NOTE 2. SUMMARY OF ACCOUNTING POLICIES AND ACCOUNTING CHANGES

Investments

Investments in Fixed Maturities include bonds, notes and redeemable preferred stocks. Investments in Fixed Maturities are classified as available for sale and reported at fair value. Net Investment Income, including amortization of purchased premiums and accretion of market discounts, on Investments in Fixed Maturities is recognized as interest earned using the effective yield method.

NOTE 2. SUMMARY OF ACCOUNTING POLICIES AND ACCOUNTING CHANGES (Continued)

Investments in Equity Securities include common and non-redeemable preferred stocks and other equity interests and are reported at fair value. Investments in common and non-redeemable preferred stocks with readily determinable fair values are classified as available for sale. Dividend income on investments in common and non-redeemable preferred stocks is recognized on the ex-dividend date. Other equity interests primarily consist of exchange traded funds and partnership interests in limited liability partnerships in which the Company’s interests are deemed minor. The Company’s share of distributed earnings from other equity interests is recognized as dividend income when received.

Unrealized appreciation or depreciation, net of applicable deferred income taxes, on fixed maturities and equity securities is reported in Accumulated Other Comprehensive Income included in Shareholders’ Equity.

Equity Method Limited Liability Investments include investments in limited liability investment companies and limited partnerships in which the Company’s interests are not deemed minor and are accounted for under the equity method of accounting.

Short-term Investments include fixed maturities that mature within one year from the date of purchase, money market mutual funds, Federal funds sold and repurchase agreements. Short-term Investments are reported at cost, which approximates fair value.

Other Investments primarily include loans to policyholders and real estate. Loans to policyholders are carried at unpaid principal balance. Real estate is carried at cost, net of accumulated depreciation. Real estate is depreciated over the estimated useful life of the asset using the straight-line method of depreciation. Real estate is evaluated for impairment when events or circumstances indicate the carrying value of the real estate may not be recoverable. An impairment on real estate is recognized when carrying value exceeds the sum of undiscounted cash flows.

Gains and losses on sales of investments are computed on the specific identification method and are reported in the Consolidated Statements of Income in the period in which the sales occur. The Company regularly reviews its investment portfolio for factors that may indicate that a decline in fair value of an investment is other than temporary. Losses are computed on the specific identification method and reported in the Consolidated Statements of Income in the period that the decline is determined to be other than temporary. The portion of an impairment of an investment in a fixed maturity attributed to a credit loss is reported in Net Impairment Losses Recognized in Earnings in the Consolidated Statement of Income, with the balance of such impairment reported in Accumulated Other Comprehensive Income.

Fair Value Measurements

The Company uses a hierarchal framework which prioritizes and ranks the market price observability used in fair value measurements. Market price observability is affected by a number of factors, including the type of asset or liability and the characteristics specific to the asset or liability being measured. Assets and liabilities with readily available, active, quoted market prices or for which fair value can be measured from actively quoted prices generally are deemed to have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. The Company classifies the inputs used to measure fair value into one of three levels as follows:


•	Level 1 — Quoted prices in an active market for identical assets or liabilities;


•	Level 2 — Observable inputs other than Level 1, quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and model-derived prices whose inputs are observable or whose significant value drivers are observable; and


•	Level 3 — Assets and liabilities whose significant value drivers are unobservable.

Observable inputs are based on market data obtained from independent sources, while unobservable inputs are based on the Company’s market assumptions. Unobservable inputs require significant management judgment or estimation. In some cases, the inputs used to measure an asset or liability may fall into different levels of the fair value hierarchy. In those instances, the Company classifies the fair value measurement using the lowest level of input that is significant to the fair value measurement. Such determination requires significant management judgment. In accordance with GAAP, the Company is not permitted to adjust quoted market prices in an active market, even if the Company owns a large investment, the sale of which could reasonably impact the quoted price.

NOTE 2. SUMMARY OF ACCOUNTING POLICIES AND ACCOUNTING CHANGES (Continued)

Deferred Policy Acquisition Costs

Costs directly associated with the successful acquisition of business, principally commissions and certain premium taxes and policy issuance costs, are deferred. On January 1, 2012, the Company retrospectively adopted ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. See discussion below under the caption “Adoption of New Accounting Standards” regarding the adoption of the new standard. Costs deferred on property and casualty insurance products and health insurance products are amortized over the period in which premiums are earned. Costs deferred on traditional life insurance products are primarily amortized over the anticipated premium-paying period of the related policies in proportion to the ratio of the annual premiums to the total premiums anticipated, which is estimated using the same assumptions used in calculating policy reserves.

