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StanCorp Financial Group, Inc. (NYSE:SFG)

Q4 2008 Earnings Call

January 28, 2009 12:00 pm ET

Executives

Jeffrey Hallin – VP IR

Eric Parsons – CEO

Floyd Chadee – SVP & CFO

Greg Ness – President & COO

Analysts

Jukka Lipponen - Keefe, Bruyette & Woods

Eric Berg - Barclays Capital

Randy Binner – FBR Capital

John Nadel - Sterne Agee

Mark Finkelstein - Fox Pitt Kelton

Elizabeth Malone – [Wonderlook]

Operator

Welcome to the StanCorp Financial Group Inc. fourth quarter 2008 financial review conference call. (Operator Instructions) At this time, I would like to turn the call over to Mr. Jeffrey Hallin, StanCorp's Assistant Vice President of Investor Relations for opening remarks and introductions; please go ahead sir.

Jeffrey Hallin

Welcome to StanCorp's fourth quarter 2008 financial review conference call. Here today to discuss the company's fourth quarter results are Eric Parsons, Chairman and Chief Executive Officer; Greg Ness, President and Chief Operating Officer; Floyd Chadee, Senior Vice President and Chief Financial Officer; Scott Hibbs, Vice President Asset Management Group; Rob Erickson, Vice President and Controller; and Mark Fisher, Vice President and Managing Director of StanCorp Mortgage Investors.

Today's call will begin with some brief comments from Eric, Floyd, and Greg, and then we will open it up for questions.

Before we begin, I need to remind you that certain comments made during this conference call will include statements regarding growth plans and other anticipated developments for StanCorp's businesses and the intent, belief, and expectation of StanCorp's management regarding future performance.

Some of these statements made are not historical facts, but are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements are subject to risks and uncertainties, actual results may differ from those expressed or implied.

Factors that could cause actual results to differ materially from those expressed or implied have been disclosed as risk factors in the company's fourth quarter earnings release and 2007 Form 10-K.

With that, I would like now like to turn the call over to Eric.

Eric Parsons

Thank you Jeffrey, and thanks to all of you who have joined us for our fourth quarter earnings call. In this slowing economy StanCorp Financial Group continues to perform well. Earnings from operations were relatively strong in the fourth quarter and set a new record of $5.00 per share in calendar year 2008, a 14.9% increase over 2007.

Our return on average equity for the year excluding net capital gains and losses and accumulated other comprehensive income and losses was 16.7%. The economy of course is challenging and behind these headlines we’re seeing a number of important trends. In our insurance services business revenue growth has been a challenge but we continue to produce solid profits.

While the conventional wisdom is the claims will increase in this environment we have not seen such a result and our block of business continues to generate favorable underwriting results. As you will hear from Greg in just a moment, this is no accident. Now more then ever our sales associates and underwriters are applying their considerable expertise to the acquisition of profitable business.

In our asset management segment our largest business unit is retirement planning which as you know is leveraged to stock market performance and an expense base that is relatively fixed in the short-term. Administrative fees and pre-tax income were both negatively effected by the significant decline in equity values in the second half of 2008 and expenses were up a bit as we completed our important business integration project.

Moving into 2009 we’ve added Scott Hibbs to our senior management team as the leader of the Asset Management Group following the retirement of Kim Ledbetter. Many of you know Scott from when he was in charge of our Investor Relations area. Reporting to Greg, Scott is working hard to expand all of our asset management businesses with particular attention to the future of retirement plans.

His focus in 2009 is to manage expenses carefully, add to our customer base, and assure that we are prepared for an eventual market recovery when we can expect that management fees will resume their growth.

We recognize that investors in life insurance companies are paying particular attention to investment portfolios and capital positions. At StanCorp both remain strong. Although we realize that additional capital losses on fixed maturity securities during the fourth quarter we believe the performance of that portfolio compares favorably to other companies as evidenced by a comparison of historical realized and unrealized losses as a percentage of investments and equity.

We have long maintained a conservative portfolio by avoiding subprime or Alt-A mortgages structured in hybrid securities and preferred stocks. Floyd will discuss our approach to impairments more fully in just a moment.

Our commercial mortgage loan portfolio continues its long history of excellent performance. The delinquency rate remains low and there were no material losses on mortgage loans during the quarter. Returns are superior on both the reported and risk adjusted basis. As you’ve heard us say many times before the commercial properties that we lend on are very different from the commercial properties that you are reading about in the news reports every day.

Certainly this is a challenging time to manage a financial institution and there will be continuing uncertainty about how the economy will play out in the short-term. But I believe StanCorp will continue to perform well and our commitment to grow our businesses in a disciplined manner allows us to react to the uncertainties we face today with a long-term view.

Clearly we will act with flexibility and maintain our focus on building long-term value. Floyd and Greg will provide further details on our approach to these challenging economic times.

With that I will first turn the call over to Floyd to discuss our financial results and then to Greg for our business units, and of course we’ll leave plenty of time for your questions at the end.

