Good day, welcome to the Unum third quarter 2018 earnings conference call. Today's call is being recorded. At this time, I would like to turn the conference over to Mr. Tom White. Please go ahead, sir.
Great. Thank you, Sinead. Good morning, everyone, welcome to the third quarter 2018 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 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, 2017, and our subsequently filed quarterly reports on Form 10-Q. Our SEC filings can be found in the Investors section of our website. I remind you that statements in today's call speak only as of the date they are made, 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 the statistical supplement on our website, also in the Investors section. Participating in this morning's conference call are Unum's President and CEO, Rick McKenney, CFO, Jack McGarry, as well as the CEOs of our business segments, Mike Simonds for Unum US, Peter O'Donnell for Unum UK, Tim Arnold for Colonial Life, and Steve Zabel for the Closed Block. Now I'll turn the call over to Rick for his comments.
Thank you, Tom, good morning, everyone. The third quarter of 2018 was both a strong and pivotal quarter for the company. Earlier in the quarter, we released the results of our long-term care review, which have now been incorporated in our financial results. More importantly, our core businesses continue to deliver strong premium growth and strong margins. In our market of employee benefits, the operating environment remains very good for us as the economy continues to perform well. A tighter labor market means full employment and wage inflation, both of which continue to provide more potential customers and increase the need for the financial protections that we provide. A stronger economy may also see higher interest rates, which is a real plus for our business. Overall, it was a good quarter, we are building momentum moving forward.
As I mentioned, the third quarter results we reported yesterday afternoon included the impact of the reserve addition to our long-term care business that we pre-announced back in mid-September. There were no material changes from that review. Adjusting for that, as well as for net realized investment gain in the quarter, our adjusted after-tax operating earnings were just over $300 million, an increase of 22% over the year-ago quarter. Adjusted operating earnings per share were $1.37 in the third quarter, an increase of just under 26% compared to the third quarter of last year's $1.09. While we will continue to address the long-term care block and update you on its trends as they evolve over time, we are very focused on the positive underlying trends we are seeing in our core business operations and the consistent financial results they're generating.
Here are a few points I'd like to highlight on the performance this quarter. First, premium growth for our core business segments remains favorable, increasing 6% this quarter on a year-over-year basis. This growth is being generated by a number of encouraging trends, including strong persistency in our Unum US business, excellent sales momentum at Colonial Life, and disciplined management of rate increases on in-force business in Unum UK. Next, we continue to see generally consistent benefits experience across the core business segments, particularly in our Unum US and Colonial Life business lines. Benefits experience in our U.K. business has been more volatile recently, but our disciplined approach to underwriting and pricing in our key U.S. and U.K. business segments continue to generate consistent results.
We also continue to see stable to improving expense ratios for the business segments through the active management of expenses and the benefits of investments that we have made and continue to make to improve the customer experience. With these strong operating trends, we continue to see excellent profit margins and returns for our core segments, which in turn drives significant financial flexibility for the company. This financial flexibility allows us to invest in the growth of our business, both organically and through the expansion of our footprint, such as with the Pramerica Życie acquisition that we closed in early October. This financial flexibility also enables us to effectively manage the legacy long-term care block with reserve and capital updates as appropriate, as well as investing in the internal resources and talent to effectively manage this complex block.
Finally, our financial flexibility allows us to return capital to shareholders, approximately $5.8 billion since 2007 through shareholder dividends and share repurchases. While we were not in the market in the third quarter repurchasing shares as we completed the long-term care reserve analysis, we will resume that activity with the completion of our third quarter reporting. It has been an active and eventful quarter for our company in many ways, and a quarter that I believe illustrates the strength of our franchise. Our management team is striving to ensure that LTC does not overshadow our core business segments and a franchise that serves a growing need in our society and delivers real value to our shareholders. Now I'll ask Jack to cover the details of the third quarter results. John?
Thank you, Rick, Good morning, everyone. As you saw in our earnings release yesterday afternoon, we reported a loss for the third quarter of 2018 of $284.7 million, or $1.30 per diluted common share.
This loss included the reserve charge for long-term care, which totaled $593.1 million or $2.71 per diluted common share and was consistent with the estimate of $590 million we pre-announced back on September 18th. In addition, we reported a net after-tax realized investment gain on our investment portfolio of $7.8 million or $0.04 per diluted common share in the third quarter. Adjusting for these items, after-tax adjusted operating income was $300.6 million or $1.37 per diluted common share. While third quarter results were consistent with our strong recent trends, there were some unusual items that affected net investment income, the tax rate and corporate expenses, which I'll explain further in my remarks.
