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StanCorp Financial Group, Inc. (NYSE:SFG)

Q2 2011 Earnings Call

July 22, 2011 12:00 PM ET

Executives

Jeffrey Hallin – Assistant VP, IR

Greg Ness – President and CEO

Floyd Chadee – CFO and SVP

James Harbolt – VP, Insurance Services Group of Standard Insurance Company

Scott Hibbs – VP, Asset Management Group of Standard Insurance Company

Daniel McMillan – VP, Insurance Services Group of Standard Insurance Company

Analysts

Edward Spehar – Bank of America Merrill Lynch

Randy Binner – FBR Capital Markets

Beth Malone – Wunderlich Securities, Inc.

Steven Schwartz – Raymond James & Associates

Christopher Giovanni – Goldman Sachs & Co.

Dustin Brumbaugh – E.K. Riley Investments

Bill Dezellem – Tieton Capital Management LLC

Eric Berg – RBC Capital Markets Equity Research

Thomas Gallagher – Credit Suisse

Operator

Ladies and gentlemen, thank you for holding. Welcome to the StanCorp Financial Group, Inc. Second Quarter 2011 Financial Review Conference Call. All lines have been placed on mute to prevent any background noise. Today’s conference call is being webcast live over the Internet and is also being recorded. A question-and-answer session will follow today’s presentation. (Operator Instructions)

At this time, I would like to turn the call over to Mr. Jeff Hallin, StanCorp’s Assistant Vice President of Investor Relations for opening remarks and introductions. Please go ahead, sir.

Jeffrey Hallin

Thank you Rob. And welcome to StanCorp’s second quarter 2011 financial review conference call. Here today to discuss the company’s second quarter results are Greg Ness, President and Chief Executive Officer; Floyd Chadee, Senior Vice President and Chief Financial Officer; Jim Harbolt, Vice President, Insurance Services Group; Dan McMillan, Vice President, Insurance Services Group; Scott Hibbs, Vice President, Asset Management Group; Mark Fisher, Vice President and Managing Director, StanCorp Mortgage Investors; and Rob Erickson, Vice President and Controller.

Today’s call will begin with some brief 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, belief and expectation of StanCorp’s management regarding future performance.

Some of these statements made are not historical facts, but are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements are subject to risks and uncertainties, actual results may differ from those expressed or implied. Factors that could cause these actual results to differ materially from those expressed or implied have been disclosed as risk factors in the company’s second quarter earnings release and the 2010 Form 10-K.

With that, I would like to turn the call over to Greg. Greg?

Greg Ness

Thanks Jeff and thanks to all of you who’ve joined us for our second quarter earnings call. While this quarter’s earnings were disappointing, it’s probably not entirely unexpected given the continuing challenges in the economy overall. Unlike prior economic downturns, this recessionary period impacted our core book of business and thus our results. Yet even with that, there are certainly positives to be gleaned from the quarter. Group insurance premiums continued to show growth. We implemented targeted pricing actions during the quarter. Asset Management had another strong quarter. Our investment portfolio was solid. Again, we returned value to shareholders through share repurchases.

Relative to our group insurance claims for the quarter, I would like to give you an update on what we are seeing in our claims results, then I would like to provide you with some detail on what we have done and are doing to counteract these elevated claim levels, and of course how we see this playing out going forward.

For the second quarter of 2011, the group insurance benefit ratio was 84.8% and was driven by long-term disability claims incidence that remains elevated but consistent with our experience for the first quarter. To put this in perspective for you, incidence in the second quarter of 2011 continues to be about 12% above historical average incidence levels.

As we discussed with you in May at our Analyst and Investor Presentation, we continue to see a correlation between incidence levels and the employment growth of our customers. For those groups with moderate employment growth, we see only a slight increase in incidence in the second quarter of this year compared to the second quarter of 2010.

In contrast, however, incidence in groups with no growth in employment increased 11%; and for groups with moderate employment losses, incidence increased 15% when compared to the second quarter of 2010. We actually observed some improved incidence levels in selected sectors that are currently experiencing employment growth in the national economy. These sectors include computer services, retail, and wholesale. As you know, these sectors are relatively minor components of our overall block of business.

We also saw some moderate improvement in our higher education sector. In contrast, incidence levels in our K-through-12 education and public sectors remain elevated when compared to historical norms.

In response to these recent claim trends, we have taken pricing action to get our profitability back to targeted levels. In the second quarter, we implemented targeted price increases on our LTD business that were on average in the high single digit range. These pricing increases apply to both new sales and renewal business. As you might expect, we will pay particular attention to those sectors and those cases that have shown the most correlation to employment levels.

While we more heavily factor in recent claims experience, our pricing will not solely be based on short-term experience. Our pricing reflects our long-term expectations that claims experience, demographic changes, return objectives, as well as interest rates, will continue to respond in an appropriate, strategic and timely manner within the parameters of our long-term successful pricing philosophy.

Pricing will take some time to roll out until we move through our heavier renewal seasons. As an example, by the end of this year, we will have had an opportunity to re-price approximately one-third of our current business. By the end of 2012, we will have the opportunity to re-price approximately three-fourths of our current business. We believe that profitability will improve both as the economy recovers and these pricing actions take hold. In retrospect it seems more clear now that our particular book of business withstood the early impacts of the economic environment very well; however, we are seeing impacts later in the cycle due to the very unusual nature of these economic conditions.

While we take action to counter the financial impact of increases in claims incidence, our operations remains strong and customers continue to respond positively to our products and services. In the second quarter, group insurance premiums increased 2% compared to the second quarter of last year as solid sales and persistency more than offset unfavorable organic growth. Going into the second half of the year, we do (inaudible) pressure based on price increases but remain confident in our ability to deliver strong value to customers.

Moving on to Asset Management, our Asset Management segment generated pre-tax income for the second quarter of $16.6 million; that was 26% higher than the second quarter of last year. Results were driven by favorable interest margins, higher commitment fees from increased commercial mortgage loan originations and continued good operating expense containment. Overall we are very pleased with the consistent results been generated by Asset Management.

In summary, we have work to do and it will take some time for the economy to continue to recover in order for our customers’ employment situation to improve and for our pricing actions to take effect. We’ll maintain our focus on building shareholder value with an emphasis on increasing long-term profitability, growing book value, maintaining a solid capital base, and returning capital when good opportunities arise.

