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StanCorp Financial Group, Inc. (NYSE:SFG)

Q1 FY08 Earnings Call

April 22, 2008, 12:00 P.M. ET

Executives

Jeffrey J. Hallin - Second VP, IR and Financial Planning

Analysts

Ed Spehar - Merrill Lynch

Keith Walsh - Citigroup

Jukka Lipponen - KBW Asset Management

Eric Berg - Lehman Brothers

Mark Finkelstein - Fox-Pitt Kelton

Ron Bobman - Capital Returns

Edward Spehar - Merrill Lynch

Jason Zucker - Viva Capital Partners

Eric E. Parsons

- Chairman, President and CEO

J. Greg Ness - Sr. VP, Insurance Services Group

Floyd Chadee - Sr. VP and CFO

Kim W. Ledbetter - Sr. VP, Asset Management Group

Operator

Ladies and gentlemen, thank you for holding. Welcome to the StanCorp Financial Group Incorporated First Quarter 2008 Financial Review Conference Call. All lines have been placed on mute to prevent any background noise. Today's conference call is being webcast live over the Internet and is also being recorded. A question-and-answer session will follow today's presentation. [Operator Instructions].

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

Jeffrey J. Hallin - Second Vice President, Investor Relations and Financial Planning

Thank you, Heather, and welcome to StanCorp's first quarter 2008 financial review conference call. Here today to discuss the company's first quarter results are Eric Parsons, Chairman, President and Chief Executive Officer; Greg Ness, Senior Vice President, Insurance Services Group; Floyd Chadee, Senior Vice President and Chief Financial Officer; Kim Ledbetter, Senior Vice President, Asset Management Group; and Rob Erickson, Assistant Vice President and Controller.

Today's call will begin with some brief comments from Eric, Greg and Floyd, and then we will open it up for questions. Before we begin, I need to remind you that certain comments made during this conference call will include statements regarding growth plans and other anticipated developments for StanCorp's businesses and the intent, belief, and expectation of StanCorp's management regarding future performance. Some of the statements made are not historical facts but are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements are subject to risk and uncertainties, actual results may differ from those expressed or implied. Factors that could cause those actual results to differ materially from those expressed or implied have been disclosed as risk factors in the company's first quarter earnings release and the 2007 Form 10-K.

With that I would now like to turn the call over to Eric. Eric?

Eric E. Parsons - Chairman, President and Chief Executive Officer

Thank you, Jeff, and thanks to all of you who have joined us for our first quarter earnings call. I'd like to begin my remarks by welcoming the newest member of our senior management team. Last month, we announced the appointment of Floyd Chadee, as Senior Vice President and Chief Financial Officer. Floyd brings strong experience and deep knowledge in our key product areas. His leadership experience and financial background fit well within StanCorp and I'm confident he will bring an important perspective as we continue our focus on delivering outstanding results for our stakeholders. Welcome Floyd. You'll all hear from him in just a moment.

Moving on to first quarter’s results, I'm pleased to report a solid quarter for StanCorp Financial Group. First quarter net income excluding after tax net capital gains and loses was $1.08 per diluted share to 22.7% increase over the first quarter of 2007. Our results were affected by three factors; continued strong performance in our core Insurance Services Group, the favorable impact of our share repurchase program, and the unfavorable impact of declining equity markets on our Asset Management Group.

In the Insurance Services Group, claims were better than our long-term average over the past four years and significantly better than our typical first quarter. In addition, premium growth continued at relatively strong pace compared to the industry as a whole. Excuse me, as we've often mentioned, excuse me, claims experience is inherently volatile when viewed on a quarterly basis.

In the Asset Management Group, a significant portion of our revenue is based on fees that are determined as a percentage of assets under administration. As asset values decline, our fee income is reduced and the amortization of deferred acquisition costs is increased, and of course our successful issue of hybrid securities and related increase in share repurchases in 2007 reduced our overall number of shares outstanding.

There seems to be no question that we'll continue to face economic uncertainties as the year unwinds. But I remain confident about StanCorp for at least three reasons. First, we like our book-of-business. You all know that a significant portion of our premiums come from industries that have historically been resistant to many of the pressures that employers face in a recession. We have not compromised our underwriting to achieve sales growth and we have one of the finest claims operations in the business. As we know from history, fluctuations are always a possibility but our core business is strong.

Second, our Asset Management business will continue to feel the effects of changing markets, but we're building a retirement plans platform that will help us continue our strong record of industry-leading customer service. And third, our balance sheet is solid. Our bond portfolio remains strong and our commercial mortgage loan portfolio continues its long history of exceptional performance.

In summary, the first quarter’s results represent a good start to the year. Although the rest of the year may present some challenges, we will continue to manage the business with focus and discipline and with an eye on the creation of long-term sustainable value.

With that, I'll first turn the call over to Greg for an overview of our Insurance Services segment and then we'll go to Floyd for the financial results and of course we'll leave plenty of time for questions at the end. Greg?

J. Greg Ness - Senior Vice President, Insurance Services Group

Thanks, Eric. The Insurance Services segment had a strong first quarter with income before income taxes up 17.6% compared to the first quarter of last year. Both premium growth and comparatively favorable claims experience in our group insurance business were a key to these results.

