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StanCorp Financial Group (NYSE:SFG)

Q2 2014 Earnings Call

July 24, 2014 12:00 pm ET

Executives

Jeffrey J. Hallin - Vice President of Investor Relations and Capital Markets

J. Gregory Ness - Chairman, Chief Executive Officer, President, Chairman of Standard Insurance Company, Chief Executive Officer of Standard Insurance Company and President of Standard Insurance Company

Floyd F. Chadee - Chief Financial Officer and Senior Vice President

Daniel J. McMillan - Vice President of Employee Benefits

James B. Harbolt - Vice President of Asset Management Group

Katherine Durham - Vice President of Individual Disability Insurance and Corporate Marketing & Communications - Standard Insurance Company

Scott A. Hibbs - Chief Investment Officer, Vice President, Chief Investment Officer of Standard Insurance Company and Vice President of Standard Insurance Company

Analysts

Seth Weiss - BofA Merrill Lynch, Research Division

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Randy Binner - FBR Capital Markets & Co., Research Division

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

Suneet L. Kamath - UBS Investment Bank, Research Division

Colin W. Devine - Citigroup Inc, Research Division

Ryan Krueger - Dowling & Partners Securities, LLC

Operator

Ladies and gentlemen, thank you for holding. Welcome to the StanCorp Financial Group Inc. Second Quarter 2014 Earnings Conference Call. [Operator Instructions] Today's conference call is being webcast live over the Internet and is also being recorded. [Operator Instructions] At this time, I would like to turn the call over to Mr. Jeff Hallin, StanCorp's Vice President of Investor Relations and Capital Markets, for opening remarks and introductions. Please go ahead, sir.

Jeffrey J. Hallin

Thank you, Christine, and welcome, everyone, to StanCorp's second quarter 2014 earnings conference call. Here today to discuss the company's second quarter results are: Greg Ness, Chairman, President and Chief Executive Officer; Floyd Chadee, Senior Vice President and Chief Financial Officer; Katherine Durham, Vice President, Individual Disability Insurance and Corporate Marketing and Communications; Jim Harbolt, Vice President Asset Management; Scott Hibbs, Vice President and Chief Investment Officer; Dan McMillan, Vice President, Employee Benefits; and Rob Erickson, Vice President and Controller. Today's call will begin with some comments from Greg and Floyd, and then we will open it up for questions.

Before we begin, I need to remind you that certain comments made during this conference call will include statements regarding growth plans and other anticipated developments for StanCorp's businesses and the intent, beliefs and expectations of StanCorp's management regarding future performance. Some of these comments are not historical facts but are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements are subject to risks and uncertainties, actual results may differ from those expressed or implied. Factors that could cause actual results to differ materially from those expressed or implied have been disclosed as risk factors in the company's second quarter 2014 earnings release and the 2013 Form 10-K.

With that, I'll turn it over to Greg. Greg?

J. Gregory Ness

Thank you, Jeff, and thanks to all of you who've joined us for our second quarter earnings call. My overall perception of the quarter is that we experienced some claims volatility, which we'll discuss in some detail in a moment. However, I remain pleased with the positive forward momentum in our business in a number of different areas. We continue to invest in our relationships with our distribution partners while exploring further opportunities for growth. We continue to be pleased with our investment performance in a persistently low interest rate environment. We like the continuing performance in our Asset Management business and we're very pleased with our opportunities to return capital to shareholders in the form of share repurchases.

Let's turn now to the specific results for the quarter. The key driver of the underperformance this quarter was less favorable claims experience in Insurance Services. As you know, the single most important driver of earnings at StanCorp is the benefit ratio for Employee Benefits. The benefit ratio for employee benefits was 82.0% for the second quarter of 2014, compared to 80.4% for the second quarter of 2013. As we have said many times before, it is very difficult to predict the benefit ratio for a short period of time such as 1 or maybe 2 quarters. We expect quarterly claims volatility to occur from time to time, and this is clearly one of those times. We manage this business for long-term results.

Within a quarter, virtually all of the volatility can occur in a single month. And that is exactly what happened this quarter. In the second quarter, claims experience for April was significantly higher than expectations, while claims experienced for both May and June came in at better than our expectations.

Some key observations that might help interpret the claim results this quarter would include: the higher claims experience was limited solely to the month of April. We did not see a higher number of claims, instance numbers remained stable and as expected. The higher benefit ratio was primarily to due to a few more large, think expensive, long-term disability claims than we would typically see in the quarter. And finally, the greater than normal number of large claims is not broad-based but is isolated within a few segments.

