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, 2016, there were 6,762,714 common shares available for future grants under the Omnibus Plan, of which 682,752 shares were reserved for future grants based on the achievement of performance goals under the terms of outstanding performance-based restricted stock unit (“RSU”) awards.

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

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, 2016 consisted of tandem stock option and stock appreciation rights (“Tandem Awards”), time-vested restricted stock, time-vested RSUs, 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 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. Recipients of RSUs and DSUs receive full dividend equivalents on the same basis as 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 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 $4.7 million, $6.5 million and $6.4 million for the years ended December 31, 2016, 2015 and 2014, respectively. Total unamortized compensation expense related to nonvested awards at December 31, 2016 was $8.1 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.

Under the Non-employee Director compensation programs in effect for 2016, each non-employee director receives an annual DSU award covering shares of Kemper common with an aggregate grant date fair value of $75,000 at the conclusion of each annual shareholder meeting. Under the Non-employee Director compensation programs in effect for 2015 and 2014, annual awards to each Non-employee Director included 500 DSUs and stock options, as described below. 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.

In addition to the annual DSU awards under the Non-employee Director compensation programs in effect for 2015 and 2014, each Non-employee Director received an initial option award to purchase 4,000 shares of Kemper common stock immediately upon becoming a director, and in addition, received an annual option award to purchase 4,000 shares of common stock on the date of each annual meeting of Kemper’s shareholders. Grants of such option awards were fully vested and exercisable on the date of grant at an exercise price equal to the fair value of Kemper’s common stock on the date of grant and expire ten years from the date of grant.

Prior to approval of the Omnibus Plan, the Company’s previous 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. However, Restorative Options could still be granted, subject to certain limitations, in connection with the exercise of original options granted before February 3, 2009. Following the exercise in 2016 of original options previously granted prior to February 3, 2009 and the automatic grant of Restorative Options in

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

connection with such exercise, there were no options outstanding at December 31, 2016 that were eligible to receive a grant of a Restorative Option. 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. 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 2016, 2015 and 2014 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, 2016, 2015 and 2014 are presented below.



	2016					2015					2014
RANGE OF VALUATION ASSUMPTIONS
Expected Volatility	25.85	%	-	42.19	%	21.31	%	-	41.65	%	25.76	%	-	44.43	%
Risk-free Interest Rate	0.77		-	2.01		1.08		-	1.96		1.07		-	2.14
Expected Dividend Yield	2.22		-	3.41		2.37		-	2.62		2.53		-	2.60
WEIGHTED-AVERAGE EXPECTED LIFE IN YEARS
Employee Grants	1		-	6.5		4		-	7		4		-	7
Director Grants	N/A					5.5					6

Tandem Award activity for the year ended December 31, 2016 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	1,428,157		$	39.75
Granted	506,675		31.09
Exercised	(251,522	)	34.04
Forfeited or Expired	(377,187	)	43.72
Outstanding at December 31, 2016	1,306,123		36.35		6.5	$	11.5
Vested and Expected to Vest at December 31, 2016	1,254,165		$	36.49	6.4	$	10.9
Exercisable at December 31, 2016	701,486		$	38.32	4.8	$	5.3

The weighted-average grant-date fair values of Tandem Awards granted during 2016, 2015 and 2014 were $5.17, $7.85 and $10.49, respectively. Total intrinsic value of Tandem Awards exercised was $2.0 million, $4.6 million and $0.4 million for the years ended December 31, 2016, 2015 and 2014, respectively. Cash received from exercises of Tandem Awards was $3.5 million, $3.9 million and $0.5 million for the years ended December 31, 2016, 2015 and 2014, respectively. Total tax benefit realized for tax deductions from exercises of Tandem Awards was $0.7 million, $1.6 million and $0.1 million for the years ended December 31, 2016, 2015 and 2014, respectively.

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

Information pertaining to Tandem Awards outstanding at December 31, 2016 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 ($)
15.01	-	20.00	4,000	16.48	2.35	4,000	16.48
20.01	-	25.00	9,500	23.37	3.06	9,500	23.37
25.01	-	30.00	316,603	27.89	8.21	116,909	28.20
30.01	-	35.00	176,845	32.43	8.18	74,742	32.33
35.01	-	40.00	437,299	36.64	7.21	270,763	36.67
40.01	-	45.00	166,376	41.33	7.02	30,072	40.70
45.01	-	50.00	195,500	49.74	0.11	195,500	49.74
15.01	-	50.00	1,306,123	36.35	6.45	701,486	38.32

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, 2016 is presented below.