Premium growth in the first quarter of 2008 was 9.1%, which is ahead of our 6% to 8% growth expectation for the year. Premium growth this quarter resulted primarily from growth in both our Group Life and Individual Disability businesses. Our group insurance benefit ratio at 76.6% was favorable compared to the first quarter of 2007 and better than our annual expected target range of 77.5% to 79.5%. However, given the volatility inherent on a quarterly basis our results were well within our normal historical range. As always, claims will fluctuate from quarter to quarter. We continue to like our mix of business. A significant portion of our premium is from our life product and a significant portion of the remaining LTD premium is from industries that have historically been resistant to recessionary pressures. With good product, industry, geographic and case size diversification, we have not seen a correlation between slowing economic conditions and our claims experience.

Sales in our group business were $120.8 million in the first quarter, slightly ahead of 120.1 million for the first quarter of 2007. Our sales results this quarter reflect a continued price competitive market environment. As we've said in the past, we will not chase cases where the market rate is significantly lower than our risk rate. We will continue to drive our sales force with the necessary resources to help them target the right cases that meet our profitability objectives.

Our Individual Disability business continues to grow steadily with premiums up 11% after the effects of reinsurance and sales up 16.3% during the quarter. Although, claims experience was comparatively less favorable than in the first quarter of last year, claims experience can fluctuate widely for this small block of business and as with the group business it was also well within our historical norms.

2007 industry growth figures were just made available to us. I'm pleased that once again we grew faster than the industry as a whole, continuing to garner more market share. While growth rates will fluctuate from quarter-to-quarter and year-to-year, the group insurance business has plenty of opportunity for growth overtime. We expect to continue to outpace industry growth and do so with our disciplined pricing approach. Our longstanding history in this business reflects our ability to grow this business in a profitable manner, through both favorable and unfavorable economic environments. Profitable growth begins with getting the right rate on the right risk. Then we backup our promises with a solid balance sheet.

With that, I'll turn the call over to Floyd. Floyd, we are glad you are here.

Floyd Chadee - Senior Vice President and Chief Financial Officer

Thank you, Greg. As we announced yesterday, our earnings per diluted share excluding after-tax net capital gains and losses were $1.08 for the quarter compared to $0.88 for the first quarter of last year. Our results were driven by good premium growth in the insurance services segment, comparatively favorable claims experience in our group business and the favorable impact of our share repurchase program.

In the Insurance Services segment, income before income taxes for the first quarter was $78.9 million compared to $67.1 million in the first quarter of last year. The primary contributing factors were the 9.1% premium growth and the comparatively favorable benefit ratio that Greg referred to in his remarks. During the first quarter, we lowered the discount rate used to establish new reserves by 35 basis points to 5.0%, a rate, which is 50 basis points lower than the 5.5% used in the first quarter of 2007. The average new money rate for the previous 12 months was 5.76%, which provides a 42 basis point margin over the average discount rate for the previous 12 months. Our portfolio margin at the end of the first quarter was 41 basis points.

In the Asset Management segment, asset fund administration declined 2.6% from the balance at the end of 2007, primarily due to equity market declines and assets in our retirement plans business, which was partially offset by net deposit growth. Pre-tax income of $8.3 million was $2.1 million less from the first quarter of 2007. These results were primarily due to the impact of declining equity markets and revenue and DAC amortization. Individual annuity sales were exceptional during the first quarter. At a $174.9 million, these sales reflect growth in our distribution channels and less competition from alternative investments.

Turning to investments. Our fixed maturity securities portfolio is well diversified and continues to perform well with the current portfolio yield of 5.54% and an average portfolio rating of A, as measured by Standard & Poor's. Our commercial mortgage loan portfolio yield was 6.3% for the quarter. In the first quarter, we originated more than $400 million of commercial mortgage loans, a 36% increase compared to the first quarter of last year. Reduced competition among lenders has created or continued to create excellent opportunities for us. And third party investors continued a strong interest in the high-quality fixed rate commercial loans we originate and service. At $2.1 billion mortgage loans managed for third party investors were 38% higher at March 31, 2008 compared to a year ago. For the remainder of 2008, we expect to continue to have strong originations.

Turning to capital, in the first quarter, we repurchased almost 230,000 shares at a total cost of $10.9 million, at an average price of $47.30 per share. We expect repurchases for the remainder of the year to be inline with the first quarter. Our pre-tax statutory earnings for the quarter was $76.5 million and the risk-based capital at our insurance subsidiaries was 303%. Overall, the first quarter’s results represent a good start to the year, and we feel we're well positioned to achieve our previously stated financial targets for 2008.

And with that, I will now turn the call back to Jeff to begin the question-and-answer session. Jeff?

Jeffrey J. Hallin - Second Vice President, Investor Relations and Financial Plan

Thank you, Floyd. Heather, we're ready to start taking calls from our participants.

Question and Answer

Operator

[Operator Instructions]. We will now take our first question from the line of Ed Spehar with Merrill Lynch.

Eric E. Parsons - Chairman, President and Chief Executive Officer

Hello, Ed?