Jumping into our operating results for the third quarter, I'll begin with Unum US, where it was another very good quarter with positive trends in premium income, very good persistency and stable benefit ratios across our major business lines. Within Unum US, adjusted operating income for group disability increased by 3.3% to $93 million in the third quarter. We saw good top-line growth and improved benefits experience, and also higher miscellaneous investment income. Miscellaneous investment income can be volatile from quarter to quarter, and in the absence of this favorable volatility, group disability income would have been in the mid-$80 million range this quarter.
Benefits experience for group disability continues to perform well, with the benefit ratio improving slightly to 76.3% in the third quarter compared to 76.7% in the year ago quarter, due primarily to lower claims incidents and favorable claim recovery experience in the group long-term disability line, which was offset by higher claims incidents in the group short-term disability line. The group life and AD&D line had a strong third quarter with adjusted operating income of $64 million, an increase of 6.5% from the year ago quarter. Premium income increased 7.8%, driven primarily by prior period sales growth and improved persistency, which increased in the group product line to 91.2% for 2018 year to date, compared to 87.7% last year. The benefit ratio was slightly higher at 71.8% in the third quarter, compared to 71.4% in the year ago quarter, due primarily to higher claims incidents.
The supplemental and voluntary lines generated excellent results, with adjusted operating income increasing by 5.2% to $113.9 million in the third quarter. Premium income increased 7.1% for the third quarter, due primarily to higher sales, including growth generated by the expansion of our dental and vision product lines. Benefits experience was very favorable in the third quarter for the voluntary benefits in dental and vision lines, while the individual disability line experienced higher claims incidents and higher average size of new claims. All in all, the supplemental and voluntary lines continue to produce strong levels of income for the company. Sales for Unum US in the third quarter declined by 5.6%, primarily driven by lower sales in the group disability and life lines.
We continue to see positive momentum in the voluntary benefits in dental and vision product lines, but market conditions seem competitive to us in the core market segments where we intend to remain disciplined with our pricing. Persistency remains very favorable within Unum US, with persistency for the group lines combined increasing to 90.6% for the first three quarters of 2018, compared to 88.2% last year. Moving to Unum UK, we continue to see a difficult business and economic environment, creating uncertainty in the marketplace. As a result, adjusted operating income remained relatively flat at GBP 20 million for the third quarter of 2018, compared to GBP 20.2 million in the year-ago quarter. Premium income was stronger this quarter, increasing 5.6% on a local currency basis, generated largely by improved persistency, rate increases on the group long-term disability block and growth in the in-force business.
The Unum UK benefit ratio was 74.2% for the third quarter of 2018 compared to 74.9% last year, driven primarily by favorable claims resolutions in the group long-term disability line, partially offset by unfavorable claims activity in the group and supplemental lines of business. Unum UK sales for the third quarter increased by 2.4% year-over-year, driven by higher sales in the group long-term disability and supplemental lines, which offset lower sales in group life. The improvement in persistency from 86.4% in the first three quarters of 2017 to 87.7% in the first three quarters of 2018, is particularly encouraging given the level of rate increases we put through the block. Colonial Life, again, produced strong results with adjusted operating income in the third quarter of $84.2 million, an increase of 3.1% from the year-ago quarter. Premium growth remained steady, increasing by 5.6% in the quarter.
Benefits experience improved slightly to 51.5% in the third quarter compared to 51.8% in the year-ago quarter, primarily due to favorable experience in the life product line. Sales at Colonial Life continued to accelerate, increasing to 13% in the third quarter compared to the year-ago quarter. The introduction of the dental product earlier this year is contributing to this growth, with sales of $7.5 million in the third quarter. In addition to the strong dental rollout, sales from other product lines also showed strong year-over-year growth. Moving to the Closed Block, we reported a loss before income taxes and net realized investment gains and losses of $718.6 million for the third quarter, which includes the increase to long-term care reserves of $750.8 million on a before-tax basis.
Excluding this reserve increase, adjusted operating income totaled $32.2 million in the third quarter of 2018, compared to $26.6 million in the year-ago quarter. In the individual disability line, the interest-adjusted loss ratio improved to 80.5% in the third quarter, compared to 82.4% in the year-ago quarter, due primarily to improved mortality experience. The results of the long-term care business lines for the third quarter reflect the new reserve assumptions we discussed in our presentation on September 18th. On this new reserve basis, the interest-adjusted benefit ratio was 87.5% in the third quarter, which is in line with the range we outlined for you of 85%-90%. The interest-adjusted benefit ratio in the year-ago quarter was 93.3%, but is not comparable given the reserve basis change.
