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StanCorp Financial Group, Inc. (NYSE:SFG)

Q4 2011 Earnings Call

January 31, 2012 12:00 pm ET

Executives

Jeff Hallin - AVP, IR

Greg Ness - President & CEO

Floyd Chadee - SVP & CFO - StanCorp Financial Group, Inc. and Standard Insurance Company

Dan McMillan - VP, Insurance Services Group - Standard Insurance Company

Jim Harbolt - VP, Insurance Services Group - Standard Insurance Company

Scott Hibbs - VP, Asset Management Group - Standard Insurance Company

Rob Erickson - VP & Controller - StanCorp Financial Group, Inc. Standard Insurance Company

Analysts

Randy Binner - FBR Capital Markets Corporation

Mark Finkelstein - Evercore Partners

Chris Giovanni - Goldman Sachs

Steven Schwartz - Raymond James & Associates

John Nadel - Sterne Agee

Ryan Krueger - Dowling & Partners

Dustin Brumbaugh - E.K. Riley Investments

Bill Dezellem -Tieton Capital Management

Tom Gallagher - Credit Suisse

Operator

Ladies and gentlemen, thank you for holding. Welcome to the StanCorp Financial Group Incorporated fourth 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’d 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.

Jeff Hallin

Thank you, Jackie, and welcome to StanCorp’s fourth quarter 2011 financial review conference call. Here today to discuss the company’s fourth quarter results are Greg Ness, Chairman, 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 of 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 the statements made are not historical facts, but are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements are subject to risks and uncertainties, actual results may differ from those expressed or implied. Factors that could cause actual results to differ materially from those expressed or implied have been disclosed as risk factors in the company’s fourth quarter earnings release and the third quarter Form 10-Q.

With that, I’ll turn the call over to Greg. Greg?

Greg Ness

Thank you, Jeff, and thanks to all of you, who’ve joined us for our fourth quarter earnings call this morning. As we look at 2011, despite the influence of the current economic environment on the benefit ratio in our Group Insurance business, a number of things went well. In the Group Insurance business, sales and persistency levels were strong and premium growth was up. In the Asset Management segment, lower operating expenses and strong interest margins contributed to higher earnings for the segment.

Our solid investment portfolio continues to perform very well. We originated more than $1 billion in commercials loans and brought the delinquency rate below 40 basis points. And we returned value to shareholders through share repurchases and increased our annual dividend per share for the 12th consecutive year.

Looking now to our quarterly results. In our Insurance Services segment, group insurance premiums for the fourth quarter increased 5.6% compared to premiums for the fourth quarter of 2010. Some of the improvement is due to lower experienced rated refunds. Excluding experienced rated refunds, group insurance premiums still increased 2.7% reflecting high customer retention and strong sales for 2011 partially offset by declining employment levels among our current customers.

Group insurance sales were $74.7 million for the fourth quarter of 2011 compared to $73.1 million for the fourth quarter of 2010. Open enrollments during the fourth quarter which are the benefit elections made by employees for 2012 returned to more normal levels after low open enrollments in the fourth quarter of 2010.

Persistency in our Group Insurance business increased slightly to 88.8% for 2011, that compares to 88.7% for 2010. Both of these are very strong retention levels and demonstrate that our products and services continue to resonate with our customers. Organic growth within our Group Insurance business continues to be a significant challenge to growing premiums as this measure depends on employment and wage growth.

Employment levels among our existing customers continue to be down around 2% year-over-year continuing the trend we saw throughout 2010 and 2011. The group insurance benefit ratio was 82.8% for the fourth quarter of 2011 compared to 77.4% for the fourth quarter of 2010. The comparative increase can be attributed to continued higher disability incidence in the fourth quarter of 2011, a reserve release made in the fourth quarter of 2010 and a lower discount rate on our on a long-term disability reserves in the fourth quarter of 2011.

While our claims incidents in the fourth quarter remain higher than our long-term expectations, we are seeing some gradual improvement and expect further improvement in the benefit ratio given the pricing actions we’re currently taking.

Like most carriers in the group insurance industry, the economy has had an adverse effect on our claims results. Some saw this impacts early on in the recession. At StanCorp, the recession had a later impact on our business and we expect a somewhat later recovery as well. We believe we are well positioned to reap the benefits of organic growth once wage and employment levels improved.

Low interest rates will also continue to put pressure on our industry and Floyd will speak to interest rates as well as guidance for 2012 in just a few moments.

In our Asset Management segment, income before income taxes was $14.5 million for the fourth quarter of 2011 compared to $16.4 million for the fourth quarter of 2010. The fourth quarter of last year benefited from gains related to hedging activity for our equity-indexed annuity product.

We like the overall trend of the last two years for our Asset Management business and our goal is to continue to grow the contributions and improve profitability of these lines of business overtime. As we begin 2012, we’re faced with the headwinds of low interest rates and the lack of significant job and wage growth. We remain focused on obtaining and retaining profitable business in order to generate superior long-term results for our shareholders.

We’re performing well in a tough economic and competitive environment and we believe our discipline, long-term approach to this business and our industry expertise will continue to benefit us going forward.

With that, I would like to turn the call over to Floyd for a further discussion of financial results as well as our 2012 financial outlook and of course we leave plenty of time for our questions. Floyd.