Floyd Chadee

Thank you Eric, as we announced our earnings per diluted share excluding after-tax net capital gains and losses were $1.20 for the quarter compared to $1.23 for the fourth quarter of last year. These results were driven mainly by favorable claims experienced in our group insurance business partially offset by lower premiums in insurance services segment and comparatively less favorable earnings in the asset management segment.

Our capital position remains strong. We currently have approximately $130 million of capital in excess of our target RBC ratio of 300%. Risk based capital at our insurance subsidiaries was 314%. During the quarter, book value per share remained relatively stable despite the recognition of some capital losses on our fixed maturity securities and the payment of an annual shareholder dividend that was 4% higher then the previous year.

In addition we currently have no outstanding borrowing against our multiyear $200 million credit line and no debt maturing until 2012. During the fourth quarter we increased the discount rate used to establish new long-term disability reserves from 5.25% to 5.75%.

The average new money interest rate margin over the average discount rate for the previous 12 months increased from 46 to 55 basis points during the quarter and our overall portfolio margin at the end of the quarter was 45 basis points.

For our fixed maturities securities portfolio credit quality remains high, in spite of an economic environment that’s saw a significant increase in issuer downgrades. On average the portfolio credit rating is A. More then 71% of the portfolio is rated A or higher, 24% is BBB and 5% of the portfolio is below investment grade.

The portfolio remains broadly diversified across industries similar to [Merin] credit index but with an underweight position in finance. Net unrealized losses in the portfolio at December 31, 2008 were $122 million compared to $150 million at September 30, 2008.

Market values of fixed income securities have changed rapidly as interest rates have fluctuated reflecting the general level of economic uncertainty rather then security specific credit assessments. Yields on the average investment grade corporate bond were up 0.8% between September and December of 2008. By itself this would result in a market value decline of 3.6% on a portfolio with similar duration to ours.

During the fourth quarter we acted assertively to further enhance the credit resilience of our portfolio in this unusual economic climate. We identified holdings which appeared vulnerable because of relatively high refinancing needs in the coming year combined with high leverage and we proceeded to reduce such holdings from the portfolio.

While bond risk in the early part of 2008 were concentrated in the finance sector, we are now seeing weakness across a wide spectrum of industries where issuers have significant leverage and limited liquidity sources.

Total capital losses for the quarter were $54 million representing bonds across several sectors that we either sold off or which we recognized as impaired at year-end. We continue to stress that our fixed maturities securities portfolio contains no CDO’s, CMBS’s or Alt-A risk and no hybrid securities.

Our conservative investment approach continues to produce steady results. We have steadfastly avoided the types of structured products that do not meet an adequate level of transparency for good decision-making. When we undertake mortgage risk we do so directly through loans that we originate and underwrite ourselves rather then in packaged products such as CMBS’s.

While the capital loss on our bond portfolio for the fourth quarter was disappointing our sales to remove holdings with potential liquidity concerns leave the portfolio in better shape for the coming quarters. The remaining holdings in the portfolio are in companies with better balance sheets, good liquidity and manageable debt securities, and they are better positioned to weather an extended economic downturn.

In our commercial mortgage loans we continue to see excellent results. The delinquency rate continues to be extremely small at 19 basis points. These loans are conservatively underwritten loans on smaller mostly multi tenant commercial property in good locations. Over the past two decades or so the highest delinquency rate that we have experienced was 1.4% in 1987. As we continue to very carefully monitor our mortgage portfolio we are yet to find evidence of the delinquency rate approaching the 1987 high of 1.4%.

The portfolio is well diversified across property type, geography, borrower, and tenant and is relatively free of the brand names that have filed bankruptcy and announced store closings. On new loans we are achieving spreads of 400 to 465 basis points over comparable treasuries. During the fourth quarter we foreclosed or took by deed in lieu of foreclosure the following; one in New Mexico, one in Kentucky, one in California, and one in Michigan with a total principal balance of $3.61 million.

The combined realized losses were $489,000. Since 1987 there were only four years where the annual realized loss on the portfolio was in excess of 10 basis points and the highest realized loss was 24 basis points in 1995. Throughout the year we expect the media to be filled with reports and commentary about the weak commercial property markets.

There is no question that vacancy is up and rents are down. It is at times like these that the strength of our excellent underwriting matters. We are not a bit surprised that the CMBS and bank delinquency rates have moved to much higher levels and we expect them to continue to climb.

The CMBS loans were poorly underwritten with high leverage on high assumed values with little recourse. The bank loans contain many development, construction, and bridge loans that were underwritten at 80% of LTV with low capitalization rates on pro forma net operating income that did not materialize.

They are now maturing at well over 100% LTV with little capital available to pay them down or refinance them. These two lender segments CMBS and banks, can be expected to experience considerable stress in the current economic environment and they stand in sharp contrast to the intensively underwritten high quality loans in our portfolio.

While we do expect to see some uptick in problem loans in the coming year, we also expect the number of such loans will be relatively contained. Given that we service these loans ourselves we are prepared to deal with them promptly and proactively.