Edward Spehar - Merrill Lynch

Thank you. Hi, how are you?

Eric E. Parsons - Chairman, President and Chief Executive Officer

Good, yourself?

Edward Spehar - Merrill Lynch

Good, thanks. I have two questions. The first is, I guess I was a little bit surprised by the reduction in the discount rate and I was wondering if you could talk a little bit more about what your new money rate looks like today, especially considering the opportunities you might see on the commercial mortgage side? And then related to that I was wondering if you could go through with us again, how we should think about an increase in mortgage originations and the related income that you might get in the Asset Management segment, and maybe what's your capacity is to originate loans because it seems like there is an opportunity to step in given what's happened in these securitization market?

Floyd Chadee - Senior Vice President and Chief Financial Officer

Ed, this is Floyd. I'll start with the question on the discount rate. The spreads have widened... the spreads have widened in the quarter, but at the same time we've seen treasuries go down. So our actual rate... new money rate for the quarter was in the order of 5.37%. Now the way we set the discount rate is, we try to maintain an average margin over the 12-weighted margin over the last 12 months. So consistent with that when we look at the new money rate in the first quarter here, given the widening spreads for the decrease in the base rates and the fact that our new money rate went down, we ended up with a 5.0%. So I think it's driven not by the... just by the widening spreads but the decrease in the base rates too. One of the things that we... when we look at single A corporate for example, I mean, the yield on those went anywhere from 544 to 519, but went as low as 502 during the quarter. So we did see a decrease in the new money rate. I mean this is something we look at every quarter and we'll see how it goes next quarter too. As far as mortgage origination goes, I'll turn that question to Kim to give you some color on that.

Kim W. Ledbetter - Senior Vice President, Asset Management Group

Hi, this is Kim Ledbetter. Generally in terms of mortgage business tracks, mortgage originations, so if we have higher originations we'll see slightly higher income. That size that business relative to the rest of company is fairly small. So I think I wouldn't expect to see a large impact on the overall company earnings from those higher originations. We are seeing, of course, more opportunities to make mortgage loans but we also see opportunities that we needed to walk away from because of less competition and so we're getting a lot of demand and so we are being very selective in how we grow that business and the mortgages that we do make. So I think you'll see originations going forward at roughly the same level, maybe a little higher going forward, but we're going to be very selective in what we do.

Edward Spehar - Merrill Lynch

And just a quick follow-up, on the new money rate, I guess if we think about today and we look at the opportunity, I think there is a lot of things have been happening recently in the commercial mortgage area, and I guess from a spread standpoint it seems like it's getting better. And I'm just wondering when you think about the new money rate and the combination of single A corporate and commercial mortgages, are we looking at a higher new money rate potentially today as we sit versus what we've seen in the last quarter or two quarters?

Floyd Chadee - Senior Vice President and Chief Financial Officer

I mean I think it's a very interesting market out there and where new money rates will end up with an average, I mean, for the second quarter is always is uncertain, but I mean, you could very well be right, and we will wait to see until the end of the second quarter where it's -- will that ends up. And if does end up higher, we certainly react to it.

Edward Spehar - Merrill Lynch

Thank you.

Eric E. Parsons - Chairman, President and Chief Executive Officer

Thank you, Ed.

Operator

Our next question comes from the line of Keith Walsh with Citigroup.

Eric E. Parsons - Chairman, President and Chief Executive Officer

Hi Keith.

Keith Walsh - Citigroup

Good morning everyone. How are you?

Eric E. Parsons - Chairman, President and Chief Executive Officer

Good.

Keith Walsh - Citigroup

Congrats on a very solid quarter. First, for Greg. Just... maybe if you give us a little color around premiums, we've been seeing several quarters in a row now of very solid growth here, maybe if you could talk a little bit about January 1 renewals and how that's been positively impacted this quarter, because I know last quarter... last, first quarter, I should say was a negative overhang? And then I guess for Floyd, just thinking about capital and maybe kind of intersecting with Ed's question a little bit, as you guys have more opportunities in the commercial mortgage arena, I would have to think the rating agencies are watching now with some concern as well and you guys run about a 300 RBC, which is pretty lean. How do you guys, you capital these days and what's your view in relative to the rating agencies view and then I've got a follow-up for Eric?

J. Greg Ness - Senior Vice President, Insurance Services Group

Okay, Keith, let me start with the premium growth question. Sure, very good premium growth in the first quarter. Keep in mind that we had some very large cases in the latter half of the year, which we're now seeing the benefit of the ongoing premium flow in the first and second quarters here. So, that's in part responsible for that result. We continue to expect to see premium growth in that 6% to 8% range for calendar 2008. And you are right that certainly that number is affected by new sales, but also by the persistency trends, which as you know we report annually at the end of the year. We've gone through our one-one renewals. I don't see anything there that is too bothersome. There is always some cases there that you like to loose that you didn't want to keep around, because they were not hitting your profitability objectives and then on occasion, there is always a case or two in there that you would like not to have lost but may be via acquisition, or something as the case goes elsewhere.

