NOTE 9. 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, 2014, there were 8,243,636 common shares available for future grants under the Omnibus Plan, of which 517,500 shares were reserved for future grants based on the achievement of performance goals under the terms of outstanding performance-based restricted stock and performance-based restricted stock unit (“RSU”) 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, RSUs and deferred stock units (“DSUs”), if settled with stock, and other stock-based awards.

Outstanding equity-based compensation awards at December 31, 2014 consisted of tandem stock option and stock appreciation rights (“Tandem Awards”), time-vested restricted stock, time-vested RSUs, performance-based restricted stock, performance-based RSUs and DSUs. Effective February 4, 2014, the Company began issuing time-based and performance-based RSUs. Recipients of restricted stock receive full dividend and voting rights on the same basis by as all other outstanding shares of Kemper common stock. RSUs and DSUs give the recipient the right to receive one share of Kemper common stock for each RSU or DSU issued. Holders of RSUs and DSUs receive full dividend equivalents on the same basis as dividends are received by holders of all other outstanding shares of Kemper common stock, but do not receive voting rights until such shares are issued. Except as described below for equity-based compensation awards granted on or after May 1, 2013 to each member of the Board of Directors who is not employed by the Company (“Non-employee Directors”), all outstanding 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 $6.4 million, $5.5 million and $5.8 million for the years ended December 31, 2014, 2013 and 2012, respectively. Total unamortized compensation expense related to nonvested awards at December 31, 2014 was $4.4 million, which is expected to be recognized over a weighted-average period of 1.8 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 Tandem Awards, material terms include the number of shares covered by such awards and the exercise price, vesting and expiration dates of such awards. Tandem Awards are non-transferable. The exercise price of Tandem Awards is the fair value of Kemper’s common stock on the date of grant. Employee Tandem Awards, time-based restricted stock awards and time-based RSU awards generally vest, beginning six months after date of grant, in four equal annual installments over a period of three and one-half years, with the Tandem Awards expiring ten years from the date of grant. Employee performance-based restricted stock and RSU awards generally vest over a period of three years, subject to achievement of performance goals and other restrictions.

Each Non-employee Director receives an initial option to purchase 4,000 shares of Kemper common stock immediately upon becoming a director. In addition, 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. Prior to May 1, 2013, such options granted to Non-employee Directors were 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 ten years from the date of grant. Effective May 1, 2013, new grants of such options are fully vested and exercisable on the date of grant at an exercise price equal to the fair market value of Kemper’s common stock on the date of grant. In addition to the option awards, effective May 1, 2013, annual awards to each Non-employee Director include 500 DSUs. The DSUs granted to Non-employee Directors are fully vested on the date of grant. Conversion of the DSUs into shares of Kemper’s common stock is deferred until the date a director’s board service terminates.

NOTE 9. LONG-TERM EQUITY-BASED COMPENSATION (Continued)

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 Tandem Award on the date of grant. The expected terms of Tandem Awards are developed by considering the Company’s historical Tandem Award 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. The dividend yield in 2014, 2013 and 2012 was calculated by taking the natural logarithm of the annualized yield divided by the Kemper common stock price on the date of grant. 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.

The assumptions used in the Black-Scholes pricing model for Tandem Awards granted during the years ended December 31, 2014, 2013 and 2012, were as follows:



	2014					2013					2012
RANGE OF VALUATION ASSUMPTIONS
Expected Volatility	25.76	%	-	44.43	%	39.10	%	-	48.23	%	29.36	%	-	53.84	%
Risk-free Interest Rate	1.07		-	2.14		0.62		-	1.38		0.16		-	1.26
Expected Dividend Yield	2.53		-	2.60		2.83		-	3.00		2.92		-	3.26
WEIGHTED-AVERAGE EXPECTED LIFE IN YEARS
Employee Grants	4		-	7		4		-	7		1		-	7
Director Grants	6					6					6

Tandem Award activity for the year ended December 31, 2014 is presented below:



	Shares Subject to Awards		Weighted- average Exercise Price Per Share ($)		Weighted- average Remaining Contractual Life (in Years)	Aggregate Intrinsic Value ($ In Millions)
Outstanding at Beginning of the Year	2,543,673		$	41.37
Granted	289,000		36.59
Exercised	(46,125	)	29.04
Forfeited or Expired	(520,837	)	46.94
Outstanding at December 31, 2014	2,265,711		39.74		3.8	$	4.3
Vested and Expected to Vest at December 31, 2014	2,242,297		$	39.80	3.8	$	4.2
Exercisable at December 31, 2014	1,944,207		$	40.59	3.0	$	3.7

The weighted-average grant-date fair values of Tandem Awards granted during 2014, 2013 and 2012 were $10.49, $10.20 and $9.40, respectively. Total intrinsic value of Tandem Awards exercised was $0.4 million, $4.1 million and $3.0 million for the years ended December 31, 2014, 2013 and 2012, respectively. Cash received from exercises of Tandem Awards was $0.5 million, $1.7 million and $1.3 million for the years ended December 31, 2014, 2013 and 2012, respectively. Total tax benefit

NOTE 9. LONG-TERM EQUITY-BASED COMPENSATION (Continued)

realized for tax deductions from exercises of Tandem Awards was $0.1 million, $1.4 million and $1.0 million for the years ended December 31, 2014, 2013 and 2012, respectively.