At $2.53 billion mortgage loans managed for third party investors were 33% higher at December 31, 2008 then compared to a year ago. These results reflect third party investors continued confidence in the high quality fixed rate commercial loans we originate and service.

We have good diversification by property type and geography. California loans represent less then 30% of our portfolio, down from around 60% in 1995. So, what have we accomplished in 2008 and what do we expect of 2009?

We view our results for the fourth quarter of 2008 and for the full 2008 calendar year as solid evidence of the effectiveness of our conservative and disciplined approach. In an economic environment characterized by severe headwinds we increased earnings per share excluding capital gains and losses by 14.9% in 2008 versus 2007 and we achieved a 16.7% return on equity excluding net capital gains and losses in accumulated other comprehensive income.

While many financial institutions have seen a substantial revision of their balance sheets our conservative investment approach has kept asset impairments relatively contained. Our mortgage portfolio has demonstrated the value of our underwriting expertise by outperforming many other asset classes once viewed as having higher credit quality and our insurance services segment continues to demonstrate the value of pricing discipline and underwriting expertise.

These factors enabled us to deliver growing value to our customer and to our stakeholders in 2008 and we believe they will continue to deliver value in 2009. However we do recognize that the economic environment that we face in 2009 can produce challenges for any business and may require an unusual flexibility of approach and nimbleness of action.

In 2009 it is our intent to one, preserve the value of our business franchise by continuing to provide excellent value to our customers. Two, preserve and enhance our financial strength by remaining disciplined in our approach, and three, continue to build value for our shareholders.

In order to achieve these ends in the near-term there are some actions that we have already determined and other actions that will be determined as circumstances change within this volatile economic environment. As a result we will diverge from more traditional approach to providing guidance as this approach might have been more appropriate in less volatile economic circumstances.

During 2009 we will continue with our long-term comprehensive strategy to improve operational efficiencies and diligently manage expenses to respond to changing market conditions. We plan to implement initiatives that will result in an estimated reduction of the annual run rate of expenses of approximately $25 million beginning in the second half of 2009.

These initiatives will require one-time cost of approximately $15 million to $20 million to be incurred in 2009. We estimate that the declining equity markets will cause an increase in the expense for pension plans of approximately $10 million over 2008. The revenues are likely to be relatively flat as long as the challenging economic environment effecting employment and wage growth persists.

We will continue to write profitable business and offer the best value to our customers. We will remain well positioned to pursue faster growth as the economy turns around. Since our growth expectations for 2009 are heavily dependent on the macroeconomic environment we are not giving specific guidance on revenue growth.

Our annual benefit ratio for the group insurance businesses range from 73.6% to 78.3% on an annual basis over the past five years. We believe our experience in 2009 will fall within that historical range. In recent years we have seen benefit ratios towards the lower end of this range and we have not observed any signs of deterioration.

However we do recognize the natural volatility of this measure. We expect to achieve an annual return on equity excluding after-tax net capital gains and losses from income and accumulated other comprehensive income and losses from equity within the range of 14% to 15%. This is consistent with our ongoing objective to protect the bottom line over the top line.

Given the continuing economic uncertainty we are not providing earnings per share guidance for 2009. Depending on one’s view of the macroeconomic environment one can easily contemplate scenarios of increasing or decreasing earnings per share in the short-term. Our intent is to be as flexible and as nimble as changing circumstances may require and to be opportunistic in this volatile environment.

We remain committed to building shareholder value in 2009. Given the uncertainty and volatility of the macroeconomic environment we cannot detail the metrics of a narrow set of scenarios that will allow us to achieve this. However we believe that our disciplined and conservative approach can be adapted to a wide range of scenarios to continue our track record of delivering value.

And now with that I will turn the call over Greg for a discussion of our insurance services and asset management business.

Greg Ness

Thanks Floyd, the insurance services segment had a strong fourth quarter with income before income taxes of 5.6% compared to a strong fourth quarter of last year. These results were driven by favorable claims experience in our group insurance business.

Premiums for the insurance services segment for the fourth quarter of 2008 were down slightly from the fourth quarter of last year. The deteriorating economy and competitive pressures have led to lower persistency and slower top line growth. While this presents a short-term top line challenge it has not translated into a bottom line impact because we were especially selective on the type of cases that we write and retain.

Persistency for the year for our group business was 82.9%. Most terminated premiums were in industries experiencing significant job losses. Persistency in sectors that are experiencing job growth continues to be around 88%. These industries represent about 47% of the US workforce however they represent about 72% of our block of business.

We continue to write business in these sectors. Persistency in areas that are experiencing job losses is around 68%. These industries represent about 53% of the US workforce but are only about 28% of our book of business, think retail, manufacturing, real estate, construction.

We are retaining customers in industries where job growth is occurring. This will position us well as we emerge from the current economic climate. Sales of small and medium sized cases were relatively stable for 2008 when compared to 2007. During 2007 we wrote a few large cases with premiums of about $85 million in addition to a single premium case of over $19 million.