In the past, we have seen seasonality in the benefit ratio, which generally provides challenging results in the first and the second quarters of the year. At this point, we have no reason to believe that these results were anything other than seasonal volatility.

Despite the increase in the benefit ratio for the second quarter, the benefit ratio improved to 81.4% for the first 6 months of 2014 compared to 82.1% for the first 6 months of 2013. The pricing actions we took in the past will continue to improve underwriting results. But of course, this improvement doesn't occur in a straight line. As I've mentioned before, we expect to see some unevenness as overall results continue to improve.

At StanCorp, we're committed to writing and retaining profitable business.

Employee Benefit premiums decreased 4% for the second quarter of 2014 compared to the second quarter of 2013. The lower premiums reflected lower sales for the second quarter, our lightest sales quarter of the year. This is further reflection of our pricing discipline in a competitive market. However, sequential quarters would demonstrate that we are beginning to see growth in premiums.

Going into the second half of the year, we are encouraged by the sales pipeline as we are seeing an increase in proposals and more high-quality proposals. Employers seem somewhat less distracted by economic and Affordable Care Act issues, although our sense is this is still uneven among employers. Based upon the various conflicting court rulings earlier this week regarding the Federal Government's ability to subsidize policies through the Federal exchanges, it seems this uncertainty will continue.

In addition, employment levels among our existing customers have slightly increased again this quarter. Although the increase is small, it is continuing the trend we have seen for the past 3 quarters now. The pronounced growth in the U.S. employment data happened in markets that were not a significant portion of our book, such as construction, manufacturing and especially temporary employees. While we don't see significant immediate positive impact from these headline reports, including the most recent positive report of this morning, we absolutely believe these trends will ultimately improve our

[Audio Gap]

book of business.

For Individual Disability, the benefit ratio was 79.3% for the second quarter of 2014. And that compares to 63.4% for the second quarter of last year. The benefit ratio can be more volatile for the smaller block of business, but produces more stable results when viewed on an annual basis. The best example of this volatility may be the comparison of the record first quarter performance of this business when compared to this quarter.

As I mentioned earlier, I am pleased with the record results in Asset Management. We had income before income taxes for the second quarter of $22 million, and that compares to $20.7 million for the second quarter of 2013. The increase was primarily due to higher administrative fees as a result of the increase in assets under administration. In addition, commercial mortgage loan prepayments fees, bond call premiums and contributions from the change in the fair values of the hedging assets and liabilities related to our equity index annuity product, added approximately $3 million of income before income taxes for both periods. Although these items contributed to our record earnings in the quarter, we also saw a good cash flow in our retirement plans business in the quarter to go along with the growth in equity assets under administration related to growth in the stock market overall.

Despite the quarterly volatility in our insurance businesses, our financial discipline continues to be key as demonstrated by our strong balance sheet and capital position. We continue to grow book value per share, our investment portfolio has performed very well, and our capital level remains strong, while we aggressively and opportunistically deployed $51 million in capital this quarter to increase shareholder value. We remain confident in our ability to deliver superior value to our customers as well as shareholders.

With that, I'll turn the call over to Floyd for a further discussion of interest rates, investments and capital. And we'll leave plenty of time for your questions at the end. Floyd.

Floyd F. Chadee

Thank you, Greg. I will begin with comments on the new money investment rate and the discount rate used for newly established long-term disability claim reserves for the second quarter. I will then comment on our investment portfolio and our capital management.

The continued low interest rate environment remains a challenge for the entire industry. We continue to see new money investment rates on bonds and commercial mortgage loans that are below our current investment portfolio yields. And this puts pressure on net investment income. Our tight asset liability management and our transparent and conservative approach to setting the discount rate allows us to be successful in periods of prolonged lower interest rates. As part of our reserve oversight, we closely monitor the adequacy of the margin between the average new money investment rate and the average reserve discount rate.

Our new money investment rate for the second quarter of 2014 was 4.56%, slightly lower than the 4.69% for the last quarter, but 40 basis points higher than the 4.16% for the second quarter of 2013. The 12-month reserve interest margin was 57 basis points for the second quarter of 2014, compared to 53 basis points for the second quarter of 2013.

The overall portfolio margin was 40 basis points at the end of the second quarter of this year. The discount rate used for newly established long-term disability claim reserves remained at 4% for the second quarter of 2014, 25 basis points higher than the 3.75% used for the second quarter of last year. The 25-basis-point increase in the discount rate results in a corresponding increase in quarterly pretax income of approximately $2 million.