Floyd Chadee - Senior Vice President and Chief Financial Officer

On the capital side, I mean, our target is above 300% of RBC. I think, we can understand in this uncertain environment, certainly given what's been happening to residential loans that I mean there is nervousness out there in terms of loans in general. But we haven't seen any deterioration in our commercial loan portfolio to really say there is any analogy that should be drawn with the residential loan situation externally. So we do understand that rating agencies will continue to look at that and be concerned. But, we haven't... we certainly haven't seen anything to cause us worry at this point.

Keith Walsh - Citigroup

And no pushback from the rating agencies as far as you guys growing that book?

Floyd Chadee - Senior Vice President and Chief Financial Officer

Yes, nothing, nothing, nothing. No.

Keith Walsh - Citigroup

Okay, and then just --.

J. Greg Ness - Senior Vice President, Insurance Services Group

One thought on that and that is that the most of the marginal originations are going to other investors who are really not increasing at any greater rate the portfolio in our own insurance companies. And that of course is what's going to drive the rating agencies and the capital requirements.

Keith Walsh - Citigroup

Okay, and then just the final one for Eric. Just maybe if you can give us an update here on Invesmart, just going back to May '07, your Investor Day and you guys talked about sort of some of the targets as far as integration... full integration by the second half of this year I believe and the 14 or 15 ROE, where do you stand today relative to those targets?

Eric E. Parsons - Chairman, President and Chief Executive Officer

Keith, thanks and I'll ask Kim to join me on this if you have some additional comments. I would say that we are as pleased as ever about the Invesmart integration. Among the things that have gone very well for us certainly are the retention of the good business that we acquired, the rapid integration of the sales force and what looks like really a very productive sales force now for us when you combine both the Invesmart group and the originally Standard group, we're seeing some good sales results. And so we like that a lot. We have continued to see some additional opportunities to enhance our service platform and so we have elongated the time period and increased the investment that we're willing to make in that to the point where we'll probably continue to be working on that now through the rest of this year. The system work is nearly done. But of course, once the system work is done, and then you've got to transfer the cases onto the system and is only after that is done that you'll start to see some real cost efficiencies. What I really like though is that we will get both cost efficiencies and I think even better customer service capabilities than we've had before. So, while the approach has changed just a little over time, the ultimate outcome I think will be at least as good and maybe a little better. [inaudible]

Keith Walsh - Citigroup

Yes, that's helpful.

Kim W. Ledbetter - Senior Vice President, Asset Management Group

I will just add that when were done with the current work that we are doing, we will have a very solid platform to grow our current [ph] plans business even faster and more efficiently and effectively than we've done in the past, and so we are pretty excited about the work that's going on and what we're going to end up with when were done.

Keith Walsh - Citigroup

Thank you.

Eric E. Parsons - Chairman, President and Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Jukka Lipponen with KBW Asset Management.

Eric E. Parsons - Chairman, President and Chief Executive Officer

Hey, Jukka, how are you?

Jukka Lipponen - KBW Asset Management

Good morning. Thank you. I'm doing well and how are you?

Eric E. Parsons - Chairman, President and Chief Executive Officer

Good, thanks. Well, a little frog in my throat but otherwise okay.

Jukka Lipponen - KBW Asset Management

I intend to have the same thing here a little bit but a couple of questions. First of all on expenses, in the insurance business, was there anything unusual in the expenses this quarter? I guess based on your fourth quarter commentary, I was expecting that the expenses would trend down a little bit perhaps?

J. Greg Ness - Senior Vice President, Insurance Services Group

Good morning, Jukka. This is Greg. Operating expenses in Q1 really were consistent with premium growth. If you look back, you'll see that we see slightly higher expenses in quarter one that seems to be our pattern, that's the quarter when we finished off some incentive compensation payments, as well as the quarter when our base salaries generally change. We watch it very closely. As you would guess, I recognize that we also added a record level of new business last year. Probably the key point is to recognize that I would not anticipate the growth rate to continue moving forward for the balance of 2008 at that level.

Jukka Lipponen - KBW Asset Management

And in the Asset Management business, seemed like the DAC amortization jumped up, given the results in the quarter. That was a little surprising and I don't know the commission and bonus line there was that primarily driven by the strong fixed annuity sales or the strong annuity sales?

Floyd Chadee - Senior Vice President and Chief Financial Officer

As far as the DAC amortization goes, Jukka, I mean that follows directly from sort of the way the calculation is done, given the drop in the equity market and the expectation... the pattern of expectation of future gross profit. So, almost formulaic in terms of how that goes. With respect to the commissions, I'll let Kim take that.

Kim W. Ledbetter - Senior Vice President, Asset Management Group

Jukka, hi. This is Kim Ledbetter. Certainly, the higher annuity sales drove the commission increase, as well as we've had good sales in our retirement plans business as well in the first quarter.

Jukka Lipponen - KBW Asset Management

And last question on excess capital and buyback, what's your excess capital position currently? And why seemingly a little bit more caution on the level of buyback this year?

