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| UNM > SEC Filings for UNM > Form 10-K on 24-Feb-2009 | All Recent SEC Filings |
24-Feb-2009
Annual Report
The discussion and analysis presented in this section should be read in conjunction with our consolidated financial statements and notes thereto in Item 8.
Executive Summary
Our primary objectives for 2008 included:
• Consistent execution of our operating plans. We continued our emphasis on disciplined, profitable growth.
• Continued innovation throughout our businesses. Within Unum US, we broadly launched Simply Unum in the small to mid sized employer marketplace. We capitalized on the introduction of a number of health related products for Colonial Life and continued to expand our enrollment capabilities and product offerings. In Unum UK, we worked on the development of new product offerings and the improvement of corporate efficiencies.
• Leveraging of our leadership positions and marketplace reputation. We built on the momentum of 2007 with increased brand and product awareness.
• Execution of our capital management strategy. We completed our share repurchase program and maintained our financial measurements at favorable levels relative to our targets.
• Professional development of our employees. We continued our emphasis on training and leadership development and talent management throughout our organization.
Through focusing on these objectives, we believe that we have instilled greater confidence in our company among our constituents. In commenting on our results for 2008, we will discuss our operating performance, strategic and capital initiatives, the current economic environment, and our major areas of focus for 2009.
Operating Performance
During 2008, Unum US reported an increase in segment operating income of 12.5 percent compared to the prior year and excluding the 2007 revision to the claim reassessment reserve estimate. The group disability benefit ratio was 88.7 percent for the fourth quarter of 2008 and 89.9 percent for full year 2008, consistent with our goal of continual profit margin improvement for this line of business. Unum US sales increased 11.0 percent in 2008 compared to 2007. Our group core market segment, which we define for Unum US as employee groups with less than 2,000 lives, had a sales increase of 23.7 percent over the prior year, and the number of new accounts increased 16.4 percent. Our supplemental and voluntary sales increased 6.8 percent in 2008 compared to last year, with a 14.6 percent increase in voluntary sales offsetting the expected decrease in sales of individual long-term care. Sales in the group large case market segment declined 1.8 percent compared to the prior year. During the third quarter of 2007, we introduced Simply Unum, an integrated platform of products and online services that we believe will transform the benefits marketplace through innovative solutions for our group core market segment and our voluntary market. The initial limited market rollout occurred in 2007, and we have now expanded the availability of Simply Unum to 45 states nationwide. We will complete the rollout to the remaining states as state approvals are received. We are also in the process of developing additional products and services.
Our Unum UK segment continues to produce excellent operating results, with an increase in segment operating income of 6.5 percent for 2008, as measured in Unum UK's local currency, relative to 2007. The functional currency of Unum UK is the British pound sterling, and we translate Unum UK's pound-denominated financial statements into dollars for our consolidated financial reporting. The recent fluctuations in the pound to dollar exchange rate have decreased our current year results relative to 2007, particularly results reported for the second half of 2008. We expect this volatility in translated financial results, which is a financial reporting issue and is not indicative of an operating problem, to continue in 2009. Overall sales in Unum UK increased 3.6 percent in 2008 compared to the prior year. Sales in 2007 benefited from the change in age equality legislation more so than in 2008. Excluding sales related to the change in age equality legislation from all comparable periods, Unum UK achieved underlying sales growth of approximately 16 percent in 2008 relative to 2007. The U.K. market remains highly competitive. We are developing new products and services to target new customer segments. During 2008 we launched a dual benefit group disability product designed for the needs of the smaller employer.
Our Colonial Life segment reported an increase in segment operating income of 9.1 percent in 2008 compared to the prior year. Colonial Life's sales increased 1.6 percent in 2008 relative to last year, with sales in the commercial market segment for employee groups with less than 100 lives increasing 6.9 percent. The number of new accounts and the average new case size both increased over the prior year. During the latter part of 2007, we introduced a new hospital confinement indemnity insurance plan product and a group limited benefit medical plan product, and in the first quarter of 2008, we introduced the new Colonial Life brand. We are pleased with the marketplace reception for our new Colonial Life brand and these new product offerings. Colonial Life continues to expand its enrollment capabilities and its product offerings. In the third quarter of 2008, Colonial Life introduced two new life products and the latest release of its enrollment system, Harmony, which offers multiple enrollment solutions. In addition, all of Colonial Life's individual products, including the two new life products, are available on Harmony.