The statutory impact of the long-term care reserve increase that we recorded in the third quarter was also in line with the expectations we previously disclosed. Of the approximately $200 million impact we estimated, our total statutory results for the third quarter included $142 million of increased disabled life reserves for our long-term care blocks, including Fairwind. The $200 million projection includes asset adequacy testing reserves related to the long-term care block, which will be finalized in the fourth quarter. The total is anticipated to be in line with the $200 million we communicated to you in September. Looking at the corporate segment, the adjusted operating loss was higher in the third quarter at $47.1 million, compared to a loss of $36.2 million in the year-ago quarter.
The higher loss ratio in the quarter was primarily driven by expenses related to Poland acquisition and restructuring costs that totaled approximately $8 million before tax. As a final comment on our operating results in the quarter, the tax rate this quarter was 17.9%, adjusted for the long-term care reserve charge and net realized investment gains. This is lower than the tax rates of the first and second quarters of this year, which were 19.9% and 19.5% respectively. The lower tax rate this quarter was primarily the result of updates to our 2017 tax filing, which added a net benefit of $6.1 million to the GAAP after-tax income for the third quarter. We anticipate the fourth quarter tax rate will be in our expected range of 19%-20%. Statutory earnings for our traditional U.S. insurance companies remain at very good levels and adequately support our capital plans.
For the third quarter, statutory after-tax operating earnings totaled $253 million, compared to $187 million in the year-ago quarter. For the first three quarters of 2018, statutory after-tax operating earnings totaled $745 million. We are encouraged by the rise in interest rates and the corresponding higher new money yields we realized in the third quarter. In the third quarter, we easily exceeded the 5.5% new money yield assumption for our long-term care business. As a reminder, our new reserve assumption set includes a 5.5% new money yield assumption through 2021. For our other U.S. businesses, new money yields are higher but remain below our portfolio yields, so we can expect to continue to see pressure on the portfolio yield and overall net investment income. Importantly, the relationship between our new money yields and new claim discount rates continue to provide a healthy margin.
Higher interest rates are very beneficial to our business, especially as we have very little disintermediation risk in our liabilities. The capital position of the company remains strong. At the end of third quarter, the risk-based capital ratio for our U.S. traditional life insurance companies remained at approximately 385%. With the implementation of RBC formula changes from tax reform at year-end 2018, we anticipate ending the year with RBC in the range of 360%-370% under the new formula. Cash at our holding companies totaled $973 million at the end of the third quarter. As we move towards year-end, that cash balance will decline with the funding of Pramerica Życie acquisition, expected cash contributions for Fairwind and First Unum, and the resumption of share repurchases.
We will resume our $100 million of quarterly rate in the fourth quarter, I anticipate making progress on the $100 million we did not buy back in the third quarter. We'll have an update on these metrics at our outlook meeting in December and feel very comfortable with where they are trending. I'll conclude my comments this morning by reiterating our expectation of growth and adjusted operating income per share in the 17%-23% range for the year, though given our performance for the first three quarters of 2018, we expect to be towards the upper end of this range. As a reminder, the base of adjusted operating earnings from 2017 is $4.24 per share, and the projection for 2018 excludes the reserve increase for long-term care. Turning the call back to Rick for his closing comments.
Thanks, Jack. All in all, it was an eventful quarter for the company. We're encouraged by the operating trends we're producing in our core businesses, and we're also pleased to have completed the LTC reserve analysis. We look forward to the growth of our core operations for the remainder of the year and as we move into 2019. We'll now move to your questions. I'll ask the operator to begin the Q&A session.
Thank you. Ladies and gentlemen, if you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Please ensure you limit yourself to one question and one follow-up question. Again, press star one to ask a question. Our first question today comes from Ryan Krueger from KBW. Please go ahead, sir. Your line is open.
Hi. Thanks. Good morning. I was hoping you could talk a little bit more about the U.S. group dynamics in terms of competition, persistency, and also kind of any early look you can provide us on January one renewal trends.
Great. Thanks, Ryan. I'll turn over to Mike for comments.
Thanks, Rick. Good morning, Ryan. I'd say we've got a competitively rational market. We've gone through stretches of time where you'd have one or two carriers that would be aggressively trying to take share. I would say that's not necessarily the case right now, but I'd say in general, the industry feels pretty good about where margins are. There's less business moving, you'd see that in our group sales numbers. Q3 is not typically a big sales quarter for us anyway, but we did see some declines in group disability and group life insurance. That was, I'd highlight, offset to a degree by continued strong growth in the subVol segment, VB. Our voluntary benefit sales were up about 6%, and encouraging to see continued strong adoption of our dental and vision product up about 27%. We'll continue to keep an eye on it.
Most importantly for us is despite it being a difficult new client acquisition market, it's proving to be a market where we're holding on to customers. I think persistency was up a couple of points over the prior year. That's really helping fuel good, strong earned premium growth that both Rick and Jack highlighted.