Goodwill

The cost of an acquired entity over the fair value of net assets acquired is reported as Goodwill. Goodwill is not amortized, but rather is tested annually for recoverability or when certain triggering events require testing. On January 1, 2012, the Company adopted ASU 2011-08, Testing Goodwill for Impairment. See discussion below under the caption “Adoption of New Accounting Standards” regarding the adoption of the new standard.

Insurance Reserves

Reserves for losses and LAE on property and casualty insurance coverage and health insurance coverage represent the estimated claim cost and loss adjustment expense necessary to cover the ultimate net cost of investigating and settling all losses incurred and unpaid. Such estimates are based on individual case estimates for reported claims and estimates for incurred but not reported losses. These estimates are adjusted in the aggregate for ultimate loss expectations based on historical experience patterns and current economic trends, with any change in the estimated ultimate liabilities being reported in the Consolidated Statements of Income in the period of change. Changes in such estimates may be material.

For traditional life insurance products, the reserves for future policy benefits are estimated on the net level premium method based on rates for expected mortality, lapse rates and interest rates, including provisions for adverse mortality. These assumptions vary by such characteristics as plan, age at issue and policy duration. Mortality assumptions are based on the Company’s historical experience and industry standards. Interest rate assumptions principally range from 3% to 7%. Lapse rate assumptions are based on actual and industry experience.

Other Receivables

Other Receivables primarily include reinsurance recoverables and accrued investment income.

Other Assets

Other Assets primarily include property and equipment, internal use software, insurance licenses acquired in business combinations, the value of other intangible assets acquired and prepaid expenses. Property and equipment is depreciated over the useful lives of the assets, generally using the straight-line or double declining balance methods of depreciation depending on the asset involved. Internal use software is primarily amortized over the useful life of the asset using the straight-line method of amortization. Insurance licenses acquired in business combinations and other indefinite life intangibles are not amortized, but rather tested periodically for recoverability.

The Company accounts for the present value of the future profits embedded in life insurance in force acquired (“Life VIF”) based on actuarial estimates of the present value of estimated net cash flows. Life VIF was $46.4 million and $52.1 million at December 31, 2012 and 2011, respectively. Life VIF is amortized using the effective interest method using interest rates consistent with the rates in the underlying insurance contracts. The Company estimates that it will record Life VIF amortization, net of interest, of $5.2 million in 2013, $4.6 million in 2014, $4.2 million in 2015, $3.7 million in 2016 and $3.2 million in 2017. The Company evaluates the Life VIF for recoverability annually.

NOTE 2. SUMMARY OF ACCOUNTING POLICIES AND ACCOUNTING CHANGES (Continued)

The Company accounts for the present value of the future profits embedded in Property and Casualty Insurance customer relationships acquired (“P&C Customer Relationships”) based on the present value of estimated future cash flows from the customer relationships acquired. P&C Customer Relationships was $18.7 million and $20.8 million at December 31, 2012 and 2011, respectively. P&C Customer Relationships is amortized using the effective interest method. P&C Customer Relationships are tested for recoverability using undiscounted projections of future cash flows and written down to estimated fair value if the carrying value exceeds the sum of such projections of undiscounted cash flows. The Company recorded a loss of $13.5 million before tax for the year ended December 31, 2011 to write down the carrying value of P&C Customer Relationships related to the acquisition of Direct Response to its estimated fair value.

Accrued Expenses and Other Liabilities

Accrued Expenses and Other Liabilities primarily include accrued salaries and commissions, pension benefits, postretirement medical benefits and accrued taxes, licenses and fees.

Recognition of Earned Premiums and Related Expenses

Property and casualty insurance and health insurance premiums are deferred when written and recognized and earned ratably over the periods to which the premiums relate. Unearned Premiums represent the portion of the premiums written related to the unexpired portion of policies in force which has been deferred and is reported as a liability. A premium deficiency reserve is established if the sum of expected claim costs, claim adjustment expenses, unamortized deferred policy acquisition costs and maintenance costs exceeds the related unearned premiums. For each business segment, the analysis is performed at a product line level, namely automobile insurance, homeowners insurance and other insurance, which is consistent with the manner in which the Company acquires, services and measures profitability. Anticipated investment income is excluded from such analysis.

