Unum Group (NYSE:UNM)
Q2 2016 Earnings Conference Call
July 28, 2016, 09:00 AM ET
Tom White - SVP, IR
Rick McKenney - President & CEO
Jack McGarry - EVP & CFO
Mike Simonds - President & CEO, Unum U.S.
Tim Arnold - President & CEO, Colonial Life
Ryan Krueger - KBW investments
Suneet Kamath - UBS
Randy Binner - FBR
Humphrey Lee - Dowling and Partners
Seth Weiss - Bank of America Merrill Lynch
Tom Gallagher - Evercore ISI
Michael Kovak - Goldman Sachs
Yaron Kinar - Deutsche Bank
Eric Berg - RBC Capital Markets
Mark Hughes - SunTrust Robinson Humphrey
Good day and welcome to the Unum Group Second Quarter 2016 Earnings Conference Call. 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 and Investor Relations, Mr. Tom White. Please go ahead, sir.
Great. Thank you, Gwen. Good morning, everyone and welcome to the second quarter 2016 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 results suggested by these forward-looking statements. Information concerning factors that could cause results to differ appears in our filings with the SEC 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, 2015 and our subsequently filed quarterly report on Form 10-Q.
Our SEC filings can be found in the Investor section of our website. I'll 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. 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.
Participating in this morning's conference call are Unum's President and CEO, Rick McKenney and our 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 now, I'll turn the call over to Rick for his opening comments.
Thank you, Tom and good morning, everyone.
Our second quarter results were excellent with operating income per share of $0.99. This is an increase of 11% over last year. Together with our strong quarter results, operating income per share grew 9% in the first half.
Our operating trends have been very strong across the company with solid levels of premium growth in Unum U.S., Unum U.K. and Colonial Life, coupled with stable benefits experienced and favorable expense management trends.
I am particularly pleased that we're achieving these strong results despite what has been a difficult business environment with historically low interest rates. The reason that we can deliver these consistent to an improving results is because we've a sound strategy and business plan in place. It is one that resonates well with our customers and the employee benefits marketplace, both in our existing group solutions as well as the growing voluntary space and it's our execution of the strategy that is generating these strong financial outcomes.
I'll discuss this in more detail in a moment, but first I want to provide a few highlights on the second quarter. First, the premium growth we're generating in our core operations remains very healthy at approximately 5% in each of our business lines.
For the second quarter, premium income growth in Unum U.S. is driven by strong persistency trends and our sales trends over the surpassed several quarters. Total sales increased slightly in the second quarter with very strong performance in the voluntary and supplemental lines offsetting a small decline in our employee benefit lines where markets remain competitive.
Unum U.K. premium growth benefitted from the National Dental Plan acquisition from last year as well as growth in the group income transaction line and finally premium growth at Colonial Life was driven by the excellent sales trends we've seen over the past few years, which continued again this quarter with growth in new sales of 13% bringing first half sales growth to just under 15%.
Next I am very pleased that we've maintained strong profit margins in our core business segments while building this positive momentum in premium growth over the past several quarters. This shows the discipline we're bringing to our markets in how we price, underwrite and mange customer relationships in order to maintain a balance between producing top line growth and maintaining industry leading profit margins.
These strong operating results drive a very strong level of statutory earnings and capital, which provides substantial financial flexibility. Our first half statutory operating earnings have been outstanding, increasing 29% year-over-year to $400 million or just over.
This enables us to continually generate free cash flow of which we've been used -- which we've used to create shareholder value through steady consistent share repurchases and annual dividend increases.
At the same time, we're able to capitalize on attractive acquisition opportunities such as National Dental Plan in the U.K. and Starmount Life Insurance Company, which is also in the dental market and we're able to capitalize on when they're available.
So in summary, it's been a very strong first half of 2016 for the company. This performance is the result of our steadfast focus on disciplined execution of our business plan. This is reflected in many facets of our business starting with our customers and includes how we're underwriting price business, how we manage claims to help people return to work, how we administer and enroll business and how we manage customer relationships.
Operationally we also continue to focus on disciplined expense management, which is evident in the favorable expense we've delivered in many of our business segments, which is also net of the investment we're making in our businesses through such things as customer facing technologies.
When you combine this disciplined execution with our market positioning and growing footprint, we see a continuation of good profitable growth.
And finally I can't say enough about our people who are responsible for this performance day in and day out. We're committed to developing our talent, building our bench strength and ensuring our people continue to drive the change necessary to remain the leader in the employee benefits marketplace.
So with those highlights and an excellent second quarter, I'll let Jack to cover our results in greater detail. Jack?
Thank you, Rick and good morning, everyone. Rick provided a high level overview of our second quarter results and now we want to provide a more in-depth view of the trends we saw in the quarter.
First I want to highlight the composition of our tax operating income per share growth of 11.2%, which was well balanced between after-tax operating income growth and capital management.
Operating income grew 5.9% over the year-ago quarter. This quarter was one of the strongest and best balanced quarters we've seen. In addition, the benefit from our share repurchase activity reduced our average shares outstanding by 4.8% compared to the year ago share count.
A key driver of our success this quarter was the performance of the Unum U.S. Second quarter operating income was very strong at $227.2 million, an increase of 12% from the year ago quarter.
