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SFG > SEC Filings for SFG > Form 10-Q on 6-Aug-2014All Recent SEC Filings

Show all filings for STANCORP FINANCIAL GROUP INC

Form 10-Q for STANCORP FINANCIAL GROUP INC


6-Aug-2014

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 related notes thereto in our 2013 Form 10-K. 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 and accumulated other comprehensive income ("AOCI") 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.

Management believes that measuring net income return on average equity excluding after-tax net capital gains and losses from net income and AOCI from equity is important to investors because the low turnover of our portfolio of fixed maturity securities-available-for-sale ("fixed maturity securities") may not be such that unrealized gains and losses reflected in AOCI are ultimately realized. Furthermore, management believes exclusion of AOCI provides investors with a better measure of return.

This management's discussion and analysis of financial condition and results of operations contain forward-looking statements. See "Forward-looking Statements."

EXECUTIVE SUMMARY

StanCorp Financial Group, Inc., through its subsidiaries marketed as The Standard - Standard Insurance Company ("Standard"), The Standard Life Insurance Company of New York, Standard Retirement Services, Inc. ("Standard Retirement Services"), StanCorp Mortgage Investors, LLC ("StanCorp Mortgage Investors"), StanCorp Investment Advisers, Inc., StanCorp Real Estate, LLC and StanCorp Equities, Inc. ("StanCorp Equities") - is a leading provider of financial products and services. StanCorp's subsidiaries offer group and individual disability insurance, group life and accidental death and dismemberment insurance ("AD&D"), group dental and group vision insurance, absence management services, retirement plans products and services, individual annuities, origination and servicing of fixed-rate commercial mortgage loans and investment advice.


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Financial Results Overview

The following table sets forth selected consolidated financial results:




                                                     Three Months Ended                   Six Months Ended
                                                          June 30,                            June 30,
                                                   2014              2013              2014              2013

                                                             (Dollars in millions-except share data)

Net income                                     $       41.9      $       57.7      $       92.0      $      104.5
After-tax net capital losses                           (0.3)             (1.6)             (1.0)             (2.6)


Net income excluding after-tax net capital
losses                                         $       42.2      $       59.3      $       93.0      $      107.1


Net capital losses                             $       (0.5)     $       (2.6)     $       (1.6)     $       (4.2)
Tax benefit on net capital losses                      (0.2)             (1.0)             (0.6)             (1.6)


After-tax net capital losses                   $       (0.3)     $       (1.6)     $       (1.0)     $       (2.6)


Net income per diluted common share:
Net income                                     $       0.96      $       1.30      $       2.09      $       2.35
After-tax net capital losses                          (0.01)            (0.04)            (0.02)            (0.06)


Net income excluding after-tax net capital
losses                                         $       0.97      $       1.34      $       2.11      $       2.41


Shareholders' equity                           $    2,261.9      $    2,077.0      $    2,261.9      $    2,077.0
Accumulated other comprehensive income                225.9             127.3             225.9             127.3


Shareholders' equity excluding accumulated
other comprehensive income                     $    2,036.0      $    1,949.7      $    2,036.0      $    1,949.7


Diluted weighted-average common shares
outstanding                                      43,710,063        44,398,120        44,027,747        44,445,155

Net income excluding after-tax net capital losses was $0.97 per diluted share for the second quarter of 2014, compared to $1.34 per diluted share for the second quarter of 2013. Operating expenses for the second quarter of 2013 reflected savings of $10.3 million or $0.15 per diluted share due to an amendment of our postretirement medical plan that did not recur for the second quarter of 2014. Excluding the operating expense savings for the second quarter of 2013, the decrease in net income was primarily due to less favorable claims experience in Employee Benefits and Individual Disability for the second quarter of 2014, partially offset by a lower effective income tax rate.

Net income excluding after-tax net capital losses was $2.11 per diluted share for the first six months of 2014, compared to $2.41 per diluted share for the first six months of 2013. The decrease was primarily due to lower operating expenses for the first six months of 2013, which reflected savings of $20.6 million or $0.30 per diluted share due to an amendment of the postretirement medical plan that did not recur for the first six months of 2014.

