of new business that we have coming in at this point, and we'll balance that as we move forward over the next couple of months.

Gregory Peters (Managing Director - Insurance)

Okay. Thanks for, for providing that color. You did mention in your answer, in your prepared remarks, this desire to start growing certain cells or test the system. Just curious how that's going to look, because with your combined ratios, reported combined ratios, where you are, they probably want the, the, the margin to improve before you start writing a bunch of new business. But provide some additional perspective on that, Joe.

Joe Lacher (Chairman, President and CEO)

Sure, Greg. We did not say we were gonna grow a bunch, and we did not say we were gonna add a bunch of new business. Those were not remotely close to the words we said. We were gonna start to write some modest amounts of incremental new business. We've got a very significant new business slowdown. If you were thinking about sort of a 2019 level, it's way off of that. We're gonna modestly add, you know, some new business at some point, probably in the fourth quarter or the first quarter, to test how the underwriting criteria as we take them off, what comes in to the book of business, how that business is performing in its early stages, how those underwriting filters work.

One of the things we've talked about before is, when you have a market and a consistent view of carriers and underwriting appetite, you know how things are gonna work. As the market hardens, and you find people put up different underwriting restrictions, or different price points, business will move around the marketplace differently. What we want to do is open the filters a little bit and we believe we know what will happen when we do that, and we're going to test it. And so we're going to launch it every day, every week, every couple of weeks, and see what's coming through in that process, and did what actually come through behave and look like from a profile perspective and a performance perspective what we expected?

Again, I've used this analogy: if you got a little bit of the stomach flu, you don't go back and eat everything you did the week before. You start out with a BRAT diet of, you know, bananas, rice, applesauce, and toast, reprime the system. So what you'll see us doing is a restricted diet and restarting the process. We're going to do that while the combined ratios are continuing to improve. There'll be a high probability in our mind that that new business will perform well. It is at 100% of new business rates when it comes in, where some of our renewal book continues to have not renewed at the newer rates. We're watching really the underlying loss ratio.

One of the things I think you've noticed, you've heard us talk about before, think about expense ratios. Our expense ratio has a little bit of a temperature, partly because there's some decline in new business, and partly because there's a decline in business overall, and partly because there's new business fees, that are charged as a contra expense. They're higher on new business than they are on renewals. So we're, we're watching and testing that underlying loss ratio, knowing that as we reopen the, the new business, and that expense ratio reverts back to its norm, that will hit the underlying target profitability.

Gregory Peters (Managing Director - Insurance)

What I'd expect if we roll forward 90 days and we're having a conversation about the fourth quarter, there is not going to be massive growth or a massive amount of new business in there. There'll be some, you know, incremental as we're testing it, and at the same time, we're watching, what we expect to be, you know, changes in our underlying results, and the underlying loss ratio.

Got it. Just a clarification. It does. In your answer, I think you said some of the business that's renewing isn't renewing at the new rates. Is that right, or did I miss?

Joe Lacher (Chairman, President and CEO)

As it renews, it gets the new rate, but our profitability right now doesn't, some of the business hasn't renewed yet, so it's still at the old rates. If the input is peak of business, not all of it is at the higher rate level, where if we started new business, all of it would be. So we actually think that by opening the filters slightly, the cohorts we're adding and the business we're adding should be better from a target return perspective on its lifetime basis than the full in-force is right now.

Gregory Peters (Managing Director - Insurance)

Okay. The last question, I don't want to hog the floor. So the last question, I'm just going to pivot to the balance sheet, parent company liquidity. It's, it's a source of concern in the marketplace when we see just, you know, on the one slide in your investor decks on page 10, you see how the parent company liquidity, the total, has gone from $1.3 billion down to $821 million. And then just, you know, looking what these numbers were like in the second quarter, it was $970 million down, down again to $821 million, at the end of the third quarter.

So as we look forward, 'cause you keep reiterating that you're adequately capitalized, can you sort of give us a roadmap of how you see uses of cash and how you see the balance sheet evolving, say, over the next couple of quarters? That might be helpful.

Brad Camden (SVP and Interim CFO)

Sure, Greg, this is Brad. You are correct. We look at the end of 2022, we had $1.3 billion-ish of cash. That was elevated versus kind of historic levels. That was mainly related to the third quarter Bermuda optimization, where we took up a dividend from the life company. So it was elevated in at the end of last year. We look at it from Q2 to Q3, we're down about $150 million. That $150 million was split between a decline in holding company cash and liquidity and a reduction in our revolver capacity. So we're at, you know, $820 million approximately.

