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Unum Group (NYSE:UNM)

Q2 2010 Earnings Call

August 4, 2010 9:00 am ET

Executives

Tom White – VP, IR

Tom Watjen – President and CEO

Rick McKenney – EVP and CFO

Kevin McCarthy – President and CEO, Unum U.S.

Analysts

Mark Finkelstein – Macquarie Research Equities

Bob Glasspiegel – Langen-McAlenney

Colin Devine – Citigroup Investment Research

Thomas Gallagher – Credit Suisse

Darin Arita – Deutsche Bank

John Nadel – Sterne, Agee & Leach

Jeff Schuman – KBW

Jack Shirk – SunTrust Robinson Humphrey

Eric Berg – Barclays Capital

Operator

Good day, and welcome to the Unum Group Second Quarter 2010 Earnings Results Conference Call. As a reminder, this call is being recorded.

At this time, for opening remarks and introductions, I would like to the call over to the Head of Investor Relations, Mr. Tom White. Please go ahead, sir.

Tom White

Thank you, Pat. Good morning, everyone and welcome to Unum’s Second Quarter 2010 Analysts and Investor Conference Call.

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 section titled “Cautionary Statement Regarding Forward-Looking Statements” and “Risk Factors” in our Annual Report on Form 10K for the fiscal year ended December 31, 2009, and also in any subsequently file Form 10Q.

Our SEC filings can be found in the Investor 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 our website in the Investor Section.

Participating in this morning’s conference call are Rick McKenney, Executive Vice President and CFO; and our business segment President Kevin McCarthy, Randy Horn, and Jack McGarry.

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

Tom Watjen

Thank you, Tom, and good morning. Despite the challenging business and economic environment, I’m generally pleased with our results for the second quarter; both our operating and investment performance, and the strength of our capital position.

And let me touch on four basic takeaways for the quarter.

First, our business has continued to produce solid margins and profitability. Excluding net realized after-tax investment gains and losses, we reported $0.69 per share in operating income for the second quarter, an increase of 6.2% compared to the year-ago quarter.

Our Core Operations continue to produce generally solid results, especially Unum U.S., with operating earnings growth of 12.9% and Colonial with a growth rate of 3.6%.

On a constant currency basis, operating earnings for our three core segments combined, which is Unum U.S., Unum U.K., Colonial Life was 4.4% higher than the second quarter of last year.

Second, we’re generating these results in obviously what continues to be a challenging business and economic environment. Unemployment in the U.S. and in the U.K. remains high and continues to pressure premium growth in both of these markets.

Additionally, we continue to see some very aggressive pricing and underwriting action by certain competitors, both in the U.S. and in the U.K. While these pressures impact our overall sales results, I am encouraged by the trends we’re seeing in the market segments we have targeted for growth, specifically the core, or smaller-case marketplace and the voluntary benefit marketplace.

While we did not see growth across all of our targeted market, our Unum U.S. voluntary benefit sales grew 51%, our Unum U.K. core market sales grew 45% on a local currency basis, and Colonial Life core market sales were up 14%.

We are continuing to take a disciplined targeted approach to growth, which is serving us well in this environment.

Third, our investment portfolio remains in very good shape. With this quarter’s net-realized investment losses, excluding the accounting for the ModCo embedded derivative, again at very low levels.

The net unrealized gain in our fixed income portfolio grew to $3.7 billion this quarter, which much of which was obviously as a result of the climbing interest rate.

While today’s low level of interest rates can present challenges to some, as Rick will discuss in his comments, as a result of our disciplined approach to interest rate management, we are well positioned to effectively manage our exposure of today’s environment.

And lastly, given our solid operating results and strong investment performance, we continue to build on our already strong capital position.

Our weighted-average risk-based capital ratio was approximately 400% at the end of the second quarter. And our holding company cash and market security position remains above $770 million. Both consistent with our March 31st levels.

We maintained these levels while also repurchasing approximately $130 million of our shares in the marketplace this last quarter.

In summary, I feel very good about our results so far this year. We continue to face premium growth challenges in certain lines of business, but our operating and investment results remains strong and we can continue to generate excess capital, which we are using to repurchase stock and support our previously announced dividend increase.

With the passage of both Healthcare Reform Legislation, and some of the changes involving the financial services sector, the insurance sector and the broader financial services industries are undergoing unparallel change.

We continue to believe though that our basic business of providing benefits to employees at the work place remains a good business where we can both make a difference in the lives of our customers and create attractive returns for our shareholders.

Now I'll turn the call over to Tom White, who will provide an overview of our operating results for this quarter. Tom?

Tom White

Great. Thanks, Tom. Net income for the second quarter was $209.7 million or $0.63 per diluted common share compared to net income of $267.2 million or $0.80 for diluted common share last year.

Included in the results for the second quarter of 2010, our net realized after-tax investment losses of $18.9 million or $0.06 per diluted common share compared to after-tax gains of 51.4 million or $0.15 per diluted common share last year.

Net-realized after-tax investment losses for the second quarter 2010 include an after-tax loss of 15.3 million resulting from changes in the fair value of an embedded derivative and a modified co-insurance contract, compared to an after-tax gain of $91 million in the second quarter of 2009.

Also included in net-realized after tax investment losses for the second quarter 2010 are net-realized after-tax investment losses of $3.6 million, related to sales and write downs of investments compared to net after-tax losses of 39.6 million in the second quarter of 2009.

So excluding these items, after-tax operating income was $228.6 million for this quarter or $0.69 per diluted common share compared to 215.8 million or $0.65 per diluted common share in the year ago quarter.

Turning to the operating segment, in total Unum U.S. operating income increased 12.9% to $216 million in the second quarter. Within Unum U.S., the group disability line reported another strong quarter with income up 23.1% to 84.1 million.

