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Unum Group (NYSE:UNM)

Q3 2009 Earnings Call Transcript

November 4, 2009 9:00 am ET

Executives

Tom White – VP, IR

Tom Watjen – President and CEO, Unum Group

Rick McKenney – EVP and CFO

Kevin McCarthy – President and CEO, Unum US

Susan Ring – President and CEO, Unum UK

Randy Horn – President and CEO, Colonial Life

Analysts

Bob Glasspiegel – Langen-McAlenney

Colin Devine – Citigroup

Mark Hughes – SunTrust

Mark Finkelstein – FPK

Mike Zaremski – Credit Suisse

Randy Binner – FBR Capital Markets

John Nadel – Sterne Agee

Steven Schwartz –Raymond James and Associates

Operator

Please stand by, we are about to begin. Good day and welcome to the Unum Group 2009 Earning Results Conference Call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Head of Investor Relations, Mr. Tom White. Please go ahead, sir.

Tom White

Great. Thank you, Clayton. Good morning, everyone, and welcome to the third quarter 2009 analysts and investor conference call for Unum.

I'd like to remind you that our remarks this morning will include forward-looking statements, which are statements that are not of current or historical fact. As a result, actual results might differ materially from results suggested by these forward-looking statements. Information concerning factors that could cause results to differ, appears in our filings with the Securities and Exchange Commission and are also located in the sections entitled "Cautionary Statement Regarding Forward-looking Statements" and "Risk Factors" in our annual report on Form 10-K for the fiscal year ended December 31, 2008, as well as on subsequently filed Form 10-Qs. Our SEC filings can be found in the Investors section of our website at www.unum.com.

Please take note that the statements in today's call speak only as of the date they are made and we undertake no obligation to publicly update or revise any forward-looking statements. A presentation of the most directly comparable GAAP measures and reconciliations of any non-GAAP financial measures included in today's presentation can be found on the website also in the Investors section. Participating in this morning's conference call are Rick McKenney, Executive Vice President and CFO, as well as the heads of our three core operating segments, Kevin McCarthy, Randy Horn, and Susan Ring.

And now I would like to turn the call over to Unum's President and CEO, Tom Watjen. Tom?

Tom Watjen

Thank you, Tom, and good morning. I would like to begin this morning's comments – call with a few observations on the third quarter before I turn it over to Tom White for a review of our operating results and then to Rick McKenney for his comments on the quarter and a review of our capital management investment portfolio results.

The third quarter was another good one for our company with a continuation of many of the business trends that we had been having over the past several quarters. Let me touch on a few highlights. First, excluding net realized after-tax investment gains, we reported $0.64 per share in operating income for the third quarter, in line with last year's third quarter. Operating results in Unum US were especially strong with earnings increasing 15%, which was driven by a continued profit improvement in our group disability line of business.

While the soft economy and continued high levels of unemployment continued to put pressure on our ability to grow the top line as it does with all of our businesses, Unum US' profitability continues to improve. Colonial Life' third quarter results were also solid with operating earnings growing 6% with just over 3% premium growth and generally stable risk experience. Finally, our Unum UK results were below our expectations with operating earnings on a local currency basis declining by 27% relative to a year ago. The decline is primarily attributable to lower premium income which we will discuss further in a few moments.

Second, despite the difficult economy, I'm encouraged by our sales results in our target markets. Specifically, we saw an 11% increase in Unum US' core market sales, 3.4% growth in sales of Colonial Life and a nice rebound in Unum UK sales. In addition, case count growth continues to be strong across all of our businesses, especially in the smaller end of the market. As I mentioned earlier, we continue to see some premium pressure as employers are not generally adding new benefits in this environment, and in many cases, the level of employment with our existing customers is down. We are likely to continue to face these headwinds into 2010 as well.

Third point is the investment portfolio continues to perform extremely well and the quality remains very high. As a result of the significant change in the interest rate environment, including rates and spreads, the value of our fixed maturity securities portfolio now stands at a net unrealized gain of 2.2 billion dollars, compared to a net unrealized loss of $2.5 billion just six months ago. And finally we continue to build financial capability with continued strong statutory earnings and the opportunistic debt financing we did late in the third quarter, further strengthening our capital position. Rick McKenney will provide greater detail on our capital position but you can expect that we will comfortably exceed the 2009 targets for holding company liquidity and risk based capital.

In summary, I feel very good about our third quarter results and our position as we move ahead. Our core operating segments continue to perform well and we are general meeting our expectations. Our solid risk results today reflect the plans we implemented over the past few years that included disciplined pricing, underwriting and risk reduction. Sales momentum in our target market remains generally positive with solid growth in our core group market. Our strong value proposition and a broad array of product choices supported by our commitment to service is serving as well in the marketplace.

While the economic conditions may continue to adversely affect premium growth, I can assure you, we will remain disciplined and we will not be (inaudible) for growth. Our investment portfolios continue to perform very well in this environment. And so last but not least, our financial position is excellent. We continue to build financial flexibility. Our excess capital remains a valuable asset, especially in this uncertain economic environment.

