Unum Group (NYSE:UNM)
Q4 2015 Earnings Conference Call
February 03, 2016, 9:00 AM ET
Thomas White - Senior Vice President, Investor Relations
Richard McKenney - President and Chief Executive Officer
Jack McGarry - Executive Vice President and Chief Financial Officer
Michael Simonds - President and Chief Executive Officer, Unum U.S.
Peter O'Donnell - President and Chief Executive Officer, Unum U.K.
Timothy Arnold - President and Chief Executive Officer, Colonial Life
Ryan Krueger - KBW
John Nadel - Piper Jaffray
Jimmy Bhullar - JPMorgan
Randy Binner - FBR
Erik Bass - Citigroup
Humphrey Lee - Dowling & Partners
Michael Kovac - Goldman Sachs
Eric Berg - RBC Capital Markets
Steven Schwartz - Raymond James
Suneet Kamath - UBS
Tom Gallagher - Credit Suisse
Seth Weiss - Bank of America
Good day, and welcome to the Unum Group fourth quarter 2015 earnings results conference. Today's conference is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to the Senior Vice President of Investor Relations, Mr. Tom White. Please go ahead, sir.
Great. Thank you, Cynthia. Good morning, everyone, and welcome to the fourth quarter 2015 earnings conference call for Unum. Our remarks today will include forward-looking statements, which are statements that are not of current or historical fact. As a result, actual results might differ materially from these results suggested by these forward-looking statements.
Information concerning factors that could cause results to differ appears in our filings with the Securities and Exchange Commission and are also located in the sections titled cautionary statement regarding forward-looking statements and risk factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, and our subsequently filed Quarterly Reports on Form 10-Q. Our SEC filings can be found in the Investors section of our website at www.unum.com.
I remind you that the statements in today's call speak only as of the date they are made and we undertake no obligation to publicly update or revise any forward-looking statements. As we discuss our financial results this quarter, I'll remind you that our prior period results have been adjusted for our retrospective adoption of the accounting standards, update for tax credit partnership investments and qualified affordable housing projects. Adjusted prior period results are available on our website in a supplemental exhibit. A presentation of the most directly comparable GAAP measures and reconciliations of any non-GAAP financial measures included in today's presentation can be found in our statistical supplement on our website also in the Investor section.
So participating in this morning's conference call are Unum's President and CEO, Rick McKenney; CFO, Jack McGarry; as well as the CEOs of our core business segments, Mike Simonds for Unum U.S.; Peter O'Donnell for Unum U.K.; and Tim Arnold for Colonial Life. And with that I'll turn the call over to Rick.
Great. Thank you, Tom, and good morning, everybody. Thanks for joining us today. We finished 2015 on a strong note, with fourth quarter operating income at $0.95 per share. That's an increase of 6.7% over last year, brining the full year EPS to $3.64, which is an increase of 3.7%. We ended the year in the middle of our outlook range of 2% to 5%, which we were tracking to all year.
I'm especially pleased with the balance performance we continue to show on our core business segments, with good levels of premium growth complemented by stable benefits experienced across all lines. This combination helps to drive strong profit margins and excellent capital generation for the company.
Our financial flexibility continues to be an important asset to us, as we move into 2016, as we look to take advantage of the opportunities for profitable growth and to expand our leadership positions in the employee and voluntary benefits markets. I'll cover a few highlights for the fourth quarter, and then Jack will provide an analysis of our results in greater detail.
I'll start with premium growth in our core business segments, which continues at a healthy and well-balanced pace. For the fourth quarter, premiums in each of our three core segments, Unum U.S., Unum U.K. and Colonial Life all increased by more than 5%.
For Unum U.S. fourth quarter's sales had a difficult comparison given the 25% jump we saw in the year-ago fourth quarter. But for the full year 2015, we generated an increase of just over 4%, at the top end of our expectations coming into 2015. In addition, Unum U.S. persistency trends remains favorable and our ongoing focus on renewals help drive the 5.5% increase in premium income.
Unum U.K. sales in local currency improved in the fourth quarter, with growth of 11%, driven largely by strong results in the core market long-term disability sales and large case group life sales. Combined with improving persistency and the benefit of a recently acquired dental business, Unum U.K. generated 5% growth in premiums in the fourth quarter as well.
Finally, at Colonial Life, sales growth continues to be quite encouraging, increasing 5% for the fourth quarter and almost 7% for the full year, helping to generate premium growth of just over 5% for the quarter.
Next, it's important that we have not sacrificed the profitability of our core businesses to generate this premium growth, as our benefits experiences remain stable across all three business segments. In fact, the benefit ratios for the three core business segments improved for the full year 2015 relative to 2014. Jack will provide additional detail on these trends in his commentary.
Given these operating results, we continue to produce a very strong level of capital, which provides us substantial financial flexibility. This flexibility allows us to fund the capital required to grow our business, while also returning capital to shareholders through share repurchases and dividends, as we bought back $427 million of stock in 2015.
In addition, we have continued to grow our book value per share, with book value now at $35.90, an increase of 8.4% for the year, consistent with the growth we have generated since 2008.
And finally, the macro-environment, including the ongoing low interest rate environment, continues to present challenges. Interest rates and investments spreads remain below historical levels and below our portfolio yields. Our focus remains on actively managing through this environment by steadily talking pricing actions, but in the near-term, it does continue to dampen our profit growth.
So with these highlights on our fourth quarter performance, I'll have Jack cover our results in greater detail. Jack?
Thank you, Rick, and good morning, everyone. Rick provided a high-level overview of our fourth quarter results, and now I want to provide a more in-depth view of the operating and business trends we saw in the quarter.