Floyd Chadee - Senior Vice President and Chief Financial Officer

Yes, our capital position is just about $90 million. Excess capital is pretty much as same as it was at the end of the fourth quarter last year. I mean you did see a significantly high average buyback last year compared with what we did in the first quarter. I mean this was coming off the hybrid debt that we took on. So, you did see that higher rate of repurchase last year, I mean we did. So what you've seen in the first quarter is the return to more normalized levels. Given the sort of uncertainty in the economic environment, the general uncertainty over there, I mean, we... I mean our intent is to be cautious in the short term here and reevaluate. What we are feeling right now is that you probably should be thinking of what you saw in the first quarter is really being the expectation for the rest of the year.

Jukka Lipponen - KBW Asset Management

Thank you.

Eric E. Parsons - Chairman, President and Chief Executive Officer

Thank you.

Operator

Our next question comes from line of Eric Berg with Lehman Brothers.

Eric E. Parsons - Chairman, President and Chief Executive Officer

Hello, Eric.

Eric Berg - Lehman Brothers

Thanks very much. Good morning. Can you hear me?

Eric E. Parsons - Chairman, President and Chief Executive Officer

Better I can. How are you today?

Eric Berg - Lehman Brothers

Everything is great, it's school break and I find myself in Florida, away from the family…

Eric E. Parsons - Chairman, President and Chief Executive Officer

That sounds good to me.

Eric Berg - Lehman Brothers

Away from the family for a little bit. So, thanks for taking my question. Couple of questions here. First, again in the capital area I know that you are running with about the same shareholders’ equity, GAAP shareholders’ equity that you are at, at the end of 2006, yet have a growing company. My question is, does this present an issue? How should we think about this? Can you continue to grow and shrink your shareholders’ equity or will the rating agencies limit that?

Eric E. Parsons - Chairman, President and Chief Executive Officer

Eric, let me take that one since it's a… this is Eric Parsons, since it's a historical question. The equity credit that we've got from the hybrids is important in that calculation and so in addition to the equity that we held a couple of years ago, which included no hybrids, we've added to that the hybrids, the equity credit that we got from the rating agencies and that, in fact, gives us a higher, what I want to say, capital equivalent than we had a couple of years ago and continues to support the business very nicely also allowing us to manage the capital more effectively, keep our cost of capital in a pretty narrow band.

Eric Berg - Lehman Brothers

That's helpful. My second question relates to the asset management and it's just a question about sort of future disclosure. As this… because you have identified this business as a growth area and a priority of the company, I was wondering whether you are considering providing more information regarding whether you plan to provide information regarding the net flows because speaking for myself only, of course, I have to say I find it hard to know whether you are really growing this business organically since we don't see the net flows and the assets under administration sort of flow from one quarter to the next, captures everything that's going on with those assets in addition to the effect of interest credited in the market. Might you offer us some additional detail to see what's going on, so to speak, organically? Thank you.

Floyd Chadee - Senior Vice President and Chief Financial Officer

Yes. I think given the somewhat dramatic changes in the equity markets, we understand fully that it's difficult to track what's going on in the current circumstance. Certainly as this business grows and we intend to grow it as part of our portfolio, I think it's reasonable to have that discussion on should we increase our disclosure to provide you more information and that's certainly something we look at as this business grows over time.

Eric Berg - Lehman Brothers

Thank you for considering it. That's it.

Eric E. Parsons - Chairman, President and Chief Executive Officer

You bet. Thank you, Eric.

Operator

Our next question comes from the line of Mark Finkelstein with FPK.

Eric E. Parsons - Chairman, President and Chief Executive Officer

Hello, Mark.

Mark Finkelstein - Fox-Pitt Kelton

Hello, good morning. I am actually going to take a slightly different crack at the capital question. I guess if we use the current run rate of repurchases, dividends, etcetera, what would you forecast year-end RBC to be in the Stan entity?

Floyd Chadee - Senior Vice President and Chief Financial Officer

I mean we are targeting 300%, so I mean we do generate about… I mean over an annual period, we do generate about $125 million to $150 million of excess capital and we use about $80 million to $85 million of that in various things such as interest rates and interest charges and dividends etcetera. So, I mean we are targeting 100… 300% in the Stan entity.

Mark Finkelstein - Fox-Pitt Kelton

So, is it fair to say then because… I might want to follow up on this, but, at a 40 plus million run rate of repurchases that would get you at year-end towards that 300% RBC level?

Floyd Chadee - Senior Vice President and Chief Financial Officer

I mean we will maintain the 300%, we intend to maintain the 300% RBC level and then what we consider excess capital is beyond that. So, I mean we are fully confident that we will be at the 300% level.

Mark Finkelstein - Fox-Pitt Kelton

Okay. Maybe another way of asking it is, would you accept that excess capital to grow by year-end if you maintain that 300% RBC?

Floyd Chadee - Senior Vice President and Chief Financial Officer

Right. I think there will be some growth and it all depends on what we do with share repurchases.

Mark Finkelstein - Fox-Pitt Kelton

Okay. Greg, just a comment, is there anything you can talk about in terms of the pipeline in the second quarter and kind of what you're seeing in terms of opportunity and I guess market competition?