Our investment strategy continues to provide benefits to our overall business performance. We are focused on both the quality of our investment portfolio and on investing new money in investments appropriate for our liabilities and with yields that will increase our portfolio yield. Our net investment income in 2008 was slightly below the level of 2007 due primarily to a decrease in the level of bond call premiums. Included in 2008 results are net realized investment losses from sales and write-downs of investments related primarily to fixed maturity securities in the financial institutions, automotive, and media sectors that we either sold or considered other than temporarily impaired during the third and fourth quarters of 2008. We believe our investment portfolio is well positioned for the current environment, with historically low levels of below-investment-grade securities, no exposure to subprime mortgages, "Alt-A" loans, or collateralized debt obligations in our asset-backed or mortgage-backed securities portfolios, and minimal exposure to collateralized debt obligations within our public bond portfolio. Further discussion is included in "Investments" contained in this Item 7.
Strategic and Capital Initiatives
The first priority of our capital management strategy is to maintain sufficient financial flexibility to support our operations over various economic cycles and to respond to opportunities in the marketplace while positioning our Company for improvements in its credit ratings. We have several financial targets which guide our capital management decisions including:
• Maintain a risk based capital ratio of 300 percent or greater for our traditional U.S. insurance subsidiaries. This is to be measured on a weighted average basis using the NAIC Company Action Level formula.
• Maintain leverage at approximately 25 percent. Leverage will be measured as total debt to total capital, which we define as total long-term and short-term debt plus stockholders' equity, excluding the net unrealized gain or loss on securities and the net gain or loss on cash flow hedges. This target level excludes the non-recourse debt and associated capital of Tailwind Holdings and Northwind Holdings.
• Maintain cash and liquid investments at our holding companies sufficient to cover one year of fixed charges (measured as interest expense plus common stock dividends) plus a capital fund which will vary with business and economic conditions.
• Maintain a common stock dividend yield that is near the median of our peer companies.
At the end of 2008, all of our financial measurements for capital management continue to compare favorably to our target levels. We have completed our $700.0 million authorized share repurchase program, and we have maintained our leverage at 21.5 percent, compared to 21.4 percent at the end of 2007.
See "Liquidity and Capital Resources" contained in this Item 7 for further detail.
Economic Environment
Analysis and stress testing are important aspects of understanding our financial risk exposure and developing proactive risk management efforts. As part of our recessionary analysis, we have identified the following potential challenges to our 2009 business outlook, as well as what we perceive to be opportunities and mitigating factors, resulting from the current economy.
Potential Challenges
• Lower premium income from fewer employees in the work-force of our markets; employer- and employee-paid cost pressures may also limit sales and reduce persistency.
• Lower net investment income from fewer long-term assets to match our liability portfolio; lower bond call prepayment income.
• Lower investment income and/or higher realized investment losses due to an increase in defaults.
• Higher unrealized investment losses.
• Higher disability claim costs.
• Higher operating expense ratios due to declining premiums.
Opportunities and Mitigating Factors
• Lower premium income may be mitigated by mix of business and by our growing position in the voluntary market.
• Lower premium income may be mitigated by the flexibility of our product design and pricing.
• We may achieve higher investment income from wider corporate spreads which enhance investment income associated with new purchases of fixed maturity securities.
• We have low levels of exposure to high risk investments.
• We believe our claim reserve discount rates are adequate relative to investment portfolio yield rates.
• We believe our risk management is strong; we have a diversified business mix, with a core market focus which generally has lower and less volatile claim incidence.
• Our historical pattern of benefits paid to revenues is consistent, even during cycles of economic downturns.