I'll being with Unum U.S., where fourth quarter operating income was $214.2 million, an increase of 2.2% from the year-ago quarter of $209.5 million. Premium income growth remains very healthy, increasing 5.5% over the year-ago quarter, while the benefit ratio for Unum U.S. segment improved slightly to 71.1% in the quarter compared to 71.3% in the year-ago quarter.
The profitability of Unum U.S. remained strong with an operating ROE of 13.1% for the fourth quarter and 13.3% for the full year. Within the Unum U.S. segment, operating income in our group disability business was $66.1 million, an increase of 0.3% from the year-ago quarter of $65.9 million.
Premium income increased 5.5% over the year-ago quarter, but we continue to see pressure on net investment income, which declined by 5.7% compared to the year-ago quarter, driven by lower asset levels, lower portfolio yields and lower miscellaneous investment income.
Benefits experience improved in the fourth quarter relative to the year-ago quarter. The benefit ratio was 81.7% for the fourth quarter compared to 83.7% a year ago, driven primarily by lower claims incidents rates and favorable claim recovery experience in our group long-term disability product line, as well as favorable benefits experience in our group short-term disability line.
Group Life and AD&D operating income was $54.3 million for the fourth quarter, a decline of 8.4% from the year-ago quarter. Premium income continues to grow at a favorable levels, increasing 5.2% over the year-ago quarter.
The benefit ratio was 72% for the fourth quarter compared to 70.8% in the year-ago quarter due to a higher average paid claim size for the group life line in the AD&D line of business. While, the benefit ratio was higher on a year-over-year basis, the portfolio experience was generally consistent with the 71.8% benefit ratio for the full year 2015.
Operating income in the supplemental and voluntary lines was very strong at $93.8 million in the fourth quarter, an increase of 11.3% compared to $84.3 million in the year ago quarter. Premium income growth trends were also strong for this line of business, increasing 5.7% in the quarter compared to last year.
From the benefits perspective, results were in line with our expectations. The fourth quarter benefit ratio for the individual disability line was 33.8% on an interest adjusted basis and 48% for the voluntary benefits lines.
Looking at Unum U.K., operating income was £24.4 million for the fourth quarter, an increase of 1.2% over the year-ago quarter of £24.1 million. The benefit ratio was 69.9% for the fourth quarter compared to 68.8% in the year-ago quarter, driven primarily by higher interest claim incidence trends in the group long-term disability and group life lines of business, which were partially offset by improved claim recoveries. Overall profitability of the U.K. segment remains quite favorable with an operating ROE at 20.6% for the fourth quarter and 18% for the full year.
Colonial Life continues to generate strong consistent results with operating income of $77.6 million, a 4.9% increase over the year-ago quarter of $74 million. The benefit ratio improved to 51.2% for the fourth quarter compared to 52.3% for the year-ago quarter, driven by favorable benefits experienced in the accident, sickness and disability product line. Margins remain strong for Colonial Life with an operating ROE at 16.4% this quarter and 16.6% for the full year.
Finally, for the Closed Block, operating income was $28.1 million in the fourth quarter compared to $29.4 million in the year-ago quarter, excluding the 2014 long-term care reserved charge. The benefits experienced for the individual disability line was in line with our expectations.
The increase in the interest adjusted loss ratio to 87.2% in the fourth quarter compared to 81% in the year-ago quarter, was largely driven by a reduction in the reserve discount rate to recognize the impact on future portfolio yields from the higher than normal level of miscellaneous net investment income. For the long-term care line, the interest adjusted loss ratio was 89.7% for the fourth quarter compared to 89.6% for the year-ago quarter, excluding the reserve charge.
The underlying risk experience for long-term care was consistent with our long-term expectations for the full year 2015 interest adjusted loss ratio of 87.6% within our expected range of 85% to 90%.
Regarding, the reserve position for long-term care, we feel good about where we finished 2015 in terms of reserved adequacy. For the year, our new money yields exceeded our interest rate assumptions and risk results remained within our long-term expectations. In addition, rate increase approvals and implementation are tracking in line with our reserve assumptions.
One additional comment on long-term care, the cash flow testing reserve addition we recorded for our New York subsidiary First Unum was $68 million at yearend 2015.
I'll now move to the growth trends we experienced across the company in the quarter. Again, starting with Unum U.S. total sales declined by 3.7% for the fourth quarter compared to a year ago. This was not unexpected, as we had very strong sales results from the year-ago fourth quarter and we continue to increase rates during the year. For the full year, Unum U.S. sales increased by 4.2%, which was solidly above the top end of our expectation of 2% to 4% growth.
Looking at the sales results by product line, LTD sales were flat in the fourth quarter, but increased 7.2% for the full year. STD sales declined by 20% for the fourth quarter, but grew slightly for the full year increasing 5.8%.
Our Group Life and AD&D sales declined 2.5% for the quarter and 5.6% for the full year. Also, within Unum U.S. we had strong sales results in individual disability for the fourth quarter, increasing 30.4% to $21 million, driven by success with large case enrollments. Full year sales growth for the individual disability line was 18.8%.
Finally, in the voluntary benefits product line, total sales declined 7.4% for the fourth quarter. Core market voluntary benefit sales showed very good growth, while large case sales were lower, against a very strong large case quarter last year. Full year 2015 sales and voluntary benefits increased 10.3% with good balance between the core market and large case sales.
Our sales outlook for 2016 for Unum U.S. calls for growth rate in 2% to 4% range again. It's likely that we'll see quarterly volatility, as we did in 2015, particularly given the volatility of timing of large case sales.