J. Greg Ness - Senior Vice President, Insurance Services Group

Mark, good question. I would say that the market competition is significant. Our reps would say that there is no lack of competitors on each case and we continue to see competitors do what we continue to believe as kind of some irrational kind of pricing behaviors and so on. But the good news is our folks are still out there issuing proposals, we are getting a look at a number of cases and that's exactly where we want to be at this stage.

Mark Finkelstein - Fox-Pitt Kelton

Okay. And then just a final question. Annuity sales kind of jumped in the quarter, can you maybe just talk about what you are seeing there?

Eric E. Parsons - Chairman, President and Chief Executive Officer

Can you maybe talk that?

J. Greg Ness - Senior Vice President, Insurance Services Group

Sure, Mark. I’ll do that. I think that the annuity sales increase in the first quarter is primarily due to what's going on in the external environment. I saw a study recently from Hewitt [ph], which showed that for 401(k) participants, that was a big movement of funds from equities to fixed-income investments. I think we saw the same thing, same effect on our annuity sales in the first quarter and in fact the annuity purchases are probably even more conservative than your typical 401(k) participant. And so, I think the external market and the fact that some alternative investments such as bank CDs and… were less attractive during the quarter. Those were the primary reasons we saw that big increase. The other reason was that we’ve done a lot of work last year to grow our distribution channel and we have many more outlooks now for our annuities and we saw the effect of that in the first quarter as well.

Mark Finkelstein - Fox-Pitt Kelton

Okay. Great. Thanks.

Operator

Our next question comes from the line of Ron Bobman with Capital Returns.

Eric E. Parsons - Chairman, President and Chief Executive Officer

Hello, Ron.

Ron Bobman - Capital Returns

Hi gentleman. Thanks for your time. I was curious on the commercial mortgage business, in particular the loans that are already outstanding. What sort of surveillance do you practice and do you make any changes to that? Thanks.

Kim W. Ledbetter - Senior Vice President, Asset Management Group

Hi, Rob. This is Kim Ledbetter. We certainly rely on our mortgage correspondents to inspect the properties each year. We collect operating data from our borrowers each year and we analyze that. And I think it's just a continuation of what we’ve always done. We haven't made any significant changes to what we’ve done, we always certainly improve our technology and our ability to analyze the data as the years go by. But we also manage very carefully any problems that we see and we are very proactive in dealing with the late payment, for example, if that ever happens on a loan, that sort of thing, so we are proactive in dealing with our borrowers, and the results that we've had over the years certainly show the effects of those activities.

Ron Bobman - Capital Returns

Do you get monthly data with respect to whether it would be vacant fees, lease rolls, cash flows at the property level or is it annual data that they are sending you in effect...

Kim W. Ledbetter - Senior Vice President, Asset Management Group

It's an annual look at the property. So, that's when get the information.

Ron Bobman - Capital Returns

Okay. Thanks a lot.

Eric E. Parsons - Chairman, President and Chief Executive Officer

You bet. Thank you.

Operator

Our next question is a follow-up question from the line of Ed Spehar with Merrill Lynch.

Edward Spehar - Merrill Lynch

Thank you. Just two quick ones. I guess one is, I understand that the hybrid that you issued is trading at, I think it’s something like 9.6% yield right now. And I'm just wondering... I know you just issued it, but if you consider sort of the option of buying back some of that versus buying back your stock?

Eric E. Parsons - Chairman, President and Chief Executive Officer

Ed, it’s a great question, in fact, it’s a… the conversation that has gone on around here because we've noticed that as well. I think we have some limitations in order to maintain the equity credit we got for it. Don't think that we aren’t looking for any way we can to maximize value if we can find one.

Edward Spehar - Merrill Lynch

Yes. Okay, that's helpful. And I guess the second question is when you look at sort of how strong your sales were in the second half of last year and you consider the comments that you are making about the competitive environment, I mean it seems like it wouldn't be unreasonable, I think the sales could be down this year. I mean is that... are you still striving to have up sales for the year or is that just something that you are going to let it fall out, however it falls out?

J. Greg Ness - Senior Vice President, Insurance Services Group

Ed, this is Greg. I think you are exactly right, very competitive environment. We've kind of gone on record time and time again to say that we won't chase the market. I do believe that there are some people out there that are doing some kind of ridiculous things whether they would be on price alone or with longer rate guarantees. I’ll give you a quick example just to give you a sense of it. Middle of last year we issued a renewal on a relatively large case that we had and it was a significant renewal increase. The customer ultimately decided to not take that increase and went with another carrier that wrote the business at about 15% or 20% less than our current rate. Now, the bad news is this was a very large mortgage lender that has been hammered by the mortgage subprime crisis and has now laid off over half of their people. So, I like the actions that we took. We went after a large rate increase because we were a little bit ahead of the curve there. And to the extent that there are other people out there that are willing to make frankly not well advised moves, we are content to step back from that, allow those cases to go on their books and they won't be profitable. They’ll come back to market inside of about two years, then the customer will be primed for a rate increase and we’ll pick it up at that time.

Edward Spehar - Merrill Lynch

Thank you.

J. Greg Ness - Senior Vice President, Insurance Services Group

You bet, Ed.

Operator

Our next question comes from the line of Jason Zucker with Viva Capital.