Traditional life insurance premiums are recognized as revenue when due. Policyholders’ benefits are associated with related premiums to result in recognition of profits over the periods for which the benefits are provided using the net level premium method.

Policyholders’ Benefits and Incurred Losses and Loss Adjustment Expenses include provisions for future policy benefits under life and certain accident and health insurance contracts and provisions for reported claims, estimates for claims incurred but not reported and loss adjustment expenses. Benefit payments in excess of policy account balances are expensed.

Reinsurance

In the normal course of business, Kemper’s insurance subsidiaries reinsure certain risks above certain retention levels with other insurance enterprises. These reinsurance agreements do not relieve Kemper’s insurance subsidiaries of their legal obligations to the policyholder. Amounts recoverable from reinsurers for benefits and losses are included in Other Receivables.

Gains related to long-duration reinsurance contracts are deferred and amortized over the life of the underlying reinsured policies. Losses related to long-duration reinsurance contracts are recognized immediately. Any gain or loss associated with reinsurance agreements for which Kemper’s insurance subsidiaries have been legally relieved of their obligations to the policyholder is recognized in the period of relief.

Income Taxes

Deferred income tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. A valuation allowance is maintained for the portion of deferred income tax assets that the Company does not expect to recover. Increases in the valuation allowance for deferred income tax assets are recognized as

income tax expense. Decreases in the valuation allowance for deferred income tax assets are recognized as income tax benefit. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period in which the change is enacted.

The Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken, or expected to be taken, in an income tax return. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense.

NOTE 2. SUMMARY OF ACCOUNTING POLICIES AND ACCOUNTING CHANGES (Continued)

Adoption of New Accounting Standards

In October 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. The standard is effective for interim and annual reporting periods beginning after December 15, 2011. The provisions of the standard can be applied either prospectively or retrospectively. The standard amends ASC Topic 944, Financial Services—Insurance, and modifies the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts. The Company adopted the standard on January 1, 2012 and applied its provisions retrospectively. The adoption of the standard reduced consolidated shareholders’ equity by $99.5 million on January 1, 2012. The Company’s financial statements have been retrospectively adjusted as if ASU 2010-26 had been adopted to all prior periods presented.

The following line items presented in the Consolidated Balance Sheets at December 31, 2012 and 2011 were affected by the adoption of the new accounting standard:



DOLLARS IN MILLIONS	As Computed without Change in Accounting		As Reported with Change in Accounting		Effect of Change
Impact on Assets at December 31, 2012:
Deferred Policy Acquisition Costs	$	467.7	$	303.4	$	(164.3	)
Total Assets	8,173.4		8,009.1		(164.3		)
Impact on Liabilities and Shareholders’ Equity at December 31, 2012:
Liabilities for Income Taxes	$	80.0	$	21.5	$	(58.5	)
Total Liabilities	5,905.9		5,847.4		(58.5		)
Retained Earnings	1,224.0		1,118.2		(105.8		)
Total Shareholders’ Equity	2,267.5		2,161.7		(105.8		)
Total Liabilities and Shareholders’ Equity	8,173.4		8,009.1		(164.3		)



DOLLARS IN MILLIONS	As Originally Reported		As Adjusted		Effect of Change
Impact on Assets at December 31, 2011:
Deferred Policy Acquisition Costs	$	448.5	$	294.0	$	(154.5	)
Current and Deferred Income Taxes	3.1		6.4		3.3
Total Assets	8,085.9		7,934.7		(151.2		)
Impact on Liabilities and Shareholders’ Equity at December 31, 2011:
Liabilities for Income Taxes	$	57.9	$	6.2	$	(51.7	)
Total Liabilities	5,869.8		5,818.1		(51.7		)
Retained Earnings	1,208.2		1,108.7		(99.5		)
Total Shareholders’ Equity	2,216.1		2,116.6		(99.5		)
Total Liabilities and Shareholders’ Equity	8,085.9		7,934.7		(151.2		)

NOTE 2. SUMMARY OF ACCOUNTING POLICIES AND ACCOUNTING CHANGES (Continued)