With that I’ll turn the call over to Floyd for a further discussion of our benefit ratio outlook, interest rates, investments and capital. Of course we’ll leave plenty of time for your questions at the end. Floyd?

Floyd Chadee

Thank you, Greg. I would like to begin by first considering our expectations on the group insurance benefit ratio. As Greg has already mentioned we expect that it will take some time for the price increases to be implemented throughout our overall block of business. In addition, the external economy continues to display signs of weakness particularly in the area of employment growth.

The guidance that we had provided at the beginning of the year did not reflect the current economic challenges. Given these circumstances it is not an unreasonable expectation for the group insurance benefit ratio to remain elevated for the next few quarters. Such a benefit ratio would reflect a level of claims activity tied to lower profitability in the short-term.

In the meantime we are moving forward vigorously with the implementation of the pricing actions that are necessary to deal with the challenges of this economic environment and to get the benefit ratio within our targeted range.

Moving on to our discount rate and our new money rate; in the second quarter, we lowered our discount rate used for newly established long-term disability claim reserves by 25 basis points to 5.25%. The 12-month reserve interest margin between our new money rate and our average reserve discount rate increased to 52 basis points for the second quarter of 2011 compared to 46 basis points for the first quarter of 2011. In the second quarter, we continued to take advantage of opportunities to invest in tax-advantaged investments, which resulted in a second quarter new money rate of 6.16% compared to 6.13% for the first quarter of 2011.

Even though the interest rate environment in the broader economy remains very low, we’re pleased that we have been able to achieve high investment yields through opportunistic acquisition of these tax-advantaged investments. We will continue to place investments on the balance sheet in a disciplined manner.

Moving on to our commercial mortgage loans; we continue to be very confident in our mortgage portfolio. The 60-day delinquency rate was 46 basis points on June 30, and the mortgage foreclosure levels remained within expectations. In the second quarter, we foreclosed on nine loans with a combined loan value of $9 million. Loan originations were strong at over $300 million for the quarter versus $200 million in the same quarter of last year.

Spreads remained strong when compared to historical levels. In the second quarter, we received approximately $21 million in proceeds from real estate sales, resulting in net gains of approximately $2 million. These sales included some of the remaining properties obtained from a single borrower. Year-to-date, we have sold one-third of the single borrower properties and continue with active negotiations on the sales of the remaining properties. In the second quarter, we took an additional $9-million impairment against the remaining properties, reflecting the most current information we have on their value.

Operating expenses for the first six months of 2011 included approximately $3 million in project costs for information technology, service changes, and other service costs. We expect to spend an additional $9 million during the second half of the year in these areas, mainly directed to information technology service efficiencies that will enhance our ability to invest in future technology improvements. The related expenses will be reported in the Other category of our segment reporting.

In looking at our capital position, the risk-based capital ratio at our insurance subsidiaries was 317% at June 30. Available capital was approximately $155 million at quarter end. The decrease in available capital during the quarter was the result of elevated claims activity combined with premium growth of the insurance subsidiaries as well as share repurchases of the holding company. In the second quarter, we bought back approximately 960,000 shares of our common stock at a total cost of $41.6 million.

Year-to-date, we have repurchased about 1.8 million shares at a cost of $80.3 million. Given the continued uncertainty in the economy, we expect to be somewhat more conservative in our capital deployment for the latter half of 2011. We will evaluate share repurchases opportunistically based on equity markets, capital levels, and/or assessment of the direction of the overall economy.

In conclusion, I’d like to emphasize the strength of our balance sheet and of our business franchise. We have the knowledge, the discipline, and the track record for managing this business through the good economic times and the challenging economic times, and we remain committed to building shareholder value.

And, with that, I’ll now turn the call back to Jeff to begin the question-and-answer portion.

Jeffrey Hallin

Thank you, Floyd. Rob, we’re ready to take the first question from our participants.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We will now take our first question from Ed Spehar from Bank of America.

Greg Ness

Good morning, Ed.

Edward Spehar – Bank of America Merrill Lynch

Thank you. How are you?

Greg Ness

Very good.

Edward Spehar – Bank of America Merrill Lynch

The question I have is on the pricing actions that you are talking about. It would seem that if you had high single digit price increases on LTD that you would – the loss ratio would still be I think well above – afterward if all I do is take your premium and say it’s 9% higher, everything else being equal, it seems like you’d still be talking about a loss ratio for this business in the 81% range, which is well above what you have talked about as the range and obviously would imply I think a much lower return on equity than what you have historically targeted.

So, I was wondering if you could comment on the return on equity expectation considering what you view as (inaudible) certain normal benefit ratio if we are going to talk about downside being worse than what we used to think when the economy is weak.

Greg Ness

Okay. Floyd, do you want to take a shot at it?

Floyd Chadee

So, on the overall question of the increase in pricing, at about a 10% increase in – these are averages – about a 10% increase in pricing, I think you get a number that’s better than actually 81%, but clearly we are biasing our expectations to improvement in the benefit ratio towards the effect of our pricing action but there is some assumption that these levels of benefit ratio would not continue, driven by the external economy. So, some lift expected from the external economy but significant action being taken on the pricing side. That makes sense, Ed?

Edward Spehar – Bank of America Merrill Lynch

Yes. I guess though that just the overall question now if we are thinking about this range of loss ratios going forward based on how you would view the cyclicality of the business, considering what we’ve learned with this cycle. I am assuming it’s going to be higher than what it has been historically even on a normal basis.

Floyd Chadee

Well, I think that would depend very much on the length of the cycle and clearly we are in a cycle that is very much unlike anything we’ve seen before. We showed you some slides at our Investor Day that showed that the effect of the economy and the businesses towards which we buyers, while not hit as dramatically as the private sector, would – might take a longer time to recover, so if we look at the lives grow, the lives growth recovering but not as quickly as in construction for example. So, it would depend on the length of the cycle.

Edward Spehar – Bank of America Merrill Lynch

Thank you.

Greg Ness

Thanks, Ed.

Operator

Thank you. Our next question is from Randy Binner of FBR Capital Markets. Please go ahead.