During 2008 we did not write the same magnitude of large cases and as we have previously mentioned we had three large case terminations of about $53 million of combined premium. The combination of these results contributed to the comparable decline in total premiums. The sales environment in all segments continues to be extremely competitive with some competitors clearly pricing irrationally to achieve growth.

Our group insurance segment experienced another very favorable benefit ratio at 72.3%. Although experience in 2008 was more favorable then our expectation we consider these results to be a normal fluctuation when measured over a very short timeframe. Current economic conditions are not having an adverse effect on our claims incidence rates. In fact, in the fourth quarter we experienced a slight decrease in incidents in both long-term disability and short-term disability claims.

In addition we continue to monitor claims having subjective features such as back, muscular, middle nervous type claims, and note that overall incidence rates have decreased. This is continuing evidence of our strategy to get the right rate on the right risk and provide expert claim services. Our premiums are well diversified for economic pressures and importantly business that is priced right will continue to produce profitable results even through difficult economic scenarios.

Premiums in our individual disability business were up 6.9% during the quarter. Claims experience was higher then the fourth quarter of last year but this is a relatively small block of business and claims may fluctuate widely from quarter to quarter. Sales of individual disability continue to be steady and grew 16.7% to $7.7 million this quarter when compared to the fourth quarter of last year.

Turning now to the asset management segment pre-tax income of $3.2 million was lower then the fourth quarter of 2007 primarily reflecting the impact of declining equity markets on revenues for the retirement business and a decline in mortgage originations based on market conditions.

Despite strong net cash flows in our retirement plans business the declining equity markets more then offset the deposit growth in assets under administration. During the fourth quarter we completed the integration efforts in our retirement plans business to bring our trust product and group annuity products on to the same system.

That system now has scaled to achieve efficiencies and support future growth. We continue to add to this business through net new deposits. Individual annuity sales continued to exhibit exceptional growth during the fourth quarter. At $398.2 million sales were significantly higher then the fourth quarter of 2007 reflecting strong current demand for our fixed rate annuities.

Looking ahead now for all of our businesses, and given the uncertain economic conditions, we will continue to be selective in the cases we write and we won’t compromise the bottom line to make the top line look good and boy if there was ever a time to be disciplined, this is surely it.

Uniquely our business can continue to generate good profits and long-term value even with a slowing top line. We continue to manage this business for the long-term. All of our business units have been implementing strategies to improve operational efficiencies. In these difficult times expense control is one of our key objectives and as Floyd just mentioned, we will continue to carry out several initiatives to reduce our expense ratios while positioning ourselves for future economic growth and recovery.

Using our expertise we sell to and retain customers in several recession resistant sectors where stronger employment growth is present in spite of the current economic slowdown. Our actions center around those which we can control. Our focus is on customer service, risk selection, pricing discipline, all while delivering superior value to our customers and shareholders in this very competitive environment.

We have operated this business profitably through several recessions and our prior experience and continued discipline leads me to believe our success will continue.

With that we are now ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jukka Lipponen - Keefe, Bruyette & Woods

Jukka Lipponen - Keefe, Bruyette & Woods

With respect to your guidance statement about the capital needs not needing capital for the foreseeable future, is that last part of it just in there just in case this economy gets even a lot worse then what we’re seeing now?

Floyd Chadee

I think we’ve been saying that for quite a while, that we are confident of the conservatism of our investment base and you haven’t seen the kinds of pressure on our realized or unrealized losses that you’ve seen with our peer group so I think that statement is entirely in line with us. For example if we look back a quarter because you can only see these results in retrospect here and we look at combined realized and unrealized losses for StanCorp for the third quarter it was about, a percentage of investments, about 2.4%.

If we look at our peer group you can see that ranging anywhere from 7%, 15%, 16% so that statement about us not anticipating a need for capital really speaks to the conservatism of our investment and our confidence in that conservatism.

Jukka Lipponen - Keefe, Bruyette & Woods

Can you give us more color on exactly the nature of the investments in your operating platform that you’re going to be making and why should we treat them as one time as opposed to normal investment in the business.

Floyd Chadee

We talked to you last year about investments that we’ve been making in our businesses, in our operations so we’ve talked to you about the systems that we’ve been developing on the asset management side, that was implemented in the fourth quarter here. And also on the insurance services side we’ve also been investing in our business there.

We’ve had long-term plans for improving our efficiency and we’ll continue to do so. The one-time cost that we’ve talked about as anticipated for 2009 would reflect some very specific things related to for example severance, lease payments, closing out leases, facilities closures, some relocation costs, so very much a one-time cost related to those activities.

I think we’ve already started down that path of improving operational efficiencies.

Greg Ness

Let me give you an example maybe this will put it in perspective, as you know we have field offices, sales offices all the way across the country. Late last year we made a change in the way those field offices operate. Formally they each had underwriting staff in each office that underwrote a certain subset of the kinds of cases that we look at. What we did was made a decision to bring those field underwriting positions into the home office and so thus we don’t do field underwriting in our field offices anymore, all underwriting is done out of our corporate office here.