Moving on to investments. We are pleased with the performance of our investment portfolio, which is composed primarily of high-quality fixed maturity securities and the commercial mortgage loans. Our fixed maturity security portfolio had an average credit quality of A- at June 30, 2014. Our high-quality commercial mortgage loan portfolio continues its long track record of providing excellent risk-adjusted returns. The portfolio yield was 5.7% as of the second quarter of 2014, with a low 60-day delinquency rate of just 26 basis points. Commercial mortgage loan originations were $372 million for the second quarter of 2014, compared to $364 million for the second quarter of last year. Our expertise in originating and underwriting commercial mortgage loans continues to provide us with a significant yield advantage.

We also continue to selectively take advantage of market opportunities for investment purposes. One example is our acquisition of tax-advantaged investments. We like both the yield and the quality of these tax-advantaged investments, which will provide tax benefits over several years.

Now I will turn to our capital position. At StanCorp, our capital position is the cornerstone of our business. We define available capital as capital in excess of our insurance subsidiaries' target RBC ratio of 300%, together with cash and capital, the Holding Company and noninsurance subsidiaries. At June 30, 2014, available capital was approximately $500 million, which is unchanged compared to last quarter.

At the beginning of this year, we provided annual share repurchase guidance of $40 million to $80 million. We have also told you that we will be opportunistic with respect to capital deployment. We are pleased with the opportunities that we saw in the first half of 2014 to effectively deploy capital. Year-to-date, we have deployed approximately $133 million through the repurchases of shares and debt. In the second quarter, we repurchased more than 850,000 shares for approximately $51 million at a volume weighted average price of $60.13 per share. This brings our year-to-date share repurchases to approximately $86 million. We will continue to be opportunistic with our share repurchases in the second half of 2014.

The estimated risk-based capital ratio at the insurance subsidiaries was approximately 400% at June 30, 2014. This was after a $40 million dividend from the insurance subsidiaries to the Holding Company in the second quarter.

Under normal circumstances, we would expect that capital of the insurance subsidiaries would not fall below 325% of RBC and that we would hold a buffer of approximately $200 million to take advantage of business opportunities and to provide for external economic risk. Currently, our capital position in excess of these normal levels, is approximately $200 million.

In addition to a strong available capital and estimated RBC ratio, we grew book value per share, excluding AOCI, by 7.3% compared to June 30, 2013.

With that, I'll now turn the call back to Jeff to begin the question-and-answer portion.

Jeffrey J. Hallin

Thank you, Floyd. Christine, we are now ready to take the first question from our participants.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Seth Weiss with Bank of America.

Seth Weiss - BofA Merrill Lynch, Research Division

A question on the higher severity. You mentioned isolated segments. If we look back to the poorer margins in 2012, is there any pattern between the segments that had difficulty this quarter versus that period?

J. Gregory Ness

Seth, let me ask Dan, to take that. Dan?

Daniel J. McMillan

Seth, this is Dan. The -- I think it's really important -- and I'll just really reflect a little bit on what Greg said earlier. It's important to make a distinction between what we saw this quarter and what you're referring to, because the difference is fairly significant, meaning that this isn't a broad-based phenomena that we saw this quarter. It's very specific and isolated to not only a quarter, but also a month, and also isolated a few segments. So we're really talking about a few claims and a few segments. We've done, as you can imagine, a fair amount of analytics around this thing that we saw in the quarter. No correlation to vintage, no correlation between the claims and really, didn't see the trend continue within the quarter, and that's why we're calling it some seasonality within the quarter.

Seth Weiss - BofA Merrill Lynch, Research Division

Okay, great. And if I could just quickly transition to Asset Management, which even after factoring out the strong prepayments and the benefit from the hedge income, seems like a stronger quarter than what you had commented on or guided to at the beginning of the year. And if we think about this $18 million to $19 million as a run rate for quarterly earnings, is that fair, given the increase asset levels? Or is there something else that maybe benefited the quarter as well?

J. Gregory Ness

Jim, give us some perspective there.