Greg Ness

Good morning, Randy.

Randy Binner – FBR Capital Markets

Good morning. Thank you. So, I guess I just wanted to drill in about – actually with a couple questions. The first would be the statutory earnings are lower. So, it seems that the excess capital generation out of the business before repurchases in capital losses has been pretty low so far year-to-date. How big a deal is that to you when you think about repurchasing stock on a forward basis, meaning would you have to really feel like you’re generating statutory capital to continue to buy back stock at a high level?

Floyd Chadee

So if you look at a decrease in capital between the end of the first quarter and the end of the second quarter, it’s exactly equal to the share repurchases we did during the quarter.

Randy Binner – FBR Capital Markets

Right.

Floyd Chadee

So, at $155 million at the end of this quarter, we still feel that’s a very solid capital base. Now, one of the things you’ve got to remember about the way we count excess capital is that we tend to be very conservative in that counting relative to say the rest of the industry. So, for example, if you look at the real estate on our balance sheet and you take out low income housing tax credits and minority interest in that, there is about $100 million of real estate that we count as zero when we do a capital tallying of excess capital.

So, we still – we feel we have a very solid capital base here, not only in that conservative counting of excess capital, but in the strength of the rest of our balance sheet. We did – we do feel that we need to be more conservative going forward....more conservative going forward with respect to share repurchases and to pay careful attention to the deployment of capital overall as we go through the cycle of re-pricing for benefit ratio.

Randy Binner – FBR Capital Markets

That’s fair. And just one more if I could on the rating agencies. It seemed like the S&P downgrade was more income statement focused. Do you have an impression overall that there – it’s more of an income issue than a capital issue with the rating agencies taking another look?

Floyd Chadee

That’s certainly our impression because the write-up would seem to reflect that.

Randy Binner – FBR Capital Markets

Right. Thank you.

Greg Ness

Thanks, Randy.

Operator

Our next question is from the line of Beth Malone of Wunderlich Securities. Please go ahead.

Greg Ness

Hey, good morning Beth.

Beth Malone – Wunderlich Securities, Inc.

Good morning. Thank you. Just on the two – first question is about the pricing actions that you’re taking...

Greg Ness

Yes.

Beth Malone – Wunderlich Securities, Inc.

...in these markets where you’re seeing this development of claims. It’s – how do you balance out – if you raise your rate to take into account the higher cost, does that mean that – what’s likely to happen to the revenue? Does that mean that your revenues are going to increase because you got better rates, or does that mean that you’re going to lose market share because you’re raising rates in a market where the competition remains difficult or what is the situation for that?

Greg Ness

Okay, good question. Jim, you want to take that one?

James Harbolt

Good morning, Beth. It might be good to remind folks as well that early in the year we took a low-single digit pricing increase and now we’re doing the higher single digit pricing increase. What we found over the years with our customers is that having good local service and being onsite with the customer and working through the renewal increases is really, really important.

We’re out there doing that right now and it’s consistent with investment that we make in local offices and we are optimistic about working through those. When you can show a customer an uptick in incidents and claims results that drive to a higher price and you’re working with them and not surprising them, we are pleased with our – historically we are pleased with our ability to work through those.

Beth Malone – Wunderlich Securities, Inc.

Okay, and then a follow-up on the claims. How – what is the situation with reserve development on your existing book? Is the rise in the benefit ratio that we saw in the quarter reflective of your taking higher cost on old book or is this totally separate? And have you then increased reserves on everything given the change in the claims trend that you are experiencing?

Greg Ness

Floyd?

Floyd Chadee

Yeah, as you know Beth, most of our reserves are reserves on actual claims on the books. Those would be totally unaffected by the increase in incidents that we’re seeing here. So those reserves are based on expectations of termination, so totally unaffected. Now, the place where you could have an effect as we look forward is would be on the IBNR, but that would – even with the way we do our calculations in IBNR, we would have some ratcheting up of that to take into consideration the increase in incidents here.

Beth Malone – Wunderlich Securities, Inc.

Okay, thank you.

Greg Ness

Thanks Beth.

Operator

Our next question is from Steven Schwartz with Raymond James. Please go ahead.

Greg Ness

Morning, Steven.

Steven Schwartz – Raymond James & Associates

Hey, good morning everybody. A couple of follow-ups. Just on Beth’s last point. I mean, your point here is that there is no active life reserves, right? This is almost like a P&C company.

Greg Ness

That’s correct mostly, yeah.

Steven Schwartz – Raymond James & Associates

Okay, I just want to make sure. If we can go back and look at the price increases and the calculation that Ed tried to do, I guess what I’m wondering first is, and only really is, what is your definition of targeted, what are we talking here about 50% of the book, 25% of the book, more, less in terms of targeted price increases?

Greg Ness

James?

James Harbolt

Steven, what we mean by targeted price increases is that we don’t go across the board with the manual rate increase and what we do is in a number of respects on credible experience is that we look at the trend and we think we use a very prudent trending factor and I don’t want to – we want to be transparent but I’d also don’t want to give away some of the secret sauce here for the competitive reasons, but we look at our trending and we look across our book, certainly some customers within certain sectors are running well and price increases in those areas are going to be lower and certain other customers are running higher.

But we look across our whole book and we target those increases to certain customers where we see the rates are going need to be raised.

Steven Schwartz – Raymond James & Associates

Okay, well, let me ask you this then, what percentage of those customers do you – of your customers do you think you are going to need to raise rates?

James Harbolt

Steven, I think – I think I don’t want to go there, because what we are saying – we are looking – we have seen claims upticks in across all sectors, but what I want to do is make sure that we look at each customer and we take actions that we think are prudent and appropriate for those customers.

Steven Schwartz – Raymond James & Associates

Okay. That’s fine, it was just my thought that that can give us more of a sense of how much you are betting on the economy (inaudible), that’s why I wanted to go there. Floyd on the discount rate, I guess my question is could you give us a sense of what you have been – or what your new money investment rate has been so far this quarter, if I am doing my numbers right, you continue to do investments in around the 620 range or so, I can see the discount rate actually going back up in the third quarter?

