We are going to get started. Pleased to have Unum with us today. Up here with me is Steven Zabel, who is the recently appointed Chief Financial Officer over the last few months. Also want to acknowledge Thomas White from investor relations. To kick it off, given, yes, your background as running on long-term care, we'll start with some questions there. It's been about a year since you did the in-depth reserve review. I was hoping you could talk a little bit about how things are progressing so far relative to those updated assumptions.
Sure. Yeah. Just to go back, last September, we completed a review of our long-term care business. We looked at all the assumptions, interest rates, our premium rate increase strategy, as well as the other liability assumptions. We published a pretty detailed report outlining both the assumptions we picked as well as comparing that to our past history. At the time, we felt good about the review, felt good about the outcome. If you roll that forward four quarters, I look at it along three different dimensions. One would just be how the liability assumptions have played out. We've given guidance to the Street just around the 85%-90% loss ratio. That's a combination of how incidence is playing out, mortality, and other factors. We've been within that range.
We've actually been towards the lower end of that range, just over 86%. Feel good about that. Each quarter, we've been either in the range, and we actually, fourth quarter of last year, we were below the range. From that perspective, we feel good about how those assumptions are playing out. It does continue to be a very volatile business, we want people to understand that if you're in the top end of the range, that's not bad, and if you're in the bottom end of the range, that's not necessarily great. It's just within our expectations. We look at that over time. We started to publish more of a rolling average of that loss ratio because that's more of how we think about it and we'd like people to think about it. From that perspective, we feel good.
From an interest rate perspective, we've actually done quite well with our new money rates. Our assumption is 5.5% in our current assumption set. We've exceeded that every quarter and now in aggregate. Feel good about what we've done there. On the rating increase strategy, we had an announcement the first part of the year that we had achieved a pretty good approval in California. Our assumption has present value of those increases at about a billion four of value. We got to about $500 million right out of the chute with California and some other approvals. We just announced in the second quarter that we're getting close to halfway against that assumption.
We feel good about it because it's a combination of some of the submissions that we had going back a few years that slowly get approved, a combination of that and also some of the more recent approvals. We're getting them on both the individual and the group side. We feel good so far, but that's one that's going to take time, and it takes several years usually to work through the processes phase.
On the new money rates, if we go back over that last five years or so.
Yep
You've consistently, I think, been able to invest new money at over 300 basis points above 30-year Treasuries.
Can you talk a little bit about the investment strategy that you're using to back the long-term care
Sure
reserves and I guess how you've been able to achieve pretty wide spreads?
Yeah. If you look at our new money strategy, it's really a combination of investment-grade fixed maturities. We invest in high-yield securities, and we also sprinkle in some alternative asset securities. If you go back and you look from really 2014 forward to more recently, and we had this in our materials that we published last September, we achieved over 6% during that period of time, which we were quite happy with. If you go back and you look at what the 30 year did, there was a point, it didn't quite hit it, but there was a point that the 30 year actually got close to 2% back in 2016. We were able to get to 6% in times that got as low as what we're looking at today. I'd tell you a couple things to think about there.
One is we allocate quite a bit of our high-yield investment in alternative assets to long-term care. We think it's a great fit for the product. That allows us to get some more spread there. The other thing is we're not an index, so we don't have to invest in everything. We can be very opportunistic, and I think our investment management team has been good, picking their spots, getting return for the risk we take. Obviously, the 30 year where it is today it becomes more difficult, but it is something that we'll continue to manage over time.
On that point, had a big drop in rates. How do you think about the timing of when you evaluate your interest rate assumption for long-term care? Is it something that you would consider doing as soon as this year just because rates are down so much, or do you tend to take a longer-term view of it?
Yeah. I'll kind of step back and maybe answer a broader question around interest rates across our entire portfolio. It's very different. The risk profile is very different across the portfolio. We have a large portion of our business, about 30%, that's voluntary benefit. Not much interest sensitivity there. We feel good about managing that book in the current environment. On our group disability, both in the U.K. and the U.S., we have flexibility to price, and we've proven we can do that in the past. We'll evaluate that as the year kind of continues, and we usually look at that as part of our reserve adequacy work to see if we need to adjust discount rates. Then we get to LTC. That's not something that we're going to make large changes for just one year of experience, especially when we've actually exceeded our target.
Yeah
Over the last four quarters. Clearly, it's something that we need to continue to monitor.
Can you touch on it a little bit, on the LTC premium increase front, can you touch a little bit on how things have gone kind of individual versus group? Generally, we're more previously focused on individual.