Now I will turn the call over to Tom White who will provide more detail on the operating results in the third quarter. Tom?

Tom White

Great. Thanks Tom. Net income for the third quarter was $221.1 million or $0.66 per diluted common share compared to net income of $108 million or $0.32 per diluted common share last year. Included in the results for the third quarter of 2009 are net realized after-tax investment gains of $9.5 million or $0.02 per diluted common share compared to losses of $108.9 million or $0.32 per diluted common share a year ago. These amounts include the impact of the embedded derivative and a modified coinsurance arrangement which resulted in a third quarter 2009 realized after-tax investment gain of 28.9 million compared to a $44.1 million after-tax loss a year ago.

Net realized after-tax investment losses related to sales and write-downs of investments were $19.4 million in the third quarter of 2009 compared to losses of 64.8 million in the year ago quarter. So excluding these items, after-tax operating income was $211.6 million for this quarter or $0.64 per diluted common share compared to 216.9 million or $0.64 per diluted common share in the year ago quarter.

Looking at the operating results for our operating segments, in total Unum US operating income increased by 14.9% to $197.1 million in the third quarter. Within Unum US, the group disability line reported another strong quarter with income up 37% to $75 million. We continue to see improvement in the benefit ratio which declined to a 85.3% in the third quarter compared to 87% in the second quarter of this year and 89.3% in the year ago quarter.

A number of factors continue to drive this improvement, including the ongoing shift in our block of business to more core market business and less large case business as well as the shift to more stable industries and away from traditionally economically sensitive industries, a generally consistent rate of claim recoveries and net favorable claims experience, and also the ongoing adherence to pricing disciplines, particularly in the large case business.

Paid claim incidents rate in our group long term disability line were slightly higher this quarter relative to the third quarter of 2008 and the second quarter of 2009 experience but the average size of the new claims was lower and therefore the financial impact of these claims was minimal. The higher claims were largely from traditionally non-economically sensitive sectors of the economy, so we believe it is normal quarterly volatility rather than a trend related to the economic environment. Also our STD or short-term disability claims experience was also somewhat higher this quarter than in the second quarter of 2009.

Moving to the group life and AD&D line, operating income declined slightly to $50 million in the third quarter compared to $50.9 million in the year ago quarter, primarily driven by lower premium income which declined by 2% and a stable benefit ratio of 70.3% in the third quarter this year compared to 70.4% in the year ago quarter. The supplemental and voluntary line third income – third-quarter income grew 9% to $72.1 million. The recently issued individual disability line and long-term care line both reported improved earnings over year ago, while the operating results in the voluntary benefit line was marginally lower.

Reported sales for Unum US declined by 7.1% in aggregate. Core market sales for our group lines which include LTD, STD, and group lines showed continued positive momentum increasing 11% for the third quarter and 15.6% for the first nine months of 2009. Sales in the large case market for these lines declined 3.3% in the third quarter. The mix of our core market and large case sales thus far in 2009 is 66% core market and 34% large case which is a very positive trend. The supplemental and voluntary lines struggled this quarter with a combined sales declined of 21.9%. Voluntary benefits had a sales decline of 17.8%. Case count growth remains positive in the voluntary benefits line which increased 24% relative to last year which reflected a continuation of the good level of activity in the under 500 life market.

Moving to our UK results, before tax operating earnings in this segment declined from $92.5 million in the year ago quarter to 58.7 million in the third quarter of this year. The decline in the value of the British pound relative to the dollar which came from a $1.89 third quarter last year to $1.64 in the third quarter of this year continued to negatively impact translated results for the Unum UK segment. The underlying operating performance was also weaker with before tax operating earnings in local currency declining 27% to 35.8 million pounds from 49 million pounds a year ago.

The primary driver of the lower operating earnings was the decline in premium income which was 103.4 million pounds this quarter compared to 118.6 million pounds in the year ago quarter and 111.6 million pounds in the second quarter of 2009. Basically the same factors that we see in the US are impacting the premium income in Unum UK, that is higher than expected levels of lapses, somewhat in the large case block; secondly a reduction in the existing block due to companies downsizing reductions and salaries and lower sales to existing accounts. And then third, the lower level of sales and lower persistency that we experienced during 2008, which reduced the size of our in force block relative to the prior year.

Also impacting the earnings in the segment this quarter was a return to what we would call a more normal level of claim incidents from the extraordinarily favorable trends we experienced in the first half of 2009. The benefit ratio in Unum UK declined to 50.2% in the third quarter compared to 52.4% a year ago and 54.4% in the second quarter. This is largely driven by the impact of lower inflation on claim reserves associated with group LTD policy containing an inflation linked benefit increase feature. The offset is reported in the net investment income line where lower net investment income results from a reduction in inflation, which reduced the return on bonds for the interest income is linked to UK inflation.

The impact this quarter was approximately 9 million pounds for both lower net investment income and reserves which would result in a benefit ratio of approximately 59% if you adjust for this. Third-quarter sales for UK were quite strong, you will see increasing 63% in local currency. We continue to benefit from the exit of our competitive in the UK group risk market and the movement of some of that business to us. We also expect to see strong fourth quarter sales as we gain this business in the open market.