James B. Harbolt

Seth, you're right. We did guide last quarter to $16 million to $17 million and we hit right in the middle of that guidance in the first quarter. I won't update quarterly guidance today or -- that's just not how we do it. But let me give you a little bit of color for this quarter. There were 3 things that went on in this particular quarter that helped push their earnings up. First, we saw the strong equity and bond market movement and that helped generate more fees from our assets under administration. The second thing is we also saw good positive cash flow on our retirement plans business. We've had good sales and client retention in the first half of the year. That helped push up our assets under administration. And then an important note is the third thing that happened is that there are 3 variable items that we have that all went our way this particular quarter. And they just helped us out there, and they all gave us some lift. And that was the prepayments on the bond calls and also on the mortgages. We also had some favorable DAC unlocking. And then we had the hedge gains. And that lift -- they all went our way this quarter and we're happy about that.

Seth Weiss - BofA Merrill Lynch, Research Division

Great. Are you able to put a number to the DAC unlocking?

James B. Harbolt

I don't think we'll do that. But it's just part of our normal annual routine work.

Operator

Our next question comes from the line of Tom Gallagher with Crédit Suisse.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Greg. Just back on the benefit ratio. On the group business, this 77% to 79% guidance that you gave at the beginning of the year. Should we still assume that that's the target? And I guess, relatedly, should we still expect to see the normal big seasonal improvement that you've seen in prior years in 3Q?

J. Gregory Ness

Floyd, why don't you talk a bit about guidance?

Floyd F. Chadee

Yes. So Tom, as you know, we don't give quarterly guidance. As we pointed out in the past that our quarterly results are subject to normal quarterly claims volatility and for that reason, we give guidance once a year and we don't really update it during the quarter. I mean, you're right. You quite rightly to point out that we, in the past, we have seen a seasonality as the course of the year progresses. But we're not really giving guidance with respect to that. But observing that, yes, that has been part in the past.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

And just back on the segments where you mentioned that was isolated to a few segments. Can you comment on what segments those were and why there would be a level of comfort that you wouldn't expect to see a repeat of the higher claim severity?

J. Gregory Ness

Jim.

James B. Harbolt

Tom, I think it's important to make the distinction that this is -- we're talking about claims severity and not claims incidence which, I think, Seth was referring to earlier. But at the same time, if we thought there was some type of a trend or phenomena here we thought was going to continue, we call out those segments and make sure we knew what those were. We just don't see that, that's the case here. And so, we're not going to go into that detail.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Okay, and then just 1 follow-up if I could on Individual Disability. And I know that's smaller, it's been volatile in the past. But this was a higher benefit ratio in that segment that you've seen in some time. Are you -- is this -- because it's been quite volatile, it's a little difficult for us to know, is that -- maybe, is this quarter achieving targeted returns? Was prior -- were you over-earning in prior quarters relative to pricing? Can you give us some perspective on how to view this quarter's result?

J. Gregory Ness

All right. Let's do that, Katherine?

Katherine Durham

I think what's really important to keep in mind with this business line is looking at it over the long term. So when we look at it over 5 years, our benefit ratio has been pretty stable. This year is a great example of how volatile this business is. Again, a very small block, as you pointed out. So Q2, we saw the benefit ratio spiked up. Q1, we had one of our most profitable and lowest benefit ratios in that same 5-year period. So if you look at year-to-date, where we are, and again look at that longer-term period, we're very comfortable with this falling in line with those expectations.

Operator

Our next question comes from the line of Randy Binner with FBR.

Randy Binner - FBR Capital Markets & Co., Research Division

I guess I'm going to try Tom Gallagher's question a little bit differently. You've commented that the employment environment improving will help your book of business. And so, kind of going back to where the losses were in this quarter that were elevated, can we surmise that those were in an area where employment growth outlook is not as good?

J. Gregory Ness

Dan.

Daniel J. McMillan

Randy, I wouldn't correlate with that with employment at all. It really just has to do with the fluctuations within this particular month that we saw in severity on some higher value claims. And again, is not -- we're not going to -- talking about a lot of claims. There's a few claims that hit during a specific period.

Randy Binner - FBR Capital Markets & Co., Research Division

Okay, fair enough. And then kind of the Obamacare comments about that being less of a distraction. I guess, I'm curious to hear, have employers kind of just learned to live with uncertainty or have they made their decisions around what they're going to do with ACA? And what is it? Are they just kind of giving up and moving on or are they actually making decisions about what they're going to do with Obamacare and then what follows from that is a decision -- concrete decision about how they're going to handle their supplemental health benefits like disability?

J. Gregory Ness

Okay, Dan, give us your sense.