Thanks. Any insight you can provide on January 1 renewal?
I think if you look up market, larger cases, decisions have largely been made, and we feel real good and that the persistency trends that we've seen shown up in the numbers are likely to continue as we head into next year. Some decisions are still to be made in the core market, so that's part of the fun of fourth quarter. In general, I wouldn't see anything other than pretty solid and sustained levels of persistency. Ryan, it also might be worth noting, when we look at the new sales, it's a tough comp to the prior year. In Q3, I think our group sales were up about 29% and a similar, almost 30% increase in Q4 of last year.
The environment we had last year was one that was conducive for us, winning some new client business and doing it at our targeted pricing levels. I'd say we're looking at a more difficult comparison this year.
Thanks. I just had one on Unum US expenses. The expense ratio was 19.9%, and it had been running more in the 20.5%-21% range. Can you give us some more color there and if there were any material timing considerations that impacted the quarter?
Yeah, I'd say it's kind of equal weighting between a little bit of timing of expenses that we would expect to kind of normalize as we go into the Q4. What I'd say has kind of been a longer-term trend over the last really 3 years or so, we've seen pretty gradual improvement in that expense ratio as we've modernized some of our processes and put some new technology. We're starting to see some of the benefits of that come through a bit. That's a slower burn.
Ryan, I'd remind you that the 6% premium growth helps as well.
True. Thanks, Jack.
Thanks, Ryan.
Thank you. Our next question comes from Jimmy Bhullar from J.P. Morgan. Please go ahead, sir, your line is open.
Hi. I had a question first on just the free cash flow. I think you're adding about $200 million to stat reserves this year, but seems like from your comments that it shouldn't really affect your ability or your free cash flow that's available for buybacks and dividends. Is that the case, and why is it that it's not being reduced next year because of the stat reserve addition?
Ryan-
It's Jimmy.
Oh, Jimmy, I'm sorry. It's not that it doesn't affect free cash flow. It's that we built it into our plans, and we expect, given the strength of our balance sheet going into this, that we'll be able to-
Absorb it
cover those uses and continue to repurchase shares
If you think about
Yeah, Jimmy Bhullar, just to add to that, the free cash flow, what's generating from the company is still very, very strong from a statutory perspective. When we look at the reserve charge we went through, we see that more as a funding need, one time in nature, similar to other things that we're doing. Free cash flow, the underlying free cash flow of the enterprise still remains very strong.
As you go beyond 2019 into 2020, would you assume that you'd have more flexibility than you've had in the past, assuming that there's no such charge or no stat reserve addition? Or is some of the 2019 free cash flow is something that is being compensated by 2018 and 2020 to some extent?
Yeah. We're going to have a strong free cash flow in 2019. You've seen the statutory earnings in 2018, which is the driver of 2019 dividends from our subsidiaries. I'd remind you that there's a lot changing in the capital world as well. We have the implementation of the RBC factors that due to tax reform, that will happen in 2018. We have the C1 factors getting updated in 2019. There continue to be things to work through, but we feel very comfortable with where we are. We feel very comfortable in our ability to meet those obligations. I would say I'd be looking probably more to 2020 and 2021 for when we really see the benefit, when we get through those changes in the capital formulas, and we really see the benefits of tax reform kicking in.
Just lastly, on the benefits ratio in the U.S. disability business. It's improved each of the last several years. It seems like it'll be better this year than it was last year. How do you think about that improvement continuing given the competitive environment and the economic backdrop?
Yeah, thanks. Can I take that one? It's Mike Simonds. Excuse me. Yeah, I'd say we're right about in line with where our expectations are, and so that's going to move around a little bit quarter to quarter. I would say probably the one thing as we look forward, we saw a bit of benefits ratio pressure in a pretty defined segment on the short-term disability side, and that's something that we're addressing through the renewal program. It's not hugely consequential, but that is something that will provide a little bit of improvement to the segment overall.
Thank you. We'll now take our next question from Mark Hughes from the SunTrust.
Thank you very-
Please go ahead, sir.
Yeah. Good morning. Thank you. You talked about the wage inflation, full employment helping your core business. You've talked about natural growth in the past. Are you seeing that actually flow through your underlying growth?
Yeah. We think about the natural growth, as we talked about in the past, comes from two different things that are coming through. One is just as employment improves over time, which we have seen. We look to pretty full employment economy. We haven't always felt the benefits of the swings around that, just given who we insure at the employee base, whether it's part-time workers, other areas of the economy we don't insure. We certainly have felt that over a period of time. The thing that we're looking at now is wage inflation. You're starting to see that in our lines that we cover as well. We'll look to have that be a lift.