Floyd Chadee

Thank you, Greg. I would begin by focusing on our long-term disability discount rate or investment portfolio and our capital position for the fourth quarter. I will then turn to our 2012 guidance.

In the fourth quarter of 2011, we lowered our discount rate used for newly established long-term disability claim reserves by 25 basis points to 4.75%. The decrease in the discount rate is primarily related to the continued low-interest rate environment.

A 25 basis point decrease in the discount rate results in a decrease in quarterly pre-tax income of approximately $1.6 million. The fourth quarter new money rate was 5.13% compared to 5.64% for the third quarter of 2011. The lower new money rate reflected lower investment yields on both our bonds and our mortgages.

The 12 month reserve interest margin between our new money rate and our average reserve discount rate increased to 64 basis points for the fourth quarter compared to 56 basis points for the third quarter. The increase in reserve margin is primarily due to the higher new money investment yields from tax advantage investments that we utilized in 2011.

Our overall portfolio margin remains at 40 basis points. We expect that interest rate pressure will continue to be a challenge over the next couple of years. We have incorporated such an expectation into our guidance. We are pleased with the solid performance of our investment portfolio. Even as this low interest rate environment persists. We continue to look for opportunities to obtain strong investment yields while maintaining a disciplined approach to interest rate risks by closely monitoring the interest margin in our reserves.

Mortgage spreads continue to be favorable when compared with other fixed income investments. We remain confident in our ability to originate high quality, commercial mortgage loans. During the fourth quarter we originated $237 million of commercial mortgage loans. Our 60-day delinquency rate dropped to 34 basis points, which represents the lowest 60-day delinquency rate since the first quarter of 2009.

Next I would like to give you an update on our real estate. In the fourth quarter we sold investment real estate and REO properties with a total book value of approximately $27 million. Net capital gains and real estate for the fourth quarter was approximately $7 million, primarily related to the sales of investment real estate.

Moving on to share repurchases and our capital position. In the fourth quarter we repurchased a relatively small number of shares at a total cost of approximately $300,000. Year-to-date we have repurchased 2.2 million shares at a cost of $90.3 million, which exceeded our 2011 guidance of approximately $80 million. At year end the risk-based capital ratio at our insurance subsidiaries was 327% and available capital was approximately $220 million.

I would now like to turn to our expectations for 2012. Our guidance will focus on two profitability measures, earnings per shares and return to equity. We expect that earnings per share excluding after-tax net capital gains and losses will be in the range of $3.60 to $3.90. After adjusting for the $3 million to $4 million increased in pre-tax expense that will result from the adoption of the new deferred acquisition cost guidance, this 2012 earnings per share range represents a 15% to 25% increase over 2011.

In line with these earnings expectation we expect annual return on average equity excluding after-tax net capital gains and losses from income and accumulated other comprehensive income from equity to be between 9% and 10%. We believe that this is not an unreasonable expectation given the current uncertainty in the general economy.

The following factors are considered in our 2012 guidance. Given pricing actions and a continued challenging economic environment, we expect group insurance premium growth to be relatively flat. We began implementing pricing actions in the second quarter of 2011 on both new and renewal long-term disability business. Strong customer retention and sales for 2011 in our group insurance business will be offset by the headwinds of low employment growth, low wage growth, a competitive pricing environment and the effect of our pricing actions.

We will continue to use our unique expertise in a originating high quality commercial mortgage loans. However, sustained low interest rates could lead to a low discount rate reduced for newly established long-term disability claim reserves and lower net investment income. If the current interest rate environment persists we estimate the discount rate would be lowered by 25 to 50 basis points over the course of 2012.

We expect our group insurance business, annual benefit ratio to be in the range of 80% to 82%. Overtime we expect the annual benefit ratio to return to our historical range of 74% to 78% but it is expected to remain elevated while the economy remains weak and until operating actions are fully implemented.

Given the continued uncertainty in the economy, we expect to be conservative in capital deployment for 2012 with share repurchases in the range of $40 million to $80 million. We will repurchase share opportunistically, based on our assessment of direction of the overall economy, trends in the equity markets and other potential opportunities for capital deployment.

We estimate our 2012 effective income tax rate will be approximately 26% to 27%. We expect the tax benefit from our purchases of tax advantage investments will continue to drive relatively lower effective tax rates for the next few years. These tax advantage instruments have largely been in low income housing tax credits driven by public policy that is encouraged by the federal government.

Finally, we will adopt the new accounting guidance for deferred acquisition cost on a retrospective basis in the first quarter of 2012. We currently estimate that implementing the change will increase the pre-tax expenses by approximately $3 million to $4 million annually, with accumulated effect adjustment to return earnings of approximately $20 million to $25 million.

It is important to note that our guidance reflects our expectations of annual results. Quarterly results exhibit seasonality and historically have been generally lower in the first two quarters. In addition, quarterly benefit ratios can fluctuate outside of the expected annual range as a result of normal volatility.

In the midst of challenges that persist in the overall economy, we will continue to manage this business with our customary discipline, our superior customer service and our focus on creating long-term shareholder value.

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

Jeff Hallin

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

Question-and-Answer Session

Operator

(Operator Instructions) Thank you. Our first question is coming from Randy Binner of FBR Capital Markets Corporation.