Daniel J. McMillan

Yes. The distraction there and the disruption that affects our business as well is not gone by any means. We've seen it taper just a little. And so employers are still working through the ambiguity. You do have a few employers that are a little more sophisticated, that have worked through and have kind of set the course there. Some of the recent events in the courts created a little uncertainty that probably was unexpected. What we're seeing though is that as this plays through, they're getting a little better handle on it than they had last year at this time. That results in a little more activity in our space because they're not quite as distracted. But it's still a major issue in the marketplace for us.

Randy Binner - FBR Capital Markets & Co., Research Division

Okay, that's helpful. But so -- so you're -- I mean, are you through the worst of it on that distraction? Or is that -- is it hard to say?

Daniel J. McMillan

It's very hard to say. It's prevalent today. It's just lessened a little bit.

Operator

Our next question comes from the line of John Nadel with Sterne Agee.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

A couple of questions for you on the group business. If we look at the claim severity in the quarter, and I don't imagine you want to actually quantify the dollar amount for us, so I'll avoid that. But would you be willing to talk about claim severity in percentage terms relative to a pricing expectation in the quarter. If the pricing expectation is 100%, how much above 100% was that claim severity?

J. Gregory Ness

Dan?

Daniel J. McMillan

Yes, John, that's not something we could quantify on the call, particularly, the -- it's really important to know that our results, as Greg alluded to earlier, in the second 2 months of the quarter were better than expected. They just didn't make up for that very specific severity of claims we saw back in April. And to think that we can relate that to broader pricing inflations and things like that is really just not reasonable.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Okay, so if you look at the other sort of key metrics, key drivers of the overall underwriting results for the group insurance business, claims incidents, claims recoveries, mortality, et cetera, can you comment on how those key metrics were trending relative to your expectations?

J. Gregory Ness

Yes. We can give you some perspective on that. Dan?

Daniel J. McMillan

Sure. The overall picture here, as you look at some broader timeframes, if you look compared to the first half of last year to the first half of this year, and really what we've seen over the last 18 to 24 months, we're pleased with the metrics around recoveries. We're pleased with the decline in incidence that we've cited earlier that, that tapering continues. And the overall claims metrics you just described were really in line with our expectations outside of the severity issue.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Okay, so it's -- is it fair for me to summarize your comment then that those other key metrics were back to your targeted levels at this point? Or are you still looking for some modest improvement in some of those other metrics as well, as you think about the pricing working through and sort of the overall recovery that targeted returns for the business generally?

Daniel J. McMillan

Yes. The overall impact of the pricing work that we did some time ago has been, really, the result is really good. If you look at how the benefit ratios perform over a longer period of time. And we're pleased with that. And the overall metrics that you mentioned before are in line with our expectations. And we see the claim numbers as they come in, to be very positive from an incidence standpoint. We don't have a broader perspective on okay, what's going to happen beyond that? But where we are right now, we're real comfortable with.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Okay, and then maybe just for Floyd. So your average share repurchases, I think, in 2Q, was at an average share price slightly above $60, maybe right around or slightly below where the stock is trading right now. Is it fair to say as we look forward and we're thinking about some modest book value growth each quarter, that you'd view the current level still as somewhat opportunistic?

Floyd F. Chadee

Absolutely, John. I mean, we continue with our opportunistic approach. We're very pleased with what we did this quarter and in the first quarter and will continue with that approach.

Operator

Our next question comes from the line of Christopher Giovanni with Goldman Sachs.

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

Just wanted to follow-up on the benefit ratio target for Floyd. And maybe I'm nitpicking. But it is hard to ignore that it was removed this quarter, as in 1Q, you did state that you would expect to achieve that target. Which to me, kind of appeared to be a reiteration of what you provided in 4Q. So I just want to see if you could give us a little bit more, in terms of if that's the target you still think you can hit this year.

Floyd F. Chadee

I mean, I think, Chris, I mean -- I'll restate it, we don't give quarterly guidance. And we think it will be foolhardy in this business, given the quarterly volatility related to claims experience to give a quarterly guidance. So we're not going to try to do that now. It's -- I mean, Dan has stated for you what the -- what our analysis shows, with the drivers of this quarter's results. And I think it is just going to depend on what we see, in terms of benefit ratio for the rest of this year. We won't try to give quarterly guidance.

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

Okay, so I guess we'll work with the annual guidance. And then, the sort of buyback activity, just following up. So there's nothing you're seeing the trends now from a loss ratio, obviously, pretty good capital generation. So you wouldn't expect, based on what you see now, that you'd be pulling back from buybacks, maybe the way that you did a few years back?