That's right.
I think now we're shifting more to group. Can you give us a sense of that?
Yeah. If you think about the $1.4 billion that I referenced, that we put in our assumption, about half of that was for previously filed rate increases. About half of it were for rate increases that we were going to file the latter part of last year into this year. A lot of the previous files were individual submissions. It was probably 50/50 split between individual and group. We've continued to see good take-up on the group business there. The majority of the new filings were group and the old group business we have. There was a newer tranche, newer era of group business that we filed. We're actually seeing pretty good success across all those quadrants. We actually feel pretty good that we're going to have success in the group space as we have in the past in the individual space.
Right. Wanted to shift to capital management and, now with you as the CFO, just wanted to get your perspective on how you view the annual sources and uses of capital generation within the company.
Yeah. You start with the capital generations and the sources. Our engine is our U.S.-regulated subsidiary. We generate about $1 billion of free cash flow from those. In 2018, it was around $960 million, and that's been the run rate for the business. We also have some smaller dividends coming from our U.K. entity, and then we have some smaller management fees that we collect off of the entities. Think $1 billion plus of free cash flow. We've talked about this in the past. We have our fixed costs, which will be service of our debt as well as we have our dividend scale. We've had roughly $400 million of stock buybacks a year, and we view that as discretionary. We've been pretty stable in being able to deliver that and deploy that.
We've also taken the opportunity sometimes where we have either an acquisition opportunity or we're managing through some other capital issues that we'll use that discretionary capital deployment. I don't see any big changes in that. We'll be able to continue to manage some of the contributions we make to our subsidiaries around long-term care. We've been able to manage that within that budget.
Is that amount that you typically put into long-term care in the $200 million range of-
I'll say historically, it's been around $200 million. The last couple of years, it's gone up a little bit. Tax reform created some capital requirements in some of our subsidiaries. Rates have created a little bit of a need to put a little bit more capital down. We're closer to $300 million-$400 million. That probably is going to continue over the next couple years.
$300 million-$400 million per year?
Yeah, per year. That will kind of grade down.
Okay
to more of that $200 million. That, we think, is going to be the ultimate run rate.
Got it.
Yeah.
I guess at one point, there was some talk about considering a potential closed block IDI transaction.
Yeah. I think my predecessor talked about that at an investor day.
Yeah
A couple of years ago. Yeah.
Haven't heard much of it lately. I wanted to see where you're at there. Kind of related to that, I guess, I think the Northwind debt matures in the next few years. When that happens, how will that improve your cash flow?
Yeah, just as background for the audience, we have a closed block of individual disability income business. We securitized it some years ago in a special purpose vehicle, and we securitized it through non-recourse debt. It was right around $800 million, I think, at the time. That debt is paid off and serviced through the statutory free cash flow of the IDI business, the disability income business. We're within now two years of paying off that debt. It's down to about $100 million outstanding. Feel pretty good about that paying off. It's been a very stable block. At that point, we'll continue to think about alternatives. I'd say those alternatives continue to be looking for a counterparty and reinsure the block, and we're always open to talk to people about those opportunities. We could relever, and that would generate some free capital there. That's something we think about.
There might be some other kind of finite risk reinsurance things that we could do there. We're always going to look at opportunities that really optimize the capital and generate more capital than maybe we otherwise could generate just by letting the block run out. We like that block. It's been very stable.
Finally getting into the core businesses more.
Yeah.
Unum US, particularly group disability, has had very good underwriting results for a long period of time. Can you talk about the underlying dynamics on claims that you're seeing that's led to this? You've gotten down to kind of the mid-70% benefit ratio level. Is that a pretty good range that you think is sustainable over time?
I would say if you go back to more historical times, we have seen improvement in that loss ratio. A lot of that is around some of our claim recovery trends. It's been pretty stable for the last several years, and we think it's sustainable, but we do not see a lot of upsides for improvement. I think it's a pretty good run rate. We've seen fairly consistent incidents and claim recovery trends, which have pretty much stabilized. I think it's a good run rate. We think we can manage the business at that level.
Got it. On the interest margin in group disability, can you give us a sense of where that stands, I guess how you feel about it at this point, and also just what Unum's approach is to setting the discount rate in-
Yep
U.S. disability?