The group disability benefit ratio fell to 84.6% in the second quarter from 87% in the year ago quarter. This result is consistent with our expectations and reflects favorable business mix shifts in our ongoing adherence to pricing discipline.

Other factors driving the positive results in our group disability line, include operating expense, discipline, and strong premium and [inaudible] persistency for both group long-term and short-term disability.

Premium income declined 3.8% in the quarter reflecting in large part the impact of today’s high level of unemployment on the natural growth of our business.

Within the Group Life and AD&D line, operating income increased 5.7% to $51.5 million. A slight improvement in premium income as well as stable risk experience helped to generate the improved earnings.

In the Supplemental and Voluntary line, second quarter income was up 8.2% to $80.4 million from 74.3 million a year ago. The improvement was driven by higher earnings contributions from both the long-term care and voluntary benefits lines of business.

Reported sales for Unum U.S. declined 16% in aggregate compared to the second quarter 2009, in what continues to be a highly-competitive pricing environment.

Sales for our group line which are LTD, STD, and Group Life and AD&D combined, declined approximately 30% in the second quarter.

Remember last year, second quarter results included unusually high large-case sales activity that was not duplicated this year, adding to the large-case market sales decline of 53.4% in the second quarter.

Sales in the core market for these lines declined by 13.2% in the second quarter. These trends were partially offset by stronger results from our supplemental and voluntary lines, especially the voluntary benefits line with sales growth of 50.8% this quarter.

Moving to Unum U.K.; Operating Income in this segment decreased 21.4% to $52.9 million. Operating income declined 18.9% in local currency with reported income for the quarter negatively impacted by the slight weakening of the British pound.

Premium income in local currency decreased 8.2% in the second quarter due to lower premium growth from existing customers and a decline in the in-force block of group LTD business, partly offset by an increase in the in-force block of group life business.

The benefit ratio in Unum U.K. increased 66% in the second quarter from 54.4% a year ago, reflecting the impact of lower earned premiums, higher claims in the Group Life and the Group Disability blocks when compared to the very favorable experience of the second quarter of last year, and the impact of higher inflation in the U.K. on an inflation index-linked group policy.

Second quarter sales increased 15.8% in local currency, driven by strong sales in the group life market and a more moderate increase in group disability.

Concluding our core operations, Colonial Life had a strong quarter with premium growth of 6.7% and operating earnings growth of 3.6%. The benefit ratio 48.3% this quarter was elevated compared to the year ago benefit ratio of 46.4% but still a very favorable result, which produced a very strong profit margin of 27.6% this quarter.

Sales at Colonial Life continue to be encouraging, increasing 7.6% for the second quarter. Underlining these results are several positive for trend, highlighted by new account growth of 13.6% compared to the second quarter of '09. In addition, recruiting trends continue to remain strong with growth in new rep contracts of 20.3% this quarter.

Finally, average weekly producers at Colonial Life increased 9.7% in the quarter compared to last year.

The Individual Disability Closed-Block operating income was $12.4 million compared to $10 million in the year ago quarter. The interest-adjusted loss ratio was slightly higher at 85.4% this quarter compared to 82% a year ago.

Premium income declined 6.8% and net investment income was flat year over year. Interest on debt and operating expenses were both lower this quarter compared to the second quarter of last year.

And finally, the Corporate and Other segment reported an operating loss of 17.6 million compared to a loss of $16 million in the year ago quarter.

Net Investment income was higher, reflecting higher levels of invested assets, while Interest Expense increased to 30.8 million this year compared to 25.6 million last year, reflecting the debt issuance from late September, 2009.

Results also reflect the impact of higher litigation expenses, which we expect to be one time in nature.

So with that review of the operating results, I’ll turn the call over to Rick McKenney for further analysis of this quarter’s results.

Rick McKenney

Good, thank you, Tom. As you can see, our operating trends this quarter remain solid, and generally consist in with our experience of the past few quarters. I'd like to discuss with you the key drivers of this quarter’s results and provide some insight on our investment portfolio, interest rate management and our capital position.

First, looking at our profit margins, our overall risk experience is preforming well though with slightly more volitility than we saw in the first half of 2009. In Unum U.S., risk experience remain generally stable across all lines and given the premium growth challenges we currently face, remains the primary driver of this quarter’s 12.9% increase in operating income.

Our group disability results remains strong with an improvement in the benefit ratio of 2.4% on a year-over-year basis. And while new claim incidence was slightly higher this quarter, we had very good long-term disability claim recovery experience relative to last year’s second quarter.

Subsequently, from the first quarter we did see an uptick in the benefit ratio of 0.4% driven by the slight increase in claim incidences while claim recoveries remain inconsistent. The volatility in new submitted claim incidences shows no real underline trends, and no signs of being economically or recession influenced.

So while we have seen some quarter-to-quarter volatility in submitted claim incidence over the last year, we believe it is within a normal level of volatility.

These results are also consistent with our view that the group disability benefit ratio will stabilize at roughly the level we experience in the last few quarters.

Looking out further, as our overall business mix for Unum U.S. shifts with the growth of our voluntary benefits business, this diversification can further improve the overall margins for the segment.

Looking to the U.K., risk results were slightly elevated from our expectations this quarter. On a second quarter 2009 to second quarter 2010 comparison basis, the benefit ratio increased from 54.4% to 66%. While this is a dramatic move there are multiple drivers to it.

First, this is largely the result of very favorable risk experience we enjoyed last year, which was well below our expectations and has returned to a more normal level in 2010.

We are also impacted by a couple of points for reserve increases due to higher inflation in the U.K. This doesn’t impact the bottom line due to the offset by a match of our inflation-linked bonds in the investment portfolio.

