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SFG > SEC Filings for SFG > Form 10-Q on 6-Nov-2012All Recent SEC Filings

Show all filings for STANCORP FINANCIAL GROUP INC

Form 10-Q for STANCORP FINANCIAL GROUP INC


6-Nov-2012

Quarterly Report


ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As used in this Form 10-Q, the terms "StanCorp," "Company," "we," "us" and "our" refer to StanCorp Financial Group, Inc. and its subsidiaries, unless the context otherwise requires. The following analysis of the consolidated financial condition and results of operations of StanCorp should be read in conjunction with the unaudited condensed consolidated financial statements and related notes thereto. See Item 1, "Financial Statements."

Our filings with the Securities and Exchange Commission ("SEC") include our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, registration statements and amendments to those reports. Access to all filed reports is available free of charge on our website at www.stancorpfinancial.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The SEC also maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov.

The following management assessment of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes thereto in our 2011 Form 10-K and our current report on Form 8-K dated July 18, 2012, which modified certain items in our annual report on Form 10-K for the retrospective adoption of Accounting Standards Update ("ASU") No. 2012-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. Those consolidated financial statements and certain disclosures made in this Form 10-Q have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during each reporting period. The estimates most susceptible to material changes due to significant judgment are identified as critical accounting policies. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure our performance. See "Critical Accounting Policies and Estimates."

Financial measures that exclude after-tax net capital gains and losses are non-GAAP measures. To provide investors with a broader understanding of earnings, we provide net income per diluted share excluding after-tax net capital gains and losses, along with the GAAP measure of net income per diluted share, because capital gains and losses are not likely to occur in a stable pattern.

We have made in this Form 10-Q, and from time to time may make in our public filings, news releases and oral presentations and discussions, certain statements, which are predictive in nature and not based on historical facts. These statements are "forward-looking" and, accordingly, involve risks and uncertainties that could cause actual results to differ materially from those discussed or implied. Although such forward-looking statements have been made in good faith and are based on reasonable assumptions, there is no assurance that the expected results will be achieved. See "Forward-looking Statements."

Executive Summary

Financial Results Overview

The following table sets forth selected consolidated financial results:



                                              Three Months Ended                       Nine Months Ended
                                                September 30,                            September 30,
                                          2012                 2011                2012                 2011

                                                        (Dollars in millions except share data)
Net income                            $        44.9        $        47.0       $       100.1        $        98.1
After-tax net capital (losses)
gains                                          (1.7 )                4.8                (4.3 )               (5.2 )

Net income excluding after-tax
net capital (losses) gains            $        46.6        $        42.2       $       104.4        $       103.3

Diluted earnings per common
share:
Net income                            $        1.01        $        1.05       $        2.26        $        2.17
After-tax net capital (losses)
gains                                         (0.04 )               0.11               (0.09 )              (0.11 )

Net income excluding after-tax
net capital (losses) gains            $        1.05        $        0.94       $        2.35        $        2.28


Diluted weighted-average common
shares outstanding                       44,238,372           44,577,667          44,349,725           45,256,407

The increase in net income excluding after-tax net capital gains and losses for the third quarter of 2012 compared to the third quarter of 2011 was primarily due to more favorable claims experience in the group insurance business, lower operating expenses and an increase in net investment income in our Asset Management segment. The comparatively lower benefit ratio in our group insurance business was partially offset by less favorable claims experience in the individual disability business and a 100 basis point decrease in our discount rate used for newly established group long term disability claim reserves. The increase in net income excluding after-tax net capital gains and losses for the first nine months of 2012 compared to the first nine months of 2011 was primarily due to an increase in net investment income in our Asset Management segment and a lower effective income tax rate. See "Consolidated Results of Operations-Income Taxes."


Table of Contents

Outlook

We manage for long-term profitability by focusing on business diversification, disciplined product pricing, sound underwriting, effective claims management and high-quality customer service. We will continue to address challenges that arise with financial discipline.

Net income excluding after-tax net capital gains and losses for the third quarter of 2012 was favorable compared to the same period of 2011, which reflected comparatively favorable claims experience in the third quarter of 2012 in our group long term disability business, an increase in net investment income, and lower operating expenses. The lower benefit ratio for the third quarter of 2012, compared to the third quarter of 2011, was primarily due to more favorable claim recoveries and improvement in claims incidence within our group long term disability business. While claims incidence improved for the third quarter of 2012 compared to the third quarter of 2011, it remains elevated compared to historical levels. We are making progress on our pricing actions to address the effects of the elevated group long term disability claims incidence and historically low interest rates in this challenging economic environment.

