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, 2018, there were 4,510,504 common shares available for future grants under the Omnibus Plan, of which 981,900 shares were reserved for future grants based on the performance results under the terms of outstanding performance-based stock unit 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 time-based restricted stock units (collectively “RSUs”), performance-based restricted stock units (“PSUs”) and deferred stock units (“DSUs”).

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

Outstanding equity-based compensation awards at December 31, 2018 consisted of tandem stock option and stock appreciation rights (“Tandem Awards”), RSUs, PSUs and DSUs. RSUs, PSUs and DSUs give the recipient the right to receive one share of Kemper common stock for each RSU, PSU or DSU issued. Recipients of RSUs, PSUs 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 awards subject to a performance condition, the Company recognizes compensation expense based upon the probable outcome of the performance condition, which on the grant date reflects an estimate of attaining 100% of the performance units granted. The estimate is revised if the actual number of PSUs expected to vest is likely to differ from the previous estimate. Compensation expense for awards is recognized on a straight-line basis over the requisite service period. 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 $18.6 million, $9.4 million and $4.7 million for the years ended December 31, 2018, 2017 and 2016, respectively. Total unamortized compensation expense related to unvested awards at December 31, 2018 was $23.0 million, which is expected to be recognized over a weighted-average period of 1.2 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. Tandem Awards and RSU awards granted to employees generally vest in three equal annual installments over a period of three years, with the Tandem Awards expiring ten years from the date of grant. Employee PSU awards generally vest over a period of three years, subject to performance results and other restrictions.

Under the Non-employee Director compensation programs in effect for 2018, 2017 and 2016, each non-employee director received an annual DSU award covering shares of Kemper common stock with an aggregate grant date fair value of $110,000, $110,000 and $75,000, respectively, at the conclusion of each annual shareholder meeting. 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.

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 2018, 2017 and 2016 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, 2018, 2017 and 2016 are presented below.



	2018					2017					2016
RANGE OF VALUATION ASSUMPTIONS
Expected Volatility	27.31	%	-	32.15	%	26.17	%	-	30.39	%	25.85	%	-	42.19	%
Risk-free Interest Rate	2.44		-	3.00		1.59		-	2.25		0.77		-	2.01
Expected Dividend Yield	1.16		-	1.72		1.39		-	2.43		2.22		-	3.41
WEIGHTED-AVERAGE EXPECTED LIFE IN YEARS
Employee Grants	4		-	6		4		-	6.5		1		-	6.5
Director Grants	N/A					N/A					N/A

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

Tandem Award activity for the year ended December 31, 2018 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	1,012,279		$	37.45
Granted	576,681		60.98
Exercised	(107,536	)	36.74
Forfeited or Expired	(47,151	)	52.06
Outstanding at December 31, 2018	1,434,273		46.48		7.86	$	28.8
Vested and Expected to Vest at December 31, 2018	1,359,250		$	46.22	7.82	$	27.7
Exercisable at December 31, 2018	586,600		$	36.18	6.71	$	17.7

The weighted-average grant-date fair values of Tandem Awards granted during 2018, 2017 and 2016 were $15.14, $8.89 and $5.17, respectively. Total intrinsic value of Tandem Awards exercised was $3.9 million, $4.9 million and $2.0 million for the years ended December 31, 2018, 2017 and 2016, respectively. Cash received from exercises of Tandem Awards was $0.9 million, $4.0 million and $3.5 million for the years ended December 31, 2018, 2017 and 2016, respectively. Total tax benefit realized for tax deductions from exercises of Tandem Awards was $0.8 million, $1.7 million and $0.7 million for the years ended December 31, 2018, 2017 and 2016, respectively.

Information pertaining to Tandem Awards outstanding at December 31, 2018 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 ($)
$	10.01	-	$	20.00	4,000	$	16.48	0.35	4,000	$	16.48
20.01		-	30.00		187,410	27.77		6.22	140,206	27.79
30.01		-	40.00		249,202	34.89		6.51	206,760	34.76
40.01		-	50.00		431,888	42.57		7.81	231,473	42.34
50.01		-	60.00		489,797	59.90		9.08	244	54.50
60.01		-	70.00		58,875	67.09		9.14	3,917	66.35
70.01		-	80.00		10,310	77.76		9.49	—	—
80.01		-	90.00		2,791	82.10		9.68	—	—
10.01		-	90.00		1,434,273	46.48		7.86	586,600	36.18

The grant-date fair values of RSUs are determined using the closing price of Kemper common stock on the date of grant. Activity related to nonvested RSUs for the year ended December 31, 2018 is presented below.



	Time-based Restricted Stock Unit Awards
	Number of Restricted Stock Units		Weighted- average Grant-date Fair Value Per Unit
Nonvested Balance at Beginning of the Year	130,247		$	40.34
Granted	249,422		73.94
Vested	(51,647	)	49.76
Forfeited	(11,781	)	38.71
Nonvested Balance at December 31, 2018	316,241		$	65.36

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

The initial number of PSUs awarded to each participant represents the number of Kemper common shares that would vest and 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 PSUs awarded to the participant. The final payout of these awards, and any forfeitures of PSUs 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, all of the PSUs will vest and 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 PSUs originally issued to the award recipient will vest; or


•	is below a “minimum” performance level, none of the PSUs originally issued to the award recipient will vest.

Activity related to nonvested PSU awards for the year ended December 31, 2018 is presented below.



	PSU Awards
	Number of PSUs		Weighted- average Grant-date Fair Value Per PSU
Nonvested Balance at Beginning of the Year	225,983		$	36.90
Granted	191,292		56.88
Vested	(77,244	)	37.63
Forfeited	(12,731	)	47.71
Nonvested Balance at December 31, 2018	327,300		$	47.14

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 PSU awards for the 2018, 2017 and 2016 three-year performance periods was 142,413 common shares, 80,999 common shares and 103,888 common shares, respectively, (as “full value awards,” the equivalent of 427,239 shares, 242,997 shares, and 311,664 shares, respectively, under the Share Authorization) at December 31, 2018.

The grant date fair values of the PSU 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 PSU 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.

Fifty percent of the PSU awards granted to employees and officers in 2018, 2017 and 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 units 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. The three-year performance periods for the 2018, 2017 and 2016 awards end on January 31, 2021, January 31, 2020 and February 28, 2019, respectively. 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)

Fifty percent of the PSU awards granted to employees and officers in 2018, 2017 and 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. The three-year performance periods for the 2018, 2017 and 2016 awards end on December 31, 2020, December 31, 2019 and December 31, 2018, respectively. 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 RSUs and PSUs that vested during the year ended December 31, 2018 was $8.7 million. The tax benefits for tax deductions realized from such awards was $1.8 million. The total fair value of RSUs and PSUs that vested during the year ended December 31, 2017 was $3.2 million. The tax benefits for tax deductions realized from such awards was $1.1 million. The total fair value of RSUs and PSUs that vested during the year ended December 31, 2016 was $1.3 million. The tax benefits for tax deductions realized from such awards was $0.5 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, 2018, 2017 and 2016 was $1.0 million, $0.9 million and $0.5 million, respectively.

Activity related to DSU awards for the year ended December 31, 2018 is presented below.



	Number of DSUs	Weighted- average Grant-date Fair Value Per DSU
Vested Balance at Beginning of the Year	44,560	$	35.54
Granted and Vested	12,780	77.50
Vested Balance at December 31, 2018	57,340	$	44.89