In the Life Line, our group life risk experience improved from the high mortality we saw in first quarter.

Finally, Colonial Life’s risk results remain solidly in line with our expectations and the trends of the past several quarters. The Colonial Life benefit ratio for the second quarter was 48.3%, higher than the year-ago level of 46.4% but in line with our view that the benefit ratio will trend up slightly over time.

So with our underlying profit margins holding generally stable, I’d like to turn to the ongoing challenges we see in growing our top line in this difficult environment of both from a business and economic perspective.

Focusing first on Unum U.S., we’ve referenced our measure of natural growth on recent conference calls. Our sense is that natural growth still represent a headwind of approximately 1%, not as bad as the 3% impact we felt in 2009, but still a drag on our book of business and therefore our ability to grow the premium line.

The market here is still slower, which benefits us by continued high persistency, but elevates the competition for new cases.

Tom outlined the challenges to grow Unum U.S. sales in the Group Disability and Group Life businesses reflecting the large case succuss we had this time last year. We benefited that time from the upheaval in the market resulting from the financial crisis but now we’re seeing ongoing price competition.

A bright spot in the growth in our sales is in our voluntary business, in both large-case and core voluntary market segments and from new and existing cases.

Within our Unum U.K. results, premium income remains under pressure with second quarter premium income down 8.2% in local currency.

New sales this quarter did increase by 15.8% with better activity in the core market and persistency remained solid. However, pressure continues on our in-force premium levels from reduction and covered lives and ongoing competitive pressures.

Looking in to our Colonial Life results, our growth metrics are in good shape. We continue to pose strong trends and new sales, recruiting trends, agent productivity, persistency, and ultimately premium growth.

Second quarter sales increased by 7.6% and have grown 5.5% over the past four quarters; very strong performance in a weak market. This success is attributed to a number of factors, but particularly strong recruiting trends over a number of years have driven noticeable success in new account growth. This was up 13.6% for the second quarter and 21.2% for the first half of the year.

This success in new account growth combined with a stable persistency we’ve experienced will allow us to grow the Colonial Life segment more quickly as the economy improves.

Rounding out my comments on profitably, I'd like to shift to the investment portfolio and trends we’re seeing. Net investment income on the quarter grew 5.4% and partially benefited from a higher level of miscellaneous net investment income.

We would expect some ongoing level of miscellaneous income from our bond portfolio, particularly from our private placement portfolio, but it’s difficult to predict.

If you look at the investment portfolio in totality, we continue to see very strong performance, driven by the ongoing rally and treasury as well as fundamental improvement in the credit profile of our portfolio.

With the rally and the treasury markets during the second quarter our net-unrealized gain position and our fixed-maturity securities portfolio improved further to a quarter-end level of $3.7 billion of unrealized gains, compared to a gain $2 billion at year-end 2009 and unrealized loss position of 2.5 billion at the worst point of the credit crisis.

Our net realized investment losses remained quite manageable at 5.9 million in second quarter, which compares to losses of 65.1 million in the year-ago quarter.

Of course, the flip side of low interest rate and tight corporate bond spreads is the challenge it presents to new money investments, and the opportunity for investors to invest across the spectrum. We would always rather be purchasing higher-yielding bonds for higher net investment income, but the key focus for our business in this environment is the interplay between our portfolio yields backing our various product lines and the aggregated discount rates imbedded in the reserves.

Looking at our results this quarter, our overall portfolio yield backing products remains stable at 6.76%. And broke down to the product line level, our product lines specific portfolio showed the same level of consistency.

Despite this low interest rate environment we believe that we are well positioned for several reasons. One, we have maintained a consistent rate for new claim discount rates while our new money investment opportunities have outperformed over the last several years. That is, we are putting money to work in what is a beneficiary of widening corporate bonds spreads during the credit crisis. This kept our yields stable while discount rate declined.

Since the crisis has abated, our investment team has done a good job of finding relative value across our asset classes. Part of that is due to our low level of new money to invest, relative to the size of our existing portfolios.

For example, over the next six quarters, or 18 months, we project approximately 75 million of new money to invest in our closed disability block on a portfolio of $11 billion.

And then our Unum U.S., long-term disability block will have about 600 million to invest on a portfolio of approximately $9 billion. Therefore, even at today’s new money rates, and a diminished impact in our closed block.

Again, a stable long-term portfolio yield, even in today’s rate environment combined with our new claim discount rates provide us with longer term stability.

So while low rates represented a challenge to us and all insurers, we remain well positioned and we believe we can tolerate for some time a prolonged low interest rate environment.

Accommodation of the strong financial and investment results are also reflected in the company’s book value per share, which was $27.12 at June 30. A sequential increase of 2.8% from March, and an increase of 20.2% relative to a year-ago.

Moving to our capital, our statutory earnings were very strong this quarter and our corresponding capital growth remains quite healthy. Net income on a statutory basis for our traditional U.S. life insurance subsidiaries in the second quarter was $176 million compared to $108 million in the year ago quarter. This continues strong performance as resulted in growth in our capital base at our insurance subsidiaries and improvement in our RBC ratio to an estimated 400%, which is at the upper end of our target of 375 to 400% range.

We also finished the quarter with continued strength at our holding companies with cash and marketable securities ending the second quarter at $773 million, essentially flat with the March 31th level of 775 million.

As announced in May, we began to return capital to our shareholders by repurchasing our shares. During the second quarter we repurchased 5.7 million shares or approximately $130 million of the $150 million authorized by our board.

We were pleased to do that while keeping all our capital metrics at very solid levels as well as our leverage below 20%.

Before I close and turn the call back to Tom, I'd like to highlight a couple of items we’re watching closely in the second half of the year, related to our growth rates.