Randy Binner - FBR Capital Markets Corporation

Good morning. Thank you. I just want to isolate the pieces of the change in the available capital in the quarter. So, it went up 20 million and I guess, there is two pieces of the question. One would be from a statutory earnings perspective. What was the statutory earnings in the quarter and how much excess statutory capital was generated there versus how much of that gain of 2011 in available capital came from real estate sales?

Floyd Chadee

Alright, so, Randy, let me walk you through firstly, the rule forward of the capital. We had a couple of large items that affected our capital rule forward in the fourth quarter here. One, we implemented a reinsurance arrangement that freed up about $70 million of capital. This is a normal type of reinsurance arrangement that you see very often among group life insurance that reinsures the tail risk on an aggregate basis. Essentially, that’s what it does. We will have some more details in our K, but that gave us about $70 million of increase in capital. .

The net of the real estate transactions, we had acquisitions and dispositions that gave us about an extra $10 million. So that’s $80 million in increase in capital. We had an hit to capital coming from a change in the discount rate applied to our pension and that pension plan on an after-tax basis that resulted in hit to capital of $40 million and we did our normal accrual of $10 million of the dividend and $10 million of interest payments this quarter, so that they would both add up to $20 million.

If you net all of those items you get the increase in $20 million in available capital for the quarter. As far as that contribution from our statutory entities the earnings in our statutory entity was almost exactly offset came in out in the wash between that earnings, the contribution from that earnings and the increase in required capital. And also we had realist gains in our real estate that was offset by losses on foreclosures. So those numbers net you directly to the $20 million of increase in capital.

Randy Binner - FBR Capital Markets Corporation

Okay. Very good. Just one follow on the reinsurance arrangement, it was tail risk related to interest rate risk.

Floyd Chadee

No, no. This is tail risk is related to our overall benefit ratio?

Randy Binner - FBR Capital Markets Corporation

Okay. So just kind of casualty tail risk?

Floyd Chadee

I am not sure what the…

Randy Binner - FBR Capital Markets Corporation

Underwriting and it is your underwriting.

Floyd Chadee

It is underwriting, absolutely yes.

Randy Binner - FBR Capital Markets Corporation

And then does that, I will look forward to the queue, but the economic impact of that is implicit in the guidance?

Floyd Chadee

Yes absolutely.

Operator

Thank you. Our next question comes from Mark Finkelstein of Evercore Partners

Mark Finkelstein - Evercore Partners

Actually just follow up on the last point. The re-insurance transaction, was that with a third party or was that with a captive or offshore vehicle?

Floyd Chadee

No, it was a third party; an outside company.

Mark Finkelstein - Evercore Partners

Just moving to pricing, I mean you have had the fourth quarter sales and you’ve also seen the first quarter at this day, the largest kind of 1/1 renewals I guess, what has been the average rate increase that you have received and how is that compared to what you’ve been targeting in the high single digits?

Greg Ness

Okay, Jim lets take that.

Jim Harbolt

We’ve been generally pleased with the rate increases that we’ve been seeing. We announced in November ‘10 that we would have low single digit rate increases and then in May, we announced the higher single digits for the incidence. We have been pleased with what we saw in the fourth quarter. We saw some business leave in the fourth quarter that wasn’t making targeted returns. But in general, we had a lot of active account management over the last six months. We met with a lot of our 1/1 renewals where incidents were suggesting double digit increases; we are going to be needed and we are generally pleased with how those have gone forward.

Mark Finkelstein - Evercore Partners

Well then, maybe I’ll ask the question slightly differently. I mean have you been targeting high single digits; if you haven't been getting those high single digits have you generally been letting the account walk or is there some ratio to that high single digits that on average you’ve been achieving?

Jim Harbolt

We don’t have visibility across all 1/1 renewals. We have among the larger ones, but of course the mid-market and the smaller cases are still coming through right now, so I don't have an answer about the whole block. But we have seen some larger increases that we’ve presented to people and if they were extremely price sensitive; we saw some of that business go away.

But I can also tell you where we’ve met with some folks where they were looking at some solid double digit rate increases and we had extremely active account management. We’re often meeting with seasoned HR professionals at those institutions and they see a lot of value in how we take care of their employees and they have decided to take those rate increases and we’ve continued to partnership with them.

Mark Finkelstein - Evercore Partners

And then, you know the first quarter was, when you see some large case business renew, I mean how should we think about the persistency; I know you’ve given the annual number, but I mean just giving us a feel for you know what that would look like first quarter with the large case renewals; that would be helpful?

Jim Harbolt

Well, I think you’re right Mark that we do report persistency annually and for the 1/1 business that will be quite always out there, but I’ll just leave it that we’re generally pleased with the activity that we’ve seen so far.

Mark Finkelstein - Evercore Partners

And then just finally on retirement plans; the AUM is largely flattish after the 11% decline in the third quarter, you know despite equity markets up and clearly not all the assets are equity market related. But, can you just talk about the trends that you are seeing in the retirement plans in terms of case retention and I mean to some degree you know what is the viability of this business at this stage knowing that a lot of changes that are occurring in the retirement plan market generally?

Greg Ness

Alright, Scott you want to take that?

Scott Hibbs

Sure, good morning Mark and first to your first point is a good one, half the member in this business are customer portfolios are generally call it a 60-40 equity fixed income split. So the correlation quarter-to-quarter with the market is perfect. We did see a slightly higher level of attrition in the fourth quarter; I can tell you that was influenced by one large plan that was not meeting our profit expectation. We have also seen this year some what of an uptick in plans that merge or just go out of business, just given the continuing economic struggles.