As we stated in our 2012 second quarter Form 10-Q, and based on the results for the first nine months of 2012, we expect that the 2012 annual benefit ratio for the group insurance business will exceed the annual guidance range of 80% to 82% that we provided earlier this year. We expect the benefit ratio to remain elevated due to the economy and the effects of the continued low interest rates putting pressure on the discount rate. As a result, we expect to be below our 2012 annual guidance range of $3.60 to $3.90 for net income per diluted share, excluding after-tax net capital gains and losses, and below the annual guidance range of 9% to 10% for return on average equity, excluding after-tax net capital gains and losses from net income and accumulated other comprehensive income ("AOCI") from equity. Additionally, we expect our effective income tax rate for 2012 will be below our annual guidance range of 26% to 27%.

We remain focused on continuing to provide excellent products and services to our customers, enhancing our financial strength and increasing value to our shareholders. We will continue to focus on optimizing shareholder value through sustainable profitability by investing in new product and service capabilities and through the strategic use of capital, as we believe these actions position us well for growth when the economy recovers.

Primary Drivers of 2012 Results

The primary drivers of our results continue to be the group insurance benefit ratio and group insurance premium growth. Our group insurance benefit ratio for the first nine months of 2012 was 84.0%, compared to 83.2% for the same period for 2011, reflecting comparatively higher claims severity and continued high claims incidence for the first half of 2012, with improvements in claim recoveries and incidence rates for the third quarter of 2012. Claims experience can fluctuate widely from quarter to quarter and tends to be more stable when measured over a longer period of time. The benefit ratio is primarily affected by reserves established based on growth of our in force block of business, claims experience and assumptions used to establish related reserves, such as our discount rate.

The interest rate environment and its effect on our discount rate is a major driver in our reserve levels. The average discount rate used for the first nine months of 2012 for newly established long term disability claim reserves was 4.25%, compared to 5.25% used for the first nine months of 2011. A 25 basis point change in the discount rate results in a corresponding change in quarterly pre-tax income of $1.8 million. The decrease in the discount rate from the third quarter of 2011 was primarily the result of a continued low interest rate environment. We expect that the continued low yield on U.S Treasuries, together with additional spread compression, will continue to place pressure on interest rates leading to potentially lower discount rates and therefore higher claim reserves across the industry. We will maintain our disciplined approach to interest rate management given the uncertainty of the future interest rate environment and the corresponding impact on new investment yields and the discount rates used to establish claim reserves.

Premiums for our Insurance Services segment increased 1.3% to $1.63 billion for the first nine months of 2012, compared to $1.60 billion for the first nine months of 2011 primarily due to the favorable impact of experience rated refunds ("ERRs"). Premium growth continues to be affected by the economic environment, which has caused lower wage rate and job growth for our group insurance customers. Sales for the group insurance businesses, reported as annualized new premiums, were $171.6 million and $261.7 million for the first nine months of 2012 and 2011, respectively. The decrease in group insurance sales was primarily due to pricing competition.

Consolidated Results of Operations

Revenues

Revenues consist of premiums, administrative fees, net investment income and net capital gains and losses. Historically, premium growth in our Insurance Services segment and administrative fee revenue growth in our Asset Management segment have been the primary drivers of consolidated revenue growth.


Table of Contents

The following table sets forth consolidated revenues:

                                                       Three Months Ended                                               Nine Months Ended
                                                         September 30,                                                    September 30,
                                                                                 Percent                                                           Percent
                                         2012                 2011               Change                  2012                  2011                Change

                                                                                      (Dollars in millions)
Revenues:
Premiums                             $       528.7        $       539.8                (2.1 )%      $      1,630.1        $      1,610.6                  1.2 %
Administrative fees                           27.8                 28.5                (2.5 )                 86.2                  87.4                 (1.4 )
Net investment income                        159.8                147.3                 8.5                  470.9                 456.9                  3.1
Net capital (losses) gains                    (2.6 )                7.7               133.8                   (6.8 )                (7.9 )              (13.9 )

Total revenues                       $       713.7        $       723.3                (1.3 )       $      2,180.4        $      2,147.0                  1.6

The decrease in consolidated revenues for the third quarter of 2012 compared to third quarter of 2011 was primarily due to a decrease in premiums from our Insurance Services segment and an increase in net capital losses, partially offset by an increase in net investment income. See "Business Segments-Other-Net Capital Gains (Losses)."

The increase in consolidated revenues for the first nine months of 2012 compared to the same period of 2011 was primarily due to an increase in premiums from our Insurance Services segment and an increase in net investment income. See "Consolidated Results of Operations-Revenues-Net Investment Income."