Floyd Chadee

Yeah, so given the way we average out discount rate, that is certainly possible. We’ve seen good rates on these tax advantage instruments, but a couple of things there, one is I mean that market is – we have no guarantee that those kinds of yields on those kinds of spreads would continue and the overall economy in terms of treasuries could certainly be continuing to stay at low level. So you could have the potential of going up. But, that’s purely based on an expectation of continued tax advantage instruments.

Steven Schwartz – Raymond James & Associates

Okay, all right. Thank you very much. I’ll get back in the queue. Thanks guys.

Greg Ness

Thank you.

Operator

Our next question is from the line of Chris Giovanni of Goldman Sachs. Please go ahead.

Christopher Giovanni – Goldman Sachs & Co.

Hey, good afternoon. Thanks so much. One quick clarification first; when you talk about re-pricing or having the ability to re-price a third of the book this year, is that assuming for January 1 of next year with the renewals come up this year or is that just pure calendar year business 2011?

Greg Ness

Jim?

James Harbolt

No Chris, your description is right. It is – it includes the January 1, 2012 renewals.

Christopher Giovanni – Goldman Sachs & Co.

Okay. And then can you...

James Harbolt

Those are being worked on right now and will throughout the fall.

Christopher Giovanni – Goldman Sachs & Co.

Okay. And then can you provide what your sort of expectations are for sales growth and maybe change in persistency as you work through some of these rate increases?

James Harbolt

Chris, this is Jim Harbolt again. Persistency, we give guidance on that once a year – or excuse me, in our guidance we report that once a year. And all I’ll say with persistency so far is that we’re pleased with where it is right now. Certainly, the price sensitive shoppers only are going to see some price increases and we expect that they will react adversely to that. We still think that for value shoppers that we have a compelling story and we expect that to play out well. As to sales for Q3 or Q4 pipeline, I’m not going to go there. I’m not going to give a forecast on what we see for sales.

Christopher Giovanni – Goldman Sachs & Co.

Okay. And then maybe one for Floyd, if it’s just an income statement event and the balance sheet remain strong and seems like that’s what rating agencies are saying, why should buybacks decline in the back half of the year? I mean, especially given where shares are trading today, and then if sales growth is going to be slowing presumably you should be freeing up more capital?

Floyd Chadee

Yeah. So, you’re absolutely right on the notion of sales growth slowing. So for this quarter, we saw zero net generation of capital from our statutory entities because the growth chewed up all of the statutory income. Now, I think the only thing that would guide us towards being quite conservative with respect to share repurchases would be the question of the overall economy and the continuing impact it could have on our benefit ratio here. So I think it’s not a question of the strength of our balance sheet, but it’s a question of the resilience of the overall economy.

Christopher Giovanni – Goldman Sachs & Co.

Okay. Thank you very much.

Greg Ness

Thank you.

Operator

Our next question is from the line of Dustin Brumbaugh from E.K. Riley Investments. Please go ahead.

Greg Ness

Good morning Dustin.

Dustin Brumbaugh – E.K. Riley Investments

Good morning guys. I just want to shift gears to a little bit off of the pricing topic here and talk about the commercial mortgage portfolio. I think as I’ve looked at it, for me there has been a bit of a disconnect when I look at some of your portfolio statistics on loan to value and some of the marks you’re taking on loans and foreclosure.

And I know the single borrower properties are kind of a one-off unique deal. But another $9 million hit to that in the quarter based – and pretty slow in terms of progress...and pretty slow in terms of progress on selling those properties out. So number one I’m wondering if you can remind me what that $9 million represents in terms of a percentage.

What were those – remind me what the book value of those single – that single borrowers properties were? And then maybe help kind of bridge the gap between the loan-to-values that you cite at 67% and some of the severities we’re seeing when you take these properties into foreclosure? Thanks.

Greg Ness

All right, Dustin, let’s have Scott address that question. Scott?

Scott Hibbs

Yeah, Dustin, first relative to the single borrower properties, the original book value there was around $110 million. So with this last impairment I think the overall impairment write-down you’ve seen is not inconsistent with the other REOs that we’ve had over the last few quarters.

In terms of your question about those values relative to the overall portfolio, I think if you go back and you look at the overall portfolio and its performance it’s hard to come to any conclusion other than it’s performed very, very well. With the discount – or a delinquency rate at less than 0.5% we’re very confident, feel good about where the portfolio is today. That being said, even a 0.4% delinquency rate means we have some distressed properties, some distressed borrowers and so we’re going to see some impairment of value on those properties as we get them back.

Greg Ness

Okay?

Dustin Brumbaugh – E.K. Riley Investments

Okay. If I can ask a follow up for Floyd on that, Floyd as you think about your capital allocation decisions and share buyback decisions, how much does that commercial mortgage portfolio play into your mind?

Floyd Chadee

It’s not huge in the overall picture. I mean we – as we think of the movements in capital here, we think of our mortgage portfolio as being very resilient in the overall story. It might take some time to when you do foreclosures and we’re very circumspect about how quickly we sell those REOs, but not a huge story in the overall capital picture given its strength.

Greg Ness

Thanks Dustin.

Dustin Brumbaugh – E.K. Riley Investments

Okay. Thank you.

Operator

Thank you. Our next question is from the line of Bill Dezellem with Tieton Capital Management. Please go ahead.

Greg Ness

Morning, Bill.

Bill Dezellem – Tieton Capital Management LLC

Good morning. We have a couple of questions. First one is relative to the pricing action, there were some earlier questions surrounding how much, where, et cetera, et cetera. When we look at the overall or average price increase is that what you’re referring to, to the high single digit, so some will be more, some will be less?

Greg Ness

Yes, Bill that’s correct.

Bill Dezellem – Tieton Capital Management LLC

So basically we could look at 100% of the book at that high-single digit is kind of what you’re currently anticipating on average?

Greg Ness

I think that’s a reasonable proxy, if you were doing a model.

Bill Dezellem – Tieton Capital Management LLC

Great. Thank you. And then the second question is what is your sense of what’s your competitors have been doing on the pricing front? And we pose the question to get some perspective on the relative increase, is that, that you believe that you will be implementing and just how aggressive your competitors are at following the early in the year increase and potentially midyear?

Greg Ness

Okay, Bill let’s ask Jim to respond to that. Jim?