• We manage our expenses aggressively and have cost management initiatives in place.
• We believe our risk-based capital and holding company liquidity position us well for an economic downturn.
Our business outlook recognizes both the challenges of the current economic environment as well as the mitigating impact of risk-reducing actions we have taken in recent years, including product diversification across sectors and locations, our mix of business, our disciplined underwriting, pricing, claims, and expense management, a reduced credit risk profile in our investment portfolio, our capital management strategy, and better risk management practices. Our outlook is responsive to our risk management framework and is consistent with our risk appetite. Although occurrence of one or more of the risk factors previously discussed herein in Item 1A may cause our results to differ from our outlook, we believe that our business outlook is built on sound operating plans that have been tested against many of the challenges presented by the current economic environment.
Focus for 2009
During 2009, we intend to continue our focus on a number of key areas.
• Consistent execution of our operating plans. We will continue our emphasis on disciplined, profitable growth.
• Maintain a strong investment portfolio. We will maintain disciplined credit analysis in our selection of investment assets and continue to be conservative within our investment risk tolerances.
• Build and effectively use capital. We intend to continue to build capital and manage it effectively within our stated capital management strategy objectives.
• Professional development of our employees. We will continue our focus on employee training and development as well as talent management.
2008 Significant Transactions and Events
Legal and Regulatory Issues
On January 12, 2009, in a two-to-one decision, the Sixth Circuit Court of Appeals reversed the District Court's earlier ruling certifying a class in the case styled, In re UnumProvident Corp. ERISA Benefits Denial Actions. On January 26, 2009, the plaintiffs filed a petition for rehearing of this decision by the full court. The District Court has yet to rule on our pending motions for judgment on the pleadings or for summary judgment.
During 2008, we reached a settlement in the Shareholder Derivative action that was originally filed in 2002. Under the terms of the settlement, which is subject to approval of the court, we have agreed to implement or continue certain corporate governance measures and pay plaintiffs' attorneys' fees in an amount to be determined by the court.
Also during 2008, we reached a settlement with the U.S. Attorney in San Diego regarding broker compensation disclosure practices dating back several years. While this settlement was only recently finalized, it covers issues that were resolved several years ago with other regulators. We have worked cooperatively with the U.S. Attorney's office since its inquiry into the industry's compensation practices began. As part of the settlement, we agreed to a payment of $5.6 million and included this expense in our 2008 results. Compliance with the terms of the settlement agreement will not require any further changes in our business practices, as we previously made changes to our broker compensation program.
During 2007, we completed the claim reassessment process required by the 2004 and 2005 regulatory settlement agreements. The lead regulators conducted a final examination and presented their findings to Unum Group's board of directors and management on April 14, 2008. The report of the multistate market conduct examination for the Maine Bureau of Insurance, Massachusetts Division of Insurance, New York State Insurance Department, Tennessee Department of Commerce and Insurance, and other participating jurisdictions as well as the report of the California Department of Insurance market conduct examination both provided that we satisfactorily complied with each of the agreements' mandates and that no fines will be assessed.
We continue to work closely with our regulators and also continue to work toward resolution of other outstanding legal and regulatory issues. See Note 14 of the "Notes to Consolidated Financial Statements" contained herein in Item 8 for information on our legal proceedings.
Financing
During 2007, Unum Group's board of directors authorized the repurchase of up to $700.0 million of Unum Group common stock. During 2008, we completed our share repurchase program and purchased 29.9 million shares of Unum Group common stock for $700.0 million.
During the second quarter of 2008, we retired the remaining $175.0 million of our 5.997% senior notes. During 2008, we made principal payments of $59.3 million and $10.0 million on our senior secured non-recourse variable rate notes issued by Northwind Holdings and Tailwind Holdings, respectively. We also purchased and retired $36.6 million of our 6.85% senior debentures due 2015 and $17.8 million of our outstanding 5.859% senior notes due in May 2009.