Moving to Colonial Life and concluding our core operations, Colonial Life's operating results remain strong with operating income of $70.4 million, a 6% increase over the third quarter of last year. Premium income in this segment grew by 3.4% while the benefit ratio of 48.2% this quarter was slightly higher than a year ago result reflecting a higher level of paid cancer claims. The third-quarter margin remains quite favorable at 27.8% against the third quarter of 2009.

Despite the difficult sales environment, sales at Colonial Life increased 3.4% in the third quarter. Many of the same trends we have discussed in recent quarters continued this quarter with favorable new account growth. Our new accounts increased 16.7% over a year ago and new account sales increased by 10.9% while sales to existing accounts remain challenging with the decline this quarter of 9/10 of a percent. This level of sales to existing accounts while is lower year-over-year does mark an improvement from the trend in the first half of the year. We also saw favorable sales growth of 19% in the public sector market which is a very important market for Colonial Life which produces about 23% of total sales against (inaudible).

Recruiting continues to remain strong with growth in new rep contracts up 45% this quarter and 31% on a year-to-date basis. The average weekly producers increased 7.6% in the third quarter. The individual disability closed block pretax earnings improved to $7.2 million from $2.5 million a year ago. The interest adjusted loss ratio was stable at 81.6% this quarter while premium income declined 6.7% and net investment income declined slightly by 2.6%.

Finally the corporate and other segments recorded an operating loss of $13.7 million compared to $7.2 million in the year ago quarter. Expenses are higher in the segment reflecting approximately $10 million of incremental quarterly pension cost. Interest expense was reduced to $24.1 million in the third quarter of 2009 compared to $28.2 million in the third quarter of last year.

So with that review of our operating results, I will turn the call over to Rick McKenney.

Rick McKenney

Thank you, Tom. As you heard in the overview of our operating results, the trends we experienced in our businesses this quarter remain consistent with those of the past several quarters. We continue to see that consistency playing out in multiple areas of our business and across each of our segments. Let me break it down into the key drivers of profit.

First we saw a generally steady risk experience across the business. We did see a slightly higher level of volatility in this quarter's claims in the US disability business. It is something we will continue to monitor closely but not something we see as a trend at this point. And the benefit ratio continued to improve. Risk results in the UK in terms of claim incidents and recovery trends were generally in line with expectations.

I would note that although this quarter's results were not as favorable, there is a very positive trends, and margins we experienced in the first half of this year, they are strong and improved from a year ago. And then when you take Colonial Life steady results, the overall picture continues to be favorable. Second, we have not been immune to the environment on the top line. We have had good sales but we have seen premiums decline in the third quarter on a year-over-year basis by 3% after adjusting for currency. The environment is causing some clear global headwinds for the growth of the benefits business.

In the quarter, this is most pronounced in our UK business, which is feeling the effects of earlier lower sales and persistency, and challenges from the economy, such as downsizing and salary reductions. These elements are true to some degree across each of our businesses and will persist until we see improvement in the economy. Third, underlying our consistency has been the performance of our investment portfolio. This was strong in this quarter reflecting the ongoing rally in the fixed income markets and the rapid tightening of corporate bond trends across the rating spectrum. Corporate bonds compose the majority of our investments.

For reference, the spread of the Lehman – the Barclays US Investment Grade Credit Index has tightened back to 198 basis points at September 30 compared to 275 basis points at June 30 and all the way from 493 basis points at year-end 2008. With this tightening, the net unrealized position of our fixed maturity securities portfolio has now swung to a net unrealized gain of 2.2 billion compared to a net unrealized loss of 2.3 billion at year-end.

With the rebound in the credit markets, the company's book value per share likewise rebounded. Book value per share was $24.86 at September 30, a sequential increase of 10% from June 30, and 23% from a year ago. Excluding accumulated other comprehensive income, book value per share was $24.06 as of September 30. With the continued tightening of credit spreads in the third quarter, it is not surprising that our new money yields declined somewhat from the levels of late 2008 and the first half of 2009. Our new money yields adjusted of hedges in the third quarter was 6.75% compared to 6.82% in the second quarter and 7.46% in the first quarter. The overall portfolio yield has remained relatively stable throughout the year and the net interest rate reserve margins for Unum US group disability continued to widen.

Finally, in the third quarter, our reported net realized investment losses excluding the embedded derivative gain of 29 million after tax totaled 19.4 million after-tax. The 19.4 million realized loss this quarter compares to 40 million in the second quarter and 57 million in the first quarter and clearly continued the trend of declining realized losses. As we look forward, some level of realized losses is likely to persist, so the amount we believe will be manageable relative to the size of our investment portfolio and our capital position.