Information pertaining to Tandem Awards outstanding at December 31, 2014 is presented below:



					Outstanding				Exercisable
Range of Exercise Prices ($)					Shares Subject to Awards	Weighted- average Exercise Price Per Share ($)		Weighted- average Remaining Contractual Life (in Years)	Shares Subject to Awards	Weighted- average Exercise Price Per Share ($)
$	10.00	-	$	15.00	15,000	$	13.55	2.26	15,000	$	13.55
15.01		-	20.00		8,000	16.48		4.35	8,000	16.48
20.01		-	25.00		29,000	23.36		3.86	29,000	23.36
25.01		-	30.00		379,000	28.84		6.17	332,998	28.74
30.01		-	35.00		226,250	33.16		8.12	130,500	32.94
35.01		-	40.00		573,250	36.91		5.86	393,498	37.11
40.01		-	45.00		184,902	43.10		0.09	184,902	43.10
45.01		-	50.00		793,541	48.59		1.15	793,541	48.59
50.01		-	55.00		56,768	51.16		0.10	56,768	51.16
10.00		-	55.00		2,265,711	39.74		3.82	1,944,207	40.59

The grant-date fair values of time-based restricted stock and time-based RSU awards are determined using the closing price of Kemper common stock on the date of grant. Activity related to nonvested time-based restricted stock and nonvested time-based RSUs for the year ended December 31, 2014 was as follows:



	Time-based Restricted Stock Awards				Time-based RSU Awards
	Number of Shares		Weighted- average Grant-date Fair Value Per Share		Number of RSUs		Weighted- average Grant-date Fair Value Per RSU
Nonvested Balance at Beginning of the Year	101,627		$	31.48	—		$	—
Granted	2,000		38.59		41,925		36.56
Vested	(25,568	)	30.56		(9,351	)	36.47
Forfeited	(24,964	)	30.96		(2,550	)	36.47
Nonvested Balance at End of Period	53,095		$	32.42	30,024		$	36.60

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 making performance-based restricted awards to certain officers and employees. The initial number of shares or RSUs awarded to each participant of a performance-based award represents the shares that would vest, or, in the case of a RSU, that would vest and would be issued, if the performance level attained were to be at the “target” performance level. For performance above the target level, each participant would receive a grant of additional shares of stock up to a maximum of 100% of the initial number of shares or RSUs awarded to the participant. The final payout of these awards, and any forfeitures of shares for performance below the “target” performance level, 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.

NOTE 9. LONG-TERM EQUITY-BASED COMPENSATION (Continued)

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, but at or above a “minimum” 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 and performance-based RSU 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 and performance-based RSU 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 and nonvested performance-based RSU awards for the year ended December 31, 2014 was as follows:



	Performance-based Restricted Stock Awards				Performance-based RSU Awards
	Number of Shares		Weighted- average Grant-date Fair Value Per Share		Number of RSUs		Weighted- average Grant-date Fair Value Per RSU
Nonvested Balance at Beginning of the Year	176,800		$	39.54	—		$	—
Granted	—		—		66,575		40.50
Vested	(54,934	)	39.83		—		—
Forfeited	(11,241	)	40.75		(4,700	)	40.50
Nonvested Balance at End of Period	110,625		$	39.28	61,875		$	40.50

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 awards for the 2014 and 2013 three-year performance periods was 61,875 common shares and 52,850 common shares, respectively, (as “full value awards,” the equivalent of 185,625 shares and 158,550 shares, respectively, under the Share Authorization) at December 31, 2014. For the 2012 three-year performance period, the Company was below the minimum performance level, and all of the related 57,775 shares of performance-based restricted shares were forfeited on January 31, 2015, the three-year anniversary of their grant date. For the 2011 three-year performance period, the Company exceeded target performance levels with a payout percentage of 118%. Accordingly, an additional 9,014 shares of stock were issued to award recipients on February 1, 2014 (the “2011 Additional Shares”). 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 (the “2010 Additional Shares”). 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 February 3, 2012 (the “2009 Additional Shares”).

The total fair value of time-vested and performance-based restricted stock and RSUs that vested during the year ended December 31, 2014 and the 2011 Additional Shares that were issued was $3.6 million and the tax benefits for tax deductions realized from such shares was $1.2 million. The total fair value of the shares of time-vested and performance-based restricted stock that vested during the year ended December 31, 2013 and the 2010 Additional Shares was $4.1 million and the tax benefits for tax deductions realized from such shares was $1.4 million. The total fair value of the shares of time-vested and performance-based restricted stock that vested during the year ended December 31, 2012 and the 2009 Additional Shares was $4.0 million and the tax benefits for tax deductions realized from such shares was $1.4 million.

NOTE 9. LONG-TERM EQUITY-BASED COMPENSATION (Continued)

The grant-date fair values of DSU awards granted to Non-employee Directors are determined using the closing price of Kemper common stock on the date of grant. DSU awards granted to Non-employee Directors are fully vested on the date of grant. The total fair value of DSUs that vested during the years ended December 31, 2014 and 2013 was $0.2 million and $0.1 million, respectively.

Activity related to DSU awards for the year ended December 31, 2014 was as follows:



	Number of DSUs	Weighted- average Grant-date Fair Value Per DSU
Vested Balance at Beginning of the Year	4,000	$	31.50
Granted and Vested	4,000	37.53
Vested Balance at End of Period	8,000	$	34.52