But, so the bottom line for us for this business is we want to attract and retain you know profitable, sustainable business and our retirement plans business continues to be more profitable and relative to this business, I think despite the conditions and fairly stagnant contributions and participation levels across the industry, we remain bullish and like the business.

Operator

Thank you. Our next question is coming from Chris Giovanni of Goldman Sachs.

Chris Giovanni - Goldman Sachs

Can you talk some about kind of what kind of fall to the rate increases and if there are any kind of further discussions around potential need to take more rate given sort of the still well cluster economy and sort of the expectations that rates stay here for longer?

Greg Ness

Jim?

Jim Harbolt

Good morning Chris. If you believe that interest rates will stay at today’s levels for the long-term then we absolutely need to make an adjustment in our prices. We will make that determination about our interest rate outlook over the next couple of months, but we think that in November of ’10, we made an early pricing adjustment, the low single digits for interest rates, it’s something that’s been on our radar screen and we’re watching very closely and we’ll probably have some information along April or May.

Chris Giovanni - Goldman Sachs

So when you say long-term for kind of the next three years, four years, so that would certainly necessitate further action?

Jim Harbolt

I think, that’s the way to think about that Chris. We try to -- we have allotted two year rate guarantee business and we think about those rate guarantees and then where interest rates are going to be a couple of years down the row.

Chris Giovanni - Goldman Sachs

And then, I guess going back to ’09, you guys did a real good job of taking expenses out of the organization and I think the past couple of years that’s probably been a bit less of an exercise; we wanted to see kind of if we stay here what type of leverage you guys could have from sort of future expense saves?

Greg Ness

Floyd?

Floyd Chadee

Yeah, so as we think of our – for expenses and we look back in 2011 and I feel we had quite a good year in terms of expenses. If you go back to 2010, our overall expenses were about 446. We ended up the year 2011 with about 471. But that includes about $11 million of non-recurring cost related to some – to make all systems and processes more efficient. So if you deduct that, you get, you went from about 446 to 460 which is about a 3% increase.

As we look forward, I mean we tend to think we’ve done a good job of managing expenses. If you see our headcount as on the quarterly statistical supplement, it’s actually below 3,000 at the end of this year. So which is the lowest it’s been in that schedule.

So as we look forward, I mean there will be pressure on expenses, but the pressure has really come not from increasing headcount, but from expenses related to the normal sorts of things you would expect, which would be merit increases for people and expenses related to our benefits. So if you think about our pension plan itself we had a contribution to our pension plan at the end of this year, because of low interest rates, we would expect an increase in the pension cost to be something little bit north of $5 million for the next year.

Chris Giovanni - Goldman Sachs

And then lastly Greg just for you, you know, there was sort of an increased discussion around moving from an annual dividend to a quarterly dividend. You know, probably in the industry and we saw a principal announced something yesterday, you know to that tune; so wanted to see kind of your thoughts, the Board’s thoughts around potentially changing the payout structure of the dividend?

Greg Ness

Chris, it’s fair to say that there are not current discussions underway relative to changing the dividend. You might know that many, many years ago when we became a public company, we were at a quarterly dividend. We ultimately decided to move that to an annual dividend, we think that’s far more cost effective for our shareholders and no plans to change it today.

Operator

Thank you. Our next question is coming from Steven Schwartz of Raymond James & Associates.

Steven Schwartz - Raymond James & Associates

I wanted to discuss the refunds; experience rated refunds did changed in the quarter, obviously year-over-year and even sequentially? And then get a sense of what you were assuming in your premium guidance for refunds?

Greg Ness

Okay. So Dan, you want to talk about ERRs?

Dan McMillan

Steven hello; the ERRs or Experience Rated Refunds is something as you noted jumps around each quarter and this is something that we saw a positive configuration premium in the quarter and I think that happened one time in 2010 as well but often as a negative contribution. This is as you know a tool that we like and we think we’re experts in terms of both designing and administering this for a portion of our block; and its less than a quarter of our business, about a quarter; but that tool was something we think is key in terms of retention and expertise for our industry. The guidance we gave around premium growth assumes historical levels of ERRs and is included in that assumption.

Steven Schwartz - Raymond James & Associates

Is that appropriate to look at I guess for this quarter, when you talk about the slight improvement in the claims incidence; so is it appropriate to look at the loss ratio ex the refunds; is that where we should we think about that?

Dan McMillan

Yeah, I wouldn’t take that out Steven. You saw a quarterly improvement in incidents throughout the year and then that occurred again in this quarter. But, because it’s always included in there and in store, I think we just leave it in.

Steven Schwartz - Raymond James & Associates

Okay. And then on to a different subject just some accounting for it, maybe on the asset management side, did the hedging of the index annuities contribute or take away from earnings at all?

Floyd Chadee

Yeah, it was virtually nothing this particular quarter.

Operator

Our next question is coming from John Nadel of Sterne Agee.

John Nadel - Sterne Agee

A couple of questions for you. So I am looking at the group benefit ratio and I am trying to connect the dots on some of your commentary on the pricing and economic employment improvement, that sort of thing and interest rates. So for the full-year 2011, it looks like the group benefit ratio was about 83% and if the midpoint of your long-term guidance I believe is 76%.