The following line items in the Consolidated Statement of Income for the year ended December 31, 2012 were affected by the adoption of the new accounting standard:



	Year Ended December 31, 2012
DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS	As Computed without Change in Accounting			As Reported with Change in Accounting			Effect of Change
Total Revenues	$	2,462.3		$	2,462.3		$	—
Expenses:
Policyholders’ Benefits and Incurred Losses and Loss Adjustment Expenses	1,582.1			1,582.1			—
Insurance Expenses	662.5			672.3			9.8
Interest and Other Expenses	85.5			85.5			—
Total Expenses	2,330.1			2,339.9			9.8
Income from Continuing Operations before Income Taxes	132.2			122.4			(9.8		)
Income Tax Expense	(34.1		)	(30.6		)	3.5
Income from Continuing Operations	98.1			91.8			(6.3		)
Income from Discontinued Operations	11.6			11.6			—
Net Income	$	109.7		$	103.4		$	(6.3	)
Income from Continuing Operations per Unrestricted Share:
Basic	$	1.65		$	1.55		$	(0.10	)
Diluted	$	1.65		$	1.54		$	(0.11	)
Net Income Per Unrestricted Share:
Basic	$	1.85		$	1.75		$	(0.10	)
Diluted	$	1.85		$	1.74		$	(0.11	)

NOTE 2. SUMMARY OF ACCOUNTING POLICIES AND ACCOUNTING CHANGES (Continued)

The following line items in the Consolidated Statement of Income for the year ended December 31, 2011 were affected by the adoption of the new accounting standard:



	Year Ended December 31, 2011
DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS	As Originally Reported			As Adjusted			Effect of Change
Total Revenues	$	2,495.0		$	2,495.0		$	—
Expenses:
Policyholders’ Benefits and Incurred Losses and Loss Adjustment Expenses	1,645.7			1,645.7			—
Insurance Expenses	669.3			683.6			14.3
Write-off of Goodwill and Other Intangibles Acquired	13.5			13.5			—
Interest and Other Expenses	83.9			83.9			—
Total Expenses	2,412.4			2,426.7			14.3
Income from Continuing Operations before Income Taxes	82.6			68.3			(14.3		)
Income Tax Expense	(11.7		)	(6.6		)	5.1
Income from Continuing Operations	70.9			61.7			(9.2		)
Income from Discontinued Operations	12.8			12.8			—
Net Income	$	83.7		$	74.5		$	(9.2	)
Income from Continuing Operations per Unrestricted Share:
Basic	$	1.17		$	1.02		$	(0.15	)
Diluted	$	1.17		$	1.02		$	(0.15	)
Net Income Per Unrestricted Share:
Basic	$	1.38		$	1.23		$	(0.15	)
Diluted	$	1.38		$	1.23		$	(0.15	)

NOTE 2. SUMMARY OF ACCOUNTING POLICIES AND ACCOUNTING CHANGES (Continued)

The following line items in the Consolidated Statement of Income for the year ended December 31, 2010 were affected by the adoption of the new accounting standard:



	Year Ended December 31, 2010
DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS	As Originally Reported			As Adjusted			Effect of Change
Total Revenues	$	2,642.5		$	2,642.5		$	—
Expenses:
Policyholders’ Benefits and Incurred Losses and Loss Adjustment Expenses	1,647.2			1,647.2			—
Insurance Expenses	675.5			685.9			10.4
Write-off of Goodwill and Other Intangibles Acquired	14.8			14.8			—
Interest and Other Expenses	68.3			68.3			—
Total Expenses	2,405.8			2,416.2			10.4
Income from Continuing Operations before Income Taxes and Equity in Net Loss of Former Investee	236.7			226.3			(10.4		)
Income Tax Expense	(67.5		)	(63.8		)	3.7
Income from Continuing Operations before Equity in Net Loss of Former Investee	169.2			162.5			(6.7		)
Equity in Net Loss of Former Investee	(0.1		)	(0.1		)	—
Income from Continuing Operations	169.1			162.4			(6.7		)
Income from Discontinued Operations	15.5			15.5			—
Net Income	$	184.6		$	177.9		$	(6.7	)
Income from Continuing Operations per Unrestricted Share:
Basic	$	2.73		$	2.62		$	(0.11	)
Diluted	$	2.73		$	2.62		$	(0.11	)
Net Income Per Unrestricted Share:
Basic	$	2.98		$	2.87		$	(0.11	)
Diluted	$	2.98		$	2.87		$	(0.11	)

