Dear Kemper Retiree:

Much has happened at Kemper since I last wrote to you in March. I wanted to take this opportunity to give you a brief recap of our situation and to let you know about some decisions that have been made regarding the 2004 benefits plan.

2003 has been the most difficult and challenging year in Kemper’s history. The challenges we’ve faced have been due to many factors. Our surplus has declined significantly in recent years as a result of underwriting losses, investment losses, mandated accounting changes and other factors.

The largest single contributor to our problems is the rising number of asbestos claims and lawsuits. Since 1980, Kemper has put up more than $2 billion in reserves to deal with the asbestos issue and other environmental claims, including more than $1 billion since 1996.

While the underwriting results in our core lines of business remained strong, we needed access to outside equity capital to sustain those results. Being a mutual company significantly inhibited our ability to raise outside equity capital, and ultimately we were unsuccessful in securing outside investment at the level we needed.

Our surplus drop, which we were unable to offset with an infusion of outside capital, resulted in numerous rating agency downgrades. These lower ratings had a significant effect on our ability to write new business and to retain existing policyholders.

As a result, we determined that the best course of action was to exit the underwriting business and focus our resources on ensuring a smooth run-off process. We decided to cease underwriting insurance and to sell certain of our business operations and renewal rights to our lines of business.

We have spent much of this year doing transactions to facilitate our departure from the underwriting business and preserve value for our policyholders. Since January 1, 2002, we have sold or put into run off 16 lines of business, 12 this year alone. In the process, we have reduced the number of employees by more than 7,500 – from 9,000 to the approximately 1,400 we have today. Fortunately, the majority of those employees accepted employment opportunities with the companies that acquired the lines of business we sold.

Now that we have substantially completed our exit from the underwriting business, we are focusing all of our efforts on achieving our goal of a successful run off. We must harness the assets and capital of the Kemper organization in a manner that allows us to satisfy our policy obligations. To do so, we must collect all of our reinsurance recoverables and efficiently and effectively manage the claim payment function, while at the same time reducing our operating expenses. And, we must balance our need to cut expenses with our desire to provide benefit to our retirees and employees.

We have recently completed a review of company benefits for both active employees and retirees. The bottom line is that we sought to preserve as many of our current benefit programs as possible. However, given our run-off environment, employees and retirees will bear more of the costs for some programs.

The company’s costs for retiree medical have grown exponentially over the last few years despite efforts to control them. These same market forces also highlight the critical need of many of our retirees to have access to medical benefits. So, for 2004, Kemper will continue to maintain a retiree medical plan. However, we will be reducing the company’s subsidy across the board, meaning that all retirees will pay more for their coverage. Even with these changes the company will spend over $5 million for retiree medical benefits in 2004.

We recognize these cost increases are significant. But operating the company in a manner that allows it to continue meeting its obligations to policyholders maximizes the likelihood that we will be able to continue subsidizing the retiree medical benefit beyond 2004.

As you know, a major factor in rising health care costs has been astronomical price increases for prescription drugs. There have been several proposals considered to add prescription drug coverage to Medicare. I encourage you to write to your congressman and senators and urge them to come to agreement on legislation that will address this issue in a meaningful way.

The other issue on the minds of our retirees is the status of the pension plan. In September, Kemper contributed more than $37 million to the plan, which brought our total funding for 2003 to more than $66 million. Due to the sharp decrease in the value of assets in the last few years, the plan liabilities continue to exceed the fair market value of the assets. Thus, additional funding into the plan will be required in 2004 and beyond. We have budgeted for and do currently intend to meet those funding obligations as they become due. Finally, we anticipate freezing the pension plan for current employees, which would limit the increases in liabilities under the plan.

Highlights of the complete 2004 Kemper benefits program are attached and we have included answers to some of your anticipated questions.

I want to thank all Kemper retirees for the contributions you made to our company in years past. We are all upset about the company’s current situation. But in looking back over the long history of Kemper, we have much to be proud of. Over the years, Kemper has helped countless individuals, families and businesses recover from the disruptions caused by losses. We did it with a degree of compassion and commitment that earned the Kemper name the respect of its customers, its agents and the industry. Your good work as active Kemper employees was important and for that you have our thanks.

Sincerely,

Highlights of 2004 Kemper benefits plan

• Access to retiree medical benefits will continue, but retirees will shoulder more of the cost. Kemper currently subsidizes health care coverage for employees who retire from the company after reaching age 55, have at least 10 years of continuous service, and meet participation requirements in a Kemper medical plan. Going forward, coverage, co-pays and deductibles will remain the same for these retirees. Changes to the program include:

  • Employees who are age 55 or older, who have more than 10 years of continuous service and meet participation requirements in a Kemper medical plan as of January 1, 2004, will continue to be eligible for subsidized coverage.
  • Employees under age 55 or who have less than 10 years of service will be provided access to retiree medical coverage, with the employee paying 100 percent of the cost, provided they reach age 55 with 10 years of service and meet participation requirements in a Kemper medical plan before leaving the company.
  • The company subsidy to retirees will be reduced by 50 percent. While access to medical coverage will be continued for spouses and dependents of retirees, there will be no company subsidy for this coverage.
  • The new subsidy is being capped at 120 percent of the company’s share of the retiree’s medical costs for 2004. For example, if Kemper’s share of a retiree’s premium is $100 per month in 2004, Kemper will pay no more than 120 percent of that $100, or $120, for that retiree in future years.