Moving to capital management, in addition to the strong gap [ph] in earnings this quarter, our statutory earnings in our traditional US life insurance companies were also solid, with third quarter 2009 after-tax operating earnings of 137 million, which brings 9 month after-tax operating earnings to almost 500 million. This level of statutory earnings continues to drive very positive momentum in our capital management metrics and overall financial strength and flexibility. Additionally, a highlight of the third quarter was the issuance of $350 million of senior debt in the last week of the quarter. Over the past 24 months, we had significantly reduced our leverage which was 18.5% at the end of the second quarter. We have expected debt issuance as part of our capital management strategy and with the rally in the credit market over the past several months, we have launched an offering late September. We are pleased with the execution and demand for the seven year note which fits well in our debt stack and priced at just over 7%.

With this financing, the companies leverage ratio excluding the securitization related debt and equity is around 21% where we are comfortable and we don't have any debt maturing under 2011. When you think of debt issue and the continuation of strong statutory earnings, we are revising expectations for year-end 2009 capital position. We now believe that risk based capital for our traditional US insurance companies will be approximately 360% at year-end, surpassing our expectations of 330% to 335% and our estimated 3Q RBC ratio of 340%.

Holding company liquidity is expected to be at around 900 million, well ahead of our expectations of 750 million, and ahead of our current level of 864 million. And finally, leverage will be around 21% in line with our prior expectations. We still believe today's economic environment dictates a strong financial position and we believe that we are in excellent shape. I hope you'll join us at our investor briefing next week when we take you through our plans for 2010. To sum up, all in all, it was a good quarter for the company. Despite the difficult business and economic conditions, we continue to perform well and build on our strong financial platform.

Now, I will turn the call back to Tom for his closing comments.

Tom Watjen

Thanks Rick. While this continues to be a difficult business and economic environment, I'm pleased with our results and extremely proud of the work our people continue to do in serving our customers and delivering on our plans. As you've heard from our comments, the recession is having an impact on our ability to grow our top line. Both here in the US and the UK, the rise in unemployment over the past several quarters has impacted the natural growth rate of our business. Importantly though, we see little evidence that employers are eliminating plans and are encouraged by our accounts growth and healthy case persistency. These position us well for future top line growth when the employment picture improves.

While the economy has had its greatest impact on our premium growth, we are also closely watching for any other factors, which could impact our profitability, such as low interest rates, expense trends, and claim incidents trends. Since I know you will ask, we have not seen any meaningful increase in claims incidence, but we are seeing some volatility in claim incidents in some parts of our business, and we will certainly be keeping a close watch on this.

As we have said many times on these calls, we are not immune to the effects of the recession, but with our diversified business mix, focus on profitable growth and solid balance sheet and capital position, we are very well positioned. While we have a great deal of confidence in our position and ability to execute our plans, we are still very cautious on the general environment which impacts our approach to business planning and capital strategy for 2010. Again as Rick said, something we'll have to discuss in further detail at our annual investor meeting to be held in New York next Monday, the 9th of November.

Finally, with respect to guidance, we continue to expect operating earnings per share for 2009 to fall within our previous guidance range of $2.50 to $2.60 per share. However, with the top line pressures we are seeing, the lower half of that range is more likely than the upper half of that range.

Operator, this completes our formal comments, and so let us move to question and answer session.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically. (Operator instructions). The first question comes from Bob Glasspiegel with Langen-McAlenney.

Bob Glasspiegel – Langen-McAlenney

Good morning, Tom. I am probably over analyzing the exact words you used, but in your concluding remarks, I think you said the economy is beginning to – or the recession is beginning to have an impact on the company. It is sort of ironic that this would be in a quarter where GDP was up 3.5%, so I suspect you are in kind of a cynical camp on that number. But specifically the question is, how much do you think you're going to lag the economic recovery? It sounds like they are just beginning to have an impact on the economy in this quarter suggests that there is a lag, because the economy has been weak for a while?

Tom Watjen

I think, Bob, it is a good question. I think when we look at the impact the economy has on the company, I want to clarify. I think we think it is mostly around the employment picture and I think that is where as you look at the unemployment rate continuing to move up, you look at the – certainly we are seeing some slowing in the deterioration in the employment picture, but still I think there is – the outlook that most economists have for 2010 continues to offer relatively slow recovery in the employment picture, and I think that is what you hear reflected in the management comments today.

I think that is something we have been watching or I think if you look back to the comments we made the last couple of quarters, I think we have talked about the premium pressure. Really the premium pressure is really coming just because of the employment picture. So again I think I like you to see some great signs that the general economy is improving and whether it is economic growth or some of the trade things but on the other hand I think our business is most focused around the employment picture.

Bob Glasspiegel – Langen-McAlenney

Thank you. And my follow-up is if you execute your plan and it seems like you've surpassed your capital goals at the holding company, when is the soonest as you think you can consider another buyback recognizing the rating agencies are a huge wild card?

Tom Watjen

Yes, we will talk more about this I think next week, Bob. I think just at this point I think again I want to clarify, we feel very confident in our company's business plans, strategy, our ability to execute that plan strategy. I think any hesitancy we have about sort of putting any work to – any capital to work in a share buyback comes more about the concerns about the general economic outlook. And so I don't want to put a time up there except to say that we were very fortunate to have the capital position we have. As Rick give you some of the guidance for year end, we are expecting to be even in a stronger position than we expected to be. Our operations continue to perform very well. But again I think it is our view at this particular point, this is a time to continue to accumulate capital, and accumulate capital to begin to sense the things that are important to our business like the unemployment picture begins to show some improvement. And I think that is the mindset I think we're going to be bringing to this as we move into 2010.