The first is premium growth, we’ve described the headwind we feel from today’s high levels of unemployment. And while the trend is stabilized somewhat, it clearly impacts our sales and premium growth. In this market we will remain disciplined.

And second, we continue to watch for the trends and risk experience given the continued volatility of the world around us.

So wrapping up, despite volatility we might see, our confidence remains high in our business and in our ability to generate strong overall margins and cash flow for our share holders. This is best exemplified in our consistent return equity which is 14% for our core businesses and 11.5% on a consolidated basis built on top of a strong capital position.

And now, I'd like to turn the call back to Tom for his closing comments.

Tom

Thanks, Rick, As you’ve heard this morning, while finding possible top-line growth opportunities remains a challenge, our overall level of earnings and cash flow remains healthy, which continues to provide us with a great deal of financial flexibility.

I continue to feel that we are in good businesses and are operating from a position of strength, both operational and financially, which is a very nice place to be in times like these.

One final comment, we plan to host our Annual Investor Briefing on the morning of November 17th in New York. We’ll get full details out to you shortly, but we all look forward to seeing many of you there where we obviously have a chance to talk about our businesses in a bit more detail.

This completes our formal comments, and Pat, let’s move to the question and answer session.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions)

We’ll go to our first question from Mark Finkelstein of Macquarie.

Mark Finkelstein – Macquarie Research Equities

Hi. Good morning. I guess just first a question for Kevin. I just want to understand the comment a little bit about the competitive environment is stabilizing. I guess, what are you seeing and what gives you the confidence that it has stabilized? And how should we think about the sales, you know, over the next couple of quarters essentially?

Kevin McCarthy

Yeah, good morning, Mark. Stabilized. We’re in a pretty soft pricing environment still. I think last year the first half of the year, as you’ll recall, a number of our competitors were struggling with a number of issues and we had a pretty robust first half of the year.

At that time we sort of anticipated that the second half of the year, and going into the beginning of this year, that the pricing environment would be softer. I think that’s proven to be true. Average prices seem to be sort of trailing down in the marketplace, and that’s resulted in us being sort of disciplined in our overall pricing and more focused on growth in our strategic businesses, our core businesses, our Simply Unum Platform, the voluntary business, all of which are up for the first half of this year.

So I think for us, the stabilization maybe has more to do with our focus on our strategy as opposed to the market pricing has stabilized. I think market prices are still soft.

Mark Finkelstein – Macquarie Research Equities

Okay. And then just, I guess a little bit of clarification on the U.K. I mean, obviously it was a little bit higher than certainly what I was expecting. I mean, should we be thinking about that business as a mid-60% loss ratio business going forward?

Kevin McCarthy

Rick?

Rick McKenney

Yeah. This is Rick. Actually, I think that that’s probably reasonable in terms of what we see. What we’ve seen in this quarter is actually, it was a little bit higher than expectations due to some inflation links, policies that we have. So actually the reserves go up a little bit faster.

But I think it’s consistent with what we’ve been talking about. So we probably would have said earlier in the year in the low-60s and somewhere in between that and trending up slightly as the book matures.

I think I would remind you very quickly though of even in those ranges, this is a very profitable book of business in generating ROEs in the 20s, which is the thing to focus on. Even at that level we’re very happy; very happy with that business.

Mark Finkelstein – Macquarie Research Equities

Okay. All right. Thank you.

Rick McKenney

Thank you, Mark.

Operator

I’ll take our next question from Bob Glasspiegel with Langen-McAlenney.

Bob Glasspiegel – Langen-McAlenney

Good morning. Staying with Mark’s U.K. question, Tom Watjen, with the management change should we change our sort of outlook for sales and top line either up or down? Any implications to that? Maybe you could give us some color on what the game plan is there now in the future versus what it has been.

Tom Watjen

Yeah, Bob. If I could, I’ll just pick up off of what Rick said. Let’s just all sort of start with the reminder that we’re in a very good position in the U.K. We’re a market leader. We’ve consistently been a market leader. As Rick said, we’ve consistently continued to produce an extremely strong return.

I think one of the things we’ve done, certainly at investor day last year, which is – we’re not changing that outlook because we have to assume we’re going to continue to see those returns decline because certainly we’ve had some very unusual returns over the past several years.

So none of that changes, I don’t think, as a result of what we’re seeing today, or any of the changes that we’ve made. Frankly, like with all of our businesses, we’ve got sort of a challenging short term. I’d say in the U.K. we’re finding even a greater challenging short-term environment with the employment picture, the competitive dynamics, those sorts of things impacting the near term.

Certainly in the U.K., we’ve – in the long-term, are very optimistic as we see hopefully broadening the market for the products and services that we think the market needs and we can provide.

So I don’t think anything changes from any of those points of view at all.

Certainly from the management-change point of view, you know, that was a decision that we made that we looked forward and looked at some of the demands on the business, looked at some of the needs that we have, looked at the recourses we have and we thought that a change was appropriate.

So again, I wouldn’t read into it any further than that.

Bob Glasspiegel – Langen-McAlenney

So you are more optimistic about the sales environment with the new team than the old team? Same game plan and execution, shouldn’t change?

Tom Watjen

No. What I would say, Bob, is again, it’s a tough – in the short term it remains a very challenging environment. So I don’t see any huge changes in direction, but I think what you see in the quarter is – and it came out both in Tom’s and Rick’s comments, we’re still cautious in that particular market because it’s just some of the short-term pressures.

Most importantly from the economy and the employment picture, especially for white-collar positions, which is where much of our business in the U.K. is directed. So again, I think we are remaining cautious in the short term because the environment remains challenging.

But again, I don’t want you to think we’re making a big wholesale change in direction because that’s not the case. But we are dealing with the realities of a tougher market condition in the U.K. right now.