That allows us to gain some specific efficiencies but it also allows us to gain some deeper expertise and experience here as well as more consistency in the underwriting that we do as a whole. So that’s a good example of what Floyd’s referring to I think.

Jukka Lipponen - Keefe, Bruyette & Woods

On the benefit ratio, the two large cases that you lost, have those been a meaningful factor in the low benefit ratio that you were experiencing last year.

Greg Ness

No sir. They have not.

Jukka Lipponen - Keefe, Bruyette & Woods

And so its still the same, that there’s no particular factor, segment, that’s contributed to the very good results last year.

Greg Ness

Yes, when we look at our benefit ratio results across the board and you know as well as anyone that we monitor that about every which way we possibly can and we are not seeing any trends, any specific industries, anything like that occurring or impacting the benefit ratio. The one thing I’ll say about the terminated premium for last year, the good news is that the terminated premium left us at an ROE significantly lower then that which we reported for the company as a whole and from my perspective that means we’re saying goodbye to the right kinds of cases.

Operator

Your next question comes from the line of Eric Berg - Barclays Capital

Eric Berg - Barclays Capital

The increase in the new claims discount rate was quite significant, what would the benefit ratio have been if you hadn’t changed that and can you review with us what drives that benefit ratio, is it the new money rate, is it the overall portfolio rate, how does that work.

Floyd Chadee

The actual benefit ratio in the fourth quarter was 72.3% without the change in discount rate it would have been 73.1%. So we saw very significant increases in our new money rate in the fourth quarter. The fourth quarter was an interesting time where we did have between 9/30 and 12/30 you did see rates come down but during the quarter rates were quite high on fixed income securities.

In fact so much so that from an investment point of view they were competing with yields we would normally get on the mortgage side. For example bonds in the fourth quarter of 2008 the bond spreads over 10 year treasuries on the order of in excess of 400 basis points. So in implementing our discount rate change we followed our normal formula looking at the margin over the last 12 months and seeing what would be the appropriate discount rate for claims that we experienced in the fourth quarter and this was the result.

Now since then we’ve seen those spreads come down, rates come down and we will appropriately adjust as we go forward. In terms of what effects the benefit ratio, remember when we, whether it’s a portfolio rate or the new money rate, remember every quarter we look at the discount rate on new claims so the change that you’re likely to see in terms of the interest rate impact on the benefit ratio is coming from that, whatever changes we make with respect to the new claims, which would be influenced by the new money rate.

Eric Berg - Barclays Capital

Regarding the broader comments you were making about the state of the bond market in general, I believe in your prepared comments you were commenting that you were seeing weakness, I wasn’t sure whether you were referring to your bond portfolio or to bonds in general, across the economy going beyond financials, and while at first blush might seem to be an obvious statement everyone knows the economy is recession, I’m wondering whether you can elaborate and provide additional detail as to exactly what you’re saying about the economy and about the likelihood of bond defaults in general. What was the big point you were trying to make there.

Floyd Chadee

I think this question gets to the impairments and the capital losses we’ve seen over the last three quarters and its interesting how this has evolved. In the second quarter of 2008 our impairments were mostly related to the experience we were seeing on the bond insurance, it’s very concentrated within the financial sector.

And then in the third quarter of 2008 our impairments were largely still concentrated in the financial sector but more broadly within the financial sector so you had AIG, Lehman, WaMu, those sorts of things. Interestingly enough in the fourth quarter of 2008 and following our normal approach to looking at the watch list and impairments and evaluating other then temporary impairments we now got to a place where in fact the impairments that we’re taking and the capital losses taken in the fourth quarter were no longer concentrated in the financial sector but if we look at the, in fact the financial sector would be third on our list.

We had basic industries and in communication we saw somewhat higher, not very much higher impairments from those sectors so as we look at the impairments across all sectors it was coming from much more broad based. So you’re right, it shouldn’t be surprising. It does reflect the financial crisis that started within the financial sector is now much more broad based. As we’ve said we were very circumspect, very assertive with respect to the actions we took in the fourth quarter with respect to sales, and looking at impairments.

We focused a great deal on issuers with liquidity concerns or with debt maturing so that they will have to go to a capital market that may not be very open. So we think we’ve taken action in the fourth quarter to increase the resilience of that portfolio and the fourth quarter for the first time reflected much more broad based economic deterioration.

Operator

Your next question comes from the line of Randy Binner – FBR Capital

Randy Binner – FBR Capital

Just looking at the financial supplement on page nine it looks like potentially some of those fixed maturity securities were private, is that where the majority of the OTTI was?

Floyd Chadee

No, I don’t think so. I think they were everywhere, not necessarily in, no particular bias I think in those. They were really spread out across all sectors.

Randy Binner – FBR Capital

Was there a rating, was it mostly BBB or is there any color you can give in kind of where they were ratings wise?