Bob Glasspiegel – Langen-McAlenney

Thanks. I'll follow-up with you next week on this. Thanks.

Tom Watjen

Okay, thanks Bob.

Operator

Next question comes from Colin Devine with Citigroup.

Colin Devine – Citigroup

Good morning.

Tom Watjen

Good morning Colin.

Colin Devine – Citigroup

A couple of questions, I guess first just following upon the capital on there, Tom, with the cash building up pretty rapidly, and obviously we generated a fair amount of cash flow on your own annually. You talked about just being I guess careful conservative, is there some thought maybe given the strengthening the capital position of the insurance businesses even further, obviously you want your ratings back, and it seemed to me something like a 400% raise might make that statement. Second question, I think we'd all appreciate just an update from Kevin and probably Susan on how the sort of the renewal season is going and pricing trends and just what we will get more next week. And that finally Randy, you know Colonial sales, I though were just extremely strong, certainly in very stark contrast to the disappointment we saw at AFLAC in the same sector. I guess what are you guys doing right because clearly your biggest competitor is struggling mightily?

Tom Watjen

Three important points, Colin. Let's get started in the capital and I will Rick to pick up on your question.

Rick McKenney

Ye, thanks Colin. I think it is important to go back to what you mentioned which is the strong free cash flow generated out of our statutory earnings. That gives us a lot of flexibility to channel those earnings into the direction we want. Over the past years, that's been building up our holding company levels, and we have done that. I think we will probably slow that down and you will see us building up in the insurance companies on a natural basis, and that would be reflected in the year end forecast of around 360. So you will see those RBC levels go up, we don't really need more cash at the holding company at this point, and the strength of our insurance companies will be the focus as well.

Tom Watjen

And maybe just shifting to market conditions in both the Unum Us and the Unum UK business, Kevin, you want to pick up on the question around renewals and the market conditions?

Kevin McCarthy

Thanks, Tom. Good morning Colin.

Colin Devine – Citigroup

Hi, Kevin.

Kevin McCarthy

The real program for 2010 will be about the same size, slightly larger than it was in 2009. The large majority of those renewals, particularly in the larger case sector have been offered already. The average increase is quite small, sort of in the 1% to 2% range and I think that reflects the fact that we have gotten through sort of everything that we needed to get through in terms of rebalancing the portfolio the last three or four years. And the real problem is really more about just being disciplined with the way in which we continue to manage that in force block. And so far, our persistency remains solid. There is nothing out there that indicates that we are going to have anything that is going to shake us up on the persistency side.

Tom Watjen

Thanks Kevin. Susan, you want to pick up on the market environment that you are facing in the UK?

Susan Ring

Yes, absolutely. Thanks, Tom. Thanks Colin. And yes, it remains a very competitive environment here in the UK, but we still believe that we are very strongly positioned and still remain a recognized market leader and all the metrics indicate that we are staying there. And so we are very focused, very disciplined, and certainly very focused on renewing our existing block. And in terms of our renewal program and (inaudible) is still saying that there is pressure on existing clients, with regards to salaries or lack of salary inflation, and also membership pressure. So it still seeing shrinkage of some of the schemes that we hold. And in particular, as you are aware, the financial services sector, the financial sector, the whole actually has been under some pressure. So that's in particular where we have seen it come through. But we are maintaining pricing discipline and ensuring that we keep our margins healthy and high.

Colin Devine – Citigroup

And I am showing – I know I can relate to the towering inflation pressure. With respect to the strong sales you are talking about for the fourth quarter, how much can that buffer the earnings impact of the slower premium growth over the next year?

Susan Ring

You want me to take that, Colin?

Tom Watjen

Yes, please. Susan, go ahead.

Susan Ring

Yes, sure. I mean we still expect – obviously we had a strong sales quarter in the third quarter and as you can see from the metrics, we were sort of about 63% invested at the same quarter last year and showing growth on the second quarter this year. And we still expect sales to be stronger in the fourth quarter and that certainly could help improve our premium position and help offsets some of the evolution that we have seen in our existing block.

Colin Devine – Citigroup

Okay, thanks.

Tom Watjen

So maybe just moving on last but not least, Randy, just the success you've had at Colonial?

Randy Horn

Yes, thanks Tom. Good morning, Colin. Yes, as a backdrop, the entire industry has seen pressure on existing case sales due to the economy. We have been no exception to that but we did see nice improvement in the third quarter. The existing accounts sales tend to be somewhere around 65% of our total sales, so that is a very important issue for us. We have instituted a lot of programs to help our agents get out and visit existing customers and talk to them about our various offerings and again seen very good improvement there.