Yeah. We target an interest margin on our claim liability that's in that 60-70 basis point range. Right now, we exceed that range, so we have a little bit of cushion with that margin. We think about it as what we can put new money to work at versus our new claim liability discount rate. We look at that continuously. We take a pretty hard look at it as we go through our reserve adequacy work. That's something, depending on what rates do over the coming months, that's something we'll think about. We always use as a sensitivity there, if we were to drop our claim liability discount rate by 25 basis points. That would be about $12 million of before-tax income.
We could offset that through premium adjustments in the high single digits, which would be pretty acceptable by the market, especially if competition is making similar moves. We've proven over the last several years, both in the U.K. as well as in the U.S., that we can put rate in the market, and we've got a pretty good service proposition that we're able to maintain business pretty well through that sort of pricing. It is something we'll evaluate.
What's the similar situation for the U.K. business?
Yeah. The U.K. business, I would say for a 25 basis point increase or decrease in discount rate, it's something that they could probably manage through in kind of that upper single digits, kind of in rough numbers.
On expenses, you've had a good run of bringing down expense ratios within the company. You illustrated at your investor day last year that you've also been increasing investment at the same time. Can you talk about that dynamic, how you're balancing investing in the business and trying to improve expense ratios going forward?
Yeah. No, definitely part of our earnings picture over the last several years is we've been able to continue to bring down our operating expense ratio. We've done that while, as you mentioned, continuing to invest in the business. We've invested in places like a lot of B2B capabilities. We're looking at opportunities where we can connect directly into our employer groups' HR systems so that we can trade information kind of on a real-time basis with them. We've had some successes there with some of the big names, the Workdays of the world, to try to build that and succeed in building that technology and rolling that out. We're going to continue to do things like that. Our strategy really is to self-fund that, though. We don't like going out with a story of earnings impacts because we're investing.
We look for areas of productivity, which we've done, both through automation as well as through process engineering, where we're able to generate the funding for those types of capabilities. LeaveLogic is another good example of that. We purchased that recently out in California. They provide some leave management capabilities to employees. Our goal would be to self-fund that while continuing to bring that operating expense ratio down. I see that continuing going forward.
Got it. Premium growth in Unum US has been pretty solid in the mid-single-digit range. Can you talk about some of the trends in terms of sales persistency and also the natural growth of the block from employment conditions.
Yeah
talk about competition.
Yeah, no. Second quarter, I think, was one of our largest premium growth for Unum US. Premium growth quarters in a long time is over 6%, and we were very happy about that. It's a combination of good sales in that business as well as our persistency has actually been pretty good. In the first quarter, we had a little bit of a bump in some of our voluntary benefit businesses, both Colonial and Unum US. Second quarter was pretty strong in those areas. I would say, just generally speaking, that the markets are pretty rational right now. If you look back over the last five years or so, there's been times where the group competitive markets weren't exactly rational, and people have had to correct.
I think what we've seen more recently is a pretty rational market, it's something that we feel like, we're not always going to be the lowest price, but we feel like the combination of our price and service proposition keeps us pretty competitive. I think our sales trends, persistency trends, have proven that out. I would say from just kind of what the economy is doing, what the market's doing, and how that impacts, it's been pretty positive recently when you think about wage growth, when you think about unemployment levels. We kind of track because as wages go up, that inherently builds, in essence, more premium growth for us within existing clients.
That's probably been a 1%-2% type of range over the last year or so as far as the wind in our back that we've gotten from those two kind of market conditions.
I'd say whole group benefits industry has been doing well for the last few years.
Claims experience has been consistently pretty favorable.
Yeah.
Are you surprised that that hasn't led to more price competition, or do you think everyone's assuming there's just going to be this reversion at some point?
Yeah. I think that there's companies, including us, that have learned their lesson around getting too aggressive with pricing. I just think that after you've been through that and you've seen what that does to kind of the loyalty with your clients and how clients react to that over the long term, I think people just understand if you really want to have a long-term value proposition, that you just have to be reasonable about how you go into groups and how you set pricing. Yeah.
At Colonial, you had a long string of good 22 quarters-
Yeah
high sales growth. Good mid to high single-digit premium growth. I guess you finally or inevitably had one tougher quarter in the second quarter, and sales were down. Do you think anything's changed in this business? Do you still feel like you can get back to that growth rate that you had?
Yeah. I joke about it, but we had 22 straight quarters of sales growth, and over that period, our average growth year-over-year was 8%. I mean, we've had really good success with Colonial. The thing about that business is it's all about feet on the street. It's all about growing your agent footprint. I'll say that's become more challenging. We really saw that come through our actual sales performance in the second quarter. It has been tougher recruiting agents with employment where it is. They have other choices that maybe they haven't had in the past. I do think that you also are a little bit. Your success sometimes catches up to you a little bit. How our agency structure works is the same people out there selling business are the ones helping companies actually implement sold business.