James Harbolt

Hi, Bill. The – what we’re hearing reports from the street on right now is that there’s some price firming particularly in the smaller case segment out there. We’ve been hearing about price firming sort of across the board from competitors. We didn’t always see it; now we’re starting to see a little bit more of it. We still seem to be surprised in the more mid-to-large case market how willing some folks seem to be to go to four, five-year rate guarantees of below current in-force rates, it just sort of seems to keep popping up not from the same folks but it’s a place that we’re not willing to go right now.

Bill Dezellem – Tieton Capital Management LLC

And so your net-net view is that you are seeing more upward bias to pricing by your competitors than you have for potentially even a number of years, is that a fair interpretation?

James Harbolt

I don’t know if I’d say a number of years, I’d just tell you the reports I’m getting from my folks on the street is that we’re seeing some price firming going on out there, but on any given day it seems somebody might be willing to drop down below.

Bill Dezellem – Tieton Capital Management LLC

And so just one more additional thought here, given that you are seeing some price firming now that would give you some hope and comfort that you would lose less business as you implement your price actions and potentially have a better persistency than you otherwise might?

James Harbolt

I would tell you, Bill, that my hope and comfort rests on the ability of my field force and my account managers to be out there working with our customers and explaining rate increases and why they’re needed and staying close to them and not just sort of showing up once a year with a surprise.

Bill Dezellem – Tieton Capital Management LLC

Thank you both.

Greg Ness

Thanks, Bill.

Operator

Our next question is coming from Eric Berg from RBC Capital Markets. Please go ahead.

Greg Ness

Hey, Eric.

Eric Berg – RBC Capital Markets Equity Research

Thanks very much; good morning to you. I find the whole conversation about the economy to be very interesting because it makes me wonder whether maybe we should have a different conversation and by that I mean this, if the economy is causing these higher claims, what it means as I understand the business is that people are going out on disability maybe not always but more than you would like to avoid the financial consequences of losing their job.

In other words, it would appear that what’s happening is there are more and more questionable claims or soft tissue claims or claims that can’t be easily diagnosed on a physician’s X-ray. So if that is in fact what’s going on why is the right answer only to raise prices? Or to put my question differently, don’t we need to have a conversation about what StanCorp is doing to put a lid on claims that you really shouldn’t be paying because the disability isn’t compensable in the first place?

Greg Ness

Okay, Eric, good question. We probably disagree with some of the premises to your question, but we’ll ask Dan to take on the claims issues. Dan?

Daniel McMillan

Hello Eric, couple of foundational elements just so that because they provide the right context to your question. The first is when – and Greg alluded to it in his comments, we have not seen the rising incidence in the current economic environment historically and that goes back several decades. So the dip in the economy that we’ve seen historically did not produce some of the same reactions in our book.

At the same time that we didn’t see them early in the current recessionary period as well, it’s only the longer, more entrenched nature of the current economic environment that has ultimately driven us way down even to those tax-based entities such as states and education that historically have been resilient for us that we’re starting to see that or have seen that over the last couple quarters. That correlation did not occur or did not – we did not see that historically.

The other kind of foundational element I think you may have mentioned this in a prior call is that pricing and again we’ve seen this incidence increase across our book in lots of different vintages, lots of different conditions, and pricing and incidence are not the same thing; pricing doesn’t drive incidence. In other words, the insured block for instance from a prior year that’s performing well, we might see incidence spike and we’ve seen some of that in more recent periods.

We have a couple of outliers; I’d like to just really to point those out because it also alludes to your point here. Vintage years 2005 and 2007 both have improved in incidence over the last two quarters. And so this is not a very homogeneous kind of picture across every element, higher education for example, which a lot of our higher education is not tax based, has also improved in incidence.

The last point that you made really around the claimants themselves and claims management and are these claimants truly disabled is one that we watch very closely and we believe that we have one of the best benefits management organizations in the business. And as we look at those various conditions what you might call soft tissue claims, more subjective conditions, we’re seeing consistent performance in acceptance rates and the diligence with which we evaluate those disabilities has not changed and closures and return to work and recoveries have been very consistent as well.

Eric Berg – RBC Capital Markets Equity Research

So the incidence of soft tissue subjective claims doesn’t stand out – in other words as we – if we were to sort of disaggregate this increase in incidence, we wouldn’t see soft tissue claims and more subjective claims standing out?

Daniel McMillan

We’ve seen increases in that category but ironically we’ve seen increases in the cardiac category –

Eric Berg – RBC Capital Markets Equity Research

Yes.

Daniel McMillan

...as well as in the nervous system. So it is pronounced but this is not the only one.

Floyd Chadee

I mean Eric there is a premise in your argument that it goes... that leans towards subjective claims but ironically even though we haven’t seen historically the economic impact that we’re seeing this time, the – many of our competitors have reported increase in very serious disabilities during hard economic times. And, anecdotally this might be supported with the notion of people who are in very bad condition sometimes using work as therapy.

So, in fact, we have seen it with some of our own employees who are in very bad condition when they come to work and in hard economic times that choice may move in a different direction. So, we’ve seen for the industry as a whole in hard economic times report increase in subjective claims but also report increases in more difficult claims too so....

Eric Berg – RBC Capital Markets Equity Research

Okay. Okay, I – that’s a helpful building block for me. I didn’t realize that you were seeing an increase in the more serious claims as well so that’s helpful. My second and final question relates to how your customers will respond to the pricing, something you have discussed. And, my question is – again is as follows. If you’re seeing firming of pricing here and there, but every day as I heard in an earlier response, someone popping up, willing to work for less, why shouldn’t we be worried about the risk of anti-selection? In other words, an outcome in which your best customers will leave for your or the more – less expensive competitors and your most sickly customers will stay with you. Why shouldn’t we be concerned about that? Thank you.

Greg Ness

Jim.

James Harbolt

Eric, this is Jim. Our definition of our best customers are value-oriented shoppers, and we ran through a number of scenarios at our Investor Day conference and I might point you back to some of those slides about customers who’ve come back to us for the value that they receive and that includes taking a look at new capabilities and services that we rolled out to them. We played a video about our workplace possibility. Some of our best customers will take a price increase and cooperate with us about trying to return people back to work as fast as medically possible. So, I guess we disagree about what our best customers are?