The way you can think about it, Mark, is we've seen probably benefit if you look over the last four or five years, probably 1% addition to our premium growth that we've seen. Out of that 6%, 1% is probably coming from an economic lift. If wage inflation really starts to kick in in our sectors, then we could see more, but that's something we'll look forward to.
On the persistency side, you touched on this, but it seems strange that your sales are a little slower. Granted, you have a tough comp, but at the same time, your persistency is quite good. Do you think that's based on your internal initiatives, or is it just more broadly business isn't moving quite as much?
Yeah, it's Mike, I can take that. I think it is a bit more of the latter. I think there's less movement in the market, the number of proposals that we're seeing coming through on the brokerage side is down year-over-year. That's a piece of it. For us, taking care of existing clients is job one. Most all of the investments we make in capabilities, we do it with an eye towards improving the experience that we're delivering there. A lot of our growth has come by expanding the number of Unum benefits that are offered by each of our clients, and with each line that we extend, we see an incremental improvement in stickiness in that relationship. Those are some of the long-term helpful dynamics. The market itself, I think, is also a bit of a tailwind for us.
Thanks, Mark.
Thank you. Our next question comes from Thomas Gallagher from Evercore. Please go ahead, sir. Your line is open.
Morning. First question is on Colonial Life. You had good sales there, but weaker persistency seems to be kind of the opposite trend you're seeing in your group business. You also had a decline in public sector sales. Can you talk a bit about what's driving that result? Is competition escalating there or any comments on that dynamic?
We'll turn that to Tim Arnold. Tim?
Yeah, thanks, Rick. Thank you, Tom, for the question. On the persistency side, we had a little bit of volatility in the first quarter of this year, and the persistency metric gets reported on a 12-month rolling basis. That will stay with us through the fourth quarter of this year, but just a little bit of volatility there. We're still inside our expected range for persistency. On the public sector side, we've seen a little bit of pressure in our educator market this year. We don't believe it's enhanced competition at this point. We had a really strong public sector sales growth here last year, so the comps are a little bit challenging. We believe that it's just this one segment of educator business that is creating the pressure.
Okay, thanks.
I think, Tom, we'd have to make sure we add into that. You referenced it, but Tim says sales have been great. We'll start with that, too. 13% growth in Tim's business. Colonial Life has been seeing very good sales growth, go ahead, Tom.
Right. Jack, just a question. Expected contributions to Fairwind in First Unum this year, are they going to be consistent with levels of prior years, or can you quantify what you would expect there?
They're going to be higher this year for a couple of reasons. One is the statutory reserve charge is going to impact capital levels in Fairwind. The new reserve basis has an impact on cash flow testing within First Unum. That kind of $200 million number is probably a decent number to think about the addition on top of kind of normal funding. Is a little bit related to the new RBC factors as a result of tax reform. That's one of the reasons why we're holding a pretty sizable cash balance going into the fourth quarter. We expect that cash balance to come down with that funding, but we would expect to land comfortably above our one-time fixed charges.
Got it. Just so I understand, there's the $200 million statutory reserve charge split between reserves plus AAT, and then on top of it, about another $200 million or?
No. The $200 million is the funding of that reserve charge. If you look at kind of our normal funding that we've had year after year where we haven't had reserve charges, there's going to be an increase on top of that as a result of the reserve charge. That's what's driving the higher level of funding this year versus some previous years.
Thank you. We'll now take our next question from Randy Binner from B. Riley. Please go ahead, sir. Your line is open.
Excuse me. Good morning. I had a question just on investing in the long-term care book, with interest rates higher. The first question is, can you kind of characterize how much higher you're getting above the yield or the hurdle there, rather? What are you seeing in the market? Are spreads wider? Is paper more attractive or private investments more attractive in the last couple of weeks? Just trying to get an idea of what this environment, this investing environment is affording you in matching those liabilities in the LTC book.
Yeah. This is Rick. Just to talk about overall market environment across all of our books. I'll touch on long-term care particular, but the higher interest rates has been good across our portfolio from what we've seen, and that actually helps a lot of our product lines. Credit spreads are still pretty tight. Those haven't moved out at all. That's something we still deal with. The all-in investor rate that we're seeing across our lines are very good. Particular to long-term care, we saw rates higher than our 5.5% that Jack talked about, comfortably above that in the quarter, given the mix of what we've invested in. The higher rates overall from the 10-year and the 30-year have been a real plus to us. It's one we fight every day in getting good investments.
It's a much better environment that we've seen this half of the year than we've seen in previous times.
I'd add to that, too, Rick, that even with the pullback in rates we've seen recently, the 30-year has held in significantly better than shorter rates.