So I sort of wanted to focus on the delta between the two and get a sense from you. If we thought about continued high-single digit sort of rate increases you know and yet the pressure from employment and wage conditions and low or sustained low interest rates, I just want to get a sense for how much of that delta can be achieved in terms of improvement from pricing versus how much of that delta, we need to see rates and new money yields or rates go up and employment and wage conditions improve.

Jim Harbolt

John, we've said from the time we announced the single digit, higher single-digit price increases last May that returning to longer-term benefit ratio guidance we would need to see some improvement in the economy as long as we see the connection or correlation between job loss and the benefit ratio or incidence and so while we've seen some improvement in incidence and its tracking was sort of the course that we said. We said it would take a while and at the same time, the bulk of the change in the benefit ratio was going to be attributed to our pricing increases and the pricing increases continue to flow along the course that we set last May.

Dan McMillan

Yeah, John I would only add to that that when you think about the general economy and job loss and job growth, we are not assuming a dramatic turnaround in the economic environment here. This is really just a stabilization of job losses and as Greg mentioned in his opening remarks that we have seen some negative number there in the quarter and we expect that to moderate some in the coming year.

John Nadel - Sterne Agee

Okay, so I guess I was hoping for a little bit more detail. Is it fair to say, maybe I’ll ask it this way. Is it fair to say that over the next couple of years, let’s assume the pricing increases fully worked their way into the book of business, at least that piece of the book of business that you are willing to retain.

Dan McMillan

Right.

John Nadel - Sterne Agee

Is it fair to say that the high end of that longer-term range is achievable and then getting further improvement is more economic conditions based?

Greg Ness

I don’t know that I would make that assumption that you are saying. I think that you are looking out a little bit too far. As we say, we’ve guided the benefit ratio in the 80% to 82% range for this particular year that reflects a little better incidence this year we expect over last year based upon some slight improvements that we’ve begun to see over the year.

But to assume that we would immediately move back to the 74% to 78% range in some period of time in this low interest rate environment and with this volatility in the economy would probably be inappropriate.

John Nadel - Sterne Agee

Yeah, I understand. I am not trying to say immediate. I understand it’s a longer-term process. The question for Floyd on the guidance range, is it fair for us to assume, I think the commentary mentioned that sustained low rates could push the discount rate lower by 25 to 50 bips, is that encompassed in the range?

Floyd Chadee

Yeah I would say, yes. To some extent, I mean there are many things that would affect your 360 to 390 range, certainly interest rate environment. But the mover of that would be where the benefit ratio actually comes out, the impact of old pricing action changes the overall economy. Again, to Dan’s point, not an improvement in the level of employment, but a tapering of the lay-offs. But also included in this range is an assumption if we see benefit incidence levels remaining high, we would anticipate pricing actively towards that. If interest rates drop off towards the low end of our already low expectation, then you would expect that we would actively manage the business around that. So, that range encompasses many of those variables.

John Nadel - Sterne Agee

And then just a question on the new money rate. I think you said 5.13%. So down, if I think about it quarter-over-quarter, down about 50 basis points, quarter-over-quarter at least from what I had from your third quarter? I guess, I am curious as to how much of that 50 basis points reduction is a matter of truly lower credit spreads available to you versus how much of that is increased allocation of new investments to the more tax advantaged asset classes where the offsets clearly come in through the tax line?

Floyd Chadee

Yes, I would say, as you move from the third quarter to the fourth quarter here, there was contribution in all fronts. On the bond side, we saw yields go down. On the mortgage side, we saw yields go down. And also, even on the low income housing tax credits that we allocated this quarter also we saw the yields go down.

Now, that’s the market that we said, that was disrupted for a while and it is coming back into place. So the yields on that, certainly we would expect dropping off fast than the overall yields and the dropoff in the overall yields, but dropping off from a pretty high level.

John Nadel - Sterne Agee

Understood and then a just quick one on commercial mortgage loans. On the loans originated in the quarter, how would the spread over comparable treasuries compare, let’s say in 4Q originations versus 3Q. Does that spread come in?

Scott Hibbs

We’ve seen a little more pressure on spreads, but they still remain very strong relative to historical standards, 300 plus over comparable treasury. So, looking in the fourth quarter, we’re still getting good volume, but we do continue to see lenders coming back to the market place. So, there would be some reasonable expectation of pressure on spreads as we move through this year.

John Nadel - Sterne Agee

And is that pressure on spreads, is that something that’s baked into your guidance as well?

Scott Hibbs

Yes it is.

Operator

Our next question is coming from Ryan Krueger of Dowling & Partners.

Ryan Krueger - Dowling & Partners

Just given your earnings guidance and flat premium expectation, can you give an updated range around free cash flow generations for next year, I know it used to be in 70 to 120 range, but the returns have also declined from previous periods, so looking for an update there?

Floyd Chadee

Yes so I am not sure, we haven’t given though the details in that. I mean you can see that the free cash flow generation this year was not quite as healthy as it’s been in the past, given though our high benefit ratio. For example, in this fourth quarter, with the benefit ratio that we had and also the good persistency that we had in terms of premium retention, we did not generate any free cash flow from the statutory entity because the earnings actually were taken up by the increase in required capital. So it will depend very much on where that benefit ratio hits next year and we have given a range to what the high end of that range you would expect the free cash flow to be relatively low next year.