In December 2008, we obtained a new credit facility. The current facility establishes a $250.0 million unsecured revolving line of credit and replaces an existing facility. We intend to use any drawn borrowings from the facility for general corporate purposes. Any actions that we may take will be consistent with our stated capital management strategy.
See "Liquidity and Capital Resources" contained in this Item 7 and Note 8 of the "Notes to Consolidated Financial Statements" contained herein in Item 8 for additional information.
Other
During the first quarter of 2008, we established a new non-insurance company, Unum Ireland Limited, which is an indirect wholly-owned subsidiary of Unum Group. The purpose of Unum Ireland Limited is to expand our information technology resource options to ensure that our resource capacity keeps pace with the growing demand for information technology support. This subsidiary, which is located in Carlow, Ireland, had approximately 40 full-time employees at the end of 2008.
Accounting Pronouncements
Effective January 1, 2008, we adopted the provisions of Statement of Financial Accounting Standards No. 157 (SFAS 157), Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The adoption of SFAS 157 did not have a material effect on our financial position or results of operations.
Effective December 31, 2008, we adopted the provisions of FASB Staff Position No. EITF 99-20-1, (FSP EITF 99-20-1), Amendments to the Impairment Guidance of EITF Issue No. 99-20. This FSP amends the impairment guidance in Emerging Issues Task Force (EITF) Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets," to achieve more consistent determination of whether an other-than-temporary impairment has occurred. The FSP also retains and emphasizes the objective of an other-than-temporary impairment assessment and the related disclosure requirements in Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, and other related guidance. The adoption of FSP EITF 99-20-1 did not have a material effect on our financial position or results of operations.
Statement of Financial Accounting Standards No. 161 (SFAS 161), Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, was issued in March 2008. SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity's financial position, financial performance, and cash flows. We will adopt the provisions of SFAS 161 effective January 1, 2009. The adoption of SFAS 161 will amend our disclosures but will have no effect on our financial position or results of operations.
FASB Staff Position No. FAS 132(R)-1, (FSP FAS 132(R)-1), Employers' Disclosures about Postretirement Benefit Plan Assets, was issued December 30, 2008. This FSP amends Statement of Financial Accounting Standards No. 132 (revised 2003), Employers' Disclosures about Pensions and Other Postretirement Benefits, to provide guidance on an employer's disclosures about plan assets of a defined benefit pension or other postretirement plan. The disclosures about plan assets required by this FSP are required for fiscal years ending after December 15, 2009. The adoption of FSP FAS 132(R)-1 will amend our disclosures but will have no effect on our financial position or results of operations.
2007 Significant Transactions and Events
Legal and Regulatory Issues
Revised Claim Reassessment Reserve Estimate
As previously noted, during 2007 we completed the claim reassessment process required by the 2004 and 2005 regulatory settlement agreements. Prior to completion of the claim reassessment process, in the second quarter of 2007 we increased our provision for the estimated cost of the claim reassessment process $53.0 million before tax and $34.5 million after tax based on changes in our emerging experience for the number of decisions being overturned and the average cost per reassessed claim. The revised second quarter of 2007 estimate was based on the cost of approximately 99 percent of the potential inventory of claim reassessment information forms returned to us, with our claim reassessment on approximately 88 percent of the forms completed at that time. At the time of our second quarter of 2007 revision, we had not yet finalized our claim reassessment on the remaining forms but had performed a financial review and included that information in our analysis of emerging experience. Additional information regarding the second quarter revision to our estimate is as follows:
2. We decreased our previous estimate for benefit costs for claims reopened for our Individual Disability - Closed Block segment $10.7 million. Although the experience relative to our assumptions for the overturn rate was slightly higher, experience indicated that the total number of claims for this segment would be less than our previous assumptions.
3. We decreased our previous estimate for the additional incremental direct claim reassessment operating expenses $12.8 million due to our projections for an earlier completion of the reassessment process. We released $10.3 million for Unum US group long-term disability and $2.5 million for our Individual Disability - Closed Block segment.