Persistency for Unum U.S. continues at healthy levels. For the group lines combined, persistency was 90.3% for the full year 2015, which was stable with the 90.5% for 2014. Given these sales trends and persistency levels, along with the underlying management of in-force renewals, we generated premium income growth for Unum U.S. this quarter of 5.5%. Full year premium growth was 6.4%, consistent with our long-term outlook for this segment and our strongest rate of growth in many years.
Sales in Unum U.K. rebounded nicely in the fourth quarter, increasing 11.2% in local currency with favorable trends in the core market group long-term disability product line and in group life. For the full year, sales grew by 6.2%. Persistency in the group disability line was 89.2% for the full year of 2015, up slightly from 2014 levels, but in line with our expectations.
Persistency for the group life line continues to recover at 80% for full year 2015, up from 76% in 2014. Premium income growth for the U.K. this quarter was 5.4% in local currency, including the impact of the acquisition of the dental business in the third quarter and 2.3% for full year, above our expectations of 0% to 2% growth.
Finally, Colonial Life sales remain on a positive trend, increasing 5.1% for the fourth quarter and 6.9% for the full year. Growth this quarter was again well-balanced between the commercial market sector, both the core market sales and large case sales and the public sector. In addition, each product line showed positive year-over-year growth.
Persistency for Colonial Life was slightly lower for the year at 78.5% compared to 79.4% for 2014, but premium growth continues to show good momentum, increasing 5.1% in the fourth quarter compared to year-ago quarter. Full year premium growth was also 5.1%, well above the top end of our expectation of 2% to 4% growth. Overall, we remain very pleased with the growth trends we see in our core business segments, as well as the profit margins we're maintaining.
Looking now at investment results, new money yields were slightly better in the fourth quarter compared to the first nine months of 2015. However, to date, new money yields remain below our current portfolio yields, so the downward pressure on our portfolio yields and net investment income continues to impact our profitability. We're actively raising prices in our markets to help manage this impact.
The credit quality of our investment portfolio remains in very good shape. Our overall default experience relative to the Moody's index was again very favorable at 15 basis points for full year 2015 compared to 80 basis points for the index.
I'd like to give you an update on our energy-related holdings, which totaled $5 billion or 11.6% of our total fixed maturity securities at yearend 2015. The severe widening of credit spreads in the energy sector during the fourth quarter reduced the net unrealized gain from $302.8 million, as of September 30, 2015, to a net unrealized loss of $51.4 million at December 31, 2015.
We saw relatively more spread widening in the oilfield services and independent oil and gas sectors of our portfolio. As we discussed with you on our Outlook Meeting at December, these sectors tend to be the most sensitive companies to oil prices. The sectors represent 4% and 29.8% of our energy holdings, respectively, and had a net unrealized loss of $114.9 million as of yearend.
The remaining two-thirds of our energy holdings are in midstream companies, integrated oil companies and refiners. These holdings are much less sensitive to oil prices and have a net unrealized gain of $63.5 million at yearend.
Our exposure to below investment grade energy credits declined slightly in the quarter to 14.1% of the energy holdings compared to 14.8% at the end of the third quarter. Approximately three quarters of the below-investment grade exposure is in the more highly rated BB category. Realized losses in energy holdings from both losses on sales and from impairments were $20.1 million pre-tax for the fourth quarter.
We have thoroughly reviewed our energy holdings and looked at a number of stressed scenarios. While downgrades of holdings and some impairments may happen over time, we feel the impacts are very manageable and do not alter our financial or capital plans.
Moving to capital management, we continue to see very favorable trends. We repurchased $100 million of our stock this quarter, bringing the total repurchases to $427 million in full year 2015, which is approximately 4.9% of our yearend 2014 outstanding shares. We estimate, we closed the year with a weighted average risk-based capital ratio for our traditional U.S. life insurance companies at approximately 400% consistent with the levels we've held throughout the year, and towards the higher end our expected range for the year.
Holding company cash and marketable securities was $475 million at yearend and statutory operating earnings were $182.4 million for the fourth quarter and $689.2 million for full year 2015, a strong sales level of earnings in an 11.5% increase over 2014.
Finally, I'll note our tax rate in the fourth quarter of 28.5% was favorable relative to the 30.9% rate that we've recorded for the first three quarters of the year. This was primarily driven by a reduction in deferred tax liability related to our U.K. operations, as a result of the enactment of future reductions in the U.K. tax rate. And also the benefit of the extension of active financing in the fourth quarter that reverse the tax expense we've recorded in the third quarter.
Wrapping up, our expectation for after-tax operating income per share for 2016 has not changed from what we previously discussed at our Outlook Meeting in December. We did finished 2015 with a higher level of income than we had anticipated, so the growth rate for 2016 off of the $3.64 up 2015 operating income per share is expected to be within a range of 3% to 6%. So overall, it was a very good fourth quarter and a very strong full year performance for the company.
Now, I'll turn things back to Rick for his closing comments.
Thanks, Jack. And just to wrap up before we go on to your questions. I'll reiterate from a company operating perspective, it was a very good quarter and year for our company. We've seen the resumption of topline growth for our core businesses and done so without sacrificing our profitability.
Our statutory earnings are strong, which helps to generate capital to not only maintain a very healthy balance sheet for a troubling macro environment, but also a flexibility to grow and also return capital to our shareholders. This all positions us very well, as we move into 2016.
We'll move now on to your questions, so I'll ask Cynthia to begin the questions-and-answer session. Cynthia?