The following line items presented in the Consolidated Statements of Comprehensive Income for the years ended December 31, 2012, 2011 and 2010 were affected by the adoption of the new accounting standard:



	Year Ended December 31, 2012
DOLLARS IN MILLIONS	As Computed without Change in Accounting		As Reported with Change in Accounting		Effect of Change
Net Income	$	109.7	$	103.4	$	(6.3	)
Total Comprehensive Income	164.4		158.1		(6.3		)



	Year Ended December 31, 2011
DOLLARS IN MILLIONS	As Originally Reported		As Adjusted		Effect of Change
Net Income	$	83.7	$	74.5	$	(9.2	)
Total Comprehensive Income	184.3		175.1		(9.2		)

NOTE 2. SUMMARY OF ACCOUNTING POLICIES AND ACCOUNTING CHANGES (Continued)



	Year Ended December 31, 2010
DOLLARS IN MILLIONS	As Originally Reported		As Adjusted		Effect of Change
Net Income	$	184.6	$	177.9	$	(6.7	)
Total Comprehensive Income	283.2		276.5		(6.7		)

The following line items in the Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010 were affected by the adoption of the new accounting standard:



	Year Ended December 31, 2012
DOLLARS IN MILLIONS	As Computed without Change in Accounting			As Reported with Change in Accounting			Effect of Change
Impact on Operating Activities:
Net Income	$	109.7		$	103.4		$	(6.3	)
Increase in Deferred Policy Acquisition Costs	(19.2		)	(9.4		)	9.8
Change in Income Taxes	(11.4		)	(14.9		)	(3.5		)
Net Cash Provided by Operating Activities	65.7			65.7			—



	Year Ended December 31, 2011
DOLLARS IN MILLIONS	As Originally Reported			As Adjusted			Effect of Change
Impact on Operating Activities:
Net Income	$	83.7		$	74.5		$	(9.2	)
Increase in Deferred Policy Acquisition Costs	(22.1		)	(7.8		)	14.3
Change in Income Taxes	22.3			17.2			(5.1		)
Net Cash Used by Operating Activities	(25.0		)	(25.0		)	—



	Year Ended December 31, 2010
DOLLARS IN MILLIONS	As Originally Reported			As Adjusted			Effect of Change
Impact on Operating Activities:
Net Income	$	184.6		$	177.9		$	(6.7	)
Increase in Deferred Policy Acquisition Costs	(15.1		)	(4.7		)	10.4
Change in Income Taxes	12.4			8.7			(3.7		)
Net Cash Provided by Operating Activities	58.5			58.5			—

Line items presented in the Investing Activities and Financing Activities sections of the Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010 were unaffected by the adoption of the new accounting standard.

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure

Requirements. The standard is effective for the first interim or annual period beginning on or after December 15, 2011. The new

standard amends the existing fair value definition and enhances disclosure requirements. The Company adopted the standard

in the first quarter of 2012 and, except for the additional disclosure requirements, the initial application of the standard did

not have an impact on the Company.

NOTE 2. SUMMARY OF ACCOUNTING POLICIES AND ACCOUNTING CHANGES (Continued)

In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment. The standard is effective for the first

interim or annual period beginning on or after December 15, 2011. The standard amends ASC Topic 350, “Intangibles” —

Goodwill and Other, and gives companies the option to first perform a qualitative assessment to determine whether it is more

likely than not that the fair value of a reporting unit is less than its carrying amount. The Company adopted the standard in the first quarter of 2012 and the initial application of the standard did not have an impact on the Company.

In December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of

Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The

standard deferred certain paragraphs in ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive

Income, related to the presentation of reclassification adjustments but also required companies to report comprehensive income

either in a single continuous financial statement or in two separate but consecutive financial statements. The Company adopted

the standard in the first quarter of 2012. Other than the inclusion of the Consolidated Statement of Comprehensive Income, the initial application of the standard did not have an impact on the Company.

Accounting Standards Not Yet Adopted

The FASB issues ASUs to amend the authoritative literature in ASC. There were seven ASUs issued in 2012 that amend the original text of the ASC. The ASUs are not expected to have a material impact on the Company.