4. These second quarter of 2007 adjustments to our claim reassessment costs decreased 2007 before-tax operating earnings for our Unum US group disability line of business $66.2 million and increased 2007 before-tax operating earnings for our Individual Disability - Closed Block segment $13.2 million.
Financing
The scheduled remarketing of the senior note element of our 2004 adjustable conversion-rate equity units (units) occurred in February 2007, as stipulated by the terms of the original offering, and we reset the interest rate on $300.0 million of senior notes due May 15, 2009 to 5.859%. We purchased $150.0 million of the senior notes in the remarketing which were subsequently retired. In May 2007, we settled the purchase contract element of the 2004 units by issuing 17.7 million shares of common stock. We received proceeds of approximately $300.0 million from the transaction.
Throughout 2007, we repaid an additional $619.5 million of our outstanding debt, for total long-term debt repayments of $769.5 million. The cost related to the early retirement of debt during 2007 decreased our 2007 operating results approximately $58.8 million before tax, or $38.3 million after tax.
On October 31, 2007, Northwind Holdings issued $800.0 million of floating rate, insured, senior, secured notes due 2037 in a private offering. The notes bear interest at a floating rate equal to the three month London Interbank Offered Rate (LIBOR) plus 0.78%. Recourse for the payment of principal, interest, and other amounts due on the notes will be dependent principally on the receipt of dividends from Northwind Reinsurance Company (Northwind Re), the sole subsidiary of Northwind Holdings. See "Liquidity and Capital Resources" contained in this Item 7 and Notes 8 and 15 of the "Notes to Consolidated Financial Statements" contained herein in Item 8 for additional information on Northwind Holdings and Northwind Re.
In December 2007, we established a $400.0 million unsecured revolving credit facility.
Dispositions
During the first quarter of 2007, we completed the sale of our wholly-owned subsidiary, GENEX Services, Inc. (GENEX), a leading workers' compensation and medical cost containment services provider. Our growth strategy is focused on the development of our primary markets, and GENEX's specialty role in case management and medical cost containment related to the workers' compensation market was no longer consistent with our overall strategic direction. We recognized an after-tax gain on the transaction of approximately $6.2 million. See Note 2 of the "Notes to Consolidated Financial Statements" contained herein in Item 8 for additional information.
Accounting Pronouncements
Effective January 1, 2007, we adopted the provisions of Statement of Position 05-1 (SOP 05-1), Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs
(DAC) on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. The cumulative effect of applying the provisions of SOP 05-1 decreased our 2007 opening balance of retained earnings $445.2 million.
Effective January 1, 2007, we adopted the provisions of Financial Accounting Standards Board Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (SFAS 109). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS 109. Unlike SFAS 109, FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The cumulative effect of applying the provisions of FIN 48 increased our 2007 opening balance of retained earnings $22.7 million.
Effective January 1, 2007, we adopted the provisions of Statement of Financial
Accounting Standards No. 155 (SFAS 155), Accounting for Certain Hybrid Financial
Instruments, an amendment of Statement of Financial Accounting Standards Nos.
133 (SFAS 133) and 140 (SFAS 140). SFAS 155: (a) permits fair value
remeasurement for any hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation; (b) clarifies which
interest-only strips and principal-only strips are not subject to the
requirements of SFAS 133; (c) establishes a requirement to evaluate beneficial
interests in securitized financial assets to identify interests that are
freestanding derivatives or that are hybrid financial instruments that contain
an embedded derivative requiring bifurcation; (d) clarifies that concentrations
of credit risk in the form of subordination are not embedded derivatives; and,
(e) eliminates restrictions on a qualifying special-purpose entity's ability to
hold passive derivative financial instruments that pertain to beneficial
interests that are or contain a derivative financial instrument. The adoption of
SFAS 155 did not have a material effect on our financial position or results of
operations.
2006 Significant Transactions and Events
Legal and Regulatory Issues
Revised Claim Reassessment Reserve Estimate
In the first quarter of 2006, we completed an analysis of our assumptions related to the reserves we established for our claim reassessment process. Our . . .
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