[Operator Instructions] Our first question comes from Ryan Krueger from KBW.
In supplemental and voluntary, the benefit ratios were a little bit higher than they have been running recently? And then DAC amortization was lower. Can you talk about what drove those two things? And if they were, I guess, related to each other?
There is some relation particularly in the voluntary benefit lines. Some of the products within those lines have active life reserves. And so if those policies terminate, you release the active life reserve and you write up the DAC associated with them. Actually, our persistency was a little better, particularly in those product lines that have those active life reserves and so that resulted in a little bit higher loss ratio and a little bit lower amortization of the DAC balance and net-net the earnings impact was very minimal.
And then on long-term care, can you remind us what interest rate trajectory you're assuming in your GAAP long-term care reserves at this point?
Jack, do you want to take that?
Yes. So as we told you -- actually its been a year ago now in the fourth quarter of 2014, we had assume that interest rates would stay level with the rates they're at somewhere around the 5% range all in for the next years and then would gradually revert to a long-term average over the subsequent five years.
So the 5% is a new money rate?
Yes, all in.
And then, Rick, you said new money rates were bit better than that in 2015? Do you know where they are now?
I mean, it's hard to tell with treasury yields have clearly gone down over the last couple of weeks, spreads have widened since the end of the year, so I wouldn't have a spot rate for you.
And next we have John Nadel from Piper Jaffray.
I guess, Rick, a bit of a philosophical question for you. I find it kind of staggering, I guess, the market is somewhere around 10% off of its all time highs and yet Unum's shares are trading 30%, 35% below your 52 week high, and sort of staggering discount to book-value per share. I am just curious how you think about the pace of capital management in particular when you think about a 400% risk-based capital ratio relative to your business mix and that coming off of a very strong year of statutory operating income in 2015?
Sure, John. Just to give you some perspectives on that, I think that one of the things that I'd bring you back to very quickly though is we operate this company in the same way we've been operating it, very consistent. We're growing the company now, margins are still very good. And we as a team here are focused very much on that.
In terms of what's going on in the market around us, so there's a lot of things out there in the news, continued lower interest rate environment, questions about the economy, there's so many things that impact our stock price, we try not to focus on that from an operating perspective.
Well, it does actually meet up with how we think about managing the capital of the company, as we are buying back our shares and have been doing so for the last several years. So when you look at that, you think about where we're buying back shares today relative to where we were, even in the fourth quarter and for over the average of the year, and how does that impact for our thinking.
And what I take you to, and this gets to your philosophical point is, we actually on that front stay very consistent as well. So we think about ourselves as being a steady returner, more capital to our shareholders. We'll buy a little bit more when prices are down and a little bit less when prices are up, but consistency of return is something that we focus on as a general philosophy of the company, but also with regards to capital management.
So as we look at where our share price is today, we would be buying a lot more shares in terms of the actual dollars that we're putting out, you'll probably see a pretty consistent level to what we've done in the past.
So no significant -- if we think about it relative to your outlook for 2016, I think you had formally indicated that dollar amount of buybacks would probably be pretty similar to the level spent in 2015, no significant adjustment there then, Rick?
I think that's probably fair. And when you think about it, we're buying back shares with the capital, with free capital we're generating, so this isn't something other than as we generate that capital, which we've done so very consistently, we're returning that to our shareholders through share repurchase, and as a result of that our steady operating performance would say that we'll be pretty steady in terms of returning capital as well.
And then a quick one on the tax rate. Just is there any implication, as you look out to 2016, Jack, as a result of the U.K. adjustment or do we stick with the 31% to 32% range that I think you guys have expected for this year?
No, I think that 31% to 32% range that was kind of a one-time shift. It's not going to really move when you've got that much going forward.
And then last one is maybe for, Mike, and that's just a question about January 1, very important, obviously, sales and retention period. Any color you can offer as to what's going on in the U.S. market there?
So first would be, you're right, it is an important date for us on the renewal front, a good news there. So persistency is in line with what our expectations are. That's great, that the big driver of the topline. But also, as you know, we've been putting gradual price increases into the market about every six months over the last 18 months to 24 months.
So sticky business is always good, but particularly, when you're gradually increasing rates, particularly in group insurance to account for the low interest rate environment that we talked about, so feel good about that.
On the new business front, you'd sort of see a slight decline in sales this year. I think we're down about 3% in the fourth quarter. But as both Rick and Jack highlighted, actually 4Q came in right in line with our expectations. We faced a really difficult comp, up 25% a year ago. So good to finish for the full year, right at or just over to top of the range we laid out to you guys at the beginning of the year.
And our next question is from Jimmy Bhullar from JPMorgan.
First, if you could discuss the potential for reductions in the disability reserve discount rate, given what's happened with interest rates? And maybe, if you could provide us some sort of sensitivity on what a basis points change in the discount rate would do to your benefits ratio in the U.S. disability business?
Jack, do you want to pick up?
Yes, so we've seen reductions, we've seen the interest rates fall since yearend. This is very similar to what happened last year, actually too, during this period. It doesn't mean they're going to stay there for the full year. We've also seen spreads widening. I'd point you back to the fourth quarter, where actually our new money rates were higher than we've seen in quite a while. And we're supportive about reserve assumptions in both disability lines, as well as long-term care lines. We keep track of that.
We keep raising rates in response to the lower interest environment. We look for opportunities to book money to work at good yields. And it's something we'll look at during the year. I'd say that we're pretty comfortable right now that throughout 2015 that we won't be forced to take a precipitous action, because we have a good margin and interest margin now in our reserves, but its something we continue to look at and decide, as we do our reserve reviews.