	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	29,448		$	33.77	85,048		$	36.84
Granted	—		—		118,622		31.48
Vested	(12,098	)	32.32		(26,006	)	33.01
Forfeited	(1,350	)	35.75		(19,303	)	36.03
Nonvested Balance at December 31, 2016	16,000		$	34.69	158,361		$	33.56

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 the Company’s performance. If, at the end of the applicable performance period, the Company’s 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 or RSUs originally issued to the award recipient will vest; or


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

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

Activity related to nonvested performance-based restricted stock and nonvested performance-based RSU awards for the year ended December 31, 2016 is presented below.



	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	51,400		$	42.12	128,100		$	41.85
Granted	—		—		146,788		29.62
Forfeited	(51,400	)	42.12		(47,304	)	39.04
Nonvested Balance at December 31, 2016	—		$	—	227,584		$	34.55

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 2016 and 2015 three-year performance periods was 137,615 common shares and 46,762 common shares, respectively, (as “full value awards,” the equivalent of 412,845 shares and 140,286 shares, respectively, under the Share Authorization) at December 31, 2016. For the 2014 three-year performance period, the Company’s performance level was below the minimum performance level, and all of the related 43,207 shares of performance-based RSUs were forfeited on February 4, 2017, the three-year anniversary of their grant date. For the 2013 three-year performance period, the Company’s performance level was below the minimum performance level, and all of the related 51,400 shares of performance-based restricted shares were forfeited on February 4, 2016, the three-year anniversary of their grant date.

The grant date fair values of the performance-based restricted stock and performance-based RSU awards with a market performance condition 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.

Performance-based awards outstanding on January 1, 2016 are measured using a market performance condition. Fair value for these awards was estimated using the Monte Carlo simulation method described above. For awards outstanding on January 1, 2016, the final payout of these awards, and any forfeitures of shares for performance below the “target” performance level, are determined based on Kemper’s total shareholder return, relative to a peer group comprised of all the companies in the S&P Supercomposite Insurance Index, over the respective three-year performance period ending on either December 31, 2017, 2016 or 2015, depending on the three-year performance period being measured. Compensation cost for these awards is recognized ratably over the requisite service period. In the event that the market performance condition is not satisfied, previously recognized compensation cost would not reverse, but it would reverse if the requisite service period is not met.

Half of the performance-based RSUs granted in 2016 are measured using a market performance condition. Fair value for these awards was estimated using the Monte Carlo simulation method described above. Final payout for these awards, and any forfeitures of shares for performance below the “target” performance level, will be based on Kemper’s total shareholder return, relative to a peer group comprised of all the companies in the S&P Supercomposite Insurance Index, over a three-year performance period ending on February 28, 2019. Compensation cost for these awards is recognized ratably over the requisite service period. In the event that the market performance condition is not satisfied, previously recognized compensation cost would not reverse, but it would reverse if the requisite service period is not met.

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

Half of the performance-based RSUs granted in 2016 are measured solely using a Company-specific metric. Final payout for these awards, and any forfeitures of shares for performance below the “target” performance level, will be determined based on Kemper’s adjusted return on equity over a three-year performance period ending on December 31, 2018. Fair value for these awards was determined using the closing price of Kemper common stock on the date of grant. Accruals of compensation cost for these awards are estimated based on the probable outcome of the performance condition.

The total fair value of time-vested and performance-based restricted stock and RSUs that vested during the year ended December 31, 2016 was $1.3 million. The tax benefits for tax deductions realized from such shares was $0.5 million. The total fair value of the shares of time-vested and performance-based restricted stock that vested during the year ended December 31, 2015 was $1.4 million. The tax benefits for tax deductions realized from such shares was $0.5 million. The total fair value of the shares of time-vested and performance-based restricted stock that vested during the year ended December 31, 2014 and the 2011 Additional Shares was $3.6 million. The tax benefits for tax deductions realized from such shares was $1.2 million.

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. The total fair value of DSUs that vested during the years ended December 31, 2016, 2015 and 2014 was $0.5 million, $0.1 million and $0.2 million, respectively.

Activity related to DSU awards for the year ended December 31, 2016 is presented below.



	Number of DSUs	Weighted- average Grant-date Fair Value Per DSU
Vested Balance at Beginning of the Year	7,000	$	36.17
Granted and Vested	14,520	31.00
Vested Balance at December 31, 2016	21,520	$	32.68