Floyd Chadee

Not a bias view on what one would expect, clearly lower rated securities would be under a lot more pressure in this market where financial strength matters a great deal in the minds of investors. But beyond that I wouldn’t say that it was any particular bias. Over time we’ve seen AAA bonds come under huge pressure. Certainly that was the case in the third quarter of 2008 when they were concentrated in some financials.

Randy Binner – FBR Capital

Was price a consideration when you looked at the impairment, where the bonds were trading and if so was there, could you share the highest and lowest price was in the OTTI group.

Floyd Chadee

I’ll talk a bit about the way we think of other then temporary impairments, clearly this market has been a challenge for the accounting rules with respect to determine what is other then temporary. So we do have a watch list that we place securities on that watch list on an ongoing basis and things get on the watch list for two reasons. One is the bright line test that says if the market value falls below 80% of book it definitely gets on the watch list. Which doesn’t mean that we impair it, it means that we start considering it.

But there may be stuff that’s over 80% of book value that we also put on the watch list. If for some reason our analysts think that they need to have some scrutiny and some of the things that may drive securities on that watch list would be stuff that we’ve talked about which would be debt coming due, high leverage, low liquidity, that sort of thing.

Then we go through a process of examining those securities one by one according to the OTTI rules and saying what do we think about this, is this other then temporary. After long discussions with auditors as one would expect in this rapidly changing environment we come to a conclusion on are those other then temporary or not.

Randy Binner – FBR Capital

So they were predominantly OTTI which means you’re keeping the bonds and therefore its not a statutory impairment at this point, is that correct?

Floyd Chadee

Our impairments do carry over to the statutory side, so they do effect, they have effected our capital position. They are already factored into the excess capital position as of the end of the year. Our impairments on a GAAP basis and a stat basis are quite similar.

Randy Binner – FBR Capital

I’m curious about the foreclosures, the $3.6 million, do you have handy what years those four loans were underwritten in?

Greg Ness

I think two of those were written in 2005 and two of them in 2003.

Randy Binner – FBR Capital

Did I hear that the realized loss against the $3.6 million was $0.05 million—

Greg Ness

Less then $500,000 yes.

Randy Binner – FBR Capital

So it was something like a 14% markdown against the four loans.

Greg Ness

That’s correct.

Randy Binner – FBR Capital

How was that 14%, how is that determined, was it just a reappraisal of the real estate.

Greg Ness

They are mark-to-market based on brand new appraisals and one of the reasons that number is what it is, is in two cases borrowers simply paid their deficiency.

Randy Binner – FBR Capital

So if the borrowers, in a pure appraisal process I would have thought it would be more then 14%, I guess you’re saying it was, and so with the borrower paying their deficiency, is that a function of the personal recourse?

Greg Ness

That is a function of the personal recourse and without that deficiency I’d say that write down would have been about [to] 20%.

Randy Binner – FBR Capital

How are those held? You own the real estate, is there a difference in accounting how that’s held for on a statutory basis versus having a loan out against it.

Floyd Chadee

The way you see it show up on our balance sheet, first of all these loans, the $3.6 would be our portion of the loans remember we do share those loans with third parties so what you would actually see on the balance sheet would be an increase in the value of real estate between the end of the third quarter and the end of the fourth quarter that would exceed that $3.6, it would be a larger number reflecting the full value of the real estate and then there’ll be an offset for the minority interest on the other side of the balance sheet.

Randy Binner – FBR Capital

Is there a notching effect or any further statutory capital requirement because you actually own it rather then having a mortgage out against it?

Floyd Chadee

Nothing of significance.

Operator

Your next question comes from the line of John Nadel - Sterne Agee

John Nadel - Sterne Agee

Just wanted to dive a bit deeper into the guidance commentary about the flattish year-over-year revenues and just get a sense what your expectations are if you broke it down a bit more granularly for us to think about the insurance services business versus asset management and then within the insurance division if you wanted to talk a bit about larger case versus smaller case growth.

Floyd Chadee

When we say that revenue, we think revenue will be relatively flat its important to note that we’re not targeting flat revenue. We have been doing things to increase our connection with our customers and our distribution. We’ve told you we’ve been investing in both the systems and both the asset management side, also on the ISG side, we’ve been investing in systems that will bring greater capabilities to our customers.

So we’re not turning away from business and we certainly continue to concentrate on our markets however we do recognize the headwind, we do recognize that there will be a reduction in demand for goods and services throughout the economy and we would expect our customer base to be no different from that in terms of that demand.

What we are saying is that given that overall economic situation and the drop in demand overall as economic activity decreases in the environment that we are not going to pursue in a sort of tunnel vision approach increases in revenue that may speak to short-term, short-lived [inaudible] gain but will not actually bring value to our shareholders.

It doesn’t mean that we won’t be opportunistic. Should we see that they are the opportunities to grow, we have the capabilities to bring to our customers and we will put those out and we will pursue growth but not in this narrow minded tunnel vision approach.