Premium income growth continued its positive trend increasing 5.1% over the year ago quarter, the benefit ratio for Unum U.S. segment improved to 69.1% of second quarter compared to 71.2% in the year ago quarter. In addition our focus on disciplined expense management was also contributed to operating results, with the other expense ratio declining to 20.9% in the quarter, compared to 21.9% in the year ago quarter.
The profitability of our Unum U.S. segment remained very strong with an operating ROE of 15.1% for the second quarter of 2016. Within the Unum U.S. segment, operating income in our Group disability business was $74.4 million in the second quarter of 2016, an increase of 21.6% over last year.
Premium income increased 5% over the year-ago quarter, but pressure on net investment income continues driven primarily by lower portfolio yields. The benefit ratio was quite positive at 80.0% for the second quarter, compared to 83.4% in the year ago quarter as we continue to see lower new claims of incidents and favorable claim recovery trends in our Group long-term disability line along with shorter claim duration periods in our Group short-term disability line.
Group Life and AD&D operating income improved to $56.9 million for the second quarter an increase of 8.4% from the year-ago quarter. Premium income grew 3.9% over the year-ago quarter with the benefit ratio improved to 71.5% for the second quarter, compared to 73.1% in the year-ago quarter, aided by favorable Group Life waiver of Premium benefits.
Operating income in the supplemental and voluntary lines was also very strong at $95.9 million in the second quarter of 2016, an increase of 7.6%, over the year-ago quarter.
Premium income growth trends remain favorable, increasing 6.7% in the quarter, compared to last year. From a benefits perspective, overall results remain in line with our expectations, with favorable trends in the voluntary benefits line offset by mildly elevated benefit ratios in the individual disability line.
Looking at Unum U.K., operating income was £25.7 million for the second quarter, an increase of 2.8% over the year-ago quarter. Premium income increased 5.7% over the year-ago quarter, driven by the acquisition of NDP and its growth of the Group Disability line.
The benefit ratio was 70.1% for the second quarter, a slight improvement relative to the 70.7% in the year-ago quarter as favorable risk experience in the disability line offset some unfavorable experience in the lifeline. Overall profitability of the Unum U.K. segment remains quite strong, with an operating ROE of 20.9% for the second quarter.
It’s too early to tell what the long-term impact that Brexit will have on our Unum U.K. operations. The lower exchange rate will impact our results deeply in third quarter. We do not expect to see much if any impact to our risk result. However, if implement trends and wage inflation slow down in U.K. and interest rates remain under pressure, we could see some negative impact to our premium growth and investment income trends.
We believe that the fundamental need for protection of profit in the U.K. has not changed as a result of the Brexit vote but we'll be monitoring very closely for any impacts on our market over the next several quarters.
Colonial Life continue to generate strong, steady results with operating income of $77.9 million in the second quarter of 2016, compared to $77.6 million in the year-ago quarter. Premium income increased 4.6% and the benefit ratio was 51.1% for the second quarter compared to 50.4% for the year ago quarter due primarily to less favorable mortality experienced in the life product line. Colonial Life continues to generate extra margins with an operating ROE of 17.4% for the quarter.
In the second quarter we completed our GAAP reviews both for Unum U.S. and Colonial Life businesses with minimal impacts on second quarter results.
Finally, for the Closed Block, operating income was $32.6 million in the second quarter of 2016, compared to the exceptionally strong $36.6 million reported in the year ago quarter. In the individual disability line we saw very favorable underlying experience.
The increase in the interest adjusted loss ratio to 84.3% in the second quarter from 83.6% in the year-ago quarter includes a reduction in the reserve discount rate to recognize the impact on future portfolio yields from the high level of bond calls and bond tenders during the second quarter of 2016.
Excluding this reduction in the discount rate, the interest adjusted loss ratio would have been slightly below 80%, one of our most favorable results in years.
For the long-term care line, the interest adjusted loss ratio was 92.6% for the second quarter compared to the unusually favorable 83.4% in the year-ago quarter. This swing in results demonstrates the volatility that this block to subject to on a quarterly basis and the importance of taking a longer-term view of the performance, which shows an interest adjusted loss ratios since our 4Q 2014 reserve review of 88.6%.
The result in long-term in this quarter were driven by an increase in new claim incidents and severity brought on in part we believe by the rate increase notifications that we delivered to policy holders recently.
We expect that this is likely to continue in the near-term and is consistent with the claim activity behavior we've experienced in the past following rate increase notifications to policy holders. As before, we expect these higher claim levels to remediate once we're through the rate increase notifications.
I am pleased that we continue to make good progress on achieving rate increases in our enforced long-term care business. In addition to making good progress with state regulators, we're also seeing strong pickup of the lending spot offset. The lending spot has the same positive impact on reserves as rate increases, but also has the added benefit of de-risking the portfolio.
Since future claims will be smaller under the lending spot, the reserves will be somewhat less sensitive to future changes and reserve assumptions.
I’ll move now to the growth trends we experienced across our business this quarter. Starting with Unum U.S. total sales increased 1.4% for the second quarter compared to a year ago. We continue to see competitive market comparisons particularly in the core market segment where we continue to increase our rates to offset interest rate pressures.
In total for LTD, STD and Group Life we saw an overall decline in sales of 3.4% with core market sales down 9.9% while large-case sales increased 12.8% reflecting continued success in our ongoing efforts to increase penetration within existing customers.