Are you seeing the better opportunity in bonds, or is it in private structures? I guess I'm just trying to understand with an update on kind of how I can think about tracking what you might be investing in that book going forward.
Yeah, the good part about Treasury rates is they float all boats, so it's kind of across the board that we're seeing more favorable investment opportunities. One of the advantages that we have is we can choose our asset classes. We're not committed to certain percentages, and so our investment approach is to really look at relative values across the board and to pick the best one.
Thank you. Our next question comes from John Nadel from UBS. Please go ahead, sir. Your line is open.
Thanks. Good morning, everybody. Jack, a question on LTC reserves and the underlying assumptions. I'm wondering, is there any data that you can disclose to investors that demonstrates what you're looking at that indicates that morbidity improvement is a reasonable assumption? I ask this because very clearly what we're hearing from some of the other larger LTC players is that they're really seeing no evidence of morbidity improvement. I'm sure you can understand why investors are somewhat skeptical over that underlying assumption, given what we're seeing and hearing from the rest of the industry.
I'd start, John, bringing you back to our September 18th presentation. We laid out a graph there that showed our actual to expected incidence rates over the past decade. They had improved on average 3% a year relative to our underlying reserve assumptions. We think with that as the historical result, assuming 1% going forward is actually a pretty conservative assumption. The other thing I'd point out, and I've said this a lot, is that morbidity improvement can only really be understood relative to your underlying reserve assumptions. When we showed that graph of 3% improvement, that was how morbidity improved using our underlying reserve assumptions as the expected base. If your underlying reserve assumptions are more aggressive than ours or have a different slope going forward than ours, based on the same claim trends, you may not see morbidity improvement relative to those assumptions.
Again, it's only meaningful on a company-by-company basis, taking into account what the underlying assumptions and reserves are. We feel very comfortable with where it is. We disagree that nobody else has seen it. We've talked to other companies. Maybe it's kind of like saving on GEICO. The companies who aren't using it tend to be the most vocal about their not using it, but there are plenty of companies out there that continue to use it and continue to see it within their blocks.
Okay. All right. That's helpful. I appreciate that. The follow-up question is just, maybe it's following up on a couple of earlier questions and thinking about RBC and targeted risk-based capital levels. It sounds like the roughly $1 billion of cash balance is apparent that you had at the end of September. Some of that's going to be used as a funding of capital injections down into the subsidiaries. Your 385% RBC ratio that was flat quarter-over-quarter, how should we think about where you're targeting for that ratio to be, considering some of the capital injections it sounds like you're going to make in 4Q, as well as taking into account some of the formula changes that are coming through, including the effective tax reform?
As we mentioned in our remarks, John, we expect to end the year in the 360%-370% range. That's largely reflecting the change in the RBC factors from tax reform, which will be implemented at year-end 2018. I think that's a little higher than we need to be. We also anticipate another change in RBC factors with the C1 changes, which will be a smaller impact but will impact 2019. That level of capital is a level we feel comfortable with going forward. I think we'd see RBC ratios decrease because the denominator increases in 2018 and then a little bit again in 2019 with the C1 factor changes.
Thank you. Our next question comes from Erik Bass, Autonomous Research. Please go ahead, sir. Your line is open.
Hi, thank you. I was just hoping you could comment on the earnings outlook for the Closed Block segment following the LTC charge. Does the resetting of the benefits ratio back to the 85%-90% range or any changes in allocated capital have any impact on the go-forward earnings expectations?
We think it's going to have minimal impact. We would expect earnings to continue for the Closed Block kind of in the range that they've been in. Certainly, you get a lift from the improvement in the loss ratio, there's also additional required interest that comes into play with the increase in the reserves, those two things kind of offset each other.
Okay. Thank you. Then on Colonial, can you just update us on where we sit in terms of the business investments that you've talked about? Should we expect the expense ratio to start coming down as we move into 2019?
Tim, do you want to take that?
Sure, yeah. We do continue to make investments in the business, both in distribution and customer experience and talent and technology. We do also believe that the OE ratio will begin to come down as the premium income continues to accelerate and the rate of investment slows just a bit. We'll continue to make investments. We do see the expense ratio coming down.
Thank you. Our next question comes from Humphrey Lee, Dowling & Partners. Please go ahead, sir. Your line is open.
Good morning, thank you for taking my questions. In Unum US, we're definitely seeing the dental and vision business continue to grow at a very good pace. I think you've talked about growing that book of business to $500 million of annual premiums in four years at your Investor Day. Do you think you're on track towards that target? Maybe can you talk about how should we think about the trajectory of that growth?
