Unum Group
Q4 2008 Earnings Call Transcript

Published: 4 Feb 2009

Operator:

Good day and welcome to the Unum Group Fourth Quarter 2008 Earnings Results Conference Call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Head of Investor Relations, Mr. Tom White. Please go ahead, sir.
Tom White:

Great, thank you, and good morning, everyone, and welcome to the fourth quarter 2008 analyst and investor conference call for Unum Group. As we get started, I want to remind you that our remarks this morning will include forward-looking statements, which are statements that are not of current or historical fact. As a result, actual results might differ materially from results suggested by these forward-looking statements. Information concerning factors that could cause results to differ appears in our filings with the Securities and Exchange Commission, and are also located in the sections titled ‘Cautionary Statement Regarding Forward-Looking Statements,’ and ‘Risk Factors’ [ph] in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 and also in our subsequently filed Form 10-Q. Our SEC filings including our Forms 10-K and 10-Q can be found in the Investors section of our website at unum.com. Please also take note that the statements in today's call speak only as of the date they are made and we undertake no obligation to publicly update or revise any forward-looking statements. As usual, a presentation of the most directly comparable GAAP measures and reconciliations of any non-GAAP financial measure is included in today's presentation can be found on our website in the Investors section. Yesterday afternoon, Unum Group reported earnings for the fourth quarter of 2008. Net income in the quarter was $41.8 million or $0.13 per diluted common share compared to net income of $160.5 million or $0.44 per diluted common share in the fourth quarter of 2007. Included in these results for the fourth quarter of '08 are net realized after-tax investment losses of $167.6 million or $0.50 per diluted common share and $16.5 million or $0.05 per diluted common share in the fourth quarter of 2007. These losses include the impact of the provisions of DIG B36 accounting, which require changes in fair value of an embedded derivative in a modified coinsurance contract to be reported as realized investment gains and losses. This accounting requirement resulted in a fourth quarter 2008 realized after-tax investment loss of $120.1 million compared to $23.3 million after-tax loss in the fourth quarter of '07. Net realized after tax investment losses related to sales and write-downs of investments were $47.5 million in the fourth quarter of ‘08 compared to net realized after tax investment gains of $6.8 million in fourth quarter of 2007. Results for the fourth quarter of 2007 also included an after tax debt extinguishment cost of $36.1 million, which is $0.10 per diluted common share. So, excluding these items, after tax operating income was $209.4 million or $0.63 per diluted common share compared to $213.1 million or $0.59 per diluted common share in the fourth quarter of 2007. On the call this morning are President and CEO, Tom Watjen; also Bob Greving, who is Executive Vice President, Chief Financial Officer, and Chief Actuary, as well as the heads of our three major operating segments – Kevin McCarthy, Susan Ring, and Randy Horn. And at this time I'd like to turn the call over to Tom.
Tom Watjen:

Thank you, Tom, and good morning. The fourth quarter was a good quarter for Unum, which closes out a pretty good year for us in 2008, and let me touch on a few of the highlights. First, as Tom mentioned in his opening remarks, excluding net realized after tax investment losses, we reported $0.63 per share in operating income for the fourth quarter, which was 7% higher than the $0.59 we reported in the fourth quarter of 2007. This brings our full year 2008 operating income to $2.51 per share, a 14% increase over 2007. Second, operating results in the quarter remained strong. Risk results were generally in line with our expectations across all our core businesses. This was tempered somewhat by lower miscellaneous net investment income, the weakness of the British pound, which impacted the translation of our U.K. earnings, and expenses primarily related to employee terminations costs associated with cost management actions taken in Unum UK. Third, we saw a continued positive momentum in our sales results. The focus across all of our operating businesses remained to profitably grow our core market businesses with the sales to small and mid-size employer marketplace and we saw good success again this quarter. Fourth, reflecting the challenging investment environment, realized investment losses remained higher than normal this quarter. However, the fourth quarter losses, excluding DIG B36, were somewhat lower than in the third quarter of 2008. While we expect to continue to see a higher than normal level of realized investment losses until the general economic and financial market environment improves, we remain confident that our portfolio is well positioned to weather this difficult business environment. And we have the financial flexibility to absorb the investment losses, which might occur in this more challenging period. Also, the net unrealized loss position in our fixed maturities portfolio widened somewhat in the fourth quarter, which again reflects the widening of spreads, particularly this past quarter in the below investment-grade sector of the market, and Tom White will have more on this in a moment. As we have discussed with you in the past, we have very predictable cash needs, and virtually no disintermediation risk in our insurance liabilities. And therefore we are under no pressure to sell investments at a loss to meet policyholder obligation. As we have stated before, these wider spreads also present favorable opportunities for new investment. And the fourth quarter provided an excellent environment to put new money to work at very attractive yields and therefore enhance our portfolio yield, and I might add, without adding [ph] any additional risk to the portfolio. Lastly, we continue to comfortably exceed our targets for capital and liquidity, leverage, and risk-based capital. This financial flexibility positions us well for the continuing challenging environment we find ourselves in. Now, before I make a few additional comments on our fourth quarter operating results, I wanted to spend a moment on the change in 2009 guidance that we announced with our operating earnings release yesterday. We provided our initial guidance for 2009 at our Investor Day meeting back on November 11, based on business indicators as of the end of October. Over the past three months, we have seen continued poor financial market performance, a dramatic weakening of the pound, the British pound, to levels not seen in over 20 years, and certainly further signs that the economic and employment picture will worsen in 2009. In light of these factors, we felt that it was prudent to adjust our guidance downward, as others have, to in our case a range of $2.45 per share to $2.55 per share in operating earnings. Again, this revised guidance reflects three things. First, a move from an exchange rate of $1.65 to $1.50; second, our higher expected pre-tax pension cost of approximately $42.5 million, which reflects the lower rate of return on plan assets during 2008, and the lower discount rate assumptions for our pension liabilities; and thirdly, while we have not yet seen any meaningful changes in our paid incidence claims as the employment picture has deteriorated since most economists have assumed further pressure on employment and consumer confidence, we felt that it was prudent to incorporate some further deterioration in our outlook for 2009. We are now projecting operating earnings in 2009 to be slightly below that of 2008, down from our earlier guidance of growth of 4% to 6%. I think it’s important to note again that at this time we have not seen any material impact on our operating results from the weak economy. But again, given the general view that things may worsen, we felt that it was appropriate to assume so in our guidance as well. Our 2009 capital guidance we presented in November is largely unchanged, with risk-based capital for our U.S. insurance subsidiary still expected in a range of 330% to 335%, the Holding Company liquidity to exceed $750 million. We are making a slight revision to our leverage expectation from our earlier projection of 18% to 19% to a range of 20% to 21%. As you can see, even with this revised operating earnings guidance for 2009, we believe Unum will maintain excellent financial flexibility, a necessity in these extraordinarily turbulent times. Now, let me come back to our fourth quarter results and provide a few comments on the performance of each of our businesses. First, Unum US, our pre-tax operating earnings for Unum US increased 13.5% to $182.6 million in the fourth quarter with favorable performance in the group disability and supplemental and voluntary lines of business, which offset lower earnings in the group life line. Group disability earnings were 38% higher with solid risk results offset somewhat by lower net investment income related to lower bond call premiums. Importantly, the group disability benefit ration for the fourth quarter improved to 88.7%, a decline of 60 basis points from the third quarter of 2008, and a decline of 280 basis points from the fourth quarter of 2007. Seasonally adjusted submitted incidence trends showed a slight rise in the quarter for our LTD line of business, but remained within the range of incidence levels we have experienced over the past several quarters. I might add that this result was within our range of 88% to 89% that we had projected for the end of 2008 or early 2009. We saw very strong results from the supplemental and voluntary lines with earnings growth of 26% while group life and AD&D results were down about 16%, driven primarily by lower group life premium income and slightly higher claim experience. Total Unum US sales increased 13% in the fourth quarter with strong results in the core market where sales grew almost 30%. Our voluntary benefit sales were flat this quarter, but full year 2008 grew at almost 15% and the pipeline for 2009 sales activity is encouraging. And Kevin McCarthy is available with us today obviously to answer some questions you may have about the business and the marketplace. Now, turning to Unum UK, our pre-tax earnings in Unum UK were $54.6 million for the fourth quarter. These results were lower relative to the fourth quarter of 2007 in large part due to the significant decline in the value of the British pound. Risk results remained in line with our longer term expectations, driven primarily by a decline in premium income, but somewhat higher than recently quarterly experience. Unum UK’s fourth quarter results were also impacted by $6.2 million of employee termination cost in the quarter as they implemented a number of cost reduction actions. These actions are intended to bring our expense base better in line with our premium expectations as well as improve our operating effectiveness. And Susan Ring is available with us here this morning to answer any questions you may have, again, of our U.K. business or the U.K. marketplace. And finally, in our Colonial operations, our pre-tax earnings increased 13% to $66.3 million in the fourth quarter as we continue enjoy solid margins in this business. While total sales increased only 1% for the fourth quarter, the lower long term expectations, our recruiting results and productivity measures are encouraging and we believe will help us grow this business in the future. And again, Randy Horn is with us here this morning to answer any questions you may have about Colonial or the Colonial marketplace. Now, let me come back to investments. I mentioned it earlier, but let me say again that our investment portfolio continues to perform well with a low, manageable level of default experienced. We are seeing good opportunities to put new money to work at attractive yields while maintaining our investment quality objective. As for the increase in our net unrealized investment losses, we attribute the majority of the growth to wider corporate bond spreads. We certainly monitor these changes in our portfolio of values. It’s not something we feel is a concern since we are not in a business, which will lead to the need to sell investment prior to maturity. And last, with regard to our capital position, we closed 2008 with what we believe to be a very solid financial position, one that positions us well for this challenging environment. Our risk based capital ratio for our traditional and U.S. life insurance companies is 327%, above our long term target of 300%. Leverage excluding the nonrecourse debt and capital of Tailwind and Northwind Holdings finished the year 21.5%, again below our long term target of 25%. And our holding company liquidity was $526 million, also comfortably above our $270 million target, which allows coverage for one-year fixed charges plus maintenance of the capital cushion for business and economic volatility. In summary, I feel good about the fourth quarter results and our position as we head into a challenging 2009. Our core operating segments continue to meet expectations with steady risk results across our major business. We have good sales momentum in our targeted core markets. Our investment portfolio continues to perform well in this slightly very difficult environment. We continue to maintain solid financial flexibility. And finally, our people are focused on executing our plans and not letting the external environment to become a distraction. Looking ahead, 2009 is certainly shaping up to be another challenging year where we are benefiting from the steps we took over the past few years to strengthen our operating and financial performance. Our primary focus is to continue to execute our plans and being alert for opportunities this environment may create. Now, I’ll turn the call back over to Tom White, who’ll provide more detail on the fourth quarter results. Tom?
Tom White:

Thanks, Tom. I want to take a few minutes to supplement Tom’s comments and provide some operating highlights on the quarter and I’ll also provide an update on the investment portfolio. First, looking at operating results for the Unum US group disability line, we continue to see improvement in the group disability benefit ratio, which declined to 88.7% for the fourth quarter. New submitted claim incidence on a seasonally adjusted basis was slightly higher in the fourth quarter than the third quarter of 2008, but remained within the range of incidence levels we have experienced over the past several quarters. Additionally, the short term disability line, which often can be a leading indicator of LTD claim incidence, continues to perform well with a low level of claim incidence in the fourth quarter. The discount rate on new claim incurrals was raised in the fourth quarter, which produced a slight benefit to our fourth quarter results. I will note, however, that the beneficial impact of the discount rate adjustment was less than the 60 basis point improvement in the overall benefit ratio from the third to the fourth quarter. Net investment income in the fourth quarter declined by slightly more than 1% from year-ago levels, primarily due to lower – a lower level of bond calls activities, which is a trend that we have seen – which we do see continuing into 2009. The Unum US group life and AD&D line results here declined to $50.3 million in the fourth quarter compared to $60.1 million in the year-ago quarter, but were in line with the $50.9 million that we reported in the third quarter of 2008. The benefit ratio was fractionally higher than a year ago at 70%, primarily reflecting an average claim size. Margins in this line were also impacted by a higher expense ratio, which is due to the mix of business shift to more smaller core market cases, and also a 3% decline in premium income. Moving to the Unum US supplemental and voluntary line, we continue to see very strong results here with record quarterly before tax operating earnings of $72.6 million, an increase of 26%. All three primary lines, which are the recently issued individual disability, the voluntary benefits, and long term care, produced year-over-year improvement in operating earnings. Premium income grew by 7.7 – and risk results were stable to slightly improved across each product line. As Tom indicated earlier, we reported sales for Unum US – our reported sales for Unum US increased by 12.7% in aggregate and there were several bright spots to highlight. Our core market sales for our group lines, which are LTD, STD, and the group life, and AD&D combined, showed continued strong momentum, increasing 29.6% for the fourth quarter and 23.7% for full year 2008. Sales in the large case market remained flat in the fourth quarter as we remained disciplined and opportunistic in that market. Voluntary benefit sales increased less than 1% in the fourth quarter, but increased 14.6% of full year 2008. Our activity in the core market remained strong with high activity levels for quotes and new coverage sales. And finally, persistency levels for our primary lines within Unum US improved over 2007 levels, most significantly in the STD and group life lines. So, to summarize the results for Unum US as a segment, continued strong risk management results across the board. Some pressure on net investment income due to lower levels of miscellaneous net investment income, but continued positive sales momentum, particularly in our targeted core markets. For Unum UK, the decline in the value of the British pound relative to the dollar negatively impacted the translated fourth quarter results for the Unum UK segment. But the underlying operating results were generally strong. The benefit ratio rose to 63% in the fourth quarter, driven primarily by the decline in premium income. We experienced an uptick in new claim incidence in the fourth quarter, primarily from our banking sector exposure. However, this increase was largely offset by strong claims management and higher claim recoveries. As mentioned previously, we recorded 3.9 million pounds or $6.2 million of expenses in the fourth quarter relate to our disciplined cost management program, which is intended to bring the expense base of Unum UK more in line with the lower level of premium income and to improve operating efficiencies, going forward. These incremental expenses totaled 4.4 million pounds in 2008, and are expected to be more than offset by cost savings and improvements in operating efficiencies in 2009. Fourth quarter sales declined 22% in dollar terms, but in local currency increased 2.4% in the fourth quarter and 3.6% for the full year. The group risk markets in the Unum UK – in U.K. remained very competitive especially in group life and the large case segments. The competitive dynamics of the U.K. market are also impacting our persistency results with persistency for group disability at 87.4%, which is below our long term expectations. This level of persistency combined with the current level of new sales activity will make top line growth difficult to achieve that we do expect the profitability of Unum UK to remain at strong levels. Moving to Colonial Life, we had continued favorable performance with $66.3 million in before tax earnings for the fourth quarter, 13% higher than the year ago levels. The benefit ratio was fractionally higher than last year, 48.3%, compared to 48% last year, reflecting slightly higher claims activity in the older cancer blocks, but generally stable performance across the other product lines. We are in the process of taking pricing actions on the underperforming older cancer product lines and no longer actively market these specific policies. Sales at Colonial Life increased by 1.1% for the fourth quarter and 1.6% for the full year, below our long term growth objectives and certainly impacted by the weak economy. We remain encouraged, however, by activity levels in the market. New account growth was up approximately 6% in the fourth quarter. We are seeing pressure on rework sales, which are the follow-up sales to existing customers. This is historically an important source of sales growth at Colonial Life. New sales rep recruiting continues to show positive trends with new contracts increasing by 4% in the fourth quarter and 28% for the full year. And finally, persistency at Colonial Life remained stable in the major product lines relative to year ago results. The individual disability – close block segment pre-tax earnings here was $7.1 million in the fourth quarter of 2008 compared to $15 million in the year ago quarter. Risk results were steady with the interest adjusted benefit ratio at 82.6% this quarter compared to 83.8% last year. Net investment income continues to be volatile and again this quarter was significantly lower than the year ago quarter primarily due to the lower level of assets supporting this run off block of business as well as the ongoing impact of fewer bond call premiums this quarter, which negatively impact net investment income by $5 million compared to year ago quarter. The corporate and other segment recorded an operating loss of $400,000 compared to a loss of $65.2 million in the year ago quarter. Excluding the debt extinguishment cost of $55.6 million, the fourth quarter 2007 loss was $9.6 million. This segment did benefit from $7.6 million of other income received in the fourth quarter related to a refund of interest primarily attributable to prior tax years. Also, point out that interest expense was reduced to $26.9 million in the fourth quarter of ’08 compared to $38.7 million in the year ago quarter. Finally, our weighted average share count, assuming dilution for the fourth quarter was 331 million shares compared to 360.7 million shares in the fourth quarter of ’07 and the actual number of shares outstanding at year-end 2008 was 331.1 million. Book value per share declined to $19.32 per share as of December 31, 2008, and this compares to $22.28 at December 31,2007. When you exclude the net unrealized gains and losses on security and the net gain on cash flow hedges, the book value per common share was $20.45 at the end of 2008 compared to $20.79 at the end of 2007. Earnings on a statutory accounting basis remained very healthy with fourth quarter 2008 net gain from operations after tax of $227.4 million for our traditional U.S. insurance subsidiaries. Net income was $143.9 million. For full year 2008, the net gain from operations, again after tax, was $682 million for our traditional U.S. insurance subsidiaries and net income was $540.8 million. Now, I’d like to spend a few minutes on the investment environment and our investment portfolio and also the capital and liquidity positions of the Company. On our third quarter conference call and at our November analyst meeting, we discussed with you our liquidity position. To summarize, Unum is primarily an employee benefits and individual disability company. For the vast majority of our in-force blocks, if a policyholder lapses a policy they will start paying as premiums, but we do not owe them any cash value on the policy. Simply stated, we have very minimal run-on-the-bank risk. It is because of this liability structure that we have the ability to hold our investments to maturity. Therefore, we are not in position to have to liquidate investments at an inopportune time such as today with the historically wide credit spreads to meet policyholder obligations. In addition, we have very little refinancing risk. At year end, we had short term debt of $190.5million, $58.3 million of that amount were reverse repurchase agreement, which will be paid off with operating cash flow, and then $132.2 million is short term debt that is due in May of 2009. We have the cash on hand to retire that debt when it comes due or will look to refinance, if market conditions improve. During the fourth quarter, the level of unrealized losses in our fixed maturity bond portfolio increased as corporate bond spreads widened further. The net unrealized loss position was $2.1 billion at December 31, 2008, compared to $1.7 billion at September 30th, 2008. When you look back at the third quarter of ’08, we commented on our call and at our investor meeting that we had experienced basically a parallel shift in the value of our fixed maturity holdings. That is, basically all securities, regardless of rating, declined in value by roughly 4.5%. Let me contrast that to what we experienced in the fourth quarter in that our more highly rated securities tended to improve in value while the lower rated securities declined in value, and you will see this in the various benchmarks. For example, the 10-year Treasury bond declined in yield by approximately 160 basis points during the fourth quarter while most benchmark corporate bond spread indices widened. The single A index widened by about 36 basis points and the Triple B index widened by 284 basis points, and the below investment-grade index widened by over 600 basis points. So when you examine Page 13.1 of our fourth quarter statistical supplement you will see that year-end we held $13.5 billion of fixed maturity bonds that had a gross unrealized gain of $1.3 billion. This will compare to third quarter of ’08 holdings of $12.7 billion of fixed maturity bonds with gross unrealized gains of $911 million. Looking again at the fourth quarter of ’08, you will see that we had $18.4 billion of fixed maturity bonds with a gross unrealized loss of $3.4 billion, and this compares to the third quarter when we had $20.2 billion of fixed maturity bonds with gross unrealized losses of $2.6 billion. A couple of points to make on those securities in a gross unrealized loss position. First, 81% of our unrealized losses were related to bonds that carry an investment-grade rating, so we would expect that the default risk to be relatively low on those. And second, when we examined the bonds trading at less than 80% of book value, 86% of these had been in a market to book value ratio of less than 80% for less than 180 days, which does indicates that the price decline has been recent and a result of the significant widening of spreads in the second half of 2008. Now, as Tom said, there is also a positive side to the widening of corporate bond spreads in that the very attractive yields that we are seeing on new money purchases. Our new money yields in the quarter were 8.47% on a hedge-adjusted basis and this compares to 6.77% on a hedge-adjusted basis in the third quarter. The average credit rating on these purchases in the fourth quarter was A2, so we were able to achieve these yields without sacrificing quality. And this has the benefit of stabilizing our duration weighted book yield at 6.72% compared to 6.70% at the end of the third quarter. There have been some additional investment classes that have been receiving a lot of attention lately, so I’d like to spend a minute discussing our exposures to CMBS and commercial mortgage loans as well as our exposure to hybrid securities. First, our CMBS exposure is nominal at $4.2 million of book value, and just as with subprime mortgages we were never a significant investor in these types of securities. Our commercial mortgage loan exposure was $1.27 billion at the end of 2008 or 3.4% of total invested assets. We currently only have one mortgage loan of $5.2 million that is delinquent, and we have another four loans, which total $30 million that are on our watch list, which is the list of investments that are presently current, but are subject to enhanced monitoring and more intensive review. We believe our overall commercial mortgage loan portfolio is of high quality with a loan-to-value ratio of approximately 67% and this is with the value based on our internal underwriting and not the appraised value, which is generally higher. We are typically – we are underweight in retail loans and on a geographic basis we are underweight in the California market. Moving to hybrid securities at year-end 2008, we had holdings of approximately $496 million on a book value basis. Approximately 64% are Tier 1 securities with the balance in the upper Tier 2 securities. We have three positions in – we have positions in three securities, which currently carry one or more below investment-grade ratings. And these Royal Bank of Scotland, Northern Rock, and Anglo Irish Bank, and our combine holdings of these three is $129 million on a book value basis. The balance of our hybrid holdings are investment-grade and all of our hybrid holdings are current on their interest payments. So, I will close my remarks with a summary of realized investment losses for the fourth quarter. Again, our reported net recognized investment losses excluding the loss of $120.1 million after tax or $184.7 million before tax on DIG B36, this totaled $47.5 million after tax or $73 million before tax. On a before tax basis, the realized losses from writedowns totaled $83.5 million while realized investment gains from sales totaled $10.5 million. The primary sources of the realized investment losses from writedowns were Ford Motor at $32 million; there were two media companies, Idearc at $21.6 million and McClatchy at $12.1 million and then Lyondell Petrochemical at $12.9 million. And we’ll be pleased to address any specific questions you may have regarding our investment holdings in the Q&A session. So, with that, let me turn it back to Tom for some final closing comments.
Tom Watjen:

Thanks, Tom. Before I move to your questions, let me conclude with a couple of final comments. As you saw yesterday, we announced that our CFO, Bob Greving, has announced his intention to retire later this year and we have initiated a search process for his successor. As you know, Bob has been an integral part of our senior leadership team for more than a decade and has been instrumental in helping us build a strong financial foundation we enjoy today. Bob has been kind enough to provide us with plenty of advance notice to ensure an orderly transition and will certainly be very involved in the process including to help to assure a transition, so Bob isn’t going to be going anywhere soon. In closing, I’d like to reiterate how pleased I am, but not complacent with the current position of the Company. We are not immune to feeling the effects of the economy, but I believe that we have the management and resources and in place to ensure that we can successfully overcome the challenges that lie ahead. Our strategy today is standing on disciplined, profitable growth with a sharp focus on risk management throughout the organization. This strategy has served us well as we are a more diversified company, better positioned for today’s challenging environment. Our investment portfolio is well positioned with historically low levels of high yield bonds and minimal exposure to the asset classes that are causing significant losses in the financial system today. While unrealized losses in the portfolio remain higher due primarily to wider corporate bonds spreads, our liquidity position is strong and the nature of our liabilities means that we do not need to sell investments to meet policyholder obligations. And our balance sheet is strong and our financial flexibility is as well with (inaudible) risk based capital, leverage, and holding company liquidity comfortably ahead of our targets. At this time, operator, we are ready to begin the question-and-answer session.
Operator:

(Operator instructions) We’ll go first to Darin Arita at Deutsche Bank.
Darin Arita:

Hi, good morning.
Tom Watjen:

Good morning, Darin.
Darin Arita:

A couple of questions here, the first one is on the – on U.S. group long term disability. I was just wondering if you could talk about any changes in claims trends that you are seeing across industries, if you look at the spectrum of lower risk to higher risk sectors?
Tom Watjen:

Sure, and maybe I’ll ask Kevin to address that one, Darin.
Kevin McCarthy:

Good morning, Darin.
Darin Arita:

Good morning.
Kevin McCarthy:

As Tom mentioned, we saw a slight uptick in incidence during the fourth quarter, but most of that was what I’ll call sort of normal noise. We didn’t see any uptick, for example, in education or finance. We saw a mild uptick in manufacturing, transportation and utilities, which we normally see. But then we look at incidence in STD or IDI or waiver premium in life and in fact, if anything, we saw slight improvements in incidence there. So, overall, it was kind of a pretty normal and stable quarter in terms of incidence and no particular trend to point to
Darin Arita:

Okay, great. And turning to the UK, I mean the competitive environment still seems difficult there. I was just wondering how quickly do you think claims trends could increase as unemployment rises, so some of your more aggressive competitor feel some pain.
Tom Watjen:

It’s a good question. Susan, you want to take that one?
Susan Ring:

Yes, sure, thanks Darin. As you say, it is quite a hostile competitive environment in the U.K. at the moment and has been pretty much throughout 2008. And in terms of claims trends we have seen an increase in incidence and during the fourth quarter, so that was primarily from our banking sector and primarily for psychological claims reasons. So – and we have already seen that come through. Having said that, we have an increase in the cap rates, which has more than offset that. So our claims run off experience has been continually very strong. And so that has already come through. And we also have a very strong investment in our return-to-work assets. So, we are seeing consistent and favorable performance on that front. So, I think that provides us some additional resilience in terms of the operating environment that we are operating in.
Tom Watjen:

And maybe, Susan too I think Darin was trying to get hold to also to the competitive environment too and I think for the most part, although you see some competition in group disability, probably the greatest competition is in group life. So even though we are seeing maybe a softer economic environment, we may not see any let down in the competitive dynamics in the group life marketplace.
Susan Ring:

No, I agree. As you say, as I was saying earlier, it is very hostile from a competitive point of view. We are seeing that really radical product expense and it’s even more aggressive in the group life sectors, which has had some impact from our persistence (inaudible) June 2008. We do expect that to continue during 2009, particularly as we know that we have a competitor entering the market and we expect them to make a lower prize play. So, we don’t really see that’s going to change in 2009.
Darin Arita:

Alrigh, thank you.
Tom Watjen:

Thank you, Darin.
Operator:

And next we’ll go to Jeff Schuman at KBW.
Tom Watjen:

Good morning, Jeff.
Jeff Schuman:

Good morning, a fairly narrow question here. The pension – the increase in pension cost, how will that emerge – it’s at $42.5 million in ’09, should I think of that as just kind of a $10 million a quarter (inaudible) going forward or is there some kind of one-time element referred to that?
Tom Watjen:

Bob, you want to take that?
Bob Greving:

Yes, hi Jeff, this is Bob Greving. Yes, it basically will be assessed on a quarterly basis, so it will be – it will emerge on a fairly level basis each quarter.
Tom Watjen:

And I will suggest, I’d to that, it will show up in the corporate and other line – expenses line there.
Bob Greving:

Right.
Jeff Schuman:

But as of the change in market conditions, it would go on – and ’09 is kind of just a new level is that how we should think of it?
Bob Greving:

Yes, as you know the accounting for pensions is kind of strange and the losses that were incurred in the year in the investment portfolio get amortized over a number of years, so we’ll still see elevated expenses for several years, but it will ultimately settle back into the kind of the normal cost range.
Tom Watjen:

Bob, I’d say at the end of the year there is another assessment of it as well as the cost, the assets and the liabilities and what’s changed in both of those, so that’s an annual process that every company goes through it.
Bob Greving:

That’s correct.
Jeff Schuman:

Okay, that’s helpful. Then one other question. You did take serious look at costs in the U.K. and took some actions this quarter. Should we anticipate that you might take a sharper look at some operations or not?
Tom Watjen:

Yes, I think just generally, Jeff, I think every one is just – I think on an everyday basis consistently looking at cost at productivity at the same time looking for ways to improve operational efficiencies and effectiveness and there were certainly some more visible things that were done in the U.K., but I’d say Kevin and Randy, in those business, you are continually looking at things, but more just kind of on a – not on a project basis, but on just an everyday basis. And I don’t know Kevin or Randy if you want to add anything to that.
Kevin McCarthy:

Tom, that’s right on. Thanks for coming up all the time. And we are just trying to take advantage of opportunities as they arise but no special project I’d focus.
Jeff Schuman:

Okay, thanks a lot guys.
Tom Watjen:

Thanks, Jeff.
Operator:

Next we’ll go to Colin Devine of Citigroup.
Colin Devine:

Good morning.
Tom Watjen:

Good morning, Colin.
Colin Devine:

A couple of questions. First, it was a DAC adjustment at Colonial, if you could comment on what that was? Second, if you can just clarify on the hybrids, if they are Tier 1 or Tier 2 and what type of Tier 2, and expand that perhaps on the U.K. And then the final question, which we’d talked about coming into this, I am certainly very happy to see the benefit ratio in group income protection improve, but I am also beginning to question how real this is in the wake of two recent second Circuit Court of Appeals decision. When you read language from the court about Unum’s behavior is arbitrary, capricious, a comment in the absence of any argument, but first Unum showing that it’s changed its internal policies. Is this becoming an obsession to get this benefit ratio down and we are going to back to where we were pre the multi-state settlement?
Tom Watjen:

Yes, le me – I will take that last one, but let’s go back to your first one and just to DAC questions on –
Colin Devine:

The DAC and the hybrids, just clarification.
Tom Watjen:

Yes, the hybrids, exactly. So I will take all three of these and ultimately take the last one, but Bob anything you want to add to this or – to Colin’s question about the Colonial DAC?
Bob Greving:

Colin, there is an annual review of the DAC factors for unlocking in the Colonial book of business every year and this was just a normal review and adjustment as a result of that unlocking.
Colin Devine:

How much of that (inaudible)?
Bob Greving:

I believe it was less than $3 million.
Tom Watjen:

I think it was $2 million.
Colin Devine:

Yes, it’s about a $28 million adjustment so I just wanted to –
Tom White:

On the – Colin, this is Tom White – on the hybrid 64% are Tier 1 securities, and the balance of those are upper Tier 2 securities. And again the book value exposure is $496 million.
Colin Devine:

Of the U.K., how much is Tier 1? Those are really the ones that everybody is excited.
Tom White:

I’ll tell you, give me just a minute and I’ll get back –
Colin Devine:

Okay. I’ll come back on that. Let’s talk about the claims procedures in the U.S.
Tom Watjen:

Yes, and I think let me start, Colin, by saying, as you know, we went through a challenging period of time, to say the least. And to say we learnt something from that experience is a dramatic understatement. I think we learnt a lot about things we need to do differently. We made those changes that we do, not just once that we did for the purposes of satisfying the regulators, but these were just important changes in business that carry on way beyond just the regulatory process we went. And as you know, some of us stayed very close to watching including the Board, how we are doing in terms of being sure that those cultural and process changes that we made were again ones that lived way, way, way beyond the regulatory process we went through. And so I’d look at things like the quality measures, the performance, I mean credibly encourages when I look at the activity in terms of complaint rates or appeals that we are seeing in our business right now. They are actually at very, very low levels, which gives me great comfort that the process changes we made and the mentality shift that we had truly is sustainable and is continuing the business. Now, we still do have some claim litigations. When you look back to time, I will say though that when you look at the inventory of claim litigations today, it’s significantly below where it was even a few years ago. When I significantly, in some cases it’s a third or a quarter of what it was just as recently as a few years ago. So, that deals with the issues of the past where again to the extent there is litigation outstanding, we’ve been systematic about the process of kind of putting those pieces of litigation behind us in a very effective way. Now, occasionally things come up like the things you are referring to, and again that’s important we can an eye on that. Because, again, we don’t want to see anything pop up like that which hinders our reputation. We worked so hard to restore that reputation, and again that’s why I think all of our people are very intent on being sure we take the actions to be sure that we don’t let those issues of the past strip [ph] back in the business. And I feel very good about that. I guess the last point I make on that too is there is probably about 40 odd appeals that we have right now outstanding. The vast majority of the appeals are even ones that actually are being brought by the other (inaudible) so to speak because – there is still activity here but we feel very good about that level of claim activity going on. I don’t know –
Colin Devine:

Tom, are you saying turn her up, are you then saying the courts’ mistaken? Because they are saying nothing’s changed. I mean you had five years to fix it –
Tom Watjen:

No, Colin, the –
Colin Devine:

This isn’t small minor courts.
Tom Watjen:

(inaudible) decisions that were made going back to –
Colin Devine:

This is December 24th of last year.
Tom Watjen:

Colin, these are claims that go back to 1995 and so the court is referencing claims activity that pre-date all of the changes that we made in our claims management process. These are claims that have gone through the court system. They are still out there and we’ve had a couple here that have been negative. But again, what the court is referring to are claims practices that go back to before 2000 and certainly before the changes that we made in our –
Colin Devine:

Oh! perhaps then I miss-read it, because that’s not the way it reads to me, gentlemen.
Tom Watjen:

Well, that’s the fact.
Bob Greving:

Yes, that’s the facts.
Colin Devine:

Well, that’s not the way it reads, but thank you.
Tom Watjen:

Yes, now and again, we truly do recognize that we had to make some cultural and permanent shifts in our business, and again I can assure those have been made and we keep a very close eye on being sure that we don’t have any drifting back to practices that we really fundamentally shifted on and I can assure that’s not the case. And every measure I look at gives me great confidence that the quality of things being done today are of the highest quality and it sounds that really we still have to deal with some resident – issues of the past. Again, that inventory of issues of the past, as I mentioned in my comments earlier, is down dramatically. But I think that’s –
Colin Devine:

Okay, thank you. I appreciate the response.
Bob Greving:

I think I just reiterate that 80% of the cases under appeal right now are ones that the claimant is appealing, where the court has ruled in our favor. There you don’t get publicity on those. You don’t get blogs on those. Those are decisions that are –
Colin Devine:

These aren’t blogs. These are from reference court decisions some place.
Tom Watjen:

Okay. And let me go back to your question about the hybrids. The three that I referred, Northern Rock is $19 million, all of that is upper Tier 2. Anglo Irish Bank is $14 million, all of that is upper Tier 2, and then Royal Bank of Scotland, the exposure is $96 million and that’s pretty much evenly split between Tier 1 and upper Tier 2.
Colin Devine:

Perfect. Thank you.
Tom Watjen:

Thank you, Colin.
Operator:

And let’s now move to Mark Hughes with SunTrust.
Mark Hughes:

Thank you. Can you talk about the policy renewals? What’s sort of the pricing trends were in the fourth quarter and then any change in your pricing strategy to help drive sales growth?
Tom Watjen:

Maybe I will ask Kevin, I think, Mark, to speak to those two points.
Kevin McCarthy:

Good morning, Mark.
Mark Hughes:

Good morning.
Kevin McCarthy:

Our renewal program that we initiated in the middle part of 2008 and that continues into our 2009 renewal program is a smaller renewal program than we had in previous years reflecting the improvements that we’ve already made to the block of business both in terms of mix of business and in terms of pricing. The average rate increase for 2008, as you know, is in the 5% to 6% range. The average price increase in renewals for 2009 is in the 2% to 3% although we are prepared to increase that level of pricing and that volume of renewal activity if the economy – the deterioration in the economy rolls over and starts to affect our claim incidence, which to-date it has not. But we have not made any changes in pricing policy either with respect to (inaudible) renewal program or with respect to new business pricing.
Mark Hughes:

Does that 2% to 3% make you a little bit more price competitive?
Kevin McCarthy:

Well – it probably doesn’t move our price up at the same rate that it did in the past, and to the extent the competitors have gone through renewal programs, I can't really tell whether that sort of gives us more competitive, less competitive or sort of on average consistent with the marketplace. I think every company to the extent that they are paying attention to both the economy and to the aging of the business ought to be sort of that in that 2% to 3% range, but I can't tell you whether they are not. I think in general, over the past several years, we’ve moved our rates up in a slightly steeper slope than the rest of the industry, although that gap sort of has stayed fairly stable in the last 12 to 24 months.
Mark Hughes:

Thank you.
Kevin McCarthy:

Okay, thanks, Mark.
Operator:

Next we move to Randy Binner at FBR Capital Markets.
Randy Binner:

Hi thanks. I just wanted to review the change in guidance, it’s about $0.20 down and the way I am reading this about $0.08 from the higher pension costs. But I am still unclear if the remainder all have to do with British pound translation or you are also transposing some broader economic weakness into that change?
Tom Watjen:

(inaudible) I want you to get the three components –
Bob Greving:

Yes, I mean the three components are basically the pension cost of $42.5 million. The second, with the U.K. we are projecting – we haven’t changed our operating projection for Unum UK earnings in pounds, we still expect that to be basically flat in 2009 here with 2008. We had earlier used an assumption of $1.65 on the exchange rate. Now, we are assuming about $1.50 on the exchange rate. So, there are still a couple of cents a share of guidance that is economic related. It would be primarily within group disability. I think we are essentially assuming about 8% unemployment rate here in the U.S. as opposed to 7.5%, which we were using before. And I think the last December report was like 7.2% unemployment rate. So the unemployment picture kind of deteriorated a little faster than we had projected, so there is a couple of cents per share that is economically driven.
Tom Watjen:

And Randy, we also widened out the range we had been using – a nickel range – and we went to $0.10, basically because of the uncertainty over the economy and also the uncertainty over the value of the British pound.
Randy Binner:

Okay. And so I guess if for those of us who think unemployment may go higher, is there any way to think about what sensitivity the benefit ratio of guidance will have if we are talking about 9% or 10% unemployment?
Bob Greving:

It’s tough to say. I will – maybe Kevin you want to address that?
Kevin McCarthy:

A couple of points there. As the unemployment goes up, although we monitor it quarterly, we also pay attention to the unemployment rate as applied to the mix of business that we actually manage, both in terms of industry and sizing. Unemployment rate in those industries is lower than that rate. In addition to that while incidence, driven by an unemployment rate correlation may move up, simultaneously we are maintaining stability and consistency in our benefit operations particularly with respect to claims management and recoveries. And we continue to move the mix of business from large to small and that sort of drives the overall average weighted incidence rate down. So I think the – while we are cognizant of it, I don’t think we’d expect a really significant effect.
Randy Binner:

Okay. So even if – so if we went from 8% to 10%, it would still wash out for those reasons. We wouldn’t necessarily expect a big step down with earnings–-
Kevin McCarthy:

I think – yes, I mean I think it’s awful hard to predict sort of the exact incidence correlation related to gross unemployment rates, but obviously if unemployment rates change by a factor of 25% or 40% or something like that, I mean obviously it has a potential to affect into a greater degree but we are not seeing it at the moment.
Randy Binner:

Okay. And just real quick, as long as Kevin – as long as I have you – could you give a little more color, I think a previous analyst asked about just kind of where the business is coming from. But may be a more kind of qualitatively what – where are you winning the small case business and getting better sales there. If you can give color around where you are winning in the market there, that would be great.
Kevin McCarthy:

Yes I think we are – we continue to execute on a strategy as you know that we try to sell multiple lines of business and cross sell as much as we can. We are simply Unum strategy (inaudible) although we don’t any specific metrics yet on simply Unum because it’s too early. We are making better than expected progress there, which means we are getting stronger mix of business in terms of package sales. 65% of our disability business was in our target markets, which tend to be the low incidence markets and the smaller case marketplace. So more on the sort of white color professional services side of the business, healthcare, as opposed to manufacturing and retail, those kind of things. But I think we are – I think our service story, the consistency of our pricing and discipline and the consistency of our marketplace execution of that couple of years I think is just – is a level of momentum that we had throughout the year and that’s what’s continuing and I think helping us to win in the market.
Randy Binner:

Thank you very much.
Kevin McCarthy:

Thank you, Randy.
Operator:

Next we’ll move to Bob Glasspiegel at Langen McAlenney.
Tom Watjen:

Good morning, Bob.
Bob Glasspiegel:

Just a follow-up to Jeff’s pension question. You said $42 million extra from prior guidance. What’s the overall pension cost in ’09 and if the market stays down 7.2% is that sort of a moving target, if you don’t earn your 7..5% in ’09?
Bob Greving:

Bob, this is Bob Greving. The overall cost for the plan is $73 million for 2009. And I haven’t gone through the math, but – of the sensitivity of actual performance, but what we’ve assumed for 2010 is that we actually earn our 7.5%. We – you actually see that – that $73 million actually drop off about $10 million between ’09 and ’10 if we actually achieve our 7.5% return. Obviously, we are hoping for a little bit of a bounce back in the market, but you never know what’s going to happen.
Bob Glasspiegel:

Okay. What’s – you contributed some money to sort of close the balance. I know achieving your capital plan is probably your primary objective versus closing the pension liability, but is there an economic argument to maybe being a little bit more aggressive in closing the – and leaving a little less capital at the holding company?
Bob Greving:

Well, we always take a look at contributions into the plan. For example, this year we made $130 million of contributions into our pension plans. So we are committed to moving it. as you know, the Pension Protection Act also has some pressure on companies to fully fund those plans over the next three years. So, we are looking at it. We do have about $70 million in our plan right now for contributions to the pension plan in the current year and that’s all built into our current capital projections that we’ve given to you.
Tom Watjen:

And Bob, actually you are getting to it. Bob, it’s an economic decision actually and so I think we have the certainly the excess capital to use but I think at this point still the way we sort of laid out the plan is the right sort of balance between capital and cost.
Bob Greving:

Well, I think the other think, Tom, is we want to see how big – the years start emerging before we make contribution commitments. As you know, Bob, you basically get credit on contributions of a plan that goes back to kind of beginning of the year. So we do want to kind of wait and see how the year actually emerges before we make those kind of commitments.
Bob Glasspiegel:

I mean at this point a dollar of capital is worth than $0.07 of earnings, I suspect, but –
Bob Greving:

That’s right.
Tom Watjen:

That’s not the way we are looking at it.
Bob Glasspiegel:

But at some point there is a tradeoff and the economics become more compelling. Just one last question. The tax rate, if any, in the quarter was what? It looks like it came down a couple of percent from run rate?
Bob Greving:

Yes, I think that the tax rate was 32.5%. We’ve been kind of in the 33.5% to close to 34% range for the prior three quarters. And it’s just kind of normal year end tax adjustments that were made that helped them. I think for your modeling purposes, somewhere in the 33.5%-34% range is what we should see.
Bob Glasspiegel:

You know me too well, you also know my next question. Thank you.
Bob Greving:

Thanks, Bob.
Operator:

We’ll go next to Tom Gallagher at Credit Suisse.
Tom Watjen:

Good morning, Tom
Tom Gallagher:

Good morning. A few questions, first, just one on the reserves. The – you had a 5% reduction in IBNR this quarter and if I think about sort of the parallel to that I would think about risk in force just being measures as premiums, were down about 2% sequentially versus 3Q. Just based on your comments earlier that you are expecting I guess the overall claims environment to get a bit worse from an incidence standpoint, why would you be releasing IBNR, not building it right now. That’s my first one.
Tom Watjen:

I think, you used the term releasing IBNR is not accurate. I mean IBNR changed from the third to fourth quarter. And it’s for LTD. It’s reflective of the fact that the volume of business is slightly lower. It reflects the fact, we commented that we did make an upward adjustment in the discount rate assumption, and so that – the way that gets accounted for is there is about $3 million of IBNR release due to that. There are some changes that we’ve made in our claims management processing as we move STD claims to an LTD basis and they are actually reported a little sooner and that has the impact probably $3 million or $4 million of movement in IBNR. But what happens on the other side is that $3 million or $4 million is added to other parts of the reserve. So, it’s not a reserve release into earnings. So – there are a lot of moving parts as we’ve described in the past, but to describe it as a reserve release I think is inaccurate.
Tom Gallagher:

Well, Tom, if I just look at the disclosure on Page 12, you went from essentially $1.9 billion of IBNR to little over $1.8 billion this quarter. and so there is $80 million some odd of a reduction. And I understand –
Tom Watjen:

Well, what time period you are looking at, Tom?
Tom Gallagher:

Just sequentially looking at –
Tom Watjen:

Okay. Keep in mind, we made a change in the – and there is a footnote in the statistical supplement, I will get Bob Greving to describe it, but a lot of that is in the closed disability block where there is a change in the reserve valuation system and it actually – why don’t I get Bob to talk about what we did there.
Bob Greving:

Yes, we actually implemented a new system that basically redistributed the reserves on that line of business, IBNR policy reserves and claim reserves. And that implementation did actually move a lot of the numbers around. It didn’t move the overall net reserve for the block as a whole. It’s rolling off. So it did have an effect on that. On a restated basis, Tom, may be to help you out, the impact of that the IBNR on the old basis, on a reported basis was $387.2 million in the third quarter. On a restated basis, it would have been $353.2 million in the third quarter and that dropped to $350.3 million in the fourth quarter, so there is only about $3 million movement on an apples-to-apples comparison for that line of business. But there is a lot going on behind the scenes, I guess, if you want to think about it as far as implementing that force system what we call the force system.
Tom Watjen:

(inaudible) speak to because we just obviously completed our year end reserve studies and all the cash flow testing studies, but – and there is a high level comfort in all work that’s been done at year end.
Bob Greving:

Yes, it’s a good point. We actually – actually we look at everything on a quarterly basis, but on an annual basis we actually execute a much tighter and more thorough review of all of the reserve basis and we do that internally as well as with our Board and our external auditors and so that has been completed and actually we are in a stronger position reserve wise this year than where we were last year and our assumptions that were used in that analysis are a bit more conservative even than what they were last year. So we are feeling pretty good with where we are on a reserve adequacy.
Tom Gallagher:

Okay. Thanks. That’s helpful. And just as I think about the IBNR, not to obsess on that one item, because I realize there is a lot of moving pieces here, should we expect that to build over time? If in fact claims insurance is expected to even pick up moderately, should I expect to see that grow relative to earned premium?
Bob Greving:

Tom, you will see two moving parts, obviously of incidence increases, you will seen an increase in the applied factors that will increase the IBNR. That will be offset by any decrease in the actual in force itself. So if there is as run off of the premium, for example, the old closed block of IDI is running off at about 5% per year, you will see that kind of run off if that business runs off. If there is a growing block of business, you will see the IBNR increase. We have not changed our practice in applying IBNR factors, whatsoever. And at least in the last two years, we have not changed our practice, whatsoever. So what you are seeing is actually the movement in the book of business.
Tom Gallagher:

Okay. And then just one last follow-up. Tom White, you had mentioned the new discount rate went up, but the benefit for the quarter is less than 60 basis points. Can you give some quantification ex the increase in the discount rate, what the benefit ratio improvement would have been–?
Tom White:

Tom, we don’t like to quantify it just because it starts to speak to too much around pricing assumptions, and so we tend not to do that. I will say that the – if we had not done the discount rate adjustment, the benefit ratio would still have improved from the third to the fourth quarter.
Tom Gallagher:

Okay. Is guidance that we should still see an improving trend in the benefit ratio still in place or maybe you can just comment prospectively what you’re looking at?
Tom White:

I think our guidance would assume a pretty flat benefit ratio throughout 2009.
Tom Gallagher:

Thanks a lot.
Tom White:

Yes. Thanks, Tom.
Operator:

Our next question comes from Eric Berg of Barclays Capital.
Tom Watjen:

Good morning, Eric.
Eric Berg:

Thank you very much. Good morning. Thank you. Good morning to everyone. Two questions. First, with respect to the U.K., it’s obvious why a reduction in premium in and of itself would send the benefit ratio higher as you referenced. Hello?
Tom Watjen:

Yes, we’re hearing, Eric.
Eric Berg:

Thanks very much. I’m on a cell and I thought we had cut out.
Tom Watjen:

No, no.
Eric Berg:

Yes. If I do, obviously you’d just go on to the next question, but (inaudible) here. My question with respect to this U.K. benefit ratio is this. I’ve been thinking the way it works is if you lose some business and therefore show lower premium, you’d also show lower benefit as well. But I would think that a loss of business would lead to no change in the current ratio because both the numerator and denominator would be going down. How does the math of that benefit ratio work when you have lower than expected premiums?
Tom Watjen:

Bob, I think you can address that because it’s not just the way it works in the U.K. It’s kind of universal. Group business I’d say.
Bob Greving:

Eric, as you know, there is a fairly long waiting period on these claims, particularly in our group income protection business. And so an immediate change, which you have to reflect in earned premium in the period, is not necessarily immediately transferable into the – a change in the claim incidence that actually is being reported because those claims are claims that actually have occurred in prior periods as they kind of work their way through the system. So there is a delayed effect. And so in the period that we actually are reporting a decrease in premium, you won’t see an immediate decrease in the claim number, but there will be a lagged effect.
Eric Berg:

That answers it. My second of three questions relates to OTTI, what is the effect, if any, of rating agency downgrades on your determination of OTTI? In other words, my question is, a rating agency’s upgrade/downgrade is its opinion, not Unum’s opinion of securities. So one would think in the first instance that what the rating agencies are doing shouldn’t affect your determination of OTTI. But I wanted to ask the question–
Tom Watjen:

Sure. And a good question. And I guess you got to need to think about at what level of rating – a rating downgrade is occurring. It’s something smoothing from a BBB to a BB. That’s still in the upper end of below-investment grade. It’s still current and it would be unusual for us to impair something at that level. Now at something down in the CCC, CC, D land, if those are being downgraded, those are the securities we’re going to take a much closer look at. And we’re going to make a determination whether or not we think the interest payments are going to be made and whether or not the value of that security can recover over our holding period time. So I think you really have to kind of think in those terms. And we did not – we did impair the four securities that I mentioned. Those were Idearc and McClatchy and Lyondell and Ford. And again those were just determinations that we made, that we didn’t think that those bonds would return in value over the holding period that we expect to have in those.
Eric Berg:

Last question maybe to Kevin is a general one about the dynamics of the business. My understanding is that the way the business works is that, as the economy sinks into joblessness, as unemployment rises, all annuity companies get reported to them an increasing number of, let’s call it, subjective claims. I don’t know whether they are feigned claims or legitimate or not, but you tend to get an increase if I understand things, in more subjective claims. And my question is, while I understand that you are expecting some increase in incidence from here, you’re not expecting as much incidence as would have been the case if you had not changed the way you do business. So my question to Kevin is, what are you doing differently in the current recession that will sort of blunt the impact that will allow you to end up with a lower rate of increase in incidence given these subjective claims than would have been the case if you hadn’t changed the way you do business?
Kevin McCarthy:

Thanks, Eric. Good morning. I’m not sure I can exactly relate one to the other. I think one would anticipate in a tight economy an uptick in submitted incidence, one might expect that would be on sort of the softer decisions as to whether person consider themselves to be disabled or not. They are probably making that decision in the light of their own employment environment, whether they are trying to hold on to their job or whether they think they might be going to lose their job. And all of those subjective factors turns out they submit a claim. It’s probably not possible for us in a general sense to know what any one person is thinking. In a marketing sense, though, we try to target markets at those industries that have lower overall expected incidence rates. We also, on an underwriting basis, to the extent that we’re talking about mid-size companies or larger, we are certainly underwriting the economic environment for that particular industry and that particular company, because to the extent that we look at any underwriting risk and think that there is a potential for downsizing or bankruptcy, that wouldn’t be a positive indicator from an underwriting perspective. And so you try to avoid sort of that effective subjective claims by avoiding the overall risk of unemployment, if you will.
Tom Watjen:

And Kevin, it’s probably worth reiterating, I think you said in your comments, but our experience has been the small and mid-size employer incidence level in softer economic conditions, it’s nowhere near as volatile as the incidence rate amongst large employers. And as I think everyone in the call knows, we made a fairly substantial change in strategic direction three or four years ago. And so our book of business entering this period of time is very different today than it was, for example, back in 2001-2002.
Kevin McCarthy:

Absolutely. And if you look at our fourth quarter sales – our 2008 sales, only 36% of our business was large case business, 64% was small and medium size full market business.
Eric Berg:

I guess just one quick – and this will be my final follow-up – in terms of adjudicating subjective claims, things that cannot be more – that cannot be easily diagnosed on a physician’s X-ray, how are you doing it differently today than would have been the case in the last – or is it different?
Kevin McCarthy:

I think it’s somewhat different in the sense that we engage discussions in a positive way with the employer and with the claimant’s physician earlier in the game. We actively use independent medical evaluations maybe to a greater degree and also earlier in the game. And we are very engaged in trying to work with the claimant and the claimant’s physician to the extent that that’s possible and the claimant’s employer to try to find a way to accommodate and get that person back to work.
Eric Berg:

Thank you all. Very helpful.
Kevin McCarthy:

Thank you, Eric.
Operator:

And our next question comes from Mark Finkelstein at FPK.
Mark Finkelstein:

Good morning.
Tom Watjen:

Good morning, Mark.
Mark Finkelstein:

I actually want to go back to the U.K., if we could. I mean, obviously, incidence did pick up. I think you attributed a little bit to the economy. Premium levels are kind of continuing to decline. I guess what I’m asking is what should we expect in terms of that disability benefit ratio and why should we be comfortable that kind of earnings on a sterling basis should be flattish with last year? I understand the expense saves, but if you could just kind of put that all in context, that would be helpful.
Tom Watjen:

Yes. Susan, may I ask you to just sort of pick up on that question. I think maybe, Tom, if you could fill in a little bit as well, if you could. But Susan, why don’t you get it started?
Susan Ring:

Yes, sure. With regard to incidence, as I said, it started to pick up in the fourth quarter. We haven’t actually seen that continue so far in the first quarter, but we do expect increased incidence come through waves of never as different industries subject to issues with regard to the current economy. Offsetting that, though, we do have very strong recovery performance, and those increased claims do tend to be (inaudible) duration. So as far as the benefit ratio is concerned going forward, I would say that the curve [ph] this is trending very similarly perhaps up a couple of percentage versus the whole of 2008. So we’d expect it to be sort of a fairly consistent performance as far as benefit ratio is concerned going forward. With regards to the earnings, we are delivering strong margins still in the UK. So we’d be – obviously we’re expecting that to be sustained and with just a slight drop in the margin performance going forward. So with regard to 2008, we saw that come through at 6% overall. And from a good long-term disability perspective, it’s (inaudible). So with regards to the (inaudible) with regard to the competitive environment, which is particularly hostile and aggressive, we don’t see that changing going forward. So I would expect the margin to drop slightly and as a result, our earnings will be fairly flat for 2008. So I hope that answers your question, Mark.
Mark Finkelstein:

Sure. Okay. And then, Kevin, I guess you talked a lot about claim incidence, can you just talk about claim duration? I guess historically how is that trended with changes in unemployment? And I guess what are you thinking about in terms of expectations on the unemployment rate moving from 7.5% to 8.0% and I guess risks of an even higher unemployment rate?
Kevin McCarthy:

Good morning, Mark. Well, as I’ve commented earlier, I mean, to the extent that unemployment correlates with incidence and it’s not a complete direct correlation, we watch the unemployment rate, we watch the way in which we underwrite, we pay attention to unemployment rate by industry, and also, as Tom mentioned, target sort of the smaller size of the marketplace (inaudible) that sort of a slower uptick in incidence and claims as a result of the economy. So we have a lot of things in place and try to watch where incidence is coming from. We watch our STD block in particular because so much of our STD block is marketed and packaged with LTD. And in fact, incidence and prevalence rates in STD are actually slightly down compared to the third quarter. So right now, as I said, we are not really seeing much in terms of recovery rates. I think to Susan’s point, to the extent that you get an uptick in claims and they are driven by the sort of “more subjective” type of claim. You would expect those durations to be shorter. Currently within our STD block, our average duration days are actually slightly down. So the durations of the claims are shorter. From a long-term disability standpoint, it’s a little bit harder to say much about that. You made me see a slight uptick in recoveries in, what we call, the first duration right after the end of the elimination period. But after that, once somebody sort of makes it through that first duration, they feel legitimately disabled and you are managing them just like any other claim.
Mark Finkelstein:

Okay. And then I guess just a follow-up on Tom’s question on IBNR. I guess I’m just looking at the numbers, Bob, that you gave. I think you said $387.2 million down to $353.2 million, that $35 million, did that essentially get moved into other reserves out of IBNR, so there is really no net impact?
Bob Greving:

Yes, basically it’s in the other reserves, your policy reserves and your claim reserves. The overall impact of the implementation of force was very nominal as far as the total reserve for that block of business.
Mark Finkelstein:

Okay. All right. Thank you.
Tom White:

Good. Thank you, Mark. And I think at this point – I mean we’ve gone a little long, but I think we probably need to close the call, but if anybody has questions that we didn’t have a chance to get to, certainly funnel those through Tom White, but thank you all for taking the time for joining us for this quarterly. And I think, operator, this will conclude the call.
Operator:

Thank you. And again, that does conclude today’s conference call. Thank you for your participation. You may now disconnect.

Unum Group Q4 2008 Earnings Call Transcript

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Unum Group
Q4 2008 Earnings Call Transcript