Bob Glasspiegel – Langen-McAlenney

Thank you.

Tom Watjen

Good. Thank you, Bob.

Operator

Our next question comes from Colin Devine out of Citi.

Colin Devine – Citigroup Investment Research

Good morning.

Tom Watjen

Good morning.

Colin Devine – Citigroup Investment Research

I have a couple of questions. Perhaps just on the corporate segment you can explain a little bit more what happened with the litigation. Obviously this has been an issue in the past and I trust it’s not going to be one again.

The second thing that I’d really like to drill on too is what’s going on in long-term care. You know, if I look at the reserves there, they’re about 1/3 of what’s in the IDI close block. I appreciate individual long-term care is effective an closed block for you, but in looking at a benefit ratio that, what, was 120.3% for the quarter, you know, you compare that to a couple of years ago when it was down around 106, and even a few years before that in the mid-90s.

What is going on there, and is this going to be a situation where you’re going to have to take some sort of charge or increase reserves? Clearly, you know, the performance of this is not going the way you expected.

Tom Watjen

Let me ask, actually, Tom White just to review the corporate segment a little bit. And then we’ll move to the long-term care where I think both Kevin and Rick can maybe offer some insights there. Tom?

Tom White

Sure. Thanks, Tom. The legal expense in the corporate and other segment was the settlement of the Colley Case, the Corporate-on-Life-Insurance blog that’s a closed blog that we had actually reinsured, I think back in 2001. So it’s a block of business that’s been gone for a while.

The litigation has been detailed in our 10K and 10Q. This past quarter we had an opportunity to settle that, so we did. The settlement costs to us was $15 million on a pre-tax basis, which is in the expense line, again, in the corporate and other segment.

Colin Devine – Citigroup Investment Research

Great. Thanks.

Tom Watjen

Okay, just to get things started, Kevin, maybe just touch on the strategy just as a reminder for where we are playing in long-term care and where we’re not actually at this point.

Kevin McCarthy

Thanks, Tom. Good morning, Colin. Well, as you mentioned, ILTC is a closed block of business. Our strategy there is basically to continue to look for efficiencies and to reprice that business as we move forward, much as many of our competitors have done already, or are in the process of doing.

On the group long-term care side, it’s a little bit different. That business is employer sponsored and is often employer subsidized or even employer paid. Average age is 15 years or so younger, you know, in terms of the average purchasing person. It’s a voluntary enrollment product, much like the remainder of our voluntary business. We support it with the same kind of education and enrollment support that we do our other supplemental lines.

And that business has performed solidly for us. It’s been pretty consistent for us. And we don’t have either the aging pressures, the repricing pressures or the sort of lapse rate differentiation pressures that we have in the ILTC business.

Colin Devine – Citigroup Investment Research

Okay. But Kevin, if that’s the case, right? That the group LTC is performing, to use your term, solidly, then the benefit ratio that I’m looking at on group and individual combined has gone from 106.1% in 2008 to 120.3% in the second quarter. And that’s with group, you know, group, I assume, stable or better which means the individual part is actually getting a lot worse.

How big is that block, and do we have a reserve charge coming?

Rick McKenney

Yeah. Let me highlight one thing, Colin, as you’re looking at that on the basis of the income statement and the not-factored in. You have to interest adjust those loss ratios. So as the reserve builds, it goes through the benefit line, but at the same time we’re accreting interest on our assets as well.

So you’re going to see that trend go up just by nature of the growth of the block as it goes through time.

Colin Devine – Citigroup Investment Research

Okay. Then Rick, maybe splitting out group and individual to back up Kevin’s point is what we want to get at here. But I don’t think anybody’s answered my question. Is individual getting a lot worse? And is there going to be a reserve charge coming? That’s, I mean, you dodged it, but let’s get to the heart of this.

Rick McKenney

Individual is not getting a lot worse. So as we look at the loss ratios, this is a very long-term loss of business that we’ll be dealing with as well. So we’ve seen loss ratios there fluctuate around, but not move dramatically in any direction.

In terms of your question about splitting –

Colin Devine – Citigroup Investment Research

Okay. What are they, Rick? What are they? Let’s just – what, you know, instead of talking in generalities, I’m asking for specifics.

Rick McKenney

Yeah. We’ll we can get you the specifics. I don’t have them right here in front of me in terms of the average block.

Colin Devine – Citigroup Investment Research

How big is the block in terms of reserves?

Rick McKenney

What’s that? The block?

Colin Devine – Citigroup Investment Research

How big is the block? Because your total long-term care reserves are 1/3 the size of the IDI block, which means, you know, this – is this block chewing up a lot of your capital? And is that why I’m looking at this supplemental line with, you know, to be blunt, you know, fairly ordinary or disappointing return on capital, you know, pre-tax is what, 13%? I'm sure you don’t price it for that.

Rick McKenney

The size of the block here, you’re right, is about $3 ½ billion of policy reserves –

Colin Devine – Citigroup Investment Research

For individual?

Rick McKenney

Total. Total long-term.

Colin Devine – Citigroup Investment Research

Well, that’s – okay. Can we get the split?

Rick McKenney

Yes. So we manage this, I mean, we should be very clear. We manage this as an aggregate block. So the strategy in terms of go-to-market relative to the individual in the group and the performance, we manage this as one block and that’s why it’s consolidated and aggregated together. And we’re not going to split that up.

Tom Watjen

And to your point, Colin, this is Tom. Obviously, this is a capital intensive line of business. So you’re question about it as reserves mature, and develop, and grow, is going to continue to be a net user of capital.

And obviously, as we continue to think about how we want to manage capital in the years ahead, obviously, as you can imagine, we think about things like that.