Mike, Humphrey. Thanks for the question. We are excited about the potential that came with the Starmount acquisition, and we're seeing really nice growth in the group dental line in particular. I'd say we are right in the range of where we would want to be towards that $500 million target. We're early in that 5 years, so we've got not just to deliver over the next 12 months, but we've got to continue to invest in the provider network, in the technology that underpins that business. The trajectory goes beyond just the reported period sales results. It's also kind of investing in the scalability of that business, and that's also on track for us.
I'd say, Humphrey, too, we've also launched through the Colonial Life business, and we've seen a great start. Tim, maybe you want to comment about that.
We launched in very late March, and at the time, we had about 35 states approved. We're up to over 44 now, getting much better national coverage. The attraction of this product in our distribution system has been better than expected. The product is on its own, performing very well. We're also noticing that when we sell the dental product, we have good traction with many of our other products and those same employers as well. Very pleased. It is very early. Pleased with the progress we're making and excited about 2019.
Okay, got it. I think in your prepared remarks, you talked about kind of right now, the dental adoption rate is kind of 27% in Unum US. To get to that 500%, what kind of adoption rates you need to get to in order to achieve that target?
Humphrey, it's Mike. The sales growth rate, I think is what you're referencing of about 27%. We need to be in that range on a sustained basis over the next several years. You should be looking for high teens, low 20s type growth. As with any kind of startup growth story, it's not going to be linear, right? There'll be some quarters where we're exceeding that, and there'll be some where we're below it. That needs to be when you take a longer-term view where we are.
Thanks, Humphrey.
Thank you. Our next question comes from Alex Scott from Goldman Sachs. Please go ahead, sir. Your line is open.
Good morning. First question I had was just on some of the accounting changes from FASB. Could you comment at all just on, I guess for long-term care specifically, what kind of discount rate you're using and if there's any way to help us think about quantification of how much reserve levels could change from the new accounting regime and if there's any offsets that I should be thinking about across the businesses aside from just sort of the interest rate impact?
Thanks, Alex. The first thing I'd note about the accounting changes is that they're GAAP-only impacts. They won't affect statutory reserves or capital. They're scheduled for implementation in 2021. We would think that would be the earliest that that implementation will happen. There have been some favorable developments in the accounting changes versus they exclude disabled life reserves, with 60% of our reserves as a company are disabled life reserves, so they won't be impacted by the accounting changes. The big impact will be on active life reserves when you change the discount rate from a discount rate based on your portfolio results to a single A discount rate. That transition change will happen through AOCI.
We actually already have a mark on our liabilities under FAS 115 and AOCI, that mark isn't as big as going to a single A rate, but it's already in there. The good news about that going through AOCI is it won't impact book value excluding AOCI, which is the way most people look at returns on equities and book value of the company. It won't impact reported GAAP earnings in a dramatic way because that's going through AOCI, and we'll continue to report earnings based on kind of our current portfolio rate in long-term care, going forward in terms of what comes through retained earnings. I think there'll be an impact from an AOCI perspective. It's a bigger mark than we currently have.
There's a lot of work to do to figure out what that is, and to get our reserving systems to align with the way things need to be calculated under the new rules.
The other good part about the rules is, at least on our initial pass, we don't see any of our products having market risk benefits associated with them. We're not going to face some of the volatility that will arise out of that. We're looking at it overall. It's going to be a ton of work. We think the result will be manageable, and we're encouraged by the fact that the impacts will be through AOCI, not through retained earnings, and kind of our historical measures will continue to apply, post-implementation.
Just to follow up on the AOCI point specifically. One of the things I've been thinking about is just part of the reason we exclude AOCI today is associated with assets being marked through AFS and liabilities sort of not being marked to the same degree. I guess, through your conversations with the rating agencies and so forth, are you finding that they will continue to look at it excluding AOCI, or will they actually look at just regular book value as well going forward, or is it sort of too early to tell?
Yeah. I think it's early to tell. In fact, if you look across the rating agencies, there's not a single way they look at it. Different rating agencies exclude different things in their leverage calculations. Again, from a rating agency perspective, it's largely about leverage as opposed to kind of the earnings and return pieces. Time will tell. There's a good amount of time to get accustomed to where it is. Again, there's no single view across rating agencies today, and I'm sure they will work to develop their views over time.
Thank you. Our next question comes from Joshua Shanker from Deutsche Bank. Please go ahead, sir. Your line is open.
Yeah. Thank you for taking my question. Much has been answered. I want to understand the expense that you guys incurred during the quarter in corporate for processing all your work on the LTC charge, like the operational expenses, and related, looking at the very good results in Unum US, to what extent do you think that the expense management and whatnot that delivered that result is sustainable in the going forward quarters?