And the sensitivity is about 25 basis points, is about roughly $12 million in BTOE on an annualized basis.
And then, on long-term care, obviously rates are challenging, but how are the other things going, as the claims trends your success in achieving price hikes versus what you might assumed when you took the reserve charge in the fourth quarter of 2014?
Yes, so actually, since we took the charge in 2014 things have been pretty much in line with our expectations. There has been some volatility quarter-to-quarter, but client trends has stayed in that range of the 85% to 90% loss ratio. And we continue to make good progress on our rate increase assumption, so both the rate of approvals and the actual implementations are pretty much in line with the underlying reserve assumptions.
And then just lastly on long-term care. As you mentioned, you're assuming stable rates or you assumed stable rates for five years and then an increase in rates thereafter. So philosophically, if rates remain lower through this year or maybe even next year, you would have gone two to three years into that. Would you review your assumptions again or would you just wait for the first five years to go through and then review them?
We consistently review our assumptions. So we do reserve reviews at the end of every year based on the assumptions, and I think the question we would ask ourselves when looking at that is has our outlook for the future changed. And it's not going to change rapidly, but certainly something we continue to look at as we do our reserve reviews.
And our next question is from Randy Binner from FBR.
I guess, I just want to follow-up on Jimmy's question there because I guess the mean reversion, I guess, by definition gets worse every year that rates stay low. So just to paraphrase that, are you saying that the mean reversion hasn't changed enough for you to unlock now, but if we're sitting at the similar or lower level rates from a year from now, would that kind of technically lead to an unlock, just because the data is changing?
No, I wouldn't say, it would technically lead to an unlock. Again, it's something we will look at what our view of the future is when we do our reserve reviews at yearend, but there is no magic kind of we have to do this if this happens associated with it.
I think unlike, you mention the word unlock, and this is not an unlock. So when you look at it, this is also not a mean reversion. So this is a view on path of interest rate, so over a 10-year period of time. And as Jack said, that's an outlook that we had last year, going to through the process, and it really hasn't changed as of now. And so it's not something that we look at a mean reversion, as you think about traditional method.
And then just jumping over to the credit side. Is there any update -- the disclosure around your energy exposure is very good relative to your peer, so we appreciate that. And as you mentioned in the opening remarks, the unrealized loss really is not that big, at least as of yearend.
I'd be interested in any update kind of on what year-to-date activities look like there from an unrealized position? And if there has been any action by Unum to de-risk energy or any other credits that are moving out or if conversely you're seeing this as maybe an opportunity to add more at wider spreads?
We're certainly not starting with the last thing first. We're not viewing this as an opportunity to add more at wider spreads. We always actively manage our portfolio. So we are a credit shop. We're looking at our energy things. Spreads have widened since yearend, so that unrealized loss would be somewhat bigger. We haven't fully valued the portfolios yet, so we don't know what the size of that is.
But again, probably the important thing to note is we are all over our energy portfolio. We looked at, we stress tested it under a number of different scenarios. When we look at it, we consider both the realized losses that we may have to take, as well as the RBC impact of any downgrades that we would foresee. And because of the strong financial position we go into 2016 with, we view this as a very manageable issue for us. There is nothing we see right now that would change our outlook for capital plans for 2016.
On the stress test is there anything you can share with those? You're talking about ratings migration down and RBC ratio, and then just, I guess, straight credit losses. Is there anything you can share on what you've run from a stress case scenario?
I mean, we start with an oil price trajectory and a set of assumptions around that. I'm not going to go into the specifics of what that trajectory is, but it's actually consistent with, if not, more conservative than kind of overall market estimates and we've taken some downside scenarios from there. And throughout, it's not that -- there are some things that come up there, but they're very manageable within our capital plan.
The next is Erik Bass from Citigroup.
I guess, as you went through the yearend enrollment season, did you see any material change in consumer behavior, particularly in terms of election rates for voluntary products?
Mike, you want to start and then we'll go to Tim.
In general, actually, we saw it's slightly higher participation rates. And while we're still debriefing and understanding, I think a couple of things contributing. First has been across both the Unum and Colonial Life brand continued investments in our enrollment and education capabilities that we always want to be a little bit better each year at what we do.
And then the other piece was we certainly saw disposable income. You look at where the price of oil that created a little of capacity I think for the average consumers, so that played through as well.
Tim, on Colonial Life?
Yes, absolutely. We saw the same trends. And the only thing I would add aside from what Mike mentioned is we continue to believe that both the Affordable Care Act, as well as employer behavior around deductibles on medical plans are helping drive some increased participation in our products as well.
And then, can you just remind this how much exposure you have to the energy sector or to related sectors from a client perspective?
Yes, sure. So I think we look at it across all the product lines, but probably most acutely in the long-term disability product line. We've got about 2% of our block in energy. And we've actually gone back and looked at the cycle of energy prices over a couple of decades and haven't really seen much for a correlation with incidence, and we're certainly not seeing any misbehaving risk from this point, but we look at pretty much every industry sector all the time.
And our next question comes from Humphrey Lee with Dowling & Partners.
Just a follow-up on the investment yield. You talked about 2015 being a little higher. What are you seeing in terms of value right now, kind of getting you to that 5% range, especially for supporting the long-term care?
I think it's driven by two things. One of the big ones is spreads widened. And although, the yield curve has flattened at the front-end, it's still stayed pretty steady at the long-end, so the spread between the 10 year and the 30 year is still in that 75 basis point to 85 basis point range.