Ryan Krueger - Dowling & Partners

Okay you said towards the high end of your guidance and you’d expect relatively low free cash flow?

Floyd Chadee

That’s correct, yes.

Ryan Krueger - Dowling & Partners

Okay and then just a follow up on the discount rate adjustment to the pension plan. If rates remained here for another year, would you anticipate another adjustment next year or is it now fully captured?

Floyd Chadee

Well I think, you might expect another adjustment, but probably not of this magnitude. Now it depends very much on what we have, half of our assets are invested in equities. So it would also depend very much on the performance of the equity markets in the coming year.

Operator

Our next question is coming from Dustin Brumbaugh of E.K. Riley Investments.

Dustin Brumbaugh - E.K. Riley Investments

So one thing that I am still having a hard time squaring is the flat premium growth expectation for next year, given the commentary around price increases going relatively well, persistency holding off one-one renewal. I am having a hard time squaring that with kind of the stabilizing employment growth, wage growth picture and how we get the flat premium growth year-over-year. Can you help us think about the puts and takes there?

Jim Harbolt

So Dustin when we look at premium guidance there's probably a good four or five components that go into that recipe and one of those is certainly persistency, which you talked about and we've given just a little color on that one. Then you have sales and then we have the organic growth. And when we talk about organic growth we look at really three components, we look at ageing, we look at the job growth and we look at wage growth. And certainly when we talk about job loss stabilization or stabilizing that, may still have a negative sign in it and that's a pretty substantial factor when we calculate into a flat premium growth guidance.

Dustin Brumbaugh - E.K. Riley Investments

Okay. So it is really in your expectations for the job and wage growth component of organic. That's where the main negative is against price increases, strong persistency, sales have been running okay, I mean that's, and is that specific, can you talk maybe a little bit how that might be specific to your book in its concentration, in kind of the public side of things as opposed to the overall job market?

Jim Harbolt

Yes. One of the things I need to be careful of we are not going to try to get around any one-one sales predictions, which we will cover in our April call but during the last two years we've seen some good traction on the private side. You are right it seems that the recovery seems to be lagging right now in the public and education side and the private side seems to see a little more job growth. That certainly is playing out in our book.

Greg Ness

Dustin, I think just one of the keys there is that we don’t necessarily to need to see organic job growth on those sides, what we need to see the stabilization as Jim and Dan mentioned earlier, our book of business has about minus 2% or so lives covered number which means its shrinking a little bit in some respect. What we need is for that to stop and then we would be probably looking at premium guidance in maybe a little bit different light.

Dustin Brumbaugh - E.K. Riley Investments

Okay, thanks. And then just on the REO sales in the quarter, would you give me the details on that? What’s the number of profits sold, the book value and then kind of the realized sales number in terms of what your loss on that book value was on those sales?

Scott Hibbs

Sure. Let me kind of give you an overview and then Floyd can fill a number if anything. As reported on the last call in October we sold substantially all of our remaining single borrower properties in Florida. So that’s was the largest sales of the quarter. We also had a dozen or so our REO properties in addition to that and a couple of investments property and that’s an active program that will continue in to 2012. So as Floyd said we had gained about $7 million on real estate sales in the quarter. On the foreclosure side we had some losses on the foreclosures, you can see that number in the statistical supplement and that offset some of that gain.

Floyd Chadee

Yes. So the numbers balance of fairly easily on the balance sheet you can see our real estate went down from about 104 to 92 we did about $30 million of dispositions, 25 of which would have represented REOs and but we also did acquisitions, mortgages into REOs of about $20 million.

Dustin Brumbaugh - E.K. Riley Investments

I guess what I am trying to get out is what was your average haircut on the REO sales that you have in the quarter relatively to book value?

Floyd Chadee

We have not had material gains or losses on those REO sales. Our track record here is, once we settles a foreclosures and mark them to current market value. We have had in aggregate no significant gains or losses on sale.

Operator

Thank you. Our next question is coming from Bill Dezellem of Tieton Capital Management.

Bill Dezellem -Tieton Capital Management

Good morning. Thank you for taking the question. A couple of them here, first of all the 60-day delinquency being down at 0.34%. As you noted it is the best in several quarters. Would you please describe the implications of this and are we potentially now really seeing a leading indicator for some of these problems going away or do you just consider this a one quarter phenomena and don’t get carried away yet?

Scott Hibbs

Yeah Bill, this is Scott. We are obviously very pleased with the delinquency rate for the quarter. Floyd mentioned lowest in a couple of years, I am not prepared to call that a trend but I can tell you that our forward-looking indicators at the end of the year, 30 day delinquencies, are a quest for forbearance, demand letters, did improve modestly. So while we are still cautious we do see some evidence of improving market conditions, vacancy levels, rents, and etcetera. So they are still at elevated levels in terms of the forward- looking indicators but some slow improvement.

Bill Dezellem -Tieton Capital Management

And secondarily, have you commented specifically on claims activity relative to the prior quarters and if not, would you please describe that in some detail? I am not talking about the benefit ratio. I am trying to exclude the premium component of this. So, just the claims activity itself.