Premiums

Insurance Services segment premiums are the primary driver of consolidated premiums and are affected by the following factors:

Sales.

Customer retention.

Organic growth in our group insurance businesses, which is derived from existing policyholders' employment and wage growth.

Experience rated refunds ("ERRs"), which represent cost sharing arrangements with certain group contract holders that provide refunds to the contract holders when claims experience is more favorable than contractual benchmarks, and provide for additional premiums to be paid when claims experience is less favorable than contractual benchmarks. ERRs can fluctuate widely from quarter to quarter depending on the underlying experience of specific contracts.

The following table sets forth premiums by segment:

                                                   Three Months Ended                                           Nine Months Ended
                                                      September 30,                                               September 30,
                                                                            Percent                                                      Percent
                                       2012               2011              Change                 2012                2011              Change

                                                                                (Dollars in millions)
Premiums:
Insurance Services                 $       527.5      $       538.3               (2.0 )%     $      1,625.1      $      1,604.4                1.3 %
Asset Management                             1.2                1.5              (20.0 )                 5.0                 6.2              (19.4 )

Total premiums                     $       528.7      $       539.8               (2.1 )      $      1,630.1      $      1,610.6                1.2

The decrease in premiums from our Insurance Services segment for the third quarter of 2012 compared to the same period of 2011 was primarily due to lower group insurance sales for the first nine months of 2012 and a decrease in ERRs for the third quarter of 2012 compared to the third quarter of 2011. ERRs decreased premiums by $6.5 million for the third quarter of 2012, and decreased premiums by $4.0 million for the same period of 2011.

The increase in premiums from our Insurance Services segment for the first nine months of 2012 compared to the same period of 2011 was primarily driven by ERR activity. ERRs for the first nine months of 2012 increased premiums by $4.7 million, while ERRs for the first nine months of 2011 decreased premiums by $14.2 million. See "Business Segments-Insurance Services Segment."

Premiums from our Asset Management segment are generated from sales of life-contingent annuities, which are a single-premium product. Due to the competitive nature of single-premium products, premiums in the Asset Management segment can fluctuate widely from quarter to quarter. See "Business Segments-Asset Management Segment."


Table of Contents

Administrative Fee Revenues

The primary driver for administrative fee revenues is the level of assets under administration in our Asset Management segment, which is largely driven by equity market performance and net customer deposits. Administrative fee revenues from our Insurance Services segment are primarily derived from insurance products for which we provide only administrative services and absence management services.

The following table sets forth administrative fee revenues by segment:

                                                         Three Months Ended                                               Nine Months Ended
                                                            September 30,                                                   September 30,
                                                                                     Percent                                                        Percent
                                           2012                  2011                Change                2012                 2011                Change

                                                                                       (Dollars in millions)
Administrative fee revenues:
Insurance Services                    $          3.1        $          3.0                  3.3 %      $        10.4        $         8.6                 20.9 %
Asset Management                                29.2                  29.7                 (1.7 )               89.1                 91.2                 (2.3 )
Other                                           (4.5 )                (4.2 )               (7.1 )              (13.3 )              (12.4 )               (7.3 )

Total administrative fee revenues     $         27.8        $         28.5                 (2.5 )      $        86.2        $        87.4                 (1.4 )

The decrease in administrative fee revenues in our Asset Management segment for the third quarter of 2012 compared to the same period for 2011 was primarily related to non-recurring adjustments of $0.7 million recorded in the third quarter of 2012. The decrease in administrative fee revenues in our Asset Management segment for the first nine months of 2012 compared to the same period for 2011 was primarily due to lower average retirement plan trust assets under administration for the first nine months of 2012 compared to the first nine months of 2011. See "Business Segments-Asset Management Segment."

The increases in administrative fee revenues in our Insurance Services segment for the third quarter and first nine months of 2012 compared to the same periods of 2011 were primarily due to an increase in administrative and absence management service fees.

Net Investment Income

Net investment income is affected by changes in levels of invested assets, interest rates, fluctuations in the fair value of our Standard & Poor's ("S&P") 500 Index call spread options ("S&P 500 Index options") related to our indexed annuity product, commercial mortgage loan prepayment fees and bond call premiums.