And so when you invest in longer maturities, which as a result of some of the M&A activity, there is a lot more long tranches available. And you put the widened spreads on top of those you get up above the 5% range through the end of the year. There is also alternative investments, we put a portion of the portfolio -- have continued to put a portion into high yield where spreads have widened as well.
And then some of your peers talked about there is some disruptions in a group insurance marketplace, because of company's exiting the business or consolidations going on. Can you just talk abut in general the overall market environments for Unum U.S. and Colonial Life?
Mike, you want to start?
Sure. So we have seen a bit of consolidation with a few names, I'd say, sort of mid-sized coming together and/or being required by an international player. I wouldn't say that that has led to a significant disruption. So if we look at things like, again, the renewal rates for us have been right in line to slightly favorable.
I think the proposal activity has been generally in line with what we've seen across the segment, so not a big disruption I would point to. But I do think if you think about the market in general, there's sort of the capabilities that are offered and we have seen a few new entrants into the market, but the good news for us is capabilities in terms of the process, the technology, and the people, they take a substantial amount of time to build, so we feel pretty good about the head start we have there.
The pricing environment, just to give you some color, I would say is pretty typical. We've got a few carriers that are having stepped back and repriced to improve margins. And then we've got a few that are probably leaning a bit more into growing their books, and I think that kind of balances out, so a pretty typical pricing environment.
Yes, I think the story is similar. We are now seeing any disruption based on consolidation. Blocks have been very stable. And where I think they will show up first will be in our large case block and we're not seeing any disruption there.
And our next question comes from Michael Kovac from Goldman Sachs.
A technical question here. I'm thinking about the bond portfolio. When we look at some of the unrealized los positions that have been there for over a year and that grew obviously in the fourth quarter relative to the third quarter, how do you determine when you take an impairment on those bonds? Is it well, sort of the level at which they're trading below fair value or is there certain time horizon? Just maybe if you could give some help in terms of thinking about when you would take such a charge?
Jack, you want to share our views on that.
So, there is no hard and fast rules around when you would recognize an impairment, but there are some guidelines, and we consider four things. The first is, is it money good, so do we believe that we're going to get principal on interest payments out of it. The second thing we'll consider is do we intend to hold it to recovery, and so if we do, that would keep it at book value.
The third thing you consider is, are they current on interest on principal payments. And then beyond that, it tends to be a security-by-security analysis, its a judgment about whether we believe over time this will recover and be money good, and so there is no hard and fast rules. We work with our investment department, we work with our auditors, and we come to judgments on the securities.
And then switching gears a little bit, thinking about the environment for rate increases in long-term care, it sounded like it came in sort of in line with your expectations. Are you seeing any change in tone from regulators, as we continue to be in a low interest rate environment, both in terms of your position in the market and in terms of seeing some other companies, maybe we consider whether they are writing new business in long-term care?
I think we've continued to see a positive tone from regulators. It's certainly better today than it was three or four years ago. Even some of the kind of late adopter states like New York are seem to be coming along and considering rate increases in a different light, given the environment. So I think it continues to get better over time.
Our next comes from Eric Berg from RBC Capital Markets.
Jack, in the Investor Day that you held back in December, I was really interested in the whole discussion about how the Closed Block of individual disability business is increasingly looking like a lifetime annuity. And I was also very interested in the distinctions that you drew in the risk characteristics of your group LTC business that is closed versus your individual business.
My inference was that maybe these businesses could be sellable, re-insurable or that somehow you could free up the capital this year. Was that the right inference? You answered no on that. And was that the right inference? And if it was the right inference, what would be the process that would follow this year to move forward on that front?
Clearly, looking at capital management opportunities on both of those blocks is something that we actively do and consistently. Whether those opportunities can actually come to fruition this year, it would be really hard to say. So it's something we look at and we're in constant communications with alternative sources of capital, but being able to predict whether something will actually happen or not would be beyond what I could do.
And if I could just ask one follow-up question and that would be to Rick. Rick, if the company is as flexible and as an opportunistic as you say it is, if you have the capital strength to be flexible and opportunistic, then why wouldn't you -- going back to John's question, why wouldn't you with the stock price where it is step up your dollar amount of share repurchase to take advantage of this opportunity?
Yes, it's a fair question, Eric. I think it gets back to the pace at which we're doing that. We do have that flexibility. We could do that if we so choose. But it comes back to the philosophy we have in the company around, as we generate the capital we're going to return it to the shareholders. Some of the excess capital positions we hold, we think about it using and how we could deploy that to grow the company in different areas. And so it's been much more on that philosophy.
You have to remember, we've been doing this now, if you go back for the last seven years. And so over that period of time, we've seen our stock price move up and down. Often times it's not related to what's going on in the company. And so we've taken advantage of some low stock prices and at the same time we bought back shares when we were at a higher price.
And so I think now is the right time to pile in, to buying a whole a lot of shares, I think that that's atypical for our company. We're much more disciplined, much more consistent in how we look at things.
Our next question is from Steven Schwartz from Raymond James.
First for Jack, I apologize I got cut out on Randy's question with regards to energy. Jack, do you know or did you say, what the market-to-market loss would be on the below investment grade energy portfolio at yearend?
No, we did not say that.
Could you share?
The high yield, let's see we were trade out -- yes, so just to breakdown the numbers, we have $51.4 million of unrealized loss at yearend, right. So on the investment grade side it was an unrealized gain of $138.3 million. And so the high yield is trading in an unrealized loss of $189.7 million.
And then another numbers question. Jack, that was a $69 million charge that you took at Unum New York for long-term care at yearend?