Our new account activity as, Tom White and Tom Watjen referred to earlier continues to be very strong, good double-digit growth there. And I think overall, Colin, we just continue to see a nice growth rate in our entire agency system. As you know we have been very focused on new rep recruiting and district manager recruiting over the last several years, starting to see that pay off at this point. I think a good indicator is that of those strong new account sales that we had in the quarter, over a third of those were from reps recruited in the last couple of years. So again good growth in the system, good focus, and we're seeing pretty good results at this point.

Colin Devine – Citigroup

Okay, thank you very much.

Tom Watjen

Thanks Colin.

Operator

The next question comes from Mark Hughes with SunTrust.

Mark Hughes – SunTrust

Thank you very much. I'm not sure if you have this level of detail but I was curious you had mentioned how employment levels have been something of a headwind, have you been able to perceive any difference in the core versus the last case customers?

Tom Watjen

To be honest, Kevin, do you think there is any reaction to Mark's question?

Kevin McCarthy

Yes, I can't think of anything sort of that pops out (inaudible) looking at metrics, Mark, that would indicate that kind of difference. The only thing I would say is that the large case market is basically fully penetrated and so the pressure – excuse me, the pressure in terms of premiums comes from those large customers having declining employment levels, which is pressuring our top line, our earned premium and our natural growth, if you will. And the fact that maybe deferring decisions about what we call MBOC [ph] or upgrades and benefits. So we see that in the larger case sector. In the smaller case sector, on the other hand, you know it is not fully penetrated, and we continue to see really, really solid new account growth. Core premium was up 11%, I think small voluntary cases were up 24%. Case count for the year is up overall. So we are not seeing sort of the same dynamic.

Mark Hughes – SunTrust

Yes, thanks for the color. And then the benefit associated with lower inflation, is that all captured in 3Q if we look at 4Q assuming no change in underlying inflation, is there any continuing effect in the fourth quarter, any benefit from that, or is that all captured in 3Q?

Tom Watjen

Go ahead, Rick.

Rick McKenney

I think it is captured in 3Q. And when you look at that, our proxies reflect that in the reserves. So it would have reflected what we saw in the inflation movement, the corresponding reduction in the benefits, as well as in the investment. This is matched up (inaudible). It would be reflected in the third quarter if it stays flat. Fourth-quarter inflation you wouldn't expect carry through on that element.

Mark Hughes – SunTrust

Thank you.

Tom Watjen

Thanks, Mark.

Operator

Next question comes from Mark Finkelstein with FPK.

Mark Finkelstein – FPK

Good morning.

Tom Watjen

Good morning, Mark.

Mark Finkelstein – FPK

Three I think quick questions. One is back to Colin's renewals question, Kevin, I'm just curious, are you seeing anything different in the buying habits of employers of group products, whether it is an extent of coverage, et cetera?

Kevin McCarthy

You know I think there is pressure on employers in terms of their employee benefits pressure, that is coming from the economy. It is also coming from sort of the healthcare side of the equation. And that of course is what drove us to invest in our Simply Unum platform and continued to invest in our voluntary products portfolio. And as we have introduced that Simply Unum initiative during the course of the last 12 months, we continue to see an increase in the number of purchases of group benefits to also buy voluntary coverage along with it, particularly in the smaller end of the market. And so in that sense, I think there is a slow but gradual shift towards maybe packaging of benefits and sharing cost, between employers and employees within the benefits program, and that is consistent with the strategy that we have been investing in.

Mark Finkelstein – FPK

Okay. I guess back to the claim activity, I guess I understand the comments around incidents being a slight up tick which are characterizing as kind of random fluctuation, but the other side of that is recoveries looked better, offsets looked better, would you characterize that as normal volatility as well, or is there anything different you are going in whether it is reserving or what have you that is part of that answer?

Kevin McCarthy

On the recovery side, we are not doing anything different, and it is not in really anything reflective of anything we are doing on the reserving side. I think we are seeing just continued good solid performance in our benefits operations area. And I think on the offset side, the same thing is true. Although there also maybe positive effects showing up from Social Security, maybe improving more claims in recent days, and also there was a cost of living adjustments during the course of this year in Social Security as well. So that probably benefits us to some small degree on the opposite side. But no I think it is just, I think it is just diligent performance.

Mark Finkelstein – FPK

Okay. And then back to the capital management question, I guess, I understand the comments, I understand the rationale of wanting to be patient or still in a somewhat volatile market, but I guess the one thing I struggle a little bit with is why not take a little bit of where we're at and top up the pension plan before year end? And I guess what I am thinking about is, you know it looks like theoretically you have got call it, 1.2 billion of capital margin today, you know you're topping up the pension plan before year end, is obviously rating agency family, cosmetically it shows a better position. I guess why not take a little bit of that, I think maybe we said around $200 million on the prior quarter call, why not do that before year end?

Tom Watjen

Rick?

Rick McKenney

Yes, so as we look at the pension in terms of how it has come down and the funding status in the course of the year, we have funded part of that earlier in the year. We're looking at potential addition by the end of the year. But we don't have a need to fund that completely right away. We do see some of those investments we have will come back over time and we like to take a little bit longer term view to it but not to say that we wouldn't put some more money in the pension before year and adjust our plans over the next couple of years. But we don't have a need to completely fund that up-to-date, watch it continue to increase, and have capital then effectively be within the pension and unable to access it.