As we look forward, you know, we expect by the end of this year to be up another $250 million+, as it relates to, that'll increase due to the Bermuda optimization effort. You'll notice, if you look to the right of that, slide on slide 10, you'll see the RBC ratio is much higher than they have been historically. You'll see a 1,000+ RBC ratio for the life company. And so we'll take that, ordinary and extraordinary dividend this quarter, increasing the cash overall. So we'll be, you know, $1 billion+ in liquidity.

As we think about our sources and uses over the next twelve months, typically, we spend about $150 million a year in cash, about $80 million in dividends, about $55 million in interest expense, and other HoldCo expense items, that's $10 million to $15 million. So when you think about that $1 billion+ of liquidity, $150 million in usage, we're covered multiple times. We can extend out for several years.

Gregory Peters (Managing Director - Insurance)

Fair enough. Are you, because of the several quarters of losses, I assume you're unable to dividend up any capital from any of the subs at this point? Is that correct, or is there still a way to pull capital out of the subs if needed?

Brad Camden (SVP and Interim CFO)

We can still pull capital out of the subs, particularly the life company.

Gregory Peters (Managing Director - Insurance)

Okay. Thank you very much for the answers.

Joe Lacher (Chairman, President and CEO)

Yeah, Greg, it just. This is Joe. Just, I wouldn't focus on the $1.3 billion. That was really an anomaly, and the $1.4 billion was a, you know, a surge of earnings in the 2020 time period when people weren't driving. And as Brad pointed out, you look at the RBC of 1,015 in the life company. In an ideal world, we would have actually moved that 250+ before the end of the quarter, and it's a timing anomaly that it's going to be done in the fourth quarter rather than inside the third. So, you know, I would definitely encourage you to look at those in combination in terms of, you know, where the cash is moving back and forth between them.

Gregory Peters (Managing Director - Insurance)

Makes sense. Thank you.

Operator (participant)

Your next question comes from Brian Meredith, from UBS. Your line is now open.

Brian Meredith (Managing Director, Senior Insurance Analyst and Financials Sector Head)

Yeah, thanks. A couple of them here. First, just on the adverse reserve development. Brad, I know you said that you're confident you're in a good position now, it's a short tail business, but, you know, if I look, you've had adverse development in your personal auto business for four quarters in a row. What gives you confidence that your personal auto is reserved adequately? Are you seeing trends kind of going down now, or are there certain things that give you more comfort? And then also on the reserve topic, if you could address commercial auto a little bit and what's going on there. I mean, you grew very rapidly for the last three years, and I know other companies are having challenges with their commercial auto, so maybe your book's different or something, and that's why. Maybe you can address that as well.

Joe Lacher (Chairman, President and CEO)

Yeah, let me - well, let's do these in reverse, and I'll do a quick one on commercial vehicle, and then Brad and I will tag team and maybe Matt as well on the PYD. The commercial vehicle, remember that, you know, that was a 93.6 underlying combined ratio. The $7 million is some BI DCC-related items. It's just the Defense and Cost Containment that's running underneath there. It's still a very strong Combined Ratio there. If you look at it over, you know, any rolling 12-month period, you'd feel good about the underlying profitability there. So that one doesn't cause us a lot of angst. It really is just a little bit of DCC and cleaning up there.

Brad Camden (SVP and Interim CFO)

Hi, Brian. On the reserve, I think about, you know, our comfort there, you know, a lot of the activity we saw that created prior development this year was related to the second half of 2022. And so, you know, we have a short tail business. As we get further away from that, you know, we're confident in what we have reserved. Additionally, related to PIP, you know, we've seen, you know, increased frequency of claims, we see higher severity. When we think about what we're reserving today, we're reserving for not necessarily, not necessarily an acceleration of claims coming through, but a higher total claim, a higher total amount of severity due to the increase in litigated claims. And we think we've captured, at this point in time, everything that we can.

Now, it is a management best estimate, but we think we've taken a very practical approach to what we think has occurred, not only over the previous years, but what we expect to occur going forward. Additionally, on PIP, you know, we're not reflecting any of the benefits that may be there related to legislative changes in the third quarter or in the first quarter of 2023.

Brian Meredith (Managing Director, Senior Insurance Analyst and Financials Sector Head)

Gotcha. And then my second question, just going back to the capital situation, you know, at the holding company. I'm just curious, you know, if things don't start turning around here quickly, will that at all impact your ability to kind of roll out the reciprocal, given that I know you're going to have to fund that with some preferred? And then I also know you mentioned in the release that you're going to reinsure some business in the reciprocal. Is that going to require some capital going in, you know, relatively soon?