Very close, $68 million.
And could you remind me is that in the statutory operating earnings that you show in the supplement?
No, I believe it's a capital adjustment, yes.
And then for, Mike, maybe you could talk about kind of fourth quarter, kind of natural growth trends. I know you said elections were up a little bit, but maybe employment as well. Talk about that, any other thing, and also obviously for Colonial?
Yes, sure. So pretty actually consistent with the last few quarters where it is a positive, but it's a very modest positive, and probably a point or a point-and-a-half lower than what we would see in a healthier part of the cycle. We definitely have been looking at the macro numbers. See good unemployment change and good employment growth. Unfortunately, a fair amount of that is coming in lower benefited part time and non-benefit eligible type employees.
So it's not flowing through at a commensurate level into our book. One would have to believe that overtime if we're able to sustain reasonable GDP growth and continued strong employment numbers, that will start moving through all the tranches on the employment base, but little bit modest at this point.
I think, probably not specific to natural growth, but we are seeing nice results in the small case market, as we shared at the Outlook Meeting. We see a lot of opportunity in that market with almost 6 million employers in the list in the less than 100 states. And we certainly think that that group is benefiting from the economic environment. We think they're growing their employee base, but we're seeing nice results there.
Our next question comes from Suneet Kamath with UBS.
So I guess to echo John Nadel's question, I mean, segment results here remain pretty strong, but you've not been able to tell from the stock price. So clearly there's something else going on which I think is based on the questions asked is the investment portfolio. So maybe would be helpful, if you give us a sense, as we think about that capital generation model that you shared with us last December, what sort of credit loses do you build into that model?
Yes. In that model, we gave an outlook on the capital plan. We didn't specifically in building out that model put the capital losses in there. We have stressed the model, however, with capital losses under various scenarios and basically the tenants of the model particularly around free cash flow generation and share repurchase hold up very well under the stresses.
We focused a lot on the energy portfolio today, but as you think about just the overall portfolio, your high-yield exposure, your BBB exposure, any more color in terms of your watch list and what you're seeing as things develop here?
The watch list has been pretty consistent. It is mostly energy and commodities at this point. We feel extremely good about the rest of the portfolio.
And the last one is again maybe more of a philosophical question. As we think about your capital allocation across your businesses, it seems like the portion that's allocated to the Closed Block is, I don't know, almost a little over a third of your capital, maybe 35%, 36%. Is that factored into your thinking, n other words, is there a limit in terms of how big you want that allocation to be?
It would seem to me that most of the capital that you're using for share repurchase is coming out of the operating segment, so naturally there would be some upward drift in that allocation. Just want to get a sense of how should we be thinking about that number? Is it a binding constraint at all? Any guidance would be helpful.
I'm not sure if it's philosophical. When we think about the capital allocation to our Closed Block, that's not where we want to be putting our capital today. So the numbers you see here today are higher than we want them to be. And I think that gets back to the question that Jack was answering is how do we free up that capital, how we reduce the capital behind those lines of business, so that we can continue to do what we've been doing in funneling more capital to our operating companies.
We're also in a fortunate position that we are generating enough capital as a company that our business lines, our main operating companies are getting all the capital that they need to continue to generate growth. I think the only constraint is more in the market and making sure that there's good profitable growth as opposed to the amount of capital we can put behind it.
So as we tell everyone inside the company is we want to funnel as much capital as we possibly can to continue to grow our lines of business. And what we haven't found is actually a shortfall to do so and that's one of the reasons we're buying back a lot of stock is because we actually can't put as much capital as we want to behind our growing lines that are generating very high returns.
So back to original question, I think that the capital allocating to our Closed Block is one that we want to reduce over time. And as we talked about different settings, that's something we're actively working on as a company.
And then just on the IDI to follow-up on Eric Berg's question. If you were to pursue a solution, just trying to get a sense of how much capital you think that could free, would it be wrong to assume that would be $200 million?
Yes. I mean, I don't think we can speculate on that until we have a better idea of what a solution might look like.
And our next question is from Tom Gallagher from Credit Suisse.
First question just on long-term care. So the interest adjusted loss ratio is in the high 80s? And I know that's in kind of the high end of the band that you all have looked at.
I guess, just a follow-up, as we think about whether it's 2016 or 2017 and potential risk of another reserved charge, is it fair to say that if this moves north of 90%, is that where you'd be potentially vulnerable for a possible reserve charge, which I presume would be more on the claim side, in terms of, if you saw an escalation of claim trends or adverse reserve development. But can you help us think about the numbers, the interest adjust loss ratio and then potentially additions to reserves?
I would say that it's a lot more complicated than that. The reserve basis of long-term care is very detail. There is a lot of sensitive assumptions that interplay. We're thinking guidance that if you were above 90% for a long period of time that would be an indication of pressure on the reserves. But it wouldn't react to one or two quarters in that range and it would really depend long-term on what the factors were that would driving you above 90%.
So I think in the past, you guys have been able to say or give some indication about what at least the next year's outlook would be? Would you say based on what you know today, there would be very low likelihood of a reserve addition in 2016 or is it too early to tell?
I mean, I don't think we've actually provided outlooks on our reserve position today at yearend. I would say we feel comfortable with where we are today. We just went through a reserve review that culminated in the quarter we're talking about. So we're as close to our ending reserve review as you can get. We feel good about that reserved review and where it ended, but I'm not going to speculate about what next year's reserve reviews are going to generate.