Eric Berg – RBC Capital Markets Equity Research

I understand your point. I understand; you are saying your best customers appreciate the value that you provide and will accept a price increase if it is – if it can be supported by the data.

Greg Ness

That’s right.

James Harbolt

Yes. Yeah, Eric, we have a couple of – in the current renewal cycle that really points for the large customers at one, one. We’ve had a couple of successes that point to the very thing that you just said and we’ve seen that happen where customers that are not performing well have taken double digit increases and renewed that business.

Eric Berg – RBC Capital Markets Equity Research

Thank you very much.

Greg Ness

Thanks, Eric.

Operator

Thank you. Our next question will come from Tom Gallagher with Credit Suisse. Please go ahead.

Greg Ness

Good morning, Tom.

Thomas Gallagher – Credit Suisse

Good morning. One question on reserves, then another one on how to think about the claim trend going forward. On the reserves, the – I guess first can you talk about how claim recoveries are performing. The second question is, Floyd, can you comment on – I know you had highlighted IBNR. Can you talk about IBNR, what that represents as a percent of total reserves today, and also have you changed your IBNR to reflect the incidents you are seeing right now? That’s the first question on reserves; then, I will follow up on the claims.

Greg Ness

All right, Tom. Let’s start with the claims. Dan?

Daniel McMillan

Tom, this is the Dan again. The recoveries that we are seeing have been strong over the last couple of quarters. What I mean by that is claimants that either recover or return to work both during the benefit waiting period and after the benefit waiting period have actually been on the rise over the quarters. So those – the impact that we are – that you might suspect there, we are not seeing on closures and recoveries.

Thomas Gallagher – Credit Suisse

All right.

Greg Ness

Floyd, do you want to take the other half?

Floyd Chadee

Yeah, I don’t have the exact answer to your question on the percentage of all reserves that represent the IBNR but this is very detailed in our financial releases in our 10-Q for example. The IBNR – it should be affected if you anticipate continued expectation of increased levels of incidence. The way our formulas work is this happens through a normal review of reserve processes on a quarterly basis, reflecting the continuing experience and the normal ratcheting up that you would see the adjustment of the IBNR to those emerging experiences. So, you wouldn’t see any big jump in our IBNR; it just happens, not really as part of the experience emerges.

Thomas Gallagher – Credit Suisse

But, Floyd, have you reflect – since you are expecting claims incidence to trend high maybe for the next couple of quarters and even to some extent through 2012 as you re-price the book, has that been reflected in a change in IBNR?

Floyd Chadee

Yeah. I mean, this would be reflected through a normal run-offs. It’s not as though you would see here is a point to which the IBNR is inadequate and here is a point at which you make some sudden change. The IBNR reflects the ongoing experience to the extent that experience gets folded into our run-off tables. Your IBNR naturally increases so that’s what you would see. If this – if incidence persists at high levels our IBNR would naturally move to a higher level.

Thomas Gallagher – Credit Suisse

Got it okay. And then just on clearing the claims expectations’ and the benefit ratio expectation; your comments of – you expect it to remain elevated for the next few quarters, remain elevated similar to the level that you’ve seen in 1Q and 2Q, close to the mid-80s, and then your comment on one-third of the book being re-priced and impacting 2012 and then three quarters being re-priced by the end of 2012.

How – assuming no economic recovery that would seem to imply to me that we might see a couple of hundred basis points as benefit ratio improvement next year if the math holds and I’m talking spread across the entire book. Is that – does that math sound about right?

Floyd Chadee

Yeah, so, a couple of things; one, our expectations for the rest of this year, I would say given the suddenness and the sharp increase in the benefit ratio here, given how – that it takes time to move through pricing increases for the book, it would not be unreasonable to expect benefit ratio in this range over the next couple of quarters. In terms of the price increases moving through the book, and we had Ed Spehar earlier doing some of the math there.

We think that the price increases that we are moving through the book should lead to an improvement that is significant here, given the fact that you would lose some of the outlying cases where you would have larger price increases on. And, we’d be fine with that that you would see an improvement in the benefit ratio that would get us into the range that we’ve talked about historically if you get some lift from the economy.

So, if – so with most of our expectation of the benefit ratio improvement coming from the pricing after the next 18 months or so, the – if the economy does not improve then – which we’re not anticipating that you would not see any improvement from this point – then we would not get the full improvement that we would be looking for. But, then of course we’d be looking at other price changes.

Thomas Gallagher – Credit Suisse

Sure. So – but I guess – and I hear your point, if you got both economy and price action then as you roll to, I think it will be 2013 where three quarters of the book has fully been re-priced, that’s when you would get back to historic norms. But, 2012 given that it’s only going to be a third, I guess my back of the envelope math would suggest a couple of hundred basis points of improvement by 2012, given that it’s only one-third of the book that is re-priced. Again, I’m assuming if we haven’t yet seen employment recovery and improvement. I don’t know if you can comment on whether that interim math is appropriate or not?

Floyd Chadee

Yeah. So, there are a couple of modifications that you might need to do to your math. One would be the third is what we’d hit the ground running as we start 2012, but there will be continued price increases throughout 2012 so there is a modification for that.

The other thing that people who are underwriters and actuaries tell us is that to the extent that you have the cases that you’re going to hit earlier would be more likely to be biased towards the cases that you would want to take the rate increases on that in cases – the cases in which we’ll be looking at later that we wouldn’t have hit say by the time you got to the end of 2012 would be cases in which you’ve historically seen better experience. There’d more of a buffer for claims through claims fluctuation reserves and that sort of things. So that notion of hitting the cases where you’d want to have the rate increases earlier might lead to another modification of your math.

Thomas Gallagher – Credit Suisse

Okay, thank you.

Greg Ness

Thank you, Tom.

Operator

Our next question is coming from Steven Schwartz with Raymond James & Associates. Please go ahead.

Greg Ness

Hey, Steven.

Steven Schwartz – Raymond James & Associates

Hey. Just a follow-up. Thank you for continuing this. I am trying to work the math here on the capital numbers and how you all went from $1,237 million down to $1,213 million. Was there a – I mean it works out to that $40 million number, you had $17 million of capital, $40 million, $41 million you spent on share repurchase, but presumably that was out of the holding company, so that wouldn’t have affected these numbers. So I’m just trying to figure out how we went down despite the fact that you generated some capital?