Mark Finkelstein – FPK

Okay, all right. Thank you.

Rick McKenney

Thank you, Mark.

Operator

Our next question comes from Tom Gallagher with Credit Suisse.

Mike Zaremski – Credit Suisse

Thanks, guys. It's Michael Zaremski filling in for Tom actually. Two questions, so spread tightening has been great for book value obviously. Some competitors have talked about lower new money yields pressuring margins though. I believe in your prepared remarks you talked about your reserve margin widening which seemed a little bit kind of intuitive, so if you can give us some color on that issue?

Tom Watjen

Tom, you want to take that one?

Tom White

Sure. Michael, I think what we're seeing is the – well, first of all just to put numbers around it, we saw the, this is just for Unum US LPT block of business that that net interest reserve margin widened from 87 basis points in the second quarter to about 91 basis point here in the third quarter. You're exactly right. New money yields have come down but I think where we are benefiting from is the fact that late last year, the early part of this year, those new money investments were so wide that it's just given us some nice momentum that will probably continue here for a couple of more quarters.

So you know if you think about it, we have got a very large investment portfolio, 6 billion, $7 billion, and we're investing for that particular block of business. In real round numbers, maybe $100 million a quarter, something like that. So anyone quarter's new money yield aren't going to have a significant impact. And you really kind of need to think of it more on kind of a rolling say fourth quarter basis and again we are still benefiting from some of the nice high yields. Now what we look at is, we project all this forward, and given where we are with the discount rate on new claim incurrals being quite a bit lower than the aggregate that we used, we're in good shape. We are – that 91 basis points I referenced, we target somewhere in the 50 basis points to 60 basis points range. So there is quite a bit of cushion there that we could potentially eat into over many, many quarters before we would be in a position to need to make any adjustments to new claim incurrals.

Mike Zaremski – Credit Suisse

So what that – I guess this gets into my next question, I guess the cushion between you're saying of 50 toward your target of 91 bps, if I look – I don't if this has anything – sort of correlate with on a statutory basis prior year reserve development, so continues to look great, I think it was positive 69 million this quarter. I believe that's slightly a net number, I don't know if there were any particularly big positives or negatives in there on a statutory basis or if this cushion…

Tom White

Mike, I don't know – there really weren't any unusual items in the statutory earnings. I think it is just a good solid quarter. And as Kevin referenced to when he was talking about operations, you know very good solid operating performance on the claims side and that leads into nice solid profitability.

Mike Zaremski – Credit Suisse

Okay, thank you guys.

Tom Watjen

Okay, thank you Michael.

Operator

The next question comes from Randy Binner with FBR Capital Markets.

Randy Binner – FBR Capital Markets

Hi thanks. Just back to the incidents thing, you made comments at one of the investor conferences in September that overall incidents and other claims trends for DI were not where they usually are relative to macro trends, most notably unemployment. So I hear the comments that you made that it is more a volatility issue rather than any kind of trends, but maybe just at a higher level, it would be nice to hear your view of kind of where you potentially saw this kind of volatility relative to past cycles, in particular as it relates to the unemployment rate?

Tom Watjen

Kevin, you want to take that? I guess maybe a good place to start is just reminding everyone about the mix shift that we have been through because I think in the past certainly we saw greater volatility and incidents amongst our large case block of business and obviously we have been through substantial change in strategy there.

Kevin McCarthy

Right. That's a gentle way [ph], Tom. I think if you remember last year, at the investor day, we modeled out sort of the idea that we might have a 5% or so up tick in incidents during the course of this year. And we haven't really seen that. And we saw a little bit of volatility during the third quarter although most of that was actually in July. And as I look at incidents, as it emerged though the rest of the third quarter, and into the beginning of the fourth quarter, it seems to have come right back to us an stabilized again.

And I think the big difference for us as a company compared to prior recession is really two things. We are much more focused on mix of business by size as Tom said. I think Tom White mentioned that two thirds of our sales were in the core during the third quarter and that is a pretty consistent pattern over the last six, seven, eight quarters. And also we often talk about our diligence about industry mix as well and shifting our mix of business away from transportation, wholesale, retail, more recession sensitive industries, and towards healthcare, education, professional services, where at least in healthcare, employment has been fairly stable in comparison to other industries. And so just – I think our management of mix of businesses has been the most critical factor in keeping that incident line stable.

Tom Watjen

Maybe this is a teaser for investor day. I think we're going to into that in more depth by industry type actually this upcoming Monday.

Kevin McCarthy

Yes.

Randy Binner – FBR Capital Markets

Okay, that is helpful. And then just maybe on new money yields, obviously the trend across the industry that new money yields are lower and so we've already seen that investment income line, just some color on kind of if there is any sort of shift in how you're looking at different asset classes on a new money basis and where you maybe see the best opportunities?