Primary Drivers of Second Quarter and First Six Months of 2014 results

Employee Benefits premiums decreased 4.0% to $467.3 million for the second quarter of 2014 from $487.0 million for the second quarter of 2013. Employee Benefits premiums decreased 4.8% to $926.7 million for the first six months of 2014 from $973.2 million for the first six months of 2013. The decreases for the second quarter and the first six months of 2014 were primarily due to lower Employee Benefits sales for 2013 and the first six months of 2014 compared to prior periods. The decline in sales for the second quarter and first six months of 2014 reflects our pricing discipline in a very price sensitive group insurance market, with fewer attractive large group insurance cases coming to market. The benefit ratio for Employee Benefits was 82.0% for the second quarter of 2014, compared to 80.4% for the second quarter of 2013. The increase in the benefit ratio for the second quarter of 2014 was primarily due to less favorable claims experience for our long term disability business as a result of a higher-than-normal number of large claims for the second quarter of 2014 and was partially offset by a 25 basis point increase in the discount rate when compared to the prior period. The less favorable claims experience for the second quarter of 2014 was primarily limited to a single month in the quarter. The benefit ratio for Employee Benefits was 81.4% for the first six months of 2014, compared to 82.1% for the first six months of 2013. The decrease in the benefit ratio was primarily due to more favorable claims experience for the first six months of 2014 compared to the first six months of 2013.

Individual Disability premiums were $48.9 million for the second quarter of 2014, compared to $46.7 million for the second quarter of 2013. Individual Disability premiums were $97.0 million for the first six months of 2014, compared to $93.7 million for the first six months of 2013. The Individual Disability benefit ratio was 79.3% for the second quarter of 2014, compared to 63.4% for the second quarter of 2013 and was 66.8% for the first six months of 2014, compared to 62.6% for the first six months of 2013. Due to the relatively small size of the Individual Disability business, the benefit ratio generally fluctuates more on a quarterly basis and tends to be more stable when measured on an annual basis.


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Asset Management reported income before income taxes of $22.0 million for the second quarter of 2014, compared to $20.7 million for the second quarter of 2013 and $38.4 million for the first six months of 2014, compared to $37.9 million for the first six months of 2013. The increases were primarily due to higher administrative fees as a result of the increase in assets under administration, reflecting higher equity values and positive cash flows for retirement plan assets under administration.

We also deployed approximately $133 million of capital through the repurchase of shares and debt for the first six months of 2014, while maintaining a strong balance sheet and growing book value per share, excluding AOCI, by 7.3% over the past 12 months.

For a discussion of our consolidated results of operations and business segment results, see "Consolidated Results of Operations."

Critical Accounting Policies and Estimates

Our consolidated financial statements and certain disclosures made in this Form 10-Q have been prepared in accordance with 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 the reporting periods. The estimates most susceptible to material changes due to significant judgment (identified as the "critical accounting policies") are those used in determining the reserves for future policy benefits and claims, investment valuations, deferred acquisition costs ("DAC'), value of business acquired ("VOBA") and other intangible assets, pension and postretirement benefit plans and the provision for income taxes. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure our performance. These estimates have a material effect on our results of operations and financial condition.

Investment Valuations

Fixed Maturity Securities

Capital gains and losses for fixed maturity securities are recognized using the specific identification method. If a fixed maturity security's fair value declines below its amortized cost, we must assess the security's impairment to determine if the impairment is other than temporary.

In our quarterly impairment analysis, we evaluate whether a decline in value of the fixed maturity security is other than temporary by considering the following factors:

The nature of the fixed maturity security.

The duration until maturity.

The duration and extent the fair value has been below amortized cost.

The financial quality of the issuer.

Estimates regarding the issuer's ability to make the scheduled payments associated with the fixed maturity security.

Our intent to sell or whether it is more likely than not we will be required to sell a fixed maturity security before recovery of the security's cost basis through the evaluation of facts and circumstances including, but not limited to, decisions to rebalance our portfolio, current cash flow needs and sales of securities to capitalize on favorable pricing.

If we determine an other-than-temporary impairment ("OTTI") exists, we separate the OTTI for fixed maturity securities into a credit loss and a noncredit loss. The OTTI related to credit loss represents the portion of losses equal to the difference between the present value of expected cash flows, discounted using the pre-impairment yields, and the amortized cost basis. All other changes in value represent the OTTI related to noncredit loss. The OTTI related to credit loss is recognized in earnings in the current period, while the OTTI related to noncredit loss is deemed recoverable and is recognized in other comprehensive income (loss). The cost basis of the fixed maturity security is permanently adjusted to reflect the credit loss. Once an impairment charge has been recorded, we continue to review the OTTI securities for further potential impairment.

We maintain an internally identified list of fixed maturity securities with characteristics that could indicate potential impairment ("watch list"). At June 30, 2014, our fixed maturity securities watch list totaled $1.6 million at both fair value and amortized cost after OTTI. We recorded $0.1 million of OTTI related to credit loss due to impairments for both the second quarter and the first six months of 2014, compared to credit losses of $0.3 million and $0.6 million of OTTI for the second quarter and the first six months of 2013, respectively. We recorded no OTTI related to noncredit loss for the second quarter and the first six months of 2014 and 2013. See Item 1, "Financial Statements-Notes to Unaudited Condensed Consolidated Financial Statements-Note 7-Investments" for further disclosures.