Floyd Chadee

Yes. So, I ‘m not sure I’m following all the numbers that you quoted there, Steven, but let me just roll you through the – our capital between the end of the first quarter and the end of the second quarter, but we started at $195 million. Our earnings within the statutory entity...

Steven Schwartz – Raymond James & Associates

Wait. Whoa, whoa, what do you mean $195 million? I’m looking at $1,237 million capital and surplus on page 2 of the supplement?

Floyd Chadee

Okay, the number I’m quoting would be the excess – the capital in excess of the 300% of RBC.

Steven Schwartz – Raymond James & Associates

Okay, I’m interested in these numbers if you could help me there.

Floyd Chadee

Yeah. I mean it – actually it – let me just walk you through how we got from the $195 million today to the $155 million and then you could back into those numbers.

Steven Schwartz – Raymond James & Associates

Okay.

Floyd Chadee

And we can take it offline to show you the consistency there.

Steven Schwartz – Raymond James & Associates

Okay.

Floyd Chadee

So we went down by $40 million.

Steven Schwartz – Raymond James & Associates

Right.

Floyd Chadee

In terms of excess capital. So excess capital is defined as the capital we have in excess of 300% of RBC. So, on the statutory entities we generated about $22 million of statutory income. We also generated an increase in required capital of about $22 million given the growth we’ve had in our insurance entities, so net generation of capital from the statutory entities being about zero.

Then if we look at the non-statutory entities, given more real estate sales, we generated about $11 million of capital, for example, selling real estate that we had not counted in our excess capital before. So that’s about $11 million if you look at the earnings from other non-statutory entities that $11 million plus about another $9 million gets you up to about $20 million.

Then we set aside $10 million for interest expense and $10 million to accrue for dividend. So the net generation from the non-statutory entities also turned out to be about zero given that math. So then the change in our excess capital was driven totally by the $40 million of share repurchases during the quarter.

So $195 million to $155 million is driven by that $40 million during the quarter. So I’ve quoted you the roll forward on the excess capital, I think the math would be entirely consistent if you then look at capital and surplus rolling forward, but then you have to look at the RBC change during the quarter and all of that.

Steven Schwartz – Raymond James & Associates

Right, but the $1,237 million I mean there was some dividend that came out of the statutory entities in the quarter?

Floyd Chadee

Yes, so the numbers I’m quoting you are the numbers overall.

Steven Schwartz – Raymond James & Associates

Right.

Floyd Chadee

So if you are just looking at those numbers, you confining yourself to the statutory entities, but when we look at excess capital, we look at excess capital at the overall SFG level.

Steven Schwartz – Raymond James & Associates

Okay, understood. All right. And one more if I may, this is more of a modeling thing I think in group. It looked to me, and tell me if am wrong or not, but it looked to me like the amount of acquisition costs that were being deferred relative to operating expense, relative to commission expense was very low. Is there anything going on there?

Floyd Chadee

Yeah. So, Steven, I mean what you’re seeing is, one, the pattern of deferrals follows the pattern of sales, which is different from the pattern of top line.

Steven Schwartz – Raymond James & Associates

All right.

Floyd Chadee

So you get some sort of anomalies that follow that and then some portion of our producer bonuses say it would be tied to other measures of performance such as persistency. So you have different deferral mechanisms on those depending on where those amounts fall out. That’s where you’ve seen that kind of anomaly.

Steven Schwartz – Raymond James & Associates

Okay, all right, great. Thank you.

Greg Ness

Thanks, Steven.

Operator

Thank you. Our next question is coming from the line of Beth Malone of Wunderlich Securities. Please state your question.

Greg Ness

Hey, Beth.

Beth Malone – Wunderlich Securities, Inc.

Hey. This is just a follow-up. I just want to understand this a little bit better. You – when you talk about the claims spiking up in this quarter, that’s an event that you’ve kind of seen going on for over a year now in different quarters, we’ve seen an elevated claims experience and each time up until now, well, a little bit more with the first quarter, you’ve said as a company well this is – first it was kind of assisted collaboration but now you’re recognizing that there is a cause and effect between this overall economy having – because it’s such an unusual recession, it’s worse than before.

So my question is, it seems like what you’re – you’re not really – yes, you’re changing your pricing but are there any other kinds of restructuring or reevaluation or self-examination that you feel like you have to go through at this point because the – the claims spike and the stock market value of your stock has all been negatively affected by these events, so I’m just wondering and how do you assure that as if it’s market condition that change, are you just going to be a victim of that and – but are there things you can proactively do to position the company to be more prepared for these kinds of events or you just – it’s just going to happen because it’s just like the weather or something, you don’t have any control over that?

Greg Ness

Beth, this is Greg. Let me start with some thoughts relative to your question, I think there was a question in there.

Beth Malone – Wunderlich Securities, Inc.

There is a question. What do you guys going to do?

Greg Ness

So here is the way we look at. 2010, we had some mixed claims results, we had a quarter or two that we’re right up about what we’d anticipate and another quarter or two that we’re a little bit higher than we would anticipate. We saw in the first quarter of this year, however, was a correlation that we had not seen before, keeping in mind that correlation is not equal to causation but we saw a correlation in the first quarter between groups that lost employees and their incidence rates.

What we saw in the second quarter is that correlation did anything but strengthen, so it’s a little stronger in the second quarter. So when we first saw this, you’ll recall that our Investor Day we showed you a claims incident chart that showed claims for January and February slightly up from the probably the ‘010, ‘08 run rate. But then in March, it took a very significant spike upward. That’s when we began looking very closely of what was causing that and by the middle of the second quarter, we had already begun taking pricing actions to recognize these new incidence rates.

What we believe is occurring is that the depth and the breadth of this economy has impacted portions of our core business like it has never impacted it before. Think specifically about public, admin, and higher education. We have not seen that type of impact on those sectors in prior recessionary periods. What we’re doing now, though, is taking affirmative pricing action to move those premium numbers up to reflect that higher incidence rate moving forward.