Joe Lacher (Chairman, President and CEO)

Yeah, it won't have any impact at all on the reciprocal. Let's remember this: we're not going to give any capital to the reciprocal. The exchange itself, the capital there is either generated by the actual policyholders there with contributions or from earnings that come off of those policies or through surplus notes. That even a surplus note is effectively a loan. So to the extent we're assisting with that, and I'm making up a number. Let's say we gave a $20 million surplus note, it would be the equivalent of us giving the exchange a $20 million loan, which it would be required to pay us back. That doesn't reduce our capital as the holding company or the parent in that process.

Reinsuring business into the reciprocal, what we can do is we can take, you know, again, I'm making something up to be illustrative. If we decided that all new business effective January fifteenth, written in state X, was going to be reinsured into the reciprocal in Georgia, then starting on January fifteenth, any new business written on Kemper paper would be reinsured over. That actually would become a capital relief for the parent company, Kemper, because we wouldn't need to hold the capital for to be able to write that new business. It actually transfers premium into the reciprocal, and the surplus note would be providing the capital for that. So it actually helps the capital situation, not hurts, and relieves the issue, doesn't restrict us.

Brian Meredith (Managing Director, Senior Insurance Analyst and Financials Sector Head)

That's the tool.

Brad Camden (SVP and Interim CFO)

Yeah. The other thing I'd add, Brian, is, I think what Joe is articulating here is it gives us actually more flexibility. It's another capability or tool that we have at our disposal. Additionally, Kemper doesn't have to be the only one supplying the reciprocal exchange with surplus notes. Eventually, when it matures, we can go out and get third-party capital as well, which provides additional benefit and potential release for Kemper, Kemper Corporation.

Joe Lacher (Chairman, President and CEO)

Sorry. This is one of the reasons, one of the reasons we're going to wind up spending some time with a special topic on the reciprocal in the first quarter. It's hard to do in an earnings call, and in one of these, we'll lay out a series of slides that sort of helps that. You know, if you can imagine this, what will happen over time is as that business naturally transfers into the exchange, you're going to see premium at Kemper Corporation go down, required capital at Kemper go down, premium inside the exchange go up, required capital inside the exchange go up, and we will never give shareholder capital to the exchange.

So, these things move back and forth, and it will make it a little more, for a short period of time as it transitions, a little complicated to read our financial statements, because of those shifts. And that's why we're going to sit down in the first quarter, as the numbers are starting to get a little bigger, to show that and help everybody see how to model it. But it really actually does ultimately release capital, as this process goes through.

Brian Meredith (Managing Director, Senior Insurance Analyst and Financials Sector Head)

Got you. And one just quick last one here, Joe. You said target profitability at some point in 2024. I'm assuming it is, you know, second, third quarter, whatever it is. And then can you remind us what your target profitability is in your personal or specialty business?

Joe Lacher (Chairman, President and CEO)

Yeah, we don't typically give a target Combined Ratio. We will definitely be there to generate. Our guidance has provided you guys a view that we're going to be a 10% ROE next year, or 10%+, next year. We've targeted a low double-digit ROE over the cycle, so we're obviously at the lower end of that range, but inside of that. To achieve that for the year, you would reasonably expect that the Combined Ratios are in the zone of our targets early on in the year.

And if you just did a little math and said, if we had 100.5 underlying combined ratio in specialty auto in the third quarter, and we've tried to point out that that has very little earned rate from California running through it, you could reasonably expect that that earned rate will more than offset loss trend and will continue to provide combined ratio improvement over the next couple of quarters. I think we've been very careful about that in describing that. So that should provide a plus. At the same time, we'll start writing a little bit more new business. That will have its new business penalty, and you will not see the combined ratio continue to improve way in excess of what might be a target that would produce that combined ratio.

Those two will converge, and we'll sort of hold our ground over the course of the year.

Brian Meredith (Managing Director, Senior Insurance Analyst and Financials Sector Head)

Great, thank you.

Operator (participant)

Next question comes from Paul Newsome of Piper Sandler. Your line is now open.

Paul Newsome (Managing Director - Insurance)

Thank you. Thank you. Always helpful in the call. Can I ask you about the, the reduction in the revolver capacity? Was that just, well, just can you tell me what's, what's driving that, is that the other piece of the holding company, liquidity that's changing?