Floyd F. Chadee

Yes. I mean, a few years back, when we pulled back, we were going through a period of elevated incidence. That -- and also, even if you go beyond that, it was just the overall economy causing many companies to pull back. We don't see either of those circumstances arising at this point.

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

And then just one quick one for Greg. I wanted to see if you could talk, at all, a little bit about M&A. I guess particularly why, maybe, we haven't seen that much in the group space over the past few years. It seems like as profitability has started to recover, industry capital continues to build and this area is a product area that people still really like? Why do you think maybe we haven't seen more activity?

J. Gregory Ness

Well, Chris, I think you partially answered your own question there. I think it's the product area that a lot of people like because of the characteristics of this in interest rate environment. It's not sensitive like a variable annuity and so on. I think it's a prized asset and I suspect it's hard to unwedge that from various organizations. I can't obviously speak to any M&A activity in particular. But I suspect that these are viewed as valuable properties and most organizations would desire to retain them.

Operator

Our next question comes from the line of Suneet Kamath with UBS.

Suneet L. Kamath - UBS Investment Bank, Research Division

So first question is on capital for Floyd. If we look at your pretax STAT earnings just sequentially, it looked like it was a pretty flat number. But if I look at your pretax GAAP earnings, just for the Insurance Services business, it looked like that number came down a decent amount. So was there anything unusual that caused the flat results on the STAT basis despite the decline sequentially on a GAAP basis?

Floyd F. Chadee

We're noticing it, I mean STAT to GAAP always contains a lot of different things moving in different directions, even on quarterly basis. So the things that normally, I mean, you have DAC issues and earnings from nonstatutory entities that affect the GAAP and STAT differently. You also have reserve changes that are very different on a STAT and GAAP basis. So if I were to think of anything that came up this quarter -- the only thing that really was unusual was, in the second quarter, you do the reserve change on a stat basis, which is driven by formula, which applies across the industry. And we did that this quarter. There was an $8 million decrease in reserves because of the discount rate went up 50 basis points. And half of that would be retroactive to the first quarter. But in reality, that was the only unusual thing going on a sequential quarter basis.

Suneet L. Kamath - UBS Investment Bank, Research Division

Okay, and then I guess, as we think about your capital plans going forward, I mean, it looked like your $500 million number was flat sequentially. So again, implying that whatever you generated in terms of earnings in the quarter, are used for capital returns. Should we think about that as sort of a rule of thumb here in terms of how you think about how much capital you want to return to shareholders? Because it seems like you have a capital cushion embedded within the $500 million. So should we think about kind of cash flow being generated or capital being generated as likely to be the driver of what you return?

Floyd F. Chadee

Yes. So we generally don't give a number on a quarterly basis. We gave guidance at the beginning of this year for share repurchases. And we're already in excess of that given the opportunities we've seen. So the most I could say is that we'll be -- we certainly be -- continue to be opportunistic. And our priorities for capital use haven't changed. I mean, the main priority is still our growth in our business. Growth wasn't there this quarter, and as a result you didn't see the change in RBC requirement go up significantly. But that still remains a priority for the business. And then as we've said in the past, our bolt-on acquisitions, the smaller RDs that would also be the second priority. And then we will be opportunistic with respect to share repurchases as we were in the first half of the year and we'll continue to be so.

Suneet L. Kamath - UBS Investment Bank, Research Division

Understood. But you're not expecting that $200 million of capital that you have after you take out the $325 million requirement and then the $200 million for business opportunities and external risk factors. You're not expecting that $200 million to increase at all, are you?

Floyd F. Chadee

I mean, we'll deal -- we'll deploy that $2 million -- $200 million opportunistically and the way we think serves our shareholders are best.

Suneet L. Kamath - UBS Investment Bank, Research Division

Okay, and then maybe just one for Greg. Just one comment in your prepared remarks I just wanted to drill into a little bit. You said that the number of proposals that you're seeing, I think him started to increase or continued to increase. And then you used the qualification, the high-quality proposals. I just want to see, that was sort of an intriguing statement. So I just want to understand what you're referring to specifically there.

J. Gregory Ness

Suneet, let me ask Dan to give you a little color on that. Dan?