The momentum in our supplemental and voluntary segments remained very encouraging. Our individual disability sales increased 12.3% compared to a year-ago quarter, driven by strong growth to existing customers. In the voluntary benefits front line, total sales increased 14% with a good balance between core market and large-case sales.
Persistency for Unum U.S. is at very healthy levels, but the employee benefits lines combined, persistency was 89.6%. This is important to us as we look to move price increases into our imports block to offset the impact of low interest rates and reduce discount rate assumptions that are implemented in recent years.
Our sales force does an excellent job of managing this balance of placing rate increases with maintaining our in-force business, which is essential to our ability to grow while protecting the strong profit margins that we have in our employee benefits block. Likewise voluntary benefits persistency of 76.7% was favorable to the prior year results as was in individual disability persistency at 91.3%.
Sales in the Unum U.K. continue to rebound, increasing 19.4% in local currency with favorable turns in the core market for Group long-term disability and Group Life overall along with the benefit of the NDP acquisition. Persistency was favorable at 85.5% helping to drive Premium income growth of 5.7% this quarter.
Finally, sales trends at Colonial Life remain very strong increasing 13.3% for the second quarter and 14.5% for the first half of the year. Growth continues to be well balanced between the commercial market sector and the public sector and between sales to existing customers and sales to new accounts.
Persistency for Colonial Life was slightly lower across all product lines in the quarter, but remains in line with our expectations. As a result, Premium growth is showing steady momentum increasing 4.6% in the second quarter, compared to the year ago quarter.
Overall, we remain very pleased with the growth trends that we see across our core business segments and as Rick highlighted earlier, the profit margin that we've been able to sustain.
Looking now at investment results, new money yields remain under pressure in the second quarter. However, I'm pleased that we were able again to exceed the new money yield assumption we have for our long-term care portfolio.
We have exceeded our target of investing cash flows at 5% rate, but every quarter since the 4Q 2014 reserve review. We remain well positioned with our Unum U.S. long-term disability business from an interest rate perspective as our interest reserve margin remains very healthy.
This is a great benefit to us as we navigate the dip in interest rates that resulted from the Brexit referendum. It’s too early to make a decision today on any future changes to the LTD discount rate, but new claim incurs, but we remain satisfied that with our margin at this time in a well custom improvement ability to deliver the offsetting rate increases into the market should an adjustment be needed.
The overall credit quality of our investment portfolio remains in very good shape. I'd like to highlight the further rebounded in the net unrealized gain position of our energy holdings to $433 million at the end of the second quarter compared to a gain of $19 million a quarter ago.
It's impressive that the gross unrealized loss on energy holdings has declined to $89.5 million at the end of the second quarter, compared to $297.4 million at the end of the first quarter.
Energy holdings in a loss position we're trading at over 90% of book value at the end of the second quarter. I believe this validates the investment decisions in credit evaluation process we've followed for the past several years, not just for our energy holdings, but for our management of the overall investment portfolio.
Moving to capital management, it was another active quarters as we repurchased 100 million of our shares, consistent with our repurchase activity in recent quarters. Our holding company liquidity position remains very healthy at approximately $600 million as of quarter end, roughly twice the level we target for holding company cash coverage needs for one year.
This cash position is net of the $350 million we're holding for the debt maturity on September 30. Subsidiary contributions in the acquisition of Starmount Life Insurance Company. As a reminder, we issued $600 million in senior debt back in early May in part to refinance this maturing debt.
Our risk-based capital ratio for our traditional U.S. life insurance company remained at approximately 319% well within our target range of 375% to 400% for this year. Statutory after-tax operating earnings were outstanding.
We had $228.4 million for the second quarter of 2016 compared to a $161.2 million in the year ago quarter an increase of 42%. This one of the best statutory quarters on record reflecting the favorable risk experienced across our primary business lines.
For the first half of 2016, statutory after-tax operating earnings totaled $412.5 million, an increase of 29% over last year. Our outlook for growth and after-tax operating income per share for 2016 is unchanged with an expected growth rate of 3% to 6%.
We now expect to be at the higher end of that range as our first half after-tax operating earnings per share growth has been a very healthy 9%. While we're not building that rate of growth into our expectations for the second half of the year, we remain very encouraged by our first half trends.
So to wrap up my comments, I'm very pleased with our first half results. In fact I would say they’ve been remarkable given the environment. We've executed very well in many parts of our strategy including delivering rate increases and exceeding new money yield targets for long-term care generating strong persistency and growth in our core business segments and maintaining pricing discipline and delivering on renewals to help achieve strong profit margins.
Given this progress we enter the second half of the year highly confident in our ability to continue to create value in this difficult environment.
Now I’ll turn the call back to Rick.
Great, thank you Jack. As we go to your questions, I'll conclude by reiterating how pleased we are with the second quarter and first half results. We continue to see good premier growth, stable benefits experience, the benefit of disciplined expense management and strong capital generation. I'm very encouraged by these trends as I believe they will continue to serve us well.
We’ll now move your questions. So I’ll ask Gwen to begin the Q&A session. Gwen?
Thank you. [Operator Instructions] And we’ll take our first question from Ryan Krueger with KBW Investments.
Hey, thanks good morning. First question was the uptick in long-term care claims that you mentioned you expected to continue while you’re implementing the rate increases, is that something that you anticipated and modeled into your reserve assumption?
Great, Ryan let me turn that first question over to Jack.