Eric E. Parsons - Chairman, President and Chief Executive Officer

Jason, how are you today?

Jason Zucker - Viva Capital Partners

Good, thanks. Good morning everybody.

Kim W. Ledbetter - Senior Vice President, Asset Management Group

Good morning, Jason.

Jason Zucker - Viva Capital Partners

Couple of questions for you. One is you mentioned in your prepared comments that you weren't seeing any correlation between a slowing economy and your book of business. Could you dissect it for us a little bit further and are you seeing any correlation in the more economically sensitive industry groups? And then separate from that, maybe a bigger picture question, if you think back to the last couple of economic slowdowns, did you see any patterns with respect to pricing changes or mergers and acquisitions.

J. Greg Ness - Senior Vice President, Insurance Services Group

Jason, this is Greg. Let me get started and see if we can make a little headway there. First of all, keep in mind that about 45% of our premium is life premium, which we would assume as not subject to recessionary pressures. Beyond that, then we look at our LTD premium and what we see there is about half of our LTD premium comes from what we would term probably recession-resistant industries, whether they be public or higher education, healthcare, those kinds of industries and so on. One of the things that… we did take a quick look at just to get a sense of it, as we went back and looked at what industries experienced job growth, say from March of '07 through March of '08 just as a proxy to get a sense of what's going on out there. When we look at that, that's about 65%, 66% of our LTD block is contained within those industries. That may very well be while we don't see correlations between a potential recessionary environment and/or claims experience, we continue to monitor that closely, but as of this stage we can't say that we see any correlation there.

Jason Zucker - Viva Capital Partners

Would you… Greg, would you expect just because you didn't see it, but do you expect to see a correlation if compared to the industry?

J. Greg Ness - Senior Vice President, Insurance Services Group

I think intuitively it might make some sense, I clearly have heard other carriers speak to that and I think it’s a function of their block of business and there is a couple of three things to keep in mind. One, you would probably see it most clearly on a short-term disability claims experience right out of the shoot. Secondly, you do have to be disabled and working when you become disabled, and thirdly you have to be disabled under the terms of the contract. So I think each carrier gets to interpret those things based on their book of business and we just don't see it.

Jason Zucker - Viva Capital Partners

Okay, great. And then if you think back historically over the last couple of sort of cycles has slowed down. Are there any… is there anything to read out of that, do we expect to see changes perhaps in pricing or in this case, I guess more of an acceleration in M&A?

J. Greg Ness - Senior Vice President, Insurance Services Group

Well, a good question. Hard to say, certainly relative to the M&A kind of experience, I think in terms of pricing, that's clearly a function of our claims experience and we will watch that carefully as it unfolds. We have the ability to slice and dice our claims experience about every which way and have the ability to in essence surgically insert price increases or decreases based on geography or plant design or industry type for all kinds of different factors. We'll continue to do that whether or not other folks in the industry follow that same kind of pattern, I can't answer that.

Floyd Chadee - Senior Vice President and Chief Financial Officer

Yes I think… I mean it’s all is interesting to think of the correlations between different companies, industry and the overall economy and how much they move in sink. I think it's generally correct to say that that companies in the group LTD business showed little pressure in recessionary times and therefore it should generate… you would expect it should generate pressure for M&A activity. But having said that though I mean this experience varies so significantly by organization. And it very much depends on the type of business they have, the book of business, the correlations between those industries that they serve and the overall economy. But also very much I mean the companies that are disciplined in good times and maintain their underwriting discipline are not quite as subject to the downturn in recessionary times, there is others. So we would expect lots of variation in terms of different companies exposure to the bad times and therefore sort of the pressure we will see on pricing in the market to be a function of that variation too.

Jason Zucker - Viva Capital Partners

Great. Thanks, everyone.

J. Greg Ness - Senior Vice President, Insurance Services Group

Thank you.

Operator

Our next question is a follow-up question from the line of Jukka Lipponen with KBW Asset Management.

Jukka Lipponen - KBW Asset Management

I have a question for, Kim, I guess, based on your current disclosure of assets for the Asset Management business, can you just remind us how we should think about the fee generation out of those assets?

Kim W. Ledbetter - Senior Vice President, Asset Management Group

Well, Jukka, there are a number of businesses in the Asset Management segment, as you know, there are different fee levels for different businesses. So, it's difficult to come up with one measure, one number. I think, if you look at the fees and if you look at how the assets have moved and how the fees have moved over the past several quarters, you'll see that they move and sink, and when assets go down, we earn less fees, and when assets go up we earn greater fees. So that's probably the close as we can get unless we're going to break it down by business, which I don't think we're going to do right now.

Jukka Lipponen - KBW Asset Management

So, would it be fair to say that if I calculate the fee flow rate just taking the total assets... average assets for this quarter that that rate should be within a certain range should be a reasonable number assuming that there is no major mix shift going forward?