Colin Devine – Citigroup Investment Research

Well, this is essentially another IDI block that’s going to chew up a lot of capital and pressure ROE.

Tom Watjen

I’m not sure that’s the case, but as I pointed, it’s a long duration of a product. It actually, is – therefore you get a large accumulation of assets to support the long-duration product. It tends to use up capital. But I don’t want to go so far as to make the analogy of a closed block at this point, but it is a block of business by its very nature for us and everybody else. It’s a long-duration, sort of asset-accumulated kind of business.

Colin Devine – Citigroup Investment Research

Okay. Thanks.

Tom Watjen

Sure.

Operator

Our next question comes from Thomas Gallagher out of Credit Suisse.

Thomas Gallagher – Credit Suisse

Hey. Not to beat a dead horse on long-term care, but just a few followups to Colin’s questions. Can you comment on back recoverability policy for U.S. supplemental and voluntary segment?

In other words, do you evaluate that kind of on a holistic basis for the segment, or do you do it on a product-specific basis?

Tom Watjen

It’s actually done on a product-specific basis.

Thomas Gallagher – Credit Suisse

And then just as a followup, I know you don’t show it in the supplement on a product-by-product basis, but are you still earning a profit on long-term care rate now? And if so, what is the margin on that business?

Rick McKenney

Yeah. We are certainly making a profit on it. You’ll see that, and you get that really with that question that you had out there. So there still is margin that’s locked and we’ll probably want to get into the details around the profitability levels of it. It’s much lower, as I think we’ve intoned by that. But we want to have all the details of that.

Tom Watjen

I’ll also add, the earnings contributions in the quarter were higher this quarter than a year ago from our long-term care business.

Thomas Gallagher – Credit Suisse

Okay . And Rick, just last followup on that and then I want to shift gears onto something else. Can I take the 80% interest adjusted benefit ratio, overlay the expense ratios a whole for the segment and get to a 1 or 2% pre-tax margin for long-term care? Or is it not that simple?

Rick McKenney

It’s not that simple.

Thomas Gallagher – Credit Suisse

Okay. I guess shifting gears. On group disability, you know, your benefit ratio is holding up pretty well. The competitors are having certainly more deterioration. Can you comment on what you see going on both from your book and what you suspect might be going on from an industry standpoint, and why you think you’re holding up better?

Tom Watjen

Kevin, why don’t you take that one.

Kevin McCarthy

Okay. Thanks, Tom. Good morning, Tom. Well, I think a couple things are going on. Our – although we’ve experienced some instance volitility, it’s been remarkably stable, I think, over the last year.

Recoveries have held up very well, as have offsets. We’ve also been pretty disciplined, as you know, with our pricing. And as the market goes softer in pricing, we didn’t go there. Our persistence though has been very, very strong in not only group disability, but in all of our life – in fact, every single line of business has persistency this year, better than last year at the same time.

So I think a lot of what’s going on for us is just staying disciplined and focused around plain management, around pricing management, around underwriting, and focusing on growing our business where we strategically want to, which is in the small-and-medium sized market and the voluntary market and staying away from sort of solo-lined price competitive cases.

Thomas Gallagher – Credit Suisse

Got it. And then lastly, just on the U.K. outlook, so if we’re expecting, we’ll call it mid-60s benefit ratio there, do you expect top-line to be relatively stable from current levels as you move forward for the next several quarters? Meaning, you know, bottom-line earnings contribution is going to be, you know, sort of flattish for time being, or what direction should we expect?

Kevin McCarthy

And I think that from an earnings contribution, looking at local currency, it is going to be relatively flattish. The premium, we’d like to see that flatten out and actually increase a little bit. Those pressures that we’ve seen in the past continue, so it’s quite hard to predict where that premium line is going to go particularly over the next year. There’s still challenges in the economy there. But I think that you can look relative to the contribution in a quarter and it will be within a range but relatively flat to where it is.

Thomas Gallagher – Credit Suisse

And then lastly, Tom, for Tom Watjen, your comments about, you know you’re sort of cautious in the sort term about the U.K. Is that a claim’s issue? Is it a competition-revenue issue? Is it both? Can you just flush that out a little bit more?

Tom Watjen

Yeah, Tom. I think it’s more of a top-line issue. I think certainly we always want to keep an eye on benefits across the entire enterprise as we recognize we’re sort of in the early stages of recovery from the economic standpoint.

But I think, as you can see, we’ve seen the deterioration really in the U.K. a little more pronounced in the top line. So the premium pressures are the ones I think that we’re most sensitive to.

And as I mentioned earlier, you know, those pressures have been a little greater than we thought.

Thomas Gallagher – Credit Suisse

Okay. And so as you think about that business overall, I assume you’ve still got to be real happy with it given that it’s still generating a real high margin and high ROA?

Tom Watjen

Absolutely. And again, if you go back and look at the results for the second quarter relative to the guidance we talked about in the fall, in many places we can actually do as well, if not better than the guidance, including on the returns.

And so again, that business is continuing to produce very strong returns, very strong margins. And as we said earlier in my comments, it continues to unquestionably be the market leader in the businesses that we’re in right now.

And frankly, some of the things that we’re investing in today which aren’t going to show up for probably a year or two, we think are poising us for some additional growth.

So we feel very good about that market. And obviously, as we said before, there’s some challenges in the short term, but we see some great long-term growth opportunities there.

Thomas Gallagher – Credit Suisse

Okay. Thanks.

Tom Watjen

Thanks, Tom.

Operator

Our next question comes from Darin Arita out of Deutsche Bank.

Darin Arita – Deutsche Bank

Good morning.

Tom Watjen

Good morning, Darin.

Darin Arita – Deutsche Bank

Turning to the U.S. Disability Business in terms of incidence, it was up sequentially from the first quarter. But how did that compare relative to the second half of ’09 and versus your pricing?