Yeah, we didn’t model it into the reserve assumptions because it's such a small blip, it's only going to go on for a few quarters. So within the spectrum of $7 billion to $8 billion of reserves it wasn’t worth putting in them.
Okay. But you view it as more -- you view it as something that’s kind of a one-off not changing…
I think Ryan, I think it's incorporated and whether we specifically model the blip over the timeframe of LTC is probably too refined, but I think in terms of…
Immaterial relative to the…
In the context of the broad out I would say, it's inclusive.
I would tell you though that we anticipated this and implementing the rate increases, it happened back in 2012 after the 2011, 2012 rate increase and these rate increases are actually larger and more targeted than those were.
Okay, thanks and then on group visibility the benefit ratio has kind of been in the 80%, low 80% range for the first half of the year, is that a level you think is sustainable going forward.
Ryan, we have great group disability results Jack and then may be Mike can comment on some of the…
Yeah, we're very encouraged by the trend. We’re not necessarily declaring victory right now. We’re continuing to actively manage that block with rate increases and price increases on new business, but again it's been happening for a couple of quarters now. We’re very encouraged by it and the fact of matter is there is actions that we've taken over the past year and half that would support that trend.
Thanks and then just one quick clarification, I think Jack you mentioned that the subsidiary contribution, is that material or what is that related to?
I would say relative to our capital position, it's not terribly material, it's kind of the balancing of risk-based capital across our subs.
Okay. All right. Thank you.
And we’ll go next to Suneet Kamath with UBS.
Thanks and good morning. So just wanted to start with long-term care also, so as you mentioned since the charge you’ve beaten your bogie of 5% every quarter, your average loan loss ratio is 88.6% that’s right in the range of what you assumed and you're not seeing the benefit of the rate increases yet although I think you expressed some confidence there.
So if I take all those things together, wouldn’t that push out any kind of charge that you might have to take towards the latter end of that typical three to five year timeframe that you’ve used in the past.
We’re very encouraged by where our investments have been over the last six quarters. I’ve talked about we’ve exceed the 5%. We’ve exceed it by a healthy margin. It certainly gives us latitude in terms of when we may face the charge. The thing we haven’t seen is the reversing to the norm as yet. So we're still hoping on for that, but I think it gives us some flexibility.
What does that mean reversion to the norm and what?
Well, we never -- when we set the charge we anticipated a 5% flat interest rate environment for four to five years and then reverse to the long term average over the next five.
Okay, but we're still in that first…
We’re still in that five-year period and so we still feel -- we feel very good about where we are and we do believe that the investment results we’ve managed to achieve to date do provide us some added cushion.
Okay. And this may be a tough one of Rick, but just it seems like no matter how good your core results are, the focus is always on the long-term care business and I guess I’m just wondering does it make sense for this company to be part of a larger organization where you just don’t get that volatility from this business that is a non-core business but it's still sizable portion of your capital base.
It's a fair question Suneet and I think that when we look at the company overall, we focus very much on our core operations to make sure that we just run great companies in terms of the ongoing and I think you see the quarter-in, quarter-out you’ve certainly seen it over the last several years and we're going to continue to focus on that.
On the Closed Block and more particularly on long term care, it is a frustration to answer a lot of these questions. We think we do it very well. We're taking all the actions that we need to with regards to price increases, thinking about capital solution everything else.
And so I think we're executing where we want to on that block, but it certainly does garner it's fair share of question and although a frustration, we're going to be keep working the same we've been working.
To get to you broader question about the volatility and how that wheeze into our position as a company overall, I think we've been clear over time that if you want to look at what's in the best interest of our shareholders, as well as all of our other constituencies.
And when we think about running our standalone company that's how we think about it because we have the wherewithal the capital and the opportunity to do so. So that's where we focus first.
But as we think about other opportunities if they came at us, we certainly would do our -- do the right thing from a governance perspective and entertain those, but we're still very focused on running those core operations through the best business they can and take all the actions necessary with regards to our Closed Block.
Got it. I appreciate that, Rick. And then just lastly for Jack. Any update on the Closed Block IDI. I know we talked about this last December in terms of some sort of capital relief solution, just wondering six months after if there is any developments there?
Nothing specifically, we continue to work on it. It's our complicated thing given that we already have securitization behind the block, but it's something we continue to actively pursue.
All right. Thanks, guys.
We'll go next to Randy Binner with FBR.
Hey, good morning. Thanks. Just a couple on the yield, you've been able to earn against the long-term care. You mentioned it was over 5%. I was wondering if you could specify exactly what it was in the quarter?
And you mentioned you were very encouraged by the yield and so that would be more bullish in the commentary we're getting from a lot of companies on yield. So I'd be curious what kind of assets you're buying that are able to give you good confidence around the risk adjusted yield there?
So, you got to remember in the long-term care business we're long-duration buyer. So our sweet spot is in the 30 year, the 30 year you can still have a reasonably steep yield curve. There is a -- there has been a 70-day basis point pick up in the 30 year.
There is also a credit curve and so credit spreads at the 30 year are significantly higher than credit spread at the 10-year, the Barclays Index over the past six quarters for BBB 30-year issuance has been it's well above 5%.
Historically, we also use some other risk classes -- asset classes whether it's private placements or other things to help boost that yield. So largely it's the fact that the longer end of the curve has maintained decent margins.
Just a couple of follow-ups, so what was it specifically in the quarter, just so we can track better the new money rate?