  Retirees can enroll on-line at www.ybr.com/benefits beginning on November 10, or by phone. Materials to facilitate enrollment will be mailed to all retirees’ homes by November 12. Open enrollment will end on November 26.

• We anticipate freezing the pension plan. This will not affect current retirees. For active employees, this would not affect benefits they have accrued through the date that the freeze took effect. However, employees would not accrue any additional benefits once the plan was frozen.

  Although future benefit accruals would stop once the plan was frozen, employees will continue to earn service toward vesting for as long as they continue to be employed by Kemper. Employees vest in, or earn rights to, their retirement plan benefit after five years of continuous service with the company.

• The employee medical and dental plans will remain in place. For those enrolled in CIGNA PPO and traditional plans, the employee share for medical coverage will increase from 20 percent to 30 percent, with the company’s share decreasing from 80 percent to 70 percent. For those enrolled in HMOs, we are eliminating current HMOs but will offer an Aetna HMO for employees located in Illinois. For both the CIGNA and Aetna plans, there will be no significant changes to coverage, co-pays or deductibles.

There are no changes in the coverage or company cost share for dental insurance.

As medical costs are increasing substantially across the country, we expect premium costs to increase for our providers as well. More details on rate increases will be available when open enrollment begins later this month.

• The 401(k) savings plan, including company contributions, will be maintained without change. Employees will continue to be able to save for retirement by making pre-tax contributions to the plan. The company will continue to match contributions using the current formula.

• The educational assistance program will be discontinued, except for those employees already receiving educational assistance toward a degree or certification.

• Many other employee benefit programs will continue substantially unchanged, including:

• Basic life insurance
• Salary continuation
• Business travel accident insurance
• Employee assistance program
• Flexible spending accounts
• Vacation buying plan
• Long term disability plan
• Voluntary optional life insurance
• Voluntary accidental death and dismemberment
• Long term care

Retiree Questions and Answers about 2004 benefits

What does “freezing accruals” in the retirement plan mean?

This change will not affect the benefits of current retirees. But we wanted you to have all pertinent information about any changes or potential changes in the retirement plan, whether or not you are affected.

It simply means that the company would be acting to limit the growth of future liabilities under the retirement plan. Upon retirement, a participant in the traditional pension program would receive whatever monthly benefit has been earned through the date the plan is frozen. However, the monthly benefit would not be increased for any additional service beyond the freeze date. Participants in the cash balance program would earn no further pay credits after the plan was frozen, but would continue to earn interest on their existing account balances until they retire or leave the company, at which time they may take their cash balance accounts with them.

In other words, no active employee will lose any retirement benefits already earned. Those benefits would simply not be increased by the company going forward.

Why is Kemper changing the subsidies on retiree medical?

The obvious reason is our need to reduce and control expenses to ensure a successful run off and to allow the company to meet its obligations to policyholders, employees and retirees in the future. The fact that Kemper is continuing to offer retiree medical benefits is bucking a trend in business generally. According to research by the Kaiser Family Foundation, only 38 percent of businesses with 200 employees or more are even offering access to medical benefits for retirees. Hewitt Associates, Kemper’s benefits administrator, recently reported that the average increase in medical benefits costs to American corporations will be in the neighborhood of 22 percent in 2004, a trend that is likely to continue in the years ahead. Clearly, we had to respond to the current medical cost environment and these changes are a part of that response. Kemper will spend almost $5 million on retiree medical benefit costs in 2004, which is more than the company will spend on medical benefits for active employees.

Did the company also decrease its share of employee medical benefits costs?

Yes. Employees will now pay 30 percent of the cost of their medical benefits instead of 20 percent as has been the case. The company’s share of the cost will reduce to 70 percent of those costs. This was done for the same reason that retiree subsidies were reduced and dependent subsidies were ended under the retiree medical benefits program, to control the company’s costs in a climate of skyrocketing medical expenses. All of us are being asked to help shoulder the impact of the company’s need to ensure a successful run-off operation.

Are the changes in retiree medical subsidies a prelude to the elimination of the program?

While no benefit plan, including retiree medical, can be guaranteed, the intent of the subsidy changes is to restructure the program to keep the program sustainable from a cost standpoint while continuing to allow access to medical benefits for current and future retirees. The company always reserves the right to amend and terminate the plan.

Why did we eliminate all HMOs except for Aetna HMO in Illinois?

Given the reduction in the number of employees over the past year, in most areas we do not have a sufficient number of employees to justify contracts with a variety of HMOs. Since Lumbermens is domiciled in Illinois, there is still a large enough employee population to warrant contracting with an HMO provider.