And then, just back on the energy portfolio $372 million of growth unrealized losses, it was the number at yearend. And I know year-to-date spreads have obviously gapped out further. Do you have an update on where that would be? And then can you also just talk a little bit about your process of looking at bonds that trade, say, less than $0.80 on the dollars. How does that process work internally? Is there further due diligence at certain levels? Is it $0.80, is at $0.70? Anyway, those are both questions I had on it.
So clearly, the spreads have widened in the energy sector since yearend, so that $370 million would be wider. We do monthly evaluations on most of the bonds in our portfolio, that's not complete right now and so we don't have a number for you that we can share.
With respect to what we look at, again, I bring you back to the first one we look at, is it money good. Do we tend to hold it through recovery? And then are they current with interest and principal payments? You talk about the review of bonds that are under a certain percent of market to book. The fact of the matter in our energy portfolio today, we are consistently reviewing those bonds.
We're looking at all the high yield bonds. We're looking at those bonds on an ongoing basis and actively working to manage through this, so I don't think there's anything special about bonds necessarily by where they're trading relative to book, because we're looking at that entire portfolio on a constant basis.
Well, just as a follow upon that, I thought the concept of OTTI was that even if bonds are money good, but it's determined to be trading at an impaired level on a permanent basis, that's where bonds are impaired, at least from a gap accounting standpoint. That sort of what I was getting at from the standpoint of, not so much are you writing it down from a statutory standpoint, but from a GAAP standpoint, the concept of OTTI is a price-driven concept, not a loss-driven concept, if you know what I mean.
And our view is it's not a bright line loss-driven concept. The big question there is, as you said, is it temporary or not? And so the question we have is do we expect it to -- if its money good it's going to recover, because ultimately it's going to pay off and you'll get all your proceeds.
And so, again, it comes back to those things, is it money good, do we intend to hold this, is it current? And clearly the longer and lower it trades, kind of the more pressure and the more work you need to do to demonstrate that those first three are actually true and believable, but it is not a bright line issue.
And our next question is from Seth Weiss from Bank of America.
Just to approach the question on sensitivity to capital on the investment portfolio, if we look at that 45% of the portfolio that's at Baa, could you help us think about how much of that may be at risk to moving to below investment grade? And then on sensitivity to the risk-based capital level, is there a rule of thumb that if you could gave us in terms of every percent increase to below investment grade? And what that may do to RBC, as we have some ratings migrations?
I can give you a couple of things to tether to. One is if we look at the portfolio, and said, if every single bond in our energy portfolio was downgraded a single notch, so Baa2 went to Baa3 and Baa3 went to BB, what would be the impact be, that's a four point impacts on our risk-based capital. The second tether point I'd give you, if everything dropped a full letter, so all our BBB's went to BB's, all of our AA's went to BBB that would be a 15 point impact to our risk-based capital.
Calculating the impact on risk-based capital is more complicated than just looking at the change in the RBC factors, because C1 capital gets tax affected and so that reduces the burden. There is also a significant diversification benefit with C1 capital that further reduces the impact relative to those numbers. So it's something that that we really need to don't work through, but it's far less of an impact then just looking at the change in the percent capital holdings and multiplying them by 3.5.
And then one very quick follow-up on just the interest margin and on LTD. I think last quarter you were at around 85 basis points in terms of that margin. Could you just give us an update of where that stands today?
It's in the low 80s.
And our next question comes from John Nadel from Piper Jaffray.
So thanks for extending and taking the follow-up. So there's a lot of questions and a lot of focus obviously on given what rates are doing on the long-term care block. I just want to make sure I had a couple of data points accurate. If I think about when you took the fourth quarter 2014 charge, it would have been based on -- if I understand it correctly, it would have been based on where interest rates were at right around that time in the end of the year.
So the tenure was at 2.17%, it averaged 2.54% for 2015, and it's now down at 1.84% or so. I mean spreads have widened enough to well offset that 30 or so basis point reduction in the tenure, have they not? I mean, it sort of seems to me like this issue of a potential long-term care charge driven by rates necessitates a view that rates fall significantly further from here, is that reasonable?
Yes, I would say that's reasonable. So we're pretty comfortable with where we are right now.
And then the last one I have for you is just a follow-up on the mechanism for the IDI Closed Block. There is a elevated level of prepayments income I believe in the Closed Block in the fourth quarter. And then if you look at the interest adjusted individual disability benefit ratio that was up, that is a mechanism by which you're essentially recognizing the faster payment of that investment income by shoring up the reserves with that investment income today, is that right?
Yes, because that money is going to be invested at new money rates, so it's going to put pressure on the portfolio rate underlying the discount rate. And so we reduced the discount rate to likely offset that impact.
And then last one is just if I go back to your Investor Day presentation, I think I'm looking at something around $950 million, maybe slightly less than a $1 billion of cash flow to invest in 2016 for the total Closed Block. And I recognize that a 1% difference in the new money yield has more than a one-year impact, right in that investment income, but we are talking about $10 million difference in a single year for 1%, is that right?
The $1 billion is roughly right, so depending on how it comes in over the year and what rates do over the year, that's pretty rough math.
But it's also that $1 billion will be invested over the year, so it's not invested one-one, so it would be less than $10 million.
I understand, but the differential between investing at a rate 1 percentage point lower on average is literally $10 million pre-tax in a year, correct?
End of Q&A
John, thanks for that follow-up. And actually, we're over time now, so I think we'll cut it off here, Cynthia. I want to thank everybody for taking the time to join us this morning. Actually, we look forward to seeing many of you at investor conferences in the weeks ahead. And so that completes our fourth quarter 2015 earnings call. Thank you.
That concludes today's conference. Thank you for your participation.
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