We don’t do that for both our new money rates…
Okay. But it was well over 5% and then are the other asset classes the alternatives you're looking at there, do they have a similar 30-year maturity, or do they -- would they be higher yield but shorter maturity than you have with a 30-year?
Just about the curve, I think one thing Randy, I think you're isolating a small piece of investment, although very important to us and something we're focused on. You have to look at the overall construct of our portfolio as well and I think you won't see major shift in our investment philosophy and how we run the portfolio, how we think about credits, how we incorporative private placements and other non-liquid assets in that mix.
And when we take all those things together, I think as Jack said we feel very good about how we've done it over the last 18 months. Even in the quarter, we invested a little bit early as our investment team does when they see the good yields out there they capture them.
And so all those things come into play and we are not going to get into dissecting every investment we put behind a particular line of business particularly not in any particular quarter.
So I think those comments are good. The interest rate environment is challenging. We mentioned that, but our team continues to outperform and we'll keep you up to date every quarter on how we did.
All right. Great. Thanks.
And we'll take our next question from Humphrey Lee with Dowling and Partners.
Good morning. Thank you for taking the questions. Jack, in your prepared remark you talk about the competitive landscape for the traditional line seems to be picking up a little bit. Can you go into a little detail in terms of what you're seeing in the traditional lines and then also can you comment on the voluntary business as well that would be helpful?
Yes, Humphrey, I'll actually look for Mike to respond to that.
Thanks and good morning, Humphrey. So you've heard us start talking about the new client acquisition pricing market in the group lines probably about three quarters ago, we started to see it -- get a little bit more aggressive and certainly we've seen this cycle many times before. We're not going to chase market share using price as a lever and so we have seen some pressure on new clienteles.
We can't really control the competitive pricing environment. So we stay very focused on what we can control, which is first and foremost take care of our clients and Rick and Jack mentioned it before but persistency is over 90%, sales into these relationships were actually up 10% in the quarter and helped to drive an overall increase in sales and you put that together with persistency and you got really nice earned premium growth.
A big part of what we're bringing into those client relationships as you highlighted is the voluntary line of business, 14% growth in the quarter really over the last several years, it's been a consistent growth story for voluntary as more and more the employee the decision maker. We see that in the Unum branded business. We also see that in the really strong results coming out of Colonial line.
And you mentioned in terms of the aggressive pricing, is it a factor of you guys raising prices for the interest rate or people actually lowering to get share?
Yeah, Humphrey, I'll give you the wholly owned satisfactory answer of little bit of both. So we have put low-to-mid single digit increases particularly on the long-term disability, but on the other group line as well into our new business pricing every six months or so over the last two years and that’s been gradual in our sales and client management teams have done a great job in taking that into the market.
We would certainly anticipate given rates that if the competitive environment would need to follow the suite, we haven’t seen that happen. In fact we've seen a few carriers come back a bit more aggressively into the market and try to recapture some share they’ve lost over the last few years and the combination of the two I think is what's putting some pressure on new clientele. But again the aggregate when you put it together is actually consistent top-line growth, which we're pleased about.
Okay. Got it. And another question on long term care, Florida recently announced they're going to do another public hearing for long-term care increase, it seems to be following Pennsylvania's footstep, do you expect more these kind of hearings from regulators that they try to strike a balance between protecting consumers and keeping the LTC business viable? And how does these kind of hearing affect some of your rate increased position going forward?
In general, these hearing have been positive. Our rate increases I know Pennsylvania held the hearing they approved the rate increase shortly thereafter. There was a successful hearing in Massachusetts. Maine actually held a hearing, it was one of the first.
So we're happy to attend those hearing. We're really engaged in them. We have a very good story about where our block is, the reason we're chasing that we're pursuing rate increases that just application for them.
I think the fact that we're not trying to restore original pricing profitability into the block that we're pursuing a sustainability strategy resonates well in the lending spot option that gives people an option to maintain their kind of premium level while continuing to maintain extremely valuable benefits resonates well. So we're encouraged by the hearings and we think it's a catalyst for action.
Okay. Thank you.
And we'll go next to Seth Weiss with Bank of America.
Hi, good morning. Thanks for taking the question. Jack, I wanted to follow-up on the commentary on the LTD discount rate. You mentioned in your prepared remarks you remain satisfied with the margin at this time, can you just remind us where that is at this point?
We haven’t typically disclosed that margin, but it's in the upper brand of that 60% to 90% range.
Okay. Great. And you mentioned it's too early to make a decision, typically when do you think about making those decisions? Is it kind of going into at December outlook call, is that when we should think about perhaps an update on that?
Yeah, we do our reserve review. We got in the third quarter and it culminates in the fourth quarter. So that would be difficult. And maybe actually Seth it's helpful to set back to, so this experience, actually Mike maybe you want to talk a little bit about how the block is performing overall inclusive of anything we may look at on that front.
Yes, thanks Rick. I appreciate. Thanks for the question. So I think we look at the discount rate on new claims incurred for LTD, but we look at it in the context of the overall health of the business. As well we continue to see good, strong and favorable paid incidence trends both in terms of count and severity.
Very importantly the recovery experience our benefits team they are clinical in both resources. We continue to invest there and to good effect. So recovery trends have been very good as well. So there is no crystal ball it is a risk taking business, but as we look forward, we feel very, very good about those fundamental and that even if we weren’t need to make an adjustment on that new claim incurred discount rate that it wouldn’t have a material impact on the earning trajectory for that group disability business.