There's a little bit of a diversion, I would say, over the last probably several quarters, as far as actually getting new clients up and running. That may have been a bit of a distraction. We're working through that. I think for the second half of the year, we're looking for growth. I think it's going to be a real challenge to hit the bottom end
Yeah
of our annual targets that we've set there. We feel pretty good about the second half of the year. We get about 40% of our sales in the fourth quarter, so there's a lot of ground that we can make up in the remainder of the year.
Margins at Colonial have generally been pretty stable.
Yes. Pretty stable.
Is that what we should expect going forward?
Yeah. I would say. Those margins have been pretty consistent over time. Although there's a lot of new entrants into the VB market, I think the pricing continues to be pretty good in that market.
Got it. In the U.K., you've kind of been consistently, your earnings have been running in this low GBP 20 million range for a while. I know it's a tough market there, but can you give an update on the situation, how the economy and Brexit are impacting that business?
Yeah. We've actually been pretty happy with the performance of our U.K. business over the last couple of years, given the environment they're operating within. I think that where you really see it is probably in the growth, in that similar to what happened in the U.S. with ACA a few years ago, a lot of employers are a bit distracted right now about how Brexit may actually impact them. That helps persistency because maybe they're not wanting to move the business. It also can dampen sales a little bit. Really through that entire environment, we've continued to have pretty stable earnings. We do not see economic impact on the actual benefit performance of the block, which we view as very positive. The other thing is our U.K. business is very much U.K. companies doing business in the U.K.
They're not necessarily dealing with this cross-border risk that might create a lot of uncertainty. I think that helps as well as far as how we think about our book. I think the business is managed pretty well through it all. It'd be nice for it to settle down. When we were coming in, I just saw another thing that they've potentially voted to extend the deadline on Brexit again. It just seems like the drama continues to play out, but it's something that the business has done well working through.
You've done some M&A bolt-on deals in recent years, both dental in both the U.S. and the U.K.
Yep.
You did the Polish acquisition. How are those deals performing so far? Are there any other areas that would be logical fits for you?
Yeah. I would say we're very happy about both the dental businesses. We bought the U.K. dental business, it's been three or four years ago now. It's been a while now. That business is scale performing very well. The U.S. business, it was more of a regional company, in the Gulf States area. It was about a $150 million business at the time. We were looking to grow to $500 million over five years. We're well on our way to do that. It's been the perfect acquisition for us because it's a product that we did not have on our shelf, but we have the distribution to push it through our existing relationships. We've done that. We're very happy about how that business is performing. I would say Poland, it's still early days. They had a really nice second quarter.
We have a lot of patience for that business. We think it's an opportunity on the road to get more into maybe the voluntary benefits space in Poland. It's a great economy, very similar to U.S. economy in a lot of ways. It also might give some flexibility in Europe for more expansion. Feel good about those acquisitions. I'll say we're also investing in stop loss business. Again, very early days there, but we're starting to see some traction there.
The stop loss, do you think you can get to where you want to be organically in the stop loss business, or is that an area you'd be considering?
I think it's something we have to evaluate.
Okay.
Right now, we're renting a lot of the capabilities.
Yeah
In that space just to test how that works in our distribution. Depending on how that goes, we're going to have to determine maybe what the longer-term model is.
I guess going back to long-term care, it's obviously impacting your valuation a lot. I'm sure it's frustrating. I guess, how big of a priority is it to try to do a risk reduction transaction and, I guess, what are the impediments to trying to get that done?
Yeah. No, capital management of that block's the highest priority.
Got it.
There's different ways you can do that. Our rate increase strategy is one, how we manage our investment portfolio is another one. We're constantly pulsing the market. Right now, though, especially with rates where they are, the bid-ask is just not economical to us, and we're not going to do anything that's not in the best interest of our shareholders. Right now, there is no deal in front of us that we would say that would be the case. We're continuing to pulse the market and see what opportunities might be out there.
Certainly, the recent drop in interest rates, I'm sure, has been pretty negative for those discussions. I guess, do you think something's more possible if we were in a better rate environment, or are there a lot of other impediments beyond just interest rates?
There are other ones. I think that's one. It would help.
Yeah.
Let's say it would help if rates went up. I think there's other things that we have to work through, usually it's time that helps.
Yeah.