So beyond that we need to think about how to deliver value to our shareholders and sometimes it might be better not to pursue this excessive growth in our product markets but to think in other ways of building shareholder value and in the circumstance in which there’s general concern about financial strength we are going to make sure that investors can count on us to continue to be financially strong company and look at our capital base in a way that reassures our investor community.

Greg Ness

The large case market is a little bit fickle and sometimes those opportunities present themselves and when they do we’re going to be in there and take a look at the opportunity and very likely provide a bid.

John Nadel - Sterne Agee

And lose to somebody very competitive.

Greg Ness

Sometimes that’s right but I have to tell you that if we price a product on a particular case one way and somebody comes in and is 20% below that they can have it. Because that means its going to be a loser and you’ve heard us say a million times that we’re not going to ruin the bottom line by growing the top line. There is premium growth that absolutely creates value and there’s absolutely premium growth that destroys value and we are not into putting dollars on the top line that are going to destroy value on down the line.

I had a chance to spend time with our field sales managers last night from both our retirement plans business as well as our EB business. What I would characterize their mood and their sentiments to be as is number one, this is a great company to be with right now. They come across competitors that are in very, very difficult straits and I think they feel very pleased to be with Standard.

Secondly they also recognize that there is some tough sledding out there but I have to tell you this is a very resilient group that is out there working at it every single day and there is a certain amount of optimism in the way they talk about what’s going on in their marketplace and their opportunity to get out in front of brokers and talk about what value we can provide.

And frankly what value it brings to a client when you’re doing business with a company that you don’t have to worry about the financial strength of the ability to pay claims, the impairment issues and so on.

John Nadel - Sterne Agee

Anything you can comment on in thinking about the bigger business, insurance versus the smaller business, asset management, I’m just trying to get a sense for how to think about modeling out, I guess we all sense that there’s going to be pressure probably in both, but it seems to me that just based on the nature of the business we should be expecting more pressure from a revenue perspective on the asset management arm then on the insurance business, is that fair.

Greg Ness

I think you’re exactly right in seeing that that business is mostly sensitive to where the equity market values are.

Scott Hibbs

We want to deliver value across all of our asset businesses but we want to do so in a long-term sustainable way. I had the same opportunity that Greg did last night to speak with some of our sales folks and on a retirement plan side they have that same optimism but also realism about what the market looks like right now. In the retirement plans business as you know we are leveraged to the equity markets and the big drop in the fourth quarter has a significant impact on our revenue going forward.

Not all of our plans are priced the same, some are asset based fees, some aren’t, but a rough rule of thumb, if we have $1 billion move in assets under administration or retirement plans that’s about $5 million in revenues. That gives you a sense of leverage there. The last point I would make is our mortgage business is an important component of our asset management segment. We did see a decline in December in the amount of new originations that may well continue for a while but again, we want to make sure that we’re delivering value, new revenue and value, but value that’s sustainable.

John Nadel - Sterne Agee

Thinking about the 400 to 460 basis points spread over treasury on new commercial mortgage originations in the quarter, can you give us a sense for what kind of LTV you’re writing at in the current environment and the geography mix, is there any large exposures to any specific state or geography. What’s the level of cash at the holding company at the end of 2008 as well as equity in the asset management segment and then just wanted to think about the expense initiatives that you mentioned in your 2009 outlook, is it fair to assume that that is centered or concentrated in also the insurance services division.

Mark Fisher

For new originations we’re actually today, our base spread is 450 over. We are seeing a lot of borrower resistance at that level. We’ve been writing mortgages in the high 6’s for five year deals and below 7’s and mid-7’s for 10-year deals but a lot of our borrowers, our traditional borrower that we really target they actually have a lot of options and they’re certainly not acquiring any new properties and they have options with their local banks and so we’re seeing a lot of resistance at that level and that’s really why originations are down. The supply of mortgages to make is way down. Which is fine. From a geographic standpoint we’re focusing on our traditional markets which are typically the larger metro cities. You’ll look at our California exposure, that’s largely Los Angeles County, San Diego County and the Bay Area counties. We don’t really have a lot of exposure, some but not a big concentration on the inland empire or the San Joaquin Valley where there’s really a lot of economic problems.

But we’re writing loans across the United States in the same diversification manner that we always have.

Floyd Chadee

In terms of the actual cash of the holding company, we have $130 million of excess capital as of the end of the year, about $75 of that is just available at the holding company in fairly liquid form. The rest of the stuff is quite accessible so when you think of excess capital, we think of the whole $130 million. We haven’t traditionally given out equity by different lines so we’ll think of that as something to include in our supplement going forward as something we may consider.

Greg Ness

About expense initiatives I think you should assume that those will be across the enterprise. They clearly are expense initiatives that are under way and have been under way for some period of time in the insurance services segment but there also are a number of initiatives under way in the asset management segment related to the completion of this integration as an example and now having all of our trust and annuity products on the same system which provides a great opportunity for future efficiency moving forward.