Okay. So I just want to make sure I am interpreting that correctly. Is that similar to saying that as underlying experience underwriting is improving, you're willing to maybe move little bit lower in that range to be part of that range in terms of the margin and the discount rate.
I think that we've been continuing to place rate increases. We had favorable underwriting results. I think more of what we're saying is if you look at the trend we entered the year on the experience that’s emerged underlying that block would keep us on that same trend even after taking discount rates are.
I see. Thanks very much.
We'll go next to Tom Gallagher with Evercore ISI.
Hey. Good morning. Wanted to start it off just on the long term care claims side. So the higher claims that you're seeing following the rate increases, I guess you’ve seen that before. So the expectation here is that you expect it to be a temporary blip.
My question related to it is aren’t you coming back though and you’ve been coming back at least every couple years on these rate increase filings and so should we except if that’s in fact the cause of effect here on higher claims when you file for rate increases. Shouldn’t we think about that as more of a recurring issue if you keep coming back for future rate increases?
First of all, I don’t think internal rate increases is forever, we've kept on coming back because the interest rate environment has deteriorated. You get more recent experience of not only within Unum, but industry tables and things.
This isn’t always get worse forever thing. I expect we will get very close in the current filing to being where we need to be to support the sustainability of the business. There may be some rate increase filings in the future. Those would be predicated on changes in our view of what the future of long term care will be.
So I don’t see rate increases being forever in our future thing. You do get a mild blip on rate increases when you do them and that’s what we're seeing now, but we believe it's temporary.
We actually think, we're much more confident in where we are in long term care in our ability to manage through not only the short term with our current reserve position, but manage through long term current general and I think others are.
And Jack just related to that, are you then in terms of the level, I don’t know, may be just a broad question, the level of rate that you're asking for, you’re actually getting around what you're requesting, it sounds like you're based on that the way you responded to it because I guess what I've heard from some others is that they might request 50% and they might get half of that, but then its spread out over three years, is that, is my example still more the situation for you or you're getting much closer to what you’re requesting in terms of rate increases?
We’re getting what we expect to get which is less than we request, but we didn’t put what we requested into our reserve assumptions. We put our expectation, so in some states you'll get 50%, in some states it will be spread out over three years. In the scheme things that’s not terribly material, if its spread out over three years given the 40 years the rest of its going to run.
So, it depends by states and many states have approved the full rate increase. Other states have approved the full rate increase but required it to be implemented over three years, but we have good data on how different states react and we’ve built that data into what we are assuming in our reserve assumptions.
Okay. That’s helpful and then as you think about -- can you just remind us your process for this year all timing, is the actuarial review for long term care is that conducted in 3Q and do you -- as part of your process, do you factor forward interest rates, do you look at the forward curve or you look at trailing because obviously forward rates matter a lot more than what you’ve accomplished over the last six quarter?
And based on I guess the claims you’ve gotten to date, how much does that factor in or is that less impactful? Is it really more of an interest rate issue at this point?
We do our reserve reviews in not only on long term care, but across the Board all of our reserve reviews in the company. We start those in the third quarter. They culminate -- they come to conclusion in the fourth quarter, so we're confident in our yearend results. That would be the same timing for long-term care.
In terms of what we look at going forward for the assumption on long term care. We told you exactly what it was. First time it was 5% for four to five years and a reversion to the long term mean thereafter we will come up with -- should we -- when we test, we'll come up with a reasonable assumption that we believe in and that its audited by external auditors. It’s not necessarily the forward curve, but it’s a reasonable assumption.
Okay. And then just my final question is I guess one of the things that surprised me a little bit was the increase in financial leverage. So pro forma the debt pay down that you expect in 3Q you're going to be at a 27% debt-to-cap.
And I guess what surprises me a little bit is, there hadn’t really been much in the way the extraordinary views need, so you’ve done a few small acquisitions but nothing too big.
So, why has the average gone up certainly and it also stands out when you just had a great statutory earnings quarter where the cash generation looked pretty good, but why the increased financial leverage? Is there a need for cash more or what’s happening?
No, first of all we feel very comfortable with where we are. At 27% there is -- it’s a comfortable place. We have great coverage ratios. So we don’t view 27% as being problematic. With that said we did prefund the debt maturity in September when we purchase -- when we announced the Starmount acquisition, we talked about funding a portion of that and debt.
And just when we looked at our capital plans and where our leverage would end up it made sense, it made sense that to make that a little bit bigger debt issuance given the rates at the time and where things were and given what we thought our equity growth would be through 2017. So we're very comfortable where we are. We expect it to come down over the ensuing few quarters, but there's nothing remarkable about it.
Okay. So no issues with the rating agencies with the…
The higher level. And then sorry, last question if I could sneak it in, do you guys expect to contribute to the long term care cap to bit off this year in terms of fair wind or the New York sub as well. And if so, what size should we expect in terms of capital contributions?
Yeah, we would expect to contribute to the New York sub. Our guidance on that has always been look at the levels that we've historically contributed as guidance. We will keep the sub well capitalized, that's our commitment. We'll see how much capital that requires when we get to yearend.
And how about the captive?
I just talked about the captive.
Oh! You just that that's the TBD?
Yeah, we'll see whatever it requires at yearend.