A lot of the things that create the bid-ask difference.
Pause, see if there's any questions in the audience. Heather? Is there a mic? Yeah, a mic's coming.
I'm not going to mention any names, some people on the sell side are still giving you a hard time on those long-term care reserves. What's your response, where do you think the difference is in how you see those reserves?
The sell side analysts?
Yeah, sell side analysts.
Yeah. That's a tough one because it's hard to refute the information that's out there because we have much more detailed information, obviously, than anyone else does about our block. When we went through our reserve study last year, we had a lot of, I'd say, internal quality review around it. We also brought in external experts to look at what we did. We really showed that to the market to make their own decision around this is our historical experience, and this is where we're setting our reserve assumptions and let the market draw their conclusions as far as whether that's reasonable or not. We don't talk about other carriers and where they may be from a reserving perspective. To me, it's just going to be time. You just need to get time behind and prove that those assumptions hold up.
Knowing that there's always going to be uncertainty around this block. It's a very long-term block. Again, I think just time helps. Any other questions in the audience?
I had a question about the, I guess, the investment portfolio.
Yeah.
Some companies have talked about later in the cycle, should we be reducing some areas around credit risk?
Right
Have you looked into that type of actions at this point? Or do you already feel comfortable?
Yeah. I would say we're always doing that.
Yeah.
We're aware that there's a belief.
Yeah
Reaching the end of the credit cycle, whether there are or not, it's debatable. We have been for many years it seems like. We'll continue to look at the portfolio and we sell out of things when we're not comfortable with it. We try to manage that within how we think about the overall portfolio risk. We're not going to do anything.
Okay
Because of the current environment.
Since you just did this yesterday, I'll ask you. You were in the market.
We were
with some debt.
Yeah.
I think you're paying down some debt and issuing some debt. Can you just review?
Yeah. We're really excited about that. There's always a silver lining to rates, right? One of it is that we have a debt stack that we manage. Just given where rates are, we felt like there was a great opportunity for us. I'd say to do two things. One is a little bit of risk management, and one is a little bit of economic management. We have quite a few longer-dated bonds that are at higher coupon rates, some over seven. We thought it was a good opportunity to swap those out and tender a portion of those. We initiated a tender to do that on that tranche. We also have a 2021 maturity coming up. From a risk management perspective, we took the opportunity or we're taking the opportunity to eliminate that rollover risk on the 2021 debt.
We went out to market with a $300 million issuance, and we were very happy with the response. We upsized that to $450 million. Ended up printing at 4.5% coupon, which we were happy with. Now we've initiated the tender, and we'll see what the. It's a combination of the actual bond holders having to opt in versus us having unilateral rights on tendering. We're going to manage all that to a cash neutral equation which will improve the coupon on some of those long-dated liabilities. Also get the 2020s off the table. We're very happy with the 30-year issuance, which for us feels very good to be able to get that risk further out in the future. Very happy with the execution there. In a very crowded market.
There's a question here in the back.
Yeah. Just that was a 30-year piece of paper you said?
Yeah.
Obviously you upsized it, there had to be a fair amount of demand. I'm just curious, what was the demand on the debt deal, do you.
Yeah. The initial demand, say four times.
It's crazy the disconnect between you had four times subscription on a debt piece of paper for your company for a long duration obligation, and your stock trades where it does. It's kind of crazy when you think about the equity market valuation.
Yeah
What you just issued debt at.
Yeah.
Can you just elaborate on just the level of urgency, like within the boardroom and the executive management? I listened to your presentation. It's a disconnect with where your stock trades. What level of urgency exists to buy more of it back here? Obviously you'd need to potentially fund it with other things, but just thoughts around that would be great.
Yeah. I would say one thing around the stock price, if you look at what the life sector has done, I just think there's a lot of fear out there around interest rates generally. If you look at the peers that have big balance sheets, you've seen what I think interest rates impact those in a very similar way to how they've impacted us. Some of that is less specific Unum credit fear versus just overall interest rate concerns. I would say the board feels like management feels that we need to continue to work on our core block, and we need to continue to grow that because that's our cash flow engine. They want us to continue to work on how we can grow that top line as much as possible in a profitable way.
Also just be smart about how we manage the capital behind the closed block. Not doing anything that's not economical for the organization, but continue to test the markets. I'd say they're pretty well aligned with how management feels about it.
All right. We will end it there.
Good. Thank you.
Thank you very much, Steve.
Yeah, thanks.
Thanks for coming.
Yeah, thanks for having me.