Daniel J. McMillan

Yes, the phenomenon, the proposal activity is something that's really encouraging to us, for one, as we look into the second half of the year, I think Greg alluded to that as well. And when we say quality quote proposals, it's really proposals that we think we have a good opportunity to provide value to that proposing entity. Where sometimes, you have a greater proportion of just market checking or something like that, or a greater proportion that is really just price-sensitive and you know that we're not going to chase the market in a really price-sensitive environment. The quality has improved, not dramatically, but noticeably to us. And we're going to pursue those opportunities as they come up.

Operator

Our next question comes from the line of Colin Devine with Jefferies.

Colin W. Devine - Citigroup Inc, Research Division

I was wondering if you could just clarify what I thought I heard with respect to RBC and your targets. And I thought I heard earlier at the beginning of the call, that for deciding, I guess, how much excess capital you have, that the base was 300%. But then I thought I heard later on it was 325% million plus a cushion. And I guess, when I think it's 300%, I don't think you've been at that level since 2007. So it struck me as a being a little out of date. Maybe you could just clarify for me.

J. Gregory Ness

We can clearly straighten that out. Floyd?

Floyd F. Chadee

Colin, this is something that we've gone into some detail in some previous calls. So if you think about the $500 million that we quote in excess of 300% of RBC, one, we think it's important for us to quote, for investors to understand that, that measure is important for us. We think 300% of RBC is a useful measure given that our business is much lower risk than other types of insurance businesses. So we don't have any variable annuity, we don't have any long-term care. So investors knowing the amount we have an excess of 300% of RBC is important. Two, we would not expect that under normal circumstances, we'd drop below 325% RBC within our statutory entities. That uses up $100 million of the $500 million. And then we say, and above that, we would normally hold a buffer for business opportunities and for external risk. That's $200 million. Before the financial crisis, that number would have been in the vicinity of $100 million. So it has been updated since before the financial crisis. So you add all of those numbers together, you get $300 million out of the $500 million, which may leave $200 million of capital that's immediately deployable.

Colin W. Devine - Citigroup Inc, Research Division

And that then another way of saying that your target RBC is 350%? Because I'm checking the $100 million and $100 million that you're sort of carrying on a normalized basis is what, practically speaking, you're managing the company to?

Floyd F. Chadee

So, Colin, I mean, we have been through this in some detail in previous calls. You could refer to a previous transcript. But the notion here is that, under normal circumstances, yes, you're right. We would hold the 300% plus an extra $300 million. But we do want shareholders to know that we're measuring in excess of 300%. And for example, if we saw business opportunities to expand and we thought that there was a very attractive deal to be done, we would want shareholders to think that we would dip into that $300 million that we're holding as buffer.

Colin W. Devine - Citigroup Inc, Research Division

Even if that was the trigger a rating downgrade by dropping that low?

Floyd F. Chadee

I think in those circumstances, Colin, you have conversations, normally, in our industry, with your rating agencies.

Operator

Our next question comes from the line of Ryan Krueger with KBW.

Ryan Krueger - Dowling & Partners Securities, LLC

I just wanted to follow-up on incidents. I think you mentioned that it was generally still trending in the right direction. Could you just give us a sense of how did group disability incidents in the current quarter compared to full year 2013 incidents?

J. Gregory Ness

Dan, can you give us perspective?

Daniel J. McMillan

Ryan, on the direct comparison like I would say that we've seen, from the time we started the pricing matching some time ago, we've seen that taper. It hasn't dramatically fallen, but it's been very kind of predictable as we've managed that book of business. It would compare probably slightly favorable to the period you're referring to because we've seen it come down gradually since then.

Ryan Krueger - Dowling & Partners Securities, LLC

Okay. So incidents was probably a bit better this quarter than maybe last year?

Daniel J. McMillan

Yes. I think you're in the realm of reasonableness there.

Ryan Krueger - Dowling & Partners Securities, LLC

All right. And the, I guess, could you remind us how much of your group insurance payment are voluntary-paid versus employer-paid at this point? And are you seeing much of a differential in the growth there?

Daniel J. McMillan

We do view the voluntary space as a growth opportunity and we are making investments there. I think we've alluded to that in the past in some detail. It is part of a very clearly articulated strategy we have for this business. Voluntary employee pay premiums are roughly 35% of our books. So it's a significant part of our business today.

Ryan Krueger - Dowling & Partners Securities, LLC

Okay, and then just one more quick one. Can you give an update on commercial mortgage spreads that you're seeing in the market and what outlook is for that?

Daniel J. McMillan

Scott, take that, will you?