Well, I think the key things Tom is our capital plans remain very much intact and so how things move around between new parenthesis is a move point. We feel very good about our capital plans, where they are, how we’ve talked about them going all the way back to last year and we'll see -- you'll see as execute on those?
And all of those have built into our expectations in the underlying free cash flow generation has actually exceeded our expectations.
Okay. Thanks guys.
All right, thanks Tom.
And we’ll go next to Michael Kovak with Goldman Sachs.
Great, good morning. Thanks for taking the question. Could you help us think about maybe some of the potential knock-on effects in the U.K. from the Brexit? I know you mentioned clearly NFX headwind and potentially some premium and net investment income, but as your team works through the last month in terms of what you're seeing from future sales and also thinking about as well potential impact on the benefit ratio visibility line in particular if the U.K. does enter some recession, thing that within the context of other GDP slowdowns that you’ve seen either in the U.S. block or in the U.K. historically?
Okay Michael, it sounds like a full analysis of our U.K. business, I'd step back one thing and make sure that investors, analysts remembers it's just about 10% of our company. We’ve very much like our U.K. business. It's a fantastic business, but relative to the enterprise it is 10%. And with that maybe I'll turn it over to Peter to just give a quick overview of Brexit and how it’s impacting us.
Thanks Rick, and thanks Michael for the question. So just to take you back, we decided to vote for exit late June and the immediate impact was quite volatile. So we saw equities drop both for the 250.
They’ve pretty much come back now to where they were pre-Brexit. We did see the risk free rate drop as well that hasn't come back yet. And obviously the thing you're seeing in our results is the exchange rate dropping to around about $1.32.
I think one of the things that if it stays there you will see continued pressure because our average exchange rates we're using at the moment in the $1.40, so that would come down if it's sticks at $1.32.
What I would say it's an uncertain environment and it's new for remainders, leavers to now we're waiters to see what's going to happen to the economy. Looking to the U.K. if you take our investment portfolio, Jack talked about this already, we're very well positioned to finance the stocks and feel very good about the investment portfolio and the robustness of that.
And if you take revenues, we've got exposure to keep some of the keep financial services friends. In talking to them though, very few have definitive plans about what they're going to do yet. Again they're more cautious I would say and we saw a bit of that come through our premiums in the first half and so therefore they're not investing in recruiting people perhaps to having more of an eye for cost control on their benefits plans, but nothing material I would say yet coming through that would affect us.
To answer your question on benefits, actually in the last recession we didn’t see a lot of impact on our benefit ratio. We saw something called presentism, people worried about their jobs and actually not going off. So that was a bit of a counter cyclical aspect for us.
This all brings very robust. So we're pretty happy that we've got a good focus on the risk free rise and what the impacts of that might be. The area that is more difficult to call is the new money rates. As I said risk free clearly the 10-year bond is below 1% for the U.K. And again like the U.S. we've got a proven track record of putting rate through.
Clearly that will probably dampen growth a bit because not all our competitors are as disciplined as Unum is both in the U.S. and the U.K. but we'll have to see how that works out and really as we go through the next few months and the government begins to set out its position we'll get a clearer picture and be able to update you on the impacts as that becomes more clear. I'll just finish that. We've got a strong business model that’s well positioned to manage Brexit. That was all I was going to say Rick.
That was great. Thanks Peter.
Great. Very helpful. And are those changes particularly the FX and investment income impact in the forward EPS guidance that you gave for the second half of the year?
We understood when we gave that guidance that that was an impact. So yes.
Yeah, great thanks and then one last one, in terms of shifting gears to the U.S. as you think about growth, can you may be give us a little bit more detail in terms of what is driving the large case market success that we've seen for the past couple quarters? Is it mostly with current customers or are you winning share with some new customers?
Yeah, great question. I appreciate it and you hit the nail on the head, it's almost entirely selling into those existing client relationships and we talked about an aggregate persistency rate of about 90%. We’re actually taking too higher than that in our large employer market.
So these are long term clients that we've been able to grow within quite effectively cross selling re-enrolling contract changes and the like. So we're encouraged about that, this is also selling season for the large employer market. Many of them make changes to their benefit plans with a January 1, effective date and to be implemented those decision need to be happening now and we feel like we’re competing effectively, but maintaining our discipline here through the new case sell season.
And are you seeing any divergence in terms of the comparative landscape between the large case and may be the core middle-to-small case markets.
Yeah, I would say across the Board it's reasonably competitive where we feel at most acutely would be in the middle market. So that’s typically employers in the say 250 employees of the say 5,000.
Typically you’ve got competitors in the space that are focused in the large case but they will go down into the mid and then you have small employer focus carriers that will go elephant hunting and that takes them up into the mid.
And so pretty much I can get a crowded space and when prices get a little bit soft we find it's a difficult place to write business within our pricing parameters, but again its much work to be done between now and the end of the year and we feel like we get a good value proposition to take into the market, but that’s where we probably felt it most acutely. Thank you, Michael.
And we’ll take our next question from Yaron Kinar with Deutsche Bank.
Good morning, everybody. I have couple of questions first I heard you talk about the claims impact from raising pricing in the long term care, can you explain the relation between the two?
Yeah, it’s been something we're seeing and it’s kind of like waking and sleeping dog, when they get the rate noticed and it’s not only the policy holder but it’s very often that caregivers or children of the policyholder that would oftentimes no person can go into and assisted living facility and not even realize that they have the coverage even know they're still paying for it and that rate increase comes out as a reminder.