We will continue to evaluate our holdings; however, we currently expect the fair values of our investments to recover either prior to their maturity dates or upon maturity. Should the credit quality of our fixed maturity securities significantly decline, there could be a material adverse effect on our business, financial position, results of operations or cash flows.

In conjunction with determining the extent of credit losses associated with debt securities, we utilize certain information in order to determine the present value of expected cash flows discounted using pre-impairment yields. The information includes, but is not limited to, original scheduled contractual cash flows, current market spread information, risk-free rates, fundamentals of the industry and sector in which the issuer operates, and general market information.


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Fixed maturity securities are classified as available-for-sale and are carried at fair value on the consolidated balance sheet. See Item 1, "Financial Statements-Notes to Unaudited Condensed Consolidated Financial Statements-Note 6-Fair Value" for a detailed explanation of the valuation methods we use to calculate the fair value of our financial instruments. Valuation adjustments for fixed maturity securities not accounted for as OTTI are reported as net increases or decreases to other comprehensive income (loss), net of tax, on the consolidated statements of comprehensive income (loss).

Commercial Mortgage Loans

The carrying value of commercial mortgage loans represents the outstanding principal balance less a loan loss allowance for probable uncollectible amounts. The commercial mortgage loan loss allowance is estimated based on evaluating known and inherent risks in the loan portfolio and consists of a general loan loss allowance and a specific loan loss allowance. The general loan loss allowance is based on our analysis of factors including changes in the size and composition of the loan portfolio, debt coverage ratios, loan to value ratios, actual loan loss experience and individual loan analysis. An impaired commercial mortgage loan is a loan where we do not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired. We also hold specific allowances for losses on certain performing loans that we continue to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which we have determined that it remains probable that we will collect all amounts due. In addition, for impaired commercial mortgage loans, we evaluate the loss to dispose of the underlying collateral, any significant out of pocket expenses the loan may incur, the loan-to-value ratio and other quantitative information we have concerning the loan. Negotiated reductions of principal are generally written off against the allowance, and recoveries, if any, are credited to the allowance. See "Liquidity and Capital Resources-Investing Cash Flows-Commercial Mortgage Loans."

Real Estate

Real estate is comprised of two components: real estate investments and real estate acquired in satisfaction of debt through foreclosure or the acceptance of deeds in lieu of foreclosure on commercial mortgage loans ("Real Estate Owned").

Our real estate investments are stated at cost less accumulated depreciation. Generally, we depreciate this real estate using the straight-line depreciation method with property lives varying from 30 to 40 years.

We record impairments when it is determined that the decline in fair value of an investment below its carrying value is other than temporary. The impairment loss is charged to net capital losses, and the cost basis of the investment is permanently adjusted to reflect the impairment.

Real Estate Owned is initially recorded at the lower of cost or net realizable value, which includes an estimate for disposal costs. This amount may be adjusted in a subsequent period as additional information is received. Our Real Estate Owned is initially considered an investment held for sale and is expected to be sold within one year from acquisition. For any real estate expected to be sold, an impairment charge is recorded if we do not expect the investment to recover its carrying value prior to the expected date of sale. Once an impairment charge has been recorded, we continue to review the investment for further potential impairment.

Total real estate was $49.2 million at June 30, 2014, compared to $65.7 million at December 31, 2013. The $16.5 million decrease in total real estate for the first six months of 2014 was primarily due to the sale of Real Estate Owned.

Other Invested Assets

Other invested assets include tax-advantaged investments, derivative financial instruments, policy loans and common stock. Valuation adjustments for these investments are recognized using the specific identification method.

Tax-advantaged Investments

Tax-advantaged investments are accounted for under the equity method of accounting. These investments are structured as limited partnerships for the purpose of investing in the construction and rehabilitation of low-income housing and projects that benefit low income communities, and to provide favorable returns to investors. We have purchased tax-advantaged investments opportunistically due to the higher risk-adjusted returns. The primary sources of investment return are tax credits and the tax benefits derived from operating losses, both of which may exhibit variability over the life of the investment. Tax credits received from these investments are reported in our consolidated statements of income as either a reduction of state premium taxes, or a reduction of income tax based on the nature of the credit. Our share of the operating losses of the limited partnerships decreases the basis in the investments and is reported as a component of net investment income. If the net present value of expected future cash flows of the tax-advantaged investments is less than the current book value of the investments, we evaluate whether a decline in value is other than temporary. If it is determined an OTTI exists, the investment is written down to the net present value of expected future cash flows and the OTTI is recognized as a capital loss.

Derivative Instruments

Interest rate swaps are recognized as either other invested assets or other liabilities in our consolidated balance sheets and are reported at fair value. The accounting for an interest rate swap depends on whether it has been designated and qualifies as part of a hedging relationship, and further, on the type of hedging relationship. To qualify for hedge accounting, we formally document at the inception of the hedging transaction, the risk management objective and strategy for undertaking the hedging transaction, as well as


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the designation of the hedge as either a fair value hedge or a cash flow hedge. Included in this documentation is how the interest rate swap is expected to hedge the designated risk related to specific assets or liabilities on our balance sheets as well as a description of the method that will be used to retrospectively and prospectively assess the interest rate swap's effectiveness, the method that will be used to measure ineffectiveness and how this ineffectiveness will be accounted for.

An interest rate swap designated as part of a hedging relationship must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is formally assessed at inception and periodically throughout the life of the designated hedging relationship, using qualitative and quantitative methods. Qualitative methods include comparison of critical terms of the interest rate swap to the hedged item. Quantitative methods include regression or other statistical analysis of changes in the fair value or cash flows associated with the hedge relationship.

Changes in the fair value of an interest rate swap designated as a fair value hedge, including amounts measured as ineffective, and changes in the fair value of the hedged item, are recognized in the consolidated statements of income as a component of capital gains and losses. The gain or loss on the termination of a fair value hedge is recognized in the consolidated statements of income as a component of net capital gains and losses during the period in which the termination occurs. When interest rate swaps are used in hedge accounting relationships, periodic settlements are recorded in net investment income.

The gain or loss on the termination of an ineffective fair value hedge is reported in the consolidated statements of income as a component of net capital gains or loses. Additionally, when a hedged item is disposed, we will terminate the related derivative instrument and recognize the gain or loss on termination in the consolidated statements of income as a component of net capital gains or losses.

For a derivative instrument not designated as part of a hedging relationship, such as our S&P 500 Index options, changes in the fair value of the derivative instrument, together with the payment of periodic fees, if applicable, are reported as a component of net investment income.

Cash settlement activity of derivative instrument contracts is reported in the consolidated statements of cash flows as a component of proceeds from or acquisition of other investments.

In the consolidated balance sheets, we offset fair value amounts recognized for derivatives executed with the same counterparty under a master netting agreement and fair value amounts recognized for the right to reclaim cash collateral or the obligation to pledge cash collateral arising from those master netting agreements. See Item 1-"Financial Statements-Notes to Unaudited Condensed Consolidated Financial Statements-Note 8-Derivative Financial Instruments."

Policy Loans

Policy loans are stated at their aggregate unpaid principal balances and are secured by policy cash values.

Common Stock

In November 2013, we became a member of the Federal Home Loan Bank of Seattle ("FHLB of Seattle") and purchased the required common stock for membership. The common stock in FHLB of Seattle we hold, relating to our membership and activity in the FHLB of Seattle, is carried at par value and accounted for under the cost method. We periodically evaluate FHLB of Seattle common stock for OTTI. Our determination of whether this investment is impaired is based on our assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value.

DAC, VOBA and Other Intangible Assets

DAC, VOBA and other acquisition related intangible assets are generally originated through the issuance of new business or the purchase of existing business, either by purchasing blocks of insurance policies from other insurers or by the outright purchase of other companies. Our intangible assets are subject to impairment tests on an annual basis or more frequently if circumstances indicate that carrying values may not be recoverable.

The following table sets forth the balances of DAC, VOBA and other intangible assets:

                                                         June 30,       December 31,        Percent
                                                           2014             2013             Change

                                                                    (Dollars in millions)

DAC                                                    $     319.8      $      319.1             0.2 %
VOBA                                                          19.0              20.1           (5.5)
Other intangible assets                                       29.2              32.1           (9.0)


Total DAC, VOBA and other intangible assets            $     368.0      $      371.3           (0.9)

We defer certain acquisition costs that vary with and are directly related to the origination of new business and placing that business in-force. Certain costs related to obtaining new business and acquiring business through reinsurance agreements have been deferred and will be amortized to match related future premiums or gross profits as appropriate. We normally defer certain acquisition-related commissions and incentive payments, certain costs of policy issuance and underwriting, and certain printing costs. Assumptions used in developing DAC and amortization amounts each period include the amount of business in-force, expected future


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persistency, withdrawals, interest rates and profitability. These assumptions . . .

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