Operator

Your next question comes from the line of Mark Finkelstein - Fox Pitt Kelton

Mark Finkelstein - Fox Pitt Kelton

Back in 2006 you gave some guidelines for excess capital relative to premium growth, one of the sensitivities for example was 6 to 8% premium growth would translate to about $130 to $150 million of excess capital, I’m just curious what is the excess capital generated at a flat premium level for 2009.

Floyd Chadee

As we look out to 2009 we said at the beginning of the year with respect to premium growth that we’re looking at that we may generate about $125 to $150 million and we use up about $80 of that in holding company needs, paying interest and all of that. As we look to 2009 and contemplate the possibility of lower growth I think when that number moves up to somewhere in the range of $150 million to as much as $200 million and where in the range we fall will depend on really how much growth we actually see.

Mark Finkelstein - Fox Pitt Kelton

So you use about $80 out of that $150 to $200 so 70 to 120 would be the right excess capital generated above and beyond holding company needs.

Floyd Chadee

That’s correct, yes.

Mark Finkelstein - Fox Pitt Kelton

The persistency numbers, were those Q1 2009 kind of what you’re seeing so far or are those 208?

Greg Ness

Those were all 2008 numbers. Remember we report persistency one time annually and so those represent where we ended up at 12/31/08.

Mark Finkelstein - Fox Pitt Kelton

Is there anything that you can say about the, just knowing it’s a big quarter, the persistency rate thus far in 2009?

Greg Ness

We’ve gone through the January 1 renewal cycle as you would expect and based upon what our projections were we would say that those renewals were as expected to maybe even slightly better then anticipated.

Mark Finkelstein - Fox Pitt Kelton

You talked about claim incidents and not really seeing any increase and some decreases, are you seeing any, across any of the different categories of business any changes in claim duration.

Greg Ness

No, we’re not seeing any change in duration. The incidents decreases were both in the long-term and short-term disability lines and not confined to a specific industry or geography or anything like that. This all comes back down to underwriting discipline, the right price, the right contract, the right plan design, all those issues.

Now its starting to play out I think.

Mark Finkelstein - Fox Pitt Kelton

On the commercial mortgage loans how much re financing of your own commercial mortgage loans are you seeing, did that actually get factored, is that classified as a new origination.

Greg Ness

We don’t refinance as many of them as we would like. We actually have, last year we had $58 million in maturing loans and that was about 62 loans and we captured 15 of them. So when we refinance a maturing loan we do call it a new origination but many of them are very small and very conservative and they’re hard to keep because our rates are typically higher then what that borrower can achieve at 50% LTV.

This year I think our maturing loans totaled $62 million and we will try to refinance them. But it is not a large portion of our new originations.

Mark Finkelstein - Fox Pitt Kelton

So the 2009 maturing loans is $62 million.

Greg Ness

Correct.

Operator

Your final question comes from the line of Elizabeth Malone – [Wonderlook]

Elizabeth Malone – [Wonderlook]

Its clear that you’re not giving guidance for 2009 however on the revenue number that you said it should be about flat does that include the capital losses that you recorded in 2008 or does that exclude them.

Floyd Chadee

The capital, when we think of revenue we’re thinking of the top line number, the premium numbers, premium and investment income.

Elizabeth Malone – [Wonderlook]

On the asset management business, the bonuses were significantly higher then other quarters and I wondered what was the nature of that?

Scott Hibbs

The commissions and bonuses increase was largely driven by the high level of annuity sales we had in the fourth quarter. Floyd mentioned earlier that the spreads we saw early in the quarter, kind of a unique time for us where our fixed rate product was very attractive. Its not a level that we expect going forward in 2009 but the majority of that increase there is related to those annuity sales.

Elizabeth Malone – [Wonderlook]

Is that compounded with the deferred acquisition costs, was that related?

Scott Hibbs

Its is.

Elizabeth Malone – [Wonderlook]

And what kind, what rates were you offering. Are these all just fixed annuities that you were providing?

Scott Hibbs

The predominance of what we are selling is fixed rate. We had that brief period of time where spreads were high, we had rates high five’s up to six and it was very attractive, more volume then we anticipated. We know what we’ve seen in spreads since that point in time, our rates have come down and you should expect to see that business operating more in line with what you would have seen historically through 2007 as opposed to the volume you saw in 2008.

Elizabeth Malone – [Wonderlook]

In the retirement plans it did decline in the fourth quarter, and you explained a lot of that has to do with the value of those assets, but are you seeing the economic impact on the retirement plans, are you losing customers because of mergers or shutting down of businesses as well.

Scott Hibbs

For the full year 2008 we saw a good net deposit growth. We did see some slowdown in the fourth quarter, net deposits were somewhat lower, but it was just one quarter. I’m not sure I’d want to put too much attribution to that. In talking to our sales folks last night they continue to have optimism that they can do well and do sales in 2009.

Jeffrey Hallin

I’d like to thank everyone once again for joining our call. There will be a replay of this call starting this afternoon and running through February 6th.

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Source: StanCorp Financial Group, Inc. Q4 2008 Earnings Call Transcript
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