Sure, Josh. This is Rick. Let me just talk about our expense management overall, and specifically in the corporate, what you're highlighting there. It's not the result of the investment in actuarial processes. What we saw there was we had some restructuring costs as we realigned some of our resources, particularly to the technology side. You're seeing that come through. Expense management as a broader theme is something we're always investing in better ways to do things, more efficiency. I think Mike covered pretty well the expense management on the U.S. side, I won't hit on that. That's a general theme across the company, is we want to be very efficient in terms of what we're delivering for our customers and seeing that come through the expense ratio.
To do that, sometimes you have to invest, sometimes you have to realign. You'll see some one-time things that happen through the corporate line. Overall, our expense management remains very much on track.
Let me just come back to the U.S. for a second. Looking about going forward, are we at levels, should we think about there's a seasonality, or is the Q3 2018, I guess, sort of a leaping off point where you guys have made material improvements that are going to be going forward into the future, I guess?
Hey, Josh. It's Mike. There is some degree of seasonality. If you look back, it's not a bad idea as you're performing estimates to look back over the last couple of years, quarter to quarter. Volumes come through in kind of a lumpy way in the employee benefits business. I'd say probably more constructive is to look at what the annual numbers have done, and I'd say we've seen pretty good gradual improvement over the last several years, and I would expect as to Rick's point, that would continue going forward. Specific to the fourth quarter in your question, I'd say, to reiterate that it's probably equal parts, some timing of expense that will come through in the fourth quarter and as well as that underlying improvement. The net of those two is what we've been seeing.
Thank you. Once again, if you would like to ask a question, please press star one. We will now take our next question from Suneet Kamath from Citi. Please go ahead. Your line is open.
Thanks. Just one cleanup question on the LTC assumptions. Just wanted to confirm, going back to the morbidity improvement and the 1% that you talked about, Jack, is that your assumption for GAAP and STAT, or are you just making that assumption on a STAT basis? I mean on a GAAP basis, excuse me.
That's a good question. If you look at long-term care, there's really three kind of sets of assumptions that company uses. There's their statutory assumptions underlying their statutory reserves. We do not have morbidity improvement in our statutory reserve assumptions. The second basis is your GAAP assumptions. We do include morbidity improvement in the GAAP assumptions. The third basis, which is a very important one as well, is the basis you're using for cash flow testing. It is quite possible for a company to not have morbidity improvement in their statutory reserves, not have morbidity improvement in their GAAP reserves, but use morbidity improvement in their capital testing assumptions to test the adequacy of both their statutory and their GAAP reserves. We do not have morbidity improvement in our statutory reserves.
We do include in our updated reserve basis, on a GAAP basis, the morbidity improvement, and we do use that same morbidity improvement assumption in our reserve adequacy testing. The exception to that would be in the state of New York, where morbidity improvement is not allowed.
Okay. I was always under the impression that we should focus on the difference between STAT and GAAP, and that should give us a sense to the extent STAT is higher, call it a cushion or a buffer. Now it seems like if you're using different assumptions for the two approaches, maybe comparing them is less relevant?
Well, no, it's very relevant. It's less important what the different assumptions are than the fact that our GAAP reserves are based on a best estimate under loss recognition. That's why we use the same basis for GAAP reserves that we do for cash flow testing. To the extent you are holding more money on a statutory basis, you have more provision for future benefits and expenses in protection of policyholders. I would focus less in the difference in the underlying assumptions for STAT and GAAP, and focus more on just the gross difference in the fact that you have a higher provision for future experience under STAT than you do GAAP.
Thank you. Our next question comes from Robert Huff from Wells Fargo Securities. Your line is open. Please go ahead, sir.
Hi. Good morning. Thanks for taking my question. A lot of moving pieces around the capital side, especially as we look towards year-end and through 2019. I was wondering if we could just dial it in and think about it in the context of your existing ratings. Is your intent through all of your capital management actions over the next year or two to maintain your existing ratings, or would you be willing to let your ratings slip from one of the agencies? Just trying to wrap my arms around how you're thinking about that looking ahead.
Yeah. Basically, you can never guarantee these things, based on everything we know, and we've had good discussions with the rating agencies, we would expect to maintain our ratings.
Thank you. This concludes today's question and answer session. I'd like to turn the conference back to Mr. Rick McKenney for any additional remarks.
Yeah. Thank you, Sinead. Thanks for all of you for taking the time to join us this morning. We look forward to seeing many of you over the next few weeks at insurance conferences. I would remind you, we put out there that our annual outlook meeting will be held on December 12th in New York, we'll look forward to seeing many of you there. Sinead, that now completes our third quarter 2018 earnings call. Thanks.
Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect.