NOTE 10. LONG-TERM EQUITY-BASED COMPENSATION

On May 4, 2011, Kemper’s shareholders approved the 2011 Omnibus Equity Plan (“Omnibus Plan”). The Omnibus Plan replaced the Company’s previous employee stock option plans, director stock option plan and restricted stock plan (collectively, the “Prior Plans”). Awards previously granted under the Prior Plans remain outstanding in accordance with their original terms. Beginning May 4, 2011, equity-based compensation awards may only be granted under the Omnibus Plan. A maximum number of 10,000,000 shares of Kemper common stock may be issued under the Omnibus Plan (the “Share Authorization”). As of December 31, 2012, there were 9,278,531 common shares available for future grants under the Omnibus Plan, of which 561,225 shares were reserved for future grants based on the achievement of performance goals under the terms of outstanding performance-based restricted stock awards.

The design of the Omnibus Plan provides for fungible use of shares to determine the number of shares available for future grants, with a fungible conversion factor of three to one, such that the Share Authorization will be reduced at two different rates, depending on the type of award granted. Each share of Kemper common stock issuable upon the exercise of stock options or stock appreciation rights will reduce the number of shares available for future grant under the Share Authorization by one share, while each share of Kemper common stock issued pursuant to “full value awards” will reduce the number of shares available for future grant under the Share Authorization by three shares. “Full value awards” are awards, other than stock options or stock appreciation rights, that are settled by the issuance of shares of Kemper common stock and include restricted stock, restricted stock units, performance shares, performance units, if settled with stock, and other stock-based awards.

NOTE 10. LONG-TERM EQUITY-BASED COMPENSATION (Continued)

Outstanding awards under the Omnibus Plan and Prior Plans at December 31, 2012 consisted of stand-alone stock options, tandem stock option and stock appreciation rights, time-vested restricted stock and performance-based restricted stock. Recipients of restricted stock are entitled to full dividend and voting rights on the same basis as all other outstanding shares of Kemper common stock, and all awards are subject to forfeiture until certain restrictions have lapsed.

For equity-based compensation awards with a graded vesting schedule, the Company recognizes compensation expense on a straight-line basis over the requisite service period for each separately-vesting portion of the awards as if each award were, in substance, multiple awards. Compensation expense is recognized only for those awards expected to vest, with forfeitures estimated at the date of grant based on the Company’s historical experience and future expectations. Equity-based compensation expense was $5.8 million, $5.3 million and $4.2 million for the years ended December 31, 2012, 2011 and 2010, respectively. Total unamortized compensation expense related to nonvested awards at December 31, 2012 was $5.3 million, which is expected to be recognized over a weighted-average period of 1.4 years.

The Compensation Committee of the Board of Directors, or the Board’s authorized designee, has sole discretion to determine the persons to whom awards under the Omnibus Plan are granted, and the material terms of the awards. For stock options, material terms include the number of shares covered by such options and the exercise price, vesting and expiration dates of such options. Options are non-transferable and are exercisable in installments. Options to purchase Kemper’s common stock are granted at prices equal to the fair value of Kemper’s common stock on the date of grant. Prior to 2003, only non-qualified stock options had been granted. Beginning in 2003, options granted to employees were coupled with tandem stock appreciation rights (“SARs”), settled in Kemper common stock. Employee options generally vest over a period of three and one-half years and expire ten years from the date of grant. Each new member of the Board of Directors who is not employed by the Company (“Non-Employee Director”) receives an initial option to purchase 4,000 shares of Kemper common stock immediately upon becoming a director. Thereafter, on the date of each annual meeting of Kemper’s shareholders, eligible Non-Employee Directors automatically receive annual grants of options to purchase 4,000 shares of common stock for so long as they remain eligible directors. Such options granted to Non-Employee Directors are exercisable one year from the date of grant at an exercise price equal to the fair market value of Kemper’s common stock on the date of grant and expire 10 years from the date of grant.

All of the Company’s prior stock option plans included provisions, subject to certain limitations, to automatically grant restorative, or reload stock options (“Restorative Options”), to replace shares of previously owned Kemper common stock that an exercising option holder surrenders, either actually or constructively, to satisfy the exercise price and/or tax withholding obligations relating to the exercise. The restorative feature was eliminated prospectively for original option awards granted on or after February 3, 2009. Restorative Options may still be granted, subject to certain limitations, in connection with the exercise of original options granted before February 3, 2009. Restorative Options are subject to the same terms and conditions as the original options, including the expiration date, except that the exercise price is equal to the fair value of Kemper common stock on the date of grant of a Restorative Option and cannot be exercised until six months after the date of grant. The grant of a Restorative Option does not result in an increase in the total number of shares and options held by an employee, but changes the mix of the two.

The Company uses the Black-Scholes option pricing model to estimate the fair value of each option on the date of grant. The expected terms of options are developed by considering the Company’s historical share option exercise experience, demographic profiles, historical share retention practices of employees and assumptions about their propensity for early exercise in the future. Further, the Company aggregates individual awards into relatively homogenous groups that exhibit similar exercise behavior to obtain a more refined estimate of the expected term of options. Expected volatility is estimated using weekly historical volatility. The Company believes that historical volatility is currently the best estimate of expected volatility. For original option grants made in 2010, the dividend yield assumed was the annualized continuous dividend yield on Kemper common stock on the date of grant. The dividend yield in 2012 and 2011 was calculated by taking the natural logarithm of the annualized yield divided by the Kemper common stock price on the date of grant. The Company believes that basing the dividend yield on the current annualized yield is likely to be more consistent with the actual yield during the expected life of the option. The risk free interest rate was the yield on the grant date of U.S. Treasury zero coupon issues with a maturity comparable to the expected term of the option.

NOTE 10. LONG-TERM EQUITY-BASED COMPENSATION (Continued)

The assumptions used in the Black-Scholes pricing model for options granted during the years ended December 31, 2012, 2011 and 2010, were as follows:



	2012					2011					2010
RANGE OF VALUATION ASSUMPTIONS
Expected Volatility	29.36	%	-	53.84	%	41.26	%	-	55.16	%	40.55	%	-	50.51	%
Risk Free Interest Rate	0.16		-	1.26		1.30		-	2.87		1.70		-	3.20
Expected Dividend Yield	2.92		-	3.26		3.15		-	3.38		3.25		-	3.58
WEIGHTED-AVERAGE EXPECTED LIFE IN YEARS
Employee Grants	1		-	7		3.5		-	7		4		-	7
Director Grants	6					6					6

Option and SAR activity for the year ended December 31, 2012 is presented below:



	Shares Subject to Options		Weighted- Average Exercise Price Per Share ($)		Weighted- Average Remaining Contractual Life (in Years)	Aggregate Intrinsic Value ($ In Millions)
Outstanding at Beginning of the Year	3,632,398		$	40.70
Granted	265,451		29.81
Exercised	(222,949	)	16.32
Forfeited or Expired	(482,846	)	47.10
Outstanding at December 31, 2012	3,192,054		40.53		3.97	$	3.0
Vested and Expected to Vest at December 31, 2012	3,162,634		$	40.64	3.93	$	2.9
Exercisable at December 31, 2012	2,736,989		$	42.69	3.24	$	2.0

The weighted-average grant-date fair values of options granted during 2012, 2011 and 2010 were $9.40, $9.11 and $7.60, respectively. Total intrinsic value of stock options exercised was $3.0 million, $0.3 million and $0.3 million for the years ended December 31, 2012, 2011 and 2010, respectively. Cash received from option exercises was $1.3 million, $0.2 million and $0.5 million for the years ended December 31, 2012, 2011 and 2010, respectively. Total tax benefits realized for tax deductions from option exercises were $1.0 million, $0.1 million and $0.1 million for the years ended December 31, 2012, 2011 and 2010, respectively.

Information pertaining to options outstanding at December 31, 2012 is presented below:



					Outstanding				Exercisable
Range of Exercise Prices ($)					Shares Subject to Options	Weighted- Average Exercise Price Per Share ($)		Weighted- Average Remaining Contractual Life (in Years)	Shares Subject to Options	Weighted- Average Exercise Price Per Share ($)
$	10.00	-	$	15.00	38,000	$	13.55	6.09	38,000	$	13.55
15.01		-	20.00		8,000	16.48		6.35	8,000	16.48
20.01		-	25.00		293,750	23.75		7.28	161,312	23.64
25.01		-	30.00		584,750	28.64		8.16	266,123	28.20
30.01		-	35.00		6,614	31.92		5.84	2,614	31.18
35.01		-	40.00		340,577	37.25		4.81	340,577	37.25
40.01		-	45.00		400,084	43.56		1.46	400,084	43.56
45.01		-	50.00		1,185,747	48.62		2.42	1,185,747	48.62
50.01		-	55.00		334,532	50.85		1.03	334,532	50.85
10.00		-	55.00		3,192,054	40.53		3.97	2,736,989	42.69

NOTE 10. LONG-TERM EQUITY-BASED COMPENSATION (Continued)

The grant-date fair values of time-based restricted stock awards are determined using the closing price of Kemper common stock on the date of grant. Activity related to nonvested time-based restricted stock for the year ended December 31, 2012 was as follows:



	Time-Based Restricted Shares		Weighted- Average Grant-Date Fair Value Per Share
Nonvested Balance at Beginning of the Year	116,784		$	23.33
Granted	72,125		29.90
Vested	(42,824	)	24.41
Forfeited	(19,736	)	26.70
Nonvested Balance at End of Period	126,349		$	26.19

Prior to February 3, 2009, only awards of time-vested restricted stock had been granted. Beginning on February 3, 2009, in addition to time-vested restricted stock granted to certain employees and officers, the Company began awarding performance-based restricted stock to certain officers and employees. The initial number of shares awarded to each participant of a performance-based restricted stock award represents the shares that would vest if the performance goals were achieved at the “target” performance level. The final payout of these awards will be determined based on Kemper’s total shareholder return over a three-year performance period relative to a peer group comprised of all the companies in the S&P Supercomposite Insurance Index.

Performance-based restricted stock awards are earned over a three-year performance period. If, at the end of the performance period, the Company’s relative performance:


•	exceeds the “target” performance level, additional shares of stock will be issued to the award recipient;


•	is below the “target” performance level, only a portion of the shares of performance-based restricted stock originally issued to the award recipient will vest; or


•	is below a “minimum” performance level, none of the shares of performance-based restricted stock originally issued to the award recipient will vest.

The grant date fair values of the performance-based restricted stock awards are determined using the Monte Carlo simulation method. The Monte Carlo simulation model produces a risk-neutral simulation of the daily returns on the common stock of Kemper and each of the other companies included in the Peer Group. Returns generated by the simulation depend on the risk-free interest rate used and the volatilities of, and the correlation between, these stocks. The model simulates stock prices and dividend payouts to the end of the three-year performance period. Total shareholder returns are generated for each of these stocks based on the simulated prices and dividend payouts. The total shareholder returns are then ranked, and Kemper’s simulated ranking is converted to a payout percentage based on the terms of the performance-based restricted stock awards. The payout percentage is applied to the simulated stock price at the end of the performance period, reinvested dividends are added back, and the total is discounted to the valuation date at the risk-free rate. This process is repeated approximately ten thousand times, and the grant date fair value is equal to the average of the results from these trials.

Activity related to nonvested performance-based restricted stock for the year ended December 31, 2012 was as follows:



	Performance-Based Restricted Shares		Weighted- Average Grant-Date Fair Value Per Share
Nonvested Balance at Beginning of the Year	172,875		$	29.86
Granted	68,575		36.65
Vested	(51,596	)	14.04
Forfeited	(2,779	)	31.11
Nonvested Balance at End of Period	187,075		$	36.70

NOTE 10. LONG-TERM EQUITY-BASED COMPENSATION (Continued)

The number of additional shares that would be granted if the Company were to meet or exceed the maximum performance levels related to the outstanding performance-based shares for the 2012 and 2011 three-year performance periods was 68,275 common shares and 63,725 common shares, respectively, (as “full value awards,” the equivalent of 204,825 shares and 191,175 shares, respectively, under the Share Authorization) at December 31, 2012. For the 2010 three-year performance period, the Company exceeded target performance levels with a payout percentage of 114%. Accordingly, an additional 6,996 shares of stock were issued to award recipients on February 2, 2013. For the 2009 three-year performance period, the Company exceeded target performance levels with a payout percentage of 183%. Accordingly, an additional 40,727 shares of stock were issued to award recipients on January 31, 2012 (the “2009 Additional Shares”).

The total fair value of restricted stock, including the 2009 Additional Shares, that vested during the year ended December 31, 2012 was $4.0 million and the tax benefits for tax deductions realized from the vesting on such restricted stock was $1.4 million. The total fair value of restricted stock that vested during the year ended December 31, 2011 was $1.4 million and the tax benefits for tax deductions realized from the vesting on such restricted stock was $0.5 million. The total fair value of restricted stock that vested during the year ended December 31, 2010 was $2.2 million and the tax benefits for tax deductions realized from the vesting on such restricted stock was $0.8 million.