Kim W. Ledbetter - Senior Vice President, Asset Management Group

Yes, I think, that's certainly one way to look at it. I think business does move over time and we do have different fee structures, there is not only... I'll tell you one of the things is not only asset based fees in there, there are fees that are based on number of participants for example or based on a plan fee at the plan level. There are some other charges that for additional work we may do that get in there. So that's going to move around from quarter-to-quarter based on how that moves around. So, I wouldn't put a 100% weight on that kind of an approach, because there will be some other things going on in particular quarter depending on what's going on with the different businesses and what's going on maybe in the regulatory environment and that sort of thing.

Jukka Lipponen - KBW Asset Management

Thank you.

J. Greg Ness - Senior Vice President, Insurance Services Group

Thank you.

Operator

Our next question is a follow-up question from the line of Eric Berg with Lehman Brothers.

Eric Berg - Lehman Brothers

Thanks very much. I just had one final question regarding the claims experience. So you target, if I would use one point for your flagship business of group insurance, a benefit ratio of call it 78.5% of premiums and in the last four years, it's been in every year modestly better than that. And this year you're expecting it to be again at the low end of the range. I have asked this before but maybe we can try to expand on previous answers. Why do you think your claims experience is proving to be... why are you getting these modest positive surprise, just what's going on in the book of business, which is producing these modest positive surprises and all these surprises taking place in the Life Insurance business or in the Disability business? Thank you.

J. Greg Ness - Senior Vice President, Insurance Services Group

Eric, this is Greg. I'll give you a start on it. I think, you're right. Our claims experience has certainly favorable this quarter. We continue to maintain that 77.5% to 79.5% range. As we've discussed previously, we are miserable at predicting where it will be on any 90-day interval. We're pretty darn [ph] good looking at it what it would be over an annual basis and over a long-run basis, frankly much better. This 90-day kind of isolated snapshot is a very difficult time frame to try to predict that claims experience. So why is it? What it is? It's a number of factors. Clearly, it's the selection of the kinds of cases that we go after. So, we understand the risk inherent in certain plan designs and certain geographies with certain industries and so on. Those things all factor into our rating. Beyond that it is the underwriting of those cases. It is getting the right rate on the right risk that means fully understanding the risk that you're assuming and in getting the right rate on it and selling the right rate to the customer. In many cases that maybe actually be on alternative funding kind of an agreement, so that we can share that risk with the customers and make sure that our interests are absolutely aligned. And then finally and very importantly it all comes down to the claims handling. How do you handle the claims when they come in? Our job is to pay every single legitimate claim as quickly as we possibly can, but we've got hundreds of the single best claims analyst here on this country today doing that day-in and day-out, and that has a big impact on our ability to get people back to work and employed where they really want to be. All those factors taking into consideration, I think, are drivers of that claims experience as a whole.

Eric Berg - Lehman Brothers

I guess my question there was, was just slightly different from the one that you answered. My question really was aimed at trying to get an answer to the question. Are you getting results consistent with your expectations? In other words, given the strength of your selection process and given the strength of your underwriting something that you are clearly very proud of and that you are actively deploying, you should be getting results consistent with that sort of tight operating procedures. My question was really, are you doing even better than you have expected?

Floyd Chadee - Senior Vice President and Chief Financial Officer

I think... this is Floyd, Eric. I mean, I think, I mean Greg described the discipline in our process which I think over longer periods of time should yield good results. No, within any short period of time you could get surprises and we've been getting surprises that are better than what we would have expected, but if you notice, I mean, our guidance sort of ranges is not very tight. It's... I mean it does represent... it does represent the possibility of having negative surprises, which you know for some of us who can remember two years ago, there were some negative surprises. So this business is inherently volatile, but I think, Greg described the kind of discipline that we would expect on average to give us good results and we think we retain... we maintain that discipline. And having talked about the... I mean, there are two conversations that we've had in the past; one about volatility, and one about seasonality. And you know, there is... I mean, this business is inherently volatile. So there may be situations where you get positive surprises, string of positive surprises, you could also get a string of negative surprises. We don't think that that type of volatility is a type of volatility that should worry your investors because this is volatility is that naturally evens out over time and it's not necessarily related to sort of market sensitivity, so that's one. And then there is a seasonality question, I mean I think you’ve always heard us talk about our first quarter being… expected to be a worst quarter and that's not just true at this organization, but I think generally from a statistical point of view it is true across the industry. No, it is a statistical statement and you will get exceptions, so, which we have seen in the first quarter here. So, I mean I think what Greg described is a disciplined process that should give us an expectation of average to be towards the lower end of our range. But not necessarily I mean we can't necessarily predict in a short period of time whether you will get a string of negative surprises or string of positive surprises.

Eric Berg - Lehman Brothers

Thanks to both. That was helpful.

J. Greg Ness - Senior Vice President, Insurance Services Group

Okay.

Operator

Mr. Hallin, at this time I show no further questions.

Jeffrey J. Hallin - Second Vice President, Investor Relations and Financial Plan

Okay. Thank you, Heather. We'd like... once again we'd like to thank everyone for joining our call. There will be a replay of this call starting this afternoon and running through April 30th. To listen to this call, you can dial 800-642-1687 and enter the conference ID number 39997506. A replay of today's webcast will also be available at www.stancorpfinancial.com/investors.

Operator

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

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Source: StanCorp Financial Group, Inc. Q1 2008 Earnings Call Transcript
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