Joe Lacher (Chairman, President and CEO)

Yeah, sure, Paul. We're hitting a covenant, a leverage covenant that's driving that and bringing that down. I'd highlight, we did our revolver last year. We upped it from $400 million to $600 million, and so we're slightly below the $400 million today. So if you look at it from a historical perspective and how we've actually shrunken new business over the last year and where we stand, you know, at $375 million, roughly, you know, that's plenty of liquidity and no concern. I don't have any concerns with that.

Paul Newsome (Managing Director - Insurance)

Great. Different topic. The accounting for the preferred business, obviously, you're running it through this non-core line, but it doesn't look like it's being treated as discontinued operations. It looks like the revenues and expenses are all going through on a consolidated basis like they were before. You're just not breaking it out as a separate segment. Is that right? Am I getting that right, or am I wrong? It's, you know, treated like a discontinued operation?

It's below the line, it's not technically below the line, right?

Joe Lacher (Chairman, President and CEO)

It technically is below the line. It's treated as non-core operations. You know, discontinued ops would have to be something that's sold or, you know, we have a deal on the table, et cetera. So it's non-core operations. It's being wound down as planned. You can see that, I think it was $7 million from non-core operations this quarter. You know, we'll try to provide as much information as possible to you. I think we also included about $14 million of catastrophe losses, et cetera, but you won't see it as a segment going forward.

Paul Newsome (Managing Director - Insurance)

But then it'll be in the consolidated numbers. Like, this consolidated revenue, for example, will include premiums from the preferred business.

Joe Lacher (Chairman, President and CEO)

You won't see any of the detail from, like, a premium standpoint, a net investment income standpoint, any of those things. It all is getting lumped into one component in non-core operations.

Yeah. So think about that segment, you know, previously, previously Kemper Preferred Insurance, all of those components are being truncated to one line, and so you're seeing the net impact of that business performance, there.

I may be wrong on this, Paul, I'm not an accountant, but I think part of the issue on the discontinued ops, you know, adding on to Brad's, I know it's the sale or the exit, but if we're just shutting it down, we didn't exit all private passenger auto so that, that was, I think, some of the advice we were getting is that's part of why we can't move it to discontinued ops.

Paul Newsome (Managing Director - Insurance)

Which is fine. I just thinking about from an operating, from a modeling perspective, because if we're modeling total revenue for the firm, in a discontinued op situation, it wouldn't show up in total revenue. But if it was just, you know, considered non-core, like it sounds like you're doing, it'll show up in consolidated total revenue on your, in 10-K or 10-Q. I think that's right. And then,

Joe Lacher (Chairman, President and CEO)

We can definitely take it off the line, Paul, and help you with the modeling pieces of how it will come through.

Paul Newsome (Managing Director - Insurance)

So, last question. I'm getting this a lot. The iteration of the 10%+ ROE, some of the pushback I'm getting is that that may be sort of, I don't know if it's designed to communicate this or not, essentially a reduction in the earnings expectations for next year because the capital is lower, because of the losses we've incurred in this quarter, for example. You know, any thoughts on that? Do you think that's fair, but the question is coming up quite a bit, so I thought I'd ask on the call.

Joe Lacher (Chairman, President and CEO)

Paul, we're trying to get a little simpler in terms of how we communicate stuff. We're, we've said that we're going to generate a 10% plus ROE. We were doing a, we did a pre-announcement, so there's a limited ability in a press release to try to describe every nuance. And I understand, there's a lot of attention on all of the pieces running around our business and where things are, and we're not trying to be cute. We're trying to actually just sort of simplify what we're doing. It's a basic gap ROE calculation. We're sticking with a 10%+. And I understand the math you're describing in it. We weren't trying to hide something in there. We weren't trying to send a different signal.

You know, maybe it's because it's Halloween, everybody's looking for ghosts, but it was trying to be a simple statement.

Paul Newsome (Managing Director - Insurance)

Appreciate that. Thank you very much.

Operator (participant)

Ladies and gentlemen, as a reminder, should you have any questions, please press star followed by the number one on your keypad. There are no further questions at this time. Mr. Joe Lacher, please proceed with your closing remarks.

Joe Lacher (Chairman, President and CEO)

Thank you, operator. Thank you, everybody, for joining our call today and for the questions. We look forward to speaking to you again in the fourth quarter or with the fourth quarter results. Thanks.

Operator (participant)

This concludes today's conference call. Thank you for participating. You may now disconnect.