Dan McMillan

Sure, Bill. Overall, we saw and you really get at the core fundamental measure around some of our products and the one that we talked about a lot historically this year, particularly in the first and second quarter, was an increase in health claims incidents. In the fourth quarter, we saw our lowest level of healthy claims incidents for the year. And while still elevated overall, relative to historical norms and pre-recession level, it didn’t experience gradual improvement each quarter throughout the year leading up to the final one. Life results return relatively to normal. That’s reflected in the benefit ratio of that you’ve already seen compared to a sequential quarter. Last quarter where we had some better than expected results in Life.

Operator

Thank you. Our next question coming from Tom Gallagher of Credit Suisse.

Tom Gallagher - Credit Suisse

Firstly I just want to come back to a comment that was made a little earlier that if interest rates remain low for beyond a few years, you would likely need to adjust pricing. Can you just comment on what kind of order of magnitude we’re talking about. And I guess, another way of asking the question would be, if rates do stay low for four to five years, lets say just to pick a point, what kind of pricing would you need to get to hit your hurdle returns. That’s my first question and I have a follow up?

Jim Harbolt

I will take the first part of that one. We won’t get into specific numbers right now. I will tell you that when we took our action in November of 2010, those were in the order of low single digits when we took an interest rate action and I think that is probably the general ballpark we have been thinking about this time.

Tom Gallagher - Credit Suisse

Got it. So even multiyear low rates we’re not looking high single-digits. Double-digit type rate necessity?

Jim Harbolt

Probably not solely for interest rate exposure there, Tom. Of course a week after when we’re new pricing, we are taking account the composition of the book, our interest rate forecasts, what we are seeing in terms of claims trends; a number of different factors could be part of that rate increase but if you isolate it solely to our interest rate exposure it is probably low, mid, single-digit range.

Tom Gallagher - Credit Suisse

Okay. And then a question for Floyd, the 80 to 82 benefit ratio guidance, does that include the lowering of the discount rate? The way I read it is that you need to factor that in separately in terms of the 25 to 50 basis point the potential impact on earnings or is that already embedded in this 80 to 82?

Floyd Chadee

That would be inclusive of uncertainty around the discount rate also. So that range encompasses that. And it encompasses the changes in the underwriting levels too. But also you have to remember the way the way it affects the earnings is the management action around that too. So we will it tie to together that way.

Tom Gallagher - Credit Suisse

Got it, Floyd. So if I look at the just below 82% ratio from this quarter and then I factor in the benefit of the re-rates which looks like that’s about 3% on the whole block, just using high single digits on about a third of the block. And then factoring in the additional headwind of the interest rate or rather the discount rate adjustment, it looks like you are assuming an improvement in claim trends then. This isn't just the re-rate benefit; you are also assuming some level of improvement in either incidents or recoveries; is that a fair assessment?

Floyd Chadee

Yeah, so a couple of things with the methodology just described, as Jim, so first of all to confirm as Jim mentioned earlier, we are assuming some improvement in the overall level of incidents driven by the external economy. Now, it’s important to note, that’s not assuming that unemployment, the level of employment is going to improve. That's assuming that the rate of layoffs would take-off. The issue with your methodology is, I don’t think it factors in clearly enough the seasonality of our business. So if you start with a benefit ratio in the fourth quarter, you might be missing some of the seasonality.

Tom Gallagher - Credit Suisse

So 4Q has somewhat higher seasonal claims, is that what I need to normalize a bit?

Floyd Chadee

Yeah, it tends to be a higher benefit ratio in the first quarter and the second quarter as we mentioned earlier.

Tom Gallagher - Credit Suisse

So I am just trying to get a sense for apples-to-apples; so I guess my question is, is there a higher seasonality component this quarter. It doesn't sound like it then?

Floyd Chadee

You can take any one quarter, I mean if you take any one quarter in isolation, you might be missing some of the seasonality. So I would start with the full year and try to project that forward.

Operator

Thank you. Our next question is coming from Randy Binner of FBR Capital Markets Corporation.

Randy Binner - FBR Capital Markets Corporation

Hey, thanks for taking the follow-up. So I just want to follow up on mine, and I think it was Ryan Krueger’s question around free cash flow generation, just to make sure how you got it isolated. So first would, when he had asked about the range that historically you had given the ranges I think 70 million to 120 million of net capital generation annually, did you say that you would come in near the lower end of the range or you would just be lower kind of near zero in general looking at 2012?

Floyd Chadee

So basically, if you look at our benefit ratio this particular quarter, our employee benefit ratio was 82.8 this particular quarter. And with that benefit ratio we did not generate any free cash flow from the statutory entity; with that benefit ratio combined with the good persistency that we had in our business that true-up required capital.

Randy Binner - FBR Capital Markets Corporation

That was the follow-up I had, so the 45 million of statutory income that got even if you will or put in the required capital, that was really a function of persistency in growth of the book of business so what have in other area. So on a go-forward basis assuming that your premium growth is lower with increased pricing then we would assume that every quarter you would not necessarily see that – I guess to put a final point on it, and I am trying to understand how much excess capital generation you are assuming to fund the buyback, the 40 million to 80 million of buybacks?

Floyd Chadee

Well, I think the one thing to note is that with the level of capital, we have right now we don’t have to assume any further capital generation in order to fund that level of buybacks. So anything that we get in excess of that would be available for buybacks.

Randy Binner - FBR Capital Markets Corporation

So are you saying then that you will be willing to buyback stocks even if you are not generating capital on a go forward basis?