Tom Watjen

Good. Rick? I'm sorry. Kevin.

Kevin McCarthy

Good morning, Darin. Incidence, it bounced around a lot since the middle of last year, but it’s basically been stable over the rolling four quarters if you will. And actually slightly below where we were in the third quarter of ’09.

Darin Arita – Deutsche Bank

It’s come down since the third quarter of ’09? And versus your pricing expectations?

Kevin McCarthy

Yes. We’re well within our pricing expectations. That’s down from third quarter ’09.

Darin Arita – Deutsche Bank

Okay, good. And turning to persistency, the sales environment has been tough. You’ve mentioned a lot of competition. I would have expected persistency to decline also, but it’s held up very well. Can you talk about why it’s held up for Unum so well?

Kevin McCarthy

Well, I don’t know if I can say why other than guess. But I think that, you know, it is up year over year. I think actually in the industry in general because the sales environment is difficult, all incumbent carriers are working hard to maybe hold onto their existing business, which is why, you know, activity levels and closing ratios and sales have been down for many companies.

But in our cases, you know, our strategy is to try to penetrate the relationship with the customers as deeply as possible. So you know, we want to sell as many lines as possible. We want to consolidate the service. We want to get that service on a single platform and make it administratively easier for the employer. And I think brokers believe that. Likelihood to renew and likelihood to recommend ratings are up for us as they have been the last several years, and persistency, you know, as you know is very strong as well.

I think it just reflects the very strong sort of customer loyalty relationship that we have.

During the second quarter, I think 39% of our sales were multi-line sales. And 18% of our sales included both group and voluntary. And that’s been consistently growing over the last several years. And every time that we deepen our relationship with the customer, we expect that we can prove our service value and therefore hold onto those customers for a longer period of time.

Darin Arita – Deutsche Bank

Great. Thanks, Kevin.

Kevin McCarthy

Thanks, Darin.

Operator

Our next question comes from John Nadel out of Sterne, Agee.

John Nadel – Sterne, Agee & Leach

Good morning, everybody. I have a data-point question. One is on the U.K. benefit ratio, if we adjusted for the inflation link piece, what was the benefit ratio?

Kevin McCarthy

I’d probably subtract two points. It would be right around 64%, somewhere in that range.

John Nadel – Sterne, Agee & Leach

Thank you. And then following up on persistency. Here’s my question for you, Kev. Case in premium persistency, you remain really strong here. So you know, I guess I take what you’re saying in response to Darin’s question. I’m just interested, can you give us a sense though, you know, on renewal business, are you seeing softer pricing there as well? I go back to your response to Mark’s question originally.

You know, in other words, are you having to give some concessions on price to keep case and premium persistency high in this competitive environment?

Kevin McCarthy

It’s a good question. The direct answer is no, we’re not really having to do that. Our renewal programs, as you know, were incredibly robust going all the way back to 2003, and as we had to reprice the entire book of business. But the sizes of our renewal program right now is about half the size in terms of volumes, than it was back in ’03, ’04, ’05. And the average price levels are, you know, plus or minus 1% in terms of, you know, what we’re doing in terms of renewal pricing.

John Nadel – Sterne, Agee & Leach

Okay.

Kevin McCarthy

So no, we’re not seeing that kind of price pressure really in, you know, if the question is sort of are we lowing prices to hold onto business, the answer is no.

John Nadel – Sterne, Agee & Leach

Okay. And then one more followup on the competitive environment on sales. You know, as you lose a case, I mean, I know it’s not always easy to see, you know, what the winning, you know, bid was relative to yours, but to the extent that you can get some color there. How much are you losing by – how big is that differential between your bid on an RFP and the winning bid?

Kevin McCarthy

If I was going to ballpark it, I would say it could tend to be in the 10 to 15% kind of range. But you know, but that varies a lot by account and what they’re looking for, how many lines of business they’re looking for, what their service interest is.

You know, what I can say is that we do track pricing levels in the marketplace, and we’ve noticed that over the last four quarters, pricing has consistently been coming down in the marketplace and we use sort of an outside research firm to help us with that. And so, you know, we have good data points around sort of relative pricing levels now that they’re moving down.

John Nadel – Sterne, Agee & Leach

So we’re coming down despite lower interest rates and probably higher costs in terms of service?

Kevin McCarthy

Yeah. Unum is – yeah.

John Nadel – Sterne, Agee & Leach

I’m sorry. My comment was an industry comment.

Kevin McCarthy

Yeah. You can add aging to your rationale too. We ought not to be seeing prices coming down in an economic environment where you know risk pressures essentially are up and you don’t have wage-inflation supporting your premium levels. And of course, you have aging of the population in general. You ought to see prices either stable or slightly up not down. Ours are stable and the industries are down.

John Nadel – Sterne, Agee & Leach

Thank you very much.

Kevin McCarthy

Thanks, John.

Operator

Our next question comes from Jeff Schuman out of KBW.

Jeff Schuman – KBW

Good morning.

Kevin McCarthy

Good morning, Jeff.

Jeff Schuman – KBW

Hey. How are you? I’m hoping to circle back once again on the U.K. I’m kind of having difficulty reconciling the pieces. I think it’s been pretty clear that you feel that this level of earnings is sort of a reasonable expectation for where we might track in the near term. You’ve talked about kind of a mid-60s loss ratio being reasonable.

But then we look at the top line and constant currency, the premium’s down 8% this quarter. And then you look at how we got there, I mean, life premiums up 19%, disability down 16%. My understanding is that you’d like to balance that out, but you don’t necessarily want to be growing life 19%. But if you throttle back in life, try to grow disability, but in a competitive environment, I guess it’s not clear that you can turn negative 8% premium growth into flat premium growth anytime soon.