Tom Watjen

Yes, Randy, really no changes there. We are basically a corporate bond investor, you know the BBB, A range is kind of the sweet spot for us. I would say we're probably seeing maybe incrementally a little bit more opportunity in some commercial mortgage loans but that is really – one of the things we benefit on, I probably should have mentioned in my other answer was, we have done a fair amount of hedging over the years, and that we get benefit from that. And part of the reason for that program is because when we get into environments like this where treasuries are low, spreads coming in, you are heading that little incremental pickup from hedges certainly helps that new money yield, and you know probably adds 20 basis points, 25 basis points to a quarter's new money yield.

Randy Binner – FBR Capital Markets

Okay, great. Thank you.

Tom Watjen

Thank you Randy.

Operator

Next question comes from John Nadel with Sterne Agee.

John Nadel – Sterne Agee

Hi, good morning everybody. So I just want to go back to the capital management issue and I assume that next week there will be some more time spent on this. So I don't want to steal any of your thunder, but thinking about the 900 million target for cash and liquidity at the holding company, if you are at 360 RBC, maybe the RBC ratio needs to be higher, sustainable, going forward than it has been historically, but you can still sort of argue 500 million to 700 million of capital cushion at the life companies under that scenario. So you're sitting on a lot, the business overall appears to be trending down in terms of the size just given macro conditions, so capital needed to support growth seems to be lower than historical, I'm just wondering if you could give us maybe a little bit better sense of understanding the caution on the outlook, macro outlook, how long would you expect to sort of maintain that extra cushion?

Tom Watjen

Rick, you want to pick up on this?

Rick McKenney

Sure. And we will talk about it in a fair amount of detail next week as well but not to delay to that, there isn't really a timeframe. We're evaluating it on a daily basis what the economy is looking like. This is a cautious stance and we've got a fair amount of capital. So we're not going to put a timeframe on it or anything we're going to do. We do have options and this flexibility doesn't give us options about where we put that capital. We will talk about more about what those options are but I think your numbers are right. We have a fair amount of capital cushion both at our insurance companies as well as at the holding company and will have to choose what to do with that over the course of the next 12 months to 18 months. I think what we said is just now isn't not that time.

John Nadel – Sterne Agee

Okay. Somewhat related, is there anything, are there any real opportunities out there from an M&A perspective?

Tom Watjen

John, I will pick up on that one. I mean we have always said our first focus is just taking our existing three businesses and investing heavily in them, especially now, and maybe some others don't have the ability to do so, just to continue to build up of our strengths in the marketplace. And so I just want to emphasize our first priority is just taking the three operations we have and continue to make them better. Having said that, we're going to – we certainly keep our eye open for acquisitions that may supplement the things we are doing in our three businesses. We obviously have the financial and capital wherewithal to do so, but we are awfully disciplined. It's got to – it would have to fit very nicely with the things we're doing, the risk would have had to be incredibly manageable, and so I would say at this particular point in time, there is not much out there. I mean we are looking, we continue the network to be sure that we have a chance to look at things that might work, but it is very slim pickings in terms of things that would be fitting the criteria that I admit are very high, but the criteria we set for an acquisition.

John Nadel – Sterne Agee

Fair enough, thank you.

Tom Watjen

Good, thanks John.

Operator

(Operator instructions). Next question comes from Steven Schwartz with Raymond James and Associates.

Steven Schwartz –Raymond James and Associates

Good morning. Just a couple of quickies here, going back to renewals on the group DI business, any change really in the trends vis-à-vis rate guarantee periods?

Tom Watjen

Kevin?

Kevin McCarthy

Good morning Steven. Not from our end at least in terms of rate guarantee periods, I think. You know we're watching the economy, we're happy with persistency, the improving persistency that we have on the back. We think the block is stable which is why our rate increases stance is pretty flat. We have seen some activity more on the sales side in the marketplace and we have larger, longer rate guarantees have been offered by some competitors but not by us. We are not moving on that.

Steven Schwartz –Raymond James and Associates

Ok, very good. And then just on the question of ratings migration as a corporate bond buyer, my assumption just sitting here looking at my screen day in and day would be that that has slowed down considerably?

Tom Watjen

Well, actually we have not seen a lot of ratings migration across our book of business in general, and certainly that would have slowed down (inaudible) but it is important to note that we did not see that much in the quality of our book and where we were over the course of time.

Tom White

Yes. Steven, it is Tom White. One thing that we will have on the investor day materials, we will break out that BBB exposure and what you will see there is the low end of the BBB, we had much less exposure. So I think there is a bit less risk of seeing downgrades because we tend to migrate to the upper end of that BBB range.

Steven Schwartz –Raymond James and Associates

Okay, very good. See you all on Monday.

Tom White

Good, thank you.

Operator

There are no other questions in queue. So I will turn it back over for closing remarks.

Tom Watjen

Well, thank you operator, and thank you all for joining us this morning. We look forward to seeing as many of you as possible next Monday for our investor day meeting and this concludes our third quarter earnings call.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Unum Group Q3 2009 Earnings Call Transcript
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