Floyd Chadee

So, the thing that would drive that decision would be -- we look at the overall economy; if the economy seems to be improving and there is less uncertainty out there, that drives us towards more share repurchases. So exclusive of our benefit ratio, we look outside the – the outside environment too. There was a time when we held $100 million of excess capital, now we come comfortably in excess of that.

Randy Binner - FBR Capital Markets Corporation

And 300, is that still your RBC bogie and you don’t see that changing going forward?

Floyd Chadee

Yeah, so the 300 is what we look at as our bogie, but you can see we have been comfortably in excess of that for quite a while. So at the end of the fourth quarter we were at [327%].

Operator

Thank you. Our next question is coming from Mark Finkelstein of Evercore Partners.

Mark Finkelstein - Evercore Partners

Thanks for the follow-up. Just a couple of questions; one, sorry if you just already, but what accounted for the staff surplus decline sequentially of $60 million?

Floyd Chadee

Let me pass that question Mark to our Financial Controller, Rob Erickson.

Rob Erickson

Hello Mark, this is Rob. There are two primary items which came up in Floyd’s discussion of the capital roll forward. Of course, we had the, little over $40 million of statutory earnings. But offsetting those two items were the pension funding of approximately $58 million and then we also had dividends between the statutory entity and the holding company which took away another $30 million.

Mark Finkelstein - Evercore Partners

And then on the tax advantage investment, I think the impact for you is certainly higher than may be what of us are seeing for some other companies. And I am just curious, you know, how do you think about that from a risk aggregation standpoint; are you bumping up against any concentration limits, is there continued supply of these in the market enough; can you just expand on that whole?

Rob Erickson

Sure. Yes, we think the continued supply is going to dry-up overtime here. This was a disrupted market and therefore you got product at very, very high rates. And from a concentration point of view, I mean this is tiny in total this year; you can see, you know, our total amount that we’ve invested and this is on the order of about $130 million so far. So it’s tiny in our overall asset.

Operator

Thank you. Our next question is coming from John Nadel of Sterne Agee.

John Nadel - Sterne Agee

Hi, just a couple of quick follow-ups. So, just following it up on the statutory surplus, so if the RBC was, I think the RBC is flat versus last quarter. I think you guys have estimated about 327 as well. So is that surplus declined quarter-over-quarter, how did the risk-based capital ratio remained unchanged then?

Rob Erickson

John, this is Rob again. So I think it’s one important to separate risk-based capital to a degree from statutory capital and surplus. And you’ll remember, the reinsurance arrangement that Floyd spoke about in the roll forward that’s really what’s the balance is hiding there.

John Nadel - Sterne Agee

And then it’s a good segway too, because that was my other follow-up was just on the reinsurance transaction. You know, I understand you’ll have something in your K that talks about this maybe in a little bit more depth, but can you give us a sense for how to think about what that discrete transaction does to you know to premiums and what it does to -- I assume there is some cost to this transaction. So what impact is it having on earnings and I guess you know for how long is this a permanent transaction or is it something that would have to be renewed at some point in time?

Rob Erickson

It’s a multi-year transaction and its cost is modest so with $70 million or so of increase in the available capital, we pay about a million dollars a year in terms of the fees. It’s virtually transparent in the GAAP basis, it flows -- it doesn’t affect the other elements of the income statement on a GAAP basis.

John Nadel - Sterne Agee

So it’s essentially just $1 million increased cost and everything else stays the same?

Rob Erickson

Pretty much, yes; on a GAAP basis, yes.

John Nadel - Sterne Agee

And then last one for Greg, the bigger picture, you know one of your bigger may be one of your bigger competitors at the smaller end of the market, Delphi was you know agreed to sell themselves last month; just wanted to get a sense from you, you know whether you felt like the Tokio Marine transaction with Delphi was something that you guys have taken a look at as well or is that in your view a discrete sort of one-off transaction and how does the M&A environment look; has that elevated perhaps the interest levels in your type of business?

Greg Ness

John, I certainly can speak in detail to that particular transaction, but my sense is that’s more of a kind of discrete one-off kind of a deal. I would say that the M&A environment as a whole is relatively unchanged. We’re not seeing significant amount of activity or noise relative to potential acquisitions at all at this stage.

Operator

Thank you. At this time, I would like to hand the floor back over to Mr. Jeff Hallin for any closing remarks.

Jeff Hallin

Hey, I am going to pass it over to Greg for a few closing remarks.

Greg Ness

Thanks Jeff. As we close our call today, I would like to leave you with just a few thoughts. At StanCorp, I am convinced we are focusing on the right things and certainly taking care of the fundamentals. Our balance sheet is strong. Our Insurance Services segment is generating profitable sales and our persistency is excellent. Our Asset Management segment has steadily increased its contribution or bottom-line and we are committed to delivering superior returns to our shareholders.

As we move into 2012, there will continue to be challenges along the way, but we are very well positioned for the future. We remain dedicated to disciplined pricing while providing the products and services our customers find valuable and they rely upon each and every day. Thanks for joining us for this call. Have a great day.

Jeff 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 February 10th. To listen to this call, you can dial 877-660-6853 and enter the Account Number 286 and Conference ID Number 385517. A replay of today’s webcast will also be available at www.stancorpfinancial.com. Thank you.

Operator

Thank you. You may disconnect your lines at this time. Thank you all for your participation.

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