You’ll also note that a lot of the talk that we’ve had in the last year or so about new services and capabilities, whether they’d be absence management, whether they’d be workplace possibilities, electronic beneficiary designation, online claims submission, and so on, most of which are very geared toward private employers.

And if we ask Jim to tell us about the number of sales that were made that had some of those new products and services associated with them, there would easily be half to three quarters of the sales would site some reason of those new capabilities, it is the reason they went with standard. Those appeal far more to private employers than they do public employers at this particular stage. So at the same time, we’re changing our mix of business moving forward as we go. Do you want to add anything? Go ahead.

Beth Malone – Wunderlich Securities, Inc.

Just a follow-up. The rate increases that you’re doing and all these actions you’ve taken, how – if the economy, let’s say, as measured I guess we would in your world that would have to be measured as unemployment or employment numbers, as payroll such a critical part. How quickly do you anticipate seeing a...benefit, like if payrolls all of a sudden next month start to improve, does that mean that your own experience is going to improve in line with that or is there a delay of a quarter or two before we start to see the benefit of any kind of improvement?

Greg Ness

Well, you are right to key in on wage growth. Wage growth is very important. We reported premium growth this particular quarter of about 2%, and that’s really all due to retention of cases as well as new sales, because our lives covered – the number of lives that we cover actually declined in the second quarter by 2%.

That number was down further from where it was in the first quarter. So wage growth is a very important component moving forward. We believe that when there is wage growth we’ll see more premium coming in since virtually all of our premium rates are based upon wage rates and so you’d start to see that on the top line probably the month following the wage increases that start to go through and then the employers reporting the wage increase to us and thus increasing the premium levels.

Beth Malone – Wunderlich Securities, Inc.

Okay. All right. Thank you.

Greg Ness

Yeah, you bet.

Operator

Thank you. Our next question is a follow-up from Edward Spehar from Bank of America. Please go ahead.

Edward Spehar – Bank of America Merrill Lynch

Thank you. And I apologize if you have answered this, but just – I don’t think I have heard, how are you thinking about pricing in terms of what full cycle experience is going to be going forward versus what you thought about in the past?

There have been references to this cycle as being different and things going on in the public sector are different, but isn’t there a reason to look at the business today and think about full cycle experience as worse potentially than what it’s been in the past and price to reflect that? And is that what you are doing or are you just sort of viewing this as an unusual thing, we’re not likely to see this on a cyclical basis when we talk about future cycles?

Floyd Chadee

I think it’s hard to talk about cycles and what full cycle would mean for public and education given that this is the first time that we’re seeing those sectors hit as significantly as they are in the – through these – through economic circumstances. We are pricing with some expectation of economic improvement but largely trying to drive the current benefit ratios within – to our target ranges through our pricing action here.

So I don’t know that it’s – whether anyone is in a position to talk about what future cycles, economic cycles might bring to public and education, but we’re certainly pricing towards this cycle and the experience that we’re seeing here. I think the longer term question that you are asking Ed which is, is public and education – would those sectors perform in the same sort of cycles that other industries perform? That’s a long-term question that depends a lot on sort of the future direction of the economy but more the future direction of the political process within the economy.

Edward Spehar – Bank of America Merrill Lynch

Well, I guess – that’s why I guess I asked this question is because we’re sitting here with the prospect of a downgrade of government, U.S. government debt. I mean, this is not an environment where you would think about sort of the public sector, and not just the next year or two but just on a longer term basis, as necessarily being safer than the private sector. I mean, what do I know?

But I am just saying that there are things out there that would suggest that maybe the public sector isn’t going to be different than the private sector for a long time. And I guess I am just trying to get – I understand we can’t answer that question definitively, but I would just like to know when you are (inaudible) pricing, are you assuming that the public sector and the private sector going forward are going to look similar versus the historical experience where they have had very different sort of cyclical profiles?

Floyd Chadee

Yeah, I mean I think the question are you asking, Ed, is a question that is difficult to answer, but I don’t think it is necessary to drive the decision that we need to make today. We’re making the assumption, one, that this cycle is likely to be long, so we need to price for the experience that we are seeing today.

Two, we don’t expect that the level of incidence that we are seeing right now will necessarily persist for a long period of time, so while we’re pricing for a lot of it, we don’t necessarily need to price for all of it. So those are the two assumptions that we need to make in the short-term here given a long cycle and we don’t need to worry about – for the actions that we need to take today on what future cycles might bring.

Edward Spehar – Bank of America Merrill Lynch

Thank you.

Greg Ness

Thanks Ed.

Floyd Chadee

Thanks.

Operator

Thank you. At this time I will now turn the floor back over to Jeff for some closing comments.

Jeffrey Hallin

Okay. We’re going to turn the call over to Greg for closing remarks.

Greg Ness

Thanks, Jeff. As we conclude our call today, I would like to leave you with just a few thoughts and I appreciate your participation with us today. I am highly confident in our underwriting methodologies and the pricing actions we have taken to address these higher claims. We’ll make substantial progress in re-pricing about three-fourths of our business through the end of next year and we’ll continue to utilize our experience and expertise to address the things that we can control. I am confident that based on these actions and gains in the economic recovery, we will make substantial progress returning to our desired profitability levels.

We had a number of positive developments this quarter confirming that we are getting the fundamentals right. Group insurance premiums continue to show growth and our Asset Management segment had another strong quarter. Our investment portfolio remained solid and we returned value to shareholders through share repurchases.

Standard & Poor’s and Moody’s both took rating actions on StanCorp and our insurance subsidiaries following this quarter’s release as you know. Our ratings continue to be of high quality investment grade and very well positioned within the insurance space. Our financial discipline has enabled us to thrive during more than a century of economic cycles and we remain strong and profitable today. As StanCorp has done in the past, we will manage through this cycle. We’re in this business for the long-term.

Thanks for your continued interest and we look forward to providing you with an update at the end of the third quarter.

Jeffrey Hallin

Thank you, Greg. I would like to thank everyone once again for joining our call. There will be a replay of this call starting this afternoon and running through July 29. To listen to this call you can dial 877-660-6853 and enter the account number 286 and conference ID number 374215. A replay of today’s web cast is also available on our website at www.stancorpfinancial.com. Thank you.

Operator

Thank you for participating in today’s telephone conference. You may now disconnect.

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