Scott A. Hibbs

Sure, Ryan. We're continuing to get good volumes and good spreads. As we've talked about in past quarters, we are seeing an increasing level of competition in the market as the economy slowly improves, and that is putting some downward pressure on the spreads. But they are still today in the 2.50 range or so over comparable treasury.

Operator

Our final question is a follow-up question from John Nadel with Sterne Agee.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Just a couple of quick ones. I think Floyd had mentioned tax-advantaged investments. And I just wanted to get a sense as we -- did you make any incremental investments in that category during the quarter and how do we think about that impacting the effective tax rate as we look forward? I think, what I've been including, what I'd been assuming, I think, was based on your original outlook that talked about $22 million or $23 million of tax benefits in 2014 from these types of securities. Is that -- do I think about that number as being a bit higher now?

J. Gregory Ness

All right. Let's take that in a couple of bites. Scott, why don't you talk about investments and then, Floyd, will you talk about the impact of the tax rate. Scott?

Scott A. Hibbs

John, we did acquire some additional tax-advantaged investments in the quarter. And our acquisitions there are opportunistic. We like the benefits we see there. So we kind of will continue to do that over time. Relative to the impact on the tax rate, I'm going to let Floyd speak to that.

Floyd F. Chadee

Yes. So, John, I think the way to think about it is that the tax-advantage in investments that got acquired this quarter would be -- would affect the tax rate by approximately 1 to 2 percentage points favorably. Now where the tax rate actually ends up for the year of course is dependent on where pretax opportunity earnings comes out.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Sure, sure.

Floyd F. Chadee

So that varies quarter-to-quarter.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Okay, and as I understand it, there's a little bit of give up rate on the actual yield, so do I think about that as -- and where do I think about seeing that? Is it all in corporate?

Floyd F. Chadee

Yes. So a lot of the effect you'd see in corporate, so for example in corporate, you'd see some of the investment income going down. But those assets actually spread throughout the business. So we do use equity method accounting for that. So you do see a negative impact on investment income. But a positive impact on the tax rate.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Got it. Okay. And then just a last question. So persistently tough interest rate environment, employment improvement, but not necessarily, at least, not to the same degree in the areas of your in-force. I mean, how do you think about -- how do we put those things together and think about -- or how do you assess the adequacy of the pricing that you've now implemented or are in the process of finishing implementing on your book of business? I mean, how does that compare against the environment your continuing to operate in today? Is it -- have you taken enough or do you think there's a chance that you may actually still need to take more?

J. Gregory Ness

All right, John, that's a good question for us to end on. Dan?

Daniel J. McMillan

John, we didn't think we've taken enough, in short. I think there's a couple of key points here. We continue to see the opportunity for profitable growth in this business. So within a market that remains disrupted from an economic to regulatory standpoint, we see opportunities to write and retain business in this space where customers value expertise, great experience and financial stability. And that's what we bring. And our strategy I referred to earlier is really pointed around 3 areas: investments in growing markets, focused distribution and foundational expertise. And we'll continue to invest in those spaces to drive some growth in these businesses as we look forward.

Jeffrey J. Hallin

I'd like to turn the call back over to Greg for some closing remarks.

J. Gregory Ness

Thanks, Jeff, and again, thanks to all of you for joining our call today. Maybe just a few thoughts as we leave you. In the past, we've seen seasonality in the benefit ratio. And at this point, we have absolutely no reason to believe that these results were anything other than seasonal volatility. Despite the unfavorable claims volatility this quarter, I remain pleased with the positive forward momentum in our business. We continue to be pleased with our investment performance in a persistently low interest rate environment. We like the continuing performance in our asset management business, and we certainly like the opportunities to return capital to shareholders in the form of share repurchases. Going into the second half of year, we are also encouraged by the sales pipeline as we're seeing an increase in proposals and as Dan noted, more high-quality proposals. We absolutely remain confident in our ability to deliver superior value to our customers and ultimately, our shareholders. Thanks for joining us on the call today. And have a great day.

Jeffrey J. Hallin

Thank you, Greg. I'd like to thank everyone, once again, for joining our call. There will be a replay of this call starting this afternoon and running through August 1. To listen to this call, you can dial (877) 660-6853 and enter the conference ID number, 13584034. A replay of today's webcast is also available at www.stancorpfinancial.com. Thank you. Christine?

Operator

Thank you for participating in today's telephone conference. You may now disconnect your lines.

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Source: StanCorp Financial Group's (SFG) CEO Gregory Ness on Q2 2014 Results - Earnings Call Transcript
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