Table of Contents

The following tables set forth net investment income by segment and associated key indicators:

                                                           Three Months Ended                                               Nine Months Ended
                                                             September 30,                                                    September 30,
                                             2012                  2011                Change                 2012                  2011                Change

                                                                                          (Dollars in millions)
Net investment income:
Insurance Services                      $         86.0        $         85.8                 0.2  %      $        254.2        $        255.6                (0.5 )%
Asset Management                                  72.3                  59.0                22.5                  210.0                 193.5                 8.5
Other                                              1.5                   2.5               (40.0 )                  6.7                   7.8               (14.1 )

Total net investment income             $        159.8        $        147.3                 8.5         $        470.9        $        456.9                 3.1

Key indicators of net investment
income:
Contribution from the change in
fair value of the S&P 500 Index
options                                 $          2.9        $         (6.8 )      $        9.7         $          7.3        $         (3.0 )      $       10.3
Commercial mortgage loan prepayment
fees                                               6.8                   2.7                 4.1                    9.8                   4.9                 4.9
Average invested assets                       12,457.5              11,667.9                 6.8  %            12,223.0              11,465.8                 6.6  %
Tax-advantaged investment operating
losses                                            (4.6 )                (1.2 )      $       (3.4 )                 (9.5 )                (3.4 )      $       (6.1 )




                                                  At September 30,
                                              2012                 2011
        Consolidated portfolio yields:
        Fixed maturity securities                  4.80  %              5.14  %
        Commercial mortgage loans                  6.16                 6.38

The increases in net investment income for the third quarter and first nine months of 2012 compared to the same periods for 2011 were primarily due to favorable changes in fair value of our S&P 500 Index options and an increase in commercial mortgage loan prepayment fees. Partially offsetting the increased net investment income were higher accrued operating losses related to our tax-advantaged investments. The benefits from these investments are recorded as either a reduction to income taxes or a reduction of state premium taxes. See "Critical Accounting Policies and Estimates-All Other Investments."

We may continue to experience lower new money investment rates in the future if credit spreads continue to tighten and interest rates remain low. New money investment rates are also affected by the current volume and mix of commercial mortgage loan originations, the purchases of fixed maturity securities, tax-advantaged investments and other investments.

We seek investments containing call or prepayment protection to ensure our expected cash flow is not adversely affected by unexpected prepayments. Callable bonds without make-whole provisions represented 8.3% of our fixed maturity security portfolio at September 30, 2012. We also originate commercial mortgage loans containing a make-whole prepayment provision requiring the borrower to pay a prepayment fee. As interest rates decrease, potential prepayment fees increase. These larger prepayment fees deter borrowers from refinancing during a low interest rate environment. Approximately 97% of our commercial mortgage loan portfolio contains this prepayment provision. Almost all of the remaining commercial mortgage loans without a make-whole prepayment provision generally contain fixed percentage prepayment fees that mitigate prepayments but may not fully protect our expected cash flows in the event of prepayment. The increases in commercial mortgage loan prepayment fees were primarily the result of a continued low interest rate environment and the improvement in the commercial real estate sales market.

Net Capital Gains (Losses)

Net capital gains and losses are reported in the Other category and are not likely to occur in a stable pattern. Net capital gains and losses primarily occur as a result of sales of our assets for more or less than carrying value, other-than-temporary impairments ("OTTI") of assets in our bond portfolio, provisions to our commercial mortgage loan loss allowance, losses recognized due to impairment of real estate and impairments of tax-advantaged investments.


Table of Contents

The following table sets forth net capital gains and losses and associated key components:

                                                      Three Months Ended                                                Nine Months Ended
                                                        September 30,                                                     September 30,
                                                                                   Dollar                                                           Dollar
                                       2012                   2011                 Change                2012                  2011                 Change

                                                                                         (In millions)
Net capital (losses) gains        $         (2.6 )       $          7.7         $      (10.3 )       $        (6.8 )       $        (7.9 )       $        1.1
Key components of net
capital gains (losses):
Fixed maturity securities         $          2.5         $          0.7         $        1.8         $         4.7         $         7.2         $       (2.5 )
Real estate investments                       -                    19.4                (19.4 )                  -                   27.9                (27.9 )
Real estate owned                           (0.2 )                 (3.6 )                3.4                  (0.9 )               (16.4 )               15.5
Commercial mortgage loan
loss allowance provision                    (5.0 )                 (7.5 )                2.5                 (11.4 )               (25.5 )               14.1

Net capital losses for the third quarter of 2012 were primarily related to our commercial mortgage loan loss allowance provision. These losses were partially offset by net capital gains related to the sale of certain fixed maturity securities. The sale of real estate investments were the primary driver of the net capital gains in the third quarter of 2011.

Net capital losses for the first nine months of 2012 were primarily related to our commercial mortgage loan loss allowance provision, which were partially offset by net capital gains related to the sale of certain fixed maturity securities. The higher net capital losses for the first nine months of 2011 were primarily due to a higher commercial mortgage loan loss allowance provision, partially offset by capital gains from the sale of real estate investments. See . . .

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