That reminder sparks people to apply for the benefits. You get some rate applications with that, people who are already -- have been in a facility for a while who are looking for back payments. So that affects the loss ratio and it just becomes an increase.
We actually looked over that past couple of quarters at the incident rates on people who received the notification versus the incident rates on people who will be receiving but haven’t received them yet and there is a 10% to 15% difference between those two with the ones being notified being 10% to 15% higher.
It impacts severity of claims as well because that lending, that notification is focused on people with inflation riders and so they tend to have higher benefits. We’ve seen it in the past, it's going to last for a while as we work through those rate increases, but we do believe it's something will abate over time.
Okay. And I guess when speaking to other I often here when I discuss shock lapse once the great increases come in, in the grand scheme of things, are you seeing more of a favorable impact from shock lapse or more of a negative impact from kind of waking these sleeping dogs?
I think shock lapse is relative. If their lapse rate go up 0.1% or 0.2% it is big relative to the lapse rate but I’m not sure I would go out of shock lapse. We really don’t see a kind of lapses with rate increases maybe a little blip and in particular because the lending spot provides the option to maintain their counter premium. We would expect to see even a less of a persistency impact from these rate increases.
Okay. And then one quick clarification if I can with regards to the updated guidance and I think you talked about it in the prepared comments, but is the move up to the top end of the prior guidance, is that pretty much predicated on better than expected results in the first half of the year or is there also some expectation that relative to how you start of the year developing when you gave the initial guidance, if there is some expectation that the second half results will be better than initially expected?
Yes we've assumed that the second half of the results will be on plan which is very consistent with your consensus estimates.
Okay. Thank you very much.
We will take our next question from Eric Berg with RBC Capital Markets.
Good morning, Eric.
Mr. Berg, your line is open.
Yep I'm ready. Sorry I was on mute. I was surprised to hear that in response to an earlier question that in the last recession in the U.K. there had not been a material increase in claims experience because that would be announced with the U.S. experience? Did I hear and interpret you Peter's response correctly and if I did, what was different back that would explain this different from U.S. experience.
Eric, maybe I will take that from an U.S. perspective first. We actually did not see the increased level of claims coming through some of the financial crisis, but we would have seen maybe as higher level of submitted but our paid claims were very stable through that period of time. So I don’t actually think there was a difference. I think the U.K. experience was actually quite similar to that which we saw in the U.S.
Okay. And then secondly finally in the long term carrier, Jack I think you mentioned in your prepared remarks that the decision by many customers, many policyholder to accept this landing, landing script option would have implication for either the volatility or the way that fill the reserves prospectively, could you just go over that concept and maybe explain it a little bit further. Thank you.
Yes. So if you pay the rate increase, your benefits continue to grow at 5% compounded annual rate. So those who pay the rate increase have a bigger benefit out there and that additional premium pays for that benefit bucket.
If you take the landing spot, they compound at 3%. So the ultimate benefits that you pay down the road are significantly smaller than they would have been had you paid the premium.
As you realize fluctuations whether it's interest rate fluctuations or underlying experience fluctuations, they don’t affect premiums. They affect the benefits much more severely and so by having a smaller pool out there you're less sensitive to interest rates or mortality fluctuations.
Which will also have lower premiums than would otherwise have been the case.
Yes but the premiums are not as low -- they're not as sensitive to those things as the benefits are. If you're going to have higher incidence down the road, premiums don’t react to that benefit.
All right, thank you. Go ahead.
It's a little like de-risking a pension plan.
In general are you -- have you said that you have been neutral towards, agnostic towards the landing, does the landing spot leave you better off than if a customer does not elect the landing spot neutral or worse off?
It's relatively neutral. But you do get that benefit of being less sensitive to future changes and assumptions.
And we will go next to Mark Hughes with SunTrust.
Yes Colonial sales have been quite strong. I wonder if you have any commentary on recruiting in sales force trends, what that might mean for second half sales?
Great, thanks Mark. We're happy to take that as our last question. I'll flip that over to Tim Arnold.
Yes Mark thanks for the question. We feel great about results that we're delivering. To your point about recruiting -- we're seeing very nice uptick in recruiting and probably more importantly have very strong growth in our sales management team. So the new recruits that we're recruiting are getting a lot of attention and the success rate in the new recruits is improving.
We like the market environment a lot right now. The market dynamics are very favorable. Employers increasingly need the solutions that we offer. It's certainly working and they need the solutions that we offer. Feel very good about our strategy, terrific execution of that strategy especially in field distribution growth, very disciplined activity levels, incredible capabilities including what we believe is unparalleled enrollment capabilities.
We do a lot of core enrollments for every dollar of claim life benefits dollars of other benefits which comes with creating a very strong value prop for small employers especially a tremendous depth of our products, capabilities and services.
And finally outstanding leadership team, strong capital implementation. So we feel very good. We had a very, very strong second half of the year in 2015. So we're up against some good numbers, but we're optimistic.
Great. Thank you, Mark for the last question. I would like to thank all of you as well for taking the time to join us this morning. We look forward to seeing many of you at various investor conferences and meetings in the weeks ahead and so operator this nor completes our second quarter 2016 earnings call.
Thank you, everyone. That does conclude today's conference. We thank you for your participation.
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