And if that’s the case, then how do we kind of hold margins and hold earnings at the same time?

Kevin McCarthy

Still basically, you have to look at one, we had in our premium number now we’ve had some prior-year adjustments. So as we’ve gone through the renewal, the sensus data has been down, so we’ve actually seen premiums come down a little bit faster than we would have expected in the current quarter.

So I think that that is the key. We’ve got to keep the premium line growing. What you talked about in the sales front is absolutely true. I don’t think we’re throttling back too much on the life business, it’s more about throttling up on the disability side. But it is about premium growth.

I think we’re happy with the margins holding at very strong levels. And so it is about that premium growth. So we’ll continue to talk about a strategy there. You know, the pricing pressures are real, but we have, you know, we have a very high piece of that market and we’re going to continue to protect that and grow with the market as well.

Jeff Schuman – KBW

So the guidance for disability payments in the U.K., is that the market is competitive but that you will retake share. Is that kind of the bottom line guidance?

Kevin McCarthy

Yeah. I think we’re not – I don’t know if it’s retake share, but I think one of the things, again, a big piece that’s contributed to the premium decline is not loss of cases. I mean, persistency has actually been very strong in the U.K. It’s really been with existing cases as a reduction in employment. As I mentioned before, much of our practice in the U.K. versus in the U.S. is really a more of a white-collar practice. That’s just the nature of the marketplace in the U.K.

So obviously, we’ve seen some shrinkage in the white-collar population be insured. We’ve seen some wave pressures of those that we do insure. And frankly, part of what we insure is an element of bonuses.

So there’s an element of things here that are actually causing the premium pressure. It doesn’t have to do with a loss of cases, it has to do with what’s happening within those particular cases actually, Jeff.

So we have seen some leveling off, I’d say, in certain aspects of that. But again, we’re remaining cautious, I think, in saying that frankly the greatest pressure probably there in that market is less around benefits than it is on premiums. But we do see is that we’ve seen that kind of stabilizing at these levels.

Jeff Schuman – KBW

Okay. So the disability premiums down 16% represent your holding share at a market down about that much?

Kevin McCarthy

We think so, yeah. I mean, again, we look at – with persistency from a case point of view is continuing to stay very strong. So our service level stays strong, our connections with the market stay strong. So again, we think there’s been shrinkage in the overall premium market, so to speak, but we’ve continued to believe we’re holding our own in that declining premium market.

Jeff Schuman – KBW

Okay. And then just one other area if I may. Unum U.S. operating expenses, you’ve controlled them very tightly for quite a while now. The expenses this year are likely to be, you know, flat to down to where they were a couple of years ago, which is great.

I guess the question is, given soft-type line, you know, maybe for an extended period here, you know, can you bring those down more? Can you maintain them? Kind of what’s the outlook there?

Kevin McCarthy

Good morning, Jeff. This is Kevin. I think maintain is probably the better answer there. I think expenses are down for a couple of reasons. One, we had a significant investment during the ’07-’09 period in building out our enrollment capacity, our Simply Unum Platform, growing our core distribution field force, and we’re largely – so the cap expenditures of having to make that invested in leveling it off.

So not having to continue to make that investment, I think, is benefited us on the expense ratio. I also think that the slower sales environment sort of basically depresses acquisition costs as well. And so we sort of benefited on the expense ratio side from that.

I think realistically, as the economy recovers, if and when the economy recovers, you know, I’d expect sort of a continued movement towards the smaller sides of the market place where acquisition costs, as you know, installation costs are higher. I’d expect to continue growth in our voluntary business, where enrollment costs are higher.

On the other hand, that benefits us directly in terms of what should be then a further downward movement in our overall employee benefit loss ratio and a growth in earnings as a result. So I don’t think – I don’t expect the expense ratio to go down much further. You know, I think it will bounce around that 20% kind of range.

What I would point out is, you know, the key productivity measure for us is sort of earnings per employee within Unum U.S. and if I look back at the last several years, you know, 2007 earnings per employee was $82,000; $92,000 in ’08; $104,000 per employee in ’09; $120,000 per employee on an annualized basis in 2010.

And so it’s not really about no loss ratio or the benefit ratio, it’s about overall earnings and how we invest our expenses and generate direct risk returns.

Jeff Schuman – KBW

That’s very helpful, Kevin. Thank you.

Kevin McCarthy

Thanks, Jeff.

Operator

Our next question comes from Jack Shirk out of Sun Trust.

Jack Shirk – SunTrust Robinson Humphrey

Thank you very much. What’s your outlook for claim recoveries and group long-term disability in the U.S.?

Kevin McCarthy

Good morning, Jeff. As you know, recoveries have been very strong over the past several years. I don’t see any reason to believe that they’re going to sort of move much in either direction right now. I think we’ve got good, solid, consistent results there. We have good, solid, consistent claim satisfaction ratings and I don’t see them changing very much.

Jack Shirk – SunTrust Robinson Humphrey

Great. Thank you very much.

Operator

Our next question comes from Eric Berg out of Barclays Capital.

Eric Berg – Barclays Capital

[Inaudible].

Kevin McCarthy

Eric, we’re not able to hear you.

Operator

(Operator Instructions)

Kevin McCarthy

Let’s see if his line cleared up.

Operator

Mr. Berg, if you are on the line, please re-prompt with star-one on your touchtone phone.

Kevin McCarthy

We certainly want to thank all of you for taking the time for joining us this morning. As always, we’re all available if there’s any further questions that people have over the course of the next several days.

Again, we look forward to hopefully seeing many of you at our Investor Day Meeting in New York in November.

I think, Operator, at this point, that will conclude our Second Quarter 2010 Earnings Call.

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